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GLOBAL BRASS & COPPER HOLDINGS, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) Readers should refer to the information presented under the caption "Risk Factors" for risk factors that may affect our future performance. The following discussion and analysis of financial condition and results of operations should be read in conjunction with "Selected Financial Data" and our consolidated financial statements and related notes included elsewhere in this annual report. In addition to historical data, this discussion contains forward-looking statements about our business, operations and financial performance based on current expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those discussed in the sections entitled "Risk Factors" and "Cautionary Statements Concerning Forward-Looking Statements" included elsewhere in this annual report. Overview Our Business Global Brass and Copper Holdings, Inc. ("Holdings" or the "Company," "we," "us," or "our") was incorporated in Delaware, on October 10, 2007. Holdings, through its wholly-owned principal operating subsidiary, Global Brass and Copper, Inc. ("GBC"), commenced commercial operations on November 19, 2007 through the acquisition of the metals business from Olin Corporation. We are a leading value-added converter, fabricator, distributor and processor of specialized copper and brass products in North America. We offer a broad range of products, and we sell our products to multiple distinct end markets including the building and housing, munitions, automotive, transportation, coinage, electronics/electrical components, industrial machinery and equipment and general consumer end markets. Unlike other metals companies, including those who may engage in mining, smelting and refining activities, we are purely a metal converter, fabricator, distributor and processor and do not attempt to generate profits from fluctuations in metal prices. We engage in melting and casting, rolling, drawing, extruding, welding and stamping to manufacture finished and semi-finished alloy products from processed scrap, copper cathode and other refined metals. We participate in two distinct segments of the fabrication value chain: (1) sheet, strip, foil, tube and plate and (2) alloy rod. For the year ended December 31, 2013, we sold 523.0 million pounds of products and we generated net sales of $1,758.5 million and adjusted sales of $549.3 million. For the year ended December 31, 2012, we sold 503.2 million pounds and we generated net sales of $1,650.5 million and adjusted sales of $524.9 million. For the year ended December 31, 2011, we sold 510.0 million pounds and we generated net sales of $1,779.1 million and adjusted sales of $530.5 million. See "-Non-GAAP Measures-Adjusted sales." Our leading market positions in each of our operating segments allow us to achieve attractive operating margins. Our strong operating margins are a function of four key characteristics of our business: (1) we earn a premium margin over the cost of metal because of our value-added processing capabilities, patent-protected technologies, and first-class service; (2) we have strategically shifted our product portfolio toward value-added, higher margin products; (3) we are driving a lean cost structure through fixed and variable cost reductions, process improvements, and workforce flexibility initiatives; and (4) we employ our balanced book approach (as discussed below) to substantially reduce the financial impact of metal price volatility on our earnings and operating margins. Our Operating Segments We operate through three reportable operating segments: Olin Brass, Chase Brass and A.J. Oster. Our Olin Brass segment is the leading manufacturer and converter of copper and copper-alloy sheet, strip, foil and tube and fabricated components in North America. While primarily processing copper and copper-alloys, the segment also rerolls and forms other metals such as stainless and carbon steel. Olin Brass's products are used in five primary end markets: building and housing, munitions, automotive, coinage, and electronics/electrical components. Over the past three years ended December 31, 2013, a per-period average of 17.4% of Olin Brass's domestic copper-based products has been sold to A.J. Oster. 57-------------------------------------------------------------------------------- Table of Contents Chase Brass is a leading North American manufacturer of brass rod. The segment principally produces brass rod in sizes ranging from 1/4 inch to 4.5 inches in diameter. The key attributes of brass rod include its machinability, corrosion resistance and moderate strength, making it especially suitable for forging and machining products such as valves and fittings. Chase Brass produces brass rod used in production applications which can be grouped into four end markets: building and housing, transportation, electronics/electrical components and industrial machinery and equipment. Our A.J. Oster segment is a leading copper-alloy distributor and processor. The segment, through its family of metal service centers, is strategically focused on satisfying its customers' needs for brass and copper strip and other products, with a high level of service, quality and flexibility by offering customization and just-in-time delivery. Our value-added processing services include precision slitting and traverse winding to provide greater customer press up-time, hot air level tinning for superior corrosion resistance and product enhancements such as edging and cutting. Important A.J. Oster end markets include building and housing, automotive and electronics/electrical components (primarily for housing and commercial construction). Over the past three years ended December 31, 2013, a per-period average of 66.8% of A.J. Oster's brass and copper material requirements have been supplied by our Olin Brass segment. All three segments generate revenue from product sales and earn a premium margin over the cost of metal as a result of our value-added processing and metal conversion capabilities and first-class service. Our financial performance is driven by metal conversion economics, not by the underlying movements in the price of copper and the other metal we use. In all three segments, most of the risk of changes in the metal cost of the products we make is borne by our customers or third parties rather than by us. We also have a Corporate and Other segment, which includes certain administrative costs and expenses that management has not allocated to our operating segments. These costs include compensation for corporate executives and officers, corporate office and administrative salaries, and professional fees for accounting, tax and legal services. The Corporate and Other segment also includes interest expense, state and federal income taxes and the elimination of intercompany balances. Financial Information and Acquisition On October 10, 2007, Holdings was formed by affiliates of KPS Capital Partners, L.P. ("KPS") as an acquisition vehicle to acquire the worldwide metals business of Olin Corporation. Prior to the date of acquisition, Holdings had no material assets or operations. Post-acquisition, Holdings has been a holding company and has had no business operations or material assets other than its ownership of 100% of the outstanding equity interests of GBC. Acquisition of the Worldwide Metals Business of Olin Corporation On November 19, 2007, we acquired Olin Corporation's worldwide metals business. The transaction was accounted for under the purchase method of accounting, and the assets and liabilities of the business were recorded at fair value at the acquisition date. The fair market value of the net assets acquired exceeded the purchase price in the acquisition, resulting in a bargain purchase event. In accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") at the time of the transaction, the excess fair value was allocated as a reduction to the amounts that otherwise would have been assigned to all of the acquired long-term assets. The remaining excess fair value was recorded as a one-time non-taxable extraordinary gain of $60.7 million in the period from November 19, 2007 to December 31, 2007 and $2.9 million in the year ended December 31, 2008. As a result of the bargain purchase event, all identified intangible assets and other non-current assets, including the acquired property, plant and equipment, were recorded at a zero value on our opening balance sheet 58-------------------------------------------------------------------------------- Table of Contents as of the acquisition date. Accordingly, our fixed assets reflect only post-acquisition capital investments, and our cost of sales and selling, general and administrative expense, depending on the nature and use of the underlying asset, includes depreciation only on capital investments made after the acquisition date. As we execute on our growth strategy and additional capital investment is made, we expect that the depreciation component of our cost of sales and selling, general and administrative expense will increase. Recent Transactions Initial Public Offering On May 29, 2013, we completed our initial public offering of 8,050,000 shares of our common stock (the "initial public offering" or "IPO"), including 1,050,000 shares of common stock sold in connection with the full exercise of the option to purchase additional shares granted to the underwriters, at a price to the public of $11.00 per share. The shares began trading on the New York Stock Exchange on May 23, 2013 under the ticker symbol "BRSS." Halkos Holdings, LLC ("Halkos"), the sole stockholder of the Company prior to the IPO, sold all of the shares in the initial public offering and received all of the net proceeds from the offering. KPS and its affiliates are the majority shareholders of Halkos. Follow-on Public Offering On October 1, 2013, we completed a follow-on public offering of 5,750,000 shares of our common stock (the "Follow-on Public Offering"), including 750,000 shares of common stock sold in connection with the full exercise of the option to purchase additional shares granted to the underwriters, at a price to the public of $16.50 per share. Halkos sold all of the shares in the Follow-on Public Offering and received all of the net proceeds from the offering. After giving effect to the Follow-on Public Offering, Halkos beneficially owned approximately 34.4% of our outstanding common stock, and as a result we ceased to be a "controlled company" under the New York Stock Exchange listing rules. Additional Follow-on Public Offering On February 3, 2014 the Company completed an additional follow-on public offering ("Additional Follow-on Public Offering") of 7,310,000 shares of its common stock, including 910,000 shares of common stock sold in connection with the full exercise of the option to purchase additional shares granted to the underwriters. Halkos sold all of the shares in the Additional Follow-on Public Offering and received all of the net proceeds from the offering. After giving effect to the Additional Follow-on Public Offering, Halkos no longer owns any of our outstanding common stock. Initiation of Dividend On November 7, 2013, we announced that our Board of Directors had approved the initiation of a quarterly dividend to our stockholders. The initial quarterly dividend of $0.0375 per share of our common stock was paid on December 6, 2013 to all stockholders of record as of November 19, 2013. The source of funds for any such dividends will be dividends paid by Global Brass and Copper, Inc. to Global Brass and Copper Holdings, Inc. which are limited by the provisions of the indenture governing our Senior Secured Notes (as defined below). Any future dividends or changes to our dividend policy will be made at the discretion of the Board of Directors and will depend on many factors, including our financial condition, earnings, legal requirements, including limitations imposed by Delaware law, restrictions in our debt agreements, including those governing the ABL Facility (as defined below) and the Senior Secured Notes (as defined below), that limit our ability to pay dividends to stockholders, strategic opportunities and other factors the Board of Directors deems relevant. Issuance of the Senior Secured Notes and the Refinancing of the Term Loan Facility On June 1, 2012, we completed a refinancing, which included the issuance of $375.0 million in aggregate principal amount of 9.50% Senior Secured Notes due 2019 (the "Senior Secured Notes") by Global Brass and 59-------------------------------------------------------------------------------- Table of Contents Copper, Inc. The Senior Secured Notes are guaranteed by Global Brass and Copper Holdings, Inc. and substantially all of Global Brass and Copper, Inc.'s existing and future wholly-owned U.S. subsidiaries. The Senior Secured Notes are secured by a senior-priority security interest in our fixed assets and by a junior-priority security interest in our accounts receivable and inventory. On October 7, 2013, we completed a registered "A/B exchange offer" with respect to the Senior Secured Notes that was required by the registration rights agreement relating to such Senior Secured Notes (the "Exchange Offer"). We used a portion of the proceeds from the Senior Secured Notes to repay in full the $266.5 million of principal outstanding under our prior $315.0 million five-year senior term loan facility (the "Term Loan Facility"), which we refer to as the "Term Loan Refinancing." In the Term Loan Refinancing, we paid our lenders a total of $275.5 million, including the $266.5 million of principal, an early repayment premium of $8.0 million and accrued and unpaid interest of $1.0 million, and we recognized a $19.6 million loss on extinguishment of debt. Amendment of the ABL Facility Concurrently with the issuance of the Senior Secured Notes and the Term Loan Refinancing on June 1, 2012, we amended the agreement governing our $150.0 million asset-based revolving loan facility (the "2010 ABL Facility", and, as currently amended, the "ABL Facility") to: • increase the commitments under the facility to $200.0 million; • extend the maturity of the ABL Facility to June 1, 2017; • permit the Transactions (as defined below); • lower the applicable margin and unused line fee under the ABL Facility; • permit us to make additional acquisitions, investments, restricted payments, asset sales and debt incurrences if certain conditions are satisfied; • increase the inventory loan limit for the borrowing base; • adjust certain reporting requirements and collateral audit requirements to make them less restrictive; and • reduce the excess availability threshold which requires us to test our fixed charge coverage ratio covenant. We refer to these amendments collectively as the "ABL Amendment". Distribution to Halkos In connection with the offering of the Senior Secured Notes, the Term Loan Refinancing and the ABL Amendment, we used a portion of the net proceeds of the issuance of the Senior Secured Notes, together with cash on hand, to make a cash distribution of $160.0 million to Halkos, which we refer to as the "Parent Distribution". Halkos distributed the proceeds of the Parent Distribution pro rata to its equityholders (which include certain of our officers and directors) in accordance with the terms of its operating agreement. We refer to the Term Loan Refinancing, the ABL Amendment and the Parent Distribution collectively as the "Transactions". Key Factors Affecting Our Results of Operations Metal Cost We are a leading, value-added converter, fabricator, distributor and processor of specialized copper and brass products in North America. Our profitability is primarily driven by the value added from the manufacturing 60-------------------------------------------------------------------------------- Table of Contents and fabrication of metal products, and not by fluctuations in the price of copper and metal. Our business model uses various methods to substantially reduce the financial impact of fluctuations in metal prices, such that our operating margins are largely unaffected by metal price trends. Nevertheless, metal price fluctuations will impact the total amount of our net sales, the cost of shrinkage loss, the impact of LIFO (hereinafter defined) liquidations and our working capital requirements. Shrinkage loss, which is primarily the loss of raw material that occurs in the melting and casting operations, is an inherent part of our metal casting process. While the shrinkage loss rate is very low relative to the total volume of metal casting, the cost of the shrinkage loss and its impact on financial performance increases as metal prices increase. We sell our products on a "toll" and "non-toll" basis. For sales on a toll basis, our customer is responsible for metal procurement. For sales on a non-toll basis, we assume responsibility for metal procurement and then recover the metal replacement cost from the customer. During the year ended December 31, 2013, 2012 and 2011, approximately 75% of our unit sales volume was on a non-toll basis. For sales on a non-toll basis, we use our balanced book approach, discussed below, to substantially reduce the impact of metal price movements on earnings and operating margins. The raw materials component of inventories that is valued on a last-in, first-out ("LIFO") basis comprises approximately 70% of total inventory at both December 31, 2013 and December 31, 2012. Under the LIFO inventory valuation method, changes in the cost of raw materials and production activities are recognized in cost of sales in the current period. The impact of LIFO accounting on our financial results may be significant with respect to period-to-period comparisons. During 2013, 2012 and 2011 certain domestic metal inventory quantities were reduced, resulting in a liquidation of LIFO inventory layers carried at lower costs prevailing in prior years as compared with current costs. The effect of this reduction of inventory decreased cost of sales by $2.0 million, $4.8 million and $15.2 million during 2013, 2012 and 2011, respectively. Metal prices also impact our investment in working capital because our collection terms with our customers are longer than our payment terms to our suppliers, so when metal prices increase, even if the number of pounds processed does not change, our working capital requirements will also increase. In 2013, the spread between our receivable collection cycle and purchase payment cycle was approximately 20 days. As a result, when metal prices are rising, we tend to draw more on the ABL Facility to cover the cash flow delay between material replacement purchase and cash collection. When metal prices fall, we replace our metal at a lower cost than the metal content of cash collections and generally reduce our use of the ABL Facility. We believe that our cash flow from operations, supplemented with cash available under the ABL Facility, will provide sufficient liquidity to meet our needs in the current metal price environment. Balanced Book Most of our sales volume is from non-toll customers. During the year ended December 31, 2013, non-toll sales accounted for approximately 75% of our unit sales volume. To substantially reduce the financial impact of metal price volatility on earnings and operating margins, we use our balanced book approach for non-toll sales to offset forward metal sales with forward metal purchases. Using our balanced book approach, we seek to minimize the financial impact of metal price movements in the period between date of order and date of shipment by matching the timing, quantity and price of the metal cost recovery component of net sales made on a non-toll basis with the timing, quantity and price of the replacement metal purchases. Our balanced book approach has improved the consistency of our margins despite underlying copper price volatility. For any non-toll sale we seek to achieve our balanced book through one of the following three mechanisms: • Metal sales and replacement purchases on "price date of shipment" terms, meaning that metal sale prices and the metal replacement prices are set on the date of shipment. The customer bears the risk of metal price changes from the date of order to the date of shipment, so all fluctuations in metal costs are passed through to the customer. 61 -------------------------------------------------------------------------------- Table of Contents • Metal sales and replacement purchases on a "firm price basis", meaning that metal sale prices are fixed on the order date, and a matching replacement purchase at a fixed price is established with a metal supplier. The supplier therefore bears the risk of metal price changes from the date of order to the date of shipment. • Metal sales on a firm price basis in circumstances where a matching firm price purchase is unavailable. In this situation, we execute a forward purchase on "price date of shipment" terms and enter into a financial derivative transaction in the form of a forward purchase contract. The impact of price changes from date of order to the date of shipment on the previously required metal replacement purchase is offset by gains or losses on the derivative contract. The derivative counterparty bears the risk of metal price changes from the date of order to the date of shipment. Price date of shipment transactions accounted for approximately 65% of non-toll unit sales volume in the year ended December 31, 2013. Firm price basis transactions that are supported with either firm price replacement purchases or price date of shipment replacement purchases plus a derivative contract accounted for the remaining approximately 35% of non-toll unit sales volume for the year ended December 31, 2013. Metal Cost Hedging In the ordinary course of business, we use derivative contracts in support of our balanced book approach. These derivative contracts are not accounted for as hedges but are recorded at fair value in accordance with ASC 820. Unrealized and realized gains and losses are reported in cost of sales. Other Initiatives We have also implemented the following initiatives to improve margins, increase profitability and reduce working capital requirements: • market-driven product mix improvements; • management-led product portfolio enhancements; • development of dedicated supply chain organizations in each business unit which have begun the implementation of robust sales and operations planning systems across the business units; • management-led productivity and production enhancements; and • establishment of more rigid business rules resulting in reduced customer optionality and improved pricing across our product portfolio. Industry and Market Trends Affecting Our Business Prior to the economic downturn beginning in 2007, demand for copper and copper-alloy sheet, strip and plate ("SSP") and rod products in North America had been relatively stable, with the SSP market averaging consumption of 1.1 billion pounds per annum from 2001 to 2007, and the rod market averaging 835 million pounds per annum from 2001 to 2007. Total industry demand for brass strip decreased in 2011 by 6% from 864 million pounds in 2010 to 808 million pounds in 2011. Total North American demand for brass strip increased by 2% from 808 million pounds in 2011 to 825 million pounds in 2012. Most recently, total North American demand for brass strip increased by 5% from 825 million pounds in 2012 to 867 million pounds in 2013. Total industry demand for North American shipments of copper and brass, sheet and strip products from distribution centers and rerolling facilities decreased by 5% from 186 million pounds in 2011 to 177 million pounds in 2012. Total industry demand for North American shipments of copper and brass, sheet and strip products from distribution centers and rerolling facilities increased by 5% from 177 million pounds in 2012 to 185 million pounds in 2013. 62-------------------------------------------------------------------------------- Table of Contents Total industry demand for brass rod remained constant at 549 million pounds in 2010 and 2011. Total industry demand for brass rod decreased by 3% from 549 million pounds in 2011 to 533 million pounds in 2012. Total industry demand for brass rod decreased by 3% from 533 million pounds in 2012 to 517 million pounds in 2013. While the 2013 total demand statistics reflect some recovery from 2009 levels, they still do not match levels of demand prior to the recession. The recovery from the recent economic downturn has been uneven and at times slower than desired, but when general U.S. economic conditions improve, we expect to see growth in demand for copper and copper-alloy SSP products from 2013 levels toward pre-recession historic levels. A return to pre-recession historic levels would provide us with significant growth opportunities and increased profitability given our much lower breakeven point. Demand for our product is driven predominantly by five sectors: building and housing, munitions, automotive, electrical/electronic and coinage. The building and housing sector, as measured by new housing starts, has been very depressed since 2008, with an average of approximately 727,000 units annually during 2010-2013 compared to an average of 1,760,000 per annum from 2001-2007. Existing home sales averaged 4,325,000 during 2010-2013 compared to an average of 6,171,000 per annum from 2001-2007. The sector improved in 2013 but remained weak as compared to historical build rates. Beginning in 2013, we have seen a positive trend in leading market indicators related to housing, although the housing market recovery has been uneven at times due to changes in the actual or potential interest rate environment as well as other factors. While our sales into the building and housing end market are positively affected by housing starts and construction and remodeling activity, the correlation between housing statistics and our sales is not entirely direct. Our key products are typically installed late in the housing construction cycle, meaning there is an inherent lag in volumes, and sales of our building and housing products can be affected by factors such as housing mix (unit size, unit price point and the mix of multi-family versus single-family construction). Sales of our products can also be impacted by the actual timing of housing starts and completions as well as to changes in the materials and fixtures used in construction that may contain fewer copper products or materials and fixtures than were used in the past. Munitions demand continues to be solid as military demand remains stable at healthy levels and commercial demand is robust. In addition, Olin Brass renewed a long-term contract in 2012 with ATK, who is under contract with the U.S. Army to it with supply it with small-caliber ammunition. Olin Brass is under contract to supply ATK with certain materials required by ATK to meet its contract obligations to the U.S. Army. The automotive sector is dependent on the level of consumer spending and replacement needs. Automotive demand is also below historical averages, with average automobile sales of 13.6 million units per annum during 2010-2013 compared to an average of 16.7 million units per annum from 2001-2007. The automobile sector's sales improved in 2013 to 15.6 million units but remained weak as compared to historical automobile sales as the average age of automobiles continues to rise. Electrical/electronic end uses include a wide range of applications, from medical to computers to aviation, and demand is largely correlated to general economic activity. Coinage is directly tied to consumer transactions and was at historical low levels in 2008-2010. In 2011, coinage volumes began to increase, and with the exception of volumes related to the $1 coin (whose production was suspended at the end of 2011), coinage demand improved further in 2012 and 2013. In addition, Olin Brass renewed a long-term contract with the U.S. Mint in 2012 to extend the supply agreement through 2017. We believe that in addition to the growth that we expect to experience upon a return to more normalized levels of demand, there are a number of growth opportunities that could create a considerable increase in demand, for copper and copper-alloy SSP products, including CuVerro™ anti-microbial products and fixtures. Olin Brass has completed the required Federal and also the applicable state registration processes necessary to market its CuVerro™ materials as having anti-microbial properties and have licensed more than a dozen 63-------------------------------------------------------------------------------- Table of Contents exclusive component manufacturers to market CuVerro™ products. Additionally, the COINS Act, which was first introduced in the U.S. House of Representatives and U.S. Senate on September 20, 2011 and January 31, 2012, respectively, and reintroduced in the U.S. Senate and U.S. House of Representatives on June 6, 2013 and October 22, 2013, respectively, is intended to modernize the U.S. currency system by replacing $1 notes with $1 coins. However, in December 2013, three members of the Federal Reserve Board of Governors issued a report that concluded that a transition to the $1 coin would result in higher net costs to the Federal government and to the public, which contrasts with previous reports by the Government Accountability Office that there would be a net benefit of approximately $146 million per year from a transition. Although it is uncertain when or if a transition to the $1 coin will be implemented, we anticipate a significant increase in the size of the coinage market if the U.S. transitions to the $1 coin and eliminates the dollar bill. For brass rod demand, we anticipate a slow, gradual recovery influenced by increasing demand in building and construction. The Federal Reduction of Lead in Drinking Water Act has mandated the use of lead-free and low-lead conduits in all drinking water plumbing devices sold after January 2014. This regulatory shift represents a significant growth opportunity for North American manufacturers of lead-free and low-lead materials made from brass rod. Management anticipates this regulatory change to accelerate the increasing demand for high-quality, lead-free and low-lead products occurring because of existing state regulations. In our distribution business, we anticipate further consolidation and rationalization to occur given the amount of excess processing capacity that exists across the United States. Management also anticipates that distributors will continue to be an important supply-channel alternative as end users work to mitigate the increased costs associated with financing their working capital needs (which are driven, in part, by high metal prices). Finally, management believes North American consumer demand has largely been satisfied by North American SSP. Offshore supply of a narrow range of SSP has historically represented a small proportion of total North American supply. On March 21, 2012, the ITC Commissioners voted to continue antidumping orders for brass sheet and strip from Germany, Italy, France, and Japan. The brass rod market has been affected recently by increased foreign competition including increased imports due to the KORUS FTA which became effective on March 15, 2012. The reduction in prices of Korean products resulting from the KORUS FTA has increased the ability of Korean manufacturers to compete with our products and has had a negative effect on our business, which, to date, has been limited but could become more significant in the future. Future levels of imported rod will be influenced by factors including domestic capacity and pricing levels, as well as costs in the import supply chain. Non-GAAP Measures In addition to the results reported in accordance with U.S. GAAP, we have provided information regarding "Consolidated EBITDA", "Segment EBITDA", "Consolidated Adjusted EBITDA", "Segment Adjusted EBITDA", and "Adjusted sales", each of which is defined below. EBITDA-Based Measures We define Consolidated EBITDA as net income (loss) attributable to Global Brass and Copper Holdings, Inc., adjusted to exclude interest expense, provision for (benefit from) income taxes, depreciation expense and amortization expense. Segment EBITDA is defined by us as income (loss) before provision for (benefit from) income taxes and equity income, adjusted to exclude interest expense, depreciation expense and amortization expense, in each case, to the extent such items are attributable to such segment. We use Consolidated EBITDA only to calculate Consolidated Adjusted EBITDA. Consolidated Adjusted EBITDA is Consolidated EBITDA, further adjusted to exclude extraordinary gains from the bargain purchase that occurred in the acquisition of the worldwide metals business of Olin Corporation, realized and unrealized gains and losses related to the collateral hedge contracts that were previously required under our former ABL Facility, unrealized gains and losses on derivative contracts in support of our balanced book approach, unrealized 64-------------------------------------------------------------------------------- Table of Contents gains and losses associated with derivative contracts related to electricity and natural gas costs, non-cash gains and losses due to lower of cost or market adjustments to inventory, LIFO-based gains and losses due to the depletion of a LIFO layer of metal inventory, non-cash compensation expense related to payments made to certain members of our management by Halkos, share-based compensation expense, loss on extinguishment of debt, non-cash income accretion related to the Dowa Joint Venture, management fees paid to affiliates of KPS, restructuring and other business transformation charges, specified legal and professional expenses and certain other items. We use Segment EBITDA only to calculate Segment Adjusted EBITDA. Segment Adjusted EBITDA is Segment EBITDA, further adjusted to include equity income, net of tax and to exclude net income attributable to noncontrolling interest, unrealized gains and losses on derivative contracts in support of our balanced book approach, unrealized gains and losses associated with derivative contracts related to electricity and natural gas costs, non-cash gains and losses due to lower of cost or market adjustments to inventory, LIFO-based gains and losses due to the depletion of a LIFO layer of metal inventory, non-cash compensation expense related to payments made to certain members of our management by Halkos, share-based compensation expense, loss on extinguishment of debt, and non-cash income accretion related to the Dowa Joint Venture, in each case, to the extent such items are attributable to the relevant segment. We present the above-described EBITDA-based measures because we consider them important supplemental measures and believe they are frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. Nevertheless, our EBITDA-based measures may not be comparable to similarly titled measures presented by other companies. We present Consolidated Adjusted EBITDA as a supplemental measure of our performance because we believe it represents a meaningful presentation of the financial performance of our core operations, without the impact of the various items excluded, in order to provide period-to-period comparisons that are more consistent and more easily understood. Management uses Consolidated Adjusted EBITDA per pound in order to measure the effectiveness of the balanced book approach in reducing the financial impact of metal price volatility on earnings and operating margins, and to measure the effectiveness of our business transformation initiatives in improving earnings and operating margins. In addition, Segment Adjusted EBITDA is the key metric used by our Chief Operating Decision Maker to evaluate the business performance of our segments in comparison to budgets, forecasts and prior-year financial results, providing a measure that management believes reflects our core operating performance. Measures similar to Consolidated Adjusted EBITDA, namely "EBITDA" and "Adjusted EBITDA", are defined and used in the agreements governing the ABL Facility and the Senior Secured Notes to determine compliance with various financial covenants and tests. Our EBITDA-based measures have limitations as analytical tools, and you should not consider them in isolation or as substitutes for analysis of our results as reported under U.S. GAAP. Some of these limitations are: • they do not reflect every expenditure, future requirements for capital expenditures or contractual commitments; • they do not reflect the significant interest expense or the amounts necessary to service interest or principal payments on our debt; • they do not reflect income tax expense, and because the payment of taxes is part of our operations, tax expense is a necessary element of our costs and ability to operate; • although depreciation and amortization are eliminated in the calculation of EBITDA-based measures, the assets being depreciated and amortized will often have to be replaced or require improvements in the future, and our EBITDA-based measures do not reflect any costs of such replacements or improvements; • they do not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations; 65 -------------------------------------------------------------------------------- Table of Contents • segment-based measures do not reflect the elimination of intercompany transactions, including those between Olin Brass and A.J. Oster; • they do not reflect limitations on our costs related to transferring earnings from our subsidiaries to us; and • other companies in our industry may calculate these measures differently from the way we do, limiting their usefulness as comparative measures. We compensate for these limitations by using our EBITDA-based measures along with other comparative tools, together with GAAP measurements, to assist in the evaluation of operating performance. Such GAAP measurements include operating income (loss), net income (loss), cash flows from operations and other cash flow data. We have significant uses of cash, including capital expenditures, interest payments, debt principal repayments, taxes and other non-recurring charges, which are not reflected in our EBITDA-based measures. Our EBITDA-based measures are not intended as alternatives to net income (loss) as indicators of our operating performance, as alternatives to any other measure of performance in conformity with GAAP or as alternatives to cash flow provided by operating activities as measures of liquidity. You should therefore not place undue reliance on our EBITDA-based measures or ratios calculated using those measures. Our GAAP-based measures can be found in our consolidated financial statements and the related notes thereto included elsewhere in this annual report. Adjusted sales Adjusted sales is defined as net sales less the metal component of net sales. Net sales is the most directly comparable GAAP measure to adjusted sales. Adjusted sales represents the value-added premium we earn over our conversion and fabrication costs. Management uses adjusted sales on a consolidated basis to monitor the revenues that are generated from our value-added conversion and fabrication processes excluding the effects of fluctuations in metal costs, reflecting our toll sales and our balanced book approach for non-toll sales. We believe that adjusted sales supplements our GAAP results to provide a more complete understanding of the results of our business, and we believe it is useful to our investors and other parties for these same reasons. Adjusted sales may not be comparable to similarly titled measures presented by other companies and is not a measure of operating performance or liquidity defined by GAAP. 66-------------------------------------------------------------------------------- Table of Contents Results of OperationsConsolidated Results of Operations for the Year Ended December 31, 2013, Compared to the Year Ended December 31, 2012. The statement of operations data presented below for the years ended December 31, 2013 and 2012 are derived from our audited consolidated financial statements. Change: For the Year Ended December 31, 2013 vs. 2012 (in millions) 2013 % of Net Sales 2012 % of Net Sales Amount Percent Net sales $ 1,758.5 100.0 % $ 1,650.5 100.0 % $ 108.0 6.5 % Cost of sales 1,576.2 89.6 % 1,467.3 88.9 % 108.9 7.4 % Gross profit 182.3 10.4 % 183.2 11.1 % (0.9 ) (0.5 %) Selling, general and administrative expenses (a) 110.8 6.3 % 92.7 5.6 % 18.1 19.5 % Operating income 71.5 4.1 % 90.5 5.5 % (19.0 ) (21.0 %) Interest expense 39.8 2.3 % 39.7 2.4 % 0.1 0.3 % Loss on extinguishment of debt - 0.0 % 19.6 1.2 % (19.6 ) N/A Other expense, net 0.3 0.0 % 0.1 0.0 % 0.2 200.0 % Income before provision for income taxes and equity income 31.4 1.8 % 31.1 1.9 % 0.3 1.0 % Provision for income taxes 22.2 1.3 % 19.2 1.2 % 3.0 15.6 % Income before equity income 9.2 0.5 % 11.9 0.7 % (2.7 ) (22.7 %) Equity income, net of tax 1.5 0.1 % 1.0 0.1 % 0.5 50.0 % Net income 10.7 0.6 % 12.9 0.8 % (2.2 ) (17.1 %) Less: Net income attributable to noncontrolling interest 0.3 0.0 % 0.4 0.0 % (0.1 ) (25.0 %) Net income attributable to Global Brass and Copper Holdings, Inc. $ 10.4 0.6 % $ 12.5 0.8 % $ (2.1 ) (16.8 %) Consolidated Adjusted EBITDA $ 118.0 6.7 % $ 115.4 7.0 % $ 2.6 2.3 % (a) Amounts include non-cash profits interest compensation expense of $29.3 million and $19.5 million for the years ended December 31, 2013 and 2012, respectively. Net sales Net sales increased by $108.0 million, or 6.5%, from $1,650.5 million for the year ended December 31, 2012 to $1,758.5 million for the year ended December 31, 2013. Net sales increased by $38.4 million due to an increase in volume, by $105.8 million as a result of the sales of unprocessed metal and by $2.5 million as a result of higher average selling prices in the year ended December 31, 2013. These increases were partially offset by lower metal prices, which decreased net sales by $38.7 million. Metal prices reflect the replacement cost recovery from the customer, whereas the sales prices represent the pricing component of adjusted sales, which we define as the excess of net sales over the metal cost recovery component of net sales. Volume increased by 19.8 million pounds, or 3.9%, from 503.2 million pounds for the year ended December 31, 2012 to 523.0 million pounds for the year ended December 31, 2013. The increase in volume was the result of higher demand in building and housing, munitions, coinage and automotive end markets. These increases were partially offset by lower demand in the electronics/ electrical components end market resulting from increased competition from foreign imports and customers sourcing their finished products offshore, thereby also increasing the amount of manufacturing offshore and consequently reducing demand for brass rod in the United States. Additionally, volume growth in the building and housing end market was dampened by foreign competition. 67-------------------------------------------------------------------------------- Table of Contents The metal cost recovery component of net sales increased by $83.6 million, or 7.4%, from $1,125.6 million for the year ended December 31, 2012 to $1,209.2 million for the year ended December 31, 2013. Higher volume increased the metal cost recovery component of net sales by $16.5 million in the year ended December 31, 2013 as compared to the same period in 2012. Additionally, sales of unprocessed metal increased the metal cost recovery component of net sales by $105.8 million in the year ended December 31, 2013 as compared to the year ended December 31, 2012. Partially offsetting the increase in the metal cost recovery component of net sales was the change in customer mix and lower metal prices, which decreased the metal cost recovery component of net sales by $38.7 million. The metal cost recovery component of net sales per pound of finished product shipped increased by 3.1%, due primarily to the inclusion of the sales of unprocessed metal, the quantity of which is not included in pounds shipped. The metal cost recovery component of net sales per pound of finished product sold excluding the sales of unprocessed metal (the quantity of which is not included in pounds shipped) decreased by 5.7%, primarily as a result of a 7.5% decrease in the average daily copper prices reported by the Commodity Exchange ("COMEX"). Adjusted sales Adjusted sales, the excess of net sales over the metal cost recovery component of net sales, increased by $24.4 million, or 4.6%, from $524.9 million for the year ended December 31, 2012 to $549.3 million for the year ended December 31, 2013. Higher volume and higher average selling prices contributed $21.9 million and $2.5 million, respectively, to the increase. Adjusted sales per pound increased in the year ended December 31, 2013 by 1.0% compared to the same period in 2012 which was the effect of changes in the mix of sales by segment relative to our consolidated sales as a whole and a net increase in average selling prices at the segment level resulting from the net effect of price increases and the shift in product mix within each segment. Adjusted sales is a non-GAAP financial measure. See "-Non-GAAP Measures-Adjusted sales". The following table presents a reconciliation of net sales to adjusted sales and net sales per pound to adjusted sales per pound: For the Year Ended Change: December 31, 2013 vs. 2012 (in millions, except per pound values) 2013 2012 Amount Percent Pounds shipped (a) 523.0 503.2 19.8 3.9 % Net sales $ 1,758.5 $ 1,650.5 $ 108.0 6.5 % Metal component of net sales 1,209.2 1,125.6 83.6 7.4 % Adjusted sales $ 549.3 $ 524.9 $ 24.4 4.6 % $ per pound shipped Net sales per pound $ 3.36 $ 3.28 $ 0.08 2.4 % Metal component of net sales per pound 2.31 2.24 0.07 3.1 % Adjusted sales per pound $ 1.05 $ 1.04 $ 0.01 1.0 % Average copper price per pound reported by COMEX $ 3.34 $ 3.61 $ (0.27 ) (7.5 %) (a) Amounts exclude quantity of unprocessed metal sold. Gross profit Gross profit decreased by $0.9 million, or 0.5%, from $183.2 million for the year ended December 31, 2012 to $182.3 million for the year ended December 31, 2013. Gross profit per pound shipped decreased from $0.36 for the year ended December 31, 2012 as compared to $0.35 for the year ended December 31, 2013. 68 -------------------------------------------------------------------------------- Table of Contents Gross profit for the year ended December 31, 2013 included a gain of $0.2 million related to net unrealized gains on derivative contracts. Gross profit for the year ended December 31, 2012 included a gain of $1.6 million related to net unrealized gains on derivative contracts. We exclude the above item in calculating Segment Adjusted EBITDA and Consolidated Adjusted EBITDA. See "-Non-GAAP Measures-EBITDA-Based Measures". Gross profit in the years ended December 31, 2013 and 2012 also reflects the reduction of certain domestic metal inventory quantities and a decrement in the base LIFO layer, resulting in a LIFO gain of $2.0 million for the year ended December 31, 2013, compared to a LIFO gain of $4.8 million in the year ended December 31, 2012. We also reduced the recorded value of inventory by $0.3 million in both the year ended December 31, 2013 and 2012 related to a non-cash lower of cost or market adjustment, which is reflected in gross profit as a component of cost of sales. We exclude the above items in calculating Segment Adjusted EBITDA and Consolidated Adjusted EBITDA. See "-Non-GAAP Measures-EBITDA-Based Measures". Depreciation expense included in gross profit increased from $6.5 million for the year ended December 31, 2012 to $7.6 million for the year ended December 31, 2013. The increase is attributable to an increase in our depreciable asset base from December 31, 2012 to December 31, 2013. Several other offsetting factors increased gross profit by $4.4 million in the year ended December 31, 2013 as compared to the same period in 2012. Higher volume, higher average selling prices and lower shrinkage costs due to lower metal costs and higher yields contributed $4.8 million, $2.5 million and $2.1 million, respectively, to the increase in gross profit. These factors were partially offset by higher manufacturing conversion costs of $3.6 million and an estimated $1.4 million of costs associated with our continuous improvement efforts and marketing and product development, labor contract negotiations and development of our information systems. Selling, general and administrative expenses Selling, general and administrative expenses increased by $18.1 million, or 19.5%, from $92.7 million for the year ended December 31, 2012 to $110.8 million for the year ended December 31, 2013. Non-cash compensation charges for vested profits interest shares included in selling, general and administrative expenses were $8.9 million and $19.5 million for the year ended December 31, 2013 and 2012, respectively. Additionally, in the year ended December 31, 2013, Halkos modified its operating agreement to eliminate its right to acquire all or a portion of the Class B Shares. This modification to its operating agreement triggered the recognition of $20.4 million of incremental non-cash compensation expense and no additional expense will be incurred by the Company in any future period. During the year ended December 31, 2013, in connection with the IPO, we terminated our Management Services Agreement with affiliates of the KPS Funds prior to the expiration of the initial term and were required to pay an early termination fee equal to the value of the advisory fee that would have otherwise been payable to affiliates of the KPS Funds through the end of the Management Services Agreement. We paid affiliates of the KPS Funds $4.5 million related to our early termination and all unpaid management advisory fees and recorded the charges in selling, general and administrative expenses. The management advisory fees for the year ended December 31, 2013 and 2012 were $0.3 million and $1.0 million, respectively. We incurred professional fees for accounting, tax, legal and consulting services related to costs incurred as a publicly traded company, including IPO efforts, costs related to the Follow-on Public Offering and the Additional Follow-on Public Offering and costs associated with the Exchange Offer, of $4.3 million during the year ended December 31, 2013. We incurred professional fees for accounting, tax, legal and consulting services related to our Exchange Offer and public company readiness efforts of $3.3 million during the year ended December 31, 2012. Additionally, for the year ended December 31, 2013, we recognized $1.2 million related to share-based compensation resulting from the grant of non-qualified stock options, restricted stock and performance-based shares to certain employees, members of our management and our Board of Directors. 69 -------------------------------------------------------------------------------- Table of Contents For the year ended December 31, 2013, we decreased the allowance for doubtful accounts by $0.2 million compared to a decrease of $0.8 million for the year ended December 31, 2012, which in both cases was due to management's change in the estimate of the recoverability of accounts receivable. Several other offsetting factors contributed to the remaining $1.7 million increase in selling, general and administrative expenses in the year ended December 31, 2013 as compared to the same period in 2012. Other selling, general and administrative costs associated with continuous improvement efforts and marketing and product development, labor contract negotiations and development of our information systems increased by an estimated $1.4 million, salaries, benefits and incentive compensation increased by $0.8 million and outside services increased by $0.4 million, partially offset by a decrease in other professional fees for accounting, tax, legal and consulting services of $0.9 million. Operating income Operating income decreased by $19.0 million, or 21.0%, from $90.5 million for the year ended December 31, 2012 to $71.5 million for the year ended December 31, 2013 due to the changes in gross profit and selling, general and administrative expenses described above. Interest expense Interest expense increased from $39.7 million for the year ended December 31, 2012 compared to $39.8 million for the year ended December 31, 2013. The increase was primarily due to higher average borrowings on our debt facilities of $389.8 in 2013 as compared to $355.4 million in 2012, offset by lower non-cash interest expense associated with interest rate cap agreements, lower interest rates (a weighted average of 9.2% per annum during 2013 compared to 9.6% per annum during 2012) and a net decrease in amortization of debt discount and debt issuance costs. The following table summarizes the components of interest expense: For the Year Ended December 31, (in millions) 2013 2012 Interest on principal $ 36.5 $ 34.0 Interest rate cap agreements - 0.2 Amortization of debt discount and issuance costs 2.5 4.6 Capitalized interest (0.1 ) - Other borrowing costs (1) 0.9 0.9 Interest expense $ 39.8 $ 39.7 (1) Includes fees related to letters of credit and unused line of credit fees. Loss on extinguishment of debt In connection with the termination prior to maturity of the Term Loan Facility, we recognized $19.6 million as loss from extinguishment of debt for the year ended December 31, 2012. The loss on extinguishment of debt includes $7.1 million of unamortized debt issuance costs and $4.9 million of unamortized debt discount as well as $6.4 million of call premium and $0.1 million of professional service fees related to the early termination. Additionally, $1.1 million of costs associated with the issuance of the Senior Secured Notes was expensed as incurred in accordance with ASC 470-50, Modifications and Extinguishments. Other expense, net We recorded other expense, net of $0.3 million for the year ended December 31, 2013 compared to $0.1 million for the year ended December 31, 2012. 70-------------------------------------------------------------------------------- Table of Contents Provision for income taxes The provision for income taxes was $22.2 million for the year ended December 31, 2013 compared to $19.2 million for the year ended December 31, 2012. The change in the provision for income taxes was primarily due to the increase in non-deductible non-cash compensation of $9.8 million for the year ended December 31, 2013, as compared to the same period in 2012. The effective income tax rate was 70.7% and 61.7% for the year ended December 31, 2013 and 2012, respectively, which was primarily due to the aforementioned non-deductible non-cash compensation of $29.3 million and $19.5 million in the years ended December 31, 2013 and 2012, respectively. The following table summarizes the effective income tax rate components for the year ended December 31, 2013 and 2012: For the Year Ended December 31, 2013 2012 Statutory provision rate 35.0 % 35.0 % Permanent differences and other items State tax provision 6.1 % 6.7 % Section 199 manufacturing credit (5.2 %) (3.2 %) Incremental tax effects of foreign earnings 0.6 % 1.8 % Return to provision adjustments (0.6 %) 1.2 % Valuation allowance 0.9 % - Re-rate of deferred taxes 0.4 % (0.8 %) Non-deductible non-cash compensation 32.7 % 22.0 % Other 0.8 % (1.0 %) Effective income tax rate 70.7 % 61.7 % Equity income Equity income, net of tax, increased by $0.5 million from $1.0 million for the year ended December 31, 2012 to $1.5 million for the year ended December 31, 2013. Net income attributable to Global Brass and Copper Holdings, Inc. Net income attributable to Global Brass and Copper Holdings, Inc. decreased by $2.1 million, or 16.8%, from $12.5 million for the year ended December 31, 2012 to $10.4 million for the year ended December 31, 2013 due to an increase in selling, general and administrative expenses, including non-cash compensation expense for vested profits interest shares and early termination management advisory fees in connection with the IPO, as well as an increase in the provision for income taxes, partially offset by the loss on extinguishment of debt in 2012, as described above. Consolidated Adjusted EBITDA Consolidated Adjusted EBITDA increased by $2.6 million, or 2.3%, from $115.4 million for the year ended December 31, 2012 to $118.0 million for the year ended December 31, 2013. The increase was due to higher volume of $4.8 million, higher average selling prices of $2.5 million, lower shrinkage cost due to lower metal costs and higher yields of $2.1 million, a decrease of $0.9 million in other professional fees for accounting, tax, legal and consulting services and a net increase in other adjustments included in the calculation of Consolidated Adjusted EBITDA of $0.5 million. Partially offsetting the increase were higher manufacturing conversion costs of $3.6 million, an estimated $1.4 million of costs associated with our continuous improvement efforts and 71-------------------------------------------------------------------------------- Table of Contents marketing and product development, labor contract negotiations and development of our information systems, an increase in salaries, benefits and incentive compensation of $0.8 million, an increase in outside services of $0.4 million, and an increase in other selling, general and administrative expenses of $1.4 million associated with continuous improvement efforts and marketing and product development, labor contract negotiations and development of our information systems, as well as the change in accounts receivable recoverability estimate resulting in the decrease in the allowance for doubtful accounts of $0.2 million in the year ended December 31, 2013 (compared to a decrease of $0.8 million for the year ended December 31, 2012). Consolidated EBITDA and Consolidated Adjusted EBITDA are non-GAAP financial measures. See "-Non-GAAP Measures-EBITDA-Based Measures". Below is a reconciliation of net income attributable to Global Brass and Copper Holdings, Inc. to Consolidated EBITDA and Consolidated Adjusted EBITDA for the years ended December 31, 2013 and 2012: For the Year Ended December 31, (in millions) 2013 2012 Net income attributable to Global Brass and Copper Holdings, Inc. $ 10.4 $ 12.5 Interest expense 39.8 39.7 Provision for income taxes 22.2 19.2 Depreciation expense 8.5 6.8 Amortization expense 0.1 0.1 Consolidated EBITDA $ 81.0 $ 78.3 Unrealized gain on derivative contracts (a) (0.2 ) (1.6 ) Gain from LIFO layer depletion (b) (2.0 ) (4.8 ) Loss on extinguishment of debt (c) - 19.6 Non-cash accretion of income of Dowa Joint Venture (d) (0.7 ) (0.7 ) Non-cash Halkos profits interest compensation expense (e) 29.3 19.5 Management fees (f) 4.8 1.0 Specified legal/professional expenses (g) 4.3 3.3 Lower of cost or market adjustment to inventory (h) 0.3 0.3 Share-based compensation expense (i) 1.2 - Other adjustments (j) - 0.5 Consolidated Adjusted EBITDA $ 118.0 $ 115.4 (a) Represents unrealized gains and losses on derivative contracts in support of our balanced book approach and unrealized gains and losses associated with derivative contracts with respect to electricity and natural gas costs. (b) Calculated based on the difference between the base year LIFO carrying value and the metal prices prevailing in the market at the time of inventory depletion. (c) Represents the loss on the extinguishment of debt recognized in connection with the termination prior to maturity of the Term Loan Facility. (d) As a result of the application of purchase accounting in connection with the November 2007 acquisition, no carrying value was initially assigned to our equity investment in the Dowa Joint Venture. This adjustment represents the accretion of equity in the Dowa Joint Venture at the date of the acquisition over a 13-year period (which represents the estimated useful life of the technology and patents of the joint venture). See note 7 to our audited consolidated financial statements, which are included elsewhere in this annual report. (e) The 2013 amount includes $20.4 million that represents incremental non-cash compensation as a result of the modification made to the Halkos LLC Agreement to eliminate Halkos' right to acquire all or a portion of the Class B Shares. The 2013 amount also includes $8.9 million that represents dividend payments made by Halkos to members of our management that resulted in a non-cash compensation charge in connection with 72 -------------------------------------------------------------------------------- Table of Contents the IPO that occurred in May 2013. The 2012 amount represents the dividend payment made by Halkos to certain members of our management that resulted in a non-cash compensation charge in connection with the Parent Distribution that occurred on June 1, 2012. See note 17 to our audited consolidated financial statements, which are included elsewhere in this annual report. (f) The 2013 amount includes a $4.5 million early termination fee, which is equal to the value of the advisory fee that would have otherwise been payable to affiliates of KPS through the end of the agreement. The 2012 amount represents the annual advisory fees payable to affiliates of KPS. See note 17 to our audited consolidated financial statements, which are included elsewhere in this annual report. (g) Specified legal/professional expenses for the year ended December 31, 2013 includes $4.3 million of professional fees for accounting, tax, legal and consulting services related to costs incurred as a publicly traded company, including IPO efforts, Follow-on Public Offering costs, Additional Follow-on Public Offering costs and costs associated with the Exchange Offer. Specified legal/professional expenses for the year ended December 31, 2012 includes $3.3 million of professional fees for accounting, tax, legal and consulting services related to the Exchange Offer and public company readiness efforts. (h) Represents non-cash lower of cost or market charges for the write down of inventory recorded during the year ended December 31, 2013 and 2012. (i) Represents share-based compensation expense resulting from the grant of non-qualified stock options, restricted stock and performance-based shares to certain employees, members of our management and our Board of Directors. (j) Represents a call premium of $0.5 million as a result of a voluntary prepayment of $15.0 million on our Term Loan Facility in April 2012. Segment Results of Operations Segment Results of Operations for the Year Ended December 31, 2013, Compared to the Year Ended December 31, 2012 See note 18 of our audited consolidated financial statements included elsewhere in this annual report for additional information regarding our segment reporting. December 31, 2013 vs. 2012 (in millions) 2013 2012 Amount Percent Pounds shipped (1) Olin Brass 279.4 266.2 13.2 5.0 % Chase Brass 216.0 216.9 (0.9 ) (0.4 %) A.J. Oster 66.9 67.2 (0.3 ) (0.4 %) Corporate & other (2) (39.3 ) (47.1 ) 7.8 16.6 % Total 523.0 503.2 19.8 3.9 % Net Sales Olin Brass $ 874.1 $ 722.9 $ 151.2 20.9 % Chase Brass 622.0 648.0 (26.0 ) (4.0 %) A.J. Oster 316.2 326.4 (10.2 ) (3.1 %) Corporate & other (2) (53.8 ) (46.8 ) (7.0 ) (15.0 %) Total $ 1,758.5 $ 1,650.5 $ 108.0 6.5 % Segment Adjusted EBITDA Olin Brass $ 48.3 $ 45.1 $ 3.2 7.1 % Chase Brass 67.2 66.6 0.6 0.9 % A.J. Oster 16.9 19.5 (2.6 ) (13.3 %) Total for operating segments $ 132.4 $ 131.2 $ 1.2 0.9 % (1) Amounts exclude quantity of unprocessed metal sold. (2) Amounts represent intercompany eliminations. 73 -------------------------------------------------------------------------------- Table of Contents Segment EBITDA and Segment Adjusted EBITDA are non-GAAP financial measures. See "-Non-GAAP Measures-EBITDA-Based Measures". Below is a reconciliation of income before provision for income taxes and equity income to Segment EBITDA and Segment Adjusted EBITDA: For the Year Ended For the Year Ended December 31, 2013 December 31, 2012 Olin Chase AJ Olin Chase AJ (in millions) Brass Brass Oster Brass Brass Oster Income before provision for income taxes and equity income: $ 42.9 $ 66.1 $ 16.6 $ 41.6 $ 65.7 $ 23.7 Interest expense - - - - - - Depreciation expense 5.0 2.9 0.3 3.8 2.4 0.3 Amortization expense - 0.1 - - 0.1 - Segment EBITDA $ 47.9 $ 69.1 $ 16.9 $ 45.4 $ 68.2 $ 24.0 Equity income, net of tax 1.5 - - 1.0 - - Net income attributable to non-controlling interest (0.3 ) - - (0.4 ) - - Gain from LIFO layer depletion (1) (0.1 ) (1.9 ) - (0.2 ) (1.6 ) (4.5 ) Non-cash accretion of income of Dowa Joint Venture (2) (0.7 ) - - (0.7 ) - - Segment Adjusted EBITDA $ 48.3 $ 67.2 $ 16.9 $ 45.1 $ 66.6 $ 19.5 (1) Calculated based on the difference between the base year LIFO carrying value and the metal prices prevailing in the market at the time of inventory depletion. (2) As a result of the application of purchase accounting in connection with the November 2007 acquisition, no carrying value was initially assigned to our equity investment in our Dowa Joint Venture. This adjustment represents the accretion of equity in our Dowa Joint Venture over a 13-year period (which represents the estimated useful life of the technology and patents of the joint venture). See note 7 to our audited consolidated financial statements, which are included elsewhere in this annual report. Olin Brass Olin Brass net sales increased by $151.2 million, or 20.9%, from $722.9 million for the year ended December 31, 2012 to $874.1 million for the year ended December 31, 2013. The increase was due to the sales of unprocessed metal, higher volume and higher average selling prices, including increases in sales prices to A.J. Oster (which are eliminated in our consolidated results) and partially offset by a shift in product mix as well as lower metal prices. The sales of unprocessed metal and higher average selling prices, partially offset by lower metal prices, increased net sales by $116.3 million for the year ended December 31, 2013 as compared to the same period in 2012. Volume increased by 13.2 million pounds, or 5.0%, from 266.2 million pounds for the year ended December 31, 2012 to 279.4 million pounds for the year ended December 31, 2013. The increase in volume, which contributed $34.9 million to the increase in net sales, was the result of higher demand in the building and housing, munitions, coinage and automotive end markets. These increases were partially offset by a lower demand in the electronics/electrical components end market as well as lower shipments to A.J. Oster. During the year ended December 31, 2013, A.J. Oster reduced purchases from Olin Brass and increased purchases from third party suppliers by approximately 7.8 million pounds compared to the same period in 2012. Excluding sales to A.J. Oster, Olin Brass volumes increased by 21.0 million pounds, or 9.6%, for the year ended December 31, 2013 compared to the same period in 2012. Segment Adjusted EBITDA of Olin Brass increased by $3.2 million, from $45.1 million for the year ended December 31, 2012 to $48.3 million for the year ended December 31, 2013. The increase was due primarily to 74-------------------------------------------------------------------------------- Table of Contents higher volume, lower shrinkage costs due to lower metal costs and higher yields, a net increase in other adjustments included in the calculation of Segment Adjusted EBITDA and higher average selling prices, including increases in sales prices to A.J. Oster (which are eliminated in our consolidated results) and partially offset by a shift in product mix. Other factors partially offsetting the increase were higher manufacturing conversion costs due to product mix and operational issues which adversely impacted product flow and yield at Olin Brass, additional expenses associated with our continuous improvement efforts and development of our information systems, an increase in outside services, an increase in salaries, benefits and incentive compensation and an increase in other selling, general and administrative expenses incurred in support of our marketing and product development, labor contract negotiations and development of our information systems. Chase Brass Chase Brass net sales decreased by $26.0 million, or 4.0%, from $648.0 million for the year ended December 31, 2012 to $622.0 million for the year ended December 31, 2013. The decrease was due primarily to lower metal prices and lower volume, partially offset by higher average selling prices. Lower metal prices, partially offset by higher average selling prices for the year ended December 31, 2013, contributed $23.1 million to the decrease in net sales as compared to the same period in 2012. Volume decreased by 0.9 million pounds, or 0.4%, from 216.9 million pounds for the year ended December 31, 2012 to 216.0 million pounds for the year ended December 31, 2013. The decrease in volume, which contributed $2.9 million to the decrease in net sales, was the result of lower demand in the electronics/electrical components end market resulting from increased competition from foreign imports and customers sourcing their finished products offshore, thereby also increasing the amount of manufacturing offshore and consequently reducing demand for brass rod in the United States. This decrease was partially offset by higher demand in the building and housing end market, which was also was dampened by foreign competition. Segment Adjusted EBITDA of Chase Brass increased by $0.6 million, from $66.6 million for the year ended December 31, 2012 to $67.2 million for the year ended December 31, 2013. The increase was due primarily to higher average selling prices and lower shrinkage costs due to lower metal costs and higher yields, partially offset by a decrease in volume, the change in management's estimate of the recoverability of accounts receivable resulting in the reversal of the provision for bad debt in 2012 greater than 2013, an increase in manufacturing conversion costs, additional expenses associated with our continuous improvement efforts and labor contract negotiations, and an increase in other selling, general and administrative expenses incurred in support of marketing and product development and development of our information systems. A.J. Oster A.J. Oster net sales decreased by $10.2 million, or 3.1%, from $326.4 million for the year ended December 31, 2012 to $316.2 million for the year ended December 31, 2013. The decrease was due primarily to lower metal prices and lower volume in the year ended December 31, 2013 compared to the same period in 2012, partially offset by higher average selling prices. Lower metal prices, partially offset by higher average selling prices for the year ended December 31, 2013 contributed $8.6 million to the decrease in net sales as compared to the same period in 2012. Volume decreased by 0.3 million pounds, or 0.4%, from 67.2 million pounds for the year ended December 31, 2012 to 66.9 million pounds for the year ended December 31, 2013. The decrease in volume, which contributed $1.6 million to the decrease in net sales, was primarily the result of lower demand in the building and housing end market, which was influenced by lower shipments to specific customers, that are partially offset by the overall recovery in the building and housing end market, and lower demand in the electronics/electrical components end market, partially offset by the higher demand in the automotive end market. 75 -------------------------------------------------------------------------------- Table of Contents Segment Adjusted EBITDA of A.J. Oster decreased by $2.6 million, from $19.5 million for the year ended December 31, 2012 to $16.9 million for the year ended December 31, 2013. The decrease was due to higher prices on purchases from Olin Brass, which resulted in higher conversion costs (which are eliminated in our consolidated results), as well as lower volume, an increase in outside services, partially offset by higher average selling prices and a decrease in salaries, benefits and incentive compensation. Consolidated Results of Operations for the Year Ended December 31, 2012, Compared to the Year Ended December 31, 2011. The statement of operations data presented below for the years ended December 31, 2012 and 2011 are derived from our audited consolidated financial statements. Change: For the Year Ended December 31, 2012 vs. 2011 (in millions) 2012 % of Net Sales 2011 % of Net Sales Amount Percent Net sales $ 1,650.5 100.0 % $ 1,779.1 100.0 % $ (128.6 ) (7.2 %) Cost of sales 1,467.3 88.9 % 1,583.5 89.0 % (116.2 ) (7.3 %) Gross profit 183.2 11.1 % 195.6 11.0 % (12.4 ) (6.3 %) Selling, general and administrative expenses (a) 92.7 5.6 % 69.4 3.9 % 23.3 33.6 % Operating income 90.5 5.5 % 126.2 7.1 % (35.7 ) (28.3 %) Interest expense 39.7 2.4 % 40.0 2.2 % (0.3 ) (0.8 %) Loss on extinguishment of debt 19.6 1.2 % - 0.0 % 19.6 N/A Other expense,net 0.1 0.0 % 0.4 0.0 % (0.3 ) (75.0 %) Income before provision for income taxes and equity income 31.1 1.9 % 85.8 4.8 % (54.7 ) (63.8 %) Provision for income taxes 19.2 1.2 % 31.4 1.8 % (12.2 ) (38.9 %) Income before equity income 11.9 0.7 % 54.4 3.1 % (42.5 ) (78.1 %) Equity income, net of tax 1.0 0.1 % 0.9 0.1 % 0.1 11.1 % Net income 12.9 0.8 % 55.3 3.1 % (42.4 ) (76.7 %) Less: Net income attributable to noncontrolling interest 0.4 0.0 % 0.2 0.0 % 0.2 100.0 % Net income attributable to Global Brass and Copper Holdings, Inc. $ 12.5 0.8 % $ 55.1 3.1 % $ (42.6 ) (77.3 %) Consolidated Adjusted EBITDA $ 115.4 7.0 % $ 122.6 6.9 % $ (7.2 ) (5.9 %) (a) Amounts include non-cash profits interest compensation of $19.5 million and $0.9 million for the years ended December 31, 2012 and 2011, respectively. Net Sales Net sales decreased by $128.6 million, or 7.2%, from $1,779.1 million for the year ended December 31, 2011 to $1,650.5 million for the year ended December 31, 2012. Decreases in metal prices, volume and sales prices decreased net sales by $116.0 million, $29.5 million, and $1.3 million, respectively for the year ended December 31, 2012 compared to the year ended December 31, 2011. Metal prices reflect the replacement cost recovery from the customer, whereas the sales prices represent the pricing component of adjusted sales, which we define as the excess of net sales over the metal component of net sales. These decreases were offset by an increase in the sales of unprocessed metal, which increased net sales by $18.2 million. Volume decreased 6.8 million pounds, or 1.3%, from 510.0 million pounds for the year ended December 31, 2011 to 503.2 million pounds for the year ended December 31, 2012. The decrease in volume was the result of our continued efforts to optimize our product mix, increased competition from foreign imports, and the suspension in $1 coin production by the United States Mint, partially offset by the increase in demand in the munitions, coinage (other than volumes associated with the $1 coin), building and housing and automotive end markets. 76 -------------------------------------------------------------------------------- Table of Contents The metal cost recovery component of net sales decreased by $123.0 million, or 9.9%, from $1,248.6 million for the year ended December 31, 2011 to $1,125.6 million for the year ended December 31, 2012. Lower metal prices contributed $116.0 million to the decrease in net sales. The metal cost recovery component of net sales per pound of finished product decreased 8.6%, which is partially dampened by the inclusion of the sales of unprocessed metal, the quantity of which is not included in pounds shipped. The metal cost recovery component of net sales per pound of finished product sold excluding the sale of unprocessed metal (the quantity of which is not included in pounds shipped) decreased by 10.1%, primarily as a result of a 9.8% decrease in average daily copper prices as reported by COMEX, during the year ended December 31, 2012 as compared to the same period in 2011. Furthermore, lower volume decreased the metal cost recovery component of net sales by $25.2 million. These decreases were offset by an increase in sales of unprocessed metal, which increased net sales by $18.2 million during the year ended December 31, 2012 as compared to the same period in 2011. Adjusted Sales Adjusted sales, the excess of net sales over the metal component of net sales, decreased by $5.6 million, or 1.1%, from $530.5 million for the year ended December 31, 2011 to $524.9 million for the year ended December 31, 2012. Lower volume and lower average selling prices contributed $4.3 million and $1.3 million to the decrease in adjusted sales. Adjusted sales per pound remained flat in 2012 compared to 2011, which was the result of a net decrease in average selling prices at the segment level, offset by the effect of changes in the mix of sales by segment relative to the company as a whole. Adjusted sales is a non-GAAP financial measure. See "-Non-GAAP Measures-Adjusted Sales". The following table presents a reconciliation of net sales to adjusted sales and net sales per pound to adjusted sales per pound: For the Year Ended Change: December 31, 2012 vs. 2011 (in millions, except per pound values) 2012 2011 Amount Percent Pounds shipped 503.2 510.0 (6.8 ) (1.3 %) Net sales $ 1,650.5 $ 1,779.1 $ (128.6 ) (7.2 %) Metal component of net sales 1,125.6 1,248.6 (123.0 ) (9.9 %) Adjusted sales $ 524.9 $ 530.5 $ (5.6 ) (1.1 %) $ per pound shipped Net sales per pound $ 3.28 $ 3.49 $ (0.21 ) (6.0 %) Metal component of net sales per pound 2.24 2.45 (0.21 ) (8.6 %) Adjusted sales per pound $ 1.04 $ 1.04 $ - 0.0 % Average copper price per pound reported by COMEX $ 3.61 $ 4.00 $ (0.39 ) (9.8 %) (a) Amounts exclude quantity of unprocessed metal sold. Gross Profit Gross profit decreased by $12.4 million, or 6.3%, from $195.6 million for the year ended December 31, 2011 to $183.2 million for the year ended December 31, 2012. Gross profit per pound decreased from $0.38 for the year ended December 31, 2011 to $0.36 for the year ended December 31, 2012. Gross profit for the year ended December 31, 2012 included a gain of $1.6 million related to net unrealized gains on derivative contracts. Gross profit for the year ended December 31, 2011 included a loss of $1.1 million related to net unrealized losses on derivative contracts. We exclude all such gains and losses in calculating Segment Adjusted EBITDA and Consolidated Adjusted EBITDA. See "-Non-GAAP Measures-EBITDA-Based Measures". 77-------------------------------------------------------------------------------- Table of Contents Gross profit in the years ended December 31, 2012 and 2011 also reflects the reduction of inventory quantities and a decrement in the base LIFO layer, which is carried at a copper price of $1.52 per pound and is significantly below weighted-average replacement costs of $3.61 per pound and $4.00 per pound for the years ended December 31, 2012 and 2011, respectively. Gross profit for the year ended December 31, 2012 included a LIFO gain of $4.8 million, compared to a LIFO gain of $15.2 million in the year ended December 31, 2011. We also reduced the recorded value of inventory by $0.3 million in the year ended December 31, 2012 related to a non-cash lower of cost or market adjustment, which is reflected in gross profit as a component of cost of sales. We exclude the above items in calculating Segment Adjusted EBITDA and Consolidated Adjusted EBITDA. See "-Non-GAAP Measures-EBITDA-Based Measures". Depreciation expense included in gross profit increased from $4.5 million for the year ended December 31, 2011 to $6.5 million for the year ended December 31, 2012. The increase is attributable to an increase in our depreciable asset base from $67.1 million at December 31, 2011 to $87.4 million at December 31, 2012. Several other offsetting factors contributed to the remaining $2.4 million decrease in gross profit in 2012. Lower volume and lower average sales prices, in the year ended December 31, 2012 contributed $3.2 million and $1.3 million, respectively, to the decrease in gross profit. These factors were partially offset by lower manufacturing conversion costs and lower shrinkage costs due to lower metal costs of $1.1 million and $1.0 million, respectively, in the year ended December 31, 2012. Selling, General and Administrative Expenses Selling, general and administrative expenses increased by $23.3 million, or 33.6%, from $69.4 million for the year ended December 31, 2011 to $92.7 million for the year ended December 31, 2012. Non-cash compensation charges for vested profits interest shares included in selling, general and administrative expenses were $19.5 million and $0.9 million for the years ended December 31, 2012 and 2011, respectively. We incurred professional fees for accounting, tax, legal and consulting services related to our Exchange Offer and public company readiness efforts of $3.3 million during the year ended December 31, 2012. During the year ended December 31, 2011, we incurred $3.9 million in professional fees for accounting, tax, legal and consulting services related to our initial public offering efforts (which occurred in May 2013) and $0.9 million related to an abandoned contemplated acquisition. In 2012, we decreased the allowance for doubtful accounts by $0.8 million compared to $4.2 million in 2011, which in both cases was due to management's change in the estimate of the recoverability of accounts receivable. Several other offsetting factors contributed to the remaining $2.8 million increase in selling, general and administrative expenses in 2012. Professional fees for accounting, tax, legal and consulting services not related to the matters above increased by $2.8 million, operating lease rental expenses increased by $0.4 million in 2012 and other miscellaneous expenses increased by $0.6. Partially offsetting the increase was a decrease of $1.0 million in incentive compensation. Operating Income Operating income decreased by $35.7 million, or 28.3%, from $126.2 million for the year ended December 31, 2011 to $90.5 million for the year ended December 31, 2012 due to the changes in gross profit and selling, general and administrative expenses described above. 78-------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense decreased by $0.3 million from $40.0 million for the year ended December 31, 2011 to $39.7 million for the year ended December 31, 2012. The decrease was primarily due to lower non-cash interest expense associated with interest rate cap agreements and lower interest rates (a weighted average of 9.6% per annum during 2012 compared to 10.3% per annum during 2011) and a net decrease in amortization of debt discount and debt issuance costs, partially offset by higher average borrowings on our debt facilities of $355.4 as compared to $319.0 million in 2011. The following table summarizes the components of interest expense: For the Year Ended December 31, (in millions) 2012 2011 Interest on principal $ 34.0 $ 32.7 Interest rate cap agreements 0.2 1.9 Amortization of debt discount and issuance costs 4.6 4.7 Capitalized interest - (0.6 ) Other borrowing costs (1) 0.9 1.3 Interest expense $ 39.7 $ 40.0 (1) Includes interest on capital lease obligations and fees related to letters of credit and unused line of credit fees. Loss on Extinguishment of Debt In connection with the Term Loan Refinancing, we recognized $19.6 million as loss from extinguishment of debt for the year ended December 31, 2012. The loss on extinguishment of debt includes the write-off of $7.1 million of unamortized debt issuance costs and $4.9 million of unamortized debt discount as well as $6.4 million of call premium and $0.1 million of professional service fees related to the early termination. Additionally, $1.1 million of costs associated with the issuance of the Senior Secured Notes was expensed as incurred in accordance with ASC 470-50, Modifications and Extinguishments. Other Expense, Net We recorded other expense, net of $0.1 million for the year ended December 31, 2012 compared to $0.4 million for the year ended December 31, 2011. Provision for Income Taxes Income tax expense decreased by $12.2 million, from $31.4 million for the year ended December 31, 2011 to $19.2 million for the year ended December 31, 2012. The decrease was due to a decrease in income before provision for income taxes and equity income of $54.7 million. The effective income tax rate increased from 36.6% for the year ended December 31, 2011 to 61.7% for the year ended December 31, 2012. The year over year increase was due to an increase in the non-deductible non-cash compensation, a higher state effective tax rate as well as higher return to provision adjustments. 79-------------------------------------------------------------------------------- Table of Contents The following table summarizes the effective income tax rate components for the years ended December 31, 2012 and 2011: For the Year Ended December 31, 2012 2011 Statutory provision rate 35.0 % 35.0 % Permanent differences and other items State tax provision 6.7 % 3.9 % Section 199 manufacturing credit (3.2 %) (2.3 %) Incremental tax effects of foreign earnings 1.8 % 0.2 % Return to provision adjustments 1.2 % (0.7 %) Re-rate of deferred taxes (0.8 %) (0.3 %) Non-deductible non-cash compensation (1) 22.0 % 0.4 % Other (1.0 %) 0.4 % Effective income tax rate 61.7 % 36.6 % (1) Reflects the increase in effective income tax rate resulting from non-cash compensation expense that was recognized by us in connection with $19.5 million of distributions made to certain members of our management by Halkos in June 2012 from the proceeds it received from us as a result of the Term Loan Refinancing. For the year ended December 31, 2011, non-cash compensation expense totaled $0.9 million. The additional selling, general and administrative expense lowered our income before provision for income taxes and equity income, which resulted in our effective tax rate being higher in the 2012 and 2011 periods. Equity Income Equity income, net of tax, remained relatively flat from $0.9 million for the year ended December 31, 2011 to $1.0 million for the year ended December 31, 2012. Net Income Attributable to Global Brass and Copper Holdings, Inc. Net income attributable to Global Brass and Copper Holdings, Inc. decreased by $42.6 million, or 77.3%, from $55.1 million for the year ended December 31, 2011 to $12.5 million for the year ended December 31, 2012 due to the loss on extinguishment of debt, non-cash compensation charges for vested profits interest shares and other changes in operating income, partially offset by the decrease in provision for income taxes, as described above. Consolidated Adjusted EBITDA Consolidated Adjusted EBITDA decreased by $7.2 million, or 5.9%, from $122.6 million for the year ended December 31, 2011 to $115.4 million for the year ended December 31, 2012. The decrease was due to lower volume of $3.2 million, lower average sales prices of $1.3 million, the change in the accounts receivable recoverability estimate resulting in the decrease in the allowance for doubtful accounts of $0.8 million in 2012 (compared to $4.2 million in 2011), increases in professional fees for accounting, tax, legal and consulting services of $2.8 million, an increase in operating lease rental expenses of $0.4 million and other miscellaneous expenses increased by $0.6 million. Partially offsetting the decrease were lower manufacturing conversion costs of $1.1 million, lower shrinkage costs of $1.0 million due to lower metal costs, lower incentive compensation costs of $1.0 million and a decrease in other adjustments included in the calculation of Consolidated Adjusted EBITDA of $1.4 million. 80 -------------------------------------------------------------------------------- Table of Contents Consolidated EBITDA and Consolidated Adjusted EBITDA are non-GAAP financial measures. See "-Non-GAAP Measures-EBITDA-Based Measures". Below is a reconciliation of net income attributable to Global Brass and Copper Holdings, Inc. to Consolidated EBITDA and Consolidated Adjusted EBITDA for the years ended December 31, 2012 and 2011: For the Year Ended December 31, (in millions) 2012 2011 Net income attributable to Global Brass and Copper Holdings, Inc. $ 12.5 $ 55.1 Interest expense 39.7 40.0 Provision for income taxes 19.2 31.4 Depreciation expense 6.8 4.5 Amortization expense 0.1 0.2 Consolidated EBITDA $ 78.3 $ 131.2 Unrealized (gain) loss on derivative contracts (a) (1.6 ) 1.1 Gain from LIFO layer depletion (b) (4.8 ) (15.2 ) Loss on extinguishment of debt (c) 19.6 - Non-cash accretion of income of Dowa Joint Venture (d) (0.7 ) (0.7 ) Non-cash Halkos profits interest compensation expense (e) 19.5 0.9 Management fees (f) 1.0 1.0 Specified legal/professional expenses (g) 3.3 4.8 Lower of cost or market adjustment to inventory (h) 0.3 - Other adjustments (i) 0.5 (0.5 ) Consolidated Adjusted EBITDA $ 115.4 $ 122.6 (a) Represents unrealized gains and losses on derivative contracts in support of our balanced book approach and unrealized gains and losses associated with derivative contracts with respect to electricity and natural gas costs. (b) Calculated based on the difference between the base year LIFO carrying value and the metal prices prevailing in the market at the time of inventory depletion. (c) Represents the loss on the extinguishment of debt recognized in connection with the Term Loan Refinancing. (d) As a result of the application of purchase accounting in connection with the November 2007 acquisition, no carrying value was initially assigned to our equity investment in the Dowa Joint Venture. This adjustment represents the accretion of equity in the Dowa Joint Venture at the date of the acquisition over a 13-year period (which represents the estimated useful life of the technology and patents of the joint venture). See note 7 to our audited consolidated financial statements, which are included elsewhere in this annual report. (e) The 2012 amount represents dividend payments made by Halkos to members of our management that resulted in a non-cash compensation charge in connection with the Parent Distribution in June 2012. The 2011 amount represents a portion of the dividend payments made by Halkos to members of our management that resulted in a non-cash compensation charge in connection with the refinancing transaction that occurred in August 2010. See note 17 to our audited consolidated financial statements, which are included elsewhere in this annual report. (f) Represents annual management fees payable to affiliates of KPS. See note 15 to our audited consolidated financial statements, which are included elsewhere in this annual report. (g) Specified legal/professional expenses for the year ended December 31, 2012 included $3.3 million of professional fees for accounting, tax, legal and consulting services related to the Exchange Offer and public company readiness efforts and certain regulatory and compliance matters. Specified legal/professional expenses for the year ended December 31, 2011 included $3.9 million of professional fees for accounting, tax, legal and consulting services related to our initial public offering efforts (which occurred in May 2013) and $0.9 million of expense related to an abandoned contemplated acquisition. 81 -------------------------------------------------------------------------------- Table of Contents (h) Represents a non-cash lower of cost or market charge for the write down of inventory. (i) The 2012 amount represents a call premium of $0.5 million as a result of a voluntary prepayment of $15.0 million on our Term Loan Facility in April 2012. The 2011 amount represents income of $2.0 million from a favorable legal settlement related to a products liability lawsuit in which we were named as a third-party defendant. Partly offsetting the income was $0.6 million of expense related to the October 2011 amendment of the Term Loan Facility and the 2010 ABL Facility and $0.9 million of expense incurred relating to a waiver obtained from our lenders under the Term Loan Facility and the 2010 ABL Facility. The waiver fee related to a waiver from the lenders under the Term Loan Facility and the 2010 ABL Facility for a technical restatement of the financial statements of Global Brass and Copper, Inc. previously delivered and an additional waiver because the consolidated financial statements of Global Brass and Copper, Inc. for the year ended December 31, 2010 could not be delivered within the prescribed time period as a result of the restatement. Segment Results of Operations Segment Results of Operations for the Year Ended December 31, 2012, Compared to the Year Ended December 31, 2011 See note 18 of our audited consolidated financial statements included elsewhere in this annual report for additional information regarding our segment reporting. For the Year Ended Change: December 31, 2012 vs. 2011 2012 2011 Amount Percent Pounds shipped (1) Olin Brass 266.2 261.9 4.3 1.6 % Chase Brass 216.9 225.8 (8.9 ) (3.9 %) A.J. Oster 67.2 70.2 (3.0 ) (4.3 %) Corporate & other (2) (47.1 ) (47.9 ) 0.8 1.7 % Total 503.2 510.0 (6.8 ) (1.3 %) Net Sales Olin Brass $ 722.9 $ 766.5 $ (43.6 ) (5.7 %) Chase Brass 648.0 705.6 (57.6 ) (8.2 %) A.J. Oster 326.4 356.2 (29.8 ) (8.4 %) Corporate & other (2) (46.8 ) (49.2 ) 2.4 4.9 % Total $ 1,650.5 $ 1,779.1 $ (128.6 ) (7.2 %) Segment Adjusted EBITDA Olin Brass $ 45.1 $ 45.3 $ (0.2 ) (0.4 %) Chase Brass 66.6 73.7 (7.1 ) (9.6 %) A.J. Oster 19.5 17.9 1.6 8.9 % Total for operating segments $ 131.2 $ 136.9 $ (5.7 ) (4.2 %) (1) Amounts exclude quantity of unprocessed metal sold. (2) Amounts represent intercompany eliminations. Segment EBITDA and Segment Adjusted EBITDA are non-GAAP financial measures. See "-Non-GAAP Measures-EBITDA-Based Measures". 82-------------------------------------------------------------------------------- Table of Contents Below is a reconciliation of income before provision for income taxes and equity income to Segment EBITDA and Segment Adjusted EBITDA: For the Year Ended For the Year Ended December 31, 2012 December 31, 2011 Olin Chase AJ Olin Chase AJ (in millions) Brass Brass Oster Brass Brass Oster Income before provision for income taxes and equity income: $ 41.6 $ 65.7 $ 23.7 $ 51.0 $ 71.8 $ 24.8 Interest expense - - - 0.1 - - Depreciation expense 3.8 2.4 0.3 2.6 1.7 0.2 Amortization expense - 0.1 - - 0.2 - Segment EBITDA $ 45.4 $ 68.2 $ 24.0 $ 53.7 $ 73.7 $ 25.0 Equity income, net of tax 1.0 - - 0.9 - - Net income attributable to non-controlling interest (0.4 ) - - (0.2 ) - - Gain from LIFO layer depletion (1) (0.2 ) (1.6 ) (4.5 ) (8.4 ) - (7.1 ) Non-cash accretion of income of Dowa Joint Venture (2) (0.7 ) - - (0.7 ) - - Segment Adjusted EBITDA $ 45.1 $ 66.6 $ 19.5 $ 45.3 $ 73.7 $ 17.9 (1) Calculated based on the difference between the base year LIFO carrying value and the metal prices prevailing in the market at the time of inventory depletion. (2) As a result of the application of purchase accounting in connection with the November 2007 acquisition, no carrying value was initially assigned to our equity investment in our Dowa Joint Venture. This adjustment represents the accretion of equity in our Dowa Joint Venture over a 13-year period (which represents the estimated useful life of the technology and patents of the joint venture). See note 7 to our audited consolidated financial statements, which are included elsewhere in this annual report. Olin Brass Olin Brass net sales decreased by $43.6 million, or 5.7%, from $766.5 million for the year ended December 31, 2011 to $722.9 million for the year ended December 31, 2012. The decrease was due to lower average sales prices primarily due to product mix changes and lower metal prices, partially offset by higher volume and an increase in the sales of unprocessed metal. Volume increased by 4.3 million pounds, or 1.6%, from 261.9 million pounds for the year ended December 31, 2011 to 266.2 million pounds for the year ended December 31, 2012. The increase in volume, which partially offset the decrease in net sales by $12.5 million, was the result of increased demand in the munitions, coinage (other than volumes associated with the $1 coin), and automotive end markets, which was partially offset by lower $1 coin demand by the United States Mint due to the suspension of the $1 coin production. Lower metal prices combined with lower average sales prices, partially offset by the sales of unprocessed metal, contributed $56.1 million to the decrease in net sales. The lower average sales prices were primarily the result of product mix changes, substantially due to lower demand from the United States Mint as a result of the suspension of the $1 coin production. Olin Brass's Segment Adjusted EBITDA decreased slightly to $45.1 million in 2012 as compared to $45.3 million in 2011, which was the result of lower average selling prices, which were partially offset by lower manufacturing conversion costs and higher volume. 83 -------------------------------------------------------------------------------- Table of Contents Chase Brass Chase Brass net sales decreased by $57.6 million, or 8.2%, from $705.6 million for the year ended December 31, 2011 to $648.0 million for the year ended December 31, 2012. The decrease was due to lower metal prices and lower volume, partially offset by higher average sales prices. Volume decreased by 8.9 million pounds, or 3.9%, from 225.8 million pounds for the year ended December 31, 2011 to 216.9 million pounds for the year ended December 31, 2012. The decrease in volume, which contributed $27.8 million to the decrease in net sales, was the result of increased competition from foreign imports, partially offset by increased demand in the building and housing end markets. Lower metal prices, partially offset by improved pricing, contributed $29.8 million to the decrease in net sales. Segment Adjusted EBITDA of Chase Brass decreased by $7.1 million, from $73.7 million for the year ended December 31, 2011 to $66.6 million for the year ended December 31, 2012. The decrease was due primarily to lower volume, higher manufacturing conversion costs and a change in management's estimate of the recoverability of accounts receivable resulting in a reversal of the provision for bad debt, partially offset by lower shrinkage costs due to lower metal costs and higher average selling prices. A.J. Oster A.J. Oster net sales decreased by $29.8 million, or 8.4%, from $356.2 million for the year ended December 31, 2011 to $326.4 million for the year ended December 31, 2012. The decrease was due primarily to lower volume as we continue to optimize our product mix and lower metal costs, partially offset by higher average sales prices. Volume decreased by 3.0 million pounds, or 4.3%, from 70.2 million pounds for the year ended December 31, 2011 to 67.2 million pounds for the year ended December 31, 2012. The decrease in volume, which decreased net sales by $15.1 million, was primarily the result of our continued efforts to optimize our product mix, partially offset by increased demand in the building and housing and automotive end markets. Lower metal prices, partially offset by improved pricing, contributed $14.7 million to the decrease in net sales. Segment Adjusted EBITDA of A.J. Oster increased by $1.6 million, from $17.9 million for the year ended December 31, 2011 to $19.5 million for the year ended December 31, 2012. The increase was due to higher average sales prices, partially offset by the impact of lower volume and higher manufacturing conversion costs. Liquidity and Capital ResourcesSources and Uses of Cash Our primary uses of cash are to fund working capital, operating expenses, debt service and capital expenditures. Historically, our primary sources of short-term liquidity have been cash flow from operations and borrowings under our ABL Facility. Holdings derives all its cash flow from its subsidiaries, including GBC, and receives dividends, distributions and other payments from them to generate the funds necessary to meet its financial obligations. However, Holdings is a holding company with no operations, no employees and no assets other than its investment in GBC. All of our operations are conducted at GBC and its subsidiaries. GBC is also the primary obligor on our indebtedness, and Holdings has no indebtedness other than its guarantee of GBC's indebtedness. The credit agreement governing the ABL Facility and the indenture governing the Senior Secured Notes do not limit the ability of subsidiaries of GBC to dividend or distribute cash to GBC to meet its obligations 84-------------------------------------------------------------------------------- Table of Contents under those agreements or to operate its business. The credit agreement governing the ABL Facility and the indenture governing the Senior Secured Notes do, however, limit the ability of GBC and its subsidiaries to dividend or distribute cash to Holdings and to its equityholders, although ordinary course dividends and distributions to meet the limited holding company expenses and related obligations at Holdings of up to $5.0 million per year are permitted under those agreements. Under the terms of the indenture governing the Senior Secured Notes, GBC is also permitted to dividend or distribute to Holdings and its equityholders up to 50% of its Consolidated Net Income (as defined in the indenture governing the Senior Secured Notes) from April 1, 2012 to the end of GBC's most recently ended quarter. As of December 31, 2013, all of the net assets of the subsidiaries are restricted except for $37.5 million, which are permitted dividend distributions under the indenture governing the Senior Secured Notes. Because these limitations apply only to dividends or distributions to a holding company and our equityholders, we do not believe that the restrictions on dividends and distributions to Holdings and its equityholders imposed by the terms of our debt agreements have any impact on our liquidity, financial condition or results of operations. We believe that these resources will be sufficient to meet our working capital and debt service needs for the next twelve months, including costs that we may incur in connection with our growth strategy. At December 31, 2013, we had $5.5 million of outstanding borrowings under our ABL Facility, $0.5 million of letters of credit, and borrowing availability of $194.0 million. The letters of credit primarily represent collateral against certain workers compensation liabilities assumed from Olin Corporation. Our borrowing base under our current ABL Facility fluctuates with changes in eligible accounts receivable and inventory, less outstanding borrowings and letters of credit. As of December 31, 2013, the value of our eligible collateral against which we can borrow exceeded our maximum committed amount of $200.0 million by $116.6 million. Consequently, increases in eligible collateral due to increases in volume, metal prices or inventory balances will not increase the borrowing base but may increase our borrowing requirements. Conversely, decreases in volume, metal prices or inventory balances will not have an immediate impact on the borrowing base due to the excess of eligible collateral over the maximum borrowing base, but may decrease our borrowing requirements. In the event of increased commodity prices as indicated by the terms of the ABL Facility agreement, we may request, but the lenders are not obligated to, increase the maximum borrowings available up to $250.0 million. At any time, if the amount outstanding under the ABL Facility exceeds the maximum allowable borrowings, we are required to make a mandatory prepayment for the amount of the excess borrowings. At any time after the occurrence and during the continuance of a Trigger Event (as defined in the agreement governing the ABL Facility), subject to certain thresholds, reinvestment rights and other exceptions, proceeds received from asset sales, equity issuances or other specified events will be required to be applied (as mandatory prepayments) in whole or in part towards the extinguishment of outstanding amounts due under the ABL Facility. We are a value-added converter, fabricator, distributor and processor and not a commodity metal producer. We employ our balanced book approach in order to substantially reduce the financial impact of fluctuations in metal costs on our earnings and operating margins. While changes in metal prices do not have a substantial impact on our earnings or margins, except for increased costs attributable to shrinkage loss that occur as a result of increased metal prices and the potential effect higher metal prices may have on our customers' demand for our products, changes in metal prices do affect our liquidity because of the difference between our payment terms for metal purchases and our credit terms with our customers. As a result, when metal prices are rising, we tend to use more cash or draw more on the ABL Facility to cover the cash flow delay between cash collection from our customers and metal replacement purchases. When metal prices fall, we replace our metal at a lower cost than the metal content of cash collections and generally increase our cash balances or reduce our use of the ABL Facility. Because the financial instruments that we use to effectuate the balanced-book approach are designed to hedge against the cost of metal used in our operations, those financial instruments do not have a material impact on our liquidity. We believe that our cash flow from operations, supplemented with cash available under the ABL Facility, will provide sufficient liquidity to meet our needs in the current metal price environment. On August 18, 2010, we refinanced the Term Loan Facility, which resulted in an increase in our interest expense. The proceeds from the Term Loan Facility were used to repay the existing related party term loan 85-------------------------------------------------------------------------------- Table of Contents facility and the existing asset-based loan facility and to fund a cash distribution of $42.5 million to Halkos. In June 2012, GBC issued $375.0 million aggregate principal amount of Senior Secured Notes and used a portion of the net proceeds to repay all outstanding amounts (including premium and unpaid interest) under the Term Loan Facility. We also used a portion of the net proceeds to pay a $160.0 million distribution to Halkos. The Senior Secured Notes bear interest at a rate of 9.50% per annum, payable in cash semi-annually on each June 1 and December 1, beginning on December 1, 2012. We manage our levels of inventory in order to be able to satisfy customers' needs in a timely fashion, while limiting our working capital requirements, to the extent possible. While we do not have a formal policy with respect to inventory, we generally keep approximately ten weeks of inventory on hand at most times of the year, subject to upward or downward adjustments depending on seasonality and management estimates of expected customer activity. Generally, we use cash on hand or borrowings under the ABL Facility to acquire inventory. We acquired a substantial base of property, plant and equipment when we acquired the worldwide metals business of Olin Corporation and therefore have operating capacity available to support growth in our base business. As such, capital improvements and replacement costs account for the majority of our capital expenditures. In late 2011 and early 2012, we undertook one substantial capacity expansion program related to Eco Brass® and other "green portfolio" products which could not be accommodated on existing equipment. This program required a total of approximately $13 million of capital expenditures. We generally meet long-term liquidity requirements, the repayment of debt and investment funding needs through cash flow from operations and additional borrowing under the ABL Facility. We believe that cash flow from operations, supplemented by cash available under the ABL Facility will be sufficient to enable us to meet our capital investment, debt service and operational obligations as they continue for at least the next twelve months. Cash Flows The following table presents the summary components of net cash provided by or used in operating, investing and financing activities for the periods indicated. As of December 31, 2013, we had cash of $10.8 million, compared to $13.9 million at December 31, 2012. The accompanying discussion should be read in conjunction with our consolidated statements of cash flows in our audited consolidated financial statements included elsewhere in this annual report. Cash Flow Analysis For the Year Ended December 31, (in millions) 2013 2012 2011Cash flows provided by operating activities $ 27.4 $ 81.9 $ 64.8 Cash flows used in investing activities $ (25.4 ) $ (20.4 ) $ (22.3 ) Cash flows used in financing activities $ (4.9 ) $ (96.8 ) $ (8.3 ) Cash flows from operating activities During the year ended December 31, 2013, net cash provided by operating activities was $27.4 million. This amount was primarily attributable to net income of $10.7 million, adjustments to net income of $42.6 million, partially offset by an increase in assets net of liabilities of $25.9 million. The $42.6 million in adjustments was primarily due to the non-cash profits interest compensation expense of $8.9 million and $20.4 million of incremental non-cash compensation expense related to the modification to the Halkos LLC Agreement. The primary contributor to the increase in assets net of liabilities was a $3.3 million increase in accounts receivable net of accounts payable (total accounts receivable increased by $7.1 million, which was partially offset by the increase in accounts payable of $3.8 million), an increase of $16.7 million in inventory, an increase in prepaid expenses and other current assets of $9.7 million, primarily due to the deferred expense related to the sales of unprocessed metal, an increase in other assets net of liabilities of $1.0 million and an increase in income taxes receivable net of income taxes payable of $2.7 million, partially offset by an increase in accrued liabilities of $7.5 million, which was primarily due to the increase in deferred revenue related to the sales of unprocessed metal. 86 -------------------------------------------------------------------------------- Table of Contents The increase in inventory is primarily due to a shift in the product mix at Olin Brass to items requiring more processing steps and operational issues affecting product flow and yield within the brass mill and downstream cupping operation. The increase in accounts receivable was due to an increase in trade receivables as a result of higher sales during the fourth quarter of 2013 as compared to the fourth quarter of 2012, partially offset by the decrease in day's sales outstanding ("DSO") from 44 days as of December 31, 2012 to 42 days at December 31, 2013. The change in DSO was due primarily to customer mix and to seasonal and intra-month fluctuations in the timing of shipments and collections. The increase in accounts payable was due to higher volume in the fourth quarter of 2013 as compared to the fourth quarter of 2012, partially offset by the decrease in the purchase payment cycle from 24 days at December 31, 2012 to 22 days at December 31, 2013. The decrease in the purchase payment cycle was due primarily to vendor mix and to seasonal and intra-month fluctuations in the timing of material receipts and payments. During the year ended December 31, 2012, net cash provided by operating activities was $81.9 million. This amount was primarily attributable to net income of $12.9 million, adjustments to net income of $47.5 million, and a decrease in assets net of liabilities of $21.5 million. The $47.5 million in adjustments included the loss on extinguishment of debt in connection with the Term Loan Refinancing of $19.6 million and non-cash profits interest compensation expense of $19.5 million. The primary contributors to the decrease in assets net of liabilities was an $11.5 million reduction in inventory due primarily to commercial and manufacturing process improvements, a decrease of prepaid expenses and other current assets of $4.7 million, a decrease in income taxes receivable net of income taxes payable of $3.7 million, a $2.1 million decrease in accounts receivable net of accounts payable (total accounts receivable increased $1.6 million, which was offset by the increase in accounts payable of $3.7 million), and an increase in accrued liabilities of $0.9 million, partially offset by a $0.6 million increase in other assets net of liabilities and a decrease in accrued interest of $0.8 million. The increase in accounts receivable was due primarily to an increase in trade receivables as a result of higher volume in the fourth quarter of 2012 as compared to the fourth quarter of 2011, as well as due to a slight increase in the day's sales outstanding ("DSO") from 43 days at December 31, 2011 to 44 days at December 31, 2012. The increase in accounts payable was due to higher volume in the fourth quarter of 2012 as compared to the fourth quarter of 2011, as well as due to a slight increase in the purchase payment cycle from 23 days at December 31, 2011 to 24 days at December 31, 2012. During the year ended December 31, 2011, net cash provided by operating activities was $64.8 million. This amount was primarily attributable to net income of $55.3 million and adjustments to net income of $19.2 million and partially offset by an increase in assets net of liabilities of $9.7 million. Included in the adjustments to net income is the provision for bad debt expense, which was a net reduction of $4.2 million from the year ended December 31, 2010, resulting from lower estimated losses. The primary contributor to the increase in assets net of liabilities was the $37.0 million reduction of accrued liabilities, primarily as a result of settlement of derivative contracts, an increase in income taxes receivable net of income taxes payable of $2.7 million, and a decrease in accrued interest of $0.1 million, which was partially offset by a decrease in prepaid expenses of $18.3 million, a reduction in inventory of $6.6 million due to manufacturing process improvements and product portfolio rationalization, a decrease in accounts receivable net of accounts payable of $3.8 million, and a net decrease in other assets and liabilities of $1.4 million. Cash flows from investing activities Net cash used in investing activities was $25.4 million for the year ended December 31, 2013, which consisted primarily of $25.6 million of capital improvements or replacement of existing capital items, partially offset by $0.2 million of proceeds from the sale of property, plant and equipment. 87-------------------------------------------------------------------------------- Table of Contents Net cash used in investing activities was $20.4 million for the year ended December 31, 2012, which consisted primarily of capital improvements or replacement of existing capital items. Net cash used in investing activities was $22.3 million for the year ended December 31, 2011, which consisted primarily of capital investment, of which $16.3 million was due to capital improvements, or replacement of existing capital items and $6.1 million was due to capacity expansion or other growth, offset by $0.1 million of proceeds from the sale of property, plant and equipment. Cash flows from financing activities Net cash used in financing activities was $4.9 million for the year ended December 31, 2013, which consisted primarily of net repayments under the ABL Facility of $9.0 million and dividends paid of $0.8 million, partially offset by a decrease of $4.9 million in the receivable due from stockholder as all amounts were received pertaining to reimbursable expenses incurred in connection with our IPO efforts. Net cash used in financing activities was $96.8 million for the year ended December 31, 2012, which was a result of the repayment of the term loan of $310.9 million (including $266.5 million associated with the Term Loan Refinancing, a voluntary prepayment of $15.0 million, a mandatory prepayment of $28.6 million and a scheduled payment of $0.8 million), the Parent Distribution to Halkos of $160.0 million, payment of $12.9 million of costs associated with the issuance of the Senior Secured Notes and the ABL Amendment, and $2.5 million receivable due from stockholder pertaining to reimbursable expenses, offset by the proceeds from the Senior Secured Notes of $375.0 million and net borrowings on the ABL Facility of $14.5 million. Net cash used in financing activities was $8.3 million for the year ended December 31, 2011, which consisted primarily of scheduled payments under the term loan of $3.3 million, a $2.4 million receivable due from stockholder pertaining to reimbursable expenses, $1.7 million of fees and expenses related to the October 2011 amendment of our Term Loan Facility and the 2010 ABL Facility and principal payments on capital lease obligation of $0.9 million. Covenant Compliance "EBITDA" (as defined in the agreement governing the ABL Facility) is used in the agreements governing the ABL Facility to measure compliance with various financial ratio tests. See "-Non-GAAP Measures-EBITDA-Based Measures". Fixed Charge Coverage Ratio Pursuant to the agreement governing the ABL Facility, the fixed charge coverage ratio is calculated each month on a rolling twelve-month basis by dividing (1) "EBITDA" (as defined in the agreement governing the ABL Facility) minus cash taxes to the extent actually paid during such period, dividends and capital expenditures paid in cash during such period, for such twelve-month period by (2) Fixed Charges for such twelve-month period. Fixed Charges are defined as all interest expense, excluding paid-in-kind, accrued or deferred interest, net of all interest income, plus all regularly scheduled principal payments of indebtedness for borrowed money, indebtedness for the deferred purchase price of any property or services or indebtedness with respect to capital leases. The fixed charge coverage ratio covenant only is tested when excess availability is less than $20.0 million for five consecutive days (10% of the $200.0 million maximum borrowing base currently in effect). Under such circumstances, we would be required to maintain a fixed charge coverage ratio of greater than or equal to 1.1:1. As of December 31, 2013, the fixed charge coverage ratio was not in effect. 88-------------------------------------------------------------------------------- Table of Contents Minimum Excess Availability Pursuant to the agreement governing the ABL Facility, for any period of two consecutive days, Excess Availability under the ABL facility may not be less than $10.0 million. "Excess Availability" is defined as (1) the lesser of: (a) the "Borrowing Base" (as defined in the agreement governing the ABL Facility) and (b) the maximum amount available under the ABL Facility at such time; minus (2) the sum of: (a) the amount of all then outstanding loans under the ABL Facility; plus (b) the amount of all reserves then established in respect of letter of credit obligations; plus (c) the aggregate amount of all then outstanding trade payables that are more than 60 days past due as of the end of the immediately preceding calendar month (other than such payables that are being contested in good faith); plus (d) without duplication, the amount of checks issued but not yet sent to pay trade payables and other obligations more than 60 days past due as of the end of the immediately preceding calendar month, plus (e) Qualified Cash (as defined in the agreement governing the ABL Facility) only in the event that Excess Availability (without giving effect to Qualified Cash) as of such date is greater than $50.0 million. As of December 31, 2013, we were in compliance with the minimum Excess Availability covenant. Outstanding Indebtedness The ABL Facility On August 18, 2010, we entered into the 2010 ABL Facility, providing for borrowings of up to the lesser of $150.0 million or the borrowing base, in each case, less outstanding loans and letters of credit. As a result of the ABL Amendment, which occurred on June 1, 2012, the maximum availability under the ABL Facility was increased to $200.0 million. The borrowing base is defined as 85% of eligible accounts; plus the lesser of (x) 80% of the value of eligible inventory, (y) 90% of the net recovery percentage for the eligible inventory multiplied by the value of such eligible inventory and (z) the Inventory Loan Limit (which was $150.0 million as of December 31, 2013); minus reserves. As of December 31, 2013, our eligible collateral for our borrowing base had a value of $316.6 million, with a maximum availability of $200.0 million. As of December 31, 2013, we had $194.0 million available for borrowing under the ABL Facility, giving effect to $5.5 million of outstanding borrowings and $0.5 million of outstanding letters of credit. In the event of increased commodity prices as indicated by the terms of the ABL Facility agreement, we may request, but the lenders are not obligated to, increase the maximum borrowings available up to $250.0 million. At any time, if the amount outstanding under the ABL Facility exceeds the maximum allowable borrowings, we may be required to make a mandatory prepayment for the amount of the excess borrowings. At any time after the occurrence and during the continuance of a Trigger Event, as defined in the agreement governing the ABL Facility, subject to certain thresholds, reinvestment rights and other exceptions, proceeds received from asset sales, equity issuances or other specified events will be required to be applied (as mandatory prepayments) in whole or in part towards the extinguishment of outstanding amounts due under the ABL Facility. We may elect to receive advances under the ABL Facility in the form of either prime rate advances or LIBOR rate advances, as defined by the agreement governing the ABL Facility. The unused portion under the ABL Facility determines the applicable spread added to the LIBOR rate. The unused portion of the ABL Facility was $194.0 million as of December 31, 2013. Unused amounts under the ABL Facility incur an unused line fee of 0.50% per annum, payable in full on a quarterly basis. Also effective with the ABL Amendment, outstanding borrowings under the ABL Facility bear interest at a rate equal to either (i) for prime rate loans, a prime rate plus a spread between 1.0% and 1.5%, depending on excess availability levels or (ii) for LIBOR rate loans, LIBOR plus a spread of 2.0% to 2.5% depending on excess availability levels. As of December 31, 2013, amounts outstanding under the ABL Facility accrued interest at a rate of 4.25%. As of December 31, 2012, amounts outstanding under the ABL Facility bore interest at a rate of 4.50%. The ABL Facility has an expiration date of June 1, 2017 and contains various debt covenants to which we are subject on an ongoing basis. The ABL Facility restricts our ability to, among other things, incur indebtedness, 89-------------------------------------------------------------------------------- Table of Contents grant liens, repurchase stock, issue cash dividends, make investments and acquisitions and sell assets, in each case subject to certain designated exceptions. Outstanding borrowings under the ABL Facility are secured by a senior-priority security interest in our accounts receivable and inventory (which secure the Senior Secured Notes on a junior-priority basis) and by a junior-priority security interest in our fixed assets (which secure the Senior Secured Notes on a senior-priority basis). As of December 31, 2013, we were in compliance with all of our covenants under the ABL Facility. The ABL Facility contains customary events of default including, among others, failure to make payment when due, materially incorrect representations and warranties, breach of covenants, events of bankruptcy, or a change in control. In the case of an event of default occurring, the applicable interest rate spread increases by 2.0%, and the lenders would have the option to call the outstanding amount due. Senior Secured Notes On June 1, 2012, GBC issued $375.0 million in aggregate principal amount of 9.50% Senior Secured Notes due 2019. A portion of the net proceeds of the Senior Secured Notes was used in the Term Loan Refinancing. A portion of the net proceeds of the Senior Secured Notes was used to make the $160.0 million Parent Distribution to Halkos. The Senior Secured Notes are guaranteed by Holdings, and substantially all of GBC's existing and future 100%-owned U.S. subsidiaries and by any future Restricted Subsidiaries (as defined in the indenture governing the Senior Secured Notes) who guarantee or incur certain types of permitted debt under the indenture governing the Senior Secured Notes. The Senior Secured Notes are secured by a senior-priority security interest in our fixed assets (which secure the ABL Facility on a junior-priority basis) and by a junior-priority security interest in our accounts receivable and inventory (which secure the ABL Facility on a senior-priority basis). The indenture governing the Senior Secured Notes contains covenants that limit our ability and the ability of restricted subsidiaries to, among other things, incur or guarantee additional debt or issue preferred stock, pay dividends, repurchase equity interests, repay subordinated indebtedness, make investments, create restrictions on the payment of dividends or other amounts to us from restricted subsidiaries, sell assets, including collateral, enter into transactions with affiliates, merge or consolidate with another person, sell or otherwise dispose of all or substantially all of our assets and create liens on our or the restricted subsidiaries' assets to secure debt. We are in compliance with all covenants relating to the Senior Secured Notes as of December 31, 2013. The Senior Secured Notes mature on June 1, 2019. Interest on the Senior Secured Notes accrues at the rate of 9.50% per annum and is payable semiannually in arrears on June 1 and December 1, commencing on December 1, 2012. We are required to offer to redeem the Senior Secured Notes at a purchase price of 101% of their principal amount (plus accrued and unpaid interest) upon the occurrence of certain change of control events. In addition, upon the completion of certain asset dispositions, we may be required to offer to redeem the Senior Secured Notes at a purchase price of 100% of their principal amount (plus accrued and unpaid interest) if we do not apply the proceeds of such asset dispositions in accordance with the indenture by certain specified deadlines. Pursuant to a registration rights agreement, on October 7, 2013, GBC completed the Exchange Offer to issue registered notes (with substantially the same terms as the Senior Secured Notes) in exchange for the Senior Secured Notes that GBC issued in a private offering on June 1, 2012. Interest Rate Caps During the fourth quarter of 2010, we entered into interest rate cap agreements in compliance with the requirement pursuant to the agreement governing the then existing Term Loan Facility to provide that at least 90-------------------------------------------------------------------------------- Table of Contents 50% of the Term Loan Facility be subject to a fixed rate or interest rate protection at least through the third anniversary of the agreement governing the Term Loan Facility. The interest rate cap agreements capped the interest rate on $300.0 million of the aggregate principal outstanding under the Term Loan Facility. We did not designate the interest rate cap agreements as an accounting hedge, so changes in the fair value of the interest rate cap agreements were recorded as non-cash interest expense in our consolidated statements of operations. The agreements expired in August 2013. Contractual Obligations The following table illustrates our contractual commitments as of December 31, 2013: Contractual commitments (in millions) 2014 2015 2016 2017 2018 Beyond Total Senior Secured Notes-Principal $ - $ - $ - $ - $ - $ 375.0 $ 375.0 Senior Secured Notes-Interest 35.6 35.6 35.6 35.6 35.6 14.8 192.8 Purchase Obligations 308.9 2.9 0.5 0.5 - - 312.8 IAM National Pension Fund 4.2 4.4 4.6 4.0 - - 17.2 Leases 2.0 1.5 1.0 0.5 0.4 - 5.4 Long-Term Incentive Plan 0.1 0.1 - - - - 0.2 Total $ 350.8 $ 44.5 $ 41.7 $ 40.6 $ 36.0 $ 389.8 $ 903.4 We are obligated to make future payments under various contracts such as debt agreements, lease agreements and collective bargaining agreements. Operating lease obligations are payment obligations under leases classified as operating leases. Most leases are for a period of three years but some last up to five years and are primarily for equipment used in our manufacturing and distribution operations. Our purchase obligations are agreements to purchase goods or services that are enforceable and legally binding on us that specify all significant terms, including fixed or minimum quantities, fixed or variable prices and the approximate timing of the transaction. Purchase obligations include the pricing of anticipated metal purchases using contractual metal prices, or where pricing is dependent on prevailing COMEX or LME prices at the time of delivery, market metal prices as of December 31, 2013, as well as natural gas and electricity prices. As a result of the variability in the pricing of many of our metal purchasing obligations, actual amounts may vary from the amounts shown above. We participate in a multi-employer pension plan under the collective bargaining agreement that covers the East Alton, Illinois operations of our Olin Brass segment and the Alliance, Ohio operations of our A.J. Oster segment. The collective bargaining agreement for our Olin Brass segment runs through November 2017 and the collective bargaining agreement for our A.J. Oster segment runs through February 2017 and both obligate us to contribute to the plan at a rate per eligible hour per covered employee as specified in the agreement. The contributions to the multi-employer plan are a function of employment levels and eligible work hours. As a result, actual amounts may vary from the amounts shown above. The ABL Facility bears interest at variable rates, and the outstanding amounts under the ABL Facility will vary from time to time, so estimating future interest and principal payments under the ABL Facility is not practicable. The ABL Facility matures on June 1, 2017. At December 31, 2013, we had a liability for uncertain tax positions, including interest and penalties, of $26.1 million, but as we are unable to reasonably estimate the ultimate amount or timing of settlement or other resolution, it is not practical to present annual payment information. Off-Balance Sheet Arrangements We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating our business. We do not have any off-balance sheet arrangements 91-------------------------------------------------------------------------------- Table of Contents or relationships with entities that are not consolidated into our financial statements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, sales, expenses, results of operations, liquidity, capital expenditures or capital resources. Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The result of this process forms the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. We review our estimates and judgments on a regular, ongoing basis. Actual results may differ from these estimates due to changed circumstances and conditions. The following accounting policies and estimates are considered critical in light of the potentially material impact that the estimates, judgments and uncertainties affecting the application of these policies might have on our reported financial information. Our accounting policies are more fully described in note 2 "Summary of Significant Accounting Policies" to our audited consolidated financial statements included elsewhere in this annual report. There have been no significant changes to our critical accounting policies or estimates for the year ended December 31, 2013. Revenue Recognition We recognize revenue when title and risk of loss are transferred to customers, which is generally the date the product is shipped. Estimates for future rebates on certain product lines and product returns are recognized in the period in which the revenue is recorded. Rebates are estimated based upon our historical experience, combined with a review of current developments. The allowance for doubtful accounts is estimated based upon our historical experience, combined with a review of current developments and the specific identification method of accounts for which payment has become unlikely. Billings to customers for shipping costs are included in net sales and the cost of shipping product to those customers is reflected as a component of cost of sales. The Company defers the revenue from the sales of the unprocessed metal to toll customers (and the corresponding deferred expense for the sales) until the finished product has been shipped, the point at which the risk of loss and title passes to the customer. The deferred revenue is recorded within accrued liabilities and the related deferred expense is recorded within prepaid expenses and other current assets on the consolidated balance sheets. Inventories Inventories include costs attributable to direct labor and manufacturing overhead but are primarily comprised of material costs. The raw materials component of inventories that is valued on a LIFO basis comprises approximately 70% of total inventory at both December 31, 2013 and 2012. Other manufactured inventories, including the non-material components and certain non-U.S. inventories, are valued on a first-in, first-out ("FIFO") basis. Elements of cost in finished goods inventory in addition to the cost of material include depreciation, amortization, utilities, consumable production supplies, maintenance, production wages and transportation costs. 92-------------------------------------------------------------------------------- Table of Contents Inventories are stated at the lower of cost or market. The market price of metals used in production and related scrap is subject to volatility. During periods when open-market prices decline below net book value, we may need to record a provision to reduce the carrying value of our inventory. We analyze the carrying value of inventory for impairment if circumstances indicate impairment may have occurred. If an impairment occurs, the amount of impairment loss is determined by measuring the excess of the carrying value of inventory over the net realizable value of inventory. We record an estimate for slow moving and obsolete inventory based upon product knowledge, physical inventory observation, estimated future demand, market conditions and an aging analysis of the inventory on hand. Our policy is to evaluate all inventories including raw material, work-in-process and finished goods. Inventory in excess of our estimated usage requirements is written down to its estimated net realizable value. Purchase Accounting Determining the fair value of certain assets, liabilities and subsidiaries assumed in a business combination is judgmental in nature and often involves the use of significant estimates and assumptions. Some of the more significant estimates and assumptions used in valuing our acquisition of the worldwide metals business of Olin Corporation in 2007 and our acquisition of the order book, customer list and certain other assets of the North American operations of Bolton Metals Product Company ("Bolton") in January 2008 included projected future cash flows and discount rates reflecting the risk inherent in future cash flows. We recognized goodwill related to the acquisition of the order book, customer list and certain other assets of Bolton's North American operations, as the purchase price exceeded the fair value of net assets. For the acquisition of the worldwide metals business of Olin Corporation, the estimated fair value of the net assets exceeded the purchase price, thus creating negative goodwill under then current GAAP guidance. As such, noncurrent assets were assigned no value in the acquisition from Olin Corporation. We own a 50% interest in the Dowa Joint Venture, a joint venture with Dowa Co. based in Japan. As a result of the acquisition of the worldwide metals business of Olin Corporation, a negative basis difference was created between our books and our share of the Dowa Joint Venture's equity. U.S. GAAP at the time of the transaction provided that the basis difference between the investor's cost and underlying equity in net assets of the investee at the date of investment required recognition unless it is attributable to a non-amortizing asset such as goodwill. The negative basis difference was created due to the bargain purchase event and was not attributable to any specific element of the joint venture itself. As the difference was not attributable to any of the assets of the Dowa Joint Venture, the equity investment as a whole was assessed to determine the appropriate accretion period for the basis difference. The purpose of the joint venture is to supply Olin Brass's high performance alloys ("HPAs") to the Asian market through the licensing of Olin Brass technology. Given consideration of this use, the negative basis difference is being accreted over a period of 13 years. Uncertain Tax Positions Our management evaluates the recognition and measurement of uncertain tax positions based on applicable tax law, regulations, case law, administrative rulings and pronouncements and the facts and circumstances surrounding the tax position. Changes in our estimates related to the recognition and measurement of the amount recorded for uncertain tax positions could result in significant changes in our provision for (benefit from) income taxes, which could be material to our consolidated statements of operations. Derivative Contracts We measure the fair value of our derivative contract positions under the provisions of ASC 820, which defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements but does not change existing guidance as to whether or not an instrument is carried at fair value. This guidance also specifies a fair value hierarchy based upon the observability of inputs used in valuation techniques. 93 -------------------------------------------------------------------------------- Table of Contents In accordance with this guidance, fair value measurements are classified under the following hierarchy: • Level 1-Quoted prices for identical instruments in active markets. • Level 2-Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs or significant value-drivers are observable in active markets. • Level 3-Model-derived valuations in which one or more significant inputs or significant value-drivers are unobservable. In accordance with ASC 820, we determine the fair value of derivative contracts using Level 2 inputs. As of December 31, 2013, we did not hold assets or liabilities requiring a Level 3 measurement, and there were not any transfers between the hierarchy levels during 2013 or 2012. We do not use hedge accounting for our derivative contracts. All gains and losses are recorded as operating expense in the consolidated statement of operations as these contracts are marked to market each period. Profits Interest Awards As of December 31, 2013, Halkos owned 34.4% of the common stock of Holdings and after giving effect to the Additional Follow-on Public Offering that occurred in February 2014, Halkos no longer owns any of the outstanding common stock of Global Brass and Copper Holdings, Inc. Halkos granted, pursuant to the Halkos Equity Plan, non-voting membership interests to select members of management titled Class B Shares. Prior to the modification discussed below, Class B Shares were accounted for as a profit-sharing arrangement. Expense on the Class B Shares was recorded in the period in which distributions from Halkos to Class B Share award holders were determined to be probable. We accounted for these distributions as non-cash compensation expense with a corresponding increase in additional paid-in capital. As a result of the modifications discussed below, we will not recognize non-cash compensation expense in connection with distributions related to future distributions on the Class B Shares. In June 2013, Halkos modified the Halkos LLC Agreement to eliminate its right to acquire all or a portion of the Class B Shares. This modification to the Halkos LLC Agreement triggered the recognition by us of additional non-cash compensation expense reflecting the fair value of vested Class B Shares as of the date of modification of the Halkos LLC Agreement. The observable market price of Holdings' publicly traded common stock was used to determine the fair value of the Class B Shares. In June 2013, we recognized $20.4 million of incremental non-cash compensation as a result of the modification and no additional expense will be incurred by the Company in any future period. Recently Issued and Recently Adopted Accounting PronouncementsFor information on recently issued and recently adopted accounting pronouncements, see note 2 to our consolidated financial statements, which is included elsewhere in this report. Inflation and Seasonality We experience effects of inflation on input costs, such as wages, natural gas, electricity, plating and other key inputs. We may not be able to offset fully the impact of inflation on these input costs or energy costs through price increases, productivity improvements or cost reduction programs. There is a slight decrease in our net sales in each fourth quarter as a result of a decrease in demand due to customer shutdowns for the holidays and holiday and year-end maintenance of plants and inventory by customers. We also typically experience slight working capital increases in the first quarter. 94-------------------------------------------------------------------------------- Table of Contents |