ERS Empire Resources, Inc.

You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our 10-K filed with the Securities and Exchange Commission on March 25, 2013. All numbers used in this discussion are in thousands, except for per share information.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements,” which include information relating to future events, future financial performance, strategies, expectations, competitive environment and regulation. Words such as “may,” “should,” “could,” “would,” “predict,” “potential,” “continue,” “expect,” “anticipate,” “future,” “intend,” “plan,” “believe,” “estimate,” and similar expressions, as well as statements in future tense, identify forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results and may not be accurate indications of when such performance or results will be achieved. Forward-looking statements are based on information we have when those statements are made or our management’s good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to:

For a discussion of these and other risks that relate to our business and investing in shares of our common stock, you should carefully review the risk factors and other cautionary statements in our Annual Report on Form 10-K for the year ended December 31, 2012 that was filed with the Securities and Exchange Commission on March 25, 2013, and those described from time to time in our other reports filed with the Securities and Exchange Commission. The forward-looking statements contained in this Quarterly Report on Form 10-Q are expressly qualified in their entirety by this cautionary statement. We do not undertake any obligation to publicly update any forward-looking statement to reflect events or circumstances after the date on which any such statement is made or to reflect the occurrence of unanticipated events.

Our Business

We are engaged in the purchase, sale and distribution of semi-finished aluminum and steel products to a diverse customer base located in the Americas, Europe, Australia and New Zealand. We sell our products through our own marketing and sales personnel as well as through commission based independent sales agents located in North America and Europe. We purchase products from suppliers located throughout the world. Our two largest suppliers furnished approximately 56% of our products during the first six months of 2013 as compared to 63% of our products during the same period in 2012. While we generally place orders with our suppliers based upon orders that we receive from our customers, we also purchase material for our own stock, which we typically use for shorter term deliveries to our customers.

Critical Accounting Policies and Estimates

The following discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. The preparation of financial statements in accordance with generally accepted accounting principles in the U.S. requires us to make estimates and assumptions that affect the amounts reported in our financial statements. The financial statements include estimates based on currently available information and our judgment as to the outcome of future conditions and circumstances. Significant estimates in these financial statements include allowance for doubtful accounts and the derivative liability for the embedded conversion option. Changes in the status of certain facts or circumstances could result in material changes to the estimates used in the preparation of the financial statements and actual results could differ from the estimates and assumptions.

Among the significant judgments made by management in the preparation of our financial statements are the following:

Allowance for Doubtful Accounts

As of June 30, 2013, we had $58,408 in trade receivables, after an allowance for doubtful accounts of $517. We report accounts receivable, net of an allowance for doubtful accounts, to represent our estimate of the amount that ultimately will be realized in cash. We review the adequacy of our allowance for doubtful accounts on an ongoing basis, using historical collection trends, aging of receivables, as well as review of specific accounts, and make adjustments in the allowance as we believe necessary. We maintain a credit insurance policy on the majority of our customers. In general, this policy has a 10% deductible; however there are some instances where the co-insurance may vary and instances where we may exceed the insured values. Changes in economic conditions could have an impact on the collection of existing receivable balances or future allowance considerations. In addition, changes in the credit insurance environment could affect the availability of credit insurance and our ability to secure it.

Accruals for Inventory Claims

Generally, our exposure on claims for defective material is relatively small, as we usually refer all claims on defects back to our suppliers. If we do not believe that a supplier will honor a material claim for a defective product, we will record an allowance for inventory adjustments.

Results of Operations

General

We are engaged in the purchase, sale and distribution of semi-finished aluminum and steel products which we purchase from producing mills around the world.  The market prices of materials we purchase, as well as the market price of materials we sell, fluctuate constantly in world markets.  Our cost of sales is composed of metal content, which is determined on world metal exchanges, plus a unique fabrication premium charged by each producer to convert the raw metal to a semi-finished product.  In turn, we typically sell to our customers based on metal content plus a premium which includes supplier fabrication margin, and costs of importation, warehousing, and delivery of material to customers.  Since metal content costs are the largest component of cost of sales and selling price, our sales pricing trends and cost of sales trends generally track consistently.

Comparison of Three Months Ended June 30, 2013 and 2012

During the three months ended June 30, 2013, net sales decreased by $35,224, from $145,692 to $110,468 or 24% from the same period in 2012.  This decrease was due to lower metal pricing as well as lower unit volume shipments in North and South America during the period ending June 30 2013 as compared to the same period in 2012.

Gross profit decreased by $1,154, to $5,267 during the three months ended June 30, 2013 from $6,421 in the same period of 2012, representing an 18% decrease. The dollar decline is attributable to lower sales volume, even as our gross profit percentage improved from the three month period of 2012 as compared to the same period in 2013, from 4.4% to 4.8%. The improvement in the percentage gross profit is attributed to lower storage costs as a result of reduced inventory levels. Additionally, rebalancing the products held in inventory allowed us to reduce processing costs.

Selling, general and administrative expenses increased 5.9% or $194, from $3,307 during the first three months ended June 30, 2012, to $3,501 in the same period 2013. Increased payroll and banking costs were partially offset by decreases in professional fees during the quarter.

As a result of reduced sales revenue operating income decreased by $1,348 during the three months ended June 30, 2013 from $3,114 to $1,766, or a decrease of 43%.

During the three months ended June 30, 2013, interest expense decreased 19.7% or $279, to $1,134 from $1,413 for the same period in 2012.  As we rationalized our inventories bank debt declined, resulting in reduced interest expense. During the three months ended June 30, 2013 and 2012, interest on our 10% Convertible Senior Subordinated Notes Due June 1, 2016 and amortization of the debt discount in connection with these notes totaled $441 in both periods.

Our 10% Convertible Senior Subordinated Notes Due June 1, 2016 has an embedded conversion option which has been bifurcated and recorded as a separate derivative liability at a fair value at issuance of the notes. The derivative liability is carried at fair value with changes in mark to market recorded in income. The changes in the fair value of the derivative liability resulted in a non-cash non-operating loss of $44 during the period ended June 30, 2013, as compared to a $195 non-cash non-operating gain during the same period in 2012.

Net income decreased from $1,168 during the three months ended June 30, 2012 to $367 during the three months ended June 30, 2013, which was attributable to the decline in sales.

Comparison of Six Months Ended June 30, 2013 and 2012

During the six months ended June 30, 2013, net sales decreased by $47,403, from $291,301 to $243,898 or 16% from the same period in 2012.  This decrease was due to lower metal pricing as well as lower unit volume shipments in North America during the period ending June 30 2013 as compared to the same period in 2012.

Gross profit decreased by $878, to $11,897 during the six months ended June 30, 2013 from $12,775 in the same period of 2012, representing a 6.9% decrease. The dollar decline is attributable to lower sales volume, even as our gross profit percentage improved from the six month period of 2012 as compared to the same period in 2013, from 4.4% to 4.9%. The improvement in the percentage gross profit is attributed in part to lower storage costs as a result of lower inventory levels as well as reduced processing costs achieved by rebalancing the products held in inventory.

Selling, general and administrative expenses during the six months ended June 30, 2013 and 2012 were flat.

As a result of reduced sales revenue operating income decreased by $878 during the six months ended June 30, 2013 from $6,016 to $5,138 during the six months ended June 30, 2012, or a decrease of 14.6%.

During the six months ended June 30, 2013, interest expense decreased by $494, to $2,247 from $2,741 for the same period in 2012.  As we rationalized our inventories bank debt declined, resulting in reduced interest expense. During the six months ended June 30, 2013 and 2012, interest on our 10% Convertible Senior Subordinated Notes Due June 1, 2016 and amortization of the debt discount in connection with these notes totaled $883 in both periods.

Our 10% Convertible Senior Subordinated Notes Due June 1, 2016 has an embedded conversion option which has been bifurcated and recorded as a separate derivative liability at a fair value at issuance of the notes. The derivative liability is carried at fair value with changes in mark to market recorded in income. The mark to market of the derivative liability resulted in non-operating, non-cash losses driven primarily by a steep increase in the Company’s stock price. The changes in the fair value of the derivative liability resulted in a non-cash non-operating loss of $2,167, during the period ended June 30, 2013, as compared to a $49 non-cash non-operating gain during the same period in 2012.

Net income decreased from $1,999 during the six months ended June 30, 2012 to $452 during the six months ended June 30, 2013, which was attributable to the decline in sales as well as the $2,167 non-operating non-cash charge for the change in derivative liability on our convertible senior subordinated debt.

  Liquidity and Capital Resources

Overview

At June 30, 2013, we had cash of $2,212, accounts receivable of $58,408, total senior secured debt of $109,000 and subordinated debt of $12,000.  Management believes that cash from operations, together with funds available under our credit facility will be sufficient to fund the cash requirements relating to our existing operations for the next twelve months. However, we will require additional debt or equity financing in connection with the future expansion of our operations.

Comparison of Periods Ended June 30, 2013 and 2012

Net cash provided by operating activities was $7,899 during the period ended June 30, 2013, as compared to $3,996 during the same period in 2012. During 2013, we continued our focus on decreasing inventory and improving inventory turns, which led to positive operating cash flows. Cash provided by operating activities during the six months ended June 30, 2013 was primarily due to decreased inventory offset by decreases in trade accounts payable and increases in accounts receivable.

We focus on our days’ sales outstanding and our inventory turnover rate to manage working capital, because accounts receivable and inventory are the two most significant elements of our working capital. During the first six months of 2013, our inventory turn rate was about 4.1 times (or 88 days on hand), compared to our June 2012 rate of about 3.7 times (or 97 days on hand). Our turns improved during the first six months of 2013, as we further reduced inventories during the period. The days payable remained stable at 24 days as of June 30, 2013 as compared to 25 days as of the same date last year. As of June 30, 2013, our days’ sales outstanding rate was approximately 43 days, as compared to 42 days as of June 30, 2012. This increase is attributable to expansion of sales in new markets which traditionally have longer payment cycles. During 2013, we intend to stay focused on decreasing inventory and improving inventory turns, which we believe will lead to continued positive operating cash flows.

Cash flows provided by investing activities during the six months ended June 30, 2013 amounted to $1,669, as compared to cash flows used in investing activities of $5,020 during the same period in 2012. Cash flows provided by investing activities during the six months ended June 30, 2013 reflects the monthly repayment by PT. Alumindo Light Metal Industry of the advance related to our supply agreement.

Cash flows used in financing activities during the six months ended June 30, 2013 amounted to $10,489, as compared to cash flows provided by financing activities of $924 during the same period in 2012.  We repaid $10,169 of our bank debt as our reduction of inventory continued to generate positive cash flow. In addition, we acquired 7 additional common shares at a cost of $21 during the period ended June 30, 2013.

As of June 30, 2013, our committed line of credit totaled $200,000. The agreement also allows additional increases in the line of credit of up to $50,000, subject to certain restrictions. Our direct borrowings amounted to $109,000 and letters of credit amounted to $59,111, leaving an availability of approximately $31,889 on our line of credit, or approximately 16%. All of the letters of credit will expire on or before October 31, 2013.

Our wholly owned Belgian subsidiary, Imbali Metals BVBA (“Imbali”), operates under a line of credit with ING Belgium S.A./N.V., with a EUR 8 million ($10,408) commitment for loans and documentary letters of credit. Direct borrowings under this line of credit amounted to EUR3, 730 ($4,853) leaving an availability of approximately EUR4,270, or approximately 53%.

Credit Agreements and Other Debt

On April 28, 2011 we entered into a working capital credit agreement with Rabobank International, for itself and as lead arranger and agent, JPMorgan Chase, for itself and as syndication agent, and ABN AMRO, BNP Paribas, RBS Citizens, Société Générale, and Brown Brothers Harriman. The $200,000 secured, asset-based credit facility matures on June 30, 2014 and refinanced our prior $175,000 credit agreement which would have matured on June 30, 2011. The agreement also allows additional increases in the line of credit of up to $50,000, subject to certain restrictions. Amounts borrowed bear interest of Eurodollar, money market or base rates, at our option, plus an applicable margin. Our borrowings under this line of credit are secured by substantially all of our assets. The credit agreement contains financial and other covenants including but not limited to, covenants requiring maintenance of minimum tangible net worth of $25,000 plus an aggregate amount equal to 25% of our positive net earnings and compliance with a leverage ratio of not more than 6.00 to 1, as well as an ownership minimum and limitations on other indebtedness, liens, and investments and dispositions of assets. The credit agreement provides that amounts under the facility may be borrowed and repaid, and re-borrowed, subject to a borrowing base test, until the maturity date of June 30, 2014.  As of June 30, 2013, we had direct borrowings of $109,000 outstanding under the credit agreement, bearing interest at 2.71% and we were in compliance with all financial covenants.

Our wholly owned Belgian subsidiary, Imbali, operates under a line of credit with ING Belgium S.A./N.V., with a EUR 8,000 commitment for loans and documentary letters of credit. Loan advances are limited to a percentage of Imbali’s pledged accounts receivables and inventory. This secured credit arrangement is unconditionally guaranteed by us. As of June 30, 2013, we had borrowings of EUR 3,730 ($4,853) under this line of credit, bearing interest at EURIBOR plus 1.75%, and we were in compliance with all financial covenants.

In addition, we are a party to a mortgage and an interest rate swap that we entered into in 2004 in connection with the purchase of our Baltimore warehouse. The mortgage loan, which had an outstanding balance of $1,377 at June 30, 2013, requires monthly payments of approximately $21.6, including interest at LIBOR plus 1.75%, and matures in December 2014. Under the related interest rate swap, which has been designated as a cash flow hedge and remains effective through the maturity of the mortgage loan, we will pay a monthly fixed interest rate of 6.37% to the counterparty bank on a notional principal equal to the outstanding principal balance of the mortgage. In return, the bank will pay us a floating rate, namely, LIBOR, to reset monthly, plus 1.75% on the same notional principal amount.

We have commitments in the form of letters of credit to some of our suppliers in the amount of $59,111 as of June 30, 2013.

On June 3, 2011, we issued $12,000 principal amount of 10% Convertible Senior Subordinated Notes Due June 1, 2016 in a private placement to selected accredited investors.  The notes are currently convertible at the option of the holders into shares of common stock at a conversion rate of 247.04 shares of common stock per $1 principal amount of notes, subject to adjustment for cash and stock dividends, stock splits and similar transactions, at any time before maturity.  The current conversion price reflects nine adjustments for dividends.  In addition, if the last reported sale price of the common stock for 30 consecutive trading days is equal to or greater than $7.00, and a registration statement is effective covering the resale of the shares of common stock issuable upon conversion of the notes, we have the right, in our sole discretion, to require the holders to convert all or part of their notes at the then applicable conversion rate.  Interest on the notes is payable in arrears on the first day of June and December every year the notes are outstanding.

Derivative Financial Instruments

Inherent in our business is the risk of matching the timing of our purchase and sales contracts. The prices of the aluminum products we buy and sell are based on a constantly moving terminal market price determined by the London Metal Exchange. Were we not to hedge such exposures, we could be exposed to significant losses due to the continually changing aluminum prices.

We use aluminum futures contracts to manage our exposure to this commodity price risk. It is generally our policy to hedge such risks to the extent practicable. We enter into hedges to limit our exposure to volatile price fluctuations that we believe would impact our gross margins on firm purchase and sales commitments. As an example, if we enter into fixed price contracts with our suppliers and variable priced sales contracts with our customers, we will generally enter into a futures contract to sell the aluminum for future delivery in the month when the aluminum is to be priced and delivered to the customer and repurchase this position once the pricing has been fixed with our customer.  If the underlying metal price increases, we suffer a hedging loss and have a derivative liability, but the sales price to the customer is based on a higher market price and offsets the loss. Conversely, if the metal price decreases, we have a hedging gain and recognize a derivative asset, but the sales price to the customer is based on the lower market price and offsets the gain.

We also enter into foreign exchange forward contracts to hedge our exposure related to commitments to purchase or sell metals denominated in some international currencies. In such cases, we will purchase or sell the foreign currency through a bank for an approximate date when we anticipate making a payment to a supplier or receiving payment from the foreign customer.

In accordance with generally accepted accounting principles in the U.S., we designate these derivative contracts as fair value hedges and recognize them on our balance sheet at fair value.  We also recognize offsetting changes in the fair value of the related firm purchase and sales commitment to which the hedge is attributable in earnings upon revenue recognition, which occurs at the time of delivery to our customers.

The potential for losses related to our hedging activities, given our hedging methodology, arises from counterparty defaults with banks for our foreign exchange hedging, the London Metal Exchange for our aluminum hedges, or customer defaults. In the event of a customer default, we might be forced to sell the material in the open market and absorb losses for metal or foreign exchange hedges that were applied to the defaulting customers’ transactions. Our results of operations could be materially impacted by any counterparty or customer default, as we might not be able to collect money owed to us and/or our hedge might effectively be cancelled.

We use futures and forward contracts as hedges, for no purpose other than to avoid exposure to changes in aluminum prices and foreign currency rates between when we buy a shipment of aluminum from a supplier and when we deliver it to a customer.  Our derivatives are not for purposes of trading in the futures market. We earn our gross profit margin through our business operations and not from the movement of aluminum prices.

As part of our business we also engage in the purchase, sale and distribution of steel products. If we do not have a matching sales contract related to such products, (for example, any steel products that are unsold in our inventory), we have price risk that we currently do not or are unable to hedge. As such, any decline in pricing for such products may adversely impact our profitability.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.