Olympic Steel Inc (ZEUS) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

And welcome to the Olympic Steel Inc. fourth-quarter 2004 earnings results conference call.

At this time, all participants are in a listen-only mode.

Following today's presentation, instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS).

I would now like to turn the conference over to Michael Siegal, Chief Executive Officer.

Please go ahead, sir.

Good morning.

And welcome to our call.

On the call with me this morning are David Wolfort, our President and Chief Operating Officer, and Rick Marabito, our Chief Financial Officer.

First, I went to thank all of you for your participation and for your interest in Olympic Steel.

Before we begin, let me remind you that forward-looking statements in this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Please refer to Olympic Steel's SEC filings for further information.

2004 was an outstanding year for Olympic Steel, as we reported record ton sold and net sales, record earnings, record returns on invested capital and our best ever accounts receivable and inventory turnover.

For the year, our sales increased 89 percent to 894 million.

And net income totaled $60.1 million or $5.88 per diluted share.

Fourth-quarter sales grew 87 percent from last year's fourth quarter to $240 million.

The net income totaled $12.2 million or $1.17 per diluted share.

As indicated in our release, we increased our bad debt reserve in the fourth quarter for a specific customer, Tower Automotive's bankruptcy filing, in February 2005, which impacted our fourth-quarter results by a negative $0.03 per share.

Our sales to end-use customers remain strong in the fourth quarter.

But service center and spot market sales were impacted by an inventory buildup in the service center sector.

The industry's inventory position increased from 3.2 months on hand to 4.2 months during the fourth quarter, according to the Metal Service Center Institute.

We anticipate this overhang will diminish during the first quarter of 2005.

Our 2004 total processing sales were impacted by the elimination from the marketplace of the Straight Line Steel Division of U.S.

Steel, a major customer of ours.

Aside from Straight Line, our total processing business grew by about 17 percent in 2004.

As I mentioned earlier, we're very pleased with the results of our focused efforts on accelerating asset turnover and managing debt last year.

Strong steel demand coupled with rapidly rising steel prices in 2004 created a tremendous increase in working capital for steel service centers -- a tremendous need.

In this environment, we ended the year with $96 million of debt, about $2 million less than where we started that year.

At the same time, our working capital needs grew by $78 million.

We accomplished this by reducing our accounts receivable days outstanding by 6 days and inventory ship days on hand by 7 days in 2004.

Overall, we reduced our cash cycle by 20 percent.

Our strengthened balance sheet is also evident in the 38-percent improvement in our debt-to-equity ratio and the 51-percent increase in our book value per share to $17.58, as our shareholders' equity increased from 112.2 million to 176.5 million during 2004.

We believe we are in a position to report full compliance with Section 404 of Sarbanes-Oxley by the March 15th deadline.

The daily execution and hard work of our employees allowed us to achieve all of this in 2004.

We remain optimistic about the steel market in 2005, as end-use demand remained strong in the expectation of a return of a strong spot market during the first half still existing.

I will now turn over the conference call to Rick Marabito to comment on some financial details.

Rick?

Thanks and good morning.

I'd like to expand on a few financial items.

Our fourth-quarter gross margins increased to 22 percent versus 21 percent last year.

Margins declined from the third quarter of '04 due to the service center inventory position that Michael referenced earlier.

Our EBITDA totaled $111.5 million or 12.5 percent of sales in 2004.

Our operating expenses in '04 increased to $139.6 million.

However, as a percentage of sales, our expenses decreased to 15.6 percent from 21.1 percent in the prior year. 2004 expense increases were all variable and increased in relation to the significant increases in our sales and profits.

We did not add any significant fixed costs or employees to our expense base in 2004.

Our 2004 return on invested capital approximated 25 percent.

And our capital spending in 2004 was only about $2 million, while depreciation for the year totaled $8.2 million.

We did add four laser processing lines during the prior year and expect to install two new laser machines in our Cleveland operation during the next 2 months and another two laser lines in our Central Region later this summer.

Now, I will turn the call over to David.

Thanks, Rick.

Before I review market conditions and comment on supply and demand, I'd like to highlight some of the operational accomplishments of Olympic Steel in 2004 that do not readily show up in our financial statements.

First of all, we sold 14.7 percent more steel in 2004 without significantly increasing our investments in property, plant and equipment, nor headcount during the year.

We completed a full review and upgrade of all physical properties in 2004.

We now have ISO quality certifications at all of our locations including our corporate offices with the exception of one facility, which is scheduled for its ISO audit next month.

In addition, our automotive operations began the process of gaining TS-1900 649 (ph) quality certification in 2004.

One of our auto operations became TS certified in 2004, and another is scheduled for its TS audit in April of 2005.

Now, let me turn to the market and make some bullet points here.

On the supply side, although there are many different opinions and predictions in the market today, the domestic supply environment continues to be one of discipline from the steel manufacturers and strength from the large-end users of steel in the United States -- our customers.

Other than scrap, raw material costs, such as iron ore and coke, continue to be on the rise and are expected to remain at high levels throughout 2005.

Energy and transportation costs remain elevated as well.

And European prices for steel are rising.

And a weak U.S. dollar may constrain steel imports, as 2005 navigation season opened shortly.

On the demand front, we see continued strong demand for steel.

The North American steel consumption outlook continues to be favorable.

And predictions for China's growth are robust.

The industrial sectors, such as rail car, farm equipment, construction and material handling equipment and energy generation are all anticipated to remain strong through 2005.

And we participate in all of these sectors.

In conclusion, Olympic is well-positioned to grow and meet our customers' anticipated needs for more steel and more value-added processing, as Rick commented on.

We are confident in our ability to meet their needs in 2005 from an equipment capacity, an inventory position, and a customer service perspective.

As many have already said, we too believe that 2005 will be another outstanding year for the steel industry and quite possibly the second-best year ever.

With that, we conclude our statements and will now open this up to your questions.

Thank you.

(OPERATOR INSTRUCTIONS).

Mark Parr.

It is Mark from Key Bank Capital Markets.

First of all, I just want to congratulate you on a great result.

And I guess what I would like to try to have a discussion on would be -- how you see margin trends emerging.

There was a fairly significant decline in the margin in the fourth quarter that was expected, given what was going on with pricing in the market.

And I guess the question would be -- are you seeing further conditions that would result in further erosion in the margin?

Is the margin stabilizing in here?

Can you talk a little bit about that, please?

Well, there are two factors to that Mark.

Number one is the service center market.

And the service center market for us operates between 10 and 15 percent of our overall mix.

Obviously, when the service center market is robust, we get very high gross margins from the service centers because we charge our competitors a lot of money for the opportunity to take our inventories to market.

So when that market starts to lag because of the inventory build-ups, obviously there is some erosion in terms of the percentage of gross margin.

Secondarily, obviously, you have the law of large numbers.

When you have steel selling in the $700-a-ton range, it's harder to make 25 percent than when you are selling at the $400 range.

So we are much more concerned about the net gross margin per dollar as opposed to percentage.

And while we do anticipate a little bit of squeezing on that margin for the factors indicated that there's inventory overhang in the first quarter from the service centers, our competitors.

And we lose that very robustness of the market when it is strong.

We would anticipate some margin erosion but not significantly from where we are at.

Okay.

All right.

Also, could you just carry the conversation on of what would be your best guess as far as tonnage numbers for the first quarter?

I have not got a clue.

We obviously think that the end-use -- just as we indicated, Mark, the end-use market is robust.

That continues to be very encouraging through literally all of our sectors.

And it's a question of when the service center overhang is eliminated that we would see the return to that.

But we have no idea -- at this point, we care not to forecast on the tonnage.

Okay, but if you just let me just make a few comments.

It sounds like your service center business will be weak in the first quarter on a year-over-year basis.

Your end-use market will be strong on a year-over-year basis.

Yes, that is correct.

So, is the net effect of that being -- would your best guess be -- would be up a touch or down a touch compared to last year based on what you're seeing right now?

Mark, that is why we appreciate your forecast.

We have no idea.

We like internally to have a direction towards growth.

And we hope -- we are pretty confident during the course of the year we will achieve that.

Okay, one last question and then I will pass it off.

Could you talk a little bit about your operating cost categories and where you see any particular cost pressure headed into '05?

Probably just transportation.

Yes, I would say, Mark, it is Rick.

I would say Michael is right.

The transportation, which is our distribution line on our income statement -- just due to as we talked about transportation cost increases as well as that really being tied into the volume.

The depreciation should be relatively consistent.

I talked about only having about $2 million of CapEx in '04.

So that should remain pretty flat.

The selling expenses, as you know, those are pretty much variable and go up and down in terms of the sales dollars.

So, we are not looking at it, as David indicated.

We are in a good position in terms of our cost base, where we are not in need of adding some fixed costs as we move forward.

Evan Steen.

Hey, there guys.

Congratulations as well.

Just a more technical question -- the equity income was up quite a bit in Q4 versus Q3 and also year-over-year.

I was just curious why.

That is the -- you're talking about the joint venture line?

Yes.

Basically, I do not know if you know, we have two joint ventures.

No, I do.

I rhyme (ph).

Both had obviously very good fourth quarters.

Our GS&P joint venture had a strong year all year, but there's really nothing specific in terms of those numbers.

Okay.

It is just surprising because I did not if there were some true-ups or something in Q4.

Because normally, Q4 would seasonally be lower.

No, there weren't any true-ups or anything like that.

Okay.

The $0.03 charge because your expenses look outstanding -- I'm just curious where it is.

If by my calculation was -- I do not know somewhere between 400, 600,000 pretax.

I just can't find it.

It would be embedded in the selling costs.

That is where our bad debt expense resides.

Okay, last question has to do with consolidation in the service center industry.

Obviously, big consolidation in the mills -- heard rumblings about potential consolidation in the service sector, which would make logical sense.

I'm curious -- your viewpoints, thoughts on that?

Again, we have to keep pace on a global market.

There is no question that our supply base is consolidating.

There is no question that our large customer base is consolidating.

It would be not likely that the guy in the power equation, which is the middle guy in supply chain management can remain fragmented when everybody else is getting disciplined.

So we would anticipate an acceleration of consolidation in our sector in the next 18 months.

Okay, fair enough.

Thanks very much, and congratulations again.

(OPERATOR INSTRUCTIONS).

Aldo Mazzaferro.

Hi Michael, it is Aldo from Goldman Sachs.

Mike, how close do you think your operating margins in the fourth quarter were to what you might call normalized?

Well, I do not know that there is anything that is normal anymore, Aldo.

I think what is interesting in terms of the margins is the fact that you know again, we've been able to maintain them within our historical gross margin spreads.

I think what has really been -- just answering a different question because nobody has asked it -- I just think the remarkable aspect of controlling expenses and not increasing our debt is a remarkable below-the-line scenario.

But clearly, Olympic Steel does sell significant steel and impactive gross margin to the service center sector.

So, without that coming back and basically eliminating in the fourth quarter and not coming back so far this year, it will have some impact on the gross margin.

Yes, if I knew nothing else about the industry, and I looked at just trends in pricing, it looks like you have kind of seen the end of the inflation boost to your margins.

Although, maybe there is a little left over in that fourth quarter.

I'm just wondering --

Again, we like to look at gross margin per ton as opposed to percentages because again you get caught up in the rule of large numbers.

Aldo, Dave Wolfort here, let me take a stab -- a little bit of a stab.

Aldo, there is a lot more discipline, I think, as you well know in the marketplace today.

And that discipline translates to higher revenue per ton.

The elimination of the weak producers through the course of 2001 through 2003 has given great support from the current producers -- U.S., Nucor, ISG, so forth.

There is much more balanced.

I don't think you can look back at past marketplaces and consider them the norm.

Those were depressed marketplaces that exhibited extension of credit where credit wasn't -- where credit was not due -- and again, depressed marketplaces.

We see much more discipline today, not only from the suppliers but from our contemporaries.

And that has elevated the margins, and we expect those to stay strong.

We hope that answers the question to some degree.

Well, I think that is very helpful.

And are you seeing anything new on the import front these days in terms of offerings?

I'm still thinking they are going to drop in the first quarter.

I am wondering how -- I heard you comment -- it sounded like you're still on that page.

I'm just wondering what you're seeing --

There are offerings, but they're high-priced.

There is certainly steel out there.

But there is nothing substantially going to change the marketplace other than just pure numbers in terms of volume.

Dave, do you want to comment?

You know, Aldo, we see a reluctance to buy foreign product.

First of all, because of the vagaries, as you well know, of all products coming in and the potential volatility of the marketplace.

But more importantly, freight costs obviously are up.

Insurance is up.

And the dollar is down.

And this is a less attractive marketplace to bring product to.

So the offerings on the whole, on flat roll and plate have been significantly diminished.

Right.

And then finally, Rick, would you mind talking a little bit about the investment capital required for a laser machine and what kind of returns are out there?

Sure.

A piece of laser equipment costs between 750 and $1 million.

And Aldo, we lease that equipment.

So the four I talked about last year and the four we will do in '05 would not be in that CapEx number.

In terms of relative returns, laser equipment gets much higher returns than the other type of service center processing.

Tom Crawley.

Tom with Smith Barney.

First of all, I want to congratulate you guys on a great year again -- terrific job.

Number one, you talked a little bit about the expenses for the year and the cost controls.

But the administrative and general line -- you seem to grow fairly dramatically.

I'm just curious what that was all about.

I think you mentioned on one of the previous calls that it was profit-sharing or something.

But there is a $44.8 million number versus last year's 22.9 million?

I will let Rick comment.

It is mostly employee compensation.

Yes, it is almost all employee compensation, Tom.

So it is 401(k), profit share, incentives, bonus plans.

And the profit share, the bonuses and the incentives are all performance-based.

So, in other words it is --

Yes, if the performance is there, that number goes up.

Obviously, in the prior years, when the performance wasn't there, those amounts weren't included in the numbers.

So you should have some pretty happy employees.

Yes.

We would hope so.

Number two -- with things obviously trend lower, those costs are going to go back down.

Correct.

You have a little bit of a -- a little help there perhaps in case things do get weaker.

The next question is -- when do we get the debt paydown?

I mean obviously, debt levels around the same as it was a year ago.

And we all know why that is -- because of the higher prices in the inventory financing and so forth.

When do you see -- I know you tried to do an offering though, and you decided to cancel that.

And it looks like that was a very good decision at this point.

Do you see doing another secondary at some point this year?

Or what is the outlook for the debt paydown?

Not that I am concerned about it because it is in much better balance with the equity component on the balance sheet.

And I guess the third -- I think the comment I want to make is that I think a lot of people are really concerned about gross margins.

But I think as you mentioned, the more thing you want to focus on is the dollar amount per ton.

And with pricing so strong, I think people should understand that even with a decline in margins, the amount of money that you can make can still be quite substantial compared to any years in the past.

Okay, what were the questions again?

No, sorry.

Go ahead, Rick.

Why don't you --

Debt paydown, let's talk about that one first.

Obviously, we talked about it.

And we think that one of the things that differentiates us is as you walk through 2004, we did have some marginal debt decrease while, as we talked about, our working capital needs grew by 78 million.

So, point number one is that I think we do an outstanding job in terms of managing our debt in relation to the market and the working capital.

Now, to specifically talk about debt paydown -- as we're looking at a more level pricing environment, let's call it, in 2005, you will see the debt come down significantly as we work our way through the year.

And much like where you had a $78 million increase in working capital and decrease the debt by 2 million -- if you kind of use that type of math.

If your working capital needs are staying relatively constant, you can see what type of potential debt paydown ability there is from Olympic Steel.

So I would say as we look out to '05, we definitely are anticipating debt paydown as we go through and move towards the end of the year.

In terms of the secondary offering, again, it looks -- at least our analysis of having made the attempt was that the market is much more receptive to equity capital when in fact there is some kind of sentinel event, an acquisition of some nature or some very important event to pay down debt of a real growth scenario.

So we would not anticipate going back to the market unless there was a need to pay down some debt of some sentinel event.

Deborah Fine (ph).

Deborah Fine, Fine (ph) Capital.

Good morning and congratulations on the strong results.

Could you comment a little bit -- just following-up on your last comments regarding M&A on where you're seeing valuations in the market for some of the private companies that are right to be consolidated?

And if you could also just comment on a more micro-basis of where you're seeing demand strength or weakness over the last couple of months.

Okay, let us deal with the second one first.

David indicated in his comments about the marketplace in terms of rail car, farm equipment, construction, material handling, energy regeneration.

Obviously, Big Three Automotive is the one that probably has the greatest concern for everybody in the marketplace, both from a volume standpoint and a credit standpoint.

Well, that is probably your high-risk sector.

Pretty much all the others steel sectors seem to be on the rise.

Overall, other than Big Three, as opposed to transplants, automotive is still anticipating an overall good year.

But Big Three is the sector that we are most concerned about.

In terms of valuations, obviously you have seen some of the deals that were done.

Again, Deborah, I would tell you it takes a willing buyer and a willing seller.

And there is certainly no shortage of investment bankers circling around our industry at the present time.

I would tell you that we have probably seen the high watermark of acquisitions in the Ryerson and Integris from a sales' standpoint.

That's sort of the benchmark on the high end.

And then, on the low-end, it has got to be something that people are willing to sell for.

So I don't anticipate that you are going to find anything below 3.5 times an EBITDA number.

But so, somewhere between that 3.5 and 7.5 times, depending on what the synergies could be and what a willing buyer and seller are willing to pay.

And what acquisition targets do you have to make sense for you to acquire somebody?

Well, targets would be somebody that has location opportunities for us for growth.

Obviously, you don't want to buy somebody that is in the same venue that you are per se as the hot button.

So anything that adds geographic penetration.

Something that may have some global penetration associated with it -- maybe a bigger presence in importing than we do.

So again, we would like to stick basically in the steel sector, and we would like to stick on flat-rolls.

But in terms of valuation criteria?

I would prefer not to comment at this point.

Well, would you be willing to do a dilutive acquisition or do they have to big accretive from day 1?

Well, everybody does -- the problem, Deborah, as you know, is I do not know that there is a CEO in the world that would ever say he is going to do a dilutive deal.

Yes, there are CEO's that say that.

Well, this is not one of them, okay?

We would not expect to do a dilutive deal.

Patrick Anderson.

Hi, it's Patrick from LCG.

My first question was regarding plates -- what you guys are seeing in the market.

Are you still in allocation -- just some general thoughts on that?

Pat, Dave Wolfort.

Our plate market remains pretty strong.

Our supply -- we believe we are a preferred channel.

And our supplied, primarily domestically and have -- both on a spot market basis and a contractual basis, Pat, we really have had no problems on the supply side.

We get a tremendous amount of support.

We have gotten growth characteristics through '04, and we expect those good characteristics to continue on plate through '05.

The edition of laser burning equipment to enhance our participation going downstream just complements our effort in that field.

Our OEM's, which we define as high-tech, highly engineered products, are demanding more of that product from us and filling up our facilities with their demands.

So we look for very strong demands on plate in '05, continuing the '04 trend.

Is that about 15, 20 percent of your tonnage?

Plate?

A little north -- a little north of that.

I was also just curious on sort of -- as you come into '05, you are negotiating contracts -- sort of the business that is not on the service center or the spot market -- are customers signing into longer-term contracts?

And how -- you are talking to the mills being disciplined -- you know, how -- are you working more closely with the mills now?

I sort of heard some of that discussion from other service centers.

Or has that relationship changed?

Well, Pat, I think there is more discipline, as we commented earlier.

We are working closely with our suppliers, and our suppliers are extremely supportive.

That we would not have been able to grow at the rate we grew last year without being able to access product.

So we have had the support both on the sheet and the plate side, primarily domestic.

And we have enjoyed that channelization and that discipline.

As far as contracts go, it really is left to the interpretation of the customer.

And we have broad range.

We have customers who prefer a year's worth.

We have others that prefer a quarter's worth.

So it's a real mixed bag in terms of the commitments.

But the support is there.

The general theme of using Olympic Steel in its facilities as a channel for the product and the franchise are very strong.

Okay, when you look at the contracts that you are signing, is there a targeted gross profit per ton that you're looking for in '05?

And then, how successful have you been in negotiating the other side with the mills to sort of lock in that gross profit?

Well, I think that is difficult to answer.

But we have a -- it is mutually beneficial for the mills and for us to have a designated channel.

The mill to us -- to the customer and the retention of that business.

One of the things, Pat, that we really pride ourselves on on the sales and marketing end of it is first and foremost is the recognition of the account and then the retention of that account.

We also have strategic alliances.

We designate the term "strategic alliance" with our supply base.

They are fully cognizant of the growth potential at that customer.

The gross profit, however -- gross profit is proprietary to Olympic Steel.

And obviously, we are trying to provide business solutions for both ends of the spectrum, our customers and our suppliers.

Sure.

Well, thank you very much and congrats.

Mark Parr.

Dave, Michael, the realized dollar per ton was up about $40 sequentially.

Okay.

Could you talk about that and help us reconcile it in the context of the weakening flat-rolled steel environment?

I'm not sure.

Again, Mark, two things -- obviously a rising tide helps the market under previously bought inventory.

Concurrently, we don't see a real big degradation in pricing from the mills.

So we might see some flattening of our gross margin dollars over time.

But you know, part of what -- our strategy, Mark, is to continue investing in high value-added equipment, so we can maintain and even accelerate our gross margin dollars.

So, I'm not exactly sure what you are asking.

I apologize.

Again, I know you have a mix between toll processing and direct sales too.

So again --

You know, Mark, additional to that, let me just comment that the broad variety of grades of steel that were manufactured 3, 4 years ago by a variety of people don't exist anymore.

So we have a narrowing of the supply base on the higher value-added products, which means that you really have to have scale in order to buy those.

So when we talk about value-added processes, we also are very focused on value -- high-valued steels.

Those high-valued steels carry a much more consistent transaction price because of the elimination of some suppliers and the concentration of where it will be manufactured.

So the elevated -- we would expect that the elevated transaction numbers -- we would be able to retain those over a much longer haul.

Okay, so in the third quarter you were about $755 a ton -- fourth quarter, 795.

So that $40 -- I mean would that reflect -- did you have some success with shifting the mix toward higher valued products in the fourth quarter?

We continually are shifting to our higher valued products and higher graded products.

And again, don't forget that also embeds what we do as toll processing, Mark, which is relatively consistent in terms of the pricing that you charge for.

So from that standpoint, if you have a lower mix of higher direct sales and lower processing, which in fact was the case -- that will also be the case.

Aldo Mazzaferro.

Hey, Michael, just a quick question.

You know very quietly over the next month, you are going to see one of the largest merges ever in the steel industry in North America.

And I'm wondering if you see that as impacting the market at all in terms of disciplined or in terms of the way service centers fit into the market?

I don't know that it changes service centers.

I think anything from our perspective as Olympic Steel, Aldo -- anytime you bring more discipline and more professionalism into this market, it bodes well for Olympic Steel.

So from the standpoint in terms of Mr. Middle, who is a committed steel producer, as opposed to Mr. Ross, who was a financer -- and I'm not trying to demean him at all, but clearly he bought it to sell it.

The fact that the sale goes to not another financial buyer but to a disciplined, global steel player, I think, will add to discipline and professionalism.

And therefore, I think that the overall market will benefit from that merger including ourselves.

Is that it, Mary?

That is it.

We do not have any more audio questions.

All right.

Well again, we want to thank you all for your participation on this call.

And again, we will speak to you in another 90 days or so.

Thank you very much.

Ladies and gentlemen, this concludes today's teleconference.

You may now disconnect.