Olympic Steel Inc (ZEUS) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Olympic Steel, Inc. third quarter 2005 earnings results.

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.

If anyone should require operator assistance during the conference, please press the star key, followed by the zero.

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 is David Wolfort, our President and Chief Operating Officer, and Rick Marabito, our Chief Financial Officer.

First, I want to thank all of you for your participation and for your continued 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 provision of the Private Securities Litigation Reform Act of 1995.

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

As indicated in our earnings release this morning, the big news is Olympic Steel's debt reduction that occurred in the third quarter.

Our diligent focus on inventory and accounts receivable turnover and our profitability and expense control over the past two years has resulted in the elimination of $70 million of debt during the past three months and $83 million from the beginning of the year.

We finished the quarter with $13 million of total debt, which includes our outstanding payables, and shareholders' equity of $19.01 per share.

To recap our sales and earnings performance, third quarter sales totaled 208.4 million, and net income for the quarter totaled $2.2 million, or $0.21 per diluted share.

For the first nine months of 2005, net sales increased 12.3% to $734.4 million, and net income totaled $14.8 million, or $1.42 per diluted share.

Unsold (ph) in the third quarter and first nine months were down from the robust levels of 2004 by 5.5% and 6.5%, respectfully.

In addition, Rick will later provide details to support our continued focus on expense control.

During the third quarter, we saw consistent demand adjusted for the seasonality in manufacturing, as facilities traditionally shut for summer retooling and vacations.

We are encouraged by the MSCI's September reported low service center inventories, low import numbers as reported by the government, and the controlled outputs and deliveries we see from the domestic steel producers.

Under these conditions, announced carbon steel prices appear to be sustainable for the remainder of the year.

Presently, we have seen the return of normal increased demand that begins during the fourth quarter.

We expect margin expansion under these conditions, and we believe that our inventory will allow us to sufficiently meet the increased needs of our customers.

We continue our focus on delivering value-added services and supply solutions to our customers as we migrate toward more processing for sustained, embedded margin improvement and growth.

In that regard, we have added four new laser processing lines in 2005, have one on order, and are considering adding an additional six lasers in 2006.

Since the very end of June, we are very pleased that three additional firms - Goldman Sachs, Jefferies and Morningstar have initiated analyst coverage on Olympic Steel, along with key bank capital markets continued coverage.

And we want to thank all of them for their interest in Olympic Steel.

I will now turn it over to Rick to comment on some financial details.

Thanks, and good morning.

First, I just wanted to quickly clarify just one item we talked about earlier.

When Michael talked about our debt and it being 13 million outstanding, inclusive of outstanding payables, it's inclusive of outstanding checks.

Right.

I just wanted to make that clear.

It does not include accounts payable.

That's a separate line item.

I'll start off, as you may have noted, our income statement presentation has been modified to show cost of materials sold as a component of cost and expenses.

So I'll do the math for you and provide you with our gross margin figures.

First, for the third quarter, gross margin totaled 33.3 million or 16% of net sales, compared to 65.6 million, or 26.9% for the third quarter of 2004.

Second, for the nine months of 2005, our gross margin totaled 118.7 million, or 16.2% of sales, and that would be compared to 189.6 or 29% last year.

And as Michael stated, we believe that the pricing and margin declines for carbon flat roll products reached their low points during the third quarter.

Currently, our average cost of inventory is about $94 per ton lower than when it peaked in 2005.

So during that time, we have been able to maintain the discipline of consistently turning our inventory profitably.

Our EBITDA for the nine months of 2005 was $33.6 million, and we continue, as Michael said, to focus on our expense controls in 2005.

Our 2005 operating expenses, and that would be excluding the cost of materials sold, continues to be lower than in 2004.

Total operating expenses for the first nine months of 2005 were $16 million, or 15%, lower than in 2004.

Our effective tax rate for the third quarter and the nine months both was 38.5%.

Now, let's turn to the balance sheet.

Accounts receivable decreased by $12.5 million during the third quarter.

The decrease is due to the lower sales volume and the seasonally slower third quarter, as well as lower average selling prices.

However, our receivable DSOs remain very strong.

We decreased our inventory during the quarter by $40.6 million, or 28%.

We are currently turning our inventory more than six times per year, and we believe that our inventory is appropriately positioned for the upcoming market conditions in the fourth quarter.

Michael discussed our debt reductions in detail, so I will only add the fact that at the end of March, we had $120 million of debt, so we had a $107 million reduction in debt in the last two quarters.

Our capital spending for the first nine months totaled $1.7 million, but in addition to that we have entered into four leases for new laser lines so far this year in 2005, and as Michael had noted, we are evaluating additional laser investments for 2006. now I will turn the call over to David.

Thank you, Rick.

As Mike and Rick reported, we are pleased with our ability to have successfully navigated the past three quarters in the wake of large inventory adjustments.

Olympic has maintained consistent profitability while undertaking an aggressive, disciplined inventory and debt reduction plan during '05, as Rick had indicated.

The result is a company today that has a well positioned inventory that turns six times, significantly faster than the industry average.

Our ability to orderly reduce our inventory in tons and value is a testimony to our close working relationships with our key vendors.

Olympic's long-term collaborative relationship with the steel industry's consolidators has strengthened our ability to continually service our customers.

We've adjusted our inventory turns and we continue to synchronize large steel production with just-in-time performance.

Our customers continue to strengthen their demand schedule.

As Michael noted, we witnessed strong demand that begins the fourth quarter.

This strength became visible midway through Q3, and is signaling strong traction for the foreseeable future.

Our tempered metal business is robust, as we bring on additional downstream processing in response to customers' growing demands.

The state of our company is very strong, concluding Q3 with having shrunk borrowing to $13 million, as described by both Mike and Rick, we have the strongest capital structure in our 51-year history.

While our financial capital continues to grow, so does our relationship capital.

We are proud to be aligned with a supplier base that has become the world's steel consolidators.

The same global exposure that supports our supply side is enhancing our position with our large OEM customers who continue to grow our collective market share.

Let me summarize our inventory management plan.

In early 2005, we developed a disciplined five-month plan to reduce our inventory levels into July.

We in fact accomplished our inventory goals on schedule.

Then, in early Q3, we began the repositioning of our inventory in collaboration with our suppliers, so it is now in a position that allows us to perform well as we enter an improving fourth quarter marketplace.

This concludes our formal comments, and we will now open the call up to our questions.

Thank you. [Operator Instructions].

And our first question comes from Aldo Mazzaferro.

Please state your company name, followed by your question.

Hi, Michael and David and Rick.

Hi, how are you doing?

The comment on the inventories that you made just now, David, on repositioning in early third quarter, is that another way of saying that you were able to acquire inventory at the low prices and possibly that $40 million decline in the inventories was really more related to value and that the tons are more or less the same?

More or less, Aldo.

What we've done is that we saw a deep degradation in pricing, I think, as you well know, from really the end of January through the end of June, and we were able to reposition that inventory and liquidate it without any significant challenges to profitability.

The position that we refer to is in fact what you allude to, and that is that our inventory is well positioned today, both in growing in tons, and in fair, appropriate value to allow us to grow our profitability for the foreseeable future.

That's really something.

I guess my other question was really going to be whether these fast-rising prices you're seeing in the fourth quarter from the mills are going to hurt your gross margins, but I think you already answered it.

I think that the reference to our collaborative style with the consolidators, the mill consolidators, are allowing us a very long-term approach to supplying very large OEMs.

And then, Michael, I wonder if you could expand a little bit on your comment in the press release about consolidation, where you said you were positioning yourself for it.

Aldo, what we've said always, and historically you know that we have - even though it may be misperceived that Olympic is not a value-added processor, in fact, we've added significant equipment and brick and mortar through a variety of scenarios, both organically and historically through acquisitions, greenfield sites and joint ventures.

We clearly would expect to use our strength in the balance sheet to be acquisitive, add fair value at accretive basis, as we see lots of opportunities out there.

So you'd be looking for something that would raise your value-added mix, possibly.

Yes.

Thank you, Mike.

Thank you, Aldo.

Thank you.

Our next question comes from Mark Parr.

Please state your company name, followed by your question.

Good morning.

KeyBanc Capital Markets.

Good morning.

That who you are?

I guess, that's what we are this week.

Hey, Mark.

Good morning.

Congratulations on the quarter.

I was curious, Michael or Dave, it's clear by the balance sheet and by your commentary that you're well positioned to show some improvement in the fourth quarter relative to the third.

Is there any color you can give us as far as potential upswing in gross margin?

I'll let Michael comment.

I want to keep my job.

Help us out a little, Mike.

Better.

What we tried to indicate to you is we're seeing strong demand.

Maybe another way of asking the question would be, given the market dynamic you see, what is a normalized margin for your mix of business?

It depends, Mark, simply on the price of steel.

The same gross margin percentage at $400 a ton is a lot different than it is at $800 a ton, and historically you can pretty much gather from our numbers that we've looked at sort of this $100 a ton gross margin kind of number that's been there.

Right.

We obviously either fall below when the market is receding, or we certainly exceed it when the market is moving in the other direction.

So we're positive in the direction of the market.

Mark, let me just comment a little bit further that I think you well know - you have a great pulse on what's going on globally - but anybody's margin is going to be challenged when you have these huge swings in the transaction prices that the mills are garnering.

So, from the end of January through July, on hot roll alone, you probably saw a degradation of close to $200 a ton.

Right.

So recognize the fact that that's not going to help any normalization process.

So as that gets more normalized, which it is, our earnings will be more normalized.

And we managed to - as I said earlier, we as a company managed to navigate a very tough six months where you saw that sort of pricing degradation.

We don't believe that that's normal circumstances.

So once that's relieved, which it has been, our earnings stream will be normalized.

Yes, I'd just like to continue to comment on that real quick, Mark.

You go back to 2004, you saw a price increase from the beginning of the year at the end of the third quarter, end of 2003, at $200 a ton and peaking at $750 a ton.

So there's a $550 a ton increase in 2004, as David indicated, somewhere greater than $200 a ton in 2005.

What we're seeing is the plateau at the bottom is a much higher number than historical, and so we think that is part of the consolidation.

We think that is part of global demand for resources, and we think that we're going to see compression in terms of peak to trough, but the volatility needs to level itself off.

And then, Mark, it's Rick.

Just to maybe to add a little specifics to the question you asked.

And we did comment that we believe the compression reached the bottom in third quarter of the industry, and specifically let's just talk about us.

So you can kind of do the math, and the second quarter we were around $113 per ton.

Forget about the percentages, because they're very erratic, as Michael said, when you have different pricing scenarios.

But we were at about $113 for our second quarter, third quarter was at $109, and we would look to be higher than both of those numbers as we enter the fourth quarter.

Thanks, if I could ask just another question, just to provide some color around your commentary in your goal of being a consolidator, how much gunpowder or how much capital do you feel like you would have to go out to help consolidate the industry at this point?

As much as necessary to do accretive deals.

I don't think that given what's going on in the overall financial marketplace is there is any constraint on the upper limit.

Okay, terrific.

Thanks very much, guys.

Thank you.

Thank you.

Our next question comes from Bill Hyler.

Please state your company name, followed by your question.

Yes, thank you, good morning.

Bill Hyler from HM Capital.

I wanted to get a little deeper into the inventory numbers at September 30th.

Could you give us a little color on maybe the inventory in tonnage rather than dollars and how lean you are right now relative to normalized levels going forward?

We're not lean at all relative to normalized levels.

What we focus on is accelerated inventory turnover.

We believe we have sufficient inventory to not only cover customer needs but growth objectives that we have internally.

And in terms of giving you color on the tonnage, we have not done that in the past and really are not prepared to do that at present.

So you don't see a major need to rebuild inventory over the next three to six months, naturally if prices ...

Borrowing any unusual spike in demand, the answer would be no.

We like our disciplines on working capital turnover, both on inventory and receivables.

We try and benchmark ourselves against the industry and be a lot better than they are, and we continue to perform in that regard.

Okay.

Okay, thank you very much.

Thank you.

Ladies and gentlemen, if there are any additional questions, please press the star key, followed by the one at this time.

And just as a reminder, if you're on speakerphone, please lift your handset before pressing the numbers.

And our next question comes from Michelle Applebaum.

Please state your company name, followed by your question.

Hi, it's Michelle Applebaum from Michelle Applebaum Research.

I wanted to ask you, on your press release, you said that the company anticipates using our financial position to take advantage of the consolidating service center industry.

Does that necessarily mean you're a buyer only?

What else do you have in mind?

Well, there's possible mergers or combinations.

You've always said, always ...

We are responsible to our shareholders, and are open to anything that would create value for them.

So that hasn't changed.

That's what I was trying to get at.

Has not changed.

Okay, because - okay.

And then, within that framework, it's interesting.

Dave Hanna has said this now two quarters in a row on Reliance's calls that he's seen more activity by financial buyers than he's ever seen before.

Do you agree with that assessment?

Who's David Hanna?

Sorry, a competitor of yours.

There is clearly lots of capital available through hedge funds, investment houses, with very little places, it seems, to put into where they're investing.

So I would tell you that, yes, we're seeing lots of money coming off of investment houses and hedge funds.

And doesn't that - I mean, in prior cycles, you go back.

I've only done this 25 years.

You've done this longer.

But every few years we see the (inaudible) syndrome, where you have ...

We remember them.

Eighty-three, I think.

You see the financial buyers coming in, and historically how has their valuation looked versus your own?

And then within that context, will it become more difficult for you to do accretive acquisitions because of that?

The answer to the second part is no.

I think, again, the marketplace in an Internet world is everybody is aware of almost everything, so there's certainly more auction processing that goes into the sale of a company than 10 years ago, five years ago.

So almost everything comes from an auction process, which means you're going to have to outbid whoever's in the game, regardless.

So does the financial buyer pay more than the synergistic buyer?

Probably not, Michelle.

The synergistic buyer, if given the same criteria of due diligence, can probably see more inherent value in an acquisition than a financial buyer.

A financial buyer has different objectives.

A financial buyer generally wants to get in, do something and get out.

A synergistic buyer is trying to build value for the company and trying to create long-term value.

I don't see any financial buyer, from the Wilbur Rosses at LTV to, as you said, the Kilmer Delillo's (ph), or even into the extent of Apollo with Metals USA.

I don't' think they have any desire to be a long-term investor in any market that they enter, including the steel service centers.

So, if you're more interested in long-term value, the synergistic buyer can see more value, both immediately and long-term, and we've seen successes, perhaps, in the Wilbur Rosses, and you've also seen some - as you indicated, the Kilmer Delillo and Poindexter of National Steel, one can argue, and there's a great company in Jorgensen, but they can speak for themselves as financial owners.

It took them 15 years to get back out.

It's a great company with great management, but I don't think any investor comes in from Wall Street to be there more than three to five years, and they get out at a profit or they get out at a loss.

Our next question is a follow-up from Aldo Mazzaferro.

Please go ahead.

Hi, Mike.

Maybe it's a one on one, but the question I have is related to just your capital structure generally.

Where do you think you might feel the limits of debt to capital ratios?

I'm sorry, Aldo, the limit this way?

We'd hope to have infinite by zero, and clearly two to one.

If we were looking at an acquisition, would we go to two and one?

Yes, I think we'd go to two to one on an outside.

After that it becomes - well, a goosy kind of risk factor.

Up to two to one on the high side and infinite on the bottom.

And then obviously on an acquisition, too, you could use some of the cash flow from the acquired company to finance debt as well, right?

We'd hope so.

Yes, all right.

Thanks.

I don't have too many more questions.

We have another follow-up from Michelle Applebaum.

Please go ahead.

Okay, since we're doing one on ones here, I just thought I'd take another shot.

Can you comment a little bit - it sounds like you've probably got your position all in place and knowing how you do your business and your purchasing for the spot and the longer - the '06 contract, can you comment on direction beyond December, and can you comment on direction on your contractual business?

Michelle, this is David.

If you're referring to where we see the market going, we can comment on that.

Is that what you're referring to?

I guess that could be another question.

I was going to say, if you've locked in '06 contracts already, where I know you've got some hedges kind of thing, what direction those were versus '05, and then also if you want to comment on where you see the market beyond December?

If you can see beyond that corner.

I think some of your customers would tell you, and your contacts would tell you, that lead times on flat roll are in fact into January, so you don't have to do too much forecasting, since it's already there, de facto.

And our belief is that raw materials will continue to escalate, that the cost of energy, particularly natural gas, will continue to escalate and affect all mills integrated, especially, and that the valuation of the product will continue to move up.

We also believe that because raw materials will continue to increase, scrap as a metallic substitute will rise again, probably - well, it's already in the press, anyhow, that it will rise this coming month, November.

So I would tell you that on the near term, transaction prices will in fact continue to escalate, and we look at '06 as being a relatively good year.

And on contracts, Michelle, one thing that's not necessarily higher or lower, but we're seeing more activity towards trying to get our contractual customer to understand indexing so that we can peg it against some index and just move according to the market conditions up and down.

It seems to be a lot more successful than it has been in years gone by, and people are more accepting the fact that they don't want to be paying the market risk, either from the supply side or the sell side, that people just need some orderly fashion (ph), and want to buy more at market than trying to play the spot market.

So you can't really say that it's up or down.

It's just we're finding that it is moving with the marketplace and we're trying to help our customers obviously grow their market share, so we're very sensitive to the price of steel on our contractual obligations.

Okay, great.

Thank you.

We have a follow-up from Mark Parr.

Please go ahead.

Thanks very much.

Michael, this is kind of a minor issue, but I was wondering if you could talk a little bit about transportation costs, trucking costs, diesel fuel, or how much of that are you absorbing versus your customers?

I noticed that some of the cost line items looked like they moved up a little bit on a year over year basis, even though tons were down.

Yes, I mean to the extent, Mark, that fuel surcharges and any other surcharges are there, we're passing them on dollar for dollar, for the most part.

I mean, there's very little movement there.

There's no question that overall trucking routes got more expensive, as it is very difficult to find truck drivers.

The biggest issue that we have going in terms of customer service is just finding trucks in total, so that it is a competitive universe with the few people that have trucks, but there's no question, I think, that transportation costs in the future will be higher than the past, but there really is a shortage of trucks and truck drivers.

Okay, all right.

Terrific.

Thanks.

Management.

I'm showing there are no further questions.

I'll turn the conference back over to you for any closing comments you may have.

We'll thank you all for your participation.

As a reminder, it is our policy not to provide forward-looking earnings estimates for the upcoming quarter.

We would anticipate releasing our fourth quarter earnings in February.

This concludes our call, and again, thank you for being on the call and your interest in Olympic Steel.

Thank you.

Ladies and gentlemen, once again, thank you for your participation, and at this time you may disconnect.