Olympic Steel Inc (ZEUS) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Olympic Steel Inc. second-quarter 2006 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). As a reminder, the conference is being recorded today, Thursday, August 3, 2006.

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

Thank you and good morning and welcome to our call. On the call with me this morning is Rick Marabito, our Chief Financial Officer. David Wolfort, our President and COO who is normally on the call, is traveling in Europe today and will not be on the call. I want to thank all of you for your participation and your continued interest in Olympic Steel.

Let me remind you all that forward-looking statements on 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.

I'm pleased to report increased sales and earnings for our second quarter ended June 30, 2006. Second-quarter sales totaled $256 million, an increase of 6.1% compared to the second quarter of 2005. The sales increase was attributable to strong volume, as our tons sold for the quarter reached 343,000 tons, which is a 7.5% increase over last year's second quarter. Our second-quarter volume was also higher than that of the first quarter of 2006. Customer demand was strong in the quarter, especially from our customers serving the industrial equipment sector of the market, and we remain optimistic about the customer demand into the third quarter.

Turning to our earnings, and as indicated in our release, our second-quarter results included a 2 million non-recurring pretax charge to further write down the assets for sale at our previous closed OLP joint venture with U.S. Steel. Absent the charge, our second-quarter after-tax earnings were $9.5 million or $0.89 per diluted share. After considering the charge, reported GAAP net income for the quarter totaled $8.4 million or $0.79 per diluted share. For comparison purposes, our net income for the second quarter of 2005 was $3 million or $0.29 per diluted share. For the six months of 2006, our net income totaled $16.4 million or $1.54 per diluted share, which includes the OLP charge, up from $12.6 million or $1.21 per share recorded last year.

Our first-half tons were up slightly, while sales were less due to lower average selling prices in the first quarter of 2006 compared to 2005. We have stated that our strategy is to grow our tons sold and to deliver additional value-added services and supply solutions to our customers by migrating toward more downstream processing such as tempering, laser processing, welding and fabrication of parts. We believe that this is a model for sustained embedded margin improvement in growth.

We have significantly increased our spending in 2006 towards this strategy. So far this year, we have purchased and equipped a 150,000 square foot facility in Chambersburg, Pennsylvania to fabricate steel plate. The facility became operational during the first quarter, and is already contributing to our earnings results.

The new facility complements our existing downstream value-added processing presence already in Chambersburg. We have installed six new laser processing lines during the first half of 2006 -- two each in our Winder, Georgia and Minneapolis facilities and one each in our Cleveland and Bettendorf, Iowa locations. This brings our company total to 23 lasers.

In June, we completed the acquisition of Precision Steel & Welding or PS&W from its British parent company, the Eliza Tinsley Group. PS&W is a full-service fabricating company that performs burning, forming, machining and painting to produce fabrications for large original equipment manufacturers of heavy construction equipment. I also believe they do welding. PS&W is profitably operating from its two facilities in North Carolina.

Lastly, in July, we announce that we commenced a project to implement a single new information system at Olympic Steel. The objective of the new system is to standardize and streamline our business processes that currently occur under our three legacy systems, and to provide a platform and support for growing our service center and fabrication businesses.

After spending a year of investigating and analyzing different systems options, we chose to enter into a licensing agreement with Steelman Software Solutions of Toronto, Canada to use their proprietary service center software. Our project plan anticipates a 30-month phased implementation, with estimated external implementation costs of approximately $14 million over that three-year period. Rick will review our capital expenditures in more detail in a few moments.

Also, I am pleased to announce that Olympic Steel's Board of Directors approved a regular quarterly cash dividend of $0.03 per share that will be paid on September 15, 2006 to shareholders of record on September 1, 2006.

In summary, we are pleased with our performance and our position in the marketplace. Our strong balance sheet and continued focus on asset turnover have positioned us to continue investing in and executing on our strategies. We are excited by our ability to invest in growth opportunities such as acquisitions, new facilities, new processing equipment and the necessary IT infrastructure to support such growth, while simultaneously rewarding our shareholders with a regular quarterly cash dividend. We will continue to investigate adding downstream capabilities such as machining, shot blasting, welding and painting, while exploring additional locations to expand our tempering capabilities.

Tempering remains a foundation for our growth plans in downstream processing. The strategy could be executed in the form of additional acquisitions or Greenfield investments, whichever we deem to be most appropriate. Our outlook for the future is favorable for continued strong demand from our primary customer base of industrial equipment manufacturers and their fabricators as well.

I'll now turn it over to Rick to comment on some of the financial results in more detail.

Thanks and good morning, everyone. As Michael stated, our tons sold increased by 7.5% for the second quarter and sales increased by 6.1%. We also achieved sequential quarterly growth of 1% in tons and 7% in sales from the first quarter of 2006. Our EBITDA in the second quarter totaled $18.1 million, and for the six months, EBITDA was $33 million.

Michael talked about our investments in new laser equipment, our new facility in Chambersburg and our acquisition in PS&W. The incremental costs associated with these investments, together with increased energy, transportation and variable compensation costs, account for the majority of the increase in our operating expenses.

With respect of the $2 million charge for the disposition of the joint venture assets, we previously announced in January the closure of our OLP joint venture, which serves the Detroit automotive market. As a reminder, in the fourth quarter of 2005, we recorded a charge to write down those OLP assets to their then-projected sale value. The additional June charge is to further write down the remaining assets for sale to their estimated current sale value.

Interest expense is significantly lower than it was last year, as our average borrowings are much lower in 2006. Our effective tax rate was 38.8% for the quarter and 37.7% for the six months. Going forward, we would also expect our tax rate to be comparable with the second quarter.

Now, turning to our balance sheet, accounts receivable increased by about $9 million during the second quarter, and that increase is due to our higher sales levels. Our days sales outstanding do remain strong, however, and are under 40 days. We have increased our inventory position by about $35 million during the second quarter, and we believe we are well-positioned for the expected continued strong customer demand in the third quarter.

All of our debt is revolver borrowings, and it is tied into our receivable and our inventory levels. So as a result of the $27 million increase in our working capital during the quarter and our acquisition of PS&W in June, our debt outstanding increased to $44.5 million. Our capital structure remain strong, however, with a debt-to-equity ratio of only 0.2 to 1.

Next, I'd like to review our capital and acquisition spending in some detail. So far this year, we have spent about $17 million on property plant equipment and acquisitions. The most significant expenditures include about $6 million for the purchase and equipping of our second facility in Chambersburg and about $9 million for the acquisition of PS&W in June.

In addition, and as Michael had commented, we did add six laser processing lines in 2006, at an approximate cost of $1 million each. These are all financed via operating leases. The costs of these leases are reflected in warehouse and processing expense in our income statement. The average annual lease expense run rate for each lease line is about $160,000.

The new system project that Michael discussed has a projected external spend of about $14 million over the next 30 months. We anticipate spending about $3 million to $4 million of this total during the remainder of 2006.

Lastly, I'll quantify our dividend declaration. We have approximately 10.4 million shares outstanding, so our quarterly dividend of $0.03 equates to about $300,000 per quarter or $1.2 million per year.

This concludes our formal comments, and at this point, we will now open the call to your questions.

(OPERATOR INSTRUCTIONS). Mark Parr, KeyBanc.

Congratulations on the results. Rick, did you say something about the tax rate? It just seems like it was almost 39%.

Yes, the tax rate was 38.8%, which is pretty much right around the range it's going to be going forward. The first quarter, it was a little bit lower. We had some state benefits that were all recorded in the first quarter. So that's why the year-to-date is a little bit lower, and that's why the first quarter was lower.

Okay, but you are looking at 38% going forward -- 38.5%?

Yes, about 38.5%.

Okay, that's helpful. Some of your operating expense numbers seemed to move up meaningfully. The warehouse and processing number was up almost $2 million from the first quarter. Could you talk a little about that?

Sure. I had alluded to the six lasers that we've added.

(Multiple speakers) seem like that would be --

Yes, their operating leases -- each one is about $160,000 a year. So we added -- phased in six of them over the year. Obviously, we have one month of PS&W included in the results. Then lastly, our volume is up.

Okay. So there's nothing unusual, then, in that number?

No.

So you can look at that as a go-forward basis. Also, the distribution side was up as well about $750,000 sequentially.

Yes. Feel costs -- the increase cost of just getting trucks and increased volumes.

So there's nothing unusual there, either. I just want to make sure these are structural numbers. With the full implementation of the lasers, what would you expect for warehouse and processing expenses in the September quarter?

Most -- we phased in -- you probably have about half a year or a one-quarter impact in the first half of those lasers. Those six were phased in pretty evenly over the first six months. So, at $160,000 a pop, you'll have a little more in the back half of the year, but not that much.

How much incremental from the acquisition?

It's not a big operation. I think we've disclosed they're about a $40 million sales organization. But their primary expenses do hit warehouse and processing.

Their charge per ton would be higher, but obviously, their sales revenue per ton is much higher as well.

Again, in the second quarter, you've got one-third of an impact of the PS&W acquisition. You had one month in there. So you'll have a little bit of a bump-up in warehouse expense.

Michael, did you talk at all about inventories, or is Dave on the call today just to give us an update on market conditions?

Dave is traveling today, Mark. What do you want to know about inventories?

Just --

They're either too high or too low, depending on who you want to talk to. (Multiple speakers). What was your question about inventories?

I know Rick thinks they're too high. What do you think?

From our perspective, there's lots of noise around whether it's Russian hot-rolled this or China that or output of this. Right now, our assessment in inventories overall are that inventories are relatively balanced in the marketplace. People always look at inventory numbers backwards, and it's very hard to forward-forecast real consumption, but obviously service centers have had record shipments this year. From pretty much everybody I talk to, everybody still remains relatively busy.

So the consumption level is clearly balanced with the supply side, and inventories will move a little bit up and down, but by and large, we saw some falloff in the production numbers of Mittal and U.S. Steel in the overall U.S. last week. We track that by week.

So I would tell you the balance now, there's probably a bigger issue that inventories may get low again in the fourth quarter, as people have hesitated to place import orders at the high numbers that we see on a global basis today. But there's lots of speculation about what's coming in right now, but as we look at the pricing on a global basis, Mark, there clearly can -- people are not out there frothily buying more inventory. So I would tell you they're balanced relative to consumption, and I think they're going to remain that way for a while. I think the risk is probably too-little inventories over the next six months, as opposed too-high inventories.

That's really helpful. Do you have any view on the outlook for price realizations in the third quarter that you could share with us relative to the second?

Price realizations of what?

For Olympic's shipments.

Well, again, our position is to focus on the gross margin per ton. As we see ourselves migrating into further participation into fabrication, we obviously are charging more for the fabricated part than we are for the rectangle of steel. So that portion of our business continues to grow. The stainless part of our business continues to grow. So while those are not big parts of our business today, they are obviously helping us on the revenue side and the gross margin side. So from that standpoint, with the lesser shipping days that are out there, again, you don't know what that means, but clearly we're very optimistic where we're at right now.

You just could have said no. That's okay. Thanks very much. I'll get back in line, but congratulations on the progress.

Aldo Mazzaferro, Goldman Sachs.

I just had two quick questions. On the long-term outlook that you have for [the steel] company going forward, what do you expect your long-term dividend payout ratio to be?

The other one is on China imports -- the only place I think there's a negative spread or a concerning spread with pricing is probably China versus the U.S. I'm just wondering, do you see hot-rolled coil and cold-rolled coil pricing hurting your market, especially from the China imports? I wondered if you could just comment on the quality of those, as well.

Let's talk about China first. Obviously, there's lots of -- I have not yet been, over the last four years, reading reports about China import impacting the price. If, in fact, you take a look at the last four years, if China imports are impacting the price, let them continue to factor in the fact, but (technical difficulty) continues to go higher.

So every year, there's a concern about China imports. Clearly, the internal China price is lower, but there's no access to that Chinese hot-roll -- or very little access to that Chinese hot-roll into the United States. So we don't see any impact of Chinese hot-roll pricing having a dramatic impact yet in the marketplace -- [and that yet is] either the last four years or at least the foreseeable future. It could at some point in time, but at this point, even though it's lower internally, there's no availability or limited availability that we see. So on your China question, we see no impact in terms of hot-roll or plate from the Chinese market.

In terms of our dividend, obviously the Board of Directors continually review that at our quarterly meetings. Obviously, we think we have some use of capital to deploy for accretive opportunities for our shareholders, but if we find that we continue to not deploy our cash in an effective manner, I would tell you that there's a lot of discussion about what the dividend ought to be, and clearly we want to induce and reward the shareholders who play along with us. So I would expect over time that we would see it consistent or growing.

Bob Schenosky, Jefferies & Co.

In terms of PS&W, you mentioned revenues. From an operating perspective, is it even meaningful for the balance of the year?

Yes, I gave the revenue number. We talked about it as additive to earnings. At this point, I'll tell you, it's accretive, but it's not going to be a material difference to the run rates on the bottom line.

Not this year, but we have a fairly robust forecast for 2007.

So it's implementing Olympic cost systems to really get that margin up?

That, performance levels, cost systems and opportunity for growth, which I think they were very much constrained under their formal capital structure.

Then you mentioned the industrial markets really helped out the quarter. Any other markets that you can comment on that were very strong, or markets you're concerned about?

Well, we're always concerned about Detroit automotive. I don't know if that will ever go out of our repertoire. But other than that, we're not participating in some the other sectors. We're not in aerospace, and we don't have a very big participation in the OCTG markets. So we're in light construction affected markets. While they may be off a little bit, they still same strong in ours, so metal buildings, truck/trailer, dirt movers, farm -- farm looks like it's going to get better, even though it's not having a robust year compared to some other sectors. No, it looks like everything remains very, very, very good at the moment, including service center activity.

What about the movement for Olympic into more of the transplant business?

Not likely.

Finally, just a general number if you don't have anything specific, but you talk more more about moving downstream, which I think is a great strategy. But can you offer us some sense of comparison, in terms of say what it was a year ago from a value-added perspective, as compared to say now or maybe towards the end of the year?

That's a good question. Rick, you got any sense?

Yes. That piece of our business, last year -- and I'm kind of going on rough numbers -- was less than 10% of the total steel volume that we moved. I'd tell you, probably by beginning part of next year, it will be in the midteens. The stuff we're investing in, in terms of the additional lasers and then what we do with those laser-cut parts, that's where a lot of obviously the investment and the growth we are looking for will come.

Absolutely. Okay, thanks for your time. Good quarter.

Debra Fine, Fine Capital.

Congratulations on the strong results. Could you talk a little bit about the scrap price decline, and if you're seeing any ripples in the market, either of concern or what your views are on how some of the [Electric Arts] people might price still going forward?

Well, only by historical standards. You'd have to ask them in terms of what their intention is. What we've seen from those guys is essentially when the scrap markets pricing goes down, they raise their base price. I think we were all caught a little bit surprised by the depth of everybody was anticipating $30, $40 -- $30, $35 [and dropped] the 70 plus that it did. So we were all caught a little bit by surprise, by what that was and what that means. I think it's a little early to tell how sustainable that lower price level is, but there is no doubt that our friends at Nucor and SDI have a history of raising the base price when the scrap surcharge or the scrap number comes down. So we would anticipate the same movement on their part.

Are you also seeing any reluctance from some of your customers, given their concerns about said activity and the slowing of the economy, to be more cautious about their orders? Or you're not seeing any concern from your customers?

We're concerned, but my customers are making, for the most part, good profit. There has been a reticence perspective over the last couple of years to spend money, because they weren't making a lot of money. I think that today, those industrial projects that are on the table are not going to be pulled back by short-term interest rates, and that, at least from everything that we've seen while everybody's talking about the Fed rate, nobody has pulled back any projects that I'm aware of.

Finally, can you talk us through the rationale of the $14 million SAP program, and how you think about the returns on that and how you're approaching that, given that most companies that embark on those ventures always cost more and add less value than they (multiple speakers)?

Well, I think SAP would be pleased if they would have gotten the order, but since it's not SAP -- but I will go (indiscernible) because SAP are very good salespeople. We think that the three legacy systems that we have all come from the mid-80s and they have been supported and are operating well, but clearly are not platforms for where we expect to take this company over the next five to six years. We have a very good team inside Olympic working on it, that we have our plan literally week-by-week laid out of what the responsibilities of all parties involved are to be doing. So we're really monitoring this very closely -- literally by the week, I tell you.

What is the opportunity? If you take the historical basis of Olympic's growth from what we show from 1984 until now, there's always been a strategy of sort of making sure that we surge the business and then plateau the business to absorb that which we then grow. So I would tell you that with the legacy systems that we have today, we are very concerned internally that we would have the next growth spurt that we anticipate under control without a new system. So I think it's embedded into the long-term strategy of taking this company up to the 2.5 million tons that we have been talking about, in terms of our ability to handle to the marketplace.

So it's a cost of doing business?

Absolutely.

(OPERATOR INSTRUCTIONS). Mark Parr, KeyBanc.

Mark? May have been a double figure, operator.

Aldo Mazzaferro, Goldman Sachs.

I had just a question for Rick quickly. When you were referring to the mix of the value-added, 10% to 15%, are you referring to it in dollars or in tons?

Dollars or tons on the --?

Tons.

In tons.

As there are no further questions, I'd like to turn the call back to management for additional remarks.

As a reminder, it is our policy not to revise forward-looking earnings estimates for the upcoming quarter or year, and not to endorse any analyst sales or earnings estimates. We anticipate releasing our third-quarter earnings on or around the final week of October. This concludes our call, and thank you again for your interest in Olympic Steel.

Thank you so much, sir. Ladies and gentlemen, this does conclude the Olympic Steel Inc. second-quarter 2006 earnings results conference call. Thank you for your participation, and have a pleasant day. You may now disconnect.