Olympic Steel Inc (ZEUS) 2006 Q4 法說會逐字稿

Welcome to the Olympic Steel, Inc. 2006 earnings release. [OPERATOR INSTRUCTIONS] At this time I would like to turn the conference over to Michael Siegal, Chairman and CEO of Olympic Steel. Please go ahead, sir.

Thank you very much.

On the call with me this morning is David Wolfort, President and COO, and Richard Marabito, our Chief Financial Officer. I want to thank all of you for your interest in Olympic Steel, and remind everybody that forward-looking statements on this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

So, please refer to Olympic Steel's SEC filings for further information on this very exciting topic.

I'm actually very pleased to report strong sales and earnings for 2006. Olympic Steel achieved record annual sales in 2006 and we completed our second most profitable year in our 52-year history.

For the year, our sales increased 4.4% to $981 million from the $939 million in 2005. Sales increase was realized on about the same amount of tons as we moved 1.27 million tons in 2006 versus the 1.28 million tons in 2005. Net income totalled $31million or $2.92 per diluted share in 2006, up from $22.1 million or $2.11 per share recorded in the previous year.

The summarized fourth quarter results sales totalled $226.1 million, an increase of 10.4% compared to the fourth quarter of 2005 and the tons sold for the quarter totalled 272,000 which was down from the 295,000 in the previous fourth quarter.

We reported net income of the fourth quarter of $3.8 million or $0.35 per diluted share. For comparison purposes again, our net income for the fourth quarter of 2005 was $7.3 million or $0.70 per diluted share.

We remain committed in investing in the value-added services and supply solutions for our customers, including facilities and equipment that reached further downstream into the value-added processing area to sort of try and settle out our earnings on a regularized basis.

We continue to invest in lasers and fabrication equipment.

We believe our migration toward more processing will allow that sustained imbedded margin improvement in growth and to that end in 2006 we spent $21 million on capital investments and acquisitions. We purchased and equipped a second value-added processing facility in Chambersburg, Pennsylvania. We acquired PS&W, a Siler City, North Carolina, steel fabricator, and invested in technology and our infrastructure.

In 2007, we intend and anticipate to continue investing in initiatives that will position Olympic Steel for margin growth and value creation, and David Wolfort will comment later on these details. As I indicated in our release this morning, the high fourth quarter inventories held at service centers impacted in our financial results. We believe that the high industry inventory levels are being corrected at present and will be adjusted by the end of the first quarter.

Customer demand is increasing. Imports as we see it are significantly lower and will be. Input costs in terms of pellets and scrap, the things that produce steel continue to rise. And we also believe that domestic steel production will continue to be controlled to remain in balance as we move forward with increased demand.

Our outlook is very positive for the year. And we were actually very excited about what's in front of us.

I'm pleased to announce that Olympic Steel's Board of Directors approved a regularly quarterly cash dividend of $0.03 per share that will be paid on March 15, 2007, to shareholders of record on March 1, 2007. I will now turn the call over to Rick to comment on our financial results.

Thanks, Michael. And good morning, everyone. I will comment on some of our financial highlights that Michael did not yet cover.

First, our annual EBITDA was $62.6 million compared to $52 million last year. Fourth quarter EBITDA totalled $8.8 million compared to $18.4 million last year.

The incremental costs associated with our 2006 capital investment, together with increased energy, transportation and variable comp costs, account for the majority of our increase in operating expenses in 2006.

The investments included: leasing six new laser lines, the new facility in Chambersburg that Michael references in our acquisition of PS&W in June and the increased variable incentives are tied directly to the increased earnings of the company.

Interest expense for the fourth quarter of 2006 totalled $1.3 million, compared to $273,000 last year, and for the year our interest expense was $2.7 million compared to $3.7 million in 2005.

Our effective tax rate for the fourth quarter was 29.2%, which brought our annual tax rate to 37.2%. The lower fourth quarter rate was primarily due to the realization of deferred tax benefits related to some net operating losses in certain state and local jurisdictions. And then going forward we expect -- we would expect our effective tax rate to be back in the 38% range.

Now turning to the balance sheet, we ended the year with about $86 million of accounts receivable. And we continue to strengthen our receivable day sales outstanding. We ended 2006 with a DSO of about 38 days. And that was an improvement of 2.5 days from 2005.

We reduced our inventory by about $4 million during the fourth quarter and ended the year with a little more than $210 million of inventory. And for the year of 2006, we turned our inventory just under five times and that would compare it to just under six times in 2005.

All of our debt is revolver borrowings and it's really tied into our working capital. And our working capital levels did increase substantially in 2006.

And in addition, we spent $9 million again for the acquisition of PS&W, and another $12 million on capital spending. So, as a result, our debt totalled $68 million at year end. And that was also a $4 million reduction from the end of the third quarter.

And then in terms of the capital spending, Michael briefly touched on it. We did spend $12 million on Capex and that included again the purchase and equipping of the second facility in Chambersburg, as well as IT and infrastructure spending on systems. Our capital structure remains strong with the debt to equity ratio of less than .3%:1% at year end.

And we had about $60 million of unused availability under our credit agreement at year end. And our shareholders equity per share increased -- decreased to $22.46 at year end.

And lastly we have about 10.4 million shares outstanding, so the quarterly dividend of $0.03 per share equates to about $1.2 million annually. And now I will turn the call over to David.

Thank you, Rick. And as Mike and Rick said, welcome to all. Also as Mike and Rick highlighted, we were investing in ourselves to support margin enhancement, which Mike mentioned earlier, and value creation.

In 2006 we significantly increased our capital spending as Rick had mentioned to $12.3 million, which exceeded our cumulative spending from the previous five years. We anticipate spending as much, or more in capital expenditures in 2007. As discussed in our previous calls, we purchased and equipped a 150,000-square-foot facility in Chambersburg, an additional facility, with robotics that compliment our steel fabrication initiatives in that area of the country.

The facility became operational during the first quarter of 2006 and quickly became a contributor to our earnings results. We had this plant up and running within three weeks of purchasing the plant.

We plan to invest in more value added and automation equipment in 2007.

As previously mentioned, we also installed and leased six new laser processing lines and one new plasma line in 2006. We envision adding several more lasers and plasma processing lines in this upcoming year 2007 providing increased and predictive margin enhancements.

Again, in June of 2006, we completed the acquisition of Precision Steel and Welding, or PS&W, which is currently operating from two facilities located in North Carolina.

PS&W is a full service fabricating company that performs burning, forming, machining, painting to produce fabrications for large OEMs of heavy construction equipment. As Rick indicated, part of our consolidated expense increase in the second half of 2006 was due to the inclusion of PS&W in our results. In 2007, we have added new management to this facility, PS&W. Our upgrading their capabilities and reducing our cost structure.

PS&W initiatives include investment in automation equipment and the consolidation of our operations into one facility from the two that we acquired.

In addition to the items I just described, we have plans to invest in more production space, leveling and shop blasting equipment ,and new information technology and infrastructure upgrades, that Mike indicated to support our future growth.

In summary, we were very pleased with our 2006 sales and earnings performance, and our position in the marketplace. Our strong balance sheet affords us the opportunity to invest in our future. We will remain disciplined in our evaluation of growth opportunities and focussed on adding downstream capabilities, such as tempering, laser and plasma cutting, shop blasting, fabricating and painting.

We continue to explore additional locations for further transformation of flat roll steel into a part or sub assembly for our customers, executed through either acquisition or Greenfield investment, whichever we deem to be most appropriate.

Lastly, as Michael indicated our outlook for the market is favorable despite some fourth quarter market pressures that have spilled into the beginning of 2007.

We are anticipating meaningful reductions in carbon flat roll inventory levels, at service centers, Olympic included, as we move through the first quarter of 2007. The anticipated inventory reduction, combined with a lower import levels, increased scrap costs, and solid demand suggest a favorable and increasing price marketplace going forward. This concludes our formal comments and we will now open the call to your questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] First question comes from Bob Schenosky with Jefferies & Co. Please go ahead with your question, sir.

Thanks. Good morning.

Hi, Bob.

One for Rick. Capex and appreciation for '07?

Yes, we are looking at Capex again around $12 million to $15 million. Depreciation won't go up much from this year so you can probably count on $8 million to $9 million.

Okay. Great. And then two for Michael here. First one, Michael, with your inventories in the fourth quarter, is any of that numbered at all opportunistic buys as we go through the first of the year? Or is that simply inventory you had in place and also with PS&W that you need to be worked out?

I think it's more the second case, Bob. Obviously, no late deliveries. Know when the market softens as it did in the fourth quarter the mills shipped late back log to the service centers and obviously that caught up in the fourth quarter and with the falling demand, probably was more than the case with inventories bloated beyond what we expected.

Okay. And one final one, please. And you talked about all of the value add you are putting into place. Can you give us some sense of what it may look like in terms of percent of total production capability, or total revenues versus what we had prior? Just give me a sense how much you are moving into that direction.

Well, again what happens is, Bob, is you convert from tons of pieces. So, some of your comparative analysis becomes less meaningful. It really is a two-fold strategy. One is to increase our investment in the traditional service center, pieces of equipment. But as we move downstream for the predictable value added, I would tell you that we are also trying to get sustainable gross margin increase, so it's a two-fold strategy. I would tell you that today we are somewhere between 15% and 20% in the value added and we obviously expect to get over 20% as soon as possible.

Could you be as much as 25% by the end of '07 with all the new Capex that you are deploying?

I would hope not. Because I would hope we would increase the other side of our equation as well -- growth.

Both are expanding. Great.

Correct.

Bob, David Wolfort here. One of the issues that pops up as we continue to go downstream is that we do need some of the traditional service center pieces of equipment to supply those downstream operations.

So, we -- as we exhaust our current capacity and temper mills and so forth and lasers, we have to again add traditional cut the length temper mill facilities in order to feed that traditional growth, also.

So, it's a two-fold strategy.

Okay. Great. Thanks.

Thank you, sir. The next question comes from the line of Mark Parr with KeyBanc Capital Markets. Please go ahead with your question, sir.

Thanks very much. Good morning, guys. Michael, couple of questions for you. You say your customers are showing increased demand. Can you give us some sense of where that might end up for you guys from a shipment perspective, both on direct tons and total process in the first quarter?

Not really, Mark. The answer is you have to temper -- customers don't have good handles on their forecasts. Okay. So it's more the sense of the pent-up demand. We were seeing good growth in the ethanol side of our business and the stainless side of our business.

In terms of the heavy construction side of the business. There is a strong sense by the end of the year that a lot of the farm agriculture, because of the ethanol taking corn pricing up, the farmers will have money and start buying new farm equipment. We have some issues that are not as robust in the light construction universe.

But by and large, the sense is that things are going to be up from the back half of the year and for a substantial [inaudible]. But I have no sense of what reality is. Hopefully, it's better.

Okay. Have you begun to see any pick up from your service center customers?

Not much. Some, but very spotty at this point.

Okay. Just -- and one other question if I could on the, just on the current operating conditions. Could you give us your best guess of where you think hot roll pricing will be in the March/April time frame and also for a plate products?

Higher. Higher than they are at present. You know what, it's another announcement today or yesterday from the middle.

I do believe that the mills want to recover what they lost in the back half of the year. There is a driving sense that they can get it close to 600 as soon as possible and I don't know what that is. But it's all subject to whether they bring more capacity on and if the demand is sustainable.

So, the answer is it will be higher, but where it settles is anybody's guess. But higher.

Okay. If I could ask one more question. One thing I was really impressed with in your fourth quarter was your ability to maintain gross profit dollars per ton.

And I was just wondering if you have any sense of how much incremental upside there could be to that in '07, based on your move into higher-value markets and I will pass it on, and congratulations on the progress.

I will let David answer that question.

Mark, a number of things. Answering some of the aspects of the earlier questions, ducktailing into this last question.

The marketplace is moving up. Obviously, we are rotating our inventories at five plus time. We suffered the same stagnation in the fourth quarter that everybody saw, which made our inventories move out a little bit.

With that in mind, remember that we were going to rotate our inventories in 2007 much like we rotated in the early part of 2006 and 2005. And as Michael commented earlier, Mark, we do see the prices moving up late first quarter and second quarter. As we commented, because of lack of imports, increases in scrap pricing, so forth and just basic demand.

With all that, with all that in mind, Mark, we see these margins at least staying at this particular level and we see regaining some of the tonnage that was stalled in fourth quarter. Value addition, we continue to move downstream as we commented earlier.

There is much more margin security, I would say, and predictability as we go downstream, and as we answered Bob's question a moment ago, again with traditional services, again what we are seeing here in total is a marketplace that is restoring itself to where it was before the tail end of fourth quarter.

Okay. Thanks again.

Thank you, sir. The next question comes from Aldo Mazzaferro with Goldman Sachs. Please go ahead with your question, sir.

Hi, Michael.

Hi, Aldo.

Say, I want to offer congratulations on your ability to maintain a high inventory turn in a volatile market.

Well, not as good as I would like. But, okay. Thanks.

Compared to some, I would say it's very good.

Thank you.

The question I have is on your product mix improvement. The way it's moving if you try balance the differences you might see, I would assume as this occurs your gross margins widened and your operating expense ratio probably rises somewhat. I noticed that's been the trend in the fourth quarter.

Where do you think that plays out? Have you seen the full impact of the PS&W acquisition in the operating expense line at this point, you think?

Oh, no. We will significantly reduce the operating cost to PS&W, as David indicated we haven't combined the two facilities, which we intend to do. We will probably wind up by the end of this year with employment at about 50% of the company that we acquired with probably more parts going out the door.

So, we're still automating that facility as well, which will cause some of the reduction of personnel. But I will tell you we anticipate having much reduced costs at PS&W in 07 ' that we did in '06.

You think that comparing -- if you just compared to the fourth quarter and you had that 6.1% of sales in warehouse and processing, that could actually decline, you think, going forward from here as a percent of sales?

Yes, we anticipate that to occur.

At the same time you still would continue to get a mixed improvement effect on the gross margin then, right?

You would hope so but the answer is, yes, we anticipate that to occur, yes.

Okay. That sounds pretty good, Michael.

Thank you.

And a question on the market if I could. Just some of the concerns people have is that the domestic production rate picking up as it is right now maybe even getting back to full run rates could offset the improvement of the market. I'm wondering how you see that balance? Are the imports just not available at this point and therefore the domestic production could go full out without impacting? Or do you think it's a risk that the domestic production over does it near term?

I will let David comment on that one.

Aldo, I think that domestic production, although the latest statistics have us at 84% of domestic production up from the trough I believe of 70% during the holiday time period in December, with a severe weather conditions as a detractor from production. Quite frankly, I don't see the domestic mills keeping up with the demand in late first quarter and second quarter, and we see almost no offerings, as you're well aware of, from the foreign side of the equation, simply because in western Europe the prices are higher than they are here in North America.

And the Middle East is chewing up steel, particularly plate and heavy plate, at a very high rate, unprecedented. And so we see a lot of product going elsewhere in the world and not coming here and obviously the U.S. currency has impact on that, too.

So, we actually see the domestic side of the equation having a difficult time keeping up with the demand particularly as we move into what we refer to as sort of a traditional service center year with second quarter being very strong.

Let me just add to that, Aldo. We clearly believe that some of the domestic producers are also exporting, not just heavy plate, but other products as well.

So, we're not so concerned that even if they increased their production rates that it's all coming into the U.S. market. So, the markets are higher priced.

That's right. It seems like there is a potential for that as well. Okay. Well, thank you, Michael. David, thanks.

Thank you, sir. Next question comes from the line of John Tumazos with Prudential Equity Group. Please go ahead, sir.

Congratulations on the good results.

Thanks, John.

As the market with changed with Reliance and Ryerson over the last 10 years merging, buying so many companies, clearly you benefit from the consolidation, or the unification of all those competitors into a couple. Do you feel any need to change your business? Or are you perfectly comfortable competing with Reliance that might be 10 times bigger than you or what not?

Not in the products that we sell. He sells, obviously a lot. Reliance has a different strategy than we do, John. Ours is really trying to accelerate the value to the heavy construction industries as you look at our customer base.

It is completely different than Reliance's.

And so from the standpoint in terms of where we used to compete against Ryerson. Ryerson really seems to have take a tact into the stainless and aluminum to some degradation in the carbon side of the business. So, I would argue that in the markets that we serve we're as big as anybody. As we look at our growth opportunities, we continue to evaluate the Greenfield versus acquisitions scenario.

There is a frothiness in terms of some of the values that are out there today that is beyond our hurdle rates. And so, while we were not opposed to looking at other service centers, like in the PS&W case we have found there are better value creations for our shareholders by looking at downstream locations, as well as equipment to service our customers better. And then less so on the service center side. I will tell you even with the consolidation, as you indicate of Reliance and Ryerson, it's still a relatively undisciplined pricing market on the service center basis.

Even with what has happened, there seems to be very little discipline in the overall market on pricing.

Thank you.

Thank you, sir. [OPERATOR INSTRUCTIONS] At this time there are question -- is a follow-up question from Mark Parr with KeyBanc Capital Markets. Please go ahead, sir.

Yes. Thanks. Rick, I was wondering if in addition to the $13 million or $14 million of Capex that you are thinking about for this year, how much capital do you have available for M&A opportunities?

Sure. Well, I commented, our existing credit facility just under formula we have in excess of $60 million available. And what I would tell you, Mark, is based on our balance sheet and low debt structure right now we could go out and finance and have in excess of $100 million pretty easily.

Okay. Terrific. Thank you very much.

Thanks, Mark.

Thank you. The next question comes from Aldo Mazzaferro with Goldman Sachs. Please go ahead.

Hi, Michael. I just had a follow up. Maybe for Rick. I'm not sure but do you measure the tons out of PS&W any more?

We do. I mean, just because we give the tons sold number, Aldo. So, obviously that's not a tonnage market. It's a part market.

So, they previously never measured tons, we do and include the amount of tonnage in our totals.

Would you mind telling us how roughly the size was?

It's tiny in terms of the tons because again they are delivered in parts.

Like 10,000?

I don't have that in front of me. But, yes, it's small. It's not impactful in the tonnage.

And Mike, I can't resist a question for you on this -- given the stock trading in some of the stocks today.

Yes, looks like Ryerson is doing well.

Doing well. And Algoma is doing well. I'm wondering, do you see combinations between mills and service centers as viable business plan, depending on the size of the mills and location? I was wondering if you see it universally as a good plan or do you see it maybe as a niche operation potential?

The answer is historically I would tell you -- look, there is always three opinions on this which is yes, no and the real. I think if the objective is to create a supply chain that brings more value to the customer, then it would be appropriate. As opposed to the standard, well, we're a mill and you're a service center and we have different objectives, and I don't think that that is true.

I think the objective is to create a more -- an efficient supply chain that historically has not existed in the domestic service center arena. And while I would tell you there is not a lot of momentum in that direction, customers are continually looking for suppliers that can create more value to them as they increase their through puts of assembly. If the combination of mill and service center can create that value than stand alone, then it ought to take place.

Thank you.

Thank you, sir. Gentlemen, at this time there are no further questions. Please go ahead.

Thank you. As a reminder, it is our policy not to provide forward-looking earnings estimates for the upcoming quarter or year. And not to endorse any analyst sales or earnings estimates. We anticipate releasing our first quarter 2007 earnings on or around April 27. So, this concludes our call and we want to thank all of you for your interest in Olympic Steel. Thank you, and good-bye.

Thank you, sir. Ladies and gentlemen, this does conclude the Olympic Steel, Inc. fourth quarter 2006 earnings release. You may now disconnect and thank you for using ACT teleconferencing.