Olympic Steel Inc (ZEUS) 2007 Q1 法說會逐字稿

Good day and welcome to the Olympic Steel first quarter 2007 conference call. Today's call is being recorded.

At this time, for opening remarks and introductions, I'd like to introduce Michael Siegal. Please go ahead, sir.

Thank you, Matt.

Good morning. 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.

I want to thank all of you for your participation and the continued interest in Olympic Steel. Let me remind you that forward-looking statements on this call, or any call, are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. And please refer to Olympic Steel's SEC filings for further information in that regard.

I'm pleased to report our sales and earnings for first quarter of 2007. For the quarter, our sales increased 8.6% to $259.4 million from $238.9 million from the first quarter of 2006. On a trailing four quarter basis, our net sales topped the $1 billion threshold for the first time.

As we stated in our release this morning, the first quarter steel market was very challenging, as the year began with high inventories in the service center market. This caused a competitive environment as carbon steel prices declined while service centers destocked. And at the same time, shipments to customers declined.

Our sales increase was achieved on 7.9% less tons sold as we moved 312,000 tons in the first quarter compared to 338,000 tons in last year's first quarter. Our year-over-year tonnage declined near the 7.4% drop in the MSCI industry-wide statistics on flat-roll service center shipments. Our tonnage decline was attributable primarily to lower sales to other service centers and the domestic automotive customers that we service.

On a sequential basis, our tons sold increased by 40,000 tons or 15% over the fourth quarter. Net income for the quarter totaled $5.3 million or $0.49 per diluted share, compared to $8 million or $0.76 per diluted share recorded in last year's first quarter. Sequentially, our net income increased by 40% over our fourth quarter results of $0.35 per diluted share.

As we enter the second quarter, we are looking for a potentially improving marketplace. This outlook is being drive by continued low levels of imports -- even though we saw them move up a little bit, I think they were misleading. They were still very low; service center inventories that now appear to be more balanced with demand; steel making input costs for materials such as scrap and pellets increasing; and a demand scenario that appears to be slowly recovering.

On a longer term view, we remain committed to investing in value-added services and supply solutions for our customers, including facilities, equipment and technology to support our future growth plans. We believe our migration toward more value-added processing will allow for sustained, embedded margin improvement and value creation.

To that end, we are spending more on capital investments. To date in 2007, we have placed orders for a new Red Bud stretcher-leveler-cut-to-length line in Minneapolis, and new laser, plasma, machining and quality testing equipment in Cleveland and Chambersburg, Pennsylvania, to support our growing value-added services for our customers.

This week, or actually last week, we also broke ground for a 54,000 square foot addition to our existing Iowa facilities.

I am 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 June 15th, 2007 to shareholders of record on June 1st, 2007.

And now, I'll turn the call over to Rick to comment on some of our financial results.

Thanks, and good morning, everyone.

Our first quarter EBITDA totaled $11.6 million compared to $8.8 million in the fourth quarter, and $14.8 million in last year's first quarter.

Operating expenses totaled 14.6% of sales compared to 15% in the fourth quarter and 14.4% in the first quarter of 2006. In terms of real dollars, our expenses increased by about $3.6 million over last year's first quarter. And the increase is primarily due to the inclusion of PS&W's expenses this year. PS&W was acquired in June of 2006. And it's also due to incremental costs associated with our new IT system project, which we began that in July of 2006.

Interest expense for the first quarter totaled $1 million compared to $154,000 last year, and our effective tax rate for the first quarter was 37.3% compared to 36.5% last year. The lower rate in 2006 was primarily due to the realization of some tax -- deferred tax benefits related to net operating losses in certain states and localities. Going forward, we would expect our effective tax rate to approximate 37% to 38%.

Now turning over to our balance sheet, we ended the quarter with $109 million of accounts receivable. That's compared to $86 million at year-end. And the increase in receivables is due to seasonally slower sales in the fourth quarter. Our receivable days sales outstanding remain very strong and healthy at 38.5 days for the first quarter, and that is consistent relatively with our 2006 DSOs.

We did reduce our inventory by about $21 million during the quarter, and we ended the quarter at $190 million. And we turned our inventory about 4.6 times during the quarter, which is a little bit less than our target and a little bit less than our past turnover rates.

All of our outstanding debt is revolver borrowings. Our working capital decreased during the quarter by about $18.6 million, and we spent $2.1 million in the quarter on capital spending. As a result, our debt was down by about $18 million from $68 million at year-end to $50 million at the end of the first quarter.

And in terms of that capital spending, the $2.1 million was spent on a downpayment for a stretcher-leveler-cut-to-length line and IT and infrastructure spending. And as Michael indicated, we are investing in our downstream strategy and anticipate spending as much as $15 million to $20 million this year on capital spending.

Our capital structure remains strong and flexible, with a debt to equity ratio of 0.2 to 1.0, and a trailing 12-month debt to EBITDA ratio of less than 1.0 to 1.0. And we finished the quarter with about $78 million of unused availability under our credit facility.

Lastly, our shareholders' equity per share increased to $22.92 at March 31st. I'll now turn the call over to David.

Thank you, Rick, and welcome again. As Michael and Rick highlighted, we are investing to support our long-term value creation strategy.

In 2006 we significantly increased our capital spending to $12.3 million, which exceeded our cumulative spending from the previous five years. For 2007, we continue to invest in Olympic Steel at a healthy and disciplined level.

This year's anticipated capital spend of $15 million to $20 million, as both Rick and Mike indicated -- spoke about, consists of several different initiatives, including expansion of our production square footage, and we just indicated our Iowa groundbreaking; the purchase of a stretcher-leveler piece of equipment, which is going to our Minneapolis coil facility; the continued expansion of our growing plasma laser and machining capacity, and that goes to our Cleveland and our Chambersburg facilities; continuing to upgrade our fabricating capabilities at PS&W; and an investment in a new IT platform for our future.

Let me expand on each of these elements.

This week we broke ground for a 54,000 square foot addition to our existing facility in Bettendorf, Iowa to provide more production space to serve our customers from this facility, which already houses a temper mill and laser processing capabilities, along with shot blasting and oxy burning. We anticipate that the new addition will become operational in 2008.

We also anticipate the new stretcher-leveler-cut-to-length line, to be located in our Minneapolis coil facility, will be operational in the first half of 2008. This equipment will serve customers with high quality sheet product, as well as feed our downstream value-add laser equipment.

In 2007 we will invest in more value-added and automation equipment. We have already committed to laser, plasma and machining equipment for Cleveland and Chambersburg, as we've mentioned earlier, which will be installed this year, 2007. We also ordered a new laser punch equipment, which will add downstream processing capabilities to our Chicago operation.

In June of 2006, we completed the acquisition of Precision Steel & Welding, or PS&W, which is currently operating from two facilities in North Carolina. PS&W is a full-service fabricating company that performs burning, forming, machining and painting to produce fabrications for large, original equipment manufactures of heavy construction equipment.

As Rick indicated, part of our consolidated first quarter expense increase was due to the inclusion of PS&W in our results. We plan to invest up to $1 million at PS&W this year to upgrade and automate their capabilities and reduce our cost structure at these facilities.

During the first quarter of 2007, we added new management to lead PS&W through this upgrade. And in the second quarter we plan on consolidating our operations into one of these facilities from the two that we acquired.

As Michael indicated, we are also investing heavily in new information technology and infrastructure upgrades, which will support our future growth. This three-year project commenced in the third quarter of 2006 and is proceeding according to plan.

In summary, we are pleased with our first quarter financial performance and our position in the marketplace. Our management team performed very well in a difficult and very competitive first quarter environment.

Our strong balance sheet affords us the opportunity to make investments in our future. We continue to explore new locations for further transformation of flat roll steel into a part or sub-assembly for our customers. We will execute our growth plan through acquisition or greenfield investments, as we've indicated previously, which we deem to be most appropriate.

Lastly, as Mike indicated, our second quarter outlook for the market is favorable, despite some conflicting market signals regarding scrap and demand. We are anticipating increased carbon steel pricing for the second quarter, driven by the supply side.

Imports are low and are not expected to be impactful this summer. Input costs are on the rise and service center inventories start the second quarter in better balance than in the first quarter. Demand looks to be steady, and may be slowly improving from Q1.

This concludes our formal comments and we will now open this call to your questions. Thank you.

Thank you, sir. (OPERATOR INSTRUCTIONS.) Mark Parr with KeyBanc Capital Markets.

Thanks a lot. Hey, congratulations. Good morning.

Thanks, Mark. Good morning.

Great quarter given all the inventory reduction you guys did. That's impressive. Just curious. Dave, you had mentioned a little bit about steady demand to up demand in the second quarter. Is there any more color that you might be able to give, order of magnitude for you guys, what the sequential momentum might be for the demand side, and also on the pricing side?

Well, Mark, on the demand side our customer base continues to show recovery from fourth quarter in inventory -- their inventory reductions. Demand has been relatively consistent. As we indicated earlier, Q1 was a difficult start for us coming off of a weak Q4.

As we enter Q2, we're coming -- the trend line looks very strong to us, much more significant demand at least from our customer base. And in fact, what we're seeing -- and in fact what we're seeing is a restoration of the transaction price, which fell in the fourth quarter. But from a demand perspective, literally all of our customers are indicating some pretty steady demand for Q2.

Okay. By steady do you mean like stable, or do you mean steady continuing to move up, I guess is where I'm trying to get to.

Yes. Well, I think it's a combination of both, Mark. I don't mean to be ducking it. I mean, it's early in the second quarter, but we see pretty consistent stronger demand than we saw at the beginning of Q1.

Okay.

So, we have much more strength as we get into Q2. And our expectations are that it will be more like a traditional service center here, where the second quarter is much strong.

We have the confluence of a number of issues here, which is the inventory reduction. We also see some reluctance from service centers to buy in the marketplace. And we think that, again, the supply side will continue to help strengthen the marketplace.

Okay. Do you have -- can you give us some color about what you anticipate doing with your inventory position in the second quarter relative to the first? And are you comfortable with where you are now?

Yes. We think we're in terrific shape. Obviously, the demand as we indicated a little bit earlier here and you just questioned us, is going to be stronger and we think the rotations will strengthen from the 4.6 turns that we had in Q1 and we'll restore ourselves to better than that. And so, right now we're in good shape.

Okay. Terrific. Also, just one other thing. As far as your mix, would you expect mix effects with all the new processing equipment you're bringing online? Could you give us a little color on what the higher end mix was, say 1Q versus 1Q, 1Q versus 4Q? Where you might expect the mix to shift to in the second quarter?

Mark, are you referring on a percentage basis?

Yes, or just however you want to characterize it. I mean, just trying to get a sense of how you're executing on the strategy to increase the value-add downstream capabilities.

Well, the mix -- it's always interesting, Mark, because one is tonnage and one is pieces-parts. So, while there isn't a lot of weight that comes into the downstream fabrication, so it's really hard to give those kinds of balances.

Obviously, in the first quarter last year we did not own PS&W, so obviously it's pretty easy to tell you that probably as a percentage -- because we have the PS&W in the first quarter numbers this year -- that our downstream mix is higher than it was a year ago.

Concurrently, there's no question that first quarter service center sales, which is generally tonnage going out the door, is lower in the first quarter '07 than it was in '06, given the high levels of service center inventories.

So, it's clearly -- the mathematics would tell you obviously that our percentage of value-added mix was higher. But again, it's not big tons and so the impact is incrementally growing as we would predict and hope, and it has a stabilizing impact on our gross margins, which you see. With a very strong decline in the marketplace, you saw our gross margin dollar per ton remain about the same. So clearly, without being specific on the percentages, it's more, the value-added stream, and we're pleased by that.

Okay. Terrific. Well, thank you -- thanks for the color there, Michael, and congratulations on all the progress.

Thanks, Mark.

Aldo Mazzaferro with Goldman Sachs.

Hi, Michael.

Hi, Aldo.

Hey, on the quarter, interesting to me that the first quarter average selling price for you guys in tons was only down about 3% when the market index looks like it was down around 9%. I guess that would be partly due to the influx of the value-added from PS&W and from other places?

Yes. Clearly.

And then the -- but my real question is the operating expense as a percent of sales sequentially declined, where I would think with the PS&W coming into the mix, you might see a higher gross margin and a higher operating expense ratio. But, in this case you didn't seem to get it. Were all the PS&W expenses all fully impacting now the first quarter, would you say?

Yes, they certainly are.

So, you did a very good job then on the operating expense line.

We did, as well as we're obviously spending more in the first quarter on our IT development than we did the first quarter of last year as well.

Great. And how about in your level of gross margin? Do you -- the 18.3%. Do you feel that that was held higher by the impact of the value-added?

Yes, yes. We do. Yes.

Good. My question on the second quarter, Mike, is with the price index in the first quarter in steel down, is there a pretty good chance your cost of sales per ton, just the material that is, on the second quarter would also be down from the first?

The trend lines are positive for what we look at, Aldo, I mean without being specific on that. Obviously, we still anticipate from our stainless side that we will see some growth on the surcharges that continue to accelerate. There's some pickup on that.

Right.

And obviously, you have inventory and those issues. Obviously, depending on where scrap goes, and there was some announcement by Nucor yesterday that they might lower the surcharge. So, those things are bouncing around a little bit.

But clearly, in terms of how we're viewing where the market is going from a price standpoint, it would seem to be accelerating a little bit in the inbound material from stuff that was bought 90 days ago, clearly it's favorable. So, there is some pickup in that. Not substantially. Ultimately, I think it's a question of mix and it's a question of our ability to continue to grow our downstream to add to that market as opposed to market timing of inventory adjustments.

Great. And then -- I think you just touched on this. The final question I had was, given the scrap decline that just happened a little bit, and Nucor is now talking about the surcharge, how do you see these two conflicting battle lines going on in the market, where you have maybe a little bit of a depressing effect on price from scrap costs, but then a -- I think a major positive impact from the supply side going away? Who do you think wins that battle in terms of pricing?

I would tell you, Aldo, it's -- I'll let David more comment on this, but it clearly is confusing and mixed signals, and it's literally changing by the week. So, it is very confusing for the customer base to understand whether the prices are going up or going down.

David, I mean, you might want to comment.

Yes. Aldo, I think you've got -- I think you're right on. You're spot on here. Quite frankly, a surge in scrap prices in the first three months of some arguably $138 a ton, a slight adjustment in April and a bigger adjustment for May.

Quite frankly, there are no imports coming in as you well know. The supply side is really driving this. We see consistent demand. Candidly, we see the consolidation process as a helpful tool in the marketplace.

And so, quite candidly, the rush of some manufacturers to raise the price dramatically had little traction. However, the consistent progress of the majority of the mills has had some good traction.

And so, I ultimately -- ultimately, we think that the price recovery from fourth quarter is stable today, if you discount the one player who leaped out way in front of everybody. And we see consistent strength there.

To answer your question, the guy who wins this is probably the guy who controls the most of his input costs.

Yes.

Really. I mean, these things are moving. The currency continues to fall. I guess the Euro hit an all time high against the dollar. That's going to constrain imports and maybe create a better market for exports from the mill.

But, the guy who controls the input costs with this huge volatility is probably a more predictable and stable, and ultimately winner in the long and short-term.

Great. Well, thank you, Mike. And you've got great numbers. I'm really very impressed with the first quarter numbers.

Thank you, Aldo.

And I just -- I'm going to get back in queue for the follow-ups.

(OPERATOR INSTRUCTIONS.) Michelle Appelbaum with Michelle Appelbaum Research.

Hi. Well, the first question I have is are you bidding for Ryerson?

Well, if we were, we wouldn't tell you.

Oh, oh. Okay. That was tongue-in-cheek.

The second question I have for you is that, historically you had put a fair amount of money back into the Company and gone downstream and value-added processing. And some of those returns never quite happened. Can you just address the difference this time versus last time?

Well, if you're referring to the automotive buy in 1995, Michelle, I mean, clearly we went into a market that was in decline. It was probably in decline before we got there. And certainly from '95 to 2007 we can say the domestic automotive industry, which is where our participation was, was a universe that was -- what's a good word -- troubled, at best.

And we're moving into a universe now, Michelle, where we're just completing the supply chain. We're not trying to service a market, per se, as much as we believe that within the inefficiency of the steel supply chain there's lots of value that is being dropped off for the ultimate end use customer.

And so, our driving strategy is to try and close the loop on the supply chain and become closer to that customer and embedded in his manufacturing process, as opposed to saying, hey, let's get into a big volume user.

And so, we're not in the vagaries of the customer base who has had a tendency to be abusive to its suppliers. We're now in a really creation of efficiencies in supply chain to a marketplace that seems to be expanding on a global basis. So, I think it's a lot different.

Okay.

And we're smarter and we're older and we learned from our previous mistakes.

Okay, yes. Okay. That's a good point, too.

Then my next question is, are you looking at growing through acquisitions in this market?

Yes. I would say that clearly we participate in much of what is going on. We are -- I won't tell you that we have been successful at some of the prices that have been paid of late. We think some of the prices are higher than our thresholds. But, we clearly are looking at acquisitions, yes.

Okay. All right. And what are you finding with valuations?

They're historically high.

Okay. But, still opportunities for accretive, synergistic--?

Yes. I mean, there's no question if you look at it from an accretive standpoint exclusively, in almost everything based upon the finance market today you can say almost anything you buy at the kind of levels that we're seeing today would be accretive.

You also have to be the highest bidder today. You can't come in second place. You've got to be in first place to win these, because a lot of these -- these are one-offs at the highest number that they can get. But, they're clearly doable deals that are out there and we're excited by some of the opportunities we're looking at.

That's great. Okay. Thanks.

(OPERATOR INSTRUCTIONS.) Mark Parr with KeyBanc Capital Markets.

Thanks. David, I was just wondering if you would be willing to venture a guess as to what average selling prices might look like 2Q -- realizations 2Q versus 1Q.

Mark, I mean, just in terms of general, we don't break those kind of things out. But, as we said earlier, we see more of a traditional service center year and there's always strength in Q2 as opposed to Q1.

So, we really like the way that we're entering this quarter as opposed to the way that we entered Q1. And so, I think that really speaks in volumes.

Okay. Sorry to keep pushing at it.

No problem. Although Michael's got his hand on my neck.

All right, guys. Hey, I'll just--.

I don't look good in an orange jumpsuit (inaudible).

I didn't ask you for the bottom line! I'm actually trying to go from the top down! Come on!

Michael's anticipating your next question.

No, I'm not going there.

Thank you, Mark.

So, yes. Hey, just keep up the great work. And thanks again, guys.

Thanks, Mark.

[Hassan Jafar] with Seneca Capital.

Hi. Thank you. I was wondering, could you comment on your view with a lot of talk about a lot of the integration players in mills coming into the service center, how do you view the industry evolving and what's your perspective in terms of how that might play out in the U.S.?

Outside of rumors of this guy doing that, or maybe that guy doing this, I mean, clearly you see some things with Nucor and Harris Steel and you see what the Wheeling-Pitt scenario is.

I think that there is a movement afoot to try and improve the supply chain from the steel producer to the end use market. I think some people are understanding that they have abdicated -- some of the steel producers have abdicated their relationship and concern for the end use market. And therefore, in trying to expand their order book and get closer to the customer base and try and take -- there's a very inefficient supply chain in carbon steel -- and bring it to some more discipline as we see the discipline and the consolidation of the supply base.

I would anticipate that those who understand that the supply chain is ultimately the value creation, you will see them moving into a much more vertical kind of penetration to the market.

And so, we would anticipate -- probably -- it's a guess, but we would -- more alignment as it relates to -- I don't know what ownership means, essentially. There could be lots of different kinds of structures to that. But, we would see better alignment in the supply chain between steel producers and distributors over the next 5 to 10 years.

And what do you think are going to be some barriers to initially sort of get that going? A lot of what you hear in the marketplace is how the service centers would react in terms of -- if a steel mill was to go out and buy one of their competitors, what's your perspective around that?

Well, when U.S. Steel owned U.S. Steel Supply and National Steel owned National Steel Supply, I mean, people bought from the steel mills. Inland owned Ryerson. People bought from Inland. I think that's somewhat overrated. I think people have -- there's less steel producers to buy from on the flat roll side. So, if you need to buy, whether they own a distributor or not, you're going to buy from the steel producer who gives you the best value equation for yourself.

So, people can stop and jump up and down but, at the end of the day, I mean, the market is efficient over time. And those who create value in the supply chain will ultimately win.

Thank you.

Aldo Mazzaferro from Goldman Sachs.

Hey, Mike, just two quick follow-ups here. As I look at the outlook here, I'm trying to get a sense for how much of your product mix might move with the market, the index movement, and how much -- given your new mix, how much might lag a little bit. Do you have a feeling for what percentage of your business might be considered spot versus something more stable than spot?

Well, we've been pretty honest about that over time. We have a desire to increase our direct business. But, I would tell you it's probably still 65%, 70% contract and 30% spot, 25%, 30% spot.

Okay. It seems like you've been beating the index consistently for the last 6 or 7 quarters if you measure how much the -- like the purchasing magazine moves and how much your average selling price moves. And I'm just wondering, as it starts to move up again in the second quarter, it's significant in terms of the sensitivity to your bottom line. Whether your pricing goes up a little bit or a lot.

Well, as I said to our board last -- yesterday at our board meeting, I give all the credit to David Wolfort, who understands elasticity and price curve better than most people.

Great. And then just the other follow-up, Mike. Can you tell us a little bit about what you're doing in Iowa with the 50,000 square feet? I know there's been quite a bit of demand coming out of the -- what do you call it, ethanol markets and maybe the wind tunnel markets. So, I'm just wondering if you're seeing that or what do you plan to do with that extra space?

I'll let David answer that.

Aldo, we're adding 54,000 square feet. As we have commented, we're also adding the stretcher-level line to Minneapolis. And it's a collaborative effort to expand our marketplace. We see some pretty significant expansion in terms of tons out the door with both of these components working concurrently.

What we're actually doing is adding some packaging space. We're a little bit bottlenecked in Iowa. We'll offload some -- a size range and get closer to our customer base in Minneapolis on some products. Therefore, we'll lower our cost of distribution out to some customers. So, we see a number of wins across the board.

But ultimate, as Michael and Rick have both talked about, with our downstream strategy well in place, and it is a process for us, we need to be able to produce more product off of our temper mills. And this addition will make us more efficient along with that stretcher-level line in coil, and will allow us to push more product into our downstream operations. So, that's number one.

Number two, as you asked a little bit earlier, we do in fact view the volume business that we have. And the volume business, we have some significant growth out in our central region, again in the surrounding Iowa area where we have performed exceedingly well. And we've had some fabulous -- we're recruited some fabulous opportunities in terms of new business out there that's a rectangular business. So, we look to fulfill all of those aspects.

But, the two markets you mentioned, Aldo, which were wind tower and ethanol, are very strong markets. There's no question.

Yes. Well, thanks. Thanks very much.

(OPERATOR INSTRUCTIONS.) And at this time, we have no further questions. I'd like to turn the call back over to management for any additional or closing comments.

Thank you, Matt.

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 second quarter 2007 earnings on or around July 31st. And this concludes our call and we thank you again for your interest and participation with Olympic Steel. Thank you.

Again, that does conclude today's call. Thank you for your participation. Have a good day.