Olympic Steel Inc (ZEUS) 2008 Q3 法說會逐字稿

Good day, and welcome to the Olympic Steel Third Quarter 2008 Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to Mr. Michael Siegel, Chairman and 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. I want to thank all of you for your participation and for your interest in Olympic Steel.

Before we begin our discussion, I want to remind everyone that during this call we will provide forward-looking statements that we do not undertake to update or that may not reflect actual results, changes and assumptions, or changes in other factors affecting such forward-looking statements. Important assumptions, risks, uncertainties, and other factors that could cause actual results to differ materially from those set forth in the forward-looking statements can be found in our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K. It's hard to say Securities and Exchange Commission without a joke after that these days.

But in any case, we are pleased to report record year-to-date 2008 financial performance. For the first nine months of 2008 we have achieved record sales and earnings while gaining market share in a depressed demand environment. We are particularly proud of our ability to perform well from an earnings perspective, maintain a strong balance sheet, and invest in new property, equipment, and technology. Let me review some of the details from our third quarter and nine-month earnings report released this morning.

Our third quarter sales totaled 335 million, up 31% from the 256 million recorded in the third quarter of 2007. For the first nine months, our sales increased 23% to a year-to-date record of 974 million, compared to 793 million in the first nine months of 2007. Our third quarter sales volume totaled 268,000 tons, compared to 309,000 tons shipped in the third quarter of 2007. For the nine months, our shipments totaled 937,000 tons, compared to 957,000 tons last year. Our year-to-date tonnage volume decreased by 2.1%, which compares favorably to the decline in the total service center shipments of 6.6% for the nine months as reported by the Metals Service Center Institute's Metals Activity Report.

Our third quarter net income increased more than four-fold to 24.2 million, or $2.21 per diluted share, compared to 6 million or $0.56 per share for the third quarter of last year. This brought our first nine months net income to a record $66.9 million, or $6.13 per diluted share, compared to 20.7 million or $1.93 per diluted share last year.

While there is much uncertainty and limited forward market visibility in this challenging economic and financial environment, we believe we are appropriately positioned with a strong, low leveraged balance sheet and a proven approach to disciplined working capital management, and turnover. At the end of the third quarter, we had shareholders equity per share totaling $20--$29.67. We continually--excuse me--we continue to actively invest in Olympic's growth with $24.4 million of year-to-date capital spending on facilities, equipment, and our new information system. We expect to improve our balance sheet strength with positive cash flow and lower debt levels in the foreseeable future.

I am also pleased to report that Olympic Steel's Board of Directors has approved a regularly--a regular--I can't read today--a regular quarterly cash dividend of $0.05 per share to be paid on December 15, 2008 to shareholders of record on December 1, 2008. As you will recall, we have increased our regular quarterly dividend from $0.04 per share to $0.05 per share last quarter.

I will now turn the call over to Rick to comment on some of our financial results in more detail.

Thanks, and good morning, everyone. Our gross margin increased $329 per ton in the third quarter, up from $163 per ton last year. Our 2008 year-to-date margin totaled $275 per ton. The strong margins were the result of higher steel and scrap prices in the first nine months of 2008, growth in our value-add business, and a sales mix of less toll processing volume. Our operating expenses totaled 50.2 million in the third quarter, compared to $39.7 million last year. Our year-to-date expenses totaled $150.9 million in 2008, and that compares to $117.5 million in 2007.

The increases in expenses are primarily due to higher variable performance-based compensation tied into the financial performance of the company, higher transportation and fuel costs, and increased costs associated with the investment that we continue to make in value-added processing facilities and equipment.

Operating income for the third quarter totaled $37.8 million, or 11.3% of sales, compared to $10.7 million, or 4.2% of sales, last year. For the nine-month period of 2008, our operating income almost tripled to $106.4 million, or 10.9% of sales, and that compares to $36 million or 4.5% of sales in the 2007 period.

Interest expense for the third quarter was 350,000, compared to $640,000 last year. And for the nine months, interest totaled $537,000, compared to $2.5 million in 2007. As indicated earlier, we expect to generate free cash flow and reduce our debt balances in the upcoming months. Our effective tax rate for 2008 is running at about 36.8%, compared to 38.0% last year. And our tax rate for the remainder of this year should remain relatively constant.

Now, taking a look at our balance sheet, we continue to manage credit and receivables well. We ended the quarter with $131.8 million of accounts receivable, which is up $43.4 million from the end of 2007. And the higher receivable level is due to higher sales as our days sales outstanding remain quite strong and actually declined about one day to 37 days in 2008 as compared to 2007. Our inventory totaled $313.6 million and that is up $135 million from December 31. Year-to-date, we have turned our inventory an average of 4.2 times in 2008 and that is slightly below our targeted turnover range, due to weaker than expected sales in the third quarter. However, we have already reduced our inventory tonnage by 14% from our mid-September peak and we expect to further reduce inventory through the fourth quarter.

Our debt increased to $89.6 million at September 30 and we finished the quarter with about $39 million of availability under our credit agreement. As a result of the decline in steel prices and the reduction in our inventory levels that I just mentioned, we are expecting strong cash flows and reduced debt in the upcoming months. We spent $24 million in CapEx in the first nine months of 2008 and we continue to invest in the future growth of Olympic Steel. And David will talk more about some of our capital investments in a few minutes.

Our capital structure remains strong. Our debt to equity ratio is 0.28 to 1, and our trailing 12-month debt to EBITDA ratio is 0.7x. Our shareholders equity per share increased to $29.67 at September 30.

Now, I'll turn the call over to David.

Thank you, Rick and Mike, and good morning to all. On our prior calls we've discussed our focus on strategically building a strong balance sheet. In today's uncertain financial and economic environment, this strategy is serving us well. We believe we are appropriately positioned with the current market with a strong, low leveraged balance sheet and a proven consistent track record of taking a disciplined approach to working capital management and turnover.

As Rick mentioned earlier, since mid-September we have reduced our inventory tonnage by 14% without the help of strong demand for steel. Our inventory volume has dropped 9% in October alone, and we expect to see inventories continue to decline through year-end as we get back to our preferred inventory turnover rate of about five times per year.

We spent $24 million in capital expenditures in the first nine months of 2008 and we've committed to a similar amount for the future. Our capital spending program includes new facilities in Dover, Ohio, and in Sumter, South Carolina, which will contribute to our operational success in 2009. We are also investing in multiple pieces of new processing equipment, such as large bed lasers, plasma cutters, press brakes, shop blasters, a blanking line in Connecticut, new stretcher leveling line in our Minneapolis coil operation.

Our new IT system implementation is progressing on plan. We successfully implemented the accounting module in the third quarter. We plan to begin the phased-in use of the business operating system in 2009. We expect to self-fund our capital spending with cash flows from operations and working capital reductions. In summary, we are very pleased with our record 2008 financial performance and the exceptional efforts of the Olympic Steel employees. We have built a company with a strong financial base and a tested and experienced field management team, which will serve us well in this unusual marketplace.

Our strong financial foundation includes $29.60 of net book value per share, the payment of regular quarterly dividends of $0.05 per share, as Mike has indicated, and a declining inventory position, and expected strong cash flows that Rick mentioned, that will result in lower debt levels. Most importantly, we continue to make prudent investments in people, systems, facilities, and equipment to ensure that we provide our customers superior quality and service in close proximity to their locations.

While global markets are currently challenged, we remain optimistic about the long-term outlook of the steel industry and for Olympic Steel. We are confident that we will successfully navigate through this business cycle, just as we have done in prior markets that demonstrated sluggish sentiment.

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

Thank you. (OPERATOR INSTRUCTIONS.) And we'll take our first question from Lloyd O'Carroll from Davenport.

Good morning.

Hi, Lloyd.

A couple questions on volume. You added some capacity in the quarter. Can you give us the same store sales change in tonnage, so we can get a feel for how much did capacity add to your numbers?

Well, we don't usually do a breakout other than what we show on the financial information, Lloyd, between the direct sales and the tolling sales. The tolling sales generally is predominant in the Detroit market. As we saw from the release, the tolling sales are down about 16,000 tons for the year, so that's the predominate decrease. Our direct sales are only about 4,000--on 840,000--830,000--we're 0.005% down on our direct sales. So, yes, I would argue that within the construct of the marketplace we're actually doing better than even the statistics show in total from a direct basis, as pretty much across the board we've seen strong markets in the markets where we're presently located. As we bring on these new facilities we're hoping for tonnage growth in the future.

Okay. How does volume evolve through the quarter and into October? Did it fall (inaudible) September. I'm mostly just trying to get a feel for what does industry in your volume look like where we sit today.

I don't think from what we've read from everybody else's announcements that we're a different market than everybody else. Mills lose their volume. They sort of upload the service center inventories. Yes, we saw probably a bigger drop-off in September than the previous two months, but October seems to be steady. We're not seeing this cliff demand--or lack of demand that others are claiming. We're selling every day.

Lloyd, this is David. As I commented at the conclusion of my statements, we characterize this more as a sluggish environment, a little bit different than the mills environment here. The mills are compelled to have to wait for a large inventory work off and our customer base is sluggish, but they're still active today.

Yes. I mean, the mills will be impacted among other things by the fact you're taking your inventory level lower.

That's correct.

As is every other service center.

That's correct.

Yes. Okay. So business is not a disaster, but it's not exactly robust either.

That's correct.

That's right.

I think the financial markets give greater pause than the actual steel market. I think today everybody is a little bit concerned about the bank more than they are about their own business. And whether their renewals are coming up for review is--we're looking at our customers' information in terms of who their banks are. I mean, it's really kind of--it's a different kind of environment than we've been through in a very long time. We have to worry more about the bank than you have to worry about your customer.

Have you seen any deterioration in the credit quality of your customers?

No, as Rick indicated in his comments, we've actually picked up a day this year. We certainly have a lot more scrutiny. We're a little bit unusual. We have our own credit department and do our own credit work. We're not depending on the credit insurance company to do the work. So we have a very strong credit performance and a long history of knowledge on who's appropriate and who's not appropriate to extend credit to.

Okay. As we all know, we've been through these cycles before. And I'm just trying to figure out how bad does it get before it improves.

Well, I said to somebody last night that I ran into that this is a normal steel market, Lloyd, and we've lived a lot more of our life in these kinds of markets than what we've seen in the last couple years. So we're very used to this market.

Yes. Okay, I appreciate it.

And we'll take our next question from Mark Parr from Keybanc Capital Markets.

Hi. Good morning. Can you hear me?

We can, Mark.

Yes, this is actually [Jason Broches] in for Mark. Mark's on the road today.

Yes.

How are you guys?

Good. How are you, Jason?

Doing okay. I just wanted to--a couple questions. I was wondering if you can talk about what you're seeing as far as the availability of imports with the strengthening dollar in recent months.

Jason, I'll respond to that. David, here. We're seeing slightly more offerings. Our expectations are that we will see more offerings as the dollar has strengthened over the last 90 days, barring a little bit of fluctuation here today. Ocean freight rates are down dramatically. The combination of both of those and a hunger for additional marketplaces I think will elevate the offering. So we're starting to see them today. Nobody is really taking advantage of them. Our expectations are that we'll see people probably toward the end of first quarter '09 taking advantage of them, if there is a significant differential.

Okay. And just in light of the credit--difficulty in the credit markets, what--has that allowed you guys to gain some market share?

I hope not. I mean, at the end of the day, I would tell you it's probably cost us sales because we're a little bit more tight with our credit than some others who are more concerned about their cash situation than we are. I would think it's the inverse, Jason, that in fact we are capable and apt to decline sales rather than extend credit.

Okay. And that's really all I had for you. Thanks.

Thank you.

(OPERATOR INSTRUCTIONS.) And we'll take our next question from Charles Bradford from Bradford Research.

Good morning.

Good morning.

Hi. Now the expected question on pricing. Are you seeing the kind of offers that we're hearing around the market, which are obviously quite low, but also quite variable?

Yes, Chuck, we are seeing a broad range of pricing, a lot of that emanating from foreign purchased North American operations that may be a little bit more heavily leverage than the consistent domestic ownership that we've seen before. We also are seeing a broader range of offerings, again, as I commented earlier on Jason's question, on foreign product. So there is, again, in our terminology a broader breadth and width of offerings.

Traditionally, [836] traded at pretty close to the same price as hot rolled coils, but in the last couple years the plate has held up substantially better--or gone up substantially more. Are you starting to see any weakness or any back to the norm in that market?

No. Chuck, we do see some pricing adjustments, but there is still a healthy and significant differential between the--the ebb and flow of flat rolled, as you well characterized, and plate, we find plate pricing is more characteristic of plateauing at different levels and we see more cyclicality with flat rolled. But there's still a healthy differential between them.

Any guess as to when your customers or your competitors--take your choice or both, if you can--might have their inventories back into a more normal position?

Actually, no, I don't think we're any better a prognosticator than our customers are themselves. I don't think anybody is going to be building inventory this quarter as we move into the new year and the new presidency. So sometime next year, but it could be anywhere from the first quarter to the third quarter. But we have varying degrees of optimism to pessimism through the gamut of our customer base.

From our perspective, Chuck, we've been here before. As Mike said earlier, we've been in the sort of sluggish environments any number of times, probably more than people would like to be - seven or eight times, I think, something along those lines over the last 35 years. And we managed to bring our inventory in line in pretty quick order, as we've demonstrated by some of the statistics that we normally don't talk about. But our customer base is working there, finished goods down, and it depends really, as Michael well says, on how sluggish the economy is on a go-forward basis as to how strong they'll bring their production back. Production will still be here. It's just a question of how strong their production will come. From our perspective, we continue to earn more market share. As we put a bigger footprint closer to the strategic customers, we garner more share of that marketplace.

It's not like there is no economic activity at all. It's just down a few percent.

That's right. There's plenty of business out there.

I mean, really, Chuck, I mean, like everybody knows, everybody is really concerned about the financial issue. We need stability in the financial markets. Whenever that occurs and until that occurs we're not going to see stability in the steel consuming marketplaces, because how can you be more confident than your ability to garner capital.

Thank you very much.

Thanks, Chuck.

(OPERATOR INSTRUCTIONS.) And we'll go next to Nat Kellogg from Next Generation Equipment.

Hi, guys. How are you doing?

Good, Matt.

I appreciate the commentary on inventories and on pricing. Just wondering if you could give us a little commentary on sort of end markets. I mean, obviously, you mentioned Detroit is a little bit slower, and I'm sure that comes as no surprise to anyone. But just what areas are you guys seeing things are continuing to go pretty nicely and maybe some areas where you are seeing a little bit of softness outside of auto?

Nat, we made a--let me just give you a little reference here. We made a significant decision five to six years ago not to be involved in low end commodity products, and so we've sort of [stayed] away from that. Obviously, what you see is appliances are down and we're not involved in the appliance end of the business. Automotive is down and we've reduced our automotive participation significantly over the last three years, but we do enjoy a small piece of it.

And so, what you see in automotive is what you get. It is a very sluggish environment there. In terms of the rest of the customer base, construction equipment, it's somewhat down. Mining equipment is not down. Agricultural equipment from our perspective is not down. One of the things that we are seeing that we have made no comment on and there really hasn't been any question, we're actually seeing products that are manufactured overseas for any number of our large OEMs coming back to this country and we're benefit from that. So the freight even though it's down, the overseas quality and overseas labor has--the labor has increased, the quality has gone down, and it has compelled large OEMs to bring product back to the United States and we are benefiting from that piece of the business. So we're seeing a little it of pickup in that regard.

And the energy markets remain pretty healthy and the military business remains pretty healthy.

Okay. That's helpful. Energy in the military. And now, also, just tell me on the inventory side, I mean, if I look at inventories in the marketplace, at least what the MSCI is sort of talking about. I mean, inventories are a little bit higher this time than they were maybe a year ago. But if I go back to '06, I mean, inventories are--on an industry wide basis are a lot lower than they were in 2006. Now, maybe the economy is a little bit weaker, so that presents a challenge. But I mean, I guess--I mean, how much inventory--I guess you had about a quarter or two you felt like would get the industry back into sort of a more appropriate inventory balance?

Again, this goes back to a financial metric, too, Nat. I mean, again, even though the levels from a days sales may be better, worse, or about the same, I mean, the dollars invested in the inventory are so much more significant for everybody. Not everybody in the service center business is well capitalized. And therefore, as you've seen this run up in pricing, people are more apt to want to liquidate quicker because of the high prices that have been across the board in inventories. So even though you would expect the inventories to have been higher in a market like this, people just couldn't afford to get the inventory. So I would think that you would see a lot of liquidation going on between now and the end of the year in the total sector because of the capitalization issue.

Okay, that's helpful. And then, just last question. I know you guys have talked a little bit about the price that you guys are seeing from the mills that went up. But just sort of curious how much discipline there is in the service center space, how much discipline you guys are seeing as far as service centers on their pricing and making sure that they keep some discipline in pricing, so that people won't get hurt with higher price inventory and all that kind of stuff? Any color there would be great.

None.

Well, Nat, part of that is (inaudible) if the service centers are absent from buying from the mills and there is no lower cost of material coming into the service center, so everybody's battling in the marketplace with the same cost of goods. So in short, nobody is advantaged. The only person who can be advantaged in this marketplace is the first person who takes their inventory down to the appropriate level that allows them to come back in as a significant buyer in this marketplace. And as Michael well said, part of that is constrained by the credit issue and can they come into this marketplace. And the other part of it the constrain is--in full proprietorships or non-public entities is what's the appetite for risk on a go-forward basis?

Yes. Nat, I think what you would see in a market like this, and we are seeing it, is that rather than step back into the mill, the service center will buy from the other service center first, because it's a much--there is no requirement of volume when you buy from another service center.

Sure.

So if you're short a truckload, you'll go and step in and buy a truckload from the service center. We looked at our service center sales and actually they're about--you would expect them to be down because service centers are actually on lower shipments. Our service center sales are pretty flat. So service centers are stepping in and buying from each other rather than buying from the mills at this present time.

And that's an excellent point, Nat. And also, large OEMs who are traditionally--do some service center buying, but do direct mill buying are also extending their service center buys because they can, again, as Michael well commented on smaller volume, they can bring in smaller volume and feed themselves on a hand to mouth basis. And so, again, we'll see inventories drop faster because of that. And there is a less suggested competitive tone out there because nobody is advantaged.

Okay, all right. Now, that's very helpful. All right, guys. Well, thanks, as always. I appreciate the color. Those were very helpful comments and we'll look forward to--good luck on the rest of the quarter. Thanks a bunch.

Thank you.

And we'll go next to Bob Richard from Longbrow Research.

Long brow? I'd better trim them. Thanks for taking our call.

Sure, Bob.

Can you comment for your customers, guys, would they--would you say that their export markets are better than the domestic markets, or are you able to provide any color there?

We'd have no idea. I don't think--they don't--we don't have that insight.

Well, from an overall perspective we wouldn't be able to comment. From an individual customer perspective, customers that we deal with that have an export position, a delivered--a deliberate export position, not one that took just advantage of a high--of a lower value dollar. Those people still have basically the same ratio of export to domestic--but they have a disciplined approach to the marketplace. We haven't seen any degradation there.

Okay, that helps. And again, the operating profit per ton, obviously very impressive. Is it fair to say, if we reach a new plateau, a new higher plateau, and still inflate pricing once this fell off, and that we should expect sequentially gross margin per ton higher than--it probably was about $175 a ton on average when prices were about 850 plateau. It would be reasonable to think that that's going to be upward if we reach a new plate plateau of about maybe $1,100.

Well, we have a stated objective of increasing our gross margin per ton by adding value-added equipment and getting into sort of first stage manufacturing for the ultimate assembler. So as we continue to invest in that downstream manufacturing opportunity, yes, the answer to your question is we would expect that our gross margin per ton increases accordingly.

Okay, that's very helpful. And great quarter and thanks.

Thank you.

And with no further questions in the queue, I'd like to turn the conference back over to your presenters for any additional or closing remarks.

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's sales or earnings estimates. We anticipate releasing our fourth quarter and full year 2008 earnings in mid-February. This concludes our call. And thank you all, again, for your interest in Olympic Steel.

And this concludes today's conference. We thank you for your participation. You may now disconnect.