Olympic Steel Inc (ZEUS) 2009 Q2 法說會逐字稿

Good day everyone and welcome to the Olympic Steel second quarter 2009 results conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to introduce Mr. Michael Siegal, Chairman and CEO. Please go ahead, sir.

Thank you, Danielle. Good morning and welcome to our call. On the call with me this morning is David Wolfort, Chief Operating Officer and President of Olympic Steel and Rick Marabito, our Chief Financial Officer. I want to thank you all of you for your participation and for your continued 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 in 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.

Earlier today we reported our financial results for the second quarter and the first half of 2009. Let me review some of the details from that release. Our second quarter sales totaled $122.4 million, which is down 66.3% from the $363.5 million recorded in the second quarter of 2008. The sales decrease was due to falling selling prices throughout the quarter and sharp decline in customer demands.

Our second quarter sales volume totaled 174,000 tons compared to 353,000 tons shipped in the second quarter of 2008. This represents a 50.8% decrease in tons shipped.

We successfully executed our expense reduction plan, reducing second quarter operating expenses year over year by $28 million or 50% to match the decline in tons sold for the comparable period.

Our second quarter net loss totaled $33.8 million or $3.11 per diluted share compared to net income of $29.6 million or $2.70 per diluted share for the second quarter of 2008. Our second quarter 2009 results include a required inventory lower of cost or market accounting adjustment of $50.5 million that was recorded as of June 30th due to the continued deep deterioration of pricing and demand that occurred during the second quarter.

Our first half sales totaled $263.3 million, which is down 58.8% from $638.4 million recorded in the first half of 2008. Our first half sales volume declined 48% or 345,000 tons compared to 669,000 tons shipped in the first half of 2008. This compares to the year-to-date 44% decline in total steel service center shipments reported in the Metal Service Center Institute's June 2009 Metals Activity Report.

Our operating expenses in the first half of 2009 were $41 million or 41% lower than the first six months of 2008.

Our first half net loss totaled $59.3 million or $5.45 per diluted share compared to net income of $42.8 million or $3.93 per diluted share for the first half of 2008.

Our first half 2009 results include total inventory lower of cost or market pre-tax adjustments of $81.8 million. Our 2009 results were impacted by the dramatic and continued decline in industrial activity in North America resulting in sequentially weaker demand for steel in the second quarter, which was most evident in our plate and fabrication operations where many of our large original equipment manufacturing customers for which we perform the preponderance of our value added services continue to experience substantially lower production levels than the market as a whole. We are not anticipating a meaningful improvement of OEM customer demand in the back half of 2009.

Our inventory turnover significantly improved in the second quarter as we executed on rightsizing our inventory to our preferred historical Olympic Steel turnover rates and worked through high-costed inventory purchased specifically for these customers. We reduced our inventory tons by 32% in the quarter and experienced operating losses in doing so. However, this generated significant cash flow and allowed us to strengthen our balance sheet and reduce debt by $57 million or 64%.

The second quarter truly was a difficult period for the income statement, but we restored our strong balance sheet position through working capital turnover while maintaining a keen focus on expense reduction and our core values. We have a bank agreement committed through December 2011 with no interim debt maturities and only $18 million borrowed today. We have a significantly lower expense base and the experienced management team that provides Olympic Steel with a strong foundation for the long-term success in the steel industry.

Also this morning we reported that we reported that we are (technical difficulty) to pay a quarterly dividend. Olympic Steel's Board of Directors has approved a regularly quarter cash dividend of $0.02 per share to be paid on September 15, 2009 to shareholders of record on September 1, 2009. I'll now turn the call over to Rick to comment on some more detailed financial results.

Thank you Michael and good morning everyone. First I'd like to cover the inventory lower cost or market charge. Similar to our first quarter charge, the inventory adjustment was taken as of quarter end in accordance with accounting rules. The primary driver of the June charge was direct selling prices that fell an additional $180 per ton or 20% during the second quarter. Cumulatively, we have taken $81.1 million of lower of cost or market adjustments in 2009 as our direct selling prices declined by $385 per ton or 34% during the first half of the year. Based upon current market price increases we do believe that these inventory charges are now behind us.

In terms of how the LCM charges are presented, the $50.5 million second quarter amount was recorded on our balance sheet as a reduction of inventory and was reflected as a separate line item in our income statement under the costs and expenses section. The adjustment was calculated in accordance with generally accepted accounting principles to state our inventory at market under a two-step process. Step one reduced our total inventory from its cost basis to our average sell price at the end of June. Step two then further reduced the inventory value for the future costs of completion to get the inventory to the point of sale.

Next, I'd like to review our banking agreement, which is committed through December of 2011. We amended our credit agreement in July to allow for up to $100 million of lower of cost or market adjustments to be excluded from our EBITDA covenant calculations. We ended the quarter with only $32 million of debt and have already reduced borrowings by another $14 million. And, as Michael said, our debt currently stands at $18 million as we end July. We anticipate further reductions and expect to eliminate our dept in the second half. We currently have approximately $44 million of availability under our credit agreement and our debt to equity ratio is only 0.12 to 1.

For the second quarter of 2009 our operating expenses totaled $27.6 million. This is a $4.3 million or 13.5% sequential reduction from the first quarter of 2009. Michael provided you with the other expense statistics where we are down year over year by 50% in the second quarter and by 41% for the first half.

Second quarter capital spending was reduced to $2.3 million bringing our year-to-date CapEx total to $9.5 million. We have reduced our CapEx projection for the second half of the year to about $4 million and that consists of maintenance capital spending, as well as our IT system project.

An income tax benefit of 38.6% was recorded in the first half of 2009 and the majority of the $37.2 million tax benefit from the first half can be carried back to prior years resulting in a significant cash refund expected in 2010. Now, I will turn the call over to David.

Thank you, Rick and good morning. During our first quarter conference call in April, we indicated that we were not satisfied with our financial performance and we outlined some specific performance goals for the second quarter that included, first off, reducing our inventory by 25% and using the cash generated to pay down debt, as both Mike and Rick described; second, preserving cash including a reduction of our capital spending plan; third, we further emphasized reducing our operating expenses while maintaining outstanding customer service and quality; and fourth, and on a longer term basis, garnering new business and greater market share at a time when customers are looking for strong, financially stable and experienced suppliers like Olympic Steel. I'd like to review our second quarter progress and accomplishments for for each of these goals.

On the inventory reduction side during the first quarter, we had too much inventory due to inaccurate customer forecasts and we targeted a 25% reduction in inventory tonnage for the second quarter. As indicated by Rick and Mike earlier on the call, we actually reduced our inventory by 32% in the quarter with a demand environment that was weaker than the first quarter. Based upon recent July shipping and inventory levels, we are approaching our historical turnover rate of five times. Since the end of the second quarter we've reduced inventory tons by another 11% and have targeted further improvements in inventory turnover for the second half of 2009.

Our second tenet was cash flow and debt reduction and we established a goal of significantly reducing our debt and potentially eliminating debt by the end of 2009, as Rick took us through a moment ago. We've made significant progress towards that goal in the second quarter by reducing debt by $57 million or 64%. Further, we've reduced debt by another $14 million in the month of July and anticipate in eliminating all outstanding debt by year end. We anticipate enhancing our cash position with significant income tax refunds occurring in 2010.

Third, scaling back on CapEx -- we suspended many of our planned 2009 capital spending projects, including our expansion in South Carolina and have now reduced our CapEx run rate to about $2 million per quarter [for] ongoing capital spending of our STEELMAN IT project and maintenance CapEx. We successfully implemented our STEELMAN IT system in Cleveland and Connecticut facilities in the first half of 2009 and have now migrated and are beginning our -- operating under the new system in our Chicago operation during the third quarter. Our strong balance sheet position and elimination of debt will allow us to consider appropriate capital spending for growth in 2010 and beyond.

Further reductions of our cost base -- again, we established a goal to lower our cost base from first to second quarter to better align our cost structure with significantly depressed levels of steel industry demand, as Mike outlined earlier. We accomplished this by sequentially saving $4.3 million or 13.4%. We've now established an annual expense base, which is about $70 million or 37% lower than in 2008. Further expense reductions will be achieved as we will not renew our Philadelphia warehouse lease that expires at the end of 2009. We will continue to service all our customers' needs in the region through our other facilities in Pennsylvania, Connecticut and Ohio.

Our fourth tenet was garnering new customers and we have experienced what we consider a flight to quality by certain well known OEM customers who are consolidating their supply and expense base by looking for large, experienced, financially stable service centers and fabricators to meet their service and cost reduction needs. Olympic Steel meets these criteria and we are being awarded significant amounts of future business as a result. We're excited about these opportunities, which will allow us to grow market share once OEM demand rebounds from the current depressed levels.

In summary, our execution to rightsize our expense base, reduce our inventory, pay down our debt, positions Olympic Steel well for a return to profitability and for growth opportunities. We have built a company with a strong foundation and tested and experienced management team, which served us well in these difficult times. We are confident in our future and our ability to successfully emerge as an even stronger company when steel demand exits its depressed state.

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

(Operator instructions) We'll pause for just a moment. And our first question will come from Sal Tharani with Goldman Sachs.

Good afternoon, guys.

Hi, Sal.

A couple of questions -- you mentioned that on inventory you had a goal of 25% and you actually exceeded and reduced the tonnage by 32%. How are you seeing at the end users? Are they also running lean and have reduced inventory dramatically like the service centers have?

Sal, David here. I'll field that. The short answer is yes. We seed the end users reducing not only their finished goods but their raw materials corresponding, quite frankly, to lower thresholds of business.

Okay, and when I look at the third quarter, you mentioned in your press release that you see things improving from the price side, how is the shipment volume looking? Do you think the third quarter volumes across the industry will be better than the second quarter?

Marginally, yes. Go ahead, David.

Sal, yeah, as Michael just indicated, we do some some marginal improvement. Of course, we've come from some very depressed rates, as you well know. And we saw that depression really start to ferment in the beginning of March and then, obviously, it cascaded dramatically in the second quarter. And from our perspective, the weakest of the market occurred at the latter part of May and then we've started to see some hints of recovery here in June and July.

Particularly in automotive. Obviously it was a very challenging second quarter from a volume perspective in automotive.

Are you seeing improvement in automotive now?

Yes, marginal.

Okay, and lastly, as a company is your goal is to reduce inventory further in the third quarter or do you think you will need to plug some holes you might have in the inventory?

Well, Sal, this is Rick. I mean our goal is to get back to our historical, you know, five plus inventory turn. We talked about almost being there. So, obviously, you know, if demand remains about the same you will see lower inventories from Olympic Steel in the third quarter. But as we move through the second half, if demand does pick up that would warrant keeping a five turn or thereabout. And toward the back half of the year there could be some increase in the inventory. But right now the answer to your question is yes, we're still lowering those inventories as we move through the third quarter.

Okay, thank you very much guys.

Thank you, Sal.

And our next question will come from Tim Hayes with Davenport and Company.

Hey, good morning.

Good morning.

Just to further ask on the trend in business -- so if shipments in Q3 could be maybe marginally higher than Q2, that's -- typically, Q3 would be below Q2 just in terms of normal seasonal patterns, correct?

Yes.

Okay, so that indicates a little bit of a cyclical upturn is how I read it.

You know, that's hard to say Tim. I mean the levels are so low. You know, you had closed auto plants. I don't know if it's seasonal or just, you know, it's better certainly not anywhere near normal, so. But you're coming off literally no production in certain cases, so.

And then on the, say, gross margins per ton, in trying to figure out what we might see in Q3, given that the steel prices have turned higher and then you've written down the inventories, I would expect gross margins to not only increase from Q2 but maybe materially?

Well, Tim, it's Rick. As you know, we don't give specific guidance on any of the line items. I think you're right. Number one is as we go through third quarter we've, obviously, got a little more wind in everybody's sail in terms of the market price increases so that's a good thing. And, you know, our anticipation is, as I said earlier, that the LCM that we took in the second quarter is it. So without giving any specific guidance, we're not looking for a massive improvement in gross margins, but yes, sequentially we should see some improvements.

Right, fair enough. My last question -- on the expected tax refund in 2010, any even ballpark range on what that might be?

Well, you know, Tim as we move through the back half of the year we will -- that number that you see on the income statement includes federal, local and state taxes. The preponderance of it is federal and the federal piece is, as we've looked it, is refundable. So if the year were to end at the end of June, we'd be in the $30 million ballpark.

Okay, thank you, that's quite helpful.

But you've got to adjust for whatever happens in the second half.

Yes, I understand. Great, thanks.

Thanks, Tim.

[Operator instructions] We'll hear next from Luke Folta with Longbow Research.

Good morning, guys.

Good morning.

Good morning, Luke.

Hey, just first congratulations on your cost execution and the balance sheet improvements. Seems you guys are doing a good job in this pretty difficult market. My first question was regarding your mix of sheet versus plate in the quarter. Can you provide us with that estimate?

Luke, we typically don't break out our product categories. As we've talked about on the last two calls, and you know that plate is a large product category for us. And the plate market has been, and continues to be, softer than the sheet market, so.

So typically less than your general 30% kind of (inaudible)?

Yes, yes.

Okay, and then can you just talk about the competitive environment in the plate market? I understand there's a bit more of an inventory issue there. Are you still seeing pricing below -- are you seeing pretty competitive pricing in that market?

Well, let me answer that, Luke. This is David. I think that we've seen the completion of the erosion in the marketplace, assisted by not only scrap elevating but the mills elevating prices. And so we are seeing a recovery on that. But in the second quarter there was extreme pressure on all products, and particularly on plate, and we are seeing recovery on the pricing of that, and sort of less draconian pricing in the marketplace. So it seems that most have vetted their inventory when it gets down to the plate side of the equation. We're not seeing those big depressions as were in the early part of third quarter.

Okay, and just lastly, on your ability to pass through these price increases, any issues there or are your end users pretty much accepting the fact that prices are rising?

Again, Luke, from a commercial perspective you'll always get a little bit of resistance early on and you'll, of course, in this great recession you'll get the pundits who don't believe that the pricing will stick. But for the most part it is being absorbed. It's being absorbed because number one, inventory levels are down dramatically. Two, there are no imports substantially coming into this country. Three, capacity at the mills have been taken offline responsibly. And when you add all of those together we just have a very low inventory threshold as the MSCI has reported ten consecutive months. And so what we really see the end result is we are seeing the absorption of the pricing increase and we're seeing very little resistance to it as we move up.

Great, thanks a lot guys and good luck to you.

Thank you.

And the next question will come from Nat Kellogg with Next Generation Equity Research.

Hey, Nat.

Hi, guys. How are you doing? Most of my questions have actually been answered, but just sort of two quick questions. I guess the first one is on the cost side. You guys have done a nice job there and I'm just sort of curious on how much of that is sustainable versus how much of that -- I mean I know, you know, you guys have talked a lot about both senior management sort of deferring or foregoing bonuses and then, obviously, all the way down. The labor structure guys are working less and sort of paring back. I'm just wondering, obviously, eventually you guys would like to begin paying bonuses again. So I'm just wondering, as things creep up, how much of that comes back and how much of that sort of is costs you guys have permanently taken out? And then, also, just the other one is if you guys could just talk about what the lead times look like at the mills, if you guys have seen any push out in lead times or whether they still remain pretty short.

Okay, Nat it's Rick. I'll take your first one on expenses. Our expense reductions in terms of what we've done with the workforce and what we've done with the pay and compensation; those are permanent. So, in other words, you know, when we reduced compensation at the company we told the entire employee base that these are permanent. So if things start to come back those aren't going to immediately revert back.

We do, as you said, have an incentive structure that's been the same structure for many years. That is a pay for performance structure. So we didn't necessarily go into this market and say we're going to forego a bonus. We have a structure and an incentive structure that says if we perform, the bonuses calculate out and if we don't, like now, there are no bonuses.

And then some of the other structural things that David talked about earlier, you know, like eliminating the leased location in Philadelphia and some of the other things, those are permanent. So what I would tell you is the things that are variable you will not see in the expenses rising until you see the performance there. So they will coincide with the profitability of the company. And then, David, I'll let you handle the second question.

Yes, Nat, I'll answer the second part of that on the mill lead times, and the answer is that the mill lead times are moving out. [Produc- --] capacity is coming back on line, not significant. I think the mills are running at about 52% or something along those lines last week. That's a marked improvement. However, lead times are starting to move out fairly significantly as low inventory levels are fostering more spot buying in the marketplace. And then what we're seeing is even a lower threshold of inventory and more demand moving into the mills and lead times are expanding.

Okay, that's great. Well, thanks guys, I'll hop back into the queue. Thanks for taking my questions.

Thank you.

(Operator instructions.) The next question will come from Mark Parr of Keybanc Capital Markets.

Hey, thanks very much. Good morning.

Good morning, Mark.

Hey, one of you guys, I think, has got a Blackberry that's too close to the microphone so you're getting a lot of Blackberry feedback.

That's me, sorry.

All right, no worries. Say, I just wanted to let you know just one thing I am curious about is with the rise in spot pricing that we're seeing in the flat rolled side, how quickly does that flow through for Olympic Steel? I mean is it a 30 day lag? I mean, Dave, what do you think you're going to be able to realize here over the next couple of quarters?

Well, Mark, I think that the short answer to that I think we're really mandated to realize all of the increases that go through. Obviously, our replacement costs reflect the announced published increases of the mills, and so we are compelled to recover all of that. We're really not lagging behind in that regard because, again, Mark, the inventory levels are so low. And there has been a reluctance for people to enter into longer term agreements, not that there aren't some that have, but there is reluctance to do that. And so it's almost immediate. So there is less than a 30 day lag time today. I can't tell you what's going to happen in the next couple of months, but I can tell you that the initial price increase of June 1 and the subsequent rethink between June 15th and June 17th were absorbed almost immediately in the marketplace, very little lag time there. And then the subsequent increases, we are out there promoting them.

Let me just comment on that too, Mark. I mean don't misconstrue the fact that it's still very competitive at the service center level for the orders that are out there. So even with the reduced inventories, you know, when you get down to a sizeable inventory it's still competitive every day in the marketplace.

Okay, I certainly would believe that. Another question, just a nuance, you know, Michael you've got a fairly significant part of your book that's other service centers. And I'm just curious if you're looking for a, you know, say a marginal recovery in volume 3Q versus 2Q is there any difference between the OEM side of your book as opposed to the service center side of your book in that upside momentum?

Well, I would tell you we do expect more service center activity as these inventories are low and not everybody has stepped up on a continuous purchasing basis. I think somebody asked earlier if there's some holes you know, we expect we fill holes in the universe. The answer is yes everybody has holes in their inventories. I mean there's a lot of service centers today that are very lean in terms of their inventory whether it's by choice or by bank constriction. I do think that, Mark, as we see the market pick up we would also see [probably a] preponderance of the service center pick up in our order book be accelerating probably a little bit faster than the OEM.

Okay, anything on the ERP implementation? Is there any sort of expectation that we could have on an EBIT margin perspective or is it really going to be more of a working capital benefit? You know, could you give us a little more color on what you think the benefits are going to be from a financial standpoint from this new system?

You know, Mark, I said from the beginning, -- sorry I've been asked that question, we expect no margin improvement. Obviously, we'd expect at a complete cut-over to have some expense improvement, but the reality is is being on one system and having the visibility of the total inventory gives us an ability to perform better for the customer. Whether or not that creates an EBIT margin -- I would expect that a system is just a system. It's people that have to execute the system. We just expect that from an overall cost perspective and the ability for growth being absorbed [and] managed perspective, having a single system gives us significant advantages as our customers look for total national solutions. And having too many systems becomes a difficult communication aspect.

Okay, and just if I could ask one last question on the market side? You know, you have three basic product categories, you know, sheet, plate and stainless. Could you talk about the relative pricing momentum in those three categories 3Q versus 2Q from what you're seeing?

David?

Yes, Mark I'm happy to. On the sheet side I answered that earlier on one of the questions and we are seeing some forward momentum there. Stainless we are seeing forward momentum there as the LME reflects, you know, higher numbers for nickel and so forth. And the momentum has been going forward. On the plate side we see less forward momentum but really no decay here. So I think it's reached its bottom. The mills are asking for more money for that product and they are getting it as lead times start to marginally expand and the scrap costs more money, obviously. So plate is the lagger of the other two, but they're all moving forward.

Okay, that's very much for all that color and good luck on the second half.

Thank you.

Thanks, Mark.

And next, thank you, we have Sal Tharani with Goldman Sachs.

Hey guys. You mentioned you're closing one of the warehouses. Which one is that?

Philadelphia, Sal.

Okay, is there other planned or this is it?

That's it to date and, you know, part of that is fostered by, as Rick well took you through -- took all of us through, it's one of our only two leased facilities. The lease is expiring at the end of the year and we've put an awful lot of capital into our Chambersburg, Pennsylvania facility. We've expanded that a couple of fold over the last three years. And so we're absorbing that facility into the Chambersburg facility, which in relative distance is reasonably close.

Sorry, it's just very important for everyone to understand that we are not exiting the market. All we're doing is servicing our customers through a lower cost solution because, as David said, we've got facilities in the region that can do that.

Yes, Sal, and the only other aspect which David, I think, mentioned is in our South Carolina operation where we bought the land and brought the building. We suspended the erection of that building so we basically have, a structural building that has never been erected at this point and that can be either erected in South Carolina or anyplace else that we choose to.

Okay, and Mike with prices now moving up on hot rolled coil above 500 are you seeing any opportunity in the import market or any offers which can entice you?

I see offers. Nothing yet entices.

Okay, thank you.

(Operator instructions.) And with no further questions, I'll turn the call back to our 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 (inaudible) sales or earnings estimates. We anticipate releasing our third quarter 2009 earnings around October 29th.

So this concludes our call. Again, I really want to thank all of you for your interest in Olympic Steel and let's hope for better times. Thank you everyone.

And once again, that does conclude today's teleconference. Thank you all for your participation.