Olympic Steel Inc (ZEUS) 2010 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Olympic Steel second quarter earnings results conference call.

(Operator instructions) I would now like to introduce your host for today's conference, Mr.

Michael Siegal, Chairman and CEO.

You may begin.

Thank you operator.

Good morning and welcome to everyone.

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 continued interest or new 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 forward-looking statements can be found in our filings with the Securities and Exchange Commission, including our 2009 Annual Report on Form 10-K and our 2010 Second Quarter Form 10-Q, which will be filed later today.

Earlier today, we reported our financial results for the second quarter and the first half of 2010.

We are pleased with our results and the sequential improvements in sales and earnings over the first quarter.

Second quarter 2010 net income totaled $3.3 million, or $0.30 per diluted share, compared to a net loss of $33.8 million, or $3.11 per diluted share, for last year's second quarter.

The 2009 results included a $50.5 million lower of cost or market pretax charge to write down the value of the inventory as of June 30, 2009.

Net sales for the second quarter of 2010 totaled $212.8 million, a 73.8% increase from the $122.4 million from the second quarter of 2009.

Our shipments in the second quarter of 2010 increased by 78,000 tons or 45.2%, to 252,000 from 174,000 in the second quarter of 2009.

Our shipments also improved sequentially over the first quarter of 2010 by 31,000 tons or 14%.

Our sales volume has now been sequentially stronger for three consecutive quarters and shipments rose in each successive month of the first half.

First half 2010 net income totaled $5 million or $0.45 per diluted share compared to a net loss of $59.3 million or $5.45 per diluted share for the first six months of last year.

The first half 2009 results included an $81.1 million of inventory lower of cost or market pretax charge.

Net sales for the first half of 2010 totaled $380.7 million or a 44.6% increase from the $263.3 million for the first half of the previous year.

Our shipments for the first half 2010 increased by 129,000 tons to 474,000 tons from 345,000 tons in 2009.

Our 37.2% increase in shipments nearly doubled the 19.1% market increase in total shipments for the first half as reported by the Metal Service Center Institute Metals Activity Report.

We are being awarded new business by large OEM customers seeking financially strong, quality suppliers like ourselves, as well as benefiting from improved customer demand as the economy has slowly recovered.

Our recent investments in our specialty metals businesses are also producing growth in our stainless steel and aluminum products.

Our balance sheet remains exceptionally strong.

In April we received our $38 million 2009 federal income tax refund and on June 30th we closed on a new $125 million five-year asset based loan facility with Bank of America as the agent bank.

The new facility, together with our $200 million three-year shelf registration filed with the SEC in 2009, provides us with a favorable capital structure to grow our business through new geographic locations and acquisition opportunities.

We expect to announce on some of these opportunities in the second half of 2010.

Despite the normal summer seasonal market softness and the accompanying price pressure that has been well documented by others, we remain confident in our growth and profit initiatives.

Today we also reported that Olympic Board of Directors approved a regular quarterly cash dividend of $0.02 per share to be paid on September 15, 2010 to shareholders of record on September 1, 2010.

And yesterday we announced that our Board elected the Honorable Dirk A.

Kempthorne as a Director of the company.

Governor Kempthorne has served as the Mayor of Boise, Idaho and as a United States Senator from Idaho.

He was also a two-term Governor of Idaho and most recently served as the 49th Secretary of the US Department of Interior from 2006 to January of 2009.

We are extremely pleased that Dirk has joined our Board of Directors.

His commitment to public service and recognized national leadership will enable Dirk to provide unique wisdom contributions and insights for Olympic Steel and its shareholders.

We look forward to Dirk's guidance as a Director.

I'll now turn the call over to Rick to comment on our financial results in more detail.

Thank you and good morning, everyone.

First I'd like to cover the new banking agreement in a little more detail.

On June 30th we did enter into a new five-year $125 million asset based revolving loan facility with Bank of America, as Michael said.

The $125 million facility may be increased by $50 million to $175 million, subject to exercising the terms of the agreement's accordion feature.

The new agreement also provides us with greater formula availability, more business flexibility and a lower cost than our previous facility.

Total borrowings outstanding on that new line that we closed on June 30th were $13 million at quarter end and we had $110 million of formula availability under the new facility at quarter end.

Taking a look at operating expenses, they increased by $10.3 million or 17.3% in the first half of 2010 as compared to the first half of 2009, as a result of our aggressive expense reductions in 2009; we are now profitable at much lower shipping levels.

The expenses continue to be managed aggressively and the 17% increase in first half expenses relates to variable cost increases associated with a 37% increase in shipments and our return to profitability in 2010.

In order to meet our increased customer demand, our headcount, the use of temporary labor and overtime have all increased in the first half.

Additionally, at the end of the first and second quarters of 2010 we phased in pay restorations for our employees' compensation that was originally reduced in 2009.

Going forward the pay restorations will result in a quarterly expense increase of about $373,000.

We also expensed in the second quarter $130,000 in unamortized bank fees to administrative expense in June related to the old credit facility.

Looking at capital spending in the first half, it totaled $6.3 million and that compares to depreciation expense in the first half of $6.5 million.

Our CapEx includes our ongoing and successful IT system implementation.

In the first half of 2010 we capitalized $2.1 million and we expensed $613,000 related to the system implementations and in July we successfully implemented the new system in our Detroit operations and we decommissioned our first legacy system after going live in Detroit.

We still expect our capital spending for 2010 to total between $10 and $14 million but that would be before considering any of the potential acquisition or greenfield growth opportunities and investments that Michael mentioned earlier.

Our first half income tax rate was 37% of pretax and that's slightly lower than the expected annual rate of 38% and the lower first half rate was primarily due to the impact of certain tax deductions phasing in at lower pretax income levels.

And then finally some other financial metrics and highlights include our inventory turnover in the first half stayed very strong; it was 5.2 times.

Our accounts receivable DSO totaled 43 days in the first half.

That was pretty consistent with what it was in the first quarter.

It's up from 38 days in 2009 and that increase is due to a combination of some slowdown in payments from customers but as well as the impact of increasing monthly sales on the DSO calculation.

For the first half our Automotive sales were strong; they totaled 12.5% of our total sales.

Typically if you remember, we've been under 10%, so Auto has continued to be one of our strongest industry segments and we've seen increasing shipments there since the second half of 2009.

Our shareholders' equity per share at June 30th was $24.30 and we've paid two quarterly dividends in the first half of $0.02 a share, so dividends in the first half total $0.04 a share or $435,000.

Now I'll turn the call over to David.

Thank you Rick, and good morning.

As both Michael and Rick commented, we are pleased with our increasing shipping volumes and gains in the market share so far this year in the first half and the second quarter.

As we highlighted earlier, we saw a continued strength in demand in the first half and our shipments per day increasing sequentially in every month of 2010 through June.

During the first six months of 2010 we are most proud of the fact that we recaptured 129,000 tons from the lows of the first half of 2009.

We are now about halfway back on volume from the depths of the recession or decline of 2009 and expect to see continued shipping improvements in the second half of the year.

We have experienced increased demand from our automotive customer base and from our large industrial equipment customers.

We are also successfully recruiting new business as Michael indicated earlier, often times providing customers with outsourcing solutions for their increasing internal steel processing and fabrication needs as the economy recovers.

The seasonal summer slowdown which was anticipated, did affect our market in June and trickled into July and our string of sequential shipping improvements will end in July, however, our July shipping volumes are still running about 20% stronger than the prior year, so we've captured additional market share even through July.

We believe we've now reached the bottom of the market's short-term correction, again, which was anticipated to occur in the back half of June and move through July and that started about eight weeks ago.

This week's price increase announcements of $30 to $40 a ton for carbon flat roll steel is evidence that the market is once again rebounding in August and provides a boost to the market's negative sentiment over the past two months.

The June MSCI Metals Activity Report also is encouraging, as it shows the steel inventories are still in balance with shipments, with 2.3 months of inventory on hand.

This is up slightly from the historical lows of two months on hand at the end of the first quarter.

Reasonable levels of inventory combined with steady demand and expected increases of input costs of raw materials such as iron ore and scrap should support the recently announced price increases as we continue to digest the recovery.

I also want to comment on the strategic benefits of our strong balance sheet and the access to capital as Rick commented on.

We are capable and ready from both a financial and operating perspective to grow our business and we are in fact doing that.

We look forward to putting our money to work on growth initiatives beyond the $10 to $14 million capital expenditures which were depicted a moment ago in our budget plan for this coming year.

During the first half of the year we have spent significant effort analyzing and planning growth initiatives and we are ready to make investments.

We anticipate that we will add at least two new locations in the second half of the year, as Michael commented on in the opening statement and order substantial service center and fab equipment for these locations.

In addition, we are also actively reviewing several acquisition opportunities.

So far in 2010 we made one small acquisition in the first quarter by adding Integrity Stainless to Olympic Steel's family.

Integrity is a profitable niche stainless steel sales organization located here in Cleveland, Ohio that was immediately accretive to our results and is part of our growth strategy to make our specialty metals business a larger component of overall Olympic Steel.

We have defined specialty metals internally as our stainless and aluminum product categories.

As I highlighted on a previous call, we recently added aluminum as a new product category in midyear 2009.

During the past year we've added stainless steel and aluminum commercial talent to the organization and that's fostering our growth.

We are confident in the future and our ability to successfully grow our business and perform for our shareholders, our customers and employees of Olympic Steel.

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

Thank you.

(Operator instructions) Our first question is from Tim Hayes of Davenport & Company.

Two questions, first on the operating expense you mentioned the pay restoration; did that actually come in Q2 or was that Q1?

I missed that.

Tim, we phased them in in two pieces; the first restoration happened at the very end of first quarter so the financial impact was in the second quarter and then the second piece of the phase and the final piece was done at the beginning of third quarter.

That's why I gave you the go-forward increase in operating expenses is about 373,000 from second quarter.

On the amount, the increase in the operating expense Q1 to Q2, which was about $5 million, I know some of that is because of the higher volumes.

Can you quantify what the dollar impact was Q1 to Q2 from the pay restoration?

I don't have that right in front of me but it was probably pretty similar to the amount that we're going to go up in the third quarter.

It was about half and half, so it was probably about $400,000 maybe.

That's close enough; that's helpful.

Just to refresh, in terms of your business and how much you're selling on the spot market versus how much you're selling where you'd have prices reset on a quarterly basis, what is that mix these days?

That varies by region but pretty close to an even mix of contract and spot business.

Out West we're more contractually obligated and out East, which would be sort of Cleveland and East, there's a heavier percentage of spot business or merchant mentality.

But when we bake it all together, we're almost looking at 50/50.

Your next question is from Richard Garchitorena from Credit Suisse.

A couple of questions.

First, I was wondering if you could give us a little color in terms of the breakdown on shipments during the quarter between plate and hot roll and also pricing, how that trended?

Well, they both trended upward, as you saw in the transaction prices that Rick depicted, Rich and that Michael talked about, so both product lines in the second quarter moved up pretty firmly.

Actually we saw some great sequential progress for the full six months and as anticipated we believe second quarter would be stronger than first quarter and in fact it was stronger than first quarter and pricing was stronger than first quarter.

We started to see pricing in both categories ebb as we go to the latter part of May and into June, with the last mill increase having been announced on flat roll, particularly hot roll, not being absorbed and then our expectations were that we would see some correction in the end of June and then through early July and we did see that.

Plate being a little bit firmer.

Plate was a little firmer, all the way through and has been resistant to significant corrections.

Flat roll has corrected a little bit more on the downside and is now recovering as I mentioned earlier with the recent price announcements of this week.

Great.

I guess looking out to the back half of Q3 and to Q4 obviously, it sounds like you're more optimistic, given the fact that you're looking at adding capacity and looking at more acquisitions or some acquisitions.

What's your view on Q4?

Do you think we could even see the price increases holding and then demand continuing to firm up?

Our view is in fact that pricing will recover.

And again, it's only some speculation on our part as we take a look at the momentum that we see going forward, but Rich, we do believe that these pricing announcements were a little bit overdue, not significantly overdue but a little bit overdue, a week or two.

We were confident that scrap would start to move up this month and we think that we'll see additional increases as we move into the latter part of third quarter and fourth quarter and I would tell you we would expect to see hot roll pricing, again, restore itself to early second quarter pricing and we have some pretty high expectations as we move through 2011 and we continue to, as we say, absorb the recovery.

Finally just on the long-term, basically on the acquisition front, it sounds like you're getting more positive on the specialty metals side.

Is it fair to say that that's one area where you want to continue to focus or are you really just basically looking at all opportunities at this point?

The answer is, we look at all opportunities.

Again, as we look at the three ways, you can sell more tons, you can increase gross margin or you can increase your product portfolio.

We know from history that within the products that we specialize in, in mostly the flat roll universe, hot roll sheet and plate, Coro-coated without more geographic locations it's going to be hard to increase the tonnage there.

So within the family of locations that we have, the increase of participation in stainless aluminum is our opportunity of our sales force and our equipment to really penetrate the market far deeper as we've brought more talented individuals to focus on that and we think that's an immediate opportunity for growth and it obviously is.

Your next question is from Yvonne Varano of Jefferies & Company.

I just want to clarify, so am I hearing your comments right that you are suggesting that EPS in Q3 should be better than Q2 because we should have some more volumes and some pricing?

I know there's added cost going in as well, but the former two factors are more of an offset?

No, I don't think that's correct, Yvonne.

I think what we said is that we would anticipate Q3 to be better than Q3 of the previous year in the comments but not necessarily better than Q2.

Okay.

On the margin side, if you're getting a little pricing that you think you'll get a little gross margin expansion in Q3?

We don't see it falling.

There are a lot of factors that have indicated, you know, we're comfortable where we're at right now with a more positive vent towards it but really not anticipating a great deal of movement, given the very competitive nature of the marketplace that's out there today.

Okay, so maybe Q3 from an EPS standpoint looks more similar to Q2?

Well, you know, that's why you have a job and we get to keep ours.

Just going into Q4, pricing obviously going up but is your feeling that that can offset volume declines that we typically see from a seasonal perspective or does Q4 sort of show more typical seasonal trend?

I think the year is turning out to be very typical and traditional, where there is a first quarter ramp-up and a strong second quarter, there's an adjustment in the early part of third quarter which makes our prediction very easy because we've experienced them for almost 40 years, so that makes it easy for us to look at that with the exception of the anomaly in 2009 and maybe 2008 too.

But we do see a short-term correction in the latter part of June specifically that's trickled into the first couple of weeks of July and then right back at it where our customers, their demands are pretty consistent.

Their inventories are low, their demands are pretty consistent.

We look to garner more business and again, third quarters really never saved anybody in the service center business.

July never saved anybody.

But we're seeing some pretty good momentum on the recovery side and we would expect Q4 to finish up the same as it traditionally finishes, up with a slower holiday season in December.

And it would not surprise me, Yvonne, to see another stimulus bill before November elections.

That should help probably more so in 2011.

Yes, but a lot of this is attitude.

The marketplace, at least our marketplace has improved pretty substantially year-over-year.

While it's not where we would like it to be in total, but we're seeing pretty good market improvements and market share improvements.

And I think when we get to the end November here, we're going to see some pretty strong improvement year-over-year.

So as we take a look at November of 2009 versus November of 2010, from a mill perspective, from a mill pricing perspective, I think you're going to see some pretty significant strengthening over that period of 12 months whether we were a little bit stronger in the first half and adjusted early in third quarter and then came back out of that trough and that's sort of the traditional view we have and as we take a look forward, we think there will be pretty significant changes when you measure it year-over-year.

Okay.

Any comments from an end market on Ag or construction?

The mining industries still remain relatively strong.

Construction remains improving but slow, ramp-ups relative to the lack of money flow for municipal participation in the bond markets for their share of government projects.

So the federal government has money, the state governments do not, so that's been a slower ramp-up.

And then as it relates to the Ag markets, you look at what John Deere said and they said they have a pretty strong year for the rest of this year.

There are some issues around commodity pricing and droughts that are affecting the long-term food pricing and so there's no reason to believe that this year's in jeopardy at all from the strength that they've shown.

And their outlook was sort of questionable for next year whether or not that's going to be sustainable because of some of the circumstances of weather and just the way the commodity prices for food has gone.

So I would say that we're not seeing any degradation and again, as we indicated in our comments, Yvonne, the strength of our balance sheet and outlook for Olympics' future is garner us more market share with those kinds of customers, so even if their business is down, our participation could be up.

Your next question is from Mark Parr of KeyBanc Capital Markets.

I think I'll make my phone work this time.

Sorry about that guys.

One of the things if you look at it, and I think it's probably an industry thing because you weren't the only public metal service center we saw this happen to, but seems like there was an erosion in pricing power as evidence in the gross profit margin in the second quarter relative to the first quarter and is there any color you could give us on that in terms of what changed?

Is it just pricing rolling over or was there something else that happened?

Was there perhaps improving credit availability?

Were the mills all of the sudden trying to get rid of steel?

Any color you could provide there I think would be really helpful.

Mark, our gross margin in the second quarter was $172 a ton and I think in the first quarter it was somewhere below $160, so we had margin expansion so I'm not sure where you get that.

Are you looking at the percentage, Mark?

Yes, I was looking at percentage.

He's looking at the percentage which went down a little bit.

I would tell you in the back half of the second quarter, Mark.

Not every service center is Olympic Steel and what we find out there is a lot of guys looking to sustain a certain percentage of volume who are very aggressive in pricing and half of our business which is not contractual.

We like to move steel too and you have to match the pricing and it's been very competitive since middle of June or actually since the beginning of June.

Very competitive out there.

Mark, our charge as we entered 2010, certainly in the back half of 2009 was to concentrate on the income statement.

We obviously always focus on the income statement.

A little difficult to create demand in 2009; you can't create demand so we had a tremendous focus on the balance sheet, so as we moved into 2010, our focus was to repair that income statement and we wanted to repair it simply by not only driving the top line but obviously by turning the bottom line black and we accomplished both of those.

And as Michael well said, as we turn in the second quarter, it did get a little bit more competitive because this whole recovery is very tactical and so while we may have half of our business on the contractual side, on the merchant side of the business the spot side, as Michael indicated, it is a tactical battle out there and everybody has different concerns and different motivations.

Our motivation was to recapture market share as we depicted and gained 129,000 additional tons through the first half of which we're happy with and our margins I think were still over 20%, our gross margins over 20%.

We saw a very small degradation in the second half I think with 20.4 versus 20.7, something in that neighborhood.

So, again as Michael declared, a little bit tactical out there.

We can't answer for everybody but our goal is to recapture market share.

We're a little better than halfway to what we would consider normal, which is back to where we were in the 2005 through 2008 tonnage and we think that we'll make even more progress as the year continues and we'll make further progress in 2011.

And then we're positioning ourselves, Mark, even more so than that, because not only are we garnering additional business which you didn't ask about, but we are garnering additional business and we are seeing the recovery from our long-term customers and we're positioning ourselves to not only be able to serve that additional business that we're recruiting today, but be in a position to once again absorb the business of our long-term customers who got us to where we are today, excluding 2009.

They didn't help us there.

So, we have a lot of participation in our fab shops in industrial equipment manufacturing and what I can tell you is the general -- when you see us going up to 12% in Automotive, those parts of our business -- the general spot market has picked up from a volume perspective better than the pieces parts business has, Mark.

And so while you're seeing the increase in sort of the generic rectangle business, for lack of a better term, while we are improving our volumes in the pieces parts fab side of our business, which elongates the margin, it's recovering slower than what the general market is.

Okay.

Q2 you said the gross profit per ton was higher than the first quarter.

In the face of increasing spot business relative to the fabrication business, does that suggest a shift in mix toward aluminum and stainless away from carbon?

It was certainly helpful on a gross margin per ton basis.

We're not shifting away; we view that silo of business as additional.

I wasn't trying to suggest that you would be deemphasizing the carbon business.

You obviously don't want to passively condone any of it Mark.

But what you're seeing here is growth in product, growth in geography and growth in personnel.

The margin on stainless and aluminum is a higher per ton margin than carbon, no question.

Yes, with a higher selling price too.

Yes.

Your next question is from Charles Bradford of Affiliated Research.

A couple of questions.

Can you get a little bit more specific on the fab business; what has that reached as a percent of your revenues?

Last year it was about 14%; it's probably down a little bit below that this year so far.

Rick, do you have that exact number?

We can get back to you on that.

We don't have it handy.

Okay, that's fine.

Since the Nucor announcement on Tuesday, I know that's only a couple of days ago, have you seen any lead times lengthening at some of your mill suppliers as people try to get their orders in before the normal lags and effective dates and that kind of thing?

Chuck, what we have seen is a moratorium on the old pricing and from what we understand from the producer side of the equation is that orders or pledges prior to this week's announcements have pretty much been terminated or will be terminated by the end of business tomorrow and then the new pricing going in, we've seen lead times move out slightly, not dramatically but slightly.

The mills have caught up on delivery at the end of second quarter.

There was a trough in the business.

We had really very short lead times here which led to degradation in pricing.

We consider this stake in the ground, cathartic and necessary and we see lead times moving out, but they're just moving out nominally because this is so fresh.

We had gotten some lead time data, pretty specific stuff, on Monday and by Tuesday we were getting corrections for that and the corrections were out a week.

That's nominal, out a week, I'd buy into that, I think that's expected.

Without putting words in your mouth, would it be fair to say that you think these increases will stick and then how long do you think it will take for them to really stick?

I do believe that these increases will be absorbed; I do think that they will stick; I do think they will be absorbed.

I think it's necessary, again, to put that stake in the ground.

We were looking for that sort of leadership from the producers to stop the deterioration, which had really already troughed anyhow and I think it's immediate.

I think it's immediate with orders that are obviously going to be produced and delivered in September and I would expect subsequent increases.

We know that spot iron ore prices are up, we know that shredded scrap is up, we know that SBQ pricing is up $40 a ton across the board.

So we think the right sentiment is out there for not only absorption of this but once again recapturing some pricing.

And on the other side of the equation, Chuck, there's no question, not every service center sells on replacement costs, so given the low levels of service center inventory, the impact of this is going to be relatively quick, but it won't be tomorrow.

Your next question is from Martin Englert of Longbow Research.

I wanted to get an idea of how much percentage of sales in tons was the stainless steel and aluminum products in the quarter?

We generally do not break out products.

And kind of looking at your exposure to Automotive now, which has stepped up quite a bit from second half of last year, do you expect to maintain that going forward in the second half?

Automotive is doing better.

We don't have an emphasis to make Automotive a bigger part of our business, it just happens to be that that market recovered quicker than some of our other markets and we've been favored with our good performance in automotive market with more business but it really isn't the place that we're saying hey let's get automotive up.

It's up because it's recovered first and faster.

(Operator instructions) Your next question is from William Florida of Advisory Research.

My question was answered.

Thank you.

I'm showing no further questions at this time.

As a reminder, it's our policy not to provide forward-looking earnings estimates for the upcoming quarter or year, not to endorse any analytic sales or earnings estimates.

We anticipate releasing our third quarter 2010 earnings on or around November 4, 2010 and this concludes our call and thanks again for your participation and interest in our company.

Ladies and gentlemen, this concludes the conference for today.

You may all disconnect and have a wonderful day.