Olympic Steel Inc (ZEUS) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Olympic Steel Third Quarter 2010 Results Conference Call. (Operator Instructions.) I would now like to introduce your host for today's conference, Mr. Michael Siegal. You may begin.

Thank you. 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 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 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 2009 Annual Report on Form 10-K and our 2010 Third Quarter Form 10-Q, which will be filed later today.

Earlier today, we reported our financial results for the third quarter and first nine months of 2010. Net sales for the third quarter of 2010 totaled $209.2 million, a 72% increase from the 121.6 million of net sales in the third quarter of 2009. Our shipments in the third quarter of 2010 increased by 59,000 tons, or 33%, to 240,000 from 181,000 tons in the third quarter of 2009. After incurring an unexpected--really unexpected--$2.1 million bad debt charge in September for the abrupt and unannounced closure of a private equity owned rack manufacturing customer, we experienced a third quarter 2010 net loss of $1.2 million, or $0.11 per share. While the market proved to be highly competitive and is likely to remain so in the near term, we were profitable in the third quarter of 2010 prior to the nonrecurring bad debt cost. In the third quarter of 2009, net income totaled 671,000, or $0.06 per share.

For the first nine months of 2010, net income totaled $3.7 million or $0.34 per share, compared to a net loss of 58.6 million or $5.39 per diluted share for the first nine months of last year. The 2009 results included the 81.1 million of inventory lower of cost or market pre-tax charges included in the first half of the prior year. Net sales for the first nine months of 2010 totaled 589.8 million, a 53.2% increase from the 384.9 million in 2009. Our shipments in the first nine months of 2010 increased by 188,000 tons to 714,000 tons from the 527,000 in 2009. Our 36% increase in 2010 shipments is significantly higher than the 20% market share increase in total steel shipments for the first nine months as reported by the Metal Service Center Institute's Metals Activity Report.

As we have stated previously, we are continually being awarded businesses or business by large OEM customers seeking financially strong quality suppliers like Olympic Steel, as well as aggressively winning new business as customer demand improves and the economy slowly recovers. Recent investments in the specialty metals business are also producing growth in our stainless steel and aluminum products. Additionally, our automotive sales have been strong and represent a larger portion of our total sales than in the past. Our balance sheet remains exceptionally strong. As previously announced on June 30, 2010, we closed a new 125 million five-year asset based loan facility with Bank America as agent. The new facility, which can be upsized by an additional $50 million through the terms of its accordion feature, together with our $200 million three-year shelf registration filed with the SEC in 2009, provides us with plenty of financing availability, and a favorable capital structure to grow our business. As indicated in our release this morning, we are putting a piece of this capital to work on a major new growth initiative.

We are most pleased to announce this morning our third and our largest gross project of 2010. In addition to the acquisition of Integrity Stainless in the first quarter and the purchase of land in a facility in Mount Sterling, Kentucky in the third quarter, we are extremely excited to announce our intent to locate Olympic Steel's third temper mill operation on U.S. Steel's Gary, Indiana site. We have selected an existing 150,000 square foot facility on the U.S. Steel Gary Works facility to house a new Olympic Steel temper mill and cut-to-length line. Purchase agreements were signed this week with Butech, Inc. for the cut-to-length line and with I2S, LLC for the new temper mill. The total project is estimated to cost approximately $25 million and the equipment is expected to be installed and operational in the first half of 2012. Once fully operational, the new equipment will add somewhere between 150,000 to 180,000 tons of new tempering capacity for Olympic Steel. And David will expand on the new temper mill project later in the call.

And another accomplishment in October 2010 was the conclusion of a new five-year agreement with our contractual employees at our Minneapolis coil facility. Today, we also reported that Olympic Steel's Board of Directors approved a regularly--quarterly cash dividend of $0.02 per share to be paid on December 15, 2010 to shareholders of record and December 1, 2010. And now, I'd like to turn the call over to Rick to comment on some of the financial results in more detail.

Thank you, Michael, and good morning, everyone. Michael spent some time talking about our tonnage and sales growth, so I'll focus on gross margins for a moment. As a percentage of net sales, gross margin totaled 17.9% in the third quarter of 2010, compared to 24.8% in the third quarter last year. For the first nine months of 2010, gross margins totaled 19.7% compared to a negative 1.4% last year. And as a reminder, last year's gross margins included that $81.1 million inventory lower of cost or market adjustment recorded. And we had two of them - one at the end of the first quarter and one at the end of the second quarter.

Internally, we measure our gross margin results on a per ton basis and margins per ton were $156 versus $167 for the third quarter of 2010, compared to 2009. So as you can see, the margin drop expressed as a percentage of sales was much greater than on a per ton basis. In addition to the impact of the highly competitive marketplace, our margin percentage was adversely impacted in the third quarter of 2010 by falling market prices for carbon and stainless steel products, our mix of sales, and the impact of our market share growth that Michael talked about.

In 2010, a larger percentage of our sales have been made to the lower margin automotive industry, and we also increased our sales of stainless steel, which carries a higher gross margin per ton, but a lower gross margin percentage than our carbon products. We have also in certain instances increased sales volumes in 2010 at lower margins in order to gain market share in a recovering economy.

Lastly, our 2009 third quarter margins were favorably impacted by the start of a market and price recovery for steel in July of 2009 on the heels of our June 30, 2009 inventory lower cost or market write-down. During the seasonally slower fourth quarter, we do not expect our margins to change much.

Turning to operating expenses, they increased by $20.7 million or 24% in the nine months of 2010, as compared to 2009. Our second and third quarter expenses were each up about $10 million over the corresponding 2009 quarters. The 24% increase in the 2010 expenses primarily relates to variable cost increases associated with the 36% increase in our shipments and a return to profitability in 2010. In order to meet increased customer demand, our headcount, the use of temporary labor, overtime, and delivery costs to customers have all increased.

Additionally, at the end of the first and second quarters of 2010, we saved in pay restorations for employees' compensation that was originally reduced in 2009. And as we stated earlier, our third quarter selling expenses included the unexpected $2.1 million bad debt charge at the end of September 2010. Capital spending so far in 2010 is consistent with our CapEx at this point last year, totaling $10.7 million for both periods. This compares to depreciation expense of $9.8 million in the first nine months of 2010. Our CapEx includes spending on IT and communication systems, new fabrication equipment, and the purchase of land and a facility in Mount Sterling, Kentucky, which David will elaborate on a little bit more in a few minutes. And to date in 2010, we have capitalized approximately $3 million and have expensed about $1 million related to our IT system implementations.

We expect capital spending for 2010 to be about $50 million, inclusive of down payments on the new temper mill and cut-to-length line. Our effective tax rate for 2010 is 37.9% and that's right on target with our expected annual rate of 38% for 2010, and fluctuations in the quarterly rates are due to the impact of estimated annual deductions at varying quarterly pre-tax income levels. And finally, some other financial metrics and highlights. Our inventory turnover for the nine months of 2010 was 4.8 times. That's just shy of our targeted turnover rate of five times. Our 2010 accounts receivable DSO totaled 42.5 days in the first nine months. That's up about five days from 2009 and that's due to some slowdown in customer payments, as well as the impact that increasing monthly sales has on the DSO calculation.

Total debt was $50 million at the end of the third quarter of 2010. And the increase in debt during the third quarter was primarily related to increased working capital requirements for sales growth. Availability under the credit facility approximates $73 million. And as Michael previously highlighted, we have plenty of access to capital to finance the temper mill project together with ongoing working capital and other CapEx needs.

2010 automotive sales totaled 12.6% of sales and auto has continued to be one of our strongest industry segments with increasing shipments seen since the second half of 2009. Shareholders equity per share was $24.16 at the end of the third quarter. And we've paid dividends totaling $0.06 a share, or $653,000 in the nine months of 2010.

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

Thank you, Rick, and good morning. We are pleased with our continued shipping strength and gains in market share in 2010. Following the expected third quarter seasonal slowdown in July and the beginning of August, we experienced the resumption of shipping strength in mid-August and through September. In fact, our days shipping rate in September was only slightly behind June's rate, which was the strongest of the year. So far through the nine months of 2010, we have recaptured 188,000 tons of sales off the lows of 2009 and that's comprised of both new tons and returning tonnage. We expect the year-over-year increased shipping trend to continue into the seasonally slower fourth quarter. We have experienced the strongest demand from our automotive customer based, from our large industrial equipment customers, and in the specialty metals area of stainless and aluminum products. As the economy recovers we continue to successfully recruit new business often times providing customers with outsourcing solutions for their increasing internal steel processing and fabrication needs.

As Rick indicated just a moment ago, the mix of this business recruitment and increased volumes did have an impact on our third quarter margins, on top of the now well documented competitive pricing pressures for carbon, flat rolled, and stainless steel products that suppressed margins during the third quarter. We believe the market will remain relatively stable for the balance of the year, subject to normal seasonal slowdowns once the November and December holidays hit. The September MSCI Metal Activity Report also is encouraging as it shows steel inventories are still in balance with shipments with 2.4 months of inventory on hand. Reasonable levels of inventory combined with steady demand and expected increases in input cost for raw materials, such as November scrap, should support an improving pricing market for steel in 2011.

On prior calls, I've commented on the benefits of our strong balance sheet, as Mike and Rick both indicated, our access to capital, and our readiness from both a financial and operating perspective to grow our business. We have also outlined our different strategic growth streams from increasing our base service center distribution footprint via geographies to growing our value added and fabrication capabilities with large and sophisticated OEMs to product expansion in stainless and aluminum. Today, it is exciting to now talk about executing on these strategies and continuing to add some significant details to some of these strategies that we've talked about in the past.

In 2010, we have commenced three strategic growth initiatives. First, we made a small but strategic acquisition in Integrity Stainless in February of 2010. Integrity is a profitable niche stainless steel sales organization located here in Cleveland, Ohio that has really been a perfect vehicle for growth in our specialty metals business. Integrity was immediately accretive to our results and we have already made some capital investments in processing equipment to allow Integrity to profitably gain sales in the stainless flat bar market. As I previously highlighted, we also added aluminum as a new product category mid-year of 2009 and we continue to add stainless steel and aluminum commercial talent to the organization to foster this growth.

While we do not provide separate sales and earnings disclosures for specialty metals, we do have a goal to grow this area faster than our carbon business in the next few years resulting in specialty metals becoming a greater share of the total consolidated sales than the 8% it constitutes today.

In August of 2010, we announced the addition of a new Olympic facility in Mount Sterling, Kentucky, which is about 30 miles east of Lexington. We purchased 14 acres of land and an existing 100,000 square foot building to perform plate burning, machining, forming, and shot blasting. Equipment has been ordered and we expect to be operational from this new facility in the first quarter of 2011. The Mount Sterling site will allow us to better serve the growing demand of our products and services from customers in this geography and reinforces our strategy of being closer to where our customers assemble their products. We are thrilled to be serving such marquee customers as Link-Belt and Hoffman, a division of Pentair, and others from this location. We also anticipated selling stainless and aluminum products from this facility and we are thankful to the Commonwealth of Kentucky for supporting our investment and welcoming Olympic Steel to the state. We are also proud to bring manufacturing jobs--job growth into Kentucky.

Our third strategic investment, as Michael indicated early on in this call, in 2010 is by far our largest. It's also our first facility in Indiana. We are absolutely thrilled to be on the site of U.S. Steel's Gary Works, a prime location to provide customers in the Chicago region with high quality tempered sheet. Once operational, this will be our third Olympic Steel temper mill augmenting our existing facilities in Cleveland, Ohio and Bettendorf, Iowa. Our Cleveland and Iowa temper mills were added in 1994 and 1996 and were significant drivers to Olympic Steel's growth at greater than 1.3 million tons and $1 billion of sales.

Our agreements with temper mill and cut-to-link line manufactures also provide us with an option to purchase a second like kind temper mill at favorable terms consistent with the original purchase orders. The new temper mill will be capable of processing 72-inch wide coils and up to one-half-inch thick. Our strategy is to use our three temper mills in concert to best service our customers from whichever location is most efficient and most cost effective. The new temper mill will also allow us to grow our market share geographically by selling tempered sheet into markets to the south and west of our existing Cleveland and Iowa temper mill markets that have not currently--we have not currently penetrated.

We are also proud to further our footprint with a processing facility in the states of Indiana and Kentucky, as I just noted. We also continue to actively review several acquisition opportunities. In terms of the market, aside from the normal fourth quarter seasonal market softness and the accompanying price pressures that have now been well documented by others, we are very confident in our growth and the profit initiatives as we enter 2011. We believe that our 2010 investments will lay the foundation for significant growth and value of our share--for our shareholders, our customers, and the employees of Olympic Steel.

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

Thank you. (Operator Instructions.) Our first question comes from Luke Folta of Longbow Research. Your line is open.

Good morning, guys.

Good morning, Luke.

My first question was just related to the new expansion. Can you give us a sense of how much of that capacity is going to be displacing the tonnage you're selling from Iowa and Cleveland now?

Yes, Luke. This is David. About a third of that capacity will migrate almost on an equal basis from Cleveland and Iowa and will afford us a terrific opportunity in terms of logistics savings to existing customers. You can extrapolate from there then the opportunity we have to move west and move south from those respective locations.

With the way you guys have been expanding market share recently, it seems like you guys are already working on that. But do you have a sense of how long it might take to take the tonnage that will be displaced and place it elsewhere?

The displaced tons will probably come very quickly. The full ramp up of the Chicago one is probably a little bit longer timeline, Luke. But as we did the justification, we've identified markets that we can clearly capture from the Cleveland and the Iowa that should be very rapidly filled for the movement of the material that goes to Chicago.

But to add a little bit of color to that, Luke, we are actively--we are diligently working in that geography now from both a sales perspective and a purchasing perspective and using--utilizing all of our vendors' assets to complement the strategy as we move forward.

Okay. And then, just certainly your comments regarding the future of your participation in the specialty metals business, with the expansion in carbon that you've announced today and your comments saying that you would like to grow the specialty business faster than carbon, that would imply a pretty meaningful growth in tonnage within the stainless and aluminum. Do you think that's going to be mostly driven by acquisition or is there any kind of Greenfield consideration there?

Well, all of the above. We have a--the door is wide open for us as we continue to grow this business. We have some very talented individuals that are chairing those products. We've had some significant growth as we outlined, and we see all of those aspects, Luke, as great opportunities for us. We see some additional geographic penetration with the Mount Sterling operation. Obviously, we'll be able to reconfigure some of our supply--some of our operations as we bring the Gary--our Gary operation, and then we do see considerations for acquisitions and for greenfields.

Great, thank you.

Thank you. Our next question today is from Tim Hayes of Davenport and Company. Your line is open.

Hey, good morning.

Tim, hi.

Your question on the new temper mill is--we certainly get with metal coming from U.S. Steel right adjacent or in the same facility--will that be an exclusive relationship in terms of getting steel from U.S. Steel or can you still get steel from other locations there?

We can do whatever we want, okay?

And any particular end market focus for that facility?

Pretty much the same markets that we have today. I mean, as we've indicated often, Tim, I mean, our target market is a highly discrete manufacturer of a unique product. So whether it's the Caterpillars, the Deeres, the typical heavy highly engineered domestic manufacturers of a product, it's still the same marketplace, just additional capacity for them.

I figured as much. Just wanted to make sure it wasn't just maybe solely or mostly auto related or under a towing contract of that nature.

No.

Okay, very good. Thanks.

Thank you.

Thank you. The next question comes from Richard Garchitorena from Credit Suisse. Your line is open.

Hi, good morning, guys.

Hi, Richard.

Hi. First question, I just wondered if you could elaborate a little on the greenfield project at Mount Sterling in terms of like CapEx tons you expect to process there in terms of products.

Rick?

Sure. Timing wise, as we said, we should begin to operate in the first quarter there. In terms of CapEx, it would be what we call our higher value add profile of equipment, so things like shot blaster, vending equipment. Plasma cutting lines, that type of thing. In terms of the size of the ramp up, we're pretty confident that within a year we can get that thing to $25 to $30 million in sales. Obviously, it will be a gradual ramp up as we'll be getting the equipment phasing in in the first quarter.

Great, okay. And then, I guess, secondly, on the temper mill, the project obviously is attractive. Does it--the fact that you're going forward, is this just because it's attractive as a project or on M&A are we still seeing valuations that are a little rich and that's why we're not seeing much action there yet?

Yes on both. The M&A market there's a lot of buyers. Everybody has come out so far publicly and said we're looking for acquisitions. Obviously, we're not seeing a very robust announcement of M&A activity. And so, the expectation you would assume of the seller might be a little bit too high. In the interim, we have the responsibility according to our mission to continue to grow and so we're not necessarily going to wait for the market for M&A. We're going to continue to add the footprint to service our customers as they grow. So we've got our initiatives on both fronts.

Great. And then, finally, I just wanted to touch on the market. Obviously, it sounds fairly optimistic on pricing going through 2011. Could you just give a little color in terms of market conditions today? What--where were volumes in October and sort of what do you see maybe in Q1 if anything?

Well, as I commented before, Richard, this is David here. We see consistency in the marketplace in the fourth quarter. And so, as Rick has commented earlier, we had 188,000 tons of what we'll call claw back in terms of new business and returning business and we expect to stay on that path. We see the consistency and we see some strength going into 2011, some strength fostered by a return of scrap pricing here in November, production turndown, weakness in dollar, less imports and so forth, and again, all under the--or in the shadow of consistent demand that we've managed to harness here over the first nine months.

Great, thank you.

Thank you. (Operator Instructions.) Our next question comes from Mark Parr of KeyBanc Capital. Your line is open.

Thanks very much. Good morning.

Mark, good morning.

A couple of questions. First, as far as the bad debt expense, was that--that was just related to one particular receivable, is that fair?

Yes.

And I guess the one question I have, was that a 100% write-off? Is there a potential for any further write-offs as we go forward?

Yes to your first question and no there's little--other than a potential deep dive look into the private equities company's misbehavior, the recovery would be negligible.

Okay.

In fact, nothing other than maybe some recovery. There's some, as we said, some stink to the private equity firm.

Right. Okay. I won't make any comments there. The--but I have an industry question, if you--if you'll bear with me. There was some trade press this morning indicating WARN paperwork being ready for the workers at Sparrows Point. And I'm just wondering if you've heard--if you could confirm or deny if you're hearing anything along those same lines or what are you--how would you handicap the odds of Sparrows being shutdown here in the next 30 days or so?

Sixty days because that's what the WARN notice is. But, okay. I think that's a better question, Mark, for the ownership that--at Severstal.

I just thought I'd give it a shot.

But if you could (inaudible).

But David, you're usually so careful about the outlook for forward pricing. And so we see--.

(Inaudible) for the slip.

Okay, terrific. The--if you would--I know you've said from a current order perspective or shipment perspective you would expect things to remain stable. And just to try to get a little more color there, the seasonal momentum that you normally would see 4Q from 3Q would be--I mean, is that how we should be looking at stable, including seasonal downdrafts? Or should we be just looking at stable relative to what was actually achieved from a tonnage perspective in the third quarter?

I think, Mark, again, what we look at may be different than how other people look at it. And we look at what is our dollars per--what is our tons per day going out the door and what's the margin spread on the tons that are going out the door. So at least what we've seen in October, as David indicated in his comments, we saw a nice pickup in activity on a daily sales basis in October. And so, we would expect sort of that same daily sales rate at least for the next two months, and then December with its typical last two weeks, we can't speak to that till it occurs.

Yes, who knows. Okay. Well, it's good to see some recovery here off of this very weak summer. And your market share gains are well recognized, and congratulations on that and look forward to future progress here in the coming quarters. Oh, also, I had one other question, because is this Gary operation going to be more light gauge than Iowa or Cleveland? Are you going to be focusing in on a little bit different gauges because you're so close to Gary?

No, Mark. They're--actually the equipment is identical and gives us--especially with the temper mill gives us a great opportunity to trade the hardware back and forth amongst all three of these facilities. We've had some great experience with both vendors and we're looking forward to this, but it is in fact very much in the same space as Iowa and Cleveland.

Okay. So is Gary going to supply you with heavier gauge material? I mean, is that the expectation?

Well, Gary has--U.S. Steel has been a long term supplier to Olympic Steel for some four decades.

Right.

And we don't expect any significant change there. Within the composition of what they've supplied us from way back when they were a plate manufacturer to the hot roll band side in downstream, they have always provided us with heavy gauge high strength and we would expect to participate at the--with the same proportional growth there.

Okay. All right, thanks very much.

Thank you. (Operator Instructions.) Okay. I'm showing no further questions in the queue.

Well, thank you very much. As a reminder, it's not our policy to provide forward looking earnings estimates for the upcoming quarter or year or next year, and not to endorse any analyst sales or earnings estimates. We anticipate releasing our fourth quarter full year 2010 earnings on or around February 24, 2011. And this concludes our call, and thank you all again for your interest in Olympic.

Thank you. Ladies and gentlemen, this concludes the conference for today. You may now disconnect and have a wonderful day.