Olympic Steel Inc (ZEUS) 2014 Q2 法說會逐字稿

Good morning, and welcome to the Olympic Steel second quarter and first half 2014 conference call.

All participants will be in listen-only mode. (Operator instructions.) Please note this event is being recorded.

Some statements made on today's call will be predictive and are intended to be made as forward-looking within the Safe Harbor protections of the Private Securities Litigation Reform Act of 1995 and may not reflect actual results.

The Company does not undertake to update such statements, 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 are set forth in the Company's reports on Form 10-K and 10-Q and press releases filed with the Securities and Exchange Commission.

Today's live broadcast will be available for replay on Olympic Steel's website.

At this time, I would like to introduce your host for today's call, Olympic Steel's Chairman and Chief Executive Officer, Mr. Michael Siegel. Please go ahead, Mr. Siegel.

Yes. Thank you, operator. Good morning, and thank you for joining us. We will be discussing our second quarter and first half 2014 results. David Wolfort, President and Chief Operating Officer; Rick Marabito, Chief Financial Officer; and Don McNeeley, the President of our Chicago Tube and Iron businesses, are with me on the call this morning.

After a first quarter that was challenged by harsh weather and supply disruptions, the second quarter was much better for Olympic Steel. Demand and pricing momentum that started in late first quarter continued through the second quarter, and we are pleased to report our highest quarterly sales level ever for Olympic Steel.

After a long string of price increases that didn't hold in recent years, the resilience in this year's market has caught some by surprise. From our perspective, market conditions in 2014 feel much more like those of an expanding economy rather than the sputtering economy we have experienced in recent years.

We are seeing strength and demand growth across a wide spectrum of our customer base, led by industrial machinery and heavy equipment manufacturers. The only sectors that we do not see strength from are the military, which is not surprising, and the mining equipment sectors, also not surprising.

Our customers are telling us that they are optimistic going into the second half of the year, and steel producers just announced another price increase in late June. Both factors bode well for Olympic Steel.

Our growing specialty metals product line, which includes stainless and aluminum materials, had another good quarter. We are experiencing organic growth and market share gains in both products. Additionally, we benefited from higher prices during the quarter.

Specifically on the aluminum side of specialty metals, we are seeing increased activity in the automotive sector. Olympic Steel is already participating in this area and is supplying aluminum to tier two and tier three auto stampers.

We believe the light-weighting trend in the automotive industry has staying power, and the relative proportion of aluminum content in vehicles will increase in future model designs.

Olympic also has a long history of supplying carbon steel in the auto sector, which, together with our aluminum product lines, makes us a bit unique as a supply chain partner for our automotive customers.

The tubular and pipe products segment increased sales in second quarter and first half. This was done entirely on higher volumes, a recurring theme across our business units, as pipe and tube prices were lower compared with last year's first half.

Price changes in these products typically lag fluctuations for flat products. Therefore, we anticipate better sequential pricing and operating margins for this segment later in the year.

One of our strategies for creating value has focused on organic growth and serving specific, targeted metal users and their diverse markets. In the aftermath of the recession, many of our traditional carbon steel customers were slashing their production, many by more than 50%, in order to match freefalling demand and for their own survival.

At Olympic, the organic strategy allowed us to invest capital to, number one, tactically diversify our mix of products; number two, increase our value-added services and equipment; three, extend our geographic presence; and four, advance our investments in systems and technologies.

As a result, today more than half of our sales mix consists of specialty metals, fabricated components, and tubular and pipe products, with the balance of our mix in the traditional and growing carbon flat steel product group.

This has positioned us in markets with opportunities of, number one, to supply and grow with new customers; two, reduce our cyclicality; and three, offer diverse products to existing customers.

We continue to grow the carbon flat side of our business and increase our share of this market, which is exactly what we need to do to improve capacity utilization. Capital deployments that have been made to advance this transition are now behind us, and we anticipate future cash flow will benefit from capital expenditures remaining below depreciation.

The immediate goal now is to further increase sales volume and drive down operating expenses. David will cover some of ongoing efforts designed to achieve those permanent cost savings in a moment.

We have heightened our corporate governance practices at the Board level by appointing existing Board member Ralph Della Ratta to a newly created position of Lead Director.

Mr. Della Ratta, who is the Managing Director of the investment banking firm Western Reserve Partners, has served Olympic Steel shareholders well as an independent director since 2004. He has experience on each of the Board's governance committees and currently serves on our Audit and Compliance Committees. Previously, he also chaired the Compensation and Nominating Committees. Mr. Della Ratta has contributed valuable perspectives to the Board, and we welcome him to this new role.

Additionally, our Board of Directors declared a regular cash dividend of $0.02 per share payable on September 16th, 2014 to the holders of record on September 2nd, 2014.

So, now I will turn the call over to Rick for a financial overview of the quarter.

Thank you, Michael, and good morning, everyone.

Flat product volume was up sharply, increasing by more than 17% in the second quarter to 330,000 tons, and that compares with 281,000 tons last year. This is the highest volume quarter for our flat products since early 2008, which is obviously very encouraging.

For the first half of 2014, flat product volume was up 10% to 630,000 tons.

The higher volume drove second quarter net sales to a quarterly record of $386 million. That's up 17% from $331 million last year.

First half sales increased 10%, reaching $733 million. On a consolidated basis, average selling prices were down slightly for both the quarter and the six-month periods.

There was a small 1% to 2% price increase on the flat product side. However, this was more than offset by lower average pricing on tubular and pipe products compared with last year. As Michael mentioned, our experience is that pipe and tube pricing lags flat roll pricing by about two quarters, so we anticipate better pipe and tube pricing.

Gross margins were compressed by the lower average selling prices, combined with a higher proportion of flat products and specialty metals sales, which have lower average gross margin percentages compared with tubular and pipe products.

Gross margin in the second quarter was 19.3% compared with 20.8% in the same quarter of 2013. For the half, gross margin was 19.9% compared with 21.1% last year.

As we disclosed in the press release, we had $400,000 of LIFO expense in the second quarter and first half of this year. Last year, we recorded LIFO income of $375,000 in the second quarter, and we had LIFO income last year of $2.3 million in the six months.

The net negative impact of these LIFO adjustments hurt our gross margin comparisons by approximately 20 basis points in the second quarter and approximately 40 basis points in the half.

Operating expenses improved as a percentage of sales to 18.1% in the first half of this year, compared with 18.8% last year. This was due to the sales growth outpacing expense increases. Year-to-date volume and sales were, as I mentioned, both up 10%, while expenses increased 6%.

Distribution, warehousing, and occupancy expenses were the biggest drivers of the expense increase, while general and administrative and depreciation costs were up between 2% and 3%, and our selling expense were flat.

Operating income grew 18% to $7.1 million in the second quarter, up from $6.0 million in the same quarter of last year.

For the half, including the LIFO impact, reported operating income was lower at $13.3 million compared with $15.6 million in the first half of 2013. But, operating income increased before considering the LIFO adjustments.

Interest and other expenses on debt was $1.8 million in the second quarter and $3.5 million in the first half. This is $100,000 higher than last year for both comparable periods. The increase was due to higher debt balances to finance increased working capital needs.

Income taxes benefitted this quarter from a $200,000 discrete Mexican tax adjustment in the second quarter. This reduced our effective income tax rate for the quarter to 34.4% and to 36% for the first half of 2014. We still anticipate that our second half effective tax rate will approximate 38%.

Net income increased to $3.5 million in the quarter, or $0.32 per diluted share, from $2.5 million, or $0.23 per diluted share, in the second quarter of 2013.

For the first six months, we reported net income of $6.3 million, or $0.57 per diluted share, down from $7.7 million, or $0.69 cents per diluted share, last year.

The LIFO adjustment had a net negative impact on our year-over-year comparisons, totaling $0.04 per share in the quarter and $0.15 per share in the first half. Excluding the LIFO impacts, net income was up in both the three and six month periods versus last year.

Now turning to the balance sheet, at the end of the quarter we amended and extended our asset-based credit facility, which was due to mature in 2016. And we replaced that with a $365 million credit facility that increases our borrowing capacity by $30 million.

The new credit facility extended the maturity date by three years to June 30th of 2019.

In addition, we lowered the pricing grid on our revolver by 25 basis points. And the current agreement also has more favorable covenants, and we removed real estate from the collateral base.

So, this puts us in excellent shape on the liquidity front. At quarter end, we had $126 million of availability, and we have enhanced flexibility moving forward.

Accounts receivable days sales outstanding averaged 40 days in the first half of the year. This is in line with the 39.4 days in last year's first half.

Inventory increased to $311 million at the end of the quarter. And that was due to adding approximately $27 million of inventory in the quarter.

Reflecting the additional working capital requirements related to increased accounts receivable and inventory from higher sales, total debt did increase $5 million to $237 million in the quarter. Debt is up $38 million from the start of the year.

Although our inventory levels are up, our inventory turnover rate for the first half of 2014 was 4.4 turns, and that is exactly the same as it was in last year's first half.

Shareholders' equity increased $7 million to $306 million at June 30th, up from $299 million at the end of the year. This equates to $27.87 on a per share basis.

And finally, as planned, capital expenditures of $5.1 million were much lower in the first half of this year than our depreciation, which was $10.9 million. Capital expenditures will be higher in the second half of the year compared to the first six months, with most of these investments being made at our Winder, Georgia, facility that in onboarding newly awarded business from Cat's new excavator and dozer operation in nearby Athens, Georgia.

I will now pass the call over to David for the operating review.

Thank you, Rick, and good morning again.

On our April conference call, we indicated that we felt pretty good about market conditions entering the second quarter. Steady manufacturing activity and lean channel inventories were pushing out lead times at our suppliers, the mills.

In addition, pricing discipline exhibited by the mills, coupled with unplanned supply side disruptions, have further supported steel pricing this past quarter. However, the backdrop of healthy underlying demand in a number of manufacturing sectors is the real story in 2014.

We are currently seeing more market resilience, particularly in the traditionally slower summer months, than we have seen since prior to 2008. As Michael stated, our strategy to grow our business from the ground up and focus on specific market sectors is paying dividends.

In recent years, we have recruited new customers and increased market share in a number of new markets. We have gone from minimal participation to almost 5% of the US flat roll stainless steel market in just the past five years.

We have added a complementary customer base with our entry into tubular and pipe segment in 2011 through our acquisition of Chicago Tube and Iron. We have also grown our market share in these products since the acquisition.

We have added new equipment and capabilities to advance our strategy of moving downstream into higher margin steel processing and fabrication in both the flat products and pipe and tube segment of our businesses.

With the major capital investments in our rearview mirror, we intend to grow these new customers, further establishing Olympic Steel as the North American metal service center of choice. As our traditional customers are now regaining their pre-recession stride, we are welcoming their increased demand back with open arms.

We are ready to help customers with a much broader selection of products and services, while continuing to foster growth in an expanding economy. We have upgraded and enhanced our facilities and equipment to do more of what we have always done from a broader geography.

This enables our customers to benefit from just in time inventory management and reduce their working capital needs. By helping customers grow and prosper, we form mutually beneficial partnerships that, in turn, allow us to grow and prosper as well.

The combination of servicing new customers enlisted from 2009 and continuing and becoming an integral part of their supply chains, while at the same time retaining our legacy customers, as their business, for many, have returned to pre-recession levels, is a genuine manifestation of the strategy put in place more than five years ago at the onset of this protracted recovery.

As discussed at the beginning of the call, steel prices have been buoyant all year, due in part to strength in underlying demand. We are hearing from a number of our customers that they are optimistic about the year's second half, which reinforces our believe that the economy is finally entering a period of sustainable growth.

Internally, we have been working to improve our operating expense ratios in conjunction with higher levels of in-house processing. On that front, we advanced our operational excellence initiatives during the quarter.

Nominating recruits from various facilities and functional areas throughout the Company are now in the midst of Six Sigma Black Belt Training. We have standardized a formal training curriculum to foster consistency across the entire organization.

It is a nine-month program that includes identifying and implementing measurable and sustainable cost reductions. These initial cost reduction projects are underway, and include projects such as development of proprietary programs to track steel from source through production to determine how metallurgical characteristics can influence various processing and quality variables.

Other lean Six Sigma projects are designed to improve safety, identify where automation can enhance productivity, and reduce scrap through improved dynamic nesting capabilities on our laser and plasma cutting equipment. This is a long-term cultural initiative that is being led by John Howard, our Director of Operational Excellence, who joined Olympic Steel in the fourth quarter of last year.

Our mission is to create disciplines and to continue that process, if you will, throughout the Company devoted to leading and teaching others to develop and employ these best practices. We are in the very early inning of this effort and believe there's a great deal of potential to generate significant and permanent structural cost savings.

We look forward to communicating our progress in this area on future calls.

With that, operator, let us open the call for questions.

We will now begin the question and answer session. (Operator instructions.) Sal Tharani, Goldman Sachs.

Good morning.

Hi, Sal.

Just wanted to ask a few questions on the industry. Have you seen any changes in the dynamics of service centers with metal, due to acquisition or rationing going public, or is this business as usual?

Business as usual, most likely, Sal. There's a lot of competition. That remains true.

Okay. That's good to know. Stainless steel, what are you seeing in there? I know you have gained quite a bit of market share. But, in general, there were some price increases announced, which stuck some of them, I think the late ones having some difficulty. And also, in terms of supply, I think Calvert is ramping up at Alto Campo. API is putting out a new 72 inch hot strip mill. How do you see that panning out over the next six to eight months?

Hello, Sal. This is David. We continue to acquire market share under the guidance of Andrew Greiff, who's our President of Specialty Metals, and Andy Markowitz, who is our Vice President of Sales and Marketing.

We've seen exponential rise in that business over the last five years, as I noted earlier, from a minimal participant to now one that has 5% of the service center business in stainless steel.

The suppliers that you nominated are both excellent suppliers of ours. We look forward to further participation with them.

Over the past five years, one of our initiatives has been to repurpose our Schaumburg facility. That is specialty metals. We've also brought on a Latrobe, Pennsylvania, facility through an acquisition, and then we organically grew our Streetsboro facility. So, we now have three facilities dedicated to specialty metals, and we look to continue to aggregate more business.

And certainly the disruption in Russia is either going to help or not help the nickel pricing. But clearly on a global scale, Sal, nickel remains in high demand, and the supply looks like it is very disruptive.

And generally do you pass it through as soon as nickel increases, or it is usually the replacement cost when you pass it?

No, we have a blend of all those marketplaces. Certain customers allow us to manage that, the flexibility of nickel prices, in many different ways. But, we certainly are proficient, and we understand the dynamics and the risks associated with that commodity.

And one more time, if I may, Michael, usually we talk about second half slowdown, summer slowdown. You had put in your press release and also mentioned seeing quite a good momentum going into the second half. Others have mentioned the same. Do you think it might be a different seasonality this year that we get a very strong second half? Is that what it looks like talking to customers and looking at the market?

Well, clearly, Sal, I think that we have no further vision than maybe two or three months out. So, a lot can happen globally for the fourth quarter, but clearly we're seeing pretty strong momentum from a demand standpoint into the third quarter.

The things that are being written about imports, clearly imports are up. But, it really isn't affecting the transaction price all that much.

So, we're seeing pretty strong demand. As we indicated in our comments, Sal, that this, for the first time in a long time, seems much more sustainable than what we've seen over the last five years.

Great. Thank you very much.

Edward Marshall, Sidoti and Company.

Good morning, guys. So, I wanted to ask the market share question maybe a little bit differently, and thanks for the quantification. Is it true that it's just in the stainless steel, or are you seeing it in the carbon flat area as well? And then also, is it a benefit of the investments that you've made over the past year, or is it just kind of a function of the industry and that you're building your capacity just to kind of meet in the investments, to match kind of the new demand that you're seeing or the higher demand that you're seeing?

Okay, let's try and get all those answers in.

One, we're seeing significant participation growth in our pipe and tube. Two, we're seeing really accelerated growth in terms of our stainless and aluminum participation, probably greater than pipe and tube and greater than carbon. And three, we're seeing increased demand in the carbon as well. So, all of our segments are working well from a demand standpoint.

Two, I would say that part of it is the economy that is improving in all the sectors that we supply other than the two that we mentioned, military, which is of course the government cutback, and mining, which many people speak about. We are not immune to that.

Everything else, from a market segment, we're seeing increased demand. And then three, to answer your question, yes, a lot of it has to do with the investments we've made in filling the capacity and in an improving economy. If I left something out, I apologize, Ed.

No, that's okay. And then, I was looking at the -- so, based on kind of the commentary surrounding how it's continuing to go in June, and June being strongest and then July picking up, it doesn't sound like this was really a catch up from bad weather in Q1. And based on your commentary, it sounds like -- to almost quote, that you said it seems like the first time that we've seen a sustainable economy. Is that right? I mean, you -- it's not a catch up. It's more of kind of real demand coming through and pulling through now.

Yes. I mean, ultimately the steel mill misses a day of shipment or a week of shipments and falls behind. The customer demand doesn't change.

And so, the customer demand may catch up. But, quite frankly, this demand is fairly robust as we have seen and as they tell us on a go-forward basis. So, there's real demand growth.

And I guess I look at the piping margin. It was pretty weak, and I think you've talked about it a little bit with the LIFO expenses and so forth. But, is there any pricing? I mean, I know the pricing decrement that you talked about. But, is it anything to do with competition there and that price is kind of your -- the competing factor right now, or is it just as simple as just being -- lagging behind what's going on on the flat side?

I think it's just lagging behind, quite frankly. The CTI brand has a long -- a very long, a hundred years of history of profitability. They manage their business well. They clearly know how to price to the market.

They are a little bit different than some other parts of Olympic Steel, where they're not really driven by volume and don't have the same level of competition. So, we just think it is the lag, and we should see them improving back later on in the year towards their more normal operating profit.

Perfect. Thanks, guys.

Luke Folta, Jefferies.

Morning.

Good morning.

Rick, can you give us the gross profit percentage breakdown for flat versus tubes? Is that something you have available?

Yes, I do.

Gross margin is really what I'm looking for there.

Yes.

Hold on one second. He's looking it up.

Bear with me a second here. So, on the flat products segment, our gross profit was, and I'll give you -- do you want the quarters? Is that what you'd like?

Yes, 2Q.

Yes. So, 2Q, 17.7% for flat products segment versus 19% last year. The pipe and tube, the gross profit is 27.1% this second quarter versus 28.8% second quarter of last year.

Okay. And then, on the flat roll side of the business, I understand that you are selling more specialty metals this year and that's having a negative impact on the percentage margin. I'm sure on the dollar margin it's good.

But, I guess there's just so much leverage in your model around if and when that flat rolled percentage margin starts to improve on a kind of per product basis, so can you just talk about, I guess, what the factors are and what you're seeing in that market in terms of just carbon specifically and stainless and aluminum? What's it going to take to where we can finally start seeing some real margin expansion in those areas more towards what you've seen historically in a historically good market, like perhaps in the last up cycle?

That's a very good question, Luke. I hope it happens soon. David, you want to comment on that one? I mean, we've already got a take on that one.

Sure. Yes. That's a lot of questions rolled into one, Luke. Let me answer a couple for you.

One, the stainless participation is up, as we nominated that. We managed those results. And you're 100% right. The margins are, as a percent, a little bit less, but the dollars are significantly more. That's part of our strategy of balancing that with Chicago Tube and Iron.

So, with Chicago Tube and Iron, as Rick nominated, their margins balancing out with some of the specialty metals, which we don't break out, and then flat roll. But, specialty metals is strong. Our aluminum participation is growing, and pricing is good there.

On the flat roll side of the equation, more stability. We noted a year ago that we were done with the recovery and that we were in an expanding economic environment where we would see the manifestation of our investments. And indeed, we are doing that as we depicted here this morning.

In conjunction with that, we see flat roll pricing gaining strength. It does have a -- it has the cyclicality that we're all used to, but we do see it gaining strength. The latest price announcement back on June 30 has traction. Demand is better.

Obviously, more the sale of some of these steel mills and the consolidation of the industry is providing more discipline, as we noted. And as Michael noted, we're seeing very, very little impact from foreign -- from imports.

And so, we see pricing sustaining itself. And we'll see those margins continue to increase, of course, as we bring better efficiencies and economy to our business.

Yes, and I think that -- Luke, it's Rick. And I think the other factor to tie into what David said in terms of the improving marketplace, the spot market returning will also enhance that.

And we're just starting to see the frontend of that here in the second quarter. We saw the spot markets just finally start to pick up a little bit. So, I think that'll be another factor going forward.

That's interesting. Okay. So, I guess is part of the margin that you're seeing in the flat roll side of the business -- I mean I know you guys have done a lot of expansions and you're trying to obviously fill those additional facilities. And it clearly seems like you're having some success there with shipments up 17% year-on-year.

Would you say that, in terms of your strategy, you're more in fill the facility mode until you can get some sort of sustained kind of margin or normalized market share, and then perhaps at that point you could start thinking about maybe getting a bit more aggressive in terms of pricing and try to expand your own margins?

Well, we have a different -- Luke, we have a different prescription for each one of our initiatives. And in fact, we're not going to sacrifice margin and enlist business at margins that we can't sustain, though we do have different strategies. We're bring on a lot of value-added equipment, as we've noted and as Michael said in his commentary.

Less than half of our business today is flat roll, and flat roll continues to grow. So, we're growing all those dimensions of the business, and we're looking to balance that. But, we're not sacrificing that margin for growth.

Okay. Last question I have is on -- when you look at your percentage of flat roll sales, spot versus contract, can you give us a sense of what that is today and kind of what that was in the last up cycle? And then, I guess -- well, I guess that'll be fine.

Yes. Again, that's a tough question to answer because our business is so different, Luke. But, I would say probably at this point in the market our spot is less than it was back in the heyday. Again, that's a reflection of mill lead time and service center inventory.

When we talk about the spot market. The spot market is essentially service centers. And we're happy to embrace those who have either less capital deployed in their inventories or maybe misjudge their inventory need and requirement.

But, clearly in a period of sustained economic growth, which we saw from 2002 to 2008, it might have been the top of or ending of the cycle, we're nowhere near close to sort of the spot market that we used to have. But, as Rick indicated, we're starting to see the beginning of that trend occur right now.

So, our overall kind of committed -- what we call our contract or committed business is probably a little bit higher as a percentage today than it was in the last uptick so far. But, we welcome the increase of the spot market.

Okay. Thanks a lot.

Aldo Mazzaferro, Macquarie.

Aldo?

Mr. Mazzaferro terminated the call, sir.

Okay.

Phil Gibbs, KeyBanc Capital Markets.

Morning.

Hi.

Michael, do you feel, with the current and pending consolidation that -- do you feel like the mills are behaving differently out there in the marketplace, or is it sort of same-same? I'm wondering if there's sort of a palpable difference in psychology.

Look, you've got some consolidation. You don't have TK in the marketplace today. You're having the changing dynamic of Severstal to the potential new ownership.

So, I think to a certain degree, you're just seeing the potential of more discipline. Certainly, an owner in the South is not going to compete against his own mill in the North. So, having said that, there's probably a little bit more discipline today than there might have been in the last few years.

But, clearly I think from just speaking at the integrated level, a 17 million unit automotive market versus 15.6 or 16 certainly changes the dynamic of an integrated steel mill's performance, as they particularly view automotive as a significant customer base.

So, I would tell you that if it's any different, it's probably reflective of, one, consolidation, and two, the increase of demand, particularly of automotive.

Okay. Terrific. And I just had a question on the oil and gas market. How much do you participate there, and what are you seeing or expecting in the second half?

Well, we participate nominally. We're like the guy who sells the shovel to the gold miners. We sell the steel to people who are making tanks and make the equipment and make trucks and so forth. But, we're not participating directly in OCTG or any of the line pipe.

Phil Gibbs Okay. This is lastly on construction. I know a lot of your products tend to touch that market. Anything as we've moved into the second half that gives you more confidence or less confidence, any signals or any changes that you're seeing from a geographic standpoint, anything stronger than the other? Just trying to get some sense of how you guys are viewing the construction markets right now.

Well, we see it through a lens of aerial lifts and construction equipment. And a lot of that is the refurbishing and repositioning of rental fleets, and we see a dramatic increase.

As you know, some of the rental companies couldn't access capital as early as 2006 and 2007. And those fleets are fatigued, and we see a dramatic amount of participation with our customers that do in fact supply some of those large rentals companies across the country. So, in that regard, we see a significant boost in participation.

Also, on-shoring. Let's not undersell the fact that there's a lot of re-shoring of manufacturing back in the United States. We're going to participate in some of that based on geography. But, that's a significant increase in demand that's coming over now and in the future.

Michael, how big of a percentage of your overall volume broadly is fabrication now versus -- call it more value add just versus the plain vanilla type business versus where it was maybe five or six years ago?

Well, five, six years ago, it was de minimis, and now we're somewhere north of 20%.

Phil, it's Rick. We're at -- about 22% right now is our mix for fabrication. And as Michael said, 10 years ago that would have been single digits. And five years ago, it probably would have been in the low teens, low to middle teens.

So, remember, as we talk about what we're calling fabrication, it is more than the first stage operation. So, part of the service centers is cutting the length and slitting. We don't call that fabrication. That's just sort of the generic stuff.

As you take it to a second stage of punching, burning holes, and bending, welding, machining, that's the value added component for us. So, our flat roll side of the business including tempering, cut to length, and slitting is growing, and yet the fabrication is outpacing the growth that we're seeing there.

And you know we do a lot of fabrication too on the pipe and tube side.

Yes. Yes, absolutely. And just the last one here, if I could, just strategically, the efficiency program that you've set forth the last several quarters here, when do you expect to see some, call it material progress, on that, and what types of things should we be looking for? Thanks.

We would hope it's every day. But, clearly, David's initiative of the Black Belts that are being trained in-house, they all have capstone projects that they're working on.

We expect that to be in double digit plus immediate as it gets implemented in the fourth quarter. You'll see the full impact of that first round fully impacted next year. And clearly, we know that there is -- without putting a number on it, it's fairly significant. It's fairly significant in all the initiatives.

So, as we have grown and migrated the different parts of our business on a synergistic basis, clearly sometimes your expenses and the people you hire get hired before the full efficiency is there. But, with our commitment to quality performance for the customer, we'll see pretty much significant decreases in the expense ratios as we go forward. And next year probably you'll see materiality to it.

Thanks, Michael.

Nathan Littlewood, Credit Suisse.

Hi. Yes. This is actually [Gail Pertergle] in for Nathan. Most of my questions have been asked, but can you give us a little bit more color on the product mix within the carbon flat roll and how that may have changed over the last quarter or relative to last year?

You mean sheets versus plates? Is that what you're looking for?

Yes. And I guess -- I know you've talked about how stainless has increased. And I guess I'm just trying to understand how much also from within the flat rolled in general is stainless versus sheet and stuff like that.

Broadly all factions of our business are growing. So, our plate business is growing, and we see a strong demand for plate. Lead times are out at the plate mills. Pricing is up.

And so, we continue to grow that business, and our flat roll business continues to grow. It's not directly proportional, but they're both in the growth mode along with all factors of our business.

Yes, that's a hard breakout. I mean, it really is a very different breakout to do that the way you're asking. So, again, we can give you sort of later on. Probably next year we're probably going to have to segment our -- because of the growth, the significant growth of our stainless and aluminum. We'd probably be able to give more clarity next year on that because it is becoming material in terms of our results.

The other factor I would also tell you, which is sort of the thing that we don't promote, is the fact that in Chicago Tube and Iron, about 17%, 18% of their mix is also in the stainless and aluminum side.

So, we don't break that out in specialty metals, but a significant part of the mix of Chicago Tube and Iron is also the stainless and aluminum markets. So, I would just say, as David said, plate market has been strong with heavy industrial, which is part of our market. So, we're seeing probably a little bit more growth than we are there on the flat roll carbon business, but all segments are growing.

And as our industry, the service center industry measures itself within our trade organization, the Metal Service Center Institute and its activity report, we see growth across the board in our product lines.

Okay. And then, just shifting gears a little bit, I guess I thought it was pretty interesting that you commented several times that imports haven't really been affecting you where we have seen them affecting some of your competitors. So, is this maybe due to your geographical footprint versus others? I mean, I know that there's import issues in some of the stainless products and such, so I'm not thinking that it's really carbon versus stainless. Can you give more color there?

Our imports are always part of our supply mix. And so, when we say we don't see it affecting us dramatically is that proportionately we are pretty much the same.

And we avail ourselves of imported product and strategic locations where it makes sense, where the logistics make sense, which is a big driver of why we would buy the imported product. And proportionately we're about the same, and we monitor that. We're significantly concentrated on domestic supply or American supply.

Yes, and the other side is if you look at the data, as David indicated, from the Metal Service Center Institute, inventories on a net basis may be up a little bit. You can say that's partly import, but the fact of the matter is, is that the days shipment in inventory are actually down.

So, you would say that the imports are necessary just to maintain an even level to meet the demand. We're not seeing an imbalance in the inventories, even with this influx of inventory.

So, in that sense, this is needed supply to just feed the market that's growing pretty strong. So, that's why we say we're not seeing it. It's just not impacting the market because it's being fed into increased demand.

Okay. Can you guys just refresh my memory? How much product do you sell that's typically something that's imported versus sourced domestically?

Well, we would be somewhere around 10% or less, but somewhere around 10%. We wouldn't be any more than 10% total perspective across the board.

Okay.

It'd be very hard for us to break that out. I mean, there's some specialty metal involved in that. There's some specialty pipe and tube. And there's some, again, specialty flat roll that we bring in. And a lot of that product is just not made in North America.

Look, we have the ability to buy more imports if we choose to, both from Mexico as well as Canada, as well as other parts unknown.

But, I would just say from a standpoint of good inventory management and working capital turnover, it behooves us to make sure that we maintain a strong domestic supply.

But, clearly, we have access to any of the import numbers and tonnage if we so choose to do that. But, as David indicated, just from a management standpoint, it doesn't really kind of get anywhere much greater than 10%.

Okay. Thank you.

Thank you.

(Operator instructions.) Aldo Mazzaferro, Macquarie.

Hi, Michael. Can you hear me all right?

Yes. Welcome back.

Yes. Sorry, I accidentally disconnected myself there.

Oh, that's modern technology. Yes.

I know. These mute buttons get very confusing.

Yes.

I just wanted to ask you a broad question about capacity utilization, if you can think about your Company in terms of what kind of a utilization rate you had in the quarter compared to a year ago. And I'm wondering what the investment you're making in Winder, Georgia, might do to your overall capacity in the Company, just in really broad terms, if you can think about it that way.

In really broad terms, we'll take more business from anybody who wants to give it to us who can pay their bill.

I would say that when you look at our value added, we're at very high capacity utilization, Aldo. We have lots of capacity in slitting, and we have some capacity on the temper mills.

And so, again, as we want to bring in business, we obviously want to meet that commitment to the things that we have the greatest opportunity to fill the capacity. So, temper mill across our three locations, we'll take more business. We'll take it on both direct business. We'll take it on a toll business. Slitting, I can tell you that is a marketplace that's very narrow in terms of its returns, but we'll take more business there.

Value added, from our standpoint, very, very full, other than what we've got reserved for things like what you indicated, which is Winder. Things that we're hearing from Caterpillar is that they're accelerating their startup. And so, while we anticipated pretty strong demand from them in January, we might get it in the fourth quarter.

So, we're very, very -- while we may have the capacity today, certainly we are reserving that for what we expect to be able to perform for the customer. So, again, we have a big welcome mat for anybody who wants to do business with us.

Great. Say, Mike, did you said in the stainless business that it's a demand-driven price recovery that you're seeing, or is a lot of it just with the nickel content going up?

I just wanted -- I heard your comments on how you really think there's a demand-driven recovery, and I have to say with the inventories as low as they are and the imports as high as they've been, you wonder where it's going. It has to be being consumed, I would think. So, I'm wondering if stainless is seeing the same thing, or is that more of a cost push pricing?

No. I mean, you don?t get 5% of the market from low percentage if you don't have a demand. So, yes, nickel pricing helps. The surcharge helps in terms of your margin profitability.

It has nothing to do with your volume. So, it clearly helps, but the second part of the business is we're garnering market share because of the service and value we bring to the market.

But, if you ask specifically about markets, I would tell you that truck trailer and food service are very strong markets for us. Lots of fast food places opening up across this country, as working families don't cook meals at home anymore and are taking their kids out to basically fast food locations, whether it's Panera or pick whatever name you like. But, the fast food industry is growing, and we service kitchens.

And, Aldo, David here. Even though you specifically asked about stainless steel, our aluminum participation has increased dramatically with automotive.

And so, as Michael indicated that early in the call, but our -- just to echo the commentary, our stainless steel business, we are just aggregating more business. And remember we've repurposed a facility, brought on a new facility in Streetsboro, and acquired a facility in Latrobe, Pennsylvania. So, you really have a trifecta there in terms of how we are participating in specialty metals.

And as Michael well says, just to add a little bit of color on picking up additional business, a lot of this business is driven by logistics. And we want to make sure that we are close to our customers and we're not absorbing extraordinary distribution expenses. So, our expansion in Winder, our expansion in Gary, gets us closer to a customer base and allows us to keep our distribution costs in check, even though that is increasing.

Yes, and just one last point on the utilization. I would tell you we have a need, Aldo, for more stainless processing equipment. And so, we're overcapacity on our ability to process stainless in-house.

Great. And say, Rick, can I follow up a little bit on the volume numbers you gave? I heard you say 330,000 tons was the flat. Do you have a breakdown between tolling and direct on that? And do you have a tubular volume number?

We don't give tube volume, just because obviously it's hollow. And so, that's just something we've never done.

But, I can give you the breakout, if you'd like, on the quarter. So, direct tons were 302,000, tolling were 28,000. That's how you get the 330,000. Last second quarter, direct was 263,000 call it, and tolling was 18,000. And that's how you get the 281,000.

Yes, clearly the stainless -- excuse me -- the tubing sales are up.

Yes. I mean internally, we obviously measure market share through volume. So, as Michael said, on the pipe and tube side, our volume was up about 9% year-over-year.

Great. And Rick, in LIFO, do you expect your -- I know you took the charge in the second quarter. Do you expect the charge in the third and fourth as well?

Yes. I mean, basically the way LIFO works is you project what you think your LIFO's going to be for the year, and you book it pro rata.

So, using that methodology, we booked $400,000 in the first half. So, we'd expect something similar in the second half. Thus, our comment about the lag on pricing and why we think pipe and tube pricing has the opportunity to move up.

Yes. Okay, I think that covers me. I appreciate it. Thanks very much.

Thank you, Aldo.

Charles Bradford, Bradford Research.

Hi. Good morning.

Morning, Charles.

Hi. I'm sure you've probably followed all the pipe and tube mills that have been announced under construction or recently entered the market. I know they're oil country typically, and that's not your product. But, between them adding new capacity, between the dumping cases, are you seeing any traditional oil country producers switching to try to get into the more specialty or structural pipe that you would normally be involved with?

The answer to that's no. I mean, it has gone the other direction and continues to go in that direction, which more of the bent toward OCTG when they've made those changes. We've not seen a change back to traditional structural and/or mechanical.

And could you talk a bit about the plate market? I mean, most of us follow the hot rolled coil market pretty closely and some of the other products. But, what's happening in plate pricing these days?

Chuck, plate pricing has steadily moved up. Demand has increased. Lead times have gone out. There's been a pretty good absorption of heat-treated product. And our specialty plate business, which would be heat-treated products, has continued to grow.

So, we just see increased demand from our customer base. Our fabrication sales have increased, and we continue to grow that market. And so, we just see a healthy demand out there for plate.

Terrific. Well, thank you very much.

This concludes the question and answer session. I would like to turn the conference back over to Mr. Siegel for any closing remarks.

Yes. Thanks. I'm a little exhausted today, but we appreciate all of the interest in Olympic Steel, and we look forward to sharing our progress with our third quarter results, which will be released in early November. Thank you all. We really appreciate the questions and answers.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.