Olympic Steel Inc (ZEUS) 2016 Q2 法說會逐字稿

Good morning, and welcome to the Olympic Steel 2016 Second Quarter Conference Call. (Operator instructions.)

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 Forms 10-K and 10-Q, and press releases filed with the Securities and Exchange Commission. This call is being recorded, and the live broadcast will be archived and available for replay on Olympic Steel's website.

And at this time, I'd like to introduce your host for today's call, Olympic Steel's Chairman and Chief Executive Officer, Michael Siegal. Please go ahead, Mr. Siegal.

Thank you, Kim. Good morning, and thank you all for joining us to discuss Olympic Steel's 2016 second quarter and first half results. On the call with me this morning are President and Chief Operating Officer, David Wolfort, Chief Financial Officer, Rick Marabito, President of our Chicago Tube and Iron business, Don McNeeley, and President of our Specialty Metals business, Andrew Greiff. Let me start by thanking each of our employees for all their efforts, their generosity, particularly as it relates to our Company-wide Make a Wish program, and for their continued commitment to improvement for the benefit of Olympic Steel and its shareholders, as we achieved record high market share for Olympic Steel. And all three of our reporting segments contributed strong operating income during the second quarter and first half of 2016.

Post- the 2008-2009 recession, we, Olympic, strategically invested early in the recovery in facilities, equipment, and new products, all designed for growth in volume and margin. Today, we are strategically adding people to our commercial enterprise leading to, we believe, ongoing market share growth. We see it in all of our new facilities, especially in Stainless and Aluminum, in the addition of tubing via Chicago Tube and Iron, and in Carbon Steels, as well. With our $300 million capital expenditure program concluded, we are focusing on operational improvements, debt reduction, and inventory and receivable management, which we believe at 5.2 inventory turns and 37 days outstanding in our receivables are the best in class.

As the marketplace improves, and we believe that it will, we are poised to take full advantage via our strong balance sheet and commitment to excellence to propel earnings growth in the future.

With that, I will turn the call over to Rick for our second quarter financial review.

Thank you, Michael, and good morning, everyone. According to the MSCI Metals activity report, year-over-year industry shipments declined again in the second quarter, resulting in 2016 service center shipments declining by almost 7% compared with the first half of last year. Our total Company shipments were off less than 2% in the first half as we continue to gain market share this year.

As Michael indicated, our market share is now higher than at any time in the Company's history. Demand in some of our end markets, such as food service and auto, is healthy, while demand from other sectors, such as mining, agriculture, and related heavy equipment manufacturing, remains challenged. While our overall volume was down less than 2% and market prices have risen in the first half of 2016, average sale prices are still 18% lower on a year-over-year basis, resulting in the net sales declines in the current year periods versus last year.

Second quarter shipments in our Carbon Flat product segment increased 2% sequentially from the first quarter to 272,000 tons. This was 2% below shipments in the second quarter of last year due to less tolling tonnage, as our direct sales tonnage increased slightly over last year. Revenue in our Carbon Flat product segment likewise improved 7% sequentially from the first quarter to $173 million. However, net sales were down 17% from $209 million last year as our average selling price for Carbon Flat products declined more than 15% from last year.

Sales volumes in our other two segments grew both sequentially from the first quarter and compared with last year's second quarter. Sales in our Specialty Metals segment increased 13% to 22,000 tons, up from 19,000 tons last year. This was also 10% sequentially higher than the first quarter volume of 20,000 tons.

Tonnage is less meaningful in our Pipe and Tube product segment, though we don't report specific tonnage figures. However, pipe and tube shipping activity was also higher than both the first quarter and the comparable quarter last year. Since our acquisition of Chicago Tube and Iron five years ago, our Pipe and Tube segment has performed exceptionally well.

Successful sales efforts led to the volume improvements and record high market share in both of these respective product categories. However, like the Carbon side of the business, the volume increases were more than offset by lower average selling prices versus last year. This resulted in lower year-over-year revenue for these two segments, as well. Specialty Metals net sales declined 6% from last year's second quarter and by 9% in the first half. Sales of Pipe and Tube product were off 4% in the quarter and down 14% year-to-date.

Gross margin improved in all three of our reporting segments, which led to a consolidated gross margin expanding 600 basis points to 24.8% compared with 18.8% in 2015 second quarter. Successfully accelerating our inventory turnover rate, rising market prices, and a higher proportion of Pipe and Tube products versus last year all boosted our consolidated gross margin. Also, as part of our ongoing profit improvement initiatives, we improved yields and reduced the percentage of scrap produced by our Flat Product segment, which further enhanced margins.

As a reminder, about 20% of our consolidated inventory, all in the Pipe and Tube segment, is valued under the LIFO method. There were no LIFO impacts in either the second quarter or the first half of this year, as we expect rising inventory costs in the second half to offset the inventory declines of the first half of 2016. In last year's first half, we recorded $650,000 of LIFO income.

Excluding the noncash intangible impairment charge from last year's results, our operating expenses were essentially flat in the second quarter, and year-to-date expenses declined by $3.8 million, or 3% compared with last year. Higher gross margin combined with our focused control on expenses resulted in operating income increasing to $8.3 million in the second quarter compared to $53,000 last year before the impairment. First half 2016 operating income more than doubled to $8.4 million, up from $3.4 million in last year's first half, again before the impairment charge.

Interest expense declined 13% to $1.3 million in the quarter versus $1.5 million in last year's second quarter. The first half interest expense declined 16% to $2.6 million from $3 million last year. The interest savings were due to lower average debt balances in 2016.

Pretax income of more than $7 million in the second quarter was higher than any quarter since the first quarter of 2013. Our 2016 effective tax rate is higher than normal due to a $700,000 state income tax valuation reserve that we booked in the second quarter, resulting in an effective rate closer to 50% for the quarter [in] the first half of this year. Our base income tax rate is still in the 38% to 40% range before the valuation reserve.

In the second quarter, net income was $3.6 million, or $0.32 per diluted share, and that compares to last year's net loss of $22.3 million, or $1.99 per share. For the first half, we reported net income of $2.8 million, or $0.25 per diluted share, and that's up from a net loss of $21.2 million last year, or $1.89 per share. The impairment charge negatively impacted last year's results by $1.91 per share.

Our balance sheet remains very strong. Accounts receivable increased $21 million from year-end, primarily the result of higher shipments versus the fourth quarter. The quality of our receivables remains excellent. Day sales outstanding averaged less than 37 days in the second quarter compared with 39 days in the second quarter of last year. Inventory was higher in the second quarter at $211 million at June 30. This represents an increase of $4 million from the $207 million in inventory held at the end of December.

Improving inventory turnover has been a focus and a contributor to our strong gross margins and profitability in 2016. Inventory turns, which we measure in tons, reached 5.2 turns in the first half of 2016. That's up from 4.2 turns in last year's first half.

Total debt was reduced by $4 million since the beginning of the year, and totaled $144 million at the end of the second quarter. More importantly, in the past 2.5 years, we've reduced our total debt by over 50% from a high of approximately $300 million in 2013 when we were in the midst of our strategic expansion program. We had $105 million of availability on our low-cost asset-based lending agreement at the end of the second quarter, and our effective borrowing rate in the first half of the year was 2.4%.

In the first half, our capital expenditures were $3.6 million, down from $4.2 million last year, and those expenditures were primarily associated with equipment and facility spending. As Michael stated earlier, we have concluded our $300 million capital investment program, with the facilities and equipment now in place to drive market share and earnings growth in an improving marketplace.

At the end of June, our shareholders equity was $257 million, or $23.48 per share. And our tangible book value per share was $21.27.

In closing, we plan to file our Form 10-Q later today, and that will provide additional details on our operating results for the quarter. I would now like to turn the call over to David for his operating (inaudible).

Thank you, Rick. And echoing both Michael and Rick's comments, our improved 2016 performance can be traced back to our strategy emerging from the 2008 and 2009 recession. At that time, we began a mission to diversify our product portfolio, to enhance our processing capabilities, and to expand our geographic reach. Investments have been made in people, facilities, and equipment, and today we are much less dependent on the carbon steel market, although we're proud of our growth in the direct carbon steel sales, as Rick noted earlier.

In the first half of the year, carbon product comprised 63% of consolidated sales, with Pipe and Tubular Products accounting for 19% of consolidated sales, and Specialty Metals making up the remaining 18%.

Just five or six years ago, carbon flat products essentially represented the entirety of our net sales. As Michael indicated, post-recession, we strategically invested in six new locations. All of these new facilities are now appropriately staffed, inventoried, and making positive contributions to consolidated profit. We are cross-selling tubular products with flat carbon and specialty metals products, and customers are responding positively. These initiatives, combined with strong execution, have led to the record market share Mike and Rick just highlighted.

Now, should demand strengthen, we expect additional operating leverage and even better profitability. In the meantime, we will continue to be disciplined on costs, inventory turnover, which is currently exceeding five turns, as Rick noted, and surpassing customers' expectations to increase our industry participation.

The supply-side dynamics that have influenced the 2016 rise in steel prices remain in place. Raw material costs are still elevated, although moderating. Import volume has decreased, and domestic steel mills continue to exhibit production discipline. These dynamics have helped the positive momentum in steel prices throughout the first half of the year.

And as a reminder, the Hot Roll CRU Index, after declining more than 40% last year, reached a low of $354 a ton in December. Since that point, it has rebounded by more than 77%, rising to $629 per ton at the end of June before settling slightly lower in July. This resulted in higher quarterly contract resets on July 1 of this year, which should contribute positively for our current quarter performance.

Now, Operator, with that, let's open the call for questions.

Thank you. (Operator instructions.) Seth Rosenfield, Jeffries.

Good morning. I just have a question on the outlook for market share gains across the US. You mentioned (inaudible) volumes had benefited from some gains relative to (inaudible). Wondered if you could give us a sense of what [forces] or market dynamics you're seeing in the environment right now. Given that share prices have recovered so strongly, or to date, what (inaudible) do you see [in more limited access] to financing among some of your peers being sustainable driver for your own market share gain (inaudible) going into H2? I'll leave it there. Thank you.

Yes, Seth, thanks for the question. I would say, from a capital and credit perspective, obviously a return to profitability probably has given some breathing room to some of our competitors, which would have been -- if you go back six months, we had a great concern about what the marketplace was going to do from a credit perspective to the industry in total back in December.

But, we've seen obviously the credit markets open up on a big scale in the debt market, and we've seen sort of a return to profitability in our sectors. So, that concern itself is probably less germane that it might have been six months ago, and I think it really is about, while we never believe that price is not fashionable, it always is, I think performance also matters.

And so, what we've seen at Olympic is obviously our commitment to the operational excellence and performance for the customer is giving us more opportunities across all segments of our business.

Great. Thank you very much.

Tyler Kenyon, Keybanc Capital Markets.

Hey, good morning. So, just thinking about the third quarter here, thinking you'll likely have probably some reduced momentum just in the carbon sheet and plate spot business, likely lower seasonal volumes but some nice upside on the contract side, so I guess my question is how should we be thinking about EBITDA in the third quarter relative to the second quarter levels? I'm just trying to figure out how all these variables work together.

Hi, Tyler, it's Rick. So, the way I would tell you to think about it is it's a typical seasonal July. I think as you look at history, this year's July follows a lot of the seasonal patterns. So, you said it right, there's obviously a weaker shipping environment in July due to the shutdowns and some of the transitions that the end users make.

So, that's what I'd tell you. I think we have good momentum in terms of continued average selling price increases going into the third quarter, and we'll just start the quarter with a little slower volume.

Okay, thanks. And then, just any color you could provide us on what you're seeing and-or hearing from your customers in some of your key end markets here? And do you get the sense that their inventories are in the right place relative to existing demand bubbles?

Yes, Tyler, Dave Wolfort here. I would tell you that I think our customers' inventories are at the appropriate levels. I think their concern relative to the marketplace didn't just [harbor] in the first six months of this year, but has been ongoing. And so, they've been cautious about what they bring in.

But, relative to your first question, and then a little bit of color on the second, is that it's not our intention to give up any market share, but in fact our intention to continue to gain market share, particularly with these six new Greenfield facilities that we've brought on. And of course, with the advent of the growth of Specialty Metals and the addition of Chicago Tube and Iron, the integration of all of these facets of our business has allowed us to penetrate markets much deeper.

Great. Thanks, David. And then, just one more if I may. Just any update on the thought process on M&A here? And could you remind us just of how large a potential target could be based on your debt leverage comfort levels?

Wow. Yes, obviously we are looking to add things that are accretive and margin-enhancing. We're looking at basically smaller, as opposed to larger, transactions. Our appetite is relative to what we think is accretive. So, I think our debt level today is appropriate relative to where we're starting to see our earnings. Obviously we want to continue to reduce our debt until such time that we see those opportunities for accretion.

But, one-to-one is always a good one, but at many times in our history I would tell you debt equity -- we've seen ourselves anywhere from two and three, but that would be kind of inappropriate in these markets. So, we're kind of looking at one-to-one kind of ratios that we would be comfortable with.

Okay, great. Thanks for all the color. I'll jump back in queue.

(Operator instructions.) Aldo Mazzaferro, Macquarie.

Hi, good morning. In your average pricing, Michael or David, it seems to me like you had a pretty understandable lag versus the index. You take that CRU Index, it looks like sequentially it was up more like almost 50% sequentially. And then, you look at the -- [your] movement, about 8% or so on pricing. I'm just wondering if -- you probably ended the second quarter at the high price for the quarter. I'm wondering, if you just hold that flat, going forward, what do you think your average pricing might average versus second quarter in the third quarter?

Average pricing related to what, Aldo?

Like, if you say your average in the second quarter carbon price versus the average you might expect in the third quarter, if you assumed sideways price trends from the end of the second quarter? I'm just thinking there must be quite a bit of potential catching up there if you take an average third quarter versus an average second.

Yes. Aldo, this is Rick. I think that's exactly right. When you look at our average sell price in relation to the Index, there's definitely a lag. Certainly on the carbon flat side where we have some significant proportion of the business that -- we'll call it contractual, we have a lot of that business that resets pricing in arrears once a quarter. So, one of us commented in our -- I think David did in his remarks that, on July 1, we did get resets on many of our contracts where the prices went up. So, yes, you'll continue to see average selling prices in the third quarter for us move up.

The second thing is, is on the Specialty side, obviously we're seeing some continued market price strength in the third quarter. So, we would envision that side of the business also increasing sell prices.

And then, lastly, the Pipe and Tube business, that business, just due to the nature of the lag of Pipe and Tube off of hot roll, we've historically in our business seen about a three-month lag on price changes in that business versus hot roll price changes. So, when you throw all those things into the mixer, we would certainly expect to see prices moving up in the third quarter.

Don, you want to comment at all on Specialty?

Well, I would tell you, Aldo, that what you'll see in the second half of the year on stainless in particular is the domestic mills, as has been reported, raised base prices approximately 18%. That will really start impacting pricing going into the second half of the year. So, we would expect to start seeing those numbers starting to come up.

Great. And I understand also -- is there a very big presence of imports in stainless? I would think with the tariffs that they announced, their preliminary basis, anyway, you'd probably start to see those dissipate, right? That's the reason why you think pricing is going to hold on the stainless?

Well, I think you're referring in particular to the Chinese. We did see a big bump, and then we saw it come off a little bit over the last month or so. We'll probably see it come off in the second half of the year. And so, you're correct, that will certainly impact the strength of pricing second half.

Great. Just one final question. You guys have been a public company for a long time. And over the course of many cycles, the operating margin has been as high as sometimes 5%, 7%, as low as a big negative number at times. And I'm wondering, the 3% that you just reported roughly operating margin, would you think that's normal today, or has that still got some upside potential? Or how do you view the earnings level you're at now compared to where you think you should be, or could be?

Well, I think it could, [in truth], be higher. Again, I mean, a 3% overall return on invested capital is not that good, Aldo. When you have to be realistic, there's not a 20% margin industry. Again, nobody kind of makes 10%. So, we try and target to get closer to 5% to 7%. Obviously we think, from a working capital standpoint, we're about best in class there. And so, really it has a lot to do with the dynamics of buying and selling. And clearly we believe that, with good discipline on cost structures and an improvement on some of the things we're working on, as Rick mentioned, like the scrap reduction scenarios, there still is a strong probability and possibility of having continued EBITDA and net income improvements over the 3%. Go ahead, David.

Well, I was -- just to echo some of Mike's sentiments before Rick gets into a little bit of detail there, Aldo, remember, this is almost a two-year cycle, not just a six-month cycle. Last year, we like to say kiddingly, if this was an EKG, we'd be dead. But, the reality of this is that the marketplace took 12 months to -- and dropped $240 a ton on hot roll, and up $277 in six months. And so, we're continuing to manage the inventory.

And as Mike and Rick have well noted, with 5.2 turns of inventory, we put ourselves in really good position. And additionally, we've disbursed that inventory over the six Greenfield sites that we have. So, [with] new geography, better logistics, things along those lines, help us mitigate the ups and downs of the marketplace, along with obviously Chicago Tube and Iron's contributions and the integration there.

And Specialty Metals, which Andrew Greiff's really being modest here, has had a fabulous quarter this last quarter, with 5.6% of the service center marketplace in Stainless flat roll. I think all those sort of things help us gain market share and moderate any particular loss, and add to that operating margin.

Yes. And I think Michael said it well in his opening comments, we've spent $300 million on investments over the last six, seven years, and I think we're poised to make those higher returns that you talk about, Aldo, certainly as demand in the marketplace comes back. Keep in mind, we're in a shrinking market here.

We talked about shipments for service centers being down 7%. We're obviously focused on gaining market share, and as David said, that's going to continue to be a push for us. But, when you're in a marketplace that's shipping less, and we're fighting it out with competitors to gain market share, it's a little bit of a tougher environment to make money versus when you have demand expanding.

And we think -- as Michael said, we do believe that the market's going to improve, going forward. So, that's the other piece of it.

Great. Well, thank you so much for all the color. Excellent.

Aldo Mazzaferro.

If no one else is going to take one, Mike, I thought I'd take one more. If you look out at 2017, Mike, and you say we might be in a demand environment similar, maybe a little better than this, but certainly not roaring demand, and then you say these tariffs have been in place now, and they've been effective, I'm wondering, over the course of 2017, how do you see the market developing? Would you expect a year similar to what we have now if the demand stays relatively similar, or do you think the imports are going to make new encroachments, or is there some risk that you're seeing that might cause supply to increase on the import side, (inaudible) like over the course of time, I mean, not like immediate change?

Yes. So, I got it. Look, criminal activity is criminal activity. Criminals don't care about the laws and don't care -- there are many people who actually view the laws as a personal challenge to break those laws. So, I would imagine you'll see, as we settle through the various cases, including the 337, that there'll be some creative people that figure on -- whether it's [boron-induced] steel or some other kind of misnomer that somebody had figured out because they have to make a living.

So, I would just say, yes, we would expect imports -- when the [suits all gets built], you would see a creeping level of imports, but that's obviously going to be greatly impacted by whether China lives up to their word of steel reduction and-or whether or not the US currency remains the only kind of real valid currency in the world. And people are trading for dollars as opposed to trading for profitability.

So, you would have to expect that imports would pick up. That's number one. Number two, we still see an environment where the consumer is still kind of leading the charge, and we're seeing auto remaining strong. That looks like it can still be that way. We're looking at sort of a rise in what we call the baby boomer migration down to the South. And so, that just means, as more kitchens, more opportunity for gains in our Stainless side as we see whether it is assisted living places or just fast food restaurants. We do see an explosion of sort of the demand for appliances continuing in that consumer-related field.

And obviously, I think the election -- there has been a big difference between our candidates in terms of their outlook for the recreation of jobs. And so, at this point, it's kind of unknown. One has said they're going to continue to close coal mines, and the other one says he's going to open up coal mines.

So, sitting here today, we do think that the industrial side of the world is going to remain somewhat challenged as it relates to the balance between the environment and the environmental concerns, and the [old mine] industrial industries. But, overall, we do think that our economy is strong, and will remain strong. And while there are black swans out there, both candidates to some degree are talking about a rebuilding of the military. That increases demand.

So, we're fairly optimistic about the demand side overall, recognizing some will be up and some will be down. We also think that our mills have shown some great discipline. We think that will continue to play out, so we think supply and demand will be more [in balanced]. And yes, there'll probably be more imports over time as our trade suits get settled and people try and figure out what that all means for themselves.

Great. All right, Michael, thank you so much again.

Okay, Aldo, thank you. Operator, let me just -- since there are no more questions in the queue, let me just say it's a bit unusual for Olympic at this point. We've had our earnings release before our Board meeting, which is unusual in our pattern, and therefore I don't want anybody to misread or think that, because we did not declare a dividend at this particular point, that we either are or are not going to.

But, in reality, we have not held our Board meeting yet, and so we did not declare a dividend until after our Board meeting, which is due to take place next week, and so we did not comment on that on this particular phone call.

So, on that, Operator, is there anything else that we need to go through?

I have no further questions.

Thank you. So, once again, thank you all for joining us and your continued interest in Olympic Steel. Have a nice day, everybody.

And that does conclude our conference call today. Thank you all for your participation.