Olympic Steel, Inc.
Q3 2010 Earnings Call Transcript

Published: 5 Nov 2010

[Operator:]

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

[Michael Siegal:]

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. For 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 rock 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 non-recurring 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 cost to market pretax charges incurred 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 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 as the economy slowly recovers. Recent investments in the specialty metals business are also producing growth, and 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 the new 125 million five-year asset-based loan facility with Bank of America as agent. The new facility which can be upsized by an additional $50 million to the terms of its accordion feature, together with our $200 million three-year self-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 growth project of 2010. In addition to the acquisition of Integrity Stainless in the first quarter and the purchase of land and 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. The 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 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 the Olympic Steel board of directors approved a regular quarterly cash dividend of $0.02 per share to be paid on December 15, 2010, the shareholders of record on 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.

[Rick Marabito:]

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 margins 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 cost to 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 to 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 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 phased-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 at 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 spent about $1 million related to our IT system implementations. We expect capital spending for 2010 to be about $15 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 and varying quarterly pretax 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.

[David Wolfort:]

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 day 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 base, 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, oftentimes providing customers with outsourcing solutions with 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 costs 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’ve 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 midyear 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 in 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, division of Pentair, and others from this location. We also anticipate 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 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 to greater than 1.3 million tons and $1 billion of sales. Our agreements with temper mill and cut-to-length line manufacturers 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-ince wide coils and up to 1/2-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 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.

[Operator:]

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

[Luke Folta:]

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?

[David Wolfort:]

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 logistic savings to existing customers. You can extrapolate from there then the opportunity we have to move west and move south from those respective locations.

[Luke Folta:]

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?

[Michael Siegal:]

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, which should be very rapidly filled for the movement of the material that comes to Chicago.

[David Wolfort:]

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.

[Luke Folta:]

Okay. And then just thirdly, your comments regarding the future of your participation in 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 and tonnage within stainless and aluminum. Do you think that that’s going to be mostly driven by acquisition, or is there any kind of greenfield consideration there?

[David Wolfort:]

Well, it’s all of the above. We have – the door is wide open for us as we continue to grow this business. We have some very talented individuals that are carrying 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.

[Luke Folta:]

Great. Thank you.

[Operator:]

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

[Tim Hayes:]

A question on the temper mill is, certainly 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?

[Michael Siegal:]

We can do whatever we want.

[Tim Hayes:]

Okay. And any particular end-market focus for that facility?

[Michael Siegal:]

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 unique products. So, whether it’s the Caterpillars, the Deeres, the typical heavy, highly-engineered domestic manufacturers of a product is still the same marketplace, just additional capacity for them.

[Tim Hayes:]

I figured [ph], but I just wanted to make sure it wasn’t just maybe solely or mostly auto-related or [inaudible] contract, of that nature.

[Michael Siegal:]

Nope.

[Tim Hayes:]

Okay. Very good. Thanks.

[Michael Siegal:]

Thank you.

[Operator:]

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

[Richard Garchitorena:]

Hi, good morning guys.

[Michael Siegal:]

Hi, Richard.

[Richard Garchitorena:]

Hi. First question, I was wondering if you could elaborate a little on the greenfield project at Mount Sterling in terms of like CapEx, time you expect to process there, and the types of products [ph].

[Michael Siegal:]

Rick?

[Rick Marabito:]

Sure. Timing-wise, as we’ve 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 shop blaster, bending 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 million to $30 million in sales. Obviously it’ll be a gradual ramp-up as we’ll be getting the equipment phasing-in in the first quarter.

[Richard Garchitorena:]

Great, okay. And then I guess secondly, on the temper mill, the project is obviously attractive. Does the fact that you’re going forward with this, is this just because of the attractiveness of the 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?

[Michael Siegal:]

Yes on both. The M&A market, there’s a lot of buyers. Everybody has come up 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 initiatives on both fronts.

[Richard Garchitorena:]

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

[David Wolfort:]

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 call-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 turn-down, 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.

[Richard Garchitorena:]

Great. Thank you.

[Operator:]

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

[Mark Parr:]

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?

[Michael Siegal:]

Yes.

[Mark Parr:]

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

[Michael Siegal:]

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

[Mark Parr:]

Okay.

[Michael Siegal:]

In fact nothing other than maybe some recovery, if there’s some, as we say, some stink to the private equity firm.

[Mark Parr:]

Right. Okay, I won’t make and comments there. But I have an industry question, if you’ll bear with me. There was some trade press this morning indicating one 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 do you – how would you handicap the odds of Sparrows being shut down here in the next 30 days or so?

[Michael Siegal:]

Sixty days because that’s what the WARN notice is [ph] but okay.

[David Wolfort:]

I think that’s a better question, Mark, for the ownership at Severstal.

[Mark Parr:]

All right. I just thought I’d give it a shot.

[Michael Siegal:]

But it’d be 60 days because that’s what WARN Act is.

[Mark Parr:]

But, David, you’re usually so careful about the outlook for forward pricing, and so we see –

[David Wolfort:]

If I would [ph] slip.

[Mark Parr:]

Okay, terrific. If you would, I know you’ve said from a current order perspective or shipment perspective, you would expect things to remain stable. 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?

[Michael Siegal:]

I think, Mark, again what we look may be different than how other people look at it. 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 the December with its typical last two weeks, we can’t speak to that till it occurs.

[Mark Parr:]

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 the future progress here in the coming quarters. 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?

[David Wolfort:]

No, Mark. 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 isn’t in fact very much in the same space as Iowa and Cleveland.

[Mark Parr:]

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

[David Wolfort:]

Well, Gary has – U.S. Steel has been a long-term supplier to Olympic Steel for some four decades and we don’t expect any significant change there. Within the composition of what they’ve supplied us from way back when, when they were a plate manufacturer, to the hot-rolled bond side and downstream, they’ve always provided us with heavy gauge, high strength, and we would expect to participate at this with the same proportional growth there.

[Mark Parr:]

Okay, all right. Thanks very much.

[Operator:]

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

[Michael Siegal:]

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 of 2011. This concludes our call, and thank you all again for your interest in Olympic.

[Operator:]

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