Olympic Steel, Inc.
Q3 2009 Earnings Call Transcript

Published: 29 Oct 2009

[Operator:]

Good day and welcome to the Olympic Steel Third Quarter 2009 Results Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to Mr. Michael Siegal. Please go ahead.

[Michael Siegal:]

Thank you, Operator. Good morning and 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 again for your participation and the interest in Olympic Steel. And before we begin, I want to remind everyone that during this call, we will provide forward-looking statements that we do not undertake to update or that may not reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements. Important assumptions, risks, uncertainties and other factors that could cause actual results to differ materially from those set forth in the forward-looking statements can be found in our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K. Earlier today, we reported our financial results for the third quarter and first nine months of 2009. We are pleased to return to profitability in the third quarter and to report an exceptionally strong balance sheet. Let me review some of the details from our earnings release. Our third quarter sales totaled 121.6 million, which is down 63.7% from the 335.2 million recorded in the third quarter of 2008. The sales decrease was due to significantly lower year-over-year customer demand and lower average selling prices. Our third quarter sales volume totaled 181,000 tons, compared to 268,000 tons shipped in the third quarter of 2008. This represents a 32.2 decrease in tons shipped. We continue to benefit from our expense reduction plan, reducing third quarter operating expenses year-over-year by 21.9 million or 44%, which exceeds the 32% decline in shipments for the period. Our third quarter net income totaled $671,000 or $0.06 per diluted share, compared to net income of 24.2 million or $2.21 per diluted share for the third quarter of 2008. Our sales totaled 384.9 million for the first nine months of 2009, which is down 60.5% from the 973.6 million recorded in the first nine months of 2008. Our 2009 year-to-date sales volume declined 43.7% to 527,000 tons, compared to 937,000 tons shipped in the first nine months of 2008. Our operating expenses in 2009 have totaled 87.9 million, which is 41.8% lower than the first months of 2008. Our nine-month net loss totaled 58.6 million or $5.39 per diluted share, compared to net income of 66.9 million or $6.13 per diluted share for the first nine months of 2008. Our year-to-date 2009 results include pre-tax inventory lower of cost or market adjustments of 81.1 million recorded in the first and second quarters. In the third quarter, we executed on our core disciplines of cash flow and balance sheet management and we enter the fourth quarter with an exceptionally strong balance sheet. We ended the third quarter with only $1.4 million of debt and have since eliminated all outstanding borrowings and accumulated cash balance in October. Our inventory is appropriately costed and is again churning our preferred rate of above five turns per year. We have avoided any material bad debt losses thus far in 2009 and remain diligent in our credit and collection practices as liquidity remains constrained for all the best credits. We have a strong balance sheet with significantly lower expense base and an experienced management team that provides Olympic Steel with the strong foundation for success in the recovering markets. We expect to grow our market share by serving our customers from positions of financial and performance strength. We maintain our view that it will be a long and slow economic recovery. While there remains little visibility related to near-term steel demand, shipments have improved in September and October. However, normal seasonal slowdowns will likely impact demand in the back half of the fourth quarter. We have also reported this morning that we are continuing to pay a quarterly dividend, Olympic Steel’s Board of Directors has approved a regular quarterly cash dividend of $0.02 per share to be paid on December 15, 2009 to shareholders of record on December 1, 2009. Also this morning, we announced the filing of a shelf registration statement with the Securities and Exchange Commission. Once the registration statement is declared effective by the SEC, it provides Olympic with advanced approval to raise up to $200 million from the offering of common stock or debt securities during the next three years. And these securities are issued in the future. Olympic Steel may use the proceeds to fund acquisitions, capital expenditures and working capital and for reducing or refinancing debt or general corporate purposes. At present, we have no immediate plans to raise capital under the registration statement. However, we believe having a shelf registration in place is prudent in the current market environment. This filing provides Olympics Steel with future financial flexibility in the event that strategic opportunities arise that may require additional capital over the next three years. We believe that there will be acquisition opportunities available during this economic cycle, as undercapitalized companies will likely not have the financial wherewithal to continue independently. I will now turn the call over to Rick to comment on some of our financial results in more detail.

[Rick Marabito:]

Thanks and good morning everybody. Michael reviewed our debt position at quarter end and our subsequent elimination of debt in October. Today, we have cash on hand and we estimate that we’ll receive income tax refunds in excess of $30 million by mid-year 2010. We currently have approximately $71 million of availability under our credit agreement. So we are in a unique position to use our strong balance sheet and our cash position to grow the company during this depressed economic cycle. For the third quarter of 2009, our operating expenses totaled $28.3 million. This is $21.9 million or 44% reduction from the third quarter of 2008. Expenses are down year-over-year by $63 million or 42%. We have an annual expense base which is now about $70 million or 37% lower than in 2008. Further expense reductions will also be achieved in 2010 as we did not renew our Philadelphia warehouse lease that expires at the end of 2009. We’ll continue servicing our Philadelphia customers from our existing facilities in Pennsylvania, Ohio and Connecticut. Third quarter capital spending was $1.2 million, bringing our year-to-date CapEx to 10.8 million. Our capital spending naturally declined throughout 2009 as we finished paying for projects that were initiated in 2008. The bulk of our ongoing capital spending is in the IT area, where we continue to successfully roll out our new IT system. We project that we will spend approximately $2 million in the fourth quarter bringing our total estimated 2009 capital spend to about $13 million. An income tax benefit of $36.6 million or 38.5% was recorded in the first nine months of 2009, the majority of which can be carried back to prior years resulting in the cash refunds that I talked about earlier. The third quarter tax rate does looks skewed at 48.1%. This is due to adjusting our year-to-date benefit rate from 38.6% to 38.5% during the third quarter. Some other financial metrics and quarterly highlights include, our 2009 year-to-date accounts receivable DSO remaining very strong at 37 days. Our current inventory turnover rate is now at 5.3 times. Our 2009 year-to-date sales out of the automotive industry did increase to 10.8% of sales. If you remember, that’s up from about 8% after six months and that’s due to increased automotive production and shipments in the third quarter. The EBITDA earned for us in the third quarter totaled $4.8 million and shareholders’ equity per share at the end of the third quarter was $24.15. And finally, during the third quarter, we ratified a new collective bargaining agreement covering our Detroit workers, which goes through August 31st of 2012. And now, I will turn the call over to David.

[David Wolfort:]

Thank you, Rick, and good morning. Thank you, Mike. During our third quarter, we realized some significant performance goals as a company. Our focus during the economic downturn has been to concentrate on what is within our control. This focus has led to some significant achievements during the third quarter. Our return-to-profitability after surviving the market collapse and incurring some $81 million of inventory LCMs, which we’ve mentioned earlier, those charges occurred in the first half, it was refreshing to return-to-profitability in the third quarter, even though industry shipments and Olympic shipments still remain down in excess of 40%. Next, we remedied our inventory. We are back to turning our inventory greater than five times as Rick indicated earlier, even though we remained longer than we’d like on our plate inventory due to continued hiatus of customers’ demand in the value-add segment of our business. We also now have an appropriately costed inventory, with the LCM charges behind us after the second quarter. To put the inventory rightsizing in perspective, by September of 2009, we have reduced our inventory dollars by a staggering $207 million or 66% in 12-month period. Next, from a credit and collection perspective as Rick mentioned, we are pleased to have maintained our DSOs of 37.6 days in 2009 in what we consider the toughest credit and banking environment of our lifetimes. We’ve also avoided the big debt losses that have hurt many and of course would have continued to attack income, and we have avoided those. We remain diligent with our credit and have a full-time presence in the field analyzing customer viability and creditworthiness. We do remain very concerned about the state of liquidity and the lack of credit availability in the supply chain, as banks remain very conservative. We are now seeing deep liquidity crunch and -- with undercapitalized companies who will likely not have the ability to fund their businesses after writing inventory liquidations to fund losses up to this point. Previously, Rick elaborated on our elimination of debt and our cash position. As our cash position grows into 2010, we are excited about the opportunities to put our money to work on some growth initiatives. We believe that there will be many opportunities to acquire other service centers and fabricators, as the economic recovery take shape. We expect smaller service centers to struggle to keep pace with expanding working capital requirements, with customer credit constraints and limited banking availability and the continued weak economy. We believe this environment presents us with opportunities for market share growth and favorably-priced acquisitions. We are also thrilled with the progress of the implementing our Steelman Software program throughout Olympic. We have successfully implemented the program in four locations in 2009, most recently in our Chicago facility. We are garnering new business and greater market share as customers are looking for strong, financially stable and experienced steel suppliers like Olympic Steel. This is what we call a flight to quality by certain well-known OEMs, customers who are consolidating their supply and expense base to meet their service and cost-reduction needs. And the flight to quality not only refers to the quality of the product, but the quality of our balance sheet. Olympic Steel fits the criteria well and we are being awarded significant amounts of future business as a result. We are excited about these opportunities, which will allow us to grow market share, once OEM demand re-bounds from the current depressed levels. In summary, our execution to right size our inventory and expense base while eliminating debt positions Olympic Steel well for growth opportunities. We have built the company with a strong foundation and a tested and experienced management team. While it appears that economic recovery will be slower and take longer than we would all like, we are confident in our future and our ability to successfully perform for shareholders, for customers and for the employees of Olympic Steel. This concludes our formal comments and we will now open the call to your questions.

[Operator:]

Thank you. (Operator Instructions). We’ll go first to Luke Folta with Longbow Research.

[Unidentified Analyst:]

This is actually, Rob, filling in for Luke right now. The first question I guess is, can you give us any more color on what the shelf registration might be for and any idea if it’s going to be a debt or equity?

[Rick Marabito:]

I was going to say really there is not much more to it than what we’ve said. So we genuinely think that the market environment was right to do it. As we said, we have no immediate plans to do anything. So the answer on whether we do debt or equity really is sort of a moot point at this point. But really what it does is, over the next three years, really just give us some additional financial tools as we look to grow and expand our market share. So, no immediate plans there.

[Unidentified Analyst:]

Okay. And then what were some of your thoughts on metal margins for the quarter and some of your expectations maybe for 4Q or 1Q ‘10?

[Michael Siegal:]

The margins itself. Well, what we saw during the course of the third quarter was steadily improving margins. I don’t know how much materiality to that is. We saw and we’re seeing a relatively good October, as we indicated in the pronouncements, but without any great vision, I mean nobody can anticipate, we have no great visibility in terms of what December is going to look like in terms of the plant shutdowns at this point. So it certainly is better at the present time that we’ve seen in the second quarter. So the indices are all better for us.

[Operator:]

We’ll take our next question from Richard Garchitorena with Credit Suisse.

[Richard Garchitorena:]

Good morning. Just a couple of questions from me; first question, you had mentioned in your comments that auto revenues went up on a percentage basis this quarter. Is that primarily from an increase in market share or is that generally just an overall higher level of shipments from autos relative to the others?

[David Wolfort:]

It’s a combination of both Richard. It’s responsiveness in the third quarter to the “Cash For Clunkers” program, some of the short fall in the marketplace and our ability to respond to that marketplace that were short on some product and obviously we had that product. Additionally, we have been awarded some significant new business, again principally because we’ve gone through an audit process and again the strength of our balance sheet has indicated that we’re an ongoing sustained company and as the auto manufacturers sort out their suppliers, we’re being anointed with some additional business.

[Richard Garchitorena:]

Great. Okay. And in terms of the, I guess, other end markets, you had said that inventory turns on the plate side are still lower than you’d like. Is that a function of a weaker demand or is it specific to the certain customers?

[David Wolfort:]

Well, the certain customers that we service have weaker demand. So our view is obviously the former that it does relate to the weak demand for construction-related equipment. We were longer on the plate product from a year ago based as we’ve explained in previous conference calls, based on predicted usages supplied by our customer base. Those, in some particular cases, have dwindled substantially. The recovery is significantly slower for some of those manufacturers and in that segment we are still a little bit longer on inventory than we’d like, although we’ve balance the inventory in total.

[Richard Garchitorena:]

Okay, thanks. And just a final question just on the tax benefits for next year, is there any indication of what you think the tax rate might be for 2010?

[Rick Marabito:]

For 2010, I don’t really see our tax rate being much different than what it is today, Richard. So that would be my best guess out of the chute right now.

[Operator:]

We’ll take our next question from Mark Parr, KeyBanc Capital Markets.

[Mark Parr:]

I had three questions, first, I was wondering if you could talk about capacity utilization in your service center business versus your manufacturing businesses sort of the value -add processing side of your business. And, I’m trying to get a sense here of which side of the organization is really ahead of the other one or if there’s some one that’s lagging the other, and I’m also trying to get a sense of how much more upside you could absorb before you need to start rehiring people and rebuilding the expense side of the ledger?

[Michael Siegal:]

Okay. Well, clearly the value-added side, which is predominantly heavier than plate side, is down significantly more than the flat-rolled side. But if you have anybody who needs steel right now, Mark, we have plenty of capacity for just about anything.

[Mark Parr:]

Okay. You’ve taken your costs out, I think collectively, what, between 40 and 45%.

[David Wolfort:]

Correct.

[Rick Marabito:]

Yeah. That’s where it’s been year-to-date.

[Mark Parr:]

Yeah, year-to-date. I mean are there any significant differences between the manufacturing side and the service center side?

[David Wolfort:]

Yeah, Mark, the labor component on the manufacturing side is significantly down, as Mike indicated, a great question on your part. Those facilities are earmarked for specific large OEMs who have substantially more depressed schedules than the general service center business. We’ve been working longer hours than we did in the second quarter and we’ve seen a nice increase of business in the service center end of the business. And that’s because of depressed inventories, that’s because of the fact that we’re stronger and we’re seeing a lot of failings out there on some of the smaller service centers and we’re able to respond to customers’ needs. So on the general service center business, much stronger and the labor force is working longer hours that we’ve called back. Value-added side of the equation, it remains pretty much on a plateaued basis, although we have taken on a number of substantially new business, which has helped to augment some of the losses of our traditional business.

[Mark Parr:]

Okay. And I guess just getting back to the strategy side of the equation, we’ve had discussions in the past about the smaller service center customer base and at some point there was an opportunity for Olympic to come in and kind of step over some of these smaller service centers that didn’t have the credit relationships in place to fund the business. And I’m just wondering how that thought process is continuing in the context of your shelf registration, where you seem now to once again be talking about thinking more aggressively on the acquisition front?

[Michael Siegal:]

I think you framed it well Mark. Our strategy is the same, which is to get into more geographic penetrations with more downstream value on the steel that we serve to our customers. So I think that where we saw pricing over the last number of years on multiples far beyond our hurdle rates, today we’re seeing opportunities to perhaps acquire assets at discounted levels that we would find to be appropriate on our strategy.

[Mark Parr:]

Okay, all right. Okay, that’s helpful. Just two other real quick questions; I’m curious as far as, particularly on the sheet side of the business, the willingness from a mill perspective to provide year-end deals and how would you handicap that in terms of normal. You think they’re more aggressive, less aggressive. How’s that looking?

[David Wolfort:]

Well, Mark, I’ll take a stab at that. I think the steel mills are fairly resolved to maintain the pricing that they’ve achieved since the beginning of June. So the price increases that they’ve currently achieved, they are holding on to. There is really no dramatic inclination to discount product and offer deals as we exit October. As for attaining the very last price increase that they announced depending on who you’re following, whether it’s up 40 or up 60, that has not been achieved and candidly it has been put aside. However, we have not seen a deep degradation in offering price from what has already been absorbed in the market.

[Mark Parr:]

Okay, good. It sounded like some of the other guys, [Lorenzo] had really talked about his feeling that lower prices were not helpful and nobody in your side of the supply chain likes to see prices come down, because it impacts your inventory values. And so I guess I’m just trying to say, I think your feeling at least from a public perspective is perhaps a bit more constructive than what some of the other guys have indicated. I just wanted --

[Michael Siegal:]

Yeah, well, look the mills do what they have to do to service their markets and we’d like to do the same. Obviously, inventory companies would rather see stable to modestly rising prices.

[Mark Parr:]

Okay.

[Michael Siegal:]

The market itself is stronger than anybody, and we all do what we believe is necessary in the benefit of our shareholders. So the comment like other people have done I think does not serve us well.

[Mark Parr:]

Okay, all right. Well, that’s certainly another way of thinking about it and I appreciate that color. Just last, is there any inventory mismatch left in your supply chain right now?

[David Wolfort:]

The only mismatch is we’re a little bit longer on plate than the customers who have fallen off on the demand side, but not substantially longer and it’s not obsolete material. It’s just a little bit longer, but we’ve done a marvelous job in terms of winding that down, Mark.

[Mark Parr:]

Boy, no kidding.

[David Wolfort:]

One of the places where we were concentrated on that was on the East Coast, and as Rick outlined, we are closing that facility at the end of this year and we’ve wound that down.

[Mark Parr:]

Yeah. Congratulations on the tremendous working capital progress and on the progress with the internal controls. I really think you’ve set the stage for some much better performance next year. So, look forward to that. Thank you very much.

[Operator:]

We’ll go next to Charles Bradford, Affiliated Research Group.

[Charles Bradford:]

Hi, good morning. What are you guys seeing in lead times from the mills? There have been a lot of stories about some of the mills like US Steel and maybe ArcelorMittal having operating problems and being delayed. Have they caught up at all?

[David Wolfort:]

Chuck, I’ll take that; Dave Wolfort, here. The answer is they have caught up on their deliveries. They were delinquent mid third quarter and as we approached the end of the quarter, obviously September, there was a great deal delinquency was wiped out and they did catch up and they are reasonably current today. Our lead times stay stretched for value-added products beyond hot roll, so cold roll lead times are still out there and coated product. They’ve come back a little bit, but not substantially. There have been some shorter lead time offerings on hot roll, but we’re talking about a week to two-week shorter, nothing substantial.

[Charles Bradford:]

Most of the people in the trade are talking about prices softening, modest amount, but meaningfully; at the same time, the mills are all talking about increasing their production. Do you think maybe they’ve brought back too much capacity?

[David Wolfort:]

Well, again, Chuck, I can’t comment on what their marketplace is, but I would characterize the market as plateauing more than receding. We’ve had – depending on which mill you’re following, as you well follow them, four to six increases depending on which mill you’re talking about, and all but the last increase has been absorbed in the marketplace. And so I would say that the market has plateaued and there is a tendency when it does plateau to recede a slight amount, and it has a tick-back of very nominal amount but nothing that’s substantial. Of course, I can’t speak for latter part of November and December. We’ll wait to see what happens there.

[Michael Siegal:]

Yeah. The only comment I would add to that Chuck is the fact that this liquidity issue in many respects is really preventing and governing the ability to rebuild inventories, both at the service center and the end-user level. So at some point next year, when the liquidity issue somewhat eased, there might be some kind of restocking at the chain and at that point the mill’s capacity I think will be more than adequately served at these levels.

[Charles Bradford:]

There seemed to be some pick up in inventories at the service center levels in September. Would you characterize that as maybe accidental in the sense that the service centers have expected to ship more and had ordered in anticipation of the higher shipments and got caught or are they beginning to get some money?

[David Wolfort:]

Chuck, again I think that is really a reflection of the surge of business that came in June and July to the steel mills and their inability to perform at that moment in time as they were ramping up some facilities. The culmination of bringing on the facilities and catching up on deliveries, I think that surge really caused service center inventory to move up for September. Purely on a speculative basis, we would expect those inventories again to reflect some modest growth in October and then potentially turning down as the service centers absorb the catch-up on deliveries from the mills.

[Operator:]

We’ll go next to Nat Kellogg, Next Generation Research.

[Nat Kellogg:]

Good morning, guys. Just two quick questions; first one is I guess just a little on mix, I mean volumes are up sequentially, and my understanding is that the overall pricing environment was obviously moving up during the third quarter and yet revenue was down a little bit. I’m just curious if that was just a mix of a little bit higher towing and sounds like a little bit less of the value-added business or if there’s something else going on in there?

[Rick Marabito:]

Nat, it’s Rick. I think part of what you saw when you look at second or third quarter is as you know prices continue to cascade downward through second quarter and really hit their lowest points in June. And July really wasn’t much better on the pricing side and then as we moved through third quarter, we started to see the rise in price. So I think the answer to your question is really just if you were to graphically look at second quarter going down and third quarter going up, the average price of those two quarters ended up being lower in third quarter, but you were certainly on the other side of the slope, instead of continuing to fall, you were on the rise. And as Michael talked about that rise, we saw in September and continuing into October.

[Nat Kellogg:]

Okay. Okay, that’s helpful. So, obviously, you guys have said who knows what happens in November and December, but assuming prices plateau, this will be sort of the first quarter where you get that sequential uptick in pricings?

[Michael Siegal:]

Hopefully, yeah.

[Nat Kellogg:]

Okay. And then just a second question. I know some folks have said and I think others have maybe been a little bit more skeptical, but the inventory levels are at a lean enough point now where folks are little less focused on liquidating inventory for cash and may be a little bit more focused on sort of profitability metrics and whatnot. And just curious if you guys are seeing that and does that help sort of the competitive pricing environment or are the demand so weak now that everyone is still scrambling for every piece of business and that keeps pressure on the pricing side on a competitive basis?

[David Wolfort:]

No, Nat, I would tell you I think there’s a combination here and you’re 100% correct. But as we exit this year, there is going to be – continue to be some price, a little bit of price pressure from people who have no liquidity and have exhausted their inventory drawdown to fund their losses and they are in a position for lack of a better expression, of desperation and they’re brokering and trading some tons. There’s a little bit of that pressure left. We don’t think a substantial amount of that pressure left. That’s why we would clarify this and call this a plateauing. Inventories have dropped substantially to where, if you have the product, I think you can retain the selling price and the margin that the restoration of the margin that we once again would put in a recovery’s mode.

[Operator:]

We’ll take our next question for Ken Hoffman, Bloomberg Equity Research.

[Ken Hoffman:]

Thank you, a couple of quick questions for you. One if you could comment on imports? It seems that the Chinese are coming back into the market a little bit. And secondly, a bit of a longer view type of question, it was the dislocation in Detroit, do you think over time that maybe there will be a shifting of suppliers and that will give you an opportunity to pick up some more market share?

[Michael Siegal:]

Well, certainly in Detroit, we think there’s going to be a lot less players on the supply chain and we would hope to pick up market share within the prudence that we’ve shown in automotive in the past. On the other side, David, do you want to comment on imports?

[David Wolfort:]

Ken, we really don’t see any substantial imports. The exports from the Chinese principally go to other continents or at least particularly into the Europe and pressing into the other parts of Asia. That does flush out some products from there as compensating measures. However, the dollar is so low here that we really have seen nothing of substance, certainly nothing that’s attractive in this marketplace, there’s very few of us I think out there willing to speculate on any long-term basis and underwrite the vagaries of imports.

[Operator:]

(Operator Instructions). We’ll go next to [Bob Richard, Iron Edge Research].

[Bob Richard:]

Good morning. Thanks for taking my call. Your comments on the credit environment were kind of interesting and your shipments were actually little less than what I had expected. I know this is a hypothetical question, but would your shipments had been better in an improved credit environment or was end demand actually that still that’s happened?

[Rick Marabito:]

Well, I think Bob this is Rick. I think end demand, as we’ve talked about, is down substantially. The piece of demand for us is off the most as Michael and David talked about is in value-add piece. It’s very hard for us to quantify what type of sales we may have lost due to the credit environment. What I will tell you is we’re very diligent on credit. So, yes, there are some opportunities out there that we passed on. But the credit environment and us passing on sales is not the major reason for our sales drop off. It’s the market, it’s still weak.

[Bob Richard:]

Okay. I appreciate that, and in the discussion on the shelf registration, I appreciate all those comments. But if I heard you right, your potential investments, it doesn’t really matter if it’s another service center business or downstream fabrication, it’s kind of where the money is. Is that an accurate summation event?

[Michael Siegal:]

Yes.

[Bob Richard:]

Okay. That’s fair enough

[Operator:]

And at this time, there are no further questions in the queue. I’d like to turn it back over to our speakers for any additional or closing remarks.

[Michael Siegal:]

Thank you, Operator. As a reminder, it is our policy not to provide forward-looking earnings estimates for the upcoming quarter or year, nor to endorse any analyst sales or earnings estimates. We anticipate releasing our fourth quarter-end 2009 annual earnings in February 2010. This concludes our call and thank you again everyone for your interest in Olympic Steel. Thank you. Bye, bye.

[Operator:]

This concludes today’s presentation. We appreciate your participation.