Olympic Steel, Inc.
Q1 2011 Earnings Call Transcript

Published: 6 May 2011

[Operator:]

Good day ladies and gentlemen, and welcome to the Olympic Steel Inc., First Quarter 20111 Earnings Results Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, today’s conference call is being recorded. I’d now like to turn the conference over to your host Mr. Michael Siegal, Chairman and CEO. Please go ahead.

[Michael Siegal:]

Thank you, Eli. 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 for your participation and again, for your interest in Olympic Steel. Before we begin our discussion, I want to remind you 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 charges 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 2011 first quarter Form 10-Q, which will be filed later today. Earlier today, we reported our financial results for the first quarter ended March 31, 2011; net sales for the first quarter of 2011 increased by 75.3% to 294.4 million from 167.9 million for the first quarter of 2010. Our shipments in the first quarter of 2011 increased 43.3% to 317,221 from the first quarter of 2010. First quarter 2011, net income totaled $10.3 million or $0.94 per diluted share compared to net income of 1.7 million or $0.16 per diluted share for last year’s first quarter. We are pleased with our strong sales and earnings growth in 2011. We’ve just completed our best quarter in terms of both sales and net income since the third quarter of 2008. For the past two years, during the economic downturn and in addition to cost control, we have been strategically focused on growing our geographic and product footprint, increasing our value-added processes and investing in personnel. These initiatives have resulted in an insignificantly increased market share for Olympic Steel and positions us to accelerate our market share penetration and overall profitability in improving North American economy. As previously reported our 2010 annual shipments increased by 34% over 2009, which outpaced the total industry growth in steel shipments of 21%, as reported in the Metal Service Center Institute’s 2010 Market Activity Report. In the first quarter of 2011, we continue to gain market share as our shipments increased by 43.3% almost doubling the pace of the market increase in total steel shipments of 23.5% as reported by the MSCI. Our strong balance sheet, low debt levels and focus on asset turnover provide us with the access to funds for increased working capital need and our capital investment growth programs. We believe our commitment to capital investment in geography, equipment and people separate Olympic Steel when customers choose long-term supply relationships. Later in the call, David will review our 2011 success and strategic initiatives, including startups in Gary, Indiana; Mount Sterling, Kentucky; Monterrey, Mexico; and Kansas City, Missouri. In addition to our internal expansion and CapEx program, we continue to actively explore growth via acquisition opportunities in 2011 and find this market more favorable in valuation than in the recent past. We are confident in our ability to provide tonnage and revenue growth and real value creation for our shareholders in a recovering economic environment in North America. Today we also reported that Olympic Steel’s Board of Directors approved a regular quarterly cash dividend of $0.02 per share to be paid on June 15, 2011 to shareholders of record on June 1, 2011. Now, I will turn the call over to Rick to comment on Olympic’s financial results in detail.

[Rick Marabito:]

Thank you Michael and good morning everyone. Michael spent some time on our tonnage and sales growth, so I will start my comments related to gross margins. As a percentage of net sales gross margin totaled 21.5% in the first quarter of 2011, up from 21.1% in the first quarter last year and up from 17.9% sequentially from the fourth quarter of 2010. Internally we measure our gross margin on a per ton basis and our first quarter 2011 margins per ton increased to $200 from $160 in the first quarter of 2010 and again on a sequential basis margins per ton increased by $49 a ton from $151 in the fourth quarter of 2010. Operating expenses in the first quarter of 2011 totaled $46.1 million, an increase of $14.1 million over the first quarter of the prior year. However, as a percentage of sales, our operating expenses actually declined to 15.7% from 19.1% last year. And on a per ton basis our operating expenses remain flat at $145 per ton for both periods. First quarter 2011 expenses include the impact of our 43% increase in shipments and dramatically increase profitability in 2011. In order to meet increased customer demand, our headcount, the use of temporary labor, overtime and delivery costs to customers have all increased. Additionally, 2011 reflects a full period of expense for all compensation and benefits that were reduced in 2009 and then sequentially restored in a phased-in basis by January 1st of 2011. EBITDA defined as our operating income before depreciation expense on the face of our income statement totaled $20.8 million in the first quarter of 2011. Capital spending so far in 2011 has totaled $7.9 million and as Michael indicated earlier, we continue to strategically invest in our recovery market with the majority of our spending related to IT and communication systems, processing equipments for the new facility in Mount Sterling, Kentucky, and down payments for the new temper mill cut-to-length line to be located on our recently acquired facility and U.S. Steels’ Gary Works site. During the first quarter of 2011, we capitalized $357,000 and we expensed $197,000 related to the IT system implementations. We expect our capital spending in 2011 to be approximately $35 million to $40 million and that would be inclusive of the payments on the new temper mill and cut-to-length line; the $4.3 million price in April that we paid for the building purchased in Gary and equipment in our new Kentucky facility as well as continuing our system rollout. Our effective income tax rate for the first quarter of 2011 was 37.5% compared to 39.4% in last year’s first quarter. Last year’s rates were higher than our normal and expected rate of 38% due to loss tax deductibility items when operating income was at lower pretax income levels. Some other financial metrics and highlights include our inventory turnover in the first quarter of 2011 which was 4.8 times. Our inventory was turning however in excess of five times by the end of quarter, as our inventory levels were lower at quarter-end versus the start of the year. We expect to accelerate inventory turns in the second quarter, as we operate with less tons on hand than in the first quarter. Our 2011 first quarter receivable DSOs totaled 42 days which is down one day from the first quarter of 2010. And as we forecasted on our year end call, our debt is higher at the end of first quarter, as we funded increased working capital needs associated with the higher sales and increased metals pricing and continued our capital expenditure investment program. Total debt increased by $26 million in the quarter to $81 million at March 31, 2011. Availability under our asset based loan credit facility was $42.5 million at quarter end. Our receivables of loan increased $54 million in the first quarter, even though as I said earlier, we collected our money one day faster than last year. And finally shareholder's equity per share was $24.95 at the end of the quarter and we paid a quarterly dividend of $0.02 per share in the first quarter. Now I will turn the call over to David.

[David Wolfort:]

Thank you, Rick and good morning. As Rick and both Mike described we’re having a busy first quarter and it also incorporates a lot of our activities from 2010 and it's ongoing to enumerate all of those activities. And we are pleased with our shipping strength and our market share growth and our profitability achieved in the first quarter of 2011, as both Mike and Rick have just described. Our timely and well planned steel purchases at the end of 2010 provided us with the inventory to meet our customers growing need for product in the first quarter, as we anticipated a quicker to start to 2011. We believe our customer demand will continue to be strong throughout 2011, even though we have seen a bit of a kink in somewhat of a nominal low in April shipping activity as compared to March and prices are now coming off their peak. However, the March MSCI Metal Activity Report provides some very encouraging support for our continued favorable business environment. The March MSCI Market Activity Report indicated that service center inventories have remained low and an increase in shipment. Shipment and pricing environment resulting in historically low levels of inventory supply on hand of 2.1 months. This favorable inventory position combined with accelerating end-demand and expected high input costs for raw materials such as iron ore point to a favorable steel environment going forward. As Michael indicated earlier, we embarked on a strategy to invest heavily in our future during the market downturn. Our strong balance sheet and access to capital provided to us with the advantage of spending money when facilities and equipment were less expensive; personnel were available and the rewards of these investments would be reaped as the market returns to growth again. We have been quit busy in 2011, and have successfully executed the following initiatives as we briefly discussed a moment ago. Equipment and startup of Mount Sterling, Kentucky facility, as we previously announced in the second half of 2010, we added a new Olympic facility in Mount Sterling, Kentucky, which is about 30 miles East of Lexington. We purchased 14 acres of land and an existing 100,000 square foot building. During the first quarter of 2011, we have been busy upgrading the building and equipment; the facility to perform plate burning, machining, forming and shot blasting. Anchored by blue-chip customers such as Link-Belt and Hoffman division of Pentair and several other key accounts in the area, we became operational from this facility at the end of the first quarter of 2011. The Mount Sterling site reinforces our strategy of being closer to where our customers assemble their products. Next, the new Butech Shear in Cleveland, in January 2011 we upgraded our Cleveland temper mill by successfully replacing the 15-year old rocking shear with a new Butech rotary shear, which is operating at expected capacity. That project has been completed. The new temper mill equipment which both Mike and Rick referred to, in November of 2010 we announced a new location of Gary, Indiana to house a $20 million investment this new temper mill and cut-to-length line. Since then construction of the line has progressed, for an on-time completion, on or around the year-end 2011. So we expect that we will be in fact starting this up by year-end. Our agreements with the temper mill and the cut-to-length line manufacturers also provide us with an option to purchase a second like-kind piece of equipment at favorable terms, consistent with the original purchase orders. Once operational in 2012, the equipment will be capable of processing approximately 150,000 new tons of high quality tempered sheet capacity for Olympic Steel and significantly reduce our in-bound and out-bound freight costs, while better serving customers from our existing two temper mills in Cleveland, Ohio and Bettendorf, Iowa. Our Cleveland and Iowa temper mills have been significant drivers of Olympic’s growth to greater than 1.3 million tons and $1 billion in sales. We believe our Temper Mill investment will be the driver of Olympic Steel’s next big growth spur. In line with that, the Gary Indiana facility as Rick noted we also are pleased to announce that we’ve have closed on the purchase of the Gary, Indiana building from U.S. Steel in April,; we are grateful to U.S. Steel for allowing us the opportunity to locate on their Gary works site. And Moses Lake, Washington; in early year 2010, we completed our move to Moses Lake, Washington to serve a customer in that region of the country. This marked our first physical location in the Western United States. In 2011, we have expanded our footprint there by adding 8,000 square feet of additional warehouse space to meet our customers growing production needs. First time outside of the U.S. in Monterrey, Mexico and during April of 2011, we entered into a lease agreement of approximately 15,000 square feet of warehouse space in Monterrey, Mexico to augment our long-existing sales presence there with the ability to stock and distribute metals in Mexico for our customers there. We anticipate that we’ll begin stocking inventory there in the next few months. Additionally, in Kansas City Missouri, as Mike noted, last week we entered into a lease-to-buy agreement for approximately 43,000 square foot space in Kansas City. This new location is part of our temper mill expansion strategy as we plan to push our market penetration further west of Bettendorf, IA location. Initially, we plan to stock sheet product in Kansas City and anticipate that shipments will commence in the third quarter. Again, accentuating our growth plans in St. Paul, Minnesota in order to free up some space in our existing Minnesota facilities for expanding processing capabilities. We are planning to lease some additional warehouse storage base in the St. Paul area. We've executed on that already, it’s an additional 56,000 square feet. We plan to feed our two Minneapolis processing facilities with coil and plate stored in this new location to optimize our processing space, reduce logistics and handling costs and increase our throughput in the region of the country. We are anticipating completing a lease for this space as we've just executed. Let me just turn now to our own truck fleet. We continue to expand our own truck fleet which yields, improved customer service that reduce total cost in Olympic Steel. During 2011, we expanded this fleet to tractor trailers to some 37 and plan to grow that fleet to approximately 60 in the next two years. In all we are adding approximately 400,000 square feet of warehouse space to our footprints since acquiring the building in Mount Sterling, Kentucky in the second half of 2010. We are excited about the growth opportunities that these investments will provide. We are confident in our strategy for growth and we believe that our timely and well planned investments in people, facilities, equipment and products provide a strong 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.

[Operator:]

(Operator Instructions). Our first question comes from Tim Hayes of Davenport & Company. Please go ahead.

[Tim Hayes:]

Two questions. One is on the M&A front and then the second will be market share. Are you finding the list of potential candidates increasing or decreasing here over the last six months or so? It seems that with the improving economy may be some marginal service centers are going to have a fighting chance, but at the same time the stress of working capital would may be push them over the edge. I’m not sure which one is windy now, I am curious to what you’re saying.

[Michael Siegal:]

We’re seeing an increasing environment.

[Tim Hayes:]

Okay, and then on the market share gains that you’re achieving, is that coming from say larger service centers or is that coming from small Mom and Pops or perhaps both?

[David Wolfort:]

Well Tim, David here, that’s coming from OEM, it’s principally coming from our large OEMs. We’ve talked about that in the previous calls where we quantify that as a flight to quality as the large OEMs recognized a strength of Olympic Steel’s balance sheet and our willingness to read it to locate facilities close to them, we’ve been able to garner a significant market share growth, from both I would say large and small service centers. Our next question comes from Sandeep SM of Goldman Sachs. Please go ahead.

[Sandeep SM:]

One question for you. Can you give us breakdown between your spot versus contract mix?

[David Wolfort:]

Yes, it’s probably, its two-thirds contract, one-third spot and didn’t see a very big change in that mix per se in the first quarter.

[Sandeep SM:]

And your contracts are based on [Lat] pricing or how does it work?

[Michael Siegal:]

All the above, I mean we do have some contracts that are back-to-back on indexes like CRU. Some of them are quarterly, triennially, monthly. Some of them are not tied to indexes. There certainly is a lot more momentum towards more indexing than in previous times.

[Sandeep SM:]

Okay. And how many months of inventory are you getting on right now?

[Michael Siegal:]

Inventory, now?

[Sandeep SM:]

Yes.

[David Wolfort:]

We are turning our inventory right over, slightly over five times right now in March, so.

[Michael Siegal:]

2.1 to 2.2.

[David Wolfort:]

Right.

[Sandeep SM:]

Okay. And how would you look at the order rates in April versus in March, is it better or is it falling or flat?

[Michael Siegal:]

There has been, it was relatively consistent till we got to the Easter weekend. We saw an adjustment in the Easter weekend Sandeep and the boring patterns came back up after the Easter weekend.

[Sandeep SM:]

So like on whole April, was below March?

[Michael Siegal:]

Yes, so far April was similar to March.

[Operator:]

Our next question comes from Mark Parr of KeyBanc. Please go ahead.

[Mark Parr:]

Isn’t leverage nice when it's working in the right direction?

[Michael Siegal:]

Yes, it is.

[Mark Parr:]

Okay. I am interested Michael in your most recent thoughts about and David you may want to chip in here as well, just about gross profit opportunities. You have, it seems like you have been doing more value add, adding more processing equipment. I think that’s a bigger piece to your mix. I am just wondering kind of think about the cost of gaining market share from the margin perspective. Again see opportunity to enhance margins as the value proposition to the customers increased. And how I should be thinking about that perhaps in the near-term, I mean if, is there a big FIFO gain in 1Q that’s not going to be repeated or are we still on a ramp as for as profitability is concerned? And then you’re looking out over the next couple of years how we should think about Olympic’s gross profit margin opportunity in the sense of more value and call it maturation of market share gains?

[Michael Siegal:]

Mark, what I would tell you is we are committed to growing our market share both in tons, which are certainly lower margin and we are certainly committed to growing the market share in the pieces parts business on fabrication side of the business. I think today we are somewhere around 14% of our dollars in terms of the value added processes. We will probably grow as a percentage of the mix toward more pieces parts until a new temper mill comes out and when we add a 150,000 ton of sort of rectangle business, we will probably see the mix go down a little bit in 2012. But we clearly have a metric of trying to get our fabrications processing up to close to 20% of the mix over time.

[Mark Parr:]

Okay. So in terms of the near-term it may do, you have LIFO gains peaked out at this point or would you expect that peak to be more in the second quarter. I mean not LIFO I mean FIFO gains, excuse me.

[Rick Marabito:]

Well Mark, its Rick. I think obviously as David commented, in his section we are seeing prices come off the high. So on the spot segment of the business there will obviously be a little bit of pressure there but as Michael talked about we've got a lot of lag pricing. So we are still in the second quarter seeing our margins to be quite strong.

[Mark Parr:]

Okay. So with the two-thirds to Sandeep's question, the two-thirds contract mix and…. Michael is there a way you can describe about the average duration of that contract mix; I mean is it 90 days, is it 60 days?

[David Wolfort:]

Mark, it is David here. I will tell you the preponderance of those contracts are three to four months.

[Mark Parr:]

Okay.

[David Wolfort:]

Most of them being a quarter, a few of them are what we call trimester that Mike referred to earlier. Also let me just give you a little color around some of the comments that we've just made. As we talk about facilities going forward we have a number of different silos of businesses you are well aware of. We take a look at most like Washington, which I referred to Monterrey, Kansas City and our efforts in St. Paul adding some facilities there. All of that means that we are looking to complement our value-added stream and continue to service the customer. The customer has asked us to do more of their front end or which has more value to it and as Michael said its measured as dollar sales as opposed to tons on that value added side of the equation requiring us to have more square footage as we add equipment and get closer to that customer without having to challenge the customer in the same labor pool, so we love it when we’re 30 miles, or within 30 miles of the customer. So we have some strategies there; but all of those components of our business including specialty metals is also expanding.

[Mark Parr:]

Thanks very much and congratulations.

[Michael Siegal:]

Thanks.

[Operator:]

Our next question comes from Richard Garchitorena of Credit Suisse. Please go ahead.

[Richard Garchitorena:]

Good morning and congratulations gentlemen.

[Michael Siegal:]

Thanks.

[Richard Marabito:]

Thanks Rich.

[Richard Garchitorena:]

So the first quarter you had very a strong quarter on the volume side. My question, first question is basically, can you quantify in terms of given the acquisitions you’ve done the expansions where your current capacity sits; how much more you can sort of be used from existing facilities and I guess with new facilities coming on line how that grow over the next 12 to 24 months?

[Michael Siegal:]

We have a wide open order book and we would tell all of our customers to keep the order slowing. Clearly, we have and truly sort of East to West; I mean there’s no question that the things that are in the Midwest in terms of farming and the mining manufacturers, the earthmover kinds of scenarios are very, very strong; our facilities in Iowa and Minnesota are pushing the limits of their capacity although again we can continue to add more business in those locations. As we move further east, the southeast is probably a little bit weaker in terms of the demand therefore we have a lot of capacity in the southeastern. So we have some capacity, availability in the New England markets as well. But that’s the marketplace, but I can tell you Richard, we are constrained on capacity to continue to take on new business. Part of the reason why we are anticipating more business, is why we and David indicated we are adding the geographic footprints.

[Richard Garchitorena:]

Great. And can you talk a little bit about the product mix, has that changed at all this quarter or in the last quarter? Also the value added obviously component, has that helped on the margins?

[David Wolfort:]

Well, we have had some significant growth on specialty metals. So we continue to increase our participation on aluminum and stainless and we’re very happy with that. We are actually proud of those accomplishments. In terms of mix of our carbon products, the ratio was pretty much the same as just more tonnage as Mike described earlier. Richard, we caught back about half of what we lost and – in 2010 we caught back about half of what we lost in 2009. We anticipated that ’11 would be off to a quick start and indeed it was and we caught back the balance of that in the first quarter. So as we look at first quarter, we’re at normalized run rates. The market responded. We had the inventory forth; additional to that is that not all of our customer base is back in total, but however over the last few years, we have continued to recruit new business. So in anticipation that our older customer base will eventually comeback to its full participation and we will retain the new business, we recognize that we need a lot more square footage and that's why we have this additional business plan out.

[Michael Siegal:]

I think it will be specific Richard, we have seen all segments of our business increase proportionally and therefore I don't think our product mix changed much. All segments of our business are growing.

[Richard Garchitorena:]

Okay, great. Thank you very much.

[Operator:]

Our next question comes from Aldo Mazzaferro of Burke and Quick. Please go ahead.

[Aldo Mazzaferro:]

You know aside from the pricing improvements, the volume was very impressive and I just wanted to ask you about your comments about growth going forward, when you look at this facilities that David listed and which ones will you say beyond the Gary plan, which ones did you say the most significant in terms of your outlook?

[Michael Siegal:]

Well, I say all the above. You know I would say they are all significant in the wrong way, but obviously being in Mexico is something unique that creates, if you go back to Olympic in 1984, Aldo when we started this right, David, his philosophically indication or you go from regional representation to regional distribution. So the fact that we’ve being in Mexico for a long time without brick and mortar speaks well to the ability to penetrate a market from a long distance and having the brick and mortar opportunity, even though it’s a small facility, half of the building with one of our customers, I would tell you Aldo the opportunity in Mexico is probably the most profound of the investments that we are making in terms of via longer-term opportunity growth.

[Aldo Mazzaferro:]

Mike, did you say how bring your footprint was down there?

[Michael Siegal:]

Aldo, it's 15,000 square feet to start.

[Rick Marabito:]

But we are taking with one of our customers, half of a new facility that we are building. This building that we are taking half of the space.

[Aldo Mazzaferro:]

So Mike, just to help us out, if you look around for your next location for the second temper mill assuming you go through with that option, is 15,000 feet enough or is it going to more like 40 or 50.

[Michael Siegal:]

Temper mill, we need a 150.

[Aldo Mazzaferro:]

150.

[Michael Siegal:]

150 for temper mill.

[Aldo Mazzaferro:]

So are any of these projects that you mentioned suitable candidates for that second [building].

[Michael Siegal:]

No, we are looking into a new geographic area where we are at presently located.

[Aldo Mazzaferro:]

And then how about your comment upfront like about the acquisition opportunities, could you, I mean I am trying to get a flavor for whether you are looking at volume expansion in commodity processing or are you looking to continue your expansion into the higher value added products and components and things like that.

[Michael Siegal:]

All of the above. I mean again when you look at acquisitions opportunity, Aldo, what we look for is two basic criteria or three basic criteria. One, we prefer a good management as opposed to turnarounds, so we've done both. I would say the first criteria is do they have good management in place. The second would be how do they look on a geographic penetration relative to where we are. We don't really need another service center in Cleveland, Ohio. So we kind of look at do they add to the geographic footprint to better service our customers. And then third would they add to the product portfolio in terms of the products that we can sell and so in no particular order other than the fact that they should have good management in place which is universal, it is product or geographic location, both of equal opportunity for us to look at.

[Aldo Mazzaferro:]

And just finally Mike, SV being some of the other indicators of price if you look at what are showing us, hot-rolled coil price in the US right now, 855 a short ton in the Midwest. Do you think that's $50 higher than it really is or.

[Michael Siegal:]

I prefer not to comment on pricing.

[Operator:]

(Operator Instructions). Our next question comes from Brad Evans of Heartland. Please go ahead.

[Michael Siegal:]

Brad?

[Operator:]

It looks like he took himself out of queue. I’m showing no further questions at this time. I’d like to turn the call back over to management for any closing remarks.

[Michael Siegal:]

Thank you, Elle. As a reminder, it is our policy not to provide forward-looking earnings estimates for the upcoming quarter or year and not to endorse any analyst sales or earnings estimates. We anticipate releasing our second quarter 2011 earnings on or around August 4 of the year. And this concludes our call and again thanks for everybody’s participation and interest in Olympic Steel. Good bye.

[Operator:]

Ladies and gentlemen, that does conclude today’s conference. You may all disconnect and have a wonderful day.