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Olympic Steel, Inc. (NASDAQ:ZEUS)

Q4 2012 Earnings Call

February 21, 2013 11:00 AM ET

Executives

Michael Siegal - CEO

Rick Marabito - CFO

David Wolfort - President and COO

Analysts

Martin Englert - Jefferies and Company

Mark Parr - KeyBanc

Aldo Mazzaferro - Macquarie

Charles Bradford - Bradford Research

Operator

Good morning, and welcome to the Olympic Steel Fourth Quarter And Full Year 2012 Conference Call. All participants will be in a listen only mode. (Operator Instructions). After today’s presentation there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded.

Some statements made on today's call will be predictive and are intended to be made as forward looking within the Safe Harbor protections of the Private Securities Litigation Reform Act of 1995 and may not reflect actual results. The company does not undertake to update such statements, changes in assumptions or changes in other factors effecting such forward-looking statements. Important assumptions, risks, uncertainties, and other factors that could cause actual results to differ materially are set forth in the Company's reports on Form 10-K and 10-Q filed and press releases filed with the Securities and Exchange Commission. Today's live broadcast will be archived and available for reply on Olympic Steel's website.

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

Michael Siegal

Yes, thank you operator. Good morning and thank you for your interest in Olympic Steel. On the call with me this morning to review our fourth quarter and full year 2012 results is David Wolfort, our President and Chief Operating Officer; and Rick Marabito, our Chief Financial Officer.

I will provide a brief overview of our results for the quarter and full year, Rick will provide additional color on the financials and then David will provide an operational update. After that, we will open up the call for questions.

We reported this morning that net sales for the fourth quarter of 2012 totaled $292 million, down 9% from $320 million in last year’s comparable quarter. For the full year net sales increased 10% to a record $1.4 billion, owing to the inclusion of four quarters worth of contributions from Chicago Tube and Iron. 2011’s financials only included CTI’s results from the second half of the year since we acquired it in July 2011.

As disclosed in the press release, based on our annual goodwill impairment testing, we concluded that goodwill related to our flat products southern region had become impaired. Consequently, at the end of the year, we wrote off $6.6 million goodwill associated with the southern region’s 2006 North Carolina acquisition.

This combined with higher depreciation from capital investment projects and continued margin pressure during the quarter resulted in a reported net loss of $10.1 million or $0.92 per diluted share, compared with the net income of $600,000 or $0.05 per diluted share in the fourth quarter of 2011.

For the full year net income totaled $2.3 million or $0.21 per diluted share, compared to $25 million or $2.28 per diluted share last year. The goodwill write-off negatively impacted EPS by approximately $0.60. Moreover the startup operating expenses, depreciation and interest associated with our six new locations adversely impacted EPS by about another $0.25.

We believe the growing pains are now largely behind us and are pleased to report that collectively the new locations have generated positive EBITDA for the year and are making meaningful contributions to net profitability in 2013. Needless to say, much of the progress made by Olympic Steel in 2012 is not readily apparent based on reported financial results. Other than previous, perhaps the higher operating expenses associated with our new equipment and facilities, that didn’t make sense, but I am sorry.

David will review these and our other growth initiatives in greater detail in a moment. However one point I would like to make is that the vast majority of cash investments related to these multi-year capital expansion projects have now been concluded.

Now our focus is turned to generating the anticipated increase in earnings and cash flow, in particular as we continue to ramp up these projects and improve fixed cost operating leverage. The tubular and pipe products segment turned in an outstanding performance in 2012. In fact that business has recently outgrown its existing distribution facility, near St. Paul, Minnesota.

To allow for continued growth we will be enlarging and enhancing that location. The expansion will provide more floor space, additional crank capacity and better throughput capabilities, increasing the facility’s footprint from approximately 90,000 square feet to 130,000 square feet.

During the past year we also successfully grew Olympics deals, specialty metals markets share in both stainless and aluminum arenas. We believe these niche sectors are ripe for opportunistic growth and we will be able to leverage our strength and satisfy a growing roster of diversified customers. We have increased our activity in the stainless market and are encouraged by the healthy demand from the food service industry.

Earlier this week 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 March 15, 2013 to shareholders on record on March 1, 2013. And so I'll now over the call to Rick for the financial highlights.

Rick Marabito

Thank you Michael and good morning everyone. I will cover additional financial highlights for the quarter and the year and then I’ll turn the call over to David for the operational review. As most of you are well aware, as Michael just pointed out, we acquired Chicago Tube and Iron on July 1, 2011 and this operation is reported as a tubular and pipe product segment.

From the date it was acquired through the end of last year, CTI contributed $118 million to consolidated net sales in 2011’s second half. In 2012, the full year contribution to net sales from this segment was $246 million, which accounted for our consolidated sales growth.

On a year-over-year pro forma basis, sales at CTI were up above 3% over the prior full year and gross profit increased to 29.7%, compared with 28.3% last year. During the fourth quarter, volume in the flat role segment decreased by 3.4% to 249,000 tons, from 257,000 tons in last year's comparable period.

For the year tonnage was up 1.4% compared with 2011, reaching 1.14 million tons. Consolidated gross margin expanded modestly during the fourth quarter to 19.5%, versus 19.3% in the third quarter of 2012 and 19.4% in the fourth quarter of 2011.

The quarterly uptick resulted primarily from the increase in margins for tubular and pipe products. This more than offset margin contraction in the flat product segment, which dropped 40 basis points during the quarter to 16.7%, compared with 17.1% last year. We had been selling higher priced inventory purchased earlier in the year and by the end of the quarter we began to turn lower cost raw materials.

For the full year consolidated gross margin was 19.5%, down from 20.1% last year. The year-over-year margin contraction was due to the less robust spot market, declining prices throughout the year and more intense pricing pressure on carbon and stainless products versus 2011.

Operating expenses as a percentage of annual sales totaled 18.2% in 2012, compared with 16.6% last year. The increase resulted primarily from noncash items such as the goodwill impairment charge which totaled 0.5% of sales and higher depreciation and amortization. In addition, we incurred routine startup operating expenses associated with our expansion efforts.

As expected capital spending decline during the year to $23.4 million, down more than 40% from $39.5 million in 2011, as the majority of our multiyear capital expansion projects were completed in 2012. Starting with 2013, capitalized investments are projected to be less than depreciation expense, which is currently running at approximately $20 million per year. We are planning for $15 million in capital spending in 2013.

The only major projects slated for this year is the expansion at our tubular and pipe products facility in St. Paul that Michael just mentioned. This location serves as a distribution hub for the upper Midwest and as that business has outgrown the existing facility’s capacity, this expansion will help us keep up with customer demand.

Our effective income tax rate for 2012 was 77.5%, compared with 33.4% last year. 2011’s rate was slightly lower than normal and that was owing to changes in unrecognized tax benefits in 2011. The rate in 2012 was unusually high due to the impact of the nondeductible $6.6 million goodwill impairment charge recorded in December.

This increased our effective tax rate by approximately 30.5%. The remainder of the tax rate reconciliation from our normal range of 38.5% to 39% is related to tax valuation reserves established in 2012 and then the impact of lower pretax income.

Our flat products inventory turnover rate was four times in 2012, less than our target of approximately five turns and lower than last year’s 4.5 turns. Inventory at yearend was $290 million, essentially flat with $289 million at the end of third quarter but up $12 million when compared to the end of 2011.

In light of declining steel prices that persisted throughout the year, our inventory levels were higher than we would have liked. Longer contract purchases, compounded by initially stocking the new startup locations contributed to the amplified inventory levels.

We anticipate our inventory will decline during the first half of the year and our turnover rate is expected to improve in 2013. The quality of our accounts receivables remains solid. Flat-rolled DSO totaled 41 days and tubular and pipe DSOs were 31 days.

Overall the financial health of our OEM customers appears to be robust. We also made good progress in reducing our debt in the fourth quarter. Our debt at year end totaled $242 million, down $35 million from the $277 million at the end of the third quarter. We also had $63 million available under our asset based loan at December 31st.

Interest and other debt related expense increased to $8.4 million, compared with $6 million in 2011. Our effective borrowing rate, exclusive of differed financing and commitment fees was 2.7% in 2012 and that’s down from 3.1% in 2011. The increased expense was a result of higher average debt balances resulting from the CTI acquisition, which did not fully offset the lower borrowing rates on our asset, based lending agreement.

Going forward, we intend to allocate excess future cash flow to reducing debt and reinforcing the balance sheet. And finally shareholders equity, after the $6.6 million goodwill impairment charge stood at $26.54 per share at the end of 2012 and that’s up from $26.28 at the end of last year.

Now I will turn the call over to David.

David Wolfort

Thank you Rick, good morning to all. In 2012 we began with some encouraging signs of market strength as hot roll prices rested above $700 a ton, some 13 months ago, January of ‘12. However after peaking in the first quarter, prices declined steadily until the third quarter when a short-lived recovery was quickly stalled out by the uncertainty that characterized our fourth quarter of 2012. Here prices declined approximately 23% by November, when compared to the beginning of the year.

From an operating standpoint we made terrific progress on a wide variety of initiatives, including our new startup facilities, that we believe will be duly reflected in future profitability. While our six new store fronts created a drag on financial performance in 2012, as Michael pointed out, they are now making a substantial positive contribution to net earnings and cash flows in the current year. Our largest capital growth project, the New Temper Mill in Gary, Indiana, is our most efficient operation and is now contributing significant tonnage and accretive earnings to our consolidated results.

This operation continues to outperform the startup sequences of both of our previous Temper Mill installations. We are very encouraged by its initial performance and anticipate an increasing contribution to earnings as we transition from base loading the equipment to pursuing higher margin market opportunities.

From a market share perspective, we also had good news to report. We increased volume of direct tons sold and significantly grew our toll processing and value-added tonnage. These increases were offset by lower sales volumes associated with trading sales activity during the full year of 2012.

Our stainless and aluminum product sales continue to grow faster than their respective markets as we successfully penetrated our selected niches for these products. Our sales of white metals grew more than 22% in 2012, which is impressive given that industry-wide sales have been flat at best according to our market sources. This is a key element to our strategic objective to moving up the industry value chain. We see excellent opportunities in specialty metals and expect this to be an area of growth in the future.

As we look forward into 2013, we have a number of reasons to be optimistic. January marked a rebound in order activity, likely the result of some pent-up demand owing to the fourth quarter downturn of volume and pricing. We are encouraged by firmer pricing which should help margins. Compounding the price effect is the fact that we have moved through much of our higher priced inventory, thus lowering the average per ton cost of current sales. We believe the combined impact of our growth projects, coupled with better inventory management and pricing disciplines for small and niche orders will result in improving financial performance in 2013 and beyond.

With that we will now open the call for your questions. I’ll turn it over back to you operator.

Question-and-Answer Session

Operator

We will now begin the question and answer session. (Operator Instructions). And the first question comes from Martin Englert from Jefferies and Company. Please go ahead.

Martin Englert - Jefferies and Company

Wanted to get an idea how much you thought that working through the higher cost of flat rolled inventory maybe negatively impacted the fourth quarter there. You have any sense?

Rick Marabito

Well I'd just say as David pointed out the price decrease really perpetuated from January through November and in the fourth quarter we saw the preponderance of that. And then the prices bottomed out there at the end of November. So as you look at our flat roll margins you see that and if you look at our flat rolled margins in fourth quarter of ’13 versus ‘12, I'm sorry ‘12 versus ‘11 that delta in the flat rolled margins is pretty much the impact as I'd quantify it.

Martin Englert - Jefferies and Company

Okay, so looking out into the first quarter now, would expect some improvement from that then.

Michael Siegal

Yes.

Martin Englert - Jefferies and Company

Okay and then just looking at the end markets there, can you talk about some of the demand trends that you're seeing out there among the different end markets and then also if you're seeing any continued I guess inventory destocking among any of the OEMs out there and if that's overshadowing real demand?

David Wolfort

Martin, I'll comment. David here. We saw in October a real stall from the OEMs perspective. We attributed that to the national elections and some of the issues, legislative issues particularly around the fiscal cliff, and so from a month-over-month perspective, for the first nine months of ‘12 we really had increased sales with every month with the exception of March, where we had significant international sales in ‘11. That trend reversed itself in October, November and December as we saw the OEMs really stall. We've seen that come back in January to the same extent that we were looking at it in September. Of course we’re early on in the first quarter. We saw pricing rebounded slightly as Rick has clarified and so we're on a better trend.

Martin Englert - Jefferies and Company

Okay thanks that helpful and if I could, one last question there, do you have sales tons and towing tons for the quarter?

Rick Marabito

Sure, let me just turn to that. Give me one second. So, and you know in our 10-K we report our flat products tons only? So we do not report volume for pipes and tube. So for 2012, I have, the total is $1.142 million, the breakout direct is $1.062 million and the total is $81,000.

Operator

Our next question comes from Mark Parr from KeyBanc, please go ahead.

Mark Parr - KeyBanc

Couple of quick questions. If you look at January activity, you have indicated it is picked up a bit. How does that compare with January of last year?

Rick Marabito

The reason we are hemming and hawing Mark is we have different ship days this January versus last January. The volume has been pretty flat, comfortably year-over-year, January to January on a per day basis but we have got different number of days in there, but we have definitely seen an improvement from fourth quarter volumes on a per day basis. And I’m not talking about just the last two weeks of December when everyone shut down. But the trend was obviously decreasing in the fourth quarter as we move through the fourth quarter October through December and then we have seen a rebound in volume and pretty similar to last year.

Mark Parr - KeyBanc

Yes, the daily amount, the daily numbers are more meaningful anyway then, because you get different days. I appreciate that color, because looking at the MSCI numbers, I think the January comp was down, it was down between 5% and 10%, I think it was down 7%. And so you guys clearly outperformed. I was just wondering if you could give some color on the end markets where you saw the most upside. I think Michael or David, I think you mentioned maybe what heavy equipment markets, were there any other areas where you saw noticeable pick-up in momentum?

David Wolfort

Mark, David here. We basically saw a significant pick-up when you compare it to fourth quarter. There was a real drop off in October, November and December and as I mentioned earlier on a month over month basis compared to '11, those were our three short months and as we talked about, we lost some tonnage there, principally tied, all tied to the fact that the OEMs had really slowed down with some significant concern about which way we were going legislatively and again based on national elections.

We have seen that all comeback. That’s all come back as Rick said, so all come back. There are surges in the marketplace. It’s not an even flow, but the tonnage has repaired itself and we look to ’13 for some nominal growth in terms of market share for us as we bring on our new facilities and we see most of our OEMs had a pretty even pace throughout the year.

Mark Parr - KeyBanc

Okay terrific. And if I could just ask a follow up, you indicated you’re seeing pricing look stronger and at least in the last couple of weeks with the February scrap number coming down pretty meaningfully, so like yesterday new core cut prices on merchant bar quality and also on structural, and those were base price cuts, those were in addition to any scrap surcharge change, and we’ve kind of been seeing, on the flat role side we’ve been seeing kind of like gradual easing and the plate markets haven’t really seemed all that robust either. I’m just curious where you’re seeing pricing stability or pricing upside, if you could give some color?

Rick Marabito

Yes I’ll be happy to. Nucor did reduce the price of that on those items, and fortunately we don’t sell them. So that’s the good news. Now they did raise the price on plate as you know by $30 tone so did SSAB and went along with that. Mark I’ll just dial it back a little bit and tell you that as you well know, because obviously analyze all this anyhow, but as you well know October was the lowest pricing for the entire year and so as we took look at the marketplace, we traditionally expect July to be the low end of the market and July was the low end of the market until October occurred.

And then there was a $20 a ton delta. At least from our perspective, between the low end of July ad low end of October. That has all come back, that’s recovered and we see flat pricing, scrap moved sideways in December and January, you’re right it’s down $9, $10 a ton for February. Expectations are that’s going to go up and probably be up in March and probably equal to where it was in January. So again much like you’ve written early on in the fourth quarter and quite frankly we think you’re spot on, we see flat prices for the year and we’re just in that flat priced mode right now. So we don’t see much deflection on the pricing in the first quarter.

Michael Siegal

Having said that, just to give you a little clarity there Mark, we’re seeing some movements in nickel pricing. When you get off of the carbon side, the nickel pricing seems like it has some momentum on the positive side?

Operator

Our next question comes from Aldo Mazzaferro of Macquarie. Please go ahead.

Aldo Mazzaferro - Macquarie

I had a couple of little questions. Michael, when you mentioned that the opportunity is right for the exploitation of the stainless and aluminum markets, does anything of that have to do with the fact that the aluminum warehouses associated with the LME are essentially very slow in getting product to the market? Does that give you more opportunity do you think in the marketplace?

Michael Siegal

The answer is somewhat, Mark, obviously we have a bigger penetration on the stainless side. We are such a small player in the aluminum, overall that, again from our perspective, we have got some keen opportunities as it relates to penetrate specific markets. On aluminum, we are already getting some great opportunities. Again, I don’t know if that specifically impacts our business, so much but clearly on the stainless side, the rising tide looks good. We’ve got some great opportunities in the food service business as I mentioned, as well as some of the transportation industries as well. So I think again we are a smaller player than some of the other guys, but we are really growing obviously our penetration rapidly there, but, yes David if you want to tell.

David Wolfort

Yes, let me get a little granular for you Aldo. First of all we really didn’t sell any aluminum prior to ‘09. We had a toe in the water 100 years before that with our first acquisition, but we entered the market in '09. The President of our Specialty Metals Group, Andy Greiff has let us through that. And quite frankly, we find it as a terrific complementary product, shipping alongside of some of our coal row participation in the marketplace. We have elevated the stainless as Michael has well said and I’ll bring your attention to the fact that one of the six new store fronts that we did open up is focused on specialty metals stainless and aluminum distribution and we’ve seen some really terrific growth there. And again as we have stated, that’s part of our specialty emphasis and we’re looking to grow that value added participation. So I don’t think we are impacted too much by what you suggested as we are more impacted by our traditional business, customers using aluminum and we didn’t participate and we continue to grow that participation now.

Aldo Mazzaferro - Macquarie

So you’re buying the aluminum is coming from the aluminum producers rather than from distributors, other distributors, right, or would you say it’s a mixture?

Michael Siegal

No, I don’t think we compete really with the producers.

David Wolfort

He is asking where we are buying.

Michael Siegal

Sure, we are buying it from the mills.

Aldo Mazzaferro - Macquarie

Yes and just on another track, I heard Rick mention that the turns on your cost of raw materials started to get better towards the end of the quarter. So, would you say if I were guess that the average for the quarter on metal spreads was lowest in the October and highest in December, would that be a good guess?

Michael Siegal

For the quarter?

Aldo Mazzaferro - Macquarie

Yes for the fourth quarter, yes.

Michael Siegal

Yes. That’s correct.

Aldo Mazzaferro - Macquarie

And I would bet the outlook going forward then with flat price means that you would probably be likely to maintain the end of year type spreads, right in your business?

Michael Siegal

Yes.

Aldo Mazzaferro - Macquarie

And then I had just one little follow up at the end is, you mentioned that there was $0.25 of startup cost. I missed whether that was a year or quarter number?

Michael Siegal

That was for the year, Aldo.

Operator

(Operator Instructions). Our next question comes from Charles Bradford of Bradford Research. Please go ahead.

Charles Bradford - Bradford Research

I don’t want overdo the stainless bid but I’m very confused about how this thing is developing with the new million ton melt shop in Alabama owned by the Europeans? Alleghany is spending a $1 billion on a hot mill. This would all seem to be in your favor as a buyer of stainless but could all this excess supply be disruptive? How do you look at it?

David Wolfort

I think your first analysis is the best. I think it’s beneficial to us. I think there is some terrific disciplines out there but needless to say, as you well know Chuck all markets are somewhat limited and if you have more supply than you have demand, obviously it’s going to put some pressure on.

Our strength is really in our ability to distribute on time and give the customers the processes that they need, not so much here in competing with low volume pricing. So, on the stainless business, as Michael well said, the influence by nickel surcharges, we look for continued growth there and we welcome the new capacity and our 33 locations help us distribute more product.

Charles Bradford - Bradford Research

I know this may be a somewhat unfair question but do you hear anything about what's going on at Thyssen Krupp on the steel side. I understand people have signed confidentiality agreements?

Michael Siegal

We're not one of them. I can certainly tell you that. No I don't think we know anything more than what's been publicized in the newspapers to date. You've heard of the bid, the combined bid, the next bid and Thyssen says things are progressing well. So I don't think we have any knowledge other than what's been in the public papers.

Charles Bradford - Bradford Research

But these are all the same players who supposedly were going to bid for RG and none of them showed up at the auction.

Michael Siegal

Well you know what, there's got to be willing buyers and willing sellers at the table and there may be some willing buyers but there may not be a willing seller at the buyer’s price so who knows. We await with great anticipation as you do.

Operator

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

Michael Siegal

Thank you operator. Once again we want to thank all of for your participation on this morning's conference call and for your interest in Olympic Steel and we look forward to sharing our first quarter results with you in May of this year. Thank you.

Operator

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

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