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Executives

Michael D. Siegal – Chairman and Chief Executive Officer

Richard T. Marabito – Chief Financial Officer

David A. Wolfort – President and Chief Operating Officer

Analysts

Luke Folta – Jefferies LLC

Aldo Mazzaferro – Macquarie Capital, Inc.

Sal Tharani – Goldman Sachs & Co.

Philip N. Gibbs – KeyBanc Capital Markets

Edward J. Marshall – Sidoti & Co. LLC

John F. Ockerman – Davenport Securities

Olympic Steel, Inc. (ZEUS) Q2 2013 Earnings Conference Call August 9, 2013 10:00 AM ET

Operator

Good morning, and welcome to the Olympic Steel Second Quarter 2013 Conference Call. All participants will be in 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 affecting such forward-looking statements.

Important assumptions, risks, uncertainties, and other factors that could cause actual results to differ materially are set forth in the Company’s reports on Form 10-K and 10-Q 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 your host for today’s call, Olympic Steel’s Chairman and Chief Executive Officer, Michael Siegal. Please go ahead, Mr. Siegal.

Michael D. Siegal

Thank you, operator. Good morning and thank you all for your continued interest in Olympic Steel. On the call with me this morning to review the 2013 second quarter and first half results are David Wolfort, President and Chief Operating Officer; Rick Marabito, Chief Financial Officer; and Donald McNeeley, President and Chief Operating Officer of CTI.

I will begin with a brief overview of our results. Then Rick will provide additional color on the financials and David will give the operational update. After that, we will open the call for your questions.

So during 2013, Olympic made significant progress on the objectives that we outlined on previous calls, specifically our six new locations are now all pre-tax profit contributors. Our gross margin percentage is improving, inventory levels are down and our inventory turnover is up. We are spending significantly less than previous years on capital investments. Additionally, we paid down a meaningful amount of debt in 2013 and we will comment more on all of these accomplishments throughout today’s call.

By now you should be aware that the second quarter, the industry itself experienced softening steel prices and less volume shift compared with last year. We were not new to these market dynamics. Our sales declined 10% in the quarter and 11% for the six months. Despite these market pressures our gross margin percentage increased in both periods compared with last year providing evidence that our recent investments did diversify our product mix, penetrate new geographies and provide more value-added processes and fabrication is working.

With the completion of our capital expansion projects, the positive contributions from our new locations and working capital improvements, we are now generating much higher levels of free cash flow, which has been used to reduce debt.

Since the beginning of the year, we paid down more than $34 million of debt, further strengthening our balance sheet. Our major IT spending on the new system development is also behind us, as we completed the final implementation. Rick will elaborate more in a moment about our working capital reductions and how we are allocating excess cash.

In spite of all that we have accomplished internally, the market itself remain challenging in the first half of 2013. Demand was down as evidenced by the year-over-year decline in service center shipments reported by the MSCI, and steel prices had been stubbornly soft. The June and July uptick in metal pricing is the result of production curtailments related to the unscheduled blast furnace outages in Middletown, Ohio and the ongoing strike at another mill in Ontario, Canada. These supply side disruptions are short-term issues that will likely be resolved. In fact the 8-K situation that has been described is already back to full production.

In terms of our segment results, flat products contributed $5 million to consolidated operating income, down from $7.3 million in the same quarter last year. We reduced variable operating expenses in this segment by $2.1 million during the quarter.

Our pipe and tube segment contributed $3 million to operating income in the second quarter, down from $4.4 million in last year’s comparable period. The decline in operating margin was due to increased variable expenses from more sales volume versus last year, as well as higher employee benefit costs.

In response to the lower sales and earnings, we initiated cost reductions late in the second quarter. These efforts will be completed in the third quarter and are expected to reduce consolidated operating expenses by more than $4 million on an annualized basis.

We also announced this morning that our Board of Directors have declared a regular cash dividend of $0.02 per share payable on Sept. 17, 2013, to holders of record on September 3 and with that Rick, I’ll turn the call over to you.

Richard T. Marabito

Thank you, Michael, and good morning everyone. I will review the financial highlights and then turn the call over to David for his operational review.

So, starting with tonnage; tonnage of flat-rolled products declined to 573,000 tons in the first half of 2013. This was 6.6% lower that last year and was driven by the weak spot sales market and softer demand from certain customers, particularly in the mining sector.

Average selling prices also were lower in the quarter compared with 2012. The lower volume and pricing resulted in consolidated second quarter net sales declining 10% to $331 million compared with $367 million last year.

For the 6-month, net sales was $669 million down 11% from $749 million in 2012 first half. Despite weaker industry demand and pricing, our gross margin percentage improved in both the three and six month periods. As previously disclosed, in this year’s first quarter, we recognized $1.9 million in pre-tax LIFO income related to recording inventory valuation adjustments from 2012.

In the second quarter, we recorded $0.4 million in 2013 LIFO income as average prices continued to decline bringing the first half LIFO income total to $2.3 million. As a reminder, LIFO is associated with CTIs inventory and LIFO positively impacted gross margin percentage by 11 basis points in the second quarter and by 34 basis points for the six months.

Excluding the LIFO income consolidated gross margin expanded to 20.7% up from 19.5% in last year's second quarter, and to 20.7% in the first half versus 19.6% in 2012. The margin improvement was driven by our ability to successfully maintain consistent per ton profitability despite the lower volumes in prices.

Consolidated operating expenses were essentially flat year-over-year, which means that they did increase as a percentage of sales given the lower revenue. Operating expenses decreased to $3.2 million in the flat product segment, partially offset by an increase of with $3.5 billion in the tubular and pipe product segment.

Fixed cost such as our occupancy, depreciation, amortization, where higher in 2013 due to our recent capital investment. This contributed to operating income declining to $6 million in the quarter from $9.7 million last year. For the six months, operating income was $15.6 million compared with $22 million last year. As Michael indicated, to enhance our future profitability, we have executed an expense reduction and these reductions do not impede our ability to service our customers.

Interest expense declined 24% to $1.7 million in the quarter down from $2.2 million last year. For the six months, interest expense was 22% lower at $3.4 million compared with last year’s $4.3 million. This was due to lower average borrowings and the lower effective interest rate. Our average interest rate was just 2.9% for the first half, and that compares with 3.2% last year.

Net income for the second quarter was $2.5 million or $0.23 per diluted share and that compares to $4.5 million or $0.41 per diluted share last quarter. For the first half of 2013, we earned $7.7 million or $0.69 per diluted share compared to $10.8 million or $0.98 per diluted share in 2012. The LIFO income had a positive net impact of $0.02 per share in the second quarter, and $0.13 per share in the first half.

As Michael said, we have transitioned from a multi-year capital investment program and we are now concentrating on optimizing these new facilities. As a result of the lower CapEx which is now running well under depreciation levels as well as our inventory reduction efforts and our other capital improvements, we generated substantial free cash flow in the first half.

In the first six months of 2013, we generated $34 million in cash from operation, reversing the $32 million in cash we used for operations in last year’s first half. Much of this was related to the reduction of the inventory which is down more than $41 million since the beginning of this year.

At June 30, we held $249 million in inventory and that compares with $290 million at the start of the year. We also improved our inventory turnover. Turns for the flat products have increased from 4.2 times in the first quarter to 4.5 times in the second quarter. Our goal is to operate the business at approximately 5 inventory turns per year. As we had commented previously, we averaged less than 4 turns in 2012 and for the first half of this year, we are now averaging 4.4 turns. During June, we were actually running at about 4.6 turns. So we are making great progress on the inventory objective in 2013.

Perhaps the most noteworthy balance sheet accomplishment is the significant amount of debt we paid down. During the quarter, we lowered outstanding debt by almost $30 million. At quarter-end, we held $208 million in total debt, down from $237 million at the end of the first quarter and $242 million at the start of this year. This lowered our debt to equity ratio from 83% at the end of 2012 to 70% currently at the end of June. Since our debt peak during last year’s second quarter, we have paid down more than $100 million of debt or 33% of total borrowings.

Our successful working capital management and inventory reductions together with operating cash flow significantly improved our financial position in the first half of 2013. Working capital needs may increase modestly in the second half of the year. We talked a little bit about the price increasing effect. However, we will remain focused on improving our inventory turnover and further fortifying the balance sheet by paying down debt.

And finally, at the end of the quarter, our shareholders equity increased to $27.25 per share versus $26.54 at the end of 2012.

Now I will turn the call over to David for the operating highlights.

David A. Wolfort

Thank you Rick. I will speak to our operations and market, but first let me speak to our operations and operationally we had a very active second quarter. Notwithstanding the markets’ challenges we continue to advance our stated objectives on a number of fronts. We are proud to report that each of our six new startup locations is operating profitably in 2013. These new storefronts provide us with product and processing expansions in new geographies. We've already detailed our favorable results in reducing inventory

We have particular success in reducing aged stock beyond our normal disciplines. We also rebalanced our inventory tonnage amongst all of our new facilities as we gained a better sense of normalized volumes in each of these facilities as they are reaching maturity. Our new locations are all appropriately inventory as we speak today.

We geographically broadened our product distribution at marginal cost with the integration of pipe and tube products at our Mexican facility in Monterrey and our Cleveland locations. This now makes three locations where we distribute both flat-rolled and pipe and tube products. Our first integrated product location was initiated in 2012 in Mount Sterling, Kentucky.

Our specialty metals team continues to win new business and increase market share in U.S. stainless steel in the US; in both stainless steel and aluminum. The operating expense reduction initiatives already highlighted by both Michael and Rick, are expected to remove more than $4 million of annualized costs from our consolidated operating results. Our actions include consolidating certain ships, reducing permanent and temporary staff, controlling overtime and gaining efficiencies and consolation of freight moment. These efforts will begin to manifest in the third quarter financial results and will be fully recognized in the fourth quarter.

Finally, as reported on our last call in January, our Cleveland Temper Mill incurred damage and was taken off-line. The equipment was quickly repaired and successfully returned to full production in May. During the downtime, we observed all of our customers’ needs on our other Temper Mills located in both Bettendorf, Iowa and Gary, Indiana. The downtime expenses are covered by insurance.

Let me turn to the market now and from a market standpoint, as Michael alluded earlier, steel prices have been deteriorating steadily all year until several unforeseen supply disruptions resulted in the swift uptick late in the second quarter in pricing. These unplanned disruptions help support the producers’ incremental price increases, which originated on May 22. The price rebound was a welcome relieve. However, the balance was off of very significantly depressed levels.

Excess global supply remains an industry issue and we are cautious in our view of the sustainability of the total of the four of these increases, which have recently been announced. Until real demand returns and in less consumption increases, lower input costs will continue to impede pricing power.

The relatively short mill lead times are allowing end-users to operate with lean levels of inventory given the forward curve and consensus for kiosks for lower prices, there is reluctance on behalf of steel buyers to jump back into the market and increased inventory levels at current pricing points.

Now, before turning the call over to questions, I would be remiss not to mention that as most of you are likely aware, since our first quarter call we lost Sol Siegal, the Founder and Chairman Emeritus of Olympic Steel. Sol was not only the driving force of the Company's founding, he also was a great man and of course Michael's father. It was a sad day for us, but we are all proud have been associated with someone that was dedicated not only to this Company, but also to his family, his country having served in World War II, his local community and many philanthropic causes. Olympic steel would not be where it is today without Sol’s high standards of business excellence and social responsibility which he exhibited throughout this lifetime.

With that, we will now open the call for your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Luke Folta at Jeffries.

Luke Folta – Jefferies LLC

Good morning, guys

Michael D. Siegal

Hi Luke.

David A. Wolfort

Hi Luke.

Luke Folta – Jefferies LLC

I am just looking through your 10-Q here, look like it was just filed and I am just trying to get the flat-rolled gross margin and I didn't looks like it’s about 19% which is the highest we’ve seen in quite a while expense versus that of ‘11, I want to get a sense of how much of that was due to the recent price movement we have seen, I was thinking that the price increases on flat-rolled to be more of a third quarter impact. So I guess, can you just help me kind of I guess think about how that’s going to flow through for you?

Richard T. Marabito

Sure, Luke it’s Rick. So first I’d say your commentary is correct, it’s not to the end of the quarter market price increases. We commented a little bit on the call earlier on the flat-rolled side we also like to look at our margins on a per volume basis or a per ton basis, so we’ve really been able to even in market price that had pricing decline, and demand shrinking industry wide. We are able to maintain our gross margins per ton.

So that consistent margin per ton as you will apply it to a lower revenue base had an impact on raising the margin percentage. But as Michael also talked about strategically we put a lot of emphasis on growing our businesses and some areas that do provide higher gross margin I think you’re also seeing that impact.

Luke Folta – Jefferies LLC

All right, and I understand you don’t want to give guidance, but when we look at the third quarter just as we think about the moving parts, which pricing now has a tailwind for you we’d expect that gross margin will likely be higher in the third quarter?

David A. Wolfort

Well, Luke, Dave Wolfort here, we are going to have to anticipate demand picking up quite a bit, to have some sustainability on these price increases. The leadership on May 22 by U.S. Steel foreshadow the next three increases but we have some questions as to how sustainable they really are, until we really some significant demand increase.

July is typically not as strong as second quarter and August has a nice rebound for us. So we will wait to see although most analysts are talking about second half being stronger, we will have to see what unfolds.

Luke Folta – Jefferies LLC

Okay. All right, and then just on the tubular side, if you look at the margin performance there in the second quarter, there has been LIFO impact first quarter to second quarter, but when you ship that out, margins were down sequentially and you kind of highlighted employee benefit and some increased variable cost being the drivers. Is it, I mean is there something kind of one-time in nature in the numbers like bonuses or something like that that impacted the second quarter that we should think about going forward?

David A. Wolfort

Not really Luke, there was no really one-time impacts. We did talk about on the pipe and tube seg we actually had, although we don’t report it because it’s not that meaningful of a number in terms of tons sold. But there volume was actually up year-over-year, so part of the expense increases due to as I said variable increases related to volume. We did call out and highlight some of the employee related costs that are up. Those are not necessarily one-time costs and we did talk about and highlight both on the flat-roll and on the pipe and tube side, will both have initiated the expense reduction plan. So really the story on the pipe and tube side is the impact of lower pricing, squeeze the margins a little bit.

Luke Folta – Jefferies LLC

Got it, okay. And then the CapEx expectation, so CapEx (inaudible) below what you thought it would be so far in the first half. Can you just talk about what the drivers are there and is there something that just relating to the timing of when you expect to have certain projects done or are there just better execution, can you help us understand that?

Richard T. Marabito

Yeah, I think, Luke it’s a combination of things. When the payments get made on projects, but we do have one project in the back half of the year, which is the expansion for Chicago Tube & Iron in St. Paul. That will probably be $3 million in the back half of the year as opposed to although $4 million project. So obviously it’s not spread equally, but now we are very discipline. We just spend a lot of money over the last three years and what we said is we’re pretty much done with a lot of the capital projects beyond maintenance. And so while we’re below our even what we expected to spend perhaps, we’re very disciplined now on the capital deployment.

Luke Folta – Jefferies LLC

And Rick, did you just give updated your full year CapEx expectation?

Richard T. Marabito

No, I didn’t. But I think you got the first half number and then Michael really gave you the guidance that I would, which is, the first half was pretty much maintenance spend, type spend. The back half we will have higher CapEx due to the timing on the Chicago Tube and Iron at St. Paul facility. So, we probably add another $3 million for the back half on top of what normalized first half was.

Luke Folta – Jefferies LLC

Okay. All right, guys for the (inaudible) on the progress there and I will turn it over. Thanks.

Richard T. Marabito

Thanks Luke.

Operator

The next question comes form Aldo Mazzaferro at Macquarie.

Aldo Mazzaferro – Macquarie Capital, Inc.

Hi, Michael, David, Rick how are you?

Michael D. Siegal

Good, Aldo thank you.

Aldo Mazzaferro – Macquarie Capital, Inc.

Thank you. That was a very nice tribute to Sol, Mike’s dad, I just want to express my condolences as well.

Michael D. Siegal

Thank you.

Aldo Mazzaferro – Macquarie Capital, Inc.

In terms of the business trends, I mean the margin seems to have kind of gone away a little bit compared to the expectations, considering your value-added investments in the aluminum and stainless. Can you talk a little bit about how much of your business mix was in those higher value-added products generally and whether that increased or decreased on a sequential basis? I’m just trying to get a feel for whether you’re seeing those businesses tougher margin compression as well as the basic (inaudible) business?

Michael D. Siegal

Yeah, I would say, Aldo, there is no question as we like to talk about. It’s kind of the figures, the largest figure. I mean, obviously when you look at just a few percentage, right, the stainless and aluminum side of the business has a lower percentage, but more real dollars and that’s why we have tried to indicate on Luke’s question about what we kind of look at is what’s the margin per ton because there are so many moving parts in all of Olympic Steel. You really kind of look at what we’re trying to accomplish, but there is no question that nickel pricing has had a dilutive effect on the transaction price in that segment year-over-year.

Obviously, like everybody we had it to some degree and we’re trying management, but I think everybody was kind of surprised over the last 18 months, that nickel felt as far as it did and as an inventory company there’s no question that we get impacted by that.

The other thing which David indicated, all of us have some degree of aged inventory, aged for a lot of different reasons. David indicated a significant reduction of aged inventory. Aged is usually product that may have some discrepant aspect to it. So you’re liquidity it for lower than traditional margins. So as we cure the balance sheet in the short-term, we did impact some margin in that regards.

Hey, Rick, will that account for the difference in the inventory reduction and the receivable increase. I guess that would have been timing towards the end of the quarter.

Richard T. Marabito

Well, the receivables, they’re a little bit different drivers on those too.

So, typically due to seasonality accounts receivable are always at their lower point at December 31. Typically the last two weeks of the year, sales really taper off. So always you see an increase in receivables even in a down year. So you see a big increase in the accounts receivable and it’s primarily driven by that. Obviously, we’ve maintained all our disciplines in the receivable turnover and that type of things.

So, on the inventory side, we really refocused our efforts because Michael and David both commented on the call in terms of getting back to the turnover rates that we liked like to see. And we’ve made – I think we commented on our opening call for the year that we’d like to, by the end of the year, get back to and close to that five inventory turn mark and we started it little under four and we’re right there.

Michael D. Siegal

So, I just want to look out on the receivables. Our receivables Aldo are probably in the best shape that they have been in the very long time. So when we look at the current kind of receivables, it is – even though it’s higher, the actual day sales and receivables is low as it’s probably been in years.

Aldo Mazzaferro – Macquarie Capital, Inc.

And then final question, Rick, can you help us understand the employee benefit increase, like magnitude and what caused it?

Richard T. Marabito

Yeah, it’s mainly healthcare costs are going up. In terms of magnitude, we quantified the increases and decreases by segment. Obviously, we’ve seen on both segments our healthcare costs go up. Also on the pipe and tube side, aside from the employee benefits, we did we probably weren’t as efficient as we could be in some works and some jobs. So we did run more overtime than we had been in prior quarters and part of our expense reduction initiatives that we have already put into place have us reducing those areas, but the specifics on the employee benefits is healthcare.

Aldo Mazzaferro – Macquarie Capital, Inc.

Okay, all right. Thanks very much guys.

Michael D. Siegal

Thank you, Aldo.

Operator

The next question comes from Sal Tharani at Goldman Sachs.

Sal Tharani – Goldman Sachs & Co.

Good morning, thanks for taking my question.

Michael D. Siegal

Hi, Sal.

Sal Tharani – Goldman Sachs & Co.

How are you?

Michael D. Siegal

Good. Thank you.

Sal Tharani – Goldman Sachs & Co.

Mike, you mentioned you have reduced inventories, is this on the new locations that you have reduced inventory?

Michael D. Siegal

No, I think, the answer is to some degree yes, Sal. I mean obviously as you open a new facility, you anticipate a certain marketplace, and you are never perfect on that, so as David indicated as they get into their maturity, you start to adjust during the course of the first 18 months of operations to get the inventories right sized, and really not just the size, but also the right product.

You assume you are going to sell something, and then it turns out to be a little bit different, but I think it’s a combination of we are doing some significant inventory reductions at almost of our locations. Clearly, short lead times, as David indicate, certainly don’t give us any comfort that we need to be long at inventory, so like everybody I think we have shorten our inventory up there across the board, but yes, at the new facilities, particularly in Gary.

Sal Tharani – Goldman Sachs & Co.

And the other thing is that Mike, this has been an unusual year, we had a much weaker first half, and then we are starting to see some strength right now, and maybe somewhat has to do with the disruption in the operations that some of the blast furnaces, is that – it is fair to assume that the second half of this year, year-over-year should be much better for you than the first half?

Michael D. Siegal

Well, if I was that smart I’d be a richer man, but I would say having Congress in 30 days break for the summer certainly calm down all the bad news out of Washington. So I think a lot of it, as you look at the actual numbers, I mean the obvious, the domestic GDP has not been strong. Obviously, there’s great concern over what China demand really is or is not. You’ve seen the disruptions in Europe. And so I would tell you, Sal we have no great confidence that GDP in the United States is going to be much higher in the back half than it is.

Sequestration is still there. Certainly when Congress comes back into session we will expect all of the name-calling and the negative news that comes out of Washington about the world is coming to an end. And clearly the news in China is building no confidence for anybody either.

So, while there are signs of certain recoveries in the marketplace, you’ve got certain other issues like mining and other parts of the consumption market that gives us pause. So, I would tell you the back-half looks for us to be whatever a normal steel market is. We’ll look at as normal steel market, not a full recovery some people are predicting.

Sal Tharani – Goldman Sachs & Co.

Okay. And on the mining sector you mentioned in your calls, but that comments again right now, are there opportunities for your existing mining business to move away from there? It looks like it will not be a weak environment for quite some time.

Michael D. Siegal

Well, our obligation, Sal is always to fill our facilities, and so if mining is depressed for a period of time, we’re going to find a bridge to or countermeasures and we’re going to find other participation. Our value-added processing is not specific to any one industry. It’s very flexible. Let me just punctuate that and reverse, just give you a little color on a couple of things here.

Remember as we offered six new facilities coming up we’re going to have some (inaudible) inventory as we support customer base as those businesses start to evolve. They’ve evolved through last here now there are all profitable as I suggested, and we’ve managed to do is de-leverage the inventory and supporting locations in favor of this new geography. So we are now well positioned and appropriately inventory and we get to reduce our inventory and reduce our distribution costs by with these new facilities.

Additionally, discipline as Mike and Rick have both outlined, whether it’s in our inventory or others or debt, certainly as always spoke with Olympic Steel and as we add more facilities, our view is that we need to maintain all of those disciplines and make sure in a marketplace like today, that we don’t get too aspirational about where market is actually going as opposed to what we, the real manifestation of the marketplace. And so the view is that we’ve had four years of recovery, we’re into a very slow growth pattern that has really just started for the second half, but it’s slow as Michel indicated and we are positioned to take advantage of that marketplace as it continues to grow.

Sal Tharani – Goldman Sachs & Co.

And that was good color. Thank you very much.

Michael D. Siegal

Thank you, Sal.

Operator

Our next question comes from Phil Gibbs at KeyBanc Capital Markets.

Philip N. Gibbs – KeyBanc Capital Markets

Good morning.

Michael D. Siegal

Hi, Phil.

David A. Wolfort

Hi, Phil.

Philip N. Gibbs – KeyBanc Capital Markets

Give us an updated on the progress of the Gary Temper Mill at this point of time,

David A. Wolfort

Really I think that when you look at the startup facilities, especially a piece of equipment that can be that complicated, we are very pleased with the configuration, with the ability of the machine itself to perform. We really can’t have the handpicked workforce up there that is very motivated to increase throughput, and we see significant kinds of production improvement over the other facilities that we have in Temper Mill.

Second, we are seeing great acceptance both from the standpoint of direct sales in a market where there is a lot of other Temper Mill as well as opening up our welcome mat for outside processing. So we are seeing really good acceptance of the Temper Mill and real good production on it.

Philip N. Gibbs – KeyBanc Capital Markets

Any sense of the utilization there Michael?

Michael D. Siegal

Well, yeah, customers are listening. We have more room to take more orders, but I would just say that we’re operating somewhere around 60% at capacity.

Philip N. Gibbs – KeyBanc Capital Markets

Fair enough. Okay. And then David when you said the startups are operating profitably, do you mean that on the net income basis or is that on a cash flow basis or both?

David A. Wolfort

Well, both, they are running well. Let me also just add as Michael has been very complementary of Gary, that without that Gary facility, we would have really been in some trouble, and as the shear went down on our Cleveland Temper Mill, so Gary was able to step-up, obviously it caused us some additional freight, we are insured business, this interruption insurance, but without the advent of Gary, we would have been in tough shape, so was (inaudible) that operation was up and running as quickly as it was.

Philip N. Gibbs – KeyBanc Capital Markets

And my last question is on the expense reduction plan; I did have in thought process that you guys would be doing a little bit of this as some of the startup cost had wind down, but how much of this is in addition to some of that startup costs winding down and is more of this focused on the pipe and tube segment or is this more broad-based?

Richard T. Marabito

Yeah. So it’s Rick, Phil. It’s broad-based in both segments and it has nothing to do with the startup costs phasing now. These are initiatives that we took to reduce current run rate expenses by $4 million.

Michael D. Siegal

Some of it in the tubing, some of it…

Richard T. Marabito

Yeah, I told them. I did it.

Michael D. Siegal

That’s the majority.

Philip N. Gibbs – KeyBanc Capital Markets

Thank you. Appreciate it, guys. Good luck.

Richard T. Marabito

Thanks.

Operator

Your next question comes from Edward Marshall of Sidoti.

Edward J. Marshall – Sidoti & Co. LLC

Good morning.

Michael D. Siegal

Good morning.

Edward J. Marshall – Sidoti & Co. LLC

I wanted to follow up with that last question about the cost reductions. You quantified, I mean it looks like it’s I guess roughly 1.5% of the operating cost to the business. Is it employee or is it structural? I assume the size of it suggest it’s employee?

Michael D. Siegal

Yeah, it’s mainly employee. We hit that on some of the items. It’s some headcount reduction. It’s the elimination of some temporary labor. We did some ship consolations. So that’s, those are the types of expenses that are being cut.

Edward J. Marshall – Sidoti & Co. LLC

Should we expect a one-time adjustment or cost on severance or anything like that?

Michael D. Siegal

No. The severance was not that significant and the severance has already been absorbed in our second quarter.

Edward J. Marshall – Sidoti & Co. LLC

Okay. It’s really early to talk about this, especially the two utilization rate of 60% in Gary, but my question is, for a while back there was a fourth Temper Mill and I’m just kind of curious with the marketing down, maybe the price advantageous to you, what are your concerns about and I understand you’ve talked about CapEx. What are your thoughts about potentially fourth Temper Mill down the line and kind of walking those prices in as the markets on deals, just curious.

Michael D. Siegal

I’d say in the near-term of that project is significantly delayed, and till that we see significant improvement in the market. Again, as you look at covering the North American market a fourth Temper Mill for us would be beneficial from a growth perspective. We’re just not to ready to do that at the present time so it’s probably a couple of years away at the earliest.

Edward J. Marshall – Sidoti & Co. LLC

Okay, thanks guys.

Operator

(Operator Instructions) And our next question comes from John Ockerman, Davenport.

John F. Ockerman – Davenport Securities

Good morning.

Michael D. Siegal

Good morning, John.

John F. Ockerman – Davenport Securities

Good morning. With very little demand recovery that you all expect in the second half, do you think that you could get to five times by year-end or is that something that really would be a 2014 sorry?

David A. Wolfort

No, I think that John, Dave Wolfort here, I think that our inventory is appropriately leveled. Today that reaching five is not anything that’s a stretch. I mean it’s significantly easy specially with the shorter lead times, have expanded here recently, but we would see some pullback unless something dramatic happens.

Also, from a demand perspective, we see demand moving up slightly. We say growth, but its nominal growth on a GDP level of course, lot of different industries, mining is down and that affects but we’ll find others. Other businesses are up some related to equipment that goes to area (inaudible), so forth has been fairly robust. So reaching five turns is our goal and we’ve made some pretty good progress year-to-date.

John F. Ockerman – Davenport Securities

Okay. And do you have a targeted debt level, debt-to-cap, something that you would want to get to before, say, making another acquisition or investing in growth?

Michael D. Siegal

We do. Obviously, the public service centers the metric that’s typically used is the debt-to-EBITDA number and after we made the pipe and tube acquisition and finished our investments, we’re obviously on the higher-end of that ratio and our initial goals were to kind of the midpoint. So, we’d like to be in the 3.0 range and that’s the target for us. We’ve obviously made some good progress on debt reduction that we highlighted here today. I think in the second half of the year, obviously with prices moving up here. We’ll have that impact going the other way in terms of potential increased working capital dollars, but we’re still very confident that we’re going to continue to march the debt down.

John F. Ockerman – Davenport Securities

Okay. Thank you.

Operator

The next question comes from (inaudible).

Unidentified Analyst

Hi, Dave, Mike, Rick. I wanted to ask you guys a little bit about the breakdown in percentage between spot and contracts that you guys are doing? And then on the spot side, what is the competition like among so to serve? I’m hearing there is a lot of that in flat-rolled. Thank you.

Michael D. Siegal

There is always a lot of competition. Spot business today is a little bit different than historically [Carina]. Spot business used to be small fabricators and service centers. A lot of small fabricators, today work off from resale programs from the large manufacturers that they supply. So to some degree the overall spot market is less than it used to be.

Clearly with short lead times at the domestic producing industry, the spot market, service centers is lower than it has been, but typical of a slow demand universe. So we probably have a bigger contract to spot business than we would like, but that’s the market that we sort of – this is the profession we’ve chosen. So that’s just the way the universe is today.

So service centers fight a lot with each other. When they sort out inventory we’ve seen a relatively small pickup in service center kind of phone calls looking for coil or plate here and there, but by and large the spot market is going to be soft until you see lead times of the domestic production industry step to extend out.

Unidentified Analyst

Thank you.

Michael D. Siegal

You’re welcome.

Operator

At this time, I show no further questions. Would you like to make any closing remarks?

Michael D. Siegal

Always. Thank you. In conclusion, let me just say that we’d like to note over the course of the last number of years Olympic Steel has basically demonstrated its resilience and its transparency not only by withstanding the recession of a slow recovery, but by emerging as a stronger and better positioned organization. We’ve improved our mix of business by diversifying into different products and new geographies. Our financial results are becoming less correlated with industry’s pricing environment. We see tremendous opportunity in front of us to grow the higher margin processing and services we offer and even gotten more market share with our specialty metals and pipe and tube businesses.

So we look forward to communicating continued progress when we report our third quarter results in the fall, and once again we thank you for participating on this morning’s conference call with us.

Richard T. Marabito

Thank you.

Operator

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

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