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Olympic Steel, Inc. (NASDAQ:ZEUS)

Q4 2009 Earnings Call

February 25, 2010 10:00 AM ET

Executives

Michael Siegal - Chairman and Chief Executive Officer

Richard Marabito - Chief Financial Officer

David Wolfort - President and Chief Operating Officer

Analysts

Michelle Applebaum – FMI

Charles Bradford – Affiliated Research Group

Richard Garchitorena – Credit Suisse

Sal Tharani - Goldman Sachs

Luke Folta - Longbow Research

Mark Parr - Keybanc Capital Markets

Nat Kellogg - Hudson Securities

Yvonne Verano - Jeffries

Tim Hayes - Davenport & Company

Bob Richard - South Ridge Investments

Operator

Please standby, we are about to begin. Good day and welcome to Olympic Steel Inc. fourth quarter 2009 earnings results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Michael Siegal. Please go ahead sir.

Michael Siegal

Thank you. Good morning and welcome to our call. On the call with me this morning is David Wolfort, our President and Chief Operating Officer and Richard Marabito, our Chief Financial Officer. I want to thank all of you for your participation and your interest in Olympic Steel.

And before we begin our discussion I want to remind you and all that during this call we will provide forward-looking statements that we do not undertake to update, or that may not reflect actual results. Changes in assumptions or changes in other factors affecting such forward-looking statements, important assumptions, risks, uncertainties and other factors that could cause actual results to differ materially from those set forth in the forward-looking statements can be found in our filings with the Securities and Exchange Commission, including our 2009 annual report on Form 10-K, which was filed today.

And earlier today we reported our financial results for the fourth quarter and full year of 2009. While 2009 was a very challenging year for the steel industry and Olympic Steel, it is also a year of balance sheet strengthening and positioning Olympic Steel for 2010. Let me review some of the details from our earnings release.

Our fourth quarter sales totaled $138.5 million, which was down 45.4% from the $253.6 million recorded in the fourth quarter of 2008. The sales decrease was due to significantly lower year-over-year customer demand and lower selling prices. Our fourth quarter ton sold totaled 194,000 tons, a 15.1% decline from the 229,000 shipped in the fourth quarter one year ago.

Fourth quarter shipments did however increase sequentially by 7% over the 181,000 tons we shipped in the third quarter of 2009. Our fourth quarter net loss totaled $2.6 million or $0.24 per diluted share compared to the net income of $776,000 or $0.07 per diluted share for the fourth quarter of 2008.

Our sales totaled $523.4 million for the full year of 2009, which is 57.4% lower than the $1.23 billion of sales recorded in 2008. Our 2009 shipping volume declined 38.1% to 721,000 tons compared to 1.17 million tons shipped in 2008.

Our net loss totaled $61.2 million in 2009 or $5.62 per diluted share compared to the next income of $67.7 million or $6.21 per diluted share for 2008. Our 2009 results included pretax inventory lower of cost for market adjustments of $81.1 million recorded in the first and second quarters. In 2009, we executed on our core disciplines of cash flow and balance sheet management and we entered 2010 with an exceptionally strong balance sheet. No debt and appropriately costed inventory, that is again turning at our preferred five times historical rates. We avoided material bad losses in 2009 and remained diligent in our credit and collect practices.

We began 2010 with a significantly lower cost base and experienced management team that provides Olympic Steel with a foundation for continued success in growth in the recovering market.

Our strong balance sheet puts us in our unique position to grow Olympic Steel, while market prices and valuations for assets and businesses remain depressed. While we expect to grow our market share by exploring new geographic locations in 2010 either by acquisition or Greenfield investments and increasing our product portfolios in both the stainless and aluminum products.

Our fourth quarter sales volume is better than the third quarter and steel demand and pricing are both on the rise since the year end. We expect these trends to continue and look for our first quarter 2010 sales and earnings to better and the year-over-year and over the fourth quarter. We optimistically enter 2010 from a position of strength in an improving marketplace.

Today we also reported that Olympic Steel’s Board of Directors has approved a regular quarterly cash dividend of $0.02 per share to be paid on March 15th, 2010 to shareholders of record on March 1st, 2010.

I will now turn the call over to Rick to comment further on the financial results. Rick?

Richard Marabito

Thanks and good morning everyone. And first off, we are filing our 10-K today that should be available after the close of business. So if you are looking for, you won’t find it till about 4:30. As Michael described, our attention to balance sheet management resulted in Olympic Steel having no debt outstanding at year end. Today we do have some borrowings outstanding as working capital requirements are ramping up due to volume of pricing increases. Offsetting those working capital borrowings however, we do expect to receive an income tax refund by midyear of about $35 million.

In the fourth quarter 2009, our operating expenses totaled $30.7 million, a $5.8 million or 15.8% decline compared to the fourth quarter of 2008. For the year expenses were reduced by $68.8 million or $36.7%. Expenses remain as aggressively as we quickly responded to the economic downturn with bold actions in late 2008 and early 2009. As a result, our cost reductions mirrored the declines that Michael talked about in our tons sold in 2009.

Taking a look at our capital spending, in 2009, they totaled about $11.9 million. That compares to depreciation expense of $11.7 million for the year. So we are about cash neutral on CapEx and depreciation. For 2010, we are projecting to spend in the range of $10 million to $14 million for CapEx, which includes our ongoing and successful IT implementation. In 2009, we capitalized $2.5 million and we expensed $2.2 million related to the system implementation.

An income tax benefit of $38.3 million or 38.5% of pretax was recorded in 2009, the majority of which can carried back to prior years, resulting in the estimated $35 million cash refund that I spoke of earlier. We expect a similar tax rate in 2010 to be in the range of 38% to 39%.

Some other financial metrics and highlights include a very strong performance in the accounts receivable and the credit area. Our 2009 bad debt write-offs totaled only 0.14% of sales and we maintained a very strong DSO in 2009 of 38 days. We aggressively managed our inventory turnover rate back to five times in the fourth quarter and today we are turning in excess of five times.

Our 2009 sales to the automotive industry totaled 11.6% of sales, that's higher if you recall than some of the prior quarters, and that was due to auto production and shipments increasing in the second half of the year. At year end we had approximately $73 million of formula availability under our bank line of credit. Our shareholders’ equity at year end totaled $23.85 per share and during the year, the full year of 2009, we paid dividends totaling $0.11 per share.

Now, I will turn the call over to David.

David Wolfort

Thank you, Rick and good morning. Looking back on 2009, needless to say, it was a very difficult year for all in the steel industry including Olympic Steel. However it was also a year where we made some significant achievements and positioned the company well for the future. It was a year to focus on what we could control and we are proud of our healthy balance sheet, which has helped Olympic Steel position itself advantageously during the recovery and well into the – and well into economic expansion.

During 2009 we acted quickly and boldly as Rick noted and made some noteworthy accomplishments. Let me highlight some of those. First, we right-sized our inventory in terms of cost and turnover. We are back to turning our inventory five plus times as both Mike and Rick indicated and have an appropriately costed inventory. To the put the inventory right-sizing in perspective during 2009, we reduced our inventory by a $144 million or 56%. From its peak in 2008, our inventory was reduced by $204 million or 65%.

Next from a credit and collection perspective, we were diligent in maintaining a consistent DSO of 38 days in the toughest credit and banking environment of our lifetimes. We also avoided big bad debt losses that were encouraged by depressed sales environment. We remain diligent with credit and have full time presence in the field analyzing customer viability and creditworthiness.

We remain vigilant in monitoring the state of liquidity of customers’ ability to fund the working capital growth required to participate in 2010 recovery as sales volume and steel pricing are on the rise.

Next we collaborated on our elimination of debt in cash position. We look forward to putting our money to work on growth initiatives beyond the $10 million to $14 million capital expenditures budgeted as discussed. We believe that there will be opportunities to acquire service centers and fabricators as the economic recovery takes shape. We expect smaller service centers to struggle to keep pace with expanding working capital requirements, customers’ credit constraints and limited bank availability. We believe this environment presents us with the opportunities for market share growth and favorably priced investments. We are also pleased with the progress implementing our new business operating systems throughout Olympic and we have now successfully implemented the program in five locations and are scheduled to go live in our Detroit location next.

As part of the project, we are adding applications for fabrications portions of our business. We expect to retire legacy systems and the cost associated with them in the latter part of 2010 and early ’11 as the system rollout continues.

In terms of 2009 capital deployment and operations, we completed a new lead certified building in Winder, Georgia. We closed our lease facility in Philadelphia and absorbed the business in our other plants. We relocated a satellite operation that we had housed in Baraga, Michigan, then we moved that to Moses Lake, Washington to accommodate a customer and improve our service capabilities. We successfully negotiated collective bargaining agreements in Detroit and Minneapolis and we added new equipment in Milford, Connecticut and in Bettendorf, Iowa locations.

Another important achievement in 2009 was a successful addition of aluminum to our product offerings. We brought experienced sales and management personnel into the company to grow our market participation in not only aluminum products but also in stainless steel. We are also introducing and exploring new value added propositions such as our Zeus Metal Works, which is now producing and marketing finished steel products.

Finally, we are being awarded new business and greater market share as customers turn to Olympic Steel for a strong financially stable and experienced supplier. This flight to quality by certain well-known OEM customers is resulting in a consolidation of their supply base to meet their service and cost reduction needs. Olympic Steel fits the criteria well and we are excited about the opportunities to grow our market share and fabrication capabilities with these OEMs as they begin their recovery during the products process.

In summary, 2009 was a year to strengthen our balance sheet, 2010 will be a year of focusing on our income statement and a return to profitable growth. We are positioned well and have built the company with strong foundation and an experienced management team. The economic recovery is now underway and we believe we are midway through the necessary progression of recovery. We expect all of our facilities to full participate in an economic expansion as the recovery continues. We are confident in our future and our ability to successfully perform for our shareholders, our customers and the employees of Olympic Steel.

This concludes our formal comment and we will now open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Michelle Applebaum at FMI.

Michelle Applebaum – FMI

Hi, good morning.

David Wolfort

Good morning.

Michelle Applebaum – FMI

Wanted to ask you a question, in terms of the margins in the quarter, since most of your cost of goods sold is material cost, I was just wondering, you seemed to have had a different trend than some of the other companies that have reported resulted. I know you can’t adjust your results to FIFO because you are already on FIFO, but I am just wondering why the contrast.

Richard Marabito

Michelle, this is Rick. I can’t really speak to the contrast to the some of the other companies. I can kind of tell you what our trend is. And you are right, we referred to FIFO but we are actually on an actual cost specific basis of inventory. But third to fourth quarter, our margins did receive a couple of things there, number one is, as you know, we had some pricing changes from market pricing changes in terms of some strength in the third quarter and then weakening in the fourth quarter until December. But more importantly, you know we took some lower cost market charges in 2009, those were taken at the very end of the first quarter and at the end of second quarter. During the third quarter and fourth quarter, we had those behind us.

So, part of the issue in terms of looking at a year and looking at a quarter, quarter-to-quarter and three month periods in a very volatile market like last year with accounting adjustments in terms of lower cost or market, you don’t get a real good and true flow.

So what I would tell you is this, it’s a combination of what happened with market pricing, in terms of strengthening in the third quarter, beginning in the third quarter and then dropping and then it had to do with the LCM charges at the end of the second quarter. And again, compared to some of our competitors, that’s hard to say, we have got – several of the public one are on LIFO.

Michelle Applebaum – FMI

Well, one of them is on FIFO and they reported significantly up margins in their steel process – in their flat rolled business, so that kind of surprised me. How does the lower cost to market charge at the end of the second quarter play out in terms of impacting margins in the fourth?

Richard Marabito

In the fourth it doesn’t, in the third it does. So at the end of the second quarter we took a charge to reduce the cost of our inventory to what was then deemed to be market, at the very end of the second quarter.

Michelle Applebaum – FMI

Okay, so it helped the third quarter, I am sorry about that. Okay, I knew that, didn’t make that connection. Okay, so the fourth quarter looks worse because the third quarter looked better.

Richard Marabito

Partly, yes, because of the lower cost to market charge at the end of the second quarter. And the fact, that as you know we are taking inventories down. So for every couple of tons of inventory we are selling, we weren’t replacing at the same rate as we continued to reduce inventory during the third quarter.

Michelle Applebaum – FMI

Michael, no one has been louder about the insanity of the volatility than I have the last nine months or so. Can you give us some insight in terms of how the trend went during the month, October through December in terms of margins and what you are looking like at the end of the quarter?

David Wolfort

Michelle, this is David. Let me field that for you. We had a – at the tail-end of the third quarter, the marketplace, as Rick started to elaborate on was strengthening as the marketplace has strengthened literally from middle of June up through September and we saw margins strengthen in September, the latter part of third quarter and then the early part of fourth quarter. As the marketplace moved toward the end of October and as it cascaded into November, we saw the marketplace weaken. There was an adjustment on pricing that then lasted quite frankly about three to four weeks, so the tail-end last week of October through Thanksgiving. And then as we exited the week somewhere around November 20th or thereabout, we saw a renewed strengthening in the marketplace and we started to see margins move up. Again in December however volume was challenged in the latter part of the month because of the holiday schedule.

That recovery has continued into the first part of 2010 as Michael indicated very early on.

Michelle Applebaum – FMI

Excuse me and let me to interrupt. You are giving me the pricing trend, and not the margin trend?

David Wolfort

No, I said it.

Michelle Applebaum – FMI

That was the margin trend also?

Michael Siegal

Yes, it’s the same, Michelle. I think that – in effect, as you saw some hesitation in the market pricing in October, November, people are waiting for that huge December buy that never came. And so, as people moved their inventories down in November in anticipation of this big December buy, which most know did not participate in, or very few for that matter, the traditional December buy was not there as mills started to move the price up, that would then reflect the marketplace improving its margins as there was this expectation of prices falling when in fact they were starting to move up.

So we are starting to see the impact of the mill announcements as early as December and moving obviously into January and we expect February as well.

Michelle Applebaum – FMI

Can you say whether or not you expect to be profitable in March quarter?

Michael Siegal

We always expect to be profitable and sometimes we are disappointed.

Michelle Applebaum – FMI

Okay, one more question. In terms of the outlook, do you think that these prices and the price increases and the further price increases we are seeing including, I don’t know if you saw the $200 to $300 of ton the Japanese are doing for second quarter. Do you think these price increases are sustainable and if so for how long?

Michael Siegal

Well, I think the current ones are going to be implemented, I don't know if we see the trend continuing along the same escalation but these are cost driven as well as China demand driven and at this moment, it appears that costs have moved up and there is lots of volatility in the world, which leads to uncertainty, which leads to more potential price increases. So I would tell that we will see the acceleration of price increases slow down but we are anticipating the mills are pretty resolute on getting as much money for the product and recovering as much cost as they can.

Operator

We will move next to Charles Bradford with Affiliated Research Group.

Charles Bradford – Affiliated Research Group

Will you guys have a pretty good view of certainly the coil market, flat rolled, coil and the plate? And over the last few years it seemed to have been a divergence from the historical norms with these products were pretty similar. It seemed to be backed more in line. Is this now the new norm or is this some reason why plate prices [cut to landslide] anyway would be a lot higher than coil prices?

David Wolfort

Well, Chuck, this is David. I think you are referring to some of the ebb and flow of the marketplace. What we generally see is a much more fluid flat rolled marketplace and a plate marketplace that has a tendency to plateau, rather going up or going down. In today’s environment, with scrap prices continuing to escalate and for those electric furnace mills that utilize scrap almost exclusively, it’s really a competition of how much revenue they are going to get for the product, whether it’s plate or flat rolled and they both have to measure equally for a lack of a better.

And so, we see plate having moved up and we see plate lead times having moved out. We see that – a number different catalysts but one certainly is the fact that inventories were down dramatically especially relative to OEM manufacturing which was really depressed last year. And is moving up – is OEM demand is increasing much stronger than we would have expected. Now remember, it’s coming off of a very low number. So that strength relative to where it was two years ago is certainly depressed but relative to where it was last year shows a pretty strong uptick and a really strong demand for plate products.

And that has lead to the competition for the raw materials in our expectations versus flat rolled. So we see them both moving up in concert.

Charles Bradford – Affiliated Research Group

Is there a significant difference in what you are seeing between the flat rolled and the plate as far as the suppliers delivering on time. We have heard a lot of stories about some of the large producers just not doing terribly well with on-time deliveries. Are you seeing much of a difference?

Michael Siegal

I think when you look at what it takes to an integrated mill versus a mini mill, obviously the integrated mill position is a much more difficult one to anticipate an on-time production schedule as well as the fact that it wasn’t just the end users and service centers are lowering their inventories, a lot of the integrated mills lowered their raw material inventories on the ground, which them put them in a material short position as market demand started to pick up, which then extends their lead times. And so, I would just tell you that I think mini mills, they need to react quicker or they can get scrapped faster and the integrated is just a more difficult process, Chuck. I don’t think it’s anything more than that.

Charles Bradford – Affiliated Research Group

And we have heard a lot of stories about the integrateds losing pretty large numbers of people because of the way they shut down whereas the mini mills shut down a little here and there, not the whole facilities and thus able to ramp up a lot quicker.

Michael Siegal

Lower inventory, less being significant people taking retirement who have experience. And when you bring an integrated mill back up, things don’t come on very easily. This is sophisticated integrated equipment that all computers have got to work, all temperatures have got to work, it’s much more difficult for the integrateds. And we have empathy for them, I can tell you that.

Charles Bradford – Affiliated Research Group

Have conditions gotten better? Because one of the arguments that people have been making about all the restarts is that a lot of it was to enable the blast furnace guys to catch up.

David Wolfort

The answer to that, Chuck, is yes, they are getting better. There is a lot of capacity that was offline, obviously specific to individual producers. There has been stronger demand, we noted that very early on. Mike did in his opening comments. The mills, there are some delinquencies as you referred to. However, they are improving. There is more capacity that's come online. That capacity is improving, deliveries are improving. And we would say that the trend line is very positive.

Charles Bradford – Affiliated Research Group

And then one last question. Have you guys been offered any deals by (Tyson Crump) as they bring their new facility up, I guess late second quarter?

David Wolfort

There is nobody here is going to answer that, Chuck.

Michael Siegal

We welcome any opportunity they want to present to us.

Charles Bradford – Affiliated Research Group

Try anyway.

Operator

We will go next to Richard Garchitorena with Credit Suisse.

Richard Garchitorena – Credit Suisse

You mentioned the inventory turns are now over five times. Can you break out among the different product groups how that is working out?

Richard Marabito

Richard, this is Rick, we don’t break out our turns or our inventory by product. But what I can tell you, in total we talked about last quarter that, our flat rolled products were turning faster than our plates, we are longest in plate and that was solely due to the drop in volume was largest with some of our large plate users. So I tell you as we move into this year, we are in pretty good shape across the board in terms of all of our products. And as you look at a group by group, plate is probably still a little bit longer than flat rolled, but we are obviously gaining on it and I tell you in pretty good shape across the board in terms of turns.

Richard Garchitorena – Credit Suisse

And on the quarter, I mean Q4, was the drops in margins potentially partly related to product mix at all? I know you are not going to say specifically but was that a factor at all or –

Richard Marabito

I don’t think we had a significant difference in product mix fourth quarter to third quarter. I really think the biggest – the bigger impact is is what I talked about where we had an adjustment at the end of the quarter due to lower cost to market and then just how the market played out in the third quarter, beginning of fourth quarter.

Richard Garchitorena – Credit Suisse

And then just generally on demand, can you just sort of give us an update on what you are seeing so far in Q1, January, February among the end markets as well as the different products as well?

David Wolfort

Well, Richard, this is David. We probably can’t answer it specifically because we don’t like to do that. But in general terms, we are seeing sequential improvement and we are very pleased with the participatory level of shipments that we are experiencing. As Rick suggested in his comments, fourth quarter was stronger than the third quarter in terms of shipments, we expect first quarter to be stronger than fourth quarter and are fully convinced that we are midway through a recovery and probably have the balance of this year, maybe a little short sight of that before we go into the infancy of expanding economy either at the tail end of this year or next year.

So we don’t expect it to be linear but it is improving. Again, we like the trend line.

Operator

We will go next to Sal Tharani with Goldman Sachs.

Sal Tharani - Goldman Sachs

What are you seeing on the import offer [current] any activity over there?

David Wolfort

Yes, Sal, it’s David again. We were seeing offerings at the tail-end of last year and we continue to see additional offerings as the dollar strengthens obviously and as the economy strengthens. So we are seeing both. It’s not a huge surge but there are certainly more offerings and they are from an array of suppliers, some of the usual suspects that we see, but there is a renewed offering, not huge but they are there.

Sal Tharani - Goldman Sachs

Are the prices very attractive compared to what we are seeing in 650 (inaudible) in U.S. now?

David Wolfort

Well, I don’t think that anybody would take advantage of an offering if they weren’t attractive, Sal. So I think it’s an issue of timing and your conviction to how well you think – where you think the market is going, where you thought the market was going in early first quarter. So if you believe that the market was going to move up, you may have bought a little bit earlier and that offering may be appropriate by the time it arrives. So I think it’s a little bit of a timing issue.

Sal Tharani - Goldman Sachs

And also clearly we are seeing an uptick in utilization rate, the shipment numbers out of service centers have been moving up and you guys had a positive commentary that sequentially things are getting better. I was just wondering if at the prices where we are reaching right now and it looks like the weather is getting worse. So probably another scrap increase perhaps followed by another steel price increase, who is incremental buyer here? Are the buyers throughout this year have been the ones who really needed it or there was some modest restocking also at the end user who (inaudible) about maybe or buying a little bit extra, you think they will continue to do that? What’s your view on that?

Richard Marabito

My view on that, Sal, is that there is a very, very modest restocking. I don’t really think there is a lot of restocking going on. I think it’s modest at best. I think that there is some real demand out there. Like many of our customers extinguished as Michael said earlier, not only their raw materials but their finished goods. And so as any demand has come back, it has put some pressure on the supply side. So, we are actually seeing manufacturing increase, finished product being sold by our customers.

Operator

And next we will move to Luke Folta with Longbow Research.

Luke Folta - Longbow Research

First question was just on acquisitions. Can you just comment on what you are seeing? Are you seeing an increase in opportunities of buyers willing to sell – sellers willing to sell? And also, can you maybe comment on the – maybe the scale of some of the opportunities you might be looking at?

Michael Siegal

Scale is – scale is pretty much all sizes. I think that you would say that there’s people that are willing to have pretty [subset] of discussions. Then it’s just a question of what valuation do you want – it’s really the valuations game more than anything else, Luke. I think everybody is willing to listen everybody has a full understanding that there is a multiple to be paid and then it’s a question of arguing whether what’s normalized and should we be looking forward and anticipating forward. So I would tell you that the discussions are active. It’s pretty much all sizes and it’s just like anything else. It’s just a matter of price and in terms of who believes, what multiple will offer what number. But I would tell you that it’s fairly active out there.

Luke Folta - Longbow Research

So in the current environment, what do you guys think of as a reasonable multiple to use on normalized earnings?

Michael Siegal

Well, you look at the historical numbers of deals have got done. It’s anywhere from on the high side, it’s eight; on the low side, it’s somewhere around three. Okay, if you say what’s somebody going to sell forward, somebody going to buy forward, somewhere probably between four and six, four and seven, but the reality is four to seven times what. I mean the multiple is not that -- it’s important to you to determine what the E is. And so, if you [get on] the E, then you can come up with the rest of it fairly easily.

Luke Folta - Longbow Research

And just finally, you had mentioned that you are looking to add some more aluminum and stainless to your mix. What do you think of as a longer term target, is sort of how much sales or shipments you look for in the non-ferrous side?

David Wolfort

Well, Luke, this is David. We won’t give you the exact number because we have a very aggressive outlook in specialty metals. We have been stainless since 1987. We have hired over the last year plus some very talented people in the industry, some that we have looked to hire for a very long period of time and they are now on board at Olympic Steel and they bring a fresh perspective, I think an elongated view of what were nominal expectations earlier.

They have also brought an experience that has allowed us to bring aluminum on as we have commented, brought that on midyear last year. That continues to grow and there are various other aspects of the specialty metals business that we want to bring on board.

The summary is that we see it overtime as a very significant part of our business. All the other silos of business will continue to expand, that business will continue to expand also and we view it again, would be redundant, as a significant player over the next half a dozen years.

Operator

Next we will go to Mark Parr with Keybanc Capital Markets.

Mark Parr - Keybanc Capital Markets

Couple of comments and just trying to get a little more color around the current business conditions. There was a fairly wide spread between gross profit margins in the third quarter and the fourth quarter. And I am wondering as we look into profitability coming into 2010, which – you think the third quarter or the fourth quarter is more representative of normalized profitability as you enter the year?

David Wolfort

Perhaps either. I mean the third quarter had the LCM impact of the second quarter, certainly the fourth quarter I think were reduced relative to our normalized market, I do think I don’t know that either one of them is normalized, Mark. Rick?

Richard Marabito

Yes, I was going to say, you know we talked about, Mark, before these big swings in ’08 and ’09. We had talked about getting to a normalized margin which we had hit, a couple of years back of about $165 a ton due to the elongation of value add and moving further downstream. So what I would tell is we have made some good progress the last two years in terms of, while some of it is hidden based on what happened in the marketplace in ’09, but we made some good progress (inaudible) to grow that piece of the business.

David talked about our entry into aluminum and the expansion of the specialty metals business. So our view is it is a normalized margin when you are looking at per ton is north of $165 a ton. So third quarter was right around that number but it was – as we said it was the impact of the LCM the prior quarter. Fourth quarter was – and so, as the market recovers and we get into whatever you want to call a normal market, we would expect our gross margin per ton to be north of the $165.

Mark Parr - Keybanc Capital Markets

Okay. I was thinking about it from a percentage standpoint but I understand where you are coming from. It just seems, David, you had mentioned this – I use your words progression of recovery and you said that you are halfway along the process in the – given what’s happened to steel prices in more recently plate prices in the last several months and given the – Michael as you mentioned, just the normal sorts of startup issues that integrated mills are going to go through and the fact that EAF flat rolled guys are pretty close to full capacity, so there is not a lot of incremental volume that they have to give.

Now you would think that there could – this pricing – it certainly adds credibility to this pricing upside that we are seeing. And given the lack of alternative, maybe the import situation is another nuance that we need to be considering because it hasn’t really been there all that aggressively over the last year or so. But is this the kind of environment here in the first half of 2010 where margins for the service center sector could expand to above normalized levels given the [possibility] of supply and the pickup in demand?

Richard Marabito

(Inaudible) possibility. I think as we move towards the tail-end of the quarter, the answer – and as the mills continue to announce price increases and the answer is certainly. With the low level of inventories, the spot market will have a tendency to be very robust if the demand continues to occur. So we are not seeing a tremendous amount of inventories. When you look at the spot market, Mark, a lot of spot market is service center selling other service centers. And if a service center is short of inventory and has to go to the other service center, you are going to get a lot bigger margin from that service center needing the steel.

So given the level of inventory, given the level of what we think the demand is improving by, there is a relative good opportunity for margin expansion for service centers who sell other service centers.

Mark Parr - Keybanc Capital Markets

And then, David, just to get back on your comments regarding the import availability, you are saying you are seeing a little more, could you talk – order of magnitude, you mean how big of an impact is the import market having say, relative – say in the February, March timeframe as opposed to December, January. And how much more of an impact are they having on the supply side?

David Wolfort

I think very little, Mark for that time period. I think that you will see them – I think you will start to see some foreign product arriving in April and May. I think there was – there is very little product that has come in in February, if any at all at least maybe down in the Houston area, which we really participate in a very nominal way. But we would expect to see more, again, as we get into the second quarter. And of course, those offers were made in the latter part of December and at latest were consummated in the first week of January or thereabout.

And then, as the market continues to strengthen and in your own words, Mark, as we see some capacity – the capacity utilization not being overwhelmed but not being excessive, then people are going to have to find alternatives to supply. So, if the EAF guys are full, as you just described, then we are going to have to find some alternatives.

But again, it’s a progression. So we see some renewed strength in foreign shipments. It’s not overwhelming but there is a presence and we will see more of that presence I think as we get deeper into the years and specifically into mid to latter part of second quarter.

Operator

We will go next to Nat Kellogg at Hudson Securities.

Nat Kellogg - Hudson Securities

Just a couple of quick ones. Rick, did you start – if I go back to ’06 and ’07, especially like the latter half of ’07, I think you guys are running at $165 gross profit per ton. I feel like it and correct me if I am wrong, I thought that sort of you guys at that point sort of talked about getting to close to $200 in gross profit ton overtime with adding (inaudible) processing and what not.

So, is that correct or I have my notes wrong?

David Wolfort

No, you got it, you are right on.

Nat Kellogg - Hudson Securities

Okay. And so, I just – obviously on ’08 and ’09, [if you forget about] trying to figure out what the underlying improvement was because you had – of what was going on in the market. But I just – I am wondering if you could sort of talk about maybe where you guys are in that process and how close you think you have gotten to sort of getting there in a more normalized market sort of ex obviously the price changes.

Richard Marabito

Well, as I spoke earlier, we are marching our way towards that. I think some of the investments we have made over the last two years are certainly items that are going to move the margin north. I think the outlook for some of the things we are looking to do and our capital expenditures over the last couple of years and moving forward, we will continue to do that.

So we are very confident that the things we are doing, the items we are investing in, the customers we are growing with will march us right to that $200 a ton.

It’s very difficult in (inaudible) last couple of years as you said to really say what is your – what is the normalized gross margin, I don’t know such a thing actually exists. But we are confident that we are on track with what we laid out as our strategy and our goals to move the margins north.

Nat Kellogg - Hudson Securities

Just on the move to stainless, you guys talked about a couple of different things. Is this more because you guys see an opportunity in the market that’s interesting to you because there is some growth there or is this more because of what’s going on over the last 12 months. There is some people who become available that makes this business more attractive to you guys.

David Wolfort

I think all of the above, Nat, we like the market, we like flat rolleds, this is David and dimension another product group that we can add to the flat rolled to our flat rolled penetration, use all of those products. And so, as we entered the stainless business a couple of decades ago and we have had some very nice growth overtime and we are – we have now committed ourselves or we are committed over a year ago to even strengthening that.

Those same consumers, a lot of the consumers who use some of our cold rolled products also were buyers of aluminum and with the expertise that we have brought on board, it just gives us another dimension to supply the customer and be more supportive of their manufacturing process.

Nat Kellogg - Hudson Securities

And just last one. You guys gave a little bit of color about sort of auto as a percentage of sales and I know you guys don’t break it all. But if you just give maybe a little more color in any other sort of key end markets that were particularly good for you guys in the quarter and maybe where you see them going forward, that would be great and I will hop back in the queue.

David Wolfort

The last construction marketplace started to recuperate in the back half – in the tail end of fourth quarter. So our large OEMs who were really nearly closed, if not closed a great deal of 2009 have come back significantly relative to being down very heavily, heavy proportion. So we see that and we see our ag businesses coming up and then we see a lot of the fabricated support that goes to supply both the OEM and the ag business has strengthened.

So we referenced I think a 11% plus on the automotive side of the equation, that strengthened. Again, some of this is – as I noted early on is that we are getting lot of OEMs who are now what we call flight to quality because of the strength of our balance sheet and their need to assess their supply side as to how sustainable it is in the future. And a lot of these OEMs had some very poor experiences, [so the nine] with undercapitalized suppliers. So we have seen that flight to us and we have been the benefactor of receiving that business. So we have seen a strengthening across all of those businesses.

Operator

Next we go to Yvonne Verano at Jeffries.

Yvonne Verano - Jeffries

I know you gave the numbers in regard to the inventory reduction on a dollar basis. Can you talk about a little on the tonnage and it looks like you have started to build inventory up a little bit. What are your plans going forward for your inventory management here?

Richard Marabito

You are right, Yvonne. The tons are moving commensurately with the dollars here, we are taking it up a bit. But the important thing is we got our inventory back to that five turn level early in the fourth quarter. We have maintained that. Our inventory is actually turning a little bit better than five turns right now. And the issue is is what David talked about, we are starting to see a lot of customers who are really dormant for several quarters start to come back to life.

So we gave you some color in terms of first quarter versus fourth quarter in terms of sales volume that our expectation is first quarter volume is going to be higher. What that will need to commensurately take up the inventory? We gave some color on that as well. I mean part of the reason we have got a small amount borrowed right now is just because prices are moving up and the volumes are moving up.

So that’s – we look to stay though within our disciplines of five turns.

Yvonne Verano – Jeffries

Can you comment to maybe on the industry inventories because we all know that they are very low here but I would think that most don’t expect them to return to prior levels?

David Wolfort

I would tell you that the credit market will probably keep the inventory on. I think that we are – there is a tendency to underestimate from an inventory perspective and from an overall service center perspective of who is going to have availability to excess credit relative to how do you build before profitability comes. Guys are already underwater on the loan agreements, it’s going to be very difficult, Yvonne. And I think that’s going to be a governor on the inventory rebuild, the lack of credit.

Yvonne Verano – Jeffries

Do you think that carries over to your customer base because your customer base is a large OEMs that they are not going to (inaudible)?

Richard Marabito

I think it – we have got lots of customers. So we have got several thousand customers. (Inaudible) and access to capital structure for the most part are in good shape. I think it’s the smaller customers and yes, I do think that that is going to be a continued area of focus for the broad economy and for service centers and Olympic Steel in remaining diligent in that because I think they are going to have a tough time getting access to steel because of the credit initiatives – their credit issues.

Yvonne Verano – Jeffries

And just separately, I know you are building in stainless and aluminum a little bit, what market specifically are you targeting?

David Wolfort

Well, we do a lot of business in food service center of the equation and we do some in lighting, some in smaller appliances, that [Medicare] and some agricultural applications.

Michael Siegal

And then as David said, a lot of it also was just going to our existing customer base, they are just – they are heavy carbon users but they do use stainless and aluminum. A chunk of those sales is just going to existing customers as well in the industry that we have today.

Operator

And next we will go to Tim Hayes with Davenport & Company.

Tim Hayes - Davenport & Company

Just a couple of questions. Again, back to the long-term target for gross profit per ton of about $200 per ton, what kind of volume level might you need to get to that? Would we have to get back north of the 1.2 million tons we saw few years ago or could you get to that target if we only had tons at say 900,000?

Richard Marabito

No, Tim, this is Rick. I think the absolute tons are really not the issue. The issue is the mix within those absolute tons. So as you know in 2009, we talked about some of our highest value of more than what the market was of and we talked a lot about that in the first and second quarter. So I think even at current shipping level, we can certainly migrate towards our gross margin goals as long as the mix is moving in the way we want the mix to move. And the way we want the mix to move is to continue to [ratch] it up and do more things with the steel for our existing customers and for new customers.

So the answer to your question is we can absolutely get there on less tons than we had before.

Tim Hayes - Davenport & Company

And then of your total steel purchases, what’s the mix that you buy from mini mills versus integrateds? And well, I will listen for the answer first on that.

David Wolfort

We don’t break that out, but I can tell you, Tim, that we participate with all the players. Regardless of the fact that our tons shipped were depressed in 2009, the real numbers are very significant numbers of tonnage of flat rolled shipped. And therefore we need to participate with all the players. And integrated mills are an integral part of our participation as our EAF mills, mini mills and a lot of that is dictated by logistics. And so the cost of logistics also indicates how much participation we are going to have with each player as strength of our participation in the market is our regionality and how close we are to customers.

And so we are really participating with all flat rolled and plate producers with the exception of West Coast players.

Tim Hayes - Davenport & Company

Okay, and then of that – of the mix between the two, how much does that change and can that change quickly, say more stable mix that only changes gradually over years?

Richard Marabito

It’s a stable mix, Tim. Consistency is a big part of our game. So whether it’s consistency of being supply or consistency of our supply to customers, our customers have come to rely on a supply chain. Again, that is predictive and part of that is the consistency of who the supplier is.

Operator

And we move next to Bob Richard with South Ridge Investments.

Bob Richard - South Ridge Investments

I will just pose with taking in into consideration your shelf registration, would you consider a rather significant investment in specialty and your specialty business as likely as in your carbon business?

Michael Siegal

Well, I think, Bob, we look at all opportunities in terms of growing our business obviously, as you look at our mix, we are highly tilted towards carbon. So that would be most of the things we are looking at, but certainly we want to grow our specialty metals. We have put some investments and people and we are growing that right now.

We look at both stainless and carbon but based on our mix, carbon is going to predominantly be most of the stuff that we are seeing and looking at.

Operator

And at this time we have no further questions. I will turn the conference back over to management for any closing remarks.

Michael Siegal

Thank you. As a reminder, it is our policy not to [update] for the upcoming quarter or year and not to endorse any analyst sales or earnings estimates. We anticipate releasing our first quarter 2010 earnings on or around April 29th of 2010. This concludes our call and thank you again for your interest in Olympic Steel.

Operator

And that does conclude today’s conference. Again, thank you for your participation.

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Source: Olympic Steel Q4 2009 Earnings Call Transcript
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