Olympic Steel, Inc. Q1 2010 Earnings Call Transcript

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 |  About: Olympic Steel, Inc. (ZEUS)
by: SA Transcripts

Olympic Steel, Inc. (NASDAQ:ZEUS)

Q1 2010 Earnings Call Transcript

April 29, 2010 10:00 am ET

Executives

Michael Siegal – Chairman and CEO

Richard Marabito – CFO

David Wolfort – President and COO

Analysts

Richard Garchitorena – Credit Suisse

Sal Tharani – Goldman Sachs

Jason Doches [ph] – KeyBanc Capital Markets

Nat Kellogg – Hudson Securities

Operator

Good day, ladies and gentlemen. Welcome to Olympic Steel's first quarter 2010 results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions on how to participate will be given at that time. (Operator Instructions). As a reminder, today's call is being recorded.

At this time, I would now like to turn the conference over to your host, Chairman and CEO, Mr. Michael Siegal. Sir, you may begin.

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 Rick Marabito, our Chief Financial Officer. I want to thank all of you for your participation and for your interest in Olympic Steel.

And before we begin our discussion, I want to remind everyone that during this call, we will provide forward-looking statements that we do not undertake to update, or that may not reflect actual results. Changes in assumptions or changes in other factors affecting such forward-looking statements, important assumptions, risks, uncertainties and other factors that could cause actual results to differ materially from those set forth in the forward-looking statements can be found in our filings with the Securities and Exchange Commission, including our 2009 Annual Report on Form 10-K, and our 2010 first quarter 10-Q, which will be filed later today.

Earlier today, we reported our financial results for the first quarter of 2010. We are pleased with the return to profitability and our sequential improvements from the fourth quarter of 2009.

First quarter 2010 net income totaled $1.7 million, or $0.16 per diluted share, compared to a net loss of $25.5 million, or $2.34 per diluted share for last year's first quarter. The 2009 results included a $30.6 million lower of costs or market pre-tax charge to write down the value of the inventory as of March 31, 2009.

Net sales for the first quarter of 2010 totaled $167.9 million or a 19.2% increase from the $140.9 million from the first quarter of 2009. Our shipments in the first quarter of 2010 increased by 50,000 tons or 29.2% to 221,000 from 171,000 in the first quarter of 2009, outpacing the market increase in total steel shipments of 11.2% as reported in the Metals Service Center Institute's Market Activity Report. Our shipments also improved sequentially over the fourth quarter of 2009 by 27,000 tons or 14%.

We are benefiting from large OEM customers awarding business to financially strong, quality suppliers like Olympic Steel, as well as improved overall customer demand as economy recovers. The recent investments that we had made in our specialty metals businesses are also producing growth in our stainless steel and aluminum sales and earnings. Our quarterly sales volume has now been sequentially stronger for two consecutive quarters, as our shipments and average sell prices as well as those in the broader steel market rose in each successive month of the first quarter, while total steel service and inventories in the supply chain remain at historical lows. We expect these month-over-month trends to continue and look for our second quarter 2010 sales and earnings to benefit from these accelerating factors.

Our balance sheet remains exceptionally strong, as our inventory turnover exceeded five times in the first quarter. In April, we also received a $38 million 2009 Federal income tax refund. We used the tax refund proceeds to eliminate all borrowings outstanding as of March 31, providing us with liquidity to advance our business as the economy continues to recover and steel pricing continues to accelerate.

We remain optimistic about Olympics Steel's strong operational and financial position in the improving and recovering steel markets. We expect to continue to grow our market share by exploring new geographic locations in 2010, either by acquisition or Greenfield Investments, and increasing our stainless steel and aluminum specialty businesses.

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

I will now turn the call over to Rick to comment on our financial results in more detail.

Rick Marabito

Thanks; and good morning, everyone. Let me cover some of our financial results in more detail. As a result of our aggressive expense reduction actions taken in early 2009, we are now profitable at much lower shipping levels. In the first quarter of 2010, our operating expenses totaled $32 million compared to $30.7 million in the fourth quarter of 2009, and $31.9 million in the first quarter of 2009.

On a per ton basis, first quarter 2010 expenses were down to $145 per ton, compared to $186 a ton in the first quarter of 2009, and $158 a ton in the fourth quarter. Expenses continue to be managed aggressively, and a small increase in the first quarter real dollar expense relates to variable cost increases associated with improving shipments and our return to profitability in 2010. We also incurred a small increase in depreciation expense that is primarily associated with the capitalization of our information system implementations.

Effective April of 2010, we did restore the wages that were cut in 2009 for all employees except the senior management team. The senior management team's 2009 wage reductions remain intact today. The impact of the wage restoration is about $250,000 per quarter, commencing with the second quarter of 2010.

Capital spending in the first quarter totaled $2.3 million. That is compared to depreciation expense of $3.2 million. 2010 CapEx includes our ongoing and successful IT system implementations. In the first quarter of 2010, we capitalized $620,000 and we expensed $324,000 related to the system implementations. We still expect capital spending for 2010 to be between $10 million and $14 million before considering any potential acquisition or retail growth investments.

Our first quarter effective tax rate was 39.4%. That was slightly higher than what we had talked about in terms of our expected annual rate, which we still anticipate to be in the range of 38% to 39%. Some other financial metrics and highlights, as Michael indicated earlier, again, we have no debt outstanding. We did use that $38 million 2009 Federal income tax refund received here in late April to pay off all the borrowings outstanding on our revolver at March 31. We now have about $100 million of combined formula availability under our line of credit, combined with cash on hand. We continue to aggressively manage our working capital, which increased by $20.6 million in the first quarter, due to increased inventory and accounts receivable associated with higher steel prices and increased shipment volumes.

Inventory is churning more than five times right now, and we incurred minimal bad debt write-offs in the first quarter. Our accounts receivable DSO disp totaled 43 days in the first quarter. That was up from 38 days for the year in 2009. The increase is due to some slowness in pay by customers, but the bigger reason is the mathematical impact that increasing monthly sales have on our DSO calculation.

Our first quarter sales to the automotive industry totaled 12.6% of sales. Auto has continued to be one of our strongest industry sectors, with increasing shipments since the second half of 2009. At March 31, our shareholders' equity per share totaled $24.01, and as Michael said and we talked about on last quarter's call, we actually paid a dividend in the first quarter of $0.02 a share. That totaled $218,000.

I will now turn the call over to David.

David Wolfort

Thank you, Rick; and good morning to everyone. As Mike stated, we are pleased to be increasing our shipments and earning of profit in this year 2010. We are now profitable at shipping levels that are much improved over 2009, but are still at only approximately 75% of the pre-recessionary levels. We are looking forward to growing our market share through geographic expansion, by using our strong liquidity position and healthy balance sheet.

Before highlighting some of our growth opportunities we are considering, I thought I would add some color to Michael's comments about the continuing trend of rising monthly prices in 2010 and how they have impacted our results. Our average selling prices in the first quarter of 2010 totaled $758 per ton, and we are actually lower than the average pricing in the first quarter of 2009, of which that total was $822. We were, of course, in a sharply declining price environment in 2009, and saw prices drop well in excess of $100 per ton during the first quarter of last year, 2009.

In 2010, we are now in an increasing price environment. The first quarter of 2010 average selling prices increased by 6.3% or $45 a ton over the average selling prices in the fourth quarter of 2009. However, when looking at pricing trends within the two quarters, our total average selling prices have increased by about $100 a ton from a low point of $677 a ton in the middle of the fourth quarter to $777 by the end of the first quarter of 2010.

Like pricing, our gross margins also followed a similar trend. After margins decreased in each month of the fourth quarter, they have now rebounded and increased in each month of the first quarter of 2010. First quarter 2010 gross margins totaled $160 per ton or 21.1% of sales, compared to $138 per ton or 19.3% of sales in the fourth quarter of 2009. This trend, combined with shipping volumes also increasing in each month of 2010 is why Michael stated that we expect to benefit from favorable first quarter trends continuing into the second quarter.

Our inventory is also positioned well, and is appropriately costed. We are currently churning our inventory more than five times, as Rick commented. The March MSCI Market Activity Report indicated that service center inventories have remained relatively stable in an increasing shipment environment, resulting in historically low levels of inventory supply on hand of two months. This low level of inventory, combined with recovering demand and increased input costs for raw materials, such as iron ore, should support the increasing price levels expected in the second quarter.

We collaborated on our elimination of borrowings outstanding in our current cash position. We look forward to putting our money to work on growth initiatives beyond the $10 million to $14 million capital expenditure budget that is planned for this year. In addition to the systems implementation, our first quarter capital spending included new re-sheeting equipment in Minneapolis and fabrication equipment in Iowa to enhance our growing value added business in those plans.

We are also revising several opportunities to acquire small service centers as the year progresses. During the first quarter, we added Integrity Stainless to Olympic Steel's family. Integrity Stainless is a profitable niche stainless steel sales organization in Cleveland, Ohio that was immediately accretive to our results, and helped propel our specialty metals group. We also have been working on plans for several Greenfield initiatives that we would hope to announce later this year.

As Michael indicated, we are being awarded new business, and gaining market share as customers turn to Olympic Steel for a strong, financially stable, and experienced supplier. This flight to quality by certain well known OEMs, combined with the recovery in customer demand, is resulting in our strong shipping growth.

We are capable and ready from both a financial and operating perspective to grow our business. The recovery and demand is underway, and we expect Olympic Steel to fully participate in the benefits of an improving economy. We are confident in our future, and our ability to successfully perform for our shareholders, for our customers, and the employees of Olympic Steel.

This concludes our formal comments. And we will now open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Richard Garchitorena at Credit Suisse.

Richard Garchitorena – Credit Suisse

Good morning, everybody.

Michael Siegal

Good morning.

Richard Garchitorena – Credit Suisse

Just a couple of questions. I guess, number one, you know, you mentioned that your stainless and aluminum business has picked up and the acquisition in Q4. Can you sort of give us a guideline as to how much that makes up of total shipments now?

Michael Siegal

Total stainless shipments?

Richard Garchitorena – Credit Suisse

Yes, and aluminum as well I guess.

Michael Siegal

The combined specialty metals, from a tonnage perspective, is probably 1% of the overall sales, and probably a little bit more than that in terms of the revenue itself.

David Wolfort

Yes, it is about 7% of the revenue.

Michael Siegal

And Richard, just for clarification, that purchase was in the first quarter of 2010.

Richard Garchitorena – Credit Suisse

Great, okay. So we will see that going forward this year?

David Wolfort

Right.

Richard Garchitorena – Credit Suisse

Great. And I also noticed on the inventories that they actually went up again this quarter. Is that just a function of pricing or are we seeing any sort of planning ahead for a pick-up in demand?

David Wolfort

Well, it is both. Obviously, with the 29% increase in volume and our comments about the second quarter volume, we have more tons in inventory. However, we are turning our inventory consistently at five times. So yes, the volume went up, but the turnover has remained consistent, and then yes, the second part of the equation, its pricing is obviously up.

Richard Garchitorena – Credit Suisse

Great, okay. And then, my final question I guess, you know, looking forward, the opportunities to expand. I know you have a bunch of opportunities potentially on the acquisition side as well as Greenfield. The acquisitions, are you seeing more competition recently from the other major service centers, given that everyone is sort of looking at growing through that avenue or–?

Michael Siegal

Well, there is two elements of acquisitions, right? There is the auction process, where, you know, somebody is trying to maximize the opportunity of the one-time sale, and that can either go to synergistic buyers or private equities, you know, you have seen that in the past. Or there is the ones where, you know, on a very quiet basis, somebody says, you know, you are the right partner in terms of the approach to the markets and how you service the community and employees. So there is quiet deals that don't always get to the public and there is obviously the public ones. We don't participate or haven't been successful in the auctions for a number of years, so that would not necessarily be the route that we would look at, but we are talking to a number of people on a quiet basis, and we really have a pretty proactive Greenfield opportunity program in front of us.

Richard Garchitorena – Credit Suisse

Great. Thanks for the color.

Operator

Our next question on the phone comes from Sal Tharani with Goldman Sachs.

Sal Tharani – Goldman Sachs

Hey, guys.

Michael Siegal

Hey, Sal.

Sal Tharani – Goldman Sachs

Mike, you mentioned something about OEM orders.

Michael Siegal

Yes.

Sal Tharani – Goldman Sachs

Which sector are you? Is it auto or – besides auto you are also getting some penetration into?

Michael Siegal

Obviously, again, we have been a good performer in the automotive market, and as we have indicated in the past, it is not where we chose to put a great deal of effort, but we have gone from, you know, under 9% to almost 13% of our penetration. So we are seeing some good results in the automotive sector, Sal. You know, the other two sectors that really have ticked up in a dynamic fashion are those that are more engaged in the mining and the agricultural marketplaces. And then just sort of the rest of the activity is coming along on a better basis, and then, the thing that really lags for us in this market, which is kind of surprising is still, you know, we have had a pretty excellent penetration into the service center market. That is still, for whatever particular reason, hasn't recovered. Service center to service center market hasn't recovered as much for us, while some of the other sectors that are consumer related, you know, anything that somehow touches residential and non-residential construction, while they are improving now, are lagging overall compared to some of the other markets we are seeing.

Sal Tharani – Goldman Sachs

Okay. And on the demand side, Mike, there has been a lot of talk about the pent and final demand and so forth. And we know that it is the inventories of the service centers that are driving. But what are you seeing from your end customers in terms of – is this any kind of rebuilding or is it the final demand you think which is driving this whole uptick?

Michael Siegal

I will tell you, there is a strong desire to rebuild inventories at the end users. It is just not happening. So I would more reflect the fact, Sal, that my experience in talking with the customers is that the things that are driving the increase in demand is real sales to the marketplace and not a rebuild of the inventory at this point. Although there is a desire from a number of our customers, we do believe that their distributorships are way under inventoried.

Sal Tharani – Goldman Sachs

Okay, and lastly, on the acquisition front, I know you have made a lot of comments on that. But what kind – what size is suitable for you? Where do you think is your niche? And what product or geography you would be more interested in?

Michael Siegal

Well, you know, Sal, we have drawn the map out, we want to show the gaps from our logistics perspective. We are looking, you know, for some expansions in Chicago where we already have a facility. We are looking for some things down sort of where we are in Georgia or looking more to the south and maybe a little bit less than where we are located and then further into the Great Plains areas were the other ones that are most attractive to us.

Sal Tharani – Goldman Sachs

And what products? Is that more on specialty now you are looking at or you are indifferent to wherever your opportunity is?

Michael Siegal

Yes, we are indifferent, but you know, again, I would tell you, we have an increased desire to penetrate into our – what we call the specialty metals, stainless and aluminum. But the book of our business is still, you know, the sort of the plate and hot-rolled business, and you know, that is probably the thing that will drive a lot of our desire.

Sal Tharani – Goldman Sachs

Great. Thank you very much.

Michael Siegal

Welcome.

Operator

(Operator Instructions). Our next question comes from Mike Parr with KeyBanc Capital Markets.

Jason Doches – KeyBanc Capital Markets

Hi. Good morning, guys. It's actually Jason Doches [ph] in for Mark. How are you?

Michael Siegal

All right.

Jason Doches – KeyBanc Capital Markets

I was just wondering – you outlined the new business won at the large OEMs and you have spoken about that before for a while. I was wondering if you could just give maybe a magnitude of that new business.

Michael Siegal

Yes, I don't know if we have a good quantification of it. David, you have any?

David Wolfort

Jason, it would be difficult for us to break that out, but simply put, as we commented, you know, we are running at about 75% of normal speed. At this time last year, we saw a denigration of business of 50%. So we are halfway back to a normalized marketplace. A good deal of that growth has come from new business flowing into Olympic Steel, as our routine customers, those that enabled us to grow our business all the way up to 2008 are still recovering from last year's problems. So we see a pretty strong influence of new business, we really won't be able to quantify the full impact of that until literally the recovery is completed and we get into an expansion. So we have – many of our customers are coming all at different speeds.

Jason Doches – KeyBanc Capital Markets

Okay. And I know – you guys have already spoken about acquisitions quite a bit in the call. But I was wondering, among service centers of comparable size to you, I mean, how much competition do you anticipate seeing for acquisitions? So of course, the big – the Ryersons, the Metals USAs, Reliances, have all talked about growing, but obviously they are looking at different sized acquisitions as you guys. So among the service centers of your size, how much competition do you anticipate kind of encountering in looking at the Chicago, Great Plains, Southeast markets?

Michael Siegal

Depending on the circumstances, I would tell you we never underestimate that there is not a lot of competition for everything that we do. So specifically, I think that if it is an auction, everybody, everybody and their grandsons will be looking at the opportunity.

Jason Doches – KeyBanc Capital Markets

Okay. All right. Well, thanks a lot, guys.

Michael Siegal

Thank you.

Operator

Our next question is a follow-up from Sal Tharani.

Sal Tharani – Goldman Sachs

Mike, you mentioned about the – I think you all mentioned that there is – the rate of growth – sorry, the rate of increasing in pricing and volume continue to exceed as you went through the quarter. And I see that your operating margin per ton went from $138 to $160. Is the intensity still the same, that growth intensity, as you are going through sort of March through April and you expect it to stay the same, or is it sort of starting to flatten out?

Michael Siegal

No. The answer is yes, we still continue to see the acceleration at this time.

Jason Doches – KeyBanc Capital Markets

Okay, great. Thank you very much.

Operator

Our next question comes from Nat Kellogg with Hudson Securities.

Nat Kellogg – Hudson Securities

Good morning, guys. Just a question on the South Carolina facility. I know you guys had gotten going on and then put a little bit of a pause on just because of what had been going on in the broader economy. And just curious with talking about Greenfield opportunities, whether that is something that is likely to come back later this year, whether that is still up for review, or where that stands.

Michael Siegal

Well, we can't sell it, Mike.

David Wolfort

We suspended that project in April of 2009. There were a number of circumstances. In all of our Greenfield opportunities, there is always an anchored tenant. The anchored tenant in this particular case was showing some strong re-fault in the recession. So the better part of judgment was unplug that. That building we owned, we did not erect it, we still own it, it is paid for. We have every expectation to erect that somewhere in the south and give us another opportunity in a different venue.

Nat Kellogg – Hudson Securities

Okay. But so, probably not where it was originally planned to go.

David Wolfort

Not where we originally planned, not even probable, not.

Nat Kellogg – Hudson Securities

Okay. Yes, okay. That is helpful. And then, I know there has been sort of a lot of back and forth. I am just kind of like trying to get a sense of where scrap prices may go this summer and how that affects steel prices. And I know in some sense it is just anyone's best guess. But just curious if you guys sort of would be willing to venture guess on what you are hearing and seeing and maybe how that affects your business over the next couple of quarters.

Michael Siegal

Well, we can tell you our iron ore pricing is going up with a great deal of confidence, looks like the met coal is going up. As it relates to scrap, you know, scrap is never a market that is easily predicted. I can promise you that our forecast is that it will probably go down and it will probably go up, and we have got as much clarity as anybody else does on scrap pricing.

David Wolfort

The momentum of the steel note pricing, as you well know, coming off of sort of March level just using hot-rolled as a base of $600 and then propelling itself to this coming month at about $740, that is a lot of momentum going forward. Additionally, there is a reluctance, as someone questioned, there is a reluctance to restock concern on this pricing. That reluctance will allow this marketplace to propel even stronger, because they will be shallower inventories, and we see a real demand, as Mike has commented earlier, is strengthening. So, in that regard, we will see momentum continue.

Nat Kellogg – Hudson Securities

Okay, that is helpful. And then, just last question. Just sort of on a competitive basis, I mean, have you guys seen sort of a – I mean, I would assume in some sense it is improved since people's inventories are a lot linear, although you guys are saying you are still only running at 75% of where you would like to be. So the people, I would assume, are still fighting pretty hard to serve the orders. So I am just curious on what you guys are seeing as far as discipline within pricing, within the service center station, maybe how it compares to three to six months ago and what you expect going forward.

David Wolfort

Hand-to-hand combat.

Michael Siegal

Pricing discipline, that is kind of an oxymoron, okay? Nothing has changed in the service center business and the 35 years that I have been in it. We don’t expect it to change now.

Nat Kellogg – Hudson Securities

Okay, fair enough. Well, thanks for the clarifications, guys, and I will hop back in the queue. Thanks so much.

Operator

(Operator Instructions). I am showing no further questions in the queue.

Michael Siegal

Great. Thank you, Joe. As a reminder, it is our policy not to provide forward-looking earnings estimates for the upcoming quarter or year nor to endorse any analyst sales or earnings estimates. We anticipate releasing our second quarter 2010 earnings on or around August 5, my birthday is August 6, if you want to send cards and letters, 2010. This concludes our call and we thank you again for your interest in Olympic Steel.

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