Olympic Steel Inc. (NASDAQ:ZEUS)
Q4 2013 Results Earnings Conference Call
February 27, 2014 11:00 AM ET
Michael Siegal - Chairman and CEO
David Wolfort - President and COO
Rick Marabito - Chief Financial Officer
Dr. Don McNeeley - President, Chicago Tube and Iron Subsidiary
Martin Englert - Jefferies
Good morning. And welcome to the Olympic Steel Fourth Quarter and Full Year 2013 Conference Call. 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 Forms 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’d like to introduce your host for today’s call, Olympic Steel’s Chairman and Chief Executive Officer, Michael Siegal. Please go ahead, Mr. Siegal.
Thank you, Operator. Good morning. And thank you all for joining us on this morning’s call and for your interest in Olympic Steel. On the call with me this morning are David Wolfort, President and Chief Operating Officer; Rick Marabito, Chief Financial Officer; and Dr. Don McNeeley, President of Chicago Tube and Iron Subsidiary.
I’ll start with the recap of the progress made over the past year and then provide an update and where we currently are with our long-term strategic plan. Lastly, I will touch on some positive reassuring trends that have started to emerge. After that Rick provide additional perspective on the quarterly and full year financials and David will wrap up our prepared comments with his operational update. Following our comments we will open the call for questions.
During the past several years we have made major headway in transforming of steel beyond traditional service center distribution. We expanded our processing capabilities and geographic reach, increasing the scope of product and services we offer in close proximity to key customers and markets.
Now that the capital build out phase of this blueprint has concluded, free cash flow increased significantly and we are now focused on improving operating efficiencies and increasing sales volume and net income.
By the end of 2013, Tubular and Pipe Products have been successfully integrated into existing facilities that formerly only sold flat products, now with minimal capital investment these products are been cross sold in Ohio, Kentucky and Georgia and Mexico.
Also during the year our Specialty Metals business continued to grow and earn a greater share of that market. Sales of aluminum increased in the automotive sector and stainless steel volume benefited from further penetration into the transportation industry, as well as the growing food service sector.
We made a commitment to grow our Specialty Metals product line in 2009 following the recession. Our investments in Streetsboro, Ohio our first dedicated Specialty Metals facility, Lester, Pennsylvania and refocusing our Schaumburg, Illinois facility resulted in our market share growing steadily from about 1% of the market five years to 4.3% in 2013 as our sales of Specialty Metals reached about $160 million plus.
We are gaining Specialty Metals market share by bundling our processing services and providing one stop shopping. This model reduces transportation and handling costs, shortens lead times and increases quality and dependability. Moving forward, we intend to continue expanding this approach and building out our existing success.
Shifting to the carbon side of our flat-rolled segment, volume and pricing were depressed until very late in the year. Volume in the Flat Product segment increased modestly during the final quarter of 2013 but declined 5% overall for the first -- for the full year.
The full year volume decline reflects weakness in certain sectors and to some extent our strategic emphasis on targeting metal consumers where we can find the most value and add the most value of partnering with customers on fabrication or pipes and integrating with their supply chain typically entails our longer selling cycle.
However, we believe this kind of business is worthy effort and it is where our procurement, processing and inventory management capability can create a long-term competitive advantage for us and our customers.
Our Winder, Georgia distribution facility perfectly simplifies what we are accomplishing. This facility is located just 12 miles from a major Fortune 100 customer, yet recently invested $200 million in a new 1 million square foot facility factory in the state of Georgia.
This new facility was located in Athens, Georgia to bring manufacturing of many hydraulic excavators formerly produced in Asia back to North America, closer to its customers here. Olympic Steel has made corresponding investments in Georgia to service our growing customer demands, there.
The first excavator rolled off the assembly line in November and production is scheduled to ramp up over the next several years. This plant is also slated to begin production of small truck-type tractors. Olympic Steel’s have to do with sophisticated just-in-time inventory management and multi-step processing perfectly complement this customer’s primary activities which are centered on major fabrications, painting and final assembly.
We are actively on boarding parts and processing services and assimilating our Winder facility to seamlessly integrate with its best-in-class operations. Other industry products have also recently taken advantage of the economic benefits of restoring. This is a growing trend and one definitive winner is industrial manufacturing and those also capable of servicing their needs.
We are optimistic that other global manufacturers will be following suite to take a fresh look at the economics of restoring. Given the game-changing impact, fracking has had enough energy concern along with cost progressively increasing overseas. The cost pendulum is beginning to swing back into the favor of the United States.
This is all very good news for Olympic Steel. During the past decade, we have added 22 facilities to our current network of 34 locations in North America. And we are preparing for the reassuring and metal processing, outsourcing trend that is taking place by industrial equipment, original equipment and manufacturers.
We have built our company to enable multi-location and single plant OEMs to be leaner operations by decreasing the raw material inventory requirements and freeing up the floor space by outsourcing non-core processing, reduce in pre-assembly inventory levels enabling phases at the customer site, ultimately compresses their cash convergent cycle and helps them succeed. This kind of collaboration bodes well for our future and aligns perfectly with the direction we are headed.
With that, I’ll turn the call over to Rick.
Thank you Michael and good morning to everyone. I will highlight the fourth quarter and full year financial comparisons and then I’ll turn the call over to David. Well, the fourth quarter is seasonally slow, flat product volume was 1% higher in 2013, compared with last year and resulted in full year total sales of 1.1 million tons on the flat-rolled side.
This was 4.7% lower versus 2012 volumes which also rounds to 1.1 million tons. Sales volumes suffered from weakness in certain end markets including the well-publicized mining industry and the defense sector.
In addition, spot sales were lower as buyers abstain from placing new orders and hopes that second half price increases from the mills would not hold. As a result, inventory levels at the OEMs have been reduced and restocking now appears to be less likely. David will provide additional color on steel pricing and current dynamics in the distribution channel in a moment.
As Michael highlighted, we experienced strong growth in the specialty metals product line of our flat-rolled segment. The pipe and tube product segments also increased its share of that market and turned in another year of strong financial performance.
Continuing to accentuate the powerful commercial integration of our flat-rolled and pipe and tube product segments. Consolidated net sales in the fourth quarter were essentially flat at $291 million. Full year sales were 8.7% lower at $1.3 billion compared with the company's record high of $1.4 billion in 2012.
Reduced volume and depressed average pricing contributed about evenly to the lower revenue figures in both the quarterly and full year periods. Gross margins expanded nicely, which is encouraging giving pricing pressures during the year combined with lower volume in the capacity utilization.
This was due to successfully maintaining the dollar value of gross profit per ton sold despite lower average prices. As we disclosed in this morning's press release, we recorded a total of $3.6 million of LIFO income during 2013 related to our pipe and tube segment.
This compares with no LIFO impact in 2012 results. The LIFO income boosted reported gross margin by 0.4% in this year’s fourth quarter and by 0.3% for all of 2013.
Gross margin increased to 20.7% in the fourth quarter of 2013, up from 19.5% in last year's fourth quarter. Before considering LIFO income, gross margins expanded by approximately 80 basis points to 20.3% in the fourth quarter. Full year gross margin was 20.9% versus 19.5% last year. Again, before considering LIFO income, the annual gross margin increased to 20.6%, compared with 19.5% in 2012.
In the final quarter of 2013, we reported a small operating loss of $125,000. While better than the $8 million operating loss in last year's fourth quarter, we would have liked to have seen stronger value. We noticed the drop in order activity during November, when steel prices were rising and uncertainties still persisted around the October government shutdown.
Operating expenses declined $4.7 million in 2013’s fourth quarter compared with 2012. This primarily reflects the $6.6 million goodwill impairment charge recorded in the fourth quarter of ’12. Expense reduction actions taken during 2013 lowered certain variable operating costs such as selling expense, and this helped offset some higher fixed costs such as occupancy and depreciation related to our growth initiatives.
Full year operating expenses declined by $6.9 million despite the higher fixed costs. Again, this is primarily attributed to the goodwill charge taken in 2012, and the expense production actions implemented during 2013. Excluding the goodwill impact, operating expenses in the Flat Product segment declined by $3.6 million during the year.
Operating expenses in the pipe and tube business increased in 2013, reflecting higher depreciation. As you may recall, we recently expanded our Chicago Tube and Iron St. Paul facility, plus we had a higher variable costs associated with shipping more volume and increased labor and benefit costs in the pipe and tube segment.
Interest expense continued to decline as a result of paying down debt and lower average interest rates during the year. Fourth quarter interest expense declined 15% to $1.7 million, down from $1.9 million last year. For the full year, interest expense was 20% lower at $6.7 million versus $8.4 million in 2012.
We reported a net loss of $1.4 million, or $0.12 per share in the fourth quarter. This was less than the loss of $10.1 million, or $0.92 per share during last year's fourth quarter, which included the impairment charge. Also, LIFO income increased this year's fourth quarter results by $0.05 per diluted share.
For the full year, net income was $7.6 million, or $0.69 per diluted share, that’s up from the $2.3 million or $0.21 per diluted share reported for 2012. Again, the $3.6 million in LIFO income increased our 2013 earnings per diluted share by $0.19.
Turning to cash flow and the balance sheet, we generated $54.7 million of cash from operating activities in 2013, that’s up from $27.7 million in 2012. Slightly more than half of this was generated from operations and the balance was generated from working capital management.
The credit quality of our receivables remains excellent and mirrors the financial health of our customer base. DSOs were 39.1 days in 2013, that’s a slight improvement from 39.5 days last year. Inventory was reduced through outmost of the year, although in the latter part of the fourth quarter, we increased inventory by about $40 million.
Inventory purchases were made prior to the year end price increases and positioned us with what we believe to be well cost of inventory entering 2014. This is reflected on our balance sheet as higher inventory and higher accounts payable at year-end compared with the end of the third quarter.
Despite adding the $40 million of inventory during the fourth quarter, we're still holding less inventories than we were at the end of 2012. Our team did a great job selling the higher cost inventory during the year at predominantly lower prices. Year-over-year inventory turnover improved to 4.3 times in 2013, up from 4.0 turns in 2012.
As stated on previous calls, we remain disciplined in our approach to investing in 2013, with $16.1 million on capital expenditures, which totals about 75% of our $21.4 million of annual depreciation in ’13.
A portion of our free cash flow was used to further reduce debt, as total debt was lowered to $199 million by the end of 2013. This improved our debt-to-equity ratio from 83% at the end of 2012 to 67% at the end of 2013. More than $110 million of debt has been paid down in less than two years since it peaked in May of 2012 at $310 million. This is a 35% reduction.
Finally, shareholder’s equity increased to $299 million or $26.99 per share at year end. This is up $9 million from the $290 million or $26.54 of shareholder’s equity at the end of 2012. For additional details on our financial results, I’ll refer you to our Form 10-K document, which we intend to file later today.
Now, I will turn the call over to David.
Thank you, Rick. And thank you to everyone joining us on today’s call. During the third quarter earnings call in October, we indicated steel prices had finally found better footing and our outlook for the next couple of quarters was perhaps better than it had been at any other time during the year.
At the beginning of 2013, [flat-rolled] prices were around $630 a ton and a drop to mid-500s by late May before rebounding back to $650 a ton at the end of third quarter of ’13. As the fourth quarter progressed, steel prices continue to decline and our near-term optimism shared in that call was positively reinforced.
North American steel making capacity was reduced during the year, as some glass furnace capacity went permanently offline. This compounded other temporary supply disruptions and enhanced pricing power at the remaining mills. As the year came to a close, lead times were extending and slack in the distribution channel was being absorbed.
Steel consumers tried to better try to wait it out assuming the prices would settle lower while they work through on-hand inventory. This mitigated shipping volumes in the second half of the year. Our OEMs returned to the market in December and January, and despite the relatively higher prices, order activity has improved since the start of this year.
Longer term, we continue to advance our strategy of welcoming new business, pursuing continuous improvement initiatives and our operations and distinguishing Olympic Steel as the service center of choice in our preferred markets.
Our progress in operating expense reduction, manufacturing efficiency enhancements, and management alignment, all weren’t being highlighted on this call. As we previously announced, we took action in the second half of 2013 to reduce variable cost and right size certain sales and operating teams.
Approximately $4 million in annualized expenses were eliminated and we entered 2014 a leaner and more efficient organization. Our new corporate structure that was put in place in 2013 now embodies our objective of a corporate executive team charged with strategic direction and oversight of al companies’ combined operations. This is accomplished by dedicated operating teams focused on profitable growth in each of our divisions.
Changing gears I do want to briefly piggyback on some of the comments that Michael made earlier, regarding the increasing popularity of manufacturers reassuring operations. In addition to the rapidly changing energy landscape, there were number of other factors reinforcing this trend. The wage gap is shrinking as labor costs in Asia escalate and the forward nature of foreign currency valuations also mitigates the advantages of offshoring.
Moreover, manufacturers have becoming increasingly concerned about issues that can potentially impact their brand reputations and operating efficiencies, such as intellectual property rights, vendor risk, and supply disruptions. Just-in-time manufacturing is now the norm and customers cannot tolerate waiting weeks or months to delivery.
We service some of our customers multiple times each day to perpetually replenish their raw inventories. Our products are often in customers production lines being assembled into their end-product within four hour of arrival. This reduces their need to hold new material inventory and helps their cash flow. We have contoured our value-added services to meet customer needs to such a degree that we describe ourselves as lean manufacturer enablers.
Another observation, we’d like to share is that when the offshoring trend was in full swing, many domestic supplier networks either followed their customers overseas or simply disappear. Olympic Steel continue to invest in North America, recognizing the efficiencies of highly engineered automation in our national effort to be energy independent.
We invested in people, we invested in facilities, we invested in equipment and we invested in technology and we invested in process improvements to develop the best supply chain possible. Now with signs of recovery in the construction industry, higher volumes at domestic OEMs are expected to improve capacity utilization. In addition, we are ideally positioned to welcome back with open arms, global manufacturers who decide to repatriate their operations.
The outlook for Olympic Steel is very bright. Internally, we have made substantial changes to improve the way we conduct our business. Externally, recent economic indicators and demand have been encouraging. Manufacturing activity expanded during the last seven months of 2013 and the recent purchasing manager’s index reading are promising although it varies by industry segment and January ‘14 was slightly down over December of ‘13.
Steel demand and prices have exhibited corresponding strength and ended 2013 on the highs of the year. This momentum is carried into 2014 with improved order activity. We are entering the New Year, better position to execute our strategy which is clearly defined that in any other time in my 30 years with the company. And we look forward to reporting continued progress as the year unfolds.
With that, we will now open the call to your questions. Operator?
(Operator Instructions) Now the first question comes from Martin Englert of Jefferies. Please go ahead.
Martin Englert - Jefferies
Hi, good morning, everyone.
Martin Englert - Jefferies
I wanted to get a sense of what the reduction and/or absence of CRU or other index-based discounting in 2014, have any material impact on company’s ability to improve the flat product margin?
Hi, Martin. This is David. As Rick commented in his statements, we actually have been able to maintain our margins as we have seen variability in pricing. So while CRU is still published and quite frankly the producers are really not using it to any great extent, we really have found very little disruption in our ability to sell and maintain our margins.
And just -- I am not sure which segment of that question you want answer, Martin. There is no question that hedging however. It is getting small momentum and so there has to be some indices out there which hedging which has been used more often is going to have a basis of both sides of the transaction. So we are seeing some increase in hedging activity and regardless of the industry whether CRU or other one, still has to exist.
Martin Englert - Jefferies
Thanks. It’s helpful. Also, looking at the SG&A expense quarter-over-quarter stepped up a bit, if you assume kind of similar sales rate, do you think that would be a good run rate on a go-forward basis?
Martin, this is Rick. The fourth quarter we had a couple of item that I characterize may be as a little bit unusual. As we looked at the fourth quarter, we had new capital expenditures. We use a half year depreciation convention. So as we capitalized several of our larger projects, we took a full half year of depreciation in the fourth quarter. So, what I would tell you is the run rate for depreciation for next year should be pretty similar to this year in total for the year, maybe even a tad bit lower. So that’s one aspect of it.
On the pipe and tube seg, we actually saw -- as I commented, we saw volume increases. And so, what I would tell you is year-over-year ‘13 versus ’12, we saw some expense increases in the depreciation and occupancy, the fixed components of our expenses. We also saw in 2013 on the variable side, I mentioned some of the benefits cost increases. So medical and workers’ comp expense were up in 2013, a lot of that did hit in the second half as well. So, I would say, you can use fourth quarter with a couple of those tweaks that I just mentioned.
And while -- it's Michael, I would say, we have a number of initiatives on operational excellence in the manufacturing side that you hope would manifest itself on an ongoing expense reduction. But clearly there is that variable component to increase volume.
Martin Englert - Jefferies
Sure. And then, it seems like just looking on a quarter-over-quarter basis, the biggest step-up would have been within the general and admin, would that be associated with some of the benefits?
Martin Englert - Jefferies
Okay. Any positive impact from inventory holding gains for the fourth quarter ended?
Not really. I mean, I think, as we talked about with the pricing environment and also evidenced by our LIFO income in the fourth quarter, I think the lag between when prices were rising versus when you realize those, the market was still pretty tough in the fourth quarter in terms of the previous nine months or 10 months of price decline.
So, we didn't really see a lot of that. I think we’ve talked about it on each of our previous calls and I mentioned it today. We've been really consistent in terms of our gross margins. So, when you look at our gross margin on the flat-rolled side, flat-rolled segment on a per ton basis, it was pretty consistent throughout the year including the fourth quarter.
Martin Englert - Jefferies
Okay. And just couple and a last one, are you able to provide the direct import tonnage for the quarter? And then, do you happen to have the segment breakout for gross profit?
Yeah, all of that will be available this afternoon. We plan to file our 10-K this afternoon. So, you will have, all of that information will be included there.
Martin Englert - Jefferies
Okay. Thank you.
Thank you, Barry.
(Operator Instructions) At this time, I show no further questions. Mr. Siegal, would you like to make any closing remarks.
Yeah. I would like to thank all of you for joining us on the morning call. And we look forward to sharing our continued progress as we report the first quarter 2014 results in April. And again, thank you all for participating in the conference call. Bye-bye.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your line.
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