Olympic Steel's CEO Discusses Q2 2012 Results - Earnings Call Transcript

| About: Olympic Steel, (ZEUS)

Olympic Steel, Inc. (NASDAQ:ZEUS)

Q2 2012 Earnings Call

August 9, 2012 10:00 AM ET

Executives

Michael Siegal – Chairman and CEO

Rick Marabito – CFO and Treasurer

David Wolfort – President and COO

Analysts

Ed Marshall – Sidoti & Company

Tim Hayes – Davenport & Company

Richard Garchitorena – Credit Suisse

Aldo Mazzaferro – Macquarie

Charles Bradford – Bradford Research

Operator

Good day, ladies and gentlemen, and welcome to the Olympic Steel Incorporated Second Quarter 2012 Earnings Results Call. At this time, all participants are in a listen-only mode. Later, we’ll have a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Michael Siegal, Chairman and Chief Executive Officer. Sir, you may begin.

Michael Siegal

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

Before we begin our discussion, I want to remind you that during this call we will provide forward-looking statements that we do not undertake to update nor – 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 2011 Form 10-K and our 2012 second quarter Form 10-Q, which we will file later day.

Earlier today we reported our financial results for the second quarter and first half ended June 30, 2012. Net sales for the second quarter of 2012 totaled $367.4 million, which is a 22.9% increase from the $299 million in the second quarter of 2011. Our second quarter 2012 net income totaled $4.5 million or $0.41 per diluted share compared to net income of $7.9 million or $0.73 per diluted share in last year’s second quarter. Net sales for the first half of 2012 totaled $749.4 million, a 26.3% increase from the $593.4 million for the first six months of 2011. First half 2012 net income totaled $10.8 million or $0.98 per diluted share compared to the net income of $18.3 million or $1.67 per diluted share for last year’s first half.

Our 2012 financial statements include the results of Chicago Tube and Iron, which was acquired by Olympic Steel on July 1, 2011. We are pleased with our sales and market share growth in the second quarter. In the second quarter, our year-over-year flat roll tonnage increased by 6.0% compared to the market increase of 4.6%, as reported by the Metals Service Center Institute’s Metals Activity Report. As indicated in our release, our second quarter earnings were impacted by the degradation of pricing in both the carbon and nickel products, which affect stainless, and by startup cost associated with our new operations that are not yet fully operational. Our current focus is on executing at our new locations, increasing our cash flows and reducing our debt. This will be accomplished by reducing working capital levels, spending less in CapEx than our annual depreciation levels starting in 2013 and garnering the future contributions of our startup locations that are in their capacity ramp-up station – stages in 2012. Our pipe and tube business continues to perform well and has been accretive to our earnings since we acquired CTI on July 1, 2011, and we have been expanding investments in both pipe and tube facilities and equipment.

Our balance sheet is strong, supported by the liquidity and four years remaining on our bank credit agreement. We also reported today that Olympic Steel’s Board of Directors approved a regular quarterly cash dividend of $0.02 per share to be paid on September 18, 2012 to the shareholders of record on September 4, 2012.

I’ll turn the call over to Rick.

Rick Marabito

Thank you, Michael, and good morning, everyone. I’ll review some additional financial highlights from the quarter and the first half. But first let me remind everybody; as Michael said, we acquired Chicago Tube and Iron on July 1 of 2011. As such, our first half of 2011 does not include CTI results. And our business results after the acquisition are reported in two segments, a flat product segment and a tubular and pipe product segment. For more information, please refer to the segment information that we provide in our earnings release as well as in our Form 10-Q, MD&A and footnote sections.

Our volume in the flat roll business totaled 614,000 tons sold for the first half of 2012 and that compares to 603,000 tons last year. In the second quarter, our tons sold increased 6% to 302,000 from 285,000 in the second quarter of 2011. We do not report tons sold in the pipe and tube segment, as it is not considered a meaningful measure for that segment.

As a percentage of net sales, consolidated gross margin totaled 19.6% in the first half. Margins in the second quarter were 19.5% versus 19.7% in the first quarter and margins were down from the robust flat roll margins of 20.9% earned in the first half of 2011. The year-over-year decline is due to a more active spot market in the first half of 2011 and 2012 and the continued pressure on carbon and stainless prices in the current year. Pipe and tube gross profit totaled 29.6% in the first half of 2012, as our pipe and tube product gross margins are higher than our traditional flat product margins.

As a percentage of sales, first half 2012 operating expenses totaled 16.7% versus 15.6% last year. Expenses are higher in 2012 due to the inclusion of CTI, which has higher operating expenses in the flat roll segment, and due to the fixed costs associated with our startup operations. The new facilities incurred about $4.8 million of incremental expense in the first half of 2012.

EBITDA which is defined as our operating income before depreciation and operating expense right off the face of our income statement totaled $32.1 million in the first half of 2012 compared to $38.2 million in the first half of 2011. Capital spending in the first half of 2012 totaled $15.7 million. The flat roll segment spent about $10.7 million of that total while the pipe and tube segment spent about $5 million. The majority of the sending related to payments for the completion of our temper mill project in Gary, Indiana, equipping facilities in Mount Sterling, Kentucky; Chambersburg, Pennsylvania; and our new stainless and aluminum startup facility in Streetsboro, Ohio. We also purchased new laser equipment for CTI. We expect our total capital spending in 2012 to be in the $30 million to $35 million range in total, and that would depend on the timing and the choices we make on lease financing. And then commencing in 2013, we do anticipate that our capital spending will decrease to levels below our $20 million of annual depreciation expense.

Our effective tax rate in the first half was 39.4% and we would expect the full year of 2012 to remain in that range. Our flat roll inventory turnover rate for the first half was 4.1 times. That is slower than our historical turnover rate of about 5 times. We are reducing inventory in the second half of 2012. As a result of the CTI acquisition about 15% of our consolidated inventory is stated on LIFO. We have no book LIFO reserve at June 30, 2012 however, because our pipe and tube inventory on LIFO has a current and a 2012 year-end projected quantity and pricing point below those of the July 1st acquisition date. So in essence, our CTI LIFO inventory is stated at FIFO at June 30, 2012.

Our flat roll accounts receivable DSO totaled 41 days. Pipe and tube DSOs are well below those 40 days. So, our receivable quality remains very good and it did improve slightly from the first quarter. Our debt at quarter-end totaled $288.5 million. That is down slightly during the quarter. And our availability was $85 million at June 30th. We are focused on reducing our debt going forward. Both inventory and debt have declined since quarter-end June 30. And finally, our shareholders equity per share increased to $27.31 at June 30th.

Now, I will call – turn the call over to David.

David Wolfort

Thank you, Rick. Good morning to all. First, let me talk about some of our startups and growth initiatives, and we have been highlighting our startup initiatives which are at various stages of capacity. Let me update you on our two most significant investments, that of our new temper mill facility in Gary, Indiana and our new stainless and aluminum specialty metals facility in Streetsboro, Ohio. Our Gary, Indiana temper mill facility continues its ramp-up to capacity during its first six months of operation. The $27.2 million project provides over 150,000 tons of new capacity.

The facility and equipment were successfully completed on time and under our targeted budget of $30 million, with the mill processing its first coil at the end of December 2011, as you will recall. Then in the first quarter of 2012, we successfully ramped up production from the first coil to ship at a run rate of approximately 190 tons per day or 30% about of capacity by the end of March of this year. By July, we achieved a shipping run rate of approximately 280 tons per day or about 47% of capacity. Gary has been a nominal operating cash flow negative in the first half, but we expect the location to generate positive operational cash flow in the second half of the year.

Now to our specialty metals business, which is currently adding processing equipment in its new facility in Streetsboro, Ohio, which just opened in April 2012. The addition of a physical location in Streetsboro with internal control of slitting, flattening, cutting capabilities in stainless and aluminum will provide continued growth in the food services and truck trailer markets.

Stainless and aluminum product sales now make up about 10% of our consolidated sales mix. We expect the equipment in Streetsboro to become operational later this month. In total, we incurred about $1.8 million of pre-tax startup losses in the first half at our startup locations of Gary, Indiana; Streetsboro, Ohio; Kansas City, Missouri; and Mexico. We confidently look forward to the future contributions of these operations.

Now, let me shift gears and turn toward our view of the market. Finally, let me briefly comment on the current market conditions. Our demand has been consistent and stronger towards the contract mix versus the spot market business when compared to last year. As highlighted earlier, our shipping pace improved in the second quarter when compared to the market, as we outpaced the industry’s shipping growth in terms of our flat roll tons sold. So, the current year trend of supply side pressure continued through July however, resulting in declining steel prices and lower margins, especially in the carbon and stainless flat roll area.

First half is usually the seasonal time for price increases, but 2012 has been a non-traditional year. Third quarter started with the expected seasonal weak month of July, but the recently announced and well publicized scrap and steel price increases should bring some relief to the downward trend of pricing experienced since the – since early in 2012. We are reducing our inventory levels in the second half, as Rick commented, and completing our three-year capital spending program and focusing on increasing cash flow and decreasing our debt going forward. We’re excited by the opportunities in front of us with our new startup locations, the continued strong performance from our pipe and tube segment, and the success of our existing businesses.

This concludes our formal comments, and we will now open the call to your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ed Marshall from Sidoti & Company. Your line is open.

Ed Marshall – Sidoti & Company

Good morning, Mike, Dave, Rick.

Michael Siegal

Hey, there.

Ed Marshall – Sidoti & Company

So the first question; you mentioned you’re taking inventory out of – off the balance sheet. Do you have an indication as to how much is going to be coming off?

Michael Siegal

Well, again, it’s a relative ratio to sales, but again as Rick indicated in his remarks, we’re traditionally trying to look at 5 inventory turns and so, as we would expect sales to maintain a relatively consistent level, we’re going to get the inventory to a 5 inventory turn level.

Ed Marshall – Sidoti & Company

And is that on the run rate at the end of the – by the end of the year, or – I mean do you anticipate maybe the third and fourth quarter to kind of look at that 5 times? I know you don’t provide guidance but you know...

Michael Siegal

Yeah. I mean, we won’t get...

Rick Marabito

Ed, it’s Rick. We’ll get – we’re at – I talked about being at 4.1 turns now. As Michael said, we’ll get to five and that will happen pro rata that over the back half of the year.

Ed Marshall – Sidoti & Company

Okay. Looking at the startup cost, I think looking back to the first call it was about $1 million in startup, we’re looking at $1.8 million, but the utilization at Gary seems as though it was moving in the right direction. So, where are the incremental costs coming from?

Michael Siegal

The Streetsboro facility at...

Ed Marshall – Sidoti & Company

Streetsboro, okay.

Rick Marabito

As David commented, we moved into that facility in April and had a whole quarter of getting the equipment installed. And so, that equipment should be up and running here in the third quarter. So, that would be the incremental piece.

Ed Marshall – Sidoti & Company

I didn’t catch if at 47% utilization is Gary profitable, is it near breakeven?

Michael Siegal

It was near breakeven.

Ed Marshall – Sidoti & Company

Near breakeven. So the majority of that $1.8 million is then Streetsboro I guess is what you’re saying?

Rick Marabito

Well, during the quarter, Ed, we obviously went from – as David commented, we were at about – at the end of March we were at about a 30% run rate.

Ed Marshall – Sidoti & Company

I see.

Rick Marabito

So you walk through Gary and we’re at zero at the beginning of the quarter to 30% at the end.

Ed Marshall – Sidoti & Company

Yeah.

Rick Marabito

So pro rata we’re at 15%. We went from 30% at the end of March and now in June we had a pickup in volume due to normal business trends in terms of quarterly contracts that started in the third quarter. So, we went from a 30% run rate at the end of March to in July 47%. So, you had a pro-rata ramp up, actually more weighted towards July in terms of that increase in volume.

Ed Marshall – Sidoti & Company

That makes sense. Now if I look through the rest of the year, I mean do we expect this kind of level, $1 million or so per quarter drag or does this become less? I know you guys continue to expand, but how should we look at these startup costs maybe throughout the rest of 2012 and I’m assuming they’ll fall off somewhat in 2013?

Rick Marabito

Yes, I – Ed, it’s Rick again. In 2013, our full expectation is that the startup costs fall off and we’re profitable. I would tell you between now and the end of the year, the expectation at Gary which is one of the bigger facilities, would be that we would continue to lessen the startup drag. I think in third quarter, as we talked about the second biggest facility is in Streetsboro, we should have that thing up and running. So I would say, in fourth quarter we cut the startup costs at Streetsboro. So in summary, I think we will see the rate continue to go down in 2012 in terms of startup costs and then 2013 we should be there for profitability.

Ed Marshall – Sidoti & Company

Okay. I don’t know that you’ll comment on this, but is there a utilization rate at Gary, say, at the end of July or is that 47% at the end of July?

Rick Marabito

That is the July rate.

Ed Marshall – Sidoti & Company

Okay. And then Mike, kind of bigger picture, you talked about pricing a little bit. You mentioned in the comments about the rate hikes that we’ve seen recently and everyone is trying to dig their heels in. What is your take? I mean are you seeing that there is sort of a reluctance for that from your customers in taking price or are they giving in to the market a little bit?

Michael Siegal

I’ll let David comment on that one.

Ed Marshall – Sidoti & Company

Okay.

Michael Siegal

Go ahead, David.

David Wolfort

Yeah, Ed, actually we do see traction. There are three price increases on the table. The first has been absorbed and we would comment that a significant portion of the second has been absorbed. You’re 100% correct; the producers are digging their heels in. And I think they are seeing some success and of course, we see that being fostered and supported by the increase in scrap in this month. So rebound from the decline of June, July in scrap here in August, and that’s supporting the price increases, and there is a resolve to bring those prices up.

Ed Marshall – Sidoti & Company

Excellent news. Okay, thanks guys.

Michael Siegal

Thanks, Ed.

Operator

Thank you. Our next question comes from Tim Hayes from Davenport & Company. Your line is open.

Tim Hayes – Davenport & Company

Hi, good morning, everyone.

Michael Siegal

Hi, Tim.

Tim Hayes – Davenport & Company

Just a couple of housekeeping items. The – Rick, hey, did you give the gross profit by the segments?

Rick Marabito

Yes.

Tim Hayes – Davenport & Company

What were those again, please?

Rick Marabito

Sure. So, let me get to it, sorry. So we had – consolidated was 19.6% in the first half. Consolidated was 19.5% in the second quarter versus consolidated 19.7% in the first quarter. Last year was 20.9% and last year obviously was all flat roll, and then 29.6% was the pipe and tube segment margins for this year.

Tim Hayes – Davenport & Company

Okay. The 29 – okay, 29.6% is – that’s a first half for CTI, right?

Rick Marabito

Yes, that’s the first-half number.

Tim Hayes – Davenport & Company

All right, and then the total volume in flat roll for Q2?

Rick Marabito

Q2 total volume was 22,000 tons versus about 18,000 tons last year – 18,000 tons or 19,000 tons last year.

Tim Hayes – Davenport & Company

And last question, just on the – generating working capital from lowering the inventories in the second half; assuming – you mentioned you’re going to get your turns up to 5, I guess with this recent snapback in steel prices, what’s your thoughts of actually generating cash from working capital even if the turns improve?

Rick Marabito

Yeah. I would tell you two things; number one, we will definitely be taking the volume down, so that will be a cash generator. In terms of the pricing on inventory, and I think if you look and kind of chart how it works, that will take some time in terms of the raising of the average cost of the inventory. So I’m still confident unless we see another couple of rounds here as we move through the rest of the quarter and the rest of the back half that we should still be in a position to reduce the inventory value in total.

Tim Hayes – Davenport & Company

Okay. One more, with this snapback in U.S. prices, is there a gap that’s opening up with prices around the world that you might start looking offshore?

Michael Siegal

No, I don’t think so, Tim. Again, inventory management is critical here. When we – outside if we have some continuous feed on the East Coast, when you look at bulk buy, it throws your disciplines of inventory management out of whack unless there is a big enough gap. So, we don’t see the big enough gap yet that would be inducing us to do that and we’re much more focused right now you on the execution of our principles.

Tim Hayes – Davenport & Company

Great, thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from Richard Garchitorena from Credit Suisse. Your line is open.

Richard Garchitorena – Credit Suisse

Thanks. Good morning, guys.

Michael Siegal

Hi, Richard.

Richard Garchitorena – Credit Suisse

Yeah, I just wanted to touch on the gross margins follow-up. On CTI, 29.6% for the first half, if I recall first quarter was above 30%, so anything you can point to for the sequential decline in the margin there or...?

Michael Siegal

Nothing more than the general market decline of all commodities. Again, there are guys at higher priced inventories being able to replace it with lower price. We’re seeing the same conditions on their – in their marketplace, which is just a little bit more competitive in the marketplace as people are liquidating high priced inventory. So I think it’s on the sales side rather than the overall spread of the engineering, value-added that they bring.

Richard Garchitorena – Credit Suisse

Okay. So I guess, with the price recovery in the last month or so, would you expect that to reverse in the third quarter and moving forward?

Rick Marabito

Well, the trend – Richard, the trend is going in that direction. Obviously, as flat roll pricing moves up, it’s a component in the pricing of tubing and so we would expect tubing to move up and of course we have inventory embedded.

Michael Siegal

And we’ve added some equipment there, as I indicated, that is actually helping propel some of the margins on the engineering side. So, we’re doing some things to help them as well.

Richard Garchitorena – Credit Suisse

Okay, great. And then just – the other question just broadly speaking on the end-market mix, and you mentioned 10% of shipments now in aluminum. I guess, where are you seeing the biggest demand? Again, I just wanted to revisit I guess where we are across all the end markets?

Michael Siegal

Yeah, again that was stainless more than aluminum. So, yeah, we call it specialty metals. So 10% is the specialty metals, which is predominantly stainless more than aluminum, so just clarification on that. Our markets are strong where they have been. I mean, the heavy highly engineered products in mining and agriculture remain very, very strong, food service applications for us remains a pretty robust market. Truck trailer is a fairly good market for us and remains relatively robust. We haven’t seen segment change pretty much at all, Richard.

Richard Garchitorena – Credit Suisse

Okay. Great, thank you.

Operator

Thank you. Our next question comes from Aldo Mazzaferro from Macquarie. Your line is open.

Aldo Mazzaferro – Macquarie

Yeah. Hi, Michael and David and Rick; how are you doing?

Michael Siegal

Good.

Aldo Mazzaferro – Macquarie

Just a – my view on the market – I guess I’m seeing this dichotomy or a difference between the trend in demand, the trend in pricing. It seems – and especially since you and a number of your competitors are reducing inventory here, which would be the kind of the opposite reaction you’d expect if the prices were really, you know, tight and going up, the market was tightening. I was wondering, how do you see your inventory strategy? Is it more lined up to the demand side of the market or would you – I mean – because it doesn’t seem like you’re going to chase these prices, if I’m reading you right, just wondering?

Michael Siegal

Yeah, Aldo, I think it’s a combination of where the market is to where it’s going. So Olympic has a certain kind of marketplace that segments itself between contract and spot.

Aldo Mazzaferro – Macquarie

Okay.

Michael Siegal

All right. And so what we would say is that our contractual inventory probably got a little bit too high relative to some indications of what we thought pricing would be and what the customer consumption would be. So when you look at what we’re going to reduce, predominantly it’s going to be the customer-specific inventory as we hope that we increase the mix of our spot market as we look at a rising price environment, which would then indicate to us that the spot market would be stronger and we would need more inventory for spot and just change the mix a great deal. So when you look at the reduction, it’s not relative to the factor that the price is going up as much as our mix of inventory for contract versus spot changed a little bit.

Aldo Mazzaferro – Macquarie

I see. Mike, could you comment on how you’re seeing some of the big sectors that you sell into relative to last quarter in terms of demand?

Michael Siegal

I’ll let David answer that one.

David Wolfort

Aldo, we see it pretty consistent. If you take a look at this over a 3-year period, 2010 had a substantial recovery for us over 2009, and 2011 was stronger and 2012 our tonnages continue to grow. And so we’ve seen a modest tonnage improvement, remembering that we’re bringing on some new facilities and we’re adjusting our inventory based on our experience with some of these new customers as we’re bringing them onboard in Gary or in Kentucky, which was last year’s theme, and that’s up and running and running well and we’re adjusting the inventories to accommodate those customers. But overall, demand continues to grow.

Aldo Mazzaferro – Macquarie

Great. And just one final – Rick, could you give us the cash number at the end of the quarter?

Rick Marabito

Sure. The cash at end of the quarter was $2.8 million.

Aldo Mazzaferro – Macquarie

All right, thank you.

Operator

Thank you. Our next question comes – is a follow-up from Tim Hayes from Davenport & Company. Your lien is open.

Tim Hayes – Davenport & Company

Thanks. My follow-up has been asked and answered. Thank you.

Michael Siegal

Okay. Thanks, Tim.

Operator

Thank you. I show no further questions at this time. Actually, we have a question from Charles Bradford from Bradford Research. Your line is open.

Charles Bradford – Bradford Research

Hi, good morning.

Michael Siegal

Hi, Chuck.

Charles Bradford – Bradford Research

Did you get a buy from Waren or any of the RG facilities? And what do you think are the possibilities of some of these getting restarted?

Rick Marabito

Well, the short answer is we didn’t buy a lot, but we did buy some. We’ve always had an historical participatory rate with those facilities. It appears to us that there is probably a better chance that maybe Warren starts other than Sparrows Point. But that’s speculation on our part, Chuck. But as the financial problems obviously were pronounced, we throttled back on any participation because we couldn’t count on their supply. So, we really don’t know anything more than you know and we know exactly what we read. And I think that the chances are of a recovery will be so small to the marketplace that it won’t even make a ripple.

Charles Bradford – Bradford Research

Thank you.

Operator

Thank you. I show no further questions at this time and would like to it turn the conference back to Mr. Michael Siegal for closing remarks.

Michael Siegal

Thank you. As a reminder, it is our policy not to provide forward-looking earnings estimates for the upcoming quarter or year and not to endorse any analyst sales or earnings estimates. We anticipate releasing our third quarter 2012 earnings on – around November 8th of 2012.

So this concludes our call, and thank you for your participation and your interest in Olympic Steel. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect at this time.

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