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Olympic Steel, Inc. (NASDAQ:ZEUS)

Q3 2012 Earnings Call

November 8, 2012 10:00 AM ET

Executives

Michael Siegal - Chairman and Chief Executive Officer

David Wolfort - President and Chief Operating Officer

Richard Marabito - Chief Financial Officer & Treasurer

Donald McNeeley - President and COO, Chicago Tube and Iron Co.

Analysts

Luke Folta - Jeffries

Richard Garchitorena - Credit Suisse

Tim Hayes - Davenport

Mark Parr - KeyBanc

Operator

Good morning, and welcome to the Olympic Steel third quarter 2012 conference results call. (Operator Instructions)

Some of the 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 effecting such forward-looking statements. Important assumptions, risks and uncertainties, and other factors that could cause actual results to differ materially are set forth in the company's reports on Form 10-K and 10-Q filed with the Securities and Exchange Commission, including its 2011 Form 10-K and 2012 third quarter Form 10-Q, which will be filed later today. Today's live broadcast will be archived and available on Olympic Steel's website.

At this time, I would like to introduce to your host for today's call, Olympic Steel's Chairman and Chief Executive Officer, Michael Siegal.

Michael Siegal

Good morning, and thank you for joining today's call to review our third quarter and nine months results. On the call with me this morning are David Wolfort, our President and Chief Operating Officer; and Rick Marabito, our Chief Financial Officer and Treasurer; and we're hoping that Don McNeeley, our President and Chief Operating Officer of Chicago Tube and Iron will be joining us later.

I'd like to thank all of you for your participation and for your interest in Olympic Steel. Earlier today we reported financial results for the third quarter and first nine months ended September 30, 2012. Net sales for the quarter totaled $343 million, down 2% from the $349 million we reported in the third quarter of 2011, due to lower pricing for metals.

Net income totaled $1.6 million or $0.15 per diluted share compared with net income of $6.1 million or $0.56 per diluted share in last year's third quarter. Net sales for the nine month period totaled $1.1 billion, up 16% versus $942 million in last year's comparable period. Net income totaled $12.4 million or $1.13 per diluted share compared with $24.4 million or $2.23 per diluted share generated last year.

Our current year-to-date results include three full quarters of contributions from Chicago Tube and Iron, which we acquired last year on July 1. We are encouraged by the operating results generated by the pipe and tube business, since the acquisition and it continues to perform well.

Margin pressure persisted during the third quarter and nine months of 2012, reflecting lower steel and nickel pricing versus the comparable periods in 2011. In addition to higher operating expenses, primarily associated with ongoing expansion projects were incurred during the current year.

Despite the difficult market conditions, third quarter and nine months tonnage volumes increased for both flat rolled and tubular and pipe products, partially offsetting the impact of lower margins. A 5.2% growth in flat-rolled tonnage volume resulted in an increase in Olympic Steel's market share during the third quarter and is indicative of our commitment, the customer satisfaction, and reliability providing higher quality product.

As we look forward to the end of the current year and into 2013, we believe steel prices will remain volatile. And look forward to focusing on things within our control, such as successfully completing our capital projects, increasing cash flow and lowering our debt levels. We also reported today that the Olympic Steel Board of Directors approved a regular quarterly cash dividend of $0.02 per share to be paid on December 17, 2012, to shareholders of record on December 3, 2012.

And I will now turn the call over to Rick.

Richard Marabito

Thank you, Mike, and good morning, everyone. I'll review additional financial highlights from the third quarter and first nine months. But first, let me breakout the impact associated with the CTI acquisition that Michael just touched on.

Of the 16% increase in year-to-date sales, roughly 13.5% can be attributed to the acquisition, while the balance is organic growth. Since we acquired CTI at the beginning of the third quarter last year, our comparative nine months results in 2011 only include three months of contribution from CTI.

As a result of the acquisition, we have been reporting in two segments, our flat product segment and tubular and pipe product segment. For more information, please refer to the segment data provided in our earnings release and in our Form 10-Q, MD&A and footnote.

Volume in the flat rolled segment increased more than 5% during the third quarter to 280,000 tons, up from 266,000 tons last year. Volume increased 3% to 894,000 ton sold for the first nine months of 2012 that compares to 869,000 tons last year. As a percentage of net sales, our consolidated gross margin contracted slightly during the third quarter to 19.3% versus 19.5% in the second quarter of this year and 19.4% in the third quarter last year.

For the nine months period, gross margin was 19.5% compared with 20.3% in the comparable period of 2011. The year-over-year margin declines in both periods are due to less robust spot market and intense pricing pressures on carbon and stainless products versus last year.

Pipe and tube gross margins expanded to 29.0% for the third quarter of 2012 compared with 26.8% in the third quarter of 2011. Last year's third quarter pipe and tube margins were hindered by purchase price accounting requirements that affected cost of good sold for one inventory turn.

For the nine months of 2012 gross profit in the pipe and tube segment reached 29.4% of sales. Operating expenses as a percentage of sales for the first nine months of 2012 totaled 17.1% versus 16.0% last year. The increase is primarily associated with the higher fixed cost related to our expansion effort.

EBITDA defined as our operating income on the face of the income statement before depreciation and amortization expense totaled $42 million in the 2012 nine months compared to $52 million in the first nine months of last year. Capital spending thus far in 2012 has totaled $20.3 million. Year-to-date we have invested $14.7 million in the flat product segment and $5.6 million in the pipe and tube segment.

The majority of CapEx related to the completion of our temper mill project in Gary, Indiana; equipping facilities in Mount Sterling, Kentucky and Chambersburg, Pennsylvania; as well as our new Streetsboro, Ohio, stainless and aluminum facility that just opened during the third quarter. In addition, we procured new laser equipment for CTI.

Total capital spending in 2012 is anticipated to be approximately $25 million for the full year, and will ultimately depend on timing of certain payments at yearend. Commencing in 2013, our capital expenditures are expected to decrease below our depreciation expense, which is at an annual run rate of approximately $20 million.

Our effective income tax rate in the first nine months was 39.0%. We expect our full year 2012 income tax provision to remain in this range. Last year's 33.3% effective tax rate was unusually low and that was due to changes in unrecognized tax benefits that we recorded due to the lapsing of the statute of limitations.

As expected, our inventory turnover rate is improving in our flat roll segment. By the end of the third quarter, our turnover rate had increased to 4.3 times compared to 4.0 times at the end of the second quarter. We still have some room to improve, as we're targeting a return to our historical turnover rate of closer to 5 times. We did reduce our inventory in the third quarter of 2012 by almost $24 million.

As a result of the CTI acquisition, about 16% of our consolidated inventory is stated on LIFO. Again, we had no book LIFO reserve at September 30, 2012, and that is because our pipe and tube inventory on LIFO has 2012 yearend projected quantities and pricing points that are below those of the July 1, 2011 acquisition date. So in an essence, our CTI LIFO inventory is stated at FIFO at September 30, 2012.

Our flat-rolled receivable DSO totaled 41.5 days. Pipe and tube DSOs totaled 31.8 days. So our collections and our receivable quality remain very good. Our debt at quarter end totaled $277.4 million that's down $11.1 million during the third quarter, and our availability was $75 million at September 30.

Going forward, we are focused on using excess cash flow to further reduce our debt. Both debt and inventory levels, in fact have continued to decline since quarter end. And finally, our shareholders' equity increased to $27.46 per share at September 30, 2012.

Now, I will turn the call over to David.

David Wolfort

Thank you, Rick, and good morning. I want to continue to brief all of you on our startup and growth initiatives. And we have been highlighting our six facility startups, which have added some 550,000 square feet of new flat-rolled plate and white metal processing capabilities during the past 21 months.

In total, we incurred about $2.7 million of pre-tax startup loses in the first nine months of 2012, related to these growth initiatives. Our sixth and final project is the new stainless and aluminum specialty metals facility in Streetsboro, Ohio, which began operating during the third quarter, amid the plunging nickel surcharges in the market.

The addition of a physical location in Streetsboro with internal control of slitting, flattening and cutting capabilities in stainless and aluminum provides for continued growth in the food services and transportation markets. Our stainless and aluminum product sales are growing, and now make up about 10% of our consolidated sales mix.

Our white metal sales have grown 36% compared to last year, while industry shipments of these products were down per the Metals Service Center Institutes, September 2012 Metals Activity Report. We expect the Streetsboro facility to ramp up quickly and be profitable in 2013.

On to our Gary, Indiana, temper mill facility, which has been the fastest startup of our three temper mills and continues its march toward full capacity. The $28 million project provides Olympic Steel with up to 150,000 tons of new tempered sheet capacity to expand our flat roll business and satisfy our growing value-added customer base.

Since the first coil was processed in December of last year 2011, we have successfully increased throughput and shipments from that zero point to 330 tons per day so far through 2012, which has brought this facility up to an EBITDA neutral status.

Going forward on a market outlook perspective, finally, let me briefly comment on current market conditions. The global oversupply of steel and negative market sentiment has challenged our financial performance this year.

While our shipments improved in the third quarter and we gained market share, the supply side pressures continue, resulting in declining steel prices and lower margins, especially in the carbon and stainless flat roll areas. The fourth quarter will be impacted by the expected yearend seasonal weakness, fewer shipped days and potential disruptions associated with Hurricane Sandy.

Heading into 2013, the steel price increases announced since mid-October should bring some relief from the continued climate of price declines experienced throughout this year, say, the slight up tick in August of 2012. It appears that market pricing has reached a bottom in October, and the seasonal price increase could be coming earlier than in the past, supported by higher November scrap prices and lower production rates.

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 Luke Folta of Jeffries.

Luke Folta - Jeffries

Couple of questions, Dave, you talked a bit about what the impact on startup cost for the new facilities. I was hoping to try to single out Gary, if we could, just for a minute, because if operating EBITDA, neutral as you said, but when I look at your results for the quarter, the overall expense ratio is a little higher. And I'm trying to get that, if we remove Gary, can you give us a sense of what sort of cost impact did Gary have in the quarter?

Richard Marabito

So first of all we're not going to breakout individual unit's expenses and margin. So obviously, as David said, we started with zero, so we've ramped up. We are basically now running a full first shift. So as we went from first to second to third quarter, we have added people. Third quarter for one shift, we've basically now got a full staff there. So in terms of labor, I tell you, as we bring new business on for next year, we'll be looking at adding a second shift.

But right now, third quarter, we would have the full compliment of the expenses. First quarter, obviously as we started out, we're EBITDA negative, second quarter we cut in to that EBITDA negative, by third quarter we're EBITDA neutral.

Going forward, in terms of expenses as I said looking at 2013, I tell you that the two areas of expense that will increase as we add second shift out in the plant. And then on depreciation, the depreciation will pick up, because we use the straight line half year convention. So year one, you've got basically half year of depreciation. So well, I didn't give you exact numbers, which were not inclined to do. Hopefully that gives you directionally some input.

Luke Folta - Jeffries

Looking on a percentage utilization basis, can you give us a sense of where Gary is utilized right now? And also the step-up in D&A, what will be all in D&A once the Streetsboro and Gary are up and fully up?

David Wolfort

Luke, I'll comment on the temper mill. I'll comment on the temper mill's capacity, as I said earlier, we're up about 330 tons and then there is full processing on top of that. We don't even include that in on the daily run, although that's fairly substantial. I would tell you we're at about 65% of the capacity right now. And it's going to continue as ramp up even through the slowdown in the third quarter. So we're very satisfied with that.

Just from an additional perspective, as I commented of our three temper mills, this has come up the fastest. This facility is also unencumbered by any other pieces of equipment. So it's just strictly a temper mill in this 177,000 square feet, and again, running at about 65% of capacity.

Luke Folta - Jeffries

Rich, can you talk about depreciation?

Richard Marabito

In terms of the annual depreciation?

Luke Folta - Jeffries

The full depreciation associated with that.

Richard Marabito

I don't have the numbers in front of me, but basically the $28 million expenditure, Luke. Rough numbers, I would say probably, because you've got building and processing equipment, you've probably got about 15 to 18 year total blended life on that stock. So my calculator in front of me, but basically a total depreciation rate would probably be close to $28 million investment divided by about 18 years.

Luke Folta - Jeffries

Last question if I could, is there any color you can give us at this point on the order books and how it's shaping up for 2013? Maybe just indications from your OEM customers on what they're seeing and are we looking for up buyings year-over-year with some of those big clients are down?

David Wolfort

I think it's a mix bag, Luke. Quite frankly, we have a number OEMs that are projecting a fairly strong 2013. We have some of our larger players, who have been in the press that are indicating smaller participation. We're on a project-by-project certain platforms that may or may not be affected by the global turn down. As it relates to domestic participation, we see continued up tick in our market share.

Operator

Our next question comes from Richard Garchitorena of Credit Suisse.

Richard Garchitorena - Credit Suisse

So my first question is basically on, you did a good job in terms of increasing the volume this quarter versus last quarter, especially versus the industry. And just wondering, was there a mix of shift that was worth noting quarter-over-quarter?

Richard Marabito

Only to the extent, Richard, that we brought on the volume of the temper mill, so it's in the mix of flat roll versus fabrication versus tubing. We probably see and then of course the white goods as we talk about. We've probably seen a little bit more increase in the flat-rolled side of the business just by the additional aspect of the tonnage coming off the temper mill.

Richard Garchitorena - Credit Suisse

And then given that, do you think margins should improve, given the fact that you're ramping up on the temper mill, the startup cost should go away and you have the Streetsboro, I guess, ramping as well?

David Wolfort

I will just say, we would expect that the margins are going to be obviously indicative of the volatility of the pricing, is probably a bigger factor than almost anything else. We would think that the traditional flat roll business is producing a lower gross margin than the other segments of our business.

Traditionally, although, the weight goods have a little bit lower margin but sort of net out pretty well. So with the increase of flat roll, without the increase of fabrication, we'd probably see a small margin degradation, historically, but we anticipate the growth in the fabrication side as well.

Richard Garchitorena - Credit Suisse

And then a just touching on Chicago Tube and Iron, can you talk a little bit about the what's driving the volume growth there and what do you see over the next couple of quarters?

Michael Siegal

Don, you want to comment on that, please.

Donald McNeeley

We're having a good year. We have seen some softening in the third quarter, but to color it up a little bit, just take two moments here, we've got this fiscal cliff and it's going to have the need to expand the debt ceiling once again at the end of the year.

We saw a stock market reaction yesterday, through the election results. We now have the question of whether or not we're going to see an extension of the Bush Tax Credits. We've got a Democratically-controlled senate, Republican-controlled House, and that sets the stage for further acrimony. And what's the takeaway for that perturbing, the businessmen and women that run our customers, they are adopting somewhat of a latency attitude, a little bit of a stand on the sidelines.

The fourth quarter is going to tell us much about what we think will unfold in '13. There is a lot of uncertainty right now. Dave mentioned earlier the MAR report, which is the benchmark by which we measure market share. At Chicago Tube and Iron, I'm very pleased to tell you, we've garnered market share increases every month sense the Olympic acquisition. And we're very proud of being able to achieve that without market gross margin denigration.

We're up to a 29% gross margin in the third quarter, over 26% in the second quarter. And to drive this all home, our business is very distinct and different than Olympics. We are in a niche market. And we offset volume limitations in a niche market with a highly value-added, highly engineered platform. And we expect very much to continue that in 2013.

So we've got a 100 year history of consecutive profitability. This is probably the deepest into a year that we have been without a good feel for the next year. So I follow the leading economic indicators of my colleague Dave Wolfort. I found his track record to be very accurate. And we will feed off that for our budgeting. So fourth quarter we're watching very closely. We're having a good, but the degree of confidence in that year is still somewhat suspect.

Richard Garchitorena - Credit Suisse

My last question, just touching on David's remarks, do you think that we are past the bottom on pricing. Can you give us your view on the recent price hikes? Are you getting any pushback from your customers? How much do you think that those price hikes will stick going forward? I know you said prices will be volatile, but if just some color on that would be great?

David Wolfort

I think that they were needed, especially U.S. deals lead on October 16, that I thought it was a terrific leading move, well needed. That was the trough in the marketplace, and then with the support of scrap pricing here in November. And then AK's move of the other day, a new core along with that, quite frankly which should I think that, the first increase has been absorbed. And I think part of the second increase will be absorbed. And I see the marketplace moving up from a very sour bottom in the recent months.

And so we do see the uptick. Part of that also, Richard, is the fact that inventories have declined quite a bit. We saw a significantly less spot business in the third quarter. We're starting to see more spot business today, because inventories are down. As Don indicated and others, we've saw an increase in supply in the first nine months. Domestic supply was up dramatically, obviously, imports were up. Pricing in July from June, was down about 8%.

As we reference, we saw a momentary uptick in August and then a slight down. We hit that trough and now these increases are supporting an upward momentum that is colored around narrow inventories, and more spot market participation.

Operator

Our next question comes from the line Tim Hayes of Davenport.

Tim Hayes - Davenport

Couple of questions, first on the flat products, do you have the direct tonnage and then the gross profit for the segment?

Richard Marabito

Tim, we'll file our 10-Q here this afternoon.

Michael Siegal

He's looking at it up, Tim.

Tim Hayes - Davenport

My second question is for Mike. Listening to Senator Boehner's comments yesterday, he seemed to reaching a cross aisle quite a bit, and maybe more normal. If you heard what he said, anything that, he said that maybe he surprised you and encourages you that two parties could come together and start working more closely together to resolve some of our country's issues?

Michael Siegal

It's hard for me to speculate on the reality of Washington. When Boehner is reaching across the aisle, it's usually with alligator arms. So when you see Harry Reid's, sort of response to Congressman Boehner, I'm not encouraged that after spending $2.5 billion that we wind up in the same place.

When you look at what the government has to really try and deal with the entitlements, it's not about taxations, it is about the entitlements. We're chewing up all of the revenue into entitlements, and I don't see any kind of discussion in real substance that says we're going to touch the thing that's driving the cost structures up in terms of attacking those entitlements.

I think it is a good reflection, and the change of the dynamics of America. We'd all just have to adjust to the obvious same reality, not a new reality, it's a same reality. So no, I'm not encouraged.

Richard Marabito

So you wanted the flat-rolled tonnage??

Tim Hayes - Davenport

Yes, the direct. I got the 280. I just wanted to get the direct?

Richard Marabito

It was 262, and about of 19,000 of toll, so 262 to direct, about 19,000 toll.

Tim Hayes - Davenport

And do you have the gross profit for the segment handy?

Richard Marabito

Yes, it was 17.1%.

Operator

Our next question comes from Mark Parr, KeyBanc.

Mark Parr - KeyBanc

I was wondering and I may have miss this, but you had a seen a significant upside in plate imports, and I just wonder, Dave or Michael if you can just picture a color on how problematic the carbon plates imports have been here for the second half profitability? And where you would see that import availability heading into the first part of next year?

David Wolfort

As you well know, we had onslaught of imports this year. Plate was a big part of that. And as this plate market of which we do participate, but not as much as we did in years passed, because of the compression of margin. And we've gone downstream as you well now into value-added.

So while there is quite a bit of import plate in the marketplace, we participated very sparingly with that product because of our need for consistency. The domestic reduction into our value-added operations, but there is no doubt that foreign plate has put a lot of pressure on plate pricing and then the domestic producers have had to respond in order to maintain their market share.

Mark Parr - KeyBanc

Do you see that pressure easing up here, as you move into the first part of next year?

Michael Siegal

Well, I think, Mark, the answer to that is I think it was pretty severe this year. And I do see it easing up, but I don't see a significant differential between domestic pricing and foreign pricing. And as long as that band is fairly narrow, along with some other issues, Chinese production, so forth, I don't think we'll have the same pressures. But again, that band, that differential between foreign pricing and domestic pricing has narrowed.

Mark Parr - KeyBanc

Dave, you're one of the best market watchers and followers that I know of. And I really do appreciate your color. One thing that we definitely noticed this year with the fall off in export pricing out of China is it seems like there is less upside support for domestic pricing, because of that spot China price. Could you give us an update on what the costs is to bring a coil into the Midwest out of Shanghai and what is the updated number?

David Wolfort

Mark, we wouldn't see that. What we would see is export out of China moving into other countries and product from those countries that's which are allowed to be exported into this country, that product moving here. But quite candidly on the flat-rolled side, we saw pricing degradation on all products, from the third week of January forward with a little respite, quite frankly, mid-March. And then rekindling of the market price erosion from April 1, through June, and then it hit that trough in July where it dropped another 8% without hitting the actual numbers.

And then we had a little staccato move where pricing bubbled up with some hope in August, and then started to slide. Now, we have the support of mid-October going forward. But all of that exaggerated by the just too much global production inclusive of this country. And we so had too much production. And you and I, and all of us have talked about the RG steels that aren't anymore and those that just chose to continue to produce without curtailing the supply and demand while it was growing.

And our numbers show that our participation grew, they didn't grow at the rate that supply grew, neither domestically nor from an overall perspective, from a global perspective. So it's too much supply, and too little demand and it's really not any more magical then that.

Operator

I'm showing no further questions at this time, and would like to turn the conference back over to Mr. Michael Siegal for any closing remarks.

Michael Siegal

Thank you. As a reminder, it is our policy not to provide or endorse any forward-looking earnings estimates for the upcoming quarter or year. We anticipate releasing our fourth quarter and full year 2012 earnings on or around February 21, 2013. So this concludes our call. And again, thanks for your participation and interest in Olympic Steel.

Operator

Ladies and gentlemen, this does conclude today's conference. You may all disconnect and have a wonderful day.

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