Olympic Steel, Inc. (NASDAQ:ZEUS) Q1 2019 Earnings Conference Call May 2, 2019 9:00 AM ET
Rick Marabito - Chief Executive Officer
David Wolfort - President
Rich Manson - Chief Financial Officer
Andrew Greiff - Executive Vice President and COO
Don McNeeley - President, Chicago Tube & Iron Business
Conference Call Participants
Martin Englert - Jefferies
Phil Gibbs - KeyBanc Capital Markets
Chris Sakai - Singular Research
Good morning, and welcome to the Olympic Steel 2019 First Quarter Financial Results Conference Call. At this time all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. [Operator Instructions]
Some statements made on today's call will be predictive and are intended to be made as forward-looking within the safe harbor protection 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 the 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.
During today's discussion, we may reference adjusted net income per diluted share, which is a non-GAAP financial measure. A reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measure is provided in the press release that was issued this morning, which can be found on our website.
Today's live broadcast will be archived and available for replay on Olympic Steel's website.
At this time I'd like to introduce your host for today's call, Olympic Steel's Chief Executive Officer, Rick Marabito. Please go ahead, Mr. Marabito.
Thank you, operator. Good morning and thank you for joining us to discuss Olympic Steel's 2019 first quarter results. Joining me on the call this morning are Olympic Steel's President, David Wolfort; CFO, Rich Manson; Executive Vice President and Chief Operating Officer, Andrew Greiff; and President of our Chicago Tube and Iron business, Don McNeeley.
During the first quarter of 2019, we delivered strong top line performance, growing net sales to $446 million. That's up nearly 20% over last year and nearly 4% over the fourth quarter, which was primarily due to higher average selling prices and higher volumes from our Specialty Metals and Pipe and Tube segments.
Given the pricing uncertainty of the fuel market throughout the quarter, we saw our shipment of carbon flat products decline year-over-year, and that was consistent with the trends seen throughout the steel service center industry. However, shipments in both of our Specialty Metals and our Pipe and Tube businesses continued to outperform their respective markets, benefiting from our recent capital investments and successful execution of growth initiatives.
Our new slitting line in Streetsboro, Ohio; and our new cut-to-length line in Schaumburg, Illinois; and our new fixed-axis laser at CTI are focused on growing business in the areas with higher returns and less volatility along with improving our operating efficiencies. We began to see the benefits of these efforts in our first quarter results with additional benefits to be recognized in future quarters as those lines become fully operational.
Net income was $2.1 million or $0.18 per diluted share in the first quarter, and that's compared with $7.6 million or $0.67 per diluted share in the same quarter of 2018.
Next I'd like to highlight our recent acquisition, McCullough Industries. We acquired McCullough in early January 2019. McCullough has been an excellent addition. The business is off to a strong start, and we're pleased with how the integration is progressing. This is the first manufacturer of metal-intensive branded products that we've added to our portfolio. And we are looking to add similar companies in the future. What's most exciting about McCullough are the real synergies we're seeing. We're able to use our service center capabilities to benefit McCullough's manufacturing process. As David will discuss later, we're excited about the growth opportunity that will come from combining the expertise of our 2 successful companies.
Looking ahead, the second quarter is usually seasonally stronger than our first quarter, and we expect this will be the case this year. We remain focused on controlling our operating expenses and improving our inventory turnover during the remainder of the year.
Lastly, our Board of Directors declared a regular cash dividend of $0.02 per share which is payable on June 17, 2019 to holders of record on June 3. This marks our 56th consecutive quarter that we paid a cash dividend.
Now I'd like to turn the call over to David for his comments.
Thank you, Rick. Now Olympic Steel continues on its quest to grow and diversify. As Rick mentioned just a moment ago, in January of 2019, we acquired McCullough Industries, our first manufacturer of metal-intensive branded products, and the integration has gone very well, and we are realizing profit return multiples that are considerably higher than service center returns.
We've enhanced profitability by using our expertise as a service center in supplying raw materials from our Cleveland location while utilizing our own trucking fleet. We've improved laser-cutting yield and efficiency, and we've generated benefits in scrap pricing due to our combination.
Our experience proves that we can continue to diversify our business by following the McCullough model by delivering strategic innovations that Olympic Steel as a service center can bring to the manufacturing process. We continue to look at innovative ways to expand our offerings without requiring a significant investment in additional assets.
We recently began utilizing new third-party space just outside Birmingham, Alabama to expand our distribution of sheeted plate products in the Southeast. We promoted Hannah Price to General Manager to lead this new project.
At Berlin Metals, we have new leadership in place. As Roy Berlin retired on April 1, Andy Tobias was appointed new General Manager. And we are confident that Berlin Metals will continue to be successful and expand its stainless steel business under his leadership.
In the Specialty Metals business, we've continued our positive momentum by adding experienced salespeople and product specialists to help grow existing business in value-added areas. Under Andy Markowitz's leadership, our Specialty Metals segment has grown significantly over the past 10 years, now representing 20% of our total sales.
All of our capital expenditures in Specialty Metals during the past 24 months are up and running and contributing to profitability. Late last year, we added a second slitter in our Streetsboro operation and a new specialty metals cut-to-length line in our Schaumburg facility. We expect both lines to be operating at full processing capacity in the second quarter.
With respect to Pipe and Tube, we have been diligent in terms of spending CapEx and continuing to refine our unique value added proposition we provide to customers. This business continues to have a strong pricing and demand environment overall, and the investments we've made over the last several years have paid dividends.
Now we are seeing a full year benefit of our growth initiatives, including the redirection of some of the focus in our Southeast to tube distribution, which has been well received by customers in the region. The result is that our Pipe and Tube segment reported both record first quarter sales and earnings.
With that, I will turn the call over to Rich for the financial review.
Thank you, David, and good morning to everyone. Before I go through our results, I want to remind everyone that our 2019 first quarter results include the operations of Berlin Metals and McCullough Industries, both of which we did not own in the first quarter of 2018.
As Rick mentioned, our top line results remained strong in the first quarter. We recorded net sales of $446 million, an increase of 19% compared with last year's first quarter. That was due to higher average selling prices and increased volumes in our Specialty Metals and Pipe and Tube segments. All 3 of our operating segments grew their net sales over the 2018 first quarter. Our sales mix was 62% Carbon Flat, 20% Specialty Metals and 18% Pipe and Tube, virtually identical for our mix in the fourth quarter and well aligned with our growth strategies.
The climb in steel pricing that started in July 2018 continued to put pressure on margins, particularly in Carbon Flat Products. As a result, our consolidated gross margin dollars for the quarter were down compared with last year. However, both our Specialty Metals and Pipe and Tube segments grew their gross margin dollars year-over-year. The emphasis on more value-added products raised our gross margin dollars per ton in the first quarter 2019 when compared with the first quarter 2018.
Our operating expenses for the quarter were $73.5 million, up $5 million or 7% over last year, and that is primarily due to the operating expenses of Berlin and McCullough, which were not included in the first quarter results of 2018, and higher operating expenses in our Specialty Metals and Pipe and Tube segments which resulted from higher year-over-year shipping volumes.
For the first quarter of 2019, we reported net income of $2.1 million or $0.18 per share compared with $7.6 million or $0.67 per share in the same quarter a year ago. In calculating our net income, we recorded an effective tax rate of 27.1% in the first quarter of 2019, and that compares to 26% in the first quarter of 2018. We expect our effective rate to be between 26% and 28% for the balance of the year.
We did not report any LIFO adjustments in the first quarter of 2019. And our results in the first quarter of 2018 included $500,000 of LIFO expense.
Our balance sheet remains strong. At March 31, 2019, we had a total of $799 million of assets, which is a $39 million increase over December 31, 2018. The increase in assets was primarily attributable to the acquisition of McCullough Industries and the recognition of the $30 million right-of-use asset under the new lease accounting standard. We remain focused on efficiently converting our accounts receivable and inventory into cash.
For the quarter, we had DSOs of 42.9 days. And we turned our flat-rolled inventory 4.7x, which is an improvement over the 4.3x we turned in 2018. Also, our inventory at March 31 declined by $26 million from the December 31 levels.
Our capital expenditures for the quarter were $2.4 million, primarily consisting of the final capitalization of the Schaumburg building expansion that houses our new specialty metals cut-to-length line. And given the market conditions, we anticipate that our capital expenditures this year will run at 75% or less of our annual depreciation run rate.
Our total debt increased by $11 million to $313 million during the quarter, and this increase was primarily attributable to the acquisition of McCullough Industries in early January. We do expect the debt level to decrease throughout 2019 as we continue to reduce inventory.
Later today, we plan to file our Form 10-Q, which will provide additional details on our operating results for the quarter of 2019.
Now operator, let's open the call for questions.
Thank you. We’ll now begin the question and answer session. [Operator Instructions] The first question is from Martin Englert, Jefferies.
Hi good morning everyone.
So within the release and then also in your prepared remarks on the call, you did call out that the quarter is typically seasonally stronger sequentially, any type of brackets that you can provide as far as the sequential increase in volumes that you may be anticipating?
Sure, Martin. It's Rick. We're looking at a pretty steady demand environment. I think we're going to see a slight tick-up in terms of the Specialty Metals business in the second quarter. The carbon side looks pretty flat quarter-to-quarter. And we're expecting another really solid quarter from CTI.
Okay. And the Carbon Flat volumes that were lower I think 8% year-on-year, from what you're seeing, what do you think is causing this shipment contraction that we're seeing? And it's not only specific to the Company, but we're seeing it across the industry.
Martin, David Wolfort here. We're seeing a lot of deleveraging in our customers. The discomfort and the tightness in the market early on in '18 influenced a lot of our larger OEMs to carry heavier inventory than they would have liked. We're seeing a deleveraging of that inventory in anticipation of prices continuing to move downward.
Okay. And any idea how long this destock could potentially persist amongst the downstream users?
Well, they're all, it's all on an individual basis. But from an overall standpoint, we see -- we still see growth in the first quarter and second quarter from our large OEMs. And so it's single-digit growth as opposed to double-digit growth of last year. The manifestation of that with deleveraging inventory is now, I think, pretty much coming to a conclusion. And we're seeing a steady ordering pattern from the customers.
And Martin, I think the other thing is that the spot market, given the pricing uncertainties, the spot market's really been down year-over-year as well.
And as I understand your comments correctly, so we're starting to see the end user destocking abating from what you see today?
Okay. Got it, if I could, one last one the carbon gross margins gross profits declined to about $166 per ton in Q1. Looking ahead of Q2, can you discuss some of the puts and takes on the gross profits per ton? Are you seeing any incremental pressure quarter-to-quarter or inventory cost declining more quickly than selling prices that may offer some relief?
Yes. So we're looking, entering into the second quarter, we're looking at that margins on the Carbon Flat being pretty, pretty stable. We're not seeing a lot of movement there. You are right. The costs side and the inventory continues to go down. We've also seen the market price from the sell side continue to erode through April. So we're looking at pretty, pretty consistent and stable market, margins, Martin.
And would say that's similar for the Specialty business as well quarter-to-quarter? Or are there different dynamics there with your growth [trend]?
Martin, this is Andrew Greiff. I would say you would, you'd expect to see the same trend.
Okay thanks a lot for detail and good luck.
Next question is Phil Gibbs, KeyBanc Capital Markets.
Rick, just curious about McCullough and how you're seeing the integration, kind of what the opportunities are and if you'd expect more to be on your plate as free cash flow starts to come back your way.
Yes. So as we talked about this morning, McCullough is off to a great start. As we expected, we have a lot of synergies to the Company. The Company was already very successful. What we like about it is all the things we highlighted in our comments in terms of the synergies that we bring as a service center to a manufacturer.
We really like the return in that business. We mentioned that the returns of the of McCullough in terms of profitability are higher than what we see in service center, the service center arena. So part of our strategy going forward is to remain focused on adding additional companies like McCullough, not necessarily in the McCullough Industries' area of low profile hoppers and high-profile hoppers, but metal-intensive manufacturers of other products. And you're right, we do see cash flow positive coming back to the Company throughout the rest of the year. And certainly, we'll be focused on using some of that cash generation in the future to buy more McCullough-like companies.
Rick, where did you, you all tuck that into?
So that is under the Carbon Flat segment.
Okay. And then a question on I think one of your newest releases that came out either yesterday or the day before. It's been a busy week. You've got a new facility opening up in the South, I believe, for plate and maybe some other products. What was the catalyst behind that?
Phil, David Wolfort here. The catalyst behind that is the trade between distribution costs and occupancy costs. And as distribution costs continue to rise and as the full-on longer distance over the road from our facilities, particularly in this case outside of Birmingham, Alabama being delivered from our Winder, Georgia facility, it is significantly advantageous for us to find a location in Alabama, which we did, and again, to distribute to a marketplace that we've served now for 20 years and making it significantly more efficient. We'll continue to explore all those options in states where we currently supply material but don't have a physical presence, again, looking to trade distribution costs for lower occupancy costs and be more efficient and be able to respond on a just-in-time basis to our current customer base.
We like that model because, as David said, I think it's very low cost, and it will allow us to expand our sales into regions we already service at a real efficient and low-cost way.
And I think, David, you hit it on the head in terms of the next line of questioning, and I was going to ask about here is just some of the inflation. Obviously, there was a lot of inflation in wages and freight and just other consumables over the course of the last 1.5 years. Has any of that abated? I mean I think we're starting to see spot freight rates decline a tick. I know the labor markets remain tight. Anything that you can comment on there in terms of what you're seeing in the baseline conversion process?
Yes. Phil, it's Rich. And what I can tell you on the distribution expenses, like when you're comparing first quarter of '19 to first quarter of 18, it's sort of an increase, and that is true because it's a full year apart. What we did see is, sequentially, our freight rates from Q1 goes down from Q4 of '18. And we think that we're in a fairly stable, and in some cases, in some markets, we are seeing decline in distribution expenses.
Yes. So we agree with you, Phil. I think freight rates have peaked a quarter or 2 ago.
We have a question from Chris Sakai, Singular Research. Please go ahead sir.
Hi good morning.
Just about McCullough, the acquisition of McCullough, can you disclose how much this will possibly add to the, your net sales?
So, no, Chris, we have not, we're not breaking out the financial results from McCullough. In the 10-Q that will be filed later this afternoon, there will be some footnote disclosures on McCullough relative to the acquisition, but we're not going to be breaking out McCullough as a separate entity going forward.
Okay. And then in the Specialty Metals segment, what were the main drivers there as far as the increase, the growth in the sales?
Well, this is Andrew Greiff. We've seen a continuation of growth in our food equipment. Our customer base, that was very strong in the first quarter. Appliance was also very strong. And automotive, for us, it's been a growing part of the Specialty Metals segment. We've seen growth both in our aluminum and in our stainless participation in that industry.
There are no further questions at this time. I'd like to turn the floor back over to Rick Marabito for closing remarks. Please go ahead, sir.
Well, thank you everybody for joining us this morning and for your interest in Olympic Steel. We look forward to speaking with some of you at our upcoming conferences. Thank you, and have a great day.
This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.