Olympic Steel - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (216) 292-3800

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No þ

Indicate the number of shares of each of the issuer’s classes of common stock, as of the latest practicable date:

The accompanying consolidated financial statements have been prepared from the financial records of Olympic Steel, Inc. and its wholly-owned subsidiaries (collectively Olympic or the Company), without audit and reflect all normal and recurring adjustments which are, in the opinion of management, necessary to fairly present the results of the interim periods covered by this report. Year-to-date results are not necessarily indicative of 2005 annual results and these financial statements should be read in conjunction with the Company’s 2004 Annual Report on Form 10-K for the period ended December 31, 2004. All significant intercompany transactions and balances have been eliminated in consolidation. Investments in the Company’s joint ventures are accounted for under the equity method.

The Company maintained allowances for doubtful accounts and unissued credits of $5.5 million and $4.3 million at September 30, 2005 and December 31, 2004, respectively. The allowance for doubtful accounts is maintained at a level considered appropriate based on historical experience and specific customer collection issues that have been identified. Estimations are based upon a calculated percentage of accounts receivable, which remains fairly level from year to year, and judgments about the probable effects of economic conditions on certain customers, which can fluctuate significantly from year to year. The Company cannot guarantee that the rate of future credit losses will be similar to past experience. The Company considers all available information when assessing each quarter the adequacy of its allowance for doubtful accounts.

Steel inventories consist of the following:

The Company’s two joint ventures are Olympic Laser Processing, LLC (OLP), a company that processes laser welded steel sheet blanks for the automotive industry, and G.S.P., LLC (GSP), a certified Minority Business Enterprise company supporting the flat-rolled steel requirements of the automotive industry. As of September 30, 2005, Olympic guaranteed 50% of OLP’s $14.3 million and 49% of GSP’s $3.7 million of outstanding debt on a several basis.

The following table sets forth selected data for the Company’s OLP joint venture:

The Company records 50% of OLP’s net income or loss to its Consolidated Statements of Operations as “Income (Loss) from Joint Ventures.”

The following table sets forth selected data for the Company’s GSP joint venture:

The Company records 49% of GSP’s net income or loss to its Consolidated Statements of Operations as “Income (Loss) from Joint Ventures.”

The Company’s secured bank-financing agreement (the Credit Facility) is a revolving credit facility collateralized by the Company’s accounts receivable, inventories, and substantially all of the property and equipment. Borrowings are limited to the lesser of a borrowing base, comprised of eligible receivables and inventories, or $110 million in the aggregate. In June 2005, the Company entered into an amendment of the Credit Facility which: (i) extended the maturity date of the existing Credit Facility from December 15, 2006 to December 15, 2008; and (ii) added an accordion feature which allows the Company to add up to $25 million of availability at a future date. The Company has the option to borrow based on the agent’s base rate or Eurodollar Rates (EURO) plus a premium. The Company’s effective borrowing rate, inclusive of deferred financing fees, for the first nine months of 2005 was 6.1% compared to 5.6% for the comparable period in 2004.

Fees and expenses associated with origination and amendments of the Credit Facility are being amortized to “Interest and Other Expense on Debt.”

The Credit Facility requires the Company to comply with various covenants, the most significant of which include: (i) minimum availability of $10 million, tested monthly, (ii) a minimum fixed charge coverage ratio of 1.25, and a maximum leverage ratio of 1.75, which are tested quarterly, (iii) restrictions on additional indebtedness, and (iv) limitations on capital expenditures.

As of September 30, 2005, the Company has $13.0 million of outstanding debt, which consisted of $7.2 million of revolver borrowings and industrial revenue bonds and $5.8 million of checks issued by the Company that have not cleared the bank. During October 2005, the Company repaid the remaining $7.2 million of outstanding debt. The Company had over $100 million of availability under its Credit Facility as of November 1, 2005 and it is in compliance with its covenants.

In 2002, the Company closed its unprofitable tube processing operation (Tubing) in Cleveland, Ohio. In accordance with Statement of Financial Accounting Standards No. 144 (SFAS No. 144), “Accounting for the Impairment or Disposal of Long-Lived Assets,” Tubing was accounted for as a discontinued operation and its assets were written down to their estimated fair value less costs to sell. The accompanying Consolidated Statements of Operations reflects a $487 thousand asset impairment charge in 2004 which reduced the carrying value of the assets held for sale to its then estimated fair value of $150 thousand. The assets were sold in the third quarter of 2004 for $150 thousand.

Earnings per share have been calculated based on the weighted average number of shares outstanding as set forth below:

At September 30, 2005, stock options to purchase 753,845 shares were outstanding, of which 635,845 were exercisable at prices ranging from $1.97 to $15.50 per share, none of which were anti-dilutive.

Statement of Financial Accounting Standards No. 123 (SFAS No. 123), “Accounting for Stock-Based Compensation,” encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock.

If the Company had elected to recognize compensation cost based on the fair value of the options granted at the grant date under SFAS No. 123, net income and earnings per share would have been reduced by the amounts shown below:

Interest paid during the first nine months of 2005 and 2004 totaled $3.0 million and $2.4 million, respectively. Taxes paid during the first nine months of 2005 and 2004 totaled $10.2 million and $15.5 million, respectively.

In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 151 (SFAS No. 151), “Inventory Costs — an amendment of ARB No. 43, Chapter 4” which clarifies that abnormal amounts of idle facility expenses, freight, handling costs and wasted materials (spoilage) should be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 is not expected to have a material impact on our financial statements.

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123-R (SFAS No. 123-R). SFAS No. 123-R establishes standards for accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those securities. SFAS No. 123-R also requires an entity to recognize the cost of employee services received in share-based payment transactions, thereby reflecting the economic consequences of those transactions in the financial statements. SFAS No. 123-R applies to all awards granted on or after July 1, 2005, and to awards modified, vested, repurchased, or canceled after that date. In April 2005, the FASB delayed the effective date of SFAS No. 123-R, so that it applies to our annual period beginning on January 1, 2006. Due to the relatively few number of stock options vesting after the effective date, SFAS No. 123-R is not expected to have a significant impact on our financial statements unless additional stock option grants are awarded.

The following discussion and analysis of our financial conditions and results are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from these estimates under different assumptions or conditions. On an ongoing basis, we monitor and evaluate our estimates and assumptions.

For further information regarding the accounting policies that we believe to be critical accounting policies and that affect our more significant judgments and estimates used in preparing our consolidated financials statements, see our Annual Report on Form 10-K for the period ended December 31, 2004.

Our results of operations are affected by numerous external factors, such as general and global business, economic and political conditions, competition, steel pricing and availability, energy prices, pricing and availability of raw materials used in the production of steel, customer demand for steel and their ability to manage their credit line availability and layoffs or work stoppages by our own, our suppliers’ or our customers’ personnel.

We sell a broad range of products, many of which have different gross profits and margins. Products that have more value-added processing generally have a greater gross profit and higher margins. Accordingly, our overall gross profit is affected by, among other things, product mix, the amount of processing performed, the availability of steel, volatility in selling prices and material purchase costs. We also perform toll processing of customer-owned steel, the majority of which is performed in our Detroit and Georgia operations.

Our two joint ventures are Olympic Laser Processing, LLC (OLP), a company that processes laser welded sheet steel blanks for the automotive industry, and G.S.P., LLC (GSP), a certified Minority Business Enterprise company supporting the flat-rolled steel requirements of the

automotive industry. Our 50% interest in OLP and 49% interest in GSP are accounted for under the equity method.

Financing costs include interest expense on debt and deferred financing and bank amendment fees amortized to expense.

We sell certain products internationally. All international sales and payments are made in United States dollars. Recent international sales have been immaterial to our consolidated financial results.

In 2002, we closed our unprofitable tube processing operation (Tubing) in Cleveland, Ohio. In accordance with Statement of Financial Accounting Standards No. 144 (SFAS No. 144), “Accounting for the Impairment or Disposal of Long-Lived Assets,” Tubing was accounted for as a discontinued operation and its assets were written down to their estimated fair value less costs to sell. The accompanying Consolidated Statements of Operations reflects a $487 thousand asset impairment charge which reduced the carrying value of the assets held for sale to its then estimated fair value of $150 thousand. The assets were sold in the third quarter of 2004 for $150 thousand.

We have four collective bargaining agreements covering approximately 185 employees at our Minneapolis and Detroit facilities. The collective bargaining agreement for employees at our Minneapolis coil facility was extended to September 30, 2010. An agreement covering other Minneapolis employees expires in 2006, while agreements covering Detroit employees expire in 2007 and 2009. We have never experienced a work stoppage and we believe that our relationship with our employees is good. However, any prolonged work stoppages by our personnel represented by collective bargaining units could have a material adverse effect on our business, financial condition, results of operations or cash flows.

The following table sets forth certain income statement data for the three and nine month periods ended September 30, 2005 (dollars are shown in thousands):

Tons sold decreased 5.5% to 306 thousand in the third quarter of 2005 from 323 thousand in the third quarter of 2004. Tons sold in the third quarter of 2005 included 256 thousand from direct sales and 50 thousand from toll processing, compared with 283 thousand direct tons and 40 thousand toll tons in the comparable period of last year. Tons sold in the first nine months of 2005 decreased 6.5% to 984 thousand from 1.05 million last year. Tons sold in the first nine months included 841 thousand from direct sales and 143 thousand from toll processing, compared with 906 thousand direct tons and 146 thousand toll tons in the comparable period of last year. The decreases in tons sold for the 2005 periods were primarily attributable to reduced sales to automotive customers, reduced sales to other service centers and lower overall demand across most sectors in 2005 when compared to 2004.

Net sales decreased 14.7% to $208.4 million in the third quarter of 2005 from $244.1 million in the third quarter of 2004. For the first nine months of 2005, net sales increased 12.3% to $734.4 million from $653.9 million in the comparable 2004 period. Average selling prices for the third quarter of 2005 decreased 9.7% from last year’s third quarter and decreased 10.0% from the second quarter of 2005. Higher levels of inventory held by steel service centers and end-use customers led to competitive pressures and reduced selling prices during the second and third quarters of 2005. Average selling prices began increasing during the end of the third quarter of 2005 and we expect that trend to continue into the fourth quarter of 2005.

As a percentage of net sales, gross profit (exclusive of depreciation) decreased to 16.0% in the third quarter of 2005 from 26.9% in the third quarter of 2004. For the first nine months of 2005, gross profit decreased to 16.2% from 29.0% in the comparable 2004 period. As the base price of steel declined, competitive pressures resulted in lower current selling prices and gross margin percentages during the first nine months of 2005. Gross margin levels began increasing during the end of the third quarter of 2005 and we expect that trend to continue into the fourth quarter of 2005.

Operating expenses in the third quarter of 2005 decreased 16.2% to $28.5 million from $34.0 million in last year’s third quarter. For the first nine months of 2005, operating expenses decreased 15.2% to $91.1 million from $107.4 million in the comparable 2004 period. The decreases in operating expenses are primarily the result of lower variable compensation in 2005. As a percentage of net sales, operating expenses decreased to 13.7% for the third quarter of 2005 from 13.9% in the comparable 2004 period. For the first nine months of 2005, operating expenses decreased to 12.4% of net sales from 16.4% in the last year’s comparable period.

Loss from joint ventures totaled $564 thousand in the third quarter of 2005, compared to income of $58 thousand in the third quarter of 2004. For the first nine months of 2005, loss from joint ventures totaled $121 thousand, compared to income of $230 thousand in 2004. We expect joint venture losses to continue in the fourth quarter.

Financing costs totaled $742 thousand for the third quarter of 2005 compared to $1.1 million for the third quarter of 2004. For the first nine months of 2005, financing costs decreased to $3.4 million from $3.5 million in 2004. Our effective borrowing rate, inclusive of deferred financing fees, for the first nine months of 2005 was 6.1% compared to 5.6% in 2004. At the end of the third quarter of 2005, we had reduced our total debt by $69.6 million to $13.0 million, which consisted of $7.2 million of revolver borrowings and industrial revenue bonds and $5.8 million of outstanding checks. During October 2005, we repaid the remaining $7.2 million of outstanding debt and, as of November 1, 2005, we had over $100 million of availability under the Credit Facility. We expect debt levels to remain low during the fourth quarter of 2005.

For the third quarter of 2005, income before income taxes totaled $3.5 million compared to $30.6 million in the third quarter of 2004. An income tax provision of 38.5% was recorded for the third quarter of 2005, compared to a provision of 39.2% for the third quarter of 2004. For the

first nine months of 2005, income before taxes totaled $24.0 million compared to $78.9 million for the first nine months of 2004. An income tax provision of 38.5% was recorded during the first nine months of 2005 compared to a 39.2% provision recorded during the comparable 2004 period. The effective tax rate decreased in 2005 due to our estimated benefit of the manufacturing deduction provided by The American Jobs Creation Act of 2004. We expect the effective tax rate to approximate 38.5% for the remainder of 2005. Taxes paid totaled $127 thousand and $11.4 million for the third quarter of 2005 and 2004, respectively. Taxes paid during the first nine months of 2005 totaled $10.2 million compared to $15.5 million for the comparable 2004 period.

Net income for the third quarter of 2005 totaled $2.2 million or $.21 per diluted share, compared to net income of $18.6 million or $1.80 per diluted share for the third quarter of 2004. Net income for the first nine months of 2005 totaled $14.8 million or $1.42 per diluted share, compared to $47.9 million or $4.70 per diluted share in the first nine months of 2004.

Our principal capital requirements include funding working capital needs, purchasing and upgrading processing equipment and facilities, and investing in joint ventures. We use cash generated from operations, leasing transactions, and our credit facility to fund these requirements.

Working capital at September 30, 2005 decreased $57.2 million from the end of the prior year. Significant working capital changes included an $82.8 million decrease in inventories from December 31, 2004, an $875 thousand decrease in accounts receivable, offset by decreases of $9.8 million in accounts payable and $12.8 million in accrued payroll and accrued liabilities.

For the nine months ended September 30, 2005, we generated $83.4 million of net cash from operations, of which $21.4 million was derived from cash earnings and $62.0 million from working capital reductions. We used $82.0 million to pay down debt and $1.7 million for capital spending. Over the next 18 months, we expect to increase our capital spending significantly over recent levels. We also anticipate using our financial position to take advantage of a consolidating service center industry.

Our secured bank-financing agreement (the Credit Facility) is a revolving credit facility collateralized by our accounts receivable, inventories, and substantially all of our property and equipment. Borrowings are limited to the lesser of a borrowing base, comprised of eligible receivables and inventories, or $110 million in the aggregate. In June 2005, we entered into an amendment of the Credit Facility which: (i) extended the maturity of the existing Credit Facility from December 15, 2006 to December 15, 2008; and (ii) added an accordion feature which allows us to add up to $25 million of availability at a future date.

Fees and expenses associated with the origination and amendments of the Credit Facility are being amortized to interest and other expense on debt.

The Credit Facility requires us to comply with various covenants, the most significant of which include: (i) minimum availability of $10 million, tested monthly, (ii) a minimum fixed charge coverage ratio of 1.25, and a maximum leverage ratio of 1.75, which are tested quarterly, (iii) restrictions on additional indebtedness, and (iv) limitations on capital expenditures. At November 1, 2005, we had over $100 million of availability under our Credit Facility and we were in compliance with our covenants.

We believe that funds available under our Credit Facility, together with funds generated from operations, will be sufficient to provide us with the liquidity necessary to fund anticipated working capital requirements and capital expenditure requirements over the next 12 months. Capital requirements are subject to change as business conditions warrant and opportunities arise.

This document contains various forward-looking statements and information that are based on management’s beliefs as well as assumptions made by and information currently available to management. When used in this document, the words “anticipate,” “expect,” “believe,” “estimate,” “project,” “plan” and similar expressions are intended to identify forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks, uncertainties and assumptions including, but not limited to:

Should one or more of these, or other risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, expected, believed, estimated, projected or planned. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to republish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof.

During 2004, steel producers were significantly impacted by a shortage of raw materials, rising raw material prices, increased product demand, producer consolidation and longer lead time requirements. These conditions resulted in unprecedented cost increases and translated into higher gross profit dollars and margin percentages. During 2004, we were able to pass producers’ price increases and surcharges on to our customers. The base price of carbon flat-rolled steel began declining in September 2004, continuing into August 2005. This decline reduced our gross profit margin percentages to levels which are lower than our historical levels. Higher levels of inventory at steel service centers and end-use customers have caused competitive pressures which have compressed gross margin percentages during the first nine months of 2005. Based on industry statistics, service center inventory levels have decreased during the third quarter of 2005, while producers increased their prices. We believe these conditions will allow margin pressures to subside during the remainder of 2005.

Approximately 12% of our net sales in the first nine months of 2005 were directly to automotive manufacturers or manufacturers of automotive components and parts. The automotive industry experiences significant fluctuations in demand based on numerous factors such as general economic conditions and consumer confidence. The automotive industry is also subject, from time to time, to labor work stoppages. The domestic automotive industry, which has experienced a number of bankruptcies, is involved in significant restructuring. Certain customers in this industry represent an increasing credit risk.

We are exposed to fluctuating steel prices. We have not entered into any steel commodity hedge transactions for speculative purposes or otherwise.

Inflation generally affects us by increasing the cost of employee wages and benefits, transportation services, processing equipment, purchased steel, energy and borrowings under our credit facility. General inflation has not had a material effect on our financial results during the past two years; however, we have experienced increased distribution expense as a result of higher fuel costs. When raw material prices increase, competitive conditions will influence how much of the steel price increase can be passed on to our customers. When raw material prices decline, customer demands for lower costed product result in lower selling prices. Declining

steel prices have generally adversely affected our net sales and net income, while increasing steel prices favorably affect net sales and net income.

Our primary interest rate risk exposure results from variable rate debt. However, given our current low level of debt and our expected low levels of debt during the fourth quarter of 2005, we do not expect to have significant interest rate exposure from variable rate debt during the remainder of the year.

We have evaluated the effectiveness of the design and operations of our disclosure controls and procedures as of September 30, 2005. These disclosure controls and procedures are the controls and other procedures that were designed to ensure that information required to be disclosed in reports that are filed with or submitted to the SEC is: (i) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures; and (ii) recorded, processed, summarized and reported within the time periods specified in applicable law and regulations. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2005, our disclosure controls and procedures were effective.

There were no changes in our internal controls over financial reporting that occurred during the third quarter of 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized.