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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-23320
OLYMPIC STEEL, INC.
(Exact name of registrant as specified in its charter)
Ohio 34-1245650
------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
5096 Richmond Road, Bedford Heights, Ohio 44146
----------------------------------------- ----------------
(Address of principal executive offices) (Zip Code)
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 (X) No ( )
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes ( ) No (X)
Indicate the number of shares of each of the issuer's classes of common stock,
as of the latest practicable date:
Class Outstanding as of November 5, 2004
------------------------------- ----------------------------------
Common stock, without par value 9,965,824
Page 1 of 30
OLYMPIC STEEL, INC.
INDEX TO FORM 10-Q
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets - September 30, 2004 (unaudited) 3
and December 31, 2003 (audited)
Consolidated Statements of Operations - for the three and nine 4
months ended September 30, 2004 and 2003 (unaudited)
Consolidated Statements of Cash Flows - for the nine months 5
ended September 30, 2004 and 2003 (unaudited)
Notes to Consolidated Financial Statements 6-11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL 12-20
CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK 21
ITEM 4. CONTROLS AND PROCEDURES 21-22
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS 23
SIGNATURES 24
EXHIBITS 25-30
Page 2 of 30
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OLYMPIC STEEL, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
September 30, December 31,
2004 2003
------------- -----------
(unaudited)
Assets
Cash $ 4,817 $ 3,087
Accounts receivable, net 108,349 56,501
Inventories 147,857 92,775
Prepaid expenses and other 1,133 2,794
Assets held for sale - 637
-------- --------
Total current assets 262,156 155,794
-------- --------
Property and equipment, at cost 153,703 152,085
Accumulated depreciation (68,399) (62,303)
-------- --------
Net property and equipment 85,304 89,782
-------- --------
Investments in joint ventures 1,843 1,625
Deferred financing fees, net 1,191 1,801
-------- --------
Total assets $350,494 $249,002
======== ========
Liabilities
Current portion of long-term debt $ 4,895 $ 4,877
Accounts payable 56,431 31,345
Accrued payroll 15,544 2,772
Other accrued liabilities 12,282 3,580
-------- --------
Total current liabilities 89,152 42,574
-------- --------
Credit facility revolver 55,173 55,537
Term loans 29,949 33,629
Industrial revenue bonds 3,280 3,754
-------- --------
Total long-term debt 88,402 92,920
-------- --------
Deferred income taxes 9,521 1,272
-------- --------
Total liabilities 187,075 136,766
-------- --------
Shareholders' Equity
Preferred stock - -
Common stock 102,305 99,790
Officer note receivable - (749)
Retained earnings 61,114 13,195
-------- --------
Total shareholders' equity 163,419 112,236
-------- --------
Total liabilities and shareholders' equity $350,494 $249,002
======== ========
The accompanying notes are an integral part of these balance sheets.
Page 3 of 30
OLYMPIC STEEL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AND TONNAGE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
2004 2003 2004 2003
---- ---- ---- ----
(UNAUDITED)
Tons sold
Direct 283,098 253,337 906,166 716,750
Toll 40,332 48,422 146,477 132,658
-------- -------- ---------- --------
323,430 301,759 1,052,643 849,408
======== ======== ========== ========
Net sales $244,142 $115,850 $ 653,948 $344,131
Cost of materials sold 178,576 90,845 464,369 271,262
-------- -------- ---------- --------
Gross profit 65,566 25,005 189,579 72,869
Operating expenses
Warehouse and processing 10,142 8,072 32,451 24,207
Administrative and general 11,703 5,697 34,740 17,257
Distribution 4,482 4,211 14,264 11,965
Selling 4,331 2,613 15,411 8,201
Occupancy 1,328 884 3,917 2,976
Depreciation 1,999 2,037 6,146 6,247
Asset impairment charge - - 487 -
-------- -------- ---------- --------
Total operating expenses 33,985 23,514 107,416 70,853
-------- -------- ---------- --------
Operating income 31,581 1,491 82,163 2,016
Income (loss) from joint ventures 58 (644) 230 (654)
-------- -------- ---------- --------
Income before financing costs and income taxes 31,639 847 82,393 1,362
Interest and other expense on debt 1,069 993 3,514 3,122
-------- -------- ---------- --------
Income (loss) before income taxes 30,570 (146) 78,879 (1,760)
Income tax provision (benefit) 11,998 (31) 30,960 (612)
-------- -------- ---------- --------
Net income (loss) $ 18,572 $ (115) $ 47,919 $ (1,148)
======== ======== ========== ========
Earnings per share:
Net income (loss) per share - basic $ 1.88 $ (0.01) $ 4.89 $ (0.12)
======== ======== ========== ========
Weighted average shares outstanding - basic 9,904 9,646 9,791 9,645
======== ======== ========== ========
Net income (loss) per share - diluted $ 1.80 $ (0.01) $ 4.70 $ (0.12)
======== ======== ========== ========
Weighted average shares outstanding - diluted 10,341 9,646 10,195 9,645
======== ======== ========== ========
The accompanying notes are an integral part of these statements.
Page 4 of 30
OLYMPIC STEEL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
(IN THOUSANDS)
2004 2003
---- ----
(UNAUDITED)
Cash flows from operating activities:
Net income (loss) $47,919 $ (1,148)
Adjustments to reconcile net income (loss) to net cash from
operating activities-
Depreciation and amortization 7,297 6,804
(Income) loss from joint ventures (230) 654
Asset impairment charge 487 -
Loss on disposition of property and equipment 58 4
Long-term deferred income taxes 8,249 (2,491)
------- --------
63,780 3,823
Changes in working capital:
Accounts receivable (51,774) (18,337)
Inventories (55,082) 19,607
Prepaid expenses and other 1,661 7,587
Accounts payable 25,086 (4,515)
Accrued payroll and other accrued liabilities 22,681 (1,291)
------- --------
(57,428) 3,051
------- --------
Net cash from operating activities 6,352 6,874
------- --------
Cash flows from (used for) investing activities:
Capital expenditures (1,698) (549)
Proceeds from disposition of property and equipment (net) 123 1,292
Distributions from (investments in) joint ventures 12 (500)
------- --------
Net cash from (used for) investing activities (1,563) 243
------- --------
Cash flows from (used for) financing activities:
Credit facility revolver payments, net (364) (599)
Scheduled repayments of long-term debt (4,137) (5,757)
Credit facility fees and expenses (541) 45
Repayment of Officer note receivable 675 -
Proceeds from exercise of stock options and employee
stock purchases 1,308 13
------- --------
Net cash used for financing activities (3,059) (6,298)
------- --------
Cash:
Net increase 1,730 819
Beginning balance 3,087 1,736
------- --------
Ending balance $ 4,817 $ 2,555
======= ========
The accompanying notes are an integral part of these statements.
Page 5 of 30
OLYMPIC STEEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
(1) BASIS OF PRESENTATION:
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 2004 annual results and
these financial statements should be read in conjunction with the Company's 2003
Form 10-K. 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.
(2) ACCOUNTS RECEIVABLE:
The Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. The
allowance 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 and
judgments about the probable effects of economic conditions on certain
customers. 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 our allowance for
doubtful accounts.
(3) INVENTORIES:
Steel inventories consist of the following:
Page 6 of 30
(in thousands) SEPTEMBER 30, 2004 DECEMBER 31, 2004
------------------ -----------------
Unprocessed $101,328 $65,709
Processed and Finished 46,529 27,066
-------- -------
Totals $147,857 $92,775
======== =======
(4) INVESTMENTS IN JOINT VENTURES:
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, 2004, Olympic guaranteed 50% of OLP's $17.1
million and 49% of GSP's $3.0 million of outstanding debt on a several basis.
The following table sets forth selected data for the Company's OLP joint
venture:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- --------------------------
RESULTS OF OPERATIONS: 2004 2003 2004 2003
- ---------------------- ------ ------- ------- -------
(in thousands)
Net sales $7,291 $ 6,909 $23,566 $22,414
Gross profit 2,581 1,979 8,955 8,069
Operating loss (299) (1,094) (119) (569)
Net loss $ (456) $(1,251) $ (607) $(1,056)
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:
Page 7 of 30
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- ------------------------
RESULTS OF OPERATIONS: 2004 2003 2004 2003
- ----------------------- ------ ------ ------- ------
(in thousands)
Net sales $4,412 $1,800 $11,049 $4,131
Gross profit 988 230 2,249 505
Operating income (loss) 613 (28) 1,146 (227)
Net income (loss) $ 584 $ (35) $ 1,088 $ (257)
The Company records 49% of GSP's net income or loss to its Consolidated
Statements of Operations as "Income (Loss) from Joint Ventures."
(5) DEBT:
In December 2002, the Company entered into a 3-year, $132 million secured
bank-financing agreement (the Credit Facility) comprised of a revolver and two
term loan components. The Credit Facility is collateralized by the Company's
accounts receivable, inventories, and substantially all property and equipment.
Revolver borrowings are limited to the lesser of a borrowing base, comprised of
eligible receivables and inventories or, effective with an August 2004 amendment
to the Credit Facility, $110 million in the aggregate. The Company has the
option to borrow based on the agent's base rate or Eurodollar Rates (EURO) plus
a premium (the Premium). The Company incurred $2.2 million of closing fees and
expenses in connection with this Credit Facility and also incurred $1 million of
subsequent bank amendment and waiver fees, all of which have been capitalized
and included in "Deferred Financing Fees, Net" on the accompanying consolidated
balance sheets. These fees and expenses are being amortized to "Interest and
Other Expense on Debt." In May 2004, the Credit Facility was extended through
December 15, 2006.
The Company's effective borrowing rate inclusive of deferred financing fees for
the first nine months of 2004 was 5.6% compared to 4.5% for the comparable
period in 2003. Monthly principal repayments of $367 commenced February 1, 2003
for the term loan components of the credit facility.
Page 8 of 30
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. At
September 30, 2004, the Company had $47.8 million of availability under its
Credit Facility and was in compliance with its covenants.
Included in the Credit Facility revolver balances on the accompanying
consolidated balance sheets are $7.6 million and $1.7 million of checks issued
that have not cleared the bank as of September 30, 2004 and December 31, 2003,
respectively.
(6) DISCONTINUED OPERATIONS:
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
carrying value of the Tubing real estate was recorded as "Assets Held for Sale"
on the accompanying balance sheets and the $637 thousand carrying value was
reduced to a balance of $150 thousand as of June 30, 2004 to reflect the
contractual sales price of the property. The sale was completed in the third
quarter of 2004. The $487 thousand reduction was recorded as an "Asset
Impairment Charge" on the accompanying Consolidated Statement of Operations.
(7) SHARES OUTSTANDING AND EARNINGS PER SHARE:
Earnings per share have been calculated based on the weighted average number of
shares outstanding as set forth below:
Page 9 of 30
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
---------------------- ----------------------
2004 2003 2004 2003
------- ------- ------- -------
(in thousands, except per share data)
Weighted average shares outstanding 9,904 9,646 9,791 9,645
Assumed exercise of stock options 437 - 404 -
------- ------- ------- -------
Weighted average diluted shares 10,341 9,646 10,195 9,645
======= ======= ======= =======
Net income (loss) $18,572 $ (115) $47,919 $(1,148)
Basic earnings (loss) per share $ 1.88 $ (0.01) $ 4.89 $ (0.12)
======= ======= ======= =======
Diluted earnings (loss) per share $ 1.80 $ (0.01) $ 4.70 $ (0.12)
======= ======= ======= =======
(8) STOCK OPTIONS:
At September 30, 2004, stock options to purchase 964,629 shares were
outstanding, of which 592,129 were exercisable at prices ranging from $1.97 to
$15.50 per share, none of which were anti-dilutive as of September 30, 2004. For
the periods ended September 30, 2003, all stock options 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:
Page 10 of 30
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
---------------------- ---------------------
2004 2003 2004 2003
------- ------- ------- -------
(in thousands, except per share data)
Net income (loss), as reported $ 18,572 $ (115) $ 47,919 $ (1,148)
Pro forma expense, net of tax (383) (4) (1,108) (242)
-------- ------- -------- --------
Pro forma net income (loss) $ 18,189 $ (119) $ 46,811 $ (1,390)
======== ======= ======== ========
Basic net income (loss) per share:
As reported $ 1.88 $ (0.01) $ 4.89 $ (0.12)
======== ======= ======== ========
Pro forma $ 1.84 $ (0.01) $ 4.78 $ (0.14)
======== ======= ======== ========
Diluted earnings (loss) per share:
As reported $ 1.80 $ (0.01) $ 4.70 $ (0.12)
======== ======= ======== ========
Pro forma $ 1.76 $ (0.01) $ 4.59 $ (0.14)
======== ======= ======== ========
(9) SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid during the first nine months of 2004 and 2003 totaled $2.4 million
and $2.3 million, respectively. Taxes paid during the first nine months of 2004
and 2003 totaled $15.5 million and $0, respectively.
Page 11 of 30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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.
OVERVIEW
Our results of operations are affected by numerous external factors, such as
general 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 in an escalating price market and layoffs
or work stoppages by suppliers' or 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 product mix, the amount of processing performed, the availability
of steel, volatility in selling prices and material purchase costs. We 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. We
guarantee portions of outstanding debt under both of the joint venture
companies' bank credit facilities. As of September 30, 2004, we guaranteed 50%
of OLP's $17.1 million and 49% of GSP's $3.0 million of outstanding debt on a
several basis.
Page 12 of 30
Financing costs include interest expense on debt and deferred financing and bank
amendment fees amortized to expense.
We sell certain products internationally, primarily in Puerto Rico and Mexico.
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 has been accounted for as a discontinued operation and its
assets were written down to their estimated fair value less costs to sell. The
carrying value of the Tubing real estate was recorded as "Assets Held for Sale"
on the accompanying balance sheets and the carrying value of $637 thousand was
reduced to a balance of $150 thousand as of June 30, 2004 to reflect the
contractual sales price of the property. The sale was completed during the third
quarter of 2004. The $487 thousand reduction is recorded as an "Asset Impairment
Charge" on the accompanying Consolidated Statements of Operations.
We have four collective bargaining agreements covering approximately 205
employees at our Minneapolis and Detroit facilities. The collective bargaining
agreement covering hourly plant employees at our Detroit facility expired on
June 30, 2004; however, such employees are scheduled to vote during the fourth
quarter of 2004 on a new agreement that, if ratified, would expire on June 30,
2009. A collective bargaining agreement for employees at our Minneapolis coil
facility expires on September 30, 2006. From time to time, union organizing
efforts have occurred at our other locations, including current activity at our
Iowa facility. While we have never experienced a work stoppage by our personnel,
any prolonged disruption in business arising from work stoppages by personnel
represented by collective bargaining units could have a material adverse effect
on our results of operations.
RESULTS OF OPERATIONS
Tons sold increased 7.2% to 323 thousand in the third quarter of 2004 from 302
thousand in the third quarter of 2003. Tons sold in the third quarter of 2004
included 283 thousand from direct sales and 40 thousand from toll processing,
compared with 253 thousand direct tons and 48 thousand toll tons in the
comparable period of last year. Tons sold in the first nine months of
Page 13 of 30
2004 increased 23.9% to 1.1 million from 849 thousand last year. Tons sold in
the first nine months included 906 thousand from direct sales and 146 thousand
from toll processing, compared with 717 thousand direct tons and 133 thousand
toll tons in the comparable period of last year. The increase in tons sold was
attributable to increased customer demand across substantially all markets. We
expect strong customer demand to continue in the last quarter of the year,
however the fourth quarter contains 3 fewer shipping days than the third
quarter, as well as normal seasonal closings of certain automotive and
manufacturing customers in December.
Net sales increased 110.7% to $244.1 million in the third quarter of 2004 from
$115.9 million in the third quarter of 2003. For the first nine months of 2004,
net sales increased 90.0% to $653.9 million from $344.1 million. Strong customer
demand, combined with tight supply and rising raw material costs for steel
production, has resulted in a dramatic increase in steel pricing in 2004.
Average selling prices for the third quarter of 2004 increased 96.6% from last
year's third quarter and increased 16.6% from the second quarter of 2004. While
market prices are expected to decline modestly during the seasonally slower
fourth quarter, we anticipate prices to remain at elevated levels for the
immediate future.
As a percentage of net sales, gross profit increased to 26.9% in the third
quarter of 2004 from 21.6% in the third quarter of 2003. For the first nine
months of 2004, gross profit increased to 29.0% from 21.2% in the comparable
2003 period. The gross profit increase is primarily the result of strong
customer demand for steel coupled with tight supply conditions. During the first
nine months of the year, we have been able to pass on to our customers steel
producers' price increases and surcharges. However, the anticipated modest
decline in steel prices increases the possibility of our gross margin
percentages returning to historical levels in the immediate future.
Operating expenses in the third quarter of 2004 increased 44.5% to $34.0 million
from $23.5 million in last year's third quarter. For the first nine months of
2004, operating expenses increased 51.6% to $107.4 million from $70.9 million in
the comparable 2003 period. The operating expense increases are primarily the
result of increased payroll, incentive compensation, retirement plan expenses
and distribution expenses associated with increases in sales volume and income
for the first nine months. As a percentage of net sales, operating expenses
decreased to 13.9% for the third quarter of 2004 from 20.3% in the comparable
2003 period. For the first nine months of 2004, operating expenses decreased to
16.4% of net sales from 20.6% in last year's comparable 2003 period.
Page 14 of 30
Income from joint ventures totaled $58 thousand in the third quarter of 2004,
compared with a $644 thousand loss in the third quarter of 2003. For the first
nine months of 2004, income from joint ventures totaled $230 thousand compared
with losses of $654 thousand in 2003.
Financing costs totaled $1.0 million for both the third quarter of 2004 and
2003. For the first nine months of 2004, financing costs increased to $3.5
million from $3.1 million in 2003. Our effective borrowing rate inclusive of
deferred financing fees for the first nine months of 2004 was 5.6% compared to
4.5% in 2003. We have the option to borrow based on the agent bank's base rate
or Eurodollar Rate (EURO) plus a premium (the Premium). Effective borrowing
rates primarily increased as a result of waiver and amendment fees charged by
our bank group for the period ended December 31, 2003.
For the third quarter of 2004, income before income taxes totaled $30.6 million
compared to the 2003 third quarter loss before income taxes of $146 thousand. An
income tax provision of 39.2% was recorded for the third quarter of 2004 and a
tax benefit of 21.2% was recorded for the third quarter of 2003. For the first
nine months of 2004, we reported income before income taxes of $78.9 million
compared to the 2003 nine months loss before income taxes of $1.8 million. An
income tax provision of 39.2% was recorded during the first nine months of 2004
compared to a 34.8% benefit recorded during the comparable 2003 period. We
expect the effective tax rate, which includes federal, state and local income
taxes, to approximate the same rate during the fourth quarter of 2004. Taxes
paid in the third quarter of 2004 and the first nine months of 2004 totaled
$11.4 million and $15.5 million, respectively. There were no taxes paid during
the first nine months of 2003.
Net income for the third quarter of 2004 totaled $18.6 million or $1.80 per
diluted share, compared to a net loss of $115 thousand or $.01 per diluted share
for the third quarter of 2003. Net income for the first nine months of 2004
totaled $47.9 million or $4.70 per diluted share, compared to a net loss of $1.1
million or $.12 per diluted share in the first nine months of 2003.
Page 15 of 30
LIQUIDITY AND CAPITAL RESOURCES
Our principal capital requirements are to fund working capital needs, the
purchase and upgrading of processing equipment and facilities, and investments
in joint ventures. We use cash generated from operations, leasing transactions,
and our credit facility to fund these requirements.
Working capital at September 30, 2004 increased $59.8 million from the end of
the prior year. The increase was primarily attributable to a $51.8 million
increase in accounts receivables and a $55.1 million increase in inventories,
offset in part by a $25.1 million increase in accounts payable and a $21.5
million increase in accrued payroll and accrued liabilities from December 31,
2003. We diligently managed our accounts receivable and inventories. Since the
beginning of 2004, days sales outstanding decreased by 7 days and the number of
shipping days held in inventory decreased by almost 8 days.
Net cash provided by operating activities totaled $6.4 million for the nine
months ended September 30, 2004. Cash generated from earnings before non-cash
items totaled $63.8 million, while cash used for working capital components
totaled $57.4 million. The increases in steel pricing and sales volume have
resulted in higher levels of inventory and accounts receivable, causing a
significant usage of working capital. Steel prices are expected to remain at
elevated levels during the fourth quarter.
During the first nine months of 2004, net cash used for investing activities
totaled $1.6 million, consisting of capital spending. We do not expect to make
significant capital expenditures during the remainder of the year. We anticipate
adding additional new laser processing equipment which will be financed through
operating leases.
Net cash used for financing activities during the first nine months of 2004
totaled $3.1 million and primarily consisted of scheduled principal repayments
under our debt agreements and reduction in borrowings under our revolving credit
line, partially offset by proceeds from the exercise of stock options and the
repayment of the Officer note receivable.
During the third quarter of 2004 our Chief Operating Officer/President, repaid
his outstanding officer note receivable, including interest.
In December 2002, we entered in to a 3-year, $132 million secured bank-financing
agreement (the Credit Facility) which significantly reduced our financing costs.
The Credit Facility is
Page 16 of 30
comprised of a revolver and two term loan components. The Credit Facility is
collateralized by our accounts receivable, inventories, and substantially all
property and equipment. Revolver borrowings are limited to the lesser of a
borrowing base, comprised of eligible receivables and inventories or, effective
with an August 2004 amendment to the Credit Facility, $110 million in the
aggregate. We incurred $2.2 million of closing fees and expenses in connection
with the Credit Facility and also incurred $1 million of subsequent bank
amendment and waiver fees, all of which have been capitalized and included in
"Deferred Financing Fees, Net" on the accompanying consolidated balance sheets.
These fees and expenses are being amortized to interest and other expense.
Monthly principal payments of $367 thousand commenced on February 1, 2003 for
the term loan components of the Credit Facility. In May 2004, the Credit
Facility was extended through December 15, 2006.
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
September 30, 2004, we had $47.8 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, capital expenditure
requirements, and scheduled debt maturities over the next 12 months. Capital
requirements are subject to change as business conditions warrant and
opportunities arise.
CRITICAL ACCOUNTING POLICIES
We believe the following critical accounting policies affect our more
significant judgments and estimates used in preparation of our consolidated
financial statements:
Allowance for Doubtful Accounts Receivable
We maintain an allowance for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. The allowance is
maintained at a level considered appropriate based on historical experience and
specific customer collection issues that we have
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identified. Estimations are based upon a calculated percentage of accounts
receivable and judgments about the probable effects of economic conditions on
certain customers. We cannot guarantee that the rate of future credit losses
will be similar to past experience. We consider all available information when
assessing each quarter the adequacy of our allowance for doubtful accounts.
Inventory Valuation
Our inventories are stated at the lower of cost or market and include the costs
of the purchased steel, internal and external processing, and inbound freight.
Cost is determined using the specific identification method. We regularly review
our inventory on hand and record provisions for obsolete and slow-moving
inventory based on historical and current sales trends. Changes in product
demand and our customer base may affect the value of inventory on hand, which
may require higher provisions for obsolete or slow-moving inventory.
Impairment of Long-Lived Assets
We evaluate the recoverability of long-lived assets and the related estimated
remaining lives whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Events or changes in circumstances which
could trigger an impairment review include significant underperformance relative
to the historical or projected future operating results, significant changes in
the manner or the use of the assets or the strategy for the overall business, or
significant negative industry or economic trends. We record an impairment or
change in useful life whenever events or changes in circumstances indicated that
the carrying amount may not be recoverable or the useful life has changed.
Income Taxes
Deferred income taxes on the December 31, 2003 consolidated balance sheet
includes, as an offset to the estimated temporary differences between the tax
basis of assets and liabilities and the reported amounts on the consolidated
balance sheets, the tax effect of operating loss and tax credit carryforwards.
If we determine that we will not be able to fully realize a deferred tax asset,
we will record a valuation allowance to reduce such deferred tax asset to its
net realizable value. During the first nine months of 2004, we generated
sufficient income to utilize all of the operating loss and tax credit
carryfowards.
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Revenue Recognition
Revenue is recognized in accordance with the Securities and Exchange
Commission's Staff Accounting Bulletin No. 104, "Revenue Recognition." For both
direct and toll shipments, revenue is recognized when steel is shipped to the
customer and title is transferred. Virtually all of our sales are shipped and
received within 1 day. Sales returns and allowances are treated as reductions to
sales and are provided for based on historical experience and current estimates
and are immaterial to the consolidated financial statements.
FORWARD-LOOKING INFORMATION
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 documents, the words
"anticipate," "expect," "believe," "estimated," "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:
- general business, economic and political conditions;
- competitive factors such as availability and pricing of steel and
fluctuations in customer demand;
- the ability of customers to maintain their credit availability in
periods of escalating prices;
- layoffs or work stoppages by our own or our suppliers' or customers'
personnel;
- equipment malfunctions or installations delays;
- the adequacy of information technology and business system software;
- the successes of our joint ventures; the successes of our strategic
efforts and initiatives to increase sales volumes, improve cash
flows and reduce debt, maintain or improve inventory turns and
reduce costs; and
- customer, supplier, and competitor consolidation or insolvency.
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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. Readers 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.
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ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
Since the beginning of 2004, steel producers have been significantly impacted by
a shortage of raw materials, rising raw materials prices, increased product
demand, producer consolidation and longer lead time requirements. These
conditions have resulted in unprecedented cost increases and have translated
into higher prices for our products. As we utilize existing steel inventories,
it has resulted in higher gross profit dollars and margins. While market prices
are anticipated to decline modestly in the fourth quarter, we anticipate prices
to remain elevated during the fourth quarter of 2004. During the first nine
months of the year, we have been able to pass on to our customers steel
producers' price increases and surcharges. However, the anticipated modest
decline in steel prices increases the possibility of our gross margin
percentages returning to historical levels in the immediate future.
We are a variable-rate borrower and future increases in interest rates could
result in increased interest expense. Based on total variable debt levels at
September 30, 2004, a one hundred basis point increase in interest rates would
increase annual interest expense by approximately $895 thousand.
ITEM 4. CONTROLS AND PROCEDURES
We have evaluated the effectiveness of the design and operations of our
disclosure controls and procedures as of September 30, 2004. 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, 2004, 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 2004 that have materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
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We have hired an outside consultant to assist with the Section 404 internal
control obligations of the Sarbanes-Oxley Act.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
Exhibit 31.1 - Certification of the Principal Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 - Certification of the Principal Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 - Certification of the Principal Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2 - Certification of the Principal Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
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.
OLYMPIC STEEL, INC.
(Registrant)
Date: November 5, 2004 By: /s/ Michael D. Siegal
---------------------------
MICHAEL D. SIEGAL
Chairman of the Board and Chief
Executive Officer
By: /s/ Richard T. Marabito
---------------------------
RICHARD T. MARABITO
Chief Financial Officer
(Principal Accounting Officer)
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