Metals USA, one of the larger flat rolled steel service center groups in North America, announced their second quarter earnings for 2010 on Tuesday of this week. The company recorded operating income during the quarter of $17.4 million compared to $12.7 million in the first quarter 2010.

The company’s colorful CEO, C. Lourenco Goncalves, has shown in the past he has a way with words and tends to speak directly to issues. The conference call with analysts was once again filled with “color” about the steel business and economy. SMU will try to go past the “catch phrases” and presented a more complete picture of the call and the various flat rolled pricing, inventory and market comments made by the company (mostly Mr. Goncalves) during

The following information is being taken directly from the transcript of the Metals USA conference call and we have attempted to be as complete as possible on any specific subject they addressed. We are not reproducing the entire transcript.

“…same volume of business working out of fewer tons of inventory”

One of the first items which hit our eye during the opening remarks by Mr. Goncalves was a reference to the company’s ability to “…do the same volume of business working out of fewer tons of inventory.” SMU believes this is not isolated to Metals USA but perhaps one of the new realities of the service center business models going forward. The old 3 month standard inventory levels and four or less turns per year is outdated and, as was proven in late 2008 through the first half 2009, potentially dangerous.

Mr. Gonsalves puts his own twist to the tale with the following:

“Let me now comment on market conditions. Given the current environment, I believe its most instructive to look at sequential results to assess progress. Metals USA shipments increased 9% in the second quarter 2010, over first quarter 2010 which we expected to be in line with the overall service center industry. We remain convinced that 2010 is a transition year and that we will return to more normalized environment in 2011. We are experiencing decent and growing demand in almost all end-markets with exception of non-residential construction. Non-risk is not out, but it certainly remains down and will continue to be for the foreseeable future. However, other end markets have been performing well and should continue to improve in Q3 and beyond.

We have experienced year-over-year shipment growth of almost 20%. In any other year, 20% year-over-year growth would be great. But I have to admit that at the beginning of the year, I was expecting year-over-year growth to reach into the mid 20s. What’s frustrating is the fact that the industrial economy is doing better than perceived by the media and could have been supporting 25 plus percent of steel consumption growth. Unfortunately, several issues are acting as barriers to higher steel consumption in the U.S.

First, MUSA have not given steel consumers the confidence that they will keep prices stable. Let’s face it. If a steel buyer thinks the price is going to be lower tomorrow, he or she will not buy today. Complicating this effect is the behavior of most service centers. With an inventory position exposed to price drops, service center will keep inventories as low as possible to mitigate the impact of adverse pricing trends. Metal USA is no exception on that.

Second, I think the average business of others operating mentality has been seriously affected by the economic crisis of 2009. By and large, end users no longer trust their own perceptions and are overly cautious to avoid the conditions they found themselves in 12 to 18 months ago. One very curious behavior that I have noted repeatedly is that business managers no longer trust their own order book and continue to buy fewer tons than they would buy two or three years ago for the same level of orders on hand.

Along similar lines, the average business manager has become pessimistic by default, and is reacting too severely to global news without determining if the news will really affect his or her business. In fact, they just assume it will. For instance, does the credit problem with Greece really reach manufacturing [inaudible] America? I believe that people have lost their ability to assess what conditions are really influence their businesses and what are not. Consequently, they overreact to all inputs…”

“…cost push will be a key driver of higher prices for the foreseeable future”

“Turning my comments toward pricing. I will continue to be an outspoken proponent that cost push will be a key driver of higher prices for the foreseeable future. Effective July 1, 2010, world prices for iron ore increased 25%. This view forces one of two possible outcomes. Finished products prices will either be increased to recoup costs or mills, we’ve experienced compressed margins. There is no alternative.

For much of the first half of 2010, prices have trended higher for this reason. Recently, prices have become unstable. Some may interpret this as an indication that a peak has occurred. I am less inclined to think like that. Too many pundits focus on installed capacity utilization as a price driver. Historically, I think that was a reasonable assumption. However in this consolidated environment, installed capacity utilization is less relevant. What’s more important now is the order book in front of furnaces that are operating. Sufficiently sized order books allow furnaces to operate in an efficient manner and optimize conversion costs. We have seen mills raise prices with low installed capacity utilization, but with good order books on hand.”

Q – Bruce Klein: Two things just on the working capital. I guess what do you attribute, I know it rose a lot less, but typical given the shipments which is great news. What do you attribute that to I guess and how sustainable is it? And secondly prices has soften some, they are still softening in your view and when do you think it would sort of bottom out?

A – Lourenco Goncalves: Bruce, let me start with pricing. During Q2, prices really softened more than we would like to see and especially at the end of the quarter. And that was motivated by, in my opinion, by the inability of the markets to realize that the international prices will receive a very strong pressure during Q3, sometime during Q3. I don’t know exactly when the new iron ore prices will kick in and will be really translated into higher costs for the integrated mills. But you make no mistake, POSCO, Nippon Steel, Thyssenkrupp, Corus, ArcelorMittal all these guys will pay higher price for our work and that will translate in higher costs, same thing is happening with coking coal.

So if the mills will continue to allow prices to deteriorate or even if they do not allow price to go up, what we are going to see will be a repeat of the dire straits that the industry was in 10 years ago. I don’t believe that the mills will allow that to happen. And we, as service centers, we have much more protection against this type of things than the mills. For them its costs, best costs or not best costs, profit or loss. In our case, by playing with the inventories and making the inventories is more than enough to mitigate the impact on pricing we can survive. So we may not deliver great profit but we still be profitable. So it’s a decision that the mills we have to make, how they’re going to treat their cost pressure because the cost pressure is real. What was the first question?

Acquisitions

A – Lourenco Goncalves: We continue to pursue acquisitions. Everything that I said during the road show, we are doing everything that we committed with we are performing. I told the potential investors during the road show that we would do one or two acquisitions this year. We closed the first one before midyear. It looks like we have been public for a long time, but I have just finished the first quarter as a public company. So one thing that investors need to understand is that things take time. So we will continue to pursue acquisitions, it’s a good time to buy. The business will not go away for good in the United States; it’s just a shaky time, so we’ll continue to take advantage.

Third Quarter Improvements

Q – Brett Levy: And then the last one is just sort of a bet [ph] for a little bit more granularity. It looks as if steel price is kind of across the board, kind of coming down from June to July to August, volumes also to some extent, what is moving up, let’s say, third quarter look like it might be stronger?

A – Robert McPherson: Volume.

Q – Brett Levy: Volume.

A – Robert McPherson: Volume.

A – Lourenco Goncalves: We are at this point enjoying better volumes than we were during the latter part of the second quarter. So volumes are picking up even in a month like July that is normally not a month in which we see volumes picking up.

Q – Brett Levy: And is there a particular area where the volumes are stronger, particularly stronger in, I don’t know shape or something like that?

A – Lourenco Goncalves: That’s too early in the quarter to give you this type of detailed granularity, if you will. So we’re seeing an overall trend of volumes increasing in then though we’ll stay at this for the time being, Brett.

Selling Prices

Q: Hi. This is Adam Rahn [ph] speaking on behalf of Sal Tharani. We had a quick question, hot rolled prices going up 16% quarter-over-quarter from the first to the second quarter. And we have average selling price few guys up 6%. We understand that there is a lag there, but we were wondering if you could provide some color as to whether there is going to be a lag if prices go down in the third quarter?

A – Lourenco Goncalves: No. Next question.

Domestic Mills are the Problem “…right here in America, right now”

Q – Phil Gibbs: Hey guys. I just had a quick question on the gross margins in the second quarter; I think we’re expecting a bit more. Was that more competitive or was that mix and how are the margins progressing through the quarter, on a month-on-month if you could give any color on that?

A – Lourenco Goncalves: Phil, you are right and we were expecting a higher gross margins as well. The problem is that in an environment in which the mills only talk prices to talk prices down in which that we are not seeing enough business to support everybody’s ability to make a boatload of money, we have to be competitive. So in Q2 we have to sacrifice gross margins in order to continue to perform well in terms of volume and we did just that. We would love to have higher gross margins, but without mill support that is next to impossible. The good news is that the mills are putting themselves in a position that if they continue to act the way they’re acting, a few of them will go out of business. We have seen that before, I don’t know how long we’ll follow this business, but I have been in this business long enough to know that if you behave like LTV, you are LTV. If you behave like [inaudible], you are [inaudible], no matter if you have a new name, no matter if you have a new owner, if you’re back to the practices of the past you are [inaudible] on the water. So the mills need to change or they will be gone, and then it’s a new start, it’s a new beginning. Everybody will be reborn and that’s great, that’s fantastic.

Q – Phil Gibbs: And Lourenco, we’ve seen supply of carbon still on a weekly basis track around 17, a little higher than that, 1.7 million tons, you think that needs to come in a little bit as we move into the second half of the year to stabilize prices to get them moving in the right direction, should we see some supply come off?

A – Lourenco Goncalves: Maybe, maybe. There are some mills in the United States that should be shut down long ago, but people keep believing in stories like when we saw old mills that were absolutely outdated combined with service centers, then being sold to a mill and then the mill thought that they had the best thing in the world and all of a sudden, they’d sell the service centers and keep the mills. So the old mills are in still active. So we need to learn with the past, instead of continue to make the same mistake, just with the new cover. It doesn’t really fly. So yeah, we need and keep the mills. So the old mills are in still active. So we need to learn with the past, instead of continue to make the same mistake, just with the new cover. It doesn’t really fly. So yeah, we need to some capacity to go out here. But we are more concerned about calling Chinese CapEx to be shut down as if it would change a bit in the United States. But we keep, especially the mills continue to really push China to reduce their installed capacity. Why they’re going to reduce their installed capacity right here in America where we have a clear problem of over capacity? Because it’s much easier to blame the Chinese because they know that that will take their tension out of where the problems are. The problem is right here in America. We have more capacity in America than we need, right here, right now.

It’s time for the mills to stop calling China the problem. They are the problem right here in America, right now. to some capacity to go out here. But we are more concerned about calling Chinese CapEx to be shut down as if it would change a bit in the United States. But we keep, especially the mills continue to really push China to reduce their installed capacity. Why they’re going to reduce their installed capacity right here in America where we have a clear problem of over capacity? Because it’s much easier to blame the Chinese because they know that that will take their tension out of where the problems are. The problem is right here in America. We have more capacity in America than we need, right here, right now. It’s time for the mills to stop calling China the problem. They are the problem right here in America, right now.

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