Friday, August 8, 2008

Additional Answers from Alloy Steel's CFO

In the last post ("Further Questions for Alloy Steel's CFO") we asked the CFO of Alloy Steel International (OTCBB: AYSI.OB) the following questions:

1) Why was the inventory (particularly the finished goods) number so high? Does this represent a pending shipment that should show up as revenue in the next quarter?

2) Did the natural gas shortage caused by the Varanus Island explosion reduce customer orders or affect deliveries in deliveries in the June quarter?

3) Did the construction of the new mill affect quarterly revenues? E.g., were workers pulled off of production to help with the construction of the new mill?

4) Are there any other specific factors which contributed to the 40% sequential decline in revenues from the March quarter to the June quarter, or is this just a result of 'lumpiness' of revenue?

5) Do you expect that higher revenue quarters will have higher margins, as a result of better allocation of fixed costs?

6) Did you hire a salesman this past quarter (I noticed you were recruiting one in Western Canada)? Was that part of the increased sales and administrative labor costs you cited as a factor in the higher SG&A?

7) Are you considering any measures to increase communications with shareholders? I know you mentioned during our previous correspondence that you were working to complete the investor section of Alloy Steel's website, but are you considering holding quarterly conference calls or issuing periodic press releases?

Here are his responses:

In response to your questions today:-

1. Inventory was built up in anticipation of a large order which has been received and revenue will emerge in the September quarter.

2/3/4. The gas problems had a small effect on orders but more particularly clients were looking at their own budgets and holding off ordering until after June 30. June 30 is the financial year end in Australia.

These factors plus in this industry there are other variables like the timing of plant shutdowns for repairs and the construction of new plant which we cannot predict; will cause fluctuations in quarterly revenue.

5. While overhead is better absorbed in high revenue quarters, it maybe that some high revenue sales have a lower profit mark up which affects the bottom line

6. We are currently negotiating with parties with the view to employment as sales persons for mainland USA and Canada.

7. Website is still unfortunately still a ‘work in progress’; we are looking at a various IR firms to possibly use for communications. We have been and will increase frequency where there is something to communicate in lodging 8Ks.

This provides some helpful clarity, particular the answer to 1), which is encouraging. I may have a follow up question re 6). I'll post any follow up Q&A in the comment thread below.

Update: As mentioned in the comment thread, since the company valued inventory in the 10Q by cost (using the GAAP standard of lower of cost or market value), the "finished goods" number mentioned in the 10Q, $785,430, actually represents about twice that amount of deferred sales, since the company has profit margins of about 50%.


DaveinHackensack said...

A commenter who goes by the name Gilead on the Investor Hub message board for Alloy Steel makes a key point regarding the inventory number -- since inventory is valued at lowest cost or market (LCM), and not sales price, the temporary inventory buildup mentioned in question 1) represents more than double that amount in deferred sales. He writes:

Inventories Oh My!

I can't believe I made that mistake given I was harping on inventory but of course inventories are valued at LCM. So inventories are going to translate into more than double their value in actual sales since part of COGS includes labor.

That means had that inventory shipped they likely would have beat last quarter. That in turn means if those finished goods actually ship and all else stays equal next quarter would be beyond a blowout.

Lets just assume for argument sake that actual inventory accounts for 40% of sales cost a very conservative number for our purposes.

That means that 800k in finished goods represents 2 million in revenue. They would have done 4.5 million in revenue had it shipped. Now imagine that ships this Q plus they do another 4.8 million given some modest contribution from the new mill.

You could have topline revenues of roughly 7 million next quarter!

Take that 7 million and apply a 55% gross margin to the incremental sales and I think you would see quarter EPS number of something like .14/share.

DaveinHackensack said...

Put in a small limit order at $1.75 but only got about a third of it filled.

DaveinHackensack said...

After looking at the numbers again, I think Gilead is overstating the case slightly. ~$800k in finished goods sold with Alloy Steel's ~50% profit margin should result in sales of about $1.6 million -- essentially, revenue that could have come in this quarter but will come in next quarter instead.