Response from Alloy Steel International's CEO

In response to the list of questions I submitted to him last week, I got an e-mail from Alloy Steel CEO Gene Kostecki a couple of hours ago. I didn't hear back from him when I asked him if I could share the text of his e-mail on this blog (bear in mind Perth time is twelve hours ahead, so he may have signed off for the night by then), so I won't quote it here verbatim. But this is the gist of it: Gene apologized for not answering the questions by today; he noted that he's been busy drawing up plans for the new mill program, and that CFO Alan Winduss has been busy working on the reports given the recent conclusion of the company's fourth quarter and fiscal year. Gene said that the company planned to issue an interim report that would answer many of the shareholder questions I submitted to him, and that they would be happy to address any questions it didn't answer.

Update on Q&A with Alloy Steel International

I mentioned this in the comment thread of a previous post, but for those who missed it,

The list of questions ended up being fairly long. Gene [Kostecki, AYSI's CEO] wrote back to say that he and Alan [Winduss, the company's CFO] planned to try to answer all the questions by midweek next week. In light of that time frame, I am going to revise my previous comment about not placing any trades until I post their response. I am going to place additional limit buy orders today but I won't modify them if they don't fill until after I have posted AYSI's responses to the questions. The salient point remains that I won't be buying or selling AYSI based on answers received from the company before posting them here.

I put in a GTC limit order in the low 2's this morning, but obviously didn't get it filled today, given today's price action. Speaking of which: commenter J.K. (who, as far as I know, is the only reader to have invested in AYSI after reading about it here), sold his shares at around $2.70 recently, because he felt that the chart suggested the stock would pull back below $2 in the near future. I've held (and added a tiny bit more) because I don't think the stock will drop below $2 before earnings are released absent materially negative news, and I don't want to risk having the stock run away from me if additional positive news is released (e.g., a big supply deal with another multinational mining company).

Essentially, J.K. feels the stock's near-term trajectory will be driven by technical factors and I think it will continue to be driven by fundamentals. It will be interesting to see which one of us turns out to be correct over the next couple of months.

Another Alloy Steel Post

In a post a couple of weeks ago ("Alloy Steel Update"), we quoted an e-mail from the CFO of Alloy Steel (OTC BB: AYSI.OB) in which he intimated that the company might file an 8-k or issue a press release about its fiscal fourth quarter results within the next week. At this point, since there's been no announcement from the company, it's likely we won't hear anything until Alloy Steel files its 10-k later this month. Alloy Steel's lack of emphasis on shareholder communication isn't new; the company still hasn't set up the investor relations section of its website. If you click on one of the tabs under the "Investors" heading on Alloy Steel's website, your taken to a generic page on the website of the company's outsourced IR web vendor (the stock image above is from that generic page.

In a discussion about Alloy Steel on its Investors Hub message board , I mentioned that I was less concerned about the previous quarter's results (which I think will be positive) than I was for the company's prospects in '09, given the global recession and the grim news from the mining industry. A commenter who goes by the handle "Littlefish¹" explained why he was confident in the company's prospects during this downturn. Below is his explanation.

I have a lot of confidence in the company being around when things recover, excepting some kind of huge technological breakthrough in wear plates that puts all alloy wear plate into permanent obsolescence.

I don't have confidence in when they'll get around to putting out prelim or audited results though:) Except probably by the end of year. Hopefully much sooner but who knows. I don't want my eyes permanently crossed so am only going to cross them for one night.

If you look at the company's operating history, it is vanilla plain clear to see they know how to weather tough times. They survived years (especially 2001-2003 tough times) on practically nothing (IMO).

Unlike many micros out there, I would say the likelihood of them making it thru the next year readying themselves for a hopeful recovery at SOME point is extremely likely.

They've been thru this before with the Aussie miners. Plus now they have a little bit of chance to get themselves into new markets. They haven't borrowed from any banks. They have no dilutive instruments. They got thru 2001-2003 w/o diluting or borrowing from lenders.

And they have mostly paid for the 2nd mill already with internally generated cash. Worst case, knowing Gene's fiscal responsibility, they could just operate one mill until a 2nd is needed and adjust headcount to keep pace with what they have for work.

What is the WORST operating earnings loss they have reported in their operating history? One thing seems pretty clear with about 8 years of filing as a public company, they don't lose much money regardless of economic conditions and sales. And have tight cash flow management.

Plus without debt and with prior history of having opertaing income even on $500K revs Qs (I think even $400K Qs if I recall), I just don't think we'll see them evaporate. The cash they have IMO they will hold or spend judiciously. If they spend it, hopefully it is to finish off the 2nd mill and/or branch out to sales in US etc.

As ambu [another I-Hub commenter] mentions, they've probably missed out on some revs growth during this last commodity bonanza go-round by being so cautious. But it also means they should be fine in this downturn.

I think this company will be in a better position than before IF/WHEN we get a recovery (because of capacity upside, cash on hand for a change).

BUT when is that recovery? Who knows.

What would be a strong endorsement to the product quality and potential IMO is to see sales actually grow in this mining industry/commodity blowup. It won't be easy but one avenue to seeing that happen would be by tapping into markets they don't sell into much now (like the US).

As I mentioned in a previous post (Vaalco Energy Update), I sold a few shares of Vaalco to free up some cash to buy some more Alloy Steel. My limit buy orders for Alloy Steel haven't been filled yet though.

¹"Littlefish" was the subject of a pair of posts here over the summer about his success with another micro cap stock, Mexco Energy: "How One Investor Found a Home Run Stock, Part I", and "... Part II".

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%.

Further Questions for Alloy Steel's CFO

Tough tape today for Alloy Steel International (OTCBB: AYSI.OB), which closed at $1.60 per share, down 36% from yesterday's closing price of $2.50 per share.

Alloy Steel's CFO, Alan Winduss, was kind enough to respond to some questions I posed to him last month (See: "Answers from Alloy Steel's CFO"). Today I sent him an e-mail with the following questions about today's 10Q. If he is nice enough to respond again this time, I'll post his answers on this blog.

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?

Update on Varanus Island

In a previous post ("Answers from Alloy Steel's CFO") among the questions answered by Alan Winduss, the CFO of Alloy Steel International (OTCBB: AYSI.OB) was this one,

Have you been materially affected, or do you anticipate being materially affected by the reduced natural gas supply as a result of the Varanus Island explosion earlier this month?

The Varanus Island plant provided 30% of Western Australia's natural gas, and the supply disruption resulting from the explosion has, according to Perth Now caused some mining companies (Alloy Steel's clients) to suspend some operations or resort to more expensive diesel to run their generators.

This was Mr. Winduss's response,

We expect to experience a slow down in orders from some mining companies effected by the gas shortage; however the timing of this cannot be determined.

Perth Now reported some positive news on this Friday ("Gas supply repairs ahead of schedule"):

US-based Apache Energy said today that output of 110 terajoules a day would resume next week, slightly ahead of schedule, following the June 3 explosion.

Full production is not expected to be restored until the end of the year.

On June 23, Apache said it hoped to bring on partial production of 200 terajoules by August 15 and full production of 350 terajoules by December.

It said the schedule was now 240 terajoules a day within a few weeks and full production by the end of the year.

[snip]

WA Premier Alan Carpenter welcomed the news the Varanus plant would be back in operation ahead of schedule, but said it did not mean the situation was resolved.

``Having 80 terajoules in that pipeline by Tuesday next week and 110 by the end of the week ... means of course that a very much improved situation is sitting out there in front of us,'' he said.