Radius Recycling Inc (RDUS) 2004 Q2 法說會逐字稿

Welcome to the Schnitzer Steel second quarter 2004 earnings conference call. My name is Mike, and I will be your conference coordinator today. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded. At this time for opening remarks and introductions, I would like to turn this call over to Chairman and Chief Executive Officer of Schnitzer Steel, Mr. Bob Philip.

Good morning. I would like to welcome our listeners to Schnitzer Steel's second quarter 2004 earnings Webcast and conference call. We will begin the call with some general comments about the second quarter and also discuss our views on the outlook for our business, and then open the call up to questions and answers from our analysts and our investors.

Before we get started I would like to go over the necessary details regarding forward-looking statements that may be made by us during the call. Our comments on this call will include estimates of future company performance and our views on future market trends, which are forward-looking statements subject to the Safe Harbor provision of federal securities law. Actual results may differ materially from those projected in our forward-looking statements. Factors that could cause actual results to differ materially from current expectations are described in detail under the heading, factors that could affect future results, in the management's discussion and analysis section of our most recent quarterly report on form 10-Q. We do not assume any obligation to update our forward-looking statements.

Overall, our second quarter was a record quarter for Schnitzer Steel. Our second quarter fully diluted earnings per share rose 102 percent and were 89 cents per share, compared to 44 cents per share in last year's second quarter. The record quarterly results were primarily attributed to the following -- continued strong international scrap markets; the rebounding U.S. economy; increasing demand for steel and scrap metal; and also, the Company reported a favorable quarterly tax rate.

I would like to now discuss the segments of our business. Our wholly-owned scrap business. Schnitzer's earnings improvement was primarily led by our wholly-owned scrap metal business. Our operating margin per ton continued to expand in the second quarter, due to modestly higher average selling prices, offset in part by rising shipping costs. Second quarter selling prices rose 13 percent from the first quarter to $158 per ton.

Ocean shipping costs for our wholly-owned scrap business rose 72 percent from last year's second quarter and 30 percent from the first quarter. The good news is we are beginning to see ocean freight rates moderate and would not be surprised to see freight rates decline modestly as the third quarter continues. Second quarter margins were also impacted by rising costs for unprocessed scrap metal, which seemed to be driven by increasing demand from the domestic steel mills.

Our Steel business, Cascade Steel. Another particularly bright spot in this quarter was the improved operating performance of our steel mill, Cascade Steel, which reported a $2.7 million profit in the second quarter, which compares to an operating loss of 1.4 million in last year's second quarter. Cascade's results included a $1.8 million payment from an electrode price-fixing settlement that was anticipated and disclosed in our January 2004 earnings release. Even without the electrode settlement, the mill generated a profit and improved its operating performance.

Our margins also expanded from both the second quarter of last year and the first quarter of fiscal 2004, primarily due to the sharp rise in selling prices. In fact, our second quarter selling price rose $41 per ton from the first quarter of fiscal 2004 and averaged $351 per ton. Overall, steel consumption appears to be improving. There appeared to be customers increasing their inventories in the second quarter in an attempt to get ahead of future price increases.

Our third section, auto parts business. The highlight in the second quarter for the auto parts business was the announced acquisition of three new stores and in Canada. These stores fit well within our business and are believed to be immediately accretive to earnings. Overall, the business continues to perform well and profits are ahead of plan. The second fiscal quarter is traditionally the weakest for this business, due to adverse weather conditions in some parts of the country reducing retail sales. Our second quarter retail sales were on par with the prior year.

Joint ventures. Overall, the joint ventures reported improvement in the second quarter. The greatest improvement came from our global trading business, where second quarter volume grew almost 100 percent as compared to last year's second quarter. The volume growth came from expanding our customer base throughout the world and trading additional commodities such as pig iron. The processing joint ventures were affected by similar factors as our wholly-owned metal recycling business.

However, the rise in ocean freight costs was the highest in our East Coast-based locations, and was significantly higher than what we experienced in our wholly-owned West Coast-based scrap business. Average East Coast freight rates rose more than 137 percent from the second quarter of last year and 36 percent above the levels incurred in the first quarter of fiscal 2004. However, since the end of the second quarter the joint ventures appeared to be experiencing similar moderation of ocean freight markets as our wholly-owned scrap business.

Our outlook for the next quarter, as today's earnings release stated -- based upon current market conditions -- we are estimating the third quarter's operating income will be in the range of 38 million to $43 million, which compares to $22 million in the fiscal 2003 third quarter.

Schnitzer Steel has been in the scrap business for nearly 100 years and has seen many cycles. We believe that we are still relatively early in the cycle and that we may be in the early stages of a new economic paradigm for our industry. The following are a few factors we have considered in giving guidance for the third quarter.

Export orders are typically contracted ahead 60 to 90 days from shipment and give us reasonably good visibility for most of our ferrous sales. These contracted orders are anticipated to benefit us through the third quarter and the early part of the fourth quarter. In contrast, domestic markets are traditionally sold on a spot basis, 30 days, and thus we have less visibility through the quarter.

We continue to see the worldwide consumption of scrap metal remaining strong. In Asia, and China in particular, steel and scrap consumption remains very strong. We do, however, believe we are seeing a similar seasonal trend that we saw last year at this time, where concerns over summer electricity availability may curtail some steel production, principally at the smaller Chinese steel mills, although Schnitzer Steel is sold into June.

The trend may allow larger steel producers better access to local scrap supplies, thus temporarily reducing their needs for imported scrap metal. We experienced a similar variation last year, which temporarily reduced Asian demand for imports and moderated prices. However, prices firmed in the latter part of the fourth quarter as concern of electricity shortages abated.

Selling prices have recently declined from the levels that were seen in late February and early March. However, today's selling prices remain well above both normalized pricing from a historical context, as well as above the averages recorded for most of the last 18 months. These price levels should allow our scrap business to continue to report good margins. We anticipate that our wholly-owned scrap business's third quarter 2004 sales volume will approximate last year's volume level. The recent price moderation can be viewed as good news, as the cost of unprocessed scrap metal that is procured from our suppliers has been reduced, which will result in improved margins.

Longer term, we believe that the fundamentals for our scrap business remain strong. Demand for scrap metal is growing. Much of the recent increases in demand have come from China and Korea, but more recently we have seen indications that India and other Southeast Asian countries will be increasing their demand for scrap metal. We have recently read that approximately 1.2 million tons of electric arc furnace production is coming online shortly.

We believe it is important to remind our investors that there is a finite supply of scrap metal available, and it comes primarily from mature economies such as the United States and Western Europe. Further, we continue to believe that Schnitzer Steel's strategy to focus its scrap metal operation on valuable deep-water ports will allow the Company to participate in these growing overseas markets.

Domestic steel consumption is improving. In fact, last week U.S. steel production achieved its highest level in recent memory. Steel prices have risen sharply and are anticipated to increase further in the third quarter. Since the end of the second quarter, Cascade Steel's two previously announced price increases are now in effect, which combined, approximate $100 per ton increases in most of its product lines. The effective dates of the announced price increases will vary through the third quarter. We expect the third quarter sales volume to be in excess of 150,000 tons.

In our auto parts business, traditionally, we experienced one of the strongest quarters for the retail sales in fiscal third quarter. This is due to generally moderate weather conditions, which, combined with the addition of the three new Canadian stores, should increase both revenue and operating income over the last year's third quarter. We intend to continue to grow this business throughout North America. In addition, we will continue to be selective in buying both existing and new Greenfield operations.

In anticipation of questions from our investors and analysts regarding public notoriety of possible bans or restrictions on the export of scrap metal, I would like to make a few comments. First, we take these types of issues and discussions very seriously. As such, we have investigated the assertions and have monitored congressional committee discussions regarding the possibility of such restrictions. At this point, however, it is our view that export restrictions on scrap metal are unlikely to come to fruition.

I would like to hand the call over to our Chief Financial Officer, Barry Rosen, who will provide some additional supplementary financial information.

Thank you, Bob. I do not intend to discuss the details of the press release, which you have already, but I would like to point out just a few items.

The stock split. On March 25, the Company completed the previously announced 3-for-2 stock split. The stock split was approved by the Company's Board of Directors in January, due in part to the Board's confidence in the long-term fundamentals of our business, as well as we believe a stock split can increase the liquidity of the stock long-term.

I would like to remind investors that the per-share information on the release was based on the number of shares outstanding before the March 25 stock split. We provided supplemental information on the face of the income statement to assist investors in analyzing the performance based on the post-split shares outstanding.

In addition, the tax rate that we mentioned in the press release needs to be discussed a little more fully. The Company released certain valuation reserves for net operating losses that were acquired in 1996. This accounting treatment resulted in a third quarter tax provision of 19 percent for the second quarter of fiscal 2004. The reversal was driven principally by the increased certainty surrounding management's belief in the ability to fully utilize the reserves before their expiration dates in 2015 to 2016.

The Generally Accepted Accounting Principles test is generally defined as whether it is more likely than not that taxable income will be sufficient to utilize the NOL benefits. Given the increased profitability of the business, including the addition of Pick-N-Pull and the belief that the long-term fundamentals for the business is good, management felt we met the test. We anticipate our full fiscal year 2004 tax rate to be in a range of 29 to 30 percent. That implies that quarter three and quarter four's effective tax rate will be approximately 34 percent.

The general and administrative expenses for the second quarter of 2004 increased 1.3 million over last year's second quarter, due primarily to three factors.

Increased management bonus accruals, which are based upon an EBA plan that directly ties compensation to the Company's improved financial performance. Schnitzer became an EBA company in 2001 fiscal year and now has nearly 350 of its employees participating in the incentive plan, which has helped us go through a cultural change in our company, not to mention has helped us produce significant improvements in our business. We also had increased insurance cost during the quarter, primarily workers compensation. And we've spent, to date, approximately $400,000 to comply with Sarbanes Oxley.

The Company continued to generate significant cash flows during the second quarter, totaling a little over $22 million from operations. This resulted in reducing our net debt outstanding to approximately $70 million as of February 29, 2004. Year-to-date capital spending was approximately $11 million, which approximates last year's amount. Total 2004 capital spending is currently estimated to approximate $25 million, much of which will be spent on a new state-of-the-art shredder in Oakland, California, and a new energy-efficient furnace for our steel mill. We estimate that depreciation and amortization will approximate $19 million for fiscal year ending August 31, 2004.

I will now pass the call back over to Bob, who will summarize the call before opening the conference call up to questions. Thank you.

To summarize, Schnitzer Steel just completed a very strong second quarter and is now anticipating an even better third quarter. Some investors may wonder if the fundamentals will change after the third quarter of fiscal 2004. We do not believe so. We do continue to believe in the strong fundamentals of our business, namely worldwide scrap metal and fuel consumption remain strong and going growing. The finite supply of scrap metal, coupled with growing consumption, should continue to provide us with good margins. Our valuable exporting facilities provide us the strong competitive advantages, and are not easy to replicate.

In addition, our joint venture businesses have not only expanded but have improved their operations and profit margins, and now provide us additional operating leverage in the worldwide scrap market. Our auto parts business is significant and growing. And finally, we believe the outlook for our finished steel business has greatly improved. These and other factors make me optimistic about the future of Schnitzer Steel. Thank you very much.

I will now open the conference to questions.

(OPERATOR INSTRUCTIONS). John Rogers with D.A. Davidson.

Just a couple of questions to clarify, in terms of the outlook for the third quarter, Bob, that you went through. Given the operating numbers that you have suggested here, I am assuming that your scrap margins should be up in the mid $30 per ton range. And I guess what I am wondering is how much of that do you believe is related to benefiting from a decline in purchasing prices? In other words, how much is sustainable beyond the third quarter?

I think that's a good question.

How should we look at that? Because obviously, it looks like in this quarter your margins might have been negatively impacted by the run-up in scrap prices or the purchase prices.

I think that it's a good question, and that as the market in the United States has moderated, we have been able to adjust our buying prices, and we are now buying scrap for shipments that we have already booked. And as those average costs are averaged down, we anticipate that our margins should increase. As we mentioned, we have pre-sold, or we have sold ahead 90 days fixed, based on where we saw the market in the last 60 days. So now we are able to fill those orders at lower prices.

So in other words, is it -- in the past, I can remember the goal was to be $20, mid $20 sort of margins. What do you think is a reasonable expectation over the next several years?

Greater than $20. Between 1993 and 1998, you are correct; we averaged about $20 per ton margin. But one thing that is different today is that we have never had a country or a market like we have in China. As the reports have stated over the past two or three weeks in the New York Times, the Wall Street Journal and other publications, the Chinese anticipate growing their steel business over the next four or five years. We will participate in that growth, both supplying scrap to the electric arc furnaces and benefiting by the additional steel production with the integrated mills, who also will use some scrap. So it's fair to say that our margins are going to be greater. You know quite well that we don't give guidance on our margins.

I know, but I've got to try.

Michelle Applebaum with Michelle Applebaum Research.

I had a question for you. We have never had a period, to my recollection, of surcharges for steel before that were reflecting the scrap market. Is there some school of thought that the surcharges have actually facilitated the rapid run-up in scrap prices, not necessarily the other way around? I was wondering if you had any thoughts about that. And there's also some talk that maybe some of these companies might be dropping the surcharge. What is your outlook on that, and do you think that is meaningful for your business one way or the other?

As you know, we only supply a limited number of steel mills in the United States with scrap -- those mills that are producing primarily rebar, wire rod and some of the lower-end products -- that only recently were able to apply surcharges to their selling prices. We have not heard, at least from the customers that we're doing business with, that any surcharges or any additional selling prices will be reduced.

I don't think that it was the surcharges that caused the scrap prices to go up, necessarily. I think that the demand for scrap throughout the world, primarily driven by Asia -- not only China. We point to China as sort of the big gorilla, but rest assured that Schnitzer Steel and our joint ventures are selling scrap every month to Mexico, to South America, from Europe to Europe to Southeast Asia, including Malaysia, Thailand, Taiwan, Indonesia, and certainly Korea and China.

But what has happened is that the demand for steel products worldwide has increased, and I think that's put pressure on the suppliers not only of scrap, but of those products that are used for making steel -- iron ore, coal, coke, pig iron, CRI. And all the products that are used for making steel have increased, coupled also with the fact that freight rates have increased to move the raw materials.

So to answer your first question, I do not think that we have heard that any of the steel mills are indicating any price reductions today.

Okay. I guess that was not what I was saying. What I was saying was the surcharge, possible elimination of the surcharge, and what (multiple speakers) --

We have not heard that; that's what I am saying. When we say surcharge, we're looking at the price for finished steel, and we have not heard from any of the steel mills that we are currently doing business with that they are indicating any reductions. As a matter of fact, our steel mills --

Not reductions, not reductions, eliminations. Like U.S. steel, I guess, has been saying that they have got a $30-a-ton surcharge on a 580 base. And so they are saying that they would actually -- I guess I have heard that they are saying -- eliminate the surcharge (indiscernible) keep transaction prices stable.

I don't know anything about it.

Let me ask another question, if I may. In the mid '90s we had a scrap price run-up similar to what we have had this cycle, but obviously not as high. And I think that we used to say that there was kind of a structural cap to scrap prices at which scrap substitutes would come in. I know that the environment for manufacturing scrap substitutes has accelerated as well; the costs have accelerated as a function of energy cost.

Is there kind of a feeling on scrap prices at which you get scrap substitutes? In any commodity you get new capacity -- right? -- at a certain prize. Is there a price in your mind, kind of an equilibrium price at which you create a lot of scrap substitutes?

There may have been one in the '90s, but when scrap was selling for $300-plus per ton, we have not heard of any new capacity coming online or any steel mills rushing to try to find scrap substitutes. 20 years ago or 15 years ago we had thought that if a price was midway through the 100, 150, that there was some incentive to take a look at scrap substitutes. But scrap passed 150 a number of months ago, passed 250 a number of weeks ago, and I have not heard of any interest on the part of either steel mills or substitute producers to activate scrap substitute plans.

Do you have any kind of reason in your mind what's changed? Because I agree with you; it was kind of $150-a-ton you thought about scrap substitutes, back in the last scrap cycle, '95, '96. What in your mind has changed, why you're not seeing that?

I think that many of the steel mills have realized that it's not only the price of the substitute itself, but it's the cost of using the substitute. Cascade Steel, our mini-mill, uses DRI and pig iron occasionally. And our melt shop feels that it costs considerably more, natural gas-wise and yield-wise, to use substitutes. Now we do use pig iron and DRI when it's available when we are making wire rods. But certainly we are not in the -- it's of no interest to us today, because the prices for pig iron and -- if it's available, it's considerably above the scrap prices.

Well, that's very interesting. Thank you.

(OPERATOR INSTRUCTIONS). Craig Thomas (ph) with SAC Capital.

Would you please walk me through a little bit what you're seeing from both the Chinese purchases in Q4? And the question I am trying to get to is, if they know your input prices are falling pretty dramatically are they going to keep paying you around $300 a ton, or does that come in a little bit in Q4?

I think that as a result of communication today, there are really no secrets on what is going on around the world. And certainly the Chinese and the Koreans and all the buyers have been watching carefully the factory bundle fluctuations in the United States. And prices have moderated from the $300 price, but they are still very close to $300. And having seen the reduction of 25 to $40, we are still at a level that so far exceeds anything that we have ever seen, and that is why we are convinced that we may be seeing the next change in the economic cycle for raw materials for the steel industry. Going into the fourth quarter, we have estimates that we think the prices might stay in this range, but we don't know. It's a little bit too far for us to predict.

Although we have -- we essentially sold cargos through the third quarter and already into now the fourth quarter. So we have are pretty good idea, at least into June, where prices are. And they are still quite strong.

So when you say you're sold out through June, that's the first month in Q4; is that right?

That's correct

And what are your customers, though, now telling you? Why the apparent slowdown from China? At least that's the color I get from some of the folks I've talked to in the brokerage business.

Normally this time of the year, which is the monsoon season in China, many of the steel mills are concerned about power availability for the summer months, which are their heaviest production months. What we think may be happening is that some of the smaller mills -- we have been led to believe that there are close to 300 steel mills in China, and 200 of those mills produce less than 100,000 tons per year. Many of them are concerned about being able to operate when electricity rates accelerate, and so they are cutting back their production, which was the major source of the local scrap. So what we're seeing is some of the bigger mills are able to buy some of the local scrap short-term. But we believe that the fourth quarter or the summer months will again return to strong production, which is similar to what happened last year when in the same time period we saw the Chinese slow down their deep-sea shipments or the deep-sea arrivals, and rely primarily on domestic scrap or short-sea shipments from Japan, Taiwan, and perhaps a little bit from Korea.

One thing that is happening now, at least from Japan, Japan has been a major exporter of scrap. The yen is now at an all-time high, and with the yen at the level today, it is going to be very difficult for the Japanese to export scrap competitively. And they were the primary factor on short-sea shipments, both to China and to Taiwan.

So we see this time of the year as normal for the Chinese to send up the yellow flag saying that perhaps their demand for scrap will wane a little bit. But there is no question in our minds that the construction industry in China is very strong and that their GNP, as reported most recently at close to 9 percent, will continue to be strong. And we see this strength going out a number of years, many say towards the Olympics. So we are very optimistic about China coming back. Remember, China has increased their capacity so much over the last two or three years that they themselves have been the factor that has changed the raw material picture for all aspects of the steel industry.

Anthony Rizzuto with Bear Stearns.

Bob, you mentioned that small steel producers in China are concerned about electricity. But I wonder -- a year ago we did not have the Chinese government trying to slow things down. And I wonder what impact, if any, do you think the government's attempts to try to slow the overheated sectors might be having on those smaller steel producers? And might this not begin to affect somewhat demand on the margin for scrap and other raw materials?

I don't think that the government necessarily will be able to put the brakes on this major capital expansion in this country. The other thing to remember is that over the last nine months, we have seeing an increase in the amount of container shipments from the United States to China, 20-ton, 22-ton shipments. We have been told that many of these smaller steel mills are buying these 24-ton container shipments. And today the docks in China are jammed full with containers of scrap that have been imported.

Our customers who are buying the 35,0000 and 40,000-ton shipments primarily are importing scrap; they are not buying these small -- they are buying local domestic scrap, and they are buying major shipments from exporters such as ourselves and others around the world. So that if in fact there is a slowdown, we think it will affect the smaller, noncapitalized mills that are in areas that are not serviced by offshore shipping companies.

So in effect, you think that the overall level of demand for scrap will remain unchanged?

No question. It may go up.

Eric Wald (ph) with Touchstone Investments.

Nice quarter. Barry, Bob, the last time we spoke a couple of months back you guys had indicated that the operating margin for the full year fiscal '04 would near $27, which to me presumably would mean that Q3 and Q4 the operating margin per ton would have to move up from where it is currently. In my model, can I still use those same assumptions, or has something changed?

You're trying to do, Eric, what John Rogers tried to do, is get us to tell you what our margins are going to be.

Sure.

Clearly, from our guidance that we gave you for the third quarter and the volume numbers that we also gave you, you can make a pretty straightforward assumption that margins are going to expand quite significantly. And as a result, that is going to be one of the key drivers of our increasing profitability. And so, yes, margins will be higher in the third quarter, certainly, than they have been for the first two quarters.

And a second question. In terms of the three Pick-N-Pull operations that you guys have acquired in Canada, since you have had them under operation in the last --- call it, I don't know -- less than a month or so, have you seen similar, I guess, operating margins from those that you were seeing from the other 20-plus yards that you had under operation prior to the acquisition?

If I understood the question -- I'm sorry, I was distracted there for a second. We think those stores are going to perform very well and have already outperformed what we had indicated they would do even since we acquired them?

Two last points I would like to make. One, not to lose sight of the fact that Southeast Asia is growing. In the last week we made contracts to steel mills that are in Southeast Asia that we have not sold in a number of years, indicating that their demand has increased.

And the second point I want to make is that we announced guidance for this last quarter, and it's fairly clear that we have exceeded our guidance for the quarter that we just completed. We are very optimistic about the scrap business, and we're optimistic about what is happening at Cascade Steel. As we mentioned in our comments, we are going to experience an increase of about $100 a ton across the board for our products that we market, effective during this quarter. So that, coupled with the potential scrap moderation, should increase our margins at the steel mill.

Anyway, we appreciate all your patience in listening to our presentation and asking questions. And if any of you have further questions that you wish to address to the Company, please feel free to call. And we certainly appreciate your support. Thank you very much.

This concludes the conference call for Schnitzer Steel. Thank you for your participation. You may now disconnect.