Radius Recycling Inc (RDUS) 2005 Q2 法說會逐字稿

Good morning and welcome to Schnitzer Steel's second-quarter fiscal 2005 earnings conference call. My name is Brian and I will be your conference call coordinator today. (OPERATOR INSTRUCTIONS) As a reminder, this call is being recorded. During the presentation, all participants will be a listen-only mode. After the speakers' remarks you will be invited to participate in a question-and-answer session.

Before we begin, the Company has asked me to read the following statement. Today's presentation by management contains forward-looking statements subject to the Safe Harbor provisions of Federal Securities Law including estimates of future Company performance and views on future market trends. Actual results may differ materially from those projected in the forward-looking statements. An example of 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 in analyst's section of the Company's most recent annual report on Form 10-K.

At this time for opening remarks and introductions, I would like to turn the call over to Chairman and Chief Executive Officer of Schnitzer Steel, Mr. Bob Philip.

Thank you and good morning. Welcome to Schnitzer Steel Industries second-quarter 2005 earnings webcast and conference call. I would like to point out our press release containing detailed financial information for the quarter can be accessed on our website. The intent of this call is to hit the highlights of the quarter as well as discuss the short- and long-term fundamentals of our business. Later in the call, Barry Rosen, our Chief Financial Officer, will cover some of the financial details contained in today's press release and provide some additional information.

Before we get started, I would like to take this time to thank our employees in all of our businesses including our joint ventures for their hard-work and dedication. While the Company is clearly benefiting from favorable market conditions, the ability of our employees and our joint venture partners to execute our business plan has truly made a difference in our results. We can't possibly begin to give enough credit for a job well done.

Today Schnitzer Steel reported strong financial results for our second fiscal quarter ended February 28, 2005 driven by record revenues and operating income in our wholly-owned metals recycling business and record revenues for our self-service auto parts business. Our operating earnings of $56.3 million exceeded the upper end of our prior earnings guidance despite a pretax charge of $7.7 million for an environmental matter. All results represent significant year-over-year increases over our second quarter of 2004, which is a function of the unprecedented positive fundamentals in our core scrap business, the impressive growth of our auto parts business, and the strong performance of our steel manufacturing business.

From an operating standpoint, we continued the outstanding performance in our wholly-owned scrap business with record revenues driven by strong demand for ferrous scrap metal both in domestic and export markets. Prices during the quarter averaged $240 per ton, an increase of $4 per ton over our first quarter of this year and $82 over our second quarter of last year. Despite higher buying prices, caused by the strong demand for scrap and higher ocean freight rates, our operating income in the business was in new record.

The customer base for our wholly-owned metals recycling business remains diversified, with approximately 25% of our volume being sold domestically to our steel mill and the remainder being sold to export markets. Of the 357,000 tons exported during the second quarter, 42% was sold to Korea, 38% to China, and the remainder to Thailand. The continued growth of worldwide steelmaking capacity bodes well for the scrap business for many years to come.

Our joint venture scrap processing and trading business has benefited from the same fundamentals as our wholly-owned business. During the quarter the joint ventures processed and sold 1.05 million tons to our U.S.-based facility and sold 722,000 tons through our international brokerage business.

Our self-service auto parts business saw the continued benefit from the three Canadian stores acquired in March of last year as well as the four new stores acquired in January of this year. The latest acquisitions are performing very well. We were able to attract additional experienced management who will help us better manage our existing store base.

Operating income in the auto parts business remains strong, although slightly lower than our first quarter. The reduction is a reflection of normal seasonality in retail sales during the winter months due to wet and cold weather conditions as well as continued spending on infrastructure to support the Company's growth plans in this segment.

In addition to the acquisition of seven new stores, we have hired a strategic marketing director who brings extensive experience in automotive retail marketing to Pick-N-Pull. We are also in the process of developing a multi-year, multi-location renovation program to improve our facilities and we are beginning a major investment in information systems that support our stores. A key to our success was a similar investment we made in the late 1990s and we plan to enhance these systems further to provide better information on the key metrics that drive store profitability.

Over the next 12 months we anticipate nearly 4 million paying customers entering our current service center store base. Today we are buying nearly 20,000 cars per month for use as inventory in these stores.

Our steel manufacturing business continued to see the benefits of strong prices for steel products as a result of excellent worldwide demand. During the quarter, our sales price averaged $517 per ton, which was up 47% from last year's second quarter. Sales volumes in the steel business declined slightly from the first quarter of '05 due to adverse weather conditions that slowed demand in our key California markets and the continued runoff of existing inventories by distributors and fabricators of finished steel.

Sales volumes for the quarter were 125,000 tons, which was only modestly below what we would consider normal sales volumes for the second quarter. Despite the reduced sales volume, we continue to see good end-user consumption through the first half of this fiscal year. Further I am pleased to report our March, 2005 sales volumes were very strong and we currently anticipate strong demand for the balance of the third quarter. In fact third quarter 2005 sales volumes should approximate last year's third-quarter level.

We have made a decision to discontinue marketing Cascade Steel rolling mills. While we still believe Cascade is not a long-term strategic fit, our near-term outlook for the business remains positive and given that, we felt we could not justify to our shareholders selling the mill at prices and terms offered. We will revisit our decision in the future if and when opportunities arise. In the meantime, we have been impressed by the s spirit and capabilities of our management team at the steel mill and will continue to provide the business our full support.

I would now like to ask Barry to go over some additional financial information regarding the quarter.

Thank you, Bob. During the second quarter, our general and administrative expense was approximately $2.7 million higher than the second quarter of 2004. This increase was caused by a number of factors including higher expenses to comply with the Sarbanes-Oxley regulations, increases in professional fees principally related to the investigation of trading practices in the Far East, and increases in infrastructure to support the Company's growth plan. It also includes increases in the Company's bonus accruals, which are tied to our financial performance.

The Company's second quarter tax rate was 34.8%, which compares to 19% reported in the same quarter of the last year. Last year's second-quarter tax rate benefited from the utilization of certain NOL carryforwards obtained as part of an earlier acquisition. Due to a significant increase in the Company's profitability as well as other factors, the Company recognized remaining tax benefits from these NOL's during last year's second-quarter.

In addition, a legislative phase out of the extraterritorial income exclusion is expected to reduce tax benefits received by the Company on export sales, which also contributes to a higher effective tax rate. The Company is currently anticipating our tax rate for the third quarter will remain at approximately 35%.

The Company's depreciation expense during the second quarter was $5.1 million and we had a $7.7 million in capital expenditures. Currently we are estimating capital expenditures for our wholly-owned business for the entire fiscal year will be approximately $48 million, with $33 million to be spent in the third and fourth quarters. This is an increase of $4 million from the guidance included in our first quarter 10-Q, with the increase primarily related to anticipated real estate and equipment purchases.

Now I would like to hand the call back to Bob, who will make a few comments about our outlook for the business.

Thank you, Barry. I would like to spend some time talking about our near-term and long-term outlook for our business segments. For the near-term, based on the current order backlog for the Company's wholly-owned metal recycling businesses, contracted average selling prices for shipments expected in the third quarter are anticipated to be slightly lower than the record average net prices recorded in the second quarter just completed. However I will remind you that we are selling up to 90 days ahead and recent evidence points toward selling prices being on the rise from current levels.

In fact the American metal market reported last week that prices for factory auto bundles in March rose an average of $28 per ton, and we have seen recent export sales prices increase.

I note a couple of recent reports which point to continued support for scrap price increases. Bloomberg reported last week that JFE Steel, Japan's second-largest steelmaker, may start buying high-quality scrap to boost production and the American metals market reported that Nippon Steel, Japan's largest steelmaker, is mulling a 15% increase in ferrous scrap purchases to lessen the impact of higher costs for iron ore and coking coal in their basic oxygen furnaces. This is significant in that Japan in recent years has been a net exporter of scrap. Any increase in scrap usage by Japanese steelmakers will likely increase pressure on an already limited scrap supply. While we have not been able to confirm evidence this has started to occur, it bears monitoring.

Second, American metal markets also reported last week that Chinese steel production for the first two months of this calendar year was slightly over 50 million tons, up 22.9% over the same period in 2004. This is consistent with projections that Chinese steel production for the year will be in excess of 300 million tons, which should provide strong support for worldwide scrap pricing.

Our auto parts business is expected to see an uptick in revenue in our third quarter as weather improves and customer traffic to our stores increase. While the market for autobodies is expected to remain competitive into the third quarter and higher prices could have a minor effect on margin, the impact of higher revenues from increased sales is expected to result in improved profitability.

As we mentioned earlier, the sales volume for steel products were slightly lower over our last two quarters, however sales volumes during the first month of our third quarter have rebounded sharply. We expect third-quarter sales to approximate last year's third-quarter levels, with prices similar to those realized during the second quarter.

On the production side, an improvement in steel conversion costs is expected. Based on the above, third quarter 2005 operating income is expected to be in the 46 million to $53 million range.

As we indicated in our press release, we have assessed our practice of providing quantitative earnings guidance and determined we will no longer provide this guidance beginning with future earnings releases. Instead we will continue to provide qualitative guidance in both our earnings press releases and on these conference calls. We think it is worth taking the time to talk about the long-term fundamentals, particularly for our core scrap business.

The primary driver of demand for scrap is worldwide steelmaking capacity. According to World Steel Dynamics, world steel capacity in 2005 will be a little over 1 billion tons and expected to increase to slightly less than 1.2 billion tons by 2010. China's steelmaking capacity alone is expected to increase from 300 million tons in 2005 to approximately 380 million tons by the year 2010. During this time the demand for scrap as a raw material in the production of steel is expected to increase from 305 million tons to 332 million tons.

While we do believe scrap prices will remains cyclical, we also believe that supply and demand fundamentals point to higher average prices through the current cycle than was experienced during previous cycles. In addition while we are very positive about the near-term prospects of our scrap business, we encourage investors to ignore temporary short-term swings in raw material prices and focus on these long-term fundamentals.

Regarding the auto parts business, we continued to be focused on growing through acquisitions. We have increased our investment in personnel focused solely on acquisition targets and continue to believe significant opportunities exist to purchase or develop additional stores in the years to come. We also believe access to capital required to invest in expanding this business will not be a limiting factor for Schnitzer Steel.

Finally I would like to mention a few additional items. First regarding our joint venture with Hugo Neu Corporation, the Company believes it is desirable for Schnitzer Steel and Hugo Neu to end the current joint venture relationship; however, the joint venture agreements do not provide a mechanism to break off the venture. The Company and Hugo Neu are presently engaged in active negotiations of a possible transaction under which the joint ventures would be terminated and the assets divided. At this point we have nothing further to report.

Second, we have also made a disclosure in our fiscal 2004 10-K regarding our four priority (ph) sales practices. We continue to cooperate in our audit committee's independent investigation which was reported to the U.S. Department of Justice and the Securities Exchange Commission and have nothing new to report.

Thirdly, our net debt at the end of February 28 -- quarter end was $31 million and is expected to decline further over the coming months. In fact as of today, our cash balances exceed our outstanding debt. We believe with the strength of our balance sheet and our access to external capital we are well positioned to pursue strategic opportunities which may arise from either the auto parts or metal recycling business.

In summary, we continue to have a positive near-term and long-term outlook for our Company and we believe we are well positioned to take advantage of positive market fundamentals. Thank you for your time and interest in Schnitzer Steel Industries. I will now open the call up to our listeners for questions.

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

Congratulations on the quarter. Bob and Barry, just a couple of quick questions on the scrap side of the business, specifically the export market. Could you talk a little bit about what you are seeing in terms of pricing? You tend to have a little more visibility than others as you go out a little further? And how that pricing compares to what you saw in the second quarter? And in a sense, did pricing come down through the quarter and now it is starting to rise or if you could give us a little bit of feel of that I would appreciate it?

Thanks, John. One of the factors that we did not mention in the call was the variability of freight prices. We saw freight rates go down slightly in the second quarter. They have come back a little bit more or they are a little bit higher in the months that we are currently shipping, but we have seen scrap prices for the April, May, June period go up from the prices that we booked for the March/April period. And with the prices of steel in Asia increasing, there is no question in my mind that we will see a continuation of the price increases.

Chin Wa (ph) Financial News as an example yesterday reported that wire rod prices in China have increased $108 for the next offerings, while rebar prices have increased $90. We also have seen that the Japanese have increased some of their prices for steel products within Japan. So to answer the long question in a short way, we definitely are seeing prices on the rise and the prices that we're now quoting from May/June shipments are much higher than they were for the March/April period.

Okay and in terms of your buying costs, are they rising similarly or will we see that margin then expand again?

(multiple speakers) have also increased their demand for scrap. Yesterday the iron age prices were posted up $12.50. Last week the factory bundled prices went up about $30. We have seen prices increase in the Midwest and somewhat on the East Coast. On the West Coast there is pressure but I cannot say that the increases in export prices are necessarily exactly the same as the increases in the buying prices. Our flows have been very good on the West Coast.

Okay and then one more question if I could. In terms of -- Bob, you talked about uses of cash for either more scrap business and I assume that includes other export yards, but -- and/or to the auto parts business. What about stock repurchases? I noticed it looks like some of the family selling is going on but has slowed down. Would you ever look at buying some of that stock?

Let me answer that, John. This is Barry. We certainly think there is ample opportunity in both growing the auto parts business and in finding opportunities to expand our metals recycling business that will take advantage of our liquidity and credit availability, but should that not occur in the same timeframe or we think there is a better opportunity to increase shareholder value by purchasing back stock, we certainly would do that.

We do not forecast that to be the case over the short run, but we always have that opportunity and we would do what we think is in the shareholder's best interest. With regard --

A note on the family buyback, if you'll notice those sales that were made during the last quarter were all made as a result of planned sale programs. You will note also that in the last four or five months there really have not been any family members selling stock. As I said, the only stock sales that have been made were made as a result of hitting certain planned sales targets for liquidity purposes and we do not anticipate at the moment we can't see family members selling stock in today's environment.

Okay, and is there a point at which the family or the Class B Stock gets to a small enough portion that you would eliminate the two classes?

That happens automatically with the sunset (ph) provision should it fall below 20% of the total shares outstanding being Class A stock, then that would convert. The two class stock would go away.

Okay and then how much now?

I think we're around 27 or 28%

I'll get back in queue, thanks.

Wayne Atwell of Morgan Stanley.

Good morning. What does this mean for Cascade? Does this mean you are going to hold it forever -- temporarily? What are we expecting in the future?

I think we meant in our release we said -- forever is a long time. We don't think that Cascade Steel necessarily fits our model as we grow our business. What we basically said is that at the moment we have discontinued any discussions with potential buyers and we will look at the Cascade situation in the future as an offer may come in or if an offer comes in, we would certainly consider it, but we are not actively going to market the mill at today's juncture.

Would it make sense to think about IPO-ing a little asset like this? Would there be a market for that, do you think?

We don't think so, Wayne. We've actually tried to explore all initiatives and opportunities and we looked at that one as well it just didn't make sense for a lot of reasons.

When you by a Pick-N-Pull type store, are these accretive from the beginning and how much capital do you have to put into them to alter them? And what kind of potential or is there a whole spectrum of what needs to be fixed and what doesn't need to be fixed?

They have invariably been accretive from day one on the Pick-N-Pull store acquisitions. We really don't give out the information as to what those capital costs might be there. There is a difference in if we buy an existing store or if we build one from scratch. There is also a difference in the timeframe of how long it takes to get them up and operational. So we don't believe that there is any real capital constraints with our growth plans and our availability of capital and cash flows that would hinder our strategic plans to grow that business substantially.

Is this a situation where let's say for instance you'd like to grow the Southeast and then the Northwest or could you pick up an attractive store wherever it happens to show up or do you basically have to build a critical mass and develop sort of a geographic location that has synergies and such?

We hired, Wayne, a marketing firm a year ago and it was their mission to identify the top MSAs, the top markets for the demographics that we think allow Pick-N-Pull to be accretive and profitable. So we have the targets which is the entire United States, we have now identified the top 50 locations which would fit our model to grow. And those are not necessarily concentrated in one area.

Of course it may be the top three or four might be in one area but we are looking across the entire spectrum of the United States. We have specific targets in mind and we will hope to grow critical mass in those areas where the demographics meet our model. And so as we noted in our press release and those that have been coming out in the last four or five months, we now have a footprint that stretches from Virginia Beach to West Coast. We have 17 stores in Northern California. We do have market penetration in California. But we are also looking at other markets throughout the United States where the similar models to California fit.

Great, and I apologize for this but I got distracted when you were going over guidance. Could you just review the guidance you provided for us please?

The guidance for the next quarter is 46 million to $53 million operating income.

Okay, and that would be analogous to what number this quarter?

This quarter is 56 million.

And that was the guidance you provided?

We provided a range of I think 46 to 56 I believe.

Okay, good. Thank you.

Trey Snow of Priority Capital.

Thanks, during the first quarter when you gave guidance for the second quarter of that 50 to 56 million, did that include the 7.7 million charge?

No.

So then really your normalized operating income was wildly above your guidance.

Without that environmental charge, that is correct.

Was there a particular business that exceeded your expectations or which one did?

Our wholly-owned metals recycling business exceeded the expectation.

So it was your internal scrap business?

Yes, that is right. The metals recycling business.

Okay, and you talked about your operating expenses being up a little bit because of the costs related the investigation in foreign sales practices.

In part, that was one.

Can you quantify what that spend is and what it is being spent on?

We have not quantified that for public dissemination at this point.

Is it likely that we will see more for the rest of the year?

No, I don't think for the rest of the year. We certainly do not know. We are not in control of that process.

Okay and you talked about in terms of scrap prices that auto bundle prices are going up, but aren't your prices more tied to heavy melt or the shredded composite type numbers?

You are correct. That is exactly true and that is why while the factory bundles or the iron age price is a psychological (ph) number that we look at, we don't process factory bundles on the West Coast and very little on the East Coast. But it's a trend and what we also have seen in scrap prices is what we watched going up in China. We get a report every week from the different provinces that publish which show what the domestic price changes have been week over week as well as the prices week over week in Japan. And the trend certainly is up and that's what we are using as a guideline to determine our export selling price.

Domestically then, what would that be tracking as far as heavy melt? Is that up, down, flat?

Everything is up. No question. We have not seen any indications that any products, heavy melt, shredded going south. They are all up.

Okay, and last question on the steel business, you are saying that you expect volumes this quarter to approximate third quarter of last year? Is that comp about 155,000?

165,000.

165, okay. Great, thanks.

John Debbs (ph) of Bodry Capital (ph).

Good morning, Bob. Good morning, Barry. Maybe you could help me in a couple of areas. First with the large increases in iron, our cost to the steel companies coming out of Australia and Brazil, does that in a way compete with scrap? And I guess you were referring to that in your comments on Japan, but how would that make your scrap product more attractive to the steelmakers because of the ability to substitute?

That is a good question. Yesterday we received a report from China which shows that the January imports of iron ore were up 67% and what that means is the cost of the product to make steel other than scrap is accelerating. And that is why we saw the announcement from JFE and Nippon Steel where they are contemplating using more ferrous scrap as a supplement to their -- actually not a supplement, the big furnaces all use some ferrous scrap but as these prices for other products ramp up, scrap becomes more competitive or more attractive.

We are not sure exactly what percentage of the feedstocks that these big mills will switch to scrap or will add but the point is that as iron ore and coking coal increase, it makes scrap more attractive. The other point that I have not made yet today is that there is always the concern or has been a concern about China and tapping the breaks a little bit. The Asian Development Bank just this morning revised their Chinese GDP numbers. You may have seen it. For this year they've increased it from 8 to 8.5 and they're suggesting that 2006 will be 8.7. In 2007, 8.9.

So while there is a lot of discussion about slowing down the GDP of China, it certainly does not look like it is going to slowdown that quickly.

The other point that there was an article this week about the infrastructure growth and it said something to the effect that today there's 18,500 miles of highways currently available in China. They are talking about increasing it by 2008 to 51,000 miles. Well all those highways require cement. China is the largest cement user in the world but they are also going to need reinforcing bar and wire rods and wire products. Those products are primarily made in the electric arc furnace area and the electric arc furnace mills as you know use primarily scrap.

So if there is a little increase in usage by the blast furnaces of the scrap, that is going to put more pressure on the electric arc furnaces to buy and pay higher prices for scrap metal and primarily imported scrap metal because what they are generating in house or within the country is pretty much being utilized.

So to come back to the original question, as other products, iron ore, coke and coal increase, that then gets the mills further interest in looking at scrap as a substitute or as a product which is going to put more pressure on the electric arc furnaces who will be using primarily scrap metal for their products.

Thanks. On a different question, for the success of your scrap business, I think what is more important to focus on is whether finished steel prices continue at these high levels or whether just the absolute level of production of steel increases. What do you think is more important in terms of health of the scrap business?

I think it's certainly the production. Certainly price -- we saw finished steel prices ramp up and sort of bellwether product in the steel industry is hot rolled coil and the hot rolled coil price reached close to $800 a ton last year, which is a huge price for a product which was selling less than $300 a ton three years ago. But what that is also saying that the spreads for the steel mills is huge. If we look at the profitability of the minimills over the last four or five quarters, their margins have really increased and I don't see any reason why if prices retract a little bit, the raw materials prices will stay up and the (technical difficulty) markup on the selling prices.

The other thing to keep in mind is in addition to scrap, electrode prices have increased as well as alloys and that is one of the other issues that as a steel mill operator, Cascade Steel, we are continuously looking at what are the other ingredients that make up the cost of steelmaking. And certainly electrodes and alloys have accelerated.

But we have also seen significant margin expansion. So to answer the question, we think that the major pressure points on scrap pricing will be production. And we don't see any way that production will decrease. With over a billion tons of production last year and certainly slight increases this year, the pressure will certainly be on the steel mills to try to source raw materials.

Okay, great. Thanks very much.

(OPERATOR INSTRUCTIONS) Aldo Mazzaferro with Goldman Sachs.

A quick question on the steel mill numbers. They seem to be on flat volume and a little bit lower pricing. It seems like the margin dropped a little more than I would've guessed. Was their impacts from possibly lower production on your fixed costs or was there -- I know you just mentioned the alloys and other electrodes and things like that. Can you describe the margin deterioration a little bit in the steel mill business?

Aldo, the real impact all came from the shutdown as a result on the installation of the new furnace we put in and I think we tried to encapsulate what we thought the impact was. It was around $5 million for the quarter for the new furnace. And that is a major difference I think between the results is the furnace installation.

That explains a lot. One other question more for Bob I think or maybe for you too, Barry. You mentioned on the call that you don't see yourself as capital constrained at all to grow the auto parts business. Now if you don't sell the steel mill, would your thinking include a possible outside financing of some type, debt or equity, or are you thinking more that you don't need outside financing at all to accomplish your growth plan?

I think for just the auto parts business with the credit availability and cash flows and matching that up with the rate of growth that we see in terms of new store acquisition and our capital requirements, we don't think we need any. If we were to do something of substance on the ferrous scrap side of the business, we would look at our capital structure and our capital needs. But at this point for the auto parts, no.

And then I know you can't comment about the future on the joint venture operations but could you comment about how they are operating today? Is this a dispute you are having or if you want call it a dispute, would you think that is influencing operations at all?

Not at all. We are selling ahead from our East Coast facilities as well as Los Angeles and our international trading business, and that business is followed in concert with our wholly-owned business and we are very optimistic. Interestingly enough, the markets for our East Coast business really expanded and we are now seeing more business ending up in the Mediterranean and in Central and South America, and that is primarily is as a result of availability of scrap from the East Coast. So we are very optimistic about the fundamentals of our processing business.

The discussions we are having really are not affecting operations and those folks that are involved in operations really have nothing to do with the discussions we are having regarding the breakup or future of the joint venture partnership.

All right, thank you.

A follow up from John Rogers, D.A. Davidson.

Just a couple of small items. Barry, do you expect any additional costs related to the new furnace in McMinnville this quarter?

No.

Okay, and then on the environmental recovery, is that something that we may hear about in the near term or something that could be stretched out over a while?

I don't think we can give you any sense of when that might or if it will occur.

Anymore costs associated with that expected?

We hope not. That we anticipate, no.

Okay and then just finally on the DOJ investigation and your own audit committee investigation and as well as with the JV, any sense on when we may hear either if that wrapped up or settled for some payments, investigations, and then on the joint venture?

No, I wish I could give you some dates certain but we just don't know at this point. I know they are working hard on it and it is an audit committee investigation, not a DOJ investigation.

Right, sorry.

I can't answer that one.

But is it something -- presumably by the end of your fiscal year would be wrapped up or is it just too hard to say?

What we hope and what we know is two different things.

Okay, and on the joint venture, is there any way to move this process along any faster or is it just --?

No, I don't think so, John. I think we are working very hard on that and it is going along about as fast as it can go.

Okay, thank you.

Michael Lukes (ph) of Appaloosa (ph).

I was wondering if you could just talk about actually what (technical difficulty) specific spread are you going for or actually view that as margin as opposed to just the price? I don't know if you've said this before. Do you think the margins will be in line with the second quarter?

We generally don't give the give the margins in terms of a forecast. Certainly you can compute the margins on an historical basis when we release our numbers. And we are I think for the third quarter I think we have indicated that we are looking for a slight narrowing.

Down into the margins?

Right.

One other thing. You talk about the $1 billion in terms of steel output in the world. And I think I'm trying to get clarification on what do you think the incremental steel production is over the next five years?

Incremental increase?

That's right.

Well, they are talking about 3 to 4% is what World Sales Dynamics quotes. We are not economists but 4% on a billion tons is a huge amount of scrap requirement that is going to be -- some of that increase is going to be in the electric arc furnace field and we don't think that is unrealistic. To give you an example, our own little minimill in McMinnville, Oregon, which produced in the range of around 650,000 tons last year, is forecasting around 15 to 20,000 ton per month increase in scrap demand. That is just a very, very, very micro look at the billion tons.

And if you take a look at the other minimills in the United States, our own industry in the U.S., most of the mills are talking about slight increases in production. Slight increases in production can cause a big wave in the demand tightening and we don't see that as unrealistic worldwide as increases in production will put more pressure on raw materials. And it also relates -- I know you folks have an interest in iron ore and coal and metallurgical additives. And we are not at all afraid of those forecasts and when we see China has increased from I said 300 million tons in our release, but they are really talking about maybe 320 million tons and that difference is huge.

Can I ask you this? To be more to the point actually because we kind of put pen to paper and at least the numbers I've seen when you talk about over the next four to five years, steel production up maybe 100 to 125 million tons broadly speaking. But that pretty much correlates with your 3% or so on a yearly basis? And that is true. Even if that was all just blast furnace, don't they need like 15% of that to be scrap? And if that is true, do you know where there is 15 million tons? Can you help walk me through right now where there is potentially incremental 15 million tons of scrap that can come out of the marketplace because most people on street say it's no problem and they will pull it out of there. I don't know -- maybe they will pull it out of their butts, but I am very curious where you think you will find 15 million tons of scrap. Do you think it is available?

I don't -- is it in the world somewhere on earth? Probably. Is it available at a higher price? Yes. Where some of it could come from maybe former CIS countries, Eastern Block. It could be unmediated plants in this country that have environmental attachments and that there needs to be a cost -- a higher cost provided to do the remediation. But you cannot turn the light switch on and all of a sudden go into an area and see 15 million tons of scrap. We agree 100%. But --.

It's just curious because you see those higher prices and you even commented there. Except didn't we see extremely high prices last year starting to get (multiple speakers)?

We didn't see extremely high volumes. That's probably your next question. At least out of the United States as prices ramped up last year we saw our volume and our production increase slightly but as the prices go back up to those levels or exceed those levels, we may see scrap flowing from countries that the transportation cost was prohibitive and now that prices are higher, we may see some of that flow. But we agree 100%, 15 million tons is a lot of extra scrap.

Great, thanks.

Michelle Applebaum of Michelle Applebaum Research.

I wanted to ask a couple questions about some of your comments. First of all you were talking about the market, what was going on in the steel business right now and something about prices and production. And I was just curious, you are talking about 3 to 4% greater production in 2005 than '04 but I wanted to ask what is the impact? We're seeing something different this cycle than we've seen in the past in terms of global consolidated producers now cutting production at the peak of the cycle to maintain a pricing structure. And we saw that in the U.S. in the fourth quarter and it wasn't a big cut. It was maybe a 5% cut but we saw scrap prices react to that. What do you think the impact is going to be if some of these more recent announcements coming out of companies like Persolor (ph) or Chison (ph) or I guess yesterday Rodaruki (ph) in terms of their production cuts?

I can't give you a real good answer to that question only because the mills that we do business with, the electric arc furnace along product mills have not indicated to us that they were cutting production either in Asia or in the United States where we're doing business. So it would be unfair for me to comment on the blast furnaces or the mills that you mentioned production.

I would think that -- I would not necessarily equate cutting production with trying to hold the prices. I'm not sure if that is the reason but as it relates to the mills that we do business with, we're seeing prices increasing. We're not seeing production curtailed. Those are the mills that I think we mentioned are the countries in China, Korea, Thailand, Malaysia, Indonesia where we're exporting.

Okay and can you talk about the outlook going forward I guess two kind of competing trends? One is you've got new capacity, new mill chop (ph) capacity coming on stream. Can you talk about the share of electric furnace versus blast furnace? Obviously the electric furnace is much more scrap intensive and would test your market more dramatically and it is obviously capacity coming out of regions you serve.

And then a related question is can you also comment on the new scrap substitutes initiative that some of the larger electric furnace steel companies are going through and what is your sense of capacity of new types of technology? I guess, nonconventional DRI, HBI kind of stuff that might be coming on that could have some impact as well.

The steel mills in Asia that we're dealing with primarily in Southeast Asia and Korea, the electric arc furnaces are increasing capacity slightly. The steel mills in China that we've all referred to are really not adding too much more capacity in the electric arc furnace field. When they are talking about 8% or 5 to 8% increases, I think half of it is probably not electric arc furnace although the countries -- the companies that we're doing business with in China, the minimills, those that we have good relations with are all adding slightly more capacity. But the big growth in China we think is not coming from electric arc furnace but the demand from the electric arc area is still very strong.

Some of the other countries that we're doing business with, in Egypt and smaller minimills in and around the Mediterranean, we are seeing slight increases in electric arc furnace technology. As it relates to the substitutes, we really are not that concerned about the amount of new capacity coming online because it is really small and those mills that have said we want (technical difficulty) able to service our raw materials requirements, those in United States that have made announcements that they have taken some positions in the scrap (technical difficulty) We think it is probably a good hedge for them. But if they didn't think scrap was going to be short long-term, they would not be spending the amount of capital that they are currently contemplating spending on these new experimental technologies.

We also haven't seen any really successful facilities come online with any serious tonnage so the more technology or the more information about alternative technology availability, the more interest other steel mills have in increasing their capacity because they might feel that this other technology is available. But in the meantime they still need to use scrap metal to make finished products.

I agree with you about the statement about a fundamental structural shift in scrap and I think if you look at Nucor's investments and the dialogue and what they have done over the last substantially 15 years now, I think they have seen a financial shift, an inflection point if you will in scrap supply. So I would agree with you 100%.

One more related question. There's lots of noise, positive stuff coming out about this cast strip project which you know has been out there for a long time. What do you think if that becomes a preferred vehicle by which some of these developing nations grow their steel capacity, what kind of role does that create for your Company?

It means that we're going to have to be closer aligned with the minimills that are going to be long-term players in the industry. The cast strip process I think was originally started by -- well actually Nucor just announced today or yesterday that they hired a fellow that was very much involved with the VHP (ph) cast strip program and it turns out he is an individual who lived in Longview, Washington, right near Portland, Oregon. So we're quite familiar with Dick Wexler.

We are really encouraged. The more announcements about new technologies to create more efficient ways to make steel is a positive for the scrap industry. And we see -- we are not sure if and when they can market this technology or if it is even viable, but all it does is it provides more fuel or more opportunity for the scrap industry to align themselves with World Class players in the steelmaking business and we are encouraged.

It is an exciting development. Thank you so much.

Gentlemen, a follow up from John Debbs of Bodry Capital.

Just following up on this question of volumes and so on, my understanding has been you basically have been sold out in your scrap. So if there is more demand from Japan than some of these other mills because of high income prices of other products, is it just going to benefit you in terms of higher selling prices or somehow do you think you'll be able to add volumes to sell into these markets?

I think the interesting thing about Japan is that for us on the West Coast, Japan is one of the closest destinations, Japan and Korea which requires less freight. And so that is very positive for us that in the event that Japan begins to start importing more scrap, we seem to think that those West Coast shippers will be the beneficiaries.

On the other hand if prices increase, which is what I alluded to a minute ago, we think that we can reach farther into areas where scrap has not been able to move as a result of the freight costs and whether it is the United States or scrap moving from offshore which is handled by our trading company. We think the opportunity to source (ph) scrap that has been unavailable because of freight economics might allow for that additional tonnage requirement that we were just talking about.

So more scrap demand by Japan is very positive certainly for us and as prices increase, I think there will be entrepreneurial companies that will figure out how to move the scrap using the most efficient transportation means to get it to the market and to the end-user.

Thanks very much.

Ladies and gentlemen, that was our final question. We would like to thank you for joining us today for the Schnitzer Steel Industries conference call. This is the end of the conference today. You may now disconnect your lines and have a great day.