Radius Recycling Inc (RDUS) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Schnitzer Steel's third quarter fiscal 2005 earnings conference call. My name is Bill, and I will be your conference call coordinator today. If at any time you require assistance, please press star zero and a conference call coordinator will assist you.

As a reminder, this call is being recorded. During the presentation, all participants will be in 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. Examples of factors that could cause actual results to differ materially from current expectations are described in detail under the headings "Factors That Could Affect Future Results" in the management's discussion and analysis section of the Company's most recent quarterly report on Form 10-Q.

At this time for opening remarks and introductions, I would like to turn this call over to President and Chief Executive Officer of Schnitzer Steel, Mr. John Carter.

Thank you and good morning. Welcome to the Schnitzer Steel Industries third quarter 2005 earnings Webcast and conference call.

Earlier this morning, we released detailed financial information for the quarter. You can obtain a copy of that press release on our Web site.

The purpose of this call is to discuss the highlights of the quarter, as well as the short and long-term fundamentals of our business. I am joined on call today by Ken Novack, Chairman, Kelly Lang, our acting CFO, and Gary Schnitzer, Executive Vice President, who will be available to respond to questions.

I've now had the opportunity to travel to many of our major locations and soon will be visiting many of our new locations on the East Coast. I personally met many of the people who make Schnitzer run. People who have the responsibility day in and day out to manage our businesses.

I've been extremely impressed by the experience and quality of these people and with their hard work and dedication to this business and to making improvements for the future. As a result of what I've seen and heard, I'm very much looking forward to the future with optimism and confidence for our business.

Current concerns about recent scrap price declines and steel mill overproduction reports should not overshadow the fact that our markets are being lifted by a number positive, long-term fundamental trends. We believe these trends, which are represented in our year-to-date results, signal a fundamental change in the behavior of our markets.

We will address this point in more detail later, but there are indications that the normal up and down cycles are operating at a higher plateau than has been the case historically. However, we don't believe that it is enough to merely float up and down with a higher tide.

The way we effectively manage our way through these inevitable but evidently higher cycles will allow us to maximize our financial performance.

We just completed a very strong quarter. We reported record revenues in our Steel Manufacturing and our Auto Parts businesses. We continue to see good demand for ferrous and non-ferrous metal products.

While our operating earnings of $55.1 million were lower than last year's record third quarter, our year-to-date earnings continue to be significantly higher than we achieved in the first nine months of last year.

Let me touch for a few moments on each of our three operating businesses.

Our Metals Recycling business had another strong quarter. Ferrous scrap prices averaged $230 per ton. That was down slightly from the average in the second quarter of $240 per ton, and $237 per ton a year ago.

Toward the end of the quarter, we did start to see a challenging market conditions which we believe will have an impact on at least our fourth quarter. Falling scrap prices and reduced demand for some steel products in some geographic areas will have some effect.

We are already seeing some firming of scrap prices, however, at what would still be historic highs for this normally slower period of the year. Our customer base remains diverse, although focused on several core relationships.

Our wholly-owned export sales volumes were approximately 58% of our total sales. We exported 289,000 tons, and we sold approximately 40% of that total to Korea, a little less than 40% to China, and about 20% to Thailand.

We shipped 190,000 tons to our wholly-owned steel mill, or 38% of our total sales volume, representing substantially all of our domestic sales of recycled metal. This is higher than previous quarters, reflecting both seasonality as the mill increased its output to support the summer construction season, as well as the increased appetite for scrap metal at the mill driven by the capabilities of the new furnace installed in December.

In addition to our wholly-owned Metals Recycling business, our joint ventures processed and sold 815,000 tons through the joint ventures U.S.-based facilities. This represents a decline of about 25% from the third quarter of last year, but that's primarily due to the timing of export shipments and lower second quarter purchases of unprocessed metal.

The latter was attributable to adverse weather conditions this winter in the Northeast during the second quarter, and that resulted in a shortage of material available for sale in the third quarter.

Also inside the joint ventures, the international trade business, managed by Hugo Neu, sold 840,000 tons into world markets. These joint ventures, trading volumes were up approximately 35% from last year's third quarter, however, volatility in the markets resulted in a net loss on these activities.

As we announced in June, we have agreed with Hugo Neu Corporation to separate the assets of these joint ventures. Our expectation is this will help reduce the risk in our business while adding to our potential upside. It will also allow us to apply our own management philosophy to these businesses.

As we've said to you before about the separation, it will give us greater control over our assets and our cash flows. It will enable us to pursue strategic growth initiatives, and it will give us a presence on both coasts that will add to the diversity of our scrap sources.

It will also expand a number of markets that we could access globally.

We anticipate the transaction will close around end of our fiscal year, and we are looking forward to welcoming the New England and Hawaii operations, as well as the Russian and Baltic Sea trading business to the Schnitzer Companies.

Turning to our Self-Service Auto Parts business.

Our record revenues, which were up 33% year-over-year were fueled by four additional stores that we acquired in January, and by strong market demand. We have purchased 45% more autos in the first three quarters than during the same period last year, and are purchasing at a rate close to 250,000 autos for the current year.

We continue to benefit from our increased emphasis on the sale of core parts to rebuilders, and we are on an annualized pace for over 4 million paid admissions to our stores, which represents a 47% increase, including our new stores, from the run rate in the third quarter of last year. These statistics underscore our belief that this segment of our business is a strong performer and a candidate for aggressive expansion.

Our Steel Manufacturing business benefited from positive general economic conditions both in terms of volumes sold and price. The mill reported record revenues in the quarter as it benefited from strong customer demand with revenues up 27% over last year.

Average sales prices of $510 a ton, while down slightly from the second quarter, were up 14% from the third quarter of 2004. Volume for the quarter was 172,000 tons, an 11% increase year-over-year.

We were able to meet the market demand in part because of the installation of a new EAF furnace in December, which interestingly enough looks as it will pay for itself in terms of production cost savings in its first six months of full operation.

We have been impressed the good performance of our team at the steel mill, and accordingly, the Cascade Steel board recently promoted Jeff Dyck to the position of President of Cascade Steel.

I'll now ask Kelly to go over some additional financial information regarding the quarter.

Thanks, John.

During the quarter our SG&A expense was approximately 900,000 higher than the third quarter of 2004. Most of the incremental cost is related to the increase in professional fees principally relating to the ongoing investigation of trading practices in the Far East.

Also included in spending on added personnel required to implement the Company's ongoing growth plans.

Our third quarter tax rate was 37.4%, compared to 34.9% in the same period of 2004. We're currently anticipating our tax rate for the fourth quarter and full-year to be approximately 36%.

The Company's depreciation expense for the third quarter was 5.4 million, and we had about 25.5 million in capital expenditures including 20 million for the purchase of property housing our Portland scrapyard. We plan to spend up to about 15 to 20 million in the fourth quarter as we continue to execute our plans to modernize our infrastructure, including projects to replace our dock in Portland, install mega-shredders in Portland and Oakland, replace the electrical transformer at our steel mill, and remodel several of our Pick-N-Pull storefronts.

I'd like to point out during the quarter we reclassified insurance costs and property taxes related to our operating facilities from SG&A expense to cost of goods sold. For consistency we restated prior quarters to reflect this change. This is a reclassification only and does not impact our previously reported operating earnings.

Finally, our net debt as of May 31 was about $10 million, down 31 million from the end of the second quarter.

John, I'd like to turn the call back to you now.

Thanks, Kelly.

As we started call out, we said we wanted to look beyond this quarter and focus on the fundamentals for Schnitzer businesses. For both the long and the short-term, we see the primary driver of demand for our core scrap business as worldwide steel production.

We expect demand for steel production in the form of steel consumption to continue to grow. Meanwhile, we expect the recoverable scrap reservoir to remain fairly constant for many years. And the pool is geographically located in areas convenient to our businesses.

As a result, we would expect the increased steel consumption to drive demand for increase steel production and thus demand for our metals recycling products would continue to rise. Since the markets are not perfect, and there are significant geographic and political influences on the growth of steel production, and the ease of import and exporting product, this rise will not always be even or consistent and cycles will persist, but the overall trend looks like very positive growth to us.

The consensus from industry observers and trade publications has been the worldwide steel production was expected to grow slightly more than 1.0 billion tons in 2005 and reach nearly 1.2 billion tons by 2010. These same sources projected the demand for scrap as raw material in the production of steel to increase from 305 million tons to 332 million tons by 2010.

Recent industry reports suggest steel production is growing faster than expected. According to an industry report from June 24, global steel production is now forecast to rise to 1.1 billion tons this year, which is already halfway to reaching the old 2010 growth projection.

Chinese production is expected to reach 345 million tons in 2005, a robust 17% increase and it is in excess of 30% of worldwide capacity.

Based on my own experience and observations, I believe the numbers relating to scrap demand in the old projections may be very conservative. World economic growth continues to fuel steel consumption.

The pressure in China and India to reduce electrical power consumption because their electrical supply has not kept pace with growing demand, favors the installation of new EAF capacity and the greater use of scrap and existing BOF furnaces. In Japan, pressures to meet the Kyoto standards for emissions also could result in a greater use of scrap and the production of steel.

The use of recycled scrap metal and EAF furnaces, according to EPA statistics, results in enormous energy savings, as well as in other environmental positives. All this points toward the demand for scrap growing at an even higher rate than currently projected.

To position Schnitzer to take advantage of these long-term fundamentals, the Company is pursuing several key strategies.

First, getting closer to its long-term sources of supply. The initial investment and expansion of the Auto Parts business have helped ensure a steady and growing supply of material, and the auto parts business has the added benefit of extracting significant value from the autos before they're sent to a shredder. We will continue to identify and lock-in other long-term sources of supply.

Improve the access to export markets is our second key strategy. The recent agreement to separate the Hugo Neu-Schnitzer joint ventures give us deep water port facilities on both coasts and the ability to sell into more foreign markets. We continue to look for other ways to broaden our export market access.

Thirdly, we're still looking at additional acquisitions. We are pursuing acquisitions in the Auto Parts business and the Metals Recycling businesses that will help us take advantage of the long-term favorable market conditions that we see.

The story of our business, however, is not just about volume. What is particularly significant, in addition to the rising demand, is the strength in pricing levels over the past cycle.

Clearly, we believe scrap prices will remain cyclical and somewhat volatile, however, we also believe that fundamentals point toward higher average prices through the current cycle than we've seen in the past, driven by a variety of factors including in our view the relatively stable supply pool of available scrap. We believe higher prices over a cycle will mean the companies that are well managed and make the required investments in their infrastructure will achieve better financial results.

That continues to be our philosophy and as many of you know, our Metals Recycling business has never experienced a fiscal year loss since the Company went public, despite the cyclical nature of our markets.

So let me speak for a moment about current market conditions in the short-term outlook.

Scrap prices are lower today than they were three months ago. In some markets the drop in prices have been steep and swift.

Have we hit the bottom? That's a question being debated throughout the industry. Clearly, we have seen evidence of scrap suppliers saying no to lower prices, and recent export market activity has shown evidence the prices may have firmed and even risen modestly on some individual sales and in some geographic areas.

Also in the Asian countries, the summer months traditionally have seen cutbacks in production and a lower demand for scrap as producers curtail their operations due to high energy costs. That's what happened last year when average selling prices fell from $237 per ton in our third quarter to $199 per ton in our fourth quarter before bouncing back in the fall during the first quarter.

We believe the long-term fundamentals point toward upward pressure on the pricing cycles as we pointed out earlier. But in the near-term we expect some increased volatility and we are unable to predict the timing or magnitude of any rebound from the current price levels.

To some extent because we are selling up to three months ahead, the impact of current decline in scrap sales prices may not be fully reflected until subsequent quarters. Nonetheless, this current drop in the cycle is hitting the floor in prices that are still much higher than historical trends would suggest.

How do these near-term trends affect each of our business? The Metals Recycling business, in periods of falling prices, oftentimes the cost of unprocessed scrap does not fall as quickly as selling prices, resulting in greater than normal margin compression.

This margin compression will be felt in the fourth quarter, although not quite as severely as in the fourth quarter of last year. Nonetheless, margins in the quarter are anticipated to remain strong and be well above historical averages.

Shipments in our wholly-owned scrap business in the quarter are expected to be lower than the 2005 quarterly run rate, but total 2005 sales should approximate last year's level. The lower fourth quarter sales volumes are due in part to the timing of export shipping dates and lower fourth quarter inventory levels.

As a result of these reduced volumes, fourth quarter revenues and operating earnings will be lower on a year-over-year basis. Regardless of the level of pricing we anticipate experiencing during the fourth quarter, indications are that margins will remain strong as noted above.

In the Auto Parts business, demand is expected to remain strong for this business, will be impacted in the fourth quarter by the rapidly falling scrap prices. Since auto bodies are purchased on average 60 to 90 days before being stripped apart and resold as scrap, rapid declines in auto body prices will generally result in lower margins.

The current scrap pricing environment will likely result in lower year-over-year earnings until such time as prices stabilize, even though revenues will be up significantly. We believe the Auto Parts business is less cyclical than our Metals Recycling business, but it is not invulnerable to cycles.

We are taking steps to manage the areas in our business model that we have identified as potentially vulnerable to industry cyclicality. We are negotiating new contracts to lock in a steady supply stream of used autos, primarily through long-term relationships with larger suppliers, which will better enable us to manage both volumes and relative pricing.

We are also investing in improved technology to help us extract even more value out of our inventory, as well as increase our inventory turns.

In the Steel Manufacturing business. This business continues to see strong consumption of long steel products. However, Cascade has recently announced price reductions for wire rod which is impacted by imports.

In addition, the Company has announced a reduction of price of rebar merchant, which was in reaction to price reductions by other domestic competitors to hold market share against imports. These lower prices will reduce our revenues in the fourth quarter but will be partially mitigated by declines in the cost of ferrous metals as you would expect from our prior discussion in the Metals Recycling business.

Overall we are continuing to modernize the infrastructure in all our segments to insure we operate as efficiently as possible. We are installing new state-of-the-art mega-shredders in our Oakland and Portland scrapyards and upgrading the dock facilities in Portland.

We installed a new furnace at our mill which is already reducing the cost of producing steel and are looking at other site improvements. We have invested in the personnel required to expand our Auto Parts business and to extract more value from our existing stores.

In short, we believe we are taking steps to position our business as well for the very positive trend for the longer term, and we are well prepared to address the softer market conditions in the short-term.

Finally, we are aware of the historical spotty results of mergers and acquisitions in our industry. We are quite comfortable with our record of thoughtful and successful acquisitions over the years.

The separation of our joint ventures with Hugo Neu facilitates our involvement in the continuing consolidation of the Metals Recycling business. We intend to be an active and disciplined participant. With that, Ken and I and the rest of the team will now take your questions.

Thank you very much, sir. [Operator instructions] And we'll wait one moment please to compile our list of questions. Again, ladies and gentlemen, that's star one for a question. Again, ladies and gentlemen, that's star one for a question. And our first question comes from the line of Julian Allen of Camel Capital. Please proceed.

Hi, good morning.

Good morning.

I have a series of questions around your cash position. The unwinding of the Hugo Neu joint venture should lead to, as you say, about a $52 million cash payment. What are your thoughts with respect to potential uses of cash? Obviously there's been some deleveraging in the quarter. But have you any thoughts with respect to the August payment?

Well, as we said earlier, and I think I said earlier in my remarks, we intend to be pretty aggressive in the use of our cash in terms of finding ways to employ that capital to the benefit of our investors and shareholders. We think that there are really good acquisition opportunities available out there and intend to pursue them.

I think the cash position obviously is affected by a number of factors including our tax position, and there's still some work that we're doing on that point. But that is our, we see strong growth available, strong acquisition potential in both the Auto Parts business and in the Metals Recycling business.

Okay. Thank you. And then a related question. Is Cascade still for sale? And if so, perhaps could you give us an update on that sale process.

Cascade is, of course, a very important customer for us, and our intent is to make sure that it remains a strong and viable operation. We are looking at different ways that we can enhance their position and their strength in the marketplace.

It may include looking at sales. It may include looking at joint venture opportunities or a variety of things that may occur there, but the emphasis that I'd like to make sure that we're focused on is, it's a good business. It's doing well right now.

We want to continue to make it a good business with a lot of strength. It's good for us. It's good for our employees and it's good for the scrap business.

Great. Thank you very much.

Thank you, sir. [Operator instructions] Our next question comes from the line of Mr. Trey Snow, Priority Capital. Please proceed.

Thank you. Can you quantify how much of the steel volume in the quarter was related to inventory clearing out and how much was demand driven?

I think that the best way to look at that is the production capabilities of the mill have increased substantially with the new furnace, and we're selling everything we can produce. We have a variety of products that come from that mill, and we have, in fact, built inventory to reflect the fact that we want to be responsive to customers that want to draw from more than one product pool. But it's a very strong command picture for that mill.

It's geographically, the West Coast, as you know, is in a [limited] position on steel product demand of the type that we make, and we continue to see that, a very strong situation both from production and the inventory management, I think, just reflects the fact that we see, we do have, for example, we have an outage coming up when we have to replace a transformer at the mill, and we're making all of the predictions and trying to do the right thing to make sure we can satisfy our customer demand during that period.

Okay. So probably shouldn't expect to see then 104,000 tons of rebar over the next couple of quarters. I mean that's a combination of demand and inventory, right?

I'll answer that one. This is Kelly. I think what the issue was there as you might recall the first six months of the year we built inventories because we saw essentially our distributors and fabricators reduce their purchases in an effort to reduce their inventory. So what we saw in our third quarter is them coming back pretty strongly and frankly, we sold through our [inaudible] inventory [inaudible] that we had from the first six months of the year.

So to answer your questions specifically, I think the rebar sales would, it'd be unlikely we'd sell 104,000 tons in this fourth quarter. But we're going to sell, as John indicated, we're selling essentially all of our production we're selling out.

Okay. And that normalizes somewhere around 80,000 tons, right?

That's about right.

Okay. Great. Thank you.

Thank you very much, sir. [Operator instructions] Our next question, ladies and gentlemen, comes from the line of Mr. John Debs of Bodri Capital Management. Please proceed.

Yes, good morning.

Good morning.

In the auto parts area, I know you have done a study of the markets and so on to look for opportunities, and I thought by now you would have made more acquisitions in this fragmented market. Can you talk about the opportunities on the acquisition side you see there? And can you talk a little more about the potential margins. I guess you're saying they're squeezed short-term because of the higher cost of the auto bodies.

Yeah. Taking the second part of your question first. As you, as I mentioned in my remarks, there's about a 90-day turn, about 60 to 90 day turn in the inventory so the purchase of the car bodies at the more robust prices earlier in the year will work its way through the system, primarily through the fourth quarter, and as a result, unless we see a strong rebound in scrap prices, that will have some effect on the margins as well as some of the things we're doing in order to prepare ourselves for the first part of your question, which is acquisitions.

We've been working hard on our systems and our management team to enable us to be able to pick up more stores and stores in significant numbers going forward. I would say in terms of the part of your question that addresses timing, we're not trying to expand the Auto Parts business just for expansion sake.

We're looking for good buys. We're looking for things that will be good for that business longer term, and over the first two or three quarters of the year with record high scrap prices, the expectations of potential sellers for pricing is what we think is a little unrealistic. And so as the prices come down, we think that acquisition market will be moving in our direction.

Thank you. On the scrap side, what impact if any, is the acquisition of the Hugo Neu by Simms that was announced subsequent to your joint venture split-up, and can you comment at all on the valuation that Simms is paying there?

Yeah, there's really two things there. I'm going to ask Gary Schnitzer to address the first part on competition, and then I'd ask Ken Novack to address the part about the valuation. Gary.

John on competing with Simms, we've been competing with them in the Bay Area for over 25 years. And with our deep water port and efficient plant and equipment, we've competed very well against them and see that going forward.

I think it's also true that fundamentally, there are a lot of other competitors in the market as well, and so we really don't see that as a significant factor. Ken, do you want to talk a little bit about the second part of that question? Well, I think, if I repeat the question the way that you were talking about it, I think what you were asking us was fundamentally to comment on the valuation that Simms paid for Hugo Neu, is that correct?

Well, and you're saying you're looking out in the market for additional acquisitions in this area. Is that a valuation that you'd be willing to pay for the right acquisition? Because the way I saw the computations, that valuation was substantially higher than the market is failing Schnitzer at this point which asks the question, would you be better off to buy Schnitzer shares versus buying other scrap businesses at the price that was paid for Hugo Neu?

Well, I think it's always difficult to comment on what motivated Simms and Hugo Neu in terms of that acquisition and how they went about it, but I can tell you that from our perspective, we obviously took a look at whether we should acquire the Hugo Neu business as part of the study we were doing on the separation, and we simply weren't able to agree on a valuation. And obviously, Simms and Hugo Neu were able to do so.

I think that that reflects more, probably an alignment of objectives and vision for this business longer term between Hugo Neu and Simms as well as their perhaps different view of market pricing than it does anything else.

For example, as we commented in our last call, and we've commented a couple of times before, Hugo Neu had a very different vision of what the business, the recycling business was about, particularly in New York City, for example, where it included a much broader range of recycled materials, including household materials. We think the skill sets that we have really are focused in the Metals Recycling business and that's a focus we want to maintain.

Again, I don't know, I can't predict what Simms objectives are in the household area, but at least we know that our objectives are quite different than the ones expressed by Hugo Neu in that area.

Okay. And then lastly, is there any update on the Korean investigation?

No, there really isn't. As you know, we can't comment on the investigation, and it's, the investigation's taking its own course. When we can comment, we will. Thank you.

Thank you very much, sir. Again, ladies and gentlemen, if you do have a question, please key star one at this time. Again, ladies and gentlemen, that's star one for a question. And at this point, we have no further questions. I'd like to turn the call back over to our speakers for any closing remarks.

All right, thank you very much for being with us today. And we appreciate the questions and the attention. So thanks and we'll talk to you again next time.

Thank you very much, sir. Thank you, ladies and gentlemen for your participation in today's conference call. This concludes the presentation and you may now disconnect. Have a good day.