Radius Recycling Inc (RDUS) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Schnitzer Steel Industries first quarter 2007 earnings conference call. [OPERATOR INSTRUCTIONS] We need to remind you that the Company's presentation and discussion today contains forward-looking statements subject to the Safe Harbor provisions of Federal Securities laws, including estimates of future 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 listed in our earnings press release, issued this morning and described in detail in the risk factors disclosure in the Company's most recent annual report on Form 10-K and under the heading factors that could affect future results in the management's discussion and analysis sections of the Company's most recent annual report on Form 10-K and quarterly report on Form 10-Q. At this time, I will now turn the presentation over to the host of today's call, Mr. John Carter, President and CEO of Schnitzer Steel Industries. Please proceed, sir.

Welcome to Schnitzer Steel Industries 2007 first quarter earnings webcast and conference call. I am joined on the call by Greg Witherspoon, our CFO. After a few introductory remarks, we will be available to answer your questions.

We put out a press release this morning with the details of our Q1 results. Our focus on the call today will be hitting the highlights of what occurred during the quarter, a discussion of management's current areas of focus, and key trends in each of our businesses. Let me start by addressing head-on the questions regarding our first quarter earnings.

While we were pleased that our operating income exceeded the first quarter of last year, we recognized that the results were short of Wall Street estimates, influenced by our record fourth quarter in 2006. As you know, the Company does not provide specific earnings guidance. Instead, we provide quantitative and qualitative guidance, regarding the factors that influence our financial results. Some of these quantitative factor, such as volumes and pricing trends, are relatively easy to be incorporated into the earnings models of analysts and investors. Other factors, such as the ones I'll describe on this call, are less easy to quantify. When these quantitative -- when these qualitative factors are expected to influence short-term results, it is sometimes difficult to communicate the impact in a way that can easily and accurately put into an earnings model. We believe the difference between our first quarter earnings and the short-term expectations of Wall Street was primarily related to the difficulty in quantifying the impact of a number of events that influenced our results. Before I go into more detail, let me make two key points.

First, the long-term fundamentals supporting each of our businesses remains strong. The strong demand for and the finite supply of scrap metal, the continued good demand for long steel products in the West Coast construction markets, the growing need for recycled auto parts to support an ever-aging fleet of vehicles on the road. All of these factors contribute to what continues to be a positive long-term outlook for our company.

Second, the Company's lower earnings relative to the record fourth quarter of fiscal '06 were in many respects attributable to a number of different, yet not unexpected factors. In short, particularly in the metals recycling business, we sacrificed short-term earnings for investments in our businesses, which we believe will improve our longer term performance. We also were affected by the timing of swings and certain market factors. The result of the last two quarters clearly demonstrate the degree to which our businesses, particularly metals recycling, exhibit a great deal of short-term variability and resolves, and the need to judge the performance of these operations over several quarters. Now let me take a few minutes to review the high-level factors that affected the first quarter results.

We continued to implement our plan to make investments in technology and infrastructure. We believe this plan will provide long-term benefits, but in some cases be disruptive to short-term results. In the metals recycling business, we completed the installation of new megashredders in our Oakland and Boston area export facilities. These new megashredders are expected to significantly increase capacity and reduce operating costs. That has been our experience in Tacoma and our early indications in Oakland and in Boston are consistent with that expectation.

As we also discussed on our last two calls, both installations were expected to create short-term disruptions to our operations during this period. In Oakland, due to the size of the facility, processing operations had to be shut down for approximately six weeks to install a new shredder. The impact of the shutdown was two-fold.

First, we had significantly lower volumes for sale, because we weren't processing. For reasons primarily related to regional differences in the cost of the acquisition of material, sales out of our West Coast export facilities are generally more profitable than sales made in other regions. Lower West Coast volumes generally means lower overall margins. Lower processing volumes in our shredding operations also means lower sales of our Zorba nonferrous product.

Second, even though we weren't processing during the installation, we still incurred fixed costs, which went straight to the bottom line. At our Boston area facility, we were able to continue processing during the installation, so we didn't have the issue of directly absorbing fixed operating costs. There were other impacts. Until the megashredder installation was completed in Boston, we continued to process using the old shredder. As we've discussed in the past, it was the oldest and least efficient of all the machines we are operating, and we experienced significant problems keeping it running and performing at reasonable levels. With the installation of the new machine, that problem is now behind us. But the situation did contribute incrementally to a higher cost per ton for the quarter.

With both of the megashredder's installations, it takes a fair amount of time, in all likelihood, a few months, to get the new machines running to full efficiency. Initially, that means processing costs per ton at these facilities may actually go up temporarily until all of the normal start-up bugs are worked out. The good news is that we are pleased with the progress that we've made in the installation of the new shredders. The machines are designed to process at least 2500 tons per day. We've had several days when we've been able to exceed that target, although not yet on a consistent basis. In Oakland, we actually processed more material than planned, which should translate to a quicker ramp up on sales volumes out of that facility in the next couple of quarters. There were also a number of other factors that impacted the first quarter's results. Let me take a minute to discuss those.

The export markets remained fairly robust as gross sales prices held up pretty well and declined only slightly compared to the strong markets in the fourth quarter. We are seeing a lot of pressure on freight rates, particularly for shipments in the Pacific, and a good portion of the decline in net prices is based on freight increases in this region. Over the past couple of quarters, we've talked about the divergence between export and domestic market prices, and overall that trend continued. Normally, because we buy based on domestic market prices, we were able to arbitrage the difference between the markets by utilizing our export facilities which provides us with a competitive advantage over other processors who lack that capability.

There is currently a fairly heated competition for the purchase of scrap metal on the eastern seaboard. As a result, margins for sales in the northeast were squeezed by a narrowing of the spread between our net sales prices and buying prices for materials sold during the quarter. While it's not clear how long this trend will continue, it demonstrates the necessity for us to remain focused on driving down our processing costs through investments to improve our productivity and by increasing the rate at which we turn our inventories. By doing these things, we should be able, over time, to mitigate the impact of market forces over which we have little control.

Turning to the steel manufacturing business, market conditions on the West Coast remain good and the business continues to perform well. We did end our streak of four consecutive quarters of record profitability, but we remain pleased with the mill's overall performance. During the quarter, we continued to make progress on capital improvements, which will expand our capacity and improve our efficiencies.

The new billet yard craneway and modifications to the reheat furnace, which will both increase overall capacity at the rolling mill, are on schedule to be completed sometime this spring. The modifications to the reheat furnace will involve a short shutdown of the facility. The project to increase wire rod capacity was completed in December. I'll let Greg take you through the details of this business in a moment.

The auto parts business continues to be impacted by higher costs for purchased vehicles at all of our locations. During the quarter, the self-service operation experienced reduced vehicle purchases and it faced higher prices. As a result, the inventory of cars at our stores was down. This impacted not only retail sales, but also resulted in reduced core sales and revenue from the sale of scrap vehicles. The decline in operating income from the fourth quarter was primarily related to the lower core and scrap sales.

We believe one of the keys to the self-service business is maintaining and increasing the volume of cars we run through our facilities. After the first quarter's experience, we have adjusted our purchasing model to ensure that we maximize car purchases, where it makes economic sense to do so. By maintaining car volumes, we give our customers a better selection of parts and increase the revenue and contribution from foreign scrap sales. We also provide more material to our metals recycling business. Now let me turn the call over to Greg to provide some more color on the quarter.

Thanks, John. As we said at the top of the call, a lot of the details regarding the quarter are included in the press release, so we encourage everyone to go through the numbers we provided there. Let me quickly go through some of the highlights.

As John discussed, the export markets continue to remain strong. Our average overall net prices for our processing operations were off only $17 a ton or 7% from the record fourth quarter prices, and these numbers were weighted down by a pretty healthy drop in domestic sales prices, and a higher freight cost for shipments made to designations in the Pacific and Atlantic. We continue to see the benefits of a diversified customer base making shipments to ten different countries led by Turkey, Malaysia, and Spain. This again demonstrates the broad strength of the international market, and the importance of having access to export facilities of both the East and West Coast. The real story during the quarter was related to volume, and the cost of purchasing materials.

On the volume side, ferrous shipments in our processing business were off 74,000 tons from both -- from the fourth quarter. The mix of shipments had a big impact on the profitability. Due to the shutdown of the Oakland facility and timing of shipments, volumes of the more profitable West Coast sales were down almost 200,000 tons. This was partially offset by higher volumes in the southeast and northeast. We had originally expected to push through even more shipments in the northeast, but due to processing difficulties with the old shredder and the timing of sales, those volumes have slipped into future quarters.

The lower volumes of material run through our shredders also resulted in higher overall processing costs per ton, which also contributed to lower margins. Nonferrous volumes were also off about 8 million pounds with about 2 million of the decline related to sales of zorba, which is a by-product of our ferrous shredding process. The zorba volumes and related income will also be made up in future quarters, as we get caught up on the tons that we run through our shredders. The other major impact during the quarter was related to purchased prices for ferrous scrap. Despite the fact we saw overall selling prices fall during the quarter, the cost value of the inventory sold fell at a lower rate, particularly in the northeast and southeast regions.

As John discussed, the problem is particularly acute for our Rhode Island and Boston operations, where those inventory costs were 10 to 15% higher than comparable costs in Oregon, California, and Washington. In the steel manufacturing business, we remain encouraged by the resilience of the West Coast construction markets, as average prices were essentially flat from record prices in the fourth quarter of 2006. As expected, we did see volumes decline about 11,000 tons as customers started reducing inventories to lower levels.

The cost of operating the rolling mills is highly sensitive to production volumes. During the quarter, we saw lower margins relative to both the first and fourth quarters of last year, primarily due to lower tons being produced. We've also seen higher costs year-over-year for alloys and electrodes used in the production of steel, which has contributed to a higher cost per ton. Compared to the first quarter of last year, we also saw a slight change in product mix, selling a lower percentage of rebar and a higher percentage of wire rod. The wire rod markets are highly susceptible to foreign competition and generally margins are lower for that product.

In the auto parts business, the biggest impact on operating income compared to the fourth quarter of 2006 was a significant drop in revenue from both core and scrap vehicle sales. As John already discussed, the auto business reduced its purchases of vehicles in the face of higher prices, which led to lower inventories of cores and scrap vehicles available for sale. Compared to the first quarter of '06, core and scrap vehicle sales dollars actually increased due to the impact of much higher prices for ferrous and nonferrous materials. However, the higher year-over-year revenues were offset by purchased vehicle prices, which on a same-store basis were approximately 40% higher. Lower inventories also served to impact self-service parts sales. Despite the normal seasonal increase in same-store admissions, same-store parts sale were actually slightly lower during the quarter and during the fourth quarter than the third quarter of last year.

In October, we opened our fifth conversion store, bringing the number of self-service operations to 35. Revenues from the five conversion stores increased from the fourth quarter, although purchased vehicle costs and these locations remain higher than for the other 30 self-service stores. We are also starting to see higher costs related to a number of information technology projects, which we have undertaken that will improve our decision making capabilities in this business. These are all expected to have future benefits that will offset the cost, but the impact probably won't be felt for several months, if not quarters.

As you're aware, we announced in November that our Board had increased in number of company shares available for repurchase for 4.7 million. Due to the timing of our year end earnings release, the window available to repurchase shares before we went into our normal blackout period was limited to four days. During that period, we bought back 250,000 shares and will evaluate further repurchases depending on market conditions for the Company stock and other needs for capital. During the quarter, capital expenditures were $24 million. As we continued to invest in projects to update our equipment and improve our infrastructure.

The primary uses of the expenditures were for work on the Portland megashredder, general improvements at our metals recycling facilities, and work on projects at the steel mill designed to increase capacity and improve productivity. Depending on the timing of expenditures, the Company expects to invest approximately 50 to $65 million for the remainder of the fiscal year. Net debt at the end of the first quarter was $129 million, with the increase from the fourth quarter due primarily due to capital expenditures, higher inventories, and the cash settlement of the SEC and DOJ investigations. Finally, depreciation during the quarter was $9 million. Let me turn the call back to John, now, to discuss our second quarter outlook.

Thanks, Greg. Let me update you on the annual guidance we provided on our last call. In the metals recycling business, we expected annual volumes in our ferrous processing business to be between 3.6 and 4.0 million tons. Depending on the timing of shipments, which is always tricky to predict, his range still looks good despite lower than expected volumes in the first quarter. We'd expected annual volumes in our treating business to be between 1.2 and 1.5 million tons, and we believe we are still on target to achieve those quantities. Our nonferrous volumes were expected to increase to between 320 and 340 million pounds, and again, despite lower first quarter shipments, we believe the guidance here continues to be achievable.

Before we discuss the second quarter outlook, let me reemphasize again the importance of judging our business over the course of a full year. In 2006, due to a number of factors, many related to the timing of specific events, operating income for the first half of the year was substantially less than the second half, yet judged as a whole, 2006 was a very successful year. Based on what we see today, we believe 2007 is shaping up to be very similar to 2006 in that regard.

Turning to the second quarter, in the metals recycling business, the export market remains strong and average net prices for ferrous metal are expected to approximate or be slightly higher than the sales prices in the first quarter. Prices for nonferrous materials, while remaining strong from a historical perspective, are expected to be down slightly from the first quarter. Freight rates for shipments in the Pacific are expected to continue to increase, but they should be offset for the most part by higher gross prices obtained for sales in that region. Freight prices in other regions are expected to remain flat.

Due to the resumption of processing in the Oakland facility and higher shipments out of the northeast, processing volumes in the second quarter are expected to be higher than in the first quarter, in a range of 1 million to 1.1 million tons. Overall, nonferrous volumes are expected to be slightly lower than the first quarter, zorba volumes which are a by-product of the shredding process are expected to be higher than in Q1, but will not increase at the same rate as ferrous volumes.

Due to the impact of winter weather in northern Russia and the Baltic, volumes for our trading business are expected to be lower than the first quarter in the 200,000 to 250,000 ton range. The higher overall volumes when compared to the second quarter are expected to be largely offset by continued increases in costs for the purchase of material at lower, nonferrous prices. The full improvement in processing costs related to the new megashredders are not expected to be realized until the second half of the year. As a result, second quarter margins in the processing business are expected to approximate first quarter. It should be noted that volumes, prices, and margins are all expected to be improved in the second quarter of 2006.

In the steel manufacturing business, demand is expected to be impacted by normal, seasonal slowdowns in the West Coast construction markets. While customer inventories are relatively low, the West Coast mills are no longer on allocation, and customers are expected to reduce inventory levels even further. As a result, second quarter volumes are expected to be up 15 to 20,000 tons from the first quarter. Average net pricing is expected to be 10 to $15 lower than the near-record prices in the first quarter.

In the Auto Parts business, continued improvement of our performance in the new self-service conversion stores is expected to offset normal seasonal declines in same-store parts, and emission sales, due to winter weather conditions. Winter weather conditions are expected to increase demand from auto body repair shops, and full service revenues are expected to improve from the first quarter. As a result, margins in the second quarter should be improved over the first quarter of this year. Compared to the second quarter of 2006, the improved conversion store and full service performance are expected to offset significantly higher costs for vehicle purchases, resulting in improved margins.

I'd like to conclude by recapping. We just completed a quarter that was impacted by a number of items under our control. Namely the infrastructure projects, which are expected to provide long-term benefits while causing short-term disruption. By focusing on improving the efficiency of which we operate, over time we believe we will improve our competitive position regardless of the market conditions in which we operate. The long-term fundamentals of our businesses remain strong and we continue to believe 2007 will be a successful year for the Company. Let me now open up the call for your questions.

[OPERATOR INSTRUCTIONS] And your first question comes from the line of John Rogers with D.A. Davidson. Please proceed, sir.

Hi, good morning.

Good morning, John.

I guess first of all, in terms of your balance sheet, which you didn't provide, I am curious, with the slowdown in processing of materials, especially in Oakland, did you build up the inventory during the quarter, and if so what price is that inventory being carried out, and is there any risk associated with it one way or the other?

This is Greg, John.

Hey, Greg.

We built up about $25 million worth of inventory, which is about a 10% increase, and there's no chance that we'd have any mark to market write-down on that currently based on the prices we're seeing.

Okay. Any chance you could have a gain as a result of it, unusual or?

It wouldn't be unusual--.

I don't mean it that way, but I guess, out of sequence or--?

No, we'll make a normal operating profit off of selling that.

Okay. And then my second question was just on the Auto Parts business. I understand your comments about the negative comp store sales in the quarter, but any further explanation on that?

Well, a couple of things on that. Let me ask Greg to address it first, then I've got a couple comments as well.

Same-store sales?

Yes.

Well, I think what John addressed earlier was the fact that we didn't have as much inventory to sell. We tried to cut back on our purchases when the prices of the scrap vehicles rose, and where we did that we obviously don't have as many car cores to sell. We don't have as many cars on the yard to have our customers pick parts from.

It's a very competitive market, John, and when we see these spikes in competition, of course, we react by trying to mitigate that. And as a result of the first quarter, the flowthrough of inventory to the Auto Parts Business was down. That was reflected because of, if you recall, we had record results in the fourth quarter, which influenced the asking price for our products that came in. Our car inventories reflected that price increase.

Did you see a slowdown on both the self-service and the full-service business, or--?

Full-service business tends to be slower during that calendar part of the year.

Right.

And will pick up now as we go into winter. So that was a seasonal slowdown, which was expected, but it wasn't significant.

The other thing is, of course, we've moved five of those stores to the self-service side.

Yes.

So there's lower potential volume out of the full service business on that standpoint.

And any thoughts on additional conversions or switches this year?

At this point, we're still looking at that. We have no specific plans for conversions at this point.

Okay. And then the last thing. Just back on the scrap business, the volume numbers that you gave us for the second quarter, does that -- how much of that is from the acquisitions?

Well, on a year-over-year basis, of course, it reflects the acquisitions, but it's essentially not a significant amount at this point. We have very good flow into the existing facilities. Even while Oakland was shut down the inflow was quite good.

Okay. So the acquisition of the business up in New Hampshire--?

That was included in the second quarter of last year. So we're at--.

No. He's talking about the new business.

The new one, yes.

Yes. That's about 5% of volume in the quarter.

It will show up later--.

Because it's partway through the quarter, right?

Right. It will show up later in the same quarter, but primarily in the -- you'll see it in third quarter. That's around 250,000 tons annually. So you'll only see a couple of months of that.

Okay, great. Thank you.

And your next question comes from the line of Saul Tharani with Goldman Sachs. Please proceed.

Good morning, Sal.

Good morning, guys, how are you?

Good.

Can you just elaborate a little bit more on these auto body inventories. It appears that you made a deliberate decision to reduce inventory. What was the reason for that? And what impact did you see on the -- did you -- were you able to lower the market price of auto bodies by doing that? And what's the reason for reversing this decision in the second quarter?

Well, I think the thing that we see in the auto business is we see spikes -- geographic spikes as well as timing spikes in terms of the pricing for auto bodies. And we react accordingly. It appears that the autobody pricing is holding up rather well, and -- from the standpoint of the sale side, and as a result, we've adjusted our model to make sure that we can increase our volumes and continue to sell through. We're getting good results on the sale side in the Auto Parts Business as well on cores and scrap. So those prices on that end are holding up, and we concluded that it's better to be back to a higher volume approach.

We were still making a profit, because we sell the crushed auto bodies, we sell the auto parts, we sell the cores, we were just trying to help level out the prices and we've gone back to our original model. Continuing to buy and keeping our volumes up.

And on the steel mill side, do you follow the general pricing which Nucor dictates on rebar, or that is because of a different set of pricing rules?

No. Generally Nucor is the 800 path rollout here, and everyone follows their pricing.

Okay. Great. Thank you very much, guys.

And your next question comes from the line of Eric Glover with Canaccord Adams. Please proceed.

Good morning, guys.

Good morning, Eric.

A couple questions. You just talked about in the press release the strength of the ferrous export markets. I'm just wondering how sustainable you think the demand is from those countries that you specified in particular?

Well, I think the demand is quite sustainable, and I think that it's reflected in a number of different ways. We've talked in the past, Eric, about the fact that increase in steel production and the general tendency to move towards more environmentally friendly ways of producing steel, which means electric furnaces and the use of more scrap, even in the basic integrator furnaces continues to be a driving force in the worldwide steel market. And as steel consumption goes up for us, it doesn't really matter what countries or regions produce more steal, because it puts the demand on a limited pool of scrap. So from our perspective, the increase in overall world steel production will continue to drive increased demand for our product. And as you know, pricing most recently has even gone up in the iron ore area, which is a knock-on benefit for us as well.

And then on the Auto Parts Business, can you -- you may have mentioned it, but can you give us some idea of what your average cost of purchased vehicles was last quarter versus this quarter?

We don't generally give out that information.

Could you talk about it on a percentage increase, maybe?

Year-over-year was a 40% increase.

Okay. Would it be possible to compare it to last quarter?

Well, slightly higher than last quarter, but not dramatically. It's in single digits. The year-over-year increase is the interesting one, simply because it reflects the overall higher demand for scrap, which is reflected in the purchase of auto bodies.

Okay. Thank you very much.

And your next question comes from the line of Wayne Atwell with North Street Capital. Please proceed.

Thank you. Could you explain why the vehicle costs went up, and why wouldn't you have just paid a little more and bumped up your pricing?

Well, competition and the prices of scrap have driven up the value of scrap vehicle used in scrap vehicles, and you have to keep in mind, when we sell the auto parts themselves, it's not a completely elastic market. We do look from time to time to increase our prices as much as we can. The prices on the salvaged vehicles we sell out at the end, the crushed vehicles, does march pretty much in line with the cost of purchasing the vehicle.

Do you think this represents an increased competition over the long-term i.e., there's more people in the vehicle business where they're selling either self-serve or full service parts?

No, I don't think so. I think really what it reflects more than anything is that people looked at the sale of scrap metal, which is represented primarily on the West Coast in the form of auto bodies was a way to make good money. A lot of people, as we've commented in the past, get into the business and find out there's a little bit more to it than they thought. So those spikes in competition come with the increase in prices. There, historically, have been the same things in the past, and then generally the market calms down and we move on.

Okay. And what's the outlook for acquisitions? Is it getting more attractive, less attractive? Is there anything -- I'm sure you can't mention any specific names, but is there anything that's boiling to the top that you're excited about?

Well, we continue to see a very good flow of acquisition potential. We see a lot of deals that are potentially interesting to us. We continue to be very disciplined about how we look at those deals, because obviously coming off two good years in the business, the expectations of the sellers for top price for their business is quite high. But we see as we did in the last quarter, we purchased the Company in New England and we continue to see opportunities and expect to see other acquisitions over the course of the year.

The margins on your used vehicle parts business, are they going to run counter to the scrap price? So if scrap prices go up, then margins come down, and if scrap prices go down, margins go up?

No, I don't believe so. I think longer term, the trend is, as we grow on the East, you'll see the margins are a little bit less than they are on the West Coast because of our dominance in northern California. But as we fill in in these areas, we expect to have those margins improve over time.

You may recall, one of our objectives in that Auto Parts Business is to be one of the dominant players in the markets that we are in. Obviously you can't start a new market as the dominant player every time, it takes a little time to build up to that layer -- to that level.

You're second largest in the country, right?

Yes.

Right. Great. Thank you very much.

[OPERATOR INSTRUCTIONS] And your next question comes as a follow-up from the line of Sal Tharani with Goldman Sachs. Please proceed.

Hi. Can you give us some idea of what kind of volume or how the shipment was on the West Coast of the Asian countries?

Well, everything that we've shipped off the West Coast with rare exceptions goes into Asia, Sal. They, as we've said, 11 countries that we've shipped to during the course of the first part of the year and a large number of those were in Asia from the West Coast. Where we looked to ship is where we could find the highest price for our product. So one of the things that we've done, done intentionally is to spread out our customer base, as you know, and that's enabled us to ship to some places in customers that we haven't in the past because we'd get a better price.

Okay. And when is the window for stock repurchase opens again?

I believe it's three days after the call.

Okay.

12.

Okay. Thank you very much.

At this time, there are no further questions. I would now turn the call over to Mr. Carter for closing remarks.

Well, we thank you very much for being with us today, and we look forward to talking to you after our next quarterly earnings. Thanks very much.

Thank you for your participation in today's conference. Ladies and gentlemen, this concludes the presentation. You may all disconnect and have a good day.