Radius Recycling Inc (RDUS) 2008 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the third quarter 2008 Schnitzer Steel Industries Inc. earnings conference call. My name is Katrina and I will be your coordinator for today. (OPERATOR INSTRUCTIONS).

Thank you operator. Good morning. I am Rob Stone, the Company's Treasurer and primary Investor Relations contact. I would like to thank everyone for taking the time to join us today, particularly in light of the short holiday week.

Before we get started, I am compelled to remind you that the Company's presentation and discussion today contains forward-looking statements subject to the Safe Harbor provisions of the 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 are described in detail under the heading, Factors That Could Affect Future Results in Management's Discussion and Analysis section of the Company's most recent quarterly report on Form 10-Q and recent annual report on Form 10-K.

Now let me turn the call over to John Carter, our President and Chief Executive Officer.

Good morning. Welcome to Schnitzer Steel Industries' 2008 third quarter earnings webcast and conference call. I'm joined on the call by Richard Peach, 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 third quarter results. On our call today we will be hitting the highlights of some very good numbers and discussing positive trends in each of our businesses. In short, we just completed the most successful quarter in our Company's history.

Consolidated revenues of $972 million, net earnings of $62 million, and fully diluted earnings per share of $2.14 were all quarterly records. Year-over-year revenues increased 37% and earnings per share increased 46%. These results were driven by the collective strength of our integrated business model. Each of our three operating businesses reported record quarterly revenues and operating income, and each showed healthy year-over-year and quarter-over-quarter growth.

Our Metals Recycling, Auto Parts, and Steel Manufacturing Businesses continued to maximize the benefits from the strong markets in which we operate through a continued focus on increasing throughput and improving operating efficiencies. We believe this focus is reflected in our financial results.

Let me spend a few minutes talking about our businesses individually. First, the Metals Recycling Business benefited from strong volumes, rising prices, significantly higher margins, and our technology investments to record a 70% increase in year-over-year operating income.

During the third quarter the worldwide markets for ferrous scrap strengthened. The very positive long-term supply and demand fundamentals which are driving the strong pricing environment, remain in place.

Growth in the developing world continues at a rapid pace, particularly in the area of fixed assets or infrastructure investment. This growth is not limited to China, but also includes large parts of the rest of Asia, the former Soviet Union, the Middle East and Turkey. The result of this development activity is an increase in steel consumption around the world, a growth in consumption that doesn't appear at the present time to be either isolated or short-term in nature.

Outside of China much of the steel to meet the higher demand is being produced by electric arc furnaces, which use recycled scrap as the primary raw material, and which have environmental advantages over traditional iron ore-based production, specifically lower usage of energy, less air and water pollution, and reduced greenhouse gas emissions, attributes which are attractive to developing countries looking to install new steel manufacturing capacity.

In addition, we have mentioned in the past that the integrated metal, historically minimal users of scrap metal, are starting to see the benefits of increasing their scrap usage to help lower their own CO2 emissions and reduce energy costs. A report on the Japanese market last week indicated that scrap purchases by the Japanese integrated mills were up 21% in the first calendar quarter of this year.

All these factors result in pricing pressures on the raw materials used to manufacture steel, particularly for recycled scrap metal, as the demand continues to outstrip the relatively slow growth in supply. During the third quarter ferrous processing sales prices set another record, with prices net of freight averaging $463 a ton, a 42% increase from the second quarter of this year.

We continue to benefit from our worldwide view in the scrap markets, which provide us the flexibility to sell to the region or customer group where demand is greatest at the time. We also benefited from our deepwater port facilities, which allow us to efficiently meet that customer demand.

Our flexibility to sell anywhere in the world was particularly advantageous during the quarter as we saw export prices begin to rise more rapidly than domestic prices. Not only does that allow us to get a better price for our product, it leads to higher margins as we purchase raw material based on the domestic market.

During the quarter operating margin per processed ferrous ton increased to $80 compared to $54 a ton in the third quarter of last year, and $46 a ton in the second quarter of this year. In addition to the significant improvement in margins, our focus on increasing throughput paid dividends as well. The inflow of the [trail] was very strong at all of our processing operations. We were able to efficiently handle the higher volumes as a result of the capital expenditures we have made to increase capacity and improve productivity, and through the outstanding efforts of our operational team.

In particular, the mega-shredders installed during the last fiscal year continue to operate at high levels, and we remained pleased with their performance.

During the quarter our processing sales volumes approximated both third quarter of last year and the second quarter of this year. The strong inflow of material resulted in high ending inventories, which will have a positive impact on fourth quarter sales, which I will discuss in a moment.

Our nonferrous sales volumes were a quarterly record, up 19% year-over-year and 33% quarter-over-quarter. This reflects not only the high volume of nonferrous purchases, but also the increased flow of material processed through the shredders and the impact of capital investments made to improve the extraction of material from that shredder flow. Nonferrous prices for the quarter averaged $1.07, up 9% sequentially.

The Steel Manufacturing Business took advantage of a rising pricing environment, coupled with strong operational performance, to post record sales volumes. Third quarter operating income increased 30% year-over-year and 73% sequentially. Average net sale prices increased to $744 per ton, driven by favorable West Coast supply and demand conditions.

As we mentioned last quarter due to weak dollar and higher overseas prices for steel, the flow of imports into the U.S. had slowed considerably. Even though the domestic demand for steel has slowed, the lack of imports has created supply pressures, resulting in record prices.

Capital improvements at our mill in the last fiscal year have increased our production capacity, as this higher capacity was utilized to support record sales volume of 218,000 tons. The high volumes were notable given simultaneous negotiations with the Steel Workers Union for a new three-year labor contract. Both the steel workers and the management team should be commended for staying focused on getting the job done.

Finally, not to be outdone, the Auto Parts Business also posted record operating income, primarily due to a continued focus on maximizing car purchases and throughput and improved productivity. This productivity and the ability to handle the increased volume is the result of good operational focus by our Auto Parts team.

Year-over-year operating income increased 64% as car purchases rose 20%, and margins on the sale of scrap and cores expanded. The team at the Auto Parts Business was able to take advantage of higher prices for recycled metal by continuing to improve the extraction of cores from vehicles before they are crushed and sold as scrap.

The improved yields help contribute to an increase in operating margins to 17% from 14% in the third quarter of last year, despite significantly higher purchase costs for scrap vehicles. Part sales in emissions also improved, contributing to the higher revenues, operating income and margins.

I would now like to turn the call over to Richard for more details on the quarter.

Let me provide a little more commentary on the highlights of this quarter's financial results. As John mentioned, each of our businesses posted record revenues and operating profits due to strong volumes and taking advantage of robust market conditions. As a reflection of the earning power of our business model, we were able to expand operating margins as a percentage of revenues at a consolidated level, and also in the Metals Recycling and Auto Parts Businesses, both sequentially and compared to the same quarter in the prior year.

We were able to accomplish this margin expansion despite across the board increases in raw material costs.

In the Steel Manufacturing Business, although the operating margin percentage improved sequentially, and operating income per ton increased both year-over-year and quarter-over-quarter, on a year-over-year basis the operating margin percentage declined as raw material costs, particularly ferrous scrap, rose at a greater rate than selling prices. However, the steel mill obtains 100% of its scrap through the Metals Recycling Business, which benefits from the higher scrap prices.

In the Metals Recycling Business processing volumes approximated the second quarter, but at higher margin. Although a small component of our overall business, trading volumes continued their trend of quarterly year-over-year declines, reflecting lower quantities of scrap available for export in the Baltic Sea region.

In the last couple of quarters we have talked a fair amount about oceangoing freight cost. In the third quarter, despite a similar level of ferrous export volumes, total outbound freight costs declined by $3 million from the second quarter, reflecting an easing in the freight markets, both in terms of costs and availability of ships.

Looking at our balance sheet, our net debt increased by $78 million, primarily due to an increase in working capital arising from higher inventories and accounts receivables. The receivables were up as a result of the higher volume of individual sales, and the number of sales completed and shipped in the last month of the quarter. Despite the higher receivables, we haven't experienced any significant issues with collectability.

The strong inflow of materials in the Metals Recycling Business was the biggest contributor to the higher inventory values, although as you might expect, the higher cost of raw materials also contributed. All of our operating divisions continue to be focused on turning our inventories as quickly as possible, supported by our ongoing investment in capital improvements that have increased capacity and improved productivity.

During the quarter we also had $23 million in capital expenditures, bringing our total for the year so far to $57 million. For the full year we still expect to spend about $85 million.

Even though our working capital was higher, our operating cash flow remains positive, and our net debt to capital ratio of 21% remains at a comfortable level. Our strong balance sheet provides us the flexibility to continue to make value enhancing investments and capital improvements and acquisitions and to return money to shareholders.

Depreciation during the quarter was $30 million, which should be a good number for the fourth quarter as well. SG&A costs in the quarter were $74 million, which were up both sequentially and year-over-year, primarily due to the impact of the Company's improved financial performance on incentive compensation expense and incremental headcount from business growth and acquisitions during the last 12 months.

Finally, our year-to-date tax rate was slightly less than 37%, which should be a good indicator of the rate through the year.

Let me turn the call back to John.

Now let me turn to our outlook for the fourth fiscal quarter. At this point all indicators are pointing to another strong quarter. In the Metals Recycling Business the overseas markets for scrap remain robust, and prices are rising. Based on the sales made to date, average selling prices net of freight are expected to increase an additional $100 to $125 per ton over the recently completed third quarter.

Due to the strong inflow of material in the third quarter, ferrous processing sales volumes are expected to increase by approximately 175,000 to 200,000 tons than the recently completed third quarter, depending on the timing of shipments. Nonferrous volumes should approximate record sales volumes shipped in the third quarter, while nonferrous sales prices are expected to decline slightly, depending on the mix of materials sold.

You may recall at the beginning of the year we provided guidance that our ferrous processing volumes for the year would be between 4.4 million and 4.7 million tons. Based on volumes shipped in the first three quarters and our expectations for the fourth quarter, it looks like we will come in towards the upper end of that range, with annualized growth in ferrous processing shipments of around 7 to 8%. At the same time we estimated that our nonferrous sales volumes would be between 390 million and 410 million pounds. Based on what we know today, nonferrous volumes will exceed that guidance by a comfortable margin, with annual growth over 13%.

At the end of the third quarter export prices for ferrous scrap accelerated at a greater pace than domestic prices. This trend is expected to continue in the fourth quarter, and as a result overall margins are expected to expand further during the quarter.

In the Steel Manufacturing Business we still haven't seen a significant pick up in import activity. And a tight supply for finished steel products is expected to continue to put upward pressure on prices. Based on the market activity we have seen to date, fourth quarter prices are expected to increase another 15 to 20% from the levels in the third quarter, although prices for steelmaking materials also continue to increase.

We expect that sales volumes will remain at fairly high levels and exceed the volumes from the fourth quarter of last year, but decline modestly from the record tonnage shipped in the recently completed third quarter.

Our beginning of the year guidance for sales volumes in the Steel Manufacturing Business, based on market conditions and higher capacity at the mill, was between 725,000 and 750,000 tons. We are currently on track to exceed that range, with annual volume growth in the 10 to 12% mange.

In the Auto Parts Business we should continue to see the benefits of higher prices for scrap and cores, and revenues are expected to increase substantially compared to the fourth quarter of last year. On a quarter-over-quarter basis higher prices for cores and scrap will likely be offset by seasonality in our self-service parts sales.

Let me conclude by recapping. We just completed another very strong quarter, one in which our people continued to take advantage of capital improvements and investments in technology to increase productivity. These factors enabled us to maximize both the benefits from strong market conditions, as well as the competitive advantages inherent in our integrated business model and export platform.

Clearly our short-term outlook is positive, as evidenced by our fourth quarter guidance. As we have discussed in the past, we evaluate our operational and financial performance and the macroeconomic fundamentals supporting our businesses over the long-term. We continue to like what we see.

Operator, let's go ahead and open up the call for questions at this time.

(OPERATOR INSTRUCTIONS). Tim Hayes, Davenport & Company.

Just a question on your guidance for the recycling business. This is pertaining to what you see for pricing up -- was it $100 to $125 a ton in the fourth quarter. What is your underlying assumption on general scrap pricing that goes into that? Are you factoring in a little bit of a decline in scrap prices as we head into the summer months, or what do you see there for scrap prices, please?

We look at the scrap pricing on the basis of our expectation for export sales. And one of the advantages of our model is we adjust our pricing on the basis -- on the purchase side, on the basis of what we see in the market. So the domestic pricing has been clearly weaker than the sales pricing on the export side. Those margins, as we have mentioned, continue to widen, and consequently we have made adequate sales in the fourth quarter to be relatively confident about our forward projections.

What about beyond Q4, any expectations for what scrap prices may do?

I think the strong market fundamentals on the supply and demand side continue to be very evident in our market, consequently -- and in the steel markets generally -- consequently, that pressure on continued consumption of steel, finished steel products internationally will continue to put pressure on steel prices. The pressure on steel prices translates to higher demand for the materials that make up steelmaking. And scrap has an important role in that and an advantage because, as you know, using scrap material is a very environmentally positive steelmaking process as opposed to the old or integrated blast furnace method making steel.

We see that actually in terms of purchases by integrated metals in Japan that have shown that the integrated metals can improve their environmental footprint and their CO2 outlet by using more scrap in the mix. All of those things say to us that there will be continued pressure on pricing in the scrap market.

Eric Glover, Canaccord.

My line was disconnected, so I apologize if you had answered this question in your commentary. But why was the nonferrous volumes up so significantly in the May quarter?

There are a couple of factors. First, our processing improvements and the technology that we have introduced to our facilities allows us to extract more metal from the flow through the shredders. In addition to which the very positive pricing environment means that we are able to see greater volumes on the purchase side. Those two components have really assisted in terms of our nonferrous for the third quarter.

Then turning to the Auto Parts Business, we have been hearing a lot about fewer miles being driven due to the high gas prices. And I am just wondering if you're seeing any impact in terms of that in your Auto Parts Business?

No.

Have you seen any competitive dynamics in the business change, given the merger between LKQ and Keystone? I know your companies don't overlap on a geographic basis, but any change there?

No, and I think you answered that question yourself in terms of the lack of overlap.

Finally, the increase in SG&A?

Let me turn that one to Richard.

I think the SG&A (inaudible) our record financial results mean that we have to accrue our performance-based compensation throughout the year, and also our share-based compensation throughout the year, so the increase in SG&A is a factor of that. And in addition to that, as you know, we have made a number of bolt-on acquisitions over the past years, so the size of the business has increased and through that business growth that comes with the growth in SG&A too.

John Rogers, D.A. Davidson.

Just following up on the SG&A side of it, I guess, Richard, how much of it is variable versus permanently higher Corporate overhead now?

Most of it is variable. It goes back to the record performance that -- the financial performance that we have announced, and you will see SG&A fluctuate related to the overall performance of the Company.

Then secondly, in terms of your scrap prices, I guess, John, how far out are you sold in the export market now?

I think we are -- as I mentioned earlier, we are sold adequately in the fourth quarter to be very comfortable with our projections on going forward.

That is through August, any -- and those prices rising through the quarter?

I think the average is what I would rather look at, and the averages are actually indicated in our opening comments. We expect those margins to be in that $100 to $120 increase area -- prices going up.

Fair enough. Lastly, in terms of just your share repurchase activity, what are your thoughts now given where the stock is relative to dividends and other uses of cash, because at this rate you're going to accrue quite a bit of cash?

Two things. First, on the share repurchase, obviously that varies depending upon what we see as the appropriate route to go with share repurchases based on price and other opportunities for us to deploy our capital.

Secondly and most importantly, we continue to see adequate runway for our strategic plan going forward for both organic growth due to investments in technology and improvements in our efficiency and productivity, but we also continue to see consolidation opportunities in the marketplace, and continue to look very aggressively for places that we can employ our model of being the dominant producer in that area, looking for good outlets, both domestically and internationally, and where we can add value through investment of our funds or investment of our people.

Thanks and congratulations on the quarter.

Sal Tharani, Goldman Sachs.

I have a couple of questions for Richard, and then a couple for you, John. Richard, can you tell us on SG&A, you mentioned that you are growing some based on the performance which was primarily in the third quarter. Have you accrued enough so what you didn't have in the first and second quarters, that means fourth quarter could be lower than the third quarter?

I think we will see the fourth quarter as slightly less than Q3. But effectively the accruals for compensation-based expense are done in a way that matches the actual performance coming through of the Company. If the performance goes up, then as I said in the answer to John's question, you will see the SG&A fluctuate in a similar fashion.

Do you have a number for your inventory turn on the ferrous scrap side handy?

As you know, we don't provide inventory turn information. We are continuing to improve our inventory turns, as our philosophy -- we're increasing our velocity, and volumes continues to be one of our positive points for strategic deficits.

Fair enough. Also, any views on mills buying scrap yards? Does it impact your business in any way?

It doesn't impact our business directly. As you know, mills have purchased and sold scrap operators from time to time over the course of this industry. So we don't see an impact. It really is just different ownership of competitors in the marketplace and don't expect to see any impact.

Do you think they will behave relatively responsibly as compared to the other scrap yards you are competing with?

I don't know what you mean by that question. And it is very difficult for me to answer a question about either the actions or motivations of the mills, or anyone else for that matter.

Let me put it a different way. When you compete against -- competing against your competitor who is a scrap yard versus a mill, which is looking for scrap, who do you think has been traditionally been a better or more responsible competitor?

I would answer the question the same way I did before.

The last thing is, you mentioned that you are saying increasing use of scrap, particularly in Japan. Have you also heard that it has to do with some -- some of it has to do with the coke shortage, or you think it is more environmentally driven?

I wouldn't speculate on the motivations, but I think that the statements from the mills have been, in Japan particularly, consistent with the ideas that they have objectives for their CO2 emissions and greenhouse gases, and use of higher level for scrap helps that in the integrated mill. There was a report last week, for example, that suggested they had increased over the last quarter 21% in their use of scrap in the mix.

John Debs, Bodri Capital.

A little more theoretical -- not theoretical, but philosophical question. Given the change in [energy] prices, given the drastic change in the automotive population of this country going forward, some people have suggested bonuses, whatever, for scraping low mileage whole cars and so on. What if there is some government action that and that business really picks up, are you prepared -- do you have capacity to take advantage of such an opportunity in both your Auto Parts and your scrap businesses?

The answer to that is yes. I think, as you know, California has had a program for some years, taking older cars off the road, and that has been very helpful to volumes of scrap cars in California. And I would expect to see something similar, if it was a broader-based policy decision, whether on a state or national level.

Obviously, one of the pieces of our strategic plan that we have talked about is that we want to increase our volumes and throughput in all of our facilities, whether it is in the Auto Parts Business or in the steel business or in the Metals Recycling Business. And in the Metals Recycling Business our investment in the these mega-shredders and other productivity investments have allowed us to handle significantly increased volumes already. And we have no doubt we can continue to do that.

So it would be not a positive or a negative, but just simply a positive in your mind if those policies are enacted by other governmental bodies and so on?

For us, just on the basis of the question about the volumes, yes, it would be a positive.

What if China -- I know China is not a big export market for you right now -- but what if the emerging markets, particularly China, really do slow down because oil prices are deflationary and so on? What do you see the impact there? Is that enough to really change the supply/demand balance in the scrap business, where there are summoning positives like the CO2 emissions and so on going for you that you could retain these record levels of prices and so on?

I think that the key to that is the overall world's fuel consumption profile, which continues to grow. Even if the developing countries slow down, there is still growth. And consequently when you add that to the comments that both of us have made here about the environmental positives of the use of scrap metal in the steelmaking process, that looks like continuation of what we have seen as very long-term sound fundamentals in our business.

Even if world GDP slows from 4 or 5, I think, last year, to 1 or 2, you still think that there's enough there to keep your businesses robust?

I think our business will continue to be robust in that scenario, because as you know, that growth, even at a lower level, is focused on increasing infrastructure and increasing various activities that use steel products around the world. So it does look very strong.

Bob Richard, Longbow Research.

Trading volumes, I appreciate your comment on the Russians pretty much getting out of the export market. A third consecutive quarter where volumes were down. Do you foresee that to be an ongoing situation?

It is very difficult to predict what the market is going to do in Russia. But at the moment, as you know, most of our trading volumes came out of the Baltic. There has been a significant reduction in export volumes out of the Baltic, primarily because the increased use of scrap material in Russia, and the steelmaking growth in Russia as that economy expands. That looks to be a long-term trend.

In addition, for us one of the initial reasons for being in the Baltic trading business was to get a broader view of the worldwide market. Our expansion of our platform and our sales into more than a dozen countries allows us to get that now through our process for our scrap, so it is a less important strategic point for us as well. We make those decisions based on what we think is the best use of our capital.

Thanks. I appreciate that. In your annual reports you give a nice -- what your sales mix was by geography. Do you have a breakdown perchance what this quarter's was between Asia and domestic and Europe?

Well, it is a little higher in Asia. It is fairly well balanced, as I think many commentators have indicated. There has been somewhat less demand out of Turkey in particular, but we have sold into Turkey. The better markets from a volume standpoint for us has actually been in Asia.

One final. The Steel Manufacturing Business, that is pretty incredible, the volumes and pricing. It kind of implies maybe a shortage situation out there. Do you have any -- is that strictly -- obviously driven by the import situation? Do you have any opportunity for exporting your product, or do you have a hard enough time taking care of your own customers?

We always look at the opportunity for export. Obviously there are various pricing considerations on handling material and freight that work into that. At the moment our primary focus is handling our long-term customer base, because we see very good profitability in that process.

Thanks very much, and great quarter.

There is no further questions. I would like to turn the call back over to Mr. John Carter for closing remarks.

Thank you very much. Thank you for being on the call today. We are obviously very pleased with our results, and continue to see significant positive opportunities going forward. Thank you.

This concludes the presentation for today, ladies and gentlemen. You may now disconnect. Have a wonderful day.