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Executives

Ali Alavi – VP of Corporate Administration, General Counsel and Secretary

Jim Hensler – Chairman, CEO and President

Bob Scherich – VP and CFO

Analysts

Brian Grad – DLS Capital Management

Robert Howard – Prospector Partners

Scott Blumenthal – Emerald Advisors

Eric Prouty – Canaccord

Luther Lu – FBR Capital Markets

Horsehead Holding Corporation (ZINC) Q1 2009 Earnings Call Transcript May 8, 2009 11:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Horsehead Holding Corporation conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. (Operator instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Ali Alavi. Please go ahead.

Ali Alavi

Good morning everyone, and thank you for joining us on our first quarter 2009 earnings release conference call. My name is Ali Alavi, and I'm Horsehead's Vice President of Corporate Administration, General Counsel, and Secretary.

Before I turn the call over to Jim Hensler, I would like to quickly remind everyone that this communication may include forward-looking statements about our company or market and our prospects that are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. These risks and uncertainties include a variety of factors, some of which are beyond our control.

These forward-looking statements speak as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these forward-looking statements to reflect events or circumstances that occur after this communication. You should refer to our filings with the U.S. Securities and Exchange Commission; including our most recent Annual Report on Form 10-K filed March 16, 2009 for a more detailed description of the risk factors that may affect our results.

With that, I'm pleased to introduce Jim Hensler, our President and CEO. Jim?

Jim Hensler

Thanks Ali. I'd like to welcome you to this conference call to discuss the first quarter 2009 results. I will review the performance of our operations and markets then turn it over to Bob Scherich, our CFO, who will review the financial results.

The first quarter's performance was weaker than expected, reflecting further softening in market conditions from an already depressed fourth quarter. Our primary focus during the quarter was to reduce costs and cut operating capacity to the demand level for our products and services.

Reported domestic steel production averaged 43% of capacity utilization during the quarter compared to 88% for the first quarter of the prior year. This affected demand for zinc products and the generation of EAF dust. As a result, we ended the quarter with significant capacity idled, including one-third of our zinc smelting capacity in Monaca, along with our recycling operations in Beaumont and Bartlesville.

In addition, we operated the entire quarter with one kiln idled in Rockwood, and took intermittent kiln outages at our Palmerton plant. We received approximately 80,000 tons of EAF dust during the quarter, a 42% reduction from the prior year quarter, and a 6% reduction from the fourth quarter.

The reduced level of EAF dust generation has provided the opportunity to utilize excess capacity to attract new sources of EAF dust. We are very pleased to announce the signing of a definitive agreement to acquire the EAF dust business of Envirosafe Services of Ohio. Envirosafe is an established provider of disposal services of EAF dust, handling over 130,000 tons in 2008 with associated revenues of approximately $10.4 million.

We would be acquiring their EAF dust service contracts with several steel mills, but not their landfill operations. We anticipate closing on this acquisition during the second quarter of this year. In addition, we have begun receiving dust from other new sources during the quarter, which partially offset the decline in dust generation. We also reduced dust inventories by approximately 24,000 tons during the quarter, which allowed us to increase the feed ratio of low-cost EAF dust to our smelter to 66% during the quarter compared to 56% in the prior year quarter.

We are not expecting dust generation from our current EAF dust customers to change substantially in the near future. Most of our steel clients are indicating that they are not expecting any improvement in their end markets, and that they expect to continue operating at these low production levels through the end of the year.

Some of our clients are hopeful that production will increase slightly in the second half of the year as destocking in their end markets winds down. We expect to service our current dust contracts, and the new contracts we acquire from Envirosafe, while operating only the recycling facilities in Palmerton and Calumet, until such time that the steel industry begins to recover.

Construction of our new EAF dust processing facility in South Carolina is progressing well. We are realizing significant cost savings in the construction of this plant from our original estimates by taking advantage of the weaker construction market and lower cost construction materials.

Through the end of the first quarter, we have committed roughly half of the capital investment required to complete this project. Our current plan is to continue construction up to a point, whereby the plant would be in a position to start up the first kiln within six months. We expect to be in that position near the end of the third quarter and total spending commitments should be about $41 million at that point.

At that time we will decide whether to suspend further construction activity or proceed, depending upon the outlook for steel production. The acquisition of the Envirosafe EAF dust service contracts when completed will likely require a significant portion of our available capacity, including Barnwell, when steel production returns to normal levels.

We want to be in a position with the Barnwell project to react to the turn in the market when it occurs, while not consuming too much additional cash in the interim. We now believe the total project can be completed for approximately $68 million. In addition, we expect to obtain new market tax credit financing of approximately $6 million, which will be used towards funding this project.

Market demand for zinc metal and zinc oxide continued to decline during the quarter. Zinc product shipments declined by about 33% compared with the first quarter of 2008 to about 28,000 tons. Shipments declined by about 8% compared with the fourth quarter of 2008. In response to generally weaker markets across the board, we cut back production of the Monaca smelter from 5 furnaces to 4 in February. We now anticipate operating at this level for the balance of the year.

Demand in the general galvanizing market has been off about 25% from last year. The market continues to be spotty; some galvanizers are showing signs of a slight pickup as we enter the construction season. We are also seeing some interest from overseas markets; however, net premiums are very low for this business. In zinc oxide, demand was off about 40% in the prior year and was impacted mostly by the tire and rubber sector.

The outlook for demand in this sector remains unclear. Moving on to discussing the pricing environment, the LME zinc prices declined 52% since the prior year quarter. Zinc prices averaged $0.53 during the first quarter compared to a $1.10 in the prior year quarter, and $0.54 in the fourth quarter of last year.

A positive development in recent weeks has been the modest increase in zinc prices, which averaged $0.62 in April, and are currently trading near $0.70. It is also worth noting that inventories held in LME warehouses declined during the quarter, suggesting some balancing of supply and demand. However, a portion of this effect is believed to be due to stockpiling of metal by the Chinese government.

The realized premiums on metal averaged about $0.04 during the quarter, slightly lower than the premium for the prior year's quarter of $0.05, and lower still from the fourth-quarter average of $0.07, which was influenced by a slight lag effect. Spot premiums are about $0.03, and competitive pressures are placing further downward pressure on prices.

Realized premiums for zinc oxide in the quarter were approximately $0.08 up from $0.01 in the prior year quarter, and down from $0.28 in the fourth quarter. These differences are mostly explained by lag – by LME price lag effects in the contractual premiums with tire producers.

The fourth-quarter 2008 realized premium was strongly influenced by the rapid decline in LME price during that quarter. Lag effects on pricing were minimal in the current quarter since LME prices have been relatively flat since October of 2008.

Spot premiums for zinc oxide are essentially zero, reflecting the weak demand of end-users and low capacity utilization of producers. We averaged approximately 50% of capacity utilization in our oxide production facilities during the quarter compared with operating at full capacity in the prior year quarter.

Given the low zinc price and low demand environment that we are facing, the focus of the business continues to be to reduce cost and conserve cash by effectively managing working capital, and eliminating investments until market conditions improve. As a result of our cost reduction efforts, we entered into a long-term agreement during the quarter to process the byproduct materials from our Palmerton (inaudible) process through a third-party smelter, which has resulted in the idling of our Bartlesville plant during the quarter.

Also during the quarter, we completed projects for pelletizing EAF dust at our Palmerton plant, and the expansion of our wells [ph] oxide washing circuit at the Monaca facility. These projects are expected to provide cost savings for the balance of the year. We have reduced staffing in all of our facilities during the first quarter, and plan additional reductions in the second quarter as we further rationalize our recycling facilities and the Monaca operations.

In total, including these initiatives, we have identified $30 million of cost reduction projects, of which $5 million were realized during the quarter. In addition, we realized $6.5 million of inventory cost reductions during the quarter of the overall planned working capital reductions of $18 million for the year.

We are pleased to have a strong liquidity position in these difficult financial markets with $96 million in cash on hand at the end of the quarter, $30 million of availability on our revolver and essentially no debt, the company is well positioned to cope with these difficult markets, and to make strategic investments such as the Envirosafe acquisition to position us well for the recovery.

And although we used about $26 million of our cash on hand in the first quarter, about $21 million of that was used for capital investment and non recurring items. Finally, we continue to focus on revenue enhancement projects such as our initiative to market the iron rich co-product of our EAF dust recycling process to the iron and steel industry.

We have taken our first commercial order for this product for delivery in the second quarter based on successful mill trials we completed in the fourth quarter of last year. And while our short-term expectations from this initiative have been lowered somewhat given the weakness in the steel industry, we continue to believe that this product offers significant revenue potential in the future.

I will now turn it over to Bob Scherich, Horsehead's CFO, to review the financial results.

Bob Scherich

Thanks, Jim. For the first quarter, loss per share was $0.42 or $0.70 lower than the prior year quarter. I'd like to provide a summary bridge of these earnings to the prior year first quarter earnings per share of $0.28.

Lower LME zinc price resulted in a reduction in gross margin of $0.40 per share. Reduced volume of shipments in EAF dust receipts resulted in a decline of $0.23. This combination of volume and price effect on gross margin reduced earnings $0.63.

Non-cash charges for the write-down of inventory to net realizable value and the mark-to-market adjustments for open hedge positions reduced earnings $0.11.

Higher fixed cost per pound due to reduced production levels had an unfavorable effect of $0.08 and was more than offset by cost reductions of $0.11.

Detail of the quarter's performance reflects a decrease in sales revenue of $75 million or 65% compared to the prior year quarter. The decrease was the result of a $31 million decrease in price realization, due primarily to the lower LME zinc price and sales volume decrease of $38 million.

Mark-to-market adjustments on hedges further reduced sales $3.6 million for the current quarter. The average sales price realization for zinc products on a zinc contained basis was $0.66 per pound or $0.13 per pound about the average LME price for the quarter compared to $1.26 per pound or $0.16 above the average LME price for the prior rear quarter.

Sales of zinc metal decreased $29 million or 63% to $17 million for the quarter. The decrease was attributable primarily to a $17 million decrease in price realization and a $12 million decrease in sales volume.

Sales of zinc oxide decreased $31 million or 66% to $16 million for the quarter. The decrease was attributable to a $13 million decrease in price realization and an $18 million decrease in sales volume.

Sales from EAF dust recycling decreased $6 million or 43% to $8 million for the quarter reflecting lower volume of receipts. Cost of sales decreased 40% or $37 million and included a $3 million charge for the write-down of inventories. The decrease in costs reflected the lower volume of shipments, along with reduced costs for purchase feeds, reduced conversion costs, and the effect of cost reduction efforts.

For the quarter, purchased feed costs declined $23 million compared to the prior rear quarter. Lower volume of shipments decreased cost of sales $25 million, conversion costs were down $13 million with energy cost $6 million below the prior rear quarter, labor cost down $3 million, and maintenance expenses down $2 million.

Cash used by operating activities excluding non-recurring payments was $5 million for the quarter. Capital spending was $16 million, including $13 million for the Barnwell project. Availability on our revolver is $30 million. We expect capital spending combined with the purchase price payments for the acquisition of assets from Envirosafe to be approximately $50 million for 2009, assuming that we do not put the Barnwell project on hold later this year.

We believe that the combination of our cash, the borrowing availability on our revolver, our cost reduction initiatives and our hedging positions will be sufficient to satisfy our liquidity and capital requirements for the foreseeable future.

As Jim mentioned earlier, we anticipate financing approximately $6 million of the remaining cost to complete the Barnwell project.

In closing, the profile of the first quarter reflected continued low LME price levels and reduced demand for our products and services. Production levels have been reduced accordingly. Cost and working capital reductions were achieved during the quarter and are expected to continue in the second quarter.

At this time, I would like to turn things back to Jim for some final comments. Jim.

Jim Hensler

Thanks Bob. In summary, before I open we open the call for questions, I would like to say while the current economic environment continues to be very challenging, we believe we are positioning the company for profitable growth when the steel industry and in general the economy recovers. We are excited about the acquisition of EAF dust service business from Envirosafe.

Envirosafe has been the leader in the EAF dust service market, and the addition of these contracts to the Horsehead portfolio helps us to fulfill our growth objectives in the dust recycling market. We anticipate that the addition of the Envirosafe business will be accretive to earnings this year. We expect that the cash investment net of additional tipping fee revenue will be approximately $3 million in 2009.

In future, deferred purchase payments are expected to be more than offset by the additional dust revenue. We believe this is the type of market in which strategic opportunities like the Envirosafe business will continue to present themselves, and we are well positioned to take advantage of those opportunities.

The significant closure rate of miners and smelters around the world combined with the increased demand for zinc in China has had a positive effect on zinc pricing in recent weeks, which we hope will continue. And while we expect to remain at the forefront of this operation at our smelter for the balance of the year, we believe that through our aggressive cost-cutting actions, we will maintain a strong liquidity position throughout the rest of this year, which will only be enhanced if zinc prices continue at their current levels or demand for our products improve.

Thank you very much, and we now like to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) We have a question from Brian Grad with DLS Capital Management. Please go ahead.

Brian Grad – DLS Capital Management

Hi guys.

Jim Hensler

Hi.

Bob Scherich

Hi.

Brian Grad – DLS Capital Management

Would you just reiterate and clarify something for me please, what are you paying for the Envirosafe assets and how much cash are you going to be spending on the South Carolina facility between now and the end of the year?

Jim Hensler

Well, for the Envirosafe, which we look to close on that acquisition later in this current quarter, we would expect to spend a net of about $3 million this year. As for Barnwell –

Bob Scherich

As for Barnwell, if we stop the project today, we would have spent – committed $34 million. So if we continue the project, but placed it on hold as I mentioned at the end of the third quarter, we will spend another $7 million.

Brian Grad – DLS Capital Management

So you got – so you are basically you have got off of your projected spend spent already?

Bob Scherich

We've got half of our projected spend committed. In terms of the actual cash that we have consumed, we have probably consumed about $25 million, $26 million of the $34 million, but there is a lag in terms of paying the bill and so, we have committed $34 million. To get to the six-month point, so to speak, we would have to spend about $41 million. If we continue to operate, continue to construct the plant uninterrupted through the end of the year, we would spend another $8 million beyond that.

Brian Grad – DLS Capital Management

So your actual cash out is $25 million to this point. You're talking at an additional $16 million and then an additional $8 million to get to – so potentially another $24.

Jim Hensler

Yes, if we continue to build out without any interruptions. That is right.

Brian Grad – DLS Capital Management

Okay, that is all I have for right now. Thanks.

Jim Hensler

Okay.

Operator

Okay, thank you. And we have a question from Robert Howard with Prospector Partners. Please go ahead.

Robert Howard – Prospector Partners

Hi, just to check on the $25 million that you said, is that today or the end of the quarter?

Jim Hensler

As of the end of the quarter.

Robert Howard – Prospector Partners

Okay, great, and I wanted to ask a question about SG&A expense, it looks like it was actually up in the quarter a little bit, I know you have been cutting a lot of cost; I was a little surprised to see that actually be a little higher.

Jim Hensler

I think versus prior year it is up slightly with a little bit of addition to bad debt reserve, a couple of hundred thousand dollars. And non-cash stock-based compensation expenses there about $100,000. Our SG&A increased last year after the first quarter, which are increases that we do expect to have here this year.

Robert Howard – Prospector Partners

Okay, and then to understand contracts that you're picking up, you are saying $3 million costs this year, is that to sort of mean that there is – you are having to I guess as you receive the debt payments, you are having to make a payment to the other guys that you have the contract from, is that how it is? You are making kind of sound like it is variable thing as it sort of goes forward?

Bob Scherich

Well, we can't go into details of the contract at this point. We haven't closed on it. But the basic structure has a fixed component to it, and a variable component. It is spread out over several years.

Robert Howard – Prospector Partners

Okay.

Jim Hensler

But in terms of cash out of our pocket, there is really going to be a cash investment here in the first year of about $3 million, after that the investment will generate significant net cash for us after we make payments to ESOI.

Robert Howard – Prospector Partners

Okay. And how long did those contracts run?

Jim Hensler

Well, the contracts – there are a variety of contracts that we will be picking up, the longest of which runs for 10 years. It is also the largest contract.

Robert Howard – Prospector Partners

And how did you go about, did they approach you or did you seek kind of seek them out of, how was the story in terms of how this deal came about?

Bob Scherich

Well, when dust generation fell off in the fourth quarter, and we had excess capacity, we began discussion with Envirosafe about the possibility of diverting dust from land filling into our recycling operations, and that evolved into basically this deal.

Robert Howard – Prospector Partners

And are any – obviously, you guys are big player in dust and they have a good share. Are there any competition issues in terms of, you know, people worried about you getting to higher a share of the market at all, or regulatory type of thing like that that could come in?

Jim Hensler

We have reviewed that with counsel. We don't believe there are any issues there.

Robert Howard – Prospector Partners

Okay. And I guess jumping back to the Barnwell construction, I didn’t quite pick up, you said $6 million of finance in that, I thought you mentioned some tax in there, could you just sort of talk about?

Bob Scherich

We have got financing under development, at times what is referred to as new market tax credit financing. It is kind of a federal-based program that is very attractive. We haven't completed that, but we are working to do that and if we complete it, it will bring about $6 million of low-cost capital into the project, and we will use it towards the completion.

Robert Howard – Prospector Partners

Would there be any possibility of with the government handing out lots of money right now for infrastructure type of things, I mean is this – can you talk about wanting to promote the build of new recycling facilities and giving you some money?

Bob Scherich

Well, we're trying to initiate those discussions. We're not sure where they will end up.

Robert Howard – Prospector Partners

Okay. And then I guess lastly just, we have been seeing in the last few weeks zinc prices going up, how quickly does it or how long does it take for those to start flowing to your bottom line?

Jim Hensler

Well, on the income statement for our metal products, we realize the change in price fairly quickly, same month. Our zinc oxide business on average has a 2 to 3 month lag to the change in pricing. But more importantly it is when it flows to cash, which – we've got average DSOs between 35 and 40 days. So, on the metal side it takes about 40 days for it to hit the cash. It is a little longer than that on oxide.

Robert Howard – Prospector Partners

Okay, great. And sorry, one last thing, other current assets, the put under there, and I just was wondering what they are currently being carried out on the balance sheet?

Bob Scherich

Yes, the carrying value of hedges is carried on in the current assets as well as any of the other big items there changes are deferred tax benefit, when reporting a loss. To kind of give you a quick number on the hedges around the put options their value on the book now is about $2.2 million after the mark-to-market adjustment.

Jim Hensler

We had originally paid about $10.4 million for them, took a mark-to-market adjustment at 12/31 of $3.6 million, and now the carrying cost is about $2.2 million for the remaining 9 months.

Operator

Okay.

Bob Scherich

Obviously no cash effect here in 2009.

Operator

Okay, thank you. And we have a question from the line of Scott Blumenthal with Emerald Advisors. Please go ahead.

Scott Blumenthal – Emerald Advisors

Thank you for taking my question.

Bob Scherich

Hi Scott.

Scott Blumenthal – Emerald Advisors

Hi Bob. Jim, could – I guess on past calls, you were trying to balance your capacity or ability to consume dust with the amount of dust that you're contracting, and now I guess with I guess ESOI, it is then that put Horsehead in a situation where if we get a surge in steel demand by some miraculous stroke of divine intervention here that our ability to consume or store dust is going to be outstripped by the volumes of dust that we will be bringing in?

Jim Hensler

Actually it's an excellent question, and that is really behind our desire to get Barnwell build out to a point where we have about six months left to complete construction, because we wanted to be positioned for an eventual turn in the market. You know, with the dust volume that we will get with ESOI contracts, if we go back to steel production levels in July or August of last year, we would be bringing in close to between 650,000 and 700,000 tons of EAF dust, and we only have capacity for about 550,000 tons without Barnwell. So, the addition of Barnwell becomes an important part of being positioned to respond to the market returning, and as I think I mentioned in the first quarter, steel capacity utilization was around 43%. If you put it in perspective, if steel capacity utilization recovers even modestly back to the 65% to 70% range, as supposed to 90% where it was in the middle of last year, we would be effectively at our full capacity without Barnwell.

So, yes we’re watching that very closely. We don’t want to be in a position where we have excess capacity, more dust volume that we can handle. Now I would say that part of the agreement we have with ESOI or Envirosafe is that if that were to happen, we would have the ability at least on a short term basis to divert some dust back to their landfill until we complete the build out at Barnwell. So I think we’re covered, but you know we certainly want to be in a position to take full advantage of the market when it does recover.

Scott Blumenthal – Emerald Advisors

Okay, and just to make sure that I understand, once if diverted to landfill, at that point it’s not going to be usable at all in any of our recycling operations, correct?

Jim Hensler

Yes, that’s correct. When it goes to the landfill it ends up being stabilized, and so it’s not available for recovery at that point.

Scott Blumenthal – Emerald Advisors

Okay, and a few questions for Bob. Bob I’m going to apologize to you beforehand because you were at through this so quickly. But you did mention, I think that the dust service fees were about $8 million. Is that correct in Q1?

Bob Scherich

Yes, yes. That was a decrease of 43%. So $8 million is the approximate number.

Scott Blumenthal – Emerald Advisors

Okay. And did you give us a tonnage also.

Bob Scherich

Yes, Jim had mentioned earlier it is right about 80,000 tons.

Scott Blumenthal – Emerald Advisors

Okay, and did you give us a realized price.

Bob Scherich

No, but based on those two numbers it is in the low $90 to $93 per ton and you did say that the percent of purchased feed stock in the quarter. I guess Jim said 66% of production came from dust. So –

Bob Scherich

That's right.

Scott Blumenthal – Emerald Advisors

Okay, all right great. Thank you.

Bob Scherich

Thank you.

Operator

And we have a question from the line Eric Prouty with Canaccord. Please go ahead.

Eric Prouty – Canaccord

Great, thanks a lot. A couple of housekeeping first, of the options, the $2.2 million that’s left on the contracts, given what the price of zinc is done lately if it stays here, would you expect the majority of that to be written down in the second quarter?

Jim Hensler

Yes, it’s based on whatever the value is as of the reporting date. So wherever zinc forwards are in June 30th will determine that valuation.

Eric Prouty – Canaccord

Okay, great and then maybe a little discussion. I know you're attempting to push down the price you’re paying for on the recyclable zinc that you purchase in metallic recycled zinc that you purchase that you can’t get from your EAF dust. Where do you stand with your ability to push down prices there?

Jim Hensler

You know, we think we've had quite a bit of success there, you know to put it in perspective. In the first quarter of 2008, we averaged about 72% of LME for the zinc contained in the purchased feeds that we are paying. In the first quarter of 2009, we brought the number down to about 49%.

Eric Prouty – Canaccord

Okay, great. And then finally just a different (inaudible), some of the conversation around steel mill utilization, I mean different utilization ranges, 65%, 70% puts you potentially at full capacity without the new plant. What capacity do you think you’d need to see to get to a you know, EBIDTA or a cash flow break even type level, and then what range for positive EPS. Could you kind of care a guess on that?

Jim Hensler

It ends up depending a little bit on what happens with demand for our end products, metal and oxide. Generally, I think it’s a fair assumption that if we see steel, you know production capacity utilization increase that's going to reflect kind of across the economic conditions that more zinc is being consumed, and you know more zinc metal and zinc oxide, but you know it really depends on that volume a little bit, but you know, we think at current zinc prices, you know basically we need that volume improvement without really price improvement to be at that breakeven.

Eric Prouty – Canaccord

Yes, it is going to hit that 60%, 65%, 70% range?

Jim Hensler

Yes, because as soon as we have increased output of steel production, you know we're going to bring additional low-cost zinc units in from EAF dust. At the current four furnace operation, if the generation of EAF dust was out there, we would be able to operate fairly close to 100% on EAF based feed, but that generation is not there today, which is why we are only at about two-thirds.

Eric Prouty – Canaccord

The material that is produced with the EAF dust, if one looks at just a unit produced in that way as opposed to kind of the average across the board, I mean is that a profitable unit produced right now or you know at what price or what utilization of the own capacity, would that be a profitable unit?

Bob Scherich

I think it is because those zinc units, even at these reduced volumes in the first quarter came to the smelter at about $0.15 per zinc pound [ph] as we, you know, we have reduced cost on the conversion side. So at $0.15 feed, you know, in this current zinc price environment that's profitable with conversion to finish zinc products.

Eric Prouty – Canaccord

All right, and then just finally more of a macro question. You obviously get some sort of indication from your customers about what they are looking at for production. Any insight looking out forward of what your customers are telling you from the steel mills side? Is there any sort of talk of utilization actually starting to creep up here or is it still pretty duller conversations being had?

Bob Scherich

Yes. I think I made some comments to this in my remarks but, you know, I think we see a lot of blank faces you know, when I asked the question because they don't have very good visibility of changes in their markets right now.

Yes, we do hear, you know, maybe some optimism from a couple that are looking what’s happening with stock levels and service centers and saying, okay, once we see that destocking get completed, then production should sort of match end-market consumption, and I think there is some logic to that but you know, we'll be happy to see it when it happens.

Eric Prouty – Canaccord

Sure thing. I'll get back in the queue. Thanks guys.

Bob Scherich

Thanks Eric.

Operator

Okay, we have a follow-up question from Luther Lu with FBR Capital Markets. Please go ahead.

Luther Lu – FBR Capital Markets

Hi Jim and Bob.

Jim Hensler

Hi Luther.

Bob Scherich

Hi Luther.

Luther Lu – FBR Capital Markets

I have a question on when you add this ESOI furnace dust to your 2Q volume, and the rest of the year. What do you think your EAF dust and the scrub mix will be?

Jim Hensler

Well, our current expectation is until we see change in market conditions to continue to see kind of the same level of production as we have at the smelter. So you know going back to the numbers as Jim has mentioned off of ESOI, they had about 130,000 tons of dust last year. You know, their markets are the same as ours. So that’s down probably 50% right now, and we don’t expect, you know, to close on that until later this quarter. So it’s about a half a year’s worth with volume down about 50%. So, not a real big impact in the current year; but it’ll creep that percentage up. I think it is about 70%.

Bob Scherich

I think the dust feed ratio will stay about the same because in the first quarter, we did take some fairly significant reductions in dust inventory, which should offset some of the low receipts, which we won't see going forward. So, you know, I think that ratio will be about the same.

Luther Lu – FBR Capital Markets

Okay, why don’t you guys comment a little bit on cost-cutting? You mention the coal prices coming down, electricity price coming down. How much more do you see that you can squeeze out of the cost?

Jim Hensler

Yes, we're taking some fairly aggressive action. I mean there's really been a transition period here for the last several months. You know, we're coming into the second quarter. We are realizing now the cost savings of Bartlesville being down completely. We will be realizing the benefit of Rockwood being down completely and essentially consolidating everything in Palmerton. We've got further cost we are cutting in the Monaca operation in the second quarter.

We are going to realize some operational cost savings as a result of the pelletizer we started up in Palmerton and the wash circuit capacity expansion in Monaca, which will allow us to take more of CZO [ph] direct as opposed to adding the (inaudible) cost. So you know, we’ve identified about $30 million in projects that we are working on, and that said we implemented about $5 million of that in the first quarter, and we expect to aggressively pursue those, you know, through the rest of the year.

Luther Lu – FBR Capital Markets

Okay, so can we – how much of that $30 million will stay even if the market recovers. In other words, how much of that $30 million is more permanent of cost cuts?

Jim Hensler

It is a good question. I mean a portion of it is raw material cost savings that we’re realizing, and you know to the extent that as market conditions improve that we have to pay more for raw materials. Then some of that would not be realized in the future, but in terms of the cost cutting on the operational side, you know, I think a lot of that is going to be permanent.

Luther Lu – FBR Capital Markets

Okay, and just on the revenue side is there anything that you can do to further operate a mix, so that you can get more premium product?

Bob Scherich

Well, we're – I think to some extent we are in a situation we've got a very competitive market that's operating at low capacity utilization. So it is difficult to raise premiums in that market. From a mix standpoint, margins are about the same, you know, for all of our products and so there's not really a great opportunity there from a mixed management standpoint. We are trying to upgrade this IRM product that I mentioned, and we do think that there are some opportunities there to substantially improve the margins on the sale. That product and we have begun taking our first orders for it, which we hope can be used at a platform to gain additional sales as we go through the year.

Luther Lu – FBR Capital Markets

Okay, great. Thank you.

Operator

And we have a follow-up question from Brian Grad with DLS Capital Market. Please go ahead.

Brian Grad – DLS Capital Market

Hi. Since basically you know, we're seeing the price of zinc rise here and you know, your hedges are kind of rolling off on a monthly basis – quarterly basis. Are you implementing new hedges at the higher prices?

Bob Scherich

We have not implemented any new hedges to date, but you know as the price gets more attractive, we monitor the forward look, you know, and it is something consistent with what we've done over the last year or two. We don't want to lock in in prices at a low level, but as we get opportunities to you know, take positions, you know on a forward basis, it is something we do constantly watch, but have not done anything to date.

Brian Grad – DLS Capital Market

What kind of price levels do you think you need to see before you'd be interested in doing that again?

Bob Scherich

Well, I mean we believe we can operate the business you know, at cash breakeven, you know at levels below the current price. So, you know, going forward you know, as we expect to see some recovery, we're going to find it more attractive at higher price levels than where we are at today. Haven’t really defined that specifically, but you need you know, an increased forward price to make it, you know, economical to even take those positions if you end up buying put options for instance. You know, want to pay, spend a lot of cash now to protect a low price.

Brian Grad – DLS Capital Market

Absolutely. So really what this whole story comes down to this quarter. It's really all about buying and nothing to really do with price so much.

Bob Scherich

Yes, price stayed relatively flat and volume was down from fourth-quarter sequentially when, you know, coming into the quarter, you know, steel producers and others all though, you know, we’re going to see flat or slight – there was a slight improvement in volume. That didn’t materialize in the quarter.

Brian Grad – DLS Capital Market

Okay.

Jim Hensler

Yes, we've responded to that by you know, adjusting production levels to the volume levels.

Brian Grad – DLS Capital Market

Okay, great. Thank you.

Operator

Okay. (Operator instructions) We have a follow-up question from Scott Blumenthal with Emerald Advisors. Please go ahead.

Scott Blumenthal – Emerald Advisors

Jim, could you give us some idea if you were to compare the ESOI contract to what you currently have, are they more favorable, less favorable, about the same?

Jim Hensler

I'd say that some are comparable and some are maybe a little less favorable.

Bob Scherich

With the long-term contract, it’s similar to you know, long-term contracts that we have when it comes to a price level.

Scott Blumenthal – Emerald Advisors

All right.

Bob Scherich

The shorter term is fairly close to what we have.

Scott Blumenthal – Emerald Advisors

Right.

Jim Hensler

They have a much higher percentage of long-term contracts.

Scott Blumenthal – Emerald Advisors

Okay, now you did characterize that the deal as accretive. I guess looking at it from another angle, the margins on the contracts, payments to the current owners aside; do you believe that those contracts are going to improve margins?

Jim Hensler

Yes, definitely. You know, the real benefit is you know, continuing the growth of EAF dust recycling and bringing more low-cost zinc units through the operation.

Scott Blumenthal – Emerald Advisors

Sure. I guess you didn’t understand my question. I guess we're looking at what we currently contract for from our EAF clients in a microcosm and compare that to what ESOI contracts with their clients. I guess, are we going to – are margins just on that going to improve or are they going to stay the same, we're just going to have more volume.

Jim Hensler

Well, I think when you net out the purchase price on the new contracts we’d pick up with ESOI that net will be on average, slightly less than where we are with our current contracts, because we are amortizing the purchase cost over the life of these contracts. But I think the way we look at it really is on a cash flow basis, and you know, we are bringing in additional zinc units, some of which were tied up in contracts, you know, very long-term contracts that we wouldn't otherwise be able to get access to and we’re able to acquire those at a very, you know, very attractive price and so you know, when we look at it on a net present value basis or free cash flow basis, we think it’s a very attractive investment.

Scott Blumenthal – Emerald Advisors

Understood, and you know you talked also about the IRM product, I think you called it?

Jim Hensler

Right.

Scott Blumenthal – Emerald Advisors

Can you give us any more details as to the terms of that, if you're able to?

Bob Scherich

Yes, I mean this product is as we've talked about in the past is basically a product that we sell into the asphalt and cement markets as an aggregate today and basically don’t really make much money on it. You know, it’s sort of a marginal product for us, and we've been developing it, refining it, and upgrading it so that we could sell it as feed material to electric furnace shops and blast furnaces and we've run some trials, at least one electric furnace shop. That's now turned into our first order with them, and we hope that we can leverage that experience and grow the sale of this product, and it significantly improves you know, the margin of the product. We generate about – well in a normal dust generation market, we generate about 350,000 tons of this product and you know, maybe about a dollar or ton on it when we sell it in the aggregate market. So every dollar we can improve upon that gets multiplied by a big number and so we, you know, we see an opportunity to move some portion of it into the iron and steel industry.

Scott Blumenthal – Emerald Advisors

Obviously, the margin is better.

Bob Scherich

Yes, our margin is much better. I mean in today’s market all iron units are cheap. So the margin is not going to be as good today as it –

Scott Blumenthal – Emerald Advisors

Might have been last year?

Bob Scherich

What it was last year, but it is substantially better than the dollar we’re getting today, even in today’s market.

Scott Blumenthal – Emerald Advisors

Okay, terrific. Thank you.

Operator

Okay, and there are no further questions.

Jim Hensler

Okay, well that ends our call. We appreciate your interest, and we’ll talk to you again next quarter. Thanks.

Operator

Okay, thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.

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Source: Horsehead Holding Corporation Q1 2009 Earnings Call Transcript
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