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Horsehead Holding Corp. (NASDAQ:ZINC)

Q1 2010 Earnings Call

May 10, 2010 11:00 a.m. ET

Executives

Ali Alavi - VP, Corporate Administration, General Counsel and Secretary

Jim Hensler - President and CEO

Bob Scherich - CFO

Analysts

Carter Driscoll - Capstone Investments

Paul Forward - Stifel Nicolaus

Robert Howard - Prospector Partners

Scott Blumenthal - Emerald Advisers

Eric Prouty - Canaccord Adams

Doug Thomas - JET Investment Research

Operator

Welcome to the first quarter 2010 earnings conference call. (Operator instructions)

I'd now like to turn the conference over to Ali Alavi.

Ali Alavi

Thank you. Good morning, everyone, and thank you for joining us on our first quarter 2010 earnings release conference call. My name is Ali Alavi and I am 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, our 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 on March 16, 2010, for a more detailed description of the risk factors that may affect our results.

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

Jim Hensler

Thanks, Ali. I would like to welcome you to this conference call to discuss the first quarter 2010 results. I'll review the performance of our operations and markets and then turn it over to Bob Scherich, our CFO, who will review the financial results.

The first quarter's results reflected an improvement over the fourth quarter of 2009, as demand for our products and services continued to increase. We operated our recycling facilities at full capacity during the quarter, and our zinc smelting operation returned to full production late in the quarter.

This is also the first quarter that INMETCO was included in our results, which gave a further boost to earnings. A stronger-than-expected recovery among stainless producers, which allowed higher remelt alloy sales, and higher commodity nickel prices contributed to a solid first quarter at INMETCO.

Net income was $6.8 million for the first quarter or $0.16 per diluted share. This compares very favorably to the prior-year quarter in which we had a net loss of $14.8 million and at the fourth quarter 2009 in which profits were breakeven.

EAF dust receipts increased 70% compared to the prior-year quarter to 136,500 tons. The prior-year quarter did not include any receipts from the acquisition of dust contracts from Envirosafe Services of Ohio, which was completed in the second quarter of 2009. While reported domestic steel production increased by 9% from last year's fourth quarter, our EAF dust receipts increased by 17%, reflecting further growth in our business.

In response to the stronger output by the steel industry, we've been working diligently on the construction of greenfield dust recycling plant in Barnwell, South Carolina, in order to start up the plant as soon as possible.

We commissioned the first of two kilns on April 16. I'm pleased to report that the startup is progressing smoothly. We have been operating the kiln at about 60% of its designed operating rate during this initial training and debugging period. We expect to gradually ramp the kiln to full output over the next several weeks.

Completion of the second kiln along with ancillary buildings and site work continued to progress according to plan. We expect to be in a position to start the second kiln before the end of the third quarter. The actual startup decision will be dictated by market demand.

We continued to realize costs savings in the construction of this plant from our original estimates. We spent slightly over $15 million in the Barnwell project through the end of the first quarter. We continue to estimate that we'll be able to complete the project for approximately $65 million, of which $5.9 million will come from the new market tax credit financing we reported on earlier. This represents a 26% savings from our original estimate.

Market demand for our zinc products, particularly zinc oxide, continued to improve this quarter. On a sequential quarter basis, comparing the first quarter this year to the fourth quarter of 2009, zinc product shipments increased 6% to 33,400 tons. Shipments increased 21% compared to the prior year's first quarter.

As a result of increased demand, we started a sixth smelting furnace on March 1. This is the first time we've operated a smelter at full output since September of 2008. In addition, we brought an extra refining column online to produce zinc oxide in April.

Zinc oxide shipments are up 29% from the prior year's quarter, and 11% from the first quarter of last year. Tire producers are telling us the demand is stronger than expected, and they expect this to continue through the summer months. Some producers have deferred planned outages, given the stronger market conditions.

Zinc metal shipments have increased 14% compared with the prior year's first quarter, and 2% since the fourth quarter of last year. Demand for PW zinc metal continues to be spotty, with some producers indicating the business is strengthening, while others are reporting lower demand compared with last year. We are also seeing increased competition from special high grade zinc producers in our traditional markets.

We are hopeful that zinc metal demand increases as we enter the peak construction season. Demand for our battery grade zinc metal has been strong. However, production difficulties affected shipments during the quarter. It is expected that these production issues will be resolved by the end of the second quarter.

Given the uncertainty of end market demand, it is possible that we may fluctuate between a five and six-furnace operating level over the next several months to control inventory levels.

We are pleased with our cost performance in the first quarter. The conversion cost per ton of zinc declined by about 17% between the current quarter and the prior year's first quarter.

In 2009, we identified $44 million in cost reduction projects of which we implemented $37 million through the end of the year. In 2010, so far we have identified an additional $15 million of cost reduction opportunities, of which $1.6 million is related to synergy and cost reduction benefits at INMETCO. We implemented $2 million of these savings during the first quarter.

Moving on to discuss the pricing environment, the LME zinc price was 95% higher than the prior-year quarter at a $1.04/lb, but only 3% higher on a sequential quarter basis.

As you will recall, we purchased put options last year on 100,000 zinc tons of shipments in 2010 at strike price of $0.65 per pound. We've initiated a similar buying program for 2011. To-date we have purchased about 25% of our requirements for 2011 at the same $0.65 per pound strike price at a total cost of approximately $900,000. We will continue to make these purchases when market prices are inside our target price range.

The realized premiums on metal averaged about $0.02 during the quarter, which is lower than the premium for the prior year's quarter of $0.04, but higher than the fourth quarter average of $0.00. Transactional premiums remain in the $0.02 to $0.03 range.

The first quarter premiums reflected slightly lower premiums taken on some export business. Realized premiums for zinc oxide in the quarter were approximately minus $0.02, down from $0.08 in the prior-year quarter, but up from minus $0.10 in the fourth quarter.

The prior quarters were affected by LME price lag effects in the contractual premiums of tire producers. The current quarter had very little lag effect, and zinc prices were fairly stable over the past several months. Transactional premiums on zinc oxide are in the $0.00 to minus $0.05 range.

We are very pleased with the performance of INMETCO during the first quarter. INMETCO'S shipments of 7,000 tons of nickel-bearing remelt alloy were up 63% from the same period last year, and 6% from the fourth quarter of 2009. INMETCO operated at full capacity.

Tolling receipts were up 38% from the first quarter of last year, and 28% from the fourth quarter of 2009, reflecting an increase in stainless steel production.

Nickel prices averaged $9.10/lb during the first quarter, which is up 14% from the fourth quarter of last year, and 92% higher than the first quarter of last year. This average nickel price was not fully realized in the quarter, since remelt alloy is priced on a one-month lag.

We believe that the INMETCO business can be grown in multiple ways, including expanding the capacity at Ellwood City, building new facilities in other geographical markets, and by making acquisitions that offer synergy with the INMETCO operation.

We recently approved an expenditure of $2 million for the first phase of a multi-phase expansion program to increase capacity at the Ellwood City operation by 15% by the beginning of next year. In total, we plan to expand the capacity of that operation by approximately 30% for a total investment of about $7 million over the next couple of years.

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

Bob Scherich

Thanks, Jim. So the first quarter, net earnings were $6.8 million or $0.16 per share. This was the first quarter that we included the results from INMETCO, which was acquired on December 31, 2009. In comparison, the prior year quarter had a loss of $14.8 million, or negative $0.42 per share.

We've reported steady improvement on a sequential quarter basis for the past five quarters, but the current quarter is showing improvement over breakeven earnings for the fourth quarter of 2009.

This improvement reflects primarily higher commodity prices, increased production and shipment levels, and cost reductions, combined with good performance from INMETCO.

Detail of the quarter's performance reflects an increase in revenue of $57 million, or 144% compared to the prior year quarter. The increase was a result of an increase in price realization of $27.5 million and a $12.7 million effect of higher shipments. The current quarter's revenues included a $0.7 million non-cash charge due to hedges, compared to a $4.2 million charge in the prior year quarter.

INMETCO added $14.4 million to our sales in the first quarter. The average sales price realization for zinc products on a zinc contained basis was $1.15/lb or $0.11/lb above the average LME price for the quarter, compared to $0.66/lb or $0.13/lb above the average LME price for the prior year quarter.

On a sequential quarter basis, the average sales price realized for zinc products increased $0.10/lb on a zinc contained basis as the LME zinc price increased $0.03, reflecting reduced lag effect, given the relatively steady LME price. Sales of zinc metal increased versus the prior year quarter, $19 million or 112% to $36 million for the quarter. This increase reflected primarily a $16.5 million increase in price realization, and a $2.4 million increase in sales volume.

On a sequential quarter basis, sales of zinc metal increased $3 million. Sales of zinc oxide increased $18 million versus the prior year quarter, or a 112% to $33 million. This increase reflected $13.1 million increase in price and a $4.5 million increase in volume. On a sequential quarter basis, sales of zinc oxide increased $6 million.

Revenues from EAF's recycling increased $2 million for the quarter, or 26%, to $9.7 million, reflecting higher volume of receipts and reduced average price realization, due primarily to added transportation costs associated with diverting dust shipments and contract acquired during the past 12 months.

On a sequential quarter basis, revenue from EAF dust increased approximately $1 million.

INMETCO's sales of $14.4 million for the quarter reflected higher commodity prices and increased production shipment levels versus the prior year quarter. Cost of sales increased 39%, or $21.7 million. The increase included $8.9 million due to INMETCO. The balance of the increase was primarily attributable to the higher shipment volume of finished products, an increase in the commodity price for purchase feeds, and an increase in transportation cost associated with the higher volume of the EAF dust receipts.

Cost of sales also included a non-cash charge of $1.1 million associated with the increase in EAF dust inventory. Smelter and refinery conversion costs per ton were 17% lower than the prior year quarter, while recycling conversion cost per ton was 22% lower. These improvements in conversion cost are due primarily to improved productivity and the effect of cost reduction initiatives implemented over the past 12 months.

SG&A expenses were $1 million higher for the quarter, with INMETCO adding $0.5 million. On a sequential quarter basis, SG&A expense was down $0.9 million. Cash provided by operating activities was $14.2 million for the quarter, as growth in working capital subsided as commodity prices leveled off.

We used $16.3 million of cash for investing activities, with capital spending of $11.8 million for the quarter, of which $10.6 million was related to Barnwell.

Post-closing adjustments for the acquisition of INMETCO were finalized during the quarter using $4.6 million of cash. We ended the quarter with $125 million of cash, of which $31.5 was restricted.

Total debt was $0.3 million at the end of the quarter. As Jim mentioned, we're very pleased with the performance of INMETCO during the first quarter, as they delivered strong margins and cash flow. They operated at full capacity during the quarter.

The tolling side of the business ramped up during the quarter. These circumstances led them sell more product in access of tolling requirements. While we expect INMETCO to continue to have good performance as we move into the next couple of quarters, the profile is expected to be different from the first quarter.

INMETCO takes an annual extended maintenance outreach, which is scheduled in May. As a result, production and shipment volume will be up for the second quarter.

We've also seen increased output in the specialty steel sector in recent months. Therefore, we would expect the tolling side of INMETCO business to utilize a larger portion of production capacity for the next couple of quarters.

In closing, the profile of the first quarter reflected improved LME price levels and improved demand for our products and services. Our cost reduction efforts combined with improved productivity and increased EAF dust receipts resulted in continued improvement in cost performance. INMETCO added nicely to earnings for the quarter.

The increased level of EAF dust receipts during the quarter resulted in higher cost as inventory grew. This had an unfavorable effect on earnings per share of $0.03 to $0.04 for the quarter. As we move into the second quarter, we expect to be processing a higher level of EAF dust with the startup of Barnwell. This should increase the proportion of low-cost feed to our smelter. We're currently operating at higher level of output than during the first quarter, which should more than offset the effect of planned outages at INMETCO.

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

Jim Hensler

Thanks, Bob. In summary, before we open the call for questions, I'd like to say that we're pleased with the continued improvement trend in our end markets.

Steel industry output has increased steadily since the beginning of the year, which has duck-tailed nicely with the construction and startup schedule for our Barnwell facility. Zinc product shipments have also increased, and we're hopeful that the trend will continue as we enter the peak construction season. The ability to operate our zinc smelter at full capacity once again helps both revenue and cost performance.

Commodity prices, while somewhat volatile in recent days, continue to be good. Our new acquisition of INMETCO is turning the solid first quarter, and we expect that as we exit their outage later this month, that performance will be solid for the balance of the year.

Horsehead continues to have a strong liquidity position, and we're generating cash. As a result, we are actively seeking investment opportunities which will expand and leverage our current business. The acquisition of INMETCO fits well with our strategy of expanding our capabilities as an environmental services provider and a diversified metals recycling business.

We are seeking other investments which will further expand the scope of our environmental services business and our geographic reach. We continue to believe that this is a type of market in which strategic opportunities will present themselves, and we're well positioned to take advantage of these opportunities.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Carter Driscoll from Capstone Investments.

Carter Driscoll - Capstone Investments

Good morning, gentlemen, excellent quarter. First question; wanted to circle back and elaborate a little bit about INMETCO. Obviously, I'd say that's an unexpected quarter on the positive side. The contribution seemed to be extremely high. Maybe you could discuss, obviously keeping in mind they are going to have planned outages taken this quarter, what you think their contribution is, if this is a similar type of margin we can expect going forward if you were to, say, hold the price of nickel constant? It just seems like an extremely strong contribution from INMETCO.

Jim Hensler

Yes, we were pleased with the quarter as well. And there were a couple of unusual aspects to the quarter. One is that since tolling receipts were sort of ramping up during the quarter, we had the opportunity to sell more excess production, excess remelt alloy than what would happen in a typical quarter. And with the stronger nickel price, that was favorable to earnings.

Now that the stainless market is picking up and they're generating quite a bit of tolling receipts, there was going to be an obligation to return those nickel units back to steelmakers over the next several quarters. And so we'll have more tolling income, but less income from excess pig sales.

So in this market with high nickel prices, obviously you'd like to be able to do more excess pig sales and less tolling revenue, but that's going to sort of flip-flop as we go forward over the next few quarters. That's going to have a moderating effect on what we saw in the first quarter, but we think the performance is still going to be pretty solid.

Carter Driscoll - Capstone Investments

And then maybe we could just discuss the capacity expansion. Obviously, it's a phased capacity expansion. You've allocated some expenditure already. The total expenditure does seem lower than you had discussed in the recent past. Could you elaborate on what exactly you're seeing some cost saving is, if I am correct in assuming that the total volume seems to be lower than we had discussed previously.

Jim Hensler

When we were in the due diligence process, INMETCO had a plan to install a new melting facility which would add about 50% to its capacity, but the price tag on that was about $40 million. We took a more in-depth look at what opportunities are there and felt that we could do a number of incremental improvements to get about 30% capacity expansion for a lot of less money, on the order of about $7 million.

Some of those projects are ready to go right now, and others are still in the engineering phase. And so we're going to move forward on the projects that we've identified in what we call Phase I, which will add about 15% to the capacity. And we expect to implement those this year and begin to realize the benefits sometime in the first quarter of next year. By the end of the year, we'll be ready to pull the trigger on the remaining projects we believe and realize those benefits sometime toward the end of 2011.

Carter Driscoll - Capstone Investments

So it's still going to be at least 12 months before you finish this expansion?

Jim Hensler

Yes. We don't think we'll realize the full benefits until the end of 2011, but we'll pick them up in increments, and we're optimistic we can actually get a little bit more out of Phase I we're facing the evaluation on. But we're fairly confident over the next 12 to 18 months we can get about 30% more throughput through that facility.

Carter Driscoll - Capstone Investments

And then outside of actual capacity expansion at INMETCO, you have discussed potentially using that technology as some type of joint venture, a technology transfer or technology sharing to expand in Asia. Could you elaborate on whether those plans have changed or if there has been any update to those or any activity there?

Jim Hensler

The plans haven't changed. We're still in the development stage there. And we'll be actually traveling to Asia in June to meet with potential co-parties in those kinds of arrangements to see where that might lead. And depending upon what we learn from that and studies we're doing in that region, we hope to be in a position to formulate the strategy by end of the second quarter or early third quarter.

Carter Driscoll - Capstone Investments

Okay. And then just housekeeping item; Bob, dust processed in the quarter, I missed it if you gave that figure?

Bob Scherich

Yes, I'm not sure we had it on there, but it was just over 127,000 tons for the quarter.

Operator

Our next question comes from the line of Paul Forward from Stifel Nicolaus.

Paul Forward - Stifel Nicolaus

I guess one more little housekeeping issue. I think you'd mentioned INMETCO had an SG&A number of just $0.5 million in the quarter. Is that a decent sustainable number?

Jim Hensler

I got to say it's probably a little lower than what we expect to be there on a quarterly basis. I think things will ramp up a little bit with some of the things that we've got to do from an audit and SOX side of things. They had a little bit of a benefit on the bad debt expense side of things for the quarter. But probably a little bit higher than that is our expectation, but it was nice to bring the low number in, in the first quarter.

Paul Forward - Stifel Nicolaus

We've seen steel capacity utilization come back. Over the past year, we've seen zinc prices come back. I guess from what I read, it seems to be encouraging at least to some extent competitors to take a look again at expansions in EAF dust processing. I was just curious could you give us some thoughts on just what the competitive environment really is at this point.

And now that you've got Barnwell up and have the second kiln up again hopefully later this year, how strong does capacity utilization in steel have to be in the U.S. among the EAF producers to really argue for increased capacity industry-wide and the ability to process the EAF dust? And are we getting kind of reasonably within reach of the need for expansions that could invite competitors to come in?

Jim Hensler

It's a good question. I think that if you look at the capacity that we have once Barnwell is fully up and running and if you look at all of the capacity that Zinc National has, including the steel dust recycling plant that they acquired toward the end of last year and their capacity in Monterey, and if you include the small facility that PIZO is operating, there is a little over $1 million tons of capacity for recycling EAF dust in the market, which would equate to steel capacity utilization levels that are in the high 80% range, 88%-89% capacity utilization, and today we're at about 70% to 73%.

So for now there is plenty of capacity to service that market. I'd say there are two dynamics at play that need to be considered that could affect those numbers. The first is that zinc up to now has both a domestic location and a location in Mexico, it would be my estimate that there seems some pressure from some of their clients to take dust domestically rather than shipping it into Mexico, which has always been a bit of a burden both from a transportation cost as well as just a logistics standpoint.

And so from that standpoint, is roughly 200,000 tons of capacity in Mexico, which may not be fully utilized going forward and that could argue for more capacity needed in the U.S. market.

The other dynamic is zinc oxide. We've been reading about their fairly visible proxy fight going on over this whole question of starting up a facility in the U.S. as their location that they've been discussing at Ohio. And I think time will tell whether they go through with that project.

It does not seem to make sense to me, given the discussion we just had about where capacity utilization is, because even if the issue with the Mexican production is correct, most of those customers are in the South and Southwest and would not be interested in capacity up in Ohio.

But I think there's a bigger issue for the zinc oxide operation. It would be, I think very difficult for them to acquire enough dust contracts to really fully utilize that facility, and the capital investment is pretty high. I mean, they're talking about $110 million roughly for a scale-back project for a plant that has capacity of a couple of 100,000 tons.

As I just mentioned, we're going to build this facility in Barnwell, South Carolina for almost half that amount with about roughly the same level of capacity. So it's sort of, in my opinion, a questionable investment. And that said, there has always been some question about the technology.

What they're attempting to put in there is a technology that's been tried by other companies and hasn't been very successful. And as we've seen with the acquisition of INMETCO, we operate both technologies today. We operate Waelz kiln technology for processing carbon steel dust, and we operate rotary hearth furnace technology to process dust from stainless steel companies. And we understand the differences and understand where the RHF technology makes sense and where the Waelz technology makes sense.

So that's a long answer to your question, Paul. But by and large, I think there is this issue about zinc ox and where they go forward. Beyond that, I think the market is in pretty good balance.

Operator

Our next question comes from the line of Robert Howard from Prospector Partners.

Robert Howard - Prospector Partners

You talked about the $15 million of cost savings identified this year. Is that all at sort of the historical old Horsehead and none in INMETCO, or is there some at both?

Bob Scherich

About $1.6 million of it is INMETCO related.

Robert Howard - Prospector Partners

Okay, so meaning the sort of the synergy type of --

Bob Scherich

So of it's synergy, and some of it's just the cost reductions at INMETCO.

Robert Howard - Prospector Partners

Okay. And the cash bubble, I guess you've got $93 million here, and then you also said you had $31 million of restricted cash on top of that. What are you guys sort of looking at is where you would like to have that cash balance? I mean, it's pretty high. I guess there's been a number of quarters it's been pretty high as well. How long is this going to be the level you want it at?

Bob Scherich

Well, we look at it as being the primary source of capital that we're going to use for a strategic investment. And that's kind of what we raise the cash for, and that's our growth outlook going forward as we are continuing to work on, and look at possible investments.

Robert Howard - Prospector Partners

And you talked about dust inventories being up. Is the zinc inventories also up as well? Or where did those move?

Jim Hensler

I think maybe our zinc metal inventory might have moved up a little bit late in the quarter, simply because we'd processed sixth furnace up and running in March. So oxide inventories have stayed relatively flat.

I think we've probably late in the quarter, built a little bit of metal inventory. But the dust inventory is one of those good news/bad news things; it's good news because we've got higher output from the steel industry, we're kind of loading the Barnwell plant ahead of time, but we end up taking a little bit of a cost penalty during the first quarter because of that.

Robert Howard - Prospector Partners

And lastly, anything new with looking at expanding into the iron waste products (market)?

Jim Hensler

Well, we are working right now to organize a trial to make some IRM briquettes and IRM mill scale briquettes, to try trials with the blast furnace operators. And we've just got through a production run of material, and we think it's a very attractive feed for blast furnaces, and we're trying to move into that market. And so, we're in the middle of that right now, and hopefully be in a position over the next quarter or two to conduct a trial like that.

Operator

(Operator Instructions) And now we'll go to the line of Scott Blumenthal from Emerald Advisers.

Scott Blumenthal - Emerald Advisers

Bob, you mentioned in your comments that you had some cost issues from diverting shipments and also new contracts. Can you elaborate on that a little bit? Are you still incurring the similar type of costs, now that we have everything up and running, and including Barnwell? And the new contracts were those just some start-up costs, or can you talk maybe about the way the margins in those contracts might be different from others?

Bob Scherich

Just really commenting on the average price realization on EAF dust receipt being lower, and lower for two reasons; the latter reason was the contracts that we acquired primarily through the ESOI acquisition were contracts that had a lower tipping fee per ton than what our average was. So, good source of low cost fee, but it affects that average tipping fee.

The other factor which we've really been seeing here for the last couple of quarters is simply, as we're bringing Barnwell up and the dust intake has been elevated, we've got to in some cases, divert the dust from some of our customers to further away processing plants. And when we do that, if the customer is arranging the freight, we give them a credit for the additional cost. And that additional cost ends up being netted out of the average tipping fee, or average price realization.

And then, kind of compounded with that is simply railcar demurrage, as the number of railcars are kind of filling up the pipeline, and we're moving them and unloading them at our facilities, you end up with the higher cost there. So ends up impacting the quarter a little bit negatively, but I'd say the real benefit is, it's really lining feed-up for stronger processing levels here, as we bring Barnwell up here during the second quarter.

Jim Hensler

I'd say, second quarter is still going to be a transition quarter, where we are experiencing some of those costs as we get Barnwell fully up and running on the first kiln and get railcars moving to the right plant locations. It's going to take us about a quarter to work through that. Of course, it depends upon what happens with steel industry output; if it goes up even further, we may still incur some of those kinds of charges until we get the second kiln up and running at Barnwell.

Scott Blumenthal - Emerald Advisers

Got it, that's really helpful. And Jim, could you talk a little bit more about the INMETCO expansion? You were talking about how we are going to have a higher percentage of tolling rather than pig sales. And maybe can you talk about, tolling customers are going to be eventually at higher production levels; when they get to what would more or less be normal operating capacities, maybe you can give us an idea as to what the tolling versus pig sales are going to be under such a scenario?

Jim Hensler

Yes, typically it's about 50-50. And in the first quarter it was more like two-thirds excess pig sales and one-third tolling-related. So that was as well unusual from that standpoint. But when it's stabilized, it's normally about 50-50.

Scott Blumenthal - Emerald Advisers

And that's kind of the expected level that we said, I guess model from here on?

Jim Hensler

Yes, I think that's about right. Bob, I'd don't know if you have any comments on that?

Bob Scherich

We're going to have to catch up on those tolling requirements. So you might see tolling requirements slightly more than 50%, but over the period, basically an annual look, I think it's going to be at that roughly 50-50 level.

Operator

And the next question comes from the line of (David Shapiro from Aegis Financial).

Unidentified Analyst

Just a few bookkeeping items here first; depreciation, amortization, the split between the two businesses roughly?

Bob Scherich

I don't know that number offhand, David. I'd have to get back to you. There wasn't much change on the Horsehead side, coming off of what the fourth quarter was, so I think taking fourth quarter on the Horsehead side, most of the change then would be introduction of INMETCO. But don't have the INMETCO piece offhand. I can get back to you on it.

Unidentified Analyst

Very good. And then on the puts that were purchased, how many pounds were purchased exactly?

Bob Scherich

We're looking at the same target of hedging about 100,000 tons on the year, so we're at about 25% of that, 25,000 tons for 2011.

Unidentified Analyst

So you're expecting your 25,000 tons for 2010 or 2011?

Bob Scherich

2011. We already have in place a 100,000 tons hedged at $0.65 put options for 2010. So now we've begun to work on 2011, which from our perspective is simply risk management buying protection on the downside. And we want to do that as cost effectively as possible.

Unidentified Analyst

And you want to work that up to 100,000 again?

Bob Scherich

Yes, that would be the idea.

Unidentified Analyst

And then the other long-term liabilities, why did that jump up there on the balance sheet?

Bob Scherich

The biggest part of it is related to deferred taxes, in particular the addition of deferred taxes under purchase price accounting on INMETCO, and even Horsehead's deferred taxes. We will be filing our 10-Q here later today, so I think you'd be able to pick up lots of detail on that.

Unidentified Analyst

And then on the conversion cost, the conversion cost seemed to come in a little bit higher than what we modeled for. I know there's a $1.1 million sort of COGS there that was sort of non-cash in nature because of the inventory build. Is there any other sort of unusual items that may have driven up the conversion cost side, or maybe some of the other costs that are buried within COGS there?

Bob Scherich

No, the EAF dust inventory charge doesn't hit conversion cost, but it does hit cost of sales. The conversion cost was relatively stable with the fourth quarter level, might have been up a penny or two. I think of anything, it's just timing items, a number of furnace or refinery column rebuilds, how many hit in that quarter versus the sequential quarter. But I think generally we were expecting about $40-$0.45/lb when we are operating at the smelter refinery at the five-furnace level, and we were pretty close to that.

Unidentified Analyst

$0.45/lb was sort of what you guys target at five-furnace?

Bob Scherich

Yes.

Unidentified Analyst

And then when you work up to six?

Bob Scherich

We expect that when we're running at full capacity at six, including the refinery operating at full capacity, moving closer to $0.40.

Unidentified Analyst

And these conversion costs are they just at smelter level or are you including oxide upgrades in there as well?

Bob Scherich

That's including the refinery. It's the Monaca operating smelter and refinery for production of oxide, and production of the special, special high grade. I did see a note, (David); at the INMETCO, depreciation, amortization was just over 600,000 in the quarter.

Unidentified Analyst

And that should be a pretty consistent run rate until you're done with your CapEx upgrade?

Bob Scherich

Yes, until we start to add new capital projects in.

Unidentified Analyst

Now, on the further CapEx at Barnwell, what cash number post quarter-end needs to be spent? Is it about $15 million left post-quarter?

Bob Scherich

I think it's about 15 left, and then the last five or six, we're going to be able to clear out of restricted cash. So it's probably a net of not much over $10 million.

Unidentified Analyst

And then there was a refund that was due post-quarter, did that come in as well? I think was a tax refund or a cash refund.

Bob Scherich

We anticipate our cash refund once we file our 2009 tax return and then file carrybacks against prior years. We expect that tax return to be filed here by the end of second quarter. It has not been filed yet, but we expect to file. As to how long it takes to get refund, best guess right now it probably occurs in third quarter.

Unidentified Analyst

And is that about $10 million?

Bob Scherich

Yes, we think it can be as much as $10 million, if not a little more. But we won't know until we finish the tax return.

Operator

And next we'll go to the line of Eric Prouty from Canaccord Adams.

Eric Prouty - Canaccord Adams

Just a couple housekeeping questions. I know the previous caller asked about depreciation and amortization. Can we expect, with Barnwell coming online, June depreciation, September, et cetera, to be meaningfully higher than it was here in the March quarter?

Bob Scherich

We haven't estimated a number yet, but we do expect, Eric, to officially say we've started that first kiln up May 1. But before we've completed all the other buildings, there is still some work. But we will put in essence the equipment related to that first kiln into the depreciation cycle starting May 1.

Most of that stuff is going to have a 15 to 20-year life to it. But we haven't concluded on that number. So it would be less than half of the total project, because it's just the equipment related to the first kiln that would be put to starting depreciation on here for the second quarter.

Eric Prouty - Canaccord Adams

Are there, beyond your COGS cost, any incremental costs for SG&A that would be associated with Barnwell, or is most of that just going to COGS?

Bob Scherich

Yes, that's just a kind of a cost operation, just another plant. We don't really see it impacting SG&A at all.

Eric Prouty - Canaccord Adams

Okay. I know you got some incremental expense, but also sounds like you got some cost savings opportunity. Should that too remain relatively stable with March quarter, or do you think it's going to continue to creep up through the year?

Bob Scherich

INMETCO was a little bit lower than what we expect through the year, so maybe slightly higher than where we're at as to our expectation.

Eric Prouty - Canaccord Adams

And then just as a reminder, once Barnwell number one and number two are up and running its full capacity, did you say that was about 200,000 tons of capacity?

Jim Hensler

It's about 180,000 tons. Each kiln is going to be about 90,000 tons. We may get a little more out of it than that. We're seeing some nice signs from the early running of the first kiln. But 180,000 tons is the nameplate capacity, so to speak.

Eric Prouty - Canaccord Adams

Okay. And then on the ash side, if we ex out some of these incremental shipping costs, et cetera, what would you say the dollar per ton you are taking in on the ash? Where will that kind of normalize out, realizing some of the new contracts sort of lowered levels. But if we add back in some of these short-term expenses you're taking, where would that normalize out?

Bob Scherich

Probably in the $80 a ton level. It could be slightly higher, but I think the conservative number would be around $80.

Eric Prouty - Canaccord Adams

Okay. And that will have a couple of more quarters where we might get bowled at as you ramp up Barnwell; but at some point, it will start averaging out to about $80 a ton?

Bob Scherich

Yes, I think we've been in the lower 70s here, the last couple of quarters. But at these commodity prices, the real value there is the zinc units coming towards not so much, a slight difference on the tipping fee itself.

Operator

And next we'll go to the line of Doug Thomas from JET Investment Research.

Doug Thomas - JET Investment Research

Good start to the year. Just a couple of questions. I know it'd be silly to ask you to predict the rest of the year. The markets are fairly volatile and so forth. I'm just wondering as it becomes clear that the weighted percentage of improvement on the mill business falls on your customer base primarily, the mini mills as opposed to the big integrated guys, does that give you a higher degree of confidence that despite the volatility we can expect a more consistent return to higher rates that are sustainable over the next, let's say, 12 months or so?

Jim Hensler

Well, on the dust side, I think we're going to see pretty good generation rates, and I think that that's going be a pretty consistent theme through the rest of the year. And that's going to have a benefit to us regardless of what happens on the smelting side.

If production goes down, we'll be able to use a higher percentage of lower-cost feeds in the smelters. So that will improve cost. And if production stays where it's at or goes up, that'll be upside. So I think that we're going to see some degree of stabilization in those terms.

The big unknown is what's going to happen with the commodity price. And there's been a quite of volatility in the last week or so. If that situation stabilizes itself, I think we'll see more stability in the earnings as well.

Doug Thomas - JET Investment Research

Just to follow up that thought, when you guys go to negotiate the pricing and so forth, and I've never had to ask this question, but is it a situation where you're using a 30 or 60-day average LME price, because obviously you wouldn't lock in at any given daily price? But how do those contracts typically work?

Bob Scherich

Speaking to the finished products?

Doug Thomas - JET Investment Research

Well, actually I'd be interested if they're different in both.

Jim Hensler

Well, the negotiations on metal and oxide really deal with the premium over what the LME price is. So the LME price is always a variable with the premium that you're negotiating. And as we've talked about on the oxide side, generally that's dominated by tire producers, and generally we are dealing with a lag in the LME price where they want to price current shipments on last month's average or last quarter's average. We tend to think it's a two-month lag on the LME price. And metal tends to price off of the current LME time of shipment or time of order LME.

Doug Thomas - JET Investment Research

When something like what we saw on Thursday or Friday happens, how quickly can you react and respond? Are you able to get orders in for any meaningful hedges or things of that nature when you see these rapid volatile swings up or down?

Jim Hensler

Our customers are watching those things. And quite often what happens when you see a dip like we saw, they want to place an order and they want to place a fixed price order. So in situations like that, we will see an uptick in orders, and we'll typically hedge those fixed price orders, so that we convert fixed to variable.

Operator

(Operator Instructions) And I'll go to the line of Carter Driscoll from Capstone Investments.

Carter Driscoll - Capstone Investments

Could you potentially estimate what the incremental SG&A costs might be for adding the second kiln? I'm sure it must be labor obviously. We know about the depreciation expense. We can estimate that. But what might be the incremental additional labor needed to run it?

Jim Hensler

Well, it wouldn't add anything to SG&A. But in terms of the operating cost, we're really talking about adding six more people. So it's a relatively small additional labor requirement. Most of the cost from an operating standpoint is on labor side when you put the first kiln in. We've designed this plant so that both kilns are sort of close-coupled and can be operated from a common pulpit. And so we don't see much additional labor.

Carter Driscoll - Capstone Investments

That's really just the depreciation expense once you've placed in service?

Jim Hensler

There are other additional energy costs associated with the running of the second kiln. But you asked about labor, and it's not very labor-intensive.

Carter Driscoll - Capstone Investments

And then just remind us again, if you take first kiln on isolation, what total recycling capacity will be left of the first and the second?

Jim Hensler

See, if you just let me go back when both kilns are up and running, we will have the capacity for about 730,000 tons of what EAF does. And the second kiln will add 90,000 tons to that.

Carter Driscoll - Capstone Investments

If you're running six smelters, holding the yield in kind of tons in, let's say, 20%, you're looking somewhere around 75% of total for just all-in feed from dust rather than purchase feed?

Jim Hensler

Yes, it really depends on whether we're operating five or six smelting furnaces. But if we're operating six and we're operating the recycling full with Barnwell, even just first Barnwell, we think that would be over 70%. That could be in the upper 70s as we bring the second kiln up as additional dust comes in.

Carter Driscoll - Capstone Investments

And then just the maintenance for INMETCO, I'm assuming that's just routine maintenance, general cleaning, that's sort of going to be the improvements you're going to try to install during that timeframe?

Jim Hensler

Actually they're making some upgrades in this. One of the things they're doing is modifying the rotary hearth furnace, so that they can take longer time between outages in the future. This is sort of an annual maintenance outage where they do extensive work on the rotary hearth furnace as well as on the submerged arc furnace.

And so it's the month where we spend almost 80% of our maintenance costs in one month. But they are making some modifications to the rotary hearth furnace in this outage, which hopefully will allow them to extend the time between outages and the length of outages going forward.

Carter Driscoll - Capstone Investments

So incremental costs will not really go up (inaudible) modifications beyond the normal maintenance costs?

Bob Scherich

I think they probably should help the other way. That probably will lower the cost going forward.

Operator

(Operator Instructions) And at this time, we have no further questions. Please continue.

Jim Hensler

Okay. Well, thank you very much, and we'll talk to you at the end of the next quarter.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: Horsehead Holding Corp. Q1 2010 Earnings Call Transcript
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