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Schnitzer Steel Industries, Inc. (NASDAQ:SCHN)

F2Q 2014 Earnings Conference Call

April 3, 2014 11:30 ET

Executives

Alexandra Deignan - Vice President, Investor Relations

Tamara Lundgren - Chief Executive Officer

Richard Peach - Chief Financial Officer

Analysts

Luke Folta - Jefferies

Brent Thielman - D.A. Davidson

Phil Gibbs - KeyBanc Capital Markets

Alexander Levy - Morgan Stanley

Sal Tharani - Goldman Sachs

David Lipschitz - CLSA

Andrew Lane - Morningstar

Thomas Van Buskirk - Sidoti & Company

Operator

Good day, ladies and gentlemen and welcome to the Schnitzer Steel Industries Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, today’s conference may be recorded.

I would now like to introduce this conference call to Ms. Alexandra Deignan. You may begin ma’am.

Alexandra Deignan

Thank you, Kevin. Good morning. I am Alexandra Deignan, the company’s Vice President of Investor Relations. Welcome to Schnitzer Steel’s second quarter fiscal 2014 earnings presentation. We are glad you are able to join us today. In addition to today’s audio comments, we have prepared a set of slides that you can access on our website at www.schnitzersteel.com or www.schn.com.

Before we get started, let me call your attention to the detailed Safe Harbor statements on Slide 2, which are also included in our press release of today and in the company’s most recent Form 10-K and Form 10-Q, which will be filed later today. These statements in summary say that in spite of management’s good faith, current opinions on various forward-looking matters, circumstances can change and not everything we think will happen always happens. Please note that we will be discussing some non-GAAP measures during our presentation today. We have included a reconciliation of those metrics to GAAP in the Appendix to our slide presentation.

Now, let me turn the call over to Tamara Lundgren, our Chief Executive Officer. She will host the call today with Richard Peach, our Chief Financial Officer.

Tamara Lundgren

Thanks, Ally. Good morning, everyone and welcome to our fiscal 2014 second quarter earnings call. This morning, I will review the highlights of our consolidated performance, provide updates on our productivity and cost savings initiatives and our progress on our strategic priorities and I will comment on recent market trends. Then Richard will provide further details on our financial results and the operating performance of our three segments. And after that, we will open up the call for questions.

So now, let’s get started and turn to Slide 4. Earlier this morning, we announced second quarter adjusted earnings per share of $0.13, a substantial, sequential increase. I’d like to thank every member of the Schnitzer team for the strong performance. The quarter was not easy and our team navigated the volatility with a dynamic operational focus in order to meet tight production and shipping schedules and to profitably increase our sales volumes over the previous quarter. So, I want to acknowledge and thank all of our employees for your dedication, your ingenuity and your tenacity.

So far in 2014, the global economy has yet to build on the strong momentum that we saw at the end of 2013. Numerous winter storms in the U.S., which meant lost days for certain of our facilities together with financial and political struggles in some of the emerging markets and decelerating growth in China, combined to inject an element of uncertainty in the global economic picture. We saw this reflected in prices softening in January, which continued into February. Although we saw weaker demand from Turkey and China, we also saw the Southeast Asia market gain momentum and we continued our strong sales into the domestic markets. These contrasting market conditions somewhat offset each other, which led to our overall ferrous sales volumes being up 5% versus Q1 and our sales to Asia were up by 22%.

Performance in our Metals Recycling Business improved significantly generating adjusted operating income of $11 per ton, which is a $10 per ton sequential improvement. Our stronger second quarter results were primarily driven by higher selling prices at the beginning of the quarter, higher sales volumes in both the export and domestic markets, and significant and sustainable benefits from our productivity improvements and other cost savings initiatives. Our Auto Parts Business experienced seasonally weaker retail sales, which were further impacted by extreme weather conditions in the Midwest and on the East Coast. And our Steel Manufacturing Business benefited from stronger prices and production efficiencies. We are seeing solid and steady demand for construction products on the West Coast.

During the second quarter, we continued to generate positive operating cash flow and were able to incrementally reduce our debt. Our CapEx of $21 million during the first half of the year is 60% lower than the same period a year ago. Our CapEx spending this fiscal year is primarily related to maintenance, including environmental and safety and to modest post-acquisition investments in our new Auto Parts stores and of course to continued non-ferrous extraction technology.

So, let’s turn now to Slide 5 for a review of market trends. As you can see on this graph, ferrous selling prices were stronger in the first part of the quarter, which was a continuation of the positive momentum we saw at the end of the 2013 calendar year. As the quarter progressed, weaker export demand and severe weather conditions in the U.S. led to sharply lower prices for both export and domestic shipments. In the second half of the quarter, softer market conditions drove average export sales prices down by approximately $30 per ton. However, the combination of shipments contracted at higher selling prices before the market fell, our strong operational focus and benefits from our productivity and cost reduction programs led to MRB’s improved performance in the second quarter. Although export prices continued to soften in March, reports for April reflect stronger prices on higher demand.

If you turn to Slide 6, we can review our second quarter shipments. Looking at the bar chart on the left, you can see that our total ferrous sales increased 5% as compared to Q1. Our overall export sales were up 7% sequentially. And as I mentioned earlier our export sales to Asia were up 22% reflecting our broad based customer reach and the diversity of demand. We shipped our ferrous and non-ferrous products to 14 countries in the second quarter. Our top ferrous export destinations were South Korea, Turkey and Indonesia. And our top non-ferrous customers were located in China, the U.S. and South Korea.

As you can see on the bar chart on the right, for the first half of fiscal 2014, we significantly increased our shipments into the domestic market versus last year by 20%. In the first half of fiscal 2014, we sold 32% of our ferrous volumes into the domestic market which includes our own mill. The quarter-to-quarter sources of demand can vary quite a bit. On a long-term basis, however, strong demand for steel in the emerging markets is expected to continue and we can see these trends if you turn to Slide 7.

Looking on Slide 7 at the chart on the left, you can see that since the 2008 global recession, 80% plus of global GDP growth has come from the emerging markets and they are expected to continue to be the source of the majority of global GDP growth. And if you look at the chart on the right, by 2017 emerging market infrastructure spending is expected to double from 2012 levels providing another driver for improving long-term demand for scrap and finished steel products.

If you turn now to Slide 8, we can look at the leading indicators of supply. As many of you know one of the most significant impacts to our operating margins since the global financial crisis has been the reduced supply of recycled scrap metal. As the U.S. economy slowed and unemployment increased, our markets experienced a tightening in the availability of end of life automobiles, obsolete white goods and scrap from construction and demolition projects. These constrained supply conditions have pressured purchase costs for raw materials leading to margin compression. However, the latest manufacturing surveys show a rebound in sentiment after softness from December to February. The purchasing managers’ index did slowdown a bit in March, but overall manufacturing activity improved from January’s winter storms.

On the consumer front, a number of indicators and trends are showing signs of improvements such as strong auto sales and increasing appliance shipments. Generally, consumer spending and consumer confidence are up versus a year ago although labor market worries are impacting the trajectory of the consumer recovery. And as I mentioned before, we are seeing the beginning of a recovery in the construction markets on the West Coast. Over time, all of these trends should generate stronger scrap flows into our MRB facilities, more end-of-life vehicles into our Pick-N-Pull stores and demand for long products, which benefits our Steel Manufacturing Business. And while we are encouraged by these improving general economic trends, we are not just waiting for the markets to recover. We are proactively pursuing organic strategies aimed at improving our productivity and generating higher returns.

So turning to Slide 9, I will review our progress on our efficiency initiatives. At the beginning of our fiscal year we embarked on a $30 million productivity improvement and cost reduction program targeting at least 70% to be achieved by the end of fiscal 2014 and the remainder by the end of fiscal 2015. We are well ahead of the target. With $10 million in cost reductions delivered in the first half of fiscal ’13. Our second quarter results included $6 million of savings which equate to an annualized run rate of nearly $25 million. At this time the majority of the benefits are coming through in MRB with the remainder appearing in SMB’s results. In light of our strong progress, we are increasing our overall target savings by $10 million through further reductions in SG&A expenses in MRB, APB and corporate. We anticipate achieving 70% of our increased target by the end of fiscal 2014 with the remainder in fiscal 2015.

On Slide 10, I will wrap up my remarks with the discussion of our strategic priorities and then I will turn it over to Richard for a more detailed discussion of our business segment performance. As we have highlighted in the past, we have three major strategic initiatives underway, productivity improvements, accelerating returns on our 2013 investments and expanding the synergies between our Metals Recycling and Auto Parts Business. In each of our segments, we have targeted productivity improvements, which are already contributing to the higher operating margins in MRB and SMB. We have also now launched similar initiatives in our Auto Parts Business, which we anticipate will benefit fiscal 2015 through a combination of revenue enhancements and store level efficiency measures across the entire APB platform.

While we do not breakout MRB’s regional results, we have seen significant year-over-year improvements in the performance of our Canadian business and we expect Canada to continue to improve its performance in the second half of this year. We are also seeing bottom line benefits from our focus on increasing synergies between MRB and APB through combining resources, leveraging our assets to maximize returns from processing scrap and cores and integrating our selling activities for both ferrous and non-ferrous materials.

Now, I will turn it over to Richard for an update on our operating segment performance and our capital structure.

Richard Peach

Thank you, Tamara. I will start with a review of our Metals Recycling Business in Slide 11. As Tamara mentioned earlier, both ferrous and non-ferrous sales volumes increased sequentially compared to the first quarter. Ferrous sales rose by 5% with the increase mainly driven by higher export volumes, which were up by 7%. Similarly, non-ferrous sales increased by 10% due to a combination of higher levels of production and additional shipments compared to the previous quarter. Average non-ferrous sales prices were lower sequentially by 3% with the decrease more pronounced in the second half of the quarter.

MRB’s adjusted operating income in the second quarter was $12 million, which represented a substantial increase from the first quarter. The second quarter benefited from our ability to navigate volatile market conditions through our sales activity, tight discipline over our commercial and operational process, productivity improvements and a favorable impact from average inventory accounting. The strong operational performance was our key contributor to MRB’s second quarter results. The productivity improvements and other cost reductions are being achieved through a variety of strategies, which are mainly focused on reducing fixed costs within our production and administrative functions. We have also trimmed our equipment portfolio, which accounts for the asset impairment charge that is included in MRB’s reported results.

Now, turning to Slide 12, I will review our Auto Parts Business. As expected, Auto Parts experienced a seasonal slowdown in retail business, but the decline was greater than normal in the Midwest and Eastern U.S. which experienced unusually harsh winter weather. This decrease in parts sales and admissions was the main reason for APB’s operating margin reducing to 7%, which excludes the performance of new stores acquired or opened in the past 12 months.

Car purchase volumes also decreased sequentially by 7% due to tighter supply flows in the second half of the year when commodity prices were lower. These weaker conditions as well as continuing integration contributed to modest operating losses of $800,000 in new stores owned for less than one year. The combination of the weaker market conditions in the second half of the quarter and unusually harsh weather were the primary reasons why APB’s performance did not improve over the previous quarter.

Now, moving to the Steel Manufacturing Business, please turn to Slide 13. SMB sales volumes were 115,000 tons, which represented an increase of 20% from the prior year quarter. This year’s second quarter volumes benefited from improved market demand for construction products and milder West Coast weather. Last year second quarter was unusually impacted by generally weaker conditions and lower inventories coming into the quarter.

On a sequential basis, sales volumes were down due to seasonal effects on construction activity. Average net sales prices of $676 per ton represented a slight increase from the first quarter due to the impact of higher average raw material costs on selling prices for finished steel products. SMB’s operating income of $4 million marked another solid quarter of profitability with benefits from higher average sales prices and ongoing productivity improvements more than offsetting the seasonally lower volumes. Finally, during the third quarter, we have a planned outage for maintenance which we estimate will impact production costs by around $1 million.

Now turning to Slide 14, I will move on to cover cash flow and capital structure. In the second quarter, we generated operating cash flow of $20 million and for the year-to-date we are positive by $46 million. This continuing trend reflects our improvement in EBITDA and our strong management and control of working capital. We invested $7 million in CapEx during the second quarter which was related to maintenance, environmental and safety projects and some localized group initiatives. For the year-to-date our CapEx was $21 million and we anticipate no more than $50 million for fiscal 2014 as a whole which is around half the level of the previous fiscal year. The combination of our positive operating cash flow, more modest levels of investment and a slight increase in cash in hand all enabled us to maintain net debt leverage at 32% which supports our balanced capital allocation strategy including our quarterly dividend.

Now, I would like to turn the presentation back over to Tamara for her summary remarks.

Tamara Lundgren

Thank you, Richard. Overall market conditions continue to be uncertain due to the impacts from the unusually severe and lengthy winter season and the political and credit conditions in a number of the emerging markets. On a longer term basis however, demand for steel is expected to continue to increase driven by the construction, industrial and automotive sectors in the emerging economies as well as in the recovering developed economies. Moreover, the heightened sensitivity to environmental concerns creates a significant opportunity to boost EAF production and recycling activity in the metals sector.

While it is still too early in the quarter to provide third quarter guidance, we will issue an update towards the end of the quarter. Our continued traction on our productivity initiatives, our improved returns from our previous investments and the positive benefits from increasing synergies between our Metals Recycling and our Auto Parts businesses should lead to sustained improvements in our financial results and deliver significant operating leverage as market demand and raw material supply improves. We will continue to focus on what we can control, improving productivity, operating efficiently, meeting our customer’s needs, generating synergies between our businesses and achieving the returns from our capital investments.

Again, I would like to thank everyone on the Schnitzer team for their significant contributions during the quarter and for making our company a safe and a productive place to work. Operator, let’s open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Luke Folta with Jefferies.

Tamara Lundgren

Good morning Luke.

Luke Folta - Jefferies

The first question I had, it was just on scrap flows, when we speak with recyclers, something that we hear more and more often now is that the reservoir for scrap is a lot more shallow than it had been. And when we look at scrap flows over the course of the cycle, probably looking back like very long-term it seems like they are certainly down over the last couple of years from the recent peaks but they are still relatively healthy relative to the long-term multi-cycle averages. So I am curious to as your thoughts on the whole idea that is it possible that during the peak market conditions in the last cycle as well as having high prices to the downturn if we didn’t just drain the reservoir to a point where we are consuming more than was being kind of generated. And going forward perhaps we don’t see a snapback to the level that we had seen over the ‘04, ‘05 to say 2010, ‘11, ‘12 timeframe, any thoughts on that?

Tamara Lundgren

Well, I think that you have hit on the big issues, but fundamentally, history has shown that scrap supply flows improve with higher prices. And when we see improving industrial productions, improving although still low GDP growth, improving consumer activity all of that generates scrap, but there is going to be a lag effect. When you see improving construction markets, at the same time you typically see demolition occur. So higher prices, better economic activity historically brings more scrap into the market. And I just think that you haven’t seen that on a sustained basis fundamentally since the global financial crisis and but I think that looking in the very short-term, we probably will expect about that from the harsh winter that we have achieved or that we have experienced, but we don’t know how quickly that will bounce back, but the stronger economy should generate more activity coming through end-of-life vehicles, coming through manufacturing and just coming through general consumer activity. So I am not sure I would conclude that we have drained the scrap flow, because it’s a pool that is always being replenished as the economy moves forward.

Luke Folta - Jefferies

It just seems like even during the pricing cycles these days over the last couple of years that even when prices do come up, it just seems like it generates a lot less scrap being pulled from, I guess you call it the reservoir, whether it’s old equipment sitting on manufacturing lots or farms or whatnot, it just seems to be like there is just less out there to pull from, so we see less of an elasticity in terms of pricing when we see those periods of strength.

Tamara Lundgren

Well, I think what you are seeing since the financial crisis with price volatility is that you are seeing that impact, because customers are keeping generally low inventories. So when there is a small – when there is a small step up in inventories, you see an outsized pickup in price activity that isn’t reflecting the fundamental scrap generation flow. And I think that’s why you haven’t seen the scrap supply flows, move in the same trajectory as you have seen the price volatility.

Luke Folta - Jefferies

Okay. And then just secondly in terms of the shredder capacity that’s out there, results for the entire sector in recycling have been pretty challenging here over the last year or two even. I am surprised when I have seen more of a shakeout in terms of shredders closing down by some of the smaller companies out there? And I just wanted you guys are starting to do, well, not starting you have been doing now for sometime now some cost-cutting efforts, why do you think we haven’t seen the bigger shakeout in capacity? Do you feel like you are more just catching up from a cost perspective to some of the smaller private companies that are out there or I guess what’s keeping this capacity alive?

Tamara Lundgren

Well, I think you are starting to see market rationalization and you are seeing that with the number of shredders being idled or closed. I think you are beginning to see smaller multi-generational companies closed down or get into financial difficulties and go bankrupt, but I think fundamentally we didn’t see as quick a – what to use your term shakeout in the industry immediately after the global financial crisis, because people came into the crisis in this industry without debt. And that’s what you would see in previous consolidations in this industry were people getting weighed down by debt. But I think that the extended period of lower profitability is pressuring some of the smaller operations. And I do – we are seeing signs of rationalization and consolidation.

Luke Folta - Jefferies

Okay, thank you for that. One last question if I could, Richard, you have said last quarter that you thought the inventory holding impact could be zero to six positive swing over the first quarter, how accurate was your forecast?

Richard Peach

I think we were pretty accurate. We had a small positive benefit from average inventory accounting in the second quarter and that was one of a basket of factors that contributed to the strong MRB results.

Luke Folta - Jefferies

So sequentially something north of $6?

Richard Peach

It was something just around and within that range just above.

Luke Folta - Jefferies

Okay, very helpful. Thank you very much.

Tamara Lundgren

Thank you.

Operator

Your next question comes from Brent Thielman with D.A. Davidson.

Tamara Lundgren

Good morning.

Brent Thielman - D.A. Davidson

If you took this quarter and split it into you had some momentum in export activity in the first part of it and obviously you kind of came off in the back half, could you give us a feel for how margins were trending between the two halves of the quarter, what the range sort of looked like?

Tamara Lundgren

Well, I am not sure we would breakdown margins over the course of the quarter because fundamentally it depends on our shipping schedules and our volumes from month-to-month. But I think you are exactly right in saying that the quarter had two parts. And interestingly it was opposite from the first quarter. And in the second quarter we had stronger prices in the first half and weaker prices and lower demand and the severe weather in the second half. But the performance in our MRB business was due to a combination of factors. We had higher selling prices. We had higher volumes. Our shipments to Asia were up 22%. We had strong benefits from our productivity initiatives, which benefited comps as well cost reductions in SG&A. And then as Richard just mentioned we had some benefit from average inventory costing, but that was really driven by strong operational performance.

Brent Thielman - D.A. Davidson

Okay. Well, and then I guess when you look at volumes obviously domestic has been relatively stronger. And Tamara I would just be kind of curious to your thoughts I know the deepwater facilities aren’t exactly arranged to address domestic demand, but are there some more low capital intensive ways you can kind of look to serve the domestic market more efficiently or to a broader scale with the existing asset base you have?

Tamara Lundgren

There are and our team really performed in this way this quarter and showed some great potential. As I mentioned in my remarks we sold 32% of our material into the domestic markets. And if you look for example at the utilization rates and I will just point to a steel mill as an example. And we sold obviously domestic to not just our steel mills, but to many others. But if you look at our steel mills we operated at 67% capacity utilization. So there as the economy improves and we see the West Coast demand gets stronger we will be able to sell even more domestically into our own steel mill. And that corresponds to third parties as well. So there is upside on domestic if they continue to stay strong.

Brent Thielman - D.A. Davidson

Okay, great. And then the impairment in the MRB, I am sorry if I missed this but could you provide us just a little more background there and then I guess is there additional charges to look for in future quarters?

Richard Peach

Yes, hi Brent. As part of our overall productivity and cost reduction measures, one thing we have been doing is looking to optimize our portfolio which includes reviewing our assets. And as part of that we have taken a look at the utilization of certain equipment relative to current volumes. So there were a couple of pieces of equipment during the quarter that we decided to stop using, not major pieces of equipment but nevertheless the impairments we took on these two items added up to around $1 million, which is included in MRB’s reported results or looking forward as part of our overall cost reduction and productivity improvement strategy we are continually reviewing our equipment portfolio and our asset utilization. And if further changes are required we wouldn’t hesitate to do so.

Brent Thielman - D.A. Davidson

Okay, great. And then just one more on the Auto Parts side, when do you expect those losses to abate for the new sites?

Richard Peach

Well, as I mentioned in my scripted remarks the loss in the second quarter was around $800,000, so it was fairly modest and mainly that came from a combination of the weather being unusually harsh and these weaker commodity prices in the second half of the quarter. So we are hopeful that in the quarters to come we get closer towards breakeven and through that side, so we are working hard on it and that’s certainly our objective.

Brent Thielman - D.A. Davidson

Okay, great. Thank you.

Operator

Our next question comes from Phil Gibbs with KeyBanc Capital Markets.

Tamara Lundgren

Good morning, Phil.

Phil Gibbs - KeyBanc Capital Markets

Could you hear me?

Tamara Lundgren

Now, we can.

Phil Gibbs - KeyBanc Capital Markets

Perfect. Good morning and thanks for taking my call.

Tamara Lundgren

Happy to do so.

Phil Gibbs - KeyBanc Capital Markets

Good. Had a couple of questions as far as just trying to get a feel for the profitability within MRB this quarter, anyway that we could get a feel for through the export ferrous profitability, the domestic ferrous profitability and maybe the non-ferrous contribution just from a higher level perspective? And how should we be thinking about that in the quarter?

Tamara Lundgren

We actually don’t break that down obviously, but what drove our performance in MRB were those four baskets that we referred to higher selling prices. So, we had average higher selling prices from Q2 versus Q1, stronger prices first half, weaker in the second half, but overall on an average basis higher, higher volumes 5% overall, 7% higher in the export markets, 22% higher in Asia, the productivity and cost savings and Richard can spend a little bit more time in discussing that and then average inventory accounting benefit, but no one part overwhelmed the others. So I think that’s the best way of looking at it.

Phil Gibbs - KeyBanc Capital Markets

Okay. And as far as your steel business, are you looking at that as a non-core asset to your growth, you are moving forward, how are you viewing it certainly moving in the right direction, but doesn’t really seem to be core to your growth strategy here?

Tamara Lundgren

In our steel business, we have said – we are situated well to return to the high levels of profits in cash flow when the U.S. economy improved and when the West Coast markets improved. And you can see that number one, it reacted very quickly in terms of leaning out and it has now disciplined its production to demand and that has given a big boost and a big tailwind as the markets have improved. We do not have any plans to add any mills to our portfolio obviously, but it is in a unique geographic position and it has rebounded very quickly as the market strengthens. And I applaud the team for taking the actions it needed to take in order to put itself in the position to benefit well when the markets have started to rebound.

Phil Gibbs - KeyBanc Capital Markets

So, it sounds like we should expect it to be part of the portfolio here or the diversification moving forward at least as you are sitting here today?

Tamara Lundgren

Well, we are anticipating continued strong performance from our steel manufacturing business.

Phil Gibbs - KeyBanc Capital Markets

Okay. And then I just had a couple of smaller ones as far as your mix in non-ferrous, how much of that should we think about as being things like zorba that moves into China versus maybe some – maybe things like copper, just trying to think how we should think about some of the things that you “produce” your non-ferrous mix?

Tamara Lundgren

Sure. Zorba sales are just one part of our overall picture. Zorba as a percentage of our non-ferrous business is about one-third and has actually been declining due to the technology investments that we have made and that we continue to make that get us closer to the intrinsic product a pure metal, which is what differentiates us as a producer. We sell our non-ferrous products to about a dozen different countries. And so we are well-diversified from a consumer base both in terms of products that they need and places where they go.

Phil Gibbs - KeyBanc Capital Markets

Okay, I appreciate all the color. I just had one last one. As far as the – as far as your inventory levels internally, how should we be thinking about those you are trending in the back half of the year if you had a view right now? Thanks.

Richard Peach

Yes, I think Phil that as our operating cash flow track record demonstrates, we have got a very strong grip over our working capital management including inventories and we expect that that discipline to continue. Based on current market conditions we are not anticipating significant changes in working capital in the remainder of the year. Inventory levels are reasonably low, but still within the range of what we have seen in the past. I think if market conditions did improve and the higher prices and better flows have the potential to lead to a growth in working capital. But we should remember that would be a profitable growth in working capital because generally improvements in market conditions lead to improved financial performance and that’s what I would say about that one.

Operator

Our next quest comes from Alexander Levy with Morgan Stanley.

Alexander Levy - Morgan Stanley

Thank you for taking my question.

Tamara Lundgren

Yes, good morning.

Alexander Levy - Morgan Stanley

So your scrap export volumes have been lower year-on-year for a few quarters now, what are your thoughts on how this trend might stabilize or reverse and what kind of factors would perk up imported scrap demand in your key markets?

Tamara Lundgren

Well, I think that higher industrial activity, higher consumer activity, higher non-residential growth all of those are leading indicators and all of those drives stronger steel markets. And with stronger steel markets that supports stronger scrap markets. And you know what – what you have seen and what I referred to I think it was Slide 7 in our materials is that when you take a longer view here not a quarter-to-quarter view, you see very strong contributions to global GDP growth from the emerging markets. And you see emerging market core infrastructure spending looking to significantly increase over the next five years with Asia remaining a key driver of that. So we are quite encouraged by the longer term trends. And even when you look at countries like China where growth is “decelerating”, their absolute growth levels are the highest in the world at 7%, 7.5%. And their government is committed to maintaining them there and providing support to fixed asset investments to move that forward. So we think the long-term trends are quite positive. And typically coming out of the winter, I would see more activity.

Alexander Levy - Morgan Stanley

And then in terms of your newly upsized efficiency and productivity initiative, could you share some specific examples and anecdotes about the kinds of things you are doing in the Metals Recycling Business that are moving costs lower?

Tamara Lundgren

Sure.

Richard Peach

Yes, I would give some examples. We are really flattening the organization. We are reducing management layers. We are also consolidating management positions and increasing the use of shared services between regions. And so if you – that’s a big part of it, in addition, reducing the amount of reliance on outside services and contractors. And then we have a major exercise ongoing with our non-scrap procurement activity in terms of things like transportation and fuel disposal costs, that type of thing. And as I mentioned earlier on, we are also being spending a fair bit of time looking at our equipment and asset portfolio making sure that that is properly matched to volumes and our resource levels that we utilize are matched and to both the volumes and the equipment utilization that we need. And lastly, I would mention that we do have some small non-core activities that we have cut out during this process. So, it’s very comprehensive. It’s a continuous process, which has a tremendous amount of senior management focus and is very specific in terms of the identified targets within our operations.

Alexander Levy - Morgan Stanley

Great, thank you.

Tamara Lundgren

Thank you.

Operator

Our next question comes from Sal Tharani with Goldman Sachs.

Tamara Lundgren

Good morning, Sal.

Sal Tharani - Goldman Sachs

Good morning. How are you? I wanted to ask you on – I was looking at the last quarter press release and your comments you mentioned that the trend during the quarter and this is the first fiscal quarter that had changed where things started to move up and you were expecting pretty significant or at least better second quarter, which you did deliver. Some of that came from the of course inventory accounting, but in this quarter, it appears that things have trended the other way. I am just wondering if third quarter we think of it as a weaker quarter now than the second quarter, I know we didn’t give out guidance, but you didn’t mention anything that in this press release like last time that how things are tending?

Tamara Lundgren

Right. Well, you made an interesting point, because we did have kind of an unusual second quarter, because typically winter weather constrains the availability of scrap and that causes prices to rise. And this year in the second quarter that was negated by weaker export demands, which flows back into the domestic market and that led to some weaker prices together with very harsh weather in February and into March, but our ability to – and I really applaud the team, they were extremely nimble and they were able to move metal units very effectively to those markets where price was strongest. And typically coming into the spring weather, we see supply flows improve and that in a typical scenario would lead to stable or weaker prices, but I think what we are seeing now because the reported April numbers are not out, but the preliminary reports on April numbers reflect strengthening and I think that is due in part to the fact that inventories at mills are quite low coming into the spring. And so it’s too early in the quarter to quantify what the bounce back will be, but history typically points to stronger activity in the next three to six months.

Sal Tharani - Goldman Sachs

Okay. Richard, you have $25 million of run rate of cost savings, about $12.5 million in the first quarter, should we consider that $5 million charge you have taken as part of it or that’s separate from that. It means did you get benefit of all $12.5 million or should we subtract $5 million out of it and assume that you got $7.5 million?

Richard Peach

Well, the restructuring charges are one-off items whereas the cost savings are sustained benefits that benefit the ongoing run-rate of costs going forward. As I think we mentioned earlier, we did achieve $6 million of cost savings in the second quarter, which equates to roughly an annualized run-rate of $25 million, but there is more to go. We have raised our cost savings target to $40 million in total. So clearly there is more to go, so we should expect moving forward in the future quarters some incremental improvement to come, but as far as the $5 million of charges – restructuring charges, these are one-off items.

Sal Tharani - Goldman Sachs

And if I am not mistaken that the $30 million initially you had was almost all of it was from MRB, now you have $10 million, which is combination of MRB and APB, can you break it down how much of the $10 million is in MRB and how much is in APB?

Richard Peach

Okay.

Sal Tharani - Goldman Sachs

Also, corporate is in there also I believe so.

Richard Peach

Yes. Let me give some color on how these targets are broken down. Starting with the $40 million in total and MRB is around two-thirds of that and the remainder is mainly split between Auto Parts and the steel manufacturing business. What we have said is that we expect 70% of the $40 million to be achieved in fiscal ‘14. Of that amount, we expect around two-thirds of that to be in our cost of goods sold and around a third of it to be in our SG&A. And of the total $20 million in fiscal ‘14, we expect around two-thirds of that to be in the Metals Recycling Business and just – and of the remainder the majority in SMB and the minority portion left split between APB and corporate. I hope that’s a helpful breakdown.

Sal Tharani - Goldman Sachs

That’s great. Thank you very much.

Tamara Lundgren

Thank you.

Operator

Your next question comes from David Lipschitz with CLSA.

Tamara Lundgren

Good morning.

David Lipschitz - CLSA

Good morning. Good afternoon.

Tamara Lundgren

Good afternoon.

David Lipschitz - CLSA

Quickly, two quick questions. I just want to follow-up on the question about the average inventory for the next quarter, in terms of you sort of had a reverse, so last time you were able to give us sort of – you sort of gave us the $6 or approximately there, so do you not have a number for the next quarter right now based on where things sort of stand or is it zero or what are we looking at?

Richard Peach

It’s too early to tell. David, there is too much uncertainty in the remainder of the quarter in terms of where scrap prices will go and scrap was near the end of the quarter. So it is too early to give a number for that.

David Lipschitz - CLSA

But I mean I am so confused, because I think your earnings estimate you gave January last years when you – but it’s the same timeframe, that’s why I am little confused…?

Tamara Lundgren

Actually, we were little later in January because January prices in the domestic market had already been set when we announced last quarter. And the April numbers aren’t out and so it’s just a little early in the quarter.

David Lipschitz - CLSA

But if we take what you sort of said was preliminary numbers, would that mean it would offset, would be a flat or I am just trying to get an idea?

Tamara Lundgren

We are really not forecasting for third quarter guidance. We will provide it later in the quarter.

David Lipschitz - CLSA

Okay. My second question is how has the impact of lower copper prices and things like that impacted, should we expect scrap for the non-ferrous prices to be down quarter-over-quarter?

Tamara Lundgren

Well, right now, non-ferrous prices have dropped in March and those are reported prices and clear. And that’s – and that drop has occurred for a variety of reasons, China’s weakness and the end of CCFDs and credit tightening and the like has driven a lot of that. But this is a spread business, so prices adjust and we pivot ourselves to customers where demand is strongest, but you can track the non-ferrous prices pretty accurately from reported levels. And they have been trending down in March and they have rebounded a little bit recently.

David Lipschitz - CLSA

And just one quick final one, we have seen iron ore prices come off from January, end of December, in January it was at $130 something now were at sort of $115, so down $15 or $20, how does the long-term impact of iron ore prices I think its consensus, but our view is prices are going to be in double – in triple digits and double digits and stuff like that, how does that impact over time if we start to see like a $90 or $95 iron ore price in terms of substitution to iron ore and things like that?

Tamara Lundgren

I think there are a couple of things there. I mean, first of all, iron ore doesn’t move dollar for dollar with scrap, because as you know, scrap is not fully substitutable for iron ore in integrateds and it is necessary for EAFs. And at the end of the day, scrap is a spread business. So we have said for a long time, it’s not absolute prices that are so relevant, it is the spread and the trend that we manage to.

David Lipschitz - CLSA

Right, but isn’t your main stuff export, which I mean China is not an EAF market, I mean I am talking the U.S. business side but not the Asian side?

Tamara Lundgren

Well, China is about 10% EAFs and in terms of what 10% or little less than 10% EAF and what it represents in absolute numbers is actually quite large. The Southeast Asia market is largely EAF. And even going back to China, the Chinese government has articulated a policy commitment to increasing the amount of scrap. And with their environmental concerns and the like, it will probably create a push environment to increase the proportion of EAF. So even if you look at our activity in Q2 where you did see significantly falling iron ore prices, you saw – you didn’t see that type of fall within the scrap market and you saw a quarter-over-quarter 22% increase in our activity to sales into Asia and that was really Southeast Asia, because Chinese demand was pretty non-existent on the ferrous side in Q2. So I think that you got to look at diversity of demand, you got to look at the fact that scrap and iron ore are fully substitutable and then you have to look at the fact that it’s a spread business and so prices adjust.

David Lipschitz - CLSA

Okay, thank you.

Tamara Lundgren

Thank you.

Operator

Our next question comes from Andrew Lane with Morningstar.

Tamara Lundgren

Good morning.

Andrew Lane - Morningstar

Good afternoon.

Tamara Lundgren

Good afternoon.

Andrew Lane - Morningstar

Based on your Q2 results for MRB, I am curious about how you expect scrap flows to Southeast Asia to change going forward? I know a couple of quarters ago you mentioned that scrap surplus in Japan allowed the country to take some share in supplying ferrous scrap to Southeast Asia. Have you witnessed a continuation or a reversal of this trend? And then from what you have seen, how have Japanese scrap generation rates compared to U.S. scrap generation rates in recent quarters?

Tamara Lundgren

Well, again, we take a – you have to take sort of a several quarter view, 6-month, 12-month view on this. When you look at sources of scrap supply, the U.S. is the largest, Europe is second and Japan is third. And there is a big gap between the amount that Japan exports versus Europe and then versus the U.S. So fundamentally, we have always said it’s a question not of whether the U.S. is in the Q, it is where you are in the Q. So currency can impact that, absolute prices can impact that, but it’s not – it puts you in a different place in the Q, it doesn’t eliminate you from the Q, because people come to the U.S. for not just quantity, but quality of scrap.

Andrew Lane - Morningstar

Okay. And then there is a follow-up from a big picture standpoint, given the likelihood that Chinese steel producers might favor electric arc furnace production for a build out of incremental steelmaking capacity, what’s the likelihood that China joins the list of your top three ferrous export destinations at some point in years to come?

Tamara Lundgren

Well, China has been in our top three for most of the last five years or so. They are typically in our top three. They weren’t in our top three this quarter. And that has happened from time-to-time, but again, if you took a long-term historical view going back five years and even going back, I think Q1 they were in our top three ferrous export destinations. So it is likely that they will stay in there for the long-term.

Andrew Lane - Morningstar

Okay, thank you.

Tamara Lundgren

Thank you.

Operator

Our next question comes from Thomas Van Buskirk with Sidoti & Company.

Thomas Van Buskirk - Sidoti & Company

Good afternoon.

Tamara Lundgren

Good afternoon.

Thomas Van Buskirk - Sidoti & Company

I have a couple of things. Just the first one real quick, the effective tax rate, which I guess you are looking at 39% now for the year, what – how should I think about the tax rate going forward into fiscal ‘15 to model something similar or is there something that popped it up this year that’s not going to continue in the future?

Richard Peach

Yes. I think Tom you should look at our – where our tax rate has been historically, if I was looking ahead into fiscal ‘15 I might be modeling something more along the lines of where it’s been historically, which would be in the 34%, 35% type of range. This year is really impacted by the expected mix of profits in the year-to-date and our projections for the rest of the year. And one thing to notice is that the amount of absolute dollars involved in taxes when the REIT changes is not that significant at current levels of profitability. So, it’s not the percentage alone is not the major factor. It’s amount of absolute tax dollars as well, but looking forward, I would be looking at something around the mid-30s as because that’s been a historical run rate.

Thomas Van Buskirk - Sidoti & Company

Okay, that makes sense. The other question is on Auto Parts Business and I apologize if you went over some of this earlier and I missed it. But I am trying to get a sense of going forward what is it – what does it take to get vehicle purchase volumes per store back up to something more aligned with historical levels. And also getting the gross margins back up and obviously what you are paying for those vehicles would be a significant piece of that, what’s – what do you need to do and how quickly do you think you can get there?

Tamara Lundgren

Well, one thing I would start out with is we don’t really look at vehicle purchases per store because the size of our stores vary quite dramatically depending upon the region and related stores around them, but your question about when – how do we see increased car purchase volumes rolling out. I think there the leading indicators are giving us a sense of improving trend. I am sure that you have seen us write and talk about the fact that average miles driven right now for cars on the road is at an all time high and the average age is 11 plus years. And so eventually those cars are going to come off the road. And while in the past they may have had several stops before they came to our facilities and became an end of life vehicle that lag effect maybe shorter. It’s generally going to be driven by improving economic environment that supports people turning over their cars. And so we are seeing leading indicators that are supporting that, but there is going to a lag when you see new auto sales increase. There is still a lag before you see if those vehicles coming to – into our facilities. And looking sort of nearer term historically we see margins admissions and car purchases increase in the second half of our fiscal year for the Auto Parts Business due to fundamentally seasonality and we have got no reason to believe this year will be any different from that.

Thomas Van Buskirk - Sidoti & Company

Okay, that makes sense. I just want to make sure I understand what you are saying about it being difficult to compare apples-to-apples from one store to the next, my concern was that there is some sort of diminishing returns on the new stores that you have opened and in terms of vehicle purchases in those stores kind of being at a lower rate although because there is smaller or whether there is something else going on there or whether it’s just a question of ramping those stores up to full operation?

Tamara Lundgren

There are really two things going on there. There is one, it’s ramping up and just developing the retail base in those new areas. Secondly, a number of our stores are Greenfield. And so those take also a longer ramp up than just a pure acquisition where we take over operations and create a Pick-N-Pull brand. So you got two factors there and then obviously there are a number of our new – of our acquisitions were in the Midwest and in the Northeast. And those were particularly hard hit by weather this past quarter.

Thomas Van Buskirk - Sidoti & Company

It makes sense. Just finally just real quick, the increasing integration between Auto Parts and the recycling business in terms of cost savings, how will we see that manifesting itself in results going forward qualitatively not numbers wise so much?

Tamara Lundgren

Well, on a qualitative basis one of the things that you are seeing and you will continue to see is that they are growing together. And that’s really important because as we grow that Auto Parts platform and we grow it along with where our MRB facilities are we get some really big inherent synergies. So growing together is something to watch for. We are integrating our selling activities for both ferrous and non-ferrous metals and so that helps I mean that gets us to best in class in terms of our ability to sell broadly and to move metal units to the strongest buyers. And then we are leveraging our assets, our shredding assets to maximize returns from processing scrap and cores. And as Richard mentioned earlier, we are combining our resources, so that we can leverage shared services in a much more efficient way as opposed to duplicating some of those activities. So that’s how you will really see the synergies and the integration hit our performance.

Thomas Van Buskirk - Sidoti & Company

That’s great. Thanks very much.

Tamara Lundgren

Thank you.

Operator

This concludes the question-and-answer session of today’s conference. I would like to turn the conference back over to our host.

Tamara Lundgren

Thank you everyone for joining us on our call and for your interest in our company. We look forward to speaking with you again in June when we announce our third quarter results. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day.

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