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Sims Metal Management Limited (NYSE:SGM)

F1Q2011 Earnings Call Transcript

October 26, 2010 8:00 pm ET

Executives

Dan Dienst – Group CEO

Rob Larry – Group CFO

Analysts

Eric Glover – Canaccord

Andrew Gibson – Goldman Sachs

Emily Behncke – Deutsche Bank

Sam Haddad – Baillieu Stockbroking

Scott Hudson – CLSA

Todd Scott – Royal Bank of Scotland

Michael Slifirski – Credit Suisse

Tony Mitchell – Ord Minnett

Michelle Applebaum – Steel Markets

Operator

Good morning, ladies and gentlemen, and welcome to the fiscal year 2011 first quarter results conference call for Sims Metal Management. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. (Operator instructions) I must advise you that this conference is being recorded today, Tuesday, the 26th of October, 2010 in the United States, and Wednesday, the 27th of October, 2010 in Australia, Asia, and Europe.

Today’s presentation may contain forward-looking statements, including statements about Sims Metal Management Limited’s financial condition, results of operations, earnings outlook, and prospects. Because these forward-looking statements are subject to assumptions and uncertainties, actual results may differ materially from those experienced or implied by these forward-looking statements.

Investors are encouraged to review the filings made by Sims Metal Management Limited with the Securities and Exchange Commission including the Form 20-F/A, which we filed with the SEC on 14th of April, 2010, which describes some of the factors that may cause the actual results to differ from these forward-looking statements.

I would now like to hand the conference over to your speaker today, Mr. Dan Dienst Sims Metal Management Group Chief Executive Officer. Please go ahead, sir.

Dan Dienst

All right. Thank you, Richard. Good morning, good evening and welcome everyone to today’s call. We are dialing in from Los Angeles, where we are touring some of our joint venture partner assets. We appreciate those in New York for hanging in there kind of late, while we approach evening there and we appreciate all others joining us for this review of the results for the first three months of fiscal '11, which ended on September 30th, 2010.

Joining me today as usual is our Group Chief Financial Officer, Rob Larry. Our call, for those who don't remember, we will follow the same accelerated format that we used in our other interim trading results update calls. First, I will provide some initial thoughts before turning the call over to Rob who will provide some details on our financial results. Then I will make some closing remarks on market condition and other observations before we take your questions as time permits.

As always, we would like to start by welcoming all the men and women of Sims Metal Management and partners at our joint ventures across the world, many of whom take the time to listen to the webcast or the call. Thank you for another hard-fought three months in the continuing economic malaise that impacts a broad swath of our operating footprint. Your hard work and commitment to Sims Metal Management is inspiring, particularly your commitment to make our company the safest in the industry.

As most of you have heard before and I've said it many times, safety is part of the Sims' DNA chain. Yes, we were coming off our safest year in company history, but we cannot be complacent. Our stated goal is to stand shoulder to shoulder with the safest manufacturing companies in the world, not just our industry. As I have traveled to many of our businesses over the past few weeks and months and huddled with our employees, I am more convinced than ever that world class is indeed achievable. Thank you, Team SMM for your commitment to keeping each other safe.

Before turning the call over to Rob to go through the financials, allow me to add some color on our first fiscal quarter results. The first quarter of our fiscal '11 marks our fifth consecutive quarter of profitability since the full effect of the global financial crisis. Against the backdrop of these anemic numbers, however, we are clearly not taking any victory lap, far from it.

Scrap flows and margins remain constrained, particularly in North America and especially for those assets that are principally domestic in focus. We continue to confront the stark realities of stagnant and tentative U.S. economies, which will continue to exhibit sluggish scrap flow generation until such time is more sustained and meaningful GDP and IP growth takes root and consumers' fears abate.

As and when such growth resumes, we are confident that our North American business will again generate significantly higher earnings and return on capital, particularly as higher volumes absorb some of our production costs and in the context of our technology investments that continue apace.

Utilizing our global market intelligence to advance and defend our market position, we continue to exercise judgment about the timing of ferrous scrap sales in the face of periods of acute trading illiquidity. This may exacerbate earnings volatility until such time as normalized trading conditions return.

In late August, as you may recall, we reported tough conditions for scrap flows, particularly in North America, as well as sluggish ferrous export markets through the end of August though we also stated at that time that we expected ferrous export markets to improve in September. That expectation was realized, but proved fleeting as the deep sea market idled again at the end of September.

We satisfied available export demand at adequate margin, but recognizing our long-term focus and expectations for better markets, particularly against a relatively tight market in terms of scrap generation, we shipped approximately 500,000 tons less scrap than we purchased in our first quarter. Ferrous scrap prices declined at the beginning of October, but have since moved higher.

I would caution investors not to take a simple view of an estimated long ferrous position by isolating a September 30th cutoff with the benefit of a look at our sales contract position, which for obvious competitive reasons we will not share this morning. We will go this far however. We are comfortable with our position in the market and are watching the recently improved ferrous markets with how should I say it, "keen interest."

In North America, against the backdrop of constrained material flows and even in the face of inconsistent demand, we continued to advance and defend our leadership position. Our coastal facilities performed relatively well but our inland domestic-focused yards and our bulk stainless division encountered significant, and I mean significant, headwinds. Though our North American metals business operated at a small operating loss in our first quarter including a negative contribution from our SA Recycling joint venture, our electronics business in North America performed well.

During our first quarter, we recorded 5.5 million Australian dollars of unrealized losses from hedge contracts in North America. Please note that this mark-to-market loss will reverse when the physical inventory ships.

Our Australasian metals businesses performed well in the quarter, though we note operating income in this segment was also reduced by unrealized hedging losses on metals contracts of approximately 5.3 million Australian dollars. The unrealized hedging losses primarily relate to losses on contracts that arose from higher copper prices, though again this will reverse when the physical shipments are made. Our fiscal 2011 capital investment program, primarily related to the installation of advanced downstream technology, non-ferrous recovery systems if you will, has made solid progress and continues on schedule.

Our European business performed well despite tougher conditions that impacted the earnings of our ferrous metals business. Our Sims Recycling Solutions business once again delivered strong results in the first fiscal quarter. SRS earnings increased significantly relative to the prior corresponding period, but did not quite achieve the level of profit of our strong fiscal fourth quarter.

Further, we are excited about the future prospects and integration of our recently completed acquisition of Wincanton PLC's e-recycling assets in the U.K. and continue to evaluate other SRS acquisition opportunities across the globe.

Our recently released Annual Report we've dedicated to what we believe is the most important piece of advanced technology that we have in our company, our people. Together with our unrivaled global footprint and financial strength, Sims Metal Management has a distinct competitive advantage and we look forward to capitalizing on growth opportunities available to us in the remainder of our 2011 fiscal year and beyond. Such growth is being explored across all geographies and all business lines, as evidenced by our announcement earlier today regarding an agreement to purchase the assets of CMRS in Queensland.

Now, Rob, I'll ask you to take them through the financial results for the quarter.

Rob Larry

Thanks, Dan and greetings to everyone on the call today. I would like to provide a brief overview of our financial results for our first fiscal – first quarter ended for fiscal year 2011, which just ended 30, September 2010.

As a reminder, Sims Metal Management is domiciled and maintains its primary listing in Australia and all dollar figures that we will speak to are in Australian dollars today, unless we otherwise note.

Sales revenues for the first three months ended 30, September 2010 was 1.88 billion Australian dollars, up 4% on the prior corresponding period. This resulted in a net profit after tax of 8.2 million Australian dollars, which was down 75% on the prior corresponding period. Basic earnings per share was 0.04 Australian dollars per share, down 78% on the prior corresponding period. EBITDA for our first quarter was 51.2 million Australian dollars, down 44% on the prior corresponding period, while EBIT was 16.7 million Australian dollars, down 69%.

In the first quarter of fiscal 2011, the company's scrap purchases were 3.4 million tons, while our shipments totaled 2.9 million tons. This compared to 3.6 million tons purchased and 3.4 million tons shipped in the prior corresponding period; was also down 6% and 22%, respectively, sequentially as compared to the fourth quarter of fiscal 2010.

Now, let's turn to our regional results. In North America, sales revenue in the first quarter of 2011 was 1.2 billion Australian dollars, roughly the same as in the prior corresponding three-month period. On a U.S. dollar equivalent basis, sales revenue was up roughly 5% to $1.1 billion. EBIT in North America was a loss of 3.6 million Australian dollars.

Tons shipped during the first fiscal quarter ended 30, September 2010 decreased by 19% to 2.1 million tons compared to 2.6 million tons shipped in the prior corresponding period. Scrap intake in North America decreased by 7% to 2.6 million tons as compared to 2.8 million tons in the prior corresponding period. Intake and shipments declined 7% and 30% sequentially in North America from our fourth fiscal quarter of 2010.

Moving now to our Australasian financial results in our first fiscal quarter, sales revenue was up 12% to 342.6 million Australian dollars on the prior corresponding. Scrap intake and shipments were 425,000 tons and 451,000 tons, respectively, a decrease of 3% and an increase of 7% versus the prior corresponding period.

In Europe, our sales revenue was up 28% on the prior corresponding three-month period to 356 million Australian dollars. EBIT in Europe was 12.3 million Australian dollars. The European segment derived a significant portion of its profit during the first fiscal quarter from continued solid performance at the SRS business. Scrap intake and shipments were 369,000 tons and 347,000 tons, respectively, a decrease of 4% and 8% versus the prior corresponding period.

As of 30, September 2010, the company had a strong balance sheet with net debt balances of approximately 96 million Australian dollars, representing only approximately 3% of total capital.

With that brief overview, I would like to turn the call back to Dan for some closing remarks today.

Dan Dienst

Thank you, Rob. Let me give you a quick overview of market conditions, make some additional comments, and then we will go with the remaining time to Q&A. I remind everyone that this is an interim results update call and not a half year or full year.

Ferrous markets initially declined and then bottomed, and firmed in October and should trade sideways to high over the balance of our second quarter. General tightness in scrap availability, especially in North America, could result in seasonally higher selling prices with the onset of Northern Hemisphere winter, especially in the important deep sea ferrous scrap markets, but we do not expect to encounter significant price volatility over the balance of this half-year period.

Additionally, sustained weakness in the U.S. dollar could support higher deep sea ferrous scrap prices in the near term, particularly for U.S. generated material. However, until ferrous demand becomes more consistent, we expect to see continued volatility in the intermediate term beyond our second quarter. The non-ferrous markets remain liquid, pricing relatively firm, and the company remains readily able to market and ship this material.

As we said in the release, given broad uncertainty as to future economic conditions that affect our business and more specifically, continuing weakness in scrap generation across North America, we will not provide quantitative or more specific guidance at this time.

One final observation I would make before we go to Q&A is that our strategy remains unchanged and we remain steadfast in our execution of the same. This is not a time to get into a fetal position and retreat from the opportunities and challenges in front of us.

To refresh your recollection, we continue to invest in the efficiencies in our operating yards and facilities; we continue to seek accretive external growth opportunities across all geographies and all business lines; we continue to invest in leading-edge technology as it relates to metallic and non-metallic value capture; and finally, we continue to nurture, invest, attract, and retain the best and brightest in our industry, all of which leads us to be optimistic about longer-term meaningful shareholder value creation.

Our company, or should I say your company, has a history of emerging the depths of the economic cycle stronger than when it entered it. This basic tenet remains unchanged and there are 5,600 people across 23 countries, five continents, and 230 locations that are working hard and safely every day to ensure this result.

Now, we will turn the call back to the operator and we will take some questions as time allows. Richard?

Question-and-Answer Session

Operator

We would now begin the question-and-answer session. (Operator instructions) Our first question comes from the line of Dirk Glover from Canaccord. Your line is now open. Please go ahead.

Eric Glover – Canaccord

Hi, good afternoon. Can you hear me?

Dan Dienst

We sure can, Dirk. How are you?

Rob Larry

Eric.

Dan Dienst

Oh, Eric.

Eric Glover – Canaccord

Yes. I was just wondering if you could remind me what percentage of your overall ferrous scrap actually comes from what you would consider to be Midwest assets.

Dan Dienst

Let me answer that slightly – I'll give you directionally how we look at it. For yards in North America that are principally what we would call the domestic-in-focus, meaning buying and selling domestically largely. And of course, there are opportunities where there are ability to take scrap offshore from remote locations, but directionally and generally, think about that business as being 20%, 25% of the North American tonnage. So you are talking about –

Eric Glover – Canaccord

Okay, great.

Dan Dienst

Yes, yards from the upper Midwest, downriver through we call the Mid-south as we reach down into Texas.

Eric Glover – Canaccord

Okay, great. And then secondly, could you explain why the SA JV recorded a loss for the quarter?

Dan Dienst

Some of it is competitive and some of it is timing. When ships were going, that is a market – as you know, the California economy is probably as acutely impacted by what we are seeing in the States for our business as any place on our map. Unemployment there, as you know, runs at percentage points higher than the national average. We have structural challenges there that we are addressing as it relates to containers and former customers who are shipping around us. That's been a theme you've heard from us for a while.

So, you have a combination of when we came to market, when shipments were made, but also some very pronounced structural issues as it relates to the state of economy around those assets and ground zero, if you will, for the inflow of boxes into the States.

Eric Glover – Canaccord

Okay. Thank you very much.

Dan Dienst

Thanks, Eric.

Operator

Your next question comes from the line of Andrew Gibson from Goldman Sachs. Your line is now open. Please go ahead.

Andrew Gibson – Goldman Sachs

Hi guys, just a few questions. First of all, if you could just clarify so there were no – not necessarily any timing issues on shipments from Q1 that will be made up in Q2? But I guess, more importantly, just looking at your intake versus shipments over the last few quarters, it looks like you've had a buildup of around, let's say, 900,000 tons or thereabouts, and historically you've talked about you know sort of matching the market, so you forward sell and then you collect and deliver into that.

I'm just wondering has there been a change in your strategy there, so you are now more willing to take a view on where you see the market going in a future period and build stock into that? Or is that just something that you are doing given the current state of the economy and going forward you'll sort of may revert to more closely matching the timing of shipments and intake? So that's – I guess, that's the first question.

And the second question is just on margins. You noted in the release that export demand was achieved at adequate margins. So was it really the Midwest that hurt the performance in the quarter? And then, finally, if you could provide a little bit of a feel as to maybe what the e-recycling business earned in the quarter?

Dan Dienst

I'll handle the first two. Rob, you can jump in on SRS. So I mean, let's talk – I mean, probably the biggest question around this call, for everybody sitting on the call, is the mismatch inbound and outbound results.

I want to tell you in direct response to your question that culturally, we really have not changed from our sell-and-repent mentality and historically, if you go back and listen to what we've said, we have historically been desirous of being as liquid as the market will allow us to be. And so if you could isolate out what you can from this data, the inbounds and outbounds, say, on non-ferrous, which remains an extremely liquid market, would perfectly match or as close as you could be on non-ferrous.

Because of course, our size and scale, which you also noted in your question/observation, there are times candidly when we are too big for the market and we have to be very careful, times when we have this market intelligence that comes to us where we exercise some judgment around what we are hearing and seeing, be it inventories, a finished deal billet, scrap on dock, scrap in ships and sort of shame on us if we don't exercise that judgment, that focus clear [ph] to us.

This is an interim results call. I'm not going to tell you that we are 900,000 tons unexposed. I cautioned in my opening comments that don't jump to easy math, I know that's what (inaudible) our sales contract looks like and timing of shipments and the like. Clearly, that has a big impact on net where we are today commercially and also we are not going to disclose that as well.

You can take – there isn't a lot of balance sheet data on the interim results that we put up for the three-month period. You get that at the half year and full year, but you can see there has not been an enormous balloon-up of debt attendance [ph] with that as well.

So, as I said, we are pretty comfortable with where we sit in the market, what we are seeing in the market, we want to continue to be as liquid as the market will allow us to be, but there is a fair amount of time-to-time illiquidity where it would be reckless, if not stupid for us to force material into the market, particularly when our bias is against such constrained scrap flow generation here in Europe that the material is not overhanging the market where there would be a huge concern. That would be our bias, to be as liquid as the market would be unless it's not that liquid. And then we will make some judgment calls as to whether we want to force material into the market, force it down or we see a trend that gives us a little more comfort.

The second one, as it relates to margins, particularly in the interior ports of the U.S., we are struggling for volume still in those markets. As you isolate the map of our North American assets and in certain cases, parts of the U.K., and you look at the economic devastation in some of these markets, it should be no surprise to draw – connect the dots, if you will, that some of these regions are – continue to be challenged.

As I noted in my opening commentary, densely populated markets that have outperformed in sort of a ferrous major contest as it relates to macro or regional macroeconomic conditions, particularly on the coast, continue to perform well, produce meaningful cash flow for us, but is dragged down a bit by some of these interior places where we operate.

As it relates to the SRS numbers, do you want to give them a buildup for the third question?

Rob Larry

Yes. I guess, Andrew, more generally speaking, as you know, half year and full year, we will give you the EBIT by product, as well as the sales by product so you will get a – I guess, a clearer picture of half year and full year.

What we've said in the release is that Q1 SRS did well. We specifically said it did better than it did in the prior corresponding period, but we also said that it didn't do quite as well as it did in the very strong Q4. So sequentially, the earnings were down relative to Q4. So, without telling you what the EBIT was in the quarter, I guess maybe this will be helpful. I think the operating margin at the EBIT level was around 11% and I think last year we were about 13% or something like that in the SRS business.

Andrew Gibson – Goldman Sachs

Thank you.

Operator

Our next question comes from the line of Emily Behncke from Deutsche Bank. Your line is now open. Please go ahead.

Emily Behncke – Deutsche Bank

Great, thank you very much. Good morning. I was just – I've got a couple of questions, I guess further to Andrew's question on the discrepancy between the volume – the intake and the purchases. I guess, I think in March, you guys have described the inventory as sort of you are taking a bit of a view on price and in June it – that you characterized that as the market sort of turned and you thought it would be more prudent to hold on to the tons.

I'm just wondering if you can provide some color as to what – what's happened in the September quarter, firstly. And I guess secondly, on the margin side of things, I think – I was just wondering if it was really the average cost that was a lot higher and you would expect that to reverse as costs came down in the September quarter? I'm just wondering if you would expect margins to look a little bit better in the second quarter.

Dan Dienst

Okay. Yes, as it relates to the margin, September, I guess our view, position as it relates to what's happening in the market and liquidity around that, you aptly noted that in the March period, it was probably a decision that agreed in information; June, it was more out of need and the liquidity; and I characterize September as probably a hybrid. So we had multiple, many markets within that period, so it's probably a culmination of both.

As it relates to margins, too early to tell. I would expect better margin for the interior assets as we head into this next or second fiscal quarter, cognizant, however, this flows around the holidays and if weather sets in quickly and we don't get the volume, you know all bets are off. That's the best way I can answer that.

Emily Behncke – Deutsche Bank

Great. And you are comfortably – has your share position remained constant or would you say that you have increased or decreased or maintained your share?

Dan Dienst

I'd say we maintained or increased in many markets and that's conscious and some of our trading position, if you want to characterize it that way, is directly related to our thoughts about how we want to position ourselves in certain markets.

Emily Behncke – Deutsche Bank

Thank you very much.

Dan Dienst

Thanks, Emily.

Operator

Your next question comes from the line of Sam Haddad from Baillieu Stockbroking. Your line is now open. Please go ahead.

Sam Haddad – Baillieu Stockbroking

Hi, Dan. Hi, Rob. Just wanted to get more idea in terms of volume growth that you are seeing in your SRS business in North America, given there's been some recent new instruction of e-waste legislation from States. Are you starting to see a step-up in volume growth in that business?

Dan Dienst

Yes. I mean, we are seeing at SRS, as you look at a – if we characterize the traditional metals business in terms of growth in sort of the gangly teenage years. You have heard us say before that SRS globally is really in its sort of toddler – infancy, plenty of opportunity, again across all geographies for that business.

As it relates to your question, in North America we continue to grab volume, sensible volume. We are learning a lot about that business, we continue to refine some of the operating practices in that business and some technology investments to make us increasingly more efficient in that business, and we are barely scratching the surface in getting started on leveraging the enormous infrastructure we have in the traditional metals business and the footprint we have coast-to-coast in the traditional metals business in North America and starting to, in certain markets, build out an SRS competency in markets where we currently don't exist. So, very excited about that opportunity, we are just getting started.

Sam Haddad – Baillieu Stockbroking

Okay. And just a question on your inventory management, once again, is there an upper limit in terms of how much inventory you are willing to hold in terms of tonnage before you start to wind down intake levels?

Dan Dienst

There is. I mean, we are not, and you may disagree with this, cowboys per se. We in earnest want to turn our inventories and our capital. We are trying to make some smart decisions in this very peculiar market. Not that you need a history lesson, Sam, but – I know you don't, but the history of the commodities business and the scrap business has been one where our business has been hurt by oversupply.

If you go back – and you've probably heard me say this before, if you go back and study the pattern of devastation and carnage in our business, it's usually been around a strong U.S. dollar and some crisis or crises around the world; a rouble crisis, an Asian currency crisis, and materials flooding the market, depressing prices, too much material.

We are in a very different market, as I said earlier in response to Eric's or Andrew's question. You've got – we are about 180 degrees in those kind of economic pattern. So, we've got a weak U.S. dollar, you've got to go figure the U.S. as the bias of infection for the global economic devastation that many sidestepped. Some have recovered from and the U.S. continues to struggle with and U.K. is starting to show some signs of life, but not quite there yet either.

You are 180 degrees from the oversupply situation where you have a tentative demand, tentative economic activity, and wickedly diminished scrap availability. And against that backdrop, it gives us some comfort to make these judgment calls. And the flipside of that obviously is we are a relatively big company, perhaps not a BHP certainly, but for our industry, relatively big. Everybody watches us. Sometimes as you've heard me say and I said earlier, we are too big for a market and sometimes we are too small for market, which is sometimes very opportunistic. In markets like these, we should be very careful in these thinly traded markets, to use I guess a term from Europe – your neck of the woods, to be very careful how we move material, how we place them.

Again, the bias against the tightness and what we see coming into the yard, that we see coming into competitors' yard, we see being generated by an economy, particularly in our biggest mine if you will – above-ground mine in the U.S., the generation of material based upon economic activity is not yet strongly rebounded and we expect continued tightness in the materials that we handle, particularly out of that market.

Sam Haddad – Baillieu Stockbroking

And so, with the level of demand at hand, are you willing to place a number in terms of tonnage that you are – your upper limit of tonnage that you would prefer not to hold above in terms of inventory levels?

Dan Dienst

Right. We have that number, I have that number. But it's not a number I'm prepared to share.

Sam Haddad – Baillieu Stockbroking

Okay. And finally just further detail, in terms of non-ferrous demand, you talk about it being – remaining liquid, but can you comment on the demand for non-ferrous?

Dan Dienst

Yes, the demand – when I say liquid, it means we have – as we generate materials in each of our regions, we can sell every pound as quickly as we generate it.

Sam Haddad – Baillieu Stockbroking

Okay.

Dan Dienst

So, the demand is there. The demand is broad-based, but particularly strong as you would expect in Asia, but also in foundries throughout Europe and in the States. So those who survived and are running their plants want material and we are certainly happy to supply it. There are obvious – some challenges as it relates to generation of material, because the same macro factors that curtails scrap generation in the ferrous business, certainly in the acutely challenged macroeconomic markets, you have diminished non-ferrous generation as well, as well as we diminished non-ferrous generation through the shredders, we call zorba, as you have diminished flows through those shredders and diminished mix (Multiple Speakers) – very responsive.

Sam Haddad – Baillieu Stockbroking

All right, thank you.

Dan Dienst

All right, thank you.

Operator

Your next question comes from the line of Scott Hudson from CLSA. Your line is now open. Please go ahead.

Scott Hudson – CLSA

Yes, hi. Thanks, Dan and Rob. But just a couple of questions. I was just wondering how you view your outlook and how it appears, I guess, relatively positive, any differences from what we are hearing from the likes of Newcore and U.S. Steel. I mean, their obvious operating environments are looking pretty tough. How do you reconcile the demand coming from that sector versus I guess, your outlook for the second quarter?

Dan Dienst

Yes, I think that's a great question, Scott. I think – and it really helps draw the illustration to some of the earlier questions as it relates to the challenges in particularly landlocked U.S. assets. And when I say landlocked, I mean without access to oceans for export.

Putting U.S. Steel aside and say the Eastern European assets, as you look at – and I haven't had a chance to spend a lot of time because I've been traveling – on their results, I guess yesterday or last night your time, what you are hearing from the Newcore's of the world, what you are hearing from the U.S. Steel's, a little bit more optimism I guess from what I saw in the headline numbers and commentary from AK Steel is that you have a U.S. economy that remains extremely challenged.

Some of that is fear that continues in the market, some of that relates to political uncertainty, which is certainly above my pay grade. But in terms of capital formation, investment, are people willing to open purse strings in the face of elections that are coming and a perception that the U.S. government is currently not particularly friendly to business, all those compounding the recovery.

So, I think if you line up the Newcore's, the U.S. Steel's, and what you are hearing from them as they limp into what is there fiscal fourth quarter or calendar fourth quarter, there are – it lines up pretty well with what you've heard us speak to on some of our domestic U.S. focused assets.

Scott Hudson – CLSA

And how are you seeing I guess the demand outlook? Obviously it's very weak in the U.S. How is it looking, I guess, across the other regions?

Dan Dienst

On the regions, as I said earlier, I mean, the U.K. seems to be taking some of their medicine and then people are buying into it. So you are seeing some signs of life there. I think seasonally as you work through the winter, people are slightly more optimistic for the prospect of next calendar year for that economy, which obviously is a big business for us. Europe seems to be a lot better than it was, say, nine months ago, sentiments are – I'm not going to say have turned, but certainly better than they were.

As it relates to the Asian economies that we do business with every night, every day, demand remains pretty good. Obviously, some of the liquidity constraints that the Chinese government is laying on and some bubble-bursting prevention methods that you see coming out of China, be it power curtailments, be it real estate, it certainly has a psychological impact. We don't see it in the non-ferrous business, but we do see some of that whipping us around the ferrous business as the Chinese come in and out. And as I say that, as you've heard me say in the past, the Chinese tend to come in with a broadly big economy, coming to the deep sea ferrous scrap market opportunistically.

Scott Hudson – CLSA

And I guess just two more questions. Firstly, the demand in the mid and I guess the potential restocking coming out of Turkey.

Dan Dienst

Yes. I mean, what are seeing now is a fair amount of market making going on. So quite period is behind us, we have a sense that it needs to be bought. Clearly, still some uncertainty as it relates to billet and rebar sales, coming out of the other side of the knolls there, but a fair basis for dialogue and some trading perhaps.

Scott Hudson – CLSA

That's great. I mean, just the last question that's for Rob. In terms of the hedging losses that you've highlighted in the report, is that a pre or post tax number that you've recorded there?

Rob Larry

Pretax.

Scott Hudson – CLSA

Pretax?

Rob Larry

Yes.

Scott Hudson – CLSA

Perfect, thanks.

Operator

Your next question comes from the line of Todd Scott from Royal Bank of Scotland. Your line is now open. Please go ahead.

Todd Scott – Royal Bank of Scotland

Thanks, guys. I thought I'd throw in just one more question on scrap inflow and inventory levels. Your intake volumes seem to be a lot less volatile than your sales volumes over the last couple of quarters. Do you expect to try to keep that intake level flat going into the December quarter, I guess, especially considering you probably want to build some inventories going into the winter season?

Dan Dienst

What – I'd look that, Scott, and be a little bit careful. You know we have yard cons and then we have what we call third-party opportunistic buyers cons, right? So we are constantly in the market – and sometimes, we are the market – market maker if you will, let's say in North America as the domestic U.S. mills back out, we may step in and buy third-party processed scrap. So those tons aggregate up on the inbounds too, not just tons coming into our yard, but also positions we may take on the river, on the rail system, from other processors out there.

So we wouldn't, per se, say have a target that we are trying to hold 3.5 million, 3.6 million tons. We are going to do it on the basis of perceived opportunity to monetize those tons with decent margin in them. Does that make sense?

Todd Scott – Royal Bank of Scotland

It does. Would it be fair to say still though that you expect to see less volatility in that inflow number?

Dan Dienst

Generally, yes. But you have seen us in periods do a couple of hundred thousand tons, less than that number. So again, it's going to be opportunistic, our views on the market, our views on how to procure that material, transportation liquidity. So a lot goes into that decision. So I don't want you to hold me to we are going to – a 3.6 number. We running, bouncing along as you know, around 3 million to 3.5 million tons a quarter and you've heard us talk about those incremental swing tons, the ones that are unloaded in ships and what a difference it makes in our business.

Todd Scott – Royal Bank of Scotland

Fair enough. In the first quarter, obviously a tough margin environment, trying to get a feel for how much was impacted by what looked to be average lower prices over this September quarter than the previous quarter. How much you think was more related to the volume impact versus a price impact and the relationship with potentially higher cost inventories held over into the quarter?

Dan Dienst

It's a good question. As you think about – let's take a look, it's the June-end period. And Rob, correct me if I'm wrong here. We probably had about just sigh of 20 million Australian dollars of inventory write-downs or adjustments, principally related to the ferrous book at June-end, which is already baked into those June numbers. We haven’t given a lot of data on the – but to give you an illustration and hopefully answer the question, we probably had directionally in September maybe 1 million Australian dollars of inventory write-down of ferrous –

Rob Larry

Less than 1 million Australian dollars.

Dan Dienst

Less than 1 million Australian dollars, ferrous. Hopefully, that gives you directionally some comfort that it's probably more volume than, say, we over-bought at higher price.

Todd Scott – Royal Bank of Scotland

That's fair. I guess then what I'm trying to get a feel for is, if we assume that prices and volumes stay relatively flat from here, can we expect the same type of margins that we saw in the last quarter?

Dan Dienst

From here, meaning today?

Todd Scott – Royal Bank of Scotland

Yes, over the December quarter.

Rob Larry

And again, assuming that the shipments are the same too, at 2.9 million tons. Is that what you are saying?

Todd Scott – Royal Bank of Scotland

Well, I guess just on a margin level, not overall EBIT.

Dan Dienst

If you add market conditions today or as we expect through the December quarter that they play out, you would see better margins.

Todd Scott – Royal Bank of Scotland

Significantly? I am getting pedantic here but just trying to get a feel.

Dan Dienst

Yes, I know and you know we don't give guidance or anything like that. So then we will get into defining significant. So I've given you better, so leave it at that.

Todd Scott – Royal Bank of Scotland

Okay. And then just one last question from me. We've seen now acquisitions in SRS and some yards in Australia in the last year. So we haven't seen anything in the U.S. ferrous space, which seems to be a targeted market for yourself for acquisitions. Can you give us a feel why we haven't even seen bolt-ons in that U.S. market?

Dan Dienst

I mean, don't forget. We did do ferrous in South Jersey – mid-South Jersey at the beginning of fiscal year, heading into last fiscal year. We continue to look at a lot of opportunity. I don't want anyone to think for a second that because the U.S. is relatively underperforming that there are not tremendous opportunities there. Fortunately or unfortunately there's no rush. If we thought the market was recovering, you might see us move real quickly. But we are looking a lot of stuff, we are trying to be very smart and we are not missing anything.

Todd Scott – Royal Bank of Scotland

Okay. That's great. Thanks a lot for your time.

Dan Dienst

Thanks, Todd.

Operator

Your next question comes from the line of Michael Slifirski from Credit Suisse. Your line is now open. Please go ahead.

Michael Slifirski – Credit Suisse

Thank you, I've got a couple of questions. First of all, could you phase out the difference between your U.S. business and that of Schnitzer and how much of the differential performance is related to scale, trading philosophy, end markets served, and period timing? And then with respect to scale, are you now too large for prevailing markets?

Dan Dienst

Good question. Let's handle in order. We – I think we've gotten that question once or twice in the past, but I'll do it again. We have a different mix of businesses, we have different geographies. If you isolate, let's say, just the ferrous business, our coastal businesses are performing well and in time, okay, is best we can tell from the limited time we take to review those results.

The Inland assets we've talked about are a different breed right now and some of the tenants of the Sims-MM merger, as you recall, with the balance in the portfolio, sometimes export does well, sometimes domestic does well. Right now, domestic is not doing well, okay? We are not going to say it any other way.

We also have other businesses. Our non-ferrous businesses do very well. Our stainless business has been lumpy and challenged as we noted in the current quarter, it's a fairly significantly sized business for us. We have an aerospace business that we fill aircraft build right start pumping back up. People in airlines start – stop parking planes and start buying planes, so that business will continue and counter headwinds. So we have a different mix of businesses to a certain extent. Our coastal export yard in the U.S. probably looks pretty similar.

Scale, your second and third questions are really related to each other. And I've said it time and time again. In this very bumpy at time, at times illiquid, thinly traded market indeed, we may be too big at times, okay? And that will self-correct. I mean, we've seen the other side of it when the market is raging and prices are high and the ability to grab materials through the yard or through opportunistic brokerage buys are there. The leverage in the business is extraordinary. We just happened to be at a point in the cycle where we have to be very careful.

Michael Slifirski – Credit Suisse

Secondly, what is your physical capacity to carry inventory in terms of available yard real estate? And are you now carrying and funding inventory that more normally you would expect your customers to do?

Dan Dienst

It's another good question. One of the things that you hear us speak to all the time and I know a lot of people think it's just mere CEO speech, so I don't necessarily direct it to the investment community, do invest – direct it to our employees who listen is, the SHAC or safety and health aspect of our business. We are very concerned always about pile heights, how we store material, how we stage it for loading ships, barges, railcars, and we intend to continue to do so. So as we trade or make a trading decision if you will, those marginal judgment calls on tonnage, we are very cognizant of not just the physical limitations of storage space, but also the safety elements around that.

Michael Slifirski – Credit Suisse

Okay. And a question I don't think you'll answer, but I'll ask anyway. If demand was adequate, could you liquidate your inventory now at profit?

Dan Dienst

Yes.

Michael Slifirski – Credit Suisse

Thank you. And finally, maybe for Rob, can you explain the unrealized hedge loss and why that will reverse?

Dan Dienst

You weren’t surprised that I answered it?

Michael Slifirski – Credit Suisse

Congratulations, I'm delighted.

Dan Dienst

All right, thank you.

Rob Larry

Michael, on the hedge losses, they are contracts that we put in place, which we mark to market at the end of a fiscal period, because they are efficient hedges as the accounting rules work. And so we have marked a loss against the future sales on the contract and the physical gain that will come when – against those contracts when the material ships. So, we will have a physical gain, which is a different period, different fiscal period than the hedge loss because of the mark-to-market accounting required.

Michael Slifirski – Credit Suisse

Okay. So it doesn't relate to an intended volume that didn't get shipped? It's just that the period-end mark to market rather than an overhang of surplus hedging that wasn't required because of lower volumes?

Rob Larry

That's correct.

Michael Slifirski – Credit Suisse

Okay, fine. Thanks, great. And then very finally, the SRS, you commented about the consecutive result being similar but a bit weaker than the fourth quarter for SRS. What did it look like in U.S. dollar terms given that the currency, the A dollar was clearly a headwind in terms of translation?

Rob Larry

It was – at the balance sheet date. So at September 30th, we had about $0.97 exchange rate that we used for the balance sheet. For all of Q1, our average exchange rate that went to the P&L was about $0.90, which is fairly steady with where we have been for the last three quarters. So the P&L effect, I think of the recently strong vary A-dollar [ph] against the U.S. dollar, while it affected the balance sheet, it really wasn't that unusual or extraordinary to the P&L.

Michael Slifirski – Credit Suisse

Okay. Thanks very much.

Dan Dienst

Thank you, Michael.

Operator

Your next question comes from the line of Andrew Gibson from Goldman Sachs. Your line is now open. Please go ahead.

Andrew Gibson – Goldman Sachs

Hi guys, just a follow-up question. You referred to the fourth generation technologies. If you could just expand on that a little, please?

Dan Dienst

So, we are keenly focused, as you may have heard us say in the past, about non-metallic. And we are touching non-metallic plastics and the like in many of our operations, SRS, through the shredder, through the New York City recycling contracts where we had a nice ceremony with the Mayor on Monday in New York. So, the next generation, particularly as we look at escalating landfill costs in Australia and the U.K., higher energy costs into the grid, plastic values that's the next adventure for us if you will in terms of creating commodity space.

Andrew Gibson – Goldman Sachs

Okay, thanks.

Operator

Your next question comes from the line of Tony Mitchell from Ord Minnett. Your line is now open. Please go ahead.

Tony Mitchell – Ord Minnett

It's actually Ord Minnett. Good morning, good evening to you. Just talking about SRS, is it – given the position you've got in the market, is it likely that – I mean it is your policy to build up that area through acquisitions over the medium term?

Dan Dienst

Well, we are – I would expect that the growth opportunities for that business over the next few years eclipse perhaps, I'm not going to say by a multiple, but significantly the opportunities to grow the traditional business on a same-store basis if you will, on or footprint basis.

Tony Mitchell – Ord Minnett

Right.

Dan Dienst

So, very excited about the prospects of that business.

Tony Mitchell – Ord Minnett

Okay. Okay. And Just apart from the unrealized losses you have mentioned there, what was the overall currency translation impact of the first quarter result in terms of EBIT and EBITDA?

Rob Larry

To the P&L, the exchange rate was fairly steady with the P&L exchange rate we've had for the last three quarters at about 0.90

Tony Mitchell – Ord Minnett

Okay.

Rob Larry

So, it wasn't that significant to the P&L. The balance sheet priced at, I think, 0.97 because that was at 30, September.

Tony Mitchell – Ord Minnett

Okay. All right, okay. All right, thanks very much. Thank you.

Dan Dienst

Thanks, Tony.

Operator

Your next question comes from the line of Michelle Applebaum from Steel Markets. Your line is now open. Please go ahead.

Michelle Applebaum – Steel Markets

Hi.

Dan Dienst

Hi, Michelle.

Michelle Applebaum – Steel Markets

I wanted to bring up something and forgive the steel-centric and the domestic-centric question I'm asking here. But we've been on the steel side hearing all about the Thyssen mill starting up in Alabama and what it's doing to the domestic sheet markets this last couple of weeks. And so I was actually thinking, isn't the importation of 4 million to 5 million tons of slabs that are made in another part of the world into the U.S. market, especially because the product is going to eventually end up in a car, some made around here, some made in other places. Isn't that actually a really good thing for the domestic scrap business ultimately?

Dan Dienst

I mean, ultimately, if you take a very Darwinian view of how this market will evolve and you have more actually said this than us certainly, but what – where will that impact be most acutely felt? Will it be on the scrap-based users of steel or will it be on the integrated producers who are obviously highly dependent upon automotive quality, sheet –

Michelle Applebaum – Steel Markets

I'm asking you a different question.

Dan Dienst

Okay.

Michelle Applebaum – Steel Markets

I'm sorry, I'm trying to find a silver lining here, because if 4 million – 4 million to 5 million tons of slabs that are made somewhere else out of raw material virgin metallics come into this country and they are rolled into cars, six, seven, eight, nine, 10 years later that will be ferrous supply. And one of the reasons I think there has been less scrap in this country and more of a press to find it has been less imports.

Dan Dienst

Yes. No, I understand the question, Michelle. I'm looking at it a little bit differently and maybe –

Michelle Applebaum – Steel Markets

Oh, you are answering the other part of the question.

Dan Dienst

I'm answering the other part of the question. If you look at the landscape of North American steel production over the next 10 years, what will it look like? Now, we all know it's very hard to kill steel production almost anywhere. And so even –

Michelle Applebaum – Steel Markets

It's hard to what? Damn hard to kill?

Dan Dienst

Kill, make steel production –

Michelle Applebaum – Steel Markets

Capacity?

Dan Dienst

Kill capacity. So even through this carnage of the late '90s, beginning of 2000's when you saw it, maybe we lost 5 million tons of nameplate capacity in North America.

Michelle Applebaum – Steel Markets

Right, right. Yes, I was kind of there.

Dan Dienst

Right.

Michelle Applebaum – Steel Markets

We were both there, we were financing it.

Dan Dienst

We were all there. So, as you look back on that and look at the carnage of what happened in that period of time. But now, you've got a structural entrance into the market that's going to take on potentially the weaker and inefficient integrated production. And you are capable of figuring out who that is and what does leave in terms of the landscape. You probably create – continue the balance of scrap-based steel production and the dynamics of what's left of U.S. steel manufacturing probably favors the mini mills who are obviously scrap focused.

Now, as it relates to the generation of scrap, attending to that material coming in, the U.S. consumer will buy a car relative to its economic prospect, its comfort level, its financial ability – financing ability, and wherever that car is made, U.S. is a highly automotive dependent world, people love their cars and they will get those cars from wherever they can. And so I'm not necessarily buying into the slab from scrap, because ultimately those cars will come from somewhere as the U.S. consumer to be in love with the automobile.

Michelle Applebaum – Steel Markets

Yes. I mean I guess, I'm just looking at if you go back long enough when the U.S. consumer was importing most of his cars, we had the net balance of scrap in our favor than the '70s and most of the '80s. And then that reverted when the currency changed and we started making more material here.

So I was just making the point in a sheet market of 60 million tons, if you get 4 million, no matter who they replace really, it's metallics that is not going to be domestically sourced, which means more availability for someone else. And even if it ends up that the minis become a bigger percentage of the total it's not necessarily more demand for scrap, it's just less of the other replaced by imported slabs. Net-to-net, more availability of ferrous resources, no?

Dan Dienst

Potentially –

Michelle Applebaum – Steel Markets

We can finish debating offline. I was just trying to find a silver lining, because obviously availability of scrap in this country hasn't been too great.

Dan Dienst

Indeed, indeed.

Michelle Applebaum – Steel Markets

Okay, thanks. Great quarter, thanks.

Dan Dienst

Thanks, Michelle.

Operator

Your next question comes from the line of Scott Hudson from CLSA. Your line is now open. Please go ahead.

Dan Dienst

Richard, after Scott, we will take one more since we've started to get follow-ups.

Scott Hudson – CLSA

Just a quick one on currency, Rob. I don't know if you have a rule-of-thumb sort of currency impact for every one-cent movement in the U.S.-Aussie exchange rate.

Rob Larry

You know what? It's – we've looked at the effect on the quarter relative to the year-ago quarter. In the year-ago quarter, we had an FX rate of $0.83, which I don't know maybe more ordinary. And the effect on an FX rate of $0.83 was indicating to us about a 7% effect on profitability at EBIT – say at the EBIT level.

Scott Hudson – CLSA

So that's about a $0.07 move in the currency and a 7% impact on the –?

Rob Larry

Right.

Scott Hudson – CLSA

Okay. Perfect, thanks.

Operator

Your final question comes from the line of Emily Behncke from Deutsche Bank. Your line is now open. Please go ahead.

Emily Behncke – Deutsche Bank

Thank you. Just very quickly, just wondering, Dan, two quick questions, if the changes to the capital gains tax rules on January 1 will mean that there might be more acquisitions around in your view? And secondly, just wondering if the 400,000 tons at the end of the June quarter that you were holding on to, if that was profitable?

Dan Dienst

Okay. The first, you would have expected to see more flurry of activity I guess for the roll of cap gains tax in a more normalized profit environment. So I think that private families, what we've seen through the relationships we have with other businesses, perhaps more keen to trade to get away from that – the underlying performance of some of the assets that may seek liquidity, those deals are not getting done based upon the underlying performance of the business. So you would have expected to see more activity and I would have expected to see more activity around that, but candidly we have not.

The 400,000 tons, some of that went off profitably, some of it went off and we spun some capital to be candid. And I can't break down lot by lot, or you know, an average price such as how, nor will I where that material has traded at.

Rob Larry

We tested the June inventories, Emily, to the July market, which was down and then August moved higher and September moved higher. So to the extent that we shipped June inventories or before June inventories into the August and September market, by definition they would have been profitable.

Dan Dienst

Largely

Emily Behncke – Deutsche Bank

Great.

Dan Dienst

That is correct.

Emily Behncke – Deutsche Bank

Thanks very much.

Operator

There are no further questions at this time. Mr. Dienst, please continue.

Dan Dienst

All right. We thank everyone for joining us this morning. I appreciate the continued interest, I appreciate the good questions as always, and we look forward to seeing everybody down under at the AGM in November. Thank you, everyone and good day.

Operator

That does conclude our conference for today. Thank you for participating. You may all now disconnect.

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