Schnitzer Steel Industries F4Q07 (Qtr End 8/31/07) Earnings Call Transcript

Oct.29.07 | About: Schnitzer Steel (SCHN)

Schnitzer Steel Industries, Inc. (NASDAQ:SCHN)

F4Q07 Earnings Call

October 29, 2007 11:30 am ET

Executives

John Carter - President and Chief Executive Officer

Greg Witherspoon - Chief Financial Officer

Analysts

John Rogers - D.A. Davidson

Sal Tharani - Goldman Sachs

Eric Glover - Canaccord Adams

Jeffrey Cole - Cardinal Partners

Operator

(Abrupt Start)

…we need to remind you that the company's presentation anddiscussion today contain forward-looking statements subject to the Safe Harborprovisions of the federal securities laws including estimates of futureperformance and views on future market trends.

Actual results may differ materially from those projected inthe forward-looking statements. Examples of factors that could cost actualresults to differ materially from current expectations are listed in ourearnings press release issued this morning and are described in detail underthe heading factors that could affect future results and the management'sdiscussion and analyst section of the company's most recent quarterly report onForm 10-Q and most recent annual report on Form 10-K.

I would now like to turn the call over to Mr. John Carter,President and Chief Executive Officer. Please proceed sir.

John Carter

Thank you and good morning. Welcome to Schnitzer SteelIndustries' 2007 fourth quarter earnings webcast and conference call. I'mjoined on the call this morning by Greg Witherspoon, our CFO. After a fewintroductory remarks we will be available to answer your questions. We put outa press release this morning with the details of our fourth-quarter results.

Before we go through the highlights of the quarter andprovide you with our outlook for the first quarter and fiscal 2008 I'd like totake a few minutes to review 2007. We had another very good year, our sixthconsecutive year of record revenues. We increased our consolidated revenues39%. Operating income was up 12%, and earnings per share were up 9%, both havebeen adjusted for unusual items, which occurred in 2006.

At this point I'd be remiss, if I didn't acknowledge thecontribution of our 3,500 employees to this year's success, and I'd like topersonally thank each and every one for their hard work. During the year wecontinued to see the benefits of our uniquely vertically integrated businessmodel. Benefits we believe have continued to increase with our emphasis onacting as one company with a unified management team.

We've talked in the past about how 2006 was atransformational year for the company as we completed and integrated a numberof major acquisitions, which established the foundation for our future.

In 2007 we took that foundation and made it even stronger byinvesting in an infrastructure that significantly expanded our productioncapacity and allowed us to become more operationally efficient.

Our metals recycling business reported a 49% increase inrevenues and a 30% increase in operating income compared to 2006. Our ferrousprocessing sales volumes were up 1 million tons or 30% and our nonferrousvolumes were up 27%.

During the year we installed three new mega-shredders andupgraded our back-end nonferrous recovery systems. We now have four highercapacity, more efficient mega-shredders operating at our export facilities inOakland, Portland, Tacoma, and Boston. The higher volumes are primarily theresult of achieving our objective of working our assets harder by increasingour throughput.

As we continue to gain efficiencies from the investmentswe're making in technology our ability to compete for new sources of supply isbeing enhanced. We continue to leverage the competitive advantage provided byour access to deepwater port facilities and we took steps to improve ourability to reach the export markets through container shipments.

Throughout the year the demand for scrap metal around theworld was strong. Our sales remained diversified as we sold to 19 differentcountries including sales for the first time to Indonesia and for the firsttime in a few years to Japan.

We also continued our disciplined approach to strategicexpansion in the metals recycling business by completing three tuck-inacquisitions, which together will add about 300,000 tons of ferrous metalannually.

In what continues to be a consolidating industries we intendto remain an active player, focused on acquisitions, which meet our strategicobjectives while creating value for our shareholders.

Turning to the steel manufacturing business, we completedthe second-best year financially in our history despite higher cost for scrapanother raw materials used in the steel making process. Volumes increased 1%even with a five-week shutdown for capital projects, projects, which haveincreased capacity and improved efficiencies at the mill. As a result of these capitalimprovements annual capacity at the mill is now in excess of 750,000 tons.

In the auto parts business revenues increased by 22%primarily due to our emphasis on increasing the purchases of scrap vehicles andgetting more out of each vehicle. Purchases increased 6% despite verycompetitive market conditions and improved yields from the extraction of coreshelped offset expenses related to improving the information technology platformin this business.

The full-service distribution network also showed goodyear-over-year growth in operating income. In 2007 we demonstrated our abilityto effectively manage our shareholders' capital. Our return capital employedwas nearly 16%, well in excess of our cost of capital.

We put in place guidelines governing returns on capitalexpenditures that target an ROI of greater than 30% and a payback of less thanthree years, unless those projects were associated with safety, environmentalrequirements or equipment replacement.

Our strong cash flow and access to capital provided us againwith the opportunity to make prudent capital investments and value creatingacquisitions as well as return money to shareholders. During the year werepurchased 2.5 million of our shares, or roughly 8% of the total sharesoutstanding.

The fundamentals in all of our businesses remain strong. Thegrowing worldwide demand for steel products and the raw materials used by steelmanufacturers remain favorable to our business. We continue to believe that theworldwide focus on sustainability and recycling has made our businesses and ourbusiness model increasingly attractive.

We remain committed to achieving further growth both throughadditional acquisitions and organically through improved productivity andinvestments in technology. We’ve built a solid foundation for the future andintend to use that base to take maximum advantage of the positive environmentin which we are operating. Before we discuss in more detail our near-termoutlook, let us review the recently completed fourth quarter.

In the quarter all three of our businesses performed well,both operationally and financially. In the metals recycling business we remaincommitted to maximizing throughput and working our assets harder, thatcommitment was apparent as we produced and shipped record ferrous volumes. Twoshipments originally scheduled for the fourth quarter were delayed into thefirst quarter of ‘08 or the ferrous numbers would have been even higher.

We continue to be pleased with the results for themega-shredders installed earlier this year as well as the new advanced sortingsystems. As we said on our last call, early indications are that we areachieving roughly a 15% increase in nonferrous recovery from the shreddingprocess and as technology evolves we may be able to see further improvementsthere.

Nonferrous volumes were exceeded only by the volumes shippedin the third quarter of this year, which included about 5 million pounds ofZorba at our northeastern operations, which had accumulated during the firsttwo quarters of the year while the new shredder was being installed and testedat Everett.

Those volumes provided a boost to third-quarter earnings, aswe previously pointed out, and account for nearly half the decline inquarter-to-quarter earnings results for our metals recycling business.

The export markets for ferrous scrap continue to be strongas net prices remained at high levels, although slightly down from the recordprices achieved during the third quarter. Net prices for shipments off the WestCoast were stronger than those made in our other regions reflecting therelative strength of the Asian markets compared to the rest of the world.

Our sales remain diversified as we made bulk shipments tocustomers in 12 countries during the quarter including Turkey and severaldestinations in the Far East. We did see a weakening of prices in the domesticmarkets for ferrous scrap with the impact felt most heavily in our Southeastoperations. Buy prices for raw material declined except in the West where thecompetition for materials is more export focused.

Operationally, while the installation of the new Portlandmega-shredder was being completed we continue to run the old shredder tomaintain production volumes. This allowed us to meet our sales commitments butthe operation of two shredders contributed to an increase in conversion costsduring the quarter at that facility.

The old shredder has since been shutdown. As with the newmachines installed earlier this year in Oakland and Boston, the new Portlandshredder will take a few months before achieving the expected operationalefficiencies, but we like the progress that we've made so far.

Finally, we announced the acquisition of a metals recyclerwith two facilities in Alabama and Georgia. This acquisition furtherstrengthens our presence in the Southeast and will add about 65,000 tons offerrous scrap annually to our sales totals.

Turning to the steel manufacturing business, markets duringthe quarter remained strong and we achieved record net sales prices. As Imentioned earlier, we have been challenged by higher raw material cost for ourmill throughout the year, scrap, alloys in flux costs have all gone up.

During the fourth quarter the record prices more than offsetthe higher cost and our operating income improved sequentially. In fact,operating income was the third highest in our history exceeded only by thethird and fourth quarters of fiscal 2006. The auto parts business producedanother quarter of solid results; revenues were a quarterly record and our operatingincome nearly matched the record income of the third quarter.

Our emphasis on increasing throughput and getting more outof every vehicle resulted in higher scrap volumes and improved core yields.Along with the full-service sales that helped offset normal seasonal declinesand self-service part sales. On a consolidated note, I should point out that wewere impacted by a number of SG&A expenses that were booked in the quarterbut that we look at internally in the context of the full year or even longer.

Our consolidated gross margin was nearly level from the Q3to Q4, so the decline in operating income was largely related to these items,which Greg will describe in a moment. Now let me turn the call over to Greg togo through some of the detailed numbers for the quarter and for the full fiscalyear. Greg?

Greg Witherspoon

Thanks, John. As we said at the top of the call, we put outa press release this morning with detailed quarterly and annual results. Let mespend a few minutes explaining those details. We ended a very good year with aquarter in which all three of our businesses reported record quarterly revenueswhich is a reflection of our focus on maximizing throughput at our facilitiesas well as good markets.

Operating income was also strong and, when combined with thethird quarter this year, represented the highest two quarters for our operatingincome any time in the company's history. As John indicated, while we saw a $7million decline in operating income from Q3 to Q4, gross margin was down only$1 million with the difference primarily being due to the timing of selling,general and administrative expenses that fell into the quarter.

In August we amended our stock based incentive plan tochange the rules regarding vesting upon retirement. As a result of theamendment we were required to accelerate the recognition of benefits ratherthen to continue to accrue the expenses over time as we were doing previously.

The incremental expense we recognized in the quarter wasabout $2 million. We also have an annual incentive compensation plan for ouremployees based on our operating divisions and the company meeting overallfinancial objectives. As the Company performs well, as it has done this year,our employees' variable pay plans increase.

During the fourth quarter we recognized an additional $2million in compensation expense to bring our annual accrual in line with theamount our compensation committee deemed appropriate for the performance of ourpeople this year. These two items account for $4 million of the $6 millionincrease in SG&A expenses for the quarter and all of them reflectingexpenses which should be viewed in the context of a full year or longer.

Turning to the full year, consolidated revenues were up $700million over 2006 with the increase driven by both higher volumes and highermarket prices. Acquisitions contributed to the higher revenues, but more than75% of the increase was related to organic growth.

Consolidated operating income increased $39 million comparedto 2006. As you may recall, we recorded a $15 million charge last year for theSEC and DOJ investigations. Excluding that charge, operating income increased$24 million or 12%. While sales prices were up year-over-year, raw materialcosts increased as well and the increased operating income was almost entirelythe result of higher volumes in all three businesses.

In the metals recycling business revenues increased $700million or 49% with processed ferrous volumes up 1 million tons or 33% andnonferrous volumes up 81 million tons or 27%. The three mega-shreddersinstalled during the year have increased our capacity significantly and highervolumes reflect our focus on maximizing the utilization of these assets.

Average ferrous and nonferrous sales prices were up 22% and17% respectively during the year reflecting the strong worldwide markets forrecycled metal. That strong demand also translated into higher raw materialcosts, which were only partially offset by lower conversion costs from ourinvestment in new technology and infrastructure.

As a result the increase in operating income was due to thehigher sales volume. In the steel manufacturing business revenues increased $38million or 10% over 2006 driven by a 1% increase in sales volume and a 9% increasein the sales price. During the year we shutdown one of the two rolling millsfor five weeks to install a new reheat furnace, but were able to keep up withsales demand by building inventory prior to the shutdown.

The installation of the new furnace and other improvementsat the mill, have increased our capacity from 600,000 tons in 2005 to over750,000 tons today. During the year cost for scrap, alloys and other rawmaterials used in making steel rose more than the increase in the sales pricesresulting in narrowing margins.

Nonetheless operating income was the second highest in themill's history exceeded only by the prior years. The auto parts businessrevenues for 2007 increased $48 million or 22% compared to fiscal 2006. Theincrease was primarily due to a 6% increase in scrap vehicles purchasedallowing for higher core and scrap sales volumes.

Also contributing were higher prices for recycled metal andhigher full-service parts sales. Operating income increased 3% as the increasedrevenues were partially offset by higher car purchasing costs and higherinformation technology expenses.

Let me close with a couple of final items regarding thequarter. During the quarter we continued our share repurchase program, buyingback 1 million shares at an average price of $53.75 per share. We have 2.2million shares left under our current Board authority and, as always, we willevaluate alternative uses for our cash and debt capacity and market conditionsfor our stock and allocate our shareholders' capital appropriately.

Finally, depreciation during the fourth quarter was $12million and capital expenditures were $16 million bringing the CapEx to theyear to $81 million. Later today we will be filing our 10-K with the Securitiesand Exchange Commission. Let me now turn the call back over to John.

John Carter

Thanks, Greg. We spent the first part of the call lookingback at a very successful year. I'd like to spend the rest of the call lookingforward and start by talking about our priorities for 2008. First, we spent alot of time discussing with you our focus on increasing operating leveragethrough productivity enhancements and improvements and higher throughput. Oursuccess in achieving this objective in 2007 does not mean that we intend torest.

And in 2008 we expect volumes and velocity in all three ofour businesses to increase. We also expect to realize benefits from the capitalinvestments we have made, both from lower conversion costs and improvedrecovery of high-value materials. For the metal recycling business we areanticipating processed ferrous volumes will grow to between, 4.4 million tonsto 4.7 million tons and nonferrous volumes will grow to between 390 millionpounds and 410 million pounds.

In the steel manufacturing business, we believe we canincrease our sales volumes to take advantage of the increased capacity at themill and sales are expected to reach between 725,000 and 750,000 tons.

Second, more opportunities remain for capital investments tobring technological improvements and provide operational efficiencies. Forexample, we intend to continue upgrading our non ferrous sorting systems andtake advantage of evolving technology that further improves the rate ofrecovery of high-value material from the shredding process. We plan to continueimprovements in our dock facilities that will allow us to load and unloadgreater volumes of material more quickly and more safely.

We will be making investments in equipment that will enableus to more efficiently load containers for export of ferrous scrap and steelproducts. Doing so will allow us to turn our inventories even faster andprovide an alternative source of transport for our export sales. And we willcontinue our work on upgrading our information technology systems to provide uswith better tools for decision-making.

Based on the projects that we see at this point capitalspending for 2008 should approximate the levels of 2007. The process weintroduced in 2006 for selecting capital investments remains in place and theprojects we included in our capital budget meet our strict criteria for returnsand payback.

Finally, the used auto parts and metals recycling industriesremain highly fragmented and present numerous opportunities for furtherconsolidation. We intend to continue our focus on increasing scale throughaccretive acquisitions. As in the past, we intend to be disciplined in ourapproach.

This means looking at opportunities that have a strongfranchise that provide opportunities to capture value to management for capitalinvestment and that offer synergies to our existing businesses. There is noquestion that all three of our industry sectors are consolidating. We willcontinue to actively look at transactions as they present themselves.

With our strong cash flows and relatively low leverage webelieve we will have more than enough capital to pursue our strategy ofinternal growth through productivity improvements and technology enhancementand external growth through acquisitions while at the same time looking for opportunitiesto return money to our shareholders through our share repurchase program.

Let me spend a few minutes talking about our outlook for thefirst fiscal quarter 2008. In the metals recycling business we expect to see agood flow of materials into our yards and customer demand appears to be fairlystrong. Our shipments and the tons produced in the fourth quarter were a recordand it will be challenging to match those totals particularly with the newshredder in Portland still getting up to speed.

We did start the quarter with pretty good inventory levels,so at this point it looks like ferrous volumes during the quarter should bebetween 1.1 million tons and 1.2 million tons. Nonferrous volumes are expectedto be down about 10% with slightly lower shredder volumes contributing to lowerZorba sales. Both our ferrous and nonferrous sales volumes will besignificantly higher than the volumes shipped in the first quarter of 2007.

Export market pricing for ferrous scrap continues to remainat good levels and we're starting to see an up tick in gross sales prices. Asyou are probably aware, ocean-going freight costs have been on the rise and itlooks like those increases are going to more than offset the higher grossprices during the quarter.

Based on our current view of the market and sales made todate, average net prices will decline slightly during the quarter, but willremain at significantly higher levels than a year ago. We've taken a number ofsteps to mitigate the increases in freight cost including entering intocontracts for future shipments and pursuing an alternative to bulk cargos.

We've begun investing in equipment, which will improve ourability to load scrap in to containers. While it takes a lot of containers tomatch the volumes we can ship in bulk, it does currently give us an opportunityto export at better margins and turn our inventories even faster.

We've also been taking advantage of opportunities at ourport locations to maximize shipments by barge to domestic steel mill customers.Taken together the barge and container sales will represent a relatively smallpercentage of our overall sales, but are something we can build on goingforward depending on the behavior of the bulk carrier market. We will continueto evaluate all possibilities that allow us to leverage our port facilities andachieve the best possible margins.

In the steel manufacturing business, our West Coast marketsremain good, but we are starting to see some softness in demand. The good newsis that customer inventories are low and outside of some product coming in fromMexico, overall imports are down.

Based on current market conditions average net pricesachieved during the quarter are expected to be down up to 5% from the recordprices in the fourth quarter, but they will still be significantly higher thanthe prices in the first quarter of 2007.

Overall sales volumes are expected to decline from thevolumes in the fourth quarter and approximate the volumes shipped during thefirst quarter of last year. Our recent investments to expand the capacity ofboth our mill shop and our rolling mills provide us with the capacity to serveour traditional customer base as well as take advantage of the opportunity toreach out to new markets when it makes economic sense.

This additional capacity has provided us with further meansto become more efficient. We are focused on utilizing this capacity to it’sfullest, to drive down conversion costs by improving our production mix andadditional sales including bill outs to both existing and new markets.

Finally, in the auto parts business compared to the fourthquarter normal seasonal improvements in the self-service parts sales should beoffset by a similar seasonal decline in full-service sales as the first quarteris generally, the weakest quarter for repair shop demand. In addition, lowermaterial prices should lead to a slight drop in foreign scrap revenues. In thisbusiness, as in our other two businesses, we are expecting year-over-yearimprovement.

I'd like to conclude by recapping. We just completed anothervery successful year and we look to 2008 with optimism. We believe we are wellpositioned to take advantage of the positive long-term fundamentals, whichsupport all of our businesses.

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

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes fromthe line of John Rogers with D.A. Davidson. Please proceeds.

John Rogers - D.A. Davidson

Hi, good morning.

Greg Witherspoon

Good Morning. Welcome.

John Rogers - D.A. Davidson

A couple of quick things, first of all, Greg, you mentioned-- it was Greg or John mentioned, CapEx would be flat in fiscal '08 with '07.Do you have what it was for fiscal '07?

Greg Witherspoon

I believe it was $81 million.

John Rogers - D.A. Davidson

Okay. And depreciation for the year?

Greg Witherspoon

$41 million.

John Rogers - D.A. Davidson

Okay.

Greg Witherspoon

Up, $10 million from '06.

John Rogers - D.A. Davidson

Okay. And then in terms of the scrap business, can you giveus a sense of the difference in margins for you between containerized shippingand bulk shipping?

John Carter

Well, as we said on that front, John. The margins for thecontainer shipping tend to be a little greater at the moment because of thebackhaul rate for containers. On the other hand, a container contains 17 tonsof scrap. So…

John Rogers - D.A. Davidson

Yes.

John Carter

When you look at the bulk rates, it's a lot of containers tomake up for one bulk shipment. Our expectation is that markets over timecorrect themselves but we want to be able to take advantage of what we see asan aberration in that shipping market at present and we will.

John Rogers - D.A. Davidson

And how much can you load in containers now? I mean I'm justtrying to get a sense.

John Carter

Well its not -- let me make sure we're clear, it's not goingto be a significant amount of overall shipments.

John Rogers - D.A. Davidson

Okay.

John Carter

What it does, it’s allows us to reach some particularcustomers that are more suited for container shipments. And it allows us toalso keep our inventory turns at a higher rate because obviously we don't haveto accumulate for a bulk shipment, if we see an opportunity to take advantageof a price change.

John Rogers - D.A. Davidson

Okay. And then the last thing is you talked about expectedpricing in margins in the first quarter. But is pricing -- and I guess marginsby virtue of freight rates, is it leveling off now or is it still coming down?Just tell me what you see there?

John Carter

Well, I think as we said and as we said a number of times,we obviously don't manage this business to a quarter-to-quarter type ofoutcome. And we see the macroeconomic effects and the trends in our businessesare still very strong.

So when we look at our business over the last two years. Asyou know, our annual financial performance has been very strong despite weakfirst quarters, and the first quarter has some attributes to it that cause somepressure on that.

And in our outlook for the 2008 first quarter is that, itwill be significantly better than in prior years, even if it might not be asstrong as the second half of 2007.

The margins are going to continue to be affected by thefreight costs and the cost acquiring material, but it's a cyclical business. Sowe expect them to go up and down as it has in the past, and we expect to beable to take advantage of the export markets, which remain very, very firm.

John Rogers - D.A. Davidson

Okay, thank you.

Operator

Next question comes from the line of Sal Tharani withGoldman Sachs.

Sal Tharani - Goldman Sachs

Good morning, John.

John Carter

Good morning, Sal.

Sal Tharani - Goldman Sachs

Quickly your comment -- I just wanted to get some color onthe West Coast pricing, buying price you said it hasn't moved downward like theother parts of the country, is that correct to say?

John Carter

The demand for customers in Asia is still very strong, andas a result, unlike the East Coast where the domestic demand was down and someof the domestic pricing on the acquisition side was weaker during the fourthquarter.

The demand for export scrap to Asia continued strong and asa result buy prices continue to be under some pressure.

Sal Tharani - Goldman Sachs

Is that -- is this demand coming from container shippersalso?

John Carter

It's a combination of the bulk shipment and the containersshipments. The bulk shipment -- I mean really it's driven by the customer sideand the customers are very -- still see very strong steel markets and are veryneedful of scrap.

As you know, Sal, that there's an also awful lot of pressureon iron ore as well. And so those iron ore prices continue to go up and thathas an effect on the scrap prices.

Sal Tharani - Goldman Sachs

Do you see, scrap prices following the iron ore out nextyear as you expect iron ore prices to be up 30% or so?

John Carter

Well, the demand for steel is what drives scrap prices andthe demand for steel remains strong. The iron ore price, part of that equationreally is a reflection of the strong demand for steel products.

And so that same strong demand for steel products means thatthere is still a very strong demand for scrap and we continue to see thosetrends very favorable for us in 2008.

Sal Tharani - Goldman Sachs

John, going back to the West Coast, I always thought thatone of the advantages that Schnitzer had was that on the West Coast there wasless of a competition than the Midwest or East Coast for the scrap and thebuying price was always lower than the East Coast price, is that still correctto say?

John Carter

Yes, I think that's still correct to say, Sal. The demandcurve for export on the West Coast still leaves us with what we think are verypositive margins on the West Coast and we're very comfortable with where we arein meeting the objectives there.

Sal Tharani - Goldman Sachs

Okay. And…

John Carter

I'd also like to point out, if I could. That our volumes, asGreg said, which are up significantly also help us deal with the pressure, theheadwinds, that we're seeing in raw material and freight costs because itimproves our productivity.

And these investments we've made in the mega-shredders arehelping us offset that significantly.

Sal Tharani - Goldman Sachs

Great. And switching to the auto parts business, can youjust give us some color on the integration? All the service centers you boughtI believe it was greenleaf acquisition has are up to speed or, is there anyimprovement you will see in some of those facilities?

John Carter

Greg you want to take that

Greg Witherspoon

Sir thanks. We feel that the full-service auto body partsare up to speed, we converted five of them over to self-service, four of themare over a year old now, the conversions, and they're going to operate with allthe rest of the self-service.

So that only remains one store that we feel is not quite gotup to speed yet. Organic growth in the auto parts business was 16% and '07 over'06 though. So it's performing very well.

Sal Tharani - Goldman Sachs

You said 16%?

Greg Witherspoon

Yes, sales growth.

Sal Tharani - Goldman Sachs

All right. Thank you very much, guys.

Operator

(Operator Instructions) And your next question comes fromthe line of Eric Glover. Please proceed sir.

Eric Glover - Canaccord Adams

Hi, good afternoon.

Greg Witherspoon

Good morning, Eric.

John Carter

Hi, Eric.

Eric Glover - Canaccord Adams

Hi. Can you just give us a better sense of what we shouldanticipate for SG&A expenses going forward?

John Carter

Greg you want to take that.

Greg Witherspoon

We think for fiscal '08, they should be flat to '07, barringany significant acquisitions.

Eric Glover - Canaccord Adams

Flat in dollar term?

Greg Witherspoon

Yes, sir.

Eric Glover - Canaccord Adams

All right. And then in the guidance you said you expectlower scrap and core volumes in the auto parts business. Can you explain whyyou expect that?

Greg Witherspoon

I think, John was saying he expected lower prices, not lowervolumes.

John Carter

But not significantly.

Eric Glover - Canaccord Adams

Okay. In the press release it says sales should be offset bylower scrap and core volumes.

Greg Witherspoon

I think its margin, Eric. I don't think we meant to sayvolumes.

John Carter

There's a possibility because this is a traditionally weakquarter in the auto business, that there's a possibility we won't be able tomatch the record volumes that we got in the fourth quarter and the firstquarter. So that's just cautionary, it's not expected to be significant.

Eric Glover - Canaccord Adams

Okay. And then finally, I was just wondering if you couldtalk about the rise in containerized shipping in general as it pertains to theindustry. Has it been a very significant increase rapidly over the past year orso given the increase in bulk freight rates? Can you just provide more colorthere?

John Carter

Well, I think as we've talked about before, the rise incontainerized shipping of scrap is really a phenomenon that's been driven bythe need to return empty containers to Asia because of the import situation. Alot of that has been focused on Southern California where we do not operate.

The containerized shipping of Zorba of course is somethingthat we've done for a long time, and to the extent that we see opportunities inour other areas which are not heavily containerized shipping ports we'll takeadvantage of the lower prices for container shipping of scrap where we thinkthat allows us to access some customers that are more comfortable with smallervolumes than the bulk shipments provide.

As far as containerized shipping effect going forward,that's really a macroeconomic question that has to do with the balance ofimports and exports. It will continue to be a significant factor at LosAngeles.

Eric Glover - Canaccord Adams

Okay, thank you.

Operator

And your next question comes from the line of Jeffrey Cole(ph) with Cardinal Partners. Please proceed.

Jeffrey Cole - Cardinal Partners

Good morning, guys.

John Carter

Good Morning.

Jeffrey Cole - Cardinal Partners

I just have three general questions about the business, basicallythe first one is how much of your scrap supply is provided by Schnitzer Steelor the auto parts division?

John Carter

Well, our scrap supply from the auto parts division isreally fundamentally provides us car bodies for our Oakland operations. Thereis some provision elsewhere, but that's the fundamental area that we get autoparts car bodies, and that's a significant amount of the Oakland intake for carbodies.

Jeffrey Cole - Cardinal Partners

And as far as your steel division, does that kind of supplyscrap to your scrap yards?

John Carter

No, just marginal, small amounts of scrap come back from themill. The mill uses scrap of course from our Portland facility, which becausewe would otherwise export it, the mill takes an export price.

Jeffrey Cole - Cardinal Partners

And I guess my next question is it looks like about 20% to25% of your scrap goes into your steel business, how is the pricing determinedon that scrap?

John Carter

I think that was the answer I just gave which was…

Jeffrey Cole - Cardinal Partners

Oh, I think we might have mixed up. The first question was,I know your steel operations probably have a lot of byproduct and I waswondering how much of that byproduct would go back in to your scrap division?

John Carter

The response to that is the same, which is not much, there'svery little that's generated and to the extent that it is it goes back into theoperation. It's not material.

Jeffrey Cole - Cardinal Partners

Okay. And then, your scrap yard provides your steel divisionor your recycling business provides your steel division with scrap and I wasjust wondering how is that pricing determined.

John Carter

And that pricing is in our company, pricing that's based onthe export price of scrap per ton.

Jeffrey Cole - Cardinal Partners

Okay.

Greg Witherspoon

Just to let you know that the steel manufacturing businesspurchased a little under 186,000 tons of scrap from our metals recycling businesswhich is just over 11% of our total profit.

Jeffrey Cole - Cardinal Partners

I noticed historically that the number was more like 20% to25% of your processed scrap goes to your steel divisions.

John Carter

I think that's probably correct. As you notice, we'veincreased the volume substantially this year and so those increases in volumeshave the knock-on effect of reducing the percentage that actually goes to themill.

Jeffrey Cole - Cardinal Partners

Understood. Okay. And my last question deals with I guessyour ferrous trading sales. I was just wondering, what kind of gross margins doyou derive from those sales?

John Carter

Are you talking about ferrous trading?

Jeffrey Cole - Cardinal Partners

Yes.

John Carter

The ferrous trading sales are really done for purposes of awindow on the export market that we don't actively participate through processscrap and those trading margins are very small, they really reflect no valueadded from processing. So, consequently they are driven by positions in thetrading business that move quickly and consequently margins are quite low.

Jeffrey Cole - Cardinal Partners

I've seen some of your competitors sometimes state a marginof 5%, is that sort of in the ballpark range?

John Carter

No, I don't think, I mean, the margins will vary a lotdepending on the timing of the scrap purchases and the scrap sales, but that'snot a margin that we would anticipate there.

Jeffrey Cole - Cardinal Partners

Okay. Thank you very much.

Operator

I show no further questions in the queue.

John Carter

Okay. Well, thank you very much. I appreciate you joining uson the call this morning and that's it.

Operator

That concludes the presentation. You may all now disconnect.Good day.

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