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Horsehead Holding Corp. (ZINC)

Q1 2008 Earnings Call Transcript

May 9, 2008 11:00 am ET

Executives

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

Jim Hensler – President & CEO

Bob Scherich – VP and CFO

Analysts

Wayne Cooperman – Cobalt Capital

John Goodman – Endeavor Capital

Cliff Hale-Sanders – CIBC World Markets

David Shapiro – Aegis Financial

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Horsehead Holding Corporation first quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. (Operator instructions) And as a reminder, this conference is being recorded.

I would now like to turn the conference over to our first speaker Ali Alavi. Please go ahead.

Ali Alavi

Good morning everyone and thank you for joining us on our first quarter 2008 earnings release conference call. My name is Ali Alavi and I'm Horsehead's Vice President of Corporate Administration, General Counsel, and Secretary. Before I turn the call over to Jim Hensler, I would like to quickly remind everyone that this communication may include forward-looking statements about our company or market and our prospects that are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. These risks and uncertainties include a variety of factors, some of which are beyond our control.

These forward-looking statements speak as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these forward-looking statements to reflect events or circumstances that occur after this communication. You should refer to our filings with the U. S. Securities and Exchange Commission, including our most recent annual report on Form 10-K filed on March 31, 2008 for a more detailed description of the risk factors that may affect our results.

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

Jim Hensler

Thanks, Ali. It's my pleasure to welcome you to this conference call to discuss the first quarter 2008 results. I will review the performance of our operations and markets, then turn it over to Bob Scherich, our CFO, who will review the financial results.

We are pleased with the continued strong market demand for our products and services as we achieve higher production levels. In particular, our EAF dust recycling business has exhibited strong growth. Receipts of electric arc furnace dust increased by 21% compared against the first quarter of 2007 to an annualized rate of 559,000 tons per year. Dust receipts also increased by 20% versus the previous quarter. In addition, new EAF dust sources are expected to begin deliveries in the second quarter of this year. We believe we are on track to meet our 2008 goal of receiving 575,000 tons of dust.

The startup of the Rockwood number two kiln on January 1 of this year added an additional 80,000 tons per year of capacity. We absorbed one time startup costs of approximately $700,000 for additional training and energy usage during the startup period.

We've selected a site in South Carolina to build a new dust recycling facility in conjunction with a multi-year agreement with Nucor steel. The Board has approved the capital investment of $88 million to install a two kiln facility with capacity of over 160,000 tons per year which will provide sufficient capacity to service Nucor and secure additional business in that region of the country. We expect to complete air permitting for the South Carolina plant by the end of June which will allow construction to begin. Kiln one is expected to start up by mid-year 2009.

Our zinc smelting operations in Monaca continue to demonstrate strong productivity gains. The zinc smelter produced 37,750 tons of zinc in the first quarter of 2008, an 18% increase compared with the prior year quarter. This occurred despite a 72 hour outage that resulted from a loss of power at the plant. We are track with meeting of our production plan of 152,000 zinc tons this year. Furthermore, the planned zinc oxide expansion came online as scheduled at our Monaca plant on April 1 and it started up with minimal problems. We are on track to meet or exceed our shipment plan of 85,000 tons of oxide this year.

Strong market demand for our products is supporting higher shipment levels. Market demand for our products was stronger in the quarter as zinc shipments increased by 6.8% compared with the first quarter of 2007 to about 37,000 tons. Shipments increased by 8.6% compared with the typical seasonally lower fourth quarter of 2007.

Demand in the general galvanizing market has improved as infrastructure related spending continues to be strong and as we enter the construction season. Oxide demand has also been steady. And we have also seen a slight increase in export shipments of oxide this year from 4.2% of total shipments during the first quarter of last year to 6.2% this year. We expect export shipments to continue to grow as we continue to partner with several of our larger customers who have global production facilities.

We experienced a temporary increase in production costs during the quarter due to transitional issues associated with the start-up of the Rockwood kiln and one-time events. At first, we had a prolonged unplanned outage at our power plant, which resulted in operating with only one of two generating units for nearly two months. This resulted in the need to purchase power at prices higher than our normal generating cost, and reduced our revenue from selling the excess power that we generate with both units operating. The outage highlighted the need to upgrade some of the electrical infrastructure in our Monaca plant and we're developing plans in this area.

Also as noted earlier, we experienced start-up related costs with the Rockwood number two kiln and we also experienced higher feed costs during the quarter as the percentage of purchased feeds increased from 41% in the first quarter of 2007 to 44% during the first quarter of this year to support the higher production rate from the smelter.

In the second quarter, Rockwood number two will be at full production and will produce sufficient crude zinc oxide to reduce the amount of purchased feeds. The cumulative impact of these events was an increase in cost of goods sold of approximately $3.7 million or $0.07 per share.

The LME zinc price declined 30% as compared against the first quarter of 2007. LME prices averaged $1.10 per pound for the quarter, also 7% lower than the previous quarter. The realized premiums on metal averaged about $0.05 during the quarter, a slight decrease from the prior quarter reflecting competitive pressures from additional supply in the market. Transactional premiums for zinc oxide remained steady, however realized premiums have declined somewhat as the lag effect on prices has lessened, as LME prices have stabilized over the past few months.

And finally, we completed the purchase of put options for 2009 bringing the total coverage to 90,000 zinc tons at a strike price of $0.90 per pound. We also hedged a similar quantity in 2008 and a strike price of $1 per pound.

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

Bob Scherich

Thanks, Jim. For the first quarter, earnings per share were $0.28. As Jim mentioned, this was off $0.07 due to the transition issues related to the startup of Rockwood number two and the unplanned outage at the power plant. Combining this with the non-cash charge for hedge mark-to-market adjustments results in a normalize EPS of approximately $0.365. Detail of our quarter performance reflects a decrease in sales of $33.4 million as lower price realization of $45.2 million was partially offset by an increase in shipment volume of $11.7 million in comparison to the prior-year quarter. This resulted in decreased sales of 23% as compared to a decrease in the underlying LME price of 30% during the same period.

Average price realization per pound on a Zinc contained basis for Zinc products reflected a $0.16 premium over the average LME for the quarter. This compares to $0.32 per pound for the prior year quarter as the lag effect on pricing for Zinc Oxide reduced as LME prices have began to stabilize. Net sales of Zinc metal were $46.1 million, a decrease of $14.7 million when compared to $60.8 million for the prior year quarter. The decrease reflects a reduced price effect of $21.3 million, partially offset by a sales volume increase of $6.6 million.

Net sales of zinc oxide were $46.8 million, a decrease of $22.1 million for the quarter when compared to the $68.9 million for the prior year quarter. Decrease in price realization of $23.8 million was partially offset by a shipment volume increase of $1.7 million.

Net sales of zinc and copper based powder were $4 million for the current quarter versus $2.9 million, reflecting both higher price and volume. Revenues from EAF dust recycling were $13.6 million, an increase of $2.3 million compared to $11.3 million for the prior year quarter, with an increased volume effect of $2.4 million and a decrease in price realization of $0.1 million.

Cost of sales decreased $4.1 million for the quarter compared to the prior year, reflecting a decrease in purchase feed cost, given the lower LME price, partially offset by a higher proportion of purchase feeds. This proportional increase reflected the requirements to meet the higher production levels, while the expanded EAF dust processing was coming online.

As Jim mentioned, the combination of this higher level of purchase feeds, start-up cost of the Rockwood kiln, and the outage at our power plants increased cost $3.7 million or approximately $0.07 per share. Depreciation expense increased $0.3 million for the quarter, reflecting the increased capital spending during the last 12 months. SG&A expenses increased $0.2 million for the quarter. Interest expense decreased $2.3 million for the quarter, reflecting lower debt levels.

Interest and other income increased $0.6 million for the quarter and our effective tax rate was 36.2% compared to 36.5% for the prior year quarter. Net income decreased to $9.9 million for the quarter compared to $26.9 million for the prior year quarter. Weighted average shares outstanding were 35,165,000 for the quarter compared to 28,855,000 for the prior year quarter, reflecting the equity offerings completed during the last 12 months.

Cash flow from operating activities was $10.5 million for the quarter after being reduced $7 million for the purchase of put options for 2009. Availability on our revolver is approximately $60 million.

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

Jim Hensler

Thanks, Bob. In summary, before we open the call for questions, I'd like to say that we continue to be pleased with the progress that we're making on our growth strategies and market demand continues to support our growth efforts. Steel production enhanced EAF dust generation has increased since last year due to strengthening of steel demand and a reduction in steel imports.

Through the first quarter, we feel confident that we can meet or exceed our operational targets for 2008, namely 152,000 tons of zinc production, 575,000 of EAF dust processed, and 85,000 tons of zinc oxide shipments. We expect stronger earnings in the second half of the year as capacity ramps up and start up are cost absorbed during the first half of the year.

We're also excited about reaching a conclusion on site selection for our new EAF dust recycling plant in South Carolina, and look forward to the start of construction in the next few months. I'm also pleased that we've executed our hedging strategy through 2009 with the purchase of additional put options. The zinc price hedges we have put in place will provide downside protection while allowing us to enjoy full upside in zinc price increases.

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

Question-and-Answer Session

Operator

I apologize, would you like to take questions at this time?

Jim Hensler

Yes.

Operator

Thank you. (Operator instructions) Our first question comes from the line of Wayne Cooperman of Cobalt Capital.

Wayne Cooperman – Cobalt Capital

Hey guys, how are you doing?

Jim Hensler

Hi.

Wayne Cooperman – Cobalt Capital

Just a question, I guess, at the last sale, your cash represents over 15% of your market cap in the company and you are solidly profitable with a pretty good growth outlook. Could you talk about share repurchase as a viable use of cash and it seems like a pretty high return based on projections on where the stock is?

Bob Scherich

Well, Wayne, I think consistent with what we have said in the past, right now, we've got the organic growth of investments that we've got underway this year and next year that we think are very high return projects. I think once we get through those projects and we have generation of cash. We certainly are going to either look for better return on investments internally or ways at that point to bring return back to the shareholders. But, nothing planned at this point in time on share repurchase.

Wayne Cooperman – Cobalt Capital

Are you expecting to spend more cash than you generate cash from the growth? I think my sense was that you weren't going to do that.

Bob Scherich

Yes, I think, with the hedges in place today, the expectation is that the operating cash flow is going to support this investment program as we have it laid out. But, we could have additional projects and as we've talked in the past, we're also kind of leaving the balance sheet open for potential acquisitions, and other investment projects.

Wayne Cooperman – Cobalt Capital

Just don't go pale off for somebody else, when we can buy ourselves at a really low price.

Bob Scherich

I understand.

Operator

We'll go on to the next question. It comes from the line of John Goodman [ph] with Endeavor Capital.

John Goodman – Endeavor Capital

Good morning. I guess the last person talked about the buyback and I guess I won't harp on that. I guess the next question I'm going to ask is, in terms of one-off costs in the quarter, what should we assume for the second quarter and for the second half?

Bob Scherich

That's on cost assumptions?

John Goodman – Endeavor Capital

Yes. Well, the $0.07 you guys referenced as one-off costs for the quarter, should we assume any of those fall over into the second quarter and to the second half?

Bob Scherich

Well, when you look at the three primary components there, the Rockwood startup is behind us with the first quarter and we expect much more normalized production here processing in second quarter. And that's also going to support a higher level of crude Zinc Oxide coming in for the smelter feed. So, we certainly do expect to have a higher proportion of the EAF dust recycled feeds going forward, and the power plant outage is also behind us. It's a little bit unusual and we're back at full operation and expect that to continue throughout the year.

Wayne Cooperman – Cobalt Capital

So that would be – most of those expenses you guys incurred in the first quarter, we shouldn't expect to fall through?

Jim Hensler

Yes. We shouldn't expect it to continue there. There are some small additional startup expenses in the second quarter with Rockwood, but very small.

Wayne Cooperman – Cobalt Capital

Okay. And the second question is, can you guys kind of discuss your hedging program and your strategy? I mean, throughout the quarter, Zinc prices were pretty volatile but they did spike up to $1.20 within the quarter. Can you kind of just walk us through how you guys decided to buy put options at $0.90 versus maybe higher strikes?

Bob Scherich

I think it was really just cost versus the strike price that gives us a level that produces what we believe is the operating cash flow in line with our investment program. It's hard to time the market as we were buying the puts early in the first quarter. We took a position on 2009 and then they got much more expensive during the quarter and then at one point, there was a momentary uptick, but overall, the $0.90 level seemed to be the best cost relationship for us.

Wayne Cooperman – Cobalt Capital

Okay, thank you.

Operator

Next, we have a question from the line of Cliff Hale-Sanders with CIBC World Markets.

Cliff Hale-Sanders – CIBC World Markets

Hi, good morning gentlemen. Just a quick question or two quick questions. First one on your new South Carolina kiln proposal. I just want to confirm or make sure that in my mind the timing of the ramp up of the two kilns there in mid '09 and I guess the second one would be following on in the first part of 2010. Is that well suited to match hopefully the operational improvements and enhancements at Monaca, so you have sufficient processing capacity there or should we expect you to be selling some crude zinc oxide in the market? And my second question is related to the cost to the put options again. I just want to know for my own clarity how you're accounting for that cost, where does that $7 million show up or is it outside of the income statements?

Jim Hensler

Just on the first question, we expect to face the startup of the South Carolina facility and we'll start the first kiln up sometime mid-year, next year. That assumes we are able to break ground by the end of June this year. And we'd expect about a three month lag before we start the second kiln up. The construction of the second kiln will sort of lag the construction of the first kiln. So, we should be fully up and running by the end of the year next year and that will allow us to bring more crude zinc oxide in the business which we were planning to consume internally and should dovetail nicely with the ramp up we expect in Monaca. If we – we don't plan on selling additional crude zinc oxide as a result of that. If necessary, we would reduce the amount of purchase feeds but our expectation is that we'll use all of that crude zinc oxide internally.

Cliff Hale-Sanders – CIBC World Markets

And on the 2007 put options, they were placed on the balance sheet in prepaid expenses and we would expect to amortize sales in 2009, although they are subject to mark-to-market accounting. There was no effect of mark-to-market accounting on the 2009 put options thus far, but absent hedge accounting of the mark-to-market adjustments, we would not expect those to hit the income statement until 2009.

Wayne Cooperman – Cobalt Capital

Okay, that clears up the question. Thanks.

Operator

We have a question from the line of David Shapiro with Aegis Financial. Please go ahead.

David Shapiro – Aegis Financial

Hi, guys.

Jim Hensler

Hi.

David Shapiro – Aegis Financial

Just a question on your purchased feedstock cost, what discounts to LME across the whole barrel of your feedstock that you are currently running at?

Bob Scherich

Well, there is the wide variety there depending on the nature and the zinc content from the skimmings [ph] up through the (inaudible). And I think what we're buying has stayed fairly consistent in line with the historical practices. We've been buying up in the – on a weighted average high 60% of LME in the tighter market. We expect to see some relief on that as the market softens a little bit. But, our actual cost then gets affected by the mix itself. If we're buying more of the (inaudible) the average will be higher, those materials have much higher zinc content and the conversion cost to produce metal out of them is much lower. So, it's a little bit of a moving target.

David Shapiro – Aegis Financial

But, right now, you think you are in the high 60s, low 70s?

Bob Scherich

Yes. I would say high 60s on an average.

David Shapiro – Aegis Financial

Okay. And then …

Jim Hensler

We should also point out, David, that with the falling LME price, from an inventory standpoint, we have higher cost purchased feeds in inventory that end up hitting the P&L as we consume them. So, the realized cost impact is slightly higher than what we are doing in the transactional level.

David Shapiro – Aegis Financial

Okay.

Bob Scherich

That lies fairly similar to what we see in the opposite on zinc oxide.

David Shapiro – Aegis Financial

Okay, that's helpful. And then, on the hedging strategy, besides just supporting the CapEx, if we were to exclude the CapEx projects, how does the firm view hedging? Is it just to offset I guess the dust feed cost? Is that what you plan to hedge that portion or do you plan to go unhedged after these CapEx requirements flow through?

Bob Scherich

The primary focus is to try to get a hedge in place on the expected output from the EAF dust zinc units because those zinc units were bringing in at a low relatively fixed cost. And so, the output being sold to LME base is subject to margin compression. So, it is really the EAF based units that we look to kind of protect a margin compression on, in particular, when we have the significant investment programs in front of us and the use of cash on these organic growth programs.

David Shapiro – Aegis Financial

Okay. And then on the CapEx targets for '08 and '09, where does that stand now and what's the timing? I mean, you talked about the timing of the production coming on, but where does the CapEx fit into that?

Bob Scherich

The biggest timing factor is going to be the South Carolina project. I think coming into the year or late last year, we thought we would be started a little bit sooner and we had our 2008 CapEx planned at about $90 million. We now will have that in a low 70s because the timing of when we start that spend later this year has moved out. So, we currently have this year at about $72 million or $73 million and I think we have shifted into next year some of that spending and have next year at about $90 million.

David Shapiro – Aegis Financial

Okay, and there's not been any material increase of the commodity prices going up and everything, is that had a material impact on your forecast?

Bob Scherich

Not on the capital spending itself. The biggest change over the last six months was the conclusion to make the South Carolina facility a two kiln operation as opposed to one. So that project where we were originally estimating at to be in a low $50 million level is now closer to $90 million.

David Shapiro – Aegis Financial

Okay. I'll get off – jump off line here and give someone else a chance.

Bob Scherich:

Sure.

Operator

At this time, speakers, there are no further questions in queue. Please continue.

Jim Hensler:

Okay. Well, then we appreciate your participation in this call and we will close it up for now and speak to you again at the end of the second quarter. Thank you very much.

Operator

This conference will be available for a replay after 1 p.m. today, through Friday, May 16 at midnight. You may access the AT&T teleconference replay system by dialing 1-800-475-6701 and entering the access code of 920758. Again, the number to dial is 1-800-475-6701 or if you're an international dialer, you may dial 320-365-3844 with the same access code of 920758. This does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: Horsehead Holding Corp. Q1 2008 Earnings Call Transcript
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