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Horsehead Holding (NASDAQ:ZINC)

Q3 2012 Earnings Call

November 05, 2012 11:00 am ET

Executives

Gary R. Whitaker - Vice President, General Counsel and Secretary

James M. Hensler - Chairman, Chief Executive Officer and President

Robert D. Scherich - Chief Financial Officer, Principal Accounting Officer and Vice President

Analysts

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

Daniel Moore - CJS Securities, Inc.

Carter W. Driscoll - Capstone Investments, Research Division

Kuni M. Chen - CRT Capital Group LLC, Research Division

Paul S. Forward - Stifel, Nicolaus & Co., Inc., Research Division

Robert Howard

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Horsehead Holding Corp. Third Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Gary Whitaker. Please go ahead.

Gary R. Whitaker

Good morning, everyone, and thank you for joining us on our third quarter 2012 earnings release conference call. My name is Gary Whitaker, and I am Horsehead's Vice President, General Counsel and Secretary.

Before I turn the call over to Jim Hensler, I would like to quickly remind everyone that this communication may include forward-looking statements about our company, our markets 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 9, 2012, and our quarterly report on Form 10-Q for the quarter ended June 30, 2012, which was filed on August 9, 2012, for a more detailed description of the risk factors that may affect our results.

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

James M. Hensler

Thanks, Gary. And I'd like to welcome you to this conference call to discuss the results of the third quarter of 2012. I will review the performance of our operations and markets, while Bob Scherich, our CFO, will review the financial results.

The consolidated net earnings for the quarter were a loss of $9.1 million or a $0.21 loss per share. This compares to earnings of $23.1 million or $0.52 per share for the third quarter of 2011. However, nearly all of the difference in reported earnings between the quarters is due to mark-to-market adjustments to hedges. Consolidated net earnings, excluding non-cash charges related to hedges and impairment charges for the third quarter of 2012, were $0.6 million or $0.01 per share. For the same period in 2011, excluding non-cash charges associated with hedges, we incurred a consolidated net loss of $0.3 million or a $0.01 loss per share.

A significant change between the quarters was a 15% lower LME zinc price and a 26% decline in the LME nickel price versus the same quarter last year, which combined to reduce earnings by an estimated $0.15 per share.

So while lower commodity prices had a noticeable effect on our earnings, I'm very pleased with the operating levels of our businesses. And when you eliminate the impact of hedge write-offs, mark-to-market adjustments and non-cash asset impairment charges, our operating results were positive despite the much lower commodity prices compared to the prior year.

Compared to the same quarter last year, zinc product shipments were up 24%, including the impact of Zochem. EAF dust receipts were up 15%, EAF dust processed was up 17%, smelter output was up 7% and the realized premium for zinc products on a zinc contained basis was up $0.05 per pound to $0.16 per pound for the quarter.

In addition to these improvements, we realized a lower conversion cost per pound to zinc as both our recycling plants and our smelter, and increased the proportion of feed to our smelter recovered from EAF dust from 73% in the prior year's quarter to 86% in the current quarter, the highest level on record.

I'd now like to discuss these operating results in more detail. We processed 163,085 tons of EAF dust during the quarter, a 17% increase from the same quarter last year. Despite the tapering off of steel industry capacity utilization at the end of the quarter, EAF dust receipts increased from the prior year's third quarter from 133,832 tons to 153,306 tons, a 15% increase. The new service contracts that started in 2012 continued to serve as the primary factor leading to this increase. According to industry statistics, domestic steel industry capacity utilization averaged approximately 74.7% during the third quarter of 2012, which is down slightly from 76.2% during the third quarter of 2011.

We believe dust receipt levels would be slightly lower during the fourth quarter of 2012 as steel production levels have softened. In response to that softening, and as I indicated in our last call as this scenario played out, we idled 1 of our 9 kilns early in the fourth quarter. We continue to pursue additional EAF dust service contracts because processing additional dust provides more low-cost feed for current zinc production and will be the primary source of feed for our new zinc plant in North Carolina.

Zinc product shipments increased by 24% to 44,287 tons compared with the prior year's third quarter, mainly due to the addition of Zochem along with another solid production quarter at Monaca and steady demand for our zinc products. Zinc production on a zinc contained basis was 40,477 tons, inclusive of Monaca and Zochem.

We realized a 7% increase in smelter production for the third quarter of 2012 compared with the third quarter of 2011, even though production was reduced by an unplanned outage by a lightning strike and the rebuild of both SSHG refining columns downstream of the smelter. The demand for zincs from the Monaca location remained steady during the quarter compared with the second quarter of 2012, reflecting solid demand in our end markets, and we expect to continue to operate our full complement of 6 smelting furnaces in the fourth quarter.

Zinc oxide shipments increased 61% compared with the third quarter of 2011, reflecting primarily the acquisition of Zochem. Zinc oxide shipments from Monaca increased by 4.4% compared with the prior year's third quarter but remained steady relative to the second quarter of 2012. Oxide shipments continued to outpace 2011 levels.

The outlook for zinc oxide in the fourth quarter is expected to be comparable to the third quarter of this year.

Total zinc metal shipments decreased by 0.5% when compared with the third quarter of 2011 as demand remained strong in the general galvanizing sector. However, shipments of SSHG metal were lower due to the need to take a 5-week outage to rebuild the 2 refining columns for this product during the quarter because both had reached our limits for safe operation. These columns were back in service in early September. Metal shipments on a year-to-date basis through the end of the third quarter in 2012 are running 4% ahead of 2011 levels.

Fourth quarter metal shipments are expected to be comparable to our year-to-date run rate as the general galvanizing industry is showing no signs of slowing down, and we are back to producing SSHG metal. The smelter is currently producing at normal levels.

Moving on to discuss the zinc pricing environment, the LME zinc price averaged $0.85 per pound during the third quarter, which was $0.02 lower than the second quarter at $0.87 per pound and $0.15 lower than the third quarter of 2011 average of $1. Zinc prices are currently trading in a fairly narrow band near $0.83 per pound. Our $0.85 put options paid $680,000 in the third quarter. The realized premiums on zinc metal averaged $0.062 during the third quarter which was up $0.026 from the third quarter of last year, and with $0.005 higher than the realized premium for the second quarter of 2012. The increase in realized premiums is primarily due to an increase in the transactional premiums on SSHG metal, which went into effect on April 1 of this year, combined with a slight increase in transactional premiums on TW metal.

Realized premiums for zinc oxide in the quarter were approximately $0.047 per pound, which is an increase of $0.061 compared to the prior year's third quarter and a decrease of $0.031 compared with the second quarter of 2012.

This increase compared with last year reflects primarily the effect of the higher premiums on Zochem. The decrease in realized premiums on a sequential quarter basis is primarily due to a temporary change in customer mix and due to the lag effect related to the increase in zinc prices, which took place at the very end of the quarter.

During the quarter, we announced our intention to increase zinc oxide prices in 2013 for certain contract business. I'm happy to report that we've been successful in securing our targeted volume at these higher price levels on several accounts thus far. We expect to take on less contract business next year than this year in anticipation of the eventual closure of the Monaca refinery.

INMETCO continued to operate at full capacity even as tolling receipts were lower than expected. Nickel remelt alloy production increased by 6% compared against the same quarter last year.

As preparations were being made to enter into its annual outage, INMETCO suffered damage at the facility on October 28, 2012, as a result of a fire in the raw material blending area. Early damage assessments indicate that there was no damage to the main operating equipment. There appears to be, however, significant damage to the roof in the area of the fire, along with some electrical wiring and potentially some damage to a storage silo. We're thankful that there were no injuries. A more complete damage assessment is underway, and our insurers have been notified. The impact to production will be minimized by virtue of the fact that we were about to enter the annual outages on the rotary hearth furnace and the submerged arc furnace. We plan to perform the emergency repairs to the building while the outage is underway. These outages, which were expected to be completed by November 14th, may be extended a few days as a result of delays caused by the fire. The damages from the fire are expected to exceed our insurance deductible of $500,000. The full repair costs will not be known until we can complete demolition of the damaged roof areas so that we can safely conduct a full damage assessment.

On a separate note, we're pleased that we've been able to extend the lives of the rotary hearth furnace and the submerged arc furnace to approximately 16 months since our last rebuild.

Nickel prices declined from $10 per pound in the prior year's quarter to $7.40 per pound in the current quarter. And we continued to expect U.S. stainless melting capacity and EAF dust generation to increase before the end of this year when ThyssenKrupp is expected to start up its new melt shop in Alabama. However, we would expect total tolling receipts for the fourth quarter to be lower than the third quarter because we have requested that some of our customers divert their waste products to a landfill temporarily as a result of the fire.

Zochem made another positive contribution to earnings during the quarter, we started to move forward with Phase 1 of our plan to expand capacity at the Zochem facility in anticipation of the eventual idling of the zinc oxide refinery at Monaca. Phase 1 includes expanding for existing furnaces. This phase is 50% complete and expected to be fully commissioned by the end of the first quarter of 2013. Phase 2 includes the addition of a new larger furnace and a building expansion, which is expected to be completed by the third quarter of next year. The total expansion, which will cost approximately $15 million, will increase zinc oxide production capacity at Zochem to 72,000 tons per year.

Lastly, project activity and the rate capital spending have increased on our new Mooresboro zinc plant in North Carolina. We believe we are on track to complete construction of the SX-EW plant and begin zinc production in the second half of 2013. As of September 30, 2012, we've spent $137 million on the project.

As we've advanced the detailed engineering on the project, we've decided to expand the scope to provide more lower long-term operating costs by upgrading the materials of construction, enhancing the recovery of coproducts, such as lead and silver, and upgrading effluent and storm water management. The net effect of these changes and our being able to quantify more precisely certain other projected costs is an increase in the cost to build the facility of approximately $40 million. This represents about 10% of the total project cost.

We have approximately $288 million of cash on hand at September 30, 2012, $44 million of unused availability on our revolving credit facility and recently, and recently entered into an agreement that should add $20 million of export credit financing. We also planned to increase our revolving credit facilities by $30 million. These financings, together with cash on hand and our expected cash flow, should provide ample liquidity to complete the project even with the inclusion of the enhancements I just described.

As Bob Scherich will discuss, the extension through the third quarter of 2013 of our $0.85 strike price put options will help to provide protection against negative cash flow from operations in the event zinc prices decline significantly during our construction and startup period.

I'll now turn it over to Bob Scherich to review the financial results. Bob?

Robert D. Scherich

Thanks, Jim. My discussion of the financial performance for the quarter excludes the non-cash effects related to hedges and assets impairment charges. I will talk about these separately a little later.

The adjusted net earnings for the quarter were $0.6 million, or $0.01 per share, compared to an adjusted loss of $0.01 per share for the third quarter of 2011. We estimate that the current quarter adjusted earnings would have been $0.12 higher with the same LME zinc price as the prior year quarter. This noticeable improvement in earnings for the current year's quarter, after allowing for the commodity price difference, is primarily attributable to lower feeding conversion costs and higher realized premiums to the LME on product sales.

Detail of the quarter's adjusted performance versus the same quarter last year reflects an increase in revenue of $1 million, or 1%, to $109 million. The increase included the effect of higher shipments, including Zochem, partially offset by a decrease in price realization as a result of the lower commodity prices. The average sales price realized for zinc products on a zinc-contained basis was $1.02 per pound or $0.16 per pound above the average LME price for the quarter, compared to $1.12 per pound or $0.11 above the average LME price for the prior year's quarter. This reflects the increased proportion of zinc oxide with the addition of Zochem and a higher premium to the LME price for metal shipments, particularly SSHG metal. Sales of zinc metal decreased $5.6 million or 12.8% to $38.3 million for the quarter, reflecting a $0.3 million decrease in sales volume and a $5.3 million decrease in price realization as the LME zinc price declined 15%.

Sales of zinc oxide increased $13.1 million to $41.8 million for the quarter, reflecting an increase in sales volume of $17.4 million related to inclusion of Zochem as well as an increase in shipment from the Monaca facility, partially offset by $4.3 million reduction in price realization.

EAF dust revenue increased $1.7 million or 18.7% to $10.5 million for the quarter as volume of receipts increased 15% as compared to the third quarter of 2011. Sales from nickel products and services, excluding the effect of hedges, decreased $1.2 million for the quarter to $14.8 million as a $2.2 million effect from higher volume of shipments was more than offset by $3.4 million effect of lower price realization reflecting the 26% decline in the LME nickel price.

Consolidated cost of sales, excluding asset impairment charges, decreased $1.6 million to $94.4 million for the quarter. This decrease reflects the inclusion of Zochem cost of sales of $13.2 million, substantially offset by the effect of an increase in EAF-based fee to the smelter a 12% reduction in recycling costs per zinc pound and a 5% reduction in conversion costs at Monaca. The effective tax rate for the third quarter of 2012 was 34.7% as the year-to-date rate was adjusted to 36.6%.

Non-cash heads charges reduced sales $8.8 million in the current quarter, while the prior year quarter included $37.7 million of non-cash mark-to-market gains, a change of $46.5 million. The remaining 2012 zinc put options had a value of $0.3 million and the 2013 put option had a value of $4.5 million as of September 30, 2012.

We recently purchased zinc put options in the same quantities as are currently hedged and with an $0.85 strike price that extends our hedging program through the third quarter of 2013 to provide protection to cash flow in the event that zinc prices fall.

Cost of sales for the current quarter included an asset impairment charge of $6.1 million to reflect plans to shut down the refinery operation in Monaca concurrent with the smelting operation, which is anticipated as the North Carolina plant commences operation.

The net book value of fixed assets at the Monaca facility was $37 million as of September 30, 2012. Cash flow from operating activities was approximately $5 million for the quarter and $38 million for the 9 months ended September 30. Capital spending was $46.5 million for the quarter and $107 million year-to-date.

Capitalized interest was $3 million for the quarter and $5.8 million year-to-date.

At quarter end, our cash balance was $287.5 million, or $12.2 million net of debt. LTM adjusted EBITDA was $42.8 million, and we had $44 million of availability on our revolver. Our current estimate is that approximately $10 million of interest will be capitalized in 2012 and another $18 million in 2013 through the completion of construction of the plant in North Carolina. We've put in an arrangement in place during the quarter for $20 million of export credit financing. We expect to add additional revolving credit arrangements for INMETCO and Zochem in a combined amount of $30 million.

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

James M. Hensler

Thanks, Bob. In summary, before we open the call for questions, I'd like to say that I'm pleased that while the third quarter was impacted by lower commodity prices for both zinc and nickel, operating levels remained strong at all of our locations and our operating results were positive when you strip away non-cash charges. I'm also pleased that we lowered our conversion costs significantly at our recycling plants and smelter.

We started Phase 1 of the expansion of our Zochem operation and we're excited about the opportunities we see to recover enhanced value from consolidating all of our zinc oxide production in one state-of-the-art, low-cost facility while at the same time eliminating the overhang of excess capacity in the North American market.

And while we have to address repairs at INMETCO as a result of the recent fire, our Ellwood City, PA facility continues to be a solid investment, delivering $17.4 million of pretax income so far this year. And I'm very pleased that project financing for our new zinc plan has come together. We had approximately $288 million of cash on hand at the end of the quarter, which included the proceeds from our recent private placement of $175 million of senior secured notes. We believe that this cash on hand, combined with existing and planned credit facilities and expected cash flow from operations, should provide ample liquidity to not only complete the project, but also to meet the working capital and the general business needs of the current operations.

Project activity and capital spending have accelerated on our new zinc plant in North Carolina, and we believe we continue to be on schedule to complete the construction and produce first zinc in the second half of 2013. And once fully operational, we continue to believe this project should provide us with annual incremental EBITDA of approximately $90 million to $110 million.

Thank you, and we'll now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] I will now go to the line of Mitesh Thakkar.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

Let me start with just the new zinc facility, the increase in CapEx. How should we think about the improvement in earnings from the increased CapEx, because I know you are spending on upgrading some of the materials and those kind of things, is that something you can quantify right now?

James M. Hensler

Well, we think that same range is still there, that $90 million to $110 million, but what we were seeing is that, for example, on the zinc and lead recovery circuit, we are beginning to see some -- had some concerns about whether the high levels of recovery we are expecting from that circuit were going to actually be realized. And so we've made a decision to go forward with certain investments that would solidify those recoveries. We also felt that while we could have saved some money following our initial investment costs following our technology provider's advice on materials of construction, we felt that in the long run we'd be spending more money for maintenance and replacement of that -- those materials and so we decided just to bite the bullet and do it now because we think in the long run it's cheaper. It's hard to sort of quantify it, although we do believe that, for instance, the value of lead and silver that we expect to recover is on the order of $18 million the $20 million a year at the current price of those commodities. And as the recoveries -- and that's assuming 95% recoveries. We were looking at potentially recoveries as well as low as 60% to 70% if we didn't make these modifications and so there was some enhanced value that we could see coming out of that.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

Okay. Great. And when you think about the amount of CapEx which has already been committed, and just the detailed engineering which has been concluded so far, how do you feel about the new CapEx number? Is it solid or could we feel -- could you find something else like which could result in an increase?

James M. Hensler

Well, I think we're at the end, or pretty close to being at the end of the design phase. So we only see much additional movement in the costs from the standpoint that we made -- we may do something different from a scope standpoint. It can move plus or minus a few million dollars due to those kinds of things. I'd say most of the change in spending at this point is if we see something different in the installation phase. It's a little too early to comment on that. We don't see anything right now that would suggest that there's an issue there but were just starting getting into that phase and that's hard to really quantify.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

And how much of this is committed already of the total CapEx, how much is committed?

James M. Hensler

We're still in about the 2/3 range of the total project there's still about 1/3 to go.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

Okay. And when you look at your cash on hand of about $288 million and almost a to-go CapEx which is roughly in that kind of range. It's good that you kind of protected your downside here with additional hedging, but do you feel a need that just to make sure that everything goes smoothly and maybe there are some opportunities which could come along the way, there could be additional need for financing?

James M. Hensler

Well, and just add to that, the cash on hand should complete this project. We also expect to continue to have cash flow from operations, were on pace this year for close to $40 million and with the hedging in place we'd expect cash flow coming out of operations next year. And the revolving credit facilities, we've got the current plus what we're looking to add so that should bring the revolving credit facilities to about $90 million plus we added about $20 million on ECF financing so we think we've got plenty of liquidity in front of us.

Operator

I will now go to the line of Daniel Moore, CJS Securities.

Daniel Moore - CJS Securities, Inc.

Can you give us a little bit more of a breakdown in terms of the $40 million incremental costs? Is it all raw materials? Is there some labor components and has the footprint of the facilities increased or changed at all?

James M. Hensler

Yes, it breaks down roughly as follows: About half of it was due to some modifications that led the recovery circuit that we -- lead and silver recovery circuit, we had to add some, essentially, additional clarifying and settling capacity, and we also had upgrade a hydrochloric acid recovery circuit in that facility. So it's -- about half of the $40 million is related to that work and then the other $20 million, sort of splits into 2 buckets, half of it upgrading materials for construction, putting in things like acid resistant coatings on concrete tanks that -- we don't expect that to be acid resistant coatings, upgrading the -- from coated carbon steel to some higher alloy steel, in some cases. And then the other area was really on the infrastructure side. We -- environmental controls are extremely important to us. We wanted to make sure that we had the capability to handle any upset conditions that might occur with respect to both the management of effluent from the facility as well as storm water management, so we made the decision to put additional capacity on-site to be able to store effluent, store storm water and manage its discharge before we would discharge it, and so we decided that was the prudent thing to do and spend the money there. So roughly it breaks down that way.

Daniel Moore - CJS Securities, Inc.

The $15 million CapEx for Zochem, how much of that has been spent? Or is that also ahead of you?

James M. Hensler

No. It -- we've spent about 20%, 25% of that so far.

Daniel Moore - CJS Securities, Inc.

Got it. And lastly the -- I know you can't really detail or pinpoint the repairs for INMETCO but can you give us any sense of magnitude, a couple of million bucks? Or is it just too early to get any real handle on that?

James M. Hensler

It's a little early because we -- part of the issue here is that the roof was taken off in that section and there's some debris that's, sort of, still hanging up there that we can't get in to really inspect very carefully until we cut that debris out. And we've been working at it around-the-clock to do that. There'll probably be another 24, 48 hours before we can actually get our structural engineers in to take a look at it. What we can see superficially, it doesn't look like it's that bad. I mean obviously we have to replace the roof. There might be a couple of beams that were affected by the fire that we may need to go in and shore up or replace. There is -- unfortunately, there was a conduit bank, electrical conduit, that was traveling right over the area that the fire took in. And so all of that got wiped out. And I guess, the one area that we're looking at right now is there was a storage silo where we bring in EAF dust and store it. We have several of those. But one of them, in particular, was close to this area and the fire. And we're not sure about the structural supports on that storage silo. So if it's just limited to those things that I mentioned to you, I would think that something under $2 million is probably a fair number, but if it goes beyond that, then -- I don't see this being a $10 million thing but it could go up from a couple million dollars. And it could be less than that too, if the damage to those things I mentioned, like the beams, isn't significant.

Robert D. Scherich

And we clearly feel it's under coverage, under our property damage on our insurance policies. We've paid the first $500,000 of repairs. So we don't see it as anything that affects our longer look at liquidity.

Operator

I will now to go to the line of Carter Driscoll, Capstone Investments.

Carter W. Driscoll - Capstone Investments, Research Division

Just following up, of the $40 million additional CapEx that you have planned for, how much of that came from recommendations from your EPC provider versus what you've learned running Monaca? If you could kind of help us understand how much of this was a change to the original assessment versus modifications on-the-fly. I'm just trying to get a sense of if there is something else that could be a surprise, will it be a recommendation from them or will it be like you said your attempt to try to drive down the longer-term costs by taking the upfront costs now? Just trying to get...

James M. Hensler

I'd say almost all of it was our decision. We were working off of our technology provider's original design basis. And then it was really taking those through detailed design, bedding some of the -- for instance the raw -- the materials of construction recommendations that they got versus looking at our own experience and the experience of others. And also, pinning down this lead and silver recovery issue through some lab testing that we requested be completed. Once we went through that analysis -- and this is not untypical of what happens in detail design, you start out with a basic design or front-end engineering design and then you break -- you drive that down through detailed design and these questions come up, these choices come up, and it comes back to the owner to decide which way they want to go. I mean if the plant has design, it would have been fine. But we decided, in the long run, it was easier to do these things today, bite the bullet so to speak, spend the money up front, and we believe it'll translate into lower operating costs, better reliability, more consistency of benefits going forward.

Carter W. Driscoll - Capstone Investments, Research Division

Okay. But this is more to -- just getting back to your reiteration of the range of incremental EBITDA. So the $40 million is additional. And I'm assuming that that range was still made off of a higher zinc price than we're currently experiencing now. Can you help us with those moving parts? I mean if we stay in the $0.85 to $0.90 range or $0.80 to $0.90 range through the end of 2013, would that have an impact on your incremental EBITDA forecast?

James M. Hensler

Well, just to be clear, the incremental EBITDA forecast we have has no impact to zinc pricing because all of those benefits really are independent of the price of zinc. What we're really calculating there is the difference between EBITDA we would get if we didn't put North Carolina in, versus what we would have with that project. So it's like kind of comparing Monaca versus the North Carolina plant. And those benefits really aren't related to the price of zinc. The only commodity exposure we have in that $90 million to $110 million range is the assumptions about lead and silver pricing that I've mentioned, which were -- are roughly in the range of where they are today, about $1 for lead and about $30 an ounce for silver.

Carter W. Driscoll - Capstone Investments, Research Division

We're really just talking about cost assumptions from...

James M. Hensler

Right. Right.

Carter W. Driscoll - Capstone Investments, Research Division

Has there been any movement, any other indication by Shell about selecting Monaca? Have you had any further discussions? It almost seems, at least from the local press, that it seems like that site is being honed in on as the potential site, but I want to hear it from you, guys, if you've had anything incremental, let's say with Shell?

James M. Hensler

Yes. I mean -- well, Shell continues to maintain a presence on the site on a regular basis. They're continuing to do their due diligence and getting quotes from demolition contractors and remediation folks and so on. And so we continue to support that effort with them. Their option doesn't run out until the end of this year and so they haven't come back to us with a formal indication of whether they're going to exercise it or not. But I agree with your assessment that if you read the local papers and you hear what is getting out of the media channels, it doesn't look like there's really another site that they have in mind, and it's really kind of a matter, whether or not they ultimately plan on going forward with the project. But we don't really know anything more than you see in the local papers. And we also have a confidentiality agreement which would restrict us from saying anything more than that.

Carter W. Driscoll - Capstone Investments, Research Division

When you're diverting some of the dust to landfill, is there any estimate of what that type of charge you might take from that? I'm assuming that you're on the hook for telling your suppliers you have to landfill it on temporary basis. Is that...

James M. Hensler

No. Actually in this case there will be no impact to us because we're not on the hook there.

Robert D. Scherich

And it's just at INMETCO.

James M. Hensler

And it's just in INMETCO. It's not at our carbon field dust recycling facilities. The dusts we're diverting would be dust that is not under contract, and would be at our discretion to say whether we're going to take it or not.

Carter W. Driscoll - Capstone Investments, Research Division

That's more of a lost opportunity than it is...

Carter W. Driscoll - Capstone Investments, Research Division

It's really more of a lost opportunity and, frankly, it's some lower grade material, so from an actual bottom line impact, isn't that insignificant. But there would be some potential loss of tolling revenue.

Carter W. Driscoll - Capstone Investments, Research Division

And just my last question, and I'll get back to queue is about the other contracts you're pursuing. Having such a large percentage of domestic dust contracts available today, I mean, what's the feasibility of your ability to secure additional dust contracts. Obviously, you had a really large percent of the feedstock which helped COGS this quarter. But -- I mean, could you potentially secure another 10% or 15% on top of what you're already kind of pulling through on a quarterly basis? Some type of magnitude about what might be feasible in terms of incremental contracts acquired.

James M. Hensler

Yes. Well, I mean, I think if you think about it on a macro sense, our capacity for dust recycling on the carbon field side is somewhere in the 710,000, 720,000 tons per year. We were receiving dust kind of in a peak period this year, probably in the 660,000 to 670,000 ton per year rate. So -- I mean in a macro sense, there's still some room for additional dust contracts. But it's less than 10% additional growth opportunity unless we add some capacity. So we see some opportunities to do that and it really depends upon what we think our short to medium term view is about steel industry capacity utilization because, obviously, we have enough dust under contract that if the steel industry gets back up to 80% capacity utilization, we'd be pretty much at our maximum capacity. So we will be very selective about taking on new dust contracts because we have to reserve the capacity for our current clients who happened to be running a little bit lower than they were a year ago. We expect that situation to turn around though. With that said we're also looking for ways to get more throughput through our existing kilns. And we look at our overall system and we think that there's an opportunity through continuous improvement to get another 3%, 5%, 10% additional throughput for the existing kilns. That's not something we'll realize in the next quarter, but it's certainly an improvement objective that we've set for our operators to strive for.

Operator

I will now go to the line of Kuni Chen, CRT Capital Group.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Just a quick one on the incremental $40 million. Is that a number that we should add to our CapEx for next year? Or does some of that maybe creep into 2014 as well?

James M. Hensler

Well, I think it's going to get spread over a little bit this year, next year and some into 2014. I don't know that it lays all in 2013 because we're beginning to order some of these materials now. And so we'll be spending some of that incremental amount this year.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Okay. Okay. Fair enough. And I guess just reading some of the industry headlines over the last few weeks. There's some talk about Glencore and Xtrata having to divest some zinc assets. What's your view on how that could play out? Does that have any impact, positive or negative, to the industry structure?

James M. Hensler

I don't see that having an impact, one way or the other. I mean, I think it looks like it's mostly a Europe situation. The EU seems to me to be the group that was commenting on that. And it looks like Glencore has offered up doing something with their Nyrstar commercial contracts. And I don't know how that will play out but at the end of the day, I look at it and say, "Those zinc units will still get produced and they'll still get consumed. And if they're not sold by Glencore they'll be sold by somebody else." So at the end of the day I don't think it really has much impact.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Okay. Great. And then just one final one, if I may. I guess, the improvement in commercial costs that you saw in the quarter, do you see that as sustainable going forward? Have those conversion costs stepped down to a new normal level?

James M. Hensler

Yes. Well, I think that there are 3 factors that affect those conversion costs. Certainly one is volume. And so if we bring 15% more volume through existing facilities, we get some benefit of lower conversion costs because of the fixed cost absorption. And certainly, that was the case in the third quarter. Of course, if the steel industry doesn't produce much dust and we bring in less and process less, we won't see that benefit going forward. But the 2 areas that are sustainable are that -- we're beginning to see some reduction in the price of coke, and coke is a major cost item in our recycling business. And so we're beginning to slowly see that come down. And the other thing which is positive and sustainable is that we've seen the operating availability of our kilns improve. So in other words, we've got more up-time on the kilns. So that generally means we're also spending some less money on maintenance, and we don't have idle time sitting there. So we're getting better utilization of our assets. So I think those 2 aspects are sustainable. The first one depends upon what kind of output we get from the steel industry.

Operator

[Operator Instructions] At this time I'll go to the line of Paul Forward, Stifel, Nicolaus.

Paul S. Forward - Stifel, Nicolaus & Co., Inc., Research Division

I wanted to ask about the lead and silver recovery circuit modifications that you're making. You'd talked about, I guess, you had come in anticipating, I think it was 95% recovery and some of your testing were suggesting you might only get 60% or 70% without some modifications in clarifying and settling. I was just wondering if you could talk about -- do you think that, that's now, with the modifications, that you're back up to a 95% recovery rate there? And then secondly, have you had any concerns in thinking about your initial assessments of what you're zinc recovery rates would be? And whether you're likely to get the product quality in zinc that you had originally estimated? Any risk that you might have to make any further modifications in order to hit your targets that you'd gone into the project and the design with targets in mind?

James M. Hensler

Good question. And I guess, the simple answer is on the zinc side, we feel very comfortable with the basic assumptions that we've been dealing with and we think that all of those assumptions have really been validated by what we see, on a commercial scale, at Akita zinc recycling in Japan and also the Scorpion plant. We think that the -- there's no question in our mind the SX process works, it will give us the through activity we want to get to get the purity of zinc we're looking for, and we believe that the recoveries have already been well demonstrated at those sites. This lead and silver recovery circuit is actually a newer development. And there aren't other full-scale commercial operations that we can really point to and get the confidence that it's been done and proven. So that's why we took the proactive step of really following up and doing a lot more benchscale testing to try to understand how this system will react with our feed materials and understand how it behaves under dynamic conditions. And the first testing we did was really kind of on a static basis, just using beakers in a lab. And you don't quite understand how a process is going to work until you start getting into a continuous mode. Once we did the testing in a continuous mode, we found that in certain cases, we get very high recovery levels. In other cases, we get some varying recovery levels. And then we had to peel back the onion and sort of figure out, from a technical standpoint, what was driving that variability and how do we design around it. And it took us a while to get to the point of saying that we needed to upgrade the front end of that process. The engineering would be -- gets fascinated by this sort of stuff. But we -- was actually it's pretty good detective work at the part of our technical folks to sort through that because they ended up getting these strange complexes being formed that only happen under certain conditions. And we -- they were able to ferret that out. And that resulted in these design modifications I described.

Paul S. Forward - Stifel, Nicolaus & Co., Inc., Research Division

All right. And going back to, I think, one of your recent presentations that you had on your website in September. Just wanted to ask about the schedule of the project. I think there you'd talked about things like the delivery of the transformer rectifier in the fourth quarter, power on at the facility in the first quarter 2013 and beginning equipment installation. Any changes to the schedules for equipment delivery or startup from what you've talked about it over the last 2 or 3 months?

James M. Hensler

No. Our target for zinc production still seems to be within reach. We look at that schedule on a weekly basis. At any point in time, when you've got a project of this scale, there are some items that threaten your schedule, and then you look at those and you say, "Well, can I beat that back into schedule?" And so far, our folks are telling me that we still seem to be on track for producing first zinc. In -- we've said second half of 2013, our internal target is by the end of the third quarter and we still believe that is doable.

Paul S. Forward - Stifel, Nicolaus & Co., Inc., Research Division

Okay. Great. And I wanted to ask about, just kind of bigger picture, world zinc markets. Over the past month we had a pretty big rise in the LME inventories. Just wondering if you could talk a little bit about what's the prospect of weaker zinc pricing, either forcing some production cuts globally or some scaling back of growth projects? Or what's your view on the prospect of a demand pick-up in 2013 that can dent those inventories?

James M. Hensler

Yes. Well, I think you see metal moving into warehouses. I don't -- one thing to keep in mind when you look at the zinc that's sitting in LME warehouses, it represents only a relatively small percentage of the total inventory in the system. So it's one piece, it's the most visible piece. When it goes up by 100,000 tons, it feels like a big deal. But you've got to realize that 100,000 tons was sitting on somebody else's floor and it was already part of world inventory. I think the significant thing that I see right now is to me it actually looks like the market is in a slight deficit from a metals production standpoint. And if you look at Wood Mackenzie's latest forecast, and if you look at what the international lead-zinc study group is showing here with the most recent statistics, it looks like in terms of metal production and metal consumption, we clip the other way, that we're actually in a slight deficit. And so I think that in terms of actual inventories, we may start to see those trend down. And a lot of that is due to the fact that zinc prices have been at these lower levels now for some period of time, marginal smelters, particularly in China, have come off-line. And so that is going to start to play out. The other thing I think that's significant is, on the mining side, we know that there are some large mines that are scheduled to come off-line, not next year, but beginning in 2014 and 2015. We just heard recently Don Lindsay's report out of Texas, that they're deferring any further zinc mining projects for some number of years until they see the supply-demand situation improve a bit on the mining side. So I think if you want to tell a bullish story on zinc, you can look at those things and you can say, supply is in deficit. Mines are coming off-line and you can argue that as a reason for higher zinc prices in the medium term. And in fact, when you look at CRU and Wood Mackenzie's forecast for next year, I think they're forecasting $1 per zinc. If you look at 2014, I think they're up around $1.20 a pound. So that makes people like me happy. Believe us. But a lot of it also depends on what happens on the consumption side? And that comes back to what is the growth rate going to be in the U.S. What's the growth rate going to be in China and in Europe? And I think that's still a little bit up for grabs. I don't if anybody really knows.

Operator

I will now go to the line of Robert Howard, Prospector Partners.

Robert Howard

The EAF dust and the feed going up to 86%, is that -- I guess I want to know a little bit more about that. Was -- is that something that's kind of sustainable? Or were there certain factors that may be kicked it up a little bit extra this quarter compared to the past? Or what's just kind of behind that record a bit?

James M. Hensler

Yes. Well, I think it is sustainable if the steel industry output is sustainable, and I think what we had in the third quarter was a combination of strong receipts from steel industry up until September. September, we started to see things get a little bit softer. And we also saw good production and good reliability from our 10 recycling kilns, so the up-time was good. So we generated a lot of zinc units. I think that the up-time issue I mentioned and -- is sustainable. I think we've made some significant gains in driving up reliability of our equipment over the last 12 months. And if the steel dust output is there, we can generate a lot of -- have a lot of recovered zinc and get that percentage up in the mid-80%s. I don't think that we're going to see that in the fourth quarter, for example, because we've taken one kiln off, and now we've got 9 kilns running instead of 10 primarily because the steel industry is not producing as much steel and as much dust. And we're still running 6 furnaces in our smelters so steel production -- or zinc production is going to be the same but the percentage that's going to come from EAF dust will probably go down.

Robert Howard

And I guess after the new facility is built is that going to kind of impact any of these percentages at all in terms of using the dust?

James M. Hensler

Well, the biggest impact of the new facility is that -- our current smelter has a zinc recovery of about 92%. And the new smelter, the recovery will be 97%, 98%, much higher. So for the same number of zinc units going out, we will need fewer zinc units coming in. So by virtue of that, we should be able to have a higher percentage of our feed for that plant coming from our own recovery zinc from EAF dust.

Robert Howard

And then I guess the size of that facility, just from the stuff when you were answering the earlier part of my question that it seems like there's reason to believe that you could have a kind of couple point increase in that dust feed in general, just because of the kiln. And if steel production were to continue to be really strong, something in the mid-80%s again.

James M. Hensler

Well, certainly. If we got to a situation where we're bringing in 700,000 tons of EAF dust, which is close to what our -- if steel industry got to 80% capacity utilization, that's about where we would be. We would be recovering about 140,000 tons of zinc from EAF dust to feed a plant that's running at 155,000 tons of zinc output. The percentage would be actually north of 85%, probably closer to 90% in that particular case.

Operator

I will now go to the line of Daniel Moore, CJS Securities.

Daniel Moore - CJS Securities, Inc.

At the risk of beating a dead horse, given that higher CapEx, are you perhaps somewhat less likely to take on other projects in the near term like shifting additional capacity for EAF dusts receipts to the mid -- recycling to the Midwest? Are you comfortable that you got ample liquidity to take on smaller opportunistic projects like that?

James M. Hensler

Well, I go to think we have ample liquidity to take on some small projects. But the shifting of dusts to the Midwest, that's not going to happen in 2013 because we think the permitting process for that is at least 12 months long, and we're just kind of getting started going down that path. So it's probably a 2014 expenditure if we go forward with a project like that. But I think small projects, I think, we're certainly capable of taking on, if they've got a good return.

Operator

Speakers, there are no more callers in queue.

James M. Hensler

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

Robert D. Scherich

Thank you.

Operator

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

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