Oct 28, 2014
Executives
Alexandra Deignan - Vice President, Investor Relations Tamara Lundgren - Chief Executive Officer Richard Peach - Chief Financial Officer
Analysts
Luke Folta - Jefferies Brent Thielman - D.A. Davidson Timna Tanners - Bank of America Merrill Lynch Sal Tharani - Goldman Sachs Andrew Lane - Morningstar Phil Gibbs - KeyBanc Capital Markets
Operator
Good day, ladies and gentlemen. And welcome to the Schnitzer Steel Fourth Quarter and Fiscal 2014 Earnings Release Conference Call.
At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time.
(Operator Instructions) As a reminder, this conference is being recorded. I will now turn the call over to your host, Alexandra Deignan.
Please go ahead.
Alexandra Deignan
Thank you, Stephanie. Good morning.
I'm Alexandra Deignan, the company's Vice President of Investor Relations. Welcome to Schnitzer Steel's fourth quarter and fiscal year end 2014 earnings presentation.
We're glad you're able to join us today. In addition to today's audio comments, we have prepared a set of slides that you can access on our website at www.schnitzersteel.com or www.schn.com.
Before we get started, let me call your attention to the detailed Safe Harbor statements on slide two, which are also included in our press release of today and in the company's Form 10-K, which will be filed later today. These statements in summary say that in spite of management's good faith, current opinions on various forward-looking matters, circumstances can change and not everything we think will happen always happens.
Please note that we will be discussing some non-GAAP measures during our presentation today. We have included a reconciliation of those metrics to GAAP in the Appendix to our slide presentation.
Now, let me turn the call over to Tamara Lundgren, our Chief Executive Officer. She will host the call today with Richard Peach, our Chief Financial Officer.
Tamara Lundgren
Good morning, everyone, and thank you for joining us on our fourth quarter earnings call. As you can see from our agenda, we have a lot to cover with you today.
But first, let me start by thanking the people who made this quarter a success, our employees. In fiscal ‘14, we demonstrated our ability to manage through volatile market conditions.
We drove significant change, while improving our operational performance. At Schnitzer, our strength comes from our employees at every level, who treat every day like it’s the only day.
Fiscal year ‘14 showed a significant improvement in many areas, from safety, where our total incident rate, our lost time incident rate and our DART rate were significantly better than last year, to our improved productivity which led to almost $30 million of contributions to operating income. Together, with our ability to take command of those things we can control like costs, productivity and safety, we delivered much stronger results this year, even though challenging market conditions existed throughout the year.
So, thank you to our over 3,300 employees for your dedication and your accomplishments, all of which contributed to our fiscal ‘14 performance. Now let's review our fourth quarter and fiscal ‘14 results, including the benefits realized from our productivity initiatives and cost reduction program, recent market trends and our strategic priorities.
After my remark, Richard, will provide further details on our segment operating performance and capital structure, and after that we'll open up the call for questions. So let’s turn to slide four to get started.
This morning we announced adjusted earnings per share from continuing operations of $0.33 for our fourth quarter. These results reflected substantially improved performance in both our Metals Recycling and Steel Manufacturing businesses and higher volumes in our Auto Parts business.
As you can see on this slide, our fourth quarter performance delivered better results on a wide range of metrics. In our Metals Recycling business, the successful execution of our productivity initiatives and cost reduction program, combined with higher sales volumes and lower price volatility, all contributed to the substantial increase in operating income, $14 per ton, which was a $10 per consequential improvement and MRB’s highest quarterly performance since fiscal 2012.
In our Steel Manufacturing business, improved demand from West Coast construction markets and productivity initiatives drove significant operating leverage, resulting in operating income of $9 million for Q4. That represents an 88% increase in operating income, against a 16% increase in volumes and demonstrates our success in improving operating leverage.
During Q4, our steel mill reached a 76% utilization rate, which was our highest level since 2008 and continued the increasing trend, which we saw throughout fiscal ’14. In our Auto Parts business, we achieved record car purchase volumes in the fourth quarter.
These increased volumes contributed to synergies with our Metals Recycling business. However, seasonally lower retail sales in part offset the benefits from these higher volumes leading to APB’s lower quarterly operating income.
Looking forward, we expect APB to benefit from the productivity initiative, which is underway and which should deliver benefits beginning in the second half of fiscal 2015, and we will discuss these actions in more detail on the later slide. On a consolidated basis, our adjusted quarterly operating income more than tripled sequentially, due in large part the strong execution and the flexibility of our platform to rapidly meet changing market dynamics.
This combined with our commitment to disciplined cost control and working capital management enabled us to deliver another quarter of strong operating cash flow of $69 million and to substantially reduce our net leverage to 28%, while returning capital to shareholders through our quarterly dividend. Let's turn now to slide five for a review of our fiscal ‘14 performance.
Looking at our year-over-year performance, operating income more than doubled. The primary drivers of our improved performance were the successful implementation of our operating efficiencies, which enabled us to redirect our shipments to markets with the highest demand.
In addition, our ability to maximize cash metal spreads and manage working capital efficiently resulted in full year operating cash flow of $141 million, which is more than 3.5 times the level achieved in fiscal year ’13. Let's turn to slide 6 to see the drivers of our improved performance.
As the bridge on these slide shows, we generated substantially higher profitability in fiscal ’14 despite challenging market conditions. After delivering $25 million in cost savings in fiscal ’13, we targeted an additional $40 million in operational savings, with 70% to be realized in fiscal ’14.
As the yellow bar show, we encountered a lot of headwinds mainly from lower export demand, which impacted average selling prices and our volumes. But despite those headwinds as the green bars indicate, we were able to deliver on our operational targets generating higher performance in both our Metals Recycling and Steel Manufacturing businesses.
The next few slides will provide more detail on this bridge. Looking at the left-hand graph on this slide, you can see total U.S.
ferrous exports declined 15% during our fiscal year. Our total sales dropped by only 4%, as we offset a decline in export sales with a larger increase in domestic sales.
In fiscal ‘14, we increased domestic shipments by 16%, shipping higher volumes to mills on both the East and West Coast. So, let's turn to slide 8 and take a look at ferrous pricing.
This slide represents general market selling prices for ferrous scrap between September 2013 and August 2014 which corresponds to our fiscal year. During fiscal ’14, ferrous scrap prices rose early in the year followed by a soft downward trend.
Scrap prices began rising in the fall of 2013, but average prices increasing $30 per ton, driven largely by the harsh winter conditions experienced across the U.S. which constricted supply flows.
This was followed by average selling prices declining approximately $40 per ton from the end of the second quarter, largely due to improved spring supply flows. Thereafter, prices remain fairly steady through the summer.
Since the end of our fourth quarter, we've seen downward pressure on ferrous scrap for export prices of roughly $60 per ton, while domestic prices have declined $25 to $30. It’s not unusual to see lower scrap prices during this time of year.
The elevated level of steel exports from China, slower global growth, historically low iron ore prices and the strong U.S. dollar have contributed to the lower global scrap prices we've seen recently.
However, as you all know, our business is fundamentally a spread business and we continually adjust our purchase prices to align with the market and to maintain positive cash metal spreads. So, let’s turn to slide 9 to review in more detail, our productivity initiatives and cost reductions.
In fiscal ‘14, we targeted $40 million in productivity initiatives and cost savings. We delivered ahead of schedule.
The bar chart on the left provides the quarterly breakdown of these results. As you can see, we increased the run rate of benefits each quarter, resulting in a cumulative total in the fiscal year of approximately $29 million, which was ahead of our target goal.
The improvements from these programs have continued to benefit fiscal ‘15 performance, as we realized a full year run rate from these benefits. In addition, we’ve launched a new major productivity initiative in our Auto Parts business.
This initiative targets $7 million in annualized benefits generated from production efficiencies through enhanced yields and vehicle processing, labor efficiency and metric driven accountability. 50% of these benefits should be reflected in APB’s margins beginning in the second half of this year with the full year benefits in fiscal ’16.
On a companywide basis, you can see the impact of these initiatives on a half year comparison basis on the right-hand graph. This illustrates an improving trend for 18-months despite the impact of market headwinds.
Our adjusted results are exclusive of restructuring and other related charges, but inclusive of the impact of average inventory accounting, which Richard will elaborate on during his segment operating review. So now let’s turn to our Steel Manufacturing business on slide 10.
We have seen greatly improved performance in our steel mill over the past five years, driven by higher volumes and amplified by operating efficiencies implemented over the past two years. West Coast construction market conditions improved in fiscal 14, which led to increased volumes throughout the year.
During Q4, the mill operated at its highest quarterly utilization level in five years and nearly tripled its operating income year-over-year. Now that completes the bridge analysis.
I will turn it over to Richard for an update on our operating segment performance and our capital structure.
Richard Peach
Thank you, Tamara. I will start with Metals Recycling on slide 11.
As the left hand chart shows our ferrous sales volumes for the quarter increased sequentially by 7%. The improvement was driven by higher export shipments, which were up by 12%, party offset by a small drop in domestic sales.
As the circular chart shows the strength of our operating platform allows us to balance ferrous sales in Asia, the Mediterranean under domestic U.S., wherever demand is greatest. Including ferrous and nonferrous product, we shipped to 21 countries with our top ferrous export destinations being Turkey, South Korea, and Malaysia for both the quarter and the fiscal year.
The right hand bar chart shows that in Q4 our nonferrous volumes were up by 12%, reflecting higher production and timing of shipments. For the whole fiscal '14, our nonferrous sales were up by 7%.
Now let’s move to slide 12 on an overview of MRB's financial performance. MRB's operating income in the fourth quarter was $50 million.
As the chart on the left shows, this represented $14 per ferrous ton, which was up by $10 per ton from previous quarter. The improved performance came from higher sales volumes, disciplined purchasing and ongoing operational efficiencies.
In the fourth quarter, relatively stable markets led to a neutral impact from average inventory accounting. However, for most of fiscal '14, we've experienced volatile markets, which have led to quarterly results being impacted by this accounting method.
Therefore to show MRB's underlying performance trend, the chart on the right includes our four quarters, excluding the impact of average inventory accounting. As shown, our underlying performance improved every quarter throughout the year.
The primary reason for that strong trend has been growing benefits from focused execution of productivity initiatives, which materially improved financial results and our operating cash flow. Now moving to slide 13, I will cover our Steel Manufacturing Business.
SMB continued to benefit from improving demand in West Coast construction markets, with Q4 sales volumes up 16% sequentially and 13% year-over-year. Rolling mill utilization in the quarter was 76% or highest since 2008.
For the full fiscal year, sales volumes increased by 45,000 tons, which was 9% higher than fiscal '13. The combination of strengthening construction markets and ongoing efficiencies led to a trend of improved financial performance every quarter throughout the year.
In the fourth quarter, operating income reached $9 million, which was SMB's best quarterly result since 2008. Now let’s move to our Auto Parts Business on side 14.
Auto Parts achieved record car purchase volumes in Q4 of 106,000, which was an increase of 8% sequentially and 13% year-over-year. APB's operating margin of 5% was down sequentially due to seasonally lower parts sales and the cost of processing the higher volumes.
With the objective of capturing more benefits from the higher volumes, we've launched a major new productivity initiative focused on increasing our operating efficiency and improving our car yields. We expect to deliver $7 million in annual benefits, with 50% in the second half of fiscal '15 and the full annual benefits in the following year.
Now moving to slide 15, I will discuss our cash flow and year-end leverage position. Our fourth quarter operating cash flow of $69 million was our 7th consecutive positive quarter.
Our full year operating cash flow of $141 million was another strong year, reflecting our improved profitability and ongoing disciplined over working capital. We invested $10 million in CapEX during the fourth quarter.
And for fiscal '14 as a whole, our CapEx was $39 million. This was less than half of last year.
The main difference being major growth projects completed in fiscal '13. Looking ahead to fiscal '15, we expect CapEx will be at similar levels.
The combination of our positive operating cash flow and lower CapEx levels enabled us to increase free cash flow and reduce net debt leverage to 28%. Now I'd like to turn the presentation back over Tamara for her summary remarks.
Tamara Lundgren
Thank you, Richard. Fiscal ‘14 was a significant year for us in many ways.
We delivered enhanced results through operational execution despite ongoing macro economic headwinds and market volatility. We demonstrated platform flexibility to adjust to rapidly changing market demand whether export or domestic.
We exceeded our savings targets for fiscal ‘14. We continue to drive supply chain and market synergies between MRB and APB and we generated significant operating leverage in our steel manufacturing business.
Together, these actions resulted in our best quarterly performance since 2012. And at the same time, we also delivered the best quarterly cash flow since 2012 strengthening our balance sheet while continuing to return capital to our shareholders.
As we embark on our fiscal 2015, our priorities are clear. In our Metals Recycling business, we expect to see a continuation of the improving trends in our recent investments, which have begun to contribute meaningfully to our bottomline.
We also expect the benefits from the full-year run rate of the productivity initiatives, we implemented in fiscal ’14. In APB, we have mapped out an aggressive program which was expected to yield higher performance in combination with the higher volumes we're currently achieving.
In SMB, we expect to further optimize our performance with higher utilization levels from improving West Coast construction activity. Throughout our organization, we plan to continue to benefit from our ability to maximize our operational flexibility, and the inherent synergies in our business, supply flows from APB to MRB and from MRB to SMB.
Our capital structure and focus on delivering strong operating cash flow through the cycle will continue to provide a strong foundation for our balanced capital strategy, which is directed to both investments in our business and return of capital to our shareholders. And as a last point, I’d like to note that last Friday we issued our fiscal 2014 sustainability report.
Now sustainability has been a core tenet of our success from the start of our company over hundred years ago. In addition to recycling responsibly, we continually look for opportunities to reduce the impact of our business on the environment while adding value to the communities in which we operate.
I hope you take the opportunity over the next few weeks to review our new sustainability report, which has now been posted on our website. Again, thank you to everyone on the Schnitzer team for a strong finish to our fiscal year and for making our company a safe and a productive place to work each and every day.
Operator, let's open up the call for questions.
Operator
(Operator Instructions) Our first question comes from Luke Folta with Jefferies. Your line is open.
Luke Folta - Jefferies
Good morning guys.
Tamara Lundgren
Good morning, Luke.
Luke Folta - Jefferies
The first question I had was -- first of all, congrats; decent quarter here. But…
Tamara Lundgren
Thank you.
Luke Folta - Jefferies
…quarter-to-date so far, things have obviously turned a bit. Can you give us some sense of, I guess, what the change has been in export volumes?
And you had talked about your business being more of a spread business. Have cash metal spreads so far in the first fiscal quarter of ‘15 remained stable or have they changed some?
Tamara Lundgren
As I’ve mentioned, we’ve seen export prices fall roughly $60 on the export side. Less than that, today on the domestic side, the domestic prices for November don’t get set until next week.
And so you what we are seeing and how we run our business is to align our purchase prices with increases or decreases on the sell side. As you know, we sell forward and buy behind.
So I think it would be fair to say that we've been continuing to follow that strategy focusing on positive metal spreads. And what we’re also seeing is supply flows are steady.
And I think that’s a reflection of a stronger U.S. economy which is -- which is helping to maintain the flows, while export prices have been declining.
Luke Folta - Jefferies
Anything on volumes you could highlight?
Tamara Lundgren
We really -- we don’t provide the guidance for the fourth -- for the first quarter on this call, Luke. So we’re not going to be providing at this time anything further on volumes.
Luke Folta - Jefferies
Okay. And then on the steel business, I guess, can you comment to the fact that, was Mexico -- imports from Mexico a big factor in your markets on the West Coast.
And I guess, do you expect some sort of long-term benefit from antidumping duties that have been imposed on the Mexican producers. And if you could comment on to the extent that there's been any sort of change in import dynamics since, whether other countries stepped in or not.
Any color there would be helpful?
Tamara Lundgren
So Mexico was a significant importer into the west coast than you saw the trade action that was filed in the resolution of that. And with that trade action, we have seen a significant change in imports from Mexico.
Having said that, there are other imports that are coming into the West Coast and into the country as a whole. But I’m sure you’ve seen imports are up quite a bit nationwide.
I think the way that we've been saying it is that the stronger demand on the West Coast and the West Coast markets has really masked the impact of imports. But we are continuing to see imports come in.
Luke Folta - Jefferies
Okay. And then just last question on the Auto Parts business, which -- margins are obviously down quite a bit over the last several years.
It looks like they are going to be down more modestly in ‘14 relative to ‘13. You've announced the cost-cutting initiatives.
Can you just talk about the, I guess, the general dynamic on margins heading into next year? I'm tempted to want to take this year's 6.5% margin or so and then just layer in the cost benefits on top of that.
But I'm -- there is some concern that we could actually see that trend -- we haven't actually seen that margin trend stabilize yet at this point. What's your thoughts on that heading into next year?
Tamara Lundgren
Well, heading into next year, we are looking at expanding margins because what we’re seeing there are significantly higher volumes. And we have undertaken this productivity program, which has generated significant savings in both SMB and MRB.
And we’re applying the same discipline into APB so that we can benefit from operating leverage that will result from these significantly higher volumes. So we’re looking into next year at improved margins -- barring some major market movements.
Luke Folta - Jefferies
Okay. Thank you very much.
Tamara Lundgren
Thank you.
Operator
Our next question comes from Brent Thielman with D.A. Davidson.
Your line is open.
Brent Thielman - D.A. Davidson
Hi. Good morning.
Tamara Lundgren
Good morning, Brent.
Brent Thielman - D.A. Davidson
Tamara, can you talk a little bit more about Schnitzer’s plan or I guess, appetite around M&A in fiscal ‘15? Do you feel like the productivity initiatives with them further along, you are in a better place to pursue some opportunities out there in MRB or Auto Parts?
Tamara Lundgren
Well, we continue to want to grow our platform in both of those areas. And I think that the productivity initiatives that we implemented, give us a stronger base from which to do that.
As you know, you can’t control when acquisition opportunities come your way and when you can execute on them. But I do anticipate more activity, probably coming through toward the second half.
Next 12 to 18 months, I think, you’re going to see more activity as the market dynamics are continuing the way they are. So we’re continued to be focused in both of those areas on acquisition opportunities.
Brent Thielman - D.A. Davidson
And on that comment, I mean, has your pipeline grown as sort of companies out there are struggling through this cycle?
Tamara Lundgren
Well, we have targets that we watch and people that we communicate with. And sellers appetite to the transactions obviously are influenced by variety of factor.
They can be anything from succession planning to state planning to just general market. And so as I said we can’t control the timing but we do have our list.
Brent Thielman - D.A. Davidson
Okay. And then just with respect to, kind of, the current market you have seen, you provided some color there, which is helpful.
Have you been able to adjust your purchase prices a little faster than perhaps past year, just given a little more supply in the market?
Tamara Lundgren
Well, I think that the supply in the market in certain regions has definitely contributed a different dynamics than what we’ve seen few years ago when we saw falls like this occur. Going into the December, January, February timeframe, we typically see supply construct.
And so I think that the U.S. -- the health of U.S.
economy has generally help supply flows but I think, we’re going to see the same seasonality that we see every year with constructive supply flows coming along with the winter weather.
Brent Thielman - D.A. Davidson
Sure. Understood.
And then lastly, the uptick in SG&A this quarter, are there any extraordinary items associated with that or is that just sort of higher sales volume?
Richard Peach
Hi, Brent. It’s Richard.
The higher SG&A is really as a result over improved performance or significantly improved performance in the fourth quarter, which led to higher incentive compensation accruals.
Brent Thielman - D.A. Davidson
Okay. Got it.
Thank you.
Tamara Lundgren
Thank you.
Operator
Our next question comes from Timna Tanners with Bank of America Merrill Lynch. Your line is open.
Timna Tanners - Bank of America Merrill Lynch
Hey, hello. Good afternoon.
Tamara Lundgren
Good morning, Timna or good afternoon.
Timna Tanners - Bank of America Merrill Lynch
Its morning out there. Sorry about that.
So just wanted to ask you a little bit more about slide 12. And I know, over the years, you get this question all the time, but I just sort of interested in if you're providing the operating income per ferrous ton, excluding average inventory accounting, it looks like you're showing progression throughout the year.
And so I just thought it was fair to maybe ask the question again about what your normalized earnings or EBIT per ton might look like? Is this indicative of a sustained improved performance because of some of your initiatives?
Tamara Lundgren
Well, the trend is clearly a function of our initiatives taking hold and continuing to amplify, which is the same thing that we’ve seen, for example, in our Steel Manufacturing business. Normalize is a great question, that we have to answer in the context of a broader market situation i.e.
exports from China, global recovery, iron ore prices, strong U.S. dollar, all of this contribute to creating an environment whether you call it normalized or short-term.
But I think that the trajectory clearly reflects the impact of our productivity initiatives. And as Richard mentioned, we still have a full year run rate benefit of about $11 coming through in fiscal ’15 and we expect this amplification from higher efficiencies.
So we’re looking forward to continued improved performance.
Timna Tanners - Bank of America Merrill Lynch
Okay. Okay.
And those are all like the self-help effort. So, I guess, my next question along those lines is, let's say that the market is down $60 a ton, not just for export, but also domestic?
And that's not out of line with what we're hearing, just from the end of the quarter to now and let's say that the scrap price is going to be more in line with the kind of trends that we've seen in iron ore, so it's sustainably lower, just for argument's sake? Is it still possible for Schnitzer to achieve these improved margins and a margin that's more in line with the improved area of the trend that you've seen lately?
Is it still possible at lower scrap prices?
Tamara Lundgren
It’s still possible at lower scrap prices. As I’ve said before, we’re a spread business, so we’ve definitely operated at significantly lower and significantly higher scrap prices.
So it really is a function of focusing on conversion costs, focusing on efficiencies and obviously, getting into a stabilized spread environment. So as you increase and decrease, that’s where you get the biggest impact from average inventory, when you see more stable prices, you don’t see these swings.
Timna Tanners - Bank of America Merrill Lynch
No, for sure. Okay.
So last question then would be, can you see a scenario where your suppliers, your peddlers or whomever your long-term suppliers would be, would they just stop selling at a certain point or do you think that if prices fall, you can continue to get that cost down and commensurate?
Tamara Lundgren
I think the issue with scrap is that scrap finds its normal level, because at the end of the day it’s a waste product that whose friction cost i.e. the cost of getting it out and into the economic stream is a function of gas prices, manufacturing activity, construction activity and alike.
So it doesn’t have the same type of extraction costs that iron ore does, which is what enable that to move in a line with sales prices. So, I think the environment that we are seeing and the economic right now, the gas prices, stronger GDP growth, is what supporting better supply flows.
Timna Tanners - Bank of America Merrill Lynch
Okay. Thank you.
Tamara Lundgren
Thank you.
Operator
Our next question comes from Sal Tharani with Goldman Sachs. Your line is open.
Sal Tharani - Goldman Sachs
Thank you.
Tamara Lundgren
Hi, Sal.
Sal Tharani - Goldman Sachs
How are you?
Tamara Lundgren
Fine. Thank you.
Sal Tharani - Goldman Sachs
Are you seeing any development in China in terms of accelerating their EF production or collecting more scrap locally or is it still the same old, which has been for the last couple of years?
Tamara Lundgren
Well, the data that we’ve seen through the first half of calendar year ‘14, shows that China is increasing its scrap usage, I think, around 9% something in that range for the first half of calendar year 2014. And obviously, their leadership continues to emphasize their commitment to environmental improvement.
So we anticipate that they will continue to increase their scrap usage. China as export partner to us in our last fiscal year -- in this past fiscal year was fourth.
So I do anticipate, I think their government anticipates increase in scrap usage in the country.
Sal Tharani - Goldman Sachs
Okay. And one last thing, we had talked about in the past about equalizing scrap prices versus the coking coal, iron ore, unit cost.
And I just want to understand is that, at what price do you think scrap collection just stops in the U.S., because we still have, in terms of unit price of iron, scrap at a higher price than the iron ore coking coal cost, which you can look in the billet price in China or other parts of the world.
Tamara Lundgren
Well. As I was saying earlier in the call, I think scrap finds its natural place.
It doesn’t have an extraction cost like iron ore. And so the friction costs, if you will, are transportation and the highest cost in transportation is gas.
So, as the friction cost of delivery and it is the health of the economy that creates the supply and then it finds its market price. And I think that’s one of the -- I think that is one of the most unique aspects of the business and where the intrinsic -- why there is always intrinsic value and why I would not anticipate saying scrap just stop.
It will find its natural price.
Sal Tharani - Goldman Sachs
Okay. One more last thing, if I may.
You had mentioned many times that you adjust your buying price based on what the market is doing on the sale side. And I was just wondering, why then so much fluctuation in the EBIT per ton or operating profit per ton?
Is it a timing issue which creates that?
Richard Peach
Hi Sal, it’s Richard here. It’s because we use an average inventory cost method to calculate our cost of goods sold.
So when we adjust our cash purchase prices up or down, the average cost of what’s in our inventory actually lags behind changes in cash prices. So, therefore, our income statement in periods of volatile prices with sharp increases or decreases are impacted by this lagging average cost, which is why we’ve said this out on slide 12 today, so that our underlying performance can be seen without this effect.
As you can see, the benefits of our productivity initiatives are showing that our underlying profitability increase throughout the year.
Sal Tharani - Goldman Sachs
Good. That was helpful.
Thank you very much.
Operator
Your next question is comes from Andrew Lane with Morningstar. Your line is open.
Andrew Lane - Morningstar
Hello.
Tamara Lundgren
Andrew, how are you?
Operator
Your line is open.
Andrew Lane - Morningstar
In your prepared remarks about the Auto Parts business, it seems you indicated that the cost of processing higher volumes weighed on margins a little bit. So, I'm curious if you could discuss the role of operating leverage for the Auto Parts business.
If operating leverage doesn't necessarily lead to margin expansion as you process higher volumes, what ultimately does lead to higher profitability for the APB?
Richard Peach
If we can reduce the time spent by our labor on each car, that will reduce the fixed costs associated with each car and give us a permanent improvement in operating margins. And secondly, in each car, we have recyclable metals and core parts that we extract from every end-of-life vehicle to maximize the value we get from that car.
What we are focused on is increasing the yield of recyclable parts and core parts from the car to increase the revenues per car coming from that area. So those two together, we believe can help us increase our annual operating income or contribute to annual operating income by $7 million, which based on our current annual revenues is about a 2% benefit to our operating margin.
And as we said earlier, we expect about half of that in fiscal '15 and reaching the full run rate the following year.
Andrew Lane - Morningstar
Okay. I appreciate the detail there.
And then to switch gears, South Korea returned to your list of top three export destinations after being absent last quarter for ferrous shipment volumes. Was that the key driver in your improved foreign shipment volumes?
Or were there other noteworthy trade routes that also materially improved?
Tamara Lundgren
There wasn't anything unique about the quarter. I think if you go back and you look at the last eight quarters, you’ll see that the top three move around a fair amount.
So it’s really more about timing and timing of shipments than any significant market move.
Andrew Lane - Morningstar
Okay. Thank you very much.
Tamara Lundgren
Thank you.
Operator
Our next question comes from Phil Gibbs with KeyBanc Capital Markets. Your line is open.
Phil Gibbs - KeyBanc Capital Markets
Hello.
Tamara Lundgren
Hi, Phil, how are you?
Phil Gibbs - KeyBanc Capital Markets
Doing well, how are you?
Tamara Lundgren
Very well. Thanks.
Phil Gibbs - KeyBanc Capital Markets
I had a question on the Auto Parts side. Now you’re tying to -- looks like you’re trying to improve the yield here.
Does that mean that you are not going to try to grow that business through incremental location adds?
Tamara Lundgren
Not at all. We will continue to grow that business, and obviously we’ll continue to implement productivity initiatives.
Those are not exclusive strategies by any means and they are actually quite synergistic.
Phil Gibbs - KeyBanc Capital Markets
So we should think about some greenfields and potential acquisitions are still being possible in those -- in that business?
Tamara Lundgren
Yes.
Phil Gibbs - KeyBanc Capital Markets
Okay. And then as far as your inventory position, you drove that down pretty nice year-on-year and particularly quarter-on-quarter here.
Should we expect inventories to start to move up seasonally in the November quarter?
Richard Peach
Hi Phil. It's Richard.
Phil Gibbs - KeyBanc Capital Markets
Hey, Richard.
Richard Peach
The way -- one way to think about this is with prices -- selling prices moving down, obviously they’re adjusting our purchased prices accordingly and that will actually have impact of reducing overall working capital subject to any increases in volumes and during that time. So what we will see generally in a falling market position is lower working capital.
And as the market improves and prices increase and flows increase, we’ll see our working capital go in a different direction.
Phil Gibbs - KeyBanc Capital Markets
So you expect to see source of funds in the first quarter is the way you are looking at it right now?
Richard Peach
We expect to continue to very closely monitor our working capital position. We are not anticipating from an inventory point of view and either any significant increase or any significant decrease this time.
Phil Gibbs - KeyBanc Capital Markets
Okay. Thank you.
Operator
Thank you. That concludes the Q&A session.
I will now turn the call back over to Tamara Lundgren for closing remarks.
Tamara Lundgren
Thank you. And thank you everyone for joining us on our call today and for your interest in our company.
We will speak with you again in January when we announce our fiscal 2015 first quarter results. Thank you very much.
Operator
Thank you, ladies and gentlemen. That does conclude today’s conference.
You may all disconnect, and everyone have a great day.