Jun 30, 2015
Executives
Alexandra Deignan - VP, IR Tamara Lundgren - President, CEO Richard Peach - CFO, SVP
Analysts
Brent Thielman - D. A.
Davidson & Co Phil Gibbs - KeyBanc Timna Tanners - Bank of America Merrill Lynch Martin Engler - Jefferies & Company Andrew Lane - Morningstar
Operator
Good day, ladies and gentlemen, and welcome to the Schnitzer Steel's Third Quarter Fiscal 2015 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, today's conference is being recorded.
I would now like to introduce your host for today's conference, Alexandra Deignan. You may begin.
Alexandra Deignan
Thank you, Kath [ph]. Good morning, everyone.
I am Alexandra Deignan, the Company's Vice President of Investor Relations. Welcome to Schnitzer Steel's third quarter 2015 earnings presentation.
Thank you for joining 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 2, which are also included in our press releases of today and in the Company's Form 10-Q, 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 of 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
Thanks, Ali. Good morning, everyone and welcome to our fiscal 2015 third quarter conference call.
We will start this morning with a summary of our consolidated performance and the market trends which impacted the quarter. I will then discuss our progress on the cost reduction and productivity activities which we initiated during the third quarter.
After my remarks, Richard will review the financial and operating performance of our business segments and our capital structure and then we will open up the call for questions. But before we begin, let me make a general comment.
Without question the third quarter brought continued challenges, while not as dramatic as the price volatility that we experienced in the first half of this fiscal year. We continue to experience the headwinds from global steel overproduction, the strong dollar and weak global demand.
Operationally however, our team has performed very well. And as you'll see in our presentation today, we are taking the actions and executing ahead of schedule on our commitment to reduce our cost and improve our productivity.
In other words, focusing on what we can control and delivering improved results from these actions. So I'd like to take a moment and thank the Schnitzer team for your steadfast focus on execution during the past quarter.
So now let's turn to Slide 4. This morning we announced a substantial sequential improvement in our third quarter results led by benefits from the cost reduction and productivity initiatives we announced in early April.
All of our businesses delivered higher operating performance versus the second quarter. On a consolidated basis, we announced breakeven adjusted earnings per share from continuing operations.
Included in these results is a significant adverse impact from average inventory accounting. In aggregate for the third quarter the impact was $15 million or approximately $0.40 a share.
And this was primarily due to the rapid decline in ferrous selling prices in February and the lagging impact of average inventory cost which carried into the third quarter. Ferrous pricing was relatively stable for the quarter and has continued to be steady through June.
We continued our focus on inventory turns and metal spreads and we were able to generate $64 million of operating cash flow. We also continued our uninterrupted record of returning capital to our shareholders through our quarterly dividend, we funded our capital investments and we reduced our debt to the lowest level since the first quarter of fiscal 2011.
While market conditions continue to be challenging, we are encouraged by the progress we have made to realign our operations to deliver improved results in this weaker market environment and we are demonstrating that those results can indeed be achieved. Let's turn now to Slide 5 to take a look at ferrous pricing during the quarter.
During the third quarter ferrous scrap pricing steadied after the severe drop that occurred in February of our second quarter and we saw ferrous prices drop as much as $100 per ton. On the East Coast as indicated by the red line on this chart, export prices increased as much as $45 per ton driven primarily by restocking activity in Turkey.
On the West Coast as indicated by the blue line, export prices moved up more moderately. During June, we've seen export prices generally move sideways while domestic prices have increased.
And while absolute prices remained weaker versus a year ago, volatility appears to have decreased. So now let's turn to slide 6.
During the third quarter each of our businesses generated higher performance sequentially. Our Metals Recycling Business and our Auto Parts Business delivered increases in adjusted operating income due to reductions in SG&A and production cost, higher ship volumes, the closing of the seven auto parts stores that we announced in April and higher seasonal retail activity.
Our steel manufacturing business delivered improved result as strong customer demand and continued West Coast nonresidential construction spending offset lower sales prices. And finally, corporate costs were lower during the quarter.
Let's turn now to Slide 7 to review in more detail the progress on our cost reduction and productivity initiatives. As you will recall, the goal of the cost reduction and productivity plan that we announced in April is to achieve an annual savings run rate of $60 million.
We originally expected to get to a quarterly run rate of $15 million by the second half of fiscal 2016. We are executing ahead of schedule.
In the third quarter we achieved $10 million of savings and we expect to see the full $15 million of savings in the fourth quarter of this 2015 fiscal year. So let me spend a couple of minutes reviewing this in more detail.
The MRB and APB savings are being generated from a combination of SG&A cost savings, lower production costs, benefits from productivity initiatives and the store closings we announced in April. Together, MRB and APB delivered approximately $9 million of savings in the third quarter and are on track to deliver an additional $5 million in the fourth quarter to reach their quarterly run rate of $14 million.
Our Corporate Shared Services division delivered $1 million of savings in the third quarter primarily from the integration of our MRB and APB divisions. In aggregate on a consolidated basis, by the fourth quarter we expect to reach our targeted quarterly run rate of $15 million in benefits.
Now I'll turn it over to Richard for a more detailed discussion on our segment performance and our capital structure.
Richard Peach
Thank you, Tamara. I'll begin on Slide 8 covering our Metals Recycling Business.
Beginning with ferrous sales volumes of 971,000 tons increased sequentially by 29%. Export shipments contributed 68% of total ferrous sales volumes which was way up from 55% in the second quarter as we took advantage of higher overseas demand.
Nonferrous sales volumes of 150 million tons increased by 21% sequentially including benefits from the resolution of the labor slowdowns at West Coast ports. Compared to the prior year, both ferrous and nonferrous volumes were slightly lower reflecting the adverse impact of weaker demand and of lower commodity prices on overall supply.
While we did see prices stabilize in the third quarter, average ferrous selling prices declined by 19% sequentially, mainly due to the impact of lower price shipments in the first part of the quarter. due to weaker global demand, average nonferrous prices also declined by 9% sequentially and by 14% from last year's third quarter.
Turning to Slide 9, I will now review MRB's financial performance. Adjusted operating income in the third quarter was higher sequentially up by almost $4 million reflecting the benefits from productivity initiatives and from the improved sales volumes.
Overall profitability continued to be adversely impacted by average inventory accounting by an estimated $13 million in the quarter or $0.14 per ton. As the current market trends are more stable and as we have now turned our higher cost inventory, we expect that in our fourth quarter adverse effects from average inventory accounting will be substantially reduced.
As you can see on the right hand chart absent average inventory accounting, recent trend of operating income per ton have been much improved. It is important to note that this significant increase has been achieved despite lower commodity prices year-over-year, despite weaker demand which has reduced our ferrous sales volumes by 12% year-to-date and despite tighter conditions for supply of raw materials.
The reasons we have been able to achieve such improvements includes our productivity initiatives, our cost reductions, adjustments to capacity to eliminate fixed costs and our strong ongoing focus on commercial discipline which ensures we sell to wherever demand is greatest and can quickly adjust our buy program to reflect changes in market conditions. Assuming stable markets we expect adjusted operating per ton excluding average inventory accounting will further expand in the fourth quarter including $3 million of additional quarterly benefits from productivity initiatives.
Now turning to Slide 10 I will review APB's third quarter performance. APB's performance in the third quarter improved significantly over the second quarter due to seasonally higher retail sales and from benefits of cost reductions and productivity initiatives.
Operating income of $3 million equated to an operating margin of 5% which included adverse average inventory costs of $2 million impacting our margins by approximately 350 basis points. Looking ahead and based on current market trends we do not anticipate significant impacts from average inventory accounting in the fourth quarter.
We also expect to achieve up to $2 million of additional quarterly benefits from our cost reductions and productivity initiatives. In total, for APB and MRB combined, we anticipate restructuring charges of approximately $1 million in the fourth quarter which is substantially less than we incurred in the third quarter.
As planned, during the third quarter we closed seven retail stores one of which was absorbed into exiting nearby locations and the results of the other six are included in discontinued operations. Now, let's move to our Steel Manufacturing Business on Slide 11.
SMB achieved sequentially higher operating income of just over $4 million. Benefits from improving demand in the West Coast construction markets and our continuing focus on productivity more than offset the adverse impacts of lower average selling prices and the pressure from imports.
Sales volumes of 142,000 tons increased by 8% sequentially and by 5% from the prior year quarter reflecting lower cost of scrap average net sales prices decreased by $36 per ton sequentially and by $71 per ton compared to the prior year's third quarter. Rolling mill utilization of 69% was lower sequentially due to a scheduled maintenance shutdown which took place during the third quarter.
Moving to slide 12, our cash flow expenditures and net debt. Our third quarter operating cash flow of $64 million enabled reductions in net debt of $51 million and supported our CapEx and our quarterly dividend.
Our end of quarter net debt was $254 million and our net leverage of 52% reflected a sequential decrease of approximately 375 basis points. The positive operating cash flow continued a strong quarterly trend and was driven by our ongoing focus on cash metal trends and our disciplined management of working capital.
Capital expenditures for maintaining the business, environmental and safety related projects totaled $7 million in the third quarter. For fiscal 2015 as a whole we anticipate total CapEx in the range of $30 million to $35 million.
Now, I'd like to turn the presentation back over to Tamara for her summary remarks.
Tamara Lundgren
Thank you, Richard. In the face of rapid price declines and lower demand we are taking substantial steps to improve our profitability and to continue our trend of positive cash flow.
As we look ahead we are not relying on the market to drive improved performance. We have taken this opportunity to reset our productivity targets and commercial strategies in order to operate efficiently at lower levels while still delivering the same customer service, competitive pricing and quality for which we are known.
We are targeting our actions on the things that we can control, lowering our cost, operating efficiently, meeting our customers' needs and generating synergies between our businesses. As a result of these actions, all three of our businesses demonstrated improvements in the third quarter.
During Q3 we also made substantial progress on our fiscal 2015 strategic actions which resulted in earlier than anticipated benefits to our operating performance. Furthermore we are well on our way to completing the integration of our Metals Recycling and Auto Parts businesses into a single division.
We expect the transition will be completed during the fourth quarter. We continue to deliver on our strong trends of positive cash flow amid soft market conditions.
Over the last four quarters we have reduced our debt by more than $100 million while continuing to invest in our businesses and return capital to our shareholders through our quarterly dividend. In closing, I’d like to thank everyone on the Schnitzer team for the extraordinary commitment and dedication you bring to the job every day.
Thank you for working safely and working together to serve our customers, our communities and our shareholders. And now operator, let’s open up the call for questions.
Operator
Thank you. [Operator Instructions] It comes from the line of Phil Gibbs with KeyBanc Capital.
Your line is open. Please go ahead.
Phil Gibbs
Thank you.
Tamara Lundgren
Good morning.
Phil Gibbs
Good morning. I had a question on the $10 million in savings that you had achieved in the third quarter, how much of that was SG&A and how much of that was cost of goods if we could get an approximation there?
Richard Peach
Well in the third quarter Phil, our SG&A in total went down by $6 million. So at least half of it was in or just that included a $2 million insurance reimbursement.
So I would see just under half of it was SG&A and the rest of it was in production costs and cost of goods sold.
Phil Gibbs
So under half in SG&A, so something like $4 million and how much of the incremental savings going forward is going to be SG&A related?
Richard Peach
I think the same proportion if you apply the same proportions.
Phil Gibbs
Okay, about 50:50 something like that?
Richard Peach
Yes.
Phil Gibbs
The insurance settlement piece, did that flow through the corporate, will that flow through corporate SG&A?
Richard Peach
Yes, that’s through corporate SG&A. That’s just a normal recurring reimbursement and we don’t adjust that our results, so because we actually incur those costs originally through our normal recurring numbers.
But we wouldn’t expect the insurance reimbursement to repeat in future quarters.
Phil Gibbs
Okay. So you’ve taken cost associated with it in the past so?
Richard Peach
That is correct. So we don’t adjust out.
Phil Gibbs
But that wasn’t part of the cost savings, was it?
Richard Peach
No that’s not counted, good question that’s not counted in the cost savings for the quarter.
Phil Gibbs
Okay. And then on the nonferrous pricing moved down to $0.74, on a quarter-on-quarter basis, how much did that impact you, I’m just trying to see how to think about that?
Richard Peach
Even though the MRB results were improved from the second quarter to the third quarter, that was probably net of around about $1 million impact of the lower nonferrous and prices and in the Auto Parts division we more than offset weakness in nonferrous prices with improved yields and other productivity savings in labor.
Phil Gibbs
Okay. And then lastly and I’ll jump back in the queue, for the MRB division, I heard you say the adjusted operating income per ton ex the accounting headwinds is going to be likely improved quarter-on-quarter and fourth?
Richard Peach
We had a very significant effect and as we had forewarned of average inventory accounting in the third quarter. So, on an adjusted basis, excluding average inventory accounting we were about $16 per ton in the third quarter.
Looking ahead to the fourth, because we have some incremental cost reductions and cost savings to come and I think we could expect if the markets are stable to improve upon that number excluding the average inventory accounting if that does not recur.
Phil Gibbs
Okay. So, lessened headwinds from that plus the productivity savings.
Okay. Thanks so much.
Operator
Thank you. Our next question comes from the line of Brent Thielman with D.
A. Davidson.
Your line is open. Please go ahead.
Tamara Lundgren
Good morning, Brent.
Brent Thielman
Thank you. Hi good morning.
In Metals Recycling, this is the first in several quarters where domestic ferrous volumes declined relative to prior year levels and to a greater extent in export volumes. Is that related to any particular assets or regions in the platform or was it kind of broadly across the segment?
Tamara Lundgren
We just misheard the first part of your question Brent, I’m sorry can you repeat it?
Brent Thielman
Well, the domestic ferrous volumes had a pretty consistent record of growth there now last several quarters and so this quarter was curious, that was related to any particular regions or kind of across the segment?
Tamara Lundgren
Well, we flex the proportion of domestic and export sales depending from the strength of the market. So I wouldn’t focus it regionally.
I think that you saw in Q3 that we saw a significant rebound in Turkey driven primarily by restocking and that’s what directed for stronger prices that flow. And so, I think you could expect going forward to see similar movements between export and domestic that’s depending upon where markets are stronger at any point in time.
And I actually think it is one of the things that is driving our improved performance versus elsewhere in the market is the diversification of our platform, the geographic diversification is very critical in the weaker global economic environment that we’re seeing.
Brent Thielman
Okay. And then on steel manufacturing from a year-on-year comparison average selling prices still are less than scrap prices and your shipment volumes are higher, but the operating profit for this segment was kind of flat for the quarter relative to last year.
Are there any other moving parts, I know you mentioned maintenance, was maintenance there last year that might have impacted that profit going forward?
Richard Peach
Hi Brent, this is Richard here, it is really going to product mix. The reason, the answer to your question is product mix and we had a higher proportion of rebar sales in the quarter and a low portion of say other products of the sale and the changes in pricing and volumes of them both was the reason why the comparison is the way it is.
Brent Thielman
Okay. And is there any maintenance plans in this quarter or is it behind you?
Richard Peach
It’s behind us.
Brent Thielman
Okay. And then just lastly you continue to take down debt here pretty rapidly, is there a definitive leverage target or ratio you want to get the company to?
Tamara Lundgren
No there is not a definitive ratio. We’ve been very pleased with our ability to generate operating cash flow and drive our debt levels down, continue to invest in our business and continue to support our dividends.
So, I think we’re very happy with that cash generation and then going forward the additional places that we look to allocate cash is stock repurchases and acquisitions that makes sense from a price, synergy and diversification perspective.
Brent Thielman
Okay. Thank you.
Tamara Lundgren
Thank you.
Operator
Thank you. Our next question comes from the line of Timna Tanners with Bank of America.
Your line is open. Please go ahead.
Timna Tanners
Yes, hello everyone.
Tamara Lundgren
Good morning.
Richard Peach
Good morning.
Timna Tanners
Good morning. I wanted to drill down a little bit, you talked a lot in the last several quarters about productivity initiatives and cost reductions and at least in the MRB business it’s a highly variable cost business driven by what you pay for scrap and what you sell scrap for us.
So can you just give a little bit more meat to that productivity initiatives? I don’t know what that means in your business, so do you have any more concrete examples of the types of things that you’re doing and can continue to do?
Richard Peach
Yes, hi Timna, it’s Richard here. You’re correct that there is a combination of variable and fixed costs and the key variable elements are truck costs and labor.
From a productivity point of view on the labor side, we look very closely at the amount of hours it takes to produce a ton and process a ton in that business and look to improve that ratio over time because that’s a permanent saving when you can improve that productivity. We’ve also looked very closely at our structures, so we’ve merged -- integrated departments together, we’ve de-layered that business, so there is less management layers.
And from a fixed cost point of view, we actually as you know adjusted capacity last quarter in the Northeast and in Canada and in Puerto Rico and as a consequence we took some fixed costs of our business. So we continued to be very focused on permanent productivity savings, taking out fixed costs and adjusting our variable cost very nimbly to reflect volumes.
Timna Tanners
Okay, that’s helpful and in the scrap business we’re hearing a lot more talk about permanent closures and rationalization, finally after, this challenging environment, can you give us any thoughts on the timeframe of getting to a more balanced market or a market where you might have some pricing power again?
Tamara Lundgren
Well, I think that we’re going to see consolidation activity occur or capacities have come out of the market voluntarily or due to bankruptcies. I think we’re going to see a steady pace of that over the next 12 to 24 months.
I think that, we’re beginning to see that get reported out steadily and what we see in the market we'll continue that and that’s probably silver linings if you will in the event that pricing weakness continues.
Timna Tanners
Okay. Alright and then just switching on quick one on to the Auto Parts Business, I’m an old timer, I guess, I'm thinking back to when this is supposed to be a really fantastic growth story and now we're shutting stores.
So, where do you see this business longer term? Is this structurally not so interesting or are there still opportunities I mean on a selective basis or how do you think about this going into the next several years?
Tamara Lundgren
Well, we still think it is a terrific business so our views haven’t changed because it really does create a differentiated buying platform for us. We routinely review our sites across all of our businesses to review their profitability, their outlook and then like.
So over the course of the last ten years that I have been here, we have routinely looked at sites closed them, expanded them, merged them. And so the seventh store that we announced, one of them obviously was merged into stores that we had nearby, six were closed.
But as we continue to improve performance in that sector, I would look to continue to invest in that because it does have excellent synergies with MRB and is one of the reasons why we’re merging the two divisions, hopefully beginning, we should be reporting out on that beginning fourth quarter.
Timna Tanners
Okay, thanks for the answers.
Tamara Lundgren
Thank you.
Operator
Thank you. Our next question comes from the line of Martin Engler with Jefferies.
Your line is open. Please go ahead.
Martin Engler
Hi, good morning everyone.
Tamara Lundgren
Good morning.
Martin Engler
Quick question on the impact from inventory headwinds in APB, it seems like it was supposed to be more initially when you had talked about it in the prior quarter. I guess what differed between the actual results and what you were previously expecting?
Richard Peach
Yes, that’s just adjustments to the cost of cars and during the quarter which really ended up changing the amount of the average inventory effects. But I would comment here Martin that we reported 5% operating margin in that business.
The average inventory accounting had about 300 basis point effect. So, if that doesn’t recur and then we have additional productivity initiatives to come, we can see our route back to a double digit margin in that business.
Martin Engler
Okay and looking forward it still seems like there is going to be some inventory cost headwinds, although I guess, from your commentary it seems like it’s a little bit more focus in MRB as opposed to APB in the upcoming quarter, any kind of guidance as far as what the impact would be in MRB per ton?
Richard Peach
Yes, I just want to clarify here. We’ve actually, in MRB we’ve shunned all of our higher cost inventory so assuming more stable market conditions in the fourth quarter we do not expect a recurrence of the headwinds in the fourth quarter.
And as we said in our commentary we would expect effect of adverse average inventory accounting to be substantially reduced in MRB segment in the fourth quarter. And as far as the Auto Parts Business goes, we’ve also turned all of the higher cost inventory in that business and although it was only $2 million in the third quarter we still expect the reduction of average inventory effects and the fourth quarter in that business as well.
So overall substantially reduced effects of average inventory accounting in the fourth quarter.
Martin Engler
So when I think about that, I should think about something closure to zero as opposed to any material impact on the fiscal fourth quarter?
Richard Peach
Correct.
Martin Engler
Okay, thank you very much.
Operator
Thank you. And our next question comes from the line of Andrew Lane with Morningstar.
Your line is open. Please go ahead.
Andrew Lane
Hey, good morning.
Tamara Lundgren
Good morning.
Andrew Lane
Yes, you delivered a nice sequential pickup in rebar shipments in the quarter, could you give us a sense as to how much of this is related to seasonality versus what might be a more sustainable improvement and demand for rebar? And then could you provide some commentary as to just going to kind how you’re seeing non-res construction activity trending along the West Coast?
Tamara Lundgren
We have seen a continued improvement in demand for rebar of the West Coast now for the last couple of years. And that’s primarily non-residential construction and some private infrastructure, but we have not yet seen any pick up in public infrastructure and obviously I'll look forward to hopefully an infrastructure bill being passed if not by the current administration, by the next administration in 2016.
And so, it is almost exclusively non-res and there has been a steady improvement. Our customer sentiment is very positive, demand is very good and while we do see some impacts from imports, we’ve seen steadily improving demand and positive settlement from our customers.
Andrew Lane
Okay, that’s great color thanks. And I'm going to change gears that we saw pretty sizable downtick in your average selling prices for nonferrous scrap after they had been relatively steady over the last couple of years, could you comment about how you’ve seen the product mix of your nonferrous shipment volumes change overtime or there any trends worth mentioning here and what was the key driver of that lower non-ferrous average selling price in the quarter.
Thanks.
Tamara Lundgren
The nonferrous weakness in pricing is really aluminum which is the primary nonferrous material in our mix. So, and that’s been driven really by the same weakness if you will or the same drivers of weakness that we see in ferrous, which is excess production, the strong dollar and the additional impact is to drawdown of LME warehouse inventories.
Andrew Lane
Great, thanks. Thanks for the color.
Tamara Lundgren
Thank you.
Operator
And that does conclude today’s question-and-answer portion. I’d like to turn the call back over to Tamara Lundgren for any closing remarks.
Tamara Lundgren
Thank you, operator and thank you for joining us on our call today and for your interest in our Company. We look forward to speaking with you when we announce our fiscal 2015 year end result in October.
Thank you.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program.
You may all disconnect. Everyone have a great day.