Jan 5, 2017
Operator
Good day, ladies and gentlemen and welcome to the Schnitzer Steel First Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.
I would now like to introduce your host for today’s conference, Ms. Alexandra Deignan, Vice President of Investor Relations.
Ma’am, you may begin.
Alexandra Deignan
Thank you, Kayleigh and good morning everyone. I am Alexandra Deignan, the company’s Vice President of Investor Relations.
Welcome to Schnitzer Steel’s first quarter fiscal 2017 earnings presentation. 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 release 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 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 and Chief of Corporate Operations.
Tamara Lundgren
Good morning, everyone. Welcome back from the holiday break and thank you for joining us on our fiscal ‘17 first quarter conference call.
This morning, we issued our press release, which is posted along with our slides on our website. On our call today, I will review our first quarter results, market trends and the drivers underpinning our performance.
Richard will then provide more details on our segment performance and capital structure and I will wrap up with some closing remarks and then we will take a few questions. So, let’s start now on Slide 4.
Earlier this morning, we announced our first quarter results. Historically, our first quarter has been seasonally lower as weather and customer de-stocking coming into calendar year end lead to lower volumes and lower sales prices.
We reported a $0.03 adjusted loss per share, which reflects a very significant improvement versus a year ago. Our year-over-year improvement was driven by our auto and metals recycling division, which delivered its best first quarter results since fiscal 2012 primarily due to continued execution on our cost savings and productivity initiatives.
In our steel manufacturing business, however, we reported lower year-over-year performance, resulting from a major equipment upgrade and a maintenance downtime, which affected our earnings per share by $0.09 as well as from the adverse impact of elevated levels of import. On a sequential basis, both AMR’s and SMB’s results reflected lower volumes and lower average selling prices as prices for scrap and finished steel products were on a downward trend coming into the quarter, before strengthening in late October and continuing to improve through November.
On a consolidated basis, we achieved approximately $7 million in additional benefits during the quarter from our $30 million of cost savings and productivity initiatives announced in the second quarter of last year. AMR generated $5 million of those benefits while the remainder was split between SMB and corporate.
We have now achieved $20 million out of the $30 million target and we expect to achieve substantially all of the remaining $10 million of annual benefits by the end of fiscal ‘17. If we look to the market, when we held our fourth quarter earnings call, we discussed key favorable industry trends to watch.
At that time, we were seeing rising iron ore and met coal prices. This continued through the first quarter and strengthened the competitiveness of scrap compared to these raw material alternatives.
Additionally, we highlighted the potential of stabilizing exports by China of both semi-finished and finished steel products as a result of production cuts and industry consolidation. All of these trends contributed to the stronger market conditions we saw in the first quarter, which combined with our own internally generated initiatives led to our year-over-year improved results.
So now, let’s turn to Slide 5 to take a more detailed look at these market trends. On this slide, you can see pricing trends for ferrous and nonferrous scrap as well as for iron ore and met coal.
As the ferrous chart in the upper left illustrates, at the beginning of the first quarter, market prices fell about $20 per ton from August levels or about 9% before strengthening in the latter half of October and then sharply rising in November and December. Unlike last year, when ferrous scrap prices dropped to $175 per ton, representing a near-decade low.
Ferrous prices during this year’s first quarter stayed above $200 per ton. As a result, we did not see the severe contraction in ferrous supply flows that we saw last year.
And in the nonferrous scrap market, we saw similar price strengthening with demand remaining steady in both the Asian and domestic markets. Looking at the graph on the upper right, iron ore pricing began the quarter with an early dip, falling below $60 per ton and then strengthening by roughly 30% to nearly $80 per ton.
Met coal prices followed a similar path driven by stronger demand in Asia amidst the tighter supply market. The sharp rise in both of these raw material costs resulted in competitive ferrous scrap pricing and increased global demand for scrap.
If we now move to Slide 6, we will review trends with finished steel markets. Between May and October pricing for imported rebar dropped by more than 20% from peak prices.
That drop in prices and the resulting advantage versus domestic prices attracted an elevated level of imports into the U.S. The overhang from this elevated summer import activity overshadowed the long product pricing improvement, which occurred during the latter part of the quarter.
This import activity was also a key contributor to the decline in domestic capacity utilization during the period. Since the end of the quarter and through December, however, steel pricing has improved as a result of higher scrap prices and customer restocking in anticipation of higher finished steel prices.
Looking forward, these market trends, combined with our own internal strategic initiatives, underpin prospects for a stronger second quarter compared to both our prior year and sequential results. In AMR, demand has been strong.
We also have tailwinds of continued execution on our cost savings and productivity initiatives, industry rationalization and the potential for increased infrastructure investment in both the U.S. and in a number of countries around the world.
Additionally, we are seeing organic growth in AMR as a result of the synergies created via the auto and metals integration. For example, collaborative buying efforts are yielding improved nonferrous and car purchase volumes, which have increased by approximately 10% and 20% year-over-year, respectively.
For SMB, while their second quarter results will still be impacted by the production ramp up, following their equipment upgrade, longer term, we are cautiously optimistic that higher demand and prices due to stronger domestic economic growth and infrastructure investment will lead to higher sales volumes and improved profitability. So, now let me turn it over to Richard for a more detailed review of our segment performance and our capital structure.
Richard Peach
Thank you, Tamara and good morning. I will start with a review of the first quarter operating trends for our auto and metals recycling business.
Compared to the prior year quarter, AMR’s adjusted operating income of $12 million was up significantly. The primary driver was the continued strong execution of our cost savings initiatives, which contributed $5 billion in additional benefits at AMR compared to last year’s first quarter.
These cost savings continued to come from several sources, including production cost efficiencies, SG&A reductions and from previous actions to optimize our asset portfolio. Adjusted operating income per ton for the quarter was $15 and excluding average inventory accounting, was $17, both measures up significantly from last year’s first quarter.
AMR’s first quarter results were adversely impacted by average inventory accounting of approximately $2 million, which compared to a $7 million adverse impact in the same quarter of last year. The reduced impact year-over-year came from less price volatility and improving market conditions in the second half of the quarter.
Compared to last year, ferrous sales volumes were up by 4% on stronger export demand. However, on a sequential basis, seasonally lower demand led to a drop in ferrous sales volumes of 9% to 834,000 tons.
Nonferrous sales were also lower sequentially by 11%, reflecting normal seasonality and particularly strong shipment levels in the previous quarter. Compared to last year, nonferrous sales volumes were up by 22% on improved market conditions and increased supply flows, including growth in car purchase volumes for our retail stores.
Looking ahead, second quarter performance is expected to include higher ferrous average selling prices and sales volumes and an anticipated favorable impact from average inventory accounting as well as continued benefits from previously announced cost reduction and productivity initiatives. Now, moving to Slide 8, I will cover the operating trends for our steel manufacturing business.
During the first quarter and to support our productivity initiatives, SMB decommissioned all rolling mill equipment and completed a major upgrade to our more technologically advanced rolling mill facility. The installation, together with maintenance, required production downtime, which led to approximately $2.5 million of expenses that could not be capitalized into inventory.
This was the primary driver of SMB’s adjusted operating loss of $3 million for the quarter. The combination of customer destocking and import competition led to sales volumes and selling prices being down sequentially by 18% and 7% respectively.
Compared to the prior year quarter, sales volumes were also lower by 18% and selling prices were down by 11% on increased pressure from lower-priced imports and an overhang from higher levels of imported long products at the end of summer 2016. During November, market conditions reversed the downward trend and by December, long product prices rose to about $500 per ton, which primarily reflected the flow through of higher raw material cost for scrap.
Looking ahead, we currently expect SMB’s second quarter performance to improve slightly on a sequential basis due to anticipated higher selling prices. However, while we expect the expenses associated with the equipment upgrades to not reoccur, we anticipate that upside will be offset by higher inventory cost associated with low production volumes resulting from the downtime and from higher raw material cost of scrap.
Moving to Slide 9, I will cover our trends on cash flow, capital expenditures and our net debt. Operating cash flow was $6 million, which represented our eighth conservative quarter of positive operating cash flow.
This trend demonstrates the resilience of our business model in different market conditions. Sequentially, the first quarter cash flow was lower from a combination of the change in profitability and from movements in working capital.
During the quarter, we invested $11 million in capital expenditures, including projects to improve our operating efficiency, equipment upgrades and replacement, environmental projects and for safety-related programs. We also returned $5 million of capital to shareholders through our 91st consecutive dividend.
As a consequence, net debt of $180 million was higher sequentially with leverage of 27%. The effective tax rate in the first quarter was 8.6% as we expect to utilize prior year tax losses to offset a high proportion of any new tax expense on this year’s performance.
For fiscal ‘17 as a whole, we currently expect the effective rate to approximate the first quarter level subject to a future performance. Now I will turn the remainder of our presentation back over to Tamara for her summary remarks.
Tamara Lundgren
Thank you, Richard. Our fiscal year is off to a better start with the delivery of higher year-over-year performance in our first quarter primarily due to the success of our cost savings and productivity initiatives, which have enabled us to deliver improved EBITDA and positive operating cash flow.
Our balance sheet remains strong with the low leverage as we maintain our focus on disciplinary investment in our business and returning capital to our shareholders. Looking ahead to our second quarter, we have seen prices continue to rise for ferrous scrap in December and early commentary for January appears to reflect further strengthening.
Demand has been strong in both the export and domestic markets and ferrous scrap remains competitive against alternative raw materials. Based on current market conditions, we expect our Q2 financial performance to be materially higher than Q1 as AMR’s operating leverage should allow us to take advantage of the volume and pricing tailwinds we have been experiencing since the end of the first quarter.
We remain on track to deliver our previously announced cost savings and productivity plans and we will continue our focus on lowering our cost, maximizing our metal spreads, delivering positive operating cash flow and driving further synergies and growth within our businesses. Our focus is clearly on increasing long-term shareholder value through a variety of strategies intended to drive operational efficiencies, meet our customers’ needs, deliver sustainable growth and achieve economic benefits.
In closing, I would like to thank our employees. You have continued to withstand significant market challenges by working together across our platform to execute our strategic plan without wavering from our core values of safety, environmental stewardship, quality, and customer service.
You’ve shown your commitment to excellence and to best-in-class operations as we continue to raise the bar. You are finding ways to improve in a still challenging market environment.
My thanks go to each of you as you have truly demonstrated why we have been a leader in the recycling industry for well over a century. Now operator, let’s open up the call for questions.
Operator
[Operator Instructions] Our first question comes from the line of Evan Kurtz with Morgan Stanley. Your line is open.
Evan Kurtz
Hey, good morning and Happy New Year, Tamara, Richard.
Tamara Lundgren
Good morning.
Evan Kurtz
So I just wanted to drill down a little bit on the 2Q guidance. I mean, it seems like a lot of things are lining up well for the second quarter.
You have rising scrap prices demand, domestic exports is strong, cost savings initiatives, inventory accounting tailwinds. Is it reasonable to assume that AMR results are going to be significantly stronger quarter-on-quarter?
I noticed you didn’t really use any adjectives other than kind of sequentially better, but I was just trying to gauge whether the consensus estimate out there for 2Q right now was kind of in the realm of possibilities for you?
Tamara Lundgren
Well, Evan, I think you are correct in saying that we are looking for a strong second quarter. And the reason we didn’t provide any further color on it is we are really only one month into our quarter.
And so it’s early on, but the indicators out there are all very positive for volumes, for demands, for prices, for our productivity initiatives, for our growth initiatives. So that’s as far as we can go at this point in the quarter.
Evan Kurtz
Okay, got it. And then just one other one I had.
You mentioned you had a major equipment upgrade in the steel business. Just wondering what specifically that was and if that has any impact on your earnings power in that segment as we look out going forward whether its new products, volumes, costs?
Richard Peach
Yes, hi, Evan. Yes, the upgrade is really connected with material handling efficiency in our more technologically advanced rolling mill.
So, the whole purpose of that is to increase our operating efficiency. And we intend as we see some improvement in the market for our steel business that that would provide benefits to our bottom line going forward and that’s why we did that at this time.
Evan Kurtz
What do you think your kind of effective capacity is in that segment right now?
Richard Peach
Well, at the moment, it’s around about 600,000 tons, which is well above our existing sales profile. So we have got quite a lot of headroom as the market improves there.
And if we saw sustainable improvement beyond that, of course, we’d further invest in our rolling mill to increase capacity.
Evan Kurtz
Great, thanks. I will hand it over.
Tamara Lundgren
Thank you.
Operator
Thank you. Our next person comes from the line of Phil Gibbs of KeyBanc.
Your line is open.
Phil Gibbs
Good morning. Happy New Year.
Richard Peach
Good morning. Happy New Year.
Took the words right out of my mouth. How are you?
Phil Gibbs
Well. Had a question on the $10 million of the benefits that you will get from the restructuring initiatives, where should we expect those to come through in terms of either on the SG&A side or more in the, call it, the procurement or cost of goods side?
Richard Peach
Hi, Phil. It’s Richard.
They are mainly going to come through on the cost of goods sold side. As far as SG&A is concerned, the savings are largely baked in at this time.
So that amount of SG&A we’ve had this quarter of $37 million would indicate an annual run-rate there of somewhere in the $150 million to $155 million level. As far as how we are generating these additional savings that are coming from a variety of places, we have some transportation efficiency initiatives going on, continuing procurement savings.
We have benefits from actions we have taken to address our asset portfolio in terms of fidary art consolidations and dealing with surplus equipment. So we have got a number of different sources of savings and we are confident that the remaining or the substantially all of the remaining $10 million of these savings will come through in the rest of fiscal ‘17, so where you will see that is really through our operating income per ton.
Phil Gibbs
Okay, great. And then on the side of the nonferrous, excuse me – the ferrous volume growth that you anticipate here on a sequential basis, is that domestically export or both?
And then just generally speaking, that being up sequentially is unusual from a historical standpoint, I think it’s normally down. So, are we to assume that that’s some restocking and some better global momentum from some of the shift that we saw in the met coal price?
Thanks.
Tamara Lundgren
So, I think the volumes will come both export and domestic and you are right in terms of the activity which is stronger. And I think you hit the nail on the head.
It’s a combination of a multiplicity of factors all of which you articulated and we agree with.
Phil Gibbs
Thank you.
Operator
Thank you. And our next question comes from the line of Andrew Lane with Morningstar.
Your line is open.
Andrew Lane
Hi, all.
Tamara Lundgren
Good morning. Happy New Year.
Andrew Lane
Good morning. Couple of questions here.
First of all, you commented in your prepared remarks that higher iron ore and met coal prices have increased the relative attractiveness of scrap. But it looks like in the quarter, your domestic and export sales mix was about the same as it was last year.
So has the increase particularly in met coal prices caused any notable change in terms of trade flows for Schnitzer?
Tamara Lundgren
I think that the met coal issue has had two effects and recognize there is a bit of a lag in terms of when it’s in place and when you see the volumes occur. One is price and the second is increased demand from a wider source of customers.
But that uptick really took place towards the latter half of the quarter and we expect to see that benefit more in the second quarter than we saw in the latter – at the end of the first quarter.
Andrew Lane
Okay, great. And then clearly, you have made a lot of progress reducing SG&A in recent years from just under about $200 million to $149 million in fiscal 2016.
Assuming no massive capacity changes for either of your segments, did you have a general kind of mid-cycle SG&A figure you are targeting in mind?
Richard Peach
Well, I think we have really kind of baked in our savings plan from the last 4 years. So, that run-rate that we are on now, on the $150 million type level, $150 million to $155 million is where we see our ongoing run-rate and SG&A.
Andrew Lane
Okay, thank you very much.
Tamara Lundgren
Thank you.
Operator
Thank you. And I am showing no further questions at this time.
I’d like to turn the call back to management for closing remarks.
Tamara Lundgren
Thank you, operator and thank you everyone for joining us on our call today and for your interest in our company. We wish you a happy and prosperous 2017 and we look forward to speaking with you again in April when we report our second quarter results.
Thank you.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect.
Everyone, have a wonderful day.