P a g e 1 Schnitzer Steel Industries, Inc. Fourth Quarter Fiscal 2018 Earnings Call October 24, 2018 Operator Good day, ladies and gentlemen, and welcome to Schnitzer Steel's fourth quarter 2018 earnings release call and webcast. (Operator Instructions). As a reminder, this conference is going to be recorded. I would now like to introduce your host for today's conference, Mr. Michael Bennett, Investor Relations. Sir, you may begin. Michael Bennett, Sr. Director Investor Relations Thank you, Sandra. Good morning. I'm Michael Bennett, the company's Senior Director of Investor Relations. I am happy to welcome you to Schnitzer Steel's fourth quarter and fiscal 2018 earnings presentation. In addition to today's audio comments, we have issued our press release and posted a set of slides, both of which you can access on our website at www.schnitzersteel.com or www.schn.com. Before we get this started, let me call your attention to the detailed safe harbor statement on Slide 2, which is also included in our press release and in the company's Form 10 K, which will be filed later today. As we note on Slide 2, we may make forward looking statements on our call today such as our statements about our outlook, targets for growth and future margin expansion. Our actual results may differ materially from those projected in our forward looking statements. Additional information concerning factors that could cause actual results to materially differ from those in the forward looking statements is contained in Slide 2 as well as our press release of today and our Form 10 K. 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. Thank you, Michael, and good morning, everyone. Thank you all for joining us on our fourth quarter and fiscal 2018 conference call. We appreciate your interest in our company, and we look forward to sharing our results with you this morning.
P a g e 2 On our call today, I'll review our quarterly and fiscal year performance, the market and macroeconomic trends underlying each of our businesses and our strategic growth initiatives. Richard will then provide more details on our segment performance and our capital structure. I'll wrap up and then we'll take your questions. But before we start, I'd like to highlight a few key accomplishments by our teams in fiscal '18. First, we delivered our best fourth quarter and full year performance in 7 years. Second, we also delivered a year ahead of schedule on our 3 year plan for volume growth and increased margins, hitting our fiscal '19 targets in fiscal '18 with company wide ferrous volumes of 4.3 million tons and AMR adjusted operating income per ton of $45. We are on our way to achieving our accelerated volume target of 5 million ferrous tons by the end of fiscal 2020, which we expect will generate additional operating leverage. Third, we delivered on our ability to reduce the impact from the disruptions in the nonferrous market, increasing our nonferrous sales volumes by 16% sequentially and by 15% for the year as a whole. We have in place a focused nonferrous business strategy that we believe will position us for success in this market. And lastly, we delivered $160 million of operating cash flow for the year. As a result, our strong balance sheet positions us to further build out our platform through investment and transactional growth. So now let's look at some of the details beginning on Slide 4. Earlier this morning, we announced our fiscal 2018 fourth quarter adjusted earnings per share of $2.06, which included a discrete tax benefit of $1.06. These results represent our best fourth quarter earnings since fiscal 2011, even when excluding that tax benefit. I can't say enough about the excellent performance of our teams this quarter and throughout the year. Both divisions delivered strong operating results year over year, notwithstanding the headwinds that were present this quarter in both the ferrous and nonferrous markets. Our adjusted consolidated operating income of $38 million reflects an increase of more than 70% versus last year's fourth quarter. AMR's ferrous sales volumes increased by 19% year over year as we continued to benefit from our commercial initiatives to expand our supply channels and diversify our sales. AMR's nonferrous sales volumes also grew, increasing by 11% year over year and 14% sequentially as our sales diversification strategy and investments in nonferrous extraction processes reduced the impact from China's trade actions and tighter import restrictions. Driven by these volume increases and the operating leverage resulting from our ongoing productivity initiatives, AMR's adjusted operating income per ton increased by 18% versus last year's fourth quarter, reaching $33 per ton. CSS also delivered excellent results in the quarter with operating income of $14 million. In line with the guidance we provided with our third quarter results, finished steel sales volume at CSS were down in the fourth quarter due to planned maintenance, including rolling mill upgrades geared to produce future gains and productivity. Despite the year over year lower volumes, operating income nearly doubled compared to last year, underpinned by higher prices and demand, metal spread expansion, low levels of imports and benefits from productivity and efficiency investments.
P a g e 3 Now let's take a look at our full year results on Slide 5. Just as the fourth quarter represented our strongest Q4 since fiscal '11, our full year results also reflect our strongest EPS and adjusted operating income since fiscal '11. On a year over year basis, our consolidated adjusted operating income almost tripled and our adjusted EBITDA almost doubled. The combination of our increased profitability and effective working capital management enabled us to generate strong operating cash flow, which allowed us to increase our investments in growth CapEx and return capital to our shareholders through both our dividend and share repurchases while reducing our debt to its lowest level in the past 8 years. Our working capital management reflects our very disciplined focus on cash metal spreads, cost efficiencies and turning inventory, and was notably effective this year, particularly in light of the rapidly changing dynamics in the nonferrous market in the last quarter. Our teams were nimble, focusing on moving material, optimizing metal spreads and generating operating leverage, all of which contributed to our very strong financial and operating results. Let's turn now to Slide 6 to review metal market trends. Although ferrous export prices weakened towards the end of the fourth quarter, driven primarily by economic volatility in Turkey, prices have since rebounded and are continuing to reflect steady and broad based demand into October. Overall, the ferrous export market exhibited significant strength in fiscal 2018 with U.S. exports up 24%. Just as importantly, steel scrap usage has significantly outpaced the growth in crude steel production through the first 6 months of calendar year 2018 in a number of key consuming countries, including China, the U.S., Japan, Turkey and Russia. The long term demand for recycled metals is expected to continue to grow, underpinned by several factors, including the increased focus on environmental policies, lowering greenhouse gas emissions and reducing energy consumption. In the domestic market, ferrous prices decreased in October I'm sorry, in August and September, on the back of seasonal mill outages. Recent domestic prices for October, however, are up versus September as demand from U.S. domestic mills remains healthy. Looking at the upper right hand chart on this slide, prices for met coal and high grade iron ore are trading at levels which are supportive of the continued competitiveness of ferrous scrap against semi finished goods such as billets. This chart also illustrates the widening price differential between low grade and high grade iron ore, which is being largely driven by China's enforcement of tighter environmental regulations. The fourth quarter was much more volatile for the nonferrous markets, primarily zorba. So now let's turn to Slide 7 for a deeper dive into our nonferrous activities and strategy. Much of the focus in the market during the quarter was on China's decision to impose a 25% tariff on all scrap imports, an additional 25% tariff on imports of aluminum scrap from the U.S., stricter quality inspection procedures and their announcement of a ban on the import of certain nonferrous materials effective January 1, 2019. All of these factors led to a significant weakening in zorba pricing. While these actions were all new in 2018, this continued a trend which began in 2013, with China's introduction of
P a g e 4 their Green Fence program followed by National Sword in 2017. Both programs were intended to increase the quality of scrap metal products imported into the country. China began buying zorba in early 2000s and quickly became the largest importer of U.S. zorba. China's move away from nonferrous scrap, for whatever reason, whether motivated by environmental concerns, retaliatory trade actions or their own supply, has precedence in the ferrous market. In 2009, China was the largest buyer of U.S. ferrous scrap, importing over 6 million tons. But by 2015, China's ferrous scrap imports fell below 700,000 tons. Yet global demand for ferrous scrap remains high. Similar to what happened with U.S. ferrous exports to China, the nonferrous market is finding new outlets for material displaced by reduced shipments to China as there continues to be broad based demand for this valuable product. Demand in countries such as India, Japan, South Korea, Malaysia, Taiwan and Thailand have largely been able to offset the drop in China's imports of aluminum scrap from the U.S. While zorba prices dropped from around $0.65 per pound to the mid $0.40s during Q4, export pricing has recovered into the $0.50s, depending on quality and destination. The surge in shipments to countries in Asia ex China is helping the export market find a new equilibrium with increased competition adding some price support. Notwithstanding the volatility in nonferrous pricing and the abrupt demand shifts during the quarter, we increased our nonferrous sales volumes by 16% sequentially. We achieved our highest quarterly nonferrous sales since 2012, while at the same time shipping only about a quarter of our nonferrous volumes to China. Our nonferrous business has two main sources of supply, nonferrous purchased from third parties and nonferrous produced from our shredding operations. Our nonferrous business strategy has been based on three principles: First, increasing the efficiency of our processes in order to produce a quality product for our customers on a cost effective basis. As it relates to zorba, we are highly focused on ensuring that the cost of increased processing to create a purer product does not outweigh the differential in price received for the product. Second, over the last 8 years, we have continued to invest in nonferrous extraction technology in order to recover more metal from the shredding process. This reduces landfill costs and also provides us with more nonferrous material from the unprocessed scrap that we have already purchased to shred. Most recently in fiscal '18, we rolled out additional copper separation technology utilizing wire choppers. We will continue to deploy this technology during fiscal '19 as well. And third, we are planning to continue to introduce additional processing technologies that will increase our throughput, lower processing costs, increase recovery rates and create products with the metallic content sought by our various customers around the world. We expect these new technologies to be rolled out during fiscal '19 with the full year run rate benefits by the end of fiscal 2020.
P a g e 5 We have a great track record in this area and expect these investments to deliver returns well in excess of our cost of capital and to pay back within 2 to 3 years. Now let's turn to Slide 8 for a review of steel market trends. During the fourth quarter, the U.S. long products market continued to remain strong. Average domestic rebar pricing in the quarter was up approximately 34% year over year supported by strong GDP growth and broad based demand across multiple industry sectors, including transport, energy and construction. The rise in rebar prices continued to outstrip the rise in scrap prices, leading to the highest rebar to scrap metal spreads in the past 8 years. Lower imports have also continued to benefit domestic utilization and pricing. We expect CSS to continue to benefit from these macroeconomic and market conditions. Let's move now to Slide 9 to review the leading economic indicators impacting our industry. The key leading indicators for scrap generation and steel demand continued to display solid fundamentals. The U.S. and industrial production index continued its year over year rise on stronger durable goods orders and improved GDP growth. Personal consumption and consumer confidence in the U.S. continued to increase. The improved white goods appliance shipment trend, the high average age of vehicles on the road and the more aggressive pricing of both used and new light vehicle sales are all supportive of continued strong supply flows of scrap, including from end of life vehicles. Furthermore, the lower tax rate environment and capital investment incentives are both spurring corporate and individual spending and benefiting the domestic steel market. Barring long term negative impacts from current and potential tariffs, these domestic economic trends, along with prospects for continued global growth, lend considerable support to greater supply and demand for recycled metals and finished steel products going forward. Let's now turn to Slide 10 to discuss the progress of our strategic initiatives. Our 3 year plan to increase our fiscal 2016 volumes by 30% and expand our margins was achieved a year early through a combination of excellent performance by our teams as well as positive market conditions that were stronger than we anticipated when we set these targets. Our company wide ferrous volumes grew to 4.3 million tons at the end of fiscal 2018, and AMR's average adjusted operating income per ton for the fiscal year reached $45. We are now targeting 5 million tons company wide by the end of fiscal 2020, which we expect will generate additional benefits from operating leverage. We have also commenced an efficiency initiative, which should deliver $10 million in annualized benefits over the course of fiscal '19. Our investments in additional nonferrous extraction and processing technologies will also continue through 2020. Together with our sales diversification strategy and purchase price adjustments, these actions should continue to mitigate the impact of lower zorba prices and support our margins at levels consistent with our fiscal '18 average assuming stable market conditions. Political, economic and regulatory uncertainties could of course, impact the timing and trajectory of these goals. Our strong balance sheet and operating cash flow also provide an opportunity for us to further build out our Auto and Metals Recycling platform through transactional growth.
P a g e 6 So now, I'll turn the presentation over to Richard for a more detailed review of our financial performance and our capital structure. Richard Peach, Senior Vice President, Chief Financial Officer and Chief of Corporate Operations Thank you, Tamara. I'll start off with a review of our consolidated financial performance in fiscal '18. For the full year, the strong operational performance in both our AMR and CSS businesses led to consolidated adjusted EBITDA of $198 million, which represented an increase of 90%. Both businesses delivered yearover year improvements in operating income in every quarter throughout the entire fiscal year. Achieving this sustained performance improvement was driven by relentless focus on volumes, margins and productivity. This approach is embedded in our culture and will continue in fiscal 2019 and beyond. Our return on capital employed also grew significantly in fiscal '18. Even excluding discrete tax benefits, we achieved an ROCE of over 15%, well in excess of our cost of capital and which demonstrated the successful execution of our growth strategy. Now let's turn to Slide 12 to discuss our Auto and Metals Recycling business in more detail. AMR's adjusted operating income per ferrous ton was $33 in the fourth quarter, which was 18% higher than last year. For fiscal '18 as a whole, AMR had adjusted operating income per ton of $45, a 55% increase year over year. In the fourth quarter, the improved year over year profitability was driven by increased ferrous sales volumes, higher average ferrous and nonferrous net selling prices, expanded metal spreads and our continuing focus on productivity. These positive factors were partly offset by a negative impact from average inventory accounting and higher SG&A expense, including impacts from higher volumes yearover year. Compared to the third quarter, AMR's operating margins were impacted by the fall in zorba prices, lower ferrous export prices to Turkey, seasonally lower retail sales and an adverse impact of average inventory accounting which compared to a benefit in Q3. In the fourth quarter, we continued to benefit from sales diversification and our commercial initiatives to increase supply. AMR's ferrous sales volumes were over 1 million tons, representing year over year growth of 19% and a sequential increase of 5%. Despite the challenges in making sales to China, our nonferrous sales volumes were also higher, up by 14% sequentially and by 11% compared to last year's fourth quarter. This demonstrated the flexibility of our sales distribution platform, our strong customer relationships and the quality of our nonferrous products. Average ferrous and nonferrous net selling prices in the fourth quarter were up year over year by 23% and 8%, respectively, but down by 5% and 7%, respectively, on a sequential basis. Average inventory accounting had a negative impact in the quarter of $2 million, which represented an adverse swing of $4 per ton sequentially and $5 per ton year over year. Looking ahead to the first quarter of fiscal '19, AMR's ferrous volumes and nonferrous volumes are both expected to increase in a range of 10% to 12% year over year. We anticipate AMR's operating income per
P a g e 7 ferrous ton to include a modest adverse impact from average inventory accounting and to be at levels consistent with the fourth quarter of fiscal '18, as the price drops which occurred in Q4 are still working their way through the first quarter of fiscal '19. Now, let's move to Slide 13 and discuss Cascade Steel and Scrap. CSS fourth quarter adjusted operating income was $14 million, an increase of $7 million compared to last year and the best quarterly performance since 2008. This significant improvement was primarily driven by the steady demand for finished steel products and lower imports, which together led to expanded metal spreads as increases in selling prices greatly outpaced the increase in costs for steelmaking raw materials. Even though finished steel sales volumes were up by 5% for the full year, volumes in the fourth quarter were down year overyear by 14% due to planned maintenance, which included upgrades to our rolling mill to enable further gains in productivity. Average selling prices for finished steel were higher by 31% year over year, which reflected the strong West Coast market environment, the reduced pressure from imports and higher cost for raw materials and consumables, including the cost of graphite electrodes. Productivity improvements for the full year totaled $6 million as we continue to see synergy benefits from the integration of our steel mill and Oregon metal recycling operations, which we completed at the end of fiscal 2017. Looking ahead to the first quarter, we expect finished steel sales volumes to approximate last year's first quarter. Operating income is expected to benefit from expanded metal spreads and be higher by $3 million year over year. Moving on, let's proceed to Slide 14 to review our capital structure. In the fourth quarter, we generated operating cash flow of $106 million. And for the full year, we achieved operating cash flow of $160 million, driven by our high profitability and effective management of working capital. This strong cash flow allowed us to reduce net debt sequentially by $60 million and resulted in a net debt to adjusted EBITDA ratio of only 0.5x at our fiscal year end. We also recently amended and extended our credit revolver and the new $700 million facility has a final maturity date of August 2023. While we are targeting another year of strong operating cash flow in fiscal 2019, our operating cash flow in the first quarter is expected to include higher working capital, primarily due to the timing of the cash payout of fiscal '18 annual incentive compensation, which we do each year in November. Capital expenditures in fiscal '18 totaled $78 million. This included a combination of normal spend on maintaining the business, upgrades and replacement of mobile equipment to support growth, major environmental capital projects and further advancement in nonferrous processing technology. Looking ahead to fiscal '19, we currently expect to invest at a similar level, excluding any further capital expenditures investments to support growth.
P a g e 8 In the fourth quarter, we returned capital to shareholders through our 98th consecutive quarterly dividend and the repurchase of 250,000 shares. During fiscal '18 as a whole, we repurchased 516,000 shares, which represents almost 2% of the total shares outstanding. Turning to corporate items, corporate costs in the fourth quarter were $11 million, a sequential reduction of $4 million, which primarily resulted from lower expense for professional services. Looking ahead to the first quarter, we expect corporate costs to be lower by $3 million compared to the prior year first quarter. Our effective tax rate in the fourth quarter was a benefit of 65% as a result of a discrete tax benefit of $30 million associated with the release of valuation allowances on certain deferred tax assets. In fiscal '19, we expect to see a normalization of our effective tax rate in the range of 25%, although our actual tax rate will be subject to our level of financial performance and other relevant factors in this complex area. I will now turn the presentation back over to Tamara for her summary remarks. Thank you, Richard. In the fourth quarter and for the full fiscal year, we delivered another strong set of financial results despite challenges in the ferrous and nonferrous markets. Our robust performance can be attributed to the steps we have taken to improve our productivity, diversify our sales, expand our supply channels and structurally reduce costs while generating synergies within our operations. Our balanced business model has consistently generated positive operating cash flow, enabling us to continue to invest in organic and transactional growth, return capital to our shareholders through our dividend and repurchase of shares and reduce our debt. In closing, I'd like to thank our employees, many of whom I know are listening into our call this morning. I also want to call out specifically our colleagues and their families who live in the areas impacted by Hurricane Michael. We are thankful that you are safe and are hopeful that our relief efforts are assisting you as you face the challenges brought on by this natural disaster. To all of you: your operational excellence is one of the cornerstones of this company's foundation, and our performance is directly related to your ability to drive best in class results without wavering from our core values of integrity, safety, environmental stewardship, quality and customer service. Thanks to your collective contributions, we delivered our best annual operating performance since fiscal '11. My thanks go to each of you as you've truly demonstrated yet again why we have continued to be a leader in our community and the recycling industry for well over a century. Now, operator, let's open up the call for questions. Philip Gibbs, KeyBanc I had a question, Tamara, just on some of the assumptions behind keeping the EBIT per ton in AMR in that $45 zip code, given all the crosscurrents. Are you assuming that the recent revisions to auto shreddable
P a g e 9 prices, meaning the fact that they've come down quite a bit since the middle of the year, are you thinking that they're going to stay subdued, or are you factoring in those coming back up a little bit to stimulate flows? Just kind of wanted to understand what your assumptions are there. And then also, some of the $10 million benefits you're looking for from the investments that you're making this year on the nonferrous side, when do those get fully absorbed? And that, is that an absolute $10 million level for '19? Or is it stepping up to that annualized rate? Sure. So let me start on the second one, on the productivity initiative. It's really based on increased throughput, on lower processing cost, improved asset management and just better efficiencies throughout our operations. The $10 million is for the full fiscal '19, so we expect to see that this fiscal year. In terms of being able to sustain our margins at fiscal '18 levels, we're really assuming there the things that I spoke about, increased sales diversification, adjusting purchase prices, the efficiencies in our system and the continued investment in nonferrous technologies. And we think with that, keeping prices at about where they are and where they have been, mid $300 s levels, depending on coast and destination, should enable us to deliver those results. Philip Gibbs, KeyBanc So you're assuming then, that recent feedstock prices hold as well in that scenario? There is obviously seasonality with respect to supply flows and prices. But over the course of the year, we're anticipating similar to last year. Philip Gibbs, KeyBanc You're assuming that feedstock costs are similar to last year, is what you're saying? Richard Peach, Senior Vice President, Chief Financial Officer and Chief of Corporate Operations It s Richard here, Phil. We were assuming that over the course of the year, we can get back up to the $45 per ton. I mean, it's a spread business, so we look to adjust the purchase prices to reflect changes in selling prices, together with the points that Tamara made about the operating leverage from increasing our volumes, the benefits from using the nonferrous technology, the productivity improvements and in combination, we believe over the course of the year, we can get back up to that level.
P a g e 10 Philip Gibbs, KeyBanc No, that I understand. I'm just the, just the simple question was, are you expecting feedstock costs to be similar to where they are now or rise, all else equal, over the course of the year? Right. So I think the distinction that you're making is you're taking a point in time and we're looking at this over the course of the year. So clearly in Q4, and as Richard mentioned in his comments, which is bleeding into Q1, we saw a big drop in both ferrous and nonferrous prices, which has since been rebounding but it's bleeding into Q1. We're taking our comment is broader based than that, in terms of taking today's point in time, because we don't talk about today's point in time in terms of prices. But we're assuming, what I said before, ferrous prices in the mid 300s and we are the supply flows appear to continue to be supported by strong GDP growth, industrial production, consumer confidence, consumer spend, CapEx spend and the like. So we don't see a disruption over the course of the year to supply flows or prices. Obviously, it's impacted by seasonality. Philip Gibbs, KeyBanc Okay. And if I could ask one more strategically. It looks like the CapEx guide for this year is similar to '18, meaning, $78 million, it looks like. I mean, how much of that is more related to addressing the, kind of the nonferrous getting to smelter ready product and that? And how much many more years of elevated, I guess CapEx, relative to depreciation should we expect? Richard Peach, Senior Vice President, Chief Financial Officer and Chief of Corporate Operations Hi, Phil, it's Richard. Yes, we said we spent $77 million in fiscal '18. We're expecting something in a similar level next year, but that would exclude additional growth investments, including in nonferrous technology, that would be on top of that. We're very fortunate, of course, we've got a very strong balance sheet, and to fund these projects and as we said, we expect growth capital investments to pay back within 2 to 3 years and have returns well in excess over cost of capital. So we're moving ahead in that light. David Lipschitz, Macquarie Just a clarification after that first question. Your first quarter you said it was going to be similar to first quarter or to fourth quarter of '18, correct? Not the average for the year. Correct.
P a g e 11 David Lipschitz, Macquarie Okay. Just wanted to make sure. And where in terms of your nonferrous prices, I think it was $0.69 in the quarter. Do you think going where we are today, you think they should be slightly down from there, as we stand here? Or I mean sort of flattish heading into the first quarter? I know there was a down, and then a little bit of up, but I was just wondering sort of an idea for your ferrous price. Non ferrous price. Right. So what I said in the remarks were prices before the fall were around $0.65. They dropped to the mid $0.40s and in October have come back to the $0.50s, depending upon quantity and destination. Beyond that, we don't put an outlook on prices. Operator And I'm showing no further questions at this time. And I'd like to return the call to Ms. Tamara Lundgren for any closing remarks. Thank you. Thank you all for joining us on our call today and for your interest in our company. We look forward to speaking with you again in January when we report our first quarter fiscal '19 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 great day.