Greetings and welcome to the Reliance Steel and Aluminum Company Third Quarter 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Brenda Miyamoto, Investor Relations. Thank you. You may now begin.

Thank you, operator. Good morning and thanks to all of you for joining our conference call to discuss our third quarter 2019 financial results. I'm joined by Jim Hoffman, our President and CEO; and Karla Lewis, our Senior Executive Vice President and CFO; Bill Sales, our Executive Vice President of Operations will also be available during the question-and-answer portion of this call. A recording of this call will be posted on the Investors section of our website at investor.rsac.com. The press release and the information on this call may contain certain forward-looking statements which are based on a number of assumptions that are subject to change and involve known and unknown risks, uncertainties or other factors, which may not be under the company's control, which may cause the actual results, performance or achievement of the company to be materially different from the results, performance or other expectations implied by these forward-looking statements. These factors include, but are not limited to those factors disclosed in the company's Annual Report on Form 10-K for the year ended December 31, 2018 under the caption Risk Factors and other reports filed with the Securities and Exchange Commission. The press release and the information on this call speak only as of today's date and the company disclaims any duty to update the information provided therein and herein. I will now turn the call over to Jim Hoffman, President and CEO of Reliance.

Thank you, Brenda. Good morning, everyone, and thank you for joining us today. I'm very pleased to discuss our 2019 third quarter results with you today. But first, I would like to address safety and thank everyone for the progress we're making in this area. Safety remains our primary core value and I applaud each of my Reliance colleagues for their relentless commitment to safety each and every moment, each and every day. Turning to our financial performance in the third quarter of 2019. We continue to execute our strategy of focusing on high levels of customer service across diverse products and end markets with increasing levels of value-added processing, which once again produced strong financial results. Demand was somewhat better than we anticipated, which along with outstanding performance by our managers in the field generated quarterly net sales of $2.69 billion and a gross profit margin of 30.3%. We believe our third quarter 2019 financial results including diluted earnings per share of $2.40, an increase of 18.2% year-over-year further highlight our unique business model and improved earnings power as well as our increased resilience to fluctuations in metals pricing. Our shipments in the third quarter were higher than we had anticipated, driven mainly by demand strength in non-residential construction. We also experienced an increase in shipments of stainless steel products, which we believe reflects a change in buying patterns due to increased nickel surcharges. While many of our businesses experienced the normal seasonal trend of lower shipping volumes compared to the second quarter, the declines were generally less than in prior years. Our tons sold in third quarter of 2019 declined only 2% from the second quarter of 2019, significantly better than the industry decline of 3.7% as reported by the MSCI for the same period. We believe our…

Thanks, Jim, and good morning, everyone. Net sales in the third quarter of 2019 decreased 6.9% from the second quarter of 2019, mainly due to lower shipments from normal seasonality trends along with continued downward pricing pressure. Our tons sold decreased 2% compared to the second quarter of 2019, which was better than our expectation of down 4% to 6%, primarily due to stronger demand in non-residential construction. Our average selling price per ton sold was down 5.1% compared to the second quarter of 2019 outside of our expected range of down 1.5% to 2.5% due to overall weaker pricing fundamentals for many of the products we sell in particular certain carbon steel products whose price is dependent upon scrap cost. As Jim highlighted, our gross profit margin for the third quarter of 2019 was 30.3% above our estimated sustainable range of 27% to 29%. This is a direct result of the outstanding performance by our managers in the field who continue to maintain pricing discipline by focusing on higher margin orders and providing more value to our customers through our ongoing investments in value-added processing equipment. In addition, our use of the LIFO inventory valuation method reduces the volatility of our gross profit margin in earnings resulting from fluctuating metal costs. Since metal prices decreased more than we expected in the third quarter of 2019, we have increased our estimated full year LIFO income to $100 million from our previous estimate of $70 million. As a result we recorded LIFO income of $40 million or $0.44 of earnings per diluted share in the third quarter of 2019 compared to LIFO income of $22.5 million or $0.25 of earnings per share in the second quarter 2019. And given our current estimate of $100 million of annual LIFO income in 2019,…

Thank you. We will now be conducing a question-and-answer session. [Operator Instructions] Our first question comes from the line of Martin Englert with Jefferies. Please proceed with your question.

Hi. Good morning, everyone.

Good morning.

Good morning.

So the better than expected volumes were encouraging on the quarter. Based on what you're seeing today with activity also speaking with your customers regarding their outlooks, would you expect that by the time we get into early 2020, we're going to start to see positive volume growth year-on-year?

Yes Martin. This is Jim. We certainly hope so. Our -- look again we -- our customer base, they're doing just fine. We had better-than-expected third quarter and the fourth quarter as you can see on our guidance reflects the seasonal traditional kind of downturn, but we also have some tailwind. The non-res construction was nice, bit of a surprise, but not really. There were some -- we knew some good things going on out there and we anticipate good things to continue in the fourth quarter. So by the time next year hits, it's kind of interesting how things work up. Usually the first quarter and the second quarter are Reliance's strongest quarters. So I anticipate that happening again in 2020.

Okay. Thanks for the detail there. And then also one thing stuck out on the volume categories there, the other volume category that's kind of implied outside of the categorized volume stepped up, I believe notably quarter-on-quarter. Could you talk about maybe what's in that mix, what was driving that and kind of how you would expect that trend moving forward?

In quarter-on-quarter are you talking Q2 to Q3 of 2019 or Q3 2018 to Q3 2019?

The sequential of 2019 correct 2 to 3.

Yes. So in that category a lot of what's in there are fabricated products so to speak in some of our higher-end value add. Also in there a big component are our scrap sales. When Reliance produces scrap, we also were able to have that recycled. So all of those scrap sales go into the category, but really strength within our fabricated products, we continue to grow that. Some of the smaller acquisitions, we completed over the last year or two has grown not necessarily Q2 to Q3, but that has been growing our other sales. Also in there we have brass, copper miscellaneous other products, our perforated metal products. We consider fab. So just kind of a mix of everything other really than what we have in there, but I think our focus on the value-add and higher levels of value-added processing are the main drivers in there.

Okay. Thanks for the detail there. If I could one last quick one, what would prompt you to increase your sustainable LIFO gross margin range having we've seen pretty solid results trending here for a while? Maybe when could we expect that or what I guess indicators are you looking at before you would revise that higher?

One of these days, I'm going to wake up and feel like we should do that. But right now we are conservative. It took us a while to kind of feel the trend is more than just a trend it's something -- it is sustainable. So we're looking at that. We're looking at that and we're going to continue to drive our model of more and more and more value added and also our customers keep asking us to do more and more. So those things continue to do so and we feel good about it. We will be the first ones to know.

We anticipated that comment probably by someone on the call today. And I think we've said over a longer term based on what we're seeing like Jim said, we expect to continue to grow the value add we're doing. With that we expect to incrementally raise that range, but we're not ready to do so today.

Okay. Excellent, thanks for the color there and very impressive result. Congratulations.

Thanks very much.

Our next question comes from the line of Matthew Korn with Goldman Sachs. Please proceed with your question.

This is Hunter Alley from Goldman Sachs on for Matthew Korn. Quick one from me. So shipments came in much better than you all expected. I know you discussed it a little bit in your prepared remarks, but could you please elaborate a little bit more on what end market surprised you most? And is there anything specific in the market that you're seeing that is driving this?

We've mentioned our non-res construction. We knew there is a little tailwind. If you remember back in the second quarter there were some weather concerns across the North America and we -- there were some let's just call pent-up kind of demand orders that were on the books that we weren't able to get to or unable to ship. There was some steel kind of stuck in the soil and rivers and what have you. So we knew there is going to be a little bit of that. So I think that's what we saw. And I'm not -- I wouldn't be surprised if that doesn't continue in the fourth quarter, but those would be the ones that we would really point to. Of course our automotive that continues to be strong. Even though the GM strike, I think still continues like they're trying to ratify here soon. That affected us towards the end of the quarter more than did in the first of the quarter, but so now you have some pent-up demand there too. So we'll see how that plays out but non-res was a bit of a surprise, but not a huge surprise.

And I think to that point -- to Jim's point that non-res wasn't much of a surprise because a bit of it was timing. So our Q2 tons while they were strong and they were good, I think we're not quite as strong as we've seen in prior years. So the decline coming into Q3 wasn't as much.

Yes. And don't forget about aerospace, that's a good one for us. That's a good one remains good backlog is nice. The prices are going up, say, all should be going up in my opinion, but those are going up and holding. So that's a good market for us as well.

Got it. Thank you. That's very helpful. And then, regarding the non-residential, I mean, is there any particular region or any particular project that you're seeing that's driving that strength?

No. It's kind of all over, all over the map, strong West. Northeast have been doing well for a long period of time. Southeast doing quite well, as far as the project themselves, kind of usual suspects. We're not the ones that get the big 40, 50 story high-rise that goes more direct. No, our sweet spot is kind of in institutional-type businesses, if you will, dormitories universities, what have you, assisted living facilities, which helps. Demographics will continue to drive that number up. So those kinds. The big campus-type projects that we had been around for the last couple of years, there's still some of those that we were involved in and – but it's kind of across the map. But, again, really we're -- our sweet spot is our sweet spot and that happens to be good right now and has been good for last couple of years.

Great. Thank you. That’s all for me and congratulations of the strong quarter.

Thanks, Hunter.

Thank you.

[Operator Instructions] Our next question comes from the line of Phil Gibbs with KeyBanc Capital Markets. Please proceed with your question.

Hey, good morning. I know restructuring and cutting costs are always hard. I think, Karla, you mentioned that there was some of that in the third quarter. Where was that specifically targeted at in terms of the end markets of the business?

Phil, you know our company. We run our company in a day-to-day week-to-week month-to-month. And when we see weakness and we think that the weakness is going to continue, we just do the right thing. We look at our headcount, we look at our expenses. And if we think it's going to be continued to be weak, we'll call it rightsizing. Whether it's in headcount or inventory control, or whatever, it's the same thing we've been doing for a long period of time. We're very disciplined when it comes to that. And we could go through every market. Energy has been tough and we think will remain a little tough, so there were some cuts there. Strong -- where we have a strong business, we probably add it. We're always continuing to invest in innovation and IT type things. Those maybe going up a little bit, but it's just kind of company-by-company, market-by-market and I can tell you exactly where they all are, but we'll continue to look at that. We always do that. Even when all the -- even when business is good, we look for ways to be more efficient and provide better value for our investors so…

Yes. And it wasn't a new directive in the third quarter, Phil, certainly were in locations, sometimes geographic, sometimes its end market, we just try to keep our expenses in line with our shipment volumes and our profitability levels, but just because we didn't call out any reductions in Q2 or Q1 at each of our individual businesses, as Jim said, kind of day-to-day week-to-week there rightsizing. So there has been some headcount and hiring activity in all quarters. It was just a little more significant this quarter and we commented on it.

Okay. Thank you for that. And then, in terms of the CapEx budget for this year, I think, last comment was maybe $245 million. That looks like it's going to be the case again based on your trends to date. Should we expect another strong growth CapEx budget in 2020 just given the continued migration of business and the capabilities?

Yes. We have a good thing going, Phil. We've got a model at work, so we're going to continue to invest where we think is the right place to invest. The new technologies out there is expensive and we've got the money to do it. And we'll continue to listen to our customers. Our customers are going to continue to ask us to do more and more in the innovative equipment that's available. It's really, really great stuff. So we'll continue to invest there. As always, some -- you guys figured, there's always $90 million or $100 million a year on just, what we call, maintenance but it's really not. It's just maintaining what we have, but even maintaining the equipment we have, it's all higher quality equipment that we can actually raise our margins, because there we have tighter tolerances on. So we don't mind. We're a company that likes to own the businesses we operate out of. We'll continue to buy buildings that we don't own. Sometimes, when you do an acquisition at the time you like to hold on to some real estate for a period of time and once it becomes clear we jump in and invest in that. My guess is as our business continues to grow and our model continues to do well that we'll expand and have a lot of internal growth, which is my favorite kind of growth. We can control that and, yes, so it's -- my guess is, we'll continue to spend, maybe not at that $245 million $260 million level, but we'll see. We'll see.

And just to clarify Phil, in Jim's comments in his script, he mentioned that we just increase the 2019 budget from $245 million to $260 million and that was just really some maintenance and growth opportunities that came up during the year. We typically build our CapEx budget once a year. We're in the process of doing that right now. So when we talk to you guys again in February, we'll be able to give you a better number on what our 2020 budget will be.

I appreciate that. I think I missed it. And specifically to the semiconductor market, I know, it's been weak. It's a very high margin business for you. So, interestingly, you're putting up very good numbers without a tailwind there, any thoughts on that market right now and if and when it stabilizes?

Yeah. Hey, Phil, it's Bill.

Hey, Bill.

As we've said, semiconductor still remains soft. We're looking for some kind of rebound as we get into next year. It seems like we slide the window a little bit. We were thinking maybe Q1 next year. We probably push that out maybe until mid-year next year where we start to see some rebound in that business, but we know it will come back and so while it's not doing as well as it had been doing, it is still doing pretty well for us and we look forward to that recovery time-frame and we will be well positioned for that.

Phil, just add on that, I think that and you know this – it speaks to the strength of our model that we can have a whole industry that's down, slower or slowing and continue to grow value in our stock and that certainly is one that has been down for a couple of quarters now, energy has been down a little bit, but we've a lot of other markets and a lot of other products that are doing quite well.

Thanks. Just interesting to note that your gross margins were solid and stable and expanded a little bit on a LIFO basis and Grainger's and Fastenal's fell so interesting.

That's pretty good mojo, isn't it Phil?

Mojo's rising.

Our next question comes from the line of Seth Rosenfeld with Exane. Please proceed with your question.

Hi, thank you for taking the questions. I have a couple. First one construction then moving over to just broader industry inventory level. With regards to construction, I think you've referenced in the past Reliance having pretty significant excess capacity in construction related distribution and processing. With demand now picking up what upside could we see from your construction shipments with existing capacity before further investments might be needed? Is there any impact we should expect from that the fixed cost leverage, historically lag or assets start there please?

Yeah. Hi, Seth and I apologize, it was kind of hard to hear the beginning part of your question, but I think you were asking about our ability to leverage our fixed cost structure in our existing non-res business that we've talked about before. And even with shipment volumes being up a bit, we still have pretty substantial amount of additional capacity where we could run volume through. We've talked in prior quarters about the fact that over the last probably 8-ish years now we've been continuing to invest in additional value-added processing equipment in those businesses. So we're doing well in those businesses on the volumes that are going through, so we're probably in most of those non-res businesses, we're probably still down volume-wise on average for the year 20%. So, we still have pretty decent amount of additional volume that we could leverage our current fixed cost structure.

That's great. Thank you. And then more generally for the industry at large, we've obviously seen a very aggressive year of destocking for peers across service centers and it's contributing to your working capital release in Q3 as well. Looking across the marketplace, do you see some of your competitors sitting on essentially unsustainably low inventories that need to be replenished or we at a new sustainable level? Given this is former are you gaining share from these peers who have aggressively cut – perhaps too aggressively cut their inventories? And then lastly any comment on working capital expectations into year-end? Thank you.

I'll handle the first part. As far as our competitors, we don't spend a whole lot of time worrying about what our competitors do. We worry about what our customers are doing. We worry about what our suppliers are doing. As far as destocking of inventory, I have never liked that term because we don't do that. What we do is order inventory in anticipation of what our customers are going to buy. We continue to do that. I don't know. With our competitors buy offshore that's their thing and that's not ours, we've always been a domestic supporter, 95% of the carbon we buy is domestic for a reason, not that we don't love those guys, because we do, they are great at what they do, and we care about the North American manufacturing market, but we understand cash is king and when you're buying domestically, that helps with your inventory terms and that's something we're going to continue to do. So destocking, restocking, Reliance just kind of – we do what we do, and I will continue to do that and our inventories is in fine shape and I don't know about anybody else's inventory.

Yeah. And I think Seth, as I commented on we did have a focus on inventory reductions and we've talked about that, we've had that for the year. We felt we are probably like a lot of other companies bought a little heavy in 2018. There was a little I think confusion so to speak in the market with how much was pre-buying by some metal customers in the second quarter of 2018. So we had a focus on reducing inventory level, throughout this year we've been making progress. We had some good improvement during the third quarter. We generated about $157 million of cash flow from operations just from inventory reduction during Q3 from June 30. Part of that, a little bit of that is lower pricing obviously throws off some dollars but we also had a focus on reducing our level to be in where Jim talked about, kind of, rightsizing the inventory. We’re not at our inventory turn goal yet for the year but we're getting pretty close and so we think we’re in good shape, which feeds into your question on working capital levels from now to the remainder of the year. So with lower shipment volumes typically we release working capital in the fourth quarter. So we would expect to generate a little more cash from operations. It's been very strong in the first three quarters already of this year. So with our continued expectation of maintaining gross profit margin level, which throws off good profit levels for us to generate cash along with the shipment volumes reducing our working capital levels, we do expect good cash flow again in the fourth quarter.

Okay. Thank you very much.

Our next question is a follow-up question from the line of Martin Englert with Jefferies. Please proceed with your question.

Hi, thanks for the time on the follow-up. I wanted to see if you could touch on your aluminum business. Volumes were a little bit lower year-on-year I believe. And then maybe if you could also contrast that on aluminum tolling business and what you're seeing with volume activity there?

Well, I think – Martin, it's Bill Sales. Yeah, the aluminum business a lot of that with common alloy side, we're seeing that market a little softer both on the demand and on the pricing front and in contrast on the heat treat side that business has stayed relatively strong. The aluminum we continue to grow on the toll processing side for aluminum as the aluminum content in automotive continues to increase and our investments that we made on the toll processing side a lot of that has been focused on the aluminum side. So, we see continued increase there from a toll processing standpoint.

Okay. And as a quick follow-up to that, can you speak to the margins on aluminum toll processing versus carbon toll processing? And then also how you see availability on the heat-treated aluminum plate side of things both aero and general engineering?

First of all, we don't comment on the margin. So I'll skip back question and on the heat-treat side for aluminum plate, we still see that market fairly strong. Lead times at the mills are still extended. There is still a little bit of tightness on the supply side. So that business we think will continue to stay strong, looks like the outlook for 2020 continues to be very positive.

Do you think that you take a step up in heat-treat aluminum volumes in 2020 or it just remains at an elevated level like what we're seeing today?

We think -- our outlook is we think the strength, the demand picture that we're seeing now will continue in 2020.

Okay. Excellent. Thanks for the incremental detail there.

Okay.

There are no further questions in the queue. I'd like to hand the call back to Jim Hoffman for closing remarks.

Thank you very much. We'd like to thank everyone on the call today for your continued support and commitment to Reliance. We'd also like to thank those of you who attended our Analyst and Investor Day back in September. For those of you who are unable to join us an archive video webcast and a corresponding presentation can be found on the Investor Section of our website at www.rsac.com. Lastly I'd like to remember -- to remind you all that we'll be in New York City next month presenting at the Goldman Sachs Global Metals and Mining Conference and also at the Cowen Chemical Metals and Mining Summit. We hope to see some of you there and I hope you enjoy the rest of your day.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.