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Good morning, ladies and gentlemen, and welcome to the 2018 First Quarter Results Conference Call for Russel Metals. Today will be hosted by Mr. John Reid, President and Chief Operating Officer; and Ms. Marion Britton, Executive Vice President and Chief Financial Officer of Russel Metals. [Operator Instructions]And I would like to turn the call over to Ms. Marion Britton. Please go ahead.
Good morning, everyone. Hopefully, you've been able to get the slide deck. And I'm going to start by reading the cautionary statement on Page 3. Certain statements made on this conference call constitute forward-looking statements or information within the meaning of applicable securities laws, including statements as to our future capital expenditures, our outlook, the availability of our future financing and our ability to pay dividends. Forward-looking statements relate to future events or our future performance. All statements, other than statements of historical fact, are forward-looking statements.Forward-looking statements are necessarily based on estimates and assumptions that, while considered reasonable by us, inherently involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially than those anticipated in such forward-looking statements. Our actual results could differ materially from those anticipated in our forward-looking statements including as a result of the risk factors described below, in our MD&A and in our Annual Information Form.While we believe that the expectations reflected in our forward-looking statements are reasonable, no assurance can be given that these expectations will prove to be correct, and our forward-looking statements included in this call should not be unduly relied upon. These statements speak only to the date of this call and, except as required by law, we do not assume any obligation to update our forward-looking statements.If you will turn forward to Page 6 on -- Page 5, sorry, on the slide deck, I'm going to speak to the first quarter results. We had a very strong first quarter. It was $0.62 EPS; earnings of $38 million. It's our highest quarter that we've had since 2018. In our comparable last year was $0.48. Free cash flow is at $0.97 per share, which is also very high. It's driven off of the earnings. Return on equity at 19% is the strongest over the last 5 years, which shows on our 5-year chart. Net cash was $20 million at the end of the quarter. Also note that, in the quarter, we did issue $150 million of 6% Senior Notes. Thus, we were able to -- we increased our net cash because of reduction in bank indebtedness to -- because of the issuance of the $150 million. We declared our dividend of $0.38 per share yesterday. And we also -- I want to note that there's a subsequent event after the quarter that we previously announced on April 16th, we completed the acquisition of DuBose Steel for USD 29 million.Turning to Slide 6. Demand and steel prices are up in all 3 segments, which is what drove the positive increase in revenues and in earning, EBIT and EPS. Metals service centers average selling price is up 8%. As you know, steel prices have been rising mainly due to 232, but there has been increased demand across certain segments. Metals service center tons were up 7% compared to Q1 2017. In addition, our revenues in that segment were increased 3% due to our acquisition of Color Steels that was completed last September, and there would be no comparable 2017 numbers for that. Rig count is up in the U.S. and has been basically flat in Canada. We're currently in Canada spring breakup; and we do anticipate that, based on seasonality, it may be extended slightly. Energy products segment revenues increased 13% from Q1 2017. We had positive results in oil field stores and line pipe; increased sales in both of those operations. In the area of our OCTG, our sales were basically flat year-over-year.Turning to Slide 7 point out the EBIT as a percent of revenue 6.5%, highest on the chart; and our EBITDA as a percent of revenue of 7.4%. The working capital is currently, in the metals operations, $996 million, which is running similar level to 2014. It's driven our revenue, if you annualize that, and we believe is going to be higher than our 2014 number. On that page also you will note that total interest-bearing debt $422.6 million; increased during the quarter based on working capital increases; and we'll look at the cash flow shortly. Also going down to the bottom of that other information section, return on capital employed 18%; the return on equity, which I previously mentioned, at 19%; both very strong for our industry.Moving forward to the cash flow, which is on Page 10 of the slide deck. Cash from operations was $71 million. We did utilize cash in the quarter of $49.8 million for working capital needs. You could see that accounts receivable increased almost $100 million; that has to do with significant increase in revenue in the -- near the end of the quarter, February-March, compared to the November-December period, and increase -- the revenue is up obviously year-over-year also. Inventories have increased in the quarter and that has been offset by significant increase in accounts payable and accrued liabilities. The income taxes line you will note that we did have payment of $31.2 million, approximately $22 million of that related to installments in Canada for our 2017 payments. So it is higher than our prior first quarter as our earnings in 2017 were significantly higher than '16. The other line that I will note on here is the purchase of property, plant and equipment of $10.9 million; higher than our 2017 number. And if you were to look at our commentary that comes later in the deck, you'll notice that we anticipate spending more during this year in relation to value-added processing equipment. So we would expect our capital expenditure to be approximately $10 million higher than our depreciation that runs around $28 million.Turning forward to Slide #14. This is the slide with all the metrics by segment and year-over-year comparisons for the quarter. As I mentioned before, all of our operations contributed to higher revenues and higher EBIT. The metals service centers, quoted the numbers previously. Selling price and tons up. Mentioned that in the steel distributors area, there was also steel price increases that drove the 21% increase in revenues as well as higher tons in Canada shipped. Going down to the gross margin as a percent of revenue 22.1% this quarter compared to 22.4% in the first quarter 2017. The -- both quarters had rising steel prices. The one thing to note is that the selling price per ton is a lot higher in this quarter compared to 2017, which is what drives the increase of 33% in our operating profit in our metals service centers. So the higher price brings more to the bottom line. Energy segment, we were -- margins were up to 19.3% in the quarter. The reason of the increase mainly is mixed. As I mentioned earlier that our Apex, our valves and fitting operation field stores, which is our Apex type operations, had higher results and improved results over the OCTG operations of the same quarter last year. So their higher gross margin would drive the gross margin higher in this quarter. There's also been some increase in selling price in the OCTG area. Steel distributors had comparable to Q1 '17, although steel selling prices were higher than they were in '17 Q1. Very strong segment operating profits as a percent of revenue, I won't go through them line by line, but you will note also [ at total operations of ] 6.5%, which was on the other slide.The other area I'll just comment on is on Page 20, the inventory. You'll note that our inventory is up based on all the previous quarters, driven by both additional tons because demand is up and driven by steel prices. The metals service centers, our tons are up approximately 7% higher than Q1 '17. In addition, we would have inventory related to Color Steels in that number; that wasn't there last -- well, was there at year ended September but not Q1 '17. And note the turns are similar to March 31, 2017. Our energy products inventory is up significantly and turns have declined in that area. Lead times have extended for some of the products and we have fairly strong activity going on in the -- our line pipe area and in the valves area. So we've been required to increase our inventory. We are watching the inventory levels in that area to ensure they're not getting too high.Those are my comments. I'm going to turn it back to the operator to ask for questions.
[Operator Instructions] And your first question will be from Brett Levy at Seelaus & Company.
Marion, can you talk a little bit about what your strategy is with respect to inventory and how that relates to the various trade cases, kind of where do you see them going and how will you position yourself based on kind of where you see things going from this point forward?
Brett, it's John. In regards to inventory, we've obviously pulled a little bit [ ahead ] in anticipation of the 232 as well as extended lead times at the mill manufacturers. So that's reflective in our turns being at 4.2, but again we've pulled [ ahead ] maybe half a turn to a turn as always. Again we will maintain our turns during the cycles, because we feel that's the best way to mitigate against risk. So we're not going to take any long positions or any long stretches there in light of what's going on with all the tariffs, or the potential quotas. We'll watch closely to see what's happening. June 1st, we feel like there will probably be quotas. So we're seeing that with South Korea and now Argentina, Brazil, and we also apparently agreed to those along with Australia. So we'll continue to watch those closely, but we feel like we're positioned either way, whether it's tariffs or if it's quotas; we're positioned either way to take advantage of that market.
And then in terms of M&A, this is a kind of traditional question, you guys have made some, I think, very additive tuck-ins in the last little bit here. Are you looking for anything bigger? Is there a particular -- a geography or a product category that seems a little bit more interesting to you as you obviously take advantage of? And by the way, congratulations, a very good quarter.
Thank you for the congratulations. I mean, we've said for 5 years we want to grow the U.S. footprint in service centers. Thank goodness, we finally did something in the U.S. in service centers after 4 years [indiscernible] Canada, but that's definitely our target market, where we see the growth just based on geography and footprint opportunities for us. We are seeing a very active market there as well as some active M&A opportunities in the field store businesses in both U.S. and Canada right now.
Next question will be from Michael Tupholme at TD.
I want to go back to, I think, one of the points you made, Marion. I just want to clarify. You've been talking about the working capital and how it was similar to 2014. And did I hear correctly? You suggested that although working capital levels are similar, you expect revenues this year to be higher than they were in 2014.
Assuming that we have continued high steel prices, we have done an acquisition in this quarter, I anticipate that we will come in higher than the 2014 number.
Okay. And when you say continued high steel prices, I mean, I guess you had -- in the outlook commentary of the MD&A, there was a suggestion that you do expect steel prices to possibly level off here in the second quarter. Any thoughts on the second half of the year in terms of -- do you think we kind of trade sideways? Or is there a thought that we could see actually some change up or down in the second half?
Again for second quarter, we think again we're going to see stable prices where they are. We think we may be plateauing a little bit given a fairly narrow bandwidth on pricing. Demand seems to be stable, increasing slightly in the U.S. with Canada being very stable. So again, barring any unforeseen changes in demand or unforeseen changes with the 232, which does appear to happen daily, but barring anything there, we think we're in a fairly stable operating environment going out as far as the second half of the year throughout. I don't see anything driving it down at this point. We think it would be fairly stable.
Got it. Okay, that's helpful. And back on the 232, you had indicated, I think, that obviously there's a lot of things -- a lot of moving pieces here and things change frequently, as you mentioned, but I think you had indicated you think possibly after June 1st, we have this -- the Canadian exemption until June 1st, but after that point, maybe looking at the possibility of quotas in Canada, but you -- maybe just elaborate on that a little bit your thoughts there. But secondly, you had indicated that you see under either scenario whether there are quotas or tariffs that Russel's well positioned to take advantage. Can you just expand on that? I mean, to the extent that there are quotas or tariffs that do come into effect that affect Canada, what might that mean as far as pricing and how does that [indiscernible] will take advantage of the situation?
I think part of the extension is, obviously they're in the middle of the NAFTA negotiations, those appear to be making traction. So I think they've extended it 30 days. It seems to be the preference to move forward quotas, obviously, to increase the productivity of U.S. steel mills with the goal -- the target goal kind of seems to be around 80%. They're running slightly under that, 75%, 76% capacity today. Without adding the additional tariff but adding the quota, that should keep manufacturing more competitive as well in the U.S. When you flip to the Canadian side, if we go onto the quota, obviously, the Canadian government needs to be prepared to react; they seem to start yesterday with some of their dialog. So we don't become the dumping ground in Canada for those products. But again, where we are positioned with Wirth and with our import opportunities, [ as we see] those going in. If the U.S. goes under the quota system, we think there will be more opportunities to import various products into Canada. Again, as long as the Canadian government moves fairly quickly to avoid being a target for dumping for other countries, then I think we'll be in a very good position based on our natural trade lines and flows that are already out there in the value chain.
So I know this is very complex but to extent that we do have quotas coming to effect in Canada, I mean, I understand the U.S. business should be a beneficiary for yourselves; but as far as the Canadian operations, am I hearing correctly that you would see possibly some upside on the steel distributors part of your business? Would that possibly be offset by some downside, I guess, on the service center side if we had quotas here in Canada?
I don't think so. Again, I think a lot of the Canadian environment that is there for the manufacturing can still move freely under the current NAFTA agreement, unless there's some significant changes there that we're not aware of. Again, as we continue to bring in -- beams are obviously not made here, heavy plates not made here in Canada; so those become more available. Again, I think we'll continue to use that through Wirth and through metals service centers. There is an opportunity, if Canada doesn't move quickly at the government level, the pricing could disconnect from the historical pricing with the U.S. market, but I don't see that at this time, it looks like Canada is moving very quickly to ensure that this doesn't happen.
Okay. That's helpful. Just with respect to the strength of margins in the energy products segment, Marion, I think you mentioned there are a couple of factors. There, I think pricing has helped but also you talked about mix. Is that favorable mix in terms of what it's doing for the margins? Is that something you expect to continue on really through the balance of the year, given what you're seeing in terms of line pipe activity and demand for the valves and fittings?
For sure, we'll see it in Q2 because OCTG is down. We do have some larger line pipe orders that would not be as high gross margin and which will come through stronger in Q3. So the mix will continue to be a factor in that quarter. Can't really see as to Q4, but I suspect, based on what -- where the activity levels are going, it's going to be a factor all year.
Okay. On the corporate costs, they're a little bit elevated in the first quarter, I think, maybe a variable comp related factor there, but should we -- how should we think about the corporate costs over the remainder of the year?
You don't need to quite annualize that, because some of the accounting requires that RSUs related to retiring individuals need to be accounted over the period to retirement, and everybody would know who I'm talking about at this point. So they are quite -- they're going to be stronger in the first half of the year than they are going to be in the second half of the year or higher; I should probably say, not stronger, higher. So don't quite annualize it unless the good thing could happen that our stock price does go up and our stock price will drive up the RSU, DSUs that are on our statements. So this caveat that at the end with stock price could have impacted stock-based comp.
[Operator Instructions] And your next question will be from Phil Gibbs at KeyBanc Capital Markets.
I have -- my question here is just on the energy side of the equation. How do you see the rest of the year playing out between, call it downhole applications and line pipe applications? And then maybe talk about whether or not that there is a difference between what you're seeing in the U.S. and Canada right now.
Line pipes are very busy in the United States right now. We're seeing a lot of large projects. We're participating in some of those, which will be very active in third and fourth quarter for us. OCTG remains very busy, especially in the Permian Basin in the U.S. Obviously, we're in a break up in Canada right now. So things are slowing down for the normal seasonal breakup. We should come back out of that late in Q2, early Q3. We're seeing a backlog in Canada that is very solid for the OCTG. And line pipe is not as robust as the U.S. but it's healthy in Canada.
Okay, John. And I know clearly freight has been an issue in the U.S. And can you tell us if you're seeing that in the Canadian markets as well and then maybe talk about how that -- the freight issues could be impacting the cross-border flows right now?
The inbound logistics, again, we are seeing some of the pressure from that but it's not impacting our business dramatically. Again, with the timing and the inventory turns, we should have time there to recover. Anything that we're sending out, we typically control our own trucking, so we do very little -- where we [ actually third party ] truck out; we have our own trucks. It will be leased or owned trucks that we manage and maintain on our service center divisions. Our energy divisions and steel distribution have seen some pressure on the outbound trucks. I think it would be normal for the industry right now that you're referring to. So I think, overall, we're not seeing this as a big impact for us at this time.
Okay. Last one from me is just how to think about gross margins for the second quarter? Pricing is up to leveling out in Q2, but I would think still up something, and we know [ costs or inbound steel ] is going higher. Should we think about the gross margins in the second quarter starting to level out as well? Or could there be further upside?
So in relation to comparison to Q1, we saw the largest increase in gross margins in the March month, so it wasn't predominant over the whole quarter. So we anticipate that service centers at 22.1% could be as high as, say, 24% or 24-and-something in the next quarter; and then after that, it'll flatten out or come down in Q3, depending on where steel prices go. So we didn't have a full quarter of ramp-up of higher prices but, as you know, once we work through our inventory, it will flatten out.
Next question is a follow-up from Michael at T.D.
Just maybe the pick up on that last question there. When we think about the service center gross margins, putting aside the impact that pricing is going to have, which is obviously very important for the second quarter, but given the continued expansion of your value-added capabilities, do you think there's been some sort of a permanent improvement in the gross margins in service centers relative to average historical levels? And if so, what is a more normalized level for the business at present?
I think, right now there's definitely improvement as we've started this process. Again as we go across, there's -- we've got a long way to go as we continue to add value-added processing. So we've talked about we're in the 28% to 30% of our volume that is being processed if you exclude our cut-to-length volume. As we continue to add to that, that should stabilize that processing margin. You'll see some upside, obviously, in operating costs from the timing; but at this point, it would be hard to quantify an exact number, as we're still in the infant stages of this growth. But I think we will see this continue to grow as we continue to add the processing there. We're having good success with those machines being full almost immediately.
Okay. And then in terms of the tons growth you've seen in service centers, 7% same-store growth in the first quarter year-over-year. I think, Marion, you said Color Steels would have added another 300 basis points to that. I guess, starting in Q2, also have the DuBose acquisition there. So when you put that in there as well, what would we be thinking about here in terms of year-over-year tonnage growth, not just on a same-store basis but with the benefit of those -- all those acquisitions or both of them?
So the comment on Color was it was 3% of revenues, so there would be a combination of selling price and tons in there. I don't have a good number on that unfortunately. I haven't tracked the tons. Maybe we can give some color on that when we do our Q2 reporting on what they're actually adding. In relation to tons, Color is seasonal because they do service the construction industry. So their tons and their addition will be much stronger in Q2, and obviously we will have DuBose for almost the whole quarter in Q2. So I'll just stop there and say that we'll give some more color about what they're doing to the tons when we do our Q2 reporting.
Okay. And then just on working capital, if steel prices level off, as you expect they may, how should we be thinking about changes in noncash working capital going forward? Maybe there's still some investment in the second quarter, given that prices were still rising through part of the second quarter, but as we get into the back half, how do we think about changes in noncash working capital in that period?
I expect that we're going to have similar increase in second quarter but not quite as high as we did first quarter, but I do anticipate some increases due to the activity levels that we're anticipating in line pipe in that during the third quarter. So maybe [ $50 million ] or slightly more during those 2 quarters to -- of additional working capital needs is my estimate at this point in time.
Sorry. That amount for each quarter or that's a cumulative?
No, that's a cumulative number.
Okay.
Exclusive of any projects or anything going on, once we hit a plateau, we'll bring our turns back to normal levels, so that should flatten out. And again, if you have additional projects that are outside the norm, they obviously have a need for working capital there.
Yes. And selling prices will flatten out, but during the quarter, we will be receiving inventory. The quarter being Q2, that's at a higher selling price. So our inventory and conceivably revenues will -- or -- sorry, AR driven by revenues will go up slightly too. So that's why I do anticipate, during the next 2 quarters, we're [ going to be ] having similar increase, similar like $50 million.
Okay. And then just lastly from me, how are you -- I mean, and you are still interested in acquisitions and you talked about that earlier, but more generally, how are you thinking about capital allocation right now? And I guess I'm thinking about the dividend; and we've had obviously a very sharp run-up in steel prices, but to the extent that you think even if we have plateau, but we can kind of hold in at somewhere in around these levels. Demand is good. Based on the earnings you did in the first quarter, I mean if you just annualize that, you're well below that 80% level you've historically talked about in terms of paying out dividends relative to earnings over the course of the cycle. So can you just speak to that the dividend, I guess, specifically and more broadly capital allocation?
So we look at capital allocation across all of our operations on a regular basis such that who's using what for inventory and revenue and where our activity is to make sure that we have proper capital location in each of the units and financing for that. In relation to the dividend, we've made this comment before that we still haven't really earned back what we paid out during the period that we were not making money, '15, '16. We'll continue to monitor where we are, but we do need to have some improvement and we want to continue to look at acquisitions. So we need to manage our capital in relation to working capital needs, acquisitions but support our dividend.
[Operator Instructions] And currently, Ms. Britton, it appears that we have no other questions.
Thank you, everyone, for attending, and we'll talk to you next quarter.
Thank you. Ladies and gentlemen, this does conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have yourselves a great day.