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Good morning, ladies and gentlemen, and welcome to the 2020 Third Quarter Results Conference Call for Russel Metals. Today's call will be hosted by Marty Juravsky, Executive Vice President and Chief Financial Officer; and John Reid, President and Chief Executive Officer of Russel Metals Inc. [Operator Instructions] I will now turn the meeting over to Marty Juravsky. Please go ahead.
Great. Thanks, Chris. Good morning, everyone. I plan on providing a brief overview of the Q3 highlights, so we have a context around the key business developments. If you want to follow along, I'll be using the PowerPoint slides that were posted last night to our website, just go into the Investor Relations section conference call part of the website. If you go to Page 3, you can read our cautionary statement regarding forward-looking information. So let me begin with -- on Page 5 with a few summary observations. This has been really unprecedented times with the changing business landscape. That being said, we couldn't be more proud of how everyone in the Russell family has worked together during these past several quarters. I think it is a real strong testament to the culture that we have within Russell. In specific relation to Q3, we are really pleased with what our team was able to accomplish and specifically how we adapted to these evolving market conditions. So talking for a few minutes about market conditions. Q3 looked a lot different than Q2 as we saw the gradual but continuing improvement across all of our business units. The activity level improved not just in Q3 compared to Q2, but also during the third quarter. As a bit of a specific example, our service center volume in September was higher than the Q3 average, and that gradual improvement that we saw in activity levels has continued into the early parts of Q4. In addition, the underlying steel prices that started to pick up quite nicely towards the tail end of Q3. The effect of that is really a bit of a lag element. And those prices that were flowing through to our part of the supply chain, we should start to see that effect kicking in, in Q4. Second topic is business optimization. We continue to refine our portfolio in a number of ways. We sold some real estate in BC that was part of the rationalization program for that region, and we realized $10 million of proceeds. OCTG and Line Pipe. We talked in the past about a focus to reduce that footprint over a 12- to 18-month period. We have an inventory reduction target of about $100 million. In Q3, we are pleased that we achieved $31 million towards that goal, and we remain committed to the target. We obviously have a little bit more work to be done on that front. We've also further rationalized some small unprofitable locations. This will reduce costs and further streamline the management of our inventories in other parts of the business. In addition, our focus has always been for the last number of years on value-added processing, and that continues to be an ongoing initiative. We completed the Trenton project in late in Q3, and we see the business backlog for that operation continues to grow very nicely. We've got 2 more laser projects in the U.S. South that are being scoped out for 2021. These are the types of projects that allow us to add value for our customers, gain market share, improve margins and generate really nice paybacks. We're generally targeting paybacks of less than 3 years for these types of projects. Liquidity and capital structure. With $81 million of cash from operating activities in Q3, liquidity greater than $500 million and a cash position that was over $120 million, we had the opportunity to make some improvements to our debt structure. So over the last little bit, we have completed a number of initiatives. We extended our bank deal under favorable arrangements. The borrowing costs under our bank lines is less than 3% today. We're in the process of redeeming $300 million of our 6% notes that were due in 2022, and this was financed -- is being financed with cash, bank line borrowings and a new issuance of longer-dated and lower-cost notes. The net result is that we'll have extended our maturities by several years, improved our credit profile, give us a little bit more flexibility and equally important, reduce our interest cost by about $8 million per year. So if we go forward now to Page 8 to talk about some of the financial highlights from the quarter. Let me start with a few items from an income statement perspective. If we look at Q3 versus Q2 2020, we did see quarter-over-quarter improvement in sales, EBITDA, EBIT and EPS. Gross margins percentage remained pretty steady at around a 19% level. The one macro observation that I would make in terms of the quarter is that when we look at our expense management philosophy and the flexible business model being core features of our culture, we saw that play out in Q3. Our Q3 employee expenses came down versus Q2 as head count management and our variable comp model continued to adjust to market conditions. A few other items of note for Q3, some of which were positive, some of which were negative, but we wanted to highlight a number of these items for discussion. One, wage subsidies were just below $20 million for the quarter, which is a level that was very comparable to Q2. We think that this government program was very helpful in creating a bit of a buffer time period to adjust to the evolving conditions and allow for markets to recover and internal cost structures to adjust to the circumstances. Property sales of $10 million, which I mentioned a little bit earlier, resulted in a gain of $6 million. We had some pre-existing capital loss carryforwards, so most of that $6 million was shielded from tax. In terms of some incremental costs for the quarter, we're starting down the path of a new ERP project. This is the first quarter where we've discussed the magnitude of the cost as the project just started off in July. The costs for the quarter were around $2 million for the quarter, and we expect that order of magnitude to continue through to 2021 with implementation planned for early 2022. We've always focused on systems as a key factor to managing our information and working capital effectively, and this project is part of that of that ongoing focus. Lastly, we had a couple of noncash expenses that negatively impacted EBITDA. We provided for a $2 million increase in our energy reserves. And in addition, there was a $2 million expense related to stock-based compensation. That's a mark-to-market adjustment. And in the quarter, our stock price went up by about $2 a share, which resulted in that increased expense for purposes of mark-to-market. From a cash flow perspective, $41 million reduction in working capital, with the biggest shifting from inventories to about $67 million. That reduction of inventories was across all of our business segments, but the energy side was the largest as we have a targeted path to reducing that footprint, as I've mentioned earlier. Accounts receivable moved up by $19 million as a function of improved business activity and sales, and our credit metrics continue to track really well and the pace of collections remain strong. CapEx of about $6 million is relatively modest. From a balance sheet perspective, net debt declined from $368 million at the end of Q $2 million to $324 million at the end of Q3, $44 million reduction. As a result, we are sitting on a net cash position of $122 million at the end of Q3. And as I discussed earlier, this provided a really nice opportunity for us to redeem our 6% notes that were due in 2022, and in the process, reduce our interest expense. For shareholders' equity, there's an accounting adjustment because of an FX shift at the end of Q3 versus the FX at the end of Q2. Final item, we've declared our quarterly dividend of $0.38 per share. Bottom line is that we have made really nice progress in this quarter in the last quarter as well in undertaking a number of initiatives. Those initiatives are focused around driving free cash flow. Notwithstanding the fact that I believe that we've made really nice progress, I think there's still more on to come. If we flip to the next page, to Page 7, we include some of our segmented P&L information. The service centers did really well as the market improved. Our revenues increased and our gross margins held in at 21%, and we did generate a higher operating profit in Q3 versus Q2. Tons shipped were up 9% versus Q2, which is actually better than the industry data that we have seen. So we continue to make inroads in terms of gaining market share. Price realizations were down 3% in Q3 versus Q2 of this year. As I mentioned earlier, there is a lag effect in terms of steel price increases, and we expect that to be realized as we move into Q4. In energy, the market conditions, revenues, operating profit improved versus Q2, but remains challenged versus historical levels. As I mentioned earlier, the focus is on inventory and cost containment generally with an emphasis on downsizing the Line Pipe OCTG part of that business. In the quarter, the field stores realized an $8 million profit, whereas the OCTG Line Pipe loss was $6 million. We're starting to see improvements in the pipe pricing part of that business into the early stages of Q4, which is helpful as we move that inventory in a prudent and thoughtful manner. Our distribution had a very comparable results in Q3 versus Q2. If we go to Page 8, we have segmented inventory information that provide a framed reference for some of our recent capital allocation shifts. If you look at our segmented inventories, it declined from $884 million at the end of the year to $790 million at the end of September or a $94 million reduction. The biggest portion of this decline is in the energy, generally in OCTG Line Pipe in particular. As we continue to adjust our portfolio composition going forward, I expect to continue to shift in the coming quarters. In terms of outlook, let me just give a couple of summary observations. One, the market is better today than it was 3 months ago with the early signs in Q4 more promising. That said, we often do see some seasonal slowdown as we get to the latter part of the quarter, given the Christmas and year-end period and fewer operating days at that point in time. But secondly, and perhaps more importantly, we have a lot of flexibility built into our business model as well as the enhanced flexibility in our capital structure. Therefore, we're really well positioned to adapt to the economy as well as take advantage of opportunities. So in closing, on behalf of John and other members of the management team, I'd like to express our appreciation to everyone within the Russell family for their tremendously hard work and nice accomplishments over the course of the past quarter. That concludes my introductory remarks. Chris, if you could open the line out to any questions, that would be great.
[Operator Instructions] Your first question comes from Mona Nazir, Laurentian Bank.
Just firstly here, we're seeing some sequential improvement, revenue contraction in kind of the high 20% range versus 37% in the prior period. In your outlook commentary, you stated that you're seeing some improvement, particularly in the latter part of Q3 that may not be fully depicted in quarterly results. I'm just wondering if you could speak about revenue contraction exit rates or where things are sitting currently.
Sure, Mona. So your comment about exit rates, I think that probably the best way to characterize that is, particularly on the service center side of it, we saw within the third quarter, progression during the quarter. Or said another way, the September activity was actually at a higher volume than we saw for the Q3 average. And generally speaking, we saw August was higher than July; September was higher than August; and September, by definition, then was higher than the Q3 average. In fact, when you look at September of this year, our volumes were very, very similar since September of last year. So notwithstanding a whole bunch of noise and a whole bunch of moving pieces, our exit rate coming out of the quarter, using September as a benchmark, was quite nice. We are starting to see some of the data points for fourth quarter continuing on with that same path. So we've never had a view that this is going to be a step function change in terms of economic recovery. But the way we've been characterizing it is a slow and gradual recovery, and we see that through Q3, and we're starting to see it in the early signs of Q4 as well.
Your next question comes from Michael Doumet, Scotiabank.
Just starting on the MSC margins. I mean I guess, were not for the Qs of $20 million in the quarter, I'm assuming there would have been alternative cost actions. So I'm just trying to get a sense for -- or maybe a little bit more clarity on the underlying margin performance. And I guess maybe another way to ask, as we go into Q4, steel price is up and volumes improving, could we expect MSC EBIT margins to fall within the more typical 5% to 6% range, let's say, excluding Qs?
Well, so let me give a couple of data points to break that down before I give you the answer. So when we talk about the $20 million -- a little less than $20 million in the wage subsidies for the quarter, that was across all our businesses, probably about $14 million, $15 million of that was related to the service center part of the business. So if you want some segmented constructs, that give you an order of magnitude. That being said, there are a bunch of moving pieces, though. So that is a piece that is migrating down, but at the same time that other things are migrating in a different direction, volume is picking up, pricing is picking up, margins are picking up, which is why we tend not to look at an individual data point in isolation. We look at it kind of holistically. But directionally, you're right, if you just took that line item out and assumed everything else being equal, the margins will come down. But we're actually looking at it where there's other things that are mitigating effects going in the other direction.
Got you. No, that's helpful. And then maybe into Q4, just a little bit of a sense, just with the moving parts that we have to consider. Typically, when steel prices have moved up as much as they have, the volumes, given your comments around September, just to push you a little bit harder, should we get margins sort of go back to the normal rate in the next quarter? Or do we have to wait a little bit into '21 to see that happen?
So Michael, I think we're moving back to that direction pretty quickly, back to normal margins, actually improved gross margins in the service centers due to our value-added process. And so I think you'll see that in the quarter. The demand is improving. If you use the steel mill production rates as a proxy, they went from 60% to 70%, and I think that you're seeing the broader industry move in a similar fashion. But we are seeing margin improvement. We are seeing steel prices increase. As Marty said earlier, as we've talked on previous calls here, you're aware Canada is a slower turn inventory just because of the logistical challenges to get product into Canada from the United States or from others. So it's about a 4-turn inventory, so that lag really hit us in late, late September. So we're starting to see those margin improvements now. And again, we turned quicker than our competition in both the U.S. and in Canada. So we'll work through that, but we are definitely seeing those improvements. And I think you can assume a normal gross margin percentage and a more similar bottom line margin percentage for Q4.
That's great. That's great. No, I appreciate it. So maybe just turning to the energy business or just OCTG. I mean you've done a great job there drawing down capital. And Marty, and to your comments, there's more to go. I guess this is a bigger-picture question. I mean, do you think you can reinvest the capital back into the business and maintain the company's overall earnings power? I mean, if you look back to the last cycle, call it, 2015 to 2018, operating income averaged about $200 million. So do you think you can reallocate capital and maintain those profit levels or near those profit levels through the next cycle?
Yes, I think so. If you look at this cycle in 2018, OCTG and Line Pipe weren't a large contributor. The returns were so par compared to the rest of our business when you looked across the -- all segments of our business. So we think we can through our value-added process and potential acquisitions. So we think we can reallocate that into a position for us that's going to put us in an improved return for our shareholders.
Right. And if I can just I just...
Just the related point, too, that I'd say is, it's also going to reduce the volatility. There's some nice highs, but there's some lows as well. And if you look at the last couple of quarters, that part of the business was generating negative operating profit. So it's reallocating capital in a way that can not only sustain our mid-cycle earnings power, but also reduce some of the volatility along the way.
That's a great point. And that was a good segue, I guess, to the last question I wanted to sneak in here. But just on the -- in the pipeline and the OCTG operating losses in the quarter. Any sense whether higher steel prices or maybe reduced industry inventories are starting to alleviate some of the margin pressure into Q4? Like should we expect continued losses the next couple of quarters for that category, at least until you guys have sold down your inventories to a desired level?
So there's 2 dynamics going on there. We are getting the inventories down. However, the industry as a whole is still overstocked just due to the level of fall that you've seen. Again, the rig count is at 296 in the U.S. and 86 in Canada as of last Friday. So those still extremely low numbers for the U.S. They're better in Canada has been in '15 and 2009 in the fall. The other is pricing is improving. So as you're seeing flat-rolled pricing, plate pricing go up, that's a substrate that makes the pipe. And as there's starting to be replacement and replenishment from North American mills, that should drive the price up. So we'll work through the inventory, I think, probably through Q4, as an industry maybe lag into Q1, as an industry as a whole, OCTG and Line Pipe distribution. Optimistic that we're going to see price increases. We're seeing worldwide flat roll and plate increase as well. So that will start to lift the pricing. So I think we should start to come out of that as we continue on our path to exit some of that business. I think it gives us a better path to do that in a more profitable fashion.
Our next question comes from Mark Stuebing, TD Securities.
It's mark on the line here for Michael. You talked about seeing a gradual but uneven recovery across Russel's segments and for the service center segment in particular. I was wondering if you can provide some commentary on what sort of the trends you're seeing across your different end markets and regions.
Yes. So construction has held up relatively well throughout this entire C-19 pandemic, and it continues to hold up well. We're seeing some manufacturing starting to return gradually. Again, as I mentioned earlier, it's in line with GDP is starting to come back as well. So we're seeing gradual improvement. Heavy equipment is showing signs of life in North America that we weren't anticipating. So that's been helpful. Obviously, wind towers, solar panels have picked up. We do participate in those markets, although on a limited basis just due to geography, but we do participate in some of those markets. But we're starting to see people coming back to work. And again, that third quarter where we saw just general manufacturing coming back -- or us manufacturers or ag manufacturers are coming back to work and getting started. So we think that will continue forward, barring any other shutdowns or anything out there from the government, that we think we'll continue to see that this climb forward as people will be really resurging to work right now.
Great. That's great color. And then can you talk a little bit about the outlook for steel prices? Obviously, we've seen a pretty strong increase hot-rolled coil and plate has also followed. Are you able to comment at all on your expectations for pricing over the coming months and also into 2021?
Yes. So again, steel pricing jumped significantly. You've seen in the last 6 to 8 weeks, coil prices jump $200 to $250 a ton. You're seeing plate increase, not as much, but increased. And part of that is due to demand is improving. We're still at 70% mill utilization, which typically you would see pricing power around 80%. And so they are booked well into right now steel mills through December for the most part, and you find a little bit of steel now. But for the most part, they're booked up through the rest of the year. Scrap prices, once again, the input -- the main input for steel mills, continues to be strong. It looks they'll either be sideways or up for November. Historically, they go down in November. So again, that's going back to demand kicking back up. So there's more demand for that product. So I think we're good going into first quarter. From there, we'll just have to see how things progress.
Okay. And then I guess, lastly for me. So you continue to make some progress in bringing inventory down in energy products. You also closed several locations related to the realignment underway. I was just wondering if you could talk about how far you are into this realignment and how much more action we can expect to see in the coming quarters.
Yes. So we closed a couple of pipe yards that are smaller yards for us. We also closed a handful of the energy field stores where we just have people shut-in wells and they're not working. Again, that's a nice low-risk business. It's got a very small lease, typically a 1- to 2-year lease in 5,000 to 10,000 square foot facilities. So we can just move inventory around. So we've closed those wells, picked back up, and we can move back into the area. I think there'll be continued closures there, and we'll see and limited 3 -- maybe 3 more stores in the U.S., maybe 1 or 2 in Canada in Q4. We'll continue to push on the OCTG and Line Pipe to bring that inventory down. Our goal is to get that down over a 12- to 18-month period, $100 million. The initial period, we got it to $31 million, and we'll continue on that target to get that down $100 million over the next 12 to 18 months in OCTG and Line Pipe inventory.
Your next question comes from Felicia Frederick, Raymond James.
I'm just wondering if you can provide some commentary on how you're viewing M&A in this environment.
Yes. Felicia, we've seen a lot of activity in M&A. We've seen a lot of things come across. Obviously, our focus is service centers, U.S. being first, Canada being second. Canada with our larger footprint, it would need to be a niche market that we're not in are a very strategic bolt-on type of acquisition that would make a lot of sense for us. So we are seeing a lot of activity there. We have seen activity in the OCTG and Line Pipe that we've elected to pass as we're trying to shrink our footprint there. So I think -- again, I think the activity is fairly robust right now.
Your next question comes from Mona Nazir, Laurentian Bank.
Sorry, just a follow-up in regards to M&A. I -- it may be early days as you're starting to see a recovery in the end market and you're progressing with the plan to reduce your energy footprint. But I'm just wondering if you could speak about the pipeline of potential targets. And have you seen potential targets come up on the back of current COVID challenges and just potential timing of such?
Yes. So we're seeing potential acquisitions, as I was saying to Felicia there, in both service centers and in energy. Our focus is on the service centers. And so some of it maybe COVID related, but I think it's more of a timing issue in the service centers where there are a lot of private service centers, third, fourth, fifth generation, that we're looking to exit. And I think they've been considering this for 2 or 3 years, maybe longer. And so they're just going through that timing. We've seen from small to medium-sized service centers out there right now. So we're very diligent and disciplined in our process as we go through looking at acquisitions. And we're looking for things that make the right fit for us, either geographically, obviously, culturally is #1 for us that it fits. And typically, we like well-run businesses. We will occasionally go in and try to improve the business, but we typically like to buy a well-run businesses.
So just a clarification, the targets really haven't changed much on the back of COVID, would that be correct?
That's right.
Okay. And then just secondly, you received $39 million in government subsidies for the period of March to September, and I appreciate your kind of quarterly breakdown of $20 million for the period. I'm just wondering if you've been able to tally COVID-related costs incurred year-to-date and have it on a quarter-by-quarter basis or even if it's similar to the amount that you have received.
Yes. So it's something that's difficult to quantify. We definitely have some COVID-related expenses where we can go through with things we've implemented. There -- obviously, the PPE that we've done. The social distancing protocols. We're putting in the plastic guards and the things that protect us in the field. The additional staffing that we've had to bring into play just for COVID and to deal with COVID the expense of medical. And the testing that we've done for our employees. So those things can be quantified. It's the difficulties that are hard to quantify and what it's done to the business and the effect. So we've had to have multiple people where we've really just had one before. With 141 locations and decentralized as we are, we're running those location by location. So we haven't spent a tremendous amount of time pinning that number down. But again, it's a substantial number to our operation, but we are seeing that wane as well. We've now got everything in place. We've kind of got our routines down. So there will be some continued protocols that have to stay in place to deal with this. Obviously, that'll be helpful to flu season or at least we hope so. But there'll be some that stay in place, but it's the -- I think they'll be more in line as the way subsidies move down that there'll be a natural offset there.
[Operator Instructions] Your question comes from Anoop Prihar, GMP.
Most of my questions have been answered, so I just have 2 quick ones. Number one, do you expect to receive wage subsidies in Q4 as well?
Yes, we do. It's a bit of a moving target in terms of the revised government program and what that means. Our expectation is it will come down, come down a fair amount, but the exact precision of it is a bit of a mug game to guess at this point. But if I were to give orders of magnitude, it'd probably be $5 million to $10 million for Q4, somewhere in that zone.
Okay. Perfect. And then my second and final question. Post the quarter, on a net basis, you refinanced about -- sorry, I beg your pardon, you retired $150 million worth of bonds. Can you give me a sense of that $150 million, how much of that was funded by cash versus your available lines?
Yes. Well, most of it was from cash. And as you can appreciate in this environment, cash is earning virtually 0 return. On our September balance sheet, we had about $120 million of cash. And as the actual redemption kicked in, that gives you some order of magnitude. So it was mostly cash, a little bit of revolver. And then the balance was basically replacing $150 million worth of notes with a new issue of $150 million of notes at a lower interest rate and a longer maturity. So that's where the $8 million of annualized interest expense savings comes from.
There are no further questions at this time. Please proceed.
Well, thank you, everybody, for paying attention and following us for the quarter. If there's any follow-up questions, feel free to give myself or John a call either this afternoon or any time. Other than that, we look forward to staying in touch and catching up over the course of the next quarter. Thanks very much.
Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.