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Good morning, ladies and gentlemen, and welcome to the 2019 Year-End and Fourth Quarter Results Conference Call. Today's conference call will be hosted by Ms. Marion Britton, Executive Vice President and Chief Financial Officer; and Mr. John Reid, President and Chief Executive Officer of Russel Metals Inc. [Operator Instructions]I'd now like to turn the conference over to Ms. Marion Britton. Please go ahead.
Good morning, everybody. I'm on the Slide 3 of our deck, which is the cautionary statement. 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 facts, 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 from those anticipated in our forward-looking statements.Our actual results could differ materially from those anticipated in our forward-looking statements, including as a result of risk factors described below in our MD&A and our annual information form. While we believe that the expectations reflected in our forward-looking statements are reasonable, no assurance can be given that 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 as of the date of this call, and except as required at law, we will not assume any obligation to update our forward-looking statements.So before I turn into the deck, I just wanted to make a comment to thank our operations employees who navigated through the steel price reductions and the rough environment that we had during the second half of 2019. Our metals service center operations and our valve and fittings operations had a solid year and continue to perform as we expect from them. Coming off a year like 2018, we were managing decline. However, Q4 ended with a few more challenges than -- which I will speak to shortly.Turning to Page 5 of the deck, give a few market conditions. During the quarter, we had a selling price decline of 15% compared to Q4 2018 and 6% compared to Q3 2019, our biggest drop during the year. Metals service center tons down 7%, which was slightly higher than our year. Compared to the Q4 '18, we still were stronger than the MSCI reported numbers. Rig count continues down in the U.S. year-over-year and in Canada is up slightly. Energy products segment was down 21% compared to Q4 mainly related to lower demand for line pipe, and that was because we had a project in Q4 '18 and rig activity.Turning over to Slide 6, fourth quarter results. As people would have noted already, we did report a loss of $7 million or $0.11 per share in the quarter compared to our 2018 Q4 when we reported $0.74. Year to -- for the year, we reported earnings of $77 million or $1.23, and that compares to the $3.53 in our stellar year in '18.We will go into a little more detail as we go through, but there was an inventory reserve of $14 million recorded in Q4 '19 related to U.S. line pipe operations, and we did have our charges related to the acquisition that was in the quarter.Free cash flow was one of the strong areas for the year. Our free cash flow was $2.20 compared to $4.84 for 2018. Particularly strong reduction in working capital during the fourth quarter of 2019 where we had $133 million reduction in working capital. For the year, it was $144 million. Return on equity for the year was 8%, and we declared a $0.38 dividend yesterday.The comparative information is on Slide 7. I'm going to skip by that and speak a little more to other pages in the deck. The one thing I'll mention is that we did file all our documents yesterday. So a complete set of statements with no details on the acquisition and other things that people may have interest have been filed on SEDAR.Turning over to Page 13 in the deck. We've included here a chart, which is a chart which includes non-GAAP measures. So I will caution you to the fact that the adjusted net earnings is a non-GAAP measure, but I think it does help you understand the abnormal increase that we had to record in Q4 and related to the year. The Q4 chart we'll get to shortly.So during the year, our net earnings of $77 million, if you consider inventory provisions, which we consider onetime, mainly the $14 million related to line pipe and $5 million related to OCTG that was actually recorded in Q3, that represented $0.18 -- or $18 million, sorry, or after tax $0.29 EPS and City Pipe acquisition cost of $4 million. And I'll speak to that a little bit later, but that's a fair value accounting of inventory and then the actual costs related to the transaction, which represented $0.07. So that, on an adjusted basis, brings our EPS to $1.59.Turning over to Page 16. I'll just highlight some of the annual numbers, and then we'll go into the quarter numbers. Revenues were down 12%. Revenues in service centers obviously off -- less than our other operations. The gross margins -- or I mean, the operating profits were down more driven by the gross margin. You'll see that our gross margin for service center ended up at 18.8%, pretty good considering the conditions we were going through. The energy service -- products segment was lower due to the reserves that we took. And similarly, in steel distributors, lower due to reserves that we took.Going forward to Page 18. The lower selling price was 1% compared to 2018. This is for the annual numbers. And tons shipped were -- was down 6%. You'll note that I had said 15% for the quarter, so it dropped significantly a lot late in the year. And the tons held up during the year, slightly better than the Q4. We also indicate here that the Canadian and U.S. service centers, MSCI numbers were 7% on an annual basis.Moving on to Page 19. I want to highlight the fact that our oilfield stores and Comco Pipe operations had strong results, and actually Comco Pipe ended up with higher revenue and EBIT than they had for 2018. So our valves and fitting side continues to operate strongly.The note under c there, there is the Q1 acquisition -- or I mean, sorry, October 1 acquisition of City Pipe. It resulted in revenues in the quarter of $34 million and $2 million of operating earnings. We did have a charge of $6 million, of which $4 million of that relates to the fair value of inventory adjustment done as part of the accounting and $2 million related to the actual cost of the transaction.Turning over to Page 20, steel distributors. Revenues were down 13%. You'll note when we get to the Q4 numbers down more due to less demand in that area, and we did take a charge against -- or an inventory provision of $5 million in our U.S. operations. Our Canadian operations tend to presell their material and continue to operate as strong in 2019 as they were in '18.I'd like now to flip to Page 28, which has our quarterly numbers. You will see on Page 27, I'll just mention this, I'm not going to go through it in detail, the non-GAAP chart. Again, for -- that brings us from the $0.11 loss to the $0.19 EPS adjusted earnings for the quarter.So if you look at the Page 28, you'll note the revenue decline is down significantly, particularly steel distributors, they had significantly less revenue in the quarter. And you'll notice, we look at inventory, that the revenues are going to be down because they stopped acquiring as much inventory due to price differentials.The good news on this page was the 18.8% metals service centers gross margin that they delivered a little stronger than I had indicated when -- in our last call. So they did perform well, and they continue to reduce their inventory to take advantage of the lower-cost inventory when they do purchase it.The selling price of 15% lower, which was highlighted on the front slide. Looking at the numbers, it looks like we're going to have a similar 15% decline Q1 '20 versus Q1 '19 because if I look at Q4 versus Q1. So there was a significant drop in selling price during the year. So we're -- and our year-over-year comp will be hit by that when we get to Q1 '20.The only other comment here is that the drop in revenue and some of the earnings at energy products is related to a larger line pipe project that we had going on in Q3, Q4 last year and has not been repeated. Actually, line pipe has been an area where demand has been significantly down during 2019.You would flip back now to Page 21. Just make a couple of comments. We did end up spending $35 million on capital expenditures during the year. A significant portion was related to value-added processing. This compares to the $41 million we spent in 2018. We have indicated that we expect to spend above depreciation, depreciation being $32 million, for the next few years as we continue to add value-added processing in the metals service centers. It has helped to keep us -- our demand better than the average, and we believe it has helped to stabilize our gross margins.Turning over to Page 22, speak to the inventory level charts on this page. You'll note the significant reduction in the inventory at metals service centers is both related to tons and to price. That strong reduction resulted in a turn of 4.5 for the year, which is in line -- or sorry, for the quarter, which is in line where we've been for the last few quarters and significantly better than where we were at the end of 2018 or the fourth quarter.The other comment would be the energy products number. Although it looks like maybe it hasn't come down as much as you would think, $47 million of that number relates to City acquisition in the quarter. So without City, it would have been $447 million, once again, the lowest number on this chart that we have. And as I mentioned earlier, steel distributors continues to reduce its inventory, which will result in lower revenues on a go-forward basis because the pricing environment doesn't -- pricing environment and demand is not driving activity in our steel distributors area.Those are my comments. I'm going to turn it over to the operator.
[Operator Instructions] Your first question comes from Devin Dodge with BMO.
I just wanted to start with maybe the service center business. Looks like it continues to perform pretty well in a tough environment. Just -- can you give us a sense for how demand has trended so far in 2020 just across your regions and end markets?
Yes. We -- so 2020 started out with the kind of a shot in the arm and it picked up from what was a slow Q4, and so we had a down Q4. So it came out pretty leveled off now, but with -- Eastern Canada has been pretty strong. Construction seems to be doing very well there. Manufacturing is doing well there. If you move to Western Canada, again, specifically in British Columbia, it has been very slow with the issues going on with the lumber and the timber industry that's out there. Oil and gas is obviously slow, and in farming, which, again, is going to affect our ag equipment. So that's kind of a tale of 2 halves for Canada. U.S. has been very steady and solid for our business in the service centers.The interesting thing, Devin, I think if you look at -- I mean, we started January of 2018, prior to the 232 Marion alluded to in her opening, we started $640 a ton on plate, shoots up to almost $1,000 a ton, $980 by the -- like Q3, early Q4 of '18. And then by early to mid-Q4 of '19, we're back down below $640. So the volatility that we saw in the pricing was not really demand driven, more of the 232 political arena that was driving all that. And I think our operators in our service centers did an exceptional job of managing and navigating that, that, to going to have a gross margin of 18.8% that Marion had mentioned earlier, I think, represents how much of that has been propped up by our value-added processing as we continue to grow that. When you're looking at $350 a ton drop in about 7, 8 months, that they did not absorb all of that through, there were no write-offs in service centers, so they absorb all that through margin. So I think they did a tremendous job there.So demand overall, it's okay. It's -- we're not seeing anything that's a catalyst to drive it through the roof, like an infrastructure project that would take off or anything like that. But again, it's in a solid place for our service centers right now.
That's good color. That's helpful. Maybe switching gears. It just -- it feels like industry conditions in the oil country tubular goods distribution is likely to stay challenging. I think there are some mills that are going direct to increase competitive pressures. Just -- so just a couple of questions related to this. Does this division earn a return on capital that is consistent with Russel's overall WACC? And have you given much thought -- or any thought to selling or winding down this business?
And so -- well, when you look at that, it also includes the field stores -- energy field stores, Apex, Comco and our lead supply partners as we merge those 2. So when you look at your OCTG and line pipes, what I think you're referring to in the energy segment, definitely challenged. You now have mills going direct. More mills have started to tiptoe around that phrase. So we're seeing as much inventory on the ground at mills as we are in the distribution side of the business. So the supply chain has definitely been disrupted. We think there may be a structural change. So we're looking at several avenues right now, reduction of capital, reduction of inventory, how do we try to get a return. But right now, that would be one of our lower-performing -- or the lowest-performing group we have would be the OCTG and the line pipe for Russel.
Okay. That makes sense. And maybe just one last one. Can you give us an update on the CFO search?
We think we're coming to an end sometime maybe early March. Marion was really gracious and gave us a long runway. So it's really let us take our time, went through the process very carefully. Coming through December, January, we've got to put the brakes on everything with the timing through the year-end schedules for both the candidates and for ourselves. But I think we're coming -- we'll be winding that to an end for an exciting candidate for us for sometime in early March.
Your next question comes from Michael Tupholme, TD.
Just building on one of the last questions, John, a question about the demand outlook for 2020. I appreciate the comments you provided. In the MD&A, you did talk about demand remaining consistent with early 2019. So I guess just to maybe try to take what you've said so far and maybe put some numbers around it if possible, but when we look at 2020 full year versus 2019, is this a year in which you think you could see sort of modest volume growth? Or should we be thinking more about kind of a flatter volume profile for 2020 versus 2019 full year?
Are we talking service centers or overall?
Sorry, this is on the service center side and -- yes, particularly.
Yes. Typically, it's going to follow GDP to some extent, so that would lend itself to a relatively flat year. I think when you're modeling, keep in mind the numbers that we mentioned there, you're going into '19 with just under $1,000 a ton plate. You can leave your flat roll, and I'm sure you see the graph as well and look at where we're going in now. So you're going to see some swings there in top line, just if we hold flat on tonnage.
Right. Okay. And then just in terms of the -- can you elaborate a little bit more on your commentary in the MD&A about the oversupply in the energy products operations for the market as a whole? I guess any sense on -- from your perspective on timing for how long it will be before we see the market's pipe inventories come back to appropriate levels? And I guess what does that mean for pricing from your perspective?
Yes. So you get, I guess, 2 real dynamics that are driving that, obviously, demand, the U.S. down 24% year-over-year on the rig count. So there's a lack of demand to stay in the U.S. with the rig count hovering about 800, 850. You've obviously got pricing that's there when you're looking at $50 oil or just slightly below. You're looking at $1.80 on natural gas. So those things are impacting demand.Also what we're seeing is, as I mentioned earlier, the mills are now carrying more inventory than they've carried, so they're competing with distribution. When there's a downturn, that compounds it. End users have been taking longer positions because of the mill programs. So we're competing with end users who are now selling into the market. So that compounds the issue.Q4 was very challenging. We're starting to see certain products now that have bounced back into Q1 that are, again, selling at, what I would call, normalized pricing. There are other products that are still overstocked. So you feel your way through your product mix, but we're starting to see the -- again, I would say, 50% to 60% of the product mix now selling at a normalized margin for us. And again, there's still a handful of items that are out there that you're highly competitive on because they're just overstocked in the marketplace.
Okay. And I know you took inventory charges. Most of the charges in the fourth quarter were in your energy products segment. So presumably, you took what you felt was necessary in the fourth quarter. But given the market dynamics, how do we think about risk of further inventory charges, specifically in energy products going forward?
Yes. So our approach has always been, again, when we see that, we identify it quickly, we try to plow through it in the quarter and get it behind us so we can move forward. If there's a downturn in pricing, there could be a further risk. But if pricing holds where it is or starts to move back up, then I think we're fine. If oil prices obviously fall, then we could have an issue there if demand changes. But if things stay status quo, I think we're fine. Again, we address it very aggressively. We want to plow through this stuff and get it behind us and move on.
Also the charge was more heavily weighted to the U.S. line pipe area, which not sure that this year is going to see a lot of projects going on with the election in that. And so we're -- we will be managing that area to make sure that we don't have the same exposure.
Okay. And then just maybe lastly, Marion, historically, you've been helpful in providing some gross margin outlook commentary by segment, at least sort of over the near term. Is there anything you can say on that front as we look out to Q1 or the first half of the year, how to think about the gross margins for your various segments in terms of any kind of a bounce back to kind of more normal levels? Or just anything you can provide on that front would be helpful.
Well, I would think that service centers is hitting back to a number with a 2 in front of it. So 2021, I'm hoping we get there in Q1. Well, a little bit wait and see on that, but I would expect at above the 18.8%, that was the Q4 and annual number. And barring all other changes in pricing, which never seems to happen in 1 year, we should be in that 21% to 22% range and before we get to the end of 2020.Energy products, it's going to be a little bit harder to sort out where we're going to go there, but I would think the Q4, 17.8%. I know last year, we were in the 19% for the year, which I think is too strong for energy. I think it will depend a bit awaiting on our oilfield and valve fitting numbers versus our numbers that we do get from OCTG, and that's really been driven a bit more by which area has the larger demand this year. And steel distributors, we're going to get back to a number that is in the range of the 12% to 13%. But once again, the revenues are going to come off in that area. So it will be even less of a factor in our total gross margin.
[Operator Instructions]
if there's no further questions, we can end the call.
We have no further questions at this time.
Okay. I thank everybody for participating, and we will talk to you in the spring. Thanks. Bye.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.