Greetings, and welcome to the Reliance Steel and Aluminum Third Quarter 2018 Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brittney Miyamoto.
Please go ahead.
Good morning, and thanks to all of you for joining our conference call to discuss our Q3 2018 financial results. I am joined by Greg Mullins, our President and CEO Paulie Lewis, our Senior Executive Vice President and CFO Jim Hoffman, our Executive Vice President and COO and Bill Sales, our Executive Vice President of Operations. 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 ks for the year ended December 31, 2017, under the caption Risk Factors and other reports filed with the Securities and Exchange Commission. The press release and the information on this call only as of today's date and the company disclaims any duty to update the information provided therein and here. I will now turn the call over to Greg Mullins, President and CEO of Reliance.
Good morning, everyone, and thank you for joining us today to discuss our financial results. Following a record second quarter, we are very pleased with our 3rd quarter performance, which was characterized by solid pricing, continued healthy demand and excellent execution by our managers in the field. Our earnings were supported by favorable pricing conditions with prices on the majority of the products we sell remaining at high levels throughout the quarter. As a result, we generated the 2nd highest quarterly net sales in Reliance's history of $2,970,000,000 which, when combined with our solid gross profit margin of 28%, produced our 2nd highest gross profit dollars of 834,300,000 and our 2nd highest non GAAP pretax income of $230,800,000 Our 3rd quarter non GAAP earnings of $2.42 per diluted share were also the 2nd highest in our company's history, growing 86.2 percent year over year. Adjusting for $0.34 per diluted share higher than expected LIFO expense that Carla will discuss in more detail, our 3rd quarter non GAAP earnings per diluted share would have been $2.76 at the high end of our guidance.
We are very encouraged by continuing positive demand conditions we are seeing across nearly all the end markets in which we operate. Our tons sold in the 3rd quarter were down 5.1% from the Q2 of 2018, slightly outside of our expected range of down 2% to 4%. The decrease was due to the normal seasonal decline we experienced during the summer months, which includes lower shipping volumes due to customer shutdowns and vacation schedules as well as one less shipping day in the Q3 compared to the Q2 of 2018. Metals pricing across all of our major commodities remained positive. Our average selling price per tonne sold increased 4.3% in the Q3 compared to the Q2 of 2018, exceeding our expectations.
Compared to the Q2 of 2017, our average selling price increased 23.0%, a testament to the strong demand and pricing environment we are experiencing as well as a more stable macro environment and increased certainty regarding trade actions compared to the same period a year ago. Given multiple price increases in 2018, we followed our normal practice and passed through higher metal prices prior to receiving the higher cost metal into inventory, which positively impacted our FIFO gross profit margin. Because the rate of increases slowed in the 3rd quarter, we achieved a FIFO gross profit margin of 30.7%, which was down from 32.8% in the Q2 of 2018, but in line with our expectations. So far, in the 4th quarter, prices have generally remained steady to positive, which we expect to continue throughout the remainder of the year, especially in light of rising scrap costs and price increases for carbon flat rolled products announced earlier this month. While it is still too early to tell whether or not the price increase will hold, we believe industry fundamentals remain solid.
We continuously evaluate each of our 300 plus operations to determine if they meet our profitability standards. This resulted in our decision to downsize 1 of our energy businesses as its future outlook has changed due to competitive factors for certain of the product it sells. Our pretax impairment and restructuring charge of $36,800,000 for the quarter included costs related to this downsizing as well as the restructuring of a few of our smaller locations. Turning to capital allocation. Our 2018 capital expenditure budget of $225,000,000 is focused on strategic investments in both equipment and facilities to drive organic growth.
As our customers demand more processed metal, we believe it is important to continue expanding our value added processing capabilities, which have also helped enhance our margins over time. As Jim will address momentarily, market, in particular, has shown significant growth and is an area in which we are continuing to invest heavily, primarily to support the increased usage of aluminum in autos. To further support growth, acquisition opportunities remain a key focus at Reliance. We continuously evaluate well run businesses that complement our diversification of products, services and geography as well as those that enhance our value added processing capabilities. Today, the pipeline for acquisition prospects is robust, and we are seeing an increasing number of opportunities in the market.
However, we will continue to be selective in our growth activities. In fact, during the quarter, we completed the acquisition of KMS Fab out of Pennsylvania and KMS South out of South Carolina, which I will refer to as the KMS Companies. The KMS Companies specialize in precision sheet metal fabrication ranging from prototypes to large production runs, utilizing a wide variety of metals and fabrication methods. As these companies perform high levels of value added processing, we have been able to fuel additional growth in their processing capabilities through investments in new equipment. The KMS companies were immediately accretive to our earnings, and their performance has been tracking in line with our expectations.
Additionally, just this week, we acquired the remaining 40% ownership interest in Acero Prime from our joint venture partner, an affiliate of United States Steel Corporation. Acero Prime is a toll processor in Mexico with 4 locations, including the recently constructed Monterrey facility, which opened in July 2016. Acquiring the remaining ownership interest in Acero Premier supports our capital allocation strategy of investing in high return opportunities that enhance our long term earnings potential. And we believe having complete ownership of Acero Cume will allow us to more fully support volume growth in important end markets such as automotive. Before I turn over the call, I'd like to reinforce that returning capital to our stockholders remains a top priority.
For 59 consecutive years, we have paid regular quarterly dividends, which we have increased 25x since our 1994 IPO. We also repurchased $80,700,000 worth of our common stock during the quarter, reflecting the trust and confidence our Board and management team have in our strong and consistent business strategy and outlook. We will continue to be opportunistic in our approach as it relates to stock repurchase activity. In summary, we are very pleased with our 3rd quarter results following a record second quarter performance. The positive demand and pricing environment in the 1st 9 months of 2018 contributed to Reliance's achievement of significant earnings milestones.
However, these accomplishments would not be possible without the extraordinary performance of our managers in the field, who remain committed to executing disciplined pricing, inventory management and expense control. Looking ahead, we continue to experience healthy activity in nearly all the end markets in which we operate, and we remain confident in our ability to maximize our earnings power and maintain our focus on increasing value to our stockholders. I will now hand the call over to Jim to comment further on our operations and market conditions. Jim? Thanks, Greg, and good
morning, everyone. Before I begin, I would like to thank our folks in the field for their many contributions to our excellent Q3 results. We greatly appreciate all of your hard work. Today, I'll focus on our outlook for certain of our key end markets as well as demand and pricing trends for our carbon steel and alloy products. Bill will then address our aluminum and stainless steel products and the related end markets.
Demand for automotive, which we serve was mainly through our toll processing operations in the U. S. And Mexico, remains very strong. We have continued to expand our presence in this market based on the significant growth we have experienced primarily due to the increased demand for aluminum content in automobiles. Our ongoing investments in value added processing capabilities to support our total processing operations, including our 100 percent ownership of Acero Premier that Greg just mentioned, are very exciting and support our strategic growth priorities as we continue to capitalize on the underlying positive demand environment.
Demand in heavy industry, which includes railcar, truck trailer, shipbuilding, barge manufacturing, tank manufacturers and wind and transmission towers continues to steadily improve. We believe tax reform has primarily supported increased spending on both construction and agriculture equipment by enabling customers to satisfy higher demand through increased capital spending budget. Demand in nonresidential construction market, including infrastructure, continues at healthy levels, though still well below peak. We believe this market will continue to improve and that we are well positioned to support increased volume in our existing footprint, including incremental volume if infrastructure spending improves. Demand for the products we sell into the energy market, which is mainly oil and natural gas, has continued its gradual improvement.
Leading indicators, including rig counts and drilling, continued to demonstrate growth with no lead times extending. We have also seen improvements in the completion activity. As the overall energy market continues to improve, we remain confident in our ability to service further increases in demand. However, due to changes in competitive factors for certain products, we decided to downsize 1 of our energy businesses, which resulted in an impairment charge in the Q3 of 2018. Turning to pricing.
No pricing for carbon steel products moderated during the Q3 following rapid increases in the first half of the year. In particular, pricing for carbon flat rolled products experienced downward pressure during the Q3. However, given our diverse product range, these products represent only a portion of our carbon exposure. Our more significant carbon products, including plate, structural and tubing, experienced flat to upward pricing moves during the quarter. Lead times still remain extended and scrap pricing is solid as a result of the healthy demand and ongoing Section 232 activity.
For the remainder of the year, we believe overall pricing for carbon steel products will remain fairly stable with the Q3 of 2018. Finally, I'd like to comment on pricing for alloy products. Positive demand trends in both automotive and energy continue to support relatively higher alloy pricing for service centers like Reliant, with extended lead times at the mill level. We continue to believe stronger overall activity in these markets should support improved alloy pricing going forward. In summary, pricing and demand remained healthy throughout the Q3.
Aside from seasonal factors, we expect these trends to continue throughout the remainder of 2018. Thank you for your attention today. I will now hand the call over to Bill to comment on our non ferrous markets. Bill? Thank you, Jim.
Good morning, everyone. I too would like to recognize our managers in the field for their solid performance during the Q3. Excellent job and keep up the great work. I'll now review pricing and demand for our aluminum and stainless steel products, including the key industry trends in the primary markets we sell these products into. Aerospace demand maintained its strong momentum throughout the Q3.
Both commercial and defense were strong with solid demand from single aisle planes and continued healthy activity from our defense customers. Lead times for aluminum aerospace plate remain extended and the backlog for orders remains consistently robust. Build rates have also been on the rise each quarter of 2018. As a result of all these factors, we maintain our positive outlook for the aerospace market and continue to focus on growing our market share through both domestic and international expansion. The semiconductor market experienced a slight pullback during the Q3 following a sustained period of rapid growth.
Our long
term outlook remains positive, and we are expanding our existing capacity in the U. S, South Korea and China to better support higher demand levels in each of these markets. Moving on to pricing. The majority of our sales into the aerospace market consist of heat treated aluminum products, especially plate as well as specialty stainless steel and titanium products. Demand for heat treated aluminum plate has been consistently strong since the last 15% price increase that went into effect in the Q2 of 2018.
In addition, we will be monitoring market support for the recently announced 5% price increase for January of 2019. For soft alloy aluminum products, the recently announced $0.06 per pound conversion price increase, which is set to take effect in January, has full mill support. Most of our common alloy aluminum products are sold to sheet metal fabricators that support a variety of end markets. Demand for common alloy aluminum sheet continues to be strong and availability is tight on the supply side. The $0.15 per pound conversion price increase announced for October had full support and is in the market.
We expect common alloy supply to remain tight throughout 2019. As a reminder, about half of our aluminum sales are to the aerospace market, which is the one area of our business where we participate in long term contracts with fixed selling prices. As a result, our average selling prices for aluminum generally will not follow market pricing as closely as many of the other products we sell. Lastly, demand for our stainless steel flat products, which are primarily sold into the kitchen equipment, appliance and construction end markets, continues to be very solid. Our average selling prices for stainless steel products also increased, mainly as a result of the price increases announced by the mills related to Section 232 actions and rising input costs.
I'd also like to note that pricing for stainless steel products is heavily impacted by nickel prices, which experienced some downward pressure during the Q3. And while lead times remain short, there appears to be a lot of pricing discipline, which has been encouraging. Thank you for your time and attention today. I'll now turn the call over to Carla to review our Q3 2018 financial results. Carla?
Thanks, Bill, and good morning, everyone. Net sales in the Q3 of 2018 were our 2nd highest at $2,970,000,000 up 21.4% from the Q3 of 2017. While our tons sold decreased 1.2% year over year, our average selling price per ton sold rose 23%, resulting in $524,400,000 more sales dollars in the Q3 of 2018 compared to the Q3 of 2017. Our net sales declined by only 0.5 percent from a record in the Q2 of 2018 with tons sold down 5.1% mainly due to normal seasonal patterns offset by a 4.3% increase in our average selling price per ton sold. We achieved a strong gross profit margin of 28.0% in the Q3 of 2018 within our estimated range of 27% to 29% and driving our 2nd highest quarterly gross profit dollars of $834,300,000 On a FIFO basis, our gross profit margin was 30.7%, up 250 basis points from 28.2% in the Q3 of 2017 and down 2 10 basis points from 32.8% in the Q2 of 2018.
These gross profit margin trends are in line with our expectations related to pricing trends. In 2018, we have experienced relatively consistent mill price increases throughout the year, benefiting our gross profit margin as we pass through higher prices to our customers in advance of receiving higher cost metals into inventory. However, when the rate of mill price increases decline, as occurred in the Q3 of 2018 compared to the Q2 of 20 18, we expect to experience downward pressure on our gross profit margin as we receive the higher cost metal into our inventory. Given that metal pricing was stronger than we had anticipated in the Q3 of 2018 and our updated view that current pricing levels will hold or be slightly up through the end of the year, we have increased our estimated annual LIFO charge or expense to $220,000,000 from our previous estimate of $175,000,000 Because our LIFO method requires us to record 9 months of the annual estimate as of September 30, our updated estimate resulted in a LIFO charge or expense of $77,500,000 or $0.80 of earnings per diluted share in the Q3 of 2018 compared to our previous estimate of $43,750,000 or $0.46 per diluted share, a difference of $0.34 per share.
We recorded LIFO expense of $6,300,000 or $0.05 of EPS in the Q3 of 2017 $62,500,000
or $0.65
of EPS in the Q2 of 2018. Given our current estimate of $220,000,000 of LIFO expense for the year, we expect to record $55,000,000 of LIFO expense in the Q4 of 2018. However, LIFO is an annual calculation and 4th quarter LIFO expense will be trued up based upon the actual calculation. As a percentage of net sales, our 3rd quarter SG and A expenses were 17 point 9 percent, down from 19.2% in the Q3 of 2017 and consistent with the Q2 of 2018. The reduction as a percentage of sales was primarily due to higher selling prices in 2018, which increased our net sales.
We recorded an impairment charge of $35,500,000 in the Q3 of 2018, primarily related to our decision to downsize 1 of our energy businesses due to changes in competitive factors for certain of the products they sell. This charge is treated as a non GAAP item. Pretax income in the Q3 of 2018 was $194,900,000 up 37.1 percent from 100 and $42,200,000 in the Q3 of 2017 and down 36.4% from our record $306,600,000 in the Q2 of 2018. On a non GAAP basis, our pretax income was the 2nd highest in our history at $230,800,000
up $91,100,000
or 65.2 percent from the Q3 of 2017. Our effective income tax rate for the Q3 was 22.9 percent, down from 30 4.4% in the 3rd quarter of 2017, primarily due to tax reform contributing positively to our earnings and cash flow. Net income attributable to Reliance for the Q3 of 2018 was $148,300,000 or $2.03 per diluted share. Non GAAP earnings per diluted share were $2.42 up 86.2 percent from $1.30 in the Q3 of 2017 and the 2nd highest in our history, trailing only our record earnings of $3.10 per diluted share in the Q2 2018. Turning to our balance sheet and cash flow.
Our strong earnings resulting from continued solid execution in a positive pricing and demand environment enabled us to generate positive cash flow from operations of $136,300,000 during the Q3 of 2018, despite higher working capital requirements. We used our strong cash flow to grow our existing businesses and return value to our stockholders, investing in capital expenditures, completing an acquisition and paying dividends to our stockholders. We also enhanced our stockholder returns with opportunistic share repurchases, buying back $80,700,000 of our stock at an average cost of $87.83 per share during the quarter. So far in October, we have repurchased $82,900,000 of our common stock or 1,000,000 shares at an average cost of $82.61 per share. On October 23, 2018, our Board of Directors extended our share repurchase program through December 31, 2021 and increased the total number of authorized shares available to be repurchased by 5,000,000 shares to a total of 10,700,000 shares, representing approximately 15% of our current outstanding shares.
At September 30, 2018, our total debt outstanding was $2,080,000,000 resulting in a net debt to total capital ratio of 28.2%. Our net debt to EBITDA multiple was 1.7 times. As of the end of the third quarter, we had $706,200,000 available on our $1,500,000,000 revolving credit facility, providing us ample liquidity to continue executing in all areas of our capital allocation strategy. Turning to our outlook. We remain optimistic about business conditions in the Q4 of 2018.
We expect that demand in the Q4 will remain healthy excluding the impact of normal seasonal patterns, which include a decline in shipping volume due to customer holiday related closures and fewer shipping days. As a result, we estimate our tons sold will be down 5% to 7% in the Q4 of 2018 compared to the Q3 of 2018. We also believe overall pricing fundamentals will remain steady to up slightly for the remainder of the year and that our average selling price per ton sold in the Q4 of 2018 will be flat to up 1% compared to the Q3 of 2018. As a result, we currently expect non GAAP earnings per diluted share to be in the range of $1.75 to $1.85 for the Q4 of 2018. In closing, we are extremely pleased with our Q3 financial results, which reflect healthy demand, a favorable pricing environment and solid execution by our managers in the field.
These factors collectively resulted in yet another quarter of strong earnings, enabling us to continue executing on our capital allocation strategy of investing in the growth of our business and stockholder return activity. That concludes our prepared remarks. Thank you for your attention. And at this time, open the call up to questions. Operator?
Thank you. We'll now be conducting a question and answer session. Our first question today is coming from Chris Terry from Deutsche Bank. Your line is now live. Hey, good morning.
This is actually Jeremy from his team.
Hi, Jeremy.
Good morning, Jeremy.
Regarding your capital deployment, you guys have done a great job of both share buybacks and dividends. I was just wondering, could you discuss a little bit more, I guess, on your preference for the share buyback versus potential kind of like a supplemental or special dividend?
Yes. I think, Jeremy, we certainly want to continue to reward our stockholders on both of those and return value to them. From a dividend standpoint on our regular quarterly dividend, our kind of driving principles are to maintain a sustainable level that we would not have to decrease or stop the dividend going forward. So we try to monitor the quarterly dividend. If you look at the difference between a special dividend versus a share buyback, The share buybacks do help us kind of permanently reduce our capital and enhance our earnings per share on a go forward basis.
So while we certainly can look at all of those different options, so far we prefer the share repurchases over a special dividend. Also, we do continue to grow the company and expect to continue to grow the company. So we also deploy part of the capital to continue both growth capital expenditures and the acquisition.
Thanks for the color on that. And then one more, if I may. The growing aluminum demand in the automotive industry, that's great for you guys, especially because you're investing more into the business. But will that more than offset volumes lost, I guess, on the steel side, both either volumes or revenue kind of outlook would be helpful there.
No, Jeremy, this is Jim. We don't anticipate that. There's still going to be a lot of steel in cars that they have to be, and the steel folks are working real hard to come up with new higher strength steels that they can use to meet the off weighting regulations that are out there. But aluminum certainly is picking up some of the share and which is good for us because we do we have kind of one of a kind type of equipment that we designed and actually built that can do the exposed aluminum sheet. So steel is a big part of our total processing, but aluminum has gained some ground.
And the aluminum is a little more difficult to process and handle than the carbon. So our pricing is a little stronger for the aluminum that we're processing and handling compared to the carbon. So we're comfortable with supporting that shift, but the continued growth on both of those.
The loss in tons on the carbon steel side and our toll processing operations is minimal.
All right. Thank you. Good luck. Thank you.
Thank you. Our next question is coming from Phil Gibbs from KeyBanc Capital Markets. Your line
is now live.
Hey, morning. How are you?
Good morning, Phil. Good morning,
Phil. The net working capital upside in the quarter was stronger than we thought by a good bit. How should we think about that in Q4? Is it still going to be a source of cash or should we expect pretty meaningful free cash in Q4?
Yes. Phil, typically in the Q4, we throw off quite a bit of cash because we do have lighter shipments because of fewer shipping days. So generally, our inventory levels come down from a quantity standpoint and so do our receivables. So we expect to see that. In Q3, we typically see a little bit of that with tons down, but because we still had some price increases and in particular, there's a timing difference between price increases announced at the mill level in the market and when we receive that into our inventory.
So we did see and it plays into the LIFO too that those higher costs coming into our inventory during the Q3 did still cause a net working capital increase Due to that, with prices flat in Q4, we would expect to throw off some cash and see our inventory levels reduced in the Q4.
Okay. Thanks, Carla. And Jim, the alloy sales or volumes rather were weakish at least relative to what we were expecting in the Q3 given how solid the energy demand has Any comments on why that may have been down? And is that all correlated to some of the reductions in footprint that you took in the quarter?
No. I hate to say it, but it kind of the mill performance. They're having a tough time to keeping up, which is it's kind of good in one side because the demand is so good, but they got real busy real quick and shipments kind of went the wrong way, but we'll
catch up. It's still strong.
And Carla, from these, you know you took an impairment in the quarter. Is there any cost benefit savings we should anticipate from some of these footprint reductions because it sounds like you called a couple of operations?
Yes. So the bulk of that impairment restructuring charge did relate to downsizing the 1 energy business. We will see a little bit of savings on our amortization expense from that. So probably about $1,500,000 a quarter because of the impairment taken there. And then on the closures, it's a handful of pretty small locations.
So certainly, we did it with the intent to improve our profitability, but it's going to be fairly marginal. I wouldn't expect to see a big impact on the overall consolidated numbers from that.
Okay. That's helpful. And one last question for me is just kind of on M and A and then also on CapEx this year. CapEx pretty solid, dollars 2.25 a lot of growth CapEx in there. To improve your through cycle margins with value added processing, which is great.
Are you expecting more of that to occur in 2019? Should we expect this level of intense CapEx to continue into the next year?
I would think, Phil, that our CapEx next year will be a little lighter than the $225,000,000 $225,000,000 was the most CapEx spending budget we've ever had. And our average is somewhere around $180,000,000 $190,000,000 rate. And I would expect 2019 to drop back to that. And M and A activity as Carla related in her presentation is very active and we would expect hopefully, you never know until the fish is in the boat that we'll continue to pursue those.
Was there a size at all of the Ceccero deal with U. S. Deal? Was it material at all in terms of the purchase price?
It was not material that we did not have to disclose it. So it was the 40% interest. I would say if you look at our income statement, the bulk of what's in that minority interest that shows on the income statement. The majority of that relates to Acero pre made, so you'll see a pickup in the net income attributable to Reliance as we get that 40% of their earnings going forward.
Our next question today is coming from Chris Olin from Longbow Research. Your line is now live. Hey, good morning.
Good morning, Chris. Good morning.
Phil might have touched on this, but my question was on the volumes. You missed your guidance by looks like 1 point down 5% quarter to quarter versus down 2% to 4%. I guess I was just wondering what drove that 1% difference? Is there anything meaningful in there?
I don't think there is anything meaningful. It's just that we have the holidays that impact us. Depending on business conditions, some of our customers just take a break. All right. And they close take the 4th July, the entire week off, very similar to what we see during the Christmas holidays and Thanksgiving.
So I think it was we had one lighter shipping day than we did in the second quarter. So I think it was just a combination of customers closing up, one less shipping day and just general seasonality that we experienced at most every year. I think 5% actually is pretty common. We thought in our guidance 2% to 4%, that it might be a little bit stronger this year, but it fell more in line with the historical numbers in the past.
Okay. That's fair. You don't get the sense that perhaps some customers went long inventory and now there's a correction coming or anything like that?
We don't have a whole lot of direct OEM business. Maybe some of those did that, Chris, I'm not sure. But with our customers living hand to mouth, now $1800 order sizes, we didn't see any meaningful we did see a little bit of that in the Q1, okay, but not so much in the Q2.
Okay. The last question I had was just I want to make sure I understand the pricing dynamics here. Nickel and aluminum seem like they had a pretty weak month here. So I would assume the surcharges are going to start coming down for some of these non ferrous products. Is that reflected in how you think about the pricing guidance already?
Yes, it is. If you look at surcharges right now, I mean for Q3, they were down just a little less than $0.03 a pound. The outlook for Q4, they'll be down more than that. We're estimating something like around $0.07 to $0.08 a pound. So but that is reflected in our pricing guidance.
Okay. Thank you. Thank you.
Thank you. We've reached the end of our question
I'd like to take this time to thank all of our employees, customers, suppliers and stockholders for their continued support and commitment to
Reliance. Finally, we would
like to remind everyone that we will be in New York City in late November presenting at the Goldman Sachs Global Metals and Mining Conference, and we hope to see many of you there. Thanks again, and have a great day.
Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.