Reliance Steel & Aluminum Co

Greetings and welcome to Reliant Steel & Aluminum Company's third quarter 2020 earnings conference call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Brenda Miyamoto. Thank you. You may begin.

Thank you, operator. Good morning and thanks to all of you for joining our conference call to discuss our third quarter 2020 financial results. I'm joined by Jim Hoffman, our president and CEO, and Karla Lewis, our senior executive vice president and CFO. Bill Sayles, our executive vice president of operations, will also be available during the question and answer portion of this call. A recording of this call will be posted on the investor 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, including the impacts of the COVID-19 pandemic and related economic conditions on our future operations, which may not be under the company's control, which may cause the actual results, performance, or achievement of the company to be materially different from the results, performance, or other expectations implied by these forward-looking statements. These factors include but are not limited to those factors disclosed in the company's annual report on Form 10-K for the year ended December 31, 2019 and as updated in the company's quarterly report on Form 10-Q for the quarter ended March 31, 2020 and the company's quarterly report on Form 10-Q for the quarter ended June 30, 2020 under the caption risk factors. disclosed in our press release this morning and other documents Reliance files or furnishes with the Securities and Exchange Commission. The press release and the information on this call speak only as of today's date, and the company disclaims any duty to update the information provided therein and herein. I will now turn the call over to Jim Hoffman, President and CEO of Reliance.

Thanks, Brenda. Good morning, everyone. and thank you all for joining us today to discuss our third quarter 2020 financial performance. We hope you're all doing well and staying healthy. We are very pleased with our third quarter results, which once again demonstrate the strength of Reliance's resilient business model. Our diverse product mix and market exposures along with our decentralized operating structure enabled us to quickly respond to varied and fluid Our gross profit margin expanded 200 basis points from the prior quarter to a record 32.4%, significantly exceeding our estimated sustainable range of 28 to 30% on net sales of $2.09 billion. Our increased gross profit margin combined with diligent expense control increased our non-GAAP earnings diluted share to $1.87, a 37.5% increase from the prior quarter, and generated strong cash flow from operations of $296.3 million. I would like to thank our managers in the field for their continued efforts to increase the value we provide to our customers during these challenging times, which meaningfully contributed to our increased earnings levels. Even more importantly, we would once again like to express our gratitude to all of our outstanding folks for their hard work and perseverance through one of the most challenging times in our company's history. Our people are truly the key ingredient of the secret sauce of Reliance, and we would not be where we are today without their unwavering commitment and support. Our managers maintain their focus on employee health and safety, including adherence to strict procedures to prevent the spread of COVID-19 and improve our safety performance on a year-to-date basis compared to the same period in 2019. We continue to support our employees and their families, as well as our customers, suppliers, and communities in a safe, positive, sustainable manner. Getting back to our third quarter financial results, our shipments surpassed our expectations, increasing 5.9% over the prior quarter, despite typical third quarter normal seasonal customer shutdowns and vacation schedules. Improved demand in the majority of our end markets as the economy continued to slowly reopen following COVID-19-related shutdowns. and project delays in the second quarter of 2020 drove this trend. In addition, our toll processing volumes increased materially compared to the second quarter levels as automotive production continued to ramp up. As a reminder, since we do not take ownership of the metal, our toll processing volumes are not reflected in our tons sold metric. Metal pricing began to improve in the third quarter as milk price increases for many of the products we sell were implemented with announcements for further price increases continuing into the fourth quarter. Despite these milk price increases, our average selling price per ton sold in the third quarter was down 4.3% compared to the second quarter, primarily as a result of product mix changes that Karla will discuss in more detail. basis points improvement on our gross profit margin to a record 32.4% was a major highlight of our third quarter financial performance, which drove a 40.6% increase in our non-GAAP pre-tax income over the prior quarter. The primary contributor to our record gross profit margin was a significant rebound in our tolling businesses that service the automotive market which generally operate at higher gross profit margins than our company-wide average. In addition, shifts in our diverse product mix along with our ability to implement price increases at the time of mill announcements collectively drove incremental increases in our third quarter gross profit margin. While we expect that the impact of certain of these factors will be temporary, We believe our managers will continue to successfully leverage the significant investments we have made to expand our value-added processing capabilities to support a sustainable higher gross profit margin. In regard to conditions in our key end markets, demand in non-residential construction, the largest market we serve, continued to slowly increase during the third quarter due to healthy bidding activity for new projects and a restart of projects that had previously been put on hold. Quoting activity remains strong for projects related to transmission towers, the military, schools, and municipalities, as well as large warehouses, data processing centers, and assisted living facilities. We have also seen an increase in certain infrastructure projects, such as roads and highways and water treatment plants. As such, we remain cautiously optimistic that demand for non-residential construction activity will continue to improve through the end of the year based on healthy backlogs and positive customer sentiment. Demand for the toll processing services we provide to the automotive market rebounded significantly in the third quarter as automotive OEMs and steel and aluminum mills continued to ramp up production following COVID-19 shutdowns in the second quarter. We simultaneously increased our processing volumes at our toll processing operations in both the U.S. and Mexico to support increased activities, and we were pleased to be able to recall the majority of our furloughed employees to our tolling operations. We remain committed to expanding our presence in toll processing in response to ongoing solid demand trends. Earlier this month, we commenced operations at a new facility in Kentucky. We will also soon break ground on a new greenfield tolling facility in Texas. These new facilities expand our carbon steel tolling capacity and will position us to better service our toll processing customers, primarily metals producers and their end users in the Ohio Valley and the eastern United States as well as in the southwestern U.S. and Mexico. Needless to say, our outlook for our tolling operations remains positive. Demand in heavy industry for both agriculture and construction equipment remain generally consistent with the second quarter. Production schedules in some areas have begun to increase, and we remain cautiously optimistic our businesses servicing the large industrial market should improve from current levels through the remainder of the year. Semiconductor demand steadily improved from the second quarter of 2020, and the market continues to be strong. Leading indicators for semiconductor space currently points to a more positive development in the fourth quarter and early 2021, and we believe we are very well positioned to participate in any improvement. Turning to aerospace. I'd like to start by noting that our aerospace businesses service diverse segments. Commercial aerospace represents about half of our aerospace exposure. In the third quarter, commercial aerospace demand continued to decline as reductions in travel due to COVID-19 persisted. In response to reduced commercial airline build rates that we expect to continue at low levels in the near term, We recorded impairment and restructuring charges related to facility closures, workforce reductions, and a negative outlook at certain of our businesses servicing the commercial aerospace market. Conversely, demand remains strong in the military, defense, and space portions of our aerospace business, which represents the other half of our aerospace exposure. We continue to see opportunities to expand our participation in defense which will help offset some of the weakness on the commercial side. We will continue to monitor and assess the health of each of our aerospace businesses and take appropriate cost reduction actions if and when needed to ensure the continued long-term profitability of these businesses. Finally, demand in the energy sector, which is mainly oil and natural gas, remains under significant pressure. As I highlighted in our last call, we have taken proactive cost reduction measures throughout 2020, including the consolidation of certain facilities and headcount reduction. As a result, we believe we are well positioned to maintain our presence as a dominant player in the energy space and support any further recovery in that market. One bright spot in particular is the renewable energy space in which we sell a significant amount of metal for solar and wind tower projects. Turning to capital allocation, our countercyclical cash flow generation enables us to remain flexible and opportunistic as we allocate capital for both growth and stockholder return opportunities in both good times and bad. Our capital expenditure budget for 2020 is weighted towards growth activities that supports our customers through the addition of innovative equipment and advanced technology to further expand and strengthen our value-added processing capabilities. We have increased our 2020 capital expenditure budget by $80 million to a total of $270 million in response to opportunities to better service our customers, including the total processing expansion in Texas. and to maintain and upgrade our equipment to provide our customers with the highest quality products and services. On the M&A front, we continue to see a healthy pipeline of prospective opportunities. As always, we evaluate potential candidates using stringent criteria to ensure the best possible fit within our family of companies. We continue to seek well-run Profitable businesses that possess strong management teams and superior levels of customer service with a focus on safety. Acquisitions must also complement our product and end market diversification strategy and be immediately accretive to our earnings. In regard to stockholder returns, we are pleased to maintain our payment of a regular quarterly dividend as we have for 61 consecutive years. without ever suspending payment or reducing our dividend rate. We've increased our dividend 27 times since our 1994 IPO, including the most recent increase of 13.6% in the first quarter of 2020. We also repurchased a small amount of our common stock during the third quarter of 2020. Another key highlight during the quarter was our diligent inventory management. We continue to right-size our inventory to reflect current demand levels through reduced buying as well as cross-selling inventory within our expansive network of service centers. And we are pleased to have achieved our company-wide goal of 4.7 inventory turns during the third quarter. In summary, We are very proud to have improved our financial results amid the unprecedented global uncertainty that continues to materially impact the economy. Our decentralized structure afforded us the flexibility to immediately respond to rapidly changing demand trends and help preserve our long-term profitability. I'd like to thank all of our folks within the Reliance family of companies for their dedication, persistence, and hard work to ensure that our entire workforce remains safe and healthy and is in a position to continue providing best-in-class customer service and producing profitable results. It is through their efforts that the unique aspects of our business model were able to really shine through, enabling us to achieve significant gross profit margin expansion to a record 32.4%. The consistent execution of our resilient business model is a testament to not only the diversity of our products and markets and geographies, but also our commitment to strong pricing discipline, diligent expense control, when needed inventory management, and leveraging our investments in organic growth and innovation. We believe customers realize increased value in our model during challenging markets as they confidently rely on us to do more for them, often in smaller sizes or on a more frequent basis. As Reliance continues to evolve as a leading diversified metal solution provider, we will leverage both the knowledge we have acquired while navigating the pandemic and our commitment to continuous improvement and innovation to provide enhanced solutions to our customers and drive stockholder value through increased efficiencies and profitability. America is going to need Reliance to rebuild. Thank you very much for your time today. I'll now turn the call over to Karla to review our third quarter 2020 financial results in more detail. Karla?

Thanks, Jim, and good morning, everyone. Our net sales of $2.09 billion for the third quarter of 2020 decreased 22.4% from the third quarter of 2019 with our tons sold down 13.1% and our average selling price down 11%. Compared to the second quarter of 2020, net sales increased 3.3% with our tons sold up 5.9% and our average selling price per ton sold down 4.3%. Our tons sold exceeded our expectations of flat to up 2% from the prior quarter as demand in many of our end markets improved with the most notable strength in non-residential construction. Although not included in our 10 sold metric, the significant rebound in our toll processing operations contributed meaningfully to our increased sales with toll processing volumes up 81.5% from the lows experienced in the second quarter of 2020. And our average selling price per ton sold declined 4.3% compared to the second quarter. Our lower average selling price in the third quarter was mainly due to shifts in our product mix rather than overall metal pricing trends. The most significant shift was a 14.9% decrease in our aerospace tons sold in the third quarter, the majority of which was heat-treated aluminum and titanium products which represent some of the higher-priced products we sell. Meanwhile, our shipments of flat-rolled carbon steel, which are among our lowest-priced products, increased as a percent of our total shipments, which also reduced our average selling price. And lastly, our alloy sales now represent a lower portion of our total ton shift due to the closure of certain of our energy businesses. Our gross profit margin for the third quarter of 2020 was a record at 32.4% and well above our estimated sustainable range of 28 to 30%. This ties our record gross profit margin set in the fourth quarter of 2019 when we recorded LIFO income of $81 million compared to LIFO income of $12.5 million in the current quarter. On a non-GAAP FIFO basis, which we believe is the best measure of our day-to-day operations, our gross profit margin of 31.8% increased 300 basis points from 28.8% in the third quarter of 2019 and increased 160 basis points from 30.2% in the second quarter of 2020. As Jim highlighted, This is a direct result of the outstanding performance by our managers in the field who, despite challenging circumstances, maintain pricing discipline by focusing on higher margin orders and providing more value to our customers through our expanded value-added processing capabilities. And these actions are the key drivers behind our ability to increase and sustain our strong gross profit margins. During the third quarter, certain other factors contributed to our increased gross profit margin, the impacts of which we believe may be more temporary. First, the significant rebound in our toll processing volumes drove a meaningful increase in our gross profit margin as our tolling businesses operate at higher margins than our company-wide average. Second, changes in our product mix contributed as our lower margin contractual commercial aerospace sales declined while shipments of lower priced carbon flat rolled products increased. Given a lower average overall selling price, value added charges are a larger component of our sales, which has a positive impact on our gross profit margin. And third, we were able to enhance our gross profit margin for certain of our carbon steel products as Mills announced price increases late in the third quarter. We recorded LIFO income of $12.5 million or 15 cents of earnings per diluted share in the third quarter of 2020 compared to LIFO income of $40 million or 44 cents of earnings per share in the third quarter of 2019 and LIFO income of $5 million or $0.06 of earnings per share in the second quarter of 2020. Given our current estimate of $50 million of annual LIFO income in 2020, we expect to record $12.5 million of LIFO income in the fourth quarter of 2020. As a reminder, we will true up to our actual LIFO adjustment at December 31st. and our LIFO reserve was $100.1 million at September 30th. Our third quarter non-GAAP SG&A expenses decreased $75.2 million or 14.5% compared to the third quarter of 2019 on a 13.1% reduction in shipments. The decline in SG&A expense was mainly due to reduced variable expenses such as plant supplies and freight costs, along with lower average headcount, which was down 13.8%, as well as lower performance-based compensation. When compared to the second quarter of 2020, our non-GAAP SG&A expenses increased only 2.6% on a 5.9% increase in our ton shift, demonstrating The efficiencies gained through our state-of-the-art processing equipment along with our continuous improvement and innovation initiatives. During the third quarter of 2020, we recorded impairment and restructuring charges of $14.6 million as we continued to close or merge a few of our smaller locations and wrote off certain intangibles due to our outlook for a more challenging environment in certain markets. We recorded an additional $14.6 million in non-recurring charges comprised of settlement charges related to the termination of multiple small frozen defined benefit plans and settlement of an obligation in our SIRP plan. We also recorded $1.8 million in debt restructuring charges related to our financing activities in the quarter for total non-recurring charges of $31 million in the third quarter of 2020. We remained solidly profitable in the third quarter of 2020 with non-GAAP pre-tax income of $158 million and a non-GAAP pre-tax margin of 7.6%. Our effective income tax rate for the third quarter was 22.6%, down from 25% in the third quarter of 2019 and up from 20.9% in the second quarter of 2020. Our lower tax rate was driven by reduced income levels in 2020 attributable to the impacts of COVID-19. At this time, we estimate our effective tax rate for the full year of 2020 will be approximately 22.5%. Non-GAAP net income attributable to Reliance for the third quarter of 2020 was $120.9 million, resulting in non-GAAP earnings for diluted share of $1.87, down from $2.39 in the third quarter of 2019, mainly due to lower pricing, demand levels, and up from $1.36 in the second quarter of 2020 due to our strong gross profit margin and recovering demand. On a GAAP basis, Our earnings per diluted share were $1.51 in the third quarter of 2020. Turning to our balance sheet and cash flow, we generated strong cash flow from operations of $296.3 million during the third quarter and $942.8 million during the first nine months of 2020 due to our continued profitable operations and effective working capital management, including a continued focus on right-sizing our inventory levels, which resulted in achieving our inventory term goals of 4.7 times. During the quarter, we issued $400 million of 1.3% five-year senior notes and $500 million of 2.15% 10-year senior notes through a public offering. We used a portion of the proceeds to repay all of our outstanding indebtedness under our unsecured revolving credit facility and term loan and will utilize the remaining proceeds for general corporate purposes. Additionally, in early September, we entered into an amended and restated $1.5 billion five-year unsecured revolving credit facility that replaced our previous credit agreement and includes an increase option for up to an additional $1 billion. The facility amendment, combined with the proceeds from the notes offering, have significantly enhanced our liquidity position and extended our debt maturity profile. At September 30, 2020, our total debt outstanding was $1.66 billion, resulting in a net debt to total capital ratio of 17.3%. Our net debt to EBITDA multiple was 1.1 times, and as of the end of the third quarter, no borrowings were outstanding on our $1.5 billion revolving credit facility. In regard to capital allocation, our increased 2020 capital expenditure budget of $270 million includes additional strategic investments to address our customers' needs and drive organic growth. We will continue to pay our regular quarterly dividend and selectively execute attractive acquisition and share repurchase opportunities. In the third quarter of 2020, we invested $38.2 million in capital expenditures and returned $41.2 million to our stockholders through dividends and share repurchases. Turning to our outlooks, While macroeconomic uncertainty stemming from the COVID-19 pandemic continues, based on current expectations and market conditions, we anticipate that overall demand will continue to slowly improve in the fourth quarter of 2020. We expect shipping volumes will decline in the fourth quarter due to normal seasonal factors, including customer holiday-related shutdowns and fewer shipping days We anticipate metals pricing, primarily for carbon steel products, will improve due to mill price increases. However, similar to the drivers behind our average selling price decline in the third quarter, we believe the impact of these price increases will be partially offset by our diverse product mix and declining sales in certain markets such as aerospace, which typically involve higher priced products. As a result, we expect our average selling price in the fourth quarter of 2020 will be flat to up 2% compared to the third quarter of 2020. Based on these expectations, we currently anticipate non-GAAP earnings per diluted share in the range of $1.30 to $1.40 for the fourth quarter of 2020. Looking ahead, we will continue to execute our business model and remain focused on managing the elements of our business that are within our control. In closing, we are very pleased with our third quarter results amid the broader macroeconomic uncertainty the pandemic has caused. Our managers in the field delivered excellent execution as demand began to slowly recover throughout the quarter, maintaining their strategic focus on high levels of customer service and value-added processing. combined with our emphasis on expense control and our ability to respond quickly to market conditions resulted in yet another quarter of solid profitability and cash flow, enabling us to support our growth and stockholder return priorities. I'd also like to echo Jim's sentiment and extend my thanks and gratitude to all of our employees in the Reliance family of companies for their ongoing commitment to health, safety, and operational excellence in this unprecedented time. We believe our people along with our proven business model are the keys to the strength and resiliency of our business. We look forward to improved conditions in the quarters ahead as we work with our employees, customers, suppliers, and communities to mitigate the ongoing impact of COVID-19. That concludes our prepared remarks. Thank you for your attention. And at this time, we would like to open the call up to questions. Operator?

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, It may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from Seth Rosenfeld with Exane BNP. Please proceed with your question.

Hi, Karla and Jim. Congrats on a very strong quarter.

If I could please kick off

If I could just kick off with a question on the outlook for margins, please. Thank you, first of all, for providing some color in your prepared remarks on the drivers of particularly robust margins in Q3. Looking forward to Q4, your guidance seems to imply a pretty sizable reduction in gross margins quarter over quarter. Can you walk us through which of the key drivers you would view as perhaps deteriorating on a quarter over quarter basis and how we should expect that, I guess, settling out going into 2021 as we expect? demand to continue to recover in line with your guidance. I'll start there, please.

Hi Seth, it's Karla. So from a Q4 perspective, you know, we're very, very pleased with the performance we've had and the gross profit margin that our folks have been able to achieve. We did build into the comments, you know, With the rebound from COVID, there's still uncertainty out there. We're seeing some changes in product mix. So, you know, we did try to highlight some of the impact both on average sell price and on gross profit margin from those. And while certainly we think we will solidly perform at the high end of our estimated sustainable gross profit margin range of 28% to 30% going forward, We are a little cautious on achieving the record performance we had in the third quarter. There are carbon steel price increases on certain products, including on flat rolled, which were pretty sizable at the end of the third quarter going into the fourth quarter, which are very positive for Reliance as that allows us to make more gross profit dollars and helps us. But as the metal price, the metal cost increases, Our gross profit margin percent that we saw from our flat rolled business in Q3 as a percent could go down a bit. So we're okay with higher prices at a slightly lower gross profit margin. And we did benefit quite a bit from our improved toll processing operations in Q3. As we've talked about, that has a positive impact on our gross profit margin, and that is sustainable. However, we think that the impact going from Q2 to Q3 was probably a little inflated just because of some of the cost-saving measures we took when we were hit hard for COVID. So we're a little cautious on being somewhere between that high end of our sustainable range and what we saw in Q3. But again, very confident, maintaining a very strong gross profit margin. but recognizing we had some temporary boosts in the third quarter.

That's very clear. And just to confirm, your last comment was you'd expect to be somewhere between the high end of that sustainable range and the Q3 performance in Q4. Did I hear that right?

We expect to be able to stay, you know, at the top of the sustainable range, yes.

Okay. Thank you. And the second question just on aerospace, given it seems to be perhaps a growing challenge for the company. Can you walk us through to what extent you'd expect further sequential volume weakness here? Or do you think that in the numbers you recognize in Q3, you're already kind of recognizing the large step-down in production rates among those customers?

Thank you. Yes, Sam. This is Bill. How are you? We think when you look at aluminum... We think when you look at it from an in-market perspective that we'll be at the bottom. We're at or close to the bottom now. And as we look into next year, we think we will slowly start to see some improvement. Our guys have done a really good job of attacking the expense side and really hitting the inventory side hard. So... If you look at the outlook as we head into Q4, there may still be a little bit of downside on the performance side, but we're close to the bottom and would look to see some improvement as we move into next year.

And just to clarify that a little bit, with what Bill talked about, we were seeing kind of continuing declines through the third quarter. So really from where we ended at the third quarter, Thank you very much. Thanks, Seth. Thanks, Seth.

Our next question comes from Alex Hacking with Citi. Pleased to speak with your question.

Good morning Jim and Karla and thanks for the call. I guess my first question was just around the auto tolling volumes or the auto tolling business. Could you quantify where those volumes are at versus normalized levels as you exited the third quarter? And then just on the new facility in Texas, Is it possible to quantify the tonnage that you would be looking at there, and would it be safe to assume that's going to be co-located at the new flat-rolled mill that's being built in Texas? Thanks.

Hey, Alex. I'll take the first part of that on the auto-tolling volume. So as we commented on in the script, Q3 overall tolling volumes, which about 60% of that is auto-related, Appliance would be the next biggest portion of that, and then some miscellaneous. Our Q3 volumes were up 81.5% compared to the second quarter. As I'm sure you're aware, you know, that ramp was pretty quick. That was a B that started the end of the second quarter and continued into the third quarter. So for the quarter, we were probably about 9%-ish, 9% to 10% below Q3. and we've continued to see a slight improvement from that coming out of the quarter. So, you know, we think we're probably at about 90% to 95% of pre-COVID levels now.

And, Alex, as far as our new operation in Texas, I can't really quantify what the times will be. I hope it's a lot. But, you know, when they open a greenfield site like that, you know, it takes a while to get up and running. And my guess is that company has probably released what their capacity is, and they intend to run at a high level. And if that's true, then we will too. So we're looking forward to that.

Yeah, and in addition to that, we also – part of Jim's remarks were that we also are in the process of opening in the fourth quarter – Another new greenfield expansion for tolling in Kentucky as well.

Okay, thanks for that. And then I guess just on the capital structure, you know, net debt now is down to around a billion-ish, like one times EBITDA. I mean, how do you think about that going forward? I mean, it seems relatively conservative given the margin stability that you guys have You know, very successfully achieved through the cycle. I mean, yeah, so how should we think about that capital structure going forward?

I'll let Karla answer that before anybody says we have a lazy balance sheet. We kind of like having all that cash, but Karla will tell you what we do with all that.

Yeah, I mean, I think, Alex, certainly we are very comfortable with where we are from a leverage standpoint. We continue... to be able to execute on all of our capital allocation priorities. As I think you know from knowing us for a while, we try to be very opportunistic and flexible in all those areas. Coming through the pandemic, the company has performed very well, but I think being a little comfortable with our financial position has not been a bad thing as we've gone through this uncertainty. But we are very confident with the model and the way we've performed. We've been ready to execute. Jim mentioned in his comments, you know, we see a lot of M&A activity. We continue to look at organic growth, and as you saw in our notes, we just increased, you know, our CapEx for this year. We're working on our CapEx for next year, but we continue to see organic growth opportunities. We pay a healthy dividend and, you know, want to continue to periodically increase that, as we've done for many years. and also jump into repurchase shares. So we're anxious for good opportunities to put our balance sheet to work a little harder.

Perfect. Thank you.

Thanks, Ellen. Our next question is from Chris Terry with Deutsche Bank. Please proceed with your question.

Well done on a solid quarter. Just my first question on the guidance for 4Q specifically. I think you're basically saying that your gross profit margin will be on the high end of the 28% to 30% sustainable range. In terms of the volumes, I think when we looked at it seasonally, you normally dip 5% to 7%, and you're saying... Maybe seasonally it might be so bad, but you saw it 4% to 6% down. Is that potentially conservative when you consider that the COVID recovery is probably a lot stronger than the normal seasonal impact?

Yeah, Chris, it is conservative, but that's kind of what we do. We manage the things we can control, and we can't control the demand or the price. So we look at the things that... will provide the most value to our shareholders and execute as we've done year after year after year. The COVID situation, I think we've done a really good job coming through that. In September, we saw things coming back a little quicker than we thought. October right now is kind of flattish to that, if you will, but we're still looking at those kind of numbers. So yeah, is it conservative? Sure, it's conservative. But we want to be able to do the best. We do the best job we can in predicting the future, but we hope to be able to get there and beyond as we have in the past.

And Chris, just as a reminder, last year our fourth quarter volumes were down just under 7% from the third quarter. So this guide is a little better than that. But as Jim said, you know, on the conservative side because there's still a lot of uncertainty out there.

And the other thing, Chris, remember, just because Reliance is an essential business doesn't mean all of our customers are that way. So we're not really sure what we're going to see. Perhaps there's some customers that will be coming out of COVID stronger, but some may not. There may be a shift in the products they're making. Remember, our customer base, 125,000 strong. There's a lot of smaller... and other customers out there who continue to need reliance more and more because of our value-added play. And depending on, you know, if it's a job shop, they call them a job shop for a reason. They go from job to job. They're not really sure what they're going to do the next month or next quarter. So a lot of those things are really out of our control, but, you know, we kind of look at it through a lens that were experienced at the guesswork involved and things like that. But we're just conservative by nature and we'll try to manage through it.

Thanks. Thanks, Jim and Karla. That all makes sense. Just a follow-up question on the CAPEX, so $270 million for 2020. I appreciate it's probably too early to fully talk about 2021, but Just trying to get a gauge of the toll project or the investment in Texas and also Kentucky. Is there an amount of that that carries forward into 2021 that we can think about on top of the normal sustaining level for how 2021 CapEx might shape up? Thanks.

Yeah, so, Chris, the way we do our CapEx budget, the full amounts of the spend for both the Kentucky and Texas projects are in the updated $270 million 2020 budget. It's possible some of that cash could trail in to be paid during 2021, but we've got the full amount of that loaded. As I mentioned, we're working on our 2021 budget now. We don't have that final number yet, but we do see, you know, continued opportunities throughout all of our companies servicing all the different markets that we work with.

Yeah, Chris, like Carla said, we're kind of in the middle of that right now. We anticipate another robust CapEx spend where our customers continue to ask us to do different and more things, and there's no reason to think they're not going to continue to ask us to do that. I can tell you we'll be there for them. So it should be another good spend for us in 2021.

Okay, that's clear.

Thanks. That's all for me.

Thanks, Chris.

Thanks, Chris. Our next question comes from Tim Natanners with Bank of America. Please proceed with your question.

Hey, good morning, guys. Good morning, Tim. I wanted to drill down again on the gross margin number because I know your guys are just 28-30% and I know you're conservative but we haven't even been in that range now for a while I guess since Q2 of last year and I'm just wondering I mean if you look at Q3 yes there's a bit of LIFO but despite the fires and despite the uncertainty despite all the things that may or may not have affected you it's a pretty phenomenal result even on a FIFO basis so I'm just wondering Is it time to start thinking about higher guidance because it makes such a big difference in forecasting for you? What would it take to see a dip actually below that 30% going forward? Whatever you can provide would be helpful.

Well, it is time to start thinking about it. We think about it all the time. A key point of your question was the word uncertainty. Once we're certain that we can get there and we can sustain that, we'll say it. This COVID thing was a son of a gun. We were able to respond in typical Reliance fashion because of our model. But again, it's tough going into this fourth quarter to say it. But we have to believe it before we say it. We hear you, and we're with you. And when we say it, you can count on the fact that it'll be sustainable. So that's the best answer I can give you right now. I wish I could tell you everything I'm thinking, but we'll see.

And just to clarify too, Tim, so the 28% to 30% is on the LIFO basis, and LIFO does help lessen some of the volatility there. So just to point that out, and as Jim said and we've been asked by many of you about raising that and we are very proud of the results we've had and that we've been you know consistently at the top end for a little while but you know things like the and it was to the positive side our product mix impact on our margin in the third quarter you know that could potentially go the other way a little bit too so that's some of that uncertainty you know Things are changing as we recover from the COVID hit. So we're watching that and hopefully, I mean, I think we're confident and I did say earlier in my remarks, we think at least through Q4, we can stay at the high end. We do think there are a lot of really good things that have happened that have driven our sustainable margin to the high end. and we'll continue to monitor that.

And as you all know, Tim, the mix has a lot to do with it. You know, the flat roll business, if that starts going up, that's at a lower margin than some of the other things that might be going the other direction. Another thing, just anticipating the next question from maybe not yours, somebody's going to ask about the fact we went from a traditional 40% of our product having added value to it to 51%, and we really haven't reported where that number is now. And when that does go up, there's not a direct correlation between those two. It's part of our strategy to get that going north, but you'd have to really drill down to find out what kind of value-added things we're doing. There's value-added that we can charge for that's not as high value-added as other type things we can do. So just the type of value-added that we're able to get. This quarter, it was nice. Some of this technology out there that's available to us from an equipment standpoint, it's pretty fascinating, really, and we're able to – offer our customers new and different things and they're willing to pay for it. And it never ceases to surprise me what they come up with because they deal with this COVID thing differently. And when they come out, they have different needs and they have different desires and we're a solution provider. So we listen to what they need and we partner up with some equipment manufacturers and come up with a solution for them. We hope that number continues to drive up at better and I don't know how high it's going to be or how high it can be but there's a lot of things that go into those numbers too.

And just because we're not ready to increase that range yet doesn't mean you can't put something higher in your model.

All right, thanks for the permission there. That's great.

I was going to say, that was nice of you, Karla.

Yeah, that was very nice. All right, the only question I wanted to sort of drill down into, and granted you just said there's a lot of components and it's complicated, but if I could, the aerospace piece of business, you know, obviously under some pressure and could be for a while, energy as well. but this auto tolling opportunity with this last quarter and with the growth, is that enough to offset those lost conceptually? Is that enough to balance out maybe the lost opportunity or the dormant opportunity maybe in energy and aerospace or how do you think about that?

I think from a profit standpoint when we're fully ramped, which is not going to be for a while yet, Thank you for joining us.

In addition to the two new greenfields, we've got some new opportunities to grow our market share through our existing tolling operations. So our plan is we're going to see that continue to have a positive impact, obviously.

And the aerospace, the defense end of the aerospace and the space end of the aerospace, that's good business. There's a lot of opportunities for us in that, and we anticipate participating and And that, just by design, is just high value-added activity. And we see some opportunities there, too. So that's kind of a bright spot.

We do, definitely.

Okay. Great, guys. Thanks again. Thanks, Brenda.

Our next question comes from Chris Owen with Tier 4 Research. Please proceed with your question.

Well, Karla, I should probably ask then, can we also put our estimate higher than the guidance?

You can put your stock price target higher.

Okay. All right. Fair enough. I know you're getting a lot of aerospace questions, but I just want to make sure I understand the numbers. I don't have any slides in front of me, but I used to ask in – It was always like 8% to 10% of total revenues. And I just want to make sure I understand how you talk about it now. Half of that was commercial aerospace, half was other aerospace. Now commercial, what they get cut in half. So your business is about 7%, 2% at risk. The rest is stable. Is that how I think about it?

So we're just an acquisition we had done back in about 2014, our aerospace. The last few years has been about 10% to 12% of our revenue dollars. With COVID, that's come down a bit. So, you know, we're a little under the bottom end of that 10% range. And it is about half and half, you know, maybe split between commercial and then defense space, et cetera, making up the other half.

and then most of commercial would be aluminum-related products. Titanium doesn't really move that much in terms of total, right?

Yeah, mostly aluminum. There is some aerospace steel and titanium products, but when you look at the commercial side, for us it's a much bigger play on aluminum.

Yeah, especially on that heat-treated plate. So, and we did talk about with our average sell price fluctuation and things. I mean, the 10% to 12% is based on sales dollars. And again, these are our higher price products. So, the tons would be a smaller percent of our total tons, but because of the high price product.

Do we need to think about contract rollovers for 2021? I don't know if somebody has that yet, and I remember it being a nice boost last year. Is that reverse going forward?

Yes, on the defense side, definitely. The JSF contract, you know, that has been extended, so that's a big program for us.

Pricing on commercial aerospace, has that stepped down now in relation to demand numbers? No.

Yeah, so far the pricing has been pretty stable on the commercial aerospace side. So, you know, I think even with the drop in demand, the mills have been very disciplined in their pricing approach there. And so pricing is, I would say, is stable. Great.

That's all I have. Thank you.

Thanks, Chris.

Our next question comes from Phil Gibbs with KeyBank Capital Markets. Please proceed with your question.

Hey, good morning.

Good morning.

The question is just on the non-res side, and I know, excuse me, I have a little something in my throat. Just in terms of what you're seeing regionally out there in the different markets that you serve, because obviously you've got a view of and so on. What should we take away regionally?

That's a good question, Phil. The good news for us is it's kind of widespread, if you will. Northeast has kind of been chugging along at a good pace for several quarters. Now the southeast, unfortunately with the weather issues, that business has really picked up. And unfortunately, for the people who live there, probably won't subside for a while. So we've seen a nice pickup in equipment going into redoing roads and bridges and water treatment plants and those type of things, electrical grid. Out west, it's been strong and it continues to be so based on the larger big box warehouse campuses for you know, electric motors, widespread as far as, you know, assisted living facilities. That's, you know, there's elderly people live everywhere. So that's a good business for us. And like we've seen, I believe I said in my comments or Karla did one that we've seen some infrastructure spend it that, you know, that was related to the Southeast. and then down in Texas, Oklahoma. Business is pretty good. Arizona, doing pretty good. There's, like I mentioned, the renewable energy business is a nice spot for us. We anticipate that to continue to get a little better. So just across, you know, anything widespread for us is a good thing. So that's what we're seeing. and I've said this comment for a long time since 2009 now. This slow burn up continues and we seem to be in the right spot for that and it continues to do that and we anticipate the fourth quarter to keep going.

Are you seeing any constraints in trucking availability? Right now in the U.S., I know you have some of your own, but any constraints that you're either seeing or you're noticing out there or, you know, in subpart, are you starting to see increased pressure on freight rates?

No, we're not, but we're in that business, so we can ramp up, and we have a lot of our own trucks for that reason. We like, and they're our employees. We consider our truck drivers and folks who do that as team members who are actually salespeople as well because they're out there flying the colors and they care about the service of our customers because that's part of our model. So if we did see a problem, we would go the way of getting more trucks on. So we have not seen that. A lot of our product that's moved around from mills into our operations go by rail. and that seems to be going well. So we've got our finger on that pretty well. We can ramp up if there's an issue. There was a time, I don't remember how many quarters ago, where there was a driver shortage that we saw coming, so we adjusted to that. So I haven't heard of anything that we're worried about, I can tell you that.

And the last question is just for Bill. Bill, if there is a change in administration and there is a change in defense spending policy, how long does that, based on your history, take to influence what's already out there? Because I know that a lot of these things are seriously well-funded by the Senate and takes their blessing. So any thoughts maybe you could give around that because I would think people are starting to at least ponder the possibility that if there is a change, what's still good and how long is it good for?

Good question, Phil. It sounds like that regardless of who wins, that defense spending is still going to be a priority. and as you say a lot of what we're seeing is already in play and so it will take some time if there is a change but when you look at the major programs that we're on we're not seeing or believing that there's going to be a significant change there over the long haul so we still are very positive on the outlook from a defense standpoint.

And isn't there, Bill, a lot of that that also goes to some foreign buyers?

Yeah, even, you know, you've probably seen a lot of the legacy fighter programs that are going to other countries now, and we're a big supporter of those programs. So that side of the business has been very positive for us also, and we think that will continue.

Thanks, everyone. Talk soon.

Thanks, Bill.

Our next question is from Tyler Kenyon with Cowan & Company. Please proceed with your question. Hi Jim, Carla, and Bill.

Hope you're all doing well. Question is just on the volume guide, down 4% to 6% sequentially. Wondering if you could break that out between the various product categories, carbon, aluminum, stainless, and alloy. or maybe just provide us a sense of how to think about each one of these categories. I think it would just help in light of some of the recent shifts in Mexico.

Yeah, I think, you know, Tyler, as we said earlier, you know, we're hopeful that's on the conservative end, but, you know, there is the normal seasonality with everything that's happened with, With COVID this year, I think there are different schools of thought, and our customers may react differently. Schools of thought being it's going to be stronger in Q4 because people are catching up from slowdowns in Q2 and have been coming out of that. The other school of thought is it's been ugly. Some of our customers, as Jim said, are not essential and are still struggling, may shut down for even longer over the holiday period. So, you know, that's a bit of the unknown that keeps us on the, you know, more cautious side towards what we've seen as a normal seasonal downturn. But the 4% to 6% is a little better. We did comment, you know, we've got good backlogs in coating activity and non-res and infrastructure. So we're probably more positive. That's more of your carbon-type products. We talked about aerospace, you know, being weak. That's more of your aluminum products. Our stainless, especially on the flat rolled side, is held in better than the other products, so that's been doing pretty well for us. On alloy, we commented our sales there are lighter because of some of the energy closures in that industry. We expect to remain under pressure, so that's kind of at a high level.

And the only thing I'd add, we put a lot of effort into our inventory management. If you notice, we call it as needed inventory versus just in time. I'm not sure what just in time means, but as needed is that's when the customers need it. So we have a basket of a lot of companies. And certain companies, their first quarter is their best quarter. Some companies, their second quarter and third and fourth. We look at all those companies differently and we flex up and flex down and make sure that we're spending our inventory dollars properly. And if your slowest quarter is the fourth quarter, then you don't need inventory in the third quarter for that. So there's a lot of analysis that goes into that. So it's really difficult to go product by product, like Karla said. You know, we're very aware of what our history has told us. And if you look at it, really, without this COVID thing, you would probably get rewarded because we're projecting a better fourth quarter than we have in the past. But because we've done so well during the pandemic, I guess the expectations are somewhat different. And I get it. I understand. When you continue to... and you've got a resilient model. We expect to perform, but we also are conservative and we understand our history. So, anyway.

Thanks for all that context. Maybe, Karla, wondering if you could help us just kind of talk about the trajectory of SG&A, you know, moving into the fourth quarter. I know that you've called some folks back as activity levels have improved and Should we expect the dollars to kind of follow the volume trend from third quarter to fourth quarter, or should we expect more of a flattish trend as some of the costs come back?

Yes, I think, Tyler, probably looking, I think Q3 kind of percent of sales is probably a decent way to look at it. Overall, the Even though it's lighter shipping volume, part of that's because we have fewer shipping days, which affects our volume, but most of those are holidays when we're still paying wages. So I wouldn't necessarily bring it down in line with volume. So I think if you look pretty consistently with Q3 dollars, it's probably the best guide that we can give you at this point.

Great, thanks for that. And then just one last one, if I could. Just wanted to take your temperature on kind of what you're seeing in the competitive landscape out there. What are you seeing among some of your competitors, and maybe if you could just provide us an update on what you're seeing in the M&A environment currently. Thanks.

Yeah, I don't know. Our competitors, we're not going to see where our competitors are nowadays. So we don't, they're doing whatever they're doing, and You know, God bless them. I hope it all works out for them. I hope they all stay healthy. But I don't know. Nothing's really, I don't think anything's really changed on that horizon. But again, we don't spend a lot of time wondering what they're doing. We kind of wonder what we're doing. And as far as the M&A, I had mentioned, it's a Target Rich Environment. We get a lot of activity. I mean, there's not a – I mean, sometimes it's daily. Sometimes it's a couple times a day. Sometimes it's, you know, we'll skip a week. But we've looked at a lot of companies. And the problem is – it's not a problem. It's just what we choose to do. The criteria is very stringent. We don't – we haven't changed that at all. There's just a lot of little things that go into – You know, we're very selective on who we'd like to join our family of companies because it's important that they fit in. And I mentioned a few of the criteria, and those haven't changed. Now, the good news is there's some out there, but a lot of what we're looking at seems – there's some things that will eliminate you pretty quickly. You know, very small companies. That's really nothing we really want to sink our teeth in because there's a lot of effort that goes into that. If it's a company that's for sale that forces us to compete with our customers, we back out. If it's a potential acquisition that forces us to compete with our suppliers, we don't do that. We want to be everybody's best customer, not just the biggest customer, so will eliminate some of those types of things. But then there's companies that just kind of are fire sailing because they didn't do very well during the COVID. And we don't do fixer uppers. And again, it all kind of rolls into the fact that we've got a good problem. We have cash. And there's different ways to use your cash. And Karla does always a wonderful job explaining

And Tyler, this is Bill

Hey, just jumping back to the competition. I mean, we do have, obviously, competitors out there, but as we've said, in this kind of market where customers are generally looking at smaller orders, faster delivery time, and needing more value-added processing, that really fits our model well. So, you know, it kind of plays right to our hand in this kind of environment.

Thanks again.

Thanks, Tyler.

Ladies and gentlemen, we have reached the end of the question and answer session. At this time, I'd like to turn the call back over to Jim Hoffman, President and CEO, for concluding remarks.

Thanks again to all of you on the call for your time and attention today. Before I conclude, I'd like to remind you all that in November, we plan to present at the Goldman Sachs Metals and Mining Conference and the Citi Basic Materials Conference which will be held virtually and webcast live over the internet. Thanks again for your continued support and commitment to Reliance and stay healthy.

This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation.