Greetings, and welcome to Reliance Steel and Aluminum Company's First Quarter 2020 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brenda Miyamoto. Please go ahead.

Thank you, Operator. Good morning, and thanks to all of you for joining our conference call to discuss our first 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 Sales, our Executive Vice President, operations, will also be available during the question-and-answer portion of this call. 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, including the impacts of COVID-19 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, under the caption Risk Factors, disclosure in our press release this morning and other reports filed 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.

Good morning, everyone, and thank you for joining us to discuss our first quarter 2020 results and our response to the COVID-19 pandemic. We had a strong start to the year, following several financial performance records in 2019. Overall demand levels were healthy, through most of the first quarter of 2020. Our strong non-GAAP gross profit margin of 31.9% was above our estimated sustainable range of 28% to 30% and produce non-GAAP gross profit dollars of $820.5 million on net sales of $2.57 billion and non-GAAP pretax income of $220.6 million. Our non-GAAP earnings per diluted share of $2.45 significantly exceeded our first quarter guidance.I will provide additional details on our Q1 performance drivers in a moment. But first, I would like to address the coronavirus pandemic and how we expect it to impact our business, and actions Reliance is taking to address this extraordinary situation. First and foremost, our thoughts and payers go out to everyone around the world fighting this war, especially those on the front line, helping the people who are directly impacted. Most of our locations continue to operate, albeit at reduced levels as essential businesses under the United States Department of Homeland Securities, Cybersecurity and Infrastructure Security Agency, CISA guidance. We continue to work closely with our suppliers and are grateful for their ongoing support and partnership to withstand these challenging circumstances.We are engaged with and listening to our customers and adapting to address and support their needs through this uncertain and difficult time. We have taken difficult actions, including workforce reductions to rightsize our operations to sustainable levels that we believe will enable us to emerge from this current crisis intact, prepared and positioned to face new business reality, including the ability to quickly ramp up with our customers and suppliers and to recall…

Thanks, Jim, and good morning, everyone. Net sales of $2.57 billion for the first quarter of 2020 decreased 13% from the first quarter of 2019, mainly due to lower metal prices, with our average selling price down 11%. Demand was healthy with only a slight 2.2% reduction in shipment levels. Compared to the fourth quarter of 2019, net sales increased 5.1%, driven by a 6.8% increase in tons sold, which was consistent with our guidance of up 6% to 8%. Our average selling price per ton sold declined 1.2% compared to the fourth quarter of 2019, and was below our guidance of up 1% to 2%, mainly as a result of downward pricing pressure due to the coronavirus pandemic.Our gross profit margin on a GAAP basis for the first quarter of 2020 was strong at 30.3% and was slightly above our estimated sustainable range of 28% to 30%. Our strong non-GAAP gross profit margin of 31.9% included $20 million of LIFO income and excluded charges related to the closure of certain of our energy businesses that resulted in a $39.8 million charge to inventory and cost of sales. On a non-GAAP FIFO basis, which is the best measure of our day-to-day operations, our gross profit margin of 31.1% increased 200 basis points from 29.1% in the fourth quarter of 2019. This is a direct result of the outstanding performance by our managers in this field, who, despite the challenging circumstances, continue to maintain pricing discipline by focusing on higher-margin orders and increasing the level of value-added processing services provided to our customers. We are very proud of and grateful for their efforts.As I mentioned, we recorded LIFO income of $20 million or $0.23 of earnings per diluted share in the first quarter of 2020 compared to LIFO income of $12.5…

[Operator Instructions]. Our first question comes from Seth Rosenfeld with Exane BNP.

Just like to get a better sense, please, of the impact of the sharp decline in the auto market on your toll processing operations. You commented earlier that, I believe, headcount has been reduced by roughly 50% in this part of your business. Is that representative of the scale of volume decline you witnessed? Or have you seen perhaps a sharper decline in that figure? And when we think about the outlook for gross margins going into Q2, obviously, the Q1 performance is particularly robust. I believe that you commented earlier in the prepared remarks, you should expect to see some compression in the margin figure. How should we think about that in terms of the risk of perhaps fixed costs under-absorption, inventory holding losses or just much lower contribution from toll processing? How should we think about the moving part in the potential scale of gross margin compression into Q2?

Okay. So a couple of questions in there. Let me talk about -- a little bit about the automotive first, and we have Bill sales, who's not in the room, but I'm going to ask Bill to jump in on the auto part. The 50% reduction, that's kind of reflective of what the business drop we saw. I'll remind you that we've been through this before, 2009 is a good example of what happens when a certain market that goes down. We're having a nice start and fulfilling our obligations to our partners. I'll remind you that our customers are not the automotive companies themselves, but the suppliers of metal. We were doing well, and they started announcing closures on the steel and aluminum market and in response to the automotive shutdowns. The good part about that is we have a schedule as to when they are coming up. We'll see those are estimates on their part. So again, we simply react to what our customers are telling us. We don't speculate. But it's a strong market for us. We've invested a lot of money in. We continue to see that as a great market going forward. And I'm going to ask Bill, if you don't mind, Bill, giving us some more color, to address Seth's question on the automotive?

Yes, Jim. Yes, the 50% reduction was really tied to those auto plant closures. And so as Jim said, we've got a schedule. It looks like a majority of those plants are going to be reopening in early May. We've got a structure in place in terms of how we structured the layoff, where those highly skilled employees, we can bring back as those plants start to ramp back up. So I think that was a snapshot in time based on the closures as things reopen and they start to ramp back up, we'll react to that and be able to meet their requirements.

And Seth, this is Karla to comment on some of your questions around cost and gross profit outlook. Certainly, with volumes down, we do see a decline there, but we can also, with our variable cost structure. The majority, 65% of our SG&A expenses are people related. So as we, unfortunately, had to do that precision strip, we did take some big workforce reductions very quickly, but we hope to be able when auto's come back up to ramp that up again very quickly. But while we're down, that takes a big chunk of our cost out of the system. There are a lot of other variable costs that go along with that. So we are scaling. We can't take out necessarily one-for-one, but we're certainly bringing our expenses down with the lower volumes that we're experiencing there. And it was most drastic because of the sudden stop in auto, but we've done that across other of our businesses as they're impacted, depending on which of their customers can continue to operate as essential businesses.So we've been focused on that. We'll continue to focus on that. You asked about inventory losses because of prices coming down. That's one of the reasons with our LIFO inventory costing method that it somewhat gives you a buffer, so to speak, from taking those inventory losses because of the LIFO reserve that we have and helps reduce the volatility in our earnings. So we're not anticipating taking inventory losses. And remember in auto, which, as we said, is the hardest hit end market has suddenly hit that we sell into, we don't own the inventory there. So there aren't any inventory losses gains, anything related to that part of the business. And I did comment in the prepared remarks that just when things are more competitive when there's less demand and there's still supply out there and people are holding higher cost inventory. Often, we can see things happen in the marketplace by competitors and others that can erode margins a bit. We weathered through this before, we still have -- we had extremely strong gross profit margins in the first quarter. And a lot of that's because of the value-add processing we're doing, our next-day delivery, our small order size. We don't think those get impacted as much as the general market, but we're just being cautious in trying to explain the landscape out there and that there could be some downward pressure.

Yes. So just one more comment, silverling, the automotive companies do not hold inventory at their plant. So when they do ramp up, they look to us to get right back in as quickly as possible, which we can do very quickly to start supplying parts to that.

If I can just press with one quick follow-up. The recently revised guidance range of 28% to 30% gross margin. Obviously, you're now expecting a greater LIFO tailwind into Q2. But are you still confident that at least the bottom end of that range can be met going into Q2?

I think we're confident about that as we are about anything right now. I mean, Q2, we're currently anticipating that, that would be the hardest hit time period as we work through this COVID-19 crisis. It extends, we'll see. But could we bump down? I think we kind of try to say it's sustainable on an annual basis. We certainly -- we think we should be in there. But as we said, depending on how things unfold because this -- I'm sure you've all seen things change every day. But currently, I think we should stay within that range on a LIFO basis.

Our next question comes from Timna Tanners with Bank of America Merrill Lynch.

So I was just hoping to clarify, I think the last questions were pretty all-encompassing. So I just wanted to drill down a little bit and understand. I think the key thing we want to understand is how much you can rightsize operations because you've done a lot. But I just want to ask on the framework for your overhead. If it's -- 2/3 of that is labor and the other 1/3. Is it fair to assume that 2/3 is flexible and then 1/3 is less variable? Or can you provide us a little bit more framework on how to think about that?

That's a good way look at it. You kind of need to factor in the -- how unusual this is. We don't know. I mean, we use the word uncertainty and challenging quite a bit when we're talking about how we're running our facilities. There is a certain level of people you need to keep to fill orders. We're filling orders as we are right now. As these -- the businesses ramp up, we'll be able to ramp up quickly. But we -- that's why we laid people off and remind them that they could be called back fairly quickly also because we are a major part of our customers' business. They continually ask us to do more and more. We anticipate or I anticipate additional value-added when they do come back. So with the choppy kind of market the way we are right now, we think we have the right level of employment right now as far as the headcount, and we have some really good people that we don't want to go elsewhere. So we keep them laid off and try to take care of them the best we can. So we've done this before, Timna, as you well know, we're good at it. And this is unusual, but we'll continue to make good decisions when it comes to rightsizing our SG&A cost.

Yes. And so -- and Timna, I can't give you a formula to plug into a model on this one because this is different than downturns that we've been through in the past. As I mentioned earlier, we think it's a fairly short list. So our approach has been a little different because of the nature of this. If we come back in a B or in U, differently than we came back from '09, where it was a very long, slow improvement. We expect to bring a lot of those employees back. So even the way we've approached our workforce reduction has been different during this downturn so far than it did. Previously, in 2009 -- 2008 and '09, over a 9-month period, we took out 23% of our workforce. We took out over half of our inventory, which is over $1 billion at the time. But again, that was over a 9-month period. That was more where we were actually letting people go, separating from employment as opposed to putting them on a temporary layoff structure. So we have to see how this evolves. We don't have a model for exactly how far we could go. A lot of our -- we do have a lot of variable costs, but a lot of our businesses are structured differently, but it's not cookie-cutter to give you a percent fixed versus variable. So as Jim said, I mean we are looking at [indiscernible] that's certainly out there.

[Indiscernible] operation by operation, depending on what that particular location is what their order count is.

Sure. So I guess to summarize, like if we look at the Q3 '08 to Q3 -- or Q2 '09, you had depressed gross profit margins for 4 quarters in a row, which is kind of this time you're thinking it could become [indiscernible]. And that's why you're talking about full year gross margins maybe being within the range or if that's what I understood you saying. So I just wanted to clarify that. And then just to understand how is it working when you go to the mills? And can you delay and extend? I mean, how are those negotiations going? Are they just understanding that you'll recoup those volumes when demand is back? Just wanted a little more color if that's unusual as well.

Yes. So, to the first part of your question, yes, you're right. Our actions are a little different this time with the way we're reacting because like we said, we think the nature of this is more short-term based on what we know today. So I think that's the positive that we're taking the appropriate actions, but we're taking it in anticipation of coming out of this fairly quickly and being able to be there to support the increased business activity at whatever level that is. And with our model, with our high-value add with our quick deliveries, we anticipate maintaining the value that we provide our customers and being able to get those gross profit margins that we've risen to over the last few years.

Yes. And as far as the mills, obviously, we don't like to do what we're doing. However, we've got long-standing relationships with these folks. We've supported them year in, year out for a long period of time. We're a domestic buyer. I'll remind you that less than 5% of our spend even in normal times has been domestic. I know they appreciate that. They appreciate Reliance. And we do everything we can to be a good partner with them. And we're -- our communication with them is almost on a daily basis, and we're here to support them in these situations, they're going to support us, and we're both going to need each other in the supply chain when this does ramp up. So they're going according to plan.

And just to clarify 95% domestic, 5% import.

Oh, what did I say? The other way around? Yes, good point.

Next question comes from Chris Terry with Deutsche Bank.

The first question I had just on working capital expectations. And just wanted to get a bit more sense on the ground. Are you getting any issues with cash collection from any of your customers? Or are there any things to think about there just[indiscernible]

[Indiscernible] on top of it. And we've seen a fall yet. So we're very positive that our customers are continuing to pay us in normal patterns. We do think there could be a little slowing in the next quarter, but we haven't seen anything yet. And we do look at working capital is really being a source of liquidity during this year because as -- with the expectation that metal pricing could come down and shipment losses coming down that reduces our accounts receivable. Therefore -- more quickly than the inventory. As we talked about, we're looking to bring inventory down. Both of those factors, lower metal pricing, bringing inventory down and that to our lower shipment levels also throws off cash. So we do anticipate some good contributions to cash flow from working capital reductions this year.

Okay. And then you talked specifically about the auto market. I just wondered if -- I think you -- if I heard correctly, you said 20% decline in April in shipments. So I just wondered if you could talk about the aerospace market, in particular, what you're seeing there? And maybe there's a bit more granularity on that 20% decline, that's excluding tolling, I assume. So just if you could talk about aerospace in the context of the different market splits?

Bill, why don't you take that one?

Okay. Chris, much like auto. I mean, the aerospace business, obviously, has been impacted negatively from this. We've always said we track build rates, backlogs and mill lead times to give us an indication of the health of that business. Airbus has announced that their build rates are going to be down by about 1/3. The picture of Boeing is not quite as clear, but we know build rates are coming down there. Backlogs are shrinking. They're seeing order cancellations. We think the backlog could shrink as much as 50%. But that still brings us to a backlog that is probably in that 3- to 4-year time frame. That if you go back and look over time, historically, that's kind of where the backlog used to be before this supercycle that we've been in. And what we're doing, much like auto is we're monitoring the situation on a program-by-program basis, and we're adjusting inventory and staffing based on what we see there. So that picture is still a little bit cloudy in terms of it's -- the commercial aerospace business is driven by passenger miles. And as we come out of this, I think we need to -- we'll just have to wait and see how quickly people go back to flying again. So we'll keep a close watch on that, but we will adjust accordingly based on what we see happening.

Yes. And Chris, Bill just address primarily the commercial market. We've also got some good exposure on the defense side. And as we've talked about the last few quarters, that's been strong. We see that continuing at strong levels. So far through April, defense has held up. And we actually just extended our Joint Strike Fighter program. We announced that about 4 years ago when we initially got that program. It's a big program for us, and we were just awarded a 5-year extension on that, about $660 million over that time frame.

Yes. That program will take us out through 2026. And then the other thing to remember about our aerospace business is we're less than 50%, probably around 40% commercial aerospace, and then the balance of that would be noncommercial aerospace with defense being a big part of that.

Okay. And just one more, if I may. The energy -- the 3 businesses you talked about supporting the energy market in your release. Just to put that in context, maybe as a percentage of your total energy exposure, just to see how big those facilities are. Can you give any color on that?

Yes, Chris. So those three businesses that we shut down. In total, annual revenue -- currently, the run rate is about $100 million. So we were -- we used to be around 10% of our total revenue dollars within energy coming out of the last downturn, we were down to about 4% to 5%. So now it's about 3% to 4%. So not a huge portion. We've still got relatively consistent energy exposure. But I think what remains are the -- what's been the better part of our energy exposure. We're going to continue to service still a good market for us, and we hope to see improvements there in the future. But we felt it was -- we had a couple of businesses that have been struggling and we didn't see that really recovering at the levels we needed, so we made the decision.

And in my prepared comments Chris I made. Those decisions have been under consideration for quite some time. The technology and drilling has just changed. So if you look at it from a metals consumption in that market, it has shrunk. And the pie is smaller, and we have every intention to be a strong player in a smaller piece of the pie, of which we are. We still have some very fine energy-related companies in the oil patch, and we'll continue to support them and be that leading player in that market.

Next question comes from Alex Hacking with Citi.

Just two follow-up on the last question. I guess, after the closures of those energy facilities, what kind of utilization rate would your residual energy business be operating at?

I can't give you a number. That's too soon to tell, but the customers that we have serviced through those companies that we decided to firmly shut. We're able to absorb in our other energy business. I can't say what percent, but that is the intent. So I don't know what the utilization will be in the new operations. But suffice it to say, it will be better than it was. I just don't know what the percent would be.

And Alex, some of the remaining energy businesses, part of the reason they're remaining is because some of them are not 100% energy. They have other parts of the business, too. So giving you a pure utilization rate would be difficult. We've, over the last few years, as we've seen declines, all of those different businesses right-sized as appropriate.So I think utilization might be a little less company-wide average during normal times, we usually operate about 2/3 of capacity. So the energy businesses are probably a little below that, but not significantly or we would have looked at it differently.

And that whole market is pretty much in shock right now with what's going on with the price of oil. So we'll let you know when the fog clears.

Okay. And then I guess within the context of your shipments being down around 20% in early April, how does construction fit into that? I would assume that construction is holding it a little better than the average. Is that fair?

Yes, that's fair. That's fair. Up until that point, we were -- okay, I said call after call, it's become a nice slow burn-up, and that continued for the majority of the first quarter. And all of a sudden, these jobs that are already in the books, they've been deferred. We don't know how long, but they have to be canceled. You can't cancel an order or a big project midstream. So we anticipate that business to come back most likely sooner than some of the others, and we're a big participant in there. And there's always I hope, I guess, even though we don't think hope is a strategy that the -- there will be an infrastructure spend perhaps on the horizon. And when that happens, that will be good for that market as well. But we're -- that's a good business for us. And it just kind of had a slow drag right now based on the end user, the way they see their business and their cash flow.So we're obviously monitoring that on a daily basis. And I'll remind you that we've spent a lot of money over the years on the value-added end of that business, and we anticipate that to actually increase when the -- in the history when you go through these kind of sudden recessions, our customers ask us to do a lot more when they do come back. And we're positioned to do that, and we have spent money again, this year, to put in innovative equipment that allow us to meet and exceed our customers' needs.

Okay. And then just one more quick one, if I may. I apologize. I should already know this, but I know about 1/3 of your shipments are into the transportation sector, roughly what's the split there between aerospace, autos and other?

Yes, Alex. So yes, we think about 1/3 is transportation, what we can identify within that is aerospace, which probably averages around 12%. This is based on total revenue dollars. Outside of that, there's very little metals sold into auto. We break out the toll processing where the majority is auto is about 4% of our total revenues. And then you just got truck trailer, barge, shipbuilding, railcar, various other things in that category.

[Operator Instructions]. Our next question comes from Phil Gibbs with KeyBanc Capital Markets.

Some of the essential growth CapEx that you're keeping for this year? Anything that we should be thinking specifically in terms of the projects?

You could -- look, in general, again, we talk about our Capex. Our CapEx is 300 line items. There are ones that we've decided to keep or orders or projects that were already placed and we need going forward. That's basically equipment, replacement equipment, maintenance. Remember, we have a piece of our CapEx every year that we could call maintenance. There's another piece of it that's growth that's the new innovative type equipment. We've kept that. It's probably easier to focus on what we've decided to hold up on. And we holding up on things like lease buyouts, resurfacing, parking lots and redecorating offices and all those types of things that they're just not mandatory. There are things that we can defer to next year if we need to do that. So we went through with a fine tooth comment realizing like I've mentioned before, that during these recessions when we come out on the other end, our customers ask us to do a lot more. So we've kept the innovative equipment that allows us to do more. And the equipment -- maintenance equipment that allows us to be more efficient. We've kept that going. So we're going to -- we're still going to be a participant in the CapEx spend and not to the degree that we had originally thought.

That makes sense, Jim. When we think about the here and now, I know a lot of people are basing their decisions on survival and cash preservation. But as you look out over the next several years, are your customers being more adamant and saying we need to diversify our supply chain away from China. We need you to make these components. We need to start moving more of these specialized value-added steps away from them. Because clearly, what happened in the last 2 or 3 months shouldn't be acceptable to anyone.

I agree. I hope -- I hope a lot of are listening. We've seen that with a way to turn for reshoring. I guess, there'll be more of that. Our strategy -- our model is modeled to do more of that, and we anticipate more of that coming back that certainly would be good for U.S. and North America, and we'll see how that goes. I mean, if I was running one of those companies, not see what's going on in the world, we talk about now not only how do we operate now, but how are we going to operate in the future. And we look to see how the business is going to change, and we want to be on front of that. And certainly, that will be one of our considerations, and it should be as far as I'm concerned. As an American, the more domestic manufacturing that does come back will be good for the country and certainly good for Reliance and our domestic suppliers.

And Phil, we can't say that this has been broad-based at this point. But certainly, with all the trade issues over the past few years. We have seen some of our customers take some actions to do that. And now we've talked about the fact that overall shipment levels are down. But within that, we have picked up some new pieces of business and seeing some opportunities where some customers and further downstream are adjusting and have to look for new partners to help them breach their products.

If I could. I appreciate that. If I could sneak in one more for Bill, and then I'll hop off. But just on the semiconductor market, Bill, what are you seeing there? And in terms of momentum and what your customers are telling you just in terms of readiness?

Yes. Sure, Phil. The semiconductor market, as Jim said earlier, has kind of been a bright spot. And we did see a little impact early in the first quarter in Asia, primarily China from the COVID virus. But that's rebounded, and our customers are still optimistic and still talking about good demand through the balance of the year. I will tell you, we're keeping a close watch on that. As you know, that market can stop on a dime. So we're watching it very closely. But so far, all the indications are, it should continue to be very good through the balance of the year.

Next question comes from John Tumazos with Very Independent Research.

Could you elaborate a little more on the outlook for acquisitions? It would seem like there could be some smaller operations here and there that with less revenue and less volume could be a lot more willing to sell because they have debt? And maybe even chances to buy things below tangible book value since inventory values have fallen so much?

Yes, John, this is Jim. Yes, they're out there. And we look -- our M&A strategy hasn't changed. We don't buy fixer uppers. They have to be immediately accretive. We've bought small companies. We've bought large companies. There's a significant amount of work involved regardless of how large or small the acquisition is. I can just tell you what we've seen has been on the extremely small side. Nothing that meets our requirements for profitability or interest, but we remain open for business over a period of time, it's been pretty fast and furious over the last couple of years of companies we look at. And I'm sure you realized, we've only pulled the trigger on one. And that was in December of 2019. We got -- we bought a really nice company there. But so far this year, there's fewer of them. And what we see it doesn't tickle our fancy, as they say.

The accounts receivable category used up about $150 million of cash in the March quarter. Is there a seasonal explanation to that or do you have some customers that are paying a little bit slower?

Yes. No, that's the typical seasonality, John, along with our sales because of the holidays and customer closures around that during Q4. Our shipment levels are down, we -- receivables go down. And then with the seasonality comes back up in Q1, our -- we monitor days sales outstanding and that stays pretty consistent quarter-over-quarter, kind of normally around 42-ish days. And so we've seen that so far, stay pretty consistent.

Thank you. There are no further questions. I would like to turn the floor over to Jim for closing comments.

Okay. Thank you very much for taking the time and attention today. And I'd like to reiterate that the health, safety of our employees, their families, our suppliers, our customers and our communities has always been our top priority. And I'd like to sincerely thank the first responders, especially the health care workers serving on the front lines to care for those needs. Our thoughts and prayers are with all of you through this difficult time. Now before I conclude, I'd like to remind everybody that in May, we plan to participate in a B&A of Merrill Lynch Global Metals and Mining Steel Conference as well as the KeyBanc Basic Materials conference both of which will be held virtually.So I'd like to thank you all for your continued support and commitment to reliance, and I hope you all stay safe and healthy. Thank you very much.

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