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Executives

Marion E. Britton - EVP, CFO and Secretary

Brian R. Hedges - President and CEO

John G. Reid - EVP and COO

Analysts

Anthony Zicha - Scotia Capital

Justin Wu - GMP Securities

Sara O'Brien - RBC Capital Markets

David Galison - CIBC World Markets

Bert Powell - BMO Capital Markets

Frederic Bastien - Raymond James

Russel Metals Inc. (OTCPK:RUSMF) Q2 2014 Results Earnings Conference Call August 13, 2014 9:00 AM ET

Operator

Good morning, ladies and gentlemen; and welcome to the Russel Metals Second Quarter 2014 Conference Call. Today’s call will be hosted by Mr. Brian Hedges, President and Chief Executive Officer; Mr. John Reid, Executive Vice President and Chief Operating Officer and Ms. Marion Britton, Executive Vice President and Chief Financial Officer; of Russel Metals Inc. Today’s presentation will be followed by a question-and-answer period. (Operator Instructions).

I will now turn the meeting over to Ms. Marion Britton. Please go ahead Ms. Britton.

Marion E. Britton

Good morning, everyone. I’m going to start on page three, the cautionary statement on forward-looking information. Certain statements made on this conference call constitute forward-looking statements or information within the meaning of applicable Securities Laws, including statements as to our outlook, future events or our future performance. All statements, other than statements of historical fact are forward-looking statements. Forward-looking statements are necessarily based on estimates and assumptions that while considered reasonable by us, inherently involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in our forward-looking statements.

Our actual results could differ materially from those anticipated in our forward-looking statements, including as a result of the risk factors described below and in our MD&A and our annual information form. While we believe that the expectations reflected in our forward-looking statements are reasonable no assurance can be given that these expectations will prove to be correct and our forward-looking statements, included in this call should not be unduly relied upon. These statements speak only as of the date of this call and as except as required by law, we do not assume any obligation to update our forward-looking statements.

Turning to page five, some comments on current market or market conditions in the quarter and currently. Positive results in the quarter were driven by year-over-year volume increases, or most significantly volume increases but pricing has been up in part holding positively during that period also. So within service center volumes were up. Russel service centers were stronger than the industry in both Canada and the U.S. The published numbers by the MSCI for the industry for Q2 were 6% up for the U.S. and flat year-over-year for Canada. Russel compared to that 4% up as we are a combination of Canada and U.S.

Metal service center selling prices were up 7% Q2 '14 over Q2 '13, which is positive on the pricing side. Drilling activity was the most significant -- and Western Canada was the most significant factor although drilling activity was up in U.S. That helped our energy sector year-over-year. We had second quarter Apex, but also our activity in the [inaudible] OCTG and Western Canada most contributing.

Steel distributors volumes up, we had anticipated that. They have seen some difference in pricing, international versus North America and had more product on order which has arrived and improved second quarter and is anticipated to improve the latter half of the year.

Turing to page six, the results compared to other periods, so Q2 '14 our EPS was $0.50 compared to Q2 '13 of $0.33 and Q1 of $0.47, $0.50 is strong for the expected seasonally lower second quarter, so we actually improved over our first quarter. Six months EPS is $0.97 compared to six months 2013 of $0.69.

Free-cash flow is normal. It's higher than our EPS and was $1.13 for 2014. Return on equity was strong at 13%. We still do have cash of $52 million and we also made an increase in our dividend of 9% to $0.38 for the quarterly dividend payout.

Turning to the next page seven, just wanted to -- like this is the page where we give all the information which is useful for the people modeling. One of the things to note is that revenue year-to-date is $1.8 billion which means we're tracking towards $3.6 billion for the year, strongest number on the chart.

Turning to the next page wanted to point out the other finance expense $4.8 million for the six months ended or $3 million for the quarter. We did put up an additional $1.5 million to increase our earn out payments anticipated for Apex and Apex Monarch due to the strength that they have had particularly in the second quarter but year-to-date the strength in those operations.

Looking forward to page 10, working capital due to the fact that our revenues are up and some anticipated revenues in our distributors and energy and I'll speak to that in the inventory segment later on when we flip to that. You all know that we have been using working capital year-to-date of $93 million made for the AR and inventory increases.

Moving to Page 15, this is a page that shows all the positive numbers year-over-year and quarter and year-to-date. You will notice a significant increase in revenue in the quarter for distributors being at 63%, all the other numbers positive, energy 16.9, that’s strong also. And then the contributing segments operating profit, still distributors taking a lot of that to the bottom line by being 72% up year-over-year and energy being up 60%. Service center positively contributing also at 24%.

You will notice gross margins, the one I’ll just mention energy is a bit stronger then would be anticipated due to mix, though little lower OCT Straight Pipe sales in the quarter helped with the higher margin products, increased the margin in the quarter. And we resulted in segment operating product as a percent of revenue of 6.3%, which is very strong number.

Looking forward to Page 17, just to point out our numbers year-to-date on shipments and selling prices. These are the year-to-date six months numbers. So 5% increase in tons sold in service center and 4% increase in selling price. So both positively contributing to a stronger bottom-line in our service center segment.

And now flipping one more page to 18, energy as I mentioned before, revenues were up 17%. The biggest increase as a percent in activity quarter-over-quarter, 2013 not over Q1 was OCTG revenues related to additional drilling activity. But as I mentioned Apex had strong results in the quarter. So they were helping. On a same-store basis which would remove the Apex Monarch operations we were up 4% in all the other operations that weren’t in to OCTG.

Moving forward to page 21, just want to comment on capital expenditures. We have made this comment on the last two calls that we anticipate capital expenditures for the year to be higher than prior year. And we current only spent $16 million. I expect larger flow out in the third quarter such that our CapEx for the year is going to result in a number of closer to $40 million. So that is still our projection.

Turning to page 22, I’d like to speak a little bit about the inventory levels. The chart at the top on [OSAT] metals service centers numbers are staying inline, consistent and even other tons are up their average price is keeping it at a fairly low level and the high turns of five tons in the quarter. Energy products, I mentioned that inventory is up and the main reason for that is activity anticipated in the second half of the year and specific works that we are doing with customers and receive product in June for that activity.

Similarly, steel distributors we have ordered a lot more product this year than in past couple of years. Most of the product is committed to customers and will be sold in the next two quarters. So we expect that energy and steel distributors numbers -- revenue or sorry inventory numbers will stay high through third quarter but should start to come down later in the year.

Those are my comments. We’ll open it up to questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions). Your first question is from Anthony Zicha, Scotia Bank. Anthony please go ahead.

Anthony Zicha - Scotia Capital

Yes, hi good morning. Marion you mentioned that the inventory turns on the metal service side were at five times, like by how much can you increase that number before you start running out of stock? And then on the energy product side what's your optimal number of turns and what are the key drivers that are helping out, is it related to construction? Are we seeing a turnaround there?

John G. Reid

On the metal service center side we think five to six would be pushing it. Again it's going to be dependent upon the middle lead times and then so right now we're in a very favorable environment. You are seeing flat roll out four to five weeks. So we can maintain those as lead times stretch out at the mills, we may have to bring the turns down. But we could operate it up as high as six before we start having issues with stock out.

Brian R. Hedges

It’s Brian, on the energy side, the problem you get with the turns is the second quarter is always the low point because always we have breakup, we don't ship anything. The turn are going to drop dramatically in the third quarter even though our inventory may not go down because we're going to ship so much more product. But if you look at it on an annual basis our goal is to get that up to four.

But some of what you're seeing right now is we're in the bottom of the trough, it happens every year because of break up but we are going to have significantly higher volumes in the next half and construction has not picked up.

Anthony Zicha - Scotia Capital

So that still represents some upside, Brian.

Brian R. Hedges

Yes. We hope so.

Anthony Zicha - Scotia Capital

Yeah, okay. And then when we look on energy product side the margins increased due to a better mix. So that's Apex is the driver. Will this momentum continue in Q3, like does it relate to specific projects or is it across the board.

Brian R. Hedges

It won't actually continue into the third and fourth quarter because the jump that we're going to see is going to be in the OCTG and line five. So although we're going to have bigger better earnings and dollars, our percentages will come down because the mix will go back to the line pipe and the OCTG. Apex will make as much money but they won't have as big a pickup in the third and fourth quarter if they don't do a [inaudible] in the second quarter then they're helping to give us better numbers in the second quarter then we did historically because they have stronger results.

So what’s going to come back in the second half for us is the traditional line pipe and OCTG.

Anthony Zicha - Scotia Capital

Okay. My last question, Brian what’s the picture of offshore steel. It looks like the Canadian international trade was looking at dumping on OCTG product. I guess its Korea, Ukraine and India. So what’s the current exposure there?

Brian R. Hedges

It's not that much exposure. I mean it’s not like the [inaudible] domestic capacity is not a concern. We're not sourcing all that much pipe right now offshore.

Anthony Zicha - Scotia Capital

Okay and overall picture with steel coming offshore.

Brian R. Hedges

John would you talk to…

John G. Reid

We're still seeing a fair amount of import, it’s coming in. You've got flat spreads on the world market, coal spreads on the world market are at the numbers that were attractive. It's really creating the ceiling from a pricing environment right now. I think the mills got probably pushed a little further, had it not been at this spread but -- so I think it’s still very much available. And we will see the import market but again I don’t see anything changing dramatically in Q3 one way or the other.

Anthony Zicha - Scotia Capital

Okay. Thank you very much.

Operator

Thank you. Your next question is from Justin Wu, GMP Securities. Justin, please go ahead.

Justin Wu - GMP Securities

Good morning. My first question is on the energy side, it sounds like you had some strong contributions from your down hole, both the [QG] business I guess I was a little bit surprised given typical Q2 seasonality. So is it just a matter of just more horizontal drilling or were there some other vacuums in it?

Brian R. Hedges

Well I think first of all the strength was actually Apex and Monarch in the quarter but we did have better numbers on the drilling side and that’s because there is more pipeline in the ground, prior to breakup so they can keep drilling breakup and there is a different profile today of the breakup that there used to be and that is caused by the fracking and it's in Canada that we were stronger. So it's just better activity then there used to be during the breakup.

Marion E. Britton

So let’s say the weather conditions were better this year then traditionally.

Justin Wu - GMP Securities

Okay, than last year, okay.

Marion E. Britton

Yes.

Justin Wu - GMP Securities

And particularly on, in the margin within your steel service center business they were pretty robust, was that a function of metal spread due to rising prices or was there mix impact?

Brian R. Hedges

Justin again I think in a rising market we do a good job of maintaining that metals margin and getting that spread quickly. So I think that was a big contributor and then obviously the continued investment in CapEx as we continued to value added, all that just strips away and continue to add margin.

Justin Wu - GMP Securities

Okay, so from the laser cutting and that sort of investments you made recently?

Brian R. Hedges

Yeah, that’s correct.

Justin Wu - GMP Securities

Okay. How do you feel about your inventory, your inventory cost currently and your ability to kind of grow that metal spread, which is I guess typical during raising price environment at least in the past?

Brian R. Hedges

This is a little different than’09, ‘08 or ’09 because I think the management is quite strong but importantly the commodity has not moved to any great extend and I think imports are going to keep that. So one of the positives of this cycle is that we see the better earnings. We don’t the inventory exposure we had in ’09 because the pricing of steel right now is pretty conservative on a historical basis. We don’t see that getting -- we don’t see that going up by $200 no matter what the demand is at this point in time.

Marion E. Britton

The increases have been flowing positive as opposed to costs.

Justin Wu - GMP Securities

Right, right. Okay, got you. And lastly, just wondering if you can comment on mill times in terms of plate and structurals relative to what we saw last quarter, has that changed much?

Brian R. Hedges

Plate lead times are still at 12 weeks, it’s still the most robust industry that’s out there right now that we are seeing on the most robust product. So there is still a solid a 12 weeks more product staying steady, the lead times really aren’t changing there at all, our own -- four to five weeks showing there.

Justin Wu - GMP Securities

And do you see the plates markets sustaining the momentum given the imports?

Brian R. Hedges

It feels -- it will be [better] right now. Again you get good end use market and so I don’t see anything driving them down in the near future.

Justin Wu - GMP Securities

Okay, great. Thank you very much.

Operator

Thank you. Your next question comes from Sara O'Brien, RBC. Sara, please go ahead.

Sara O'Brien - RBC Capital Markets

Hi, good morning. Can you comment just a bit about the U.S. market, seemed to be down 4% year-on-year despite the FX being positive? Just wonder if you comment, it seems that is in the energy segment but can you give us some more detail there?

Marion E. Britton

Well the line pipe was one of the contributors to the fact that the U.S. wasn’t down. So you are looking at the segment number. So it’s basically U.S. line pipe revenues.

Sara O'Brien - RBC Capital Markets

Okay.

Brian R. Hedges

Service centers were up.

Marion E. Britton

Yeah, service centers were up.

Sara O'Brien - RBC Capital Markets

Okay. So in the line pipe is there a particular reason there like is it just a seasonal issue, I just wonder if there is a rebound factor that will contribute more positive from the U.S. there?

Brian R. Hedges

Sara you look at the last two years, we had a lot of large project going on. Again just they are not repeatable and so it’s a large diameter project. You are looking at 24 inch -26 inch pipe, the bigger sections those haven’t repeated themselves. We do see some of that opportunity coming up in 2015.

Sara O'Brien - RBC Capital Markets

Okay. And then in the balance sheet Marion, almost two times the EBITDA on leverage, I know there is huge capacity with your line of credit but I just wonder what’s the comfort level of Russel going forward on a debt-to-EBITDA basis?

Marion E. Britton

We haven’t really looked at that recently. We have had cash on the balance sheet so I guess I’ll say we are pretty comfortable and we could take up a lot more debt based on our working capital but we would then it bring down as revenues came down with the EBITDA.

Sara O'Brien - RBC Capital Markets

Okay.

Brian R. Hedges

I mean at this point in time given where the price of our stock is you’ve pretty well got to take 175 convertible and treat it as this equity.

Sara O'Brien - RBC Capital Markets

Yeah.

Brian R. Hedges

That’s 2016. So that’s a pretty big swing if you pump a 175 in to equity and drop debt by that we don’t have enough left.

Sara O'Brien - RBC Capital Markets

Yeah, right. Okay and then maybe Brian on the acquisition pipeline just wonder what are you looking at targets now, what kind of pricing environment are you seeing and are you interested in making acquisitions at this point?

Brian R. Hedges

We are always interested. We are seeing lots of little things and we are poking around but it is not the same level of activity as it was this time last year. There has also been some deals we’ve looked at and we've walked away from but in the end they didn’t even get done. I think some of people's expectations on what they're going to get is not realistic and so they pulled that -- nobody bids that, so they don't, they pull their deal. So we are seeing some of that as well. So I may be getting into that frothy territory where we're not likely to be a buyer but we are looking at a fair number of things. But it's just not the normal flow we had last year.

Sara O'Brien - RBC Capital Markets

Okay. And in terms of the targets that you would be interested in, is it more on the service center or complementary products within service centers or is it more kind of Apex and distribution on the servicing side that you are looking at?

Brian R. Hedges

The focus would be Apex expansion and the Greenfields or acquisitions in United States or geographic expansion in United States for the service centers. As always product extensions we talked about numerous times let's say the non-[fair] or something those would not be as high priority right now.

Sara O'Brien - RBC Capital Markets

Okay.

Brian R. Hedges

Or the probability of it happening is not as high.

Sara O'Brien - RBC Capital Markets

Okay, that's helpful, thank you.

Operator

Thank you. Your next question is from David Galison, CIBC World Markets. David, please go ahead.

David Galison - CIBC World Markets

Good morning, everyone. So the first question was just wondering when you purchased the Apex you were talking about opportunities to expand that business in the U.S. and just wondering how that was going and may be when you -- some thoughts on when you thought it would start to have a meaningful contribution?

Brian R. Hedges

Well I think Wellington has got two phases to it. The first was it wasn't profitable and in a manner we put a senior person from Apex Canada down there now. And the culture there is changing, the focus is changing. They are now nicely profitable and so we've turned that around. So there’s already been a turnaround on the earnings line. And we're continuing to do Greenfields and look at acquisitions, probably little more cautious than we would like but that's always -- I would rather be cautious than that. So the top line hasn't moved as dramatically yet but I think that will be over the next two years.

David Galison - CIBC World Markets

Yeah and then just on the distributor segment. You talked about the increase coming from a couple of orders. Is that a potential for that to be repeatable or is that really just going to tail off after the second half?

Brian R. Hedges

Yeah I can't see out far. Right now it's the -- as John mentioned the spread between on plate and flat rolled is very attractive for bringing imports in. And as long as that's true we'll continue to do it. But we certainly think that second half will be fine. We don’t have visibility into the first half of next year.

David Galison - CIBC World Markets

And then just a final one on the inventory purchases, with the increase in the quarter have you purchased all the additional steel that you think you need to satisfy the demand and the energy in the distributor segment or whether there still be some more coming in the second half?

Brian R. Hedges

We have a fair amount on order. We're seeing record shipment levels in both our line pipe and our OCTG operation in Canada. So there is more coming in but it's going to go out faster than it's going to come in.

David Galison - CIBC World Markets

Thank you very much.

Operator

Thank you. Your next question is from Bert Powell, BMO Capital Markets. Bert, please go ahead.

Bert Powell - BMO Capital Markets

Yeah, thanks Brian I just want to stay on steel distributors. For the balance of the year this Q2 revenue looked like about what you would expect and are spreads holding in, in that business, are they starting to compress a bit?

Brian R. Hedges

Spreads are holding. I don’t even look at revenue to be twofold but I can -- I’m pretty sure I can confidently say the earnings are going to be up.

Bert Powell - BMO Capital Markets

Up year-over-year, up relative to Q2?

Brian R. Hedges

Up relative to Q2, so the EBIT will be up.

Bert Powell - BMO Capital Markets

So Marion you're going to say?

Marion E. Britton

Well I was going to say the revenue in Q2 is definitely more like what we will see in Q3 than Q1 was, I mean we were up. And Q2 is definitely repeatable. It has a little bit to do when shipments arrive and then customers take them up. But probably be up from Q2.

Bert Powell - BMO Capital Markets

Okay. That's perfect. And just you spent some money on IT this quarter. Just wondering what your current thinking is on that front?

Brian R. Hedges

Well I look at [inaudible]. We spent that, we spent…

We want to make clear to everybody what we have invested in that is all being expensed, is not being capitalized and we are still evaluating it. I think the jury is out which way we are going go ahead with it or shut it down.

Marion E. Britton

Yeah, so we will be…

Bert Powell - BMO Capital Markets

Nothing conclusive out of what you did this quarter?

Marion E. Britton

Yeah, no and we will be working on it again for the next quarter and by the end of the year we will know where we are going.

Bert Powell - BMO Capital Markets

Okay, and then just back to OCTG the ruling in the U.S. does that -- can that have the impact of pushing product into this market and pricing down?

Brian R. Hedges

There will be a little product that moves around but this market has always brought in a fair amount of import and it’s going to come from the same place. And there is dumping action here too. So people are going to be cautious. I don’t think it’s going to press prices down. I think it will keep prices from rising in a strong market which is what you would expect.

Bert Powell - BMO Capital Markets

Okay, that’s perfect. Thank you.

Operator

(Operator Instructions). Your next question is from Frederic Bastien, Raymond James. Frederic, please go ahead.

Frederic Bastien - Raymond James

Good morning guys. Just one question for me. I was wondering if you could provide an update on your Greenfielding efforts both on the Apex side and on the service center side.

Brian R. Hedges

On the service center side we are moving ahead right now with -- in Southern U.S. we are actually expanding an existing facility and then we are continuing to look in the extended geography, in the Southern U.S. The ones we mentioned again off of our Bacall operations, right now we are kind of finalizing everything where we are with site specific location we are planning exactly where we want to be. So those are moving ahead as well.

And then of course Edmonton, again I think you were specific to the U.S. but the Edmonton you got the land deal closed in Q3 and we should start the construction phase hopefully before winter conditions set in. So we should be somewhere in 18 months moving into that new facility as well.

Frederic Bastien - Raymond James

Great, that’s helpful. Congrats on the result.

Brian R. Hedges

Thanks.

John G. Reid

Remington has two or three new locations. They are expanding them. They start with obviously small numbers when we do it and that’s going to continue so. But again it’s just in the infancy of the expansion.

Frederic Bastien - Raymond James

Got it, thanks.

Operator

Thank you. There are no further questions at this time. Please proceed.

Marion E. Britton

Hey, thanks everybody for attending and we will talk to you next quarter. Thanks, operator.

Operator

Thank you. Ladies and gentlemen, this concludes the conference call for today. Thank you for participating and now you may please disconnect your lines.

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