reliance steel & aluminum 2007_Q3_Conference_call_transcript

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Conference Call Transcript

RS - Q3 2007 Reliance Steel Earnings Conference Call

Event Date/Time: Oct. 18. 2007 / 10:00AM CT

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Oct. 18. 2007 / 10:00AM CT, RS - Q3 2007 Reliance Steel Earnings Conference Call



C O R P O R A T E P A R T I C I P A N T S David Hannah Reliance Steel - CEO

Gregg Mollins Reliance Steel - President & COO

Karla Lewis Reliance Steel - EVP & CFO

C O N F E R E N C E C A L L P A R T I C I P A N T S Nate Carruthers Michelle Applebaum Research - Analyst

Timna Tanners UBS - Analyst

Michelle Applebaum Michelle Applebaum Research - Analyst

Michael Willemse CIBC - Analyst

Tony Rizzuto Jr. Bear Stearns - Analyst

Yvonne Varano Jefferies & Co. - Analyst

Mark Parr KeyBanc - Analyst

Daniel Altman Zweig - Analyst

Sal Tharani Goldman Sachs - Analyst

Timothy Hayes Davenport & Co. - Analyst

P R E S E N T A T I O N

Operator

Good morning, ladies and gentlemen and welcome to the Reliance Steel & Aluminum 2007 third-quarter and year-to-date financial results conference call. At this time, all lines have been placed on a listen-only mode and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, David Hannah, the CEO. Sir, the floor is yours.

David Hannah - Reliance Steel - CEO

Good morning and thank you for taking the time to listen to our report and financial results conference call for the third quarter and nine months ended September 30, 2007. Gregg Mollins, our President and Chief Operating Officer, and Karla Lewis, our Executive Vice President and Chief Financial Officer are also here with me today.

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For the 2007 third quarter, net income was $93.6 million, or $1.22 per diluted share compared with net income of $107.5 million, or $1.41 per diluted share for the 2006 third quarter. 2007 third quarter sales were $1.81 billion, an increase of 11% compared with 2006 third quarter sales of $1.63 billion. For the nine months ended September 30, 2007, net income amounted to a record $328 million, up 17% compared with net income of $279.9 million for the same period in 2006. Earnings per diluted share were $4.28 for the nine months ended September 30, 2007, compared with earnings of $3.83 per diluted share for the nine months ended September 30, 2006. Sales for the 2007 year-to-date period were a record $5.55 billion, an increase of 33% compared with 2006 nine month sales of $4.17 billion. All share and per share amounts have been adjusted for our two-for-one stock split effective July 19, 2006. For the 2007 third quarter, our volume increased 8% and average pricing increased 3% compared to the 2006 third quarter, driven mainly by our acquisitions in both 2006 and 2007. Our volume was down 4% and average pricing decreased 1% compared to the 2007 second quarter. For the 2007 year-to-date period volume increased 20% and average prices increased 12% compared to the 2006 period. For the 2007 third quarter, carbon steel products were 46% of our revenues, aluminum was 19%, stainless steel was 21%, alloy was 7%, toll processing was 3%, and the remaining 4% was miscellaneous, including titanium, copper and brass. Overall, considering market factors, we were pleased with our performance in the 2007 third quarter. It was, I believe, based on market conditions and the overall business environment, the most challenging quarter we have had since 2003. If you wondered lately whether this can still be a cyclical business, I think you have your answer, even though we have done our best to make Reliance less cyclical through our product, customer and geographic diversification strategies. During the quarter, pricing on many carbon steel products was soft, common alloy aluminum (driven by LME based pricing) decreased somewhat unexpectedly, and stainless prices were falling faster and lower than expected. Demand for our products was, however, relatively stable for a third quarter with our volume off only about 4% from our record 2007 second quarter amounts. (Please keep in mind also that the third quarter had one less shipping day than the second quarter, or about 1.5 %.) We managed our receivables and inventories well which, when combined with our operating profits, resulted in very strong cash flow. Our operating profit, EBITDA and net income were a very respectable 9.4%, 10.5% and 5.2% of revenue, respectively. So, you are asking, why the estimated earnings per share miss? The answer is Gross Profit. We said during our 2007 second quarter financial results conference call in July 2007 that our guidance anticipated a 3-5% decrease in volume from the 2007 second quarter. Volume was down 4%. We also estimated a 1% drop in Gross Profit margins, but it was down about 2%. That additional 1% is equivalent to $.15 per diluted share and is directly related to the drop in stainless steel gross profits that were off about four percentage points compared to the first-half of 2007, with the major impact occurring in September. Gross Profit margins on our carbon, aluminum and alloy products, by comparison, were down about 1% compared to first-half levels. During the quarter, we completed the acquisition of Clayton Metals, Inc., headquartered in Wood Dale, IL, with three additional service centers in California, North Carolina and New Jersey. Clayton’s sales were $123 million for their year ended December 31, 2006. Effective October 1, we acquired the outstanding capital stock of Metalweb plc headquartered in Birmingham, England, with three additional service centers located in London, Manchester and Oxford, England. Metalweb was established in 2001 and specializes in the processing and distribution of primarily aluminum products for non-structural aerospace components and general engineering parts used in high-end industrial applications. Metalweb’s net sales for the fiscal year ended May 31, 2007 were approximately $53 million. This transaction will bring an additional global presence to Reliance and marks our first metals service center based in the United Kingdom. Also during the quarter, we repurchased about 1.7 million shares of our common stock at an average cost of $49.10 per share under our Stock Repurchase Plan. We began repurchasing our shares in August when the price dropped down to the low $40 per share range. At that point it was more accretive for us to purchase our own shares than acquiring other companies based on our established valuation parameters. It is important to note that we are not purchasing our stock in lieu of acquisitions or internal growth projects, but given our strong cash flow and relatively low debt levels, it was the right thing to do and we will continue to look for these opportunities going forward. On July 18, 2007, the Board of Directors declared a regular quarterly cash dividend of $.08 per share of common stock. The 2007 third quarter dividend was paid on September 14, 2007 to shareholders of record August 24, 2007. The Company has paid regular quarterly dividends for 47 consecutive years. We still expect record sales and earnings for the year 2007. Our strong operating results, solid balance sheet and cash flow will continue to provide us opportunities for future growth. We are proud of our performance and our leadership position in our industry and believe that our

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proven ability to grow both internally and by successful, accretive acquisitions through varying market conditions will result in continued strong operating results going forward. We expect demand to soften further in the fourth quarter due to the normal seasonal holiday slowdown, as well as cautious buying by our customers in the midst of an uncertain economic environment, leading us to anticipate relatively flat pricing and only a slight improvement in gross profit margins. As a result, we currently estimate earnings per diluted share for the 2007 fourth quarter in a range of $.95 to $1.05. I will now turn the floor over to Gregg for some additional comments on our operations and market conditions. Thank you.

Gregg Mollins - Reliance Steel - President & COO

Thank you, Dave and Good Morning. We knew going into the third quarter it was going to be a challenge, but we feel our managers did the very best they could in a very competitive environment. We have said on several of our most recent financial results conference calls that managing gross profit margins was our biggest challenge and that certainly was the case in the 2007 third quarter. Nickel surcharges on stainless fell $.74 cents a pound in the quarter, the largest decline ever, and Midwest spot aluminum ingot dropped $.13 cents a pound. Carbon steel was also extremely competitive, with several price discounts announced in flat-roll and plate products. The race to reduce inventories was intense, to say the least, and our customers bought only what they absolutely had to have at the time, expecting prices to continue to fall. It was a battle that was, and continues to be, hard fought. In spite of all this, we managed to produce an 8.3% pre-tax profit. Many companies haven’t achieved this in the best of times. Our product diversity, broad geographic coverage and outstanding customer service has served us well. Many of the industries we support continue to be busy. These include aerospace, non-residential construction, energy, machine tool, heavy machinery, ship building and infrastructure as well as electronics and semiconductor. From a cost perspective, stainless surcharges appear to have hit bottom in October 2007 with type 304 at $1.26 a pound increasing $.10 cents a pound in November and an expected $.05 to $.10 cents a pound increase in December. This should create some stability in our stainless and nickel product lines. Midwest spot aluminum ingot has leveled off at the $1.10 to $1.15 a pound range. Carbon steel flat-rolled increased $20 a ton effective October 1, 2007 and has held, as have increases in wide flange and mini-mill products. Future price increases in carbon steel products are expected as imports continue to decline as a result of the weak dollar. Raw materials such as coke and iron ore continue to rise and service centers should begin to replenish inventories. These are all positive signs for our company and our industry. Internal growth through investment in property, plant and equipment is doing very well. We will be moving into a new Greenfield site near Green Bay, Wisconsin in December of this year, and we’ve recently acquired property in Las Vegas. We also intend to purchase a facility near Cincinnati, Ohio and numerous other expansion initiatives are in the works. We are excited about our internal and external growth opportunities, and we are confident in our ability to navigate through ever-changing markets. Although there may be some short-term challenges, our future looks bright. That concludes my report. I will now turn the program over to Karla to review the financials.

Karla Lewis - Reliance Steel - EVP & CFO

Thanks, Gregg and good morning. Same-store sales, which exclude the sales of our 2006 and 2007 acquisitions, were $1.04 billion in the 2007 third quarter, down 0.6% from the 2006 third quarter, with a 2.2% decrease in our tons sold and a 2.0% increase in our average selling price per ton sold. For the 2007 nine-month period, our same-store sales were $3.25 billion, up 4.9% from 2006, with a 2.1% decrease in our tons sold and a 7.6% increase in our average selling price per ton sold. (Please note that our tons sold and average selling price per ton sold amounts exclude the sales of Precision Strip because of the “toll processing” nature of its business.) Although we have continued to see fairly stable end market demand during 2007, our same-store sales volumes are down somewhat from the 2006 periods mainly because of the substantial growth experienced in many of our markets in 2006, especially non-residential construction and aerospace. Our same-store average selling price increased because of increased costs for most of our products compared to 2006 levels, especially stainless steel products. Our 2007 third quarter same-store sales decreased 6.4% from the 2007 second quarter. This included a 3.1% decrease in our tons sold, which was expected due to normal seasonal slowness. Our average selling price per ton sold decreased 3.8% mainly due to the significant reductions in the nickel surcharge that affected the stainless products that we sell. Our 2007 third quarter gross profit was $440.0 million, or 24.3% as a percentage of sales in the 2007 third quarter, compared to 26.6% in the 2006 third quarter and 26.2% in the 2007 second quarter. For the 2007 nine-month period our gross profit was $1.4 billion, or 25.4% as a

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percentage of sales, compared to 26.9% in the 2006 nine-month period. Our gross profit margins have been lower in 2007 as compared to 2006 mainly due to competitive pressures resulting from excess inventories throughout the industry and, with regard to the 2007 third quarter, our margins were adversely impacted because nickel surcharges on stainless products experienced significant decreases, lowering our stainless selling prices more rapidly than our inventory costs on hand were lowered, resulting in reduced margins. Our 2007 third quarter LIFO expense, which is included in our cost of sales, was $12.5 million, or $.10 per diluted share(1), compared to $33.3 million, or $.27 per diluted share(1) in the 2006 third quarter. In the 2007 nine-month period we recorded LIFO expense of $45.0 million, or $.37 earnings per diluted share(1), compared to $56.3 million, or $.48 earnings per diluted share(1), in 2006. Our 2007 LIFO expense is mainly due to continued increased costs for stainless steel products in 2007 over the 2006 levels. Based on actual results to-date and our expectations for the remainder of 2007, we have lowered our annual LIFO expense estimate to $60 million from $65 million, which results in an estimated fourth quarter LIFO expense of $15 million. The reason for lowering our estimate is primarily due to the larger than anticipated stainless price decreases experienced in the third quarter, along with the unexpected decreases in common alloy aluminum pricing in the 2007 third quarter. Our 2007 warehouse, delivery, selling, general and administrative expenses have increased mainly due to our 2006 and 2007 acquisitions. As a percent of sales, our 2007 third quarter expenses were 13.9% compared to 13.8% in the 2006 third quarter and for the 2007 nine-month period were 13.9% compared to 14.1% in the 2006 period. Our 2007 depreciation and amortization expense increased $12.3 million over 2006 mainly because of our 2006 and 2007 acquisitions. Operating profit for the 2007 nine-months was $588.2 million, or 10.6%(2), compared to $494.5 million, or 11.8%(2), in 2006. The operating profit dollars increased due to the increased business levels provided from our 2006 and 2007 acquisitions; however, our operating profit margins have deteriorated because of the lower gross profit margins experienced in 2007. Interest expense for the 2007 nine-months was $60.2 million, compared to $42.0 million in 2006. The increase is mainly due to the increased borrowings to fund our 2006 and 2007 acquisitions. Our 2007 effective income tax rate was 37.5% compared to 38.0% in 2006. The 2007 rate is lower mainly due to our increased international exposure and tax benefits from certain of our 2006 and 2007 acquisitions. Net of acquisitions, our accounts receivable balance increased $66.6 million and our inventory levels decreased $16.5 million at September 30, 2007 from our year-end 2006 amounts. Our accounts receivable days sales outstanding rate was consistent with year end at approximately 40 days. Our inventory turn rate of 4.4 times was equivalent to about 2.7 months on hand, consistent with our year-end 2006 rate. Our focus on reducing inventories and continued solid profit levels provided net cash flow from operations of $384.7 million in the 2007 nine-months, with $214.4 million of this being generated in the 2007 third quarter. This included $111.9 million of cash flow from the reduction of inventories in the third quarter. Our outstanding debt at September 30, 2007 was $1.28 billion, which included $390 million borrowed on our $1.1 billion revolving line of credit. Our net debt-to-total capital ratio was 36.7%(3) at September 30, 2007, down from our year-end 2006 rate of 37.6%. In the 2007 nine months we used our borrowings and cash flow to fund our increased working capital needs, capital expenditures of $88.4 million and acquisitions of $257.6 million. In addition, we purchased $82.2 million of our common stock in the 2007 third quarter. The significant cash flows generated in the 2007 third quarter allowed us to completely finance our acquisitions of Clayton Metals and Metalweb, our stock repurchases and our capital expenditures during the quarter with cash flow from operations. The Metalweb acquisition was completed on October 1, 2007. We repurchased 1,673,467 shares of our common stock during the 2007 third quarter, at an average cost of $49.10 per share. This was the first time that we have repurchased our stock since 2000. Since initiating our Stock Repurchase Plan in 1994, we have repurchased 12,750,017 shares at an average cost of $12.93 per share. Repurchased shares are redeemed and treated as authorized but unissued shares. We currently have authorization to purchase an additional 10,326,533 shares under our plan. Our book value per share was $27.12 at September 30, 2007, up from $23.07 per share at December 31, 2006. Thank you. We will now open the discussion for questions.

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Regulation G Reconciliations

(1) LIFO expense is included in cost of sales. The per diluted share effect is calculated as follows (in thousands, except for share and

per share data):

(2) Operating profit is calculated as follows (in thousands):

2007 2006 Nine months ended September 30: Net sales $ 5,550,018 $ 4,173,416 Cost of sales 4,140,105 3,051,289 Gross margin 1,409,913 1,122,127 Warehouse, delivery, selling, general and administrative

expenses 772,118

587,245

Depreciation expense 49,602 40,429 Income from operations $ 588,193 $ 494,453

(3) Net debt-to-total capital is calculated as total debt (net of cash) divided by shareholders’ equity plus total debt (net of cash).

This conference call may contain forward-looking statements relating to future financial results. Actual results may differ materially as a result of factors over which Reliance Steel & Aluminum Co. has no control. These risk factors and additional information are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 and other reports on file with the Securities and Exchange Commission.

2007 2006 Three months ended September 30: LIFO expense/(income) $ 12,500 $ 33,250 Tax rate 37.5% 38.0% Net LIFO expense/(income) $ 7,813 $ 20,615 Weighted average shares outstanding – diluted

76,476,928

76,016,596 Per share effect $.10 $.27 Nine months ended September 30: LIFO expense/(income) $ 45,000 $ 56,250 Tax rate 37.5% 38.0% Net LIFO expense/(income) $ 28,125 $ 34,875 Weighted average shares outstanding – diluted

76,613,307

72,985,065 Per share effect $.37 $.48

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QUESTION AND ANSWER

Operator

(OPERATOR INSTRUCTIONS). Mr. Carruthers, your line is now live.

Nate Carruthers - Michelle Applebaum Research - Analyst

Hi, everyone. Good morning. I was wondering how your daily sales in October are comparing to September and then what was the trend during the third quarter month by month?


First off, in terms of -- and we will dig that information out if we have got it, but in terms of month by month, July actually turned out exactly how we had forecast it to be in terms of earnings and earnings per share. Then I think we talked before about July being the softest month of the quarter and then August stepping back up. August did not step back up this year and then usually we get a step up in September and I think in September, we did get a slight step up, but it pretty much just offset what we -- we actually softened up a little bit on sales per day in August. So it was kind of a -- it was a different kind of a quarter than we had seen traditionally, but the trend -- overall, the average sales per day was pretty positive. We were about $28.8 million in July and $28.5 million in August and about $29.1 million in September. September only had 19 days, so that has an impact as well, but overall, I think from a demand standpoint or a volume standpoint, we didn't see any real big slowdown that surprised us. We were, from a demand standpoint, seeing regular activity, although we certainly noticed the pressure on the margins and this, as I mentioned earlier, was a quarter where we had, and rarely does this happen, but we had prices on pretty much all three of our product groups -- carbon, stainless and aluminum -- going down at the same time. That is something that we don't often see, so it made the quarter quite a challenge.


And how is October looking versus September?


October right now from what -- it is hard to tell, but it looks similar. It is not trending up, it is not trending down, it is just right in line with what we have been experiencing.


All right. Thank you very much.

Operator

Timna Tanners, UBS.

Timna Tanners - UBS - Analyst

Hi, good morning. Thanks for the great detail. I guess I just wanted to ask if you could elaborate a little bit more on how much of the challenging market circumstances had to do with underlying demand and how much had to do with excess inventory in the channel?

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I think pretty much the challenge was in the excess inventory and really the race to get the inventory that you had in stock that was being devalued guide your inventory to get to the lower cost, lower replacement cost as quickly as possible. Demand is not that bad. We have seen it a lot worse than it is today, but the competitive environment is very, very extreme because of the devaluation of -- a severe devaluation -- I think stainless has gone down $1.01 a pound from October. We have never seen anything like that in our lives. Now we never saw it go up like it did , but now it has corrected itself and it is a little bit -- I mean it hurts right now, but for the long term, we think it's an in the best interest for our customers and the stainless surcharges are trading at a more reasonable rate than they were earlier in the year.


Okay. So along those lines, do you see a lot of pent-up demand in stainless on the one hand and then if you could help us understand the mills seem to be talking about demand staying quite consistent and that is the thing that you've been talking about, but we are getting quite a different picture from some of the machinery end customers about demand weakening on non-residential. How do we reconcile the difference and tone about the non-residential market?


I think the non-residential market for us is still pretty healthy. It's not -- as we pointed out early in the year, it's not accelerating like it did in 2006, but it is maintaining at reasonable levels. I don't know what to tell you about how you can reconcile that with whoever you are getting information from. All I can tell you is what we are experiencing here at Reliance and non-residential construction is still pretty healthy in our book..


It may too, Timna, have a -- it may result -- if you look at the MSCI statistics that I think just came out that the volume year to date was off 8% and we are off year to date same-store 2%, so I think our people are doing a great job out there working the street and selling. That is pretty important to us and that is on a same-store basis and one of the things that we have talked about consistently is growing the Company through varying market conditions. And our volume is actually up 20% if you just look at pure numbers year to date versus -- '07 versus '06. So we have been successful in finding ways to profitably grow the Company through all these different market conditions and yes, a lot of that is due this year to acquisitions, but acquisitions is a part of our ongoing strategy.


Okay. That's helpful. And then just finally if you could comment on given that your leverage has declined a bit and we have seen in the past when you have moved below your target leverage, you have done sometimes larger deals like EMJ, can you talk about the priorities of cash use on a go-forward basis?


Yes, well, first off, we will pay down debt. That is -- the initial use of cash is to pay down debt. We are net borrowers. I think Karla mentioned that we have just under $400 million borrowed on our revolver, so as we produce cash, we use it to pay down debt. Then after -- then we borrow on our revolving line typically for capital expenditures to fund internal growth, for acquisitions and for dividends of course and then for stock repurchases lately. And we will continue to view all of those things and I think you will see us doing all of those things as we go forward.


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The order of that, Timna, obviously would depend upon what we have in the acquisition pipeline because as we look at using our cash, we are always looking at what is on the near-term horizon. So it may not fall exactly in the order Dave gave depending upon what the opportunities are at the time.


Sure. Okay. Great. Thanks, again.


We could -- just as a last comment, if we levered up the rest of our revolver, so if we borrowed another $700 million, our debt to cap would go up only to 48%, which is on the high end of our comfort range, but still it is in the comfort range, it is not in the range where we think that we have to go back and delever.


Okay. Great.

Operator

Michelle Applebaum, Michelle Applebaum Research.

Michelle Applebaum - Michelle Applebaum Research - Analyst

Hi. Yes, not a bad quarter in a tough environment. I wanted to ask you if you could give me the implicit same-store sales forecast in your fourth-quarter forecast.


Yes. Michelle, that is probably -- I guess we haven't calculated that because typically when we are forecasting for the next quarter, we are not separating -- the same-store numbers that we report technically exclude all of our acquisitions from the prior year and the current year. So when we are forecasting for instance in this case for the fourth quarter, we are looking at our third-quarter sales. So the only difference going from third quarter to fourth quarter this year will be the addition of Metalweb effective for the full fourth quarter, which their annual revenues last year were $53 million, so that is really not a big factor. When we did look at forecasting sales, it was a little difficult because we were a little uncertain about what is going on with both demand and pricing and we have probably -- we have got some factored for demand and some for pricing, so demand we have probably got looking down about anywhere from 4% to 8% decline in demand.


But that would be kind of a proxy for same-store sales.


Yes, yes. It's basically same-store from third to fourth.


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It's a little tougher in the fourth quarter because you can count shipping days, which obviously makes a big difference to us in this business, but then you have to look and figure out what are the good shipping days and with the holidays the way that they fall this year, you've got the Monday before New Year's and the Monday before Christmas that are technically for us days that we are open and shipping, but not much is going to happen on those days. And then in between Christmas and New Year's is always interesting. We still have a pretty good slowdown there because customers do slow their business down. Many still close during that time period.


Okay. But I remember, as I was growing up my learning curve, talking to people like you and then you that the periods of time when you actually might be closed on a Monday but open -- closed on Monday, Tuesday, open Wednesday, Thursday, Friday, your same-store -- your daily orders on those three days that you are open would actually reflect some of the closure -- some of the kind of people packing it in for those three days, so you can't -- it's not a perfect count


You're right. You are right and that is what makes it kind of difficult. If you count the days, there are 62. We know practically it is less than that, but how many less we don't really know.


Okay. Because on the quarter, you get a lot more smoothing -- a month or a week, you are going to feel it. In reconciling -- I know that you are gaining market share and it is evident looking at the trends at MSCI, but also there are different pieces of non-residential that are weaker. My sense is that the residential-related non-residential is weaker, so the kind of corollary building that you get with a housing development, whether it is institutional or strip malls and that kind of stuff and is your mix more industrial non-residential and maybe you wouldn't be seeing some of that? Do you get that deep into it?


We do. We do participate in mini malls, the hospitals.


So you are seeing -- are you seeing --


That part of non-residential construction is weaker than it was in 2006.


Correct.


But overall, if you look at our nonresidential construction business, it is still pretty active.


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And we throw infrastructure in there and then schools and hospitals that are good industrial and commercial. That has all been not as good as last year, but it's certainly fairly strong.


Keith Busse, CEO of Steel Dynamics, Inc., said yesterday less frenzied was his -- I am sorry, I don't mean this sarcastic-- but we are talking about euphemisms for weaker and his comment was less frenzied in the non-residential side. Are you seeing less frenzied?


I think it is probably just weaker.


Oh, my goodness. You get a star.


But it is still okay by historical standards. We are still real happy with it.


We are all coming from the same place and using that “W” word is so painful, I understand.


Right. Right. But we haven't had to use it in a while.


I know, I know.


Since 2004 and it is probably -- although we do not like to have to use it, it is a good thing to wake some people up and realize that things can come down, they don't always just go up and up and up as much as we would like them to.


Right. Well, there were a bunch of us a few years ago who had to be sort of retrofit to think that things actually could go up. So it is a high-class problem. But let me ask another one too. I have got to ask my question I always ask and it is more hopefully relevant now than usual, which is your piece of paper, your M&A target list.


My list, yes. Well, it is still there, but Karla is encouraging me to throw that thing away and just use the listing in the Purchasing magazines of all the service centers.

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I am not encouraging him to throw it away, but I don't want to give the sense that the numbers that we talk about on that are imminently in process because some of these we have been talking to for 10 to 12 years and we don't want to give listeners the wrong idea that we are working on a huge revenue base currently.


Okay. So let me ask it the right way. You have got a target acquisition list that is essentially your targets on the piece of paper and there is a percentage that will get completed and I am not asking at all on the percentage that will get completed; I am asking what is out there and attractive to you. You will buy some of these, is that a good way to ask it?


We will buy some of what we are looking at currently and we will be buying some stuff that we don't even know about yet.


So on this target list of potential companies that you might want to buy in the next 10 years, how many dollars of revenue and how many names and then how many of them aren't on the Purchasing magazine list?


Michelle, I should have anticipated your question, but I don't have the list --


I ask it every quarter.


I know you do, but I didn't bring the list with me, but I don't -- it has got a few more names than the last time I answered the question and no, it's not a huge change.


Okay, but there is incrementally -- and then -- what is Gregg saying?


He said it is just hard to identify what kind of volume we might be acquiring because you never really know when these things are going to happen.


Yes, I am really not asking -- I am not asking that. I am asking what is out there because people have a tendency to look at Purchasing magazine and Purchasing does a fabulous job coming up with that list, but even they will acknowledge that they are shocked at the number of companies that they have never heard of.

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Oh yes. Probably half the people on the list I've got, I don't know, 15, 18 people on that list or something like that now and I bet half of them aren't in the ranking.


Well, that is kind of -- that is what I am asking is your target market is bigger than what might be apparent to us.


Yes.


And that's why I ask it every quarter.


Yes, it is.


And then in terms of -- financing has gotten a little bit more challenging I have heard, but Platinum has got Ryerson and there was something else that happened. Are you seeing private equity a little bit less active?


Not really. I don't think -- as you know, most of -- the vast majority of the deals that we have done in the past have not been shopped deals; they have come to us. So right now, obviously the private equity is in some deals, but we haven't seen a big change or a change at all in their activity level.


But we are not competing with them directly in deals either.


Yes, I understand. I understand. Okay, thank you so much.


You bet. Thanks.

Operator

Michael Willemse, CIBC.

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Michael Willemse - CIBC - Analyst

Great, thank you. I just wanted to check -- first check a couple of things that was said at the beginning. Did you say that gross margins on stainless declined by about 4% versus the first half of the year?


Yes.


And would you expect that to be about the same in the fourth quarter or even lower?


No, we don't expect it to be lower. Slightly better and if you ask how much slightly is we just don't know. We weren't very good at anticipating what it was last quarter, but we do expect that the margins will be a little better than they were. As Gregg mentioned, the stainless surcharges have -- announcements have come up slightly, so that helps from a demand standpoint, from a customer buying standpoint and from a pricing standpoint.


Whenever you see a price increase, especially after you've seem the amount of discounting that has gone on over the past 90 days, it helps to stabilize it and it also allows us breathing room whereby you don't have to chase prices down to the next level. So when that happens, generally speaking, our margins improve.


So I know this is a tough guess, but would you say stainless has stabilized now -- stainless prices?


Well, let me put it this way. Prices have hit bottom this month in stainless. So there was still $0.34 a pound discount in the month of October. So I would say going forward -- November, December -- with the increases of $0.10 a pound announced in November and a potential $0.05 to $.10 a pound in December, that is when they would begin to become more stable.


Okay and just going back to the gross margin, would it be safe to say that in the first half of the year, the gross margin on stainless was pretty close to the average gross margin for the Company, which was about 26%?


It probably would be maybe a point lower, because stainless flat-rolled as a percent is generally one of the more competitive product lines in all the metals business, but bar stock is more profitable from a percent standpoint than stainless steel is.


And probably half of our stainless is in bar and plate too.

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The other half flat-rolled.


Okay. And just going back to the question on acquisitions, are you seeing any competitors that might be struggling financially now after the pretty tough quarter either in the stainless business or one other business that Reliance isn't a big player in is tubeless and tubular products and prices have come down over the last year there as well.

Dave Hannah - Reliance Steel - President & COO

I am not aware of anybody that is in any financial difficulty because of that. I think times were pretty good and maybe some activity has backed off and some pricing has backed off, but I think people are still making money; they are just making less than what they did last year and maybe the year before. So I am not aware of anybody that is any dire straits. We did see -- I think we mentioned this on a call earlier that there would seem to be a very high level of activity of stainless-related businesses for sale. We have seen a lot of deals come across that had to do with stainless products, but I think that was because things were so high particularly in the first half of this year and last year.

Gregg Mollins - Reliance Steel - CEO

And many of those companies were very energy-related. I think they felt that they were peaking and saw that as good a time for them to go to the street.


Okay. And then a couple more. On the import side, if I recall correctly, does Reliance import about usually 10% to 15% of your steel buys and could that go to 0% over the next few months and is that going to impact margins much or not really?


I don't think it will ever go to 0%, but it is certainly going to be less than 10% and will it impact margins? I think that the public in general in the service center sector are all backing away from offshore purchases because they are just not attractive and there is less offerings out there. So will it hurt our margins, I don't think so at all.


Some of why it won't go to 0%, Michael, is because there are some products that we buy offshore that you just can't get here.


Right, right. And just last question, what were the fully diluted shares outstanding at the end of the quarter?


At the end of the quarter, sorry, it was 74.6 million.

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And that was basic?


Yes, that's basic.


Okay. Thank you.

Operator

Tony Rizzuto Jr., Bear Stearns.

Tony Rizzuto Jr. - Bear Stearns - Analyst

Thanks very much.. I have got several questions. First of all, you guys have been pretty nimble in the past when the margins have come under pressure. Can you discuss any cost-containment efforts that you might have going on right now? I have got a couple more questions too. I hate to beat a dead horse, but I have a question about acquisitions and another one too about the aluminum heat-treated market..


Sure. We are looking at overhead, Tony, right now in all of our locations in an effort that if if this continues, we attack costs. It's that simple. So I can't elaborate on that too much because we are right in the middle of it, but it is fair to say that we're probably going to have a few less people here by the end of this month than at the beginning of last month.


Right, is that more -- so given your nimble capabilities there, is it more a reflection maybe that you see possibly a softening maybe sustaining a little bit further out possibly into 2008?


Well, the answer to that is yes. I think we are going to see some softening in the fourth quarter and we are hopeful that that will correct itself, but we are not going to count on it. We are going to plan our -- plan for the worst and hope for the best.


All right. You guys have talked about acquisitions and just a slightly different angle, is it fair to say that with all the margin pressure that clearly is going on in the industry, would this accelerate consolidation activities in your view? Perhaps bring more folks to your doorstep so to speak?


It could, Tony. What we have seen in the past is when times are roaring along at relatively high levels, people are pretty happy and you get some at that point that consider, as we said earlier, about the energy-related stainless businesses that have kind of floated in front of us that they felt, well, maybe this is a good time to get out because things are maybe as good as we have ever seen them.

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But we have also seen when things tend to tighten up a little bit that that reminds people that this is a cyclical business and that it is not going to stay at these high levels forever and that maybe they should consider selling at that point. So there are different things that drive different people and we really -- it is almost like each one has its own story, but we wouldn't be surprised to see a little bit more activity not because these businesses are going to be losing money because it is simply not that bad out there. Most of us are making less obviously than we did before.


Okay, David. The final question I have is I didn't hear anything about the aluminum heat-treat market and I was wondering if you guys could discuss current demand levels, pricing and with the dislocation with the Airbus A380 easing and now the 787 issues, how do you see that playing out in the marketplace and from your standpoint?


Lead times, Tony, on heat-treat aluminum two and seven series, still Alcoa's lead times of 10 to 15 weeks, so it is still fairly tight. It's not being as allocated as closely as it was a year ago, but the business itself, we are still doing well. Our customers are telling us that Boeing is not cutting back on their -- in other words -- putting out some of their parts that they have out on the street with the machine shops and what not. They are just continuing to sell them to keep manufacturing for us. They are taking them into their inventory and they are banking them. So what happens with the Dreamliner, I think we're being told by mills and our customers that it is really kind of a non-event right this minute, but they've also got a caveat that says if there is another push out, then there's going to be problems.


It could be a similar situation that we had with the A380.


Right.


And it also seems -- it seems like we still have some of that overhang working its way through the system even though it seems like the delays are behind us. We still have a little inventory sloshing around from the A380. Is that pretty much all cleared out or are you guys still seeing some dislocation there?


There is still some of that out there, Tony.


And what is your best guess, Gregg, as to when we are really going to see that demand pick up again in earnest from that program?


You asked a tough question. We are hopeful that we should be able to realize some better market conditions right around the spring of 2008.


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Okay. That's pretty consistent with what we're hearing elsewhere. I appreciate it, guys. Thank you very much.


Sure. You know, Tony, too, aerospace is one of the highlights for us still. Again, last year, it was really flying high, but this year is still really great and solid high-level performance by our aerospace-related companies and, as Gregg said, that is one of the areas that we do expect to get some strength-building as we go through 2008. That and the energy side really is the other piece of our business that is very strong right now and we expect that it is going to stay that way. So those are the two really big areas for us that are strong and we think will be strong going forward.


Okay. I appreciate it. Thank you very much.

Operator

Yvonne Varano, Jefferies & Co.

Yvonne Varano - Jefferies & Co. - Analyst

Thanks. Wondering if you could talk a little bit about what your strategy is for potentially expanding more internationally. Metalweb obviously puts you in the UK for the first time, but what more can be done out there?


As you know, Yvonne, our international businesses outside of North America -- we have gone to the countries where we have already expanded because of a need from a customer perspective. We haven't gone over and established ourselves and tried to be all things to all people and we don't intend to do that going forward. So the answer to your question depends in large part upon what we see from a customer standpoint here in the US where our customers are actually establishing additional businesses offshore and the support they might need for us to go and follow them. And certainly we have done that in South Korea. We have done it in China. We have done it in Belgium and we will continue to do that. I think you will see us grow more internationally. As a percentage if you just look at our international revenue and what we expect that to grow to, I think the percentage increases will be fairly substantial, but the actual dollar amounts are still going to be very small compared to the rest of the Company. You will see more growth in North America than you -- and in particular the US -- in terms of actual size than anything that we see today offshore even though the growth rates might be greater offshore.


We really take a rifle approach when it comes to going outside of North America and, as Dave said in the past, strongly going forward, we will be pulled there by our customer mix.


Do you see a lot of acquisition opportunities over there?


We see some acquisition opportunities outside of North America, not a lot, but we see some. Certainly Metalweb was a different deal and that was one -- it was an opportunity and we have known the management team there for quite some time. Metalweb was only established in 2001,

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but we have known these folks for 20 years or more when they were at their predecessor company. So that is a little different. We didn't have customers pulling us there, but Metalweb will be an important -- an important platform for us to grow. The management team there is very knowledgeable about international business more than we are very honestly. That was one of the things that was very attractive to us with that deal and we expect them to help us grow internationally not only in Europe, but in areas outside of Europe.


Would you see growth there potentially more organically?


Yes. I think so.


No question about it. They have some very, very good internal growth opportunities for us and we can bring to them products that would complement their own that they are currently not able to acquire from other mills.


So the resources we bring them are -- they are pretty excited about that.


And Gregg, on the Common alloy aluminum, it seemed that you were a little surprised by the prices coming down. What changed there?


I think the market itself got a little soft, the end-use market. I think the domestic auto producers had a negative effect on them and maybe some other end-use markets. I was taken by surprise, maybe some others weren't, but I thought business conditions were better than they were and that the prices would hold up, but obviously I was wrong.


Thanks, very much.

Operator

Mark Parr, KeyBanc.

Mark Parr - KeyBanc - Analyst

Thanks very much. Good morning. I guess it's afternoon now; morning still where you are. I was -- I had a couple of follow-up questions and I wanted to try to get a little more color if I could on your assumptions in the fourth-quarter guidance relative to the third. I think you have talked generically about margins being about stable in the fourth quarter relative to the third. I think you talked about stainless margins actually coming up a touch and I am just wondering if you could give us any color on how you would look for the profitability in some of the other main product categories?


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On carbon steel products, I think that with the price increase that was announced that went into place October 1 on flat-rolled with the plated product increase that was passed and that was supposed to go in December. I think that is questionable. I think Mittal came out and markets reacted December 1 and now others came out December 1. I think that is going to help us. It normally does. Our margins tend to expand when prices are going up and tend to contract as prices are going down. I would expect that trend to continue going forward. Right now, we are just trying to fight through this stainless.


And I would say, Mark, on the carbon, everything Gregg said is true. We are a little cautious looking at fourth quarter because of some of the uncertainty and you have to remember too the different carbon products that we are carrying. The carbon flat-rolled is only 8% of our business. So there's expectations on some other companies improving in the fourth quarter because of sheet price increases. You are not going to see as much of that reflected in our earnings because of what a small percentage it is. In stainless, we are fairly uncertain. We think, based on the price increases Gregg talked about, kind of steady, hopefully up a little bit compared to the third quarter and aluminum we looked at. We are fairly steady. So those are the assumptions we used. Are we right? We don't know.


There was even an announcement just recently on stainless that surcharges definitely were going to increase to try to keep people more consistent at inventory levels and orders of production of stainless flat-rolled. So all those signs are positive. They are positive for us and we are going to work our tails off to try to maximize our gross profit margins as best we can.


Okay. So is it fair to say then that the majority of the sequential reduction in guidance just relates to the outlook that you had for the demand environment as opposed to the pricing momentum?


Yes, that's pretty much true.


Yes, we think it is going to be softer in the fourth quarter and as Dave pointed out. Those number of days -- more and more companies nowadays, certainly far more than 10 years ago, they close up that last week of December.


Right.


There is just a lot of shipping days that when you look at your calendar and you think are there that aren't and I think we are being a little bit cautious too because I think -- I am looking at all three of us here, we were a little bit surprised with what the heck happened in that third quarter. We didn't think the prices were going to fall that far.


We knew they were coming down, but we just didn't think they -- on the stainless side, we didn't think they would come down that far that fast.

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Gregg, another question on customer inventories. You look at the MSCI numbers, inventories on balance look like they are in pretty good shape. And just wondering if you could give any color as far as what kind of condition you think your customers are in from an inventory perspective?


I think they are in great shape. I really do. I think that they, like ourselves, our customers did the same thing in the third quarter that we did. We just quit buying. We basically told our purchasing people to take their purchase order book in stainless, put it in the drawer, pull it out when you are out of stock and I think our customers are doing the exact same thing. They are buying -- they are being very cautious, they are buying only what they need for that particular job and there is plenty of inventory even though inventories are in good shape at service centers and whatnot according to the MSCI's statistics. There is still inventory out there. They are not worried about supply.


And on the carbon side, it has been going on for longer because the carbon prices were trending down over a longer number of months. So I think our customers began earlier buying only what they needed because they saw that trend and they anticipated that while I can buy it later or whenever later, whether it is a week or a month, it is something lower than what I just bought today. I think because of that what Gregg said that customers are in real good shape from an inventory standpoint. They continue to buy what they need and only what they need and the big catalyst for margin improvement from our perspective is going to be demand. That is the thing I think all of us are waiting for are the things that you talk about and others talk about. Some of the input costs at the mills are going up and if scrap goes up over time, but the real thing that is going to cause us to be able to raise prices is a good boost in demand and we certainly haven't seen that, we are not expecting it in the fourth quarter.


Probably, Dave, the only thing that would create some of that in December is if people thought inventories in the pipeline were so low that there may be some supply availability issues emerging in the first quarter. What you are saying is pretty much what we are hearing on our end across the board for the fourth quarter. I had one last question if I could and this is kind of a nitpicky thing. It is a little selfish, but could you tell me -- give me some color on the difference between flat-rolled stainless and some of the bar and tube on the stainless side? Have you seen any difference in the margin performance of the respective stainless product lines or in the demand environment for either one of those two?


Yes, the margin deterioration was greater in flat-rolled than it was in bar and tube. That is not to say that bar and tube maintained. It did not. It went down, but bar and tube maintain their margins much, much better than flat-rolled.


Okay, terrific. I really appreciate all the help and thanks for letting the call go over and thank you very much. Congratulations on all the progress.


Thanks, Mark.


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Thanks, Mark.

Operator

Luke Fulta, Longbow Research.

Luke Fulta, Longbow Research

Hello, good morning. Most of my questions have been answered already. I did have one. I know this isn't a large business for you, but can you kind of talk about what is going on in the high nickel alloy and titanium markets as far as pricing and demand are concerned?


Well, pricing in titanium has come down certainly from its peak. Demand though for titanium is still very strong, but the price could come down. We are trying to find something here to give you an idea. They were kind of at their peak back in the very first quarter and they have come down maybe 25% into October. In October -- October and September have been their lowest for the year.


Now can you talk about what maybe volume growth was over that period?


I'm sorry. Can you repeat --


Can you talk about what volume growth was over that same period?


We don't have that information with us in the room here, but titanium is only about 1.5%, 2% of what we do, so it is pretty small. But we don't have the volume -- we would fill the room with paper if we had volume by product in here.


Just directionally, are things flattening out or are they headed down?


On titanium?


Yes.


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I think it is fairly steady. The only thing, as far as from a demand point of view, I know it is strong. The only thing down is from a pricing point of view, with less money in titanium inventory this year.


Okay. Thanks a lot. Good luck.

Operator

Daniel Altman, Zweig.

Daniel Altman - Zweig - Analyst

Hi, thanks very much. You commented on fourth-quarter margin outlook given competition and given stainless. Just wondering if that changes at all your outlook for 2008? Do you have a target margin for next year? Thanks.


We do not have a target margin for next year. We would expect it to be something more than the margin we just had in the third quarter. But we don't -- we are in the midst right now of putting together our projections for next year.


Yes, our long-term gross profit expectation is in the 26% to 27% range over a long-term period. That hasn't changed, but whether or not we get there in '08, we are a little uncertain about right now.


It really depends on the pricing and demand and pricing dependent to a great extent on what happens on the demand side. But if pricing -- it seems that all the pricing decreases and all of our product groups that was occurring in the third quarter has now stopped and some of them have started back up again. So if that continues and demand holds up then we will approach the margin. Our historical gross profit margins, which, like Karla said, are in that 26%, 27% range.


Okay. Is the competitive factors that you mentioned, is that also working into the equation or is it just a question on volume issue?


Competition has been, as Gregg pointed out in his talk, it has been fierce really over the last -- well, pretty much all year this year. If you look at different products, early in the year, there was a surplus of carbon inventory out there, particularly in the flat-rolled side. So the environment there competitively was very high because people were trying to work off carbon and work off their inventories anticipating that prices would eventually soften. And in fact carbon pricing did start to soften and then that accelerated that whole activity. So it has been a tough year from a competitive standpoint. Stainless too. I mean even early in the year when stainless prices were going up, there were some things going on that caused margins to be lower than what they should have been because of some competitive issues out there and also a surplus of material.


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Right. Availability of it.


Okay. Thanks very much.

Operator

(OPERATOR INSTRUCTIONS). Sal Tharani, Goldman Sachs.

Sal Tharani - Goldman Sachs - Analyst

Thank you. Good morning, guys. A couple of quick questions. Karla, can you give us the same-store operating margins for the third quarter? Is that handy?


No, we actually don't give out the same-store margins -- just revenue.


Okay. And how about in terms of volume on inventory, how much was it down? Do you have that handy?


How much was inventory down?


Yes. At the end of third quarter and the second quarter.


In dollars?


No, in volume.


Hold on one second.


Just let us dig it out here. Do we even have that?

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We have that.


In the meantime, Gregg, can you give us some view on how you are seeing the demand from the ethanol plant construction? You mentioned that in the past it was very good at the beginning of the year. Has it turned down now?


On ethanol?


Yes.


No, it is still very active.


You are still seeing ethanol plants -- because we heard that some of them have delayed their projects as the conditions have deteriorated in that market.


I was speaking with a couple of our guys earlier this week that just got a view of some very good orders -- well, fairly significant to them, not to the entire Company.


Okay.


The pounds or tons in inventory, Sal, decreased 8.2% from June to September.


So very much in line with what MSCI inventory has decreased.


Yes, yes.


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Also, Karla, did Clayton Metals -- was Clayton Metals fully included in the third quarter or was there any inventory reevaluation in the quarter for that?


Clayton -- we are still working on finalizing the purchase price allocation, but certainly from inventories, they should be properly valued and we made estimated write-ups for fixed assets. So it is pretty small numbers in our total consolidated amount.


Okay and lastly on the price increases we are seeing in flat steel, are you having any trouble passing it on to the customers or are they pretty much accepting it as the mills are increasing the prices?


No, we are able to pass them through, Sal. I am not saying that it's not a competitive market and that it is really easy to do it, but eventually they are very much aware and I think our people out in the field are aware that basically they hit the bottom, $500 to $520 a ton on hot-rolled in August and we were very pleased to see that the mills drew the line in the sand once again and then provided some price increases. We very much enjoyed that. We do not like it to go below $500 a ton anytime. So our customers -- we are constantly telling our customers that basically that is where they draw the line and the average is probably going to be somewhere around $550 to $560 in our minds. I think we've pretty much conveyed that through to our customers. Now if there is an increase in demand, if there is any improvement in demand in the first quarter of next year -- we don't believe that is going to happen this quarter -- but if there is, I will tell you what. With inventories as low as they are, with the reduction in imports that are coming in, we could have a little bit of fun in 2008 with some price increases.


Dave, in the beginning comments, you gave some qualitative guidance. You said fourth-quarter prices expect to be flat while volume slightly better. Is that correct?


Volume slightly worse.


We said that we expect demand to soften further in the fourth quarter due to really two things -- just the seasonal nature of the fourth quarter and less shipping days, as well as we expect our customers just to continue to buy cautiously. There is a lot of uncertainty out there and most people you talk to think the economy is worse than it really is and eventually if we all start believing that, it is going to get worse. So hopefully we are not building a self-fulfilling prophecy there, but all in all, we do know that our customers are currently buying cautiously and we expect them to continue to do that. Again, as Gregg pointed out, if all of a sudden their business starts to pick up, that could cause some opportunity for some significant price increases.


Great. Thank you very much.

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Operator

Timothy Hayes, Davenport & Co.

Timothy Hayes - Davenport & Co. - Analyst

Thank you, good morning. A couple of questions on what is your estimate on when industry destocking will end?


I think it is about as close to being there right now as we speak, but I think everybody that I speak with -- everyone is taking a very cautious approach on how they are buying going forward and a lot of the problems that we normally see when people are restocking, after they have been destocking, they do it with offshore and now that's not really available right now in many products referring to carbon. Nothing is really attractive, just some plate items that are relatively attractive, but most other items aren't. So I think you are just going to see people holding close to the vest because, as Dave pointed out just a second ago, all you are hearing is doom and gloom in every newspaper you pick up. We see demand being reasonable, but everybody you talk to they don't seem to think that way. So I think everybody is just going to take a cautious approach to their inventories. They are going to keep it with domestic suppliers whose lead times are very short and we are just asking everybody to be holding their breath waiting for demand to pick up.


And then what about the destocking specific to stainless products? When might the timing on that -- when might that end?


Well, it depends on how quickly you turn your inventory. In our stainless platform, we turn our inventories very, very well. We will be in good shape this month.


We are in pretty good shape at the end of September from a stainless flat-rolled standpoint and I think we would like to be a little thinner, but we are in pretty good shape now.


Yes, we are and I think by the end of October we are going to be just fine.


Okay and then finally just to verify some numbers on the same-store sequential changes, what was the increase in unit revenue and the increase or the change in unit revenue and the change in volume?


The same-store sequential, the volume was down 3.1% and the selling price was down 3.8%


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And then same-store sales then were down --


6.4%.


Okay. Thank you.

Operator

Ladies and gentlemen, there are no further questions in the queue at this time. Do you have any closing comments you would like to finish with?


No, just thank you for your time and we look forward to talking to you again in February I believe. Thank you again. Have a good day.

Operator

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

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reliance steel & aluminum 2007_Q3_Conference_call_transcript

Economy & Finance

Transcript of reliance steel & aluminum 2007_Q3_Conference_call_transcript