Reliance Steel & Aluminum Co. (RSAC) - 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2006. Reliance Steel & Aluminum Co. is a large accelerated filer engaged in the distribution and processing of metal products. The reporting period is significantly impacted by the acquisition of Earle M. Jorgensen Company (EMJ) on April 3, 2006, and a two-for-one stock split declared in May 2006 and distributed in July 2006. All share and per-share data have been retroactively adjusted to reflect the split.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended June 30, 2006 |
Three Months Ended June 30, 2005 |
Six Months Ended June 30, 2006 |
Six Months Ended June 30, 2005 |
|---|---|---|---|---|
| Net Sales | $1,559,222 | $816,342 | $2,547,208 | $1,628,249 |
| Gross Profit | $419,873 | $222,235 | $690,058 | $438,171 |
| Gross Margin % | 26.9% | 27.2% | 27.1% | 26.9% |
| Operating Profit | $179,993 | $88,241 | $302,107 | $172,018 |
| Operating Margin % | 11.5% | 10.8% | 11.9% | 10.6% |
| Net Income | $100,505 | $49,049 | $172,360 | $95,412 |
| Diluted EPS | $1.32 | $0.74 | $2.41 | $1.44 |
| Cash & Equivalents | $10,104 | $35,022 (Dec 31, 2005) | N/A | |
| Total Debt | $1,082,644 | $350,800 (Dec 31, 2005) | N/A | |
| Working Capital | $1,010,001 | $513,529 (Dec 31, 2005) | N/A |
Note: Operating profit excludes interest, taxes, and minority interest. Debt figures include current maturities.
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 91% for the quarter and 56.4% for the six-month period compared to 2005. This growth is primarily driven by the acquisition of EMJ (April 2006) and Chapel Steel (July 2005). Same-store sales (excluding acquisitions) increased 18.2% for the quarter and 14.8% for the six-month period.
- Profitability: Net income more than doubled for both the quarter and six-month periods. Operating margins improved to 11.5% (Q2) and 11.9% (YTD) due to increased sales volume and effective expense control, despite a slight compression in gross margins due to the inclusion of EMJ and Chapel Steel, which operate at slightly lower margins.
- Balance Sheet Expansion: Total assets nearly doubled from $1.77 billion to $3.46 billion. Total debt increased from $350.8 million to $1.08 billion, largely due to borrowings to fund the EMJ acquisition ($368.7 million cash portion) and the assumption of EMJ's debt ($252.9 million).
- Cash Flow: Operating cash flow turned negative, using $77.2 million for the six months ended June 30, 2006, compared to providing $83.3 million in the prior year. This shift was caused by significant increases in accounts receivable ($118.9 million) and inventory ($126.2 million) to support higher sales volumes.
Guidance, Outlook, and Risks
- Acquisition Activity: The company continues its acquisition strategy. Subsequent to the reporting period, on August 1, 2006, Reliance acquired Yarde Metals, Inc. for $100 million plus the assumption of approximately $102 million in debt.
- Capital Structure: The company increased its syndicated credit facility to $700 million to support the EMJ acquisition. A new $100 million, 364-day credit facility was entered into on July 31, 2006, to finance the Yarde acquisition.
- Stock Split: A two-for-one stock split was effected in July 2006. The dividend rate was increased by 20%.
- Risks and Contingencies:
- Market Risk: Exposure to fluctuations in interest rates, foreign currency exchange rates, and metals pricing.
- Goodwill: Goodwill increased to $723.5 million (20.9% of total assets). Management performed impairment testing as of November 1, 2005, with no impairment identified, and is not aware of events affecting recoverability as of June 30, 2006.
- Seasonality: Revenues in July, November, and December are traditionally lower due to reduced working days.
- Management Commentary: Management attributes the strong performance to increased customer demand in aerospace, non-residential construction, and energy markets. They note that LIFO expense was $18.0 million for the quarter and $23.0 million for the six months, reflecting rising costs for carbon and stainless steel products.
Investor Verification Checklist
- Acquisition Integration: Verify the final purchase price allocation for the EMJ acquisition, which was preliminary as of June 30, 2006, and its impact on future amortization and depreciation.
- Debt Covenants: Review the specific covenants in the new $700 million credit facility and the assumed EMJ senior secured notes, particularly regarding leverage ratios and dividend restrictions.
- Working Capital Trends: Monitor the trend in Days Sales Outstanding (DSO) and inventory turnover. DSO improved to 38 days, but inventory turnover slowed to 4.8 times (from 5.7 times in 2005), partly due to EMJ's inclusion.
- Stock-Based Compensation: Confirm the ongoing impact of SFAS No. 123R adoption on future earnings, as the company recognized $2.7 million in stock-based compensation expense for the six months ended June 30, 2006.
- Subsequent Acquisitions: Assess the financial impact of the Yarde Metals acquisition (closed August 1, 2006) on the upcoming quarterly results.