Business Context and Reporting Period
Company: Reliance Steel & Aluminum Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2009
Business Overview: Reliance is a leading distributor of steel, aluminum, and other metals. The reporting period reflects the impact of a severe global economic recession, which significantly reduced demand and commodity prices. The company also integrated the PNA Group acquisition (closed August 2008), which added significant volume but lower-margin carbon steel products to its portfolio.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended June 30, 2009 |
Three Months Ended June 30, 2008 |
Six Months Ended June 30, 2009 |
Six Months Ended June 30, 2008 |
|---|---|---|---|---|
| Net Sales | $1,242,978 | $2,095,068 | $2,801,513 | $4,003,238 |
| Gross Profit | $282,885 | $586,934 | $637,327 | $1,079,213 |
| Gross Margin % | 22.8% | 28.0% | 22.7% | 27.0% |
| Operating Income | $5,430 | $267,916 | $53,391 | $457,201 |
| Operating Margin % | 0.4% | 12.8% | 1.9% | 11.4% |
| Net Income (Loss) Attributable to Reliance | $(5,787) | $156,596 | $14,331 | $263,991 |
| Diluted EPS | $(0.08) | $2.12 | $0.19 | $3.58 |
| Cash Flow from Operations (6mo) | $681,259 | $128,381 | ||
| Free Cash Flow (approx. 6mo) | ||||
| Total Debt (Outstanding) | $1.27 billion | $1.77 billion | ||
| Cash and Equivalents | ||||
| Working Capital | $1.19 billion | $1.65 billion | ||
| Inventory |
Note: Free Cash Flow is estimated as Operating Cash Flow less Capital Expenditures ($40.8 million for six months ended June 30, 2009).
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 40.7% in Q2 2009 and 30.0% in the first six months of 2009 compared to 2008. This was driven by a 7.4% decrease in tons sold (Q2) and a 34.8% decrease in average selling price per ton (Q2) due to collapsing steel prices.
- Profitability Compression: Operating income margins collapsed from 12.8% to 0.4% in Q2 2009. Gross margins declined due to selling prices falling faster than inventory costs (LIFO impact) and a shift in product mix toward lower-margin carbon steel products from the PNA acquisition.
- LIFO Benefit: The company recorded a significant LIFO credit (income) of $75.0 million in Q2 2009 and $150.0 million for the six-month period, offsetting some of the margin compression caused by falling commodity prices.
- Cost Reductions: SG&A expenses decreased 16.7% in Q2 2009. The company reduced its workforce by 2,340 employees (21%) since September 2008 and implemented reduced hours for remaining staff.
- Balance Sheet Strengthening: Despite lower sales, the company generated strong operating cash flow ($681.3 million for six months), allowing it to reduce total debt by approximately $500 million and increase cash reserves from $52.0 million to $179.4 million.
Guidance, Outlook, and Risks
- Outlook: Management expects inventory turns to improve as business conditions stabilize. They anticipate the PNA acquisition margins will improve to levels consistent with Reliance's historical averages once demand and pricing recover.
- Liquidity Strategy: The company is limiting capital expenditures to essential items and maintaining its quarterly dividend ($0.10 per share declared for Q3 2009). It plans to use free cash flow to further reduce debt or increase cash.
- Debt Covenants: The company is currently in compliance with all debt covenants. However, management noted that the weak economic environment could affect the ability to satisfy the minimum interest coverage ratio in future periods. Discussions with the lead lender regarding a potential amendment to the credit facility are underway to avoid any potential event of default.
- Risks:
- Economic Recession: Continued weak demand and falling prices pose a significant risk to revenue and margins.
- Credit Exposure: The company wrote off $10.8 million in receivables in the first six months of 2009. Days Sales Outstanding (DSO) increased to 43.5 days, indicating slower customer payments.
- Impairment: While no impairment was noted as of June 30, 2009, continuous declines in market conditions or stock price could trigger future impairment charges on goodwill ($1.08 billion) and intangible assets ($730.3 million).
Key Facts for Investor Verification
- Debt Covenant Compliance: Verify the status of discussions with lenders regarding the interest coverage ratio covenant and whether an amendment has been finalized.
- Inventory Valuation: Monitor the LIFO reserve ($237.8 million at June 30, 2009) and the impact of potential price stabilization on future cost of sales.
- Receivables Quality: Track the allowance for doubtful accounts ($22.7 million) and future write-offs given the rising DSO and economic downturn.
- Dividend Sustainability: Confirm the company's ability to maintain the quarterly dividend given the shift from net income to net loss in Q2 2009, though cash flow remains strong.
- Goodwill Impairment: Watch for the results of the annual goodwill impairment test scheduled for November 1, 2009, given the significant decline in operating income.