Reliance Steel & Aluminum Co. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010; filed November 5, 2010. The filing is for Reliance Steel & Aluminum Co.
Business context and results
Reliance distributes and processes metals. Management described demand as gradually recovering from its June 2009 low; most markets improved year over year, while non-residential construction remained weak and represented about one-third of revenue. Sales growth reflected higher shipment volumes and average selling prices.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $1.654 billion | $1.243 billion | $4.728 billion | $4.045 billion |
| Operating income | $88.2 million | $74.3 million | $282.6 million | $127.7 million |
| Operating margin | 5.3% | 6.0% | 6.0% | 3.2% |
| Gross profit / margin | $396.2 million / 24.0% | $356.5 million / 28.7% | $1.191 billion / 25.2% | $993.8 million / 24.6% |
| Net income attributable to Reliance | $48.7 million | $41.8 million | $154.9 million | $56.1 million |
| Diluted EPS | $0.65 | $0.57 | $2.08 | $0.76 |
| Cash dividends per share | $0.10 | $0.10 | $0.30 | $0.30 |
Cash flow, liquidity and debt
- Operating cash flow for the first nine months was $47.7 million, versus $807.2 million a year earlier. Higher receivables and inventory absorbed cash as sales, demand and metal prices recovered; increased payables partly offset the working-capital investment.
- Capital expenditures were $65.8 million versus $55.0 million. The company had budgeted about $140 million for 2010 but expected full-year spending below budget, with some projects continuing into 2011.
- Cash was $186.5 million at September 30, 2010, compared with $43.0 million at year-end 2009. Total debt was $1.097 billion, versus $937.7 million at year-end. The company said its September debt included $270 million drawn on its $1.1 billion revolving facility and borrowings for an acquisition that closed October 1.
- Net debt-to-total capital was 24.7%, compared with 25.6% at 2009 year-end. The company reported covenant compliance: interest coverage of approximately 6.6x against a 3.0x minimum and leverage of 29.2% against a 60% maximum. It had $151.3 million of debt obligations due before the revolving facility expires in November 2012.
- The company repaid $78 million of private-placement notes that matured October 15, 2010. On October 20, the board declared a fourth-quarter dividend of $0.10 per share.
Changes and management commentary
- Year-over-year Q3 sales rose 33.0%, including a 10.8% increase in tons sold and a 19.8% rise in average selling price per ton. Nine-month sales increased 16.9%, with tons up 5.5% and average selling price up 10.1%.
- Q3 gross margin declined to 24.0% from 28.7%, and operating margin fell to 5.3% from 6.0%, despite higher sales and operating income. Management attributed margin pressure to price reductions announced by mills during Q3 and sales of higher-cost inventory ordered earlier. The prior-year quarter also benefited from unusually favorable LIFO effects.
- Nine-month profitability improved substantially: operating income rose to $282.6 million from $127.7 million, and net income attributable to Reliance rose to $154.9 million from $56.1 million. Management cited better demand and pricing conditions and only moderate operating-expense growth.
- Effective June 30, 2010, revolving-credit covenants returned to pre-amendment levels and restrictions on certain uses of cash were removed. The company stated it expected adequate cash flow and revolver capacity for debt, working capital, capital expenditures and growth, and anticipated continued acquisition activity.
- On October 1, 2010, Reliance acquired Diamond Consolidated Industries and affiliated businesses, which manufacture and distribute specialty perforated materials and custom punches. Their combined unaudited sales for the nine months through September 30 were approximately $75 million.
Guidance, risks and unusual items
- Management estimated a 2010 full-year LIFO adjustment expense of approximately $33 million, citing expected higher year-end inventory quantities and costs than at the start of the year. The filing separately reports a $24.8 million nine-month LIFO reserve charge and says the actual nine-month LIFO calculation produced $36.8 million of expense.
- Metal prices and demand remain important sensitivities. Management reported weak carbon-steel prices in Q3, while stainless and aluminum price increases had been announced for Q4. The company also identified interest rates, competition, foreign exchange, metal pricing, and product demand and availability as market risks.
- Environmental remediation obligations relate to former EMJ manufacturing operations. Insurance was expected to cover most costs, and Reliance did not expect a material adverse effect on its financial position, results or cash flows.
- Goodwill was $1.082 billion and net intangible assets were $707.7 million at quarter-end. Management reported no impairment indicators as of September 30, but noted impairment estimates depend on assumptions about future cash flows and market conditions; its 2010 annual goodwill test was planned for November 1.
- The filing reported no material changes to previously disclosed risk factors or off-balance-sheet commitments. Management said disclosure controls were effective and there were no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether sales and volume growth persist, particularly given weakness in non-residential construction and the Q3 reduction in gross margin.
- Actual year-end LIFO expense and inventory levels, including the difference between the reported reserve adjustment and the stated actual LIFO calculation.
- Cash conversion and working-capital requirements as receivables and inventories expand; operating cash flow fell sharply year over year.
- Debt repayment, revolver availability, covenant headroom and the funding and performance of the October 1 Diamond acquisition.
- Results of the planned goodwill impairment review and the eventual costs and insurance recoveries for environmental remediation.