RS

Business Context and Reporting Period

Company: Reliance Steel & Aluminum Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2008
Business Overview: Reliance is a leading metals service center company processing and distributing carbon steel, stainless steel, aluminum, and other metals. The company operates through a network of service centers across the United States, Canada, and the United Kingdom.

Key Financial Metrics

All figures in thousands, except per share data.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 10.5% for the quarter and 7.1% for the six-month period compared to the same periods in 2007. This growth was driven primarily by a 13.2% increase in average selling price per ton, offsetting a 2.2% decrease in tons sold.
• Margin Expansion: Gross profit margins improved to 28.0% (Q2) and 27.0% (YTD) from 26.2% and 25.9% in the prior year, respectively. This was largely due to significant increases in carbon steel prices passed through to customers.
• LIFO Impact: The LIFO reserve adjustment resulted in a pre-tax expense of $40.0 million for the quarter and $57.5 million for the six-month period, compared to $13.75 million and $32.5 million in the prior year periods.
• Operating Expenses: Selling, general, and administrative (S,G&A) expenses increased 12.5% for the quarter, driven by higher energy/fuel costs and increased incentive pay.
• Acquisitions: The company acquired Dynamic Metals International LLC in April 2008. Several major acquisitions occurred in 2007 (Metalweb, Clayton Metals, Encore Group, Crest Steel, Industrial Metals) which contributed to the comparative base.

Guidance, Outlook, and Risks

• Pending Acquisition (PNA Group): On June 16, 2008, Reliance entered an agreement to acquire PNA Group Holding Corporation. The estimated total transaction value is approximately $1.125 billion, including the purchase price ($315 million) and the repayment/refinancing of PNA's debt (up to $750 million). Closing is expected in early August 2008, subject to regulatory approvals.
• Financing Strategy: The PNA acquisition is expected to be funded by a proposed equity offering (6.75 million shares), a new $250 million senior term loan facility, and borrowings from the existing revolving credit facility.
• Capital Allocation: The company repurchased 2.44 million shares of common stock for $114.8 million during the six-month period. Capital expenditures were $88.3 million for the period, with a 2008 budget of approximately $210 million.
• Market Risks: Management notes that while demand remains at reasonable levels, seasonal slowness is expected in the third quarter. There is a risk that if the PNA acquisition fails to close after the equity offering, earnings per share could decline due to the increased share count without the offsetting earnings from the acquisition.
• Liquidity: Working capital needs have increased due to higher inventory costs. The company maintains a $1.1 billion revolving credit facility (expandable to $1.6 billion) with $292 million outstanding as of June 30, 2008.

Investor Verification Checklist

• PNA Acquisition Status: Verify the closing of the PNA Group acquisition and the successful completion of the associated equity offering and term loan facility.
• Steel Price Volatility: Monitor future carbon steel mill price announcements and the company's ability to pass these costs to customers to maintain gross margins.
• LIFO Reserve Adjustments: Track the impact of LIFO reserve adjustments on future earnings, as management revised the 2008 year-end estimate upward to $115 million.
• Debt Covenants: Confirm continued compliance with debt covenants (minimum net worth, interest coverage, maximum leverage) given the increased debt load from the PNA transaction.
• Seasonal Demand: Assess third-quarter sales volumes to confirm management's expectation of seasonal softness versus actual market demand.