RS

Business Context and Reporting Period

Company: Reliance Steel & Aluminum Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2005
Business Overview: The Company is a metals service center that processes and distributes carbon and alloy steel, stainless steel, and aluminum products. A significant event during the period was the acquisition of Chapel Steel Corp. on July 1, 2005, for approximately $94.2 million in cash plus assumed debt.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 11.0% in the third quarter and 13.6% for the nine-month period compared to 2004. The third-quarter increase was driven by a 12.6% rise in tons sold, partially offset by a 1.5% decrease in average selling price per ton. The nine-month increase was driven by an 18.0% increase in average selling price, despite a 3.7% decrease in tons sold.
• Margin Compression: Gross profit margins declined to 26.3% in Q3 (from 27.4% in 2004) and 26.7% for the nine months (from 28.7% in 2004). This was primarily due to selling prices for carbon steel falling faster than costs and the inclusion of Chapel Steel, which operates at lower margins.
• LIFO Impact: LIFO expense decreased significantly to $4.0 million in Q3 (from $32.5 million in 2004) and $16.5 million for the nine months (from $92.5 million in 2004), reflecting declining carbon steel costs in 2005 compared to the sharp increases in 2004.
• Acquisition Impact: The acquisition of Chapel Steel contributed to sales volume and increased SG&A expenses but lowered overall consolidated gross margins. Goodwill increased to $404.5 million, including a preliminary $62.7 million allocation for Chapel Steel.

Guidance, Outlook, and Risks

• Liquidity and Capital: The Company replaced its $335 million credit facility with a new $600 million unsecured revolving credit facility in June 2005. As of September 30, 2005, $40 million was drawn on this facility. The net debt-to-total capital ratio improved to 29.7% from 33.6% at year-end 2004.
• Market Risks: The Company is exposed to fluctuations in metals pricing, availability, and foreign currency exchange rates. Management does not consider interest rate risk material as they do not use derivative instruments to manage exposure.
• Seasonality: Operations generally do not show material seasonal trends, though revenues in November and December are traditionally lower due to holidays and reduced working days.
• Internal Controls: The acquisition of Chapel Steel constitutes a change in internal control over financial reporting that materially affected the Company's controls during the quarter. Chapel Steel was not included in the 2005 assessment of internal controls.

Investor Verification Checklist

• Acquisition Integration: Verify the final purchase price allocation for Chapel Steel, specifically the valuation of intangible assets and goodwill, which was preliminary as of the filing date.
• Margin Sustainability: Monitor the trend of carbon steel selling prices versus costs to assess if the margin compression observed in 2005 stabilizes or worsens in the fourth quarter.
• Debt Covenants: Confirm continued compliance with the new $600 million credit facility covenants, including minimum net worth, interest coverage, and maximum leverage ratios.
• Inventory Management: Review inventory turnover rates and days sales outstanding to ensure working capital efficiency remains strong despite the acquisition.
• Goodwill Impairment: Watch for any future indicators of goodwill impairment, particularly related to the new Chapel Steel assets, as the annual impairment test was last performed in November 2004.