RELIANCE, INC. annual report, FY2013

Business context and reporting period

Reliance Steel & Aluminum Co. (NYSE: RS) filed this Form 10-K for the fiscal year ended December 31, 2013, including unaudited fourth-quarter results. The company distributes and processes metals through more than 290 service centers in the U.S. and 10 other countries, serving over 125,000 customers. It reported one operating and reportable segment: metals service centers.

Financial performance and position

Metric	FY 2013	FY 2012
Net sales	$9,223.8 million	$8,442.3 million
Gross profit / margin	$2,397.6 million / 26.0%	$2,206.9 million / 26.1%
Operating income / margin	$551.9 million / 6.0%	$659.2 million / 7.8%
Net income attributable to Reliance	$321.6 million	$403.5 million
Diluted EPS	$4.14	$5.33
Cash provided by operations	$633.3 million	$601.9 million
Capital expenditures	$168.0 million	$214.0 million

Gross profit and gross margin are company-presented non-GAAP measures that exclude associated depreciation and amortization.

Fourth quarter: Sales were $2,306.7 million versus $1,889.0 million in Q4 2012; net income attributable to Reliance was $61.8 million versus $80.4 million; diluted EPS was $0.79 versus $1.06.
Balance sheet at year-end: Cash was $83.6 million; working capital was $2,165.5 million; total assets were $7,341.0 million; and Reliance shareholders’ equity was $3,874.6 million.
Debt and liquidity: Total debt was $2,112.3 million, up from $1,208.9 million; net debt-to-capital was 34.3% versus 23.8% at year-end 2012. The company had $480 million drawn on its $1.5 billion revolving facility. It reported covenant compliance; interest coverage was 7.3x against a 3.0x minimum, and covenant leverage was 35.8% against a 60% maximum.
Shareholder returns: Dividends paid were $1.26 per share in 2013 versus $0.80 in 2012. In February 2014, the quarterly dividend was raised 6% to $0.35 per share.

Material changes versus the prior comparable period

Sales rose 9.3%, primarily due to the April 2013 acquisition of Metals USA, which contributed $1.24 billion of sales after acquisition. Tons sold increased 21.4% company-wide, while same-store tons increased only 0.9% and same-store sales fell 6.6%.
Average selling price per ton fell 10.0% overall (7.5% same-store), reflecting lower mill prices, raw-material costs, imports, and product mix. Management said pricing declines weighed more heavily on earnings than volume changes.
Despite higher sales and gross-profit dollars, operating income fell 16.3% and Reliance-attributable net income fell 20.3%. Lower selling prices, higher selling and administrative costs, acquisition expenses, restructuring, impairment, and increased interest expense contributed.
Metals USA was acquired for a stated transaction value of approximately $1.25 billion, including assumed debt. Reliance also acquired Haskins Steel and a real-estate holding company. Net cash used for acquisitions was $821.1 million.
Cash from operations increased by $31.4 million; management attributed support to $84 million of cash generated by Metals USA inventory-reduction initiatives, offsetting lower profitability. Inventory turnover improved to 4.2x from 4.0x.

Outlook, risks, contingencies and unusual items

Management was cautiously optimistic that U.S. recovery would continue in 2014, improving demand and pricing, and cited stronger same-store volume momentum in the second half of 2013 continuing into 2014. It provided no specific sales or earnings guidance.
The 2014 capital expenditure budget was approximately $220 million, including growth projects; estimated maintenance spending was $80–85 million. Management said spending could be reduced if necessary.
Key risks include cyclical end markets, volatility and availability of metals, inability to pass through price changes, competition, customer credit, supplier concentration, acquisition integration and execution, and substantial indebtedness. The company estimated that a 1 percentage-point rise in rates on $969.2 million of variable-rate debt would add about $9.7 million of annual interest expense.
Unusual items included a $14.9 million impairment of a trade name following an operational consolidation, $2.5 million of restructuring charges, and approximately $11.4 million of Metals USA transaction costs. Lower metal costs generated $50.2 million of LIFO income in 2013, compared with $64.1 million in 2012.
Contingencies include an antitrust lawsuit brought by former employees; Reliance said it considers the claims without merit but could not estimate the outcome or potential exposure. Environmental remediation involving former EMJ operations could involve significant cleanup costs, though insurance is expected to cover most costs; management did not expect a material financial effect. Tax audits may also result in additional assessments.
Contractual obligations totaled $3,268.6 million, including $2,112.3 million of debt obligations, estimated debt interest, operating leases and other purchase obligations. The company reported no off-balance-sheet arrangements. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.

Important facts for investors to verify

How much of 2013’s reported growth and future earnings depends on Metals USA, and whether its integration and expected synergies are being realized.
Whether same-store demand and selling prices improve, and how metals-price movements affect margins and inventory valuation.
Debt repayment and refinancing capacity, covenant headroom, variable-rate exposure, and the $39.2 million mortgage balloon payment due in October 2016.
Whether planned 2014 growth capital spending generates adequate returns while maintaining liquidity and supporting dividends.
Developments in the antitrust litigation, environmental remediation and tax matters, including any material change in estimated exposure or insurance recovery.
The carrying values of goodwill and intangible assets, which totaled approximately $2.91 billion at year-end and are sensitive to future operating and market assumptions.