Reliance Steel & Aluminum Co. - 10-Q Summary (Q3 2006)
Business Context and Reporting Period
This filing covers the quarterly period ended September 30, 2006. Reliance Steel & Aluminum Co. is a leading distributor of metal products. The reporting period was defined by aggressive expansion through acquisitions, most notably the purchase of Earle M. Jorgensen Company (EMJ) in April 2006 and Yarde Metals, Inc. in August 2006. The company also executed a two-for-one stock split in July 2006.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 |
|---|---|---|
| Net Sales | $1,626.2 million | $4,173.4 million |
| Gross Profit | $432.1 million (26.6% margin) | $1,122.1 million (26.9% margin) |
| Operating Profit | $192.6 million (11.8% margin) | $494.7 million (11.9% margin) |
| Net Income | $107.5 million | $279.9 million |
| Diluted EPS | $1.41 | $3.83 |
| Cash Flow from Operations | $88.7 million (Q3 only) | $11.5 million (YTD) |
| Total Debt | $1.26 billion (including current maturities) | |
| Working Capital | $1.15 billion |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 86.9% in Q3 and 67.0% YTD compared to 2005. This growth is primarily driven by the 2006 acquisitions (EMJ, Yarde Metals, Flat Rock, Everest Metals) and increased same-store sales volume (up 19.4% in Q3).
- Profitability: Net income more than doubled in Q3 (up 117%) and nearly doubled YTD (up 93%). Operating margins improved from 10.1% to 11.8% in Q3 due to higher selling prices and effective expense control.
- Balance Sheet Expansion: Total assets grew from $1.77 billion to $3.73 billion. Long-term debt increased significantly from $301 million to $1.15 billion to fund acquisitions. Goodwill nearly doubled to $759.7 million.
- Cash Flow Dynamics: While operating cash flow was strong in Q3 ($88.7 million), YTD operating cash flow was only $11.5 million due to significant increases in working capital (accounts receivable and inventory) required to support higher sales volumes.
Outlook, Risks, and Management Commentary
- Acquisition Strategy: Management continues to pursue growth through acquisitions. On November 2, 2006, the company announced an agreement to acquire Crest Steel Corporation, expected to close in early 2007.
- Debt Restructuring: The company launched a cash tender offer in October 2006 to repurchase approximately $250 million of EMJ's 9.75% senior secured notes. This is intended to eliminate restrictive covenants and is expected to be funded by a new $1 billion unsecured credit facility.
- Market Risks: The company faces exposure to variable interest rates on $650 million of credit facility borrowings. A 1% rate increase would reduce annual pre-tax income by $6.5 million. Additionally, the company is exposed to fluctuations in metal pricing and availability.
- Internal Controls: The acquisition of Yarde Metals was excluded from the assessment of internal controls over financial reporting for the quarter, constituting a material change in internal control.
Investor Verification Checklist
- Debt Covenants: Verify the terms of the new $1 billion credit facility and the success of the tender offer for EMJ notes to ensure compliance with leverage ratios.
- Working Capital Efficiency: Monitor inventory turnover (currently 4.6x) and days sales outstanding (40 days) to ensure they remain stable as sales volumes grow.
- Acquisition Integration: Assess the integration progress of EMJ and Yarde Metals, specifically regarding the realization of projected synergies and the finalization of purchase price allocations.
- Commodity Exposure: Review the impact of rising raw material costs (specifically stainless steel and aluminum) on future LIFO expenses and gross margins.