Business Context and Reporting Period
Company: Reliance Steel & Aluminum Co.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2007
Business Overview: Reliance is a leading distributor of metal products, operating through a network of service centers. The reporting period reflects significant growth driven by strategic acquisitions, including Crest Steel Corporation, Industrial Metals and Surplus, Inc., and the Encore Group in early 2007, following the major acquisition of Earle M. Jorgensen Company (EMJ) in 2006.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2007 |
Six Months Ended June 30, 2006 |
Three Months Ended June 30, 2007 |
Three Months Ended June 30, 2006 |
|---|---|---|---|---|
| Net Sales | $3,737,926 | $2,547,208 | $1,896,036 | $1,559,222 |
| Gross Profit | $969,949 | $690,058 | $497,497 | $419,873 |
| Gross Margin % | 25.9% | 27.1% | 26.2% | 26.9% |
| Operating Profit | $417,250 | $301,975 | $216,497 | $179,908 |
| Operating Margin % | 11.2% | 11.9% | 11.4% | 11.5% |
| Net Income | $234,480 | $172,360 | $122,784 | $100,505 |
| Diluted EPS | $3.06 | $2.41 | $1.59 | $1.32 |
| Cash Flow from Operations | $170,239 | ($77,167) | N/A | N/A |
| Total Debt (Long-term + Current) | $1,275,556 | $1,105,352 | $1,275,556 | $1,105,352 |
| Cash and Equivalents | $74,950 | $35,022 | $74,950 | $35,022 |
| Working Capital | $1,354,852 | $1,124,650 | $1,354,852 | $1,124,650 |
Note: All figures in thousands except per share data and percentages.
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 46.7% for the six months ended June 30, 2007, compared to the prior year. This was driven by a 25.8% increase in tons sold and a 17.7% increase in average selling price per ton. Acquisitions accounted for the majority of the volume increase.
- Margin Compression: Gross profit margins declined slightly (27.1% to 25.9% for the six-month period) due to competitive pressures from high industry inventory levels and lower margins on aerospace products compared to the tight supply conditions of 2006.
- Acquisition Impact: The company completed three major acquisitions in early 2007 (Crest, Industrial Metals, Encore Group) totaling approximately $217.7 million. These acquisitions significantly increased goodwill (up to $918.1 million) and intangible assets.
- Cost of Sales: LIFO expense increased to $32.5 million for the six months ended June 30, 2007, from $23.0 million in the prior year, primarily due to rising stainless steel costs.
- Interest Expense: Interest expense rose 75.4% year-over-year for the six-month period due to additional borrowings used to fund acquisitions.
Guidance, Outlook, and Risks
- Outlook: Management expects to finance working capital needs through operating cash flow and the $1.1 billion syndicated credit facility. The 2007 capital expenditure budget is approximately $145 million, focused on facility expansion and equipment upgrades.
- Dividends: The Board declared a 33% increase in the quarterly cash dividend to $0.08 per share in February 2007.
- Subsequent Event: On July 1, 2007, the company acquired Clayton Metals, Inc. for an undisclosed cash price funded by the credit facility.
- Risks and Contingencies:
- Tax Audits: The IRS is examining 2002-2004 federal returns regarding inventory costing and LIFO methods. The company contests proposed adjustments but does not anticipate a material charge.
- Market Risk: Exposure to fluctuations in metal prices, interest rates, and foreign currency exchange rates. The company generally passes metal price increases to customers.
- Goodwill: Goodwill represents 22.0% of total assets. No impairment was identified in the annual test performed in November 2006.
Investor Verification Checklist
- Acquisition Integration: Verify the realization of synergies and revenue contributions from the 2007 acquisitions (Crest, Industrial Metals, Encore) and the 2006 EMJ acquisition.
- Inventory Levels: Monitor inventory turnover rates, which were impacted by acquisitions carrying slower-turning products (currently ~4.4 times for the six-month period).
- Debt Servicing: Review the impact of increased interest expense on future earnings, given the 75% increase in interest costs and the $1.27 billion total debt load.
- LIFO Reserve: Track the LIFO expense estimate, which management reduced to $65 million for the full year 2007 due to recent stainless steel price declines.
- IRS Audit Resolution: Monitor the status of the IRS examination regarding inventory costing and LIFO methods for potential future tax liabilities.