Reliance - 10-Q quarterly report FY

 

                            For the transition period from                                         to                                         

(Exact name of registrant as specified in its charter)

350 South Grand Avenue, Suite 5100
Los Angeles, California 90071
(213) 687-7700
(Address of principal executive offices and telephone number)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No ¨

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ     No ¨

     As of July 31, 2005, 32,964,049 shares of the registrant’s common stock, no par value, were outstanding.

  i

CONSOLIDATED BALANCE SHEETS
(In thousands except share amounts)

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
(In thousands except share and per share amounts)

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
(In thousands except share and per share amounts)

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation with respect to the interim financial statements have been included. The results of operations for the three- and six-month periods ended June 30, 2005 are not necessarily indicative of the results for the full year ending December 31, 2005. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2004, included in the Reliance Steel & Aluminum Co. Form 10-K.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in the Company’s consolidated financial statements and the accompanying notes. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform to the current year presentation.

The Company’s consolidated financial statements include the assets, liabilities and operating results of majority-owned subsidiaries. The ownership of the other interest holders of consolidated subsidiaries is reflected as minority interest. All significant intercompany accounts and transactions have been eliminated.

In April 2005, the United States Securities and Exchange Commission (“SEC”) approved a new rule that delays the effective date of Statement of Financial Accounting Standards (“SFAS”) No. 123R,Share-Based Payment. Except for this deferral of the effective date, the guidance in SFAS No. 123R is unchanged. Under the SEC’s rule, SFAS No. 123R is now effective for the Company for annual, rather than interim, periods that begin after June 15, 2005. The Company will apply this Statement to all awards granted on or after January 1, 2006 and to awards modified, repurchased, or cancelled after that date. We expect that the implementation of the provisions of SFAS No. 123R will have an impact consistent with our disclosures included under SFAS No. 148 in our December 31, 2004 Form 10-K.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections—A Replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 requires retrospective application to prior periods’ financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

In June 2005, the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force reached a consensus on Issue No. 05-6, “Determining the Amortization Period for Leasehold Improvements” (“EITF 05-6”). The guidance requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. The guidance is effective for periods beginning after June 29, 2005. The adoption of EITF 05-6 will not have an impact on our consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Long-term debt consists of the following:

The Company had a five-year syndicated credit agreement, as amended, with ten banks for an unsecured revolving line of credit with a borrowing limit of $335,000,000. On June 13, 2005, the Company entered into a new syndicated Credit Agreement with 15 banks as lenders. The Credit Agreement provides for an unsecured, $600,000,000 revolving credit facility with a term of five years and replaces the Company’s previous $335,000,000 credit facility. The Company intends to use the new credit facility for working capital and general corporate purposes, internal growth initiatives and funding acquisitions. The syndicated credit facility includes a commitment fee on the unused portion, currently at an annual rate of 0.125%.

At June 30, 2005 the Company also had $15,605,000 of letters of credit outstanding under the syndicated credit facility with availability to issue an additional $34,395,000 of letters of credit.

The Company has $370,000,000 of outstanding senior unsecured notes issued in private placements of debt. The outstanding senior notes bear interest at an average fixed rate of 6.17% and have an average remaining life of 4.5 years, maturing from 2005 to 2013.

Both the $335,000,000 syndicated credit agreement and the senior notes became secured on July 1, 2003 concurrent with the Company’s acquisition of Precision Strip, Inc. The personal property pledged as collateral included, but was not limited to, the outstanding securities of each of the Company’s material corporate subsidiaries. The security interest was to terminate when the Company met certain conditions, including a required leverage ratio. In the first quarter of 2005 the security interest granted under our $335,000,000 syndicated credit facility and our senior note

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

agreements was automatically released as the Company met the required conditions of the release. The senior note agreements and the $600,000,000 credit facility are unsecured.

The $600,000,000 syndicated credit agreement also requires the Company to maintain a minimum net worth and interest coverage ratio, a maximum leverage ratio, and includes certain restrictions on the amount of cash dividends the Company may pay, among other things.

In the six months ended June 30, 2005, the Company issued 250,375 shares of common stock in connection with the exercise of employee stock options for total proceeds of approximately $6,203,000. The tax benefit to the Company associated with these exercises amounted to approximately $1,509,000. In addition, 5,582 shares of common stock were issued to division managers of the Company in February 2005 under the Key Man Incentive Plan for 2004. In May 2005, the Company amended and restated its stock repurchase program, authorizing up to an additional 6,000,000 shares of its common stock to be repurchased. The Company did not repurchase any shares of its common stock during the six-month period ended June 30, 2005.

Statement of Financial Accounting Standards (“SFAS”) No. 130, Reporting Comprehensive Income, defines comprehensive income (loss) as non-stockholder changes in equity. Comprehensive income (loss) for each of the three- and six-month periods ended June 30, 2005 and 2004, respectively, included the following:

Accumulated other comprehensive income included the following:

Foreign currency translation adjustments are not generally adjusted for income taxes as they relate to indefinite investments in foreign subsidiaries. Unrealized gain on investments and minimum pension liability are net of taxes of $(49,000) and $694,000, respectively, as of June 30, 2005 and $(54,000) and $692,000 respectively, as of December 31, 2004.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

In accordance with SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, the Company continues to account for stock-based compensation plans using the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees and related interpretations. Under APB No. 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock at the date of grant, no compensation expense is recognized.

If the Company had elected to recognize compensation cost based on the estimated fair value of the options granted at the grant date as prescribed by SFAS No. 148, net income and earnings per share would have been reduced to the pro forma amounts shown below:

The Company maintains a Supplemental Executive Retirement Plan (“SERP”), which is a nonqualified pension plan that provides post-retirement pension benefits to key officers of the Company. Separate SERP plans exist for one of the companies acquired during 1998 and for the Company’s 50.5%-owned company, each of which provides post-retirement benefits to its respective key employees.

The Company maintains, through various subsidiaries, defined benefit pension plans for certain of its employees. These plans generally provide benefits of stated amounts for each year of service or provide benefits based on the participant’s hourly wage rate and years of service.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The net periodic pension costs for the SERP and defined benefit plans were as follows (in thousands):

The Company previously disclosed in its financial statements for the year ended December 31, 2004, included in its Form 10-K, that it expected to contribute $1,697,000 to its defined benefit plans in 2005. As of June 30, 2005, contributions of $376,000 had been made. The Company also disclosed in its Form 10-K for the year ended December 31, 2004 that it terminated one of the defined benefit plans as of that date and expects to distribute the assets in 2005.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The Company calculates basic and diluted earnings per share as required by SFAS No. 128, Earnings Per Share. Basic earnings per share exclude any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is calculated including the dilutive effects of warrants, options, and convertible securities, if any.

The following table sets forth the computation of basic and diluted earnings per share:

There were no anti-dilutive shares reserved for issuance upon exercise of stock options for the three and six months ended June 30, 2005 and 2004.

On July 1, 2005, the Company acquired 100% of the outstanding capital stock of Chapel Steel Corp. (“Chapel”), headquartered in Spring House (Philadelphia), Pennsylvania. The Company paid $94,200,000 in cash plus the assumption of approximately $16,800,000 of debt for all of the outstanding capital stock of Chapel.

Chapel is a privately held metals service center company founded in 1972 that processes and distributes carbon and alloy steel plate products from five facilities in Pottstown (Philadelphia), PA; Bourbonnais (Chicago), IL; Houston, TX; Birmingham, AL; and Portland, OR. Chapel also warehouses and distributes its products in Cincinnati, OH and Hamilton, Ontario, Canada. Chapel’s net sales for the fiscal year ended December 31, 2004 were approximately $273,000,000. Chapel will operate as a wholly-owned subsidiary of Reliance. The acquisition was funded on July 1, 2005 with borrowings on the Company’s existing $600,000,000 syndicated credit facility.

The following table sets forth certain income statement data for the three- and six-month periods ended June 30, 2005 and 2004 (dollars are shown in thousands and certain amounts may not calculate due to rounding):

Our 2005 second quarter consolidated sales were our highest ever at $816.3 million, up 7.3% from our 2004 second quarter sales. This includes a 6.7% decrease in our tons sold and a 14.8% increase in our average selling price per ton sold (the tons sold and average selling price per ton sold exclude the amounts related to Precision Strip).

We believe that our volume declined in the 2005 second quarter because there was an unusually high volume of purchases in the 2004 second quarter in advance of announced price increases for carbon steel products. Our average selling price per ton sold increased by 14.8% because of increased costs for most products that we sell and a shift in product mix. Carbon steel costs rose significantly beginning in the second quarter of 2004, and, although these costs have declined somewhat in 2005, the 2005 second quarter average cost is above the 2004 second quarter average cost. Aluminum and stainless steel costs for aerospace products increased steadily throughout 2004 and have continued to increase through the first half of 2005. The improved demand for aerospace products has also resulted in a slight shift in product mix with aluminum, stainless steel and titanium products increasing as a percent of our sales. Carbon steel sales as a percent of our total sales decreased 6.4% in the 2005 second quarter compared to the 2004 second quarter. The shift to higher priced products also contributed to our increased average selling prices in the second quarter of 2005.

Our 2005 second quarter gross profit was $222.2 million, down 2.7% from the 2004 second quarter. Gross profit as a percentage of sales in the 2005 second quarter was 27.2%, down from 30.0% in the 2004 second quarter, but up from 26.6% in the 2005 first quarter. During the second quarter of 2004, we were able to expand our gross profit margin due to our ability to pass the significant carbon steel cost increases on to our customers before we received the higher cost material in our inventory. In the 2005 second quarter the higher carbon steel costs are fully reflected and selling prices for most of these products declined during the quarter which reduced our gross profit margin. Our second quarter 2005 results had no incremental LIFO expense compared to $32.5 million in the second quarter of 2004. The difference was mainly because of the decline in costs for carbon steel products.

Warehouse, delivery, selling, general and administrative (“S,G&A”) expenses increased $2.8 million, or 2.4%, compared to the 2004 second quarter due mainly to general increases for labor, insurance and other costs. S,G&A expenses as a percentage of sales for the 2005 second quarter were 15.1%, down from 15.9% for the 2004 second

quarter, due mainly to our increased selling prices.

Depreciation expense in the 2005 second quarter was $10.4 million compared to $10.3 million in the 2004 second quarter. Amortization expense was $2.5 million in the 2005 second quarter compared to $0.8 million in the 2004 second quarter. The increase was mainly due to the write-off of the deferred financing costs related to our $335 million syndicated credit facility that we replaced in June of 2005.

Operating profit in the 2005 second quarter was $88.2 million, or 10.8% of sales, compared to $97.5 million, or 12.8% of sales, in the 2004 second quarter. The decrease is mainly due to lower gross profit margins in 2005, as discussed above.

Interest expense decreased to $6.2 million in the 2005 second quarter from $7.3 million in the 2004 second quarter, due to lower borrowing levels because of the strong cash flow that we generated in late 2004 and the first half of 2005. Also, the pricing on our credit facility decreased due to our improved profitability levels.

Minority interest expense in the 2005 second quarter decreased by $1.9 million from the 2004 second quarter mainly because we purchased the remaining 30.5% interest from the other shareholder in Valex Korea in July of 2004. The 2005 minority interest represents the net income attributed to the 49.5% of American Steel, L.L.C. that we do not own.

Our effective income tax rate for the 2005 second quarter was 38.0%, down from 39.3% in the 2004 second quarter. Our 2004 full-year tax rate was 37.1%. The changes in our tax rate are mainly due to changes in the geographic composition of our income, lower tax rates from our foreign operations and benefits from state and city income tax credits.

Our 2005 six-month consolidated sales of $1.63 billion were up 14.9% from the 2004 six-month period. This includes an 11.2% decrease in tons sold and a 29.6% increase in our average selling price per ton.

Our volume was down from the prior year period mainly because of the unusually high volume of purchases that occurred in the first half of 2004 when our customers were trying to build inventory ahead of the significant carbon steel price increases that occurred in the first half of 2004. Because carbon steel prices have been declining in 2005, our customers are not building inventory. However, demand for aerospace products has increased in 2005 over the 2004 periods. Our average selling price per ton sold increased because of increased costs for most products that we sell and a shift in product mix compared to the prior year period. The shift to higher priced aluminum, stainless steel and titanium products contributed to our increased average selling prices in the 2005 six-month period.

Our gross profit for the 2005 six-month period was $438.2 million compared to $415.9 million in 2004 because of our higher sales levels in 2005. However, our gross profit margin in the 2005 six-month period was 26.9%, down from 29.4% in the 2004 six-month period. Our 2004 gross profit margin reflected our ability to pass the significant carbon steel cost increases on to our customers before we received the higher cost material in our inventory, especially in the second quarter of 2004.

Our LIFO expense for the 2005 six-month period is significantly lower than in the same period of 2004 mainly because of changes in our costs for carbon steel products. Costs for carbon steel products have declined in 2005 from the beginning of the year. However, the increased costs of aluminum and stainless steel products have more than offset the LIFO impact of the decline. For the 2005 six-month period, we recorded LIFO expense, which is included in our cost of sales, of $12.5 million compared to LIFO expense of $60 million in the 2004 six-month period.

In the 2005 six-month period our warehouse, delivery, selling, general and administrative (S,G&A) expenses increased $6.1 million, or 2.6% compared to 2004. The expenses as a percent of sales in the 2005 six-month period were 15.1% compared to 16.9% in the 2004 period. The declines as a percent of sales are mainly due to our increased selling prices in 2005.

Depreciation expense for the 2005 six-month period was $20.8 million compared to $20.5 million in 2004. Amortization expense increased $0.9 million in the 2005 six-month period due to the write-off of deferred financing costs related to our $335 million syndicated credit facility that we replaced in June of 2005.

Our 2005 six-month operating profit was $172.0 million, resulting in an operating profit margin of 10.6%, compared to $156.2 million, or an 11.0% operating profit margin in the 2004 period. Our higher sales levels provided increased operating profit dollars in 2005, although our increased metal costs resulted in a slightly lower operating profit margin.

Interest expense for the 2005 six-month period decreased $2.2 million, or 15.1%, due to lower borrowing levels because of the strong cash flow that we generated over the last year. Also, the pricing on our credit facility decreased due to our improved profitability levels.

In the 2005 six-month period minority interest expense decreased from the 2004 six-month period mainly because we purchased the remaining 30.5% interest from the other shareholder in Valex Korea in July of 2004.

Our 2005 six-month period effective income tax rate was 38.0%, down from 39.3% in the 2004 six-month period. The full-year 2004 rate was 37.1%. The changes in our tax rate are mainly due to changes in the geographic composition of our income, lower tax rates from our foreign operations and benefits from state and city income tax credits.

At June 30, 2005, our working capital was $501.1 million compared to $458.6 million at December 31, 2004. The increase was mainly due to an increase in our accounts receivable of $32.0 million and an increase in our inventory of $19.9 million resulting from improved sales levels, offset by higher accounts payable and accrued expense balances of $11.1 million mainly due to our increased inventory purchases in 2005 to support our increased sales levels.

To manage our working capital, we focus on our number of days sales outstanding to monitor accounts receivable and on our inventory turnover rate to monitor our inventory levels, as receivables and inventory are our two most significant elements of working capital. As of June 30, 2005, our days sales outstanding were approximately 41 days, consistent with our rate at December 31, 2004. (We calculate our days sales outstanding as an average of the most recent two-month period.) Our inventory turn rate at June 30, 2005 was about 4.9 times, down slightly from 5.1 times in 2004.

Our primary sources of liquidity are generally from internally generated funds from operations and our revolving line of credit. Cash flow provided by operations was $83.3 million in the six-month period ended June 30, 2005 compared to $3.7 million in the same period in 2004. We used this cash flow to pay down debt of $53.3 million and to fund our capital expenditures of $21.1 million in the six months ended June 30, 2005. Our outstanding debt at June 30, 2005 was $374.0 million, compared to $427.3 million at December 31, 2004. At June 30, 2005, we had no outstanding borrowings on our $600 million revolving line of credit. We paid down a $23 million private placement note when it matured on January 2, 2005. Our net debt-to-total capital ratio was 28.0% at June 30, 2005, down from 33.6% at December 31, 2004.

In June 2005, we replaced our $335 million credit facility with a $600 million, five-year, unsecured revolving credit facility with fifteen banks. The $335 million facility was scheduled to mature in October 2006. At June 30, 2005, we had $15.6 million of letters of credit outstanding under our $600 million credit facility with availability to issue an additional $34.4 million of letters of credit. The new $600 million syndicated credit facility requires that we maintain a minimum net worth and interest coverage ratio, and a maximum leverage ratio and includes restrictions on the amount of cash dividends we may pay. The Company intends to use the new credit facility for working capital and general corporate purposes, internal growth initiatives and funding acquisitions.

On July 1, 2005, we completed the acquisition of Chapel Steel Corp. and funded the $94.2 million purchase price and the pay down of approximately $16.8 million of Chapel’s debt with borrowings on our new revolving line of credit.

The Company also has $370 million of outstanding senior unsecured notes issued in private placements of debt. The outstanding senior notes bear interest at an average fixed rate of 6.17% and have an average remaining life of 4.5 years, maturing from 2005 to 2013.

Both the $335 million syndicated credit agreement and the senior notes became secured on July 1, 2003 concurrent with our acquisition of Precision Strip, Inc. The personal property pledged as collateral included, but was not limited to, the outstanding securities of each of our material corporate subsidiaries. The security interest was to terminate when we met certain conditions, including a required leverage ratio. In the first quarter of 2005 the security interest granted under our syndicated credit facility and our senior note agreements was automatically released as we met the required conditions of the release. The senior note agreements and our new $600 million credit facility are unsecured.

In May 2005, we amended and restated our stock repurchase program authorizing up to an additional six million shares of our common stock to be repurchased. We did not repurchase any shares of our common stock during the six-month period ended June 30, 2005. Proceeds from the issuance of common stock upon exercise of stock options during the first half of 2005 were $6.2 million.

Capital expenditures were $21.1 million for the six months ended June 30, 2005. We had no material changes in commitments for capital expenditures, operating lease obligations or purchase obligations as of June 30, 2005, as compared to those disclosed in our table of contractual obligations included in our Form 10-K for the year ended December 31, 2004, other than the acquisition of Chapel Steel Corp. noted above. We anticipate that funds generated from operations and funds available under our line of credit will be sufficient to meet our working capital and capital expenditure needs and to fund acquisitions in the foreseeable future.

Some of our customers may be in seasonal businesses, especially customers in the construction industry. As a result of our geographic, product and customer diversity, however, our operations have not shown any material seasonal trends. Revenues in the months of November and December traditionally have been lower than in other months because of a reduced number of working days for shipments of our products and holiday closures for some of our customers. We cannot assure you that period-to-period fluctuations will not occur in the future. Results of any one or more quarters are, therefore, not necessarily indicative of annual results.

Goodwill, which represents the excess of cost over the fair value of net assets acquired, amounted to $341.8 million at June 30, 2005, or approximately 21.1% of total assets or 37.1% of consolidated shareholders’ equity.

Pursuant to SFAS No. 142, we review the recoverability of goodwill annually or whenever significant events or changes occur which might impair the recovery of recorded costs. Our annual impairment tests of goodwill were performed as of November 1, 2004 and it was determined that the recorded amounts for goodwill are recoverable and that no impairment existed. We are not aware of any significant events or changes that would affect the recoverability of those amounts as of June 30, 2005.

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our unaudited Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. When we prepare these financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during

the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to accounts receivable, inventories, deferred tax assets, goodwill and intangible assets and long-lived assets. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

For further information regarding the accounting policies that we believe to be critical accounting policies and that affect our more significant judgments and estimates used in preparing our consolidated financial statements see our December 31, 2004 Form 10-K.

In the ordinary course of business, we are exposed to various market risk factors, including changes in general economic conditions, domestic and foreign competition, foreign currency exchange rates, and metals pricing and availability. Additionally, we are exposed to market risk primarily related to our fixed rate long-term debt. Market risk is the potential loss arising from adverse changes in market rates and prices, such as interest rates. Decreases in interest rates may affect the market value of our fixed rate debt. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. Based on our debt, we do not consider the exposure to interest rate risk to be material. Our fixed rate debt obligations are not callable until maturity.

Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 or 15d-15(e) under the Securities Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of the end of the period covered in this report, the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company required to be included in the Company’s periodic filings with the SEC. There have been no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.