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RS > SEC Filings for RS > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for RELIANCE STEEL & ALUMINUM CO

Form 10-K for RELIANCE STEEL & ALUMINUM CO


27-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Although we faced challenging market conditions in 2013, our teams in the field did an excellent job servicing their customers, allowing us to maintain our gross profit margins at 26%. We also completed our largest acquisition to-date in April 2013, with a transaction value of $1.25 billion, and generated strong cash flow to end the year with a healthy balance sheet and ample liquidity to continue our growth.

Our sales increased 9.3% from 2012 mainly due to our acquisition of Metals USA, with our tons sold up 21.4%. Unfortunately, however, metals pricing was 10% lower in 2013 which had a significant impact on our profitability, resulting in lower net income in 2013 from 2012 despite the meaningful contributions from Metals USA.

We did see slight improvement in our same-store tons sold in 2013, with more positive momentum in the second half that has continued into 2014. In 2013, our sales to the auto industry, mainly through our toll processing operations, were up from 2012 levels. Our sales into the aerospace and energy (oil and gas) end markets were strong in 2013, though down from prior periods. Non-residential construction remains our largest end market, and although we saw some indications of improving demand from some of our customers during 2013, overall activity levels in the non-residential construction end market remain well below the peak levels in 2006.

As mentioned, we acquired Metals USA in April 2013 which contributed $1.24 billion to our 2013 sales. We also acquired Haskins Steel in November 2013 and, also in April, we acquired a real estate holding company that owns 18 real estate properties that we had been leasing. We invested $168 million in capital expenditures in 2013, with the majority related to growth activities, including the expansion and relocation of existing facilities, enhancing and adding processing capabilities, penetrating new geographic markets and expanding product offerings at existing locations. We materially increased our return of cash to shareholders, with a 57.5% increase in our dividend paid per share in 2013 compared to 2012.

To fund these activities, we amended and extended our $1.5 billion revolving credit facility and added a $500 million term loan, both with five year terms and favorable pricing. We also issued $500 million of 4.5% senior notes due in 2023. In 2013, we repaid $330 million of borrowings subsequent to the $1.25 billion used to fund the Metals USA transaction.

As of December 31, 2013, our net debt-to-capital ratio was 34.3%, down from 39.4% upon funding the Metals USA acquisition in April 2013.

We believe we have significantly higher earnings capacity due to our exposure to industries that are poised for growth in the years ahead, our broad and diverse product base, and our wide geographic footprint. We are cautiously optimistic that the U.S. economy will continue its recovery throughout 2014, resulting in better demand and pricing for our products.

We will continue to focus on working capital management, maximizing profitability of our existing businesses and achieving profitable growth through both acquisitions and internal investment. Our operating and growth strategies have helped us achieve industry-leading operating results on a consistent basis and we remain confident in our ability to continue our track record of success going forward.

Effect of Demand and Pricing Changes on our Operating Results

Customer demand can have a significant impact on our results of operations. When volume increases our revenue dollars increase, which contributes to increased gross profit dollars. Variable costs also increase with volume including increases in our warehouse, delivery, selling, general and administrative expenses. Conversely, when volume declines, we typically produce fewer revenue dollars, which can reduce


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our gross profit dollars. We can reduce certain variable expenses when volumes decline, but we cannot easily reduce our fixed costs.

Pricing for our products can have a more significant impact on our results of operations than customer demand levels. As pricing increases, so do our revenue dollars. Our pricing usually increases when the cost of our materials increase. If prices increase and we maintain the same gross profit percentage, we generate higher levels of gross profit and pre-tax income dollars for the same operational efforts. Conversely, if pricing declines, we will typically generate lower levels of gross profit and pre-tax income dollars. Because changes in pricing do not require us to adjust our expense structure other than for profit-based compensation, the impact on our results of operations from changes in pricing is typically much greater than the effect of volume changes.

In addition, when volume or pricing increases, our working capital requirements typically increase, which may require us to increase our outstanding debt. This usually increases our interest expense. When our customer demand falls, we typically generate stronger levels of cash flow from operations as our working capital needs decrease.

2013 Acquisitions

On November 1, 2013, through our wholly-owned subsidiary American Metals Corporation, we acquired all of the issued and outstanding capital stock of Haskins Steel Co., Inc. ("Haskins Steel"), located in Spokane, Washington. Founded in 1955, Haskins Steel processes and distributes primarily carbon steel and aluminum products of various shapes and sizes to a diverse customer base in the Pacific Northwest. Their in-house processing capabilities include shearing, sawing, burning and forming. Net sales of Haskins Steel during the period from November 1, 2013 through December 31, 2013 were $4.3 million.

On April 30, 2013, we acquired Travel Main Holdings, LLC ("Travel Main"), a real estate holding company with a portfolio of 18 real estate properties, all of which are leased by certain of our subsidiaries. The transaction value of $78.9 million included the assumption of $43.8 million of indebtedness.

On April 12, 2013, we acquired all of the issued and outstanding capital stock of Metals USA Holdings Corp. ("Metals USA"). Metals USA is one of the largest metals service center businesses in the United States and a leading provider of value-added processed aluminum, brass, copper, carbon steel, stainless steel, manufactured metal components and inventory management services. Metals USA sells its products and services to a diverse customer base and broad range of end markets, including the aerospace, auto, defense, heavy equipment, marine transportation, commercial construction, office furniture manufacturing, energy and oilfield service industries, among several others. This acquisition added a total of 44 service centers strategically located throughout the United States to our existing operations and complements our existing customer base, product mix and geographic footprint. Net sales of Metals USA during the period from April 13, 2013 through December 31, 2013 were $1.24 billion.

2012 Acquisitions

On October 1, 2012, through our wholly owned subsidiary Feralloy Corporation ("Feralloy"), we acquired all of the issued and outstanding capital stock of GH Metal Solutions, Inc. (formerly known as The Gas House, Inc.) ("GH"), a value added processor and fabricator of carbon steel products located in Fort Payne, Alabama that will allow Feralloy to better serve the increasing demands of its diverse customer base. GH operates as a wholly owned subsidiary of Feralloy and had net sales of $59.1 million for the year ended December 31, 2013.

On October 1, 2012, we acquired all the outstanding limited liability company interests of Sunbelt Steel Texas, LLC ("Sunbelt"), a value added distributor of special alloy steel bar and heavy-wall tubing products to the oil and gas industry, headquartered in Houston, Texas with an additional location in Lafayette, Louisiana. Sunbelt had net sales of $43.2 million for the year ended December 31, 2013.


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On July 6, 2012, we acquired substantially all of the assets of Airport Metals (Australia) Pty Ltd., a subsidiary of Samuel Son & Co., Limited, through our newly-formed subsidiary Bralco Metals (Australia) Pty Ltd. ("Airport Metals"). Airport Metals, based in Melbourne, operates as a stocking distributor of aircraft materials and supplies. Airport Metals had net sales of $2.8 million for the year ended December 31, 2013.

On April, 27, 2012, through our wholly owned subsidiary Precision Strip, Inc. ("PSI"), we acquired the assets of the Worthington Steel Vonore, Tennessee plant, a processing facility owned by Worthington Industries, Inc. The Vonore plant operates as a PSI location which processes and delivers carbon steel, aluminum and stainless steel products on a "toll" basis, processing the metal for a fee without taking ownership of the metal. The Vonore location had net sales of $2.7 million for the year ended December 31, 2013.

On April 3, 2012, we acquired all the issued and outstanding limited liability company interests of National Specialty Alloys, LLC ("NSA"), a global specialty alloy processor and distributor of premium stainless steel and nickel alloy bars and shapes, headquartered in Houston, Texas with additional locations in Anaheim, California; Buford, Georgia; Tulsa, Oklahoma and Mexico City, Mexico. NSA had net sales of $77.2 million for the year ended December 31, 2013.

On February 1, 2012, through our wholly owned subsidiary Diamond Manufacturing Company, we acquired McKey Perforating Co., Inc. ("McKey"), headquartered in New Berlin, Wisconsin and its subsidiary, McKey Perforated Products Co., Inc., located in Manchester, Tennessee. McKey provides a full range of metal perforating and fabrication services to customers located primarily in the U.S. McKey had net sales of $18.9 million for the year ended December 31, 2013.

Internal Growth Activities

We continued to maintain our focus on internal growth by opening new facilities, building or expanding existing facilities and adding processing equipment with total capital expenditures of $168.0 million in 2013, with the majority of this spent on growth activities. We added and upgraded processing equipment to enable us to provide higher quality services to our existing and potential customers. We also built or purchased 19 new facilities in 2013 and expanded and reconfigured certain other facilities. In addition to gaining market share from these growth activities, we also improved our operating efficiencies.


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Results of Operations

The following table sets forth certain income statement data for each of the three years ended December 31 (dollars are shown in millions and certain amounts may not calculate due to rounding):

                              2013                      2012                      2011
                                    % of                      % of                      % of
                         $        Net Sales        $        Net Sales        $        Net Sales
Net sales            $ 9,223.8         100.0 % $ 8,442.3         100.0 % $ 8,134.7         100.0 %
Cost of sales
(exclusive of
depreciation and
amortization
expense shown
below)                 6,826.2          74.0     6,235.4          73.9     6,148.7          75.6
Gross profit(1)        2,397.6          26.0     2,206.9          26.1     1,986.0          24.4
Warehouse,
delivery, selling,
general and
administrative
expense ("S,G&A")      1,638.4          17.8     1,396.2          16.5     1,280.1          15.7
Depreciation
expense                  137.5           1.5       106.1           1.3        97.3           1.2
Amortization
expense                   54.9           0.6        42.9           0.5        35.8           0.4
Impairment of
intangible asset          14.9           0.2         2.5           0.0         0.0           0.0


Operating income     $   551.9           6.0 % $   659.2           7.8 % $   572.8           7.0 %


(1)
Gross profit, calculated as net sales less cost of sales, and gross profit margin, calculated as gross profit divided by net sales, are non-GAAP financial measures as they exclude depreciation and amortization expense associated with the corresponding sales. The majority of our orders are basic distribution with no processing services performed. For the remainder of our sales orders, we perform "first-stage" processing, which is generally not labor intensive as we are simply cutting the metal to size. Because of this, the amount of related labor and overhead, including depreciation and amortization, is not significant and is excluded from our cost of sales. Therefore, our cost of sales is primarily comprised of the cost of the material we sell. We use gross profit and gross profit margin as shown above as measures of operating performance. Gross profit and gross profit margin are important operating and financial measures as their fluctuations can have a significant impact on our earnings. Gross profit and gross profit margin, as presented, are not necessarily comparable with similarly titled measures for other companies.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Net Sales

                                       Year Ended
                                      December 31,         Dollar    Percentage
                                    2013        2012       Change      Change
                                      (in millions)
          Net sales               $ 9,223.8   $ 8,442.3   $  781.5           9.3 %

Net sales, same-store $ 7,777.8 $ 8,327.8 $ (550.0 ) (6.6 )%

                                        Year Ended
                                       December 31,         Tons     Percentage
                                     2013        2012      Change      Change
                                      (in thousands)
           Tons sold                 5,388.8     4,440.3     948.5          21.4 %
           Tons sold, same-store     4,458.8     4,420.0      38.8           0.9 %


                                                 Year Ended
                                                December 31,       Price      Percentage
                                               2013      2012      Change       Change
Average selling price per ton sold            $ 1,712   $ 1,903   $ (191.0 )        (10.0 )%
Average selling price per ton sold,
same-store                                    $ 1,745   $ 1,886   $ (141.0 )         (7.5 )%


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Tons sold and average selling price per ton sold amounts exclude our toll processing sales. Same-store amounts exclude the results of our 2013 and 2012 acquisitions.

Our consolidated sales and tons are up significantly in 2013 compared to 2012, mainly due to our acquisition of Metals USA in April of 2013. Metals USA contributed $1.24 billion of net sales. In general, business activity in most all of our end markets was flat in 2013 compared to 2012 as our same-store tons sold increased by only 0.9% in 2013 compared to 2012, consistent with industry data reported by the Metals Service Center Institute ("MSCI"), which was up 0.3% during the same period. During the 2013 fourth quarter we experienced a normal seasonal slowdown, however the fall-off from the 2013 third quarter was less than typical. One end market that grew for us in 2013 as compared to 2012 was auto, primarily through our toll processing businesses in the U.S. and Mexico. Our other major industries that performed reasonably well were aerospace and farm equipment. The energy (oil and gas) market, although down from 2012 and 2011 levels, still continues to be one of our strongest. Non-residential construction, our largest end market, exhibited slight improvement, although at significantly reduced demand levels from its peak in 2006.

Since we primarily purchase and sell our inventories in the "spot" market, the changes in our average selling prices generally fluctuate in accordance with the changes in the costs of the various metals we purchase. The mix of products sold can also have an impact on our average selling prices.

Our 2013 average selling prices declined from 2012 mainly due to lower mill pricing as a result of lower raw material costs, increased imports and domestic increases in capacity for certain of the products we sell. Lower London Metal Exchange aluminum prices and reduced nickel surcharges were primarily responsible for the drop in common alloy aluminum and stainless steel prices, respectively.

As a result of decreasing mill prices during most of the year, we sold most products at lower average selling prices compared to 2012 levels. Our major product same-store selling prices decreased in 2013 from 2012 levels as follows:
carbon steel down 7.8%; aluminum down 4.2%; stainless steel down 9.7%; and alloy down 8.2%. As carbon steel sales represent slightly more than 50% of our sales dollars, changes in carbon steel prices have a significant impact on changes in our overall average price per ton sold.

Our acquisition of Metals USA in 2013 contributed to the overall increase in our carbon steel products from 51% of total sales dollars in 2012 to 53% in 2013, which contributed to our company-wide average selling price per ton decline of 10.0% as compared to a 7.5% decline on a same-store basis.

Cost of Sales

                                Year Ended December 31,
                            2013                      2012
                                  % of                      % of       Dollar     Percentage
                       $        Net Sales        $        Net Sales    Change       Change
                                 (dollars in millions)

   Cost of sales   $ 6,826.2          74.0 % $ 6,235.4          73.9 % $ 590.8            9.5 %

The increase in cost of sales in 2013 compared to 2012 is mainly due to increases in our tons sold resulting from our 2012 and 2013 acquisitions offset by lower mill pricing for most of our products. See "Net Sales" above for trends in both demand and costs of our products.

Our inventory LIFO valuation reserve adjustment, which is included in cost of sales and, in effect, reflects cost of sales at current replacement costs, resulted in a credit, or income, of $50.2 million in 2013 compared to a credit, or income, of $64.1 million in 2012. Our LIFO valuation reserve as of December 31, 2013 and 2012 was $88.6 million and $138.8 million, respectively. Lower metal costs across all our major products in 2013 as compared to December 31, 2012 levels resulted in LIFO income.


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Gross Profit

                                Year Ended December 31,
                            2013                      2012
                                  % of                      % of       Dollar     Percentage
                       $        Net Sales        $        Net Sales    Change       Change
                                 (dollars in millions)

    Gross profit   $ 2,397.6          26.0 % $ 2,206.9          26.1 % $ 190.7            8.6 %

The increase in our gross profit is primarily due to the contribution from our acquisition of Metals USA on April 12, 2013 offseting the impact of the overall decline in our selling prices. See "Net Sales" and "Cost of Sales" for discussion on product pricing trends and our LIFO valuation reserve adjustments, respectively.

Our gross profit margin was consistent and in our historical range of 25% to 27%. Our local managers were able to maintain margins in a declining price environment by providing high quality products and customer service.

Expenses

                                   Year Ended December 31,
                               2013                      2012
                                     % of                      % of       Dollar     Percentage
                          $        Net Sales        $        Net Sales    Change       Change
                                    (dollars in millions)

S,G&A expense         $ 1,638.4          17.8 % $ 1,396.2          16.5 % $ 242.2           17.3 %
Depreciation &
amortization
expense               $   192.4           2.1 % $   149.0           1.8 % $  43.4           29.1 %
Impairment of
intangible asset      $    14.9           0.2 % $     2.5           0.0 % $  12.4          496.0 %

Our expenses increased mainly due to the additional expenses of our 2013 and 2012 acquisitions and Metals USA acquisition related costs. The additional expenses provided by our 2013 and 2012 acquisitions were somewhat offset by lower variable costs, including profit-based compensation, as a result of lower levels of demand and profitability. Our S,G&A expense as a percent of net sales increased mainly due to reduced pricing in 2013.

The increase in depreciation and amortization expense was mainly due to our 2013 and 2012 acquisitions and depreciation expense from our recent capital expenditures.

We recorded impairment charges of $14.9 million and $2.5 million related to one of our trade name intangibles for the years ended December 31, 2013 and 2012, respectively. The 2013 impairment charge resulted from combining two of our operations to more efficiently service our customers in their markets, with the trade name associated with one of the operations no longer being used.

Operating Income

                                 Year Ended December 31,
                             2013                      2012
                                   % of                      % of        Dollar     Percentage
                        $        Net Sales        $        Net Sales     Change       Change
                                  (dollars in millions)
 Operating income   $   551.9           6.0 % $   659.2           7.8 % $ (107.3 )        (16.3 )%

Our operating income was lower in 2013 due to declines in our average selling prices, which were offset by contributions of our 2013 and 2012 acquisitions. Our operating income margin declined in 2013 mainly due to declines in our selling prices along with non-recurring acquisition related expenses, restructuring costs, and an impairment charge.


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Other Income and Expense

                                  Year Ended December 31,
                               2013                     2012
                                    % of                     % of        Dollar     Percentage
                          $       Net Sales        $       Net Sales     Change       Change
                                   (dollars in millions)
 Interest              $ (77.5 )        (0.8 )% $ (58.4 )        (0.7 )% $ (19.1 )         32.7 %
 Other income
 (expense), net        $   3.9           0.0 %  $   8.6           0.1 %  $  (4.7 )        (54.7 )%

Interest expense increased in 2013 compared to 2012 primarily due to additional borrowings to fund our $1.25 billion acquisition of Metals USA in April 2013, including our new $500.0 million 4.5% senior notes. See discussion in the "Liquidity and Capital Resources" section of our "Management's Discussion and Analysis of Financial Condition and Results of Operations."

The change in other income (expense), net in 2013 compared to 2012 was primarily due to foreign currency gains in 2012 on our intercompany balances with our Canadian operations that decreased significantly in 2013 due to positive cash flow from our Canadian operations.

Income Tax Rate

    Our effective income tax rate in 2013 was 32.1% compared to our 2012 rate of
33.0%. Permanent items that lowered our effective income tax rates from the
federal statutory rate were not materially different in amounts during both
years and relate mainly to company-owned life insurance policies, domestic
production activities deductions and foreign income levels that are taxed at
rates lower than the U.S. statutory rate of 35%.

Net Income

                                    Year Ended December 31,
                                 2013                    2012
                                      % of                    % of       Dollar     Percentage
                            $       Net Sales       $       Net Sales    Change       Change
                                     (dollars in millions)
Net income
attributable to
Reliance                 $ 321.6           3.5 % $ 403.5           4.8 % $ (81.9 )        (20.3 )%

The decrease in our net income was primarily the result of lower gross profit dollars offset by contributions from our 2013 and 2012 acquisitions. The decline in our net income as a percentage of net sales is due to declines in our selling prices along with non-recurring acquisition related expenses, restructuring costs, and an impairment charge.


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Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Net Sales

                                       Year Ended
                                      December 31,        Dollar    Percentage
                                    2012        2011      Change      Change
                                      (in millions)
          Net sales               $ 8,442.3   $ 8,134.7   $ 307.6           3.8 %

Net sales, same-store $ 7,885.4 $ 7,930.0 $ (44.6 ) (0.6 )%

                                       Year Ended
                                      December 31,         Tons      Percentage
                                    2012        2011      Change       Change
                                     (in thousands)
          Tons sold                 4,440.3     4,213.5     226.8            5.4 %
          Tons sold, same-store     4,299.1     4,157.0     142.1            3.4 %




                                                 Year Ended
                                                December 31,         Price    Percentage
                                              2012        2011      Change      Change
Average selling price per ton sold          $ 1,894.0   $ 1,930.0   $ (36.0 )        (1.9 )%
Average selling price per ton sold,
same-store                                  $ 1,827.0   $ 1,907.0   $ (80.0 )        (4.2 )%

Tons sold and average selling price per ton sold amounts exclude our toll . . .

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