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Reliance Steel & Aluminum Co. (NYSE:RS)

Q2 FY08 Earnings Call

July 17, 2008, 11:00 AM ET

Executives

David H. Hannah - Chairman of the Board and CEO

Gregg J. Mollins - President and COO

Karla R. Lewis - EVP and CFO

Analysts

Timna Tanners - UBS

Brett Levy - Jefferies & Company

Sal Tharani - Goldman Sachs

Anthony Rizzuto - Dahlman Rose & Co.

Michael Willemse - CIBC World Markets

Bob Richard - Longbow Research

Mark Parr - KeyBanc Capital Markets

Timothy Hayes - Davenport & Company

Jonathan Goldberg - Highline Capital Management

Operator

Good morning, ladies and gentlemen, and welcome to Reliance Steel & Aluminum's 2008 Second Quarter Financial Results Conference Call. At this time, all lines have been placed on a listen-only mode and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Mr. David Hannah, Chairman and CEO. Sir, the floor is yours.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Thank you. Good morning and thank you all for taking the time to listen to our conference call for the second quarter and six months ended, June 30th of 2008. Gregg Mollins, our President and Chief Operating Officer and Karla Lewis, our Executive VP and CFO are also here with me today.

This conference call may contain forward-looking statements relating to future financial results. Actual results may differ materially as a result of factors over which Reliance Steel & Aluminum Co. has no control. These risk factors and additional information are included in the company's Annual Report on Form 10-K for the year ended, December 31st, 2007 and other reports on file with the Securities and Exchange Commission. A transcript of this conference call, including Regulation G reconciliation will be posted on our web site at www.rsac.com/investorinformation.

Okay, for the 2008 second quarter, our net income was a record $156.6 million, that's up 27.5% compared with net income of $122.8 million for the 2007 second quarter, and it's up 45.8% from $107.4 million for the 2008 first quarter. Earnings per diluted share were also a record at $2.12 compared to $1.59 for the 2007 second quarter and $1.46 for the 2008 first quarter.

2008 second quarter sales were a record $2.1 billion, an increase of 10.5% compared with 2007 second quarter sales of $1.9 billion, and up 9.8% from our 2008 first quarter.

For the first six months ended June 30, 2008, net income amounted to a record $264 million, up 12.6% compared with net income of $234.5 million for the same period in 2007. Earnings per diluted share were a record $3.58 compared with earnings of $3.06 per diluted share for the six months ended June 30, 2007.

Sales for the 2008 year-to-date period were a record $4.0 billion, an increase of 7.1% compared with 2007 six-month sales of $3.74 billion. For the 2008 second quarter, our volume decreased 2.2% and average prices increased 13.2% compared to the 2007 second quarter. Our volume was down about 1.1% and average pricing was up 11.2% compared to the 2008 first quarter. For the 2008 second quarter, carbon steel products were 51% of our revenue dollars, aluminum was 17%, stainless was 16%, alloy 9%, toll processing 2% and the remaining 5% was miscellaneous including titanium, copper and brass.

The second quarter turned out to be quite a bit better than we had originally anticipated, which resulted in our updated guidance on June 24th. The main reason for the increased earnings was the higher carbon steel prices, which resulted in higher gross profit margins as we quickly passed through the increases to our customers. While we expected carbon steel pricing to continue upwards during the second quarter, the increases were larger than we had anticipated.

Additionally, these higher-than-expected prices led us to adjust our LIFO expense estimate for the year from $70 million at the end of the first quarter to $115 million currently, resulting in a pre-tax LIFO expense of $40 million or $0.34 per diluted share in the second quarter.

Our gross profit margin as reported on a LIFO basis, increased to 28% in the 2008 second quarter from 25.8% in the 2008 first quarter. On a FIFO basis, our gross profit margins were 29.9%, up from 26.7% in the 2008 first quarter. Once again, our managers and our sales personnel did an outstanding job managing our margins. Demand in the second quarter was about even with the first quarter as evidenced by our tons sold decrease of only about 1%, which was in line with our expectations.

We continue to manage our working capital well with receivables in good shape and inventory still representing between 2.6 and 2.7 months on hand. Our net debt to total capital was 32% at the end of the quarter.

Now looking at the third quarter, we expect pricing to be slightly above second quarter levels. While we do not expect any unusual changes in demand, we do expect the normal seasonal softness compared to the 2008 second quarter, and we recognize there is still a good deal of uncertainty surrounding the overall economic activity. We therefore are anticipating our volume to decrease slightly and our gross profit margins to be a bit lower because the rate of carbon steel price increases will be below that of the 2008, second quarter.

As a result, we currently estimate earnings per diluted share for the 2008 third quarter to be in a range of $1.80 to $1.90. Now this guidance does not include the impact of the acquisition of PNA or any of the related financing activities. We expect the PNA acquisition and the related financing activities to close in early August and to be accretive to our third quarter earnings.

During the quarter, we are very excited to announce that we have reached an agreement to acquire PNA Group Holding Corporation, a leading steel service center group. PNA is an outstanding company that fits well with the Reliance family and our strategic goals for product, geographic and customer diversification. We have known and respected the management teams at the PNA operations for many years and we are looking forward to the opportunities that this combination present.

The transaction is valued at approximately $1.1 billion, comprised of about $315 million for PNA’s equity plus up to $750 million of debt. PNA processes and distributes primarily carbon steel plate, bar, structural and flat-rolled products. 2007 and first quarter 2008 revenues for PNA were about $1.6 billion and $474 million, respectively. PNA has 23 steel service centers throughout the United States, as well as five joint ventures that operate a total of seven service centers in the U.S. and Mexico. The major markets served by PNA include infrastructure, non-residential construction, machinery and equipment manufacturing, oil and gas, telecom and utility.

We plan to finance the transaction, including the repayment of PNA's existing debt through a combination of borrowings under our existing credit facility and by raising approximately $750 million through new bank debts and the proceeds from an equity financing that we announced this morning. All of the outstanding PNA notes were validly tendered and we expect them to be retired subject to the closing of the PNA acquisition.

On April 16th of 2008, our Board of Directors declared a regular quarterly cash dividend of $0.10 per share of common stock. The 2008 second quarter dividend was paid, June 23rd, to shareholders of record, June 2. The Company has paid regular quarterly dividend for 47 consecutive years. Once again, we are proud of our performance, and our leadership position in the industry, and believe that our proven ability is robust internally and by successful accretive acquisition on a consistent basis and through varying market conditions will result in continued strong operating results going forward.

I'll now turn the floor over to Gregg for some additional comments on our operations and market conditions. Thank you. Gregg?

Gregg J. Mollins - President and Chief Operating Officer

Thank you, Dave. Good morning. We are very pleased with our record sales and profits in the second quarter. Once again, our managers did an outstanding job passing through historically high price increases to our customers and expanding our margins. We improved our gross profit margins to 28% in the quarter, up from 25.8% in the first quarter. This is by no means an easy task. With our focus on outstanding customer service, our breadth of inventory, along with the disciplined approach to managing our gross profit, we were able to accomplish this improvement in margin.

Our inventory turn was consistent with the first quarter. As always, we will keep a close eye on our inventory and make concerted efforts to improve our turns. From a demand standpoint, our same-store tons sold in the first half of 2008 compared to the first half of 2007, fell 1%.

The MSCI reported member volumes down 3.8% for the first half of 2008 versus 2007. This supports our belief that you can increase margins and market share simultaneously through outstanding customer service. We still see strength in many of the key markets and industries we supported. These include aerospace, energy, electronics, wind towers, barge and shipbuilding, railcar, agricultural equipment, non-residential construction, infrastructure and heavy equipment. The three industries that continue to struggle are domestic auto, residential construction, and appliance. Fortunately, we do very little business in these industries.

The most significant change in the quarter and the year thus far has been the increase in our cost of goods. It looks like carbon steel prices will continue to increase in the third quarter, with price increases already announced for August and September. Skyrocketing raw material costs, the weak dollar, low imports, low service and inventories, and high energy and freight rates are all impacting the price of steel. Carbon plate, as an example, was at $820 a ton in January and will be just shy of $1,500 a ton in August, an increase of almost 80%. Every time we believe the price is in peak, they go up again. The important thing is passing these increases through to our customers, which we have done.

As for aluminum, Midwest spot ingot is up $0.36 a pound versus January and roughly $1.5 [ph] a pound. Demand for commercial grade aluminum is relatively flat at reasonable levels. Aerospace for us, in spite of the delays of the 787, is still quite strong. Stainless demand is off from a year ago and nickel surcharges are trending down. Our inventory is in good shape in expectation of further reductions in surcharges and/or base price.

To summarize, demand in most of the major industries we support is still pretty good. Pricing, particularly in carbon steel, is at record levels with signs of further increases. We will continue to focus our attention on superior customer service, managing our gross profit margins, and turning our inventory. We look forward to another good year at Reliance.

Now I'll turn the program over to Karla to review our financials. Karla?

Karla R. Lewis - Executive Vice President and Chief Financial Officer

Thanks, Gregg. Good morning. Our 2008, second quarter consolidated sales were a record at $2.1 billion as were our 2008 six month consolidated sales of $4 billion. Our 2008 six month sales included 1.5% decrease in tons sold and a 9% increase in our average selling price per ton sold compared to the first half of 2007. And please note that our tons sold and average selling price amount excludes the sales of Precision Strip because of the toll processing nature of the business.

For the 2008 six month period, same-store sales, which exclude the sale of our 2007 and 2008 acquisitions were $3.7 billion, up 4.9% from the 2007’s first half, with a 1% decrease in our tons sold and a 6.3% increase in our average selling price per tons sold. As the numbers indicate, we believe the demand is still at reasonable levels for the markets that we sell to. Our average selling price increased mainly because of the significant price increases the carbon steel products experienced in the 2008 second quarter.

Our 2008 second quarter gross profit was a record $586.9 million, up 18% from the 2007 second quarter. For the six month period, our gross profit margin was 27.0% in 2008, up from 25.9% in 2007. The improvement in our 2008 gross profit margin is mainly due to the carbon steel price increases, effective mostly in the 2008 second quarter. Typically, when our suppliers announce price increases, we push these increases through to our customers at that time, before we receive the higher cost of metal [ph] into our inventory. This results in a temporary improvement in our gross profit margins. Because the significant and rapid carbon steel mill price increases in the 2008 second quarter were, for the most part, accepted by our customers, we were able to significantly increase our gross profit margins.

As the mill pricing level is off in the future, we expect our gross profit margin spread to compress somewhat, as our cost and inventory will have caught up with our selling prices. Our 2007 second quarter LIFO expense was $40 million or $0.34 per diluted share compared to $13.75 million or $0.11 per diluted share in the 2007 second quarter. In the 2008 six months period, we reported LIFO expense of $57.5 million or $0.49 earnings per diluted share, up from our 2007 six months LIFO expense of $32.5 million or $0.26 earnings per diluted share.

The 2008 LIFO expense is due to our increased costs for carbon steel products in 2008 as compared to 2007 levels. We have increased our full-year LIFO expense estimate to $115 million [ph], based upon the carbon steel price increases announced through August, along with additional increases now expected for certain carbon steel products announced just last week, and after our revised second quarter guidance was issued. We also anticipate further increases in aluminum prices in 2008, due to recent LME aluminum price increases. And our LIFO expense is included in our cost of sales.

Our warehouse delivery, selling, general, and administrative expenses have increased 11.4% in the first half of 2008 compared to 2007, due to the expenses of our 2007 and 2008 acquisitions, increased cost for energy and fuel, and higher incentives paid, due to our improved operating performance. As a percent of sales, our 2008 second quarter expenses were 14.2% compared to 14.0% in the 2007 second quarter, and 14.5% in the 2008 first half compared to 13.9% in the 2007 first half.

Our 2008 six month depreciation and amortization expense increased $5.1 million over 2007, and includes the depreciation from our 2007 and 2008 acquisitions and from our capital expenditures made since June of 2007.

Operating income for the 2008 second quarter was $267.9 million or 12.8% compared to $213.7 million or 11.3% in 2007's second quarter. Our operating income improved because of our higher gross profit margins achieved in 2008. Interest expense for the 2008 six months, decreased $7 million or 17.5% due to both lower interest rates in 2008 and lower average borrowings during 2008 as compared to 2007.

Our effective income tax rate for the 2008 period was 37.7% compared to 37.5% in the 2007 period, and our annual 2007 rate was 37.6%. Our working capital needs increased significantly in the 2008 second quarter because of the significant increases in carbon steel prices. Net of acquisitions, our accounts receivable balance increased $257.2 million, and our inventory levels increased $205 million at June 30th, 2008, from our year-end 2007 amounts.

Our accounts receivable day sales outstanding rate was approximately 40 days for the 2008 first half, consistent with our 2007 rate. Although we have not seen a deterioration in our customers' payment pattern, as might be expected because of their increased working capital needs and general economic uncertainty, many of our customers are requesting increased credit limits and payment term, and we continue to closely monitor our customer exposure.

Our inventory turn rate was 4.5 times for the 2008 first half compared to 4.4 turns for 2007. And our high earnings levels offset by our increased working capital needs provided cash flow from operation of $21.2 million in the 2008 second quarter and $128.4 million in the 2008 first half. Our outstanding debt at June 30th, 2008 was $1.16 billion, which included $292 million borrowed on our $1.1 billion revolving line of credit, and our net debt to total capital ratio was 32.0% at June 30th, 2008, down from our year-end 2007 rate of 32.4%.

In 2008 first half, we used our borrowings and cash flow to fund our increased working capital needs. Capital expenditures were approximately $88.3 million, and acquisition for approximately $13.3 million, and stock repurchases of approximately $114.8 million. In the 2008 first quarter and the 2007 third quarter, we repurchased shares of our common stock, resulting in approximately 4% fewer shares outstanding in the 2008 first half compared to 2007 first half. Book value per share was $30.93 per share at June 30th, 2008, up from $28.12 per share at December 31st, 2007.

And we expect to fund approximately $1.1 billion purchase of PNA Group Holding Corporation with the proceeds from our proposed equity financing of approximately $250 million from a new term loan. We'll fund the remaining balance with borrowings under our existing credit facility. The $1.1 billion transaction value with the purchase of PNA includes the repayment or refinancing of up to $750 million of their outstanding debt at the closing. This includes their secured credit facility, as well as $250 million of 10.75% outstanding fixed rate notes, and $170 million of outstanding floating rate notes.

We initiated tender offers and consent solicitations for both of these series of notes, and 100% of the notes were tendered as of the expiration of our consent period on July 15th. The settlement date for the tendered notes is August 4th, 2008. Although we paid a premium for the tender of the fixed rate notes, we expect to save approximately $13 million compared to the make-whole premium amount, and expect to realize savings by lower borrowing costs immediately for the $420 million of PNA notes that have been tendered.

Earlier today, we filed with the SEC, Form 8-K that includes certain financial statements of the PNA, and pro forma financial information reflecting the PNA acquisition and related financing activities for the respective periods included in the filing. We also filed a Form S-3 Registration Statement related to the proposed equity financing.

Thank you. And we'll now open the discussion for questions.

Question and Answer

Operator

Thank you. Ladies and gentlemen, the floor is now open for questions. [Operator Instructions]. Our first question today is coming from Timna Tanners at UBS.

Timna Tanners - UBS

Hi, good morning.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Hi Timna.

Timna Tanners - UBS

Just, I really appreciate all the great detail on the call, and really I think what... I'd like to hear more about is if you could give us some more detail on the end market, I know you said that auto, residential, and appliance really were you're seeing weakness. So, you don't seem to have a lot of exposure than since [inaudible] reported a decline in volumes. I just wonder if you can give a little bit more even within non-residential construction, a little further breakdown of what you see happening?

David H. Hannah - Chairman of the Board and Chief Executive Officer

Sure. The... yes, we don't have really any sales at all of any significance of any type of metal into the auto industry or the appliance or the not high residential related construction industries. We do some thought processing however for the auto industry, actually we do it on behalf of the domestic mills. And we have seen some slowdown in terms of tonnage being cost us [ph] through our toll processing business, but at the same time our people there had really done an outstanding job replacing that tonnage with new business, really coming from other applications. So, the weakness, if you want to call it that, in our ton sold, which was down about 1%, actually less than 1% on a same-store type basis, it was about 0.6% or 0.7%. The stronger part of that is our carbon steel business. Actually, we've seen the largest decrease in the aluminum side. So… I understand as well, but aluminum has been... it's off a little more than 5% in terms of tons, first quarter to second quarter this year. So… and that goes hand-in-hand with kind of a slowdown in the aerospace side. It's still a very good. As Greg mentioned in his discussion that aerospace is still strong by historical standards for us, but certainly not what it was in 2006 through 2007. So that's... I don't know if that answers your question exactly, Timna, but we really haven't seen any meaningful reductions in the non-res side.

Timna Tanners - UBS

Okay, that's really helpful. And can you tell a little bit more maybe on what you're seeing in stainless, if you could?

Gregg J. Mollins - President and Chief Operating Officer

Mainly we're being affected in stainless flat-rolled, okay [inaudible] in general manufacturing purposes, okay. Stainless has gone up, as you know Timna for the last two years to pretty high levels. And our customers, we think are postponing any programs if they can, especially when they start seeing the decrease in the surcharge taking place, which they had over the past few months. And their feeling is, is that they expect that to continue, we’d be happy to agree with that, by the way. So the outline, only what they need and they are not in any projects that they can delay until they see prices down in a more reasonable level they are doing.

David H. Hannah - Chairman of the Board and Chief Executive Officer

I think one other thing to point out to, Timna is the service center industry overall, I think, second quarter volume was down about, little less than 4%, I think from an industry standpoint and were down around 1%, less than 1% on a same-store basis. So I think that we’re very selective in our quest to increase our gross profit margins, we are being very selective in how we sell that material. So could we sell more? Yes, we could sell more. But we think we can make more money selling less at higher prices.

Timna Tanners - UBS

Okay. That makes sense. And then the other... the other thing I really want to ask is that, in the last conference call, you also talked about you're not seeing a lot of weakness in non-res, but given the preponderance of leading indicators and the chatter that you're doing is so forth to talk about conservatism in your forecast. Is there anything that stems [ph] there that you might be seeing indeed and what your customers are exhibiting right now, given further outlook?

Gregg J. Mollins - President and Chief Operating Officer

No, I think, we're still in the same position that we were three months ago, and that is we hear a lot about the reasons why it should be slowing down. But we really haven't witnessed that yet.

Timna Tanners - UBS

Okay, great. Thank you again very much.

Gregg J. Mollins - President and Chief Operating Officer

Thanks, Timna.

Operator

Thank you. Our next question today is coming from Brett Levy at Jefferies & Company.

Brett Levy - Jefferies & Company

Hey guys, good quarter. After the PNA transaction, are you guys taking the foot off the pedal a little bit on the acquisition front? And then are you seeing any kind of distress offerings of kind of mom and pop size guys because of liquidity issues, because of the high prices?

David H. Hannah - Chairman of the Board and Chief Executive Officer

With this we're taking our foot off of the pedal in a room [ph]. We... there aren't a lot of $2 billion companies out there, Brett. As you probably know yourself, we will continue to look for acquisition opportunities, and actually acquisition opportunity cheat [ph] us out on a regular basis. But, obviously, with the size of the PNA transaction we will... we’ll need some time to digest that certainly before anything other… any other transaction of any significance should come along. But are we going to stop looking? I think the answer to that is, is no. We've looked continually for over… longer than I've been with the company and that's 27 years. So it predates our IPO.

Brett Levy - Jefferies & Company

And second question is, and maybe I wasn't following the headlines closely enough, but I thought initially when you announced the PNA transaction, it looked like you was going to be funded with banks and bonds. Is the market for BBB bonds that weak at this point?

Karla R. Lewis - Executive Vice President and Chief Financial Officer

Brett, basically what we announced initially when we have a transaction was that we would raise $750 through a combination of debt and equity. We were considering all the different markets at that time one of our goals was to maintaining our pre-payable debt because we feel that cash flow will be strong over the near-term and that was one of the main reasons we went to the deck that market is opposed to a long-term on market.

Brett Levy - Jefferies & Company

Thanks very much guys.

David H. Hannah - Chairman of the Board and Chief Executive Officer

That's Brett.

Operator

Thank you. Our next question today is coming from Sal Tharani at Goldman Sachs.

Sal Tharani - Goldman Sachs

Good morning guys.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Hey Sal.

Sal Tharani - Goldman Sachs

Gregg, you mentioned that you expect -- if I heard correctly that you expect base price on stainless also to come down.

Gregg J. Mollins - President and Chief Operating Officer

I think that's a possibility. [inaudible] but I think it's possible.

Sal Tharani - Goldman Sachs

Is that because you're seeing demand declining very rapidly there?

Gregg J. Mollins - President and Chief Operating Officer

Yes.

Sal Tharani - Goldman Sachs

Okay. Also on the pricing, you’re still seeing the long part of the price is rising further, slightly [ph].

Gregg J. Mollins - President and Chief Operating Officer

Yes. Those price increases are… have been announced and are in place, we had many mill and being price increases that took place in July, that stuff and then there was basically, Nucor announced a $65 a ton increase on long products, which is directly associated with the $65 scrap increase and that's in place for August.

Sal Tharani - Goldman Sachs

What do you think on the flat side?

Gregg J. Mollins - President and Chief Operating Officer

On the flat side, there is a $40 ton increase announced by AK in U.S. for the September timeframe. Both held their prices in place for July and August. Nucor had an increase… they held their prices in July and they had an increase of $30 a ton in August. I don't believe Nucor is yet to follow that $40 a ton increase announced by U.S. and [inaudible] for September, but it is pretty likely that they will.

Sal Tharani - Goldman Sachs

So, on the hot rolled the average price is about, more than 1,100, 1,120, 1,130 something like that?

Gregg J. Mollins - President and Chief Operating Officer

Yes. About 1,120.

Sal Tharani - Goldman Sachs

Okay.

Gregg J. Mollins - President and Chief Operating Officer

For August with potentially that $40 increase going in, in September.

Sal Tharani - Goldman Sachs

And are you seeing any push back from the client in terms of… or any cases where people maybe responding to projects or canceling the projects, any demand instruction going on?

Gregg J. Mollins - President and Chief Operating Officer

You know not really. I think when you get into some of the loan products we would expect that some of the non-residential construction projects would have been delayed, some infrastructure work being delayed, but really our sales have held up every well with that. So in our… everything that you read would suggest that projects are and maybe and future ones that they never were purchasing any steel form to begin with or being delayed. I'm not sure, some of those are, but I tell you the structural business has held up very well for us. We are very pleased with it. And of course plate, there was a plate increase that was announced, about $100 a ton for August, which puts plate just below $1,500 a ton and... but that market is... that's the strongest of all the steel segments is the plate business.

Sal Tharani - Goldman Sachs

And last question on inventory. How do you see inventories over the next four, five, six months of the second half, do you see that increasing, staying steady?

Gregg J. Mollins - President and Chief Operating Officer

We'd like to think that at Reliance our inventories are going to be going down the next six months, okay, which they generally do, historically they’ve always done that. So we're going to have a big push on getting our inventories lower than they are today going forward. But we understand that there is some price increases that are going to take place, so that's certainly is going to affect your inventory, but hopefully it will… turns themselves will improve.

Sal Tharani - Goldman Sachs

Great. Thank you very much.

Gregg J. Mollins - President and Chief Operating Officer

Thank you.

Operator

Thank you. Our next question today is coming from Tony Rizzuto at Dahlman Rose & Company.

Anthony Rizzuto - Dahlman Rose & Co.

Thank you very much. Hi, good morning everyone.

Gregg J. Mollins - President and Chief Operating Officer

Good morning, Tony.

Anthony Rizzuto - Dahlman Rose & Co.

I've got several questions here. Just the first one is kind of a house cleaning a little bit, but you mentioned the aluminum tons were down 5% sequentially. I didn't here the number for carbon tons and stainless steel tons?

Gregg J. Mollins - President and Chief Operating Officer

Yes, you didn't hear it because we didn't say, Tony. I just remember the aluminum number what I saw then it was big. The other ones are right around, I think stainless tons are pretty flat and carbon is off about 1%. The aluminum one struck in my mind because it was bigger.

Anthony Rizzuto - Dahlman Rose & Co.

All right. If you could... in all those markets that you’re seeing continued strength and with the exception of the three that you really don't dabble in, if you could look at all those markets that you mentioned, generally what percentage of your overall business or revenues would those markets comprise?

Gregg J. Mollins - President and Chief Operating Officer

That's a tough one, Tony, because as we've said many times before, most of our customers are chop shops and fabricators and we just don't know what they are doing with a lot of our material.

Anthony Rizzuto - Dahlman Rose & Co.

Okay.

Gregg J. Mollins - President and Chief Operating Officer

So, as much as we’d like is to give you an answer, I don't know if we could come up with any meaningful answer for you because it's just too hard for us to tell.

Anthony Rizzuto - Dahlman Rose & Co.

Understood, but I've got a question on the margins and you guys indicated that the third quarter margin... gross margin overall would be a bit lower. Should we be losing some where in the 26 to 27 more of your normalized range, overall?

Gregg J. Mollins - President and Chief Operating Officer

Karla?

Karla R. Lewis - Executive Vice President and Chief Financial Officer

I don't know if we can get that specific with you, Tony. I think, probably may be we can say is that pricing levels are still strong and there are still more price increases happening in the third quarter so often times we are above that historical range during that type of a pricing environment. But we don't... as we said, we don't expect to be in the same level in the second quarter.

Anthony Rizzuto - Dahlman Rose & Co.

That's helpful, Karla. I appreciate that. And then I would just follow-up, I wanted to ask you... I'm sorry, David.

David H. Hannah - Chairman of the Board and Chief Executive Officer

[inaudible].

Anthony Rizzuto - Dahlman Rose & Co.

All right. I wanted to also just ask you about, how should we look at the PNA margins, relative to Reliance overall?

David H. Hannah - Chairman of the Board and Chief Executive Officer

Well...

Karla R. Lewis - Executive Vice President and Chief Financial Officer

They have public filings, you have that are out with the SEC through the first quarter. Yes, we just filed [inaudible] by reference, but they are out there any way. Hence, if you use at the PNA Group Inc. level, which they are operating entities, and then they also have filings at the PNA intermediate level, which holds some of their debt and then their S-1 filings where I see PNA Group Holding Corporation levels but if you look at those you can see that their gross profit returns were lower than historically in their filings that were last...

Anthony Rizzuto - Dahlman Rose & Co.

Okay. We’ll take a look at that. And then my final question would be on, one of my favorites, heat treat market for aluminum and you indicated at the market while we're seeing obvious weakness in the common alloy area, heat treat has been holding a new area in spite of delays with 787 and then A380. What… have you seen any discernible changes at all, are margins still pretty good in that market. Have you seen any diminution of margins. And secondly, I didn't hear anything about the defense, are you also able to supply some of the demand for armor plate?

Gregg J. Mollins - President and Chief Operating Officer

We're not involved really in the armor plate business, although I wish we would, Tony, but we're not. As far as the demand for the heat-treat plate business, that's still pretty strong for us. The difference is that in… when material was on allocation, which by the way aluminum plate [inaudible] in particular is still being outdated, but when demand was very, very strong in 2006, plate was on allocation. The difference between today and then is that our margins were significantly high. Okay, they were higher in 2006 and we've ever had margins on heat-treat plate in all of years in the business. But now, as you know because of the delays and what not and the increases in production capacity at Alcoa and Kaiser Aluminum, there has been more supply out there. So, because of that, [inaudible] some of those super high levels of 2006 down to more historically normal margins in 2007 and 2008.

Anthony Rizzuto - Dahlman Rose & Co.

Great, Gregg. And how would you characterize the inventories within the chain on the heat-treat side?

Gregg J. Mollins - President and Chief Operating Officer

They are little lower than what we reported, like 4.5 times. They would be somewhere around four ton level at this point in time. Yes, about 3.8 to 4.0 for us. I can't speak to the rest of the industry because I really don't know if they even publish that, but our inventory is in the heat-treat plate market, they were around 3.8 to 4 tons.

Anthony Rizzuto - Dahlman Rose & Co.

All right, Gregg. I appreciate it. Thank you.

Gregg J. Mollins - President and Chief Operating Officer

Not at all, have a good day.

Operator

Thank you. Our next question today is coming from Michael Willemse of CIBC.

Michael Willemse - CIBC World Markets

Gregg, thank you. Good morning.

Gregg J. Mollins - President and Chief Operating Officer

Hey, Michael.

Michael Willemse - CIBC World Markets

In the press release you mentioned your guidance does not include the PNA Group acquisition. Do you think the PNA group acquisition will be accretive in the third quarter?

David H. Hannah - Chairman of the Board and Chief Executive Officer

Yes, Michael. I had mentioned in my remarks briefly that, yes, the combination of the PNA acquisition and the proposed financing that we announced today in a share offering that… the net of those two will still be accretive to our third quarter. We didn't include any guidance in there because we don't know exactly when it will close or at what price the new shares might be issued. So, with the... our guidance includes only Reliance as we are today. The answer is a very strong yes, it will be accretive in our third quarter.

Michael Willemse - CIBC World Markets

Okay. And I'm not sure, maybe Karla you mentioned, how much of the charges being related to the retirement of the notes held by PNA?

Karla R. Lewis - Executive Vice President and Chief Financial Officer

We didn't actually give that… give the savings, but in the... it will be part of the purchase price so it will flow through the balance sheet in our purchase price allocation. In the Form 8-K filing that we filed this morning, you could see that the premium cost is about $54.8 million for the… for both periods of note.

Gregg J. Mollins - President and Chief Operating Officer

[inaudible].

Michael Willemse - CIBC World Markets

Okay. Just going on more on the industry, what is the availability like for steel right now? Are you having trouble, even some of your competitors might be having trouble getting steel from the mills or the order books, fair enough that people can still get steel.

Gregg J. Mollins - President and Chief Operating Officer

All the plate… flat-rolled is the weakest of the commodities and it's readily available, but many mill product being brought at many mills, lead times are six weeks, which is fairly normal. So all the steel related items are pretty easy to access. I don't think people would have problems with the exception of plate and in particular if you want to get into even more detail, the heat-treat plate is much more difficult to get there than any other product. It's been allocated, it's difficult for us to get, we're getting what we need, okay, but it's not easy and I would guess that if we're having difficultly to get it, getting that, everybody is having difficulty to get it.

Michael Willemse - CIBC World Markets

Okay. How would you characterize inventories, may be not for yourself, but may be for the rest of the industry. In a rising steel price environmental life there is tough time you see some service centers try to speculate and over volume inventory. Any sense of any service center that might have built up inventory too much over the last couple of months or do you think everyone is still trying to stay as low as possible?

Gregg J. Mollins - President and Chief Operating Officer

I think, for the most part, at least the data from the MSCI suggest that everybody is keeping their inventory in line at pretty low levels, I mean, like ten-year low levels.

David H. Hannah - Chairman of the Board and Chief Executive Officer

It's actually in pretty good shape, better than we… as you alluded to, better than we typically see in this kind of a rising price environment on the steel side. But one of the reasons might be a very big reason, why it might be that way is because there really aren't any low price imports to run out and buy and usually that is what drives inventories up is when prices start to go up here, people run offshore and buy large quantities of cheaper imports and then that creates this inventory bubble that we've seen on and on again, but that's not happening. So, the industry itself is in pretty good shape with respect to inventories and the environment is kind of protecting the industry from itself, from its desire to run off and buy too much from somewhere else.

Michael Willemse - CIBC World Markets

Okay. And just one last question. Do you see any competitors that are really struggling in this environment, perhaps if they don't have liquidity or if things are getting squeezed between the steel mills and some of their end customers?

Gregg J. Mollins - President and Chief Operating Officer

Not really. No. You expect if that was probably be the case, common sense tells you that some of the small and privately held companies, [inaudible] with prices down or whatever they are would have a negative impact on their cash flow, but I haven't heard anything really that would suggest that, I will say that we do... we've seen holes in inventories, okay. But that's because we think that we pass on business that was very, very competitive when prices were going up, and then we saw those same customers come back to us, and give us orders, add back the prices that we had… that we originally lost. We assume that to be that good across [inaudible] competitors were selling it at a lower level [inaudible] stock, and then our customers came back to us to get the material. One of the reasons why our margins go up is, because that's best, a bit of [inaudible] how we operate.

Michael Willemse - CIBC World Markets

Okay, great. Thank you very much.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Thanks, Michael.

Operator

Thank you. Our next question today is coming from Bob Richard at Longbow Research.

Bob Richard - Longbow Research

Hi, good morning, and thanks for taking my call.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Hey, Bob.

Bob Richard - Longbow Research

With relation to the MSDI specifics, one category that did stand out a little bit was the inventory on flat-rolled seem to be up, and it's on our continuing trends for the last three months. Again, not nearly to the level that we are seeing since the liquidation started, but can you give any insight is that kind of parallel with what you guys are seeing or could you give any insight as to why maybe those might be picking up?

Gregg J. Mollins - President and Chief Operating Officer

I guess, your guess is probably as good as ours. Our flat-rolled inventories had no risen. They maintain itself at a good level, good low level. And there is... availability is out there. The product is very readily available to get. So I would suggest that maybe the only reason why that would be taking place if in fact people are actually trying to set gas price increases and maybe over volume a little bit for that reason. But there is a very cautious atmosphere out there, a monster of centers, just because of all the negative press that you have. So I would only think that people are… they are not increasing their inventories because demand is increasing. Let's put it that way. So they must be trying to dime underneath price increases.

Bob Richard - Longbow Research

Okay. Thank you. And that's helpful. And my follow-up, aluminum pricing, a little more robust then what your expectations were on a prior conference call, some pretty bullish estimates out there for next year. Where do you guys... could you guys provide your take on that?

Gregg J. Mollins - President and Chief Operating Officer

Well, only what you read, you hear about aluminum smelters being shut down or taken out of production in China. You've got some energy related problems down in South Africa. And of that, we didn’t think that... we thought [inaudible] and say, going down in the quarter. And it's just the opposite. It went from like $1.38 to $1.50 [inaudible] because of those announcements that I just described. Will it stay up? I don't know. I will... what I [inaudible] because last call I said I thought it was going down but it went up [inaudible]. Sorry about that.

Bob Richard - Longbow Research

I understand, sir. But all things being equal, Gregg, [inaudible] right?

Gregg J. Mollins - President and Chief Operating Officer

We liked it when the prices are going up, and that’s a nice surprise to have.

Bob Richard - Longbow Research

Okay. I'll leave in at that. Thank you very much.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Thanks, Bob.

Operator

Thank you. Our next question today is coming from Mark Parr at KeyBanc Capital Markets.

Mark Parr - KeyBanc Capital Markets

Hi, good morning.

Gregg J. Mollins - President and Chief Operating Officer

Mark, how are you?

Mark Parr - KeyBanc Capital Markets

Good, terrific. So it's even a nice day in Cleveland. But it's always a nice day in Southern California. Two questions, it's been… just I want to congratulate you on the quarter and thanks for all the great color, and not only are you helpful in making a new stock act well, but I think you really help us with color on the rest of the industry. So I really appreciate that, thank you very much.

Gregg J. Mollins - President and Chief Operating Officer

You're welcome. Thanks.

Mark Parr - KeyBanc Capital Markets

Just... this is a housekeeping question for Karla, I think what I heard was with your updated LIFO expectation for the full year that you've got, did you say $57 million year-to-date?

Karla R. Lewis - Executive Vice President and Chief Financial Officer

Yes, we had $57.5 million for the first six months, but based on our current estimate, it would be the same amount for the last half of the year, $28.75 million per quarter.

Mark Parr - KeyBanc Capital Markets

Okay. So on a sequential basis then the LIFO charge will come down about $12 million compared to the second quarter, okay. I wanted to make sure I had that right. And so I appreciate that. And then I have a question for Gregg. I was wondering if you could give us some sense, we've got... we've got a fairly subdued demand environment, yes, we've got a fairly easy supply situation, or call it normal to easy, I guess would be a fair way of describing it.

Gregg J. Mollins - President and Chief Operating Officer

Yes.

Mark Parr - KeyBanc Capital Markets

How are the service centers, how's the competitive environment out there. Do you think that there is a lot of low price material in the pipeline or do you think people are maybe thinking about, giving away material because the demand is a little soft. Are you seeing supply discipline on the service center side of the supply chain?

Gregg J. Mollins - President and Chief Operating Officer

It depends on the competitor, and it depends on the product mix.

Mark Parr - KeyBanc Capital Markets

Is it getting worse or is it getting better.

Gregg J. Mollins - President and Chief Operating Officer

No, it's not getting worse. I would say if anything has gotten better. Okay, well, with... really the most competitive item that we have, that's one of the things that we're struggling with is too stainless flat-rolled, I can always… as Dave mentioned earlier, [inaudible]. The... we could optimize [ph] our chance on stainless. There is no question about it. But we are not going to sell a single-digit [inaudible] it's just not a part of our culture. But in general, to answer to your question, I think that margin is being held by competitors in the marketplace, so probably a little bit better than they are on a normal basis.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Most of the service centers we know, Mark are making more money than they have ever made before. When you go to an MSCI meeting and other conference and most of the people running around there have smiles on their face. So it's a pretty good environment out there.

Mark Parr - KeyBanc Capital Markets

I'd certainly hope so.

David H. Hannah - Chairman of the Board and Chief Executive Officer

I mean, what the exciting thing is, is that here we are in the midst of this market that everybody kind of stomping through, thinking that it’s probably… should be worse than it is and demand is about robust and I mean, this is what you hear off there. But, here we are along with others in the industry doing very, very well. So that's exciting for us because when these economic uncertainties resolve themselves, think about what’s going to happen there. I mean we're not going to see prices coming down in carbon steel to the low levels that we've had before. So if you have a better economic environment with pricing at maybe not the levels we are at now, but certainly not $700 or $600 a ton. You've got some really exciting times.

Mark Parr - KeyBanc Capital Markets

Okay. Well it's good to see... clearly, you can see the supply discipline at the mills pretty easily. It's a little harder to see it at the service center level, so I really appreciate that color. Thanks so much and good luck on the balance of the year.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Thanks Mark.

Gregg J. Mollins - President and Chief Operating Officer

Thanks Mark.

Mark Parr - KeyBanc Capital Markets

Good luck on your deal too.

Gregg J. Mollins - President and Chief Operating Officer

Yes thank you [inaudible].

Operator

Our next question today is coming from Tim Hayes at Davenport & Company.

Timothy Hayes - Davenport & Company

Hey, good morning.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Hey, Tim.

Timothy Hayes - Davenport & Company

Just some housekeeping questions. The... again what was your same-store sales compared to the first quarter of '08, the percent change?

Karla R. Lewis - Executive Vice President and Chief Financial Officer

Same-store on a ton basis, we were down 0.7% and our pricing was up 10.2%.

Timothy Hayes - Davenport & Company

Okay. And then could you go through those comparisons to the year-ago quarter again please?

Karla R. Lewis - Executive Vice President and Chief Financial Officer

[inaudible]. I just gave you…

Timothy Hayes - Davenport & Company

That was 2Q08, 2Q07.

Karla R. Lewis - Executive Vice President and Chief Financial Officer

Right. [inaudible] okay. So on a consolidated basis, Q208 to Q207 tons were down 2.2% and pricing was up [ph] 13.2%.

Timothy Hayes - Davenport & Company

Okay. And then your average daily sales, how does that trend in each of the months of the second quarter?

David H. Hannah - Chairman of the Board and Chief Executive Officer

It trended up pretty much every month. We went then with the --

Karla R. Lewis - Executive Vice President and Chief Financial Officer

Average sales per day.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Yes, average sales per day is what we are talking about. The revenue dollars per day but yes, each of the month April, May and June went up. And April was up... the most significant amount compared to March. So it has been trending up which you would expect with the price increases the way that they've been.

Timothy Hayes - Davenport & Company

Okay, very good. Thank you.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Thanks Tim.

Operator

Thank you our next question is a follow up question from Tony Rizzuto.

Anthony Rizzuto - Dahlman Rose & Co.

Thank you very much. I have another question about the acquisition front. I know you've mentioned about... it’s a good thing that you're seeing continued resilience on the part of the customer base that you serve. But I'm wondering with the administration going to change with the election year, and there’s a lot of concern about the state taxes changing very, very substantially. I wonder if that’s a concern that maybe, maybe getting a lot of these folks to think about what that's going to do and maybe causing them to get to the table a little bit more quickly. Are you guys sensing any of that?

David H. Hannah - Chairman of the Board and Chief Executive Officer

Yeah. Tony, we have had some discussions with folks as we do on a regular basis. And there is some concern out there about tax rates going up and may be that will spur them to make decisions to sell businesses this year sometime as oppose to next year. But, yes, people out there are thinking about that.

Anthony Rizzuto - Dahlman Rose & Co.

Thanks Dave.

Operator

Thank you. [Operator Instructions]. Our last question today is coming from Jonathan Goldberg at Highline Capital Management.

Jonathan Goldberg - Highline Capital Management

Hey guys, good morning.

David H. Hannah - Chairman of the Board and Chief Executive Officer

Hey, Jonathan.

Jonathan Goldberg - Highline Capital Management

Question for you, you touched on this a little bit, but on carbon product, could you just talk a little bit more about the import situation in terms of what the quantity of offers is like, what the pricing is like, what the lead times are like? And are they buying any.

Gregg J. Mollins - President and Chief Operating Officer

We're buying very, very, very less probably today than we have in years and years and years, may be ever. The import offerings are just... they're just not there, and if they are there, they're not very attractive. And again also in addition to that, okay, because of the uncertainty, what they always… all the negative questions you read about. People are just not wanting to go and take the chance of going offshore and having to come in when prices may have gone down. But that's still of what's being offered is very, very small quantities and the prices are not attractive enough to spurring interest.

Jonathan Goldberg - Highline Capital Management

And would you say that's equally true between long products and flat products, or is that --

Gregg J. Mollins - President and Chief Operating Officer

Yes.

Jonathan Goldberg - Highline Capital Management

Okay, thank you.

Operator

Thank you. Our next question today is a follow-up from Sal Tharani.

Sal Tharani - Goldman Sachs

A quick question. Your sequential prices, if you look at between April, May, June, and now July, they have continuously been rising sequentially, is that fair to say?

Gregg J. Mollins - President and Chief Operating Officer

Yes.

Sal Tharani - Goldman Sachs

Okay, great. Thank you.

Operator

Thank you. There appear to be no further questions in the queue at this time. Do you have any closing comments you'd like to finish with?

David H. Hannah - Chairman of the Board and Chief Executive Officer

No, that's good. We're excited about the next quarter, we've got a lot of work to do, we've got business to run as well as a company to acquire and then offerings to undertake. So, we are going to get out of here and go do some work. Thank you very much, and we'll talk to you all three months from now.

Operator

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

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Source: Reliance Steel & Aluminum Co. Q2 2008 Earnings Call Transcript

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