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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2008
Commission File Number 333-146181
METALS USA HOLDINGS CORP.
(Exact name of Registrant as Specified in its Charter)
Delaware | 20-3779274 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
One Riverway, Suite 1100 Houston, Texas | 77056 | |
(Address of Principal Executive Offices) | (Zip Code) |
Registrants’ telephone number, including area code: (713) 965-0990
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 x No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “accelerated filer, large accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes ¨ No x
Number of shares of common stock outstanding at November 3, 2008 of Metals USA Holdings Corp.: 14,077,500
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SAFE HARBOR STATEMENT—FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains statements reflecting assumptions, expectations, projections, intentions or beliefs about future events that are intended as “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this Quarterly Report, other than statements of historical fact, that address activities, events or developments that we expect, believe or anticipate will or may occur in the future are forward-looking statements. These statements appear in a number of places, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements represent our reasonable judgment on the future based on various factors and using numerous assumptions and are subject to known and unknown risks, uncertainties and other factors that could cause our actual results and financial position to differ materially from those contemplated by the statements. You can identify these statements by the fact that they do not relate strictly to historical or current facts. They use words such as “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “may,” “should,” “plan,” “project” and other words of similar meaning. In particular, these include, but are not limited to, statements relating to the following:
• | projected operating or financial results, including anticipated cash flows from operations and asset sale proceeds; |
• | expectations regarding capital expenditures, interest expense and other payments; |
• | our beliefs and assumptions relating to our liquidity position, including our ability to adapt to changing market conditions; and |
• | our ability to compete effectively for market share with industry participants. |
Any or all of our forward-looking statements may turn out to be wrong. They can be affected by inaccurate assumptions or by known or unknown risks, uncertainties and other factors including, among others:
• | supply, demand, prices and other market conditions for steel and other commodities; |
• | the timing and extent of changes in commodity prices; |
• | the effects of competition in our business lines; |
• | the condition of the steel and metal markets generally, which will be affected by interest rates, foreign currency fluctuations and general economic conditions; |
• | the ability of our counterparties to satisfy their financial commitments; |
• | tariffs and other government regulations relating to our products and services; |
• | adverse developments in our relationship with both our key employees and unionized employees; |
• | operational factors affecting the ongoing commercial operations of our facilities, including catastrophic weather-related damage, regulatory approvals, permit issues, unscheduled blackouts, outages or repairs, unanticipated changes in fuel costs or availability of fuel emission credits or workforce issues; |
• | our ability to operate our businesses efficiently, manage capital expenditures and costs (including general and administrative expenses) and generate earnings and cash flow; |
• | our substantial indebtedness; |
• | general political conditions and developments in the United States and in foreign countries whose affairs affect supply, demand and markets for steel, other metals and metal products; |
• | our ability to retain key employees; and |
• | our expectations with respect to our acquisition activity. |
In addition, there may be other factors that could cause our actual results to be materially different from the results referenced in the forward-looking statements, some of which are included elsewhere in this Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Many of these factors will be important in determining our actual future results. Consequently, no forward-looking statement can be guaranteed. Our actual future results may vary materially from those expressed or implied in any forward-looking statements. All forward-looking statements contained in this Form 10-Q are qualified in their entirety by this cautionary statement. Forward-looking statements speak only as of the date they are made, and we disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of this Form 10-Q, except as otherwise required by applicable law.
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METALS USA HOLDINGS CORP. AND
SUBSIDIARIES
PART I.—FINANCIAL INFORMATION | ||||
Item 1. | Financial Statements | |||
Unaudited Condensed Consolidated Balance Sheets at September 30, 2008 and December 31, 2007 | 3 | |||
4 | ||||
5 | ||||
Notes to Unaudited Condensed Consolidated Financial Statements | 6 | |||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 28 | ||
Item 3. | 49 | |||
Item 4. | 49 | |||
PART II.—OTHER INFORMATION | ||||
Item 1. | 51 | |||
Item 1A. | 51 | |||
Item 2. | 51 | |||
Item 3. | 51 | |||
Item 4. | 51 | |||
Item 5. | 51 | |||
Item 6. | 51 | |||
52 | ||||
Certifications |
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share amounts)
September 30, 2008 | December 31, 2007 | |||||||
Assets | ||||||||
Current Assets: | ||||||||
Cash and cash equivalents | $ | 173.1 | $ | 13.6 | ||||
Accounts receivable, net of allowance of $8.7 and $8.3, respectively | 277.8 | 196.8 | ||||||
Inventories | 562.5 | 409.8 | ||||||
Deferred income tax asset | 22.0 | 19.7 | ||||||
Prepayments and other | 7.3 | 7.5 | ||||||
Total current assets | 1,042.7 | 647.4 | ||||||
Property and equipment, net | 190.1 | 202.1 | ||||||
Assets held for sale, net | 1.8 | — | ||||||
Intangible assets, net | 16.3 | 23.3 | ||||||
Goodwill | 57.9 | 60.2 | ||||||
Other assets | 26.5 | 26.0 | ||||||
Total assets | $ | 1,335.3 | $ | 959.0 | ||||
Liabilities and Stockholders’ Deficit | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 85.1 | $ | 75.5 | ||||
Accrued liabilities | 81.5 | 63.3 | ||||||
Current portion of long-term debt | 1.6 | 2.3 | ||||||
Total current liabilities | 168.2 | 141.1 | ||||||
Long-term debt, less current portion | 1,116.2 | 855.0 | ||||||
Deferred income tax liability | 64.5 | 67.4 | ||||||
Other long-term liabilities | 24.2 | 21.1 | ||||||
Total liabilities | 1,373.1 | 1,084.6 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ Deficit: | ||||||||
Common stock, $.01 par value, 30,000,000 shares authorized, 14,077,500 issued and outstanding at September 30, 2008 and December 31, 2007 | 0.1 | 0.1 | ||||||
Additional paid-in capital | 6.3 | 0.7 | ||||||
Retained deficit | (47.5 | ) | (127.1 | ) | ||||
Accumulated other comprehensive income | 3.3 | 0.7 | ||||||
Total stockholders’ deficit | (37.8 | ) | (125.6 | ) | ||||
Total liabilities and stockholders’ deficit | $ | 1,335.3 | $ | 959.0 | ||||
See notes to unaudited condensed consolidated financial statements.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Net Sales | $ | 617.7 | $ | 469.6 | $ | 1,699.8 | $ | 1,413.1 | ||||||||
Operating costs and expenses: | ||||||||||||||||
Cost of sales (exclusive of operating and delivery, and depreciation and amortization shown below) | 446.4 | 363.2 | 1,245.9 | 1,083.2 | ||||||||||||
Operating and delivery | 48.6 | 43.7 | 144.6 | 133.6 | ||||||||||||
Selling, general and administrative | 33.9 | 28.3 | 96.5 | 86.5 | ||||||||||||
Depreciation and amortization | 5.3 | 5.2 | 16.2 | 15.5 | ||||||||||||
Gain on sale of property and equipment | (0.9 | ) | — | (2.4 | ) | — | ||||||||||
Impairment of property and equipment | — | — | — | 0.2 | ||||||||||||
Operating income | 84.4 | 29.2 | 199.0 | 94.1 | ||||||||||||
Other (income) expense: | ||||||||||||||||
Interest expense | 20.4 | 24.7 | 65.4 | 63.7 | ||||||||||||
Loss on extinguishment of debt | — | 8.4 | — | 8.4 | ||||||||||||
Other (income) expense, net | 0.2 | (0.7 | ) | 0.2 | (0.8 | ) | ||||||||||
Income (loss) before income taxes | 63.8 | (3.2 | ) | 133.4 | 22.8 | |||||||||||
Provision for income taxes | 27.8 | 0.2 | 53.8 | 10.7 | ||||||||||||
Net income (loss) | $ | 36.0 | $ | (3.4 | ) | $ | 79.6 | $ | 12.1 | |||||||
See notes to unaudited condensed consolidated financial statements.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Nine Months Ended September 30, | ||||||||
2008 | 2007 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 79.6 | $ | 12.1 | ||||
Adjustments to reconcile net income to net cash (used in) provided by operating activities: | ||||||||
(Gain) loss on sale of property and equipment | (2.4 | ) | — | |||||
Impairment of property and equipment | — | 0.2 | ||||||
Provision for bad debts | 2.3 | 1.7 | ||||||
Depreciation and amortization | 18.2 | 16.6 | ||||||
Loss on debt extinguishment | — | 8.4 | ||||||
Amortization of debt issuance costs and discounts on long-term debt | 4.4 | 3.6 | ||||||
Deferred income taxes | (1.9 | ) | (4.5 | ) | ||||
Stock-based compensation | 0.8 | 4.5 | ||||||
Changes in operating assets and liabilities, net of acquisitions: | ||||||||
Accounts receivable | (81.8 | ) | (16.4 | ) | ||||
Inventories | (152.7 | ) | 50.6 | |||||
Prepayments and other | (0.6 | ) | 3.5 | |||||
Accounts payable and accrued liabilities | 26.9 | 14.2 | ||||||
Other | 9.5 | 3.7 | ||||||
Net cash (used in) provided by operating activities | (97.7 | ) | 98.2 | |||||
Cash flows from investing activities: | ||||||||
Sales of assets | 9.5 | 1.0 | ||||||
Purchases of assets | (8.9 | ) | (16.0 | ) | ||||
Acquisition costs, net of cash acquired | — | (38.4 | ) | |||||
Net cash provided by (used in) investing activities | 0.6 | (53.4 | ) | |||||
Cash flows from financing activities: | ||||||||
Borrowings on credit facility | 959.5 | 337.0 | ||||||
Repayments on credit facility | (698.0 | ) | (366.0 | ) | ||||
Issuances of long-term debt | — | 291.0 | ||||||
Repayments of long-term debt | (2.3 | ) | (150.5 | ) | ||||
Deferred financing costs | (2.6 | ) | (6.3 | ) | ||||
Dividends paid | — | (288.5 | ) | |||||
Net cash provided by (used in) financing activities | 256.6 | (183.3 | ) | |||||
Net increase (decrease) in cash and cash equivalents | 159.5 | (138.5 | ) | |||||
Cash and cash equivalents, beginning of period | 13.6 | 155.8 | ||||||
Cash and cash equivalents, end of period | $ | 173.1 | $ | 17.3 | ||||
Supplemental Cash Flow Information: | ||||||||
Cash paid for interest | $ | 58.1 | $ | 44.3 | ||||
Cash paid for income taxes | $ | 28.1 | $ | 21.2 | ||||
See notes to unaudited condensed consolidated financial statements.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in millions, except share amounts)
1. Organization and Basis of Presentation
Organization
On May 18, 2005, Metals USA Holdings Corp. (formerly named Flag Holdings Corporation), a Delaware corporation (“Metals USA Holdings”), and its wholly owned subsidiary, Flag Acquisition Corporation, a Delaware corporation (“Flag Acquisition”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Metals USA, Inc. (“Metals USA”). On November 30, 2005, Flag Acquisition, then a wholly owned subsidiary of Flag Intermediate Holdings Corporation (“Flag Intermediate”) merged with and into Metals USA (the “Merger”), with Metals USA being the surviving corporation. Metals USA Holdings and its wholly owned subsidiaries, Flag Intermediate and Metals USA, are referred to collectively herein as the “Company.”
We believe that we are a leading provider of value-added processed carbon steel, stainless steel, aluminum and specialty metals, as well as manufactured metal components. For the nine months ended September 30, 2008, approximately 94% of our revenue was derived from our metals service center and processing activities, which are segmented into two groups: Flat Rolled and Non-Ferrous Group and Plates and Shapes Group. The remaining portion of our revenue was derived from our Building Products Group, which principally manufactures and sells aluminum products related to the residential remodeling industry. We purchase metal from primary producers that generally focus on large volume sales of unprocessed metals in standard configurations and sizes. In most cases, we perform the customized, value-added processing services required to meet the specifications provided by end-use customers. Our Plates and Shapes Group and Flat Rolled and Non-Ferrous Group customers are in the land and marine transportation, energy, aerospace, defense, electrical and appliance manufacturing, fabrication, furniture, commercial construction, and machinery and equipment industries. Our Building Products Group customers are primarily distributors and contractors engaged in the residential remodeling industry.
Basis of Presentation
Principles of Consolidation—The condensed consolidated financial statements include the accounts of Metals USA Holdings, Flag Intermediate, and Metals USA and its subsidiaries. Intercompany accounts and transactions have been eliminated in the consolidated financial statements.
Interim Financial Information—The interim consolidated financial statements included herein are unaudited; however, they include adjustments of a normal recurring nature which, in our opinion, are necessary to present fairly the interim consolidated financial information as of and for the periods indicated. Accounting measurements at interim dates inherently involve greater reliance on estimates than at year-end. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the entire year.
Use of Estimates and Assumptions—The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and (iii) the reported amount of net sales and expenses recognized during the periods presented. Adjustments made with respect to the use of estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements; accordingly, actual results could differ from these estimates.
Allowance for Doubtful Accounts—The determination of collectibility of the Company’s accounts receivable requires management to make frequent judgments and estimates in order to determine the appropriate amount of allowance needed for doubtful accounts. The Company’s allowance for doubtful accounts is estimated
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
to cover the risk of loss related to accounts receivable. This allowance is maintained at a level we consider appropriate based on historical and other factors that affect collectibility. These factors include historical trends of write-offs, recoveries and credit losses, the careful monitoring of customer credit quality, and projected economic and market conditions. Different assumptions or changes in economic circumstances could result in changes to the allowance.
Inventories—Inventories are stated at the lower of cost or market. Our inventories are accounted for using a variety of methods including specific identification, average cost and the first-in first-out method of accounting. Inventory quantities are regularly reviewed and provisions for excess or obsolete inventory are recorded primarily based on our forecast of future demand and market conditions.
Financial Derivatives—We use financial derivatives to mitigate the Company’s exposure to volatility in interest rates. The Company hedges only exposures in the ordinary course of business. The Company accounts for its derivative instruments in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activity” (“SFAS 133”), which requires all derivatives to be carried on the balance sheet at fair value and meet certain documentary and analytical requirements to qualify for hedge accounting treatment. Hedge accounting creates the potential for a statement of operations match between the changes in fair values of derivatives and the changes in cost of the associated underlying transactions, in this case interest expense. Derivatives held by the Company are designated as hedges of specific exposures at inception, with an expectation that changes in the fair value will essentially offset the change in cost for the underlying exposure. Fair values of derivatives are determined from market observation or dealer quotations. Interest rate swap derivatives outstanding at September 30, 2008, all have remaining terms of approximately three years or less and the associated underlying transactions are expected to occur within that time frame.
The effective portion of the change in fair value of derivatives is reported in other comprehensive income, a component of stockholders’ deficit, until the underlying transaction occurs. Any determination that an underlying transaction is not probable of occurring will result in the recognition in earnings of gains and losses deferred in other comprehensive income. Amounts due from counterparties (unrealized hedge gains) or owed to counterparties (unrealized hedge losses) are included in other assets and accrued liabilities, respectively.
See Note 5 for additional information on underlying hedge categories, notional and fair values of derivatives, types and classifications of derivatives used, and gains and losses from hedging activity.
Goodwill—We use estimates and judgments to allocate the purchase price paid for acquisitions to the fair value of net tangible and identifiable intangible assets acquired. Goodwill represents the excess of the cost of an acquired business over the net amounts assigned to assets acquired and liabilities assumed.
Intangible Assets—Intangible assets consist primarily of customer lists. We are amortizing the customer lists over five years using an accelerated amortization method which approximates their useful life and economic value to us.
Debt Issuance Costs—We defer certain expenses incurred to obtain debt financing and amortize these costs to interest expense over the terms of the respective agreements. See Note 6 for additional information on debt issuance costs.
Fair Value of Financial Assets and Liabilities—Statement of Financial Accounting Standard No. 157 “Fair Value Measurements” (“SFAS 157”) defines fair value as the exchange price that would be received for an asset
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 classifies the inputs used to measure fair value into the following hierarchy:
Level 1—Quoted prices in active markets for identical assets or liabilities. The Company uses stock quotes from an active, established stock market for the valuation of its short-term investments, which are reported in other current assets in the Company’s consolidated balance sheet.
Level 2—Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company’s interest rate swap derivatives are valued using market data which is derived by combining certain inputs with quantitative models and processes to generate interest rate forward curves and discount factors (see Note 5).
Level 3—Unobservable inputs that are supported by little or no market activity, but which are significant to the fair value of the assets or liabilities as determined by market participants.
Assets and liabilities measured at fair value on a recurring basis are summarized below:
Fair Value Measurements as of September 30, 2008 | ||||||||||||
Total | Level 1 | Level 2 | Level 3 | |||||||||
Short-term investments | $ | 0.2 | $ | 0.2 | $ | — | $ | — | ||||
Interest rate swaps | 2.7 | — | 2.7 | — | ||||||||
Total | 2.9 | 0.2 | 2.7 | — | ||||||||
Unrealized gains or losses on short-term investments and derivatives are recorded in accumulated other comprehensive income (loss) at each measurement date.
Revenue recognition—We recognize revenues generally when products are shipped and our significant obligations have been satisfied. Shipping and handling costs billed to our customers are accounted for as revenues. Risk of loss for products shipped passes at the time of shipment. Provisions are made currently for estimated returns.
Cost of sales—Our Plates and Shapes and Flat Rolled and Non-Ferrous Groups classify, within cost of sales, the underlying commodity cost of metal purchased in mill form, the cost of inbound freight charges together with third-party processing cost, if any.
Cost of sales for our Building Products Group includes the cost of raw materials, manufacturing labor and overhead costs, together with depreciation and amortization expense associated with property, buildings and equipment used in the manufacturing process.
Operating and delivery expense—Our operating and delivery expense reflects the cost incurred by our Plates and Shapes and Flat Rolled and Non-Ferrous Groups for labor and facility costs associated with the value- added metal processing services that we provide. With respect to our Building Products Group, operating costs are associated with the labor and facility costs attributable to the warehousing of our finished goods at our sales center facilities. Delivery expense reflects labor, material handling and other third party costs incurred with the delivery of product to customers.
Delivery expense totaled $13.5, $11.8, $39.8 and $35.0 for the three and nine months ended September 30, 2008 and 2007, respectively.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
Selling, general and administrative expenses—Selling, general and administrative expenses include sales and marketing expenses, executive officers’ compensation, office and administrative salaries, insurance, accounting, legal, computer systems and professional services costs not directly associated with the processing, manufacturing, operating or delivery costs of our products.
Depreciation and amortization—Depreciation and amortization expense represents the costs associated with property, buildings and equipment used throughout the Company except for depreciation and amortization expense associated with the manufacturing assets employed by our Building Products Group, which is included within cost of sales. This caption also includes amortization of intangible assets.
Foreign Currency Translation—The functional currency for our Canadian subsidiary, Allmet, is the Canadian dollar. We translate the functional currency into U.S. dollars based on the current exchange rate at the end of the period for the balance sheet and a weighted average rate for the period on the statement of operations. The resulting translation adjustments are recorded in accumulated other comprehensive income (loss), a component of stockholders’ deficit.
New Accounting Pronouncements
In May 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 162, “Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). This statement is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements of nongovernmental entities that are presented in conformity with GAAP. This statement will be effective 60 days following the U.S. Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendment to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 162 on its consolidated financial statements.
In April 2008, the FASB issued FASB Staff Position (“FSP”) No. SFAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP SFAS 142-3”). FSP SFAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). The intent of FSP SFAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141R (revised 2007), “Business Combinations” (“SFAS 141R”) and other applicable accounting literature. FSP SFAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and must be applied prospectively to intangible assets acquired after the effective date. The Company is currently evaluating the potential impact, if any, of FSP SFAS 142-3 on its consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”), which expands the disclosure requirements in SFAS 133 about an entity’s derivative instruments and hedging activities. SFAS 161’s disclosure provisions apply to all entities with derivative instruments subject to SFAS 133 and its related interpretations. The provisions also apply to related hedged items, bifurcated derivatives, and nonderivative instruments that are designated and qualify as hedging instruments. Entities with instruments subject to SFAS 161 must provide more robust qualitative disclosures and expanded quantitative disclosures. Such disclosures, as well as existing SFAS 133 required disclosures, generally will need to be presented for every annual and interim reporting period. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the potential impact of adopting SFAS 161, if any, on its consolidated financial statements.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”), which replaces SFAS 141. SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired in connection with a business combination. The Statement also establishes disclosure requirements that will enable users to evaluate the nature and financial effect of the business combination. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of an entity’s first fiscal year that begins after December 15, 2008. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 141R on the Company’s financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 requires that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 160 also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This Statement is effective as of the beginning of an entity’s first fiscal year beginning after December 15, 2008. The Company has not yet determined the impact, if any, that SFAS 160 will have on its financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 expands the use of fair value accounting but does not affect existing standards which require assets and liabilities to be carried at fair value. Under SFAS 159, a company may elect to use fair value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accounts payable, guarantees, issued debt and other eligible financial instruments. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company did not elect to measure additional financial assets and liabilities at fair value.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”), which requires the recognition of the funded status of benefit plans in the balance sheet. SFAS 158 also requires certain gains and losses that are deferred under current pension accounting rules to be recognized in accumulated other comprehensive income, net of tax effects. These deferred costs (or income) will continue to be recognized as a component of net periodic pension cost, consistent with current recognition rules. For entities with no publicly traded equity securities, the effective date for the recognition of the funded status is for fiscal years ending after June 15, 2007. In addition, the ability to measure the plans’ benefit obligations, assets and net periodic cost at a date prior to the fiscal year-end date is eliminated for fiscal years ending after December 15, 2008. The adoption of the recognition element of SFAS 158 had no effect on the Company’s financial statements. The adoption of the measurement date element of SFAS 158 is not expected to have a material impact on the Company’s financial statements.
In September 2006, the FASB issued SFAS 157, which enhances existing guidance for measuring assets and liabilities using fair value. SFAS 157 provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted market prices in active markets. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS 157, as it relates to financial assets and financial liabilities, was effective for the Company as of January 1, 2008. SFAS 157 did not require any new fair value measurements for existing assets and liabilities on the
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
Company’s balance sheet as of the date of adoption. Rather, the provisions of SFAS 157 are to be applied prospectively. As such, there was no impact to the Company’s financial statements as of the January 1, 2008 adoption date, and for the nine months ended September 30, 2008, we have included the Statement’s expanded disclosures about the use of fair value to measure assets and liabilities within the Company’s financial statements.
In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”), which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on at least an annual basis, until fiscal years beginning after November 15, 2008. The Company is currently evaluating the potential impact of adopting FSP FAS 157-2, if any, on its consolidated financial statements.
2. Acquisitions
2007 Acquisition
On July 2, 2007, we purchased the business operations of Lynch Metals (“Lynch Metals”), for approximately $42.4. The purchase price was funded by borrowings under the asset-based revolving credit facility entered into by Metals USA (the “ABL facility”) in connection with the Merger, $38.4 of which was paid at closing, and approximately $4.0 of which was deferred and is being paid in various installments over a period of two years from the closing date. The excess of the aggregate purchase price over the estimated fair value of net assets acquired was approximately $20.5, which was allocated to goodwill. The estimated fair value of accounts receivable, inventories, and property and equipment acquired were $4.4, $4.2 and $1.8, respectively. The estimated fair value of customer list and trade name intangible assets was $10.1 and $3.3, respectively. The estimated fair value of accounts payable and accrued liabilities assumed was $2.3. In connection with the completion of the valuation of property and equipment in the second quarter of 2008, $0.4 was reclassified from goodwill to property and equipment. The results of operations for the Lynch Metals acquisition are included in the Company’s consolidated results of operations beginning July 2, 2007.
Lynch Metals is a value-added, metal service center that focuses on specialty aluminum, with locations in New Jersey and California. Lynch Metals uses enhanced technologies in slitting, shearing, and cut-to-length to service the just-in-time requirements of its customers, who are predominately manufacturers of air/heat transfer products specifically focused on aerospace, automotive and industrial applications. This acquisition is an important strategic addition to our Flat Rolled and Non-Ferrous Group because it supports our continued shift in product mix from ferrous products to non-ferrous and stainless products and strengthens our non-ferrous presence in the strategic Northeast and Southern California regions. Lynch Metals’ product line and processing capabilities are highly complementary to our Flat Rolled and Non-Ferrous segment, and we expect to expand sales of Lynch Metals’ non-ferrous products into our existing geographic base, as well as expand sales of non-ferrous and stainless products into Lynch Metals’ geographic base.
Pro Forma Results
The following unaudited pro forma information presents the Company’s consolidated results of operations for the nine months ended September 30, 2007 as if the Lynch Metals acquisition had occurred on January 1, 2007.
Nine Months Ended September 30, 2007 | |||
Revenues | $ | 1,428.7 | |
Net Income | 12.9 |
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
3. Inventories
Inventories consist of the following:
September 30, 2008 | December 31, 2007 | |||||
Raw materials— | ||||||
Plates and Shapes | $ | 341.9 | $ | 222.9 | ||
Flat Rolled and Non-Ferrous | 149.9 | 117.0 | ||||
Building Products | 13.5 | 13.6 | ||||
Total raw materials | 505.3 | 353.5 | ||||
Work-in-process and finished goods— | ||||||
Plates and Shapes | — | — | ||||
Flat Rolled and Non-Ferrous | 38.8 | 35.8 | ||||
Building Products | 18.4 | 20.5 | ||||
Total work-in-process and finished goods | 57.2 | 56.3 | ||||
Total inventories | $ | 562.5 | $ | 409.8 | ||
4. Intangible Assets
The carrying amounts of the Company’s intangible assets are as follows:
September 30, 2008 | December 31, 2007 | |||||||
Customer lists | $ | 41.6 | $ | 41.6 | ||||
Effect of foreign currency | 0.1 | 0.5 | ||||||
Less: Accumulated amortization | (28.6 | ) | (22.2 | ) | ||||
$ | 13.1 | $ | 19.9 | |||||
Trade name | $ | 3.3 | $ | 3.3 | ||||
Less: Accumulated amortization | (0.2 | ) | (0.1 | ) | ||||
$ | 3.1 | $ | 3.2 | |||||
Patents | $ | 0.6 | $ | 0.6 | ||||
Less: Accumulated amortization | (0.5 | ) | (0.4 | ) | ||||
$ | 0.1 | $ | 0.2 | |||||
Aggregate amortization expense for the three and nine months ended September 30, 2008 and 2007 was $2.0, $6.6, $2.2 and $6.9, respectively.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
The following table represents the total estimated amortization of customer list intangible assets, excluding the effect of foreign currency, for the five succeeding years:
For the Year Ending | Estimated Amortization Expense | ||
2008 (remaining three months) | $ | 2.0 | |
2009 | $ | 5.4 | |
2010 | $ | 3.6 | |
2011 | $ | 1.6 | |
2012 | $ | 0.5 |
5. Derivatives
In February 2008, we entered into a series of interest rate swap agreements that entitle us to receive quarterly payments of interest at a floating rate indexed to the three-month London Interbank Offered Rate (“LIBOR”) and pay a fixed rate that ranges from 2.686% to 2.997%, thereby converting a portion of the outstanding borrowings on our ABL facility from a floating rate obligation to a fixed rate obligation. The interest rate swap agreements all have initial terms of approximately three years or less and the associated underlying transactions are expected to occur within that time frame.
We have designated the interest rate swaps as cash flow hedges for accounting purposes. We account for these hedges in accordance with SFAS 133, and therefore defer in accumulated other comprehensive income (loss), a component of stockholders’ deficit, the effective portion of cash flow hedging gains and losses that equal the change in cost of the underlying hedged transactions. As the underlying hedged transactions occur, the associated deferred hedging gains and losses are reclassified into earnings to match the change in cost of the transaction.
Below are the notional transaction amounts and fair value for the Company’s outstanding derivatives at September 30, 2008. Because we hedge only with derivatives that have high correlation with the underlying transaction cost, changes in derivatives fair value and the underlying cost are expected to largely offset.
September 30, 2008 | ||||||
Notional Amount | Fair Value | |||||
Interest rate swaps | $ | 250.0 | $ | 2.7 | ||
We recognized a pretax loss of $2.4 in earnings (interest expense) during the nine months ended September 30, 2008, which was due to the change in fair value of the interest rate swap derivatives previous to their qualification for hedge accounting treatment. Other pretax realized gains and losses from derivatives which were recognized in earnings during the nine months ended September 30, 2008, subsequent to qualification for hedge accounting treatment, amounted to $0.2 of additional interest expense. These gains and losses effectively offset changes in the cost of the Company’s hedged exposure, and no amount of such gains and losses resulted from hedge ineffectiveness, nor was any component of these gains and losses excluded from the Company’s assessment of hedge effectiveness. The fair value of the Company’s interest rate swaps was $2.7 at September 30, 2008, with $1.6 classified as other current assets and $1.1 classified as other noncurrent assets in the consolidated balance sheet.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
6. Other Assets
Other assets consist of the following:
September 30, 2008 | December 31, 2007 | |||||
Deferred financing costs | $ | 8.7 | $ | 7.9 | ||
Deferred debt offering costs | 10.0 | 11.3 | ||||
Deferred management fees | 5.2 | 6.1 | ||||
Noncurrent portion of interest rate swaps | 1.1 | — | ||||
Other | 1.5 | 0.7 | ||||
Total other assets | $ | 26.5 | $ | 26.0 | ||
Aggregate amortization of debt issuance costs for the three and nine months ended September 30, 2008 and 2007 was $1.1, $3.1, $4.8 and $6.4, respectively.
7. Accrued Liabilities
Accrued liabilities consist of the following:
September 30, 2008 | December 31, 2007 | |||||
Accrued salaries and employee benefits | $ | 20.7 | $ | 15.2 | ||
Accrued income taxes | 10.6 | — | ||||
Accrued taxes, other than income | 5.0 | 4.4 | ||||
Accrued interest | 20.5 | 13.8 | ||||
Accrued insurance | 5.2 | 5.1 | ||||
Accrued audit and tax fees | 2.5 | 0.6 | ||||
Accrued warranty liability | 0.5 | 0.5 | ||||
Accrued lease terminations | 0.3 | 0.5 | ||||
Accrued management fees | 5.3 | 6.6 | ||||
Accrued Merger consideration—Predecessor common shares outstanding | 8.1 | 8.1 | ||||
Other | 2.8 | 8.5 | ||||
Total accrued liabilities | $ | 81.5 | $ | 63.3 | ||
8. Debt
Debt consists of the following:
September 30, 2008 | December 31, 2007 | |||||
Senior Secured Asset-Based Revolving Credit Facility (ABL facility) | $ | 542.0 | $ | 280.5 | ||
11 1/8% Senior Secured Notes due 2015 (Metals USA Notes) | 275.0 | 275.0 | ||||
Senior Floating Rate Toggle Notes due 2012 (2007 Notes) | 293.2 | 291.9 | ||||
Industrial Revenue Bond | 5.7 | 5.7 | ||||
Other | 1.9 | 4.2 | ||||
Total debt | 1,117.8 | 857.3 | ||||
Less—current portion of debt | 1.6 | 2.3 | ||||
Total long-term portion of debt | $ | 1,116.2 | $ | 855.0 | ||
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
The weighted average interest rates under the ABL facility for the three and nine months ended September 30, 2008 and 2007 were 3.93%, 4.44%, 6.76% and 7.14%, respectively.
Senior Secured Asset-Based Revolving Credit Facility
The ABL facility permits us to borrow on a revolving basis through November 30, 2011. Substantially all of our subsidiaries are borrowers under the ABL facility.
On June 8, 2007, we executed an amendment to the ABL facility (the “June 2007 amendment”), which increased the commitment from $450.0 to $525.0, comprised of $500.0 of Tranche A Commitments and $25.0 of Tranche A-1 Commitments. Additionally, the June 2007 amendment reduced the borrowing cost on the Tranche A facility by 25 basis points, reduced the borrowing cost on the Tranche A-1 facility by 75 basis points and gave us the option to increase the Tranche A Commitments by $100.0. The June 2007 amendment did not have any impact on our covenant compliance. Costs incurred in connection with the June 2007 amendment totaled $1.6, and are being amortized over the existing term of the ABL facility, which expires November 30, 2011.
On July 1, 2008, we executed our option to increase the Tranche A Commitments by $100.0, which increased the total commitment from $525.0 to $625.0. All other existing terms under the ABL facility remained unchanged. Costs incurred to exercise the option to increase the ABL facility totaled $2.4, and are being amortized over the existing term of the ABL facility.
The maximum availability under the ABL facility is based on eligible receivables and eligible inventory, subject to certain reserves. During September 2008, we borrowed approximately $160.0 on the ABL facility in response to concerns about credit markets. As of September 30, 2008, we had eligible collateral of $618.7, $542.0 in outstanding advances, $15.2 in open letters of credit and $61.5 of additional borrowing capacity. As of September 30, 2008, we had $173.1 of available cash and cash equivalents.
The obligations under the ABL facility are guaranteed by the Company and certain of our domestic subsidiaries and are secured (i) on a first-priority lien basis by accounts receivable and inventory and (ii) on a second-priority lien basis by other assets, subject to certain exceptions and permitted liens.
The ABL facility bears interest with respect to loans utilizing the Tranche A Commitments at the bank’s base rate plus an applicable margin ranging between -0.25% and -0.50%, or LIBOR, at our option, plus an applicable margin ranging between 1.00% and 1.75% as determined in accordance with the amended loan and security agreement governing the ABL facility. The ABL facility bears interest with respect to the Tranche A-1 Commitments at the bank’s base rate plus an applicable margin of 0.75%, or LIBOR, at our option, plus an applicable margin of 2.75% under the June 2007 amendment. The marginal rates related to the Tranche A Commitments will vary with our financial performance as measured by the fixed charge coverage ratio (the “FCCR”). The FCCR is determined by dividing (i) the sum of Adjusted EBITDA (as defined by the loan and security agreement governing the ABL facility) minus income taxes paid in cash minus non-financed capital expenditures by (ii) the sum of certain distributions paid in cash, cash interest expense and scheduled principal reductions on debt, and is calculated based on such amounts for the most recent period of four consecutive fiscal quarters. As long as our borrowing availability is greater than or equal to $45.0, we do not have to maintain a minimum fixed charge coverage ratio. Should borrowing availability fall below $45.0, we must maintain a fixed charge coverage ratio of at least 1.0 to 1.0. As of September 30, 2008, our FCCR was 3.21.
Interest on base rate loans is payable on the last day of each quarter. Interest on LIBOR loans is payable on maturity of the LIBOR loan or on the last day of the quarter if the term of the LIBOR loan exceeds 90 days. A
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
commitment fee of 0.25% per annum is payable on any unused commitments under the ABL facility. The applicable base rate and the effective LIBOR rate for the Tranche A Commitments and Tranche A-1 Commitments were 5.00% and 4.05%, respectively, as of September 30, 2008.
The loan and security agreement governing the ABL facility requires us to comply with limited affirmative, negative and subjective covenants, the most significant of which are: (i) the maintenance of a borrowing base availability of at least $45.0, or, if such required borrowing base availability is not maintained, the maintenance of the FCCR, (ii) restrictions on additional indebtedness and (iii) restrictions on liens, guarantees and quarterly dividends. There are no limitations with respect to capital expenditures.
The loan and security agreement governing the ABL facility provides for up to $15.0 of swingline loans and up to $100.0 for the issuance of letters of credit. Both the face amount of any outstanding letters of credit and any swingline loans will reduce borrowing availability under the ABL facility on a dollar-for-dollar basis.
The ABL facility contains customary representations, warranties and covenants as a precondition to lending, which includes a material adverse change in the business, limitations on our ability to incur or guarantee additional debt, subject to certain exceptions, pay dividends, or make redemptions and repurchases with respect to capital stock, repay debt, create or incur certain liens, make certain loans or investments, make acquisitions or investments, engage in mergers, acquisitions, asset sales and sale lease-back transactions, and engage in certain transactions with affiliates. In addition, the ABL facility requires a lock-box arrangement, which as long as borrowing availability is greater or equal to $45.0 and in the absence of default, is controlled by the Company.
The ABL facility contains events of default with respect to: default in payment of principal when due, default in the payment of interest, fees or other amounts after a specified grace period, material breach of the representations or warranties, default in the performance of specified covenants, failure to make any payment when due under any indebtedness with a principal amount in excess of a specified amount, certain bankruptcy events, certain ERISA violations, invalidity of certain security agreements or guarantees, material judgments or a change of control. In the event of default the agreement may permit the lenders to: (i) restrict the account or refuse to make revolving loans; (ii) cause customer receipts to be applied against borrowings under the ABL facility causing the Company to suffer a rapid loss of liquidity and the ability to operate on a day-to-day basis; (iii) restrict or refuse to provide letters of credit; or ultimately: (iv) terminate the commitments and the agreement; or (v) declare any or all obligations to be immediately due and payable if such default is not cured in the specified period required. Any payment default or acceleration under the ABL facility would also result in a default under the Metals USA Notes and the 2007 Notes that would provide the holders of the Metals USA Notes and the 2007 Notes with the right to demand immediate repayment. We are in compliance with all covenants as of September 30, 2008.
In February 2008, $250.0 notional amount of outstanding borrowings under the ABL facility was swapped from a floating LIBOR-based rate to a fixed rate (see Note 5).
Costs related to the establishment of the ABL facility, in addition to subsequent amendments to the ABL facility, were capitalized and are being charged to interest expense over the life of the ABL facility. Unamortized issuance costs of $8.7 as of September 30, 2008, are included in other non-current assets.
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
Senior Floating Rate Toggle Notes due 2012
On July 10, 2007, Metals USA Holdings issued $300.0 initial aggregate principal amount of Senior Floating Rate Toggle Notes due 2012 (the “2007 Notes”). The 2007 Notes are senior unsecured obligations that are not guaranteed by any of Metals USA Holdings’ subsidiaries. As such, the 2007 Notes are structurally subordinated to all indebtedness and other liabilities (including trade payables) of Metals USA Holdings’ subsidiaries.
The initial five interest payments on the 2007 Notes were paid solely in cash. Metals USA Holdings must make an election regarding whether subsequent interest payments will be made in cash or through PIK Interest prior to the start of the applicable interest period. Metals USA Holdings may elect to pay interest (1) entirely in cash or (2) entirely by increasing the principal amount of the 2007 Notes or issuing new 2007 Notes (“PIK Interest”), or (3) on 50% of the outstanding principal amount of the 2007 Notes in cash and on 50% of the outstanding principal amount of the 2007 Notes by increasing the principal amount of the outstanding 2007 Notes or by issuing new 2007 Notes (“Partial PIK Interest”). Cash interest on the 2007 Notes will accrue at a rate per annum, reset quarterly, equal to LIBOR plus a spread of 6.00%, which increases by 0.25% to 6.25% in year 2, by 0.50% to 6.50% in year 3, and by 0.75% to 6.75% in year 4. In the event PIK Interest is paid on the 2007 Notes after the first four interest periods, the then-applicable margin over LIBOR on the 2007 Notes would increase by 0.75% for each period in which PIK Interest is paid. If Metals USA Holdings elects to pay any PIK Interest, Metals USA Holdings will increase the principal amount on the 2007 Notes or issue new 2007 Notes in an amount equal to the amount of PIK Interest for the applicable interest payment period to holders of the 2007 Notes on the relevant record date. Interest is payable quarterly in arrears on January 1, April 1, July 1 and October 1. PIK Interest notes, resulting from the conversion of interest into PIK notes, when paid will be treated as an operating activity in the Consolidated Statements of Cash Flows in accordance with SFAS No. 95 “Statement of Cash Flows” (“SFAS 95”).
Flag Intermediate provided funds to Metals USA Holdings to fund the initial five quarterly interest payments on the 2007 Notes, which were paid on October 1, 2007, January 2, 2008, April 1, 2008, July 1, 2008, and October 1, 2008 and which totaled $7.7, $8.4, $8.1, $6.5 and $6.6, respectively.
On September 26, 2008, we made a permitted election under the indenture governing the 2007 Notes to pay all interest that is due on January 1, 2009, for the interest period beginning on October 1, 2008, and ending on December 31, 2008, entirely through PIK Interest. The Company must make an election regarding whether subsequent interest payments will be made in cash, through PIK Interest, or Partial PIK Interest, prior to the start of the applicable interest period. In the absence of such an election for any interest period, interest on the 2007 Notes will be payable according to the election for the previous interest period. As a result, the PIK Interest election is now the default election for future interest periods unless we elect otherwise not later than the commencement of an interest period.
The terms of the ABL facility, as well as the indenture governing the Metals USA Notes, restrict Flag Intermediate and certain of its subsidiaries from making payments or transferring assets to Metals USA Holdings, including dividends, loans, or distributions. Such restrictions include prohibition of dividends in an event of default and limitations on the total amount of dividends paid to Metals USA Holdings. In the event these agreements do not permit Flag Intermediate to provide Metals USA Holdings with sufficient distributions to fund interest and principal payments on the 2007 Notes when due, Metals USA Holdings may default on the 2007 Notes unless other sources of funding are available. Amounts available under these restricted payment provisions amounted to $75.3 under the indenture governing the Metals USA Notes and $130.4 under the loan and security agreement governing the ABL facility as of September 30, 2008.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
On or after January 15, 2008, Metals USA Holdings may redeem some or all of the 2007 Notes at certain redemption prices, plus accrued and unpaid interest and additional interest, if any, to the redemption date. If Metals USA Holdings makes certain public offerings, sales or issuances of common stock, and does not redeem the 2007 Notes, it will be required to make an offer to repurchase the maximum principal amount of the 2007 Notes that may be purchased out of the proceeds thereof, at a price equal to 100% of the principal amount, plus accrued and unpaid interest and additional interest, if any, to the date of repurchase.
If Metals USA Holdings experiences a change of control and does not redeem the 2007 Notes, it will be required to make an offer to repurchase the 2007 Notes at a price equal to 101% of the principal amount, plus accrued interest and unpaid interest and additional interest, if any, to the date of repurchase.
We will pay interest on overdue principal at 1% per annum in excess of the rates discussed above and will pay interest on overdue installments of interest at such higher rate to the extent lawful. The indenture governing the 2007 Notes contains covenants described under “Covenant Compliance” below.
The indenture governing the 2007 Notes contains covenants that, among other things, limit Metals USA Holdings’ ability and the ability of certain of its subsidiaries to incur or guarantee additional indebtedness or issue disqualified or preferred stock, repurchase or redeem capital stock or subordinated indebtedness, pay dividends or make distributions to its stockholders, incur restrictions on the ability of its subsidiaries to pay dividends or to make other payments to Metals USA Holdings, transfer or sell assets, create liens, enter into transactions with affiliates, make investments or acquisitions, and merge or consolidate with other companies or transfer all or substantially all of its assets.
Our affiliates, which include Apollo Management V L.P. (“Apollo Management” and together with its affiliated investment entities “Apollo”), as well as our Chief Executive Officer and our Chief Financial Officer, have purchased a portion of our 2007 Notes in the market. As of September 30, 2008, the amount of outstanding 2007 Notes held by our affiliates was $91.4, $90.9 of which were held by Apollo, with the remainder held by the executive officers referred to above. From time to time, depending upon market, pricing and other conditions, as well on cash balances and liquidity, we, our subsidiaries or affiliates may seek to purchase or sell additional indebtedness of us or our affiliates. Any such future purchases or sales may be made in the open market, privately negotiated transactions, tender offers or otherwise.
On February 26, 2008, we exchanged $216.0 aggregate principal amount of the $300.0 aggregate principal amount privately placed 2007 Notes for substantially identical 2007 Notes registered under the Securities Act of 1933, as amended.
Costs related to the issuance of the 2007 Notes were capitalized and are being charged to interest expense over the life of the 2007 Notes. Unamortized issuance costs of $3.7 as of September 30, 2008, are included in other non-current assets.
11 1/8% Senior Secured Notes Due 2015
On November 30, 2005, Flag Acquisition sold $275.0 million aggregate principal amount of the Metals USA Notes. The Metals USA Notes bear interest at a rate per annum equal to 11 1/8%, payable semi-annually in arrears, on June 1 and December 1 of each year, commencing on June 1, 2006. The Metals USA Notes will mature on December 1, 2015. We may redeem some or all of the Metals USA Notes at any time on or after December 1, 2010 at a predetermined redemption price plus accrued and unpaid interest and additional interest, if any, to the applicable redemption date. In addition, on or prior to December 1, 2008, we may redeem up to 35% of the aggregate principal amount of the Metals USA Notes with the net proceeds of certain equity offerings. If
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
we experience a change of control and we do not redeem the Metals USA Notes, we will be required to make an offer to repurchase the Metals USA Notes at a price equal to 101% of the principal amount, plus accrued and unpaid interest and additional interest, if any, to the date of repurchase.
As a result of the Merger, Metals USA assumed the obligations of Flag Acquisition including the Metals USA Notes. All domestic operating subsidiaries of Metals USA have agreed, jointly and severally with Flag Intermediate (“Guarantors”), to unconditionally and irrevocably guarantee Metals USA’s obligations under the Metals USA Notes and Indenture dated as of November 30, 2005. Additionally, Flag Intermediate has unconditionally guaranteed to be a primary obligor of the due and punctual payment and performance of the obligations under the Indenture.
Metals USA Holdings is not a guarantor of the Metals USA Notes. There is a limitation on the amount of funds which can be transferred by the Guarantors to Metals USA Holdings in the form of dividends. The amount of dividends available for distribution to Metals USA Holdings was $75.3 as of September 30, 2008. Such amount available for distribution shall be increased by an amount equal to 50% of Consolidated Net Income, as defined, or reduced by an amount equal to 100% of Consolidated Net Loss, as defined.
The indebtedness evidenced by the Metals USA Notes and the guarantees will rank: equally with all of our and the Guarantors’ existing and future senior indebtedness; junior in priority as to collateral that secures the ABL facility on a first-priority lien basis with respect to our and the Guarantors’ obligations under the ABL facility, any other debt incurred after December 1, 2005 that has a priority security interest relative to the Metals USA Notes in the collateral that secures the ABL facility, any hedging obligations related to the foregoing debt and all cash management obligations incurred with any lender under the ABL facility; equal in priority as to collateral that secures the Metals USA Notes and the guarantees on a first-priority lien basis with respect to our and the Guarantors’ obligations under any other equivalent priority lien obligations incurred after December 1, 2005; and senior to all of our and the Guarantors’ existing and future subordinated indebtedness. The Metals USA Notes will also be effectively junior to the liabilities of the non-guarantor subsidiaries.
The Metals USA Notes contain covenants that are customary for debt instruments, including limitations on our or the guarantors’ ability to incur or guarantee additional debt, subject to certain exceptions, pay dividends, or make redemptions and repurchases with respect to capital stock, create or incur certain liens, make certain loans or investments, make acquisitions or investments, engage in mergers, acquisitions, asset sales and sale lease-back transactions, and engage in certain transactions with affiliates.
The Metals USA Notes indenture contains certain customary events of default, including (subject, in some cases, to customary cure periods thresholds) defaults based on (1) the failure to make payments under the Metals USA indenture when due, (2) breach of covenants, (3) cross-defaults to other material indebtedness, (4) bankruptcy events and (5) material judgments. We were in compliance with all covenants as of September 30, 2008.
Costs related to the establishment of the Metals USA Notes were capitalized and are being charged to interest expense over the life of the Metals USA Notes. Unamortized issuance costs of $6.3 as of September 30, 2008, are included in other non-current assets.
Industrial Revenue Bond
The Industrial Revenue Bond (“IRB”) is payable on May 1, 2016 in one lump sum payment. The interest rate assessed on the IRB varies from month to month and was 8.48% at September 30, 2008. The IRB is secured by real estate and equipment acquired with proceeds from the IRB. The IRB places various restrictions on certain
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
of our subsidiaries, including but not limited to maintenance of required insurance coverage, maintenance of certain financial ratios, limits on capital expenditures and maintenance of tangible net worth and is supported by a letter of credit. We were in compliance with all covenants as of September 30, 2008.
9. Stockholders’ Deficit
Common Stock—In accordance with its Certificate of Incorporation dated May 9, 2005, and as amended on November 28, 2005, Metals USA Holdings was authorized to issue 30,000,000 shares of capital stock, all of which were shares of common stock, $.01 par value. At September 30, 2008, 14,077,500 shares were issued and outstanding.
January 2007 Dividend—On January 3, 2007, Metals USA Holdings used the net proceeds from the issuance of $150.0 initial aggregate principal amount of Senior Floating Rate Toggle Notes due 2012 (the “2006 Notes”), as well as $8.2 of additional borrowings under the ABL facility, to pay a cash dividend of approximately $144.8 to its stockholders, which include Apollo and certain members of our management, to make a cash payment (partially in lieu of the cash dividend) of $4.2 to its vested stock option holders (the cash payment and the cash dividend are referred to collectively as the “January 2007 Dividend”), which include certain members of our management, and to pay fees and expenses related to the issuance of the 2006 Notes, including a $1.5 transaction fee to Apollo.
In connection with the January 2007 Dividend, the outstanding employee stock options under the Amended and Restated 2005 Stock Incentive Plan were adjusted a second time (see Note 10 for a discussion of the adjustments to the stock options). The combination of the reduction of the per share exercise price of the stock options and the cash payment to vested stock option holders was, on a per share basis, approximately equal to the per share amount of the dividend.
July 2007 Dividend—On July 10, 2007, Metals USA Holdings used the net proceeds from the issuance of the 2007 Notes, as well as approximately $8.3 of additional borrowings under the ABL facility, to redeem the 2006 Notes (for approximately $150.0 plus accrued and unpaid interest of approximately $5.4 ), to pay a cash dividend of approximately $130.3 to its stockholders, which include Apollo and certain members of management, to make a cash payment (partially in lieu of the cash dividend) of approximately $9.2 to its stock option holders (the cash payment and the cash dividend are referred to collectively as the “July 2007 Dividend”), which include certain members of our management, and to pay fees and expenses related to the offering of the 2007 Notes.
10. Stock-Based Compensation
Metals USA Holdings’ Amended and Restated 2005 Stock and Incentive Plan (the “Plan”) permits the issuance of options and restricted stock awards on Metals USA Holdings’ stock to employees and directors of, or consultants to, the Company, except that consultants may only receive awards with the consent of the president of Metals USA. A total of $0.1, $0.3, $0.8 and $4.5 were recorded as stock-based employee compensation during the three and nine months ended September 30, 2008 and 2007, respectively.
On January 3, 2007, the Board of Directors of Metals USA Holdings adopted the Metals USA Holdings Corp. 2006 Deferred Compensation Plan (the “Deferred Compensation Plan”). The Deferred Compensation Plan was adopted in connection with the January 2007 Dividend, and credits to individual accounts established for stock option holders an amount equal to $6.56 per share on certain unvested options, for a total of approximately $2.3. Payment of this liability is subject to continued employment for two years following the adoption date, and
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
will be paid in one lump sum upon completion of such period. Expense of $1.4 related to the Deferred Compensation Plan will be recognized over a two-year vesting period beginning on the date of adoption of the Deferred Compensation Plan. A total of $0.2, $0.6, $0.2 and $0.5 were recorded as deferred compensation during the three and nine months ended September 30, 2008 and 2007, respectively.
Description of Share Option Plan
The Plan has reserved for issuance up to 1.4 million shares of common stock. The Plan has two tranches of options, Tranche A and Tranche B. Tranche A options vest on a pro-rata basis over five years, have a term of ten years, and expire if not exercised. Tranche B options, which include both a service and a performance condition, vest on the eighth anniversary of the date of grant or earlier dependent on the satisfaction of an internal rate of return on capital invested, have a term of ten years from date of grant, and expire if not exercised. Awards are generally granted with an exercise price equal to the fair value of Metals USA Holdings’ stock at the date of grant. The fair value of the stock is a calculated value based on the date of each of the respective grants using a combination of discounted cash flows and financial metrics from companies with similar characteristics of Metals USA Holdings. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the Plan).
In connection with a $25.0 dividend paid to our stockholders in May 2006 (the “May 2006 Dividend”) and pursuant to the Plan’s provisions of rights preservation, the Board of Directors modified the outstanding options by reducing the per share exercise price by $1.78 in order to retain the participants’ rights proportionate with those prior to the dividend payment.
In connection with the January 2007 Dividend, the outstanding employee stock options under the Plan were adjusted a second time by an amount approximately equal to the per share amount of this dividend. The per share exercise price of the options granted on November 30, 2005, was decreased by $4.22 to $4.00 and the per share exercise price of the options granted on March 17, 2006, was reduced by $4.89 to $4.00.
Because the payment of the January 2007 Dividend resulted in the internal rate of return of the funds managed by Apollo with respect to its investment in Metals USA Holdings to be near 25%, the Board of Directors exercised its discretion under the Plan to vest all of the outstanding Tranche B options. In addition, the Board of Directors exercised its discretion to vest all Tranche A options granted to directors affiliated with Apollo. In connection with the accelerated vesting of these options, we recognized $1.8 of non-cash stock-based compensation expense, net of related tax effects, in the first quarter of 2007.
In connection with the July 2007 Dividend, stock option holders were paid approximately $9.25 per share on outstanding options (an amount equal to the per-share amount of the July 2007 Dividend), for a total of approximately $9.2. The cash payment to holders of outstanding options to acquire shares of Metals USA Holdings’ common stock was made to equitably adjust such option holders by the Metals USA Holdings Board of Directors pursuant to the exercise of its discretion to preserve the rights of options holders under the Plan. As a result of the cash payment on outstanding options, we were required to recognize $0.3 of non-cash stock-based compensation expense, net of related tax effects, in the third quarter of 2007.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
Tranche A Options
The fair value of Tranche A option awards was estimated on the date of grant using a black-scholes option valuation model. No options have been granted since the first quarter of 2006. The following is a summary of valuation assumptions for Tranche A option grants outstanding as of September 30, 2008:
Expected dividend yield | 0% | |
Expected stock price volatility | 54.7%-54.9% | |
Risk free interest rate | 4.0%-4.6% | |
Expected life of options (in years) | 6.5-10.0 |
The following is a summary of stock option activity for Tranche A options for the nine-month period ended September 30, 2008:
Weighted Average Fair Value | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (Years) | Number of Options | |||||||
Balance, December 31, 2007 | $ | 6.58 | $ | 4.00 | 595,630 | |||||
Granted | — | — | — | |||||||
Exercised | — | — | — | |||||||
Canceled or expired | — | — | — | |||||||
Balance, September 30, 2008 | $ | 6.58 | $ | 4.00 | 7.2 | 595,630 | ||||
Vested and Exercisable as of: | ||||||||||
September 30, 2008 | $ | 4.00 | 7.2 | 334,254 | ||||||
A summary of nonvested Tranche A stock options for the nine-month period ended September 30, 2008, is presented below:
Weighted Average Grant-Date Fair Value | Number of Options | |||||
Nonvested at December 31, 2007 | $ | 6.58 | 265,455 | |||
Granted | — | — | ||||
Vested | 6.58 | (4,079 | ) | |||
Exercised | — | — | ||||
Canceled or expired | — | — | ||||
Nonvested at September 30, 2008 | $ | 6.58 | 261,376 | |||
As of September 30, 2008, there was $1.0 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Tranche A options, which will be amortized over a remaining period of 2.2 years.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
Tranche B Options
The fair value of the Tranche B options was also estimated on the date of grant using the same option valuation model used for the Tranche A options. No options have been granted since the first quarter of 2006. The following is a summary of valuation assumptions for Tranche B option grants outstanding as of September 30, 2008:
Expected dividend yield | 0% | |
Expected stock price volatility | 54.3%-54.7% | |
Risk free interest rate | 4.0%-5.0% | |
Expected life of options (in years) | 8.0-10.0 |
The following is a summary of stock option activity for Tranche B options for the nine-month period ended September 30, 2008:
Weighted Average Fair Value | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (Years) | Number of Options | |||||||
Balance, December 31, 2007 | $ | 6.92 | $ | 4.00 | 395,631 | |||||
Granted | — | — | — | |||||||
Exercised | — | — | — | |||||||
Canceled or expired | — | — | — | |||||||
Balance, September 30, 2008 | $ | 6.92 | $ | 4.00 | 7.2 | 395,631 | ||||
Vested and Exercisable as of: | ||||||||||
September 30, 2008 | $ | 4.00 | 7.2 | 395,631 | ||||||
All Tranche B stock options outstanding as of September 30, 2008 are fully vested and exercisable.
Restricted Stock
The Plan allows for grants of restricted stock as long-term compensation for directors and employees of, or consultants to, the Company or any of its subsidiaries. Grants of restricted stock have a vesting period that is determined at the discretion of the Board of Directors. The Company amortizes stock-based compensation expense associated with restricted stock ratably over the vesting period. For the nine-month period ending September 30, 2008, there were no shares of nonvested restricted stock outstanding.
11. Income Taxes
As of September 30, 2008, our unrecognized tax benefits totaled $9.3, and based on the contingent and uncertain nature of our liability, we are unable to make an estimate of the period of potential cash settlement, if any, with respective taxing authorities. The total amount of unrecognized tax benefits that, if recognized, would impact the Company’s effective tax rate is $2.9 for the nine months ended September 30, 2008.
We file numerous consolidated and separate income tax returns in the United States and various foreign jurisdictions. We are no longer subject to U.S. Federal income tax examinations for years before 2002 and are no longer subject to state and local, or foreign income tax examinations for years before 2000.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
We account for any applicable interest and penalties on uncertain tax positions as a component of income tax expense. As of September 30, 2008, the liability for uncertain income taxes includes interest and penalties of $2.5, of which $1.1 and $1.6 is included in our statement of operations and impacted the Company’s effective income tax rate for the three and nine months ended September 30, 2008.
We expect total unrecognized tax benefits to decrease by $1.0 to $1.5 over the next twelve months due to the expiration of the statute of limitation for a filing position.
12. Segment and Related Information
The following tables show summarized financial information for our reportable segments. The amounts shown as an operating loss under the column heading “Corporate and Other” consist primarily of general and administrative costs that are not allocated to the segments. Goodwill and customer list intangible assets resulting from the Merger are assigned to reporting units solely for testing for impairment. The reconciliation of operating income to net income before income taxes is shown within the Consolidated Statements of Operations and therefore is not separately presented.
Three Months Ended September 30 | ||||||||||||||||
Plates and Shapes | Flat Rolled and Non-Ferrous | Building Products | Corporate and Other | Total | ||||||||||||
2008: | ||||||||||||||||
Net sales | $ | 339.9 | $ | 244.5 | $ | 37.8 | $ | (4.5 | ) | $ | 617.7 | |||||
Operating income (loss) | 62.4 | 28.0 | 1.8 | (7.8 | ) | 84.4 | ||||||||||
Capital expenditures | 2.7 | 0.9 | — | 0.4 | 4.0 | |||||||||||
Depreciation and amortization(1) | 2.3 | 1.7 | 0.7 | 1.1 | 5.8 | |||||||||||
2007: | ||||||||||||||||
Net sales | $ | 225.3 | $ | 205.6 | $ | 41.7 | $ | (3.0 | ) | $ | 469.6 | |||||
Operating income (loss) | 23.2 | 12.5 | 1.1 | (7.6 | ) | 29.2 | ||||||||||
Capital expenditures | 3.3 | 1.2 | 0.4 | 0.1 | 5.0 | |||||||||||
Depreciation and amortization(1) | 2.1 | 1.1 | 0.5 | 1.9 | 5.6 |
Nine Months Ended September 30 | |||||||||||||||||
Plates and Shapes | Flat Rolled and Non-Ferrous | Building Products | Corporate and Other | Total | |||||||||||||
2008: | |||||||||||||||||
Net sales | $ | 915.1 | $ | 695.0 | $ | 100.3 | $ | (10.6 | ) | $ | 1,699.8 | ||||||
Operating income (loss) | 155.0 | 72.1 | (6.4 | ) | (21.7 | ) | 199.0 | ||||||||||
Capital expenditures | 6.0 | 1.8 | 0.6 | 0.5 | 8.9 | ||||||||||||
Depreciation and amortization(1) | 6.9 | 5.4 | 2.5 | 3.4 | 18.2 | ||||||||||||
2007: | |||||||||||||||||
Net sales | $ | 672.7 | $ | 630.1 | $ | 121.0 | $ | (10.7 | ) | $ | 1,413.1 | ||||||
Operating income (loss) | 73.7 | 42.9 | 2.4 | (24.9 | ) | 94.1 | |||||||||||
Capital expenditures | 11.6 | 2.6 | 1.4 | 0.4 | 16.0 | ||||||||||||
Depreciation and amortization(1) | 6.6 | 2.9 | 1.6 | 5.5 | 16.6 |
(1) | Includes depreciation expense reflected in cost of goods sold for the Building Products Group. |
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
September 30, 2008 | December 31, 2007 | |||||
Total Assets: | ||||||
Plates and Shapes | $ | 617.6 | $ | 449.1 | ||
Flat Rolled and Non-Ferrous | 397.9 | 330.3 | ||||
Building Products | 73.6 | 80.7 | ||||
Corporate and Other | 246.2 | 98.9 | ||||
Consolidated | $ | 1,335.3 | $ | 959.0 | ||
Goodwill: | ||||||
Plates and Shapes | $ | 15.9 | $ | 16.4 | ||
Flat Rolled and Non-Ferrous | 20.3 | 20.9 | ||||
Building Products | 2.3 | 2.4 | ||||
Corporate and Other | 19.4 | 20.5 | ||||
Consolidated | $ | 57.9 | $ | 60.2 | ||
Changes in goodwill for the nine months ended September 30, 2008 are primarily due to the recognition of tax benefits.
We have implemented certain initiatives within our Building Products segment in response to the downturn in the housing and residential remodeling markets, including reductions in square footage under lease, standardization of sales center layouts, and manufacturing consolidation. During the first nine months of 2008, we closed five sales centers (Memphis, Tennessee, Overland, Missouri, Holly Hill, Florida, Harrisburg, Pennsylvania and Corona, California), in addition to our Houston, Texas manufacturing facility. In July 2008, we sold our Houston, Texas manufacturing facility for $4.9 in cash. We recognized a gain of $0.7 in the third quarter of 2008 related to this sale. Total facility closure costs charged to operating expense during the nine months ended September 30, 2008, net of the gain on the sale of the Houston plant, amounted to $4.0. We continue to evaluate various alternative strategies for our building products business.
Assets classified as held for sale as of September 30, 2008 are associated with two facilities within our metals service center business that were closed during the first quarter of 2007. We continue to serve the marketing areas of the closed facilities with our existing sales force by expanding the responsible territories of other facilities, and through the use of common carrier for product delivery.
13. Commitments and Contingencies
Letters of Credit
Letters of credit outstanding at September 30, 2008 consist of a letter of credit in the amount of $5.8 in conjunction with the IRB (see Note 8) and other letters of credit aggregating $9.4 (total letters of credit of $15.2 at September 30, 2008). Other letters of credit consist primarily of collateral support for our property and casualty insurance program. All letters of credit reduce the amount available to borrow under the ABL Facility.
Dividends Relating to 2007 Notes
See Note 8 for a discussion of the extent to which Metals USA Holdings is dependent on Flag Intermediate’s cash flows to service its debt.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
Contingencies
From time to time, we are involved in a variety of claims, lawsuits and other disputes arising in the ordinary course of business. We believe the resolution of these matters and the incurrence of their related costs and expenses should not have a material adverse effect on our consolidated financial position, results of operations, cash flows or liquidity.
14. Related Party Transactions
Upon completion of the Merger, Metals USA Holdings entered into a management agreement with Apollo under which Apollo or its affiliates provide us with management services. Pursuant to the agreement, Apollo receives an annual management fee equal to $2.0, payable on March 15 of every year, starting on March 15, 2006. The management agreement will terminate on December 31, 2012, unless terminated earlier by Apollo. Apollo elected to waive $0.5 of the annual management fee indefinitely, but reserved the right to revoke this waiver. The payment obligation has been recorded as a current liability (see Note 7) at the present value of minimum future annual payments of $1.5. A discount rate of 6.1% was used in the determination of present value, which approximated our incremental borrowing rate at the inception of the agreement. Deferred management fees of $8.6 were recorded as a current asset, and are being amortized on a straight-line basis over the term of the agreement. For the three and nine month periods ended September 30, 2008 and 2007, amortization of deferred management fees was $0.3, $0.9, $0.3 and $0.9, respectively, with $0.1, $0.3, $0.1 and $0.3 recorded as interest expense and $0.2, $0.6, $0.2 and $0.6 recorded as administrative expense, respectively, during the periods.
The management agreement also provides that affiliates of Apollo will be entitled to receive a fee in connection with certain subsequent financing, acquisition, disposition and change of control transactions with a value of $25.0 or more, with such fee to be equal to 1% of the gross transaction value of any such transaction. In connection with the issuance of the 2006 Notes, Apollo was paid a fee of $1.5. Apollo elected to waive transaction fees of $3.0 payable in connection with the issuance of the 2007 Notes and $1.0 payable in connection with the exercise of the option to increase the Tranche A Commitments under the ABL facility in July 2008.
Upon a termination of the management agreement prior to December 31, 2012, Apollo will be entitled to receive the present value of (a) $14.0, less (b) the aggregate amount of management fees that were paid to it under the agreement prior to such termination, and less (c) management fees waived. Both the management agreement and transaction fee agreement contain customary indemnification provisions in favor of Apollo and its affiliates, as well as expense reimbursement provisions with respect to expenses incurred by Apollo and its affiliates in connection with its performance of services thereunder.
Our affiliates, which include Apollo Management V L.P. (“Apollo Management” and together with its affiliated investment entities “Apollo”), as well as our Chief Executive Officer and our Chief Financial Officer, have purchased a portion of our 2007 Notes in the market. As of September 30, 2008, the amount of outstanding 2007 Notes held by our affiliates was $91.4, $90.9 of which were held by Apollo, with the remainder held by the executive officers referred to above. From time to time, depending upon market, pricing and other conditions, as well on cash balances and liquidity, we, our subsidiaries or affiliates may seek to purchase or sell additional indebtedness of us or our affiliates. Any such future purchases or sales may be made in the open market, privately negotiated transactions, tender offers or otherwise.
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METALS USA HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in millions, except share amounts)
15. Comprehensive Income
The following table sets forth comprehensive income, net of applicable taxes, for the three and nine months ended September 30, 2008 and 2007.
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2008 | 2007 | 2008 | 2007 | ||||||||||||
Net income (loss) | $ | 36.0 | $ | (3.4 | ) | $ | 79.6 | $ | 12.1 | ||||||
Other comprehensive income (loss): | |||||||||||||||
Foreign currency translation adjustments | (0.3 | ) | 0.3 | (0.4 | ) | 1.1 | |||||||||
Unrealized gains (losses) on derivatives | (0.9 | ) | — | 3.2 | — | ||||||||||
Unrealized losses on investment securities | (0.1 | ) | — | (0.2 | ) | — | |||||||||
Total comprehensive income (loss) | $ | 34.7 | $ | (3.1 | ) | $ | 82.2 | $ | 13.2 | ||||||
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ITEM 2.Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
This section contains statements that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. See disclosure presented on the inside of the front cover of this Form 10-Q for cautionary information with respect to such forward-looking statements. Readers should refer to “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2007, for risk factors that may affect future performance.
Overview
All references to the “Company” include Metals USA Holdings, Flag Intermediate, its wholly owned subsidiary Metals USA, and the wholly owned subsidiaries of Metals USA.
We believe that we are a leading provider of value-added processed carbon steel, stainless steel, aluminum and specialty metals, as well as manufactured metal components. For the nine months ended September 30, 2008, approximately 94% of our revenue was derived from our metals service center and processing activities, which are segmented into two groups: Flat Rolled and Non-Ferrous Group and Plates and Shapes Group. The remaining portion of our revenue was derived from our Building Products Group, which principally manufactures and sells aluminum products related to the residential remodeling industry. We purchase metal from primary producers that generally focus on large volume sales of unprocessed metals in standard configurations and sizes. In most cases, we perform the customized, value-added processing services required to meet the specifications provided by end-use customers. Our Plates and Shapes Group and Flat Rolled and Non-Ferrous Group customers are in the land and marine transportation, energy, aerospace, defense, electrical and appliance manufacturing, fabrication, furniture, commercial construction, and machinery and equipment industries. Our Building Products Group customers are primarily distributors and contractors engaged in the residential remodeling industry.
Matters Impacting Comparability of Results
2007 Acquisition
On July 2, 2007, we purchased the business operations of Lynch Metals, for approximately $42.4 million. The purchase price was funded by borrowings under the ABL facility, $38.4 million of which was paid at closing, and approximately $4.0 million of which was deferred and is being paid in various installments over a period of two years from the closing date. The excess of the aggregate purchase price over the estimated fair value of net assets acquired was approximately $20.5 million, which was allocated to goodwill. The estimated fair value of accounts receivable, inventories, and property and equipment acquired were $4.4 million, $4.2 million and $1.8 million, respectively. The estimated fair value of customer list and trade name intangible assets was $10.1 million and $3.3 million, respectively. The estimated fair value of accounts payable and accrued liabilities assumed was $2.3 million. In connection with the completion of the valuation of property and equipment in the second quarter of 2008, $0.4 million was reclassified from goodwill to property and equipment. The results of operations for the Lynch Metals acquisition are included in the Company’s consolidated results of operations beginning July 2, 2007.
Lynch Metals is a value-added, metal service center that focuses on specialty aluminum, with locations in New Jersey and California. Lynch Metals uses enhanced technologies in slitting, shearing, and cut-to-length to service the just-in-time requirements of its customers, who are predominately manufacturers of air/heat transfer products specifically focused on aerospace, automotive and industrial applications. This acquisition is an important strategic addition to our Flat Rolled and Non-Ferrous Group because it supports our continued shift in product mix from ferrous products to non-ferrous and stainless products and strengthens our non-ferrous presence in the strategic Northeast and Southern California regions. Lynch Metals’ product line and processing capabilities are highly complementary to our Flat Rolled and Non-Ferrous segment, and we expect to expand sales of Lynch Metals’ non-ferrous products into our existing geographic base, as well as expand sales of non-ferrous and stainless products into Lynch Metals’ geographic base.
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Selected Operational Information
Net sales—We derive the net sales of our Plates and Shapes and Flat Rolled and Non-Ferrous Groups from the processing and sale of metal products to end-users including metal fabrication companies, general contractors and OEMs. Pricing is generally based upon the underlying metal cost as well as a margin associated with customized value-added services as specified by the customer. The net sales of our Building Products Group are derived from the sales of finished goods primarily to general contractors who are generally engaged in the residential remodeling industry.
Cost of sales—Our Plates and Shapes and Flat Rolled and Non-Ferrous Groups follow the normal industry practice which classifies within cost of sales the underlying commodity cost of metal purchased in mill form, and the cost of inbound freight charges, together with third-party processing cost, if any. Generally, the cost of metal approximates 75% of net sales for the Plates and Shapes and Flat Rolled and Non-Ferrous Groups. Cost of sales for our Building Products Group includes the cost of raw materials, manufacturing labor and overhead costs, together with depreciation and amortization expense associated with property, buildings and equipment used in the manufacturing process. Amounts included within this caption may not be comparable to similarly titled captions reported by other companies.
Operating and delivery expense—Our operating and delivery expense reflects the cost incurred by our Plates and Shapes and Flat Rolled and Non-Ferrous Groups for labor and facility costs associated with the value-added metal processing services that we provide. With respect to our Building Products Group, operating costs are associated with the labor and facility costs attributable to warehousing of our finished goods at our service center facilities. Delivery expense reflects labor, material handling and other third party costs incurred with the delivery of product to customers. Amounts included within this caption may not be comparable to similarly titled captions reported by other companies.
Selling, general and administrative expenses—Selling, general and administrative expenses include sales and marketing expenses, executive officers’ compensation, office and administrative salaries, insurance, accounting, legal, computer systems, and professional services and costs not directly associated with the processing, manufacturing, operating or delivery costs of our products. Amounts included within this caption may not be comparable to similarly titled captions reported by other companies.
Depreciation and amortization—Depreciation and amortization expense represents the costs associated with property, buildings and equipment used throughout the company except for depreciation and amortization expense associated with the manufacturing assets employed by our Building Products Group, which is included within cost of sales. This caption also includes amortization of intangible assets.
Industry Trends
Metals Service Centers
The metals production and distribution industries have experienced unprecedented revenue and profit expansion over the last five years. Global demand for steel and other metals has grown at an extraordinary pace driven largely by new market development in China, Brazil, Russia, and India, as well as Europe in general. Over the last 5 years global demand has increased approximately 9% per year, on average. Through the first half of 2008, demand growth outpaced supply inputs creating upward cost pressure on commodity inputs such as ores, energy and transportation.
However, recent global and economic conditions are significantly less favorable compared with those experienced during the first half of 2008. The level of global economic activity has declined through the latter part of 2008, as the world’s major economies, including the U.S. and European region, are experiencing difficulties related to, in large part, the tightening of credit conditions globally. As interbank lending constricts, the cost of borrowing for the steel sector and steel-consuming industries is likely to increase. We believe that
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steel demand in most regions of the world will slow, and as a result, industry participants will be cautious about the near-term outlook for metal prices. The timing of the effect that further price trends will have on the domestic steel market is difficult to predict, and any number of political or general economic factors could cause prices to decline.
Building Products
The current state of the housing and mortgage markets is causing significant contraction in the home improvement remodeling industry. According to Harvard University’s Joint Center for Housing Studies, spending on home remodeling dropped 5.6% for the second quarter of 2008, to $139.2 billion, compared with the same quarter of 2007. The center’s Leading Indicator of Remodeling Activity (LIRA) projects that homeowner improvement activity will continue to decline, falling by an annual rate of 11.1% by the first quarter of 2009. The LIRA measures and projects a portion of the U.S. home improvement market, namely spending by homeowners on property improvements. Research indicates that remodeling activity is pro-cyclical with both new residential construction and the broader economy, but remodeling lags homebuilding by several quarters. The high cyclicality of remodeling activity appears to be driven by discretionary improvements, similar to the products sold by our building products business, which are quite volatile. Improvement spending is expected to be much more cyclical and more sensitive to upturns and downturns in the general economy, whereas maintenance and repair spending is expected to be fairly stable over time. This has continued negative implications for our building products business, since remodeling activity lags homebuilding, and improvement remodeling lags overall remodeling activity.
We have implemented certain initiatives in response to the downturn in the housing and improvement remodeling markets primarily directed at systematic cost reduction and reducing manufacturing capacity to better match the addressable market. During 2007 we closed three sales centers and announced the future closure of four sales center locations as well as our manufacturing facility in Houston Texas. Consequently, production volumes were re-allocated to our Groveland, Florida and Buena Park, California manufacturing facilities. All closures were completed by April 2008. We continue to evaluate various alternative strategies for our building products business.
Product demand for the Company’s Building Products Group may be influenced by numerous factors such as interest rates, general economic conditions, consumer confidence and other factors beyond our control. Declines in existing home sales and improvement remodeling expenditures due to such factors could continue to significantly reduce the segment’s performance.
Critical Accounting Policies and Estimates
The discussion and analysis of the Company’s financial condition and results of operations is based upon the Company’s consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The result of this process forms the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. We review our estimates and judgments on a regular, ongoing basis. Actual results may differ from these estimates due to changed circumstances and conditions.
The following accounting policies and estimates are considered critical in light of the potential material impact that the estimates, judgments and uncertainties affecting the application of these policies might have on the Company’s reported financial information.
Accounts Receivable—We generally recognize revenue as product is shipped (risk of loss for our products generally passes at time of shipment), net of provisions for estimated returns. Financial instruments, which
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potentially subject us to concentrations of credit risk, consist principally of trade accounts and notes receivable. Collections on our accounts receivable are made through several lockboxes maintained by our lenders. Credit risk associated with concentration of cash deposits is low as we have the right of offset with our lenders for a substantial portion of our cash balances. Concentrations of credit risk with respect to trade accounts receivable are within several industries. Generally, credit is extended once appropriate credit history and references have been obtained. We perform ongoing credit evaluations of customers and set credit limits based upon reviews of customers’ current credit information and payment history. We monitor customer payments and maintain a provision for estimated credit losses based on historical experience and specific customer collection issues that we have identified. Provisions to the allowance for doubtful accounts are made monthly and adjustments are made periodically based upon our expected ability to collect all such accounts. Generally we do not require collateral for the extension of credit.
Each month we consider all available information when assessing the adequacy of the provision for allowances, claims and doubtful accounts. Adjustments made with respect to the allowance for doubtful accounts often relate to improved information not previously available. Uncertainties with respect to the allowance for doubtful accounts are inherent in the preparation of financial statements. The rate of future credit losses may not be similar to past experience.
Inventories—Inventories are stated at the lower of cost or market. Our inventories are accounted for using a variety of methods including specific identification, average cost and the first-in, first-out method of accounting. We regularly review inventory on hand and record provisions for damaged and slow-moving inventory based on historical and current sales trends. Changes in product demand and our customer base may affect the value of inventory on hand which may require higher provisions for damaged and slow-moving inventory.
Adjustments made with respect to the inventory valuation allowance often relate to improved information not previously available. Uncertainties with respect to the inventory valuation allowance are inherent in the preparation of financial statements. The rate of future losses associated with damaged or slow moving inventory may not be similar to past experience.
Results of Operations
The following unaudited consolidated financial information reflects our historical financial statements.
Consolidated Results—Three Months Ended September 30, 2008 Compared to September 30, 2007
2008 | % | 2007 | % | |||||||||||
(In millions, except percentages) | ||||||||||||||
Net sales | $ | 617.7 | 100.0 | % | $ | 469.6 | 100.0 | % | ||||||
Cost of sales (exclusive of operating and delivery, and depreciation and amortization shown below) | 446.4 | 72.3 | % | 363.2 | 77.3 | % | ||||||||
Operating and delivery | 48.6 | 7.9 | % | 43.7 | 9.3 | % | ||||||||
Selling, general and administrative | 33.9 | 5.5 | % | 28.3 | 6.0 | % | ||||||||
Depreciation and amortization | 5.3 | 0.9 | % | 5.2 | 1.1 | % | ||||||||
Gain on sale of property and equipment | (0.9 | ) | -0.1 | % | — | — | ||||||||
Operating income | 84.4 | 13.7 | % | 29.2 | 6.2 | % | ||||||||
Interest expense | 20.4 | 3.3 | % | 24.7 | 5.3 | % | ||||||||
Loss on extinguishment of debt | — | — | 8.4 | 1.8 | % | |||||||||
Other (income) expense, net | 0.2 | 0.0 | % | (0.7 | ) | -0.1 | % | |||||||
Income (loss) before income taxes | $ | 63.8 | 10.3 | % | $ | (3.2 | ) | -0.7 | % | |||||
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Net sales. Net sales increased $148.1 million, or 31.5%, from $469.6 million for the three months ended September 30, 2007 to $617.7 million for the three months ended September 30, 2008. The increase was primarily attributable to a 31.4% increase in average realized prices, in addition to an 3.2% increase in volumes for our Flat Rolled and Non-Ferrous and Plates and Shapes Product Groups, partially offset by a net sales decrease of $3.9 million for our Building Products Group.
Cost of sales. Cost of sales increased $83.2 million, or 22.9%, from $363.2 million for the three months ended September 30, 2007, to $446.4 million for the three months ended September 30, 2008. The increase was primarily attributable to a 21.8% increase in the average cost per ton, in addition to an 3.2% increase in volumes for our Flat Rolled and Non-Ferrous and Plates and Shapes Product Groups, partially offset by a $2.6 million decrease in cost of sales for our Building Products Group. Cost of sales as a percentage of net sales decreased from 77.3% for the third quarter of 2007 to 72.3% for the third quarter of 2008 as sales prices increased faster than the corresponding cost of material sold.
Operating and delivery. Operating and delivery expenses increased $4.9 million, or 11.2%, from $43.7 million for the three months ended September 30, 2007 to $48.6 million for the three months ended September 30, 2008. The increase was a result of higher variable costs associated with increased shipments. As a percentage of net sales, operating and delivery expenses decreased from 9.3% for the three months ended September 30, 2007 to 7.9% for the three months ended September 30, 2008.
Selling, general and administrative. Selling, general and administrative expenses increased $5.6 million, or 19.8%, from $28.3 million for the three months ended September 30, 2007 to $33.9 million for the three months ended September 30, 2008. Higher variable costs of $4.0 million associated with increased incentive compensation were the primary contributor to the period-over-period increase. As a percentage of net sales, selling, general and administrative expenses decreased from 6.0% for the three months ended September 30, 2007 to 5.5% for the three months ended September 30, 2008.
Depreciation and amortization. Depreciation and amortization expense increased $0.1 million, or 1.9%, from $5.2 million for the three months ended September 30, 2007 to $5.3 million for the three months ended September 30, 2008. The increase was primarily due to machinery and equipment additions to our Plates and Shapes Products Group, partially offset by lower amortization of customer list intangible assets recorded in connection with the acquisitions completed in May 2006 and the Merger.
Operating income. Operating income increased $55.2 million, or 189.0%, from $29.2 million for the three months ended September 30, 2007 to $84.4 million for the three months ended September 30, 2008. The increase was primarily a result of the increase in net sales discussed above. As a percentage of net sales, operating income increased from 6.2% for the three months ended September 30, 2007 to 13.7% for the three months ended September 30, 2008.
Interest expense. Interest expense decreased $4.3 million, or 17.4%, from $24.7 million for the three months ended September 30, 2007 to $20.4 million for the three months ended September 30, 2008. This decrease was primarily a function of lower average interest rates on our ABL facility and a lower LIBOR base rate on the 2007 Notes. While the weighted average outstanding balance on our ABL facility increased $59.5 million for the three months ended September 30, 2008 versus the same period of 2007, the weighted average interest rate decreased from 6.76% for the three months ended September 30, 2007 to 3.93% for the three months ended September 30, 2008.
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Consolidated Results—Nine Months Ended September 30, 2008 Compared to September 30, 2007
2008 | % | 2007 | % | |||||||||||
(In millions, except percentages) | ||||||||||||||
Net sales | $ | 1,699.8 | 100.0 | % | $ | 1,413.1 | 100.0 | % | ||||||
Cost of sales (exclusive of operating and delivery, and depreciation and amortization shown below) | 1,245.9 | 73.3 | % | 1,083.2 | 76.7 | % | ||||||||
Operating and delivery | 144.6 | 8.5 | % | 133.6 | 9.5 | % | ||||||||
Selling, general and administrative | 96.5 | 5.7 | % | 86.5 | 6.1 | % | ||||||||
Depreciation and amortization | 16.2 | 1.0 | % | 15.5 | 1.1 | % | ||||||||
Gain on sale of property and equipment | (2.4 | ) | -0.1 | % | — | — | ||||||||
Impairment of property and equipment | — | — | 0.2 | 0.0 | % | |||||||||
Operating income | 199.0 | 11.7 | % | 94.1 | 6.7 | % | ||||||||
Interest expense | 65.4 | 3.8 | % | 63.7 | 4.5 | % | ||||||||
Loss on extinguishment of debt | — | — | 8.4 | 0.6 | % | |||||||||
Other (income) expense, net | 0.2 | 0.0 | % | (0.8 | ) | 0.0 | % | |||||||
Income before income taxes | $ | 133.4 | 7.8 | % | $ | 22.8 | 1.6 | % | ||||||
Net sales. Net sales increased $286.7 million, or 20.3%, from $1,413.1 million for the nine months ended September 30, 2007 to $1,699.8 million for the nine months ended September 30, 2008. The Lynch Metals acquisition accounted for $18.6 million of increased sales for the period. The remaining increase of $268.1 million was primarily attributable to an 16.2% increase in average realized prices and a 5.4% increase in volumes for our Flat Rolled and Non-Ferrous and Plates and Shapes Product Groups partially offset by a net sales decrease of $20.7 million for our Building Products Group.
Cost of sales. Cost of sales increased $162.7 million, or 15.0%, from $1,083.2 million for the nine months ended September 30, 2007, to $1,245.9 million for the nine months ended September 30, 2008. The Lynch Metals acquisition accounted for $11.3 million of additional cost of sales for the period. The remaining increase of $151.4 million was primarily attributable to a 10.1% increase in the average cost per ton and a 5.4% increase in volumes for our Flat Rolled and Non-Ferrous and Plates and Shapes Groups partially offset by a decrease of $9.0 million in cost of sales for our Building Products Group. Cost of sales as a percentage of net sales decreased from 76.7% for the nine months ended September 30, 2007 to 73.3% for the same period in 2008.
Operating and delivery. Operating and delivery expenses increased $11.0 million, or 8.2%, from $133.6 million for the nine months ended September 30, 2007 to $144.6 million for the nine months ended September 30, 2008. The acquisition of Lynch Metals accounted for $0.8 million of additional operating and delivery expenses for the period. The remaining increase was a result of higher variable costs of $10.2 million associated with increased shipments. As a percentage of net sales, operating and delivery expenses decreased from 9.5% for the nine months ended September 30, 2007 to 8.5% for the nine months ended September 30, 2008.
Selling, general and administrative. Selling, general and administrative expenses increased $10.0 million, or 11.6%, from $86.5 million for the nine months ended September 30, 2007 to $96.5 million for the nine months ended September 30, 2008. The Lynch Metals acquisition accounted for $1.9 million of the increase while increased incentive compensation accounted for an additional $7.5 million of the increased selling, general and administrative expenses for the period. These increases were partially offset by a decrease in stock-based compensation expense of $3.0 million, an amount which was recognized in the first quarter of 2007 due to the accelerated vesting of stock options in connection with the January 2007 Dividend. As a percentage of net sales, selling, general and administrative expenses decreased from 6.1% for the nine months ended September 30, 2007 to 5.7% for the nine months ended September 30, 2008.
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Depreciation and amortization. Depreciation and amortization increased $0.7 million, or 4.5%, from $15.5 million for the nine months ended September 30, 2007 to $16.2 million for the nine months ended September 30, 2008. The Lynch Metals acquisition accounted for $2.4 million of additional depreciation and amortization for the period. This increase was partially offset by a decrease of $1.7 million for the period, which resulted primarily from lower amortization of customer list intangible assets recorded in connection with the acquisitions completed in May 2006 and the Merger.
Operating income. Operating income increased $104.9 million, or 111.5%, from $94.1 million for the nine months ended September 30, 2007 to $199.0 million for the nine months ended September 30, 2008. The Lynch Metals acquisition contributed $2.2 million of operating income for the period. The remaining increase of $102.7 million resulted primarily from the increased net sales during the current period. As a percentage of net sales, operating income increased from 6.7% for the nine months ended September 30, 2007 to 11.7% for the nine months ended September 30, 2008.
Interest expense. Interest expense increased $1.7 million, or 2.7%, from $63.7 million for the nine months ended September 30, 2007 to $65.4 million for the nine months ended September 30, 2008. The increase in incremental interest expense when comparing the nine months ended September 30, 2008 to the same period of 2007 reflects the issuance of the 2007 Notes and redemption of the 2006 Notes in July 2007, which resulted in increased interest expense on the $150.0 million incremental borrowings. The effect of increased debt levels on interest expense was partially offset by lower average interest rates on our ABL facility. While the weighted average outstanding balance on our ABL facility increased $24.4 million for the nine months ended September 30, 2008 versus the same period of 2007, the weighted average interest rate decreased from 7.14% for the nine months ended September 30, 2007 to 4.44% for the nine months ended September 30, 2008.
Segment Results—Three Months Ended September 30, 2008 Compared to September 30, 2007
Net Sales | Operating Costs and Expenses | Operating Income (Loss) | Capital Spending | Tons Shipped(1) | |||||||||||||
(in millions, except tonnage) | |||||||||||||||||
2008: | |||||||||||||||||
Plates and Shapes | $ | 339.9 | $ | 277.5 | $ | 62.4 | $ | 2.7 | 212 | ||||||||
Flat Rolled and Non-Ferrous | 244.5 | 216.5 | 28.0 | 0.9 | 151 | ||||||||||||
Building Products | 37.8 | 36.0 | 1.8 | — | — | ||||||||||||
Corporate and other | (4.5 | ) | 3.3 | (7.8 | ) | 0.4 | (3 | ) | |||||||||
Total | $ | 617.7 | $ | 533.3 | $ | 84.4 | $ | 4.0 | 360 | ||||||||
2007: | |||||||||||||||||
Plates and Shapes | $ | 225.3 | $ | 202.1 | $ | 23.2 | $ | 3.3 | 207 | ||||||||
Flat Rolled and Non-Ferrous | 205.6 | 193.1 | 12.5 | 1.2 | 144 | ||||||||||||
Building Products | 41.7 | 40.6 | 1.1 | 0.4 | — | ||||||||||||
Corporate and other | (3.0 | ) | 4.6 | (7.6 | ) | 0.1 | (2 | ) | |||||||||
Total | $ | 469.6 | $ | 440.4 | $ | 29.2 | $ | 5.0 | 349 | ||||||||
(1) | Shipments are expressed in thousands of tons and are not an applicable measure for the Building Products Group. |
Plates and Shapes. Net sales increased $114.6 million, or 50.9%, from $225.3 million for the three months ended September 30, 2007 to $339.9 million for the three months ended September 30, 2008. The increase was primarily attributable to a 47.3% increase in average realized prices, in addition to a 2.4% increase in shipments for the three months ended September 30, 2008, compared to the three months ended September 30, 2007.
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Operating costs and expenses increased $75.4 million, or 37.3%, from $202.1 million for the three months ended September 30, 2007 to $277.5 million for the three months ended September 30, 2008. The increase was primarily attributable to a 37.4% increase in the average cost per ton, in addition to a 2.4% increase in shipments for the three months ended September 30, 2008, compared to the three months ended September 30, 2007.
Operating income increased by $39.2 million, or 169.0%, from $23.2 million for the three months ended September 30, 2007 to $62.4 million for the three months ended September 30, 2008. The increase primarily resulted from higher net sales which were driven by an increase in average realized prices, and to a lesser extent increased shipments, as discussed above. Operating income as a percentage of net sales increased from 10.3% for the three months ended September 30, 2007 to 18.4% for the three months ended September 30, 2008.
Flat Rolled and Non-Ferrous. Net sales increased $38.9 million, or 18.9%, from $205.6 million for the three months ended September 30, 2007 to $244.5 million for the three months ended September 30, 2008. The increase was primarily attributable to a 13.4% increase in average realized prices, in addition to a 4.9% increase in shipments for the three months ended September 30, 2008, compared to the three months ended September 30, 2007. Sales of non-ferrous metals accounted for 37.9% of the segment’s sales product mix for the third quarter of 2008, compared to 52.6% for the third quarter of 2007.
Operating costs and expenses increased $23.4 million, or 12.1%, from $193.1 million for the three months ended September 30, 2007 to $216.5 million for the three months ended September 30, 2008. The remaining increase was primarily attributable to an increase in the average cost per ton of 6.3% in addition to an increase in volume of 4.9%. Operating costs and expenses as a percentage of net sales decreased from 93.9% for the three months ended September 30, 2007 to 88.5% for the three months ended September 30, 2008.
Operating income increased by $15.5 million, or 124.0%, from $12.5 million for the three months ended September 30, 2007 to $28.0 million for the three months ended September 30, 2008. The increase was primarily attributable to the increase in sales volumes discussed above. Operating income as a percentage of net sales increased from 6.1% for the three months ended September 30, 2007 to 11.5% for the three months ended September 30, 2008.
Building Products. Net sales decreased $3.9 million, or 9.4%, from $41.7 million for the three months ended September 30, 2007 to $37.8 million for the three months ended September 30, 2008. The sales decrease was driven by lower home improvement remodeling activity. Consumer spending on residential remodeling has decreased dramatically due to the depreciation of homes, lower limits on home equity loans and decreased access to affordable credit for homeowners and residential remodeling contractors. These factors, in addition to lower sales of new and previously owned homes, have led to significant contraction in the remodeling industry and negative growth in our Building Products Group.
Operating costs and expenses decreased $4.6 million, or 11.3%, from $40.6 million for the three months ended September 30, 2007 to $36.0 million for the three months ended September 30, 2008. The decrease was primarily due to lower sales volume and a decrease in variable costs related to lower market demand. Operating costs and expenses as a percentage of net sales decreased from 97.4% for the three months ended September 30, 2007 to 95.2% for the three months ended September 30, 2008.
Operating income increased by $0.7 million, or 63.6%, from $1.1 million for the three months ended September 30, 2007 to $1.8 million for the three months ended September 30, 2008. The increase was primarily attributable to a $0.7 million gain on the sale of the segment’s Houston, Texas manufacturing facility, in addition to the decline in operating costs and expenses discussed above. Operating income as a percentage of net sales increased from 2.6% for the three months ended September 30, 2007 to 4.8% for the three months ended September 30, 2008.
Corporate and other. This category reflects certain administrative costs and expenses management has not allocated to its industry segments. These costs include compensation for executive officers, insurance,
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professional fees for audit, tax and legal services and data processing expenses. The negative net sales amount represents the elimination of intercompany sales. The operating loss increased $0.2 million, or 2.6%, from $7.6 million for the three months ended September 30, 2007 to $7.8 million for the three months ended September 30, 2008.
Segment Results—Nine Months Ended September 30, 2008 Compared to September 30, 2007
Net Sales | Operating Costs and Expenses | Operating Income (Loss) | Capital Spending | Tons Shipped(1) | |||||||||||||
(in millions, except tonnage) | |||||||||||||||||
2008: | |||||||||||||||||
Plates and Shapes | $ | 915.1 | $ | 760.1 | $ | 155.0 | $ | 6.0 | 672 | ||||||||
Flat Rolled and Non-Ferrous | 695.0 | 622.9 | 72.1 | 1.8 | 483 | ||||||||||||
Building Products | 100.3 | 106.7 | (6.4 | ) | 0.6 | — | |||||||||||
Corporate and other | (10.6 | ) | 11.1 | (21.7 | ) | 0.5 | (8 | ) | |||||||||
Total | $ | 1,699.8 | $ | 1,500.8 | $ | 199.0 | $ | 8.9 | 1,147 | ||||||||
2007: | |||||||||||||||||
Plates and Shapes | $ | 672.7 | $ | 599.0 | $ | 73.7 | $ | 11.6 | 626 | ||||||||
Flat Rolled and Non-Ferrous | 630.1 | 587.2 | 42.9 | 2.6 | 467 | ||||||||||||
Building Products | 121.0 | 118.6 | 2.4 | 1.4 | — | ||||||||||||
Corporate and other | (10.7 | ) | 14.2 | (24.9 | ) | 0.4 | (8 | ) | |||||||||
Total | $ | 1,413.1 | $ | 1,319.0 | $ | 94.1 | $ | 16.0 | 1,085 | ||||||||
(1) | Shipments are expressed in thousands of tons and are not an appropriate measure for the Building Products Group. |
Plates and Shapes. Net sales increased $242.4 million, or 36.0%, from $672.7 million for the nine months ended September 30, 2007 to $915.1 million for the nine months ended September 30, 2008. The increase was primarily attributable to a 26.7% increase in average realized prices, in addition to a 7.3% increase in shipments for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007.
Operating costs and expenses increased $161.1 million, or 26.9%, from $599.0 million for the nine months ended September 30, 2007 to $760.1 million for the nine months ended September 30, 2008. The increase was primarily attributable to a 20.3% increase in the average cost per ton, in addition to a 7.3% increase in shipments for the nine months ended September 30, 2008, compared to the nine months ended September 30, 2007. Operating costs and expenses as a percentage of net sales decreased from 89.0% for the nine months ended September 30, 2007 to 83.0% for the nine months ended September 30, 2008.
Operating income increased by $81.3 million, or 110.3%, from $73.7 million for the nine months ended September 30, 2007 to $155.0 million for the nine months ended September 30, 2008. The increase was primarily attributable to the increase in net sales and the decrease in operating costs and expenses as a percentage of net sales, as discussed above. Operating income as a percentage of net sales increased from 11.0% for the nine months ended September 30, 2007 to 16.9% for the nine months ended September 30, 2008.
Flat Rolled and Non-Ferrous. Net sales increased $64.9 million, or 10.3%, from $630.1 million for the nine months ended September 30, 2007 to $695.0 million for the nine months ended September 30, 2008. The Lynch Metals acquisition contributed $18.6 million of additional net sales for the nine month period ended September 30, 2008. The remaining increase was primarily due to a 4.5% increase in average realized prices in addition to a 2.8% increase in shipments for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007. Sales of non-ferrous metals accounted for 41.9% of the segment’s sales product mix for the nine months ended September 30, 2008, compared to 48.8% for the same period of 2007.
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Operating costs and expenses increased $35.7 million, or 6.1%, from $587.2 million for the nine months ended September 30, 2007 to $622.9 million for the nine months ended September 30, 2008. The acquisition of Lynch Metals accounted for $16.4 million of additional operating costs and expenses for the nine months ended September 30, 2008. The remaining increase of $19.3 million was attributable to an increase in shipments of 2.8% in addition to an increase in the cost of raw materials of 0.6% for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007. Operating costs and expenses as a percentage of net sales decreased from 93.2% for the nine months ended September 30, 2007 to 89.6% for the nine months ended September 30, 2008.
Operating income increased by $29.2 million, or 68.1%, from $42.9 million for the nine months ended September 30, 2007 to $72.1 million for the nine months ended September 30, 2008. The Lynch Metals acquisition contributed $2.2 million of operating income for the nine months ended September 30, 2008. The balance of the increase was primarily attributable to the increase in net sales discussed above. Operating income as a percentage of net sales increased from 6.8% for the nine months ended September 30, 2007 to 10.4% for the nine months ended September 30, 2008.
Building Products. Net sales decreased $20.7 million, or 17.1%, from $121.0 million for the nine months ended September 30, 2007 to $100.3 million for the nine months ended September 30, 2008. Declines in the home improvement remodeling market, which were impacted by the continued downturn in the housing sector, contributed to the period-over-period net sales decrease for our Building Products Group.
Operating costs and expenses decreased $11.9 million, or 10.0%, from $118.6 million for the nine months ended September 30, 2007 to $106.7 million for the nine months ended September 30, 2008. The decrease was due to lower operating costs and expenses associated with lower sales volumes, in addition to certain initiatives the segment has taken in response to the downturn in the housing and home improvement remodeling markets, including reductions in square footage under lease, standardization of sales center layouts, and manufacturing consolidation. Despite the decrease in sales volumes, operating costs and expenses as a percentage of net sales increased from 98.0% for the nine months ended September 30, 2007 to 106.4% for the nine months ended September 30, 2008. The increase in operating costs as a percentage of net sales is due in part to additional costs incurred during the first nine months of 2008 related to the closure of underperforming sales center locations and the discontinuance of certain product lines, as management has continued to focus on cost reduction in order to mitigate the impact of lower operating levels resulting from the market downturn. In July 2008, we sold our Houston, Texas manufacturing facility for $4.9 million in cash. We recognized a gain of $0.7 in the third quarter of 2008 related to this sale. Total facility closure costs charged to operating expense during the nine months ended September 30, 2008, net of the gain on the sale of the Houston plant, amounted to $4.0 million.
Operating income (loss) decreased by $8.8 million, or 366.7%, from income of $2.4 million for the nine months ended September 30, 2007 to a loss of $(6.4) million for the nine months ended September 30, 2008. The decrease was primarily attributable to the decline in net sales discussed above, which exceeded the rate of decline in operating costs and expenses. Operating income (loss) as a percentage of net sales decreased from 1.9% for the nine months ended September 30, 2007 to (6.4)% for the nine months ended September 30, 2008.
Corporate and other. This category reflects certain administrative costs and expenses management has not allocated to its industry segments. These costs include compensation for executive officers, insurance, professional fees for audit, tax and legal services and data processing expenses. The negative net sales amount represents the elimination of intercompany sales. The operating loss decreased $3.2 million, or 12.9%, from $24.9 million for the nine months ended September 30, 2007 to $21.7 million for the nine months ended September 30, 2008. This decrease was primarily attributable to $3.0 million of higher stock-based compensation expense incurred during the nine months ended September 30, 2007, due to the accelerated vesting of stock options in connection with the January 2007 dividend paid by Metals USA Holdings to its stockholders.
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Liquidity and Capital Resources
Our primary sources of short-term liquidity are borrowings under the ABL facility and our cash flow from operations. We believe these resources will be sufficient to meet our working capital and capital expenditure requirements for the next year.
In operating our business, we need to finance our investment in working capital. Our ABL facility is the principal means by which we finance our investment in working capital (e.g., raw materials such as metal, which are crucial to operating our business) and therefore our ABL facility is crucial to our ability to purchase inventory. We recently increased the size of the ABL facility (see “Financing Activities—The ABL facility” below) given its importance to us as a means to access additional capital. Access to the ABL facility and the cost of borrowing under it are constrained by certain covenants contained in the loan and security agreement governing the ABL facility and the indentures governing the Metals USA Notes and the 2007 Notes. These covenants are each based on Adjusted EBITDA, as discussed more fully below (see also “Financing Activities—Covenant Compliance” below).
The FCCR is also an important measure of our liquidity and affects our ability to take certain actions, including paying dividends to our stockholders, making acquisitions and incurring additional debt. In addition, the applicable interest rates associated with the ABL facility are determined by the FCCR (see “Financing Activities—The ABL facility—Interest Rate and Fees” and “Financing Activities—Covenant Compliance” below).
The ability to implement strategic “bolt-on” acquisitions is one of our key strategies, and our ability to incur additional debt is a necessary element to support this strategy. The indentures governing the Metals USA Notes and the 2007 Notes contain covenants that restrict our ability to take certain actions, such as incurring additional debt, if we are unable to meet defined Adjusted EBITDA to fixed charges and consolidated total debt ratios (each, as defined). See “Financing Activities—Covenant Compliance” below for further discussion of our restrictive covenants.
During September 2008, we borrowed approximately $160.0 million on the ABL facility in response to concerns about credit markets. As of September 30, 2008, we had eligible collateral of $618.7 million, $542.0 million in outstanding advances, $15.2 million in open letters of credit and $61.5 million of additional borrowing capacity. As of September 30, 2008, we had $173.1 million of available cash and cash equivalents. Our borrowing availability fluctuates daily with changes in eligible accounts receivables and inventory, less outstanding borrowings and letters of credit. See Financing Activities below.
We generally meet long-term liquidity requirements, the repayment of debt and investment funding needs, through additional borrowings under the ABL facility and the issuance of debt securities. At September 30, 2008, our long-term debt consisted of $542.0 million of outstanding borrowings on the ABL facility, $275.0 million principal amount of the Metals USA Notes, $293.2 million principal amount of the 2007 Notes, an Industrial Revenue Bond with $5.7 million principal amount outstanding and $0.3 million in vendor financing and purchase money notes.
With respect to long-term liquidity, we believe that we will be able to meet our working capital, capital expenditures and debt service obligations. Our ability to meet long-term liquidity requirements is subject to obtaining additional debt and/or equity financing. Decisions by lenders and investors to enter into such transactions with us will depend upon a number of factors, such as our historical and projected financial performance, compliance with the terms of our current credit agreements, industry and market trends, the availability of capital, and the relative attractiveness of alternative lending or investment opportunities.
Although we do not produce any metal, our financial performance is affected by changes in metal prices. When metal prices rise, the prices at which we are able to sell our products generally increase over their historical costs; accordingly, our working capital (which consists primarily of accounts receivable and inventory) tends to increase in a rising price environment. Conversely, when metal prices fall, our working capital tends to decrease. Our working capital (current assets less current liabilities) increased from $506.3 million at December 31, 2007 to $874.5 million at September 30, 2008.
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Changes in metal prices also affect our liquidity because of the time difference between our payment for our raw materials and our collection of cash from our customers. We sell our products and typically collect our accounts receivable within 45 days after the sale; however, we tend to pay for replacement materials (which are more expensive when metal prices are rising) over a much shorter period, primarily to benefit from early-payment discounts that are substantially higher than our cost of incremental debt. As a result, when metal prices are rising, we tend to draw more on the ABL facility to cover the cash flow cycle from material purchase to cash collection. When metal prices fall, we can replace our inventory at lower cost and, thus, generally do not need to access the ABL facility as much to cover the cash flow cycle. We believe our cash flow from operations, supplemented with the cash available under the ABL facility, will provide sufficient liquidity to meet the challenges and obligations we face during the current metal price environment. Additionally, we intend to look for value-added businesses that we can acquire at reasonable prices. We intend to use cash flows from operations and excess cash available under the ABL facility to fund future acquisitions.
The following discussion of the principal sources and uses of cash should be read in conjunction with our Unaudited Condensed Consolidated Statements of Cash Flows which are set forth under Item 1—“Financial Statements.”
During the nine months ended September 30, 2008, net cash used in operating activities was $97.7 million. This amount represents net income, adjusted for costs that did not involve cash flows for the period and gains on the sale of property and equipment, of $101.0 million, in addition to changes in operating assets and liabilities that resulted in a cash outflow of $198.7 million for the period, an amount that was primarily attributable to increases in accounts receivable and inventories, partially offset by increases in accounts payable and accrued liabilities. During the nine months ended September 30, 2007, net cash provided by operating activities was $98.2 million. This amount represents net income, adjusted for costs that did not involve cash flows for the period, of $42.6 million, offset by changes in operating assets and liabilities that resulted in a cash inflow of $55.6 million for the period, an amount that was primarily attributable to decreases in inventories and increases in accounts payable and accrued liabilities, partially offset by an increase in accounts receivable.
Net cash provided by investing activities was $0.6 million for the nine months ended September 30, 2008, and consisted of proceeds from sales of assets of $9.5 million partially offset by $8.9 million of purchases of assets. For the nine months ended September 30, 2008, the most significant internal capital project was the expansion of our New Orleans Plates and Shapes facility. Net cash used in investing activities was $53.4 million for the nine months ended September 30, 2007, and consisted primarily of $38.4 million of acquisition costs incurred in connection with the Lynch Metals acquisition, in addition to $16.0 million of purchases of assets, partially offset by proceeds from sales of assets of $1.0 million. For the nine months ended September 30, 2007, the most significant internal capital project was the expansion of our New Orleans Plates and Shapes facility.
Net cash provided by financing activities was $256.6 million for the nine months ended September 30, 2008, and consisted primarily of net borrowings on the ABL facility of $261.5 million, partially offset by $2.3 million of repayments of long-term debt and $2.6 million of deferred financing costs. Net cash used in financing activities was $183.3 million for the nine months ended September 30, 2007, and consisted primarily of dividends paid of $288.5 million, repayment of long-term debt of $150.5 million, and net repayments on the ABL facility of $29.0 million, partially offset by issuances of long-term debt of $291.0 million.
Adjusted EBITDA
EBITDA represents net income before interest, income taxes, depreciation and amortization. Adjusted EBITDA (as defined by the loan and security agreement governing the ABL facility and the indentures governing the Metals USA Notes and the 2007 Notes) is defined as EBITDA further adjusted to exclude certain non-cash, non-recurring and realized (or in the case of the indentures, expected) future cost savings directly related to prior acquisitions. EBITDA and Adjusted EBITDA are not defined terms under GAAP. Neither EBITDA nor Adjusted EBITDA should be considered an alternative to operating income or net income as a measure of operating results or an alternative to cash flow as a measure of liquidity. There are material
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limitations associated with making the adjustments to our earnings to calculate EBITDA and Adjusted EBITDA and using these non-GAAP financial measures as compared to the most directly comparable GAAP financial measures. For instance, EBITDA and Adjusted EBITDA do not include:
• | interest expense, and, because we have borrowed money in order to finance our operations, interest expense is a necessary element of our costs and ability to generate revenue; |
• | depreciation and amortization expense, and, because we use capital assets, depreciation and amortization expense is a necessary element of our costs and ability to generate revenue; and |
• | income tax expense, and because the payment of taxes is part of our operations, tax expense is a necessary element of our costs and ability to operate. |
We present EBITDA because we consider it an important supplemental measure of our performance and believe it is frequently used by our investors and other interested parties, as well as by our management, in the evaluation of companies in our industry, many of which present EBITDA when reporting their results. In addition, EBITDA provides additional information used by our management and board of directors to facilitate internal comparisons to historical operating performance of prior periods. Further, management believes EBITDA facilitates their operating performance comparisons from period to period because it excludes potential differences caused by variations in capital structure (affecting interest expense), tax positions (such as the impact of changes in effective tax rates or net operating losses) and the age and book depreciation of facilities and equipment (affecting depreciation expense).
We believe that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA are appropriate to provide additional information to investors about the performance of the business, and we are required to reconcile net income to Adjusted EBITDA to demonstrate compliance with debt covenants. Management uses Adjusted EBITDA as a key indicator to evaluate performance of certain employees.
Reconciliation of Net Income to EBITDA and Adjusted EBITDA
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2008 | 2007 | 2008 | 2007 | ||||||||||||
(in millions) | |||||||||||||||
Net income | $ | 36.0 | $ | (3.4 | ) | $ | 79.6 | $ | 12.1 | ||||||
Depreciation and amortization(1) | 5.8 | 5.6 | 18.2 | 16.6 | |||||||||||
Interest expense | 20.4 | 24.7 | 65.4 | 63.7 | |||||||||||
Loss on extinguishment of debt | — | 8.4 | — | 8.4 | |||||||||||
Provision for income taxes | 27.8 | 0.2 | 53.8 | 10.7 | |||||||||||
Other (income) expense | 0.2 | (0.7 | ) | 0.2 | (0.8 | ) | |||||||||
EBITDA | 90.2 | 34.8 | 217.2 | 110.7 | |||||||||||
Covenant defined adjustments: | |||||||||||||||
Facilities closure(2) | (0.7 | ) | 0.2 | 4.0 | 0.2 | ||||||||||
Stock options and grant expense(3) | 0.3 | 0.8 | 0.9 | 4.5 | |||||||||||
Management fees(4) | 0.3 | 0.3 | 0.9 | 0.9 | |||||||||||
Adjusted EBITDA(5) | $ | 90.1 | $ | 36.1 | $ | 223.0 | $ | 116.3 | |||||||
Fixed charge coverage ratio numerator(6) | $ | 210.1 | $ | 96.9 | $ | 210.1 | $ | 96.9 | |||||||
Fixed charge coverage ratio denominator(6) | $ | 65.4 | $ | 78.0 | $ | 65.4 | $ | 78.0 | |||||||
Fixed charge coverage ratio(6) | 3.21 | 1.24 | 3.21 | 1.24 | |||||||||||
(1) | Includes depreciation for Building Products that is included in cost of sales. |
(2) | This amount represents charges in the Building Products Group for the closure of six facilities during 2008 and two facilities during the first nine months of 2007. |
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(3) | Non-cash stock option and stock grant expense. |
(4) | Includes accrued expenses related to the management agreement we have with Apollo. |
(5) | As defined by the loan and security agreement governing the ABL facility. Given the wide variety of capital structures used to finance working capital in our industry, we believe that Adjusted EBITDA is a useful tool in addition to net income to evaluate our financial condition. |
(6) | These amounts represent the FCCR numerator, the FCCR denominator, and the FCCR, each as defined by the ABL facility. |
Financing Activities
The ABL Facility
The ABL facility permits us to borrow on a revolving basis through November 30, 2011. Substantially all of our subsidiaries are borrowers under the ABL facility.
On June 8, 2007, we executed the June 2007 amendment to the ABL facility, which increased the commitment from $450.0 million to $525.0 million, comprised of $500.0 million of Tranche A Commitments and $25.0 million of Tranche A-1 Commitments. Additionally, the June 2007 amendment reduced the borrowing cost on the Tranche A facility by 25 basis points, reduced the borrowing cost on the Tranche A-1 facility by 75 basis points and gave us the option to increase the Tranche A Commitments by $100.0 million. The June 2007 amendment did not have any impact on our covenant compliance. Costs incurred in connection with the June 2007 amendment totaled $1.6 million, and are being amortized over the existing term of the ABL facility, which expires November 30, 2011.
On July 1, 2008, we executed our option to increase the Tranche A Commitments by $100.0 million, which increased the total commitment from $525.0 million to $625.0 million. All other existing terms under the ABL facility remained unchanged. Costs incurred to exercise the option to increase the ABL facility totaled $2.4 million, and are being amortized over the existing term of the ABL facility.
Borrowing Base. The maximum availability under the ABL facility is based on eligible receivables and eligible inventory, subject to certain reserves. Our borrowing availability fluctuates daily with changes in eligible receivables and inventory, less outstanding borrowings and letters of credit. The borrowing base is equal to the lesser of (a) the aggregate amount of the Tranche A Commitments and the Tranche A-1 Commitments and (b) the sum of:
• | 85% of the net amount of eligible accounts receivable; |
• | the lesser of (x) 70% of the lesser of the original cost or market value of eligible inventory and (y) 90% of the net orderly liquidation value of eligible inventory; and |
• | at all times prior to the termination of the Tranche A-1 Commitments, the sum of 5% of the net amount of eligible accounts receivable and 5% of the net orderly liquidation value of eligible inventory. |
Initial borrowings under the ABL facility were used to repay the outstanding amounts drawn under our existing revolving credit facility and to fund other costs and expenses related to the Merger. The loan and security agreement governing the ABL facility provides for up to $15.0 million of swing-line loans and up to $100.0 million for the issuance of letters of credit. Both the face amount of any outstanding letters of credit and any swing-line loans will reduce borrowing availability under the ABL facility on a dollar-for-dollar basis.
During September 2008, we borrowed approximately $160.0 million on the ABL facility in response to concerns about credit markets. As of September 30, 2008, we had eligible collateral of $618.7 million, $542.0 million in outstanding advances, $15.2 million in open letters of credit and $61.5 million of additional borrowing capacity. As of September 30, 2008, we had $173.1 million of available cash and cash equivalents.
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In January 2007, we used the net proceeds from the issuance of the 2006 Notes, as well as $8.2 million of additional borrowings under the ABL facility, to pay a cash dividend of approximately $144.8 million to our stockholders, to make a cash payment (partially in lieu of the cash dividend) of $4.2 million to our vested stock option holders, and to pay fees and expenses related to the issuance of the 2006 Notes, including a $1.5 million transaction fee to Apollo.
On July 2, 2007, we purchased the business operations of Lynch Metals for approximately $42.4 million. The purchase price was funded by borrowings under the ABL facility, $38.4 million of which was paid at closing, and approximately $4.0 million of which is deferred and will be paid in various installments over a period of two years from the closing date.
Also in July 2007, we issued $300.0 million initial aggregate principal amount of the 2007 Notes. The net proceeds from the issuance of the 2007 Notes, as well as approximately $8.3 million of additional borrowings under the ABL facility, were used to redeem the 2006 Notes (for approximately $150.0 million plus accrued and unpaid interest of approximately $5.4 million), to pay a cash dividend of approximately $130.3 million to its stockholders, which include Apollo and certain members of management, to make a cash payment (partially in lieu of the cash dividend) of approximately $9.2 million to its stock option holders, which include certain members of our management, and to pay fees and expenses related to the offering of the 2007 Notes.
Guarantees and Security. Substantially all of our subsidiaries are defined as “borrowers” under the loan and security agreement governing the ABL facility. The obligations under the ABL facility are guaranteed by Flag Intermediate and certain of our domestic subsidiaries and are secured (i) on a first-priority lien basis by our, the other borrowers’ and the guarantors’ accounts, inventory, cash and proceeds and products of the foregoing and certain assets related thereto and (ii) on a second-priority lien basis by substantially all of our, the other borrowers’ and the guarantors’ other assets, subject to certain exceptions and permitted liens.
Interest Rate and Fees. Interest is calculated based upon a margin (established within a specific pricing grid for loans utilizing Tranche A Commitments) over reference rates. The marginal rates vary with our financial performance as measured by the FCCR. The FCCR is determined by dividing (i) the sum of Adjusted EBITDA (as defined by the loan and security agreement governing the ABL facility) minus income taxes paid in cash minus non-financed capital expenditures by (ii) the sum of certain distributions paid in cash, cash interest expense and scheduled principal reductions on debt, and is calculated based on such amounts for the most recent period of four consecutive fiscal quarters.
The interest rates with respect to loans utilizing the Tranche A Commitments are, at our option, (i) the higher of (a) the prime rate of Credit Suisse in effect at its principal office in New York City and (b) the federal funds effective rate plus 0.5%; plus, in each case, an applicable margin ranging between -0.25% and -0.50% as determined in accordance with the loan and security agreement governing the ABL facility or (ii) the rate (as adjusted for statutory reserves) for Eurodollar deposits for one, two, three, six or, if agreed to by all lenders under the loan and security agreement, nine or twelve months, as selected by us, by reference to the British Bankers’ Association Interest Settlement Rates, plus an applicable margin ranging between 1.00% and 1.75% as determined in accordance with the loan and security agreement governing the ABL facility. The interest rates with respect to loans utilizing the Tranche A-1 Commitments are, at our option, (i) the higher of (a) the prime rate of Credit Suisse in effect at its principal office in New York City and (b) the federal funds effective rate plus 0.5%; in each case plus an applicable margin of 0.75% or (ii) the rate (as adjusted for statutory reserves) for Eurodollar deposits for one, two, three, six or, if agreed to by all lenders under the loan and security agreement, nine or twelve months, as selected by us, by reference to the British Bankers’ Association Interest Settlement Rates, plus an applicable margin of 2.75%.
A commitment fee is payable on any unused commitments under the ABL facility of 0.25% per annum. The applicable base rate and the effective LIBOR rate for the Tranche A Commitments and Tranche A-1 Commitments were 5.00% and 4.05%, respectively, as of September 30, 2008.
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Certain Covenants. The ABL facility contains customary representations, warranties and covenants as a precondition to lending, including a material adverse change in the business, limitations on our ability to incur or guarantee additional debt, subject to certain exceptions, pay dividends, or make redemptions and repurchases, with respect to capital stock, repay debt, create or incur certain liens, make certain loans or investments, make acquisitions or investments, engage in mergers, acquisitions, asset sales and sale lease-back transactions, and engage in certain transactions with affiliates. In addition, the ABL facility requires a lock-box arrangement, which, as long as borrowing availability is greater or equal to $45.0 million and in the absence of default, is controlled by Metals USA. As long as our borrowing availability is greater than or equal to $45.0 million, we do not have to maintain a minimum FCCR. Should borrowing availability fall below $45.0 million, we must maintain an FCCR of at least 1.0 to 1.0.
Additionally, payments to affiliates are limited to the greater of $3.0 million or 3% of Adjusted EBITDA (as defined in the loan and security agreement governing the ABL facility) provided borrowing availability equals at least $25.0 million. Further, distributions in respect of capital stock are limited to the payment of up to $25.0 million, plus $5.0 million for each full fiscal quarter (with any amount not used in any fiscal quarter being permitted to be used in succeeding fiscal quarters), plus 50% of cumulative consolidated net income, or if a loss, minus 100% of the amount thereof, plus 100% of the aggregate net proceeds received by us from certain sales and issuances of capital stock or from certain capital contributions, of dividends in any fiscal quarter provided that borrowing availability is greater than $50.0 million and the FCCR is at least 1.0 to 1.0.
The ABL facility contains events of default with respect to: default in payment of principal when due, default in the payment of interest, fees or other amounts after a specified grace period, material breach of the representations or warranties, default in the performance of specified covenants, failure to make any payment when due under any indebtedness with a principal amount in excess of a specified amount, certain bankruptcy events, certain ERISA violations, invalidity of certain security agreements or guarantees, material judgments, or a change of control. In the event of default the agreement may permit the lenders to: (i) restrict the account or refuse to make revolving loans; (ii) cause customer receipts to be applied against borrowings under the ABL facility causing the Company to suffer a rapid loss of liquidity and the ability to operate on a day-to-day basis; (iii) restrict or refuse to provide letters of credit; or ultimately: (iv) terminate the commitments and the agreement; or (v) declare any or all obligations to be immediately due and payable if such default is not cured in the specified period required. Any payment default or acceleration under the ABL facility would also result in a default under the Metals USA Notes and the 2007 Notes that would provide the holders of the Metals USA Notes and the 2007 Notes with the right to demand immediate repayment.
Interest Rate Swaps. In February 2008, $250.0 million notional amount of outstanding borrowings under the ABL facility were swapped from a floating LIBOR-based rate to a fixed rate. The swaps entitle us to receive quarterly payments of interest at a floating rate indexed to the three-month LIBOR and pay a fixed rate that ranges from 2.686% to 2.997%, converting a portion of the outstanding borrowings on our ABL facility from a floating rate obligation to a fixed rate obligation. We recognized a pretax loss of $2.4 million in earnings (interest expense) during the nine months ended September 30, 2008, which was due to the change in fair value of the interest rate swap derivatives previous to their qualification for hedge accounting treatment. Other pretax realized gains and losses from derivatives which were recognized in earnings during the nine months ended September 30, 2008, subsequent to qualification for hedge accounting treatment, amounted to $0.2 million of additional interest expense. These gains and losses effectively offset changes in the cost of the Company’s hedged exposure, and no amount of such gains and losses resulted from hedge ineffectiveness, nor was any component of these gains and losses excluded from the Company’s assessment of hedge effectiveness. The fair value of the Company’s interest rate swaps was $2.7 million at September 30, 2008, with $1.6 million classified as other current assets and $1.1 million classified as other noncurrent assets in the consolidated balance sheet.
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The Metals USA Notes
On the closing date of the Merger, we received approximately $268.0 million of net cash proceeds from the sale of $275.0 million in aggregate principal amount of the Metals USA Notes, after deducting expenses of the offering. Interest on the Metals USA Notes accrues at the rate of 11 1/8% per annum and is payable semiannually in arrears on June 1 and December 1 and commenced on June 1, 2006. The Metals USA Notes will mature on December 1, 2015. We may redeem some or all of the Metals USA Notes at any time on or after December 1, 2010, at a predetermined redemption price plus accrued and unpaid interest and additional interest, if any, to the applicable redemption date. In addition, on or prior to December 1, 2008, we may redeem up to 35% of the aggregate principal amount of the Metals USA Notes with the net proceeds of certain equity offerings. If we experience a change of control and we do not redeem the Metals USA Notes, we will be required to make an offer to repurchase the Metals USA Notes at a price equal to 101% of the principal amount, plus accrued and unpaid interest and additional interest, if any, to the date of repurchase.
We will pay interest on overdue principal at 1% per annum in excess of the above rate and will pay interest on overdue installments of interest at such higher rate to the extent lawful. The indenture governing the Metals USA Notes contains the covenants described under “Covenant Compliance” below.
The Metals USA Notes indenture contains certain customary events of default, including (subject, in some cases, to customary cure periods thresholds) defaults based on (1) the failure to make payments under the Metals USA indenture when due, (2) breach of covenants, (3) cross-defaults to other material indebtedness, (4) bankruptcy events and (5) material judgments. We were in compliance with all covenants as of September 30, 2008.
2007 Notes
On July 10, 2007, we issued $300.0 million initial aggregate principal amount of the 2007 Notes due July 1, 2012. The 2007 Notes were issued at an initial issue price of 97% of the principal amount thereof, and original issue discount is being amortized to interest expense over the life of the 2007 Notes. The 2007 Notes are senior unsecured obligations that are not guaranteed by any of Metals USA Holdings’ subsidiaries. As such, the 2007 Notes are structurally subordinated to all indebtedness and other liabilities (including trade payables) of Metals USA Holdings’ subsidiaries.
The initial five interest payments on the 2007 Notes were paid solely in cash. Metals USA Holdings must make an election regarding whether subsequent interest payments will be made in cash or through PIK Interest prior to the start of the applicable interest period. For any interest period thereafter, Metals USA Holdings may elect to pay interest (1) entirely in cash or (2) entirely by increasing the principal amount of the 2007 Notes or issuing new 2007 Notes (“PIK Interest”), or (3) on 50% of the outstanding principal amount of the 2007 Notes in cash and on 50% of the outstanding principal amount of the 2007 Notes by increasing the principal amount of the outstanding 2007 Notes or by issuing new 2007 Notes (“Partial PIK Interest”). Cash interest on the 2007 Notes will accrue at a rate per annum, reset quarterly, equal to LIBOR plus a spread of 6.00%, which increases by 0.25% to 6.25% in year 2, by 0.50% to 6.50% in year 3, and by 0.75% to 6.75% in year 4. In the event PIK Interest is paid on the 2007 Notes after the first four interest periods, the then-applicable margin over LIBOR on the 2007 Notes would increase by 0.75% for each period in which PIK Interest is paid. If Metals USA Holdings elects to pay any PIK Interest, Metals USA Holdings will increase the principal amount on the 2007 Notes or issue new 2007 Notes in an amount equal to the amount of PIK Interest for the applicable interest payment period to holders of the 2007 Notes on the relevant record date. Interest is payable quarterly in arrears on January 1, April 1, July 1 and October 1. PIK Interest notes, resulting from the conversion of interest into PIK notes, when paid will be treated as an operating activity in the Consolidated Statements of Cash Flows in accordance with SFAS 95.
Flag Intermediate provided funds to Metals USA Holdings to fund the initial five quarterly interest payments on the 2007 Notes, which were paid on October 1, 2007, January 2, 2008, April 1, 2008, July 1, 2008, and October 1, 2008 and which totaled $7.7 million, $8.4 million, $8.1 million, $6.5 million and $6.6 million, respectively.
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On September 26, 2008, we made a permitted election under the indenture governing the 2007 Notes to pay all interest that is due on January 1, 2009, for the interest period beginning on October 1, 2008, and ending on December 31, 2008, entirely through PIK Interest. The Company must make an election regarding whether subsequent interest payments will be made in cash, through PIK Interest, or Partial PIK Interest, prior to the start of the applicable interest period. In the absence of such an election for any interest period, interest on the 2007 Notes will be payable according to the election for the previous interest period. As a result, the PIK Interest election is now the default election for future interest periods unless we elect otherwise not later than the commencement of an interest period.
The terms of the ABL facility, as well as the indenture governing the Metals USA Notes, restrict Flag Intermediate and certain of its subsidiaries from making payments or transferring assets to Metals USA Holdings, including dividends, loans, or distributions. Such restrictions include prohibition of dividends in an event of default and limitations on the total amount of dividends paid to Metals USA Holdings. In the event these agreements do not permit Flag Intermediate to provide Metals USA Holdings with sufficient distributions to fund interest and principal payments on the 2007 Notes when due, Metals USA Holdings may default on the 2007 Notes unless other sources of funding are available. Amounts available under these restricted payment provisions amounted to $75.3 million under the indenture governing the Metals USA Notes and $130.4 million under the loan and security agreement governing the ABL facility as of September 30, 2008.
On or after January 15, 2008, Metals USA Holdings may redeem some or all of the 2007 Notes at certain redemption prices, plus accrued and unpaid interest and additional interest, if any, to the redemption date. If Metals USA Holdings makes certain public offerings, sales or issuances of common stock, and does not redeem the 2007 Notes, it will be required to make an offer to repurchase the maximum principal amount of the 2007 Notes that may be purchased out of the proceeds thereof, at a price equal to 100% of the principal amount, plus accrued and unpaid interest and additional interest, if any, to the date of repurchase.
If Metals USA Holdings experiences a change of control and does not redeem the 2007 Notes, it will be required to make an offer to repurchase the 2007 Notes at a price equal to 101% of the principal amount, plus accrued interest and unpaid interest and additional interest, if any, to the date of repurchase.
We will pay interest on overdue principal at 1% per annum in excess of the rates discussed above and will pay interest on overdue installments of interest at such higher rate to the extent lawful. The indenture governing the 2007 Notes contains covenants described under “Covenant Compliance” below.
The indenture governing the 2007 Notes contains covenants that, among other things, limit Metals USA Holdings’ ability and the ability of certain of its subsidiaries to incur or guarantee additional indebtedness or issue disqualified or preferred stock, repurchase or redeem capital stock or subordinated indebtedness, pay dividends or make distributions to its stockholders, incur restrictions on the ability of its subsidiaries to pay dividends or to make other payments to Metals USA Holdings, transfer or sell assets, create liens, enter into transactions with affiliates, make investments or acquisitions, and merge or consolidate with other companies or transfer all or substantially all of its assets.
Our affiliates, which include Apollo Management V L.P. (“Apollo Management” and together with its affiliated investment entities “Apollo”), as well as our Chief Executive Officer and our Chief Financial Officer, have purchased a portion of our 2007 Notes in the market. As of September 30, 2008, the amount of outstanding 2007 Notes held by our affiliates was $91.4 million, $90.9 million of which were held by Apollo, with the remainder held by the executive officers referred to above. From time to time, depending upon market, pricing and other conditions, as well on cash balances and liquidity, we, our subsidiaries or affiliates may seek to purchase or sell additional indebtedness of us or our affiliates. Any such future purchases or sales may be made in the open market, privately negotiated transactions, tender offers or otherwise.
On February 26, 2008, we exchanged $216.0 million aggregate principal amount of the $300.0 million aggregate principal amount privately placed 2007 Notes for substantially identical 2007 Notes registered under the Securities Act of 1933, as amended.
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Covenant compliance
Our FCCR as defined by the ABL facility is calculated based on a numerator consisting of Adjusted EBITDA less cash taxes and capital expenditures and a denominator consisting of interest expense and certain distributions, and is calculated based on such amounts for the most recent period of four consecutive fiscal quarters. As of September 30, 2008, our FCCR was 3.21. As of September 30, 2008, we had $61.5 million of additional borrowing capacity under the ABL facility. Failure to comply with the FCCR covenant of the ABL facility can result in limiting our long-term growth prospects by hindering our ability to incur future indebtedness or grow through acquisitions.
The indentures governing the Metals USA Notes and the 2007 Notes contain covenants that restrict our ability to take certain actions, such as incurring additional debt and making certain acquisitions, if we are unable to meet defined Adjusted EBITDA to Fixed Charges and consolidated total debt ratios (each, as defined). The covenants in the indenture requires us to have an Adjusted EBITDA to Fixed Charge ratio (measured on a trailing four-quarter basis and calculated differently from the fixed charge coverage ratio as defined by the ABL facility) of 2.0 to 1.0 to incur “ratio” indebtedness and a consolidated total debt ratio of no greater than 4.75 to 1.0 to incur “ratio” indebtedness in connection with acquisitions. Based on the calculations for the trailing four quarters, we are able to satisfy these covenants and incur additional indebtedness under these ratios, including for acquisition purposes, under our indentures. The most restrictive of the covenants in all of our debt agreements is the FCCR in our ABL facility; accordingly, we have presented our covenant compliance on that basis.
The FCCR (as defined in the loan and security agreement governing the ABL facility) is determined by dividing (i) the sum of Adjusted EBITDA (as defined by the loan and security agreement governing the ABL facility) minus income taxes paid in cash minus non-financed capital expenditures by (ii) the sum of certain distributions paid in cash, cash interest expense and scheduled principal reductions on debt, and is calculated based on such amounts for the most recent period of four consecutive fiscal quarters. Adjusted EBITDA is defined as EBITDA further adjusted to exclude certain non-cash, non-recurring and realized or expected future cost savings directly related to prior acquisitions. We believe that the inclusion of the supplemental adjustments applied in calculating Adjusted EBITDA is appropriate to provide additional information to investors to demonstrate compliance with our financial covenants and assess our ability to incur additional indebtedness in the future. EBITDA, adjusted EBITDA and fixed charges are not defined terms under GAAP. Adjusted EBITDA should not be considered an alternative to operating income or net income as a measure of operating results or an alternative to cash flows as a measure of liquidity. Fixed charges should not be considered an alternative to interest expense. Because we are highly leveraged, we believe that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA are appropriate to provide additional information to investors to demonstrate compliance with the covenants in our debt agreements.
As of September 30, 2008, we were in compliance with all of the debt covenants including those of the loan and security agreement governing the ABL facility and the indentures governing the Metals USA Notes and the 2007 Notes. Both the loan and security agreement governing the ABL facility and the indentures governing the Metals USA Notes and the 2007 Notes contain restrictions as to the payment of dividends. As of September 30, 2008, under the most restrictive of these covenants, the maximum amount of dividends that could be paid was $130.4 million under the loan and security agreement governing the ABL facility and $75.3 million under the indenture governing the Metals USA Notes. As of September 30, 2008, Flag Intermediate and its wholly-owned subsidiary, Metals USA, had $257.8 million of total stockholder’s equity.
We believe the cash flow from operations, supplemented by the cash available under the ABL facility, will be sufficient to enable us to meet our debt service and operational obligations as they come due for at least the next twelve months.
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Commitments and Contingencies
From time to time, we are involved in a variety of claims, lawsuits and other disputes arising in the ordinary course of business. We believe the resolution of these matters and the incurrence of their related costs and expenses should not have a material adverse effect on our consolidated financial position, results of operations, liquidity or cash flows.
Off-Balance Sheet Arrangements
We were not engaged in off-balance sheet arrangements through any unconsolidated, limited purpose entities and no material guarantees of debt or other commitments to third parties existed at September 30, 2008.
New Accounting Pronouncements
In May 2008, the FASB issued SFAS No. 162, “Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). This statement is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements of nongovernmental entities that are presented in conformity with GAAP. This statement will be effective 60 days following the U.S. Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendment to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 162 on its consolidated financial statements.
In April 2008, the FASB issued FASB Staff Position (“FSP”) No. SFAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP SFAS 142-3”). FSP SFAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). The intent of FSP SFAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141R (revised 2007), “Business Combinations” (“SFAS 141R”) and other applicable accounting literature. FSP SFAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and must be applied prospectively to intangible assets acquired after the effective date. The Company is currently evaluating the potential impact, if any, of FSP SFAS 142-3 on its consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”), which expands the disclosure requirements in SFAS 133 about an entity’s derivative instruments and hedging activities. SFAS 161’s disclosure provisions apply to all entities with derivative instruments subject to SFAS 133 and its related interpretations. The provisions also apply to related hedged items, bifurcated derivatives, and nonderivative instruments that are designated and qualify as hedging instruments. Entities with instruments subject to SFAS 161 must provide more robust qualitative disclosures and expanded quantitative disclosures. Such disclosures, as well as existing SFAS 133 required disclosures, generally will need to be presented for every annual and interim reporting period. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the potential impact of adopting SFAS 161, if any, on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”), which replaces SFAS 141. SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired in connection with a business combination. The Statement also establishes disclosure requirements that will enable users to evaluate the nature and financial effect of the business combination. SFAS 141R applies prospectively to business combinations for
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which the acquisition date is on or after the beginning of an entity’s first fiscal year that begins after December 15, 2008. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 141R on the Company’s financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 requires that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 160 also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This Statement is effective as of the beginning of an entity’s first fiscal year beginning after December 15, 2008. The Company has not yet determined the impact, if any, that SFAS 160 will have on its financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 expands the use of fair value accounting but does not affect existing standards which require assets and liabilities to be carried at fair value. Under SFAS 159, a company may elect to use fair value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accounts payable, guarantees, issued debt and other eligible financial instruments. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company did not elect to measure additional financial assets and liabilities at fair value.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS 158”), which requires the recognition of the funded status of benefit plans in the balance sheet. SFAS 158 also requires certain gains and losses that are deferred under current pension accounting rules to be recognized in accumulated other comprehensive income, net of tax effects. These deferred costs (or income) will continue to be recognized as a component of net periodic pension cost, consistent with current recognition rules. For entities with no publicly traded equity securities, the effective date for the recognition of the funded status is for fiscal years ending after June 15, 2007. In addition, the ability to measure the plans’ benefit obligations, assets and net periodic cost at a date prior to the fiscal year-end date is eliminated for fiscal years ending after December 15, 2008. The adoption of the recognition element of SFAS 158 had no effect on the Company’s financial statements. The adoption of the measurement date element of SFAS 158 is not expected to have a material impact on the Company’s financial statements.
In September 2006, the FASB issued SFAS 157, which enhances existing guidance for measuring assets and liabilities using fair value. SFAS 157 provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted market prices in active markets. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS 157, as it relates to financial assets and financial liabilities, was effective for the Company as of January 1, 2008. SFAS 157 does not require any new fair value measurements for existing assets and liabilities on the Company’s balance sheet as of the date of adoption. Rather, the provisions of SFAS 157 are to be applied prospectively. As such, there was no impact to the Company’s financial statements as of the January 1, 2008 adoption date, and for the nine months ended September 30, 2008, we have included the Statement’s expanded disclosures about the use of fair value to measure assets and liabilities within the Company’s financial statements.
In February 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”), which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on at least an annual basis, until fiscal years beginning after November 15, 2008. The Company is currently evaluating the potential impact of adopting FSP FAS 157-2, if any, on its consolidated financial statements.
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ITEM 3. Quantitative And Qualitative Disclosures About Market Risk
In the normal course of our business, we are exposed to market risk, primarily from changes in interest rates and the cost of metal we hold in inventory. We continually monitor exposure to market risk and develop appropriate strategies to manage this risk. With respect to our metal purchases, there is no recognized market to purchase derivative financial instruments to reduce the inventory exposure risks. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for a discussion of market risk relative to steel prices.
Our exposure to market risk for changes in interest rates relates primarily to the ABL facility and the 2007 Notes, both of which are subject to variable interest rates. As of September 30, 2008, outstanding borrowings under the ABL facility were $542.0 million. Based on the weighted average borrowings outstanding on the ABL facility during the nine months ended September 30, 2008, a one percent increase or decrease in the weighted average facility rate would have resulted in a change to pretax interest expense of approximately $2.7 million for the period.
As of September 30, 2008, the outstanding principal amount of the 2007 Notes was $293.2 million. Based on this amount, a one percent increase or decrease in the base rate would have resulted in a change to pretax interest expense of $2.3 million for the nine months ended September 26, 2008. At September 26, 2008, the 2007 Notes were traded at approximately 85.0% of face value, based on quoted market prices.
In February 2008, $250.0 million notional amount of outstanding borrowings under the ABL facility were swapped from a floating LIBOR-based rate to a fixed rate. The swaps entitle us to receive quarterly payments of interest at a floating rate indexed to the three-month LIBOR and pay a fixed rate that ranges from 2.686% to 2.997%, converting a portion of the outstanding borrowings on our ABL facility from a floating rate obligation to a fixed rate obligation. We recognized a pretax loss of $2.4 million in earnings (interest expense) during the nine months ended September 30, 2008, which was due to the change in fair value of the interest rate swap derivatives previous to their qualification for hedge accounting treatment. Other pretax realized gains and losses from derivatives which were recognized in earnings during the nine months ended September 30, 2008, subsequent to qualification for hedge accounting treatment, amounted to $0.2 million of additional interest expense. These gains and losses effectively offset changes in the cost of the Company’s hedged exposure, and no amount of such gains and losses resulted from hedge ineffectiveness, nor was any component of these gains and losses excluded from the Company’s assessment of hedge effectiveness. The fair value of the Company’s interest rate swaps was $2.7 million at September 30, 2008, with $1.6 million classified as other current assets and $1.1 million classified as other noncurrent assets in the consolidated balance sheet.
$275.0 million aggregate principal amount of Metals USA Notes were outstanding at September 30, 2008, with a fixed interest rate of 11 1/8%. Changes in market interest rates will not impact cash interest payable on the Metals USA Notes. At September 26, 2008, the Metals USA Notes were traded at approximately 99.0% of face value, based on quoted market prices.
ITEM 4.Controls And Procedures
As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of our management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) of Metals USA Holdings Corp, of the effectiveness of our disclosure controls and procedures (as defined pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934).
Based on that evaluation, the CEO and CFO of Metals USA Holdings Corp. have concluded that our disclosure controls and procedures are effective to ensure that the information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is
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accumulated and communicated to our management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.
We maintain a system of internal accounting controls that are designed to provide reasonable assurance that our books and records accurately reflect our transactions and that our policies and procedures are followed. There have been no changes in our internal controls over financial reporting or in other factors that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
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PART II. OTHER INFORMATION
From time to time, we are involved in a variety of claims, lawsuits and other disputes arising in the ordinary course of business. We believe the resolution of these matters and the incurrence of their related costs and expenses should not have a material adverse effect on our consolidated financial position, results of operations, liquidity or cash flows. While it is not feasible to predict the outcome of all pending suits and claims, the ultimate resolution of these matters as well as future lawsuits could have a material adverse effect on our business, financial condition, results of operations, cash flows or reputation.
There have been no material changes to the disclosure related to risk factors made in our Annual Report on Form 10-K for the year ended December 31, 2007.
ITEM 2.Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3.Defaults Upon Senior Securities
None.
ITEM 4.Submission of Matters to a Vote of Security Holders
None.
None.
Exhibit | Description | |
31.1* | Certification of the Chief Executive Officer of Metals USA Holdings Corp., dated November 3, 2008, pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2* | Certification of the Chief Financial Officer of Metals USA Holdings Corp., dated November 3, 2008, pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1* | Certification of the Chief Executive Officer of Metals USA Holdings Corp., dated November 3, 2008, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2* | Certification of the Chief Financial Officer of Metals USA Holdings Corp., dated November 3, 2008, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Filed herewith. |
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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, who has signed this report on behalf of the Registrant and as the principal financial officer of the Registrant.
METALS USA HOLDINGS CORP. | ||||||||
Date: November 3, 2008 | By: | /s/ ROBERT C. MCPHERSON, III | ||||||
Robert C. McPherson, III Senior Vice President and Chief Financial Officer |
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