Business context and reporting period
Steel Dynamics, Inc. (SDI) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2014. SDI manufactures steel and recycles metals, with steel operations, metals recycling and ferrous resources, and steel fabrication segments. Comparisons are with the corresponding 2013 periods unless noted.
On September 16, SDI acquired Severstal Columbus, LLC, adding 3.4 million tons of annual hot-roll steel capacity. Columbus is included in results from the acquisition date; its brief contribution and acquisition-related costs affect comparability.
Financial performance and position
- Third-quarter results: Net sales were $2.339 billion, up 22%; gross profit was $288.5 million, up 46%; operating income was $188.6 million, up 67%; and net income attributable to SDI was $91.2 million, up 59%. Diluted EPS was $0.38 versus $0.25.
- Nine-month results: Net sales were $6.239 billion, up 13%; gross profit was $674.6 million, up 29%; operating income was $401.5 million, up 44%; and net income attributable to SDI was $202.1 million, up 50%. Diluted EPS was $0.85 versus $0.59.
- Margins: Third-quarter gross and operating margins were approximately 12.3% and 8.1%, respectively, compared with 10.3% and 5.9% a year earlier. Nine-month gross and operating margins were approximately 10.8% and 6.4%, versus 9.5% and 5.1%.
- Cash flow: Nine-month operating cash flow was $298.0 million, compared with $245.7 million. Investing used $1.696 billion, principally reflecting the $1.647 billion cash outflow for the Columbus acquisition; financing provided $1.163 billion. Cash declined by $235.6 million to $159.6 million.
- Debt and liquidity: Total debt was approximately $3.062 billion at September 30, versus approximately $2.108 billion at December 31, 2013. SDI reported total liquidity of $1.184 billion, including $159.6 million cash and $1.025 billion revolver availability. Long-term debt to capitalization increased to 50.2% from 44.7%. The company reported compliance with its credit-facility covenants: interest coverage of 5.71:1 and net-debt leverage of 2.79:1.
- Other measures: Capital expenditures were $82.9 million for the first nine months, down from $146.7 million. The quarterly dividend increased 5% to $0.115 per share. As of October 31, 2014, 240,415,834 common shares were outstanding.
Material changes versus prior comparable periods
- Management attributed stronger results to record steel and fabrication shipments, improved selling prices relative to raw-material costs, strong plant utilization, and volume-related cost efficiencies. Third-quarter steel shipments rose 18% and fabrication shipments rose 41%.
- Steel-segment operating income rose 37% in the quarter to $200.1 million. Fabrication operating income rose to $19.5 million from $3.3 million. Metals recycling and ferrous resources reported a $5.3 million operating loss, improved from a $17.1 million loss.
- Columbus increased assets and debt substantially. SDI issued $700 million of 5.125% senior notes due 2021 and $500 million of 5.500% senior notes due 2024, and drew $117.8 million under its secured credit facility to help fund the acquisition.
- Third-quarter other expense included $25.0 million of Columbus acquisition and related financing costs. Columbus reported $126.5 million in revenue and $13.5 million pretax income for September 16–30, before $14.5 million of purchase-accounting cost-of-goods-sold charges.
Outlook, risks and unusual items
- SDI gave no specific earnings or revenue guidance. Management expected operating cash flow and other available funding, including revolver availability, to be adequate for the next 12 months to meet debt service, working-capital needs, and anticipated capital expenditures. It anticipated maintaining the current quarterly dividend for the rest of 2014, subject to board discretion and debt restrictions.
- Management described demand as strong in automotive, manufacturing, and energy, and improving in nonresidential construction. It also noted improved production, quality, and costs at the Minnesota iron nugget operation, while acknowledging the facility’s continuing operational, quality-control, and production-cost challenges.
- Key risks include cyclical demand, steel and scrap price competition, raw-material and energy cost changes and the ability to pass them through, integration of acquired businesses, and unexpected plant outages. Environmental regulation and permitting may also raise costs.
- A steel-pricing antitrust class action remained pending; the court had not ruled on class certification. SDI said it could not estimate exposure and did not then consider a material loss reasonably possible, but stated an adverse outcome could materially affect its financial condition, results, or liquidity. Routine litigation was not expected to have a material impact.
- Acquisition purchase-price allocations were preliminary, including the valuation of acquired assets, liabilities, intangibles, and any goodwill. SDI was evaluating and integrating Columbus’s financial-reporting controls and excluded Columbus from its internal-control effectiveness assessment for the acquisition year, as permitted by SEC rules.
Important facts for investors to verify
- How the Columbus acquisition performs after integration, including realized capacity, product mix, margins, and final purchase-accounting adjustments.
- Whether higher shipment volumes and improved spreads persist, particularly if steel prices, scrap costs, or demand conditions change.
- Debt-service capacity and covenant headroom after the acquisition-related increase in debt, as well as revolver availability and refinancing needs.
- Progress and remaining costs or risks at the Minnesota iron operations, and the outcome of the steel antitrust class-certification process.
- Whether working-capital needs, capital spending, and dividends remain consistent with management’s liquidity expectations.