Steel Dynamics, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Unaudited results; dollar amounts below are in millions unless noted.
Business context and financial performance
Steel Dynamics is a domestic steel producer and metals recycler, with steel operations, metals recycling and ferrous resources, and steel fabrication segments.
| Metric | Q2 2014 | Q2 2013 | H1 2014 | H1 2013 |
|---|---|---|---|---|
| Net sales | $2,069.8 | $1,801.3 | $3,899.8 | $3,597.0 |
| Gross profit | $222.8 | $147.7 | $386.1 | $324.0 |
| Operating income | $131.9 | $69.2 | $212.8 | $165.4 |
| Net income attributable to SDI | $72.3 | $29.0 | $110.9 | $77.2 |
| Diluted EPS | $0.31 | $0.13 | $0.48 | $0.34 |
Q2 gross margin was about 10.8% versus 8.2% a year earlier; operating margin was 6.4% versus 3.8%. For H1, gross margin was about 9.9% versus 9.0%, and operating margin 5.5% versus 4.6%.
- Cash flow: H1 operating cash flow was $48.8 million, versus $62.4 million in H1 2013. Capital expenditures were $58.4 million, versus $94.6 million; operating cash flow less capital expenditures was approximately negative $9.6 million.
- Liquidity: June 30 cash and equivalents were $357.5 million; revolver availability was $1,086.0 million; reported total liquidity was $1,443.5 million.
- Debt: Total debt, including current maturities, was approximately $1.804 billion, down $303.7 million from year-end 2013. Debt-to-capitalization was 37.9%, down from 44.7%. The company reported 5.88x interest coverage and 2.06x net debt leverage, and compliance with facility covenants.
- Balance sheet: Total assets were $5.985 billion and total equity was $2.835 billion at June 30, 2014. Accounts receivable rose to $910.8 million from $720.6 million at year-end; inventory was $1.321 billion, broadly unchanged.
Material changes and segment trends
- Q2 sales increased 15% and operating income 91% year over year. Management attributed the improvement mainly to steel operations: higher shipments, expanded metal spreads, and lower conversion costs. Steel segment sales rose 17% and operating income 82%; steel shipments rose 10%.
- H1 sales increased 8%, operating income 29%, and attributable net income 44%. Management said severe winter weather constrained Q1 shipments and increased production costs; Q2 improved beyond a simple recovery, with stronger volumes and operating conditions across platforms.
- Metals recycling and ferrous resources recorded a $6.1 million Q2 operating loss, improved from a $7.3 million loss. For H1, the segment loss widened to $21.6 million from $17.1 million, as weaker recycling income outweighed improvement in Minnesota iron operations. Ferrous scrap spreads faced elevated procurement competition.
- Steel fabrication operating income rose to $7.6 million in Q2 from $2.3 million and to $10.7 million for H1 from $3.9 million, on higher volumes, pricing, market-share gains, and manufacturing efficiencies.
- The 5.125% convertible notes matured in June. Holders converted $271.8 million principal into 15.9 million treasury shares; the remaining $15.7 million was repaid in cash. The conversion contributed to the reduction in debt and increased shares outstanding.
Outlook, risks, contingencies, and unusual items
- Acquisition after quarter-end: On July 18, 2014, SDI agreed to acquire Severstal Columbus for $1.625 billion, cash-free and debt-free, subject to working-capital adjustments, regulatory approvals, and other customary conditions. Closing was planned before year-end. Funding was expected from cash, the $1.1 billion revolver, and new debt; banks also committed, subject to conditions, up to $1.0 billion in bridge financing if needed.
- Capital spending and liquidity outlook: Management estimated 2014 capital expenditures for existing operations of $130–$150 million and believed available resources would cover the next 12 months’ debt service, working capital, and anticipated capex. This assessment predates the planned acquisition and its financing needs.
- Dividend: The quarterly dividend increased 5% to $0.115 per share. Management anticipated maintaining that level for the remainder of 2014, subject to board approval, financial needs, growth plans, and debt restrictions.
- Operating risks: Management cited cyclical demand, steel and scrap price competition, raw-material and energy costs and the ability to pass through increases, imports, outages, and integration or startup challenges. Minnesota iron nugget operations continued to face operating, quality, and cost challenges; Q2 trials were encouraging, but consistent cost performance still needed confirmation.
- Legal and environmental matters: A steel-price antitrust class action remained pending; the court had taken class certification under advisement. The company said a material loss was not presently reasonably possible and had not estimated exposure, but noted an adverse result could materially affect financial condition, results, or liquidity. Routine litigation was not expected to have a material impact. Environmental requirements could become more stringent.
- Other: The company was evaluating the impact of the newly issued revenue-recognition standard ASC 606. No material changes to previously disclosed risk factors or internal controls were reported.
Most important facts for investors to verify
- Whether the Severstal Columbus transaction closed as planned, its final purchase price and working-capital adjustments, and the resulting debt, interest costs, and covenant headroom.
- Whether operating cash flow, receivables, and working capital improved after the substantial H1 receivables increase.
- Whether steel margins and shipments remained resilient as raw-material costs, selling prices, and import competition changed.
- Whether Minnesota iron operations achieved consistent production, quality, yield, and cost performance.
- Any developments in the antitrust class-certification ruling, potential loss accruals, or environmental obligations.