Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2009
OR
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number 0-21719
Steel Dynamics, Inc.
(Exact name of registrant as specified in its charter)
Indiana
35-1929476
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
6714 Pointe Inverness Way, Suite 200, Fort Wayne, IN
46804
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (260) 969-3500
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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
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 “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act).
(Check one):
Large accelerated filer x
Non-accelerated filer o
Accelerated filer o
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of May 5, 2009, Registrant had 182,187,461 outstanding shares of common stock.
STEEL DYNAMICS, INC.
Page
PART I. Financial Information
Item 1.
Financial Statements:
Consolidated Balance Sheets as of March 31, 2009 (unaudited) and December 31, 2008
1
Consolidated Statements of Operations for the three-month periods ended March 31, 2009 and 2008 (unaudited)
2
Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2009 and 2008 (unaudited)
3
Notes to Consolidated Financial Statements (unaudited)
4
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
15
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
22
Item 4.
Controls and Procedures
PART II. Other Information
Legal Proceedings
23
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Submission of Matters to a Vote of Security Holders
Item 5.
Other Information
Item 6.
Exhibits
Signatures
25
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31,
December 31,
2009
2008
(unaudited)
Assets
Current assets
Cash and equivalents
$
16,067
16,233
Accounts receivable, net
335,715
453,011
Accounts receivable-related parties
26,124
49,921
Inventories, net
833,074
1,023,235
Deferred income taxes
26,631
23,562
Income taxes receivable
93,475
86,321
Other current assets
35,725
57,632
Total current assets
1,366,811
1,709,915
Property, plant and equipment, net
2,108,657
2,072,857
Restricted cash
16,217
18,515
Intangible assets, net
551,489
614,786
Goodwill
812,161
770,438
Other assets
70,744
67,066
Total assets
4,926,079
5,253,577
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable
239,355
259,742
Accounts payable-related parties
4,559
3,651
Accrued expenses
91,547
148,627
Accrued interest
58,191
30,874
Accrued payroll and benefits
39,492
34,303
Accrued profit sharing
56
62,561
Senior secured revolving credit facility, due 2012
231,000
366,000
Current maturities of long-term debt
65,450
65,223
Total current liabilities
729,650
970,981
Long-term debt
Senior secured term A loan, due 2012
487,700
503,800
7 3/8% senior notes, due 2012
700,000
6 3/4% senior notes, due 2015
500,000
7 3/4% senior notes, due 2016
Other long-term debt
30,314
15,361
2,218,014
2,219,161
373,712
365,496
Other liabilities
65,759
65,626
Commitments and contingencies
Stockholders’ equity
Common stock voting, $.0025 par value; 900,000,000 shares authorized; 218,771,002 and 218,733,363 shares issued; and 182,130,997 and 181,820,012 shares outstanding, as of March 31, 2009 and December 31, 2008, respectively
545
Treasury stock, at cost; 36,640,005 and 36,913,351 shares, as of March 31, 2009 and December 31, 2008, respectively
(734,083
)
(737,319
Additional paid-in capital
544,971
541,686
Other accumulated comprehensive loss
(1,073
(1,411
Retained earnings
1,714,310
1,820,385
Total Steel Dynamics, Inc. stockholders’ equity
1,524,670
1,623,886
Noncontrolling interests
14,274
8,427
Total stockholders’ equity
1,538,944
1,632,313
Total liabilities and stockholders’ equity
See notes to consolidated financial statements.
(in thousands, except per share data)
Three Months Ended
Net sales
Unrelated parties
787,810
1,814,083
Related parties
26,840
88,122
Total net sales
814,650
1,902,205
Costs of goods sold
855,277
1,554,896
Gross profit (loss)
(40,627
347,309
Selling, general and administrative expenses
57,320
64,865
Profit sharing
(42
18,507
Amortization of intangible assets
15,698
11,530
Total selling, general and administrative expenses
72,976
94,902
Operating income (loss)
(113,603
252,407
Interest expense, net capitalized interest
36,251
29,807
Other income, net
(748
(7,806
Income (loss) before income taxes
(149,106
230,406
Income taxes (benefit)
(59,332
87,374
Net income (loss)
(89,774
143,032
Net income (loss) attributable to noncontrolling interests
(1,912
475
Net income (loss) attributable to Steel Dynamics, Inc.
(87,862
142,557
Basic earnings (loss) per share attributable to Steel Dynamics, Inc. stockholders
(.48
.75
Weighted average common shares outstanding
182,000
189,039
Diluted earnings (loss) per share attributable to Steel Dynamics, Inc. stockholders, including the effect of assumed conversions when dilutive
.72
Weighted average common shares and share equivalents outstanding
199,317
Dividends declared per share
.10
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
Operating activities
Adjustments to reconcile net income (loss) attributable to Steel Dynamics, Inc. to net cash provided by operating activities
Depreciation and amortization
56,963
53,212
Equity-based compensation
8,579
3,929
7,695
(973
(Gain) loss on disposal of property, plant and equipment
(272
14
Changes in certain assets and liabilities
Accounts receivable
141,093
(185,793
Inventories
193,097
9,575
17,825
2,633
(34,054
114,515
Income taxes payable
(4,107
72,608
(82,350
844
Net cash provided by operating activities
214,695
213,596
Investing activities
Purchases of property, plant and equipment
(74,338
(93,764
Purchases of securities
—
(20,373
Other investing activities
(3,223
1,329
Net cash used in investing activities
(77,561
(112,808
Financing activities
Issuance of current and long-term debt
237,059
218,000
Repayment of current and long-term debt
(358,666
(233,214
Debt issuance costs
(453
(1,946
Issuance of common stock (net of expenses) and proceeds from exercise of stock options, including related tax effect
(2,058
7,177
Purchase of treasury stock
(46,128
Contribution from noncontrolling investor
5,000
Dividends paid
(18,182
(14,274
Net cash used in financing activities
(137,300
(70,385
Increase (decrease) in cash and equivalents
(166
30,403
Cash and equivalents at beginning of period
28,486
Cash and equivalents at end of period
58,889
Supplemental disclosure information:
Cash paid for interest
11,984
11,385
Cash paid for federal and state income taxes, net of refunds
(55,430
1,387
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1. Description of the Business, Significant Accounting Policies, and Recent Accounting Pronouncements
Description of the Business
Steel Dynamics, Inc. (SDI), together with its subsidiaries (the company), is a domestic manufacturer of steel products. The company has three reporting segments: steel operations, metals recycling and ferrous resources operations, and steel fabrication operations.
Steel Operations. Steel operations include the company’s Flat Roll Division, Structural and Rail Division, Engineered Bar Products Division, Roanoke Bar Division, Steel of West Virginia (SWVA) and The Techs operations. These operations consist of mini-mills, producing steel from steel scrap, using electric arc furnaces, continuous casting, automated rolling mills, and downstream finishing facilities. The company’s steel operations sell directly to end users and service centers. These products are used in numerous industry sectors, including the automotive, construction, commercial, transportation and industrial machinery markets. Steel operations accounted for approximately 59% and 58% of the company’s net sales during the three-month periods ended March 31, 2009 and 2008, respectively.
Metals Recycling and Ferrous Resources Operations. Metals recycling and ferrous resources operations primarily are composed of the company’s steel scrap procurement and processing locations, operated through the company’s wholly-owned subsidiary, OmniSource Corporation (OmniSource), as well as Iron Dynamics (IDI), the company’s iron-substitute production facility. In addition, the impact related to the construction of the Mesabi Nugget iron-making facility and future mining operations in Hoyt Lakes, Minnesota is also included in this segment. Metals recycling and ferrous resources operations accounted for approximately 33% and 37% of the company’s net sales during the three-month periods ended March 31, 2009 and 2008, respectively.
Steel Fabrication Operations. Steel fabrication operations represent the company’s New Millennium Building Systems plants located throughout the eastern United States. Revenues from these plants are generated from the fabrication of trusses, girders, steel joists and steel decking used within the non-residential construction industry. Steel fabrication operations accounted for approximately 7% and 4% of the company’s net sales during the three-month periods ended March 31, 2009 and 2008, respectively.
Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements include the accounts of SDI, together with its subsidiaries, after elimination of significant intercompany accounts and transactions. Noncontrolling interest represents the minority shareholders’ proportionate share in the equity or income of the company’s consolidated subsidiaries.
Use of Estimates. These financial statements are prepared in conformity with accounting principles generally accepted in the United States and, accordingly, include amounts that require management to make estimates and assumptions that affect the amounts reported in the financial statements and in the notes thereto. Significant items subject to such estimates and assumptions include the carrying value of property, plant and equipment, intangible assets and goodwill; valuation allowances for trade receivables, inventories and deferred income tax assets; unrecognized tax benefits; potential environmental liabilities, litigation claims and settlements. Actual results may differ from these estimates and assumptions.
In the opinion of management, these financial statements reflect all normal recurring adjustments necessary for a fair presentation of the interim period results. These financial statements and notes should be read in conjunction with the audited financial statements and notes thereto included in the company’s Annual Report on Form 10-K for the year ended December 31, 2008.
Uncertain Tax Positions. The company files income tax returns in the U.S. federal jurisdiction and in various state jurisdictions. The state of Indiana completed its examination of the calendar years 2000 through 2005 in the third quarter of 2008. The company paid additional taxes of $20.7 million as a result of the examinations. This amount was recorded as an unrecognized tax benefit when the company adopted Financial Accounting Standards Board (FASB) Interpretation 48 (FIN 48) on January 1, 2007. It is reasonably possible that the amount of unrecognized tax benefits could change in the next twelve months as a result of state income tax audits. Based on current audits in process, the payment of additional taxes could be in an amount from zero to $2.0 million during 2009, primarily related to state nexus issues. With few exceptions, the company is no longer subject to federal, state and local income tax examinations by tax authorities for years ended before 2005.
Included in the amount of unrecognized tax benefits at March 31, 2009, are potential benefits of $37.1 million that, if recognized, would affect the company’s effective tax rate. The company recognizes interest and penalties related to its tax contingencies on a net-of-tax basis in income tax expense. During the three months ended March 31, 2009, the company recognized interest of $329,000, net of tax, and benefits of $29,000. At March 31, 2009, the company had $7.5 million accrued for the payment of interest and penalties.
Comprehensive Income (Loss) Attributable to Steel Dynamics, Inc. The components of comprehensive income (loss) are summarized in the following table (in thousands):
Unrealized loss on available-for-sale securities, net of tax
(1,761
Unrealized gain on interest rate swap, net of tax
338
Comprehensive income (loss) attributable to Steel Dynamics, Inc.
(87,524
140,796
Other accumulated comprehensive loss consisted of the following (in thousands):
Unrealized loss on interest rate swap
(1,745
(2,294
Tax effect
672
883
Total other accumulated comprehensive loss
Recent Accounting Pronouncements.
On January 1, 2009, the company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, (SFAS 157) as it relates to nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair value in the financial statements on at least an annual basis. SFAS 157 defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America (GAAP), and expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements and are to be applied prospectively with limited exceptions. The adoption of SFAS 157, as it relates to nonfinancial assets and nonfinancial liabilities, had no impact on the company’s financial statements for the three months ended March 31, 2009. The provisions of SFAS 157 will be applied at such time a fair value measurement of a nonfinancial asset or nonfinancial liability is required, which may result in a fair value that is materially different than would have been calculated prior to the adoption of SFAS 157.
On January 1, 2009, the company adopted SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133, (SFAS 161). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities, including (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (SFAS 133), and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Other than the required disclosures, the adoption of SFAS 161 had no impact on the company’s financial statements.
On January 1, 2009, the company adopted SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51, (SFAS 160). SFAS 160 amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This standard defines a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. SFAS 160 requires, among other items, that a noncontrolling interest be included in the consolidated balance sheets within equity separate from the parent’s equity; consolidated net income to be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statements of income; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. The presentation and disclosure requirements of SFAS 160 were applied retrospectively. The adoption of SFAS 160 did not have a material impact on the company’s financial statements.
On January 1, 2009, the company adopted SFAS No. 141 (revised 2007), Business Combinations, (SFAS 141(R)), which replaces SFAS No. 141,Business Combinations, (SFAS 141) but retains the fundamental requirements in SFAS 141, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS 141(R) requires an acquirer in a business combination, including business combinations achieved in stages (step acquisition), to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. Additionally, SFAS 141(R) requires acquisition-related costs to be expensed in the period in which the costs are incurred and the services are received instead of including such costs as part of the acquisition price. The adoption of SFAS 141(R) had no impact on the company’s financial statements.
5
On January 1, 2009, the company adopted Financial Accounting Standards Board (FASB) Staff Position (FSP) No. FAS 142-3, Determination of the Useful Life of Intangible Assets, (FSP FAS 142-3). FSP FAS 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 FASB Statement No. 142, Goodwill and Other Intangible Assets, (SFAS 142) in order 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 141(R) and other GAAP. The adoption of FSP FAS 142-3 had no impact on the company’s financial statements.
On January 1, 2009, the company adopted FSP No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities, (FSP EITF 03-6-1). FSP EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The adoption of FSP EITF 03-6-1 had no impact on the company’s financial statements.
The company adopted FSP 107-1, Disclosures About Fair Value of Financial Instruments, as of March 31, 2009. FSP 107-1 requires disclosures about fair value of all financial instruments for interim reporting periods. The applicable disclosures are included in Note 8 to the company’s financial statements included in this filing. The adoption of FSP 107-1 had no impact on the company’s financial statements.
Note 2. Acquisition.
On June 9, 2008, the company completed its acquisition of Recycle South, one of the nation’s largest, privately-held, regional scrap metal recycling companies, headquartered in Spartanburg, South Carolina. OmniSource (which already owned 25% of Recycle South), acquired the remaining 75% equity interest for a purchase price of approximately $376.3 million. The company paid approximately $236.6 million in cash, including transaction costs, and issued 3,938,000 shares of Steel Dynamics, Inc. common stock valued at $139.8 million. In addition, the company assumed $144.9 million of net debt, of which approximately $142.8 million was repaid upon the closing of the acquisition. The cash portion of the acquisition was funded from the company’s available cash which included proceeds from the issuance of the $500 million 7¾% senior notes due April 2016. The company valued the common stock issued at $35.49 per share based on the average stock price of the company’s common stock during the two days before and after the date the acquisition was agreed to and announced (May 8, 2008).
The company purchased Recycle South to expand its metals recycling business. Recycle South provides a significant presence in the southeastern United States through its 22 locations within North Carolina, South Carolina and Georgia. Recycle South’s consolidated operating results have been reflected in the company’s financial statements since June 9, 2008, in the metals recycling and ferrous resources reporting segment.
The purchase price of $376.3 million for the remaining 75% equity interest in Recycle South, combined with the 25% interest owned pursuant to the OmniSource acquisition, results in an aggregate purchase price of $501.8 million. During the first quarter of 2009, the company adjusted the initial purchase price allocation to reflect additional refinement in valuation of the acquisition. The following allocation of the purchase price is still preliminary, and is subject to adjustments based on further determination of actual acquisition costs and the fair values, lives, and amortization methods of the acquired assets, assumed liabilities and identifiable intangible assets (in thousands):
December 31,2008
Adjustments
March 31,2009
213,513
Property, plant & equipment
94,484
4,919
99,403
Intangible assets
155,000
(48,000
107,000
272,355
42,880
315,235
5,406
Total assets acquired
740,758
(201
740,557
Current liabilities, excluding debt
94,015
93,814
Debt
144,947
Total liabilities assumed
238,962
238,761
Net assets acquired
501,796
Preliminary goodwill and intangible assets of $315.2 million and $107.0 million, respectively, were recorded as a result of the acquisition. The goodwill is deductible for tax purposes.
6
The preliminary valuation of identifiable intangible assets related to the acquisition consisted of the following (in thousands):
Amount
Useful Life
Customer relationships
21,000
20 years
Scrap generator relationships
57,000
Trademarks
16,000
3 years
Covenants not to compete
13,000
5 years
The company utilizes an accelerated amortization methodology for customer and scrap generator relationships in order to follow the pattern in which the economic benefits of the intangible assets are anticipated to be consumed. Finite-lived trademarks and covenants not to compete are amortized using a straight line methodology. The related aggregate amortization expense recognized for the three-month period ended March 31, 2009 was $7.3 million. The estimated intangible asset amortization expense related to the total acquisition of Recycle South for the next five years and thereafter follows (in thousands):
2009 (including January 1 to March 31)
18,367
2010
14,883
2011
11,361
2012
9,394
2013
7,277
Thereafter
41,714
Total
102,996
Unaudited Pro Forma Information. The following unaudited pro forma information is presented below as if the acquisition of Recycle South (effective on June 9, 2008) had occurred as of January 1, 2008 (in thousands, except per share amounts):
March 31, 2008
2,071,091
Net income attributable to Steel Dynamics, Inc.
149,752
Basic earnings per share attributable to Steel Dynamics, Inc. stockholders
.78
Diluted earnings per share attributable to Steel Dynamics, Inc. stockholders
.74
The information presented above is for information purposes only and is not necessarily indicative of the actual results that could have occurred had the acquisition been consummated at January 1, 2008, nor is it necessarily indicative of future operating results of the combined companies under the ownership and management of the company. The pro forma results reflect the inclusion of the acquired operations of Recycle South for the three-month period ended March 31, 2008, The actual results of Recycle South for the three-month period ended March 31, 2009 are included in the consolidated results of the company.
Note 3. Earnings Per Share
The company computes and presents earnings per common share in accordance with FASB Statement No. 128, Earnings Per Share. Basic earnings per share is based on the weighted average shares of common stock outstanding during the period. Diluted earnings per share assumes, in addition to the above, the weighted average dilutive effect of common share equivalents outstanding during the period. Common share equivalents represent dilutive stock options and dilutive shares related to the company’s convertible subordinated debt and are excluded from the computation in periods in which they have an anti-dilutive effect.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED
The following table presents a reconciliation of the numerators and the denominators of the company’s basic and diluted earnings per share computations for net income (loss) attributable to Steel Dynamics, Inc. (in thousands, except per share data):
Three Months Ended March 31,
Net Loss(Numerator)
Shares(Denominator)
Per ShareAmount
Net Income(Numerator)
Basic earnings per share
Dilutive stock option effect
1,516
Convertible subordinated 4.0% notes
212
8,762
Diluted earnings per share
142,769
As of March 31, 2009, all of the company’s convertible subordinated 4.0% notes have been converted. Options to purchase 2.1 million shares were anti-dilutive at March 31, 2009. No options were excluded at March 31, 2008.
Note 4. Inventories
Inventories are stated at lower of cost or market. Cost is determined principally on a first-in, first-out basis. The inventories at March 31, 2009 reflect a lower of cost or market reserve of $83.3 million. The Company recorded lower of cost or market adjustments of $36.6 million to certain inventories at December 31, 2008. Inventory consisted of the following, of which all ferrous materials residing at both the steel and metals recycling operations are included in raw materials (in thousands):
Raw materials
380,652
554,815
Supplies
235,952
224,710
Work-in-progress
43,289
57,489
Finished goods
173,181
186,221
Total inventories, net
Note 5. Long-Term Debt
Senior Secured Credit Facility
The company’s senior secured credit agreement contains financial covenants and other covenants that limit or restrict the company’s ability to make capital expenditures; incur indebtedness; permit liens on property; enter into transactions with affiliates; make restricted payments or investments; enter into mergers, acquisitions or consolidations; conduct asset sales; pay dividends or distributions and enter into other specified transactions and activities. The company’s ability to borrow funds within the terms of the revolver is dependent upon its continued compliance with its financial covenants and other covenants contained in the senior secured credit agreement. The financial covenants state that the company must maintain at all times an interest coverage ratio of not less than 2.00:1.00 and must maintain a total debt to consolidated last-twelve-months trailing EBITDA (earnings before interest, taxes, depreciation, amortization, and certain other non-cash transaction adjustments as defined in the credit agreement) ratio of not more than 5.00:1.00. If the total debt to EBITDA ratio exceeds 3.50:1.00, then the ability of the company to make restricted payments as defined in the credit agreement (which includes cash dividends to stockholders and share purchases, among other things), is limited to $25 million per quarter.
The company was in compliance with these covenants at March 31, 2009, with an interest coverage ratio of 5.41 and total debt to EBITDA ratio of 2.81. However, based on the current economic environment and the company’s outlook, the company believes it may be in violation of its financial covenants during 2009, which if not resolved, could also constitute a cross default under other debt instruments. The company is considering a number of alternatives to address this situation, including but not limited to obtaining a waiver from its bank group. The company may incur additional costs related to these alternatives.
8
Note 6. Changes in Stockholders’ Equity
The following table provides a reconciliation of the beginning and ending carrying amounts of total stockholders’ equity, equity attributable to stockholders of Steel Dynamics, Inc. and equity attributable to the noncontrolling interests (in thousands):
Stockholders of Steel Dynamics, Inc.
Common
Additional Paid-In
Retained
OtherAccumulatedComprehensive
Treasury
Noncontrolling
Stock
Capital
Earnings
Income (Loss)
Interests
Balances at January 1, 2009
Dividends declared
(18,213
Contributions from noncontrolling investor
Tax adjustment to noncontrolling interest
2,759
5,343
3,236
Comprehensive income and net loss attributable to Steel Dynamics, Inc.
(89,436
Balances at March 31, 2009
Note 7. Derivative Financial Instruments
Financial Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (FAS 133) requires companies to recognize all of their derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship, and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge or a cash flow hedge.
The company is exposed to certain risks relating to its ongoing business operations. The primary risks mitigated by using derivative instruments by the company are commodity margin risk, interest rate risk, and foreign currency exchange rate risk. Forward contracts on various commodities are entered into to manage the price risk associated with forecasted purchases and sales of non-ferrous materials from the company’s metals recycling and ferrous resources operations. Interest rate swaps are entered into to manage interest rate risk associated with the company’s fixed and floating-rate borrowings. Forward exchange contracts on various foreign currencies are entered into to manage the foreign currency exchange rate risk as necessary.
In accordance with FAS 133, the company designated its interest rate swap as a cash flow hedge of floating-rate borrowings. Forward contracts on various commodities and forward exchange contracts on various foreign currencies are not designated as hedging instruments.
Cash Flow Hedging Strategy. For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same line item associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings (e.g., in “interest expense” when the hedged transactions are interest cash flows associated with floating-rate borrowings). The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any (i.e., the ineffectiveness portion), or hedge components excluded from the assessment of effectiveness, are recognized in the statement of operations during the current period.
9
Commodity futures contracts. The following summarizes the company’s commodity futures contract commitments as of March 31, 2009 (MT represents metric tons and Lbs represents pounds):
Commodity
Long/Short
Aluminum
Long
10,425
MT
Short
9,600
Copper
14,413
5,803
Nickel
138
954
Silver
1,029
Lbs
The following summarizes the location and amounts of the fair values and gains related to derivatives included in the company’s financial statements as of March 31, 2009 and December 31, 2008, and for the three-month periods ended March 31, 2009 and 2008 (in thousands):
Location in Consolidated Balance Sheets
Fair ValueMarch 31, 2009
Fair ValueDecember 31, 2008
Commodity futures net liability
18,816
38,371
Interest rate swap liability
1,745
2,294
Location in Consolidated Statements of Operations
Gain forPeriod EndedMarch 31, 2009
Gain forPeriod EndedMarch 31, 2008
Commodity futures contracts
19,555
7,400
Interest rate swap
Other comprehensive income
549
Note 8. Fair Value Measurements
FASB Statement No. 157 (FAS 157), Fair Value Measurements, provides a comprehensive framework for measuring fair value and expands disclosures which are required about fair value measurements. Specifically, FAS 157 sets forth a definition of fair value and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable value inputs. FAS 157 defines levels within the hierarchy as follows:
· Level 1—Unadjusted quoted prices for identical assets and liabilities in active markets;
· Level 2—Quoted prices for similar assets and liabilities in active markets (other than those included in Level 1) which are observable for the asset or liability, either directly or indirectly; and
· Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
The following table sets forth financial assets and liabilities measured at fair value in the consolidated balance sheet and the respective levels to which the fair value measurements are classified within the fair value hierarchy as of March 31, 2009, and December 31, 2008 (in thousands):
Quoted Prices inActive Marketsfor IdenticalAssets(Level 1)
SignificantOtherObservableInputs(Level 2)
SignificantUnobservableInputs(Level 3)
Commodity futures — financial assets
8,970
Commodity futures
27,786
Financial liabilities
29,531
10
Quoted Prices in Active Marketsfor IdenticalAssets(Level 1)
15,866
54,237
56,531
The fair value of long-term debt, including current maturities, was approximately $2.0 billion and $2.1 billion at March 31, 2009, and December 31, 2008, respectively.
Note 9. Commitments and Contingencies
On February 1, 2008, the company was sued by Prime Eagle Group Limited (Plaintiff), a corporation with its principal place of business in Thailand, alleging damages in excess of $1.1 billion, arising out of Steel Dynamics’ activities in providing consulting services to a Thailand-based steel company, Nakornthai Strip Mill Public Company, Limited (NSM) in its operational start-up in 1998. On April 30, 2008, Steel Dynamics filed a Motion to Dismiss the lawsuit, and on February 23, 2009, the court dismissed the complaint with prejudice and denied the plaintiffs leave to amend their complaint. The Plaintiff has appealed this dismissal.
On September 17, 2008, Steel Dynamics, Inc. was served with a class action antitrust complaint alleging violations of Section 1 of the Sherman Act, brought by Standard Iron Works of Scranton, Pennsylvania, against Steel Dynamics and eight other steel manufacturing companies. The Complaint, filed in the United States District Court for the Northern District of Illinois in Chicago, alleges that the defendants conspired to fix, raise, maintain and stabilize the price at which steel products were sold in the United States by artificially restricting the supply of such steel products. Six additional lawsuits, each of them materially similar to the original, have also been filed in the same federal court, each of them likewise seeking similar class certification. All but one of the Complaints purport to be brought on behalf of a class consisting of all purchasers of steel products directly from the defendants between January 1, 2005 and the present. The other Complaint purports to be brought on behalf of a class consisting of all indirect purchasers of steel products from the defendants within the same time period. All Complaints seek treble damages and costs, including reasonable attorney fees, pre- and post-judgment interest and injunctive relief. On January 2, 2009, the defendants in these cases filed a Joint Motion to Dismiss all of the lawsuits. On January 30, 2009, the plaintiffs filed their response to the Motion to Dismiss, and on February 20, 2009, the defendants filed their reply. Although the company believes that the lawsuits are without merit and plans to aggressively defend these actions, the company cannot presently predict the outcome of this litigation or make any judgment with respect to its potential exposure, if any.
On March 18, 2009, Steel Dynamics, Inc., together with its Chairman and Chief Executive Officer, Keith E. Busse, and John Bates, a member of its board of directors, were served with a complaint, captioned Panasuk v. Steel Dynamics, Inc., et al., Civil Action No. 1109cv0066, filed in the United States District Court for the Northern District of Indiana, Fort Wayne Division, and purporting to represent a class of purchasers of Steel Dynamics common stock between January 26, 2009 and March 11, 2009. The complaint alleges securities fraud in connection with the company’s issuance of certain earnings guidance and seeks damages in an unspecified amount. The company believes that the complaint is without merit and will appropriately defend its interests.
Note 10. Segment Information
The company has three reportable segments: steel operations, metals recycling and ferrous resources operations, and steel fabrication operations. These operations are described in Note 1 to the financial statements. Revenues included in the category “All Other” are from subsidiary operations that are below the quantitative thresholds required for reportable segments and primarily consist of further processing, slitting, and sale of certain steel products and the resale of certain secondary and excess steel products. In addition, “All Other” also includes certain unallocated corporate accounts, such as the company’s senior secured credit facilities, senior notes, certain other investments, and certain profit sharing expenses.
The company’s operations are primarily organized and managed by operating segment. Operating segment performance and resource allocations are primarily based on operating results before income taxes. The accounting policies of the reportable segments are consistent with those described in Note 1 to the financial statements. Refer to the company’s Annual Report on Form 10-K for the year ended December 31, 2008, for more information related to the company’s segment reporting. Inter-segment sales and any related profits are eliminated in consolidation. The company’s segment results for the three-month periods ended March 31 are as follows (in thousands):
11
For the three months ended
Metals Recycling /
Steel Fabrication
March 31, 2009
Steel Operations
Ferrous Resources
Operations
Other
Eliminations
Consolidated
Net Sales
External
488,140
222,399
60,785
11,107
782,431
External Non-U.S.
16,902
15,307
32,219
Other segments
22,072
58,702
1,057
(81,853
527,114
296,408
60,807
12,174
(68,914
(24,466
3,000
(13,546)
(1)
(9,677)
(2)
(85,900
(34,189
1,354
(19,367
(11,004
24,692
29,808
1,757
706
Capital expenditures
31,088
43,664
(466
52
74,338
As of March 31, 2009
2,303,344
2,099,817
180,322
505,615
(3)
(163,019)
(4)
Liabilities
199,811
184,708
10,706
3,132,625
(5)
(140,715)
(6)
3,387,135
Footnotes related to March 31, 2009 segment results (in millions):
Corporate SG&A
11.4
Other expenses
2.1
13.5
Margin impact from inter-company sales
(9.7
Deferred tax asset
313.7
92.6
18.0
81.3
505.6
Elimination of inter-company receivables
(20.0
Deferred taxes elimination
(112.8
(30.2
(163.0
2,483.1
Deferred taxes
493.6
155.9
3,132.6
(111.0
Intercompany debt
(26.4
(3.3
(140.7
1,135,817
566,181
78,457
33,608
1,814,063
47,512
40,578
88,142
73,473
197,005
66
367
(270,911
1,256,802
803,764
78,523
34,027
234,557
47,176
3,644
(24,674
(8,296
220,113
46,041
2,248
(29,700
33,992
16,820
1,835
565
64,372
22,273
5,237
1,882
93,764
As of March 31, 2008
2,661,670
1,764,120
221,521
308,314
(134,013
4,821,612
392,461
317,812
12,678
2,596,919
(114,315
3,205,555
Certain 100%-owned subsidiaries of SDI have fully and unconditionally guaranteed all of the indebtedness relating to the issuance of the company’s senior notes due 2012, 2015, and 2016. Following are the company’s condensed consolidating financial statements, including the guarantors, which present the financial position, results of operations and cash flows of (i) SDI (in each case, reflecting investments in its consolidated subsidiaries under the equity method of accounting), (ii) the guarantor subsidiaries of SDI, (iii) the non-guarantor subsidiaries of SDI, and (iv) the eliminations necessary to arrive at the information for the company on a consolidated basis. The following statements should be read in conjunction with the accompanying consolidated financial statements and the company’s Annual Report on Form 10-K for the year ended December 31, 2008.
12
Condensed Consolidating Balance Sheets (in thousands)
Combined
Consolidating
Parent
Guarantors
Non-Guarantors
609
14,414
1,044
148,206
439,392
5,605
(231,364
361,839
494,628
309,999
20,627
7,820
164,785
23,621
316
(32,891
155,831
808,228
787,426
27,592
(256,435
1,190,594
747,607
170,456
Other assets, including investments in subs
2,797,868
287,650
9,139
(3,007,696
86,961
4,796,690
3,186,333
207,187
(3,264,131
106,739
129,645
27,535
(20,005
243,914
110,637
123,868
915
(46,134
189,286
296,179
271
14,907
(14,907
296,450
513,555
253,784
43,357
(81,046
2,202,892
63
48,620
(33,561
367,929
2,344,584
8,067
(2,281,109
439,471
Common stock
19,753
7,833
(27,586
Treasury stock
117,753
105,000
(222,753
1,901,954
450,396
(19,964
(618,076
1,712,314
587,902
92,869
(868,415
107,143
As of December 31, 2008
1,389
11,514
3,330
266,709
461,366
8,410
(233,553
502,932
612,731
369,412
23,408
17,684
126,969
46,949
351
(6,754
167,515
1,007,798
889,241
35,499
(222,623
1,186,317
751,904
134,636
2,480,319
259,610
8,922
(2,663,270
85,581
4,674,434
3,285,979
179,057
(2,885,893
119,969
124,009
43,322
(23,907
263,393
165,547
155,962
3,910
(49,054
276,365
431,172
51
14,906
(14,906
431,223
716,688
280,022
62,138
(87,867
2,219,085
76
6,703
(6,703
353,294
2,424,175
12,600
(2,350,521
431,122
101,973
(219,726
1,581,866
444,200
(12,192
(193,489
1,385,367
581,706
97,614
(440,801
106,041
13
Condensed Consolidating Statements of Operations (in thousands)
For the three months ended,
349,803
864,973
(412,300
415,235
823,298
14,463
(397,719
(65,432
41,675
(2,289
(14,581
Selling, general and administrative
28,066
45,469
2,932
(3,491
Operating loss
(93,498
(3,794
(5,221
(11,090
20,452
14,486
279
1,034
Other (income) expense, net
25,669
(26,728
17
294
Income (loss) before income taxes and equity in net income of subsidiaries
(139,619
8,448
(5,517
(12,418
(56,552
2,252
(1,359
(3,673
(83,067
6,196
(4,158
(8,745
Equity in net income (loss) of subsidiaries
2,038
(2,038
Net loss attributable to noncontrolling interests
(81,029
(2,246
(10,783
865,069
2,082,312
(1,079,203
662,014
1,923,869
31,174
(1,062,161
Gross profit
203,055
158,443
2,853
(17,042
49,340
47,753
2,125
(4,316
153,715
110,690
728
(12,726
16,523
13,291
163
(170
58,395
(66,260
(142
201
78,797
163,659
707
(12,757
29,943
59,978
88
(2,635
48,854
103,681
619
(10,122
Equity in net income of subsidiaries
104,300
(104,300
Net income attributable to noncontrolling interests
153,154
144
(114,422
Condensed Consolidating Statements of Cash Flows (in thousands)
Net cash provided by (used in) operating activities
153,764
81,368
(20,437
(20,611
(17,791
(39,159
Net cash provided by (used in) financing activities
(133,933
(60,677
57,310
(780
2,900
(2,286
130,004
75,270
8,322
(73,828
(30,814
(8,166
Net cash provided by (used in) in financing activities
(61,908
(17,242
8,765
(5,732
27,214
8,921
6,327
20,096
2,063
595
47,310
10,984
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This report contains some predictive statements about future events, including statements related to conditions in the steel marketplace, our revenue growth, and costs of raw materials, future profitability and earnings, and the operation of new or existing facilities. These statements are intended to be made as “forward-looking,” subject to many risks and uncertainties, within the safe harbor protections of the Private Securities Litigation Reform Act of 1995. Such predictive statements are not guarantees of future performance, and actual results could differ materially from our current expectations. Factors that could cause such predictive statements to turn out other than as anticipated or predicted include, among others: changes in global economic conditions affecting steel consumption, steel scrap and non-ferrous material consumption; continuation of the current financial crisis; increased foreign imports; reduced domestic exports; increased price competition; difficulties in integrating acquired businesses; risks and uncertainties involving new products or new technologies; changes in the availability or cost of steel scrap or substitute materials; increases in energy costs; occurrence of unanticipated equipment failures and plant outages; labor unrest; and the effect of the elements on production or consumption.
In addition, we refer you to the sections titled Special Note Regarding Forward-Looking Statements and Risk Factorsin our annual report on Form 10-K for the year ended December 31, 2008, as well as in other reports which we file with the Securities and Exchange Commission, for a more detailed discussion of some of the many factors, variable risks and uncertainties that could cause actual results to differ materially from those we may have expected or anticipated. These reports are available publicly on the SEC web site, www.sec.gov, and on our web site,www.steeldynamics.com. Forward-looking or predictive statements we make are based on our knowledge of our businesses and the environment in which they operate as of the date on which the statements were made. Due to these risks and uncertainties, as well as matters beyond our control which can affect forward-looking statements, you are cautioned not to place undue reliance on these predictive statements, which speak only as of the date of this report. We undertake no duty to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
Operating Statement Classifications
Net Sales. Net sales from our operations are a factor of net tons shipped, product mix and related pricing. We charge premium prices for certain grades of steel, product dimensions, certain smaller volumes, and for value-added processing or coating of the steel products. Except for our steel fabrication operations segment, we recognize revenue from sales and the allowance for estimated costs associated with returns from these sales at the time the title of the product is transferred to the customer. Provision is made for estimated product returns and customer claims based on estimates and actual historical experience. Net sales from steel fabrication operations are recognized from construction contracts utilizing a percentage-of-completion method, which is based on the percentage of steel consumed to date as compared to the estimated total steel required for each contract.
Costs of Goods Sold. Our costs of goods sold represent all direct and indirect costs associated with the manufacture of our products. The principal elements of these costs for our steel operations are steel scrap and scrap substitutes, alloys, zinc, natural gas, argon, direct and indirect labor and related benefits, electricity, oxygen, electrodes, depreciation, materials and freight. Our metallic raw materials, steel scrap and scrap substitutes, represent the most significant single component of our costs of goods sold. The primary costs related to our metals recycling and ferrous resources operations is the cost of raw materials, freight costs, and processing expenses.
Selling, General and Administrative Expenses. Selling, general and administrative expenses consist of all costs associated with our sales, finance and accounting, and administrative departments. These costs include, among other items, labor and benefits, professional services, insurance expense, property taxes, profit-sharing, and amortization of intangible assets.
Interest Expense, net Capitalized Interest. Interest expense consists of interest associated with our senior credit facilities and other debt (described in the notes to our financial statements included in our 2008 Annual Report on Form 10-K) net of capitalized interest costs that are related to construction expenditures during the construction period of material capital projects.
Other Income, net. Other income consists of interest income earned on our cash balances and any other non-operating income activity, including gains on certain short-term investments and income from equity investments. Other expense consists of any non-operating costs.
Acquisition
On June 9, 2008, we completed our acquisition of Recycle South, one of the nation’s largest, privately-held, regional scrap metal recycling companies, headquartered in Spartanburg, South Carolina. OmniSource (which already owned 25% of Recycle South), acquired the remaining 75% equity interest for a purchase price of approximately $376.3 million. We paid approximately $236.6 million in cash, including transaction costs, and issued 3,938,000 shares of Steel Dynamics, Inc. common stock valued at $139.8 million. In addition, we assumed $144.9 million of net debt, of which approximately $142.8 million was repaid upon the closing of the acquisition.
We purchased Recycle South to expand our metals recycling business. Recycle South provides a significant presence in the southeastern United States through its 22 locations within North Carolina, South Carolina and Georgia. Recycle South’s consolidated operating results have been reflected in our financial statements since June 9, 2008, in the metals recycling and ferrous resources reporting segment.
First Quarter Operating Results 2009 vs. 2008
Outlook. Net loss attributable to Steel Dynamics, Inc. was $87.9 million, or $.48 per diluted share, during the first quarter of 2009, compared with net income attributable to Steel Dynamics, Inc. of $142.6 million, or $.72 per diluted share, during the first quarter of 2008. As is the case throughout the global steel industry, we have been adversely impacted in recent quarters by the overall economic recession. While the negative trend in falling demand and pricing for our products appears to be slowing, we are still anticipating sluggish activity. We have taken steps to further reduce production and other costs, as our utilization rates were less than 50% of operational production capacity during the quarter. Certain raw material inputs at our steel operations were also written down during the quarter. With this even further reduced cost structure, we believe that we are well positioned in the near term to capitalize on any increase in demand given our low variable cost structure, which allows us to generate operating income even at reduced utilization rates.
Gross Profit. When comparing the first quarter of 2009 with the first quarter of 2008, our net sales decreased $1.1 billion, or 57%, to $815 million. Our gross profit percentage was a negative 5% during the first quarter of 2009 as compared to a positive 18% for the first quarter of 2008, and as compared to a negative 3% on a linked-quarter basis. The most significant non-operating component of our first quarter 2009 loss was a non-cash adjustment to inventory values of $83.3 million, or $.27 per diluted share, due principally to the rapid decline in flat-rolled steel product values. Excluding inventory write downs, gross profit percentage was 5% and 0% for the three-month periods ended March 31, 2009, and December 31, 2008, respectively.
Three Months
Ended
Shipments (net tons)
Flat Roll Division
303,938
685,320
361,145
Structural and Rail Division
129,555
299,687
228,132
Engineered Bar Products Division
71,540
147,948
123,449
Roanoke Bar Division
76,610
151,368
94,374
Steel of West Virginia
43,124
75,724
45,788
The Techs
118,359
262,011
89,551
Total shipments
743,126
1,622,058
942,439
Intra-company
(52,012
(130,685
(51,803
External shipments
691,114
1,491,373
890,636
Steel operations accounted for 59% and 58% of our net sales during the first quarter of 2009 and 2008, respectively. First quarter 2009 shipments were down dramatically compared to the same period in 2008 at all our steel operations divisions due to the depressed economic climate. We also experienced decreased linked-quarter shipments at all our steel operations divisions, with the exception of The Techs, which increased shipments by 29,000 tons, or 32%, due primarily to the timing of shipments rather than an increase in order entry activity.
Our first quarter 2009 average steel operations’ selling price per ton shipped decreased $62 compared with the first quarter of 2008 and $193 compared with the fourth quarter of 2008. Demand for steel products has remained weak into the second quarter of 2009, putting further downward pressure on selling prices. Steel services center customers, which normally comprise approximately 60% of our steel operations shipments, have continued destocking efforts through the first quarter of 2009. We do not anticipate a meaningful increase in our steel operations shipping volumes until service center buying activity resumes. Likewise, our end markets are concentrated in the non-residential construction, heavy equipment, and automotive industries, sectors that have been negatively impacted by the economic downturn.
16
Average Quarterly Steel Selling Prices
Metallic raw materials used in our electric arc furnaces represent our most significant manufacturing cost. Our metallic raw material cost per net ton consumed in our steel operations decreased $56 compared with the first quarter of 2008, and $78 on a linked-quarter basis. During the first quarter of 2009 and 2008, respectively, our metallic raw material costs represented 49% and 62% of our steel operation’s manufacturing costs, excluding the operations of The Techs, which purchases, rather than produces, the steel it further processes. During the first quarter of 2009, our steel operations’ costs of goods sold included $83.3 million in additional costs related to decreasing our inventory values, which were above prevailing market selling values. We anticipate steel scrap prices to remain relatively steady during the remainder of 2009 which, when combined with the revaluation of our inventories at the end of 2008 and beginning of 2009, should result in a favorable cost structure.
Metals Recycling and Ferrous Resources Operations
Ferrous metals shipments
729,869
1,391,382
897,922
(246,728
(463,893
(438,532
483,141
927,489
459,390
Non-ferrous metals shipments (thousands of pounds)
190,394
238,788
177,246
Iron Dynamics shipments
Liquid pig iron
41,226
45,443
21,171
Hot briquetted iron
20,326
19,741
27,005
674
2,809
3,834
62,226
67,993
52,010
Metals recycling and ferrous resources operations accounted for 33% and 37% of our net sales during the first quarters of 2009 and 2008, respectively. Our metals recycling operations primarily engage in the brokerage, collection and processing of ferrous and non-ferrous metals for resale to steel companies, brokers and other metals processors. During the first quarter of 2009, this segment recorded external shipments of 483,000 tons of ferrous metals and 190.4 million pounds of non-ferrous materials, compared with 927,000 tons and 238.8 million pounds during the same period in 2008. On a linked-quarter basis, external shipments of ferrous metals and non-ferrous materials increased by 24,000 tons and 13.1 million pounds, respectively. External shipments for the quarter fell substantially compared to the same period in 2008, in spite of the acquisition in June 2008 of Recycle South. Due to the global economic recession, electric arc furnace utilization is running at levels below 50%, thus suppressing demand for ferrous metals. Conversely, the market for non-ferrous materials, particularly copper, has shown modest signs of strengthening, with demand from China appearing to be the primary driver.
We anticipate ferrous and non-ferrous material costs to remain relatively stable during the remainder of 2009, as suppressed demand is being offset by limited supply due to low levels of manufacturing activity, which generates our supply of industrial scrap.
Steel Fabrication Operations
Steel fabrication operations accounted for 7% and 4% of our net sales during the first quarters of 2009 and 2008, respectively. Our average steel fabrication operations’ selling price per ton shipped increased $198, or 17%, during the first quarter of 2009 when compared with 2008, and decreased $117, or 8%, on a linked-quarter basis. The purchase of various steel products is the largest single cost of production for our steel fabrication operations. During the first quarters of 2009 and 2008, respectively, the cost of steel products purchased represented 75% and 70% of the total cost of manufacturing for our steel fabrication operations. In spite of the weak economy and decreased activity in non-residential construction, our steel fabrication segment was able to generate operating income in the first quarter of 2009. We anticipate non-residential construction activity to remain slow during the remainder of 2009, resulting in decreased shipping volumes and selling prices for this segment of our operations compared to 2008.
Average Quarterly FabricationSelling Prices
Selling, General and Administrative Expenses. Selling, general and administrative expenses (including profit sharing and amortization of intangible assets) were $73.0 million during the first quarter of 2009, as compared to $94.9 million during the first quarter of 2008, a decrease of $21.9 million, or 23%. Our selling, general and administrative expenses represented 9% and 5% of our total net sales during the first quarters of 2009 and 2008, respectively. The percentage increase is primarily a result of the significant decline in nets sales in the first quarter of 2009 compared with the prior year.
The decrease in our selling, general and administrative expenses were due primarily to not recording profit sharing expense during the first quarter of 2009 as a result of the quarter’s net loss. We recorded expense of $16.3 million during 2008 related to our Steel Dynamics performance-based profit sharing plan allocation. During 2008 the company’s board of directors modified the contribution percentage for this plan to consist of 2% of consolidated pretax earnings plus a unique percentage of each of the company’s operating segments’ pretax earnings. The resulting total contribution percentage was 8% of consolidated pretax earnings during the first quarter of 2008. During the first quarter of 2008, we recorded additional profit sharing expense of $2.2 million related to certain subsidiaries whose employees did not participate in the aforementioned plan.
Amortization of intangible assets increased $4.2 million during the first quarter of 2009 compared to the same period in 2008. This increase includes $4.8 million of additional amortization of intangible assets required to be recorded due to the adjustment of the purchase price allocation and intangible asset valuations related to the acquisition of Recycle South in June 2008. The Recycle South valuation of finite-lived intangibles is still preliminary, which could cause a change in the amount of amortization on a prospective basis.
Interest Expense, net Capitalized Interest. During the first quarter of 2009, gross interest expense increased $5.5 million, or 16%, to $39.3 million, and capitalized interest decreased $2.0 million to $3.1 million, when compared to the same period in 2008. This increase in interest expense was due to increased borrowings of $496.6 million. The interest capitalization that occurred during these periods resulted from the interest required to be capitalized with respect to construction activities at our various operating segments. Our weighted-average interest rate on our outstanding borrowings was 5.8% and 6.1% at March 31, 2009 and December 31, 2008, respectively. We currently anticipate gross interest expense to remain relatively stable during the remainder of 2009.
Other Income, net Other Expense. Other income was $748,000 during the first quarter of 2009, as compared to $7.8 million during the same period in 2008. During the first quarter of 2008, other income of $6.7 million was attributable to earnings from investments in scrap
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procurement and processing entities which were accounted for under the equity method of accounting. As of the date of its acquisition, Recycle South, which was $6.4 million of other income during the first quarter of 2008, is no longer included in other income, as its results are consolidated in our financial statements after acquisition.
Income Taxes (Benefit). During the first quarter of 2009, our income tax provision was a benefit of $59.3 million, as compared to expense of $87.4 million during the same period in 2008. Our effective income tax rate was 40.3% and 38.0% during the first quarters of 2009 and 2008, respectively. Our first quarter 2009 effective income tax rate was impacted by a tax credit. We project our effective income tax rate to be 39.3% for the remainder of 2009. We account for income taxes and the related accounts under the liability method. Deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted rates expected to be in effect during the year in which the basis differences reverse.
Included in the amount of unrecognized tax benefits at March 31, 2009, are potential benefits of $37.1 million that, if recognized, would affect our effective tax rate. We recognize interest and penalties related to our tax contingencies on a net-of-tax basis in income tax expense. During the first quarter of 2009, we recognized interest of $329,000, net of tax, and benefits of $29,000. At March 31, 2009, we had $7.5 million accrued for the payment of interest and penalties.
We file income tax returns in the U.S. federal jurisdiction and in various state jurisdictions. The state of Indiana completed its examination of the calendar years 2000 through 2005 in the third quarter of 2008. We paid additional taxes of $20.7 million as a result of the examinations. This amount was recorded as an unrecognized tax benefit when we adopted Financial Accounting Standards Board (FASB) Interpretation 48 (FIN 48) on January 1, 2007. It is reasonably possible that the amount of unrecognized tax benefits could change in the next twelve months as a result of state income tax audits. Based on current audits in process, the payment of additional taxes could be in an amount from zero to $2.0 million during 2009, primarily related to state nexus issues. With few exceptions, we are no longer subject to federal, state and local income tax examinations by tax authorities for years ended before 2005.
Liquidity and Capital Resources
Our business is capital intensive and requires substantial expenditures for, among other things, the purchase and maintenance of equipment used in our steelmaking and finishing operations and to remain in compliance with environmental laws. Our short-term and long-term liquidity needs arise primarily from capital expenditures, working capital requirements and principal and interest payments related to our outstanding indebtedness. We have met these liquidity requirements with cash provided by operations, equity, long-term borrowings, state and local grants and capital cost reimbursements.
Working Capital. During the first quarter of 2009, our operational working capital position, representing our cash invested in trade receivables and inventories less trade payables and accruals decreased $224.7 million to $761.7 million compared to December 31, 2008. Trade receivables decreased $141.1 million, or 28%, during the first quarter of 2009 to $361.8 million, of which 94% were current or less than 60 days past due. Our largest customer is an affiliated company, Heidtman Steel, which represented 7% and 10% of our outstanding trade receivables at March 31, 2009 and December 31, 2008, respectively. Trade receivables declined substantially during the first quarter of 2009 due to a continued decrease in shipping volumes and product prices. The dollar value of our raw materials, primarily steel scrap inventories, decreased by approximately $174.2 million during the quarter. Approximately $78.9 million of this decrease related to the $83.3 million non-cash inventory write down. Steel scrap inventory volumes, including both steel operations and metals recycling and ferrous resources, increased by 41,000 gross tons during the first quarter of 2009. The dollar value of total inventories decreased $190.2 million, or 19%, to $833.1 million during the quarter, with volumes of work-in-process and finished goods inventories remaining relatively stable. Our trade payables and general accruals decreased $106.6 million, or 20%, during the first quarter of 2009. This is a reflection of the slowdown in our production process and commodity raw material prices purchased during the first quarter of 2009 to match the decrease in the demand for our products, as well as the payment in March 2009 of $61.7 million of accrued profit sharing related to calendar year 2008.
Capital Expenditures. During the first quarter of 2009, we invested $74.3 million in property, plant and equipment, of which $13.3 million related primarily to the addition of a second rolling mill at our Structural and Rail Division, $7.2 million related to metals recycling operations and $36.1 million related to construction at Mesabi Nugget, our planned iron-nugget manufacturing facility and related mining operations. The other capital expenditures of $17.7 million primarily represented maintenance projects at our other facilities. We believe these capital investments will benefit our net sales and related cash flows as each project reaches completion.
Capital Resources and Long-term Debt. During the first quarter of 2009, our total outstanding debt decreased $135.9 million to $2.5 billion. Our total long-term debt to capitalization ratio, representing our long-term debt, including current maturities divided by the sum of our long-term debt and our total stockholders’ equity, was 62% at March 31, 2009 and December 31, 2008. At March 31, 2009, there were outstanding borrowings of $231.0 million under our $874.0 million senior secured revolver and $552.1 million outstanding under our term A loan (both due July 2012).
The senior secured credit agreement contains financial covenants and other covenants that limit or restrict our ability to make capital expenditures; incur indebtedness; permit liens on property; enter into transactions with affiliates; make restricted payments or investments; enter into mergers, acquisitions or consolidations; conduct asset sales; pay dividends or distributions and enter into other specified transactions and activities. Our ability to borrow funds within the terms of the revolver is dependent upon our continued compliance with the financial covenants and other covenants contained in the senior secured credit agreement. The financial covenants state that we must maintain at all times an interest coverage ratio of not less than 2.00:1.00 and must maintain a total debt to consolidated last-twelve-months trailing EBITDA (earnings before interest, taxes, depreciation, amortization, and certain other non-cash transaction adjustments as defined in the credit agreement) ratio of not more than 5.00:1.00. If the total debt to EBITDA ratio exceeds 3.50:1.00, then our ability to make restricted payments as defined in the credit
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agreement (which includes cash dividends to stockholders and share purchases, among other things), is limited to $25 million per quarter. We were in compliance with these covenants at March 31, 2009 with an interest coverage ratio of 5.41 and a total debt to EBITDA ratio of 2.81. However, based on the current economic environment and our outlook, we believe we may be in violation of our financial covenants during 2009, which if not resolved, could also constitute a cross default under other debt instruments. We are considering a number of alternatives to address this situation, including but not limited to obtaining a waiver from our bank group. We may incur additional costs related to these alternatives.
Cash Dividends. We declared cash dividends of $18.2 million, or $.10 per share, during the first quarter of 2009 and $18.9 million, or $.10 per share, during the first quarter of 2008. We paid cash dividends of $18.2 million and $14.3 million during the first quarters of 2009 and 2008, respectively. Our board of directors, along with executive management, approves the payment of dividends on a quarterly basis. The determination to pay cash dividends in the future will be at the discretion of our board of directors, after taking into account various factors, including our financial condition, results of operations, outstanding indebtedness, current and anticipated cash needs and growth plans. In addition, the terms of our senior secured revolving credit agreement and the indenture relating to our senior notes restrict the amount of cash dividends we can pay.
Other. Our ability to meet our debt service obligations and reduce our total debt will depend upon our future performance which, in turn, will depend upon general economic, financial and business conditions, along with competition, legislation and regulatory factors that are largely beyond our control. In addition, we cannot assure you that our operating results, cash flow and capital resources will be sufficient for repayment of our indebtedness in the future. We believe that based upon current levels of operations and anticipated growth, cash flow from operations, together with other available sources of funds, including additional borrowings under our senior secured credit agreement, will be adequate for the next two years for making required payments of principal and interest on our indebtedness, funding working capital requirements and anticipated capital expenditures.
Other Matters
Inflation. We believe that inflation has not had a material effect on our results of operations.
Environmental and Other Contingencies. We have incurred, and in the future will continue to incur, capital expenditures and operating expenses for matters relating to environmental control, remediation, monitoring, and compliance. We believe, apart from our dependence on environmental construction and operating permits for our existing and proposed manufacturing facilities, that compliance with current environmental laws and regulations is not likely to have a material adverse effect on our financial condition, results of operations, or liquidity; however, environmental laws and regulations are subject to change, and we may become subject to more stringent environmental laws and regulations in the future.
Critical Accounting Policies and Estimates
Goodwill and Other Indefinite-Lived Intangible Assets. At least once annually or when indicators of impairment exist, we perform an impairment test for goodwill and other indefinite-lived intangible assets as required by FASB Statement No. 142, Goodwill and Other Intangible Assets (as amended).
Goodwill is allocated to various reporting units, which are generally one level below our operating segments. We utilize a two-stepped approach to measuring goodwill impairment. The first step of the test determines if there is potential goodwill impairment. In this step we compare the fair value of the reporting unit to its carrying amount (which includes goodwill). The fair value of the reporting unit is determined by using an estimate of future cash flows and a risk-adjusted discount rate to compute a net present value of future cash flows. If the carrying amount exceeds the fair value, we perform the second step of the test, which measures the amount of impairment loss to be recorded, if any. In the second step, we compare the carrying amount of the goodwill to the net fair value of the recognized and unrecognized assets and liabilities of the reporting unit. If the implied fair value is less than the carrying value, an impairment loss is recorded to the extent that the fair value of the goodwill is less than its carrying value.
Our annual testing for goodwill impairment is performed during the fourth quarter of each year. However, given the current global economic recession, we examined both our overall market capitalization as well as an assessment of profitability and financial forecasts within our reporting units to which goodwill has been allocated to determine whether indicators of possible impairment existed as of March 31, 2009. We determined that, based on continued operating losses during the quarter and a significant change in financial forecasts since the fourth quarter of 2008, indicators of possible impairment did exist within our OmniSource reporting unit, which includes the goodwill associated with the Elizabethton, OmniSource, and Recycle South acquisitions. Based on this assessment, we performed a discounted cash flow valuation of the OmniSource reporting unit, utilizing updated five-year financial projections and estimates of cash flows, discounted using our weighted average cost of capital based on market conditions as of the testing date. For periods beyond our five-year projections, we used an assumed 2.0% terminal growth rate. This methodology was consistent with that used in our annual testing for impairment, although our revised financial forecasts resulted in a lower valuation result than was achieved during our annual testing. Our testing found that no goodwill impairment existed as of March 31, 2009. We applied sensitivity analysis procedures to our valuation and found that a discount rate 1.0% higher would have no impact on our conclusion; likewise, a terminal growth rate as low as 0.1% would not change our conclusions regarding impairment. Fluctuations in the financial forecasts or discount rates used beyond these sensitivity thresholds could result in a material impairment charge in future periods.
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Our other indefinite-lived intangible assets are related to trademarks acquired through various business combinations as follows, as of March 31, 2009 (in thousands):
81,800
OmniSource Corporation
108,000
189,800
We test indefinite-lived intangible assets for impairment through the comparison of the fair value of the specific intangible asset with its carrying amount. The fair value of the intangible asset is determined by using an estimate of future cash flows attributable to the asset and a risk-adjusted discount rate to compute a net present value of future cash flows. If the fair value is less than the carrying value, an impairment loss is recorded in an amount equal to the excess in carrying value. Due to the indicators of possible impairment described above related the goodwill associated with OmniSource, we updated our valuation of the indefinite-lived intangible asset associated with OmniSource. Our testing found that no indefinite-lived intangible asset impairment existed as of March 31, 2009. Fluctuations in the financial forecasts or discount rates used could result in a material impairment charge in future periods.
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Interest Rate Risk
In the normal course of business, we are exposed to interest rate changes. Our objectives in managing exposure to interest rate changes are to limit the impact of these rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve these objectives, we primarily use interest rate swaps to manage net exposure to interest rate changes related to our portfolio of borrowings. We generally maintain fixed rate debt as a percentage of our net debt between a minimum and maximum percentage. A portion of our debt has an interest component that resets on a periodic basis to reflect current market conditions. We have an interest rate swap agreement (Swap Agreement) with a notional amount of $185 million in order to mitigate interest-rate volatility exposure associated with the cost of our senior secured credit facility. The Swap Agreement is scheduled to terminate on October 28, 2009. Under the terms of the Swap Agreement, we are entitled to receive on the 28th of each month interest payments at a floating-rate based on the one month LIBOR rate and we are obligated to make interest payments on the 28th of each month at a fixed rate of 2.21%. At March 31, 2009, no material changes had occurred related to our interest rate risk from the information disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008
Commodity Risk
In the normal course of business we are exposed to the market risk and price fluctuations related to the sale of steel products and to the purchase of commodities used in our production process, such as metallic raw materials, electricity, natural gas and alloys. Our risk strategy associated with product sales has generally been to obtain competitive prices for our products and to allow operating results to reflect market price movements dictated by supply and demand.
Our risk strategy associated with the purchase of commodities utilized within our production process has generally been to make certain commitments with suppliers relating to future expected requirements for such commodities. Certain commitments contain provisions which require us to “take or pay” for specified quantities without regard to actual usage for periods of up to 23 months for physical commodity requirements and for up to 12 years for commodity transportation requirements. We fully utilized all such “take or pay” requirements during the past three years under these contracts. We believe that production requirements will be such that consumption of the products or services purchased under these commitments will occur in the normal production process. We also purchase electricity consumed at our Flat Roll Division pursuant to a contract which extends through December 2012. The contract designates 160 hours annually as “interruptible service” and establishes an agreed fixed-rate energy charge per Mill/kWh consumed for each year through the expiration of the agreement. At March 31, 2009, no material changes had occurred related to these commodity risks from the information disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008.
In our metals recycling operations we have certain fixed price contracts with various customers for future delivery of nonferrous metals. Our risk strategy has generally been to enter into base metal financial contracts with the goal to protect the profit margin, within certain parameters, that was contemplated when we entered into the transaction with the customer. At March 31, 2009 we had a cumulative unrealized loss primarily associated with these financial contracts of $18.8 million. We expect the customer contracts to be fully consummated.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our principal executive officer and our principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2009. The term “disclosure controls and procedures,” as we use that term and as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures that are designed to provide reasonable assurance that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that information is accumulated and communicated to management, including the principal executive and financial officer, as appropriate to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as of March 31, 2009, our principal executive officer and our principal financial officer concluded that, as of such date, our disclosure controls and procedures were effective.
(b) Changes in Internal Controls Over Financial Reporting. During the quarter ended March 31, 2009, there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fiscal quarter ended March 31, 2009, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Steel Dynamics, Inc. as well as its various subsidiaries, is from time to time involved in various lawsuits and/or governmental claims in the ordinary course of business. None of these lawsuits or claims at the present time, singly or in the aggregate, except as disclosed below, is material.
ITEM 1A. RISK FACTORS.
No material changes have occurred to the indicated risk factors as disclosed in our 2008 Annual Report on Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
Executive Officer Certifications
31.1*
Certification of Chief Executive Officer required by Item 307 of Regulation S-K as promulgated by the Securities and Exchange Commission and pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of Chief Financial Officer required by Item 307 of Regulation S-K as promulgated by the Securities and Exchange Commission and pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Certification of Chief Executive Officer 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 Chief Financial Officer Pursuant to 18 U.S.C Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed concurrently herewith
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SIGNATURE
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.
May 11, 2009
By:
/s/ Theresa E. Wagler
Theresa E. Wagler
Chief Financial Officer