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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
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Forward-Looking Statements |
Statements made in this report that are not statements of historical fact are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include, without limitation, any statements that may project, indicate or imply future results, events, performance or achievements. We refer you, however, to the section denominated “Forward-Looking Statements” and “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2003, which we incorporate herein by reference, for a more detailed discussion of some of the many factors, variables, risks and uncertainties that could cause actual results to differ materially from those we may have expected or anticipated. We caution that any forward-looking statement reflects only our reasonable belief at the time the statement is made.
Income Statement Classifications |
Net Sales. Our total net sales are a factor of net tons shipped, product mix and related pricing. Our net sales are determined by subtracting product returns, sales discounts, return allowances and claims from total sales. We charge premium prices for certain grades of steel, dimensions of product, or certain smaller volumes, based on our cost of production. We also charge marginally higher prices for our value-added products from our cold mill. These products include hot-rolled and cold-rolled galvanized products, cold-rolled products, and painted products.
Cost of Goods Sold. Our cost of goods sold represents all direct and indirect costs associated with the manufacture of our products. The principal elements of these costs are steel scrap and scrap substitutes, alloys, natural gas, argon, direct and indirect labor and related benefits, electricity, oxygen, electrodes, depreciation and freight. Our metallic raw materials, steel scrap and scrap substitutes, represent the most significant component of our cost of goods sold.
Selling, General and Administrative Expenses. Selling, general and administrative expenses consist of all costs associated with our sales, finance and accounting, materials and transportation, and administrative departments. These costs include labor and benefits, professional services, financing cost amortization, property taxes, profit-sharing expense and start-up costs associated with new projects.
Interest Expense. Interest expense consists of interest associated with our senior credit facilities and other debt agreements as described in the notes to our financial statements set forth in our most recent Annual Report on Form 10-K, net of capitalized interest costs that are related to construction expenditures during the construction period of capital projects.
Other (Income) Expense. 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. Other expense consists of any non-operating costs.
Second Quarter 2004 vs. Second Quarter 2003 Operating Results |
Net income was $67.3 million or $1.20 per diluted share during the second quarter of 2004, compared with $5.4 million or $.11 per diluted share during the second quarter of 2003. This increase in our net income during 2004 was due to increased selling values and increased shipping volumes.
Gross Profit. During the second quarter of 2004, our net sales increased $307.0 million, or 140%, to $525.7 million and our consolidated shipments increased 236,000 tons, or 36%, to 889,000 tons, compared with the second quarter of 2003. The increase in shipments was primarily due to increased shipments of 101,000 tons from our Structural and Rail Division, which started commercial operations mid-2002 and shipments of 82,000 tons from our Bar Products Division, which started commercial operations during the first quarter of 2004. Our second quarter 2004 average consolidated selling price increased $256 per ton compared with the second quarter of 2003 and increased $110 per ton compared with the first quarter of 2004. We continue to see signs of a strengthening US economy and we are experiencing a related increase in demand and product base-pricing; however, our increase in selling values during the first half of 2004 was also due in part to the steel industry’s initiation of a surcharge mechanism, derived from an indexed scrap number, designed to pass some of the increased costs associated with rising metallic prices through to its customers.
Our metallic raw material cost per net ton charged increased $82 during the first half of 2004, of which $16 per ton occurred during the second quarter. When compared to the first half of 2003, our metallic raw material cost per net ton charged increased $98, or 81%. Our metallic raw material costs as a percentage of total cost of goods sold increased to 62%, a 12% increase from the first half of 2003. This increase in the cost of our primary raw material as a percentage of our total manufacturing costs necessitated the surcharge. We anticipate a further increase in our metallic raw material costs, specifically steel scrap, during the remainder of 2004. If these costs fall from historical highs, the surcharge will also decline and may eventually cease to be utilized in our product price determination.
We also expect to realize an increase in our product base-prices during the third quarter of 2004 as the US economy continues to strengthen and demand of steel products continues to increase. We believe this will result in a corresponding increase in our margins and, combined with an anticipated increase in our shipments due to the continued ramp-up of our Structural and Rail Division and the continued start-up of our Bar Products Division, would result in increased operating income.
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Selling, General and Administrative Expenses. Selling, general and administrative expenses were $28.1 million during the second quarter of 2004, as compared to $14.7 million during the same period in 2003, an increase of $13.4 million, or 91%. This increase was attributed to increased profit sharing expense of $5.3 million, due to our increased income before taxes and to our June 2004 refinancing which resulted in a write-off of previously capitalized financing costs in the amount of $3.1 million. During the second quarter of 2004 and 2003, selling, general and administrative expenses represented approximately 5% and 7% of net sales, respectively.
Interest Expense. During the second quarter of 2004, gross interest expense increased 13% to $12.0 million and capitalized interest decreased $254,000 to $1.4 million, as compared to the same period in 2003. Gross interest expense remained relatively flat during the first half of 2004. The interest capitalization that occurred during 2004 resulted from the interest required to be capitalized with respect to construction activities at our Bar Products Division and Structural and Rail Division. We anticipate gross interest expense and capitalized interest to continue to decrease slightly through the end of the year.
Other (Income) Expense. Other income was $3.1 million during the second quarter of 2004, as compared to $400,000 during 2003. During the first quarter of 2004 we entered into a short-term U.S. Treasury Bond transaction which is intended to address interest rate exposure and generate capital gains. During the second quarter of 2004, we recorded a $1.9 million gain as a result of this transaction. We also recorded a $1.0 million gain from the early extinguishment of certain debt associated with our Structural and Rail Division.
Income Taxes. During the second quarter of 2004, our income tax provision was $40.4 million, as compared to $3.3 million during the same period in 2003. Our effective income tax rate was 37.5% for both periods; however, if our profitability is sustained or increases during the second half of 2004, we may increase our effective income tax rate to 38%. This increase would be necessary due to an increase in state income taxes created by higher profitability.
First Half 2004 vs. First Half 2003 Operating Results |
Net income was $99.3 million or $1.78 per diluted share during the first half of 2004, compared with $21.2 million or $.44 per diluted share during the first half of 2003. This increase in our net income during 2004 was due to increased selling values and increased shipping volumes.
Gross Profit. During the first half of 2004, our net sales increased $455.7 million, or 100%, to $909.8 million and our consolidated shipments increased 387,000 tons, or 30%, to 1.7 million tons, compared with the first half of 2003. The increase in shipments was primarily due to increased shipments of 232,000 tons from our Structural and Rail Division, which started commercial operations mid-2002 and shipments of 102,000 tons from our Bar Products Division, which started commercial operations during the first quarter of 2004. Our first half 2004 average consolidated selling price increased $190 per ton, or 54%, compared with the first half of 2003. This is due in part to the previously discussed increase in base-prices resulting from strong demand, the surcharge mechanism and our shipping product mix becoming higher-value added with the addition of the Flat Roll Division’s painted products and the continued ramp-up of our Bar Products Division.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $51.1 million during the first half of 2004, as compared to $29.7 million during the same period in 2003, an increase of $21.5 million, or 72%. This increase was attributed to increased profit sharing expense of $6.4 million, due to our increased income before taxes and to our June 2004 refinancing which resulted in a write-off of previously capitalized financing costs in the amount of $3.1 million. During the first half of 2004 and 2003, selling, general and administrative expenses represented approximately 6% and 7% of net sales, respectively.
Interest Expense. Interest expense remained relatively flat at $20.1 million during the first half of 2004, as compared to $18.1 million during the first half of 2003. During the first half of 2004, gross interest expense increased 12% to $23.9 million and capitalized interest increased $636,000 to $3.8 million, as compared to the same period in 2003. The interest capitalization that occurred during the first half of 2004 resulted from the interest required to be capitalized with respect to construction activities at our Bar Products Division and Structural and Rail Division.
Other (Income) Expense. Other income was $5.2 million during the first half of 2004, as compared to $250,000 during the first half of 2003. During the first quarter of 2004 we entered into a short-term U.S. Treasury Bond transaction which is intended to address interest rate exposure and generate capital gains. During the first half of 2004, we recorded a $3.3 million gain as a result of this transaction. We also recorded a $1.0 million gain from the early extinguishment of certain debt associated with our Structural and Rail Division during the second quarter.
Income Taxes. During the first half of 2004, our income tax provision was $59.6 million, as compared to $12.7 million during the same period in 2003. Our effective tax rate was 37.5% for both periods.
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.
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Working Capital. During the first half of 2004, our operational working capital position, representing our cash invested in trade receivables and inventories less trade payables and accruals increased $112.6 million to $285.8 million compared to December 31, 2003. Due to higher selling prices and increased sales volume, trade receivables increased $73.1 million during the first half to $199.2 million, of which $197.1 million, or 99%, were less than 60 days past due. Our largest customer is an affiliated company, Heidtman Steel, which represented 14% and 20% of our outstanding trade receivables at June 30, 2004 and December 31, 2003, respectively. During the first half our inventories increased $95.7 million to $280.2 million, due primarily to the increased cost and volume of our metallic raw materials on-hand and to the start-up production of our Bar Products Division. Our trade payables increased $41.6 million during the first half, a significant portion of which was associated with the amount we owed various vendors for metallic raw material purchases.
Capital Expenditures. We invested $54.7 million in property, plant and equipment during the first half of 2004 related to our new divisions and improvement projects in our existing facilities. Approximately 67% of our capital investments were related to the continued conversion of our Bar Products Division. We believe these capital investments will increase our net sales and related cash flows as each project continues to develop.
Capital Resources. On June 30, 2004, we completed a refinancing of our senior secured credit facilities and entered into a new 4-year $230 million senior secured revolving credit facility. A portion of the proceeds from the new revolver and cash on hand were used to prepay certain existing senior secured debt, including our term loan B facility of $108 million. At June 30, 2004, with the completion of the refinancing, we increased our credit facility liquidity from approximately $75 million to $130 million. The proceeds from the revolver will be available for working capital and other general corporate purposes. As a result of this refinancing we wrote-off $3.1 million of previously capitalized financing costs associated with the refinanced debt. Our ability to draw down the revolver is dependent upon our continued compliance with the financial covenants and other covenants contained in our senior secured credit agreement. We were in compliance with these covenants at June 30, 2004, and expect to remain in compliance during the next twelve months.
Our new senior secured credit agreement allows us to pay cash dividends dependent upon our continued compliance with the financial covenants and other covenants within the agreement. On July 14, 2004, our Board of Directors declared our first cash dividend. The dividend of $0.075 (seven and one-half cents) per common share is payable August 13, 2004 to shareholders of record at the close of business on July 26, 2004. We estimate the aggregate dividend payment will be $3.7 million.
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 regulation 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 twelve months for making required payments of principal and interest on our indebtedness and for funding anticipated capital expenditures and working capital requirements.
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 have changed rapidly in recent years and we may become subject to more stringent environmental laws and regulations in the future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Market 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. At June 30, 2004, 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, 2003.
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 of these commitments contain provisions which require us to “take or pay” for specified quantities without regard to actual usage for periods of up to 3 years. We believe that our production requirements will be such that consumption of the products or services purchased under these commitments will occur in the normal production process. At March 31, 2004, 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, 2003.
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ITEM 4. CONTROLS AND PROCEDURES |
(a) Evaluation of Disclosure Controls and Procedures. An evaluation was performed under the supervision and with the participation of registrant’s management, including the chief executive officer and chief financial officer, of the effectiveness of the design and operation of registrant’s disclosure controls and procedures, as of the end of the period covered by this report. Based upon their evaluation, registrant’s principal executive officer and principal financial officer have concluded that registrant’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) were effective to ensure that information required to be disclosed by registrant in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
(b) Changes in Internal Controls. There have been no significant changes in registrant’s internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation. There were no significant deficiencies or material weaknesses, and, therefore, there were no corrective actions taken.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS |
On August 4, 2004 the Oakland County (Michigan) Circuit Court granted Steel Dynamics’ motion to dismiss General Motors Corporation’s complaint for breach of an alleged steel supply contract, which GM had filed on March 18, 2004 and which Steel Dynamics described in its March 25, 2004 press release and Form 8-K filed on the same date. The Court dismissed the complaint, with prejudice, for failure to state any legally sufficient claim, finding that a January 22, 2003 GM drafted letter to Steel Dynamics, upon which GM had relied in asserting the existence of a multi-year supply contract, lacked mutuality of obligation and did not constitute an enforceable agreement.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
The Annual Meeting of Shareholders was held May 20, 2004. Proxies were solicited for the Annual Meeting in accordance with the requirements of The Securities Exchange Act 1935. At the Annual Meeting, the following occurred:
| | • | With respect to Item 1 in our Proxy Statement (Election of Directors): |
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Director | | Shares Voted For | | Shares Voted
Against or Withheld | |
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| Keith E. Busse | | 45,252,340 | | 2,102,563 | |
| Mark D. Millett | | 43,908,275 | | 3,446,628 | |
| Richard P. Teets, Jr. | | 43,907,264 | | 3,447,639 | |
| John C. Bates | | 44,362,433 | | 2,992,470 | |
| Paul B. Edgerley | | 45,093,684 | | 2,261,219 | |
| Richard J. Freeland | | 30,518,867 | | 16,836,036 | |
| Naoki Hidaka | | 45,380,465 | | 1,974,438 | |
| James E. Kelley | | 45,248,975 | | 2,105,928 | |
| Dr. Jürgen Kolb | | 45,252,340 | | 2,102,563 | |
| Joseph D. Ruffolo | | 45,250,537 | | 2,104,366 | |
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| | • | With respect to Item 2 in our Proxy Statement (Ratification of the Appointment of Independent Auditors), Ernst & Young LLP was approved as our independent auditors for the year 2004: |
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| Shares Voted For | | 44,804,733 | |
| Shares Voted Against | | 2,471,584 | |
| Abstentions | | 78,585 | |
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| | • | With respect to Item 3 in our Proxy Statement (Approval of Employee Stock Purchase Plan), the Employee Stock Purchase Plan was approved: |
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| Shares Voted For | | 36,633,960 | |
| Shares Voted Against | | 5,624,672 | |
| Abstentions | | 13,798 | |
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| ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K |
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| | | | 31.1 | Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | | | 31.2 | Principal Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | | | 32.1 | Chief Executive Officer Certification pursuant to 18 U.S.C. § 1350 |
| | | | 32.2 | Principal Financial Officer Certification pursuant to 18 U.S.C. § 1350 |
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| | | | We filed the following reports on Form 8-K during the three months ended June 30, 2004. |
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| | Date of Filing | Description | Reported | |
| | | | | |
| | April 15, 2004 | Item 12” Disclosure of Results of
Operations and Financial Condition” | Earnings press release for the quarter
ended March 31, 2004 | |
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| | April 6, 2004 | Item 9 “Regulation FD Disclosure” | Press release titled “Steel Dynamics
Forecasts Strong 2004 Performance” | |
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| | May 7, 2004 | Item 9 “Regulation FD Disclosure” | Press release titled “Steel Dynamics’ Bar
Bar Products Mill Achieves Profitability in April” | |
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| | May 10, 2004 | Item 5 “Other events and
Regulation FD Disclosure” | Press release to disclose the limitation of
share issuances for the Employee Stock
Purchase Plan | |
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| | May 20, 2004 | Item 9 “Regulation FD Disclosure” | Press release titled “Steel Dynamics Updates 2004 Outlook” | |
Items 2, 3 and 5 of Part II are not applicable for this reporting period and have been omitted.
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Pursuant to the requirements of Section 13 or 15(d) of Securities Exchange Act of 1934, Steel Dynamics, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
August 9, 2004
| | | STEEL DYNAMICS, INC. |
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| | By: | /s/ | TRACY L. SHELLABARGER |
| | | | Tracy L. Shellabarger |
| | | | Vice President and Chief Financial Officer |
| | | | (Principal Financial and Accounting Officer and Duly Authorized Officer) |
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