| STEEL DYNAMICS INC ITEM 1A RISK FACTORS Our profitability is subject to the risks described under this section on “Risk Factors” described below |
| Although the following are not necessarily the only ones facing our company, our business, financial condition or results of operations could be materially adversely affected by any of the following risks: Risks Related to Our Industry In recent years, imports of steel into the United States have adversely affected, and may yet again adversely affect, US steel prices, which would impact our sales, margins and profitability |
| Excessive imports of steel into the United States as a result of excess world supply, have in recent years exerted, and may again in the future exert downward pressure on US steel prices and significantly reduce our sales, margins and profitability |
| US steel producers compete with many foreign producers |
| Competition from foreign producers is typically strong, is periodically exacerbated by weakening of the economies of certain foreign steelmaking countries, and is further intensified during periods when the US dollar is strong relative to foreign currencies |
| Greater steel exports to the United States tend to occur at depressed prices when steel producing countries experience periods of economic difficulty, decreased demand for steel products or excess capacity |
| In addition, we believe the downward pressure on, and periodically depressed levels of US steel prices in some recent years have been further exacerbated by imports of steel involving dumping and subsidy abuses by foreign steel producers |
| Some foreign steel producers are owned, controlled or subsidized by foreign governments |
| As a result, decisions by these producers with respect to their production, sales and pricing are often influenced to a greater degree by political and economic policy considerations than by prevailing market conditions, realities of the marketplace or consideration of profit or loss |
| Tariffs and quotas are currently in effect for various steel products imported from a number of countries that have been found to have been unfairly pricing steel imports to the US When these measures expire or if they are relaxed or repealed, or if consistently higher US steel prices enable foreign steelmakers to export their steel products to the United States, despite the presence of duties or tariffs, the resurgence of substantial imports of foreign steel could again create downward pressure on US steel prices |
| China’s current steelmaking overcapacity coupled with a reduction or slowdown in China’s steel consumption could have a material adverse effect on domestic and global steel pricing and could result in increased steel exports into the United States |
| A significant factor in the worldwide strengthening of steel pricing over the past several years has been the explosive growth in Chinese steel consumption, which had until recently vastly outpaced that country’s capacity to produce steel in sufficient quantity to serve its internal demand, particularly during 2004 |
| The shortage of Chinese domestic steel supply resulted not only in heightened Chinese demand for imported steel and other raw materials, with a consequent upward spiral in world wide steel pricing, but also led to a rapid and significant expansion of steel production capacity in China |
| That, in addition to the existence of a large amount of outdated, inefficient and government subsidized production capacity, has resulted in a situation in which China’s steel producing capacity currently exceeds that country’s demand for certain steel products |
| A combination of a slowdown in China’s economic growth rate and its consumption of steel, coupled with its own expansion of steelmaking capacity, has caused a reduction and could result in a substantial weakening of both domestic and global steel demand and steel pricing |
| Should Chinese demand weaken, China might not only become a net exporter of steel but many Asian and European steel producers whose steel output currently feeds China’s steel import needs could find their way into the US market, through increased steel imports, thus causing an erosion of margins and a reduction in pricing |
| 21 ______________________________________________________________________ Domestic and worldwide consolidation in the steel industry and the emergence of more efficient integrated steel producers has eroded some of the historical cost advantages of mini-mills |
| Until recent years, our primary competitors were other mini-mills, which had cost structures and management cultures similar to ours and were more efficient and lower cost producers in many product areas than integrated mills |
| However, largely as a result of restructurings and consolidation within the US and worldwide steel industry and the resulting emergence of a number of integrated steel producers with lower capital costs, new or renegotiated union work rules and labor costs, the elimination or reduction of health care and pension legacy costs, the introduction of more incentive based compensation, and a more decentralized management structure, some of these integrated producers now have cost structures that are much more competitive |
| Likewise, with their lesser dependence on scrap as a component of their melt mix than mini-mills, these producers may enjoy a raw material cost advantage over mini-mills during periods of high scrap costs |
| The reduction in costs enjoyed by many integrated steel producers further increases the competitive environment in the steel industry and may contribute to future pricing pressures |
| Increases in prices and limited availability of raw materials and energy may constrain operation levels and reduce profit margins |
| Steel producers require large amounts of raw materials such as scrap |
| Steel producers also consume large amounts of energy |
| Over the last several years, prices for raw materials and energy have increased significantly, in many cases by a greater margin than corresponding price increases for the sale of steel products |
| Depending upon applicable raw material and energy prices, over which we may have little control, we and other steel producers may be faced in the future with difficulty in obtaining sufficient raw materials and energy in a timely manner or for reasonable costs, resulting in potential production curtailments |
| Our level of production and our sales and earnings are subject to significant fluctuations as a result of the cyclical nature of the steel industry and the industries we serve, particularly the auto industry |
| The price of steel may fluctuate significantly due to many factors beyond our control |
| This fluctuation directly affects our product mix, production volumes and our sales and earnings |
| The steel industry is highly cyclical and the sale of our products is directly affected by demand for our products in other highly cyclical industries, such as the automotive, oil and gas, gas transmission, residential and commercial/industrial construction, commercial equipment, rail transportation, appliance, agricultural and durable goods industries |
| Currently, the domestic automotive industry, which is a major consumer of new steel and a major generating of steel scrap, is suffering from a substantial downturn, and continued economic difficulties, stagnant economies, supply/demand imbalances and currency fluctuations in the United States or globally could further decrease the demand for our products or increase the amount of imports of steel into the United States, which would decrease our sales, margins and profitability |
| We are also particularly sensitive to trends and events, including strikes and labor unrest that may adversely impact these industries |
| These industries are significant markets for our products and are themselves highly cyclical |
| Risks Related to Our Business and Our Company We may encounter supply shortages and increases in the cost of raw materials, energy and transportation |
| Steel production requires substantial amounts of raw materials and energy, including steel scrap, pig iron, iron ore, natural gas, coal and other alloys or materials used in the process of making steel |
| Any prolonged interruption in the supply of raw materials or energy, or substantial increases in their costs, could adversely affect our business, financial condition, results of operations or prospects |
| Prices of raw materials have substantially increased over the past several years and may continue to increase |
| The 22 ______________________________________________________________________ availability and prices of raw materials may be negatively affected by new laws or regulations, allocation by suppliers, interruptions in production, accidents or natural disasters, changes in exchange rates, worldwide price fluctuations, and the availability and cost of transportation |
| Energy costs, including the cost of natural gas and electricity, make up a substantial portion of the cost of goods sold by steel companies, and the price of natural gas and electricity varies as a result of market conditions and other factors beyond the control of steel companies |
| Moreover, global developments, particularly the dramatic increase in the demand for raw materials, including scrap, and other inputs used in steel manufacturing from China and other Asian countries, have in the past caused shortages and may continue to cause severe shortages and/or substantial price increases in key raw materials, as well as in ocean transportation capacity and costs |
| Inability to recoup these cost increases from increases in the selling prices of steel products, or the inability to pass all or any substantial part of these cost increases through scrap or other surcharges, or the inability to provide for customers’ needs because of the potential unavailability of key raw materials or other inputs, may have a material adverse effect on our business, financial condition, results of operations or prospects |
| We may face significant price and other forms of competition from other steel producers, which could have a material adverse effect on our business, financial condition, results of operation or prospects |
| The global markets in which steel companies conduct business are highly competitive and could become even more so due to increasing consolidation in the steel industry |
| Increased competition could cause us to lose market share, increase operating costs or reduce pricing, any one of which could have a material adverse effect on our business, financial condition, results of operations or prospects |
| The global steel industry has historically suffered from substantial over-capacity, and excess capacity exists in some of our product lines |
| This could cause us to reduce prices for our products and, as a result, have a material adverse affect on our business, financial condition, results of operations or prospects |
| We compete primarily on the basis of price, quality and the ability to meet our customers’ product needs and delivery schedules |
| Some of our competitors may have advantages due to greater capital resources, different technologies, lower raw material costs, lower energy costs or favorable exchange rates |
| Competition from other products may have a material adverse effect on our business, financial condition, results of operations or prospects |
| In many applications, steel competes with other materials, such as aluminum and plastics (particularly in the automobile industry), cement, composites, glass and wood |
| Additional substitution of these or other substitutes for steel products could adversely affect future market prices and demand for steel products |
| We may face risks associated with the implementation of our growth strategy |
| Our growth strategy subjects us to various risks |
| As part of our growth strategy, we have expanded and may further expand existing facilities, build additional plants, acquire other businesses and steel assets (such as our anticipated acquisition of Roanoke), enter into joint ventures, or form strategic alliances that we believe will complement our existing business |
| These transactions will likely involve some or all of the following risks: · the difficulty of competing for acquisitions and other growth opportunities with companies having greater financial resources than ours; · the difficulty of integrating the acquired operations and personnel into existing businesses; · the potential disruption of ongoing businesses; · the diversion of resources; 23 ______________________________________________________________________ · the inability of management to maintain uniform standards, controls, procedures and policies; · the difficulty of managing the growth of a larger company; · the risk of entering markets in which we have little experience; · the risk of becoming involved in labor, commercial, or regulatory disputes or litigation related to the new enterprise; · the risk of contractual or operational liability to other venture participants or to third parties as a result of the participation by us; · the inability to work efficiently with joint venture or strategic alliance partners; and · the difficulties of terminating joint ventures or strategic alliances |
| There are risks associated with acquisitions |
| The success of any future acquisition, such as our anticipated acquisition of Roanoke, will depend substantially on our ability to integrate the acquired operations successfully with our existing operations in an efficient and effective manner |
| If we are unable to integrate new operations successfully, our financial results could suffer |
| Additional risks associated with acquisitions include the diversion of management’s attention from other business concerns, the potential loss of key employees and customers of the acquired companies, the potential assumption of unknown liabilities, and the inherent risks in entering markets or lines of business in which we have limited or no prior experience |
| Equipment downtime or shutdowns could adversely affect our business, financial condition, results of operations or prospects |
| Steel manufacturing processes are dependent on critical steelmaking equipment, such as furnaces, continuous casters, rolling mills and electrical equipment (such as transformers), and this equipment may incur downtime as a result of unanticipated failures or other events, such as fires or furnace breakdowns, as well as other unusual and unplanned maintenance requirements |
| Our manufacturing plants have experienced, and may in the future experience plant shutdowns or periods of reduced production as a result of such equipment failures or other events |
| These disruptions could have an adverse affect on our operations, customer service levels and financial results |
| Environmental regulation imposes costs and limitations on our operations |
| We are subject to the risk of environmental liability and limitations on our operations brought about by the requirements of environmental laws and regulations |
| We are subject to various federal, state and local environmental, health and safety laws and regulations concerning such issues as air emissions, wastewater discharges, solid and hazardous materials and waste handling and disposal, and the investigation and remediation of contamination |
| These laws and regulations are increasingly stringent |
| While we believe that our facilities are and will continue to be in material compliance with all applicable environmental laws and regulations, the risks of substantial costs and liabilities related to compliance with these laws and regulations are an inherent part of the business, and it is possible that future conditions may develop, arise or be discovered that create substantial environmental remediation liabilities and costs |
| For example, steelmaking operations produce some waste products, such as electric arc furnace dust, which are classified as hazardous waste and must be properly disposed of under applicable environmental laws |
| These laws can impose clean up liability on generators of hazardous waste and other substances that are shipped off-site for disposal, regardless of fault or the legality of the disposal activities |
| Other laws may require us to investigate and remediate contamination at our properties, including contamination that was caused in whole or in part by third parties |
| While we believe we can comply with environmental legislation 24 ______________________________________________________________________ and regulatory requirements and that the costs of doing so have been included within budgeted cost estimates, it is possible that this compliance will prove to be more limiting and costly than anticipated |
| In addition to potential clean up liability, in the past we have been, and in the future may become, subject to monetary fines and penalties for violation of applicable laws, regulations or administrative conditions |
| We may also be subject from time to time to legal proceedings brought by private parties or governmental agencies with respect to environmental matters, including matters involving alleged property damage or personal injury |
| Technology, operating and start-up risks associated with our scrap substitute projects, such as our Iron Dynamics project and our Mesabi Nugget joint venture, may prevent us from realizing the anticipated benefits from one or both of these projects and could result in a loss of currently invested funds, as well as future required funding for the ongoing operation of Iron Dynamics and the commercialization of the nugget project |
| If we should abandon or substantially reduce the scope of our ongoing Iron Dynamics project, we will not be able to realize the expected benefits of this project and could suffer the loss of all or a substantial part of our entire investment |
| As of December 31, 2005, investment in the Iron Dynamics project was approximately dlra190 million |
| Since 1997, we have been involved in the development and commercialization of a pioneering process of producing a form of iron to serve as a lower cost substitute for a portion of the metallic raw material mix that goes into the Flat Roll Division’s electric arc furnaces to be melted into new steel |
| This scrap substitute project involves processes that are based on various technical assumptions and new applications of technologies that have yet to be fully commercially proven |
| The Iron Dynamics project has taken considerably longer and has required us to expend considerably greater resources than originally anticipated |
| While we remain optimistic that certain continuing operational difficulties with the equipment, technology, systems and processes can be resolved, the Iron Dynamics facility may not be able to consistently operate or be able to produce steel scrap substitute material, whether direct reduced iron, hot briquetted iron or liquid pig iron, in the quantities and for costs that will enable it to be cost competitive with scrap or with purchased pig iron |
| Moreover, the Iron Dynamics facility may experience additional shutdowns or equipment failures |
| We also plan to invest approximately dlra30 million over the next year in Mesabi Nugget, a joint venture with Kobe Steel, Ltd |
| Cleveland-Cliffs, Inc |
| to build an iron nugget plant using Kobe’s proprietary ITmK3® process |
| We and our other joint venture partners have successfully built and operated a small scale pilot project using this process |
| However, while we believe that a full scale commercial plant should work as well as the pilot project and that, when built, it should be capable of consistently producing iron nuggets in sufficient quantities and with a cost structure that will compare favorably with the cost of scrap and of other scrap substitute products, including pig iron, there can be no assurance that these expectations can be achieved |
| If Mesabi Nugget encounters cost overruns, construction delays or systems or process difficulties during or after start-up, the anticipated capital and other costs could materially increase, the expected operating cost benefits from the development of the iron nugget product could be diminished or lost, and we could also lose our investment in the project |
| Our senior secured credit agreement, the indenture relating to its 9½% senior unsecured notes due 2009 and the indenture relating to its 4prca convertible subordinated notes due 2012 contain restrictive covenants that may independently limit our flexibility |
| Restrictions and covenants in our existing debt agreements, including our senior secured credit agreement, the indenture relating to our 9½% senior unsecured notes due 2009, and the indenture relating to our 4prca convertible subordinated notes due 2012 and any future financing agreements, may impair our 25 ______________________________________________________________________ ability to finance future operations or capital needs or to engage in other business activities |
| Specifically, these agreements restrict our ability to: · incur additional indebtedness; · pay dividends or make distributions with respect to our capital stock; · repurchase or redeem capital stock; · make certain investments; · create liens and enter into sale and leaseback transactions; · make certain capital expenditures; · enter into transactions with affiliates or related persons; · issue or sell stock of certain subsidiaries; · sell or transfer assets; and · participate in some joint ventures, acquisitions or mergers |
| A breach of any of the restrictions or covenants in one or more of these debt agreements could cause a default under our senior secured credit agreement, other debt or the notes and a significant portion of our indebtedness may become immediately due and payable |
| We are in compliance with these restrictions and covenants at February 28, 2006 and expect to remain in compliance during the next twelve months |
| Our stock price may be volatile and could decline substantially |
| Our stock price may decline substantially as a result of the volatile nature of the stock market and other factors beyond our control |
| Many factors may cause the market price of our common stock to decline, including: · the failure of operating results to meet the expectations of securities analysts or investors in any quarter; · downward revisions in securities analyst estimates of our earnings or of general market or economic conditions; · consolidation by other competitors in the industry; · speculation regarding potential acquisitions or takeovers; · material company or industry announcements by us or our competitors; · market perceptions concerning the steel cycle and our future earnings prospects; · sales of a substantial number of shares of our common stock; · governmental regulatory action; or · adverse changes in general market conditions or economic trends |
| Shares eligible for public sale could adversely affect our stock price |
| The future sale of a substantial number of shares of our common stock in the public market, or the perception that these sales could occur, could significantly reduce our stock price |
| It could also make it more difficult for us to raise funds through equity offerings in the future |
| As of March 6, 2006, we had 43cmam644cmam062 shares of our common stock outstanding |
| This number does not include the 6cmam762cmam874 shares of 26 ______________________________________________________________________ common stock that are issuable upon conversion of our 4prca convertible subordinated notes due 2012, our anticipated issuance of approximately 4cmam459cmam100 shares to Roanoke Electric Steel shareholders in the pending merger, or approximately 1cmam553cmam126 shares reserved as of December 31, 2005, for issuance in connection with outstanding stock options or incentive plans |
| In addition, large institutions or other holders may from time to time take positions in or in derivative securities representing shares of our common stock |
| We may not continue to pay cash dividends in the future |
| From the time of our initial public offering in 1996, through June 2004, we did not declare cash or other dividends on our common stock |
| Both in July and October 2004, we paid a cash dividend of 7½ cents per share and for the fourth quarter of 2004, increased the quarterly cash dividend to 10 cents per share |
| We paid cash dividends of 10 cents per share for each quarter of 2005, and we recently announced a regular 10 cent dividend and a special 10 cent dividend for the first quarter of 2006 and our expectation to continue both for the balance of 2006 |
| We cannot assure you, however, that we will continue to pay cash dividends, or, if we do, that we will do so at the current rate |
| We may elect at any time to retain all future earnings for use in the operation of our business and to fund future growth |
| Moreover, the terms of our senior secured credit agreement and the indenture relating to our senior notes impose specified restrictions on our ability to pay cash dividends |
| Even if these restrictions are removed, any future cash dividends will depend upon our results of operations, financial condition, cash requirements, and other factors |