Steel Dynamics, Inc. (STLD) Q2 2013 Earnings Report, Transcript and Summary

Good day, and welcome to the Steel Dynamics Second Quarter 2013 Earnings Conference Call. [Operator Instructions] Please be advised, this call is being recorded today, July 18, 2013, and your participation implies consent to our recording this call. If you do not agree to these terms, simply disconnect. At this time, I would like to turn the conference over to Marlene Owen, Director, Investor Relations. Please go ahead.

Thank you, Christine. Good morning, everyone, and welcome to Steel Dynamics Second Quarter 2013 Earnings Conference Call. As a reminder, today's conference is being recorded and will be available on the company's website for replay later today. Leading today's call are Mark Millett, President and Chief Executive Officer of Steel Dynamics; and Theresa Wagler, Executive Vice President and Chief Financial Officer. We also have the company's operating platform leaders, including Dick Teets, President and Chief Operating Officer for our Steel Operations; Russ Rinn, President and Chief Operating Officer for our Metals Recycling Operations; and Chris Graham, President of our Fabrication Operations. Please be advised that certain comments made today may involve forward-looking statements that, by their nature, are predictive. These are intended to be covered by the Safe Harbor protections of the Private Securities Litigation Reform Act of 1995. Such statements, however, speak only as of this date, today, July, 18, 2013, and involve risks and uncertainties related to our metals business or to general business and economic conditions which may cause actual results to turn out differently. More detailed information about such risks and uncertainties may be found at the Investor Center Advisory Information tab on our Steel Dynamics website, in our Form 10-K Annual Report under the captions Forward-looking Statements and Risk Factors, or as applicable in subsequently filed forms 10-Q filed with the Securities and Exchange Commission. For opening remarks, I'm pleased to turn the call over to Mark.

Well, thanks, Marlene. Good morning. Again, thanks for joining us today to discuss our second quarter results and to get our view of the steel industry and along with the opportunities that lay ahead for SDI that I believe will further differentiate us from our peers and continue to grow shareholder value. But before I turn the call over to Theresa's comments regarding our financial results for the quarter, I'd like to introduce Chris Graham, who recently became President of our Fabrication Business at the New Millennium Building Systems. Chris has been with Steel Dynamics from the very beginning. He has a broad experience in both our steel and fabrication operations, and we are more than happy to have him join the leadership team. So welcome, Chris. It's good to have you aboard, mate. So Theresa?

Thank you, Mark. Good morning, everyone. For the second quarter of 2013, our net income was $29 million or $0.13 per diluted share, at the upper range of our earnings guidance of between $0.10 and $0.14. Net sales of $1.8 billion were basically unchanged from the first quarter. However, comparative consolidated operating income decreased $27 million or 28%, as our consolidated gross margin percentage declined over 160 basis points compared to the first quarter. Despite somewhat higher revenues, which spun from higher volume, operating income from our steel operations decreased $34 million or 28%. The culprit was metal spread. Steel metal margins compressed in the second quarter as our average overall quarterly steel price per ton shipped decreased more than the cost of scrap used for our furnaces, most notably at our sheet and structural steel operations. Overall operating income per ton shipped for our steel operations decreased from $85 in the first quarter of this year to $59 in the second quarter, a 31% decrease. Operating income from our metals recycling operations, or OmniSource, decreased $9 million from first quarter results, resulting in second quarter profitability of $16 million. During the quarter, ferrous volumes decreased slightly and metal spread expanded 2%. In contrast, nonferrous volumes decreased 9% and metal spread declined 10%. Directionally, fabrication continues to be a bright spot for us, which is a positive sign for nonresidential construction. Shipments increased 11% in the quarter compared to the first quarter results, and operating income, although a smaller number compared to our other segments, improved more than 50%, making it our fifth consecutive quarter of profitability since the severe downturn in nonresidential. Gross interest expense for the second quarter was $32 million, compared to $35 million in the first quarter and $41 million in the second quarter of last year, over a 21% reduction from a year ago, a significant benefit derived from our refinancing activity. We're very pleased with the execution of our capital structure initiatives that were initiated in the fall of 2012, and more recently, in March and April of this year. In early April, as part of the completion of our most recent transaction, we decreased total outstanding debt by $100 million. We've created even greater long-term strength and sustainability on our capital structure through both debt reductions, the extension of our debt maturity profile and through the meaningful reduction in interest burden. Our year-to-date effective tax rate was 36.5%. However, our second quarter rate increased to 40.3%, as the first quarter effective rate included a favorable adjustment related to 2012 research and development tax credits that were approved by Congress in January. Based on current expectations, our full year effective rate is expected to be closer to 38%. You may have noticed that our diluted shares in the second quarter were lower than usual. We were required to exclude this share impact of our convertible notes because the result would've been anti-dilutive or, in other words, would have actually slightly increased our diluted EPS during the quarter. At June 30, outstanding shares were 220.7 million. Cash flows from operations provided $33 million of funding during the second quarter, similar to the sequential first quarter result of $30 million. Customer receivables rebuilt from lower levels at the end of March, as net sales increased in May and in June time frame. There has not been deterioration in portfolio quality. Days outstanding and overall credit profiles remain good. Reduction in accounts payable and accruals, including a $28 million payment for estimated taxes, reduced cash flow in the quarter by $42 million. We currently don't expect significant working capital fluctuations any time in the second half of the year. At March 31, our liquidity totaled $1.3 billion, just less than the $1.4 billion that we had available at the end of the first quarter. It includes available cash of $244 million and the benefit of a $1.1 billion revolving credit facility that remains undrawn. Our credit metrics remain strong and well within any covenant requirements. Total debt is $2.1 billion, with minimal secured borrowings of less than 15%. Our net debt is $1.85 billion, resulting in net debt to trailing adjusted EBITDA of 3.2x. If you add back the refinancing charges in the trailing EBITDA number, that number -- that addback is about $25 million and our net adjusted leverage is then 3.08x. It's still slightly above our preferred level of 3x, but we believe we'll be back in line very shortly. Capital investments in the quarter totaled $49 million. Of that, $35 million related to our steel operations, primarily for the continuation of the engineered special bar quality rolling mill expansion and the addition of premium rail capabilities. Both projects are on schedule to be commissioned at the end of this year. Our current estimate for full year 2013 capital investment is in the range of $200 million. This is slightly less than our early estimates. Mostly, it has to do with the timing of payments toward the end of the year with our larger projects. We consider over 75% of that $200 million investment to be growth oriented for projects that are intended to increase capacity, efficiency and margin in future periods. Current maturities of long-term debt increased in the quarter to $324 million. This primarily represents the $287.5 million convertible senior notes that mature in June of next year. There are 16.7 million shares underlying the security. We're comfortable with the timing of the maturity and believe we have many options available to us, including partial or forward payment with available cash and various other refinancing alternatives. The strength of our balance sheet is derived from our low-cost, highly-variable operating platforms, which provide strong cash flow generation. Our strong, resilient capital structure has the flexibility to sustain not only current operations, but to support future growth. Lastly, I know there's many of you on the call that like to track the specific commodities within our Flat Roll division, so I'd like to give you the second quarter shipments now. We shipped 307,000 tons of hot rolled, 102,000 tons of pickle and oil, 24,000 tons of cold rolled, 119,000 tons of hot-rolled galvanized, 53,000 tons of cold-rolled galvanized, 89,000 tons of painted product and 26,000 tons of Galvalume, resulting in 720,000 tons of shipments. With that, I'll turn the call back over to Mark.

Well, great. Thanks, Theresa. And to begin, I'd like to commend our team for their continued safety improvement. Our performance has consistently been better than industry standards, and we strive toward 0 incidents, absolutely no accidents, and we continue to make progress towards that goal. Roughly 75% of our 125 locations worked the first half of 2013 without a single recordable incident. My hats off to each and every one of those facilities. It's a tremendous, tremendous record. And my thanks to each and every one of our dedicated employees for continuing to keep safety the top priority. There is nothing more important, we believe, than the safety and welfare of each and every member of the SDI family. Switching gears, from my perspective, the domestic economy continues to experience constrained growth. GDP, although slightly improved since our last call, though, remains weaker than we needed it to be to support meaningful growth on a sustainable basis. Misunderstood or perhaps misinterpreted messages from the Federal Reserve seem to fuel general skepticism that the likelihood of sustainable growth absent [indiscernible] support. Although consumer confidence improved in the second quarter, it's still not where it needs to be, and the broader market dynamic continues to be influenced by forecasts of negative growth in the European community and slowed growth in China. For us, steel order input rates softened early in the quarter, as import activities spiked and as many customers expected steel prices to decrease in sympathy with ferrous scrap prices. April Flat Roll imports were over 10% higher than the 2013 monthly [ph] average, and May long product imports were over 35% higher. These factors, coupled with continued domestic oversupply, decreased sequential quarterly steel prices, especially in our sheet products and our structural business. However, later in June, and certainly so far in July, our sheet operations have experienced extended lead times for certain products, and as such, pricing has increased in tandem and is supporting the recent range. This is supported by incremental improvement in demand, coupled with reduced domestic sheet production capacity that has gone off temporarily -- off-line for various reasons. I continue to think that the key macro drivers that predict steel consumption still support optimism through the second half of 2013, and certainly in the years ahead. The most recent growth forecast for the automotive market indicates a 16 million build rate for 2013. Construction spending, albeit still low, continues to improve, up over 6% for 2013. And the seasonally adjusted construction spending in May was 5.4% higher than a year ago. Despite the disappointing June data [ph] , I believe residential construction appears to have sustainability. Housing starts increased through May and have materially improved over 2012. June housing starts were still up 10% year-over-year and permit's up 16% year-over-year. This certainly bodes well for future nonresidential construction activity and the overall ABI index also benched up over 50 after taking a 1-month dip. And more importantly, I think beyond the macro market indicators, we're seeing these improvements incrementally in our order book. In addition, and perhaps a little longer term, there are still many companies with significant cash positions, and when coupled with the low interest rate environment, will eventually lead to fixed asset investments. And as I mentioned before, over the even longer term, inexpensive shale gas has the potential to make the U.S. energy long, providing a tremendous incentive for fixed asset investment and associated job growth and thus, strong growth for steel-related consumption. We will be the beneficiaries of that associated economic growth as we leverage our latent production capacity. Since 2008, we've expanded capacity, and though we have been shipping at record levels these past few years, and so far in 2013, market conditions have prevented us from leveraging our full production capability. As nonresidential construction demand strengthens, all our platforms can benefit. In 2012, we had approximately 1.5 million tons of steel capacity that was not utilized due to these market conditions. Of that, about 55% of those tons had a very high correlation to the nonresidential construction market. As domestic steel mill utilization improves, so will the demand for ferrous scrap, benefiting our metals recycling operations. Similarly, we have over 150,000 tons of additional fabrication capacity directly tied to nonresidential construction in our pocket. In aggregate, I believe we have greater leverage to the recovering construction sector than our peers. Focusing on steel. It was a challenging quarter, particularly for our steel sheet and structural operations. As noted, steel imports increased and selling values declined, thus, compressing metal margins. Heading into the third quarter, however, we believe the recent price increases for steel sheet will remain intact, as the supply and demand dynamic has resulted in extended mill lead times. In spite of a challenging market, coupled with planned maintenance downtime in our Flat Roll and Engineered Bar divisions, our second quarter production utilization rate was still 83% as compared to 89% in the first quarter. But more importantly, on a year-to-date basis, we continue to perform above the industry average, which attests to the dedication of our employees and the diversity within our product portfolio. Our Structural and Rail division's utilization rate continued to improve, achieving 65% in the second quarter, slightly higher than the prior quarter and 12.5% ahead of the second quarter 2012. Domestic metals recycling industry experienced another volatile quarter. We indicated in our second quarter guidance we anticipated some challenges, and that was indeed the case. Where ferrous volumes and metal spreads were relatively flat, nonferrous was quite the opposite. Volumes there and margins decreased meaningfully, as index nonferrous pricing declined between 10% and 15% in some cases. I think China's enforcement of the Green Fence has definitely reduced nonferrous export demand and, in turn, has contracted metal spread. In fabrication, once again, we are pleased to report that our fabrication business delivered its fifth consecutive profitable quarter, so the momentum there is great. The team continues to make inroads in the market using the benefit of our national footprint. We see a strengthening trend in our quote and more importantly, order activity. And we continue to see improvements in that business as Chris and the team are focused on the right market opportunities: continue to gain market share and improve operating efficiency at our newer locations that are ramping up. Our pioneering efforts in Minnesota continue to make steady progress. As we indicated in our first quarter report, we took a planned outage during the month of April in order to make certain equipment and process changes. The upgrades were installed successfully and the gradual restart of capacity is going well. The facility achieved production of 25,500 metric tons in June, with a plant availability of 84%. With continued improvement in plant availability and operating rates, production is still expected to reach a 30,000 metric ton monthly rate before the end of the year. We anticipate the impact of losses really to Minnesota operations for the third quarter to be somewhat similar, maybe a little improved when compared to this past quarter, as we focus on production ramp-up and most importantly, production yield and consumption rates. We believe we could be at a breakeven run rate exiting 2013, so our expectations to-date, anyway, have not changed, although there is still much work to be done. Relative to our other iron operation, Iron Dynamics, I believe another congratulations to the team is in order. They achieved a record quarterly production of 62,500 metric tons of liquid pig iron. Their contribution to the Flat Roll's division -- Flat Rolled division's positivity shouldn't be overlooked, and I think it's a wonderful sustainability story, as they are now 100% recyclers of steel mill wastes. A reflection on our entrepreneurial culture, we continuously work to create opportunities rather than just wait for market dynamics to improve. I think several organic growth projects have been implemented in 2013 that will provide increased earnings potential specific to Steel Dynamics. I talked about each of them the last quarter and I'm happy to say that those projects are all on track and on budget. And I think a quick recap of the 2 larger and more impactful projects. At Engineered Bar division, it's adding 325,000 tons of production capacity for high-precision, smaller-diameter bars that will further broaden our product portfolio. This project will make our facility the largest single-site supplier of engineered and SBQ bars in North America, with an annual production capacity of 950,000 tons. As I said, the project is on schedule and on budget and is expected to be commissioned in the fourth quarter of this year, with no material interruption of current operations. Also, in capacity, a potential 200,000 tons of semifinished blooms could be supplied by our Structural and Rail division, thereby effectively diversifying their product mix and increasing through-cycle utilization. And that should moderate earnings volatility at the bottom of the cycle in the future. We're also excited about the addition of premium rail production capability at our Structural and Rail division, an additional avenue to increase the mills through-cycle utilization and to further diversify our markets with value-added products. Construction has also started on this project, and it, too, is on budget, on schedule and set for commissioning close to the end of this year. We will have the capability to produce up to 350,000 tons of standard strength and premium rail for North America's railroad industry. Test material has already been approved by several of the major domestic railroads. And I think the new rail capabilities will position us to become North America's preeminent rail manufacturer for rail quality and straightness and dimensional control. Furthermore, the product will provide exceptional customer value, adding the capability of 320-foot weld lengths that can be further welded into 1,600-foot strings, which significantly reduces the installation time and track maintenance costs for the rail customer. But as I think you can see, the company continues to drive towards maximizing opportunities to effectively and efficiently perform through the cycle to maintain a sustainable differentiated business from our peers. We believe our superior operating and financial performance clearly demonstrates the sustainability of our business model, whether in good or challenging times. In keeping with the entrepreneurial spirit that flows throughout the company, we will continue to assess opportunities for growth, whether new products, new technologies or new business lines. We are focused on providing exceptional value to our customers, committing to the highest levels of quality and timeliness, and importantly, to partnering with them to deliver not only the needs of today, but their needs for the future. The focus is toward not only top-level revenue growth, but growth that will enhance and provide consistency to our margins and provide our shareholders with returns that demonstrate our commitment: Making Steel Dynamics the preferred investment decision. The strong character and fortitude that our employees continue to demonstrate is exceptional. Their passion and spirit drives them to excellence and to outperform our peers, both operationally and financially, while maintaining our low-cost, highly-competitive position. I'd like to thank each and every one of them for their continued hard work and dedication, and to remind them, guys, always be safe, both at work and at home. And so with that, Christine, I'd like to open the call for any questions, either for me or for the leadership team.

[Operator Instructions] Our first question comes from the line of Brett Levy with Jefferies. Brett M. Levy - Jefferies & Company, Inc. Fixed Income Research: You said that lead times have extended significantly, particularly in sheet. Can you give some sense as to sort of how far out and maybe even break it down a little bit between the various grades of sheet your lead times have gotten to at this point?

I think Dick can probably give greater color, but I think in sheet, the value-added finished products are probably 8 through August and September, and I think hot band [ph] Dick is...

Probably in August. At August, pickle and oil in the end of August then hot-rolled galvanize is in late August and the...

8 [ph] weeks.

Yes. Even into September, so forth, yes. Brett M. Levy - Jefferies & Company, Inc. Fixed Income Research: And in terms of, I don't know, additional price increases, is that something that's being contemplated? Or is it just sort of kind of catching up with the ones that have already been announced at this point?

Well, I think the market is certainly firmly entrenched and solid where it is. It should remain at least stable there. I think the -- obviously, the market will dictate pricing going forward. There is a little bit of a headwind currently, I guess, for a great upward movement because of the spread between domestic and global pricing. But certainly, would suggest that stable to maybe slightly up for the rest of the year. Brett M. Levy - Jefferies & Company, Inc. Fixed Income Research: All right. And then the last one actually, I mean, this is probably a tougher question with prices now going back up again. But on the trade front, can you guys sort of talk about anything you're doing to kind of stem the tide of imports at this point? Or sort of how discussions went in Washington?

On that, I'd just say that we watch all of the products that we produce and also ones that we supply to our customers. And we talk to our trade attorneys and we know that they also represent competitors of ours, and we participate in any and all trade cases where we believe we have the legitimacy, and we will continue to aggressively pursue what we believe are unfairly-traded products that enter our markets.

I think, Brett, the recent OCTG filing could be beneficial to us, in Butler, for sure. I think, just generally, we wish that the administration, would just enforce -- if nothing else, enforce the current laws. We have a reasonably effective gauge relative to import licenses, and our problem in this country is that we have to prove harm before any action is taken as opposed to being a little proactive and utilizing the system that we have in place.

Our next question comes from the line of Martin Englert with Jefferies. Martin Englert - Jefferies & Company, Inc., Research Division: Was there a negative impact on results from the outages during the quarter and the previous inventory build in anticipation of those outages?

Well, needless to say, anytime you have an outage, there's a negative impact because you're not producing, you're not compressing your fixed costs and so forth, so of course. We anticipated our outages. They went as planned. We were very satisfied with the durations and the extent of the expenses that were incurred, and so they weren't negative as far as any surprises that resulted. But from a financial perspective, overall, of course, they were impacted, but the results were as expected.

The only thing that I would add to that is they were particularly impactful only because of the 2 divisions that ended up taking their maintenance outage in April, because they are 2 of our more profitable divisions at most times, which is our Flat Roll division and Engineered Bar.

We also took outage at Roanoke, we took outages as we required them in any of the divisions that had them scheduled, and so it just became more visible at those 2, yes. Martin Englert - Jefferies & Company, Inc., Research Division: Are you able to quantify at all how much that impacted EPS overall for the quarter?

I'm not prepared to do that today, no. Martin Englert - Jefferies & Company, Inc., Research Division: Okay. And for the Magnetation operation and Mesabi there, is Mesabi beginning to see any benefit from the lower-cost concentrate yet?

I think it's starting to see benefit later in the quarter. It didn't see full benefit, in all honesty, because the mining resource operation kind of struggled a little bit with the spring thaw. It's the first time we've gone through that and we sank a couple of some pretty large pieces of equipment in the muck, and we will certainly stockpile and be prepared for that next year, next time around. So the Magnetation material, mining resource material flowing into the Mesabi Nugget wasn't at that -- quite at that $50 per ton range, but I think we'll see some continued benefit through the rest of the year. I think as long as we're talking about Mesabi, because I'm sure there's going to be a question at some point. But as I said, I think they have seen some significant progress since April in both availability and potential operating rates, and the transition actually there is -- or the focus is transitioning from sustaining present operating rate, I guess, you could say, to reducing our consumption rates and getting our yields in shape, such that we can be at the expected breakeven by year end. Martin Englert - Jefferies & Company, Inc., Research Division: That's helpful. And if I could, one last question. Just looking at the pickup in lead times there within the Flat Roll division and -- I guess, how does overall utilization look across the steel operations now in July?

Well, needless to say, they were masked a bit because of the outage that occurred. But we are running very well. We're running our 2 casters basically at full bore at Butler, so we're in the mid 90s, upper 90s at the Butler operations. So we're well set.

I think, currently, we would expect utilization to be similar to what we saw in the first quarter versus the second quarter overall.

Our next question comes from the line of Evan Kurtz with Morgan Stanley.

Just one on SBQ. It seemed like the SBQ market was firming up a little bit in April and it slipped a little bit in May and June. Just wanting to get your thoughts there, what you're seeing as far as destocking. Is it mostly behind us? Is there any restocking at all on-site? And also, what sort of impact on the SBQ, I wonder, could we expect from this OCTG case?

Well, the -- from an inventory perspective, it remains steady. It has improved slightly, but it's not as robust as anyone would like. We continue to operate at the same rate at Pittsboro, but we continue to see a redefining of what products we are receiving. We are constantly taking orders for qualifications for products that we have not made in the past, but we will be making on the new mill once it's up and running. And so we are doing those tests and product deliveries and the performance qualifications now. And so we're satisfied with that, but we're not running the mill shop during the day, during the weeks when we don't need to, from a cost effectiveness perspective. From the OCTG standpoint, sure, all SBQ suppliers will see the benefit of it, because there is definitely an impact that will come as people become worried about being affected by the case and ramifications of the charges that occur, financial charges.

Great. And then just maybe one on Mesabi. We haven't talked about this in a long time, but I assume they're still pursuing the mining permits for the operations up there for the existing iron ore mine? Is that something that's still kind of on your radar? Is that -- where do those stand?

Well, I think, given the activity at Mining Resources and their ability to supply all our concentrate requirements at a good cost, the priority, I guess, is less up there. We do continue to pursue a permit. It's the -- we've got the rights and the land to eventually reopen that, so there's a lot of value in that mine that we could avail ourselves in the future at some point in time. But I would say yes, we're still pursuing, still on the radar screen, but not as actively, perhaps, as we were 1.5 years ago.

Our next question comes from the line of Curt Woodworth with Nomura.

Mark, I was wondering if you could comment on some of the divergence we're seeing in growth rates among the portfolio. I mean, it seems like the bar markets are showing pretty meaningful year-on-year declines, whereas beam is flat and the sheet market's showing modest growth. Do you feel like that's indicative of just the fact that the non-res cycle is sort of stabilizing and maybe we're seeing, at least on the bar side, more weakness than on the industrial equipment side?

Well, I'm not so sure that we're seeing our bar side depreciate like that. I think we're somewhat steady. I think the -- generally, our order rate at the structurals is sort of steady to up incrementally.

It is. And to the point of the bar, like SBQ, it has rebounded, but it's stabilized. It's -- again, you're right, the off-road [ph] and so forth, because of I think worldwide demand. Many of our domestic customers do supply worldwide. And when it cooled off in South America and in China and so forth, it became a lower demand issue and, certainly, domestically because of the, needless to say, coal mining and so forth that really gotten damper. But when you compare them with the flat rolled, it's a much bigger market. And as we specialize in a number of products, even small improvements in the residential garage doors and so forth, as those improve, the truck-trailer markets, those have strengthened due to distribution opportunities. We see that improvement both in steel at West Virginia and in Butler. They correspond very closely, and so those have strengthened in both of those arenas. So yes, there is some truth to what you're saying, but I would -- I wouldn't characterize the bar market as being -- falling. I think we've been very steady. We don't see yet any rapid growth to it in the second half, but we see it very steady and slightly improving.

And obviously, the largest, I guess, deviance [ph] would be engineered bar year-over-year or first half over first half, and we all recognize, I think, that, that was associated with the inventory realignment.

And we're optimistic with our expansion with our new products coming on. That will be a growth opportunity for us, and necessarily in the market, but we always are looking for opportunities to bring product differentiation and -- into the marketplace.

Okay. And then just one final question on long product pricing. It seems like the last couple of months, you see more shift in the industry to try and to settle the bar and beam prices ahead of the scrap settlement and kind of representing potential shift away from scrap surcharging mechanisms in the long products. I mean, do you guys see that happening? And is that happening in response to trying to establish a price in the market that, kind of regardless of where scrap settles month-to-month, you're going to have a price that will be competitive versus an import, which you identified earlier as seeing a little bit more pressure there, at least in May?

I think the reasoning, obviously, Nucor attempts to be out there ahead of everyone else, and I wouldn't want to speculate on why they're doing it at this point in time.

Our next question comes from the line of Michelle Applebaum with Steel Market Intelligence.

I think this is the first time Mesabi Nugget has beaten your guidance, and it looks like the numbers on Rail were particularly good, SBQ. I mean, everything is kind of cooking in a market that's not. So good for you, guys. I wanted to ask a question about what the outlook for the scrap market is. And in particular, with Nucor starting up their DRI facility in the late third quarter, I was wondering if you could talk about what impact that might have on the scrap market as well.

Russ?

Yes. Michelle, I think, again, I think they've got to go through the start-ups and, certainly, that will have some impact. But that, predominantly, I think will impact the pig iron and the other substitute markets. Currently, the pig iron markets are showing some strength, and the recent numbers that are being quoted for September-October delivery are actually up. So I think until those plants come online and start producing materials and it gets out in the marketplace, it's just too early to tell. Certainly, there's other factors that are going to impact scrap, where the strength of the euro versus the dollar is going to determine where the Turks buy, and that will have a big impact, particularly on our footprint. But, again, I think the mill utilization rate is going to be the key driver we've got for scrap.

So you think -- so you're saying that the DRI facility would not -- the sort of the DRI would not provide new capacity of [ph] or impact supply of pig or primes?

I think it really -- I think it will impact the supply of pig over time, it's just a matter of how long it takes for that to come get up and running. Certainly, that's the primary target that that's going to displace, at least first.

Can you give me some ideas...

I think, as we would imagine, Nucor's going to displace the [indiscernible].

[indiscernible], yes.

So wouldn't that depress pig iron prices?

It'll either depress it or make it unaffordable to bring in.

Okay. And so wouldn't that lower your raw material -- wouldn't that have a knock on effect on primes?

It will sure impact the [indiscernible]. Again, they will track -- they're all -- it's all talking about iron units in the end. It's whatever iron units -- what the cost of an cost iron unit is. So certainly, any impact is going to move it up or down, depending on what the availabilities are.

Does this depend on where the...

But I think, Michelle, your point, perhaps longer term, is right on point. Because we expect a sort of a softening environment. As iron ore starts to come up, obviously, there's interconnectivity between scrap and iron ore, and so that will bring it down. The -- we're going to have, hopefully, an economic recovery in America, which is going to generate a little bit more flow. And as Russ said, depending on where foreign exchange goes, it may -- in a world where the American economy should rebound before everyone else, one would expect that the dollar is going to strengthen and that's going to mitigate exports. So generally, I think longer term, we feel scrap is going to moderate.

By moderate, you mean decline?

Yes.

Yes.

Okay. On the -- as a result of declining iron ore prices?

A combination of things. It just won't be cheap [ph] iron ore, but it's a drop in the commodity prices, a -- the mitigation from export and slightly increased generation domestically as the -- our economy comes back.

Okay. Have you talked about the conversation out there about a potential Turkish rebar case?

You have to say more than that.

Okay. There's a conversation out there about a potential Turkish rebar case. Is it coming? And do you think there are damages? And could you win one? Was that good, Dick?

We're not a -- we aren't a big enough rebar producer to really worry about it, participate in it. I think the legal costs would surpass the earnings that we make on the little bit of rebar we sell, so we're not discussing it.

Our next question comes from the line of Timna Tanners with Bank of America Merrill Lynch.

Can you please remind us of the timing and, if possible, some of the piece of benefit for the start-up of the rail expansion and SBQ expansion? When we should expect benefit, and how much and when it will be fully on, if you can give us some of that timing detail?

Well, the SBQ construction, Dick and I were down there just 2 weeks ago, and it -- as I said earlier, it's going to schedule right now, to budget, and they anticipate commissioning November, December of this year. And so I think you will see ramp-up through 2014. Barry and the team are doing a good job. They're already pre-approving some customer products applications, so that hopefully will expedite the market penetration. And it's -- I wouldn't call it a pioneering effort in any way. It's standard technology. The guys are more than familiar with the mills, the patrols, the dryers and everything. So from an equipment start-up perspective, it should go very rapidly. So our expectation is a good ramp-up through 2014.

So annualized, full start up end of the year?

Sorry?

Oh, sorry, I'm just clarifying. Annualized, full start up by the end of the year then?

Well, I never say full start up by the end of the year. It's not like you turn the key on and it runs, so there's always a learning curve with new equipment. But we'll be, maybe, at the full rate by the end of the year. That could -- Barry and his team are very optimistic, yes.

Okay. And I'm sorry I interrupted. On the rail side?

That's okay. Head-hardened rail, again, construction is in progress, it's on budget, it's on schedule. Probably, we'll start seeing some product move through a bit sort of December or January. Is that right?

Yes, yes.

And so, again, ramp-up through 2014. So if you look at just the earnings catalyst for us, 2013 is a little bit of kind of an implementation year. And we have, I think, a lot of good things going on in 2014. We should see some material change in the losses at Mesabi. We're going to see the ramp of SBQ, the ramp-up at rail.

Timna, all I'd like to add about to the rail is that is a new process and a new product for SDI, and that definitely will not be as speedy of a ramp-up in production and in sales and so forth as the SBQ bars. I mean, we're very optimistic about it. We have full confidence in it, but it is new for us in that customers will always be a little more leery and they'll want to see a little bit more testing and so forth, and we've been supplying them with prototype testing. But it's always the proof's in the pudding of the last -- of the final product. So there will be some skepticism of it, and it'll have to be earned. So I just want to put a little cautionary note on that ramp-up.

Okay, that's super helpful. Then my second question was really about Mesabi. So I just was a little surprised, given that there won't be an outage until third quarter -- I don't think, unless I missed it. Why are you guiding to more of a flat to slightly improved quarter if you're going to be running better and have completed this outage?

Well, again, we are guiding to similar to a little better. Obviously, we like it to be a lot better, but it depends on the rate of improvement in yield performance and the consumption of materials, more than anything else.

Our next question comes from the line of Andrew O'Connor with BMO Asset Management.

Mark, overall, how would you compare and contrast the current domestic market environment with the cycles the company has been through since the crash in 2008 if you were to boil it down to just a few lines?

I would describe it with optimism, I guess. The general market, I think, has a lot of good things going for it. If you look at just the macro drivers out there compared to the crash in 2009, I guess, is where we're comparing it to, you got automotive, solidly strong, 16 million tons -- 16 million unit type rate. And our conversations with the automotive folks are suggesting that this can be sustained for some time to come. As I said earlier, residential -- and I guess, my greatest optimism comes from the rebound in residential this year that we just haven't seen in '09, '10, '11, or '12 for that matter. And that is, in my mind, the foundation for a sustainable sort of job space, sort of economic growth. And as I said earlier, it's beyond the macro market indices, where we're actually starting to see that in our order book. I think, they're seeing it somewhat in the sheet business and serves [ph] and auto, HVAC and radiator, dash, door panel material. Chris is seeing a little bit of a greater activity on the truest application side of things. So I think, in aggregate, any one data point wouldn't necessarily make me excited. But when you put them all together, I think things will -- the momentum is positive. And you couple that with the fact that the service center and supply-chain inventory is at an incredible low -- I don't know what it is, but it's the lowest it's been for several years. I think, and I said this before, but I think we're at a -- closer to an inflection point than a lot of people think. The industry utilization rate is about 79% with service center, inventory is down at 2.3 months. They are living or have been living off our short lead times. And as they start to stretch out, I think one will see a dramatic change, as we did in -- whenever it was, March, April time frame with 2011, when things got a little over kilter, they were short and we saw some great expansion of spreads.

Got you. That's helpful. And then secondly, what would be the priority for any free cash flow generation by the company in the second half of '13?

Well, we're continually looking at our opportunities. Obviously, I think we've done a pretty good job here recently, paying down a little bit of debt. We also increased our dividend incrementally earlier this year, to bring a little more value to our shareholders. But I think we are squarely focused on, first and foremost, leveraging our existing assets through organic expansion. You're seeing the implementation this year, the SBQ, the head-hardening, smaller but material, I think, the sheet correction line going out in up in Butler and a few other little projects. And I think Dick and the team have some other opportunities for next year. So squarely focused on really effective capital use of expansion. And then obviously, looking at potential opportunities, either around growing product or growing in other businesses.

Our next question comes from the line of Mark Parr with KeyBanc Capital Markets.

Mark and Theresa, I really appreciate all the color that you've given this morning. It's been really helpful. And actually, I think it is important to note, the utilization rates continue to creep up in the face of very low service center inventories. I mean, that could create some very interesting upside for the group, especially in light of the recent underperformance that we've seen in the stocks. But one thing, I'm just wondering if you could add and give a little more color on some of the cost reduction and productivity enhancements going on at OmniSource. This is something a couple years ago that I think you'd spent some time working on, and Russ has been very involved in that. Just like to get an update there if I could.

Russ?

Yes. We continue -- as we look at the available marketplace and the economic dynamics that are involved in -- across our spectrum, Mark, we continue to look at what the size of our business is versus the markets we serve. And certainly, we had an awful lot of areas where we were probably overstaffed. And I think in the last couple of years, 1.5 years or so, we made a concerted effort to rightsize our business to the markets that they serve. I think our team has done a successful job with it, to try to get those -- get that in balance. I think we're seeing the benefits of it. If you look at the year, last year versus this year, certainly, we are seeing that benefit, as we're more aligned with what our markets are. Again, our business is a trading business. It's a buy-sell business, so we've got to make sure we're keenly focused on it. And again, our team has done a tremendous job of focusing on those markets that make sense for us and, again, moving away from those that don't. Again, at the end of the day, we've got a certain amount of capital that's been invested in this, and we've got to make the return. I think the other thing is -- some of the other things we have done, we've continued to look at refining our downstream. We, this year, have got the benefit of 2 new automotive shredder residue plants, the ASR plants, one in Toledo and one in Indianapolis, that have come online very well. They've had -- they've got bumped up a little bit with a Green Fence in China. But again, our team continues to work on the resolution of that, and I think those things will pay us dividends very well as we further segment the material and recover the material that's actually going into landfills. So projects like that, where we're tweaking and tuning our business opportunities, have worked well for us. Mark mentioned the automotive rebound that has occurred in the last year, and some of that has had a benefit for us, as many of those customers are our customers, and we're buying material from -- or service to -- are coming out of the automotive, as well as many of the customers we sell products to. So again, we're kind of focused on the things that make sense for us, both short term and long term.

Russ, there were some -- if I could just ask a follow-up. Earlier, say, in the April-May time frame, there was some discussion that the auto carcass collectors were withholding material from the market, and just flows in general were a bit weaker than what people were looking for. Could you give an update on how scrap flows are unfolding here for the June-July time frame? Have they picked up from where they were later in the second quarter?

Mark, they have -- they've been steady. They're not robust, they're not overrunning us, but they've been steady. And -- so I think that's the best categorization for it. I think the inventory in the scrap yards, inventories in the mills -- mill scrap supplies, just like those service center inventories, are pretty thin. So I think you've got an almost direct pull from the consumers. So as the mill rates ramp up, I think you'll see more scrap coming out of the fields. But it has not been a concern, at least not in the last 60 days, of being able to get the flows in.

Okay. Are you seeing any material coming in from the East Coast, I mean, stuff that was originally headed for export markets and then reverting back to mills here in this country?

Oh, the answer to that question is yes, particularly when the Turks find Europe much more attractive. Again, they've got the ability to play the currency game between Europe and the U.S. And when the U.S. dollar gets strong, they're going to go to Europe. So we did see -- particularly early in the quarter, we did see a pretty significant impact of mill -- of product flowing back off the coasts.

All right. Do you see that continuing here in the third quarter?

Mark, I think we will see -- again, it's going to depend upon -- on those currencies and on their...

On the appetite.

Yes, the appetite. I think the Turks are certainly the driver in that game. There has been some discussion or some rumors of Europe trying to restrict their scrap exports. And if that happens, that certainly will change the game with the Turks in a different direction. But all that is all pure speculation.

Our next question comes from the line of Chris Haberlin with Davenport Securities. J. Christopher Haberlin - Davenport & Company, LLC, Research Division: You all have showed some nice growth off the bottom in Engineered Bar, and I just wanted to see kind of what your outlook is there. Can you maintain that trajectory? Or are you starting to see demand levels starting to flatten out?

We see it going up, continuing, and so we're comfortable with that direction. And there's no indication that it will, I mean, flatten out. Again, we started from a pretty low, low at the depths of the dropoff. But again, we are very comfortable with the direction, with the pace and with the expansion to help continue that.

And as Dick mentioned earlier, I find it a little exciting that the team down there is getting a lot of new interest with different products, different applications that are going through the approval process, parts that haven't necessarily been available to us before.

Just one general comment. I know Chris didn't ask it in this manner, but with Mark and I making our trip to many of the plants, the enthusiasm across the board at Steel of West Virginia and Roanoke, we're making new parts, Columbia City on the #2 mill. We are developing new parts, new products that -- all of these and the enthusiasm is -- we're not sitting around just waiting for a market to increase. It's not going back to where it was. We recognize the economy. It isn't going to be 2007 again. So we're out there beating the bushes, looking for new opportunities, who's doing what, what parts and sections are being imported, who should we be going after and so forth. So it's very enthusiastic, whether it be Engineered Bar, whether it be Steel of West Virginia. Roanoke is making new small merchant sections [ph] today and they're adding to their portfolios, steel at Columbia City, again, on the #2 mill. So hey, whether it be Engineered Bar or others, it -- we're very thrilled with the pace of product development. J. Christopher Haberlin - Davenport & Company, LLC, Research Division: So is it safe to say that your optimism is a function of both underlying improving demand trends, as well as expanding product -- expanded product offerings?

Most definitely. I mean...

Absolutely.

Most definitely.

And as you may have seen -- and again, Dick's point is absolutely on point. We've been challenging the teams to do just that, to use the creativity and the innovation that's driven our success in the past. And as a sort of an emphasis on that, you might say -- you may have seen John Nolan transition to a high-level product development position. Again, that is to try and identify for us what are the needs of our customers, what steels will the automotive guys need 3, 5 years from now. What can we do in tank? What can we do in appliance? Trying to penetrate new markets, partner with our customers to get into that value add and keep ahead of the rest of the industry. J. Christopher Haberlin - Davenport & Company, LLC, Research Division: And then, Mark, you mentioned elevated long product import levels during the second quarter. How has that impacted margins? And kind of what's your outlook for imports over the back half of the year?

I don't know. Relative to the rest of the year, it -- I think short term has picked up a little bit. And interesting enough, I think, if you looked at the service center shipments into June, structural was up, which -- again, if you think there's a little bit more import here, and service centers typically want a bit more, it tends to do -- solidify the thought that things are slowly incrementally improving. Where they're going to be going forward, I would hesitate to speculate. It shouldn't be any greater than where they are. No drivers for them to be greater.

And it's going to be very fluid. And as someone pointed -- asked earlier, there's going to be trade case discussion, and there's so many external forces that are going to be influencing the desire to buy, the timeliness of it, the exchange rate and so forth, that I don't know how you would speculate through the end of the year. J. Christopher Haberlin - Davenport & Company, LLC, Research Division: And then just last question for me. As you look out into 2014 with the SBQ expansion and the rail expansion kind of wrapping up here at the end of the year, how do you all think about CapEx just directionally looking into next year?

Well, I'll jump on that real quick. I've got a backlog of stuff I'd love to present, and I know there's limits. And so -- we were very creative on the steel side. I know Chris, and Russ also has theirs, and there's limits to everything. We're being very -- I think we're being very astute with what we're doing here. We have a plan. I think Mark is guiding us down that path. And so there's just lots of opportunities, and we're trying to pick and choose them. We're doing our maintenance where we need to. We focused very much this year on safety projects, quality projects. We haven't looked at a lot of expansion projects. We've done product expansions, but not necessarily capacity expansion, because we have capacities. We're trying to utilize the existing capacities that we have by bringing things to market, but I just want to have fun and throw that out.

Yes.

And I'll just add to that. We -- Dick is exactly right. We're laughing because usually it's a push-pull between you and I. But additionally, from a maintenance capital perspective, the company can run at anywhere between $75 million to $100 million a year. So when we decide that there's an opportunity to actually add bottom line benefits, then we start to go outside of that. And the hurdle rates that we do look at are internal rate of returns of at least 15% and return on assets of at least 20%. So the projects that everybody has, they understand where they have to get to from a hurdle perspective. Mark, I don't if you have anything to add.

No, I think that's well said.

Our next question comes from the line of Brian Yu with Citi.

Mark, it seems like at Mesabi Nugget, the team there is making good process -- progress, the needle is moving in the right direction. With the 30,000-ton run rate guidance you guys have given -- because that obviously -- it takes the facility to 75% capacity utilization. What -- how are you guys thinking about the next steps to get it closer to the nameplate and perhaps begin to get a return on capital from that investment?

Yes. The recent improvements -- well, again, the -- look, the confidence of getting to that 30,000 monthly run rate has been boosted here since April, and that has been with, again, some of the equipment enhancements we made and also some process changes. We have not yet implemented the oxygen enrichment. And again, part of the downtime was to put in different burners for oxygen enrichment on the rotary hearth furnace. We're waiting on the installation of the actual [indiscernible] oxygen plant, which is going in, I think, as we speak, and should be available to us. So the expectation is the utilization of the oxygen should increase the thermal efficiency of the furnace and give us some boost in productivity to get us from the sort of a 360,000-a-year run rate up to the 400,000, 425,000 that we have mentioned. I think we also mentioned that the original sort of capability of 450,000, 500,000 is going to be a long way out. So our target is, again, by the end of the year, kind of a 360,000 annualized rate and then get it up to the 400,000 to 425-ish, 450-ish, following that.

So the oxygen enrichment, that's helping you get to the 360,000 already? Or is that going to take you from the 360,000 to 400,000 to 425,000?

No, the expectation is that, that gets us beyond that 30,000-a-month rate.

Got it. And the second question I got is on the nonferrous recycling, where you guys had some margin squeeze in the quarter. Can you remind me, I thought you guys had hedged out your metal exposure historically, so that you're making that a constant spread on the product? Is that not correct?

We hedge out the marginal spread at that moment in time. But unfortunately, the spreads that we're hedging to are contracted.

You can't mix your margin, the same margin, indefinitely. The margin will move with the market. And so we're just not taking risks with either too much inventory supply or too many fixed contracts. So we're keeping a flat book, but that margin contracts and expands.

Okay. And the way it's reported, are there mark-to-market losses on those hedged positions that flow through this quarter? Or are they treated as operating cash flow hedges, though -- there's no mark-to-market?

No, there is a mark-to-market, that flows through the quarter. And if you look at the third page of our press release, we give it to you for each peak period. This quarter, we had an unrealized loss of $1.6 million, and that compares to a $700,000 gain in the first quarter.

Our next question comes from the line of John Tumazos with John Tumazos Very Independent Research.

My question, it concerns the Green Fence in China. Other than radioactive steel scrap, it would seem to me that the dirtiest grades of scrap in any metal are cleaner than virgin output. So the Green Fence isn't really green. Do you think that it's just a tactic by the Chinese to cause #2 or #3 grades of scrap in each metal to trade at bigger discounts so they can buy at cheaper prices? Or do you think they also have such a weak economy that they don't want the scrap or are trying to protect their aluminum smelters or their copper smelters or their -- from competing scrap supply? Clearly, scrap is green.

I can't believe you're being cynical, John, relative to the environmental wherewithal of China. Russ, do you want to tackle that?

Yes. John, I think the driving -- one of the driving factors was when the new Premier -- the leader of China went out for his opening ceremony, he couldn't see the crowd. But again, the Green Fence is actually -- what they're doing, it's not new regulations, they're actually just enforcing the regulations that are on the books. And what they're really trying to avoid is everybody exporting their trash into China. Certainly, I understand it. Certainly, as we work through, we've got the capability of cleaning it up. But the material that was traditionally exported to China, it certainly was the stuff that we couldn't find at home for without adding a lot of costs to in the U.S. So is there a bit of cynicism? It could be partly due to trying to regulate the flow. But I think as those LME warehouses draw down, they're going to have to open up again. And quite frankly, us included, the scrap industry is going to have to deal with the reality that you're going to have to provide a product that matches up to those specs or face the consequences. And we've been very, very diligent in getting to the point where we can do that on a consistent basis before we start going back in there in a big way. So we're working through that process. Others may or may not decide to take that chance. But again, it's just one of those things that's [indiscernible]...

Now during better times, the Chinese loved to have containers of electronics scrap so that they could have cheap labor dismantle it and get the copper, the precious metals, or whatever. So it would seem like something is different that they don't think it's economically to their benefit to do that anymore.

Well, they're trying to raise the metallic content of what they're buying. So again -- so they're not buying a bunch of trash, and I think that's part of the drive towards green in China, to rather limit some of the air pollution that they've got, that -- again, I was watching CBS News last night, and I saw they have an article, and it was -- you couldn't see the Imperial Palace hardly because it's just -- it's terrible. So I understand it was a part of the emphasis. But again, it's our duty as a supplier to react appropriately and provide the customer what he wants.

Just one final comment. I wanted to agree with Michelle. You should sue the Turks. And my father would have suggested much more.

Our next question comes from the line of Charles Bradford with Bradford Research.

Okay. A simple question. Do you have any idea how much of your hot-rolled ends up in oil countries, tubular goods? I understand the difficulties because the pipe mills can vary between making line pipe and OCTG pretty readily.

We're not really a strong pipe and tube supplier, Chuck. I can't give you the number, but it's not something we focus on because that tends to be the bottom in the market.

Yes, we don't -- we make x52, and we've dabbled in making stronger grades. But it's not something that we pursue very much, and so we don't focus on it. And so we don't have access to the river that we ship in down into the Houston market and the tubers. We had some tubing customers, but it's not a big market for us. So I could research it or something, but I don't have any kind of number or any kind of good guesstimate for you, Charles.

Well, if you don't know, then it probably isn't important?

It's definitely not. If that's an acceptable answer, that's my answer.

Probably as importantly, it's probably Pittsboro that we do greater [indiscernible]

[indiscernible]

Yes, it's Pittsboro.

Just seamless.

And energy products there, both the copper [ph] lines and line pipes and mechanical pipe and tubing for the energy industry. We do quite a bit there.

So maybe that's what the question should have been. How much of the Pittsboro output ends up in the energy market?

Off the top of my head I want to say it's something like 10%, but it could be as easily 15%. So...

I don't know. I can research it, Charles, and send you an e-mail. I'd be happy to. But again, it's fluid. It's been fluid. But I'll send you an e-mail.

Okay. And another area, there's been some talk around the industry about high-strength rebar. Have you seen any penetration of a market by this product? Or is this something you might be interested in?

There's conversation about it. We've had discussions with the people with the technology. We actually produced it as a -- on a tolling basis at Pittsboro years ago for them, and just got paid to produce it. So we're experienced with the product. And now I know -- and I know the individuals and so forth and the companies, and we've had discussions with them. So we continue to look at it. We continue to consider the changing marketplace, the different DOTs, the applications, both in construction and in highway. And so yes, we're aware of it, and we have an interest, but we haven't done anything with it.

Okay. I'm assuming that next year, when you're facing the large redemption potential or maturity on the convertible, which is, I guess, around $17.50 a share, something like that -- but because of your unused revolver, you can use that to pay it off if necessary. Or would you delay some CapEx to see just which way that goes? Because your stock could go up to $17.50 or above.

Yes. The strike price now, Chuck, is $17.21. And as I mentioned, given the strength of our cash flow generation, too -- because right now, we still have $244 million of cash on the balance sheet. And given the generation expectations for the rest of this year and with no meaningful maturities in the interim, I could see us easily paying that back with cash on hand and revolver. But obviously, when we look at all the capital projects Dick has got in his back pocket since November, that's something that we'll be mindful of as well. Because we're looking at always keeping an appropriate capital structure in line with our growth projects.

That concludes our question-and-answer session. I'd now like to turn the call back over to Mr. Millett for any final and closing remarks.

Well, just thanks, Christine. And thank you, everyone, for your continued loyal support of our company. And most importantly, to other constituents, our customers, we certainly appreciate your loyalty and support. And again, to our employees, thanks for the phenomenal job that you guys do. And from each and every one of us, just be safe out there. Have a great day. Bye-bye.

Once again, ladies and gentlemen, that concludes today's call. Thank you for your participation, and have a great day.