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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended February 29, 200428, 2005
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ________ to .
------- -------________.
Commission filesfile number 0-22496
SCHNITZER STEEL INDUSTRIES, INC.
--------------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
OREGON 93-0341923
- ------------------------------- ------------------------------------------------ ---------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3200 N.W. Yeon Ave.
P.O Box 10047
Portland, OR 97296-0047
- ------------------------------------------------------------------------------ ----------
(Address of principal executive offices) (Zip Code)
(503) 224-9900
----------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [_]
The Registrant had 21,098,38922,482,227 shares of Class A Common Stock, par value of $1.00
per share, and 8,965,0797,985,366 shares of Class B Common Stock, par value of $1.00 per
share, outstanding at April 1, 2004.2005.
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SCHNITZER STEEL INDUSTRIES, INC.
INDEX
-----
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets at February 29, 200428, 2005
and August 31, 2003................................... 32004......................................................3
Condensed Consolidated Statement of Operations for the Three
Months and Six Months Ended February 29, 200428, 2005 and February 28, 2003.................................... 429, 2004......4
Condensed Consolidated Statement of Shareholders' Equity for the
Year Ended August 31, 20032004 and the Six Months
Ended February 29, 2004.................................................... 528, 2005..................................................5
Condensed Consolidated Statement of Cash Flows for the
Six Months Ended February 29, 200428, 2005 and February 28, 2003.......................................................... 629, 2004.................6
Notes to Condensed Consolidated Financial Statements.......................... 7Statements.........................7
Management's Discussion and Analysis of
Financial Condition and Results of Operations........................................15Operations............................16
Quantitative and Qualitative Disclosures about Market Risk....................28Risk..................33
Controls and Procedures.......................................................29Procedures.....................................................33
PART II. OTHER INFORMATION
Legal Proceedings ..........................................................34
Submission of Matters to a Vote of Security Holders...........................30
Exhibits and Reports on Form 8-K..............................................31Holders.........................34
Exhibits....................................................................35
SIGNATURE PAGE................................................................32PAGE..............................................................36
2
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in(in thousands, except per share amounts)
(Unaudited)
Feb. 29,FEB. 28, 2005 AUG. 31, 2004
Aug. 31, 2003
------------- -------------
Assets
------------------ ------------
ASSETS
------
Current Assets:assets:
Cash and cash equivalents $ 13,19917,271 $ 1,68711,307
Accounts receivable, less allowance for
doubtful accounts of $843$798 and $712 34,653 38,428
Accounts receivable from related parties 44 555$772 65,001 43,444
Inventories (Note 2) 52,960 61,14391,018 80,167
Deferred income taxes 4,595 4,5245,383 5,383
Prepaid expenses and other 2,160 7,400
------------- -------------11,798 6,859
------------ ------------
Total current assets 107,611 113,737190,471 147,160
Net property, plant and equipment 142,509 141,224144,857 138,438
Other assets:
Investment in and advances to joint venture partnerships 133,993 119,066182,864 182,845
Notes receivable, less current portion 1,349 1,337
Goodwill 118,021 107,209151,026 131,178
Intangibles and other 9,097 6,658
------------- -------------5,545 5,015
------------ ------------
$ 511,231676,112 $ 487,894
============= =============
Liabilities and Shareholders' Equity605,973
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current portion of long-term debt $ 232148 $ 220225
Accounts payable 23,931 21,53732,534 31,881
Accrued payroll liabilities 8,709 8,89616,087 20,183
Current portion of environmental liabilities 10,600 4,6399,350 9,373
Accrued income taxes 511 4,954
Other accrued liabilities 7,369 6,004
------------- -------------8,642 7,450
------------ ------------
Total current liabilities 50,841 41,29667,272 74,066
Deferred income taxes 22,521 33,09324,884 24,884
Long-term debt, less current portion 82,919 87,04547,760 67,801
Environmental liabilities, net of current portion 10,301 17,13915,582 12,126
Other long-term liabilities 2,778 2,7042,399 2,295
Minority interests 4,107 3,6205,682 5,921
Commitments and contingencies -- --
Shareholders' equity:
Preferred stock--20,000 shares authorized, none issued -- --
Class A common stock-75,000stock--75,000 shares $1 par value authorized,
21,09822,425 and 12,44522,022 shares issued and outstanding 21,098 12,44522,425 22,022
Class B common stock--25,000 shares $1 par value authorized,
8,9657,998 and 7,0618,306 shares issued and outstanding 8,965 7,0617,998 8,306
Additional paid-in capital 108,752 104,249125,716 110,177
Retained earnings 198,949 179,242
------------- -------------356,263 278,374
Accumulated other comprehensive income:
Foreign currency translation adjustment 131 1
------------ ------------
Total shareholders' equity 337,764 302,997
------------- -------------512,533 418,880
------------ ------------
$ 511,231676,112 $ 487,894
============= =============605,973
============ ============
The accompanying notes are an integral part of this statement.THE ACCOMPANYING NOTES TO THE UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THIS STATEMENT.
3
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited, in thousands, except per share amounts)
For The Three Months Ended For The Six Months Ended
Feb.FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
------------------------------ ------------------------------
FEB. 28, 2005 FEB. 29, Feb.2004 FEB. 28, Feb.2005 FEB. 29, Feb. 28,
2004
2003 2004 2003
--------- --------- --------- ---------------------- ------------- ------------- -------------
Revenues $ 215,746 $ 161,603 $ 124,659414,707 $ 289,979
$ 215,326
Cost and expenses:Operating Expenses:
Cost of goods sold and other operating expenses154,523 135,631 106,156293,478 242,329
182,949
Impairment and other non-recurring charges -- 2,100 -- 2,100
Selling and commission expenses1,392 1,106 1,2573,099 2,384 2,442
General and administrative expenses12,016 9,333 8,04322,675 17,565
15,147
--------- --------- --------- ---------Environmental matter 7,725 -- 8,225 --
------------- ------------- ------------- -------------
Income from consolidatedwholly-owned operations 40,090 15,533 7,10387,230 27,701
12,688
IncomeOperating income from joint ventures 16,205 8,684 6,19436,669 14,621
9,369
--------- --------- --------- ---------
Income from operations------------- ------------- ------------- -------------
Operating income 56,295 24,217 13,297123,899 42,322 22,057
Other income (expense):
Interest expense (346) (486) (310)(630) (926) (690)
Other income (expense), net 86 (50) (27)(360) 154
(216)
--------- --------- --------- ---------------------- ------------- ------------- -------------
(260) (536) (337)(990) (772)
(906)------------- ------------- ------------- -------------
Income before cumulative effect of change in accounting
principle, income taxes and minority interests and
pre-acquisition interests56,035 23,681 12,960122,909 41,550 21,151
Income tax provision (19,500) (4,582) (3,502)(42,772) (9,764)
(5,517)
--------- --------- --------- ---------------------- ------------- ------------- -------------
Income before cumulative effect of change in accounting
principle, minority interests and pre-acquisition
interests36,535 19,099 9,45880,137 31,786 15,634
Minority interests, net of tax (554) (550) (354)(1,220) (1,060)
(801)
Pre-acquisition interests, net of tax -- (695) -- (2,547)
--------- --------- --------- ---------
Income before cumulative effect of change in accounting
principle 18,549 8,409 30,726 12,286
Cumulative effect of change in accounting principle -- -- -- (983)
--------- --------- --------- ---------------------- ------------- ------------- -------------
Net income $ 35,981 $ 18,549 $ 8,40978,917 $ 30,726
$ 11,303
========= ========= ========= ====================== ============= ============= =============
Net income per share - basic: Income before cumulative effect of change in
accounting principle$ 1.18 $ 0.62 $ 0.302.60 $ 1.03
$ 0.45
Cumulative effect of change in accounting principle -- -- -- (0.04)
--------- --------- --------- ---------
Net Income $ 0.62 $ 0.30 $ 1.03 $ 0.41
========= ========= ========= ====================== ============= ============= =============
Net income per share - diluted: Income before cumulative effect of change
in accounting principle$ 1.15 $ 0.60 $ 0.302.53 $ 0.99
$ 0.44
Cumulative effect of change in accounting principle -- -- -- (0.04)
--------- --------- --------- ---------
Net Income $ 0.60 $ 0.30 $ 0.99 $ 0.40
========= ========= ========= ====================== ============= ============= =============
The accompanying notes are an integral part of this statement.THE ACCOMPANYING NOTES TO THE UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THIS STATEMENT.
4
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands)
(unaudited)
ClassCLASS A ClassCLASS B Common Stock Common Stock Additional
--------------------------------------- Paid-in Retained
Shares Amount Shares Amount Capital Earnings Total
-------ACCUMULATED
COMMON STOCK COMMON STOCK ADDITIONAL OTHER
------------------- ------------------- PAID-IN RETAINED COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS INCOME TOTAL
-------- -------- -------- -------- --------- ------- --------- ---------- ---------- ------------------ -------- -----------
Balance at August 31, 2002 5,0252003 12,445 $ 5,025 4,18012,445 7,061 $ 4,1807,061 $ 96,074104,249 $179,242 $ 147,669-- $ 252,948302,997
Net income 111,181 111,181
Foreign currency translation
adjustment 1 1
-----------
111,182
Class B common stock converted
to Class A common stock 635 635 (635) (635)1,743 1,743 (1,743) (1,743) --
Class A common stock issued 547 547 8,175 8,722
Net income 43,201 43,201802 802 5,928 6,730
Stock dividend 6,238 6,238 3,516 3,516 (9,754)7,032 7,032 2,988 2,988 (10,020) --
Cash dividends paid - common
($0.100.068 per share) (1,874) (1,874)
-------(2,029) (2,029)
-------- -------- -------- -------- --------- ------- --------- ---------- ------------------ -------- -----------
Balance at August 31, 2003 12,445 12,445 7,061 7,061 104,249 179,242 302,9972004 22,022 22,022 8,306 8,306 110,177 278,374 1 418,880
Net income 78,917 78,917
Foreign currency translation
adjustment 130 130
-----------
79,047
Class B common stock converted
to Class A common stock 1,083 1,083 (1,083) (1,083)308 308 (308) (308) --
Class A common stock issued 538 538 4,503 5,041
Net income 30,726 30,726
Stock dividend 7,032 7,032 2,987 2,987 (10,019) --95 95 1,163 1,258
Tax benefits from employee
stock option plan 14,376 14,376
Cash dividends paid - common
($0.030.034 per share) (1,000) (1,000)
-------(1,028) (1,028)
-------- -------- -------- -------- --------- ------- --------- ---------- ---------- ------------------ -------- -----------
Balance at February 29, 2004 21,09828, 2005 22,425 $ 21,098 8,96522,425 7,998 $ 8,9657,998 $ 108,752125,716 $356,263 $ 198,949131 $ 337,764
=======512,533
======== ======== ======== ======== ========= ======= ========= ========== ========== ================== ======== ===========
The accompanying notes are an integral part of this statement.THE ACCOMPANYING NOTES TO THE UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THIS STATEMENT.
5
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
For The Six Months Ended
------------------------
Feb.FOR THE SIX MONTHS ENDED
--------------------------------------
FEBRUARY 28, 2005 FEBRUARY 29, Feb. 28,
2004
2003
---------- --------------------------- -----------------
Operations:
Net income $ 30,72678,917 $ 11,30330,726
Noncash items included in income:
Cumulative effect of change in accounting principle -- 983
Depreciation and amortization 10,143 10,057
9,918
Minority and pre-acquisition interests 1,874 1,387 4,524
Equity in income of joint ventures (36,669) (14,621) (9,369)
Deferred income tax -- (10,643)
(34)Tax benefit from employee stock option plan 14,376 --
(Gain) Lossloss on disposal of assets 183 (196) 18
Cash provided (used) by changes in working capital:
Accounts receivable (21,557) 4,286
(1,496)
Inventories (10,851) 8,183 (7,142)
Prepaid expenses and other (4,939) 5,240 (1,666)
Accounts payable 653 2,394 2,821
Accrued liabilities (7,347) 915 (67)
Environmental liabilities 633 (877) 1,414
Other assets and liabilities 252 (436)
1,240
---------- --------------------------- -----------------
Net cash provided by operations 25,668 36,415
12,447
---------- --------------------------- -----------------
Investing:
Capital expenditures (15,221) (10,941) (10,121)
Investment in subsidiaries (22,176) (13,083) (64,923)
Cash received from joint ventures 40,050 363 233
Cash paid to joint ventures (851) (745) (945)
Proceeds from sale of assets 495 476
577
---------- --------------------------- -----------------
Net cash usedprovided (used) by investments 2,297 (23,930)
(75,179)
---------- --------------------------- -----------------
Financing:
Issuance of Class A common stock 1,258 5,041 46
Distributions to minority and pre-acquisition interests (2,113) (900) (3,620)
Dividends declared and paid (1,028) (1,000) (921)
Decrease in long-term debt (20,118) (4,114)
37,848
---------- --------------------------- -----------------
Net cash provided (used)used by financing (22,001) (973)
33,353
---------- --------------------------- -----------------
Net increase (decrease) in cash and cash equivalents 5,964 11,512
(29,379)
Cash and cash equivalents at beginning of period 11,307 1,687
32,974
---------- --------------------------- -----------------
Cash and cash equivalents at end of period $ 17,271 $ 13,199
$ 3,595
========== =========================== =================
The accompanying notes are an integral part of this statement.THE ACCOMPANYING NOTES TO THE UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THIS STATEMENT.
6
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIXTHREE MONTHS ENDED FEBRUARY 29, 200428, 2005 AND FEBRUARY 28, 200329, 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
- ---------------------
The accompanying unaudited condensed interim financial statements of Schnitzer
Steel Industries, Inc. (the Company) have been prepared pursuant to the rules
and regulations of the Securities and Exchange Commission (SEC). Certain
information and note disclosures normally included in annual financial
statements have been condensed or omitted pursuant to those rules and
regulations. The condensed unaudited balance sheet for the year ended August 31,
2003 is derived from the audited balance sheet for the year ended August 31,
2003. In the opinion of management, all adjustments, consisting only of
normal, recurring adjustments considered necessary for a fair presentation, have
been included. Although management believes that the disclosures made are
adequate to ensure that the information presented is not misleading, management
suggests that these financial statements be read in conjunction with the
financial statements and notes thereto included in the Company's annual report
for the fiscal year ended August 31, 2003.2004. The results for the three and six
months ended February 29, 200428, 2005 and February 28, 200329, 2004 are not necessarily
indicative of the results of operations for the entire year.
Note 3 of the Notes to the Condensed Consolidated Financial Statements describes
an acquisition that occurred on February 14, 2003. Under Statement of Financial
Accounting Standards No. 141 ("SFAS 141"), "Business Combinations," the
acquisition is considered a "step" acquisition due to the fact that the Company
had a significant joint venture interest in the acquired business for a number
of years. Additionally, since the acquisition occurred during the year, the
Company elected to include it in the consolidated results as though it had
occurred at the beginning of fiscal 2003. Thus, the 2003 statement of
operations, balance sheet and statement of cash flows have been adjusted to
consolidate the acquisition as of September 1, 2002. For the period from
September 1, 2002 through February 14, 2003, net income was reduced by $2.5
million of pre-acquisition interests, net of income taxes, representing the
share of income attributable to the former joint venture partner prior to the
acquisition.
Note 7 of the Notes to the Condensed Consolidated Financial Statements describes
the stock split which was effective March 25, 2004 and is retroactively applied
to the period ended February 29, 2004.
RECLASSIFICATIONS
- -----------------
Certain prior year amounts have been reclassified to conform to the fiscal 2004current year
presentation. These changes had no impact on previously reported results of
operations or shareholders'shareholder's equity.
CASH AND CASH EQUIVALENTS
- -------------------------
Cash and cash equivalents include short-term securities that have an original
maturity date of 90 days or less.
EARNINGS AND DIVIDENDS PER SHARE
- --------------------------------
Basic earnings per share (EPS) are computed based upon the weighted average
number of common shares outstanding during the period. Diluted EPS reflects the
potential dilution that would occur if securities or other contracts to issue
common stock were exercised or converted into common stock.
7
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
The following represents reconciliation from basic EPS to diluted EPS (in
thousands, except per share amounts):
For the Three Months Ended For the Six Months Ended
----------------------------- -----------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
Income before cumulative effect of change in
accounting principle $ 18,549 $ 8,409 $ 30,726 $ 12,286
Cumulative effect of change in accounting
principle -- -- -- (983)
------------ ------------ ------------ ------------
Net income $ 18,549 $ 8,409 $ 30,726 $ 11,303
============ ============ ============ ============
Computation of shares (1):
Average common shares outstanding 30,021 27,618 29,800 27,615
Stock options 1,083 741 1,245 594
------------ ------------ ------------ ------------
Diluted average common shares outstanding 31,104 28,359 31,045 28,209
============ ============ ============ ============
Basic EPS:
Income before cumulative effect of change
in accounting principle $ 0.62 $ 0.30 $ 1.03 $ 0.45
Cumulative effect of change in accounting
principle -- -- -- (0.04)
------------ ------------ ------------ ------------
Net income $ 0.62 $ 0.30 $ 1.03 $ 0.41
============ ============ ============ ============
Diluted EPS:
Income before cumulative effect of change
in accounting principle $ 0.60 $ 0.30 $ 0.99 $ 0.44
Cumulative effect of change in accounting
principle -- -- -- (0.04)
------------ ------------ ------------ ------------
Net income $ 0.60 $ 0.30 $ 0.99 $ 0.40
============ ============ ============ ============
Dividend per share(1) $ 0.017 $ 0.017 $ 0.033 $ 0.033
============ ============ ============ ============
For the Three For the Six
Months Ended Months Ended
--------------------- ---------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
--------- --------- --------- ---------
(Unaudited)
Net income $ 35,981 $ 18,549 $ 78,917 $ 30,726
========= ========= ========= =========
Computation of shares (1):
Average common shares outstanding 30,422 30,021 30,386 29,800
Stock options 773 1,083 784 1,245
--------- --------- --------- ---------
Diluted average common
shares outstanding 31,195 31,104 31,170 31,045
========= ========= ========= =========
Basic net income per share $ 1.18 $ 0.62 $ 2.60 $ 1.03
========= ========= ========= =========
Diluted net income per share $ 1.15 $ 0.60 $ 2.53 $ 0.99
========= ========= ========= =========
Dividend per share(1) $ 0.017 $ 0.017 $ 0.034 $ 0.033
========= ========= ========= =========
(1) Basic and diluted earnings per share and dividends per common share for the
three and six months ended February 28, 2003,29, 2004, have been adjusted to reflect
the one-for-one shareone-for-two stock dividend paid on August 14, 2003, to shareholders of
record on July 24, 2003. Additionally, the per share data for all periods
have been adjusted retroactively to reflect the three-for-two stock split
paid March 25, 2004, to shareholders of record on March 4, 2004.
Options to purchase 1,305,000 shares were outstanding at February7
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2003, but
are not included in the computation of diluted earnings per share because the
options' exercise prices were greater than the average market price of the
common shares and, therefore, the effect would be anti-dilutive. All of the
options for fiscal2005 AND FEBRUARY 29, 2004 are considered to be dilutive and are reflected in the
above table.
STOCK INCENTIVE PLAN
- --------------------
The Company's compensation expense for its stock incentive plans is determined
using the intrinsic value method. Accordingly, because the exercise price generally equals
the market price on the date of the grant, no compensation expense is recognized
by the Company for stock options issued to employees
consultants and directors. If the fair
value based method had been applied in measuring stock compensation expense, the
pro forma effect on net income per share would have been as follows (in
thousands, except earnings per share):
8
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARYFor the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 AND FEBRUARY 28, 2003
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
Reported net income $ 18,549 $ 8,409 $ 30,726 $ 11,303
Stock compensation expense, net of tax (266) (151) (266) (295)
------------ ------------ ------------ ------------
Pro forma net income $ 18,283 $ 8,258 $ 30,460 $ 11,008
============ ============ ============ ============
Reported basic income per share $ 0.62 $ 0.30 $ 1.03 $ 0.41
Pro forma basic income per share $ 0.61 $ 0.30 $ 1.02 $ 0.40
Reported diluted income per share $ 0.60 $ 0.30 $ 0.99 $ 0.40
Pro forma diluted income per share $ 0.59 $ 0.29 $ 0.98 $ 0.39
2005 2004
-------- -------- -------- --------
(Unaudited)
Reported net income $ 35,981 $ 18,549 $ 78,917 $ 30,726
Add: Stock based compensation
expense included in reported net
income, net of tax 224 -- 449 --
Deduct: Total stock based
employee compensation expense
under fair value based method
for all awards, net of tax (214) (266) (401) (266)
-------- -------- -------- --------
Pro forma net income $ 35,991 $ 18,283 $ 78,965 $ 30,460
======== ======== ======== ========
Reported basic income per share $1.18 $0.62 $2.60 $1.03
Pro forma basic income per share $1.18 $0.61 $2.60 $1.02
Reported diluted income per share $1.15 $0.60 $2.53 $0.99
Pro forma diluted net income per share for the quarter ended February 28, 2003
is computed excluding potential common shares of 1,305,000, as their effect is
anti-dilutive.$1.15 $0.59 $2.53 $0.98
All of the options issued and outstanding for the periods in fiscal 2005 and
fiscal 2004 are considered to be dilutive and are reflected in the above table.table above.
The Company obtains an income tax benefit related to stock issued to employees
through stock options plans, which is recorded as additional paid-in capital
and, therefore, does not benefit the income tax provision. For income tax
purposes the Company can deduct the amount an employee would report as ordinary
income. The deduction is allowed in the year the employee exercises the stock
option and the tax benefit is recorded at the time the Company includes the
deduction in the Company's tax return. In the second fiscal quarter of 2005, the
Company recorded a tax benefit from employee stock option plans of $14.4
million.
On December 16, 2004 the FASB finalized SFAS No. 123R "Shared-Based Payment"
which will be effective for interim or annual reporting periods beginning after
June 15, 2005. The new standard will require the Company to expense stock
options. The Company has begun the process to analyze how the utilization of a
binomial lattice model could impact the valuation of the options. The effect of
expensing stock options on our financial results using the Black-Scholes model
is presented in the table above.
GOODWILL AND INTANGIBLE ASSETS
- ------------------------------
The changes in the carrying amount of goodwill for the six months ended February
29, 2004,28, 2005, are as follows (in thousands):
Metals Steel
Recycling Manufacturing Auto Parts
Business Business Business Total
------------ ------------ ------------ ------------
Balance as of August 31, 2003, audited $ 34,771 -- $ 72,438 $ 107,209
Acquisition (Note 3) -- -- 10,812 10,812
------------ ------------ ------------ ------------Metals
Recycling Auto Parts
Business Business Total
--------- --------- ---------
Balance as of August 31, 2004 $ 34,771 $ 96,407 $ 131,178
Auto Parts Business Acquisition
(see Note 3) -- 19,848 19,848
--------- --------- ---------
Balance as of February 28, 2005 $ 34,771 $116,255 $ 151,026
========= ========= =========
8
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004 unaudited $ 34,771 $ -- $ 83,250 $ 118,021
============ ============ ============ ============
The Company performs impairmentsimpairment tests annually and whenever events and
circumstances indicate that the value of goodwill and other indefinite-lived
intangible assets might be impaired. As of February 29, 2004, based onDue to the operating results of each of the
businesses identified above business segments and based upon the Company's impairment tests performed,testing
completed in the second quarter of fiscal 2005, the Company determined that none
of the above balances were considered impaired.
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
In December 2003, the Financial Accounting Standards Board ("FASB") revised SFAS
No. 132, "Employers' Disclosures about Pensions and Other Post Retirement
Benefits." This revision requires additional disclosures to those in the
original SFAS No. 132 about assets, obligations, cash flows and the periodic
benefit cost of deferred benefit pension plans and other deferred benefit
post-retirement plans. The required information should be provided separately
for pension plans and for other post-retirement benefit plans. This statement
revision is effective for the fiscal years ended after December 14, 2003 and
interim periods beginning after December 15, 2003. The interim disclosure
requirements are effective for the Company's third fiscal quarter ending May 31,
2004. Additionally, it is anticipated that this revised pronouncement will not
have a material impact on the consolidated financial statements.
9
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
NOTE 2 - INVENTORIES:
Inventories consisted of the following (in thousands):
February 29,28, August 31,
2005 2004
2003
------------ ------------
(Unaudited) (Audited)----------- ---------
Recycled metals $ 16,39431,739 $ 21,11534,551
Work in process 5,830 8,2544,538 10,045
Finished goods 18,192 19,91241,995 23,808
Supplies 12,544 11,862
------------ ------------12,746 11,763
--------- --------
$ 52,96091,018 $ 61,143
============ ============80,167
========= =========
NOTE 3 - BUSINESS COMBINATIONS:ACQUISITIONS
On February 14, 2003, the Company's wholly owned subsidiary, Norprop, Inc.
("Norprop") closed its acquisition (the "Acquisition") of all of the stock of
Pick and Pull Auto Dismantling, Inc., which was the Company's 50% partner inJanuary 10, 2005, Pick-N-Pull Auto Dismantlers, a California general partnership (the "Joint
Venture") and allwholly-owned subsidiary of
the membership interestsCompany, acquired the assets and leased the sites for four self-service used
auto parts stores in Pick-N-Pull Auto Dismantlers,
Stockton,St. Louis and Kansas City, Missouri; Columbus, Ohio; and
Virginia Beach, Virginia from Vehicle Recycling Solutions, LLC and certain of
its wholly-owned subsidiaries ("Stockton"VRS"). The total acquisition cost of the Acquisition$22.1
million consisted of $71.4a cash purchase price of $18.8 million, of cash paid to the seller at closing, $3.3 million of debt assumed and
immediately paid off, $0.6$0.5 million of
acquisition costsexpenses and $0.5 million of tax
related expenses. In addition, Norprop assumed approximately $12.5 million of
debt owed by the Joint Venture to the Company. Two additional payments have been
made during fiscal 2004. The first payment of $4.7 million was made during the
fiscal quarter ended November 30, 2003,environmental reserves recorded as a result
of due diligence of $2.8 million. The St. Louis, Kansas City and Columbus stores
increase the Company's existing mid-west store base. The Virginia Beach store
provides Pick-N-Pull with an amendmenteastern presence giving it the ability to expand
along the Purchase Agreement.East Coast. The secondfour new stores will be operated under the Pick-N-Pull
name and final payment of $7.1 million was made during
the fiscal quarter ended February 29, 2004, and relates to a purchase price
adjustment one year after closing based upon calendar year 2002 and 2003
earnings before interest, taxes, depreciation and amortization (EBITDA) of the
acquired Auto Parts Business. The total purchase price was $100.1 million (or
$96.5 million net of the seller's $3.6 million share of the Joint Venture's cash
on hand at closing). The Joint Venture stores together with the Stockton store
are one of the country's leading self-service used auto parts network. At the
time of this acquisition, there were 23 store locations, 17 in northern
California, two in Nevada, and one in each of Texas, Utah, Illinois and Indiana.
The Company has since expanded its operations into Canada, with the purchase of
three stores in an unrelated transaction which is described in Note 7 -
Subsequent Events in the Notes to the Condensed Consolidated Financial
Statements. This additional purchase bringsincrease the total number of stores to 26.30 for the Company's Auto Parts
Business segment. The following is a summaryresults of operations for these four stores after the
acquisition date are reflected in the consolidated results of the Company's Auto
Parts Business for the second fiscal 2005 quarter.
NOTE 4 - ENVIRONMENTAL LIABILITIES
The Company considers various factors when estimating its environmental
liabilities. Adjustments to the liabilities are made when additional information
becomes available that affects the estimated fair valuescosts to remediate. The factors,
which the Company considers in its recognition and measurement of environmental
liabilities, include the following:
o Current regulations both at the time the reserve is established and
during the course of the assets acquiredclean-up which specify standards for
acceptable remediation;
o Information about the site, which becomes available as the site is
studied and liabilities assumed asremediated;
o The professional judgment of both senior-level internal staff and
external consultants who take into account similar, recent instances
of environmental remediation issues, among other considerations;
o Technologies available that can be used for remediation; and
o The number and financial condition of other potentially responsible
parties and the extent of their responsibility for the remediation.
9
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
PORTLAND HARBOR
In December 2000, the United States Environmental Protection Agency (EPA) named
the Portland Harbor, a 5.5 mile stretch of the date of the acquisition (in millions):
Property, plant and equipment $ 13.3
Identified intangible assets 3.7
Other assets 5.4
Liabilities (3.8)
Goodwill 81.5
------------
Total $ 100.1
============
Goodwill of $81.5 million represents the excess of purchase price over the fair
value of the net tangible and identified intangible assets acquired, and,Willamette River in Portland,
Oregon, as a result ofSuperfund site. The Company's metals recycling and deep water
terminal facility in Portland, Oregon is located adjacent to the Portland
Harbor. Crawford Street Corporation, a tax election filed jointly byCompany subsidiary, also owns property
adjacent to the Portland Harbor. The EPA has identified 69 potentially
responsible parties (PRPs), including the Company and seller, substantially
allCrawford Street
Corporation, which own or operate sites adjacent to the Portland Harbor
Superfund site. The Company leases the metals recycling and deep water terminal
facility from Schnitzer Investment Corp. (SIC), a related party, and is
obligated under its lease with SIC to bear the costs relating to the
investigation and remediation of itthe property. The precise nature and extent of
any clean-up of the Portland Harbor, the parties to be involved, and the process
to be followed for such a clean-up have not yet been determined. It is unclear
whether or to what extent the Company or Crawford Street Corporation will be
deductibleliable for tax purposes over a 15-year period. Also,
approximately $1.8 million of goodwill existed onenvironmental costs or damages associated with the Joint Venture's balance
sheet priorSuperfund site. It
is also unclear whether natural resource damage claims or third party
contribution or damages claims will be asserted against the Company. While the
Company and Crawford Street Corporation participated in certain preliminary
Portland Harbor study efforts, they are not parties to the Acquisition but was not shown separately in accordanceconsent order entered
into by the EPA with other PRPs (Lower Willamette Group) for a Remedial
Investigation/Feasibility Study; however, the Company could become liable for a
share of the costs of this study at a later stage of the proceedings.
Separately, the Oregon Department of Environmental Quality (DEQ) has requested
operating history and other information from numerous persons and entities which
own or conduct operations on properties adjacent to or upland from the Portland
Harbor, including the Company and Crawford Street Corporation. The DEQ
investigations at the Company and Crawford Street sites are focused on
controlling any current releases of contaminants into the Willamette River. The
Company has agreed to a voluntary Remedial Investigation/Source Control effort
with the equity methodDEQ regarding its Portland, Oregon deep water terminal facility and the
site owned by Crawford Street Corporation. DEQ identified these sites as
potential sources of accounting. Therefore,contaminants that could be released into the total increaseWillamette
River. The Company believes that improvements in the operations at these sites,
often referred to goodwillas Best Management Practices (BMPs), will be sufficient to
effectively provide source control and avoid the release of contaminants from
these sites, and has proposed to DEQ the implementation of BMPs as the
resolution of this investigation.
While the cost of the investigations associated with these properties and the
cost of employment of source control BMPs are not expected to be material at
February 28, 2005, $0.3 million has been accrued for studies related to the
Acquisitionpending Portland Harbor Superfund site. No estimate is currently possible and
none has been made as to the cost of remediation for the Portland Harbor or the
Company's adjacent properties.
MANUFACTURING MANAGEMENT, INC.
In 1994, Manufacturing Management, Inc. (MMI) recorded a reserve for the
estimated cost to cure certain environmental liabilities. This reserve was
$83.3carried over to the Company's financial statements when MMI was acquired in
1995. The reserve is evaluated quarterly according to Company policy. On
February 28, 2005, the reserve aggregated $13.1 million.
In accordanceGeneral Metals of Tacoma (GMT), a subsidiary of MMI, owns and operates a metals
recycling facility located in the State of Washington on the Hylebos Waterway, a
part of Commencement Bay, which is the subject of an ongoing remediation project
by the United States Environmental Protection Agency (EPA) under the
Comprehensive Environmental Response, Compensation and Liability Act (CERCLA).
GMT and more than 60 other parties were named potentially responsible parties
(PRPs) for the investigation and clean-up of contaminated sediment along the
Hylebos Waterway. On March 25, 2002, EPA issued Unilateral Administrative Orders
(UAOs) to GMT and another party (Other Party) to proceed with StatementRemedial Design
and Remedial Action (RD/RA) for the head of Financial Accounting Standards No. 142,the Hylebos and to two other parties
to proceed with the RD/RA for the balance of the waterway. The issuance of the
UAOs did not require the Company to change its previously recorded estimate of
environmental liabilities for this site. The UAO for the head of the Hylebos
Waterway was converted to a voluntary consent
10
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIXTHREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
decree in 2004, pursuant to which GMT and the Other Party agreed to remediate
the head of the Hylebos Waterway.
There are two phases to the remediation of the head of the Hylebos Waterway. The
first phase was the intertidal and bank remediation, which was conducted in 2003
and early 2004. The second phase is dredging in the head of Hylebos Waterway,
which began on July 15, 2004. During the first half of fiscal 2005, the Company
incurred remediation costs of $10.2 million related to Hylebos dredging which
were charged to the environmental reserve. The Company's cost estimates were
based on the assumption that dredge removal of contaminated sediments would be
accomplished within one dredge season during July 2004 - February 2005. However,
due to a variety of factors, including equipment failures, dredge contractor
operational issues and other dredge related delays, the dredging was not
completed during the first dredge season. As a result, the Company recorded
environmental charges of $8.2 million in the first half of fiscal 2005 primarily
to account for additional estimated costs to complete this work during a second
dredging season. The Company and the Other Party have asserted a claim for
relief from the dredge contractor for a significant portion of the increased
costs, and are currently engaged in mediation of this dispute. However,
generally accepted accounting principles do not allow the Company to recognize
the benefits of any such relief until receipt is highly probable.
GMT and the Other Party are pursuing settlement negotiations and legal actions
against other non-settling, non-performing PRPs to recover additional amounts
that may be applied against the head of the Hylebos remediation costs.
Uncertainties continue to exist regarding the total cost to remediate this site
as well as the Company's share of those costs; nevertheless, the Company's
estimate of its liabilities related to this site is based on information
currently available.
The Natural Resource Damage Trustees (Trustees) for Commencement Bay have
asserted claims against GMT and other PRPs within the Hylebos Waterway area for
alleged damage to natural resources. In March 2002, the Trustees delivered a
draft settlement proposal to GMT and others in which the Trustees suggested a
methodology for resolving the dispute, but did not indicate any proposed damages
or cost amounts. In June 2002, GMT responded to the Trustees' draft settlement
proposal with various corrections and other comments, as did twenty other
participants. It is unknown at this time whether, or to what extent, GMT will be
liable for natural resource damages. The Company's previously recorded
environmental liabilities include an estimate of the Company's potential
liability for these claims.
The Washington State Department of Ecology named GMT, along with a number of
other parties, as Potentially Liable Parties (PLPs) for a site referred to as
Tacoma Metals. GMT operated on this site under a lease prior to 1982. The
property owner and current operator have taken the lead role in performing a
Remedial Investigation and Feasibility Study (RI/FS) for the site. The RI/FS is
now completed and the parties are currently involved in a mediation settlement
process to address cost allocations. The Company's previously recorded
environmental liabilities include an estimate of the Company's potential
liability at this site.
MMI is also a named PRP at another third-party site at which it allegedly
disposed of automobile shredder residue (ASR). The site has not yet been subject
to significant remedial investigation. MMI has been named as a PRP at several
other sites for which it has agreed to de minimis settlements. In addition to
the matters discussed above, the Company's environmental reserve includes
amounts for potential future cleanup of other sites at which MMI has conducted
business or has allegedly disposed of other materials.
11
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
PROLER AND JOINT VENTURES
In 1996, prior to the Company's acquisition of Proler International Corp.
(Proler), Proler recorded a liability for the probable costs to remediate its
wholly-owned properties. This reserve was carried over to the Company's
financial statements upon acquiring Proler in 1996. The reserve is evaluated
quarterly according to Company policy. On February 28, 2005, the reserve
aggregated $3.4 million.
As part of the Proler acquisition, the Company became a 50% owner of Hugo
Neu-Proler Company (HNP). HNP has agreed, as part of its 1996 lease renewal with
the Port of Los Angeles (POLA), to conduct a multi-year, phased remedial
clean-up project involving certain environmental conditions on its metals
recycling facility at its Terminal Island site in Los Angeles, California, which
was completed in 2002. HNP is waiting for final certification from POLA and the
regulatory agencies overseeing the cleanup. Remediation included excavation and
off-site disposal of contaminated soils, paving and groundwater monitoring.
Other environmentally protective actions included installation of a stormwater
management system and construction of a noise barrier and perimeter wall around
a substantial portion of the facility.
Additionally, other Proler joint venture sites with potential environmental
clean-up issues have been identified. Estimated clean-up costs associated with
these sites have been accrued for by the joint ventures.
During the second quarter of fiscal 2005, in connection with the negotiation of
a possible transaction for the split-up of the Company's metals recycling joint
ventures with Hugo Neu Corporation, the Company conducted an environmental due
diligence investigation of certain joint venture businesses it proposes to
directly acquire. As a result of this investigation, the Company identified
certain environmental risks and accrued $2.6 million for its share of the
estimated costs to remediate these risks.
AUTO PARTS BUSINESS
Since 2003, "Goodwillthe Company has completed three acquisitions of businesses in the
Auto Parts Business segment. At the time of each acquisition, the Company
conducts an environmental due diligence investigation related to locations
involved in the acquisition. As a result of the environmental due diligence
investigations, the Company has accrued $4.9 million in environmental
liabilities for remediation costs at the Auto Parts Business' store locations,
including $2.8 million in connection with the acquisition completed in the
second quarter of fiscal 2005. No environmental proceedings are pending at any
of these sites, other than discussed below.
On January 6, 2004, the Auto Parts Business was served with a Notice of
Violation (NOV) of the general permit requirements on its diesel powered car
crushers at the Rancho Cordova and Other Intangible Assets," goodwillSacramento locations from the Sacramento
Metropolitan Air Quality Management District (SMAQMD). Since receiving the NOV,
the Sacramento and Rancho Cordova locations have converted their diesel powered
car crushers to electric powered. The Company is engaged in an ongoing
evaluation of our car crushing systems and expects to enter discussions with the
SMAQMD to address the potential regulatory enforcement penalties. As a result,
the Company recorded a reserve of $0.6 million during 2004 for the estimated
potential exposure for this matter.
NOTE 5 - OTHER CONTINGENCIES
The Company and Hugo Neu Corporation ("HNC") are the 50% members of Hugo Neu
Schnitzer Global Trade, LLC ("HNSGT"), a joint venture engaged in global
brokering of recycled metals. HNC manages the day-to-day activities of HNSGT. In
January 2004, HNC advised the Company that it would charge HNSGT a 1% commission
on HNSGT's recycled metal sales, and began deducting those commissions. While
some reasonable reimbursement of HNC's costs may be appropriate, the Company has
responded that the 1% commission is excessive and that HNC had no authority to
unilaterally impose such commissions on HNSGT. The Company has not yet commenced
litigation in this dispute. As of February 28, 2005, the Company estimated that
its 50% share of the disputed commissions totaled $4.3 million. In recording
operating income from joint ventures, the Company has excluded from joint
venture expenses the excess of these disputed commissions over the Company's
estimate of reasonable reimbursements.
12
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
The Company was advised in 2004 that its practice of paying commissions to the
purchasing manager of customers in connection with export sales of recycled
ferrous metals to the Far East may raise questions of possible violations of
U.S. and foreign laws, and the practice was stopped. Thereafter, the Audit
Committee was advised and conducted a preliminary compliance review. On November
18, 2004, on the recommendation of the Audit Committee, the Board of Directors
authorized the Audit Committee to engage independent counsel and conduct a
thorough, independent investigation and directed that the existence and the
results of the investigation be voluntarily reported to the U.S. Department of
Justice (DOJ) and the Securities and Exchange Commission (SEC), and that the
Company cooperate fully with those agencies. The investigation is ongoing, and
the DOJ and SEC have been advised of its progress. The investigation is not
amortized andexpected to affect the Company's previously reported financial results,
including those reported in this 10-Q. The Company cannot predict the results of
the investigation or whether the Company or any of its employees will be testedsubject
to any penalties or other remedial actions following completion of the
investigation.
NOTE 6 - EMPLOYEE BENEFITS
The Company has a number of retirement benefit plans that cover both union and
non-union employees. The Company makes contributions following the provisions in
each plan.
Primary actuarial assumptions are determined as follows:
o The expected long-term rate of return on plan assets is based on our
estimate of long-term returns for impairmentequities and fixed income securities
weighted by the allocation of assets in the plans. The rate is
affected by changes in general market conditions, but because it
represents a long-term rate, it is not significantly affected by
short-term market swings. Changes in the allocation of plan assets
would also impact this rate.
o The assumed discount rate is used to discount future benefit
obligations back to today's dollars. The U.S. discount rate is as of
the measurement date, August 31, 2004. This rate is sensitive to
changes in interest rates. A decrease in the discount rate would
increase our obligation and expense.
o The expected rate of compensation increase is used to develop benefit
obligations using projected pay at least annually.retirement. This rate represents
average long-term salary increases and is influenced by our
compensation policies. An increase in this rate would increase our
obligation and expense.
DEFINED BENEFIT PENSION PLAN
- ----------------------------
For certain nonunion employees, the Company maintains a defined benefit pension
plan. The components of net periodic pension benefit cost are (in thousands):
For the Three For the Six
Months Ended Months Ended
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
Service cost $259 $211 $527 $432
Interest cost 158 137 323 280
Expected return on plan assets (194) (156) (395) (319)
Amortization of past service cost 1 1 2 2
Recognized actuarial loss 45 39 92 79
---- ---- ---- ----
Net periodic pension benefit cost $269 $232 $549 $474
==== ==== ==== ====
For the year ended August 31, 2005, the Company expects to contribute $1.0
million to its defined benefit pension plan. As of February 28, 2005, the
Company has not yet made its fiscal contributions to this plan. The Company
typically makes annual contributions to the plan after it receives the annual
actuarial valuation report. These payments are typically made in the Company's
third and fourth fiscal quarters.
13
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
DEFINED CONTRIBUTION PLANS
The Company has several defined contribution plans covering nonunion employees.
Company contributions to the defined contribution plans were as follows (in
thousands):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
Plan costs $ 190 $ 357 $ 536 $ 722
MULTIEMPLOYER PENSION PLANS
In accordance with collective bargaining agreements, the Company contributes to
multiemployer pension plans. Company contributions are as follows (in
thousands):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
Plan contributions $ 753 $ 769 $1,336 $1,490
The Company is not the sponsor or administrator of these multiemployer plans.
Contributions were determined in accordance with provisions of negotiated labor
contracts. The Company is unable to determine its relative portion of or
estimate its future liability under the plans.
The Company learned during fiscal 2004 that one of the multiemployer plans would
not meet ERISA minimum funding standards for the plan year ending September 30,
2004. The trustees of that plan have applied to the Internal Revenue Service for
certain relief from this minimum funding standard, but cannot determine whether
this relief will be granted. Absent relief, the plan's contributing employers
will be required to make additional contributions or pay excise tax that may
equal or exceed the full amount of that deficiency. The Company estimates its
share of the required additional contribution for the 2004 plan year is
approximately $1.1 million and accrued for such amount in fiscal 2004.
NOTE 47 - SEGMENT INFORMATION:
The Company operates in three industry segments: metal processing and recycling
(Metals Recycling Business), mini-mill steel manufacturing (Steel Manufacturing
Business) and self-service used retail auto parts (Auto Parts Business). Additionally,
the Company is a non-controlling partner in joint ventures, which are eitherin the
metals recycling business. The Joint Ventures in the metals recycling business or are suppliers of unprocessed
metals. The Joint Ventures in the Metals Recycling Business
sell recycled metals that have been processed at their facilities (Processing)
and also buy and sell third parties' processed metals (Brokering). The Company
considers these joint ventures to be separate segments because they are managed
separately. These joint ventures are accounted for using the equity method. As
such, the operating information related to the joint ventures is shown
separately from consolidated information, except for the Company's equity in the
net income of, investments in and advances to the joint ventures. Additionally,
assets and capital expenditures are not shown for the joint ventures as
management does not use that information to allocate resources or assess
performance. The Company does not allocate corporate interest income and
expense, income taxes or other income and expenses related to corporate activity
to its operating segments.
14
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
Revenues from external customers for the Company's consolidated operations are
as follows (in thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
Metals Recycling Business $ 109,327 $ 85,716 $ 188,929 $ 131,290
Steel Manufacturing Business 59,861 41,271 113,080 84,101
Auto Parts Business 17,245 14,755 34,905 30,894
Intersegment revenues (24,830) (17,083) (46,935) (30,959)
------------ ------------ ------------ ------------
Consolidated revenues $ 161,603 $ 124,659 $ 289,979 $ 215,326
============ ============ ============ ============
The joint ventures'For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
Metals Recycling Business $152,080 $109,327 $296,612 $188,929
Steel Manufacturing Business 66,820 59,861 136,842 113,080
Auto Parts Business 24,448 17,245 47,834 34,905
Intersegment revenues (27,602) (24,830) (66,581) (46,935)
-------- -------- -------- --------
Consolidated revenues $215,746 $161,603 $414,707 $289,979
======== ======== ======== ========
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
Total revenues from external
customers are as follows (in
thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
Joint Ventures in the Metals
Recycling Business:
Processing $ 232,207 $ 153,070 $ 386,213 $ 265,356
Brokering 120,514 42,672 230,460 93,204
Joint Venture Suppliers of Metals 1,678 2,155 4,050 4,949
------------ ------------ ------------ ------------
Total revenues $ 354,399 $ 197,897 $ 620,723 $ 363,509
============ ============ ============ ============
11
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003recognized by:
Joint Ventures:
Processing $369,294 $233,885 $ 676,102 $390,263
Brokering 214,846 120,514 437,210 230,460
-------- -------- ---------- --------
Total revenues $584,140 $354,399 $1,113,312 $620,723
======== ======== ========== ========
The Company's operating income (loss) from operations is as follows (in thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
Metals Recycling Business $ 13,162 $ 8,482 $ 23,085 $ 11,565
Auto Parts Business 5,094 5,021 10,983 10,231
Steel Manufacturing Business 2,691 (1,358) 2,549 (2,615)
Joint Ventures in the Metals Recycling Business 8,990 6,471 15,076 9,542
Joint Venture Suppliers of Metals (306) (277) (455) (173)
Corporate expense (3,018) (2,529) (5,664) (4,553)
Eliminations (2,396) (413) (3,252) 160
Impairment and other non-recurring charges -- (2,100) -- (2,100)
------------ ------------ ------------ ------------
ConsolidatedFor the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
Metals Recycling Business $ 39,481 $ 13,162 $ 73,769 $ 23,085
Auto Parts Business 7,245 5,094 14,591 10,983
Steel Manufacturing Business 5,358 2,691 18,118 2,549
Joint Ventures (1) 16,205 8,684 36,669 14,621
Corporate expense (5,008) (3,018) (8,599) (5,664)
Intercompany profit eliminations 739 (2,396) (2,424) (3,252)
Environmental matter (7,725) -- (8,225) --
-------- -------- -------- --------
Total operating income $ 56,295 $ 24,217 $123,899 $ 42,322
======== ======== ======== ========
(1) Operating income from operations $ 24,217 $ 13,297 $ 42,322 $ 22,057
============ ============ ============ ============
Income from operations generated by the joint ventures representsincludes environmental expenses of
$2.6 million for the Company's
equity in the income or loss of these entities.three and six months ended February 28, 2005.
The Company's share of depreciation and amortization expense included in the
determination of joint ventures' income from operations is as follows (in
thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
Joint Ventures in the Metals Recycling Business $ 1,729 $ 1,624 $ 3,462 $ 3,260
Joint Venture Suppliers of Metals 59 70 125 144
------------ ------------ ------------ ------------
Total $ 1,788 $ 1,694 $ 3,587 $ 3,404
============ ============ ============ ============
NOTE 5 - INCOME TAX PROVISION:
As part of the 1996 Proler International, Inc. acquisition,Three For the Company acquired
federal income tax net operating loss carryforwards ("NOLs"). As of FebruarySix
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 the NOLs totaled $15.3 million and, if not used, will expire in 2015 and
2016. In addition to the expiration dates, the NOLs are subject to annual
limitations of $2.4 million that can be utilized to offset taxable income.
In accordance with generally accepted accounting principles ("GAAP"), the
Company established valuation reserves for the acquired NOLs. The valuation
reserves were required to the extent management believed that it was uncertain
whether the Company's future taxable income, over the life of the NOLs, would be
available to utilize the NOLs. Historically, Management reviewed the need for
valuation reserves on a quarterly basis and released the reserves only to the
extent they felt the uncertainty was mitigated.
During the second quarter of fiscal2005 2004
management made a determination that
it was more likely than not that the Company's future taxable income would be
available to fully utilize the NOLs. Management's determination was based upon a
number of factors including profitability trends, industry fundamentals and
recent profitable acquisitions. Accordingly, the Company's $6.1 million deferred
tax asset valuation allowance was reversed in this quarter, resulting in a
corresponding reduction in the income tax provision for the three and six month
periods. This reversal, offset in part by a change in the estimate of the tax
benefit from Extraterritorial Income Exclusions, reduced the Company's second
quarter tax rate from approximately 29% to 19%. The change in the Company's GAAP
tax rate associated with the reversal of the valuation reserves had no
12
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
impact on the Company's cash flow; however, the cash taxes paid by the Company
are anticipated to continue to benefit from the NOLs through the year 2016.
NOTE 6 - ENVIRONMENTAL LIABILITIES:
PROLER
- ------
Metals Recycling L.L.C. (Metals) is a scrap metals processing business with
locations in Rhode Island and Massachusetts. The members of Metals are one of
the Company's joint ventures, Proler International Corp. (Proler) and Izzo
Group, Inc. On June 9, 1999, the Rhode Island Department of Environmental
Management (DEM) issued a Notice of Violation (NOV) against Metals, alleging
Metals had violated federal and state regulations relating to the storage,
management and transportation of hazardous waste and seeking to impose an
administrative penalty of $0.7 million. Metals filed an answer to the NOV in
which it denied the allegations and requested an adjudicatory hearing. In
January of 1999, federal and state officials searched Metals' Johnston, Rhode
Island and Worcester, Massachusetts facilities. Metals was advised that the
search was part of a state criminal investigation into possible violations of
state and federal hazardous waste programs and a Rhode Island statute that
prohibits the disposal of out-of-state solid waste at the landfill operated by
Rhode Island Resource Recovery Corporation (RIRRC). A grand jury was empanelled
to consider the allegations and issued an indictment on August 30, 2002 against
Metals for storing hazardous waste without a permit, operating a hazardous waste
disposal facility without a permit, causing transportation of hazardous waste
without a permit, causing transportation of hazardous waste without a manifest
and operating a solid waste management facility without a license. Metals
pleaded not guilty on all counts and vigorously contested the state's
allegations. Settlement discussions with DEM and the Rhode Island Attorney
General's Office resulted in the dismissal with prejudice of the criminal
charges and Metals' settlement of the DEM's civil NOV by payment of $250,000
pursuant to a Consent Agreement entered into on December 4, 2003.
AUTO PARTS BUSINESS
- -------------------
On January 6, 2004, Pick-N-Pull Auto Dismantlers (PNP), one of the Company's
subsidiaries in the Auto Parts Business segment, was served with a Notice of
Violation (NOV) of the general permit requirements on its diesel powered car
crushers at the Rancho Cordova and Sacramento locations from the Sacramento
Metropolitan Air Quality Management District (SMAQMD). The NOV required PNP to
cease operation of the car crushers at these locations. Since receiving this
notification, the Sacramento location has converted its diesel powered car
crusher to electric powered, and the Rancho Cordova location has received an
interim permit from SMAQMD to operate its diesel powered car crusher, with
modifications, for one year. The Company is engaged in an ongoing evaluation of
its car crushing systems and discussions with the SMAQMD to assure compliance
and address the potential regulatory enforcement penalties. The Company is
cooperating with the SMAQMD, but, as this is a new enforcement initiative and a
first time violation, it is difficult to reasonably estimate the amount, if any,
of the penalties. However, the Company accrued an immaterial amount to cover
what it currently believes is the potential exposure in the quarter ending
February 29, 2004.
For further information relating to environmental matters of the Company, Metals
and other joint ventures of Proler, please refer to Note 7 - Environmental
Liabilities in the Notes to the Condensed Consolidated Financial Statements
included in Item 8 of Form 10-K for the fiscal year ended August 31, 2003.
13
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
NOTE 7 - SUBSEQUENT EVENTS:
ACQUISITION
- -----------
On March 8, 2004, the Company, through its wholly owned subsidiary, PNP Auto
Parts Canada Co., acquired the assets and leased the sites of three self service
used auto parts stores in Calgary and Edmonton, Alberta and Kelowna, British
Columbia from Sheppard Holdings Ltd. of Calgary, Alberta, Canada, or its
affiliates. The three stores currently operate under the name of Pick Your Part.
The purchase and the results of operations for these three stores will be
reflected in the consolidated results of the Company during the third fiscal
2004 quarter.
STOCK SPLIT
- -----------
On January 27, 2004, the Company's Board of Directors approved a three-for-two
stock split, to be effected as a share dividend, for both classes of its common
stock. The share dividend was payable March 25, 2004, to shareholders of record
on March 4, 2004.
14-------- -------- -------- --------
Joint Ventures $1,881 $1,788 $3,557 $3,587
15
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The CompanySchnitzer Steel Industries, Inc. (the Company) operates in three industry segments. The Company's Metals Recycling
Business collects, processesvertically
integrated business segments that include the wholly-owned and recycles steel and otherjoint venture
metals through its
facilities. The Company's Steel Manufacturing Business operates a mini-mill near
Portland, Oregon, which melts recycled metal, produces finished steel products
and maintains one mill depot in Southern California and a third party depot in
Central California. The Company's Auto Parts Business purchases used and wrecked
automobiles and allows retail customers the opportunity of extracting parts for
purchase in its self-service auto parts stores, with 17 located in California,
two in Nevada and one store in each of Texas, Utah, Illinois and Indiana. The
results do not reflect the recent expansion ofrecycling businesses, the Auto Parts Business into
Canada withand the purchaseSteel Manufacturing
Business. The wholly-owned Metals Recycling Business and certain joint venture
businesses collect, process and recycle metals by operating one of three stores (see Note 7 - Subsequent Eventsthe largest
metals recycling businesses in the NotesUnited States. The Auto Parts Business
operates as Pick-N-Pull in the United States and Canada, and the Company
believes it is one of the country's leading self-service used auto parts
networks with 30 retail store locations. Additionally, Pick-N-Pull is a supplier
of autobodies to the Condensed Consolidated Financial Statements). Additionally,Metals Recycling Business which processes the Companyautobodies
into sellable recycled metal. The Steel Manufacturing Business purchases
recycled metals from the Metals Recycling Business and uses its mini-mill to
process the recycled metals into finished steel products. As a result of the
Company's vertically integrated business, it is a non-controlling partner inable to transform autobodies and
other unprocessed metals into finished steel products. The joint ventures that are either in the
metals recycling business or are suppliers of unprocessed metals. The Joint
Ventures in the Metals Recycling Business sell recycled metals that have been processed at their
facilities (Processing) and also buy and sell third parties' processed metals
(Brokering).
RESULTS OF OPERATIONS
The Company's revenues and operating results by business segment are summarized
below (in thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
REVENUES:
Metals Recycling Business:
Ferrous sales $ 95,545 $ 72,630 $ 161,439 $ 106,561
Nonferrous sales 12,078 11,669 24,487 21,784
Other sales 1,704 1,417 3,003 2,945
------------ ------------ ------------ ------------
Total sales 109,327 85,716 188,929 131,290
Auto Parts Business 17,245 14,755 34,905 30,894
Steel Manufacturing Business 59,861 41,271 113,080 84,101
Intercompany sales eliminations (24,830) (17,083) (46,935) (30,959)
------------ ------------ ------------ ------------
Total $ 161,603 $ 124,659 $ 289,979 $ 215,326
============ ============ ------------ ------------
INCOME (LOSS) FROM OPERATIONS:
Metals Recycling Business $ 13,162 $ 8,482 $ 23,085 $ 11,565
Auto Parts Business 5,094 5,021 10,983 10,231
Steel Manufacturing Business 2,691 (1,358) 2,549 (2,615)
Joint Ventures in the Metals Recycling Business 8,990 6,471 15,076 9,542
Joint Venture Suppliers of Metals (306) (277) (455) (173)
Corporate expense (3,018) (2,529) (5,664) (4,553)
Intercompany eliminations (2,396) (413) (3,252) 160
Impairment and other non-recurring charges -- (2,100) -- (2,100)
------------ ------------ ------------ ------------
Total $ 24,217 $ 13,297 $ 42,322 $ 22,057
============ ============ ============ ============
NET INCOME $ 18,549 $ 8,409 $ 30,726 $ 11,303
============ ============ ============ ============
15For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
REVENUES:
Metals Recycling Business:
Ferrous sales $133,647 $ 95,545 $260,479 $161,439
Nonferrous sales 16,943 12,078 32,597 24,487
Other sales 1,490 1,704 3,536 3,003
-------- -------- -------- --------
Total sales 152,080 109,327 296,612 188,929
Auto Parts Business 24,448 17,245 47,834 34,905
Steel Manufacturing Business 66,820 59,861 136,842 113,080
Intercompany sales eliminations (27,602) (24,830) (66,581) (46,935)
-------- -------- -------- --------
Total revenues $215,746 $161,603 $414,707 $289,979
======== ======== ======== ========
OPERATING INCOME (LOSS):
Metals Recycling Business $ 39,481 $ 13,162 $ 73,769 $ 23,085
Auto Parts Business 7,245 5,094 14,591 10,983
Steel Manufacturing Business 5,358 2,691 18,118 2,549
Joint Ventures (1) 16,205 8,684 36,669 14,621
Corporate expense (5,008) (3,018) (8,599) (5,664)
Intercompany profit eliminations 739 (2,396) (2,424) (3,252)
Environmental matter (7,725) -- (8,225) --
-------- -------- -------- --------
Total operating income $ 56,295 $ 24,217 $123,899 $ 42,322
======== ======== ======== ========
NET INCOME $ 35,981 $ 18,549 $ 78,917 $ 30,726
======== ======== ======== ========
(1) Operating income from the joint ventures includes environmental expenses of
$2.6 million for the three and six months ended February 28, 2005.
16
SCHNITZER STEEL INDUSTRIES, INC.
The Joint Ventures' revenues and results of operations were as follows (in
thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
Total revenues from external customers recognized by:
Joint Ventures in the Metals Recycling Business
Processing $ 232,207 $ 153,070 $ 386,213 $ 265,356
Brokering 120,514 42,672 230,460 93,204
Joint Venture Suppliers of Metals 1,678 2,155 4,050 4,949
------------ ------------ ------------ ------------
$ 354,399 $ 197,897 $ 620,723 $ 363,509
============ ============ ------------ ------------
Income (loss) from joint ventures recognized by the Company from:
Joint Ventures in the Metals Recycling Business $ 8,990 $ 6,471 $ 15,076 $ 9,542
Joint Venture Suppliers of Metals (306) (277) (455) (173)
------------ ------------ ------------ ------------
$ 8,684 $ 6,194 $ 14,621 $ 9,369
============ ============ ============ ============
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
Total revenues from external
customers recognized by:
Joint Ventures
Processing $369,294 $233,885 $ 676,102 $390,263
Brokering 214,846 120,514 437,210 230,460
-------- -------- ---------- --------
$584,140 $354,399 $1,113,312 $620,723
======== ======== ========== ========
Operating income from Joint
Ventures (1) $ 16,205 $ 8,684 $ 36,669 $ 14,621
======== ======== ========== ========
(1) Operating income from the joint ventures includes environmental expenses of
$2.6 million for the three and six months ended February 28, 2005.
The following table summarizes certain selected operating data for the Company
and its joint venture businesses:
For the Three Months Ended For the Six
Months Ended ------------------------------ ------------------------------Months Ended
------------------- -------------------
Feb. 28, Feb. 29, 2004 Feb. 28, 2003 Feb. 29,
2005 2004 Feb. 28, 2003
------------ ------------ ------------ ------------2005 2004
-------- -------- -------- --------
(Unaudited)
METALS RECYCLING BUSINESS:
Ferrous Recycled Metal Sales Pricesrecycled metal sales
prices ($/ton) (1,2)
Domestic $ 220 $ 168 $ 108221 $ 150
Export $ 104
Export247 $ 154 $ 113246 $ 150
Average $ 110
Average240 $ 158 $ 111238 $ 150 $ 108
Ferrous recycled metal shipments
(tons in thousands)(2)
To Steel Manufacturing Business 110 132 141269 290 256
To other unaffiliated domestic customers 9 14 1226 29 49
To export customers 357 355 402652 591
545
------------ ------------ ------------ ------------------ ------ ------ ------
Total ferrous recycled metal 476 501 555947 910
850
============ ============ ============ ================== ====== ====== ======
Nonferrous metal shipments (pounds in thousands) 30,900 24,900 28,20060,300 53,200
53,700
============ ============ ============ ================== ====== ====== ======
AUTO PARTS BUSINESS
Number of stores open at quarter end 30 23 30 23
1617
SCHNITZER STEEL INDUSTRIES, INC.
For the Three Months Ended For the Six
Months Ended ------------------------------ ------------------------------Months Ended
------------------- -------------------
Feb. 28, Feb. 29, 2004 Feb. 28, 2003 Feb. 29,
2005 2004 Feb. 28, 2003
------------ ------------ ------------ ------------2005 2004
-------- -------- -------- --------
(Unaudited)
(Unaudited)
STEEL MANUFACTURING BUSINESS:
Sales PricesAverage sales price ($/ton)ton ) (1,2) Rebar $ 354 $ 269 $ 331 $ 271
Other $ 347 $ 299 $ 330 $ 295
Average517 $ 351 $ 283525 $ 331
$ 283
------------ ------------ ------------ ------------
Finished steel products sold
(tons in thousands) (2) 125 162 137251 325
279
============ ============ ============ ============
JOINT VENTURES IN THE METALS RECYCLING BUSINESS:VENTURES:
Ferrous recycled metal shipments
(tons in thousands) (2)
Processed 1,050 828 9411,979 1,502
1,577
Brokered 722 623 3041,472 1,301
774
------------ ------------ ------------ ----------------- ----- ----- -----
1,772 1,451 1,2453,451 2,803
2,351
============ ============ ============ ================= ===== ===== =====
(1) The Company reports revenues that include shipping costs billed to
customers. However, average net selling prices are shown net of shipping
costs.
(2) Tons for ferrous recycled metals are long tons (2,240 pounds) and for
finished steel products are short tons (2,000 pounds).
SECOND QUARTER FISCAL 20042005 COMPARED TO SECOND QUARTER FISCAL 2003
GENERAL.2004
RESULTS OF OPERATIONS
- ---------------------
During the second quarter of fiscal 2004,2005, the Metals Recycling Business
and related Joint Ventures continuedCompany's operations improved
dramatically compared to experience improved market conditions.
Global demand for ferrous recycled metal has increased primarily due to the
growing Asian economies, in particular, China and worldwide economic
improvements. Throughout fiscal 2003 and into the second quarter of fiscal 2004 selling prices continued to rise primarily due toas a result of higher
pricing for its products, which is directly a result of strong Asian demand, the tight
supplyworldwide
consumption of ferrousboth recycled metal available in the export market, rising domestic demand
and the weaknessfinished steel products.
The results of operations of the U.S. dollar relative to other foreign currencies.
Demand, which is being fueled primarily by China, continues to remain strong. In
2000, China produced an estimated 129 million tons of steel representing 16% of
the world's production. By the end of 2003, China produced an estimated 220
million tons of crude steel representing 23% of the world's total production.
This growing steel production is directly increasingCompany depend in large part upon demand and
prices for recycled ferrous metal. Although China is the main driving force behind the
recent strong export demand, the Company is also seeing indications of growing
demand from other customers locatedmetals in Mexicoworld markets and other Southeast Asian
countries.
More recently, the Company has experienced increases in demand domestically due
to improvementssteel products in the U.S. economy. Overall, domestic marketWestern
United States. Beginning in fiscal 2004, and continuing into the first half of
fiscal 2005, strong worldwide demand combined with a tight supply of recycled
metals created significant price volatility and drove the Metals Recycling
Business' average selling prices to unprecedented highs. Market prices for
recycled ferrous metals fluctuate periodically and have a significant impact on
the results of operations for the wholly-owned operations and Joint Ventures in
the metals recycling business.
The Auto Parts Business purchases used and salvaged vehicles, sells parts from
those vehicles through its retail facilities and wholesale operations and sells
the remaining portion of the vehicles to metal rose rapidly inrecyclers. The Auto Parts
Business has acquired seven new stores since the end of the second fiscal
quarter of last year, which represents a 30% increase in the number of stores.
These new stores have led to increases in both retail and wholesale revenues and
operating income. In addition, revenues for the wholesale product lines are
principally affected by commodity prices and shipping schedules. As mentioned
earlier in the discussion regarding the Metals Recycling Business, recycled
metal prices have increased dramatically over the last year, which increased the
revenues and profits of the Auto Parts Business. The self-service retail
operations are somewhat seasonal and affected by weather conditions and
promotional events. Since the stores are open to the natural elements, during
periods of prolonged wet, cold or extreme heat, the retail business tends to
slow down due to the difficult customer working conditions. As a result, the
Company's first and third fiscal quarters tend to generate the most retail sales
and the second and fourth fiscal quarters are the slowest in terms of retail
sales.
18
SCHNITZER STEEL INDUSTRIES, INC.
The Steel Manufacturing Business' sales volumes normally decline to their lowest
levels during the Company's second fiscal quarter of each year due to adverse
weather conditions that slow demand. In addition, the Steel Manufacturing
Business' sales volumes were unusually low during the second quarter of fiscal
2005 due to abnormally high inventory levels held by its customers who fabricate
and distribute steel. Throughout the second half of fiscal 2004, demand and
selling prices for finished steel grew quickly. The rise in selling prices
caused many fabricators and distributors to buy ahead of end user demand in
anticipation of even higher prices. This buying pattern resulted in unusually
high market inventory levels of finished steel. In anticipation of seasonal
declines in consumption that occur in the late fall and winter months, many
distributors and fabricators reduced their steel purchases to balance their
inventories. At the same time, West Coast steel manufacturers (including the
Company) built inventory levels in anticipation of the spring construction
period. Sales volumes of rebar and wire rod products were adversely affected by
rising levels of imports in the second quarter. The Company believes that the
rise in import levels is attributable to the increase in selling prices in the
West Coast market, which potentially allow the import sales to be more
profitable to the foreign companies. The increased supply of imports on the West
Coast caused market prices to drop significantly on 20-foot rebar segments and
to a lesser degree on wire rod products.
The Company's steel mill successfully completed the installation of a new
electric arc furnace in December 2004. It is anticipated that the new furnace
will improve productivity of the mill as well as reduce operating costs,
including the consumption of electricity. To date, the new furnace is performing
well and exceeding productivity expectations.
REVENUES. Consolidated revenues for the quarter ended February 28, 2005
increased $54.1 million or 34% to $215.7 million from $161.6 million in the
second quarter of fiscal 2004. Revenues in the second quarter of fiscal 2005
increased for all Company business segments primarily as a result of increased
prices and demand in the worldwide ferrous metals market. Significant
improvements in world wide demand, coupled with higher raw material cost, led to
increases in selling prices for finished steel products sold by the Steel
Manufacturing Business. The Auto Parts Business benefited from the increased
ferrous metals prices in the sales of autobodies and higher core sale revenues.
In addition, the Auto Parts Business acquired three retail locations in Canada
in the third quarter of fiscal 2004 and four retail locations in the United
States in January 2005 that added revenue and operating income to the segment
over the prior year.
The Metals Recycling Business generated revenues of $152.1 million for the
quarter ended February 28, 2005, before intercompany eliminations, which was an
increase of $42.8 million or 39% over the same period of the prior year. Ferrous
revenues increased $38.1 million, or 40%, to $133.6 million as a result of
higher average selling prices net of shipping cost (average net selling prices)
and higher shipping costs billed to customers, partially offset by a decrease in
the volume sold. The average net sales price for ferrous metals for the second
quarter increased 52% to $240 per ton, which represents $39.2 million of the
revenue increase over the prior year quarter. The cost of freight that was
included in revenues increased by $2.9 million over the fiscal 2004 second
quarter due primarily to higher ocean chartering costs. Average export shipping
costs increased 17% over the strengthprior year quarter. Total ferrous sales volumes
decreased by approximately 25,300 tons or 5%, which represents a decrease in
demandrevenue of $4.0 million from steel manufacturers who saw their finished
product order backlogthe prior year quarter and prices grow. Fiscal 2004 second quarter average
domestic selling prices actually increased at a greater rate than the average
export selling prices, which was primarily caused bydue to
normal variation in the timing of when orders are received and shipped. Export orders are typically received 60-90 days aheadultimately sold.
Sales to the Steel Manufacturing Business decreased 21,800 tons, or 17%, to
110,000 tons as a result of shipment, whereas domestic sales are typically shipped within 30 daysthe installation of order.
Demand for nonferrous recycled metals, particularly from China, continues to be
strong and boosted nonferrous metals selling prices.a new furnace at the Steel
Manufacturing Business during December 2004. During the same period,furnace installation,
melt shop production halted, which led to a decreased need for scrap metals. The
decreased sales volume to the cost of unprocessed metal rose as well, which, combined with rising shipping
costs, partially offset theSteel Manufacturing Business was temporary. The
new furnace has caused a modest increase in selling prices. Export sales shipping
costs rose 72% from the second quarterrate of last year, due toscrap consumption at the
combination of
higher fuel prices and an increase in Asian demand for bulk cargo vessels that
traditionally ship scrap metal and other bulk commodity products.
17Steel Mill.
19
SCHNITZER STEEL INDUSTRIES, INC.
The Joint VenturesRevenue from nonferrous metal sales increased $4.9 million over the prior year
second quarter which was a result of a $0.06 or 13% increase in average net
sales price to $0.54 per pound and a 6 million pound or 24% increase in the
Metals Recyclingpounds shipped. The increase in sales price per pound was a result of increased
Asian demand for nonferrous metals. The increase in pounds shipped over the
prior year second quarter was a result of more scrap metals being processed
through the Company's shredders as well as the implementation of a system to
improve recovery of nonferrous metals from the shredding process. Nonferrous
metals are a byproduct of the shredding process, and quantities available for
shipment are affected by the volume of materials processed in the Company's
shredders.
The Auto Parts Business reportedgenerated revenue of $24.4 million, before intercompany
eliminations, for the quarter ended February 28, 2005, which was an increase of
$7.2 million or 42% over the same period of the prior year. This increase was a
result of higher wholesale revenues driven by higher average sales prices for
scrapped autobodies due to rising ferrous recycled metal prices and higher core
sale revenues in both the Company's recently acquired and existing store
locations. In addition, retail revenues increased profit
primarily as a result of significant margin improvementthe acquisition
of three retail store locations in Canada in March 2004 and four retail store
locations in the Brokering Joint
Venture that has been growing its market shareUnited States in January 2005 and, is now serving additional
markets and customers. The Processing Joint Ventures reported relatively flat
operating income in the fiscal 2004 second quarter as compared to the prior year
period, and did not experience thea lesser extent, same
rise in profitability as the Company's
wholly-owned Metals Recycling Business. The Processing Joint Ventures, which are
mainly based in the northeastern U.S. and southern California, experienced
similar gross selling prices (before freight and ship loading costs) as the
Company's west coast based wholly-owned Metals Recycling Business; however, the
east coast based Processing Joint Ventures' export shipping and raw material
costs were significantly higher than was experienced by the west coast
businesses, which compressed margins. In addition,store sales volumes from the
Processing Joint Ventures declined 12% from the prior year quarter primarily due
to the fact that last year's second quarter volume was near record levels and
was the result of customer order delays from the first quarter of fiscal 2003.improvement.
The Steel Manufacturing Business saw highergenerated revenues of $66.8 million for the
quarter ended February 28, 2005, which is an increase of $7.0 million, or 12%
over the prior year quarter. The average net selling price increased $166 per
ton, or 47% to $517 per ton, which represents a $20.7 million revenue increase.
The increase in average net selling prices and higherwas due to a combination of factors
including increased steel consumption. Sales volumes decreased 23% to 125,000
tons, which reduced revenues by $13.2 million. The lower sales volumesvolume during the
second quarter of fiscal 2004 compared with the second
quarter of fiscal 2003. Domestic steel producers continued2005 was primarily due to raise selling
prices in an attempt to offset the sharp rise in raw materialabnormally high inventory
levels held by fabricators and energy costs.
Additionally, the Steel Manufacturing Business experienced a shift in sales mix
to higher priced products. Sales prices and volumes also benefited from lower
steel imports, which is partially attributed to the weakness of the U.S. dollar
and higher ocean freight rates. Additionally, sales volumes have increased over
the second quarter of fiscal 2003 due primarily to increases in steel
consumption, industry consolidation and customers' efforts to buy ahead of
announced price increases. Partially offsetting the higher selling prices and
volumes was an increase in the cost of raw materials resulting from increases in
worldwide demand for recycled ferrous metal. The Steel Manufacturing Business
also received $1.8 million during the second quarter of fiscal 2004 as a final
payment regarding an electrode price fixing settlement that was settled in favor
of a numberdistributors of steel, mills, includingas discussed above, and
the Company's steel mill. This amount is
included in incomeimpact of lower priced imports from operations.
The Auto Parts Business continues to experience strong growth in wholesale
revenues, which originate from the saleAsia on certain lengths of scrap metal ("scrap sales")rebar and
other
parts wholesale ("core sales"). Scrap sales benefited from rising prices caused
by many of the factors experienced by the Metals Recycling Business. Core sales
also benefited from rising prices which are due to both increased demand and
operational improvements. This increased revenue was partially offset by
increased vehicle purchasing costs and higher labor costs. Retail revenues
increased modestly from the second fiscal 2003 quarter due to increased retail
pricing and volumes. On March 8, 2004, a newly formed Canadian subsidiary of the
Company acquired three stores in Calgary, Edmonton and Kelowna, Canada,
increasing the number of stores in the Auto Parts Business segment to 26. It is
anticipated that the addition of these three stores will positively affect
operating results beginning with the Company's third fiscal quarter of 2004.
Net income for the second quarter of fiscal 2004 compared with the same quarter
in the previous fiscal year benefited from improvements in allwire rod products. Many of the Company's business segments. The Metals Recycling Business andcustomers used the Steel Manufacturing
Business experienced higher operating income due to higher average selling
prices as well as higher sales volumes. The Auto Parts Business saw a modest
increasenormal seasonal
decline in operating income. Revenues have increased year over year, with
corresponding increases in vehicle purchase and labor costs, which have
compressed margins. The joint ventures in the metals recycling business also saw
higher income primarily due to growth in market share of the Brokering Joint
Venture.
REVENUES. Consolidated revenues for the quarter ended February 29, 2004
increased 30% from $124.7 million to $161.6 million compared with the second
quarter of fiscal 2003. The increase was primarily a result of a significant
rise in the Metals Recycling Business' average net selling price per ton and
increases in the Steel Manufacturing Business' sales volume and average net
selling price per ton. The Auto Parts Business wholesale revenues also rose
significantly while its retail revenues saw a modest increase.
18
SCHNITZER STEEL INDUSTRIES, INC.
Revenues for the Metals Recycling Business for the quarter ended February 29,
2004, before intercompany eliminations, increased $23.6 million (28%) compared
with the fiscal 2003 quarter primarily due to higher average net selling prices
per ton and higher shipping costs billed to customers offset by lower ferrous
sales volumes. Total ferrous sales volumes decreased by approximately 54,000
tons (10%) due to the fact that the second quarter of fiscal 2003 was a record
quarter in terms of sales volumes as customers delayed orders from the first
quarter of fiscal 2003 in anticipation of price declines, which did not
materialize. The average sales price, net of shipping costs (average net sales
price), for ferrous metals increased $47 per ton (42%) to $158 per ton from the
second quarter of fiscal 2004 due to the lower supplies of competing metal in
global markets, strong demand in Asia and increased demand domestically.
Nonferrous selling price per pound increased 18% in the current quarter versus a
year ago, and was primarily attributable to continued strong demand from China
and Korea. Nonferrous sales volumes declined 12% due to lower beginning
inventory levels this quarter compared to last year's quarter. The high demand
for nonferrous metal during last year's second quarter enabled the Company to
decrease its inventory levels. Nonferrous inventory levels continued to remain
lowconsumption during the second quarter ended 2004 and this, coupled with reduced
availability of raw materials, caused nonferrous volumeswinter months to decline.
The Steel Manufacturing Business' revenues for the quarter ended February 29,
2004 increased $18.6 million (45%), to $59.9 million compared with the prior
year quarter, reflecting higher average sales prices and higher volumes.
Finished steel shipments were 18% higher than the prior year with the average
finished steel net selling price up $68 per ton (24%) to $351 per ton compared
with the same quarter last year. Sales volumes improved due to industry
consolidation, reduced imports and customer buying activities mentioned in the
"General" section. The price increases were primarily caused by improved
consumption, a higher-priced sales mix and steel producers' attempts to offset
the sharp rise in raw material and energy costs.
Revenues for the Auto Parts Business for the second quarter ended February 29,
2004, before intercompany eliminations, increased $2.5 million (17%) compared
with the fiscal 2003 quarter primarily due to an increase in wholesale revenues
driven by higher sales prices for scrapped auto bodies due to rising ferrous
recycled metal prices. Wholesale prices also benefited from the implementation
of improved efficiencies and changes in work practices, which were caused in
part by a new distribution center. This, coupled with strong pricing, resulted
in increased sales volumes. Retail revenues increased slightly due to increased
pricing, while admissions were consistent with the fiscal 2003 quarter.reduce their inventory
levels.
COST OF GOODS SOLD. Consolidated cost of goods sold increased $29.5$18.9 million (28%)or
14% for the second quarter ended February 29, 2004,28, 2005, compared with the same
period last year. Cost of goods sold decreased as a percentage of revenues from
85%84% to 84%72%. Gross profit increased $7.5$35.3 million to $26.0$61.2 million during the
latest quarter compared to the prior year quarter driven by profit margin
improvements at the Company's MetalMetals Recycling, Auto Parts and Steel
Manufacturing Business segments.
ForCost of goods sold for the MetalMetals Recycling Business theincreased $16.2 million or
18% to $107.6 million. As a percentage of revenues, cost of goods sold as a percentage of
revenues decreased
compared with the second quarter of fiscal 20032004 from 85%84% to 84%71%. Gross profit
increased by $5.0$26.5 million to $18.0$44.5 million. The increase in gross profit was
primarily attributable to higher average net selling prices per ton.ton and to
inventory write-ups which were partially offset by lower sales volumes. During
the second quarter of 2005, several piles of ferrous metal inventory were fully
utilized revealing higher inventory volumes than the Company had previously
estimated, resulting in a decrease in cost of goods sold of $5.4 million for the
inventory adjustments. Compared with the second quarter of last year, the
average ferrous metals cost of sales per ton increased 40%22% due primarily to
higher purchase costs for unprocessed ferrous metals and higher export sales shipping costs.metals. Generally, thea change in the
cost of unprocessed metal has a strong correlation to changes in the average
selling price. Thus, as selling prices rose compared with last year's quarter,
so did the cost of unprocessed metal.
ForThe Auto Parts Business' cost of goods sold increased $4.3 million or 42% during
the second quarter of fiscal 2004,2005 as compared to the cost of goods sold for the
Steel
Manufacturing Business increased $14.6 million (35%) compared to the same period
last year. Costfiscal 2004 second quarter. The higher cost of goods sold per ton increased 15%sales was primarily due to higher
raw
materialcar purchase costs partially offset by lower rolling mill conversion coststhat resulted from higher scrap metal prices and the receiptaddition
of seven new stores since last year. As a percentage of revenues, cost of goods
sold remained consistent with the $1.8prior year quarter. Gross profit increased
$2.9 million electrode price fixing settlement mentioned earlier.or 41% over the prior year quarter due to increased wholesale
revenue earned from the higher market rates for scrap metals coupled with new
store acquisitions.
20
SCHNITZER STEEL INDUSTRIES, INC.
The Steel Manufacturing Business' cost of goods sold increased $4.2 million or
8% during the second quarter of fiscal 2005 as compared to the cost of goods
sold for the fiscal 2004 second quarter. As a percentage of revenues, cost of
goods sold decreased from 101% to 94%. Incompared with the second quarter of fiscal 2004 from 94% to
91%. Average cost of goods sold per ton increased $137 per ton or 42% compared
to the gross profit was $3.5 million compared
19
SCHNITZER STEEL INDUSTRIES, INC.
with a gross loss of $0.5 million in the secondprior year quarter, of last year. This
improvementwhich was primarily attributable tocaused by higher selling pricesraw material
costs for recycled metal and alloys and effects of the electrode settlement.
The Auto Parts Business'melt shop shutdown in
December 2004. As this increase in cost of sales was $2.0more than offset by the
$166 per ton increase in average net selling price, gross profit improved by
$2.7 million, (24%) higherto $6.2 million for the quarter. The Steel Mill incurred
approximately $5.0 million in costs during the second quarter of fiscal 2004 as compared2005
related to the cost of sales for the fiscal
2003 quarter. As a percentage of revenues, the cost of sales increased to 60%
from 56% for the fiscal 2003 quarter. The higher cost of sales was due to
increased car purchase costs that were the result of higher scrap metal pricesmelt shop shut down and increased labor costs.furnace replacement project completed in
December 2004.
JOINT VENTURES. The Joint Ventures in the Metals Recycling Businessmetals recycling business
predominantly sell recycled ferrous metal.and nonferrous metals. Revenues for this
segment in the second quarter of fiscal 20042005 increased $157.0$229.7 million (80%)or 65%
compared with the prior year quarter primarily due to higher average net selling prices per ton.
Additionally, the Brokering Joint Venture experienced a 105% increase in sales
volumes compared with the prior year quarter. The Processing Joint Ventures'49% higher average net
selling price per ton forand a 21% increase in the volume of ferrous recycled metals increasedmetal
sold, over the prior year quarter. The increase in average net selling price per
ton was due to primarily the same supply and demand circumstances described
earlier for the Company's wholly owned businesses while sales volumes decreased 12% over the prior year
due to the fact that last year's second quarter sales volumes were near record
levels and were the resultwholly-owned businesses.
The Company's share of customer order delays from the first quarter of
fiscal 2003.
Income from Joint Ventures amounted to $8.7 millionVenture operating income for the second quarter of
fiscal 2004 compared2005 increased to $6.2$16.2 million from $8.7 million in last year'sthe second quarter.quarter
of fiscal 2004. The increase in income from these Joint Ventures was primarily
caused by higher selling prices and volumes. The Company's share of operating
income from the global brokering joint ventures' quarterly income came primarilyventure decreased from a significant margin
improvement$3.2 million in
the Brokering Joint Venture that has been growingsecond quarter of fiscal 2004 to $2.8 million in the second quarter of
fiscal 2005, a 12% decrease. The Company's share of joint venture operating
income in the second quarter of fiscal 2005 included a charge of $2.6 million
for its market
share and is now serving additional markets and customers.
IMPAIRMENT AND OTHER NON-RECURRING CHARGES. Inof estimated environmental costs. During the second quarter of
fiscal 2005, in connection with the 2003
acquisitionnegotiation of a possible transaction for
the split-up of the Auto Parts Business,Company's metals recycling joint ventures with Hugo Neu
Corporation, the Company conducted an environmental due diligence investigation
of certain joint venture businesses it proposes to directly acquire, and
accrued $2.1identified certain environmental risks for which estimated remediation costs
were accrued. The Company's share of joint venture operating income also
included an estimated $1.0 million from a joint venture contract with New York
City for the processing and disposal of curbside recycling materials that
commenced in environmental
liabilities.April 2004. The contract with New York City is an interim contract,
and the Company's present intention is not to participate in the anticipated
long-term contract. Therefore, the income stream from this contract could end at
any time.
GENERAL AND ADMINISTRATIVE EXPENSE. Compared with the second quarter of fiscal
2003,2004, general and administrative expense for the same quarter this fiscal year
increased $1.3$2.7 million or 29%. Approximately $1.1 million of the change is
related to increased headcount, primarily duein the Auto Parts Business for
development of its management infrastructure to allow growth of this business
segment, and higher bonus accruals givendue to increased profitability. In addition,
the Company's improved performanceCompany incurred increased expenses for Sarbanes-Oxley compliance and costs associated withother
professional fees, including $0.7 million related to the Company's
compliance with Section 404Audit Committee's
investigation of payment practices in the Sarbanes Oxley Act.Far East as discussed in Note 5 to the
condensed consolidated financial statements. As a percentage of revenues,
general and administrative expenses haveexpense has decreased by 0.2% percentage points, from
6.5%5.8% to 5.8%5.6% due to spreading the Company's fixed coststhese expenses over higher revenues.
ENVIRONMENTAL MATTER. During the second quarter of fiscal 2005, the Company
recorded environmental charges of $7.7 million for additional estimated costs
related to the ongoing remediation of the head of the Hylebos Waterway adjacent
to the Company's Tacoma, Washington metals processing facility. An estimate of
this liability was initially recognized as part of the 1995 acquisition of the
Tacoma facility. The cost estimate was based on the assumption that dredge
removal of contaminated sediments would be accomplished within one dredge season
during July 2004 - February 2005. However, due to a variety of factors,
including equipment failures, dredge contractor operational issues and other
dredge related delays, the dredging was not completed during the first dredge
season. As a result, the Company increased its environmental accrual by $7.7
million related to this project primarily to account for additional estimated
costs to complete this work during a second
21
SCHNITZER STEEL INDUSTRIES, INC.
dredging season. The Company has asserted a claim for relief from the dredge
contractor to seek relief for a significant portion of the increased costs, and
is currently engaged in mediation of this dispute. However, generally accepted
accounting principles do not allow the Company to recognize the benefits of any
such relief until receipt is highly probable.
INTEREST EXPENSE. Interest expense for the second quarter of fiscal 2004
increased $0.2 million2005
decreased 29% to $0.5$0.3 million compared with the second quarter of fiscal 2003.2004.
The increasedecrease was primarily a result of higherlower average debt balances during the fiscal 20042005
second quarter compared with the fiscal 20032004 quarter.
INCOME TAX PROVISION. The tax rate of 34.8% for the second quarter of fiscal
20042005 was approximatelyhigher than the 19%, compared with a tax rate of 27% for the priorsame quarter last year quarter.
The Company's $6.1 million deferred tax valuation allowance was reversed in this
quarter, resulting in a corresponding reduction in the income tax provision for the period, which was offset in part by a change in the estimate of the tax
benefit fromtwo main
reasons. First, the Extraterritorial Income Exclusion. ItExclusion (ETI) tax benefit on
export sales is anticipated that the
rate will be 34% in the third and fourth quarter of fiscal 2004, reflecting the
full utilization of the NOL tax benefits and the lower estimated tax benefits of
the Extraterritorial Income Exclusion. The change in the Company's GAAPprojected to decrease. Secondly, last year's tax rate associated withbenefited
from the reversalfinal release of a valuation allowance that had once offset net
operating losses. The 34.8% rate approximates the valuation reserves had no impact on35% Federal statutory rate
because the Company's cash flow; however, the cash taxes paidprojected ETI benefits are largely offset by the Company are anticipated
to continue to benefit from the NOLs through the year 2016. See Note 5 - Income
Tax Provision in the Notes to the Condensed Consolidated Financial Statements.
PRE-ACQUISITION INTERESTS. For the second quarter of fiscal 2003,
pre-acquisition interests of $0.7 million, which are net of tax, represent the
share ofprojected state
income attributable to the former joint venture partner prior to the
2003 acquisition. See Note 3 of the Notes to the Condensed Consolidated
Financial Statements.
20
SCHNITZER STEEL INDUSTRIES, INC.
MINORITY INTERESTS. Minority interests, net of tax, represent the share of
income attributable to various continuing minority partners within the Auto
Parts Business segment. During the three month period ended February 29, 2004,
minority interests increased $0.2 million due to improved operating performance
at locations which have minority partners.taxes.
FIRST HALF OF FISCAL 2005 COMPARED TO FIRST HALF OF FISCAL 2004
VS. FIRST HALFRESULTS OF FISCAL 2003OPERATIONS
- ----------------------------------------------------------------------------
REVENUES. Consolidated revenues for the six months ended February 29, 200428, 2005
increased $74.7$124.7 million (35%)or 43% to $414.7 million from $290.0 million for the
same period last year. The higher revenues were primarily attributed to increased sales volumes and higher average
selling prices for the Metals Recycling Business and the Steel Manufacturing
Business and higher wholesale revenues for the Auto Parts Business. DuringIn addition,
the Metals Recycling Business had an overall increase in the volume of ferrous
metals shipped over the prior year period. Revenues in the first half of fiscal
2005 increased for all Company business segments primarily as a result of
increased prices and demand in the worldwide ferrous metals market. Significant
improvements in demand, coupled with higher raw material cost led to increases
in selling prices for finished steel products sold by the Steel Manufacturing
Business. The Auto Parts Business benefited from the increased ferrous metals
prices in the sales of autobodies and higher core sale revenues. In addition,
the Auto Parts Business acquired three retail locations in Canada in the third
quarter of fiscal 2004 and four retail locations in the second quarter of fiscal
2005 that added both revenue and operating income to the segment over the prior
year.
The Metals Recycling Business generated revenues of $296.6 million for the six
month period ended February 28, 2005, before intercompany eliminations, which
was an increase of $107.7 million or 57% over the same period of the prior year.
Ferrous revenues increased $99.0 million, or 61% to $260.5 million as a result
of higher average selling prices net of shipping cost (average net selling
prices), higher shipping costs billed to customers and an increase in the volume
sold. The average net sales price for ferrous metals increased 59% to $238 per
ton, which represents $83.6 million of the revenue increase over the prior year
six month period. The cost of freight that was included in revenues increased by
$9.8 million over the six month period ended February 28, 2004 due primarily to
higher ocean chartering costs. Average export shipping costs increased 27% over
the same period in the prior year period. Total ferrous sales volumes increased
by approximately 37,000 tons or 4%, which represents $5.5 million of the revenue
increase over the prior year six month period and was primarily due to normal
variation in the timing of when orders are received and ultimately sold.
Sales to the Steel Manufacturing Business decreased by 20,000 tons or 7% to
269,000 tons due to a temporary closure of the steel mill melt shop while a new
furnace was installed in December 2004. Nonferrous revenue increased $8.1
million or 33% to $32.6 million due primarily to higher average selling prices.
The average net nonferrous selling price in the six months ended February 29, 2004, revenues for the Metals Recycling28,
2005 was $0.53 per pound, an increase of $0.07 per pound or 16%. In addition,
sales volume increased 13% to 60.3 million pounds. The increases in average
selling price and volume are related to strong worldwide demand, especially from
Asia.
22
SCHNITZER STEEL INDUSTRIES, INC.
The Auto Parts Business generated revenue of $47.8 million, before intercompany
eliminations, increased $57.6 million (44%), which
is attributed to average ferrous recycled metals selling prices, higher ferrous
sales volumes, and higher shipping costs billed to customers. Ferrous sales
volumes increased by 7% over the 2003 period. Average net selling prices for
ferrous metals were up 39% and nonferrous metals were up 14% compared with the
first half of fiscal 2003. The higher prices were caused by continued strong
demand from Asian countries, improvements in demand domestically, and a decrease
in supply available in the global market.
The Steel Manufacturing Business' revenues for the six months ended February 29,
2004 increased $29.028, 2005, which is an increase
of $12.9 million (34%), to $113.1 million, fromor 37% over the first halfsame period of the prior year. TheThis increase in revenues
was a result of higher wholesale revenues driven by higher average sales prices
for scrapped autobodies due to rising ferrous recycled metal prices and higher
core sale revenues in both the Company's recently acquired and existing store
locations. In addition, retail revenues increased as a 45,500 ton increase
(16%)result of the acquisition
of three retail store locations in products sold duringMarch 2004 and four retail store locations in
January 2005.
The Steel Manufacturing Business generated revenues of $136.8 million for the first
six months ended February 28, 2005, which was an increase of $23.8 million, or
21% over the same period of the last fiscal 2004 comparedyear. The average net selling price
increased $195 per ton, or 59% to the prior year due to increasing consumption and industry consolidation. Average$526 per ton, which represents a $48.9 million
revenue increase. The increase in average net selling prices was due to a
combination of factors including increased 17% due primarilyworldwide steel consumption. However,
sales volumes decreased 23% to improved consumption, a
higher-priced251,000 tons, which reduced revenues by $24.5
million. The lower sales mix and steel producers' attempts to offset the sharp rise
in raw material and energy costs.
Revenues for the Auto Parts Business increased by $4.0 million (13%) forvolume during the first half of fiscal 2004 compared2005 was
primarily due to abnormally high inventory levels held by fabricators and
distributors of steel, as discussed above. Many of the Company's customers are
using the normal seasonal decline in consumption during the winter months to
reduce their inventory levels. In addition, Asian imports to the same period in 2003. The higher
revenues were primarily caused by an increase in wholesale revenues driven by
rising prices for car bodiesWest Coast have
created market pressure to grant price concessions on certain lengths of rebar
and increasing volumes and price for cores.wire rod.
COST OF GOODS SOLD. Consolidated cost of goods sold increased by $59.4$51.1 million (32%)or
21% for the six months ended February 29, 2004,28, 2005, compared with the same period
last year. Cost of goods sold decreased as a percentage of revenues from 85%84% to
84%, which contributed71%. Gross profit increased $73.6 million to $121.2 million during the latest
six month period compared to the same period in the prior year, driven by profit
margin improvements at the Company's Metals Recycling and Steel Manufacturing
Business segments.
Cost of goods sold for the Metals Recycling Business increased $56.2 million or
36% to $212.8 million. As a $15.3 million increase in gross profit forpercentage of revenues, cost of goods sold decreased
compared with the first six months of fiscal 2004 as comparedfrom 83% to the prior year.72%. Gross profit
increased by $51.5 million to $83.8 million. The higherincrease in gross profit reflected the increased volumes andwas
primarily attributable to higher average net selling prices for the Metals Recycling
Business and the Steel Manufacturing Businessper ton, a decrease
in cost of goods sold related to inventory adjustments and higher wholesale prices for
the Auto Parts Business.
Duringsales volumes.
Compared with the first six months of fiscal 2004,last year, the Metals Recyclingaverage ferrous metals cost
of sales per ton increased 31% due primarily to higher purchase costs for
unprocessed ferrous metals. Generally, a change in the cost of unprocessed metal
has a strong correlation to changes in the average selling price. Thus, as
selling prices rose compared with last first half, so did the cost of
unprocessed metal.
The Auto Parts Business' cost of goods sold increased $45.3$7.4 million over the prior year. The cost of goods
sold as a percentage of revenues decreased from 85% foror 36% during
the first half of fiscal 20032005 as compared to 83%the cost of goods sold for the same
period of last fiscal year. The higher cost of sales was primarily due to higher
car purchase costs that resulted from higher scrap metal prices and the addition
of seven new stores since last year. As a percentage of revenues, cost of goods
sold remained consistent with the prior year. Gross profit increased $5.4
million or 38% over the first half of the prior year related to increased
wholesale revenue earned from the higher market rates for scrap metals.
The Steel Manufacturing Business' cost of goods sold increased $8.0 million or
7% during the first half of fiscal 2005 as compared to the cost of goods sold
for the first half of fiscal 2004. As a result, gross profit
increased by $12.4 million to $32.3 million. The increase in gross margin in the
first six monthspercentage of fiscal 2004 is attributable to higher average selling prices
per ton and higher sales volumes partially offset by higher average amounts paid
for unprocessed metal and higher export sales shipping costs compared with the
first six months of fiscal 2003.
During the first six months of fiscal 2004,revenues, cost of goods
sold for the Steel
Manufacturing Business increased $23.7 million compared to the same period last
year and decreased as a percentage of revenues from 101% to 96%. This decrease
is attributable to higher average selling prices, higher sales volumes and the
receipt of the $1.8 million electrode price fixing settlement. Gross margin
improved from a loss of $1.1 million to a profit of $4.2 million compared with the first half of lastfiscal 2004 from 96% to 85%. The
average cost of goods sold per ton increased $128 per ton or 40% compared to the
prior year six month period, which was primarily duecaused by higher raw material
costs for recycled metal and alloys and the effects of the melt shop shut down
in December 2004. The increase in cost of sales was more than offset by the $195
per ton increase in average net selling price, and gross profit improved by
$15.8 million, to higher average selling prices,
higher sales
21$20.0 million for the six month period ended February 28,
2005.
23
SCHNITZER STEEL INDUSTRIES, INC.
volumesJOINT VENTURES. The Joint Ventures in the metals recycling business
predominantly sell recycled ferrous and the electrode price fixing settlement. This improvement is partially
offset by higher raw material and conversion costs compared with the first six
months of fiscal 2003.
The Auto Parts Business' cost of sales as a percentage of revenues increased to
59% from 57% duringnonferrous metals. Revenues for this
segment in the first half of fiscal 2004 as2005 increased $492.6 million or 79%
compared to the fiscal 2003
period due primarily to higher labor and car purchase costs.
JOINT VENTURES. For the six months ended February 29, 2004, revenues for Joint
Ventures in the Metals Recycling Business increased by $258.1 million from the
first six months of last year. The increase was primarily due to higher average
net sales prices for ferrous metals and higher ferrous sales volumes for the
Brokering Joint Venture. These higher average sales prices were caused by the
same market conditions as described for the Metals Recycling Business. The
higher sales volumes are a result of increased market share at the Brokering
Joint Venture. For the first six months of fiscal 2004, income recognized from
these joint ventures increased by $5.5 million over the first six months of
fiscal 2003 to $15.1 million. The improved operating results were primarily
caused by higher average net selling prices per ton and higher sales volumes.
GENERAL AND ADMINISTRATIVE EXPENSE. For the six months ended February 29, 2004,
general and administrative expense increased $2.4 million overwith the same period last year primarily due to a 60% higher bonus accruals givenaverage
net selling price per ton and a 28% increase in the volume of ferrous recycled
metal sold, over the prior year period. The increase in the average net selling
price per ton was due to the same supply and demand circumstances described
earlier for the Company's improved
performancewholly-owned businesses.
The Company's share of Joint Venture operating income for the first six months
of fiscal 2005 increased to $36.7 million from $14.6 million in the first half
of fiscal 2004. The increase in income from these Joint Ventures was primarily
caused by higher selling prices and costs associatedvolumes. The Company's share of operating
income from the global brokering joint venture increased from $5.1 million in
the first half of fiscal 2004 to $7.0 million in the first half of fiscal 2005,
a 38% increase. The Company's share of joint venture operating income in the
first half of fiscal 2005 included a charge of $2.6 million for its share of
environmental costs. During the first half of fiscal 2005, in connection with
the Company's compliance with Section 404negotiation of a possible transaction for the split-up of the Company's
metals recycling Joint Ventures with Hugo Neu Corporation, the Company conducted
an environmental due diligence investigation of certain of its joint venture
businesses it proposes to directly acquire, and identified certain environmental
risks for which estimated remediation costs were accrued. The Company's share of
joint venture operating income in the first half of fiscal 2005 also included an
estimated $2.6 million from a joint venture contract with New York City for the
processing and disposal of curbside recycling materials that commenced in April
2004. The contract with New York City is an interim contract, and the Company's
present intention is not to participate in the anticipated long-term contract.
Therefore, the income stream from this contract could end at any time.
GENERAL AND ADMINISTRATIVE EXPENSE. Compared with the first six months of fiscal
2004, general and administrative expense for the same period this fiscal year
increased $5.1 million or 29%. Approximately $2.1 million of the change is
related to increased headcount primarily in the Auto Parts Business for
development of its management infrastructure to allow growth of this business
segment. In addition, the Company incurred increased expenses related to
Sarbanes-Oxley Act.compliance and other professional fees including $0.9 million
related to the Audit Committee's investigation of payment practices in the Far
East. As a percentage of revenues, general and administrative expense has
decreased by 0.6% percentage points, from 7%6.1% to 6%5.5% due to spreading fixed coststhese
expenses over higher revenues.
ENVIRONMENTAL MATTER. During the first half of fiscal 2005, the Company
recorded environmental charges of $8.2 million for additional estimated costs
related to the ongoing remediation of the head of the Hylebos Waterway adjacent
to the Company's Tacoma, Washington metals processing facility. An estimate of
this liability was initially recognized as part of the 1995 acquisition of the
Tacoma facility. The cost estimate was based on the assumption that dredge
removal of contaminated sediments would be accomplished within one dredge season
during July 2004 - February 2005. However, due to a variety of factors,
including equipment failures, dredge contractor operational issues and other
dredge related delays, the dredging was not completed during the first dredge
season. As a result, the Company increased its environmental accrual by $8.2
million related to this project primarily to account for additional estimated
costs to complete this work during a second dredging season. The Company has
asserted a claim for relief from the dredge contractor to seek relief for a
significant portion of the increased costs, and is currently engaged in
mediation of this dispute. However, generally accepted accounting principles do
not allow the Company to recognize the benefits of any such relief until receipt
is highly probable.
INTEREST EXPENSE. ForInterest expense for the first half of fiscal 2005 decreased
32% to $0.6 million compared with the first half of fiscal 2004. The decrease
was a result of lower average debt balances during the first six months ended February 29, 2004, interest expense
increased $0.2 million to $0.9 millionof
fiscal 2005 compared with the same period last year.
The increase was primarily a result of higher average borrowings year over year.in fiscal 2004.
24
SCHNITZER STEEL INDUSTRIES, INC.
INCOME TAX PROVISION. The tax rate of 34.8% for the first six months of fiscal
20042005 was approximatelyhigher than the 23%, compared with a tax rate of 26% for the first six months of
fiscal 2003. The Company's $6.1 million deferred tax valuation allowance was
reversed in this quarter, resulting in a corresponding reduction in the income
tax provisionsame period last year for the period, which was offset in part by a change in the
estimate of the tax benefit fromtwo main
reasons. First, the Extraterritorial Income Exclusion. ItExclusion (ETI) tax benefit on
export sales is anticipated that the rate will be 34% in the third and fourth quarter of fiscal
2004 reflecting the full utilization of the NOL tax benefits and the lower
estimated tax benefits of the Extraterritorial Income Exclusion. The change in
the Company's GAAPprojected to decrease. Secondly, last year's tax rate associated withbenefited
from the reversalfinal release of a valuation allowance that had once offset net
operating losses. The 34.8% rate approximates the valuation
reserves had no impact on35% Federal statutory rate
because the Company's cash flow; however, the cash taxes paidprojected ETI benefits are largely offset by the Company are anticipated to continue to benefit from the NOLs through the
year 2016. See Note 5 - Income Tax Provision in the Notes to the Condensed
Consolidated Financial Statements.
PRE-ACQUISITION INTERESTS. For the six months ended February 28, 2003,
pre-acquisition interests of $2.5 million, which are net of tax, represent the
share ofprojected state
income attributable to the former joint venture partner prior to the
acquisition. See Note 3 of the Notes to the Condensed Consolidated Financial
Statements.
MINORITY INTERESTS. Minority interests, net of tax, represent the share of
income attributable to various continuing minority partners within the Auto
Parts Business segment. During the six month period ended February 29, 2004,
minority interests increased $0.3 million due to improved operating performance
at locations which have minority partners.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. The Company performed a
transitional impairment test of its goodwill and intangible assets during the
second quarter of fiscal 2003. As a result of this test, the Company recorded a
non-cash impairment charge of $983,000, effective September 1, 2002, and
reported it as a "Cumulative effect of change in accounting principle" on the
Consolidated Statement of Operations.taxes.
LIQUIDITY AND CAPITAL RESOURCES.RESOURCES
Cash provided by operations for the six months ended February 29, 200428, 2005 was $36.4$25.7
million compared with $12.4$36.4 million for the same period in the prior fiscal
year. The improveddecrease in cash flow from operations was primarily related to an
increase in inventories and accounts receivable. Inventories at the Steel
Manufacturing Business increased $23.9 million or 63% over the prior year, led
by finished goods inventory. The increase was a result of lower sales volume due
to normal seasonality that slows demand and the rebalancing of inventory levels
by distributors and fabricators in the first half of fiscal 2005. Even though
sales volumes were low, the Company continued to manufacture finished steel
products in order to meet anticipated demand for the spring construction season.
Accounts receivable balances were higher due to higher average sales prices and
timing of when export metal shipments are made and the payments from customers
are collected. The effect of these is partially offset by a significant
improvement in net income and reductions in inventory and accounts receivable forfrom the current period compared to increases in the previous year.
22
SCHNITZER STEEL INDUSTRIES, INC.Company's wholly-owned operations.
Capital expenditures for the six months ended February 29, 200428, 2005 were $10.9$15.2
million compared with $10.1$10.9 million during the first six months of fiscal 2003.2004.
The increase was primarilylargely due to improvement projects at the Company's Oakland,
California recycling facility and itsthe furnace installation at the Company's
steel mill. The Company initially
estimated that the electric arc furnace in the steel mill's melt shop would be
replaced by the end of fiscal 2004. The Company has revised that estimated
completion date and is now targeting an installation date closer to the end of
calendar 2004. The Company expects to spend approximately $14.9$33.0 million on capital
improvement projects during the remainder of fiscal 2004.
As a result of acquisitions completed in prior years the Company had $20.9
million of accrued2005.
Accrued environmental liabilities as of February 29, 2004.28, 2005 were $24.9 million.
Over the next twelve12 months, the Company expects to pay approximately $9.5$9.4 million
relating to a previously accrued remediation project in connection with one of
its metals recycling facilities located inprojects including the State of Washingtonremediation on
the Hylebos Waterway (please refer toas discussed in Note 7 - Environmental Liabilities in the
Notes4 to the Consolidated Financial Statements included in Item 8 of Form 10-K
for the fiscal year ended August 31, 2003).consolidated condensed
financial statements. Additionally, the Company expects to
require significantanticipates future cash outlays
as it incurs the actual costscost relating to the remediation of other suchidentified
environmental liabilities. The future cash outlays are anticipated to be within
the amounts established as environmental liabilities.
As of February 29, 2004,28, 2005, the Company had a committed unsecured bank credit
facility totaling $150 million that matures in May 2006. The credit facility
contains a provision whereby the Company may, upon obtaining consent of the bank
group, extend the term of the agreement by one year to May 2007. The Company has
provided notice of its intention to request such an extension and the bank group
has agreed to the request. The extension is subject to the Company providing
standard representations and warranties as of the May 2006 original maturity
date. The Company currently anticipates it will be able to provide the required
representations and warranties and the agreement will be extended. The Company
also had anhas additional unsecured line of credit of $10lines totaling $20 million, which isare
uncommitted. The Company's debt agreements have certain restrictive covenants.
As of February 29,
2004,28, 2005, the Company had aggregate bank borrowings outstanding
under these facilities of $40.0 million and was in compliance with such
covenants and had aggregate bank
borrowings outstanding of $75 million.covenants.
In July 2002, the Company's metals recycling joint ventures with Hugo Neu
Corporation entered into a $70 million revolving credit facility ("JV(JV Credit Facility")Facility) with a
group of banks for working capital and general corporate purposes. Prior to that
time, the joint ventures' working capital and other cash needs had been met by
advances provided equally by the Company and its partner, Hugo Neu Corporation.
During February 2004, the facility was increased to $110 million. The JV Credit
Facility expires inon July 200431, 2005 and is secured by the inventory and
receivables of the joint venture businesses. The Company is not a guarantor of
the JV Credit Facility. The JV Credit Facility has a number of covenants and
restrictions, including restrictions on the level of distributions to the joint
venture partners. As of February 29, 2004, theThe joint ventures were in compliance with such covenants. Borrowingsthese covenants as
of February 28, 2005. As of February 28, 2005, $12.9
25
SCHNITZER STEEL INDUSTRIES, INC.
million was outstanding under the JV Credit Facility
totaled $79.0 million at February 29, 2004.Facility. The increased borrowing levels weredecline in borrowings
outstanding of $70.0 since November 30, 2004 was primarily caused by additional working capital requirements resultingthe result of strong
earnings from carrying higher levelsthe joint venture businesses and reductions in inventories. Upon
expiration of inventory for the Brokering Joint Venture. Also,
during the quarter ended May 31, 2004, the Joint Ventures expect to obtain an
additional $36 million in secured financing to purchase three new automobile
shredders.
The JV Credit facility mentioned above includes restrictionsFacility, the Company and its partner will need to
revert to funding the cash needs of the joint ventures on the level ofan equal basis.
The joint venture agreements allow for distributions to the joint venture
partners. Over the last 18 months,eighteen month period ended February 28, 2005, the Company
has recorded $39.4$98.2 million ofin operating income representing its share in the
earnings of joint ventures. During the six months ended February 28, 2005, the
joint ventures. However,ventures distributed cash of $40.0 million to the Company has not received cash
distributions. Instead,Company. The difference
between the Hugo-Neuoperating income recognized by the joint ventures haveand cash
distributions received has been utilizing all of
their available cashutilized by the joint ventures to fund expansion
of working capital, business growth, and investment in state-of-the-art
equipment to improve the efficiencies and capabilities of their businesses.business.
The joint ventures in the metals recycling business are purchasing and
installing one new mega-shredder and related equipment in fiscal 2005 for an
estimated cost of $12 million. In addition, the joint ventures will purchase
equipment and begin the long-term construction planning for the installation of
two additional mega-shredders and related equipment that are anticipated to be
completed in fiscal 2006.
The Company makes contributions to a defined benefit pension plan, several
defined contribution plans and several multiemployer pension plans.
Contributions vary depending on the plan and are based upon plan provisions,
actuarial valuations and negotiated labor agreements. The Company anticipates
making contributions of approximately $6.0 million to the various pension plans
in fiscal 2005.
Pursuant to a stock repurchase program, which began October 2000, the Company is authorized to repurchase
up to 3.0 million shares of its stock when the market price of the Company's
stock is not reflective of management's opinion of an appropriate valuation of
the stock. Management believes that repurchasing shares under these conditions
enhances shareholder value. During the first six months of fiscal 2004,2005, the
Company made no share repurchases. As of February 29, 2004,28, 2005, the Company had
repurchased a total of 1.3 million shares under this program.
23
SCHNITZER STEEL INDUSTRIES, INC.
The Company believes that its current cash balance,resources, internally generated funds,
and existing credit facilities and access to the capital markets will provide
adequate financing for capital expenditures, working capital, joint ventures,
stock repurchases, debt service requirements, post retirement obligations and
future environmental obligations for the next twelve months. In the longer term,
the Company may seek to finance business expansion with additional borrowing
arrangements or additional equity financing.
OUTLOOK. As mentioned earlier, the ferrous recycled metal market continuedRecycled metals markets continue to strengthen throughout the second quarter of fiscal 2004. However, the market for
recycled metal continues to remain volatile and difficult to predict. The Metals
Recycling Business normally accepts orders 60 to 90 days before shipment.experience significant price
volatility; however, consumption remains strong. Based upon the Company's
wholly-owned Metals Recycling Businesses' third quarter 2004current order backlog, contracted
average selling prices that are on average, significantly higher than the amounts
realizedexpected to be shipped in the second quarter of fiscal 2004 and the third quarter of
fiscal 2003. Third2005 are anticipated to be slightly lower than the amounts reported in
its second fiscal quarter 2004of fiscal 2005. The Metals Recycling Business' third
quarter 2005 ferrous sales volumes arevolume is anticipated to be in the general
range of last year's third quarter level.430,000 to 475,000
ton range. Ocean freight rates continue to remain high from a historical context however, it appears freight ratesand are
beginningexpected to stabilize and may begin to show a modest decline in the coming months.approximate second quarter 2005 levels. The cost of unprocessed
ferrous metal also remains very competitive and volatile. We
anticipate the cost of unprocessed metal to generally follow the trend of market
selling prices.volatile, which may adversely
impact third quarter 2005 margins.
The joint venture processors in the metals recycling business are anticipatedexpected to
experience similar market trends as the Company's wholly ownedwholly-owned Metals Recycling
Business; however, their financial results may vary depending on geographical
locations, competition and other factors. The domestic economy appears to be improving, which has spurred an increase in
demand for finished steeljoint venture businesses located
on the Northeastern seaboard of the United States experienced unusually harsh
and has benefited the Company's Steel Manufacturing
Business. Overprolonged winter weather over the last few months, finished steel selling prices steadily rose
across all product lines. Finished steelwhich reduced the inbound
flow of recycled metal into the processing facilities. The reduced flow is
anticipated to reduce third quarter sales volumes traditionally increase involumes.
26
SCHNITZER STEEL INDUSTRIES, INC.
The Auto Parts Business generally experiences one of its strongest periods for
retail demand during the Company's third fiscal quarter due to seasonal improvements in demand. However,
management believes that certainimproving weather
conditions allowing customers appeargreater access to have built inventories
during the second quarter, whichparts inventory. The Auto Parts
Business continues to experience increasing costs to procure inventory due to
rising ferrous metal prices. This trend is expected to modestly reducecontinue into the third
quarter of fiscal 2005 and may impact margins.
The Steel Manufacturing Business's sales volumes. It'svolumes have been abnormally low over
the last two fiscal quarters as its customers, steel distributors and
fabricators, reduced their inventories. During this time, we understand end user
consumption remained good. Sales volumes during the first month of the Company's
third fiscal quarter rebounded and are strong today. It is anticipated that
third quarter 2005 sales volumes will be in
excess of 150,000 tons. Market prices are expected to continue to rise
throughout theapproximate last year's third quarter. The higher sellingquarter
levels. Third quarter 2005 average sales prices are anticipated to beapproximate
the average prices realized during the second quarter. Steel conversion costs
are expected to decline in the third quarter as production levels improve over
the second quarter; however, rising alloy, refractory and electrode costs are
expected to partially offset by higher raw material costs. Overall, it is estimatedreduce the benefits received from the increased
productivity.
On May 5, 2004, the Company announced its intention to explore strategic
alternatives for its Steel Manufacturing Business, including the possible sale
or merger of the business. Since this time, the Company actively marketed the
mill for sale, but was unable to achieve acceptable terms to effect a sale. The
Company continues to believe that the Steel Manufacturing Business will beis not a
long-term strategic asset, but believes the current business prospects are
attractive. Accordingly, the Company plans to continue to be profitableoperate and maintain
this business into the foreseeable future and will review strategic alternatives
in the future as opportunities arise.
The Company's effective third quarter of fiscal 2004.
The Auto Parts Business typically experiences increased retail demand in the
third quarter of each year as customer admissions increase in concert with
improving weather conditions. Wholesale revenues should remain strong and may
improve modestly over the second quarter of this fiscal year. The anticipated
increase in revenuestax rate is expected to be offset in part by higher inventory costs.approximate 35%.
The Auto Parts Business's operating profits are also anticipated to benefit from
the addition of the three new Canadian stores.
Overall, the Company estimates its third quarter 20042005 operating income from operations to be in the $38$46
million to $43$53 million range. This amount compares to operating income from
operations of $22.0$67.3
million reported for the third quarter of fiscal 2003.2004.
Over the last few years, the Company has provided in its quarterly reports a
range of its estimated operating income for the next quarter to assist the
public in understanding its business trends. The Company's effective tax rate shouldCompany recently assessed this
practice in consultations with its financial and legal advisers, reviewed
reporting trends of other publicly traded companies, and determined that it will
no longer provide quantitative earnings guidance beginning with future reports.
It will however, continue to benefit from
Extraterritorial Income Exclusion benefits associated with certain export sales.
These, as well as other factors, including increased profitability, should
resultprovide qualitative guidance in an effective fiscal 2004 annual tax rate in the 29% to 30% range.future reports.
FACTORS THAT COULD AFFECT FUTURE RESULTS. Management's Discussion and Analysis
of Financial Condition and Results of Operations, particularly "Outlook" above,
contains forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Act of 1934, that are
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. One can generally identify these forward-looking statements
because they contain "expect", "believe" "anticipate", "estimate" and other
words which convey a similar meaning. One can also identify these statements as
24
SCHNITZER STEEL INDUSTRIES, INC.
they do not relate strictly to historical or current facts. Examples of factors
affecting Schnitzer Steel Industries, Inc.'s consolidated operations and its
joint ventures (the Company) that could cause actual results to differ
materially are the following:
CYCLICALITY AND GENERAL MARKET CONSIDERATIONS:Cyclicality and General Market Considerations: Purchase and selling prices for
recycled metals are highly cyclical in nature and subject to worldwide economic
conditions. In addition, the cost and availability of recycled metals are
subject to global supply and demand conditions which are volatile and beyond the
Company's control, resulting in periodic fluctuations in recycled metals prices
and working capital requirements. While the Company attempts to maintain and
grow margins by responding to changing recycled metals selling prices through
adjustments to its metals purchase prices, the Company's ability to do so is
limited by competitive and other market factors. Additionally, changing prices
could potentially impact the volume of recycled metal available to the Company,
the subsequent volume of processed metal sold by the Company,
27
SCHNITZER STEEL INDUSTRIES, INC.
inventory levels and the timing of collections and levels relating to the
Company's accounts receivable balances. Moreover, increases in recycled metals
selling prices can adversely affect the operating results of the Company's Steel
Manufacturing Business because increases in steel prices generally lag increases
in ferrous recycled metals prices.
The steel industry is also highly cyclical in nature and sensitive to general
economic conditions. Future economic downturns or a stagnant economy may
adversely affect the performance of the Company.
The Company expects to continue to experience seasonal fluctuations in its
revenues and net income. Revenues can fluctuate significantly quarter-to-quarterquarter to quarter
due to factors such as the seasonal slowdown in the construction industry, which
is an important consumerbuyer of both the Company's finished steel productsproducts. In addition,
weather and other
customers who buy recycled metal. The timingeconomic conditions n the United States and extent of the slowdown isabroad can also dependent on the weather.cause
fluctuations in revenue and net income.
Another factor which may affect revenues relates to the seasonal reduction in
demand for recycled metal from foreign customers who tend to reduce their finished steel production
and corresponding scrap metal requirements, during the summer months to offset
higher energy costs. Also, severe weather conditions may affect the Company's
global market conditions.
The Company makes a number of large ferrous recycled metals shipments to foreign
steel producers each year. Customer requirements, shipping schedules and other
factors limit the Company's control over the timing of these shipments.
Variations in the number of foreign shipments from quarter to quarter will
result in fluctuations in quarterly revenues and earnings. The Company's
expectations regarding ferrous metal sales prices and volumes, as well as
earnings, are based in part on a number of assumptions which are difficult to
predict (for example, uncertainties relating to customer orders, metal
availability, estimated freight rates, ship availability, weather, cost and
volume of unprocessed inventory yet to be processed, and production output, etc.).
The Auto Parts Business experiences modest seasonal fluctuations in demand. The
retail stores are open to the natural elements. During periods of extreme temperatures
and precipitation, customers tend to delay their purchases and wait for milder
conditions. As a result, retail sales are generally higher during the spring and
fall of each calendar year and lower in the winter and summer months.
Additionally, the Auto Parts Business is subject to a number of other risks that
could prevent it from maintaining or exceeding its current levels of
profitability, such as volatile supply and demand conditions affecting prices
and volumes in the markets for its products, services and raw materials;
environmental issues; local and worldwide economic conditions; increasedincreasing
competition; changes in automotive technology; the ultimate success of the
Company's growth and acquisition plans; ability to build the infrastructure to
support the Company's growth plans; and business integration and management
transition issues.
COMPETITION:Competition: The recycled metals industry is highly competitive, with the volume
of purchases and sales subject to a number of competitive factors, principally
price. The Company competes with both large and numerous smaller companies in
its markets for the purchase of recyclable metals. The Company also competes
with a number of domestic and foreign recycled metals processors and brokers for
processed and unprocessed metal as well as for 25
SCHNITZER STEEL INDUSTRIES, INC.
sales to domestic and foreign
customers. For example, in the recent past,2001 and 2002, lower cost ferrous recycled metals
supplies from certain foreign countries have adversely affected market selling prices
for ferrous recycled metals. Since then, many of these countries are believed to have imposed
export restrictions which have significantly reduced their export volumes and
lowered the worldwide supply of ferrous recycled metals. These restrictions are
believed to have had a positive effect on the Company's selling prices. Given
the intricacies in which the global markets operate, the Company cannot predict
when or if foreign countries will change their trading policies and what effect,
if any, such changes might have on the Company's operating results.
28
SCHNITZER STEEL INDUSTRIES, INC.
From time to time, both the United States and foreign governments impose
regulations and restrictions on trade in the markets in which the Company
operates. In the second quarter of fiscal 2005, the Company received a
certificate from China that allows the Company to continue shipping recycled
metals into China. The certificate is part of a process designed to ensure safe
industrial and agricultural production in China. Also, it is not unusual for
various constituencies to petition government entities to impose new
restrictions or change current laws. If imposed, these restrictions could affect
the Company's margins as well as its ability to ship goods to foreign customers.
Alternatively, restrictions could also affect the global availability of ferrous
recycled metals, thereby affecting the Company's volumes and margins. As a
result, it is difficult to predict what, if any, impact pending or future trade
restrictions will have on the operations of the Company.
SomeFor the Metals Recycling Business, some of the more significant domestic
competitors include regional steel mills and their brokers who compete for
recycled metal for the purpose of providing the mill with feedstock to produce
finished steel. During periods when market supplies of metal are in short
supply, these buyers may, at times, react by raising buying prices to levels
that are not reasonable in relation to more normal market conditions. As a
result, the Company may have to raise its buying prices to maintain its
production levels which may result in compressed margins.
The domestic steel industry also is highly competitive. Steel prices can be
highly volatile and price is a significant competitive factor. The Company
competes domestically with several steel producers in the Western United States
for sales of its products. In recent years, the Company has experienced
significant foreign competition, which is sometimes subsidized by large foreign
government agencies. There can be no assurance that such competition will not
increase in the future. In March and April 2002, the ITC imposed tariffs on
imported steel, under Section 201 of the 1974 Trade Act, to temporarily aid the
domestic steel industry. On December 4, 2003, President Bush, in response to
pressure by the World Trade Organization, terminated these tariffs. However,
management is of the belief that the tariffs did not significantly benefit
selling prices for finished steel products on the West Coast of the United
States. In the spring of 2002, the U.S. Government imposed anti-dumping and
countervailing duties against wire rod products from eight foreign countries.
These duties have assisted the Company in increasing sales of wire rod products;
any expiration or termination of the duties could have a corresponding adverse
effect.
In December 2002, Nucor Corporation ("Nucor") assumed ownership of the assets of
Birmingham Steel Corp., and acquired a steel manufacturing business in Seattle,
Washington. Nucor Corporation, the leader in setting finished steel prices in
the Company's finished steel markets, has a significant share of the West Coast
steel market and is considered an aggressive competitor. The long term impact,
if any, which Nucor's ownership and operation of Birmingham Steel's Seattle
facility will have on the Steel Manufacturing Business' and the Metals Recycling
Business' operating results cannot be determined at this time. Additionally,
until recently the Steel Manufacturing Business also competed with the North
Star steel mill in Kingman, Arizona, a producer of wire rod and rebar products,
which was sold to Nucor. That facility is currently idle, but any future
start-up of its operations could negatively impact the Company's recycled metal
and finished steel markets, prices and margins.
The Auto Parts Business competes with both full-service and self-service auto
dismantlers as well as larger well financed more traditional retail auto parts
chains for retail customers. Periodically, the Auto Parts Business increases
prices, which may affect customer flow and buying patterns. Additionally, in
markets where the Company has only a few stores, it does not have the same
pricing power it experiences in markets where it has more than one store in
which it operates. As this segment expands, the Company may experience new
competition from others attempting to replicate the Company's business model.
The ultimate impact of these dynamics cannot be predicted. Also, the business
competes for its automobile inventory with other dismantlers, used car dealers,
auto auctions and 26
SCHNITZER STEEL INDUSTRIES, INC.
metal recyclers. Inventory costs can fluctuate significantly
depending on market conditions and prices for recycled metal.
GEOGRAPHICAL CONCENTRATION:The domestic steel industry also is highly competitive. Steel prices can be
highly volatile and price is a significant competitive factor. The Company
competes domestically with several steel producers in the Western United States
for sales of its products. In recent years, the Company has experienced
significant foreign competition, which is sometimes subsidized by large
government agencies. There can be no assurance that such competition will not
increase in the future. In the spring of 2002, the U.S. Government imposed
anti-dumping and countervailing duties against wire rod products from eight
foreign countries. These duties have assisted the Company in increasing sales of
wire rod products; any expiration or termination of the duties could have a
corresponding adverse effect. The Company has experienced increased competition
for certain products by foreign importers during fiscal 2005. The Company
believes that the rise in import levels is attributable to the increase in
selling prices in the West Coast market, which potentially allow the import
sales to be more profitable to the foreign companies.
The steel manufacturing industry has been consolidating over the last several
years and as a result several west coast manufacturing facilities have been
closed and remain idle. Any future start-up of operations of the currently idle
facilities could negatively impact the Company's recycled metal and finished
steel markets, prices, margins and potentially, cash flow.
Geographical Concentration: The Company competes in the scrap metal business
through its wholly-owned Metals Recycling Business as well as through its joint
venture businesses. Over the last few years, a significant portion of the
revenues and operating profits earned in these segments have been generated from
sales to Asian countries, principally China and South Korea. In addition, the
Company's sales in these countries are also concentrated with relatively few
customers that vary depending on buying cycles and general market conditions.
Due to the concentration of sales in these countries and to a relatively small
customer base, a significant change in buying patterns, change in political
events, change in regulatory requirements, tariffs and other export restrictions
within
29
SCHNITZER STEEL INDUSTRIES, INC.
the United States or these foreign countries, severe weather conditions or
general changes in economic conditions could adversely affect the financial
results of the Company.
JOINT VENTURES:Ferrous Sales to Far East: As discussed in Part II, Item 1 "Legal Proceedings"
in this Form 10-Q, the Company recently terminated its practice of paying
commissions to the purchasing managers of customers in connection with export
sales of recycled ferrous metals to the Far East. Termination of this practice
could put the Company at a competitive disadvantage and could have a negative
impact on the Company's ferrous metal sales volumes and prices. In addition,
termination of this practice could have a greater impact under weaker ferrous
metal market conditions. The Company is therefore unable to determine whether
the termination of this practice will have an adverse effect on its customer
relationships or business.
Union Contracts: The Company has a number of union contracts that expire in
fiscal year 2005. Labor contract negotiations opened during the second quarter
of fiscal 2005 with the union at the Steel Manufacturing Business. If the
Company is unable to reach agreement on the terms of a new contract with any of
these unions, the Company could be subject to work slowdowns or work stoppages.
Post Retirement Benefits: The Company has a number of post retirement benefit
plans that include defined benefit, Supplemental Executive Retirement Benefit
Plan (SERBP) and multiemployer plans. The Company's contributions to the defined
benefit and SERBP plans are based upon actuarial calculations which are based on
a number of estimates including the expected long-term rate of return on plan
assets, allocation of plan assets between equity or fixed income investments,
expected rate of compensation increases as well as other factors. Changes in
these actual rates from year to year cause increases or decreases in the
Company's annual contributions into the defined benefit plans and changes to the
expenses recognized in a current fiscal year. Management and the actuary
evaluate these rates annually and adjust if necessary.
The Company's union employees participate in a number of multiemployer pension
plans. The Company is not the sponsor or administrator of these multiemployer
plans. Contributions are determined in accordance with provisions of the
negotiated labor contracts. The Company is unable to determine its relative
portion or estimate its future liability under the multiemployer pension plans.
The Company learned during the fourth quarter of 2004 that one of the
multiemployer plans would not meet ERISA minimum funding standards for the plan
year ending September 30, 2004. The trustees of that plan have applied to the
Internal Revenue Service for certain relief from this minimum funding standard,
but cannot determine whether this relief will be granted. Absent relief, the
plan's contributing employers will be required to make additional contributions
or pay excise tax that may equal or exceed the full amount of that deficiency.
The Company estimates its share of the required additional contribution for the
2004 plan year is approximately $1.1 million and has accrued for such amount in
fiscal 2004.
Joint Ventures: The Company has significant investments in joint venture
companies. The Company does not managecompanies, the most substantial of which are its five metals recycling joint
ventures with Hugo Neu Corporation (HNC). In each case, the day-to-day
activities of these
businesses.the joint venture business are managed by the Company's joint
venture partner, not the Company. As a result, itthe Company does not have the
same ability to control or predict the operations, cash flow, expenditures,
debt, and related financial results as it does with its consolidated businesses.
TheseTherefore, it is difficult to predict the financial results of the joint
ventures.
In recent years, the Company's relationship with the chief executive officer of
HNC, its most significant joint venture partner, has deteriorated. There have
been disagreements regarding business decisions as well as personality clashes,
but the Company does not believe that these issues have materially affected the
operations or operating results of the joint ventures, which have shown dramatic
financial improvement since fiscal 2000. The Company is currently disputing
HNC's recent unilateral assertion of a right to be paid certain commissions on
sales by the joint venture engaged in global brokering of recycled metals, as
described in more detail in Note 5 of Notes to Consolidated Financial
Statements.
30
SCHNITZER STEEL INDUSTRIES, INC.
The Company believes it desirable for the Company and HNC to end the current
joint venture relationships; however, the joint venture agreements do not
provide for a mechanism to break up the ventures. The Company and HNC are
presently engaged in active negotiation of a possible transaction under which
the joint ventures would be terminated and assets divided. There can be no
assurance that these negotiations will result in a transaction.
The joint venture businesses are however, affected by many of the same risk factors
mentioned in this document. Therefore, it is
difficult to predict the financial results of these businesses. Additionally, two of these joint ventures continue
to use LIFO inventory accounting, which tends to defer income taxes.
Historically, the effects of LIFO adjustments, which are recorded during the
fourth quarter of each fiscal year, have been difficult to predict.
ENERGY SUPPLY:Replacement or Installation of Capital Equipment: The Company and its joint
venture partners install new equipment and construct facilities or overhaul
existing equipment and facilities (including export terminals) from time to
time. Some of these projects take several months to complete, require the use of
outside contractors and experts, require special permits and easements and have
higher degrees of risk. Examples of such major capital projects include the
installation of a mega-shredder at a metal recycling yard, the overhaul of an
export loading facility or the furnace replacement at the steel mill. Many times
in the process of preparing the site for installation, the Company is required
to temporarily halt or limit production for a period of time. If problems are
encountered during the installation and construction process, the Company may
lose the ability to process materials which may impact the amount of revenue it
is able to earn or may increase operating expenses. In either case, the
Company's ability to reasonably predict financial results may be hampered.
Reliance on Key Pieces of Equipment: The Company and its joint venture partners
rely on key pieces of equipment in the various manufacturing processes. Key
items include the shredders and ship loading facilities at the metals recycling
locations and the transformer, furnace, melt shop and rolling mills at the
Company's steel manufacturing business, including the electrical power and
natural gas supply into all of our locations. If one of these key pieces of
equipment were to have a mechanical failure and the Company were unable to
correct the failure, revenues and operating impact may be adversely impacted.
Where practical, the Company has taken steps to reduce these risks such as
maintaining a supply of spare parts, performing a regular preventative
maintenance program and maintaining a well trained maintenance team that is
capable or making most of the Company's repairs.
Energy Supply: The Company and its joint ventures utilize various energy sources
to operate their facilities. In particular, electricity and natural gas
currently represent approximately 9%8% of the cost of steel manufactured for the
Company's Steel Manufacturing Business. The Steel Manufacturing Business
purchases electric power under a long-term contract from McMinnville Water &
Light (McMinnville), which in turn relies on the Bonneville Power Administration
(BPA). Historically, these contracts have had favorable prices and are long-term
in nature. The Company has a five-yearCompany's electrical power contract that expires in September 2006.2011. On
October 1, 2001, the BPA increased its electricity rates due to increased demand
on the West Coast and lower supplies. This increase was in the form of a Cost
Recovery Adjustment Clause (CRAC) added to BPA's contract with McMinnville. The
CRAC is an additional monthly surcharge on selected power charges to recover
costs associated with buying higher priced power during the West Coast power
shortage. Because the BPA can adjust the CRAC every six months, it is not possible
to predict future rate changes.
The Steel Manufacturing Business also has a contract for natural gas.gas at $4.50
per MMBTU. The current annual contract expires on OctoberMay 31, 2009 and obligates the
business to purchase minimum amounts of gas at a fixed rate. Effective November
1, 2004, the natural gas rate was reduced to $4.39 per MMBTU. This is a take or
pay contract with a minimum average usage of 3,575 MMBTU per day. Gas not used
is sold on the open market and reflected a 15% increase
over the previous year's contract.gains or losses are recorded in cost of sales.
31
SCHNITZER STEEL INDUSTRIES, INC.
If the Company is unable to negotiate favorable terms of electricity, natural
gas and other energy sources, this could adversely affect the performance of the
Company.
TAX LAWS:Environmental Matters: The Company records accruals for estimated environmental
remediation claims. A loss contingency is accrued when the Company's assessment
indicates that it is probable that a liability has been ableincurred and the amount
of the liability can be reasonably estimated. The Company's estimates are based
upon currently available facts and presently enacted laws and regulations. These
estimated liabilities are subject to reduce its effectiverevision in future periods based on actual
costs, new information or changes in laws and regulations.
Tax Laws: The Company's tax rate below the
federal statutory tax rate for each of the last three years by using a
combination of Net Operating Loss Carryforwards (NOLs),has benefited from state
income tax credits, in Statefrom the federal Extraterritorial Income Exclusion (ETI) on
export sales, and from the final releases of California Enterprise Zones,a valuation allowance once
offsetting the net operating losses that had accompanied a 1996 business
acquisition. The Company's present and tax benefits associated with making foreign
sales. Futurefuture tax rates are apt to be higher, though,will likely benefit only
from the first of these three factors because the NOLs have been
fully usedrecently-enacted American Jobs
Creation Act of 2004 (the Act) eliminated the ETI benefit and because there is
no further valuation allowance to release. Compensating for GAAP purposes and discoverythe Company's loss
of a significant amount of further
credits is not anticipated. Furthermore, Federal legislation has been proposed
to eliminate or mitigateETI benefit will be the foreign sales tax benefits. The Company cannot
predictnew deduction under the likelihood of enactmentAct for Qualified Production
Activities Income, but the effect of this or any other proposed legislation.
CURRENCY FLUCTUATIONS:new deduction on the Company's
effective tax rate will be not be determinable until final regulations
explaining it are issued. Currently, a tax rate between 34% and 37% is projected
for fiscal 2005.
Currency Fluctuations: Demand from the Company's foreign customers is partially
driven by foreign currency fluctuations relative to the U.S. dollar. Recent
weakness of the U.S. dollar relative to foreign currencies is believed to have
hadhas been a
significant effectfactor in the increases in recycled metals prices over the last
year, as well as resulted in increasing the cost of certain finished steel
imports. Strengthening of the U.S. dollar could adversely affect the
competitiveness of the Company's products in the markets in which the Company
competes. Additionally, global economic forces can cause fluctuations in the
currency of the foreign countries in which the
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SCHNITZER STEEL INDUSTRIES, INC.
Company competes as well as trigger a revaluation of that currency. The Company has no control over such fluctuations and, as such, these
dynamics could affect the Company's revenues and earnings.
SHIPPING AND HANDLING:Shipping and Handling: Both the Metals Recycling Business and the Steel
Manufacturing Business often rely on third parties to handle and transport their
products to end users in a timely manner. The cost to transport the products in
particular by ocean freight, can
be affected by circumstances over which the Company has no control such as fuel
prices, political events, governmental regulations on transportation and changes
in market rates due to carrier availability. In estimating future operating
results, the Company makes certain assumptions regarding shipping costs.
The Metals Recycling Business relies on ocean freight carriers to deliver
product to overseas customers. Given the recent tightness in the ocean freight
market, the Company has experienced significant increases in its shipping costs
which have adversely affected operating income. Since it is difficult to predict
the future costs for shipping the Company's products, actual resultresults could
differ materially from forecasts.
The Steel Manufacturing Business relies on the availability of rail cars to
transport finished goods to customers and raw materials to the mill for use in
the production process. Market demand for rail cars along the west coast has
been very high which has reduced the number of rail cars available to the Steel
Manufacturing Business to transport finished goods. In estimating quarterly volumesaddition, adverse weather
conditions in California have caused certain rail lines to be damaged. The
damaged lines may have an impact on the availability of ferrous metal exports,additional rail cars in
the future and may also increase the cost for the Company makes
assumptions regardingto deliver its
finished steel products to the anticipated timingCalifornia construction market. In addition, the
Steel Manufacturing Business utilizes rail cars to provide an inexpensive form
of ship arrival into loading ports
andtransportation for delivering scrap metal to the estimated timemill for production.
Although the Company expects to load the ships. The actual timingbe able to maintain an adequate supply of ship departure,
and thus the ultimate revenue recognition, can vary due to ship availability,
weather, mechanical delays, and governmental regulatory delays. One export
ferrous shipment can range from 25,000 to 40,000 tons representingscrap
metal, a significantlarger portion of the Company's quarterly revenue and profit. Thus, the delay of one
shipment into the next quarter can significantly affect the quarterly financial
results.
INSURANCE:those materials are anticipated to be delivered using
trucks. The Company anticipates this change in delivery may lead to increased
raw material costs.
Insurance: The cost of the Company's insurance is affected not only by its own
loss experience but also by cycles in the insurance market. The Company cannot
predict future events and circumstances which could cause rates or claims to materially
change such as war, terrorist activities or natural disasters.
INTERCOMPANY SALES:32
SCHNITZER STEEL INDUSTRIES, INC.
Asset Acquisition and Disposition: Throughout the Company's history, it has made
a number of acquisitions and divestures as management attempts to improve the
value of the Company for its shareholders. Over the last few years this activity
has principally been limited to acquisitions related to the Auto Parts Business.
It is anticipated that the Company will continue to pursue additional expansion
of the Auto Parts Business as well as other business segments. Each acquisition
or disposition comes with its own inherent risks that make it difficult to
predict the ultimate success of the transaction. An acquisition or disposition
may have a negative and/or unexpected impact on the Company's cash flow,
operating income, net income, earnings per share and financial position.
Intercompany Sales: The Auto Parts Business sells autobodies to the Metals
Recycling Business, and the Metals Recycling Business sells ferrous recycled
metal to the Steel Manufacturing Business, at prices that are intended to
approximate market. When the Company consolidates its results in accordance with
generally accepted accounting principles, the Company eliminates the
intercompany sales and purchases and also eliminates the estimated profit
remaining in inventory ("Profit Elimination") at the end of each reporting
period. In estimating future operating and financial performance, the Company
makes assumptions regarding the forecasted Profit Elimination computation and
its impact on the quarterly financial results of the Company. Small variations
in price, sales volume, production volume, and purchase prices and volumes from
both within the Company and from third parties can result in significant
differences between forecasted Profit Elimination and actual results.
One should understand that itIt is not possible to predict or identify all factors that could cause actual
results to differ from the Company's forward-looking statements. Consequently,
the reader should not consider any such list to be a complete statement of all
potential risks or uncertainties. Further, the Company does not assume any
obligation to update any forward-looking statement.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company periodically uses derivative financial instruments to limit exposure
to changes in interest rates. Because such derivative instruments are used
solely as hedges and not for speculative trading purposes, they do not represent
incremental risk to the Company. For further discussion of derivative financial
instruments, refer to "FAIR VALUE OF FINANCIAL INSTRUMENTS" in the consolidated
Financial Statements included in Item 8 of Form 10-K for the fiscal year ended
August 31, 2003.
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SCHNITZER STEEL INDUSTRIES, INC.2004.
ITEM 4. CONTROLS AND PROCEDURES
Schnitzer Steel Industries, Inc. management, under supervision of the Chief
Executive Officer and Chief Financial Officer, is responsible for establishing
and maintaining disclosure controls and procedures for Schnitzer Steel
Industries, Inc. and its subsidiaries. As of February 29, 2004,28, 2005, with the
participation of the Chief Executive Officer and the Chief Financial Officer,
management completed an evaluation of the Company's disclosure controls and
procedures. Based upon this evaluation, the Company's Chief Executive Officer
and Chief Financial Officer have concluded that the disclosure controls and
procedures are effective to ensure that all material information relating to
Schnitzer Steel Industries, Inc. and its subsidiaries is made known to them by
others within the organization as appropriate to allow timely decisions
regarding required disclosures.
There were no changes in the Company's internal control over financial reporting
during the second fiscal quarter that have materially affected, or are
reasonably likely to materially affect, the internal control over financial
reporting.
29The Company's Audit Committee may, as a result of its investigation into Far
East payment practices discussed in Part II, Item 1 immediately below, recommend
improvements to certain aspects of the Company's internal control over financial
reporting and/or disclosure controls and procedures related to Far East
transactions.
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SCHNITZER STEEL INDUSTRIES, INC.
PART II
ITEM 4 -1. LEGAL PROCEEDINGS
The Company was advised in 2004 that its practice of paying commissions to the
purchasing manager of customers in connection with export sales of recycled
ferrous metals to the Far East may raise questions of possible violations of
U.S. and foreign laws, and the practice was stopped. Thereafter, the Audit
Committee was advised and conducted a preliminary compliance review. On November
18, 2004, on the recommendation of the Audit Committee, the Board of Directors
authorized the Audit Committee to engage independent counsel and conduct a
thorough, independent investigation and directed that the existence and the
results of the investigation be voluntarily reported to the U.S. Department of
Justice (DOJ) and the Securities and Exchange Commission (SEC), and that the
Company cooperate fully with those agencies. The investigation is ongoing, and
the DOJ and SEC have been advised of its progress. The investigation is not
expected to affect the Company's previously reported financial results,
including those reported in this 10-Q. The Company cannot predict the results of
the investigation or whether the Company or any of its employees will be subject
to any penalties or other remedial actions following completion of the
investigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The 20042005 annual meeting of the shareholders was held on January 26, 2004.31, 2005.
Holders of 12,289,65021,564,606 shares of the Company's Class A common stock,
entitled to one vote per share, and 6,180,6767,760,636 shares of the Company's Class
B common stock, entitled to ten votes per share, were present in person or
by proxy at the meeting.
(b) Robert W. Philip, Kenneth M. Novack, Gary Schnitzer, Dori Schnitzer, Carol
S. Lewis, Scott Lewis, Jean S. Reynolds, Robert S. Ball, William A. Furman,
and Ralph R. Shaw were elected directors of the Company.
(c) The meeting was called for the following purposes:
1. To elect Robert W. Philip, Kenneth M. Novack, Gary Schnitzer, Dori
Schnitzer, Carol S. Lewis, Scott Lewis, Jean S. Reynolds, Robert S.
Ball, William A. Furman, and Ralph R. Shaw as directors of the
Company.
This proposal was approved as follows:
Votes For Votes Withheld/Against
------------------- ----------------------
Robert W. Philip 69,647,938 4,448,47292,358,642 6,812,324
Kenneth M. Novack 69,618,425 4,477,98592,332,157 6,838,809
Gary Schnitzer 69,614,363 4,482,04792,323,242 6,847,724
Dori Schnitzer 69,010,912 5,085,49892,334,584 6,836,382
Carol S. Lewis 69,012,474 5,083,93692,333,124 6,837,842
Scott Lewis 68,972,704 5,123,70692,338,216 6,832,750
Jean S. Reynolds 69,014,117 5,082,29392,337,096 6,833,870
Robert S. Ball 72,436,608 1,659,80298,143,048 1,027,918
William A. Furman 72,437,708 1,659,20298,114,153 1,056,813
Ralph R. Shaw 72,437,188 1,659,222
2. To consider a shareholder proposal regarding the composition of the
Board of Directors
This proposal was rejected by the stockholders with 7,100,262 votes
cast for and 63,472,379 votes cast against. There were 49,277
abstentions and 3,474,492 broker non-votes.
3098,118,560 1,052,406
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SCHNITZER STEEL INDUSTRIES, INC.
2. To approve the proposed Executive Annual Bonus Plan.
This proposal was approved by the stockholders with 98,349,947 votes
cast for, 786,269 votes cast against and 34,750 abstentions.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(B) REPORTS ON FORM 8-K
The following report was filed on Form 8-K during the fiscal quarter ended
February 29, 2004:
On January 7, 2004, the Company filed a Current Report on Form 8-K,
to report under Item 12 the issuance of a press release announcing
financial results for the Company's quarter ended November 30,
2003.
3135
SCHNITZER STEEL INDUSTRIES, INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCHNITZER STEEL INDUSTRIES, INC.
(Registrant)
DateDate: April 14, 20048, 2005 By: /s/Barry A. Rosen
-------------- ---------------------------------------- -----------------------------
Barry A. Rosen
Vice President, Finance and
Chief Financial Officer
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