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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended August 31, 2004
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from _____________ to _____________
Commission File Number 0-22496
SCHNITZER STEEL INDUSTRIES, INC.
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(Exact name of registrant as specified in its charter)
OREGON 93-0341923
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(State of (I.R.S. Employer
Incorporation) Identification No.)
3200 N.W. YEON AVE., P.O. BOX 10047
PORTLAND, OR 97296-0047
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (503) 224-9900
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Class A Common Stock, $1 par value
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(Title of class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [_]
The aggregate market value of the registrant's voting common stock outstanding
held by non-affiliates on February 29, 2004 was $606,285,000.
The Registrant had 22,073,373 shares of Class A Common Stock, par value of $1.00
per share, and 8,272,866 shares of Class B Common Stock, par value of $1.00 per
share, outstanding at November 1, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the 2005 Annual
Meeting of Shareholders are incorporated herein by reference in Part III.
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SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
TABLE OF CONTENTS
PART ITEM PAGE
I 1. BUSINESS...........................................................3
Overview.........................................................3
Business Strategy................................................4
Metals Recycling Business........................................6
Auto Parts Business.............................................10
Steel Manufacturing Business....................................11
Environmental Matters...........................................14
Employees.......................................................17
Available Information...........................................17
2. PROPERTIES........................................................18
3. LEGAL PROCEEDINGS.................................................19
4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS.............................................19
4(a). EXECUTIVE OFFICERS OF THE REGISTRANT..............................19
II 5. MARKET FOR REGISTRANT'S COMMON EQUITY,
RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES..................................21
6. SELECTED FINANCIAL DATA...........................................22
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................23
7A QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK...............................................39
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................40
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE..........................72
9A CONTROLS AND PROCEDURES...........................................72
9B OTHER INFORMATION.................................................72
III 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT......................................................73
11. EXECUTIVE COMPENSATION............................................73
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS......................73
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................73
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES............................73
IV 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES........................74
2
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
PART I
ITEM 1. BUSINESS
OVERVIEW
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Schnitzer Steel Industries, Inc. (the Company) operates in three vertically
integrated business segments that include the wholly-owned and joint venture
metals recycling businesses, the Auto Parts Business and the Steel Manufacturing
Business. The wholly-owned Metals Recycling Business and certain joint venture
businesses collect, process and recycle metals by operating one of the largest
metals recycling businesses in the United States. The Auto Parts Business
operates as Pick-N-Pull in the United States and as Pick-Your-Part in Canada,
and the Company believes it is one of the country's leading self-service used
auto parts networks. Additionally, Pick-N-Pull is a supplier of autobodies to
the Metals Recycling Business which processes the autobodies into sellable
recycled metal. The Steel Manufacturing Business purchases recycled metals from
the Metals Recycling Business and use its mini-mill to process the recycled
metals into finished steel products. As a result of the Company's vertically
integrated business, it is able to transform autobodies and other unprocessed
metals into finished steel products. The Company believes that its Metals
Recycling, Steel Manufacturing, and Auto Parts Businesses are cost competitive
in their markets.
The Company's wholly-owned metals recycling business (the Metals Recycling
Business) and its joint ventures have major collection and processing facilities
in the following locations:
Metals Recycling Business Joint Venture Operations
------------------------- ------------------------
Tacoma, WA Portland, ME
Portland, OR Madbury, NH
Eugene, OR Everett, MA
Sacramento, CA Providence, RI
Oakland, CA Long Island, NY
Fresno, CA Jersey City, NJ
Los Angeles, CA
The Company's wholly-owned Metals Recycling Business' eleven yards, including
the major facilities shown above, sold 1.8 million ferrous tons, of which 0.2
million tons were brokered, in fiscal 2004. Approximately 63% of our recycled
ferrous metal volume was sold to Asian steel producers. As a result of the
strategic geographic locations at many of the major deep-water ports in the
United States, the Metals Recycling Business and its joint venture partners
benefit.
Through its joint ventures, the Company participates in the ownership of an
additional 28 metals recycling collection and processing facilities including
the major facilities shown above. These processing joint ventures sold 3.6
million ferrous tons in fiscal 2004. Additionally, one joint venture provides
international and domestic services, which broker metal processed by third
parties. In fiscal 2004, this brokerage business approximated 2.7 million tons.
The Auto Parts Business purchases salvaged vehicles, sells used parts from those
vehicles through its retail stores and wholesale operations, and sells the
remaining portion of the vehicles to metal recyclers. With a network of 23
retail locations in the United States and 3 retail locations in Canada, our
business model has created a competitive position in our markets due to the
consistent approach of offering customers a large selection of cars to obtain
parts and our efficient processing of autobodies. We believe our model can be
efficiently duplicated in other geographic locations and we continue to evaluate
strategic relationships in markets that we believe would provide an economic
benefit to the business.
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SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
The Company's Steel Manufacturing Business consists of its wholly-owned
subsidiary, Cascade Steel Rolling Mills, Inc. The Steel Manufacturing Business
produces steel reinforcing bar (rebar), wire rod, merchant bar, coiled rebar and
other specialty products. The Company believes that the Steel Manufacturing
Business has a competitive position in its market due to its readily available
source of recycled metals, efficient production processes, well-located shipping
and transportation facilities, access to competitively priced electric power and
proximity to California and other major western markets.
On May 5, 2004, the Company announced its intention to explore various strategic
alternatives, including the possible sale or merger of its Steel Manufacturing
Business. To date, there has not been any decision made to change the direction
of the Steel Manufacturing Business and it continues to be managed as an ongoing
business segment of the Company.
BUSINESS STRATEGY
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The Company's business strategy emphasizes continued growth of the ferrous
recycled metals business and auto parts business through accretive acquisitions,
new store developments and joint ventures, and maintaining its status as an
efficient and competitive producer of both recycled metal and finished steel
products, as well as a low-cost provider of retail and wholesale used auto
parts, through investments in state-of-the-art manufacturing equipment and
increased production efficiencies.
The Company considers itself, first and foremost, a ferrous metals recycling
company with historically over 60% of its operating income, before corporate
expenses and eliminations and impairment and other nonrecurring charges, derived
from the Metals Recycling Business and its Joint Ventures in the metals
recycling business. The Metals Recycling Business is one of the leading
processors in each of the markets in which it operates. The combined operations
of the wholly-owned Metals Recycling Business and joint venture partners make us
the largest United States exporter of scrap metals. The Company intends to
continue its focus on increasing the Company's position as one of the premier
recycled metals processors in the country.
The Company's Metals Recycling Business enters into export sales contracts by
selling forward 45 to 90 days and purchases metals on a daily basis. By knowing
the price for which the processed material will be sold and the costs involved
in processing the metals, the Company is generally able to take advantage of
this differential in timing between purchases and sales and negotiate prices
with suppliers that secure profitable transactions.
GROWTH STRATEGY. The Company has developed a multi-part growth strategy, which
includes the following elements:
o EXPAND METALS RECYCLING OPERATIONS. The Company will continue to seek
expansion opportunities within both its existing markets and elsewhere
by working to increase its sources of ferrous metals and through
selective acquisitions or through joint ventures with other metals
processors and suppliers of metal.
o EXPAND AUTO PARTS BUSINESS. In fiscal 2003, the Company acquired our
partners' interest in the joint venture and formed the Auto Parts
Business segment. The Auto Parts Business provides the Company with
strong vertical integration in Northern California. Pick-N-Pull is one
of the country's leading self-service used auto parts networks. Over
the last 15 years it has developed a strong management team and
internal systems that are believed to provide it with the ability to
efficiently replicate the business model in other locations. In fiscal
2004, the Auto Parts Business acquired the assets and leased the sites
for three self-service used auto parts stores in Canada. We intend to
seek additional expansion opportunities for the Auto Parts Business
throughout North America.
o COMPLETE VALUE CREATING ACQUISITIONS. The Company intends to complete
acquisitions it believes will create shareholder value and over the
long-term will earn after tax income in excess of its cost of capital.
With a strong balance sheet, cash flows and available borrowing
capacity, the Company believes it is in an attractive position to
complete an acquisition should one fitting the Company's long-term
strategic plans become available and if a reasonable price can be
attained.
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SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
INVEST IN STATE-OF-THE-ART PROCESSING AND MANUFACTURING. The Company's objective
is to be an efficient and competitive producer of both recycled metals and
finished steel products in order to maximize the operating margin for both
operations. To meet this objective, the Company has focused on and will continue
to emphasize the cost-effective purchasing and efficient processing of metals.
The Company has made significant investments in state-of-the art equipment to
ensure that its operations have cost effective technology to produce high
quality products and to maximize economies of scale. The Company will continue
to invest in equipment to improve the efficiency and capabilities of its
businesses. During the last five years, the Company spent $65.8 million on
capital improvements in the wholly-owned Metals Recycling Business and Steel
Manufacturing Business. The Joint Ventures in the metals recycling business
continue to invest in state-of-the-art processing equipment and environmental
technology to retain their competitive advantage and grow the business. Capital
spending by these joint ventures in fiscal 2001 through 2004 totaled over $80
million.
The wholly-owned and the Joint Ventures in the metals recycling business
continually review the state of processing equipment and evaluate whether the
current equipment is capable of efficiently processing the required quantities
and grades. Some of our significant planned additions during fiscal 2005
include:
o Install a state-of-the-art mega shredder in the Oakland, CA facility,
which will reduce operating costs and improve product quality as well
as allow us to shred materials that were not previously shredded;
o Replace key pieces of loading equipment, including adding a ship
loading conveyor system in its Tacoma facility to reduce operating
costs and increase efficiency;
o The Company is developing a reconfiguration and modernization plan for
the Portland, Oregon facility that will encompass the consideration of
a new state-of-the-art mega shredder, more efficient nonferrous
processing and ship loading facilities. Spending will likely take
place over a period of several years to complete the reconfiguration
and modernization plan.
o The joint ventures will install three state-of-the-art mega shredders,
a nonferrous sorting system and will complete significant work on
docks, and storm water processing and collection systems, all aimed at
improving production efficiency.
In addition, all three of the Metals Recycling Business' export facilities
continue to invest in sorting technologies to recover increased volumes of
high-valued nonferrous metal from the shredding process.
The Steel Manufacturing Business operates an electric arc furnace and two
rolling mills. Management continually reviews operations to identify bottlenecks
in the process and areas where efficiencies can be obtained with an appropriate
cost benefit. Some of our significant planned additions during fiscal 2005
include:
o Replace the electric arc furnace in the melt shop to reduce energy
consumption, reduce conversion costs and improve production capacity
in addition to increasing the product quality;
o Replace the billet craneway to allow for more efficient handling of
billets into the rolling mills and reheat furnaces.
o Repairs to the hotbed on rolling mill #1 will improve product quality.
USE OF INFORMATION TECHNOLOGY. One of Pick-N-Pull's primary business strategies
is to utilize information systems technology to collect data regarding
production, processing costs and customer sales. To this end, Pick-N-Pull
continues to invest in its core information systems to leverage its competitive
advantage.
CAPTURE BENEFITS OF INTEGRATION. The Company has historically sought to capture
the potential benefits of business integration whenever possible. The Company
believes it enjoys a competitive advantage over non-vertically integrated
mini-mill steel producers as a result of its extensive metals recycling
operation. Beginning with the source of raw materials, the Auto Parts Business
has the capability to supply the Metals Recycling Business with a portion of its
autobodies for use in its metals recycling process. The Metals Recycling
Business then has the capability to provide the Steel Manufacturing Business
with a predictable, high quality supply of recycled metals in an optimal mix of
grades for efficient melting. Likewise, the Steel Manufacturing Business ensures
a steady market for a portion of the Metals Recycling Business' production.
5
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
METALS RECYCLING BUSINESS
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The Company is one of the largest metals processors and exporters in the United
States, with eleven wholly-owned metals collection and processing facilities.
The Company purchases, processes and sells ferrous metals to foreign and
domestic steel producers and to the Steel Manufacturing Business. The Metals
Recycling Business also engages in the brokerage business by purchasing
processed metal from other recycled metals processors for shipment to either the
Steel Manufacturing Business or third party customers without further
processing. To a lesser extent, the Company also buys, processes and sells
nonferrous metals to both the domestic and export markets.
Due to the large capital investment required for metals recycling equipment and
the scarcity of potential yard sites that are properly zoned and have access to
waterways, highways and railroads, the recycled metals industry is characterized
by a relatively small number of large dominant metals processors, such as the
Company's Metals Recycling Business and its joint venture operations and many
smaller regional metals processors. The large processors collect raw metals from
a variety of sources, including smaller metal recyclers and dealers, and then
sort, clean and cut it into sizes and grades suitable for use by steel
manufacturers.
The Company's Portland, Oakland and Tacoma metals recycling facilities are
located at deep water terminals operated by the Company and also have rail and
highway access. As a result, the Company believes it is strategically located,
both for collection of unprocessed metals from suppliers and for efficient
distribution of processed recycled metals to western United States and foreign
steel producers.
In addition, we have invested in joint ventures that are engaged in the metals
recycling business. We are a 50% partner in six joint ventures and a 30% partner
in another smaller joint venture. The joint ventures in the metal recycling
business includes 28 metals collection and processing facilities, including
deep-water export terminals located in:
o Los Angeles, California;
o Everett, Massachusetts;
o Portland, Maine;
o Providence, Rhode Island;
o Jersey City, New Jersey, and
o Albany, New York.
In fiscal 2004 and 2003, these joint ventures processed and sold approximately
3.6 million and 3.3 million long tons of ferrous metals, respectively. In fiscal
2004 and 2003, these joint ventures brokered approximately 2.7 million and 1.7
million long tons of ferrous metals, respectively. In addition, these joint
ventures added operating income of $61.6 million and $24.4 million during fiscal
2004 and 2003, respectively.
6
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
CUSTOMERS AND MARKETING. The following table sets forth information about the
amount of ferrous recycled metals sold by the Company's wholly-owned Metals
Recycling Business to certain groups of customers during the last five fiscal
years:
Year Ended August 31,
------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------------- ---------------- ---------------- ---------------- ----------------
Sales Vol.1 Sales Vol.1 Sales Vol.1 Sales Vol.1 Sales Vol.1
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
(dollar amounts in millions)
FERROUS RECYCLED METALS
Asian Steel Producers
and Representatives $270.0 1,170 $178.7 1,157 $126.8 1,068 $ 91.8 777 $ 91.7 761
Steel Manufacturing
Business:
Processed 76.3 402 34.8 303 29.7 313 42.6 471 39.2 411
Brokered 2 35.8 216 26.0 232 7.9 94 7.1 95 7.1 87
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
112.1 618 60.8 535 37.6 407 49.7 566 46.3 498
Other US Steel
Producers 10.8 57 15.8 120 9.1 82 14.1 139 26.0 247
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total ferrous
recycled metals $392.9 1,845 $255.3 1,812 $173.5 1,557 $155.6 1,482 $164.0 1,506
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1 In thousands of long tons (2,240 pounds).
2 Consists of recycled metal that is purchased from other suppliers for direct shipment and is not processed by the Metals
Recycling Business.
The Company sells recycled metals to foreign and unaffiliated domestic steel
producers or their representatives and to the Steel Manufacturing Business. The
Company has developed long-standing relationships with Asian and United States
steel producers. The Company's primary Asian recycled metals customers are
located in China and South Korea, with additional sales to Thailand, India,
Japan and Taiwan. Over the last five years, in excess of 60% of our export sales
have been to China with South Korean companies purchasing approximately 25% of
our total exports. In fiscal 2004, South Korean companies purchased 53% of our
export sales with China purchasing 34%. In addition, new customers in Thailand
and India purchased 10% of our total export sales. The Company has established
representatives in South Korea, China and Japan to better serve these markets.
The Metals Recycling Business' five largest customers accounted for 69% of
recycled metals sales to unaffiliated customers in fiscal 2004. However, the
Company's recycled metals customers vary from year to year due to demand,
competition, relative currency values and other factors. Substantially all
recycled metals sales are denominated in United States dollars and substantially
all ferrous recycled metals shipments to foreign customers are supported by
letters of credit.
Ferrous recycled metals prices are subject to market cycles which are influenced
by many factors including worldwide demand from steel producers and readily
available supplies of ferrous materials that can be processed into sellable
scrap. Market prices for recycled ferrous metals reached historical highs during
fiscal 2004 with the Company's wholly-owned Metals Recycling Business average
selling price for fiscal 2004 reaching $184 per ton compared to $122 per ton in
fiscal 2003 and $94 per ton in fiscal 2002. Prices for both domestic and foreign
recycled metals are generally established through a competitive bidding process
based on prevailing market rates. Foreign recycled metals sales contracts
typically provide for shipment within 45 to 90 days after the price is agreed
to, which, in most cases, includes freight. The Company attempts to respond to
changing export price levels by adjusting its purchase prices at its metals
recycling yards to maintain its operating margin dollars per ton. However, the
Company's ability to fully maintain its operating margin per ton through periods
of rapidly declining prices can be limited by the impact of lower purchase
prices on the volume of recycled metals flowing to the Company from marginal
unprocessed metal suppliers. Accordingly, the Company believes it generally
benefits from rising recycled metals prices, which provide the Company greater
ability to maintain or expand both margins and unprocessed metals flow into its
yards.
The Company also sells recycled nonferrous metals to foreign customers. Demand
from Asian countries, especially China, continues to increase. The Company's
efficiency in recovering nonferrous metals from its shredding process
7
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
provides increasing supplies to sell to foreign customers. Also, the Company
purchases nonferrous metals, in smaller quantities, directly from other
suppliers for sale overseas. The nonferrous cargoes are loaded into ocean going
containers which are shipped to the customer. The following table sets forth
information about the amount of nonferrous recycled metals sold by the Company's
wholly-owned Metals Recycling Business during the last five fiscal years:
Year Ended August 31,
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2004 2003 2002 2001 2000
---------------- ---------------- ---------------- ---------------- ----------------
Sales Vol.(1) Sales Vol.(1) Sales Vol.(1) Sales Vol.(1) Sales Vol.(1)
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(dollar amounts in millions)
NONFERROUS RECYCLED METALS
Nonferrous recycled metals $ 57.0 117,922 $ 47.8 113,378 $ 41.7 112,622 $ 43.0 114,441 $ 38.9 96,207
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
(1) In thousands of pounds
SOURCES OF UNPROCESSED METALS. The most common forms of raw metals purchased by
the Company are obsolete machinery and equipment such as automobiles, railroad
cars, railroad tracks, home appliances and demolition metal from buildings and
other obsolete structures. The metals are acquired from suppliers at posted
prices at the Company's eleven metals recycling yards, from Company drop boxes
at a diverse base of suppliers' industrial sites and through negotiated
purchases from railroads and other large suppliers. The Company purchases
unprocessed metals from a large number of suppliers, including railroads,
industrial manufacturers, automobile salvage yards, metals dealers, landfills
and individuals. Metals recycling yards situated nearest to unprocessed metals
sellers and major transportation routes have a competitive advantage because of
the significance of freight charges relative to the value of metals. The
Portland, Tacoma and Oakland yards receive raw metals using major railroad
routes, deep water ports and major highways. Most of our other yards have access
to railways to both receive and then ship metals to our three major yards using
railroad cars, which we believe provides us with a competitive advantage. The
locations of our facilities allow us to competitively purchase raw metals from
the San Francisco Bay area (one of the largest metropolitan regions in the
country) north up the West Coast to British Columbia and to the east including
Idaho, Montana, Utah and Nevada.
The Company is a 50% partner in two joint ventures operating out of Richmond,
California which are industrial plant demolition contractors. These joint
ventures dismantle industrial plants, perform environmental remediation, resell
any machinery or pieces of steel that are salvaged from the plants in a usable
form and sell other recovered metals, primarily to the Company. The Company
purchased substantially all of the ferrous metals generated by these joint
ventures during fiscal 2004 and 2003, which included 63,000 long tons and 53,000
long tons, respectively. Purchase terms are negotiated at arms-length between
the Company and the other partners to the joint ventures.
METALS RECYCLING. The Company processes raw metal by sorting, shearing,
shredding, torching and processing metal into pieces of a size, density and
purity required by customers for use in their melting furnaces. Smaller, more
homogenous pieces of processed metals have more value because they melt more
easily than larger pieces and more completely fill a steel mill's furnace charge
bucket. Over 70% of the ferrous metals collected by the Company's metals
recycling facilities requires processing before sale.
One of the most efficient ways to process and sort metal is by the use of
shredding systems. The Portland and Oakland facilities each operate a large
shredder capable of processing up to 1,500 tons of metal per day and the Tacoma
facility has a mega shredder capable of shredding over 2,500 tons per day. The
Oakland facility is planning to install a mega-shredder in fiscal 2005, which
will give it the ability to shred 2,500 tons per day as well as more efficiently
process larger and thicker pieces of metal than were previously processed using
other more costly techniques. Mega shredders are designed to provide a denser
product and a more pure form of ferrous metal, which is preferred as the metal
can be more efficiently used by steel mills. Having a larger machine gives the
Company the ability to broaden the types of material that can be fed into the
shredder, and thus processed more efficiently than other more traditional
processes. Shredders reduce automobile bodies, home appliances and other light
gauge sheet metal
8
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
into fist-size pieces of shredded recycled metal in seconds. The shredded
material is then carried by conveyor under magnetized drums, which attract the
ferrous recycled metal and separate it from the nonferrous metals and other
residue found in the shredded material, resulting in a relatively pure and clean
shredded steel product. The remaining nonferrous metal and residue then pass
through a process that mechanically separates the nonferrous metals from the
residue. The remaining nonferrous metals are either hand sorted and graded
before being sold or sold unsorted.
DEEP WATER TERMINAL FACILITIES. The Company delivers ferrous and nonferrous
recycled metals to foreign steel producers by ship or container. The Company
achieves cost efficiencies by operating deep water terminal facilities at
Portland, Tacoma and Oakland. The Company owns the Oakland and Tacoma facilities
and leases the Portland location from a related party. Additionally, because the
Company operates the terminal facilities, it is not normally subject to the same
berthing delays often experienced by users of unaffiliated terminals. The
Company's loading costs are believed to be lower than they would be if the
Company was to utilize third party terminal facilities.
During fiscal 2002, the Company's Portland, Oregon metals recycling facility
embarked on a dock and loading facility renovation. The renovation was suspended
in fiscal 2003 when issues with the dock's substructure were detected. Upon
review of new engineering designs focused on operational efficiency and safety
specifications, an impairment charge of $3.5 million was recorded in the fourth
quarter of 2004 to write-off renovation costs incurred prior to the suspension.
The Company is now developing a larger plan to upgrade and modernize its metals
processing facility in Portland which includes the dock and loading facility.
Expenditures related to the modernization would occur over a period of several
years.
Through its Joint Ventures in the metals recycling business, the Company
participates in the ownership of export terminals in Los Angeles, California,
Everett, Massachusetts, Portland, Maine, Providence, Rhode Island, Albany, New
York and Jersey City, New Jersey. The joint ventures deliver by ship recycled
metals to steel producers throughout the world. As a result of owning or leasing
these facilities, the joint ventures are not subject to berthing delays
sometimes experienced by users of unaffiliated terminal facilities.
COMPETITION. The Company competes for both the purchase of metals from suppliers
and the sale of processed recycled metals to finished steel producers.
Competition for metals purchased in the Metals Recycling Business' markets comes
primarily from well financed large recyclers of metal as well as smaller metals
yards and dealers. Many of these recyclers have varying types and sizes of
processing equipment that include fixed and mobile shears and large and small
ferrous metal shredders, all with varying effects on the selling price of
recycled metal. The Company also competes with brokers who buy product on behalf
of domestic and foreign mills. The predominant competitive factors that impact
the Company's recycled metals sales and its ability to obtain unprocessed metals
are price, including shipping costs, availability, and reliability of service
and product quality.
The Company competes with a number of domestic and foreign recycled metals
processors for export sales. Price, including shipping costs, and availability
are the two most important competitive factors, but reliability and quality are
also important.
SEASONALITY. The Company makes a number of large ferrous metals shipments to
foreign steel producers each year. The Company's control over the timing of
shipments is limited by customers' requirements, shipping schedules and other
factors. Variations in the number of shipments from quarter to quarter can
result in significant fluctuations in quarterly revenues, earnings and inventory
levels.
BACKLOG. On August 31, 2004, the Company's Metals Recycling Business had a
backlog of firm orders of $78.7 million, as compared to $44.9 million on August
31, 2003. The backlog on August 31, 2004 was related to export ferrous metal
shipments.
9
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
AUTO PARTS BUSINESS
- -------------------
The Auto Parts Business competes in the auto dismantling and used auto parts
industry. Our stores are self-service stores in which customers remove used auto
parts from a vehicle in our inventory and then pay a standard price for that
part. Unlike more traditional full service stores, we do not remove parts for
customers or perform automotive repairs. The Company believes it has developed
one of the largest networks of self-service used auto parts stores in the United
States with 23 stores in six states and an additional 3 stores in western
Canada. Seventeen of the U.S. stores are located in Northern California, with
the remaining stores located in Nevada, Utah, Illinois, Indiana and Texas. The
Company purchases salvaged vehicles and sells the parts from those vehicles
through its retail store facilities and wholesale operations, and then sells the
remaining portion of the vehicles to metal recyclers, including the Company's
Metals Recycling Business.
The Company is dedicated to supplying low-cost used auto parts to its customers.
In general, management believes that the price of its parts are significantly
lower than full service auto dismantling prices, retail car part store prices
and car dealership prices. Each store offers an extensive selection of vehicles
from which consumers can remove parts. The average store is located on 14 acres
and contains approximately 1,600 cars available to the customer. The Company
carries domestic and foreign cars, vans and light trucks and rotates its
inventory frequently which provides its customers with access to new parts
inventory.
The Company typically seeks to locate its facilities with convenient access to
major streets and major population centers. By operating its stores at locations
that are convenient and visible to the target customer, the stores become the
first stop a customer makes in acquiring their used auto parts. Convenient
locations also make it easier and less expensive for suppliers to deliver
vehicles.
PRODUCTS AND MARKETING. The following table sets forth information about the
significant components of sales made by the Company's Auto Parts Business and
predecessor companies during the last five fiscal years:
Year Ended August 31,
--------------------------------------------------------------------------------------------------------------
2004 2003 2002(1) 2001(1) 2000(1)
------------------ ------------------ ------------------ ------------------ ------------------
Sales %. Sales %. Sales %. Sales %. Sales %.
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(dollar amounts in millions)
Retail sales $48,131 59% $44,463 68% $42,257 73% $37,826 74% $32,965 74%
Wholesale sales 33,387 41% 20,762 32% 16,018 27% 13,505 26% 11,792 26%
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total $81,518 100% $65,225 100% $58,275 100% $51,331 100% $44,757 100%
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
(1) The sales for periods prior to fiscal 2003 are not included in the Company's consolidated revenues. Please refer
to Note 1 and Note 3 in the NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.
The Company sells used auto parts from each of its retail locations. Upon
arriving at a store, a customer typically pays an admission charge and signs a
liability waiver before entering the facility. When a customer finds a desired
part on a vehicle, the customer removes it and pays a standard retail price for
the part.
Once the vehicle is removed from the customer area, certain remaining parts that
can be sold wholesale (cores) are removed from the vehicle. In California, these
cores, such as engines, transmissions and alternators, are consolidated at a
central facility. From this facility, the parts are sold, via an auction system,
to a variety of different wholesale buyers. Due to larger volumes generated via
this consolidation process, the Company has been able to obtain increasingly
higher prices for these cores.
10
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
After the core removal process is complete, the remaining auto body is crushed
and sold as scrap metal in the wholesale market. The autobodies are sold on a
price per ton basis. This price is subject to fluctuations in the recycled
ferrous metal markets. During fiscal 2004, the Auto Parts Business had sales of
$8.7 million to the Metals Recycling Business, thereby making it the Auto Parts
Business' single largest customer. The Company's wholesale business consists of
its core and scrap sales.
COMPETITION. The Company competes with both full-service and self-service auto
dismantlers as well as larger well-financed retail auto parts businesses for
retail customers. Also, the Company competes for its vehicle inventory with
other dismantlers, used car dealers, auto auctions and metal recyclers. Vehicle
costs can fluctuate significantly depending on market conditions and prices for
recycled metal.
SOURCES OF VEHICLES. The Company obtains vehicles from four primary sources: tow
companies, private parties, auto auctions and charities. The Company employs car
buyers who travel to vendors and bid on vehicles. The Company also has a program
to purchase vehicles from private parties called "Cash for Junk Cars." This
program is advertised in telephone directories and newspapers. Private parties
call a toll free number and receive a quote for their vehicle. The private party
can either deliver the vehicle to one of the retail locations or the Company can
arrange for the vehicle to be picked up.
SEASONALITY. Retail sales and admissions are somewhat seasonal and principally
affected by weather 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.
STEEL MANUFACTURING BUSINESS
- ----------------------------
The Steel Manufacturing Business consists of the Company's wholly-owned
subsidiary, Cascade Steel Rolling Mills, Inc., located in McMinnville, Oregon
(approximately 45 miles southwest of Portland) and includes two distribution
centers located in Central and Southern California. The Steel Manufacturing
Business produces steel reinforcing bar (rebar), wire rod, merchant bar, coiled
rebar and other specialty products. We believe the Steel Manufacturing Business
has a competitive position in its market due to its readily available source of
recycled metals, efficient production processes, well-located West Coast
shipping and transportation facilities, access to competitively priced electric
power and proximity to California and other major western markets. In addition,
the steel mill has access to major railroad routes which reduce the Steel
Manufacturing Business' delivery costs to major West Coast markets.
PRODUCTS AND MARKETING. The Steel Manufacturing Business produces rebar,
merchant bar, coiled products and specialty products. Sales of these products
during the last five fiscal years were as follows:
Year Ended August 31,
------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------------- ---------------- ---------------- ---------------- ----------------
Sales Vol.1 Sales Vol.1 Sales Vol.1 Sales Vol.1 Sales Vol.1
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
(dollar amounts in millions)
Rebar $143.7 340 $ 97.4 327 $ 86.7 307 $ 91.8 309 $ 91.1 308
Coiled products 94.5 233 67.9 223 51.6 179 39.2 137 59.5 214
Merchant bar 31.8 66 23.4 65 21.3 67 28.8 83 40.7 117
Other products 1.3 3 3.2 7 7.0 16 7.8 17 12.3 27
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total $271.3 642 $191.9 622 $166.6 569 $167.6 546 $203.6 666
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
1 In thousands of short tons (2,000 pounds).
11
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
Rebar is steel rod used to increase the tensile strength of poured concrete.
Merchant bar consists of round, flat, angle and square steel bars used by
fabricators or manufacturers to produce a wide variety of products, including
gratings, steel floor and roof joists, safety walkways, ornamental furniture,
stair railings and farm equipment. Coiled products consist of wire rod and
coiled rebar. Wire rod is steel wire, delivered in coiled form, and is used by
fabricators to produce a variety of products such as chain link fencing, nails,
wire and stucco netting. Coiled rebar is rebar delivered in coils rather than in
straight lengths, a method preferred by some fabricators as it reduces the waste
and improves yield generated by cutting individual lengths to meet customer
specifications.
The Steel Manufacturing Business sells directly from its mill in McMinnville,
Oregon and from its Company owned distribution center located in El Monte,
California (Los Angeles area) and one third-party distribution center in
Stockton, California. The distribution centers facilitate sales by maintaining a
ready inventory of products close to major customers for just-in-time delivery.
The Steel Manufacturing Business communicates regularly with major customers to
determine their anticipated needs and plans its rolling mill production schedule
accordingly. The Steel Manufacturing Business also produces and inventories a
mix of products forecasted to meet the needs of other customers. Shipments to
customers are made by common carrier, either truck or rail.
During fiscal 2004, the Steel Manufacturing Business sold its steel products to
approximately 350 customers primarily located in the 10 western states. In that
period, approximately 43% of the Steel Manufacturing Business' sales were made
to customers in California. The Steel Manufacturing Business' customers are
principally steel service centers, construction industry subcontractors, steel
fabricators, wire drawers and major farm and wood product suppliers. The Steel
Manufacturing Business' 10 largest customers accounted for approximately 44% of
its revenues during fiscal 2004.
RECYCLED METALS SUPPLY. The Company believes it operates the only mini-mill in
the Western United States which has the ability to obtain its entire recycled
metals requirement from its own affiliated metals recycling operations. There
have at times been regional shortages of recycled metals with some mills being
forced to pay higher prices for recycled metals shipped from other regions or to
temporarily curtail operations. The Company's Metals Recycling Business has the
ability to supply the Steel Manufacturing Business both with recycled metals
that it has processed and with recycled metals that it has purchased from
third-party processors. The Metals Recycling Business is also able to deliver to
the Steel Manufacturing Business an optimal mix of recycled metal grades to
achieve maximum efficiency in its melting operations. Since the Company's Steel
Mill and major metals recycling yards are located on rail routes, the Company
takes advantage of the cost benefit of shipping recycled metal by rail.
ENERGY SUPPLY. Electricity and natural gas represented approximately 6% and 2%,
respectively, of the Steel Manufacturing Business' cost of goods sold in the
year ended August 31, 2004.
The Steel Manufacturing Business purchases electric power from McMinnville Water
& Light (McMinnville), a municipal utility, and is McMinnville's largest
customer. The Steel Manufacturing Business has a five-year contract with
McMinnville that expires September 30, 2006. McMinnville obtains power from the
Bonneville Power Administration (BPA) and resells it to the Steel Manufacturing
Business at its cost plus a fixed charge per kilowatt hour and a 3% city
surcharge. The rate McMinnville obtains from BPA is for firm power; therefore,
the Steel Manufacturing Business is not forced to sacrifice the reliability of
its power supply for a lower interruptible power rate as is the case with
certain other mini-mills. 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. The CRAC, which can be adjusted
every six months, has varied from a low of 39% to a high of 50%. The current
rate, which became effective on April 1, 2004, is 47%. Since BPA has been
successful in its cost reduction programs, BPA will pass on a 7.5% reduction in
selected electric power rates effective October 1, 2004. The annual savings are
estimated at over $1.0 million.
12
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
The Steel Manufacturing Business purchases natural gas for use in the reheat
furnaces from IGI Resources of Boise, Idaho, pursuant to a contract that
obligates the business to purchase minimum amounts of gas at a fixed rate. This
is a take or pay contract. The current contract expires on October 31, 2005. All
natural gas used by the Steel Manufacturing Business must be transmitted via a
pipeline owned by Northwest Natural Gas Company that also serves local
residential customers of Northwest Natural Gas Company. To protect against
interruptions in gas supply, the Steel Manufacturing Business maintains stand-by
propane gas storage tanks that have the capacity to hold enough gas to operate
one of the rolling mills for at least three days without refilling.
MANUFACTURING OPERATIONS AND EQUIPMENT. The Steel Manufacturing Business'
melt-shop includes a 108-ton capacity electric-arc furnace, ladle refining
furnace and five-strand continuous billet caster. The melt shop has enhanced
steel chemistry refining capabilities, permitting the mill to produce special
alloy grades of steel not currently produced by other mills on the West Coast.
In December 2004, the Steel Manufacturing Business plans to replace the electric
arc furnace with a 108-ton capacity furnace that will be more energy efficient,
reduce melting time and modestly increase production volume. The melt shop
produced 652,000, 636,000 and 483,000 tons of billets during fiscal 2004, 2003
and 2002, respectively. Melt shop production in fiscal 2002 was curtailed due to
sluggish domestic economic conditions.
The Company operates two computerized rolling mills that allow for synchronized
operations of the rolling mills and related equipment. The billets produced in
the melt shop are reheated in two natural gas-fueled furnaces and are then
hot-rolled through one of the two mills to produce finished products. Rolling
mill #1 is a 17-stand mill that was rebuilt in 1986. Rolling mill #2 is an
18-stand mill, which was installed in 1996. In 1997, a rod block and related
equipment for the manufacture of wire and coiled rebar was added to rolling mill
#2. Since then, the Company has completed a wide variety of improvement projects
to both mills designed to increase the operating efficiency of each mill as well
as increase the types of products that can be competitively produced. Management
continues to monitor the market for new products as well as discuss new
requirements our customers have to identify additional opportunities to enhance
the value of our product offerings. In fiscal 2005, the Company plans major
repairs to the hotbed in rolling mill #1. The hotbed cools the hot-rolled steel.
The repairs will improve the yield and quality of products produced.
COMPETITION. The principal competitive factors in the Steel Manufacturing
Business' market are price, product availability, quality and service. The
mill's primary domestic competitors are Nucor, with manufacturing facilities in
Utah and Washington, and Tamco with a facility in California.
In addition to domestic competition, the Steel Manufacturing Business has
historically competed intensely with foreign steel producers principally located
in Asia, Canada, Mexico, and Central and South America in certain of its product
lines, principally in shorter length rebar and in certain wire rod grades. As a
result, 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 remain in effect today, are periodically reviewed, and do not have
a set expiration date. Recently, imports of steel were also affected by foreign
currency fluctuations. Relevant foreign currencies generally strengthened
relative to the U.S. dollar in fiscal 2004 and 2003, making imports into the
U.S. more expensive. Imports were also adversely impacted by rising ocean
freight rates in fiscal 2004. As a result of the duties, changes in foreign
exchange rates and freight rates and generally good market conditions in the
foreign countries, the Company has recently experienced less competition from
foreign steel producers.
SEASONALITY. The Steel Manufacturing Business' revenues can fluctuate
significantly between quarters due to factors such as the seasonal slowdown in
the construction industry, which occurs from the late fall through early spring,
and in other industries it serves. In the past, the Steel Manufacturing Business
has generally experienced its lowest sales during the second quarter of the
fiscal year. The Company expects this pattern to continue in the future.
BACKLOG. The Steel Manufacturing Business generally ships products within days
after the receipt of purchase orders. Backlogs are seasonal and would be larger
in fiscal quarters three and four.
13
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
ENVIRONMENTAL MATTERS
- ---------------------
Compliance with environmental laws and regulations is a significant factor in
the Company's business. Some of the Company's businesses are subject to local,
state, federal and supranational environmental laws and regulations concerning,
among other matters, solid waste disposal, hazardous waste disposal, air
emissions, water quality and discharge, dredging and employee health.
Environmental legislation and regulations have changed rapidly in recent years
and it is likely that the Company will be subject to even more stringent
environmental standards in the future.
PORTLAND HARBOR
In December 2000, the United States Environmental Protection Agency (EPA) named
the Portland Harbor, a 5.5 mile stretch of the Willamette River in Portland,
Oregon, as a Superfund 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 Company subsidiary, also owns property
adjacent to the Portland Harbor. The EPA has identified 69 potentially
responsible parties (PRPs), including the Company and Crawford 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 the 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
liable for environmental costs or damages associated with the Superfund 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 consent 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 DEQ regarding its Portland, Oregon deep water terminal facility and the
site owned by Crawford Street Corporation. DEQ identified these sites as
potential sources of contaminants that could be released into the Willamette
River. The Company believes that improvements in the operations at these sites,
often referred to as 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
August 31, 2004, however $0.3 million has been accrued for studies related to
the pending six mile Portland Working Harbor Willamette River sediment 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
carried over to the Company's financial statements when MMI was acquired in
1995, and at August 31, 2004 aggregated $15.1 million.
General 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
14
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
Hylebos Waterway. On March 25, 2002, EPA issued Unilateral Administrative Orders
(UAOs) to GMT and another party (Other Party) to proceed with Remedial Design
and Remedial Action (RD/RA) for the head of 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 UOA for the head of the Hylebos
Waterway was converted to a voluntary consent decree in May 2004, pursuant to
which GMT and the Other Party agreed to remediate the head of the Hylebos
Waterway. The consent decree was finalized and entered by the court in September
2004, at which time approximately $7.0 million in settlement funds previously
collected by the EPA from other PRPs became available for reimbursement of
remediation costs incurred by GMT and the Other Party. As of May 31, 2004, the
Company recorded $3.5 million in other current assets representing the Company's
share of the expected EPA reimbursements and, because the expectation of
contributions from other PRPs in this amount had previously been taken into
account as a reduction in the Company's reserve for environmental liabilities,
the Company also recorded a $3.5 million increase in environmental liabilities.
There are two phases to the Clean-up 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. Approximately 117,500 cubic yards of an estimated 310,000
cubic yards total have been removed as of October 30, 2004. Dredging and other
in-water work is scheduled to be completed during fiscal 2005.
GMT and the Other Party may pursue 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. Significant 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 two third-party sites at which it allegedly disposed
of transformers. At one site, MMI entered into a settlement under which it paid
$825,000 towards remediation of the site. Remediation of the site has been
completed and it is now subject to a five year monitoring program. The other
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.
PROLER
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. The Company carried over the aggregate reserve to its
financial statements upon acquiring Proler, and $3.4 million remained
outstanding on August 31, 2004.
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
15
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
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.
METALS RECYCLING BUSINESS
After the shredding of automobile bodies and other obsolete machinery and
appliances and the separation of ferrous and salable nonferrous metals, the
remaining auto shredder residue must be managed. State and federal standards
prescribe sampling protocols requiring representative samples of auto shredder
residue to be analyzed to determine if they are likely to leach heavy metals,
PCBs or other hazardous substances in excess of acceptable levels. Auto shredder
residue from the Company's metals recycling operations in Oakland and Tacoma
undergo an in-line chemical stabilization treatment prior to beneficial use as
an alternative daily landfill cover.
STEEL MANUFACTURING BUSINESS
The Steel Manufacturing Business' electric arc furnace generates dust (EAF
dust), which is classified as a hazardous waste by the EPA because of its zinc
and lead content. The EAF dust is shipped to a firm in the United States that
applies a treatment that allows the EAF dust to be delisted as hazardous so it
can be disposed of as a non-hazardous, solid waste. By maintaining an annual
renewable export license, the Company retains flexibility of having the option
to send the EAF dust to a secondary smelter in Mexico that recycles the EAF dust
into commercial products.
The Steel Manufacturing Business has an operating permit issued under Title V of
the Clean Air Act Amendment of 1990, which governs certain air quality
standards. The permit was first issued in 1998 and has since been renewed
through the year 2007. The permit allows the Steel Manufacturing Business to
melt up to 900,000 tons of recycled metals per year and produce finished steel
products totaling 450,000 tons on Rolling mill #1 and 525,000 tons on Rolling
mill #2. As the mill's production grows beyond current levels, the Steel
Manufacturing Business has anticipated that it would need to enhance its
existing facilities to properly control increased emissions in order to remain
in compliance with the Title V operating permit.
AUTO PARTS BUSINESS
In connection with the acquisition of the Auto Parts Business, the Company
conducted an environmental due diligence investigation. Based upon new
information obtained in this investigation, the Auto Parts Business accrued $2.1
million in environmental liabilities in the second quarter of fiscal 2003 for
remediation costs at the Auto Parts Business's store locations. No environmental
proceedings are pending at any of these sites.
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 Sacramento locations from the Sacramento
Metropolitan Air Quality Management District (SMAQMD). The NOV required us to
cease operation of the car crushers at these locations. Since receiving the NOV,
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. We are engaged in an ongoing evaluation of our car crushing systems and
discussions with the SMAQMD to assure compliance and address the potential
regulatory enforcement penalties. We recorded a reserve during 2004 for the
estimated potential exposure for this matter.
It is not possible to predict the total size of all capital expenditures or the
amount of any increases in operating costs or other expenses that may be
incurred by the Company or its subsidiaries to comply with environmental
requirements applicable to the Company, its subsidiaries and their operations,
or whether all such cost increases can be passed on to
16
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
customers through product price increases. Moreover, environmental legislation
has been enacted, and may in the future be enacted, to create liability for past
actions that were lawful at the time taken but have been found to affect the
environment and to increase public rights of action for environmental conditions
and activities. As is the case with steel producers and recycled metals
processors in general, if damage to persons or the environment has been caused,
or is in the future caused, by the Company's hazardous materials activities or
by hazardous substances now or hereafter located at the Company's facilities,
the Company may be fined and/or held liable for such damage and, in addition,
may be required to remedy the condition. Thus, there can be no assurance that
potential liabilities, expenditures, fines and penalties associated with
environmental laws and regulations will not be imposed on the Company in the
future or that such liabilities, expenditures, fines or penalties will not have
a material adverse effect on the Company.
The Company has, in the past, been found not to be in compliance with certain
environmental laws and regulations and has incurred liabilities, expenditures,
fines and penalties associated with such violations. The Company's objective is
to maintain compliance. Efforts are ongoing to be responsive to environmental
regulations.
The Company believes that it is in material compliance with currently applicable
environmental regulations as discussed above and, except as discussed above,
does not anticipate any substantial capital expenditures for new environmental
control facilities during fiscal 2005 or 2006.
EMPLOYEES
- ---------
As of August 31, 2004, the Company had 1,624 full-time employees, consisting of
464 employees at the Company's Metals Recycling Business, 458 employees at the
Steel Manufacturing Business, 633 employees at the Auto Parts Business and 69
corporate administrative employees. Of these employees, as of August 31, 2004,
619 are covered by collective bargaining agreements with twelve unions. The
Steel Manufacturing Business' contract with the United Steelworkers of America
covers 336 of these employees and expires on April 1, 2005. The Metals Recycling
Business' contract with the Warehouse, Automotive, Food, Public Employees,
Driver Sales & Special Services covers 43 employees and expires September 1,
2005. The Company believes that its labor relations generally are good.
AVAILABLE INFORMATION
- ---------------------
The Company's website is located at www.schnitzersteel.com. The Company makes
available free of charge on or through its website, its annual, quarterly and
current reports, and any amendments to those reports, as soon as reasonably
practicable after electronically filing such reports with the Securities and
Exchange Commission ("SEC"). Information contained on the Company's website is
not part of this report or any other report filed with the SEC.
17
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
ITEM 2. PROPERTIES
The Company's Portland metals recycling facility, Portland deep water terminal
facilities, and the related buildings and improvements are located on an
approximately 60-acre industrial site owned by Schnitzer Investment Corp. (SIC),
a related party, and leased to the Company under a long-term lease. See Part
III, Item 13 "Certain Relationships and Related Transactions." Approximately 17
acres are occupied by the Company's deep water terminal facilities, and the
balance is used for recycling metal.
The Pasco, Washington and Anchorage, Alaska operations are located on sites
leased from third parties.
The following metals recycling operations are all located on sites owned by the
Company or subsidiaries:
LOCATION ACREAGE OWNED AT SITE
-------- ---------------------
Oakland, CA 33
Tacoma, WA 26
Fresno, CA 17
Sacramento, CA 13
Eugene, OR 11
White City, OR 4
Bend, OR 3
Grants Pass, OR 1
The Steel Manufacturing Business' steel mill and administrative offices are
located on an 83-acre site owned by the Steel Manufacturing Business in
McMinnville, Oregon. The Steel Manufacturing Business also owns its 87,000 sq.
ft. distribution center in El Monte, California. Additionally, in fiscal 2002,
the Company purchased 51 acres near the mill site in McMinnville, Oregon;
however, this site is not currently utilized by the Steel Manufacturing
Business.
The Auto Parts Business has retail facilities in the following locations:
Number of Total
Locations Acreage
--------- -------
Northern California 17 211
Nevada 2 30
Texas 1 33
Utah 1 12
Illinois 1 17
Indiana 1 29
Canada 3 45
----- -----
Total 26 377
===== =====
The Company owns the properties located in Indiana and Nevada. Additionally, it
owns approximately 25 acres in California, 6 acres in Illinois and 2.5 acres in
Utah. The remainder of the California, Illinois and Utah facilities are leased.
In addition, all the Canadian and Texas facilities are located on sites leased
by the Company.
The equipment and facilities on each of the foregoing sites are described in
more detail in the descriptions of each of the Company's businesses. The Company
believes its present facilities are adequate for operating needs for the
foreseeable future.
18
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
The Company's principal executive offices are located at 3200 and 3300 NW Yeon
Avenue in Portland, Oregon in 48,000 sq. ft. of space leased from SIC under
long-term leases. See Part III, Item 13 "Certain Relationships and Related
Transactions."
ITEM 3. LEGAL PROCEEDINGS
Until recently, the Company had a practice of paying commissions to the
purchasing managers of customers in connection with export sales of recycled
ferrous metals to the Far East. The Company was recently advised that this
practice 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 and the
Securities and Exchange Commission, and that the Company cooperate fully with
those agencies. The investigation is not expected to affect the Company's
previously reported financial results, including those reported in this 10-K.
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.
Except as described above under Part I, Item 1 "Business -- Environmental
Matters", the Company is not a party to any material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 4(a). EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Office
- ---- --- ------
Robert W. Philip 57 Chairman, President and Chief Executive Officer
Gary Schnitzer 62 Executive Vice President
Barry A. Rosen 59 Vice President, Finance and Chief Financial Officer
Ilene Dobrow Davidson 53 Secretary and General Counsel
Kelly E. Lang 43 Vice President, Corporate Controller
Jay Robinovitz 46 Vice President
Kurt C. Zetzsche 65 President, Cascade Steel Rolling Mills, Inc.
ROBERT W. PHILIP joined the Company in 1984 and has been President of the
Company since March 1991, Chief Executive Officer since January 2002 and
Chairman since January 2004.
GARY SCHNITZER has been Executive Vice President in charge of the Company's
California metals recycling operations since 1980. Gary Schnitzer is a first
cousin of Robert Phillip's wife.
BARRY A. ROSEN has been Vice President, Finance and Chief Financial Officer of
the Company since 1982. Mr. Rosen will retire from the Company in June 2005.
ILENE DOBROW DAVIDSON has been Secretary and General Counsel of the Company
since 2001 and became an executive officer in November 2004. Ms. Davidson was
the Executive Vice President and General Counsel of U.S. RealTel from 1998 until
joining the Company. Ms. Davidson previously practiced law as a partner of
Sachnoff & Weaver in Chicago, Illinois.
KELLY E. LANG joined the Company in September 1999 as Vice President-Corporate
Controller. From 1996 to September 1999, he was employed by Tektronix Inc. in
various financial capacities, the last of which was Vice President, Finance for
Tektronix Inc.'s Color Printing and Imaging Division. While with Price
Waterhouse LLP, Mr. Lang was a Certified Public Accountant.
19
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
JAY ROBINOVITZ joined the Company in January 1993 and has held various senior
management positions, including four years serving as General Manager of the
Company's Tacoma yard and most recently, the Company's Vice President of
Northwest metals recycling operations.
KURT C. ZETZSCHE joined the Company in February 1993 as President of the Steel
Manufacturing Business. Mr. Zetzsche has been in the steel production business
since 1966. Mr. Zetzsche retired from the Company on November 5, 2004.
20
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Class A Common Stock is traded on the Nasdaq National Market tier
of the Nasdaq Stock Market under the symbol SCHN. The approximate number of
shareholders of record on September 30, 2004 was 129. The stock has been trading
since November 16, 1993. The following table sets forth the high and low prices
reported at the close of trading on the Nasdaq Stock Market and the dividends
paid per share for the periods indicated, all as adjusted for the one-for-one
stock dividend effected August 14, 2003 and the one-for-two stock dividend
effected March 25, 2004.
Fiscal Year 2004
---------------------------------------------
Dividends
High Price Low Price Per Share
---------- --------- ---------
First Quarter $ 36.57 $ 16.20 $.017
Second Quarter $ 42.52 $ 26.38 $.017
Third Quarter $ 37.70 $ 22.60 $.017
Fourth Quarter $ 35.79 $ 26.01 $.017
Fiscal Year 2003
---------------------------------------------
Dividends
High Price Low Price Per Share
---------- --------- ---------
First Quarter $ 6.39 $ 5.56 $.017
Second Quarter $ 8.00 $ 5.91 $.017
Third Quarter $ 11.23 $ 7.85 $.017
Fourth Quarter $ 17.49 $ 11.69 $.017
21
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
ITEM 6. SELECTED FINANCIAL DATA
Year Ended August 31,
------------------------------------------------------------------------------------
2004 2003(1) 2002 2001 2000
------------ ------------ ------------ ------------ ------------
(In millions, except per share, per ton and shipment data)
INCOME STATEMENT DATA:
Revenues $ 688.2 $ 496.9 $ 350.6 $ 322.8 $ 367.5
Operating income $ 166.9 $ 68.8 $ 9.8 $ 15.1 $ 14.8
Income before cumulative effect of
change in accounting principle,
income taxes, minority interests
and pre-acquisition interests $ 164.3 $ 66.4 $ 7.7 $ 11.3 $ 11.0
Income tax provision $ (50.7) $ (17.9) $ (1.1) $ (3.4) $ (0.6)
Cumulative effect of change in
accounting principle -- (1.0) -- -- --
Net income $ 111.2 $ 43.2 $ 6.6 $ 7.9 $ 10.4
============ ============ ============ ============ ============
Basic earnings per share(2) $ 3.71 $ 1.55 $ 0.24 $ 0.28 $ 0.35
============ ============ ============ ============ ============
Diluted earnings per share(2) $ 3.58 $ 1.47 $ 0.23 $ 0.28 $ 0.35
============ ============ ============ ============ ============
Dividends per common share(2) $ 0.068 $ 0.067 $ 0.067 $ 0.067 $ 0.067
============ ============ ============ ============ ============
OTHER DATA:
Shipments (in thousands)(3):
Ferrous recycled metal (tons) 1,845 1,812 1,557 1,482 1,506
Nonferrous (pounds) 117,992 113,378 112,622 114,441 96,207
Finished steel products (tons) 642 622 569 546 666
Average net selling price(3,4):
Ferrous recycled metal (per ton) $ 184 $ 122 $ 94 $ 91 $ 95
Nonferrous (per pound) $ 0.48 $ 0.42 $ 0.36 $ 0.37 $ 0.40
Finished steel products (per ton) $ 404 $ 291 $ 276 $ 292 $ 289
Depreciation and amortization $ 20.4 $ 19.4 $ 18.6 $ 18.8 $ 18.4
Cash provided by operations $ 73.2 $ 40.9 $ 36.4 $ 8.6 $ 35.4
Number of Auto Parts Stores(5) 26 23 23 23 22
Joint venture shipments (in thousands):
Ferrous processed (tons)(6) 3,582 3,323 3,700 3,400 3,100
Ferrous brokerage (tons)(6) 2,676 1,699 1,200 1,000 900
22
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
As of August 31,
------------------------------------------------------------
2004 2003 2002 2001 2000
-------- -------- -------- -------- --------
(In millions)
BALANCE SHEET DATA:
Working capital $ 73.1 $ 72.4 $ 39.4 $ 91.4 $ 79.9
Cash and equivalents 11.3 1.7 32.9 1.9 2.4
Total assets 606.0 487.9 405.0 425.9 426.3
Short-term debt 0.2 0.2 60.2 0.2 0.2
Long-term debt 67.8 87.0 8.3 93.8 93.1
Shareholders' equity $ 418.9 $ 303.0 $ 252.9 $ 248.1 $ 248.4
(1) The 2003 data includes the Auto Parts Business acquisition, which occurred on
February 14, 2003. Please refer to Note 1 and Note 3 of the NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS. The consolidated results include the results of
the Auto Parts Business as though the acquisition had occurred at the beginning of
fiscal 2003. Adjustments have been made for minority interests, which represents the
ownership interests the Company did not own during the reporting period and
pre-acquisition interests, which represents the share of income attributable to the
former joint venture partner for the period from September 1, 2002 through February
14, 2003. The financial results of the former auto parts joint venture for all
periods prior to fiscal 2003 continue to be accounted for using the equity method
and are included in the line "Operating income from joint ventures."
(2) Basic and diluted earnings per share and dividends per common share have been
adjusted to reflect the one-for-one stock dividend paid on August 14, 2003, to
shareholders of record on July 24, 2003 and the one-for-two stock dividend effected
March 25, 2004.
(3) Tons for ferrous recycled metals are long tons (2,240 pounds) and for finished steel
products are short tons (2,000 pounds).
(4) The Company reports revenues that include shipping costs billed to customers.
However, average net selling prices are shown net of shipping costs.
(5) For fiscal years 2002 to 2000, the Auto Parts Business was a component of the
Company's Joint Ventures in suppliers of metals.
(6) Joint venture tons shipped represent 100% of the joint venture shipments and not
just the Company's share.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
- --------
The Company operates in three industry segments. The Company's Metals Recycling
Business collects, processes and recycles steel and other 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 one 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,
three in Canada, two in Nevada and one store in each of Texas, Utah, Illinois
and Indiana. Additionally, the Company is a non-controlling partner in joint
ventures that are either in the metals recycling business or are suppliers of
unprocessed metals. These 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).
23
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- ------------------------------------------
The Company's discussion and analysis of its financial condition and results of
operations are based upon its consolidated financial statements, which have been
prepared in accordance with Generally Accepted Accounting Principles. The
preparation of these financial statements requires the Company to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities. On an
ongoing basis, the Company evaluates its estimates. The Company bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances. These estimates and
assumptions provide a basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions, and these differences may be material.
The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements:
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined using
the average cost method. The production and accounting process utilized by the
Company to record recycled metals inventory quantities relies on significant
estimates. The Company relies upon perpetual inventory records that utilize
estimated recoveries and yields that are based upon historical trends and
periodic tests for certain unprocessed metal commodities. Over time, these
estimates are reasonably good indicators of what is ultimately produced;
however, actual recoveries and yields can vary depending on product quality,
moisture content and source of the unprocessed metal. To assist in validating
the reasonableness of the estimates, the Company not only runs periodic tests,
but also performs monthly physical inventories. Physical inventories may detect
significant variations in volume, but because of variations in product density,
holding period and production processes utilized to manufacture the product,
physical inventories will not generally detect smaller variations. To mitigate
this risk, the Company adjusts it physical inventories when the volume of a
commodity is low and a physical inventory can more accurately predict the
remaining volume. In addition, the Company establishes inventory reserves to
further mitigate the risk of significant adjustments when determined reasonable.
REVENUE RECOGNITION
The Company recognizes revenue when it has a contract or purchase order from a
customer with a fixed price, the title and risk of loss transfer to the buyer
and collectibility is reasonably assured. Title for both metals and finished
steel products transfers upon shipment based on either C.I.F. or F.O.B. terms.
For retail sales by the Company's Auto Parts Business, revenues are recognized
when customers pay for salvaged vehicle parts or when wholesale products are
shipped to the customer location.
ENVIRONMENTAL COSTS
The Company operates in industries that inherently possess environmental risks.
To manage these risks, the Company employs both its own environmental staff and
outside consultants. These consultants and finance personnel meet regularly to
stay updated on environmental risks. The Company estimates future costs for
known environmental remediation requirements and accrues for them on an
undiscounted basis when it is probable that the Company has incurred a liability
and the related costs can be reasonably estimated. The regulatory and government
management of these projects is extremely complex, which is one of the primary
factors that make it difficult to assess the cost of potential and future
remediation of potential sites. When only a wide range of estimated amounts can
be reasonably established, and no other amount within the range is better than
another, the minimum amount of the range is recorded in the financial
statements. Adjustments to the liabilities are made when additional information
becomes available that affects the estimated costs to remediate. In a number of
cases, it is possible the Company may receive reimbursement through prior
insurance or from other potentially responsible parties identified in a claim.
In these situations, recoveries of environmental remediation costs from other
parties are recorded as an asset when realization of the claim for recovery is
deemed probable and reasonably estimable.
24
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
GOODWILL
In assessing the recoverability of goodwill and other intangible assets with
indefinite lives, management must make assumptions regarding estimated future
cash flows and other factors to determine the fair value of the respective
assets. If these estimates and related assumptions change in the future, we may
be required to record impairment charges not previously recorded. We have
adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and
Other Intangible Assets, and are required to assess goodwill for impairment at a
minimum annually, using a two-step process that begins with an estimation of the
fair value of the reporting unit. The first step is a screen for impairment and
the second step measures the amount of any impairment. These tests utilize fair
value amounts that are determined by estimated future cash flows developed by
management.
LONG-LIVED ASSETS
We are required to assess potential impairments of long-lived assets in
accordance with SFAS 144, Accounting for Impairment of Long-lived Assets, if
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. An impaired asset is written down to its estimated fair
value based upon the most recent information available. Estimated fair market
value is generally measured by discounting estimated future cash flows developed
by management. The Company's long-lived assets primarily include property, plant
and equipment used in operations.
TAXES
Deferred income taxes reflect the differences between the financial reporting
and tax bases of assets and liabilities at year-end based on enacted tax laws
and statutory tax rates. Tax credits are recognized as a reduction of income tax
expense in the year the credit arises. A valuation allowance is established when
necessary to reduce deferred tax assets, including net operating loss
carryforwards, to the amount more likely than not to be realized. Periodically,
the Company reviews the deferred tax assets to assess whether the valuation
allowances are necessary.
RESULTS OF OPERATIONS
- ---------------------
During fiscal 2004, the Company's operations improved dramatically, resulting in
a record year for revenue and net income. Both the Company's Metals Recycling
Business and Steel Manufacturing Business recognized marked improvements over
last year. As well, the Company's Joint Ventures in the metals recycling
business benefited from rising selling prices to improve their profitability by
148%. In addition, the Auto Parts Business contributed to earnings growth during
the year.
The results of operations of the Company depend in large part upon demand and
prices for recycled metals in world markets and steel products in the Western
United States. In fiscal 2004, strong worldwide demand and a limited supply of
recycled metals drove the Metals Recycling Business' average selling prices to
all time highs. Market prices for recycled ferrous metals fluctuate periodically
and have a significant impact on the results of operations for the wholly-owned
and Joint Ventures in the metals recycling business.
The Steel Manufacturing Business saw significantly higher average selling prices
and slightly higher sales volumes during fiscal 2004 compared with fiscal 2003.
Sales prices and volumes benefited from strong demand for steel products on the
west coast of the United States, improvements in the U.S. economy, and lower
steel imports, which is partially attributed to the weakness of the U.S. dollar
and higher ocean freight rates.
The Auto Parts Business segment was formed in the second quarter of fiscal 2003
as the result of an acquisition. It purchases salvaged vehicles, sells parts
from those vehicles through its retail facilities and wholesale operations and
sells the remaining portion of the vehicles to metal recyclers. The retail
operations are somewhat seasonal and principally 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. The Auto Parts Business' other primary source of revenue is the sale of
scrap metal and other parts wholesale. Revenues for the wholesale product lines
are principally affected by commodity prices and shipping schedules. As
mentioned earlier in the discussions regarding the Metal
25
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
Recycling Business, recycled metal prices have increased dramatically over
fiscal 2003 which positively affected the revenues and profits of the Auto Parts
Business. In addition, the Auto Parts Business completed an acquisition during
fiscal 2004 which added three stores in Canada to the original 23 stores
acquired in fiscal 2003.
The following tables set forth information regarding the breakdown of revenues
between the Company's Metals Recycling Business, Steel Manufacturing Business
and Auto Parts Business, and the breakdown of operating income from the Metals
Recycling Business, the Steel Manufacturing Business, the Auto Parts Business,
Joint Ventures, Corporate and eliminations. Additional financial information
relating to business segments is contained in Note 12 of the NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS.
Revenues
Year Ended August 31,
------------------------------------
(In millions)
2004 2003 2002
-------- -------- --------
Metals Recycling Business:
Ferrous $ 392.9 $ 255.3 $ 173.5
Nonferrous 57.0 47.8 41.7
Other 6.4 5.5 6.6
-------- -------- --------
Recycled metals total $ 456.3 $ 308.6 $ 221.8
Auto Parts Business 81.5 65.2 --
Steel Manufacturing Business 271.3 191.9 166.6
Intercompany sales eliminations(3) (120.9) (68.8) (37.8)
-------- -------- --------
Total $ 688.2 $ 496.9 $ 350.6
======== ======== ========
Operating Income (Loss)
Year Ended August 31,
------------------------------------
(In millions)
2004 2003 2002
-------- -------- --------
Metals Recycling Business $ 77.3 $ 35.8 $ 11.5
Auto Parts Business 26.8 22.0 --
Steel Manufacturing Business 24.6 (2.5) (5.7)
JVs in the metals recycling business(1) 61.7 24.8 13.8
JV suppliers of metals (0.1) (0.4) 5.6
Corporate expense (2) (15.6) (10.0) (8.1)
Intercompany eliminations(3) (4.3) 1.2 (0.2)
Impairment and other nonrecurring charges(4) (3.5) (2.1) (7.1)
-------- -------- --------
Operating Income $ 166.9 $ 68.8 $ 9.8
======== ======== ========
(1) Includes year-end LIFO adjustments that reduced operating income by $6.1 million,
$2.2 million and $1.2 million in fiscal 2004, 2003 and 2002, respectively.
(2) Corporate expense consists primarily of unallocated corporate expense for services
that benefit all three business segments. Because of this unallocated expense, the
operating income of each segment does not reflect the operating income the segment
would have as a stand-alone business.
(3) Ferrous recycled metal sales from the Metals Recycling Business to the Steel
Manufacturing Business, and autobody sales from the Auto Parts Business to the
Metals Recycling Business, are made at negotiated rates per ton that are intended to
approximate market. Consequently, these intercompany sales produce intercompany
profits, which are eliminated until the finished products are sold to third parties.
(4) Impairment and other nonrecurring charges related to the Metals Recycling Business
in fiscal 2004 and 2002 and to the Auto Parts Business in fiscal 2003. The amounts
are shown separately to assist in understanding the business' financial results.
26
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
FISCAL 2004 COMPARED TO FISCAL 2003
- -----------------------------------
REVENUES. Consolidated revenues increased $191.4 million (39%) to $688.2 million
for fiscal 2004 compared with fiscal 2003. Revenues in fiscal 2004 increased for
all Company businesses primarily as a result of increased prices and demand in
the worldwide ferrous metals market, including the addition of new export
customers located outside of China. Significant improvements in demand coupled
with lower steel imports 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 its sales of autobodies.
In addition, the Auto Parts Business acquired three retail locations in Canada
that added revenue and operating income to the segment.
METALS RECYCLING BUSINESS
The Metals Recycling Business generated revenues of $456.3 million, before
intercompany eliminations, which is an increase of $147.7 million (48%). Ferrous
revenues increased $137.8 million (54%) to $393.0 million as a result of higher
average selling prices net of shipping cost (average net selling prices), higher
shipping costs billed to customers and a slight increase in the volume sold. The
average net selling price of ferrous recycled metal increased $62 per ton, or
51%, to $184 per ton which represents $111.8 million of the revenue increase.
Average export shipping costs increased 57% over the prior year and represent
$19.9 million of the revenue increase. In addition, ferrous sales volumes
increased 1.8% or 33,000 tons which represents $4.1 million of the increase in
ferrous revenue. Export volume is up 1.1% over prior year. Moreover, over 60% of
our total ferrous sales were export shipments to Asia in the last two fiscal
years. In fiscal 2004, ferrous export sales to China decreased to 34% of the
total ferrous exports compared to more than 60% in fiscal 2003. In addition,
ferrous export sales to South Korea increased to approximately 53% of our total
ferrous export sales in fiscal 2004 compared to 28% of ferrous export sales in
fiscal 2003. New customers in Thailand and India purchased 10% of our export
sales volume in fiscal 2004.
Sales volume to the Company's Steel Manufacturing Business increased 15% to
618,000 tons due to increased demand in this finished steel business. Nonferrous
revenues increased $9.2 million (19%) to $57.0 million due primarily to higher
average prices. The average net nonferrous selling price in fiscal 2004 was
$0.48 per pound, an increase of $0.06 per pound from fiscal 2003.
AUTO PARTS BUSINESS
The Auto Parts Business generated revenue of $81.5 million, before intercompany
eliminations, which is an increase of $16.3 million or 25% from prior year. This
increase is a result of higher wholesale revenues driven by higher average sales
prices for scrapped autobodies due to rising ferrous recycled metal prices and
the March 2004 acquisition of three retail store locations in Canada.
STEEL MANUFACTURING BUSINESS
The Steel Manufacturing Business' generated revenues of $271.3 million, which is
an increase of $79.4 million or 41% from prior year. Sales prices increased $113
per ton or 39% which represents $70.7 million of the increase and sales volumes
increased 3% which represents $5.9 million of the revenue increase. The increase
in selling prices are a combination of increased demand and passing along
rapidly rising raw materials and energy costs required in the production
process.
COST OF GOODS SOLD. Consolidated cost of goods sold increased $117.2 million or
28% over the prior year. Cost of goods sold decreased as a percentage of revenue
from 83% in fiscal 2003 to 77% in fiscal 2004. The reduction in cost of goods
sold as a percentage of revenue is due to profit margin improvements at all of
the Company's business segments, led by the Steel Manufacturing Business.
METALS RECYCLING BUSINESS
Cost of goods sold for the Metal Recycling Business increased $102.0 million or
40% to $357.9 million. The cost of goods sold as a percentage of revenues
decreased from 83% in fiscal 2003 to 78% in fiscal 2004. Gross profit increased
by $45.7 million to $98.4 million for the year. The increase in gross profit was
attributable to higher average net selling prices per ton. Compared with fiscal
2003, the average ferrous metals cost of sales per ton
27
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
increased 37% due primarily to higher purchase costs for unprocessed ferrous
metals and higher export sales shipping costs. Generally, the change in the cost
of unprocessed metal has a strong correlation to changes in the average selling
price; however there is generally a delay in the timing between changes in net
selling prices and the change in the cost of unprocessed metal. Thus, as selling
prices rose compared with last year, so did the cost of unprocessed metal. Since
purchase costs did not increase at the same rate as selling prices, we
experienced significant increases in margins.
AUTO PARTS BUSINESS
The Auto Parts Business' cost of goods sold increased $10.2 million or 28% over
the prior year. As a percentage of revenue, cost of goods sold increased from
55% to 57%. This increase was due to higher car purchase costs and increases in
labor costs. Gross profit increased $6.1 million or 21% over the prior year due
to increased revenue.
STEEL MANUFACTURING BUSINESS
Cost of goods sold for the Steel Manufacturing Business increased $51.5 million
or 27% to $242.5 million. Cost of goods sold as a percentage of revenues in
fiscal 2004 decreased to 89% from 100% in fiscal 2003. The decrease in cost of
goods sold as a percentage of revenue is attributable to higher average selling
prices, higher sales volumes and the receipt of the final $1.8 million electrode
price fixing settlement, offset by a $1.1 million pension charge. Average cost
of goods sold per ton increased $69 per ton or 24% compared to the prior fiscal
year. As this increase in cost of sales per ton was more than offset by the $114
per ton increase in average net selling price, gross profit improved by $27.9
million in fiscal 2004 compared to fiscal 2003.
IMPAIRMENT AND OTHER NONRECURRING CHARGES. During fiscal 2002, the Company's
Portland, Oregon metals recycling facility embarked on a dock and loading
facility renovation. The renovation was suspended in fiscal 2003 when issues
with the dock's substructure were detected. Upon review of new engineering
designs focused on operational efficiency and safety specifications, an
impairment charge of $3.5 million was recorded in the fourth quarter of fiscal
2004 to write-off renovation costs incurred prior to the suspension.
In connection with the acquisition of the Auto Parts Business, the Company
conducted an environmental due diligence investigation. Based upon new
information obtained in this investigation, the Joint Venture accrued $2.1
million in environmental liabilities in the second quarter of fiscal 2003 for
remediation costs at the Auto Parts Business's store locations. No environmental
proceedings are pending at any of these sites.
OPERATING INCOME FROM JOINT VENTURES. The Company's joint ventures' revenues and
results of operations were as follows (in thousands):
Year Ended August 31,
------------------------------
2004 2003
------------ ------------
Total revenues from external customers recognized by:
Joint Ventures in the metals recycling business:
Processing $ 1,038,373 $ 616,958
Brokering 489,030 251,431
Joint Venture suppliers of metals 12,644 8,877
------------ ------------
$ 1,540,047 $ 877,266
============ ============
Operating income from joint ventures recognized by the Company:
Joint Ventures in the metals recycling business $ 61,672 $ 24,827
Joint Venture suppliers of metals (101) (406)
------------ ------------
$ 61,571 $ 24,421
============ ============
The Joint Ventures in the metals recycling business predominantly sell recycled
ferrous and nonferrous metals. The increase in revenues recognized by these
joint ventures is attributable to higher average net ferrous selling prices and
higher volumes. Shipments of ferrous metal processed by the joint ventures were
3.6 million tons for the year ended
28
SCHNITZER STEEL INDUSTRIES, INC.
FORM 10-K
August 31, 2004 compared with 3.3 million tons in the prior year. The volume of
ferrous metal brokered by the joint ventures increased to 2.7 million tons in
fiscal 2004 compared to 1.7 million tons in the prior year, which came primarily
from increased market share in Mexico and Latin America coupled with product
line expansion into other scrap metal related commodities. The average net
selling price of ferrous recycled metal increased during that period to $187 per
ton from $118 per ton, due to the same worldwide supply and demand factors
affecting the wholly-owned Metals Recycling Business.
In fiscal 2004, the Company's share of income from Joint Ventures in th