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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended February 28, 2005
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ________ to ________.
Commission file number 0-22496
SCHNITZER STEEL INDUSTRIES, INC.
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(Exact name of registrant as specified in its charter)
OREGON 93-0341923
------------------------------ ---------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3200 N.W. Yeon Ave.
P.O Box 10047
Portland, OR 97296-0047
-------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(503) 224-9900
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [_]
The Registrant had 22,482,227 shares of Class A Common Stock, par value of $1.00
per share, and 7,985,366 shares of Class B Common Stock, par value of $1.00 per
share, outstanding at April 1, 2005.
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SCHNITZER STEEL INDUSTRIES, INC.
INDEX
PAGE NO.
PART I. FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets at February 28, 2005
and August 31, 2004......................................................3
Condensed Consolidated Statement of Operations for the Three
Months and Six Months Ended February 28, 2005 and February 29, 2004......4
Condensed Consolidated Statement of Shareholders' Equity for the
Year Ended August 31, 2004 and the Six Months
Ended February 28, 2005..................................................5
Condensed Consolidated Statement of Cash Flows for the
Six Months Ended February 28, 2005 and February 29, 2004.................6
Notes to Condensed Consolidated Financial Statements.........................7
Management's Discussion and Analysis of
Financial Condition and Results of Operations............................16
Quantitative and Qualitative Disclosures about Market Risk..................33
Controls and Procedures.....................................................33
PART II. OTHER INFORMATION
Legal Proceedings ..........................................................34
Submission of Matters to a Vote of Security Holders.........................34
Exhibits....................................................................35
SIGNATURE PAGE..............................................................36
2
SCHNITZER STEEL INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
(Unaudited)
FEB. 28, 2005 AUG. 31, 2004
------------ ------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 17,271 $ 11,307
Accounts receivable, less allowance for
doubtful accounts of $798 and $772 65,001 43,444
Inventories (Note 2) 91,018 80,167
Deferred income taxes 5,383 5,383
Prepaid expenses and other 11,798 6,859
------------ ------------
Total current assets 190,471 147,160
Net property, plant and equipment 144,857 138,438
Other assets:
Investment in and advances to joint venture partnerships 182,864 182,845
Notes receivable, less current portion 1,349 1,337
Goodwill 151,026 131,178
Intangibles and other 5,545 5,015
------------ ------------
$ 676,112 $ 605,973
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current portion of long-term debt $ 148 $ 225
Accounts payable 32,534 31,881
Accrued payroll liabilities 16,087 20,183
Current portion of environmental liabilities 9,350 9,373
Accrued income taxes 511 4,954
Other accrued liabilities 8,642 7,450
------------ ------------
Total current liabilities 67,272 74,066
Deferred income taxes 24,884 24,884
Long-term debt, less current portion 47,760 67,801
Environmental liabilities, net of current portion 15,582 12,126
Other long-term liabilities 2,399 2,295
Minority interests 5,682 5,921
Commitments and contingencies -- --
Shareholders' equity:
Preferred stock--20,000 shares authorized, none issued -- --
Class A common stock--75,000 shares $1 par value authorized,
22,425 and 22,022 shares issued and outstanding 22,425 22,022
Class B common stock--25,000 shares $1 par value authorized,
7,998 and 8,306 shares issued and outstanding 7,998 8,306
Additional paid-in capital 125,716 110,177
Retained earnings 356,263 278,374
Accumulated other comprehensive income:
Foreign currency translation adjustment 131 1
------------ ------------
Total shareholders' equity 512,533 418,880
------------ ------------
$ 676,112 $ 605,973
============ ============
THE ACCOMPANYING NOTES TO THE UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THIS STATEMENT.
3
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited, in thousands, except per share amounts)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
------------------------------ ------------------------------
FEB. 28, 2005 FEB. 29, 2004 FEB. 28, 2005 FEB. 29, 2004
------------- ------------- ------------- -------------
Revenues $ 215,746 $ 161,603 $ 414,707 $ 289,979
Operating Expenses:
Cost of goods sold 154,523 135,631 293,478 242,329
Selling 1,392 1,106 3,099 2,384
General and administrative 12,016 9,333 22,675 17,565
Environmental matter 7,725 -- 8,225 --
------------- ------------- ------------- -------------
Income from wholly-owned operations 40,090 15,533 87,230 27,701
Operating income from joint ventures 16,205 8,684 36,669 14,621
------------- ------------- ------------- -------------
Operating income 56,295 24,217 123,899 42,322
Other income (expense):
Interest expense (346) (486) (630) (926)
Other income (expense), net 86 (50) (360) 154
------------- ------------- ------------- -------------
(260) (536) (990) (772)
------------- ------------- ------------- -------------
Income before income taxes and minority interests 56,035 23,681 122,909 41,550
Income tax provision (19,500) (4,582) (42,772) (9,764)
------------- ------------- ------------- -------------
Income before minority interests 36,535 19,099 80,137 31,786
Minority interests, net of tax (554) (550) (1,220) (1,060)
------------- ------------- ------------- -------------
Net income $ 35,981 $ 18,549 $ 78,917 $ 30,726
============= ============= ============= =============
Net income per share - basic: $ 1.18 $ 0.62 $ 2.60 $ 1.03
============= ============= ============= =============
Net income per share - diluted: $ 1.15 $ 0.60 $ 2.53 $ 0.99
============= ============= ============= =============
THE ACCOMPANYING NOTES TO THE UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THIS STATEMENT.
4
SCHNITZER STEEL INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands)
(unaudited)
CLASS A CLASS B ACCUMULATED
COMMON STOCK COMMON STOCK ADDITIONAL OTHER
------------------- ------------------- PAID-IN RETAINED COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS INCOME TOTAL
-------- -------- -------- -------- --------- -------- -------- -----------
Balance at August 31, 2003 12,445 $ 12,445 7,061 $ 7,061 $ 104,249 $179,242 $ -- $ 302,997
Net income 111,181 111,181
Foreign currency translation
adjustment 1 1
-----------
111,182
Class B common stock converted
to Class A common stock 1,743 1,743 (1,743) (1,743) --
Class A common stock issued 802 802 5,928 6,730
Stock dividend 7,032 7,032 2,988 2,988 (10,020) --
Cash dividends paid - common
($0.068 per share) (2,029) (2,029)
-------- -------- -------- -------- --------- -------- -------- -----------
Balance at August 31, 2004 22,022 22,022 8,306 8,306 110,177 278,374 1 418,880
Net income 78,917 78,917
Foreign currency translation
adjustment 130 130
-----------
79,047
Class B common stock converted
to Class A common stock 308 308 (308) (308) --
Class A common stock issued 95 95 1,163 1,258
Tax benefits from employee
stock option plan 14,376 14,376
Cash dividends paid - common
($0.034 per share) (1,028) (1,028)
-------- -------- -------- -------- --------- -------- -------- -----------
Balance at February 28, 2005 22,425 $ 22,425 7,998 $ 7,998 $ 125,716 $356,263 $ 131 $ 512,533
======== ======== ======== ======== ========= ======== ======== ===========
THE ACCOMPANYING NOTES TO THE UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THIS STATEMENT.
5
SCHNITZER STEEL INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
FOR THE SIX MONTHS ENDED
--------------------------------------
FEBRUARY 28, 2005 FEBRUARY 29, 2004
----------------- -----------------
Operations:
Net income $ 78,917 $ 30,726
Noncash items included in income:
Depreciation and amortization 10,143 10,057
Minority interests 1,874 1,387
Equity in income of joint ventures (36,669) (14,621)
Deferred income tax -- (10,643)
Tax benefit from employee stock option plan 14,376 --
(Gain) loss on disposal of assets 183 (196)
Cash provided (used) by changes in working capital:
Accounts receivable (21,557) 4,286
Inventories (10,851) 8,183
Prepaid expenses and other (4,939) 5,240
Accounts payable 653 2,394
Accrued liabilities (7,347) 915
Environmental liabilities 633 (877)
Other assets and liabilities 252 (436)
----------------- -----------------
Net cash provided by operations 25,668 36,415
----------------- -----------------
Investing:
Capital expenditures (15,221) (10,941)
Investment in subsidiaries (22,176) (13,083)
Cash received from joint ventures 40,050 363
Cash paid to joint ventures (851) (745)
Proceeds from sale of assets 495 476
----------------- -----------------
Net cash provided (used) by investments 2,297 (23,930)
----------------- -----------------
Financing:
Issuance of Class A common stock 1,258 5,041
Distributions to minority interests (2,113) (900)
Dividends declared and paid (1,028) (1,000)
Decrease in long-term debt (20,118) (4,114)
----------------- -----------------
Net cash used by financing (22,001) (973)
----------------- -----------------
Net increase in cash and cash equivalents 5,964 11,512
Cash and cash equivalents at beginning of period 11,307 1,687
----------------- -----------------
Cash and cash equivalents at end of period $ 17,271 $ 13,199
================= =================
THE ACCOMPANYING NOTES TO THE UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THIS STATEMENT.
6
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
- ---------------------
The accompanying unaudited condensed interim financial statements of Schnitzer
Steel Industries, Inc. (the Company) have been prepared pursuant to the rules
and regulations of the Securities and Exchange Commission (SEC). Certain
information and note disclosures normally included in annual financial
statements have been condensed or omitted pursuant to those rules and
regulations. In the opinion of management, all adjustments, consisting only of
normal, recurring adjustments considered necessary for a fair presentation, have
been included. Although management believes that the disclosures made are
adequate to ensure that the information presented is not misleading, management
suggests that these financial statements be read in conjunction with the
financial statements and notes thereto included in the Company's annual report
for the fiscal year ended August 31, 2004. The results for the three and six
months ended February 28, 2005 and February 29, 2004 are not necessarily
indicative of the results of operations for the entire year.
RECLASSIFICATIONS
- -----------------
Certain prior year amounts have been reclassified to conform to the current year
presentation. These changes had no impact on previously reported results of
operations or shareholder's equity.
CASH AND CASH EQUIVALENTS
- -------------------------
Cash and cash equivalents include short-term securities that have an original
maturity date of 90 days or less.
EARNINGS AND DIVIDENDS PER SHARE
- --------------------------------
Basic earnings per share (EPS) are computed based upon the weighted average
number of common shares outstanding during the period. Diluted EPS reflects the
potential dilution that would occur if securities or other contracts to issue
common stock were exercised or converted into common stock.
The following represents reconciliation from basic EPS to diluted EPS (in
thousands, except per share amounts):
For the Three For the Six
Months Ended Months Ended
--------------------- ---------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
--------- --------- --------- ---------
(Unaudited)
Net income $ 35,981 $ 18,549 $ 78,917 $ 30,726
========= ========= ========= =========
Computation of shares (1):
Average common shares outstanding 30,422 30,021 30,386 29,800
Stock options 773 1,083 784 1,245
--------- --------- --------- ---------
Diluted average common
shares outstanding 31,195 31,104 31,170 31,045
========= ========= ========= =========
Basic net income per share $ 1.18 $ 0.62 $ 2.60 $ 1.03
========= ========= ========= =========
Diluted net income per share $ 1.15 $ 0.60 $ 2.53 $ 0.99
========= ========= ========= =========
Dividend per share(1) $ 0.017 $ 0.017 $ 0.034 $ 0.033
========= ========= ========= =========
(1) Basic and diluted earnings per share and dividends per common share for the
three and six months ended February 29, 2004, have been adjusted to reflect
the one-for-two stock dividend paid on March 25, 2004.
7
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
STOCK INCENTIVE PLAN
- --------------------
The Company's compensation expense for its stock incentive plans is determined
using the intrinsic value method. Accordingly, because the exercise price equals
the market price on the date of the grant, no compensation expense is recognized
by the Company for stock options issued to employees and directors. If the fair
value based method had been applied in measuring stock compensation expense, the
pro forma effect on net income per share would have been as follows (in
thousands, except earnings per share):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
Reported net income $ 35,981 $ 18,549 $ 78,917 $ 30,726
Add: Stock based compensation
expense included in reported net
income, net of tax 224 -- 449 --
Deduct: Total stock based
employee compensation expense
under fair value based method
for all awards, net of tax (214) (266) (401) (266)
-------- -------- -------- --------
Pro forma net income $ 35,991 $ 18,283 $ 78,965 $ 30,460
======== ======== ======== ========
Reported basic income per share $1.18 $0.62 $2.60 $1.03
Pro forma basic income per share $1.18 $0.61 $2.60 $1.02
Reported diluted income per share $1.15 $0.60 $2.53 $0.99
Pro forma diluted income per share $1.15 $0.59 $2.53 $0.98
All of the options issued and outstanding for the periods in fiscal 2005 and
fiscal 2004 are considered to be dilutive and are reflected in the table above.
The Company obtains an income tax benefit related to stock issued to employees
through stock options plans, which is recorded as additional paid-in capital
and, therefore, does not benefit the income tax provision. For income tax
purposes the Company can deduct the amount an employee would report as ordinary
income. The deduction is allowed in the year the employee exercises the stock
option and the tax benefit is recorded at the time the Company includes the
deduction in the Company's tax return. In the second fiscal quarter of 2005, the
Company recorded a tax benefit from employee stock option plans of $14.4
million.
On December 16, 2004 the FASB finalized SFAS No. 123R "Shared-Based Payment"
which will be effective for interim or annual reporting periods beginning after
June 15, 2005. The new standard will require the Company to expense stock
options. The Company has begun the process to analyze how the utilization of a
binomial lattice model could impact the valuation of the options. The effect of
expensing stock options on our financial results using the Black-Scholes model
is presented in the table above.
GOODWILL AND INTANGIBLE ASSETS
- ------------------------------
The changes in the carrying amount of goodwill for the six months ended February
28, 2005, are as follows (in thousands):
Metals
Recycling Auto Parts
Business Business Total
--------- --------- ---------
Balance as of August 31, 2004 $ 34,771 $ 96,407 $ 131,178
Auto Parts Business Acquisition
(see Note 3) -- 19,848 19,848
--------- --------- ---------
Balance as of February 28, 2005 $ 34,771 $116,255 $ 151,026
========= ========= =========
8
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
The Company performs impairment tests annually and whenever events and
circumstances indicate that the value of goodwill and other indefinite-lived
intangible assets might be impaired. Due to the operating results of each of the
businesses identified above and based upon the Company's impairment testing
completed in the second quarter of fiscal 2005, the Company determined that none
of the above balances were considered impaired.
NOTE 2 - INVENTORIES:
Inventories consisted of the following (in thousands):
February 28, August 31,
2005 2004
----------- ---------
Recycled metals $ 31,739 $ 34,551
Work in process 4,538 10,045
Finished goods 41,995 23,808
Supplies 12,746 11,763
--------- --------
$ 91,018 $ 80,167
========= =========
NOTE 3 - ACQUISITIONS
On January 10, 2005, Pick-N-Pull Auto Dismantlers, a wholly-owned subsidiary of
the Company, acquired the assets and leased the sites for four self-service used
auto parts stores in St. Louis and Kansas City, Missouri; Columbus, Ohio; and
Virginia Beach, Virginia from Vehicle Recycling Solutions, LLC and certain of
its wholly-owned subsidiaries ("VRS"). The total acquisition cost of $22.1
million consisted of a cash purchase price of $18.8 million, $0.5 million of
acquisition expenses and additional environmental reserves recorded as a result
of due diligence of $2.8 million. The St. Louis, Kansas City and Columbus stores
increase the Company's existing mid-west store base. The Virginia Beach store
provides Pick-N-Pull with an eastern presence giving it the ability to expand
along the East Coast. The four new stores will be operated under the Pick-N-Pull
name and increase the total number of stores to 30 for the Company's Auto Parts
Business segment. The results of operations for these four stores after the
acquisition date are reflected in the consolidated results of the Company's Auto
Parts Business for the second fiscal 2005 quarter.
NOTE 4 - ENVIRONMENTAL LIABILITIES
The Company considers various factors when estimating its environmental
liabilities. Adjustments to the liabilities are made when additional information
becomes available that affects the estimated costs to remediate. The factors,
which the Company considers in its recognition and measurement of environmental
liabilities, include the following:
o Current regulations both at the time the reserve is established and
during the course of the clean-up which specify standards for
acceptable remediation;
o Information about the site, which becomes available as the site is
studied and remediated;
o The professional judgment of both senior-level internal staff and
external consultants who take into account similar, recent instances
of environmental remediation issues, among other considerations;
o Technologies available that can be used for remediation; and
o The number and financial condition of other potentially responsible
parties and the extent of their responsibility for the remediation.
9
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
PORTLAND HARBOR
In December 2000, the United States Environmental Protection Agency (EPA) named
the Portland Harbor, a 5.5 mile stretch of the 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
February 28, 2005, $0.3 million has been accrued for studies related to the
pending Portland Harbor Superfund site. No estimate is currently possible and
none has been made as to the cost of remediation for the Portland Harbor or the
Company's adjacent properties.
MANUFACTURING MANAGEMENT, INC.
In 1994, Manufacturing Management, Inc. (MMI) recorded a reserve for the
estimated cost to cure certain environmental liabilities. This reserve was
carried over to the Company's financial statements when MMI was acquired in
1995. The reserve is evaluated quarterly according to Company policy. On
February 28, 2005, the reserve aggregated $13.1 million.
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
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 UAO for the head of the Hylebos
Waterway was converted to a voluntary consent
10
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
decree in 2004, pursuant to which GMT and the Other Party agreed to remediate
the head of the Hylebos Waterway.
There are two phases to the remediation of the head of the Hylebos Waterway. The
first phase was the intertidal and bank remediation, which was conducted in 2003
and early 2004. The second phase is dredging in the head of Hylebos Waterway,
which began on July 15, 2004. During the first half of fiscal 2005, the Company
incurred remediation costs of $10.2 million related to Hylebos dredging which
were charged to the environmental reserve. The Company's cost estimates were
based on the assumption that dredge removal of contaminated sediments would be
accomplished within one dredge season during July 2004 - February 2005. However,
due to a variety of factors, including equipment failures, dredge contractor
operational issues and other dredge related delays, the dredging was not
completed during the first dredge season. As a result, the Company recorded
environmental charges of $8.2 million in the first half of fiscal 2005 primarily
to account for additional estimated costs to complete this work during a second
dredging season. The Company and the Other Party have asserted a claim for
relief from the dredge contractor for a significant portion of the increased
costs, and are currently engaged in mediation of this dispute. However,
generally accepted accounting principles do not allow the Company to recognize
the benefits of any such relief until receipt is highly probable.
GMT and the Other Party are pursuing settlement negotiations and legal actions
against other non-settling, non-performing PRPs to recover additional amounts
that may be applied against the head of the Hylebos remediation costs.
Uncertainties continue to exist regarding the total cost to remediate this site
as well as the Company's share of those costs; nevertheless, the Company's
estimate of its liabilities related to this site is based on information
currently available.
The Natural Resource Damage Trustees (Trustees) for Commencement Bay have
asserted claims against GMT and other PRPs within the Hylebos Waterway area for
alleged damage to natural resources. In March 2002, the Trustees delivered a
draft settlement proposal to GMT and others in which the Trustees suggested a
methodology for resolving the dispute, but did not indicate any proposed damages
or cost amounts. In June 2002, GMT responded to the Trustees' draft settlement
proposal with various corrections and other comments, as did twenty other
participants. It is unknown at this time whether, or to what extent, GMT will be
liable for natural resource damages. The Company's previously recorded
environmental liabilities include an estimate of the Company's potential
liability for these claims.
The Washington State Department of Ecology named GMT, along with a number of
other parties, as Potentially Liable Parties (PLPs) for a site referred to as
Tacoma Metals. GMT operated on this site under a lease prior to 1982. The
property owner and current operator have taken the lead role in performing a
Remedial Investigation and Feasibility Study (RI/FS) for the site. The RI/FS is
now completed and the parties are currently involved in a mediation settlement
process to address cost allocations. The Company's previously recorded
environmental liabilities include an estimate of the Company's potential
liability at this site.
MMI is also a named PRP at another third-party site at which it allegedly
disposed of automobile shredder residue (ASR). The site has not yet been subject
to significant remedial investigation. MMI has been named as a PRP at several
other sites for which it has agreed to de minimis settlements. In addition to
the matters discussed above, the Company's environmental reserve includes
amounts for potential future cleanup of other sites at which MMI has conducted
business or has allegedly disposed of other materials.
11
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
PROLER AND JOINT VENTURES
In 1996, prior to the Company's acquisition of Proler International Corp.
(Proler), Proler recorded a liability for the probable costs to remediate its
wholly-owned properties. This reserve was carried over to the Company's
financial statements upon acquiring Proler in 1996. The reserve is evaluated
quarterly according to Company policy. On February 28, 2005, the reserve
aggregated $3.4 million.
As part of the Proler acquisition, the Company became a 50% owner of Hugo
Neu-Proler Company (HNP). HNP has agreed, as part of its 1996 lease renewal with
the Port of Los Angeles (POLA), to conduct a multi-year, phased remedial
clean-up project involving certain environmental conditions on its metals
recycling facility at its Terminal Island site in Los Angeles, California, which
was completed in 2002. HNP is waiting for final certification from POLA and the
regulatory agencies overseeing the cleanup. Remediation included excavation and
off-site disposal of contaminated soils, paving and groundwater monitoring.
Other environmentally protective actions included installation of a stormwater
management system and construction of a noise barrier and perimeter wall around
a substantial portion of the facility.
Additionally, other Proler joint venture sites with potential environmental
clean-up issues have been identified. Estimated clean-up costs associated with
these sites have been accrued for by the joint ventures.
During the second quarter of fiscal 2005, in connection with the negotiation of
a possible transaction for the split-up of the Company's metals recycling joint
ventures with Hugo Neu Corporation, the Company conducted an environmental due
diligence investigation of certain joint venture businesses it proposes to
directly acquire. As a result of this investigation, the Company identified
certain environmental risks and accrued $2.6 million for its share of the
estimated costs to remediate these risks.
AUTO PARTS BUSINESS
Since 2003, the Company has completed three acquisitions of businesses in the
Auto Parts Business segment. At the time of each acquisition, the Company
conducts an environmental due diligence investigation related to locations
involved in the acquisition. As a result of the environmental due diligence
investigations, the Company has accrued $4.9 million in environmental
liabilities for remediation costs at the Auto Parts Business' store locations,
including $2.8 million in connection with the acquisition completed in the
second quarter of fiscal 2005. No environmental proceedings are pending at any
of these sites, other than discussed below.
On January 6, 2004, the Auto Parts Business was served with a Notice of
Violation (NOV) of the general permit requirements on its diesel powered car
crushers at the Rancho Cordova and Sacramento locations from the Sacramento
Metropolitan Air Quality Management District (SMAQMD). Since receiving the NOV,
the Sacramento and Rancho Cordova locations have converted their diesel powered
car crushers to electric powered. The Company is engaged in an ongoing
evaluation of our car crushing systems and expects to enter discussions with the
SMAQMD to address the potential regulatory enforcement penalties. As a result,
the Company recorded a reserve of $0.6 million during 2004 for the estimated
potential exposure for this matter.
NOTE 5 - OTHER CONTINGENCIES
The Company and Hugo Neu Corporation ("HNC") are the 50% members of Hugo Neu
Schnitzer Global Trade, LLC ("HNSGT"), a joint venture engaged in global
brokering of recycled metals. HNC manages the day-to-day activities of HNSGT. In
January 2004, HNC advised the Company that it would charge HNSGT a 1% commission
on HNSGT's recycled metal sales, and began deducting those commissions. While
some reasonable reimbursement of HNC's costs may be appropriate, the Company has
responded that the 1% commission is excessive and that HNC had no authority to
unilaterally impose such commissions on HNSGT. The Company has not yet commenced
litigation in this dispute. As of February 28, 2005, the Company estimated that
its 50% share of the disputed commissions totaled $4.3 million. In recording
operating income from joint ventures, the Company has excluded from joint
venture expenses the excess of these disputed commissions over the Company's
estimate of reasonable reimbursements.
12
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
The Company was advised in 2004 that its practice of paying commissions to the
purchasing manager of customers in connection with export sales of recycled
ferrous metals to the Far East may raise questions of possible violations of
U.S. and foreign laws, and the practice was stopped. Thereafter, the Audit
Committee was advised and conducted a preliminary compliance review. On November
18, 2004, on the recommendation of the Audit Committee, the Board of Directors
authorized the Audit Committee to engage independent counsel and conduct a
thorough, independent investigation and directed that the existence and the
results of the investigation be voluntarily reported to the U.S. Department of
Justice (DOJ) and the Securities and Exchange Commission (SEC), and that the
Company cooperate fully with those agencies. The investigation is ongoing, and
the DOJ and SEC have been advised of its progress. The investigation is not
expected to affect the Company's previously reported financial results,
including those reported in this 10-Q. The Company cannot predict the results of
the investigation or whether the Company or any of its employees will be subject
to any penalties or other remedial actions following completion of the
investigation.
NOTE 6 - EMPLOYEE BENEFITS
The Company has a number of retirement benefit plans that cover both union and
non-union employees. The Company makes contributions following the provisions in
each plan.
Primary actuarial assumptions are determined as follows:
o The expected long-term rate of return on plan assets is based on our
estimate of long-term returns for equities and fixed income securities
weighted by the allocation of assets in the plans. The rate is
affected by changes in general market conditions, but because it
represents a long-term rate, it is not significantly affected by
short-term market swings. Changes in the allocation of plan assets
would also impact this rate.
o The assumed discount rate is used to discount future benefit
obligations back to today's dollars. The U.S. discount rate is as of
the measurement date, August 31, 2004. This rate is sensitive to
changes in interest rates. A decrease in the discount rate would
increase our obligation and expense.
o The expected rate of compensation increase is used to develop benefit
obligations using projected pay at retirement. This rate represents
average long-term salary increases and is influenced by our
compensation policies. An increase in this rate would increase our
obligation and expense.
DEFINED BENEFIT PENSION PLAN
- ----------------------------
For certain nonunion employees, the Company maintains a defined benefit pension
plan. The components of net periodic pension benefit cost are (in thousands):
For the Three For the Six
Months Ended Months Ended
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
Service cost $259 $211 $527 $432
Interest cost 158 137 323 280
Expected return on plan assets (194) (156) (395) (319)
Amortization of past service cost 1 1 2 2
Recognized actuarial loss 45 39 92 79
---- ---- ---- ----
Net periodic pension benefit cost $269 $232 $549 $474
==== ==== ==== ====
For the year ended August 31, 2005, the Company expects to contribute $1.0
million to its defined benefit pension plan. As of February 28, 2005, the
Company has not yet made its fiscal contributions to this plan. The Company
typically makes annual contributions to the plan after it receives the annual
actuarial valuation report. These payments are typically made in the Company's
third and fourth fiscal quarters.
13
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
DEFINED CONTRIBUTION PLANS
The Company has several defined contribution plans covering nonunion employees.
Company contributions to the defined contribution plans were as follows (in
thousands):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
Plan costs $ 190 $ 357 $ 536 $ 722
MULTIEMPLOYER PENSION PLANS
In accordance with collective bargaining agreements, the Company contributes to
multiemployer pension plans. Company contributions are as follows (in
thousands):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
Plan contributions $ 753 $ 769 $1,336 $1,490
The Company is not the sponsor or administrator of these multiemployer plans.
Contributions were determined in accordance with provisions of negotiated labor
contracts. The Company is unable to determine its relative portion of or
estimate its future liability under the plans.
The Company learned during fiscal 2004 that one of the multiemployer plans would
not meet ERISA minimum funding standards for the plan year ending September 30,
2004. The trustees of that plan have applied to the Internal Revenue Service for
certain relief from this minimum funding standard, but cannot determine whether
this relief will be granted. Absent relief, the plan's contributing employers
will be required to make additional contributions or pay excise tax that may
equal or exceed the full amount of that deficiency. The Company estimates its
share of the required additional contribution for the 2004 plan year is
approximately $1.1 million and accrued for such amount in fiscal 2004.
NOTE 7 - SEGMENT INFORMATION:
The Company operates in three industry segments: metal processing and recycling
(Metals Recycling Business), mini-mill steel manufacturing (Steel Manufacturing
Business) and self-service used auto parts (Auto Parts Business). Additionally,
the Company is a non-controlling partner in joint ventures, which are in the
metals recycling business. The Joint Ventures in the metals recycling business
sell recycled metals that have been processed at their facilities (Processing)
and also buy and sell third parties' processed metals (Brokering). The Company
considers these joint ventures to be separate segments because they are managed
separately. These joint ventures are accounted for using the equity method. As
such, the operating information related to the joint ventures is shown
separately from consolidated information, except for the Company's equity in the
net income of, investments in and advances to the joint ventures. Additionally,
assets and capital expenditures are not shown for the joint ventures as
management does not use that information to allocate resources or assess
performance. The Company does not allocate corporate interest income and
expense, income taxes or other income and expenses related to corporate activity
to its operating segments.
14
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2005 AND FEBRUARY 29, 2004
Revenues from external customers for the Company's consolidated operations are
as follows (in thousands):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
Metals Recycling Business $152,080 $109,327 $296,612 $188,929
Steel Manufacturing Business 66,820 59,861 136,842 113,080
Auto Parts Business 24,448 17,245 47,834 34,905
Intersegment revenues (27,602) (24,830) (66,581) (46,935)
-------- -------- -------- --------
Consolidated revenues $215,746 $161,603 $414,707 $289,979
======== ======== ======== ========
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
Total revenues from external
customers recognized by:
Joint Ventures:
Processing $369,294 $233,885 $ 676,102 $390,263
Brokering 214,846 120,514 437,210 230,460
-------- -------- ---------- --------
Total revenues $584,140 $354,399 $1,113,312 $620,723
======== ======== ========== ========
The Company's operating income (loss) is as follows (in thousands):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
Metals Recycling Business $ 39,481 $ 13,162 $ 73,769 $ 23,085
Auto Parts Business 7,245 5,094 14,591 10,983
Steel Manufacturing Business 5,358 2,691 18,118 2,549
Joint Ventures (1) 16,205 8,684 36,669 14,621
Corporate expense (5,008) (3,018) (8,599) (5,664)
Intercompany profit eliminations 739 (2,396) (2,424) (3,252)
Environmental matter (7,725) -- (8,225) --
-------- -------- -------- --------
Total operating income $ 56,295 $ 24,217 $123,899 $ 42,322
======== ======== ======== ========
(1) Operating income from the joint ventures includes environmental expenses of
$2.6 million for the three and six months ended February 28, 2005.
The Company's share of depreciation and amortization expense included in the
determination of joint ventures' income from operations is as follows (in
thousands):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
Joint Ventures $1,881 $1,788 $3,557 $3,587
15
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
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 Canada, and the Company
believes it is one of the country's leading self-service used auto parts
networks with 30 retail store locations. Additionally, Pick-N-Pull is a supplier
of autobodies to the Metals Recycling Business which processes the autobodies
into sellable recycled metal. The Steel Manufacturing Business purchases
recycled metals from the Metals Recycling Business and uses its mini-mill to
process the recycled metals into finished steel products. As a result of the
Company's vertically integrated business, it is able to transform autobodies and
other unprocessed metals into finished steel products. The joint ventures in the
metals recycling business sell recycled metals that have been processed at their
facilities (Processing) and also buy and sell third parties' processed metals
(Brokering).
RESULTS OF OPERATIONS
The Company's revenues and operating results by business segment are summarized
below (in thousands):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
REVENUES:
Metals Recycling Business:
Ferrous sales $133,647 $ 95,545 $260,479 $161,439
Nonferrous sales 16,943 12,078 32,597 24,487
Other sales 1,490 1,704 3,536 3,003
-------- -------- -------- --------
Total sales 152,080 109,327 296,612 188,929
Auto Parts Business 24,448 17,245 47,834 34,905
Steel Manufacturing Business 66,820 59,861 136,842 113,080
Intercompany sales eliminations (27,602) (24,830) (66,581) (46,935)
-------- -------- -------- --------
Total revenues $215,746 $161,603 $414,707 $289,979
======== ======== ======== ========
OPERATING INCOME (LOSS):
Metals Recycling Business $ 39,481 $ 13,162 $ 73,769 $ 23,085
Auto Parts Business 7,245 5,094 14,591 10,983
Steel Manufacturing Business 5,358 2,691 18,118 2,549
Joint Ventures (1) 16,205 8,684 36,669 14,621
Corporate expense (5,008) (3,018) (8,599) (5,664)
Intercompany profit eliminations 739 (2,396) (2,424) (3,252)
Environmental matter (7,725) -- (8,225) --
-------- -------- -------- --------
Total operating income $ 56,295 $ 24,217 $123,899 $ 42,322
======== ======== ======== ========
NET INCOME $ 35,981 $ 18,549 $ 78,917 $ 30,726
======== ======== ======== ========
(1) Operating income from the joint ventures includes environmental expenses of
$2.6 million for the three and six months ended February 28, 2005.
16
SCHNITZER STEEL INDUSTRIES, INC.
The Joint Ventures' revenues and results of operations were as follows (in
thousands):
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
Total revenues from external
customers recognized by:
Joint Ventures
Processing $369,294 $233,885 $ 676,102 $390,263
Brokering 214,846 120,514 437,210 230,460
-------- -------- ---------- --------
$584,140 $354,399 $1,113,312 $620,723
======== ======== ========== ========
Operating income from Joint
Ventures (1) $ 16,205 $ 8,684 $ 36,669 $ 14,621
======== ======== ========== ========
(1) Operating income from the joint ventures includes environmental expenses of
$2.6 million for the three and six months ended February 28, 2005.
The following table summarizes certain selected operating data for the Company
and its joint venture businesses:
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
METALS RECYCLING BUSINESS:
Ferrous recycled metal sales
prices ($/ton) (1,2)
Domestic $ 220 $ 168 $ 221 $ 150
Export $ 247 $ 154 $ 246 $ 150
Average $ 240 $ 158 $ 238 $ 150
Ferrous recycled metal shipments
(tons in thousands) (2)
To Steel Manufacturing Business 110 132 269 290
To other unaffiliated domestic customers 9 14 26 29
To export customers 357 355 652 591
------ ------ ------ ------
Total ferrous recycled metal 476 501 947 910
====== ====== ====== ======
Nonferrous metal shipments (pounds in thousands) 30,900 24,900 60,300 53,200
====== ====== ====== ======
AUTO PARTS BUSINESS
Number of stores open at quarter end 30 23 30 23
17
SCHNITZER STEEL INDUSTRIES, INC.
For the Three For the Six
Months Ended Months Ended
------------------- -------------------
Feb. 28, Feb. 29, Feb. 28, Feb. 29,
2005 2004 2005 2004
-------- -------- -------- --------
(Unaudited)
STEEL MANUFACTURING BUSINESS:
Average sales price ($/ton ) (1,2) $ 517 $ 351 $ 525 $ 331
Finished steel products sold
(tons in thousands) (2) 125 162 251 325
JOINT VENTURES:
Ferrous recycled metal shipments
(tons in thousands) (2)
Processed 1,050 828 1,979 1,502
Brokered 722 623 1,472 1,301
----- ----- ----- -----
1,772 1,451 3,451 2,803
===== ===== ===== =====
(1) The Company reports revenues that include shipping costs billed to
customers. However, average net selling prices are shown net of shipping
costs.
(2) Tons for ferrous recycled metals are long tons (2,240 pounds) and for
finished steel products are short tons (2,000 pounds).
SECOND QUARTER FISCAL 2005 COMPARED TO SECOND QUARTER FISCAL 2004
RESULTS OF OPERATIONS
- ---------------------
During the second quarter of fiscal 2005, the Company's operations improved
dramatically compared to the second quarter of fiscal 2004 as a result of higher
pricing for its products, which is directly a result of strong worldwide
consumption of both recycled metal and finished steel products.
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. Beginning in fiscal 2004, and continuing into the first half of
fiscal 2005, strong worldwide demand combined with a tight supply of recycled
metals created significant price volatility and drove the Metals Recycling
Business' average selling prices to unprecedented highs. Market prices for
recycled ferrous metals fluctuate periodically and have a significant impact on
the results of operations for the wholly-owned operations and Joint Ventures in
the metals recycling business.
The Auto Parts Business purchases used and salvaged vehicles, sells parts from
those vehicles through its retail facilities and wholesale operations and sells
the remaining portion of the vehicles to metal recyclers. The Auto Parts
Business has acquired seven new stores since the end of the second fiscal
quarter of last year, which represents a 30% increase in the number of stores.
These new stores have led to increases in both retail and wholesale revenues and
operating income. In addition, revenues for the wholesale product lines are
principally affected by commodity prices and shipping schedules. As mentioned
earlier in the discussion regarding the Metals Recycling Business, recycled
metal prices have increased dramatically over the last year, which increased the
revenues and profits of the Auto Parts Business. The self-service retail
operations are somewhat seasonal and affected by weather conditions and
promotional events. Since the stores are open to the natural elements, during
periods of prolonged wet, cold or extreme heat, the retail business tends to
slow down due to the difficult customer working conditions. As a result, the
Company's first and third fiscal quarters tend to generate the most retail sales
and the second and fourth fiscal quarters are the slowest in terms of retail
sales.
18
SCHNITZER STEEL INDUSTRIES, INC.
The Steel Manufacturing Business' sales volumes normally decline to their lowest
levels during the Company's second fiscal quarter of each year due to adverse
weather conditions that slow demand. In addition, the Steel Manufacturing
Business' sales volumes were unusually low during the second quarter of fiscal
2005 due to abnormally high inventory levels held by its customers who fabricate
and distribute steel. Throughout the second half of fiscal 2004, demand and
selling prices for finished steel grew quickly. The rise in selling prices
caused many fabricators and distributors to buy ahead of end user demand in
anticipation of even higher prices. This buying pattern resulted in unusually
high market inventory levels of finished steel. In anticipation of seasonal
declines in consumption that occur in the late fall and winter months, many
distributors and fabricators reduced their steel purchases to balance their
inventories. At the same time, West Coast steel manufacturers (including the
Company) built inventory levels in anticipation of the spring construction
period. Sales volumes of rebar and wire rod products were adversely affected by
rising levels of imports in the second quarter. The Company believes that the
rise in import levels is attributable to the increase in selling prices in the
West Coast market, which potentially allow the import sales to be more
profitable to the foreign companies. The increased supply of imports on the West
Coast caused market prices to drop significantly on 20-foot rebar segments and
to a lesser degree on wire rod products.
The Company's steel mill successfully completed the installation of a new
electric arc furnace in December 2004. It is anticipated that the new furnace
will improve productivity of the mill as well as reduce operating costs,
including the consumption of electricity. To date, the new furnace is performing
well and exceeding productivity expectations.
REVENUES. Consolidated revenues for the quarter ended February 28, 2005
increased $54.1 million or 34% to $215.7 million from $161.6 million in the
second quarter of fiscal 2004. Revenues in the second quarter of fiscal 2005
increased for all Company business segments primarily as a result of increased
prices and demand in the worldwide ferrous metals market. Significant
improvements in world wide demand, coupled with higher raw material cost, led to
increases in selling prices for finished steel products sold by the Steel
Manufacturing Business. The Auto Parts Business benefited from the increased
ferrous metals prices in the sales of autobodies and higher core sale revenues.
In addition, the Auto Parts Business acquired three retail locations in Canada
in the third quarter of fiscal 2004 and four retail locations in the United
States in January 2005 that added revenue and operating income to the segment
over the prior year.
The Metals Recycling Business generated revenues of $152.1 million for the
quarter ended February 28, 2005, before intercompany eliminations, which was an
increase of $42.8 million or 39% over the same period of the prior year. Ferrous
revenues increased $38.1 million, or 40%, to $133.6 million as a result of
higher average selling prices net of shipping cost (average net selling prices)
and higher shipping costs billed to customers, partially offset by a decrease in
the volume sold. The average net sales price for ferrous metals for the second
quarter increased 52% to $240 per ton, which represents $39.2 million of the
revenue increase over the prior year quarter. The cost of freight that was
included in revenues increased by $2.9 million over the fiscal 2004 second
quarter due primarily to higher ocean chartering costs. Average export shipping
costs increased 17% over the prior year quarter. Total ferrous sales volumes
decreased by approximately 25,300 tons or 5%, which represents a decrease in
revenue of $4.0 million from the prior year quarter and was primarily due to
normal variation in the timing of when orders are received and ultimately sold.
Sales to the Steel Manufacturing Business decreased 21,800 tons, or 17%, to
110,000 tons as a result of the installation of a new furnace at the Steel
Manufacturing Business during December 2004. During the furnace installation,
melt shop production halted, which led to a decreased need for scrap metals. The
decreased sales volume to the Steel Manufacturing Business was temporary. The
new furnace has caused a modest increase in the rate of scrap consumption at the
Steel Mill.
19
SCHNITZER STEEL INDUSTRIES, INC.
Revenue from nonferrous metal sales increased $4.9 million over the prior year
second quarter which was a result of a $0.06 or 13% increase in average net
sales price to $0.54 per pound and a 6 million pound or 24% increase in the
pounds shipped. The increase in sales price per pound was a result of increased
Asian demand for nonferrous metals. The increase in pounds shipped over the
prior year second quarter was a result of more scrap metals being processed
through the Company's shredders as well as the implementation of a system to
improve recovery of nonferrous metals from the shredding process. Nonferrous
metals are a byproduct of the shredding process, and quantities available for
shipment are affected by the volume of materials processed in the Company's
shredders.
The Auto Parts Business generated revenue of $24.4 million, before intercompany
eliminations, for the quarter ended February 28, 2005, which was an increase of
$7.2 million or 42% over the same period of the prior year. This increase was a
result of higher wholesale revenues driven by higher average sales prices for
scrapped autobodies due to rising ferrous recycled metal prices and higher core
sale revenues in both the Company's recently acquired and existing store
locations. In addition, retail revenues increased as a result of the acquisition
of three retail store locations in Canada in March 2004 and four retail store
locations in the United States in January 2005 and, to a lesser extent, same
store sales improvement.
The Steel Manufacturing Business generated revenues of $66.8 million for the
quarter ended February 28, 2005, which is an increase of $7.0 million, or 12%
over the prior year quarter. The average net selling price increased $166 per
ton, or 47% to $517 per ton, which represents a $20.7 million revenue increase.
The increase in average net selling prices was due to a combination of factors
including increased steel consumption. Sales volumes decreased 23% to 125,000
tons, which reduced revenues by $13.2 million. The lower sales volume during the
second quarter of fiscal 2005 was primarily due to abnormally high inventory
levels held by fabricators and distributors of steel, as discussed above, and
the impact of lower priced imports from Asia on certain lengths of rebar and
wire rod products. Many of the Company's customers used the normal seasonal
decline in consumption during the winter months to reduce their inventory
levels.
COST OF GOODS SOLD. Consolidated cost of goods sold increased $18.9 million or
14% for the second quarter ended February 28, 2005, compared with the same
period last year. Cost of goods sold decreased as a percentage of revenues from
84% to 72%. Gross profit increased $35.3 million to $61.2 million during the
latest quarter compared to the prior year quarter driven by profit margin
improvements at the Company's Metals Recycling, Auto Parts and Steel
Manufacturing Business segments.
Cost of goods sold for the Metals Recycling Business increased $16.2 million or
18% to $107.6 million. As a percentage of revenues, cost of goods sold decreased
compared with the second quarter of fiscal 2004 from 84% to 71%. Gross profit
increased by $26.5 million to $44.5 million. The increase in gross profit was
primarily attributable to higher average net selling prices per ton and to
inventory write-ups which were partially offset by lower sales volumes. During
the second quarter of 2005, several piles of ferrous metal inventory were fully
utilized revealing higher inventory volumes than the Company had previously
estimated, resulting in a decrease in cost of goods sold of $5.4 million for the
inventory adjustments. Compared with the second quarter of last year, the
average ferrous metals cost of sales per ton increased 22% due primarily to
higher purchase costs for unprocessed ferrous metals. Generally, a change in the
cost of unprocessed metal has a strong correlation to changes in the average
selling price. Thus, as selling prices rose compared with last year's quarter,
so did the cost of unprocessed metal.
The Auto Parts Business' cost of goods sold increased $4.3 million or 42% during
the second quarter of fiscal 2005 as compared to the cost of goods sold for the
fiscal 2004 second quarter. The higher cost of sales was primarily due to higher
car purchase costs that resulted from higher scrap metal prices and the addition
of seven new stores since last year. As a percentage of revenues, cost of goods
sold remained consistent with the prior year quarter. Gross profit increased
$2.9 million or 41% over the prior year quarter due to increased wholesale
revenue earned from the higher market rates for scrap metals coupled with new
store acquisitions.
20
SCHNITZER STEEL INDUSTRIES, INC.
The Steel Manufacturing Business' cost of goods sold increased $4.2 million or
8% during the second quarter of fiscal 2005 as compared to the cost of goods
sold for the fiscal 2004 second quarter. As a percentage of revenues, cost of
goods sold decreased compared with the second quarter of fiscal 2004 from 94% to
91%. Average cost of goods sold per ton increased $137 per ton or 42% compared
to the prior year quarter, which was primarily caused by higher raw material
costs for recycled metal and alloys and effects of the melt shop shutdown in
December 2004. As this increase in cost of sales was more than offset by the
$166 per ton increase in average net selling price, gross profit improved by
$2.7 million, to $6.2 million for the quarter. The Steel Mill incurred
approximately $5.0 million in costs during the second quarter of fiscal 2005
related to the melt shop shut down and furnace replacement project completed in
December 2004.
JOINT VENTURES. The Joint Ventures in the metals recycling business
predominantly sell recycled ferrous and nonferrous metals. Revenues for this
segment in the second quarter of fiscal 2005 increased $229.7 million or 65%
compared with the prior year quarter primarily due to a 49% higher average net
selling price per ton and a 21% increase in the volume of ferrous recycled metal
sold, over the prior year quarter. The increase in average net selling price per
ton was due to primarily the same supply and demand circumstances described
earlier for the Company's wholly-owned businesses.
The Company's share of Joint Venture operating income for the second quarter of
fiscal 2005 increased to $16.2 million from $8.7 million in the second quarter
of fiscal 2004. The increase in income from these Joint Ventures was primarily
caused by higher selling prices and volumes. The Company's share of operating
income from the global brokering joint venture decreased from $3.2 million in
the second quarter of fiscal 2004 to $2.8 million in the second quarter of
fiscal 2005, a 12% decrease. The Company's share of joint venture operating
income in the second quarter of fiscal 2005 included a charge of $2.6 million
for its share of estimated environmental costs. During the second quarter of
fiscal 2005, in connection with the negotiation of a possible transaction for
the split-up of the Company's metals recycling joint ventures with Hugo Neu
Corporation, the Company conducted an environmental due diligence investigation
of certain joint venture businesses it proposes to directly acquire, and
identified certain environmental risks for which estimated remediation costs
were accrued. The Company's share of joint venture operating income also
included an estimated $1.0 million from a joint venture contract with New York
City for the processing and disposal of curbside recycling materials that
commenced in April 2004. The contract with New York City is an interim contract,
and the Company's present intention is not to participate in the anticipated
long-term contract. Therefore, the income stream from this contract could end at
any time.
GENERAL AND ADMINISTRATIVE EXPENSE. Compared with the second quarter of fiscal
2004, general and administrative expense for the same quarter this fiscal year
increased $2.7 million or 29%. Approximately $1.1 million of the change is
related to increased headcount, primarily in the Auto Parts Business for
development of its management infrastructure to allow growth of this business
segment, and higher bonus accruals due to increased profitability. In addition,
the Company incurred increased expenses for Sarbanes-Oxley compliance and other
professional fees, including $0.7 million related to the Audit Committee's
investigation of payment practices in the Far East as discussed in Note 5 to the
condensed consolidated financial statements. As a percentage of revenues,
general and administrative expense has decreased by 0.2% percentage points, from
5.8% to 5.6% due to spreading these expenses over higher revenues.
ENVIRONMENTAL MATTER. During the second quarter of fiscal 2005, the Company
recorded environmental charges of $7.7 million for additional estimated costs
related to the ongoing remediation of the head of the Hylebos Waterway adjacent
to the Company's Tacoma, Washington metals processing facility. An estimate of
this liability was initially recognized as part of the 1995 acquisition of the
Tacoma facility. The cost estimate was based on the assumption that dredge
removal of contaminated sediments would be accomplished within one dredge season
during July 2004 - February 2005. However, due to a variety of factors,
including equipment failures, dredge contractor operational issues and other
dredge related delays, the dredging was not completed during the first dredge
season. As a result, the Company increased its environmental accrual by $7.7
million related to this project primarily to account for additional estimated
costs to complete this work during a second
21
SCHNITZER STEEL INDUSTRIES, INC.
dredging season. The Company has asserted a claim for relief from the dredge
contractor to seek relief for a significant portion of the increased costs, and
is currently engaged in mediation of this dispute. However, generally accepted
accounting principles do not allow the Company to recognize the benefits of any
such relief until receipt is highly probable.
INTEREST EXPENSE. Interest expense for the second quarter of fiscal 2005
decreased 29% to $0.3 million compared with the second quarter of fiscal 2004.
The decrease was a result of lower average debt balances during the fiscal 2005
second quarter compared with the fiscal 2004 quarter.
INCOME TAX PROVISION. The tax rate of 34.8% for the second quarter of fiscal
2005 was higher than the 19% rate for the same quarter last year for two main
reasons. First, the Extraterritorial Income Exclusion (ETI) tax benefit on
export sales is projected to decrease. Secondly, last year's tax rate benefited
from the final release of a valuation allowance that had once offset net
operating losses. The 34.8% rate approximates the 35% Federal statutory rate
because the projected ETI benefits are largely offset by the projected state
income taxes.
FIRST HALF OF FISCAL 2005 COMPARED TO FIRST HALF OF FISCAL 2004
RESULTS OF OPERATIONS
- ---------------------
REVENUES. Consolidated revenues for the six months ended February 28, 2005
increased $124.7 million or 43% to $414.7 million from $290.0 million for the
same period last year. The higher revenues were attributed to higher average
selling prices for the Metals Recycling Business and the Steel Manufacturing
Business and higher wholesale revenues for the Auto Parts Business. In addition,
the Metals Recycling Business had an overall increase in the volume of ferrous
metals shipped over the prior year period. Revenues in the first half of fiscal
2005 increased for all Company business segments primarily as a result of
increased prices and demand in the worldwide ferrous metals market. Significant
improvements in demand, coupled with higher raw material cost led to increases
in selling prices for finished steel products sold by the Steel Manufacturing
Business. The Auto Parts Business benefited from the increased ferrous metals
prices in the sales of autobodies and higher core sale revenues. In addition,
the Auto Parts Business acquired three retail locations in Canada in the third
quarter of fiscal 2004 and four retail locations in the second quarter of fiscal
2005 that added both revenue and operating income to the segment over the prior
year.
The Metals Recycling Business generated revenues of $296.6 million for the six
month period ended February 28, 2005, before intercompany eliminations, which
was an increase of $107.7 million or 57% over the same period of the prior year.
Ferrous revenues increased $99.0 million, or 61% to $260.5 million as a result
of higher average selling prices net of shipping cost (average net selling
prices), higher shipping costs billed to customers and an increase in the volume
sold. The average net sales price for ferrous metals increased 59% to $238 per
ton, which represents $83.6 million of the revenue increase over the prior year
six month period. The cost of freight that was included in revenues increased by
$9.8 million over the six month period ended February 28, 2004 due primarily to
higher ocean chartering costs. Average export shipping costs increased 27% over
the same period in the prior year period. Total ferrous sales volumes increased
by approximately 37,000 tons or 4%, which represents $5.5 million of the revenue
increase over the prior year six month period and was primarily due to normal
variation in the timing of when orders are received and ultimately sold.
Sales to the Steel Manufacturing Business decreased by 20,000 tons or 7% to
269,000 tons due to a temporary closure of the steel mill melt shop while a new
furnace was installed in December 2004. Nonferrous revenue increased $8.1
million or 33% to $32.6 million due primarily to higher average selling prices.
The average net nonferrous selling price in the six months ended February 28,
2005 was $0.53 per pound, an increase of $0.07 per pound or 16%. In addition,
sales volume increased 13% to 60.3 million pounds. The increases in average
selling price and volume are related to strong worldwide demand, especially from
Asia.
22
SCHNITZER STEEL INDUSTRIES, INC.
The Auto Parts Business generated revenue of $47.8 million, before intercompany
eliminations, for the six months ended February 28, 2005, which is an increase
of $12.9 million or 37% over the same period of the prior year. This increase
was a result of higher wholesale revenues driven by higher average sales prices
for scrapped autobodies due to rising ferrous recycled metal prices and higher
core sale revenues in both the Company's recently acquired and existing store
locations. In addition, retail revenues increased as a result of the acquisition
of three retail store locations in March 2004 and four retail store locations in
January 2005.
The Steel Manufacturing Business generated revenues of $136.8 million for the
six months ended February 28, 2005, which was an increase of $23.8 million, or
21% over the same period of the last fiscal year. The average net selling price
increased $195 per ton, or 59% to $526 per ton, which represents a $48.9 million
revenue increase. The increase in average net selling prices was due to a
combination of factors including increased worldwide steel consumption. However,
sales volumes decreased 23% to 251,000 tons, which reduced revenues by $24.5
million. The lower sales volume during the first half of fiscal 2005 was
primarily due to abnormally high inventory levels held by fabricators and
distributors of steel, as discussed above. Many of the Company's customers are
using the normal seasonal decline in consumption during the winter months to
reduce their inventory levels. In addition, Asian imports to the West Coast have
created market pressure to grant price concessions on certain lengths of rebar
and wire rod.
COST OF GOODS SOLD. Consolidated cost of goods sold increased $51.1 million or
21% for the six months ended February 28, 2005, compared with the same period
last year. Cost of goods sold decreased as a percentage of revenues from 84% to
71%. Gross profit increased $73.6 million to $121.2 million during the latest
six month period compared to the same period in the prior year, driven by profit
margin improvements at the Company's Metals Recycling and Steel Manufacturing
Business segments.
Cost of goods sold for the Metals Recycling Business increased $56.2 million or
36% to $212.8 million. As a percentage of revenues, cost of goods sold decreased
compared with the first six months of fiscal 2004 from 83% to 72%. Gross profit
increased by $51.5 million to $83.8 million. The increase in gross profit was
primarily attributable to higher average net selling prices per ton, a decrease
in cost of goods sold related to inventory adjustments and higher sales volumes.
Compared with the first six months of last year, the average ferrous metals cost
of sales per ton increased 31% due primarily to higher purchase costs for
unprocessed ferrous metals. Generally, a change in the cost of unprocessed metal
has a strong correlation to changes in the average selling price. Thus, as
selling prices rose compared with last first half, so did the cost of
unprocessed metal.
The Auto Parts Business' cost of goods sold increased $7.4 million or 36% during
the first half of fiscal 2005 as compared to the cost of goods sold for the same
period of last fiscal year. The higher cost of sales was primarily due to higher
car purchase costs that resulted from higher scrap metal prices and the addition
of seven new stores since last year. As a percentage of revenues, cost of goods
sold remained consistent with the prior year. Gross profit increased $5.4
million or 38% over the first half of the prior year related to increased
wholesale revenue earned from the higher market rates for scrap metals.
The Steel Manufacturing Business' cost of goods sold increased $8.0 million or
7% during the first half of fiscal 2005 as compared to the cost of goods sold
for the first half of fiscal 2004. As a percentage of revenues, cost of goods
sold decreased compared with the first half of fiscal 2004 from 96% to 85%. The
average cost of goods sold per ton increased $128 per ton or 40% compared to the
prior year six month period, which was primarily caused by higher raw material
costs for recycled metal and alloys and the effects of the melt shop shut down
in December 2004. The increase in cost of sales was more than offset by the $195
per ton increase in average net selling price, and gross profit improved by
$15.8 million, to $20.0 million for the six month period ended February 28,
2005.
23
SCHNITZER STEEL INDUSTRIES, INC.
JOINT VENTURES. The Joint Ventures in the metals recycling business
predominantly sell recycled ferrous and nonferrous metals. Revenues for this
segment in the first half of fiscal 2005 increased $492.6 million or 79%
compared with the same period last year primarily due to a 60% higher average
net selling price per ton and a 28% increase in the volume of ferrous recycled
metal sold, over the prior year period. The increase in the average net selling
price per ton was due to the same supply and demand circumstances described
earlier for the Company's wholly-owned businesses.
The Company's share of Joint Venture operating income for the first six months
of fiscal 2005 increased to $36.7 million from $14.6 million in the first half
of fiscal 2004. The increase in income from these Joint Ventures was primarily
caused by higher selling prices and volumes. The Company's share of operating
income from the global brokering joint venture increased from $5.1 million in
the first half of fiscal 2004 to $7.0 million in the first half of fiscal 2005,
a 38% increase. The Company's share of joint venture operating income in the
first half of fiscal 2005 included a charge of $2.6 million for its share of
environmental costs. During the first half of fiscal 2005, in connection with
the negotiation of a possible transaction for the split-up of the Company's
metals recycling Joint Ventures with Hugo Neu Corporation, the Company conducted
an environmental due diligence investigation of certain of its joint venture
businesses it proposes to directly acquire, and identified certain environmental
risks for which estimated remediation costs were accrued. The Company's share of
joint venture operating income in the first half of fiscal 2005 also included an
estimated $2.6 million from a joint venture contract with New York City for the
processing and disposal of curbside recycling materials that commenced in April
2004. The contract with New York City is an interim contract, and the Company's
present intention is not to participate in the anticipated long-term contract.
Therefore, the income stream from this contract could end at any time.
GENERAL AND ADMINISTRATIVE EXPENSE. Compared with the first six months of fiscal
2004, general and administrative expense for the same period this fiscal year
increased $5.1 million or 29%. Approximately $2.1 million of the change is
related to increased headcount primarily in the Auto Parts Business for
development of its management infrastructure to allow growth of this business
segment. In addition, the Company incurred increased expenses related to
Sarbanes-Oxley compliance and other professional fees including $0.9 million
related to the Audit Committee's investigation of payment practices in the Far
East. As a percentage of revenues, general and administrative expense has
decreased by 0.6% percentage points, from 6.1% to 5.5% due to spreading these
expenses over higher revenues.
ENVIRONMENTAL MATTER. During the first half of fiscal 2005, the Company
recorded environmental charges of $8.2 million for additional estimated costs
related to the ongoing remediation of the head of the Hylebos Waterway adjacent
to the Company's Tacoma, Washington metals processing facility. An estimate of
this liability was initially recognized as part of the 1995 acquisition of the
Tacoma facility. The cost estimate was based on the assumption that dredge
removal of contaminated sediments would be accomplished within one dredge season
during July 2004 - February 2005. However, due to a variety of factors,
including equipment failures, dredge contractor operational issues and other
dredge related delays, the dredging was not completed during the first dredge
season. As a result, the Company increased its environmental accrual by $8.2
million related to this project primarily to account for additional estimated
costs to complete this work during a second dredging season. The Company has
asserted a claim for relief from the dredge contractor to seek relief for a
significant portion of the increased costs, and is currently engaged in
mediation of this dispute. However, generally accepted accounting principles do
not allow the Company to recognize the benefits of any such relief until receipt
is highly probable.
INTEREST EXPENSE. Interest expense for the first half of fiscal 2005 decreased
32% to $0.6 million compared with the first half of fiscal 2004. The decrease
was a result of lower average debt balances during the first six months of
fiscal 2005 compared with the same period in fiscal 2004.
24
SCHNITZER STEEL INDUSTRIES, INC.
INCOME TAX PROVISION. The tax rate of 34.8% for the first six months of fiscal
2005 was higher than the 23% rate for the same period last year for two main
reasons. First, the Extraterritorial Income Exclusion (ETI) tax benefit on
export sales is projected to decrease. Secondly, last year's tax rate benefited
from the final release of a valuation allowance that had once offset net
operating losses. The 34.8% rate approximates the 35% Federal statutory rate
because the projected ETI benefits are largely offset by the projected state
income taxes.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operations for the six months ended February 28, 2005 was $25.7
million compared with $36.4 million for the same period in the prior fiscal
year. The decrease in cash flow from operations was primarily related to an
increase in inventories and accounts receivable. Inventories at the Steel
Manufacturing Business increased $23.9 million or 63% over the prior year, led
by finished goods inventory. The increase was a result of lower sales volume due
to normal seasonality that slows demand and the rebalancing of inventory levels
by distributors and fabricators in the first half of fiscal 2005. Even though
sales volumes were low, the Company continued to manufacture finished steel
products in order to meet anticipated demand for the spring construction season.
Accounts receivable balances were higher due to higher average sales prices and
timing of when export metal shipments are made and the payments from customers
are collected. The effect of these is partially offset by a significant
improvement in net income from the Company's wholly-owned operations.
Capital expenditures for the six months ended February 28, 2005 were $15.2
million compared with $10.9 million during the first six months of fiscal 2004.
The increase was largely due to improvement projects at the Company's Oakland,
California recycling facility and the furnace installation at the Company's
steel mill. The Company expects to spend approximately $33.0 million on capital
improvement projects during the remainder of fiscal 2005.
Accrued environmental liabilities as of February 28, 2005 were $24.9 million.
Over the next 12 months, the Company expects to pay approximately $9.4 million
relating to previously accrued remediation projects including the remediation on
the Hylebos Waterway as discussed in Note 4 to the consolidated condensed
financial statements. Additionally, the Company anticipates future cash outlays
as it incurs the actual cost relating to the remediation of identified
environmental liabilities. The future cash outlays are anticipated to be within
the amounts established as environmental liabilities.
As of February 28, 2005, the Company had a committed unsecured bank credit
facility totaling $150 million that matures in May 2006. The credit facility
contains a provision whereby the Company may, upon obtaining consent of the bank
group, extend the term of the agreement by one year to May 2007. The Company has
provided notice of its intention to request such an extension and the bank group
has agreed to the request. The extension is subject to the Company providing
standard representations and warranties as of the May 2006 original maturity
date. The Company currently anticipates it will be able to provide the required
representations and warranties and the agreement will be extended. The Company
also has additional unsecured credit lines totaling $20 million, which are
uncommitted. The Company's debt agreements have certain restrictive covenants.
As of February 28, 2005, the Company had aggregate bank borrowings outstanding
under these facilities of $40.0 million and was in compliance with such
covenants.
In July 2002, the Company's metals recycling joint ventures with Hugo Neu
Corporation entered into a revolving credit facility (JV Credit Facility) with a
group of banks for working capital and general corporate purposes. Prior to that
time, the joint ventures' working capital and other cash needs had been met by
advances provided equally by the Company and its partner, Hugo Neu Corporation.
During February 2004, the facility was increased to $110 million. The JV Credit
Facility expires on July 31, 2005 and is secured by the inventory and
receivables of the joint venture businesses. The Company is not a guarantor of
the JV Credit Facility. The JV Credit Facility has a number of covenants and
restrictions, including restrictions on the level of distributions to the joint
venture partners. The joint ventures were in compliance with these covenants as
of February 28, 2005. As of February 28, 2005, $12.9
25
SCHNITZER STEEL INDUSTRIES, INC.
million was outstanding under the JV Credit Facility. The decline in borrowings
outstanding of $70.0 since November 30, 2004 was primarily the result of strong
earnings from the joint venture businesses and reductions in inventories. Upon
expiration of the JV Credit Facility, the Company and its partner will need to
revert to funding the cash needs of the joint ventures on an equal basis.
The joint venture agreements allow for distributions to the joint venture
partners. Over the eighteen month period ended February 28, 2005, the Company
recorded $98.2 million in operating income representing its share in the
earnings of joint ventures. During the six months ended February 28, 2005, the
joint ventures distributed cash of $40.0 million to the Company. The difference
between the operating income recognized by the joint ventures and cash
distributions received has been utilized by the joint ventures to fund expansion
of working capital, business growth, and investment in state-of-the-art
equipment to improve the efficiencies and capabilities of their business.
The joint ventures in the metals recycling business are purchasing and
installing one new mega-shredder and related equipment in fiscal 2005 for an
estimated cost of $12 million. In addition, the joint ventures will purchase
equipment and begin the long-term construction planning for the installation of
two additional mega-shredders and related equipment that are anticipated to be
completed in fiscal 2006.
The Company makes contributions to a defined benefit pension plan, several
defined contribution plans and several multiemployer pension plans.
Contributions vary depending on the plan and are based upon plan provisions,
actuarial valuations and negotiated labor agreements. The Company anticipates
making contributions of approximately $6.0 million to the various pension plans
in fiscal 2005.
Pursuant to a stock repurchase program, the Company is authorized to repurchase
up to 3.0 million shares of its stock when the market price of the Company's
stock is not reflective of management's opinion of an appropriate valuation of
the stock. Management believes that repurchasing shares under these conditions
enhances shareholder value. During the first six months of fiscal 2005, the
Company made no share repurchases. As of February 28, 2005, the Company had
repurchased a total of 1.3 million shares under this program.
The Company believes its current cash resources, internally generated funds,
existing credit facilities and access to the capital markets will provide
adequate financing for capital expenditures, working capital, joint ventures,
stock repurchases, debt service requirements, post retirement obligations and
future environmental obligations for the next twelve months. In the longer term,
the Company may seek to finance business expansion with additional borrowing
arrangements or additional equity financing.
OUTLOOK. Recycled metals markets continue to experience significant price
volatility; however, consumption remains strong. Based upon the Company's
wholly-owned Metals Recycling Businesses' current order backlog, contracted
average selling prices that are expected to be shipped in the third quarter of
fiscal 2005 are anticipated to be slightly lower than the amounts reported in
its second fiscal quarter of fiscal 2005. The Metals Recycling Business' third
quarter 2005 ferrous sales volume is anticipated to be in the 430,000 to 475,000
ton range. Ocean freight rates remain high from a historical context and are
expected to approximate second quarter 2005 levels. The cost of unprocessed
ferrous metal also remains very competitive and volatile, which may adversely
impact third quarter 2005 margins.
The joint venture processors in the metals recycling business are expected to
experience similar market trends as the Company's wholly-owned Metals Recycling
Business; however, their financial results may vary depending on geographical
locations, competition and other factors. The joint venture businesses located
on the Northeastern seaboard of the United States experienced unusually harsh
and prolonged winter weather over the last few months, which reduced the inbound
flow of recycled metal into the processing facilities. The reduced flow is
anticipated to reduce third quarter sales volumes.
26
SCHNITZER STEEL INDUSTRIES, INC.
The Auto Parts Business generally experiences one of its strongest periods for
retail demand during the Company's third fiscal quarter due to improving weather
conditions allowing customers greater access to parts inventory. The Auto Parts
Business continues to experience increasing costs to procure inventory due to
rising ferrous metal prices. This trend is expected to continue into the third
quarter of fiscal 2005 and may impact margins.
The Steel Manufacturing Business's sales volumes have been abnormally low over
the last two fiscal quarters as its customers, steel distributors and
fabricators, reduced their inventories. During this time, we understand end user
consumption remained good. Sales volumes during the first month of the Company's
third fiscal quarter rebounded and are strong today. It is anticipated that
third quarter 2005 sales volumes will approximate last year's third quarter
levels. Third quarter 2005 average sales prices are anticipated to approximate
the average prices realized during the second quarter. Steel conversion costs
are expected to decline in the third quarter as production levels improve over
the second quarter; however, rising alloy, refractory and electrode costs are
expected to partially reduce the benefits received from the increased
productivity.
On May 5, 2004, the Company announced its intention to explore strategic
alternatives for its Steel Manufacturing Business, including the possible sale
or merger of the business. Since this time, the Company actively marketed the
mill for sale, but was unable to achieve acceptable terms to effect a sale. The
Company continues to believe that the Steel Manufacturing Business is not a
long-term strategic asset, but believes the current business prospects are
attractive. Accordingly, the Company plans to continue to operate and maintain
this business into the foreseeable future and will review strategic alternatives
in the future as opportunities arise.
The Company's effective third quarter tax rate is expected to approximate 35%.
The Company estimates its third quarter 2005 operating income to be in the $46
million to $53 million range. This amount compares to operating income of $67.3
million reported for the third quarter of fiscal 2004.
Over the last few years, the Company has provided in its quarterly reports a
range of its estimated operating income for the next quarter to assist the
public in understanding its business trends. The Company recently assessed this
practice in consultations with its financial and legal advisers, reviewed
reporting trends of other publicly traded companies, and determined that it will
no longer provide quantitative earnings guidance beginning with future reports.
It will however, continue to provide qualitative guidance in future reports.
FACTORS THAT COULD AFFECT FUTURE RESULTS. Management's Discussion and Analysis
of Financial Condition and Results of Operations, particularly "Outlook" above,
contains forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Act of 1934, that are
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. One can generally identify these forward-looking statements
because they contain "expect", "believe" "anticipate", "estimate" and other
words which convey a similar meaning. One can also identify these statements as
they do not relate strictly to historical or current facts. Examples of factors
affecting Schnitzer Steel Industries, Inc.'s consolidated operations and its
joint ventures (the Company) that could cause actual results to differ
materially are the following:
Cyclicality and General Market Considerations: Purchase and selling prices for
recycled metals are highly cyclical in nature and subject to worldwide economic
conditions. In addition, the cost and availability of recycled metals are
subject to global supply and demand conditions which are volatile and beyond the
Company's control, resulting in periodic fluctuations in recycled metals prices
and working capital requirements. While the Company attempts to maintain and
grow margins by responding to changing recycled metals selling prices through
adjustments to its metals purchase prices, the Company's ability to do so is
limited by competitive and other market factors. Additionally, changing prices
could potentially impact the volume of recycled metal available to the Company,
the subsequent volume of processed metal sold by the Company,
27
SCHNITZER STEEL INDUSTRIES, INC.
inventory levels and the timing of collections and levels relating to the
Company's accounts receivable balances. Moreover, increases in recycled metals
selling prices can adversely affect the operating results of the Company's Steel
Manufacturing Business because increases in steel prices generally lag increases
in ferrous recycled metals prices.
The steel industry is also highly cyclical in nature and sensitive to general
economic conditions. Future economic downturns or a stagnant economy may
adversely affect the performance of the Company.
The Company expects to continue to experience seasonal fluctuations in its
revenues and net income. Revenues can fluctuate significantly quarter to quarter
due to factors such as the seasonal slowdown in the construction industry, which
is an important buyer of the Company's finished steel products. In addition,
weather and economic conditions n the United States and abroad can also cause
fluctuations in revenue and net income.
Another factor which may affect revenues relates to the seasonal reduction in
demand from foreign customers who tend to reduce their finished steel production
and corresponding scrap metal requirements, during the summer months to offset
higher energy costs. Also, severe weather conditions may affect the Company's
global market conditions.
The Company makes a number of large ferrous recycled metals shipments to foreign
steel producers each year. Customer requirements, shipping schedules and other
factors limit the Company's control over the timing of these shipments.
Variations in the number of foreign shipments from quarter to quarter will
result in fluctuations in quarterly revenues and earnings. The Company's
expectations regarding ferrous metal sales prices and volumes, as well as
earnings, are based in part on a number of assumptions which are difficult to
predict (for example, uncertainties relating to customer orders, metal
availability, estimated freight rates, ship availability, weather, cost and
volume of unprocessed inventory and production output, etc.).
The Auto Parts Business experiences modest seasonal fluctuations in demand. The
retail stores are open to the elements. During periods of extreme temperatures
and precipitation, customers tend to delay their purchases and wait for milder
conditions. As a result, retail sales are generally higher during the spring and
fall of each calendar year and lower in the winter and summer months.
Additionally, the Auto Parts Business is subject to a number of other risks that
could prevent it from maintaining or exceeding its current levels of
profitability, such as volatile supply and demand conditions affecting prices
and volumes in the markets for its products, services and raw materials;
environmental issues; local and worldwide economic conditions; increasing
competition; changes in automotive technology; the ultimate success of the
Company's growth and acquisition plans; ability to build the infrastructure to
support the Company's growth plans; and business integration and management
transition issues.
Competition: The recycled metals industry is highly competitive, with the volume
of purchases and sales subject to a number of competitive factors, principally
price. The Company competes with both large and numerous smaller companies in
its markets for the purchase of recyclable metals. The Company also competes
with a number of domestic and foreign recycled metals processors and brokers for
processed and unprocessed metal as well as for sales to domestic and foreign
customers. For example, in 2001 and 2002, lower cost ferrous recycled metals
supplies from certain foreign countries adversely affected market selling prices
for ferrous recycled metals. Since then, many of these countries have imposed
export restrictions which have significantly reduced their export volumes and
lowered the worldwide supply of ferrous recycled metals. These restrictions are
believed to have had a positive effect on the Company's selling prices. Given
the intricacies in which the global markets operate, the Company cannot predict
when or if foreign countries will change their trading policies and what effect,
if any, such changes might have on the Company's operating results.
28
SCHNITZER STEEL INDUSTRIES, INC.
From time to time, both the United States and foreign governments impose
regulations and restrictions on trade in the markets in which the Company
operates. In the second quarter of fiscal 2005, the Company received a
certificate from China that allows the Company to continue shipping recycled
metals into China. The certificate is part of a process designed to ensure safe
industrial and agricultural production in China. Also, it is not unusual for
various con