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EX-24.1 - POWERS OF ATTORNEY - SCHNITZER STEEL INDUSTRIES INCdex241.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 - SCHNITZER STEEL INDUSTRIES INCdex321.htm
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

[ x ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended August 31, 2010

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.

(Exact name of registrant as specified in its charter)

 

OREGON   93-0341923
(State of Incorporation)   (I.R.S. Employer Identification No.)

 

3200 NW Yeon Ave.,

Portland, OR

  97210
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (503) 224-9900

Securities registered pursuant to Section 12(b) of the Act:

 

Class A Common Stock, $1 par value   The NASDAQ Global Select Market
(Title of Each Class)   (Name of each Exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes [ x ]    No [    ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes [    ]    No [ x ]

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 has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files) Yes [    ]    No [    ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [    ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one)

 

Large Accelerated Filer [ x ]   Accelerated Filer [    ]
Non-Accelerated Filer [    ]   Smaller Reporting company [    ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [    ]    No [ x ]

The aggregate market value of the registrant’s voting common stock outstanding held by non-affiliates on February 28, 2010 was $1,012,089,697.

The Registrant had 22,699,657 shares of Class A common stock, par value of $1.00 per share, and 4,720,760 shares of Class B common stock, par value of $1.00 per share, outstanding as of October 12, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for the January 2011 Annual Meeting of Shareholders are incorporated herein by reference in Part III.


Table of Contents

SCHNITZER STEEL INDUSTRIES, INC.

FORM 10-K

TABLE OF CONTENTS

 

          PAGE

FORWARD LOOKING STATEMENTS

   1

PART I

     

Item 1

   Business    2

Item 1A

   Risk Factors    14

Item 1B

   Unresolved Staff Comments    19

Item 2

   Properties    20

Item 3

   Legal Proceedings    20

Item 4

   Reserved    20

PART II

     

Item 5

  

Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   21

Item 6

   Selected Financial Data    23

Item 7

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    24

Item 7A

   Quantitative and Qualitative Disclosures About Market Risk    43

Item 8

   Financial Statements and Supplementary Data    44

Item 9

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    84

Item 9A

   Controls and Procedures    84

Item 9B

   Other Information    84

PART III

     

Item 10

   Directors, Executive Officers and Corporate Governance    85

Item 11

   Executive Compensation    86

Item 12

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   86

Item 13

   Certain Relationships and Related Transactions, and Director Independence    86

Item 14

   Principal Accounting Fees and Services    86

PART IV

     

Item 15

   Exhibits and Financial Statement Schedules    87

SIGNATURES

   90


Table of Contents

 

FORWARD-LOOKING STATEMENTS

Statements and information included in this Annual Report on Form 10-K by Schnitzer Steel Industries, Inc. (the “Company”) that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and are made pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All references to “we,” “our,” “us” and “SSI” refer to the Company.

Forward-looking statements in this Annual Report on Form 10-K include statements regarding our expectations, intentions, beliefs and strategies regarding the future, including statements regarding trends, cyclicality and changes in the markets we sell into; strategic direction; changes to manufacturing processes; the cost of compliance with environmental and other laws; expected tax rates and deductions; the realization of deferred tax assets; planned capital expenditures; liquidity positions; ability to generate cash from continuing operations; the potential impact of adopting new accounting pronouncements; expected results, including pricing, sales volumes and profitability; obligations under our retirement plans; savings or additional costs from business realignment and cost containment programs; and the adequacy of accruals.

When used in this report, the words “believes,” “expects,” “anticipates,” “intends,” “assumes,” “estimates,” “evaluates,” “may,” “could,” “opinions,” “forecasts,” “future,” “forward,” “potential,” “probable,” and similar expressions are intended to identify forward-looking statements.

We may make other forward-looking statements from time to time, including in press releases and public conference calls. All forward-looking statements we make are based on information available to us at the time the statements are made, and we assume no obligation to update any forward-looking statements, except as may be required by law. Our business is subject to a number of risks and uncertainties that could cause actual results to differ materially from those included in, or implied by, such forward-looking statements. Some of these risks and uncertainties are discussed in Item 1A. Risk Factors of Part I of this Form 10-K. Other examples include volatile supply and demand conditions affecting prices and volumes in the markets for both our products and raw materials we purchase; world economic conditions; world political conditions; our ability to match raw material intake and finished product output with demand; changes in federal and state income tax laws; government regulations and environmental matters; the impact of pending or new laws and regulations regarding imports into and exports from the United States and other countries; foreign currency fluctuations; competition; seasonality, including weather; energy supplies; freight rates and availability of transportation; loss of key personnel; the inability to obtain sufficient quantities of scrap metal to support current orders; purchase price estimates made during acquisitions; business integration issues relating to acquisitions of businesses; creditworthiness of and availability of credit to suppliers and customers; new accounting pronouncements; availability of capital resources; business disruptions resulting from installation or replacement of major capital assets; and the adverse impact of climate change, including as a result of treaties, legislation or regulations.

 

Schnitzer Steel Industries, Inc. Form 10-K 2010  /  1


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PART I

 

 

ITEM 1. BUSINESS

General

Founded in 1906, Schnitzer Steel Industries, Inc., an Oregon corporation, is one of the nation’s largest recyclers of ferrous and nonferrous scrap metal, a leading recycler of used and salvaged vehicles and a manufacturer of finished steel products. Our founding business practice is a commitment to sustainability – recycling metal to generate additional value while achieving profitable growth. The worldwide demand for scrap metal is driven by continued demand for new steel products, electric arc furnace steel mill technology which relies on scrap metal as its primary feedstock and, to a certain extent, the use by blast furnaces of scrap metal because it reduces energy costs, virgin materials use, water use and mining wastes.

Through our North American metals recycling business, we collect and recycle autobodies, rail cars, home appliances, industrial machinery, manufacturing scrap and construction demolition from bridges, buildings and other obsolete structures. With 43 operating facilities located in 14 states and Puerto Rico, we are uniquely positioned to efficiently collect scrap metal throughout North America and export product to where demand is greatest. Utilizing our seven deep water ports, we have the capability to export to customers around the world.

Our metals recycling business also benefits from synergies with our auto parts business. Our auto parts business, which has 45 retail locations, buys end-of-life vehicles, sells parts to retail customers and sells scrap metal to our metals recycling business depending upon location. In addition, our metals recycling business benefits from synergies with our steel manufacturing business by selling scrap metal to our steel mini-mill that produces finished steel products such as rebar, wire rod, coiled rebar, merchant bar and other specialty products using nearly 100% recycled metal.

We report the operations of these three businesses in three segments: the Metals Recycling Business (“MRB”), the Auto Parts Business (“APB”) and the Steel Manufacturing Business (“SMB”). See Note 20 – Segment Information in the notes to the consolidated financial statements in Part II, Item 8 of this report.

Metals Recycling Business

Business

MRB buys, collects, processes, recycles, sells and brokers ferrous scrap metal (containing iron) to foreign and domestic steel producers, including SMB, and nonferrous scrap metal (not containing iron) to both foreign and domestic markets. MRB processes mixed and large pieces of scrap metal into smaller pieces by sorting, shearing, shredding and torching, resulting in scrap metal pieces of a size, density and purity required by customers to meet their production needs. The manufacturing process includes physical separation of materials through manual and sophisticated mechanical processes into ferrous and nonferrous sub-classifications, each of which has a value and metal content of importance to different customers for their end product.

One of the most efficient ways to process and sort recycled scrap metal is through the use of shredding systems. Currently, each of MRB’s facilities in Everett, Massachusetts; Portland, Oregon; Oakland, California; and Tacoma, Washington has a mega-shredder capable of processing over 2,500 tons of scrap metal per day. MRB’s Johnston, Rhode Island facility operates a large shredder capable of processing up to 1,500 tons of scrap metal per day, MRB’s Salinas, Puerto Rico facility operates a shredder that can process up to 500 tons of scrap metal per day and the Kapolei, Hawaii; Anchorage, Alaska; and Concord, New Hampshire facilities each operate smaller shredders. Mega-shredders are designed to provide a denser product and, in conjunction with new separation equipment, a more refined and preferable form of ferrous scrap metal which can be more efficiently used by steel mills. The larger shredders are also able to accept more types of material, resulting in more efficient processing. Shredders can reduce autobodies, home appliances and other scrap metal into fist-size pieces of shredded recycled scrap metal. The shredded material is then carried by conveyor under magnetized drums that attract the recycled ferrous scrap metal and separate it from the nonferrous scrap metal and other residue found in the shredded material, resulting in a consistent and high quality shredded ferrous product. The remaining nonferrous scrap metal and residue then pass through a series of

 

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additional mechanical and manual sorting systems designed to separate the nonferrous metal from the residue. The remaining nonferrous metal is then hand-sorted and graded before being sold or sold as a mixed product. MRB continues to invest in nonferrous metal separation technologies in order to maximize the recoverability of valuable nonferrous metal. MRB also purchases nonferrous metal directly from industrial vendors and other suppliers and bundles this metal to sell to customers.

Products

MRB sells both ferrous and nonferrous scrap metal. The primary product produced is ferrous scrap metal, which is a key feedstock used in the production of finished steel products. Ferrous scrap metal is categorized into plate and structural, or “bonus,” heavy melting steel (“HMS”) and shredded scrap. Our nonferrous products include aluminum, copper, stainless steel, nickel, brass, titanium, lead, high temperature alloys and joint products such as zorba (primarily mixed nonferrous material) and zurik (predominantly stainless steel).

Customers

MRB sells its products to steel mills and smelters located in the United States (“US”) and around the world and provides substantially all of the ferrous scrap metal required by SMB.

Presented below are MRB revenues by continent for the last three years ended August 31 (dollars in thousands):

 

     2010     % of
Revenue
    2009     % of
Revenue
    2008     % of
Revenue
 

Asia

   $ 1,228,022      67   $ 981,127      70   $ 1,437,850      53

North America

     503,651      28     301,093      22     917,485      34

Europe

     162,284      9     176,754      13     446,012      16

Africa

     85,813      5     48,681      3     261,503      9

Sales to SMB

     (155,310   (9 %)      (109,985   (8 %)      (328,412   (12 %) 
                              

Total revenues (net of
intercompany)

   $ 1,824,460      100   $ 1,397,670      100   $ 2,734,438      100
                              

In fiscal 2010, MRB generated revenues of $10 million or more from customers in 12 countries, including the United States, China, South Korea, Taiwan, Malaysia, Thailand, India, Turkey, Egypt, Greece, Indonesia and Japan. MRB generated revenues of $10 million or more from customers in 12 countries in fiscal 2009 and 14 countries in fiscal 2008. MRB had no external customers that accounted for 10% or more of consolidated revenues in fiscal 2010, 2009 or 2008.

MRB’s five largest external ferrous scrap metal customers accounted for 35%, 35% and 37% of recycled ferrous metal revenues in fiscal 2010, 2009 and 2008, respectively. Customer purchase volumes of ferrous scrap metal vary from year to year due to demand, competition, economic growth, infrastructure spending, relative currency values, availability of credit and other factors. Ferrous metal sales are generally denominated in US dollars, and almost all of the largest shipments of ferrous scrap metal to foreign customers are supported by letters of credit.

The table below sets forth, on a revenue and volume basis, the amount of recycled ferrous scrap metal sold by MRB to foreign and domestic customers during the last three fiscal years ended August 31:

 

     2010    2009    2008
     Revenues(1)    Volume(2)    Revenues(1)    Volume(2)    Revenues(1)    Volume(2)

Foreign

   $ 1,188,490    3,122    $ 1,032,571    3,436    $ 1,935,084    3,655

SMB

     155,310    458      109,985    335      328,412    737

Other domestic

     214,864    651      106,752    418      327,300    805
                                   

Total

   $ 1,558,664    4,231    $ 1,249,308    4,189    $ 2,590,796    5,197
                                   

 

 

 

(1)

Revenues stated in thousands of dollars.

(2)

Volume stated in thousands of long tons (one long ton = 2,240 pounds).

 

Schnitzer Steel Industries, Inc. Form 10-K 2010  /  3


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MRB also sells nonferrous scrap metal to foreign and domestic customers. MRB continues to grow its nonferrous volumes available for sale by extracting higher amounts of nonferrous products due to improvements in the extraction processes used to recover nonferrous metal from the shredding process and by expanding its nonferrous collection facilities.

The table below sets forth, on a revenue and volume basis, the amount of recycled nonferrous scrap metal sold by MRB to foreign and domestic customers during the last three fiscal years ended August 31:

 

     2010    2009    2008
     Revenues(1)    Volume(2)    Revenues(1)    Volume(2)    Revenues(1)    Volume(2)

Foreign

   $ 288,472    351,821    $ 174,756    294,016    $ 239,765    260,798

Domestic

     124,455    126,665      76,752    103,040      220,874    178,672
                                   

Total

   $ 412,927    478,486    $ 251,508    397,056    $ 460,639    439,470
                                   

 

 

 

(1)

Revenues stated in thousands of dollars.

(2)

Volume stated in thousands of pounds.

Pricing

Domestic and foreign prices for ferrous scrap metal are generally based on prevailing market rates, which can differ by region and are subject to market cycles that are influenced by worldwide demand from steel and other metal producers and by the availability of materials that can be processed into saleable scrap metal, among other factors. Export recycled ferrous metal sales contracts generally provide for shipment within 30 to 90 days after the price is agreed to which, in most cases, includes freight. MRB responds to changing price levels by adjusting scrap metal purchase prices at its recycling facilities in order to manage the impact on its operating income. The spread between selling prices and the cost of purchased material is subject to a number of factors, including differences in the market conditions in the domestic regions where recycled metal is acquired and the areas in the world where the processed materials are sold, market volatility from the time the selling price is agreed with the customer until the time the raw material is purchased, and changes in the assumed costs of transportation to the buyer’s facility. We believe MRB generally benefits from rising recycled metal selling prices, which allow it to better maintain or expand both operating income and unprocessed metal flow into its facilities, and suffers when recycled metal selling prices decline, which tend to compress its operating margins.

Markets

In recent years, worldwide demand for finished steel products has been growing at a faster rate than the available supply of recycled ferrous metal, which is one of the primary raw materials used in manufacturing steel. During this time, the demand for finished steel has been growing most rapidly in developing countries in Asia and the Mediterranean, which currently do not possess an adequate supply of raw materials to produce steel. As a result of this demand, MRB’s ferrous exports have made up 74%, 82% and 70% of its total ferrous sales volume in fiscal 2010, 2009 and 2008, respectively. The Asian developing countries have also been the primary recipients of MRB’s nonferrous products with nonferrous exports making up 74%, 74% and 59% of its total nonferrous sales volumes in fiscal 2010, 2009 and 2008, respectively. Unlike the ferrous export market, China has been the largest destination for MRB’s nonferrous export sales.

Consolidation in the Scrap Metal Industry

The metals recycling industry has been consolidating over the last several years, primarily due to a high degree of fragmentation and the ability of large, well-capitalized processors to achieve competitive advantages by investing in capital improvements to improve efficiencies and lower processing costs. We believe that we are in a position to make reasonably priced acquisitions in the metals recycling industry as a result of our low levels of debt, historical ability to generate cash from operations and available borrowing capacity.

 

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Distribution

MRB delivers recycled ferrous and nonferrous scrap metal to foreign customers by ship and to domestic customers by barge, rail and over the road transportation networks. Cost efficiencies are achieved by operating deep water terminal facilities at Everett, Massachusetts; Portland, Oregon; Oakland, California; Tacoma, Washington; and Providence, Rhode Island, all of which are owned except for the Providence, Rhode Island facility, which is operated under a long-term lease. We also have access to deep water terminal facilities at Kapolei, Hawaii and Salinas, Puerto Rico through public docks. These seven deep water terminals enable us to load large vessels capable of trans-oceanic shipments. Additionally, because we own most of the terminal facilities in which MRB operates, MRB is not normally subject to the same berthing delays often experienced by users of unaffiliated terminals. We believe that MRB’s loading costs are lower than they would be if it utilized third party terminal facilities. From time to time MRB may enter into contracts of affreightment, which guarantee the availability of ocean going vessels, in order to manage the risks associated with ship availability and freight costs.

Sources of Unprocessed Metal

The most common forms of purchased raw metal are obsolete machinery and equipment, such as automobiles, railroad cars, railroad tracks, home appliances and other consumer goods, waste metal from manufacturing operations and demolition metal from buildings and other obsolete structures. This metal is acquired from suppliers who unload at MRB’s facilities, from drop boxes at a diverse base of suppliers’ industrial sites and through negotiated purchases from other large suppliers, including railroads, industrial manufacturers, automobile salvage facilities, metal dealers, various government entities and individuals. The majority of MRB’s scrap metal collection and processing facilities receive raw metal via major railroad routes, waterways or major highways. Metal recycling facilities situated near unprocessed metal sellers and major transportation routes have the competitive advantage of reduced freight costs because of the significant cost of freight relative to the cost of metal. The locations of MRB’s West Coast facilities allow it to competitively purchase raw metal from the Northern California region, northwards up the West Coast to Western Canada and Alaska and to the east, including Idaho, Montana, Utah, Colorado and Nevada. The locations of the East Coast facilities provide access to sources of unprocessed metal in New York, Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont, Eastern Canada and, from time to time, the Midwest. In the Southeastern US, approximately half of MRB’s ferrous and nonferrous unprocessed metal volume is purchased from industrial companies, including domestic and international auto manufacturers, with the remaining volume being purchased from smaller dealers and individuals. These industrial companies provide MRB with metals that are by-products of their manufacturing processes. The supply of scrap metal from these manufacturers can fluctuate with the level of automotive and other manufacturing production in the region.

Backlog

As of October 13, 2010, MRB had a backlog of orders to sell $221 million of export ferrous metal compared to $73 million as of October 13, 2009. Additionally, as of September 30, 2010, MRB had a backlog of orders to sell $20 million of export nonferrous metal compared to $18 million as of September 30, 2009.

Competition

MRB faces stiff competition for both the purchase and sale of scrap metal. MRB competes domestically for the purchase of scrap metal with large, well-financed recyclers of scrap metal, steel mills that own scrap yards and smaller metal facilities and dealers. In general, the competitive factors impacting the purchase of scrap metal are the price offered by the purchaser and the proximity of the purchaser to the scrap metal source. MRB also competes with brokers who buy scrap metal on behalf of domestic and foreign steel mills.

MRB competes globally for the sale of processed recycled metal to finished steel producers. The predominant competitive factors that impact recycled metal sales are price (including shipping cost), reliability of service, product quality and availability of scrap metal and scrap metal substitutes.

 

Schnitzer Steel Industries, Inc. Form 10-K 2010  /  5


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We believe MRB’s ability to process substantial volumes of scrap metal products, state of the art equipment, number of locations, access to a variety of different modes of transportation, geographic dispersion and cross-divisional synergies provide its business with competitive advantages.

Auto Parts Business

Business and Products

APB procures used and salvaged vehicles and sells serviceable used auto parts from these vehicles through its 45 self-service auto parts stores which are located across the US and Western Canada. The remaining portions of the vehicles, primarily autobodies, cores (which include engines, transmissions, alternators and catalytic converters) and nonferrous materials, are sold to metal recyclers, including MRB where geographically feasible. APB completed the sale of its full-service used auto parts operation to LKQ Corporation in October 2009.

Customers

Self-service stores generally serve customers who are looking to obtain serviceable used auto parts at a competitive price. These customers remove the used auto parts from vehicles in inventory without the assistance of store employees. In addition, APB sells the cores to a variety of wholesale buyers and the scrap metal from end-of-life vehicles to MRB and third party recycling yards throughout the US and Western Canada.

We believe that APB has an enhanced competitive advantage through its various information technology systems, which are used to centrally manage and operate the geographically diverse network of stores; by applying a consistent approach to offering customers a large selection of vehicles from which to obtain parts; and by its efficient processing of autobodies. APB had no external customers that accounted for 10% or more of consolidated revenues in fiscal 2010, 2009 or 2008.

APB is dedicated to supplying low-cost used auto parts to its customers. In general, we believe that the sale prices of auto parts at APB’s self-service stores are significantly lower than those offered at full-service auto dismantlers, retail car parts stores and car dealerships. Each self-service store offers an extensive selection of vehicles (including domestic and foreign cars, vans and light trucks) from which consumers can remove parts. APB regularly rotates its vehicle inventory to provide its customers greater access to a continually changing parts inventory.

The table below sets forth APB revenues from domestic and foreign customers for the last three fiscal years ended August 31 (in thousands):

 

     2010     2009     2008  

Domestic

   $ 225,403      $ 144,346      $ 213,643   

Foreign

     15,830        8,861        14,439   

Sales to MRB

     (49,538     (26,916     (48,759
                        

Total revenues (net of intercompany)

   $ 191,695      $ 126,291      $ 179,323   
                        

Fragmentation of the Auto Parts Industry

The auto parts industry is characterized by diverse and fragmented competition and is comprised of a large number of aftermarket and used auto parts suppliers of all sizes. These companies range from large, multinational corporations, which serve both original equipment manufacturers and the aftermarket on a worldwide basis, to small, local producers which supply only a few parts for a particular car model.

Distribution

APB sells used auto parts from each of its self-service retail stores. Upon arriving at a self-service store, a customer typically pays an admission charge and signs a liability waiver before entering the car lot. When a customer finds a desired part on a vehicle, the customer removes it and pays a pre-established price for the part.

The wholesale component of APB’s business consists of core and scrapped vehicle sales. Once the vehicle is removed from the customer area, cores are removed from the vehicle and consolidated at central facilities in California, Florida,

 

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Texas and Calgary, Canada. From these facilities, the cores are sold to a variety of wholesale buyers through a competitive bidding process. Due to the larger quantities generated by this consolidation process, APB is able to obtain higher prices by focusing on larger wholesale customers that purchase in volume. After the core removal process is complete, the remaining autobody is crushed and sold as scrap metal in the wholesale market. The autobodies are sold on a price per ton basis, which is subject to fluctuations in the recycled ferrous metal markets. During fiscal 2010, 2009 and 2008, APB generated revenues of $50 million, $27 million and $49 million, respectively, from sales to MRB, making MRB the single largest customer of APB.

Marketing

APB has customized marketing initiatives that are unique to its self-service brand. The brand marketing plan focuses on the acquisition of private party vehicles and attracting auto parts customers into the stores. The marketing plan targets the local markets surrounding the stores and incorporates various strategies including the use of radio advertising to promote vehicle purchasing, regularly scheduled in-store promotions and other forms of product promotion. Each store has a customized marketing calendar designed for its market and the community it serves.

APB typically seeks to locate its facilities with convenient access to major streets and in major population centers. By operating at locations that are convenient and visible to the target customer, the stores seek to become the customer’s first stop in acquiring used auto parts.

Sources of Vehicles

APB obtains vehicles from five primary sources: private parties, tow companies, charities, auto auctions and city contracts. APB has a program to purchase vehicles from private parties called “Cash for Junk Cars,” which is advertised in local markets. Private parties call a toll-free number and receive a quote for their vehicle. The private party can either deliver the vehicle to one of APB’s retail locations or arrange for the vehicle to be picked up. APB also employs car buyers who travel to vendors and bid on vehicles. In fiscal 2010, APB’s ability to obtain additional and higher quality vehicles was temporarily enhanced through the government’s Cash-For-Clunkers stimulus program.

Competition

APB competes for the purchase of vehicles with other auto dismantlers, used car dealers, auto auctions and metal recyclers. APB competes for the sale of used auto parts with other self-service and full-service auto dismantlers as well as larger well-financed retail auto parts businesses.

Steel Manufacturing Business

Business

SMB operates a steel mini-mill in McMinnville, Oregon that produces a wide range of finished steel products using recycled metal and other raw materials. SMB purchases substantially all of its recycled metal from MRB at rates that approximate export market prices for shipments from the West Coast of the US.

Manufacturing

SMB’s melt shop includes an electric arc furnace (“EAF”), a ladle refining furnace, a five-strand continuous billet caster and has enhanced steel chemistry refining capabilities, permitting the mill to produce special alloy grades of steel not currently produced by other mills on the US West Coast. The melt shop produced 494 thousand, 401 thousand and 802 thousand tons of steel in the form of billets during fiscal 2010, 2009 and 2008, respectively. SMB continues to reinvest in its melt shop to improve efficiencies in the melting process.

SMB also operates two computerized rolling mills that allow for synchronized operations of the rolling mills and related equipment. Billets produced in SMB’s melt shop are reheated in two natural gas-fueled furnaces and are then hot-rolled through one of the two rolling mills to produce finished products. SMB has completed a number of improvement projects to both mills designed to increase both their operating efficiency and the types of products that can be competitively produced. SMB continues to monitor the market for new products and, through discussions with customers, identify additional opportunities to expand its product lines and sales.

 

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SMB’s effective annual finished goods production capacity is approximately 800 thousand tons under current conditions.

Products

SMB produces semi-finished goods (billets) and finished goods consisting of rebar, coiled rebar, wire rod, merchant bar and other specialty products. Semi-finished goods are predominantly used for SMB’s finished products, but also have been produced for sale to other steel mills. Rebar is produced in either straight length steel bars or coils and used to increase the tensile strength of poured concrete. Coiled rebar is preferred by some manufacturers because it reduces the waste generated by cutting individual lengths to meet customer specifications and, therefore, improves yield. Wire rod is steel rod, delivered in coiled form, used by manufacturers to produce a variety of products such as chain link fencing, nails, wire and stucco netting. Merchant bar consists of round, flat, angle and square steel bars used by manufacturers to produce a wide variety of products, including gratings, steel floor and roof joists, safety walkways, ornamental furniture, stair railings and farm equipment. SMB is also certified to produce high quality rebar to support nuclear power plant construction.

The table below sets forth, on a revenue and volume basis, the sales of these products during the last three fiscal years ended August 31:

 

     2010    2009    2008
     Revenues(1)    Volume(2)    Revenues(1)    Volume(2)    Revenues(1)    Volume(2)

Rebar

   $ 122,879    217,302    $ 129,750    226,796    $ 352,087    470,111

Wire rod

     102,690    157,677      67,800    88,512      133,815    178,508

Coiled rebar

     25,762    43,005      25,404    38,618      51,020    67,598

Merchant bar

     19,381    25,432      22,221    27,181      49,324    59,565

Other products(3)

     14,373    40,199      18,094    32,664      16,943    32,048
                                   

Total

   $ 285,085    483,615    $ 263,269    413,771    $ 603,189    807,830
                                   

 

 

 

(1)

Revenues stated in thousands of dollars.

(2)

Volume stated in short tons (one short ton = 2,000 pounds).

(3)

Includes primarily sales of billets (semi-finished goods).

Customers

SMB’s customers are principally steel service centers, construction industry subcontractors, steel fabricators, wire drawers and major farm and wood products suppliers. During fiscal 2010, SMB sold its finished steel products to customers located primarily in the Western US and Canada and its billets to customers in Asia. Customers in California accounted for 34% of SMB’s revenue in fiscal 2010. SMB’s ten largest customers accounted for 54%, 47% and 36% of its revenues during fiscal 2010, 2009 and 2008, respectively. SMB had no external customers that accounted for 10% or more of consolidated revenues in fiscal 2010, 2009 or 2008.

The table below sets forth SMB revenues from domestic and foreign customers for the last three fiscal years ended August 31 (in thousands):

 

     2010    2009    2008

Domestic

   $ 206,943    $ 226,675    $ 515,629

Foreign(1)

     78,142      36,594      87,560
                    

Total

   $ 285,085    $ 263,269    $ 603,189
                    

 

 

 

(1)

Includes sales to Canada of $56 million, $27 million and $52 million in fiscal 2010, 2009 and 2008, respectively.

 

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Consolidation in the Steel Industry

While the pace of consolidation in the global steel industry has slowed due to the impact of the global economic crisis, we continue to see consolidation of smaller steel producers or fabricators. In addition, cross-border consolidation remains attractive due to the potential for achieving greater efficiency and economies of scale, particularly in response to the consolidation undertaken by raw material suppliers and consumers of steel products.

Distribution

SMB sells directly from its mini-mill in McMinnville, Oregon, its owned distribution center in El Monte, California (Los Angeles area) and a third party distribution center in Lathrop, California (Central California). Products are shipped from the mini-mill to the distribution centers primarily by rail. The distribution centers facilitate sales by maintaining an inventory of products close to major customers for just-in-time delivery. SMB communicates regularly with major customers to determine their anticipated needs and plans its rolling mill production schedule accordingly. Shipments to customers are made by common carrier, primarily truck or rail.

Recycled Metal Supply

We believe SMB operates the only mini-mill in the Western US that obtains substantially all of its recycled metal requirements from affiliated metal recycling operations. MRB is able to deliver a mix of recycled metal grades to achieve optimum efficiency in SMB’s melting operations. As the steel mill and various MRB facilities are located on railway routes, SMB benefits from the ability to ship by either rail or truck.

Energy Supply

SMB needs a significant amount of electricity to run its operations, primarily its EAF. SMB purchases electricity under a long-term contract with McMinnville Water & Light that expires in September 2011, which in turn relies on the Bonneville Power Administration. Electricity represented 4%, 3% and 3% of SMB’s cost of goods sold in fiscal 2010, 2009 and 2008, respectively.

SMB also needs a significant amount of natural gas to run its reheat furnaces, which are used to reheat billets prior to running them through the rolling mills. SMB meets this demand through a take-or-pay natural gas contract that expires on May 31, 2011 and obligates it to purchase minimum quantities of natural gas per day through October 2010, whether or not the amount is utilized. Natural gas represented 3%, 2% and 2% of SMB’s cost of goods sold in fiscal 2010, 2009 and 2008, respectively. See Note 14 – Derivative Financial Instruments and Fair Value Measurements in the notes to the consolidated financial statements in Part II, Item 8 of this report for further detail.

Backlog

SMB generally ships products within days after the receipt of purchase orders. As of September 30, 2010 SMB had a backlog of orders of $24 million, compared to $6 million as of September 30, 2009.

Competition

SMB’s primary domestic competitors for the sale of finished steel products include Nucor Corporation’s manufacturing facilities in Arizona, Utah and Washington, TAMCO Steel’s facility in California and Commercial Metals Company’s manufacturing facility in Arizona. In addition to domestic competition, SMB has historically competed with foreign steel producers, principally located in Asia, Canada, Mexico and Central and South America, primarily in shorter length rebar and certain wire rod grades. The principal competitive factors in SMB’s market are price, product availability, quality and service. In addition, demand and the resulting level of steel imports are impacted by general economic conditions and the value of the US dollar.

In 2002, the US Government imposed anti-dumping and countervailing duties against wire rod products from eight foreign countries. These duties remain in effect today, are periodically reviewed and do not have a set expiration date. In 2007, the International Trade Commission extended existing rebar anti-dumping duties of up to 233% on imports from seven nations through 2012.

 

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Strategic Focus

Use of our Seven Deep Water Ports to Access Global Demand

We maintain deep water terminal facilities adjacent to our operating facilities in Everett, Massachusetts; Portland, Oregon; Oakland, California; Tacoma, Washington; and Providence, Rhode Island and also have access to deep water terminal facilities at Kapolei, Hawaii and Salinas, Puerto Rico through public docks. These seven deep water terminals enable us to load large vessels capable of trans-oceanic shipments, which allows us to ship product globally to wherever demand is highest. Cost efficiencies are achieved because we own the majority of these terminal facilities, as we are not normally subject to the same berthing delays often experienced by users of unaffiliated terminals.

Acquisitions and Divestitures

We continue to focus on growth through value-creating acquisitions and will pursue acquisition opportunities we believe will create shareholder value and generate long-term returns in excess of our cost of capital. With our historically strong balance sheet, cash flows from operations and available borrowing capacity, we believe we are in a position to continue to complete reasonably priced acquisitions fitting our long-term strategic plans.

During fiscal 2010, we spent $41 million to acquire six self-service used auto parts stores and a metals recycler. These acquisitions were as follows:

 

   

In October 2009, we acquired four self-service used auto parts stores located near our MRB export facility in Portland, Oregon. This acquisition represented our first used auto parts operations in the Pacific Northwest.

   

In January 2010, we acquired two self-service used auto parts stores, which increased to four the number of used auto parts facilities that we operate in the Dallas-Fort Worth Metroplex.

   

In April 2010, we acquired a metals recycler in Montana to provide an additional source of scrap metal for our Tacoma, Washington export facility.

In October 2009, we sold our full-service used auto parts operation, which had operated as part of the APB reporting segment, to LKQ Corporation. The full-service used auto parts operation is not included in APB’s results of operations in fiscal 2010, 2009 or 2008 because the results of this discontinued operation have been reclassified for all periods presented.

In fiscal 2009, we acquired the following:

 

   

In December 2008, we acquired a metals recycler in Washington to provide an additional source of scrap metal to MRB’s Tacoma, Washington export facility.

   

In February 2009, we acquired the leading metals recycler in Puerto Rico. This acquisition expanded our presence into a new region, increased our processing capability and provided new sources of scrap metal and access to international export facilities.

   

In February 2009, we acquired an additional 16.66% equity interest in an auto parts business located in California, and in April 2009, we acquired the remaining 8.34% minority equity interest in this business, thus increasing our equity ownership in this business to 100%. The acquired equity was previously consolidated into our financial statements because we maintained operating control over the entity.

   

In February 2009, we acquired a self-service used auto parts business with two locations in California, strengthening our presence in Northern California.

   

In March 2009, we acquired a metals recycler in Nevada, providing an additional source of scrap metal for MRB’s Oakland, California export facility.

In fiscal 2008, we acquired the following:

 

   

In September 2007, we acquired a mobile metals recycling business that provides additional sources of scrap metal to MRB’s Everett, Massachusetts facility.

   

In November 2007, we acquired two metals recycling businesses and in February 2008 we acquired one metals recycling business that expanded our presence in the Southeastern US.

 

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In February 2008, we acquired the remaining 50% equity interest in an auto parts business located in Nevada in exchange for our 50% interest in the land and buildings owned by the business. The acquired business was previously consolidated into our financial statements because we maintained operating control over the entity.

   

In August 2008, we acquired a self-service used auto parts business with three locations in the Southern US.

Processing and Manufacturing Technology Improvements

We aim to be an efficient and competitive producer of both recycled metal and finished steel products in order to maximize the operating income for both operations. To meet this objective, we have historically focused on, and will continue to emphasize, the cost-effective purchasing and efficient processing of scrap metal.

During fiscal 2010, 2009 and 2008, we spent $64 million, $59 million and $84 million, respectively on capital improvements. These capital expenditures primarily reflect our significant investments in modern equipment to improve the efficiency and capabilities of our businesses and to further maximize our economies of scale. Our capital expenditures in fiscal 2010 included further investments in technology to improve the recovery of nonferrous materials from the shredding process and investments to further improve efficiency and increase capacity, increase worker safety and enhance environmental systems, including investments in storm water systems and in equipment to ensure ongoing compliance with air quality and other environmental regulations.

Capital projects in fiscal 2011 are expected to include continued investments in technology to improve the recovery of nonferrous materials from the shredding process, material handling and processing equipment, enhancements to our information technology infrastructure, improvements to our facilities’ environmental and safety infrastructure and normal equipment replacement and maintenance. We believe these investments will create or protect value for our shareholders.

Continued Improvements in Productivity and Focus on Cost Containment

We have continuous improvement programs that focus on increasing production from shredders, improving existing scrap metal recovery processes and ongoing performance initiatives throughout our operations. The objective of these programs is to identify areas in existing processes that may be inefficient or where current performance could be improved, and to recommend and implement solutions that may increase revenues or reduce costs by increasing output or recovery.

Environmental Matters

Impact of Legislation and Regulation

Compliance with environmental laws and regulations is a significant factor in our operations. Our businesses are subject to extensive local, state and federal environmental protection, health, safety and transportation laws and regulations relating to, among others:

 

   

The US Environmental Protection Agency (“EPA”);

   

Remediation under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”);

   

The discharge of materials and emissions into the air;

   

The prevention and remediation of soil and groundwater contamination;

   

The management and treatment of wastewater and storm water;

   

Global climate change;

   

The treatment, handling and/or disposal of solid waste and hazardous waste; and

   

The protection of our employees’ health and safety.

These environmental laws regulate, among other things, the release and discharge of hazardous materials into the air, water and ground; exposure to hazardous materials; and the identification, storage, treatment, handling and disposal of hazardous materials. Environmental legislation and regulations have changed rapidly in recent years, and it is likely that we will be subject to even more stringent environmental standards in the future.

 

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Concern over climate change, including the impact of global warming, has led to significant US and international regulatory and legislative initiatives to limit greenhouse gas (“GHG”) emissions. In 2007 the US Supreme Court ruled that the EPA was authorized to regulate carbon dioxide under the US Clean Air Act. As a consequence, the EPA initiated a series of regulatory efforts aimed at addressing greenhouse gases as pollutants, including finding that GHG emissions endanger public health, implementing mandatory GHG emission reporting requirements, setting carbon emission standards for light-duty vehicles and promulgating a New Source Review/Title V “tailoring rule” setting emissions thresholds beyond which stationary sources will require permits. Legislation has also been proposed in the US Congress to address GHG emissions and global climate change, including “cap and trade” programs, and some form of federal climate change legislation or additional federal regulation is possible. In addition, we are required to annually report our GHG emissions to the State of Oregon Department of Environmental Quality, effective March 2010, and to the US EPA effective March 2011. A number of other states, including states in which we have operations and facilities, have considered, are considering or have already enacted legislation to develop information or address climate change and GHG emissions as well.

We have, in the past, been found not to be in compliance with certain environmental laws and regulations and have incurred liabilities, expenditures, fines and penalties associated with such violations. Our objective is to maintain compliance with applicable environmental regulations, and we believe that we are materially in compliance with currently applicable environmental regulations (see Note 12 – Commitments and Contingencies in the notes to the consolidated financial statements in Part II, Item 8 of this report). In fiscal 2010, capital expenditures related to ongoing environmental compliance were $13 million, and we expect to spend approximately $18 million on capital expenditures for ongoing environmental compliance in fiscal 2011.

Indirect Consequences of Future Legislation and Regulation

Increased regulation regarding climate change and GHG emissions could impose significant costs on our business and our customers and suppliers, including increased energy, capital equipment, environmental monitoring and reporting and other costs in order to comply with regulations concerning and limitations imposed on climate change and GHG emissions. The potential costs of allowances, offsets or credits that may be part of “cap and trade” programs or similar future regulatory measures are still uncertain. Any adopted future climate change and GHG regulations could negatively impact our ability (and that of our customers and suppliers) to compete with companies situated in areas not subject to such limitations. Furthermore, even without such regulation, increased awareness and any adverse publicity in the global marketplace about the GHGs emitted by companies in the metal recycling and steel manufacturing industries could harm our reputation and reduce customer demand for our products.

GHG legislation and regulation is also expected to have an effect on the price of electricity, especially when generated using carbon-based fuels. As such, demand for SMB’s steel products could increase as its costs of production become more competitive, since they are manufactured using an EAF, which uses less energy than the blast furnaces of some of our competitors. Since the electricity supply for SMB includes a significant element of hydro-generated production, SMB’s energy costs are less likely to be impacted than those of our competitors using electricity generated by carbon-based fuels. In addition, demand for scrap metal may increase as a result of mills with blast furnaces seeking to maximize the scrap metal component of raw material infeed, as melting scrap metal involves less energy than is required for melting iron ore.

Since the use of recycled iron and steel instead of iron ore to make new steel results in savings in the consumption of energy, virgin materials and water and reduces mining wastes, we believe our recycled metal products position us to be more competitive in the future for business from companies wishing to reduce their carbon footprint and impact on the environment. In addition, our electric arc furnaces generate fewer greenhouse gas emissions than the traditional blast furnaces.

Physical Impacts of Climate Change on Our Costs and Operations

There has been public discussion that climate change may be associated with extreme weather conditions such as rising sea levels and more intense hurricanes, thunderstorms, tornados and snow or ice storms. Extreme weather conditions

 

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may increase our costs or cause damage to our facilities, and any damage resulting from extreme weather may not be fully insured. As many of our recycling facilities are located near deep water ports, significantly rising sea levels may disrupt our ability to receive scrap metal, process the scrap metal through our mega-shredders and ship product to our customers. Our MRB and APB operations can also be impacted by severe weather conditions. Periods of extended adverse weather conditions may inhibit our supply of scrap metal which could cause us to fail to meet our sales commitments. In addition, if temperature levels in the summer were to significantly increase for a sustained period in areas where our APB operations are located, this could result in less customer traffic, thus resulting in reduced admissions and parts sales.

Employees

As of September 30, 2010, we had 3,237 full-time employees, consisting of 1,491 employees at MRB, 1,178 employees at APB, 413 employees at SMB and 155 corporate administrative employees. Of these employees, 832 were covered by collective bargaining agreements. The SMB contract with the United Steelworkers of America, which covers 297 of these employees, was ratified in June 2008 and will expire on March 31, 2012. We believe that in general our labor relations are good.

Available Information

Our internet address is www.schnitzersteel.com. The content of our website is not incorporated by reference into this Annual Report on Form 10-K. We make all filings with the Securities and Exchange Commission (“SEC”) available on our website, free of charge, under the caption “Investors – SEC Filings.” Included in these filings are our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, which are available as soon as reasonably practicable after electronically filing with or furnishing such materials to the SEC pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934.

The public may read and copy any materials that are filed with the SEC at the SEC’s Public Reference Room located at 100 F Street NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains electronic versions of reports on its website, www.sec.gov.

 

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ITEM 1A. RISK FACTORS

Described below are risks, which are categorized as “Risk Factors Relating to Our Business,” “Risk Factors Relating to the Regulatory Environment” and “Risk Factors Relating to Our Employees,” that could have a material adverse effect on our results of operations and financial condition or could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report. See “Forward-Looking Statements” that precedes Part I of this report. Additional risks and uncertainties that we are unaware of or that we currently deem immaterial may in the future have a material adverse effect on our results of operations and financial condition.

Risk Factors Relating to Our Business

Potential costs related to the environmental cleanup of Portland Harbor may be material to our financial position and liquidity

We have been notified by the EPA under the CERCLA that we are a potentially responsible party (“PRP”) that owns or operates or formerly owned or operated sites adjacent to the Portland Harbor Superfund site (the “Site”). The precise nature and extent of any cleanup of the Site, the parties to be involved, the process to be followed for any cleanup and the allocation of the costs for any cleanup among responsible parties have not yet been determined. A group of PRPs is currently conducting a remedial investigation and feasibility study (“RI/FS”) to identify and characterize the contamination at the Site and develop alternative approaches to remediation of the contamination. A separate process to allocate the costs of the RI/FS and the ultimate remedy is also currently underway. The EPA has indicated that it expects to issue a record of decision that will discuss remedial alternatives for the Site sometime in 2012. Separately, the natural resource damages trustees for the Site are conducting a process to determine the amount of natural resource damages at the Site and identify the persons liable for such damages. It is currently unclear to what extent we will be liable for environmental costs or damages associated with the Site or for natural resource damage claims or third party contribution or damage claims with respect to the Site; however, given the size of the Site, the costs to date of the RI/FS and the nature of the conditions identified to date, the total cost of the investigations, remediation and natural resource damages claims are likely to be substantial. Significant cash outflows in the future related to the Site could reduce the amount of our borrowing capacity that could otherwise be used for investment in capital expenditures and acquisitions. Because there has not been a determination of the total investigation costs, the remediation that will be required, the amount of natural resource damages or how the costs of the ongoing investigations and any remedy and natural resource damages will be allocated among the PRPs, it is not presently possible to estimate the costs which we are likely to incur in connection with the Site, although such costs could be significant and material to our financial position, results of operations and cash flows. See Contingencies – Environmental in Note 12 – Commitments and Contingencies in the notes to the consolidated financial statements in Part II, Item 8 of this report.

Consolidation in the steel industry may reduce demand for our products

There has been a significant amount of consolidation in the steel industry in recent years that has included steel mills acquiring steel fabricators. This activity has been accelerated by the recent economic downturn where steel mills have acquired these customers to ensure demand for their products. If any of our significant customers were to be acquired by competing steel mills, this could reduce the demand for our products and force us to lower our prices, reducing our revenues, or to reduce production, which could increase our unit costs and have a material adverse effect on our financial condition and results of operations.

Significant decreases in scrap metal prices may adversely impact our operating results

The timing and magnitude of the cycles in the industries in which we operate are difficult to predict and are influenced by different economic conditions in domestic (where we typically acquire our raw materials) and foreign (where we typically sell a significant portion of our products) markets. Purchase prices for autobodies and scrap metal and selling prices for scrap and recycled metal are volatile and beyond our control. While we attempt to respond to changing recycled metal selling prices through adjustments to our metal purchase prices, our ability to do so is limited

 

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by competitive and other market factors. A significant reduction in selling prices for recycled metal may adversely impact both our operating income and our ability to recover purchase costs from end customers.

Changes in the availability or price of raw materials could restrict our ability to meet our sales commitments

Our businesses require certain materials that are sourced from third party suppliers. Although our cross-divisional synergies allow us to be our own source for some raw materials, particularly with respect to scrap metal for SMB, we rely on other suppliers as well as industry supply conditions generally, which involves risks, including the possibility of shortages of raw materials, increases in raw material costs and reduced control over delivery schedules. Failure to obtain a steady supply of scrap material could both adversely impact our ability to meet sales commitments and reduce our operating margins. Failure to obtain an adequate supply of end-of-life vehicles could adversely impact our ability to attract customers and charge admission fees and reduce our parts sales. Failure to obtain raw materials such as alloys used in the steel-making process could adversely impact our ability to make steel to the specifications of our customers.

Uncertain economic conditions may cause customers to be unable to fulfill their contractual obligations

We enter into export ferrous sales contracts preceded by negotiations that include fixing price, quantity, shipping terms and other contractual elements. Upon finalization of these terms and satisfactory completion of other contractual contingencies, the customer typically opens a letter of credit to satisfy its obligation under the contract prior to our shipment of the cargo. Although not considered normal course of business, during uncertain economic conditions, we are at risk on consummating the transaction until successful completion of the letter of credit. As a result, customers may not be able to fulfill their contractual obligations in times of illiquid market conditions. As of August 31, 2010 and 2009, 43% and 49%, respectively, of our trade accounts receivable balance was covered by letters of credit.

Fluctuations in the value of the US dollar relative to other currencies may reduce the demand for our products

A significant portion of MRB’s revenues and operating income earned is generated from sales to foreign customers, including customers located in Asia, Africa and Europe. A strong US dollar would make our products more expensive for non-US customers, which could negatively impact export sales. A strong US dollar would also make imported metal products less expensive, resulting in an increase in imports of scrap metal, scrap substitutes and steel products into the US. As a result, our products, which are made in the US, may become more expensive relative to imported raw metal and steel products, which could have a material adverse effect on our financial condition and results of operations.

Increases in imports of foreign steel into the US may reduce domestic demand for our products

Economic expansion in China and other foreign countries has affected the availability and increased the price volatility of recycled metal and steel products. Expansions and contractions in these economies can significantly affect the price of commodities used and sold by our business, as well as the price of finished steel products. Additionally, in a number of foreign countries, such as China, steel producers are generally government-owned and may therefore make production decisions based on political or other factors that do not reflect market conditions. Disruptions in foreign markets from excess steel production may encourage importers to target the US with excess capacity at aggressive prices, and existing trade laws and regulations may be inadequate to prevent unfair trade practices, which could have a material adverse effect on our financial condition and results of operations. If foreign steel production significantly exceeds consumption in those countries, imports of steel products into the US could increase, resulting in lower volumes and selling prices for SMB’s steel products.

Reliance on third party shipping companies may restrict our ability to ship our products

MRB and SMB generally rely on third parties to handle and transport their raw materials to their production facilities and finished products to end users. Due to factors beyond our control, including changes in fuel prices, political events, governmental regulation of transportation, changes in market rates, carrier availability and disruptions in transportation infrastructure, our suppliers may be forced to increase their charges for transportation services or

 

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otherwise reduce the availability of their vehicles or ships, and thus we may not be able to transport our products in a timely and cost-effective manner, which could have a material adverse effect on our financial condition and results of operations and may harm our reputation.

Equipment upgrades and equipment failures may lead to production curtailments or shutdowns

Our recycling and manufacturing processes depend upon critical pieces of equipment, including shredders and furnaces, which may be out of service occasionally for scheduled upgrades or maintenance. Our equipment is also subject to failure and the risk of catastrophic loss due to unanticipated events such as fires, accidents or violent weather conditions. As a result, we may experience interruptions in our processing and production capabilities, which could inhibit our ability to meet our sales commitments and thus have a material adverse effect on our financial condition and results of operations.

The cost and availability of electricity and natural gas are subject to volatile market conditions and may restrict our ability to manufacture our products

We rely on third parties for our supply of energy resources that are consumed in the manufacturing of our products. The prices for and availability of electricity, natural gas and other energy resources are subject to volatile market conditions which can be affected by weather conditions and political and economic factors that are beyond our control. Disruptions in the supply of energy resources could impair our ability to process and manufacture our products for our customers or result in increases in our energy costs, which could have a material adverse effect on our financial condition and results of operations.

Goodwill impairment charges may adversely affect our operating results

We test our goodwill balances for impairment on an annual basis and if events occur or circumstances change that would reduce the fair value of the reporting segment below the reporting segment’s carrying amount. In determining fair value, we use an income approach based on the present value of expected future cash flows utilizing a market-based weighted average cost of capital. Given that market prices of our reporting segments are not readily available, we make various estimates and assumptions in determining the estimated fair values of the reporting segments, including forecasts of future sales and operating costs, prices, capital expenditures, working capital requirements, discount rates, growth rates and general market conditions. Fair value determinations require considerable judgment and are sensitive to inherent uncertainties and changes in the factors described above. However, in light of current economic conditions, impairments to one or more of our reporting segments could occur in interim periods, whether or not connected to the annual goodwill impairment analysis. A sustained decline in the quoted market prices of our stock could denote a triggering event indicating that the fair value of goodwill may be impaired. At that time, additional testing would be performed to evaluate the recoverability of goodwill and assess the need for an impairment charge, which could have an adverse effect on our financial condition and results of operations.

Inability to integrate future acquisitions may adversely impact our operating results

We have completed a number of recent acquisitions and expect to continue making acquisitions of, and strategic alliances with, complementary businesses to enable us to enhance our customer base and grow our revenues. Execution of this strategy involves a number of risks, including:

 

   

Inaccurate assessment of or undisclosed liabilities;

   

Difficulty integrating the acquired businesses’ personnel and operations;

   

Potential loss of key employees or customers of the acquired business;

   

Difficulties in realizing anticipated cost savings, efficiencies and synergies;

   

Competition for such acquisitions and alliances;

   

Inability to maintain uniform standards, controls and procedures; and

   

Managing the growth of a larger company.

Failure to successfully integrate acquisitions could have a material adverse effect on our financial condition and results of operations.

 

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Potential limitations on our ability to access credit facilities may restrict our ability to operate

Although we believe we have adequate access to contractually committed borrowings, we could be adversely affected if our banks refused to honor their contract commitments or ceased lending. While we believe the lending institutions participating in our credit arrangements are financially capable, recent events in the global credit markets, including the failure, takeover or rescue by various government entities of major financial institutions, have created uncertainty of credit availability to an extent not experienced in recent decades. Failure to access our credit facilities could restrict our ability to fund operations or make strategic acquisitions.

Product liability claims may adversely impact our operating results

We could inadvertently acquire radioactive scrap metal that could potentially end up in mixed scrap metal shipped to consumers worldwide. Although we have invested in radiation detection equipment in certain of our locations to address this risk, failure to detect radioactive scrap metal remains a possibility. Even though we maintain insurance to address the risk of this failure in detection, there can be no assurance that the insurance coverage would be adequate or will continue to be available on acceptable terms. In addition, if we fail to meet contractual requirements for a product we may be subject to product warranty costs and claims. These costs are generally not insured and could both have a material adverse effect on our financial condition and results of operations and harm our reputation.

Increases in consumer fuel costs and decreases in the miles they drive may decrease demand for our auto parts

In times of rapid increases in crude oil and gasoline prices, motorists may reduce the amount of travel by automobile. As the economy slows, consumer confidence weakens and fuel costs become a more significant factor in buying decisions and discretionary driving. Over time, significantly reduced driving leads to fewer accidents and lower demand for replacement parts, which may impact APB’s parts sales.

Risk Factors Relating to the Regulatory Environment

Environmental regulations may cause us to incur significant compliance costs

Compliance with environmental laws and regulations is a significant factor in our business. We are subject to local, state and federal environmental laws and regulations in the US and other countries relating to, among other matters:

 

   

Waste disposal;

   

Air emissions;

   

Waste water and storm water management and treatment;

   

Soil and groundwater contamination remediation;

   

Global climate change;

   

The discharge, storage, handling and disposal of hazardous materials; and

   

Employee health and safety.

We are also required to obtain environmental permits from governmental authorities for certain operations. Violation of or failure to obtain permits or comply with these laws or regulations could result in our business being fined or otherwise sanctioned by regulators or becoming subject to litigation by private parties. Our operations use and generate hazardous substances. In addition, previous operations by others at facilities that we currently or formerly owned, operated or otherwise used may have caused contamination from hazardous substances. As a result, we are exposed to possible claims under environmental laws and regulations, especially for the remediation of waterways and soil or groundwater contamination. These laws can impose liability for the cleanup of hazardous substances even if the owner or operator was neither aware of nor responsible for the release of the hazardous substances. We have, in the past, been found not to be in compliance with certain of these laws and regulations, and have incurred liabilities, expenditures, fines and penalties associated with such violations. Although we believe that we are currently in material compliance with all applicable environmental laws and regulations, future environmental compliance costs may increase because of new laws and regulations and changing interpretations by regulatory authorities, uncertainty regarding adequate pollution control levels, the future costs of pollution control technology and issues related to global climate change. Environmental compliance costs and potential environmental liabilities could have a material adverse effect on our financial condition and results of operations.

 

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Climate change may adversely impact our facilities and our ongoing operations

The potential physical impacts of climate change on our operations are highly uncertain, and will be particular to the geographic circumstances. These may include significant rising sea levels at our deep water port facilities, changing storm patterns and intensities, and changing temperature levels. As many of our recycling facilities are located near deep water ports, rising sea levels may disrupt our ability to receive scrap metal, process the scrap metal through our mega-shredders and to ship product to our customers. Our MRB and APB operations are also dependent upon weather conditions. Periods of extended adverse weather conditions may inhibit our supply of scrap metal which could cause us to fail to meet our sales commitments. In addition, if temperature levels in the summer were to significantly increase for a sustained period in areas where our APB operations are located, this could result in less customer traffic, thus resulting in reduced admissions and parts sales.

Our effective tax rate could increase if our earnings from operations in Puerto Rico are taxed at higher rates

We currently calculate the taxes on our earnings in Puerto Rico to include benefits from industrial tax exemptions available to companies doing business there. Should it be determined by Puerto Rican taxing authorities that we are not entitled to all or a portion of these exemptions, the taxes on our earnings from operations in Puerto Rico and our consolidated effective tax rate could increase, which would adversely impact our results of operations and financial position.

Compliance with existing and new greenhouse gas emission regulations may adversely impact our operating results

Increased regulation regarding climate change and GHG emissions could impose significant costs on our business and our customers and suppliers, including increased energy, capital equipment, environmental monitoring and reporting and other costs in order to comply with regulations concerning and limitations imposed on climate change and GHG emissions. The potential costs of allowances, offsets or credits that may be part of “cap and trade” programs or similar future regulatory measures are still uncertain. Any adopted future climate change and GHG regulations could negatively impact our ability (and that of our customers and suppliers) to compete with companies situated in areas not subject to such limitations. Until the timing, scope and extent of any future regulation becomes known, we cannot predict the effect on our financial condition, operating performance or ability to compete. Furthermore, even without such regulation, increased awareness and any adverse publicity in the global marketplace about the GHGs emitted by companies in the metal recycling and steel manufacturing industries could harm our reputation and reduce customer demand for our products. See Environmental Matters in Part I, Item 1 of this report for further detail.

Governmental agencies may refuse to grant or renew our licenses and permits, thus restricting our ability to operate

We conduct certain of our operations subject to licenses, permits and approvals from state and local governments. Governmental agencies often resist the establishment of certain types of facilities in their communities, including auto parts facilities. In addition, from time to time, both the US and foreign governments impose regulations and restrictions on trade in the markets in which we operate. In some countries, governments can require us to apply for certificates or registration before allowing shipment of recycled metal to customers in those countries. There can be no assurance that future approvals, licenses and permits will be granted or that we will be able to maintain and renew the approvals, licenses and permits we currently hold. Failure to obtain these approvals could cause us to limit or discontinue operations in these locations or prevent us from developing or acquiring new facilities, which could have a material adverse effect on our financial condition and results of operations.

Risk Factors Relating to Our Employees

Reliance on employees subject to collective bargaining may restrict our ability to operate

Approximately 26% of our full-time employees are represented by unions under collective bargaining agreements. As these agreements expire, we may not be able to negotiate extensions or replacements of such agreements on acceptable terms. Any failure to reach an agreement with one of our unions may result in strikes, lockouts or other labor actions, including work slowdowns or stoppages, which could have a material adverse effect on our results of operations.

 

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The underfunded status of our multiemployer pension plans may cause us to increase our contributions to the plans

As discussed in Note 15 – Employee Benefits in the notes to the consolidated financial statements in Part II, Item 8 of this report, we have been notified that the multiemployer plan benefiting union employees of SMB has an accumulated funding deficiency (i.e., a failure to satisfy the minimum funding requirements) for the current plan year and is therefore “in critical status.” Because the plan is in “critical status,” it is required to adopt a rehabilitation plan, which may involve contribution increases, benefit reductions or a combination of the two. At this time, we are not required to make surcharge payments as we are already signatory to an agreement that requires annual six percent contribution increases. Our withdrawal liability, which would be triggered if we were to withdraw or partially withdraw from the plan, was calculated by the plan actuary to be $28 million as of September 30, 2009. Because we have no current intention of withdrawing from the plan, we have not recognized a liability for this contingency. However, if such a liability were triggered it would have a material adverse effect on our results of operations and cash flows. Our contributions to this plan could also increase as a result of a diminished contribution base due to the insolvency or withdrawal of other employers who currently contribute to the plan, the inability or failure of withdrawing employers to pay their withdrawal liability or other funding deficiencies, as we would need to fund the retirement obligations of these employers.

Approximately 60% of our multiemployer pension plan contributions are made to the Western Independent Shops Pension Trust (the “WISP Trust”) for the benefit of union employees of SMB. In 2004, the Internal Revenue Service (“IRS”) approved a seven-year extension of the period over which the WISP Trust may amortize unfunded liabilities, conditioned upon maintenance of certain minimum funding levels. Based on the actuarial valuation for the WISP Trust as of October 1, 2009 (the latest available actuarial information), the funded percentage of the WISP Trust (based on the ratio of the market value of assets to the accumulated benefits liability (present value of accrued benefits)) was 65.4%, which is below the targeted funding ratio specified in the agreement with the IRS. As a result, the WISP Trust is in the process of seeking relief from the specified funding requirement from the IRS. If the WISP Trust cannot obtain relief, revocation by the IRS of the amortization extension retroactively to the 2002 plan year could occur and result in a material liability for our share of the resulting funding deficiency, the extent of which currently cannot be estimated.

ITEM 1B. UNRESOLVED STAFF COMMENTS

There are currently no unresolved issues with respect to any SEC staff written comments that were received 180 days or more before the end of fiscal 2010 that relate to our periodic or current reports under the Securities and Exchange Act of 1934.

 

Schnitzer Steel Industries, Inc. Form 10-K 2010  /  19


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ITEM 2. PROPERTIES

Our facilities and administrative offices by type, including their total acreage, were as follows as of August 31, 2010:

 

Division

  

No. of

Facilities

   Acreage
      Leased    Owned    Total

Corporate offices – Domestic

   2    1    0    1

Metal Recycling Business:

           

Domestic:

           

Collection and processing

   37    26    652    678

Collection

   6    2    21    23

Inactive

   5    0    24    24

Auto Parts Business:

           

Domestic(1)

   42    563    108    671

Foreign(2)

   3    46    0    46

Steel Manufacturing Business:

           

Domestic:

           

Steel mill and administrative offices

   2    0    85    85

Inactive

   2    2    51    53
                   

Total company:

           

Domestic

   96    594    941    1,535

Foreign(2)

   3    46    0    46
                   

Total

   99    640    941    1,581
                   

 

 

 

(1)

We jointly own 36 acres in California at three of our sites with minority interest partners.

(2)

Foreign facilities are located in Canada.

We consider all properties, both owned and leased, to be well-maintained, in good operating condition and suitable and adequate to carry on our business.

ITEM 3. LEGAL PROCEEDINGS

From time to time, we are involved in various litigation matters that arise in the normal course of business involving normal and routine claims. Environmental compliance issues represent a significant portion of those claims. Management currently believes that the ultimate outcome of these proceedings, individually or in the aggregate, will not have a material adverse effect on our consolidated financial position, results of operations, cash flows or business. For additional information regarding litigation to which we are a party, which is incorporated into this item, see Note 12 – Commitments and Contingencies in the notes to the consolidated financial statements in Part II, Item 8 of this report.

ITEM 4. RESERVED

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our Class A common stock is listed on the NASDAQ Global Select Market (“NASDAQ”) under the symbol SCHN. There were 217 holders of record of Class A common stock on October 12, 2010. The stock has been trading since November 16, 1993. The following table sets forth the high and low prices reported at the close of trading on NASDAQ and the dividends paid per share for the periods indicated.

 

     Fiscal 2010  
     High Price      Low Price      Dividends Per Share  

First Quarter

   $ 59.00       $ 41.59       $ 0.017   

Second Quarter

   $ 56.95       $ 40.03       $ 0.017   

Third Quarter

   $ 60.12       $ 43.46       $ 0.017   

Fourth Quarter

   $ 49.53       $ 37.00       $ 0.017   
     Fiscal 2009  
     High Price      Low Price      Dividends Per Share  

First Quarter

   $ 67.84       $ 16.45       $ 0.017   

Second Quarter

   $ 47.70       $ 22.52       $ 0.017   

Third Quarter

   $ 55.92       $ 23.35       $ 0.017   

Fourth Quarter

   $ 63.98       $ 44.75       $ 0.017   

Our Class B common stock is not publicly traded. There were 12 holders of record of Class B common stock on October 12, 2010.

Issuer Purchases of Equity Securities

Pursuant to a share repurchase program as amended in 2001 and 2006, we were authorized to repurchase up to 6 million shares of our Class A common stock when management deems such repurchases to be appropriate. In November 2008, our Board of Directors approved an increase in the shares authorized for repurchase by 3 million, to 9 million. Prior to fiscal 2010, we had repurchased approximately 5.1 million shares of our Class A common stock under the program. In fiscal 2010, we repurchased a total of 412,994 shares of our Class A common stock under this program, leaving approximately 3.5 million shares available for repurchase under existing authorizations.

The share repurchase program does not require us to acquire any specific number of shares and we may suspend, extend or terminate the program at any time without prior notice and the program may be executed through open-market purchases, privately negotiated transactions or utilizing Rule 10b5-1 programs. We evaluate long- and short-range forecasts as well as anticipated sources and uses of cash before determining the course of action that would best enhance shareholder value.

 

Schnitzer Steel Industries, Inc. Form 10-K 2010  /  21


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During the fourth quarter of fiscal 2010, we repurchased 412,994 shares of our Class A common stock in open-market transactions at a cost of $17 million. The table below presents a summary of our share repurchases during the quarter ended August 31, 2010:

 

Period   

Total Number

of Shares
Purchased

    

Average

Price Paid

per Share

    

Total Number

of Shares
Purchased as
Part of Publicly
Announced
Plans or Programs

    

Maximum Number

of Shares that may
yet be Purchased
Under the Plans or
Programs

 

June 1, 2010 – June 30, 2010

     0       $ 0         0         3,864,290   

July 1, 2010 – July 31, 2010

     412,994       $ 41.53         412,994         3,451,296   

August 1, 2010 – August 31, 2010

     0       $ 0         0         3,451,296   
                       

Total Fourth Quarter

     412,994       $ 41.53         412,994      

Performance Graph

The following graph and related information compares cumulative total shareholder return on our Class A common stock for the five-year period from September 1, 2005 through August 31, 2010 with the cumulative total return for the same period of (i) the S&P 500 Index, (ii) the S&P Steel Index and (iii) the NASDAQ Composite Index. These comparisons assume an investment of $100 at the commencement of the period and that all dividends are reinvested. The stock performance outlined in the performance graph below is not necessarily indicative of our future performance, and we do not endorse any predictions as to future stock performance.

LOGO

 

     Year ended August 31,  
     2005         2006         2007         2008         2009         2010   

Schnitzer Steel Industries

   $ 100       $ 111       $ 205       $ 240       $ 190       $ 156   

S&P 500

     100         109         125         111         91         96   

S&P Steel Index

     100         172         238         239         142         146   

NASDAQ

     100         102         122         112         96         102   

 

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ITEM 6. SELECTED FINANCIAL DATA

 

     Year ended August 31,
     2010     2009     2008     2007    2006

STATEMENT OF OPERATIONS DATA:

           

(in thousands, except per share and dividend data)

           

Revenues

   $ 2,301,240      $ 1,787,230      $ 3,516,950      $ 2,462,077    $ 1,767,832

Operating income (loss)

   $ 125,897      $ (51,124   $ 403,235      $ 211,959    $ 174,093

Income (loss) from continuing operations

   $ 84,508      $ (27,149   $ 254,653      $ 133,974    $ 145,147

Income (loss) from discontinued operations, net of tax(1)

   $ (13,832   $ (4,214   $ (613   $ 1,015    $ 615

Net income (loss) attributable to SSI

   $ 66,750      $ (32,229   $ 248,683      $ 131,334    $ 143,068

Income (loss) per share from continuing operations attributable to SSI (diluted)

   $ 2.86      $ (0.99   $ 8.63      $ 4.29    $ 4.63

Net income (loss) per share attributable to SSI (diluted)

   $ 2.37      $ (1.14   $ 8.61      $ 4.32    $ 4.65

Dividends declared per common share

   $ 0.068      $ 0.068      $ 0.068      $ 0.068    $ 0.068

OTHER DATA:

           

Shipments (in thousands)(2):

           

Recycled ferrous metal (tons)(3)

     4,231        4,189        5,197        5,504      4,561

Recycled nonferrous metal (pounds)

     478,486        397,056        439,470        383,086      301,610

Finished steel products (tons)

     444        381        776        710      703

Average net selling price(2,4):

           

Recycled ferrous metal (per ton)

   $ 328      $ 264      $ 436      $ 267    $ 218

Recycled nonferrous metal (per pound)

   $ 0.83      $ 0.61      $ 1.03      $ 1.02    $ 0.87

Finished steel products (per ton)

   $ 587      $ 617      $ 728      $ 575    $ 528

Number of auto parts stores(1)

     45        39        38        35      34
     August 31,
     2010     2009     2008     2007    2006

BALANCE SHEET DATA (in thousands):

           

Total assets

   $ 1,343,418      $ 1,268,233      $ 1,554,853      $ 1,151,414    $ 1,044,724

Long-term debt and capital lease obligations, net of current maturities

   $ 99,240      $ 110,414      $ 158,933      $ 124,079    $ 102,829

 

 

 

(1)

In fiscal 2010, the Company sold its full-service used auto parts operation, which had been operated as part of the Auto Parts Business reporting segment. The Company concluded that the divestiture met the definition of a discontinued operation. Accordingly, the results of this discontinued operation have been removed from continuing operations for all periods presented.

(2)

Tons for recycled ferrous metal are long tons (2,240 pounds) and for finished steel products are short tons (2,000 pounds).

(3)

In fiscal 2010 and 2009, the Schnitzer Global Exchange business accounted for no shipments. In fiscal 2008, 2007 and 2006 it accounted for shipments of recycled ferrous metal (in thousands) of 444 tons, 1,212 tons, and 1,272 tons, respectively.

(4)

In accordance with generally accepted accounting principles, the Company reports revenues that include amounts billed for freight to customers, however, average net selling prices are shown net of amounts billed for freight.

 

Schnitzer Steel Industries, Inc. Form 10-K 2010  /  23


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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This section includes a discussion of our operations for the three fiscal years ended August 31, 2010. The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of our results of operations and financial condition. The discussion should be read in conjunction with the Consolidated Financial Statements and the related notes thereto in Part II, Item 8 of this report and the Selected Financial Data contained in Part II, Item 6 of this report.

Business

We operate in three reporting segments (MRB, APB and SMB) that collectively provide an end-of-life cycle solution for a variety of products through our integrated businesses. We use operating income (loss) to measure our segment performance. Corporate expense consists primarily of unallocated expense for management and administrative services that benefit all three reporting segments. As a result of this unallocated expense, the operating income (loss) of each reporting segment does not reflect the operating income (loss) the reporting segment would have as a stand-alone business. For further information regarding our reporting segments, including financial information about geographic areas, see Note 20 – Segment Information in the notes to the consolidated financial statements in Part II, Item 8 of this report.

MRB buys, collects, processes, recycles, sells and brokers ferrous scrap metal (containing iron) to foreign and domestic steel producers, including SMB, and nonferrous scrap metal (not containing iron) to both foreign and domestic markets. MRB processes mixed and large pieces of scrap metal into smaller pieces by sorting, shearing, shredding and torching, resulting in scrap metal pieces of a size, density and purity required by customers to meet their production needs.

APB procures used and salvaged vehicles and sells serviceable used auto parts from these vehicles through its self-service auto parts stores. The remaining portions of the vehicles, primarily autobodies, cores and nonferrous materials, are sold to metal recyclers, including MRB where geographically feasible.

SMB operates a steel mini-mill that produces a wide range of finished steel products. SMB purchases substantially all of its recycled metal from MRB at rates that approximate export market prices for shipments from the West Coast of the US and uses its mini-mill near Portland, Oregon to melt recycled metal and other raw materials to produce finished steel products. SMB also maintains mill depots in Central and Southern California.

Our results of operations depend in large part on the demand and prices for recycled metal in foreign and domestic markets and steel products in the Western US. Our deep water port facilities on both the East and West coasts of the US (in Everett, Massachusetts; Oakland, California; Portland, Oregon; Tacoma, Washington; and Providence, Rhode Island) and access to public deep water port facilities (in Kapolei, Hawaii and Salinas, Puerto Rico) allow us to meet the demand for recycled metal by steel manufacturers located in Europe, Asia, Central America and Africa. Our processing facilities in the Southeastern US also provide access to the automobile and steel manufacturing industries in that region.

Key economic factors and trends affecting the industries in which we operate

Our financial results largely depend on supply of raw materials in the US and demand for recycled metal in foreign and domestic markets and for steel products in the Western US. Fluctuating or volatile supply and demand conditions affect market prices for and volumes of recycled ferrous and nonferrous metal in global markets and for steel products in the Western US and can have a significant impact on the results of operations for all three reporting segments.

In fiscal 2010, we continued to experience the effects of the 2009 global economic crisis. The US economy began to show some signs of a gradual recovery through increased US steel mill utilization over the prior year and slightly improved availability of raw materials. Better economic conditions in overseas markets, particularly in Asia, led to a continuing strong demand for exports of ferrous and nonferrous recycled materials. However, the global economy was

 

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still hampered by other factors, including the European sovereign debt crisis and the tightening of credit availability in China. Although our overall financial performance benefited from the gradually improving global economy, the still uncertain nature of the recovery and resulting market volatility led to variable quarterly results throughout fiscal 2010.

Strategic factors

As we continue to closely monitor the economic situation, we remain focused on our core strategies which we believe will meet our business objectives:

 

   

Use of our seven deep water ports to access customers directly around the world and to meet demand wherever it is greatest;

   

Growth through acquisitions in existing and new geographic regions that create value and generate returns in excess of our cost of capital;

   

Continued investment in and benefit from technologies and process improvements which increase the separation and recovery of recycled materials from our shredding process; and

   

Continued improvement in our productivity, focus on cost containment and optimization of the spreads between our selling prices and the cost of acquiring materials.

In fiscal 2010, we acquired from LKQ Corporation four self-service used auto parts stores which are located near MRB’s export facility in Portland, Oregon and two self-service used auto parts stores which increased our presence in the Dallas-Fort Worth Metroplex. We also acquired a metals recycler in Montana to provide an additional source of scrap metal for our Tacoma, Washington export facility and sold our full-service used auto parts operation to LKQ Corporation.

Executive Overview of Financial Results

In fiscal 2010, our operating results benefited from increased average selling prices due to continuing strong demand for scrap and recycled metal products and saw us return to profitability, with revenues growing by $514 million to $2.3 billion and net income attributable to SSI of $67 million compared to a loss of ($32) million in fiscal 2009. Diluted net income attributable to SSI was $2.37 per share for fiscal 2010 compared to a net loss of ($1.14) per share in fiscal 2009.

 

LOGO   LOGO

The following items summarize our consolidated financial performance for fiscal 2010:

 

   

Revenues of $2.3 billion, compared to $1.8 billion in the prior year;

   

Operating income of $126 million, compared to operating loss of ($51) million in the prior year;

   

Net income from continuing operations attributable to SSI of $81 million, or $2.86 per share (diluted), compared to a net loss from continuing operations attributable to SSI of ($28) million, or ($0.99) per share (diluted), in the prior year; and

   

Net income attributable to SSI of $67 million, or $2.37 per share (diluted), compared to a net loss attributable to SSI of ($32) million, or ($1.14) per share (diluted), in the prior year.

 

Schnitzer Steel Industries, Inc. Form 10-K 2010  /  25


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LOGO   LOGO

The following items summarize our consolidated cash flow and balance sheet information for fiscal 2010:

 

   

Net cash provided by operating activities of $90 million, compared to $288 million in the prior year;

   

Cash on hand of $30 million, compared to $41 million as of the prior year-end; and

   

Debt, net of cash, of $70 million, compared to $71 million as of the prior year-end (see the reconciliation of Debt, net of cash in Non-GAAP Financial Measures at the end of Item 7).

In fiscal 2010, our MRB segment generated revenues of $2.0 billion, a $472 million increase from fiscal 2009, which included a $309 million, or 25%, increase in ferrous revenues and a $161 million, or 64%, increase in nonferrous revenues. The increase in ferrous revenues was primarily driven by a 24% increase in average net selling price, resulting from strong demand in Asian markets and to a lesser extent improved domestic markets for scrap metal. The increase in nonferrous revenues was driven by a 36% increase in the average net selling price and a 21% increase in pounds sold due to higher demand and increased availability of raw materials. MRB had operating income of $118 million compared to $13 million in fiscal 2009.

In fiscal 2010, our APB segment set records for self-service revenues and operating income with revenues of $241 million and operating income of $51 million. The $88 million increase in revenues over the prior year was driven by a $37 million increase in scrap vehicle revenue and a $32 million increase in core revenue primarily due to higher sales volumes and selling prices, and a $15 million increase in parts revenues. APB had operating income of $51 million compared to $4 million in fiscal 2009.

In fiscal 2010, our SMB segment generated revenues of $285 million, a $22 million increase from fiscal 2009. The increase over prior year reflected an increase in sales volumes for finished steel products of 63 thousand tons, or 17%, to 444 thousand tons in fiscal 2010. However, the average net selling price decreased $30 per ton, or (5%), to $587 per ton in fiscal 2010. The increases in sales volume reflected improved, but still weak, demand for finished steel products in western North America. SMB had an operating loss of ($6) million compared to ($42) million in fiscal 2009.

Share Repurchases

During fiscal 2010, we repurchased 412,994 shares of Class A common stock, or approximately 2% of the total Class A and Class B shares outstanding, at a total cost of $17 million under the authority granted by our Board of Directors.

 

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Results of Operations

 

     For the year ended August 31,  
                       % Increase/(Decrease)  
($ in thousands)    2010     2009     2008     2010 vs 2009     2009 vs 2008  

Revenues:

          

Metals Recycling Business

   $ 1,979,770      $ 1,507,655      $ 3,062,850      31   (51 %) 

Auto Parts Business

     241,233        153,207        228,082      57   (33 %) 

Steel Manufacturing Business

     285,085        263,269        603,189      8   (56 %) 

Intercompany revenue eliminations(1)

     (204,848     (136,901     (377,171   50   (64 %) 
                            

Total revenues

     2,301,240        1,787,230        3,516,950      29   (49 %) 
                            

Cost of goods sold:

          

Metals Recycling Business

     1,791,221        1,419,237        2,619,376      26   (46 %) 

Auto Parts Business

     147,511        112,887        137,866      31   (18 %) 

Steel Manufacturing Business

     284,258        299,311        522,200      (5 %)    (43 %) 

Intercompany cost of goods sold eliminations(1)

     (203,226     (149,493     (368,108   36   (59 %) 
                            

Total cost of goods sold

     2,019,764        1,681,942        2,911,334      20   (42 %) 
                            

Selling, general and administrative expense:

          

Metals Recycling Business

     73,467        82,381        97,959      (11 %)    (16 %) 

Auto Parts Business

     42,426        36,719        43,895      16   (16 %) 

Steel Manufacturing Business

     6,689        5,958        8,689      12   (31 %) 

Corporate(2)

     36,223        38,352        63,990      (6 %)    (40 %) 
                            

Total SG&A expense

     158,805        163,410        214,533      (3 %)    (24 %) 
                            

Environmental matters:

          

Metals Recycling Business

     (291     (5,846     919      (95 %)    NM   

Auto Parts Business

     200        37        (1,365   441   NM   
                            

Total environmental matters

     (91     (5,809     (446   (98 %)    1202
                            

(Income) loss from joint ventures:

          

Metals Recycling Business

     (3,076     (669     (12,277   360   (95 %) 

Change in intercompany (profit) loss elimination(3)

     (59     (520     571      (89 %)    NM   
                            

Total income from joint ventures

     (3,135     (1,189     (11,706   164   (90 %) 
                            

Operating income (loss):

          

Metals Recycling Business

     118,449        12,552        356,873      844   (96 %) 

Auto Parts Business

     51,096        3,564        47,686      1334   (93 %) 

Steel Manufacturing Business

     (5,862     (42,000     72,300      (86 %)    NM   
                            

Segment operating income (loss)

     163,683        (25,884     476,859      NM      NM   

Corporate expense

     (36,223     (38,352     (63,990   (6 %)    (40 %) 

Change in intercompany (profit) loss elimination(4)

     (1,563     13,112        (9,634   NM      NM   
                            

Total operating income (loss)

   $ 125,897      $ (51,124   $ 403,235      NM      NM   
                            

 

 

NM = Not Meaningful

(1)

MRB sells recycled ferrous metal to SMB at rates per ton that approximate West Coast export market prices. In addition, APB sells auto bodies to MRB. These intercompany revenues and cost of goods sold are eliminated in consolidation.

(2)

Corporate expense consists primarily of unallocated expenses for services that benefit all three business segments. As a consequence of this unallocated expense, the operating income of each segment does not reflect the operating income the segment would have as a stand-alone business.

(3)

The joint ventures sell recycled ferrous metal to MRB and then subsequentely to SMB at rates per ton that approximate West Coast export market prices. Consequently, these intercompany revenues produce intercompany operating income (loss), which is not recognized until the finished products are sold to third parties; therefore, intercompany profit is eliminated while the products remain in inventory.

(4)

Intercompany (profits) losses are not recognized until the finished products are sold to third parties, therefore intercompany profit is eliminated while the products remain in inventory.

 

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Revenues

Fiscal 2010 compared with fiscal 2009

Consolidated revenues for fiscal 2010 increased $514 million, or 29%, to $2.3 billion. Revenues in fiscal 2010 increased for all reporting segments primarily due to continuing strong worldwide demand for scrap and recycled metal, which led to higher average net selling prices and sales volumes, and to a lesser extent increased Western US demand for finished steel products.

Fiscal 2009 compared with fiscal 2008

Consolidated revenues for fiscal 2009 decreased $1.7 billion, or 49%, to $1.8 billion. Revenues in fiscal 2009 decreased for all reporting segments primarily due to the worldwide economic crisis which reduced demand for scrap and recycled metal and finished steel products throughout the period. This reduced demand resulted in lower scrap and recycled metal and finished steel sales volumes and lower average selling prices.

Operating Income (Loss)

Fiscal 2010 compared with fiscal 2009

Consolidated operating income was $126 million for fiscal 2010 compared to a consolidated operating loss of ($51) million for fiscal 2009. As a percentage of consolidated revenues, consolidated operating income increased by 8.3 percentage points for fiscal 2010 compared to fiscal 2009. This improvement in consolidated operating income was primarily due to higher average net selling prices, which increased more than the average cost of raw materials, and increased availability of raw materials, which widened operating margins. The improvement in consolidated operating income also benefited from a decrease in consolidated selling, general and administrative (“SG&A”) expense of $5 million, to $159 million for fiscal 2010. The decrease included $9 million in higher bad debt expense recognized in the prior year, $6 million in current year benefits recognized from legal settlements, $6 million in environmental and legal cost reimbursements, including $3 million in the fourth quarter of fiscal 2010, and $6 million in reduced professional service fees. These decreases were partially offset by an $18 million increase in incentive compensation due to improvements in financial performance and the reinstatement of employer contributions to our defined contribution plans effective April 2010, and by $2 million of increased expense related to the amortization of intangibles.

Fiscal 2009 compared with fiscal 2008

Consolidated operating loss was ($51) million for fiscal 2009 compared to a consolidated operating income of $403 million for fiscal 2008. As a percentage of consolidated revenues, consolidated operating income decreased by 14.3 percentage points for fiscal 2009 compared to fiscal 2008. Weaker year-over-year demand and the impact of declines in selling prices, which outpaced the decline in purchase prices, resulted in the reduction in operating income that included a non-cash net realizable value (“NRV”) inventory write down of $52 million in fiscal 2009. This decrease in consolidated operating income (loss) was partially offset by a $4 million release of environmental reserves and a $3 million gain recognized in fiscal 2009, primarily related to resolution of the Hylebos Waterway litigation. Additionally, decreases in consolidated cost of goods sold and consolidated SG&A expense were due to our implementation of cost containment measures that included a decrease in headcount of 8%, the suspension of employer contributions to our defined contribution plans effective in March 2009 and other non-labor cost reductions for fiscal 2009. Consolidated SG&A expense decreased $51 million to $163 million for fiscal 2009 compared to $214 million for fiscal 2008 primarily due to decreased compensation-related expenses of $49 million, and reduced expenses of $7 million resulting from cost containment measures and other non-compensation related costs including professional and outside services expense. The reduction in compensation-related expenses was primarily due to a decrease in annual incentive and share-based compensation expense resulting from operating losses incurred and a $5 million benefit arising from nondeductible executive incentive compensation that was awarded and included as nondeductible officers’ compensation for fiscal 2008 but was voluntarily and irrevocably declined in fiscal 2009. The decline in professional services expense was primarily the result of reduced consulting fees in fiscal 2009. Also included in the consolidated operating loss for fiscal 2009 was a $2 million gain related to a settlement agreement

 

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to resolve disputes that had arisen from the separation and termination agreement relating to the dissolution of our joint venture with Hugo Neu in September 2005. These reductions were partially offset by a $5 million increase in bad debt expense for fiscal 2009 compared to the prior year resulting from bankruptcies and adverse financial conditions experienced by certain of our customers, which affected their ability to satisfy their obligations.

Interest Expense

Interest expense was $2 million, $3 million and $9 million for fiscal 2010, 2009 and 2008, respectively. The decrease from fiscal 2009 to fiscal 2010 is the result of lower average interest rates and lower outstanding debt. For more information about our outstanding debt balances, see Note 11 – Long-Term Debt and Capital Lease Obligations in the notes to the consolidated financial statements in Part II, Item 8 of this report.

Other Income, Net, Excluding Interest Expense

Other income, net, excluding interest expense was $2 million, $7 million and $3 million for fiscal 2010, 2009 and 2008, respectively. Other income decreased by $5 million in fiscal 2010 compared to the prior year because fiscal 2009 included a pre-tax gain of $5 million from a settlement agreement relating to the dissolution of our joint venture with Hugo Neu in September 2005.

Income Tax Expense

Fiscal 2010 compared with fiscal 2009

Our effective tax rate for fiscal 2010 was 32.6% (provision on income) compared to (42.3%) (benefit on a loss) for fiscal 2009. The level of the decrease in the effective rate primarily reflects the impact of tax credits on lower taxable income (loss) in fiscal 2009 compared with fiscal 2010, a lower state tax rate in fiscal 2010 resulting from the reduction in the reserve for unrecognized tax benefits and a more favorable manufacturing deduction in fiscal 2010 which included the restoration of a previously disallowed deduction due to a newly enacted law. Fiscal 2009 also included a reduction in the reserve for unrecognized tax benefits, which increased the effective rate benefit on the loss.

Fiscal 2009 compared with fiscal 2008

Our effective tax rate for fiscal 2009 was (42.3%) (benefit on a loss) compared to 35.9% (provision on income) for fiscal 2008. The increase in the effective rate primarily reflects our net loss in fiscal 2009, the contingent state tax liabilities that were reduced because a settlement was negotiated with one state and the statute of limitations expired in two other states and the non-taxable income caused by the reversal of $5 million of nondeductible executive incentive compensation expense that was treated as nondeductible in fiscal 2008, and which was voluntarily and irrevocably declined in fiscal 2009.

Financial results by reporting segment

We operate our business across three reporting segments: MRB, APB and SMB. Additional financial information relating to these reporting segments is contained in Note 20 – Segment Information in the notes to the consolidated financial statements in Part II, Item 8 of this report.

 

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Metals Recycling Business

 

     For the Year Ended August 31,  
                       % Increase/(Decrease)  
($ in thousands, except for prices)    2010     2009     2008     2010 vs 2009     2009 vs 2008  

Ferrous revenues

   $ 1,558,664      $ 1,249,308      $ 2,590,796      25   (52 %) 

Nonferrous revenues

     412,927        251,508        460,639      64   (45 %) 

Other

     8,179        6,839        11,415      20   (40 %) 
                            

Total segment revenues

     1,979,770        1,507,655        3,062,850      31   (51 %) 

Cost of goods sold

     1,791,221        1,419,237        2,619,376      26   (46 %) 

Selling, general and administrative expense

     73,467        82,381        97,959      (11 %)    (16 %) 

Environmental matters

     (291     (5,846     919      (95 %)    NM   

(Income) from joint ventures

     (3,076     (669     (12,277   360   (95 %) 
                            

Segment operating income

   $ 118,449      $ 12,552      $ 356,873      844   (96 %) 
                            

Average ferrous recycled metal sales prices ($/LT):(1)

          

Steel Manufacturing Business(2)

   $ 339      $ 328      $ 446      3   (26 %) 

Other domestic

   $ 311      $ 232      $ 388      34   (40 %) 

Foreign

   $ 330      $ 262      $ 445      26   (41 %) 

Average

   $ 328      $ 264      $ 436      24   (39 %) 

Ferrous sales volume (LT, in thousands):

          

Steel Manufacturing Business

     458        335        737      37   (55 %) 

Other domestic

     651        418        805      56   (48 %) 
                            

Total domestic

     1,109        753        1,542      47   (51 %) 

Foreign

     3,122        3,436        3,655      (9 %)    (6 %) 
                            

Total ferrous sales volume (LT, in thousands)

     4,231        4,189        5,197      1   (19 %) 
                            

Average nonferrous sales price ($/pound)(1)

   $ 0.83      $ 0.61      $ 1.03      36   (41 %) 

Nonferrous sales volumes (pounds, in thousands)

     478,486        397,056        439,470      21   (10 %) 

Outbound freight included in cost of goods sold (in thousands)

   $ 187,454      $ 150,775      $ 332,777      24   (55 %) 

 

 

 

(1)

Price information is shown after netting the cost of freight incurred to deliver the product to the customer.

(2)

The fiscal 2009 average ferrous recycled metal sales price to SMB was significantly higher than the average foreign sales price because when compared to foreign customers, sales to SMB were greater in volume during the first quarter of the year, when sales prices were higher, then in the latter three quarters.

LT = Long Ton, which is 2,240 pounds

NM = Not Meaningful

 

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Fiscal 2010 compared with fiscal 2009

Revenues

MRB revenues increased $472 million, or 31%, to $2.0 billion for fiscal 2010. This increase was primarily attributable to higher ferrous average net selling prices and higher nonferrous sales volumes, caused by increased demand for and availability of scrap metal.

Ferrous revenues increased $309 million, or 25%, to $1.6 billion for fiscal 2010. The increase in ferrous revenues was primarily driven by higher average net selling prices. We experienced increasing prices during the year as the average net ferrous selling price increased $64 per long ton, or 24%, compared to the prior year due to strong demand in Asian markets and to a lesser extent improved demand in domestic markets, which provided support to both domestic and foreign selling prices.

Nonferrous revenues increased $161 million, or 64%, to $413 million for fiscal 2010. The increase in nonferrous revenues was driven by increases in both the average nonferrous net selling price and sales volumes. The average net selling price increased $0.22, or 36%, to $0.83 per pound during fiscal 2010 primarily due to stronger demand. In addition, nonferrous volumes sold increased 81 million pounds, or 21%, to 478 million pounds for fiscal 2010, caused by increased recovery of nonferrous materials from the shredding process, more nonferrous collection activity and higher demand due to stronger global market conditions.

Segment Operating Income

Operating income for MRB was $118 million, or 6.0% of revenues for fiscal 2010 compared to $13 million, or 0.8%, of revenues for fiscal 2009. The increase in operating income reflects the impact of improved worldwide demand for scrap and recycled metal, which led to higher average net selling prices that increased more than the average cost of raw materials, increased availability of raw materials and continued benefits from improved production operating efficiencies. In addition, income from joint ventures increased by $2 million over the prior year primarily due to the stronger demand for scrap metal.

Included in fiscal 2010 operating income for MRB was a decrease in SG&A expense of $9 million compared to the prior year, primarily due to a reduction of $8 million in bad debt expense, $6 million in current year benefits from legal settlements and $3 million in environmental cost reimbursements. Offsetting these decreases were a $7 million increase in incentive compensation due to improvements in financial performance and a $1 million increase in expense related to the amortization of intangibles.

Fiscal 2009 compared with fiscal 2008

Revenues

MRB revenues decreased $1.6 billion, or 51%, to $1.5 billion for fiscal 2009. This decrease was primarily attributable to lower average net selling prices and lower sales volumes, caused by lower demand and reduced availability of raw materials due to weaker global market conditions in fiscal 2009.

Ferrous revenues decreased $1.4 billion, or 52%, to $1.2 billion for fiscal 2009. This decrease was driven by reductions in both ferrous sales volumes and average net selling prices. Ferrous sales volumes decreased 1.0 million tons, or 19%, to 4.2 million tons in fiscal 2009. Ferrous foreign sales volumes decreased 219 thousand tons, or 6%, to 3.4 million tons for fiscal 2009 due to a reduction in trading volumes. Ferrous domestic sales volumes decreased 789 thousand tons, or 51%, to 753 thousand tons in fiscal 2009. These decreases in volume were primarily due to a combination of lower demand and reduced availability of raw materials. We also experienced declining prices during the year as the average net ferrous selling price decreased $172 per long ton, or 39%, compared to the prior year due to lower demand and weaker global market conditions.

Nonferrous revenues decreased $209 million, or 45%, to $252 million for fiscal 2009. This decrease was primarily driven by a decrease in both the average nonferrous net selling price and sales volumes, caused by lower demand and weaker global market conditions. The average net selling price decreased $0.42 per pound, or 41%, to $0.61 per

 

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pound during fiscal 2009 primarily due to weaker demand. In addition, due to a combination of lower demand and reduced availability, nonferrous pounds shipped decreased 42 million pounds, or 10%, to 397 million pounds for fiscal 2009.

Segment Operating Income

Operating income for MRB was $13 million, or 0.8% of revenues for fiscal 2009 compared to $357 million, or 11.7% of revenues for fiscal 2008. The decrease in operating income reflects the impact of the lower net selling prices for ferrous and nonferrous metal, which declined more than the costs of raw materials and freight, and decreased processed ferrous and nonferrous volumes that resulted in a non-cash NRV inventory write down of $29 million in fiscal 2009. In addition, income from joint ventures decreased by $12 million, or 95% over the prior year primarily due to the weaker demand for scrap metal.

Weaker year-over-year demand and the impact of declines in selling prices, which outpaced the decline in purchase prices, combined with a number of customer renegotiations, deferrals, and cancellations during the first quarter of fiscal 2009, resulted in the reduction in operating income. Offsetting the decreases in average selling prices and volume was a $16 million decrease in MRB’s SG&A expense compared to the prior year, primarily due to $12 million of lower compensation-related expenses, including annual incentive compensation expense, resulting from our weaker financial and operating performance and decreased headcount, a $5 million decrease in professional and outside services, and a $4 million decrease in share-based compensation expense, partially offset by an increase in bad debt of $4 million and a $3 million increase in legal reserves due to ongoing trade disputes. Also included in the operating income loss was a $4 million release of environmental reserves and a $3 million gain recognized in the first quarter of fiscal 2009, primarily related to the resolution of the Hylebos Waterway litigation.

Outlook

MRB’s results are dependent upon the worldwide demand for scrap metal which is used in the production of steel products, and on the available supply and cost of raw materials which are sourced in the United States. Despite the depressed worldwide economic conditions that continue to inhibit production by industrial producers of steel, we believe that the long-term fundamentals supporting the demand for recycled metals remain positive. As the market prices for scrap metal are subject to short-term movements caused by changes in economic conditions, we are not able to provide guidance for market prices of scrap metal; however we expect volumes to be above those seen in fiscal 2010.

Auto Parts Business

 

     For the Year Ended August 31,  
                         % Increase/(Decrease)  
($ in thousands)    2010      2009      2008     2010 vs 2009     2009 vs 2008  

Revenues

   $ 241,233       $ 153,207       $ 228,082        57     (33 %) 

Cost of goods sold

     147,511         112,887         137,866        31     (18 %) 

Selling, general and administrative expense

     42,426         36,719         43,895        16     (16 %) 

Environmental matters

     200         37         (1,365     441     NM   
                              

Segment operating income

   $ 51,096       $ 3,564       $ 47,686        1334     (93 %) 
                              

Number of stores at period end

     45         39         38        15     3

Cars purchased (in thousands)

     329         258         311        28     (17 %) 

 

 

NM = Not Meaningful

Fiscal 2010 compared with fiscal 2009

Revenues

APB’s record self-service revenues of $241 million in fiscal 2010 represented an $88 million, or 57%, increase over fiscal 2009. The increase in revenues included a $37 million increase in scrap vehicle revenue, a $32 million increase

 

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in core revenue and a $15 million increase in parts revenue compared to fiscal 2009. These record revenues were driven by an increase from 39 to 45 self-service store locations, improved production operating efficiencies, improvements in commodity prices, increased sales of used auto parts attributable to benefits recognized from purchasing higher quality vehicles and increased volumes of purchases of scrapped vehicles including additional vehicles purchased pursuant to the Cash-For-Clunkers government stimulus program.

Segment Operating Income

Operating income for APB was $51 million, or 21% of revenues, for fiscal 2010 compared to $4 million, or 2% of revenues, for fiscal 2009. The increase in operating income for fiscal 2010 reflected the impact of higher selling prices and volumes for scrapped vehicles, cores and parts, which resulted primarily from increases in commodity prices, an increase from 39 to 45 self-service store locations and improved production operating efficiencies.

Included in operating income was an increase in SG&A expense of $6 million for fiscal 2010, primarily due to a $4 million increase in compensation expenses, including increases in share-based and incentive compensation, due to improvements in operating results over the prior year and a $1 million increase in expense related to the amortization of intangibles.

APB’s results of operations do not include operating results from discontinued operations. See Note 7 – Business Combinations in the notes to the consolidated financial statements in Part II, Item 8 of this report.

Fiscal 2009 compared with fiscal 2008

Revenues

APB revenues decreased $75 million, or 33%, to $153 million for fiscal 2009, driven by reduced sales volumes and lower average selling prices for scrapped vehicles and cores resulting from the impact of the economic downturn. This included a $46 million decrease in scrap vehicle revenue due to a $126 decrease in the average selling price for scrapped vehicles and a decrease of 49 thousand tons, or 13%, in volumes shipped. Core revenue decreased $31 million over the prior year, primarily due to a $101 decrease in the average selling price per core. Partially offsetting these decreases was parts revenue that increased $2 million over the prior year.

Segment Operating Income

Operating income for APB was $4 million, or 2% of revenues, for fiscal 2009 compared to $48 million, or 21% of revenues, for fiscal 2008. The decrease in operating income for fiscal 2009 reflects the impact of lower sales volumes and prices for scrapped vehicles and cores, and the impact of inventory costs not falling as rapidly as selling prices. Included in the operating income were reductions in SG&A expense of $7 million for fiscal 2009, due to $4 million in lower compensation-related expenses, including incentive compensation, and reduced expenses resulting from cost containment measures which reduced headcount and other non-compensation related costs compared to the same periods in the prior year.

Outlook

APB’s results are dependent upon both the supply and cost of end-of-life vehicles as well as the market prices of ferrous and nonferrous scrap metals, which are in turn a function of overall global economic conditions. As average ferrous and nonferrous selling prices increased in fiscal 2010 compared to fiscal 2009 due to improved worldwide demand for these metals, APB was able to raise its purchase prices of vehicles and still maintain its margins, which contributed to a record year in terms of revenue and operating income. Given current price levels, APB expects volumes in fiscal 2011 to be slightly above those seen in fiscal 2010, with volumes from new stores acquired in fiscal 2010 likely offsetting the one-time benefits of the government’s Cash-For-Clunkers program.

 

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Steel Manufacturing Business

 

     For the Year Ended August 31,  
                       % Increase/(Decrease)  
($ in thousands, except price)    2010     2009     2008     2010 vs 2009     2009 vs 2008  

Revenues(1)

   $ 285,085      $ 263,269      $ 603,189        8     (56 %) 

Cost of goods sold

     284,258        299,311        522,200        (5 %)      (43 %) 

Selling, general and administrative expense

     6,689        5,958        8,689        12     (31 %) 
                            

Segment operating income (loss)

   $ (5,862   $ (42,000   $ 72,300        (86 %)      NM   
                            

Finished goods average sales price ($/ton)(2)

   $ 587      $ 617      $ 728        (5 %)      (15 %) 

Finished steel products sold (tons, in thousands)

     444        381        776        17     (51 %) 

Rolling mill utilization

     58     46     99     26     (54 %) 

 

 

 

(1)

Revenues include sales of semi-finished goods (billets) and finished steel products.

(2)

Price information is shown after netting the cost of freight incurred to deliver the product to the customer.

NM = Not Meaningful

Fiscal 2010 compared with fiscal 2009

Revenues

SMB revenues increased $22 million, or 8%, to $285 million for fiscal 2010 as a result of higher sales volumes. Finished goods sales volumes increased 63 thousand tons, or 17%, to 444 thousand tons in fiscal 2010. The increase in volume was partially offset by a $30 per ton, or (5%), decrease in the finished goods average sales price to $587 per ton for fiscal 2010. The increase in sales volumes and the decrease in averages sales prices reflected global market conditions as well as improved, but still weak, Western US demand for finished steel products.

Segment Operating Loss

Operating loss for SMB was ($6) million for fiscal 2010 compared to ($42) million for fiscal 2009. As a percentage of revenues, operating loss decreased by 13.9 percentage points in fiscal 2010. This improvement reflects the impact of increased sales volumes in the current year. Included in operating income were increases in SG&A expense of $1 million for fiscal 2010, resulting from an increase in incentive compensation, including share-based compensation, due to improvements in operating results over the prior year. SMB acquired substantially all of its scrap metal requirements from MRB at rates that approximate export market prices for shipments from the West Coast of the US.

Fiscal 2009 compared with fiscal 2008

Revenues

SMB revenues decreased $340 million, or 56%, to $263 million for fiscal 2009 as a result of both reduced sales volumes and average selling prices for finished steel products. Finished goods sales volumes decreased by 395 thousand tons, or 51%, to 381 thousand tons for fiscal 2009 primarily due to reduced demand resulting from the weakened market conditions. Average finished goods selling prices for fiscal 2009 decreased $111 per ton, or 15%, to $617 per ton as a result of the reduced demand.

Segment Operating Income (Loss)

Operating loss for SMB was ($42) million for fiscal 2009 compared to an operating income of $72 million for fiscal 2008. As a percentage of revenues, operating income decreased by 27.9 percentage points in fiscal 2009. The decrease in operating income reflects the impact of lower sales volumes caused by weaker market conditions, selling prices that declined faster than costs and lower anticipated future selling prices that resulted in a non-cash NRV inventory write down of $32 million in fiscal 2009. Included in the operating loss were reductions in SG&A expense of $3 million for fiscal 2009, due to lower compensation-related expenses, including incentive compensation, and reduced expenses resulting from cost containment measures which reduced headcount and other non-compensation related costs

 

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compared to the same periods in the prior year. SMB acquired substantially all of its scrap metal requirements from MRB at rates that approximate export market prices for shipments from the West Coast of the US.

Outlook

SMB’s results are dependent upon demand for its products by companies operating in the construction industry on the West Coast of the US and Canada. As the economic downturn continues to hamper construction spending, demand for SMB’s finished steel products is expected to remain soft in fiscal 2011. Sales volumes and margins are heavily dependent upon the timing and strength of the US economic recovery and we are currently unable to provide any guidance for prices and volumes for the fiscal year as a whole.

Liquidity and Capital Resources

We rely on cash provided by operating activities as a primary source of liquidity, supplemented by current cash on hand and existing credit facilities.

Sources and Uses of Cash

We had cash balances of $30 million and $41 million as of August 31, 2010 and 2009, respectively. Cash balances are intended to be used primarily for working capital and capital expenditures. We use excess cash on hand to reduce amounts outstanding on credit facilities. As of August 31, 2010, debt, net of cash, was $70 million compared to $71 million as of August 31, 2009 (see the Non-GAAP Financial Measures below).

Operating Activities

Net cash provided by operating activities in fiscal 2010 was $89 million, compared to $288 million in fiscal 2009 and $142 million in fiscal 2008.

Cash provided by operating activities in fiscal 2010 included income tax refunds of $49 million, an increase in accrued payroll liabilities of $12 million due to increased incentive compensation and an increase of $8 million in accounts payable due to timing of payments. Uses of cash included a $109 million increase in inventory (excluding $35 million of inventory sold as a part of the divestiture of the full-service auto parts operation) due to higher purchase costs and higher volumes of material on hand at year-end and an increase in accounts receivable of $12 million due to the timing of collections.

Cash provided by operating activities in fiscal 2009 included a $199 million decrease in inventory due to lower purchase costs and lower volumes of material purchased and a decrease in accounts receivable of $190 million resulting from cash collections of receivables. These sources of cash were partially offset by uses of cash that included a $79 million decrease in accounts payable due to the reduction in price and volumes of material purchases, a $46 million increase in refundable income taxes, a $42 million decrease in accrued income taxes due to tax payments related to fiscal 2008 and a $36 million decrease in accrued payroll liabilities mainly due to the payment of fiscal 2008 incentive compensation awards.

Cash provided by operating activities in fiscal 2008 included a $54 million increase in accounts payable due to the timing of payments and higher material costs, a $38 million increase in accrued income taxes and a $21 million increase in compensation-related liabilities, including performance incentive related liabilities, principally due to our improved financial and operating performance. These sources of cash were partially offset by an increase in inventory of $216 million due to higher material costs and volumes and a $135 million increase in accounts receivable mainly due to increased sales and timing of collections.

Investing Activities

Net cash used in investing activities in fiscal 2010 was $64 million, compared to $150 million in fiscal 2009 and $128 million in fiscal 2008.

 

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Cash used in investing activities in fiscal 2010 included $64 million in capital expenditures to upgrade our equipment and infrastructure and $41 million for completed acquisitions, partially offset by $41 million in proceeds from the sale of the full-service auto parts business and other assets.

Cash used in investing activities in fiscal 2009 included $93 million for completed acquisitions and $59 million in capital expenditures to upgrade our equipment and infrastructure.

Cash used in investing activities in fiscal 2008 included $84 million in capital expenditures to upgrade our equipment and infrastructure and $47 million for completed acquisitions.

Financing Activities

Net cash used in financing activities for fiscal 2010 was $36 million, compared to $111 million in fiscal 2009 and $12 million in fiscal 2008.

Cash used in financing activities in 2010 was primarily due to an $11 million reduction in long-term debt and $17 million in repurchases of outstanding shares of our Class A common stock.

Cash used in financing activities in fiscal 2009 was primarily due to $76 million in debt repayments which were funded by higher levels of cash generation and $30 million in repurchases of outstanding shares of our Class A common stock.

Cash used in financing activities in fiscal 2008 was primarily due to $45 million in repurchases of outstanding shares of our Class A common stock, which was financed with a $40 million increase in debt.

Credit Facilities

Our short-term borrowings consist primarily of a one year, unsecured, uncommitted $25 million credit line with Wells Fargo Bank, N.A. that expires on March 1, 2011. Interest rates on outstanding indebtedness under the unsecured line of credit are set by the bank at the time of borrowing. We had no borrowings outstanding under this credit line as of August 31, 2010 or August 31, 2009.

We maintain a $450 million revolving credit facility that matures in July 2012 pursuant to an unsecured committed bank credit agreement with Bank of America, N.A., as administrative agent, and the other lenders party thereto. Interest rates on outstanding indebtedness under the amended agreement are based, at our option, on either the London Interbank Offered Rate plus a spread of between 0.50% and 1.00%, with the amount of the spread based on a pricing grid tied to our leverage ratio, or the greater of the prime rate or the federal funds rate plus 0.50%. In addition, annual commitment fees are payable on the unused portion of the credit facility at rates between 0.10% and 0.25% based on a pricing grid tied to our leverage ratio. As of August 31, 2010 and 2009, we had borrowings outstanding under the credit facility of $90 million and $100 million, respectively. The weighted average interest rate on this line was 0.79% and 0.78% as of August 31, 2010 and 2009, respectively.

The two bank credit agreements contain various representations and warranties, events of default and financial and other covenants, including covenants regarding maintenance of a minimum fixed charge coverage ratio and a maximum leverage ratio. As of August 31, 2010, we were in compliance with all such covenants. We use these credit facilities to fund share repurchases, acquisitions, capital expenditures and working capital requirements.

In addition, as of August 31, 2010 and 2009, we had $8 million of long-term indebtedness in the form of bonds maturing in January 2021.

Acquisitions

The aggregate purchase price paid for acquisitions during fiscal 2010 was $41 million compared to $96 million during fiscal 2009 which included cash acquired and amounts to be paid of $3 million. During fiscal 2010, we continued to expand our presence in regions in which we operate and in new locations through the acquisition of value-creating businesses. See Note 7 – Business Combinations in the notes to the consolidated financial statements in Part II, Item 8 of this report for additional information on business acquisitions.

 

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Capital Expenditures

Capital expenditures totaled $64 million, $59 million and $84 million for fiscal 2010, 2009 and 2008, respectively. During fiscal 2010, we continued our investment in general improvements at a number of our metals recycling facilities, including investments in technology to improve the recovery of nonferrous materials from the shredding process and investments to further improve efficiency and increase capacity, increase worker safety and enhance environmental systems. We plan to invest up to $135 million in capital expenditures in fiscal 2011, which is expected to be spent on continued investments in technology to improve the recovery of nonferrous materials from the shredding process, material handling and processing equipment, enhancements to our information technology infrastructure, improvements for the facilities, environmental and safety infrastructure and normal equipment replacement and maintenance. We believe these investments will create value for our shareholders. We expect to use cash from operations and available lines of credit to fund capital expenditures in fiscal 2011.

Environmental Compliance

Our commitment to sustainable recycling and operating our business in an environmentally responsible manner requires us to continue to invest in facilities that improve our environmental presence in the communities in which we operate. Consistent with this commitment, we invested $13 million, $9 million and $10 million in capital expenditures for environmental projects in fiscal 2010, 2009 and 2008, respectively. We plan to invest a further $18 million in capital expenditures for environmental projects in fiscal 2011. These projects include investments in storm water systems and equipment to ensure ongoing compliance with air quality and other environmental regulations.

Our environmental programs also require us to incur costs to remediate conditions at existing sites and to monitor previously remediated sites. We incurred $2 million, $2 million and $3 million in environmental expenditures, which were either expensed or reduced recorded reserves, in fiscal 2010, 2009 and 2008, respectively. We expect to incur similar amounts of expenditures going forward.

We have been identified by the EPA as a PRP that owns or operates or formerly owned or operated sites adjacent to the Portland Harbor Superfund site. Because there has not been a determination of the total investigation costs, the remediation that will be required, the amount of natural resource damages or how the costs of the ongoing investigations and any remedy and natural resource damages will be allocated among the PRPs, it is not presently possible to estimate the costs which we are likely to incur in connection with the Site, although such costs could be significant and material to our future cash flows. Recording of material liabilities related to the Site could result in our failure to maintain compliance with certain covenants in our debt agreements. Significant cash outflows in the future related to the Site could reduce the amount of our borrowing capacity that could otherwise be used for investment in capital expenditures and acquisitions. The EPA has indicated that it expects to issue a record of decision that will discuss remedial alternatives for the Site sometime in 2012. See Contingencies – Environmental in Note 12 – Commitments and Contingencies in the notes to the consolidated financial statements in Part II, Item 8 of this report.

Share Repurchase Program

Pursuant to a share repurchase program as amended in 2001 and 2006, we were authorized to repurchase up to 6.0 million shares of our Class A common stock when management deems such repurchases to be appropriate. In November 2008, our Board of Directors approved an increase in the shares authorized for repurchase by 3.0 million, to 9.0 million. We evaluate long- and short-range forecasts as well as anticipated sources and uses of cash before determining the course of action that would best enhance shareholder value. Prior to fiscal 2010, we had repurchased approximately 5.1 million shares under the program. In fiscal 2010, we repurchased a total of 412,994 shares of our Class A common stock under this program. As a result, as of August 31, 2010 there were approximately 3.5 million shares available for repurchase under existing authorizations.

Pension Contributions

We make contributions to a defined benefit pension plan, several defined contribution plans and several multiemployer defined benefit pension plans. Contributions vary depending on the plan and are based upon plan provisions, actuarial valuations and negotiated labor agreements. In fiscal 2006, we froze further benefit accruals in

 

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our defined benefit plan. In fiscal 2010, we made a $2 million contribution to the defined benefit plan due to a reduction in its funding status as a result of a reduction in the single discount rate assumptions used for determining pension obligations. While we do not anticipate making additional contributions to the defined benefit plan in fiscal 2011, we may elect or be required to do so.

In addition, during fiscal 2011 we anticipate making $4 million of contributions to the multiemployer plans in which we participate, including contributions totaling $2 million for the multiemployer plan benefiting union employees of SMB. We believe any additional funding requirements will not have a material impact on our financial condition. See Note 15 – Employee Benefits in the notes to the consolidated financial statements in Part II, Item 8 of this report for further discussion of our retirement benefit plans.

Effective in March 2009, we suspended employer contributions to our defined contribution plans. We resumed contributions to these plans in April 2010 and expect to make contributions of $3 million to our defined contribution plans in fiscal 2011.

Assessment of Liquidity and Capital Resources

Historically, our available cash resources, internally generated funds, credit facilities and equity offerings have financed our acquisitions, capital expenditures, working capital and other financing needs.

We generally believe our current cash resources, internally generated funds, existing credit facilities and access to the capital markets will provide adequate financing for acquisitions, capital expenditures, working capital, joint ventures, stock repurchases, debt service requirements, post-retirement obligations and future environmental obligations for the next 12 months. However, continued weak general market conditions may result in further utilizing our available credit lines and curtailing capital and operating expenditures, delaying or restricting acquisitions and share repurchases and reassessing working capital requirements. Should we determine, at any time, that we require additional short-term liquidity, we will evaluate available alternatives and take appropriate steps to obtain sufficient additional funds, but there can be no assurance that any such supplemental funding, if sought, could be obtained or, if obtained, would be adequate or on acceptable terms. However, we believe that our balance sheet as of August 31, 2010, expected cash flow from operations and existing credit facilities should provide additional sources of liquidity if required.

Off-Balance Sheet Arrangements

With the exception of operating leases and letters of credit, we are not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, results of operations or cash flows. We enter into operating leases for both new equipment and property. See Note 12 – Commitments and Contingencies in the notes to the consolidated financial statements in Part II, Item 8 of this report for additional information on our operating leases.

 

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Contractual Obligations and Commitments

We have certain contractual obligations to make future payments. The following table summarizes these future obligations as of August 31, 2010 (in thousands):

 

     Payment Due by Period
     2011    2012    2013    2014    2015    Thereafter    Total

Contractual Obligations

                    

Long-term debt

   $ 645    $ 90,000    $ 0    $ 0    $ 0    $ 7,700    $ 98,345

Interest payments on long-term debt

     736      678      29      29      29      159      1,660

Capital leases, including interest

     673      645      589      397      90      2      2,396

Pension funding obligations

     150      239      181      180      179      1,902      2,831

Other accrued liabilities

     524      300      457      300      0      0      1,581

Reserve for uncertain tax positions

     1,553      406      0      0      0      0      1,959

Operating leases

     15,178      13,196      11,070      8,348      4,731      5,205      57,728

Service obligation

     1,399      418      83      30      30      0      1,960

Purchase obligations:

                    

Materials purchase commitment

     1,124      749      0      0      0      0      1,873

Natural gas contract(1)

     2,204      0      0      0      0      0      2,204

Electricity contract(2)

     1,553      141      0      0      0      0      1,694
                                                

Total

   $ 25,739    $ 106,772    $ 12,409    $ 9,284    $ 5,059    $ 14,968    $ 174,231
                                                

 

 

 

(1)

SMB has a take-or-pay natural gas contract that currently requires a minimum purchase per day through October 2010, whether or not the amount is utilized.

(2)

SMB has an electricity contract with MWL that requires a minimum purchase of electricity at a rate subject to variable pricing, whether or not the amount is utilized. The fixed portion of the contract obligates SMB to pay $141 thousand per month for eleven months each year until the contract expires in September 2011.

Our reserve for uncertain tax positions was $2 million and $4 million as of August 31, 2010 and 2009, respectively. See Note 17 – Income Taxes in the notes to the consolidated financial statements in Part II, Item 8 of this report for additional information.

Critical Accounting Policies and Estimates

We have identified certain critical accounting estimates, which are those that are most important to the portrayal of our financial condition and operating results. These estimates require difficult and subjective judgments, including whether estimates are required to be made about matters that are inherently uncertain, if different estimates reasonably could have been used, or if changes in the estimates that are reasonably likely to occur could materially impact the financial statements. Significant estimates underlying the accompanying consolidated financial statements include inventory valuation, goodwill and other intangible asset valuation, environmental costs, accounting for business combinations and revenue recognition.

Inventories

Our inventories primarily consist of scrap metal (ferrous, nonferrous, processed and unprocessed), nonferrous recovered joint product, used and salvaged vehicles, semi-finished steel products (billets) and finished steel products (primarily rebar, merchant bar and wire rod). Inventories are stated at the lower of cost or market. MRB determines the cost of ferrous and nonferrous inventories principally using the average cost method and capitalizes substantially all direct costs and yard costs into inventory. MRB allocates material and production costs to joint products using the gross margin method. APB establishes cost for used and salvaged vehicle inventory based on the average price paid for a vehicle, capitalizing the vehicle cost into inventory. SMB establishes its finished steel product inventory cost based on a weighted average cost and capitalizes all direct and indirect costs of manufacturing into inventory. Indirect costs of manufacturing include general plant costs, maintenance and yard costs. We evaluate whether our inventory is properly valued at the lower of cost or market on a quarterly basis. We consider estimated future selling prices when

 

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determining the estimated net realizable value for our inventory. However, as MRB generally sells its export recycled ferrous metal under contracts that provide for shipment within 30 to 90 days after the price is agreed, it utilizes the selling prices under committed contracts and sales orders for determining the estimated market price of quantities on hand that will be shipped under these contracts and orders.

The accounting process we use to record unprocessed metal and used and salvaged vehicle inventory quantities relies on significant estimates. With respect to unprocessed metal inventory, we rely on weighed quantities that are reduced by estimated amounts that are moved into production. These estimates utilize estimated recoveries and yields that are based on historical trends. Over time, these estimates are reasonably good indicators of what is ultimately produced; however, actual recoveries and yields can vary depending on product quality, moisture content and source of the unprocessed metal. If ultimate recoveries and yields are significantly different than estimated, the value of our inventory could be materially overstated or understated. To assist in validating the reasonableness of these estimates, we run periodic tests and perform monthly physical inventory estimates. However, due to variations in product density, holding period and production processes utilized to manufacture the product, physical inventories will not necessarily detect all variances. To mitigate this risk, we adjust the ferrous physical inventories when the volume of a commodity is low and a physical inventory count can more accurately predict the remaining volume.

Goodwill and Other Intangible Assets

We evaluate goodwill and intangibles with an indefinite life annually during the second fiscal quarter and upon the occurrence of certain triggering events or substantive changes in circumstances that indicate that the fair value of goodwill or indefinite lived intangible assets may be impaired. Impairment of goodwill is tested at the reporting segment level. Our reporting segments, for which goodwill has been allocated, are equivalent to our operating segments, as all of the components of the respective segments have similar economic characteristics.

The goodwill impairment test follows a two step process. In the first step, the fair value of a reporting segment is compared to its carrying value. If the carrying value of a reporting segment exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting segment is allocated to all of the assets and liabilities of the reporting segment to determine an implied goodwill value. This allocation is similar to a purchase price allocation. If the carrying amount of the reporting segment’s goodwill exceeds the implied fair value of goodwill, an impairment loss will be recognized in an amount equal to that excess. In the event of a divestiture of a business unit within a reporting segment, goodwill of the reporting segment is allocated to that business unit based on the fair value of the unit being divested to the total fair value of the reporting segment and a gain or loss is determined. The remaining goodwill in the reporting segment from which the assets were divested is subsequently re-evaluated for impairment.

We estimate the fair value of the reporting segments using an income approach based on the present value of expected future cash flows utilizing a market-based weighted average cost of capital (“WACC”). To estimate the cash flows that extend beyond the final year of the discounted cash flow model, we employ a terminal value technique, whereby we use estimated operating cash flows minus capital expenditures and adjust for changes in working capital requirements in the final year of the model, then discount it by the WACC to establish the terminal value. We include the present value of the terminal value in the fair value estimate. Given that market prices of our reporting segments are not readily available, we make various estimates and assumptions in determining the estimated fair values of the reporting segments, which is the price that would be received to sell the reporting segment as a whole in an orderly transaction between market participants. Forecasts of future cash flows are based on our best estimate of future sales and operating costs, pricing expectations and general market conditions.

In addition, we test indefinite-lived intangibles for impairment by either comparing the carrying value of the intangible to the projected discounted cash flows from the intangible or using the relief from royalties method. If the carrying value exceeds the projected discounted cash flows attributed to the intangible asset, the carrying value is no longer considered recoverable and we will record an impairment.

 

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Environmental Costs

We operate in industries that inherently possess environmental risks. To manage these risks, we employ both our own environmental staff and outside consultants. Environmental staff and finance personnel meet regularly to stay updated on environmental risks. We estimate future costs for known environmental remediation requirements and accrue for them on an undiscounted basis when it is probable that we have incurred a liability and the related costs can be reasonably estimated but the timing of incurring the estimated costs is unknown. The regulatory and government management of these projects is complex, which is one of the primary factors that make it difficult to assess the cost of potential and future remediation. When only a wide range of estimated amounts can be reasonably established and no other amount within the range is better than another, the low end of the range is recorded in the financial statements. If further developments or resolution of an environmental matter result in facts and circumstances that are significantly different than the assumptions used to develop these reserves, the accrual for environmental remediation could be materially understated or overstated. Adjustments to these liabilities are made when additional information becomes available that affects the estimated costs to study or remediate any environmental issues or when expenditures for which reserves are established are made. The factors we consider in the recognition and measurement of environmental liabilities include:

 

   

Current regulations, both at the time the reserve is established and during the course of the remediation process, which specify standards for acceptable remediation;

   

Information about the site which becomes available as the site is studied and remediated;

   

The professional judgment of senior-level internal staff, who take into account similar, recent instances of environmental remediation issues, and studies of our sites, among other considerations;

   

Technologies available that can be used for remediation; and

   

The number and financial condition of other potentially responsible parties and the extent of their responsibility for the costs of study and remediation.

The accrued environmental liabilities as of August 31, 2010 included $1 million related to third party investigation costs for the Portland Harbor Superfund site. Although future costs for the Portland Harbor Superfund site could be material to our financial position, results of operations or cash flows, it is not possible to estimate additional costs which we might incur in connection with the ongoing investigations and remediation because there has not been a determination of the total investigation costs, the remediation that will be required, the amount of natural resource damages or how the costs of the ongoing investigations and any remedy and natural resource damages will be allocated among the PRPs. As such, it is not presently possible to estimate the costs which we are likely to incur in connection with the site and therefore no amounts have been accrued. See Contingencies – Environmental in Note 12 – Commitments and Contingencies in the notes to the consolidated financial statements in Part II, Item 8 of this report.

Business Combinations

On September 1, 2009, we adopted the revised accounting standard for business combinations, which requires us to recognize the assets acquired, the liabilities assumed, and any noncontrolling interests in the acquiree at the acquisition date, measured at their fair values as of that date, generally using a market-based income approach. Measuring assets and liabilities at fair value requires us to determine the price that would be paid by a third party market participant based on the highest and best use of the assets or interests acquired. We utilize management estimates that incorporate input from an independent third party valuation firm in our determination of these fair values. Such estimates and valuations require us to make significant assumptions, including projections of future events and operating performance and determining the highest and best use of the assets or interests acquired. In addition, following the adoption of this standard, acquisition costs are expensed as incurred.

Revenue Recognition

We recognize revenue when we have a contract or purchase order from a customer with a fixed price, the title and risk of loss transfer to the buyer and collectibility is reasonably assured. Title for both metal and finished steel products

 

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transfers based on contract terms. A significant portion of our ferrous export sales of recycled metal are made with letters of credit, reducing credit risk. However, domestic recycled ferrous metal sales, nonferrous sales and sales of finished steel are generally made on open account. Nonferrous export sales typically require a deposit prior to shipment. All sales made on open account are evaluated for collectibility prior to revenue recognition. Additionally, we recognize revenues on partially loaded shipments when detailed documents support revenue recognition based on transfer of title and risk of loss. For APB, retail revenues are recognized when customers pay for parts and wholesale product revenues are recognized when customer weight certificates are received following shipment. Historically, there have been very few sales returns and adjustments that impact the ultimate collection of revenues; therefore, no material provisions have been made when the sale is recognized. We present taxes assessed by governmental authorities collected from customers on a net basis. Therefore, the taxes are excluded from revenue and are shown as a liability on our consolidated balance sheet until remitted. See the discussion on credit risk contained in Item 7a of this report.

Recently Issued Accounting Standards

For a description of recent accounting pronouncements that may have an impact on our financial condition, results of operations or cash flows, see Note 3 – Recent Accounting Pronouncements in the notes to the consolidated financial statements in Part II, Item 8 of this report.

Non-GAAP Financial Measures

Debt, net of cash

Debt, net of cash is the difference between (i) the sum of long-term debt and short-term debt (i.e., total debt) and (ii) cash and cash equivalents. Management believes that debt, net of cash is a useful measure for investors. In management’s view, because cash and cash equivalents can be used, among other things, to repay indebtedness, netting this against total debt is a useful measure of our leverage.

Management believes that this non-GAAP financial measure allows for a better understanding of our operating and financial performance. This non-GAAP financial measure should be considered in addition to, but not as a substitute for, the most directly comparable US GAAP measure. The following is a reconciliation of debt, net of cash (in thousands):

 

     August 31,
2010
     August 31,
2009
     August 31,
2008
 

Short-term borrowings and capital lease obligations, current

   $ 1,189       $ 1,317       $ 25,490   

Long-term debt and capital lease obligations, net of current maturities

     99,240         110,414         158,933   
                          

Total debt

     100,429         111,731         184,423   

Less: cash and cash equivalents

     30,342         41,026         15,039   
                          

Total debt, net of cash

   $ 70,087       $ 70,705       $ 169,384   
                          

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Commodity Price Risk

We are exposed to commodity price risk, mainly associated with variations in the market price for finished steel products, ferrous and nonferrous metals, including scrap metal, autobodies and other commodities. The timing and magnitude of industry cycles are difficult to predict and are impacted by general economic conditions. We respond to increases and decreases in forward selling prices by adjusting purchase prices on a timely basis. We actively manage our exposure to commodity price risk and monitor the actual and expected spread between forward selling prices and purchase costs and processing and shipping expense. Sales contracts are based on prices negotiated with our customers, and generally orders are placed 30 to 90 days ahead of shipment date. However, financial results may be negatively impacted when forward selling prices fall more quickly than we can adjust purchase prices or when customers fail to meet their contractual obligations. We assess the net realizable value of inventory each quarter based upon contracted sales orders and estimated future selling prices. Based on contracted sales and estimates of future selling prices at August 31, 2010, a 10% decrease in the selling price per ton of finished steel products would cause an NRV inventory write down of approximately $3 million at SMB.

Interest Rate Risk

We are exposed to market risk associated with changes in interest rates related to our debt obligations. Our credit line and revolving credit facility are variable in rate and therefore have exposure to changes in interest rates. If market interest rates had changed 10% from actual interest rate levels in fiscal 2010 or 2009, the effect on our interest expense and net income would not have been material.

Credit Risk

Credit risk relates to the risk of loss that might occur as a result of non-performance by counterparties of their contractual obligations to take delivery of scrap metal and finished steel products and to make financial settlements of these obligations. We manage our exposure to credit risk through a variety of methods, including shipping ferrous scrap metal exports under letters of credit, collection of deposits prior to shipment for certain nonferrous export customers and establishment of credit limits for sales on open terms.

MRB generally ships ferrous bulk sales to foreign customers under contracts supported by letters of credit issued or confirmed by banks it deems credit worthy. The letters of credit ensure payment by the customer. As MRB generally sells its export recycled ferrous metal under contracts or orders that generally provide for shipment within 30 to 90 days after the price is agreed, MRB’s customers typically do not have difficulty obtaining letters of credit from their banks in periods of rising ferrous prices, as the value of the letters of credit are collateralized by the value of the inventory on the ship. However, in periods of declining prices, MRB’s customers may not be able to obtain letters of credit for the full sales value of the inventory to be shipped. As such, we may need to extend credit on open terms for the difference between the sales value under the contract and the value supported by the letter of credit. In addition, we could be exposed to loss if a customer fails to pay or the bank providing the letter of credit fails.

As of August 31, 2010 and 2009, 43% and 49%, respectively, of our trade accounts receivable balance was covered by letters of credit. Of the remaining balance as of August 31, 2010, 89% was less than 60 days past due, compared to 85% as of August 31, 2009.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Management’s Annual Report on Internal Control Over Financial Reporting

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

The Company’s internal control over financial reporting includes policies and procedures that relate to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company; provide reasonable assurance that all transactions are recorded as necessary to permit the preparation of the Company’s consolidated financial statements in accordance with generally accepted accounting principles and that the proper authorization of receipts and expenditures of the Company are being made in accordance with authorization of the Company’s management and directors; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods is subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may deteriorate.

Management of the Company assessed the effectiveness of the Company’s internal control over financial reporting using the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on its assessment, management determined that the Company’s internal control over financial reporting was effective as of August 31, 2010.

PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this Annual Report, also audited the effectiveness of the Company’s internal control over financial reporting as of August 31, 2010, as stated in their report included herein.

 

Tamara L. Lundgren

   Richard D. Peach

President and Chief Executive Officer

   Sr. Vice President and Chief Financial Officer

October 20, 2010

   October 20, 2010

 

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Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of Schnitzer Steel Industries, Inc.:

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Schnitzer Steel Industries, Inc. and its subsidiaries as of August 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of August 31, 2010, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

As discussed in Note 7 to the consolidated financial statements, the Company changed the manner in which it accounts for business combinations as of September 1, 2009. As discussed in Note 3 to the consolidated financial statements, the Company changed the manner in which it accounts for noncontrolling interests as of September 1, 2009.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness as to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PricewaterhouseCoopers LLP

Portland, Oregon

October 20, 2010

 

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SCHNITZER STEEL INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

 

     August 31,  
     2010     2009  
Assets     

Current assets:

    

Cash and cash equivalents

   $ 30,342      $ 41,026   

Accounts receivable, net

     126,156        117,666   

Inventories, net

     268,103        184,455   

Deferred income taxes

     9,037        10,027   

Refundable income taxes

     14,610        46,972   

Prepaid expenses and other current assets

     12,546        10,868   
                

Total current assets

     460,794        411,014   

Property, plant and equipment, net

     460,810        447,228   

Other assets:

    

Investments in joint venture partnerships

     13,706        10,812   

Goodwill

     380,332        366,559   

Intangibles, net

     20,444        20,422   

Other assets

     7,332        12,198   
                

Total assets

   $ 1,343,418      $ 1,268,233   
                
Liabilities and Equity     

Current liabilities:

    

Long-term debt and capital lease obligations

   $ 1,189      $ 1,317   

Accounts payable

     91,879        72,289   

Accrued payroll and related liabilities

     34,162        23,636   

Environmental liabilities

     2,588        3,148   

Accrued income taxes

     1,816        776   

Other accrued liabilities

     28,479        38,963   
                

Total current liabilities

     160,113        140,129   

Deferred income taxes

     58,630        44,523   

Long-term debt and capital lease obligations, net of current maturities

     99,240        110,414   

Environmental liabilities, net of current portion

     37,286        38,760   

Other long-term liabilities

     8,517        11,657   
                

Total liabilities

     363,786        345,483   
                

Commitments and contingencies (Note 12)

    

Schnitzer Steel Industries, Inc. (“SSI”) shareholders’ equity:

    

Preferred stock – 20,000 shares $1.00 par value authorized, none issued

     0        0   

Class A common stock – 75,000 shares $1.00 par value authorized,

    

22,700 and 21,402 shares issued and outstanding

     22,700        21,402   

Class B common stock – 25,000 shares $1.00 par value authorized,

    

4,721 and 6,268 shares issued and outstanding

     4,721        6,268   

Additional paid-in capital

     1,815        0   

Retained earnings

     948,642        894,243   

Accumulated other comprehensive loss

     (2,552     (2,546
                

Total SSI shareholders’ equity

     975,326        919,367   

Noncontrolling interests

     4,306        3,383   
                

Total equity

     979,632        922,750   
                

Total liabilities and equity

   $ 1,343,418      $ 1,268,233   
                

See Notes to the Consolidated Financial Statements

 

46  /  Schnitzer Steel Industries, Inc. Form 10-K 2010


Table of Contents

 

SCHNITZER STEEL INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

     Year Ended August 31,  
     2010     2009     2008  

Revenues

   $ 2,301,240      $ 1,787,230      $ 3,516,950   

Operating expense:

      

Cost of goods sold

     2,019,764        1,681,942        2,911,334   

Selling, general and administrative

     158,805        163,410        214,533   

Environmental matters

     (91     (5,809     (446

Income from joint ventures

     (3,135     (1,189     (11,706
                        

Operating income (loss)

     125,897        (51,124     403,235   

Other income (expense):

      

Interest income

     459        1,179        748   

Interest expense

     (2,343     (3,342     (8,649

Other income, net

     1,320        6,223        1,887   
                        

Total other income (expense)

     (564     4,060        (6,014
                        

Income (loss) from continuing operations before income taxes

     125,333        (47,064     397,221   

Income tax (expense) benefit

     (40,825     19,915        (142,568
                        

Income (loss) from continuing operations

     84,508        (27,149     254,653   

Loss from discontinued operations, net of tax

     (13,832     (4,214     (613
                        

Net income (loss)

     70,676        (31,363     254,040   

Net income attributable to noncontrolling interests

     (3,926     (866     (5,357
                        

Net income (loss) attributable to SSI

   $ 66,750      $ (32,229   $ 248,683   
                        

Basic:

      

Income (loss) per share from continuing operations attributable to SSI

   $ 2.90      $ (0.99   $ 8.81   

Loss per share from discontinued operations attributable to SSI

     (0.50     (0.15     (0.02
                        

Net income (loss) per share attributable to SSI

   $ 2.40      $ (1.14   $ 8.79   
                        

Diluted:

      

Income (loss) per share from continuing operations attributable to SSI

   $ 2.86      $ (0.99   $ 8.63   

Loss per share from discontinued operations attributable to SSI

     (0.49     (0.15     (0.02
                        

Net income (loss) per share attributable to SSI

   $ 2.37      $ (1.14   $ 8.61   
                        

Weighted average number of common shares:

      

Basic

     27,832        28,159        28,278   

Diluted

     28,147        28,159        28,894   

Dividends declared per common share

   $ 0.068      $ 0.068      $ 0.068   

See Notes to the Consolidated Financial Statements

 

Schnitzer Steel Industries, Inc. Form 10-K 2010  /  47


Table of Contents

 

SCHNITZER STEEL INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(in thousands)

 

    Common Stock    

Additional

Paid-in

Capital

   

Retained

Earnings

   

Accumulated

Other

Comprehensive

Income (loss)

   

Total SSI

Shareholders’

Equity

   

Noncontrolling

Interests

   

Total

Equity

 
  Class A     Class B              
  Shares     Amount     Shares     Amount              

Balance as of August 31, 2007

    21,231      $ 21,231        7,328      $ 7,328      $ 41,344      $ 693,470      $ 1,691      $ 765,064      $ 5,373      $ 770,437   

Net income

    0        0        0        0        0        248,683        0        248,683        5,357        254,040   

Foreign currency translation adjustment (net of tax benefit of $194)

    0        0        0        0        0        0        (251     (251     0        (251

Pension obligations, net (net of tax benefit of $939)

    0        0        0        0        0        0        (1,831     (1,831     0        (1,831
                                     

Comprehensive income

                  246,601        5,357        251,958   

Distributions to noncontrolling interests

    0        0        0        0        0        0        0        0        (4,705     (4,705

Noncontrolling interest buyout

    0        0        0        0        0        0        0        0        (1,626     (1,626

Cummulative effect related to adoption of tax standard

    0        0        0        0        0        (1,055     0        (1,055     0        (1,055

Share repurchases

    (694     (694     0        0        (44,165     0        0        (44,859     0        (44,859

Class A common stock issued

    8        8        0        0        527        0        0        535        0        535   

Restricted stock withheld for taxes

    (22     (22     0        0        (2,212     0        0        (2,234     0        (2,234

Issuance of restricted stock

    60        60        0        0        (60     0        0        0        0        0   

Stock options exercised and restricted stock units vested

    26        26        0        0        497        0        0        523        0        523   

Class B common stock converted to Class A common stock

    983        983        (983     (983     0        0        0        0        0        0   

Share-based compensation expense

    0        0        0        0        14,487        0        0        14,487        0        14,487   

Excess tax benefits from share-based payment arrangements

    0        0        0        0        1,007        0        0        1,007        0        1,007   

Cash dividends ($0.068 per share)

    0        0        0        0        0        (1,917     0        (1,917     0        (1,917
                                                                               

Balance as of August 31, 2008

    21,592        21,592        6,345        6,345        11,425        939,181        (391     978,152        4,399        982,551   

Net income (loss)

    0        0        0        0        0        (32,229     0        (32,229     866        (31,363

Foreign currency translation adjustment (net of tax benefit of $268)

    0        0        0        0        0        0        (358     (358     0        (358

Pension obligations, net (net of tax benefit of $796)

    0        0        0        0        0        0        (1,260     (1,260     0        (1,260

Change in net unrealized loss on cash flow hedges (net of tax benefit of $313)

    0        0        0        0        0        0        (537     (537     0        (537
                                     

Comprehensive income (loss)

                  (34,384     866        (33,518

Distributions to noncontrolling interests

    0        0        0        0        0        0        0        0        (1,286     (1,286

Noncontrolling interest buyout

    0        0        0        0        0        0        0        0        (596     (596

Share repurchases

    (600     (600     0        0        (18,495     (10,801     0        (29,896     0        (29,896

Class A common stock issued

    106        106        0        0        (106     0        0        0        0        0   

Restricted stock withheld for taxes

    (132     (132     0        0        (3,863     0        0        (3,995     0        (3,995

Issuance of restricted stock

    239        239        0        0        (239     0        0        0        0        0   

Stock options exercised

    120        120        0        0        1,561        0        0        1,681        0        1,681   

Class B common stock converted to Class A common stock

    77        77        (77     (77     0        0        0        0        0        0   

Share-based compensation expense

    0        0        0        0        8,898        0        0        8,898        0        8,898   

Excess tax benefits from share-based payment arrangements

    0        0        0        0        819        0        0        819        0        819   

Cash dividends ($0.068 per share)

    0        0        0        0        0        (1,908     0        (1,908     0        (1,908
                                                                               

Balance as of August 31, 2009

    21,402        21,402        6,268        6,268        0        894,243        (2,546     919,367        3,383        922,750   

Net income

    0        0        0        0        0        66,750        0        66,750        3,926        70,676   

Foreign currency translation adjustment (net of tax of $210)

    0        0        0        0        0        0        523        523        0        523   

Pension obligations, net (net of tax benefit of $550)

    0        0        0        0        0        0        (949     (949     0        (949

Change in net unrealized gain on cash flow hedges (net of tax of $247)

    0        0        0        0        0        0        420        420        0        420   
                                     

Comprehensive income

                  66,744        3,926        70,670   

Distributions to noncontrolling interests

    0        0        0        0        0        0        0        0        (3,003     (3,003

Share repurchases

    (413     (413     0        0        (6,266     (10,468     0        (17,147     0        (17,147

Class A common stock issued

    13        13        0        0        (13     0        0        0        0        0   

Restricted stock withheld for taxes

    (81     (81     0        0        (3,518     0        0        (3,599     0        (3,599

Issuance of restricted stock

    196        196        0        0        (196     0        0        0        0        0   

Stock options exercised

    36        36        0        0        901        0        0        937        0        937   

Class B common stock converted to Class A common stock

    1,547        1,547        (1,547     (1,547     0        0        0        0        0        0   

Share-based compensation expense

    0        0        0        0        11,035        0        0        11,035        0        11,035   

Excess tax deficiency from stock options exercised and restricted stock units vested

    0        0        0        0        (128     0        0        (128     0        (128

Cash dividends ($0.068 per share)

    0        0        0        0        0        (1,883     0        (1,883     0        (1,883
                                                                               

Balance as of August 31, 2010

    22,700      $ 22,700        4,721      $ 4,721      $ 1,815      $ 948,642      $ (2,552   $ 975,326      $ 4,306      $ 979,632   
                                                                               

See Notes to the Consolidated Financial Statements

 

48  /  Schnitzer Steel Industries, Inc. Form 10-K 2010


Table of Contents

 

SCHNITZER STEEL INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

     Year Ended August 31,  
     2010     2009     2008  

Cash flows from operating activities:

      

Net income (loss)

   $ 70,676      $ (31,363   $ 254,040   

Adjustments to reconcile net income (loss) to cash provided by operating activities:

      

Depreciation and amortization

     63,418        60,681        51,362   

Inventory write-down

     368        51,968        48,967   

Deferred income taxes

     10,891        24,727        2,582   

Undistributed equity in earnings of joint ventures

     (3,076     (537     (12,277

Share-based compensation expense

     11,035        8,898        14,487   

Excess tax (benefit) deficiency from share-based payment arrangements

     128        (819     (1,007

(Gain) loss on disposal of a business and other assets

     16,943        (2,034     414   

Environmental matters

     (1,391     (3,510     (603

Voluntary incentive award forfeitures

     0        (5,504     0   

Unrealized (gain) loss on derivatives

     (4,299     1,161        2,541   

Bad debt expense (recoveries), net

     (255     8,916        4,445   

Gain on settlement of joint venture separation and termination agreement

     0        (6,761     0   

Changes in assets and liabilities:

      

Accounts receivable

     (11,569     189,511        (135,140

Inventories

     (109,138     198,840        (215,812

Refundable income taxes

     32,237        (46,147     881   

Prepaid expenses and other current assets

     (2,640     4,185        (3,756

Intangibles and other long-term assets

     (206     (4,514     (3,564

Accounts payable

     8,479        (79,086     54,108   

Accrued payroll liabilities

     12,010        (35,851     21,251   

Other accrued liabilities

     (2,519     (4,858     15,396   

Accrued income taxes

     1,040        (41,998     38,162   

Environmental liabilities

     (944     (577     (1,243

Other long-term liabilities

     (2,128     (1,574     (320

Distributed equity in earnings of joint ventures

     430        3,825        6,850   
                        

Net cash provided by operating activities

     89,490        287,579        141,764   
                        

Cash flows from investing activities:

      

Capital expenditures

     (64,324     (59,044     (84,262

Acquisitions, net of cash acquired

     (40,944     (93,053     (46,888

(Advances to) payments from joint ventures, net

     (340     (1,876     3,092   

Proceeds from sale of business and other assets

     41,319        3,497        917   

Cash flows used in non-hedge derivatives

     0        0        (822
                        

Net cash used in investing activities

     (64,289     (150,476     (127,963
                        

Cash flows from financing activities:

      

Proceeds from line of credit

     402,600        331,700        490,500   

Repayment of line of credit

     (402,600     (356,700     (485,500

Borrowings from long-term debt

     577,900        440,500        1,414,600   

Repayment of long-term debt

     (589,242     (491,329     (1,379,946

Repurchase of Class A common stock

     (17,147     (29,896     (44,859

Stock withheld for taxes under employee share-based compensation plan

     (3,599     (3,995     (2,234

Excess tax benefit (deficiency) from share-based payment arrangements

     (128     819        1,007   

Stock options exercised and restricted stock units vested

     937        1,681        523   

Distributions to noncontrolling interests

     (3,003     (1,286     (4,705

Dividends paid

     (1,416     (2,386     (1,434
                        

Net cash used in financing activities

     (35,698     (110,892     (12,048
                        

Effect of exchange rate changes on cash

     (187     (224     (124

Net increase (decrease) in cash and cash equivalents

     (10,684     25,987        1,629   

Cash and cash equivalents at beginning of year

     41,026        15,039        13,410   
                        

Cash and cash equivalents at end of year

   $ 30,342      $ 41,026      $ 15,039   
                        

SUPPLEMENTAL DISCLOSURES:

      

Cash paid (received) during the year for:

      

Interest

   $ 2,569      $ 3,329      $ 8,400   

Income taxes paid (refunds received), net

   $ (3,783   $ 42,443      $ 97,825   

See Notes to the Consolidated Financial Statements

 

Schnitzer Steel Industries, Inc. Form 10-K 2010  /  49


Table of Contents

 

SCHNITZER STEEL INDUSTRIES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1 – Nature of Operations

Founded in 1906, Schnitzer Steel Industries, Inc. (the “Company”), an Oregon corporation, is currently one of the nation’s largest recyclers of ferrous and nonferrous scrap metal, a leading recycler of used and salvaged vehicles and a manufacturer of finished steel products.

The Company operates in three reporting segments that include the Metals Recycling Business (“MRB”), the Auto Parts Business (“APB”) and the Steel Manufacturing Business (“SMB”). MRB buys, collects, processes, recycles, sells and brokers recycled metal by operating one of the largest metal recycling businesses in the United States (“US”). APB is one of the country’s leading self-service used auto parts networks. Additionally, APB is a supplier of autobodies to MRB, which processes the autobodies into sellable recycled metal. SMB purchases recycled metal from MRB and uses its mini-mill to process the recycled metal into finished steel products. The Company provides an end-of-life cycle solution for a variety of products through its cross-divisional synergies, including sale of used auto parts, procuring autobodies and other metal products, recycling them into scrap metal and manufacturing them into finished steel products.

As of August 31, 2010, all of the Company’s facilities were located in the US and its territories and Canada.

Note 2 – Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its majority-owned and wholly-owned subsidiaries. In addition, the Company holds a 50% interest in five joint ventures which are accounted for under the equity method. All significant intercompany account balances, transactions, profits and losses have been eliminated as of August 31, 2010 and 2009 and for the years ended August 31, 2010, 2009 and 2008.

Cash and Cash Equivalents

Cash and cash equivalents include short-term securities that are not restricted by third parties and have an original maturity date of 90 days or less. Included in accounts payable are book overdrafts of $25 million and $23 million as of August 31, 2010 and 2009, respectively.

Accounts Receivable, net

Accounts receivable represent amounts due from customers on product and other sales. These accounts r