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EXCEL - IDEA: XBRL DOCUMENT - SCHNITZER STEEL INDUSTRIES INCFinancial_Report.xls
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - SCHNITZER STEEL INDUSTRIES INCschnex312_2015228-q2.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - SCHNITZER STEEL INDUSTRIES INCschnex321_2015228-q2.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - SCHNITZER STEEL INDUSTRIES INCschnex311_2015228-q2.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - SCHNITZER STEEL INDUSTRIES INCschnex322_2015228-q2.htm

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
 
For the Quarterly Period Ended February 28, 2015
Or
o
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 or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
299 SW Clay St., Suite 350
Portland, OR
 
97201
(Address of principal executive offices)
 
(Zip Code)
 (503) 224-9900
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  x    No  o
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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  x    No  o
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 the 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
o
Non-accelerated filer
o
Smaller Reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  o    No  x
The Registrant had 26,480,095 shares of Class A common stock, par value of $1.00 per share, and 305,900 shares of Class B common stock, par value of $1.00 per share, outstanding as of April 2, 2015.

 
 
 
 
 



SCHNITZER STEEL INDUSTRIES, INC.
INDEX
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS (UNAUDITED)
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per share amounts)
 
February 28, 2015
 
August 31, 2014
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
7,601

 
$
25,672

Accounts receivable, net of allowance for doubtful accounts of $2,668 and $2,720
112,202

 
189,359

Inventories
255,931

 
216,172

Deferred income taxes
5,724

 
6,865

Refundable income taxes
13,005

 
1,756

Prepaid expenses and other current assets
18,747

 
24,108

Total current assets
413,210

 
463,932

Property, plant and equipment, net of accumulated depreciation of $668,653
 and $659,872
440,874

 
523,433

Investments in joint venture partnerships
15,409

 
14,624

Goodwill
176,732

 
325,903

Intangibles, net of accumulated amortization of $6,820 and $15,612
7,211

 
9,835

Other assets
17,170

 
17,483

Total assets
$
1,070,606

 
$
1,355,210

Liabilities and Equity
 
 
 
Current liabilities:
 
 
 
Short-term borrowings
$
618

 
$
523

Accounts payable
74,139

 
103,453

Accrued payroll and related liabilities
19,343

 
32,127

Environmental liabilities
191

 
1,062

Accrued income taxes
353

 
3,202

Other accrued liabilities
35,922

 
36,903

Total current liabilities
130,566

 
177,270

Deferred income taxes
20,150

 
22,746

Long-term debt, net of current maturities
312,902

 
318,842

Environmental liabilities, net of current portion
47,354

 
47,287

Other long-term liabilities
14,295

 
13,088

Total liabilities
525,267

 
579,233

Commitments and contingencies (Note 6)

 

Schnitzer Steel Industries, Inc. (“SSI”) shareholders’ equity:
 
 
 
Preferred stock – 20,000 shares $1.00 par value authorized, none issued

 

Class A common stock – 75,000 shares $1.00 par value authorized, 26,480 and 26,384 shares issued and outstanding
26,480

 
26,384

Class B common stock – 25,000 shares $1.00 par value authorized, 306 and 306 shares issued and outstanding
306

 
306

Additional paid-in capital
21,304

 
19,164

Retained earnings
529,158

 
737,571

Accumulated other comprehensive loss
(36,148
)
 
(12,641
)
Total SSI shareholders’ equity
541,100

 
770,784

Noncontrolling interests
4,239

 
5,193

Total equity
545,339

 
775,977

Total liabilities and equity
$
1,070,606

 
$
1,355,210

The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements
are an integral part of these statements.

3


SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share amounts)
 
 
Three Months Ended February 28,
 
Six Months Ended February 28,
 
2015
 
2014
 
2015
 
2014
Revenues
$
439,232

 
$
626,147

 
$
994,822

 
$
1,213,891

Operating expense:
 
 
 
 
 
 
 
Cost of goods sold
408,783

 
571,140

 
918,805

 
1,113,558

Selling, general and administrative
42,737

 
45,856

 
88,103

 
93,406

Income from joint ventures
(609
)
 
(367
)
 
(1,109
)
 
(777
)
Goodwill impairment charge
141,021

 

 
141,021

 

Other asset impairment charges
43,838

 
928

 
43,838

 
928

Restructuring charges and other exit-related costs
8,371

 
2,006

 
8,994

 
3,819

Operating income (loss)
(204,909
)
 
6,584

 
(204,830
)
 
2,957

Interest expense
(2,345
)
 
(2,816
)
 
(4,769
)
 
(5,517
)
Other income (expense), net
1,620

 
(142
)
 
2,372

 
33

Income (loss) before income taxes
(205,634
)
 
3,626

 
(207,227
)
 
(2,527
)
Income tax (expense) benefit
9,752

 
(986
)
 
9,743

 
(201
)
Net income (loss)
(195,882
)
 
2,640

 
(197,484
)
 
(2,728
)
Net (income) loss attributable to noncontrolling interests
240

 
(851
)
 
(631
)
 
(1,712
)
Net income (loss) attributable to SSI
$
(195,642
)
 
$
1,789

 
$
(198,115
)
 
$
(4,440
)
 
 
 
 
 
 
 
 
Net income (loss) per share attributable to SSI:
 
 
 
 
 
 
 
Basic
$
(7.24
)
 
$
0.07

 
$
(7.34
)
 
$
(0.17
)
Diluted
$
(7.24
)
 
$
0.07

 
$
(7.34
)
 
$
(0.17
)
Weighted average number of common shares:
 
 
 
 
 
 
 
Basic
27,020

 
26,825

 
26,982

 
26,790

Diluted
27,020

 
26,947

 
26,982

 
26,790

Dividends declared per common share
$
0.1875

 
$
0.1875

 
$
0.3750

 
$
0.3750

The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements
are an integral part of these statements.

4


SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited, in thousands)

 
Three Months Ended February 28,
 
Six Months Ended February 28,
 
2015
 
2014
 
2015
 
2014
Net income (loss)
$
(195,882
)
 
$
2,640

 
$
(197,484
)
 
$
(2,728
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(12,601
)
 
(5,688
)
 
(19,873
)
 
(6,579
)
Cash flow hedges, net
(2,785
)
 
(229
)
 
(3,693
)
 
(108
)
Pension obligations, net
23

 
45

 
59

 
89

Total other comprehensive loss, net of tax
(15,363
)
 
(5,872
)
 
(23,507
)
 
(6,598
)
Comprehensive loss
(211,245
)
 
(3,232
)
 
(220,991
)
 
(9,326
)
Less net (income) loss attributable to noncontrolling interests
240

 
(851
)
 
(631
)
 
(1,712
)
Comprehensive loss attributable to SSI
$
(211,005
)
 
$
(4,083
)
 
$
(221,622
)
 
$
(11,038
)
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements
are an integral part of these statements.


5


SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
Six Months Ended February 28,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net loss
$
(197,484
)
 
$
(2,728
)
Adjustments to reconcile net loss to cash provided by operating activities:
 
 
 
Goodwill impairment charge
141,021

 

Other asset impairment charges
43,838

 
928

Other exit-related asset impairments and accelerated depreciation
6,352

 
566

Depreciation and amortization
36,871

 
41,047

Inventory write-down
3,031

 

Deferred income taxes
(858
)
 
1,803

Undistributed equity in earnings of joint ventures
(1,109
)
 
(777
)
Share-based compensation expense
4,300

 
7,180

Excess tax benefit from share-based payment arrangements
(94
)
 
(54
)
Gain on disposal of assets
(1,032
)
 
(66
)
Unrealized foreign exchange gain (loss), net
(1,610
)
 
808

Bad debt (recoveries) expense, net
(67
)
 
400

Changes in assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
69,434

 
5,342

Inventories
(38,404
)
 
(7,581
)
Income taxes
(15,325
)
 
(3,284
)
Prepaid expenses and other current assets
5,143

 
1,464

Intangibles and other long-term assets
33

 
273

Accounts payable
(22,195
)
 
1,758

Accrued payroll and related liabilities
(12,525
)
 
(1,771
)
Other accrued liabilities
(4,382
)
 
(115
)
Environmental liabilities
(52
)
 
(337
)
Other long-term liabilities
638

 
(198
)
Distributed equity in earnings of joint ventures
325

 
1,040

Net cash provided by operating activities
15,849

 
45,698

Cash flows from investing activities:
 
 
 
Capital expenditures
(16,828
)
 
(21,064
)
Joint venture payments, net
(1
)
 
(1,468
)
Proceeds from sale of assets
1,358

 
635

Acquisitions, net of cash acquired
(150
)
 
(2,160
)
Net cash used in investing activities
(15,621
)
 
(24,057
)
Cash flows from financing activities:
 
 
 
Proceeds from line of credit
145,000

 
257,500

Repayment of line of credit
(145,000
)
 
(266,000
)
Borrowings from long-term debt
109,694

 
185,027

Repayment of long-term debt
(114,965
)
 
(180,477
)
Taxes paid related to net share settlement of share-based payment arrangements
(1,360
)
 
(676
)
Excess tax benefit from share-based payment arrangements
94

 
54

Stock options exercised

 
240

Distributions to noncontrolling interest
(1,585
)
 
(1,072
)
Contingent consideration paid relating to business acquisitions
(759
)
 

Dividends paid
(10,087
)
 
(9,983
)
Net cash used in financing activities
(18,968
)
 
(15,387
)
Effect of exchange rate changes on cash
669

 
668

Net (decrease) increase in cash and cash equivalents
(18,071
)
 
6,922

Cash and cash equivalents as of beginning of period
25,672

 
13,481

Cash and cash equivalents as of end of period
$
7,601

 
$
20,403


The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements
are an integral part of these statements.

6



SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 - Summary of Significant Accounting Policies

Basis of Presentation
The accompanying Unaudited Condensed Consolidated Financial Statements of Schnitzer Steel Industries, Inc. (the “Company”) have been prepared pursuant to generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and the rules and regulations of the United States Securities and Exchange Commission (the “SEC”) for Form 10-Q, including Article 10 of Regulation S-X. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. Certain information and note disclosures normally included in annual financial statements have been condensed or omitted pursuant to the rules and regulations of the SEC. In the opinion of management, all normal, recurring adjustments considered necessary for a fair statement have been included. Management suggests that these Unaudited Condensed Consolidated Financial Statements be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended August 31, 2014. The results for the three and six months ended February 28, 2015 and 2014 are not necessarily indicative of the results of operations for the entire fiscal year.
Accounting Changes
In July 2013, an accounting standards update was issued that clarifies the financial statement presentation of certain unrecognized tax benefits. The amendments require that an unrecognized tax benefit be presented as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that such carryforwards and losses are not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position, or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, in which case the unrecognized tax benefit should be presented in the financial statements as a liability. The Company adopted the new requirement in the first quarter of fiscal 2015 with no significant impact to the Unaudited Condensed Consolidated Financial Statements.
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 representing outstanding checks in excess of funds on deposit of $22 million and $35 million as of February 28, 2015 and August 31, 2014, respectively.
Other Assets
The Company’s other assets, exclusive of prepaid expenses, consist primarily of receivables from insurers, notes and other contractual receivables, and assets held for sale. Other assets are reported within either prepaid expenses and other current assets or other assets in the Unaudited Condensed Consolidated Balance Sheets based on their expected use either during or beyond the current operating cycle of one year from the reporting date. As of August 31, 2014, other assets were reported net of an allowance for credit losses on notes and other contractual receivables of $8 million. During the first quarter of fiscal 2015, the contractual receivables against which the $8 million allowance for credit losses was recorded were written off.
As of February 28, 2015 and August 31, 2014, the Company reported $3 million of assets held for sale within prepaid expenses and other current assets in the Unaudited Condensed Consolidated Balance Sheets. During the second quarter of fiscal 2015 and 2014, the Company recorded impairment charges for the initial and subsequent write-down of certain equipment held for sale to its fair value less cost to sell of $2 million and $1 million, respectively, which are reported within other asset impairment charges in the Unaudited Condensed Consolidated Statements of Operations. The Company determined fair value using Level 3 inputs under the fair value hierarchy consisting of information provided by brokers and other external sources along with management's own assumptions. See Note 10 - Fair Value Measurements for further detail.
Long-Lived Assets
The Company tests long-lived tangible and intangible assets for impairment at the asset group level, which is determined based on the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. The Company tests its asset groups for impairment when certain triggering events or changes in circumstances indicate that the carrying value of the asset group may be impaired. If the carrying value of the asset group is not recoverable because it exceeds the Company’s estimate of future undiscounted cash flows from the use and eventual disposition of the asset group, an impairment loss is recognized by the amount the carrying value exceeds its fair value, if any. The impairment loss is

7

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

allocated to the long-lived assets of the group on a pro rata basis using the relative carrying amounts of those assets, except that the loss allocated to an individual long-lived asset of the group shall not reduce the carrying amount of that asset below its fair value. Fair value is determined primarily using the cost and market approaches.
During the second quarter of fiscal 2015, the Company recorded impairment charges on long-lived tangible and intangible assets associated with certain regional metals recycling operations and used auto parts store locations. These charges are reported within other asset impairment charges or, if related to a site closure, restructuring charges and other exit-related costs in the Unaudited Condensed Consolidated Statements of Operations for the three and six months ended February 28, 2015 and 2014 (in thousands):
 
2015
 
2014
Other asset impairment charges:
 
 
 
MRB
$
41,544

 
$

Restructuring charges and other exit-related costs:
 
 
 
APB
2,666

 

Total long-lived asset impairment charges
$
44,210

 
$

Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the net amount of identifiable assets acquired and liabilities assumed in a business combination measured at fair value. The Company evaluates goodwill for impairment annually during the fourth fiscal quarter and upon the occurrence of certain triggering events or substantive changes in circumstances that indicate that the fair value of goodwill may be impaired. Impairment of goodwill is tested at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment (referred to as a component). The Company has determined that its reporting units for which goodwill has been allocated are equivalent to the Company’s operating segments, as all of the components of each operating segment meet the criteria for aggregation.
When testing goodwill for impairment, the Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of a reporting unit is less than its carrying amount. If the Company elects to perform a qualitative assessment and determines that an impairment is more likely than not, the Company is then required to perform the two-step quantitative impairment test, otherwise no further analysis is required. The Company also may elect not to perform the qualitative assessment and, instead, proceed directly to the two-step quantitative impairment test.
In the first step of the two-step quantitative impairment test, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit 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 unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of goodwill, an impairment loss will be recognized in an amount equal to that excess.

The Company estimates the fair value of its reporting units using an income approach based on the present value of expected future cash flows, including terminal value, utilizing a market-based weighted average cost of capital (“WACC”) determined separately for each reporting unit. The determination of fair value involves the use of significant estimates and assumptions, including revenue growth rates driven by future commodity prices and volume expectations, operating margins, capital expenditures, working capital requirements, tax rates, terminal growth rates, discount rates, benefits associated with a taxable transaction and synergistic benefits available to market participants. In addition, to corroborate the reporting units’ valuation, the Company uses a market approach based on earnings multiple data and a reconciliation of the Company’s estimate of the aggregate fair value of the reporting units to the Company’s market capitalization, including consideration of a control premium. See Note 4 - Goodwill for further detail including the recognition of a goodwill impairment charge of $141 million during the second quarter of fiscal 2015.
The Company tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is necessary to perform a quantitative impairment test. If the Company believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of the indefinite-lived intangible asset is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. The Company did not record any impairment charges on indefinite-lived intangible assets in any of the periods presented.

8

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Other Asset Impairment Charges
The following impairment charges were recorded within other asset impairment charges in the Unaudited Condensed Consolidated Statements of Operations for the three and six months ended February 28, 2015 and 2014 (in thousands):
 
2015
 
2014
Long-lived assets
$
41,544

 
$

Assets held for sale
1,549

 
928

Other
745

 

Total
$
43,838

 
$
928


All of the other asset impairment charges presented in the table above were recorded during the second quarter of each fiscal year.
Derivative Financial Instruments
The Company records derivative instruments in prepaid expenses and other current assets or other accrued liabilities in the Unaudited Condensed Consolidated Balance Sheets at fair value, and changes in the fair value are either recognized in other comprehensive income (loss) in the Unaudited Condensed Consolidated Statements of Comprehensive Loss or net income (loss) in the Unaudited Condensed Consolidated Statements of Operations, as applicable, depending on the nature of the underlying exposure, whether the derivative has been designated as a hedge and, if designated as a hedge, the extent to which the hedge is effective. Amounts included in accumulated other comprehensive loss are reclassified to earnings in the period in which earnings are impacted by the hedged items, in the period that the hedged transaction is deemed no longer likely to occur, or in the period that the derivative is terminated. For cash flow hedges, a formal assessment is made, both at the hedge’s inception and on an ongoing basis, to determine whether the derivatives that are designated as hedging instruments have been highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. To the extent the hedge is determined to be ineffective, the ineffective portion is immediately recognized in earnings. When available, quoted market prices or prices obtained through external sources are used to measure a derivative instrument’s fair value. The fair value of these instruments is a function of underlying forward commodity prices or foreign currency exchange rates, related volatility, counterparty creditworthiness and duration of the contracts. Cash flows from derivatives are recognized in the Unaudited Condensed Consolidated Statements of Cash Flows in a manner consistent with the underlying transactions. See Note 11 - Derivative Financial Instruments for further detail.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents, accounts receivable, notes and other contractual receivables and derivative financial instruments. The majority of cash and cash equivalents are maintained with two major financial institutions (Bank of America and Wells Fargo Bank, N.A.). Balances with these institutions exceeded the Federal Deposit Insurance Corporation insured amount of $250,000 as of February 28, 2015. Concentration of credit risk with respect to accounts receivable is limited because a large number of geographically diverse customers make up the Company’s customer base. The Company controls credit risk through credit approvals, credit limits, credit insurance, letters of credit or other collateral, cash deposits and monitoring procedures. The Company is exposed to a residual credit risk with respect to open letters of credit by virtue of the possibility of the failure of a bank providing a letter of credit. The Company had $24 million and $74 million of open letters of credit relating to accounts receivable as of February 28, 2015 and August 31, 2014, respectively. The counterparties to the Company's derivative financial instruments are major financial institutions.
Financial Instruments
The Company’s financial instruments include cash and cash equivalents, accounts receivable, accounts payable, debt and derivative contracts. The Company uses the market approach to value its financial assets and liabilities, determined using available market information. The net carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the short-term nature of these instruments. For long-term debt, which is primarily at variable interest rates, fair value is estimated using observable inputs (Level 2) and approximates its carrying value. Derivative contracts are reported at fair value. See Note 11 - Derivative Financial Instruments for further detail.
Fair Value Measurements
Fair value is measured using inputs from the three levels of the fair value hierarchy. Classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The three levels are described as follows:
Level 1 – Unadjusted quoted prices in active markets for identical assets and liabilities.

9

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the determination of the fair value of the asset or liability, either directly or indirectly.
Level 3 – Unobservable inputs that are significant to the determination of the fair value of the asset or liability.

When developing the fair value measurements, the Company uses quoted market prices whenever available or seeks to maximize the use of observable inputs and minimize the use of unobservable inputs when quoted market prices are not available.
Restructuring Charges
Restructuring charges consist of severance, contract termination and other restructuring-related costs. A liability for severance costs is typically recognized when the plan of termination has been communicated to the affected employees and is measured at its fair value at the communication date. Contract termination costs consist primarily of costs that will continue to be incurred under operating leases for their remaining terms without economic benefit to the Company. A liability for contract termination costs is recognized at the date the Company ceases using the rights conveyed by the lease contract and is measured at its fair value, which is determined based on the remaining contractual lease rentals reduced by estimated sublease rentals. A liability for other restructuring-related costs is measured at its fair value in the period in which the liability is incurred. See Note 7 - Restructuring Charges and Other Exit-Related Costs for further detail.

Note 2 - Recent Accounting Pronouncements
In April 2014, an accounting standard update was issued that amends the requirements for reporting discontinued operations, which may include a component of an entity or a group of components of an entity. The amendments limit discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have, or will have, a major effect on an entity's operations and financial results. The amendments require expanded disclosure about the assets, liabilities, revenues and expenses of discontinued operations. Further, the amendments require an entity to disclose the pretax profit or loss of an individually significant component that is being disposed of that does not qualify for discontinued operations reporting. The standard is applicable to the Company and is to be applied prospectively to all disposals or classifications as held for sale of components that occur beginning in the first quarter of fiscal 2016, and interim periods within that fiscal year, and all businesses that, on acquisition, are classified as held for sale that occur beginning in the first quarter of fiscal 2016, and interim periods within that fiscal year. Upon adoption, the standard will impact how the Company assesses and reports discontinued operations.
In May 2014, an accounting standard update was issued that clarifies the principles for recognizing revenue. The guidance is applicable to all contracts with customers regardless of industry-specific or transaction-specific fact patterns. Further, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. The standard is effective for the Company beginning in the first quarter of fiscal 2018, including interim periods within that fiscal year. Early application is not permitted. Upon becoming effective, the Company will apply the amendments in the updated standard either retrospectively to each prior reporting period presented, or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application. The Company is evaluating the impact of adopting this standard on its consolidated financial position, results of operations and cash flows.
Note 3 - Inventories

Inventories consisted of the following (in thousands):
 
February 28, 2015
 
August 31, 2014
Processed and unprocessed scrap metal
$
143,993

 
$
106,877

Semi-finished goods (billets)
7,764

 
12,920

Finished goods
65,123

 
59,039

Supplies
39,051

 
37,336

Inventories
$
255,931

 
$
216,172



10

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 4 - Goodwill

The Company tests the goodwill of each of its reporting units annually on July 1 and upon the occurrence of certain triggering events or substantive changes in circumstances that indicate that the fair value of goodwill may be impaired. In the second quarter of fiscal 2015, management identified the combination of a significant further weakening in market conditions, continued constrained supply of raw materials due to the lower price environment which negatively impacted volumes, the planned idling or closure of certain production facilities and retail stores, the Company’s recent financial performance and a decline in the Company’s market capitalization during the first half of fiscal 2015 as a triggering event requiring an interim impairment test of goodwill allocated to its reporting units. In connection with the interim impairment test performed in the second quarter of fiscal 2015, the Company used a measurement date of February 1, 2015.

For the MRB reporting unit with goodwill of $141 million as of February 1, 2015, the first step of the impairment test showed that the fair value of the MRB reporting unit was less than its carrying amount, indicating a potential impairment. Based on the second step of the impairment test, the Company concluded that no implied fair value of goodwill remained for the MRB reporting unit, resulting in an impairment of the entire carrying amount of MRB’s goodwill totaling $141 million.

For the APB reporting unit with goodwill of $176 million as of February 1, 2015, the estimated fair value of the reporting unit exceeded its carrying value by approximately 20%. The projections used in the income approach for APB took into consideration the impact of current market conditions for ferrous and nonferrous commodities, the cost of obtaining adequate supply flows of end-of-life vehicles and recent trends of self-serve parts sales. The projections assumed a recovery of operating margins from current depressed levels over a multi-year period, including the benefits from recently initiated productivity improvements and cost-saving measures, but remaining significantly below the level of operating margins experienced in fiscal years 2010 and 2011. The market-based WACC used in the income approach for APB was 10.37%. The terminal growth rate used in the discounted cash flow model was 1%. Assuming all other components of the fair value estimate were held constant, an increase in the WACC of 1.5% or more or weaker than anticipated improvements in operating margins could result in a failure of the step one quantitative impairment test for the APB reporting unit.

The Company also used a market approach based on earnings multiple data and the Company’s market capitalization to corroborate the reporting units’ valuations. The Company reconciled its market capitalization to the aggregated estimated fair value of its reporting units, including consideration of a control premium representing the estimated amount a market participant would pay to obtain a controlling interest. The implied control premium resulting from the difference between the Company's market capitalization (based on the average trading price of our Class A common stock for the two-week period ended February 1, 2015) and the higher aggregated estimated fair value of its reporting units was within the historical range of average and mean premiums observed on historical transactions within the steel-making, scrap processing and metals industries. The Company identified specific reconciling items, including market participant synergies, which supported the implied control premium as of February 1, 2015.

The determination of fair value of the reporting units used to perform the first step of the impairment test requires judgment and involves significant estimates and assumptions about the expected future cash flows and the impact of market conditions on those assumptions. Due to the inherent uncertainty associated with forming these estimates, actual results could differ from those estimates. Future events and changing market conditions may impact the Company’s assumptions as to future revenue growth rates, pace and extent of operating margin and volume recovery, market-based WACC and other factors that may result in changes in the estimates of the Company’s reporting units’ fair value. Although management believes the assumptions used in testing the Company’s reporting units’ goodwill for impairment are reasonable, it is possible that market and economic conditions could deteriorate further or not improve as expected. Additional declines in or a lack of recovery of market conditions from current levels, a trend of weaker than anticipated financial performance including the pace and extent of operating margin recovery for the APB reporting unit, a further deterioration in the Company’s share price from current levels for a sustained period of time, or an increase in the market-based WACC, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on the Company’s financial condition and results of operations.


11

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The gross changes in the carrying amount of goodwill by reporting segment for the six months ended February 28, 2015 were as follows (in thousands):
 
Metals Recycling Business
 
Auto Parts Business
 
Total
Balance as of August 31, 2014
$
146,108

 
$
179,795

 
$
325,903

Acquisitions

 
201

 
201

Foreign currency translation adjustment
(5,087
)
 
(3,264
)
 
(8,351
)
Goodwill impairment charge
(141,021
)
 

 
(141,021
)
Balance as of February 28, 2015
$

 
$
176,732

 
$
176,732


Accumulated goodwill impairment charges were $462 million and $321 million as of February 28, 2015 and August 31, 2014.

Note 5 - Short-Term Borrowings

The Company has an unsecured, uncommitted $25 million credit line with Wells Fargo Bank, N.A. As of March 1, 2015, the term of this credit facility was renewed and extended to April 1, 2016. Interest rates are set by the bank at the time of borrowing. The Company had no borrowings outstanding under this credit line as of February 28, 2015 and August 31, 2014. The credit agreement contains various representations and warranties, events of default and financial and other covenants, including covenants regarding maintenance of a minimum fixed charge ratio and a maximum leverage ratio.

Note 6 - Commitments and Contingencies

The Company evaluates the adequacy of its environmental liabilities on a quarterly basis. Adjustments to the liabilities are made when additional information becomes available that affects the estimated costs to study or remediate any environmental issues or expenditures are made for which liabilities were established.

Changes in the Company’s environmental liabilities for the six months ended February 28, 2015 were as follows (in thousands):
Reporting Segment
 
Balance as of August 31, 2014
 
Liabilities Established (Released), Net
 
Payments and Other
 
Balance as of February 28, 2015
 
Short-Term
 
Long-Term
Metals Recycling Business
 
$
30,139

 
$
178

 
$
(994
)
 
$
29,323

 
$
160

 
$
29,163

Auto Parts Business
 
17,822

 
200

 
(131
)
 
17,891

 

 
17,891

Corporate
 
388

 

 
(57
)
 
331

 
31

 
300

Total
 
$
48,349

 
$
378

 
$
(1,182
)
 
$
47,545

 
$
191

 
$
47,354


Metals Recycling Business (“MRB”)
As of February 28, 2015, MRB had environmental liabilities of $29 million for the potential remediation of locations where it has conducted business and has environmental liabilities from historical or recent activities.
 
Portland Harbor
In December 2000, the Company was notified by the United States Environmental Protection Agency (“EPA”) under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) that it is one of the potentially responsible parties (“PRPs”) that own or operate or formerly owned or operated sites which are part of or 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, but the process of identifying additional PRPs and beginning allocation of costs is underway. It is unclear to what extent the Company will be liable for environmental costs or natural resource damage claims or third party contribution or damage claims with respect to the Site. While the Company participated in certain preliminary Site study efforts, it is not party to the consent order entered into by the EPA with certain other PRPs, referred to as the “Lower Willamette Group” (“LWG”), for a remedial investigation/feasibility study (“RI/FS”).

During fiscal 2007, the Company and certain other parties agreed to an interim settlement with the LWG under which the Company made a cash contribution to the LWG RI/FS. The Company has also joined with more than 80 other PRPs, including the LWG, in

12

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

a voluntary process to establish an allocation of costs at the Site. These parties have selected an allocation team and have entered into an allocation process design agreement. The LWG has also commenced federal court litigation, which has been stayed, seeking to bring additional parties into the allocation process.

In January 2008, the Natural Resource Damages Trustee Council (“Trustees”) for Portland Harbor invited the Company and other PRPs to participate in funding and implementing the Natural Resource Injury Assessment for the Site. Following meetings among the Trustees and the PRPs, a funding and participation agreement was negotiated under which the participating PRPs agreed to fund the first phase of the natural resource damage assessment. The Company joined in that Phase I agreement and paid a portion of those costs. The Company did not participate in funding the second phase of the natural resource damage assessment.

On March 30, 2012, the LWG submitted to the EPA and made available on its website a draft feasibility study (“draft FS”) for the Site based on approximately ten years of work and $100 million in costs classified by the LWG as investigation related. The draft FS identifies ten possible remedial alternatives which range in estimated cost from approximately $170 million to $250 million (net present value) for the least costly alternative to approximately $1.08 billion to $1.76 billion (net present value) for the most costly and estimates a range of two to 28 years to implement the remedial work, depending on the selected alternative. The draft FS does not determine who is responsible for remediation costs, define the precise cleanup boundaries or select remedies. The draft FS is being revised by the EPA and the revisions may be significant and could materially impact the scope or cost of remediation. While the draft FS is an important step in the EPA’s development of a proposed plan for addressing the Site, a final decision on the nature and extent of the required remediation will occur only after the EPA has prepared a proposed plan for public review and issued a record of decision (“ROD”). Currently available information indicates that the EPA does not expect to issue its final ROD selecting a remedy for the Site until at least 2017 or commence remediation activities until 2024. Responsibility for implementing and funding the EPA’s selected remedy will be determined in a separate allocation process, which is currently underway.

Because there has not been a determination of the total cost of the investigations, 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, the Company believes it is not possible to reasonably estimate the amount or range of costs which it is likely or reasonably possible that the Company may incur in connection with the Site, although such costs could be material to the Company’s financial position, results of operations, cash flows and liquidity. Among the facts currently not known or available are detailed information on the history of ownership of and the nature of the uses of and activities and operations performed on each property within the Site, which are factors that will play a substantial role in determining the allocation of investigation and remedy costs among the PRPs. The Company has insurance policies that it believes will provide reimbursement for costs it incurs for defense and remediation in connection with the Site, although there is no assurance that those policies will cover all of the costs which the Company may incur. Further, the Company has a cost sharing arrangement under which a third party is paying 50% of costs, net of insurance recoveries. The Company previously recorded a liability for its estimated share of the costs of the investigation of $1 million.

The Oregon Department of Environmental Quality is separately providing oversight of voluntary investigations by the Company involving the Company’s sites adjacent to the Portland Harbor which are focused on controlling any current “uplands” releases of contaminants into the Willamette River. No liabilities have been established in connection with these investigations because the extent of contamination (if any) and the Company’s responsibility for the contamination (if any) has not yet been determined.

Other MRB Sites
As of February 28, 2015, the Company had environmental liabilities related to various MRB sites other than Portland Harbor of $28 million. The liabilities relate to the potential future remediation of soil contamination, groundwater contamination and storm water runoff issues and were not individually material at any site.

Auto Parts Business (“APB”)
As of February 28, 2015, the Company had environmental liabilities related to various APB sites of $18 million. The liabilities relate to the potential future remediation of soil contamination, groundwater contamination and storm water runoff issues and were not individually material at any site.

Steel Manufacturing Business (“SMB”)
SMB’s electric arc furnace generates dust (“EAF dust”) that is classified as hazardous waste by the EPA because of its zinc and lead content. As a result, the Company captures the EAF dust and ships it in specialized rail cars to a firm that applies a treatment that allows the EAF dust to be delisted as hazardous waste so it can be disposed of as a non-hazardous solid waste.


13

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SMB has an operating permit issued under Title V of the Clean Air Act Amendments of 1990, which governs certain air quality standards. The permit is based on an annual production capacity of 950 thousand tons. The permit was first issued in 1998 and has since been renewed through February 1, 2018.
 
SMB had no environmental liabilities as of February 28, 2015.

Other than the Portland Harbor Superfund site, which is discussed above, management currently believes that adequate provision has been made for the potential impact of these issues and that the ultimate outcomes will not have a material adverse effect on the Unaudited Condensed Consolidated Financial Statements of the Company as a whole. Historically, the amounts the Company has ultimately paid for such remediation activities have not been material in any given period.

In addition, the Company is party to various legal proceedings arising in the normal course of business. Management believes that adequate provisions have been made for these contingencies. The Company does not anticipate that the resolution of legal proceedings arising in the normal course of business will have a material adverse effect on its results of operations, financial condition, or cash flows.
 
Note 7 - Restructuring Charges and Other Exit-Related Costs

In the fourth quarter of fiscal 2012, the Company undertook a number of restructuring initiatives designed to extract greater synergies from the significant acquisitions and technology investments made in recent years, achieve further integration between MRB and APB, and realign the Company’s organization to support its future growth and decrease operating expenses by streamlining functions and reducing organizational layers (the “Q4'12 Plan”).

In the first quarter of fiscal 2014, the Company announced and began implementing additional restructuring initiatives to further reduce its annual operating expenses through headcount reductions, productivity improvements, procurement savings and other operational efficiencies (the “Q1'14 Plan”).

In the first quarter of fiscal 2015, the Company announced and began implementing additional productivity initiatives at APB to improve profitability through a combination of revenue drivers and cost reduction initiatives (the “Q1'15 Plan”).

At the end of the second quarter of fiscal 2015, the Company initiated additional restructuring and exit-related initiatives by undertaking strategic actions consisting of idling underutilized assets at MRB and initiating the closure of seven APB stores to more closely align the Company's business to the prevalent market conditions. The Company expanded these initiatives in April 2015 by announcing measures aimed at further reducing the Company's annual operating expenses, primarily selling, general and administrative expenses, at Corporate, MRB and APB through headcount reductions, reducing organizational layers, consolidating shared service functions and other non-headcount measures. Collectively, these initiatives are referred to as the "Q2'15 Plan."

The vast majority of the restructuring charges require the Company to make cash payments.

In addition to the restructuring charges recorded related to these initiatives, the Company incurred other exit-related costs consisting of asset impairments and accelerated depreciation due to shortened useful lives in connection with site closures.


14

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Restructuring charges and other exit-related costs were comprised of the following (in thousands):
 
Three Months Ended February 28, 2015
 
Three Months Ended February 28, 2014
 
Q1’14 Plan
 
Q1’15 Plan
 
Q2’15 Plan
 
Total Charges
 
Q4’12 Plan
 
Q1’14 Plan
 
Total Charges
Restructuring charges:
 
 
 
 
 
 
 
 
 
 
 
 
 
Severance costs
$
(57
)
 
$
428

 
$
540

 
$
911

 
$
(39
)
 
$
1,182

 
$
1,143

Contract termination costs
56

 

 
79

 
135

 
106

 
(9
)
 
97

Other restructuring costs

 
880

 
93

 
973

 

 
200

 
200

Total restructuring charges
(1
)
 
1,308

 
712

 
2,019

 
67

 
1,373

 
1,440

Other exit-related costs:
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset impairments and accelerated depreciation

 

 
6,352

 
6,352

 

 
566

 
566

Total other exit-related costs

 

 
6,352

 
6,352

 

 
566

 
566

Total restructuring charges and other exit-related costs
$
(1
)
 
$
1,308

 
$
7,064

 
$
8,371

 
$
67

 
$
1,939

 
$
2,006


 
Six Months Ended February 28, 2015
 
Six Months Ended February 28, 2014
 
Q1’14 Plan
 
Q1’15 Plan
 
Q2’15 Plan
 
Total Charges
 
Q4’12 Plan
 
Q1’14 Plan
 
Total Charges
Restructuring charges:
 
 
 
 
 
 
 
 
 
 
 
 
 
Severance costs
$
(30
)
 
$
428

 
$
540

 
$
938

 
$
(13
)
 
$
2,259

 
$
2,246

Contract termination costs
309

 

 
79

 
388

 
568

 
29

 
597

Other restructuring costs

 
1,223

 
93

 
1,316

 

 
410

 
410

Total restructuring charges
279

 
1,651

 
712

 
2,642

 
555

 
2,698

 
3,253

Other exit-related costs:
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset impairments and accelerated depreciation

 

 
6,352

 
6,352

 

 
566

 
566

Total other exit-related costs

 

 
6,352

 
6,352

 

 
566

 
566

Total restructuring charges and other exit-related costs
$
279

 
$
1,651

 
$
7,064

 
$
8,994

 
$
555

 
$
3,264

 
$
3,819

 
Total Charges
 
Q4'12 Plan
 
Q1’14 Plan
 
Q1'15 Plan
 
Q2'15 Plan
 
Total
Total restructuring charges to date
$
13,549

 
$
6,049

 
$
1,651

 
$
712

 
$
21,961

Total expected restructuring charges
$
13,549

 
$
6,100

 
$
1,651

 
$
9,900

 
$
31,200



15

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following illustrates the reconciliation of the restructuring liability by major type of costs for the six months ended February 28, 2015 (in thousands):
 
All Other Plans
 
Q2’15 Plan
 
All Plans
 
Balance 8/31/2014
 
Charges
 
Payments and Other
 
Balance 2/28/2015
 
Balance 8/31/2014
 
Charges
 
Payments and Other
 
Balance 2/28/2015
 
Total Charges to Date
 
Total Expected Charges
Severance costs
$
669

 
$
398

 
$
(1,033
)
 
$
34

 
$

 
$
540

 
$
(31
)
 
$
509

 
$
10,729

 
$
15,800

Contract termination costs
1,489

 
309

 
(813
)
 
985

 

 
79

 

 
79

 
5,441

 
8,000

Other restructuring costs

 
1,223

 
(772
)
 
451

 

 
93

 

 
93

 
5,791

 
7,400

Total
$
2,158

 
$
1,930

 
$
(2,618
)
 
$
1,470

 
$

 
$
712

 
$
(31
)
 
$
681

 
$
21,961

 
$
31,200


Due to the immateriality of the activity and liability balances for each of the Q4'12 Plan, Q1'14 Plan and Q1'15 Plan, the reconciliation of the restructuring liability is provided in aggregate.

The amounts of restructuring charges and other exit-related costs relating to each segment were as follows (in thousands):
 
Three Months Ended February 28,
 
Six Months Ended February 28,
 
Total Charges
to Date
 
Total Expected Charges
 
2015
 
2014
 
2015
 
2014
 
 
Restructuring charges:
 
 
 
 
 
 
 
 
 
 
 
Metals Recycling Business
$
322

 
$
860

 
$
577

 
$
2,152

 
$
9,256

 
$
11,300

Auto Parts Business
1,634

 
435

 
2,008

 
496

 
3,537

 
8,500

Unallocated (Corporate)
63

 
145

 
57

 
605

 
9,168

 
11,400

Total restructuring charges
2,019

 
1,440

 
2,642

 
3,253

 
21,961

 
31,200

Other exit-related costs:
 
 
 
 
 
 
 
 
 
 
 
Metals Recycling Business
3,235

 
566

 
3,235

 
566

 
3,801

 
 
Auto Parts Business
3,117

 

 
3,117

 

 
3,117

 
 
Total other exit-related costs
6,352

 
566

 
6,352

 
566

 
6,918

 


Total restructuring charges and other exit-related costs
$
8,371

 
$
2,006

 
$
8,994

 
$
3,819

 
$
28,879

 


The Company does not allocate restructuring charges and other exit-related costs to the segments’ operating results because management does not include this information in its measurement of the performance of the operating segments.

16

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 8 - Changes in Equity
 
The following is a summary of the changes in equity for the six months ended February 28, 2015 and 2014 (in thousands):
 
Fiscal 2015
 
Fiscal 2014
 
SSI Shareholders’
Equity
 
Noncontrolling
Interests
 
Total
Equity
 
SSI Shareholders’
Equity
 
Noncontrolling
Interests
 
Total
Equity
Balance - September 1 (Beginning of period)
$
770,784

 
$
5,193

 
$
775,977

 
$
776,558

 
$
4,641

 
$
781,199

Net income (loss)
(198,115
)
 
631

 
(197,484
)
 
(4,440
)
 
1,712

 
(2,728
)
Other comprehensive loss, net of tax
(23,507
)
 

 
(23,507
)
 
(6,598
)
 

 
(6,598
)
Distributions to noncontrolling interests

 
(1,585
)
 
(1,585
)
 

 
(1,072
)
 
(1,072
)
Restricted stock withheld for taxes
(1,360
)
 

 
(1,360
)
 
(676
)
 

 
(676
)
Stock options exercised

 

 

 
240

 

 
240

Share-based compensation
4,300

 

 
4,300

 
7,180

 

 
7,180

Excess tax deficiency from stock options exercised and restricted stock units vested
(704
)
 

 
(704
)
 
(674
)
 

 
(674
)
Dividends
(10,298
)
 

 
(10,298
)
 
(10,094
)
 

 
(10,094
)
Balance - February 28 (End of period)
$
541,100

 
$
4,239

 
$
545,339

 
$
761,496

 
$
5,281

 
$
766,777


Note 9 - Accumulated Other Comprehensive Loss

Changes in accumulated other comprehensive loss, net of tax, were comprised of the following (in thousands):
 
Three Months Ended February 28, 2015
 
Three Months Ended February 28, 2014
 
Foreign Currency Translation Adjustments
 
Pension Obligations, net
 
Net Unrealized Gain (Loss) on Cash Flow Hedges
 
Total
 
Foreign Currency Translation Adjustments
 
Pension Obligations, net
 
Net Unrealized Gain (Loss) on Cash Flow Hedges
 
Total
Balances - December 1 (Beginning of period)
$
(17,935
)
 
$
(2,000
)
 
$
(850
)
 
$
(20,785
)
 
$
(7,314
)
 
$
(2,773
)
 
$

 
$
(10,087
)
Other comprehensive loss before reclassifications
(12,601
)
 

 
(3,424
)
 
(16,025
)
 
(5,688
)
 

 
(305
)
 
(5,993
)
Income tax benefit

 

 

 

 

 

 
76

 
76

Other comprehensive loss before reclassifications, net of tax
(12,601
)
 

 
(3,424
)
 
(16,025
)
 
(5,688
)
 

 
(229
)
 
(5,917
)
Amounts reclassified from accumulated other comprehensive loss

 
38

 
853

 
891

 

 
71

 

 
71

Income tax benefit

 
(15
)
 
(214
)
 
(229
)
 

 
(26
)
 

 
(26
)
Amounts reclassified from accumulated other comprehensive loss, net of tax

 
23

 
639

 
662

 

 
45

 

 
45

Net periodic other comprehensive income (loss)
(12,601
)
 
23

 
(2,785
)
 
(15,363
)
 
(5,688
)
 
45

 
(229
)
 
(5,872
)
Balances - February 28 (End of period)
$
(30,536
)
 
$
(1,977
)
 
$
(3,635
)
 
$
(36,148
)
 
$
(13,002
)
 
$
(2,728
)
 
$
(229
)
 
$
(15,959
)

17

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


 
Six Months Ended February 28, 2015
 
Six Months Ended February 28, 2014
 
Foreign Currency Translation Adjustments
 
Pension Obligations, net
 
Net Unrealized Gain (Loss) on Cash Flow Hedges
 
Total
 
Foreign Currency Translation Adjustments
 
Pension Obligations, net
 
Net Unrealized Gain (Loss) on Cash Flow Hedges
 
Total
Balances - September 1 (Beginning of period)
$
(10,663
)
 
$
(2,036
)
 
$
58

 
$
(12,641
)
 
$
(6,423
)
 
$
(2,817
)
 
$
(121
)
 
$
(9,361
)
Other comprehensive loss before reclassifications
(19,873
)
 

 
(5,136
)
 
(25,009
)
 
(6,579
)
 

 
(305
)
 
(6,884
)
Income tax benefit

 

 
428

 
428

 

 

 
76

 
76

Other comprehensive loss before reclassifications, net of tax
(19,873
)
 

 
(4,708
)
 
(24,581
)
 
(6,579
)
 

 
(229
)
 
(6,808
)
Amounts reclassified from accumulated other comprehensive loss

 
87

 
1,354

 
1,441

 

 
140

 
98

 
238

Income tax (benefit) expense

 
(28
)
 
(339
)
 
(367
)
 

 
(51
)
 
23

 
(28
)
Amounts reclassified from accumulated other comprehensive loss, net of tax

 
59

 
1,015

 
1,074

 

 
89

 
121

 
210

Net periodic other comprehensive income (loss)
(19,873
)
 
59

 
(3,693
)
 
(23,507
)
 
(6,579
)
 
89

 
(108
)
 
(6,598
)
Balances - February 28 (End of period)
$
(30,536
)
 
$
(1,977
)
 
$
(3,635
)
 
$
(36,148
)
 
$
(13,002
)
 
$
(2,728
)
 
$
(229
)
 
$
(15,959
)

Reclassifications from accumulated other comprehensive loss, both individually and in the aggregate, were immaterial to the impacted captions in the Unaudited Condensed Consolidated Statements of Operations.

Note 10 - Fair Value Measurements

The following table presents information about the Company’s assets and liabilities measured at fair value as of February 28, 2015 and August 31, 2014, and indicates the fair value hierarchy of the valuation techniques utilized by the Company and the type of measurement.
(in thousands)
Assets (Liabilities) at Fair Value
 
Fair Value Measurement Level
 
Type of Measurement
 
Balance Sheet Classification
 
February 28, 2015
 
August 31, 2014
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
Assets held for sale
$
2,839

 
$

 
Level 3
 
Non-recurring
 
Prepaid expenses and other current assets
Foreign currency exchange forward contracts
12

 
202

 
Level 2
 
Recurring
 
Prepaid expenses and other current assets
Total assets
$
2,851

 
$
202

 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Foreign currency exchange forward contracts
$
(3,653
)
 
$
(46
)
 
Level 2
 
Recurring
 
Other accrued liabilities
Total liabilities
$
(3,653
)
 
$
(46
)
 
 
 
 
 
 

Note 11 - Derivative Financial Instruments

The Company entered into a series of foreign currency exchange forward contracts to sell U.S. dollars in order to hedge a portion of its exposure to fluctuating rates of exchange on anticipated U.S. dollar-denominated sales by its Canadian subsidiary with a functional currency of the Canadian dollar. The Company utilized intercompany foreign currency derivatives and offsetting derivatives with external counterparties in order to designate the intercompany derivatives as hedging instruments. Once the U.S. dollar-denominated sales have been recognized and the corresponding receivables collected, the Company utilized foreign currency

18

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

exchange forward contracts to sell Canadian dollars, achieving a result similar to net settling the contracts to sell U.S. dollars. The foreign currency exchange forward contracts to sell Canadian dollars are not designated as hedging instruments.
As of February 28, 2015, the Company had foreign currency exchange forward contracts with external counterparties to buy Canadian Dollars for a total notional amount of $35 million, which have various settlement dates through September 30, 2015, and foreign currency exchange forward contracts with external counterparties to sell Canadian Dollars for a total notional amount of $4 million, all of which have a settlement date of March 31, 2015. The contracts with external counterparties are reported at fair value in the Unaudited Condensed Consolidated Balance Sheets measured using quoted foreign currency exchange rates.

The fair value of derivative instruments in the Unaudited Condensed Consolidated Balance Sheets is as follows (in thousands):
 
Asset (Liability) Derivatives
 
Balance Sheet Location
 
February 28, 2015
 
August 31, 2014
Foreign currency exchange forward contracts
Prepaid expenses and other current assets
 
$
12

 
$
202

Foreign currency exchange forward contracts
Other accrued liabilities
 
$
(3,653
)
 
$
(46
)

The results of foreign currency exchange derivatives are comprised of the following (in thousands):
 
Derivative Gain (Loss) Recognized
 
Three Months Ended February 28, 2015
 
Three Months Ended February 28, 2014
 
Other Comprehensive Income (Loss)
 
Revenues - Effective Portion
 
Other Income (Expense), net
 
Other Comprehensive Income (Loss)
 
Revenues - Effective Portion
 
Other Income (Expense), net
Foreign currency exchange forward contracts - designated as cash flow hedges
$
(3,424
)
 
$
(853
)
 
$
121

 
$
(229
)
 
$

 
$

Foreign currency exchange forward contracts - not designated as cash flow hedges
$

 
$

 
$
(117
)
 
$

 
$

 
$


 
Derivative Gain (Loss) Recognized
 
Six Months Ended February 28, 2015
 
Six Months Ended February 28, 2014
 
Other Comprehensive Income (Loss)
 
Revenues - Effective Portion
 
Other Income (Expense), net
 
Other Comprehensive Income (Loss)
 
Revenues - Effective Portion
 
Other Income (Expense), net
Foreign currency exchange forward contracts - designated as cash flow hedges
$
(5,136
)
 
$
(1,354
)
 
$
175

 
$
(229
)
 
$

 
$

Foreign currency exchange forward contracts - not designated as cash flow hedges
$

 
$

 
$
(122
)
 
$

 
$

 
$


There was no hedge ineffectiveness with respect to the forward currency exchange cash flow hedges for the three and six months ended February 28, 2015 and 2014.

Note 12 - Share-Based Compensation

In the first quarter of fiscal 2015, as part of the annual awards under the Company’s Long-Term Incentive Plan, the Compensation Committee of the Company's Board of Directors granted 268,988 restricted stock units (“RSUs”) and 268,988 performance share awards to the Company's key employees and officers under the Company’s 1993 Amended and Restated Stock Incentive Plan.

The RSUs have a five-year term and vest 20% per year commencing October 31, 2015. The fair value of the RSUs granted was based on the market closing price of the underlying Class A common stock on the grant date and totaled $6 million. The compensation expense associated with the RSUs is recognized over the requisite service period of the awards, net of forfeitures.

19

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


The performance-based awards have a two-year performance period consisting of the Company’s fiscal 2015 and fiscal 2016. The performance targets are based on the Company's EBITDA (weighted at 50%) and return on equity (weighted at 50%) for the two years of the performance period, with award payouts ranging from a threshold of 50% to a maximum of 200% for each portion of the awards. Awards will be paid in Class A common stock as soon as practicable after October 31 following the end of the performance period. The estimated fair value of the performance-based awards at the date of grant was $6 million.

In the second quarter of fiscal 2015, the Company granted deferred stock units ("DSU") to each of its non-employee directors under the Company's 1993 Stock Incentive Plan. John Carter, the Company's Chairman, and Tamara Lundgren, President and Chief Executive Officer, receive compensation pursuant to their employment agreements and do not receive DSUs. Each DSU gives the director the right to receive one share of Class A common stock at a future date. The grant included an aggregate of 43,347 shares that will vest on the day before the Company's 2016 annual meeting, subject to continued Board service. The total value of these awards is not material.

Note 13 - Income Taxes

The effective tax rate for the Company’s operations for each of the three and six months ended February 28, 2015 was a benefit of 4.7%, compared to an expense of 27.2% and 8.0%, respectively, for the three and six months ended February 28, 2014.

A reconciliation of the difference between the federal statutory rate and the Company’s effective rate is as follows:
 
Three Months Ended February 28,
 
Six Months Ended February 28,
 
2015(1)
 
2014
 
2015(1)
 
2014(1)
Federal statutory rate
35.0
 %
 
35.0
 %
 
35.0
 %
 
35.0
 %
State taxes, net of credits
1.1

 
0.5

 
1.1

 
5.5

Foreign income taxed at different rates
(7.4
)
 
1.7

 
(7.5
)
 
(18.2
)
Section 199 deduction

 
(1.9
)
 

 
0.3

Non-deductible officers’ compensation
(0.1
)
 
0.7

 
(0.1
)
 
(0.3
)
Noncontrolling interests
0.5

 
(2.3
)
 
0.5

 
1.1

Research and development credits
0.1

 
(0.3
)
 
0.1

 
0.3

Valuation allowance on deferred tax assets
(20.6
)
 
(8.5
)
 
(20.5
)
 
(29.3
)
Non-deductible goodwill
(2.8
)
 

 
(2.7
)
 

Unrecognized tax benefits
(0.5
)
 
1.4

 
(0.5
)
 
(2.0
)
Other
(0.6
)
 
0.9

 
(0.7
)
 
(0.4
)
Effective tax rate
4.7
 %
 
27.2
 %
 
4.7
 %
 
(8.0
)%
_____________________________
(1)
For periods with reported pre-tax losses, the effect of reconciling items with positive signs is tax benefit in excess of the benefit calculated by applying the federal statutory rate to the pre-tax loss.

The effective tax rate for the second quarter and first six months of fiscal 2015 was impacted primarily by the recognition of valuation allowances of $42 million on current period benefits in multiple taxing jurisdictions and the impact of the lower financial performance of foreign operations, which are taxed at more favorable rates. The deferred tax assets for which a valuation allowance was recorded were related primarily to deductible temporary differences created in the second quarter by the impairment charges to goodwill and other assets.
The Company recorded a valuation allowance on substantially all of its deferred tax assets as of February 28, 2015. The valuation allowance was recognized as a result of negative evidence, including recent losses, outweighing the more subjective positive evidence, indicating that it is more likely than not that the associated tax benefit will not be realized. Realization of deferred tax assets is dependent upon the Company generating a consistent trend of profitability to objectively forecast sufficient taxable income in multiple tax jurisdictions in future years to obtain benefit from the reversal of net deductible temporary differences and from utilization of net operating losses.
The effective tax rate for the first six months of fiscal 2014 was impacted primarily by the recognition of a full valuation allowance on the current period benefit associated with foreign operations losses and the impact of the lower financial performance of foreign operations, which are tax at more favorable rates. The effective tax rate for the second quarter of fiscal 2014 benefited primarily

20

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

from the partial realization of previously reserved tax benefits in the foreign jurisdiction as a result of taxable income generated during the period.
The Company files federal and state income tax returns in the U.S. and foreign tax returns in Puerto Rico and Canada. For U.S. federal income tax returns, fiscal years 2011 to 2014 remain subject to examination. At this time, the Company is not under examination in any of its taxing jurisdictions.

Note 14 - Net Income (Loss) Per Share

The following table sets forth the information used to compute basic and diluted net income (loss) per share attributable to SSI (in thousands):
 
Three Months Ended February 28,
 
Six Months Ended February 28,
  
2015
 
2014
 
2015
 
2014
Net income (loss)
$
(195,882
)
 
$
2,640

 
$
(197,484
)
 
$
(2,728
)
Net (income) loss attributable to noncontrolling interests
240

 
(851
)
 
(631
)
 
(1,712
)
Net income (loss) attributable to SSI
$
(195,642
)
 
$
1,789

 
$
(198,115
)
 
$
(4,440
)
Computation of shares:
 
 
 
 
 
 
 
Weighted average common shares outstanding, basic
27,020

 
26,825

 
26,982

 
26,790

Incremental common shares attributable to dilutive stock options, performance share awards, DSUs and RSUs

 
122

 

 

Weighted average common shares outstanding, diluted
27,020

 
26,947

 
26,982

 
26,790

 
Common stock equivalent shares of 1,365,274 were considered antidilutive and were excluded from the calculation of diluted net loss per share for each of the three and six months ended February 28, 2015, compared to the 591,662 and 1,175,976 common stock equivalent shares for the three and six ended February 28, 2014.

Note 15 - Related Party Transactions

The Company purchases recycled metal from its joint venture operations at prices that approximate fair market value. These purchases totaled $6 million and $7 million for the three months ended February 28, 2015 and 2014, respectively, and $13 million and $14 million for the six months ended February 28, 2015 and 2014, respectively. Amounts receivable from joint venture partners were zero and $1 million as of February 28, 2015 and August 31, 2014, respectively.

Thomas D. Klauer, Jr., who had been President of the Company’s Auto Parts Business prior to his retirement on January 5, 2015, is the sole shareholder of a corporation that is the 25% minority partner in a partnership in which the Company is the 75% partner and which operates five self-service stores in Northern California. Mr. Klauer’s 25% share of the profits, through the date of his retirement, of this partnership totaled less than $1 million and $1 million for the three and six months ended February 28, 2015, respectively, and less than $1 million and $1 million for the three and six months ended February 28, 2014, respectively. The partnership leases properties from entities in which Mr. Klauer has ownership interests under agreements that expire in March 2016 with options to renew the leases, upon expiration, for multiple periods. The rent paid by the partnership, through the date of his retirement, to the entities in which Mr. Klauer has ownership interests was less than $1 million for each of the three and six months ended February 28, 2015, and less than $1 million for each of the three and six months ended February 28, 2014.

Note 16 - Segment Information

The accounting standards for reporting information about operating segments define operating segments as components of an enterprise that engages in business activities from which it may earn revenues and incur expenses and for which discrete financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the Chief Executive Officer. The Company is organized by line of business. While the Chief Executive Officer evaluates results in a number of different ways, the line of business management structure is the primary basis for which the allocation of resources and financial results are assessed. Under the aforementioned criteria, the Company operates in three operating and reporting segments: metal purchasing, processing, recycling

21

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

and selling (MRB), used auto parts (APB) and mini-mill steel manufacturing (SMB). Additionally, the Company is a noncontrolling partner in joint ventures, which are either in the metals recycling business or are suppliers of unprocessed metal.

MRB buys and processes ferrous and nonferrous metal for sale to foreign and other domestic steel producers or their representatives and to SMB. MRB also purchases ferrous metal from other processors for shipment directly to SMB.

APB purchases used and salvaged vehicles, sells parts from those vehicles through its retail facilities and wholesale operations, and sells the remaining portion of the vehicles to metal recyclers, including MRB.

SMB operates a steel mini-mill that produces a wide range of finished steel products using recycled metal and other raw materials.

Intersegment sales from MRB to SMB are made at rates that approximate market prices for shipments from the West Coast of the U.S. In addition, the Company has intersegment sales of autobodies from APB to MRB at rates that approximate market prices. These intercompany sales tend to produce intercompany profits which are not recognized until the finished products are ultimately sold to third parties.

The information provided below is obtained from internal information that is provided to the Company’s chief operating decision maker for the purpose of corporate management. The Company uses operating income to measure segment performance. The Company does not allocate corporate interest income and expense, income taxes, other income and expenses related to corporate activity or corporate expense for management and administrative services that benefit all three segments. In addition, the Company does not allocate restructuring charges and other exit-related costs to the segment operating income because management does not include this information in its measurement of the performance of the operating segments. Because of this unallocated income and expense, the operating income of each reporting segment does not reflect the operating income the reporting segment would report as a stand-alone business.

The table below illustrates the Company’s operating results by reporting segment (in thousands):
 
Three Months Ended February 28,
 
Six Months Ended February 28,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Metals Recycling Business:
 
 
 
 
 
 
 
Revenues
$
340,543

 
$
535,690

 
$
796,820

 
$
1,025,999

Less: Intersegment revenues
(44,728
)
 
(45,140
)
 
(100,009
)
 
(94,893
)
MRB external customer revenues
295,815

 
490,550

 
696,811

 
931,106

Auto Parts Business:
 
 
 
 
 
 
 
Revenues
69,135

 
76,360

 
150,056

 
155,995

Less: Intersegment revenues
(18,844
)
 
(22,219
)
 
(40,389
)
 
(42,790
)
APB external customer revenues
50,291

 
54,141

 
109,667

 
113,205

Steel Manufacturing Business:
 
 
 
 
 
 
 
Revenues
93,126

 
81,456

 
188,344

 
169,580

Total revenues
$
439,232

 
$
626,147

 
$
994,822

 
$
1,213,891



22

SCHNITZER STEEL INDUSTRIES, INC.
 
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The table below illustrates the reconciliation of the Company’s segment operating income (loss) to income (loss) before income taxes (in thousands):
 
Three Months Ended February 28,
 
Six Months Ended February 28,
 
2015
 
2014
 
2015
 
2014
Metals Recycling Business
$
(186,679
)
 
$
10,605

 
$
(184,757
)
 
$