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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended February 28, 2003
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 or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3200 N.W. Yeon Ave.
P.O Box 10047
Portland, OR 97296-0047
------------- ----------
(Address of principal executive offices) (Zip Code)
(503) 224-9900
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The Registrant had 5,071,311 shares of Class A Common Stock, par value of $1.00
per share, and 4,144,858 shares of Class B Common Stock, par value of $1.00 per
share, outstanding at April 1, 2003.
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SCHNITZER STEEL INDUSTRIES, INC.
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Consolidated Balance Sheet at February 28, 2003
and August 31, 2002.....................................................3
Consolidated Statement of Operations for the
Three Months and Six Months Ended February 28, 2003 and 2002 ...........4
Consolidated Statement of Shareholders' Equity for the
Year Ended August 31, 2002 and the Six Months
Ended February 28, 2003.................................................5
Consolidated Statement of Cash Flows for the
Six Months Ended February 28, 2003 and 2002.............................6
Notes to Consolidated Financial Statements..................................7
Management's Discussion and Analysis of
Financial Condition and Results of Operations...........................15
Quantitative and Qualitative Disclosures about Market Risk.................27
Controls and Procedures....................................................27
PART II. OTHER INFORMATION
Submission of Matters to a Vote of Security Holders........................28
Exhibits and Reports on Form 8-K...........................................29
SIGNATURE PAGE.............................................................30
CERTIFICATIONS.............................................................31
2
SCHNITZER STEEL INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
Feb. 28, Aug. 31,
2003 2002
-------- --------
(Unaudited) (Audited)
ASSETS
- ------
Current Assets:
Cash $ 3,595 $ 32,974
Accounts receivable, less allowance for
doubtful accounts of $780 and $905 35,513 33,516
Accounts receivable from related parties 686 813
Inventories (Note 2) 67,045 57,917
Deferred income taxes 4,115 3,966
Prepaid expenses and other 2,766 2,521
-------- --------
Total current assets 113,720 131,707
Net property, plant and equipment 141,811 111,759
Other assets:
Investment in and advances to joint venture partnerships 101,898 96,440
Notes receivables less current portion 2,027 27,067
Goodwill 106,970 35,754
Other 2,291 2,279
-------- --------
TOTAL ASSETS $468,717 $405,006
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current portion of long-term debt $102,620 $ 60,220
Accounts payable 21,556 18,205
Accrued payroll liabilities 5,317 5,887
Current portion of environmental liabilities 3,028 3,030
Other accrued liabilities 8,200 5,014
-------- --------
Total current liabilities 140,721 92,356
Deferred income taxes 30,859 30,860
Long-term debt less current portion 8,153 8,305
Environmental liabilities, net of current portion 19,561 18,045
Other long-term liabilities 3,173 2,492
Minority interests 2,874 --
Commitments and contingencies -- --
Shareholders' equity:
Preferred stock--20,000 shares authorized, none issued -- --
Class A common stock--75,000 shares $1 par value
authorized, 5,028 and 5,025 shares issued and outstanding 5,028 5,025
Class B common stock--25,000 shares $1 par value
authorized, 4,180 shares issued and outstanding 4,180 4,180
Additional paid-in capital 96,117 96,074
Retained earnings 158,051 147,669
-------- --------
Total shareholders' equity 263,376 252,948
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $468,717 $405,006
======== ========
The accompanying notes are an integral part of this statement.
3
SCHNITZER STEEL INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited, in thousands, except per share amounts)
For The Three Months Ended For The Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
--------- --------- --------- ---------
Revenues $ 124,659 $ 78,362 $ 215,326 $ 155,196
--------- --------- --------- ---------
Costs and expenses:
Cost of goods sold and
other operating expenses 103,636 74,570 177,794 146,081
Impairment and other non-recurring charges 2,100 2,260 2,100 2,260
Selling and commission expenses 873 709 1,636 1,373
General and administrative expenses 11,132 6,289 21,341 12,308
--------- --------- --------- ---------
Income (loss) from consolidated operations 6,918 (5,466) 12,455 (6,826)
Income from joint ventures 6,194 4,323 9,369 9,194
--------- --------- --------- ---------
Income (loss) from operations 13,112 (1,143) 21,824 2,368
--------- --------- --------- ---------
Other income (expense):
Interest expense (310) (558) (690) (1,335)
Other income 158 18 17 204
--------- --------- --------- ---------
(152) (540) (673) (1,131)
--------- --------- --------- ---------
Income (loss) before cumulative effect of change
in accounting principle, income taxes,
minority interests and pre-acquisition interests 12,960 (1,683) 21,151 1,237
Income tax (provision) benefit (3,502) 629 (5,517) (247)
--------- --------- --------- ---------
Income (loss) before cumulative effect of change
in accounting principle, minority interests and
pre-acquisition interests 9,458 (1,054) 15,634 990
Minority interests, net of tax (354) -- (801) --
Pre-acquisition interests, net of tax (695) -- (2,547) --
--------- --------- --------- ---------
Income (loss) before cumulative effect of change
in accounting principle 8,409 (1,054) 12,286 990
Cumulative effect of change in accounting principle -- -- (983) --
--------- --------- --------- ---------
Net income (loss) $ 8,409 $ (1,054) $ 11,303 $ 990
========= ========= ========= =========
Net income (loss) per share - basic:
Income (loss) before cumulative effect of change
in accounting principle $ 0.91 $ (0.12) $ 1.33 $ 0.11
Cumulative effect of change in accounting principle -- -- (0.10) --
--------- --------- --------- ---------
Net income (loss) $ 0.91 $ (0.12) $ 1.23 $ 0.11
========= ========= ========= =========
Net income (loss) per share - diluted:
Income (loss) before cumulative effect of change
in accounting principle $ 0.89 $ (0.12) $ 1.31 $ 0.11
Cumulative effect of change in accounting principle -- -- (0.11) --
--------- --------- --------- ---------
Net income (loss) $ 0.89 $ (0.12) $ 1.20 $ 0.11
========= ========= ========= =========
The accompanying notes are an integral part of this statement.
4
SCHNITZER STEEL INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Unaudited, in thousands)
Class A Class B
Common Stock Common Stock Additional
---------------------- ---------------------- Paid-in Retained
Shares Amount Shares Amount Capital Earnings Total
-------- -------- -------- -------- -------- -------- --------
Balance at August 31, 2001 4,896 $ 4,896 4,304 $ 4,304 $ 95,923 $142,946 $248,069
Class B common stock converted
to Class A common stock 124 124 (124) (124) --
Class A common stock repurchased (99) (99) (1,157) (1,256)
Class A common stock issued 104 104 1,308 1,412
Net income 6,553 6,553
Dividends paid (1,830) (1,830)
-------- -------- -------- -------- -------- -------- --------
Balance at August 31, 2002 5,025 5,025 4,180 4,180 96,074 147,669 252,948
Class A common stock issued 3 3 43 46
Net income 11,303 11,303
Dividends paid (921) (921)
-------- -------- -------- -------- -------- -------- --------
Balance at February 28, 2003 5,028 $ 5,028 4,180 $ 4,180 $ 96,117 $158,051 $263,376
======== ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of this statement.
5
SCHNITZER STEEL INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited, in thousands)
For The Six Months Ended
Feb. 28, Feb. 28,
2003 2002
-------- --------
Operations:
Net income $ 11,303 $ 990
Noncash items included in income:
Cumulative effect in accounting principle change 983 --
Depreciation and amortization 9,918 9,423
Minority and pre-acquisition interests 4,524 --
Equity in income of joint ventures (9,369) (9,194)
Deferred income taxes (34) (1,392)
Loss on disposal of assets 18 854
Cash provided (used) by changes in working capital:
Accounts receivable (1,496) (323)
Inventories (7,142) 11,378
Prepaid expenses (1,666) (1,329)
Accounts payable 2,821 2,604
Accrued liabilities (67) (2,562)
Environmental liabilities 1,414 1,994
Other assets and liabilities 1,240 (690)
-------- --------
Net cash provided by operations 12,447 11,753
-------- --------
Investing:
Capital expenditures (10,121) (4,418)
Investments in subsidiaries (64,923) --
Cash received from joint ventures 233 96,128
Cash used by joint ventures (945) (83,063)
Proceeds from sale of assets 577 22
-------- --------
Net cash provided (used) by investments (75,179) 8,669
-------- --------
Financing:
Repurchase of Class A common stock -- (1,256)
Issuance of Class A common stock 46 282
Distributions to minority and pre-acquisition interests (3,620) --
Dividends declared and paid (921) (914)
Increase (decrease) in long-term debt 37,848 (5,816)
-------- --------
Net cash provided (used) by financing 33,353 (7,704)
-------- --------
Net increase (decrease) in cash (29,379) 12,718
Cash at beginning of period 32,974 1,877
-------- --------
Cash at end of period $ 3,595 $ 14,595
======== ========
The accompanying notes are an integral part of this statement.
6
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2003 AND 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
- ---------------------
The accompanying unaudited interim financial statements of Schnitzer Steel
Industries, Inc. (the Company) have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). Certain information
and note disclosures normally included in annual financial statements have been
condensed or omitted pursuant to those rules and regulations. In the opinion of
management, all adjustments, consisting only of normal, recurring adjustments
considered necessary for a fair presentation, have been included. Although
management believes that the disclosures made are adequate to ensure that the
information presented is not misleading, management suggests that these
financial statements be read in conjunction with the financial statements and
notes thereto included in the Company's annual report for the fiscal year ended
August 31, 2002. The results for the three and six months ended February 28,
2003 and 2002 are not necessarily indicative of the results of operations for
the entire year.
Note 3 of the Notes to the Consolidated Financial Statements describes an
acquisition that occurred on February 14, 2003. Under Statement of Financial
Accounting Standards No. 141 ("SFAS 141"), "Business Combinations," the
acquisition is considered a "step" acquisition due to the fact that the Company
had a significant joint venture interest in the acquired business for a number
of years. Additionally, since the acquisition occurred during the year, the
Company elected to include it in the consolidated results as though it had
occurred at the beginning of fiscal 2003. Thus, the 2003 statement of
operations, balance sheet, and statement of cash flows have been adjusted to
consolidate the acquisition as of September 1, 2002. Also, the acquired
businesses were consolidated with the Company's previous interest in the
business to form a separate reporting segment called the Auto Parts Business. As
such, the financial statement information that was reported in the Company's
Form 10-Q for the quarter ended November 30, 2002 has been restated.
Additionally, consolidation accounting requires the Company to adjust its
earnings for the ownership interests it did not own during the reporting period.
During the three and six month periods ended February 28, 2003, net income was
reduced by $0.4 million and $0.8 million of minority interests, respectively,
net of income taxes, representing the share of income attributable to various
continuing minority partners of the business. Also, during the most recent
quarter and six month period, net income was reduced by $0.7 million and $2.5
million of pre-acquisition interests, respectively, net of income taxes,
representing the share of income attributable to the former joint venture
partner prior to the acquisition. The financial results of the acquired business
for periods prior to fiscal 2003 continue to be accounted for using the equity
method and are included in the joint venture businesses reporting segment.
RECLASSIFICATIONS
- -----------------
Certain prior year amounts have been reclassified to conform to fiscal 2003
presentation. These changes had no impact on previously reported results of
operations or shareholders' equity.
EARNINGS AND DIVIDENDS PER SHARE
- --------------------------------
Basic earnings per share (EPS) are computed based upon the weighted average
number of common shares outstanding during the period. Diluted EPS reflect the
potential dilution that would occur if securities or other contracts to issue
common stock were exercised or converted into common stock.
7
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2003 AND 2002
The following represents reconciliation from basic EPS to diluted EPS (in
thousands, except per share amounts):
For the Three Months Ended For the Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
---------- ---------- ---------- ----------
(Unaudited)
Income (loss) before cumulative effect
of change in accounting principle $ 8,409 $ (1,054) $ 12,286 $ 990
Cumulative effect of change in accounting
principle -- -- (983) --
---------- ---------- ---------- ----------
Net income (loss) $ 8,409 $ (1,054) $ 11,303 $ 990
========== ========== ========== ==========
Computation of shares:
Average common shares outstanding 9,206 9,112 9,205 9,137
Stock options 247 -- 198 39
---------- ---------- ---------- ----------
Diluted average common shares outstanding 9,453 9,112 9,403 9,176
========== ========== ========== ==========
Basic EPS:
Income (loss) before cumulative effect
of change in accounting principle $ 0.91 $ (0.12) $ 1.33 $ 0.11
Cumulative effect of change in accounting
principle -- -- (0.10) --
---------- ---------- ---------- ----------
Net income (loss) $ 0.91 $ (0.12) $ 1.23 $ 0.11
========== ========== ========== ==========
Diluted EPS:
Income (loss) before cumulative effect
of change in accounting principle $ 0.89 $ (0.12) $ 1.31 $ 0.11
Cumulative effect of change in accounting
principle -- -- (0.11) --
---------- ---------- ---------- ----------
Net income (loss) $ 0.89 $ (0.12) $ 1.20 $ 0.11
========== ========== ========== ==========
Dividend per share $ 0.05 $ 0.05 $ 0.10 $ 0.10
========== ========== ========== ==========
Options to purchase 435,000 and 1,181,000 shares were outstanding at February
28, 2003 and 2002 respectively, but not included in the computation of diluted
earnings per share because the options' exercise prices were greater than the
average market price of the common shares and, therefore, the effect would be
anti-dilutive.
GOODWILL & INTANGIBLE ASSETS:
- -----------------------------
In July 2001, the Financial Accounting Standards Board (FASB) issued Statements
of Financial Accounting Standards Nos. 141 and 142 (SFAS 141 and SFAS 142),
"Business Combinations" and "Goodwill and Other Intangible Assets." SFAS 141
replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It
also provides guidance on purchase accounting related to the recognition of
intangible assets and accounting for negative goodwill. Effective September 1,
2002, the Company adopted SFAS 142. This statement changed the accounting for
goodwill and indefinite-lived intangible assets from an amortization approach to
an impairment-only approach. As required under the transitional accounting
provisions of SFAS 142, the Company completed steps during the second quarter of
fiscal 2003 to identify and measure goodwill impairment at its two reporting
units, which existed at the time of adoption, the Metals Recycling Business and
the Steel Manufacturing Business. The reporting units were measured for
impairment by comparing implied fair value of the reporting units' goodwill with
the carrying amount of the goodwill. Historical earnings were used as a basis to
project future earnings to determine whether any impairment of goodwill existed
at the reporting units. As a result of this evaluation, the Company determined
that goodwill associated with its Steel Manufacturing Business was impaired. The
Company recorded a non-cash impairment charge for the entire $983,000 of
remaining goodwill,
8
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2003 AND 2002
effective September 1, 2002, and reported it as a "Cumulative effect of change
in accounting principle" on the Consolidated Statement of Operations. The
goodwill was not deductible for tax purposes, thus the amount was not tax
affected. The implementation of SFAS 142 required the use of judgments,
estimates and assumptions in the determination of fair value and impairment
amounts related to the required testing. Prior to adoption of SFAS 142, the
Company had historically evaluated goodwill for impairment by comparing the
entity level unamortized balance of goodwill to projected undiscounted cash
flows, which did not result in an indicated impairment. In the future, the
Company will perform impairments tests annually and whenever events and
circumstances indicate that the value of goodwill and other indefinite-lived
intangible assets might be impaired.
The following table presents a reconciliation of reported net income and income
per share, as if SFAS 142 had been in effect (in thousands, except per share
amounts):
For the Three Months Ended For the Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
---------- ---------- ---------- ----------
(Unaudited)
Reported net income $ 8,409 $ (1,054) $ 11,303 $ 990
Goodwill amortization, net of tax: -- 319 -- 660
---------- ---------- ---------- ----------
Adjusted net income $ 8,409 $ (735) $ 11,303 $ 1,650
========== ========== ========== ==========
Reported basic income per share $ 0.91 $ (0.12) $ 1.23 $ 0.11
Goodwill amortization, net of tax: -- 0.04 -- 0.07
---------- ---------- ---------- ----------
Adjusted basic income per share $ 0.91 $ (0.08) $ 1.23 $ 0.18
========== ========== ========== ==========
Reported diluted income per share $ 0.89 $ (0.12) $ 1.20 $ 0.11
Goodwill amortization, net of tax: -- 0.04 -- 0.07
---------- ---------- ---------- ----------
Adjusted diluted income per share $ 0.89 $ (0.08) $ 1.20 $ 0.18
========== ========== ========== ==========
The changes in the carrying amount of goodwill for the six months ending
February 28, 2003 are as follows (in thousands):
Metals Steel
Recycling Manufacturing Auto Parts
Business Business Business Total
--------- --------- --------- ---------
Balance as of year ending
August 31, 2002, audited $ 34,771 $ 983 $ -- $ 35,754
Acquisition (Note 3) -- -- 72,199 72,199
Impairment charge -- (983) -- (983)
--------- --------- --------- ---------
Balance as of February 28, 2003
unaudited $ 34,771 -- $ 72,199 $ 106,970
========= ========= ========= =========
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
143 (SFAS 143), "Accounting for Asset Retirement Obligations." SFAS 143 requires
entities to record the fair value of a liability for an asset retirement
obligation in the period in which it is incurred. When the liability is
initially recorded, the entity is required to capitalize the cost by increasing
the carrying amount of the related long-lived asset. Over time, the liability is
accreted to its present value each period, and the capitalized cost is
depreciated over the useful life of the related asset. SFAS 143 is effective for
fiscal years beginning after June 15, 2002 and was adopted by the Company
effective September 1, 2002. The adoption of this standard did not have a
material impact on the consolidated financial statements.
9
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2003 AND 2002
On October 3, 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS
144). SFAS 144 superceded SFAS 121. SFAS 144 applies to all long-lived assets
(including discontinued operations) and consequently amends Accounting
Principles Board Opinion No. 30 "Reporting Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business." SFAS 144 develops one
accounting model for long-lived assets that are to be disposed of by sale. SFAS
144 requires that long-lived assets that are to be disposed of by sale be
measured at the lower of book value or fair value less cost to sell.
Additionally, SFAS 144 expands the scope of discontinued operations to include
all components of an entity with operations that (1) can be distinguished from
the rest of the entity and (2) will be eliminated from the ongoing operations of
the entity in a disposal transaction. SFAS 144 was effective for the Company for
all financial statements issued beginning September 1, 2002. The adoption of
this standard did not have a material effect on the consolidated financial
statements.
In May 2002, the FASB issued SFAS No. 145, (SFAS 145) "Rescission of FAS Nos. 4,
44, and 64, Amendment of FAS 13, and Technical Corrections." Among other things,
SFAS 145 rescinds various pronouncements regarding early extinguishment of debt
and allows extraordinary accounting treatment for early extinguishment only when
the provisions of Accounting Principles Board Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" are met. SFAS 145 provisions regarding early extinguishment of
debt are generally effective for fiscal years beginning after May 15, 2002. The
adoption of this statement did not have a material impact on the consolidated
financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." The standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. Costs covered by
the standard include lease termination costs and certain employee severance
costs that are associated with a restructuring, discontinued operation, plant
closing, or other exit or disposal activity. This statement is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The adoption of this statement did not have a material impact on the
consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure," an amendment of FASB Statement No.
123" (SFAS 148). This statement amends SFAS No. 123 "Accounting for Stock Based
Compensation" (SFAS 123) to provide alternative methods of voluntarily
transitioning to the fair value based method of accounting for stock-based
employee compensation. SFAS 148 also amends the disclosure requirements of SFAS
123 to require disclosure of the method used to account for stock-based employee
compensation and the effect of the method on reported results in both annual and
interim financial statements. The disclosure provisions will be effective for
the Company beginning with the Company's quarter ended May 31, 2003. The Company
has not yet completed the evaluation of the options presented by SFAS 148.
However, within the next quarter, the Company expects to reach a determination
of whether and, if so, when to change the Company's existing accounting for
stock-based compensation to the fair value method in accordance with the
transition alternatives of SFAS 148.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN 45 are effective for any guarantees that are
issued or modified after December 31, 2002. The adoption of this interpretation
did not have a material impact on the consolidated financial statements.
In January 2003, FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). FIN 46 requires a variable interest entity
to be consolidated by a company if that company is subject to a majority of the
risk of loss from the variable interest entity's activities or entitled to
receive a majority of the entity's residual
10
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2003 AND 2002
returns or both. FIN 46 also requires disclosures about variable interest
entities that a company is not required to consolidate but in which it has a
significant variable interest. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003 and to
existing entities in the first fiscal year or interim period beginning after
June 15, 2003. The Company is in the process of assessing what impact this
pronouncement will have on its consolidated financial statements.
NOTE 2 - INVENTORIES:
Inventories consisted of the following (in thousands):
February 28, August 31,
2003 2002
------- -------
(Unaudited) (Audited)
Recycled metals $16,060 $13,432
Work in process 10,426 6,495
Finished goods 28,145 25,245
Supplies 12,414 12,745
------- -------
$67,045 $57,917
======= =======
NOTE 3 - BUSINESS COMBINATIONS:
On February 14, 2003, the Company closed its acquisition (the "Acquisition" ) of
all of the stock of Pick and Pull Auto Dismantling, Inc., which was the
Company's 50% partner in Pick-N-Pull Auto Dismantlers, a California general
partnership (the "Joint Venture") and all of the membership interests in
Pick-N-Pull Auto Dismantlers, Stockton, LLC ("Stockton"). The cost of the
Acquisition consisted of $71.4 million cash paid to the seller at closing, $3.3
million of debt assumed and immediately paid off, the cancellation of the
seller's $12.5 million share of debt owed by the Joint Venture to the Company,
and $0.7 million of acquisition costs, for a total of $87.9 million (or $84.3
million net of the seller's $3.6 million share of the Joint Venture's cash on
hand at closing). The Joint Venture stores together with the Stockton store are
one of the country's leading self-service used auto parts networks with 23 store
locations, 17 in northern California, two in Nevada, and one in each of Texas,
Utah, Illinois and Indiana.
The purchase price of the Acquisition was allocated to tangible and intangible
identifiable assets and liabilities assumed based on an estimate of their fair
values. Certain tangible net assets, such as real estate, are being valued by
independent third parties and the equipment was valued by Company management.
The excess of the aggregate purchase price over the fair value of the
identifiable net assets acquired of approximately $70.5 million was recognized
as goodwill. Approximately $1.7 million of goodwill existed on the Joint
Venture's balance sheet prior to the Acquisition but was not shown separately in
accordance with the equity method of accounting. Therefore, the total increase
to goodwill related to the Acquisition was $72.2 million.
Additionally, in connection with the Acquisition, the Company conducted an
environmental due diligence investigation. Based upon new information obtained
in this investigation, the Joint Venture accrued $2.1 million in environmental
liabilities in the second quarter of 2003 for probable and reasonably estimable
future remediation costs at the Auto Parts Business' store locations. No
environmental proceedings are pending at any of these sites.
The initial purchase price is subject to the terms of the Purchase Agreement,
which provides for a purchase price adjustment one year after closing based upon
calendar year 2002 and 2003 earnings before interest, taxes, depreciation and
amortization (EBITDA) of the acquired Auto Parts Business. As defined by the
Purchase
11
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2003 AND 2002
Agreement, the contingent future adjustment may increase or decrease the initial
purchase price by up to $12 million.
The purchase price allocation has been prepared on a preliminary basis, and
reasonable changes are expected as additional information becomes available. The
following is a summary of the estimated fair values of the assets acquired and
liabilities assumed as of the date of the acquisition (in millions):
Property, plant and equipment $ 16.3
Other tangible assets 5.6
Liabilities (4.5)
Goodwill 70.5
------
Total $ 87.9
======
Goodwill of $70.5 million represents the excess of purchase price over the fair
value of the net tangible assets acquired, and the majority of it is not
deductible for tax purposes. In accordance with SFAS 142, goodwill is not
amortized and will be tested for impairment at least annually.
The following table is prepared on a pro forma basis for the three and six month
periods ended February 28, 2003 and February 28, 2002 as though the Auto Parts
Business had been acquired as of the beginning of the period presented, after
including the estimated impact of certain adjustments such as interest expense
(in thousands, except per share amounts).
Three Months Ended February 28, Six Months Ended February 28,
2003 2002 2003 2002
----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited)
Net revenues $ 124,659 $ 88,862 $ 215,326 $ 177,600
Net income $ 9,104 $ (712) $ 13,850 $ 2,065
Net income per share:
Basic $ 0.99 $ (0.08) $ 1.50 $ 0.23
Diluted $ 0.96 $ (0.08) $ 1.47 $ 0.23
The pro forma results are not necessarily indicative of what would have occurred
if the acquisitions had been in effect for the periods presented. In addition,
they are not intended to be a projection of future results and do not reflect
any synergies that might be achieved from combining operations.
NOTE 4 - INCOME TAXES:
The Company's effective tax rate increased to 26% for the six months ending
February 28, 2003, from 14% for the prior fiscal year. The tax rate last year
benefited from the recognition of California Enterprise Zone income tax credits.
The Company does not anticipate receiving credits of comparable size in the
current fiscal year.
NOTE 5 - RELATED PARTIES & IMPAIRMENTS:
During the second quarter of fiscal 2003, the Company accrued $2.1 million in
environmental liabilities relating to the acquisition of the Auto Parts Business
(refer to Note 3). In the second quarter of fiscal 2002, the Company recorded a
loss of $1.5 million related to the early termination of two vessel charter
agreements with a related company. Also in that quarter, the Company sold a
non-strategic steel forging business that was part of a
12
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2003 AND 2002
1995 Metals Recycling Business acquisition to an unrelated party and recorded a
loss of $0.8 million on the sale.
NOTE 6 - SEGMENT INFORMATION:
The Company's consolidated businesses operate in three industry segments: metal
processing and recycling (Metals Recycling Business), mini-mill steel
manufacturing (Steel Manufacturing Business) and self-service used auto parts
(Auto Parts Business). Additionally, the Company is a non-controlling partner in
joint ventures, which are in the metals recycling business or suppliers of
unprocessed metals. The Joint Ventures in the Metals Recycling Business sell
recycled metals that have been processed at their facilities (Processing) and
also buy and sell third parties' processed metals (Trading). The Company
considers all joint ventures to be separate business segments because they are
managed separately. These joint ventures are accounted for using the equity
method. As such, the Joint Venture operating information provided below is shown
separately from consolidated information, except for the Company's equity in the
income from the joint ventures. The information was obtained from internal data
that was provided to the Company's chief operating decision-makers for the
purpose of corporate management. The Company does not allocate corporate
interest income and expense, income taxes or other income and expenses related
to corporate activity to its operating segments. Assets and capital expenditures
are not shown for the joint ventures as management does not use that information
to allocate resources or assess performance.
Note 3 of the Notes to the Consolidated Financial Statements describes an
acquisition that occurred on February 14, 2003. Under Statement of Financial
Accounting Standards No. 141 ("SFAS 141"), "Business Combinations", the
acquisition is considered a "step" acquisition due to the fact that the Company
had a significant joint venture interest in the acquired business for a number
of years. Additionally, since the acquisition occurred during the year, the
Company elected to include it in the consolidated results as though it had
occurred at the beginning of fiscal 2003. Thus, the 2003 statement of
operations, balance sheet, and statement of cash flows have been adjusted to
consolidate the acquisition as of September 1, 2002. Also, the acquired
businesses were consolidated with the Company's previous interest in the
business to form a separate reporting segment called the Auto Parts Business. As
such, the financial statement information that was reported in the Company's
Form 10-Q for the quarter ended November 30, 2002 has been restated. The
financial results of the acquired business for periods prior to fiscal 2003
continue to be accounted for using the equity method and are included in the
joint venture businesses reporting segment.
Revenues from external customers for the Company's consolidated operations are
as follows (in thousands):
For the Three Months Ended For the Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
--------- --------- --------- ---------
Metals Recycling Business $ 85,716 $ 52,682 $ 131,290 $ 101,123
Steel Manufacturing Business 41,271 33,902 84,101 70,304
Auto Parts Business 14,755 -- 30,894 --
Intersegment revenues (17,083) (8,222) (30,959) (16,231)
--------- --------- --------- ---------
Consolidated revenues $ 124,659 $ 78,362 $ 215,326 $ 155,196
========= ========= ========= =========
13
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 28, 2003 AND 2002
The joint ventures' revenues from external customers are as follows (in
thousands):
For the Three Months Ended For the Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
--------- --------- --------- ---------
Joint Ventures in the Metals
Recycling Business:
Processing $ 150,947 $ 110,477 $ 255,517 $ 231,304
Trading 14,830 27,342 65,362 58,254
Joint Venture Suppliers of Metals 2,414 14,665 4,509 28,804
--------- --------- --------- ---------
Total revenues $ 168,191 $ 152,484 $ 325,388 $ 318,362
========= ========= ========= =========
The Company's income (loss) from operations is as follows (in thousands):
For the Three Months Ended For the Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
--------- --------- --------- ---------
Metals Recycling Business $ 8,358 $ 640 $ 11,454 $ 1,618
Auto Parts Business 4,960 -- 10,109 --
Steel Manufacturing Business (1,358) (2,074) (2,615) (2,322)
Joint Ventures in the Metals Recycling Business 6,471 3,707 9,542 7,406
Joint Venture Suppliers of Metals (277) 616 (173) 1,788
Corporate expense (2,529) (1,819) (4,553) (3,785)
Eliminations (413) 47 160 (77)
Impairment and other non-recurring charges (2,100) (2,260) (2,100) (2,260)
--------- --------- --------- ---------
Consolidated income (loss) from operations $ 13,112 $ (1,143) $ 21,824 $ 2,368
========= ========= ========= =========
Income from operations generated by the joint ventures represents the Company's
equity in the income or loss of these entities.
The Company's share of depreciation and amortization expense included in the
determination of joint ventures' income from operations is as follows (in
thousands):
For the Three Months Ended For the Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
--------- --------- --------- ---------
Joint Ventures in the Metals
Recycling Business $ 1,624 $ 1,530 $ 3,260 $ 3,077
Joint Venture Suppliers of Metals 70 539 144 1,066
--------- --------- --------- ---------
Total $ 1,694 $ 2,069 $ 3,404 $ 4,143
========= ========= ========= =========
14
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company operates in three industry segments. The Company's Metals Recycling
Business collects, processes and recycles steel and other metals through its
facilities. The Company's Steel Manufacturing Business operates a mini-mill near
Portland, Oregon, which melts recycled metal, produces finished steel products
and maintains two mill depots in Southern California and one in Central
California. The Company's Auto Parts Business purchases used and wrecked
automobiles and allows retail customers the opportunity of extracting parts for
purchase in its self-service auto parts stores, with 17 located in California,
two in Nevada and one store in each of Texas, Utah, Illinois and Indiana.
Additionally, the Company is a non-controlling partner in joint ventures that
are either in the metals recycling business or are suppliers of unprocessed
metals. The Joint Ventures in the Metals Recycling Business sell recycled metals
that have been processed at their facilities (Processing) and also buy and sell
third parties' processed metals (Trading).
Note 3 of the Notes to the Consolidated Financial Statements describes an
acquisition that occurred on February 14, 2003. Under Statement of Financial
Accounting Standards No. 141 ("SFAS 141"), "Business Combinations," the
acquisition is considered a "step" acquisition due to the fact that the Company
had a significant joint venture interest in the acquired business for a number
of years. Additionally, since the acquisition occurred during the year, the
Company elected to include it in the consolidated results as though it had
occurred at the beginning of fiscal 2003. Thus, the 2003 statement of
operations, balance sheet, and statement of cash flows have been adjusted to
consolidate the acquisition as of September 1, 2002. Also, the acquired
businesses were consolidated with the Company's previous interest in the
business to form a separate reporting segment called the Auto Parts Business. As
such, the financial statement information that was reported in the Company's
Form 10-Q for the quarter ended November 30, 2002 has been restated.
Additionally, consolidation accounting requires the Company to adjust its
earnings for the ownership interests it did not own during the reporting period.
During the three and six month periods ended February 28, 2003, net income was
reduced by $0.4 million and $0.8 million of minority interests, respectively,
net of income taxes, representing the share of income attributable to various
continuing minority partners of the business. Also, during the most recent
quarter and six month period, net income was reduced by $0.7 million and $2.5
million of pre-acquisition interests, respectively, net of income taxes,
representing the share of income attributable to the former joint venture
partner prior to the acquisition. The financial results of the acquired business
for periods prior to fiscal 2003 continue to be accounted for using the equity
method and are included in the joint venture businesses reporting segment.
15
SCHNITZER STEEL INDUSTRIES, INC.
RESULTS OF OPERATIONS
The Company's revenues and operating results by business segment are summarized
below (in thousands):
For the Three Months Ended For the Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
--------- --------- --------- ---------
(Unaudited)
REVENUES:
Metals Recycling Business:
Ferrous sales $ 72,630 $ 41,780 $ 106,561 $ 78,773
Nonferrous sales 11,669 8,726 21,784 18,616
Other sales 1,417 2,176 2,945 3,734
--------- --------- --------- ---------
Total sales 85,716 52,682 131,290 101,123
Auto Parts Business 14,755 -- 30,894 --
Steel Manufacturing Business 41,271 33,902 84,101 70,304
Intercompany sales eliminations (17,083) (8,222) (30,959) (16,231)
--------- --------- --------- ---------
Total $ 124,659 $ 78,362 $ 215,326 $ 155,196
========= ========= ========= =========
INCOME (LOSS) FROM OPERATIONS:
Metals Recycling Business $ 8,358 $ 640 $ 11,454 $ 1,618
Auto Parts Business 4,960 -- 10,109 --
Steel Manufacturing Business (1,358) (2,074) (2,615) (2,322)
Joint Ventures in the Metals Recycling Business 6,471 3,707 9,542 7,406
Joint Venture Suppliers of Metals (277) 616 (173) 1,788
Corporate expense (2,529) (1,819) (4,553) (3,785)
Intercompany eliminations (413) 47 160 (77)
Impairment and other non-recurring charges (2,100) (2,260) (2,100) (2,260)
--------- --------- --------- ---------
Total $ 13,112 $ (1,143) $ 21,824 $ 2,368
========= ========= ========= =========
NET INCOME (LOSS) $ 8,409 $ (1,054) $ 11,303 $ 990
========= ========= ========= =========
The Joint Ventures' revenues and results of operations were as follows (in
thousands):
For the Three Months Ended For the Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
--------- --------- --------- ---------
(Unaudited)
Total revenues from external customers recognized by:
Joint Ventures in the Metals Recycling Business
Processing $ 150,947 $ 110,477 $ 255,517 $ 231,304
Trading 14,830 27,342 65,362 58,254
Joint Venture Suppliers of Metals 2,414 14,665 4,509 28,804
--------- --------- --------- ---------
$ 168,191 $ 152,484 $ 325,388 $ 318,362
========= ========= ========= =========
Income from joint ventures recognized by the Company from:
Joint Ventures in the Metals Recycling Business $ 6,471 $ 3,707 $ 9,542 $ 7,406
Joint Venture Suppliers of Metals (277) 616 (173) 1,788
--------- --------- --------- ---------
$ 6,194 $ 4,323 $ 9,369 $ 9,194
========= ========= ========= =========
16
SCHNITZER STEEL INDUSTRIES, INC.
The following table summarizes certain selected operating data for the Company
and its joint venture businesses:
For the Three Months Ended For the Six Months Ended
Feb. 28, Feb. 28, Feb. 28, Feb. 28,
2003 2002 2003 2002
--------- --------- --------- ---------
(Unaudited)
SHIPMENTS (in thousands):
METALS RECYCLING BUSINESS:
Ferrous recycled metal (long tons):
To Steel Manufacturing Business 141 98 256 191
To other unaffiliated domestic customers 12 17 49 23
To export customers 402 286 545 535
--------- --------- --------- ---------
Total ferrous recycled metal 555 401 850 749
========= ========= ========= =========
Nonferrous metal (pounds) 28,200 24,100 53,700 53,300
========= ========= ========= =========
STEEL MANUFACTURING BUSINESS:
Finished steel products (net tons) 137 117 279 241
========= ========= ========= =========
JOINT VENTURES IN THE METALS RECYCLING BUSINESS:
Ferrous recycled metal (long tons):
Processing 940 891 1,577 1,785
========= ========= ========= =========
Trading 266 258 654 498
========= ========= ========= =========
SECOND QUARTER FISCAL 2003 COMPARED TO SECOND QUARTER FISCAL 2002
GENERAL. During the second quarter of fiscal 2003, the Metals Recycling Business
continued to experience improved market conditions, which have not been seen
since before the 1997 Asian financial crisis. Prices began to rise in early
calendar 2002 as supplies of ferrous recycled metals from the countries of the
former Soviet Union decreased as a result of export tariffs and bans in certain
countries. By the end of the Company's 2002 fiscal year, foreign steel producers
delayed placing new orders due to the rapid rise in prices. By the end of the
Company's fiscal 2003 first quarter, foreign buyers needed to replenish their
inventories and began to place orders at price levels that were at or above
prices recognized in the first two months of the quarter. As a result, the
Metals Recycling Business' ferrous sales volumes were unusually low in the first
quarter of fiscal 2003. Throughout most of the second quarter, selling prices
continued to rise and demand remained firm, much of which was fueled by China
and Korea. During the same period, the cost of unprocessed metal rose as well,
which combined with rising ocean freight rates partially offset the increase in
selling prices. The Joint Ventures in the Metals Recycling Business were
affected by the same supply and demand factors as the Company's wholly-owned
Metals Recycling Business. However, the Joint Ventures that operate in the
Northeastern U.S. were adversely affected by unusually cold winter weather
slowing production volumes. Continued strong demand for nonferrous recycled
metals, particularly from China, boosted nonferrous metals selling prices.
The Steel Manufacturing Business saw higher sales volumes and selling prices in
the second quarter of fiscal 2003 compared with the second quarter of fiscal
2002. The sales volume increases were primarily driven by wire rod sales and to
a lesser extent rebar sales. During the spring of 2002, the U.S. Government
imposed anti-dumping and countervailing duties on certain wire rod imports,
which combined with higher worldwide ferrous recycled metals prices (the primary
raw material used to produce wire rod) improved the competitive position of
domestic wire rod producers. The Steel Manufacturing Business turned this price
parity with imported wire products into increased sales and market share. Also,
towards the end of the fiscal 2003 second quarter, the Company and other steel
producers increased their selling prices for rebar, which is believed to have
spurred
17
SCHNITZER STEEL INDUSTRIES, INC.
wholesale customer demand to buy inventory ahead of the effective date for the
price increases. The Company believes that merchant bar and rebar prices have
not seen a significant positive impact from the temporary tariffs imposed in
March 2002 by the Federal Government under section 201 of the Trade Act of 1974.
However, merchant bar selling prices have increased modestly industry-wide in
order to adjust up to the cash costs of production. In the second quarter of
fiscal 2003, the Steel Manufacturing Business completed two capital projects to
one of the rolling mills, which allow it to now produce higher margin specialty
wire products, to improve the packaging of coiled products and increase the
productivity on all wire production. Production costs per ton for the Steel
Manufacturing Business improved as output in the melt shop and the rolling mills
increased by 50% and 35%, respectively, compared with the second quarter of
fiscal 2002. However, this efficiency improvement was partially offset by higher
raw material prices, primarily recycled ferrous metal.
The Auto Parts Business is focused on the self-service auto parts business. Its
retail customers pay an admission to enter the store. When a customer finds a
desired part on an automobile, the customer removes it and pays a retail price
for the part. Retail sales and admissions are somewhat seasonal and principally
affected by weather and promotional events. Since the stores are open to the
natural elements, during periods of prolonged wet, cold or extreme heat, the
retail business tends to slow down due to the difficult customer working
conditions. Further, the Company generally runs promotional events during
seasonably moderate times of the year when it is most likely to affect the
buying patterns of its retail customers. As a result, the Company's fiscal first
and third quarters tend to generate the most retail sales and the fiscal second
and fourth quarters are the slowest in terms of retail sales. The winter of
fiscal 2003 has been considered extreme in the Midwest and Eastern U.S., which
is in sharp contrast to the weather experienced in the second quarter of fiscal
2002. The more harsh weather conditions adversely affected retail sales in the
Company stores in those parts of the country. The Northern California stores
experienced normal seasonal weather patterns during both years.
The Auto Parts Business' other primary source of revenue is the sale of scrap
metal and other parts wholesale. Revenues for the wholesale product lines are
principally affected by commodity prices and shipping schedules. As mentioned
earlier in the discussions regarding the Metal Recycling Business, recycled
metal prices have increased dramatically since the second quarter of fiscal
2002, which has positively affected the revenues and profits of the Auto Parts
Business.
Net income for the second quarter of fiscal 2003 compared with the same quarter
in the previous fiscal year benefited from higher average selling prices for
ferrous recycled metals as well as higher sales volumes for both the Metals
Recycling Business and the Steel Manufacturing Business. Also, the most recent
quarter benefited from the inclusion of the Auto Parts Business as a wholly
owned company and higher income for the joint ventures in the metals recycling
business primarily due to the same factors as the Company's wholly owned Metals
Recycling Business.
REVENUES. Consolidated revenues for the three months ended February 28, 2003
increased 59% from $78.4 million to $124.7 million compared with the second
quarter of fiscal 2002. The increase was primarily a result of increases in the
Metals Recycling Business' sales volume and average net selling price per ton as
well as the acquisition of the Auto Parts Business and its inclusion as a
consolidated business. The Steel Manufacturing Business also showed gains in
sales volume and average selling prices.
For the second quarter of fiscal 2003, revenues for the Metals Recycling
Business, before intercompany eliminations, increased $33.0 million (63%)
compared with the second quarter of fiscal 2002 primarily due to higher average
net selling prices per ton and higher ferrous sales volumes. Total ferrous sales
volumes increased 153,500 tons (38%) due primarily to the market conditions
previously mentioned in the "General" paragraph. Ferrous export sales volumes
increased 116,200 tons (41%) to 402,400 tons due to good international demand
combined with increased demand from the Steel Manufacturing Business. Sales to
the Steel Manufacturing Business increased 42,800 tons (44%) to 140,800 tons as
the melt shop ramped up billet production which is in contrast to the production
curtailment that occurred during last year's second quarter, which reduced
recycled metal revenues. The average sales price, net of shipping costs (average
net sales price),
18
SCHNITZER STEEL INDUSTRIES, INC.
for ferrous metals increased $24 per ton (28%) to $111 per ton from the second
quarter of fiscal 2002 due to the lower supplies of competing metal in global
markets and strong demand in Asia. Nonferrous sales volume increased 17% and the
average selling price per pound increased 15%, which was primarily attributable
to continued strong demand from China.
The Steel Manufacturing Business' revenues for the three months ended February
28, 2003 increased $7.4 million (22%), to $41.3 million compared with the prior
year quarter, reflecting higher sales volumes and higher average sales prices.
Finished steel shipments increased 20,200 tons (17%) to 137,000 tons with the
average finished steel net selling price up $8 per ton (3%) to $283 per ton
compared with the same quarter last year. The increase in sales volumes is
primarily due to higher sales of wire rod (refer to the "General" paragraph
above). These price increases had a minor effect on the 2003 second quarter.
However, it did cause customers to place orders to buy ahead of the effective
day of the price increase, which resulted in increased second quarter sales
volumes. The wire rod average net sales price was up 11% compared with the
second quarter of fiscal 2002. However, the Company believes that the tariffs
imposed under Section 201 of the Trade Act of 1974 in March and April 2002 on
lower priced imported steel products have not resulted in any significant
increases in price for other finished steel products, especially rebar and
merchant bar. Merchant bar selling prices have increased 13% from extremely low
levels as cash production costs for most suppliers were higher than selling
prices and selling prices needed to be adjusted upward. Also, as the second
quarter of fiscal 2003 ended, both the Steel Manufacturing Business and other
competing domestic steel mills announced modest price increases for both rebar
and merchant bar to offset the higher raw material and energy costs.
As previously mentioned, the Auto Parts Business was acquired on February 14,
2003 and was considered a "step" acquisition requiring the consolidation of its
financial results as of the beginning of fiscal 2003. As such, revenues for the
second quarter of 2003 included $14.8 million related to the Auto Parts Business
with no comparable revenues being recognized for financial statement purposes in
the 2002 second quarter. In order to aid the reader's understanding of the
financial performance of this segment, the pro forma fiscal 2002 second quarter
revenues for the Auto Parts Business were $12.4 million. The $2.4 million (19%)
increase was primarily caused by an increase in wholesale revenues driven by
higher ferrous recycled metal prices and the timing of wholesale shipments.
Wholesale sales volumes were lower during the 2002 quarter due to the timing of
shipments between quarters.
COST OF GOODS SOLD. Consolidated cost of goods sold increased $29.1 million
(39%) for the three months ended February 28, 2003, compared with the same
period last year. Cost of goods sold decreased as a percentage of revenues from
95% to 83%. Gross profit increased $17.2 million to $21.0 million during the
latest quarter as compared to the prior year quarter as profit margins increased
for the Metals Recycling Business and gross profits of the Auto Parts Business
were included.
For the Metal Recycling Business, the cost of goods sold as a percentage of
revenues decreased compared with the second quarter of fiscal 2002 from 91% to
85%. Gross profit increased by $7.9 million to $12.9 million. The increase in
gross profit was attributable to higher average net selling prices per ton and
higher sales volumes. Compared with the second quarter of last year, the average
ferrous metals cost of sales per ton increased 14% due to higher purchase costs
for unprocessed ferrous metals. Generally, a change in the cost of unprocessed
metal has a strong correlation to changes in the average selling price. Thus, as
selling prices rose compared with last year's quarter, so did the cost of
unprocessed metal.
For the second quarter of fiscal 2003, cost of goods sold for the Steel
Manufacturing Business increased $6.6 million (19%) compared to the same period
last year and as a percentage of revenues decreased from 104% to 101%. Cost of
goods sold per ton was consistent with last year's second quarter. In the second
quarter of fiscal 2003, the negative gross margin was ($0.5) million compared
with a negative gross margin of $(1.3) million in the second quarter of last
year. Anticipated margin improvements did not materialize in the second quarter
of 2003 as compared to the first quarter of fiscal 2003 due to the increase in
cost of goods sold. This increase was primarily caused by a 21% increase in the
cost of ferrous recycled metals, the main raw material component of mini-mill
steel manufacturing, and a product mix shift to wire rod, which has higher
production costs than rebar.
19
SCHNITZER STEEL INDUSTRIES, INC.
This increase in raw material cost was partially offset by lower fixed costs per
ton due to higher overall production volumes.
The Auto Parts Business' cost of sales was $1.0 million (15%) lower during the
second quarter of fiscal 2003 as compared to the pro forma cost of sales for the
fiscal 2002 quarter due primarily to lower automobile purchases, offset in part
by higher average purchase costs and slightly higher wage costs. During the
second quarter of fiscal 2003, the Auto Parts Business reported operating income
of $5.0 million. On a comparable pro forma basis, this business segment had $1.4
million of operating income during the fiscal 2002 quarter. The higher operating
profits were mainly caused by higher fiscal 2003 wholesale revenues driven by
improved pricing for dismantled autobodies sold for scrap metal coupled with
increased sales volumes.
JOINT VENTURES. The Joint Ventures in the Metals Recycling Business
predominantly sell recycled ferrous metal. Revenues for this segment in the
second quarter of fiscal 2003 increased $28.0 million (20%) compared with the
prior year quarter primarily due to increased sales volumes and higher average
net selling prices per ton. Due to the same supply and demand circumstances
described earlier for the Company's wholly-owned businesses, the joint ventures
that process recycled metals had a 5% increase in sales volume and a 28%
increase in the average net selling price per ton for ferrous recycled metals.
The Company's equity in income from its Joint Ventures in the Metals Recycling
Business for the second quarter of fiscal 2003 increased to $6.5 million from
$3.7 million in the second quarter of fiscal 2002. The increase in income from
these Joint Ventures was primarily caused by the earlier mentioned strong sales
volumes and higher selling prices of the processing Joint Ventures.
Additionally, the Joint Ventures have worked to reduce the cost of unprocessed
inventory as a percentage of the selling price and to improve operational
efficiencies, thereby increasing their operating margins per ton.
Revenues of the Joint Venture Suppliers of Metals decreased by $12.3 million
from the second quarter for fiscal 2002 as compared to the 2003 second quarter.
Most of this decrease was caused by the reclassification in fiscal 2003 of the
Pick-n-Pull Joint Venture, which is now consolidated and included as a new
business segment, the Auto Parts Business. Excluding the change caused by this
reclassification, revenues decreased $2.5 million during the second quarter of
fiscal 2003 compared to the second quarter of last year. During the second
quarter of fiscal 2002, the Company's plant demolition and reclamation joint
venture was engaged in a large remediation and demolition job, which resulted in
the higher than usual revenue. For the three months ended February 28, 2003, the
Company's equity in income from these joint ventures decreased $0.4 million
primarily due to the slowdown in the U.S. economy.
IMPAIRMENT AND OTHER NON-RECURRING CHARGES. In connection with the acquisition
of the Auto Parts Business, the Company conducted an environmental due diligence
investigation. Based upon new information obtained in this investigation, the
Joint Venture accrued $2.1 million in environmental liabilities in the second
quarter of 2003 for remediation costs at the Auto Parts Business' store
locations. No environmental proceedings are pending at any of these sites.
In the second quarter of fiscal 2002, the Company recorded a loss of $1.5
million related to the early termination of two vessel charter agreements with a
related company. Also in that quarter, the Company sold a non-strategic steel
forging business that was part of a 1995 Metals Recycling Business acquisition
to an unrelated party and recorded a loss of $0.8 million on the sale.
GENERAL AND ADMINISTRATIVE EXPENSE. Compared with the second quarter of fiscal
2002, general and administrative expense for the same quarter this fiscal year
increased $4.8 million, which was almost solely due to the consolidation of the
Auto Parts Business.
INTEREST EXPENSE. Interest expense for the second quarter of fiscal 2003
decreased 44% to $0.3 million compared with the second quarter of fiscal 2002.
The decrease was primarily a result of lower average principal
20
SCHNITZER STEEL INDUSTRIES, INC.
balances outstanding in the second quarter of fiscal 2003 as compared with last
year's second quarter, as well as lower average interest rates.
INCOME TAX PROVISION. The tax rate for the second quarter of fiscal 2003 was
approximately 27%, compared with a tax benefit of 37% for the prior year
quarter. The current quarter rate of 27% is lower than the 35% federal statutory
tax rate for three primary reasons: (1) The implementation of SFAS 142 has
eliminated the amortization of goodwill, some of which have been nondeductible;
(2) export sales, which under Federal law are taxed at a lower rate than
domestic sales, have increased; and (3) net operating loss carryforwards that
accompanied an earlier acquisition continue to provide benefit.
FIRST HALF OF FISCAL 2003 VS. FIRST HALF OF FISCAL 2002
- -------------------------------------------------------
REVENUES. Consolidated revenues for the six months ended February 28, 2003
increased $60.1 million (39%) from the same period last year. The higher
revenues were primarily attributed to increased sales volumes and higher average
selling prices for the Metals Recycling Business, higher sales volumes for the
Steel Manufacturing Business and the inclusion of the Auto Parts Business as a
consolidated business.
During the six months ended February 28, 2003, revenues for the Metals Recycling
Business, before intercompany eliminations, increased $30.2 million (30%), which
is attributed to higher sales volumes and higher average ferrous recycled metals
selling prices. Ferrous sales volumes increased by 13% over the 2002 period.
Average sales prices for ferrous metals were up 24% and nonferrous metals were
up 17% compared with the first half of fiscal 2002. The higher ferrous sales
volumes were caused by continued good demand from Asian countries and a decrease
in supply coming from the countries of the former Soviet Union.
The Steel Manufacturing Business' revenues for the six months ended February 28,
2003 increased $13.8 million (20%), to $84.1 million, from the first half of the
prior year. The increase in revenues was a result of a 43,300 ton increase (97%)
in wire rod shipments during the first six months of fiscal 2003 compared to the
prior year. The increased demand for wire rod was a result of price parity with
imported products as described above in the "General" paragraph. Sales volumes
of other products approximated last year's levels. Average selling prices
increased modestly led by increases in merchant bar and to a smaller extent by
rebar prices. Merchant bar selling prices increased 11% from extremely low
levels as cash production costs for most suppliers were higher than selling
prices. Thus, selling prices were adjusted upward.
Revenues for the Auto Parts Business increased by $4.7 million (18%) for the
first half of fiscal 2003 compared to the pro forma revenue for the same period
in 2002. The higher revenues were primarily caused by an increase in wholesale
revenues driven by higher ferrous recycled metal prices and the timing of sales
between periods.
COST OF GOODS SOLD. Consolidated cost of goods sold increased by $31.7 million
(22%) for the six months ended February 28, 2003, compared with the same period
last year. Cost of goods sold decreased as a percentage of revenues from 94% to
83%, which contributed to a $28.4 million increase in gross profit for the first
six months of fiscal 2003 as compared to the prior year. The higher gross profit
reflected the increased volumes and selling prices for the Metals Recycling
Business and the inclusion of the Auto Parts Business as a consolidated
business.
During the first six months of fiscal 2003, the Metals Recycling Business' cost
of goods sold increased $20.0 million over the prior year. The cost of goods
sold as a percentage of revenues decreased from 90% for the first half of fiscal
2002 to 85% during the first half of fiscal 2003. As a result, gross profit
increased by $9.8 million to $19.8 million. The increase in gross margin in the
first six months of fiscal 2003 is attributable to higher average selling prices
per ton and higher sales volumes partially offset by higher average purchase
prices paid for unprocessed metal compared with the first six months of fiscal
2002.
21
SCHNITZER STEEL INDUSTRIES, INC.
During the first six months of fiscal 2003, cost of goods sold for the Steel
Manufacturing Business increased $14.0 million compared to the same period last
year and was consistent as a percentage of revenues at 101%. Gross margin
declined further from a loss of $0.8 million to a loss of $1.1 million compared
with the first half of last year. Although the average sales price per ton was
slightly higher compared with the first six months of fiscal 2002 and production
increases lowered fixed cost per ton, the average cost of goods sold per ton
increased. This increase was attributed to higher raw material costs (primarily
recycled metal) and a product mix shift to wire rod, which has higher production
costs than rebar.
The Auto Parts Business' cost of sales was 5% lower during the first half of
fiscal 2003 as compared to pro forma cost of sales for the fiscal 2002 period
due primarily to lower purchase costs, offset in part by slightly higher wage
costs.
JOINT VENTURES. For the six months ended February 28, 2003, revenues for Joint
Ventures in the Metals Recycling Business increased by $31.3 million from the
first six months of last year. The increase was primarily due to higher average
net sales prices for ferrous metals, which were partially offset by lower
ferrous sales volumes. These higher average sales prices were caused by the same
market conditions as described for the Metals Recycling Business. Fiscal 2002
sales volumes were unusually high due to the significant volume of metal coming
from the World Trade Center tragedy. For the first six months of fiscal 2003,
income recognized from these joint ventures increased by $2.1 million over the
first six months of fiscal 2002 to $9.5 million. The improved operating results
were primarily caused by higher average net selling prices per ton partially
offset by lower sales volumes.
Revenues of Joint Venture Suppliers of Metal decreased from $8.1 million to $4.5
million (excluding the change caused by the reclassification of the Auto Parts
Business) due to lower selling prices and lower demolition revenue coming from
the joint ventures in this business. Year-to-date, the Company's equity in
income from these joint ventures decreased to a loss of $0.2 million from a
profit of $0.2 million for the previous year.
GENERAL AND ADMINISTRATIVE EXPENSE. For the six months ended February 28, 2003,
general and administrative expense increased $9.0 million over with the same
period last year. This increase was primarily due to the consolidation of the
Auto Parts Business.
INTEREST EXPENSE. For the six months ended February 28, 2003, interest expense
decreased $0.6 million to $0.7 million compared with the same period last year.
The decrease was primarily a result of lower average borrowings caused by cash
flow generated from operations, distributions from joint ventures and lower
interest rates.
INCOME TAX PROVISION. The Company's effective rate of 26% for the first six
months of fiscal 2003 is lower than the 35% federal statutory tax rate for three
primary reasons: (1) The implementation of SFAS 142 has eliminated the
amortization of goodwill, some of which have been nondeductible; (2) export
sales, which under Federal law are taxed at a lower rate than domestic sales,
have increased; and (3) net operating loss carryforwards that accompanied an
earlier acquisition continue to provide benefit. The prior year's tax rate of
20% benefited from the two latter items, as well as from the one-time
recognition of California tax credits that had been generated over the previous
ten years.
LIQUIDITY AND CAPITAL RESOURCES. Cash provided by operations for the six months
ended February 28, 2003 was $12.4 million compared with $11.8 million for the
same period in the prior fiscal year. The $0.6 million increase in cash flow was
due primarily to higher net income in the current year offset by increases in
inventory.
Capital expenditures for the six months ended February 28, 2003 were $10.1
million compared with $4.4 million during the first six months of fiscal 2002.
The increase was due to the costs associated with dock renovation and
improvement projects at the Company's Portland, Oregon and Oakland, California
recycling facilities. The Company expects to spend approximately $6.9 million on
capital projects during the remainder of fiscal 2003.
22
SCHNITZER STEEL INDUSTRIES, INC.
As a result of acquisitions completed in both the current and prior years the
Company had $22.6 million of accrued environmental liabilities as of February
28, 2003. The Company expects to require significant future cash outlays as it
incurs the actual costs relating to the remediation of such environmental
liabilities.
As of February 28, 2003, the Company had a committed unsecured bank credit
facility totaling $175 million that matures in June 2003. The Company also had
additional unsecured lines of credit of $40 million, which were uncommitted. In
the aggregate, the Company had bank borrowings outstanding totaling $102.4
million at February 28, 2003. These borrowings are classified as a current
liability due to the June 2003 expiration of the bank credit facility.
Management intends to replace the bank credit facility with a new agreement and
believes it has the ability to refinance the facility based upon the Company's
financial position. In addition, the Company has signed an agreement with a bank
to use its best efforts to syndicate a new bank credit facility. Management
believes the new bank credit facility will be completed before June 1, 2003. The
Company's debt agreements have certain restrictive covenants. As of February 28,
2003, the Company was in compliance with such covenants.
In July 2002, the Company's metals recycling joint ventures with Hugo Neu
Corporation entered into a $70 million revolving credit facility ("JV Credit
Facility") with a group of banks for working capital and general corporate
purposes. Prior to that time, the joint ventures' working capital and other cash
needs had been met by advances provided equally by the Company and its partner,
Hugo Neu Corporation. The JV Credit Facility expires in July 2004, is secured by
the inventory and receivables of the joint venture businesses and has certain
restrictions on future borrowings. The Company is not a guarantor of the JV
Credit Facility. The JV Credit Facility has a number of covenants and
restrictions, including restrictions on the level of distributions to the joint
venture partners. As of February 28, 2003, the joint ventures were in compliance
with such covenants. Borrowings under the JV Credit Facility totaled $25.0
million at February 28, 2003.
The Company has certain contractual obligations and commercial commitments to
make future payments. The following table summarizes these future obligations
and commitments as of February 28, 2003 (in thousands):
Less than 1-3 4-5 After 5
Total 1 Year Years Years Years
-------- -------- -------- -------- --------
Long-term debt(1) $110,772 $102,637 $ 371 $ 64 $ 7,700
Operating leases(2) 110,869 6,238 9,596 5,348 89,687
Letters of credit 3,930 3,930 -- -- --
JV credit facility (50%)(3) 12,500 -- 12,500 -- --
-------- -------- -------- -------- --------
Total $238,071 $112,805 $ 22,467 $ 5,412 $ 97,387
======== ======== ======== ======== ========
(1) The Company has a $175 million credit facility with a group of banks for
working capital and other general purposes. The facility expires in June
2003 and has therefore been classified by the Company as a current
liability at February 28, 2003. Management believes it has the ability
to refinance the facility and expects to complete the refinancing in
2003.
(2) The Company's operating leases increased by $12.4 million as a result of
the acquisition of the Auto Parts Business.
(3) This disclosure assumes that if the JV Credit Facility is not renewed or
refinanced upon expiration, the Company and Hugo Neu Corporation would
restore their previous arrangement under which each funded one-half of
the joint ventures' cash needs.
Pursuant to a stock repurchase program, the Company is authorized to repurchase
up to 3.0 million shares of its stock when the market price of the Company's
stock is not reflective of management's opinion of an appropriate valuation of
the stock. Management believes that repurchasing shares under these conditions
enhances shareholder
23
SCHNITZER STEEL INDUSTRIES, INC.
value. During the first six months of fiscal 2003, the Company made no share
repurchases. As of February 28, 2003, the Company had repurchased a total of 1.3
million shares under this program.
The Company believes that its current cash balance, internally generated funds,
existing credit facilities and its anticipation of being able to refinance its
credit facilities will provide adequate financing for capital expenditures,
working capital, stock repurchases and debt service requirements for the next
twelve months. In the longer term, the Company may seek to finance business
expansion, including potential acquisitions, with additional borrowing
arrangements or additional equity financing.
OUTLOOK. Since the spring of 2002, the Company's metal recycling businesses have
experienced improved market conditions brought about by the combination of
increased Asian demand coupled with reduced world-wide supplies of ferrous
recycled metal. Markets have also benefited from temporary production shut-downs
of metal substitutes mainly due to political unrest in Venezuela and harsh
winter weather conditions in Eastern Europe and Northern Asia. Fiscal third
quarter prices are expected to show further improvement, which should benefit
both the Company's wholly-owned operations and joint ventures in the metals
recycling business. However, the benefits from the increasing selling prices are
expected to be partially tempered by the rising cost of unprocessed metal as
well as higher ocean freight rates.
The Auto Parts Business traditionally experiences modest improvements in retail
revenues during the third fiscal quarter of each year, which is primarily due to
seasonal weather improvements and promotional events. As such, the Company
anticipates a modest improvement in retail sales during the third quarter.
The Steel Manufacturing Business normally experiences seasonal improvements in
demand in the third quarter of each year. Further, the Company anticipates
average selling prices will show modest improvement over the second quarter,
caused by recently announced price increases. Much of the price improvement is
expected to offset the rising cost of recycled ferrous metal and seasonal
increases in energy costs. The Company anticipates that this business segment
will be near break-even from an operating income perspective in the third
quarter.
Overall, the Company estimates third quarter operating income will be in the $17
to $19 million range. The Company anticipates that its effective tax rate will
continue to benefit from net operating loss carryforwards that were acquired as
part of an earlier acquisition. This, as well as existing state tax credits,
should result in an effective tax rate in the mid to high twenty percent range.
FACTORS THAT COULD AFFECT FUTURE RESLTS. Management's Discussion and Analysis of
Financial Condition and Results of Operations, particularly "Outlook" above,
contains forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Act of 1934, that are
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. One can generally identify these forward-looking statements
because they contain "expect", "believe" and other words which convey a similar
meaning. One can also identify these statements as they do not relate strictly
to historical or current facts. Examples of factors affecting Schnitzer Steel
Industries, Inc.'s consolidated operations and its joint ventures (the Company)
that could cause actual results to differ materially are the following:
Cyclicality and General Market Considerations:
- ---------------------------------------------
Selling prices for recycled metals are highly cyclical in nature and subject to
worldwide economic conditions. In addition, the cost and availability of
recycled metals are subject to volatile supply and demand conditions beyond the
Company's control, resulting in periodic fluctuations in recycled metals prices.
While the Company attempts to maintain margins by responding to changing
recycled metals selling prices through adjustments to its metals purchase
prices, the Company's ability to do so is limited by competitive factors as well
as the impact of lower prices on the volume of scrap available to the Company.
Moreover, increases in recycled metals prices can adversely affect the operating
results of the Company's Steel Manufacturing Business because increases in steel
prices generally lag increases in ferrous recycled metals prices.
24
SCHNITZER STEEL INDUSTRIES, INC.
The steel industry is also highly cyclical in nature and sensitive to general
economic conditions. Future economic downturns or a stagnant economy may
adversely affect the performance of the Company.
The Company expects to continue to experience seasonal fluctuations in its
revenues and net income. Revenues can fluctuate significantly quarter to quarter
due to factors such as the seasonal slowdown in the construction industry, which
is an important buyer of the Company's finished steel products. The timing and
extent of the slowdown is also dependent on the weather.
The Company makes a number of large ferrous recycled metals shipments to foreign
steel producers each year. Customer requirements, shipping schedules and other
factors limit the Company's control over the timing of these shipments.
Variations in the number of foreign shipments from quarter to quarter will
result in fluctuations in quarterly revenues and earnings. The Company's
expectations regarding ferrous metal sales prices and volumes, as well as
earnings, are based in part on the assumption that orders from customers for
larger shipments are not cancelled or delayed.
The Auto Parts Business experiences modest seasonal fluctuations in demand. The
retail stores are open to the elements. During periods of extreme temperatures
and precipitation, customers tend to delay their purchases and wait for milder
conditions. As a result, retail sales are generally higher during the spring and
fall of each fiscal year and lower in the winter and summer months.
Competition:
- ------------
The recycled metals industry is highly competitive, with the volume of purchases
and sales subject to a number of competitive factors, principally price. The
Company has competition from both large and numerous smaller companies in its
markets for the purchase of recyclable metals. The Company competes with a
number of domestic and foreign recycled metals processors for sales to foreign
customers. In the recent past lower cost ferrous recycled metals supplies from
the countries of the former Soviet Union have adversely affected the Company's
ferrous recycled metals selling prices and volumes. Currently, those countries
have export tariffs and some outright export bans which have significantly
reduced their export volumes and lowered the worldwide supply of ferrous
recycled metals. These tariffs and bans have had a positive effect on the
Company's selling prices and volumes. However, the Company cannot predict when
or if the countries of the former Soviet Union will change their export policies
and what effect, if any, such changes might have on the Company's operating
results.
The domestic steel industry also is highly competitive. Steel prices can be
highly volatile and price is a significant competitive factor. The Company
competes with several steel producers in the Western United States for sales of
its products. In addition, in recent years, the Company has experienced
significant foreign competition, which is sometimes subsidized by large
government agencies. There can be no assurance that such competition will not
increase in the future. In March and April 2002, the ITC imposed tariffs on
imported steel, under Section 201 of the 1974 Trade Act, to temporarily aid the
domestic steel industry. Recently, these tariffs were found to be in violation
of global trade rules by a World Trade Organization ("WTO") dispute panel.
However, a final report has not been issued and it is expected that the ITC
would appeal the decision. To date, those tariffs have not significantly
benefited selling prices for finished steel products, however, the Company
cannot predict the outcome of the WTO decision. In October 2002, the ITC
announced duty margins of up to 360% and subsidy rates of up to 18% against wire
rod products from eight foreign countries. The Company cannot, however, predict
the impact of these duty margins and subsidy rates on prices and operating
results. In December 2002, Nucor Corporation assumed ownership of the assets of
Birmingham Steel Corp., a steel manufacturing business in Seattle, Washington.
Nucor Corporation has a significant share of the West Coast finished steel
market and is considered an aggressive competitor. The impact, if any, that
Nucor's ownership and operation of Birmingham Steel's Seattle facility will have
on the Steel Manufacturing Business' and the Metals Recycling Business'
operating results cannot be determined at this time.
The Auto Parts Business competes with both full-service and self-service auto
dismantlers as well as larger well financed retail auto parts businesses for
retail customers. Also, the business competes for its automobile inventory
25
SCHNITZER STEEL INDUSTRIES, INC.
with other dismantlers, used car dealers, auto auctions and metal recyclers.
Inventory costs can fluctuate significantly depending on market conditions and
prices for recycled metal.
Joint Ventures:
- ---------------
The Company has significant investments in joint venture companies. The Company
does not manage the day-to-day activities of these businesses. As a result, it
does not have the same ability to control the operations and related financial
results as it does with its consolidated businesses. These businesses are,
however, affected by many of the same risk factors mentioned above. Therefore,
it is difficult to predict the financial results of these businesses.
Energy Supply:
- --------------
The Company and its joint ventures utilize various energy sources to operate
their facilities. In particular, electricity and natural gas currently represent
approximately 13% of the cost of steel manufactured for the Company's Steel
Manufacturing Business. The Steel Manufacturing Business purchases electric
power under a long-term contract from McMinnville Water & Light (McMinnville)
which in turn relies on the Bonneville Power Administration (BPA). Historically,
these contracts have had favorable prices and are long-term in nature. The
Company has a five-year contract that expires in September 2006. On October 1,
2001, the BPA increased its electricity rates due to increased demand on the
West Coast and lower supplies. This increase was in the form of a Cost Recovery
Adjustment Clause (CRAC) added to BPA's contract with McMinnville. The CRAC is
an additional monthly surcharge on selected power charges to recover costs
associated with buying higher priced power during the West Coast power shortage.
Because the BPA can adjust the CRAC every six months, it is not possible to
predict future rate changes.
The Steel Manufacturing Business also has long-term contracts for natural gas.
In October 2000, the Company entered into a new contract set to expire on
October 31, 2003. The latest contract negotiations resulted in rates that were
30% higher then the previous agreement. As this contract comes to an end, the
Company will attempt to negotiate a new long-term contract; however, it is not
possible to predict the terms of the contract.
The inability of the Company to negotiate favorable terms of electricity,
natural gas and other energy sources could adversely affect the performance of
the Company.
Tax Laws:
- ---------
The Company has been able to reduce its effective tax rate below the federal
statutory tax rate for each of the last three years by using a combination of
Net Operating Loss Carryforwards (NOLs), State of California Enterprise Zone tax
credits and Foreign Sales Corporations or Extraterritorial Income Exclusions.
The Company cannot predict how future tax law changes might affect the Company's
effective tax rate.
Shipping and Handling:
- ----------------------
Both the Metals Recycling Business and the Steel Manufacturing Business often
rely on third parties to handle and transport their products to end users in a
timely manner. The cost to transport the products, in particular by ocean
freight, can be affected by circumstances over which the Company has no control
such as fuel prices, political events, governmental regulations on
transportation and changes in market rates due to carrier availability.
Insurance:
- ----------
The cost of the Company's insurance is affected not only by its own loss
experience but also by cycles in the insurance market. Though the Company's loss
record and relationship with its underwriters is good, it cannot predict future
events and circumstances which could cause rates to materially change such as
war, terrorist activities or natural disasters.
Pick-n-Pull Acquisition:
- ------------------------
The Company has previously issued forward looking statements predicting that the
Pick-n-Pull acquisition will be accretive to the Company's earnings. However,
this business is subject to a number of risks that could prevent it from
maintaining or exceeding its current levels of profitability, such as volatile
supply and demand conditions affecting prices and volumes in the markets for its
products, services and raw materials; environmental issues; local and worldwide
economic conditions; increased competition; purchase accounting assumptions
surrounding intangibles and goodwill; and business integration and management
transition issues.
26
SCHNITZER STEEL INDUSTRIES, INC.
One should understand that it is not possible to predict or identify all factors
that could cause actual results to differ from the Company's forward-looking
statements. Consequently, the reader should not consider any such list to be a
complete statement of all potential risks or uncertainties. Further, the Company
does not assume any obligation to update any forward-looking statement.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company periodically uses derivative financial instruments to limit exposure
to changes in interest rates. Because such derivative instruments are used
solely as hedges and not for speculative trading purposes, they do not represent
incremental risk to the Company. For further discussion of derivative financial
instruments, refer to "FAIR VALUE OF FINANCIAL INSTRUMENTS" in the consolidated
Financial Statements included in Item 8 of Form 10-K for the fiscal year ended
August 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
Schnitzer Steel Industries, Inc. management, including the Chief Executive
Officer and Chief Financial Officer, has conducted an evaluation of the
effectiveness of disclosure controls and procedures pursuant to Exchange Act
Rule 13a-15 within 90 days of the filing of this report. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the disclosure controls and procedures are effective in ensuring that all
material information required to be filed in this quarterly report has been made
known to them in a timely fashion. There have been no significant changes in
internal controls, or in factors that could significantly affect internal
controls, subsequent to the date the Chief Executive Officer and Chief Financial
Officer completed their evaluation.
27
SCHNITZER STEEL INDUSTRIES, INC.
PART II
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The 2003 annual meeting of the shareholders was held on January 27,
2003. Holders of 4,175,537 shares of the Company's Class A common
stock, entitled to one vote per share, and 3,499,638 shares of the
Company's Class B common stock, entitled to ten votes per share, were
present in person or by proxy at the meeting.
(b) Leonard Schnitzer, Robert W. Philip, Kenneth M. Novack, Gary Schnitzer,
Dori Schnitzer, Carol S. Lewis, Scott Lewis, Jean S. Reynolds, Robert
S. Ball, William A. Furman, and Ralph R. Shaw were elected directors of
the Company.
(c) The meeting was called for the following purposes:
1. To elect Leonard Schnitzer, Robert W. Philip, Kenneth M.
Novack, Gary Schnitzer, Dori Schnitzer, Carol S. Lewis, Scott
Lewis, Jean S. Reynolds, Robert S. Ball, William A. Furman,
and Ralph R. Shaw as directors of the Company.
This proposal was approved as follows:
Votes For Votes Withheld
--------- --------------
Leonard Schnitzer 37,846,199 1,325,718
Robert W. Philip 37,847,685 1,324,232
Kenneth M. Novack 37,845,933 1,325,984
Gary Schnitzer 37,847,588 1,324,329
Dori Schnitzer 39,084,341 87,576
Carol S. Lewis 39,086,786 85,131
Scott Lewis 39,085,696 86,221
Jean S. Reynolds 39,086,886 85,031
Robert S. Ball 39,086,993 84,924
William A. Furman 39,088,693 83,224
Ralph R. Shaw 39,087,493 84,424
2. To consider a shareholder proposal regarding the composition
of the Board of Directors
This proposal was rejected by the stockholders with 3,177,726
votes cast for and 35,604,161 votes cast against. There were
357,150 abstentions and 635,080 broker non-votes.
28
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(B) REPORTS ON FORM 8-K
The following report was filed on Form 8-K during the fiscal quarter
ended February 28, 2003:
On February 18, 2003, the Company filed a Current Report on Form 8-K
to report under Item 2 the closing on February 14, 2003 of the
Company's acquisition of the Auto Parts Business.
29
SCHNITZER STEEL INDUSTRIES, INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCHNITZER STEEL INDUSTRIES, INC.
(Registrant)
Date: April 11, 2003 By: /s/ Barry A. Rosen
------------------------ ---------------------------------
Barry A. Rosen
Vice President, Finance and Chief
Financial Officer
30
SCHNITZER STEEL INDUSTRIES, INC.
CERTIFICATION
I, Robert W. Philip, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Schnitzer Steel
Industries, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
April 11, 2003
/s/ Robert W. Philip
- -------------------------------------
Robert W. Philip
President and Chief Executive Officer
31
SCHNITZER STEEL INDUSTRIES, INC.
CERTIFICATION
I, Barry A. Rosen, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Schnitzer Steel
Industries, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
April 11, 2003
/s/ Barry A. Rosen
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Barry A. Rosen
Vice President, Finance and Chief Financial Officer
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