================================================================================
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 May 31, 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 5,452,600 shares of Class A Common Stock, par value of $1.00
per share, and 3,986,994 shares of Class B Common Stock, par value of $1.00 per
share, outstanding at July 1, 2003.
================================================================================
SCHNITZER STEEL INDUSTRIES, INC.
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Consolidated Balance Sheet at May 31, 2003 and August 31, 2002 ................3
Consolidated Statement of Operations for the Three Months and
Nine Months Ended May 31, 2003 and 2002 ...................................4
Consolidated Statement of Shareholders' Equity for the Year
Ended August 31, 2002 and the Nine Months Ended May 31, 2003...............5
Consolidated Statement of Cash Flows for the Nine Months Ended
May 31, 2003 and 2002......................................................6
Notes to Consolidated Financial Statements.....................................7
Management's Discussion and Analysis of Financial Condition and
Results of Operations.....................................................17
Quantitative and Qualitative Disclosures about Market Risk....................29
Controls and Procedures.......................................................29
PART II. OTHER INFORMATION
Exhibits and Reports on Form 8-K..............................................30
SIGNATURE PAGE................................................................31
CERTIFICATIONS................................................................32
2
SCHNITZER STEEL INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
May 31, 2003 Aug. 31, 2002
------------ ------------
(Unaudited) (Audited)
ASSETS:
- ------
Current Assets:
Cash $ 1,132 $ 32,974
Accounts receivable, less allowance for
doubtful accounts of $785 and $905 32,853 33,516
Accounts receivable from related parties 472 813
Inventories (Note 2) 70,510 57,917
Deferred income taxes 4,115 3,966
Prepaid expenses and other 4,526 2,521
------------ ------------
Total current assets 113,608 131,707
Net property, plant and equipment 141,900 111,759
Other assets:
Investment in and advances to joint venture partnerships 112,487 96,440
Notes receivables, less current portion 1,666 27,067
Goodwill 106,970 35,754
Other 2,553 2,279
------------ ------------
TOTAL ASSETS $ 479,184 $ 405,006
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current portion of long-term debt $ 220 $ 60,220
Accounts payable 20,273 18,205
Accrued payroll liabilities 6,587 5,887
Current portion of environmental liabilities 2,638 3,030
Other accrued liabilities 7,631 5,014
------------ ------------
Total current liabilities 37,349 92,356
Deferred income taxes 30,860 30,860
Long-term debt, less current portion 104,119 8,305
Environmental liabilities, net of current portion 19,423 18,045
Other long-term liabilities 3,297 2,492
Minority interests 3,336 --
Commitments and contingencies -- --
Shareholders' equity:
Preferred stock--20,000 shares authorized, none issued -- --
Class A common stock--75,000 shares $1 par value
authorized, 5,324 and 5,025 shares issued and outstanding 5,324 5,025
Class B common stock--25,000 shares $1 par value
authorized, 4,070 and 4,180 shares issued and outstanding 4,070 4,180
Additional paid-in capital 98,797 96,074
Retained earnings 172,609 147,669
------------ ------------
Total shareholders' equity 280,800 252,948
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 479,184 $ 405,006
============ ============
The accompanying notes are an integral part of this statement.
3
SCHNITZER STEEL INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF INCOME
(Unaudited, in thousands, except per share amounts)
For The Three Months Ended For The Nine Months Ended
------------------------------ ------------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
Revenues $ 127,944 $ 95,364 $ 343,270 $ 250,560
------------ ------------ ------------ ------------
Costs and expenses:
Cost of goods sold and other operating expenses 105,051 87,644 288,111 233,724
Impairment and other non-recurring charges -- -- 2,100 2,260
Selling and commission expenses 1,369 713 3,827 2,089
General and administrative expenses 8,377 6,743 23,630 19,051
------------ ------------ ------------ ------------
Income (loss) from wholly-owned operations 13,147 264 25,602 (6,564)
Income from joint ventures 8,840 4,599 18,209 13,793
------------ ------------ ------------ ------------
Income from operations 21,987 4,863 43,811 7,229
------------ ------------ ------------ ------------
Other income (expense):
Interest expense (444) (527) (1,134) (1,862)
Other income (expense) (21) (128) (4) 78
------------ ------------ ------------ ------------
(465) (655) (1,138) (1,784)
Income before cumulative effect of change in
accounting principle, income taxes, minority
interests and pre-acquisition interests 21,522 4,208 42,673 5,445
Income tax provision (5,945) (841) (11,462) (1,088)
------------ ------------ ------------ ------------
Income before cumulative effect of change in
accounting principle, minority interests,
and pre-acquisition interests 15,577 3,367 31,211 4,357
Minority interests, net of tax (549) -- (1,350) --
Pre-acquisition interests, net of tax -- -- (2,547) --
------------ ------------ ------------ ------------
Income before cumulative effect of change
in accounting principle 15,028 3,367 27,314 4,357
Cumulative effect of change in accounting principle -- -- (983) --
------------ ------------ ------------ ------------
Net income $ 15,028 $ 3,367 $ 26,331 $ 4,357
============ ============ ============ ============
Net income per share - basic:
Income before cumulative effect of change
in accounting principle $ 1.62 $ 0.37 $ 2.96 $ 0.48
Cumulative effect of change in accounting principle -- -- (0.11) --
------------ ------------ ------------ ------------
Net Income $ 1.62 $ 0.37 $ 2.85 $ 0.48
============ ============ ============ ============
Net income per share - diluted:
Income before cumulative effect of change
in accounting principle $ 1.56 $ 0.36 $ 2.87 $ 0.47
Cumulative effect of change in accounting principle -- -- (0.10) --
------------ ------------ ------------ ------------
Net Income $ 1.56 $ 0.36 $ 2.77 $ 0.47
============ ============ ============ ============
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 189 189 2,723 2,912
Class B common stock converted
to Class A common stock 110 110 (110) (110) --
Net income 26,331 26,331
Dividends paid (1,391) (1,391)
-------- -------- -------- -------- -------- -------- --------
Balance at May 31, 2003 5,324 $ 5,324 4,070 $ 4,070 $ 98,797 $172,609 $280,800
======== ======== ======== ======== ======== ======== ========
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 Nine Months Ended
------------------------------
May 31, 2003 May 31, 2002
------------ ------------
Operations:
Net income $ 26,331 $ 4,357
Noncash items included in income:
Cumulative effect in accounting principle change 983 --
Depreciation and amortization 14,709 14,005
Minority and pre-acquisition interests 5,267 --
Equity in income of joint ventures (18,209) (13,793)
Deferred income taxes (33) (1,343)
(Gain) loss on disposal of assets (106) 858
Cash provided (used) by changes in working capital:
Accounts receivable 1,378 (5,353)
Inventories (10,607) 22,127
Prepaid expenses (3,426) (565)
Accounts payable 1,538 1,747
Accrued liabilities 725 (1,605)
Environmental liabilities 885 (872)
Other assets and liabilities 1,427 2,860
------------ ------------
Net cash provided by operations 20,862 22,423
------------ ------------
Investing:
Capital expenditures (14,810) (7,049)
Investments in subsidiaries (64,923) --
Cash received from joint ventures 260 119,999
Cash used by joint ventures (2,842) (109,167)
Proceeds from sale of assets 577 39
------------ ------------
Net cash provided (used by) investments (81,738) 3,822
------------ ------------
Financing:
Repurchase of Class A common stock -- (1,256)
Issuance of Class A common stock 2,910 558
Distributions to minority and pre-acquisition interests (3,901) --
Dividends declared and paid (1,389) (1,371)
Increase (decrease) in long-term debt 31,414 (10,877)
------------ ------------
Net cash used by financing 29,034 (12,946)
------------ ------------
Net increase (decrease) in cash (31,842) 13,299
Cash at beginning of period 32,974 1,877
------------ ------------
Cash at end of period $ 1,132 $ 15,176
============ ============
The accompanying notes are an integral part of this statement.
6
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED MAY 31, 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 nine months ended May 31, 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 nine month periods ended May 31, 2003, net income was
reduced by $0.5 million and $1.3 million of minority interests, respectively,
net of income taxes, representing the share of income attributable to various
continuing minority partners of the business. Also, for the period from
September 1, 2002 through February 14, 2003, net income was reduced by $2.5
million of pre-acquisition interests, 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 current and prior year amounts have been reclassified to conform to
fiscal 2003 presentation for the periods ending May 31, 2003 & 2002. 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 NINE MONTHS ENDED MAY 31, 2003 AND 2002
The following represents a reconciliation from basic EPS to diluted EPS (in
thousands, except per share amounts):
For the Three Months Ended For the Nine Months Ended
May 31, May 31,
------------------------- -------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(Unaudited)
Income before cumulative effect of accounting change $ 15,028 $ 3,367 $ 27,314 $ 4,357
Cumulative effect of change in accounting principle -- -- (983) --
---------- ---------- ---------- ----------
Net income $ 15,028 $ 3,367 $ 26,331 $ 4,357
========== ========== ========== ==========
Computation of shares:
Average common shares outstanding 9,275 9,134 9,229 9,136
Stock options 389 173 263 98
---------- ---------- ---------- ----------
Diluted average common shares outstanding 9,664 9,307 9,492 9,234
========== ========== ========== ==========
Basic EPS:
Income before cumulative effect of accounting change $ 1.62 $ 0.37 $ 2.96 $ 0.48
Cumulative effect of change in accounting principle -- -- (0.11) --
---------- ---------- ---------- ----------
Net income $ 1.62 $ 0.37 $ 2.85 $ 0.48
========== ========== ========== ==========
Diluted EPS:
Income before cumulative effect of accounting change $ 1.56 $ 0.36 $ 2.87 $ 0.47
Cumulative effect of change in accounting principle -- -- (0.10) --
---------- ---------- ---------- ----------
Net income $ 1.56 $ 0.36 $ 2.77 $ 0.47
========== ========== ========== ==========
Dividend per share $ 0.05 $ 0.05 $ 0.15 $ 0.15
========== ========== ========== ==========
Options to purchase 456,000 and 545,000 shares were outstanding for the three
and nine month periods ended May 31, 2002, respectively, and options to purchase
268,000 shares were outstanding for the nine month period ended May 31, 2003,
but were 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, 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
8
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED MAY 31, 2003 AND 2002
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 for all periods presented (in
thousands, except per share amounts):
For the Three Months Ended For the Nine Months Ended
------------------------- -------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
---------- ---------- ---------- ----------
(Unaudited)
Reported net income $ 15,028 $ 3,367 $ 26,331 $ 4,357
Goodwill amortization, net of tax -- 317 -- 978
---------- ---------- ---------- ----------
Adjusted net income $ 15,028 $ 3,684 $ 26,331 $ 5,335
========== ========== ========== ==========
Reported basic income per share $ 1.62 $ 0.37 $ 2.85 $ 0.48
Goodwill amortization, net of tax -- $ 0.03 -- $ 0.11
---------- ---------- ---------- ----------
Adjusted basic income per share $ 1.62 $ 0.40 $ 2.85 $ 0.59
========== ========== ========== ==========
Reported diluted income per share $ 1.56 $ 0.36 $ 2.77 $ 0.47
Goodwill amortization, net of tax -- $ 0.03 -- $ 0.11
---------- ---------- ---------- ----------
Adjusted diluted income per share $ 1.56 $ 0.39 $ 2.77 $ 0.58
========== ========== ========== ==========
The changes in the carrying amount of goodwill for the nine months ending May
31, 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 May 31, 2003
unaudited $ 34,771 $ -- $ 72,199 $ 106,970
============ ============ ============ ============
STOCK INCENTIVE PLAN:
- ---------------------
The Company records stock-based compensation under the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
(APB25) and related Interpretations. Under this method, compensation expense for
its stock incentive plans is determined using the intrinsic value method.
Accordingly, because the exercise price equals the market price on the date of
the grant, no compensation expense is recognized by the Company for stock
options issued to employees, consultants, and directors.
On December 31, 2002, FASB issued Statement of Financial Accounting Standards
No. 148 (SFAS 148), "Accounting for Stock-Based Compensation - Transition and
Disclosure," which amends Statement of Financial Accounting Standards No. 123
(SFAS 123), "Accounting for Stock-Based Compensation." SFAS No. 148 provides
alternative methods of transition for voluntary change to the fair value method
9
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED MAY 31, 2003 AND 2002
of accounting for stock-based compensation. In addition, SFAS No. 148 requires
more prominent disclosures in both annual and interim financial statements about
the method of accounting for stock-based employee compensation and the effect of
the method used on reported results. At this time, the Company has elected to
adopt the annual and interim disclosure requirements of SFAS No. 148.
Had compensation expense for the Company's stock options been recognized based
upon the estimated fair value on the grant date under the fair value methodology
allowed by SFAS No. 123 (the Company uses the Black-Scholes option pricing
model), as amended by SFAS No. 148, the Company's net income and net income per
share would have been as follows (in thousands, except earnings per share):
Three Months Ended Nine Months Ended
------------------------------ ------------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
Reported net income $ 15,028 $ 3,367 $ 26,331 $ 4,357
Stock compensation expense, net of tax (173) (229) (561) (666)
------------ ------------ ------------ ------------
Pro forma net income $ 14,855 $ 3,138 $ 25,770 $ 3,691
============ ============ ============ ============
Reported basic income per share $ 1.62 $ 0.37 $ 2.85 $ 0.48
Pro forma basic income per share $ 1.60 $ 0.34 $ 2.79 $ 0.40
Reported diluted income per share $ 1.56 $ 0.36 $ 2.77 $ 0.47
Pro forma diluted income per share $ 1.55 $ 0.34 $ 2.75 $ 0.41
Pro forma diluted net income per share for the quarter and nine months ended May
31, 2002 and the nine months ended May 31, 2003 is computed excluding potential
common shares of 456,000, 545,000 and 268,000, respectively, as their effect is
anti-dilutive.
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 statement did not have a
material impact on the consolidated financial statements.
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 superseded 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 statement 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
10
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED MAY 31, 2003 AND 2002
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 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 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 has
determined that it does not have relationships with any entities which meet the
definition of a variable interest entity.
NOTE 2 - INVENTORIES:
Inventories consisted of the following (in thousands):
May 31, August 31,
2003 2002
---------- ----------
(Unaudited) (Audited)
Recycled metals $ 21,952 $ 13,432
Work in process 9,054 6,495
Finished goods 27,312 25,245
Supplies 12,192 12,745
---------- ----------
$ 70,510 $ 57,917
========== ==========
NOTE 3 - BUSINESS COMBINATIONS:
On February 14, 2003, the Company's wholly-owned subsidiary, Norprop, Inc.
("Norprop") 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
11
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED MAY 31, 2003 AND 2002
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 of cash paid to the seller at closing, $3.3 million of debt assumed and
immediately paid off, and $0.7 million of acquisition costs. In addition,
Norprop assumed approximately $12.5 million of debt owed by the Joint Venture to
the Company, bringing the total purchase price to $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 is being 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 $3.7 million of goodwill existed on the
Joint Venture's balance sheet prior to the Acquisition, but the Company's $1.7
million share of this amount 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 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 nine
month periods ended May 31, 2003 and 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).
12
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED MAY 31, 2003 AND 2002
Three Months Ended May 31, Nine Months Ended May 31,
----------------------------- -----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(unaudited) (unaudited) (unaudited) (unaudited)
Net revenues $ 127,944 $ 108,913 $ 343,270 $ 288,087
Net income $ 15,028 $ 4,743 $ 28,878 $ 7,487
Net income per share:
Basic $ 1.62 $ 0.52 $ 3.13 $ 0.82
Diluted $ 1.56 $ 0.51 $ 3.04 $ 0.81
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 27% for the nine months ending May
31, 2003, from 20% 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 - LONG TERM DEBT:
On May 30, 2003, the Company entered into an agreement to refinance its
revolving bank credit facility. The new facility is unsecured, matures in May
2006, totals $150 million and has a varying interest rate. As of June 2, 2003,
the Company had borrowings outstanding under this new facility of $85 million,
and the initial interest rate was 2.82%. The Company also has an additional
unsecured line of credit of $20 million, which is uncommitted. The committed
bank credit facility and other borrowings contain financial covenants. The
Company was in compliance with these covenants at May 31, 2003.
NOTE 6 - 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 1995 Metals Recycling
business acquisition to an unrelated party and recorded a loss of $0.8 million
on the sale.
NOTE 7 - 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
13
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED MAY 31, 2003 AND 2002
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 businesses 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 Nine Months Ended
------------------------------ ------------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
Metals Recycling Business $ 79,318 $ 56,832 $ 210,608 $ 157,955
Steel Manufacturing Business 51,076 49,085 135,177 119,389
Auto Parts Business 17,311 -- 48,205 --
Intersegment revenues (19,761) (10,553) (50,720) (26,784)
------------ ------------ ------------ ------------
Consolidated revenues $ 127,944 $ 95,364 $ 343,270 $ 250,560
============ ============ ============ ============
The joint ventures' revenues from external customers are as follows (in
thousands):
For the Three Months Ended For the Nine Months Ended
------------------------------ ------------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
Joint Ventures in the Metals
Recycling Business:
Processing $ 174,732 $ 103,100 $ 430,249 $ 334,404
Trading 58,088 34,387 151,292 92,641
Joint Venture Suppliers of Metals 1,642 13,111 6,151 41,915
------------ ------------ ------------ ------------
Total revenues $ 234,462 $ 150,598 $ 587,692 $ 468,960
============ ============ ============ ============
14
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED MAY 31, 2003 AND 2002
The Company's income (loss) from operations is as follows (in thousands):
For the Three Months Ended For the Nine Months Ended
------------------------------ ------------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
Metals Recycling Business $ 10,114 $ 3,769 $ 21,568 $ 5,386
Auto Parts Business 5,965 -- 16,074 --
Steel Manufacturing Business (283) (1,339) (2,898) (3,663)
Joint Ventures 8,840 4,599 18,209 13,793
Corporate expense (2,445) (2,169) (6,998) (5,953)
Eliminations (204) 3 (44) (74)
Impairment and other
non-recurring charges -- -- (2,100) (2,260)
------------ ------------ ------------ ------------
Consolidated income
from operations $ 21,987 $ 4,863 $ 43,811 $ 7,229
============ ============ ============ ============
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 Nine Months Ended
------------------------------ ------------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
Joint Ventures in the Metals
Recycling Business $ 1,461 $ 1,505 $ 4,721 $ 4,582
Joint Venture Suppliers of Metals 69 562 213 1,628
------------ ------------ ------------ ------------
Total $ 1,530 $ 2,067 $ 4,934 $ 6,210
============ ============ ============ ============
NOTE 8 - SUBSEQUENT EVENT:
On June 23, 2003, the Company's Board of Directors approved a two for one stock
split, to be effected as a share dividend, for both classes of its common stock.
The share dividend is payable August 14, 2003, to shareholders of record on July
24, 2003.
The following table represents the effect on earnings per share had the stock
split occurred on May 31, 2003:
For the Three Months Ended For the Nine Months Ended
May 31, May 31,
------------------------- -------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(Unaudited)
Income before cumulative effect of accounting change $ 15,028 $ 3,367 $ 27,314 $ 4,357
Cumulative effect of change in accounting principle -- -- (983) --
---------- ---------- ---------- ----------
Net income $ 15,028 $ 3,367 $ 26,331 $ 4,357
========== ========== ========== ==========
Computation of shares - pro forma:
Average common shares outstanding 18,550 18,268 18,458 18,272
Stock options 778 346 526 196
---------- ---------- ---------- ----------
Diluted average common shares outstanding 19,328 18,614 18,984 18,468
========== ========== ========== ==========
15
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED MAY 31, 2003 AND 2002
For the Three Months Ended For the Nine Months Ended
May 31, May 31,
------------------------- --------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(Unaudited)
Pro forma basic EPS;
Income before cumulative effect of accounting change $ 0.81 $ 0.18 $ 1.48 $ 0.24
Cumulative effect of change in accounting principle -- -- (0.05) --
---------- ---------- ---------- ----------
Net income $ 0.81 $ 0.18 $ 1.43 $ 0.24
========== ========== ========== ==========
Pro forma diluted EPS:
Income before cumulative effect of accounting change $ 0.78 $ 0.18 $ 1.44 $ 0.24
Cumulative effect of change in accounting principle -- -- (0.05) --
---------- ---------- ---------- ----------
Net income $ 0.78 $ 0.18 $ 1.39 $ 0.24
========== ========== ========== ==========
Pro forma options to purchase 912,000 and 1,090,000 shares were outstanding for
the three and nine month periods ended May 31, 2002, respectively, and pro forma
options to purchase 536,000 shares were outstanding for the nine month period
ended May 31, 2003, but were not included in the computation of pro forma
diluted earnings per share because the pro forma options' exercise prices were
greater than the average market price of the common shares and, therefore, the
effect would be anti-dilutive.
16
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 one mill depot in Southern California and one in Central
California. The Company's Auto Parts Business purchases used and wrecked
automobiles and allows retail customers the opportunity of extracting parts for
purchase in its self-service auto parts stores, with 17 located in California,
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 nine month periods ended May 31, 2003, net income was
reduced by $0.5 million and $1.3 million of minority interests, respectively,
net of income taxes, representing the share of income attributable to various
continuing minority partners of the business. Also, for the period from
September 1, 2002 through February 14, 2002, net income was reduced by $2.5
million of pre-acquisition interests, 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.
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 Nine Months Ended
----------------------------- -----------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
(Unaudited)
REVENUES:
Metals Recycling Business:
Ferrous sales $ 65,172 $ 43,639 $ 171,732 $ 122,412
Nonferrous sales 12,764 11,633 34,548 30,249
Other sales 1,382 1,560 4,328 5,294
------------ ------------ ------------ ------------
Total sales 79,318 56,832 210,608 157,955
17
SCHNITZER STEEL INDUSTRIES, INC.
For the Three Months Ended For the Nine Months Ended
------------------------------ ------------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
(Unaudited)
Auto Parts Business 17,311 -- 48,205 --
Steel Manufacturing Business 51,076 49,085 135,177 119,389
Intercompany sales eliminations (19,761) (10,553) (50,720) (26,784)
------------ ------------ ------------ ------------
Total $ 127,944 $ 95,364 $ 343,270 $ 250,560
============ ============ ============ ============
INCOME (LOSS) FROM OPERATIONS:
Metals Recycling Business $ 10,114 $ 3,769 $ 21,568 $ 5,386
Auto Parts Business 5,965 -- 16,074 --
Steel Manufacturing Business (283) (1,339) (2,898) (3,663)
Joint Ventures 8,840 4,599 18,209 13,793
Corporate expense (2,445) (2,169) (6,998) (5,953)
Intercompany eliminations (204) 3 (44) (74)
Impairment and other non-recurring charges -- -- (2,100) (2,260)
------------ ------------ ------------ ------------
Total $ 21,987 $ 4,863 $ 43,811 $ 7,229
============ ============ ============ ============
NET INCOME $ 15,028 $ 3,367 $ 26,331 $ 4,357
============ ============ ============ ============
The Joint Ventures' revenues and results of operations were as follows (in
thousands):
For the Three Months Ended For the Nine Months Ended
------------------------------ ------------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
(Unaudited)
Total revenues from external customers recognized by:
Joint Ventures in the Metals Recycling Business
Processing $ 174,732 $ 103,100 $ 430,249 $ 334,404
Trading 58,088 34,387 151,292 92,641
Joint Venture Suppliers of Metals 1,642 13,111 6,151 41,915
------------ ------------ ------------ ------------
Total revenues of Joint Ventures $ 234,462 $ 150,598 $ 587,692 $ 468,960
============ ============ ============ ============
Income from joint ventures recognized by the Company from:
Joint Ventures in the Metals Recycling Business $ 9,117 $ 2,867 $ 18,659 $ 10,273
Joint Venture Suppliers of Metals (277) 1,732 (450) 3,520
------------ ------------ ------------ ------------
Total income from Joint Ventures $ 8,840 $ 4,599 $ 18,209 $ 13,793
============ ============ ============ ============
18
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 Nine Months Ended
----------------------------- -----------------------------
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
(Unaudited)
SHIPMENTS (in thousands):
METALS RECYCLING BUSINESS:
Ferrous recycled metal (long tons):
To Steel Manufacturing Business 144 112 400 303
To other unaffiliated domestic customers 48 13 98 36
To export customers 240 268 784 803
------------ ------------ ------------ ------------
Total ferrous recycled metal 432 393 1,282 1,142
============ ============ ============ ============
Nonferrous metal (pounds) 29,100 30,300 82,800 83,600
============ ============ ============ ============
STEEL MANUFACTURING BUSINESS:
Finished steel products (net tons) 164 169 444 410
============ ============ ============ ============
JOINT VENTURES IN THE METALS RECYCLING BUSINESS:
Ferrous recycled metal (long tons):
Processing 880 897 2,458 2,682
============ ============ ============ ============
Trading 350 336 1,004 834
============ ============ ============ ============
THIRD QUARTER FISCAL 2003 COMPARED TO THIRD QUARTER FISCAL 2002
GENERAL. During the third 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 much of the second and third quarters,
selling prices continued to rise primarily due to the tight supply of ferrous
metal available in the export market and the weakness of the U.S. dollar
relative to other foreign currencies. Demand, which is being fueled primarily by
China and Korea, increased significantly during the second fiscal 2003 quarter
and has declined slightly in the third fiscal 2003 quarter, although it still
remains firm. The market demand weakened slightly in the third fiscal quarter as
customers purchased more in the second quarter in anticipation of the higher
prices. The volumes for the third quarter are still well above those seen in the
prior year. Additionally, continued strong demand for nonferrous recycled
metals, particularly from China, boosted nonferrous metals selling prices.
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. Ocean freight costs rose 36% from the third quarter of last
year, due to the combination of higher fuel prices coupled with the concerns
about the war with Iraq.
The Joint Ventures in the Metals Recycling Business were affected by many of the
same business fundamentals as the Company's wholly-owned Metals Recycling
Business during the third fiscal 2003 quarter.
19
SCHNITZER STEEL INDUSTRIES, INC.
The Steel Manufacturing Business saw higher average selling prices while sales
volumes remained relatively flat during the third quarter of fiscal 2003
compared with the third quarter of fiscal 2002. Sales prices benefited from a
higher valued product sales mix (discussed below) and lower volumes of competing
imported steel, which is partially attributed to the weakness of the U.S.
dollar. Additionally, 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 much of the world's 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 demand as wholesale customers bought inventory ahead of
the effective date for the price increases. Additionally, merchant bar selling
prices have increased modestly industry-wide in order to adjust up to the 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 29% and
9%, respectively, compared with the third 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 Company saw
growth in retail revenue during the third fiscal quarter of 2003 compared to the
third fiscal quarter of 2002. This was primarily driven by growth in parts
sales, as both volumes and prices increased, and in admissions, as the admission
price per customer has increased year to year.
The Auto Parts Business' other primary source of revenue is the sale of scrap
metal and other auto 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 third quarter of
fiscal 2002, which has positively affected the revenues and profits of the Auto
Parts Business.
Net income for the third 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 the Metals Recycling
Business. The Steel Manufacturing Business saw improved margins for the quarter
due to higher sales prices coupled with improvements in production efficiency.
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 May 31, 2003
increased 34% from $95.4 million to $127.9 million compared with the third
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
average selling prices while sales volumes remained relatively flat compared to
the prior year.
20
SCHNITZER STEEL INDUSTRIES, INC.
For the third quarter of fiscal 2003, revenues for the Metals Recycling
Business, before intercompany eliminations, increased $22.5 million (40%)
compared with the third quarter of fiscal 2002 primarily due to higher average
net selling prices per ton and higher ferrous sales volumes. Total ferrous sales
volumes increased by approximately 39,000 tons (10%) due primarily to the market
conditions previously mentioned in the "General" paragraph while ferrous export
sales volumes remained firm. Sales to the Steel Manufacturing Business increased
by 32,000 tons (29%) to 144,000 tons as the steel mill's melt shop ramped up
production, which is in contrast to the production curtailment that occurred
during last year's third quarter. The average sales price, net of shipping costs
(average net sales price), for ferrous metals increased $38 per ton (39%) to
$133 per ton from the third quarter of fiscal 2002 due to the lower supplies of
competing metal in global markets and strong demand in Asia. Nonferrous sales
volume decreased 4% while 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 May 31,
2003 increased $2 million (4%), to $51.1 million compared with the prior year
quarter, reflecting higher average sales prices. Finished steel shipments were
relatively flat compared to the prior year with the average finished steel net
selling price up $19 per ton (7%) to $293 per ton compared with the same quarter
last year. These price increases were driven by the need to offset increased
costs of production. The wire rod average net sales price was up 8% compared
with the third quarter of fiscal 2002, primarily a result of the tariffs imposed
under Section 201 of the Trade Act of 1974 in March and April 2002, as mentioned
in the "General" section. Average rebar selling prices have increased 7% and
merchant bar selling prices have increased 16% from the third fiscal 2002
quarter. These increases were due to market dynamics in which the production
costs for most suppliers were higher than selling prices and selling prices
needed to be adjusted upward. The Company does not believe that the tariffs
imposed under Section 201 of the Trade Act of 1974 mentioned above have
significantly affected the selling prices of rebar and merchant bar.
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
third quarter of 2003 included $17.3 million related to the Auto Parts Business
with no comparable revenues being recognized for financial statement purposes in
the 2002 third quarter. In order to aid the reader's understanding of the
financial performance of this segment, the pro forma fiscal 2002 third quarter
revenues for the Auto Parts Business were $15.5 million. The $1.8 million (12%)
increase was primarily caused by an increase in wholesale revenues driven by
higher sales prices for scrapped auto bodies due to rising ferrous recycled
metal prices. Wholesale prices also benefited from the implementation of a new
distribution center. Retail revenues were also up due to growth in part sales.
COST OF GOODS SOLD. Consolidated cost of goods sold increased $17.4 million
(20%) for the three months ended May 31, 2003, compared with the same period
last year. Cost of goods sold decreased as a percentage of revenues from 92% to
82%. Gross profit increased $15.2 million to $22.9 million during the latest
quarter compared to the prior year quarter as profit margins increased for all
of the Company's wholly-owned business units.
For the Metal Recycling Business, the cost of goods sold as a percentage of
revenues decreased compared with the third quarter of fiscal 2002 from 85% to
82%. Gross profit increased by $6.2 million to $14.5 million. The increase in
gross profit was attributable to higher average net selling prices per ton and
higher sales volumes. Compared with the third quarter of last year, the average
ferrous metals cost of sales per ton increased 31% due primarily to higher
purchase costs for unprocessed ferrous metals. Generally, a change in the cost
of unprocessed metal has a strong correlation to changes in the average selling
price. Thus, as selling prices rose compared with last year's quarter, so did
the cost of unprocessed metal.
For the third quarter of fiscal 2003, cost of goods sold for the Steel
Manufacturing Business increased $0.8 million (2%) compared to the same period
last year and as a percentage of revenues decreased from 101% to 99%. Cost of
goods sold per ton increased 4% due to higher raw material costs. In the third
21
SCHNITZER STEEL INDUSTRIES, INC.
quarter of fiscal 2003, the gross margin was $0.6 million compared with a gross
margin of ($0.5) million in the third quarter of last year. This improvement was
primarily attributable to higher prices and increased production efficiency
offset by higher raw material costs.
The Auto Parts Business' cost of sales was $0.2 million (2%) higher during the
third quarter of fiscal 2003 as compared to the pro forma cost of sales for the
fiscal 2002 quarter due primarily to higher labor costs. During the third
quarter of fiscal 2003, the Auto Parts Business reported operating income of
$6.0 million. On a comparable pro forma basis, this business segment had $4.5
million of operating income during the fiscal 2002 quarter. The higher operating
profits were mainly caused by higher fiscal 2003 wholesale and retail part sales
revenues discussed previously, offset by higher labor costs.
JOINT VENTURES. The Joint Ventures in the Metals Recycling Business
predominantly sell recycled ferrous metal. Revenues for this segment in the
third quarter of fiscal 2003 increased $95.3 million (69%) compared with the
prior year quarter primarily due to 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 54% increase in the average net selling price per ton for ferrous
recycled metals while sales volumes remained relatively flat with the prior
year.
The Company's equity in income from its Joint Ventures in the Metals Recycling
Business for the third quarter of fiscal 2003 increased to $9.1 million from
$2.9 million in the third quarter of fiscal 2002. The increase in income from
these Joint Ventures was primarily caused by the earlier-mentioned 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 $11.5 million
from the third quarter of fiscal 2002 as compared to the 2003 third 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 $3.3 million during the third quarter of
fiscal 2003 compared to the third quarter of last year due to lower selling
prices and lower demolition revenue. For the three months ended May 31, 2003,
the Company's equity in income from these Joint Ventures decreased $0.6 million
primarily due to the slowdown in the U.S. economy.
GENERAL AND ADMINISTRATIVE EXPENSE. Compared with the third quarter of fiscal
2002, general and administrative expense for the same quarter this fiscal year
increased $1.6 million, which was primarily due to the consolidation of the Auto
Parts Business.
INTEREST EXPENSE. Interest expense for the third quarter of fiscal 2003
decreased 16% to $0.4 million compared with the third quarter of fiscal 2002.
The decrease was primarily a result of lower average interest rates during the
fiscal 2003 quarter compared with the fiscal 2002 quarter.
INCOME TAX PROVISION. The tax rate for the third quarter of fiscal 2003 was
approximately 27.6%, compared with a tax rate of 20% for the prior year quarter.
The current quarter rate 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 had 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.
22
SCHNITZER STEEL INDUSTRIES, INC.
FIRST NINE MONTHS OF FISCAL 2003 VS. FIRST NINE MONTHS OF FISCAL 2002
- ---------------------------------------------------------------------
REVENUES. Consolidated revenues for the nine months ended May 31, 2003 increased
$92.7 million (37%) 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 prices for the Steel
Manufacturing Business and the inclusion of the Auto Parts Business as a
consolidated business.
During the nine months ended May 31, 2003, revenues for the Metals Recycling
Business, before intercompany eliminations, increased $52.7 million (33%), which
is attributed to higher sales volumes and higher average ferrous recycled metals
selling prices. Ferrous sales volumes increased by 12% over the 2002 period.
Average sales prices for ferrous metals were up 30% and nonferrous metals were
up 16% compared with the first nine months of fiscal 2002. The higher ferrous
sales volumes were caused by continued firm demand from Asian countries and a
decrease in supply coming from the countries of the former Soviet Union as
discussed in the "General" section.
The Steel Manufacturing Business' revenues for the nine months ended May 31,
2003 increased $15.8 million (13%), to $135.2 million, from the first nine
months of the prior year. The increase in revenues was a result of a 34,000 ton
increase (8%) in overall shipments during the first nine months of fiscal 2003
compared to the prior year primarily due to increased demand for wire rod as 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 and wire rod prices. Merchant bar selling
prices increased 13% from extremely low levels as production costs for most
suppliers were higher than selling prices. Thus, selling prices were adjusted
upward.
Revenues for the Auto Parts Business increased by $6.4 million (15%) for the
first nine months of fiscal 2003 compared to the pro forma revenue of $41.8
million for the same period in 2002. The higher revenues were primarily caused
by an increase in wholesale revenues driven by higher sales prices for scrapped
autobodies due to rising ferrous recycled metal prices, increased part sales
revenues and increased admissions revenues.
COST OF GOODS SOLD. Consolidated cost of goods sold increased by $54.4 million
(23%) for the nine months ended May 31, 2003, compared with the same period last
year. Cost of goods sold decreased as a percentage of revenues from 93% to 84%,
which contributed to a $38.3 million increase in gross profit for the first nine
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, the inclusion of the Auto Parts Business as a consolidated business,
and increased average prices for the Steel Manufacturing Business.
During the first nine months of fiscal 2003, the Metals Recycling Business' cost
of goods sold increased $36.6 million over the prior year. The cost of goods
sold as a percentage of revenues decreased from 88% for the first nine months of
fiscal 2002 to 84% during the first nine months of fiscal 2003. As a result,
gross profit increased by $16.1 million to $34.3 million. The increase in gross
margin in the first nine 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 nine
months of fiscal 2002.
During the first nine months of fiscal 2003, cost of goods sold for the Steel
Manufacturing Business increased $14.9 million compared to the same period last
year and decreased as a percentage of revenues from 101% in the prior year's
first nine months to 100% for the first fiscal nine months ending 2003. Gross
margin improved from a loss of $1.4 million to a loss of $0.5 million compared
with the first nine months of last year. This improvement was attributed to
higher average sales price per ton and lowered fixed cost per ton, due to larger
production volumes spreading the fixed costs over more tons produced.
23
SCHNITZER STEEL INDUSTRIES, INC.
The Auto Parts Business' cost of sales was 3% lower during the first nine months
of fiscal 2003 as compared to pro forma cost of sales for the fiscal 2002 period
due primarily to lower raw material costs offset by higher labor costs.
JOINT VENTURES. For the nine months ended May 31, 2003, revenues for Joint
Ventures in the Metals Recycling Business increased by $154.5 million from the
first nine 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 nine months of fiscal 2003,
income recognized from these joint ventures increased by $8.4 million over the
first nine months of fiscal 2002 to $18.7 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 $13.0 million to
$6.2 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 $0.5 million from a
profit of $0.6 million for the previous year. The reduced profitability was
caused primarily by fewer demolition projects resulting from slower economic
activity.
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's store
locations. No environmental proceedings are pending at any of these sites.
GENERAL AND ADMINISTRATIVE EXPENSE. For the nine months ended May 31, 2003,
general and administrative expense increased $4.6 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 nine months ended May 31, 2003, interest expense
decreased $0.7 million to $1.1 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 and lower interest rates.
INCOME TAX PROVISION. The Company's effective rate of 27% for the first nine
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 had 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 nine months
ended May 31, 2003 was $20.9 million compared with $22.4 million for the same
period in the prior fiscal year. The $1.5 million decrease in cash flow was due
primarily to increases in inventory, which resulted from the timing of large
export sales offset by higher net income in the current year.
Capital expenditures for the nine months ended May 31, 2003 were $14.8 million
compared with $7.0 million for the first nine months of fiscal 2002. The
increase was due primarily 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 $10.2 million
on capital projects during the remainder of fiscal 2003.
24
SCHNITZER STEEL INDUSTRIES, INC.
As a result of acquisitions completed in both the current and prior years, the
Company had $22.1 million of accrued environmental liabilities as of May 31,
2003. The Company expects to require significant future cash outlays as it
incurs the actual costs relating to the remediation of such environmental
liabilities.
On May 30, 2003, the Company entered into an agreement to refinance its
revolving bank credit facility. The new facility is unsecured, matures in May
2006, and provides for up to $150 million of credit availability. The facility's
interest rates vary and the initial borrowing rate under the credit facility was
2.82%. As of June 2, 2003, the Company had borrowings outstanding under this new
facility of $85 million. The Company also has an additional unsecured line of
credit of $20 million, which is uncommitted. The Company's debt agreements have
certain restrictive covenants. As of May 31, 2003, the Company was in compliance
with such covenants and had aggregate bank borrowings outstanding of $96
million.
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 May 31, 2003, the joint ventures were in compliance with
such covenants. Borrowings under the JV Credit Facility totaled $38 million at
May 31, 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 May 31, 2003 (in thousands):
Less than 1-3 4-5 After 5
Total 1 Year Years Years Years
-------- -------- -------- -------- --------
Long-term debt(1) $104,339 $ 250 $ 96,343 $ 46 $ 7,700
Operating leases(2) 112,643 6,205 10,416 6,346 89,676
Letters of credit 1,993 1,993 -- -- --
JV credit facility (50%)(3) 19,000 -- 19,000 -- --
-------- -------- -------- -------- --------
Total $237,975 $ 8,448 $125,759 $ 6,392 $ 97,376
======== ======== ======== ======== ========
(1) The Company has a $150 million credit facility with a group of banks for
working capital and other general purposes. The facility expires in May
2006.
(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 Class A Common stock when the market price of
the Company's stock is not reflective of management's opinion of an appropriate
valuation of the stock. Management believes that repurchasing shares under these
conditions enhances shareholder value. During the first nine months of fiscal
2003, the Company made no share repurchases. As of May 31, 2003, the Company had
repurchased a total of 1.3 million shares under this program.
25
SCHNITZER STEEL INDUSTRIES, INC.
The Company believes that its current cash balance, internally generated funds
and existing 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. In early 2002, certain countries of the former Soviet Union enacted
export tariffs and export bans to restrict the export of recycled metal and
retain the valuable resource to grow their domestic economies. These
restrictions resulted in the market rebounding to more normal conditions that
have not existed since before the 1998 Asian financial crisis. Ferrous export
prices have, for the most part, steadily risen since these restrictions were
enacted and, for a short time in early 2003, spiked to near record highs. Since
then, prices have receded 10-15% from the short-term peaks and have stabilized
for the present. Another factor affecting recent price trends are seasonal
reduction in demand from foreign customers who tend to reduce their finished
steel production during the summer months when energy prices traditionally
spike. However, current selling prices continue to remain significantly above
prices reported a year ago. The cost of unprocessed metals, as well as ocean
freight rates, also appeared to have peaked.
Similar factors are expected to affect our Joint Ventures in the Metals
Recycling Business. In addition, two of these joint ventures continue to use
LIFO inventory accounting, which tends to defer income taxes. Historically, the
affects of LIFO are difficult to predict.
There continue to be signs that the domestic economy is improving, which should
provide needed relief for domestic markets and businesses, including the
Company's Steel Manufacturing Business where end user demand remains poor.
Overall, market prices are expected to hold steady; however, the Company's steel
business should experience modest improvement in its average prices recognized
in the fourth quarter due to the timing of price increases that were announced
earlier in the year, but have not been fully reflected in the average as of the
end of the third quarter. The higher average prices, coupled with lower raw
material costs, should modestly improve margins for this business segment in the
fourth quarter. The anticipated margin expansion is expected to be offset in
part, by seasonal increases in electricity rates. The Company believes this
business segment will report a modest operating profit in the fourth quarter,
which would be the first quarterly operating profit reported since the fourth
quarter of fiscal 2001.
The Auto Parts Business traditionally shows modest declines in retail demand
during the fourth fiscal quarter due to seasonably hot weather during this time
of year. Average retail prices are expected to grow slightly from last year's
fourth quarter. Over the last few quarters, wholesale revenues have been
increasing due in part to higher prices paid for dismantled autobodies. It is
expected that dismantled autobody prices will level off and modestly recede in
the fourth quarter.
Overall, the Company estimates fourth quarter operating income, before year-end
LIFO inventory accounting adjustments, to be in the $18 million to $20 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 state tax credits, should result in an effective
annual tax rate in the high twenty percent range.
FACTORS THAT COULD AFFECT FUTURE RESULTS. Management's Discussion and Analysis
of Financial Condition and Results of Operations, particularly "Outlook" above,
contains forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Act of 1934, that are
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. One can generally identify these forward-looking statements
because they contain "expect", "believe" "anticipate", "estimate" and other
words which convey a similar meaning. One can also identify these statements as
they do not relate strictly to historical or current facts. Examples of factors
26
SCHNITZER STEEL INDUSTRIES, INC.
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.
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.
Another factor which may affect revenues relates to the seasonal reduction in
demand from foreign customers who tend to reduce their finished steel production
during the summer months to offset higher energy costs. Also, severe weather
conditions may affect the Company's global market conditions.
The Company makes a number of large ferrous recycled metals shipments to foreign
steel producers each year. Customer requirements, shipping schedules and other
factors limit the Company's control over the timing of these shipments.
Variations in the number of foreign shipments from quarter to quarter will
result in fluctuations in quarterly revenues and earnings. The Company's
expectations regarding ferrous metal sales prices and volumes, as well as
earnings, are based in part on a number of assumptions (for example,
uncertainties relating to customer orders, metal availability, and production
output, etc.).
The Auto Parts Business experiences modest seasonal fluctuations in demand. The
retail stores are open to the elements. During periods of extreme temperatures
and precipitation, customers tend to delay their purchases and wait for milder
conditions. As a result, retail sales are generally higher during the spring and
fall of each 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.
In June 2003, Oregon Steel Mills, Inc. shut down its Portland melt shop for the
third time this calendar year. Although this is considered to be temporary, a
restart date has not been announced. This closure is expected to reduce the
demand for unprocessed metal in the Portland, Oregon market.
27
SCHNITZER STEEL INDUSTRIES, INC.
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 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. Additionally, two of these joint ventures continue
to use LIFO inventory accounting, which tends to defer income taxes.
Historically, the effects of LIFO adjustments are difficult to predict.
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 10% 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. 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.
28
SCHNITZER STEEL INDUSTRIES, INC.
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.
Currency Fluctuations: Demand from the Company's foreign customers is partially
driven by foreign currency fluctuations relative to the U.S. dollar. The Company
has no control over such fluctuations and, as such, these dynamics could affect
the Company's revenues and earnings.
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.
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.
29
SCHNITZER STEEL INDUSTRIES, INC.
PART II
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
10.1 Credit Agreement dated May 30, 2003 between the
Registrant, Bank of America, NA, and the Other Lenders
Party Thereto.
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 reports were filed on Form 8-K during the fiscal
quarter ended May 31, 2003:
On April 3, 2003, the Company filed a Current Report on Form
8-K, to report under Item 9, pursuant to Item 12, the issuance
of a press release announcing financial results for the
Company's quarter and six months ended February 28, 2003, and
Item 7, Financial Statements and Exhibits.
On April 25, 2003, the Company filed a Current Report on Form
8-K/A, Amendment No. 1, to report under Item 2, the closing on
February 14, 2003 of the Company's acquisition of the Auto
Parts Business, and Item 7, Financial Statements, Pro Forma
Financial Information and Exhibits.
30
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: July 14, 2003 By: /s/ Barry A. Rosen
----------------- -----------------------------------
Barry A. Rosen
Vice President,
Finance and Chief Financial Officer
31
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 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.
July 14, 2003
/s/ Robert W. Philip
- --------------------
Robert W. Philip
President and Chief Executive Officer
32
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.
July 14, 2003
/s/ Barry A. Rosen
- ------------------
Barry A. Rosen
Vice President, Finance and Chief Financial Officer
33