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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended February 29, 2004
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to .
------- -------
Commission files 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 [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [X] No [_]
The Registrant had 21,098,389 shares of Class A Common Stock, par value of $1.00
per share, and 8,965,079 shares of Class B Common Stock, par value of $1.00 per
share, outstanding at April 1, 2004.
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SCHNITZER STEEL INDUSTRIES, INC.
INDEX
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PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets
at February 29, 2004 and August 31, 2003................................... 3
Condensed Consolidated Statement of Operations
for the Three Months and Six Months Ended
February 29, 2004 and February 28, 2003.................................... 4
Condensed Consolidated Statement of Shareholders' Equity
for the Year Ended August 31, 2003 and the Six Months
Ended February 29, 2004.................................................... 5
Condensed Consolidated Statement of Cash Flows
for the Six Months Ended February 29, 2004 and
February 28, 2003.......................................................... 6
Notes to Condensed Consolidated Financial Statements.......................... 7
Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................15
Quantitative and Qualitative Disclosures about Market Risk....................28
Controls and Procedures.......................................................29
PART II. OTHER INFORMATION
Submission of Matters to a Vote of Security Holders...........................30
Exhibits and Reports on Form 8-K..............................................31
SIGNATURE PAGE................................................................32
2
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except per share amounts)
Feb. 29, 2004 Aug. 31, 2003
------------- -------------
Assets
------
Current Assets:
Cash and equivalents $ 13,199 $ 1,687
Accounts receivable, less allowance for doubtful
accounts of $843 and $712 34,653 38,428
Accounts receivable from related parties 44 555
Inventories (Note 2) 52,960 61,143
Deferred income taxes 4,595 4,524
Prepaid expenses and other 2,160 7,400
------------- -------------
Total current assets 107,611 113,737
Net property, plant and equipment 142,509 141,224
Other assets:
Investment in and advances to joint venture partnerships 133,993 119,066
Goodwill 118,021 107,209
Intangibles and other 9,097 6,658
------------- -------------
$ 511,231 $ 487,894
============= =============
Liabilities and Shareholders' Equity
------------------------------------
Current liabilities:
Current portion of long-term debt $ 232 $ 220
Accounts payable 23,931 21,537
Accrued payroll liabilities 8,709 8,896
Current portion of environmental liabilities 10,600 4,639
Other accrued liabilities 7,369 6,004
------------- -------------
Total current liabilities 50,841 41,296
Deferred income taxes 22,521 33,093
Long-term debt, less current portion 82,919 87,045
Environmental liabilities, net of current portion 10,301 17,139
Other long-term liabilities 2,778 2,704
Minority interests 4,107 3,620
Commitments and contingencies -- --
Shareholders' equity:
Preferred stock--20,000 shares authorized, none issued -- --
Class A common stock-75,000 shares $1 par value
authorized, 21,098 and 12,445 shares issued and outstanding 21,098 12,445
Class B common stock--25,000 shares $1 par value
authorized, 8,965 and 7,061 shares issued and outstanding 8,965 7,061
Additional paid-in capital 108,752 104,249
Retained earnings 198,949 179,242
------------- -------------
Total shareholders' equity 337,764 302,997
------------- -------------
$ 511,231 $ 487,894
============= =============
The accompanying notes are an integral part of this statement.
3
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited, in thousands, except per share amounts)
For The Three Months Ended For The Six Months Ended
Feb. 29, Feb. 28, Feb. 29, Feb. 28,
2004 2003 2004 2003
--------- --------- --------- ---------
Revenues $ 161,603 $ 124,659 $ 289,979 $ 215,326
Cost and expenses:
Cost of goods sold and other operating expenses 135,631 106,156 242,329 182,949
Impairment and other non-recurring charges -- 2,100 -- 2,100
Selling and commission expenses 1,106 1,257 2,384 2,442
General and administrative expenses 9,333 8,043 17,565 15,147
--------- --------- --------- ---------
Income from consolidated operations 15,533 7,103 27,701 12,688
Income from joint ventures 8,684 6,194 14,621 9,369
--------- --------- --------- ---------
Income from operations 24,217 13,297 42,322 22,057
Other income (expense):
Interest expense (486) (310) (926) (690)
Other income (expense) (50) (27) 154 (216)
--------- --------- --------- ---------
(536) (337) (772) (906)
Income before cumulative effect of change in accounting
principle, income taxes, minority interests and
pre-acquisition interests 23,681 12,960 41,550 21,151
Income tax provision (4,582) (3,502) (9,764) (5,517)
--------- --------- --------- ---------
Income before cumulative effect of change in accounting
principle, minority interests, and pre-acquisition
interests 19,099 9,458 31,786 15,634
Minority interests, net of tax (550) (354) (1,060) (801)
Pre-acquisition interests, net of tax -- (695) -- (2,547)
--------- --------- --------- ---------
Income before cumulative effect of change in accounting
principle 18,549 8,409 30,726 12,286
Cumulative effect of change in accounting principle -- -- -- (983)
--------- --------- --------- ---------
Net income $ 18,549 $ 8,409 $ 30,726 $ 11,303
========= ========= ========= =========
Net income per share - basic:
Income before cumulative effect of change in
accounting principle $ 0.62 $ 0.30 $ 1.03 $ 0.45
Cumulative effect of change in accounting principle -- -- -- (0.04)
--------- --------- --------- ---------
Net Income $ 0.62 $ 0.30 $ 1.03 $ 0.41
========= ========= ========= =========
Net income per share - diluted:
Income before cumulative effect of change
in accounting principle $ 0.60 $ 0.30 $ 0.99 $ 0.44
Cumulative effect of change in accounting principle -- -- -- (0.04)
--------- --------- --------- ---------
Net Income $ 0.60 $ 0.30 $ 0.99 $ 0.40
========= ========= ========= =========
The accompanying notes are an integral part of this statement.
4
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands)
(unaudited)
Class A Class B
Common Stock Common Stock Additional
--------------------------------------- Paid-in Retained
Shares Amount Shares Amount Capital Earnings Total
------- --------- ------- --------- ---------- ---------- ----------
Balance at August 31, 2002 5,025 $ 5,025 4,180 $ 4,180 $ 96,074 $ 147,669 $ 252,948
Class B common stock converted
to Class A common stock 635 635 (635) (635) --
Class A common stock issued 547 547 8,175 8,722
Net income 43,201 43,201
Stock dividend 6,238 6,238 3,516 3,516 (9,754) --
Cash dividends - common ($0.10 per share) (1,874) (1,874)
------- --------- ------- --------- ---------- ---------- -----------
Balance at August 31, 2003 12,445 12,445 7,061 7,061 104,249 179,242 302,997
Class B common stock converted
to Class A common stock 1,083 1,083 (1,083) (1,083) --
Class A common stock issued 538 538 4,503 5,041
Net income 30,726 30,726
Stock dividend 7,032 7,032 2,987 2,987 (10,019) --
Cash dividends - common ($0.03 per share) (1,000) (1,000)
------- --------- ------- --------- ---------- ---------- ----------
Balance at February 29, 2004 21,098 $ 21,098 8,965 $ 8,965 $ 108,752 $ 198,949 $ 337,764
======= ========= ======= ========= ========== ========== ==========
The accompanying notes are an integral part of this statement.
5
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
For The Six Months Ended
------------------------
Feb. 29, Feb. 28,
2004 2003
---------- ----------
Operations:
Net income $ 30,726 $ 11,303
Noncash items included in income:
Cumulative effect of change in accounting principle -- 983
Depreciation and amortization 10,057 9,918
Minority and pre-acquisition interests 1,387 4,524
Equity in income of joint ventures (14,621) (9,369)
Deferred income tax (10,643) (34)
(Gain) Loss on disposal of assets (196) 18
Cash provided (used) by changes in working capital:
Accounts receivable 4,286 (1,496)
Inventories 8,183 (7,142)
Prepaid expenses and other 5,240 (1,666)
Accounts payable 2,394 2,821
Accrued liabilities 915 (67)
Environmental liabilities (877) 1,414
Other assets and liabilities (436) 1,240
---------- ----------
Net cash provided by operations 36,415 12,447
---------- ----------
Investing:
Capital expenditures (10,941) (10,121)
Investment in subsidiaries (13,083) (64,923)
Cash received from joint ventures 363 233
Cash paid to joint ventures (745) (945)
Proceeds from sale of assets 476 577
---------- ----------
Net cash used by investments (23,930) (75,179)
---------- ----------
Financing:
Issuance of Class A common stock 5,041 46
Distributions to minority and pre-acquisition interests (900) (3,620)
Dividends declared and paid (1,000) (921)
Decrease in long-term debt (4,114) 37,848
---------- ----------
Net cash provided (used) by financing (973) 33,353
---------- ----------
Net increase (decrease) in cash 11,512 (29,379)
Cash at beginning of period 1,687 32,974
---------- ----------
Cash at end of period $ 13,199 $ 3,595
========== ==========
The accompanying notes are an integral part of this statement.
6
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
- ---------------------
The accompanying unaudited condensed interim financial statements of Schnitzer
Steel Industries, Inc. (the Company) have been prepared pursuant to the rules
and regulations of the Securities and Exchange Commission (SEC). Certain
information and note disclosures normally included in annual financial
statements have been condensed or omitted pursuant to those rules and
regulations. The condensed unaudited balance sheet for the year ended August 31,
2003 is derived from the audited balance sheet for the year ended August 31,
2003. 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, 2003. The results for the three and six months
ended February 29, 2004 and February 28, 2003 are not necessarily indicative of
the results of operations for the entire year.
Note 3 of the Notes to the Condensed 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. 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.
Note 7 of the Notes to the Condensed Consolidated Financial Statements describes
the stock split which was effective March 25, 2004 and is retroactively applied
to the period ended February 29, 2004.
RECLASSIFICATIONS
- -----------------
Certain prior year amounts have been reclassified to conform to the fiscal 2004
presentation. These changes had no impact on previously reported results of
operations or shareholders' equity.
EARNINGS AND DIVIDENDS PER SHARE
- --------------------------------
Basic earnings per share (EPS) are computed based upon the weighted average
number of common shares outstanding during the period. Diluted EPS reflects 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 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
The following represents reconciliation from basic EPS to diluted EPS (in
thousands, except per share amounts):
For the Three Months Ended For the Six Months Ended
----------------------------- -----------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
Income before cumulative effect of change in
accounting principle $ 18,549 $ 8,409 $ 30,726 $ 12,286
Cumulative effect of change in accounting
principle -- -- -- (983)
------------ ------------ ------------ ------------
Net income $ 18,549 $ 8,409 $ 30,726 $ 11,303
============ ============ ============ ============
Computation of shares (1):
Average common shares outstanding 30,021 27,618 29,800 27,615
Stock options 1,083 741 1,245 594
------------ ------------ ------------ ------------
Diluted average common shares outstanding 31,104 28,359 31,045 28,209
============ ============ ============ ============
Basic EPS:
Income before cumulative effect of change
in accounting principle $ 0.62 $ 0.30 $ 1.03 $ 0.45
Cumulative effect of change in accounting
principle -- -- -- (0.04)
------------ ------------ ------------ ------------
Net income $ 0.62 $ 0.30 $ 1.03 $ 0.41
============ ============ ============ ============
Diluted EPS:
Income before cumulative effect of change
in accounting principle $ 0.60 $ 0.30 $ 0.99 $ 0.44
Cumulative effect of change in accounting
principle -- -- -- (0.04)
------------ ------------ ------------ ------------
Net income $ 0.60 $ 0.30 $ 0.99 $ 0.40
============ ============ ============ ============
Dividend per share(1) $ 0.017 $ 0.017 $ 0.033 $ 0.033
============ ============ ============ ============
(1) Basic and diluted earnings per share and dividends per common share for the
three and six months ended February 28, 2003, have been adjusted to reflect
the one-for-one share dividend paid on August 14, 2003, to shareholders of
record on July 24, 2003. Additionally, the per share data for all periods
have been adjusted retroactively to reflect the three-for-two stock split
paid March 25, 2004, to shareholders of record on March 4, 2004.
Options to purchase 1,305,000 shares were outstanding at February 28, 2003, but
are 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. All of the
options for fiscal 2004 are considered to be dilutive and are reflected in the
above table.
STOCK INCENTIVE PLAN
- --------------------
The Company's compensation expense for its stock incentive plans is determined
using the intrinsic value method. Accordingly, because the exercise price
generally 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. If the fair value based method had been applied in
measuring stock compensation expense, the pro forma effect on net income per
share would have been as follows (in thousands, except earnings per share):
8
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
Reported net income $ 18,549 $ 8,409 $ 30,726 $ 11,303
Stock compensation expense, net of tax (266) (151) (266) (295)
------------ ------------ ------------ ------------
Pro forma net income $ 18,283 $ 8,258 $ 30,460 $ 11,008
============ ============ ============ ============
Reported basic income per share $ 0.62 $ 0.30 $ 1.03 $ 0.41
Pro forma basic income per share $ 0.61 $ 0.30 $ 1.02 $ 0.40
Reported diluted income per share $ 0.60 $ 0.30 $ 0.99 $ 0.40
Pro forma diluted income per share $ 0.59 $ 0.29 $ 0.98 $ 0.39
Pro forma diluted net income per share for the quarter ended February 28, 2003
is computed excluding potential common shares of 1,305,000, as their effect is
anti-dilutive. All of the options for fiscal 2004 are considered to be dilutive
and are reflected in the above table.
GOODWILL
The changes in the carrying amount of goodwill for the six months ended February
29, 2004, are as follows (in thousands):
Metals Steel
Recycling Manufacturing Auto Parts
Business Business Business Total
------------ ------------ ------------ ------------
Balance as of August 31, 2003, audited $ 34,771 -- $ 72,438 $ 107,209
Acquisition (Note 3) -- -- 10,812 10,812
------------ ------------ ------------ ------------
Balance as of February 29, 2004, unaudited $ 34,771 $ -- $ 83,250 $ 118,021
============ ============ ============ ============
The Company performs impairments tests annually and whenever events and
circumstances indicate that the value of goodwill and other indefinite-lived
intangible assets might be impaired. As of February 29, 2004, based on the
results of the above business segments and the impairment tests performed, none
of the above balances were impaired.
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
In December 2003, the Financial Accounting Standards Board ("FASB") revised SFAS
No. 132, "Employers' Disclosures about Pensions and Other Post Retirement
Benefits." This revision requires additional disclosures to those in the
original SFAS No. 132 about assets, obligations, cash flows and the periodic
benefit cost of deferred benefit pension plans and other deferred benefit
post-retirement plans. The required information should be provided separately
for pension plans and for other post-retirement benefit plans. This statement
revision is effective for the fiscal years ended after December 14, 2003 and
interim periods beginning after December 15, 2003. The interim disclosure
requirements are effective for the Company's third fiscal quarter ending May 31,
2004. Additionally, it is anticipated that this revised pronouncement will not
have a material impact on the consolidated financial statements.
9
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
NOTE 2 - INVENTORIES:
Inventories consisted of the following (in thousands):
February 29, August 31,
2004 2003
------------ ------------
(Unaudited) (Audited)
Recycled metals $ 16,394 $ 21,115
Work in process 5,830 8,254
Finished goods 18,192 19,912
Supplies 12,544 11,862
------------ ------------
$ 52,960 $ 61,143
============ ============
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
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, $0.6 million of acquisition costs and $0.5 million of tax
related expenses. In addition, Norprop assumed approximately $12.5 million of
debt owed by the Joint Venture to the Company. Two additional payments have been
made during fiscal 2004. The first payment of $4.7 million was made during the
fiscal quarter ended November 30, 2003, as a result of an amendment to the
Purchase Agreement. The second and final payment of $7.1 million was made during
the fiscal quarter ended February 29, 2004, and relates to 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. The total purchase price was $100.1 million (or
$96.5 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 network. At the
time of this acquisition, there were 23 store locations, 17 in northern
California, two in Nevada, and one in each of Texas, Utah, Illinois and Indiana.
The Company has since expanded its operations into Canada, with the purchase of
three stores in an unrelated transaction which is described in Note 7 -
Subsequent Events in the Notes to the Condensed Consolidated Financial
Statements. This additional purchase brings the total number of stores to 26.
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 $ 13.3
Identified intangible assets 3.7
Other assets 5.4
Liabilities (3.8)
Goodwill 81.5
------------
Total $ 100.1
============
Goodwill of $81.5 million represents the excess of purchase price over the fair
value of the net tangible and identified intangible assets acquired, and, as a
result of a tax election filed jointly by the Company and seller, substantially
all of it will be deductible for tax purposes over a 15-year period. Also,
approximately $1.8 million of goodwill existed on the Joint Venture's balance
sheet prior to the Acquisition but was not shown separately in accordance with
the equity method of accounting. Therefore, the total increase to goodwill
related to the Acquisition was $83.3 million. In accordance with Statement of
Financial Accounting Standards No. 142,
10
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
"Goodwill and Other Intangible Assets," goodwill is not amortized and will be
tested for impairment at least annually.
NOTE 4 - SEGMENT INFORMATION:
The Company operates in three industry segments: metal processing and recycling
(Metals Recycling Business), mini-mill steel manufacturing (Steel Manufacturing
Business) and self-service used retail auto parts (Auto Parts Business).
Additionally, the Company is a non-controlling partner in joint ventures, which
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 (Brokering). The Company considers these joint
ventures to be separate segments because they are managed separately. These
joint ventures are accounted for using the equity method. As such, the operating
information related to the joint ventures is shown separately from consolidated
information, except for the Company's equity in the net income of, investments
in and advances to the joint ventures. Additionally, assets and capital
expenditures are not shown for the joint ventures as management does not use
that information to allocate resources or assess performance. The Company does
not allocate corporate interest income and expense, income taxes or other income
and expenses related to corporate activity to its operating segments.
Revenues from external customers for the Company's consolidated operations are
as follows (in thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
Metals Recycling Business $ 109,327 $ 85,716 $ 188,929 $ 131,290
Steel Manufacturing Business 59,861 41,271 113,080 84,101
Auto Parts Business 17,245 14,755 34,905 30,894
Intersegment revenues (24,830) (17,083) (46,935) (30,959)
------------ ------------ ------------ ------------
Consolidated revenues $ 161,603 $ 124,659 $ 289,979 $ 215,326
============ ============ ============ ============
The joint ventures' revenues from external customers are as follows (in
thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
Joint Ventures in the Metals
Recycling Business:
Processing $ 232,207 $ 153,070 $ 386,213 $ 265,356
Brokering 120,514 42,672 230,460 93,204
Joint Venture Suppliers of Metals 1,678 2,155 4,050 4,949
------------ ------------ ------------ ------------
Total revenues $ 354,399 $ 197,897 $ 620,723 $ 363,509
============ ============ ============ ============
11
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
The Company's income (loss) from operations is as follows (in thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
Metals Recycling Business $ 13,162 $ 8,482 $ 23,085 $ 11,565
Auto Parts Business 5,094 5,021 10,983 10,231
Steel Manufacturing Business 2,691 (1,358) 2,549 (2,615)
Joint Ventures in the Metals Recycling Business 8,990 6,471 15,076 9,542
Joint Venture Suppliers of Metals (306) (277) (455) (173)
Corporate expense (3,018) (2,529) (5,664) (4,553)
Eliminations (2,396) (413) (3,252) 160
Impairment and other non-recurring charges -- (2,100) -- (2,100)
------------ ------------ ------------ ------------
Consolidated income from operations $ 24,217 $ 13,297 $ 42,322 $ 22,057
============ ============ ============ ============
Income from operations generated by the joint ventures represents the Company's
equity in the income or loss of these entities.
The Company's share of depreciation and amortization expense included in the
determination of joint ventures' income from operations is as follows (in
thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
Joint Ventures in the Metals Recycling Business $ 1,729 $ 1,624 $ 3,462 $ 3,260
Joint Venture Suppliers of Metals 59 70 125 144
------------ ------------ ------------ ------------
Total $ 1,788 $ 1,694 $ 3,587 $ 3,404
============ ============ ============ ============
NOTE 5 - INCOME TAX PROVISION:
As part of the 1996 Proler International, Inc. acquisition, the Company acquired
federal income tax net operating loss carryforwards ("NOLs"). As of February 29,
2004, the NOLs totaled $15.3 million and, if not used, will expire in 2015 and
2016. In addition to the expiration dates, the NOLs are subject to annual
limitations of $2.4 million that can be utilized to offset taxable income.
In accordance with generally accepted accounting principles ("GAAP"), the
Company established valuation reserves for the acquired NOLs. The valuation
reserves were required to the extent management believed that it was uncertain
whether the Company's future taxable income, over the life of the NOLs, would be
available to utilize the NOLs. Historically, Management reviewed the need for
valuation reserves on a quarterly basis and released the reserves only to the
extent they felt the uncertainty was mitigated.
During the second quarter of fiscal 2004, management made a determination that
it was more likely than not that the Company's future taxable income would be
available to fully utilize the NOLs. Management's determination was based upon a
number of factors including profitability trends, industry fundamentals and
recent profitable acquisitions. Accordingly, the Company's $6.1 million deferred
tax asset valuation allowance was reversed in this quarter, resulting in a
corresponding reduction in the income tax provision for the three and six month
periods. This reversal, offset in part by a change in the estimate of the tax
benefit from Extraterritorial Income Exclusions, reduced the Company's second
quarter tax rate from approximately 29% to 19%. The change in the Company's GAAP
tax rate associated with the reversal of the valuation reserves had no
12
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
impact on the Company's cash flow; however, the cash taxes paid by the Company
are anticipated to continue to benefit from the NOLs through the year 2016.
NOTE 6 - ENVIRONMENTAL LIABILITIES:
PROLER
- ------
Metals Recycling L.L.C. (Metals) is a scrap metals processing business with
locations in Rhode Island and Massachusetts. The members of Metals are one of
the Company's joint ventures, Proler International Corp. (Proler) and Izzo
Group, Inc. On June 9, 1999, the Rhode Island Department of Environmental
Management (DEM) issued a Notice of Violation (NOV) against Metals, alleging
Metals had violated federal and state regulations relating to the storage,
management and transportation of hazardous waste and seeking to impose an
administrative penalty of $0.7 million. Metals filed an answer to the NOV in
which it denied the allegations and requested an adjudicatory hearing. In
January of 1999, federal and state officials searched Metals' Johnston, Rhode
Island and Worcester, Massachusetts facilities. Metals was advised that the
search was part of a state criminal investigation into possible violations of
state and federal hazardous waste programs and a Rhode Island statute that
prohibits the disposal of out-of-state solid waste at the landfill operated by
Rhode Island Resource Recovery Corporation (RIRRC). A grand jury was empanelled
to consider the allegations and issued an indictment on August 30, 2002 against
Metals for storing hazardous waste without a permit, operating a hazardous waste
disposal facility without a permit, causing transportation of hazardous waste
without a permit, causing transportation of hazardous waste without a manifest
and operating a solid waste management facility without a license. Metals
pleaded not guilty on all counts and vigorously contested the state's
allegations. Settlement discussions with DEM and the Rhode Island Attorney
General's Office resulted in the dismissal with prejudice of the criminal
charges and Metals' settlement of the DEM's civil NOV by payment of $250,000
pursuant to a Consent Agreement entered into on December 4, 2003.
AUTO PARTS BUSINESS
- -------------------
On January 6, 2004, Pick-N-Pull Auto Dismantlers (PNP), one of the Company's
subsidiaries in the Auto Parts Business segment, was served with a Notice of
Violation (NOV) of the general permit requirements on its diesel powered car
crushers at the Rancho Cordova and Sacramento locations from the Sacramento
Metropolitan Air Quality Management District (SMAQMD). The NOV required PNP to
cease operation of the car crushers at these locations. Since receiving this
notification, the Sacramento location has converted its diesel powered car
crusher to electric powered, and the Rancho Cordova location has received an
interim permit from SMAQMD to operate its diesel powered car crusher, with
modifications, for one year. The Company is engaged in an ongoing evaluation of
its car crushing systems and discussions with the SMAQMD to assure compliance
and address the potential regulatory enforcement penalties. The Company is
cooperating with the SMAQMD, but, as this is a new enforcement initiative and a
first time violation, it is difficult to reasonably estimate the amount, if any,
of the penalties. However, the Company accrued an immaterial amount to cover
what it currently believes is the potential exposure in the quarter ending
February 29, 2004.
For further information relating to environmental matters of the Company, Metals
and other joint ventures of Proler, please refer to Note 7 - Environmental
Liabilities in the Notes to the Condensed Consolidated Financial Statements
included in Item 8 of Form 10-K for the fiscal year ended August 31, 2003.
13
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003
NOTE 7 - SUBSEQUENT EVENTS:
ACQUISITION
- -----------
On March 8, 2004, the Company, through its wholly owned subsidiary, PNP Auto
Parts Canada Co., acquired the assets and leased the sites of three self service
used auto parts stores in Calgary and Edmonton, Alberta and Kelowna, British
Columbia from Sheppard Holdings Ltd. of Calgary, Alberta, Canada, or its
affiliates. The three stores currently operate under the name of Pick Your Part.
The purchase and the results of operations for these three stores will be
reflected in the consolidated results of the Company during the third fiscal
2004 quarter.
STOCK SPLIT
- -----------
On January 27, 2004, the Company's Board of Directors approved a three-for-two
stock split, to be effected as a share dividend, for both classes of its common
stock. The share dividend was payable March 25, 2004, to shareholders of record
on March 4, 2004.
14
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company operates in three industry segments. The Company's Metals Recycling
Business collects, processes and recycles steel and other metals through its
facilities. The Company's Steel Manufacturing Business operates a mini-mill near
Portland, Oregon, which melts recycled metal, produces finished steel products
and maintains one mill depot in Southern California and a third party depot 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. The
results do not reflect the recent expansion of the Auto Parts Business into
Canada with the purchase of three stores (see Note 7 - Subsequent Events in the
Notes to the Condensed Consolidated Financial Statements). 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 (Brokering).
RESULTS OF OPERATIONS
The Company's revenues and operating results by business segment are summarized
below (in thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
REVENUES:
Metals Recycling Business:
Ferrous sales $ 95,545 $ 72,630 $ 161,439 $ 106,561
Nonferrous sales 12,078 11,669 24,487 21,784
Other sales 1,704 1,417 3,003 2,945
------------ ------------ ------------ ------------
Total sales 109,327 85,716 188,929 131,290
Auto Parts Business 17,245 14,755 34,905 30,894
Steel Manufacturing Business 59,861 41,271 113,080 84,101
Intercompany sales eliminations (24,830) (17,083) (46,935) (30,959)
------------ ------------ ------------ ------------
Total $ 161,603 $ 124,659 $ 289,979 $ 215,326
============ ============ ------------ ------------
INCOME (LOSS) FROM OPERATIONS:
Metals Recycling Business $ 13,162 $ 8,482 $ 23,085 $ 11,565
Auto Parts Business 5,094 5,021 10,983 10,231
Steel Manufacturing Business 2,691 (1,358) 2,549 (2,615)
Joint Ventures in the Metals Recycling Business 8,990 6,471 15,076 9,542
Joint Venture Suppliers of Metals (306) (277) (455) (173)
Corporate expense (3,018) (2,529) (5,664) (4,553)
Intercompany eliminations (2,396) (413) (3,252) 160
Impairment and other non-recurring charges -- (2,100) -- (2,100)
------------ ------------ ------------ ------------
Total $ 24,217 $ 13,297 $ 42,322 $ 22,057
============ ============ ============ ============
NET INCOME $ 18,549 $ 8,409 $ 30,726 $ 11,303
============ ============ ============ ============
15
SCHNITZER STEEL INDUSTRIES, INC.
The Joint Ventures' revenues and results of operations were as follows (in
thousands):
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
Total revenues from external customers recognized by:
Joint Ventures in the Metals Recycling Business
Processing $ 232,207 $ 153,070 $ 386,213 $ 265,356
Brokering 120,514 42,672 230,460 93,204
Joint Venture Suppliers of Metals 1,678 2,155 4,050 4,949
------------ ------------ ------------ ------------
$ 354,399 $ 197,897 $ 620,723 $ 363,509
============ ============ ------------ ------------
Income (loss) from joint ventures recognized by the Company from:
Joint Ventures in the Metals Recycling Business $ 8,990 $ 6,471 $ 15,076 $ 9,542
Joint Venture Suppliers of Metals (306) (277) (455) (173)
------------ ------------ ------------ ------------
$ 8,684 $ 6,194 $ 14,621 $ 9,369
============ ============ ============ ============
The following table summarizes certain selected operating data for the Company
and its joint venture businesses:
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
METALS RECYCLING BUSINESS:
Ferrous Recycled Metal Sales Prices ($/ton) (1,2)
Domestic $ 168 $ 108 $ 150 $ 104
Export $ 154 $ 113 $ 150 $ 110
Average $ 158 $ 111 $ 150 $ 108
Ferrous recycled metal shipments
(tons in thousands)(2)
To Steel Manufacturing Business 132 141 290 256
To other unaffiliated domestic customers 14 12 29 49
To export customers 355 402 591 545
------------ ------------ ------------ ------------
Total ferrous recycled metal 501 555 910 850
============ ============ ============ ============
Nonferrous metal shipments (pounds in thousands) 24,900 28,200 53,200 53,700
============ ============ ============ ============
16
SCHNITZER STEEL INDUSTRIES, INC.
For the Three Months Ended For the Six Months Ended
------------------------------ ------------------------------
Feb. 29, 2004 Feb. 28, 2003 Feb. 29, 2004 Feb. 28, 2003
------------ ------------ ------------ ------------
(Unaudited)
STEEL MANUFACTURING BUSINESS:
Sales Prices ($/ton) (1,2)
Rebar $ 354 $ 269 $ 331 $ 271
Other $ 347 $ 299 $ 330 $ 295
Average $ 351 $ 283 $ 331 $ 283
------------ ------------ ------------ ------------
Finished steel products (tons in thousands) (2) 162 137 325 279
============ ============ ============ ============
JOINT VENTURES IN THE METALS RECYCLING BUSINESS:
Ferrous recycled metal shipments
(tons in thousands) (2)
Processed 828 941 1,502 1,577
Brokered 623 304 1,301 774
------------ ------------ ------------ ------------
1,451 1,245 2,803 2,351
============ ============ ============ ============
(1) The Company reports revenues that include shipping costs billed to
customers. However, average net selling prices are shown net of shipping
costs.
(2) Tons for ferrous recycled metals are long tons (2,240 pounds) and for
finished steel products are short tons (2,000 pounds).
SECOND QUARTER FISCAL 2004 COMPARED TO SECOND QUARTER FISCAL 2003
GENERAL. During the second quarter of fiscal 2004, the Metals Recycling Business
and related Joint Ventures continued to experience improved market conditions.
Global demand for ferrous recycled metal has increased primarily due to the
growing Asian economies, in particular, China and worldwide economic
improvements. Throughout fiscal 2003 and into the second quarter of fiscal 2004,
selling prices continued to rise primarily due to strong Asian demand, the tight
supply of ferrous metal available in the export market, rising domestic demand
and the weakness of the U.S. dollar relative to other foreign currencies.
Demand, which is being fueled primarily by China, continues to remain strong. In
2000, China produced an estimated 129 million tons of steel representing 16% of
the world's production. By the end of 2003, China produced an estimated 220
million tons of crude steel representing 23% of the world's total production.
This growing steel production is directly increasing demand and prices for
recycled ferrous metal. Although China is the main driving force behind the
recent strong export demand, the Company is also seeing indications of growing
demand from other customers located in Mexico and other Southeast Asian
countries.
More recently, the Company has experienced increases in demand domestically due
to improvements in the U.S. economy. Overall, domestic market selling prices for
recycled metal rose rapidly in the second fiscal quarter of 2004 due primarily
to the strength in demand from steel manufacturers who saw their finished
product order backlog and prices grow. Fiscal 2004 second quarter average
domestic selling prices actually increased at a greater rate than the average
export selling prices, which was primarily caused by the timing of when orders
are received and shipped. Export orders are typically received 60-90 days ahead
of shipment, whereas domestic sales are typically shipped within 30 days of
order.
Demand for nonferrous recycled metals, particularly from China, continues to be
strong and boosted nonferrous metals selling prices. During the same period, the
cost of unprocessed metal rose as well, which, combined with rising shipping
costs, partially offset the increase in selling prices. Export sales shipping
costs rose 72% from the second quarter of last year, due to the combination of
higher fuel prices and an increase in Asian demand for bulk cargo vessels that
traditionally ship scrap metal and other bulk commodity products.
17
SCHNITZER STEEL INDUSTRIES, INC.
The Joint Ventures in the Metals Recycling Business reported increased profit
primarily as a result of significant margin improvement in the Brokering Joint
Venture that has been growing its market share and is now serving additional
markets and customers. The Processing Joint Ventures reported relatively flat
operating income in the fiscal 2004 second quarter as compared to the prior year
period, and did not experience the same rise in profitability as the Company's
wholly-owned Metals Recycling Business. The Processing Joint Ventures, which are
mainly based in the northeastern U.S. and southern California, experienced
similar gross selling prices (before freight and ship loading costs) as the
Company's west coast based wholly-owned Metals Recycling Business; however, the
east coast based Processing Joint Ventures' export shipping and raw material
costs were significantly higher than was experienced by the west coast
businesses, which compressed margins. In addition, sales volumes from the
Processing Joint Ventures declined 12% from the prior year quarter primarily due
to the fact that last year's second quarter volume was near record levels and
was the result of customer order delays from the first quarter of fiscal 2003.
The Steel Manufacturing Business saw higher average selling prices and higher
sales volumes during the second quarter of fiscal 2004 compared with the second
quarter of fiscal 2003. Domestic steel producers continued to raise selling
prices in an attempt to offset the sharp rise in raw material and energy costs.
Additionally, the Steel Manufacturing Business experienced a shift in sales mix
to higher priced products. Sales prices and volumes also benefited from lower
steel imports, which is partially attributed to the weakness of the U.S. dollar
and higher ocean freight rates. Additionally, sales volumes have increased over
the second quarter of fiscal 2003 due primarily to increases in steel
consumption, industry consolidation and customers' efforts to buy ahead of
announced price increases. Partially offsetting the higher selling prices and
volumes was an increase in the cost of raw materials resulting from increases in
worldwide demand for recycled ferrous metal. The Steel Manufacturing Business
also received $1.8 million during the second quarter of fiscal 2004 as a final
payment regarding an electrode price fixing settlement that was settled in favor
of a number of steel mills, including the Company's steel mill. This amount is
included in income from operations.
The Auto Parts Business continues to experience strong growth in wholesale
revenues, which originate from the sale of scrap metal ("scrap sales") and other
parts wholesale ("core sales"). Scrap sales benefited from rising prices caused
by many of the factors experienced by the Metals Recycling Business. Core sales
also benefited from rising prices which are due to both increased demand and
operational improvements. This increased revenue was partially offset by
increased vehicle purchasing costs and higher labor costs. Retail revenues
increased modestly from the second fiscal 2003 quarter due to increased retail
pricing and volumes. On March 8, 2004, a newly formed Canadian subsidiary of the
Company acquired three stores in Calgary, Edmonton and Kelowna, Canada,
increasing the number of stores in the Auto Parts Business segment to 26. It is
anticipated that the addition of these three stores will positively affect
operating results beginning with the Company's third fiscal quarter of 2004.
Net income for the second quarter of fiscal 2004 compared with the same quarter
in the previous fiscal year benefited from improvements in all of the Company's
business segments. The Metals Recycling Business and the Steel Manufacturing
Business experienced higher operating income due to higher average selling
prices as well as higher sales volumes. The Auto Parts Business saw a modest
increase in operating income. Revenues have increased year over year, with
corresponding increases in vehicle purchase and labor costs, which have
compressed margins. The joint ventures in the metals recycling business also saw
higher income primarily due to growth in market share of the Brokering Joint
Venture.
REVENUES. Consolidated revenues for the quarter ended February 29, 2004
increased 30% from $124.7 million to $161.6 million compared with the second
quarter of fiscal 2003. The increase was primarily a result of a significant
rise in the Metals Recycling Business' average net selling price per ton and
increases in the Steel Manufacturing Business' sales volume and average net
selling price per ton. The Auto Parts Business wholesale revenues also rose
significantly while its retail revenues saw a modest increase.
18
SCHNITZER STEEL INDUSTRIES, INC.
Revenues for the Metals Recycling Business for the quarter ended February 29,
2004, before intercompany eliminations, increased $23.6 million (28%) compared
with the fiscal 2003 quarter primarily due to higher average net selling prices
per ton and higher shipping costs billed to customers offset by lower ferrous
sales volumes. Total ferrous sales volumes decreased by approximately 54,000
tons (10%) due to the fact that the second quarter of fiscal 2003 was a record
quarter in terms of sales volumes as customers delayed orders from the first
quarter of fiscal 2003 in anticipation of price declines, which did not
materialize. The average sales price, net of shipping costs (average net sales
price), for ferrous metals increased $47 per ton (42%) to $158 per ton from the
second quarter of fiscal 2004 due to the lower supplies of competing metal in
global markets, strong demand in Asia and increased demand domestically.
Nonferrous selling price per pound increased 18% in the current quarter versus a
year ago, and was primarily attributable to continued strong demand from China
and Korea. Nonferrous sales volumes declined 12% due to lower beginning
inventory levels this quarter compared to last year's quarter. The high demand
for nonferrous metal during last year's second quarter enabled the Company to
decrease its inventory levels. Nonferrous inventory levels continued to remain
low during the second quarter ended 2004 and this, coupled with reduced
availability of raw materials, caused nonferrous volumes to decline.
The Steel Manufacturing Business' revenues for the quarter ended February 29,
2004 increased $18.6 million (45%), to $59.9 million compared with the prior
year quarter, reflecting higher average sales prices and higher volumes.
Finished steel shipments were 18% higher than the prior year with the average
finished steel net selling price up $68 per ton (24%) to $351 per ton compared
with the same quarter last year. Sales volumes improved due to industry
consolidation, reduced imports and customer buying activities mentioned in the
"General" section. The price increases were primarily caused by improved
consumption, a higher-priced sales mix and steel producers' attempts to offset
the sharp rise in raw material and energy costs.
Revenues for the Auto Parts Business for the second quarter ended February 29,
2004, before intercompany eliminations, increased $2.5 million (17%) compared
with the fiscal 2003 quarter primarily due to 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 improved efficiencies and changes in work practices, which were caused in
part by a new distribution center. This, coupled with strong pricing, resulted
in increased sales volumes. Retail revenues increased slightly due to increased
pricing, while admissions were consistent with the fiscal 2003 quarter.
COST OF GOODS SOLD. Consolidated cost of goods sold increased $29.5 million
(28%) for the second quarter ended February 29, 2004, compared with the same
period last year. Cost of goods sold decreased as a percentage of revenues from
85% to 84%. Gross profit increased $7.5 million to $26.0 million during the
latest quarter compared to the prior year quarter driven by profit margin
improvements at the Company's Metal Recycling and Steel Manufacturing Business
segments.
For the Metal Recycling Business, the cost of goods sold as a percentage of
revenues decreased compared with the second quarter of fiscal 2003 from 85% to
84%. Gross profit increased by $5.0 million to $18.0 million. The increase in
gross profit was attributable to higher average net selling prices per ton.
Compared with the second quarter of last year, the average ferrous metals cost
of sales per ton increased 40% due primarily to higher purchase costs for
unprocessed ferrous metals and higher export sales shipping costs. Generally,
the change in the cost of unprocessed metal has a strong correlation to changes
in the average selling price. Thus, as selling prices rose compared with last
year's quarter, so did the cost of unprocessed metal.
For the second quarter of fiscal 2004, cost of goods sold for the Steel
Manufacturing Business increased $14.6 million (35%) compared to the same period
last year. Cost of goods sold per ton increased 15% primarily due to higher raw
material costs partially offset by lower rolling mill conversion costs and the
receipt of the $1.8 million electrode price fixing settlement mentioned earlier.
As a percentage of revenues, cost of goods sold decreased from 101% to 94%. In
the second quarter of fiscal 2004, the gross profit was $3.5 million compared
19
SCHNITZER STEEL INDUSTRIES, INC.
with a gross loss of $0.5 million in the second quarter of last year. This
improvement was primarily attributable to higher selling prices and the
electrode settlement.
The Auto Parts Business' cost of sales was $2.0 million (24%) higher during the
second quarter of fiscal 2004 as compared to the cost of sales for the fiscal
2003 quarter. As a percentage of revenues, the cost of sales increased to 60%
from 56% for the fiscal 2003 quarter. The higher cost of sales was due to
increased car purchase costs that were the result of higher scrap metal prices
and increased labor costs.
JOINT VENTURES. The Joint Ventures in the Metals Recycling Business
predominantly sell recycled ferrous metal. Revenues for this segment in the
second quarter of fiscal 2004 increased $157.0 million (80%) compared with the
prior year quarter primarily due to higher average net selling prices per ton.
Additionally, the Brokering Joint Venture experienced a 105% increase in sales
volumes compared with the prior year quarter. The Processing Joint Ventures'
average net selling price per ton for ferrous recycled metals increased due to
the same supply and demand circumstances described earlier for the Company's
wholly owned businesses while sales volumes decreased 12% over the prior year
due to the fact that last year's second quarter sales volumes were near record
levels and were the result of customer order delays from the first quarter of
fiscal 2003.
Income from Joint Ventures amounted to $8.7 million for the second quarter of
fiscal 2004 compared to $6.2 million in last year's second quarter. The increase
in the joint ventures' quarterly income came primarily from a significant margin
improvement in the Brokering Joint Venture that has been growing its market
share and is now serving additional markets and customers.
IMPAIRMENT AND OTHER NON-RECURRING CHARGES. In connection with the 2003
acquisition of the Auto Parts Business, the Company conducted an environmental
due diligence investigation and accrued $2.1 million in environmental
liabilities.
GENERAL AND ADMINISTRATIVE EXPENSE. Compared with the second quarter of fiscal
2003, general and administrative expense for the same quarter this fiscal year
increased $1.3 million primarily due to higher bonus accruals given the
Company's improved performance and costs associated with the Company's
compliance with Section 404 of the Sarbanes Oxley Act. As a percentage of
revenues, general and administrative expenses have decreased from 6.5% to 5.8%
due to spreading the Company's fixed costs over higher revenues.
INTEREST EXPENSE. Interest expense for the second quarter of fiscal 2004
increased $0.2 million to $0.5 million compared with the second quarter of
fiscal 2003. The increase was primarily a result of higher average debt balances
during the fiscal 2004 quarter compared with the fiscal 2003 quarter.
INCOME TAX PROVISION. The tax rate for the second quarter of fiscal 2004 was
approximately 19%, compared with a tax rate of 27% for the prior year quarter.
The Company's $6.1 million deferred tax valuation allowance was reversed in this
quarter, resulting in a corresponding reduction in the income tax provision for
the period, which was offset in part by a change in the estimate of the tax
benefit from the Extraterritorial Income Exclusion. It is anticipated that the
rate will be 34% in the third and fourth quarter of fiscal 2004, reflecting the
full utilization of the NOL tax benefits and the lower estimated tax benefits of
the Extraterritorial Income Exclusion. The change in the Company's GAAP tax rate
associated with the reversal of the valuation reserves had no impact on the
Company's cash flow; however, the cash taxes paid by the Company are anticipated
to continue to benefit from the NOLs through the year 2016. See Note 5 - Income
Tax Provision in the Notes to the Condensed Consolidated Financial Statements.
PRE-ACQUISITION INTERESTS. For the second quarter of fiscal 2003,
pre-acquisition interests of $0.7 million, which are net of tax, represent the
share of income attributable to the former joint venture partner prior to the
2003 acquisition. See Note 3 of the Notes to the Condensed Consolidated
Financial Statements.
20
SCHNITZER STEEL INDUSTRIES, INC.
MINORITY INTERESTS. Minority interests, net of tax, represent the share of
income attributable to various continuing minority partners within the Auto
Parts Business segment. During the three month period ended February 29, 2004,
minority interests increased $0.2 million due to improved operating performance
at locations which have minority partners.
FIRST HALF OF FISCAL 2004 VS. FIRST HALF OF FISCAL 2003
- -------------------------------------------------------
REVENUES. Consolidated revenues for the six months ended February 29, 2004
increased $74.7 million (35%) 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 and the Steel Manufacturing
Business and higher wholesale revenues for the Auto Parts Business.
During the six months ended February 29, 2004, revenues for the Metals Recycling
Business, before intercompany eliminations, increased $57.6 million (44%), which
is attributed to average ferrous recycled metals selling prices, higher ferrous
sales volumes, and higher shipping costs billed to customers. Ferrous sales
volumes increased by 7% over the 2003 period. Average net selling prices for
ferrous metals were up 39% and nonferrous metals were up 14% compared with the
first half of fiscal 2003. The higher prices were caused by continued strong
demand from Asian countries, improvements in demand domestically, and a decrease
in supply available in the global market.
The Steel Manufacturing Business' revenues for the six months ended February 29,
2004 increased $29.0 million (34%), to $113.1 million, from the first half of
the prior year. The increase in revenues was a result of a 45,500 ton increase
(16%) in products sold during the first six months of fiscal 2004 compared to
the prior year due to increasing consumption and industry consolidation. Average
net selling prices increased 17% due primarily to improved consumption, a
higher-priced sales mix and steel producers' attempts to offset the sharp rise
in raw material and energy costs.
Revenues for the Auto Parts Business increased by $4.0 million (13%) for the
first half of fiscal 2004 compared to the same period in 2003. The higher
revenues were primarily caused by an increase in wholesale revenues driven by
rising prices for car bodies and increasing volumes and price for cores.
COST OF GOODS SOLD. Consolidated cost of goods sold increased by $59.4 million
(32%) for the six months ended February 29, 2004, compared with the same period
last year. Cost of goods sold decreased as a percentage of revenues from 85% to
84%, which contributed to a $15.3 million increase in gross profit for the first
six months of fiscal 2004 as compared to the prior year. The higher gross profit
reflected the increased volumes and selling prices for the Metals Recycling
Business and the Steel Manufacturing Business and higher wholesale prices for
the Auto Parts Business.
During the first six months of fiscal 2004, the Metals Recycling Business' cost
of goods sold increased $45.3 million over the prior year. The cost of goods
sold as a percentage of revenues decreased from 85% for the first half of fiscal
2003 to 83% during the first half of fiscal 2004. As a result, gross profit
increased by $12.4 million to $32.3 million. The increase in gross margin in the
first six months of fiscal 2004 is attributable to higher average selling prices
per ton and higher sales volumes partially offset by higher average amounts paid
for unprocessed metal and higher export sales shipping costs compared with the
first six months of fiscal 2003.
During the first six months of fiscal 2004, cost of goods sold for the Steel
Manufacturing Business increased $23.7 million compared to the same period last
year and decreased as a percentage of revenues from 101% to 96%. This decrease
is attributable to higher average selling prices, higher sales volumes and the
receipt of the $1.8 million electrode price fixing settlement. Gross margin
improved from a loss of $1.1 million to a profit of $4.2 million compared with
the first half of last year primarily due to higher average selling prices,
higher sales
21
SCHNITZER STEEL INDUSTRIES, INC.
volumes and the electrode price fixing settlement. This improvement is partially
offset by higher raw material and conversion costs compared with the first six
months of fiscal 2003.
The Auto Parts Business' cost of sales as a percentage of revenues increased to
59% from 57% during the first half of fiscal 2004 as compared to the fiscal 2003
period due primarily to higher labor and car purchase costs.
JOINT VENTURES. For the six months ended February 29, 2004, revenues for Joint
Ventures in the Metals Recycling Business increased by $258.1 million from the
first six months of last year. The increase was primarily due to higher average
net sales prices for ferrous metals and higher ferrous sales volumes for the
Brokering Joint Venture. These higher average sales prices were caused by the
same market conditions as described for the Metals Recycling Business. The
higher sales volumes are a result of increased market share at the Brokering
Joint Venture. For the first six months of fiscal 2004, income recognized from
these joint ventures increased by $5.5 million over the first six months of
fiscal 2003 to $15.1 million. The improved operating results were primarily
caused by higher average net selling prices per ton and higher sales volumes.
GENERAL AND ADMINISTRATIVE EXPENSE. For the six months ended February 29, 2004,
general and administrative expense increased $2.4 million over the same period
last year primarily due to higher bonus accruals given the Company's improved
performance and costs associated with the Company's compliance with Section 404
of the Sarbanes-Oxley Act. As a percentage of revenues, general and
administrative expense has decreased from 7% to 6% due to spreading fixed costs
over higher revenues.
INTEREST EXPENSE. For the six months ended February 29, 2004, interest expense
increased $0.2 million to $0.9 million compared with the same period last year.
The increase was primarily a result of higher average borrowings year over year.
INCOME TAX PROVISION. The tax rate for the first six months of fiscal 2004 was
approximately 23%, compared with a tax rate of 26% for the first six months of
fiscal 2003. The Company's $6.1 million deferred tax valuation allowance was
reversed in this quarter, resulting in a corresponding reduction in the income
tax provision for the period, which was offset in part by a change in the
estimate of the tax benefit from the Extraterritorial Income Exclusion. It is
anticipated that the rate will be 34% in the third and fourth quarter of fiscal
2004 reflecting the full utilization of the NOL tax benefits and the lower
estimated tax benefits of the Extraterritorial Income Exclusion. The change in
the Company's GAAP tax rate associated with the reversal of the valuation
reserves had no impact on the Company's cash flow; however, the cash taxes paid
by the Company are anticipated to continue to benefit from the NOLs through the
year 2016. See Note 5 - Income Tax Provision in the Notes to the Condensed
Consolidated Financial Statements.
PRE-ACQUISITION INTERESTS. For the six months ended February 28, 2003,
pre-acquisition interests of $2.5 million, which are net of tax, represent the
share of income attributable to the former joint venture partner prior to the
acquisition. See Note 3 of the Notes to the Condensed Consolidated Financial
Statements.
MINORITY INTERESTS. Minority interests, net of tax, represent the share of
income attributable to various continuing minority partners within the Auto
Parts Business segment. During the six month period ended February 29, 2004,
minority interests increased $0.3 million due to improved operating performance
at locations which have minority partners.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. The Company performed a
transitional impairment test of its goodwill and intangible assets during the
second quarter of fiscal 2003. As a result of this test, the Company recorded a
non-cash impairment charge of $983,000, effective September 1, 2002, and
reported it as a "Cumulative effect of change in accounting principle" on the
Consolidated Statement of Operations.
LIQUIDITY AND CAPITAL RESOURCES. Cash provided by operations for the six months
ended February 29, 2004 was $36.4 million compared with $12.4 million for the
same period in the prior fiscal year. The improved cash flow was primarily due
to higher net income and reductions in inventory and accounts receivable for the
current period compared to increases in the previous year.
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SCHNITZER STEEL INDUSTRIES, INC.
Capital expenditures for the six months ended February 29, 2004 were $10.9
million compared with $10.1 million during the first six months of fiscal 2003.
The increase was primarily due to improvement projects at the Company's Oakland,
California recycling facility and its steel mill. The Company initially
estimated that the electric arc furnace in the steel mill's melt shop would be
replaced by the end of fiscal 2004. The Company has revised that estimated
completion date and is now targeting an installation date closer to the end of
calendar 2004. The Company expects to spend approximately $14.9 million on
capital projects during the remainder of fiscal 2004.
As a result of acquisitions completed in prior years the Company had $20.9
million of accrued environmental liabilities as of February 29, 2004. Over the
next twelve months, the Company expects to pay approximately $9.5 million
relating to a previously accrued remediation project in connection with one of
its metals recycling facilities located in the State of Washington on the
Hylebos Waterway (please refer to Note 7 - Environmental Liabilities in the
Notes to the Consolidated Financial Statements included in Item 8 of Form 10-K
for the fiscal year ended August 31, 2003). Additionally, the Company expects to
require significant future cash outlays as it incurs the actual costs relating
to the remediation of other such environmental liabilities.
As of February 29, 2004, the Company had a committed unsecured bank credit
facility totaling $150 million that matures in May 2006. The Company also had an
additional unsecured line of credit of $10 million, which is uncommitted. The
Company's debt agreements have certain restrictive covenants. As of February 29,
2004, the Company was in compliance with such covenants and had aggregate bank
borrowings outstanding of $75 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. During February 2004, the facility was increased to $110
million. The JV Credit Facility expires in July 2004 and is secured by the
inventory and receivables of the joint venture businesses. The Company is not a
guarantor of the JV Credit Facility. The JV Credit Facility has a number of
covenants and restrictions, including restrictions on the level of distributions
to the joint venture partners. As of February 29, 2004, the joint ventures were
in compliance with such covenants. Borrowings under the JV Credit Facility
totaled $79.0 million at February 29, 2004. The increased borrowing levels were
primarily caused by additional working capital requirements resulting from
carrying higher levels of inventory for the Brokering Joint Venture. Also,
during the quarter ended May 31, 2004, the Joint Ventures expect to obtain an
additional $36 million in secured financing to purchase three new automobile
shredders.
The JV Credit facility mentioned above includes restrictions on the level of
distributions to the joint venture partners. Over the last 18 months, the
Company has recorded $39.4 million of operating income representing its share in
the earnings of the joint ventures. However, the Company has not received cash
distributions. Instead, the Hugo-Neu joint ventures have been utilizing all of
their available cash to fund expansion of working capital, business growth and
investment in state-of-the-art equipment to improve the efficiencies and
capabilities of their businesses.
Pursuant to a stock repurchase program which began October 2000, the Company is
authorized to repurchase up to 3.0 million shares of its stock when the market
price of the Company's stock is not reflective of management's opinion of an
appropriate valuation of the stock. Management believes that repurchasing shares
under these conditions enhances shareholder value. During the first six months
of fiscal 2004, the Company made no share repurchases. As of February 29, 2004,
the Company had repurchased a total of 1.3 million shares under this program.
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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, joint ventures, stock repurchases, debt service
requirements and future environmental obligations for the next twelve months. In
the longer term, the Company may seek to finance business expansion with
additional borrowing arrangements or additional equity financing.
OUTLOOK. As mentioned earlier, the ferrous recycled metal market continued to
strengthen throughout the second quarter of fiscal 2004. However, the market for
recycled metal continues to remain volatile and difficult to predict. The Metals
Recycling Business normally accepts orders 60 to 90 days before shipment. Based
upon the Metals Recycling Businesses' third quarter 2004 order backlog,
contracted selling prices are, on average, significantly higher than the amounts
realized in the second quarter of fiscal 2004 and the third quarter of fiscal
2003. Third quarter 2004 sales volumes are anticipated to be in the general
range of last year's third quarter level. Ocean freight rates continue to remain
high from a historical context, however, it appears freight rates are beginning
to stabilize and may begin to show a modest decline in the coming months. The
cost of unprocessed ferrous metal remains very competitive and volatile. We
anticipate the cost of unprocessed metal to generally follow the trend of market
selling prices.
The joint venture processors in the metals recycling business are anticipated to
experience similar market trends as the Company's wholly owned Metals Recycling
Business; however, their financial results may vary depending on geographical
locations, competition and other factors.
The domestic economy appears to be improving, which has spurred an increase in
demand for finished steel and has benefited the Company's Steel Manufacturing
Business. Over the last few months, finished steel selling prices steadily rose
across all product lines. Finished steel sales volumes traditionally increase in
the third fiscal quarter due to seasonal improvements in demand. However,
management believes that certain customers appear to have built inventories
during the second quarter, which is expected to modestly reduce third quarter
sales volumes. It's anticipated that third quarter sales volumes will be in
excess of 150,000 tons. Market prices are expected to continue to rise
throughout the third quarter. The higher selling prices are anticipated to be
partially offset by higher raw material costs. Overall, it is estimated that the
Steel Manufacturing Business will be continue to be profitable in the third
quarter of fiscal 2004.
The Auto Parts Business typically experiences increased retail demand in the
third quarter of each year as customer admissions increase in concert with
improving weather conditions. Wholesale revenues should remain strong and may
improve modestly over the second quarter of this fiscal year. The anticipated
increase in revenues is expected to be offset in part by higher inventory costs.
The Auto Parts Business's operating profits are also anticipated to benefit from
the addition of the three new Canadian stores.
Overall, the Company estimates its third quarter 2004 income from operations to
be in the $38 million to $43 million range. This amount compares to income from
operations of $22.0 million reported for the third quarter of fiscal 2003.
The Company's effective tax rate should continue to benefit from
Extraterritorial Income Exclusion benefits associated with certain export sales.
These, as well as other factors, including increased profitability, should
result in an effective fiscal 2004 annual tax rate in the 29% to 30% 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
24
SCHNITZER STEEL INDUSTRIES, INC.
they do not relate strictly to historical or current facts. Examples of factors
affecting Schnitzer Steel Industries, Inc.'s consolidated operations and its
joint ventures (the Company) that could cause actual results to differ
materially are the following:
CYCLICALITY AND GENERAL MARKET CONSIDERATIONS: Purchase and selling prices for
recycled metals are highly cyclical in nature and subject to worldwide economic
conditions. In addition, the cost and availability of recycled metals are
subject to global supply and demand conditions which are volatile and beyond the
Company's control, resulting in periodic fluctuations in recycled metals prices
and working capital requirements. While the Company attempts to maintain and
grow margins by responding to changing recycled metals selling prices through
adjustments to its metals purchase prices, the Company's ability to do so is
limited by competitive and other market factors. Additionally, changing prices
could potentially impact the volume of recycled metal available to the Company,
the subsequent volume of processed metal sold by the Company, inventory levels
and the timing of collections and levels relating to the Company's accounts
receivable balances. 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 consumer of both the Company's finished steel products and other
customers who buy recycled metal. 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 for recycled metal 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 which are difficult to
predict (for example, uncertainties relating to customer orders, metal
availability, estimated freight rates, ship availability, cost and volume of
inventory yet to be processed, and production output, etc.).
The Auto Parts Business experiences modest seasonal fluctuations in demand. The
retail stores are open to the natural elements. During periods of extreme
temperatures and precipitation, customers tend to delay their purchases and wait
for milder conditions. As a result, retail sales are generally higher during the
spring and fall of each calendar year and lower in the winter and summer months.
Additionally, the Auto Parts Business is subject to a number of other risks that
could prevent it from maintaining or exceeding its current levels of
profitability, such as volatile supply and demand conditions affecting prices
and volumes in the markets for its products, services and raw materials;
environmental issues; local and worldwide economic conditions; increased
competition; and business integration and management transition issues.
COMPETITION: The recycled metals industry is highly competitive, with the volume
of purchases and sales subject to a number of competitive factors, principally
price. The Company competes with both large and numerous smaller companies in
its markets for the purchase of recyclable metals. The Company also competes
with a number of domestic and foreign recycled metals processors and brokers for
processed and unprocessed metal as well as for
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SCHNITZER STEEL INDUSTRIES, INC.
sales to domestic and foreign customers. For example, in the recent past, lower
cost ferrous recycled metals supplies from certain foreign countries have
adversely affected market selling prices for ferrous recycled metals. Since
then, many of these countries are believed to have imposed export restrictions
which have significantly reduced their export volumes and lowered the worldwide
supply of ferrous recycled metals. These restrictions are believed to have had a
positive effect on the Company's selling prices. Given the intricacies in which
the global markets operate, the Company cannot predict when or if foreign
countries will change their trading policies and what effect, if any, such
changes might have on the Company's operating results.
From time to time, both the United States and foreign governments impose
regulations and restrictions on trade in the markets in which the Company
operates. Also, it is not unusual for various constituencies to petition
government entities to impose new restrictions or change current laws. If
imposed, these restrictions could affect the Company's margins as well as its
ability to ship goods to foreign customers. Alternatively, restrictions could
also affect the global availability of ferrous recycled metals, thereby
affecting the Company's volumes and margins. As a result, it is difficult to
predict what, if any, impact pending or future trade restrictions will have on
the operations of the Company.
Some of the more significant domestic competitors include regional steel mills
and their brokers who compete for recycled metal for the purpose of providing
the mill with feedstock to produce finished steel. During periods when market
supplies of metal are in short supply, these buyers may, at times, react by
raising buying prices to levels that are not reasonable in relation to more
normal market conditions. As a result, the Company may have to raise its buying
prices to maintain its production levels which may result in compressed margins.
The domestic steel industry also is highly competitive. Steel prices can be
highly volatile and price is a significant competitive factor. The Company
competes domestically with several steel producers in the Western United States
for sales of its products. In recent years, the Company has experienced
significant foreign competition, which is sometimes subsidized by large foreign
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. On December 4, 2003, President Bush, in response to
pressure by the World Trade Organization, terminated these tariffs. However,
management is of the belief that the tariffs did not significantly benefit
selling prices for finished steel products on the West Coast of the United
States. In the spring of 2002, the U.S. Government imposed anti-dumping and
countervailing duties against wire rod products from eight foreign countries.
These duties have assisted the Company in increasing sales of wire rod products;
any expiration or termination of the duties could have a corresponding adverse
effect.
In December 2002, Nucor Corporation ("Nucor") assumed ownership of the assets of
Birmingham Steel Corp., and acquired a steel manufacturing business in Seattle,
Washington. Nucor Corporation, the leader in setting finished steel prices in
the Company's finished steel markets, has a significant share of the West Coast
steel market and is considered an aggressive competitor. The long term impact,
if any, which 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. Additionally,
until recently the Steel Manufacturing Business also competed with the North
Star steel mill in Kingman, Arizona, a producer of wire rod and rebar products,
which was sold to Nucor. That facility is currently idle, but any future
start-up of its operations could negatively impact the Company's recycled metal
and finished steel markets, prices and margins.
The Auto Parts Business competes with both full-service and self-service auto
dismantlers as well as larger well financed retail auto parts chains for retail
customers. Periodically, the Auto Parts Business increases prices, which may
affect customer flow and buying patterns. Additionally, in markets where the
Company has only a few stores, it does not have the same pricing power it
experiences in markets where it has more than one store in which it operates. As
this segment expands, the Company may experience new competition from others
attempting to replicate the Company's business model. The ultimate impact of
these dynamics cannot be predicted. Also, the business competes for its
automobile inventory with other dismantlers, used car dealers, auto auctions and
26
SCHNITZER STEEL INDUSTRIES, INC.
metal recyclers. Inventory costs can fluctuate significantly depending on market
conditions and prices for recycled metal.
GEOGRAPHICAL CONCENTRATION: The Company competes in the scrap metal business
through its wholly-owned Metals Recycling Business as well as through its joint
venture businesses. Over the last few years, a significant portion of the
revenues and operating profits earned in these segments have been generated from
sales to Asian countries, principally China and South Korea. In addition, the
Company's sales in these countries are also concentrated with relatively few
customers that vary depending on buying cycles and general market conditions.
Due to the concentration of sales in these countries and to a relatively small
customer base, a significant change in buying patterns, change in political
events, change in regulatory requirements, tariffs and other export restrictions
within the United States or these foreign countries, severe weather conditions
or general changes in economic conditions could adversely affect the financial
results of the Company.
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, cash flow, expenditures, debt, and related financial results as it
does with its consolidated businesses. These businesses are, however, affected
by many of the same risk factors mentioned in this document. 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,
which are recorded during the fourth quarter of each fiscal year, have been
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 9% 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 a contract for natural gas. The
current annual contract expires on October 31, 2004 and reflected a 15% increase
over the previous year's contract.
If the Company is unable to negotiate favorable terms of electricity, natural
gas and other energy sources, this could adversely affect the performance of the
Company.
TAX LAWS: The Company has been able to reduce its effective tax rate below the
federal statutory tax rate for each of the last three years by using a
combination of Net Operating Loss Carryforwards (NOLs), tax credits in State of
California Enterprise Zones, and tax benefits associated with making foreign
sales. Future tax rates are apt to be higher, though, because the NOLs have been
fully used for GAAP purposes and discovery of a significant amount of further
credits is not anticipated. Furthermore, Federal legislation has been proposed
to eliminate or mitigate the foreign sales tax benefits. The Company cannot
predict the likelihood of enactment of this or any other proposed legislation.
CURRENCY FLUCTUATIONS: Demand from the Company's foreign customers is partially
driven by foreign currency fluctuations relative to the U.S. dollar. Recent
weakness of the U.S. dollar relative to foreign currencies is believed to have
had a significant effect in the increases in recycled metals prices over the
last year, as well as resulted in increasing the cost of certain finished steel
imports. Strengthening of the U.S. dollar could adversely affect the
competitiveness of the Company's products in the markets in which the Company
competes. Additionally, global economic forces can cause fluctuations in the
currency of the foreign countries in which the
27
SCHNITZER STEEL INDUSTRIES, INC.
Company competes as well as trigger a revaluation of that currency. 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. In estimating future operating results, the Company makes certain
assumptions regarding shipping costs. Given the recent tightness in the ocean
freight market, the Company has experienced significant increases in its
shipping costs which have adversely affected operating income. Since it is
difficult to predict the future costs for shipping the Company's products,
actual result could differ materially from forecasts.
In estimating quarterly volumes of ferrous metal exports, the Company makes
assumptions regarding the anticipated timing of ship arrival into loading ports
and the estimated time to load the ships. The actual timing of ship departure,
and thus the ultimate revenue recognition, can vary due to ship availability,
weather, mechanical delays, and governmental regulatory delays. One export
ferrous shipment can range from 25,000 to 40,000 tons representing a significant
portion of the Company's quarterly revenue and profit. Thus, the delay of one
shipment into the next quarter can significantly affect the quarterly financial
results.
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. The Company cannot
predict future events and circumstances which could cause rates or claims to
materially change such as war, terrorist activities or natural disasters.
INTERCOMPANY SALES: The Auto Parts Business sells autobodies to the Metals
Recycling Business, and the Metals Recycling Business sells ferrous recycled
metal to the Steel Manufacturing Business, at prices that are intended to
approximate market. When the Company consolidates its results in accordance with
generally accepted accounting principles, the Company eliminates the
intercompany sales and purchases and also eliminates the estimated profit
remaining in inventory ("Profit Elimination") at the end of each reporting
period. In estimating future operating and financial performance, the Company
makes assumptions regarding the forecasted Profit Elimination computation and
its impact on the quarterly financial results of the Company. Small variations
in price, sales volume, production volume, and purchase prices and volumes from
both within the Company and from third parties can result in significant
differences between forecasted Profit Elimination and actual results.
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, 2003.
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SCHNITZER STEEL INDUSTRIES, INC.
ITEM 4. CONTROLS AND PROCEDURES
Schnitzer Steel Industries, Inc. management, under supervision of the Chief
Executive Officer and Chief Financial Officer, is responsible for establishing
and maintaining disclosure controls and procedures for Schnitzer Steel
Industries, Inc. and its subsidiaries. As of February 29, 2004, with the
participation of the Chief Executive Officer and the Chief Financial Officer,
management completed an evaluation of the Company's disclosure controls and
procedures. Based upon this evaluation, the Company's Chief Executive Officer
and Chief Financial Officer have concluded that the disclosure controls and
procedures are effective to ensure that all material information relating to
Schnitzer Steel Industries, Inc. and its subsidiaries is made known to them by
others within the organization as appropriate to allow timely decisions
regarding required disclosures.
There were no changes in the Company's internal control over financial reporting
during the second fiscal quarter that have materially affected, or are
reasonably likely to materially affect, the internal control over financial
reporting.
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SCHNITZER STEEL INDUSTRIES, INC.
PART II
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The 2004 annual meeting of the shareholders was held on January 26, 2004.
Holders of 12,289,650 shares of the Company's Class A common stock,
entitled to one vote per share, and 6,180,676 shares of the Company's Class
B common stock, entitled to ten votes per share, were present in person or
by proxy at the meeting.
(b) Robert W. Philip, Kenneth M. Novack, Gary Schnitzer, Dori Schnitzer, Carol
S. Lewis, Scott Lewis, Jean S. Reynolds, Robert S. Ball, William A. Furman,
and Ralph R. Shaw were elected directors of the Company.
(c) The meeting was called for the following purposes:
1. To elect Robert W. Philip, Kenneth M. Novack, Gary Schnitzer, Dori
Schnitzer, Carol S. Lewis, Scott Lewis, Jean S. Reynolds, Robert S.
Ball, William A. Furman, and Ralph R. Shaw as directors of the
Company.
This proposal was approved as follows:
Votes For Votes Withheld/Against
---------- ----------------------
Robert W. Philip 69,647,938 4,448,472
Kenneth M. Novack 69,618,425 4,477,985
Gary Schnitzer 69,614,363 4,482,047
Dori Schnitzer 69,010,912 5,085,498
Carol S. Lewis 69,012,474 5,083,936
Scott Lewis 68,972,704 5,123,706
Jean S. Reynolds 69,014,117 5,082,293
Robert S. Ball 72,436,608 1,659,802
William A. Furman 72,437,708 1,659,202
Ralph R. Shaw 72,437,188 1,659,222
2. To consider a shareholder proposal regarding the composition of the
Board of Directors
This proposal was rejected by the stockholders with 7,100,262 votes
cast for and 63,472,379 votes cast against. There were 49,277
abstentions and 3,474,492 broker non-votes.
30
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32.1 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.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(B) REPORTS ON FORM 8-K
The following report was filed on Form 8-K during the fiscal quarter ended
February 29, 2004:
On January 7, 2004, the Company filed a Current Report on Form 8-K,
to report under Item 12 the issuance of a press release announcing
financial results for the Company's quarter ended November 30,
2003.
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SCHNITZER STEEL INDUSTRIES, INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCHNITZER STEEL INDUSTRIES, INC.
(Registrant)
Date April 14, 2004 By: /s/ Barry A. Rosen
-------------- ---------------------------
Barry A. Rosen
Vice President, Finance and
Chief Financial Officer
32