UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ
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Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the quarterly period ended February 28, 2007 or
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o
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Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for
the transition period from
to
.
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Commission file number 0-22496
SCHNITZER STEEL INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
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OREGON
(State or other jurisdiction of
incorporation or organization)
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93-0341923
(I.R.S. Employer
Identification No.)
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3200 N.W. Yeon Ave.
P.O Box 10047
Portland, OR
(Address of principal executive offices)
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97296-0047
(Zip Code)
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(503) 224-9900
(Registrants 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
þ
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
þ
Non-accelerated filer
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes
o
No
þ
The Registrant had 21,817,565 shares of Class A common stock, par value of $1.00 per share, and
7,666,108 shares of Class B Common Stock, par value of $1.00 per share, outstanding at March 31,
2007.
SCHNITZER STEEL INDUSTRIES, INC.
INDEX
2
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per share amounts)
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February 28, 2007
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August 31, 2006
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Assets
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Current assets:
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Cash and cash equivalents
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$
|
22,593
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|
$
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25,356
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Restricted cash
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|
|
|
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7,725
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|
Accounts receivable, net
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|
166,321
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|
|
|
118,839
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|
Inventories
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|
246,785
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|
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|
263,583
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|
Deferred income taxes
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|
9,530
|
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|
7,285
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|
Prepaid expenses and other current assets
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|
16,231
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15,956
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|
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|
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Total current assets
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461,460
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438,744
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Property, plant and equipment, net
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347,155
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312,907
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Other assets:
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Investment in and advances to joint venture partnerships
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8,499
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8,859
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Goodwill
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279,670
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266,675
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Intangibles
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10,353
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10,899
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Other assets
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6,949
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6,640
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Total assets
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$
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1,114,086
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$
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1,044,724
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Liabilities and Shareholders Equity
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Current liabilities:
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Current portion of long-term debt
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$
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15,049
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$
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100
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Accounts payable
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80,490
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64,506
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Accrued payroll and related liabilities
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31,852
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36,809
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Investigation reserve
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|
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15,225
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Current portion of environmental liabilities
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4,853
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|
3,648
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Accrued income taxes
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3,654
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4,265
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Other accrued liabilities
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27,287
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26,585
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Total current liabilities
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163,185
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151,138
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Deferred income taxes
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13,430
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9,916
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Long-term debt, net of current portion
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159,804
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102,829
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Environmental liabilities, net of current portion
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38,047
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37,754
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|
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Other long-term liabilities
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5,328
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|
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3,855
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Minority interests
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4,972
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5,133
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Commitments and contingencies (Note 4)
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Shareholders equity:
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Preferred stock20,000 shares authorized, none issued
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Class A common stock75,000 shares $1.00 par value
authorized, 21,811 and 22,793 shares issued and outstanding
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21,811
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22,793
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Class B common stock25,000 shares $1.00 par value
authorized, 7,667 and 7,986 shares issued and outstanding
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7,667
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7,986
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Additional paid-in capital
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86,573
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137,281
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Retained earnings
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612,723
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564,165
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Accumulated other comprehensive income:
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Foreign currency translation adjustment
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|
546
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1,874
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Total shareholders equity
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729,320
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|
734,099
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Total liabilities and shareholders equity
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$
|
1,114,086
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|
$
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1,044,724
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The accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of these statements.
3
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited, in thousands, except per share amounts)
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For The Three Months Ended
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For The Six Months Ended
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February 28,
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February 28,
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2007
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2006
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|
2007
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2006
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|
|
|
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|
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Revenues
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$
|
604,442
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|
$
|
403,285
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|
$
|
1,114,296
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|
|
$
|
744,516
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|
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Operating expense:
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Cost of goods sold
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515,618
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338,561
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950,324
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623,667
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Selling, general and administrative
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42,741
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|
33,540
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|
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|
85,599
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73,884
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|
(Income) from joint ventures
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|
(1,181
|
)
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|
(386
|
)
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|
(2,467
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)
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|
(2,138
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)
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|
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|
Operating income
|
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|
47,264
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|
|
31,570
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|
80,840
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49,103
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|
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|
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Other income (expense):
|
|
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|
|
|
|
|
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|
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Interest expense
|
|
|
(2,305
|
)
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|
|
(401
|
)
|
|
|
(3,367
|
)
|
|
|
(836
|
)
|
Other income, net
|
|
|
285
|
|
|
|
689
|
|
|
|
1,402
|
|
|
|
56,223
|
|
|
|
|
|
|
|
|
|
|
|
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|
Other income (expense)
|
|
|
(2,020
|
)
|
|
|
288
|
|
|
|
(1,965
|
)
|
|
|
55,387
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
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|
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|
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|
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|
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Income before income taxes, minority interests
and pre-acquisition interests
|
|
|
45,244
|
|
|
|
31,858
|
|
|
|
78,875
|
|
|
|
104,490
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
16,265
|
|
|
|
10,591
|
|
|
|
28,336
|
|
|
|
41,726
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before minority interests and
pre-acquisition interests
|
|
|
28,979
|
|
|
|
21,267
|
|
|
|
50,539
|
|
|
|
62,764
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority interests, net of tax
|
|
|
(533
|
)
|
|
|
(149
|
)
|
|
|
(935
|
)
|
|
|
(302
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-acquisition interests, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
186
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
28,446
|
|
|
$
|
21,118
|
|
|
$
|
49,604
|
|
|
$
|
62,648
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share basic
|
|
$
|
0.94
|
|
|
$
|
0.69
|
|
|
$
|
1.62
|
|
|
$
|
2.05
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share diluted
|
|
$
|
0.93
|
|
|
$
|
0.68
|
|
|
$
|
1.60
|
|
|
$
|
2.03
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of these statements.
4
SCHNITZER STEEL INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
|
|
|
|
|
|
|
|
|
|
|
For The Six Months Ended February 28,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
49,604
|
|
|
$
|
62,648
|
|
Noncash items included in income:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
18,371
|
|
|
|
13,992
|
|
Minority and pre-acquisition interests
|
|
|
935
|
|
|
|
476
|
|
Deferred income taxes
|
|
|
2,470
|
|
|
|
(10,846
|
)
|
Distributed
(undistributed) equity in earnings of joint ventures
|
|
|
(512
|
)
|
|
|
15,797
|
|
Stock-based compensation expense
|
|
|
2,957
|
|
|
|
1,415
|
|
Gain on disposition of joint venture assets
|
|
|
|
|
|
|
(54,618
|
)
|
Excess tax benefit from stock options exercised
|
|
|
(614
|
)
|
|
|
(632
|
)
|
Loss on disposal of assets
|
|
|
363
|
|
|
|
277
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(43,813
|
)
|
|
|
14,315
|
|
Inventories
|
|
|
24,689
|
|
|
|
18,719
|
|
Prepaid expenses and other current assets
|
|
|
(511
|
)
|
|
|
13,757
|
|
Other assets
|
|
|
(538
|
)
|
|
|
310
|
|
Accounts payable
|
|
|
13,969
|
|
|
|
(16,264
|
)
|
Accrued liabilities
|
|
|
(3,740
|
)
|
|
|
5,078
|
|
Investigation reserve
|
|
|
(15,225
|
)
|
|
|
|
|
Environmental liabilities
|
|
|
(1,662
|
)
|
|
|
(3,266
|
)
|
Other liabilities
|
|
|
1,482
|
|
|
|
(909
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
48,225
|
|
|
|
60,249
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
|
(43,634
|
)
|
|
|
(37,466
|
)
|
Acquisitions, net of cash acquired
|
|
|
(29,252
|
)
|
|
|
(76,722
|
)
|
(Advances to) payments from joint ventures, net
|
|
|
872
|
|
|
|
(790
|
)
|
Proceeds from sale of assets
|
|
|
184
|
|
|
|
19
|
|
Cash flows from non-hedge derivatives
|
|
|
(269
|
)
|
|
|
|
|
Restricted cash
|
|
|
7,725
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(64,374
|
)
|
|
|
(114,959
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Borrowings from line of credit
|
|
|
204,700
|
|
|
|
69,000
|
|
Repayment of line of credit
|
|
|
(189,700
|
)
|
|
|
(69,000
|
)
|
Borrowings from long-term debt
|
|
|
437,500
|
|
|
|
184,232
|
|
Repayment of long-term debt
|
|
|
(380,576
|
)
|
|
|
(114,000
|
)
|
Issuance of Class A common stock
|
|
|
862
|
|
|
|
854
|
|
Repurchase of Class A common stock
|
|
|
(56,441
|
)
|
|
|
|
|
Excess tax benefit from stock options exercised
|
|
|
614
|
|
|
|
632
|
|
Distributions to minority interests
|
|
|
(2,156
|
)
|
|
|
(2,430
|
)
|
Dividends declared and paid
|
|
|
(1,046
|
)
|
|
|
(1,038
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
13,757
|
|
|
|
68,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash
|
|
|
(371
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
(2,763
|
)
|
|
|
13,540
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at beginning of period
|
|
|
25,356
|
|
|
|
20,645
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period
|
|
$
|
22,593
|
|
|
$
|
34,185
|
|
|
|
|
|
|
|
|
The accompanying notes to the unaudited condensed consolidated financial statements
are an integral part of these statements.
5
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
Note 1 Summary of Significant Accounting Policies:
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Schnitzer Steel
Industries, Inc. (the Company) have been prepared pursuant to generally accepted accounting
principles in the United States (U.S. GAAP) and the rules and regulations of the United States
Securities and Exchange Commission (SEC). The year-end condensed consolidated balance sheet was
derived from audited financial statements, but does not include all disclosures required by U.S.
GAAP. Certain information and note disclosures normally included in annual financial statements
have been condensed or omitted pursuant to those rules and regulations. In the opinion of
management, all 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 unaudited condensed
consolidated financial statements be read in conjunction with the financial statements and notes
thereto included in the Companys annual report for the fiscal year ended August 31, 2006. The
results for the three and six months ended February 28, 2007 and 2006 are not necessarily
indicative of the results of operations for the entire year.
Acquisitions that occurred during the first quarter of fiscal 2006 are described in Note 3
Business Combinations. Under Statement of Financial Accounting Standards (SFAS) No. 141,
Business Combinations (SFAS 141) and Accounting Research Bulletin 51, Consolidated Financial
Statements (ARB 51), the acquisition of Prolerized New England Company and Subsidiaries (PNE)
and Hugo Neu Schnitzer Global Trade-Baltic Operations (HNSGT-Baltic), two of the three businesses
acquired under the Hugo Neu Corporation (HNC) separation and termination agreement, were treated
as step acquisitions because the Company had a joint venture interest in those two businesses.
The Company did not have a prior interest in the third business acquired under the HNC separation
and termination agreement, THS Recycling LLC, dba Hawaii Metal Recycling Company (HMR).
Additionally, during the first quarter of fiscal 2006, the Company acquired the assets of Regional
Recycling LLC (Regional) and purchased GreenLeaf Auto Recyclers, LLC (GreenLeaf), two
businesses in which the Company did not have a previous interest. Since the PNE and HNSGT-Baltic
acquisitions occurred early in the fiscal year, consolidation accounting allowed the Company to
include PNE and HNSGT-Baltic in the consolidated results as though they had occurred at the
beginning of fiscal 2006, with an adjustment to earnings for the pre-acquisition interest the
Company did not own during the reporting period. As such, the unaudited condensed consolidated
statements of income are presented as if the PNE and HNSGT-Baltic acquisitions had occurred on
September 1, 2005.
Cash and Cash Equivalents
Cash and cash equivalents include short-term securities that are not restricted by third parties
and have an original maturity date of 90 days or less. The Company funds its accounts as checks are
presented and cleared at the bank, not when checks are written. As a result, the Company maintains
no cash balances in its primary operating accounts and book overdrafts of $25 million and $13
million were reclassified out of cash and cash equivalents and included in accounts payable as of
February 28, 2007 and August 31, 2006, respectively.
Restricted Cash
In August 2006, in connection with the expected settlement of the investigations by the United
States Department of Justice (DOJ) and the staff of the SEC, the Company deposited $8 million
into a custody account. Interest on the amount deposited accrued for the benefit of the Company and
was recognized as interest income when earned. In October 2006, the deposited funds were released
to the SEC upon completion of the settlement.
Accounts Receivable, net
Accounts receivable represent amounts due from customers on product, broker and other sales. These
accounts receivable, which are reduced by an allowance for doubtful accounts, are recorded at the
invoiced amount and do not bear interest. The Company evaluates the collectibility of its accounts
receivable based on a combination
6
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
of factors. In cases where management is aware of circumstances that may impair a specific
customers ability to meet its financial obligations, management records a specific allowance
against amounts due and reduces the net recognized receivable to the amount the Company believes
will be collected. For all other customers, the Company maintains a reserve that considers the
total receivables outstanding, historical collection rates and economic trends. The allowance for
doubtful accounts was $1 million at February 28, 2007 and August 31, 2006.
Inventory
The Companys inventories primarily consist of ferrous and nonferrous unprocessed metal, used and
salvaged vehicles and finished steel products consisting of rebar, coiled rebar, wire rod and
merchant bar. Inventories are stated at the lower of cost or market. The Metals Recycling Business
determines the cost of ferrous and nonferrous inventories principally using the average cost method
and capitalizes substantially all direct costs and yard costs into inventory. The Auto Parts
Business establishes cost for used and salvage vehicle inventory based on the average price the
Company pays for a vehicle. The self-service business capitalizes only the vehicle cost into
inventory; while the full-service business capitalizes the vehicle cost, dismantling, and where
applicable, storage and towing fees into inventory. The Steel Manufacturing Business establishes
its finished steel product inventory cost based on a weighted average cost, and capitalizes all
direct and indirect costs of manufacturing into inventory. Indirect costs of manufacturing include
general plant costs, maintenance, human resources and yard costs.
Goodwill
The changes in the carrying amount of goodwill resulting from business combinations (see Note 3
Business Combinations) during the six months ended February 28, 2007 were as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Metals
|
|
|
Auto
|
|
|
|
|
|
|
Recycling
|
|
|
Parts
|
|
|
|
|
|
|
Business
|
|
|
Business
|
|
|
Total
|
|
Balance as of August 31, 2006
|
|
$
|
143,106
|
|
|
$
|
123,569
|
|
|
$
|
266,675
|
|
Translation adjustment
|
|
|
|
|
|
|
(869
|
)
|
|
|
(869
|
)
|
Acquisitions
|
|
|
13,864
|
|
|
|
|
|
|
|
13,864
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of February 28, 2007
|
|
$
|
156,970
|
|
|
$
|
122,700
|
|
|
$
|
279,670
|
|
|
|
|
|
|
|
|
|
|
|
The Company performs impairment tests at least annually, during the second quarter of the fiscal
year and whenever events and circumstances indicate that the value of goodwill might be impaired.
Based on the operating results of each of the reportable segments above and the Companys
impairment testing completed in the second quarter of fiscal 2007, the Company determined that none
of the above balances were considered impaired as of February 28, 2007.
Derivative Financial Instruments
To manage the exposure to exchange risk associated with accounts receivable denominated in a
foreign currency, the Company enters into foreign currency forward contracts to stabilize the
United States dollar amount of the transaction at maturity. These contracts are not designated as
hedging instruments under SFAS 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133), SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities an amendment of SFAS 133 or under SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities.
Net realized and unrealized losses related to foreign currency contract settlements and
mark-to-market adjustments on open foreign currency contracts were $632,000 and $620,000 for the
three and six months ended February 28, 2007, respectively. The net amounts of realized and
unrealized gains and losses related to foreign currency contract settlements and mark-to-market
adjustments on open foreign currency contracts were not material for the three and six months ended
February 28, 2006.
7
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
The Company held foreign currency forward contracts denominated in euros with total notional
amounts of
19 million and
16 million at February 28, 2007 and August 31, 2006, respectively. The
fair value of these contracts was estimated based on quoted market prices as of February 28, 2007
and August 31, 2006. The mark- to-market adjustments on these contracts resulted in a derivative
liability of $364,000 and $12,000 as of February 28, 2007 and August 31, 2006, respectively. The
related mark-to-market expense is recorded as part of other expense for the Metals Recycling
Business.
Foreign Currency Translation
In accordance with SFAS No. 52, Foreign Currency Translation (SFAS 52), assets and liabilities
of foreign operations are translated into United States dollars at the period-end exchange rate and
revenues and expenses of foreign operations are translated into United States dollars at the
average exchange rate for the period. Translation adjustments are not included in determining net
income for the period, but are recorded as a separate component of shareholders equity. Foreign
currency transaction gains and losses are generated from the effects of exchange rate changes on
transactions denominated in a currency other than the functional currency of the Company, which is
the United States dollar. SFAS 52 generally requires that gains and losses on foreign currency
transactions be recognized in the determination of net income for the period. The Company record
these gains and losses in other income.
The aggregate amounts of net realized and unrealized transaction gains were $753,000 and $927,000
for the three and six months ended February 28, 2007, respectively. The aggregate amounts of net
realized and unrealized transaction gains and losses were not material for the three and six months
ended February 28, 2006.
Comprehensive Income
The following table sets forth the reconciliation of comprehensive income (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Net income
|
|
$
|
28,446
|
|
|
$
|
21,118
|
|
|
$
|
49,604
|
|
|
$
|
62,648
|
|
Foreign currency
translation
adjustment
|
|
|
820
|
|
|
|
112
|
|
|
|
1,328
|
|
|
|
52
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
29,266
|
|
|
$
|
21,230
|
|
|
$
|
50,932
|
|
|
$
|
62,700
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in Shareholders Equity
During the first six months of fiscal 2007, the Company repurchased 1.5 million shares of its Class
A common stock in open-market transactions at a cost of $56 million.
During the first six months of fiscal 2007, stock-based compensation accounted for a $4 million
increase in shareholders equity and was partially offset by a decrease of $1 million for dividends
paid.
Shareholder Rights Plan
On March 21, 2006 the Company adopted a shareholder rights plan (the Rights Plan). Under the
Rights Plan, the Company issued a dividend distribution of one preferred share purchase right (a
Right) for each share of Class A Common Stock or Class B Common Stock held by shareholders of
record as of the close of business on April 4, 2006. The Rights generally become exercisable if a
person or group has acquired 15% or more of the Companys outstanding common stock or announces a
tender offer or exchange offer which, if consummated, would result in ownership by a person or
group of 15% or more of the Companys outstanding common stock (Acquiring Person). The Schnitzer
Steel Industries, Inc. Voting Trust and its trustees, in their capacity as trustees, are not deemed
to beneficially own any common stock by virtue of being bound by the Voting Trust Agreement
governing the trust. Each Right entitles shareholders to buy one one-thousandth of a share of
Series A Participating Preferred Stock (Series A Shares) of the Company at an exercise price of
$110, subject to
8
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
adjustments. Holders of Rights (other than an Acquiring Person) are entitled to
receive upon exercise Series A Shares, or in lieu thereof, common stock of the Company having a
value of twice the Rights then-current exercise price. The Series A Shares are not redeemable by
the Company and have voting privileges and certain dividend and liquidation preferences. The Rights
will expire on March 21, 2016, unless such date is extended or
the Rights are redeemed or exchanged on an earlier date.
Segments
SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, requires
disclosures related to components of a company for which separate financial information is
available that is evaluated regularly by a companys chief operating decision maker in deciding the
allocation of resources and assessing performance. The Company operates in three industry segments:
metals processing, recycling and trading (Metals Recycling Business), self-service and
full-service used auto parts sales (Auto Parts Business) and mini-mill steel manufacturing
(Steel Manufacturing Business).
Net Income and Dividends per Share
The following table sets forth the reconciliation from basic net income per share to diluted net
income per share (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Net income
|
|
$
|
28,446
|
|
|
$
|
21,118
|
|
|
$
|
49,604
|
|
|
$
|
62,648
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Computation of shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average common shares
outstanding
|
|
|
30,366
|
|
|
|
30,528
|
|
|
|
30,566
|
|
|
|
30,503
|
|
Assumed conversion of
dilutive stock options and
awards
|
|
|
241
|
|
|
|
329
|
|
|
|
340
|
|
|
|
351
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted average common
shares
outstanding
|
|
|
30,607
|
|
|
|
30,857
|
|
|
|
30,906
|
|
|
|
30,854
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per share
|
|
$
|
0.94
|
|
|
$
|
0.69
|
|
|
$
|
1.62
|
|
|
$
|
2.05
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income per share
|
|
$
|
0.93
|
|
|
$
|
0.68
|
|
|
$
|
1.60
|
|
|
$
|
2.03
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend per share
|
|
$
|
0.017
|
|
|
$
|
0.017
|
|
|
$
|
0.034
|
|
|
$
|
0.034
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share is computed using net income, the weighted average number of common shares
outstanding during the period and vested deferred stock units (DSU). Diluted earnings per share
is computed using net income and the weighted average number of common shares outstanding, assuming
dilution. Weighted average common shares outstanding, assuming dilution, include potentially
dilutive common shares outstanding during the period. Potentially dilutive common shares include
the assumed exercise of stock options and assumed vesting of Long-Term Incentive Program (LTIP)
performance share, DSU and restricted stock unit (RSU) awards using the treasury stock method.
Stock options and LTIP performance share, DSU and RSU awards totaling approximately 252,000 and
406,000 shares for the three and six months ended February 28, 2007, respectively, were excluded
from the calculation of diluted earnings per share because they were antidilutive, although they
could become dilutive in the future.
9
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
These changes had no impact on previously reported operating income, net income, shareholders
equity or cash flows from operating activities.
Recent Accounting Pronouncements
In June 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154, Accounting
Changes and Error Corrections a replacement of APB No. 20 and FASB Statement No. 3 (SFAS
154). SFAS 154 provides guidance on the accounting for and reporting of accounting changes and
error corrections. It requires retrospective application to prior period financial statements of
changes in accounting principle, unless this would be impracticable. SFAS 154 also redefines the
term restatement to mean the correction of an error by revising previously issued financial
statements. This statement is effective for fiscal years beginning after December 15, 2005. The
Company adopted this pronouncement as of September 1, 2006. This statement had no impact on the
consolidated financial statements at adoption.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments, which is effective for all financial instruments acquired or issued after the
beginning of an entitys first fiscal year that begins after September 15, 2006. This statement
amends SFAS 133 and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities (SFAS 140). The Company intends to adopt this pronouncement for
fiscal year 2008 and does not anticipate this pronouncement to have a material impact on the
consolidated financial statements.
In July 2006, the FASB issued FASB Interpretation 48, Accounting for Uncertainty in Income Taxes
an interpretation of FASB Statement No. 109 (FIN 48). This interpretation clarifies the
accounting for uncertainty in income taxes recognized in an entitys financial statements in
accordance with SFAS No. 109, Accounting for Income Taxes (SFAS 109). It prescribes a
recognition threshold and measurement attribute for financial statement recognition and disclosure
of tax positions taken or expected to be taken on a tax return. This interpretation is effective
for fiscal years beginning after December 15, 2006. The Company will be required to adopt FIN 48 in
the first quarter of fiscal year 2008. Management is currently evaluating the requirements of the
interpretation and has not yet determined the impact of adoption on the Companys consolidated
financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157
defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands
disclosures about fair value measurements. SFAS 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.
Earlier application is encouraged, provided that the reporting entity has not yet issued financial
statements for that fiscal year, including financial statements for an interim period within that
fiscal year. The Company will be required to adopt SFAS 157 in the first quarter of fiscal year
2009. Management is currently evaluating the requirements of SFAS 157 and has not yet determined
the impact on the Companys consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension
and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS
158), which requires employers to fully recognize the funded status of single-employer defined
benefit pension, retiree healthcare and other postretirement plans in their financial statements
and to recognize as a component of other comprehensive income, net of tax, the gains or losses and
prior service costs or credits that arise during the period but are not recognized as components of
net periodic costs. The requirement of SFAS 158 to recognize the funded status of a benefit plan
and the disclosure requirements will be effective as of the end of the fiscal year ending August
31, 2007.
10
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
Based on the defined benefit pension plan obligations of the Company as of August 31, 2006, the
adoption of SFAS 158 would increase total assets by approximately $1 million, increase total
liabilities by approximately $3 million and reduce total shareholders equity by approximately $2
million. The adoption of SFAS 158 will not materially affect the results of the Companys
operations. As a result of the June 2006 curtailment of the defined benefits plan, the Company does
not expect the impact to be significantly different than the estimate based on August 31, 2006
balances.
SFAS 158 also requires employers to measure defined benefit plan assets and obligations as of the
date of the Companys fiscal year-end balance sheet and disclose in the notes to financial
statements additional information about certain effects on net periodic benefit cost for the next
fiscal year that arise from delayed recognition of the gains or losses, prior service costs or
credits, and transition asset or obligation. The requirement to measure plan assets and benefit
obligations as of the date of the employers fiscal year-end balance sheet will be effective for
the fiscal year ending August 31, 2009. The Company is currently in compliance with the latter
requirement of SFAS 158, using a measurement date of August 31 for all plans.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects
of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements
(SAB 108). SAB 108 was issued in order to eliminate the diversity of practice surrounding how
public companies quantify financial statement misstatements. In SAB 108, the SEC staff established
an approach that requires quantification of financial statement misstatements based on the effects
of the misstatements on each of the companys financial statements and the related financial
statement disclosures. The Company will adopt SAB 108 in its annual financial statements for the
year ending August 31, 2007. The Company has assessed the impact of applying SAB 108 for evaluating
misstatements on its previously issued financial statements and does not expect the impact of
adoption to be material.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilitiesincluding an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159
establishes a fair value option under which entities can elect to report certain financial asset
and liabilities at fair value (the fair value option), with changes in fair value recognized in
earnings. SFAS 159 is effective for financial statements issued for fiscal years beginning after
November 15, 2007. Earlier application is encouraged, provided that the reporting entity also
elects to apply the provisions of SFAS 157. SFAS 159 becomes effective for the Company in the first
quarter of fiscal year 2009. Management is currently evaluating the requirements of SFAS 159 and
has not yet concluded if the fair value option will be adopted.
Note 2 Inventories:
Inventories consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
February 28, 2007
|
|
|
August 31, 2006
|
|
Recycled metals
|
|
$
|
144,854
|
|
|
$
|
170,405
|
|
Work in process
|
|
|
12,157
|
|
|
|
15,093
|
|
Finished goods
|
|
|
71,688
|
|
|
|
62,151
|
|
Supplies
|
|
|
18,086
|
|
|
|
15,934
|
|
|
|
|
|
|
|
|
|
|
$
|
246,785
|
|
|
$
|
263,583
|
|
|
|
|
|
|
|
|
11
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
Note 3 Business Combinations:
Metals Recycling Business
In fiscal 2006, the Company completed the following acquisitions:
|
|
|
In September 2005, the Company and HNC and certain of their subsidiaries closed a
transaction to separate and terminate their metals recycling joint venture relationships.
As part of the separation and termination agreement, the Company received from HNC various
joint venture interests, other businesses and a $37 million cash payment; while HNC
received various other joint venture interests. Purchase accounting has been finalized and
a dispute exists between the Company and HNC over post-closing adjustments. The Company
believes it has adequately accrued for the disputed amounts.
|
|
|
|
|
In October 2005, the Company acquired substantially all of the assets and certain
liabilities of Regional, a metals recycling business with nine facilities in Georgia and
Alabama. The purchase price of $69 million was paid in cash.
|
|
|
|
|
In March 2006, the Company purchased the 40% minority interest in Metals Recycling LLC,
its Rhode Island metals recycling subsidiary, and assumed certain liabilities. The
purchase price of $25 million was paid in cash.
|
In the second quarter of fiscal 2007 the Company continued its growth strategy by completing the
acquisition of a metals recycling business that provides additional sources of scrap metal for the
newly installed mega-shredder at its Everett, Massachusetts facility. The acquisition was not
material to the Companys financial position and results of operations. Pro forma operating results
for the acquisition are not presented, since the results would not be significantly different than
historical results.
Auto Parts Business
In September 2005, the Company acquired GreenLeaf, five store properties previously leased by
GreenLeaf and certain GreenLeaf liabilities. The purchase price of $45 million was paid in cash.
The following table is prepared on a pro forma basis for the six-month period ended February 28,
2006 as though all of the businesses acquired through the HNC separation and termination agreement
and the GreenLeaf and Regional acquisitions had occurred on September 1, 2005 (in thousands, except
per share amounts):
|
|
|
|
|
|
|
For the Six Months Ended
|
|
|
February 28, 2006
|
|
|
(unaudited)
|
Gross revenues
|
|
$
|
791,958
|
|
Net income
|
|
$
|
70,593
|
|
Net income per share:
|
|
|
|
|
Basic
|
|
$
|
2.31
|
|
Diluted
|
|
$
|
2.29
|
|
The pro forma results are not necessarily indicative of what would have occurred if the
acquisitions had been in effect for the full six month period. In addition, the pro forma results
are not intended to be a projection of future results and do not reflect any synergies that might
be achieved from combining operations.
12
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
Note 4 Environmental Liabilities and Other Contingencies:
The Company evaluates the adequacy of its environmental reserves on a quarterly basis in accordance
with Company policy. Adjustments to the liabilities are made when additional information becomes
available that affects the estimated costs to study or remediate any environmental issues. The
factors which the Company considers in its recognition and measurement of environmental liabilities
include the following:
|
|
|
Current regulations, both at the time the reserve is established and during the course
of the clean-up, which specify standards for acceptable remediation;
|
|
|
|
|
Information about the site, which becomes available as the site is studied and
remediated;
|
|
|
|
|
The professional judgment of both senior-level internal staff and external consultants,
who take into account similar, recent instances of environmental remediation issues, among
other considerations;
|
|
|
|
|
Technologies available that can be used for remediation; and
|
|
|
|
|
The number and financial condition of other potentially responsible parties and the
extent of their responsibility for the remediation.
|
Metals Recycling Business
At February 28, 2007 and August 31, 2006, environmental reserves for the Metals Recycling Business
aggregated $25 million and $23 million, respectively, and consist primarily of the reserves
established in connection with acquisitions in fiscal 2006 and the Hylebos Waterway Remediation
(see below). No environmental compliance proceedings are pending with respect to any of these
sites. In addition to the matters discussed below, the Companys environmental reserve includes
amounts for potential future clean-up of other sites at which the Company or its subsidiaries have
conducted business or allegedly disposed of other materials. None of these reserves are material,
individually or in the aggregate.
Hylebos Waterway Remediation.
General Metals of Tacoma, Inc. (GMT), a subsidiary of the Company,
owns and operates a metals recycling facility located in the State of Washington on the Hylebos
Waterway, a part of Commencement Bay, which is the subject of an ongoing remediation project by the
United States Environmental Protection Agency (EPA) under the Comprehensive Environmental
Response, Compensation and Liability Act. GMT and more than 60 other parties were named potentially
responsible parties (PRPs) for the investigation and clean-up of contaminated sediment along the
Hylebos Waterway. On March 25, 2002, the EPA issued Unilateral Administrative Orders (UAOs) to
GMT and another party (Other Party) to proceed with Remedial Design and Remedial Action (RD/RA)
for the head of the Hylebos Waterway and to two other parties to proceed with the RD/RA for the
balance of the waterway. The UAO for the head of the Hylebos Waterway was converted to a voluntary
consent decree in 2004, pursuant to which GMT and the Other Party agreed to remediate the head of
the Hylebos Waterway.
There are two phases to the remediation of the head of the Hylebos Waterway. The first phase was
the intertidal and bank remediation, which was conducted in 2003 and early 2004. The second phase
was dredging in the head of the Hylebos Waterway, which commenced in July 2004 and was completed in
February 2006. During fiscal 2005, the Company paid remediation costs of $16 million related to
Hylebos Waterway dredging, which resulted in a reduction of the recorded environmental liability.
The Companys cost estimates were based on the assumption that dredge removal of contaminated
sediments would be accomplished within one dredge season during July 2004 through February 2005.
However, due to a variety of factors, including dredge contractor operational issues and other
dredge related delays, the dredging was not completed during the first dredge season. As a result,
the Company recorded environmental charges of $14 million in fiscal 2005, primarily to account for
additional estimated costs to complete this work during a second dredging season. During fiscal
2006, the Company incurred remediation costs of $7 million, which were charged to the environmental
reserve. The Company and the Other Party filed a complaint in the United States District Court for
the Western District of Washington at Tacoma against the dredge contractor to recover damages and a
significant portion of cost overruns incurred in the second dredging season to complete the
project. Following a trial that concluded in February 2007, a jury awarded the Company and the
Other Party damages in the amount of $6 million. The
13
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
judgment is subject to appeal by the dredge
contractor. No accrual or reduction of liabilities is recorded until all legal options have been
resolved and the award is certain and deemed collectible.
GMT and the Other Party are pursuing settlement negotiations with and legal actions against other
non-settling, non-performing PRPs to recover additional amounts that may be applied against the
head of the Hylebos Waterway remediation costs. The pending legal action is scheduled to go to
trial in May 2007. During fiscal 2005, the Company recovered $1 million from four non-performing
PRPs, and during the first quarter of fiscal 2006, the Company recovered an additional immaterial
amount from two non-performing PRPs. This amount had previously been taken into account as a
reduction in the Companys reserve for environmental liabilities. On February 28, 2007 and August
31, 2006, environmental reserves for the Hylebos Waterway aggregated $4 million, with no material
charges against the reserve in the first six months of fiscal 2007.
The Natural Resource Damage Trustees (Trustees) for Commencement Bay have asserted claims against
GMT and other PRPs within the Hylebos Waterway area for alleged damage to natural resources. In
March 2002, the Trustees delivered a draft settlement proposal to GMT and others in which the
Trustees suggested a methodology for resolving the dispute, but did not indicate any proposed
damages or cost amounts. In June 2002, GMT responded to the Trustees draft settlement proposal
with various corrections and other comments, as did twenty other participants. In February 2004,
GMT submitted a settlement proposal to the Trustees for a complete settlement of Natural Resource
Damage liability for the GMT site. The proposal included three primary components: (1) an offer to
perform a habitat restoration project; (2) reimbursement of Trustee past assessment costs; and (3)
payment of Trustee oversight costs. The parties have reached agreement on the terms of the
settlement, which is subject to final agency approval. The Companys previously recorded
environmental liabilities include an estimate of the Companys potential liability for these
claims.
The Washington State Department of Ecology named GMT, along with a number of other parties, as a
Potentially Liable Party for a site referred to as Tacoma Metals. GMT operated on this site under a
lease until 1982. The property owner and current operator have taken the lead role in performing a
Remedial Investigation/Feasibility Study (RI/FS) for the site. The Companys previously recorded
environmental liabilities include an estimate of the Companys potential liability at this site.
Portland Harbor.
In December 2000, the EPA designated the Portland Harbor, a 5.5 mile stretch of
the Willamette River in Portland, Oregon, as a Superfund site. The Companys metals recycling and
deep water terminal facility in Portland, Oregon is located adjacent to the Portland Harbor. The
EPA has identified at least 69 PRPs, including the Company and Crawford Street Corporation (CSC),
a subsidiary of the Company, which own or operate or formerly owned or operated sites adjacent to
the Portland Harbor Superfund site. The precise nature and extent of any clean-up of the Portland
Harbor, the parties to be involved, the process to be followed for any clean-up and the allocation
of any costs for the clean-up among responsible parties have not yet been determined. It is unclear
whether or to what extent the Company or CSC will be liable for environmental costs or damages
associated with the Superfund site. It is also unclear to what extent natural resource damage
claims or third party contribution or damage claims will be asserted against the Company or CSC.
While the Company and CSC participated in certain preliminary Portland Harbor study efforts, they
are not parties to the consent order entered into by the EPA with other certain PRPs, referred to
as the Lower Willamette Group (LWG), for an RI/FS; however, the Company and CSC could become
liable for a share of the costs of this study at a later stage of the proceedings. The Company is
cooperating in discussions with the EPA, the Oregon Department of Environmental Quality (DEQ) and
the LWG and continuing to evaluate alleged liabilities in context of the available technical,
factual and legal information.
During fiscal 2006, the Company and CSC, together with approximately 27 other PRPs who are not
participating in the LWGs RI/FS, received letters from the LWG and one of its members with respect
to participating in the LWG RI/FS and demands from various parties in connection with environmental
response costs allegedly incurred in investigating contamination at the Portland Harbor Superfund
site. In an effort to develop a coordinated strategy and response to these demands, the Company and
CSC joined with more than twenty other newly-noticed parties to form the Blue Water Group (BWG).
All members of the BWG declined to join the LWG. As a result of discussions between the BWG, LWG,
EPA and DEQ regarding a potential cash
14
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
contribution to the RI/FS, certain members of the BWG,
including the Company and CSC, have agreed to an interim settlement with the LWG under which the
Company and CSC would contribute toward the BWGs total settlement amount.
The BWG also undertook efforts to oppose a separate settlement between the LWG and DEQ memorialized
in a consent judgment lodged in Oregon state court in October 2006. The BWG opposed that consent
judgment on the grounds that it contains terms that may violate federal and state law and would
unduly prejudice the BWG. The Oregon state court, however, denied the BWGs motions to intervene and entered the consent
judgment. The BWG appealed the denial of the motions to intervene, and the appeals court granted a
stay of certain parts of the consent judgment pending resolution of the appeal. As a result of the
interim settlement referred to above, that appeal will be dismissed.
Separately, DEQ has requested operating history and other information from numerous persons and
entities which own or conduct operations on properties adjacent to or upland from the Portland
Harbor, including the Company and CSC. The DEQ investigations at the Company and CSC sites are
focused on controlling any current releases of contaminants into the Willamette River. The Company
has agreed to a voluntary Remedial Investigation/Source Control effort with the DEQ regarding its
Portland, Oregon deep water terminal facility and the site formerly owned by CSC. DEQ identified
these sites as potential sources of contaminants that could be released into the Willamette River.
The Company believes that improvements in the operations at these sites, often referred to as Best
Management Practices (BMPs), will provide effective source control and avoid the release of
contaminants from these sites and has proposed to DEQ the implementation of BMPs as the resolution
of this investigation. Additionally, the EPA recently released and made available to the public the
LWGs Round Two data, involving hundreds of sediment samples taken throughout the 5.5 mile harbor
site, and the LWG recently released its interim report to the EPA on its RI/FS. The Company is in
the process of reviewing this data and the report. The cost of the investigations and remediation
associated with these properties and the cost of employment of source control BMPs is not
reasonably estimable until the completion of the data review and further investigations now being
conducted by the LWG. In fiscal 2006, the Company recorded a liability for its estimated share of
the costs of the investigation incurred by the LWG to date. The Companys estimated share of these
costs is not considered to be material. No liability has been recorded for either future
investigation costs or remediation of the Portland Harbor.
Other Metals Recycling Business Sites.
For a number of years prior to the Companys 1996
acquisition of Proler International Corp. (Proler), Proler operated a shredder with an on-site
industrial waste landfill in Texas, which Proler utilized to dispose of auto shredder residue
(ASR) from the operations. In August 2002, Proler entered the Texas Commission on Environmental
Quality Voluntary Cleanup Program toward the pursuit of a Voluntary Cleanup Program Certificate of
Completion for the former landfill site. In fiscal 2005, the Texas Commission on Environmental
Quality issued a Conditional Certificate of Completion requiring Proler to perform ongoing
groundwater monitoring and annual inspections, maintenance and reporting. As a result of the
resolution of this issue, the Company reduced its reserve related to this site by $2 million in
fiscal 2005. Reserves related to this site at February 28, 2007 and August 31, 2006 were $1
million, with no material charges against the reserve during the first six months of fiscal 2007.
15
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
During the second quarter of fiscal 2005, in connection with the negotiation of the separation and
termination agreement relating to the Companys metals recycling joint ventures with HNC (see Note
3 Business Combinations), the Company conducted an environmental due diligence investigation of
certain joint venture businesses it proposed to acquire. As a result of this investigation, the
Company identified certain environmental risks and accrued $3 million for its share of the
estimated costs to remediate these risks. During the first quarter of fiscal 2006, an additional
$12 million was recorded in conjunction with purchase accounting, representing the remaining
portion of the environmental liabilities associated with the HNC separation and termination
agreement and the Regional acquisition.
During the second quarter of fiscal 2007, in connection with an acquisition, the Company conducted
an environmental due diligence investigation. As a result of this investigation, the Company
identified certain environmental risks and accrued $3 million for its share of the estimated costs
to remediate these risks. The reserve was recorded as part of purchase accounting for the
acquisition.
Auto Parts Business
At February 28, 2007 and August 31, 2006, environmental reserves for the Auto Parts Business
aggregated $18 million. No environmental enforcement proceedings are pending with respect to any of
these sites and no amounts were charged to these reserves in fiscal 2006 or the first six months of
fiscal 2007.
Steel Manufacturing Business
The Steel Manufacturing Business electric arc furnace generates dust (EAF dust) that is
classified as hazardous waste by the EPA because of its zinc and lead content. As a result, the
Company gathers the EAF dust and ships it via specialized rail cars to a domestic firm that applies
a treatment that allows the EAF dust to be delisted as hazardous waste so it can be disposed of as
a non-hazardous, solid waste.
The Steel Manufacturing Business has an operating permit issued under Title V of the Clean Air Act
Amendments of 1990, which governs certain air quality standards. The permit was first issued in
fiscal 1998 and has since been renewed through fiscal year 2007. The permit allows the Steel
Manufacturing Business to produce up to 900,000 tons of billets per year and allows varying rolling
mill production levels based on levels of emissions. The Company submitted an application for the
renewal of the permit during fiscal 2006; the application remains pending at February 28, 2007.
Contingencies-Other
The Company had a past practice of making improper payments to the purchasing managers of nearly
all of the Companys customers in Asia in connection with export sales of recycled ferrous metal.
The Company stopped this practice after it was advised in 2004 that it raised questions of possible
violations of United States and foreign laws. Thereafter, the Audit Committee was advised and
conducted a preliminary compliance review. On November 18, 2004, on the recommendation of the Audit
Committee, the Board of Directors authorized the Audit Committee to engage independent counsel and
conduct a thorough, independent investigation. The Board also authorized and directed that the
existence and the results of the investigation be voluntarily reported to the DOJ and the SEC, and
that the Company cooperate fully with those agencies. The Audit Committee notified the DOJ and the
SEC of the independent investigation, engaged outside counsel to assist in the independent
investigation and instructed outside counsel to fully cooperate with the DOJ and the SEC and to
provide those agencies with the information obtained as a result of the independent investigation.
On October 16, 2006, the Company finalized settlements with the DOJ and the SEC resolving the
investigation. Under the settlement, the Company agreed to a deferred prosecution agreement with
the DOJ (the Deferred Prosecution Agreement) and agreed to an order, issued by the SEC,
instituting cease-and-desist proceedings, making findings, and imposing a cease-and-desist order
pursuant to Section 21C of the Securities Exchange Act of 1934 (the Order). Under the Deferred
Prosecution Agreement, the DOJ will not prosecute the Company if the Company meets the conditions
of the agreement for a period of three years including, among other things, that the
16
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
Company engage
a compliance consultant to advise its compliance officer and its Board of Directors on the
Companys compliance program. Under the Order, the Company agreed to cease-and-desist from the past
practices that were the subject of the investigation and to disgorge $8 million of profits and
prejudgment interest. The Order also contains provisions comparable to those in the Deferred
Prosecution Agreement regarding the engagement of the compliance consultant. In addition, under the
settlement, the Companys Korean subsidiary, SSI International Far East, Ltd., pled guilty to
Foreign Corrupt Practices Act anti-bribery and books and records provisions, conspiracy and wire
fraud charges and paid a fine of $7 million. These amounts were accrued during fiscal 2006 and paid
in the first quarter of fiscal 2007. The investigation settlement in the first quarter of fiscal
2007 did not affect the Companys previously reported financial results. Under the settlement, the
Company has agreed to cooperate fully with any ongoing, related DOJ and SEC investigations.
The Company has incurred expenses, and may incur further expenses, in connection with the
advancement of funds to, or indemnification of, individuals involved in such investigations. Under
the terms of its corporate bylaws, the Company is obligated to indemnify all current and former
officers or directors involved in civil, criminal or investigative matters, in connection with
their service. The Company is also obligated to advance fees and expenses, but only if the involved
officer or director acted in good faith. The Company also has the option to indemnify employees
and to advance fees and expenses, but only if the involved employees acted in good faith. There
is no limit on the indemnification payments the Company could be required to make under these
provisions. The Company did not record a liability for these indemnification obligations based on
the fact that they are employment-related costs. At this time, the Company does not believe that
any indemnity payments the Company may be required to make will be material.
Note 5 Long Term Debt:
On November 8, 2005, the Company entered into an amended and restated unsecured committed bank
credit agreement with Bank of America, N.A., as administrative agent, and the other lenders party
thereto. The agreement provides for a five-year, $400 million revolving credit facility loan
maturing in November 2010. Interest on outstanding indebtedness under the restated agreement is
based, at the Companys option, on either the London Interbank Offered Rate (LIBOR) plus a spread
of between 0.625% and 1.25%, with the amount of the spread based on a pricing grid tied to the
Companys leverage ratio, or the greater of the prime rate or the federal funds rate plus 0.50%. In
addition, annual commitment fees are payable on the unused portion of the credit facility at rates
between 0.15% and 0.25% based on a pricing grid tied to the Companys leverage ratio. As of
February 28, 2007, the Company had borrowings outstanding under the credit facility of $152
million. The Company also has an additional unsecured credit line, which was increased on March 1,
2007, by $5 million to $20 million. Interest on outstanding indebtedness under the unsecured line
of credit is set by the bank at the time of borrowing. The credit available under this agreement is
uncommitted, and as of February 28, 2007, the Company had $15 million outstanding under this
agreement. Both credit agreements contain various representations and warranties, events of default
and financial and other covenants, including covenants regarding maintenance of a minimum fixed
charge coverage ratio and a maximum leverage ratio. As of February 28, 2007, the Company was in
compliance with all such covenants, representations and warranties. Additionally, as of February
28, 2007, the Company had $8 million of long-term debt due in January 2021.
17
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
Note 6 Related Party Transactions:
Certain shareholders of the Company own significant interests in, or are related to owners of, the
entities discussed below. As such, these entities are considered related parties for financial
reporting purposes. All transactions with the Schnitzer family (including Schnitzer family
companies) require the approval of the Companys Audit Committee, and the Company is in compliance
with this policy.
The Company purchases recycled metal from its joint venture operations at prices that approximate
fair market value. These purchases totaled $4 million and $2 million in the second quarter of
fiscal 2007 and 2006, respectively, and $7 million and $5 million in the first six months of fiscal
2007 and 2006, respectively. Advances to these joint ventures were $1 million and $2 million as of
February 28, 2007 and August 31, 2006, respectively. Included in other assets are notes receivable
from joint venture businesses of $445,000 and $544,000 as of February 28, 2007 and August 31, 2006,
respectively.
Thomas D. Klauer, Jr., President of the Companys Auto Parts Business, is the sole shareholder of a
corporation that is the 25% minority partner in a partnership with the Company. This partnership
operates four self-service stores in Northern California. Mr. Klauers 25% share of the profits of
this partnership totaled $253,000 and $228,000 in the second quarter of fiscal 2007 and 2006,
respectively and $577,000 and $618,000 in the first six months of fiscal 2007 and 2006,
respectively. Mr. Klauer also owns the property at one of these stores, which is leased to the
partnership under a lease providing for annual rent of $228,000, subject to annual adjustments
based on the Consumer Price Index, and a term expiring in December 2010. The partnership has the
option to renew the lease upon its expiration for a five-year period.
Schnitzer Investment Corp. (SIC) is a real estate company that owns, develops and manages various
commercial and residential real estate projects; it is owned by members of the Schnitzer family,
who are collectively controlling shareholders of the Company through their ownership of Class B
common stock. The Company leases its administrative offices from SIC under an operating lease that
expires in 2015. The annual rent expense in fiscal 2006 was $501,000, and the annual rent
commitment for fiscal 2007 is $515,000.
The Company, SIC and another Schnitzer family company are also parties to a shared services
agreement for the performance of various administrative services. During fiscal 2006, substantially
all services performed by the Company under this agreement were eliminated. Under the shared
services agreement, the Company billed SIC a total of $10,000 and $24,000 in the three and six
months ended February 28, 2007, respectively, and a total of $51,000 and $110,000, respectively, in
the three and six months ended February 28, 2006. Included in accounts receivable are amounts due
from SIC of $122,000 and $21,000 as of February 28, 2007 and August 31, 2006, respectively. The
Company also repays SIC for various reimbursable expenses. In the three and six months
ended February 28, 2007, the Company paid SIC a total of $157,000 and $159,000, respectively, and
in the three and six months ended February 28, 2006, the Company paid SIC a total of $19,000 and
$140,000, respectively, for reimbursable expenses.
Note 7 Stock Incentive Plan:
Fiscal 2007 2009 Long-Term Incentive Awards
On November 27, 2006, the Companys Compensation Committee approved performance-based awards under
the Companys 1993 Stock Incentive Plan (the Plan) and the entry by the Company into Long-Term
Incentive Award Agreements evidencing the award of these performance shares. The Compensation
Committee established a series of performance targets based on the Companys average growth in
earnings per share (weighted at 50%) and the Companys average return on capital employed (weighted
at 50%), for the three years of the performance period corresponding to award payouts ranging from
threshold at 50% to maximum at 200% of the weighted portions of the target awards. For measuring
earnings per share growth in fiscal 2007, the Compensation Committee set the fiscal 2006 diluted
earnings per share amount lower than the actual amount,
18
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
reflecting the elimination of certain large
nonrecurring items. A participant generally must be employed by the Company on the October 31
following the end of the performance period to receive an award payout, although adjusted awards
will be paid if employment terminates earlier on account of death, disability, retirement,
termination without cause after the first year of the performance period or a sale of the Company.
Awards will be paid in Class A common stock as soon as practicable after the October 31 following the end of
the performance period. The Company recognized $507,000 in compensation expense for the FY 07 FY
09 Performance Awards in the second quarter and first six months of fiscal 2007.
Restricted Stock Units
In connection with the approval of stock option awards by the Compensation Committee on July 25,
2006, the Committee authorized the Company to permit option grantees to elect to receive the value
of the option awards in restricted shares of Class A common stock of the Company. In October 2006,
the Company commenced a tender offer under which the recipients of the July 25, 2006 option grants
were allowed to exchange the options for RSUs on a 2:1 basis, an exchange ratio determined to be
equivalent under a Black-Scholes pricing model. The RSUs vest on the same schedule as the options
granted on July 25, 2006 would have vested. As of the close of the tender offer on November 6,
2006, stock options for 272,000 shares were exchanged for 136,000 RSUs. The estimated fair value of
the RSUs issued on November 7, 2006 was $5 million based on the market closing price of the
underlying Class A common stock on November 6, 2006 of $37.65. As a result of the exchange, the
Company estimated the incremental compensation expense to be $541,000, which is being recognized
over the remaining portion of the five-year vesting term of the RSUs.
Deferred Stock Units
On January 31, 2007, the Compensation Committee granted DSUs to each of its non-employee directors.
Each grant was equal to $87,500 ($131,250 for the Chairman of the Board) divided by the closing
market price of the Class A common stock on January 31, 2007. The total number of DSUs granted on
January 31, 2007 was 23,864 shares. The DSUs will become fully vested on the day before the 2008
annual meeting, subject to continued Board service. The Company recognized $107,000 in compensation
expense for these DSUs in the second quarter of fiscal 2007.
Note 8 Employee Benefits:
The Company has retirement benefit plans that cover both union and non-union employees. The Company
makes contributions in accordance with the provisions of each plan.
Defined Benefit Pension Plan
The Company maintains a defined benefit pension plan for certain non-union employees.
The primary actuarial assumptions are determined as follows:
|
|
|
The expected long-term rate of return on plan assets is based on the Companys estimate
of long-term returns for equities and fixed income securities weighted by the allocation
of assets in the plans. The rate is affected by changes in general market conditions, but
because it represents a long-term rate, it is not significantly affected by short-term
market swings. Changes in the allocation of plan assets would also impact this rate.
|
|
|
|
|
The assumed discount rate is used to discount future benefit obligations back to
current dollars. The discount rate was 5.9% as of the measurement date of August 31, 2006.
This rate is sensitive to changes in interest rates. A decrease in the discount rate would
increase the Companys obligation and expense.
|
|
|
|
|
The expected rate of compensation increase is used to develop benefit obligations using
projected pay at retirement. This rate represents average long-term salary increases and
is influenced by the Companys compensation policies. An increase in this rate would
increase the Companys obligation and expense. Effective June 30, 2006, the Company ceased
the accrual of further benefits under the plan, and the expected rate of compensation
increase is no longer applicable in calculating benefit obligations.
|
19
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
The components of net periodic pension benefit cost were (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Service cost
|
|
$
|
|
|
|
$
|
395
|
|
|
$
|
|
|
|
$
|
695
|
|
Interest cost
|
|
|
192
|
|
|
|
226
|
|
|
|
384
|
|
|
|
396
|
|
Expected return on plan assets
|
|
|
(231
|
)
|
|
|
(280
|
)
|
|
|
(462
|
)
|
|
|
(493
|
)
|
Amortization of past service cost
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
2
|
|
Recognized actuarial loss
|
|
|
38
|
|
|
|
68
|
|
|
|
76
|
|
|
|
121
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic pension (benefit) cost
|
|
$
|
(1
|
)
|
|
$
|
410
|
|
|
$
|
(2
|
)
|
|
$
|
721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due to the Companys decision to freeze benefits, the Company did not make contributions to the
plan during the six months ended February 28, 2007 and does not expect to make contributions during
the remainder of fiscal 2007. The need for future contributions will be evaluated periodically and
will be determined by a number of factors, including market investment returns and interest rates.
Defined Contribution Plans
The Company has several defined contribution plans covering non-union employees. Company
contributions to the defined contribution plans were $1 million and $2 million for the three and
six months ended February 28, 2007, respectively, and $192,000 and $1 million for the three and six
months ended February 28, 2006, respectively.
Multiemployer Pension Plans
In accordance with collective bargaining agreements, the Company contributes to multiemployer
pension plans. Company contributions to the multiemployer plans were $1 million and $2 million for
the three and six months ended February 28, 2007, respectively, and $541,000 and $1 million for the
three and six months ended February 28, 2006, respectively.
The Company is not the sponsor or administrator of these multiemployer plans. Contributions were
determined in accordance with provisions of negotiated labor contracts. The Company is unable to
determine its relative portion of, or estimate its future liability under, these plans.
Note 9 Segment Information:
The Company operates in three industry segments: metals processing, recycling and trading (Metals
Recycling Business), self-service and full-service used auto parts sales (Auto Parts Business)
and mini-mill steel manufacturing (Steel Manufacturing Business). Corporate expense consists
primarily of unallocated corporate expense for management and administrative services that benefit
all three business segments. The Company does not allocate interest income and expense, income
taxes, or other income and expenses related to corporate activity to its operating segments.
Because of this unallocated expense, the operating income of each segment does not reflect the
operating income the segment would have as a stand-alone business.
20
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
Revenues from external customers and from intersegment transactions for the Companys consolidated
operations were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Metals Recycling Business
|
|
$
|
486,120
|
|
|
$
|
294,983
|
|
|
$
|
886,605
|
|
|
$
|
536,413
|
|
Auto Parts Business
|
|
|
59,786
|
|
|
|
49,982
|
|
|
|
120,594
|
|
|
|
95,904
|
|
Steel Manufacturing Business
|
|
|
98,924
|
|
|
|
89,535
|
|
|
|
194,984
|
|
|
|
178,691
|
|
Intersegment revenues
|
|
|
(40,388
|
)
|
|
|
(31,215
|
)
|
|
|
(87,887
|
)
|
|
|
(66,492
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated revenues
|
|
$
|
604,442
|
|
|
$
|
403,285
|
|
|
$
|
1,114,296
|
|
|
$
|
744,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The reconciliation of the Companys segment operating income to income before income taxes,
minority interest and pre-acquisition interest is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Metals Recycling Business
|
|
$
|
39,756
|
|
|
$
|
18,867
|
|
|
$
|
64,599
|
|
|
$
|
32,601
|
|
Auto Parts Business
|
|
|
5,007
|
|
|
|
3,630
|
|
|
|
8,802
|
|
|
|
11,367
|
|
Steel Manufacturing Business
|
|
|
11,910
|
|
|
|
16,246
|
|
|
|
27,269
|
|
|
|
32,316
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment operating income
|
|
|
56,673
|
|
|
|
38,743
|
|
|
|
100,670
|
|
|
|
76,284
|
|
Corporate expense
|
|
|
(11,074
|
)
|
|
|
(8,987
|
)
|
|
|
(20,768
|
)
|
|
|
(28,466
|
)
|
Intercompany eliminations
|
|
|
1,665
|
|
|
|
1,814
|
|
|
|
938
|
|
|
|
1,285
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
47,264
|
|
|
|
31,570
|
|
|
|
80,840
|
|
|
|
49,103
|
|
Other income (expense)
|
|
|
(2,020
|
)
|
|
|
288
|
|
|
|
(1,965
|
)
|
|
|
55,387
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes,
minority interest and
pre-acquisition interest
|
|
$
|
45,244
|
|
|
$
|
31,858
|
|
|
$
|
78,875
|
|
|
$
|
104,490
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Companys total assets are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
As of February
|
|
|
As of August
|
|
|
|
28, 2007
|
|
|
31, 2006
(1)
|
|
Metals Recycling Business
|
|
$
|
793,784
|
|
|
$
|
728,985
|
|
Auto Parts Business
|
|
|
231,950
|
|
|
|
231,617
|
|
Steel Manufacturing Business
|
|
|
269,015
|
|
|
|
243,652
|
|
|
|
|
|
|
|
|
Total segment assets
|
|
|
1,294,749
|
|
|
|
1,204,254
|
|
Corporate and Eliminations
|
|
|
(180,663
|
)
|
|
|
(159,530
|
)
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,114,086
|
|
|
$
|
1,044,724
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Consistent with changes in internal reporting, total assets by segment include
reclassifications made during the first six months of fiscal 2007 relative to certain
intercompany balances and eliminations. Prior period balances have been reclassified for
consistency. There was no change in total assets.
|
21
SCHNITZER STEEL INDUSTRIES, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2007 AND 2006
Note 10 Income Taxes
For interim financial reporting purposes, tax expense is calculated based on the annual statutory
tax rate, adjusted to give effect to anticipated permanent differences. The tax rate of 36% for the
second quarter of the current fiscal year exceeds the tax rate of 33% for the comparable period
last year because the prior years rate benefited from state tax refunds resulting from a tax
credit study. The tax rate for the first six months of fiscal 2007 was 36%, compared to a tax rate
of 40% for the same period last year, a rate that was higher than usual because the Company had
accrued $11 million of nondeductible penalties and profit disgorgement in connection with the
estimated settlements of the SEC and DOJ investigations (see Note 4, Environmental Liabilities and
Other Contingencies.) In addition, the tax rate of 38% that applied to the non-recurring $55
million gain in the first quarter of fiscal 2006 arising from the HNC separation and termination
(see Note 3 Business Combinations) was higher than the tax rate applicable to the Companys
recurring income. The 36% current year tax rate comprises the 35% federal statutory rate and a 2%
state rate, offset by a 1% benefit from the Section 199 manufacturing deduction and the
Extraterritorial Income Exclusion benefit on export sales.
22
SCHNITZER STEEL INDUSTRIES, INC.
|
|
|
ITEM 2.
|
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
|
The following discussion and analysis provides information which management believes is relevant to
an assessment and understanding of the results of operations and financial condition of Schnitzer
Steel Industries, Inc. (the Company). The discussion should be read in conjunction with the
Unaudited Condensed Consolidated Financial Statements and the related notes thereto.
Forward-looking Statements
This Quarterly Report on
Form 10-Q
, including Item 2 Managements Discussion and Analysis of
Financial Condition and Results of Operations, and including particularly, the Outlook section,
contains forward-looking statements, within the meaning of Section 21E of the Securities Exchange
Act of 1934, as amended (the Exchange Act), which are made pursuant to the safe harbor provisions
of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include,
without limitation, statements regarding the Companys outlook for the business and statements as
to expected pricing, sales volume, operating margins and operating income. Such statements can
generally be identified because they contain expect, believe, anticipate, estimate and
other words that convey a similar meaning. One can also identify these statements as statements
that do not relate strictly to historical or current facts. Examples of factors affecting the
Company that could cause actual results to differ materially from current expectations are the
following: volatile supply and demand conditions affecting prices and volumes in the markets for
both the Companys products and the raw materials it purchases; world economic conditions; world
political conditions; changes in federal and state income tax laws; government regulations and
environmental matters; impact of pending or new laws and regulations regarding imports and exports
into the United States and other foreign countries; foreign currency fluctuations; competition;
seasonality, including weather; energy supplies; freight rates; loss of key personnel; the
inability to obtain sufficient quantities of scrap metal to support current orders; purchase price
estimates made during acquisitions; business integration issues relating to acquisitions of
businesses; and business disruptions resulting from installation or replacement of major capital
assets, as discussed in more detail in Managements Discussion and Analysis of Financial Condition
and Results of Operations in the Companys most recent Annual Report on
Form 10-K
or Quarterly
Report on
Form 10-Q
. One should understand that it is not possible to predict or identify all
factors that could cause actual results to differ from the Companys forward-looking statements.
Consequently, the reader should not consider any such list to be a complete statement of all
potential risks or uncertainties. The Company does not assume any obligation to update any
forward-looking statement.
General
Founded in 1906 as a one-man scrap operation, the Company is currently one of the nations largest
recyclers of ferrous and nonferrous metals, a leading recycler of used and salvaged vehicles and a
manufacturer of finished steel products.
The Company provides an end of life cycle solution for a variety of products through its vertically
integrated business, including processing auto bodies and other metal products, the resale of used
auto parts and manufacturing scrap metal into finished steel products. The Company operates in
three business segments: the Metals Recycling Business, the Auto Parts Business and the Steel
Manufacturing Business. The Metals Recycling Business buys, collects, processes, recycles, sells,
trades and brokers recycled ferrous metals (containing iron) to foreign and domestic steel
producers, including its Steel Manufacturing Business, and nonferrous metals (not containing iron)
to both the domestic and export markets. The Auto Parts Business purchases used and salvaged
vehicles and sells used parts from these vehicles through its 35 self-service and 17 full-service
auto parts operations located in the United States and Canada. The remaining portions of the
scrapped vehicles are sold to metals recyclers, including the Metals Recycling Business where
geographically
feasible. The Steel Manufacturing Business purchases recycled metal from the Metals Recycling
Business and uses its mini-mill to process the recycled metal into finished steel products.
Corporate expense consists
23
SCHNITZER STEEL INDUSTRIES, INC.
primarily of unallocated corporate expense for management and administrative services that benefit
all three business segments. Because of this unallocated expense, the operating income of each
segment does not reflect the operating income the segment would have as a stand-alone business.
Metals Recycling Business
The Company operates one of the largest metals recycling businesses in the United States, with
processing facilities on the West Coast and in the Northeast and Southeast regions of the country.
The Company processes raw metal by sorting, shearing, shredding, torching and baling, resulting in
metal processed into pieces of a size, density and purity required by customers for use in their
production. Smaller, more homogenous pieces of processed metal have more value because they melt
more easily than larger pieces and more completely fill a steel mills furnace charge bucket, which
results in lower energy usage and shorter cycle times.
One of the most efficient ways to process and sort metal is to use shredding systems. Currently,
the Company operates state-of-the art mega-shredders capable of processing over 2,500 tons of metal
per day at its Everett, Massachusetts; Oakland, California; and Tacoma, Washington facilities; and
shredders capable of processing up to 1,500 tons per day at its Johnston, Rhode Island and
Portland, Oregon facilities. The Company also currently operates a smaller shredder in Kapolei,
Hawaii. In addition to the greater capacity, the mega-shredders provide the ability to shred more
efficiently and process a greater range of materials, including larger and thicker pieces of metal.
The Company is in the process of completing the installation of an additional mega-shredder at its
Portland, Oregon facility. Mega-shredders are designed to provide a denser product and, in
conjunction with new separation equipment, a more pure (refined) and preferable form of ferrous
metal that can be more efficiently used by steel mills. The use of mega-shredders broadens the
types of material that can be fed into the shredder, resulting in more efficient processing.
Shredders can reduce auto bodies, home appliances and other metal into fist-sized pieces of
shredded recycled metal in seconds. The shredded material is then carried by conveyor under
magnetized drums, which attract the recycled ferrous metal and separate it from the nonferrous
metal and other residue found in the shredded material, resulting in a relatively pure and clean
shredded ferrous product. The remaining nonferrous metal and residue then pass through a process
that separates the nonferrous metal from the residue. The Company has recently installed induction
sorting systems, which have helped further improve the recoverability of stainless steel, copper
and other valuable nonferrous metal in the Companys Everett, Massachusetts; Johnston, Rhode
Island; Oakland, California; and Tacoma, Washington facilities and expects to continue to invest in
new technology in order to maximize the recovery of such materials.
In addition, Schnitzer Global Exchange, a component of the Metals Recycling Business, purchases
processed metal from scrap metal processing companies that operate in Russia, certain Baltic
countries, and certain other countries and sells this metal to foreign steel mills. Russia and the
Baltic countries have an ample supply of unprocessed metal due to Cold War era infrastructures,
many of which are closed or obsolete. Similarly, another component of the Metals Recycling Business
brokers processed scrap metal purchased from Japan which it sells to customers in Korea and trades
other processed scrap metal. The Company believes this business complements the processing
business, allows the Company to further meet its customers needs and expands the Companys
presence in the global recycled ferrous metals market.
Auto Parts Business
The Company sells used auto parts from each of its self-service and full-service locations.
Self-service stores serve customers who remove used auto parts from vehicles that are in inventory,
without the assistance of the store employees. A self-service customer typically pays an admission
charge and signs a liability waiver before entering the facility. When a customer finds a desired
part on a vehicle, the customer removes it and pays a pre-established price for the part. The
full-service business sells its parts primarily to collision and mechanical
repair shops through its sales force. Purchased salvaged vehicles are dismantled and the parts put
into inventory. Once these parts are sold, they are pulled from inventory, cleaned, tested and
shipped to the customer by truck.
24
SCHNITZER STEEL INDUSTRIES, INC.
Once a vehicle has been removed from the self-service customer area or is ready to be removed from
the full-service holding yard, certain remaining parts that can be sold wholesale (cores) are
removed from the vehicle, consolidated at central facilities and sold through auction to a variety
of different wholesale buyers. After the core removal process is complete, the remaining vehicle
body is crushed and sold as scrap metal in the wholesale market.
Steel Manufacturing Business
The Steel Manufacturing Business purchases all of its scrap at market prices from the Metals
Recycling Business and uses its mini-mill, located in McMinnville, Oregon, to process the recycled
metals into finished steel products, including steel reinforcing bar (rebar), wire rod, merchant
bar, coiled rebar, billets and other specialty products. Through investments in technology and
upgrades to equipment, the Company has increased its annual production capacity at the mill to
approximately 750,000 tons of finished steel products. Customers are located predominantly on the
West Coast of the United States and in Western Canada and are principally steel service centers,
construction industry subcontractors, steel fabricators, wire drawers and major farm and wood
product suppliers.
Business Combinations
Metals Recycling Business
In fiscal 2006, the Company completed the following acquisitions:
|
|
|
In September 2005, the Company and the Hugo Neu Corporation (HNC) and certain of
their subsidiaries closed a transaction to separate and terminate their metals recycling
joint venture relationships. As part of the separation and termination agreement, the
Company received from HNC various joint venture interests, other businesses and a $37
million cash payment; while HNC received various other joint venture interests. Purchase
accounting has been finalized and a dispute exists between the Company and HNC over
post-closing adjustments. The Company believes it has adequately accrued for the disputed
amounts.
|
|
|
|
|
In October 2005, the Company acquired substantially all of the assets and certain
liabilities of Regional Recycling LLC, a metals recycling business with nine facilities in
Georgia and Alabama. The purchase price of $69 million was paid in cash.
|
|
|
|
|
In March 2006, the Company purchased the 40% minority interest in Metals Recycling LLC,
its Rhode Island metals recycling subsidiary, and assumed certain liabilities. The
purchase price of $25 million was paid in cash.
|
In the second quarter of fiscal 2007, the Company continued its growth strategy by completing the
acquisition of a metals recycling business that provides additional sources of scrap metal for the
newly installed mega-shredder at its Everett, Massachusetts facility. The acquisition was not
material to the Companys financial position and results of operations.
Auto Parts Business
In September 2005, the Company acquired GreenLeaf Auto Recyclers, LLC (GreenLeaf), five store
properties previously leased by GreenLeaf and certain GreenLeaf liabilities. The purchase price of
$45 million was paid in cash. GreenLeaf is a full-service supplier of recycled auto parts,
primarily to commercial customers. This acquisition expanded the Auto Parts Business national
footprint, providing growth potential in both the self-service and full-service markets. The
acquired locations are in Arizona, Florida, Georgia, Illinois, Massachusetts, Michigan, Nevada,
North Carolina, Ohio, Virginia and Texas. Four of these locations have been converted to
self-service stores and one has combined operations. Two of the 22 locations initially acquired
have been closed.
25
SCHNITZER STEEL INDUSTRIES, INC.
Summary
Management believes that these acquisitions position the Company well as it continues to execute
its growth strategy. The consideration for these acquisitions was funded by the Companys cash
balances and borrowings under its bank credit facility. See Item 1 Financial Statements
(unaudited) Notes to Condensed Consolidated Financial Statements, Note 3 Business
Combinations for further information regarding these acquisitions. The Company has recorded
estimated environmental liabilities as a result of due diligence performed in connection with these
acquisitions. See Item 1 Financial Statements (unaudited) Notes to Condensed Consolidated
Financial Statements, Note 4 Environmental Liabilities and Other Contingencies for further
information regarding environmental and other contingencies.
Executive Overview of Quarterly Results
The Companys operating results by business segment are summarized below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
OPERATING INCOME:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Metals Recycling Business
|
|
$
|
39,756
|
|
|
$
|
18,867
|
|
|
$
|
64,599
|
|
|
$
|
32,601
|
|
Auto Parts Business
|
|
|
5,007
|
|
|
|
3,630
|
|
|
|
8,802
|
|
|
|
11,367
|
|
Steel Manufacturing Business
|
|
|
11,910
|
|
|
|
16,246
|
|
|
|
27,269
|
|
|
|
32,316
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment
operating income
|
|
|
56,673
|
|
|
|
38,743
|
|
|
|
100,670
|
|
|
|
76,284
|
|
Corporate expense
|
|
|
(11,074
|
)
|
|
|
(8,987
|
)
|
|
|
(20,768
|
)
|
|
|
(28,466
|
)
|
Intercompany profit eliminations
|
|
|
1,665
|
|
|
|
1,814
|
|
|
|
938
|
|
|
|
1,285
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating income
|
|
$
|
47,264
|
|
|
$
|
31,570
|
|
|
$
|
80,840
|
|
|
$
|
49,103
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the second quarter of fiscal 2007, the Company benefited from improved financial results in
its Metals Recycling and Auto Parts Businesses. Consolidated operating income increased $16
million, or 50%, for the second quarter of fiscal 2007 compared to the same period last year.
Diluted net income per share for the quarter was $0.93, a 37% increase over the second quarter of
fiscal 2006.
Operating income for the Metals Recycling Business increased $21 million, or 111%, for the second
quarter of fiscal 2007 compared to the same period last year due to increased sales volumes and
prices.
Operating income for the Auto Parts Business increased $1 million, or 38%, for the second quarter
of fiscal 2007 compared to the same period last year due primarily to improved profitability at the
full-service stores.
Operating income for the Steel Manufacturing Business decreased $4 million, or 27%, in the second
quarter of fiscal 2007 compared to the same period last year. Higher sales volumes and higher
average sales prices were more than offset by higher prices for raw materials, principally scrap
metal.
26
SCHNITZER STEEL INDUSTRIES, INC.
Results of Operations
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
|
($ in thousands)
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Metals Recycling Business
|
|
$
|
486,120
|
|
|
$
|
294,983
|
|
|
$
|
886,605
|
|
|
$
|
536,413
|
|
Auto Parts Business
|
|
|
59,786
|
|
|
|
49,982
|
|
|
|
120,594
|
|
|
|
95,904
|
|
Steel Manufacturing Business
|
|
|
98,924
|
|
|
|
89,535
|
|
|
|
194,984
|
|
|
|
178,691
|
|
Intercompany revenue
eliminations
|
|
|
(40,388
|
)
|
|
|
(31,215
|
)
|
|
|
(87,887
|
)
|
|
|
(66,492
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
$
|
604,442
|
|
|
$
|
403,285
|
|
|
$
|
1,114,296
|
|
|
$
|
744,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated revenues for the quarter ended February 28, 2007 increased $201 million, or 50%, to
$604 million from $403 million in the second quarter of fiscal 2006 and increased $370 million, or
50%, to $1.1 billion from $745 million in the first six months of fiscal 2006. Revenues in the
second quarter and first six months of fiscal 2007 increased for all Company business segments.
Metals Recycling Business
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
%
|
|
|
|
2007
|
|
|
2006
|
|
|
increase
|
|
|
increase
|
|
|
2007
|
|
|
2006
|
|
|
increase
|
|
|
increase
|
|
Ferrous Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Processing
|
|
$
|
315,930
|
|
|
$
|
205,579
|
|
|
$
|
110,351
|
|
|
|
54
|
%
|
|
$
|
539,022
|
|
|
$
|
335,116
|
|
|
$
|
203,906
|
|
|
|
61
|
%
|
Trading
|
|
|
80,414
|
|
|
|
33,312
|
|
|
|
47,102
|
|
|
|
141
|
%
|
|
|
171,927
|
|
|
|
112,001
|
|
|
|
59,926
|
|
|
|
54
|
%
|
Nonferrous revenues
|
|
|
87,931
|
|
|
|
54,301
|
|
|
|
33,630
|
|
|
|
62
|
%
|
|
|
169,925
|
|
|
|
85,829
|
|
|
|
84,096
|
|
|
|
98
|
%
|
Other
|
|
|
1,845
|
|
|
|
1,791
|
|
|
|
54
|
|
|
|
3
|
%
|
|
|
5,731
|
|
|
|
3,467
|
|
|
|
2,264
|
|
|
|
65
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
$
|
486,120
|
|
|
$
|
294,983
|
|
|
$
|
191,137
|
|
|
|
65
|
%
|
|
$
|
886,605
|
|
|
$
|
536,413
|
|
|
$
|
350,192
|
|
|
|
65
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Ferrous Recycled Metal Sales Prices ($/LT)
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic
|
|
$
|
233
|
|
|
$
|
202
|
|
|
$
|
31
|
|
|
|
15
|
%
|
|
$
|
226
|
|
|
$
|
204
|
|
|
$
|
22
|
|
|
|
11
|
%
|
Export
|
|
$
|
238
|
|
|
$
|
195
|
|
|
$
|
43
|
|
|
|
22
|
%
|
|
$
|
235
|
|
|
$
|
199
|
|
|
$
|
36
|
|
|
|
18
|
%
|
Average for all processing
|
|
$
|
237
|
|
|
$
|
197
|
|
|
$
|
40
|
|
|
|
20
|
%
|
|
$
|
232
|
|
|
$
|
201
|
|
|
$
|
31
|
|
|
|
15
|
%
|
Trading
|
|
$
|
257
|
|
|
$
|
178
|
|
|
$
|
79
|
|
|
|
44
|
%
|
|
$
|
254
|
|
|
$
|
203
|
|
|
$
|
51
|
|
|
|
25
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ferrous Processing Sales Volume (LT, in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Steel Manufacturing Business
|
|
|
151
|
|
|
|
148
|
|
|
|
3
|
|
|
|
2
|
%
|
|
|
342
|
|
|
|
302
|
|
|
|
40
|
|
|
|
13
|
%
|
Other Domestic
|
|
|
175
|
|
|
|
158
|
|
|
|
17
|
|
|
|
11
|
%
|
|
|
331
|
|
|
|
217
|
|
|
|
114
|
|
|
|
53
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Domestic
|
|
|
326
|
|
|
|
306
|
|
|
|
20
|
|
|
|
7
|
%
|
|
|
673
|
|
|
|
519
|
|
|
|
154
|
|
|
|
30
|
%
|
Export
|
|
|
817
|
|
|
|
606
|
|
|
|
211
|
|
|
|
35
|
%
|
|
|
1,338
|
|
|
|
942
|
|
|
|
396
|
|
|
|
42
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total processed ferrous
|
|
|
1,143
|
|
|
|
912
|
|
|
|
231
|
|
|
|
25
|
%
|
|
|
2,011
|
|
|
|
1,461
|
|
|
|
550
|
|
|
|
38
|
%
|
Ferrous Trading Sales Volumes (LT, in thousands)
|
|
|
276
|
|
|
|
154
|
|
|
|
122
|
|
|
|
79
|
%
|
|
|
596
|
|
|
|
461
|
|
|
|
135
|
|
|
|
29
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Ferrous Sales Volume (LT, in thousands)
|
|
|
1,419
|
|
|
|
1,066
|
|
|
|
353
|
|
|
|
33
|
%
|
|
|
2,607
|
|
|
|
1,922
|
|
|
|
685
|
|
|
|
36
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Nonferrous Sales Price ($/pound)
|
|
$
|
0.96
|
|
|
$
|
0.74
|
|
|
$
|
0.22
|
|
|
|
30
|
%
|
|
$
|
0.99
|
|
|
$
|
0.69
|
|
|
$
|
0.30
|
|
|
|
43
|
%
|
Nonferrous Sales Volumes (pounds, in thousands)
|
|
|
90,140
|
|
|
|
71,800
|
|
|
|
18,340
|
|
|
|
26
|
%
|
|
|
169,868
|
|
|
|
121,835
|
|
|
|
48,033
|
|
|
|
39
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outbound freight included in revenues
|
|
$
|
56
|
|
|
$
|
32
|
|
|
$
|
24
|
|
|
|
75
|
%
|
|
$
|
95
|
|
|
$
|
62
|
|
|
$
|
33
|
|
|
|
53
|
%
|
|
|
|
(1)
|
|
Price information is shown after a reduction for the cost of freight incurred to deliver the product to the customer. LT refers to long ton which is 2,240 pounds.
|
The Metals Recycling Business generated revenues of $486 million for the quarter ended February 28,
2007, before intercompany eliminations, an increase of $191 million, or 65%, over the same period
of the prior year, and generated revenues of $887 million for the six months ended February 28,
2007, before intercompany eliminations, an increase of $350 million, or 65%, over the same period
of the prior year. The increases over the second quarter and first six months of the prior year
were caused by higher volumes resulting from the timing of shipments and higher average net selling
prices. Outbound freight costs, which are included in gross sales prices and revenues, increased by
75% to $56 million for the second quarter of fiscal 2007 and increased by 53% to $95
27
SCHNITZER STEEL INDUSTRIES, INC.
million for the first six months of fiscal 2007 compared with the same periods last year, primarily
due to increased volumes and higher ocean freight rates.
Ferrous revenues increased $157 million, or 66%, to $396 million during the quarter ended February
28, 2007 and increased $264 million, or 59%, to $711 million during the six months ended February
28, 2007, compared to the same periods last year due to increased volumes and higher average net
sales prices. Ferrous processing export sales volumes increased by 211,000 tons, or 35%, to 817,000
tons in the second quarter of fiscal 2007 and increased by 396,000 tons, or 42%, to 1.3 million
tons in the first six months of fiscal 2007 compared to the same periods in the prior year. The
increase in the second quarter and first six months of fiscal 2007 compared to the same periods
last year is primarily a result of the Companys efforts to increase throughput at all of its
processing facilities. Ferrous trading sales volumes increased by 122,000 tons, or 79%, to 276,000
tons in the second quarter of fiscal 2007 and increased by 135,000 tons, or 29%, to 596,000 tons in
the first six months of fiscal 2007 compared to the same periods last year. These increases are due
to a slightly milder 2007 winter, allowing for additional tonnage flow from the Baltic region and
additional support from new customers added during the last half of fiscal 2006. Other domestic
sales volume increased 11% to 175,000 tons in the second quarter of this year, and increased 53% to
331,000 tons in the first six months of fiscal 2007; both increases are primarily a result of the
Regional acquisition during fiscal 2006. Regional is situated in a growing recycled metals market
in the Southeastern United States, which is home to many automobile and auto parts manufacturers.
Nonferrous revenues increased $34 million, or 62%, to $88 million during the quarter ended February
28, 2007 over the same period last year, which was the result of a $0.22, or 30%, increase in
average net sales price to $0.96 per pound and an 18 million, or 26%, increase in pounds shipped to
over 90 million pounds in the second quarter of fiscal 2007 compared to the same period last year.
Nonferrous revenues increased $84 million, or 98%, over the same period last year, which was the
result of a $0.30, or 43%, increase in average net sales price to $0.99 per pound and a 48 million,
or 39%, increase in pounds shipped to nearly 170 million pounds in the first six months of fiscal
2007 compared to the same period last year. The increase in sales price per pound was due to the
additional value of the nonferrous product mix as a result of the Regional acquisition and
increased Asian demand for nonferrous metals. The increase in pounds shipped was primarily due to
the acquired businesses and the higher overall volumes being processed at the Companys facilities.
Certain nonferrous metals are a byproduct of the shredding process, and quantities available for
shipment are affected by the volume of materials processed in the Companys shredders.
Auto Parts Business
|
|
|
|
|
|
|
|
|
|
|
As of February 28,
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
Self-Service Locations
|
|
|
30
|
|
|
|
30
|
|
Conversion Stores
|
|
|
5
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
Total Self-Service Locations
|
|
|
35
|
|
|
|
31
|
|
Full-Service Locations
|
|
|
17
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
Total Self-Service and Full-Service Locations
|
|
|
52
|
|
|
|
51
|
|
|
|
|
|
|
|
|
|
|
The Auto Parts Business generated revenues of $60 million, before intercompany eliminations, for
the quarter ended February 28, 2007, an increase of $10 million, or 20%, over the same period last
year driven by increased sales of scrapped vehicles and cores due to higher average sales prices.
In addition, full-service net sales increased $3 million due to higher parts sales across several
product types. Revenues increased $25 million, or 26%, to $121 million for the first six months of
fiscal 2007 compared to the same period last year due to higher sales volumes and higher average
sales prices of scrapped vehicles and cores and as a result of a full six months of revenues from
GreenLeaf, which was acquired midway through the first quarter of fiscal 2006. During the first six
months of fiscal 2007, the Auto Parts Business also benefited from the improved revenue
contribution of the five stores converted from full-service to self-service compared to the same
period last year.
28
SCHNITZER STEEL INDUSTRIES, INC.
Steel Manufacturing Business
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
For the Six Months Ended
|
|
|
February 28,
|
|
February 28,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
%
|
|
|
2007
|
|
2006
|
|
increase
|
|
increase
|
|
2007
|
|
2006
|
|
increase
|
|
increase
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Sales Price ($/ton)
(1)
|
|
$
|
536
|
|
|
$
|
522
|
|
|
$
|
14
|
|
|
|
3
|
%
|
|
$
|
541
|
|
|
$
|
519
|
|
|
$
|
22
|
|
|
|
4
|
%
|
Finished Steel Products Sold (tons, in thousands)
|
|
|
177
|
|
|
|
165
|
|
|
|
12
|
|
|
|
7
|
%
|
|
|
347
|
|
|
|
331
|
|
|
|
16
|
|
|
|
5
|
%
|
|
|
|
(1)
|
|
Price information is shown after a reduction for the cost of freight incurred to deliver the product to the customer.
|
Revenues increased $9 million, or 10%, to $99 million and increased $16 million, or 9%, to $195
million for the second quarter and first six months of fiscal 2007, respectively, over the same
periods last year, primarily due to increased sales volumes and higher sales prices for finished
steel products. Sales volumes increased 7% to 177,000 tons in the second fiscal quarter of 2007 and
increased 5% to 347,000 tons in the first six months of fiscal 2007 compared to the same periods
last year. While the steel industry experienced normal seasonal softness due to wet winter weather
during the second quarter of fiscal 2007, the West Coast construction markets remained strong.
Sales volumes accelerated during the latter part of the quarter as customer activity increased in
anticipation of future price increases. The average net selling price increased $14 per ton, or 3%,
to $536 per ton in the second quarter of fiscal 2007 compared to the same period last year and
resulted in increased revenues of $3 million. The average net selling price increased $22 per ton,
or 4%, to $541 per ton in the first six months of fiscal 2007 compared to the same period last year
and resulted in increased revenues of $7 million.
Cost of Goods Sold
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
2007
|
|
|
% of Revenues
|
|
|
2006
|
|
|
% of Revenues
|
|
|
2007
|
|
|
% of Revenues
|
|
|
2006
|
|
|
% of Revenues
|
|
|
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Metals Recycling Business
|
|
$
|
430,330
|
|
|
|
89
|
%
|
|
$
|
265,261
|
|
|
|
90
|
%
|
|
$
|
790,530
|
|
|
|
89
|
%
|
|
$
|
484,274
|
|
|
|
90
|
%
|
Auto Parts Business
|
|
|
41,759
|
|
|
|
70
|
%
|
|
|
34,191
|
|
|
|
68
|
%
|
|
|
83,767
|
|
|
|
69
|
%
|
|
|
62,948
|
|
|
|
66
|
%
|
Steel Manufacturing Business
|
|
|
85,582
|
|
|
|
87
|
%
|
|
|
72,138
|
|
|
|
81
|
%
|
|
|
164,853
|
|
|
|
85
|
%
|
|
|
144,221
|
|
|
|
81
|
%
|
Eliminations
|
|
|
(42,053
|
)
|
|
|
n/m
|
|
|
|
(33,029
|
)
|
|
|
n/m
|
|
|
|
(88,826
|
)
|
|
|
n/m
|
|
|
|
(67,776
|
)
|
|
|
n/m
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Cost of Goods Sold
|
|
$
|
515,618
|
|
|
|
85
|
%
|
|
$
|
338,561
|
|
|
|
84
|
%
|
|
$
|
950,324
|
|
|
|
85
|
%
|
|
$
|
623,667
|
|
|
|
84
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated cost of goods sold increased $177 million, or 52%, to $516 million for the quarter
ended February 28, 2007, and increased $327 million, or 52%, to $950 million for the six months
ended February 28, 2007, compared to the same periods last year. Cost of goods sold in the second
quarter and first six months of fiscal 2007 increased for all business segments. As a percentage of
revenues, cost of goods sold remained relatively flat for the second quarter and first six months
of fiscal 2007 compared to the same periods last year.
Metals Recycling Business
Cost of goods sold for the Metals Recycling Business increased $165 million, or 62%, to $430
million for the second quarter of fiscal 2007 and increased $306 million, or 63%, to $791 million
for the first six months of fiscal 2007 compared to the same periods last year. The increase in cost of goods sold for the
second quarter and first six months of fiscal 2007 was primarily attributable to the increased cost
of raw materials and higher processing volumes, which increased by 33% and 36%, respectively, over
the same periods last year. As a percentage of revenues, cost of goods sold remained relatively
flat for the second quarter and first six months of fiscal 2007 compared to the same periods last
year.
Auto Parts Business
Cost of goods sold for the Auto Parts Business increased $8 million, or 22%, to $42 million for the
second quarter of fiscal 2007 and increased $21 million, or 33%, to $84 million for the first six
months of fiscal 2007 compared to the same periods last year, due primarily to higher purchased
vehicle costs. As a percentage of revenues, cost of goods sold was 70% and 69% for the second
quarter and first six months of fiscal 2007
29
SCHNITZER STEEL INDUSTRIES, INC.
compared to 68% and 66% for the same periods last year.
The slightly higher cost of goods sold as a percentage of revenues for the second quarter and first
six months of fiscal 2007 was due to higher purchased vehicle costs at the Companys self-service
stores due to increased demand and competition for unprocessed metals.
Steel Manufacturing Business
Cost of goods sold for the Steel Manufacturing Business increased $13 million, or 19%, to $86
million for the second quarter of fiscal 2007 and increased $21 million, or 14%, to $165 million
for the first six months of fiscal 2007 compared to the same periods last year. As a percentage of
revenues, cost of goods sold was 87% and 81% for the second quarter of fiscal 2007 and fiscal 2006,
respectively, due primarily to a 14% increase in the cost of scrap metal, which outpaced the 3%
increase in average sales prices per ton for the same period, and $1 million of mark-to-market
expense related to its take-or-pay natural gas contract recorded during the second quarter of
fiscal 2007. As a percentage of revenues, cost of goods sold was 85% and 81% for the first six
months of fiscal 2007 and fiscal 2006, respectively, due primarily to a 14% increase in the cost of
scrap metal, which outpaced the 4% increase in average sales prices per ton for the same period.
The Steel Manufacturing Business acquired 100% of its scrap at market prices from the Metals
Recycling Business.
Selling, General and Administrative (SG&A) Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
February 28,
|
|
|
February 28,
|
|
|
|
2007
|
|
|
% of Revenues
|
|
|
2006
|
|
|
% of Revenues
|
|
|
2007
|
|
|
% of Revenues
|
|
|
2006
|
|
|
% of Revenues
|
|
|
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Metals Recycling Business
|
|
$
|
17,215
|
|
|
|
4
|
%
|
|
$
|
11,241
|
|
|
|
4
|
%
|
|
$
|
33,944
|
|
|
|
4
|
%
|
|
$
|
21,676
|
|
|
|
4
|
%
|
Auto Parts Business
|
|
|
13,021
|
|
|
|
22
|
%
|
|
|
12,161
|
|
|
|
24
|
%
|
|
|
28,025
|
|
|
|
23
|
%
|
|
|
21,588
|
|
|
|
23
|
%
|
Steel Manufacturing
Business
|
|
|
1,432
|
|
|
|
1
|
%
|
|
|
1,151
|
|
|
|
1
|
%
|
|
|
2,862
|
|
|
|
1
|
%
|
|
|
2,154
|
|
|
|
1
|
%
|
Corporate
|
|
|
11,073
|
|
|
|
n/m
|
|
|
|
8,987
|
|
|
|
n/m
|
|
|
|
20,768
|
|
|
|
n/m
|
|
|
|
28,466
|
|
|
|
n/m
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total SG&A Expense
|
|
$
|
42,741
|
|
|
|
7
|
%
|
|
$
|
33,540
|
|
|
|
8
|
%
|
|
$
|
85,599
|
|
|
|
8
|
%
|
|
$
|
73,884
|
|
|
|
10
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SG&A expense increased $9 million, or 27%, to $43 million for the second quarter of fiscal 2007 and
increased $12 million for the first six months of fiscal 2007, or 16%, to $86 million compared to
the same periods last year. The $9 million increase over the second quarter of last year was due to
higher SG&A expense at each of the operating segments totaling $7 million combined with a $2
million increase at Corporate. These increases were the result of higher compensation expense due
to increased headcount and higher information technology costs. The increase over the first six
months of last year was due to increases at each of the operating segments totaling $19 million
offset in part by an $8 million decrease at Corporate. The total increase at the operating segments
was due primarily to higher information technology costs of $6 million associated with the
implementation and maintenance of an enterprise resource planning software application and related
hardware upgrades and support, the costs of which were allocated across the business segments. The
net decrease at Corporate over the first six months of the prior year was due primarily to the $11
million charge in the first quarter of fiscal 2006 associated with the establishment of a reserve
related to the penalties that the Company
estimated would be imposed by the United States Department of Justice (DOJ) and the United States
Securities and Exchange Commission (SEC) in connection with the past payment practices in Asia
discussed in Item 1 Financial Statements (unaudited) Notes to Condensed Consolidated
Financial Statements, Note 4 Environmental Liabilities and Other Contingencies. This decrease
at Corporate for the first six months of fiscal 2007 was offset in part by $3 million of higher
other SG&A costs compared to the same period last year due to higher compensation costs resulting
from increased headcount and stock-based compensation expense and additional information technology
costs as described above.
Interest Expense
Interest expense increased by $2 million, or 475%, to $2 million for the second quarter of fiscal
2007 and increased by $3 million, or 303%, to $3 million for the first six months of fiscal 2007
compared with the same periods last year. The increases for the second quarter of fiscal 2007 and
the first six months of fiscal 2007 resulted from higher average debt balances during these
periods. For more information about the Companys
30
SCHNITZER STEEL INDUSTRIES, INC.
outstanding debt balances, see Item 1
Financial Statements (unaudited) Notes to Condensed Consolidated Financial Statements, Note 5
Long Term Debt.
Other Income, Net
Other income was $285,000 and $1 million for the three and six months ended February 28, 2007,
respectively, and was $689,000 and $56 million for the three and six months ended February 28,
2006, respectively. During the first quarter of fiscal 2006, the Company recorded a pre-tax gain of
$55 million that arose from the HNC separation and termination. Based on the valuation of the
assets and liabilities acquired and assumed, the Company recorded a gain for the difference between
the excess values of businesses acquired over the carrying value of the businesses sold. For a more
detailed discussion of the HNC joint venture separation and termination agreement, see Item 1
Financial Statements (unaudited) Notes to Condensed Consolidated Financial Statements, Note 3
Business Combinations.
Income Tax Expense
The tax rate of 36% for the second quarter of the current fiscal year exceeds the tax rate of 33%
for the comparable period last year because the prior years rate benefited from state tax refunds
resulting from a tax credit study. The tax rate for the first six months of fiscal 2007 was 36%
compared to a tax rate of 40% for the same period last year, a rate that was higher than usual
because the Company had accrued $11 million of nondeductible penalties and profits disgorgement in
connection with the estimated settlements of the SEC and DOJ investigations. In addition, the tax
rate of 38% that applied to the non-recurring $55 million gain in the first quarter of fiscal 2006
that arose from the HNC separation and termination (see Item 1 Financial Statements, Notes to
Condensed Consolidated Financial Statements, Note 3 Business Combinations) was higher than the
tax rate applicable to the Companys recurring income. The 36% current year tax rate comprises the
35% federal statutory rate and a 2% state rate, offset by a 1% benefit from the Section 199
manufacturing deduction and the Extraterritorial Income Exclusion benefit on export sales.
Management does not expect the tax rate to change materially for the balance of the fiscal year.
Liquidity and Capital Resources
The Company relies on cash provided by operating activities as a primary source of liquidity,
supplemented by current cash resources and existing credit facilities.
Sources and Uses of Cash
At February 28, 2007, the Company had cash, which is intended to be used for working capital and
capital expenditures, of $23 million, compared to $25 million at August 31, 2006.
Sources of cash for the first six months of fiscal 2007 included $48 million provided by
operations, $72 million provided by net borrowings and $8 million provided by the release of
restricted cash due to the settlement of the SEC and DOJ investigations.
Cash provided by operations included a $25 million decrease in inventories, primarily due to
increased shipments of scrap inventories, and a $14 million increase in accounts payable due to the
timing of payments to vendors. These increases were offset by the growth in accounts receivable of
$44 million due to the high volume of shipments made toward the end of the quarter and a $15
million payment to reduce the SEC/DOJ investigation reserve.
Other uses of cash for the first six months of fiscal 2007 included $56 million in share
repurchases, $44 million in capital expenditures to upgrade the Companys equipment and
infrastructure and $29 million in acquisitions.
31
SCHNITZER STEEL INDUSTRIES, INC.
Credit Facilities
On November 8, 2005, the Company entered into an amended and restated unsecured committed bank
credit agreement with Bank of America, N.A., as administrative agent, and the other lenders party
thereto. The agreement provides for a five-year, $400 million revolving credit facility loan
maturing in November 2010. Interest on outstanding indebtedness under the restated agreement is
based, at the Companys option, on either the London Interbank Offered Rate (LIBOR) plus a spread
of between 0.625% and 1.25%, with the amount of the spread based on a pricing grid tied to the
Companys leverage ratio, or the greater of the prime rate or the federal funds rate plus 0.50%. In
addition, annual commitment fees are payable on the unused portion of the credit facility at rates
between 0.15% and 0.25% based on a pricing grid tied to the Companys leverage ratio. As of
February 28, 2007 and August 31, 2006, the Company had borrowings outstanding under the credit
facility of $152 million and $95 million, respectively. The Company also has an additional
unsecured credit line, which was increased on March 1, 2007, by $5 million to $20 million. Interest
on outstanding indebtedness under the unsecured line of credit is set by the bank at the time of
borrowing. The credit available under this agreement is uncommitted; the Company had $15 million
and $0 outstanding under this agreement as of February 28, 2007 and August 31, 2006, respectively.
Both credit agreements contain various representations and warranties, events of default and
financial and other covenants, including covenants regarding maintenance of a minimum fixed charge
coverage ratio and a maximum leverage ratio. As of February 28, 2007, the Company was in compliance
with all such covenants, representations and warranties. Additionally, as of February 28, 2007, the
Company had $8 million of long-term debt due in January 2021.
Capital Expenditures
Capital expenditures during the first six months of fiscal 2007 were $44 million, compared to $37
million for the same period last year. During the first six months of fiscal 2007, the Company
continued its investment in infrastructure improvement projects, including work on the installation
of a new mega-shredder at its Portland, Oregon export facility, general improvements at a number of
its metals recycling facilities and work on a new reheat furnace and billet craneway at its steel
manufacturing facility designed to improve efficiency and increase capacity. The Company plans to
invest $35 million to $45 million in capital improvement projects for the remainder of the fiscal
year. Additionally, the Company continues to explore other capital projects and acquisitions that
are expected to provide productivity improvements and add shareholder value.
Future Liquidity and Commitments
The Company makes contributions to a defined benefit pension plan, several defined contribution
pension plans and several multiemployer pension plans. Contributions vary depending on the plan and
are based upon plan provisions, actuarial valuations and negotiated labor agreements.
At August 31, 2006, the Company had 1.7 million shares of Class A common stock authorized for
repurchase under then existing authorizations. In October 2006, the Companys Board of Directors
amended its share repurchase program to increase the number of shares of Class A common stock
authorized for repurchase by 3.0 million, to 4.7 million. As of February 28, 2007, the Company had
repurchased an additional 1.5 million shares, and under the authority granted by the Companys
Board of Directors, 3.2 million shares remain available for repurchase.
Accrued environmental liabilities as of February 28, 2007 were $43 million, compared with $41
million as of August 31, 2006. The increase was due to an acquisition during the second quarter of
fiscal 2007, offset in part by spending charged against the environmental reserve during the first
six months of fiscal 2007. The Company expects to pay $5 million related to previously accrued
remediation projects over the next twelve months. The future cash outlays are anticipated to be
within the amounts established as environmental liabilities.
The Company believes its current cash resources, internally generated funds, existing credit
facilities and access to the capital markets will provide adequate financing for capital
expenditures, working capital, stock repurchases, debt service requirements, post-retirement
obligations and future environmental obligations for the
32
SCHNITZER STEEL INDUSTRIES, INC.
next twelve months. In the longer term, the Company may seek to finance business expansion with
additional borrowing arrangements or additional equity financing.
Contractual Obligations
Total debt as reported in the contractual obligations table in the Companys Annual Report on Form
10-K for the fiscal year ended August 31, 2006, has increased to $175 million as of February 28,
2007, due to $72 million in additional borrowings under the Companys credit agreements as
described above under Liquidity and Capital Resources.
As of February 28, 2007, there were no material changes outside of the ordinary course of business
to the amounts disclosed in the contractual obligations table in the Companys Annual Report on
Form 10-K for the fiscal year ended August 31, 2006.
Critical Accounting Policies and Estimates
Managements Discussion and Analysis of Financial Condition and Results of Operations is based on
the Companys unaudited condensed consolidated financial statements, which have been prepared in
accordance with generally accepted accounting principles in the United States (U.S. GAAP). The
preparation of these financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenue and expenses and related
disclosure of contingent assets and liabilities. Management bases its estimates on historical
experience and various other assumptions that it believes to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Senior management has discussed the
development, selection and disclosure of these estimates with the Audit Committee of the Companys
Board of Directors. Actual results may differ from these estimates under different assumptions or
conditions. We have updated the disclosures related to the following critical accounting policies
since our Annual Report on Form 10-K for the year ended August 31, 2006.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made
based on assumptions about matters that are highly uncertain at the time the estimate is made, if
different estimates reasonably could have been used, or if changes in the estimate that are
reasonably likely to occur could materially impact the financial statements.
Inventories
The Companys inventories primarily consist of ferrous and nonferrous unprocessed metals, used and
salvaged vehicles and finished steel products consisting of rebar, coiled rebar, wire rod and
merchant bar. Inventories are stated at the lower of cost or market. The Metals Recycling Business
determines the cost of ferrous and nonferrous inventories principally using the average cost method
and capitalizes substantially all direct costs and yard costs into inventory. The Auto Parts
Business establishes cost for used and salvage vehicle inventory based on the average price the
Company pays for a vehicle. The self-service business capitalizes only the vehicle cost into
inventory; while the full-service business capitalizes the vehicle cost, dismantling and, where
applicable, storage and towing fees into inventory. The Steel Manufacturing Business establishes
its finished steel product inventory cost based on a weighted average cost, and capitalizes all
direct and indirect costs of manufacturing into inventory. Indirect costs of manufacturing include
general plant costs, maintenance, human resources and yard costs.
The accounting process utilized by the Company to record unprocessed metal and used and salvage
vehicle inventory quantities relies on significant estimates. With respect to unprocessed metals
inventory, the Company relies on perpetual inventory records that utilize estimated recoveries and
yields that are based on historical trends and periodic tests for certain unprocessed metal
commodities. Over time, these estimates are reasonably good indicators of what is ultimately
produced; however, actual recoveries and yields can vary depending on product quality, moisture
content and source of the unprocessed metals. If ultimate recoveries and yields are
33
SCHNITZER STEEL INDUSTRIES, INC.
significantly different than estimated, the value of the Companys inventory could be materially overstated or
understated. To assist in validating the reasonableness of these estimates, the Company not only
runs periodic tests, but also performs monthly physical inventory estimates. However, due to
variations in product density, holding period and production processes utilized to manufacture the product, physical inventories
will not necessarily detect significant variances and will seldom detect smaller variations. To
mitigate this risk, the Company adjusts the value of its ferrous physical inventories when the
volume of a commodity is low and a physical inventory count can more accurately predict the
remaining volume. In addition, the Company establishes inventory reserves based upon historical
experience of adjustments to further mitigate the risk of significant adjustments when determined
reasonable. Currently the reserve is established at 0.5% of ferrous inventory. An increase in the
reserve of 0.5% would result in a reduction in the value of inventory of less than $1 million. The
Company does not maintain a reserve for non-ferrous inventory as quantities on hand by yard are
typically low enough that amounts on hand can be accurately determined. In addition, the Company
performs a lower of cost or market analysis at least quarterly to ensure that inventory is
appropriately valued.
Environmental Costs
The Company operates in industries that inherently possess environmental risks. To manage these
risks, the Company employs both its own environmental staff and outside consultants. These
consultants, environmental staff and finance personnel meet regularly to stay updated on
environmental risks. The Company estimates future costs for known environmental remediation
requirements and accrues for them on an undiscounted basis when it is probable that the Company has
incurred a liability and the related costs can be reasonably estimated. The regulatory and
government management of these projects is extremely complex, which is one of the primary factors
that make it difficult to assess the cost of potential and future remediation of potential sites.
When only a wide range of estimated amounts can be reasonably established and no other amount
within the range is better than another, the low end of the range is recorded in the financial
statements. If further developments or resolution of an environmental matter results in facts and
circumstances that are significantly different than the assumptions used to develop these reserves,
the accrual for environmental remediation could be materially understated or overstated.
Adjustments to these liabilities are made when additional information becomes available that
affects the estimated costs to remediate. In a number of cases, it is possible that the Company may
receive reimbursement through insurance or from other potentially responsible parties identified in
a claim. In these situations, recoveries of environmental remediation costs from other parties are
recorded as an asset when realization of the claim for recovery is deemed probable and reasonably
estimable.
Deferred Taxes
Deferred income taxes reflect the fiscal year-end differences between the financial reporting and
tax bases of assets and liabilities, based on enacted tax laws and statutory tax rates. Tax credits
are recognized as a reduction of income tax expense in the year the credit arises. A valuation
allowance is established when necessary to reduce deferred tax assets, including net operating loss
carryforwards, to the extent the assets are more likely than not to be realized. Periodically, the
Company reviews its deferred tax assets to assess whether a valuation allowance is necessary.
Although realization is not assured, management believes it is more likely than not that the
Companys deferred tax assets will be realized. If the ultimate realization of the Companys
deferred tax assets is significantly different than the Companys expectations, the value of the
Companys deferred tax assets could be materially overstated.
Pension Plans
The Company sponsors a defined benefit pension plan for certain of its non-union employees. Pension
plans are a significant cost of doing business, and the related obligations are expected to be
settled far in the future. Accounting for defined benefit pension plans results in the current
recognition of liabilities and net periodic pension cost over employees expected service periods
based on the terms of the plans and the impact of the Companys investment and funding decisions.
The measurement of pension obligations and recognition of liabilities and costs require significant
assumptions. Two critical assumptions, the discount rate and the expected long-term rate of return
on the assets of the plan, may have an impact on the Companys financial
34
SCHNITZER STEEL INDUSTRIES, INC.
condition and results of operations. Actual results will often differ from assumptions relating to long-term rates of return
for equities and fixed income securities because of economic and other factors. The discount rate
assumption is 5.9%. A 0.5% increase (or decrease) in the discount rate would reduce (or increase)
the net pension liability by approximately $1.2 million as of August 31, 2006. Accumulated other
comprehensive income would be reduced (or increased) by the same amount adjusted for taxes. Net
periodic cost for the fiscal year ending August 31, 2007 would be reduced (or increased) by
approximately $140,000. The weighted average expected return on assets assumption is 7.0%. The expected return on assets is a long-term
assumption whose accuracy can only be measured over a long period based on past experience. A 0.5%
increase (or decrease) in this assumption would reduce (or increase) net periodic pension cost by
approximately $66,000 but would have no balance sheet impact.
Recent Accounting Pronouncements
In June 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154, Accounting
Changes and Error Corrections a replacement of APB No. 20 and FASB Statement No. 3 (SFAS
154). SFAS 154 provides guidance on the accounting for and reporting of accounting changes and
error corrections. It requires retrospective application to prior period financial statements of
changes in accounting principle, unless this would be impracticable. SFAS 154 also redefines the
term restatement to mean the correction of an error by revising previously issued financial
statements. This statement is effective for fiscal years beginning after December 15, 2005. The
Company adopted this pronouncement as of September 1, 2006. This statement had no impact on the
consolidated financial statements at adoption.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments, which is effective for all financial instruments acquired or issued after the
beginning of an entitys first fiscal year that begins after September 15, 2006. This statement
amends SFAS 133 and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities (SFAS 140). The Company intends to adopt this pronouncement for
fiscal year 2008 and does not anticipate this pronouncement to have a material impact on the
consolidated financial statements.
In July 2006, the FASB issued FASB Interpretation 48, Accounting for Uncertainty in Income Taxes
an interpretation of FASB Statement No. 109 (FIN 48). This interpretation clarifies the
accounting for uncertainty in income taxes recognized in an entitys financial statements in
accordance with SFAS No. 109, Accounting for Income Taxes (SFAS 109). It prescribes a
recognition threshold and measurement attribute for financial statement recognition and disclosure
of tax positions taken or expected to be taken on a tax return. This interpretation is effective
for fiscal years beginning after December 15, 2006. The Company will be required to adopt FIN 48 in
the first quarter of fiscal year 2008. Management is currently evaluating the requirements of the
interpretation and has not yet determined the impact of adoption on the Companys consolidated
financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157
defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands
disclosures about fair value measurements. SFAS 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.
Earlier application is encouraged, provided that the reporting entity has not yet issued financial
statements for that fiscal year, including financial statements for an interim period within that
fiscal year. The Company will be required to adopt SFAS 157 in the first quarter of fiscal year
2009. Management is currently evaluating the requirements of SFAS 157 and has not yet determined
the impact on the Companys consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension
and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS
158), which requires employers to fully recognize the funded status of single-employer defined
benefit pension, retiree healthcare and other postretirement plans in their financial statements
and to recognize as a component of other comprehensive income, net of tax, the gains or losses and
prior service costs or credits that arise during the period but are not recognized as components of
net periodic costs. The requirement of SFAS 158 to
35
SCHNITZER STEEL INDUSTRIES, INC.
recognize the funded status of a benefit plan and the disclosure requirements will be effective as of
the end of the fiscal year ending August 31, 2007.
Based on the defined benefit pension plan obligations of the Company as of August 31, 2006, the
adoption of SFAS 158 would increase total assets by approximately $1 million, increase total
liabilities by approximately $3 million and reduce total shareholders equity by approximately $2
million. The adoption of SFAS 158 will not materially affect the results of the Companys
operations. As a result of the June 2006 curtailment of the defined benefits plan, the Company does
not expect the impact to be significantly different than the estimate based on August 31, 2006
balances.
SFAS 158 also requires employers to measure defined benefit plan assets and obligations as of the
date of the Companys fiscal year-end balance sheet and disclose in the notes to financial
statements additional information about certain effects on net periodic benefit cost for the next
fiscal year that arise from delayed recognition of the gains or losses, prior service costs or
credits, and transition asset or obligation. The requirement to measure plan assets and benefit
obligations as of the date of the employers fiscal year-end balance sheet will be effective for
the fiscal year ending August 31, 2009. The Company is currently in compliance with the latter
requirement of SFAS 158, using a measurement date of August 31 for all plans.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects
of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements
(SAB 108). SAB 108 was issued in order to eliminate the diversity of practice surrounding how
public companies quantify financial statement misstatements. In SAB 108, the SEC staff established
an approach that requires quantification of financial statement misstatements based on the effects
of the misstatements on each of the companys financial statements and the related financial
statement disclosures. The Company will adopt SAB 108 in its annual financial statements for the
year ending August 31, 2007. The Company has assessed the impact of applying SAB 108 for evaluating
misstatements on its previously issued financial statements and does not expect the impact of
adoption to be material.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilitiesincluding an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159
establishes a fair value option under which entities can elect to report certain financial asset
and liabilities at fair value (the fair value option), with changes in fair value recognized in
earnings. SFAS 159 is effective for financial statements issued for fiscal years beginning after
November 15, 2007. Earlier application is encouraged, provided that the reporting entity also
elects to apply the provisions of SFAS 157. SFAS 159 becomes effective for the Company in the first
quarter of fiscal year 2009. Management is currently evaluating the requirements of SFAS 159 and
has not yet concluded if the fair value option will be adopted.
Off-Balance Sheet Arrangements
There have been no material changes to any off-balance sheet arrangements as discussed in
Managements Discussion and Analysis of Financial Condition and Results of Operations in the
Companys most recent Annual Report on Form 10-K.
36
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk
The Companys international operations are subject to risks typical of an international business,
including, but not limited to: differing economic conditions, changes in political climate,
differing tax structures, foreign exchange rate volatility and other regulations and restrictions.
Accordingly, future results could be materially and adversely affected by changes in these or other
factors. The Company is also exposed to foreign exchange rate fluctuations as the balance sheets
and income statements of its foreign subsidiaries are translated into United States dollars during
the consolidation process. Because exchange rates vary, these results, when translated, may vary
from expectations and adversely affect overall expected profitability. The Company enters into
sales contracts denominated in foreign currencies; therefore, its financial results are subject to
the variability that arises from exchange rate movements. To mitigate foreign currency exchange
risk, the Company uses foreign currency forward contracts related to cash receipts from sales
denominated in foreign currencies and not for trading purposes. These contracts generally mature
within three months and entitle the Company, upon its delivering euros, to receive U.S dollars at
the stipulated rates during the contract periods. The fair value of these contracts was estimated
based on quoted market prices as of February 28, 2007 and August 31, 2006. The mark-to-market
adjustments on these contracts resulted in a derivative liability of $364,000 and $12,000 as of
February 28, 2007 and August 31, 2006, respectively. The related mark-to-market expense is recorded
as part of other expense for the Metals Recycling Business.
Other Risks
The Company has considered its market risk conditions, including interest rate risk, commodity
price risk and other relevant market risks, as they relate to the consolidated assets and
liabilities as of February 28, 2007 and does not believe that there is a risk of material
fluctuations as a result of changes in these factors.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
During the fiscal period covered by this report, the Companys management, with the participation
of the Chief Executive Officer and Chief Financial Officer, completed an evaluation of the
effectiveness of the design and operation of the Companys disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based upon this evaluation, the
Companys Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of
the fiscal period covered by this report, the Companys disclosure controls and procedures were
effective to ensure that information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is recorded, processed, summarized and reported within the
time periods specified by the SECs rules and forms and that such information is accumulated and
communicated to management, including the Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosures.
Changes in Internal Control Over Financial Reporting
There were no changes in the Companys internal control over financial reporting during the fiscal
quarter covered by this report that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.
37
SCHNITZER STEEL INDUSTRIES, INC.
PART II
ITEM 1. LEGAL PROCEEDINGS
On October 16, 2006, the Company finalized settlements with the United States Department of Justice
and the United States Securities and Exchange Commission resolving the investigation of the
Companys past practice of making improper payments to the purchasing managers of nearly all of the
Companys customers in Asia in connection with export sales of recycled ferrous metal. See also
Item 1 Financial Statements (unaudited) Notes to Condensed Consolidated Financial Statements,
Note 4 Environmental Liabilities and Other Contingencies.
Except as described above under Item 1 Financial Statements (unaudited) Notes to Condensed
Consolidated Financial Statements, Note 4 Environmental Liabilities and Other Contingencies,
the Company is not a party to any material pending legal proceedings.
ITEM 1A.
RISK FACTORS
The Companys business is subject to a number of risks and uncertainties, including those
identified in Item 1A of the Companys 2006 Annual Report on Form 10-K filed with the United States
Securities and Exchange Commission, that could have a material adverse effect on the Companys
results of operations, financial condition or liquidity or that could cause actual results to
differ materially from the results contemplated by the forward-looking statements contained in this
Quarterly Report on Form 10-Q. The Company faces additional risks beyond those described in the
Companys 2006 Annual Report on Form 10-K, including risks that are common to most companies and
businesses, risks that are not currently known to the Company and risks that the Company currently
deems to be immaterial but which in the future could have a material adverse effect on the
Companys results of operations, financial condition or liquidity. There have been no material
changes to the risk factors described in the Companys 2006 Annual Report on Form 10-K or any new
material risk factors identified.
38
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) None.
(b) None.
(c) Stock Repurchases
At August 31, 2006, the Company had 1.7 million shares of Class A common stock authorized for
repurchase under then existing authorizations. In October 2006, the Companys Board of Directors
amended its share repurchase program to increase the number of shares of Class A common stock
authorized for repurchase by 3.0 million, to 4.7 million. As of February 28, 2007, the Company had
repurchased an additional 1.5 million shares, and under the authority granted by the Companys
Board of Directors, 3.2 million shares remain available for repurchase.
The share repurchase program does not require the Company to acquire any specific number of shares,
may be suspended, extended or terminated by the Company at any time without prior notice and may be
executed through open-market purchases, privately negotiated transactions or utilizing Rule 10b5-1
programs. Management evaluates long- and short-range forecasts as well as anticipated sources and
uses of cash before determining the course of action that would best enhance shareholder value.
During the first quarter of fiscal 2007, the Company repurchased 250,000 shares in open-market
transactions at a cost of $10 million. During the second quarter of fiscal 2007, the Company
repurchased 1.25 million shares in open-market transactions at a cost of $46 million. A summary of
the Companys share repurchases during the quarter ended February 28, 2007 is presented in the
following table:
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Total Number of
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Maximum Number of
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Shares Purchased as
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Shares that may yet
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Part of Publicly
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be Purchased Under
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Total Number of
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Average Price Paid
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Announced Plans or
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the Plans or
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Period
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Shares Purchased
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per Share
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Programs
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Programs
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December 1, 2006 December 31, 2006
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$
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4,409,790
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January 1, 2007 January 31, 2007
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500,000
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$
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35.57
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500,000
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3,909,790
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February 1, 2007 February 28, 2007
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750,000
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$
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38.29
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750,000
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3,159,790
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39
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a)
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The 2007 annual meeting of the shareholders was held on January 31, 2007. Holders of
21,922,098 shares of the Companys Class A common stock, entitled to one vote per share, and
7,650,427 shares of the Companys Class B common stock, entitled to ten votes per share, were
present in person or by proxy at the meeting.
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(b)
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William A. Furman, Scott Lewis and William D. Larsson were elected directors of the Company,
each to serve until the 2010 Annual Meeting of Shareholders and until a successor has been
elected and qualified.
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Other directors whose term of office as a director continued after the meeting are as
follows:
Jill Schnitzer Edelson
Judith A. Johansen
Mark L. Palmquist
Ralph R. Shaw
Robert S. Ball
John D. Carter
Kenneth M. Novack
Jean S. Reynolds
(c)
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The meeting was called for the following purposes:
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1.
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To elect three directors, each to serve until the 2010 Annual meeting of
Shareholders and until a successor has been elected and qualified.
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This proposal was approved as follows:
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Votes For
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Votes Withheld/Against
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William A. Furman
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92,726,665
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5,699,703
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Scott Lewis
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92,716,404
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5,709,964
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William D. Larsson
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97,942,233
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484,135
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2.
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To transact such other business as may properly be brought before the meeting
or any adjournment of postponement thereof.
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ITEM 5. OTHER INFORMATION
An Annual
Incentive Compensation Plan was adopted by the Companys
Compensation Committee by action dated as of March 27,
2007, effective September 1, 2006, and is filed as Exhibit 10.1 hereto. In connection with the
Committees approval, the Companys EVA bonus plans were terminated as of September 1, 2006.
40
SCHNITZER STEEL INDUSTRIES, INC.
ITEM 6. EXHIBITS
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4.1
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Rights Agreement, dated March 21, 2006, between the Registrant and Wells Fargo
Bank, N.A. Filed as Exhibit 4.1 to the Registrants Current Report on Form 8-K filed on
March 22, 2006, and incorporated herein by reference.
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10.1
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Annual Incentive Compensation Plan effective September 1, 2006.
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31.1
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Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
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31.2
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Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes Oxley Act of 2002.
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32.1
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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.
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32.2
|
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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.
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41
SCHNITZER STEEL INDUSTRIES, INC.
SIGNATURES
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.
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SCHNITZER STEEL INDUSTRIES, INC.
(Registrant)
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Date:
April 9, 2007
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By:
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/s/ John D. Carter
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John D. Carter
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Chief Executive Officer
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Date:
April 9, 2007
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By:
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/s/ Gregory J. Witherspoon
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Gregory J. Witherspoon
|
|
|
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Chief Financial Officer
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42