EXPLANATORY
NOTE
This
Form
10-Q/A amends the Quarterly Report on Form 10-Q that was originally filed
on
January 9, 2006 (the “Original Form 10-Q”) by Schnitzer Steel Industries, Inc.
(the “Company”) for the quarterly period ended November 30, 2005. The Company
identified errors related to the application of purchase accounting and the
reporting of cash flows. Accordingly, this Form 10-Q/A:
· |
restates
the Company’s condensed consolidated statements of operations and
consolidated statements of cash flows for the three months ended
November
30, 2005 and related disclosures;
|
· |
discloses
the determination that as of November 30, 2005, material weaknesses
existed in the Company’s internal control over financial reporting related
to the application of purchase accounting and reporting of cash
flows;
|
· |
discloses
that due to the aforementioned material weaknesses as of the quarter
ended
November 30, 2005 the Company’s disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as
discussed
under Item 4 were not effective.
|
The
revised assessment relating to the Company’s disclosure control and procedures
and a description of the changes in internal control over financial reporting
are included herein under Part 1, Item 4.
No
attempt has been made in this amendment to modify or update disclosures
presented in the Original Form 10-Q, except with respect to the foregoing
and
certain enhancements in disclosure included in Part I. Accordingly, this
amendment on Form 10-Q/A should be read in conjunction with the Company’s
filings made with the Securities and Exchange Commission (the “SEC”) subsequent
to the filing of the Original Form 10-Q, including any amendments to these
filings.
In
addition, this amendment on Form 10-Q/A includes currently dated Sarbanes-Oxley
Act Section 302 and Section 906 certifications of the Chief Executive Officer
and Chief Financial Officer, attached hereto as Exhibits 31.1, 31.2, 32.1
and
32.2.
The
aforementioned restatement corrects an error relating to the interpretation
and
application of generally accepted accounting principles as related to purchase
accounting. During the three months ended November 30, 2005, as a result
of a
separation and termination agreement with Hugo Neu Corporation (“HNC”), the
Company acquired the assets of Prolerized New England Company and Subsidiaries
(“PNE”), Hugo Neu Schnitzer Global Trade-Baltic Operations (“HNSGT-Baltic”), and
THS Recycling LLC, dba Hawaii Metal Recycling Company (“HMR”). Additionally,
during the three months ending November 30, 2005, the Company acquired the
assets of Regional Recycling, LLC (“Regional”) and purchased GreenLeaf Auto
Recyclers, LLC (“GreenLeaf”). In the condensed consolidated statements of
operations for the three months ended November 30, 2005 included in the
Company’s Original Form 10-Q, the Company accounted for the operations of all of
the acquired businesses on a consolidated basis as of the beginning of the
Company’s fiscal year 2006 (September 1, 2005) with a corresponding deduction
for the pre-acquisition operating results in arriving at net income. In
addition, an error related to the application of purchase accounting affected
the statement of cash flows. The cash flow from the Company‘s investments in
Regional, HMR, Greenleaf, PNE and HNSGT-Baltic were classified as cash flow
from
operations in error. The restatement corrects these errors in purchase
accounting for acquisitions and reclassifies the cash received as a result
of
the acquisitions as net cash (used) provided by investments.
During
the third quarter ending May 31, 2006, management began reevaluating the
accounting treatment for the acquisitions that occurred during the first
quarter
fiscal 2006. Through the reevaluation, it was determined that the acquired
entities in which the Company did not have a previous equity interest, HMR,
Regional and GreenLeaf, were accounted for incorrectly in the Company’s
condensed consolidated statements of operations for the three months ended
November 30, 2005 included in the Company’s Original Form 10-Q. ARB 51 allows
the results of operations of entities acquired through a “step” acquisition to
be consolidated as of the beginning of the fiscal year or as of the date
of the
acquisition. If the results of operations are consolidated as of the beginning
of the fiscal year, there must be an offset for the pre-acquisition interests
prior to arriving at net income. As the Company had prior joint venture
interests in PNE and HNSGT-Baltic, the acquisitions of PNE and HNSGT-Baltic
were
each “step” acquisitions and the Company’s consolidation of their operations as
of the beginning of fiscal year 2006 was appropriate. However, as the Company
did not have a previous interest in HMR, Regional, and GreenLeaf the
acquisitions of HMR, Regional and GreenLeaf were not “step” acquisitions and
their results of operations should have only been consolidated as of the
respective dates of acquisition.
The
restatement also corrects an error relating to the application of purchase
accounting, which affected the consolidated statements of cash flows. Cash
acquired from the Company‘s investments in Regional, HMR, Greenleaf, PNE and
HNSGT-Baltic was classified as net
cash
provided by operations
in
error. This restatement corrects these errors and reclassifies the cash proceeds
as a result of the acquisitions as net
cash
(used) provided by investments. The
restatement of the statement
of cash flows affects minority interest, accrued liabilities, equity in income
of joint ventures and other assets and liabilities.
Lastly,
the restatement corrects an error in classification with respect to cash
flows
received from its interest in joint ventures. Previously, the Company considered
certain cash flows received from its joint ventures as returns of its investment
and had therefore classified these cash flows as investing activities. However,
the Company has subsequently determined that these cash flows should have
been
considered a return on investment and classified as an operating activity
as
distributed/(undistributed) equity in earnings of joint ventures. Additionally,
the Company has corrected its presentation of changes in other assets and
changes in other liabilities within the cash flows from operating activities
section and proceeds from line of credit, repayments of line
of credit, proceeds from long-term debt, and repayments of long-term debt,
within the cash flows from financing activities section of the consolidated
statements of cash flows, to reflect these items gross rather than net. These
errors did not impact the Company’s consolidated statements of operations or
consolidated statements of shareholders’ equity for the quarters ended November
30, 2005 and November 30, 2004, nor did it have an impact on the consolidated
balance sheets as of November 30, 2005 and November 30, 2004.
SCHNITZER
STEEL INDUSTRIES, INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
(Unaudited,
in thousands, except per share amounts)
|
|
Nov.
30, 2005
|
|
Aug.
31, 2005
|
|
Assets
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
36,776
|
|
$
|
20,645
|
|
Accounts
receivable, less allowance for
|
|
|
|
|
|
|
|
doubtful
accounts of $1,296 and
$810
|
|
|
106,813
|
|
|
51,101
|
|
Accounts
receivable from related parties
|
|
|
273
|
|
|
226
|
|
Inventories
|
|
|
211,728
|
|
|
106,189
|
|
Deferred
income taxes
|
|
|
4,094
|
|
|
3,247
|
|
Prepaid
expenses and other
|
|
|
13,126
|
|
|
15,505
|
|
Total
current assets
|
|
|
372,810
|
|
|
196,913
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
254,365
|
|
|
166,901
|
|
|
|
|
|
|
|
|
|
Other
assets:
|
|
|
|
|
|
|
|
Investment
in and advances to joint venture partnerships
|
|
|
7,505
|
|
|
184,151
|
|
Notes
receivable, less current portion
|
|
|
3,098
|
|
|
1,234
|
|
Goodwill
|
|
|
266,827
|
|
|
151,354
|
|
Intangibles
and other assets
|
|
|
5,019
|
|
|
8,905
|
|
|
|
|
|
|
|
|
|
|
|
$
|
909,624
|
|
$
|
709,458
|
|
Liabilities
and Shareholders’ Equity
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Current
portion of long-term debts
|
|
$
|
64
|
|
$
|
71
|
|
Accounts
payable
|
|
|
56,645
|
|
|
33,192
|
|
Accrued
payroll liabilities
|
|
|
16,132
|
|
|
21,783
|
|
Current
portion of environmental liabilities
|
|
|
6,881
|
|
|
7,542
|
|
Accrued
income taxes
|
|
|
23,656
|
|
|
140
|
|
Other
accrued liabilities
|
|
|
37,462
|
|
|
8,307
|
|
Total
current liabilities
|
|
|
140,840
|
|
|
71,035
|
|
|
|
|
|
|
|
|
|
Deferred
income taxes
|
|
|
8,753
|
|
|
26,987
|
|
|
|
|
|
|
|
|
|
Long-term
debt, less current portion
|
|
|
85,966
|
|
|
7,724
|
|
|
|
|
|
|
|
|
|
Environmental
liabilities, net of current portion
|
|
|
38,497
|
|
|
15,962
|
|
|
|
|
|
|
|
|
|
Other
long-term liabilities
|
|
|
3,899
|
|
|
3,578
|
|
|
|
|
|
|
|
|
|
Minority
interests
|
|
|
10,679
|
|
|
4,644
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Shareholders’
equity:
|
|
|
|
|
|
|
|
Preferred
stock--20,000 shares authorized, none issued
|
|
|
—
|
|
|
—
|
|
Class
A common stock--75,000 shares $1 par value
|
|
|
|
|
|
|
|
authorized,
22,493 and 22,490 shares issued and outstanding
|
|
|
22,493
|
|
|
22,490
|
|
Class
B common stock--25,000 shares $1 par value
|
|
|
|
|
|
|
|
authorized,
7,986 shares issued and outstanding
|
|
|
7,986
|
|
|
7,986
|
|
Additional
paid-in capital
|
|
|
126,353
|
|
|
125,845
|
|
Retained
earnings
|
|
|
464,189
|
|
|
423,178
|
|
Accumulated
other comprehensive income/(loss):
|
|
|
|
|
|
|
|
Foreign
currency translation adjustments
|
|
|
(31
|
)
|
|
29
|
|
Total
shareholders’ equity
|
|
|
620,990
|
|
|
579,528
|
|
|
|
|
|
|
|
|
|
|
|
$
|
909,624
|
|
$
|
709,458
|
|
The
accompanying notes to the unaudited condensed consolidated financial
statements
are
an
integral part of these statements.
SCHNITZER
STEEL INDUSTRIES, INC.
CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited,
in thousands, except per share amounts)
|
|
For
The Three Months Ended November 30,
|
|
|
|
2005(1)
|
|
2004
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
341,231
|
|
$
|
198,961
|
|
|
|
|
|
|
|
|
|
Operating
Expenses:
|
|
|
|
|
|
|
|
Cost
of goods sold
|
|
|
285,106
|
|
|
139,752
|
|
Selling,
general and administrative
|
|
|
40,344
|
(2)
|
|
11,867
|
|
Environmental
matter
|
|
|
—
|
|
|
500
|
(3) |
|
|
|
|
|
|
|
|
Income
from wholly-owned operations
|
|
|
15,781
|
|
|
46,842
|
|
|
|
|
|
|
|
|
|
Income
from joint ventures
|
|
|
1,752
|
|
|
20,464
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
17,533
|
|
|
67,306
|
|
|
|
|
|
|
|
|
|
Other
income (expense):
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
(435
|
)
|
|
(284
|
)
|
Other
income (expense)
|
|
|
55,534
|
(4)
|
|
(148
|
)
|
|
|
|
|
|
|
|
|
|
|
|
55,099
|
|
|
(432
|
)
|
|
|
|
|
|
|
|
|
Income
before income tax and minority interests
|
|
|
72,632
|
|
|
66,874
|
|
|
|
|
|
|
|
|
|
Income
tax provision
|
|
|
(31,135
|
)
|
|
(23,272
|
)
|
|
|
|
|
|
|
|
|
Income
before minority interests
|
|
|
41,497
|
|
|
43,602
|
|
|
|
|
|
|
|
|
|
Minority
interests, net of tax
|
|
|
(153
|
)
|
|
(666
|
)
|
|
|
|
|
|
|
|
|
Pre-acquisition
interests, net of tax
|
|
|
186
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
41,530
|
|
$
|
42,936
|
|
|
|
|
|
|
|
|
|
Net
income per share - basic:
|
|
$
|
1.36
|
|
$
|
1.41
|
|
|
|
|
|
|
|
|
|
Net
income per share - diluted:
|
|
$
|
1.34
|
|
$
|
1.38
|
|
(1) |
The
Company elected to consolidate results of two of the businesses
acquired
through the Hugo Neu Corporation (“HNC”)
separation
and termination agreement as though the transaction had occurred at
the beginning of the fiscal 2006, instead of the date of
acquisition. The increase in revenues and operating income that
resulted from the election are offset by pre-acquisition interests,
net of
tax.
|
(2) |
Includes
a charge of $11.0 million associated with the investigation
reserve (see
Note 5).
|
(3) |
Fiscal
2005 amounts relate to environmental matters primarily associated
with the
Hylebos Waterway project.
|
(4) |
Includes
a gain on disposition of joint ventures of $54.6
million.
|
The
accompanying notes to the unaudited condensed consolidated financial
statements
are
an
integral part of these statements.
SCHNITZER
STEEL INDUSTRIES, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited,
in thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
Class
A
|
|
Class
B
|
|
Additional
|
|
|
|
Other
|
|
|
|
|
|
Common
Stock
|
|
Common
Stock
|
|
Paid-in
|
|
Retained
|
|
Comprehensive
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Shares
|
|
Amount
|
|
Capital
|
|
Earnings
|
|
Income/(Loss)
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at August 31, 2004
|
|
|
22,022
|
|
$
|
22,022
|
|
|
8,306
|
|
$
|
8,306
|
|
$
|
110,177
|
|
$
|
278,374
|
|
$
|
1
|
|
$
|
418,880
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
146,867
|
|
|
|
|
|
146,867
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28
|
|
|
28
|
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
146,895
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class
B common stock converted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
to
Class A common stock
|
|
|
320
|
|
|
320
|
|
|
(320
|
)
|
|
(320
|
)
|
|
|
|
|
|
|
|
|
|
|
—
|
|
Class
A common stock issued
|
|
|
148
|
|
|
148
|
|
|
|
|
|
|
|
|
1,511
|
|
|
|
|
|
|
|
|
1,659
|
|
Tax
benefits from stock options exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14,157
|
|
|
|
|
|
|
|
|
14,157
|
|
Cash
dividends paid - common
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($0.068
per share)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,063
|
)
|
|
|
|
|
(2,063
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at August 31, 2005
|
|
|
22,490
|
|
|
22,490
|
|
|
7,986
|
|
|
7,986
|
|
|
125,845
|
|
|
423,178
|
|
|
29
|
|
|
579,528
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41,530
|
|
|
|
|
|
41,530
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(60
|
)
|
|
(60
|
)
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41,470
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based
compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
494
|
|
|
|
|
|
|
|
|
494
|
|
Class
A common stock issued
|
|
|
3
|
|
|
3
|
|
|
|
|
|
|
|
|
14
|
|
|
|
|
|
|
|
|
17
|
|
Cash
dividends paid - common
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($0.017
per share)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(519
|
)
|
|
|
|
|
(519
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at November, 2005
|
|
|
22,493
|
|
$
|
22,493
|
|
|
7,986
|
|
$
|
7,986
|
|
$
|
126,353
|
|
$
|
464,189
|
|
$
|
(31
|
)
|
$
|
620,990
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes to the unaudited condensed consolidated financial
statements
are
an
integral part of these statements.
SCHNITZER
STEEL INDUSTRIES, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited,
in thousands)
|
|
For
The Three Months Ended November 30,
|
|
|
|
2005
|
|
2004
|
|
|
|
(as
restated)
|
|
(as
restated)
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
41,530
|
|
$
|
42,936
|
|
Noncash
items included in net income:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
6,241
|
|
|
5,050
|
|
Minority
and pre-acquisition interests
|
|
|
320
|
|
|
1,021
|
|
Deferred
income taxes
|
|
|
(10,206
|
)
|
|
—
|
|
Distributed/(undistributed)
equity in earnings of joint ventures
|
|
|
15,787
|
|
|
491
|
|
Stock
based compensation expense
|
|
|
494
|
|
|
—
|
|
Gain
on disposal of assets
|
|
|
(54,618
|
)
|
|
(127
|
)
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
21,321
|
|
|
13,972
|
|
Inventories
|
|
|
(7,753
|
)
|
|
(12,587
|
)
|
Prepaid
expenses and other current assets
|
|
|
11,556
|
|
|
(108
|
)
|
Other
assets
|
|
|
1,630
|
|
|
53
|
|
Accounts
payable
|
|
|
(12,684
|
)
|
|
(1,162
|
)
|
Accrued
liabilities
|
|
|
21,409
|
|
|
(8,295
|
)
|
Environmental
liabilities
|
|
|
(2,959
|
)
|
|
(3,156
|
)
|
Other
liabilities
|
|
|
(767
|
)
|
|
159
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
|
31,301
|
|
|
38,247
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(15,823
|
)
|
|
(7,531
|
)
|
Acquisitions,
net of cash acquired
|
|
|
(75,548
|
)
|
|
—
|
|
Cash
paid to joint ventures
|
|
|
(449
|
)
|
|
(313
|
)
|
Proceeds
from sale of assets
|
|
|
12
|
|
|
398
|
|
|
|
|
|
|
|
|
|
Net
cash used in investing activities
|
|
|
(91,808
|
)
|
|
(7,446
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Proceeds
from line of credit
|
|
|
43,000
|
|
|
48,300
|
|
Repayment
of line of credit
|
|
|
(33,000
|
)
|
|
(30,800
|
)
|
Proceeds
from long-term debt
|
|
|
140,184
|
|
|
69,500
|
|
Repayment
of long-term debt
|
|
|
(72,000
|
)
|
|
(104,547
|
)
|
Issuance
of Class A common stock
|
|
|
17
|
|
|
1,182
|
|
Distributions
to minority interests
|
|
|
(1,045
|
)
|
|
(1,273
|
)
|
Dividends
declared and paid
|
|
|
(518
|
)
|
|
(515
|
)
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) financing activities
|
|
|
76,638
|
|
|
(18,153
|
)
|
|
|
|
|
|
|
|
|
Net
increase in cash
|
|
|
16,131
|
|
|
12,648
|
|
|
|
|
|
|
|
|
|
Cash
at beginning of period
|
|
|
20,645
|
|
|
11,307
|
|
|
|
|
|
|
|
|
|
Cash
at end of period
|
|
$
|
36,776
|
|
$
|
23,955
|
|
The
accompanying notes to the unaudited condensed consolidated financial
statements
are
an
integral part of these statements.
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
Note
1 - Restatement:
The
condensed consolidated statements of operations for the three months ended
November 30, 2005 have been restated due to the following:
The
restatement corrects errors related to the interpretation and application
of
purchase accounting and the reporting of cash flows. During the three months
ended November 30, 2005, as a result of a separation and termination agreement
with Hugo Neu Corporation (“HNC”), the Company acquired the assets of Prolerized
New England Company and Subsidiaries (“PNE”), Hugo Neu Schnitzer Global
Trade-Baltic Operations (“HNSGT-Baltic”), and THS Recycling LLC, dba Hawaii
Metal Recycling Company (“HMR”). Additionally, during the three months ending
November 30, 2005, the Company acquired the assets of Regional Recycling,
LLC
(“Regional”) and purchased GreenLeaf Auto Recyclers, LLC (“GreenLeaf”). In the
condensed consolidated statements of operations for the three months ended
November 30, 2005, included in the Company’s Original Form 10-Q, the Company
accounted for the operations of all of the acquired businesses on a consolidated
basis, as of the beginning of the Company’s fiscal year 2006, with a
corresponding deduction for the pre-acquisition operating results in arriving
at
net income.
It
was
determined that the acquired entities in which the Company did not have a
previous interest, HMR, Regional and GreenLeaf, were accounted for incorrectly
in the Company’s condensed consolidated statements of operations for the three
months ended November 30, 2005 included in the Company’s Original Form 10-Q. ARB
51 allows the results of operations of entities acquired through a “step”
acquisition to be consolidated as of the beginning of the fiscal year or
as of
the date of the acquisition. If the results of operations are consolidated
as of
the beginning of the fiscal year, there must be an offset for the
pre-acquisition interests prior to arriving at net income. As the Company
had
prior joint venture interests in PNE and HNSGT-Baltic, the acquisitions of
PNE
and HNSGT-Baltic were each “step” acquisitions and the Company’s decision to
consolidate their operations as of the beginning of fiscal year 2006 was
appropriate. However, as the Company did not have a previous interest in
HMR,
Regional, and GreenLeaf, these acquisitions, under the provisions of SFAS
141,
were not “step” acquisitions and their results of operations should have been
consolidated as of the relevant dates of acquisition.
While
the
error did not impact net income or net income per share, it did result in
the
misstatement of a number of line items in the condensed consolidated statements
of operations for the three months ended November 30, 2005, as presented.
The
error had no impact on the condensed consolidated balance sheets as of November
30, 2005 or the consolidated statements of cash flows for the three months
ended
November 30, 2005.
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
A
summary
of the restatements included in the condensed consolidated statements of
operations in this amended filing are:
|
|
As
Previously
Reported
|
|
Adjustment
|
|
As
Restated
|
|
Statement
of Operations for the three months
ended
November 30, 2005
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
388,673
|
|
$
|
(47,442
|
)
|
$
|
341,231
|
|
Cost
of goods sold
|
|
|
326,710
|
|
|
(41,604
|
)
|
|
285,106
|
|
Selling,
general and administrative
|
|
|
41,990
|
|
|
(1,646
|
)
|
|
40,344
|
|
Interest
expense
|
|
|
(981
|
)
|
|
546
|
|
|
(435
|
)
|
Other
income, net
|
|
|
64,441
|
|
|
(8,907
|
)
|
|
55,534
|
|
Income
tax provision
|
|
|
(35,557
|
)
|
|
4,422
|
|
|
(31,135
|
)
|
Pre-acquisition
interests, net of tax
|
|
|
(7,945
|
)
|
|
8,131
|
|
|
186
|
|
Net
income
|
|
|
41,530
|
|
|
—
|
|
|
41,530
|
|
Additionally,
as a result of the error in purchase accounting, cash acquired from the
Company‘s investments in Regional, HMR, Greenleaf, PNE and HNSGT-Baltic was
classified as net
cash
provided by operations
in
error. This restatement corrects this error and reclassifies the cash acquired
as a result of the acquisitions as net
cash
(used) provided by investments. The
restatement of the consolidated statements
of cash flows affects the minority interest, accrued liabilities, equity
in
income of joint ventures and other assets and liabilities line items in the
consolidated statements of cash flows.
Finally,
the consolidated statements of cash flows for the quarters ended November
30,
2005 and November 30, 2004 have been restated to correct an error in the
classification of cash flows received from its interest in joint ventures.
The
Company had previously considered cash flows received from its joint ventures
as
returns of its investment and had therefore classified these cash flows as
investing activities. However, the Company has now determined that the cash
flows from its joint ventures should have been considered a return on its
investment and classified as an operating activity as
distributed/(undistributed) equity in earnings of joint ventures. The
restatement does not affect net income or earnings per share and did not
have an
impact on the Company’s consolidated statements of operations or consolidated
statements of shareholders’ equity for the quarters ended November 31, 2005 and
November 31, 2004, nor did it have an impact on the consolidated balance
sheets
as of November 31, 2005 and November 31, 2004. Additionally, the Company
has
corrected its presentation of changes in other assets and changes in other
liabilities within the cash flows from operating activities section and proceeds
from line of credit, repayments of line of credit, proceeds from long-term
debt,
and repayments of long-term debt, within the cash flows from financing
activities section of the consolidated statements of cash flows, to reflect
these items gross rather than net.
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
Restated
consolidated statements of cash flows for all affected periods reflecting
the
aforementioned adjustments are presented below (amounts in
thousands):
|
|
For
The Three Months Ended November 30, 2005
|
|
|
|
As
reported
|
|
Adjustment
|
|
As
restated
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
41,530
|
|
$
|
—
|
|
$
|
41,530
|
|
Noncash
items included in net income:
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
6,241
|
|
|
|
|
|
6,241
|
|
Minority
and pre-acquisition interests
|
|
|
493
|
|
|
(173
|
)
|
|
320
|
|
Deferred
income taxes
|
|
|
(10,206
|
)
|
|
|
|
|
(10,206
|
)
|
Distributed/(undistributed)
equity in earnings of joint ventures
|
|
|
(1,345
|
)
|
|
17,132
|
|
|
15,787
|
|
Stock
based compensation expense
|
|
|
494
|
|
|
|
|
|
494
|
|
Gain
on disposal of assets
|
|
|
(54,617
|
)
|
|
(1
|
)
|
|
(54,618
|
)
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
21,321
|
|
|
|
|
|
21,321
|
|
Inventories
|
|
|
(7,753
|
)
|
|
|
|
|
(7,753
|
)
|
Prepaid
expenses and other current assets
|
|
|
11,556
|
|
|
|
|
|
11,556
|
|
Other
assets
|
|
|
|
|
|
1,630
|
|
|
1,630
|
|
Accounts
payable
|
|
|
(12,684
|
)
|
|
|
|
|
(12,684
|
)
|
Accrued
liabilities
|
|
|
27,533
|
|
|
(6,124
|
)
|
|
21,409
|
|
Environmental
liabilities
|
|
|
(2,958
|
)
|
|
(1
|
)
|
|
(2,959
|
)
|
Other
liabilities
|
|
|
|
|
|
(767
|
)
|
|
(767
|
)
|
Other
assets and liabilities
|
|
|
3,546
|
|
|
(3,546
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
|
23,151
|
|
|
8,150
|
|
|
31,301
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(15,823
|
)
|
|
|
|
|
(15,823
|
)
|
Acquisitions,
net of cash acquired
|
|
|
(85,641
|
)
|
|
10,093
|
|
|
(75,548
|
)
|
Cash
received from joint ventures
|
|
|
17,957
|
|
|
(17,957
|
)
|
|
|
|
Cash
paid to joint ventures
|
|
|
(163
|
)
|
|
(286
|
)
|
|
(449
|
)
|
Proceeds
from sale of assets
|
|
|
12
|
|
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash used in investing activities
|
|
|
(83,658
|
)
|
|
(8,150
|
)
|
|
(91,808
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from line of credit
|
|
|
|
|
|
43,000
|
|
|
43,000
|
|
Repayment
of line of credit
|
|
|
|
|
|
(33,000
|
)
|
|
(33,000
|
)
|
Proceeds
from long-term debt
|
|
|
|
|
|
140,184
|
|
|
140,184
|
|
Repayment
of long-term debt
|
|
|
|
|
|
(72,000
|
)
|
|
(72,000
|
)
|
Issuance
of Class A common stock
|
|
|
17
|
|
|
|
|
|
17
|
|
Distributions
to minority interests
|
|
|
(1,045
|
)
|
|
|
|
|
(1,045
|
)
|
Dividends
declared and paid
|
|
|
(518
|
)
|
|
|
|
|
(518
|
)
|
Increase
(decrease) in long-term debt
|
|
|
78,184
|
|
|
(78,184
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by financing activities
|
|
|
76,638
|
|
|
|
|
|
76,638
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase in cash
|
|
|
16,131
|
|
|
|
|
|
16,131
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
at beginning of period
|
|
|
20,645
|
|
|
|
|
|
20,645
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
at end of period
|
|
$
|
36,776
|
|
$
|
|
|
$
|
36,776
|
|
|
|
|
|
|
|
|
|
|
|
|
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
|
|
For
The Three Months Ended November 30, 2004
|
|
|
|
As
reported
|
|
Adjustment
|
|
As
restated
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
42,936
|
|
$
|
—
|
|
$
|
42,936
|
|
Noncash
items included in net income:
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
5,050
|
|
|
|
|
|
5,050
|
|
Minority
and pre-acquisition interests
|
|
|
1,021
|
|
|
|
|
|
1,021
|
|
Distributed/(undistributed)
equity in earnings of joint ventures
|
|
|
(20,464
|
)
|
|
20,955
|
|
|
491
|
|
Stock
based compensation expense
|
|
|
|
|
|
|
|
|
|
|
Gain
on disposal of assets
|
|
|
(127
|
)
|
|
|
|
|
(127
|
)
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
13,972
|
|
|
|
|
|
13,972
|
|
Inventories
|
|
|
(12,587
|
)
|
|
|
|
|
(12,587
|
)
|
Prepaid
expenses and other current assets
|
|
|
(108
|
)
|
|
|
|
|
(108
|
)
|
Other
assets
|
|
|
|
|
|
53
|
|
|
53
|
|
Accounts
payable
|
|
|
(1,162
|
)
|
|
|
|
|
(1,162
|
)
|
Accrued
liabilities
|
|
|
(8,295
|
)
|
|
|
|
|
(8,295
|
)
|
Environmental
liabilities
|
|
|
(3,156
|
)
|
|
|
|
|
(3,156
|
)
|
Other
liabilities
|
|
|
|
|
|
159
|
|
|
159
|
|
Other
assets and liabilities
|
|
|
212
|
|
|
(212
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
|
17,292
|
|
|
20,955
|
|
|
38,247
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(7,531
|
)
|
|
|
|
|
(7,531
|
)
|
Cash
received from joint ventures
|
|
|
20,955
|
|
|
(20,955
|
)
|
|
|
|
Cash
paid to joint ventures
|
|
|
(313
|
)
|
|
|
|
|
(313
|
)
|
Proceeds
from sale of assets
|
|
|
398
|
|
|
|
|
|
398
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by investing activities
|
|
|
13,509
|
|
|
(20,955
|
)
|
|
(7,446
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from line of credit
|
|
|
|
|
|
48,300
|
|
|
48,300
|
|
Repayment
of line of credit
|
|
|
|
|
|
(30,800
|
)
|
|
(30,800
|
)
|
Proceeds
from long-term debt
|
|
|
|
|
|
69,500
|
|
|
69,500
|
|
Repayment
of long-term debt
|
|
|
|
|
|
(104,547
|
)
|
|
(104,547
|
)
|
Issuance
of Class A common stock
|
|
|
1,182
|
|
|
|
|
|
1,182
|
|
Distributions
to minority interests
|
|
|
(1,273
|
)
|
|
|
|
|
(1,273
|
)
|
Dividends
declared and paid
|
|
|
(515
|
)
|
|
|
|
|
(515
|
)
|
Increase
(decrease) in long-term debt
|
|
|
(17,547
|
)
|
|
17,547
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash used in financing activities
|
|
|
(18,153
|
)
|
|
|
|
|
(18,153
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase in cash
|
|
|
12,648
|
|
|
|
|
|
12,648
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
at beginning of period
|
|
|
11,307
|
|
|
|
|
|
11,307
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
at end of period
|
|
$
|
23,955
|
|
$
|
|
|
$
|
23,955
|
|
|
|
|
|
|
|
|
|
|
|
|
Note
2 - 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 and the rules and regulations of the Securities
Exchange Commission (“SEC”). Certain information and note disclosures normally
included in annual financial statements have been condensed or omitted pursuant
to those rules and regulations. In the opinion of management, all adjustments,
consisting only of normal, recurring adjustments considered necessary for
a fair
presentation, have been included. Although management believes that the
disclosures made are adequate to ensure that the information presented is
not
misleading, management suggests that these financial statements be read in
conjunction with the financial statements and notes thereto included in the
Company’s annual report for the fiscal
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
year
ended August 31, 2005. The results for the three months ended November 30,
2005
and 2004 are not necessarily indicative of the results of operations for
the
entire year.
Reclassifications
Certain
prior year amounts have been reclassified to conform to the current year
presentation. These changes had no impact on previously reported results
of
operations or shareholders’ equity.
Cash
and Cash Equivalents
Cash
and
cash equivalents include short-term securities that are not restricted by
third
parties and have an original maturity date of 90 days or less. Included
in accounts payable are book overdrafts of $12.6 million and $11.5 million
as of
November 30, 2005 and August 31, 2005, respectively.
Earnings
and Dividends per Share
Basic
earnings per share (EPS) is computed based upon the weighted average number
of
common shares outstanding during the period. Diluted EPS reflects the potential
dilution that would occur if securities or other contracts to issue common
stock
were exercised or converted into common stock. All of the options issued
through
and outstanding as of November 30, 2005, except for 155,900 shares granted
on
November 29, 2005, are considered to be dilutive.
The
following represents the reconciliation from basic EPS to diluted EPS (in
thousands, except per share amounts):
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
Net
Income
|
|
$
|
41,530
|
|
$
|
42,936
|
|
|
|
|
|
|
|
|
|
Computation
of shares:
|
|
|
|
|
|
|
|
Average
common shares outstanding
|
|
|
30,477
|
|
|
30,350
|
|
Stock
options
|
|
|
560
|
|
|
793
|
|
Diluted
average common shares outstanding
|
|
|
31,037
|
|
|
31,143
|
|
|
|
|
|
|
|
|
|
Basic
EPS
|
|
$
|
1.36
|
|
$
|
1.41
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
$
|
1.34
|
|
$
|
1.38
|
|
|
|
|
|
|
|
|
|
Dividend
per share
|
|
$
|
0.017
|
|
$
|
0.017
|
|
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
Goodwill
and Intangible Assets
The
changes in the carrying amount of goodwill for the three months ended November
30, 2005 are as follows (in thousands):
|
|
Metals
Recycling
Business
|
|
Auto
Parts
Business
|
|
Total
|
|
Balance
as of August 31, 2005
|
|
$
|
34,771
|
|
$
|
116,583
|
|
$
|
151,354
|
|
Acquisition
of GreenLeaf Auto Recyclers, LLC
(see
Note 4)
|
|
|
|
|
|
14,001
|
|
|
14,001
|
|
Separation
and termination of joint venture relationships with Hugo Neu Corporation
(see
Note 4)
|
|
|
61,557
|
|
|
|
|
|
61,557
|
|
Acquisition
of Regional Recycling LLC assets
(see
Note 4)
|
|
|
39,915
|
|
|
|
|
|
39,915
|
|
Balance
as of November 30, 2005
|
|
$
|
136,243
|
|
$
|
130,584
|
|
$
|
266,827
|
|
The
Company performs impairment tests annually during the second quarter of the
fiscal year and whenever events and circumstances indicate that the value
of
goodwill and other indefinite-lived intangible assets might be impaired.
Based
on to the operating results of each of the businesses identified above and
the
Company’s impairment testing completed in the second quarter of fiscal 2005, the
Company determined that none of the above balances were considered
impaired.
New
Accounting Pronouncements
In
November 2004, the Financial Accounting Standards Board (FASB) issued SFAS
151,
“Inventory Costs”. This statement clarifies the accounting for abnormal amounts
of idle facility expense and freight and handling costs when those costs
may be
so abnormal as to require treatment as period charges. This statement is
effective for fiscal years beginning after June 15, 2005. The Company adopted
SFAS 151 on September 1, 2005 with no material impact on the consolidated
financial statements.
In
December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets.” This
statement explains that exchanges of nonmonetary assets should be measured
based
on the fair value of the assets exchanged. This statement is effective for
fiscal years beginning after June 15, 2005. The Company adopted SFAS 153
on
September 1, 2005 with no material impact on the consolidated financial
statements.
In
June
2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections.” This
statement revises the reporting requirements related to changes in accounting
principles or adoption of new accounting pronouncements. This statement is
effective for fiscal years beginning after December 15, 2005. The Company
does
not anticipate this pronouncement to have a material impact on the consolidated
financial statements.
In
December 2004, the FASB finalized SFAS No. 123(R) “Share-Based Payment“, which
will be effective for the first interim reporting period of the first fiscal
year beginning after June 15, 2005. The new standard requires the Company
to
expense stock options beginning in the first quarter of fiscal 2006. The
Company
adopted SFAS No. 123(R), effective September 1, 2005. SFAS 123(R) requires
the
recognition of the fair value of stock-based compensation in net income.
The
Company recognizes stock-based compensation expense over the requisite service
period of the individual grants, which generally equals the vesting period.
See
Note 8 for further information regarding stock based
compensation.
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
Note
3 - Inventories:
Inventories
consisted of the following (in thousands):
|
|
|
November
30,
2005
|
|
|
August
31,
2005
|
|
Recycled
metals
|
|
$
|
124,702
|
|
$
|
38,027
|
|
Work
in process
|
|
|
8,084
|
|
|
17,124
|
|
Finished
goods
|
|
|
62,984
|
|
|
36,304
|
|
Supplies
|
|
|
15,958
|
|
|
14,734
|
|
|
|
$ |
211,728 |
|
$ |
106,189 |
|
Note
4 - Business Combinations
Hugo
Neu Corporation Separation and Termination Agreement
On
September 30, 2005, the Company, HNC and certain of their subsidiaries closed
a
transaction to separate and terminate their metals recycling joint venture
relationships. The Company received the following as a result of the HNC
joint
venture separation and termination:
· |
The
assets and related liabilities of Hugo Neu Schnitzer Global Trade
related
to a trading business in parts of Russia and the Baltic region,
including
Poland, Denmark, Finland, Norway and Sweden, and a non-compete
agreement
from HNC that bars it from buying scrap metal in certain areas
in Russia
and the Baltic region for a five-year period ending on June 8,
2010.
|
· |
The
joint ventures’ various interests in the New England operations that
primarily operate in Massachusetts, New Hampshire, Rhode Island
and
Maine.
|
· |
Full
ownership in the Hawaii metals recycling business that was previously
owned 100% by HNC.
|
· |
A
payment of $36.6 million in cash, net of debt paid, subject to
post-closing adjustments.
|
HNC
received the following as result of the HNC joint venture separation and
termination:
· |
The
joint venture operations in New York, New Jersey and California,
including
the scrap processing facilities, marine terminals and related ancillary
satellite sites, the interim New York City recycling contract,
and other
miscellaneous assets.
|
· |
The
assets and related liabilities of Hugo Neu Schnitzer Global Trade
that are
not related to the Russian and Baltic region trading
business.
|
The
agreement provides for potential purchase price adjustments based on the
closing
date working capital of the acquired Hawaii business as well as the joint
ventures’ ending balances. The Company has not determined whether any purchase
price adjustments will be necessary.
In
accordance with SFAS 141, “Business Combinations,” the purchase price of the
acquired assets and liabilities assumed under the separation and termination
agreement is the fair value of the joint venture interests given up as part
of
the exchange as well as cash received, other liabilities assumed and acquisition
costs, net of cash received. As a result, the purchase price is estimated
to be
$165.1 million, including acquisition costs of approximately $6.3 million.
The
$54.6 million gain resulting from the joint venture divesture represents
the
difference between the fair value of $160.1 million and the carrying value
of
$105.5 million of the joint ventures.
The
purchase price was allocated to tangible and intangible identifiable assets
acquired and liabilities assumed based on an estimate of the respective fair
values. Final valuation reports are pending from a third party. The excess
of
the aggregate purchase price over the fair value of the identifiable net
assets
acquired of approximately $57.6 million was recognized as goodwill.
Approximately $3.8 million of goodwill existed on the joint
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
ventures’
balance sheets prior to the separation and termination but was not shown
separately in accordance with the equity method of accounting. Therefore,
the
total increase to goodwill related to the HNC Separation and Termination
Agreement was $61.6 million.
The
purchase price allocation has been prepared on a preliminary basis, and
reasonable changes are expected as additional information, such as final
valuation reports and any purchase price adjustments, becomes available.
The
following is a summary of the estimated fair values as November 30, 2005,
for
the assets acquired and liabilities assumed as of the date of the acquisition
(in millions):
|
|
|
|
Cash,
net of debt paid
|
|
$
|
36.6
|
|
Property,
plant and equipment
|
|
|
26.1
|
|
Inventory
|
|
|
35.4
|
|
Other
assets
|
|
|
30.8
|
|
Identified
intangible assets
|
|
|
3.0
|
|
Liabilities
|
|
|
(24.4
|
)
|
Goodwill
|
|
|
57.6
|
|
Total
purchase price
|
|
$
|
165.1
|
|
GreenLeaf
Acquisition
On
September 30, 2005, the Company acquired GreenLeaf, five properties previously
leased by GreenLeaf and certain GreenLeaf debt obligations. GreenLeaf is
engaged
in the business of auto dismantling and recycling and sells its products
primarily to collision and mechanical repair shops. GreenLeaf currently operates
in one wholesale sales office and 19 commercial locations throughout the
United
States. Total purchase price for the acquisition, including acquisition costs,
was $44.7 million, subject to post-closing adjustments.
The
purchase price of the GreenLeaf acquisition was allocated to tangible and
intangible identifiable assets acquired and liabilities assumed based on
an
estimate of fair value. The machinery and equipment is being valued by the
Company’s management. The excess of the aggregate purchase price over the
estimated fair value of the identifiable net assets acquired of $14.0 million
was recognized as goodwill.
The
purchase price allocation has been prepared on a preliminary basis, and
reasonable changes are expected as additional information becomes available,
such as final valuation reports and any post-closing adjustments. The following
is a summary of the estimated fair values as of November 30, 2005, for the
assets acquired and liabilities assumed on the date of the acquisition (in
millions):
Property,
plant and equipment
|
|
$
|
14.6
|
|
Inventory
|
|
|
20.8
|
|
Other
assets
|
|
|
18.8
|
|
Liabilities
|
|
|
(23.5
|
)
|
Goodwill
|
|
|
14.0
|
|
Total
purchase price
|
|
$
|
44.7
|
|
Regional
Recycling Acquisition
On
October 31, 2005, the Company purchased substantially all of the assets of
Regional for $65.5 million in cash and the assumption of certain liabilities,
a
working capital adjustment of $2.9 million and acquisition costs of
approximately $0.5 million. Regional operates 10 metals recycling facilities
located in the states of Georgia and Alabama which process ferrous and
nonferrous scrap metals without the use of shredders.
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
The
purchase price of the Regional acquisition was allocated to tangible and
intangible identifiable assets acquired and liabilities assumed based on
an
estimate of the respective fair values. Final valuation reports are pending
from
a third party. The excess of the aggregate purchase price over the estimated
fair value of the identifiable net assets acquired of approximately $39.9
million was recognized as goodwill.
The
purchase price allocation has been prepared on a preliminary basis, and
reasonable changes are expected as additional information becomes available,
such as final valuation reports. The following is a summary of the estimated
fair values as November 30, 2005, for the assets acquired and liabilities
assumed as of the date of the acquisition (in millions):
|
|
|
|
Property,
plant and equipment
|
|
$
|
10.6
|
|
Accounts
Receivable
|
|
|
27.7
|
|
Inventory
|
|
|
4.9
|
|
Other
assets
|
|
|
1.1
|
|
Liabilities
|
|
|
(15.3
|
)
|
Goodwill
|
|
|
39.9
|
|
Total
purchase price
|
|
$
|
68.9
|
|
The
total
aggregate goodwill recognized from the recent acquisitions amounted to $115.5
million. In accordance with SFAS 142, goodwill is not amortized and will
be
tested for impairment at least annually. Goodwill recognized in connection
with
the HNC separation and termination and the Regional acquisition is deductible
for tax, whereas that recognized in connection with GreenLeaf, an acquisition
of
equity interests, is not. Payment
of the consideration for the recently acquired businesses was funded by the
Company’s existing cash balances and credit facility.
During
the first quarter of fiscal 2006, the Company recorded a gain of $54.6 million
related to the disposition of assets pursuant to the HNC separation and
termination. The transaction, which included selling certain assets previously
owned through the joint venture, was recorded using the fair value of the
assets
with consideration of business valuations performed by a third party. The
fair
value of net assets received exceeded the carrying value of the assets sold,
resulting in the gain recorded. Any change to the fair value in the final
third
party valuations would directly impact the gain recorded.
In
connection with the HNC separation and termination, and the GreenLeaf and
Regional acquisitions, the Company conducted environmental due diligence
reviews
of the acquired assets. Based upon the information obtained in the reviews
in
the first quarter of fiscal 2006, the Company accrued $24.8 million in
environmental liabilities for probable and reasonably estimable future
remediation costs at the acquired facilities. No environmental proceedings
are
pending with respect to any of these facilities.
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
The
following table is prepared on a pro forma basis, for the three month period
ended November 30, 2005 and 2004, respectively, as though all of the businesses
acquired through the HNC separation and termination agreement and the GreenLeaf
and Regional acquisitions had occurred as of the beginning of the periods
presented
(in
thousands, except per share amounts).
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
|
|
(pro
forma)
|
|
(pro
forma)
|
|
Gross
revenues
|
|
$
|
388,673
|
|
$
|
440,861
|
|
Net
Income
|
|
$
|
49,475
|
|
$
|
48,679
|
|
Net
Income per share:
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.62
|
|
$
|
1.60
|
|
Diluted
|
|
$
|
1.60
|
|
$
|
1.56
|
|
The
pro
forma results are not necessarily indicative of what would have occurred
if the
acquisitions had been in effect for the periods presented. In addition, 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.
Note
5 - Environmental Liabilities and Other Contingencies:
The
Company considers various factors when estimating its environmental liabilities.
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 remediation, which specify standards for acceptable
remediation;
|
· |
Information
about the site that 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;
|
· |
Available
technologies 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
In
connection with acquisitions in the Metals Recycling Business in 1995 and
1996,
the Company carried over to its financial statements reserves for environmental
liabilities previously recorded by the acquired companies. These reserves
are
evaluated quarterly according to Company policy. On November 30, 2005,
environmental reserves for the Metals Recycling Business aggregated $26.7
million.
Hylebos
Waterway Remediation.
General
Metals of Tacoma (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 (CERCLA).
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, 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 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
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
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 is dredging in the head of the Hylebos Waterway,
which began on July 15, 2004. During fiscal 2005, the Company paid remediation
costs of $15.9 million related to Hylebos dredging which resulted in a reduction
of the recorded environmental liability. The Company’s cost estimates were based
on the assumption that dredge removal of contaminated sediments would be
accomplished within one dredge season during July 2004 - 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
$13.5
million in fiscal 2005 primarily to account for additional estimated costs
to
complete this work during a second dredging season, and the total reserve
for
this site was $10.6 million at August 31, 2005. In the first quarter of fiscal
2006, the Company incurred remediation costs of $3.9 million which were charged
to the environmental reserves, and on November 30, 2005, environmental reserves
for the Hylebos Waterway aggregated $6.7 million. The Company and the Other
Party have filed a complaint in the United States District Court for the
Western
District of Washington against the dredge contractor to recover damages and
a
significant portion of the increased costs incurred in the second dredging
season to complete the project.
GMT
and
the Other Party are pursuing settlement negotiations and legal actions against
other non-settling, non-performing PRPs to recover additional amounts that
may
be applied against the head of the Hylebos remediation costs. During fiscal
2005, the Company recovered $0.7 million from four non-performing PRPs.
This
amount had previously been taken into account as a reduction in the Company’s
reserve for environmental liabilities. Uncertainties continue to exist regarding
the total cost to remediate this site as well as the Company’s share of those
costs; nevertheless, the Company’s estimate of its liabilities related to this
site is based on information currently available.
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 agreement
would also address liability sub-allocation to other parties historically
associated with the facility. In December 2005 the Trustees responded to
the GMT
proposal. There remain significant differences between the parties and
negotiations are continuing. It is unknown at this time whether, or to what
extent, GMT will be liable for natural resource damages. The Company’s
previously recorded environmental liabilities include an estimate of the
Company’s potential liability for these claims.
Portland
Harbor.
In
December 2000, the United States Environmental Protection Agency (EPA) named
the
Portland Harbor, a 5.5 mile stretch of the Willamette River in Portland,
Oregon,
as a Superfund site. The Company’s metals recycling and deep water terminal
facility in Portland, Oregon is located adjacent to the Portland Harbor.
Crawford Street Corporation (CSC), a Company subsidiary, also owns property
adjacent to the Portland Harbor. The EPA has identified 69 PRPs, including
the
Company and CSC, which own or operate 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 such a
clean-up, and the allocation of
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
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 whether or to what extent natural resource damage claims or third
party
contribution or damages claims will be asserted against the Company. 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 PRPs (Lower Willamette Group) for a Remedial Investigation/Feasibility
Study (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.
Separately,
the Oregon Department of Environmental Quality (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 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.
The
cost
of the investigations associated with these properties and the cost of
employment of source control BMPs are not expected to be material. No estimate
is currently possible, and none has been made, as to the cost of remediation
for
the Portland Harbor or the Company’s or CSC’s adjacent properties.
Other
Metals Recycling Business Sites. For
a
number of years prior to the Company’s 1996 acquisition of Proler International
Corp. (Proler), Proler operated an industrial waste landfill in Texas, which
Proler utilized to dispose of auto shredder residue (ASR) from one of its
operations. In August 2002, Proler entered the Texas Commission on Environmental
Quality (TCEQ) Voluntary Cleanup Program (VCP) toward the pursuit of a VCP
Certificate of Completion for the former landfill site. In fiscal 2005, TCEQ
issued a Conditional Certificate of Completion, requiring the Company to
perform
on-going 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 $1.6 million in fiscal 2005.
During
the second quarter of fiscal 2005, in connection with the negotiation of
the
separation and termination agreement relating to the Company’s metals recycling
joint ventures with HNC (see Note 4), 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 $2.6 million for its share of the estimated
costs to remediate these risks upon completion of the separation. During
the
first quarter of fiscal 2006, an additional $12.8 million was recorded
representing the remaining portion of the environmental liabilities associated
with the separation and termination agreement as well as the Regional
acquisition of which $0.3 million was expended in remediation efforts. No
environmental proceedings are pending with respect to any of these sites.
The
Washington State Department of Ecology named GMT, along with a number of
other
parties, as Potentially Liable Parties (PLPs) for a site referred to as Tacoma
Metals. GMT operated on this site under a lease prior to 1982. The property
owner and current operator have taken the lead role in performing a Remedial
Investigation and Feasibility Study (RI/FS) for the site. The Company’s
previously recorded environmental liabilities include an estimate of the
Company’s potential liability at this site.
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
A
Company
subsidiary is also a named PRP at another third-party site at which it allegedly
disposed of automobile shredder residue. The site has not yet been subject
to
significant remedial investigation. In addition to the matters discussed
above,
the Company’s environmental reserve includes amounts for potential future
cleanup of other sites at which the Company or its acquired subsidiaries
have
conducted business or allegedly disposed of other materials.
Auto
Parts Business
From
fiscal 2003 through the first quarter of fiscal 2006, the Company completed
four
acquisitions of businesses in the Auto Parts Business segment. At the time
of
each acquisition, the Company conducted an environmental due diligence
investigation related to locations involved in the acquisition. As a result
of
the environmental due diligence investigations, the Company recorded a reserve
for the estimated cost to address certain environmental matters. The reserve
is
evaluated quarterly according to the Company policy. On November 30, 2005,
environmental reserves for the Auto Parts Business aggregated $18.7 million,
which includes an environmental reserve for the GreenLeaf acquisition. No
environmental proceedings are pending with respect to any of these sites.
Other
Contingencies
The
Company had a past practice of making improper payments to the purchasing
managers of customers in Asia in connection with export sales of recycled
ferrous metals. The Company stopped this practice after it was advised in
2004
that it raised questions of possible violations of U.S. 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
of Directors also authorized and directed that the existence and the results
of
the investigation be voluntarily reported to the U.S. Department of Justice
(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 August 23, 2005, the Company received from
the SEC
a formal order of investigation related to the independent investigation.
The
Audit Committee is continuing its independent investigation. The Company,
including the Audit Committee, continues to cooperate fully with the DOJ
and the
SEC. The investigations of the Audit committee, the DOJ and the SEC are not
expected to affect the Company’s previously reported financial results. However,
the Company expects to enter into agreements with the DOJ and the SEC to
resolve
the above-referenced matters and believes that it is probable that the DOJ
and
SEC will impose penalties on, and require disgorgement of certain profits
by,
the Company as a result of their investigations. The Company estimates
that the total amount of these penalties and disgorgement will be within
a range
of $11.0 million to $15.0 million. In the first quarter of 2006, the Company
established a reserve totaling $11.0 million in connection with this estimate.
The precise terms of any agreements to be entered into with the DOJ and the
SEC,
however, remain under discussion with these two agencies. The Company,
therefore, cannot predict with certainty the results of the aforementioned
investigations or whether the Company or any of its employees will be subject
to
any additional remedial actions following completion of these investigations.
Note
6 - 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, $400.0 million revolving credit facility loan maturing in November
2010. The agreement prior to restatement provided for a $150.0 million revolving
credit facility maturing in May 2006. Interest on outstanding indebtedness
under
the restated agreement is based, at the Company’s option, on either 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 Company’s leverage ratio, or the greater of the prime
rate or the federal funds rate plus 0.50%. In addition, annual commitment
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
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 Company’s leverage ratio. The restated
agreement contains various representations and warranties, events of default
and
financial and other covenants, including covenants requiring maintenance
of a
minimum fixed charge coverage ratio and a maximum leverage ratio. The Company
also has an additional unsecured credit line totaling $10.0 million, which
is
uncommitted. This additional debt agreement also has certain restrictive
covenants. The fair value of long-term debt is deemed to be the same as that
reflected in the condensed consolidated balance sheets given the variable
interest rates. As of November 30, 2005, the Company had aggregate borrowings
outstanding under its credit facilities of $86.0 million and was in
compliance with the representations, warranties and covenants of its debt
agreements.
Note
7 - Related Party Transactions
The
Company leases its administrative offices under operating leases from Schnitzer
Investment Corp. (SIC), a Schnitzer family controlled business engaged in
real
estate. The current leases expire in 2013, and annual rent was $0.4 million
in
fiscal 2005. Lease amendments have been executed under which, upon completion
of
tenant improvements, one lease will be terminated; the premises leased under
the
other lease will be increased; annual rent will accordingly increase to $0.5
million; and the lease term will be extended to 2015.
The
Company and SIC are parties to a shared services agreement. Starting in fiscal
2005 and continuing into fiscal 2006, the Company has reduced or ceased the
sharing of administrative services with SIC and other Schnitzer family companies
in a number of areas as part of a process expected to eliminate substantially
all the sharing of services between the Company and SIC in fiscal 2006. All
transactions with the Schnitzer family (including Schnitzer family companies)
require the approval of the Company’s Audit Committee, and the Company is in
compliance with this policy.
Thomas
D.
Klauer, Jr., President of the Company’s Auto Parts Business, is the sole
shareholder of a corporation that is the 25% minority partner in a partnership
with the Company that operates four Pick-N-Pull stores in Northern California.
Mr. Klauer’s 25% share of the profits of this partnership totaled $0.4 million
in the first fiscal quarter of 2006 and $1.6 million in fiscal 2005. 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 $0.2 million, 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.
Note
8
- Stock Incentive Plan
The
Company has adopted the 1993 Stock Incentive Plan (Plan) for its employees,
consultants, and directors. Pursuant to the provisions of the Plan, as amended,
the Company is authorized to issue up to 7,200,000 shares of Class A Common
Stock. Stock options are granted to employees at exercise prices equal to
the
fair market value of the Company’s stock at the dates of grant. Generally, stock
options granted to employees fully vest five years from the date of grant
and
have a contractual term of 10 years.
Adoption
of SFAS 123(R). The
Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” effective
September 1, 2005. SFAS 123(R) requires the recognition of the fair value
of
stock-based compensation in net income. The Company recognizes stock-based
compensation expense over the requisite service period of the individual
grants,
which generally equals the vesting period.
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
Prior
to
September 1, 2005, the Company accounted for the Plan under the intrinsic
value
method described in Accounting Principles Board (APB) Opinion No. 25,
“Accounting for Stock Issued to Employees,” and related Interpretations. The
Company, applying the intrinsic value method, did not record stock-based
compensation cost in net income because the exercise price of its stock options
equaled the market price of the underlying stock on the date of grant. The
Company has elected to utilize the modified prospective transition method
for
adopting SFAS 123(R). Under this method, the provisions of SFAS 123(R) apply
to
all awards granted or modified after the date of adoption. In addition, the
unrecognized expense of awards unvested at the date of adoption, determined
under the original provisions of SFAS 123, will be recognized in net income
in
the periods after the date of adoption.
The
Company recognized stock-based compensation costs in the amount of $0.5 million
for the three months ended November 30, 2005.
The
fair
value of each option grant under the Plan was estimated at the date of grant
using the Black-Scholes Option Pricing Model, which utilizes assumptions
related
to volatility, the risk-free interest rate, the dividend yield, and employee
exercise behavior. Expected volatilities utilized in the model are based
primarily on the historical volatility of the Company’s stock price and other
factors. The risk-free interest rate is derived from the U.S. Treasury yield
curve in effect at the time of grant. The model incorporates exercise and
post-vesting forfeiture assumptions based on an analysis of historical data.
The
expected lives of the grants are derived from historical data and other factors.
As
of
November 30, 2005, the total remaining unrecognized compensation cost related
to
non-vested stock options amounted to $5.8 million. The weighted average
remaining requisite service period of the non-vested stock options was 27
months.
In
accordance with the applicable provisions of SFAS 123(R) and FASB Staff Position
(FSP) FAS 123(R)-3 issued on November 10, 2005, the Company elected to use
the
short-form method to calculate the Windfall tax pool (Windfall) as of September
1, 2005, against which any future deficiency in actual tax benefits from
exercises of stock options as compared to tax benefits recorded under SFAS
123(R), defined as “Shortfall,” will be offset.
Periods
Prior to Adoption.
SFAS
123(R) requires the Company to present pro forma information for periods
prior
to adoption as if the Company had accounted for all stock-based compensation
under the fair value method of that statement. For purposes of pro forma
disclosure, the estimated fair value of the options at the date of grant
is
amortized over the requisite service period, which generally equals the vesting
period. The following table illustrates the effect on net income and earnings
per share as if the Company had applied the fair value recognition provisions
to
its stock-based employee compensation:
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
|
|
For
the Three Months
Ended
November
30, 2004
|
|
|
|
|
|
|
Reported
net income
|
|
$
|
42,936
|
|
Add:
Stock based compensation costs included in
reported
net income, net of tax
|
|
|
225
|
|
Deduct:
Total stock based employee
compensation
benefit (expense) under fair value
based
method for all awards, net of tax
|
|
|
(125
|
)
|
|
|
|
|
|
Pro
forma net income
|
|
$
|
43,036
|
|
|
|
|
|
|
Reported
basic income per share
|
|
$
|
1.41
|
|
Pro
forma basic income per share
|
|
$
|
1.42
|
|
|
|
|
|
|
Reported
diluted income per share
|
|
$
|
1.38
|
|
Pro
forma diluted income per share
|
|
$
|
1.38
|
|
Note
9 - Employee Benefits
The
Company has a number of retirement benefit plans that cover both union and
non-union employees. The Company makes contributions following the provisions
in
each plan.
Primary
actuarial assumptions are determined as follows:
· |
The
expected long-term rate of return on plan assets is based on the
Company’s
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 U.S. discount rate is as of the measurement
date
of August 31, 2005. This rate is sensitive to changes in interest
rates. A
decrease in the discount rate would increase the Company’s 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 Company’s
compensation policies. An increase in this rate would increase
the
Company’s obligation and expense.
|
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
Defined
Benefit Pension Plan
The
Company maintains a defined benefit pension plan for certain nonunion
employees. The components of net periodic pension benefit cost are (in
thousands):
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
Service
cost
|
|
$
|
294
|
|
$
|
164
|
|
Interest
cost
|
|
|
180
|
|
|
106
|
|
Expected
return on plan assets
|
|
|
(220
|
)
|
|
(121
|
)
|
Amortization
of past service cost
|
|
|
1
|
|
|
1
|
|
Recognized
actuarial loss
|
|
|
51
|
|
|
30
|
|
Net
periodic pension benefit cost
|
|
$
|
306
|
|
$
|
180
|
|
The
Company expects to contribute $1.2 million to its defined benefit pension
plan
for the year ending August 31, 2006. During the quarter ended November 30,
2005, the Company made no contributions to the defined benefit pension plan.
The
Company typically makes annual contributions to the plan after it receives
the
annual actuarial valuation report. These payments are typically made in the
Company’s third and fourth fiscal quarters.
Defined
Contribution Plans
The
Company has several defined contribution plans covering nonunion employees.
Company contributions to the defined contribution plans were as follows (in
thousands):
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
Multiemployer
Pension Plans
In
accordance with collective bargaining agreements, the Company contributes
to
multiemployer pension plans. Company contributions were as follows (in
thousands):
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
Plan
contributions
|
|
$
|
870
|
|
$
|
738
|
|
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 the plans.
The
Company learned during fiscal 2004 that
one
of the multiemployer plans for the Steel Manufacturing Business would not
meet
Employee Retirement Income Security Act of 1974 minimum funding standards
for
the plan year ended September 30, 2004. The trustees of that plan have applied
to the Internal Revenue Service (IRS) for certain relief from this minimum
funding standard. The IRS has tentatively responded, indicating a willingness
to
consider granting the relief provided the plan’s contributing employers,
including the Company, agree to increased contributions. The increased
contributions are estimated to average 6% per year, compounded annually,
until
the plan reaches the funding status required by the IRS. These increases
would
be based on the Company’s current contribution level to the plan of
approximately $1.7 million per year. Based
on
commitments from the majority of employers participating in the plan to make
the
increased contributions, the plan trustees have proceeded with the relief
request and are awaiting formal approval from the IRS.
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
Absent
relief by the IRS, the plan’s contributing employers will be required to make
additional contributions or pay an excise tax that may equal or exceed the
full
amount of the funding deficiency. The Company estimated its share of the
required additional contribution for the 2004 plan year to be approximately
$1.1
million and accrued for such amount in fiscal 2004. The Company did not accrue
additional amounts for fiscal 2005 or the first quarter of fiscal 2006, based
on
the Company’s belief that it is probable the IRS will grant relief.
Note
10 - Segment Information
The
Company operates in three industry segments: metal processing and recycling
(Metals Recycling Business), self-service and full-service used auto parts
sales
(Auto Parts Business) and mini-mill steel manufacturing (Steel Manufacturing
Business). Additionally, the Company is a non-controlling partner in joint
ventures that are suppliers of unprocessed metals and, prior to October 1,
2005,
other joint ventures in the metals recycling business. In prior fiscal years,
the Company considered these joint ventures to be separate segments because
they
were managed separately. These joint ventures are accounted for using the
equity
method. As such, the operating information related to the joint ventures
is
shown separately from consolidated information, except for the Company’s equity
in the net income of, investments in and advances to the joint ventures.
Additionally, assets and capital expenditures are not shown for the joint
ventures, as management does not use that information to allocate resources
or
assess performance. The Company does not allocate corporate interest income
and
expense, income taxes or other income and expenses related to corporate activity
to its operating segments.
Revenues
from external customers and from intersegment transactions for the Company’s
consolidated operations are as follows (in thousands):
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
|
|
(as
restated) |
|
|
|
Metals
Recycling Business
|
|
$
|
241,430
|
(1)
|
$
|
144,532
|
|
Auto
Parts Business
|
|
|
45,922
|
|
|
23,386
|
|
Steel
Manufacturing Business
|
|
|
89,156
|
|
|
70,022
|
|
Intersegment
revenues
|
|
|
(35,277
|
)
|
|
(38,979
|
)
|
Consolidated
revenues
|
|
$
|
341,231
|
|
$
|
198,961
|
|
SCHNITZER
STEEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE
THREE MONTHS ENDED NOVEMBER 30, 2005 AND 2004
The
Company’s operating income is as follows (in thousands):
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
|
|
(as
restated) |
|
|
|
Metals
Recycling Business
|
|
$
|
12,002
|
(1) |
$
|
33,788
|
(2) |
Auto
Parts Business
|
|
|
7,737
|
|
|
7,048
|
|
Steel
Manufacturing Business
|
|
|
16,070
|
|
|
12,760
|
|
Joint
Ventures (3)
|
|
|
1,732
|
|
|
20,464
|
|
Total
segment operating income
|
|
|
37,541
|
|
|
74,060
|
|
Corporate
expense
|
|
|
(19,479
|
)
|
|
(3,591
|
)
|
Intercompany
profit eliminations
|
|
|
(529
|
)
|
|
(3,163
|
)
|
Total
operating income
|
|
$
|
17,533
|
|
$
|
67,306
|
|
(1)
|
The
Company elected to consolidate results of two of the businesses
acquired
through the HNC separation and termination agreement as though
the
transaction had occurred at the beginning of fiscal 2006, instead
of the
date of acquisition. The increase in revenues and operating income
that
resulted from the election is offset by pre-acquisition interests,
net of
tax. See Note 2 and Note 4 to the condensed consolidated financial
statements.
|
(2) |
Includes
$500 thousand of environmental expenses related to the Hylebos
Waterway
project.
|
(3) |
As
a result of the HNC joint venture separation and termination agreement,
the Joint Venture segment was eliminated and the results for the
businesses acquired in this transaction that the Company is now
managing,
along with other smaller joint ventures, have been consolidated
into the
Metals Recycling Business beginning in fiscal 2006. Included in
the Joint
Venture segment for fiscal 2005 is estimated operating income for
these
two businesses of $9,465 for the three months ended November 30,
2005.
|
SCHNITZER
STEEL INDUSTRIES, INC.
ITEM
2. |
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
|
Restatement
The
Company has restated its condensed consolidated statement of operations for
the
quarter ended November 30, 2005 and its condensed consolidated statements of cash flows for the quarter ended November 30, 2005 and 2004. See Note 1 to the condensed consolidated
financial statements for additional details. All amounts in the following
discussion have been restated where necessary for the effect of the
restatement.
General
Schnitzer
Steel Industries, Inc. (the Company) operates in three vertically integrated
business segments that include metal processing and recycling (Metals Recycling
Business), self-service and full-service used auto parts sales (Auto Parts
Business) and mini-mill steel manufacturing (Steel Manufacturing Business).
The
Metals Recycling Business collects, processes and recycles metals by operating
one of the largest metals recycling businesses in the United States. The
Auto
Parts Business operates as Pick-N-Pull, which the Company believes is one
of the
country’s leading self-service used auto parts networks, and GreenLeaf, the
acquisition of which positions the Company in the full-service market.
Additionally, Pick-N-Pull is a supplier of auto bodies to the Metals Recycling
Business, which processes the auto bodies into sellable recycled metal. The
Steel Manufacturing Business purchases recycled metals from the Metals Recycling
Business and other sources and uses its mini-mill to process the recycled
metals
into finished steel products. As a result of the vertical integration the
Company is able to transform auto bodies and other unprocessed metals into
finished steel products.
Metals
Recycling Business
The
Company operates one of the largest metal recycling businesses in the United
States. The Company buys, processes and sells ferrous metals to foreign and
domestic steel producers, including its Steel Manufacturing Business and
nonferrous metals to both the domestic and export markets. In addition, the
Metals Recycling Business including Schnitzer Global Exchange engage in the
metals trading business by purchasing processed metal from other recycled
metals
processors for shipment to either the Steel Manufacturing Business or third
party customers without further processing.
On
September 30, 2005, the Company and Hugo Neu Corporation (HNC) closed a
transaction to separate and terminate their metals recycling joint venture
relationships as discussed below under “acquisitions and transactions”.
As
a
result of the completion of this transaction, in addition to its previous
recycling operations in Northern California, Washington and Oregon, the Company
now has significant recycling operations in New England and Hawaii and operates,
through its wholly owned subsidiary Schnitzer Global Exchange Corp. (Schnitzer
Global Exchange), a metals trading business which purchases metals in parts
of
Russia and the Baltic region. In addition, as discussed below under
“Acquisitions and Transactions”, on October 31, 2005, the Company purchased
substantially all of the assets of Regional, which operates metals recycling
facilities located in the southeastern United States and gives the Company
a
significant presence in this growing market. For a more detailed discussion
of
the HNC joint venture separation and termination and the Regional acquisition,
see “Acquisitions and Transactions” and Note 4 to the condensed consolidated
financial statements.
Auto
Parts Business
The
Auto
Parts Business operates as Pick-N-Pull
in the United States and Canada. The Company believes Pick-N-Pull is one
of the
country’s leading self-service used auto parts networks. The Auto Parts Business
purchases salvaged vehicles, sells used parts from those vehicles through
its
retail stores and wholesale operations, and sells the remaining portion of
the
vehicles to metal recyclers, including the Company’s Metals Recycling Business.
Until
SCHNITZER
STEEL INDUSTRIES, INC.
September
30, 2005, the Auto Parts Business consisted of a network of retail locations
operating exclusively as self-service used auto parts stores. These stores
are
self-service in that customers themselves remove used auto parts from vehicles
in inventory.
During
the first quarter of fiscal 2006, the Company acquired GreenLeaf, which is
engaged in the business of full-service auto dismantling and recycling and
sells
its products primarily to collision and mechanical repair shops. This
acquisition
significantly increased Auto Parts Business presence in the Southern, Eastern
and Midwestern United States and represents the Company’s initial venture into
the substantial full-service segment of the recycled auto parts market that
services commercial customers. In full-service stores, professional staff
members dismantle, test and inventory individual parts, which are then delivered
to business or wholesale customers. Full-service stores also generally maintain
newer cars in inventory. The Company is in
the
process of integrating GreenLeaf’s operations into Pick-N-Pull. Management has
identified several GreenLeaf stores to convert to self-service locations;
others
will combine both full-service and self-service and some will remain exclusively
full service. For
a
more detailed discussion of the Greenleaf acquisition, see “Acquisitions and
Transactions” and Note 4 to the condensed consolidated financial
statements.
Steel
Manufacturing Business
The
Steel
Manufacturing Business purchases recycled metals from the Metals Recycling
Business as well as from third parties and uses its mini-mill to process
the
recycled metals into finished steel products, including steel reinforcing
bar
(rebar), wire rod, merchant bar, coiled rebar and other specialty products.
Acquisitions
and Transactions
Metals
Recycling Business.
On
September 30, 2005, the Company, HNC and certain of their subsidiaries closed
a
transaction to separate and terminate their metals recycling joint venture
relationships. The Company received the following as a result of the HNC
joint
venture separation and termination:
· |
The
assets and related liabilities of Hugo Neu Schnitzer Global Trade
related
to a trading business in parts of Russia and the Baltic region,
including
Poland, Denmark, Finland, Norway and Sweden, and a non-compete
agreement
from HNC that bars it from buying scrap metal in certain areas
in Russia
and the Baltic region for a five-year period ending on June 8,
2010.
|
· |
The
joint ventures’ various interests in the New England operations that
primarily operate in Massachusetts, New Hampshire, Rhode Island
and
Maine.
|
· |
Full
ownership in the Hawaii metals recycling business that was previously
owned 100% by HNC.
|
· |
A
payment of $36.6 million in cash, net of debt paid, subject to
post-closing adjustments.
|
HNC
received the following as result of the HNC joint venture separation and
termination:
· |
The
joint venture operations in New York, New Jersey and California,
including
the scrap processing facilities, marine terminals and related ancillary
satellite sites, the interim New York City recycling contract,
and other
miscellaneous assets.
|
· |
The
assets and related liabilities of Hugo Neu Schnitzer Global Trade
that are
not related to the Russian and Baltic region trading
business.
|
As
described above, the separation resulted in the exchange of the joint venture
interests, as well as cash and other assets, to provide for an equitable
division. The agreement provides for potential purchase price adjustments
based
on the closing date working capital of the acquired Hawaii business as well
as
the joint ventures’ ending balances. The Company has not determined whether any
purchase price adjustment will be necessary.
SCHNITZER
STEEL INDUSTRIES, INC.
On
October 31, 2005, the Company purchased substantially all of the assets of
Regional for $65.5 million in cash and the assumption of certain liabilities.
Regional operates 10 metals recycling facilities located in the states of
Georgia and Alabama which process ferrous and nonferrous scrap metals without
the use of shredders.
Auto
Parts Business. On
September 30, 2005, the Company acquired GreenLeaf, five properties previously
leased by GreenLeaf and certain GreenLeaf debt obligations. GreenLeaf currently
operates its full-service auto dismantling business in one wholesale sales
office and 19 commercial locations throughout the United States. Total purchase
price for the acquisition was $44.7 million, subject to post-closing
adjustments. This acquisition may have a modestly dilutive to neutral effect
on
earnings in fiscal 2006 as the conversion process is executed, but is expected
to provide earnings growth in future years.
Management
believes that the HNC joint venture separation and termination and the Regional
and GreenLeaf acquisitions position the Company well as it continues to execute
its growth strategy. Consideration
for these recently acquired businesses was funded by the Company’s cash balances
on hand and borrowings under its bank credit facility. The Company has recorded
estimated environmental liabilities as a result of due diligence performed
in
connection with these acquisitions. See Note 5 to the condensed consolidated
financial statements for further information regarding
contingencies.
SCHNITZER
STEEL INDUSTRIES, INC.
Results
of Operations
The
Company’s revenues and operating results by business segment are summarized
below (in thousands):
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
|
|
(as
restated)
|
|
|
|
REVENUES:
|
|
|
|
|
|
Metals
Recycling Business:
|
|
|
|
|
|
Ferrous
|
|
$
|
208,227
|
|
$
|
126,832
|
|
Nonferrous
|
|
|
31,526
|
|
|
15,654
|
|
Other
|
|
|
1,677
|
|
|
2,046
|
|
Total
Metals Recycling Business
|
|
|
241,430
|
(1)
|
|
144,532
|
|
|
|
|
|
|
|
|
|
Auto
Parts Business
|
|
|
45,922
|
|
|
23,386
|
|
Steel
Manufacturing Business
|
|
|
89,156
|
|
|
70,022
|
|
Intercompany
revenue eliminations
|
|
|
(35,277
|
)
|
|
(38,979
|
)
|
Total
revenues
|
|
$
|
341,231
|
|
$
|
198,961
|
|
|
|
|
|
|
|
|
|
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
|
|
(as
restated)
|
|
|
|
OPERATING
INCOME:
|
|
|
|
|
|
Metals
Recycling Business
|
|
$
|
12,002
|
(1)
|
$
|
33,788
|
(2)
|
Auto
Parts Business
|
|
|
7,737
|
|
|
7,048
|
|
Steel
Manufacturing Business
|
|
|
16,070
|
|
|
12,760
|
|
Joint
Ventures
|
|
|
1,732
|
|
|
20,464
|
|
Total
segment operating income
|
|
|
37,541
|
|
|
74,060
|
|
Corporate
expense
|
|
|
(19,479
|
)
|
|
(3,591
|
)
|
Intercompany
profit eliminations
|
|
|
(529
|
)
|
|
(3,163
|
)
|
Total
operating income
|
|
$
|
17,533
|
|
$
|
67,306
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
$
|
41,530
|
|
$
|
42,936
|
|
(1) |
The
Company elected to consolidate results of two of the businesses
acquired
through the HNC separation and termination agreement as though
the
transaction had occurred at the beginning of fiscal 2006. The increased
revenues and operating income that resulted from the election was
offset
by pre-acquisition interests, net of tax. See Note 4 to the condensed
consolidated financial statements.
|
(2) |
Includes
$500 thousand of environmental expenses related to the Hylebos
Waterway
project.
|
SCHNITZER
STEEL INDUSTRIES, INC.
The
following table summarizes certain selected operating data for the
Company:
|
|
For
the Three Months Ended
November
30,
|
|
|
|
2005
|
|
2004
|
|
|
|
(as
restated)
|
|
|
|
METALS
RECYCLING BUSINESS:
|
|
|
|
|
|
Average
Ferrous Recycled Metal Sales Prices ($/LT)(1)
|
|
|
|
Domestic
|
|
$
|
207
|
|
$
|
221
|
|
Export
|
|
$
|
204
|
|
$
|
245
|
|
Total
Processing
|
|
$
|
205
|
|
$
|
236
|
|
Trading
|
|
$
|
216
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
Ferrous
Domestic Sales Volume (LT, in thousands)(2)(3)
|
|
|
|
Processed
|
|
|
181
|
|
|
134
|
|
Brokered
|
|
|
31
|
|
|
42
|
|
Total
|
|
|
212
|
|
|
176
|
|
|
|
|
|
|
|
|
|
Ferrous
International Sales Volume (LT, in thousands)(3)
|
|
|
|
|
|
|
|
Processed
|
|
|
337
|
|
|
295
|
|
Trading
|
|
|
307
|
|
|
|
|
Total
|
|
|
644
|
|
|
295
|
|
|
|
|
|
|
|
|
|
Total
Ferrous Sales Volume (LT, in thousands)(2)(3)
|
|
|
856
|
|
|
471
|
|
|
|
|
|
|
|
|
|
Ferrous
Volumes Sold to Steel Manufacturing Business (LT, in
thousands)
|
|
|
154
|
|
|
159
|
|
|
|
|
|
|
|
|
|
Nonferrous
Sales Volumes (pounds, in thousands) (3)
|
|
|
50,000
|
|
|
29,400
|
|
|
|
|
|
|
|
|
|
STEEL
MANUFACTURING BUSINESS:
|
|
|
|
|
|
|
|
Average
Sales Price ($/ton) (1)
|
|
$
|
517
|
|
$
|
534
|
|
|
|
|
|
|
|
|
|
Finished
Steel Products Sold (tons, in thousands)
|
|
|
166
|
|
|
126
|
|
|
|
|
|
|
|
AUTO
PARTS BUSINESS
|
|
|
|
|
|
Number
of Self-Service Locations at End of Quarter
|
|
|
30
|
|
|
26
|
|
Number
of Full-Service Locations at End of Quarter(4)
|
|
|
19
|
|
|
|
|
(1)
Price
information is shown after a reduction for the cost of freight
incurred to
deliver the product to the customer.
|
(2)
Includes sales to the Steel Manufacturing Business.
|
(3)
The Company elected to consolidate results of two of the businesses
acquired through the HNC separation and termination agreement as
though
the transaction had occurred at the beginning of fiscal 2006 instead
of
the date of acquisition. As a result, ferrous volume increased
on a pro
forma basis by 490,000 tons and nonferrous volume increased by
18,000
pounds. See Note 1 to the condensed consolidated financial
statements.
|
(4)
Reflects the addition of GreenLeaf to the Auto Parts Business in
the first
quarter of fiscal 2006.
|
SCHNITZER
STEEL INDUSTRIES, INC.
First
Quarter Fiscal 2006 Compared to First Quarter Fiscal 2005
General.
The
first quarter of fiscal 2006 marked the beginning of the Company’s
transformation. The Company completed the separation and termination of its
joint ventures with HNC and closed two acquisitions, and as a result revenues
increased 72% compared to the first quarter of fiscal 2005. The Company began
the process of integrating the newly acquired businesses into its existing
operations during the first quarter of fiscal 2006. The Company also continued
on a major capital spending program to upgrade and replace infrastructure
and
equipment. The recent acquisitions and capital improvements are expected
to
provide long-term benefits, although management expects they will result
in some
short-term disruption to operations.
It
was
another strong quarter for the Steel Manufacturing Business and the Auto
Parts
Business. Compared to last year’s first quarter, operating results for the Steel
Manufacturing Business improved due to higher sales volumes primarily on
rebar
products. The Metals Recycling Business was impacted by a number of short
term
factors that reduced sales volumes and margins, and as a result, earnings
did
not reflect what the Company considers a normalized state of operations.
Operating income declined for the Metals Recycling Business as margins for
ferrous metals were compressed by lower selling prices, higher purchase costs
for unprocessed metal and lower export volumes at the Company’s previously owned
West Coast operations. The entities acquired as part of the HNC separation
and
termination, which were reported for the first time in the Metals and Recycling
Business segment, were impacted by low beginning inventories and a planned
production shutdown. Additionally, operating income from Joint Ventures
decreased by over 91% due to the elimination of the HNC joint ventures results
from this segment. As a result of the HNC joint venture separation and
termination, the Joint Venture segment will be eliminated and the results
for
the businesses acquired in this transaction, and other smaller joint ventures
will be consolidated into the Metals Recycling Business in future periods.
Finally, average segment margins are expected to decrease due to the Company’s
new trading business, has different characteristics and produces lower margins
than the processing business.
The
Company’s results of operations depend in large part on demand and prices for
recycled metals in world markets and steel products in the Western United
States. Beginning in fiscal 2004, and continuing into the first half of fiscal
2005, strong worldwide demand combined with a tight supply of recycled metals
created significant price volatility and drove the Metals Recycling Business’
average selling prices to unprecedented highs. Average selling prices for
recycled ferrous metals declined in the second half of fiscal 2005 due to
the
unsettled Asian markets, and continued to modestly decline in the first fiscal
quarter of 2006. In particular, the fluctuations of prices for recycled ferrous
metals have a significant impact on the results of operations for the Metals
Recycling Business and to a lesser extent on the Auto Parts
Business.
The
Auto
Parts Business purchases used and salvaged vehicles, sells parts from those
vehicles through its retail facilities and wholesale operations, and sells
the
crushed auto bodies to metal recyclers. On September 30, 2005, the Auto Parts
Business acquired GreenLeaf, which 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 newly acquired locations are in
Arizona, Florida, Georgia, Illinois, Massachusetts, Michigan, Nevada, North
Carolina, Ohio, Virginia, and Texas. As
the
Company integrates these stores with its existing business, some of the sites
will be converted to Pick-N-Pull’s self-service model, while others will remain
full-service or have combined operations. Two of the initial 22 acquired
locations have been closed, and a third is a wholesale sales office. This
acquisition is expected to have a modestly dilutive to neutral effect on
earnings in fiscal 2006 as the conversion process is executed, but is
anticipated to provide earnings growth in future years.
SCHNITZER
STEEL INDUSTRIES, INC.
Prior
to
the GreenLeaf acquisition, the Auto Parts Business had existing operations
in
nine states and two Canadian provinces that achieved an annual pace of more
than
four million paid customer admissions per year. As a result of the Greenleaf
acquisition and the acquisition of four self-service auto parts stores in
January 2005, the Auto Parts Business has increased revenue by 128% for the
first fiscal quarter of 2006 as compared to the same period last year. For
both
the full-service and self-service business, revenues for the wholesale product
lines are principally affected by commodity metal prices. The Auto Parts
Business also benefited from improved pricing for crushed auto bodies as
compared to the fourth quarter of last year, which was partially offset by
higher purchase prices for those vehicles. The self-service retail operations
are somewhat seasonal and affected by weather conditions and promotional
events.
Since the stores are open to the natural elements, during periods of prolonged
wet, cold or extreme heat, the retail business tends to slow due to the
difficult working conditions for customers. As a result, the Company’s first and
third fiscal quarters tend to generate the greatest retail sales and the
second
and fourth fiscal quarters are slower for these operations.
Average
net selling prices for the finished steel products of the Steel Manufacturing
Business declined 3% compared to the first quarter of fiscal of 2005. Customer
demand for steel products on the West Coast is good, and average prices remain
strong by historical standards, increasing 5% from the fourth quarter of
fiscal
2005. However, there has been an increase in the amount of imported wire
rod
which has lower selling prices than the Company’s comparable products being
delivered on the West Coast.
Revenues.
Consolidated revenues for the quarter ended November 30, 2005 increased $142.3
million, or 72%, to $341.2 million from $199.0 million in the first quarter
of
fiscal 2005. Revenues in the first quarter of fiscal 2006 increased for all
Company business segments. The Metals Recycling Business revenue increased
primarily as a result of the businesses acquired in HNC separation and
termination, and the acquisition of Regional. Although there continues to
be a
strong demand in the worldwide metals markets for scrap metals, the fourth
fiscal quarter of 2005 was affected by the unsettled Asian market and this
condition continued into the first fiscal quarter of 2006. The Auto Parts
Business benefited from the acquisition of GreenLeaf in September 2005 and
four
newly acquired self-service stores in January 2005, increased prices for
auto
bodies and higher revenues from sales of cores. The Steel Manufacturing Business
benefited from the strong West Coast demand, which led to higher selling
prices
for finished steel products and higher sales volumes.
The
Metals Recycling Business generated revenues of $241.4 million for the
quarter
ended November 30, 2005,
before
intercompany eliminations, an increase of $96.9 million, or 67%, over the
same
period of the prior year. Ferrous revenues increased $81.4 million, or 64%,
to
$208.2 million. This increase was caused by higher sales volume provided
by the
newly acquired businesses, which added revenue of approximately $136.1 million,
and was partially offset by an approximately $39.2 million decline in revenues
from the Company’s previously owned West Coast recycled metals facilities due to
the timing of shipments and lower average net selling prices. Total
ferrous sales volume increased 385,000 tons, or 82%, to 856,000 tons over
the
prior year first quarter, which was primarily due to the newly acquired
businesses in the Southeast and Northeast as well as the addition of Schnitzer
Global Exchange trading volume. This increase in volume was offset by a 13%
decrease in the average processing net sales price to $205 per ton. The freight
that is included in revenue increased $1.9 million compared with the prior
year
first quarter, primarily due to the increased volumes. The
entities acquired as part of the HNC separation and termination, which were
reported for the first time in the Metals and Recycling Business segment,
were
impacted by low beginning inventories and a planned production shutdown.
Sales
to
the Steel Manufacturing Business decreased 5,400 tons, or 3%, to 154,000
tons,
while other domestic sales increased from 17,000 tons in the first fiscal
quarter of 2005 to 58,000 tons in the same quarter of this year as a result
of
the Regional acquisition. Regional
is situated in a growing recycled metals market in the Southeastern United
States, which is home to many automobile and auto parts manufacturers. Regional
sells its ferrous metal to domestic steel mills in its area, of which there
are
approximately 23.
SCHNITZER
STEEL INDUSTRIES, INC.
Revenue
from nonferrous metal sales increased $15.9 million, or 101%, over the prior
year first quarter, which was the result of a $0.09, or 17%, increase in
average
net sales price to $0.62 per pound and 20.7 million pounds, or 70%, increase
in
pounds shipped. Total nonferrous shipped for the first fiscal quarter of
2006
was 50.0 million pounds. The increase in sales price per pound was a
result of 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,
which
accounted for an additional 18.3 million pounds sold in the first quarter
of
fiscal 2006. 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 Company’s shredders.
The
Auto
Parts Business generated revenues of $45.9 million, before intercompany
eliminations, for the quarter ended November 30, 2005, an increase of $22.5
million, or 96%, over the same period of the prior year. This increase in
revenues was primarily due to the acquisition of GreenLeaf in September 2005.
Revenues also increased as a result of higher wholesale revenues driven by
higher average sales prices for scrapped auto bodies and higher revenues
from
sales of cores.
The
Steel
Manufacturing Business generated revenues of $89.2 million for the quarter
ended
November 30, 2005, an increase of $19.1 million,
or 27%, over the prior year quarter. Sales volumes in the first fiscal quarter
of 2006 increased 31% to 166,000 tons over the same period last
year, increasing
revenues by $21.4 million, partially due to strong demand for rebar products.
Additionally, during the first quarter of fiscal 2005, customers reduced
purchases of steel in an effort to reduce inventories on hand. By contrast,
during the first quarter of fiscal 2006, customers were buying steel to replace
inventories, and consumption of steel was strong. The average net selling
price
decreased $17 per ton, or 3%, to $517 per ton, which resulted in decreased
revenue of $2.8 million as compared to record high prices in the first fiscal
quarter of 2005.
However,
average selling prices during the first quarter of fiscal 2006 were 5% higher
than the fourth quarter of fiscal 2005, reflecting several price increases
announced earlier in the quarter. The decrease in average net selling prices
compared to the first quarter of the prior year was due to a stabilization
of
the market after a number of price increases caused by increased steel
consumption.
Cost
of Goods Sold.
Consolidated cost of goods sold increased $144.9 million, or 103%, for the
quarter
ended November 30, 2005,
compared with the same period last year. Cost of goods sold increased as
a
percentage of revenues from 70% to 84%.
Cost
of
goods sold for the Metals Recycling Business increased $112.5 million, or
106%,
to $219.0 million compared to the first fiscal quarter of 2005. As a percentage
of revenues, cost of goods sold increased compared with the prior year quarter
from 74% to 91%. The increase in cost of goods sold was primarily attributable
to the recent HNC separation and termination and the Regional acquisition,
as
these businesses operate in different markets and are currently experiencing
narrower margins than the Company’s historical West Coast business. The margin
variations for these businesses are due, in part, to differing markets for
materials in the regions in which they operate, higher operating expenses
due to
the costs of integration and restructuring, higher freight costs to access
certain foreign markets and the lower margins generally inherent in the Global
Exchange trading business. Additionally, in the first quarter of fiscal 2006,
strong domestic demand for unprocessed metals caused purchase prices to rise
at
a time of declining export sales prices, resulting in narrowing margins.
While
Schnitzer Global Exchange, the Company’s new trading business, provides
increased revenues, the associated trading margins are lower than the historical
Metals Recycling Business. Although the Company attempts to maintain and
grow
margins by responding to changing recycled metals selling prices through
adjustments to its metals purchase prices, the Company’s ability to do so in the
trading business is particularly limited by competitive and other market
factors. In addition, East Coast processing volumes were negatively impacted
by
a two-month shutdown of the Rhode Island shredder to install a new, more
efficient, and environmentally friendly shredder motor as well as low beginning
inventories at all the New England yards. The lower processing volumes
contributed to higher processing costs, which caused the East Coast operations
to record a small loss for the quarter.
SCHNITZER
STEEL INDUSTRIES, INC.
Cost
of
goods sold for the Auto Parts Business increased $15.4 million, or 115%,
compared to the fiscal 2005 first quarter. As a percentage of revenues, cost
of
goods sold increased compared with the prior year quarter from 57% to 63%.
The
higher cost of goods sold was primarily due to the acquisition of GreenLeaf
in
September 2005 and four self-service stores in January 2005, but also due
to
higher car purchase costs that resulted from higher unprocessed metal prices,
as
GreenLeaf typically purchases newer vehicles resulting in a higher purchase
price and lower margins as compared to the older model vehicles that Pick-N-Pull
purchases. During the quarter, the operations acquired in the GreenLeaf
transaction recorded a slight loss as the Company began the process of
integrating GreenLeaf’s operations into the Auto Parts Business’
operations.
Cost
of
goods sold for the Steel Manufacturing Business increased $15.9 million,
or 28%,
as compared to the fiscal 2005 first quarter. As a percentage of revenues,
cost
of goods sold increased slightly compared with the prior year quarter from
80%
to 81%. Average cost of goods sold per ton decreased $10 per ton, or 2%,
compared to the prior year quarter, which was primarily caused by lower raw
material costs for recycled metal and alloys and improved productivity, which
were offset by higher energy costs. The overall increase in cost of goods
sold
was primarily caused by a 31% increase in sales volume. The Steel Manufacturing
Business continues to see the benefits from the new furnace installed at
its
mini-mill last year, production incentives recently negotiated with the
steelworkers union and other improvements in business practices. As a result,
the increased production volumes and lower cost per ton of producing steel
more
than offset a $17 per ton decrease in average selling prices.
Selling,
General and Administrative Expense. Compared
with the first quarter of fiscal 2005 selling, general and administrative
expense for the same quarter this fiscal year increased $28.5 million, or
240%,
to $40.3 million. As a percentage of revenues, selling, general and
administrative expense increased by 6% percentage points, from 6% to 12%.
A
significant portion of the increase, $11.0 million, was attributed to the
acquisitions that took place in the first quarter of fiscal 2006 that nearly
doubled the Company’s revenue. The increase in selling, general and
administrative expense was also due, in part, to the charge associated with
the
reserve of $11.0 million related to the penalties that the Company estimates
will be imposed by the DOJ and the SEC in connection with the past payment
practices in Asia discussed in Note 5 to the condensed consolidated financial
statements. Other significant increases included higher legal, accounting
and
professional fees of $2.2 million, which includes $1.5 million related to
the
Audit Committee’s investigation of past payment practices in the Asia as
discussed in Note 5 to the condensed consolidated financial statements, and
the
adoption of FAS 123(R) in fiscal 2006, which resulted in stock based
compensation expense of $0.5 million.
Other
Income (Expense). The
Company recorded a gain of $54.6 million which arose from the HNC separation
and
termination. Based on the values determined by the valuations 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 Notes 1 and 4 to the condensed
consolidated financial statements.
Interest
Expense. Interest
expense for the first quarter of fiscal 2006 increased by $0.2 million, or
53%,
to $0.4 million compared with the first quarter of fiscal 2005. The increase
was
a result of higher average debt balances and an increase in the loan rate during
the fiscal 2006 first quarter compared with the fiscal 2005 first quarter.
For
more information, see Note 6 to the condensed consolidated financial statements.
SCHNITZER
STEEL INDUSTRIES, INC.
Income
Tax Provision.
The tax
rate for the first quarter of fiscal 2006 was 42.9%, compared to a 34.8%
rate
for the same quarter last year. The rate was higher as a direct result of
the
$11.0 million charge associated with the investigation reserve recorded as
a
result of the DOJ and SEC investigation. At the end of the investigation,
the
Company will be able to determine the extent of the tax deductible portion
if
any, of the reserve, which currently is anticipated to be nondeductible.
During
the first quarter of fiscal 2006, the Company recorded a gain of $54.6 million
which arose from the HNC separation and termination. Based on the values
determined by the valuations 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. The tax
on
the gain was recorded using a 38% effective tax rate.
Liquidity
and Capital Resources
Certain
items within the consolidated statements of cash flows have been
restated. See Note 1 to the condensed consolidated financial statements
for details of the restatements. Cash
provided by operations for the three months ended November 30, 2005 was $31.3
million, compared with $38.2 million for the same period in the prior fiscal
year. Cash provided by operating activities was primarily related to net
income,
accounts receivable, prepaid expenses and other
current assets, accrued liabilities and the change in equity
accounting for the joint ventures association with the HNC separation and
termination agreement, which is offset by the gain on the disposition of
the
joint ventures, the change in deferred income taxes and increases in accounts
payable.
Capital
expenditures for the three months ended November 30, 2005 were $15.8 million
compared with $7.5 million during the first three months of fiscal 2005.
The
increase was due to capital improvement projects at the Company’s Portland,
Oregon recycling facility related to dock repairs and preparation for the
installation of a mega-shredder, as well as other operational improvements
at
the Oakland and Sacramento, California recycling facilities and a number
of
store remodels and equipment upgrades at the Auto Parts Business locations.
The
Company expects to spend approximately $75.0 million on capital improvement
projects during the remainder of fiscal 2006. Additionally, the Company
continues to explore other capital projects that will provide productivity
improvements and add shareholder value.
As
a
result of the Regional and GreenLeaf acquisitions the Company entered into
during the first fiscal quarter of 2006, the Company had higher borrowings
under
the credit facility of $78.2 million. In addition, these transactions resulted
in investments in acquisitions, net of cash acquired of $85.6
million.
Accrued
environmental liabilities as of November 30, 2005 were $45.4 million, which
increased since August 31, 2005 by $21.9 million due to the acquisitions
discussed in Note 4 and were partially offset by spending charged against
the
environmental reserve. During the next 12 months, the Company expects to
pay
approximately $6.9 million relating to previously accrued remediation projects,
including the remediation on the Hylebos Waterway located in the State of
Washington as discussed in Note 5 to the condensed consolidated financial
statements. Additionally, the Company anticipates future cash outlays as
it
incurs the actual cost relating to the remediation of identified environmental
liabilities. The future cash outlays are anticipated to be within the amounts
established as environmental liabilities.
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 new agreement provides for
a
five-year, $400.0 million revolving loan maturing in November 2010. The
agreement prior to restatement provided for a $150.0 million revolving loan
maturing in May 2006. Interest on outstanding indebtedness under the restated
agreement is based, at the Company’s option, on either 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 Company’s 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 Company’s leverage ratio. The restated
agreement contains various representations and warranties, events of default
and
financial and other covenants, including covenants requiring maintenance
of a
minimum fixed charge
SCHNITZER
STEEL INDUSTRIES, INC.
coverage
ratio and a maximum leverage ratio. The
Company also has an additional unsecured credit line totaling $10.0 million,
which is uncommitted. This additional debt agreement also has certain
restrictive covenants. As of November 30, 2005, the Company had aggregate
borrowings outstanding under its credit facilities of $86.0 million. As a
result
of the restatement, as discussed in Note 1 to the consolidated financial
statements, the Company was not in compliance with their restrictive covenants.
As such, a waiver was obtained from the lender, dated July 27, 2006, to waive
any events of default provided the Company delivers it financial statements
to
the lender on or before September 8, 2006.
In
July
2002, the Company’s metals recycling joint ventures with HNC entered into a
revolving credit facility (JV Credit Facility) with a group of banks for
working
capital and general corporate purposes. During February 2004, the facility
was
increased to $110.0 million.
Upon
the
closing of the agreement for the separation and termination of the Company’s
joint ventures with HNC
on
September 30, 2005, as described in Note 4 of the condensed consolidated
financial statements, HNC paid the Company $52.3 million in cash. The Company
also received approximately $1.4 million for previously undistributed earnings
of the joint ventures net of the Company’s share of outstanding borrowings under
the JV Credit Facility as of that date. Following such earnings distributions,
the Company and HNC each were obligated to repay the portion of the JV Credit
Facility borrowed on behalf of the joint venture businesses it acquired in
the
transaction. The outstanding balance was paid off and the JV Credit Facility
was
terminated and repaid upon closing of the separation and termination agreement
on September 30, 2005.
On
September 30, 2005, the Company acquired GreenLeaf, five store properties
leased
by GreenLeaf and certain GreenLeaf debt obligations. Total consideration
for the
acquisition was $44.7 million, subject to post-closing adjustments.
On
October 31, 2005, the Company acquired substantially all of the assets of
Regional, a metal recycling business with ten facilities located in Georgia
and
Alabama. The purchase price was $65.5 million in cash and the assumption
of
certain liabilities.
The
increase in borrowings outstanding since August 31, 2005 was primarily the
result of the acquisitions that occurred in the first quarter of fiscal
2006.
The
Company makes contributions to a defined benefit pension plan, several defined
contribution plans and several multiemployer pension plans. Contributions
vary
depending on the plan and are based upon plan provisions, actuarial valuations
and negotiated labor agreements. The Company anticipates making contributions
of
approximately $5.0 million to the various benefit plans in fiscal
2006.
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 fiscal 2004 and 2005, the Company made significant
investments in capital equipment and completed several acquisitions to both
grow
the business and enhance shareholder value. The Company is currently engaged
in
a growth strategy to enhance shareholder value. Pursuant to a stock repurchase
program approved in 1996, the Company is authorized to repurchase up to 3.0
million shares of its stock when the market price of the Company’s stock is not
reflective of management’s opinion of an appropriate valuation of the stock.
During the first three months of fiscal 2006, the Company made no share
repurchases. As of November
30, 2005,
the
Company had repurchased a total of 1.3 million shares under this
program.
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 next twelve months. In the longer term, the Company may
seek
to finance business expansion with additional borrowing arrangements or
additional equity financing.
SCHNITZER
STEEL INDUSTRIES, INC.
Outlook
The
company said the factors that will affect its results in
the
second quarter of 2006 include:
Metals
Recycling Business
Pricing:
The
uncertainty in the Asian export markets that was experienced beginning in
the
second half of last year and into the first quarter of 2006 is expected to
continue through the second quarter. Domestic markets are expected to remain
stronger than export markets. Sales orders completed in the early part of
the
second quarter would indicate an average price per ton of between $185 and
$195.
The
Company has seen recent evidence of declines in scrap acquisition costs which
are greater than the declines in export sales prices, providing the potential
for improved margins.
The
Russian and Baltic region trading business generally purchases inventory
in
advance of making sales, has a lower overall margin on sales than the domestic
metals processing business and thus can be impacted by small changes in price
between the time of purchase and sale. During the second quarter, the trading
business is expected to sell inventory that is valued higher than the current
market price. As a result, margins related to these sales are expected to
be
negative, absent strengthening of the market.
Sales
volumes: Ferrous
scrap volumes in the domestic processing business are expected to rebound
in the
second quarter, primarily due to the timing of export orders. For the second
quarter, volumes shipped from the Company’s domestic yards should increase from
approximately 660,000 tons in the first quarter to between 800,000 and 850,000
tons.
Sales
volumes in the Russian and Baltic region trading business are expected to
decline approximately 40% from the first quarter to 175,000 tons. In addition
to
the impact of normal seasonable winter shipping conditions, lower market
prices
for scrap metal has significantly reduced the availability of processed metal
available for purchase from Russia and the Baltic region.
For
the
year, the Company expects sales volumes to be approximately 3.5 million tons
in
the domestic processing business and 1.0 million tons in the Russian and
Baltic
region trading business.
Auto
Parts Business
Retail
demand in the self-service Auto Parts Business is affected by seasonal changes,
with inclement winter weather in the second quarter expected to depress customer
traffic and result in lower revenues when compared with the first quarter.
For
the second quarter, margins are expected to be affected by lower selling
prices
for scrapped cars and a high cost basis of cars sold from existing inventory
compared to the second quarter of 2005.
The
integration of GreenLeaf’s operations is expected to result in the conversion of
one full-service location to a self-service store toward the end of the second
quarter. The GreenLeaf operation is expected to post a modest loss during
the
quarter.
Steel
Manufacturing Business
Pricing:
West
Coast consumption of finished steel long products continues to remain strong,
and the Company is seeing good demand for rebar and merchant bar. Based on
current market conditions, the Company expects average prices for the second
quarter to be slightly higher than both the first quarter of this year and
the
second quarter of last year. Higher prices on the West Coast relative to
other
markets could, however, result in an increase of foreign imports, putting
downward pressure on pricing.
SCHNITZER
STEEL INDUSTRIES, INC.
Volumes:
The
Company typically sees a reduction in second quarter sales volumes due to
the
impact of winter weather on construction projects. However, this year customer
inventories remain low and the Company expects demand to remain good through
the
quarter. As a result, second quarter sales volumes should be significantly
higher than during the second quarter of 2005, but lower than the volumes
in the
first quarter of this year.
Factors
That Could Affect Future Results
This
Form
10-Q, including Item 2 “Management’s 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, 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 Company’s
outlook for the business, and can be identified generally 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 Company’s products and
raw materials it purchases; world economic conditions; world political
conditions; changes in federal and state income tax laws; 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 complete expected large scrap export shipments
in
the current quarter; consequences of the pending investigation by the Company’s
audit committee into past payment practices in Asia; business integration
issues
relating to acquisitions of businesses and the separation of the joint venture
business described above; and business disruptions resulting from installation
or replacement of major capital assets, as discussed in more detail under
the
heading “Factors That Could Affect Future Results” in the Company’s 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 Company’s forward-looking statements.
Consequently, the reader should not consider any such list to be a complete
statement of all potential risks or uncertainties. The Company does not assume
any obligation to update any forward-looking statement.
Examples
of factors affecting the Company that could cause actual results to differ
materially are the following:
Cyclicality
and General Market Considerations: Purchase
and selling prices for recycled metals are highly cyclical in nature and
subject
to worldwide economic conditions. In addition, the cost and availability
of
recycled metals are subject to global supply and demand conditions which
are
volatile and beyond the Company’s control, resulting in periodic fluctuations in
recycled metals prices and working capital requirements. While the Company
attempts to maintain and grow margins by responding to changing recycled
metals
selling prices through adjustments to its metals purchase prices, the Company’s
ability to do so is limited by competitive and other market factors.
Additionally, changing prices could potentially impact the volume of recycled
metal available to the Company, the subsequent volume of processed metal
sold by
the Company, inventory levels and the timing of collections and levels relating
to the Company’s accounts receivable balances. Moreover, increases in recycled
metals selling prices can adversely affect the operating results of the
Company’s Steel Manufacturing Business because increases in steel prices
generally lag increases in ferrous recycled metals prices.
The
steel
industry is also highly cyclical in nature and sensitive to general economic
conditions. Future economic downturns or a stagnant economy may adversely
affect
the performance of the Company.
SCHNITZER
STEEL INDUSTRIES, INC.
The
Company expects to continue to experience seasonal fluctuations in its revenues
and net income. Revenues can fluctuate significantly quarter to quarter due
to
factors such as the seasonal slowdown in the construction industry, which
is an
important buyer of the Company’s finished steel products. Weather and economic
conditions in the United States and abroad can also cause fluctuations in
revenue and net income.
Another
factor which may affect revenues relates to the seasonal reduction in demand
from foreign customers who tend to reduce their finished steel production
and
corresponding scrap metal requirements, during the summer months to offset
higher energy costs.
The
Company makes a number of large ferrous recycled metals shipments to foreign
steel producers each year. Customer requirements, shipping schedules and
other
factors limit the Company’s control over the timing of these shipments.
Variations in the number of foreign shipments from quarter to quarter will
result in fluctuations in quarterly revenues and earnings. The Company’s
expectations regarding ferrous metal sales prices and volumes, as well as
earnings, are based in part on a number of assumptions which are difficult
to
predict (for example, uncertainties relating to customer orders, metal
availability, estimated freight rates, ship availability, cost and volume
of
unprocessed inventory and production output, etc.).
As
a
percentage of revenue, the Auto Parts Business’ wholesale sales, including sales
of auto bodies as well as cores, such as engines, transmissions, alternators
and
other nonferrous metals, have continued to grow in the past few years. Due
to
the nature of the wholesale business, which is more closely tied to the prices
for recycled metals, the Auto Parts Business’ results are increasingly subject
to the volatility in the global recycled metals market more than they had
been
historically.
The
Auto
Parts Business experiences modest seasonal fluctuations in demand. The retail
stores are open to the elements. During periods of extreme temperatures and
precipitation, customers tend to delay their purchases and wait for milder
conditions. As a result, retail sales are generally higher during the spring
and
fall of each calendar year and lower in the winter and summer
months.
Additionally,
the Auto Parts Business is subject to a number of other risks that could
prevent
it from maintaining or exceeding its current levels of profitability, such
as
volatile supply and demand conditions affecting prices and volumes in the
markets for its products, services and raw materials; environmental issues;
local and worldwide economic conditions; increasing competition; changes
in
automotive technology; the ultimate success of the Company’s growth and
acquisition plans; ability to build the infrastructure to support the Company’s
growth plans; and integration issues of the full-service business
model.
Backlog:
Historically,
the Company has generally entered into export ferrous sales contract by selling
forward 60 to 90 days. The backlog of sales contracts, coupled with knowledge
of
the price at which the processed material will be sold and the costs involved
in
processing the metals, allows the Company to take advantage of this differential
in timing between purchases and sales and negotiate prices with suppliers
that
secure profitable sales transactions. As the difference in timing between
the
date the sales contracts are executed and the date of shipment grows shorter,
it
reduces the ability to manage the purchase price of raw material against
the
future sales price. The timing of forward contracts may impact the Company’s
revenue on a quarter-to-quarter basis as well as profitability on export
shipments of ferrous metals.
SCHNITZER
STEEL INDUSTRIES, INC.
Competition:
The
recycled metals industry is highly competitive, with the volume of purchases
and
sales subject to a number of competitive factors, principally price. The
Company
competes with both large and numerous smaller companies in its markets for
the
purchase of recyclable metals. The Company also competes with a number of
domestic and foreign recycled metals processors and brokers for processed
and
unprocessed metal as well as for sales to domestic and foreign customers.
For
example, in 2001 and 2002, lower cost ferrous recycled metals supplies from
certain foreign countries adversely affected market selling prices for ferrous
recycled metals. Since then, many of these countries have imposed export
restrictions which have significantly reduced their export volumes and lowered
the worldwide supply of ferrous recycled metals. These restrictions are believed
to have had a positive effect on the Company’s selling prices. Given the
intricacies in which the global markets operate, the Company cannot predict
when
or if foreign countries will change their trading policies and what effect,
if
any, such changes might have on the Company’s operating results.
From
time
to time, both the United States and foreign governments impose regulations
and
restrictions on trade in the markets in which the Company operates. In the
second quarter of fiscal 2005, the Company received a certificate from China
that allows the Company to continue shipping recycled metals into China.
The
certificate is part of a process designed to ensure safe industrial and
agricultural production in China. Also, it is not unusual for various
constituencies to petition government entities to impose new restrictions
or
change current laws. If imposed, these restrictions could affect the Company’s
margins as well as its ability to ship goods to foreign customers.
Alternatively, restrictions could also affect the global availability of
ferrous
recycled metals, thereby affecting the Company’s volumes and margins. As a
result, it is difficult to predict what, if any, impact pending or future
trade
restrictions will have on the operations of the Company.
For
the
Metals Recycling Business, some of the more significant domestic competitors
include regional steel mills and their brokers who compete for recycled metal
for the purpose of providing the mills with feedstock to produce finished
steel.
During periods when market supplies of metal are in short supply, these buyers
may, at times, react by raising buying prices to levels that are not reasonable
in relation to more normal market conditions. As a result, the Company may
have
to raise its buying prices to maintain its production levels which may result
in
compressed margins.
The
Auto
Parts Business competes with both full-service and self-service auto dismantlers
as well as larger well financed more traditional retail auto parts chains
for
retail customers. Periodically, the Auto Parts Business increases prices,
which
may affect customer flow and buying patterns. Additionally, in markets where
the
Company has one or only a few stores it does not have the same pricing power
it
experiences in markets where it has multiple locations. As this segment expands,
the Company may experience new competition from others attempting to replicate
the Company’s business model. The ultimate impact of these dynamics cannot be
predicted. Also, the business competes for its automobile inventory with
other
dismantlers, used car dealers, auto auctions and metal recyclers. Inventory
costs can fluctuate significantly depending on market conditions and prices
for
recycled metal.
The
domestic steel industry also is highly competitive. Steel prices can be highly
volatile and price is a significant competitive factor. The Company competes
domestically with several steel producers in the Western United States for
sales
of its products. In recent years, the Company has experienced significant
foreign competition, which is sometimes subsidized by large government agencies.
There can be no assurance that such competition will not increase in the
future.
In the spring of 2002, the U.S. Government imposed anti-dumping and
countervailing duties against wire rod products from eight foreign countries.
However, there are other countries that import wire rod products where the
imports are not subject to duties. These duties have assisted the Company
in
increasing sales of wire rod products; any expiration or termination of the
duties could have a corresponding adverse effect. The Company has experienced
increased competition for certain products by foreign importers during fiscal
2005 and 2006. The Company believes that the rise in import levels is
attributable to the increase in selling prices in the West Coast market,
which
potentially allow the import sales to be more profitable to the foreign
companies.
SCHNITZER
STEEL INDUSTRIES, INC.
The
steel
manufacturing industry has been consolidating over the last several years
and as
a result one West Coast manufacturing facility has been closed and remains
idle.
Any future start-up of operations of the currently idle facilities could
negatively impact the Company’s recycled metal and finished steel markets,
prices, margins and potentially, cash flow.
In
general, given the unprecedented profitability levels of the Company and
other
recycled metals and steel companies over the last two years, competitors
may be
attracted to the Company’s markets, which may adversely affect the Company’s
ability to protect its profit margins.
Geographical
Concentration:
The
Company competes in the scrap metal business through its Metals Recycling
Business. Over the last few years, a significant portion of the revenues
and operating profits earned by this business has been generated from sales
to
Asian countries, principally China and South Korea. In addition, the
Company’s sales in these countries are also concentrated with relatively few
customers that vary depending on buying cycles and general market
conditions. The Company’s sales have expanded to a broader geographic area
with recent business acquisitions. As always, a significant change in buying
patterns, change in political events, change in regulatory requirements,
tariffs
and other export restrictions within the United States or these foreign
countries, severe weather conditions or general changes in economic conditions
could adversely affect the financial results of the Company.
Pending
Investigation: As
discussed in Part
II,
Item 1 “Legal Proceedings” and Note 5 to the consolidated financial
statements,
the
Board of Directors authorized the Audit Committee to engage independent counsel
and conduct a thorough, independent investigation of the Company’s past practice
of making improper payments to the purchasing managers of customers in Asia
in
connection with export sales of recycled ferrous metals. The Board of Directors
also authorized and directed that the existence and the results of the
investigation be voluntarily reported to the U.S. Department of Justice (DOJ)
and the Securities and Exchange Commission (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 August 23, 2005, the Company
received from the SEC a formal order of investigation related to the independent
investigation. The Audit Committee is continuing its independent investigation.
The Company, including the Audit Committee, continues to cooperate fully
with
the DOJ and the SEC. The investigations of the Audit Committee, the DOJ and
the
SEC of the Company’s past practice of making improper payments are not expected
to affect the Company’s previously reported financial results. However, the
Company expects to enter into agreements with the DOJ and the SEC to resolve
the
above-referenced matters and believes that it is probable that DOJ and the
SEC
will impose penalties on, and require disgorgement of certain profits by,
the
Company as a result of their investigations. The Company estimates that
the total amount of these penalties and disgorgement will be within a range
of
$11.0 million to $15.0 million. In the first fiscal quarter of 2006, the
Company
established a reserve totaling $11.0 million in connection with this estimate.
The precise terms of any agreements to be entered into with the DOJ and the
SEC,
however, remain under discussion with these two agencies. The Company,
therefore, cannot predict with certainty the final outcome of the aforementioned
investigations or whether the Company or any of its employees will be subject
to
any additional remedial actions following completion of these investigations.
It
is also possible that these investigations could lead to criminal charges,
civil
enforcement proceedings and civil lawsuits.
Union
Contracts:
The
Company has a number of union contracts, several of which were recently
re-negotiated, including the contract covering the Company’s Steel Manufacturing
Business. If the Company is unable to reach agreement on the terms of new
contracts with any of its unions during future negotiations, the Company
could
be subject to work slowdowns or work stoppages.
SCHNITZER
STEEL INDUSTRIES, INC.
Post
Retirement Benefits: The
Company has a number of post retirement benefit plans that include defined
benefit, Supplemental Executive Retirement Benefit Plan (SERBP) and
multiemployer plans. The Company’s contributions to the defined benefit and
SERBP plans are determined by actuarial calculations which are based on a
number
of estimates including the expected long-term rate of return on plan assets,
allocation of plan assets between equity or fixed income investments, expected
rate of compensation increases as well as other factors. Changes in these
actual
rates from year to year cause increases or decreases in the Company’s annual
contributions into the defined benefit plans and changes to the expenses
recognized in a current fiscal year. Management and the actuary evaluate
these
rates annually and adjust if necessary.
The
Company’s union employees participate in a number of multiemployer pension
plans. The Company is not the sponsor or administrator of these multiemployer
plans. Contributions are determined in accordance with provisions of the
negotiated labor contracts.
The
Company learned during fiscal 2004 that one of the multiemployer plans of
the
Steel Manufacturing Business would not meet Employee Retirement Income Security
Act of 1974 minimum funding standards for the plan year ending September
30,
2004. The trustees of that plan have applied to the Internal Revenue Service
(IRS) for certain relief from this minimum funding standard. The IRS has
tentatively responded, indicating a willingness to consider granting the
relief,
provided the plan’s contributing employers, including the Company, agree to
increased contributions. The increased contributions are estimated to average
6%
per year, compounded annually, until the plan reaches the funding status
required by the IRS. These increases would be based on the Company’s current
contribution level to the plan of approximately $1.7 million per year.
Based
on
commitments from the majority of employers participating in the Plan to make
the
increased contributions, the Plan Trustees have proceeded with the relief
request, and are awaiting formal approval from the IRS.
Absent
relief by the IRS, the plan’s contributing employers will be required to make
additional contributions or pay excise tax that may equal or exceed the full
amount of the funding deficiency. The Company estimated its share of the
required additional contribution for the 2004 plan year to be approximately
$1.1
million and accrued for such amount in fiscal 2004. Future funding deficiency
assessments against the Company are possible until the multiemployer plan
obtains a waiver from the IRS or the plan reaches the minimum funded status
level required by the IRS.
Recently
Acquired Businesses and Future Business Acquisitions:
As
discussed in Note 4 - Business Combinations, the Company recently completed
transactions to separate and terminate its metals recycling joint venture
relationships with HNC and to purchase Regional and GreenLeaf. With the
separation of the joint ventures, the Company acquired direct ownership of
metals recycling businesses in New England and Hawaii and a metals trading
business in parts Russia and the Baltic region. The day-to-day operations
of
these businesses were overseen by HNC prior to the separation. The Company
will
depend on key employees of those businesses, particularly those involved
in the
metals trading operations, providing for the continuity of those businesses.
As
well, the Company will be hiring additional key employees to help manage
those
businesses. Loss of or failure to hire key personnel or other transition
issues
could adversely affect the Company.
Additionally,
given the significance of these recently acquired businesses relative to
the
size of the Company, integration of these businesses will be challenging.
Any
failure to adequately integrate these businesses may result in adverse impacts
on the Company’s profitability.
Throughout
the Company’s history, it has made a number of acquisitions as management
attempts to improve the value of the Company for its shareholders. It is
anticipated that the Company will continue to pursue additional expansion
of the
Metals
Recycling Business and Auto Parts Business. Each acquisition comes with its
own
inherent risks that make it difficult to predict the ultimate success of
the
transaction. An acquisition may have a negative and/or unexpected impact on the
Company’s cash flow, operating income, net income, earnings per share and
financial position.
SCHNITZER
STEEL INDUSTRIES, INC.
Trading
Business Risks:
Schnitzer Global Exchange (SGE), the Company’s trading entity acquired in
September 2005, has various risks associated with its business operations.
SGE
operates in foreign countries with varying degrees of political risk. It
advances and occasionally loans money to suppliers for the delivery of materials
at a later date. Credit is also periodically extended to foreign steel mills.
Due to the nature of the business, profit margins are thinner than for the
Company’s processing business; thus, unsold inventory may be more susceptible to
losses. In addition, inventory is generally purchased in advance of sale,
and
the Company has a lesser ability to manage the risk against adverse movements
than in its domestic processing business. Also, the trading business has
lower
barriers to entry, making the Company potentially more susceptible to
competition than in its processing business.
Replacement
or Installation of Capital Equipment: The
Company installs new equipment and constructs facilities or overhauls existing
equipment and facilities (including export terminals) from time to time.
Some of
these projects take several months to complete, require the use of outside
contractors and experts, require special permits and easements and have high
degrees of risk. Examples of such major capital projects include the
installation of a mega-shredder at a metal recycling yard, the overhaul of
an
export loading facility or the furnace replacement at the steel mill. Many
times
in the process of preparing the site for installation, the Company is required
to temporarily halt or limit production for a period of time. If problems
are
encountered during the installation and construction process, the Company
may
lose the ability to process materials which may impact the amount of revenue
it
is able to earn or may increase operating expenses. Additionally, it may
also
result in the building of inventory levels. If market conditions then occur
which result in lower selling prices, the Company’s profit margins may be
adversely impacted. In either case, the Company’s ability to reasonably predict
financial results may be hampered.
Reliance
on Key Pieces of Equipment:
The
Company relies on key pieces of equipment in the various manufacturing
processes. Key items include the shredders and ship loading facilities at
the
metals recycling locations and the transformer, furnace, melt shop and rolling
mills at the Company’s steel manufacturing business, including the electrical
power and natural gas supply into all of the Company’s locations. If one of
these key pieces of equipment were to have a mechanical failure and the Company
were unable to correct the failure, revenues and operating income may be
adversely impacted. Where practical, the Company has taken steps to reduce
these
risks such as maintaining a supply of spare parts, performing a regular
preventative maintenance program and maintaining a well trained maintenance
team
that is capable of making most of the Company’s repairs.
Energy
Supply:
The
Company utilizes various energy sources to operate its facilities. In
particular, electricity and natural gas currently represent approximately
9% of
the cost of steel manufactured for the Company’s Steel Manufacturing Business.
The Steel Manufacturing Business purchases electric power under a long-term
contract from McMinnville Water & Light (McMinnville) which in turn relies
on the Bonneville Power Administration (BPA). Historically, these contracts
have
had favorable prices and are long-term in nature. The Company’s electrical power
contract expires in September 2011. On October 1, 2001, the BPA increased
its
electricity rates due to increased demand on the West Coast and lower
supplies. This increase was in the form of a Cost Recovery Adjustment
Clause (CRAC) added to BPA’s contract with McMinnville. The CRAC is
an additional monthly surcharge on selected power charges to recover costs
associated with buying higher priced power during the West Coast power
shortage. Because BPA can adjust the CRAC every six months, it is not
possible to predict future rate changes.
SCHNITZER
STEEL INDUSTRIES, INC.
The
Steel
Manufacturing Business also has a contract for natural gas that expires on
May
31, 2009 and obligates the business to purchase minimum amounts of gas at
fixed
rates, which adjust periodically. Effective November 1, 2005, the natural
gas
rate increased to $6.90 per MMBTU. This is a take or pay contract with a
minimum
average usage of 3,575 MMBTU per day. Gas not used is sold on the open market
and gains or losses are recorded in cost of goods sold.
If
the
Company is unable to negotiate favorable terms of electricity, natural gas
and
other energy sources, this could adversely affect the performance of the
Company.
Environmental
Matters:
The
Company records accruals for estimated environmental remediation claims.
A loss
contingency is accrued when the Company’s assessment indicates that it is
probable that a liability has been incurred and the amount of the liability
can
be reasonably estimated. The Company’s estimates are based upon currently
available facts and presently enacted laws and regulations. These estimated
liabilities are subject to revision in future periods based on actual costs,
new
information or changes in laws and regulations.
Tax
Laws:
The
Company’s tax rate the last three years has benefited from state income tax
credits, from the federal Extraterritorial Income Exclusion (ETI) on export
sales, and from the final releases of a valuation allowance previously
offsetting the net operating losses and minimum tax credit carryforwards
that
had accompanied a 1996 business acquisition. The Company’s future tax rates will
benefit from the ETI, although the American Jobs Creation Act of 2004 (the
Act)
will gradually eliminate the ETI benefit. Compensating for the Company’s loss of
ETI benefit will be the new deduction under the Act for Qualified Production
Activities Income, but the effect of this new deduction on the Company’s
effective tax rate will not be determinable until the newly issued final
regulations explaining it are examined by the Company. The Company will also
likely continue to benefit from trade tax credits.
Currency
Fluctuations:
Demand
from the Company’s foreign customers is partially driven by foreign currency
fluctuations relative to the U.S. dollar. Strengthening of the U.S. dollar
could
adversely affect the competitiveness of the Company’s products in the markets in
which the Company competes. The Company has no control over such fluctuations
and, as such, these dynamics could affect the Company’s revenues and earnings.
The Company conducts most transactions in U.S. dollars.
Shipping
and Handling:
Both the
Metals Recycling Business and the Steel Manufacturing Business often rely
on
third parties to handle and transport their products to end users in a timely
manner. The cost to transport the products can be affected by circumstances
over
which the Company has no control such as fuel prices, political events,
governmental regulations on transportation and changes in market rates due
to
carrier availability. In estimating future operating results, the Company
makes
certain assumptions regarding shipping costs.
The
Steel
Manufacturing Business relies on the availability of rail cars to transport
finished goods to customers and raw materials to the mill for use in the
production process. Market demand for rail cars along the west coast has
been
very high which has reduced the number of rail cars available to the Steel
Manufacturing Business to transport finished goods. In addition, the Steel
Manufacturing Business utilizes rail cars to provide an inexpensive form
of
transportation for delivering scrap metal to the mill for production. Although
the Company expects to be able to maintain an adequate supply of scrap metal,
a
larger portion of those materials are anticipated to be delivered using trucks.
The Company anticipates this change in delivery may lead to increased raw
material costs.
The
Metals Recycling Business relies on the availability of cargo ships to transport
their ferrous and non ferrous bulk exports to Asian and other overseas markets.
Demand for ocean going vessels has been strong, which has reduced the number
of
ships available to the Metals Recycling Business to transport product to
markets. Although the Company anticipates that it will continue to find
available vessels in a timely manner, the tight supply of ships could cause
delays in meeting delivery schedules if vessels are not available.
SCHNITZER
STEEL INDUSTRIES, INC.
The
Company’s Providence, Rhode Island facility, acquired in conjunction with the
separation and termination of its metals recycling joint ventures with HNC,
as
discussed in Part I, Item II, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Acquisitions and Transactions” and Note 4
to the condensed consolidated financial statements, is leased from the Port
of
Providence. A long-term lease of this facility expired several years ago.
The
parties are finalizing the terms for a long-term lease of the facility. If
the
new lease is not finalized and the Company fails to secure another similar
facility, the Company’s ability to ship recycled metals cost-effectively from
this region would be significantly impacted.
Insurance:
The
cost
of the Company’s insurance is affected not only by its own loss experience but
also by cycles in the insurance market. The Company cannot predict future
events
and circumstances which could cause rates to materially change such as war,
terrorist activities or natural disasters.
It
is not
possible to predict or identify all factors that could cause actual results
to
differ from the Company’s forward-looking statements. Consequently, the reader
should not consider any such list to be a complete statement of all potential
risks or uncertainties. Further, the Company does not assume any obligation
to
update any forward-looking statement.
ITEM
3. |
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
The
Company periodically uses derivative financial instruments to limit exposure
to
changes in interest and foreign currency rates. Because such derivative
instruments are used solely as hedges and not for speculative trading purposes,
they do not represent incremental risk to the Company. For further discussion
of
derivative financial instruments, refer to “Fair
Value of Financial Instruments”
in the
consolidated Financial Statements included in Item 8 of Form 10-K for the
fiscal
year ended August 31, 2005.
ITEM
4. |
CONTROLS
AND PROCEDURES
|
Disclosure
Controls and Procedures
The
Company’s management, with the participation of the Chief Executive Officer and
Chief Financial Officer, has completed an evaluation of the effectiveness
of the
design and operation of the Company’s disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act
of
1934, as amended (the “Exchange Act”)). Based on this evaluation, the Company’s
Chief Executive Officer and Chief Financial Officer have concluded that,
as of
the end of the fiscal period covered by the Original Form 10-Q, the Company’s
disclosure controls and procedures were not 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 Securities and Exchange Commission’s 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.
In
making
this determination the Company’s Chief Executive Officer and Chief Financial
Officer considered, among other things, that:
The
Company determined that it did not timely file with the SEC financial statements
of the businesses it acquired through the termination and separation of its
joint ventures with HNC on September 30,
SCHNITZER
STEEL INDUSTRIES, INC.
2005,
as
required under Rule 3-05 and Article 11 of Regulation S-X. The Company filed
the
required financial statements with the SEC on July 10, 2006.
Further,
the Company determined that the following material weaknesses existed as
of
November 30, 2005. A material weakness is a control deficiency or combination
of
control deficiencies that results in more than a remote likelihood that a
material misstatement of the annual or interim financial statements will
not be
prevented or detected.
1. |
As
of November 30, 2005, the
Company did not maintain effective controls over the accurate preparation
and review of our consolidated statements of cash flows. Specifically,
the
Company did not maintain effective controls to ensure that (i)
certain
cash flows received from joint ventures as returns on investment
were
accurately classified as net cash provided by operations and
(ii) debt proceeds and repayments and changes in other assets and
liabilities were accurately presented on a gross basis, as required
by generally accepted accounting principles. This control deficiency
resulted in the restatement of the Company’s consolidated financial
statements for the fiscal years ended August 31, 2005, 2004, and
2003,
each of the quarters in fiscal 2005, the first two quarters of
fiscal 2006
and adjustments to the third quarter of 2006. Additionally, this
control
deficiency could result in a misstatement of operating and investing
cash
flows in the consolidated statements of cash flows that would result
in a
material misstatement of the annual or interim consolidated financial
statements that would not be prevented or detected. Accordingly,
management has concluded that this control deficiency constitutes
a
material weakness.
|
2. |
As
of November 30, 2005, the Company did not maintain effective controls
over
its application and review of the completeness and accuracy of
purchase
accounting. Specifically, the Company did not maintain effective
controls
to ensure that purchase business combinations were accurately recorded
as
of the acquisition date in accordance with generally accepted accounting
principles. This control deficiency resulted in the restatement
of
revenue, cost of goods sold, selling, general and administrative
expense,
interest expense, other income, net, income tax provision, pre-acquisition
interests, net of tax, and operating and investing cash flows in
the
condensed consolidated financial statements for the three months
ended
November 30, 2005 and the six months ended February 28, 2006. Additionally,
this control deficiency could result in the misstatement of the
aforementioned accounts and disclosures that would result in a
material
misstatement of the annual or interim consolidated financial statements
that would not be prevented or detected. Accordingly, management
has
concluded that this control deficiency constitutes a material
weakness.
|
Remediation
Plan
As
of the
date of the filing of this amendment on Form 10-Q/A, the Company has taken
or
will take the following steps to remediate the material weaknesses:
· |
The
Company has created new accounting and financing positions, hired
additional accounting and finance personnel and replaced accounting
and
finance personnel hired earlier in fiscal year 2006.
|
· |
The
Company has engaged outside consultants to review the Company’s accounting
position where the accounting treatment is considered by the Company
to be
particularly complex or, under certain circumstances, to involve
subjective decision making.
|
· |
The
Company reassembled its Technical Accounting Team, which includes
the
divisional CFO of the Auto Parts Business, the divisional Director
of
Finance of the Metals Recycling Business, the divisional Controllers
of
all the Company’s business segments, the corporate Controller, the
corporate Assistant Controller, the Finance Manager and the corporate
Senior Accounting Manager. The Technical Accounting Team holds
bi-monthly
meetings to address accounting issues relevant to the
Company.
|
· |
The
Company has taken a thorough review of the classification requirements
of
each component line item and the individual elements that comprise
each
line item of the Consolidated Statements of Cash Flows in accordance
with
FAS 95.
|
SCHNITZER
STEEL INDUSTRIES, INC.
· |
The
SEC reporting manager will now utilize a detailed checklist to
review
appropriate classification of cash flows in accordance with FAS
95.
|
· |
The
Company has contracted with a public accounting firm (other than
its
independent auditors) to perform a thorough review of the detailed
checklist to ensure that the cash flows have been prepared in accordance
with FAS 95.
|
Changes
in Internal Control Over Financial Reporting
Other
than the material weakness identified related to the application and review
of the completeness and accuracy of purchase accounting discussed above,
there
were no changes in the Company’s 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 Company’s internal control
over financial reporting.
SCHNITZER
STEEL INDUSTRIES, INC.
PART
II
ITEM
1. |
LEGAL
PROCEEDINGS
|
The
Company had a past practice of making improper payments to the purchasing
managers of customers in Asia in connection with export sales of recycled
ferrous metals. The Company stopped this practice after it was advised in
2004
that it raised questions of possible violations of U.S. 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
of Directors also authorized and directed that the existence and the results
of
the investigation be voluntarily reported to the U.S. Department of Justice
(DOJ) and the Securities and Exchange Commission (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 August 23, 2005,
the
Company received from the SEC a formal order of investigation related to
the
independent investigation. The Audit Committee is continuing its independent
investigation. The Company, including the Audit Committee, continues to
cooperate fully with the DOJ and the SEC. The investigations of the Audit
Committee, the DOJ and the SEC are not expected to affect the Company’s
previously reported financial results. However, the Company expects to enter
into agreements with the DOJ and the SEC to resolve the above-referenced
matters
and believes that it is probable that the SEC and DOJ will impose penalties
on,
and require disgorgement of certain profits by, the Company as a result of
their
investigations. The Company estimates that the total amount of these
penalties and disgorgement will be within a range of $11.0 million to $15.0
million. In the first fiscal quarter of 2006, the Company established a reserve
totaling $11.0 million in connection with the penalties this estimate. The
precise terms of any agreements to be entered into with the DOJ and the SEC,
however, remain under discussion with these two agencies. The Company,
therefore, cannot predict with certainty the final outcome of the aforementioned
investigations or whether the Company or any of its employees will be subject
to
any additional remedial actions following completion of these investigations.
SCHNITZER
STEEL INDUSTRIES, INC.
|
3.1
|
1993
Restated Articles of Incorporation f the Registrant. (incorporated
by
reference to Exhibit 3.1 to the Registrant’s Registration Statement on
Form S-1. Registration No. 33.69352 (the Form
S-1).
|
|
3.2
|
Restated
Bylaws of the Registrant. (incorporated by reference to Exhibit
3.2 to the
Registrant’s Registration Statement on Form 10-Q for the quarter ended May
31, 2005).
|
|
10.1
|
Amendment
No. 1 to Lease, 3200 Yeon (incorporated by reference to Exhibit
10.1 to
the Registrant’s Registration Statement on Form 10-Q filed January 9,
2006).
|
|
10.2
|
Amendment
No. 2 to Yeon
Business Center Lease Agreement,
3200 Yeon (incorporated
by reference to Exhibit 10.0 to the Registrant’s Registration Statement on
Form 10-Q filed January 9, 2006).
|
|
10.3
|
Amendment
No. 1 to Lease, 3330 Yeon (incorporated
by reference to Exhibit10.3 to the Registrant’s Registration Statement on
Form 10-Q filed January 9, 2006).
|
|
10.4
|
Amendment
to Yeon Business Center Lease Agreement, 3330 Yeon (incorporated
by reference to Exhibit 10.4 to the Registrant’s Registration Statement on
Form 10-Q filed January 9, 2006).
|
|
10.5
|
Non-Employee
Director Compensation Summary (incorporated by reference to Exhibit
10.5
to the Registrant’s Registration Statement on Form 10-Q filed January 9,
2006).
|
|
31.1
|
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
|
31.2
|
Certification
of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley
Act of 2002
|
|
32.1
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as
adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
32.2
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as
adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
SCHNITZER
STEEL INDUSTRIES, INC.