UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended May 31, 1998 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _______ to _______. Commission file number 0-22496 SCHNITZER STEEL INDUSTRIES, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) OREGON 93-0341923 ------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3200 N.W. Yeon Ave., P.O Box 10047 Portland, OR 97296-0047 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (503) 224-9900 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The Registrant had 5,555,026 shares of Class A Common Stock, par value of $1.00 per share and 4,430,328 shares of Class B Common Stock, par value of $1.00 per share outstanding at July 1, 1998.
SCHNITZER STEEL INDUSTRIES, INC. INDEX ----- PAGE NO. -------- PART I. FINANCIAL INFORMATION Consolidated Balance Sheet at May 31, 1998 and August 31, 1997.......................................................3 Consolidated Statement of Operations for the Three Months and Nine Months Ended May 31, 1998 and 1997...................................4 Consolidated Statement of Shareholders' Equity for the Year Ended August 31, 1997 and the Nine Months Ended May 31, 1998........................................................5 Consolidated Statement of Cash Flows for the Nine Months Ended May 31, 1998 and 1997...................................6 Notes to Financial Statements.................................................7 Management's Discussion and Analysis of Financial Condition and Results of Operations.............................12 PART II. OTHER INFORMATION Exhibits and Reports on Form 8-K.............................................18 SIGNATURE PAGE...............................................................19 2
<TABLE> <CAPTION> SCHNITZER STEEL INDUSTRIES, INC. CONSOLIDATED BALANCE SHEET (in thousands, except per share amounts) May 31, 1998 August 31, 1997 ------------ --------------- (Unaudited) (Audited) <S> <C> <C> ASSETS CURRENT ASSETS: Cash $ 1,666 $ 3,106 Accounts receivable, less allowance for doubtful accounts of $485 and $524 30,043 31,010 Accounts receivable from related parties 499 1,215 Inventories (Note 2) 104,506 95,154 Deferred income taxes 10,737 10,737 Prepaid expenses and other 6,834 3,168 ---------- ---------- TOTAL CURRENT ASSETS 154,285 144,390 ---------- ---------- NET PROPERTY, PLANT AND EQUIPMENT 142,925 151,136 ---------- ---------- OTHER ASSETS: Investment in joint venture partnerships 105,578 74,605 Advances to joint venture partnerships 9,161 7,145 Goodwill 41,320 42,230 Intangibles and other 9,753 8,480 ---------- ---------- $ 463,022 $ 427,986 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt (Note 7) $ 166 $ 361 Accounts payable 15,673 19,456 Accrued payroll liabilities 4,355 5,158 Current portion of environmental liabilities (Note 4) 5,152 5,787 Other accrued liabilities 9,107 8,730 ---------- ---------- TOTAL CURRENT LIABILITIES 34,453 39,492 ---------- ---------- DEFERRED INCOME TAXES 28,117 28,409 ---------- ---------- LONG-TERM DEBT LESS CURRENT PORTION (Note7) 128,988 92,881 ---------- ---------- ENVIRONMENTAL LIABILITIES, NET OF CURRENT PORTION (Note 4) 23,030 24,530 ---------- ---------- OTHER LONG-TERM LIABILITIES 3,311 3,613 ---------- ---------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Preferred stock--20,000 shares authorized, none issued Class A common stock--75,000 shares $1 par value authorized, 5,555 and 5,737 shares issued and outstanding 5,555 5,737 Class B common stock--25,000 shares $1 par value authorized, 4,431 and 4,445 shares issued and outstanding 4,431 4,445 Additional paid-in capital 105,124 109,994 Retained earnings 130,013 118,885 ----------- ---------- 245,123 239,061 ----------- ---------- $ 463,022 $ 427,986 =========== ========== The accompanying notes are an integral part of this statement. </TABLE> 3
<TABLE> <CAPTION> SCHNITZER STEEL INDUSTRIES, INC. CONSOLIDATED STATEMENT OF OPERATIONS (in thousands, except per share amounts) (unaudited) For The Three Months Ended For The Nine Months Ended May 31, May 31, -------------------------- -------------------------- 1998 1997 1998 1997 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> REVENUES $ 80,918 $ 89,297 $ 268,216 $ 248,596 ----------- ----------- ----------- ----------- COSTS AND EXPENSES: Cost of goods sold and other operating expenses 71,296 76,230 237,567 219,434 Selling and administrative 5,520 4,888 16,150 15,443 ----------- ----------- ----------- ----------- 76,816 81,118 253,717 234,877 ----------- ----------- ----------- ----------- INCOME FROM JOINT VENTURES 1,417 2,720 8,380 4,500 ----------- ----------- ----------- ----------- INCOME FROM OPERATIONS 5,519 10,899 22,879 18,219 ----------- ----------- ----------- ----------- OTHER INCOME (EXPENSE): Interest expense (1,849) (1,551) (4,537) (3,583) Other income 283 3,416 1,096 4,441 ----------- ----------- ----------- ----------- (1,566) 1,865 (3,441) 858 ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAXES 3,953 12,764 19,438 19,077 Income tax provision (1,384) (4,340) (6,803) (6,494) ----------- ----------- ----------- ----------- NET INCOME $ 2,569 $ 8,424 $ 12,635 $ 12,583 =========== =========== =========== =========== BASIC EARNINGS PER SHARE $ 0.26 $ 0.81 $ 1.25 $ 1.22 =========== =========== =========== =========== DILUTED EARNINGS PER SHARE $ 0.26 $ 0.81 $ 1.25 $ 1.21 =========== =========== =========== =========== The accompanying notes are an integral part of this statement. </TABLE> 4
<TABLE> <CAPTION> SCHNITZER STEEL INDUSTRIES, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (in thousands) (unaudited) Class A Class B Common Stock Common Stock Additional ----------------------- ----------------------- Paid-in Retained Shares Amount Shares Amount Capital Earnings Total ---------- ---------- ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> BALANCE AT 8/31/96 5,773 $ 5,773 4,575 $ 4,575 $ 113,747 $ 99,718 $ 223,813 Class B common stock converted to Class A common stock 130 130 (130) (130) Class A common stock repurchased (166) (166) (3,753) (3,919) Net income 21,225 21,225 Dividends paid (2,058) (2,058) ---------- ---------- ---------- ---------- ---------- ---------- ---------- BALANCE AT 8/31/97 5,737 5,737 4,445 4,445 109,994 118,885 239,061 Net Income 12,635 12,635 Class B common stock converted to Class A common stock 14 14 (14) (14) Class A common stock repurchased (196) (196) (4,870) (5,066) Dividends paid (1,507) (1,507) ---------- ---------- ---------- ---------- ---------- ---------- ---------- BALANCE AT 5/31/98 5,555 $ 5,555 4,431 $ 4,431 $ 105,124 $ 130,013 $ 245,123 ========== ========== ========== ========== ========== ========== ========== The accompanying notes are an integral part of this statement. </TABLE> 5
<TABLE> <CAPTION> SCHNITZER STEEL INDUSTRIES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) (unaudited) For The Nine Months Ended May 31, ---------------------------- 1998 1997 ---------- ---------- <S> <C> <C> OPERATIONS: Net income $ 12,635 $ 12,583 Noncash items included in income: Depreciation and amortization 14,123 13,055 Deferred income taxes (292) (2,211) Equity in earnings of joint ventures and other investments (8,380) (4,500) Gain on disposal of assets (113) (65) Cash provided (used) by assets and liabilities: Accounts receivable 1,683 64 Inventories (9,352) (13,618) Prepaid expenses and other (2,608) 1,855 Accounts payable (3,783) (5,987) Deferred revenue (76) 3,327 Accrued expenses (351) 1,855 Environmental liabilities (2,135) (861) Other assets and liabilities (1,491) (367) ---------- ---------- NET CASH (USED) PROVIDED BY OPERATIONS (140) 5,130 ---------- ---------- INVESTMENTS: Payment for purchase of Proler (42,456) Capital expenditures (7,512) (10,499) Advances to joint ventures (2,016) (4,396) Investments in joint ventures (22,892) 18,721 Proceeds from sale of assets 2,986 4,859 Other (1,205) (1,057) ---------- ---------- NET CASH USED BY INVESTMENTS (30,639) (34,828) ---------- ---------- FINANCING: Repurchase of Class A common stock (5,066) (2,350) Dividends declared and paid (1,507) (1,551) Increase in long-term debt 36,200 63,526 Reduction in long-term debt (288) (27,866) ---------- ---------- NET CASH PROVIDED BY FINANCING 29,339 31,759 ---------- ---------- NET (DECREASE) INCREASE IN CASH (1,440) 2,061 CASH AT BEGINNING OF PERIOD 3,106 1,896 ---------- ---------- CASH AT END OF PERIOD $ 1,666 $ 3,957 ========== ========== The accompanying notes are an integral part of this statement. </TABLE> 6
SCHNITZER STEEL INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED MAY 31, 1998 and 1997 (in thousands, except per share amounts) (Unaudited) Note 1 - Summary Of Significant Accounting Policies: Basis of Presentation --------------------- The accompanying unaudited interim financial statements of Schnitzer Steel Industries, Inc. (the Company) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and note disclosures normally included in annual financial statements have been condensed or omitted pursuant to those rules and regulations. In the opinion of management, all adjustments, consisting only of normal, recurring adjustments considered necessary for a fair presentation, have been included. Although management believes that the disclosures made are adequate to ensure that the information presented is not misleading, it is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Company's annual report for the fiscal year ended August 31, 1997. The results for the nine months ended May 31, 1998 are not necessarily indicative of the results of operations for the entire year. Earnings Per Share ------------------ The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per share", which specifies the computation, presentation and disclosure requirements for earnings per share ("EPS"). SFAS 128 replaces the presentation of primary and fully diluted EPS with basic and diluted EPS. Basic 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. The following represents a reconciliation from basic EPS to diluted EPS: <TABLE> <CAPTION> Three Months Ended May 31, 1998 ------------------------------------------- Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- --------- <S> <C> <C> <C> Basic EPS $ 2,569 9,985 $ 0.26 Options -- 62 ========= ----------- ------------- Diluted EPS $ 2,569 10,047 $ 0.26 =========== ============= ========= Three Months Ended May 31, 1997 ------------------------------------------- Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- --------- Basic EPS $ 8,424 10,343 $ 0.81 Options -- 28 ========= ----------- ------------- Diluted EPS $ 8,424 10,371 $ 0.81 =========== ============= ========= </TABLE> 7
SCHNITZER STEEL INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED MAY 31, 1998 and 1997 (in thousands, except per share amounts) (Unaudited) <TABLE> <CAPTION> Nine Months Ended May 31, 1998 ------------------------------------------- Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- --------- <S> <C> <C> <C> Basic EPS $ 12,635 10,070 $ 1.25 Options -- 71 ========= ----------- ------------- Diluted EPS $ 12,635 10,141 $ 1.25 =========== ============= ========= Nine Months Ended May 31, 1997 ------------------------------------------- Income Shares Per-share (Numerator) (Denominator) Amount ----------- ------------- --------- <S> <C> <C> <C> Basic EPS $ 12,583 10,340 $ 1.22 Options -- 59 ========= ----------- ------------- Diluted EPS $ 12,583 10,399 $ 1.21 =========== ============= ========= </TABLE> Note 2 - Inventories: Inventories consist of the following (in thousands): <TABLE> <CAPTION> May 31, 1998 August 31, 1997 ------------ --------------- (Unaudited) (Audited) <S> <C> <C> Scrap metals $ 25,864 $ 26,897 Work in process 11,783 24,358 Finished goods 50,690 28,109 Supplies 16,169 15,790 ---------- ---------- $ 104,506 $ 95,154 ========== ========== </TABLE> Scrap metal inventories are valued at LIFO; the remainder are at FIFO. Interim LIFO calculations are based on the Company's estimates of expected year-end inventory levels and costs. The cost of scrap metal inventories exceeded the stated LIFO value by $8,039 at May 31, 1998 and August 31, 1997. 8
SCHNITZER STEEL INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED MAY 31, 1998 and 1997 (in thousands, except per share amounts) (Unaudited) Note 3 - Related Party Transactions: Certain shareholders of the Company own significant interests in, or are related to owners of, the entities discussed below. As such, these entities are considered related parties for financial reporting purposes. Transactions Affecting Cost of Goods Sold and Other Operating Expenses ---------------------------------------------------------------------- The Company charters several vessels from related shipping companies to transport scrap metal to foreign markets. In 1993, the Company signed a five-year time-charter agreement for one vessel. The agreement guarantees the ship owner a residual market value of $2,500 at the end of the time-charter. The Company entered into two additional seven-year time-charters in May 1995. Charges incurred for these charters were $1,522 and $1,841 for the three months ended May 31, 1998 and 1997, respectively, and $5,836 and $6,332 for the nine months ended May 31, 1998 and 1997, respectively. The Company purchased scrap metals from certain of its joint venture operations totaling $4,452 and $3,879 for the three months ended May 31, 1998 and 1997, respectively, and $12,307 and $9,019 for the nine months ended May 31, 1998 and 1997, respectively. The Company leases certain land and buildings from a real estate company which is a related entity. The rent expense was $338 and $387 for the three months ended May 31, 1998 and 1997, respectively, and $998 and $1,098 for the nine months ended May 31, 1998 and 1997, respectively. Transactions Affecting Selling and Administrative Expenses ---------------------------------------------------------- The Company performs some administrative services and provides operation and maintenance of management information systems for certain related parties. These services are charged to the related parties based upon costs plus a 15% margin for overhead and profit. The administrative charges totaled $233 and $285 for the three months ended May 31, 1998 and 1997, respectively, and $969 and $795 for the nine months ended May 31, 1998 and 1997, respectively. Transactions Affecting Other Income (Expense) --------------------------------------------- The vessels discussed above are periodically sub-chartered to third parties. In this case, a related shipping agency company acts as the Company's agent in the collection of income and payment of expenses related to sub-charter activities. Charges incurred for these sub-charters were $123 for the three months ended May 31, 1998, and $743 and $871 for the nine months ended May 31, 1998 and 1997, respectively. There was no subcharter income for the three months ended May 31, 1998 and 1997. These charges were offset by income of $408 and $747 for the nine months ended May 31, 1998 and 1997, respectively. 9
SCHNITZER STEEL INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED MAY 31, 1998 and 1997 (in thousands, except per share amounts) (Unaudited) Note 4 - Environmental Liabilities: During fiscal 1995, in conjunction with the due diligence proceedings for the Company's acquisition of Manufacturing Management, Inc. (MMI), the Company hired an independent third-party consultant to estimate the costs to cure both current and future potential environmental liabilities. The cumulative provision for the total cost specified in the consultant's report was included in MMI's statement of operations prior to its acquisition by the Company. This reserve was carried over to the Company's balance sheet and at May 31, 1998 aggregated $20,200. A portion of the liability recorded in fiscal 1995 relates to MMI's status as a potentially responsible party (PRP) for the investigation and cleanup of sediment along the Hylebos Waterway, on which the Schnitzer Steel of Tacoma (SST) scrap yard is located. SST and five other PRPs voluntarily entered into an Administrative Order of Consent with the Environmental Protection Agency (EPA) to fund a pre-remedial study of sediment contamination and remediation alternatives. SST's share of the study, which is expected to be complete in 1998, is approximately $2,000. Any further potential liabilities, if any, cannot be estimated at this time. In 1996, prior to the Company's acquisition of Proler International Corp. (Proler) (see Note 5), an independent third party consultant was engaged to estimate the costs to cure present and future potential liabilities related to Proler's wholly-owned and joint venture properties. Proler recorded a liability of $8,600 for the probable costs to remediate its wholly-owned properties based upon the consultant's estimates, increasing its environmental reserves to $9,800. The Company carried over the aggregate reserve to its financial statements upon acquiring Proler and $8,000 remained outstanding on May 31, 1998. Concurrently, based upon the consultant's estimates, Proler's joint venture operations recorded additional liabilities of $4,100 for the probable costs to remediate their properties. The liability was recorded prior to the Company's acquisition of Proler. Between 1982 and 1987, MRI Corporation (MRI), a wholly-owned subsidiary of Proler, operated a tin can shredding and detinning facility in Tampa, Florida. In 1989 and 1992, the EPA conducted a preliminary site investigation of this property, and in December 1996, added the site to the "National Priorities List". MRI and Proler, along with several other parties, have been named as PRPs for this site by the EPA. Proler included the probable costs associated with this site in the aforementioned reserve. Additionally, Proler and this subsidiary have been named or identified as PRPs at several other sites. As part of the Proler acquisition, the Company became a fifty-percent owner of Hugo Neu-Proler Company (HNP). HNP has agreed, as part of its lease renewal with the Port of Los Angeles, to be responsible for a multi-year, remedial clean-up project involving certain environmental conditions at its Terminal Island Site in Los Angeles, California by the year 2001. Remediation will include limited excavation and treatment of contaminated soils, paving, installation of a stormwater management system, construction of a noise barrier and perimeter wall around the facility and groundwater monitoring. The probable costs to remediate this property are included in the aforementioned reserve. Certain of the Company's joint ventures have completed acquisitions or made investments in joint ventures. Prior to the closing of these transactions, the joint ventures caused environmental liabilities totaling approximately $5.0 million to be recorded on the books of these new entities. 10
SCHNITZER STEEL INDUSTRIES, INC. NOTES TO FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED MAY 31, 1998 and 1997 (in thousands, except per share amounts) (Unaudited) Note 5 - Acquisition of Proler International Corp.: Between November 29, 1996 and December 6, 1996, PIC Acquisition Corp. (PIC), a wholly-owned subsidiary of the Company, acquired 100% of the common stock of Proler. On December 6, 1996, the Company completed the merger of PIC with Proler and, as a result, Proler became a wholly-owned subsidiary of the Company. The Company accounted for this acquisition using the purchase method. Accordingly, the purchase price has been allocated to the assets acquired and the liabilities assumed based on their estimated fair values as of the effective date of the acquisition. The following unaudited pro forma information presents a summary of consolidated results of operations of the Company and Proler as though the acquisition had occurred at the beginning of the period shown. For the Nine Months Ended May 31, 1997 ------------------------- Revenues $ 251,742 Net income $ 5,964 =========== Earnings per share $ .57 =========== These pro forma results have been prepared for comparative purposes only and include certain adjustments to give effect for the acquisition, together with related income tax effects. They do not purport to be indicative of the results of operations which actually would have resulted had the combination been in effect at the beginning of the period presented or of future results of operations of the consolidated entities. Note 6 - Disposal of Lathrop, California Facility: In May 1998, the Company disposed of a tin scrap processing facility in Lathrop, California. The facility was acquired as part of the Proler acquisition (Note 5). The sale resulted in a gain of $1.1 million, of which $.8 million was recorded as a reduction in cost of goods sold and $.3 million as a gain on sale of assets for the three months ended May 31, 1998. Note 7 - Interest Rate Instruments: In February 1998, the Company entered into interest rate swap agreements with two of its banks for the purpose of managing its exposure to adverse movements in interest rates and lowering the cost of various debt instruments. The Company does not use financial instruments for trading purposes, and is not a party to leveraged derivatives. Pursuant to the swap agreements, the Company exchanged its floating rate interest obligations on $50,000 notional principal amount for a fixed interest obligation of 5.55% for three years. The differential paid or received on interest rate agreements is recognized as an adjustment to interest expense. 11
SCHNITZER STEEL INDUSTRIES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The Company operates in two business segments. Scrap Operations collects, processes and recycles steel scrap through facilities in Oregon, Washington, Alaska and California. Additionally, the Company participates, through joint ventures, in the management of 29 scrap collection and processing facilities, including export terminals in Los Angeles, California; Everett, Massachusetts; Portland, Maine; Providence, Rhode Island and Jersey City, New Jersey. Steel Operations operates a mini-mill in Oregon which produces steel reinforcing bar, merchant bar, coiled rebar and wire rod. Mill depots are maintained in California. Results of Operations The Company's revenues and operating results by business segment are summarized below (in thousands): <TABLE> <CAPTION> For the Three Months Ended For the Nine Months Ended --------------------------- --------------------------- May 31, 1998 May 31, 1997 May 31, 1998 May 31, 1997 ------------ ------------ ------------ ------------ (unaudited) <S> <C> <C> <C> <C> REVENUES: Scrap Operations: Ferrous sales $ 40,497 $ 47,325 $ 143,361 $ 132,156 Nonferrous sales 7,998 7,484 20,005 18,944 Other sales 3,672 5,456 12,267 11,738 --------- --------- --------- --------- Total sales 52,167 60,265 175,633 162,838 Ferrous sales to Steel Operations (16,430) (18,161) (44,546) (40,909) Steel Operations 45,181 47,193 137,129 126,667 --------- --------- --------- --------- Total $ 80,918 $ 89,297 $ 268,216 $ 248,596 ========= ========= ========= ========= INCOME FROM OPERATIONS: Scrap Operations $ 2,866 $ 8,261 $ 13,886 $ 15,126 Steel Operations 3,137 1,518 5,775 3,712 Joint ventures 1,417 2,720 8,380 4,500 Corporate expense & eliminations (1,901) (1,600) (5,162) (5,119) --------- --------- --------- --------- Total $ 5,519 $ 10,899 $ 22,879 $ 18,219 ========= ========= ========= ========= NET INCOME $ 2,569 $ 8,424 $ 12,635 $ 12,583 ========= ========= ========= ========= </TABLE> 12
SCHNITZER STEEL INDUSTRIES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued): <TABLE> <CAPTION> For the Three Months Ended For the Nine Months Ended --------------------------- --------------------------- May 31, 1998 May 31, 1997 May 31, 1998 May 31, 1997 ------------ ------------ ------------ ------------ (unaudited) <S> <C> <C> <C> <C> SHIPMENTS: SCRAP OPERATIONS Ferrous scrap (long tons): To Steel Operations 148 149 379 353 To unaffiliated customers 200 221 746 722 --------- --------- --------- --------- Total 348 370 1,125 1,075 ========= ========= ========= ========= Export tons 117 177 547 583 ========= ========= ========= ========= STEEL OPERATIONS Finished steel products (short tons) 131 140 392 378 ========= ========= ========= ========= </TABLE> Revenues. Consolidated revenues for the three months ended May 31, 1998 decreased $8.4 million (9%) over the same quarter last year. For the nine months ended May 31, 1998, consolidated revenues increased $19.6 million (8%) over the same period last year. Revenue increases for the nine months ended May 31, 1998 were generated by both Scrap and Steel Operations. Revenues from Scrap Operations, before intercompany eliminations, decreased $8.1 million (13%) for the three months ended May 31, 1998, reflecting a decrease in ferrous tons shipped at lower average selling prices. Ferrous scrap revenues decreased $6.8 million (14%). Average selling prices decreased $11 to $117 per ton compared to the quarter ended May 31, 1997. This decrease in average selling price is primarily attributable to the decline in export prices related to the Asian financial crisis. Ferrous tons shipped to Steel Operations decreased 1%. For the nine months ended May 31, 1998, Scrap Operations' revenues, before intercompany eliminations, were $12.8 million (8%) over the same period last year. The increase is due to a 5% increase in ferrous tons shipped, at a 4% higher average selling price. For the three months ended May 31, 1998, Steel Operations' revenues decreased by $2.0 million (4%) to $45.2 million. The Company's sales of finished steel decreased 9,000 tons, primarily as a result of adverse weather conditions in California. The effect of decreased tonnage shipped was partially offset by an increase in average selling price for finished steel products of $7 per ton (2%) to $344 per ton over the same period last year. Revenues also increased due to increased sales of wire rod and coiled rebar. These products were first introduced into the product mix during the third quarter of 1997 and production of these higher priced items has risen steadily since that time. For the three and nine months ended May 31, 1998, the Company sold 12,700 tons and 41,100 tons of these new products, respectively. This compares to 5,300 tons for the three and nine months ended May 31, 1997. For the nine months ended May 31, 1998, revenues from Steel Operations increased 8% to $137.1 million. Finished steel shipments increased 14,000 tons (4%) to 392,000 tons. Increased tonnage shipped, coupled with a slight increase in selling prices resulted in higher sales for the period. Additionally, a change in product mix to higher priced products contributed to the increase in revenue and average selling price. 13
SCHNITZER STEEL INDUSTRIES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued): Cost of Goods Sold. Overall cost of goods sold decreased $4.9 million (6%) during the third quarter of fiscal 1998 compared with the third quarter of fiscal 1997. Cost of goods sold as a percentage of revenues increased from 85% to 88%. Gross profit in total decreased by $3.4 million (26%) primarily as a result of decreases in export prices realized by Scrap Operations. For the nine months ended May 31, 1998, consolidated cost of goods sold increased $18.1 million, compared with the same period last year. Cost of goods sold as a percentage of revenues increased from 88% to 89% for the same period, and gross profit increased $1.5 million (5%), due to an increase in scrap and finished steel tons shipped at higher average selling prices. For the three months ended May 31, 1998, cost of goods sold for Scrap Operations decreased $2.8 million and increased as a percentage of revenues from 82% to 89%. Scrap Operations' gross profit decreased from $11 million to $5.7 million. The decrease was due to the impact of reduced tonnage shipped and lower average selling prices. For the nine months ended May 31, 1998, Scrap Operations' average ferrous scrap cost of goods sold increased 5% to $112 per ton. Cost of goods sold as a percentage of revenues increased slightly from 86% to 87%. The increase in tonnage and selling prices, offset by increased cost of raw scrap resulted in a $.7 million (3%) decrease in gross profit to $22.7 million. As a part of its acquisition of Proler (Note 5), the Company acquired a tin scrap processing facility in Lathrop, California that was sold in May 1998. The Company had recorded an environmental reserve for the property when it was acquired. The remaining reserve was reversed upon sale of the facility. The sale resulted in a gain of $1.1 million, of which $.8 million is recorded as a reduction of cost of goods sold and $.3 million as gain on sale of assets for the three months ended May 31, 1998. Steel Operations' cost of goods sold for the third quarter of fiscal 1998 decreased $3.8 million (9%) to $41.1 million and decreased as a percentage of revenue from 95% to 91%. The decrease in cost of goods sold is attributable to a decrease in finished steel shipments, a change in the mix of products shipped, and lower scrap prices. Cost of goods sold per ton, excluding billet sales, decreased from $318 to $308 per ton. Gross profit increased 78% from $2.3 million to $4.1 million as a result of a change in the mix of products shipped and increased plant efficiencies. For the nine months ended May 31, 1998, Steel Operations' average cost of goods sold per ton decreased from $320 to $319. Cost of sales as a percentage of revenues dropped from 95% to 94%. These reductions were the result of increased rolling mill efficiencies. Income from Joint Ventures. The Company's joint ventures generated $93.9 million of revenues and contributed $1.4 million to income for the quarter ended May 31, 1998. This compares with $92.2 million of revenues, and $2.7 million contribution to income for the same period last year. The Joint Ventures in the Scrap Processing Business shipped 601,000 tons and 619,000 tons for the same periods, respectively. For the nine months ended May 31, 1998, the joint ventures generated $287.8 million of revenues and contributed $8.4 million to income. This compares with $261.8 million of revenues and $4.5 million contribution to income for the same period last year. The Joint Ventures in the Scrap Processing Business shipped 1.8 million tons for each of the nine months ended May 31, 1998 and 1997. Income from Joint Ventures decreased from $2.7 million for the quarter ended May 31, 1997 to $1.4 million for the quarter ended May 31, 1998. The decrease was due primarily to the Joint Ventures in the Scrap Processing business being negatively impacted by the Asian financial crisis. The revenues, contribution to income, and tons shipped for the nine months ended May 31, 1997 in the discussion above include activity which occurred prior to the Company's acquisition of Proler. 14
SCHNITZER STEEL INDUSTRIES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued): The increase in income from joint ventures fiscal year to date compared to the same period last year is primarily attributable to the Proler joint ventures, which the company acquired in November 1996. Income for the nine months ended May 31, 1997 includes only six months of earnings from these operations. Export Sales. The Company to date has been able to ship and receive payment for all export sales that it has booked and it anticipates this will continue to be the case. However, the Company has experienced, and for the near term expects to experience, reduced margins on export sales. Selling prices for export scrap to Asia have dropped over $40 per ton since the first of the fiscal year, and while the Company is adjusting buying prices, it has not yet been able to drop the buying price enough to make up for the drop in selling prices. Additionally, the Company continues to see softening in demand for scrap in certain regions of Asia. In addition to lowering its scrap purchase price, the Company has increased its domestic sales volume and has begun selling to Asian countries it has not historically sold to. Concurrently, the Company has implemented a variety of cost control measures. With the increased emphasis on domestic sales, the Company believes that fiscal 1998 sales to Asia will be less than 60% of tonnage sold, which has been the average over the last several years. The Company's Joint Ventures in the Scrap Processing Business are less dependent upon Asian sales, expecting to ship approximately 45% of total tonnage to Asia this fiscal year. The Company believes the joint ventures in the Northeast are particularly well positioned over the next several years to take advantage of increasing capacity and demand for scrap in the steel producing areas in the Eastern United States. While the Company cannot predict how long the Asian crisis will impact its business operations, it believes that the factors cited above will serve to help minimize the financial impact. Other Income (Expense). In February 1997, the Company entered into an interest rate agreement for the sole purpose of locking in the interest rate on a planned private placement of debt. The Company decided against pursuing the private placement in April 1997, and thus recognized the deferred gain on the agreement of approximately $3 million. This amount is included in other income in the accompanying statement of operations for the three and nine months ended May 31, 1997. Interest Expense. Interest expense increased from $1.5 million for the three months ended May 31, 1997 to $1.8 million for the same period this year primarily as a result of higher average borrowings. For the nine months ended May 31, 1998, compared to the same period last year, interest expense increased $.9 million to $4.5 million. This occurred because average borrowings in the first quarter of 1998 were higher than during the first quarter of 1997, primarily as a result of the Proler acquisition. 15
SCHNITZER STEEL INDUSTRIES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued): Year 2000. The Company continues to assess the potential impact that the Year 2000 issue will have on its reporting systems and operations. The Company has determined that the operating and financial software systems it is currently implementing are Year 2000 compliant. The Company will test new systems for Year 2000 compliance as they are implemented. Additionally, the Company does not believe that the cost of bringing any of its retained software into year 2000 compliance will be material. The Company does not believe that it is substantially reliant on any one customer or supplier and therefore does not believe that the Year 2000 compliance of such companies will have a significant impact on the Company. The Company does not anticipate that the Year 2000 issue will have a significant impact on its financial position or results of operations. Liquidity and Capital Resources. Cash used by operations for the nine months ended May 31, 1998 was $140,000, compared with cash provided of $5.1 million for the same period last year. The decrease in cash flow is primarily attributable to the growth in inventories and a reduction in accounts payable compared to the same period last year. Capital expenditures for the three months ended May 31, 1998 totaled $2.8 million compared with $2.4 million during the same period last year. For the nine months ended May 31, 1998 and 1997, capital expenditures totaled $7.5 million and $10.5 million, respectively. The Company anticipates spending approximately $3.5 million on capital expenditures during the remainder of fiscal 1998. As a result of certain acquisitions, the Company carries environmental reserves totaling $28.2 million. The Company expects to require significant future cash outlays as it incurs the actual costs related to the remediation of such environmental liabilities. As of May 31, 1998, the Company had an unsecured revolving line of credit totaling $200 million maturing in 2002. The Company had additional unsecured lines of credit available of $55 million, of which $20 million was committed. In the aggregate, the Company had borrowings outstanding under these lines totaling $118.8 million at May 31, 1998. Pursuant to a stock repurchase program announced by the Company in May 1994 and amended in April 1998, the Company is authorized to repurchase up to 1.6 million shares of its stock when the market price of the Company's stock is not reflective of management's opinion of an appropriate valuation of the stock. Management believes that repurchasing shares under these conditions enhances shareholder value. As of May 31, 1998, a total of 448,300 shares had been purchased under this program. During the nine months ended May 31, 1998, the Company repurchased 196,000 shares of its stock for a total of $5.1 million. The Company believes that the current cash balance, internally generated funds, and existing credit facilities will provide adequate financing for capital expenditures, working capital, stock repurchases, and debt service requirements for the next twelve months. In the longer term, the Company may seek to finance business expansion, including potential acquisitions, with additional borrowing arrangements or additional equity financing. 16
SCHNITZER STEEL INDUSTRIES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued): Forward Looking Statements. Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934, all of which are subject to risks and uncertainties. One can identify these forward looking statements through the use of words such as "expect," "believe," and other words which convey a similar meaning. One can also identify these statements as they do not relate strictly to historical or current facts. They are likely to address the Company's business strategy, financial projections and results and other global factors affecting the Company's financial prospects. An example of this is the current financial crisis facing certain Asian countries and Year 2000 compliance matters. Other factors that could cause actual results to differ materially are the following: supply and demand conditions; the Company's ability to mitigate the effects of the Asian situation and foreign fiscal policies on its profitability; railroad service difficulties; competitive factors and pricing pressures from national steel companies; imports of foreign steel; availability of scrap supply; fluctuations in scrap prices and seasonality of results. One should understand that it is not possible to predict or identify all factors that could cause actual results to differ from the Company's forward looking statements. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. Further, the Company does not assume any obligation to update any forward looking statement. 17
SCHNITZER STEEL INDUSTRIES, INC. PART II ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K: (a) Exhibits 3.2 Restated Bylaws of the Registrant (b) Reports on Form 8-K None 18
SCHNITZER STEEL INDUSTRIES, INC. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SCHNITZER STEEL INDUSTRIES, INC. (Registrant) Date: July 15, 1998 By: /s/ BARRY A. ROSEN ------------- ------------------------------------- Barry A. Rosen Vice President, Finance 19