This section includes a discussion of our operations for the three and six months endedFebruary 29, 2020 andFebruary 28, 2019 . The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of our financial condition and results of operations. The discussion should be read in conjunction with our Annual Report on Form 10-K for the year endedAugust 31, 2019 , and the Unaudited Condensed Consolidated Financial Statements and the related Notes thereto included in Part I, Item 1 of this report. General
Founded in 1906,
Our internal organizational and reporting structure includes two operating
and reportable segments: the Auto and
AMR sells ferrous and nonferrous recycled scrap metal in both foreign and domestic markets. AMR acquires, processes and recycles auto bodies, rail cars, home appliances, industrial machinery, manufacturing scrap and construction and demolition scrap through its 90 auto and metals recycling facilities. Our largest source of auto bodies is our own network of retail auto parts stores, which operate under the commercial brand-name Pick-n-Pull. AMR procures salvaged vehicles and sells serviceable used auto parts from these vehicles through its 51 self-service auto parts stores located acrossthe United States andWestern Canada . Upon acquiring a salvaged vehicle, we remove catalytic converters, aluminum wheels and batteries for separate processing and sale prior to placing the vehicle in our retail lot. After retail customers have removed desired parts from a vehicle, we may remove remaining major component parts containing ferrous and nonferrous metals, which are primarily sold to wholesalers. The remaining auto bodies are crushed and shipped to our metals recycling facilities to be shredded or sold to third parties where geographically more economical. AMR then processes mixed and large pieces of scrap metal into smaller pieces by crushing, torching, shearing, shredding and sorting, resulting in scrap metal pieces of a size, density and metal content required by customers to meet their production needs. The manufacturing process includes physical separation of ferrous and nonferrous materials through automated and manual processes into various sub-classifications, each of which has a value and metal content used by our customers for their end products. AMR uses a variety of shredding and separation systems to efficiently process and sort recycled scrap metal. CSS operates a steel mini-mill inMcMinnville, Oregon that produces a range of finished steel long products such as reinforcing bar (rebar) and wire rod. The primary feedstock for the manufacture of its products is ferrous recycled scrap metal. CSS's steel mill obtains substantially all of its scrap metal raw material requirements from its integrated metals recycling and joint venture operations. CSS's metals recycling operations comprise a collection, shredding and export operation inPortland, Oregon , four feeder yard operations located inOregon andSouthern Washington , and one metals recycling joint venture ownership interest. Additionally, CSS purchases small volumes of ferrous scrap metal from AMR and sells ferrous and nonferrous recycled scrap metal primarily into the export market. We use segment operating income to measure our segment performance. We do not allocate corporate interest income and expense, income taxes and other income and expense to our reportable segments. Certain expenses related to shared services that support operational activities and transactions are allocated from Corporate to the segments. Unallocated Corporate expense consists primarily of expense for management and certain administrative services that benefit both reportable segments. In addition, we do not allocate certain items to segment operating income because management does not include the information in its measurement of the performance of the operating segments. Such unallocated items include restructuring charges and other exit-related activities, charges (net of recoveries) related to legacy environmental matters, and provisions for certain legal matters. Because of the unallocated income and expense, the operating income of each reportable segment does not reflect the operating income the reportable segment would report as a stand-alone business. The results of discontinued operations are excluded from segment operating income and are presented separately, net of tax, from the results of ongoing operations for all periods presented.
For further information regarding our reportable segments, see Note 13 - Segment Information in the Notes to the Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this report.
Our results of operations depend in large part on the demand and prices for recycled metal in foreign and domestic markets and on the supply of raw materials, including end-of-life vehicles, available to be processed at our facilities. We respond to changes in selling prices for processed metal by seeking to adjust purchase prices for unprocessed scrap metal in order to manage the impact on our operating income. We believe we generally benefit from sustained periods of stable or rising recycled scrap metal selling prices, which allow us to 28
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better maintain or increase both operating income and unprocessed scrap metal flow into our facilities. When recycled scrap metal selling prices decline, either sharply or for a sustained period, our operating margins typically compress.
Our deep water port facilities on both the East and West Coasts of theU.S. (inEverett, Massachusetts ;Providence, Rhode Island ;Oakland, California ;Tacoma, Washington ; andPortland, Oregon ) and access to public deep water port facilities (inKapolei, Hawaii andSalinas ,Puerto Rico ) allow us to efficiently meet the global demand for recycled ferrous metal by enabling us to ship bulk cargoes to steel manufacturers located inEurope ,Africa , theMiddle East ,Asia ,North America ,Central America andSouth America . Our exports of nonferrous recycled metal are shipped in containers through various public docks to specialty steelmakers, foundries, aluminum sheet and ingot manufacturers, copper refineries and smelters, brass and bronze ingot manufacturers, wire and cable producers, wholesalers, and other recycled metal processors globally. We also transport both ferrous and nonferrous metals by truck, rail and barge in order to transfer scrap metal between our facilities for further processing, to load shipments at our export facilities, and to meet regional domestic demand. Our results of operations also depend on the demand and prices for our finished steel products, the manufacture of which uses internally sourced ferrous recycled scrap metal as the primary feedstock, as well as other raw materials. Our steel mill inOregon sells to industrial customers primarily inNorth America . Our quarterly operating results fluctuate based on a variety of factors including, but not limited to, changes in market conditions for ferrous and nonferrous recycled metal and finished steel products, the supply of scrap metal in our domestic markets, and varying demand for used auto parts from our self-service retail stores. Certain of these factors are influenced, to a degree, by the impact of seasonal changes including severe weather conditions, which can impact the timing of shipments and inhibit construction activity utilizing our products, scrap metal collection at our facilities and production levels in our yards, and retail admissions and parts sales at our auto parts stores. Further, trade actions, including tariffs and any retaliation by affected countries, and licensing and inspection requirements can impact the level of profitability on sales of our products and, in certain cases, impede or restrict our ability to sell to certain export markets or require us to direct our sales to alternative market destinations, which can cause our quarterly operating results to fluctuate. Our operations expose us to risks associated with pandemics, epidemics or other public health emergencies, such as the recent outbreak of coronavirus disease 2019 (COVID-19) which has spread fromChina to many other countries includingthe United States . InMarch 2020 , theWorld Health Organization categorized COVID-19 as a pandemic, and the President ofthe United States declared the COVID-19 outbreak a national emergency. The outbreak has resulted in governments around the world implementing increasingly stringent measures to help control the spread of the virus, including quarantines, "shelter in place" and "stay at home" orders, travel restrictions, business curtailments, school closures, and other measures. In addition, governments and central banks in several parts of the world have enacted fiscal and monetary stimulus measures to counteract the impacts of COVID-19. We are a company operating in a critical infrastructure industry, as defined by theU.S. Department of Homeland Security . Consistent with federal guidelines and with state and local orders to date, we currently continue to operate across our footprint. Notwithstanding our continued operations, COVID-19 has begun to have and may have further negative impacts on our operations, supply chain, transportation networks and customers, which may compress our margins, including as a result of preventative and precautionary measures that we, other businesses and governments are taking. The COVID-19 outbreak is a widespread public health crisis that is adversely affecting the economies and financial markets of many countries. Any resulting economic downturn could adversely affect demand for our products and contribute to volatile supply and demand conditions affecting prices and volumes in the markets for our products, services and raw materials. The progression of this matter could also negatively impact our business or results of operations through the temporary closure of our operating locations or those of our customers or suppliers, disrupting scrap metal inflows to our recycling facilities, limiting our ability to process scrap metal through our shredders, inhibiting the manufacture of steel products at our steel mill, reducing retail admissions and parts sales at our auto parts stores, and delaying or preventing deliveries to our customers, among others. In addition, the ability of our employees and our suppliers' and customers' employees to work may be significantly impacted by individuals contracting or being exposed to COVID-19, or as a result of the control measures noted above, which may significantly hamper our production throughout the supply chain and constrict sales channels. Our customers may be directly impacted by business curtailments or weak market conditions and may not be willing or able to fulfill their contractual obligations or open letters of credit. We may also experience delays in obtaining letters of credit or processing letter of credit payments due to the impacts of COVID-19 on foreign issuing andU.S. intermediary banks. Furthermore, the progression of and global response to the COVID-19 outbreak has begun to cause and increases the risk of further delays in construction activities and equipment deliveries related to our capital projects, including potential delays in obtaining permits from government agencies. The extent of such delays and other effects of COVID-19 on 29
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our capital projects, certain of which are outside of our control, is unknown, but they may impact or delay the timing of anticipated benefits on capital projects.
Our bank credit agreement requires that we maintain certain financial and other covenants. Events resulting from the effects of COVID-19 may negatively impact our ability to comply with these covenants, which could lead us to seek an amendment or waivers from our lenders, limit access to or require accelerated repayment of our existing credit facilities, or require us to pursue alternative financing. We have no assurance that any such alternative financing, if required, could be obtained at terms acceptable to us, or at all, including as a result of the effects of COVID-19 on financial markets at such time. OnMarch 27, 2020 , the President ofthe United States signed and enacted into law the Coronavirus Aid, Relief and Economic Security (CARES) Act, a$2 trillion economic relief bill. We are evaluating the impact of the CARES Act on our business. Since the end of our second quarter onFebruary 29, 2020 , we have begun to see the impacts of COVID-19 on our markets and operations including significant decreases in both export and domestic prices for ferrous and nonferrous metal, softening demand, supply chain disruptions, reduced availability of containers, and other logistics constraints. The extent to which COVID-19 may adversely impact our business depends on future developments, which are highly uncertain and unpredictable, including new information concerning the severity of the outbreak and the effectiveness of actions globally to contain or mitigate its effects. While we expect this matter to negatively impact our results of operations, cash flows and financial position, the current level of uncertainty over the economic and operational impacts of COVID-19 means the related financial impact cannot be reasonably estimated at this time. Our consolidated financial statements and discussion and analysis of financial condition and results of operations reflect estimates and assumptions made by management as ofFebruary 29, 2020 , before the escalation of COVID-19 to pandemic status. Events and changes in circumstances arising afterFebruary 29, 2020 , including those resulting from the impacts of COVID-19, will be reflected in management's estimates for future periods. For further discussion of this matter, refer "Item 1A. Risk Factors" in Part II of this report.
Executive Overview of Financial Results for the Second Quarter of Fiscal 2020
We generated consolidated revenues of$439 million in the second quarter of fiscal 2020, a decrease of 7% from the$474 million of consolidated revenues in the second quarter of fiscal 2019, primarily due to lower average net selling prices for our ferrous and nonferrous products, in both export and domestic markets, and reduced nonferrous sales volumes compared to the prior year quarter. These decreases were driven by weaker market conditions for most recycled metals, particularly for ferrous recycled metals in the domestic market, and structural changes to the market for certain recycled nonferrous products resulting from Chinese import restrictions and tariffs. Compared to the prior year quarter, domestic average net selling prices for AMR's ferrous products decreased by 15% and ferrous domestic sales volumes at AMR decreased by 20%, reflecting softer demand and reduced supply of raw materials including end-of-life vehicles due to the lower price environment. Nonferrous revenues at AMR in the second quarter of fiscal 2020 decreased by 12% compared to the prior year quarter, as nonferrous average net selling prices and sales volumes at AMR decreased by 5% and 20%, respectively, the effects of which were partially offset by increased sales revenues from higher-priced platinum group metal ("PGM") products, compared to the prior year quarter. Steel revenues in the second quarter of fiscal 2020 increased by 16% compared to the prior year quarter reflecting the impact of increased finished steel sales volumes, partially offset by lower average net selling prices for our finished steel products. Consolidated operating income was$8 million in the second quarter of fiscal 2020, compared to$19 million in the second quarter of fiscal 2019. Adjusted consolidated operating income was$14 million in the second quarter of fiscal 2020, compared to$20 million in the second quarter of fiscal 2019. Adjusted consolidated operating income for each period excludes the impact of charges for legacy environmental matters, net of recoveries, asset impairment charges, business development costs and restructuring charges and other exit-related activities. See the reconciliation of adjusted consolidated operating income in Non-GAAP Financial Measures at the end of this Item 2. AMR reported operating income in the second quarter of fiscal 2020 of$19 million , compared to$22 million in the prior year period. The lower price environment in the second quarter of fiscal 2020 adversely impacted operating margins and overall operating results at AMR for the period. In the second quarter of fiscal 2020, ferrous metal spreads at AMR and average net selling prices for AMR's nonferrous joint products that are recovered from the shredding process, comprising primarily zorba, each declined by approximately 15%, compared to the prior year quarter. The adverse effects of the market conditions on AMR's operating results in the second quarter of fiscal 2020 were partially offset by positive contributions from increased sales revenues from higher-priced PGM products compared to the prior year period, a favorable impact from average inventory accounting, and benefits from productivity and restructuring initiatives implemented subsequent to the prior year quarter. 30
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Table of ContentsSCHNITZER STEEL INDUSTRIES, INC. CSS reported operating income of$4 million in the second quarter of fiscal 2020, compared to$6 million in the prior year quarter. The decrease in operating results primarily reflected lower finished steel margins due to the declining price environment for finished steel products during fiscal 2020. Finished steel average net selling prices declined$110 per ton, or 15%, compared to the prior year period, the adverse effects of which were partially offset by higher finished steel sales volumes and benefits from productivity initiatives compared to the prior year period. Consolidated selling, general and administrative ("SG&A") expense in the second quarter of fiscal 2020 increased by$7 million , or 18%, compared to the prior year quarter primarily due to higher employee-related expenses, including from higher incentive compensation accruals, and higher professional services fees. Net income from continuing operations attributable to SSI shareholders in the second quarter of fiscal 2020 was$4 million , or$0.14 per diluted share, compared to$13 million , or$0.46 per diluted share, in the prior year quarter. Adjusted net income from continuing operations attributable to SSI shareholders in the second quarter of fiscal 2020 was$9 million , or$0.31 per diluted share, compared to$14 million , or$0.50 per diluted share, in the prior year quarter. See the reconciliation of adjusted net income (loss) from continuing operations attributable to SSI shareholders and adjusted diluted earnings (loss) per share from continuing operations attributable to SSI shareholders in Non-GAAP Financial Measures at the end of this Item 2.
The following items further highlight selected liquidity and capital structure metrics:
• For the first six months of fiscal 2020, net cash provided by operating
activities of$17 million , compared to$23 million in the prior year comparable period;
• Debt of
• Debt, net of cash, of
million as of
in Non-GAAP Financial Measures at the end of this Item 2).
• Share repurchases totaling
2020, compared to$10 million in the prior year comparable period. 31
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Table of Contents SCHNITZER STEEL INDUSTRIES, INC. Results of Operations Three Months Ended Six Months Ended February 29, February 28, Change February 29, February 28, Change ($ in thousands) 2020 2019 % 2020 2019 % Revenues: Auto and Metals Recycling$ 337,669 $ 386,065 (13 )%$ 650,426 $ 822,477 (21 )% Cascade Steel and Scrap 104,159 90,398 15 % 198,425 220,784 (10 )% Intercompany revenue eliminations(1) (2,346 ) (2,898 ) (19 )% (3,785 ) (5,676 ) (33 )% Total revenues 439,482 473,565 (7 )% 845,066 1,037,585 (19 )% Cost of goods sold: Auto and Metals Recycling 286,026 336,281 (15 )% 566,155 715,017 (21 )% Cascade Steel and Scrap 96,804 81,463 19 % 183,048 195,798 (7 )% Intercompany cost of goods sold eliminations(1) (2,310 ) (3,056 ) (24 )% (3,923 ) (5,995 ) (35 )% Total cost of goods sold 380,520 414,688 (8 )% 745,280 904,820 (18 )% Selling, general and administrative expense: Auto and Metals Recycling 32,080 28,008 15 % 65,599 62,774 5 % Cascade Steel and Scrap 3,896 3,386 15 % 7,841 7,834 (- )% Corporate(2) 10,450 8,095 29 % 19,760 20,300 (3 )% Total selling, general and administrative expense 46,426 39,489 18 % 93,200 90,908 3 % (Income) loss from joint ventures: Auto and Metals Recycling (125 ) 35 NM (164 ) (135 ) 21 % Cascade Steel and Scrap (65 ) (219 ) (70 )% (225 ) (534 ) (58 )% Total income from joint ventures (190 ) (184 ) 3 % (389 ) (669 ) (42 )% Asset impairment charges: Auto and Metals Recycling 384 - NM 1,964 63 NM Corporate 18 - NM 130 - NM Total asset impairment charges 402 - NM 2,094 63 NM Operating income: Auto and Metals Recycling 19,304 21,741 (11 )% 16,872 44,758 (62 )% Cascade Steel and Scrap 3,524 5,768 (39 )% 7,761 17,686 (56 )% Segment operating income 22,828 27,509 (17 )% 24,633 62,444 (61 )% Restructuring charges and other exit-related activities(3) (4,633 ) (536 ) NM (5,100 ) (738 ) NM Corporate expense(2) (10,468 ) (8,095 ) 29 % (19,890 ) (20,300 ) (2 )% Change in intercompany profit elimination(4) (36 ) 158 NM 138 319 (57 )% Total operating income (loss)$ 7,691 $ 19,036 (60 )% $ (219 )$ 41,725 NM NM = Not Meaningful
(1) AMR sells a small portion of its recycled ferrous metal to CSS at prices that
approximate local market rates. These intercompany revenues and cost of goods
sold are eliminated in consolidation.
(2) Corporate expense consists primarily of unallocated expenses for management
and certain administrative services that benefit both reportable segments.
(3) Restructuring charges consist of expense for severance, contract termination
and other restructuring costs that management does not include in its
measurement of the performance of the reportable segments. Other exit-related
activities consist primarily of asset impairments and accelerated depreciation, net of gains on exit-related disposals, related to site closures.
(4) Intercompany profits are not recognized until the finished products are sold
to third parties; therefore, intercompany profit is eliminated while the
products remain in inventories.
We operate our business across two reportable segments: AMR and CSS. Additional financial information relating to these reportable segments is contained in Note 13 - Segment Information in the Notes to the Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this report. 32
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Table of ContentsSCHNITZER STEEL INDUSTRIES, INC.
Auto and
Three Months Ended Six Months Ended February 29, February 28, Change February 29, February 28, Change ($ in thousands, except for prices) 2020 2019 % 2020 2019 % Ferrous revenues$ 222,465 $ 257,488 (14 )%$ 414,937 $ 556,300 (25 )% Nonferrous revenues 87,901 99,484 (12 )% 177,713 203,665 (13 )% Retail and other revenues 27,303 29,093 (6 )% 57,776 62,512 (8 )% Total segment revenues 337,669 386,065 (13 )% 650,426 822,477 (21 )% Segment operating income$ 19,304 $ 21,741 (11 )%$ 16,872 $ 44,758 (62 )% Average ferrous recycled metal sales prices ($/LT)(1): Domestic $ 243 $ 286 (15 )% $ 221 $ 288 (23 )% Foreign $ 257 $ 288 (11 )% $ 243 $ 301 (19 )% Average $ 253 $ 287 (12 )% $ 238 $ 297 (20 )% Ferrous sales volume (LT, in thousands): Domestic 275 343 (20 )% 522 683 (24 )% Foreign 576 515 12 % 1,159 1,094 6 % Total ferrous sales volume (LT, in thousands)(2) 850 858 (1 )% 1,680 1,777 (5 )% Average nonferrous sales price ($/pound)(1)(3) $ 0.55 $ 0.58 (5 )% $ 0.54 $ 0.59 (8 )% Nonferrous sales volume (pounds, in thousands)(3) 112,765 141,307 (20 )% 244,266 294,176 (17 )% Cars purchased (in thousands)(4) 85 89 (4 )% 168 183 (8 )% Number of auto parts stores at period end 51 51 (- )% 51 51 (- )%
LT = Long Ton, which is equivalent to 2,240 pounds
(1) Price information is shown after netting the cost of freight incurred to
deliver the product to the customer.
(2) May not foot due to rounding.
(3) Average sales price and volume information excludes PGMs in catalytic
converters.
(4) Cars purchased by auto parts stores only.
AMR Segment Revenues
Revenues in the second quarter and first six months of fiscal 2020 decreased by 13% and 21%, respectively, compared to the same periods in the prior year primarily due to lower average net selling prices for our ferrous and nonferrous products, in both export and domestic markets, and reduced nonferrous sales volumes compared to the prior year periods. These decreases were driven by weaker market conditions for most recycled metals, particularly for ferrous recycled metals in the domestic market, and structural changes to the market for certain recycled nonferrous products resulting primarily from Chinese import restrictions and tariffs. Compared to the prior year quarter and six-month period, domestic average net selling prices for AMR's ferrous products decreased by 15% and 23%, respectively, and ferrous domestic sales volumes decreased by 20% and 24%, respectively, reflecting softer demand and reduced supply of raw materials including end-of-life vehicles due to the lower price environment. Nonferrous revenues in the second quarter and first six months of fiscal 2020 decreased by 12% and 13%, respectively, compared to the prior year periods, driven by lower nonferrous average net selling prices and sales volumes, the effects of which were partially offset by increased sales revenues from higher-priced PGM products, compared to the prior year periods.
AMR Segment Operating Income
Operating income in the second quarter and first six months of fiscal 2020 was$19 million and$17 million , respectively, compared to$22 million and$45 million in the prior year comparable periods. The lower price environment in the first half of fiscal 2020, which included a sharp decline in commodity prices during most of the first quarter of fiscal 2020 before recovering moderately in the second quarter, adversely impacted operating margins and overall operating results at AMR in the period. In the second quarter and first six months of fiscal 2020, ferrous metal spreads at AMR and average net selling prices for AMR's nonferrous joint products that are recovered from the shredding process, comprising primarily zorba, each declined by approximately 15%, compared to the same periods in the prior year. Additionally, in the first six months of fiscal 2020, the lower price environment adversely impacted the supply of scrap metal including end-of-life vehicles, which resulted in lower processed volumes compared to the prior year period. The adverse effects of the market conditions on AMR's operating results in the second quarter and first six months of fiscal 2020 were partially offset by positive contributions from increased sales revenues from higher-priced PGM products compared to the prior year periods and benefits from productivity and restructuring initiatives implemented subsequent to the prior year periods. Operating results at AMR in the second quarter and the first six months of fiscal 2019 included$6 million and$15 million , respectively, in positive contributions from a 33
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Table of Contents SCHNITZER STEEL INDUSTRIES, INC. limited-duration contract, which was substantially complete at the end of fiscal 2019, and which had provided a high margin source of supply. AMR selling, general and administrative ("SG&A") expense in the second quarter and first six months of fiscal 2020 increased by 15% and 5%, respectively, compared to the same periods in the prior year primarily due to increased employee-related expenses, including from higher incentive compensation accruals. Cascade Steel and Scrap (CSS) Three Months Ended Six Months Ended February 29, February 28, Change February 29, February 28, Change ($ in thousands, except for price) 2020 2019 % 2020 2019 % Steel revenues(1)$ 85,539 $ 74,025 16 %$ 162,864 $ 175,362 (7 )% Recycling revenues(2) 18,620 16,373 14 % 35,561 45,422 (22 )% Total segment revenues 104,159 90,398 15 % 198,425 220,784 (10 )% Segment operating income$ 3,524 $ 5,768 (39 )%$ 7,761 $ 17,686 (56 )% Finished steel average sales price ($/ST)(3) $ 627 $ 737 (15 )% $ 635 $ 743 (15 )% Finished steel sales volume (ST, in thousands) 129 94 37 % 242 213 14 % Rolling mill utilization(4) 72 % 76 % (5 )% 79 % 81 % (2 )%
ST =
(1) Steel revenues include primarily sales of finished steel products,
semi-finished goods (billets) and steel manufacturing scrap.
(2) Recycling revenues include primarily sales of ferrous and nonferrous recycled
scrap metal to export markets.
(3) Price information is shown after netting the cost of freight incurred to
deliver the product to the customer.
(4) Rolling mill utilization is based on effective annual production capacity
under current conditions of 580 thousand tons of finished steel products.
CSS Segment Revenues Revenues in the second quarter of fiscal 2020 increased by$14 million , or 15%, compared to the prior year period primarily reflecting significantly higher finished steel sales volumes, partially offset by lower average net selling prices for our finished steel products. Revenues in the first six months of fiscal 2020 decreased by$22 million , or 10%, compared to the prior year period primarily due to lower average net selling prices for our finished steel products and decreased sales of ferrous recycled scrap metal, partially offset by higher finished steel sales volumes. In the first half of fiscal 2019, CSS's finished steel sales volumes were adversely affected by the impact of construction delays in theWest Coast markets due to unusually severe winter weather inCalifornia and thePacific Northwest at the time.
CSS Segment Operating Income
Operating income in the second quarter and first six months of fiscal 2020 was$4 million and$8 million , respectively, compared to$6 million and$18 million , respectively, in the prior year periods, with the decreases primarily reflecting the impact of the declining price environment for finished steel during the first half of fiscal 2020. The declining prices led to a compression of finished steel margins in the first half of fiscal 2020, as decreases in selling prices outpaced the reduction in raw material purchase prices and other input costs. Finished steel average net selling prices in the second quarter and first six months of fiscal 2020 declined 15% compared to the prior year periods, the adverse effects of which were partially offset by higher finished steel sales volumes and benefits from productivity and restructuring initiatives compared to the prior year periods. The higher average net selling prices for our finished steel products in the prior year periods reflected the impacts of reduced pressure from steel imports and higher steel-making raw material costs at the time. Corporate Expense Corporate SG&A expense for the second quarter of fiscal 2020 increased by$2 million , or 29%, compared to the prior year quarter primarily due to higher employee-related expenses, including from higher incentive compensation accruals, and higher professional services fees. Corporate SG&A expense for the first six months of fiscal 2020 was materially consistent with the prior year period.
Productivity Initiatives and Restructuring Charges
In order to mitigate the weaker price environment in the ferrous and nonferrous markets, in fiscal 2019 we implemented productivity initiatives aimed at delivering$35 million in annual benefits primarily through a combination of production cost efficiencies and reductions in SG&A expense. Of the total, approximately 75% of the targeted benefits are in AMR with the remainder split between CSS and Corporate. For fiscal 2019, we achieved approximately$30 million in benefits as a result of these initiatives, with the full amount 34
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Table of ContentsSCHNITZER STEEL INDUSTRIES, INC. expected to be achieved in fiscal 2020. Our fiscal 2020 performance to date reflects achievement of the full quarterly run rate of these initiatives. In addition, in fiscal 2020 we also initiated and have substantially implemented productivity initiatives aimed at further reducing our annual operating expenses at Corporate, AMR and CSS, mainly through reductions in non-trade procurement spend, including outside and professional services, lower employee-related expenses and other non-headcount measures. We are targeting$15 million in realized benefits in fiscal 2020 from these additional initiatives, and we achieved approximately$4 million and$6 million in the second quarter and first six months of fiscal 2020, respectively. We expect to incur aggregate estimated restructuring charges and other exit-related costs of approximately$7 million in connection with these initiatives, the substantial majority of which are expected to be recognized in fiscal 2020 and will require the Company to make cash payments. The estimated charges consist primarily of professional services costs of$4 million , employee termination benefits of$2 million , and a loss associated with a lease contract termination of$1 million . In the second quarter of fiscal 2020, we incurred restructuring charges and other exit-related costs of$5 million related to these initiatives.
Income Tax
The effective tax rate from continuing operations for the second quarter and first six months of fiscal 2020 was an expense of 28.2% and a benefit of 26.8%, respectively, compared to an expense of 22.3% and 20.9%, respectively, for the comparable prior year periods. The effective tax rate from continuing operations for the second quarter and first six months of fiscal 2020 was higher than theU.S. federal statutory rate of 21% primarily due to the impact of non-deductible officers' compensation and other expenses, as well as the aggregate impact of state taxes, on the projected annual effective tax rate applied to the quarterly results.
Liquidity and Capital Resources
We rely on cash provided by operating activities as a primary source of liquidity, supplemented by current cash on hand and borrowings under our existing credit facilities.
Sources and Uses of Cash
We had cash balances of$10 million and$12 million as ofFebruary 29, 2020 andAugust 31, 2019 , respectively. Cash balances are intended to be used primarily for working capital, capital expenditures, dividends, share repurchases, investments and acquisitions. We use excess cash on hand to reduce amounts outstanding under our credit facilities. As ofFebruary 29, 2020 , debt was$142 million compared to$105 million as ofAugust 31, 2019 , and debt, net of cash, was$132 million as ofFebruary 29, 2020 compared to$93 million as ofAugust 31, 2019 (refer to Non-GAAP Financial Measures at the end of this Item 2). Operating Activities
Net cash provided by operating activities in the first six months of fiscal 2020
was
Sources of cash in the first six months of fiscal 2020 included a$9 million decrease in inventories due to lower raw material purchase prices and the timing of purchases and sales. Uses of cash in the first six months of fiscal 2020 included a$18 million increase in accounts receivable primarily due to the timing of sales and collections, a$8 million decrease in accounts payable primarily due to lower raw material purchase prices and the timing of payments, and a$7 million decrease in accrued payroll and related liabilities primarily due to the payment of incentive compensation previously accrued for under our fiscal 2019 plans. Sources of cash other than from earnings in the first six months of fiscal 2019 included a$16 million decrease in inventories due to lower raw material purchase prices, lower volumes on hand and the timing of purchases and sales. Uses of cash in the first six months of fiscal 2019 included a$26 million decrease in accrued payroll and related liabilities primarily due to incentive compensation payments in the first quarter of fiscal 2019, and a$24 million decrease in accounts payable primarily due to timing of payments.
Investing Activities
Net cash used in investing activities was
Cash used in investing activities in the first six months of fiscal 2020 included capital expenditures of$37 million to upgrade our equipment and infrastructure and for investments in advanced metals recovery technology and environmental and safety-related assets, compared to$41 million in the prior year period. 35
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Table of ContentsSCHNITZER STEEL INDUSTRIES, INC. Financing Activities
Net cash provided by financing activities in the first six months of fiscal 2020
was
Cash flows from financing activities in the first six months of fiscal 2020 included$36 million in net borrowings of debt, compared to$55 million in the prior year period (refer to Non-GAAP Financial Measures at the end of this Item 2). Uses of cash in the first six months of fiscal 2020 and 2019 included$11 million for the payment of dividends. Cash used in financing activities in the first six months of fiscal 2020 and 2019 also included$1 million and$10 million , respectively, for share repurchases.
Debt
Our senior secured revolving credit facilities, which provide for revolving loans of$700 million andC$15 million , mature inAugust 2023 pursuant to a credit agreement withBank of America, N.A ., as administrative agent, and other lenders party thereto. Interest rates on outstanding indebtedness under the credit agreement are based, at our option, on either the London Interbank Offered Rate ("LIBOR"), or the Canadian equivalent for C$ loans, plus a spread of between 1.25% and 2.75%, with the amount of the spread based on a pricing grid tied to our consolidated funded debt to EBITDA ratio, or the greater of (a) the prime rate, (b) the federal funds rate plus 0.50% or (c) the daily rate equal to one-month LIBOR plus 1.75%, in each case plus a spread of between zero and 1.50% based on a pricing grid tied to our consolidated funded debt to EBITDA ratio. In addition, commitment fees are payable on the unused portion of the credit facilities at rates between 0.15% and 0.45% based on a pricing grid tied to our consolidated funded debt to EBITDA ratio. We had borrowings outstanding under our credit facilities of$133 million as ofFebruary 29, 2020 and$97 million as ofAugust 31, 2019 . The weighted average interest rate on amounts outstanding under our credit facilities was 3.31% and 3.78% as ofFebruary 29, 2020 andAugust 31, 2019 , respectively. We use the credit facilities to fund working capital, capital expenditures, dividends, share repurchases, investments and acquisitions. The credit agreement contains various representations and warranties, events of default and financial and other customary covenants which limit (subject to certain exceptions) our ability to, among other things, incur or suffer to exist certain liens, make investments, incur or guaranty additional indebtedness, enter into consolidations, mergers, acquisitions, and sales of assets, make distributions and other restricted payments, change the nature of our business, engage in transactions with affiliates and enter into restrictive agreements, including agreements that restrict the ability of our subsidiaries to make distributions. The financial covenants under the credit agreement include (a) a consolidated fixed charge coverage ratio, defined as the four-quarter rolling sum of consolidated adjusted EBITDA less defined maintenance capital expenditures and certain environmental expenditures divided by consolidated fixed charges and (b) a consolidated leverage ratio, defined as consolidated funded indebtedness divided by the sum of consolidated net worth and consolidated funded indebtedness. As ofFebruary 29, 2020 , we were in compliance with the financial covenants under the credit agreement. The consolidated fixed charge coverage ratio was required to be no less than 1.50 to 1.00 and was 2.90 to 1.00 as ofFebruary 29, 2020 . The consolidated leverage ratio was required to be no more than 0.55 to 1.00 and was 0.18 to 1.00 as ofFebruary 29, 2020 . Our obligations under the credit agreement are guaranteed by substantially all of our subsidiaries. The credit facilities and the related guarantees are secured by senior first priority liens on certain of our and our subsidiaries' assets, including equipment, inventory and accounts receivable. While we currently expect to remain in compliance with the financial covenants under the credit agreement, we may not be able to do so in the event market conditions or other negative factors have a significant adverse impact on our results of operations and financial position. If we do not maintain compliance with our financial covenants and are unable to obtain an amendment or waiver from our lenders, a breach of a financial covenant would constitute an event of default and allow the lenders to exercise remedies under the agreements, the most severe of which is the termination of the credit facility under our committed bank credit agreement and acceleration of the amounts owed under the agreement. In such case, we would be required to evaluate available alternatives and take appropriate steps to obtain alternative funds. We cannot assure that any such alternative funds, if sought, could be obtained or, if obtained, would be adequate or on acceptable terms.
Capital Expenditures
Capital expenditures totaled$37 million for the first six months of fiscal 2020, compared to$41 million for the prior year period. We currently plan to invest up to$90 million in capital expenditures in fiscal 2020, including$50 million for investments in growth, including advanced metals recovery technology and to support volume initiatives and other growth projects, using cash generated from 36
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Table of ContentsSCHNITZER STEEL INDUSTRIES, INC. operations and available credit facilities. The progression of and global response to the COVID-19 outbreak has begun to cause and increases the risk of further delays in construction activities and equipment deliveries related to our capital projects, including potential delays in obtaining permits from government agencies, resulting in deferral of capital expenditures. Given the rapid and evolving nature of the COVID-19 matter, the extent of such deferrals is uncertain.
Environmental Compliance
Building on our commitment to recycling and operating our business in an environmentally responsible manner, we continue to invest in facilities that improve our environmental presence in the communities in which we operate. As part of our capital expenditures discussed in the prior paragraph, we invested$5 million in capital expenditures for environmental projects in the first six months of fiscal 2020, and currently plan to invest up to$10 million for such projects in fiscal 2020. These projects include investments in storm water systems and equipment to ensure ongoing compliance with air quality and other environmental regulations. We have been identified by theUnited States Environmental Protection Agency as one of the potentially responsible parties that own or operate or formerly owned or operated sites which are part of or adjacent to the Portland Harbor Superfund site (the "Site"). See Note 5 - Commitments and Contingencies in the Notes to the Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this report for a discussion of this matter, as well as other legacy environmental loss contingencies. We believe it is not possible to reasonably estimate the amount or range of costs which we are likely to or which it is reasonably possible that we will incur in connection with the Site, although such costs could be material to our financial position, results of operations, cash flows and liquidity. We have insurance policies that we believe will provide reimbursement for costs we incur for defense (including pre-remedial design investigative activities), remedial design, remedial action and mitigation for natural resource damages claims in connection with the Site, although there are no assurances that those policies will cover all of the costs which we may incur. Significant cash outflows in the future related to the Site and other environmental matters could reduce the amounts available for borrowing that could otherwise be used for working capital, capital expenditures, dividends, share repurchases, investments and acquisitions and could result in our failure to maintain compliance with certain covenants in our debt agreements, and could adversely impact our liquidity.
Dividends
OnJanuary 30, 2020 , our Board of Directors declared a dividend for the second quarter of fiscal 2020 of$0.1875 per common share, which equates to an annual cash dividend of$0.75 per common share. The dividend totaling$5 million was paid onFebruary 24, 2020 . Share Repurchase Program Pursuant to our amended share repurchase program, as ofFebruary 29, 2020 , we had existing authorization remaining under the program to repurchase up to approximately 706 thousand shares of our Class A common stock when we deem such repurchases to be appropriate. We may repurchase our common stock for a variety of reasons, such as to optimize our capital structure and to offset dilution related to share-based compensation arrangements. We consider several factors in determining whether to make share repurchases including, among other things, our cash needs, the availability of funding, our future business plans and the market price of our stock. In the second quarter of fiscal 2020, we repurchased 53 thousand shares of our Class A common stock in open-market transactions for a total of$0.9 million .
Assessment of Liquidity and Capital Resources
Historically, our available cash resources, internally generated funds, credit facilities and equity offerings have financed our acquisitions, capital expenditures, working capital and other financing needs.
We generally believe our current cash resources, internally generated funds, existing credit facilities and access to the capital markets will provide adequate short-term and long-term liquidity needs for working capital, capital expenditures, dividends, share repurchases, investments and acquisitions, joint ventures, debt service requirements, environmental obligations and other contingencies. However, in the event of a sustained market deterioration, we may need additional liquidity, which would require us to evaluate available alternatives and take appropriate steps to obtain sufficient additional funds. There can be no assurances that any such supplemental funding, if sought, could be obtained or, if obtained, would be adequate or on acceptable terms.
Off-Balance Sheet Arrangements
None requiring disclosure pursuant to Item 303 of Regulation S-K under the Securities Exchange Act of 1934.
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Contractual Obligations
There were no material changes related to contractual obligations and
commitments from the information provided in our Annual Report on Form 10-K for
the fiscal year ended
We maintain stand-by letters of credit to provide support for certain
obligations, including workers' compensation and performance bonds. As of
Critical Accounting Policies and Estimates
There were no material changes to our critical accounting policies and estimates as described in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of our Annual Report on Form 10-K for the year endedAugust 31, 2019 , except as follow:
We evaluate goodwill for impairment annually onJuly 1 and upon the occurrence of certain triggering events or substantive changes in circumstances that indicate that the fair value of goodwill may be impaired. There were no triggering events identified during the first half of fiscal 2020 requiring an interim goodwill impairment test. A lack of recovery or further deterioration in market conditions related to the general economy and the metals recycling industry, a sustained trend of weaker than anticipated financial performance, a lack of recovery or further decline in our share price for a sustained period of time, or an increase in the market-based weighted average cost of capital, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have a material adverse effect on our financial condition and results of operations. See "Subsequent Event" in Note 1 - Summary of Significant Accounting Policies in the Notes to the Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this report for discussion of the impact of COVID-19 on our estimates and assumptions relating to goodwill as ofFebruary 29, 2020 .
Leases
Refer to "Accounting Changes" within Note 1 - Summary of Significant Accounting Policies and Note 3 - Leases in the Notes to the Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this report for disclosures relating to our adoption of the new lease accounting standard in the first quarter of fiscal 2020.
Recently Issued Accounting Standards
We have not identified any recent accounting pronouncements that are expected to have a material impact on our financial condition, results of operations or cash flows upon adoption. Non-GAAP Financial Measures Debt, net of cash Debt, net of cash is the difference between (i) the sum of long-term debt and short-term borrowings (i.e., total debt) and (ii) cash and cash equivalents. We believe that debt, net of cash is a useful measure for investors because, as cash and cash equivalents can be used, among other things, to repay indebtedness, netting this against total debt is a useful measure of our leverage.
The following is a reconciliation of debt, net of cash (in thousands):
February 29, 2020 August 31, 2019 Short-term borrowings $ 1,411 $ 1,321 Long-term debt, net of current maturities 140,521
103,775
Total debt 141,932
105,096
Less cash and cash equivalents 10,326 12,377 Total debt, net of cash $ 131,606 $ 92,719 38
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Table of ContentsSCHNITZER STEEL INDUSTRIES, INC.
Net borrowings (repayments) of debt
Net borrowings (repayments) of debt is the sum of borrowings from long-term debt and repayments of long-term debt. We present this amount as the net change in borrowings (repayments) for the period because we believe it is useful to investors as a meaningful presentation of the change in debt. The following is a reconciliation of net borrowings (repayments) of debt (in thousands): Six Months EndedFebruary 29 ,February 28, 2020 2019
Borrowings from long-term debt
(208,614 ) (190,892 )
Net borrowings (repayments) of debt
Adjusted consolidated operating income (loss), adjusted AMR operating income, adjusted Corporate expense, adjusted net income (loss) from continuing operations attributable to SSI shareholders, and adjusted diluted earnings (loss) per share from continuing operations attributable to SSI shareholders.
Management believes that providing these non-GAAP financial measures adds a meaningful presentation of our results from business operations excluding adjustments for charges for legacy environmental matters, net of recoveries, asset impairment charges, restructuring charges and other exit-related activities, business development costs, and the income tax expense (benefit) allocated to these adjustments, items which are not related to underlying business operational performance, and improves the period-to-period comparability of our results from business operations. 39
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Table of Contents SCHNITZER STEEL INDUSTRIES, INC. The following is a reconciliation of adjusted consolidated operating income (loss), adjusted AMR operating income and adjusted Corporate expense (in thousands): Three Months Ended Six Months Ended February 29, February 28, February 29, February 28, 2020 2019 2020 2019 Consolidated operating income (loss): As reported$ 7,691 $ 19,036 $ (219 )$ 41,725 Charges for legacy environmental matters, net(1) 451 697 1,744 1,168 Restructuring charges and other exit-related activities 4,633 536 5,100 738 Business development costs 801 - 801 - Asset impairment charges 402 - 2,094 63 Adjusted$ 13,978 $ 20,269 $ 9,520 $ 43,694 AMR operating income: As reported$ 19,304 $ 21,741 $ 16,872 $ 44,758 Asset impairment charges 384 - 1,964 63 Adjusted$ 19,688 $ 21,741 $ 18,836 $ 44,821 Corporate expense: As reported$ 10,468 $ 8,095 $ 19,890 $ 20,300 Charges for legacy environmental matters, net(1) (451 ) (697 ) (1,744 ) (1,168 ) Business development costs (801 ) - (801 ) - Asset impairment charges (18 ) - (130 ) - Adjusted$ 9,198 $ 7,398
$ 17,215 $ 19,132
(1) Legal and environmental charges for legacy environmental matters, net of
recoveries. The prior year period has been recast for comparability. Legacy
environmental matters include charges (net of recoveries) related to the
Portland Harbor Superfund site and to other legacy environmental loss
contingencies. See Note 5 - Commitments and Contingencies, "
and "Other Legacy Environmental Loss Contingencies" in the Notes to the Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this report. 40
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Table of Contents SCHNITZER STEEL INDUSTRIES, INC. The following is a reconciliation of adjusted net income (loss) from continuing operations attributable to SSI shareholders and adjusted diluted earnings (loss) per share from continuing operations attributable to SSI shareholders (in thousands, except per share data): Three Months Ended Six Months Ended February 29, February 28, February 29, February 28, 2020 2019 2020 2019 Net income (loss) from continuing operations attributable to SSI shareholders: As reported$ 3,882 $ 13,030 $ (3,141 ) $ 29,290 Charges for legacy environmental matters, net(1) 451 697 1,744 1,168 Restructuring charges and other exit-related activities 4,633 536 5,100 738 Business development costs 801 - 801 - Asset impairment charges 402 - 2,094 63 Income tax benefit allocated to adjustments(2) (1,464 ) (259 ) (2,615 ) (443 ) Adjusted$ 8,705 $ 14,004 $ 3,983 $ 30,816 Diluted earnings (loss) per share from continuing operations attributable to SSI shareholders: As reported $ 0.14 $ 0.46$ (0.11 ) $ 1.04 Charges for legacy environmental matters, net, per share(1) 0.02 0.02 0.06 0.04 Restructuring charges and other exit-related activities, per share 0.16 0.02 0.18 0.03 Business development costs, per share 0.03 - 0.03 - Asset impairment charges, per share 0.01 - 0.08 - Income tax benefit allocated to adjustments, per share(2) (0.05 ) (0.01 ) (0.09 ) (0.02 ) Adjusted(3) $ 0.31 $ 0.50 $ 0.14 $ 1.09
(1) Legal and environmental charges for legacy environmental matters, net of
recoveries. The prior year period has been recast for comparability. Legacy
environmental matters include charges (net of recoveries) related to the
Portland Harbor Superfund site and to other legacy environmental loss
contingencies. See Note 5 - Commitments and Contingencies, "
and "Other Legacy Environmental Loss Contingencies" in the Notes to the
Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of
this report.
(2) Income tax allocated to the aggregate adjustments reconciling reported and
adjusted net income (loss) from continuing operations attributable to SSI
shareholders and diluted earnings (loss) per share from continuing operations
attributable to SSI shareholders is determined based on a tax provision
calculated with and without the adjustments.
(3) May not foot due to rounding.
We believe that these non-GAAP financial measures allow for a better understanding of our operating and financial performance. These non-GAAP financial measures should be considered in addition to, but not as a substitute for, the most directly comparableU.S. GAAP measures. Although we find these non-GAAP financial measures useful in evaluating the performance of our business, our reliance on these measures is limited because the adjustments often have a material impact on our consolidated financial statements presented in accordance with GAAP. Therefore, we typically use these adjusted amounts in conjunction with our GAAP results to address these limitations. 41
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