10-Q 1 c01962e10vq.txt QUARTERLY REPORT 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 DECEMBER 31, 2005 [ ] 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 0-14836 --------------------------- METAL MANAGEMENT, INC. (Exact Name of Registrant as Specified in Its Charter) --------------------------- DELAWARE 94-2835068 (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 325 N. LASALLE STREET, SUITE 550, CHICAGO, IL 60610 (Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (312) 645-0700 --------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Large accelerated filer ___ Accelerated filer X Non-accelerated filer ___ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ___ No X Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No ___ As of January 18, 2006, the registrant had 25,657,614 shares of common stock outstanding. INDEX
PAGE ---- PART I: FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Operations -- three and nine months ended December 31, 2005 and 2004 (unaudited) 1 Consolidated Balance Sheets -- December 31, 2005 and March 31, 2005 (unaudited) 2 Consolidated Statements of Cash Flows -- nine months ended December 31, 2005 and 2004 (unaudited) 3 Consolidated Statement of Stockholders' Equity -- nine months ended December 31, 2005 (unaudited) 4 Notes to Consolidated Financial Statements (unaudited) 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 3. Quantitative and Qualitative Disclosures about Market Risk 26 Item 4. Controls and Procedures 26 PART OTHER INFORMATION II: Item 1. Legal Proceedings 28 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29 Item 6. Exhibits 30 Signatures 31
PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS METAL MANAGEMENT, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited, in thousands, except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED --------------------------- --------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 2005 2004 2005 2004 ------------ ------------ ------------ ------------ NET SALES $ 395,090 $ 447,553 $ 1,155,025 $ 1,239,736 OPERATING EXPENSES: Cost of sales (excluding depreciation) 345,984 377,211 1,025,411 1,051,056 General and administrative 20,469 19,955 58,711 56,951 Depreciation and amortization 4,891 4,687 13,868 13,896 Asset impairment charge 995 0 995 0 ---------- ---------- ------------ ------------ OPERATING INCOME 22,751 45,700 56,040 117,833 Income from joint ventures 2,964 3,911 6,466 11,848 Interest expense (418) (649) (1,176) (2,883) Interest and other income (expense), net 376 (47) 1,433 27 Loss on debt extinguishment 0 0 0 (1,653) ---------- ---------- ------------ ------------ Income before income taxes 25,673 48,915 62,763 125,172 Provision for income taxes 10,327 19,433 25,050 49,112 ---------- ---------- ------------ ------------ NET INCOME $ 15,346 $ 29,482 $ 37,713 $ 76,060 ========== ========== ============ ============ EARNINGS PER SHARE: Basic $ 0.63 $ 1.26 $ 1.54 $ 3.29 ========== ========== ============ ============ Diluted $ 0.60 $ 1.19 $ 1.48 $ 3.11 ========== ========== ============ ============ CASH DIVIDENDS DECLARED PER SHARE $ 0.075 $ 0.075 $ 0.225 $ 0.075 ========== ========== ============ ============ WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: Basic 24,556 23,329 24,429 23,088 ========== ========== ============ ============ Diluted 25,733 24,833 25,533 24,437 ========== ========== ============ ============
See accompanying notes to consolidated financial statements 1 METAL MANAGEMENT, INC. CONSOLIDATED BALANCE SHEETS (unaudited, in thousands)
DECEMBER 31, MARCH 31, 2005 2005 ------------ ---------- ASSETS Current assets: Cash and cash equivalents $ 44,319 $ 52,821 Short-term investments 30,335 0 Accounts receivable, net 133,175 153,056 Inventories 111,516 96,345 Deferred income taxes 5,135 5,103 Prepaid expenses and other assets 8,838 4,193 ---------- ---------- TOTAL CURRENT ASSETS 333,318 311,518 Property and equipment, net 121,951 111,253 Goodwill and other intangibles, net 2,674 2,591 Deferred income taxes, net 8,725 10,996 Investments in joint ventures 40,431 39,782 Other assets 2,367 2,642 ---------- ---------- TOTAL ASSETS $ 509,466 $ 478,782 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 376 $ 367 Accounts payable 110,666 122,666 Income taxes payable 5,746 3,601 Other accrued liabilities 29,757 31,686 ---------- ---------- TOTAL CURRENT LIABILITIES 146,545 158,320 Long-term debt, less current portion 1,951 2,164 Other liabilities 4,832 5,682 ---------- ---------- TOTAL LONG-TERM LIABILITIES 6,783 7,846 Stockholders' equity: Preferred stock 0 0 Common stock 257 249 Warrants 233 395 Additional paid-in capital 177,929 167,649 Deferred compensation (6,777) (8,154) Accumulated other comprehensive loss (1,913) (1,913) Retained earnings 186,409 154,390 ---------- ---------- TOTAL STOCKHOLDERS' EQUITY 356,138 312,616 ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 509,466 $ 478,782 ========== ==========
See accompanying notes to consolidated financial statements 2 METAL MANAGEMENT, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited, in thousands)
NINE MONTHS ENDED ---------------------------- DECEMBER 31, DECEMBER 31, 2005 2004 ------------ ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 37,713 $ 76,060 Adjustments to reconcile net income to cash flows from operating activities: Depreciation and amortization 13,868 13,896 Deferred income taxes 2,350 29,003 Income from joint ventures (6,259) (11,848) Distributions of earnings from joint ventures 4,360 0 Stock-based compensation expense 5,545 3,299 Asset impairment charge 995 0 Amortization of debt issuance costs 476 574 Loss on debt extinguishment 0 1,653 Tax benefit on exercise of stock options and warrants 170 4,732 Other 1,150 1,896 Changes in assets and liabilities: Accounts and other receivables 19,502 (29,898) Inventories (15,171) (56,415) Accounts payable (15,525) 2,052 Income taxes 380 3,856 Other accrued liabilities (6,140) 3,371 Other (4,392) (4,667) ----------- ------------- Net cash provided by operating activities 39,022 37,564 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (22,065) (9,295) Proceeds from sale of property and equipment 798 1,232 Purchases of short-term investments (116,620) 0 Sales of short-term investments 86,285 0 Distributions of capital from joint ventures 1,250 0 Other 0 30 ----------- ------------- Net cash used in investing activities (50,352) (8,033) CASH FLOWS FROM FINANCING ACTIVITIES: Issuances of long-term debt 427,809 1,243,459 Repayments of long-term debt (428,013) (1,272,533) Proceeds from exercise of stock options and warrants 5,678 3,068 Cash dividends paid to stockholders (5,694) (1,808) Other 3,048 (1,470) ----------- ------------- Net cash provided by (used in) financing activities 2,828 (29,284) ----------- ------------- Net increase (decrease) in cash and cash equivalents (8,502) 247 Cash and cash equivalents at beginning of period 52,821 1,155 ----------- ------------- Cash and cash equivalents at end of period $ 44,319 $ 1,402 =========== ============= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash interest paid $ 690 $ 2,370 =========== ============= Cash income taxes paid $ 22,523 $ 11,520 =========== =============
See accompanying notes to consolidated financial statements 3 METAL MANAGEMENT, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (unaudited, in thousands)
ACCUMULATED ADDITIONAL DEFERRED OTHER COMMON STOCK PAID-IN STOCK-BASED COMPREHENSIVE RETAINED SHARES AMOUNT WARRANTS CAPITAL COMPENSATION LOSS EARNINGS TOTAL BALANCE AT MARCH 31, 2005 24,878 $ 249 $ 395 $ 167,649 $ (8,154) $ (1,913) $ 154,390 $ 312,616 Net income 0 0 0 0 0 0 37,713 37,713 ----------- Total comprehensive income 37,713 Issuance of restricted stock (net of cancellations) 203 2 0 4,166 (4,168) 0 0 0 Exercise of stock options and warrants and related tax benefits 572 6 (162) 6,004 0 0 0 5,848 Cash dividends paid to stockholders 0 0 0 0 0 0 (5,694) (5,694) Other 0 0 0 110 0 0 0 110 Stock-based compensation expense 0 0 0 0 5,545 0 0 5,545 ------ ------- -------- ---------- ---------- ---------- ----------- ----------- BALANCE AT DECEMBER 31, 2005 25,653 $ 257 $ 233 $ 177,929 $ (6,777) $ (1,913) $ 186,409 $ 356,138 ====== ======= ======== ========== ========== ========== =========== ===========
See accompanying notes to consolidated financial statements 4 METAL MANAGEMENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 -- BASIS OF PRESENTATION Organization and Business Metal Management, Inc., a Delaware corporation, and its wholly owned subsidiaries (the "Company") are principally engaged in the business of collecting and processing ferrous and non-ferrous scrap metals. The Company collects industrial scrap metal and obsolete scrap metal, processes it into reusable forms, and supplies the recycled metals to its customers, including electric-arc furnace mills, integrated steel mills, foundries, secondary smelters and metals brokers. These services are provided through the Company's recycling facilities located in 15 states. The Company's ferrous products primarily include shredded, sheared, cold briquetted and bundled scrap metal, and other purchased scrap metal, such as turnings, cast and broken furnace iron. The Company also processes non-ferrous metals, including aluminum, stainless steel and other nickel-bearing metals, copper, brass, titanium and high-temperature alloys, using similar techniques and through application of certain of the Company's proprietary technologies. The Company has one reportable segment operating in the scrap metal recycling industry, as determined in accordance with Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosure about Segments of an Enterprise and Related Information." Basis of Presentation The accompanying unaudited consolidated financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). All significant intercompany accounts, transactions and profits have been eliminated. Certain information related to the Company's organization, significant accounting policies and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These unaudited consolidated financial statements reflect, in the opinion of management, all material adjustments (which include normal recurring adjustments) necessary to fairly state the financial position and the results of operations for the periods presented. Operating results for interim periods are not necessarily indicative of the results that can be expected for a full year. These interim financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended March 31, 2005. Reclassifications Certain reclassifications have been made to prior year's financial information to conform to the current year presentation. On the statements of operations, stock-based compensation expense has been reclassified to general and administrative expenses. Such reclassifications had no material effect on the previously reported consolidated balance sheet, results of operations or cash flows of the Company. Revenue Recognition The Company's primary source of revenue is from the sale of processed ferrous and non-ferrous scrap metals. The Company also generates revenues from the brokering of scrap metals or from services performed, including but not limited to tolling, stevedoring and dismantling. Revenues from processed ferrous and non-ferrous scrap metal sales are recognized when title passes to the customer. Revenues relating to brokered sales are recognized upon receipt of the materials by the customer. Revenues from services are recognized as the service is performed. Sales adjustments related to price and weight differences and allowances for uncollectible receivables are accrued against revenues as incurred. 5 Revenues by product category were as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED --------------------------- --------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 2005 2004 2005 2004 ------------ ------------ ------------ ------------ Ferrous metals $ 255,731 $ 335,847 $ 747,482 $ 901,296 Non-ferrous metals 116,177 92,790 344,650 284,818 Brokerage -- ferrous 15,437 13,804 42,925 37,725 Brokerage -- non-ferrous 1,513 428 5,040 1,780 Other 6,232 4,684 14,928 14,117 ---------- ---------- ------------ ------------ Net sales $ 395,090 $ 447,553 $ 1,155,025 $ 1,239,736 ========== ========== ============ ============
Recently Issued Accounting Pronouncements In November 2004, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 151, "Inventory Costs -- an amendment of ARB No. 43, Chapter 4." SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage), requiring that these items be recognized as current-period charges and not capitalized in inventory overhead. In addition, this statement requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this statement is not expected to materially impact the Company's consolidated financial statements. In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment." The revised statement eliminates the ability to account for share-based compensation transactions using Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." This statement instead requires that all share-based payments to employees be recognized as compensation expense in the statement of operations based on their fair value over the applicable vesting period. The provisions of this statement are effective for fiscal years beginning after June 15, 2005. The Company will transition to SFAS No. 123(R) using the "modified prospective application" effective April 1, 2006. Under the "modified prospective application," compensation costs will be recognized in the financial statements for all new share-based payments granted after April 1, 2006. Additionally, the Company will recognize compensation costs for the portion of previously granted awards for which the requisite service has not been rendered ("nonvested awards") that are outstanding as of the effective date over the remaining requisite service period of the awards. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections -- a replacement of APB Opinion No. 20 and SFAS No. 3." This statement provides guidance on the accounting for and reporting of accounting changes and error corrections. It requires, unless impracticable, retrospective application for reporting a change in accounting principle, unless the newly adopted accounting principle specifies otherwise, and reporting of a correction of an error. The provisions of this statement are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of this statement is not expected to materially impact the Company's consolidated financial statements. 6 NOTE 2 -- EARNINGS PER SHARE Basic earnings per share ("EPS") is computed by dividing net income by the weighted average common shares outstanding. Diluted EPS reflects the potential dilution that could occur from the exercise of stock options and warrants and from unvested restricted stock. The following is a reconciliation of the numerators and denominators used in computing EPS (in thousands, except for per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED --------------------------- --------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 2005 2004 2005 2004 ------------ ------------ ------------ ------------ NUMERATOR: Net income $ 15,346 $ 29,482 $ 37,713 $ 76,060 ========= ========= ========= ========= DENOMINATOR: Weighted average common shares outstanding, basic 24,556 23,329 24,429 23,088 Incremental common shares attributable to dilutive stock options and warrants 786 1,275 806 1,210 Incremental common shares attributable to unvested restricted stock 391 229 298 139 --------- --------- --------- --------- Weighted average common shares outstanding, diluted 25,733 24,833 25,533 24,437 ========= ========= ========= ========= Basic income per share $ 0.63 $ 1.26 $ 1.54 $ 3.29 ========= ========= ========= ========= Diluted income per share $ 0.60 $ 1.19 $ 1.48 $ 3.11 ========= ========= ========= =========
For the three and nine months ended December 31, 2005, options and warrants to purchase 305,000 and 345,000 weighted average shares of common stock, respectively, were excluded from the diluted EPS calculation. For the three and nine months ended December 31, 2004, options and warrants to purchase 305,000 and 399,699 weighted average shares of common stock, respectively, were excluded from the diluted EPS calculation. These shares were excluded from the diluted EPS calculation as the option and warrant exercise prices were greater than the average market price of the Company's common stock for the respective periods referenced above, and therefore their inclusion would have been anti-dilutive. NOTE 3 -- STOCK-BASED COMPENSATION The Company accounts for stock-based compensation in accordance with APB No. 25 and related interpretations. Compensation expense for stock options and warrants is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of grant over the exercise price of the stock option or warrant. Compensation expense for restricted stock awards is measured at fair value on the date of grant based on the number of shares granted and the quoted market price of the Company's common stock. Such value is recognized as expense over the vesting period of the award. To the extent restricted stock awards are forfeited prior to vesting, the previously recognized expense is reversed. 7 The following table illustrates the pro forma effects on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" to stock-based compensation (in thousands, except for earnings per share):
THREE MONTHS ENDED NINE MONTHS ENDED --------------------------- --------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 2005 2004 2005 2004 ------------ ------------ ------------ ------------ Net income, as reported $ 15,346 $ 29,482 $ 37,713 $ 76,060 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 1,305 680 3,332 2,006 Deduct: Total stock-based compensation expense determined under the fair value method for all awards, net of related tax effects (1,547) (1,094) (4,002) (3,210) ----------- ----------- ----------- ----------- PRO FORMA NET INCOME $ 15,104 $ 29,068 $ 37,043 $ 74,856 =========== =========== =========== =========== Earnings per share: Basic -- as reported $ 0.63 $ 1.26 $ 1.54 $ 3.29 =========== =========== =========== =========== Basic -- pro forma $ 0.62 $ 1.25 $ 1.52 $ 3.24 =========== =========== =========== =========== Diluted -- as reported $ 0.60 $ 1.19 $ 1.48 $ 3.11 =========== =========== =========== =========== Diluted -- pro forma $ 0.59 $ 1.17 $ 1.45 $ 3.06 =========== =========== =========== ===========
Restricted Stock Restricted stock grants consist of shares of the Company's common stock which are awarded to employees. The grants are restricted such that they are subject to substantial risk of forfeiture and to restrictions on their sale or other transfer by the employee. In the three months ended December 31, 2005, the Company granted 25,000 shares of restricted stock, with a per share weighted average fair value of $24.20. There were no restricted stock grants made in the three months ended December 31, 2004. In the nine months ended December 31, 2005 and 2004, the Company granted 220,081 shares and 19,500 shares of restricted stock, with a per share weighted average fair value of $19.77 and $17.69, respectively. The Company recorded stock-based compensation expense related to restricted stock of approximately $2.2 million and $1.1 million in the three months ended December 31, 2005 and 2004, respectively, and $5.5 million and $3.3 million in the nine months ended December 31, 2005 and 2004, respectively. Summarized information for restricted stock issued by the Company is as follows:
SHARES --------- Restricted stock outstanding at March 31, 2005 569,258 Granted 220,081 Vested (4,500) Cancelled (17,552) --------- Restricted stock outstanding at December 31, 2005 767,287 =========
Employee Stock Purchase Plan On October 1, 2005, the Metal Management, Inc. Employee Stock Purchase Plan (the "ESPP") became effective and 1.0 million shares of the Company's common stock were reserved for issuance. Eligible employees may purchase a limited number of shares of the Company's common stock at a discount of 15% of 8 the lesser of the fair market value of the Company's common stock at the beginning of an offering period or the end of an offering period. The ESPP has four quarterly offering periods per year. NOTE 4 -- OTHER BALANCE SHEET INFORMATION Short-term Investments All investments with original maturities of greater than 90 days are accounted for in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Company determines the appropriate classification at the time of purchase. At December 31, 2005, the Company had short-term investments of approximately $30.3 million, which mainly consisted of investments in auction rate securities which are classified as available-for-sale. Auction rate securities consist of tax-free bonds issued by municipalities which mainly carry AAA ratings. Investments in auction rate securities are recorded at cost, which approximates fair value due to their variable interest rates which reset every 7 to 30 days. As a result, these securities are classified as current assets. Despite the long-term nature of their stated contractual maturities, there is a readily liquid market for these securities. As a result, the Company had no cumulative gross unrealized holding gains (losses) or gross realized gains (losses) from its short-term investments. All income generated from these investments was recorded as other income. Inventories Inventories for all periods presented are stated at the lower of cost or market. Cost is determined principally on the average cost method. Inventories consist of the following at (in thousands):
DECEMBER 31, MARCH 31, 2005 2005 --------------- ------------ Ferrous metals $ 59,639 $ 58,215 Non-ferrous metals 51,698 37,888 Other 179 242 ----------- ---------- $ 111,516 $ 96,345 =========== ==========
Property and Equipment Property and equipment consists of the following at (in thousands):
DECEMBER 31, MARCH 31, 2005 2005 --------------- ------------ Land and improvements $ 32,241 $ 30,704 Buildings and improvements 24,673 22,069 Operating machinery and equipment 112,146 98,978 Automobiles and trucks 11,135 10,687 Computer equipment and software 1,930 1,995 Furniture, fixtures and office equipment 783 790 Construction in progress 9,242 6,709 ----------- ----------- 192,150 171,932 Less -- accumulated depreciation (70,199) (60,679) ----------- ----------- $ 121,951 $ 111,253 =========== ===========
At December 31, 2005, the Company recorded $4 million of construction in progress and an offsetting liability in other accrued liabilities relating to the construction of a stevedoring crane to be leased by the Company upon completion. The Company expects the stevedoring crane to be delivered in April 2006. The Company is considered the owner of the stevedoring crane during its construction and must record the amount paid to-date by the lessor for the construction as an asset and liability. In the three months ended December 31, 2005, the Company completed a strategy designed to improve the profitability of its Chicago-area scrap yards. As a part of that strategy, a decision was made to consolidate 9 processing activities at the Chicago-area scrap yards. In the three months ended December 31, 2005, the Company idled a shredder and a baler. The baler was sold to a third party at approximately its net book value. The shredder is categorized as held and used and its carrying value was written down to its estimated fair value resulting in a $1.0 million asset impairment charge. Other Accrued Liabilities Other accrued liabilities consist of the following at (in thousands):
DECEMBER 31, MARCH 31, 2005 2005 ------------ ----------- Accrued employee compensation and benefits $ 16,519 $ 21,731 Accrued insurance 5,063 4,324 Accrued real and personal property taxes 1,672 2,237 Accrued equipment purchase commitment 4,000 0 Other 2,503 3,394 --------- --------- $ 29,757 $ 31,686 ========= =========
Accrued Severance and Other Charges During the year ended March 31, 2004, the Company implemented a management realignment that resulted in the recognition of $6.2 million of charges consisting mainly of employee severance payments. As of December 31, 2005, approximately $1.2 million is remaining to be paid, which is reflected in other accrued liabilities. These payments were to be made in July 2005, however, the Company is contesting these payments (see Note 8 -- Commitments and Contingencies). Income Taxes In November 2005, the Internal Revenue Service ("IRS") commenced an examination of the Company's federal income tax return for fiscal 2004. At this preliminary stage of the examination, no matters have been brought to the Company's attention by the IRS, nor is the Company aware of any tax matters, which would have a material adverse effect on its consolidated balance sheet, results of operations or cash flows. NOTE 5 -- GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and other intangible assets consist of the following at (in thousands):
DECEMBER 31, 2005 MARCH 31, 2005 ------------------------- ------------------------- GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED AMOUNT AMORTIZATION AMOUNT AMORTIZATION ------ ------------ ------ ------------ Other intangibles: Customer lists $ 1,280 $ (277) $ 1,280 $ (213) Non-compete agreement 290 (197) 290 (144) Pension intangible 98 0 98 0 Goodwill 1,480 0 1,280 0 ---------- --------- ---------- --------- Goodwill and other intangibles, net $ 3,148 $ (474) $ 2,948 $ (357) ========== ========= ========== =========
The increase in goodwill in the nine months ended December 31, 2005 was due to contingent consideration paid in connection with an acquisition. Total amortization expense for other intangibles in the three and nine months ended December 31, 2005 was $39,000 and $117,000, respectively. Based on the other intangible assets recorded as of December 31, 2005, annual amortization expense for other intangible assets will be approximately $0.1 million for each of the fiscal years 2007 through 2011. 10 NOTE 6 -- LONG-TERM DEBT Long-term debt consists of the following at (in thousands):
DECEMBER 31, MARCH 31, 2005 2005 ------------ ------------ Mortgage loan (interest rate of 5.50%) due January 2009 $ 1,967 $ 2,193 Other debt (including capital leases) 360 338 ---------- ---------- 2,327 2,531 Less -- current portion of long-term debt (376) (367) ---------- ---------- $ 1,951 $ 2,164 ========== ==========
Credit Agreement In June 2004, the Company entered into a $200 million secured four-year revolving credit and letter of credit facility, as amended, with a maturity date of June 28, 2008 (the "Credit Agreement"). As of December 31, 2005, the Company had no outstanding borrowings under its Credit Agreement. Interest rates under the Credit Agreement are based on variable rates tied to the prime rate plus a margin or the London Interbank Offered Rate ("LIBOR") plus a margin. The margin is based on the Company's leverage ratio (as defined in the Credit Agreement) as determined for the trailing four fiscal quarters. Based on the Company's current leverage ratio, LIBOR and prime rate margins are 125 basis points and 0 basis points, respectively. Borrowings under the Credit Agreement are generally subject to borrowing base limitations based upon a formula equal to 85% of eligible accounts receivable plus the lesser of $65 million or 70% of eligible inventory. Inventories cannot represent more than 40% of the total borrowing base. A security interest in substantially all of the Company's assets and properties, other than equipment, fixtures and real property, unless and until the average excess availability for any two consecutive months is less than $10 million, has been granted to the agent for the lenders as collateral against the Company's obligations under the Credit Agreement. Pursuant to the Credit Agreement, the Company pays a fee on the undrawn portion of the facility that is determined by the leverage ratio. As of December 31, 2005, that fee was 0.25% per annum. Under the Credit Agreement, the Company is required to satisfy specified financial covenants, including a maximum leverage ratio of 2.50 to 1.00, a minimum consolidated fixed charge coverage ratio of 1.50 to 1.00 and a minimum tangible net worth of not less than the sum of $110 million plus 25% of consolidated net income earned in each fiscal quarter. The leverage ratio and consolidated fixed charge coverage ratio are tested for the twelve-month period ending each fiscal quarter. The Credit Agreement also limits capital expenditures to $20 million for the twelve-month period ending each fiscal quarter. As a result of an amendment to the Credit Agreement, the Company's limit on capital expenditures was increased to $40 million for fiscal 2006. The Credit Agreement contains restrictions which, among other things, limits the Company's ability to (i) incur additional indebtedness; (ii) pay dividends under certain conditions; (iii) enter into transactions with affiliates; (iv) enter into certain asset sales; (v) engage in certain acquisitions, investments, mergers and consolidations; (vi) prepay certain other indebtedness; (vii) create liens and encumbrances on Company assets; and (viii) engage in other matters customarily restricted in such agreements. The Company's ability to meet financial ratios and tests in the future may be affected by events beyond its control, including fluctuations in operating cash flows and working capital. While the Company currently expects to be in compliance with the covenants and satisfy the financial ratios and tests in the future, there can be no assurance that the Company will meet such financial ratios and tests or that it will be able to obtain future amendments or waivers to the Credit Agreement, if so needed, to avoid a default. In the event of a default, the lenders could elect to not make loans available to the Company and declare all amounts borrowed under the Credit Agreement to be due and payable. On June 28, 2004, the Company paid off all balances under its previous credit agreement with proceeds from its Credit Agreement. The Company recognized a loss on debt extinguishment of $1.7 million associated 11 with the repayment of its previous credit agreement. This amount represented a write-off of a portion of the unamortized deferred financing costs associated with the previous credit agreement. NOTE 7 -- EMPLOYEE BENEFIT PLANS The Company sponsors three defined benefit pension plans for employees at certain of its subsidiaries. Only employees covered under collective bargaining agreements accrue future benefits under these defined benefit pension plans. These benefits are based either on years of service and compensation or on years of service at fixed benefit rates. The Company's funding policy for the pension plans is to contribute amounts required to meet regulatory requirements. The components of net pension costs were as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED --------------------------- --------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 2005 2004 2005 2004 ------------ ------------ ------------ ------------ Service cost $ 41 $ 33 $ 124 $ 98 Interest cost 174 173 524 521 Expected return on plan assets (174) (158) (523) (473) Amortization of prior service cost 24 24 71 71 Recognized net actuarial loss 49 34 147 100 -------- -------- -------- -------- Net periodic benefit cost $ 114 $ 106 $ 343 $ 317 ======== ======== ======== ========
In the nine months ended December 31, 2005, the Company made cash contributions of $0.7 million to its pension plans. Based on estimates provided by its actuaries, the Company expects to make cash funding contributions to its pension plans of approximately $0.2 million by March 31, 2006. NOTE 8 -- COMMITMENTS AND CONTINGENCIES Environmental Matters The Company is subject to comprehensive local, state, federal and international regulatory and statutory environmental requirements relating to, among others, the acceptance, storage, treatment, handling and disposal of solid waste and hazardous waste, the discharge of materials into air, the management and treatment of wastewater and storm water, the remediation of soil and groundwater contamination, the restoration of natural resource damages and the protection of employees' health and safety. The Company believes that it and its subsidiaries are in material compliance with currently applicable statutes and regulations governing the protection of human health and the environment, including employee health and safety. However, environmental legislation may in the future be enacted and create liability for past actions and the Company or its subsidiaries may be fined or held liable for damages. Certain of the Company's subsidiaries have received notices from the United States Environmental Protection Agency ("EPA"), state agencies or third parties that the subsidiary has been identified as potentially responsible for the cost of investigation and cleanup of landfills or other sites where the subsidiary's material was shipped. In most cases, many other parties are also named as potentially responsible parties. The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA" or "Superfund") enables EPA and state agencies to recover from owners, operators, generators and transporters the cost of investigation and cleanup of sites which pose serious threats to the environment or public health. In certain circumstances, a potentially responsible party can be held jointly and severally liable for the cost of cleanup. In other cases, a party who is liable may only be liable for a divisible share. Liability can be imposed even if the party shipped materials in a lawful manner at the time of shipment and the liability for investigation and cleanup costs can be significant, particularly in cases where joint and several liability may be imposed. CERCLA, including the Superfund Recycling Equity Act of 1999, limits the exposure of scrap metal recyclers for sales of certain recyclable material under certain circumstances. However, the recycling defense is subject to conducting reasonable care evaluations of current and potential consumers. 12 Because CERCLA can be imposed retroactively on shipments that occurred many years ago, and because EPA and state agencies are still discovering sites that present problems to public heath or the environment, the Company can provide no assurance that it will not become liable in the future for significant costs associated with investigation and remediation of CERCLA waste sites. On July 1, 1998, Metal Management Connecticut, Inc. ("MTLM-Connecticut"), a subsidiary of the Company, acquired the scrap metal recycling assets of Joseph A. Schiavone Corp. (formerly known as Michael Schiavone & Sons, Inc.). The acquired assets include real property in North Haven, Connecticut upon which MTLM-Connecticut's scrap metal recycling operations are currently performed (the "North Haven Facility"). The owner of Joseph A. Schiavone Corp. was Michael Schiavone ("Schiavone"). On March 31, 2003, the Connecticut Department of Environmental Protection ("CTDEP") filed suit against Joseph A. Schiavone Corp., Schiavone, and MTLM-Connecticut in the Superior Court of the State of Connecticut -- Judicial District of Hartford. The suit alleges, among other things, that the North Haven Facility discharged and continues to discharge contaminants, including oily material, into the environment and has failed to comply with the terms of certain permits and other filing requirements. The suit seeks injunctions to restrict MTLM-Connecticut from maintaining discharges and to require MTLM-Connecticut to remediate the facility. The suit also seeks civil penalties from all of the defendants in accordance with Connecticut environmental statutes. At this stage, the Company is not able to predict MTLM-Connecticut's potential liability in connection with this action or any required investigation and/or remediation. The Company believes that MTLM-Connecticut has meritorious defenses to certain of the claims asserted in the suit and MTLM-Connecticut intends to vigorously defend itself against the claims. In addition, the Company believes it is entitled to indemnification from Joseph A. Schiavone Corp. and Schiavone for some or all of the obligations and liabilities that may be imposed on MTLM-Connecticut in connection with this matter under the various agreements governing its purchase of the North Haven Facility from Joseph A. Schiavone Corp. The Company cannot provide assurances that Joseph A. Schiavone Corp. or Schiavone will have sufficient resources to fund any or all indemnifiable claims that the Company may assert. In a letter dated July 13, 2005, MTLM-Connecticut and the Company received notification from Schiavone of his demand seeking indemnification (including the advance of all costs, charges and expenses incurred by Schiavone in connection with his defense) from MTLM-Connecticut and the Company to those claims made against Schiavone in the action brought by CTDEP. Schiavone's demand refers to his employment agreement and to the certificate of incorporation of MTLM-Connecticut, which provide for indemnification against claims by reason of his being or having been a director, officer, employee, or agent of MTLM-Connecticut, or serving or having served at the request of MTLM-Connecticut as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, or other enterprise to the fullest extent permitted by applicable law. The Company has engaged in settlement discussions with Joseph A. Schiavone Corp., Schiavone and CTDEP regarding the possible characterization of the North Haven Facility, and the subsequent remediation thereof should contamination be present at concentrations that require remedial action. The Company is currently working with an independent environmental consultant to develop an acceptable characterization plan. The Company cannot provide assurances that it will be able to reach an acceptable settlement of this matter with the other parties. On April 29, 1998, Metal Management Midwest, Inc. ("MTLM-Midwest"), a subsidiary of the Company, acquired substantially all of the operating assets of 138 Scrap, Inc. ("138 Scrap") that were used in its scrap metal recycling business. Most of these assets were located at a recycling facility in Riverdale, Illinois (the "Facility"). In early November 2003, MTLM-Midwest was served with a Notice of Intent to Sue (the "Notice") by The Jeff Diver Group, L.L.C., on behalf of the Village of Riverdale, alleging, among other things, that the release or disposal of hazardous substances within the meaning of CERCLA has occurred at an approximately 57 acre property in the Village of Riverdale (which includes the 8.8 acre Facility that was leased by MTLM-Midwest until December 31, 2003). The Notice indicates that the Village of Riverdale intends to file suit against MTLM-Midwest (directly and as a successor to 138 Scrap) and numerous other third parties under one or both of CERCLA and the Resource Conservation and Recovery Act. At this preliminary stage, the Company cannot predict MTLM-Midwest's potential liability, if any, in connection 13 with such lawsuit or any required remediation. The Company believes that it has meritorious defenses to certain of the claims outlined in the Notice and MTLM-Midwest intends to vigorously defend itself against any claims ultimately asserted by the Village of Riverdale. In addition, although the Company believes that it would be entitled to indemnification from the sellers of 138 Scrap for some or all of the obligations that may be imposed on MTLM-Midwest in connection with this matter under the agreement governing its purchase of the operating assets of 138 Scrap, the Company cannot provide assurances that any of the sellers will have sufficient resources to fund any indemnifiable claims to which the Company may be entitled. On September 22, 2005 and September 23, 2005, CTDEP's Bureau of Water Management and Bureau of Waste Management each issued a Notice of Violation ("NOV") to Metal Management Aerospace, Inc. ("MTLM-Aerospace"), a subsidiary of the Company, for alleged violations at MTLM-Aerospace's facility, including, among other things, (1) operation of a solid waste facility without the approval of CTDEP; (2) failure to comply with certain environmental regulations regarding the handling of used oil, the performance of certain hazardous waste determinations, the disposal of PCBs and the discharge of oils and coolants; (3) failure to comply with certain discharge reporting obligations; (4) creation of certain potential environmental hazards; (5) inadequacy or improper maintenance of certain pollution management devices, including erosion and sediment controls and release detection for an underground diesel storage tank; and (6) failure to comply with a pollution prevention plan. On October 21, 2005, MTLM-Aerospace submitted substantive responses to CTDEP regarding the NOVs. At this time, the Company is unable to determine MTLM-Aerospace's potential liability in connection with these NOVs. The Company believes that MTLM-Aerospace has meritorious defenses to certain of the allegations outlined in the NOVs. In addition, although the Company believes that by virtue of certain consent orders, Connecticut Transfer Act obligations, and lease/transactional documents executed by the lessor and former owner, certain environmental liabilities noted in the NOVs will be the responsibility of the lessor and former owner, there can be no assurance that the lessor and former owner will have sufficient resources to fund any or all of such liabilities. On August 22, 2005, the Occupational Safety and Health Administration ("OSHA") requested that MTLM-Aerospace conduct an internal investigation of a recent accident. MTLM-Aerospace responded to this request in a timely manner. OSHA subsequently determined to conduct its own investigation, following which it issued citations to MTLM-Aerospace generally involving preventive maintenance procedures and safety procedures and training. On January 23, 2006, MTLM-Aerospace entered into an informal settlement agreement with OSHA pursuant to which MTLM-Aerospace agreed, among other things, to pay an aggregate penalty in the amount of $24,662.50, to maintain a formal preventive maintenance program and to engage an engineer to develop certain procedures in which employees are to be trained and monitored to ensure compliance. On November 24, 2005, OSHA commenced an investigation into a recent accident at the Company's Newark facility that involved an employee fatality. The Company is cooperating with OSHA's ongoing investigation. At this time, OSHA has not taken any action with respect to this incident. At this preliminary stage, the Company cannot predict the likelihood of any citations, the extent of any penalties or other impact to the Company of such investigation. Legal Proceedings In January 2003, the Company received a subpoena requesting that it provide documents to a grand jury that is investigating scrap metal purchasing practices in the four state region of Ohio, Illinois, Indiana and Michigan. The Company is fully cooperating with the subpoena and the grand jury's investigation. The Company is unable at this stage to determine future legal costs or other costs to be incurred in responding to such subpoena or other impact to the Company of such investigation. As a result of internal audits conducted by the Company, the Company determined that current and former employees of certain business units engaged in activities relating to cash payments to individual industrial account suppliers of scrap metal that may have involved violations of federal and state law. In May 2004, the Company voluntarily disclosed its concerns regarding such cash payments to the U.S. Department of 14 Justice. The Board of Directors appointed a special committee, consisting of all of its independent directors, to conduct an investigation of these activities. The Company is cooperating with the U.S. Department of Justice. The Company implemented policies to eliminate cash payments to industrial customers. During the year ended March 31, 2004, such cash payments to industrial customers represented approximately 0.7% of the Company's consolidated ferrous and non-ferrous yard shipments. The fines and penalties under applicable statutes contemplate qualitative as well as quantitative factors that are not readily assessable at this stage of the investigation, but could be material. The Company is not able to predict at this time the outcome of any actions by the U.S. Department of Justice or other governmental authorities or their effect on the Company, if any, and accordingly, the Company has not recorded any amounts in the financial statements. The Company has incurred legal and other costs related to this matter of approximately $2.3 million to date. On July 15, 2005, the Company and MTLM-Midwest filed a complaint (the "Complaint") against former officers and directors Albert A. Cozzi, Frank J. Cozzi, and Gregory P. Cozzi (collectively, the "Defendants") in the Circuit Court of Cook County Illinois, County Department, Chancery Division. The Complaint seeks damages from Frank J. Cozzi and Gregory P. Cozzi for their actions in designing, implementing, and maintaining cash payment practices in MTLM-Midwest's accounts payable that violated Company policy and, potentially, federal law. The Complaint also alleges that the Defendants breached the non-competition and non-solicitation provisions of their respective separation and release agreements by seeking to engage in business activities and seeking to solicit suppliers, customers and service providers in competition with the Company's business. The Complaint seeks, among other things, monetary compensation for the Company's actual losses and damages, and an injunction restraining and enjoining the Defendants from breaching their respective separation and release agreements. On October 21, 2005, Defendants moved to dismiss the Complaint or in the alternative to compel arbitration and stay the judicial proceedings. Defendants also filed a counterclaim seeking recovery of unpaid employee severance payments of approximately $1.2 million. From time to time, the Company is involved in various litigation matters involving ordinary and routine claims incidental to its business. A significant portion of these matters result from environmental compliance issues and workers compensation related claims arising from the Company's operations. There are presently no legal proceedings pending against the Company, which, in the opinion of the Company's management, is likely to have a material adverse effect on its business, financial condition or results of operations. 15 This Form 10-Q includes certain statements that may be deemed to be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Statements in this Form 10-Q which address activities, events or developments that Metal Management, Inc. (herein, "Metal Management," the "Company," "we," "us," "our" or other similar terms) expects or anticipates will or may occur in the future, including such things as future acquisitions (including the amount and nature thereof), business strategy, expansion and growth of our business and operations, general economic and market conditions and other such matters are forward-looking statements. Although we believe the expectations expressed in such forward-looking statements are based on reasonable assumptions within the bounds of our knowledge of our business, a number of factors could cause actual results to differ materially from those expressed in any forward-looking statements. These and other risks, uncertainties and other factors are discussed under "Risk Factors" appearing in our Annual Report on Form 10-K for the year ended March 31, 2005, as the same may be amended from time to time. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the unaudited consolidated financial statements and notes thereto included under Item 1 of this Report. In addition, reference should be made to the audited consolidated financial statements and notes thereto and related Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended March 31, 2005 ("Annual Report"). OVERVIEW We are one of the largest domestic scrap metal recycling companies with approximately 40 facilities in 15 states. We enjoy leadership positions in many major metropolitan markets, such as Birmingham, Chicago, Cleveland, Denver, Hartford, Houston, Memphis, Newark, New Haven, Phoenix, Pittsburgh, Salt Lake City, Toledo and Tucson. We have a 28.5% equity ownership position in Southern Recycling, L.L.C. ("Southern"), one of the largest scrap metals recyclers in the Gulf Coast region. We operate in one reportable segment, the scrap metal recycling industry. Our operations primarily involve the collection and processing of ferrous and non-ferrous scrap metals. We collect industrial scrap metal and obsolete scrap metal, process it into reusable forms and supply the recycled metals to our customers, including electric-arc furnace mills, integrated steel mills, foundries, secondary smelters and metal brokers. In addition to buying, processing and selling ferrous and non-ferrous scrap metals, we are periodically retained as demolition contractors in certain of our large metropolitan markets in which we dismantle obsolete machinery, buildings and other structures containing metal and, in the process, collect both the ferrous and non-ferrous metals from these sources. At certain of our locations adjacent to commercial waterways, we provide stevedoring services. We also operate a bus dismantling business combined with a bus replacement parts business in Newark, New Jersey. We believe that we provide one of the most comprehensive product offerings of both ferrous and non-ferrous scrap metals. Our ferrous products primarily include shredded, sheared, cold briquetted and bundled scrap metal, and other purchased scrap metal, such as turnings, cast and broken furnace iron. We also process non-ferrous scrap metals, including aluminum, copper, stainless steel and other nickel-bearing metals, brass, titanium and high-temperature alloys, using similar techniques and through application of our proprietary technologies. RECENT EVENTS Southern operates approximately 15 scrap metals facilities in the Gulf Coast region across the states of Louisiana, Mississippi, Alabama and Florida, with its largest single processing facility in New Orleans. Due to Hurricane Katrina in August 2005, Southern incurred damage at its facilities and suffered disruptions to its operations in New Orleans and Gulfport, Mississippi. Southern has recently relocated its headquarters from New Orleans to Covington, Louisiana. Southern has advised us that it recently restarted its New Orleans processing facility and that its overall operations are currently operating at approximately 95% of capacity. 16 RESULTS OF OPERATIONS After achieving record results in fiscal 2005, our results for the three and nine months ended December 31, 2005 were impacted by extreme price volatility in ferrous scrap metals. In the three months ended June 30, 2005, we experienced lower domestic demand for ferrous scrap metals as a result of a buildup in steel mill raw material inventories exacerbated by slower demand for finished steel. In the months of May and June 2005, prices for certain grades of ferrous scrap declined by more than $100 per ton. As a result, ferrous scrap metal prices declined and we experienced lower ferrous scrap metal margins in the three months ended June 30, 2005. Ferrous scrap metal prices rebounded in August and September 2005 and our metal margins improved accordingly in the three months ended September 30, 2005. Ferrous prices fluctuated greatly again in the three months ended December 31, 2005, with factory bundle prices declining by approximately $73 per ton in October 2005 before increasing by approximately $53 per ton in November 2005. Factory bundle prices were largely unchanged in December 2005 compared to November 2005. Extreme volatility in ferrous scrap metal prices in calendar 2005 has caused significant fluctuations in our profitability and rendered the business more complex to manage. The volatility in ferrous scrap metal prices is evident in data published by the American Metal Market ("AMM"). According to AMM, the average price for #1 Heavy Melting Steel Scrap -- Chicago (which is a common indicator for ferrous scrap) declined from $217 per ton in April 2005 to approximately $125 per ton in June 2005 and then recovered to $241 per ton in September 2005. The average price for #1 Heavy Melting Steel Scrap -- Chicago declined again in October 2005 but recovered to $242 per ton in December 2005. Our non-ferrous businesses continued to perform well in the three and nine months ended December 31, 2005, primarily due to strong demand from our consumers in the aerospace industry. This also resulted in higher pricing for high-temperature alloys and nickel-based metals and alloys, which resulted in higher sales and material margins and also increased requirements for investments in non-ferrous inventories. As of December 31, 2005 investments in inventory at our non-ferrous operations were nearly $52 million, primarily because of increasing prices. Although our results of operations in the three and nine months ended December 31, 2005 demonstrated lower profitability compared to the three and nine months ended December 31, 2004, our objective of turning our inventories rather than speculating on commodity prices allowed us to remain profitable, despite lower ferrous metal prices in fiscal 2006 compared to fiscal 2005. 17 The following table sets forth selected statement of operations and sales volume data for the three and nine months ended December 31, 2005 and 2004. STATEMENT OF OPERATIONS SELECTED ITEMS ($ IN THOUSANDS)
THREE MONTHS ENDED DECEMBER 31, NINE MONTHS ENDED DECEMBER 31, ----------------------------------- --------------------------------------- 2005 % 2004 % 2005 % 2004 % ---- - ---- - ---- - ---- - SALES BY COMMODITY: Ferrous metals $255,731 64.7% $335,847 75.0% $ 747,482 64.7% $ 901,296 72.7% Non-ferrous metals 116,177 29.4 92,790 20.7 344,650 29.8 284,818 23.0 Brokerage - ferrous 15,437 3.9 13,804 3.1 42,925 3.7 37,725 3.0 Brokerage - non-ferrous 1,513 0.4 428 0.1 5,040 0.4 1,780 0.2 Other 6,232 1.6 4,684 1.1 14,928 1.4 14,117 1.1 -------- ----- -------- ----- ---------- ----- ---------- ----- Net sales 395,090 100.0% 447,553 100.0% 1,155,025 100.0% 1,239,736 100.0% Cost of sales (excluding depreciation) 345,984 87.6 377,211 84.3 1,025,411 88.8 1,051,056 84.8 General and administrative expense 20,469 5.2 19,955 4.5 58,711 5.1 56,951 4.6 Depreciation and amortization expense 4,891 1.2 4,687 1.0 13,868 1.2 13,896 1.1 Asset impairment charge 995 0.3 0 0.0 995 0.1 0 0.0 Income from joint ventures 2,964 0.8 3,911 0.9 6,466 0.6 11,848 1.0 Interest expense (418) 0.1 (649) 0.1 (1,176) 0.1 (2,883) 0.2 Interest and other income (expense), net 376 0.1 (47) 0.0 1,433 0.1 27 0.0 Loss on debt extinguishment 0 0.0 0 0.0 0 0.0 (1,653) 0.1 Provision for income taxes 10,327 2.6 19,433 4.4 25,050 2.1 49,112 4.0 -------- ----- -------- ----- ---------- ----- ---------- ----- Net income $ 15,346 3.9% $ 29,482 6.6% $ 37,713 3.3% $ 76,060 6.2% ======== ===== ======== ===== ========== ===== ========== =====
SALES VOLUME BY COMMODITY 2005 2004 2005 2004 (IN THOUSANDS): ---- ---- ---- ---- Ferrous metals (tons) 1,060 1,129 3,210 3,433 Non-ferrous metals (lbs.) 124,334 115,362 355,784 367,801 Brokerage - ferrous (tons) 69 51 207 150 Brokerage - non-ferrous (lbs.) 1,478 551 4,720 1,994
NET SALES Consolidated net sales decreased by $52.5 million (11.7%) and $84.7 million (6.8%) to $395.1 million and $1.16 billion in the three and nine months ended December 31, 2005, respectively, compared to consolidated net sales of $447.6 million and $1.24 billion in the three and nine months ended December 31, 2004, respectively. The decrease in consolidated net sales was primarily due to lower average ferrous selling prices and lower unit shipments of ferrous products. Ferrous Sales Ferrous sales decreased by $80.1 million (23.9%) and $153.8 million (17.1%) to $255.7 million and $747.5 million in the three and nine months ended December 31, 2005, respectively, compared to ferrous sales of $335.8 million and $901.3 million in the three and nine months ended December 31, 2004, respectively. The decrease in the three months ended December 31, 2005 was due to lower average selling prices which decreased by $56 per ton (18.9%) to $241 per ton, and sales volumes which declined by 69,000 tons (6.1%). The decrease in the nine months ended December 31, 2005 was due to lower average selling prices, which decreased by $30 per ton (11.3%) to $233 per ton, and sales volumes which declined by 223,000 tons (6.5%). Lower unit shipments of ferrous products reflected both slower inbound activity from suppliers, due to lower prices, and generally weaker demand from consumers compared to the three and nine months ended December 31, 2004. 18 The decrease in selling prices for ferrous scrap is evident in data published by AMM. According to AMM data, the average price for #1 Heavy Melting Steel Scrap -- Chicago was approximately $231 per ton and $198 per ton in the three and nine months ended December 31, 2005, respectively, compared to $236 per ton and $221 per ton in the three and nine months ended December 31, 2004, respectively. Non-ferrous Sales Non-ferrous sales increased by $23.4 million (25.2%) and $59.9 million (21.0%) to $116.2 million and $344.7 million in the three and nine months ended December 31, 2005, respectively, compared to non-ferrous sales of $92.8 million and $284.8 million in the three and nine months ended December 31, 2004, respectively. The increase was primarily due to higher average selling prices. In the three and nine months ended December 31, 2005, the average selling price for non-ferrous products increased by approximately $0.13 per pound (16.3%) to $0.93 per pound and $0.19 per pound (24.7%) to $0.97 per pound, respectively. Non-ferrous sales volumes increased by 9.0 million pounds (7.8%) in the three months ended December 31, 2005, but decreased by 12.0 million pounds (3.3%) compared to the nine months ended December 31, 2004. Non-ferrous sales volumes increased in the three months ended December 31, 2005 primarily due to an increase in stainless steel shipments of approximately 8.7 million pounds (17.2%), while sales volumes of stainless steel decreased by approximately 8.1 million pounds (4.9%) in the nine months ended December 31, 2005. Our non-ferrous operations have benefited from rising prices for copper, aluminum and stainless steel (nickel base metal), with the exception of average nickel prices which declined in the three months ended December 31, 2005. The increase in non-ferrous prices is evident in data published by the London Metals Exchange ("LME") and COMEX. According to COMEX data, average prices for copper were 44% and 34% higher in the three and nine months ended December 31, 2005, respectively, compared to the three and nine months ended December 31, 2004. According to LME data, average nickel prices were 10% lower in the three months ended December 31, 2005 while average nickel prices were 8% higher in the nine months ended December 31, 2005. Average prices for aluminum were 13% and 9% higher in the three and nine months ended December 31, 2005, respectively, compared to the three and nine months ended December 31, 2004. We believe non-ferrous prices are strong due, in part, to increases in industrial production and demand from industrializing China. Our non-ferrous sales are also impacted by the mix of non-ferrous metals sold. Generally, prices for copper are higher than prices for aluminum and stainless steel. In addition, the amount of high-temperature alloys that we sell, and the selling prices for these metals, will impact our non-ferrous sales as prices for these metals are generally higher than other non-ferrous metals. Brokerage Sales Brokerage ferrous sales increased by $1.6 million (11.8%) and $5.2 million (13.8%) to $15.4 million and $42.9 million in the three and nine months ended December 31, 2005, respectively, compared to brokerage ferrous sales of $13.8 million and $37.7 million in the three and nine months ended December 31, 2004, respectively. The increase in brokerage ferrous sales was the result of higher brokered ferrous sales volumes offset, in part, by lower average selling prices. Brokered ferrous volumes increased by 18,000 tons (35.3%) and 57,000 tons (38.0%) in the three and nine months ended December 31, 2005, respectively, compared to the three and nine months ended December 31, 2004. Brokerage ferrous sales increased despite $47 per ton (17.3%) and $44 per ton (17.5%) declines in average selling prices for brokered ferrous metals in the three and nine months ended December 31, 2005, respectively, compared to the three and nine months ended December 31, 2004. The average selling price for brokered ferrous metals is significantly affected by the product mix, such as prompt industrial grades versus obsolete grades, which can vary significantly between periods. Prompt industrial grades of ferrous scrap metal are generally associated with higher unit prices. COST OF SALES (EXCLUDING DEPRECIATION) Cost of sales decreased by $31.2 million (8.3%) and $25.6 million (2.4%) to $346.0 million and $1.02 billion in the three and nine months ended December 31, 2005, respectively, compared to cost of sales of 19 $377.2 million and $1.05 billion in the three and nine months ended December 31, 2004, respectively. The decrease is primarily due to lower material costs related to ferrous metals. The decrease in the nine months ended December 31, 2005 was partially offset by higher freight and processing costs. Freight costs were higher due to increases in freight rates resulting from higher fuel costs and increased export activity. Cost of sales represented approximately 88% and 89% of sales in the three and nine months ended December 31, 2005, respectively, compared to 84% and 85% of sales in the three and nine months ended December 31, 2004, respectively. The increase in cost of sales percentage was due to processing costs which did not decline commensurately with the decline in sales. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expense was $20.5 million and $58.7 million in the three and nine months ended December 31, 2005, respectively, compared to general and administrative expense of $20.0 million and $57.0 million in the three and nine months ended December 31, 2004, respectively. The increase in the three months ended December 31, 2005 was due to higher stock-based compensation expense which increased by $1.1 million from the three months ended December 31, 2004. The increase in the nine months ended December 31, 2005 is mainly due to higher compensation expense partially offset by lower professional fees. The increase in compensation expense was primarily due to higher salaries, as a result of an increase in headcount, and higher stock-based compensation expense which increased by $2.2 million from the nine months ended December 31, 2004. Professional fees were $0.8 million lower in the nine months ended December 31, 2005 compared to the nine months ended December 31, 2004. In the nine months ended December 31, 2004, we incurred legal fees and related costs of $2.1 million as a result of the investigations performed in connection with our voluntary disclosure to the U.S. Department of Justice regarding cash payments made to certain industrial account suppliers (see the section entitled "Legal Proceedings" in Part II of this report). DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expense was $4.9 million and $13.9 million in the three and nine months ended December 31, 2005, respectively, compared to depreciation and amortization expense of $4.7 million and $13.9 million in the three and nine months ended December 31, 2004, respectively. The increase in depreciation expense in the three months ended December 31, 2005 was due to an increase in capital expenditures. ASSET IMPAIRMENT CHARGE In the three months ended December 31, 2005, we completed a strategy designed to improve the profitability of our Chicago-area scrap yards. As a part of that strategy, a decision was made to consolidate processing activities at our Chicago-area scrap yards which resulted in a shredder and baler being idled. The baler was sold to a third party for approximately its net book value. The idled shredder is categorized as held and used and its carrying value was written down to its estimated fair value resulting in an asset impairment charge of approximately $1.0 million in the three months ended December 31, 2005. INCOME FROM JOINT VENTURES Income from joint ventures was $3.0 million and $6.5 million in the three and nine months ended December 31, 2005, respectively, compared to income from joint ventures of $3.9 million and $11.8 million in the three and nine months ended December 31, 2004, respectively. Income from joint ventures primarily represents our 28.5% share of income from Southern and our 50% share of earnings from three other joint ventures. The decline in income from joint ventures is primarily attributable to business interruptions at Southern as a result of Hurricane Katrina in August 2005, relatively weaker demand and prices for ferrous scrap metals in the nine months ended December 31, 2005 and losses incurred by our Metal Management Nashville, LLC ("Nashville") joint venture. In the three months ended December 31, 2005, Southern completed its insurance claim adjustment process related to damages from Hurricane Katrina. Our share of earnings arising from the claims adjustment 20 process at Southern in the three months ended December 31, 2005 increased income from joint ventures by $1.8 million. Losses incurred at Nashville are primarily associated with start-up expenses that continue to be incurred during the installation of a mega-shredder and costs related to a contract termination. We expect the mega-shredder to be operational in Nashville in June 2006. The decline in income from Southern and Nashville was mitigated, to some degree, by income from our joint venture in Albany, New York which commenced operations in February 2005 and is performing well. INTEREST EXPENSE Interest expense was $0.4 million and $1.2 million in the three and nine months ended December 31, 2005, respectively, compared to interest expense of $0.6 million and $2.9 million in the three and nine months ended December 31, 2004, respectively. The decrease in interest expense was a result of lower borrowings. Average debt was approximately $2.4 million in the three and nine months ended December 31, 2005 compared to average debt of approximately $25.9 million and $46.7 million in the three and nine months ended December 31, 2004, respectively. Our interest expense primarily consists of amortization of deferred financing costs, unused line fees under our Credit Agreement and interest on mortgage loans. INTEREST AND OTHER INCOME (EXPENSE), NET Interest and other income recognized in the three and nine months ended December 31, 2005 was $0.4 million and $1.4 million, respectively. As a result of our cash balances and short-term investments, our interest and dividend income recognized has increased. In the three and nine months ended December 31, 2004, we did not have any cash balances earning interest nor did we have any short-term investments. In addition, in the nine months ended December 31, 2005, we received insurance reimbursements of $0.7 million. LOSS ON DEBT EXTINGUISHMENT In the nine months ended December 31, 2004, we recognized a loss on debt extinguishment of $1.7 million associated with the repayment of our previous credit agreement with proceeds from the Credit Agreement. This amount represented a write-off of unamortized deferred financing costs associated with the previous credit agreement. PROVISION FOR INCOME TAXES In the three and nine months ended December 31, 2005, we recognized income tax expense of $10.3 million and $25.1 million, respectively, resulting in an effective tax rate of approximately 40%. In the three and nine months ended December 31, 2004, our income tax expense was $19.4 million and $49.1 million, respectively, resulting in an effective tax rate of 39.7% and 39.2%, respectively. The effective tax rate differs from the federal statutory rate mainly due to state taxes and permanent tax items. In November 2005, the Internal Revenue Service ("IRS") commenced an examination of our federal income tax return for fiscal 2004. At this preliminary stage of the examination, no matters have been brought to our attention by the IRS, nor are we aware of any tax matters, which would have a material adverse effect on our consolidated balance sheet, results of operations or cash flows. NET INCOME Net income was $15.3 million and $37.7 million in the three and nine months ended December 31, 2005, respectively, compared to net income of $29.5 million and $76.1 million in the three and nine months ended December 31, 2004, respectively. Net income decreased due to lower ferrous material margins attributable to weaker and volatile ferrous metal market conditions, lower unit shipments, and lower income from joint ventures, partially offset by lower interest expense. LIQUIDITY AND CAPITAL RESOURCES Our financial condition remained strong in the nine months ended December 31, 2005. At December 31, 2005, our total indebtedness was $2.3 million (primarily a single property real estate mortgage). We had no borrowings outstanding on our Credit Agreement and had cash, cash equivalents and short-term investments 21 of $74.7 million at December 31, 2005. Our primary source of working capital is collections from customers supplemented by financing under our Credit Agreement. Cash Flows Net cash provided by operating activities was $39.0 million in the nine months ended December 31, 2005 compared to $37.6 million in the nine months ended December 31, 2004. Although net income was lower, cash from operating activities increased due to lower investments in working capital compared to the nine months ended December 31, 2004. Cash provided by operating activities in the nine months ended December 31, 2005 was a result of cash generated from net income, adjusted for non-cash items, of $60.3 million that was offset by a $21.3 million increase in working capital. The working capital increase was mainly due to higher inventories ($15.2 million) and lower accounts payable ($15.5 million) offset, in part, by lower accounts receivable ($19.5 million). Inventories increased due to higher levels of both ferrous and non-ferrous inventory on hand at December 31, 2005 as compared to March 31, 2005 and higher prices for non- ferrous scrap metals. Accounts payable decreased due to lower purchase prices for ferrous scrap metals. Accounts receivable decreased due to lower sales in December 2005 as compared to March 2005 and due to improved cash collections. Net cash used in investing activities was $50.4 million in the nine months ended December 31, 2005 compared to $8.0 million in the nine months ended December 31, 2004. The increase was due to higher capital expenditures and the net purchase of $30.3 million of short-term investments. Our capital expenditures in the current fiscal year are higher due to investments we are making in our operations to improve operational efficiency and create competitive advantages. Net cash provided by financing activities was $2.8 million in the nine months ended December 31, 2005 compared to net cash used in financing activities of $29.3 million in the nine months ended December 31, 2004. In the nine months ended December 31, 2004, cash flows from operating activities was used to repay amounts outstanding under our Credit Agreement. In the nine months ended December 31, 2005, we paid cash dividends of $5.7 million and received $5.7 million from the exercise of stock options and warrants. Indebtedness The Credit Agreement is a revolving credit and letter of credit facility that is available to support our working capital requirements and for general corporate purposes. Borrowing costs are based on variable rates tied to the prime rate plus a margin or the London Interbank Offered Rate ("LIBOR") plus a margin. The margin is based on our leverage ratio (as defined in the Credit Agreement) as determined for the trailing four fiscal quarters. Based on our current leverage ratio, our LIBOR and prime rate margins are 125 basis points and 0 basis points, respectively. Borrowings under the Credit Agreement are generally subject to borrowing base limitations based upon a formula equal to 85% of eligible accounts receivable plus the lesser of $65 million or 70% of eligible inventory. Inventories cannot represent more than 40% of the total borrowing base. A security interest in substantially all of our assets and properties, other than equipment, fixtures and real property, unless and until the average excess availability for any two consecutive months is less than $10 million, has been granted to the agent for the lenders as collateral against our obligations under the Credit Agreement. Pursuant to the Credit Agreement, we pay a fee on the undrawn portion of the facility that is determined by the leverage ratio. As of December 31, 2005, that fee was 0.25% per annum. Under the Credit Agreement, we are required to satisfy specified financial covenants, including a maximum leverage ratio of 2.50 to 1.00, a minimum consolidated fixed charge coverage ratio of 1.50 to 1.00 and a minimum tangible net worth of not less than the sum of $110 million plus 25% of consolidated net income earned in each fiscal quarter. The leverage ratio and consolidated fixed charge coverage ratio are tested for the twelve-month period ending each fiscal quarter. The Credit Agreement also limits capital expenditures to $20 million for the twelve-month period ending each fiscal quarter. An amendment to our Credit Agreement permits capital expenditures of up to $40 million in fiscal 2006. The Credit Agreement contains restrictions which, among other things, limit our ability to (i) incur additional indebtedness; (ii) pay dividends under certain conditions; (iii) enter into transactions with affiliates; (iv) enter into certain asset sales; 22 (v) engage in certain acquisitions, investments, mergers and consolidations; (vi) prepay certain other indebtedness; (vii) create liens and encumbrances on our assets; and (viii) engage in other matters customarily restricted in such agreements. As of December 31, 2005, we were in compliance with all financial covenants contained in the Credit Agreement. As of January 19, 2006, we had no outstanding borrowings under the Credit Agreement, and had undrawn availability of approximately $173 million. Future Capital Requirements We expect to fund our working capital needs, dividend payments and capital expenditures over the next twelve months with cash generated from operations, supplemented by undrawn borrowing availability under the Credit Agreement. Our future cash needs will be driven by working capital requirements, planned capital expenditures and acquisition objectives, should attractive acquisition opportunities present themselves. Capital expenditures were $22.1 million in the nine months ended December 31, 2005. Consistent with the plan that we announced at the start of the fiscal year, and depending on the timing of a planned land purchase that would expand an existing facility, we expect that our total capital expenditures in fiscal 2006 will be between $30 and $40 million. In addition, due to favorable financing terms made available by equipment manufacturing vendors, we have entered into operating leases for new equipment. Since April 2002, we have entered into 83 operating leases for equipment which would have cost approximately $24.6 million to purchase. These operating leases are attractive to us since the implied interest rates are lower than interest rates under our Credit Agreement. We expect to selectively use operating leases for new material handling equipment or trucks required by our operations. In the nine months ended December 31, 2005, we received $5.6 million from the exercise of Series A Warrants. As of December 31, 2005, we had 379,237 Series A Warrants outstanding. The exercise price of the Series A Warrants is $21.19 per warrant and each warrant represents the right to purchase two shares of common stock. The Series A Warrants expire on June 29, 2006. If all the Series A Warrants are exercised, we would receive cash proceeds of approximately $8.0 million over the next six months. We anticipate that our Board of Directors will continue to declare cash dividends; however, the continuance of cash dividends is not guaranteed and dependent on many factors, some of which are beyond our control. We believe these sources of capital will be sufficient to fund planned capital expenditures, working capital requirements and dividend payments for the next twelve months and any acquisitions we may choose to pursue, although there can be no assurance that this will be the case. OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS Off-Balance Sheet Arrangements Other than operating leases, we do not have any off-balance sheet arrangements that are likely to have a current or future effect on our financial condition, results of operations or cash flows. Contractual Obligations We have various financial obligations and commitments assumed in the normal course of our operations and financing activities. Financial obligations are considered to represent known future cash payments that we are required to make under existing contractual arrangements, such as debt and lease agreements. 23 The following table sets forth our known contractual obligations as of December 31, 2005, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):
LESS THAN ONE TO THREE TO TOTAL ONE YEAR THREE YEARS FIVE YEARS THEREAFTER ----- --------- ----------- ---------- ---------- Long-term debt and capital leases $ 2,626 $ 495 $ 921 $ 1,210 $ 0 Operating leases 60,108 11,506 19,384 11,641 17,577 Other contractual obligations* 2,871 2,471 400 0 0 ---------- ---------- ---------- ---------- ---------- Total contractual cash obligations $ 65,605 $ 14,472 $ 20,705 $ 12,851 $ 17,577 ========== ========== ========== ========== ==========
* Includes $1.2 million of employee termination benefits scheduled for payment in July 2005 for which we are contesting the payments (see "Legal Proceedings" under Part II, Item 1 of this report). Other Commitments We are required to make contributions to our defined benefit pension plans. These contributions are required under the minimum funding requirements of the Employee Retirement Income Security Act (ERISA). However, due to uncertainties regarding significant assumptions involved in estimating future required contributions, such as pension plan benefit levels, interest rate levels and the amount of pension plan asset returns, we are not able to reasonably estimate the amount of future required contributions beyond fiscal 2006. Our minimum required pension contributions for fiscal 2006 are approximately $0.9 million, of which we paid $0.7 million in the nine months ended December 31, 2005. At December 31, 2005, we recorded $4.0 million of construction in progress and an offsetting liability relating to the construction of a stevedoring crane which we committed to lease upon completion. We expect the stevedoring crane to be delivered in April 2006. We are considered the owner of the stevedoring crane during its construction. We also enter into letters of credit in the ordinary course of operating and financing activities. As of January 19, 2006, we had outstanding letters of credit of $6.2 million, much of which is securing insurance policies. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires the use of estimates and judgments that affect the reported amounts and related disclosures of commitments and contingencies. We rely on historical experience and on various other assumptions that we believe to be reasonable under the circumstances to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates. We believe the following critical accounting policies, among others, affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. Revenue Recognition Our primary source of revenue is from the sale of processed ferrous and non-ferrous scrap metals. We also generate revenue from the brokering of scrap metals or from services performed, including, but not limited to, tolling, stevedoring and dismantling. Revenues from processed ferrous and non-ferrous scrap metal sales are recognized when title passes to the customer. Revenues relating to brokered sales are recognized upon receipt of the materials by the customer. Revenues from services are recognized as the service is performed. Sales adjustments related to price and weight differences and allowances for uncollectible receivables are accrued against revenues as incurred. Short-term Investments All investments with original maturities of greater than 90 days are accounted for in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." We determine the appropriate classification at the time of purchase. At 24 December 31, 2005, we had short-term investments of approximately $30.3 million, which mainly consisted of investments in auction rate securities which are classified as available-for-sale. Auction rate securities consist of tax-free bonds issued by municipalities which mainly carry AAA ratings. Investments in auction rate securities are recorded at cost, which approximates fair value due to their variable interest rates which reset every 7 to 30 days. As a result, these securities are classified as current assets. Despite the long-term nature of their stated contractual maturities, there is a readily liquid market for these securities. As a result, we had no cumulative gross unrealized holding gains (losses) or gross realized gains (losses) from our short-term investments. All income generated from these investments was recorded as dividend income. Accounts Receivable and Allowance for Uncollectible Accounts Receivable Accounts receivable consist primarily of amounts due from customers from product and brokered sales. The allowance for uncollectible accounts receivable totaled $1.8 million and $2.7 million at December 31, 2005 and March 31, 2005, respectively. Our determination of the allowance for uncollectible accounts receivable includes a number of factors, including the age of the balance, past experience with the customer account, changes in collection patterns and general industry conditions. Inventory Our inventories primarily consist of ferrous and non-ferrous scrap metals and are valued at the lower of average purchased cost or market. Quantities of inventories are determined based on our inventory systems and are subject to periodic physical verification using estimation techniques including observation, weighing and other industry methods. As indicated in our Annual Report under the section entitled "Risk Factors -- Prices of commodities we own may be volatile and markets are competitive," we are exposed to risks associated with fluctuations in the market price for both ferrous and non-ferrous metals, which are at times volatile. We attempt to mitigate this risk by seeking to rapidly turn our inventories. Long-lived Assets We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset are compared to the asset's carrying amount to determine if an impairment of such asset is necessary. The effect of any impairment would be the recognition of a loss representing the difference between the fair value of such asset and its carrying value. Self-insured Accruals We are self-insured for medical claims for most of our employees. We are self-insured for workers' compensation claims that involve a loss of not greater than $350,000 per claim. Our exposure to claims is protected by stop-loss insurance policies. We record an accrual for reported but unpaid claims and the estimated cost of incurred but not reported ("IBNR") claims. IBNR accruals are based on either a lag estimate (for medical claims) or on actuarial assumptions (for workers' compensation claims). Income Taxes Income taxes are accounted for under the asset and liability method prescribed by SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Contingencies We record accruals for estimated liabilities, which include environmental remediation, potential legal claims and IBNR claims. A loss contingency is accrued when our assessment indicates that it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Our estimates are 25 based upon currently available facts and presently enacted laws and regulations. These estimated liabilities are subject to revision in future periods based on actual costs or new information. The above listing is not intended to be a comprehensive list of all of our accounting policies. Please refer to our Annual Report, which contains accounting policies and other disclosures required by generally accepted accounting principles. RECENT ACCOUNTING PRONOUNCEMENTS In November 2004, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 151, "Inventory Costs -- an amendment of ARB No. 43, Chapter 4." SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage), requiring that these items be recognized as current-period charges and not capitalized in inventory overhead. In addition, this statement requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this statement is not expected to materially impact our consolidated financial statements. In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment." The revised statement eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." This statement instead requires that all share-based payments to employees be recognized as compensation expense in the statement of operations based on their fair value over the applicable vesting period. The provisions of this statement are effective for fiscal years beginning after June 15, 2005. We will transition to SFAS No. 123(R) using the "modified prospective application" effective April 1, 2006. Under the "modified prospective application," compensation costs will be recognized in the financial statements for all new share-based payments granted after April 1, 2006. Additionally, we will recognize compensation costs for the portion of previously granted awards for which the requisite service has not been rendered ("nonvested awards") that are outstanding as of the effective date over the remaining requisite service period of the awards. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections -- a replacement of APB Opinion No. 20 and SFAS No. 3." This statement provides guidance on the accounting for and reporting of accounting changes and error corrections. It requires, unless impracticable, retrospective application for reporting a change in accounting principle, unless the newly adopted accounting principle specifies otherwise, and reporting of a correction of an error. The provisions of this statement are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of this statement is not expected to materially impact our consolidated financial statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial risk resulting from fluctuations in interest rates and commodity prices. We seek to minimize these risks through regular operating and financing activities. We do not use derivative financial instruments. Refer to Item 7A of the Annual Report. ITEM 4. CONTROLS AND PROCEDURES Evaluation of our Disclosure Controls and Procedures. As of the end of the period covered by this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")). This evaluation was done under the supervision and with the participation of management, including Daniel W. Dienst, our Chairman of the Board, Chief Executive Officer and President ("CEO"), and Robert C. Larry, our Executive Vice President, Finance and Chief Financial Officer ("CFO"). The evaluation of our disclosure controls and procedures by our CEO and CFO included a review of the controls' objectives and design, the controls' implementation by the Company and the effect of the controls on 26 the information generated for use in this report. Based upon the controls evaluation, our CEO and our CFO have concluded that our disclosure controls and procedures were effective at the reasonable assurance level, in enabling us to record, process, summarize, and report information required to be included in our periodic SEC filings within the required time period, and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow for timely decisions regarding disclosure. Changes in Internal Control over Financial Reporting. As reported in the Company's Form 10-Q/A for the quarter ended June 30, 2005, as of June 30, 2005, the Company reported a material weakness relating to controls over the reporting of cash distributions of earnings from joint ventures in the cash flow category required by generally accepted accounting principles. During the quarter ended December 31, 2005, the Company fully implemented procedures to address the issue reported in the June 2005 Form 10-Q/A, including a review of the classification requirements of each component line item and the individual elements that comprise each line item of the statement of cash flows in accordance with Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows." Other than the actions noted above, there have been no changes in our internal control over financial reporting during the three months ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. CEO and CFO Certifications. As an exhibit to this report, there are "Certifications" of the CEO and CFO. The first form of Certification is required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. This section of the quarterly report is the information concerning the controls evaluation referred to in the Section 302 Certifications and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented. Limitations on the Effectiveness of Controls. Our management, including our CEO and the CFO, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected. 27 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On September 22, 2005 and September 23, 2005, the Connecticut Department of Environmental Protection's ("CTDEP") Bureau of Water Management and Bureau of Waste Management each issued a Notice of Violation ("NOV") to Metal Management Aerospace, Inc. ("MTLM-Aerospace"), a subsidiary of the Company, for alleged violations at MTLM-Aerospace's facility, including, among other things (1) operation of a solid waste facility without the approval of CTDEP; (2) failure to comply with certain environmental regulations regarding the handling of used oil, the performance of certain hazardous waste determinations, the disposal of PCBs and the discharge of oils and coolants; (3) failure to comply with certain discharge reporting obligations; (4) creation of certain potential environmental hazards; (5) inadequacy or improper maintenance of certain pollution management devices, including erosion and sediment controls and release detection for an underground diesel storage tank; and (6) failure to comply with a pollution prevention plan. On October 21, 2005, MTLM-Aerospace submitted substantive responses to CTDEP regarding the NOVs. At this time, the Company is unable to determine MTLM-Aerospace's potential liability in connection with these NOVs. The Company believes that MTLM-Aerospace has meritorious defenses to certain of the allegations outlined in the NOVs. In addition, although the Company believes that by virtue of certain consent orders, Connecticut Transfer Act obligations, and lease/transactional documents executed by the lessor and former owner, certain environmental liabilities noted in the NOVs will be the responsibility of the lessor and former owner, there can be no assurance that the lessor and former owner will have sufficient resources to fund any or all of such liabilities. On August 22, 2005, the Occupational Safety and Health Administration ("OSHA") requested that MTLM-Aerospace conduct an internal investigation of a recent accident. MTLM-Aerospace responded to this request in a timely manner. OSHA subsequently determined to conduct its own investigation, following which it issued citations to MTLM-Aerospace generally involving preventive maintenance procedures and safety procedures and training. On January 23, 2006, MTLM-Aerospace entered into an informal settlement agreement with OSHA pursuant to which MTLM-Aerospace agreed, among other things, to pay an aggregate penalty in the amount of $24,662.50, to maintain a formal preventive maintenance program and to engage an engineer to develop certain procedures in which employees are to be trained and monitored to ensure compliance. On November 24, 2005, OSHA commenced an investigation into a recent accident at the Company's Newark facility that involved an employee fatality. The Company is cooperating with OSHA's ongoing investigation. At this time, OSHA has not taken any action with respect to this incident. At this preliminary stage, the Company cannot predict the likelihood of any citations, the extent of any penalties or other impact to the Company of such investigation. As a result of internal audits conducted by the Company, the Company determined that current and former employees of certain business units engaged in activities relating to cash payments to individual industrial account suppliers of scrap metal that may have involved violations of federal and state law. In May 2004, the Company voluntarily disclosed its concerns regarding such cash payments to the U.S. Department of Justice. The Board of Directors appointed a special committee, consisting of all of its independent directors, to conduct an investigation of these activities. The Company is cooperating with the U.S. Department of Justice. The Company implemented policies to eliminate cash payments to industrial customers. During the year ended March 31, 2004, such cash payments to industrial customers represented approximately 0.7% of the Company's consolidated ferrous and non-ferrous yard shipments. The fines and penalties under applicable statutes contemplate qualitative as well as quantitative factors that are not readily assessable at this stage of the investigation, but could be material. The Company is not able to predict at this time the outcome of any actions by the U.S. Department of Justice or other governmental authorities or their effect on the Company, if any, and accordingly, the Company has not recorded any amounts in the financial statements. The Company has incurred legal and other costs related to this matter of approximately $2.3 million to date. 28 On July 15, 2005, the Company and its subsidiary Metal Management Midwest, Inc. ("MTLM-Midwest") filed a complaint (the "Complaint") against former officers and directors, Albert A. Cozzi, Frank J. Cozzi, and Gregory P. Cozzi (collectively, the "Defendants") in the Circuit Court of Cook County Illinois, County Department, Chancery Division. The Complaint seeks damages from Frank J. Cozzi and Gregory P. Cozzi for their actions in designing, implementing, and maintaining cash payment practices in MTLM-Midwest's accounts payable that violated Company policy and potentially federal law. The Complaint also alleges that the Defendants breached the non-competition and non-solicitation provisions of their respective separation and release agreements by seeking to engage in business activities and seeking to solicit suppliers, customers and service providers in competition with the Company's business. The Complaint seeks, among other things, monetary compensation for the Company's actual losses and damages, and an injunction restraining and enjoining the Defendants from breaching their respective separation and release agreements. On October 21, 2005, Defendants moved to dismiss the Complaint or in the alternative to compel arbitration and stay the judicial proceedings. Defendants also filed a counterclaim seeking recovery of unpaid employee severance payments of approximately $1.2 million. From time to time, we are involved in various litigation matters involving ordinary and routine claims incidental to our business. A significant portion of these matters result from environmental compliance issues and workers compensation related claims applicable to our operations. Management currently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on our results of operations or financial condition. Please refer to Part I, Item 3 of the Annual Report for a description of other litigation in which we are currently involved. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS In the three months ended December 31, 2005, we sold 450,486 shares of our common stock pursuant to exercise of Series A Warrants that were issued to our predecessor company shareholders in connection with our emergence from bankruptcy on June 29, 2001. We received proceeds of approximately $4.8 million from these sales and used the proceeds for general corporate purposes. The sales are exempt from registration pursuant to Section 1145(a) of the Bankruptcy Code (Title 11, United States Code). 29 ITEM 6. EXHIBITS 2.1 Disclosure Statement with respect to First Amended Joint Plan of Reorganization of Metal Management, Inc. and its Subsidiary Debtors, dated May 4, 2001 (incorporated by reference to Exhibit 2.1 of the Company's Annual Report on Form 10-K for the year ended March 31, 2001). 3.1 Second Amended and Restated Certificate of Incorporation of the Company, as filed with the Secretary of State of the State of Delaware on June 29, 2001 (incorporated by reference to Exhibit 3.1 of the Company's Annual Report on Form 10-K for the year ended March 31, 2001). 3.2 Amended and Restated By-Laws of the Company adopted as of April 29, 2003 (incorporated by reference to Exhibit 3.2 of the Company's Annual Report on Form 10-K for the year ended March 31, 2003). 4.1 Credit Agreement, dated as of June 28, 2004, among Metal Management, Inc. and LaSalle Bank National Association (incorporated by reference to Exhibit 4.1 of the Company's Current Report on Form 8-K dated June 28, 2004). 4.2 Third Amendment to the Credit Agreement, dated as of December 31, 2005, among Metal Management, Inc. and certain subsidiaries of Metal Management, Inc. specified therein, as borrowers, the lenders party thereto and LaSalle National Bank Association, in its capacity as agent for the lenders (incorporated by reference to Exhibit 4.1 of the Company's Current Report on Form 8-K, dated December 31, 2005). 31.1 Certification of Daniel W. Dienst pursuant to Section 240.13a-14(a) and Section 240.15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Robert C. Larry pursuant to Section 240.13a-14(a) and Section 240.15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Daniel W. Dienst and Robert C. Larry pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
30 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. METAL MANAGEMENT, INC. By: /s/ Daniel W. Dienst --------------------------------- Daniel W. Dienst Chairman of the Board, Chief Executive Officer and President (Principal Executive Officer) By: /s/ Robert C. Larry --------------------------------- Robert C. Larry Executive Vice President, Finance, Chief Financial Officer, Treasurer and Secretary (Principal Financial Officer) By: /s/ Amit N. Patel --------------------------------- Amit N. Patel Vice President, Finance and Controller (Principal Accounting Officer) Date: February 2, 2006 31