-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HxNpwVs6TX1MvMEooBm84yEyi1itXFScdfKWpLCzavncBE/efwegaJoAGmJEfQI1 uwYv2HQHb0yUwlkTTunKmQ== 0001072613-03-001901.txt : 20031124 0001072613-03-001901.hdr.sgml : 20031124 20031124170015 ACCESSION NUMBER: 0001072613-03-001901 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20030831 FILED AS OF DATE: 20031124 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCHNITZER STEEL INDUSTRIES INC CENTRAL INDEX KEY: 0000912603 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-MISC DURABLE GOODS [5090] IRS NUMBER: 930341923 STATE OF INCORPORATION: OR FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-22496 FILM NUMBER: 031021189 BUSINESS ADDRESS: STREET 1: 3200 NW YEON AVE STREET 2: P O BOX 10047 CITY: PORTLAND STATE: OR ZIP: 97210-0047 BUSINESS PHONE: 5032249900 MAIL ADDRESS: STREET 1: P O BOX 10047 CITY: PORTLAND STATE: OR ZIP: 97210 10-K 1 form10-k_12345.txt SCHNITZER STEEL INDUSTRIES, INC. FORM 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended August 31, 2003 Commission File Number 0-22496 SCHNITZER STEEL INDUSTRIES, INC. (Exact name of registrant as specified in its charter) OREGON 93-0341923 ------ ---------- (State of Incorporation) (I.R.S. Employer Identification No.) 3200 N.W. Yeon Ave., P.O. Box 10047 Portland, OR 97296-0047 ------------ ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (503) 224-9900 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock, $1 par value (Title of class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ] The aggregate market value of the registrant's voting common stock outstanding held by non-affiliates on February 28, 2003 was $118,329,105 The Registrant had 13,304,516 shares of Class A Common Stock, par value of $1.00 per share, and 6,639,486 shares of Class B Common Stock, par value of $1.00 per share, outstanding at November 1, 2003. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement for the 2004 Annual Meeting of Shareholders are incorporated herein by reference in Part III. ================================================================================ SCHNITZER STEEL INDUSTRIES, INC. FORM 10-K TABLE OF CONTENTS PART ITEM PAGE I 1. BUSINESS.....................................................3 Overview.................................................4 Business Strategy........................................4 Metals Recycling Business................................7 Joint Ventures..........................................10 Steel Manufacturing Business............................11 Auto Parts Business.....................................15 Environmental Matters...................................17 Employees...............................................20 2. PROPERTIES..................................................21 3. LEGAL PROCEEDINGS...........................................22 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.....................................22 4(a). EXECUTIVE OFFICERS OF THE REGISTRANT........................22 II 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.............................24 6. SELECTED FINANCIAL DATA.....................................25 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.....................26 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......................................41 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................42 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..................75 9A CONTROLS AND PROCEDURES.....................................75 III 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..............................................76 11. EXECUTIVE COMPENSATION......................................76 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.....................................76 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............76 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES......................76 IV 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.....................................77 2 PART I ITEM 1. BUSINESS Overview Schnitzer Steel Industries, Inc. (the Company) and its joint venture businesses collect, process and recycle metals by operating one of the largest metals recycling businesses in the United States. The Company also manufactures finished steel products at its technologically advanced steel mini-mill (the Steel Manufacturing Business). On February 14, 2003, the Company's wholly-owned subsidiary, Norprop, Inc. ("Norprop"), acquired all of the stock of Pick and Pull Auto Dismantling, Inc., which was the Company's 50% partner in Pick-N-Pull Auto Dismantlers, a California general partnership, and all of the membership interests in Pick-N-Pull Auto Dismantlers, Stockton, LLC. The acquired companies were consolidated with the Company's previous interest in the business to form a separate reporting segment (the Auto Parts Business) also referred to as "Pick-N-Pull". Pick-N-Pull is one of the country's leading self-service used auto parts networks. Additionally, Pick-N-Pull is a major supplier of auto bodies to the Company's Metals Recycling Business. As a result of its vertically integrated business, the Company is able to transform auto bodies and other unprocessed metals into finished steel products. The Company believes that its Metals Recycling, Steel Manufacturing, and Auto Parts Businesses are cost competitive in their markets. The Company's wholly-owned recycling business (the Metals Recycling Business) and its joint ventures have major collection and processing facilities in the following locations: Metals Recycling Business Joint Venture Operations ------------------------- ------------------------ Portland, OR Jersey City, NJ Oakland, CA Long Island, NY Tacoma, WA Los Angeles, CA Sacramento, CA Everett, MA Eugene, OR Providence, RI Fresno, CA Madbury, NH The Metals Recycling Business' eleven yards, including the major facilities shown above, sold 1.8 million ferrous tons, of which 0.2 million tons were brokered, in fiscal 2003. Additionally, through joint ventures, the Company participates in the management of an additional 30 metals recycling collection and processing facilities including the major facilities shown above. These processing joint ventures sold 3.3 million ferrous tons in fiscal 2003. Additionally, these joint ventures provide international and domestic services which broker metal processed by third parties. In fiscal 2003, this brokerage business approximated 1.8 million tons. As the steel industry in the United States consolidates, the Company believes it is well positioned to remain a leader in the major markets in which it participates. In addition, it is anticipated that the demand for recycled ferrous metals will increase due to the continued transformation of the world's steel producers from virgin iron ore based blast furnaces to newer, technologically advanced electric arc furnace (EAF) mini-mills. In the last 25 years, steel production using recycled metals and the EAF process has grown dramatically. The EAF process, which uses 85%-95% recycled metal compared with the traditional steel-making process that uses less than 35% recycled metal, is more environmentally sound and energy efficient. By recycling steel, limited natural resources are preserved and the need to disrupt the environment with the mining of virgin iron ore is greatly reduced. Further, when recycled metal, instead of iron ore is used for new steel production, air and water pollution generated by the production process decreases. Currently, almost half of domestic steel and much of foreign-based steel is produced using the EAF process. Since 1995, global EAF production has grown 30%. Most of the growth has come from China, the world's largest and fastest growing steel producing country, and other Asian countries. Future growth in EAF production, as 3 well as in other steel alternative production technologies, projected by industry analysts, translates into expected growth in demand for recycled metals. Using the EAF process to produce new steel makes the recycled ferrous metal commodity a strategic raw material for both domestic and foreign markets. Further benefiting the Company and its joint ventures in the metals recycling business is their strategic geographic locations at many of the major deep-sea ports in the United States. These ports allow the Company and its joint ventures the option of supplying foreign steel producers as well as domestic steel mills. The Company's Steel Manufacturing Business consists of its wholly-owned subsidiary, Cascade Steel Rolling Mills, Inc. The Steel Manufacturing Business produces steel reinforcing bar (rebar), wire rod, merchant bar and coiled rebar. The Company believes that the Steel Manufacturing Business has a competitive position in its market due to its readily available source of recycled metals, efficient production processes, state-of-the-art technology, well-located shipping and transportation facilities, access to competitively priced electric power and proximity to California and other major western markets. The Company's self-service used auto parts business (the Auto Parts Business) has retail facilities in the following locations: Northern California 17 Nevada 2 Texas 1 Utah 1 Illinois 1 Indiana 1 ---- Total 23 ==== The Auto Parts Business purchases salvaged vehicles, sells parts from those vehicles through its retail facilities and wholesale operations, and sells the remaining portion of the vehicles to metal recyclers. The Company believes the Auto Parts Business has a competitive position in its markets due to its consistent approach and efficient processing of auto bodies. Business Strategy - ----------------- The Company's business strategy emphasizes continued growth of the ferrous recycled metals business and auto parts business through additive acquisitions and joint ventures, and maintaining its status as an efficient and competitive producer of both recycled metal and finished steel products, as well as a low-cost provider of retail and wholesale used auto parts, through investments in state-of-the-art manufacturing equipment and increased production efficiencies. The Company considers itself, first and foremost, a ferrous metals recycling company with historically over 60% of its operating income, before corporate expenses and eliminations and impairment and other nonrecurring charges, derived from the Metals Recycling Business and its Joint Ventures in the Metals Recycling Business. The Metals Recycling Business is one of the leading processors in each of the markets in which it operates. The Company intends to continue its focus on increasing the Company's position as one of the premier recycled metals processors in the country. The Company's Metals Recycling Business enters into export sales contracts by selling forward 45 to 90 days and purchases metals on a daily basis. The typical supplier of unprocessed metal is a relatively small, local business or manufacturer who sells metals in limited quantities. These typical suppliers generally do not have the ability to inventory material in significant quantities, and therefore lack the market leverage to influence prices. By knowing the price for which the processed material will be sold and the costs involved in processing the metals, the Company is generally able to take advantage of this differential in timing between purchases and sales and negotiate prices with suppliers that secure profitable transactions. 4 The Company has developed a multi-part growth strategy, which includes the following elements: EXPAND METALS RECYCLING OPERATIONS. The Company will continue to seek expansion opportunities within both its existing markets and elsewhere. Since the Company's initial public offering in 1993, the Company has focused on and will continue to emphasize increasing its sources of ferrous metals through its existing network and through selective acquisitions or through joint ventures with metals processors and suppliers of metal. Examples since the Company's initial public offering include: o In fiscal 1998, the Company and Hugo Neu Corporation, one of the Company's joint venture partners, increased their East Coast market position through the buyout of a third joint venture partner and the completion of two other strategic joint venture acquisitions; o In November 1996, the Company acquired Proler International Corp. (Proler). At that time, Proler's joint ventures with Hugo-Neu Corporation of New York processed approximately 3 million long tons of ferrous metals per year; o In March 1995, the Company purchased Manufacturing Management, Inc. (MMI), another metals processor which added approximately 500,000 long tons per year to the Company's ferrous recycled metals volume; and o In December 1993, the Company acquired four metals collection and processing facilities in central and southern Oregon. The Company has also made a series of investments in other joint ventures, which has increased the Company's sources of metals supply. COMPLETE VALUE CREATING ACQUISITIONS. The Company intends to complete acquisitions it believes will earn income, after tax, in excess of its cost of capital. With a strong balance sheet, cash flows and available borrowing capacity, the Company believes it is in an attractive position to complete an acquisition should one fitting the Company's long-term strategic plans become available and if a reasonable price can be attained. EXPAND AUTO PARTS BUSINESS In fiscal 2003, the Company acquired one of its largest suppliers of unprocessed metal and joint venture partners and formed the Auto Parts Business segment. The Auto Parts Business provides the Company with strong vertical integration. Pick-N-Pull is one of the country's leading self-service used auto parts networks and over the last 15 years it has developed a strong management team and internal systems and processes that are believed to provide it with the ability to efficiently replicate the business model in other locations. The Company intends to seek expansion opportunities for Pick-N-Pull within both its existing markets and elsewhere in North America. INVEST IN STATE-OF-THE-ART PROCESSING AND MANUFACTURING. The Company's objective is to be an efficient and competitive producer of both recycled metals and finished steel products in order to maximize the operating margin for both operations. To meet this objective, the Company has focused on and will continue to emphasize the cost-effective purchasing and efficient processing of metals. The Company has made significant investments in state-of-the art equipment to ensure that its operations have cost effective technology to produce high quality products and to maximize economies of scale. The Company continues to invest in equipment to improve the efficiency and capabilities of its businesses. During the last five years, the Company has spent $63.4 million on capital improvements. During fiscal 2000, the Metals Recycling Business completed the installation of a state-of-the-art automobile shredder (also known as a "mega-shredder"), capable of shredding over 2,000 tons per day, at its Tacoma facility. This shredder replaced two older shredders that on a combined basis were capable of producing 1,000 tons per day. The mega-shredder has reduced operating costs and improved product quality; moreover, it enables the Tacoma metals recycling facility to shred material that was not previously shredded and had to be sold as lower margin materials. The Company has also entered into an agreement to purchase a mega-shredder for its Oakland facility that is expected to be installed in late 2004. Additionally, the dock and bulkhead at the Tacoma facility were rebuilt during fiscal 1999 to more effectively handle the increased shredder capacity, the exporting of metals and receipt of 5 bulk unprocessed metals via marine sources. Also, all three of the Metals Recycling Business' export facilities continue to invest in sorting technologies to recover more high-valued nonferrous metal from the auto shredding process. During fiscal 2002, the Company's Portland, Oregon metals recycling facility embarked on a dock and loading facility renovation, including the acquisition of a portside crane, in order to increase its efficiency in loading recycled metals export cargos. The renovation was temporarily suspended in fiscal 2003 when severe deterioration of the dock's substructure was detected during demolition activities. The project is being reengineered to rebuild the substructure and to accommodate additional heavy industrial requirements, which will better serve the Company's long term needs. One of Pick-N-Pull's primary business strategies is to utilize information systems technology to collect data regarding production and processing costs and customer sales. To this end, Pick-N-Pull continues to invest in its systems to maintain them as state of the art. In fiscal 2002, the Steel Manufacturing Business completed the installation of a static var compensator at the Steel Manufacturing Business' mini-mill. It provides a more uniform and efficient power supply in the steel making process. The Steel Manufacturing Business also made improvements to the dust collection system and waste water treatment facilities to meet or exceed environmental compliance with its operating permits. In fiscal 2003, the Steel Manufacturing Business enhanced the wire rod segment of its business with the installation of a ring distributor and improvements to the product cooling system. These improvements enhanced the product yield and packaging of wire rod products. Product quality was also improved, allowing the Company to sell higher grade product at a premium price. In fiscal 2004, the Steel Manufacturing Business plans to replace the electric arc furnace in the melt shop. The new furnace is expected to reduce energy consumption and improve productivity. CAPTURE BENEFITS OF INTEGRATION. The Company has historically sought to capture the potential benefits of business integration whenever possible. The Company believes it enjoys a competitive advantage over non-vertically integrated mini-mill steel producers as a result of its extensive metals recycling operation. Beginning with the source of raw materials, the Auto Parts Business has the capability to supply the Metals Recycling Business with a portion of its auto bodies for use in its metals recycling process when market conditions are such that it is prudent to do so. The Metals Recycling Business then has the capability to provide the Steel Manufacturing Business with a predictable, high quality supply of recycled metals in an optimal mix of grades for efficient melting. Likewise, the Steel Manufacturing Business ensures a steady market for a portion of the Metals Recycling Business' production. The Company leverages a portion of shared administrative services with certain of its joint venture partners and related companies which reduces the cost of these services to the Company. ECONOMIC VALUE ADDED. In fiscal year 2001, the Company and certain of its joint ventures implemented an Economic Value Added (EVA(R)) financial measurement and compensation system. EVA measures the value of, and guides, economic decision making based on established return on investment criteria that the Company believes meets the expectations of the financial markets. Decisions made under EVA are designed to create long-term, sustainable value. In addition, the decision making is decentralized and provides managers with the financial analysis tools to make better decisions. Managers' incentive pay is directly linked to success in creating value and is designed to motivate and reward reasonable and sensible risk taking. EVA measures and evaluates the performance of the Company and its employees by explicitly recognizing the cost of equity, as well as debt, capital and quantifying the results. On a periodic basis, the EVA plan is recalibrated. 6 METALS RECYCLING BUSINESS - ------------------------- The Company is one of the largest metals processors in the United States, with eleven wholly-owned metals collection and processing facilities. The Company buys, processes and sells ferrous metals to foreign and domestic steel producers and to the Steel Manufacturing Business. The Metals Recycling Business also engages in the brokerage business by purchasing metal from other recycled metals processors for shipment directly to the Steel Manufacturing Business without further processing by the Metals Recycling Business. To a lesser extent, the Company also buys, processes and sells nonferrous metals to both the domestic and export markets. A significant portion of the nonferrous volume comes as a by-product of the ferrous shredding process. Due to the large capital investment required for metals recycling equipment and the scarcity of potential yard sites that are properly zoned and have access to waterways, highways and railroads, the recycled metals industry is characterized by a relatively small number of large dominant metals processors, such as the Company's Metals Recycling Business, and many smaller regional metals processors. The large processors collect raw metals from a variety of sources, including smaller metal recyclers and dealers, and then sort, clean and cut it into sizes and grades suitable for use by steel manufacturers. The Company's Portland, Oakland, and Tacoma metals recycling facilities are located at deep water terminals operated by the Company and also have rail and highway access. As a result, the Company believes it is strategically located, both for collection of unprocessed metals from suppliers and for distribution of processed recycled metals to West Coast and foreign steel producers. The Company owns the Oakland and Tacoma facilities and leases the Portland location from a related party. Additionally, because the Company operates the terminal facilities, it is not normally subject to the same berthing delays often experienced by users of unaffiliated terminals. The Company's loading costs are believed to be lower than they would be if the Company was to utilize third party terminal facilities. Customers and Marketing. The following table sets forth information about the amount of ferrous recycled metals sold by the Company's Metals Recycling Business to certain groups of customers during the last five fiscal years:
Year Ended August 31, ----------------------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---------------- ---------------- ----------------- ---------------- ---------------- Sales Vol.1 Sales Vol.1 Sales Vol.1 Sales Vol.1 Sales Vol.1 ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- (dollar amounts in millions) Asian Steel Producers and Representatives $178.7 1,157 $126.8 1,068 $91.8 777 $ 91.7 761 $ 48.4 491 Steel Manufacturing Business: Processed 34.8 303 29.7 313 42.6 471 39.2 411 39.2 447 Brokered 2 26.0 232 7.9 94 7.1 95 7.1 87 6.1 92 ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- 60.8 535 37.6 407 49.7 566 46.3 498 45.3 539 Other US Steel Producers 15.8 120 9.1 82 14.1 139 26.0 247 18.5 194 ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- Total $255.3 1,812 $173.5 1,557 $155.6 1,482 $164.0 1,506 $112.2 1,224 ====== ===== ====== ===== ====== ===== ====== ===== ====== =====
1 In thousands of long tons (2,240 pounds). 2 Consists of recycled metal that is purchased from other suppliers for direct shipment and is not processed by the Metals Recycling Business. The Company sells recycled metals to foreign and unaffiliated domestic steel producers or their representatives and to the Steel Manufacturing Business. The Company has developed long-standing relationships with Asian and United States steel producers. The Company's primary Asian recycled metals customers are located in China, South Korea and Taiwan. To serve these customers more effectively, the Company operates a wholly-owned subsidiary, SSI International 7 Far East Ltd., in Seoul, South Korea, and has an agent in China. Additionally, the Company uses representatives in Tokyo, Japan to provide market data. The Company believes these representatives not only enhance the Company's service to its Asian customers, but also provide a valuable local presence and source of information in these markets. The Metals Recycling Business' five largest customers accounted for 64% of recycled metals sales to unaffiliated customers. However, the Company's recycled metals customers vary from year to year due to demand, competition, relative currency values and other factors. All recycled metals sales are denominated in United States dollars and substantially all ferrous recycled metals shipments to foreign customers are supported by letters of credit. Historically, ferrous recycled metals prices have on average increased over the long term; such prices, however, are subject to market cycles. Prices for foreign recycled metals shipments are generally established through a competitive bidding process. The Company generally negotiates domestic prices based on export price levels. Foreign recycled metals sales contracts typically provide for shipment within 45 to 90 days after the price is agreed to, which, in most cases, includes freight. The Company attempts to respond to changing export price levels by adjusting its purchase prices at its metals recycling yards to maintain its operating margin dollars per ton. However, the Company's ability to fully maintain its operating margin per ton through periods of rapidly declining prices can be limited by the impact of lower purchase prices on the volume of recycled metals flowing to the Company from marginal unprocessed metal suppliers. Accordingly, the Company believes it benefits from rising recycled metals prices, which provide the Company greater flexibility to maintain or widen both margins and unprocessed metals flow into its yards. The Company also sells recycled nonferrous metals to foreign customers. Demand from Asian countries, especially China, continues to increase. The Company's efficiency in recovering nonferrous metals from its shredding process provides increasing supplies to sell to foreign customers. Also, the Company purchases nonferrous metals directly from other suppliers for sale overseas. The nonferrous cargoes are loaded into ocean going containers which are shipped to the customer. The following table sets forth information about the amount of nonferrous recycled metals sold by the Company's Metals Recycling Business during the last five fiscal years:
Year Ended August 31, ------------------------------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---------------- ----------------- ---------------- ---------------- ---------------- Sales Vol.(1) Sales Vol.(1) Sales Vol.(1) Sales Vol.(1) Sales Vol.(1) ----- ------- ----- ------- ----- ------- ----- ------- ----- ------- (dollar amounts in millions) Nonferrous recycled metals $47.8 113,378 $41.7 112,622 $43.0 114,441 $38.9 96,207 $26.4 74,497 ===== ======= ===== ======= ===== ======= ===== ====== ===== ======
(1) In thousands of pounds SOURCES OF UNPROCESSED METALS. The most common forms of raw metals purchased by the Company are obsolete machinery and equipment such as automobiles, railroad cars, railroad tracks, home appliances and demolition metal from buildings and other obsolete structures. The metals are acquired from drive-in sellers at posted prices at the Company's eleven metals recycling yards, from drop boxes at a diverse base of suppliers' industrial sites and through negotiated purchases from railroads and other large suppliers. The Company purchases unprocessed metals from a large number of suppliers, including railroads, industrial manufacturers, automobile salvage yards, metals dealers, landfills and individuals. Metals recycling yards situated nearest to unprocessed metals sellers and major transportation routes have a competitive advantage because of the significance of freight charges relative to the value of metals. The Company's Portland yard benefits from northwestern rail, highway and water transportation routes allowing it to attract sellers from Oregon, Washington, Idaho, Montana, Utah, Nevada and Northern California. The Eugene, Grants Pass, White City and Bend yards are smaller facilities that serve as collection points from central and southern Oregon. Two of these yards also have some processing capabilities. These yards primarily use trucks and railroads to transport their products. The Oakland yard gives the Company sourcing capability in the San Francisco Bay area, one of the largest metropolitan regions in the country. The Sacramento and Fresno yards are facilities that serve as collection and processing points for metals from the growing central valley of California and Western Nevada and are served by rail and trucks. These facilities provide materials for the Company's Oakland export operation, ship material to domestic customers and ship certain products directly to the Company's Steel Manufacturing Business. The Company's Tacoma 8 yard, along with its collection facilities, collect metals from Seattle and the entire Puget Sound area as well as from throughout Washington, Montana, Idaho, Alaska and Western Canada. Product is shipped and received via rail, truck and water (e.g. ship or barge). METALS RECYCLING. The Company processes raw metal by sorting, shearing, shredding, torching and processing metal into pieces of a size, density and purity required by customers for use in their melting furnaces. Smaller, more homogenous pieces of processed metals have more value because they melt more easily than larger pieces and more completely fill a steel mill's furnace charge bucket. Over 70% of the ferrous metals collected by the Company's metals recycling facilities requires processing before sale. Seven of the Company's eleven wholly-owned metals recycling facilities operate large capacity guillotine-style shears for cutting large pieces of ferrous metal into smaller, more saleable pieces. At six of the facilities, the Company also has large scissor shears mounted on portable material handlers that move about the yards and cut bulky pieces of metal into sizes that can be further processed by the guillotine shears. These mobile shears are capable of reducing a railroad boxcar to useable recycled metal in approximately 30 minutes. One of the most efficient ways to process and sort metal is by the use of shredding systems. The Portland and Oakland facilities each operate a large shredder capable of processing up to 1,500 tons of metal per day. In fiscal 2000, the Tacoma facility completed the installation of a state-of-the-art mega-shredder capable of shredding over 2,000 tons per day. The Company has also entered into an agreement to purchase a mega-shredder for its Oakland facility that is expected to be installed in late 2004. These shredders are designed to provide a denser product, which is efficiently used by steel mills and broadens the types of material that can be shredded. They reduce automobile bodies, home appliances and other light gauge sheet metal into fist-size pieces of shredded recycled metal in seconds. The shredded material is then carried by conveyor under magnetized drums, which attract the ferrous recycled metal and separate it from the nonferrous metals and other residue found in the shredded material, resulting in a relatively pure and clean shredded steel product. The remaining nonferrous metal and residue then pass through a process that mechanically separates the nonferrous metals from the residue. The remaining nonferrous metals are either hand sorted and graded before being sold or sold unsorted. During fiscal 2000, the Portland yard installed a new indoor nonferrous sorting system, which reduces the moisture content of the unprocessed material and allows for greater recovery of high value nonferrous metallics. In fiscal 2003, the Oakland yard began upgrading its nonferrous sorting capabilities with similar eddy current separators to increase capacity and improve the nonferrous recovery from the shredding process. DEEP WATER TERMINAL FACILITIES. The Company delivers ferrous recycled metals to foreign steel producers by ship. The Company achieves cost efficiencies by operating deep water terminal facilities at its Portland, Tacoma and Oakland facilities. As a result, the Company is generally not subject to normal berthing delays sometimes experienced by users of unaffiliated terminal facilities. The Oakland and Portland docks also have berths serviced by a bulk loading conveyor for loading shredded metal. The Oakland facility has a 350 foot concrete wharf, with the ability to handle longer ships, which was placed into service in 1990, and a 40-ton container crane, which has been modified to load and unload bulk cargo. The crane will be upgraded over the next year as the facility's shipping schedule allows. The Tacoma marine terminal is serviced by a 250-ton gantry crane and one 40-ton crane. A new 400 foot dock and bulkhead were completed at the Tacoma yard during fiscal 1999. Currently, the Portland dock has three operating berths for ships and two tie-up berths, and is equipped with three 60-ton cranes for loading and unloading heavy materials, and a bulk loading conveyor capable of loading up to 700 tons of shredded recycled metals per hour directly into a ship's hold. During fiscal 2002, the Company's Portland, Oregon metals recycling facility embarked on a dock and loading facility renovation, including the acquisition of a portside crane, in order to increase its efficiency in loading recycled metals export cargos. The renovation was temporarily suspended in fiscal 2003 when severe deterioration of the dock's substructure was detected during demolition activities. The project is being reengineered to rebuild the substructure and to accommodate additional heavy industrial requirements, which will better serve the Company's long term needs. 9 The Oakland, Tacoma and Portland terminals are used for loading metals shipments to the Company's foreign customers. In addition, the Portland terminal sells bulk cargo storage, docking, loading and warehousing services to unrelated parties. COMPETITION. The Company competes for both the purchase of metals from suppliers and the sale of processed recycled metals to finished steel producers. Competition for metals purchased in the Metals Recycling Business' markets comes primarily from well financed larger recyclers of metal as well as smaller metals yards and dealers. Many of these recyclers have varying types and sizes of processing equipment that include fixed and mobile shears and large and small ferrous metal shredders, all with varying effects on the selling price of recycled metal. The Company also competes with brokers who buy product on behalf of domestic and foreign mills. The predominant competitive factors impacting the Company's recycled metals sales and its ability to obtain unprocessed metals are price, including shipping costs, availability, reliability of service and product quality. The Company competes with a number of domestic and foreign recycled metals processors for export sales. Price, including shipping costs, and availability are the most important competitive factors, but reliability and quality are also important. During the last year, the ferrous export market experienced decreased supplies of metal coming out of the countries that were part of the former Soviet Union compared with the previous two years. The lower supplies were primarily driven by political policy changes in these countries whereby export tariffs and/or bans were enacted to retain recycled metal for use in their domestic economies. The quality of the product from these countries is generally good and their pricing was generally aggressive, as they tended to operate for the generation of cash flow versus focusing on traditional income and return on investment theory. The Company believes that its size and locations allow it to compete effectively with other domestic and foreign metals recyclers. SEASONALITY. The Company makes a number of large ferrous metals shipments to foreign steel producers each year. The Company's control over the timing of shipments is limited by customers' requirements, shipping schedules and other factors. Variations in the number of shipments from quarter to quarter result in fluctuations in quarterly revenues, earnings and inventory levels. BACKLOG. On August 31, 2003, the Company's Metals Recycling Business had a backlog of firm orders of $44.9 million, as compared to $13.2 million on August 31, 2002. All of the backlog on August 31, 2003 was related to export ferrous metal shipments. JOINT VENTURES - -------------- The Company has invested in certain joint ventures which process and sell recycled metals to third parties and other joint ventures that supply unprocessed metals to the Company's operations and other metals buyers. The Company's joint ventures with Hugo Neu Corporation recognized revenues of $858.3 million in fiscal 2003 and $618.1 million in fiscal 2002. Other joint ventures recognized revenues of $19.0 million in fiscal 2003 and $22.9 million in fiscal 2002. I. JOINT VENTURES IN THE METALS RECYCLING BUSINESS The Company owns interests in five joint ventures that are engaged in buying, processing, selling and brokering primarily ferrous metal. The Company is a 50% partner in four of these joint ventures and is a 30% partner in another smaller joint venture. In fiscal 2003, these joint ventures processed and sold approximately 3.3 million long tons of ferrous metals. Through these joint ventures, the Company participates in the management of 28 metals collection and processing facilities, including export terminals in Los Angeles, California, Everett, Massachusetts, Portland, Maine, Providence, Rhode Island, Jersey City, New Jersey and 23 feeder yards. At the feeder yards, metal is collected, processed and then transported to one of the joint venture's deep-water terminals for subsequent export or domestic sale or sold directly to domestic purchasers. Additionally, the trading joint venture, begun in 1999, that brokers metals in foreign markets has increased its tonnage to 1.7 million tons in fiscal 2003 from 1.2 million tons in 10 the prior year with the growth in global trade. The Company also owns a 50% interest in two smaller metals recycling joint ventures in the Western United States. METALS PROCESSING AND SUPPLY. The joint ventures predominantly produce shredded recycled metal and other grades of ferrous recycled metal, primarily heavy melting and premium grades. Like the Metals Recycling Business, the joint ventures process metals by shredding, sorting, baling, shearing or cutting the metals into pieces suitable for melting. Processed metals are either inventoried for later shipment or shipped directly by ship, barge, rail or truck to foreign or domestic steel mills. The joint ventures also sell nonferrous metals, which are mainly a by-product of the ferrous production process. Over the next few years, these joint ventures have committed to replace three of their older shredders with three highly efficient shredders at their facilities. DEEP WATER TERMINAL FACILITIES. Through its joint ventures, the Company participates in the management of export terminals in Los Angeles, California, Everett, Massachusetts, Portland, Maine, Providence, Rhode Island and Jersey City, New Jersey. The joint ventures deliver by ship recycled metals to steel producers throughout the world. As a result of owning or leasing these facilities, the joint ventures are not subject to berthing delays sometimes experienced by users of unaffiliated terminal facilities. In fiscal 2003, the export terminal in New Jersey completed a dredging project, increasing the depth of water at the berth and in the channel to more efficiently load deeper draft ships. Final new navigational markers and lights should be in place by early fiscal 2004. In the past, the facility incurred unusually high handling costs on many of its ferrous export shipments due to water depth limitations. It is anticipated that this project will significantly reduce ship loading costs for the joint venture. The Everett, Massachusetts wharf facility completed a major dock renovation in fiscal 2003, increasing efficiency of ship loading. COMPETITION. The predominant competitive factors which impact the joint ventures' ability to obtain unprocessed metals as a raw material and recycled metals sales are price, including shipping costs, availability, reliability of service and product quality. See "Competition" in the Metals Recycling Business section of this report. II. JOINT VENTURE SUPPLIERS OF METALS The Company is a 50% partner in two joint ventures operating out of Richmond, California which are industrial plant demolition contractors. These joint ventures dismantle industrial plants, perform environmental remediation, resell any machinery or pieces of steel that are salvaged from the plants in a usable form and sell other recovered metals, primarily to the Company. During fiscal 2003, the Company purchased substantially all of the ferrous metals generated by these joint ventures. The Company purchased 53,000 and 40,000 long tons of ferrous metals from these joint ventures in fiscal 2003 and 2002, respectively. Purchase terms are negotiated at arms-length between the Company and the other partners to the joint ventures. STEEL MANUFACTURING BUSINESS The Company's Steel Manufacturing Business consists of its wholly-owned subsidiary, Cascade Steel Rolling Mills, Inc., located in McMinnville, Oregon (approximately 45 miles southwest of Portland). The Steel Manufacturing Business' mini-mill was originally constructed in 1968, acquired by the Company in 1984 and was significantly modernized and expanded in the 1990's. Since the Company purchased the mill in 1984, it has made a number of improvements, which have modernized the machinery and equipment at the Steel Manufacturing Business and have made it possible for the melt shop to process 11 700,000 tons annually, compared with less than 400,000 tons for the previous melt shop. In fiscal 1996, the Company finished the installation of a second rolling mill (Rolling Mill #2). Rolling Mill #2 is state-of-the-art and able to produce more finished goods. In fiscal 1997, the Company installed a rod block and finishing equipment at Rolling Mill #2, which allowed the Steel Manufacturing Business to expand and enhance its product line. In fiscal 2001, the Company installed a static var compensator that provides a more uniform electric power supply for the steel manufacturing process. This enhancement has increased efficiency and production in the billet making process, which allows the Steel Manufacturing Business to take advantage of the greater efficiencies gained on Rolling Mill #2. In fiscal 2003, the Steel Manufacturing business enhanced the wire rod production process by installing a new ring distributor that improved yield and produced a more uniformly packaged product, which is preferred by steel fabricators. In addition, improvements to the wire rod cooling system allow for the manufacture of high carbon wire rod which sells at a premium price. In fiscal 2004, the Steel Manufacturing Business plans to replace the electric arc furnace in the melt shop at an estimated cost of $2.5 million. The new furnace will be more efficient and will use less energy. The improvement is expected to be completed in the fourth quarter of fiscal year 2004. See further discussion under "Manufacturing Operations and Equipment" below. Products and Marketing. The Steel Manufacturing Business produces rebar, merchant bar, coiled products and specialty products. Sales of these products during the last five fiscal years were as follows:
Year Ended August 31, --------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Sales Vol.1 Sales Vol.1 Sales Vol.1 Sales Vol.1 Sales Vol.1 ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- (dollar amounts in millions) Rebar $ 97.4 327 $ 86.7 307 $ 91.8 309 $ 91.1 308 $ 103.0 340 Coiled products 67.9 223 51.6 179 39.2 137 59.5 214 22.2 81 Merchant bar 23.4 65 21.3 67 28.8 83 40.7 117 39.0 113 Other products 3.2 7 7.0 16 7.8 17 12.3 27 17.5 37 ------- --- ------- --- ------- --- ------- --- ------- --- Total $ 191.9 622 $ 166.6 569 $ 167.6 546 $ 203.6 666 $ 181.7 571 ======= === ======= === ======= === ======= === ======= ===
1 In thousands of short tons (2,000 pounds). Rebar is steel rod used to increase the tensile strength of poured concrete. Merchant bar consists of round, flat, angle and square steel bars used by fabricators or manufacturers to produce a wide variety of products, including gratings, steel floor and roof joints, safety walkways, ornamental furniture, stair railings and farm equipment. Coiled products consist of wire rod and coiled rebar. Wire rod is steel wire, delivered in coiled form, and is used by fabricators to produce a variety of products such as chain link fencing, nails, wire and stucco netting. Coiled rebar is rebar delivered in coils rather than in flat lengths, a method preferred by some fabricators as it reduces the waste and improves yield generated by cutting individual lengths to meet customer specifications. The Steel Manufacturing Business sells directly from its mill in McMinnville, Oregon and from its company owned distribution center located in El Monte, California (Los Angeles area) and one third-party distribution center in Stockton, California. The distribution centers facilitate sales by holding a ready inventory of products close to major customers for just-in-time delivery. The Steel Manufacturing Business communicates regularly with major customers to determine their anticipated needs and plans its rolling mill production schedule accordingly. The Steel Manufacturing Business also produces and inventories a mix of products forecasted to meet the needs of other customers. Shipments to customers are made by common carrier, either truck or rail. During fiscal 2003, the Steel Manufacturing Business sold its steel products to approximately 350 customers primarily located in the 10 western states. In that period, approximately 22% of the Steel Manufacturing Business' sales were 12 made to customers in California. The Steel Manufacturing Business' customers are principally steel service centers, construction industry subcontractors, steel fabricators, wire drawers and major farm and wood product suppliers. The Steel Manufacturing Business' 10 largest customers accounted for approximately 46% of its revenues during fiscal 2003. RECYCLED METALS SUPPLY. The Company believes it operates the only mini-mill in the Western United States which has the ability to obtain its entire recycled metals requirement from its own affiliated metals recycling operations. There have at times been regional shortages of recycled metals with some mills being forced to pay higher prices for recycled metals shipped from other regions or to temporarily curtail operations. The Company's Metals Recycling Business has the ability to supply the Steel Manufacturing Business both with recycled metals that it has processed and with recycled metals that it has purchased from third-party processors. See Metals Recycling Business. The Metals Recycling Business is also able to deliver to the Steel Manufacturing Business an optimal mix of recycled metal grades to achieve maximum efficiency in its melting operations. ENERGY SUPPLY. Electricity and natural gas represented approximately 8% and 3%, respectively, of the Steel Manufacturing Business' cost of goods sold in the year ended August 31, 2003. The Steel Manufacturing Business purchases electric power from McMinnville Water & Light (McMinnville), a municipal utility, and is McMinnville's largest customer. The Steel Manufacturing Business has a five-year contract with McMinnville that expires September 30, 2006. McMinnville obtains power from the Bonneville Power Administration (BPA) and resells it to the Steel Manufacturing Business at its cost plus a fixed charge per kilowatt hour and a 3% city surcharge. The rate McMinnville obtains from BPA is for firm power; therefore, the Steel Manufacturing Business is not forced to sacrifice the reliability of its power supply for a lower interruptible power rate as is the case with certain other mini-mills. On October 1, 2001, the BPA increased its electricity rates due to increased demand on the West Coast and lower supplies. This increase was in the form of a Cost Recovery Adjustment Clause (CRAC) added to BPA's contract with McMinnville. The CRAC is an additional monthly surcharge on selected power charges to recover costs associated with buying higher priced power during the West Coast power shortage. The CRAC, which can be adjusted every six months, has varied from its inception on October 1, 2002 from a low of 39% to a high of 50%. The current rate, which became effective on October 1, 2003, is 45%. The Steel Manufacturing Business purchases natural gas for use in the reheat furnaces from IGI Resources of Boise, Idaho, pursuant to a contract that obligates the business to purchase minimum amounts of gas at a fixed rate or pay a demand charge. The current contract expires on October 31, 2004. All natural gas used by the Steel Manufacturing Business must be transmitted by a single pipeline owned by Northwest Natural Gas Company that also serves local residential customers of Northwest Natural Gas Company. To protect against interruptions in gas supply, the Steel Manufacturing Business maintains stand-by propane gas storage tanks that have the capacity to hold enough gas to operate one of the rolling mills for at least three days without refilling. MANUFACTURING OPERATIONS AND EQUIPMENT. The Steel Manufacturing Business' melt shop includes a 108-ton capacity electric-arc furnace and a five-strand continuous billet caster. The melt shop is highly computerized and automated. The 108-ton capacity of the furnace accommodates larger, less expensive grades of scrap. Energy savings result in part from efficiencies of the larger furnace, but also as a result of post-combustion equipment added to the furnace in 1995. This technology injects oxygen into the furnace during melting operations which creates energy by combusting carbon monoxide. The melt shop also has enhanced steel chemistry refining capabilities, permitting the mill to produce higher margin products using special alloy quality grades of steel not currently produced by other mills on the West Coast. The static var compensator increases the efficiency and production in the billet making process, thereby allowing the Steel Manufacturing Business to take advantage of the greater efficiencies gained on Rolling Mill #2. During fiscal 2003, 2002 and 2001, the melt shop produced 636,000, 483,000 and 680,000 tons of billets, respectively. Due in part to the sluggish domestic economic conditions in fiscal 2002 and part of fiscal 2003, the Company curtailed melt shop production to reduce billet inventories and improve cash flow. During the first quarter 13 of fiscal 2003, billet inventories reached targeted levels. As a result, in November, 2002, the melt shop resumed full operations of seven days per week. Billets produced by the melt shop are reheated in one of two natural gas-fueled reheat furnaces and then hot-rolled through one of two rolling mills. Rolling Mill #1, a 17-stand mill, was rebuilt in 1986. The mill is computerized, allowing for efficient synchronized operations of the rolls and related equipment. The computer controls include a self-diagnostic system that detects and identifies electronic and mechanical malfunctions in Rolling Mill #1. In 1994, the Steel Manufacturing Business completed the installation of in-line straightening, stacking and bundling equipment on the end of Rolling Mill #1. The addition of this equipment has permitted the Steel Manufacturing Business to improve the packaging and quality of its products and to produce its merchant bar products more efficiently by automating the straightening and bundling function. It has also permitted the Steel Manufacturing Business to expand its higher-margin merchant bar product line. Rolling Mill #2, a technologically advanced 18-stand mill, was completed in February 1996. The mill is computerized, allowing for efficient synchronized operations of the rolls and related equipment. The computer controls include a self-diagnostic system that detects and identifies electronic and mechanical malfunctions in the mill. In fiscal 1997, the Company installed a rod block and finishing equipment at Rolling Mill #2 which allowed the Steel Manufacturing Business to expand and enhance its product line into coiled steel products. In the first quarter of fiscal 2003, the Steel Manufacturing Business enhanced the wire rod production process by installing a ring distributor and making improvements to the wire rod cooling system. The ring distributor improved yield and produces a more uniformly packaged product. Improvements to the wire rod cooling system allow for the manufacture of larger diameter and high carbon wire rod which sells at a premium price. In fiscal 2004, the Steel Manufacturing Business plans to replace the electric arc furnace in the melt shop at a cost of $2.5 million. The new furnace, with a 110-ton capacity, will be more efficient and will reduce electric power consumption. The final installation of the furnace is expected to be completed over a period of less than two weeks during the fourth quarter of fiscal 2004. Peripheral structures will be completed prior to that time while the existing furnace is in operation. In order to accommodate the rolling mills' need for billets during the installation shut-down, the Steel Manufacturing Business will increase billet inventory leading up to the final installation. Management expects to add 10,000 tons to the billet inventory during December 2003 when the operation is normally shut down. As the final installation gets closer, management will reassess the anticipated needs of the rolling mills and adjust the billet inventory accordingly. TRANSPORTATION. The Steel Manufacturing Business makes extensive use of rail and truck transportation for shipment of its products to its distribution centers and customers in California and for the shipment of recycled metals to the mill both from the Metals Recycling Business' yards and other metal recyclers in Oregon and California. Competition. The Steel Manufacturing Business competes with the following Western United States steel producers for sales of rebar and merchant bar: Nucor Corporation (Nucor) in Plymouth, Utah, Seattle, Washington and Kingman, Arizona (currently idle); Tamco in Los Angeles, California; and Chaparral Steel Company in Midlothian, Texas. In December 2002, Nucor acquired Birmingham Steel, which has a steel mill in operation located in Seattle, Washington, and also acquired the North Star Mill in Kingman, Arizona plant that remains idle. For sales of wire rod, the Steel Manufacturing Business competes with an Oregon Steel Mills, Inc. plant located in Pueblo, Colorado, other domestic producers located primarily on the West Coast and importers. Other domestic mills located east of the Rocky Mountains generally do not compete in the Steel Manufacturing Business' market area because of transportation costs. The principal competitive factors in the Steel Manufacturing Business' market are price (including freight cost), product availability, quality and service. Certain of the Steel Manufacturing Business' competitors have substantially greater financial resources than the Steel Manufacturing Business. In addition to domestic competition, the Steel Manufacturing Business has historically competed intensely with foreign steel producers principally located in Asia, Canada, Mexico, and Central and South America in certain of its product lines. During fiscal 2001, the Steel Manufacturing Business experienced significant competition from low-priced steel imports. In March and April 2002, the United States International Trade Commission (ITC) imposed tariffs on imported steel, under Section 201 of the 1974 Trade Act to 14 temporarily aid the domestic steel industry. To date, however, these tariffs have not significantly benefited selling prices for finished steel products on the West Coast of the United States. In the spring of 2002, the U.S. Government imposed anti-dumping and countervailing duties against wire rod products from eight foreign countries. In fiscal 2003, imports of steel were also affected by foreign currency fluctuations. Relevant foreign currencies generally strengthened relative to the U.S. dollar, making imports into the U.S. more expensive. As a result of the duties and these changes in foreign exchange rates, the Company has recently experienced less competition from foreign steel producers. In June 2003, Oregon Steel Mills, Inc. permanently shut down its Portland melt shop. Although Oregon Steel Mills' (OSM) finished products do not directly compete with the Company, OSM has historically competed for recycled metal supplies in the Pacific Northwest. Thus, this closure is expected to reduce the end user demand for unprocessed metal in the Portland, Oregon market. SEASONALITY. The Steel Manufacturing Business' revenues can fluctuate significantly between quarters due to factors such as the seasonal slowdown in the construction industry, which occurs from the late fall through early spring, and in other industries it serves. In the past, the Steel Manufacturing Business has generally experienced its lowest sales during the second quarter of the fiscal year. The Company expects this pattern to continue in the future. BACKLOG. The Steel Manufacturing Business generally ships products within days after the receipt of purchase orders. Backlogs are seasonal and would be larger in fiscal quarters three and four. AUTO PARTS BUSINESS - ------------------- The auto dismantling and used auto parts industry is very fragmented, with few dominant players. This is particularly the case in the self-service sector of the used auto parts industry. With 23 stores in six states, the Company believes it has one of the largest self-service used auto parts networks in the United States. Seventeen of these stores are located in Northern California, with the remaining stores located in Nevada, Utah, Illinois, Indiana and Texas. The Company purchases salvaged vehicles, sells parts from those vehicles through its retail store facilities and wholesale operations, and sells the remaining portion of the vehicles to metal recyclers, including the Company's Metals Recycling Business. The Company is dedicated to supplying low cost used auto parts to its customers. In general, management believes that the price of parts is significantly lower than full service auto dismantling prices, retail car part store prices and car dealership prices. Each store offers an extensive selection of vehicles from which consumers can remove parts. The average store is located on 14 acres and contains 1,600 cars available to the customer. The Company carries domestic and foreign cars, vans and light trucks. The Company rotates its inventory frequently, providing customers with access to new parts. The Company does not remove parts for its customers or perform automotive repairs. The Company typically seeks to locate its facilities with convenient access to major streets and major population centers. By operating its stores at locations that are convenient and visible to the target customer, the stores become the first stop a customer makes in acquiring their used auto parts. Convenient locations also make it easier and less expensive for suppliers to deliver vehicles. 15 Products and Marketing. The following table sets forth information about the significant components of sales made by the Company's Auto Parts Business and predecessor companies during the last five fiscal years:
Year Ended August 31, --------------------- 2003 2002(1) 2001(1) 2000(1) 1999(1) ---- ------- ------- ------- ------- Sales %. Sales %. Sales %. Sales %. Sales %. ----- -- ----- -- ----- -- ----- -- ----- -- (dollar amounts in millions) Retail sales $44,463 68% $42,257 73% $37,826 74% $32,965 74% $29,031 76% Wholesale sales 20,762 32% 16,018 27% 13,505 26% 11,792 26% 9,043 24% ------- --- ------- --- ------- --- ------- --- ------- --- Total $65,225 100% $58,275 100% $51,331 100% $44,757 100% $38,074 100% ======= === ======= === ======= === ======= === ======= ===
(1) The sales for periods prior to fiscal 2003 are not included in the Company's consolidated revenues. Please refer to Note 1 and Note 3 in the Notes to the Consolidated Financial Statements. The Company sells auto parts from each of its retail locations. Upon arriving at a store, a customer pays an admission charge and signs a liability waiver before entering the facility. When a customer finds a desired part on a vehicle, the customer removes it and pays a standard retail price for the part. Once the vehicle is removed from the customer area, certain remaining parts that can be sold wholesale ("cores") are removed from the vehicle. In California, these cores, such as engines, transmissions and alternators, are consolidated at a central facility. From this facility, the parts are sold, via an auction system, to a variety of different wholesale buyers. Due to larger volumes generated via this consolidation process, the Company has been able to obtain increasingly higher prices for these cores. After the core removal process is complete, the remaining auto body is crushed and sold as scrap metal in the wholesale market. The auto bodies are sold on a price per ton basis. This price is subject to fluctuations in the recycled ferrous metal markets. Traditionally, the majority of the Northern California stores' auto bodies are sold to the Metals Recycling Business's Oakland facility. During fiscal 2003, the Auto Parts Business had sales of $7.7 million to the Metals Recycling Business, thereby making it the Auto Parts Business' single largest customer. The Company's wholesale business consists of its core and scrap sales. COMPETITION. The Company competes with both full-service and self-service auto dismantlers as well as larger well-financed retail auto parts businesses for retail customers. Also, the Company competes for its vehicle inventory with other dismantlers, used car dealers, auto auctions and metal recyclers. Vehicle costs can fluctuate significantly depending on market conditions and prices for recycled metal. SOURCES OF VEHICLES. The Company obtains vehicles from three primary sources: tow companies, private parties and charities. The Company employs car buyers who travel to tow companies and bid on vehicles. The Company also has a program to purchase vehicles from private parties called "Cash for Junk Cars." This program is advertised in telephone directories and newspapers. Private parties call a toll free number and receive a quote for their vehicle. The private party can either deliver the vehicle to one of the retail locations or the Company can arrange for the vehicle to be picked up. SEASONALITY. Retail sales and admissions are somewhat seasonal and principally affected by weather and promotional events. Since the stores are open to the natural elements, during periods of prolonged wet, cold or extreme heat, the retail business tends to slow down due to the difficult customer working conditions. As a result, the Company's first and third fiscal quarters tend to generate the most retail sales and the second and fourth fiscal quarters are the slowest in terms of retail sales. 16 ENVIRONMENTAL MATTERS - --------------------- Compliance with environmental laws and regulations is a significant factor in the Company's business. Some of the Company's businesses are subject to local, state, federal and supranational environmental laws and regulations concerning, among other matters, solid waste disposal, hazardous waste disposal, air emissions, water quality and discharge, dredging and employee health. Environmental legislation and regulations have changed rapidly in recent years and it is likely that the Company will be subject to even more stringent environmental standards in the future. PORTLAND HARBOR In December 2000, the United States Environmental Protection Agency (EPA) named the Portland Harbor, a 5.5 mile stretch of the Willamette River in Portland, Oregon, as a Superfund site. The Company's metals recycling and deep water terminal facility in Portland, Oregon is located adjacent to the Portland Harbor. Crawford Street Corporation, a Company subsidiary, also owns property adjacent to the Portland Harbor. The EPA has identified 69 potentially responsible parties (PRPs), including the Company and Crawford Street Corporation, which own or operate sites adjacent to the Portland Harbor Superfund site. The Company leases the metals recycling and deep water terminal facility from Schnitzer Investment Corp. (SIC), a related party, and is obligated under its lease with SIC to bear the costs relating to the investigation and remediation of the property. The precise nature and extent of any clean-up of the Portland Harbor, the parties to be involved, and the process to be followed for such a clean-up have not yet been determined. It is unclear whether or to what extent the Company or Crawford Street Corporation will be liable for environmental costs or damages associated with the Superfund site. It is also unclear whether natural resource damage claims or third party contribution or damages claims will be asserted against the Company. While the Company and Crawford Street Corporation participated in certain preliminary Portland Harbor study efforts, they are not parties to the consent order entered into by the EPA with other PRPs (Lower Willamette Group) for a Remedial Investigation/Feasibility Study; however the Company could become liable for a share of the costs of this study at a later stage of the proceedings. Separately, the Oregon Department of Environmental Quality (DEQ) has requested operating history and other information from numerous persons and entities which own or conduct operations on properties adjacent to or upland from the Portland Harbor, including the Company and Crawford Street Corporation. The DEQ investigations at the Company and Crawford Street sites are focused on controlling any current releases of contaminants into the Willamette River. The Company has agreed to a voluntary Remedial Investigation/Source Control effort with the DEQ regarding its Portland, Oregon deep water terminal facility and the site owned by Crawford Street Corporation. DEQ identified these sites as potential sources of contaminants that could be released into the Willamette River. The Company believes that improvements in the operations at these sites, often referred to as Best Management Practices (BMPs), will be sufficient to effectively provide source control and avoid the release of contaminants from these sites, and has proposed to DEQ the implementation of BMPs as the resolution of this investigation. While the cost of the investigations associated with these properties and the cost of employment of source control BMPs are not expected to be material, no estimate is currently possible and none has been made as to the cost of remediation, if any. No accrual for remediation of the Portland Harbor or the Company's adjacent properties had been established as of August 31, 2003. MANUFACTURING MANAGEMENT, INC. In 1994, Manufacturing Management, Inc. (MMI) recorded a reserve for the estimated cost to cure certain environmental liabilities. This reserve was carried over to the Company's financial statements when MMI was acquired in 1995, and at August 31, 2003 aggregated $15.6 million. General Metals of Tacoma (GMT), a subsidiary of MMI, owns and operates a metals recycling facility located in the State of Washington on the Hylebos Waterway, a part of Commencement Bay, which is the subject of an ongoing remediation project by the United States Environmental Protection Agency (EPA) under the Comprehensive 17 Environmental Response, Compensation and Liability Act (CERCLA). GMT and more than 60 other parties were named potentially responsible parties (PRPs) for the investigation and clean-up of contaminated sediment along the Hylebos Waterway. On March 25, 2002, EPA issued Unilateral Administrative Orders (UAOs) to GMT and another party to proceed with Remedial Design and Remedial Action (RD/RA) for the head of the Hylebos and to two other parties to proceed with the RD/RA for the balance of the waterway. It is anticipated that the UAOs will soon be converted to more specific voluntary consent decrees and that EPA will take additional action against other PRPs. The issuance of the UAOs did not require the Company to change its previously recorded estimate of environmental liabilities for this site. Significant uncertainties continue to exist regarding the total cost to remediate this site as well as the Company's share of those costs; nevertheless, the Company's estimate of its liabilities related to this site is based on information currently available. The Natural Resource Damage Trustees (Trustees) for Commencement Bay have asserted claims against GMT and other PRPs within the Hylebos Waterway area for alleged damage to natural resources. In March 2002, the Trustees delivered a draft settlement proposal to GMT and others in which the Trustees suggested a methodology for resolving the dispute, but did not indicate any proposed damages or cost amounts. In June 2002, GMT responded to the Trustees' draft settlement proposal with various corrections and other comments, as did twenty other participants. It is unknown at this time whether, or to what extent, GMT will be liable for natural resource damages. The Company's previously recorded environmental liabilities include an estimate of the Company's potential liability for these claims. The Washington State Department of Ecology named GMT, along with a number of other parties, as Potentially Liable Parties (PLPs) for a site referred to as Tacoma Metals. GMT operated on this site under a lease prior to 1982. The property owner and current operator have taken the lead role in performing a Remedial Investigation and Feasibility Study (RI/FS) for the site. The RI/FS is now completed and the parties are currently involved in a mediation settlement process to address cost allocations. The Company's previously recorded environmental liabilities include an estimate of the Company's potential liability at this site. MMI is also a named PRP at two third-party sites at which it allegedly disposed of transformers. At one site, MMI entered into a settlement under which it paid $825,000 towards remediation of the site. Remediation of the site has been completed and it is now subject to a five year monitoring program. The other site has not yet been subject to significant remedial investigation. MMI has been named as a PRP at several other sites for which it has agreed to de minimis settlements. In addition to the matters discussed above, the Company's environmental reserve includes amounts for potential future cleanup of other sites at which MMI has conducted business or has allegedly disposed of other materials. PROLER In 1996, prior to the Company's acquisition of Proler International Corp. (Proler), Proler recorded a liability for the probable costs to remediate its wholly-owned properties. The Company carried over the aggregate reserve to its financial statements upon acquiring Proler, and $3.5 million remained outstanding on August 31, 2003. As part of the Proler acquisition, the Company became a 50% owner of Hugo Neu-Proler Company (HNP). HNP has agreed, as part of its 1996 lease renewal with the Port of Los Angeles (POLA), to conduct a multi-year, phased remedial clean-up project involving certain environmental conditions on its metals recycling facility at its Terminal Island site in Los Angeles, California, which was completed in 2002. HNP is waiting for final certification from POLA and the regulatory agencies overseeing the cleanup. Remediation included excavation and off-site disposal of contaminated soils, paving and groundwater monitoring. Other environmentally protective actions included installation of a stormwater management system and construction of a noise barrier and perimeter wall around a substantial portion of the facility. Metals Recycling L.L.C. (Metals) is a scrap metals processing business with locations in Rhode Island and Massachusetts. The members of Metals are one of the Company's Proler joint ventures and Izzo Group, Inc. On June 9, 1999, the Rhode Island Department of Environmental Management (DEM) issued a Notice of Violation (NOV) against Metals, alleging Metals had violated federal and state regulations relating to the storage, management 18 and transportation of hazardous waste and seeking to impose an administrative penalty of $0.7 million. Metals has filed an answer to the NOV in which it denied the allegations and requested an adjudicatory hearing. In January of 1999, federal and state officials searched Metal's Johnston, Rhode Island and Worcester, Massachusetts facilities. Metals was advised that the search was part of a state criminal investigation into possible violations of state and federal hazardous waste programs and a Rhode Island statute that prohibits the disposal of out-of-state solid waste at the landfill operated by Rhode Island Resource Recovery Corporation (RIRRC). A grand jury was empanelled to consider the allegations and issued an indictment on August 30, 2002 against Metals for storing hazardous waste without a permit, operating a hazardous waste disposal facility without a permit, causing transportation of hazardous waste without a permit, causing transportation of hazardous waste without a manifest and operating a solid waste management facility without a license. Metals has pleaded not guilty on all counts and has vigorously contested the state's allegations. Settlement discussions with DEM and the Rhode Island Attorney General's Office to settle the civil NOV and the criminal charges are being held. In August 1999, the DEM issued a NOV to RIRRC, that included a civil penalty of $0.3 million, relating to the alleged disposal of hazardous waste by Metals at a landfill operated by RIRRC. RIRRC settled this matter with DEM, and in response to RIRRC's claim against Metals for contribution, RIRRC and Metals agreed to a settlement in which Metals paid RIRRC $0.2 million in 2003. On March 15, 2002, DEM issued a NOV against Metals' Johnston, Rhode Island facility, alleging violations of provisions of the Rhode Island Clean Air Act and the regulations promulgated thereunder, and seeking to impose administrative penalties of $1.1 million against Metals. On April 5, 2002, Metals filed its answer and request for a hearing, in which it denied liability for such alleged violations. In August 2003, Metals and DEM agreed to a settlement of this matter providing for payment by Metals of a reduced fine of $0.7 million payable in 2003 through 2007, which is further reduced to $0.3 million payable in 2003 through 2004 if Metals installs electric engines, converting from diesel. Metals' results of operations for the past few years have included accruals for the probable costs to remediate or settle the above mentioned environmental situations. Additionally, other Proler joint venture sites with potential environmental clean-up issues have been identified. Estimated clean-up costs associated with these sites have been accrued for by the joint ventures. METALS RECYCLING BUSINESS After the shredding of automobile bodies and other obsolete machinery and appliances and the separation of ferrous and salable nonferrous metals, the remaining auto shredder residue must be managed. State and federal standards prescribe sampling protocols requiring representative samples of auto shredder residue to be analyzed to determine if they are likely to leach heavy metals, PCBs or other hazardous substances in excess of acceptable levels. Auto shredder residue from the Company's metals recycling operations in Oakland and Tacoma undergo an in-line chemical stabilization treatment prior to beneficial use as an alternative daily landfill cover. STEEL MANUFACTURING BUSINESS Cascade Steel Rolling Mills, Inc.'s steel mini-mill generates electric arc furnace (EAF) dust, which is classified as a hazardous waste by the EPA because of its zinc and lead content. Currently, the EAF dust is shipped to a firm in the United States that applies a treatment that allows the EAF dust to be delisted as hazardous so it can be disposed of as a non-hazardous, solid waste. By maintaining an annual renewable export license, the Company retains flexibility by having an option to send EAF dust to a secondary smelter in Mexico that recycles EAF dust to produce commercial grade zinc and lead. The Steel Manufacturing Business' mini-mill operating permit under Title V of the Clean Air Act Amendment of 1990, which governs certain air quality standards, was first issued in 1998 and has since been renewed through the year 2007. The mini-mill's air permit allows the Steel Manufacturing Business to melt up to 900,000 tons of 19 recycled metals per year and produce finished steel products totaling 450,000 tons for Rolling Mill #1 and 525,000 tons for Rolling Mill #2. As the mini-mill's production grows beyond current levels, the Steel Manufacturing Business has anticipated that it would need to enhance its existing facilities to properly control increased emissions in order to remain in compliance with the operating permit. In fiscal 2001, the Steel Manufacturing Business installed an expanded baghouse system that more efficiently and effectively controls emissions. The installation was completed at a cost of $0.6 million. In fiscal year 2002, the baghouse was expanded further at a cost of $0.7 million. In fiscal 2003, the caster cooling water system was expanded at a cost of $0.3 million which provided cleaner and cooler water to the billet casting section of the melt shop. AUTO PARTS BUSINESS In connection with the acquisition of the Auto Parts Business, the Company conducted an environmental due diligence investigation. Based upon new information obtained in this investigation, the Joint Venture accrued $2.1 million in environmental liabilities in the second quarter of fiscal 2003 for remediation costs at the Auto Parts Business's store locations. No environmental proceedings are pending at any of these sites. It is not possible to predict the total size of all capital expenditures or the amount of any increases in operating costs or other expenses that may be incurred by the Company or its subsidiaries to comply with environmental requirements applicable to the Company, its subsidiaries and their operations, or whether all such cost increases can be passed on to customers through product price increases. Moreover, environmental legislation has been enacted, and may in the future be enacted, to create liability for past actions that were lawful at the time taken but have been found to affect the environment and to increase public rights of action for environmental conditions and activities. As is the case with steel producers and recycled metals processors in general, if damage to persons or the environment has been caused, or is in the future caused, by the Company's hazardous materials activities or by hazardous substances now or hereafter located at the Company's facilities, the Company may be fined and/or held liable for such damage and, in addition, may be required to remedy the condition. Thus, there can be no assurance that potential liabilities, expenditures, fines and penalties associated with environmental laws and regulations will not be imposed on the Company in the future or that such liabilities, expenditures, fines or penalties will not have a material adverse effect on the Company. The Company has, in the past, been found not to be in compliance with certain environmental laws and regulations and has incurred liabilities, expenditures, fines and penalties associated with such violations. The Company's objective is to maintain compliance. Efforts are ongoing to be responsive to environmental regulations. The Company believes that it is in material compliance with currently applicable environmental regulations as discussed above and, except as discussed above, does not anticipate any substantial capital expenditures for new environmental control facilities during fiscal 2004 or 2005. EMPLOYEES As of August 31, 2003, the Company had 1,495 full-time employees, consisting of 465 employees at the Company's Metals Recycling Business, 451 employees at the Steel Manufacturing Business, 519 employees at the Auto Parts Business and 60 corporate administrative employees. Of these employees, as of August 31, 2003, 623 are covered by collective bargaining agreements with twelve unions. The Steel Manufacturing Business' contract with the United Steelworkers of America covers 334 of these employees and expires on April 1, 2005. The Company believes that its labor relations generally are good. 20 AVAILABLE INFORMATION The Company's website is located at www.schnitzersteel.com. The Company makes available free of charge on or through its website, its annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the Securities and Exchange Commission ("SEC"). Information contained on the Company's website is not part of this report or any other report filed with the SEC. ITEM 2. PROPERTIES The Company's Portland metals recycling facility, Portland deep water terminal facilities, and the related buildings and improvements are located on an approximately 120-acre industrial site owned by Schnitzer Investment Corp. (SIC), a related party, and leased to the Company under a long-term lease. See Part III, Item 13 "Certain Relationships and Related Transactions." Approximately 17 acres are occupied by the Company's deep water terminal facilities, and the balance is used by for recycling metal. Since 1973, the Sacramento recycled metals operations have been located on a 7-acre site, most of which was leased from SIC under a long-term lease. In August 2003, the Company purchased this leased land from SIC at fair market value. See Part III, Item 13, "Certain Relationships and Related Transactions." The Pasco, Washington and Anchorage, Alaska operations are located on sites leased from third parties. The following metals recycling operations are all located on sites owned by the Company or subsidiaries: LOCATION ACREAGE OWNED AT SITE -------- --------------------- Oakland, CA 33 Tacoma, WA 26 Fresno, CA 17 Sacramento, CA 13 Eugene, OR 11 White City, OR 4 Bend, OR 3 Grants Pass, OR 1 The Steel Manufacturing Business' steel mill and administrative offices are located on an 83-acre site owned by the Steel Manufacturing Business in McMinnville, Oregon. In fiscal 2002, the Company purchased 51 acres near the mill site in McMinnville, Oregon. The Steel Manufacturing Business also owns its 87,000 sq. ft. distribution center in El Monte, California. The Auto Parts Business has retail facilities in the following locations: Number of Total Locations Acreage --------- ------- Northern California 17 211 Nevada 2 30 Texas 1 33 Utah 1 12 Illinois 1 17 Indiana 1 29 --- --- Total 23 332 === === 21 The Company owns the properties located in Indiana and Nevada. Additionally, it owns approximately 25 acres in California, 6 acres in Illinois and 2.5 acres in Utah. The remainder of the California and Illinois facilities and the Texas facility are located on sites leased by the Company from third parties. The equipment and facilities on each of the foregoing sites are described in more detail in the descriptions of each of the Company's businesses. The Company believes its present facilities are adequate for operating needs for the foreseeable future. The Company's principal executive offices are located at 3200 and 3300 NW Yeon Avenue in Portland, Oregon in 48,000 sq. ft. of space leased from SIC under long-term leases. See Part III, Item 13 "Certain Relationships and Related Transactions." ITEM 3. LEGAL PROCEEDINGS Except as described above under Part I, Item 1 "Business -- Environmental Matters", the Company is not a party to any material pending legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended August 31, 2003. ITEM 4(a). EXECUTIVE OFFICERS OF THE REGISTRANT Name Age Office - ---- --- ------ Robert W. Philip 56 President and Chief Executive Officer Gary Schnitzer 61 Executive Vice President - California Metals Recycling Business Barry A. Rosen 58 Vice President - Finance and Treasurer and Chief Financial Officer Kurt C. Zetzsche 64 President, Cascade Steel Rolling Mills, Inc. Terry L. Glucoft 55 Vice President - Domestic Trading Jay Robinovitz 45 Vice President - Operations Kelly E. Lang 42 Vice President - Corporate Controller Robert W. Philip has been President of the Company since March 1991 and Chief Executive Officer since January 2002. He had been a Vice President of the Company since 1984 with responsibility for the Company's Metra Steel distribution division from 1984 to the time of its sale in July 1990. Gary Schnitzer has been Executive Vice President in charge of the Company's California metals recycling operations since 1980. Gary Schnitzer is a first cousin of Robert Philip's wife. 22 Barry A. Rosen has been Vice President-Finance, Treasurer, and Chief Financial Officer of the Company since 1982. Prior to joining the Company, Mr. Rosen was Chief Financial Officer of a privately held real estate developer. In addition, Mr. Rosen held financial management positions with Sara Lee Corporation and was an Audit Manager with Price Waterhouse. Kurt C. Zetzsche joined the Company in February 1993 as President of the Steel Manufacturing Business. Mr. Zetzsche has been in the steel production business since 1966. From 1990 to 1993, he was President of Tennessee Valley Steel, a mini-mill steel producer. From 1976 to 1989, he was President of Knoxville Iron Co., also a mini-mill steel producer. Terry L. Glucoft joined the Company in February 1985 and has held a number of management positions within the Metals Recycling Business, the latest of which is Vice President of Domestic Trading where he overseas the Northwest recycled metals sales operations. Prior to joining Schnitzer Steel, Mr. Glucoft was employed by Judson Steel Company, a steel mini-mill in California, from 1979 to 1985. Jay Robinovitz joined the Company in January 1993 and has held various senior management positions, including the last four years serving as General Manager of the Company's Tacoma yard. Prior to joining Schnitzer, Mr. Robinovitz was employed by Aerospace Industries, Inc., in Hartford, Connecticut from 1986 to 1993. Kelly E. Lang joined the Company in September 1999 as Vice President-Corporate Controller. From 1996 to September 1999, he was employed by Tektronix Inc. in various financial capacities, the last of which was Vice President, Finance for Tektronix Inc.'s Color Printing and Imaging Division. From 1994 to 1996, he was Treasurer of Crown Pacific Partners, LP. Mr. Lang was also a CPA with Price Waterhouse LLP. Mr. Lang has resigned his position with the Company effective as of December 1, 2003. 23 SCHNITZER STEEL INDUSTRIES, INC. FORM 10-K PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's Class A Common Stock is traded on the Nasdaq National Market tier of the Nasdaq Stock Market under the symbol SCHN. The approximate number of shareholders of record on October 31, 2003 was 111. The stock has been trading since November 16, 1993. The following table sets forth the high and low prices reported at the close of trading on the Nasdaq Stock Market and the dividends paid per share for the periods indicated, all as adjusted for the 1-for-1 stock dividend effected August 14, 2003. Fiscal Year 2003 ---------------- High Price Low Price Dividends Per Share ---------- --------- ------------------- First Quarter $ 9.58 $ 8.34 $.025 Second Quarter 12.00 8.87 .025 Third Quarter 16.84 11.78 .025 Fourth Quarter 26.24 17.53 .025 Fiscal Year 2002 ---------------- High Price Low Price Dividends Per Share ---------- --------- ------------------- First Quarter $ 7.18 $ 5.46 $.025 Second Quarter 8.25 6.52 .025 Third Quarter 10.70 7.50 .025 Fourth Quarter 11.16 9.02 .025 24 ITEM 6. SELECTED FINANCIAL DATA
Year Ended August 31, ------------------------------------------------------------------- 2003(1) 2002 2001 2000 1999 ------- ---- ---- ---- ---- (In millions, except per share, per ton and shipment data) INCOME STATEMENT DATA: Revenues $ 496.9 $ 350.6 $ 322.8 $ 367.5 $ 284.9 Cost of goods sold and other operating expenses (413.0) (324.4) (290.9) (330.7) (258.9) Impairment and other non- recurring charges (2.1) (7.1) -- -- -- Selling and commission expense (5.3) (2.9) (2.2) (2.5) (2.8) General and administrative (32.2) (25.8) (24.4) (24.0) (20.8) Income from joint ventures 24.4 19.4 9.8 4.5 3.5 ---------- ---------- ---------- ---------- ---------- Income from operations 68.7 9.8 15.1 14.8 5.9 Interest expense (1.8) (2.3) (5.1) (7.4) (7.0) Other income (expense) (0.5) 0.2 1.3 3.6 2.5 ---------- ---------- ---------- ---------- ---------- Income before cumulative effect of change in accounting principle, income taxes, minority interests and pre-acquisition interests 66.4 7.7 11.3 11.0 1.4 Income tax provision (17.9) (1.1) (3.4) (0.6) (0.8) Minority interests, net of tax (1.8) -- -- -- -- Pre-acquisition interests, net of tax (2.5) -- -- -- -- Cumulative effect of change in accounting principle (1.0) -- -- -- -- ---------- ---------- ---------- ---------- ---------- Net income $ 43.2 $ 6.6 $ 7.9 $ 10.4 $ 0.6 ========== ========== ========== ========== ========== Basic earnings per share(2) $ 2.32 $ 0.36 $ 0.42 $ 0.53 $ 0.03 ========== ========== ========== ========== ========== Diluted earnings per share(2) $ 2.20 $ 0.35 $ 0.42 $ 0.53 $ 0.03 ========== ========== ========== ========== ========== Dividends per common share(2) $ 0.10 $ 0.10 $ 0.10 $ 0.10 $ 0.10 ========== ========== ========== ========== ========== OTHER DATA: Shipments (in thousands)(3): Ferrous recycled metal (tons) 1,812 1,557 1,482 1,506 1,224 Nonferrous (pounds) 113,378 112,622 114,441 96,207 74,497 Finished steel products (tons) 622 569 546 666 571 Average net selling price(3,4): Ferrous recycled metal (per ton) $ 122 $ 94 $ 91 $ 95 $ 83 Nonferrous (per pound) 0.42 0.36 0.37 0.40 0.35 Finished steel products (per ton) 291 276 292 289 303 Depreciation and amortization $ 19.4 $ 18.6 $ 18.8 $ 18.4 $ 17.7 Capital expenditures 21.8 9.6 9.3 10.7 12.0
25 August 31, ------------------------------------------ 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- (In millions) BALANCE SHEET DATA: Working capital $ 72.4 $ 39.4 $ 91.4 $ 79.9 $ 93.4 Total assets 487.9 405.0 425.9 426.3 446.4 Short-term debt 0.2 60.2 0.2 0.2 0.4 Long-term debt 87.0 8.3 93.8 93.1 119.8 Shareholders' equity 303.0 252.9 248.1 248.4 240.3 (1) The 2003 data includes the Auto Parts Business acquisition, which occurred on February 14, 2003. Please refer to Note 1 and Note 3 of the Notes to the Consolidated Financial Statements. The consolidated results include the results of the Auto Parts Business as though the acquisition had occurred at the beginning of fiscal 2003. Adjustments have been made for minority interests, which represents the ownership interests the Company did not own during the reporting period and pre-acquisition interests, which represents the share of income attributable to the former joint venture partner for the period from September 1, 2002 through February 14, 2003. The financial results of the former auto parts joint venture for all periods prior to fiscal 2003 continue to be accounted for using the equity method and are included in the line "Income from joint ventures." (2) Basic and diluted earnings per share and dividends per common share have been adjusted to reflect the 1-for-1 share dividend paid on August 14, 2003, to shareholders of record on July 24, 2003. (3) Tons for ferrous recycled metals are long tons (2,240 pounds) and for finished steel products are short tons (2,000 pounds). (4) The Company reports revenues that include shipping costs billed to customers. However, average net selling prices are shown net of shipping costs. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW - -------- The Company operates in three industry segments. The Company's Metals Recycling Business collects, processes and recycles steel and other metals through its facilities. The Company's Steel Manufacturing Business operates a mini-mill near Portland, Oregon, which melts recycled metal, produces finished steel products and maintains one mill depot in Southern California and one in Central California. The Company's Auto Parts Business purchases used and wrecked automobiles and allows retail customers the opportunity of extracting parts for purchase in its self-service auto parts stores, with 17 located in California, two in Nevada and one store in each of Texas, Utah, Illinois and Indiana. Additionally, the Company is a non-controlling partner in joint ventures that are either in the metals recycling business or are suppliers of unprocessed metals. The Joint Ventures in the Metals Recycling Business sell recycled metals that have been processed at their facilities (Processing) and also buy and sell third parties' processed metals (Brokering). Note 3 of the Notes to the Consolidated Financial Statements describes the Auto Parts Business acquisition that occurred on February 14, 2003. Under Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations," the acquisition is considered a "step" acquisition due to the fact that the Company had a significant joint venture interest in the acquired business for a number of years. Additionally, since the acquisition occurred during the year, the Company elected to include it in the consolidated results as though it had occurred at the beginning of fiscal 2003. Thus, the fiscal 2003 statement of operations, balance sheet and statement of cash flows have been adjusted to consolidate the acquisition as of September 1, 2002. Also, the acquired businesses were consolidated with the Company's previous interest in the business to form a separate reporting segment called the Auto Parts Business. Consolidation accounting requires the Company to adjust its earnings for the ownership interests it did not own during the reporting period. During fiscal 2003, net income was reduced by $1.8 million for minority interests, net of income taxes, representing the share of income attributable to various continuing minority partners of the business. Also, for the 26 period from September 1, 2002 through February 14, 2003, net income was reduced by $2.5 million of pre-acquisition interests, net of income taxes, representing the share of income attributable to the former joint venture partner prior to the acquisition. The financial results of the acquired business for periods prior to fiscal 2003 continue to be accounted for using the equity method and are included in the joint venture businesses reporting segment. CRITICAL ACCOUNTING POLICIES AND ESTIMATES - ------------------------------------------ The Company's discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with Generally Accepted Accounting Principles. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. These estimates and assumptions provide a basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and these differences may be material. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined using the average cost method. The production and accounting process utilized by the Company to record recycled metals inventory quantities relies on significant estimates. The Company relies upon perpetual inventory records that utilize estimated recoveries and yields that are based upon historical trends and periodic tests for certain unprocessed metal commodities. Over time, these estimates are reasonably good indicators of what is ultimately produced; however, actual recoveries and yields can vary depending on product quality, moisture content and source of the unprocessed metal. To assist in validating the reasonableness of the estimates, the Company not only runs periodic tests, but also performs physical inventories. Physical inventories can normally detect significant variations in volume, but because of variations in product density, holding period and production processes utilized to manufacture the product, physical inventories will not generally detect smaller variations. To mitigate this risk, the Company adjusts it physical inventories when the volume of a commodity is low and a physical inventory can more accurately predict the remaining volume. REVENUE RECOGNITION The Company recognizes revenue when it has a contract or purchase order from a customer with a fixed price, the title and risk of loss transfer to the buyer, and collectibility is reasonably assured which is generally upon shipment. Title for both metals and finished steel products transfers upon shipment. For retail sales by the Company's Auto Parts Business, revenues are recognized when customers pay for salvaged vehicle parts or when wholesale products are shipped to the customer location. Substantially all of the Company's ferrous export sales of recycled metal are made with letters of credit, minimizing credit risk. However, domestic ferrous recycled metal sales, nonferrous sales and sales of finished steel are generally made on open account. Historically, there have been very few sales returns and adjustments that impact the ultimate collection of revenues; therefore no provisions are made when the sale is recognized. BAD DEBT RESERVES The Company evaluates the collectibility of its accounts, notes and advances receivable based on a combination of factors. In cases where management is aware of circumstances that may impair a specific customer's ability to meet its financial obligations to the Company, management records a specific allowance against amounts due and reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers, the Company maintains a reserve that considers the total receivables outstanding, historical collection rates and economic trends. 27 ENVIRONMENTAL COSTS The Company operates in industries that inherently possess environmental risks. To manage these risks, the Company employs both its own environmental staff and outside consultants. These consultants and finance personnel meet regularly to stay updated on environmental risks. The Company estimates future costs for known environmental remediation requirements and accrues for them on an undiscounted basis when it is probable that the Company has incurred a liability and the related costs can be reasonably estimated. The regulatory and government management of these projects is extremely complex, which is one of the primary factors that make it difficult to assess the cost of potential and future remediation of potential sites. When only a wide range of estimated amounts can be reasonable established, and no other amount within the range is better than another, the minimum amount of the range is recorded in the financial statements. Adjustments to the liabilities are made when additional information becomes available that affects the estimated costs to remediate. In a number of cases, it is possible the Company may receive reimbursement through prior insurance. In these situations, recoveries of environmental remediation costs from other parties are recorded as assets when collection is accomplished. TAXES Deferred income taxes reflect the differences between the financial reporting and tax bases of assets and liabilities at year-end based on enacted tax laws and statutory tax rates. Tax credits are recognized as a reduction of income tax expense in the year the credit arises. A valuation allowance is established when necessary to reduce deferred tax assets, including net operating loss carryforwards, to the amount more likely than not to be realized. Periodically, the Company reviews the deferred tax assets to assess whether the valuation allowances continue to be necessary. The valuation allowances will be reversed when there is significant evidence that it is more likely than not that the assets will be realized. GOODWILL AND OTHER INTANGIBLES Effective June 1, 2001, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," under which goodwill and other intangible assets with indefinite lives are no longer amortized. The Company reviews its goodwill and non-amortizable intangibles on an annual basis for impairment, or more frequently if impairment indicators arise, in accordance with the provisions of SFAS No. 142. Prior to adoption of SFAS No. 142, the Company amortized goodwill and other intangible assets over their estimated useful lives. RESULTS OF OPERATIONS - --------------------- During fiscal 2003, the Company's operations improved dramatically, resulting in a record year for revenue and net income. Both the Company's Metals Recycling Business and Steel Manufacturing Business recognized marked improvements over last year. As well, the Company's Joint Ventures in the Metals Recycling Business benefited from rising selling prices to improve their profitability by nearly 80%. Also, as explained further below, the Company acquired a new business segment, the Auto Parts Business, in fiscal 2003. This segment significantly contributed to earnings during the year. The results of operations of the Company depend in large part upon demand and prices for recycled metals in world markets and steel products in the Western United States. For example, increasing steel demand and prices led to improved profitability during the period of fiscal 1995 through fiscal 1997. However, during fiscal 1998 and 1999, the Asian financial crisis severely curtailed demand and decreased prices, causing a negative impact on the results of the Metal Recycling Business. During fiscal 2000, the Company saw demand for recycled metal rise, but unusually large supplies of recycled ferrous metal became available from certain countries that were part of the former Soviet Union, thereby holding prices down. In addition, domestic demand for finished steel products was strong, but lower cost imports, primarily from Asia, caused average prices to generally decline. In fiscal 2001, the demand for recycled metals declined in the United States as domestic steel production declined; however, demand in Asia, particularly in China, remained firm. Selling prices also continued to be adversely affected by supplies coming out of the former Soviet Union 28 and during the first six months of fiscal 2002, recycled metals prices approached record lows due primarily to this surplus coupled with weak domestic demand. Domestic demand for finished steel products declined due to the slowing United States economy and competition from lower cost imports. The result was a record low average net selling price for the Steel Manufacturing Business during fiscal 2002. During the second half of fiscal 2002, certain countries of the former Soviet Union started imposing export tariffs and bans on recycled ferrous metal. As a result, recycled ferrous metal supplies to global markets declined causing prices to increase. Many of the Company's customers postponed purchases during the first quarter of fiscal 2003 believing that these delays would cause prices to decline. However, demand, which is being fueled primarily by China and Korea, continued to remain strong and the Company continues to experience improved market conditions. Throughout much of the remainder of fiscal 2003, selling prices continued to rise primarily due to the tight supply of ferrous metal available in the export market and the weakness of the U.S. dollar relative to other foreign currencies. The Joint Ventures in the Metals Recycling Business were affected by the same supply and demand factors as the Company's wholly-owned Metals Recycling Business. The Steel Manufacturing Business saw higher average selling prices and higher sales volumes during fiscal 2003 due primarily to a higher valued product sales mix and lower volumes of competing imported steel, which is partially attributed to the weakness of the U.S. dollar. Additionally, during the spring of 2002, the U.S. Government imposed anti-dumping and countervailing duties on certain wire rod imports from eight foreign countries, which combined with higher worldwide ferrous recycled metals prices (the primary raw material used to produce much of the world's wire rod), improved the competitive position of domestic wire rod producers. The Steel Manufacturing Business turned this price parity with imported wire products into increased sales and market share. In the second quarter of fiscal 2003, the Steel Manufacturing Business completed two capital projects to one of the rolling mills, which now allow it to produce higher margin specialty wire products, to improve the packaging of coiled products and increase the productivity on all wire production. The Auto Parts Business segment was formed in the second quarter of fiscal 2003 as a result of the acquisition referred to in the "Overview" section. It purchases salvaged vehicles, sells parts from those vehicles through its retail facilities and wholesale operations and sells the remaining portion of the vehicles to metal recyclers. The retail operations are somewhat seasonal and principally affected by weather conditions and promotional events. Since the stores are open to the natural elements, during periods of prolonged wet, cold or extreme heat, the retail business tends to slow down due to the difficult customer working conditions. Further, the Company generally runs promotional events during seasonably moderate times of the year when it is most likely to affect the buying patterns of its retail customers. As a result, the Company's first and third fiscal quarters tend to generate the most retail sales and the second and fourth fiscal quarters are the slowest in terms of retail sales. The Auto Parts Business' other primary source of revenue is the sale of scrap metal and other parts wholesale. Revenues for the wholesale product lines are principally affected by commodity prices and shipping schedules. As mentioned earlier in the discussions regarding the Metal Recycling Business, recycled metal prices have increased dramatically since the second quarter of fiscal 2002, which has positively affected the revenues and profits of the Auto Parts Business. The following tables set forth information regarding the breakdown of revenues between the Company's Metals Recycling Business, Steel Manufacturing Business and Auto Parts Business, and the breakdown of income from operations between the Metals Recycling Business, the Steel Manufacturing Business, the Auto Parts Business, Joint Ventures, Corporate and eliminations. Additional financial information relating to business segments is contained in Note 12 of the Notes to Consolidated Financial Statements. 29 Revenues Year Ended August 31, --------------------- (In millions) 2003 2002 2001 ---- ---- ---- Metals Recycling Business: Ferrous $ 255.3 $ 173.5 $ 155.6 Nonferrous 47.8 41.7 43.0 Other 5.5 6.6 6.5 ------- ------- ------- Recycled metals total 308.6 221.8 205.1 Auto Parts Business 65.2 -- -- Steel Manufacturing Business 191.9 166.6 167.6 Intercompany sales eliminations(1) (68.8) (37.8) (49.9) ------- ------- ------- Total $ 496.9 $ 350.6 $ 322.8 ======= ======= ======= Income (Loss) from Operations Year Ended August 31, --------------------- (In millions) 2003 2002 2001 ---- ---- ---- Metals Recycling Business $ 35.8 $ 11.5(4) $ 8.4 Auto Parts Business 22.0 -- -- Steel Manufacturing Business (2.5) (5.7) 4.9 JVs in the Metals Recycling Business(2) 24.8 13.8 6.5 JV Suppliers of Metals (0.4) 5.6 3.3 Corporate expense (3) (10.0) (8.1) (7.9) Intercompany eliminations(1) 1.2 (0.2) (0.1) Impairment and other nonrecurring charges (2.1)(4) (7.1)(4) -- ------- ------- ------- Income from operations $ 68.8 $ 9.8 $ 15.1 ======= ======= ======= (1) Ferrous recycled metal sales from the Metals Recycling Business to the Steel Manufacturing Business, and auto body sales from the Auto Parts Business to the Metals Recycling Business, are made at negotiated rates per ton that are intended to approximate market. Consequently, these intercompany sales tend to produce intercompany profits, which are eliminated until the finished products are ultimately sold to third parties. (2) Includes year-end LIFO adjustments that reduced income from operations by $2.2 million and $1.2 million in fiscal 2003 and 2002, respectively, and increased income from operations by $0.9 million in fiscal 2001. (3) Corporate expense consists primarily of unallocated corporate expense for services that benefit all three business segments. Because of this unallocated expense, the income from operations of each segment does not reflect the income from operations the segment would have as a stand-alone business. (4) Impairment and other nonrecurring charges related to the Metals Recycling Business in fiscal 2002 and to the Auto Parts Business in fiscal 2003. The amounts are shown separately to assist in understanding the business' financial results. FISCAL 2003 COMPARED TO FISCAL 2002 - ----------------------------------- REVENUES. Consolidated revenues increased $146.2 million (42%) to $496.9 million for fiscal 2003 compared with fiscal 2002. Revenues for the Metals Recycling Business increased due to higher selling prices and volumes as worldwide demand for ferrous metals strengthened through the year. Revenues for the Steel Manufacturing Business 30 also increased due to higher average net selling prices and increased sales volumes. Consolidated revenues also increased by $65.2 million due to the addition of the Auto Parts Business as a consolidated business. The Metals Recycling Business generated revenues of $308.6 million, before intercompany eliminations, which is an increase of $86.7 million (39%). Ferrous revenues increased $81.8 million (47%) to $255.3 million as a result of an increase in tons sold and higher average selling prices net of shipping cost (average net selling prices). Ferrous sales volumes increased 255,000 tons (16%) and the average net selling price of ferrous recycled metal increased $28 (30%) to $122 per ton. Curtailed supplies of ferrous recycled metals from the countries of the former Soviet Union, growing worldwide demand and the weakness of the U.S. dollar drove the volume and price increases. Asia, especially China and Korea, continues to be the primary destination of export sales. In fiscal 2003, the Metals Recycling Business made export shipments aggregating 1.2 million tons, an increase of 89,000 tons (8%) compared with fiscal 2002. Domestic third-party ferrous tonnage also increased by 38,000 tons (46%) to 120,000 tons. Sales to the Company's Steel Manufacturing Business increased 31% to 535,000 tons due to increased demand in this business. Nonferrous revenues increased $6.1 million (15%) to $47.8 million due primarily to higher average prices. The average net nonferrous selling price in fiscal 2003 was $0.42 per pound, an increase of $0.06 per pound from fiscal 2002. The Steel Manufacturing Business' revenues increased $25.3 (15%) from revenues recognized in the prior year to $191.9 million in fiscal 2003 primarily due to higher average net selling prices and higher volumes for all major product lines. The volume of finished steel products sold increased, along with the average net selling price per ton, compared with fiscal 2002. Sales of finished steel products were up 9% to 622,000 tons while the average net selling price per ton increased $15 per ton (5%) to $291 per ton. The increase in the average sales price per ton was primarily due to a higher valued product sales mix and lower supplies of competing importing steel, which was partially attributed to the weakness of the U.S. dollar. Also, towards the end of the fiscal 2003 second quarter, the Company and other steel producers increased their selling prices for rebar. Additionally, merchant bar selling prices have increased modestly to adjust to the costs of production. The increase in sales volume was due to a 30% increase in the volume of wire rod and a 6% increase in sales volume of rebar. The higher wire rod volume was due to import duties imposed by the U.S. Government in the spring of 2002 on certain wire rod products. The increase in rebar volumes is primarily due to increased demand as wholesale customers bought inventory ahead of the effective date of announced price increases. As previously mentioned, the Auto Parts Business was acquired on February 14, 2003 and was considered a "step" acquisition allowing the consolidation of its financial results as of the beginning of fiscal 2003. As such, revenues for fiscal 2003 included $65.2 million related to the Auto Parts Business with no comparable revenues being recognized for financial statement purposes in fiscal 2002. In order to aid the reader's understanding of the financial performance of this segment, the pro forma fiscal 2002 revenues for the Auto Parts Business were $58.3 million. The $6.9 million (12%) increase was primarily caused by an increase in wholesale revenues driven by higher average sales prices for scrapped auto bodies due to rising ferrous recycled metal prices. Wholesale prices also benefited from the implementation of a new "core" distribution center that aggregated production volumes and provided an improved venue to sell these products to competing customers. Retail revenues were also up due to growth in part sales and admissions pricing. COST OF GOODS SOLD. Consolidated cost of goods sold increased $88.6 million (27%) to $413.0 million and was 83% percent of revenues compared with 93% in fiscal 2002. The decrease to 83% was primarily due to improved margins, coming principally from higher selling prices, for all of the Company's business segments. Cost of goods sold for the Metals Recycling Business increased $56.0 million (28%) to $255.9 million before intercompany eliminations. The cost of goods sold as a percentage of revenues decreased from 90% for fiscal 2002 to 83% during fiscal 2003, contributing to a $30.7 million increase in gross profit. This increase in gross margin in fiscal 2003 was primarily attributable to higher selling prices and higher sales volume, partially offset by higher prices paid to suppliers of ferrous recycled metals and higher export freight rates, resulting in an $18 per ton (18%) increase in the average ferrous metals cost of sales per ton. Cost of sales per ferrous ton increased as higher selling prices and higher demand for processed metal pushed up the purchase price the Company paid for unprocessed metal. Competition from other recyclers for the purchase of unprocessed metal was also a factor in the cost increases. The average export freight rate climbed $4 per ton in fiscal 2003 compared with fiscal 2002. Cost of goods sold for the Steel Manufacturing Business increased $21.8 million (13%) to $191.0 million and decreased as a percentage of revenues from 102% in fiscal 2002 to 100% in fiscal 2003. The decrease was due to a higher average sales price per ton and lowered fixed cost per ton, due to larger production volumes spreading the fixed costs over more tons produced, partially offset by higher prices paid for scrap metal. Melt shop production increased 32% and rolling mill production increased 16% compared with fiscal 2002. Fiscal 2002 production volumes were temporarily curtailed in order to reduce inventory to better match it with customer demand. Average cost of sales per ton increased $10 per ton (3%) compared with the prior fiscal year. As this increase in cost of sales per ton was more than offset by the $15 per ton increase in average net selling price, gross profit improved by $3.5 million (135%) in fiscal 2003 compared with fiscal 2002. 31 The Auto Parts Business' cost of sales was $0.5 million (1%) lower during fiscal 2003 as compared to the pro forma cost of sales for fiscal 2002. As a percentage of revenues, cost of sales decreased from 63% to 55%. This improvement was due to higher margins realized on wholesale sales partially offset by higher labor costs. IMPAIRMENT AND OTHER NONRECURRING CHARGES. In connection with the acquisition of the Auto Parts Business, the Company conducted an environmental due diligence investigation. Based upon new information obtained in this investigation, the Joint Venture accrued $2.1 million in environmental liabilities in the second quarter of fiscal 2003 for remediation costs at the Auto Parts Business's store locations. No environmental proceedings are pending at any of these sites. The Company recorded impairment and other nonrecurring charges of $7.1 million in fiscal 2002. The Company recorded nonrecurring charges of $1.9 million for the early termination of a fixed-price Alaska barge contract of affreightment that management determined was not cost effective. The Alaska barge contract charge included a $0.9 million write-off of a note receivable and a $1.0 million payment to terminate the contract. Also, an impairment charge of $1.8 million was recorded for the elimination of an unprofitable car-crushing business and an impairment charge of $1.1 million was recorded for the closure of an under-performing yard in Reno, Nevada. Nonrecurring charges of $1.5 million were recorded for the loss on the early termination of two vessel charter contracts with a related company. The Company terminated the leases in order to take advantage of market rates which were $7 to $8 per ton lower than the all-in contracted rates. Shipping cost savings as a result of the contract termination totaled approximately $2.0 million. Additionally, a loss of $0.8 million was recorded for the sale of a non-strategic steel forging business. INCOME FROM JOINT VENTURES. The Company's joint ventures' revenues and results of operations were as follows (in thousands): Year Ended August 31, --------------------- 2003 2002 ---- ---- Total revenues from external customers recognized by: Joint Ventures in the Metals Recycling Business: Processing $ 616,958 $ 480,157 Brokering 251,431 144,962 Joint Venture Suppliers of Metals 8,877 61,762 --------- --------- $ 877,266 $ 686,881 ========= ========= Income from joint ventures recognized by the Company: Joint Ventures in the Metals Recycling Business $ 24,827 $ 13,766 Joint Venture Suppliers of Metals (406) 5,624 --------- --------- $ 24,421 $ 19,390 ========= ========= The Joint Ventures in the Metals Recycling Business predominantly sell recycled ferrous and nonferrous metals. The increase in revenues recognized by these joint ventures is attributable to higher average net ferrous selling prices. Shipments of ferrous metal processed by the joint ventures were 3.3 million tons for the year ended August 32 31, 2003 compared with 3.5 million tons in the prior year. The volume of ferrous metal brokered by the joint ventures increased to 1.8 million tons in fiscal 2003 compared to 1.2 million tons in the prior year. The average net selling price of ferrous recycled metal increased during that period to $118 per ton from $90 per ton, predominantly due to strong demand from Asia, especially China and Korea. These joint ventures also increased their sales margins by improving operational efficiencies. In fiscal 2003, the Company's share of income from Joint Ventures in the Metals Recycling Business increased to $24.8 million due to higher average net selling prices, increased margins and more efficient operations. The Company's joint ventures with Hugo Neu Corporation, which earned the majority of the income, instituted EVA concurrently with the Company in fiscal 2001. The use of EVA coupled with management changes has continued to result in improved operational efficiencies and increased profitability. Operating income in fiscal 2003 was reduced by $2.2 million representing the Company's share of the JV LIFO inventory adjustment compared with a reduction of $1.2 million in fiscal 2002. Revenues of the Joint Venture Suppliers of Metals decreased by $52.9 million from fiscal 2002 as compared to the fiscal 2003. Most of this decrease was caused by the reclassification in fiscal 2003 of the Pick-N-Pull Joint Venture, which is now consolidated and included as a new business segment, the Auto Parts Business. Excluding the change caused by this reclassification, revenues decreased $7.0 million during fiscal 2003 compared to last year due to lower selling prices and lower demolition revenue. The Company's equity in income from these Joint Ventures, excluding the impact of Pick-N-Pull, decreased $1.1 million primarily due to the slowdown in the U.S. economy. SELLING AND COMMISSION EXPENSES. These expenses increased $2.4 million compared with fiscal 2002 primarily due to an increase in export commission expense caused from higher ferrous recycled metals export sales. GENERAL AND ADMINISTRATIVE EXPENSES. Compared with fiscal 2002, general and administrative expenses increased $6.2 million. The consolidation of the Auto Parts Business represents $5.0 million of this increase. The remainder of this increase is primarily due to increased bonus accruals directly related to the improvement in the Company's EVA performance. INTEREST EXPENSE. In fiscal 2003, interest expense decreased $0.5 million compared with fiscal 2002 due to lower average interest rates and borrowings. The Company's borrowings averaged $70.5 million in fiscal 2003 compared to $75.9 million in fiscal 2002. The average interest rate for fiscal 2003 was 2.1% compared with 2.7% for fiscal 2002. OTHER INCOME AND EXPENSES. Other income and expenses decreased $0.7 million in fiscal 2003 compared with fiscal 2002. The difference is principally due to the addition of the Auto Parts Business and a harbor maintenance tax refund received in fiscal 2002. In addition, this line item includes market value adjustments for changes in investment performance for securities held in a trust for the purpose of funding future non-qualified pension payments. The Company recognized gains from the trust fund assets in the amount of $0.4 million in fiscal 2003 and losses of $0.4 million in fiscal 2002. INCOME TAX PROVISION. The Company's effective rate of 27% was lower than the 35% federal statutory tax rate for three primary reasons: (1) the implementation of SFAS 142 has eliminated the amortization of goodwill, some of which had been nondeductible; (2) export sales, which under Federal law are taxed at a lower rate than domestic sales, have increased; and (3) net operating loss carryforwards that accompanied an earlier acquisition continue to provide benefit. The prior year's tax rate of 20% benefited from the two latter items, as well as from the one-time recognition of California tax credits that had been generated over the previous ten years. As part of the 1996 acquisition of Proler International Corp. (Proler), the Company acquired $31.4 million of federal net operating loss carryforwards (NOLs). The Company recognized no immediate tax benefit for the NOLs. Instead, the Company set up an offsetting $31.4 million valuation allowance because the ultimate use of the NOLs were uncertain given the then-current federal tax law proscription against applying the NOLs to any taxable income other than the post-acquisition income generated by Proler. A change to federal tax law in 1999, however, has 33 allowed an annual $2.4 million of NOL to be applied to taxable income from all sources, not just from Proler. Due to this change in tax law, the Company released an annual $2.4 million from the valuation allowance, and recognized the corresponding $0.8 million in tax benefit, in fiscal years 2001, 2002 and 2003. This is a major reason why the Company's effective tax rates have been lower than the statutory rates for those years. The remaining balance of unused NOLs, which stands at $15.3 million as of August 31, 2003, will expire in fiscal years 2007 through 2012 if not used by then. The Company also acquired $0.7 million of credits as part of the Proler acquisition. As with the NOLs, a valuation allowance was set up to offset the credits, the ultimate use of which has been made more likely by the subsequent liberalization of federal tax law. No part of the valuation allowance has yet to be released. The credits are not likely to be used until after the NOLs have been used or expire. The credits can be carried forward indefinitely. In fiscal 2002, the Company qualified for $2.1 million of Enterprise Zone tax credits in the state of California. These credits can be used to offset California state income taxes to the extent that each corporation in the consolidated group has a California franchise (income) tax liability. Any credits in excess of the tax liability can be carried forward indefinitely. These credits, combined with the release of $2.4 million of valuation allowance pertaining to the NOLs, were major reasons the Company's effective tax rate of 14% for fiscal 2002 was well below the statutory rate of 34%. FISCAL 2002 COMPARED TO FISCAL 2001 - ----------------------------------- REVENUES. Consolidated revenues increased $27.8 million (9%) to $350.6 million for fiscal 2002 compared with fiscal 2001. Revenues for the Metals Recycling Business increased due to higher selling prices and volumes as worldwide demand for ferrous metals strengthened through the year. Revenues for the Steel Manufacturing Business were slightly lower primarily due to lower average net selling prices partially offset by increased sales volumes. The Metals Recycling Business generated revenues of $221.8 million, before intercompany eliminations, an increase of $16.6 million (8%). Ferrous revenues increased $17.9 million (12%) to $173.5 million as a result of an increase in tons sold and higher average selling prices net of shipping cost (average net selling prices). Ferrous volumes increased 75,000 tons (5%) and the average net selling price of ferrous recycled metal increased $3 to $94 per ton (3%). Diminished supplies of ferrous recycled metals from the countries of the former Soviet Union and growing worldwide demand drove the volume and price increases. Asia, especially China and Korea, continued to be the primary destination of export sales. In fiscal 2002, the Metals Recycling Business made export shipments aggregating 1,068,000 tons, an increase of 291,000 tons (37%) compared with fiscal 2001. Because of the continued soft United States economy, domestic third-party ferrous tonnage decreased 57,000 ton (41%) to 82,000 tons. Sales to the Company's Steel Manufacturing Business decreased 28% to 407,000 tons due to production curtailments in this business. Nonferrous revenues decreased $1.3 million (3%) to $41.7 million due to a corresponding reduction in sales volume. The average net nonferrous selling price in fiscal 2002 was $0.36 per pound, a decline of $0.01 per pound from fiscal 2001. The Steel Manufacturing Business recognized revenues of $166.6 million in fiscal 2002, a decrease of 1% from revenues recognized in the prior year. The volume of finished steel products sold increased, but the average net selling price per ton decreased compared with fiscal 2001. Sales of finished steel products were up 4% to 569,000 tons while the average net selling price per ton decreased $16 per ton (5%) to $276 per ton, a record low. The decrease in sales revenue was primarily due to lower average net selling prices for all major product lines which were partially offset by the increase in sales volumes. The decrease in the average sales price per ton was primarily due to the sluggish United States economy and weak end user demand, continuing competition from lower cost steel imports and a shift in product mix from merchant bar to wire rod. The increase in sales volume was due to a 31% greater sales volume of wire rod, which was partially offset by a decline in the sales volume of merchant bar. The higher wire rod volume was due to additional demand by a major customer. Tariffs on selected imported steel products enacted in March and April 2002 by the International Trade Commission (ITC) under Section 201 of the 1974 Trade Act did not produce any significant price benefits. 34 COST OF GOODS SOLD. Consolidated cost of goods increased $33.5 million (11%) to $324.4 million and was 93% percent of revenues compared with 90% in fiscal 2001. The increase to 93% was primarily due to eroded margins for the Steel Manufacturing Business. Gross profit decreased $5.6 million (18%) to $26.2 million. Cost of goods sold for the Metals Recycling Business increased $18.4 million (10%) to $199.9 million before intercompany eliminations. The cost of goods sold as a percentage of revenues increased from 88% for fiscal 2001 to 90% during fiscal 2002. Gross profit increased $1.8 million compared with fiscal 2001. This increase in gross margin in fiscal 2002 was primarily attributable to higher selling prices and higher sales volume, partially offset by higher prices paid to suppliers for ferrous recycled metals, resulting in a $5 per ton (5%) increase in the average ferrous metals cost of sales per ton. Cost of sales per ferrous ton increased as higher selling prices and higher demand for processed metal pushed up the purchase price the Company paid for unprocessed metal. Lower shipping costs per ton partially offset the purchase price increases. Competition from other recyclers for the purchase of unprocessed metal was also a factor in the cost increases. Cost of goods sold for the Steel Manufacturing Business increased $9.8 million (6%) to $169.2 million and increased as a percentage of revenues from 95% in fiscal 2001 to over 100% in fiscal 2002. The increase was due to higher fixed costs being spread over fewer production tons as mill curtailments that began in August 2001 continued throughout fiscal 2002. Melt shop production fell 29% and rolling mill production fell 11% compared with fiscal 2001. Also, contributing to the increase was a 15% rise in energy costs. Energy cost increased due to the 2001 Western energy shortage which increased contracted power rates. Average cost of sales per ton increased $4 per ton (2%) compared with the prior fiscal year. This increased cost of sales per ton, combined with the $16 per ton reduction in average net selling price, resulted in a decrease in gross profit of $10.8 million (131%) in fiscal 2002 compared with fiscal 2001. IMPAIRMENT AND OTHER NONRECURRING CHARGES. The Company recorded impairment and other nonrecurring charges of $7.1 million in fiscal 2002. The Company recorded nonrecurring charges of $1.9 million for the early termination of a fixed-price Alaska barge contract of affreightment that management determined was not cost effective. The Alaska barge contract charge included a $0.9 million write-off of a note receivable and a $1.0 million payment to terminate the contract. Also, an impairment charge of $1.8 million was recorded for the elimination of an unprofitable car-crushing business and an impairment charge of $1.1 million was recorded for the closure of an under-performing yard in Reno, Nevada. The Company now sublets the Reno facility and leases the equipment to a third party that sells its recycled metal output to the Company. Nonrecurring charges of $1.5 million were recorded for the loss on the early termination of two vessel charter contracts with a related company. The Company terminated the leases in order to take advantage of market rates which were $7 to $8 per ton lower than the all-in contracted rates. Shipping cost savings as a result of the contract termination totaled approximately $2.0 million. Additionally, a loss of $0.8 million was recorded for the sale of a non-strategic steel forging business. A number of the charges were a direct result of the Company's 2001 implementation of Economic Value Added (EVA) which is a tool used to measure financial performance and acceptable returns on investment as well as compensate management on the change in EVA performance. Since implementing EVA, the Company has re-analyzed the business performance and related outlook for many of its assets. The result of these reviews, using the EVA tool, led to many operational and management changes in the Company's business. 35 INCOME FROM JOINT VENTURES. The Company's joint ventures' revenues and results of operations were as follows (in thousands): Year Ended August 31, --------------------- 2002 2001 --------- --------- Total revenues from external customers recognized by: Joint Ventures in the Metals Recycling Business: Processing $ 480,157 $ 447,689 Brokering 144,962 108,274 Joint Venture Suppliers of Metals 61,762 53,381 --------- --------- $ 686,881 $ 609,344 ========= ========= Income from joint ventures recognized by the Company: Joint Ventures in the Metals Recycling Business $ 13,766 $ 6,549 Joint Venture Suppliers of Metals 5,624 3,288 --------- --------- $ 19,390 $ 9,837 ========= ========= The Joint Ventures in the Metals Recycling Business predominantly sell recycled ferrous and nonferrous metals. The increase in revenues recognized by these joint ventures was attributable to higher average net ferrous selling prices and an increase in tonnage shipped. Shipments of ferrous metal processed by the joint ventures increased to 3.5 million tons for the year ended August 31, 2002 from 3.1 million tons in the prior year. The average net selling price of ferrous recycled metal increased during that period to $90 per ton from $86 per ton, predominantly due to strong demand from Asia, especially China and Korea. These joint ventures also increased their sales margins by improving operational efficiencies. In fiscal 2002, the Company's share of income from Joint Ventures in the Metals Recycling Business increased to $13.8 million due to increased sales volume, higher average net selling prices, increased margins and more efficient operations. The Company's joint ventures with Hugo Neu Corporation, which earned the majority of the income, instituted EVA concurrently with the Company in fiscal 2001. The use of EVA has continued to result in improved operational efficiencies and increased profitability. Operating income in fiscal 2002 was reduced by $1.2 million representing the Company's share of the JV LIFO inventory adjustment compared with a benefit of $0.9 million in fiscal 2001. Operating income in fiscal 2002 also benefited by $0.9 million representing the Company's share of a nonrecurring gain on sale of JV property. Both revenues and income from the Joint Venture Suppliers of Metal increased from fiscal 2001 to fiscal 2002 primarily due to increased sales by the Company's self-service auto dismantling joint venture. Increased sales prices, more efficient operations, and lower interest costs drove the revenue growth and income improvements. SELLING AND COMMISSION EXPENSES. These expenses increased $0.7 million compared with fiscal 2001 primarily due to an increase in export commission expense caused from higher ferrous recycled metals export sales. GENERAL AND ADMINISTRATIVE EXPENSES. Compared with fiscal 2001, general and administrative expenses increased $1.4 million primarily due to a $1.0 million increase in wages as a result of annual merit increases and bonus accruals related to the Company's EVA performance and a $0.4 million in increased insurance expense due to adverse insurance market conditions since September 11, 2001. INTEREST EXPENSE. In fiscal 2002, interest expense decreased $2.8 million compared with fiscal 2001 due to lower average borrowings and lower average interest rates. The Company's borrowings averaged $75.9 million in fiscal 2002 compared to $81.5 million in fiscal 2001. The decrease in average borrowings reflected improved cash flow as a result of substantial decreases in inventory during fiscal 2002. The average interest rate for fiscal 2002 was 2.7% compared with 5.8% for fiscal 2001. 36 OTHER INCOME. Other income decreased $1.2 million in fiscal 2002 compared with fiscal 2001 primarily due to a $1.6 million decrease in interest income as a result of lower interest rates charged on variable interest rate advances and notes to joint venture businesses. In addition, this line item includes market value adjustments for changes in investment performance for securities held in a trust for the purpose of funding future non-qualified pension payments. During fiscal 2002 and 2001, the Company recognized losses from the trust fund assets in the amount of $0.7 million and $0.4 million, respectively. INCOME TAX PROVISION. As part of the 1996 acquisition of Proler International Corp. (Proler), the Company acquired $31.4 million of federal net operating loss carryforwards (NOLs). Prior to fiscal 2000, federal tax law placed limitations on the source of the income that could be offset by the NOLs. Accordingly, the Company was not able to record the potential tax benefits from the NOLs because of the lack of certainty in being able to realize these benefits. In fiscal 2000, a change in federal tax law allowed the Company to use the NOLs to offset taxable income from all sources, subject to a limit of $2.4 million per year. During fiscal 2001, the Company continued to benefit from the use of $2.4 million of NOLs, which was one of the primary reasons the effective rate was 30% as compared to the statutory rate of 34%. In fiscal 2002, it was determined that the Company qualified for $2.1 million of Enterprise Zone tax credits in the state of California. These credits can be used to offset California state income taxes to the extent that each corporation in the consolidated group has a California franchise (income) tax liability. Any credits in excess of the tax liability can be carried forward indefinitely. The combination of NOLs and Enterprise Zone tax credits made the Company's effective tax rate 14% for fiscal 2002 as compared with a statutory rate of 34%. As noted above, Federal income tax law limits the Company's use of NOLs to $2.4 million per year. Unused NOLs may be carried forward and used in subsequent fiscal years, though they will ultimately expire in fiscal years 2007 through 2012, if not used by then. Subject to the annual limit, there remains at August 31, 2002 $17.7 million of Proler NOLs that may be used in future years before they expire. LIQUIDITY AND CAPITAL RESOURCES. For fiscal 2003, cash generated by operations was $40.9 million, compared to $36.4 million last year. The increase in cash flow provided by operations was primarily the result of improved operating profits. In fiscal 2002, inventories declined $31.2 million, generating cash flow of this amount. Capital expenditures totaled $21.8 million, $9.6 million, and $9.3 million for fiscal years 2003, 2002 and 2001, respectively. The increase was due primarily to costs associated with dock renovation and improvement projects at the Company's Portland, Oregon and Oakland, California recycling facilities. As a result of acquisitions completed in both the current and prior years, the Company had environmental liabilities that aggregated $21.8 million as of August 31, 2003. The Company expects significant future cash outlays as it incurs the actual costs relating to the remediation of such environmental liabilities. On May 30, 2003, the Company entered into an agreement to refinance its revolving bank credit facility. The new facility is unsecured, matures in May 2006, and provides for up to $150 million of credit availability. The facility's interest rates vary. The Company also has an additional unsecured line of credit of $20 million, which is uncommitted. The Company's debt agreements have certain restrictive covenants. As of August 31, 2003, the Company was in compliance with such covenants and had aggregate bank borrowings outstanding of $79 million. In July 2002, the Company's metals recycling joint ventures with Hugo Neu Corporation entered into a $70 million revolving credit facility ("JV Credit Facility") with a group of banks for working capital and general credit purposes. Prior to that time, the joint ventures' working capital and other cash needs had been met by advances provided equally by the Company and Hugo Neu Corporation. The JV Credit Facility expires in July 2004 and is secured by 37 the inventory and receivables of the joint venture businesses. The Company is not a guarantor of the JV Credit Facility. The JV Credit Facility has a number of covenants and restrictions, including restrictions on the level of distributions to the joint venture partners. As of August 31, 2003, the joint ventures were in compliance with such covenants. Borrowings under the JV Credit Facility totaled $30 million at August 31, 2003. Because the interest rates under the JV Credit Facility are higher than those obtained by the Company, management generally considers it prudent for the joint ventures to reduce the facility balance before remitting cash to the joint venture partners. The joint venture agreements allow for distributions to the joint venture partners. No such distributions were declared for fiscal 2003. Instead, cash flow from operations was primarily used to fund working capital and capital expenditures. As such, cash received from joint ventures in fiscal 2003 was lower than in fiscal 2002. The Company has certain contractual obligations and commercial commitments to make future payments. The following table summarizes these future obligations and commitments as of August 31, 2003 (in thousands): Less than 1-3 4-5 After 5 Total 1 Year Years Years Years -------- -------- -------- ------- -------- Long-term debt(1) $ 87,265 $ 220 $ 79,315 $ 30 $ 7,700 Operating leases(2) 130,018 7,021 11,555 7,520 103,922 Letters of Credit 1,993 1,993 JV Credit Facility (50%)(3) 15,000 15,000 -------- -------- -------- ------- -------- Total $234,276 $ 24,234 $ 90,870 $ 7,550 $111,622 ======== ======== ======== ======= ======== (1) The Company has a $150 million credit facility with a group of banks for working capital and other general purposes. The facility expires in May 2006. (2) The Company's operating leases increased by $14.7 million as a result of the acquisition of the Auto Parts Business. (3) This disclosure assumes that if the JV Credit Facility is not renewed or refinanced upon expiration, the Company and Hugo Neu Corporation would restore their previous arrangement under which each funded one-half of the joint ventures' cash needs. Pursuant to a stock repurchase program, the Company is authorized to repurchase up to 3 million shares of its stock when the market price of the Company's stock is not reflective of management's opinion of an appropriate valuation of the stock. Management believes that repurchasing shares under these conditions enhances shareholder value and helps the Company manage its targeted capital structure. During fiscal 2003, the Company made no share repurchases. As of August 31, 2003, a total of 1.3 million shares had been purchased under this program. The Company believes that the current cash balance, internally generated funds and existing credit facilities will provide adequate financing for capital expenditures, working capital, joint ventures, stock repurchases, debt service requirements and future environmental obligations for the next year. In the longer term, the Company may seek to finance business expansion with additional borrowing arrangements or additional equity financing. FACTORS THAT COULD AFFECT FUTURE RESULTS. This Form 10-K, including Item 1 of Part 1and Items 7 and 7(a) of Part II, contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934, that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. One can generally identify these forward-looking statements because they contain "expect," "believe," "anticipate," "estimate," "plans," and other words which convey a similar meaning. One can also identify these statements as they do not relate strictly to historical or current facts. Examples of factors affecting Schnitzer Steel Industries, Inc.'s wholly-owned operations and its joint ventures (the Company) that could cause actual results to differ materially are the following: 38 Cyclicality and General Market Considerations: Selling prices for recycled metals are highly cyclical in nature and subject to worldwide economic conditions. In addition, the cost and availability of recycled metals are subject to volatile supply and demand conditions beyond the Company's control, resulting in periodic fluctuations in recycled metals prices. While the Company attempts to maintain margins by responding to changing recycled metals selling prices through adjustments to its metals purchase prices, the Company's ability to do so is limited by competitive factors as well as the impact of lower prices on the volume of recycled metal available to the Company. Moreover, increases in recycled metals prices can adversely affect the operating results of the Company's Steel Manufacturing Business because increases in steel prices generally lag increases in ferrous recycled metals prices. The steel industry is also highly cyclical in nature and sensitive to general economic conditions. Future economic downturns or a stagnant economy may adversely affect the performance of the Company. The Company expects to continue to experience seasonal fluctuations in its revenues and net income. Revenues can fluctuate significantly quarter to quarter due to factors such as the seasonal slowdown in the construction industry, which is an important buyer of the Company's finished steel products. The timing and extent of the slowdown is also dependent on the weather. Another factor which may affect revenues relates to the seasonal reduction in demand from foreign customers who tend to reduce their finished steel production during the summer months to offset higher energy costs. Also, severe weather conditions may affect the Company's global market conditions. The Company makes a number of large ferrous recycled metals shipments to foreign steel producers each year. Customer requirements, shipping schedules and other factors limit the Company's control over the timing of these shipments. Variations in the number of foreign shipments from quarter to quarter will result in fluctuations in quarterly revenues and earnings. The Company's expectations regarding ferrous metal sales prices and volumes, as well as earnings, are based in part on a number of assumptions (for example, uncertainties relating to customer orders, metal availability, estimated freight rates, cost and volume of inventory yet to be processed, and production output, etc.). The Auto Parts Business experiences modest seasonal fluctuations in demand. The retail stores are open to the elements. During periods of extreme temperatures and precipitation, customers tend to delay their purchases and wait for milder conditions. As a result, retail sales are generally higher during the spring and fall of each fiscal year and lower in the winter and summer months. Competition: The recycled metals industry is highly competitive, with the volume of purchases and sales subject to a number of competitive factors, principally price. The Company has competition from both large and numerous smaller companies in its markets for the purchase of recyclable metals. The Company competes with a number of domestic and foreign recycled metals processors for sales to foreign customers. In the recent past, lower cost ferrous recycled metals supplies from the countries of the former Soviet Union have adversely affected the Company's ferrous recycled metals selling prices and volumes. Currently, those countries have export tariffs and some outright export bans which have significantly reduced their export volumes and lowered the worldwide supply of ferrous recycled metals These tariffs and bans have had a positive effect on the Company's selling prices and volumes. However, the Company cannot predict when or if the countries of the former Soviet Union will change their export policies and what effect, if any, such changes might have on the Company's operating results. The domestic steel industry also is highly competitive. Steel prices can be highly volatile and price is a significant competitive factor. The Company competes with several steel producers in the Western United States for sales of its products. In recent years, the Company has experienced significant foreign competition, which is sometimes subsidized by large government agencies. There can be no assurance that such competition will not increase in the future. In March and April 2002, the ITC imposed tariffs on imported steel, under Section 201 of the 1974 Trade Act, to temporarily aid the domestic steel industry. In 2003, these tariffs were found to be in violation of global trade rules by a World Trade Organization ("WTO") dispute panel. The WTO has not issued a final report and it is expected that the U.S. Government would appeal the decision. To date, however, those tariffs have not significantly benefited selling prices for finished steel products on the West Coast of the United States. In the spring of 2002, the 39 U.S. Government imposed anti-dumping and countervailing duties against wire rod products from eight foreign countries. These duties have assisted the Company in increasing sales of wire rod products; any expiration or termination of the duties could have a corresponding adverse effect. In December 2002, Nucor Corporation assumed ownership of the assets of Birmingham Steel Corp., a steel manufacturing business in Seattle, Washington. Nucor Corporation, the leader in setting prices in the Company's markets, has a significant share of the West Coast finished steel market and is considered an aggressive competitor. The long term impact, if any, that Nucor's ownership and operation of Birmingham Steel's Seattle facility will have on the Steel Manufacturing Business' and the Metals Recycling Business' operating results cannot be determined at this time. Additionally, until recently the Steel Manufacturing Business also competed with the North Star mill in Kingman, Arizona, which was sold to Nucor. That facility is currently idle, but any future start-up of its operations could impact the Company's market. Joint Ventures: The Company has significant investments in joint venture companies. The Company does not manage the day-to-day activities of these businesses. As a result, it does not have the same ability to control the operations and related financial results as it does with its consolidated businesses. These businesses are, however, affected by many of the same risk factors mentioned above. Therefore, it is difficult to predict the financial results of these businesses. Additionally, two of these joint ventures continue to use LIFO inventory accounting, which tends to defer income taxes. Historically, the effects of LIFO adjustments are difficult to predict. Energy Supply: The Company and its joint ventures utilize various energy sources to operate their facilities. In particular, electricity and natural gas currently represent approximately 10% of the cost of steel manufactured for the Company's Steel Manufacturing Business. The Steel Manufacturing Business purchases electric power under a long-term contract from McMinnville Water & Light (McMinnville) which in turn relies on the Bonneville Power Administration (BPA). Historically, these contracts have had favorable prices and are long-term in nature. The Company has a five-year contract that expires in September 2006. On October 1, 2001, the BPA increased its electricity rates due to increased demand on the West Coast and lower supplies. This increase was in the form of a Cost Recovery Adjustment Clause (CRAC) added to BPA's contract with McMinnville. The CRAC is an additional monthly surcharge on selected power charges to recover costs associated with buying higher priced power during the West Coast power shortage. Because the BPA can adjust the CRAC every six months, it is not possible to predict future rate changes. The Steel Manufacturing Business also has a contract for natural gas. The current contract expires on October 31, 2003 and a new contract has been signed which expires October 31, 2004. The new contract price has increased by 15%. If the Company is unable to negotiate favorable terms of electricity, natural gas and other energy sources, this could adversely affect the performance of the Company. Tax Laws: The Company has been able to reduce its effective tax rate below the federal statutory tax rate for each of the last three years by using a combination of Net Operating Loss Carryforwards (NOLs), State of California Enterprise Zone tax credits and Foreign Sales Corporations or Extraterritorial Income Exclusions. The Company cannot predict how future tax law changes might affect the Company's effective tax rate. Currency Fluctuations: Demand from the Company's foreign customers is partially driven by foreign currency fluctuations relative to the U.S. dollar. Recent weakness of the U.S. dollar relative to foreign currencies has been a significant factor in the increases in recycled metals prices over the last year, as well as resulted in increasing the cost of certain finished steel imports. Strengthening of the U.S. dollar could adversely affect the competitiveness of the Company's products in the markets in which the Company competes. The Company has no control over such fluctuations and, as such, these dynamics could affect the Company's revenues and earnings. Shipping and Handling: Both the Metals Recycling Business and the Steel Manufacturing Business often rely on third parties to handle and transport their products to end users in a timely manner. The cost to transport the products, in particular by ocean freight, can be affected by circumstances over which the Company has no control such as fuel prices, political events, governmental regulations on transportation and changes in market rates due to carrier availability. 40 Insurance: The cost of the Company's insurance is affected not only by its own loss experience but also by cycles in the insurance market. The Company cannot predict future events and circumstances which could cause rates to materially change such as war, terrorist activities or natural disasters. Auto Parts Business: The Auto Parts Business competes with both full-service and self-service auto dismantlers as well as larger well financed retail auto parts businesses for retail customers. Periodically, the Auto Parts Business increases prices, which may affect customer flow and buying patterns. The ultimate impact of these changes cannot be predicted. Also, the business competes for its automobile inventory with other dismantlers, used car dealers, auto auctions and metal recyclers. Inventory costs can fluctuate significantly depending on market conditions and prices for recycled metal. The Auto Parts Business is subject to a number of other risks that could prevent it from maintaining or exceeding its current levels of profitability, such as volatile supply and demand conditions affecting prices and volumes in the markets for its products, services and raw materials; environmental issues; local and worldwide economic conditions; increased competition; and business integration and management transition issues. One should understand that it is not possible to predict or identify all factors that could cause actual results to differ from the Company's forward-looking statements. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. Further, the Company does not assume any obligation to update any forward-looking statement. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company periodically uses derivative financial instruments to limit exposure to changes in interest rates. Because such derivative instruments are used solely as hedges and not for speculative trading purposes, they do not represent incremental risk to the Company. For further discussion of derivative financial instruments, refer to "Fair Value of Financial Instruments" in the Consolidated Financial Statements included in Item 8, Note 1 of the "Notes to the Consolidated Financial Statements". 41 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Consolidated Financial Statements and Schedules Page Report of Independent Accountants....................................43 Consolidated Balance Sheets - August 31, 2003 and 2002...............44 Consolidated Statement of Operations - Years ended August 31, 2003, 2002 and 2001................................45 Consolidated Statement of Shareholders' Equity - Years ended August 31, 2003, 2002 and 2001................................46 Consolidated Statement of Cash Flows - Years ended August 31, 2003, 2002 and 2001................................47 Notes to Consolidated Financial Statements...........................48 Schedule II - Valuation and Qualifying Accounts......................73 Report of Independent Accountants on Financial Statement Schedule....74 All other schedules and exhibits are omitted, as the information is not applicable or is not required. 42 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Schnitzer Steel Industries, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Schnitzer Steel Industries, Inc. and its subsidiaries at August 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in the footnotes to the consolidated financial statements, effective September 1, 2002 the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. PRICEWATERHOUSECOOPERS LLP Portland, Oregon October 1, 2003 43 SCHNITZER STEEL INDUSTRIES, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts)
August 31, ---------------------------- 2003 2002 ---------- ---------- Assets ------ Current assets: Cash $ 1,687 $ 32,974 Accounts receivable, less allowance for doubtful accounts of $712 and $1,005 38,428 31,627 Accounts receivable from related parties 555 813 Inventories (Note 2) 61,143 57,917 Deferred income taxes (Note 8) 4,524 3,966 Prepaid expenses and other 7,400 4,410 ---------- ---------- Total current assets 113,737 131,707 Net property, plant and equipment (Note 4) 141,224 111,759 Other assets: Investment in and advances to joint venture partnerships (Note 12) 119,066 96,440 Notes receivable less current portion (Note 9) 1,565 27,067 Goodwill 107,209 35,754 Intangibles and other 5,093 2,279 ---------- ---------- Total assets $ 487,894 $ 405,006 ========== ========== Liabilities and Shareholders' Equity ------------------------------------ Current liabilities: Current portion of long-term debt (Note 6) $ 220 $ 60,220 Accounts payable 21,537 18,205 Accrued payroll liabilities 8,896 5,887 Current portion of environmental liabilities (Note 7) 4,639 3,030 Other accrued liabilities 6,004 5,014 ---------- ---------- Total current liabilities 41,296 92,356 Deferred income taxes (Note 8) 33,093 30,860 Long-term debt, less current portion (Note 6) 87,045 8,305 Environmental liabilities, net of current portion (Note 7) 17,139 18,045 Other long-term liabilities (Note 10) 2,704 2,492 Minority interests 3,620 -- Commitments and contingencies (Notes 4, 7 and 9) -- -- Shareholders' equity: Preferred stock--20,000 shares authorized, none issued -- -- Class A common stock--75,000 shares $1.00 par value authorized, 12,445 and 5,025 shares issued and outstanding 12,445 5,025 Class B common stock--25,000 shares $1.00 par value authorized, 7,061 and 4,180 shares issued and outstanding 7,061 4,180 Additional paid-in capital 104,249 96,074 Retained earnings 179,242 147,669 ---------- ---------- Total shareholders' equity 302,997 252,948 ---------- ---------- Total liabilities and shareholders' equity $ 487,894 $ 405,006 ========== ==========
The accompanying notes are an integral part of this statement 44 SCHNITZER STEEL INDUSTRIES, INC. CONSOLIDATED STATEMENT OF OPERATIONS (in thousands, except per share amounts)
Year Ended August 31, ------------------------------------------------ 2003 2002 2001 ---------- ---------- ---------- Revenues $ 496,866 $ 350,648 $ 322,831 Cost of goods sold and other operating expenses 413,043 324,435 290,974 Impairment and other non-recurring charges 2,100 7,100 -- Selling and commission expenses 5,311 2,863 2,199 General and administrative expenses 32,048 25,815 24,426 ---------- ---------- ---------- Income (loss) from wholly-owned operations 44,364 (9,565) 5,232 Income from joint ventures (Note 12) 24,421 19,390 9,837 ---------- ---------- ---------- Income from operations 68,785 9,825 15,069 Other income (expense): Interest expense (1,778) (2,314) (5,120) Other income (expense) (540) 136 1,371 ---------- ---------- ---------- (2,318) (2,178) (3,749) ---------- ---------- ---------- Income before cumulative effect of change in accounting principle, income taxes, minority interests and pre-acquisition interests 66,467 7,647 11,320 Income tax provision (Note 8) (17,946) (1,094) (3,401) ---------- ---------- ---------- Income before cumulative effect of change in accounting principle, minority interests and pre-acquisition interests 48,521 6,553 7,919 Minority interests, net of tax (1,824) -- -- Pre-acquisition interests, net of tax (2,513) -- -- ---------- ---------- ---------- Income before cumulative effect of change in accounting principle 44,184 6,553 7,919 Cumulative effect of change in accounting principle (983) -- -- ---------- ---------- ---------- Net income $ 43,201 $ 6,553 $ 7,919 ========== ========== ========== Net income per share - basic: Income before cumulative effect of change in accounting principle $ 2.37 $ 0.36 $ 0.42 Cumulative effect of change in accounting principle (0.05) -- -- ---------- ---------- ---------- Net income $ 2.32 $ 0.36 $ 0.42 ========== ========== ========== Net income per share - diluted: Income before cumulative effect of change in accounting principle $ 2.25 $ 0.35 $ 0.42 Cumulative effect of change in accounting principle (0.05) -- -- ---------- ---------- ---------- Net income $ 2.20 $ 0.35 $ 0.42 ========== ========== ==========
The accompanying notes are an integral part of this statement 45 SCHNITZER STEEL INDUSTRIES, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (in thousands)
Class A Class B Common Stock Common Stock Additional ----------------------- ---------------------- Paid-in Retained Shares Amount Shares Amount Capital Earnings Total --------- --------- --------- --------- --------- --------- --------- Balance at August 31, 2000 5,389 $ 5,389 4,312 $ 4,312 $ 101,840 $ 136,889 $ 248,430 Class B common stock converted to Class A common stock 8 8 (8) (8) -- Class A common stock repurchased (506) (506) (6,185) (6,691) Class A common stock issued 5 5 54 59 Stock options issued 214 214 Net income 7,919 7,919 Dividends paid (1,862) (1,862) --------- --------- --------- --------- --------- --------- --------- Balance at August 31, 2001 4,896 4,896 4,304 4,304 95,923 142,946 248,069 Class B common stock converted to Class A common stock 124 124 (124) (124) -- Class A common stock repurchased (99) (99) (1,157) (1,256) Class A common stock issued 104 104 1,308 1,412 Net income 6,553 6,553 Dividends paid (1,830) (1,830) --------- --------- --------- --------- --------- --------- --------- Balance at August 31, 2002 5,025 5,025 4,180 4,180 96,074 147,669 252,948 Class B common stock converted to Class A common stock 635 635 (635) (635) -- Class A common stock issued 547 547 8,175 8,722 Net income 43,201 43,201 Stock dividend 6,238 6,238 3,516 3,516 (9,754) -- Cash dividends paid (1,874) (1,874) --------- --------- --------- --------- --------- --------- --------- Balance at August 31, 2003 12,445 $ 12,445 7,061 $ 7,061 $ 104,249 $ 179,242 $ 302,997 ========= ========= ========= ========= ========= ========= =========
The accompanying notes are an integral part of this statement 46 SCHNITZER STEEL INDUSTRIES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)
Year Ended August 31, ------------------------------------------------ 2003 2002 2001 ---------- ---------- ---------- Operations: Net income $ 43,201 $ 6,553 $ 7,919 Noncash items included in income: Cumulative effect of change in accounting principle 983 -- -- Depreciation and amortization 19,441 18,631 18,742 Minority and pre-acquisition interests 5,942 -- -- Deferred income taxes 1,791 692 1,787 Equity in earnings of joint ventures (24,421) (19,390) (9,837) Impairment and other non-recurring charges 2,100 6,100 (Gain) loss on disposal of assets (93) 85 (304) Cash provided (used) by changes in working capital: Accounts receivable (6,169) (8,675) 3,813 Inventories (1,240) 31,174 (13,008) Prepaid expenses and other (4,411) 426 (843) Accounts payable 2,802 1,166 (1,356) Accrued liabilities 1,317 (1,768) (135) Environmental liabilities (1,998) (966) (492) Other assets and liabilities 1,692 2,357 2,362 ---------- ---------- ---------- Net cash provided by operations 40,937 36,385 8,648 ---------- ---------- ---------- Investing: Capital expenditures (21,796) (9,569) (9,297) Investments in subsidiaries (64,923) -- -- Cash received from joint ventures 286 145,060 167,354 Cash paid to joint ventures (3,272) (113,703) (160,193) Proceeds from sale of assets 585 39 882 ---------- ---------- ---------- Net cash (used) provided by investing (89,120) 21,827 (1,254) ---------- ---------- ---------- Financing: Repurchase of Class A common stock -- (1,256) (6,691) Issuance of Class A common stock 8,722 1,412 273 Distributions to minority and pre-acquisition interests (4,292) -- -- Cash dividends declared and paid (1,874) (1,830) (1,862) Increase (decrease) in long-term debt 19,000 (23,900) 356 Decrease in other long-term debt (4,660) (1,541) -- ---------- ---------- ---------- Net cash provided (used) by financing 16,896 (27,115) (7,924) ---------- ---------- ---------- Net (decrease) increase in cash (31,287) 31,097 (530) Cash at beginning of year 32,974 1,877 2,407 ---------- ---------- ---------- Cash at end of year $ 1,687 $ 32,974 $ 1,877 ========== ========== ==========
The accompanying notes are an integral part of this statement 47 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF BUSINESS Schnitzer Steel Industries, Inc. (the Company) operates a metal recycling business, a self-service used auto parts business, and, through its Cascade Steel Rolling Mills, Inc. subsidiary, a mini-mill steel manufacturing business. The Company's wholly-owned recycling facilities are located in Alaska, Washington, Oregon and California. Additionally, through joint ventures, the Company participates in the management of additional metals processing and recycling businesses in Arizona, California, Connecticut, Idaho, Illinois, Indiana, Maine, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, Texas and Utah. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. The Company, through subsidiaries, holds a 50% interest in nine joint ventures and a 30% interest in one, which are accounted for using the equity method. All intercompany transactions and balances have been eliminated. BASIS OF PRESENTATION Note 3 of the Notes to the Consolidated Financial Statements describes an acquisition that occurred on February 14, 2003. Under Statement of Financial Accounting Standards No. 141 (SFAS No. 141), "Business Combinations," the acquisition is considered a "step" acquisition due to the fact that the Company had a significant joint venture interest in the acquired business for a number of years. Additionally, since the acquisition occurred during the year, the Company elected to include it in the consolidated results as though it had occurred at the beginning of fiscal 2003. Thus, the 2003 statement of operations, balance sheet, and statement of cash flows have been adjusted to consolidate the acquisition as of September 1, 2002. Also, the acquired businesses were consolidated with the Company's previous interest in the business to form a separate reporting segment called the Auto Parts Business. As such, the financial statement information that was reported in the Company's Form 10-Q for the quarter ended November 30, 2002 has been restated. Additionally, consolidation accounting requires the Company to adjust its earnings for the ownership interests it did not own during the reporting period. During fiscal 2003, net income was reduced by $1.8 million of minority interests, net of income taxes, representing the share of income attributable to various continuing minority partners of the business. Also, for fiscal 2003, net income was reduced by $2.5 million of pre-acquisition interests, net of income taxes, representing the share of income attributable to the former joint venture partner prior to the acquisition. The financial results of the acquired business for periods prior to fiscal 2003 continue to be accounted for using the equity method and are included in the joint venture businesses reporting segment. CASH AND CASH EQUIVALENTS Cash and cash equivalents include short-term securities that have an original maturity date of 90 days or less. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined using the average cost method. The production and accounting process utilized by the Company to record recycled metals inventory quantities relies on significant estimates, which can be affected by weight imprecision, moisture, production yields and other factors. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are recorded at cost. Major renewals and improvements are capitalized. Substantially all expenditures for maintenance and repairs are charged to operations as incurred. Depreciation is determined principally using the straight-line method over estimated useful lives of approximately 20 to 40 years for buildings and approximately 3 to 15 years for equipment. Leasehold improvements are amortized over the 48 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS estimated useful lives of the property or the remaining lease term, whichever is less. When assets are retired or sold, the related cost and accumulated depreciation are removed from the accounts and resulting gains or losses are generally included in operating income. LONG-LIVED ASSETS Statement of Financial Accounting Standards No. 142 (SFAS No. 142), "Goodwill and Other Intangible Assets" requires that intangibles with finite useful lives be reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 144 (SFAS No. 144), "Accounting for the Impairment or Disposal of Long-Lived Assets." In September 2002, the Company adopted SFAS No. 144, which supersedes Statement of Financial Accounting Standards No. 121 (SFAS No. 121), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", and Accounting Principles Board Opinion No. 30, "Reporting the Results of Operation-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144 establishes a single accounting model for long-lived assets to be disposed of by sale, whether they were previously held and used or newly acquired, and it also broadens the presentation of discontinued operations to include more disposal transactions. The Company assesses its long-lived assets for impairment at the lowest level for which there are identifiable cash flows whenever changes in circumstances indicate that the carrying amount may not be recoverable. Factors the Company considers important which could trigger an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner in which an asset is utilized and substantial negative industry or economic trends. When such events or changes in circumstances occur, the Company assesses the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through the discounted expected future cash flow. If the future discounted cash flow is less than the carrying amount of these assets, the Company recognizes an impairment loss based on the excess of the carrying amount over the fair value of the assets in accordance with SFAS No. 144. GOODWILL Effective September 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142). This statement changed the accounting for goodwill and indefinite-lived intangible assets from an amortization approach to an impairment-only approach. As required under the transitional accounting provisions of SFAS No. 142, the Company completed steps during the second quarter of fiscal 2003 to identify and measure goodwill impairment at its two reporting units, which existed at the time of adoption, the Metals Recycling Business and the Steel Manufacturing Business. The reporting units were measured for impairment by comparing the implied fair value of the reporting units' goodwill with the carrying amount of the goodwill. Historical earnings were used as a basis to project future earnings to determine whether any impairment of goodwill existed at the reporting units. As a result of this evaluation, the Company determined that goodwill associated with its Steel Manufacturing Business was impaired. The Company recorded a non-cash impairment charge for the entire $983,000 of remaining goodwill, effective September 1, 2002, and reported it as a "Cumulative effect of change in accounting principle" on the Consolidated Statement of Operations. The goodwill was not deductible for tax purposes, thus the amount was not tax effected. The implementation of SFAS No. 142 required the use of judgments, estimates and assumptions in the determination of fair value and impairment amounts related to the required testing. Prior to adoption of SFAS No. 142, the Company had historically evaluated goodwill for impairment by comparing the entity level unamortized balance of goodwill to projected undiscounted cash flows, which did not result in an indicated impairment. In the future, the Company will perform impairments tests annually and whenever events and circumstances indicate that the value of goodwill and other indefinite-lived intangible assets might be impaired. 49 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table presents a reconciliation of reported net income and income per share, as if SFAS No. 142 had been in effect for all periods presented (in thousands, except per share amounts): For the year ended August 31, ----------------------------- 2003 2002 2001 ---- ---- ---- Reported net income $ 43,201 $ 6,553 $ 7,919 Goodwill amortization, net of tax -- 1,269 1,251 -------- -------- -------- Adjusted net income $ 43,201 $ 7,822 $ 9,170 ======== ======== ======== Reported basic income per share $ 2.32 $ 0.36 $ 0.42 Goodwill amortization, net of tax -- 0.07 0.07 -------- -------- -------- Adjusted basic income per share $ 2.32 $ 0.43 $ 0.49 ======== ======== ======== Reported diluted income per share $ 2.20 $ 0.35 $ 0.42 Goodwill amortization, net of tax -- 0.07 0.07 -------- -------- -------- Adjusted diluted income per share $ 2.20 $ 0.42 $ 0.49 ======== ======== ======== The changes in the carrying amount of goodwill for the year ending August 31, 2003 are as follows (in thousands): Metals Steel Recycling Manufacturing Auto Parts Business Business Business Total -------- -------- -------- ----- Balance as of year ending August 31, 2002, audited $ 34,771 $ 983 $ - $ 35,754 Acquisition (Note 3) - - 72,438 72,438 Impairment charge - (983) - (983) -------- ------- -------- -------- Balance as of August 31, 2003 $ 34,771 $ - $ 72,438 $107,209 ======== ======= ======== ======== COMMON STOCK Each share of Class A common stock is entitled to one vote and each share of Class B common stock is entitled to ten votes. Additionally, each share of Class B common stock may be converted to one share of Class A common stock. EARNINGS PER SHARE On July 23, 2003, the Company's Board of Directors approved a two-for-one stock split, to be effected as a 100% share dividend, for both classes of its common stock, par value $1.00 per share. Shareholders received one share of common stock for every share owned. The share dividend was payable August 14, 2003 to shareholders of record on July 24, 2003. The fiscal 2002 and 2001 common stock outstanding have been adjusted to reflect this stock dividend. Basic EPS is computed based upon the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock. The following represents a reconciliation from basic EPS to diluted EPS giving effect to the share dividend referred to above (in thousands, except per share amounts): 50 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Income before cumulative effect of accounting change $ 44,184 $ 6,553 $ 7,919 Cumulative effect of change in accounting principle (983) - - -------- -------- -------- Net income $ 43,201 $ 6,553 $ 7,919 ======== ======== ======== Computation of shares: Average common shares outstanding 18,650 18,296 18,742 Stock options 1,003 270 38 -------- -------- -------- Diluted average common shares outstanding 19,653 18,566 18,780 ======== ======== ======== Basic EPS: Income before cumulative effect of accounting change $ 2.37 $ 0.36 $ 0.42 Cumulative effect of change in accounting principle (0.05) - - -------- -------- -------- Net income $ 2.32 $ 0.36 $ 0.42 ======== ======== ======== Diluted EPS: Income before cumulative effect of accounting change $ 2.25 $ 0.35 $ 0.42 Cumulative effect of change in accounting principle (0.05) - - -------- -------- -------- Net income $ 2.20 $ 0.35 $ 0.42 ======== ======== ======== Dividend per share $ 0.10 $ 0.10 $ 0.10 ======== ======== ========
Options with an exercise price greater than the average market price were not included in the computation of diluted earnings per share because to do so would be antidilutive. These options totaled 178,000 in 2003, 1,171,800 in 2002, and 2,042,000 in 2001. The Company records stock-based compensation under the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations. Under this method, compensation expense for its stock incentive plans is determined using the intrinsic value method. Accordingly, because the exercise price equals the market price on the date of the grant, no compensation expense is recognized by the Company for stock options issued to employees, consultants and directors. On December 31, 2002, the FASB issued Statement of Financial Accounting Standards No. 148 (SFAS No. 148), "Accounting for Stock-Based Compensation - Transition and Disclosure," which amends Statement of Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative methods of transition for voluntary change to the fair value method of accounting for stock-based compensation. In addition, SFAS No. 148 requires more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. At this time, the Company has elected to adopt the annual and interim disclosure requirements of SFAS No. 148. INTEREST AND INCOME TAXES PAID The Company paid $1.5 million, $2.4 million, and $5.1 million in interest during fiscal years 2003, 2002 and 2001, respectively. In fiscal years 2003 and 2001, the Company paid $17.2 million and $1.4 million in income taxes, respectively. During fiscal 2002, the Company received tax refunds of $0.5 million. 51 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FAIR VALUE OF FINANCIAL INSTRUMENTS Cash, receivables and current liabilities in the consolidated financial statements are considered to reflect the fair value because of the short-term maturity of these instruments. The fair value of long-term debt is deemed to be the same as that reflected in the consolidated financial statements given the variable interest rates on the significant credit facilities. There are no quoted prices for the Company's investments in joint ventures accounted for on the equity method. A reasonable estimate of fair value could not be made without incurring excessive costs. USE OF ESTIMATES IN FINANCIAL STATEMENT PREPARATION The preparation of financial statements in accordance with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from those estimates. REVENUE RECOGNITION The Company recognizes revenue when it has a contract or purchase order from a customer with a fixed price, the title and risk of loss transfer to the buyer and collectibility is reasonably assured. Title for both metals and finished steel products transfers upon shipment. For retail sales, revenues are recognized when customers pay for salvaged parts. All shipping costs billed to customers are recorded as revenue with the related costs being included under cost of sales. ENVIRONMENTAL COSTS The estimated future costs for known environmental remediation requirements are accrued on an undiscounted basis when it is probable that the Company has incurred a liability and the related costs can be reasonably estimated. When only a range of amounts is established, and no amount within the range is better than another, the minimum amount of the range is recorded. Recoveries of environmental remediation costs from other parties are recorded as assets when collection is probable. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to fiscal year 2003 presentation. These changes had no impact on previously reported results of operations or shareholder's equity. NEW ACCOUNTING PRONOUNCEMENTS In July 2001, the FASB issued Statement of Financial Accounting Standards No. 143 (SFAS No. 143), "Accounting for Asset Retirement Obligations." SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity is required to capitalize the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002 and was adopted by the Company effective September 1, 2002. The adoption of this statement did not have a material impact on the consolidated financial statements. In May 2002, the FASB issued SFAS No. 145, (SFAS No. 145) "Rescission of FAS Nos. 4, 44, and 64, Amendment of FAS 13, and Technical Corrections." Among other things, SFAS No. 145 rescinds various pronouncements regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" are met. SFAS 145 provisions regarding early extinguishment of debt are generally effective for fiscal years beginning after May 15, 2002. The adoption of this statement did not have a material impact on the consolidated financial statements. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather 52 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS than at the date of a commitment to an exit or disposal plan. Costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. This statement is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of this statement did not have a material impact on the consolidated financial statements. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" (SFAS No. 149). SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. In particular, SFAS No. 149 clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative and when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003 and is not expected to have a material impact on the Company's financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity", which establishes standards for how financial instruments that have characteristics of both liabilities and equity instruments should be classified on the balance sheet. The requirements of SFAS No. 150 generally state that financial instruments that give the issuer a choice of settling an obligation with a variable number of securities or settling an obligation with a transfer of assets or any mandatorily redeemable security should be classified as a liability on the balance sheet. As of August 31, 2003, the Company does not have any instruments that are within the scope of SFAS No. 150. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 are effective for any guarantees that are issued or modified after December 31, 2002. The adoption of this interpretation did not have a material impact on the consolidated financial statements. In January 2003, FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003 and to existing entities in the first fiscal year or interim period beginning after June 15, 2003. The Company has determined that it does not have relationships with any entities which meet the definition of a variable interest entity. Note 2 - Inventories: Inventories consist of the following (in thousands): August 31, ---------- 2003 2002 ---- ---- Recycled metals $ 21,115 $ 13,432 Work in process 8,254 6,495 Finished goods 19,912 25,245 Supplies 11,862 12,745 -------- -------- $ 61,143 $ 57,917 ======== ======== 53 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The production and accounting process utilized by the Company to record recycled metals inventory quantities relies on significant estimates, which can be affected by weight imprecisions, moisture, production yields and other factors. Note 3 - Business Combinations: On February 14, 2003, the Company's wholly-owned subsidiary, Norprop, Inc. ("Norprop") closed its acquisition (the "Acquisition" ) of all of the stock of Pick and Pull Auto Dismantling, Inc., which was the Company's 50% partner in Pick-N-Pull Auto Dismantlers, a California general partnership (the "Joint Venture") and all of the membership interests in Pick-N-Pull Auto Dismantlers, Stockton, LLC ("Stockton"). The cost of the Acquisition consisted of $71.4 million of cash paid to the seller at closing, $3.3 million of debt assumed and immediately paid off, and $0.6 million of acquisition costs. In addition, Norprop assumed approximately $12.5 million of debt owed by the Joint Venture to the Company, bringing the total purchase price to $87.8 million (or $84.2 million net of the seller's $3.6 million share of the Joint Venture's cash on hand at closing). The Joint Venture stores together with the Stockton store are one of the country's leading self-service used auto parts networks with 23 store locations, 17 in northern California, two in Nevada, and one in each of Texas, Utah, Illinois and Indiana. The purchase price of the Acquisition was allocated to tangible and intangible identifiable assets and liabilities assumed based on an estimate of their fair values. Certain tangible net assets, such as real estate, were valued by independent third parties and the equipment was valued by Company management. The excess of the aggregate purchase price over the fair value of the identifiable net assets acquired of approximately $70.6 million was recognized as goodwill. Approximately $3.7 million of goodwill existed on the Joint Venture's balance sheet prior to the Acquisition, but the Company's $1.8 million share of this amount was not shown separately in accordance with the equity method of accounting. Therefore, the total increase to goodwill related to the Acquisition was $72.4 million. Additionally, in connection with the Acquisition, the Company conducted an environmental due diligence investigation. Based upon new information obtained in this investigation, the Joint Venture accrued $2.1 million in environmental liabilities in the second quarter of 2003 for probable and reasonably estimable future remediation costs at the Auto Parts Business' store locations. No environmental proceedings are pending at any of these sites. The initial purchase price is subject to the terms of the Purchase Agreement, which provides for a purchase price adjustment one year after closing based upon calendar year 2002 and 2003 earnings before interest, taxes, depreciation and amortization (EBITDA) of the acquired Auto Parts Business. As defined by the Purchase Agreement, the contingent future adjustment may increase or decrease the initial purchase price by up to $12 million. The purchase price allocation has been prepared on a preliminary basis. The purchase price allocation is subject to changes in the purchase price due to the contingent future adjustment mentioned above. The following is a summary of the estimated fair values of the assets acquired and liabilities assumed as of the date of the acquisition (in millions): Property, plant and equipment $13.3 Other tangible assets 2.6 Other assets 5.4 Liabilities (4.1) Goodwill 70.6 ----- Total $87.8 ===== Goodwill of $70.6 million represents the excess of purchase price over the fair value of the net tangible assets acquired. In accordance with SFAS No. 142, goodwill is not amortized and will be tested for impairment at least annually. The following table is prepared on a pro forma basis for fiscal 2003 and 2002 as though the Auto Parts Business had been acquired as of the beginning of the period presented, after including the estimated impact of certain adjustments such as interest expense (in millions, except per share amounts). 54 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year Ended August 31, --------------------- 2003 2002 ------- ------- Net revenues $ 496.9 $ 402.3 Income before cumulative effect of change in accounting principle $ 46.7 $ 11.4 Net income $ 45.7 $ 11.4 Net income per share: Basic $ 2.45 $ 0.62 Diluted $ 2.33 $ 0.61 The pro forma results are not necessarily indicative of what would have occurred if the acquisitions had been in effect for the periods presented. In addition, they are not intended to be a projection of future results and do not reflect any synergies that might be achieved from combining operations. NOTE 4 - PROPERTY, PLANT AND EQUIPMENT AND OPERATING LEASES: Property, plant and equipment consist of the following (in thousands): August 31, ---------- 2003 2002 -------- -------- Machinery and equipment $222,604 $242,243 Land and improvements 50,348 37,831 Buildings and leasehold improvements 70,861 14,932 Construction in progress 10,351 2,467 -------- -------- 354,164 297,473 Less: accumulated depreciation (212,940) (185,714) -------- -------- $141,224 $111,759 ======== ======== Depreciation expense from operations was $19.3 million in fiscal 2003, $16.7 million in fiscal 2002, and $16.8 million in fiscal 2001. The Company leases certain property and equipment. The future minimum rental payments under the operating leases are (in thousands): Year Amount ---- ------ 2004 $4,894 2005 4,232 2006 2,885 2007 1,804 2008 1,236 Thereafter 834 Rent expense was $3.6 million, $1.1 million and $1.4 million for fiscal years 2003, 2002 and 2001, respectively. See discussion of additional leases with related parties in Note 9. 55 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 - IMPAIRMENT AND OTHER NONRECURRING CHARGES: During the second quarter of fiscal 2003, the Company accrued $2.1 million in environmental liabilities relating to the acquisition of the Auto Parts Business (refer to Note 3). During the fourth quarter of fiscal 2002, the Metals Recycling Business discontinued the operations of two businesses that were not providing an adequate return and terminated a fixed-price barge contract of affreightment that was determined not to be cost effective. The Company recognized a charge of $4.8 million, including a $0.4 million write down of property, plant and equipment, a $2.4 million write down of goodwill, a $1.0 million write down of other assets and a $1.0 million payment to terminate the barge contract. Revenue from the discontinued operations during fiscal 2002 and 2001 was $1.6 million and $2.6 million, respectively. Operating results (defined as operating income or loss before taxes) were losses of $0.8 million and $0.6 million for fiscal 2002 and 2001, respectively. In the second quarter of fiscal 2002, the Company sold a non-strategic steel forging business that was part of a 1995 Metals Recycling Business acquisition and recorded a loss of $0.8 million on the sale. Also in that quarter, the Company recorded a loss of $1.5 million related to the early termination of two vessel charter agreements with a related company (see Note 9 "Related Party Transactions"). During fiscal 2002 and 2001, revenue from the closed steel forging business was $0.4 million, and $1.4 million, respectively. Operating results for fiscal 2002 and 2001, (defined as operating income or loss before taxes) were losses of $0.1 million for both periods. NOTE 6 - LONG-TERM DEBT: Long-term debt consists of the following (in thousands): August 31, ---------- 2003 2002 -------- -------- Bank unsecured revolving credit facilities $ 79,000 $ 60,000 Tax-exempt economic development revenue bonds due January 2022, interest payable monthly at a variable rate (0.95 % at August 31, 2003), secured by a letter of credit 7,700 7,700 Other 565 825 -------- -------- Total long-term debt 87,265 68,525 Less: portion due within one year (220) (60,220) -------- -------- Long-term debt less current portion $ 87,045 $ 8,305 ======== ======== In May 2003, the Company entered into an agreement to refinance its revolving bank credit facility. The new facility for $150 million is unsecured, matures in May 2006 and bears interest at varying interest rates. As of August 31, 2003, such rates on outstanding borrowings averaged 2.6%. Interest is payable at varying dates not to exceed the maturity of each advance under the line. 56 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In addition to the above facility, the Company has an additional unsecured line of credit totaling $20 million, all of which is uncommitted. The committed bank credit facilities and other borrowings contain financial covenants, including covenants related to net worth, interest coverage and leverage. The Company was in compliance with these covenants at August 31, 2003. Payments on long-term debt during the next five fiscal years and thereafter are as follows (in thousands): Year Amount ---- ------ 2004 220 2005 244 2006 79,071 2007 30 2008 -- Thereafter 7,700 -------- $ 87,265 ======== NOTE 7 - ENVIRONMENTAL LIABILITIES: PORTLAND HARBOR In December 2000, the United States Environmental Protection Agency (EPA) named the Portland Harbor, a 5.5 mile stretch of the Willamette River in Portland, Oregon, as a Superfund site. The Company's metals recycling and deep water terminal facility in Portland, Oregon is located adjacent to the Portland Harbor. Crawford Street Corporation, a Company subsidiary, also owns property adjacent to the Portland Harbor. The EPA has identified 69 potentially responsible parties (PRPs), including the Company and Crawford Street Corporation, which own or operate sites adjacent to the Portland Harbor Superfund site. The Company leases the metals recycling and deep water terminal facility from Schnitzer Investment Corp. (SIC), a related party, and is obligated under its lease with SIC to bear the costs relating to the investigation and remediation of the property. The precise nature and extent of any clean-up of the Portland Harbor, the parties to be involved, and the process to be followed for such a clean-up have not yet been determined. It is unclear whether or to what extent the Company or Crawford Street Corporation will be liable for environmental costs or damages associated with the Superfund site. It is also unclear whether natural resource damage claims or third party contribution or damages claims will be asserted against the Company. While the Company and Crawford Street Corporation participated in certain preliminary Portland Harbor study efforts, they are not parties to the consent order entered into by the EPA with other PRPs (Lower Willamette Group) for a Remedial Investigation/Feasibility Study; however the Company could become liable for a share of the costs of this study at a later stage of the proceedings. Separately, the Oregon Department of Environmental Quality (DEQ) has requested operating history and other information from numerous persons and entities which own or conduct operations on properties adjacent to or upland from the Portland Harbor, including the Company and Crawford Street Corporation. The DEQ investigations at the Company and Crawford Street sites are focused on controlling any current releases of contaminants into the Willamette River. The Company has agreed to a voluntary Remedial Investigation/Source Control effort with the DEQ regarding its Portland, Oregon deep water terminal facility and the site owned by Crawford Street Corporation. DEQ identified these sites as potential sources of contaminants that could be released into the Willamette River. The Company believes that improvements in the operations at these sites, often referred to as Best Management Practices (BMPs), will be sufficient to effectively provide source control and avoid the release of contaminants from these sites, and has proposed to DEQ the implementation of BMPs as the resolution of this investigation. While the cost of the investigations associated with these properties and the cost of employment of source control BMPs are not expected to be material, no estimate is currently possible and none has been made as to the cost of remediation, 57 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS if any. No accrual for remediation of the Portland Harbor or the Company's adjacent properties had been established as of August 31, 2003. MANUFACTURING MANAGEMENT, INC. In 1994, Manufacturing Management, Inc. (MMI) recorded a reserve for the estimated cost to cure certain environmental liabilities. This reserve was carried over to the Company's financial statements when MMI was acquired in 1995, and at August 31, 2003 aggregated $15.6 million. General Metals of Tacoma (GMT), a subsidiary of MMI, owns and operates a metals recycling facility located in the State of Washington on the Hylebos Waterway, a part of Commencement Bay, which is the subject of an ongoing remediation project by the United States Environmental Protection Agency (EPA) under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). GMT and more than 60 other parties were named potentially responsible parties (PRPs) for the investigation and clean-up of contaminated sediment along the Hylebos Waterway. On March 25, 2002, EPA issued Unilateral Administrative Orders (UAOs) to GMT and another party to proceed with Remedial Design and Remedial Action (RD/RA) for the head of the Hylebos and to two other parties to proceed with the RD/RA for the balance of the waterway. It is anticipated that the UAOs will soon be converted to more specific voluntary consent decrees and that EPA will take additional action against other PRPs. The issuance of the UAOs did not require the Company to change its previously recorded estimate of environmental liabilities for this site. Significant uncertainties continue to exist regarding the total cost to remediate this site as well as the Company's share of those costs; nevertheless, the Company's estimate of its liabilities related to this site is based on information currently available. The Natural Resource Damage Trustees (Trustees) for Commencement Bay have asserted claims against GMT and other PRPs within the Hylebos Waterway area for alleged damage to natural resources. In March 2002, the Trustees delivered a draft settlement proposal to GMT and others in which the Trustees suggested a methodology for resolving the dispute, but did not indicate any proposed damages or cost amounts. In June 2002, GMT responded to the Trustees' draft settlement proposal with various corrections and other comments, as did twenty other participants. It is unknown at this time whether, or to what extent, GMT will be liable for natural resource damages. The Company's previously recorded environmental liabilities include an estimate of the Company's potential liability for these claims. The Washington State Department of Ecology named GMT, along with a number of other parties, as Potentially Liable Parties (PLPs) for a site referred to as Tacoma Metals. GMT operated on this site under a lease prior to 1982. The property owner and current operator have taken the lead role in performing a Remedial Investigation and Feasibility Study (RI/FS) for the site. The RI/FS is now completed and the parties are currently involved in a mediation settlement process to address cost allocations. The Company's previously recorded environmental liabilities include an estimate of the Company's potential liability at this site. MMI is also a named PRP at two third-party sites at which it allegedly disposed of transformers. At one site, MMI entered into a settlement under which it paid $825,000 towards remediation of the site. Remediation of the site has been completed and it is now subject to a five year monitoring program. The other site has not yet been subject to significant remedial investigation. MMI has been named as a PRP at several other sites for which it has agreed to de minimis settlements. In addition to the matters discussed above, the Company's environmental reserve includes amounts for potential future cleanup of other sites at which MMI has conducted business or has allegedly disposed of other materials. PROLER In 1996, prior to the Company's acquisition of Proler International Corp. (Proler), Proler recorded a liability for the probable costs to remediate its wholly-owned properties. The Company carried over the aggregate reserve to its financial statements upon acquiring Proler, and $3.5 million remained outstanding on August 31, 2003. 58 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As part of the Proler acquisition, the Company became a 50% owner of Hugo Neu-Proler Company (HNP). HNP has agreed, as part of its 1996 lease renewal with the Port of Los Angeles (POLA), to conduct a multi-year, phased remedial clean-up project involving certain environmental conditions on its metals recycling facility at its Terminal Island site in Los Angeles, California, which was completed in 2002. HNP is waiting for final certification from POLA and the regulatory agencies overseeing the cleanup. Remediation included excavation and off-site disposal of contaminated soils, paving and groundwater monitoring. Other environmentally protective actions included installation of a stormwater management system and construction of a noise barrier and perimeter wall around a substantial portion of the facility. Metals Recycling L.L.C. (Metals) is a scrap metals processing business with locations in Rhode Island and Massachusetts. The members of Metals are one of the Company's Proler joint ventures and Izzo Group, Inc. On June 9, 1999, the Rhode Island Department of Environmental Management (DEM) issued a Notice of Violation (NOV) against Metals, alleging Metals had violated federal and state regulations relating to the storage, management and transportation of hazardous waste and seeking to impose an administrative penalty of $0.7 million. Metals has filed an answer to the NOV in which it denied the allegations and requested an adjudicatory hearing. In January of 1999, federal and state officials searched Metal's Johnston, Rhode Island and Worcester, Massachusetts facilities. Metals was advised that the search was part of a state criminal investigation into possible violations of state and federal hazardous waste programs and a Rhode Island statute that prohibits the disposal of out-of-state solid waste at the landfill operated by Rhode Island Resource Recovery Corporation (RIRRC). A grand jury was empanelled to consider the allegations and issued an indictment on August 30, 2002 against Metals for storing hazardous waste without a permit, operating a hazardous waste disposal facility without a permit, causing transportation of hazardous waste without a permit, causing transportation of hazardous waste without a manifest and operating a solid waste management facility without a license. Metals has pleaded not guilty on all counts and has vigorously contested the state's allegations. Settlement discussions with DEM and the Rhode Island Attorney General's Office to settle the civil NOV and the criminal charges are being held. In August 1999, the DEM issued a NOV to RIRRC, that included a civil penalty of $0.3 million, relating to the alleged disposal of hazardous waste by Metals at a landfill operated by RIRRC. RIRRC settled this matter with DEM and in response to RIRRC's claim against Metals for contribution, RIRRC and Metals agreed to a settlement in which Metals paid RIRRC $0.2 million in 2003. On March 15, 2002, DEM issued a NOV against Metals' Johnston, Rhode Island facility, alleging violations of provisions of the Rhode Island Clean Air Act and the regulations promulgated thereunder, and seeking to impose administrative penalties of $1.1 million against Metals. On April 5, 2002, Metals filed its answer and request for a hearing, in which it denied liability for such alleged violations. In August 2003, Metals and DEM agreed to a settlement of this matter providing for payment by Metals of a reduced fine of $0.7 million payable in 2003 through 2007, which is further reduced to $0.3 million payable in 2003 through 2004 if Metals installs electric engines, converting from diesel. Metals' results of operations for the past few years have included accruals for the probable costs to remediate or settle the above mentioned environmental situations. Additionally, other Proler joint venture sites with potential environmental clean-up issues have been identified. Estimated clean-up costs associated with these sites have been accrued for by the joint ventures. In connection with the acquisition of the Auto Parts Business, the Company conducted an environmental due diligence investigation. Based upon new information obtained in this investigation, the Joint Venture accrued $2.1 million in environmental liabilities in the second quarter of fiscal 2003 for remediation costs at the Auto Parts Business's store locations. No environmental proceedings are pending at any of these sites. The Company considers various factors when estimating its environmental liabilities. Adjustments to the liabilities are made when additional information becomes available that affects the estimated costs to remediate. The factors, which the Company considers in its recognition and measurement of environmental liabilities, include the following: 59 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS o Current regulations both at the time the reserve is established and during the course of the clean-up which specify standards for acceptable remediation; o Information about the site, which becomes available as the site is studied and remediated; o The professional judgment of both senior-level internal staff and external consultants who take into account similar, recent instances of environmental remediation issues, among other considerations; o Technologies available that can be used for remediation; and o The number and financial condition of other potentially responsible parties and the extent of their responsibility for the remediation. NOTE 8 - INCOME TAXES: The provision for income taxes is as follows (in thousands): Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Current: Federal $13,363 $ 508 $ 318 State 3,011 686 610 Deferred: Federal 1,051 1,436 2,325 State 521 (1,536) 148 ------- ------- ------- $17,946 $ 1,094 $ 3,401 ======= ======= ======= Deferred tax assets and liabilities are as follows (in thousands): August 31, ---------- 2003 2002 ---- ---- California Enterprise Zone credit carryforward $ 200 $ 200 AMT carryforward 374 529 Segment held for sale (176) 29 Inventory valuation methods 2,897 2,170 Employee benefit accruals 906 891 State income tax and other 323 147 -------- -------- Net current deferred tax assets $ 4,524 $ 3,966 ======== ======== California Enterprise Zone credit carryforward $ (1,500) $ (1,500) Accelerated depreciation and basis differences 44,409 42,010 Environmental liabilities (8,711) (8,430) Net operating loss carryforwards and credits (6,090) (6,928) Other (1,105) (1,220) -------- -------- 27,003 23,932 Deferred tax asset valuation allowance 6,090 6,928 -------- -------- Net non-current deferred tax liabilities $33,093 $ 30,860 ======== ======== 60 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The reasons for the difference between the effective income tax rate and the statutory federal income tax rate are as follows: Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Federal statutory rate 35% 34% 34% Foreign sales corporation/Extraterritorial Income Exclusion (1) (11) (7) (5) State taxes, net of credit 5 11 7 State taxes, Californian Enterprise Zone -- (22) -- Proler NOLs (1) (10) (7) Amortization of goodwill -- 11 3 Other (1) (3) (2) ---- ---- ---- Effective tax rate 27% 14% 30% ==== ==== ==== (1) During 2000, in response to allegations by the World Trade Organization (WTO) that the federal tax benefit conferred on Foreign Sales Corporations (FSC) constituted an illegal trade subsidy, Congress enacted legislation to replace the FSC rules with the Extraterritorial Income Exclusion (ETI) taxation scheme. The Company adopted the new ETI rules for export sales made after October 1, 2000. The Company has found that these rules provide a tax benefit comparable to what the FSC rules would have provided. The WTO has since alleged that ETI is also an illegal trade subsidy, but no further tax legislation has been passed to address this latest allegation. As part of the 1996 acquisition of Proler International Corp. (Proler), the Company acquired $31.4 million of federal net operating loss carryforwards (NOLs). The Company recognized no immediate tax benefit for the NOLs. Instead, the Company set up an offsetting $31.4 million valuation allowance, because the ultimate use of the NOLs was uncertain given the then-current federal tax law proscription against applying the NOLs to any taxable income other than the post-acquisition income generated by Proler. A change to federal tax law in 1999, however, has allowed an annual $2.4 million of NOL to be applied to taxable income from all sources, not just from Proler. Due to this change in tax law, the Company released an annual $2.4 million from the valuation allowance, and recognized the corresponding $0.8 million in tax benefit, in fiscal years 2001, 2002 and 2003. This is a major reason why the Company's effective tax rates have been lower than the statutory rates for those years. The remaining balance of unused NOLs, which stands at $15.3 million as of August 31, 2003, will expire in fiscal years 2007 through 2012 if not used by then. The Company also acquired $0.7 million of credits as part of the Proler acquisition. As with the NOLs, a valuation allowance was set up to offset the credits, the ultimate use of which has been made more likely by the subsequent liberalization of federal tax law. No part of the valuation allowance has yet to be released. The credits are not likely to be used until after the NOLs have been used or expire. The credits can be carried forward indefinitely. In fiscal 2002, the Company qualified for $2.1 million of Enterprise Zone tax credits in the state of California. These credits can be used to offset California state income taxes to the extent that each corporation in the consolidated group has a California franchise (income) tax liability. Any credits in excess of the tax liability can be carried forward indefinitely. These credits, combined with the release of $2.4 of valuation allowance pertaining to the NOLs, were major reasons the Company's effective tax rate of 14% for fiscal 2002 was well below the statutory rate of 34%. 61 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 - RELATED PARTY TRANSACTIONS: Certain shareholders of the Company own significant interest in, or are related to owners of, the entities discussed below. As such, these entities are considered related parties for financial reporting purposes. TRANSACTIONS AFFECTING COST OF GOODS SOLD AND OTHER OPERATING EXPENSES Periodically, the Company charters vessels from related companies at market rates to transport recycled metal to foreign markets. The number of vessels chartered varies from year to year depending on the availability of their vessels. In 1995, the Company signed seven-year time-charter agreements for two vessels scheduled to expire in July 2002. Due in part to the world economic slow-down in 2002, ocean freight rates declined sharply. As a result, in the second quarter of fiscal 2002, the Company terminated the leases in order to take advantage of market rates which were $7 to $8 per ton lower than the all-in contracted rates. The lease terminations resulted in a loss of $1.5 million in the second quarter of fiscal 2002. Charges incurred for both open market and long-term time charters were $1.9 million, $4.7 million and $13.5 million for 2003, 2002 and 2001, respectively. A primary reason for entering into a number of the Company's joint ventures was to secure the supply of recyclable metal for the Metals Recycling Business. The Company purchased recycled metals from its joint venture operations at prices that approximate market. Purchases from these joint ventures totaled $5.0 million, $10.4 million and $12.1 million in 2003, 2002 and 2001, respectively. The Company leases certain land and buildings from Schnitzer Investment Corp. ("Landlord"), a related real estate company, under operating leases. The following table summarizes the lease terms, annual rents and future minimum rents (in thousands): Lease Current Location: Expirations Annual Rent --------- ----------- ----------- Metals Recycling Business: Portland facility and marine terminal 2063 $1,834 Administrative offices 2014 319 Minimum Year Rents ---- ----- 2004 $2,127 2005 2,215 2006 2,225 2007 2,235 2008 2,245 Thereafter 103,089 Rent expense was $2.1 million, $1.9 million, and $1.7 million for 2003, 2002 and 2001, respectively. In accordance with a lease agreement dated September 1988, the rent for the Metals Recycling Business's Portland facility was adjusted in 2003 and will be adjusted every 15 years thereafter to market rates. This 2003 adjustment was based on an analysis of market rates performed by independent experts and consultations with independent counsel and was approved by a majority of the Company's independent directors. In 2008 and every five years thereafter, except in the year of a market rate adjustment, the rent will be adjusted based on the Consumer and Producer Price Indices. 62 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In August 2003, the Company entered into a new agreement with Landlord for the lease of its administrative offices in conjunction with a reconfiguration of the space it occupies. The rent, according to the new agreement, was based on an analysis of market rates performed by independent experts and consultations with independent counsel and was approved by a majority of the Company's independent directors. Until August 2003, the Company leased the property upon which its Sacramento operation is located from Landlord. Upon expiration of the lease in August 2003, the Company purchased the property from Landlord. The purchase price of $1.1 million was determined by an independent appraisal and was approved by a majority of the Company's independent directors. TRANSACTIONS AFFECTING SELLING AND ADMINISTRATIVE EXPENSES The Company performs some administrative services and provides operation and maintenance of management information systems for certain related parties. These services are charged to the related parties based upon cost plus a 15% margin for overhead and profit. These administrative charges totaled $0.9 million, $1.0 million and $1.1 million in 2003, 2002 and 2001, respectively. TRANSACTIONS AFFECTING OTHER INCOME (EXPENSE) Included in other assets are $1.1 million and $28.3 million of notes receivable from joint venture businesses at August 31, 2003 and 2002, respectively. In fiscal 2002, Company converted $28.3 million in advances to its self-service auto parts dismantling joint venture into a note receivable. The note, dated February 22, 2002, had a scheduled maturity of March 1, 2009. In conjunction with the Company's acquisition of Pick-N-Pull, this note has been eliminated in consolidation (see Note 3). The Company recorded interest income on notes and certain other advances to joint ventures. This income totaled $0.1 million, $0.5 million and $2.0 million fiscal years 2003, 2002 and 2001, respectively. NOTE 10 - EMPLOYEE BENEFITS: In accordance with union agreements, the Company contributed to union pension plans $2.5 million, $2.3 million and $2.6 million in fiscal 2003, 2002 and 2001, respectively. These are multi-employer plans and, consequently, the Company is unable to determine its relative portion of or estimate its future liability under the plans. The Company has several defined contribution plans covering nonunion employees. The pension cost related to these plans totaled $1.2 for fiscal 2003, and $1.1 million for each of fiscal 2002 and 2001. For certain nonunion employees, the Company also maintains a defined benefit pension plan. The following table sets forth the change in benefit obligation, change in plan assets and funded status at August 31, 2003 and 2002 in accordance with SFAS 132, "Employer's Disclosure About Pensions and Other Postretirement Benefits" (in thousands): 63 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS August 31, ---------- 2003 2002 ---- ---- Change in benefit obligation: Benefit obligation at beginning of year $ 7,662 $ 6,693 Service cost 792 754 Interest cost 549 501 Actuarial loss 1,053 500 Transfers -- (19) Benefits paid (475) (767) ------- ------- Benefit obligation at end of year $ 9,581 $ 7,662 ======= ======= Change in plan assets: Fair value of plan assets at beginning of year $ 6,656 $ 5,873 Actual return on plan assets 514 (872) Employer contribution 1,690 2,441 Transfers 2 (19) Benefits paid (475) (767) ------- ------- Fair value of plan assets at end of year $ 8,387 $ 6,656 ======= ======= Funded status: Plan assets less than benefit obligation $(1,193) $(1,006) Unrecognized actuarial (gain) loss 3,543 2,590 Unrecognized prior service cost 45 50 ------- ------- Prepaid (accrued) benefit cost $ 2,395 $ 1,634 ======= ======= Assumptions used each year in determining the defined benefit net pension cost are: August 31, ---------- 2003 2002 2001 ---- ---- ---- Weighted average discount rate 6.3% 7.0% 7.0% Expected rate of investment return 8.0% 8.0% 9.0% Expected rate of compensation increase 3.8% 4.0% 4.0% The components of net periodic pension benefit cost are (in thousands): Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Service cost $792 $754 $690 Interest cost 549 501 442 Expected return on plan assets (541) (537) (576) Amortization of past service cost 4 4 4 Recognized actuarial loss 126 24 -- ---- ---- ---- Net periodic pension benefit cost $930 $746 $560 ==== ==== ==== The Company has adopted a nonqualified supplemental retirement plan for certain executives. A restricted trust fund has been established and invested in life insurance policies which can be used for plan benefits, but are subject to claims of general creditors. The trust fund and deferred compensation expense are classified as other assets. The status of this plan is summarized as follows (in thousands): 64 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS August 31, ---------- 2003 2002 2001 ---- ---- ---- Restricted trust fund $1,540 $1,191 $1,562 Deferred compensation expense 374 347 182 Long-term pension liability 2,570 2,174 1,705 Pension cost 273 305 236 The trust fund assets experience stock market gains and losses, which are included in other income (expense). During fiscal 2003, 2002 and 2001, the Company recognized gains (losses) totaling $0.4 million, $(0.4) million and $(0.7) million, respectively. When the Company acquired Proler, it assumed a liability for deferred compensation payable to certain ex-employees of Proler. As of August 31, 2003, 2002 and 2001, the remaining liability aggregated $0.1 million, $0.3 million and $0.7 million, respectively. These amounts are included in other long-term liabilities in the accompanying consolidated balance sheet. NOTE 11 - STOCK INCENTIVE PLAN: The Company has adopted a stock incentive plan for employees, consultants and directors of the Company. The plan covers 4,800,000 shares of Class A common stock. All options have a ten-year term and, except for options granted in fiscal 1999 and 2001, become exercisable for 20% of the shares covered by the option on each of the first five anniversaries of the grant. The options granted in fiscal 1999 became fully exercisable on the first anniversary of the grant. The options granted in fiscal 2001 become exercisable as follows: 33% after one year from the date of grant, 66% after two years from the date of grant, and 100% after two and one-half years from the date of grant. The vesting periods for these options varied from the standard because the Company granted them to certain employees in lieu of annual salary revisions. The Company records stock-based compensation under the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations. An alternative method of accounting exists under Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," (SFAS No. 123) which requires the use of option valuation models. Under APB 25, because the exercise price of the Company's employee stock options equaled the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information for fiscal years 2003, 2002 and 2001 regarding net income and earnings per share is required by SFAS No. 123, as amended by Statement of Financial Accounting Standards No. 148 (SFAS No. 148), "Accounting for Stock-Based Compensation - Transition and Disclosure", and has been determined as if the Company had accounted for its employee stock options under the fair value method. The fair value for these awards was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions: Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Risk-free interest rate 3.7% 4.7% 4.8% Dividend yield 1.0% 1.0% 1.0% Weighted average expected life of options 7.0 Years 7.0 Years 7.0 Years Volatility .35 .40 .43 65 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Had compensation expense for the Company's stock options been recognized based upon the estimated fair value on the grant date under the fair value methodology allowed by SFAS No. 123, as amended by SFAS No. 148, the Company's net income and net income per share would have been as follows (in thousands, except earnings per share): Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Reported net income $ 43,201 $ 6,553 $ 7,919 Stock compensation expense, net of tax (830) (786) (739) -------- ------- ------- Pro forma net income $ 42,371 $ 5,767 $ 7,180 ======== ======= ======= Reported basic income per share $ 2.32 $ 0.36 $ 0.42 Pro forma basic income per share $ 2.27 $ 0.32 $ 0.38 Reported diluted income per share $ 2.20 $ 0.35 $ 0.42 Pro forma diluted income per share $ 2.16 $ 0.31 $ 0.38 A summary of the Company's stock option activity and related information is as follows (in thousands, except per share amounts):
Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ------- ----- ------- ----- ------- ----- Outstanding-beginning of year 2,144 $ 8.85 2,254 $ 8.60 1,836 $ 9.10 Options granted 397 $ 13.01 118 $ 10.01 468 $ 6.75 Options exercised (1,062) $ 8.22 (208) $ 6.82 (10) $ 6.00 Options canceled (24) $ 8.61 (20) $ 8.68 (40) $ 10.67 ----- ----- ----- Outstanding - end of year 1,455 $ 10.44 2,144 $ 8.85 2,254 $ 8.60 ===== ===== ===== Exercisable at end of year 636 $ 10.67 1,464 $ 9.38 1,312 $ 9.35 ===== ===== ===== Weighted-average fair value of options granted during year $ 5.21 $ 4.24 $ 3.26 ========= ========= =========
Exercise prices for options outstanding as of August 31, 2003 ranged from $6.75 to $18.00. The weighted-average remaining contractual life of those options is 6.6 years. During fiscal 2001, the Company also issued 128,392 options to a consultant. The options were fully vested as of September 15, 2001 and expire on September 15, 2005. The exercise price is $8.71 per share. During fiscal 2003, the consultant exercised 97,120 of these options. The Company recorded an expense of $0.2 million in fiscal 2001 related to this transaction. 66 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 12 - Segment Information: The Company operates in three industry segments: metal processing and recycling (Metals Recycling Business), mini-mill steel manufacturing (Steel Manufacturing Business) and self-service used auto parts (Auto Parts Business). Additionally, the Company is a non-controlling partner in joint ventures, which are either in the metals recycling business or are suppliers of unprocessed metals. The Company also considers these to be separate segments because they are managed separately. These joint ventures are accounted for using the equity method. As such, the operating information provided below related to the joint ventures is shown separately from consolidated information, except for the Company's equity in the net income of, investment in and advances to the joint ventures. The Metals Recycling Business buys and processes ferrous and nonferrous metals for sale to foreign and other domestic steel producers or their representatives and to the Steel Manufacturing Business. The Metals Recycling Business also purchases ferrous metals from other processors for shipment directly to the Steel Manufacturing Business. The Steel Manufacturing Business produces rebar, merchant bar, wire rod, coiled rebar and other specialty products. The Auto Parts Business purchases salvaged vehicles, sells parts from those vehicles through its retail facilities and wholesale operations, and sells the remaining portion of the vehicles to metal recyclers, including the Metals Recycling Business. Note 3 describes the acquisition that occurred on February 14, 2003. Under Statement of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business Combinations", the acquisition is considered a "step" acquisition due to the fact that the Company had a significant joint venture interest in the acquired business for a number of years. Additionally, since the acquisition occurred during the year, the Company elected to include it in the consolidated results as though it had occurred at the beginning of fiscal 2003. Thus, the 2003 statement of operations, balance sheet, and statement of cash flows have been adjusted to consolidate the acquisition as of September 1, 2002. The financial results of the acquired businesses for periods prior to fiscal 2003 continue to be accounted for using the equity method and are included in the joint venture businesses reporting segment. Intersegment sales from the Metals Recycling Business to the Steel Manufacturing Business, and from the Auto Parts Business to the Metals Recycling Business, are transferred at negotiated market rates per ton. These intercompany sales tend to produce intercompany profits, which are eliminated until the finished products are ultimately sold to third parties. The Joint Ventures in the Metals Recycling Business are also engaged in buying, processing and selling primarily ferrous metal. Recycled metals are sold to foreign and domestic steel mills. The Joint Venture Suppliers of Metals are industrial plant demolition contractors. These joint ventures dismantle industrial plants perform environmental remediation and sell recovered metals and machinery. The Company purchases substantially all of the ferrous recycled metals generated by these joint ventures. The information provided below is obtained from internal information that is provided to the Company's chief operating decision-maker for the purpose of corporate management. The Company does not allocate corporate interest income and expense, income taxes or other income and expenses related to corporate activity to its operating segments. Assets and capital expenditures are not shown for the joint ventures as management does not use that information to allocate resources or assess performance. 67 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Revenues from external customers (in thousands): Metals Recycling Business $308,553 $221,811 $205,168 Auto Parts Business 65,225 -- -- Steel Manufacturing Business 191,861 166,586 167,554 Intersegment revenues (68,773) (37,749) (49,891) -------- -------- -------- Consolidated revenues $496,866 $350,648 $322,831 ======== ======== ======== The joint ventures' revenues from external customers are as follows (in thousands): Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Joint Ventures in the Metals Recycling Business Processing $616,958 $480,157 $447,689 Brokering 251,431 144,962 108,274 Joint Venture Suppliers of Metals 8,877 61,762 53,381 -------- -------- -------- $877,266 $686,881 $609,344 ======== ======== ======== Revenues by geographic area (in thousands): Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- Metals Recycling Business: Asia $223,490 $164,512 $130,459 United States 85,063 57,299 74,709 Sales to Steel Manufacturing Business (61,052) (37,730) (49,845) -------- -------- -------- Sales to external customers 247,501 184,081 155,323 Auto Parts Business: United States 65,225 -- -- Sales to Metals Recycling Business (7,721) -- -- -------- -------- -------- Sales to external customers 57,504 -- -- Steel Manufacturing Business: United States 191,861 166,586 167,554 Interdivision sales -- (19) (46) -------- -------- -------- Sales to external customers 191,861 166,567 167,508 -------- -------- -------- Consolidated revenues $496,866 $350,648 $322,831 ======== ======== ========
68 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Joint Ventures in the Metals Recycling Business do not maintain revenues by geographic area and it would be impracticable to provide such disclosure. Sales by the Joint Venture Suppliers of Metals are all made to customers in the United States. See Note 9 regarding the Company's purchases from its joint ventures.
Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- (in thousands) Income (loss) from operations: Metals Recycling Business $ 35,781 $ 11,535 $ 8,387 Auto Parts Business 21,968 -- -- Steel Manufacturing Business (2,522) (5,718) 4,860 Joint Ventures in the Metals Recycling Business 24,827 13,766 6,549 Joint Venture Suppliers of Metals (406) 5,624 3,288 Corporate expense and eliminations (8,763) (8,282) (8,015) Impairment and other nonrecurring charges (2,100) (7,100) -- -------- -------- -------- Consolidated income from operations $ 68,785 $ 9,825 $ 15,069 ======== ======== ========
In fiscal 2003, the Company reported $2.1 milllion of impairment and other non-recurring charges related to the Auto Parts Business segment. The amount is shown separately to allow the reader of the financial statements to better understand the operating results. See Note 5. Income from operations from the joint ventures represents the Company's equity in the net income of these entities.
Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- (in thousands) Depreciation and amortization expense: Metals Recycling Business $ 6,052 $ 8,903 $ 8,957 Auto Parts Business 4,017 -- -- Steel Manufacturing Business 8,915 9,368 9,412 Corporate expense and eliminations 457 360 373 -------- -------- -------- Consolidated depreciation and amortization expense $ 19,441 $ 18,631 $ 18,742 ======== ======== ========
The Company's share of depreciation and amortization expense included in the determination of the joint ventures' net income is as follows:
Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- (in thousands) Joint Ventures in the Metals Recycling Business $6,539 $6,542 $5,890 Joint Venture Suppliers of Metals 286 1,132 966
69 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following is a summary of the Company's total assets and capital expenditures:
Year Ended August 31, --------------------- 2003 2002 2001 ---- ---- ---- (in thousands) Total assets: Metals Recycling Business $136,137 $119,088 $127,143 Auto Parts Business 105,283 -- -- Steel Manufacturing Business 113,384 122,036 150,715 Investment in and advances to: Joint Ventures in the Metals Recycling Business 115,924 90,433 105,522 Joint Venture Suppliers of Recycled Metal 3,124 6,006 6,101 Corporate 14,042 67,443 36,389 -------- -------- -------- $487,894 $405,006 $425,870 ======== ======== ======== Capital expenditures: Metals Recycling Business $ 16,176 $ 5,962 $ 5,358 Auto Parts Business 2,932 -- -- Steel Manufacturing Business 2,496 3,182 3,591 Corporate 192 425 348 -------- -------- -------- $ 21,796 $ 9,569 $ 9,297 ======== ======== ========
In fiscal years 2003 and 2001, one customer accounted for 21% and 10% of the Company's consolidated revenues, respectively. During fiscal 2002, no single customer accounted for more than 10% of consolidated revenues. During fiscal 2003, 2002 and 2001, sales to China aggregated 23%, 24% and 19%, respectively, of consolidated revenues. During fiscal 2002, one customer accounted for 11% of combined revenues for these joint ventures, respectively, while during fiscal 2003 and 2001, no single customer accounted for more than 10% of combined revenues for these joint ventures. NOTE 13 - SUMMARIZED FINANCIAL INFORMATION OF JOINT VENTURES: A summary of combined operations of joint ventures in which the Company is a partner is as follows: Year Ended August 31, --------------------- 2003 2002 ---- ---- (in thousands) Current assets $ 150,461 $ 130,284 Noncurrent assets 132,390 126,252 --------- --------- $ 282,851 $ 256,536 ========= ========= Current liabilities $ 87,418 $ 79,740 Noncurrent liabilities 8,917 35,894 Partners' equity 186,516 140,902 --------- --------- $ 282,851 $ 256,536 ========= ========= 70 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year Ended August 31, ------------------------------------- 2003 2002 2001 -------- -------- -------- (in thousands) Revenues $877,266 $686,881 $609,344 ======== ======== ======== Income from operations $ 52,162 $ 39,833 $ 13,526 ======== ======== ======== Net income before taxes $ 50,464 $ 39,824 $ 19,477 ======== ======== ======== The Company performs some administrative services and provides operation and maintenance of management information systems to some of these joint ventures. These administrative charges totaled $0.1 million in fiscal years 2003, 2002 and 2001. Advances from and to joint venture partnerships from the Company are included in noncurrent assets and liabilities above. Certain advances bear interest. NOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS): Fiscal Year 2003 ---------------- First Second Third Fourth ----- ------ ----- ------ Revenues $ 90,667(1) $124,659 $127,944 $153,596 Income from operations 8,771(1) 13,174 22,028 24,812 Net income 2,891(2) 8,409 15,028 16,873 Diluted earnings per share(3) $ 0.21 $ 0.45 $ 0.78 $ 0.84 Fiscal Year 2002 ---------------- First Second Third Fourth ----- ------ ----- ------ Revenues $ 76,834 $ 78,362 $ 95,363 $100,089 Income from operations 3,490 (1,164) 4,842 2,657 Net income (loss) 2,044 (1,054) 3,367 2,196 Diluted earnings per share $ 0.11 $ (0.06) $ 0.19 $ 0.12 Fiscal Year 2001 ---------------- First Second Third Fourth ----- ------ ----- ------ Revenues $ 87,036 $ 87,849 $ 77,046 $ 70,900 Income from operations 3,004 3,856 2,215 5,994 Net income 1,355 2,105 1,465 2,994 Diluted earnings per share $ 0.07 $ 0.11 $ 0.08 $ 0.16 (1) Differences from amounts previously reported are due to the acquisition of Pick-N-Pull which occurred during the Company's second fiscal quarter of 2003, but are reflected in the consolidated results as if the transaction had occurred on September 1, 2002. See Notes 1 and 3. 71 SCHNITZER STEEL INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (2) During the second fiscal quarter of 2003, the Company recorded a non-cash impairment charge of $1.0 million related to the implementation of SFAS 142 "Goodwill and other Intangible Assets" effected September 1, 2002, and reported it as a "Cumulative effect of change in accounting principle" on the Consolidated Statement of Operations. Net income was restated due to this change. (2) Diluted earnings per share has been adjusted to reflect the share dividend which occurred on August 14, 2003. 72 Schedule II - Valuation and Qualifying Accounts For the Years Ended August 31, 2003, 2002 and 2001 (In thousands)
Column A Column B Column C - Additions Column D Column E - -------------------------------------- ----------- ----------------------- ---------- ---------- Balance at Charged to Charged to Balance at beginning Cost and other end of Description of period expenses accounts Deductions period - -------------------------------------- ----------- ---------- ---------- ---------- ---------- Fiscal 2003 ----------- Allowance for doubtful accounts $ 1,005 $ 21 $ $ (314) $ 712 Inventories - net realizable value 1,071 (10) 1,061 Deferred tax asset valuation allowance 6,928 (838) 6,090 Fiscal 2002 ----------- Allowance for doubtful accounts 920 85 1,005 Inventories - net realizable value 1,338 (267) 1,071 Deferred tax asset valuation allowance 7,766 (838) 6,928 Fiscal 2001 ----------- Allowance for doubtful accounts 670 250 920 Inventories - net realizable value 1,536 (198) 1,338 Deferred tax asset valuation allowance 8,605 (839) 7,766
73 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors and Shareholders of Schnitzer Steel Industries, Inc. Our audits of the consolidated financial statements referred to in our report dated October 1, 2003 appearing in this Form 10-K also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PricewaterhouseCoopers LLP Portland, Oregon October 1, 2003 74 SCHNITZER STEEL INDUSTRIES, INC. FORM 10-K ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE. ITEM 9A CONTROLS AND PROCEDURES Schnitzer Steel Industries, Inc. management, under supervision of the Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining disclosure controls and procedures for Schnitzer Steel Industries, Inc. and its subsidiaries. As of August 31, 2003, with the participation of the Chief Executive Officer and the Chief Financial Officer, management completed an evaluation of the Company's disclosure controls and procedures. Based upon this evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures are effective to ensure that all material information relating to Schnitzer Steel Industries, Inc. and its subsidiaries is made known to them by others within the organization as appropriate to allow timely decisions regarding required disclosures. There were no changes in the Company's internal control over financial reporting during the fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting. 75 SCHNITZER STEEL INDUSTRIES, INC. FORM 10-K PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required by Item 401 of Regulation S-K regarding directors is included under "Election of Directors" in the Company's Proxy Statement for its 2004 Annual Meeting of Shareholders and is incorporated herein by reference. Information with respect to executive officers of the Company is included under Item 4(a) of Part I of this Report. Information required by Item 405 of Regulation S-K is included under "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement for its 2004 Annual Meeting of Shareholders and is incorporated herein by reference. The Company has adopted a Code of Business Conduct and Ethics that is applicable to all of its employees. It includes additional provisions that apply to the Company's principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions (the "Senior Financial Officers"). It also provides a code of business conduct and ethics for members of the Company's Board of Directors. This document is posted on the Company's internet website (www.schnitzersteel.com) and is available free of charge by calling the Company or submitting a request to ir@schn.com. The Company intends to disclose any amendments to or waivers from these Codes for directors, executive officers or Senior Financial Officers on its website. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is included under "Executive Compensation" in the Company's Proxy Statement for its 2004 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Information with respect to security ownership of certain beneficial owners and management is included under "Voting Securities and Principal Shareholders" in the Company's Proxy Statement for its 2004 Annual Meeting of Shareholders and is incorporated herein by reference. Information with respect to securities authorized for issuance under equity compensation plans is included under "Equity Compensation Plan Information" in the Company's Proxy Statement for its 2004 Annual Meeting of Shareholders, and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is included under Certain Transactions in the Company's Proxy Statement for its 2004 Annual Meeting of Shareholders and is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information regarding the Company's principal accountant fees and services is included under "Independent Auditors" in the Company's Proxy Statement for its 2004 Annual Meeting of Shareholders and is incorporated herein by reference. 76 SCHNITZER STEEL INDUSTRIES, INC. FORM 10-K PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. The following financial statements are filed as part of this report: See Index to Consolidated Financial Statements and Schedule on page 42 of this report. 2. The following schedule and report of independent accountants are filed as part of this report: Page ---- Schedule II Valuation and Qualifying Accounts 73 Report of Independent Accountants on Financial Statement Schedule 74 All other schedules are omitted as the information is either not applicable or is not required. 3. Exhibits: 2.1 Stock and Membership Interest Purchase Agreement dated January 8, 2003 among Bob Spence, Pick and Pull Auto Dismantling, Inc., Pick-N-Pull Auto Dismantlers, Pick-N-Pull Auto Dismantlers, Stockton, LLC and Norprop, Inc. Filed as Exhibit 2.1 to Registrant's Form 10-Q for the quarter ended November 30, 2002, and incorporated herein by reference. 3.1 1993 Restated Articles of Incorporation of the Registrant. Incorporated by reference to Exhibit 3.1 to the Registrant's Registration Statement on Form S-1, Registration No. 33-69352 (the Form S-1). 3.2 Restated Bylaws of the Registrant. Filed as Exhibit 3.2 to Registrant's Form 10-Q for the quarter ended May 31, 1998, and incorporated herein by reference. 9.1 Schnitzer Steel Industries Inc. 2001 Restated Voting Trust and Buy-Sell Agreement dated March 26, 2001. Filed as Exhibit 9.1 to Registrant's Form 10-K for the fiscal year ended August 31, 2001 and incorporated herein by reference. 10.1 Lease Agreement dated August 7, 2003 between Schnitzer Investment Corp. and the Registrant, relating to the corporate headquarters. 10.2 Lease Agreement dated August 7, 2003 between Schnitzer Investment Corp. and the Registrant, relating to the corporate headquarters. 10.3 Lease Agreement dated September 1, 1988 between Schnitzer Investment Corp. and the Registrant, as amended, relating to the Portland metals recycling operation. Incorporated by reference to Exhibit 10.3 to the Form S-1. 10.4 Second Amendment to Lease dated October 28, 1994 between Schnitzer Investment Corp. and the Registrant, relating to Portland metals recycling operation. Filed as Exhibit 10.1 to Registrant's Form 10-Q for the quarterly period ended November 30, 1995, and incorporated herein by reference. 77 SCHNITZER STEEL INDUSTRIES, INC. FORM 10-K 10.5 Third Amendment to Lease dated February 1998 between Schnitzer Investment Corp. and the Registrant, relating to Portland metals recycling operation. Filed as Exhibit 10.25 to Registrant's Form 10-K for the fiscal year ended August 31, 2000, and incorporated herein by reference. 10.6 Fourth Amendment to Lease dated July 1, 1998, between Schnitzer Investment Corp. and the Registrant, relating to Portland metals recycling operation. Filed as Exhibit 10.26 to Registrant's Form 10-K for the fiscal year ended August 31, 2000, and incorporated herein by reference. 10.7 Letter dated March 22, 1999 amending the lease between Schnitzer Investment Corp. and the Registrant related to the Portland metals recycling operation. Filed as Exhibit 10.1 to Registrant's Form 10-Q for the quarter ended November 30, 2001, and incorporated herein by reference. 10.8 Fifth Amendment to Lease dated July 9, 2001 between Schnitzer Investment Corp. and the Registrant related to the Portland metals recycling operation. 10.9 Sixth Amendment to Lease dated August 7, 2003 between Schnitzer Investment Corp. and the Registrant related to the Portland metals recycling operation. 10.10 Purchase and Sale Agreement dated August 7, 2003 between Schnitzer Investment Corp. and the Registrant, relating to the Sacramento metals recycling operation's real estate. 10.11 Second Amended Shared Services Agreement dated September 13, 1993 between the Registrant and certain entities controlled by shareholders of the Registrant. Incorporated by reference to Exhibit 10.5 to the Form S-1. 10.12 Amendment dated September 1, 1994 to Second Amended Shared Services Agreement between the Registrant and certain entities controlled by shareholders of the Registrant. Filed as Exhibit 10.6 to Registrants Form 10-K for the fiscal year ended August 31, 1995, and incorporated herein by reference. *10.13 1993 Stock Incentive Plan of the Registrant. Filed as Exhibit 10.1 to Registrant's Form 10-Q for the quarter ended February 28, 2002, and incorporated herein by reference. *10.14 Supplemental Executive Retirement Bonus Plan of the Registrant. Filed as Exhibit 10.24 to Registrant's Form 10-K for the fiscal year ended August 31, 2001, and incorporated herein by reference. *10.15 Amendment to the Supplemental Executive Retirement Bonus Plan of the Registrant effective January 1, 2002. Filed as Exhibit 10.25 to Registrant's Form 10-K for the fiscal year ended August 31, 2001, and incorporated herein by reference. *10.16 Deferred Bonus Agreement between the Company and an executive officer. Filed as Exhibit 10.3 to Registrant's Form 10-Q for the quarterly period ended May 31, 1996, and incorporated herein by reference. *10.17 Schnitzer Steel Industries, Inc. Economic Value Added Bonus Plan. Filed as Exhibit 10.27 to Registrant's Form 10-K for the fiscal year ended August 31, 2001, and incorporated herein by reference. 78 SCHNITZER STEEL INDUSTRIES, INC. FORM 10-K 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Accountants. 24.1 Powers of Attorney 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *Management contract or compensatory plan or arrangement (b) Reports on Form 8-K The following report was filed on Form 8-K during the fiscal quarter ended August 31, 2003: On July 1, 2003, the Company filed a Current Report on Form 8-K, to report under Item 9, pursuant to Item 12, the issuance of a press release announcing financial results for the Company's quarter and nine months ended May 31, 2003, and Item 7, Financial Statements and Exhibits. 79 SCHNITZER STEEL INDUSTRIES, INC. FORM 10-K SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SCHNITZER STEEL INDUSTRIES, INC. Dated November 24, 2003 By: /s/BARRY A. ROSEN ------------------------------------- Barry A. Rosen Vice President, Finance and Treasurer and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant : November 24, 2003 in the capacities indicated. Signature Title - --------- ----- Principal Executive Officer: *ROBERT W. PHILIP President and - ----------------------------------- Chief Executive Officer and Director Robert W. Philip Principal Financial Officer: /s/ BARRY A. ROSEN Vice President, Finance and Treasurer - ----------------------------------- and Chief Financial Officer Barry A. Rosen Principal Accounting Officer: /s/ KELLY E. LANG Vice President, Corporate Controller - ----------------------------------- Kelly E. Lang 80 Directors: *ROBERT S. BALL Director - ----------------------------------- Robert S. Ball *WILLIAM S. FURMAN Director - ----------------------------------- William S. Furman *CAROL S. LEWIS Director - ----------------------------------- Carol S. Lewis *SCOTT LEWIS Director - ----------------------------------- Scott Lewis *KENNETH M. NOVACK Director - ----------------------------------- Kenneth M. Novack *JEAN S. REYNOLDS Director - ----------------------------------- Jean S. Reynolds *DORI SCHNITZER Director - ----------------------------------- Dori Schnitzer *GARY SCHNITZER Director - ----------------------------------- Gary Schnitzer *RALPH R. SHAW Director - ----------------------------------- Ralph R. Shaw *By: /s/ BARRY A. ROSEN ----------------------------------- Attorney-in-fact, Barry A. Rosen 81 INDEX TO EXHIBITS 2.1 Stock and Membership Interest Purchase Agreement dated January 8, 2003 among Bob Spence, Pick and Pull Auto Dismantling, Inc., Pick-N-Pull Auto Dismantlers, Pick-N-Pull Auto Dismantlers, Stockton, LLC and Norprop, Inc. Filed as Exhibit 2.1 to Registrants Form 10-Q for the quarter ended November 30, 2002, and incorporated herein by reference. 3.1 1993 Restated Articles of Incorporation of the Registrant. Incorporated by reference to Exhibit 3.1 to the Registrant's Registration Statement on Form S-1, Registration No. 33-69352 (the Form S-1). 3.2 Restated Bylaws of the Registrant. Filed as Exhibit 3.2 to Registrants Form 10-Q for the quarter ended May 31, 1998, and incorporated herein by reference. 9.1 Schnitzer Steel Industries, Inc. 2001 Restated Voting Trust and Buy-Sell Agreement dated March 26, 2001. Filed as Exhibit 9.1 To Registrants Form 10-K for the rascal year ended August 31, 2001, and incorporated herein by reference. 10.1 Lease Agreement dated August 7, 2003 between Schnitzer Investment Corp. and the Registrant, relating to the corporate headquarters. 10.2 Lease Agreement dated August 7, 2003 between Schnitzer Investment Corp. and the Registrant, relating to the corporate headquarters. 10.3 Lease Agreement dated September 1, 1988 between Schnitzer Investment Corp. and the Registrant, as amended, relating to the Portland metals recycling operation. Incorporated by reference to Exhibit 10.3 to the Form S-1. 10.4 Second Amendment to Lease dated October 28, 1994 between Schnitzer Investment Corp. and the Registrant, relating to Portland metals recycling operation. Filed as Exhibit 10.1 to Registrants Form 10-Q for the quarterly period ended November 30, 1995, and incorporated herein by reference. 10.5 Third Amendment to Lease dated February 1998, between Schnitzer Investment Corp. and the Registrant relating to Portland recycled metals recycling operation. Filed as Exhibit 10.25 to Registrants Form 10-K for the fiscal year ended August 31, 2000, and incorporated herein by reference. 10.6 Fourth Amendment to Lease dated July 1, 1998, between Schnitzer Investment Corp. and the Registrant relating to Portland metals recycling operation. Filed as Exhibit 10.26 to Registrants Form 10-K for the fiscal year ended August 31, 2000, and incorporated herein by reference 82 10.7 Letter dated March 22, 1999 amending the lease between Schnitzer Investment Corp. and the Registrant relating to the Portland recycled metals recycling operation. Filed as Exhibit 10.1 to Registrants Form 10-Q for the quarter ended November 30, 2001, and incorporated herein by reference. 10.8 Fifth Amendment to Lease dated July 9, 2001 between Schnitzer Investment Corp. and the Registrant related to Portland metals recycling operation. 10.9 Sixth Amendment to Lease dated August 7, 2003 between Schnitzer Investment Corp. and the Registrant related to Portland metals recycling operation. 10.10 Purchase and Sale Agreement dated August 7, 2003 between Schnitzer Investment Corp. and the Registrant, relating to the Sacramento metals recycling operations real estate. 10.11 Second Amended Shared Services Agreement dated September 13, 1993 between the Registrant and certain entities controlled by shareholders of the Registrant. Incorporated by reference to Exhibit 10.5 to the Form S-1. 10.12 Amendment dated September 1, 1994 to Second Amended Shared Services Agreement between the Registrant and certain entities controlled by shareholders of the Registrant. Filed as Exhibit 10.6 to Registrants Form 10-K for the fiscal year ended August 31, 1995, and incorporated herein by reference. *10.13 1993 Stock Incentive Plan of the Registrant. Filed as Exhibit 10.1 to Registrants Form 10-Q for quarter ended February 28, 2002, and incorporated herein by reference. *10.14 Supplemental Executive Retirement Bonus Plan of the Registrant. Filed as Exhibit 10.24 to Registrants Form 10-K for fiscal year ended August 31, 2001, and incorporated herein by reference. *10.15 Amendment to the Supplemental Executive Retirement Bonus Plan of the Registrant effective January 1, 2002. Filed as Exhibit 10.25 to Registrants Form 10-K for fiscal year ended August 31, 2001, and incorporated herein by reference. *10.16 Deferred Bonus Agreement between the Company and an executive officer. Filed as Exhibit 10.3 to Registrants Form 10-Q for the quarterly period ended May 31, 1996, and incorporated herein by reference. *10.17 Schnitzer Steel Industries, Inc. Economic Value Added Bonus Plan. Filed as Exhibit 10.27 to Registrants Form 10-K for fiscal year ended August 31, 2001, and incorporated herein by reference. 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Accountants. 83 24.1 Powers of Attorney. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 84 EX-10.1 3 exh10-1_12345.txt LEASE AGREEMENT DATED AUGUST 7, 2003 EXHIBIT 10.1 ------------ YEON BUSINESS CENTER (3200 NW YEON AVENUE) LEASE AGREEMENT SCHNITZER INVESTMENT CORP. (LANDLORD) AND SCHNITZER STEEL INDUSTRIES, INC. (TENANT) DATED: AUGUST 7, 2003 LEASE AGREEMENT THIS LEASE ("Lease") dated as of the 7th day of August, 2003, is made by and between SCHNITZER INVESTMENT CORP., an Oregon corporation ("Landlord"), and SCHNITZER STEEL INDUSTRIES, INC., an Oregon corporation ("Tenant"). ARTICLE I DEFINITIONS 1.1 DEFINED TERMS. The following terms shall have the meanings specified in this Section, unless otherwise specifically provided. Other terms may be defined in other parts of the Lease. (a) Landlord: SCHNITZER INVESTMENT CORP. (b) Landlord's Address: c/o Schnitzer Northwest, LLC 5800 Meadow Road, Suite 200 Lake Oswego, OR 97035 Telephone: (503) 598-1842 Facsimile: (503) 598-1843 With a Copy to: Ball Janik LLP 101 SW Main Street, Suite 1100 Portland, Oregon 97204 Attn: Barbara W. Radler Telephone: (503) 228-2525 Facsimile: (503) 295-1058 (c) Landlord's Address Schnitzer Investment Corp. for payment of Rent PO Box 4000 M/S 78 Portland, OR 97208 (d) Tenant: SCHNITZER STEEL INDUSTRIES, INC. (e) Tenant's Address: 3200 NW Yeon Avenue PO Box 10047 Portland, OR 97296-0047 Attn: Kelly E. Lang (f) Tenant's Use: General office use, information services, and related, incidental uses (g) Project: Yeon Business Center, including all buildings and Common Areas thereon and related thereto, as depicted on the Project Site Plan attached as Exhibit "B." (h) Building: That certain building designated as the 3200 Building on the Project Site Plan attached hereto as Exhibit B with a rentable area of approximately 30,774 square feet, and with a street address of 3200 NW Yeon Avenue, Portland, Oregon. (i) Premises: Approximately 7,905 rentable square feet on the lower level and approximately 11,266 rentable square feet on the first floor of the Building as depicted on the attached Exhibit "C." (j) Term: Commencing upon the Substantial Completion (as defined in Section 3.2) of the Tenant Improvements (as defined in Section 3.1) and expiring on the last day of the month during the month that is ten (10) years after the date of the Substantial Completion of the Tenant Improvements. (k) Base Rent: MONTHS RENT PRSF (ANNUAL) MONTHLY INSTALLMENTS LOWER LEVEL FIRST FLOOR 1-12 $13.00 $17.00 $24,523.92 13-24 $13.33 $17.43 $25,145.01 25-36 $13.66 $17.87 $25,775.49 37-48 $14.00 $18.32 $26,421.93 49-60 $14.35 $18.78 $27,084.36 61-72 $14.71 $19.25 $27,762.77 73-84 $15.08 $19.73 $28,457.14 85-96 $15.45 $20.22 $29,167.49 97-108 $15.84 $20.73 $29,903.21 109-120 $16.24 $21.25 $30,654.90 (l) Base Year: 2004 (m) Prepaid Rent: $0.00 (n) Security Deposit: $0.00 (o) Tenant's Share of Building: 62.3% (p) Tenant's Share of Project: 7.14% (q) Surface Parking Spaces: 51 uncovered reserved surface parking spaces in the Project shall be provided in the parking area adjacent to the Building for the exclusive use of Tenant, its employees and visitors, subject to reduction due to governmental regulation. (r) Exhibits: Exhibit A: Intentionally omitted Exhibit B: Project Site Plan Exhibit C: Floor Plan Exhibit D: Work Schedule Exhibit E: Schedule of Tenant Improvement Plans Exhibit F: Lease Confirmation Exhibit G: Estoppel Certificate Exhibit H: Rules and Regulations ARTICLE II PREMISES AND COMMON AREAS LEASED 2.1 PREMISES. (a) Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord, subject to the provisions of this Lease, certain premises as more fully described on the attached Exhibit C ("Premises") located within that certain building ("Building") owned by Landlord and which is a portion of the "Project" identified in Section 1.1(g). The Site Plan for the Project attached hereto as Exhibit B is attached for location reference purposes only and shall not constitute a representation or warranty by Landlord to be the final plan of the Project, or to require Landlord to build any improvements, or to otherwise comply with the site plan or require Landlord to lease space to a particular tenant or type of tenant. (b) The rentable areas of the Premises and of the Building specified in Section 1.1 are approximate but based on measurements using the American National Standard Method of Measuring Floor Area in Office Buildings, ANSI-BOMA Z65.1-1996, published by the Building Owners and Managers Association International ("BOMA Standards"), and the measurements take into account the shared uses described in Section 2.3. Tenant is satisfied with such approximations and with Landlord's measurement of the rentable areas of the Premises and of the Building. Tenant acknowledges that, except as otherwise expressly set forth in this Lease, neither Landlord nor any agent, property manager or broker of Landlord has made any representation or warranty with respect to the Premises, the Building, the Common Areas or the Project or their suitability for the conduct of Tenant' s business, and that except only for any improvements that Landlord has expressly agreed herein to construct and install, the Premises is leased in its "As-Is" condition existing at the time of execution of this Lease. 2.2 COMMON AREAS. In addition to the Premises, Tenant shall have the non-exclusive right to use in common with other tenants and/or occupants of the Project, the following areas appurtenant to the Building: parking areas and facilities, roadways, sidewalks, walkways, parkways, plazas, levees, driveways and landscaped areas and similar areas and facilities situated within the exterior areas of the Project and not otherwise designated for the exclusive or restricted use by Landlord and/or individual tenants of other buildings located within the Project (collectively, "Common Areas"). Common Areas also include shared lobbies, entryways, hallways, elevators, and restrooms, as modified from time to time. Tenant's right to utilize the Common Areas shall at all times be subject to Landlord's reserved rights therein as described in Section 17.5 hereof, the Rules and Regulations referred to in Section 17.15 hereof, all encumbrances, easements, ground leases, and covenants, conditions and restrictions ("CC&Rs") now affecting or encumbering the Project and all encumbrances, easements, ground leases, and CC&R's affecting or encumbering the Project in the future, to the extent they do not materially and adversely affect Tenant's rights to use the Common Areas under this Lease. 2.3 SHARED USE OF BUILDING AREAS. (a) IN THE PREMISES. Landlord reserves for itself and its contractors, employees, and agents, and Tenant grants to Landlord and its contractors, employees, and agents, the right to use of, and access to, the areas in the Premises designated as "building common areas" on the attached Exhibit C such as the furnace room and the lunch room (the "Shared Areas"). The measurement of the net rentable area of the Premises, using BOMA Standards, has taken into account such rights of joint use of Shared Areas in the Premises. If Landlord elects to terminate its right to use any Shared Area, which Landlord may do from time to time throughout the Term, (i) Landlord shall remeasure the Premises to reflect such change, using BOMA Standards, and (ii) Base Rent, Tenant's Share of the Building, Tenant's Share of the Project, and Tenant's Share of the Operating Expense Increase shall change accordingly (collectively, the "Adjustments"). Beginning on the first day of the first calendar month following Landlord's written notice to Tenant of the Adjustments, and continuing thereafter throughout the Term (or until such earlier date on which another Adjustment takes place), Tenant shall pay Base Rent and Additional Rent in accordance with Landlord's notice of the Adjustment. (b) IN LANDLORD'S PREMISES. Unless terminated as provided below, Tenant shall have the nonexclusive right to use the conference room located on the second floor of the Building (the "Conference Room"), on a first come-first served basis. All use of the Conference Room must be scheduled in advance with Landlord. Landlord may terminate Tenant's rights to use of the Conference Room after giving 30 days' prior written notice to Tenant if (i) Schnitzer Investment Corp. ("SIC") vacates the offices on the second floor of the Building, or (ii) SIC conveys its interest in the Building to a third party, or (iii) Landlord elects to change the use of the Conference Room to something other than a shared conference room. As of the commencement of the Lease, the Conference Room is considered common area for purposes of determining Operating Expenses. However, if Tenant's right to use the Conference Room terminates as provided in this Section 2.3(b), then, from and after that termination, the Conference Room shall not be considered common area for purposes of calculating net rentable area. Landlord shall calculate the Adjustments resulting from such change as described in Section 2.3(a). Then, beginning on the first day of the first calendar month following Landlord's written notice to Tenant of the Adjustments, and continuing thereafter throughout the Term (or until such earlier date on which another Adjustment takes place), Tenant shall pay Base Rent and Additional Rent in accordance with Landlord's notice of the Adjustment. (c) MULTI-TENANT BUILDING. If SIC vacates the offices on the second floor of the Building, then (a) Landlord shall have the right to reconfigure the Premises, at Landlord's sole cost and expense, so as to make the Building more suitable for occupancy by unaffiliated tenants (such as by adding common area corridors), (b) Tenant shall cooperate with such changes, and (c) Landlord shall make any appropriate Adjustments resulting from such reconfiguration. Then, beginning on the first day of the first calendar month following Landlord's written notice to Tenant of the Adjustments, and continuing thereafter throughout the Term (or until such earlier date on which another Adjustment takes place), Tenant shall pay Base Rent and Additional Rent in accordance with Landlord's notice of the Adjustment. Any reconfiguration of the Premises pursuant to this Section 2.3(c) shall not materially and adversely affect Tenant's use of the Premises. The construction of new public corridors in the Premises shall not be considered material or adverse. ARTICLE III IMPROVEMENTS 3.1 CONSTRUCTION OF PREMISES. (a) COMPLETION SCHEDULE. Attached hereto as Exhibit D is a schedule (the "Work Schedule") setting forth the estimated timetable for the planning, permitting, construction and completion of the tenant improvements to be constructed by Landlord at the Premises ("Tenant Improvements"). (b) PREMISES PLANS. The plans and specifications for the Tenant Improvements (the "Tenant Improvement Plans") are described on the attached Exhibit E. No changes to the Tenant Improvement Plans shall be made except with the approval of both Landlord and Tenant. (c) CONSTRUCTION OF TENANT IMPROVEMENTS. Landlord shall work with a general contractor chosen by Landlord (the "Contractor") for construction of the Tenant Improvements. After building permits have been issued, Landlord shall cause the Tenant Improvements to be constructed by the Contractor in accordance with the Tenant Improvement Plans. Landlord shall supervise the completion of such work and shall use its good faith efforts to secure substantial completion of the Tenant Improvements in accordance with the Work Schedule. The cost of Tenant Improvements shall be paid as provided in Paragraph 3.1(f) below. (d) CHANGE ORDERS. In the event Tenant requests any changes to the Tenant Improvement Plans, Landlord shall not unreasonably withhold, delay, or condition its consent to any such changes. Tenant shall pay the costs, fees, and expenses incurred by Landlord in connection with such changes within 15 days after billing therefor. (e) COMPLIANCE WITH LAWS. Landlord shall cause the Tenant Improvements to be completed in a good and workmanlike manner and in compliance with the building permit issued therefor by the City of Portland. (f) PAYMENT OF TENANT IMPROVEMENTS COSTS. (i) Landlord will pay for the Tenant Improvements included in the Tenant Improvement Plans. (ii) Tenant will, at its sole cost and expense, pay for any improvements to the Premises not expressly included in the Tenant Improvement Plans and all costs, fees, and expenses incurred by Landlord due to any changes in the Tenant Improvement Plans requested by Tenant and approved by Landlord (which approval shall not be unreasonably withheld). Tenant shall arrange for the installation of all Tenant's furniture, fixtures and equipment associated with its business. Costs associated with Tenant's equipment, layout, design and construction coordination are also the sole responsibility of Tenant. (g) TENANT DELAY IN COMPLETION. If there shall be a delay in substantial completion of the Tenant Improvements to the Premises or the issuance of a Certificate of Occupancy for the same as a result of: (i) Tenant's failure to approve any item or perform any other obligation within three (3) business days after receipt of notice from Landlord; (ii) Tenant's request for changes in materials, finishes or installations other than those readily available; (iii) Tenant's request to deviate from the Plans; or (iv) Tenant's interference with Landlord's construction of the Tenant Improvements to Premises during Tenant's work within the Premises (whether such work is performed by Tenant or its contractor or by Landlord or its contractor on Tenant's behalf); (each of which shall be deemed a "Tenant Delay") then the Commencement Date of the Term of the Lease shall be accelerated by the number of days of such delay. 3.2 COMPLETION AND DELIVERY. The terms "substantial completion," "Substantial Completion," "Substantially Complete," "Substantially complete" and words of similar import (whether or not spelled with initial capitals) as used in the Lease shall mean the date of substantial completion of the Tenant Improvements pursuant to the Tenant Improvement Plans such that Tenant may commence the installation of any of Tenant's equipment and occupy the Premises for the conduct of its business (subject to the completion of any additional construction to be performed by Tenant). The Tenant Improvements shall be deemed substantially complete notwithstanding the fact that minor details of construction, mechanical adjustments or decorations which do not materially interfere with Tenant's use and enjoyment of the Premises remain to be performed (items normally referred to as "punch list" items). Certification by Landlord's architect as to the substantial completion of the Tenant Improvements shall be conclusive and binding upon Landlord and Tenant. By taking occupancy of the Premises, Tenant shall be deemed to have accepted the Premises as substantially complete, except that Tenant shall, within five (5) days after entering into possession of the Premises, provide Landlord with a list of incomplete and/or corrective items present in the Tenant Improvements. Landlord shall diligently complete, as soon as reasonably possible, any items of work and adjustment on such list as are not completed upon substantial completion of the Tenant Improvements. The Commencement Date shall not be delayed because of the existence of uncorrected punch list items. 3.3 RELOCATION; CONTINUANCE OF CURRENT LEASE DURING CONSTRUCTION. Tenant currently leases the Premises pursuant to Lease Agreement dated September 1, 1988, as amended by an Amendment of Lease dated May 31, 1991, an Extension of Lease dated August 27, 1993, a Second Amendment of Lease dated October 18, 1995, a Second Extension of Lease dated May 28, 1996, a Third Amendment of Lease dated August 3, 1998, and a Fourth Amendment of Lease dated June 26, 2001 (collectively, the "Current Lease"). The Current Lease shall continue in full force and effect until the Commencement Date of this Lease. Effective immediately prior to the Commencement Date of this Lease (the "Termination Date"), the Current Lease shall terminate and all rights and obligations of Landlord and Tenant under the Current Lease shall terminate except for rights and obligations accrued as of the Termination Date pertaining to events occurring on or prior to the Termination Date. Promptly upon notice from Landlord, Tenant shall vacate the Building and relocate into its premises in the building located at 3330 NW Yeon Avenue. Tenant shall continue to pay rent, additional rent, and all other charges under the Current Lease and comply with its obligations under the Current Lease through the Termination Date while Landlord constructs the Tenant Improvements in the Premises. Landlord agrees to contract with, and pay the reasonable expenses charged by, a third party moving company to move Tenant's personal property and equipment from the Building into the 3330 NW Yeon Avenue building. 3.4 REPAINT AND RECARPETING. Between the 60th and 72nd month of the Initial Term of this Lease, Landlord shall repaint and recarpet the Premises using materials of similar quality as those in the Tenant Improvements. ARTICLE IV TERM 4.1 INITIAL TERM. Subject to Section 3.1(g), the Term shall commence on the Commencement Date, as set forth in Section 1.1(j). The Term shall expire upon the date set forth in Section 1.1(j), unless sooner terminated as hereinafter provided. 4.2 NOTICE OF COMMENCEMENT DATE. Landlord shall use good faith efforts to inform Tenant of the estimated date of substantial completion at least five (5) days prior to such date. Upon ascertaining the date of substantial completion and the Commencement Date, Landlord shall deliver to Tenant a written confirmation in the form attached hereto as Exhibit F ("Lease Confirmation") of said dates of substantial completion and the Commencement Date. The Lease Confirmation shall be binding upon Tenant unless Tenant objects to the notice in writing delivered to Landlord within five (5) days of Tenant's receipt of said Lease Confirmation. 4.3 OPTION TO EXTEND. (a) Subject to and upon the terms and conditions set forth below, Tenant will have one option to extend the term of this Lease for one additional successive period of five years (the "Renewal Term"). (b) Tenant's option to extend the Term must be exercised by written notice given to Landlord (the "Renewal Notice") no less than 365 days prior to the end of the Initial Term. (c) Tenant shall not be permitted to extend the Term of this Lease if there exists any uncured Event of Default by Tenant as of the date of the Renewal Notice. (d) The Renewal Term will be on the same terms and conditions as this Lease except for the amount of monthly Base Rent. During the Renewal Term, Tenant shall pay as monthly Base Rent an amount equal to the greater of (a) the Base Rent and Additional Rent payable by Tenant immediately prior to the commencement of the Renewal Term or (b) Market Rent for the Premises for the Renewal Term. Market Rent during the Renewal Term shall be equal to rents typically payable for the five year Renewal Term for comparable space by tenants of buildings of comparable quality in the vicinity of the Premises, taking into account the base year for the Renewal Term as described in Section 4.3(f) below. Landlord and Tenant agree that once Tenant has timely delivered its Renewal Notice, both parties will be responsible for their respective rights and obligations under this Lease for the Renewal Term, regardless of the outcome of the Base Rent determination. The word "Term" shall be used throughout this Lease to include both the Initial Term and the Renewal Term, if applicable. (e) The Market Rent for the Renewal Term will be determined as follows: (i) If Tenant properly exercises its option to extend the Term for the Renewal Term, Landlord and Tenant shall attempt to agree as to the Market Rent at least 270 days prior to the expiration of the Initial Term. If Landlord and Tenant do not agree as to the Market Rent by such date, then no later than 210 days prior to the expiration of the Initial Term, each shall designate a real estate broker having at least ten (10) years' experience in leasing space comparable to the Premises in the Portland metropolitan area or an MAI-certified appraiser having at least five (5) years' experience in the appraisal of lease rates of office space in the Portland metropolitan area. The two representatives so appointed shall determine the Market Rent for the Premises for the Renewal Term and each shall submit a copy of his or her determination of such Market Rent, along with supporting documentation, to Landlord and Tenant in writing, not less than 150 days prior to the expiration of the Initial Term. In the event a party fails to designate a representative at least 210 days prior to the expiration of the Initial Term, the determination of Market Rent by the representative designated by the other party shall be binding upon the parties for purposes of this Section 4.3(e). In the event a representative fails to submit the required written determination of Market Rent at least 150 days prior to the expiration of the Initial Term, the determination of the Market Rent by the other representative shall be binding upon the parties for the purposes of this Section 4.3(e). (ii) If the determination of the Market Rent given by the two representatives so appointed shall differ by less than ten percent (10%) of the greater of such two representatives' determinations, then the Market Rent shall be deemed to be the average of such two Market Rent determinations. In the event such determinations differ by ten percent (10%) or more of the greater of such two representatives' determinations, then Landlord and Tenant shall attempt to agree on the Market Rent. If the parties are unable to reach agreement at least 90 days before the expiration of the Initial Term, the two representatives originally designated shall designate a third representative, who shall meet the qualifications set forth in Section 4.3(e)(i) and who shall be the arbitrator. If the two representatives are unable to agree on an arbitrator, then either of the parties to this Lease, after giving not less than five days' prior notice to the other party, may apply to the presiding judge of the Multnomah County Circuit Court for the selection, as soon as is reasonably practicable, of an arbitrator who meets the foregoing qualifications. (iii) The arbitrator shall, by not later than 30 days prior to the expiration of the Initial Term, select the more reasonable of the two Market Rent determinations submitted by the first two representatives. The determination of Market Rent set forth in the written submission selected by the arbitrator shall be binding upon the parties for purposes of this Section 4.3(e). (iv) Landlord and Tenant shall each pay all costs of the representative selected by it pursuant to Section 4.3(e)(i). Landlord and Tenant shall share equally the cost of any arbitrator designated pursuant to Section 4.3(e)(ii). (v) In the event the Market Rent for the Renewal Term has not been determined by the arbitrator pursuant to the above procedure as of the commencement of the Renewal Term, Tenant shall continue to pay monthly installments of Base Rent based upon the Base Rent in effect as of the expiration of the Initial Term and, within ten (10) days after the Market Rent has been determined by the arbitrator, Tenant shall pay to Landlord the difference between (A) the total amount that should have been paid by Tenant as Base Rent with respect to the period from the commencement of the Renewal Term to the date of Tenant's payment (based on the arbitrator's determination), and (B) the total amount actually paid by Tenant with respect to such period. (f) If Tenant extends the Term of this Lease as set forth above, the "Base Year" for determining Tenant's obligation for the Operating Expense Increase will be adjusted to the last full calendar year of the Initial Term. ARTICLE V RENT 5.1 BASE RENT. The Base Rent ("Base Rent") shall be as set forth in Section 1.1(k). The Base Rent shall be paid in advance on the first day of each and every month during the Term to Landlord at the address set forth in Section 1.1(c) hereof or at such other place as Landlord may direct in writing, without any prior notice or demand therefor and without any abatement, deduction, offset or setoff whatsoever. If the Term commences on any day other than the first day of a calendar month and/or ends on any day other than the last day of a calendar month, Base Rent for the fraction(s) of a month at the commencement and/or upon the expiration of the Term shall be prorated based upon the actual number of days in such fractional month(s). 5.2 ADDITIONAL RENT. In addition to Base Rent, Tenant shall pay to Landlord all sums of money or other charges required to be paid by the Tenant under this Lease (other than Base Rent), including but not limited to Tenant's Share of Operating Expense Increase (as defined in Article VI hereof) (all such sums being herein deemed "Additional Rent"), and whether or not the same are designated "Additional Rent" the same shall be payable in lawful money of the United States of America without deduction, set-off or abatement whatsoever. Any Additional Rent provided for in this Lease shall become due with the next monthly installment of Base Rent unless otherwise provided. The term "Rent", as used in this Lease, shall refer collectively to "Base Rent" and "Additional Rent." 5.3 LATE PAYMENT. If any payment of Rent is not received by Landlord within five (5) days after the same is due, Tenant shall pay to Landlord a late payment charge equal to three percent (3%) of the amount of such delinquent payment of Rent in addition to the installment of Rent then owing, regardless of whether or not a notice of default has been given by Landlord. In addition, Tenant shall pay interest on such late payment and late charge from the due date of the late payment at an interest rate equal to the higher of: (a) twelve percent (12%) or (b) the prevailing prime (reference) rate as published by Bank of America (or any successor bank) at its Seattle main branch office, or any successor rate of interest, plus three (3) percentage points, but in no event higher than the maximum rate permitted by applicable law (hereafter the "Default Rate"), until such amounts are paid. Landlord and Tenant recognize that the damages which Landlord will suffer as a result of Tenant's failure to timely pay Rent are difficult or impracticable to ascertain, and agree that said interest and late charge are a reasonable approximation of the damages which Landlord will suffer in the event of Tenant' s late payment. This provision shall not relieve Tenant from payment of Rent at the time and in the manner herein specified. Acceptance by Landlord of any such interest and late charge shall not constitute a waiver of Tenant's default with respect to said overdue amount, nor shall it prevent Landlord from exercising any other rights or remedies available to Landlord. 5.4 SECURITY DEPOSIT. Intentionally deleted. ARTICLE VI ADDITIONAL RENT AND CHARGES 6.1 OPERATING EXPENSES. In addition to Base Rent and other sums payable by Tenant under this Lease, Tenant shall pay to Landlord, as Additional Rent, Tenant's Share of the Operating Expense Increase (as such term is defined below). The "Operating Expense Increase" is defined as the amount by which the Operating Expenses of the Project in each calendar year, beginning with calendar year 2005, exceed the Operating Expenses of the Project for the Base Year. For the Initial Term of this Lease, the Base Year is calendar year 2004. (a) ESTIMATED EXPENSES. (i) Upon the Commencement Date, and thereafter prior to the commencement of each calendar year occurring wholly or partially within the Term or as soon as practical thereafter, Landlord shall estimate the annual Operating Expense Increase payable by Tenant pursuant to this provision, and Tenant shall pay to Landlord on the first day of each month in advance, one-twelfth (1/12th) of Tenant's Share of the estimated Operating Expense Increase. Landlord's estimate will be reasonable and based on standard real estate accounting practices consistently and fairly applied. If Tenant requests, Landlord will provide Tenant with reasonably detailed documentation to support Landlord's estimate. In the event that during any calendar year of the Term, Landlord reasonably determines that the actual Operating Expense Increase for such year will exceed the estimated Operating Expense Increase, Landlord may revise such estimate by written notice to Tenant, and Tenant shall pay to Landlord, concurrently with the regular monthly rent payment next due following the receipt of the revised estimate, an amount equal to the difference between the initial monthly estimate and the revised monthly estimate multiplied by the number of months expired during such calendar year and shall also pay an amount equal to the revised monthly estimate for the month of such payment. Subsequent installments shall be payable concurrently with the regular monthly Base Rent due for the balance of the calendar year and shall continue until the next calendar year's estimate is rendered or Landlord next revises its estimate of the Operating Expense Increase, whichever occurs sooner . (ii) Within one hundred twenty (120) days following the end of each year or a reasonable time thereafter, Landlord shall provide Tenant with a written statement (the "Statement") of the actual total Operating Expenses for such year, showing in reasonable detail (A) the actual Operating Expenses for the calendar year, broken down by component expenses, such as repairs, administration, utilities, janitorial, and Real Property Taxes; (B) the Base Year Operating Expenses; (C) the Operating Expense Increase for the calendar year; (D) the amount of Tenant's Share of the Operating Expense Increase; (E) the amount actually paid by Tenant during the calendar year toward the Operating Expense Increase; (F) the amount Tenant owes toward the Operating Expense Increase or the amount Landlord owes as a refund, and (G) the "gross-up" information required by Section 6.1(a)(iii) of this Lease. If Tenant has overpaid the amount of the Operating Expense Increase owing pursuant to this provision, Landlord shall, provided Tenant is not then in default hereunder beyond any applicable cure period, return to Tenant the amount of such overpayment within thirty (30) days after Landlord's itemized Statement is delivered to Tenant. If Tenant has underpaid the amount of the Operating Expense Increase owing pursuant to this provision, Tenant shall pay the total amount of such deficiency to Landlord as Additional Rent with the next payment of Base Rent due under this Lease following delivery of written notice of said deficiency from Landlord to Tenant. (iii)In the event the average occupancy level of the Building or Project, as the case may be, for any calendar year was or is not one hundred percent (100%) of full occupancy, then the estimated Operating Expenses and actual Operating Expenses for such year shall be proportionately adjusted by Landlord to reflect those costs which would have occurred had the Building and/or Project, as the case may be, been one hundred percent (100%) occupied during such year. Such adjustment shall be based on Landlord's reasonable estimate consistently and fairly applied using standard real estate practices in the Portland, Oregon metropolitan area. (iv) Landlord shall keep its books of account and records concerning Operating Expenses in compliance with generally accepted standard real estate practices and retain the same for two (2) years after the calendar year for which they were prepared. Unless Tenant objects in writing regarding specific discrepancies in the Operating Expense calculations for any calendar year within 270 days after receipt of Landlord's final calculations for such calendar year, Tenant shall be deemed to have approved the same and to have waived the right to object to such calculations. Tenant, upon at least ten (10) days' advance written notice to Landlord and during business hours, may examine any invoices, receipts, canceled checks, vouchers or other records used to support the figures shown on the Statement, provided, however, that Tenant shall be entitled to such an examination only once in each calendar year and such examination shall only be of the Operating Expenses for the calendar year shown on the Statement. Tenant may only audit a specific calendar year once. Landlord may condition such review upon Tenant's (and its auditor's) execution of a reasonable form of confidentiality agreement. Except as provided in Section 6.1(a)(v) below, all costs of the review shall be borne by Tenant. If Tenant examines or audits Landlord's books and records under Section 6.1(a)(iv) or Section 6.1(a)(v)more than twice during the Term, Tenant shall reimburse all costs, fees, and expenses incurred by Landlord and its property manager in connection with the examination or audit, including, without limitation, photocopy charges, and administration fees for the time spent in connection with the audit or examination. All audits and examinations conducted by Tenant shall be conducted by an independent auditor with at least five years experience with standard real estate accounting practices in the Portland, Oregon area and such auditor shall not be compensated on a contingency fee basis. (v) Each Statement given by Landlord pursuant to this Section shall be conclusive and binding upon Tenant unless within 270 days after the receipt of such Statement Tenant shall notify Landlord that it disputes the correctness of the Statement, specifying the particular respects in which the Statement is claimed to be incorrect. If such disputes shall not have been settled by agreement, Tenant, at Tenant's expense, and after giving Landlord reasonable advance notice, may cause an examination or audit to be made of Landlord's books and records relating to such Statement by a certified public accountant, subject to the limitations set forth in Section 6.1(a)(iv). If the examination or audit discloses an error in the billings to Tenant, Tenant shall promptly pay the underpayment. If Landlord does not dispute the results of the audit, Landlord shall promptly pay to Tenant the overpayment, and if there has been an overpayment of greater than five percent (5%) of the amount of estimated Operating Expenses for the year in question, Landlord shall reimburse Tenant for the reasonable cost of the examination or audit. If Landlord disputes the results of the audit, Landlord and Tenant shall engage an independent certified public accountant (the "CPA") who shall resolve the dispute by choosing the results of Tenant's audit or Landlord's position. If the CPA agrees with Tenant, Landlord shall pay the fees of the CPA. If the CPA agrees with Landlord, Tenant shall pay the fees of the CPA. (b) DEFINED TERMS. (i) OPERATING EXPENSES INCLUSIONS. For purposes of this Lease, "Operating Expenses" means an amount equivalent to the total of all expenses and costs incurred in connection with the ownership, operation, management, maintenance, repair and replacement of the Project, the Building and the Common Areas, including, but in no way limited to, the following: A. The costs of operating, maintaining, repairing and replacing the Project, the Building and the Common Areas, including but not limited to: gardening and landscaping; painting; lighting; sanitary control; personal property taxes; public liability insurance and property damage insurance; utilities for Common Areas; licenses and fees for Common Area facilities; sweeping; removal of snow and ice, trash, rubbish, garbage and other refuse; repairing, restriping and resurfacing of parking area; and maintenance of and property taxes on personal property, machinery and equipment used in Common Area maintenance. B. All Real Property Taxes (as defined below) assessed against the Project, the Building and/or the Common Areas, as applicable, including land, building(s) (including the Building) and improvements thereon or thereto. C. All premiums for liability, terrorism, fire, extended coverage and other insurance the Landlord reasonably deems necessary and keeps in force on or with respect to the Project, the Building of which the Premises are a part and/or the Common Areas, as the case may be, and commercially reasonable deductibles payable in connection therewith. D. The cost of operating, maintaining, repairing and replacing any electrical, mechanical, automatic fire sprinkler and other utilities systems serving the Premises which serve the Premises in common with the entire Building. E. The cost of maintenance, repair and replacement of the structural and non-structural portions of the roof, roof membrane, exterior walls, foundation, and other exterior portions of the Project and Building, and reasonable reserves for the same. F. Reasonable property management charges together with the costs incurred in the operation of a management office relating to the Project, including, but not limited to the cost of rent and utilities with respect thereto, not to exceed the amount charged by an owner or an independent management company of comparable quality and experience. G. Annual amortization of capital improvements (x) made subsequent to the Commencement Date which are designed with a reasonable probability of improving the operating efficiency of the Project, or some part thereof, or (y) which are reasonably required under any amendment to any applicable law, any new law, or any new interpretation (as hereinafter defined) which amendment, law, or new interpretation is adopted or arose after the Commencement Date of this Lease, or (z) made subsequent to the Commencement Date and which are repairs or replacements of initial improvements. For the purposes of this Lease, a "new interpretation" shall mean any interpretation, enforcement or application occurring after the Commencement Date of a law enacted prior to the Commencement Date, which interpretation, enforcement or application imposes requirements with respect to the Project or Building that were not at the time of Landlord's execution of this Lease, applicable to the Project or Building. Annual amortization shall be determined by dividing the applicable capital expenditure over the useful life of such capital expenditure (as determined by GAAP) at an interest rate equal to the Prime Rate of Wells Fargo Bank plus two percent (2%). H. Any other costs levied, assessed or imposed by or at the direction of, or resulting from statutes or regulations or interpretations thereof promulgated by any federal or governmental authority in connection with the use or occupancy of the Project. I. Assessments made on or with respect to the Project made pursuant to any CC&Rs, Local Improvement District conditions and/or owner's associations affecting the Project, or any portion thereof. J. Compensation (including wages and employer paid benefits and taxes ) of employees and contractors engaged in the operation and maintenance of the Project, and/or Building. (ii) OPERATING EXPENSE EXCLUSIONS. Notwithstanding the foregoing, Operating Expenses to be reimbursed by Tenant shall not include: A. Expenses which are separately metered or calculated for the Premises or other leased area of the Project or the Building, as the case may be, which expenses shall be billed separately to Tenant or such other tenant(s), as applicable. B. Costs incurred in connection with the initial construction or design of the Building or to correct defects in the original construction or design of the Building. C. Depreciation. D. Costs, fines or penalties incurred due to violation by Landlord of any applicable law. E. Expenses incurred by Landlord in respect of individual tenants and/or the improvement or renovation of tenants' leasehold improvements, including leasing commissions, attorneys' fees arising from lease disputes arising out of a tenant's failure to pay rent under its lease and other specific costs incurred for the account of, separately billed to and paid by specific tenants. F. Repairs or replacements to the extent that the cost of the same is recoverable by the Landlord pursuant to original construction warranties. G. Interest on debt or capital retirement of debt, and costs of capital improvements except as expressly provided above. H. Legal fees and disbursements relating to the entity that owns the Project. I. Costs incurred due to the gross negligence of Landlord or breach by Landlord of its obligations under any lease. J. Fines or penalties incurred due to violation by Landlord of any applicable law. K. Costs incurred because Landlord breached the terms of any lease. L. Overhead and profit paid to subsidiaries or affiliates of Landlord for management or other services on or to the Project or for supplies or other materials, to the extent that the costs of the services, supplies or materials exceed the amount customarily charged by an independent entity for similar services, supplies or materials of same or better quality. M. Compensation paid to clerks, attendants and other persons in commercial concessions operated by Landlord. N. Advertising and promotional expenditures (except for Project identification and directional signage). O. Repairs or other work needed because of fire, windstorm or other casualty or cause insured against by Landlord to the extent Landlord receives insurance proceeds therefor. P. Costs of sculpture, paintings or other art. Q. Legal fees, costs, and disbursements relating to (i) disputes with tenants, (ii) enforcing any leases, or (iii) the defense of Landlord's title to, or interest in, the Buildings or Project. R. Costs incurred due to the intentional misconduct or intentional breach by Landlord of its obligations under any lease. S. Landlord's general corporate overhead and administrative expenses. T. Costs of capital improvements and replacements except as permitted under Section 6.1(b)(i)(G). Additional Rent payable by Tenant which would not otherwise be due until after the date of the expiration or earlier termination of the Lease shall, if the exact amount is uncertain at the time this Lease expires or terminates, be paid by Tenant to Landlord upon such expiration or termination in an amount to be reasonably determined by Landlord, with an adjustment to be made once the exact amount is known. (iii)TENANT'S SHARE. For purposes of this Lease, "Tenant 's Share" means the percentage, as set forth in Section 1.1(o) or Section 1.1(p), as appropriate, and obtained by dividing the rentable area of the Premises by the aggregate rentable area of all premises available for lease, whether leased or not, in the Building or the Project, as applicable with respect to any specific Operating Expense, subject to adjustment in the event of changes in rentable area of the Project, Building and/or Premises. Notwithstanding the above, Landlord shall have the right, but not the obligation, to equitably adjust Tenant's Share of any specific Operating Expense so as to render such expense payable proportionately by those tenants benefited by the same or otherwise in order to appropriately allocate such Operating Expense to cover the area covered by such Operating Expense. (iv) REAL PROPERTY TAXES. For purposes of this Lease, "Real Property Taxes" shall consist of all real estate taxes and all other taxes relating to the Building, the Project, the Common Areas and/or the Project, as applicable, all other taxes which may be levied in lieu of real estate taxes, all assessments, local improvement districts, assessment bonds, levies, fees and other governmental charges, including, but not limited to, charges for traffic facilities and improvements, water service studies, and improvements or amounts necessary to be expended because of governmental orders, whether general or special, ordinary or extraordinary, unforeseen as well as foreseen, of any kind and nature for public improvements, services, benefits, or any other purpose, which are assessed, levied, confirmed, imposed or become a lien upon the Building or any portion of the Project, and/or the Common Areas, or become payable during the Term (or which become payable after the expiration or earlier termination hereof and are attributable in whole or in part to any period during the Term hereof), together with all costs and expenses incurred by Landlord in successfully contesting, resisting or appealing any such taxes, rates, duties, levies or assessments. Any special assessments which may be paid in installments shall be deemed paid over the longest period allowable by law and only the installment due in any calendar year shall be included in Real Property Taxes. "Real Property Taxes" shall exclude any franchise, estate, inheritance or succession transfer tax of Landlord, or any federal or state income, profits or revenue tax or charge upon the net income of Landlord from all sources; provided, however, that if at any time during the Term there is levied or assessed against Landlord a federal, state or local tax or excise tax on rent, or any other tax however described on account of rent or gross receipts or any portion thereof, Tenant shall pay one hundred percent (100%) of the Tenant's Share of any said tax or excise applicable to Tenant's Rent as Additional Rent. (c) POLICY STATEMENT. The purpose of this Section 6.1 is to fairly reimburse Landlord for the increased costs of those Operating Expenses for operating, maintaining, repairing, and managing the Buildings which benefit all of the Buildings' tenants. The reimbursement is not intended to provide an additional source of profit to Landlord. Accordingly, the purpose described above and the following principles are a statement of the parties' intent regarding Section 6.1: (i) Landlord will operate, maintain, repair, and manage the Building in a manner of at least the quality as other comparable buildings in Portland, Oregon. (ii) Landlord shall perform its obligation set forth in Section 6.1 in a cost-effective manner. (iii)The Operating Expenses shall be fairly and accurately calculated by Landlord. (iv) Examples of fair calculations include the exclusions in Section 6.1(b)(ii), and not charging for the same service in two different categories (such as an in-house manager and a management fee). 6.2 ADJUSTMENTS. (a) CREDITS/REIMBURSEMENTS. Operating Expenses shall be reduced by reimbursements, credits, discounts, reductions, or other allowances received by Landlord for items of cost included in Operating Expenses. (b) TAX REFUND. If Landlord receives a refund of any portion of Real Property Taxes that were included in the Operating Expenses actually paid by Tenant as an increase over the Real Property taxes for the Base Year, then Landlord shall reimburse Tenant Tenant's Share of the refunded taxes to the extent actually paid by Tenant, less any expenses that Landlord reasonably incurred to obtain the refund. (c) PRORATIONS. If this Lease (or an extended term hereof) begins or ends on a day other than the last day of a calendar year, Tenant's obligation to pay Tenant's Share of the Operating Expense Increase for that calendar year shall be prorated by multiplying Tenant's Share of that Operating Expense Increase by a fraction expressed as a percentage, the numerator of which is the number of days of the calendar year included within the Term of this Lease and the denominator of which is 365. 6.3 TENANT'S PERSONAL PROPERTY TAXES. Tenant shall pay or cause to be paid, prior to delinquency, any and all taxes and assessments levied upon all trade fixtures, inventories and other real or personal property placed or installed in and upon the Premises by Tenant. If any such taxes on Tenant's personal property or trade fixtures are levied against Landlord or Landlord's property or if the assessed value of the Building is increased by the inclusion therein of a value placed upon such real or personal property or trade fixtures of Tenant, and if Landlord pays the taxes based upon such increased assessment, Tenant shall, upon demand, repay to Landlord the taxes so levied or the portion of such taxes resulting from such increase in the assessment. ARTICLE VII INSURANCE 7.1 LANDLORD'S INSURANCE. During the Term, Landlord shall procure and maintain in full force and effect with respect to the Building (i) a policy or policies of standard "all-risk" fire insurance with extended coverage against damage and destruction by fire, vandalism, and all other "all risk" perils. The amount of such insurance shall be equal to the full replacement value of the Building, as the value may exist from time to time (including, to the extent required, sprinkler leakage, vandalism and malicious mischief coverage, and any other endorsements required by the holder of any fee or leasehold mortgage and earthquake, flood and terrorism insurance to the extent Landlord reasonably deems prudent and/or to the extent required by any mortgagee); and (ii) a policy of commercial general liability insurance, in the form and content acceptable to Landlord, insuring Landlord's activities with respect to the Premises, the Common Areas and the Project for loss, damage or liability for personal injury or death of any person or loss or damage to property occurring in, upon or about the Premises, Common Areas or Project. If the annual premiums charged Landlord for such casualty and/or liability insurance exceed the standard premium rates because the nature of Tenant's operations results in increased exposure, then Tenant shall, upon receipt of appropriate premium invoices, reimburse Landlord for such increased amount. Landlord shall have the right, at its option, to keep and maintain in full force and effect during the Term such other insurance in such amounts and on such terms as Landlord and/or any mortgagees or the beneficiary of any first trust deed against the Building, or the portion of the Project, may reasonably require from time to time in form, in amounts and for insurance risks against which a prudent Landlord would protect itself, including but not limited to rental abatement, rental interruption, earthquake, flood and terrorism insurance. 7.2 TENANT'S PUBLIC LIABILITY. Tenant shall, at its own cost and expense, keep and maintain in full force during the Term and any other period of occupancy of the Premises by Tenant, a policy or policies of commercial general liability insurance, written by a reputable insurance company authorized to do business in the State of Oregon in form and content reasonably acceptable to Landlord insuring Tenant's activities with respect to the Premises, the Common Areas and the Project for loss, damage or liability for personal injury or death of any person or loss or damage to property occurring in, upon or about the Premises in an amount of not less than Three Million Dollars ($3,000,000) combined single limit or such larger amounts as may hereafter be reasonably requested by Landlord. The policy shall insure the hazards of the Premises and Tenant's operations therein, shall include independent contractor and contractual liability coverage (covering the indemnity contained in Section 7.8 hereof) and shall (a) name Landlord, Landlord's managing agent and the Landlord's mortgagee under a mortgage or beneficiary under a deed of trust either having a lien against the Building or Project (the "Lender") as an additional insured; (b) contain a cross-liability provision and; (c) contain a provision that the insurance provided hereunder shall be primary and non-contributing with any other insurance available to Landlord. 7.3 TENANT'S PROPERTY AND OTHER INSURANCE. Tenant shall, at its own cost and expense, keep and maintain in full force during the Term and any other period of occupancy of the Premises, a policy or policies of standard form property insurance insuring against the perils of fire, extended coverage, vandalism, malicious mischief, special extended coverage and sprinkler leakage. This insurance policy shall be upon all property owned by Tenant, for which Tenant is legally liable or that was installed at Tenant's expense, and which is located in the Premises, including without limitation, furniture, fittings, installations, cabling, fixtures (other than the improvements installed by Landlord), and any other personal property, in the amount of not less than one hundred percent (100%) of the full replacement costs thereof. 7.4 FORM OF INSURANCE/CERTIFICATES. All policies shall be written in a form satisfactory to Landlord and shall be taken out with insurance companies licensed in the state in which the Building is located and holding a General Policy Holder' s Rating of "A" and a financial rating of "X" or better, as set forth in the most current issues of Best's Insurance Guide. Each party shall furnish to the other, prior to the Commencement Date and thereafter within ten (10) days prior to the expiration of each such policy, a certificate of insurance (or renewal thereof) issued by the insurance carrier of each policy of insurance carried by the party pursuant hereto and, upon request by the other party, a copy of each such policy of insurance. Said certificates shall expressly provide that such policies shall not be cancelable or subject to reduction of coverage below the minimum amounts required by this Lease or required by any lender having an interest in the Building or otherwise be subject to modification except after thirty (30) days prior written notice to the parties named as insured in Section 7.2. 7.5 TENANT'S FAILURE. If Tenant fails to maintain any insurance required in the Lease, Tenant shall be liable for any loss or cost resulting from said failure, and Landlord shall have the right to obtain such insurance on Tenant's behalf and at Tenant's sole expense. This Section 7.5 shall not be deemed to be a waiver of any of Landlord's rights and remedies under any other section of this Lease. If Landlord obtains any insurance which is the responsibility of Tenant to obtain under this Article VII, Landlord shall deliver to Tenant a written statement setting forth the cost of any such insurance and showing in reasonable detail the manner in which it has been computed and Tenant shall promptly remit said amount as Additional Rent to Landlord. 7.6 WAIVER OF SUBROGATION. Any all risk policy or policies of fire, extended coverage or similar casualty insurance which either party obtains in connection with the Building, the Premises or Tenant's personal property therein shall include a clause or endorsement denying the insurer any rights of subrogation against the other party to the extent rights have been waived by the insured prior to the occurrence of injury or loss. Landlord and Tenant waive any rights of recovery against the other for liability, injury or loss due to hazards covered by insurance containing such a waiver of subrogation clause or endorsement to the extent of the liability, injury or loss covered thereby. 7.7 TENANT'S PROPERTIES AND FIXTURES. Tenant assumes the risk of damage to any furniture, equipment, machinery, goods, supplies or fixtures which are or remain the property of Tenant or as to which Tenant retains the right of removal from the Premises, except to the extent due to the gross negligence or willful misconduct of Landlord. Tenant shall not do or keep anything in or about the Premises (except those things Tenant presently does and keeps in connection with the uses set forth in Section 10.1) which will in any way tend to increase insurance rates paid by Landlord and maintained with respect to the Premises and/or the Project unless Tenant pays directly to Landlord the increase cost of the premiums. In no event shall Tenant carry on any activities which would invalidate any insurance coverage maintained by Landlord. If at any time Tenant's occupancy or business in, or on, the Premises, whether or not Landlord has consented to the same, results in any increase in premiums for the insurance carried by Landlord with respect to the Building and/or the Project, Tenant shall pay any such increase in premiums as Additional Rent within ten (10) days after being billed therefore by Landlord. In determining whether increased premiums are a result of Tenant's use of the Building, a schedule issued by the organization computing the insurance rate on the Building and/or the Project showing the various components of such rate shall be conclusive evidence of the several items and charges which make up such rate. Tenant shall promptly comply with all reasonable requirements of the insurance underwriters and/or any governmental authority having jurisdiction thereover, necessary for the maintenance of reasonable fire and extended insurance for the Building and/or the Project. 7.8 INDEMNIFICATION. (a) Tenant, as a material part of the consideration to be rendered to Landlord, hereby indemnifies and agrees to defend and hold Landlord, Landlord's managing agent and Lender, the Premises, and the Project harmless for, from and against (i) any and all liability, penalties, losses, damages, costs and expenses, demands, causes of action, claims, judgments or appeals arising from any injury to any person or persons or any damage to any property to the extent as a result of Tenant's or Tenants' officers, employees, agents, assignees, subtenants, concessionaires, licensees, contractors or invitees' use, maintenance, occupation, operation or control of the Premises during the Term, or resulting from any breach or default in the performance of any obligation to be performed by Tenant hereunder or for which Tenant is responsible under the terms of this Lease or pursuant to any governmental or insurance requirement, or to the extent arising from any act, neglect, fault or omission of Tenant or any of Tenant's officers, employees, agents, servants, subtenants, concessionaires, licensees, contractors or invitees, and (ii) from and against all reasonable legal costs and charges, including reasonable attorneys' and other reasonable professional fees, incurred in and about any of such matters and the defense of any action arising out of the same or in discharging the Project and/or Premises or any part thereof from any and all liens, charges or judgments which may accrue or be placed thereon by reason of any act or omission of the Tenant, except and to the extent as may arise out of the negligence or willful misconduct of Landlord and/or its agents, officers, employees, contractors or invitees. (b) Landlord, as a material part of the consideration to be rendered to Tenant, hereby indemnifies and agrees to defend and hold Tenant and the Premises harmless from and against (i) any and all liability, penalties, losses, damages, costs and expenses, demands, causes of action, claims, judgments or appeals arising from any injury to any person or persons or any damage to any property to the extent as a result of Landlord's or Landlord's employees, agents, or contractors, gross negligence or willful misconduct, or resulting from any breach or default in the performance of any obligation to be performed by Landlord hereunder or for which Landlord is responsible under the terms of the Lease or pursuant to any governmental or insurance requirement, and (ii) from and against all reasonable legal costs and charges, including reasonable attorneys' and other reasonable professional fees, incurred in and about any of such matters and the defense of any action arising out of the same or in discharging Tenant and/or Premises or any part thereof from any and all liens, charges or judgments which may accrue or be placed thereon by reason of any act or omission of the Landlord, except and to the extent as may arise out of the negligence or willful misconduct of Tenant and/or its officers, agents, employees, assignees, subtenants, concessionaires, licensees, contractors, or invitees. (c) In no event shall Landlord, its agents, employees and/or contractors be liable for any personal injury or death or property damage caused by other lessees or persons in or about the Premises, the Project and/or the Building, as the case may be, or caused by public or quasi-public work, or for consequential damages arising out of any loss of the use of the Premises or any equipment or facilities therein by Tenant or any person claiming through or under Tenant. 7.9 DAMAGE TO TENANT'S PROPERTY. Notwithstanding the provisions of Section 7.8 to the contrary, except to the extent due to the gross negligence or willful misconduct of Landlord, Landlord, its agents, employees and/or contractors shall not be liable for (i) any damage to property entrusted to employees or security officers of the Project or the Building, (ii) loss or damage to any property by theft or otherwise, or (iii) any injury or damage to persons or property resulting from fire, explosion, falling substances or materials, steam, gas, electricity, water or rain which may leak from any part of the Building, the Common Areas, or the Project or from the pipes, appliances or plumbing work therein or from the roof, street, or subsurface or from any other place or resulting from dampness or any other cause, except to the extent Landlord receives consideration for such damage or injury from a third party. Neither Landlord nor its agents, employees or contractors shall be liable for interference with light. Tenant shall give prompt notice to Landlord and appropriate emergency response officials if Tenant is or becomes aware of fire or accidents in the Building, the Common Areas or any other portion of the Project or of defects therein in the fixtures or equipment. ARTICLE VIII REPAIRS AND MAINTENANCE 8.1 LANDLORD REPAIRS AND MAINTENANCE. Subject to Landlord's right to reimbursement from Tenant pursuant to Sections 6.1 and 8.3, Landlord shall at its expense maintain in good condition and repair the Building including without limitation the foundation, roof and membrane and shall maintain in good condition the exterior of the Building, utilities, the Building systems (including HVAC, plumbing, electrical, and mechanical), common area doors, windows, and walls, and light fixtures, and the Common Areas of the Project. Landlord shall not be liable for any failure to make any repairs or to perform any maintenance unless such failure shall persist for an unreasonable time after written notice of the need for such repairs or maintenance is given to Landlord by Tenant. There shall be no abatement of Rent and, except for the gross negligence or willful misconduct of Landlord or its employees, no liability of Landlord by reason of any injury to or interference with Tenant's business arising from the making of any repairs, alterations or improvement in or to any portion of the Premises or in or to fixtures, appurtenances and equipment therein; provided, that Landlord, its employees, agents and contractors use reasonable efforts not to unreasonably interfere with Tenant's business in exercise of Landlord's rights or obligations hereunder. Except as may otherwise be expressly set forth herein, Tenant affirms that (a) neither Landlord nor any agent, employee or officer of Landlord has made any representation regarding the condition of the Premises, the Building, the Common Areas or the Project, and (b) Landlord shall not be obligated to undertake any repair, alteration, remodel, improvement, painting or decorating. 8.2 UTILITIES AND SERVICES. Subject to reimbursement pursuant to Sections 6.1 and 8.3, Landlord shall furnish or cause to be furnished to the Premises water, natural gas for hot water, electricity, sewage, heating, ventilating, air conditioning services, and janitorial services of the quality provided to office buildings of similar quality, style, and age in the Portland metropolitan area. Tenant shall pay before delinquency, at its sole cost and expense, all charges for water, heat, electricity, power, telephone service, sewer service charges and other utilities or services charged or attributable directly to the Premises; provided, however, that if any such services or utilities shall be billed to Landlord and are not separately billed to the Premises, Tenant shall pay to Landlord as Additional Rent, an amount equal to that proportion of the total charges therefor which the rentable area of the Premises bears to the rentable area of leased area covered by such charges. Notwithstanding the above, in the event Tenant uses any heating, ventilating and air conditioning services during non-standard building hours, or if Tenant uses any utility services beyond standard office usage as reasonably determined by Landlord, Tenant shall pay the actual cost of such after-hours services or above-standard services, as the case may be, used by Tenant based on Landlord's reasonable estimate therefor. At Landlord's option, Landlord may install separate meters to measure above-standard consumption of services. Tenant shall reimburse the costs of the purchase and installation of such meters within 15 days after Landlord's billing therefor. 8.3 TENANT REPAIRS AND MAINTENANCE. Tenant shall, at its expense, (a) keep the Premises and fixtures in good order, and keep Tenant's personal property in good order and repair; and (b) make repairs and replacements to the Premises and pay Landlord for the repairs or replacements to the Buildings if any such repairs or replacements are needed because of Tenant's misuse or primary negligence, except to the extent that a claim for such repairs or replacements is waived under Section 7.6. Upon expiration or earlier termination of the Term, Tenant shall surrender the Premises to Landlord in the same condition as when leased except for (i) ordinary wear and tear, (ii) damage by the elements, fire, or other casualty not required to be repaired, replaced or paid for by Tenant pursuant to this Lease, (iii) condemnation, and (iv) alterations as permitted under this Lease unless consent was conditioned on their removal. 8.4 NON-LIABILITY OF LANDLORD. Notwithstanding anything to the contrary contained in Sections 8.1 or 8.2 above or elsewhere in this Lease, but except as expressly provided below, Landlord shall not be in default hereunder or be liable for any damages directly or indirectly resulting from, nor shall the Rent herein reserved be abated or rebated by reason of (a) the interruption or curtailment of the use of the Premises as a result of the installation of any equipment in connection with the Building or Project; or (b) any failure to furnish or delay in furnishing any services required to be provided by Landlord, unless and to the extent such failure or delay is caused by any condition created by Landlord's active gross negligence; or (c) the limitation, curtailment, rationing or restriction of the use of water or electricity, gas or any other form of energy or any other service or utility whatsoever serving the Premises or Project. However, if, as a result of Landlord's act or omission, Landlord causes one of the events described in clause (a), (b), or (c) of this paragraph, and as a result of such event, the Premises are rendered unsuitable for Tenant's use and Tenant, in fact does not occupy the Premises for its business operations for seven consecutive days, Base Rent shall abate beginning on the eighth consecutive day and continuing until such time as the Premises are again rendered suitable for Tenant's use. 8.5 INSPECTION OF PREMISES. Landlord may enter the Premises to complete construction undertaken by Landlord on the Premises, to inspect, clean, improve or repair the same, to inspect the performance by Tenant of the terms and conditions hereof, show the Premises to prospective purchasers, tenants and lenders and for all other purposes as Landlord shall reasonably deem necessary or appropriate; provided, that Landlord shall use reasonable efforts not to interfere with Tenant's business in exercise of Landlord's rights hereunder. Tenant hereby waives any claim for damages for any injury or inconvenience to or interference with Tenant's business, any loss of occupancy or quiet enjoyment of the Premises and any other loss in, upon or about the Premises, arising from exercise by Landlord of its rights hereunder except as otherwise provided in Article XI hereof. 8.6 ACCESS BY TENANT. Tenant and its employees, agents, and invitees shall have access to the Premises 24 hours a day, seven days a week, subject to restrictions due to governmental regulation, casualty, and weather. ARTICLE IX FIXTURES, PERSONAL PROPERTY AND ALTERATIONS 9.1 FIXTURES AND PERSONAL PROPERTY. Tenant, at Tenant's expense, may install any necessary trade fixtures, equipment and furniture in the Premises, provided that such items are installed and are removable without damage to the structure of the Premises , including, but not limited to, damage to drywall, doors, door frames and floors. Landlord reserves the right to approve or disapprove of any interior improvements which are visible from outside the Premises or which violate the CC&R's on wholly aesthetic grounds, but such approval shall not be unreasonably withheld, conditioned or delayed. Such improvements must be submitted for Landlord's written approval prior to installation, or Landlord may remove or replace such items at Tenant's sole expense. Said trade fixtures, equipment, furniture and personal property shall remain Tenant's property and shall be removed by Tenant upon the expiration or earlier termination of the Lease. As a covenant which shall survive the expiration or earlier termination of the Lease, Tenant shall repair, at Tenant's sole expense, or at Landlord's election, reimburse Landlord for the cost to repair all damage caused by the installation or removal of said trade fixtures, equipment, furniture, personal property or temporary improvements. If Tenant fails to remove the foregoing items prior to or upon the expiration or earlier termination of this Lease, Landlord, at its option and without liability to Tenant for loss thereof, may keep and use them or remove any or all of them and cause them to be stored or sold in accordance with applicable law, and Tenant shall, upon demand of Landlord, pay to Landlord as Additional Rent hereunder all costs and expenses incurred by Landlord in so storing and/or selling said items. In the event any such fixtures, equipment, and/or furniture of Tenant are sold by Landlord, the proceeds of such sale shall be applied, first, to all expenses of Landlord incurred in connection with storage and sale; second, to any amounts owed by Tenant to Landlord under this Lease or otherwise, and, third, the remainder, if any, shall be paid to Tenant. 9.2 ALTERATIONS. Tenant shall not make or allow to be made any material alterations, additions or improvements to the Premises (defined as alterations, additions or improvements costing in excess of $1,000.00 individually or in the aggregate with respect to separate items relating to the same improvement or alteration or any alterations, additions or improvements that affect the structure or exterior of the Building or any building, mechanical, electrical or life safety system), either at the inception of the Lease or subsequently during the Term, without obtaining the prior written consent of Landlord which consent may be withheld in Landlord's sole discretion with respect to any alteration, addition or improvement that affects the structure or exterior of the Building or any building, mechanical, electrical or life safety systems. Tenant shall deliver to Landlord the contractor's name, references and state license number, a certificate of liability insurance naming Landlord and Landlord' s manager and lender(s) as an additional insured, as well as full and complete plans and specifications of all such alterations, additions or improvements, and any subsequent modifications or additions to such plans and specifications, and no proposed work shall be commenced or continued by Tenant until Landlord has received and given its written approval of each of the foregoing. Landlord shall either approve or disapprove any proposed alteration, addition or improvement on or before fifteen (15) days following receipt of all of the foregoing items. Landlord does not expressly or implicitly covenant or warrant that any plans or specifications submitted by Tenant are accurate, safe or sufficient or that the same comply with any applicable laws, ordinances, building codes, or the like. Further, Tenant shall indemnify, protect, defend and hold Landlord and Landlord's agents, employees and contractors harmless for, from and against any loss, damage, liability, claims, cost or expense, including attorneys' fees and costs, incurred as a result of any defects in design, materials or workmanship resulting from Tenant's alterations, additions or improvements to the Premises. All alterations, telephone or telecommunications lines, cables, conduits and equipment and all other additions or improvements to the Premises made by Tenant shall remain the property of Tenant until termination of this Lease, at which time they shall, unless otherwise elected by Landlord by written notice to Tenant, be and become the property of Landlord. Landlord may, as a condition to approval of any such alterations, additions or improvements, require Tenant to remove any partitions, counters, railings, telephone and telecommunications lines, cables, conduits and equipment and/or other improvements installed by Tenant during the Term, and Tenant shall repair all damage resulting from such removal or, at Landlord's option, shall pay to Landlord all costs arising from such removal. All repairs, alterations, additions and restorations by Tenant hereinafter required or permitted shall be done in a good and workmanlike manner and in compliance with the plans and specifications approved by Landlord and in compliance with all applicable laws and ordinances, building codes, bylaws, regulations and orders of any federal, state, county, municipal or other public authority and of the insurers of the Premises and as-built plans and specifications shall be provided to Landlord by Tenant upon completion of the work. If required by Landlord, and only if Tenant is not Schnitzer Steel Industries, Inc., Tenant shall secure at Tenant's own cost and expense a completion and lien indemnity bond or other adequate security, including without limitation an indemnity agreement from Tenant's parent in form and substance reasonably satisfactory to Landlord. Tenant shall reimburse Landlord for Landlord's reasonable out-of-pocket costs (including any professional fees incurred by Landlord and a reasonable administrative fee payable to Landlord's manager) for reviewing and approving or disapproving plans and specifications for any proposed alterations and observing the alterations. 9.3 LIENS. Tenant shall promptly file and/or record, as applicable, all notices of completion provided for by law, and shall pay and discharge all claims for work or labor done, supplies furnished or services rendered at the request of Tenant or at the request of Landlord on behalf of Tenant, and shall keep the Premises and the Project free and clear of all mechanics' and materialmen's liens in connection therewith. Landlord shall have the right, and shall be given ten (10) business days written notice by Tenant prior to commencement of the work, to post or keep posted on the Premises, or in the immediate vicinity thereof, any notices of non-responsibility for any construction, alteration, or repair of the Premises by Tenant. If any such lien is filed, Tenant shall cause same to be discharged of record within ten (10) days following written notice thereof, or if Tenant disputes the correctness or validity of any claim of lien, Landlord may, in its reasonable discretion, permit Tenant to post or provide security in a form and amount acceptable to Landlord to insure that title to the Project remains free from the lien claimed. If said lien is not timely discharged Landlord may, but shall not be required to, take such action or pay such amount as may be necessary to remove such lien and Tenant shall pay to Landlord as Additional Rent any such amounts expended by Landlord, together with interest thereon at the Default Rate (as defined in Section 5.3 hereof), within five (5) days after notice is received from Landlord of the amount expended by Landlord. ARTICLE X USE AND COMPLIANCE WITH LAWS 10.1 GENERAL USE AND COMPLIANCE WITH LAWS. Tenant shall use the Premises only for Tenant's business described in Section 1.1(f) above, and uses customarily incidental thereto and for no other use without the prior written consent of Landlord which consent shall not be unreasonably withheld, conditioned or delayed. Tenant shall, at Tenant's sole cost and expense, comply with applicable requirements of municipal, county, state, federal and other applicable governmental authorities now or hereafter in force pertaining to Tenant's business operations, alterations and/or specific use of the Premises and/or the Project, and shall secure any necessary permits therefore and shall faithfully observe in the use of the Premises and the Project, applicable municipal, county, state, federal and other applicable governmental entities' requirements which are now or which may hereafter be in force. Tenant, in Tenant's use and occupancy of the Premises, shall not subject or permit the Premises and/or the Project to be used in any manner which would tend to damage any portion thereof, or which would increase the cost of any insurance paid by Landlord with respect thereto. Tenant shall not do or permit anything to be done in or about the Premises, the Common Areas and/or the Project which will in any way obstruct or interfere with the rights of other tenants or occupants of the Common Areas and/or the Project or use or allow the Premises or any portion of the Project to be used for any improper, immoral, unlawful or objectionable purpose, nor shall Tenant cause, maintain or permit a nuisance in, on or about the Premises, the Common Areas and/or the Project. Tenant shall comply with all covenants and obligations in the CC&R's which affect the use and operation of the Premises, the Common Areas and/or the Project. 10.2 HAZARDOUS MATERIALS. (a) DEFINED TERMS. (i) "HAZARDOUS MATERIALS" means, among other things, any of the following, in any amount: (a) any petroleum or petroleum derived or derivative product, asbestos in any form, urea formaldehyde and polychlorinated biphenyls and medical wastes; (b) any radioactive substance; (c) any toxic, infectious, reactive, corrosive, ignitable or flammable chemical or chemical compound; and (d) any chemicals, materials or substances, whether solid, liquid or gas, defined as or included in the definitions of "hazardous substances," "hazardous wastes," "hazardous materials," "extremely hazardous wastes," "restricted hazardous wastes," "toxic substances," "toxic pollutants," "solid waste," or words of similar import in any federal, state or local statute, law, ordinance or regulation or court decisions now existing or hereafter existing as the same may be interpreted by government offices and agencies. (ii) "HAZARDOUS MATERIALS LAWS" means any federal, state or local statutes, laws, ordinances or regulations or court decisions now existing or hereafter existing that control, classify, regulate, list or define Hazardous Materials or require remediation of Hazardous Materials contamination. (b) COMPLIANCE WITH HAZARDOUS MATERIALS LAWS. Tenant will not cause any Hazardous Material to be brought upon, kept, generated or used on the Project in a manner or for a purpose prohibited by or that could result in liability under any Hazardous Materials Law; provided, however, in no event shall Tenant allow any Hazardous Material to be brought upon, kept, generated or used on the Project other than those Hazardous Materials for which Tenant has received Landlord's prior written consent (other than small quantities of cleaning or other/industrial supplies as are customarily used by a tenant in the ordinary course in a general office facility). Tenant, at its sole cost and expense, will comply with (and obtain all permits required under) all Hazardous Materials Laws, groundwater wellhead protection laws, storm water management laws, fire protection provisions, and prudent industry practice relating to the presence, storage, transportation, disposal, release or management of Hazardous Materials in, on, under or about the Project that Tenant brings upon, keeps, generates or uses on the Project (including, without limitation, but subject to this Section 10.2, immediate remediation of any Hazardous Materials in, on, under or about the Project that Tenant brings upon, keeps, generates or uses on the Project in compliance with Hazardous Materials Laws) and in no event shall Tenant allow any liens or encumbrances pertaining to Tenant's use of Hazardous Materials to attach to any portion of the Project. On or before the expiration or earlier termination of this Lease, Tenant, at its sole cost and expense, will completely remove from the Project (regardless whether any Hazardous Materials Law requires removal), in compliance with all Hazardous Materials Laws, all Hazardous Materials Tenant causes to be present in, on, under or about the Project. Tenant will not take any remedial action in response to the presence of any Hazardous Materials in on, under or about the Project, nor enter into (or commence negotiations with respect to) any settlement agreement, consent decree or other compromise with respect to any claims relating to or in any way connected with Hazardous Materials in, on, under or about the Project, without first notifying Landlord of Tenant's intention to do so and affording Landlord reasonable opportunity to investigate, appear, intervene and otherwise assert and protect Landlord's interest in the Project. Landlord shall have the right from time to time to inspect the Premises to determine if Tenant is in compliance with this Section 10.2. (c) NOTICE OF ACTIONS. Tenant will notify Landlord of any of the following actions affecting Landlord, Tenant or the Project that result from or in any way relate to Tenant's use of the Project immediately after receiving notice of the same: (a) any enforcement, clean-up, removal or other governmental or regulatory action instituted, completed or threatened under any Hazardous Materials Law; (b) any claim made or threatened by any person relating to damage, contribution, liability, cost recovery, compensation, loss or injury resulting from or claimed to result from any Hazardous Material; and (c) any reports made by any person, including Tenant, to any environmental agency relating to any Hazardous Material, including any complaints, notices, warnings or asserted violations. Tenant will also deliver to Landlord, as promptly as possible and in any event within five (5) business days after Tenant first receives or sends the same, copies of all claims, reports, complaints, notices, warnings or asserted violations relating in any way to the Project or Tenant's use of the Project. Upon Landlord's written request, Tenant will promptly deliver to Landlord documentation acceptable to Landlord reflecting the legal and proper disposal of all Hazardous Materials removed or to be removed from the Premises. All such documentation will list Tenant or its agent as a responsible party and the generator of such Hazardous Materials and will not attribute responsibility for any such Hazardous Materials to Landlord or Landlord's property manager. (d) DISCLOSURE AND WARNING OBLIGATIONS. Tenant acknowledges and agrees that all reporting and warning obligations required under Hazardous Materials Laws resulting from or in any way relating to Tenant's use of the Premises or Project are Tenant's sole responsibility, regardless whether the Hazardous Materials Laws permit or require Landlord to report or warn. (e) INDEMNIFICATION. Tenant releases and will indemnify, defend (with counsel reasonably acceptable to Landlord), protect and hold harmless the Landlord and Landlord's agents, employees and contractors for, from and against any and all claims, liabilities, damages, losses, costs and expenses whatsoever arising or resulting, in whole or in part, directly or indirectly, from the presence, treatment, storage, transportation, disposal, release or management of Hazardous Materials in, on, under, upon or from the Project (including water tables and atmosphere) that Tenant brings upon, keeps, generates or uses on the Premises or the Project. Tenant's obligations under this Section include, without limitation and whether foreseeable or unforeseeable, (a) the costs of any required or necessary repair, clean-up, detoxification or decontamination of the Project; (b) the costs of implementing any closure, remediation or other required action in connection therewith as stated above; (c) the value of any loss of use and any diminution in value of the Project, and (d) consultants ' fees, experts' fees and response costs. The Tenant's obligations under this section survive the expiration or earlier termination of this Lease. Landlord releases and will indemnify, defend (with counsel reasonably acceptable to Tenant), protect and hold harmless the Tenant and Tenant's agents, employees and contractors for, from and against any and all claims, liabilities, damages, losses, costs and expenses whatsoever arising or resulting, in whole or in part, directly or indirectly, from the presence, treatment, storage, transportation, disposal, release or management of Hazardous Materials in, on, under, upon or from the Project (including water tables and atmosphere) that Landlord brings upon, keeps, generates or uses on the Premises or the Project. Landlord's obligations under this Section include, without limitation and whether foreseeable or unforeseeable, (a) the costs of any required or necessary repair, clean-up, detoxification or decontamination of the Project; (b) the costs of implementing any closure, remediation or other required action in connection therewith as stated above; (c) the value of any loss of use and any diminution in value of the Project, and (d) consultants ' fees, experts' fees and response costs. The Landlord's obligations under this section survive the expiration or earlier termination of this Lease. (f) HAZARDOUS MATERIALS REPRESENTATION BY LANDLORD. Landlord represents to Tenant that, to its actual knowledge and except as Landlord has previously disclosed to Tenant, Landlord has not caused the generation, storage or release of Hazardous Materials upon the Premises, except in accordance with Hazardous Materials Laws and prudent industry practices regarding construction of the Premises. 10.3 SIGNS. The Tenant shall not paint, display, inscribe, place or affix any sign, picture, advertisement, notice, lettering, or direction on any part of the outside of the Building or the Project or visible from the outside of the Premises, the Building or the Project, except as first approved by Landlord or as may be set forth in the Tenant Improvement Plans. Landlord's approval of any proposed sign, picture, advertisement, notice, lettering, or direction shall not be unreasonably withheld, conditioned, or delayed. ARTICLE XI DAMAGE AND DESTRUCTION 11.1 RECONSTRUCTION. If the "Relevant Space" (which means the Premises, reasonable access to the Premises, or any part of either Building or the Project that provides essential services to the Premises) is damaged or destroyed during the Term, Landlord shall, except as hereinafter provided, diligently repair or rebuild it to substantially the condition in which it existed immediately prior to such damage or destruction. If Landlord is obligated or elects to repair or restore as herein provided, Landlord shall be obligated to make repair or restoration of only those portions of the Premises which were initially provided at Landlord's expense or as part of the original installation by Landlord for Tenant and the repair and/or restoration of other items within the Premises shall be the obligation of the Tenant. 11.2 RENT ABATEMENT. Rent due and payable hereunder shall be abated proportionately during any period in which, by reason of any such damage or destruction, there is substantial interference with the operation of Tenant's business in the Premises. Such abatement shall continue for the period commencing with such damage or destruction and ending with a substantial completion by Landlord of the work of repair or reconstruction which Landlord is obligated or undertakes to do. If it be determined that continuation of business is not practical pending reconstruction, and if Landlord does not elect to or is unable to provide alternative temporary space for continuation of such business, then Rent due and payable hereunder shall abate, until reconstruction is substantially completed or until business is totally or partially resumed, whichever is the earlier. Tenant shall not be entitled to any claim, compensation or damages for loss in the use in the whole or any part of the Premises (including loss of business) and/or any inconvenience or annoyance occasioned by such damage, repair, reconstruction or restoration. 11.3 EXCESSIVE DAMAGE OR DESTRUCTION. If the Relevant Space is damaged or destroyed to the extent that it cannot within Landlord's reasonable discretion, with reasonable diligence, be fully repaired or restored by Landlord (using standard working methods and procedures) within the earlier of (i) one hundred twenty (120) days after the date of the damage or destruction, or (ii) the expiration of the Term hereof, Landlord may terminate this Lease by written notice to Tenant within thirty (30) days of the date of the damage or destruction. If Landlord does not terminate the Lease, this Lease shall remain in full force and effect and Landlord shall diligently repair and restore the damage as soon as reasonably possible. 11.4 UNINSURED CASUALTY. Notwithstanding anything contained herein to the contrary, in the event of damage to or destruction of all or any portion of the Building, which damage or destruction is not fully covered by the insurance proceeds received by Landlord under the insurance policies required under Section 7.1 hereinabove, Landlord may terminate this Lease by written notice to Tenant given within sixty (60) days after the date of notice to Landlord that said damage or destruction is not so covered. If Landlord does not elect to terminate this Lease, the Lease shall remain in full force and effect and the Building shall be repaired and rebuilt in accordance with the provisions for repair set forth in Section 11.1 hereinabove. 11.5 WAIVER. With respect to any damage or destruction which Landlord is obligated to repair or may elect to repair under the terms of this Article XI, and to the extent permitted by law, Tenant hereby waives any rights to terminate this Lease pursuant to rights otherwise accorded by law to tenants, except as expressly otherwise provided herein. 11.6 MORTGAGEE'S RIGHT. Notwithstanding anything herein to the contrary, if the holder of any indebtedness secured by a mortgage or deed of trust covering the Building and/or the Project requires that the insurance proceeds be applied to such indebtedness, then Landlord shall have the right to terminate this Lease by delivering written notice of termination to Tenant within fifteen (15) days after such requirement is made. Upon any termination of this Lease under the provisions hereof, the parties shall be released without further obligation to the other from date possession of the Premises is surrendered to Landlord, except for items which are theretofore accrued and are then unpaid. 11.7 DAMAGE NEAR END OF TERM. Notwithstanding anything to the contrary contained in this Article XI, in the event the Premises or the Building are subject to excessive damage (as defined in Section 11.3) during the last twenty-four (24) months of the Term or any applicable extension periods, Landlord may elect to terminate this Lease by written notice to Tenant within thirty (30) days after the date of such damage. ARTICLE XII EMINENT DOMAIN In the event the whole of the Premises, Building, Project and/or Common Areas, as the case may be, and/or such part thereof as shall materially interfere with Tenant's use and occupation thereof, shall be taken for any public or quasi-public purpose by any lawful power or authority by exercise of the right of appropriation, condemnation or eminent domain, or is sold in lieu of or to prevent such taking, then Tenant shall have the right to terminate this Lease effective as of the date possession is required to be surrendered to said authority. In the event the whole of the Premises, Building, Project, and/or Common Areas, as the case may be, or such part thereof as shall substantially interfere with Landlord's use and occupation thereof, or if any access points to adjoining streets, shall be taken for any public or quasi-public purpose by any lawful power or authority by exercise of the right of appropriation, condemnation or eminent domain, or is sold in lieu of or to prevent such taking, then Landlord shall have the right to terminate this Lease effective as of the date possession is required to be surrendered to said authority. Except as provided below, Tenant shall not assert any claim against Landlord or the taking authority for any compensation because of such taking, and Landlord shall be entitled to receive the entire amount of any award without deduction for any estate or interest of Tenant in the Premises. Nothing contained in this Article XII shall be deemed to give Landlord any interest in any separate award made to Tenant for the taking of personal property and fixtures belonging to Tenant or for Tenant's moving expenses. In the event the amount of property or the type of estate taken shall not materially interfere with the conduct of Tenant's business, Landlord shall be entitled to the entire amount of the award without deduction for any estate or interest of Tenant, Landlord shall promptly proceed to restore the Building to substantially their same condition prior to such partial taking less the portion thereof lost in such condemnation, and the Base Rent shall be proportionately reduced by the time during which, and the portion of the Premises which, Tenant shall have been deprived of possession on account of said taking and restoration. ARTICLE XIII DEFAULT 13.1 EVENTS OF DEFAULT. The occurrence of any of the following events shall constitute an "Event of Default" on the part of the Tenant: (a) Tenant shall fail to pay on or before the due date any installment of Rent or other payment required pursuant to this Lease within five (5) days after Tenant's receipt of written notice from Landlord of Tenant's failure to make such payment; (b) Tenant shall fail to comply with any term, provision, or covenant of this Lease, other than the payment of Rent or other sums of money due hereunder, and such failure is not cured within fifteen (15) days after written notice thereof to Tenant (said notice being in lieu of, and not in addition to, any notice required as a prerequisite to a forcible entry and detainer or similar action for possession of the Premises); provided that if the nature of such cure is such that a longer cure period is necessary, Tenant shall only be in default if Tenant shall have failed to commence such cure within said fifteen (15) day period and thereafter to have diligently prosecuted such cure to completion; (c) Tenant shall file a petition or be adjudged a debtor or bankrupt or insolvent under the United States Bankruptcy Code, as amended, or any similar law or statute of the United States or any State; or a receiver or trustee shall be appointed for all or substantially all of the assets of Tenant and such appointment or petition, if involuntary, is not dismissed within sixty (60) days of filing; or (d) Tenant shall make an assignment for the benefit of creditors. 13.2 REMEDIES. (a) Upon the occurrence of any Event of Default set forth in this Lease, in addition to any other remedies available to Landlord at law or in equity, Landlord shall have the immediate option to terminate this Lease and all rights of Tenant hereunder. In the event that Landlord shall elect to so terminate this Lease, then Landlord may recover from Tenant: (i) any unpaid rent which has been earned at the time of such termination plus interest at the rates contemplated by this Lease; plus (ii) the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided plus interest at the rates contemplated by this Lease; plus (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the Term after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided; plus (iv) the unamortized balance of the value of any free Rent, tenant improvement costs, commissions and any other monetary concessions provided to Tenant pursuant to this Lease, as amortized over the initial Term of this Lease; plus (v) any other amount necessary to compensate Landlord for all the damage proximately caused by Tenant's failure to perform Tenant's obligation under this Lease or which in the ordinary course of things would be likely to result therefrom, including, but not limited to, costs to restore the Premises to good condition, costs to remodel, renovate or otherwise prepare the Premises, or portions thereof, for a new tenant, leasing commissions, marketing expenses, attorneys' fees, and free rent, moving allowances and other types of leasing concessions. As used in Subsections 13.2(a) (iii) above, the "worth at the time of award" is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). Landlord agrees to use its commercially reasonable efforts to mitigate its damages. (b) In the event of any such default by Tenant, Landlord shall also have the right with or without terminating this Lease, to re-enter the Premises and remove all persons and property from the Premises; such property may be removed and stored in a public warehouse or elsewhere at the cost of and for the account of the Tenant. No re-entry or taking possession of the Premises by Landlord pursuant to this Section 13.2(b) shall be construed as an acceptance of a surrender of the Premises or an election to terminate this Lease unless a written notice of such intention is given to Tenant or unless the termination thereof is decreed by a court of competent jurisdiction. (c) In the event that Landlord shall elect to re-enter as provided above or shall take possession of the Premises pursuant to legal proceedings or pursuant to any notice provided by law, then if Landlord does not elect to terminate this Lease as provided above, Landlord may from time to time, without terminating this Lease, either recover all Rent as it becomes due or relet the Premises or any part thereof for the Term of this Lease on terms and conditions as Landlord at its sole discretion may deem advisable with the right to make alterations and repairs to the Premises. (d) In the event that Landlord shall elect to so relet, the rents received by Landlord from such reletting shall be applied: first to the payment of any indebtedness other than Rent due hereunder from Tenant to Landlord; second to the payment of any costs of such reletting; third, to the payment of the cost of any alterations and repairs to the Premises; fourth, to the payment of Rent due and unpaid hereunder; and the residual, if any, shall be held by Landlord and applied to payment of future Rent as the same shall become due and payable hereunder. Should that portion of such rents received from such reletting during the month which is applied to the payment of Rent be less than the Rent payable during that month by Tenant hereunder, then Tenant shall pay any such deficiency to Landlord immediately upon demand therefor by Landlord. Such deficiency shall be calculated and paid monthly. Tenant shall also pay to Landlord, as soon as is certain, any of the costs and expenses incurred by Landlord in such reletting or in making such alterations and repairs not covered by the rents received from such reletting. (e) All rights, options and remedies of Landlord contained in this Lease shall be construed and held to be cumulative, and no one of them shall be exclusive of the other, and Landlord shall have the right to pursue any one or all of such remedies or any other remedy or relief which may be provided by law, whether or not stated in this Lease. No waiver of any default of Tenant hereunder shall be implied from any acceptance by Landlord of any Rent or other payments due hereunder or any omission by Landlord to take any action on account of such default if such default persists or is repeated, and no express waiver shall affect defaults other than as specified in said waiver. The consent or approval of Landlord to or of any act by Tenant requiring Landlord's consent or approval shall not be deemed to waive or render unnecessary Landlord's consent or approval to or of any subsequent similar acts by Tenant. (f) In the event that during the term of this Lease, Tenant commits more than two (2) acts or omissions of default for which default notices are given by Landlord pursuant to this Article XIII (whether or not such defaults are cured by Tenant), and if the defaults are material in Landlord's reasonable judgment, Landlord may, at its option, elect to terminate this Lease. Landlord's election to exercise its early termination rights shall be effective only upon written notice delivered to Tenant specifying Landlord's election to cause an early termination of this Lease. Such early termination shall be in effect when such written notice is provided to Tenant. Landlord's right of early termination shall be in addition to all other rights and remedies available to Landlord at law or in equity. 13.3 LANDLORD'S DEFAULT. Landlord shall not be in default unless Landlord fails to perform its obligations under this Lease within thirty (30) days after written notice by Tenant, or if such failure is not reasonably capable of being cured within such thirty (30) day period, Landlord shall not be in default unless Landlord has failed to commence the cure and diligently pursue the cure to completion. In no event shall Tenant have the remedy to terminate this Lease except upon final adjudication of competent jurisdiction authorizing such default. In no event shall Landlord be liable to Tenant or any person claiming through or under Tenant for consequential, exemplary or punitive damages. ARTICLE XIV FILING OF PETITION Landlord and Tenant (as either debtor or debtor-in-possession) agree that if a petition ("Petition") is filed by or against Tenant under any chapter of Title 11 of the United States Code (the "Bankruptcy Code"), the following provisions shall apply: (a) Adequate protection for Tenant's obligations accruing after filing of the Petition and before this Lease is rejected or assumed shall be provided within 15 days after filing in the form of a security deposit equal to three months ' Base Rent and Additional Rent and other Lease charges, to be held by the court or an escrow agent approved by Landlord and the court. (b) The sum of all amounts payable by Tenant to Landlord under this Lease constitutes reasonable compensation for the occupancy of the Premises by Tenant. (c) Tenant or Trustee shall give Landlord at least 30 days written notice of any abandonment of the Premises or any proceeding relating to administrative claims. If Tenant abandons without notice, Tenant or Trustee shall stipulate to entry of an order for relief from stay to permit Landlord to reenter and relet the Premises. (d) If Tenant failed to timely and fully perform any of its obligations under this Lease before the filing of the Petition, whether or not Landlord has given Tenant written notice of that failure and whether or not any time period for cure expired before the filing of the Petition, Tenant shall be deemed to have been in default on the date the Petition was filed for all purposes under the Bankruptcy Code. (e) For the purposes of Section 365(b)(1) of the Bankruptcy Code, prompt cure of defaults shall mean cure within 30 days after assumption. (f) For the purposes of Section 365(b)(1) and 365(f)(2) of the Bankruptcy Code, adequate assurance of future performance of this Lease by Tenant, Trustee or any proposed assignee will require that Tenant, Trustee or the proposed assignee deposit three months of Base Rent and Additional Rent into an escrow fund (to be held by the court or an escrow agent approved by Landlord and the court) as security for such future performance. In addition, if this Lease is to be assigned, adequate assurance of future performance by the proposed assignee shall require that: (i) the assignee have a tangible net worth not less than the net worth of Tenant as of the Commencement Date or that such assignee's performance be unconditionally guaranteed by a person or entity that has a tangible net worth not less than the net worth of Tenant as of the Commencement Date; (ii) the assignee demonstrate that it possesses a history of success in operating a business of similar size and complexity in a similar market as Tenant's business; and (iii) assignee assume in writing all of Tenant's obligations relating to the Premises or this Lease. (g) If Tenant or Trustee intends to assume and/or assign this Lease, Tenant or Trustee shall provide Landlord with 30 days written notice of the proposed action, separate from and in addition to any notice provided to all creditors. Notice of a proposed assumption shall state the assurance of prompt cure, compensation for loss and assurance of future performance to be provided to Landlord. Notice of a proposed assignment shall state: (i) the name, address, and federal tax identification and registration numbers of the proposed assignee; (ii) all of the terms and conditions of the proposed assignment, and (iii) the assignee's proposed adequate assurance of future performance to be provided to Landlord. (h) If Tenant is in default under this Lease when the Petition is filed, Landlord shall not be required to provide Tenant or Trustee with services or supplies under this Lease or otherwise before Tenant assumes this Lease, unless Tenant compensates Landlord for such services and supplies in advance. ARTICLE XV ASSIGNMENT AND SUBLETTING 15.1 PROHIBITION. Tenant shall not assign, mortgage, pledge or otherwise transfer or encumber this Lease, in whole or in part, nor sublet, assign, or permit occupancy by any party other than Tenant of all or any part of the Premises, without the prior written consent of Landlord in each instance which consent shall not be unreasonably withheld, conditioned, or delayed. Tenant shall at the time the Tenant requests the consent of Landlord, deliver to Landlord such information in writing as Landlord may reasonably require respecting the proposed assignee or subtenant including, without limitation, the name, address, nature of business, ownership, financial responsibility and standing of such proposed assignee or subtenant and Landlord shall have not less than twenty (20) business days after receipt of all required information to elect one of the following: (a) consent to such proposed assignment, encumbrance or sublease, or (b) refuse such consent, or (c) elect to terminate this Lease, in the case of a proposed assignment, or elect to terminate the Lease with respect to the portion of the Premises proposed to be subleased, as applicable. Without making a formal request for consent to an assignment or sublease, Tenant may request that Landlord give Tenant its decision whether it intends to enforce the recapture provision in clause (c). Landlord agrees to respond to such request within 20 days after Tenant's request for the decision. In addition, as a condition to Landlord's consent to any assignment, sublease or encumbrance of this Lease shall be the delivery to Landlord of a true copy of the fully executed instrument of assignment, transfer or encumbrance and an agreement executed by the assignee, sublessee or other transferee in form and substance reasonably satisfactory to Landlord and expressly enforceable by Landlord, whereby the assignee assumes and agrees to be bound by the terms and provisions of this Lease and perform all the obligations of Tenant hereunder with respect to the assigned or subleased portion of the Premises. No assignment or subletting by Tenant shall relieve Tenant of any obligation under this Lease, including Tenant's obligation to pay Base Rent and Additional Rent hereunder. Any purported assignment or subletting contrary to the provisions hereof without consent shall be void. The consent by Landlord to any assignment or subletting shall not constitute a waiver of the necessity for such consent to any subsequent assignment of subletting. Tenant 's sole remedy for Landlord's refusal to consent to a proposed assignee or sublessee of Tenant will be an action or proceeding for specific performance, injunction or declaratory relief. Tenant shall pay Landlord's reasonable processing costs and attorneys' fees incurred in reviewing any proposed Assignment or sublease. 15.2 EXCESS RENTAL. If Tenant assigns this Lease or subleases the Premises, Tenant shall pay to Landlord as Additional Rent under this Lease fifty percent (50%) of the Profit on such transaction as herein provided. For purposes of this Section 15.2, the term "Profit" means the consideration received by Tenant from an assignee or subtenant in excess of the amount Tenant must pay Landlord under this Lease, which amount is to be prorated where a part of the Premises is subleased or assigned. In determining the Profit, the consideration received by Tenant shall be deemed to be reduced by the leasing commissions paid by Tenant, payments attributable to the costs of improvements made to the Premises at Tenant's cost for the assignee or sublessee, and other reasonable, out-of-pocket costs paid by Tenant, such as attorney fees related to Tenant's obtaining an assignee or sublessee, costs of advertising or marketing the space, moving expenses paid by Tenant for the assignee or subtenant, and other economic concessions given by Tenant to the assignee or sublessee. Tenant shall pay fifty percent (50%) of the Profit to Landlord within thirty (30) days after the end of each calendar year during which Tenant collects any Profit. 15.3 SCOPE. The prohibition against assigning or subletting contained in this Article XV shall be construed to include a prohibition against any assignment or subletting by operation of law. If this Lease be assigned, or if the underlying beneficial interest of Tenant is transferred, or if the Premises or any part thereof be sublet or occupied by anybody other than Tenant, Landlord may collect rent from the assignee, subtenant or occupant and apply the net amount collected to the Rent herein reserved and apportion any excess rent so collected in accordance with the terms of the immediately preceding paragraph, but no such assignment, subletting, occupancy or collection shall be deemed a waiver of this covenant, or the acceptance of the assignee, subtenant or occupant as tenant, or a release of Tenant from the further performance by Tenant of covenants on the part of Tenant herein contained. No assignment or subletting shall affect the continuing primary liability of Tenant (which, following assignment, shall be joint and several with the assignee), and Tenant shall not be released from performing any of the terms, covenants and conditions of this Lease. 15.4 WAIVER. Notwithstanding any assignment or sublease, or any indulgences, waivers or extensions of time granted by Landlord to any assignee or sublessee or failure of Landlord to take action against any assignee or sublease, Tenant hereby agrees that Landlord may, at its option, and upon not less than ten (10) days' notice to Tenant, proceed against Tenant without having taken action against or joined such assignee or sublessee, except that Tenant shall have the benefit of any indulgences, waivers and extensions of time granted to any such assignee or sublessee. 15.5 CHANGE IN CONTROL. So long as Tenant is not in default of the Lease, Tenant shall have the right to assign this Lease to any corporation or other entity which is controlled by, under the control of, or under common control with Tenant, or any corporation into which Tenant may be merged or consolidated, or which purchases all or substantially all of the assets or stock of Tenant (each an "Affiliate of Tenant"); provided, however, (a) Tenant shall not be released from its obligations under this Lease, (b) Landlord shall be given at least 15 days prior written notice of the assignment, (c) Landlord shall be given a copy of the document effecting the assignment at least 15 days prior to the date on which the assignment shall occur, and (d) from and after the date of the assignment, Tenant shall be jointly and severally liable with the Affiliate of Tenant with respect to all obligations of Tenant under this Lease. ARTICLE XVI ESTOPPEL CERTIFICATE, ATTORNMENT AND SUBORDINATION 16.1 ESTOPPEL CERTIFICATES. Within ten (10) business days after request therefor by Landlord, or if on any sale, assignment or hypothecation by Landlord of Landlord's interest in the Project and/or the Premises, or any part thereof, an estoppel certificate shall be required from Tenant, Tenant shall deliver a certificate in the form attached hereto as Exhibit G, or in such other form as requested by Landlord, to any proposed mortgagee or purchaser, and to Landlord, certifying (if such be the case) that this Lease is in full force and effect, the date of Tenant's most recent payment of Rent, and that Tenant has no defenses or offsets outstanding, or stating those claimed by Tenant, and any other information contained in such Exhibit G or reasonably requested by Landlord or such proposed mortgagee or purchaser. Tenant's failure to deliver said statement within said period shall, at Landlord's option be an Event of Default hereunder and shall in any event be conclusive upon Tenant that: (i) this Lease is in full force and effect, without modification except as may be represented by Landlord; (ii) there are no uncured defaults in Landlord's performance and Tenant has no right to offset, counterclaim or deduction against Rent hereunder; and (iii) no more than one period's Base Rent has been paid in advance. Landlord agrees that it shall, at any time upon not less than ten days' prior written request from Tenant, execute, acknowledge, and deliver a statement in writing (i) certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect); (ii) certifying the date to which Rent and other charges are paid in advance, if any, and the amount of any security deposit which has been paid; (iii) acknowledging that there are not, to Landlord's knowledge, any uncured defaults on the part of Tenant, or specifying such defaults, if any are claimed; and (iv) certifying to Tenant correct and reasonably ascertainable facts that are covered by the terms of this Lease. Any such statement may be conclusively relied upon by any prospective purchaser of the Premises, any assignee of this Lease, or any lender or prospective lender. 16.2 ATTORNMENT. Tenant shall, in the event any proceedings are brought for the foreclosure of, or in the event of exercise of the power of sale under, any mortgage or deed of trust made by Landlord, its successors or assigns, encumbering the Building, or any part thereof or in the event of termination of a ground lease, if any, and if so requested, attorn to the purchaser upon such foreclosure or sale or upon any grant of a deed in lieu of foreclosure and recognize such purchaser as Landlord under this Lease; provided, that such purchaser recognizes Tenant's rights under this Lease and agrees not to disturb Tenant's quiet possession of the Premises for so long as Tenant is not in default hereunder. 16.3 SUBORDINATION. The rights of Tenant hereunder are and shall be, at the election of any mortgagee or the beneficiary of a deed of trust encumbering the Project (or the portion thereof on which the Building is located) and/or Building, subject and subordinate to the lien of such mortgage or deed of trust, or the lien resulting from any other method of financing or refinancing, now or hereafter in force against the Project (or the portion thereof on which the Building is located) and/or the Building, and to all advances made or hereafter to be made upon the security thereof. If requested, Tenant agrees to execute such documentation as may be reasonably required by Landlord or its lender to further effect the provisions of this Article so long as the holder of the mortgage, deed of trust or other lien at issue agrees not to disturb Tenant's rights under this Lease so long as Tenant is not in default of this Lease. 16.4 RECORDING. Tenant covenants and agrees with Landlord that Tenant shall not record this Lease. At Tenant's request, Landlord agrees to execute and acknowledge a memorandum of this Lease and deliver such memorandum to Tenant so that Tenant may record the same. Notwithstanding the provisions of Section 16.3, in the event that Landlord or its lender requires this Lease or a memorandum thereof to be recorded in priority to any mortgage, deed of trust or other encumbrance which may now or at any time hereafter affect in whole or in part the Building, the Project (or the portion thereof on which the Building is located), and whether or not any such mortgage, deed of trust or other encumbrance shall affect only the Building, the Project (or the portion thereof on which the Building is located), or shall be a blanket mortgage, deed of trust or encumbrance affecting other premises as well, the Tenant covenants and agrees with Landlord that the Tenant shall execute promptly upon request from Landlord any reasonable certificate, reasonable priority agreement or other reasonable instrument which may from time to time be requested to give effect thereto. 16.5 SUBORDINATION OF LANDLORD'S LIEN. Landlord agrees to subordinate its landlord's lien on Tenant's personal property to the lien of Tenant's lender if the terms of such subordination are reasonably acceptable to Landlord. ARTICLE XVII MISCELLANEOUS 17.1 NOTICES. All notices required to be given hereunder shall be in writing and mailed postage prepaid by certified or registered mail, return receipt requested, or by personal delivery or nationally recognized courier service, to the appropriate address indicated in Section 1.1(b) or Section 1.1(e), as appropriate, at such street address or street addresses (but not more than three such addresses) as either Landlord or Tenant may, from time to time, respectively, designate in a written notice given to the other. Notices shall be deemed sufficiently served upon the earlier of actual receipt or the expiration of three (3) days after the date of mailing thereof. Tenant agrees to accept service of process for all matters related to this Lease at the Premises. 17.2 SUCCESSORS BOUND. This Lease and each of its covenants and conditions shall be binding upon and shall inure to the benefit of the parties hereto and their respective assignees, subject to the provisions hereof. Whenever in this Lease a reference is made to Landlord, such reference shall be deemed to refer to the person in whom the interest of Landlord shall be vested, and Landlord shall have no obligation hereunder as to any claim arising after the transfer of its interest in the Building. Any successor or assignee of the Tenant who accepts an assignment of the benefit of this Lease and enters into possession or enjoyment hereunder shall thereby assume and agree to perform and be bound by the covenants and conditions thereof. Nothing herein contained shall be deemed in any manner to give a right of assignment without the prior written consent of Landlord pursuant to, or otherwise as provided in, Article XV hereof. 17.3 WAIVER. No waiver of any default or breach of any covenant by either party hereunder shall be implied from any omission by either party to take action on account of such default if such default persists or is repeated, and no express waiver shall affect any default other than the default specified in the waiver and said waiver shall be operative only for the time and to the extent therein stated. Waivers of any covenant, term or condition contained herein by either party shall not be construed as a waiver of any subsequent breach of the same covenant, term or condition. The consent or approval by either party to or of any act by either party requiring further consent or approval shall not be deemed to waive or render unnecessary their consent or approval to or of any subsequent similar acts. 17.4 SUBDIVISION AND EASEMENTS. Landlord reserves the right to: (a) subdivide the Project; (b) alter the boundaries of the Project; and (c) grant easements on the Project and dedicate for public use portions thereof; provided, however, that no such subdivision, alteration of boundaries, grant or dedication shall materially interfere with Tenant's use of the Premises. Tenant hereby consents to such subdivision, boundary revision, and/or grant or dedication of easements and agrees from time to time, at Landlord's request, to execute, acknowledge and deliver to Landlord, in accordance with Landlord's instructions, any and all documents, instruments, maps or plats necessary to effectuate Tenant's consent thereto. 17.5 LANDLORD'S RESERVED RIGHTS IN COMMON AREAS. Landlord reserves the right from time to time, provided that Tenant's use and enjoyment of, and access to and from, the Premises is not materially and adversely affected thereby, to: (a) install, use, maintain, repair and replace pipes, ducts, conduits, wires and appurtenant meters and equipment for service to other parts of the Building above the ceiling surfaces, below the floor surfaces, within the walls and in the central core areas, and to relocate any pipes, ducts, conduit, wires and appurtenant meters in the Building which are so located or located elsewhere outside the Building; (b) make changes to the Common Areas and/or the parking facilities located thereon, including, without limitation, changes in the location, size, shape and number of driveways, entrances, parking spaces, parking areas, loading and unloading areas, ingress, egress, direction of traffic, landscaped areas and walkways; (c) close temporarily all or any portion of the Common Areas and/or the Building in order to perform any of the foregoing or any of Landlord's obligations under this Lease, so long as reasonable access to the Building remains available during normal business hours; and (d) alter, relocate or expand, and/or to add additional structures and improvements to, or remove same from, all or any portion of the Common Areas or other portions of the Project. 17.6 ACCORD AND SATISFACTION. No payment by Tenant or receipt by Landlord of a lesser amount than the Rent herein stipulated shall be deemed to be other than on account of the Rent, nor shall any endorsement or statement on any check or any letter accompanying any check or payment as Rent be deemed an accord and satisfaction, and Landlord may accept such check or payment without prejudice to Landlord's right to recover the balance of such Rent or pursue any other remedy provided in this Lease. 17.7 LIMITATION OF LANDLORD'S LIABILITY. The obligations of Landlord under this Lease do not constitute personal obligations of the individual partners, directors, officers, members, employees or shareholders of Landlord or its partners, and Tenant shall look solely to the Project, and the rents and profits therefrom, for satisfaction of any liability in respect of this Lease and will not seek recourse against the individual partners, directors, officers, members, employees or shareholders of Landlord or its partners or any of their personal assets for such satisfaction. 17.8 SURVIVAL. The obligations and liabilities of each party which are incurred or accrue prior to the expiration of this Lease or the termination of this Lease or of Tenant's right of possession shall survive such expiration or termination, as shall all provisions by which a party is to provide defense and indemnity to the other party, all provisions waiving or limiting the liability of Landlord, and all attorneys' fees provisions. 17.9 ATTORNEYS' FEES. In the event either party requires the services of an attorney in connection with enforcing the terms of this Lease or in the event suit is brought for the recovery of any Rent due under this Lease or the breach of any covenant or condition of this Lease, or for the restitution of the Premises to Landlord and/or eviction of Tenant during the Term of this Lease, or after the expiration thereof, the substantially prevailing party will be entitled to a reasonable sum for attorneys' fees, witness fees and other court costs, both at trial and on appeal. 17.10 CAPTIONS AND ARTICLE NUMBERS. The captions, article, paragraph and section numbers and table of contents appearing in this Lease are inserted only as a matter of convenience and in no way define, limit, construe or describe the scope or intent of such sections or articles of this Lease nor in any way affect this Lease. 17.11 SEVERABILITY. If any term, covenant, condition or provision of this Lease, or the application thereof to any person or circumstance, shall to any extent be held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, covenants, conditions or provisions of this Lease, or the application thereof to any person or circumstance, shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 17.12 APPLICABLE LAW. This Lease, and the rights and obligations of the parties hereto, shall be construed and enforced in accordance with the laws of the state in which the Building is located. 17.13 SUBMISSION OF LEASE. The submission of this document for examination and negotiation does not constitute an offer to lease, or a reservation of or option for leasing the Premises. This document shall become effective and binding only upon execution and delivery hereof by Landlord and Tenant. No act or omission of any officer, employee or agent of Landlord or Tenant shall alter, change or modify any of the provisions hereof. 17.14 HOLDING OVER. Should Tenant, or any of its successors in interest, hold over the Premises or any part thereof after the expiration or earlier termination of this Lease without Landlord's prior written consent, such holding over shall constitute and be construed as tenancy at sufferance only, at a monthly rent equal to one hundred fifty percent (150%) of the Base Rent owed during the final month of the Term of this Lease and otherwise upon the terms and conditions in the Lease, so far as applicable. Should Tenant, or any of its successors in interest, hold over the Premises or any part thereof after the expiration or earlier termination of this Lease with Landlord's prior written consent, such holding over shall constitute and be construed as a tenancy from month to month only, at a fair market monthly rent as agreed by Landlord and Tenant and otherwise upon the terms and conditions of this Lease, so far as applicable. The acceptance by Landlord of Rent after such expiration or early termination shall not result in a renewal or extension of this Lease. The foregoing provisions of this Section 17.14 are in addition to and do not affect Landlord's right of re-entry or any other rights of Landlord hereunder or as otherwise provided by law. If Tenant fails to surrender the Premises on the expiration of this Lease and/or to remove all Tenant's fixtures and/or personal property pursuant to Section 9.1 hereof, Tenant shall indemnify and hold Landlord harmless for, from and against all claims, damages, loss or liability, including without limitation, any claim made by any succeeding tenant resulting from such failure to surrender by Tenant and any attorneys' fees and costs incurred by Landlord with respect to any such claim. 17.15 RULES AND REGULATIONS. At all times during the Term, Tenant shall comply with Rules and Regulations for the Building and the Project, as set forth in Exhibit H attached hereto, together with such amendments thereto as Landlord may from time to time reasonably adopt and enforce in a non-discriminatory fashion; provided that: (a) Tenant is given fifteen (15) days' advance notice of such modifications or new rules and regulations; and (b) Such modifications or new rules and regulations are (i) for the safety, care, order and cleanliness of the Project, (ii) do not unreasonably and materially interfere with Tenant's conduct of its business or Tenant's use and enjoyment of or its access to the Premises, or (iii) are of the type customarily imposed for similar buildings. If a Rule or Regulation conflicts with or is inconsistent with any Lease provision, the Lease provision controls. Landlord agrees not to enforce the Rules and Regulations in a discriminatory fashion. 17.16 PARKING. Unless Tenant is in default hereunder and subject to any reduction due to governmental requirements, Tenant shall be entitled to the number of reserved vehicle parking spaces designated in Section 1.1(q) hereof for the exclusive use of Tenant, its employees, visitors and customers. All unreserved parking spaces shall be available for the common use of the tenants, subtenants and invitees of the Project on a non-exclusive basis, subject to any reasonable restrictions from time to time imposed by Landlord. Tenant shall not use or permit its officers, employees or invitees to use more than the number of spaces designated in Section 1.1(q) or any spaces which have been specifically reserved by Landlord to other tenants or for such other uses as have been designated by appropriate governmental entities as being restricted to certain uses. Tenant shall at all times comply and cause its officers, employees and invitees to comply with any parking Rules and Regulations as Landlord may from time to time reasonably adopt. 17.17 NO NUISANCE. Tenant shall conduct its business and control its agents, employees, invitees and visitors in such a manner as not to create any nuisance, or interfere with, annoy or disrupt any other tenant or Landlord in its operation of the Building or Project. 17.18 BROKER; AGENCY DISCLOSURE. Landlord has not engaged any real estate broker or agent in connection with this Lease. Tenant has entered into an agreement with Colliers International ("Colliers") pursuant to which Colliers has advised Tenant. Tenant is responsible for the payment of all fees and commissions to Colliers in connection with this Lease. Landlord has no responsibility for any such fees or commissions. Tenant shall indemnify and hold harmless Landlord from and against any and all claims, demands, losses, liabilities, lawsuits, judgments, costs and expenses (including without limitation, attorneys' fees and costs) with respect to any leasing commission or equivalent compensation alleged to be owing on account of Tenant's discussions, negotiations and/or dealings with Colliers, whose fee shall be paid by Tenant. 17.19 LANDLORD'S RIGHT TO PERFORM. Upon Tenant's failure to perform any obligation of Tenant hereunder after notice from Landlord pursuant to Section 13.1 above, including without limitation, payment of Tenant's insurance premiums and charges of contractors who have supplied materials or labor to the Premises. Landlord shall have the right to perform such obligation of Tenant on behalf of Tenant and/or to make payment on behalf of Tenant to such parties. Tenant shall reimburse Landlord the reasonable cost of Landlord's performing such obligation on Tenant's behalf, including reimbursement of any amounts that may be expended by Landlord, plus interest at the Default Rate, as Additional Rent. 17.20 ASSIGNMENT BY LANDLORD. In the event of a sale, conveyance, or other transfer by Landlord of the Building, the Project, or portion thereof on which the Building is located, or in the event of an assignment of this Lease by Landlord, the same shall operate to release Landlord from any further liability upon any of the covenants or conditions, express or implied, herein contained on the part of Landlord, and from any and all further liability, obligations, costs and expenses, demands, causes of action, claims or judgments arising out of this Lease from and after the effective date of said release. In such event, Tenant agrees to look solely to the successor in interest of Landlord with respect to liabilities accruing after the date of such sale, conveyance, transfer, or assignment. If any Security Deposit is given by Tenant to secure performance of Tenant's covenants hereunder, Landlord shall transfer such Security Deposit to any purchaser and thereupon Landlord shall be discharged from any further liability in reference thereto. Notwithstanding anything in this Lease to the contrary, however, (i) in no event shall Landlord's lender, who may have succeeded to the interest of Landlord by foreclosure, deed in lieu of foreclosure, or any other means, have any liability for any obligation of Landlord to protect, defend, indemnify or hold harmless Tenant or any other person or entity except for those matters arising from the lender's breach of the terms of this Lease after the date of such foreclosure, deed in lieu of foreclosure or any other means, and (ii) such succeeding lender shall have no liability for any representations or warranties of the Landlord contained herein except for those matters arising from the lender's breach of the terms of this Lease after the date of such foreclosure, deed in lieu of foreclosure or any other means. 17.21 ENTIRE AGREEMENT. This Lease sets forth all covenants, promises, agreements, conditions and understandings between Landlord and Tenant concerning the Building and the Project, and there are no covenants, promises, agreements, conditions or understandings, either oral or written, between Landlord and Tenant other than as are herein set forth. No subsequent alteration, amendment, change or addition to the Lease shall be binding upon Landlord or Tenant unless reduced to writing and signed by Landlord and Tenant. 17.22 FINANCIAL COVENANTS. If Tenant is not a publicly traded company with its financial information readily available to the public on the Internet, at Landlord's request, Tenant shall provide Landlord with current annual audited financial statements and quarterly unaudited financial statements (all such statements shall be prepared in compliance with GAAP standards) setting forth Tenant's financial condition. 17.23 CONSENTS. Whenever the approval or consent of Landlord or Tenant is required under the terms of this Lease, such consent shall not be unreasonably withheld or delayed unless a different standard of approval is specifically set forth in the particular Section containing that particular consent requirement. 17.24 EXHIBITS. Exhibits A through H are attached to this Lease after the signatures and by this reference incorporated herein. 17.25 TIME. Time is of the essence with respect to the performance of every provision of this Lease in which time of performance is a factor. 17.26 AUTHORITY TO BIND LANDLORD. The individuals signing this Lease on behalf of Landlord hereby represent and warrant that they are empowered and duly authorized to bind Landlord to this Lease. 17.27 AUTHORITY TO BIND TENANT. The individuals signing this Lease on behalf of Tenant hereby represent and warrant that they are empowered and duly authorized to bind Tenant to this Lease. 17.28 INTERPRETATION. The parties hereto specifically acknowledge and agree that the terms of this Lease have been mutually negotiated and the parties hereby specifically waive the rule or principle of contract construction which provides that any ambiguity in any term or provision of a contract will be interpreted or resolved against the party which drafted such term or provision. 17.29 EXCUSED DELAYS. Except as otherwise set forth in this Section 17.30, neither party shall have liability to the other on account of the following acts (each of which is an "Excused Delay" and jointly all of which are "Excused Delays")" which shall include: (a) the inability to fulfill, or delay in fulfilling, any obligations under this Lease by reason of strike, lockout, other labor trouble, dispute or disturbance; (b) governmental regulation, moratorium, action, preemption or priorities or other controls; (c) shortages of fuel, supplies or labor; (d) any failure or defect in the supply, quantity or character of electricity or water furnished to the Premises by reason of any requirement, act or omission of the public utility or others furnishing the Building with electricity or water; or (e) for any other reason, whether similar or dissimilar to the above, or for act of God beyond a party's reasonable control. If this Lease specifies a time period for performance of an obligation of a party, that time period shall be extended by the period of any delay in the party's performance caused by any of the events of Excused Delay described herein; provided, that notwithstanding anything to the contrary above, no payment of money (whether as Base Rent, Tenant's Share of Operating Expenses, or any other payment due under this Lease) shall be postponed, delayed or forgiven by reason of any of the foregoing events of Excused Delay. 17.30 QUIET ENJOYMENT. Until such time as this Lease has expired or been terminated pursuant to this Lease, Tenant shall peaceably and quietly have, hold, and enjoy the Premises for the Term of this Lease without hindrance or disturbance by anyone. Landlord will defend Tenant's right to quiet enjoyment of the Premises from the lawful claims of all persons claiming through Landlord during the Term of the Lease. 17.31 LANDLORD'S REPRESENTATIONS AND WARRANTIES. Landlord represents and warrants as follows: (a) Landlord has received no written notice of any liens to be assessed against the Premises, Buildings, or Project; (b) Landlord has received no written notice or any current violation of any laws relating to the Premises, Buildings, or Project; (c) The execution, delivery, and performance of this Lease by Landlord will not result in any breach of, or constitute any default under, or result in the imposition of any lien or encumbrance on the Premises under any agreement or other instrument to which Landlord is a party or by which Landlord or the Premises might be bound; (d) To the best of Landlord's actual knowledge, there are no legal actions, suits, or other legal or administrative proceedings, including condemnation cases, pending or threatened, against the Premises, and Landlord is not aware of any fact that might result in any such action, suit, or other proceeding. ARTICLE XVIII RIGHT OF FIRST OFFER If space becomes available for lease in the Building, and Landlord elects to lease such space to a third party, Landlord agrees to give Tenant a one-time right of first offer as follows: Landlord shall give Tenant written notice of Landlord's intention to market such premises for lease (the "Offer Premises") and the terms under at which Landlord intends to market the Offer Premises for lease (the "Notice"). Landlord agrees not to market the Offer Premises for lease for 30 days following the date of the Notice (the "Negotiation Period") and, if Tenant is interested in leasing the Offer Premises at the price set forth in the Notice, Landlord agrees to negotiate in good faith with Tenant during the Negotiation Period the terms of Tenant's lease of the Offer Premises. If Landlord and Tenant do not enter into a binding written lease pertaining to the lease of the Offer Premises before the end of the Negotiation Period, Tenant's rights under this Article XVIII shall terminate and be of no further force or effect. IN WITNESS WHEREOF, the parties have executed this Lease as of the date first above written. "Landlord" "Tenant" SCHNITZER INVESTMENT CORP. SCHNITZER STEEL INDUSTRIES, INC. By: /s/ K. Novack By: /s/ R. Philip ----------------------------- ---------------------------- Its: CEO Its: CEO ---------------------------- ---------------------------- EXHIBIT A INTENTIONALLY OMITTED EXHIBIT B PROJECT SITE PLAN EXHIBIT C FLOOR PLAN EXHIBIT D WORK SCHEDULE WORK ACTIVITY MILESTONE - ------------- --------- REVIEW TENANT'S INITIAL SPACE PLAN Tenant Improvements Pricing Complete Pull Tenant Improvement Permit Commence Tenant Improvements Tenant Improvements Certificate of Occupancy Tenant's Occupancy & Lease Commencement Punch List Completion EXHIBIT E SCHEDULE OF TENANT IMPROVEMENT PLANS 3200 Yeon Remodel - First Floor and Lower Level Prepared by Yost Grube Hall DRAWING INDEX 6/27/03 ARCHITECTURAL - ------------- A0.01 Cover Sheet & Code Summary A1.01 Lower & First floor Demolition Plans A2.01 Lower & First Floor Floor Plans A4.01 Enlarged Plans - Toilet Rooms A6.01 Interior Elevations A7.01 Lower & First Floor Reflected Ceiling Plans A9.01 Partition Types & Typ Interior Details A9.02 Typ Ceiling Details A9.03 Interior Details A10.01 Lower & First Floor Finish Plans MECHANICAL - ---------- M0.01 Mechanical Legend & Abbreviations M1.02 Mechanical Details M0.02 Mechanical Details M0.03 Mechanical Schedules M0.04 Mechanical Specifications M1.01 Mechanical Demolition Floor Plans M2.01 Mechanical Floor Plans M2.02 Mechanical Roof Plans ELECTRICAL - ---------- E0.01 Electrical Legend & Abbreviations E0.02 Electrical Schedules E0.03 Specifications E1.01 Electrical Demolition Floor Plans - Power & Signal E1.02 Electrical Demolition Floor Plans - Lighting E2.01 Electrical Floor Plans Floor Plans - Power & Signal E2.02 Electrical Floor Plans - Lighting E2.02E Electrical Floor Plans - Egress Lighting E2.03 Electrical Roof Plans - Power E6.01 Electrical Single Line Diagram E7.01 Electrical Details EXHIBIT F LEASE CONFIRMATION This Lease Confirmation is made __________, 20__, by ____________________, a _______________________ ("Tenant"), who agree as follows: 1. Landlord and Tenant entered into a lease dated _______________, 20__, in which Landlord leased to Tenant and Tenant leased from Landlord the premises described in Section 2.1 of said Lease ("Premises"). All capitalized terms herein are as defined in the Lease. 2. Pursuant to the Lease, Landlord and Tenant agreed to and do hereby confirm the following matters as of the Commencement of the Term: a. _______________, 20__ is the Commencement Date of the Term of the Lease; b. _______________, 20___ is the expiration date of the Term of the Lease; c. The initial Base Rent under the Lease, subject to adjustments as provided in the Lease, is $__________. 3. Tenant confirms that: a. It has accepted possession of the Premises as provided in the Lease; b. The improvements required to be furnished by Landlord under the Lease have been furnished (subject to any corrective work or punch-list items of which Tenant has notified Landlord in accordance with the Lease); c. Landlord has fulfilled all its duties of an inducement nature; d. The Lease is in full force and effect and has not been modified, altered, or amended, except as follows: ______________________________________________ ______________________________________________; and e. There are no setoffs or credits against Rent, and no Security Deposit or prepaid rent has been paid except as provided by the Lease. 4. The provisions of this Lease Confirmation shall inure to the benefit, or bind, as the case may require, the parties and their respective successors and assigns, subject to the restrictions on assignment and subleasing contained in the Lease. Initials Landlord: _________________ Tenant: ___________________ EXHIBIT G ESTOPPEL CERTIFICATE __________________ __________________ __________________ Re: Lease dated __________, 2___ ("Lease") by and between ______________ ("Landlord"), and _______________ ("Tenant") Ladies and Gentlemen: Reference is made to the above-described Lease in which the undersigned is the Tenant. We understand that you are accepting an assignment of Landlord's rights under the Lease as ____________________, and we hereby, as a material inducement for you to consummate the transaction, represent that: 1. There are no modifications amendments, supplements, arrangements, side letters or understandings, oral or written, of any sort, modifying, amending, altering, supplementing or changing the terms of the Lease, except for those attached to this Certificate. 2. The Lease is in full force and effect, and the Lease has been duly executed and delivered by, and is a binding obligation of, the Tenant as set forth therein. 3. The undersigned acknowledges (a) that rent on the Lease has been paid up to and including _____________, 2___ (b) that monthly rent during the ______________ (___) years of the term of the Lease is $___________ per month, and (c) that rent has not been paid for any period after ____________, 2___ and shall not, except for any Prepaid Rent as specified in the Lease, be paid for a period in excess of one (1) month in advance. 4. To the current knowledge of the undersigned, the improvements on the Building are free from defects in design, materials and workmanship and the improvements meet all governmental requirements, including, but not limited to, zoning and environmental requirements. 5. To the current knowledge of the undersigned, the Lease is not in default, and Landlord has performed the obligations required to be preformed by Landlord under the terms thereof through the date hereof. Dated: ________________, 2___. Very truly yours, "Tenant" ___________________________ ___________________________ ___________________________ By: _______________________ Its: ______________________ EXHIBIT H OFFICE RULES AND REGULATIONS 1. SIGN. No sign, placard, picture, advertisement, name or notice shall be inscribed, displayed, printed or affixed on or to any part of the outside or inside of the Building, the Premises or the surrounding area without the written consent of the Landlord being first obtained. If such consent is given by Landlord, Landlord may regulate the manner of display of the sign, placard, picture, advertisement, name or notice. Landlord shall have the right to remove any sign, placard, picture, advertisement, name or notice which has not been approved by Landlord or is being displayed in a non-approved manner without notice to and at the expense of the Tenant. Tenant shall not place anything or allow anything to be placed near the glass of any window, door, partition or wall which may appear unsightly from outside of the Premises. 2. DIRECTORY. The bulletin board or directory of the Building will be provided exclusively for the display of the name and location of tenants and Landlord reserves the right to exclude any other names therefrom. 3. ACCESS. The sidewalks, halls, passages, exits, entrances, elevators and stairways shall not be obstructed by any of the tenants or used by them for any purpose other than for ingress to and egress from their respective Premises. The halls, passages, entrances, exits, elevators, stairways, balconies and roof are not for the use of the general public and the Landlord shall in all cases retain the right to control thereof and prevent access thereto by all persons whose presence in the judgment of the Landlord shall be prejudicial to the safety, character, reputation and interests of the Building or its tenants; provided, however, that nothing herein contained shall be construed to prevent access by persons with whom the Tenant normally deals in the ordinary course of Tenant's business unless such persons are engaged in illegal activities. No Tenant and no employees or invitees of any Tenant shall go upon the roof of the Building. 4. LOCKS. Tenant shall not alter any lock or install any new additional locks or any bolts on any door of the Premises without the written consent of Landlord. 5. RESTROOMS. The toilet rooms, urinals, wash bowls and other apparatus shall not be used for any purpose other than that for which they were constructed and no foreign substance of any kind whatsoever shall be thrown therein. The expense of any breakage, stoppage or damage resulting from a violation of this rule shall be borne by the Tenant who, or whose employees, sublessees, assignees, agents, licensees, or invitees shall have caused it. 6. NO DEFACING PREMISES. Tenant shall not overload the floor of the Premises, shall not mark on or drive nails, screw or drill into the partitions, woodwork or plaster (except as may be incidental to the hanging of wall decorations), and shall not in any way deface the Premises or any part thereof. 7. SAFES AND HEAVY EQUIPMENT. No furniture, freight or equipment of any kind shall be brought into the Building without the consent of Landlord and all moving of the same into or out of the Building shall be done at such time and in such manner as Landlord shall designate. Landlord shall have the right to prescribe the times and manner of moving all heavy equipment in and out of the Building. Landlord will not be responsible for loss of or damage to any such safe or property from any cause and all damage done to the Building by moving or maintaining any such safe or other property shall be repaired at the expense of Tenant. There shall not be used in any Premises or in the public halls of the Building, either by any tenant or others, any hand trucks except those equipped with rubber tires and side guards. Elevators must be padded while moving freight via the elevators. All such heavy equipment shall be subject to the requirements of Rule 25 below. 8. NUISANCE. Tenant shall not use, keep or permit to be used or kept any noxious gas or substance in the Premises, or permit or suffer the Premises to be occupied or used in a manner offensive or objectionable to the Landlord or other occupants of the Building by reason of excessive noise, odors and/or vibrations, or unreasonably interfere in any way with other tenants or those having business in the Building. No animals or birds shall be brought in or kept in or about the Premises or the Building. No Tenant shall make or permit to be made any unreasonably disturbing noises or unreasonably disturb or interfere with occupants of this or neighboring Buildings or Premises, or with those having business with such occupants by the use of any musical instrument, radio, phonograph, unusual noise, or in any other way. No Tenant shall throw anything out of doors or down the passageways. 9. PERMITTED USE. The Premises shall not be used for manufacturing or for the storage of merchandise except as such storage may be incidental to the use of the Premises for general office purposes. No Tenant shall occupy or permit any portion of its Premises to be occupied for the manufacture or sale of liquor, narcotics, or tobacco in any form, or as a medical office, or as a barber shop or manicure shop except with prior written consent of Landlord. No Tenant shall advertise for laborers giving an address at the Premises. The Premises shall not be used for lodging or sleeping or for illegal purposes. 10. HAZARDOUS SUBSTANCES. Tenant shall not use or keep in the Premises or the Building any kerosene, gasoline or inflammable or combustible fluid or material or any Hazardous Materials as defined in Section 10.2 of the Lease or use any method of heating or air conditioning other than that supplied by Landlord. 11. TELEPHONES. Landlord will direct electricians as to where and how telephone and telegraph wires are to be introduced. No boring or cutting for or stringing of wires will be allowed without the consent of Landlord. The location of telephones, call boxes and other office equipment affixed to the Premises shall be subject to the approval of Landlord. 12. KEYS. All keys to the Building, Premises, rooms and toilet rooms shall be obtained from Landlord's office and Tenant shall not from any other source duplicate or obtain keys or have keys made. The Tenant, upon termination of the tenancy, shall deliver to the Landlord the keys to the Building, Premises, rooms and toilet rooms which shall have been furnished and shall pay the Landlord the cost of replacing any lost key or of changing the lock or locks opened by such lost key if Landlord deems it necessary to make such change. 13. FLOOR COVERING. No Tenant shall lay linoleum, tile, carpet or other similar floor coverings so that the same shall be affixed to the floor or the Premises in any manner except as approved by the Landlord. The expense of repairing any damage resulting from a violation of this rule or removal of any floor covering shall be borne by the Tenant by whom, or by whose contractors, agents, sublessees, licensees, employees or invitees, the floor covering shall have been laid. 14. BUILDING CLOSURE. During all hours on legal holidays and such other times as reasonably determined by Landlord from time to time, access to the Building or to the halls, corridors, or stairways in the Building, or to the Premises may be refused unless the person seeking access is known to any person or employee of the Building in charge and has a pass or is properly identified. The Landlord shall in no case be liable for damages for any error with regard to the admission to or exclusion from the Building of any person. In case of invasion, mob, riot, public excitement, or other commotion, the Landlord reserves the right to prevent access to the Building during the continuance of the same, by closing the doors or otherwise, for the safety of the tenants and protection of the Building and property located therein. Anything to the foregoing notwithstanding, Landlord shall have no duty to provide security protection for the Building at any time or to monitor access thereto. 15. PREMISES CLOSURE. Tenant shall see that the doors of the Premises are closed and securely locked before leaving the Building and that all water faucets, and water apparatus are entirely shut off before Tenant or Tenant's employees leave the Building. Tenant shall be responsible for any damage to the Building or other tenants caused by a failure to comply with this rule. Tenant shall at all times keep the perimeter doors and windows to the Premises closed. 16. DISORDERLY CONDUCT. Landlord reserves the right to exclude or expel from the Building any person who, in the judgment of Landlord, is intoxicated or under the influence of liquor or drugs, or who shall in any manner do any act in violation of any of the rules and regulations of the Building. 17. TENANT REQUESTS. Any requests of Tenant will be considered only upon application at the office of the Landlord. Employees of Landlord shall not be requested to perform any work or do anything outside of their regular duties unless under special instructions from the Landlord. 18. VENDING MACHINES. No vending machine shall be installed, maintained or operated upon the Premises without the written consent of the Landlord. 19. BUILDING NAME AND ADDRESS. Landlord shall have the right, exercisable without notice and without liability to Tenant, to change the name and the street address of the Building of which the Premises are a part. 20. EMERGENCY REGULATIONS. Tenant agrees that it shall comply with all emergency regulations that may be issued from time to time by Landlord and Tenant also shall provide Landlord with the names of a designated responsible employee to represent Tenant in all matters pertaining to emergency regulations. 21. TENANT ADVERTISING. Without the written consent of Landlord, Tenant shall not use the name of the Building in connection with or in promotion or advertising the business of Tenant except as Tenant's address. 22. EMERGENCY INFORMATION. Tenant must provide Landlord with names and telephone numbers to contact in case of emergency. Tenant must fill out a tenant emergency information sheet and return it to Landlord's office within three (3) days of occupancy. 23. INSTALLATION OF BURGLAR AND INFORMATIONAL SERVICES. If Tenant requires telegraphic, telephonic, burglar alarm or similar services, it shall first obtain, and comply with, Landlord's instructions in their installation. 24. FLOOR LOADS. Tenant shall not place a load upon any floor of the Premises which exceeds the load per square foot, which such floor was designed to carry and which is allowed by law. Landlord shall have the right to prescribe the weight, size and position of all equipment, materials, furniture or other property brought into the Building. Heavy objects shall, if considered necessary by Landlord, stand on such platforms as determined by Landlord to be necessary to properly distribute the weight, which platforms shall be provided at Tenant's expense. Business machines and mechanical equipment belonging to Tenant, which cause noise or vibration that may be transmitted to the structure of the Building or to any space therein to such a degree as to be objectionable to Landlord or to any tenants in the Building, shall be placed and maintained by Tenant, at Tenant's expense, on vibration eliminators or other devices sufficient to eliminate noise or vibration. The persons employed to move such equipment in or out of the Building must be acceptable to Landlord. Landlord will not be responsible for loss of, or damage to, any such equipment or other property from any cause, and all damage done to the Building by maintaining or moving such equipment or other property shall be repaired at the expense of Tenant. 25. ENERGY CONSERVATION. Tenant shall not waste electricity, water or air conditioning and agrees to cooperate fully with Landlord to assure the most effective operation of the Building's heating and air-conditioning and to comply with any governmental energy-saving rules, laws or regulations of which Tenant has actual notice, and shall refrain from attempting to adjust controls. Tenant shall keep corridor doors closed. 26. NO ANTENNAS. Tenant shall not install any radio or television antenna, loudspeaker or other devices on the roof or exterior walls of the Building. Tenant shall not interfere with radio or television broadcasting or reception from or in the Building or elsewhere. 27. NO SOLICITING. Canvassing, soliciting and distribution of handbills or any other written material, and peddling in the Building are prohibited, and Tenant shall cooperate to prevent such activities. 28. PROHIBITED USES. The Premises shall not be used for any improper, immoral or objectionable purpose. No cooking shall be done or permitted on the Premises without Landlord's consent, except that use by Tenant of Underwriters Laboratory approved equipment for brewing coffee, tea, hot chocolate and similar beverages or use of microwave ovens for employee use shall be permitted, provided that such equipment and use is in accordance with all applicable federal, state, county and city laws, codes, ordinances, rules and regulations. 29. ENFORCEMENT OF RULES. Landlord may waive any one or more of these Rules and Regulations for the benefit of Tenant or any other Tenant but no such waiver by Landlord shall be construed as a waiver of such Rules and Regulations in favor of Tenant, nor prevent Landlord from thereafter enforcing any such Rules and Regulations against any or all of the tenants of the Building. 30. LEASE. These Rules and Regulations are in addition to, and are made a part of, the terms, covenants, agreements and conditions of Tenant's Lease of its Premises in the Building. 31. ADDITIONAL RULES. Landlord reserves the right to make such other Rules and Regulations or amendments hereto as, in its reasonable judgment, may from time to time be needed for safety and security, for care and cleanliness of the Building and for the preservation of good order therein. Tenant agrees to abide by all such Rules and Regulations hereinabove stated and any additional rules and regulations which are adopted. 32. OBSERVANCE OF RULES. Tenant shall be responsible for the observance of all of the foregoing rules by Tenant's employees, agents, licensees, sublessees, assigns, and invitees. 33. MAINTENANCE OF FIRE EXTINGUISHERS. Tenant shall maintain in the Premises during the entire Lease Term, not less than the minimum number of fire extinguishers required by law and Tenant shall inspect all such fire extinguishers not less frequently than once each month to assure that the same are fully charged and in good operational condition. Annually the Tenant shall have all fire extinguishers inspected by an authorized and qualified inspector who shall certify that each such fire extinguisher complies with all applicable requirements of the NFPA. If any such fire extinguishers fail to obtain such certification, then within three (3) business days after such failure such fire extinguishers shall be replaced, or repaired, and re-inspected and a certification shall be issued certifying that all such fire extinguishers comply with all applicable requirements of the NFPA. 34. EMERGENCY. In the event of a fire or other emergency threatening property or health and safety, Tenant shall immediately notify the appropriate emergency response officials and Landlord of such emergency. TABLE OF CONTENTS Page ARTICLE I DEFINITIONS....................................................1 1.1 Defined Terms..................................................1 ARTICLE II PREMISES AND COMMON AREAS LEASED...............................3 2.1 Premises.......................................................3 2.2 Common Areas...................................................3 2.3 Shared Use of Building Areas...................................3 ARTICLE III IMPROVEMENTS...................................................4 3.1 Construction of Premises.......................................4 3.2 Completion and Delivery........................................5 3.3 Relocation; Continuance of Current Lease During Construction...5 3.4 Repaint and Recarpeting........................................6 ARTICLE IV TERM...........................................................6 4.1 Initial Term...................................................6 4.2 Notice of Commencement Date....................................6 4.3 Option to Extend...............................................6 ARTICLE V RENT...........................................................7 5.1 Base Rent......................................................7 5.2 Additional Rent................................................8 5.3 Late Payment...................................................8 5.4 Security Deposit. Intentionally deleted.......................8 ARTICLE VI ADDITIONAL RENT AND CHARGES....................................8 6.1 Operating Expenses.............................................8 6.2 Adjustments...................................................13 6.3 Tenant's Personal Property Taxes..............................13 ARTICLE VII INSURANCE.....................................................13 7.1 Landlord's Insurance..........................................13 7.2 Tenant's Public Liability.....................................14 7.3 Tenant's Property and Other Insurance.........................14 7.4 Form of Insurance/Certificates................................14 7.5 Tenant's Failure..............................................14 7.6 Waiver of Subrogation.........................................14 7.7 Tenant's Properties and Fixtures..............................15 7.8 Indemnification...............................................15 7.9 Damage to Tenant's Property...................................16 ARTICLE VIII REPAIRS AND MAINTENANCE.......................................16 8.1 Landlord Repairs and Maintenance..............................16 8.2 Utilities and Services........................................16 8.3 Tenant Repairs and Maintenance................................16 8.4 Non-liability of Landlord.....................................17 8.5 Inspection of Premises........................................17 8.6 Access by Tenant..............................................17 ARTICLE IX FIXTURES, PERSONAL PROPERTY AND ALTERATIONS...................17 9.1 Fixtures and Personal Property................................17 9.2 Alterations...................................................17 9.3 Liens.........................................................18 ARTICLE X USE AND COMPLIANCE WITH LAWS..................................18 10.1 General Use and Compliance with Laws..........................18 10.2 Hazardous Materials...........................................19 10.3 Signs.........................................................20 ARTICLE XI DAMAGE AND DESTRUCTION........................................21 11.1 Reconstruction................................................21 11.2 Rent Abatement................................................21 11.3 Excessive Damage or Destruction...............................21 11.4 Uninsured Casualty............................................21 11.5 Waiver........................................................21 11.6 Mortgagee's Right.............................................21 11.7 Damage Near End of Term.......................................22 ARTICLE XII EMINENT DOMAIN................................................22 ARTICLE XIII DEFAULT.......................................................22 13.1 Events of Default.............................................22 13.2 Remedies......................................................23 13.3 Landlord's Default............................................24 ARTICLE XIV FILING OF PETITION............................................24 ARTICLE XV ASSIGNMENT AND SUBLETTING.....................................25 15.1 Prohibition...................................................25 15.2 Excess Rental.................................................25 15.3 Scope.........................................................26 15.4 Waiver........................................................26 15.5 Change in Control.............................................26 ARTICLE XVI ESTOPPEL CERTIFICATE, ATTORNMENT AND SUBORDINATION............26 16.1 Estoppel Certificates.........................................26 16.2 Attornment....................................................27 16.3 Subordination.................................................27 16.4 Recording.....................................................27 16.5 Subordination of Landlord's Lien..............................27 ARTICLE XVII MISCELLANEOUS.................................................27 17.1 Notices.......................................................27 17.2 Successors Bound..............................................27 17.3 Waiver........................................................27 17.4 Subdivision and Easements.....................................28 17.5 Landlord's Reserved Rights in Common Areas....................28 17.6 Accord and Satisfaction.......................................28 17.7 Limitation of Landlord's Liability............................28 17.8 Survival......................................................28 17.9 Attorneys' Fees...............................................28 17.10 Captions and Article Numbers..................................28 17.11 Severability..................................................29 17.12 Applicable Law................................................29 17.13 Submission of Lease...........................................29 17.14 Holding Over..................................................29 17.15 Rules and Regulations.........................................29 17.16 Parking.......................................................29 17.17 No Nuisance...................................................30 17.18 Broker; Agency Disclosure.....................................30 17.19 Landlord's Right to Perform...................................30 17.20 Assignment by Landlord........................................30 17.21 Entire Agreement..............................................30 17.22 Financial Covenants...........................................30 17.23 Consents......................................................30 17.24 Exhibits......................................................31 17.25 Time..........................................................31 17.26 Authority to Bind Landlord....................................31 17.27 Authority to Bind Tenant......................................31 17.28 Interpretation................................................31 17.29 Excused Delays................................................31 17.30 Quiet Enjoyment...............................................31 17.31 Landlord's Representations and Warranties.....................31 ARTICLE XVIII RIGHT OF FIRST OFFER..........................................32 EX-10.2 4 exh10-2_12345.txt LEASE AGREEMENT DATED AUGUST 7, 2003 EXHIBIT 10.2 ------------ YEON BUSINESS CENTER (3330 NW YEON AVENUE) LEASE AGREEMENT SCHNITZER INVESTMENT CORP. (LANDLORD) AND SCHNITZER STEEL INDUSTRIES, INC. (TENANT) DATED: AUGUST 7, 2003 LEASE AGREEMENT THIS LEASE ("Lease") dated as of the 7th day of August, 2003, is made by and between SCHNITZER INVESTMENT CORP., an Oregon corporation ("Landlord"), and SCHNITZER STEEL INDUSTRIES, INC., an Oregon corporation ("Tenant"). ARTICLE I DEFINITIONS 1.1 DEFINED TERMS. The following terms shall have the meanings specified in this Section, unless otherwise specifically provided. Other terms may be defined in other parts of the Lease. (a) Landlord: SCHNITZER INVESTMENT CORP. (b) Landlord's Address: c/o Schnitzer Northwest, LLC 5800 Meadow Road, Suite 200 Lake Oswego, OR 97035 Telephone: (503) 598-1842 Facsimile: (503) 598-1843 With a Copy to: Ball Janik LLP 101 SW Main Street, Suite 1100 Portland, Oregon 97204 Attn: Barbara W. Radler Telephone: (503) 228-2525 Facsimile: (503) 295-1058 (c) Landlord's Address Schnitzer Investment Corp. for payment of Rent PO Box 4000 M/S 78 Portland, OR 97208 (d) Tenant: SCHNITZER STEEL INDUSTRIES, INC. (e) Tenant's Address: 3200 NW Yeon Avenue PO Box 10047 Portland, OR 97296-0047 Attn: Kelly E. Lang (f) Tenant's Use: General office use, information services, and related, incidental uses (g) Project: Yeon Business Center, including all buildings and Common Areas thereon and related thereto, as depicted on the Project Site Plan attached as Exhibit A. (h) Building: That certain building designated as Building 3 on the Project Site Plan attached hereto as Exhibit A with a rentable area of approximately 16,852 square feet, and with a street address of 3330 NW Yeon Avenue, Portland, Oregon. (i) Premises: Approximately 5,043 rentable square feet on the second floor of the Building as depicted on the attached Exhibit B. -1- (j) Term: Commencing on the commencement date of the Lease Agreement between Landlord and Tenant pertaining to premises in the 3200 NW Yeon Building dated as of the same date of this Lease (the "Commencement Date"), and expiring on the last day of the month during the month that is ten (10) years after the Commencement Date. (k) Base Rent: MONTHS RENT PRSF (ANNUAL) MONTHLY INSTALLMENTS 1-12 $16.00 $6,724.00 13-24 $16.40 $6,892.10 25-36 $16.81 $7,064.40 37-48 $17.23 $7,240.91 49-60 $17.66 $7,421.62 61-72 $18.10 $7,606.53 73-84 $18.55 $7,795.64 85-96 $19.01 $7,988.95 97-108 $19.49 $8,190.67 109-120 $19.98 $8,396.60 (l) Base Year: 2004 (m) Prepaid Rent: $0.00 (n) Security Deposit: $0.00 (o) Tenant's Share of Building: 29.93% (p) Tenant's Share of Project: 1.88% (q) Surface Parking Spaces: 14 uncovered unreserved surface parking spaces in the Project shall be provided in the parking area adjacent to the Building for the non-exclusive use of Tenant, its employees and visitors, subject to reduction due to governmental regulation. (r) Exhibits: Exhibit A: Project Site Plan Exhibit B: Floor Plan Exhibit C: Lease Confirmation Exhibit D: Estoppel Certificate Exhibit E: Rules and Regulations ARTICLE II PREMISES AND COMMON AREAS LEASED 2.1 PREMISES. (a) Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord, subject to the provisions of this Lease, certain premises as more fully described on the attached Exhibit B ("Premises") located within that certain building ("Building") owned by Landlord and which is a portion of the "Project" identified in Section 1.1(g). The Site Plan for the Project attached hereto as Exhibit A is attached for location reference purposes only and shall not constitute a representation or warranty by Landlord to be the final plan of the Project, or to require Landlord to build any improvements, or to otherwise comply with the site plan or require Landlord to lease space to a particular tenant or type of tenant. -2- (b) The rentable areas of the Premises and of the Building specified in Section 1.1 are approximate. Tenant is satisfied with such approximations and with Landlord's measurement of the rentable areas of the Premises and of the Building. Tenant acknowledges that, except as otherwise expressly set forth in this Lease, neither Landlord nor any agent, property manager or broker of Landlord has made any representation or warranty with respect to the Premises, the Building, the Common Areas or the Project or their suitability for the conduct of Tenant' s business, and that except only for any improvements that Landlord has expressly agreed herein to construct and install, the Premises is leased in its "As-Is" condition existing at the time of execution of this Lease. 2.2 COMMON AREAS. In addition to the Premises, Tenant shall have the non-exclusive right to use in common with other tenants and/or occupants of the Project, the following areas appurtenant to the Building: parking areas and facilities, roadways, sidewalks, walkways, parkways, plazas, levees, driveways and landscaped areas and similar areas and facilities situated within the exterior areas of the Project and not otherwise designated for the exclusive or restricted use by Landlord and/or individual tenants of other buildings located within the Project (collectively, "Common Areas"). Common Areas also include the Building lobby, and shared entryways, restrooms, corridors, stairways, and elevators, as modified from time to time. Tenant's right to utilize the Common Areas shall at all times be subject to Landlord's reserved rights therein as described in Section 17.5 hereof, the Rules and Regulations referred to in Section 17.15 hereof, all encumbrances, easements, ground leases, and covenants, conditions and restrictions ("CC&Rs") now affecting or encumbering the Project and all encumbrances, easements, ground leases, and CC&R's affecting or encumbering the Project in the future, to the extent they do not materially and adversely affect Tenant's rights to use the Common Areas under this Lease. ARTICLE III IMPROVEMENTS 3.1 CONSTRUCTION OF PREMISES. (a) TENANT IMPROVEMENTS. Landlord or Landlord's space planner or architect, in cooperation with Tenant and its consultants, shall prepare plans and specifications for improvements (the "Tenant Improvements") to the Premises (the "Tenant Improvement Plans") which shall be subject to the approval of Landlord and Tenant, which approval shall not be unreasonably withheld. After the Tenant Improvement Plans have been prepared and approved by the parties, final pricing has been approved by Landlord and Tenant and building permits have been issued (if any), Landlord shall cause the Tenant Improvements to be constructed in accordance with the Tenant Improvement Plans. After final approval of the Tenant Improvement Plans, no changes to the Tenant Improvement Plans shall be made except with the approval of both Landlord and Tenant. Landlord shall cause the Tenant Improvements to be completed in a good and workmanlike manner and in compliance with the building permit issued therefor (if any) by the City of Portland. Landlord shall work diligently and in good faith to complete the Tenant Improvements within one year following the Commencement Date. Upon substantial completion of the Tenant Improvements in the Premises, Landlord's architect shall measure the number of rentable square feet in the Premises (using the American National Standard Method of Measuring Floor Area in Office Buildings, ANSI-BOMA Z65.1-1996, published by the Building Owners and Managers Association International). The resulting number shall be the number of rentable square feet in the Premises for all purposes of the Lease. If the resulting number differs from 5,043 rentable square feet, then Base Rent, Tenant's Share of the Building, Tenant's Share of the Project, and Tenant's Share of the Operating Expense Increase shall be adjusted accordingly. (b) PAYMENT OF TENANT IMPROVEMENTS COSTS. Landlord will pay up to the sum of $50,430.00 (the "Improvement Allowance") ($10.00 per rentable square foot of the Premises) toward the Tenant Improvements pursuant to the Tenant Improvement Plans, which costs shall include all costs, fees, and expenses incurred by Landlord in connection with the planning, design, installation, labor, materials and construction of the Tenant Improvements (collectively "Tenant Improvement Costs"). Any costs for the Tenant Improvements in excess of the Improvement Allowance shall be paid by Tenant within 15 days after Landlord's billing therefor. Tenant will, at its sole cost and expense, pay for any improvements to the Premises not expressly included in the Tenant Improvement Plans and shall arrange for the installation of all Tenant's furniture, fixtures and equipment associated with its business. Costs associated with Tenant's equipment, layout, design and construction coordination are also the sole responsibility of Tenant. -3- 3.2 CONTINUANCE OF CURRENT LEASE DURING CONSTRUCTION OF TENANT IMPROVEMENTS. Tenant currently leases the Premises pursuant to (a) a Lease Agreement dated February 18, 1997, as amended by a First Amendment of Lease dated February 22, 2002; (b) a Lease Agreement dated March 24, 1980, as amended by an Extension of Lease dated April 19, 1985, an Amendment to Lease dated June 4, 1987, a Second Extension of Lease dated April 15, 1988, a Third Extension of Lease dated September 1, 1988, a Second Amendment of Lease dated April 1, 1991, a Fourth Extension of Lease dated August 27, 1993, a Third Amendment of Lease dated May 29, 1996, a Fourth Amendment of Lease dated March 31, 1997, a Fifth Extension of Lease dated August 21, 1998, and a Sixth Extension of Lease dated February 22, 2002; (c) a Lease Agreement dated July 19, 2002; and (d) an Office Lease dated March 1, 1995, as amended by an Amendment of Lease dated March 31, 1997, an Extension of Lease dated August 21, 1998, and a Second Extension of Lease dated February 22, 2002 (collectively, the "Current Lease"). The Current Lease shall continue in full force and effect until the Commencement Date of this Lease. Effective immediately prior to the Commencement Date of this Lease (the "Termination Date"), the Current Lease shall terminate and all rights and obligations of Landlord and Tenant under the Current Lease shall terminate except for rights and obligations accrued as of the Termination Date pertaining to events occurring on or prior to the Termination Date. ARTICLE IV TERM 4.1 INITIAL TERM. The Term shall commence on the Commencement Date, as set forth in Section 1.1(j). The Term shall expire upon the date set forth in Section 1.1(j), unless sooner terminated as hereinafter provided. 4.2 NOTICE OF COMMENCEMENT DATE. Landlord shall use good faith efforts to inform Tenant of the estimated date of substantial completion at least five (5) days prior to such date. Upon ascertaining the date of substantial completion and the Commencement Date, Landlord shall deliver to Tenant a written confirmation in the form attached hereto as Exhibit C ("Lease Confirmation") of said dates of substantial completion and the Commencement Date. The Lease Confirmation shall be binding upon Tenant unless Tenant objects to the notice in writing delivered to Landlord within five (5) days of Tenant's receipt of said Lease Confirmation. 4.3 OPTION TO EXTEND. (a) Subject to and upon the terms and conditions set forth below, Tenant will have one option to extend the term of this Lease for one additional successive period of five years (the "Renewal Term"). (b) Tenant's option to extend the Term must be exercised by written notice given to Landlord (the "Renewal Notice") no less than 365 days prior to the end of the Initial Term. (c) Tenant shall not be permitted to extend the Term of this Lease if there exists any uncured Event of Default by Tenant as of the date of the Renewal Notice. (d) The Renewal Term will be on the same terms and conditions as this Lease except for the amount of monthly Base Rent. During the Renewal Term, Tenant shall pay as monthly Base Rent an amount equal to the greater of (a) the Base Rent and Additional Rent payable by Tenant immediately prior to the commencement of the Renewal Term or (b) Market Rent for the Premises for the Renewal Term. Market Rent during the Renewal Term shall be equal to rents typically payable for the five year Renewal Term for comparable space by tenants of buildings of comparable quality in the vicinity of the Premises, taking into account the base year for the Renewal Term as described in Section 4.3(f) below. Landlord and Tenant agree that once Tenant has timely delivered its Renewal Notice, both parties will be responsible for their respective rights and obligations under this Lease for the Renewal Term, regardless of the outcome of the Base Rent determination. The word "Term" shall be used throughout this Lease to include both the Initial Term and the Renewal Term, if applicable. (e) The Market Rent for the Renewal Term will be determined as follows: (i) If Tenant properly exercises its option to extend the Term for the Renewal Term, Landlord and Tenant shall attempt to agree as to the Market Rent at least 270 days prior to the expiration of the -4- Initial Term. If Landlord and Tenant do not agree as to the Market Rent by such date, then no later than 210 days prior to the expiration of the Initial Term, each shall designate a real estate broker having at least ten (10) years' experience in leasing space comparable to the Premises in the Portland metropolitan area or an MAI-certified appraiser having at least five (5) years' experience in the appraisal of lease rates of office space in the Portland metropolitan area. The two representatives so appointed shall determine the Market Rent for the Premises for the Renewal Term and each shall submit a copy of his or her determination of such Market Rent, along with supporting documentation, to Landlord and Tenant in writing, not less than 150 days prior to the expiration of the Initial Term. In the event a party fails to designate a representative at least 210 days prior to the expiration of the Initial Term, the determination of Market Rent by the representative designated by the other party shall be binding upon the parties for purposes of this Section 4.3(e). In the event a representative fails to submit the required written determination of Market Rent at least 150 days prior to the expiration of the Initial Term, the determination of the Market Rent by the other representative shall be binding upon the parties for the purposes of this Section 4.3(e). (ii) If the determination of the Market Rent given by the two representatives so appointed shall differ by less than ten percent (10%) of the greater of such two representatives' determinations, then the Market Rent shall be deemed to be the average of such two Market Rent determinations. In the event such determinations differ by ten percent (10%) or more of the greater of such two representatives' determinations, then Landlord and Tenant shall attempt to agree on the Market Rent. If the parties are unable to reach agreement at least 90 days before the expiration of the Initial Term, the two representatives originally designated shall designate a third representative, who shall meet the qualifications set forth in Section 4.3(e)(i) and who shall be the arbitrator. If the two representatives are unable to agree on an arbitrator, then either of the parties to this Lease, after giving not less than five days' prior notice to the other party, may apply to the presiding judge of the Multnomah County Circuit Court for the selection, as soon as is reasonably practicable, of an arbitrator who meets the foregoing qualifications. (iii) The arbitrator shall, by not later than 30 days prior to the expiration of the Initial Term, select the more reasonable of the two Market Rent determinations submitted by the first two representatives. The determination of Market Rent set forth in the written submission selected by the arbitrator shall be binding upon the parties for purposes of this Section 4.3(e). (iv) Landlord and Tenant shall each pay all costs of the representative selected by it pursuant to Section 4.3(e)(i). Landlord and Tenant shall share equally the cost of any arbitrator designated pursuant to Section 4.3(e)(ii). (v) In the event the Market Rent for the Renewal Term has not been determined by the arbitrator pursuant to the above procedure as of the commencement of the Renewal Term, Tenant shall continue to pay monthly installments of Base Rent based upon the Base Rent in effect as of the expiration of the Initial Term and, within ten (10) days after the Market Rent has been determined by the arbitrator, Tenant shall pay to Landlord the difference between (A) the total amount that should have been paid by Tenant as Base Rent with respect to the period from the commencement of the Renewal Term to the date of Tenant's payment (based on the arbitrator's determination), and (B) the total amount actually paid by Tenant with respect to such period. (f) If Tenant extends the Term of this Lease as set forth above, the "Base Year" for determining Tenant's obligation for the Operating Expense Increase will be adjusted to the last full calendar year of the Initial Term. ARTICLE V RENT 5.1 BASE RENT. The Base Rent ("Base Rent") shall be as set forth in Section 1.1(k). The Base Rent shall be paid in advance on the first day of each and every month during the Term to Landlord at the address set forth in Section 1.1(c) hereof or at such other place as Landlord may direct in writing, without any prior notice or demand therefor and without any abatement, deduction, offset or setoff whatsoever. If the Term commences on any day other than the first day of a calendar month and/or ends on any day other than the last day of a calendar month, -5- Base Rent for the fraction(s) of a month at the commencement and/or upon the expiration of the Term shall be prorated based upon the actual number of days in such fractional month(s). 5.2 ADDITIONAL RENT. In addition to Base Rent, Tenant shall pay to Landlord all sums of money or other charges required to be paid by the Tenant under this Lease (other than Base Rent), including but not limited to Tenant's Share of Operating Expense Increase (as defined in Article VI hereof) (all such sums being herein deemed "Additional Rent"), and whether or not the same are designated "Additional Rent" the same shall be payable in lawful money of the United States of America without deduction, set-off or abatement whatsoever. Any Additional Rent provided for in this Lease shall become due with the next monthly installment of Base Rent unless otherwise provided. The term "Rent", as used in this Lease, shall refer collectively to "Base Rent" and "Additional Rent." 5.3 LATE PAYMENT. If any payment of Rent is not received by Landlord within five (5) days after the same is due, Tenant shall pay to Landlord a late payment charge equal to three percent (3%) of the amount of such delinquent payment of Rent in addition to the installment of Rent then owing, regardless of whether or not a notice of default has been given by Landlord. In addition, Tenant shall pay interest on such late payment and late charge from the due date of the late payment at an interest rate equal to the higher of: (a) twelve percent (12%) or (b) the prevailing prime (reference) rate as published by Bank of America (or any successor bank) at its Seattle main branch office, or any successor rate of interest, plus three (3) percentage points, but in no event higher than the maximum rate permitted by applicable law (hereafter the "Default Rate"), until such amounts are paid. Landlord and Tenant recognize that the damages which Landlord will suffer as a result of Tenant's failure to timely pay Rent are difficult or impracticable to ascertain, and agree that said interest and late charge are a reasonable approximation of the damages which Landlord will suffer in the event of Tenant' s late payment. This provision shall not relieve Tenant from payment of Rent at the time and in the manner herein specified. Acceptance by Landlord of any such interest and late charge shall not constitute a waiver of Tenant's default with respect to said overdue amount, nor shall it prevent Landlord from exercising any other rights or remedies available to Landlord. 5.4 SECURITY DEPOSIT. Intentionally deleted. ARTICLE VI ADDITIONAL RENT AND CHARGES 6.1 OPERATING EXPENSES. In addition to Base Rent and other sums payable by Tenant under this Lease, Tenant shall pay to Landlord, as Additional Rent, Tenant's Share of the Operating Expense Increase (as such term is defined below). The "Operating Expense Increase" is defined as the amount by which the Operating Expenses of the Project in each calendar year, beginning with calendar year 2005, exceed the Operating Expenses of the Project for the Base Year. For the Initial Term of this Lease, the Base Year is calendar year 2004. (a) ESTIMATED EXPENSES. (i) Upon the Commencement Date, and thereafter prior to the commencement of each calendar year occurring wholly or partially within the Term or as soon as practical thereafter, Landlord shall estimate the annual Operating Expense Increase payable by Tenant pursuant to this provision, and Tenant shall pay to Landlord on the first day of each month in advance, one-twelfth (1/12th) of Tenant's Share of the estimated Operating Expense Increase. Landlord's estimate will be reasonable and based on standard real estate accounting practices consistently and fairly applied. If Tenant requests, Landlord will provide Tenant with reasonably detailed documentation to support Landlord's estimate. In the event that during any calendar year of the Term, Landlord reasonably determines that the actual Operating Expense Increase for such year will exceed the estimated Operating Expense Increase, Landlord may revise such estimate by written notice to Tenant, and Tenant shall pay to Landlord, concurrently with the regular monthly rent payment next due following the receipt of the revised estimate, an amount equal to the difference between the initial monthly estimate and the revised monthly estimate multiplied by the number of months expired during such calendar year and shall also pay an amount equal to the revised monthly estimate for the month of such payment. Subsequent installments shall be payable concurrently with the regular monthly Base Rent due for the balance of the calendar year and shall continue until the next calendar year's estimate is rendered or Landlord next revises its estimate of the Operating Expense Increase, whichever occurs sooner. -6- (ii) Within one hundred twenty (120) days following the end of each year or a reasonable time thereafter, Landlord shall provide Tenant with a written statement (the "Statement") of the actual total Operating Expenses for such year, showing in reasonable detail (A) the actual Operating Expenses for the calendar year, broken down by component expenses, such as repairs, administration, utilities, janitorial, and Real Property Taxes; (B) the Base Year Operating Expenses; (C) the Operating Expense Increase for the calendar year; (D) the amount of Tenant's Share of the Operating Expense Increase; (E) the amount actually paid by Tenant during the calendar year toward the Operating Expense Increase; (F) the amount Tenant owes toward the Operating Expense Increase or the amount Landlord owes as a refund, and (G) the "gross-up" information required by Section 6.1(a)(iii) of this Lease. If Tenant has overpaid the amount of the Operating Expense Increase owing pursuant to this provision, Landlord shall, provided Tenant is not then in default hereunder beyond any applicable cure period, return to Tenant the amount of such overpayment within thirty (30) days after Landlord's itemized Statement is delivered to Tenant. If Tenant has underpaid the amount of the Operating Expense Increase owing pursuant to this provision, Tenant shall pay the total amount of such deficiency to Landlord as Additional Rent with the next payment of Base Rent due under this Lease following delivery of written notice of said deficiency from Landlord to Tenant. (iii) In the event the average occupancy level of the Building or Project, as the case may be, for any calendar year was or is not one hundred percent (100%) of full occupancy, then the estimated Operating Expenses and actual Operating Expenses for such year shall be proportionately adjusted by Landlord to reflect those costs which would have occurred had the Building and/or Project, as the case may be, been one hundred percent (100%) occupied during such year. Such adjustment shall be based on Landlord's reasonable estimate consistently and fairly applied using standard real estate practices in the Portland, Oregon metropolitan area. (iv) Landlord shall keep its books of account and records concerning Operating Expenses in compliance with generally accepted standard real estate practices and retain the same for two (2) years after the calendar year for which they were prepared. Unless Tenant objects in writing regarding specific discrepancies in the Operating Expense calculations for any calendar year within 270 days after receipt of Landlord's final calculations for such calendar year, Tenant shall be deemed to have approved the same and to have waived the right to object to such calculations. Tenant, upon at least ten (10) days' advance written notice to Landlord and during business hours, may examine any invoices, receipts, canceled checks, vouchers or other records used to support the figures shown on the Statement, provided, however, that Tenant shall be entitled to such an examination only once in each calendar year and such examination shall only be of the Operating Expenses for the calendar year shown on the Statement. Tenant may only audit a specific calendar year once. Landlord may condition such review upon Tenant's (and its auditor's) execution of a reasonable form of confidentiality agreement. Except as provided in Section 6.1(a)(v) below, all costs of the review shall be borne by Tenant. If Tenant examines or audits Landlord's books and records under Section 6.1(a)(iv) or Section 6.1(a)(v)more than twice during the Term, Tenant shall reimburse all costs, fees, and expenses incurred by Landlord and its property manager in connection with the examination or audit, including, without limitation, photocopy charges, and administration fees for the time spent in connection with the audit or examination. All audits and examinations conducted by Tenant shall be conducted by an independent auditor with at least five years experience with standard real estate accounting practices in the Portland, Oregon area and such auditor shall not be compensated on a contingency fee basis. (v) Each Statement given by Landlord pursuant to this Section shall be conclusive and binding upon Tenant unless within 270 days after the receipt of such Statement Tenant shall notify Landlord that it disputes the correctness of the Statement, specifying the particular respects in which the Statement is claimed to be incorrect. If such disputes shall not have been settled by agreement, Tenant, at Tenant's expense, and after giving Landlord reasonable advance notice, may cause an examination or audit to be made of Landlord's books and records relating to such Statement by a certified public accountant, subject to the limitations set forth in Section 6.1(a)(iv). If the examination or audit discloses an error in the billings to Tenant, Tenant shall promptly pay the underpayment. If Landlord does not dispute the results of the audit, Landlord shall promptly pay to Tenant the overpayment, and if there has been an overpayment of greater than five percent (5%) of the amount of estimated Operating Expenses for the year in question, Landlord shall reimburse Tenant for the reasonable cost of the examination or audit. If Landlord disputes the results of the audit, Landlord and Tenant shall engage an independent -7- certified public accountant (the "CPA") who shall resolve the dispute by choosing the results of Tenant's audit or Landlord's position. If the CPA agrees with Tenant, Landlord shall pay the fees of the CPA. If the CPA agrees with Landlord, Tenant shall pay the fees of the CPA. (b) DEFINED TERMS. (i) OPERATING EXPENSES INCLUSIONS. For purposes of this Lease, "Operating Expenses" means an amount equivalent to the total of all expenses and costs incurred in connection with the ownership, operation, management, maintenance, repair and replacement of the Project, the Building and the Common Areas, including, but in no way limited to, the following: A. The costs of operating, maintaining, repairing and replacing the Project, the Building and the Common Areas, including but not limited to: gardening and landscaping; painting; lighting; sanitary control; personal property taxes; public liability insurance and property damage insurance; utilities for Common Areas; licenses and fees for Common Area facilities; sweeping; removal of snow and ice, trash, rubbish, garbage and other refuse; repairing, restriping and resurfacing of parking area; and maintenance of and property taxes on personal property, machinery and equipment used in Common Area maintenance. B. All Real Property Taxes (as defined below) assessed against the Project, the Building and/or the Common Areas, as applicable, including land, building(s) (including the Building) and improvements thereon or thereto. C. All premiums for liability, terrorism, fire, extended coverage and other insurance the Landlord reasonably deems necessary and keeps in force on or with respect to the Project, the Building of which the Premises are a part and/or the Common Areas, as the case may be, and commercially reasonable deductibles payable in connection therewith. D. The cost of operating, maintaining, repairing and replacing any electrical, mechanical, automatic fire sprinkler and other utilities systems serving the Premises which serve the Premises in common with the entire Building. E. The cost of maintenance, repair and replacement of the structural and non-structural portions of the roof, roof membrane, exterior walls, foundation, and other exterior portions of the Project and Building, and reasonable reserves for the same. F. Reasonable property management charges together with the costs incurred in the operation of a management office relating to the Project, including, but not limited to the cost of rent and utilities with respect thereto not to exceed the amount charged by an owner or an independent management company of comparable quality and experience. G. Annual amortization of capital improvements (x) made subsequent to the Commencement Date which are designed with a reasonable probability of improving the operating efficiency of the Project, or some part thereof, or (y) which are reasonably required under any amendment to any applicable law, any new law, or any new interpretation (as hereinafter defined) which amendment, law, or new interpretation is adopted or arose after the Commencement Date of this Lease, or (z) made subsequent to the Commencement Date and which are repairs or replacements of initial improvements. For the purposes of this Lease, a "new interpretation" shall mean any interpretation, enforcement or application occurring after the Commencement Date of a law enacted prior to the Commencement Date, which interpretation, enforcement or application imposes requirements with respect to the Project or Building that were not at the time of Landlord's execution of this Lease, applicable to the Project or Building. Annual amortization shall be determined by dividing the applicable capital expenditure over the useful life of such capital expenditure (as determined by GAAP) at an interest rate equal to the Prime Rate of Wells Fargo Bank plus two percent (2%). -8- H. Any other costs levied, assessed or imposed by or at the direction of, or resulting from statutes or regulations or interpretations thereof promulgated by any federal or governmental authority in connection with the use or occupancy of the Project. I. Assessments made on or with respect to the Project made pursuant to any CC&Rs, Local Improvement District conditions and/or owner's associations affecting the Project, or any portion thereof. J. Compensation (including wages and employer paid benefits and taxes ) of employees and contractors engaged in the operation and maintenance of the Project, and/or Building. (ii) OPERATING EXPENSE EXCLUSIONS. Notwithstanding the foregoing, Operating Expenses to be reimbursed by Tenant shall not include: A. Expenses which are separately metered or calculated for the Premises or other leased area of the Project or the Building, as the case may be, which expenses shall be billed separately to Tenant or such other tenant(s), as applicable. B. Costs incurred in connection with the initial construction or design of the Building or to correct defects in the original construction or design of the Building. C. Depreciation. D. Costs, fines or penalties incurred due to violation by Landlord of any applicable law. E. Expenses incurred by Landlord in respect of individual tenants and/or the improvement or renovation of tenants' leasehold improvements, including leasing commissions, attorneys' fees arising from lease disputes arising out of a tenant's failure to pay rent under its lease and other specific costs incurred for the account of, separately billed to and paid by specific tenants. F. Repairs or replacements to the extent that the cost of the same is recoverable by the Landlord pursuant to original construction warranties. G. Interest on debt or capital retirement of debt, and costs of capital improvements except as expressly provided above. H. Legal fees and disbursements relating to the entity that owns the Project. I. Costs incurred due to the gross negligence of Landlord or breach by Landlord of its obligations under any lease. J. Fines or penalties incurred due to violation by Landlord of any applicable law. K. Costs incurred because Landlord breached the terms of any lease. L. Overhead and profit paid to subsidiaries or affiliates of Landlord for management or other services on or to the Project or for supplies or other materials, to the extent that the costs of the services, supplies or materials exceed the amount customarily charged by an independent entity for similar services, supplies or materials of same or better quality. -9- M. Compensation paid to clerks, attendants and other persons in commercial concessions operated by Landlord. N. Advertising and promotional expenditures (except for Project identification and directional signage). O. Repairs or other work needed because of fire, windstorm or other casualty or cause insured against by Landlord to the extent Landlord receives insurance proceeds therefor. P. Costs of sculpture, paintings or other art. Q. Legal fees, costs, and disbursements relating to (i) disputes with tenants, (ii) enforcing any leases, or (iii) the defense of Landlord's title to, or interest in, the Buildings or Project. R. Costs incurred due to the intentional misconduct or intentional breach by Landlord of its obligations under any lease. S. Landlord's general corporate overhead and administrative expenses. Additional Rent payable by Tenant which would not otherwise be due until after the date of the expiration or earlier termination of the Lease shall, if the exact amount is uncertain at the time this Lease expires or terminates, be paid by Tenant to Landlord upon such expiration or termination in an amount to be reasonably determined by Landlord, with an adjustment to be made once the exact amount is known. T. Costs of capital improvements and replacements except as permitted under Section 6.1(b)(i)(G). (iii) TENANT'S SHARE. For purposes of this Lease, "Tenant 's Share" means the percentage, as set forth in Section 1.1(o) or Section 1.1(p), as appropriate, and obtained by dividing the rentable area of the Premises by the aggregate rentable area of all premises available for lease, whether leased or not, in the Building or the Project, as applicable with respect to any specific Operating Expense, subject to adjustment in the event of changes in rentable area of the Project, Building and/or Premises. Notwithstanding the above, Landlord shall have the right, but not the obligation, to equitably adjust Tenant's Share of any specific Operating Expense so as to render such expense payable proportionately by those tenants benefited by the same or otherwise in order to appropriately allocate such Operating Expense to cover the area covered by such Operating Expense. (iv) REAL PROPERTY TAXES. For purposes of this Lease, "Real Property Taxes" shall consist of all real estate taxes and all other taxes relating to the Building, the Project, the Common Areas and/or the Project, as applicable, all other taxes which may be levied in lieu of real estate taxes, all assessments, local improvement districts, assessment bonds, levies, fees and other governmental charges, including, but not limited to, charges for traffic facilities and improvements, water service studies, and improvements or amounts necessary to be expended because of governmental orders, whether general or special, ordinary or extraordinary, unforeseen as well as foreseen, of any kind and nature for public improvements, services, benefits, or any other purpose, which are assessed, levied, confirmed, imposed or become a lien upon the Building or any portion of the Project, and/or the Common Areas, or become payable during the Term (or which become payable after the expiration or earlier termination hereof and are attributable in whole or in part to any period during the Term hereof), together with all costs and expenses incurred by Landlord in successfully contesting, resisting or appealing any such taxes, rates, duties, levies or assessments. Any special assessments which may be paid in installments shall be deemed paid over the longest period allowable by law and only the installment due in any calendar year shall be included in Real Property Taxes. "Real Property Taxes" shall exclude any franchise, estate, inheritance or succession transfer tax of Landlord, or any federal or state income, profits or revenue tax or charge upon the net income of Landlord from all sources; provided, however, that if at any time during the Term there is levied or assessed against Landlord a federal, state or local tax or excise tax on rent, or any other tax however described on account of rent or gross -10- receipts or any portion thereof, Tenant shall pay one hundred percent (100%) of the Tenant's Share of any said tax or excise applicable to Tenant's Rent as Additional Rent. (c) POLICY STATEMENT. The purpose of this Section 6.1 is to fairly reimburse Landlord for the increased costs of those Operating Expenses for operating, maintaining, repairing, and managing the Buildings which benefit all of the Buildings' tenants. The reimbursement is not intended to provide an additional source of profit to Landlord. Accordingly, the purpose described above and the following principles are a statement of the parties' intent regarding Section 6.1: (i) Landlord will operate, maintain, repair, and manage the Building in a manner of at least the quality as other comparable buildings in Portland, Oregon. (ii) Landlord shall perform its obligation set forth in Section 6.1 in a cost-effective manner. (iii) The Operating Expenses shall be fairly and accurately calculated by Landlord. (iv) Examples of fair calculations include the exclusions in Section 6.1(b)(ii), and not charging for the same service in two different categories (such as an in-house manager and a management fee). 6.2 ADJUSTMENTS. (a) CREDITS/REIMBURSEMENTS. Operating Expenses shall be reduced by reimbursements, credits, discounts, reductions, or other allowances received by Landlord for items of cost included in Operating Expenses. (b) TAX REFUND. If Landlord receives a refund of any portion of Real Property Taxes that were included in the Operating Expenses actually paid by Tenant as an increase over the Real Property taxes for the Base Year, then Landlord shall reimburse Tenant Tenant's Share of the refunded taxes to the extent actually paid by Tenant, less any expenses that Landlord reasonably incurred to obtain the refund. (c) PRORATIONS. If this Lease (or an extended term hereof) begins or ends on a day other than the last day of a calendar year, Tenant's obligation to pay Tenant's Share of the Operating Expense Increase for that calendar year shall be prorated by multiplying Tenant's Share of that Operating Expense Increase by a fraction expressed as a percentage, the numerator of which is the number of days of the calendar year included within the Term of this Lease and the denominator of which is 365. 6.3 TENANT'S PERSONAL PROPERTY TAXES. Tenant shall pay or cause to be paid, prior to delinquency, any and all taxes and assessments levied upon all trade fixtures, inventories and other real or personal property placed or installed in and upon the Premises by Tenant. If any such taxes on Tenant's personal property or trade fixtures are levied against Landlord or Landlord's property or if the assessed value of the Building is increased by the inclusion therein of a value placed upon such real or personal property or trade fixtures of Tenant, and if Landlord pays the taxes based upon such increased assessment, Tenant shall, upon demand, repay to Landlord the taxes so levied or the portion of such taxes resulting from such increase in the assessment. ARTICLE VII INSURANCE 7.1 LANDLORD'S INSURANCE. During the Term, Landlord shall procure and maintain in full force and effect with respect to the Building (i) a policy or policies of standard "all-risk" fire insurance with extended coverage against damage and destruction by fire, vandalism, and all other "all risk" perils. The amount of such insurance shall be equal to the full replacement value of the Building, as the value may exist from time to time (including, to the extent required, sprinkler leakage, vandalism and malicious mischief coverage, and any other endorsements required by the holder of any fee or leasehold mortgage and earthquake, flood and terrorism insurance to the extent Landlord reasonably deems prudent and/or to the extent required by any mortgagee); and (ii) a policy of commercial -11- general liability insurance, in the form and content acceptable to Landlord, insuring Landlord's activities with respect to the Premises, the Common Areas and the Project for loss, damage or liability for personal injury or death of any person or loss or damage to property occurring in, upon or about the Premises, Common Areas or Project. If the annual premiums charged Landlord for such casualty and/or liability insurance exceed the standard premium rates because the nature of Tenant's operations results in increased exposure, then Tenant shall, upon receipt of appropriate premium invoices, reimburse Landlord for such increased amount. Landlord shall have the right, at its option, to keep and maintain in full force and effect during the Term such other insurance in such amounts and on such terms as Landlord and/or any mortgagees or the beneficiary of any first trust deed against the Building, or the portion of the Project, may reasonably require from time to time in form, in amounts and for insurance risks against which a prudent Landlord would protect itself, including but not limited to rental abatement, rental interruption, earthquake, flood and terrorism insurance. 7.2 TENANT'S PUBLIC LIABILITY. Tenant shall, at its own cost and expense, keep and maintain in full force during the Term and any other period of occupancy of the Premises by Tenant, a policy or policies of commercial general liability insurance, written by a reputable insurance company authorized to do business in the State of Oregon in form and content reasonably acceptable to Landlord insuring Tenant's activities with respect to the Premises, the Common Areas and the Project for loss, damage or liability for personal injury or death of any person or loss or damage to property occurring in, upon or about the Premises in an amount of not less than Three Million Dollars ($3,000,000) combined single limit or such larger amounts as may hereafter be reasonably requested by Landlord. The policy shall insure the hazards of the Premises and Tenant's operations therein, shall include independent contractor and contractual liability coverage (covering the indemnity contained in Section 7.8 hereof) and shall (a) name Landlord, Landlord's managing agent and the Landlord's mortgagee under a mortgage or beneficiary under a deed of trust either having a lien against the Building or Project (the "Lender") as an additional insured; (b) contain a cross-liability provision and; (c) contain a provision that the insurance provided hereunder shall be primary and non-contributing with any other insurance available to Landlord. 7.3 TENANT'S PROPERTY AND OTHER INSURANCE. Tenant shall, at its own cost and expense, keep and maintain in full force during the Term and any other period of occupancy of the Premises, a policy or policies of standard form property insurance insuring against the perils of fire, extended coverage, vandalism, malicious mischief, special extended coverage and sprinkler leakage. This insurance policy shall be upon all property owned by Tenant, for which Tenant is legally liable or that was installed at Tenant's expense, and which is located in the Premises, including without limitation, furniture, fittings, installations, cabling, fixtures (other than the improvements installed by Landlord), and any other personal property, in the amount of not less than one hundred percent (100%) of the full replacement costs thereof. 7.4 FORM OF INSURANCE/CERTIFICATES. All policies shall be written in a form satisfactory to Landlord and shall be taken out with insurance companies licensed in the state in which the Building is located and holding a General Policy Holder' s Rating of "A" and a financial rating of "X" or better, as set forth in the most current issues of Best's Insurance Guide. Each party shall furnish to the other, prior to the Commencement Date and thereafter within ten (10) days prior to the expiration of each such policy, a certificate of insurance (or renewal thereof) issued by the insurance carrier of each policy of insurance carried by the party pursuant hereto and, upon request by the other party, a copy of each such policy of insurance. Said certificates shall expressly provide that such policies shall not be cancelable or subject to reduction of coverage below the minimum amounts required by this Lease or required by any lender having an interest in the Building or otherwise be subject to modification except after thirty (30) days prior written notice to the parties named as insured in Section 7.2. 7.5 TENANT'S FAILURE. If Tenant fails to maintain any insurance required in the Lease, Tenant shall be liable for any loss or cost resulting from said failure, and Landlord shall have the right to obtain such insurance on Tenant's behalf and at Tenant's sole expense. This Section 7.5 shall not be deemed to be a waiver of any of Landlord's rights and remedies under any other section of this Lease. If Landlord obtains any insurance which is the responsibility of Tenant to obtain under this Article VII, Landlord shall deliver to Tenant a written statement setting forth the cost of any such insurance and showing in reasonable detail the manner in which it has been computed and Tenant shall promptly remit said amount as Additional Rent to Landlord. -12- 7.6 WAIVER OF SUBROGATION. Any all risk policy or policies of fire, extended coverage or similar casualty insurance which either party obtains in connection with the Building, the Premises or Tenant's personal property therein shall include a clause or endorsement denying the insurer any rights of subrogation against the other party to the extent rights have been waived by the insured prior to the occurrence of injury or loss. Landlord and Tenant waive any rights of recovery against the other for liability, injury or loss due to hazards covered by insurance containing such a waiver of subrogation clause or endorsement to the extent of the liability, injury or loss covered thereby. 7.7 TENANT'S PROPERTIES AND FIXTURES. Tenant assumes the risk of damage to any furniture, equipment, machinery, goods, supplies or fixtures which are or remain the property of Tenant or as to which Tenant retains the right of removal from the Premises, except to the extent due to the gross negligence or willful misconduct of Landlord. Tenant shall not do or keep anything in or about the Premises (except those things Tenant presently does and keeps in connection with the uses set forth in Section 10.1) which will in any way tend to increase insurance rates paid by Landlord and maintained with respect to the Premises and/or the Project unless Tenant pays directly to Landlord the increase cost of the premiums. In no event shall Tenant carry on any activities which would invalidate any insurance coverage maintained by Landlord. If at any time Tenant's occupancy or business in, or on, the Premises, whether or not Landlord has consented to the same, results in any increase in premiums for the insurance carried by Landlord with respect to the Building and/or the Project, Tenant shall pay any such increase in premiums as Additional Rent within ten (10) days after being billed therefore by Landlord. In determining whether increased premiums are a result of Tenant's use of the Building, a schedule issued by the organization computing the insurance rate on the Building and/or the Project showing the various components of such rate shall be conclusive evidence of the several items and charges which make up such rate. Tenant shall promptly comply with all reasonable requirements of the insurance underwriters and/or any governmental authority having jurisdiction thereover, necessary for the maintenance of reasonable fire and extended insurance for the Building and/or the Project. 7.8 INDEMNIFICATION. (a) Tenant, as a material part of the consideration to be rendered to Landlord, hereby indemnifies and agrees to defend and hold Landlord, Landlord's managing agent and Lender, the Premises, and the Project harmless for, from and against (i) any and all liability, penalties, losses, damages, costs and expenses, demands, causes of action, claims, judgments or appeals arising from any injury to any person or persons or any damage to any property to the extent as a result of Tenant's or Tenants' officers, employees, agents, assignees, subtenants, concessionaires, licensees, contractors or invitees' use, maintenance, occupation, operation or control of the Premises during the Term, or resulting from any breach or default in the performance of any obligation to be performed by Tenant hereunder or for which Tenant is responsible under the terms of this Lease or pursuant to any governmental or insurance requirement, or to the extent arising from any act, neglect, fault or omission of Tenant or any of Tenant's officers, employees, agents, servants, subtenants, concessionaires, licensees, contractors or invitees, and (ii) from and against all reasonable legal costs and charges, including reasonable attorneys' and other reasonable professional fees, incurred in and about any of such matters and the defense of any action arising out of the same or in discharging the Project and/or Premises or any part thereof from any and all liens, charges or judgments which may accrue or be placed thereon by reason of any act or omission of the Tenant, except and to the extent as may arise out of the negligence or willful misconduct of Landlord and/or its agents, officers, employees, contractors or invitees. (b) Landlord, as a material part of the consideration to be rendered to Tenant, hereby indemnifies and agrees to defend and hold Tenant and the Premises harmless from and against (i) any and all liability, penalties, losses, damages, costs and expenses, demands, causes of action, claims, judgments or appeals arising from any injury to any person or persons or any damage to any property to the extent as a result of Landlord's or Landlord's employees, agents, or contractors, gross negligence or willful misconduct, or resulting from any breach or default in the performance of any obligation to be performed by Landlord hereunder or for which Landlord is responsible under the terms of the Lease or pursuant to any governmental or insurance requirement, and (ii) from and against all reasonable legal costs and charges, including reasonable attorneys' and other reasonable professional fees, incurred in and about any of such matters and the defense of any action arising out of the same or in discharging Tenant and/or Premises or any part thereof from any and all liens, charges or judgments which may -13- accrue or be placed thereon by reason of any act or omission of the Landlord, except and to the extent as may arise out of the negligence or willful misconduct of Tenant and/or its officers, agents, employees, assignees, subtenants, concessionaires, licensees, contractors, or invitees. (c) In no event shall Landlord, its agents, employees and/or contractors be liable for any personal injury or death or property damage caused by other lessees or persons in or about the Premises, the Project and/or the Building, as the case may be, or caused by public or quasi-public work, or for consequential damages arising out of any loss of the use of the Premises or any equipment or facilities therein by Tenant or any person claiming through or under Tenant. 7.9 DAMAGE TO TENANT'S PROPERTY. Notwithstanding the provisions of Section 7.8 to the contrary, except to the extent due to the gross negligence or willful misconduct of Landlord, Landlord, its agents, employees and/or contractors shall not be liable for (i) any damage to property entrusted to employees or security officers of the Project or the Building, (ii) loss or damage to any property by theft or otherwise, or (iii) any injury or damage to persons or property resulting from fire, explosion, falling substances or materials, steam, gas, electricity, water or rain which may leak from any part of the Building, the Common Areas, or the Project or from the pipes, appliances or plumbing work therein or from the roof, street, or subsurface or from any other place or resulting from dampness or any other cause, except to the extent Landlord receives consideration for such damage or injury from a third party. Neither Landlord nor its agents, employees or contractors shall be liable for interference with light. Tenant shall give prompt notice to Landlord and appropriate emergency response officials if Tenant is or becomes aware of fire or accidents in the Building, the Common Areas or any other portion of the Project or of defects therein in the fixtures or equipment. ARTICLE VIII REPAIRS AND MAINTENANCE 8.1 LANDLORD REPAIRS AND MAINTENANCE. Subject to Landlord's right to reimbursement from Tenant pursuant to Sections 6.1 and 8.3, Landlord shall at its expense maintain in good condition and repair the Building including without limitation the foundation, roof and membrane and shall maintain in good condition the exterior of the Building, utilities, the Building systems (including HVAC, plumbing, electrical, and mechanical), common area doors, windows, and walls, and light fixtures, and the Common Areas of the Project. Landlord shall not be liable for any failure to make any repairs or to perform any maintenance unless such failure shall persist for an unreasonable time after written notice of the need for such repairs or maintenance is given to Landlord by Tenant. There shall be no abatement of Rent and, except for the gross negligence or willful misconduct of Landlord or its employees, no liability of Landlord by reason of any injury to or interference with Tenant's business arising from the making of any repairs, alterations or improvement in or to any portion of the Premises or in or to fixtures, appurtenances and equipment therein; provided, that Landlord, its employees, agents and contractors use reasonable efforts not to unreasonably interfere with Tenant's business in exercise of Landlord's rights or obligations hereunder. Except as may otherwise be expressly set forth herein, Tenant affirms that (a) neither Landlord nor any agent, employee or officer of Landlord has made any representation regarding the condition of the Premises, the Building, the Common Areas or the Project, and (b) Landlord shall not be obligated to undertake any repair, alteration, remodel, improvement, painting or decorating. 8.2 UTILITIES AND SERVICES. Subject to reimbursement pursuant to Sections 6.1 and 8.3, Landlord shall furnish or cause to be furnished to the Premises water, natural gas for hot water, electricity, sewage, heating, ventilating, air conditioning services, and janitorial services of the quality provided to office buildings of similar quality, style, and age in the Portland metropolitan area. Tenant shall pay before delinquency, at its sole cost and expense, all charges for water, heat, electricity, power, telephone service, sewer service charges and other utilities or services charged or attributable directly to the Premises; provided, however, that if any such services or utilities shall be billed to Landlord and are not separately billed to the Premises, Tenant shall pay to Landlord as Additional Rent, an amount equal to that proportion of the total charges therefor which the rentable area of the Premises bears to the rentable area of leased area covered by such charges. Notwithstanding the above, in the event Tenant uses any heating, ventilating and air conditioning services during non-standard building hours, or if Tenant uses any utility services beyond standard office usage as reasonably determined by Landlord, Tenant shall pay the actual cost of such after-hours services or above-standard services, as the case may be, used by Tenant based on Landlord's reasonable estimate therefor. At Landlord's option, Landlord may install separate meters to measure above-standard -14- consumption of services. Tenant shall reimburse the costs of the purchase and installation of such meters within 15 days after Landlord's billing therefor. 8.3 TENANT REPAIRS AND MAINTENANCE. Tenant shall, at its expense, (a) keep the Premises and fixtures in good order, and keep Tenant's personal property in good order and repair; and (b) make repairs and replacements to the Premises and pay Landlord for the repairs or replacements to the Buildings if any such repairs or replacements are needed because of Tenant's misuse or primary negligence, except to the extent that a claim for such repairs or replacements is waived under Section 7.6. Upon expiration or earlier termination of the Term, Tenant shall surrender the Premises to Landlord in the same condition as when leased except for (i) ordinary wear and tear, (ii) damage by the elements, fire, or other casualty not required to be repaired, replaced or paid for by Tenant pursuant to this Lease, (iii) condemnation, and (iv) alterations as permitted under this Lease unless consent was conditioned on their removal. 8.4 NON-LIABILITY OF LANDLORD. Notwithstanding anything to the contrary contained in Sections 8.1 or 8.2 above or elsewhere in this Lease, but except as expressly provided below. Landlord shall not be in default hereunder or be liable for any damages directly or indirectly resulting from, nor shall the Rent herein reserved be abated or rebated by reason of (a) the interruption or curtailment of the use of the Premises as a result of the installation of any equipment in connection with the Building or Project; or (b) any failure to furnish or delay in furnishing any services required to be provided by Landlord, unless and to the extent such failure or delay is caused by any condition created by Landlord's active gross negligence; or (c) the limitation, curtailment, rationing or restriction of the use of water or electricity, gas or any other form of energy or any other service or utility whatsoever serving the Premises or Project. However, if, as a result of Landlord's act or omission, Landlord causes one of the events described in clause (a), (b), or (c) of this paragraph, and as a result of such event, the Premises are rendered unsuitable for Tenant's use and Tenant, in fact, does not occupy the Premises for its business operations for seven consecutive days, Base Rent shall abate beginning on the eighth consecutive day and continuing until such time as the Premises are again rendered suitable for Tenant's use. 8.5 INSPECTION OF PREMISES. Landlord may enter the Premises to complete construction undertaken by Landlord on the Premises, to inspect, clean, improve or repair the same, to inspect the performance by Tenant of the terms and conditions hereof, show the Premises to prospective purchasers, tenants and lenders and for all other purposes as Landlord shall reasonably deem necessary or appropriate; provided, that Landlord shall use reasonable efforts not to interfere with Tenant's business in exercise of Landlord's rights hereunder. Tenant hereby waives any claim for damages for any injury or inconvenience to or interference with Tenant's business, any loss of occupancy or quiet enjoyment of the Premises and any other loss in, upon or about the Premises, arising from exercise by Landlord of its rights hereunder except as otherwise provided in Article XI hereof. 8.6 ACCESS BY TENANT. Tenant and its employees, agents, and invitees shall have access to the Premises 24 hours a day, seven days a week, subject to restrictions due to governmental regulation, casualty, and weather. ARTICLE IX FIXTURES, PERSONAL PROPERTY AND ALTERATIONS 9.1 FIXTURES AND PERSONAL PROPERTY. Tenant, at Tenant's expense, may install any necessary trade fixtures, equipment and furniture in the Premises, provided that such items are installed and are removable without damage to the structure of the Premises , including, but not limited to, damage to drywall, doors, door frames and floors. Landlord reserves the right to approve or disapprove of any interior improvements which are visible from outside the Premises or which violate the CC&R's on wholly aesthetic grounds, but such approval shall not be unreasonably withheld, conditioned or delayed. Such improvements must be submitted for Landlord's written approval prior to installation, or Landlord may remove or replace such items at Tenant's sole expense. Said trade fixtures, equipment, furniture and personal property shall remain Tenant's property and shall be removed by Tenant upon the expiration or earlier termination of the Lease. As a covenant which shall survive the expiration or earlier termination of the Lease, Tenant shall repair, at Tenant's sole expense, or at Landlord's election, reimburse Landlord for the cost to repair all damage caused by the installation or removal of said trade fixtures, equipment, furniture, personal property or temporary improvements. If Tenant fails to remove the foregoing items prior to or upon the expiration or earlier termination of this Lease, Landlord, at its option and without liability to Tenant for loss thereof, may keep and use them or remove any or all of them and cause them to be stored or sold in accordance -15- with applicable law, and Tenant shall, upon demand of Landlord, pay to Landlord as Additional Rent hereunder all costs and expenses incurred by Landlord in so storing and/or selling said items. In the event any such fixtures, equipment, and/or furniture of Tenant are sold by Landlord, the proceeds of such sale shall be applied, first, to all expenses of Landlord incurred in connection with storage and sale; second, to any amounts owed by Tenant to Landlord under this Lease or otherwise, and, third, the remainder, if any, shall be paid to Tenant. 9.2 ALTERATIONS. Tenant shall not make or allow to be made any material alterations, additions or improvements to the Premises (defined as alterations, additions or improvements costing in excess of $1,000.00 individually or in the aggregate with respect to separate items relating to the same improvement or alteration or any alterations, additions or improvements that affect the structure or exterior of the Building or any building, mechanical, electrical or life safety system), either at the inception of the Lease or subsequently during the Term, without obtaining the prior written consent of Landlord which consent may be withheld in Landlord's sole discretion with respect to any alteration, addition or improvement that affects the structure or exterior of the Building or any building, mechanical, electrical or life safety systems. Tenant shall deliver to Landlord the contractor's name, references and state license number, a certificate of liability insurance naming Landlord and Landlord' s manager and lender(s) as an additional insured, as well as full and complete plans and specifications of all such alterations, additions or improvements, and any subsequent modifications or additions to such plans and specifications, and no proposed work shall be commenced or continued by Tenant until Landlord has received and given its written approval of each of the foregoing. Landlord shall either approve or disapprove any proposed alteration, addition or improvement on or before fifteen (15) days following receipt of all of the foregoing items. Landlord does not expressly or implicitly covenant or warrant that any plans or specifications submitted by Tenant are accurate, safe or sufficient or that the same comply with any applicable laws, ordinances, building codes, or the like. Further, Tenant shall indemnify, protect, defend and hold Landlord and Landlord's agents, employees and contractors harmless for, from and against any loss, damage, liability, claims, cost or expense, including attorneys' fees and costs, incurred as a result of any defects in design, materials or workmanship resulting from Tenant's alterations, additions or improvements to the Premises. All alterations, telephone or telecommunications lines, cables, conduits and equipment and all other additions or improvements to the Premises made by Tenant shall remain the property of Tenant until termination of this Lease, at which time they shall, unless otherwise elected by Landlord by written notice to Tenant, be and become the property of Landlord. Landlord may, as a condition to approval of any such alterations, additions or improvements, require Tenant to remove any partitions, counters, railings, telephone and telecommunications lines, cables, conduits and equipment and/or other improvements installed by Tenant during the Term, and Tenant shall repair all damage resulting from such removal or, at Landlord's option, shall pay to Landlord all costs arising from such removal. All repairs, alterations, additions and restorations by Tenant hereinafter required or permitted shall be done in a good and workmanlike manner and in compliance with the plans and specifications approved by Landlord and in compliance with all applicable laws and ordinances, building codes, bylaws, regulations and orders of any federal, state, county, municipal or other public authority and of the insurers of the Premises and as-built plans and specifications shall be provided to Landlord by Tenant upon completion of the work. If required by Landlord, and only if Tenant is not Schnitzer Steel Industries, Inc., Tenant shall secure at Tenant's own cost and expense a completion and lien indemnity bond or other adequate security, including without limitation an indemnity agreement from Tenant's parent in form and substance reasonably satisfactory to Landlord. Tenant shall reimburse Landlord for Landlord's reasonable out-of-pocket costs (including any professional fees incurred by Landlord and a reasonable administrative fee payable to Landlord's manager) for reviewing and approving or disapproving plans and specifications for any proposed alterations and observing the alterations. 9.3 LIENS. Tenant shall promptly file and/or record, as applicable, all notices of completion provided for by law, and shall pay and discharge all claims for work or labor done, supplies furnished or services rendered at the request of Tenant or at the request of Landlord on behalf of Tenant, and shall keep the Premises and the Project free and clear of all mechanics' and materialmen's liens in connection therewith. Landlord shall have the right, and shall be given ten (10) business days written notice by Tenant prior to commencement of the work, to post or keep posted on the Premises, or in the immediate vicinity thereof, any notices of non-responsibility for any construction, alteration, or repair of the Premises by Tenant. If any such lien is filed, Tenant shall cause same to be discharged of record within ten (10) days following written notice thereof, or if Tenant disputes the correctness or validity of any claim of lien, Landlord may, in its reasonable discretion, permit Tenant to post or provide security in a form and amount acceptable to Landlord to insure that title to the Project remains free from the lien claimed. If said lien is not timely discharged Landlord may, but shall not be required to, take such action or pay such amount as may be necessary to remove such lien and Tenant shall pay to Landlord as Additional Rent any such amounts expended by -16- Landlord, together with interest thereon at the Default Rate (as defined in Section 5.3 hereof), within five (5) days after notice is received from Landlord of the amount expended by Landlord. ARTICLE X USE AND COMPLIANCE WITH LAWS 10.1 GENERAL USE AND COMPLIANCE WITH LAWS. Tenant shall use the Premises only for Tenant's business described in Section 1.1(f) above, and uses customarily incidental thereto and for no other use without the prior written consent of Landlord which consent shall not be unreasonably withheld, conditioned or delayed. Tenant shall, at Tenant's sole cost and expense, comply with applicable requirements of municipal, county, state, federal and other applicable governmental authorities now or hereafter in force pertaining to Tenant's business operations, alterations and/or specific use of the Premises and/or the Project, and shall secure any necessary permits therefore and shall faithfully observe in the use of the Premises and the Project, applicable municipal, county, state, federal and other applicable governmental entities' requirements which are now or which may hereafter be in force. Tenant, in Tenant's use and occupancy of the Premises, shall not subject or permit the Premises and/or the Project to be used in any manner which would tend to damage any portion thereof, or which would increase the cost of any insurance paid by Landlord with respect thereto. Tenant shall not do or permit anything to be done in or about the Premises, the Common Areas and/or the Project which will in any way obstruct or interfere with the rights of other tenants or occupants of the Common Areas and/or the Project or use or allow the Premises or any portion of the Project to be used for any improper, immoral, unlawful or objectionable purpose, nor shall Tenant cause, maintain or permit a nuisance in, on or about the Premises, the Common Areas and/or the Project. Tenant shall comply with all covenants and obligations in the CC&R's which affect the use and operation of the Premises, the Common Areas and/or the Project. 10.2 HAZARDOUS MATERIALS. (a) DEFINED TERMS. (i) "HAZARDOUS MATERIALS" means, among other things, any of the following, in any amount: (a) any petroleum or petroleum derived or derivative product, asbestos in any form, urea formaldehyde and polychlorinated biphenyls and medical wastes; (b) any radioactive substance; (c) any toxic, infectious, reactive, corrosive, ignitable or flammable chemical or chemical compound; and (d) any chemicals, materials or substances, whether solid, liquid or gas, defined as or included in the definitions of "hazardous substances," "hazardous wastes," "hazardous materials," "extremely hazardous wastes," "restricted hazardous wastes," "toxic substances," "toxic pollutants," "solid waste," or words of similar import in any federal, state or local statute, law, ordinance or regulation or court decisions now existing or hereafter existing as the same may be interpreted by government offices and agencies. (ii) "HAZARDOUS MATERIALS LAWS" means any federal, state or local statutes, laws, ordinances or regulations or court decisions now existing or hereafter existing that control, classify, regulate, list or define Hazardous Materials or require remediation of Hazardous Materials contamination. (b) COMPLIANCE WITH HAZARDOUS MATERIALS LAWS. Tenant will not cause any Hazardous Material to be brought upon, kept, generated or used on the Project in a manner or for a purpose prohibited by or that could result in liability under any Hazardous Materials Law; provided, however, in no event shall Tenant allow any Hazardous Material to be brought upon, kept, generated or used on the Project other than those Hazardous Materials for which Tenant has received Landlord's prior written consent (other than small quantities of cleaning or other/industrial supplies as are customarily used by a tenant in the ordinary course in a general office facility). Tenant, at its sole cost and expense, will comply with (and obtain all permits required under) all Hazardous Materials Laws, groundwater wellhead protection laws, storm water management laws, fire protection provisions, and prudent industry practice relating to the presence, storage, transportation, disposal, release or management of Hazardous Materials in, on, under or about the Project that Tenant brings upon, keeps, generates or uses on the Project (including, without limitation, but subject to this Section 10.2, immediate remediation of any Hazardous Materials in, on, under or about the Project that Tenant brings upon, keeps, generates or uses on the Project in compliance with Hazardous Materials Laws) and in no event shall Tenant allow any liens or encumbrances -17- pertaining to Tenant's use of Hazardous Materials to attach to any portion of the Project. On or before the expiration or earlier termination of this Lease, Tenant, at its sole cost and expense, will completely remove from the Project (regardless whether any Hazardous Materials Law requires removal), in compliance with all Hazardous Materials Laws, all Hazardous Materials Tenant causes to be present in, on, under or about the Project. Tenant will not take any remedial action in response to the presence of any Hazardous Materials in on, under or about the Project, nor enter into (or commence negotiations with respect to) any settlement agreement, consent decree or other compromise with respect to any claims relating to or in any way connected with Hazardous Materials in, on, under or about the Project, without first notifying Landlord of Tenant's intention to do so and affording Landlord reasonable opportunity to investigate, appear, intervene and otherwise assert and protect Landlord's interest in the Project. Landlord shall have the right from time to time to inspect the Premises to determine if Tenant is in compliance with this Section 10.2. (c) NOTICE OF ACTIONS. Tenant will notify Landlord of any of the following actions affecting Landlord, Tenant or the Project that result from or in any way relate to Tenant's use of the Project immediately after receiving notice of the same: (a) any enforcement, clean-up, removal or other governmental or regulatory action instituted, completed or threatened under any Hazardous Materials Law; (b) any claim made or threatened by any person relating to damage, contribution, liability, cost recovery, compensation, loss or injury resulting from or claimed to result from any Hazardous Material; and (c) any reports made by any person, including Tenant, to any environmental agency relating to any Hazardous Material, including any complaints, notices, warnings or asserted violations. Tenant will also deliver to Landlord, as promptly as possible and in any event within five (5) business days after Tenant first receives or sends the same, copies of all claims, reports, complaints, notices, warnings or asserted violations relating in any way to the Project or Tenant's use of the Project. Upon Landlord's written request, Tenant will promptly deliver to Landlord documentation acceptable to Landlord reflecting the legal and proper disposal of all Hazardous Materials removed or to be removed from the Premises. All such documentation will list Tenant or its agent as a responsible party and the generator of such Hazardous Materials and will not attribute responsibility for any such Hazardous Materials to Landlord or Landlord's property manager. (d) DISCLOSURE AND WARNING OBLIGATIONS. Tenant acknowledges and agrees that all reporting and warning obligations required under Hazardous Materials Laws resulting from or in any way relating to Tenant's use of the Premises or Project are Tenant's sole responsibility, regardless whether the Hazardous Materials Laws permit or require Landlord to report or warn. (e) INDEMNIFICATION. Tenant releases and will indemnify, defend (with counsel reasonably acceptable to Landlord), protect and hold harmless the Landlord and Landlord's agents, employees and contractors for, from and against any and all claims, liabilities, damages, losses, costs and expenses whatsoever arising or resulting, in whole or in part, directly or indirectly, from the presence, treatment, storage, transportation, disposal, release or management of Hazardous Materials in, on, under, upon or from the Project (including water tables and atmosphere) that Tenant brings upon, keeps, generates or uses on the Premises or the Project. Tenant's obligations under this Section include, without limitation and whether foreseeable or unforeseeable, (a) the costs of any required or necessary repair, clean-up, detoxification or decontamination of the Project; (b) the costs of implementing any closure, remediation or other required action in connection therewith as stated above; (c) the value of any loss of use and any diminution in value of the Project, and (d) consultants ' fees, experts' fees and response costs. The Tenant's obligations under this section survive the expiration or earlier termination of this Lease. Landlord releases and will indemnify, defend (with counsel reasonably acceptable to Tenant), protect and hold harmless the Tenant and Tenant's agents, employees and contractors for, from and against any and all claims, liabilities, damages, losses, costs and expenses whatsoever arising or resulting, in whole or in part, directly or indirectly, from the presence, treatment, storage, transportation, disposal, release or management of Hazardous Materials in, on, under, upon or from the Project (including water tables and atmosphere) that Landlord brings upon, keeps, generates or uses on the Premises or the Project. Landlord's obligations under this Section include, without limitation and whether foreseeable or unforeseeable, (a) the costs of any required or necessary repair, clean-up, detoxification or decontamination of the Project; (b) the costs of implementing any closure, remediation or other required action in connection therewith as stated above; (c) the value of any loss of use and any diminution in value of the Project, and (d) consultants ' fees, experts' fees and response costs. The Landlord's obligations under this section survive the expiration or earlier termination of this Lease. -18- (f) HAZARDOUS MATERIALS REPRESENTATION BY LANDLORD. Landlord represents to Tenant that, to its actual knowledge and except as Landlord has previously disclosed to Tenant, Landlord has not caused the generation, storage or release of Hazardous Materials upon the Premises, except in accordance with Hazardous Materials Laws and prudent industry practices regarding construction of the Premises. 10.3 SIGNS. The Tenant shall not paint, display, inscribe, place or affix any sign, picture, advertisement, notice, lettering, or direction on any part of the outside of the Building or the Project or visible from the outside of the Premises, the Building or the Project, except as first approved by Landlord or as may be set forth in the Tenant Improvement Plans. Landlord's approval of any proposed sign, picture, advertisement, notice, lettering, or direction shall not be unreasonably withheld, conditioned, or delayed. ARTICLE XI DAMAGE AND DESTRUCTION 11.1 RECONSTRUCTION. If the "Relevant Space" (which means the Premises, reasonable access to the Premises, or any part of either Building or the Project that provides essential services to the Premises) is damaged or destroyed during the Term, Landlord shall, except as hereinafter provided, diligently repair or rebuild it to substantially the condition in which it existed immediately prior to such damage or destruction. If Landlord is obligated or elects to repair or restore as herein provided, Landlord shall be obligated to make repair or restoration of only those portions of the Premises which were initially provided at Landlord's expense or as part of the original installation by Landlord for Tenant and the repair and/or restoration of other items within the Premises shall be the obligation of the Tenant. 11.2 RENT ABATEMENT. Rent due and payable hereunder shall be abated proportionately during any period in which, by reason of any such damage or destruction, there is substantial interference with the operation of Tenant's business in the Premises. Such abatement shall continue for the period commencing with such damage or destruction and ending with a substantial completion by Landlord of the work of repair or reconstruction which Landlord is obligated or undertakes to do. If it be determined that continuation of business is not practical pending reconstruction, and if Landlord does not elect to or is unable to provide alternative temporary space for continuation of such business, then Rent due and payable hereunder shall abate, until reconstruction is substantially completed or until business is totally or partially resumed, whichever is the earlier. Tenant shall not be entitled to any claim, compensation or damages for loss in the use in the whole or any part of the Premises (including loss of business) and/or any inconvenience or annoyance occasioned by such damage, repair, reconstruction or restoration. 11.3 EXCESSIVE DAMAGE OR DESTRUCTION. If the Relevant Space is damaged or destroyed to the extent that it cannot within Landlord's reasonable discretion, with reasonable diligence, be fully repaired or restored by Landlord (using standard working methods and procedures) within the earlier of (i) one hundred twenty (120) days after the date of the damage or destruction, or (ii) the expiration of the Term hereof, Landlord may terminate this Lease by written notice to Tenant within thirty (30) days of the date of the damage or destruction. If Landlord does not terminate the Lease, this Lease shall remain in full force and effect and Landlord shall diligently repair and restore the damage as soon as reasonably possible. 11.4 UNINSURED CASUALTY. Notwithstanding anything contained herein to the contrary, in the event of damage to or destruction of all or any portion of the Building, which damage or destruction is not fully covered by the insurance proceeds received by Landlord under the insurance policies required under Section 7.1 hereinabove, Landlord may terminate this Lease by written notice to Tenant given within sixty (60) days after the date of notice to Landlord that said damage or destruction is not so covered. If Landlord does not elect to terminate this Lease, the Lease shall remain in full force and effect and the Building shall be repaired and rebuilt in accordance with the provisions for repair set forth in Section 11.1 hereinabove. 11.5 WAIVER. With respect to any damage or destruction which Landlord is obligated to repair or may elect to repair under the terms of this Article XI, and to the extent permitted by law, Tenant hereby waives any rights to terminate this Lease pursuant to rights otherwise accorded by law to tenants, except as expressly otherwise provided herein. -19- 11.6 MORTGAGEE'S RIGHT. Notwithstanding anything herein to the contrary, if the holder of any indebtedness secured by a mortgage or deed of trust covering the Building and/or the Project requires that the insurance proceeds be applied to such indebtedness, then Landlord shall have the right to terminate this Lease by delivering written notice of termination to Tenant within fifteen (15) days after such requirement is made. Upon any termination of this Lease under the provisions hereof, the parties shall be released without further obligation to the other from date possession of the Premises is surrendered to Landlord, except for items which are theretofore accrued and are then unpaid. 11.7 DAMAGE NEAR END OF TERM. Notwithstanding anything to the contrary contained in this Article XI, in the event the Premises or the Building are subject to excessive damage (as defined in Section 11.3) during the last twenty-four (24) months of the Term or any applicable extension periods, Landlord may elect to terminate this Lease by written notice to Tenant within thirty (30) days after the date of such damage. ARTICLE XII EMINENT DOMAIN In the event the whole of the Premises, Building, Project and/or Common Areas, as the case may be, and/or such part thereof as shall materially interfere with Tenant's use and occupation thereof, shall be taken for any public or quasi-public purpose by any lawful power or authority by exercise of the right of appropriation, condemnation or eminent domain, or is sold in lieu of or to prevent such taking, then Tenant shall have the right to terminate this Lease effective as of the date possession is required to be surrendered to said authority. In the event the whole of the Premises, Building, Project, and/or Common Areas, as the case may be, or such part thereof as shall substantially interfere with Landlord's use and occupation thereof, or if any access points to adjoining streets, shall be taken for any public or quasi-public purpose by any lawful power or authority by exercise of the right of appropriation, condemnation or eminent domain, or is sold in lieu of or to prevent such taking, then Landlord shall have the right to terminate this Lease effective as of the date possession is required to be surrendered to said authority. Except as provided below, Tenant shall not assert any claim against Landlord or the taking authority for any compensation because of such taking, and Landlord shall be entitled to receive the entire amount of any award without deduction for any estate or interest of Tenant in the Premises. Nothing contained in this Article XII shall be deemed to give Landlord any interest in any separate award made to Tenant for the taking of personal property and fixtures belonging to Tenant or for Tenant's moving expenses. In the event the amount of property or the type of estate taken shall not materially interfere with the conduct of Tenant's business, Landlord shall be entitled to the entire amount of the award without deduction for any estate or interest of Tenant, Landlord shall promptly proceed to restore the Building to substantially their same condition prior to such partial taking less the portion thereof lost in such condemnation, and the Base Rent shall be proportionately reduced by the time during which, and the portion of the Premises which, Tenant shall have been deprived of possession on account of said taking and restoration. ARTICLE XIII DEFAULT 13.1 EVENTS OF DEFAULT. The occurrence of any of the following events shall constitute an "Event of Default" on the part of the Tenant: (a) Tenant shall fail to pay on or before the due date any installment of Rent or other payment required pursuant to this Lease within five (5) days after Tenant's receipt of written notice from Landlord of Tenant's failure to make such payment; (b) Tenant shall fail to comply with any term, provision, or covenant of this Lease, other than the payment of Rent or other sums of money due hereunder, and such failure is not cured within fifteen (15) days after written notice thereof to Tenant (said notice being in lieu of, and not in addition to, any notice required as a prerequisite to a forcible entry and detainer or similar action for possession of the Premises); provided that if the nature of such cure is such that a longer cure period is necessary, Tenant shall only be in default if Tenant shall have failed to commence such cure within said fifteen (15) day period and thereafter to have diligently prosecuted such cure to completion; -20- (c) Tenant shall file a petition or be adjudged a debtor or bankrupt or insolvent under the United States Bankruptcy Code, as amended, or any similar law or statute of the United States or any State; or a receiver or trustee shall be appointed for all or substantially all of the assets of Tenant and such appointment or petition, if involuntary, is not dismissed within sixty (60) days of filing; or (d) Tenant shall make an assignment for the benefit of creditors. 13.2 REMEDIES. (a) Upon the occurrence of any Event of Default set forth in this Lease, in addition to any other remedies available to Landlord at law or in equity, Landlord shall have the immediate option to terminate this Lease and all rights of Tenant hereunder. In the event that Landlord shall elect to so terminate this Lease, then Landlord may recover from Tenant: (i) any unpaid rent which has been earned at the time of such termination plus interest at the rates contemplated by this Lease; plus (ii) the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided plus interest at the rates contemplated by this Lease; plus (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the Term after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided; plus (iv) the unamortized balance of the value of any free Rent, tenant improvement costs, commissions and any other monetary concessions provided to Tenant pursuant to this Lease, as amortized over the initial Term of this Lease; plus (v) any other amount necessary to compensate Landlord for all the damage proximately caused by Tenant's failure to perform Tenant's obligation under this Lease or which in the ordinary course of things would be likely to result therefrom, including, but not limited to, costs to restore the Premises to good condition, costs to remodel, renovate or otherwise prepare the Premises, or portions thereof, for a new tenant, leasing commissions, marketing expenses, attorneys' fees, and free rent, moving allowances and other types of leasing concessions. As used in Subsections 13.2(a) (iii) above, the "worth at the time of award" is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). Landlord agrees to use its commercially reasonable efforts to mitigate its damages. (b) In the event of any such default by Tenant, Landlord shall also have the right with or without terminating this Lease, to re-enter the Premises and remove all persons and property from the Premises; such property may be removed and stored in a public warehouse or elsewhere at the cost of and for the account of the Tenant. No re-entry or taking possession of the Premises by Landlord pursuant to this Section 13.2(b) shall be construed as an acceptance of a surrender of the Premises or an election to terminate this Lease unless a written notice of such intention is given to Tenant or unless the termination thereof is decreed by a court of competent jurisdiction. (c) In the event that Landlord shall elect to re-enter as provided above or shall take possession of the Premises pursuant to legal proceedings or pursuant to any notice provided by law, then if Landlord does not elect to terminate this Lease as provided above, Landlord may from time to time, without terminating this Lease, either recover all Rent as it becomes due or relet the Premises or any part thereof for the Term of this Lease on terms and conditions as Landlord at its sole discretion may deem advisable with the right to make alterations and repairs to the Premises. (d) In the event that Landlord shall elect to so relet, the rents received by Landlord from such reletting shall be applied: first to the payment of any indebtedness other than Rent due hereunder from Tenant to Landlord; second to the payment of any costs of such reletting; third, to the payment of the cost of any alterations and repairs to the Premises; fourth, to the payment of Rent due and unpaid hereunder; and the residual, if any, shall be held by Landlord and applied to payment of future Rent as the same shall become due and payable hereunder. Should that portion of such rents received from such reletting during the month which is applied to the payment of Rent be less than the Rent payable during that month by Tenant hereunder, then Tenant shall pay any such deficiency to Landlord immediately upon demand therefor by Landlord. Such deficiency shall be calculated and paid monthly. Tenant shall also pay to Landlord, as soon as is certain, any of the costs and expenses incurred by -21- Landlord in such reletting or in making such alterations and repairs not covered by the rents received from such reletting. (e) All rights, options and remedies of Landlord contained in this Lease shall be construed and held to be cumulative, and no one of them shall be exclusive of the other, and Landlord shall have the right to pursue any one or all of such remedies or any other remedy or relief which may be provided by law, whether or not stated in this Lease. No waiver of any default of Tenant hereunder shall be implied from any acceptance by Landlord of any Rent or other payments due hereunder or any omission by Landlord to take any action on account of such default if such default persists or is repeated, and no express waiver shall affect defaults other than as specified in said waiver. The consent or approval of Landlord to or of any act by Tenant requiring Landlord's consent or approval shall not be deemed to waive or render unnecessary Landlord's consent or approval to or of any subsequent similar acts by Tenant. (f) In the event that during the term of this Lease, Tenant commits more than two (2) acts or omissions of default for which default notices are given by Landlord pursuant to this Article XIII (whether or not such defaults are cured by Tenant), and if the defaults are material in Landlord's reasonable judgment, Landlord may, at its option, elect to terminate this Lease. Landlord's election to exercise its early termination rights shall be effective only upon written notice delivered to Tenant specifying Landlord's election to cause an early termination of this Lease. Such early termination shall be in effect when such written notice is provided to Tenant. Landlord's right of early termination shall be in addition to all other rights and remedies available to Landlord at law or in equity. 13.3 LANDLORD'S DEFAULT. Landlord shall not be in default unless Landlord fails to perform its obligations under this Lease within thirty (30) days after written notice by Tenant, or if such failure is not reasonably capable of being cured within such thirty (30) day period, Landlord shall not be in default unless Landlord has failed to commence the cure and diligently pursue the cure to completion. In no event shall Tenant have the remedy to terminate this Lease except upon final adjudication of competent jurisdiction authorizing such default. In no event shall Landlord be liable to Tenant or any person claiming through or under Tenant for consequential, exemplary or punitive damages. ARTICLE XIV FILING OF PETITION Landlord and Tenant (as either debtor or debtor-in-possession) agree that if a petition ("Petition") is filed by or against Tenant under any chapter of Title 11 of the United States Code (the "Bankruptcy Code"), the following provisions shall apply: (a) Adequate protection for Tenant's obligations accruing after filing of the Petition and before this Lease is rejected or assumed shall be provided within 15 days after filing in the form of a security deposit equal to three months ' Base Rent and Additional Rent and other Lease charges, to be held by the court or an escrow agent approved by Landlord and the court. (b) The sum of all amounts payable by Tenant to Landlord under this Lease constitutes reasonable compensation for the occupancy of the Premises by Tenant. (c) Tenant or Trustee shall give Landlord at least 30 days written notice of any abandonment of the Premises or any proceeding relating to administrative claims. If Tenant abandons without notice, Tenant or Trustee shall stipulate to entry of an order for relief from stay to permit Landlord to reenter and relet the Premises. (d) If Tenant failed to timely and fully perform any of its obligations under this Lease before the filing of the Petition, whether or not Landlord has given Tenant written notice of that failure and whether or not any time period for cure expired before the filing of the Petition, Tenant shall be deemed to have been in default on the date the Petition was filed for all purposes under the Bankruptcy Code. -22- (e) For the purposes of Section 365(b)(1) of the Bankruptcy Code, prompt cure of defaults shall mean cure within 30 days after assumption. (f) For the purposes of Section 365(b)(1) and 365(f)(2) of the Bankruptcy Code, adequate assurance of future performance of this Lease by Tenant, Trustee or any proposed assignee will require that Tenant, Trustee or the proposed assignee deposit three months of Base Rent and Additional Rent into an escrow fund (to be held by the court or an escrow agent approved by Landlord and the court) as security for such future performance. In addition, if this Lease is to be assigned, adequate assurance of future performance by the proposed assignee shall require that: (i) the assignee have a tangible net worth not less than the net worth of Tenant as of the Commencement Date or that such assignee's performance be unconditionally guaranteed by a person or entity that has a tangible net worth not less than the net worth of Tenant as of the Commencement Date; (ii) the assignee demonstrate that it possesses a history of success in operating a business of similar size and complexity in a similar market as Tenant's business; and (iii) assignee assume in writing all of Tenant's obligations relating to the Premises or this Lease. (g) If Tenant or Trustee intends to assume and/or assign this Lease, Tenant or Trustee shall provide Landlord with 30 days written notice of the proposed action, separate from and in addition to any notice provided to all creditors. Notice of a proposed assumption shall state the assurance of prompt cure, compensation for loss and assurance of future performance to be provided to Landlord. Notice of a proposed assignment shall state: (i) the name, address, and federal tax identification and registration numbers of the proposed assignee; (ii) all of the terms and conditions of the proposed assignment, and (iii) the assignee's proposed adequate assurance of future performance to be provided to Landlord. (h) If Tenant is in default under this Lease when the Petition is filed, Landlord shall not be required to provide Tenant or Trustee with services or supplies under this Lease or otherwise before Tenant assumes this Lease, unless Tenant compensates Landlord for such services and supplies in advance. ARTICLE XV ASSIGNMENT AND SUBLETTING 15.1 PROHIBITION. Tenant shall not assign, mortgage, pledge or otherwise transfer or encumber this Lease, in whole or in part, nor sublet, assign, or permit occupancy by any party other than Tenant of all or any part of the Premises, without the prior written consent of Landlord in each instance which consent shall not be unreasonably withheld, conditioned, or delayed. Tenant shall at the time the Tenant requests the consent of Landlord, deliver to Landlord such information in writing as Landlord may reasonably require respecting the proposed assignee or subtenant including, without limitation, the name, address, nature of business, ownership, financial responsibility and standing of such proposed assignee or subtenant and Landlord shall have not less than twenty (20) business days after receipt of all required information to elect one of the following: (a) consent to such proposed assignment, encumbrance or sublease, or (b) refuse such consent, or (c) elect to terminate this Lease, in the case of a proposed assignment, or elect to terminate the Lease with respect to the portion of the Premises proposed to be subleased, as applicable. Without making a formal request for consent to an assignment or sublease, Tenant may request that Landlord give Tenant its decision whether it intends to enforce the recapture provision in clause (c). Landlord agrees to respond to such request within 20 days after Tenant's request for the decision. In addition, as a condition to Landlord's consent to any assignment, sublease or encumbrance of this Lease shall be the delivery to Landlord of a true copy of the fully executed instrument of assignment, transfer or encumbrance and an agreement executed by the assignee, sublessee or other transferee in form and substance reasonably satisfactory to Landlord and expressly enforceable by Landlord, whereby the assignee assumes and agrees to be bound by the terms and provisions of this Lease and perform all the obligations of Tenant hereunder with respect to the assigned or subleased portion of the Premises. No assignment or subletting by Tenant shall relieve Tenant of any obligation under this Lease, including Tenant's obligation to pay Base Rent and Additional Rent hereunder. Any purported assignment or subletting contrary to the provisions hereof without consent shall be void. The consent by Landlord to any assignment or subletting shall not constitute a waiver of the necessity for such consent to any subsequent assignment of subletting. Tenant 's sole remedy for Landlord's refusal to consent to a proposed assignee or sublessee of Tenant will be an action or proceeding for specific performance, injunction or declaratory relief. Tenant shall pay Landlord's reasonable processing costs and attorneys' fees incurred in reviewing any proposed Assignment or sublease. -23- 15.2 EXCESS RENTAL. If Tenant assigns this Lease or subleases the Premises, Tenant shall pay to Landlord as Additional Rent under this Lease fifty percent (50%) of the Profit on such transaction as herein provided. For purposes of this Section 15.2, the term "Profit" means the consideration received by Tenant from an assignee or subtenant in excess of the amount Tenant must pay Landlord under this Lease, which amount is to be prorated where a part of the Premises is subleased or assigned. In determining the Profit, the consideration received by Tenant shall be deemed to be reduced by the leasing commissions paid by Tenant, payments attributable to the costs of improvements made to the Premises at Tenant's cost for the assignee or sublessee, and other reasonable, out-of-pocket costs paid by Tenant, such as attorney fees related to Tenant's obtaining an assignee or sublessee, costs of advertising or marketing the space, moving expenses paid by Tenant for the assignee or subtenant, and other economic concessions given by Tenant to the assignee or sublessee. Tenant shall pay fifty percent (50%) of the Profit to Landlord within thirty (30) days after the end of each calendar year during which Tenant collects any Profit. 15.3 SCOPE. The prohibition against assigning or subletting contained in this Article XV shall be construed to include a prohibition against any assignment or subletting by operation of law. If this Lease be assigned, or if the underlying beneficial interest of Tenant is transferred, or if the Premises or any part thereof be sublet or occupied by anybody other than Tenant, Landlord may collect rent from the assignee, subtenant or occupant and apply the net amount collected to the Rent herein reserved and apportion any excess rent so collected in accordance with the terms of the immediately preceding paragraph, but no such assignment, subletting, occupancy or collection shall be deemed a waiver of this covenant, or the acceptance of the assignee, subtenant or occupant as tenant, or a release of Tenant from the further performance by Tenant of covenants on the part of Tenant herein contained. No assignment or subletting shall affect the continuing primary liability of Tenant (which, following assignment, shall be joint and several with the assignee), and Tenant shall not be released from performing any of the terms, covenants and conditions of this Lease. 15.4 WAIVER. Notwithstanding any assignment or sublease, or any indulgences, waivers or extensions of time granted by Landlord to any assignee or sublessee or failure of Landlord to take action against any assignee or sublease, Tenant hereby agrees that Landlord may, at its option, and upon not less than ten (10) days' notice to Tenant, proceed against Tenant without having taken action against or joined such assignee or sublessee, except that Tenant shall have the benefit of any indulgences, waivers and extensions of time granted to any such assignee or sublessee. 15.5 CHANGE IN CONTROL. So long as Tenant is not in default of the Lease, Tenant shall have the right to assign this Lease to any corporation or other entity which is controlled by, under the control of, or under common control with Tenant, or any corporation into which Tenant may be merged or consolidated, or which purchases all or substantially all of the assets or stock of Tenant (each an "Affiliate of Tenant"); provided, however, (a) Tenant shall not be released from its obligations under this Lease, (b) Landlord shall be given at least 15 days prior written notice of the assignment, (c) Landlord shall be given a copy of the document effecting the assignment at least 15 days prior to the date on which the assignment shall occur, and (d) from and after the date of the assignment, Tenant shall be jointly and severally liable with the Affiliate of Tenant with respect to all obligations of Tenant under this Lease. ARTICLE XVI ESTOPPEL CERTIFICATE, ATTORNMENT AND SUBORDINATION 16.1 ESTOPPEL CERTIFICATES. Within ten (10) business days after request therefor by Landlord, or if on any sale, assignment or hypothecation by Landlord of Landlord's interest in the Project and/or the Premises, or any part thereof, an estoppel certificate shall be required from Tenant, Tenant shall deliver a certificate in the form attached hereto as Exhibit D, or in such other form as requested by Landlord, to any proposed mortgagee or purchaser, and to Landlord, certifying (if such be the case) that this Lease is in full force and effect, the date of Tenant's most recent payment of Rent, and that Tenant has no defenses or offsets outstanding, or stating those claimed by Tenant, and any other information contained in such Exhibit D or reasonably requested by Landlord or such proposed mortgagee or purchaser. Tenant's failure to deliver said statement within said period shall, at Landlord's option be an Event of Default hereunder and shall in any event be conclusive upon Tenant that: (i) this Lease is in full force and effect, without modification except as may be represented by Landlord; (ii) there are no uncured defaults in Landlord's performance and Tenant has no right to offset, counterclaim or deduction against Rent hereunder; and (iii) no more than one period's Base Rent has been paid in advance. Landlord agrees that it shall, at any time upon not less than ten days' prior written request from Tenant, execute, acknowledge, and deliver a -24- statement in writing (i) certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect); (ii) certifying the date to which Rent and other charges are paid in advance, if any, and the amount of any security deposit which has been paid; (iii) acknowledging that there are not, to Landlord's knowledge, any uncured defaults on the part of Tenant, or specifying such defaults, if any are claimed; and (iv) certifying to Tenant correct and reasonably ascertainable facts that are covered by the terms of this Lease. Any such statement may be conclusively relied upon by any prospective purchaser of the Premises, any assignee of this Lease, or any lender or prospective lender. 16.2 ATTORNMENT. Tenant shall, in the event any proceedings are brought for the foreclosure of, or in the event of exercise of the power of sale under, any mortgage or deed of trust made by Landlord, its successors or assigns, encumbering the Building, or any part thereof or in the event of termination of a ground lease, if any, and if so requested, attorn to the purchaser upon such foreclosure or sale or upon any grant of a deed in lieu of foreclosure and recognize such purchaser as Landlord under this Lease; provided, that such purchaser recognizes Tenant's rights under this Lease and agrees not to disturb Tenant's quiet possession of the Premises for so long as Tenant is not in default hereunder. 16.3 SUBORDINATION. The rights of Tenant hereunder are and shall be, at the election of any mortgagee or the beneficiary of a deed of trust encumbering the Project (or the portion thereof on which the Building is located) and/or Building, subject and subordinate to the lien of such mortgage or deed of trust, or the lien resulting from any other method of financing or refinancing, now or hereafter in force against the Project (or the portion thereof on which the Building is located) and/or the Building, and to all advances made or hereafter to be made upon the security thereof. If requested, Tenant agrees to execute such documentation as may be reasonably required by Landlord or its lender to further effect the provisions of this Article so long as the holder of the mortgage, deed of trust or other lien at issue agrees not to disturb Tenant's rights under this Lease so long as Tenant is not in default of this Lease. 16.4 RECORDING. Tenant covenants and agrees with Landlord that Tenant shall not record this Lease. At Tenant's request, Landlord agrees to execute and acknowledge a memorandum of this Lease and deliver such memorandum to Tenant so that Tenant may record the same. Notwithstanding the provisions of Section 16.3, in the event that Landlord or its lender requires this Lease or a memorandum thereof to be recorded in priority to any mortgage, deed of trust or other encumbrance which may now or at any time hereafter affect in whole or in part the Building, the Project (or the portion thereof on which the Building is located), and whether or not any such mortgage, deed of trust or other encumbrance shall affect only the Building, the Project (or the portion thereof on which the Building is located), or shall be a blanket mortgage, deed of trust or encumbrance affecting other premises as well, the Tenant covenants and agrees with Landlord that the Tenant shall execute promptly upon request from Landlord any reasonable certificate, reasonable priority agreement or other reasonable instrument which may from time to time be requested to give effect thereto. 16.5 SUBORDINATION OF LANDLORD'S LIEN. Landlord agrees to subordinate its landlord's lien on Tenant's personal property to the lien of Tenant's lender if the terms of such subordination are reasonably acceptable to Landlord. ARTICLE XVII MISCELLANEOUS 17.1 NOTICES. All notices required to be given hereunder shall be in writing and mailed postage prepaid by certified or registered mail, return receipt requested, or by personal delivery or nationally recognized courier service, to the appropriate address indicated in Section 1.1(b) or Section 1.1(e), as appropriate, at such street address or street addresses (but not more than three such addresses) as either Landlord or Tenant may, from time to time, respectively, designate in a written notice given to the other. Notices shall be deemed sufficiently served upon the earlier of actual receipt or the expiration of three (3) days after the date of mailing thereof. Tenant agrees to accept service of process for all matters related to this Lease at the Premises. -25- 17.2 SUCCESSORS BOUND. This Lease and each of its covenants and conditions shall be binding upon and shall inure to the benefit of the parties hereto and their respective assignees, subject to the provisions hereof. Whenever in this Lease a reference is made to Landlord, such reference shall be deemed to refer to the person in whom the interest of Landlord shall be vested, and Landlord shall have no obligation hereunder as to any claim arising after the transfer of its interest in the Building. Any successor or assignee of the Tenant who accepts an assignment of the benefit of this Lease and enters into possession or enjoyment hereunder shall thereby assume and agree to perform and be bound by the covenants and conditions thereof. Nothing herein contained shall be deemed in any manner to give a right of assignment without the prior written consent of Landlord pursuant to, or otherwise as provided in, Article XV hereof. 17.3 WAIVER. No waiver of any default or breach of any covenant by either party hereunder shall be implied from any omission by either party to take action on account of such default if such default persists or is repeated, and no express waiver shall affect any default other than the default specified in the waiver and said waiver shall be operative only for the time and to the extent therein stated. Waivers of any covenant, term or condition contained herein by either party shall not be construed as a waiver of any subsequent breach of the same covenant, term or condition. The consent or approval by either party to or of any act by either party requiring further consent or approval shall not be deemed to waive or render unnecessary their consent or approval to or of any subsequent similar acts. 17.4 SUBDIVISION AND EASEMENTS. Landlord reserves the right to: (a) subdivide the Project; (b) alter the boundaries of the Project; and (c) grant easements on the Project and dedicate for public use portions thereof; provided, however, that no such subdivision, alteration of boundaries, grant or dedication shall materially interfere with Tenant's use of the Premises. Tenant hereby consents to such subdivision, boundary revision, and/or grant or dedication of easements and agrees from time to time, at Landlord's request, to execute, acknowledge and deliver to Landlord, in accordance with Landlord's instructions, any and all documents, instruments, maps or plats necessary to effectuate Tenant's consent thereto. 17.5 LANDLORD'S RESERVED RIGHTS IN COMMON AREAS. Landlord reserves the right from time to time, provided that Tenant's use and enjoyment of, and access to and from, the Premises is not materially and adversely affected thereby, to: (a) install, use, maintain, repair and replace pipes, ducts, conduits, wires and appurtenant meters and equipment for service to other parts of the Building above the ceiling surfaces, below the floor surfaces, within the walls and in the central core areas, and to relocate any pipes, ducts, conduit, wires and appurtenant meters in the Building which are so located or located elsewhere outside the Building; (b) make changes to the Common Areas and/or the parking facilities located thereon, including, without limitation, changes in the location, size, shape and number of driveways, entrances, parking spaces, parking areas, loading and unloading areas, ingress, egress, direction of traffic, landscaped areas and walkways; (c) close temporarily all or any portion of the Common Areas and/or the Building in order to perform any of the foregoing or any of Landlord's obligations under this Lease, so long as reasonable access to the Building remains available during normal business hours; and (d) alter, relocate or expand, and/or to add additional structures and improvements to, or remove same from, all or any portion of the Common Areas or other portions of the Project. 17.6 ACCORD AND SATISFACTION. No payment by Tenant or receipt by Landlord of a lesser amount than the Rent herein stipulated shall be deemed to be other than on account of the Rent, nor shall any endorsement or statement on any check or any letter accompanying any check or payment as Rent be deemed an accord and satisfaction, and Landlord may accept such check or payment without prejudice to Landlord's right to recover the balance of such Rent or pursue any other remedy provided in this Lease. 17.7 LIMITATION OF LANDLORD'S LIABILITY. The obligations of Landlord under this Lease do not constitute personal obligations of the individual partners, directors, officers, members, employees or shareholders of Landlord or its partners, and Tenant shall look solely to the Project, and the rents and profits therefrom, for satisfaction of any liability in respect of this Lease and will not seek recourse against the individual partners, directors, officers, members, employees or shareholders of Landlord or its partners or any of their personal assets for such satisfaction. 17.8 SURVIVAL. The obligations and liabilities of each party which are incurred or accrue prior to the expiration of this Lease or the termination of this Lease or of Tenant's right of possession shall survive such -26- expiration or termination, as shall all provisions by which a party is to provide defense and indemnity to the other party, all provisions waiving or limiting the liability of Landlord, and all attorneys' fees provisions. 17.9 ATTORNEYS' FEES. In the event either party requires the services of an attorney in connection with enforcing the terms of this Lease or in the event suit is brought for the recovery of any Rent due under this Lease or the breach of any covenant or condition of this Lease, or for the restitution of the Premises to Landlord and/or eviction of Tenant during the Term of this Lease, or after the expiration thereof, the substantially prevailing party will be entitled to a reasonable sum for attorneys' fees, witness fees and other court costs, both at trial and on appeal. 17.10 CAPTIONS AND ARTICLE NUMBERS. The captions, article, paragraph and section numbers and table of contents appearing in this Lease are inserted only as a matter of convenience and in no way define, limit, construe or describe the scope or intent of such sections or articles of this Lease nor in any way affect this Lease. 17.11 SEVERABILITY. If any term, covenant, condition or provision of this Lease, or the application thereof to any person or circumstance, shall to any extent be held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, covenants, conditions or provisions of this Lease, or the application thereof to any person or circumstance, shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 17.12 APPLICABLE LAW. This Lease, and the rights and obligations of the parties hereto, shall be construed and enforced in accordance with the laws of the state in which the Building is located. 17.13 SUBMISSION OF LEASE. The submission of this document for examination and negotiation does not constitute an offer to lease, or a reservation of or option for leasing the Premises. This document shall become effective and binding only upon execution and delivery hereof by Landlord and Tenant. No act or omission of any officer, employee or agent of Landlord or Tenant shall alter, change or modify any of the provisions hereof. 17.14 HOLDING OVER. Should Tenant, or any of its successors in interest, hold over the Premises or any part thereof after the expiration or earlier termination of this Lease without Landlord's prior written consent, such holding over shall constitute and be construed as tenancy at sufferance only, at a monthly rent equal to one hundred fifty percent (150%) of the Base Rent owed during the final month of the Term of this Lease and otherwise upon the terms and conditions in the Lease, so far as applicable. Should Tenant, or any of its successors in interest, hold over the Premises or any part thereof after the expiration or earlier termination of this Lease with Landlord's prior written consent, such holding over shall constitute and be construed as a tenancy from month to month only, at a fair market monthly rent as agreed by Landlord and Tenant and otherwise upon the terms and conditions of this Lease, so far as applicable. The acceptance by Landlord of Rent after such expiration or early termination shall not result in a renewal or extension of this Lease. The foregoing provisions of this Section 17.14 are in addition to and do not affect Landlord's right of re-entry or any other rights of Landlord hereunder or as otherwise provided by law. If Tenant fails to surrender the Premises on the expiration of this Lease and/or to remove all Tenant's fixtures and/or personal property pursuant to Section 9.1 hereof, Tenant shall indemnify and hold Landlord harmless for, from and against all claims, damages, loss or liability, including without limitation, any claim made by any succeeding tenant resulting from such failure to surrender by Tenant and any attorneys' fees and costs incurred by Landlord with respect to any such claim. 17.15 RULES AND REGULATIONS. At all times during the Term, Tenant shall comply with Rules and Regulations for the Building and the Project, as set forth in Exhibit E attached hereto, together with such amendments thereto as Landlord may from time to time reasonably adopt and enforce in a non-discriminatory fashion; provided that: (a) Tenant is given fifteen (15) days' advance notice of such modifications or new rules and regulations; and (b) Such modifications or new rules and regulations are (i) for the safety, care, order and cleanliness of the Project, (ii) do not unreasonably and materially interfere with Tenant's conduct of its business or -27- Tenant's use and enjoyment of or its access to the Premises, or (iii) are of the type customarily imposed for similar buildings. If a Rule or Regulation conflicts with or is inconsistent with any Lease provision, the Lease provision controls. Landlord agrees not to enforce the Rules and Regulations in a discriminatory fashion. 17.16 PARKING. Unless Tenant is in default hereunder, Tenant shall be entitled to the number of unreserved vehicle parking spaces designated in Section 1.1(q) hereof for the non-exclusive use of Tenant, its employees, visitors and customers. All parking spaces shall be available for the common use of the tenants, subtenants and invitees of the Project on a non-exclusive basis, subject to any reasonable restrictions from time to time imposed by Landlord. Tenant shall not use or permit its officers, employees or invitees to use more than the number of spaces designated in Section 1.1(q) or any spaces which have been specifically reserved by Landlord to other tenants or for such other uses as have been designated by appropriate governmental entities as being restricted to certain uses. Tenant shall at all times comply and cause its officers, employees and invitees to comply with any parking Rules and Regulations as Landlord may from time to time reasonably adopt. 17.17 NO NUISANCE. Tenant shall conduct its business and control its agents, employees, invitees and visitors in such a manner as not to create any nuisance, or interfere with, annoy or disrupt any other tenant or Landlord in its operation of the Building or Project. 17.18 BROKER; AGENCY DISCLOSURE. Landlord has not engaged any real estate broker or agent in connection with this Lease. Tenant has entered into an agreement with Colliers International ("Colliers") pursuant to which Colliers has advised Tenant. Tenant is responsible for the payment of all fees and commissions to Colliers in connection with this Lease. Landlord has no responsibility for any such fees or commissions. Tenant shall indemnify and hold harmless Landlord from and against any and all claims, demands, losses, liabilities, lawsuits, judgments, costs and expenses (including without limitation, attorneys' fees and costs) with respect to any leasing commission or equivalent compensation alleged to be owing on account of Tenant's discussions, negotiations and/or dealings with Colliers, whose fee shall be paid by Tenant. 17.19 LANDLORD'S RIGHT TO PERFORM. Upon Tenant's failure to perform any obligation of Tenant hereunder after notice from Landlord pursuant to Section 13.1 above, including without limitation, payment of Tenant's insurance premiums and charges of contractors who have supplied materials or labor to the Premises. Landlord shall have the right to perform such obligation of Tenant on behalf of Tenant and/or to make payment on behalf of Tenant to such parties. Tenant shall reimburse Landlord the reasonable cost of Landlord's performing such obligation on Tenant's behalf, including reimbursement of any amounts that may be expended by Landlord, plus interest at the Default Rate, as Additional Rent. 17.20 ASSIGNMENT BY LANDLORD. In the event of a sale, conveyance, or other transfer by Landlord of the Building, the Project, or portion thereof on which the Building is located, or in the event of an assignment of this Lease by Landlord, the same shall operate to release Landlord from any further liability upon any of the covenants or conditions, express or implied, herein contained on the part of Landlord, and from any and all further liability, obligations, costs and expenses, demands, causes of action, claims or judgments arising out of this Lease from and after the effective date of said release. In such event, Tenant agrees to look solely to the successor in interest of Landlord with respect to liabilities accruing after the date of such sale, conveyance, transfer, or assignment. If any Security Deposit is given by Tenant to secure performance of Tenant's covenants hereunder, Landlord shall transfer such Security Deposit to any purchaser and thereupon Landlord shall be discharged from any further liability in reference thereto. Notwithstanding anything in this Lease to the contrary, however, (i) in no event shall Landlord's lender, who may have succeeded to the interest of Landlord by foreclosure, deed in lieu of foreclosure, or any other means, have any liability for any obligation of Landlord to protect, defend, indemnify or hold harmless Tenant or any other person or entity except for those matters arising from the lender's breach of the terms of this Lease after the date of such foreclosure, deed in lieu of foreclosure or any other means, and (ii) such succeeding lender shall have no liability for any representations or warranties of the Landlord contained herein except for those matters arising from the lender's breach of the terms of this Lease after the date of such foreclosure, deed in lieu of foreclosure or any other means. -28- 17.21 ENTIRE AGREEMENT. This Lease sets forth all covenants, promises, agreements, conditions and understandings between Landlord and Tenant concerning the Building and the Project, and there are no covenants, promises, agreements, conditions or understandings, either oral or written, between Landlord and Tenant other than as are herein set forth. No subsequent alteration, amendment, change or addition to the Lease shall be binding upon Landlord or Tenant unless reduced to writing and signed by Landlord and Tenant. 17.22 FINANCIAL COVENANTS. If Tenant is not a publicly traded company with its financial information readily available to the public on the Internet, at Landlord's request, Tenant shall provide Landlord with current annual audited financial statements and quarterly unaudited financial statements (all such statements shall be prepared in compliance with GAAP standards) setting forth Tenant's financial condition. 17.23 CONSENTS. Whenever the approval or consent of Landlord or Tenant is required under the terms of this Lease, such consent shall not be unreasonably withheld or delayed unless a different standard of approval is specifically set forth in the particular Section containing that particular consent requirement. 17.24 EXHIBITS. Exhibits A through E are attached to this Lease after the signatures and by this reference incorporated herein. 17.25 TIME. Time is of the essence with respect to the performance of every provision of this Lease in which time of performance is a factor. 17.26 AUTHORITY TO BIND LANDLORD. The individuals signing this Lease on behalf of Landlord hereby represent and warrant that they are empowered and duly authorized to bind Landlord to this Lease. 17.27 AUTHORITY TO BIND TENANT. The individuals signing this Lease on behalf of Tenant hereby represent and warrant that they are empowered and duly authorized to bind Tenant to this Lease. 17.28 INTERPRETATION. The parties hereto specifically acknowledge and agree that the terms of this Lease have been mutually negotiated and the parties hereby specifically waive the rule or principle of contract construction which provides that any ambiguity in any term or provision of a contract will be interpreted or resolved against the party which drafted such term or provision. 17.29 EXCUSED DELAYS. Except as otherwise set forth in this Section 17.30, neither party shall have liability to the other on account of the following acts (each of which is an "Excused Delay" and jointly all of which are "Excused Delays")" which shall include: (a) the inability to fulfill, or delay in fulfilling, any obligations under this Lease by reason of strike, lockout, other labor trouble, dispute or disturbance; (b) governmental regulation, moratorium, action, preemption or priorities or other controls; (c) shortages of fuel, supplies or labor; (d) any failure or defect in the supply, quantity or character of electricity or water furnished to the Premises by reason of any requirement, act or omission of the public utility or others furnishing the Building with electricity or water; or (e) for any other reason, whether similar or dissimilar to the above, or for act of God beyond a party's reasonable control. If this Lease specifies a time period for performance of an obligation of a party, that time period shall be extended by the period of any delay in the party's performance caused by any of the events of Excused Delay described herein; provided, that notwithstanding anything to the contrary above, no payment of money (whether as Base Rent, Tenant's Share of Operating Expenses, or any other payment due under this Lease) shall be postponed, delayed or forgiven by reason of any of the foregoing events of Excused Delay. 17.30 QUIET ENJOYMENT. Until such time as this Lease has expired or been terminated pursuant to this Lease, Tenant shall peaceably and quietly have, hold, and enjoy the Premises for the Term of this Lease without hindrance or disturbance by anyone. Landlord will defend Tenant's right to quiet enjoyment of the Premises from the lawful claims of all persons claiming through Landlord during the Term of the Lease. 17.31 LANDLORD'S REPRESENTATIONS AND WARRANTIES. Landlord represents and warrants as follows: (a) Landlord has received no written notice of any liens to be assessed against the Premises, Buildings, or Project; -29- (b) Landlord has received no written notice or any current violation of any laws relating to the Premises, Buildings, or Project; (c) The execution, delivery, and performance of this Lease by Landlord will not result in any breach of, or constitute any default under, or result in the imposition of any lien or encumbrance on the Premises under any agreement or other instrument to which Landlord is a party or by which Landlord or the Premises might be bound; (d) To the best of Landlord's actual knowledge, there are no legal actions, suits, or other legal or administrative proceedings, including condemnation cases, pending or threatened, against the Premises, and Landlord is not aware of any fact that might result in any such action, suit, or other proceeding. IN WITNESS WHEREOF, the parties have executed this Lease as of the date first above written. "Landlord" "Tenant" SCHNITZER INVESTMENT CORP. SCHNITZER STEEL INDUSTRIES, INC. By: /s/ K. Novack By: /s/ R. Philip ------------------------------------ --------------------------------- Its: CEO Its: CEO ------------------------------------ --------------------------------- -30- EXHIBIT A PROJECT SITE PLAN -31- EXHIBIT B FLOOR PLAN -32- EXHIBIT C LEASE CONFIRMATION This Lease Confirmation is made ________________, 20__, by __________________________________, a _______________________________ ("Tenant"), who agree as follows: 1. Landlord and Tenant entered into a lease dated _______________, 20__, in which Landlord leased to Tenant and Tenant leased from Landlord the premises described in Section 2.1 of said Lease ("Premises"). All capitalized terms herein are as defined in the Lease. 2. Pursuant to the Lease, Landlord and Tenant agreed to and do hereby confirm the following matters as of the Commencement of the Term: a. _____________________, 20__ is the Commencement Date of the Term of the Lease; b. _____________________, 20___ is the expiration date of the Term of the Lease; c. The initial Base Rent under the Lease, subject to adjustments as provided in the Lease, is $________________________. 3. Tenant confirms that: a. It has accepted possession of the Premises as provided in the Lease; b. The improvements required to be furnished by Landlord under the Lease have been furnished (subject to any corrective work or punch-list items of which Tenant has notified Landlord in accordance with the Lease); c. Landlord has fulfilled all its duties of an inducement nature; d. The Lease is in full force and effect and has not been modified, altered, or amended, except as follows: _________________________________________________________ _______________________________________________; and e. There are no setoffs or credits against Rent, and no Security Deposit or prepaid rent has been paid except as provided by the Lease. 4. The provisions of this Lease Confirmation shall inure to the benefit, or bind, as the case may require, the parties and their respective successors and assigns, subject to the restrictions on assignment and subleasing contained in the Lease. Initials Landlord: _________________ Tenant: ___________________ -33- EXHIBIT D ESTOPPEL CERTIFICATE _____________________ _____________________ _____________________ Re: Lease dated __________, 2___ ("Lease") by and between ______________________________ ("Landlord"), and _______________________________ ("Tenant") Ladies and Gentlemen: Reference is made to the above-described Lease in which the undersigned is the Tenant. We understand that you are accepting an assignment of Landlord's rights under the Lease as _________________________________, and we hereby, as a material inducement for you to consummate the transaction, represent that: 1. There are no modifications amendments, supplements, arrangements, side letters or understandings, oral or written, of any sort, modifying, amending, altering, supplementing or changing the terms of the Lease, except for those attached to this Certificate. 2. The Lease is in full force and effect, and the Lease has been duly executed and delivered by, and is a binding obligation of, the Tenant as set forth therein. 3. The undersigned acknowledges (a) that rent on the Lease has been paid up to and including _____________, 2___ (b) that monthly rent during the _________________ (_______) years of the term of the Lease is $______________ per month, and (c) that rent has not been paid for any period after ____________, 2___ and shall not, except for any Prepaid Rent as specified in the Lease, be paid for a period in excess of one (1) month in advance. 4. To the current knowledge of the undersigned, the improvements on the Building are free from defects in design, materials and workmanship and the improvements meet all governmental requirements, including, but not limited to, zoning and environmental requirements. 5. To the current knowledge of the undersigned, the Lease is not in default, and Landlord has performed the obligations required to be preformed by Landlord under the terms thereof through the date hereof. Dated: _________________, 2___. Very truly yours, "Tenant" _________________________ _________________________ By:_______________________ Its:_______________________ -34- EXHIBIT E OFFICE RULES AND REGULATIONS 1. SIGN. No sign, placard, picture, advertisement, name or notice shall be inscribed, displayed, printed or affixed on or to any part of the outside or inside of the Building, the Premises or the surrounding area without the written consent of the Landlord being first obtained. If such consent is given by Landlord, Landlord may regulate the manner of display of the sign, placard, picture, advertisement, name or notice. Landlord shall have the right to remove any sign, placard, picture, advertisement, name or notice which has not been approved by Landlord or is being displayed in a non-approved manner without notice to and at the expense of the Tenant. Tenant shall not place anything or allow anything to be placed near the glass of any window, door, partition or wall which may appear unsightly from outside of the Premises. 2. DIRECTORY. The bulletin board or directory of the Building will be provided exclusively for the display of the name and location of tenants and Landlord reserves the right to exclude any other names therefrom. 3. ACCESS. The sidewalks, halls, passages, exits, entrances, elevators and stairways shall not be obstructed by any of the tenants or used by them for any purpose other than for ingress to and egress from their respective Premises. The halls, passages, entrances, exits, elevators, stairways, balconies and roof are not for the use of the general public and the Landlord shall in all cases retain the right to control thereof and prevent access thereto by all persons whose presence in the judgment of the Landlord shall be prejudicial to the safety, character, reputation and interests of the Building or its tenants; provided, however, that nothing herein contained shall be construed to prevent access by persons with whom the Tenant normally deals in the ordinary course of Tenant's business unless such persons are engaged in illegal activities. No Tenant and no employees or invitees of any Tenant shall go upon the roof of the Building. 4. LOCKS. Tenant shall not alter any lock or install any new additional locks or any bolts on any door of the Premises without the written consent of Landlord. 5. RESTROOMS. The toilet rooms, urinals, wash bowls and other apparatus shall not be used for any purpose other than that for which they were constructed and no foreign substance of any kind whatsoever shall be thrown therein. The expense of any breakage, stoppage or damage resulting from a violation of this rule shall be borne by the Tenant who, or whose employees, sublessees, assignees, agents, licensees, or invitees shall have caused it. 6. NO DEFACING PREMISES. Tenant shall not overload the floor of the Premises, shall not mark on or drive nails, screw or drill into the partitions, woodwork or plaster (except as may be incidental to the hanging of wall decorations), and shall not in any way deface the Premises or any part thereof. 7. SAFES AND HEAVY EQUIPMENT. No furniture, freight or equipment of any kind shall be brought into the Building without the consent of Landlord and all moving of the same into or out of the Building shall be done at such time and in such manner as Landlord shall designate. Landlord shall have the right to prescribe the times and manner of moving all heavy equipment in and out of the Building. Landlord will not be responsible for loss of or damage to any such safe or property from any cause and all damage done to the Building by moving or maintaining any such safe or other property shall be repaired at the expense of Tenant. There shall not be used in any Premises or in the public halls of the Building, either by any tenant or others, any hand trucks except those equipped with rubber tires and side guards. Elevators must be padded while moving freight via the elevators. All such heavy equipment shall be subject to the requirements of Rule 25 below. 8. NUISANCE. Tenant shall not use, keep or permit to be used or kept any noxious gas or substance in the Premises, or permit or suffer the Premises to be occupied or used in a manner offensive or objectionable to the Landlord or other occupants of the Building by reason of excessive noise, odors and/or vibrations, or unreasonably interfere in any way with other tenants or those having business in the Building. No animals or birds shall be brought in or kept in or about the Premises or the Building. No Tenant shall make or permit to be made any unreasonably disturbing noises or unreasonably disturb or interfere with occupants of this or neighboring Buildings or Premises, or with those having business with such occupants by the use of any musical instrument, radio, -35- phonograph, unusual noise, or in any other way. No Tenant shall throw anything out of doors or down the passageways. 9. PERMITTED USE. The Premises shall not be used for manufacturing or for the storage of merchandise except as such storage may be incidental to the use of the Premises for general office purposes. No Tenant shall occupy or permit any portion of its Premises to be occupied for the manufacture or sale of liquor, narcotics, or tobacco in any form, or as a medical office, or as a barber shop or manicure shop except with prior written consent of Landlord. No Tenant shall advertise for laborers giving an address at the Premises. The Premises shall not be used for lodging or sleeping or for illegal purposes. 10. HAZARDOUS SUBSTANCES. Tenant shall not use or keep in the Premises or the Building any kerosene, gasoline or inflammable or combustible fluid or material or any Hazardous Materials as defined in Section 10.2 of the Lease or use any method of heating or air conditioning other than that supplied by Landlord. 11. TELEPHONES. Landlord will direct electricians as to where and how telephone and telegraph wires are to be introduced. No boring or cutting for or stringing of wires will be allowed without the consent of Landlord. The location of telephones, call boxes and other office equipment affixed to the Premises shall be subject to the approval of Landlord. 12. KEYS. All keys to the Building, Premises, rooms and toilet rooms shall be obtained from Landlord's office and Tenant shall not from any other source duplicate or obtain keys or have keys made. The Tenant, upon termination of the tenancy, shall deliver to the Landlord the keys to the Building, Premises, rooms and toilet rooms which shall have been furnished and shall pay the Landlord the cost of replacing any lost key or of changing the lock or locks opened by such lost key if Landlord deems it necessary to make such change. 13. FLOOR COVERING. No Tenant shall lay linoleum, tile, carpet or other similar floor coverings so that the same shall be affixed to the floor or the Premises in any manner except as approved by the Landlord. The expense of repairing any damage resulting from a violation of this rule or removal of any floor covering shall be borne by the Tenant by whom, or by whose contractors, agents, sublessees, licensees, employees or invitees, the floor covering shall have been laid. 14. BUILDING CLOSURE. During all hours on legal holidays and such other times as reasonably determined by Landlord from time to time, access to the Building or to the halls, corridors, or stairways in the Building, or to the Premises may be refused unless the person seeking access is known to any person or employee of the Building in charge and has a pass or is properly identified. The Landlord shall in no case be liable for damages for any error with regard to the admission to or exclusion from the Building of any person. In case of invasion, mob, riot, public excitement, or other commotion, the Landlord reserves the right to prevent access to the Building during the continuance of the same, by closing the doors or otherwise, for the safety of the tenants and protection of the Building and property located therein. Anything to the foregoing notwithstanding, Landlord shall have no duty to provide security protection for the Building at any time or to monitor access thereto. 15. PREMISES CLOSURE. Tenant shall see that the doors of the Premises are closed and securely locked before leaving the Building and that all water faucets, and water apparatus are entirely shut off before Tenant or Tenant's employees leave the Building. Tenant shall be responsible for any damage to the Building or other tenants caused by a failure to comply with this rule. Tenant shall at all times keep the perimeter doors and windows to the Premises closed. 16. DISORDERLY CONDUCT. Landlord reserves the right to exclude or expel from the Building any person who, in the judgment of Landlord, is intoxicated or under the influence of liquor or drugs, or who shall in any manner do any act in violation of any of the rules and regulations of the Building. 17. TENANT REQUESTS. Any requests of Tenant will be considered only upon application at the office of the Landlord. Employees of Landlord shall not be requested to perform any work or do anything outside of their regular duties unless under special instructions from the Landlord. -36- 18. VENDING MACHINES. No vending machine shall be installed, maintained or operated upon the Premises without the written consent of the Landlord. 19. BUILDING NAME AND ADDRESS. Landlord shall have the right, exercisable without notice and without liability to Tenant, to change the name and the street address of the Building of which the Premises are a part. 20. EMERGENCY REGULATIONS. Tenant agrees that it shall comply with all emergency regulations that may be issued from time to time by Landlord and Tenant also shall provide Landlord with the names of a designated responsible employee to represent Tenant in all matters pertaining to emergency regulations. 21. TENANT ADVERTISING. Without the written consent of Landlord, Tenant shall not use the name of the Building in connection with or in promotion or advertising the business of Tenant except as Tenant's address. 22. EMERGENCY INFORMATION. Tenant must provide Landlord with names and telephone numbers to contact in case of emergency. Tenant must fill out a tenant emergency information sheet and return it to Landlord's office within three (3) days of occupancy. 23. INSTALLATION OF BURGLAR AND INFORMATIONAL SERVICES. If Tenant requires telegraphic, telephonic, burglar alarm or similar services, it shall first obtain, and comply with, Landlord's instructions in their installation. 24. FLOOR LOADS. Tenant shall not place a load upon any floor of the Premises which exceeds the load per square foot, which such floor was designed to carry and which is allowed by law. Landlord shall have the right to prescribe the weight, size and position of all equipment, materials, furniture or other property brought into the Building. Heavy objects shall, if considered necessary by Landlord, stand on such platforms as determined by Landlord to be necessary to properly distribute the weight, which platforms shall be provided at Tenant's expense. Business machines and mechanical equipment belonging to Tenant, which cause noise or vibration that may be transmitted to the structure of the Building or to any space therein to such a degree as to be objectionable to Landlord or to any tenants in the Building, shall be placed and maintained by Tenant, at Tenant's expense, on vibration eliminators or other devices sufficient to eliminate noise or vibration. The persons employed to move such equipment in or out of the Building must be acceptable to Landlord. Landlord will not be responsible for loss of, or damage to, any such equipment or other property from any cause, and all damage done to the Building by maintaining or moving such equipment or other property shall be repaired at the expense of Tenant. 25. ENERGY CONSERVATION. Tenant shall not waste electricity, water or air conditioning and agrees to cooperate fully with Landlord to assure the most effective operation of the Building's heating and air-conditioning and to comply with any governmental energy-saving rules, laws or regulations of which Tenant has actual notice, and shall refrain from attempting to adjust controls. Tenant shall keep corridor doors closed. 26. NO ANTENNAS. Tenant shall not install any radio or television antenna, loudspeaker or other devices on the roof or exterior walls of the Building. Tenant shall not interfere with radio or television broadcasting or reception from or in the Building or elsewhere. 27. NO SOLICITING. Canvassing, soliciting and distribution of handbills or any other written material, and peddling in the Building are prohibited, and Tenant shall cooperate to prevent such activities. 28. PROHIBITED USES. The Premises shall not be used for any improper, immoral or objectionable purpose. No cooking shall be done or permitted on the Premises without Landlord's consent, except that use by Tenant of Underwriters Laboratory approved equipment for brewing coffee, tea, hot chocolate and similar beverages or use of microwave ovens for employee use shall be permitted, provided that such equipment and use is in accordance with all applicable federal, state, county and city laws, codes, ordinances, rules and regulations. 29. ENFORCEMENT OF RULES. Landlord may waive any one or more of these Rules and Regulations for the benefit of Tenant or any other Tenant but no such waiver by Landlord shall be construed as a waiver of such -37- Rules and Regulations in favor of Tenant, nor prevent Landlord from thereafter enforcing any such Rules and Regulations against any or all of the tenants of the Building. 30. LEASE. These Rules and Regulations are in addition to, and are made a part of, the terms, covenants, agreements and conditions of Tenant's Lease of its Premises in the Building. 31. ADDITIONAL RULES. Landlord reserves the right to make such other Rules and Regulations or amendments hereto as, in its reasonable judgment, may from time to time be needed for safety and security, for care and cleanliness of the Building and for the preservation of good order therein. Tenant agrees to abide by all such Rules and Regulations hereinabove stated and any additional rules and regulations which are adopted. 32. OBSERVANCE OF RULES. Tenant shall be responsible for the observance of all of the foregoing rules by Tenant's employees, agents, licensees, sublessees, assigns, and invitees. 33. MAINTENANCE OF FIRE EXTINGUISHERS. Tenant shall maintain in the Premises during the entire Lease Term, not less than the minimum number of fire extinguishers required by law and Tenant shall inspect all such fire extinguishers not less frequently than once each month to assure that the same are fully charged and in good operational condition. Annually the Tenant shall have all fire extinguishers inspected by an authorized and qualified inspector who shall certify that each such fire extinguisher complies with all applicable requirements of the NFPA. If any such fire extinguishers fail to obtain such certification, then within three (3) business days after such failure such fire extinguishers shall be replaced, or repaired, and re-inspected and a certification shall be issued certifying that all such fire extinguishers comply with all applicable requirements of the NFPA. 34. EMERGENCY. In the event of a fire or other emergency threatening property or health and safety, Tenant shall immediately notify the appropriate emergency response officials and Landlord of such emergency. -38- TABLE OF CONTENTS Page ---- ARTICLE I DEFINITIONS.....................................................1 1.1 Defined Terms...................................................1 ARTICLE II PREMISES AND COMMON AREAS LEASED................................2 2.1 Premises........................................................2 2.2 Common Areas....................................................3 ARTICLE III IMPROVEMENTS....................................................3 3.1 Construction of Premises........................................3 3.2 Continuance of Current Lease During Construction of Tenant Improvements.............................................4 ARTICLE IV TERM............................................................4 4.1 Initial Term....................................................4 4.2 Notice of Commencement Date.....................................4 4.3 Option to Extend................................................4 ARTICLE V RENT............................................................5 5.1 Base Rent.......................................................5 5.2 Additional Rent.................................................6 5.3 Late Payment....................................................6 5.4 Security Deposit. Intentionally deleted........................6 ARTICLE VI ADDITIONAL RENT AND CHARGES.....................................6 6.1 Operating Expenses..............................................6 6.2 Adjustments....................................................11 6.3 Tenant's Personal Property Taxes...............................11 ARTICLE VII INSURANCE......................................................11 7.1 Landlord's Insurance...........................................11 7.2 Tenant's Public Liability......................................12 7.3 Tenant's Property and Other Insurance..........................12 7.4 Form of Insurance/Certificates.................................12 7.5 Tenant's Failure...............................................12 7.6 Waiver of Subrogation..........................................13 7.7 Tenant's Properties and Fixtures...............................13 7.8 Indemnification................................................13 7.9 Damage to Tenant's Property....................................14 ARTICLE VIII REPAIRS AND MAINTENANCE........................................14 8.1 Landlord Repairs and Maintenance...............................14 8.2 Utilities and Services.........................................14 8.3 Tenant Repairs and Maintenance.................................15 8.4 Non-liability of Landlord......................................15 8.5 Inspection of Premises.........................................15 8.6 Access by Tenant...............................................15 -39- ARTICLE IX FIXTURES, PERSONAL PROPERTY AND ALTERATIONS....................15 9.1 Fixtures and Personal Property.................................15 9.2 Alterations....................................................16 9.3 Liens..........................................................16 ARTICLE X USE AND COMPLIANCE WITH LAWS...................................17 10.1 General Use and Compliance with Laws...........................17 10.2 Hazardous Materials............................................17 10.3 Signs..........................................................19 ARTICLE XI DAMAGE AND DESTRUCTION.........................................19 11.1 Reconstruction.................................................19 11.2 Rent Abatement.................................................19 11.3 Excessive Damage or Destruction................................19 11.4 Uninsured Casualty.............................................19 11.5 Waiver.........................................................19 11.6 Mortgagee's Right..............................................20 11.7 Damage Near End of Term........................................20 ARTICLE XII EMINENT DOMAIN.................................................20 ARTICLE XIII DEFAULT........................................................20 13.1 Events of Default..............................................20 13.2 Remedies.......................................................21 13.3 Landlord's Default.............................................22 ARTICLE XIV FILING OF PETITION.............................................22 ARTICLE XV ASSIGNMENT AND SUBLETTING......................................23 15.1 Prohibition....................................................23 15.2 Excess Rental..................................................24 15.3 Scope..........................................................24 15.4 Waiver.........................................................24 15.5 Change in Control..............................................24 ARTICLE XVI ESTOPPEL CERTIFICATE, ATTORNMENT AND SUBORDINATION.............24 16.1 Estoppel Certificates..........................................24 16.2 Attornment.....................................................25 16.3 Subordination..................................................25 16.4 Recording......................................................25 16.5 Subordination of Landlord's Lien...............................25 ARTICLE XVII MISCELLANEOUS..................................................25 17.1 Notices........................................................25 17.2 Successors Bound...............................................26 17.3 Waiver.........................................................26 17.4 Subdivision and Easements......................................26 17.5 Landlord's Reserved Rights in Common Areas.....................26 17.6 Accord and Satisfaction........................................26 17.7 Limitation of Landlord's Liability.............................26 17.8 Survival.......................................................26 17.9 Attorneys' Fees................................................27 17.10 Captions and Article Numbers...................................27 17.11 Severability...................................................27 -40- 17.12 Applicable Law.................................................27 17.13 Submission of Lease............................................27 17.14 Holding Over...................................................27 17.15 Rules and Regulations..........................................27 17.16 Parking........................................................28 17.17 No Nuisance....................................................28 17.18 Broker; Agency Disclosure......................................28 17.19 Landlord's Right to Perform....................................28 17.20 Assignment by Landlord.........................................28 17.21 Entire Agreement...............................................29 17.22 Financial Covenants............................................29 17.23 Consents.......................................................29 17.24 Exhibits.......................................................29 17.25 Time...........................................................29 17.26 Authority to Bind Landlord.....................................29 17.27 Authority to Bind Tenant.......................................29 17.28 Interpretation.................................................29 17.29 Excused Delays.................................................29 17.30 Quiet Enjoyment................................................29 17.31 Landlord's Representations and Warranties......................29 EX-10.8 5 exh10-8_12345.txt FIFTH AMENDMENT TO LEASE DATED AUGUST 7, 2003 EXHIBIT 10.8 ------------ FIFTH AMENDMENT TO LEASE THIS FIFTH AMENDMENT TO LEASE is written and made in duplicate on this 9th day of July, 2001, by and between SCHNITZER INVESTMENT CORP. ("Landlord") and SCHNITZER STEEL INDUSTRIES, INC. ("Tenant"). Each may be referred to from time to time as a "Party" and collectively as the "Parties." RECITALS WHEREAS, under a certain indenture of Lease (the "Lease") dated September 1, 1988, as amended by the Amendment of Lease dated July 2, 1990, the Second Amendment of Lease dated October 28, 1994, the Third Amendment of Lease dated February, 1998 and the Fourth Amendment of Lease dated July 1, 1998, which are, with the Lease, incorporated by this reference, Landlord leased certain real property in Portland, Multnomah County, Oregon, as described in the Lease to Tenant. WHEREAS, Landlord and Tenant have agreed to temporarily modify Tenant's "Base Rent", as that term is defined in the Lease; and it is the purpose of the Fifth Amendment of Lease to set forth all the terms and conditions of the Parties agreement in that regard. AGREEMENT NOW, THEREFORE, in consideration of the mutual covenants and conditions contained in this Fifth Amendment of Lease, the Parties covenant and agree as follows: 1. RENT REDUCTION: Notwithstanding anything to the contrary in the Lease, Tenant's Base Rent for the months of August, 2001 and September, 2001 will be $91.767.00 per month. 2. OTHER TERMS: Except as they may be modified in this Fifth Amendment of Lease, all the other terms and conditions of the Lease shall remain unmodified and in full force and effect. IN WITNESS WHEREOF, the Parties have executed this Fifth Amendment to Lease as of the date first hereinabove written. LANDLORD: TENANT: SCHNITZER INVESTMENT CORP. SCHNITZER STEEL INDUSTRIES, INC. By: Linda M. Wakefield By: Terry Glucoft --------------------- --------------------- Linda Wakefield Vice President Title: V.P. ------------------ EX-10.9 6 exh10-9_12345.txt SIXTH AMENDMENT TO LEASE DATED AUGUST 7, 2003 EXHIBIT 10.9 ------------ SIXTH AMENDMENT TO SSI INTERNATIONAL TERMINALS LEASE AGREEMENT DATED: August 7, 2003 BETWEEN: SCHNITZER INVESTMENT CORP., an Oregon corporation ("Lessor") AND: SCHNITZER STEEL INDUSTRIES, INC., an Oregon corporation ("Lessee") Recitals: - --------- A. Lessor and Lessee are parties to the SSI International Terminals Lease Agreement dated September 1, 1988 (the "Lease Agreement"), as amended by an Amendment to Lease dated July 2, 1990, a Second Amendment to Lease dated October 28, 1994, a Third Amendment to lease dated February, 1998, a Fourth Amendment to Lease dated July 1, 1998, and a Fifth Amendment to Lease dated July 9, 2001 (collectively, the "Lease"). Lessor and Lessee have completed the process to determine the Annual Rent effective on September 1, 2003, pursuant to Section 3.5 of the Lease Agreement (the "Process"). In connection with the Process, the parties have agreed on the Annual Rent effective on September 1, 2003, and the parties have agreed to clarify and amend certain provisions of the Lease. B. Capitalized terms which are used in this Sixth Amendment to SSI International Terminals Lease Agreement (the "Amendment") which are defined in the Lease shall have the meanings given to them in the Lease. Agreements: - ----------- NOW, THEREFORE, in consideration of the mutual promises of the parties set forth in this Amendment, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Annual Rent. Effective on September 1, 2003, and continuing through August 31, 2008, Annual Rent shall equal $1,834,102.00. 2. Fair Market Rental Value. When the Annual Rent is adjusted effective on each Market Adjustment Date to equal the fair market rental value of the Premises, the parties agree that the fair market rental value of the Premises shall be determined (a) assuming the Premises are in the condition required by the Lease, whether or not the Premises are maintained in the condition required by the Lease, and (b) with no deduction from fair market rental value relating to the environmental condition of the Premises. 3. Environmental Condition of the Premises. 3.1 Remediation. Lessee shall, no later than the expiration date of the Term or any earlier termination of the Lease, return the Premises to Lessor with all Hazardous Substances on, in, related to, or under the Premises remediated or removed from the Premises as required by applicable laws, regulations, and governmental requirements at Lessee's expense. No later than the expiration date of the Term or any earlier termination of the Lease, Lessee shall give to Lessor a No Further Action letter (or its equivalent) issued by the applicable governmental authorities in a form reasonably acceptable to Lessor. 3.2 Forbearance. Lessor agrees not to give written notice to Lessee to enforce Section 18.2 of the Lease Agreement unless or until one of the following occurs: (a) the Oregon Department of Environmental Quality ("DEQ"), the Environmental Protection Agency ("EPA") or other governmental entity commences enforcement action or requires action arising from or related to the Premises, the use of the Premises or the environmental condition on, in, under, or related to the Premises (the "Environmental Issues"), or (b) a third party commences litigation or other proceeding or takes other action against Lessor regarding any Environmental Issues. Lessee shall comply, at its expense, with the requirements of DEQ, EPA, and any other governmental agency related to the Environmental Issues, when and as directed by DEQ, EPA, or such other governmental agency. If Lessor enforces Section 18.2 of the Lease Agreement due to governmental action as provided in clause (a) above in this Section 3.2, Lessor's enforcement of Section 18.2 in that instance shall not exceed the requirements of DEQ, EPA, or other governmental agency. If Lessor enforces Section 18.2 of the Lease Agreement due to litigation or other proceeding or action as provided in clause (b) above in this Section 3.2, Lessor's enforcement of Section 18.2 in that instance shall not exceed that which will resolve the claims of the third party commencing the litigation, proceeding or other action whether such resolution is through a judgment, injunction, court order, arbitration decision, settlement, or otherwise. If a third party commences litigation or other proceeding or takes other action against Lessor regarding any Environmental Issues, Lessor shall give Lessee prompt written notice thereof. 4. No Waiver or Estoppel. Lessor and Lessee agree that either party's election not to enforce any provisions of the Lease now or in the future does not and will not constitute a waiver or an estoppel or otherwise affect that party's right to do so in the future. 5. Consolidated Restatement of Lease. At either party's option, the parties shall execute and deliver to each other an amended and restated lease that incorporates within one document the Lease Agreement, all amendments to the Lease Agreement, and this Amendment. 6. Additional Amendments. 6.1 Market Adjustment. Section 3.5.1 of the Lease is deleted and replaced with the following: Effective as of each Market Adjustment Date and continuing for the five Rent Years immediately following such Market Adjustment Date, Annual Rent shall be adjusted to equal the greater of (a) the fair market rental value of the Premises, determined in accordance with this Section 3.5, or (b) the Annual Rent for the Rent Year immediately prior to such Market Adjustment Date (the "Floor"). The Floor shall not apply if, as of the Market Adjustment Date, the Premises cannot be lawfully used for industrial purposes due to a reason not caused by Lessee and not related to Hazardous Substances. 6.2 Cross-Default. Section 19.1.5 of the Lease is deleted. 6.3 Nondisturbance. The following sentence is added to the end of Section 20.1: Notwithstanding the foregoing or any other provision of this Lease, this Lease shall not be subordinate to any Mortgage placed against the Premises after the date of this Lease unless the holder of such Mortgage agrees in writing that so long as Lessee is not in default under this Lease past any applicable cure period, Lessee's possession of the Premises and rights under this Lease will not be disturbed or otherwise affected by such holder in the event such holder acquires Lessor's interest in this Lease by foreclosure, deed in lieu of foreclosure, or other action. 6.4 Affiliate. The phrase "51 percent of" is replaced with "51 percent or more of" in each place it appears in Section 14.1 of the Lease. 6.5 Profits on Assignment or Sublease. Section 14.2 of the Lease is deleted. 6.6 Subordination of Landlord's Lien. Lessor agrees to subordinate its landlord's lien on Lessee's personal property to the lien of Lessee's lender if the terms of such subordination are reasonably acceptable to Lessor. 6.7 Right of First Offer. If Lessor decides to market for sale all or any part of the Premises or the property owned by Lessor that is adjacent to the Premises, Lessor agrees to give Lessee a one-time right of first offer as follows: Lessor shall give Lessee written notice of Lessor's intention to market such property (the "Offer Property") and the price at which Lessor intends to market the Offer Property (the "Notice"). Lessor agrees not to market the Offer Property for sale for 30 days following the date of the Notice (the "Negotiation Period") and, if Lessee is interested in purchasing the Offer Property at the price set forth in the Notice, Lessor agrees to negotiate in good faith with Lessee during the Negotiation Period the terms of Lessee's purchase of the Offer Property. If Lessor and Lessee do not enter into a binding written agreement pertaining to the purchase and sale of the Offer Property before the end of the Negotiation Period, Lessee's rights under this Section 6.7 shall terminate and be of no further force or effect. 7. Effect of Amendment. Lessor and Lessee ratify and confirm all provisions of the Lease. Except as expressly amended by this Amendment, the Lease remains unmodified and in full force and effect. IN WITNESS WHEREOF, the parties have executed this Amendment effective as of the date first set forth above. LESSOR: SCHNITZER INVESTMENT CORP., an Oregon corporation By: /s/ K. Novack ------------------------------ Its: CEO ----------------------------- LESSEE: SCHNITZER STEEL INDUSTRIES, INC., an Oregon corporation By: /s/ R. Philip ------------------------------ Its: CEO ----------------------------- EX-10.10 7 exh10-10_12345.txt PURCHASE AND SALE AGREEMENT DATED AUGUST 7, 2003 EXHIBIT 10.10 ------------- PURCHASE AND SALE AGREEMENT (SACRAMENTO COUNTY PROPERTY) DATED: August 7, 2003 BETWEEN: SCHNITZER INVESTMENT CORP., an Oregon corporation ("Seller") AND: SCHNITZER STEEL INDUSTRIES, INC., an Oregon corporation ("Buyer") Recitals: - --------- A. Seller owns the real property legally described on the attached Exhibit A and improvements thereon located on Folsom Boulevard in Sacramento County, California (the "Property"). Seller leases the Property to Buyer pursuant to a Lease Agreement between Seller and Buyer dated September 1, 1988, as amended by an Amendment to Lease dated February 8, 1995 (together, the "Lease"). The term of the Lease expires on August 31, 2003. B. Seller desires to sell the Property to Buyer and Buyer desires to purchase the Property from Seller prior to the expiration date of the term of the Lease, on the terms and subject to the conditions set forth in the Purchase and Sale Agreement (the "Agreement"). Agreements: - ----------- In consideration of the promises of the parties set forth in this Agreement, the receipt and adequacy of which are hereby acknowledged, the parties agree as follows: 1. PURCHASE AND SALE. Seller agrees to sell and Buyer agrees to purchase the Property (together with all Seller's rights, privileges, and easements appurtenant to the Property, including, without limitation all of Seller's right, title, and interest in and to all minerals, oil, gas, and other hydrocarbon substances on and under the Property, all development rights, air rights, water, water rights, riparian rights, and water stock relating to the Property and any rights-of-way or other appurtenances used in connection with the beneficial use and enjoyment of the Property, and all of Seller's right, title, and interest in and to all roads and alleys adjoining or servicing the Property, all of Seller's interest in assignable continuing business licenses, utility contracts, warranties, governmental approvals, building permits, and all other intangible personal property relating to the Property, and Seller's right, title, and interest in and to the Checo bridge crane located on the Property) in accordance with the terms, and subject to the conditions, set forth in this Agreement. 2. PURCHASE PRICE. The purchase price of the Property is One Million Sixty Four Thousand Nine Hundred Sixteen and no/100 Dollars ($1,064,916.00) (the "Purchase Price"). -1- The Purchase Price was determined by (a) multiplying $4.00 by the number of square feet of land area of the Property, and (b) subtracting from such product $150,000.00 due to the lack of potable water at the Property. The Purchase Price shall be paid all in cash at closing, as described in Section 6 of this Agreement (the "Closing"). 3. TITLE. Seller has ordered and Buyer has received and approved of a preliminary title report dated as of May 9, 2003, issued under order no. NCS-28991-SC (the "Title Report") from First American Title Insurance Company at 1737 North First Street, San Jose, California 95112 (the "Title Company"). All exceptions in the Title Report, the Prior Agreements, as defined in the Lease; all liens, encumbrances, and other exceptions to title created or suffered by Buyer; interests of tenants or other parties in possession; liens for real estate taxes and assessments; the preprinted exceptions and exclusions set forth in the Title Policy; and any other exceptions to title disclosed by the public records which would be disclosed by an inspection and/or survey of the Property (collectively, the "Conditions to Title") are approved by Buyer. 4. REPRESENTATIONS AND WARRANTIES. 4.1 BY SELLER. Seller represents and warrants the following to Buyer: 4.1.1 Seller is not a "foreign person" as defined in Section 1445 of the Internal Revenue Code of 1986, as amended (the "Code") and any related regulations. 4.1.2 This Agreement (i) has been duly authorized, executed and delivered by Seller, and (ii) does not violate any provision of any agreement or judicial order to which Seller is a party or to which Seller is subject. 4.1.3 Seller has the power and authority to enter into this Agreement and to perform its obligations hereunder. 4.1.4 Seller is duly formed, validly existing, and in good standing under the laws of the State of Oregon. Seller makes no, and hereby expressly disclaims, any representations and warranties with respect to the Property, including with respect to the matters (the "Disclosure Items") set forth in Schedule 1 attached hereto and made a part hereof. Notwithstanding anything to the contrary contained in this Agreement or in any document delivered in connection herewith, Seller shall have no liability with respect to the Disclosure Items. 4.2 BY BUYER. Buyer represents and warrants the following to Seller: 4.2.1 This Agreement (i) has been duly authorized, executed and delivered by Buyer, and (ii) does not violate any provision of any agreement or judicial order to which Buyer is a party or to which Buyer or the Property is subject. 4.2.2 Buyer has the power and authority to enter into this Agreement and to perform its obligations hereunder. -2- 4.2.3 Buyer is duly formed, validly existing, and in good standing under the laws of the State of Oregon. 4.2.4 Buyer has had no contact with any broker or finder with respect to the Property and Buyer has taken no action that may cause any broker or finder to make any claim for a commission or other compensation related to this transaction. 4.3 BUYER'S INDEPENDENT INVESTIGATION. 4.3.1 Buyer acknowledges that Buyer has been in possession of most of the Property since 1973 and most of the remainder of the Property since 1994. Buyer agrees that it has been given a full opportunity to inspect and investigate each and every aspect of the Property, either independently or through agents of Buyer's choosing, including, without limitation: (a) All matters relating to title, together with all governmental and other legal requirements such as taxes, assessments, zoning, use permit requirements and building codes. (b) The physical condition and aspects of the Property, including, without limitation, the interior, the exterior, the square footage within the improvements of the Property, the structure, seismic aspects of the Property, the paving, the utilities, and all other physical and functional aspects of the Property. Such examination of the physical condition of the Property includes an examination for the presence or absence of Hazardous Materials, as defined below. For purposes of this Agreement, "Hazardous Materials" shall mean inflammable explosives, radioactive materials, asbestos, polychlorinated biphenyls, lead, lead-based paint, under and/or above ground tanks, hazardous materials, hazardous wastes, hazardous substances, oil, or related materials, which are listed or regulated in the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (42 U.S.C. Sections 6901, et seq.), the Resources Conservation and Recovery Act of 1976 (42 U.S.C. Section 6901, et seq.), the Clean Water Act (33 U.S.C. Section 1251, et seq.), the Safe Drinking Water Act (14 U.S.C. Section 1401, et seq.), the Hazardous Materials Transportation Act (49 U.S.C. Section 1801, et seq.), the and Toxic Substance Control Act (15 U.S.C. Section 2601, et seq.), the California Hazardous Waste Control Law (California Health and Safety Code Section 25100, et seq.), the Porter-Cologne Water Quality Control Act (California Water Code Section 13000, et seq.), and the Safe Drinking Water and Toxic Enforcement Act of 1986 (California Health and Safety Code Section 25249.5, et seq.) and any other applicable federal, state or local laws (collectively, "Laws"). (c) Any easements and/or access rights affecting the Property. (d) All other matters of material significance affecting the Property. (e) BUYER SPECIFICALLY ACKNOWLEDGES AND AGREES THAT SELLER IS SELLING AND BUYER IS PURCHASING THE PROPERTY ON AN "AS IS WITH ALL FAULTS" BASIS AND THAT BUYER IS NOT RELYING ON ANY REPRESENTATIONS OR WARRANTIES OF ANY KIND WHATSOEVER, EXPRESS -3- OR IMPLIED, FROM SELLER, ITS AGENTS, OR REPRESENTATIVES AS TO ANY MATTERS CONCERNING THE PROPERTY, INCLUDING WITHOUT LIMITATION: (i) the quality, nature, adequacy and physical condition and aspects of the Property, including, but not limited to, the structural elements, seismic aspects of the Property, foundation, roof, appurtenances, access, landscaping, parking facilities and the electrical, mechanical, HVAC, plumbing, sewage, and utility systems, facilities and appliances, or the square footage of the land or the improvements of the Property, (ii) the quality, nature, adequacy, and physical condition of soils, geology and any groundwater, (iii) the existence, quality, nature, adequacy and physical condition of utilities serving the Property, (iv) the development potential of the Property, and the Property's use, habitability, merchantability, or fitness, suitability, value or adequacy of the Property for any particular purpose, (v) the zoning or other legal status of the Property or any other public or private restrictions on use of the Property, (vi) the compliance of the Property or its operation with any applicable codes, laws, regulations, statutes, ordinances, covenants, conditions and restrictions of any governmental or quasi-governmental entity or of any other person or entity, (vii) the presence of Hazardous Materials on, under or about the Property or the adjoining or neighboring property, (viii) the quality of any labor and materials used in any improvements on the Real Property, (ix) the condition of title to the Property, (x) any agreements affecting the Property and (xi) the economics of the operation of the Property. 4.4 RELEASE. 4.4.1 Without limiting the above, Buyer on behalf of itself and its successors and assigns waives its right to recover from, and forever releases and discharges, Seller, Seller's affiliates, the partners, trustees, beneficiaries, shareholders, members, directors, officers, employees and agents of each of them, and their respective heirs, successors, personal representatives and assigns (collectively, the "Seller Related Parties"), from any and all demands, claims, legal or administrative proceedings, losses, liabilities, damages, penalties, fines, liens, judgments, costs or expenses whatsoever (including, without limitation, attorneys' fees and costs), whether direct or indirect, known or unknown, foreseen or unforeseen, that may arise on account of or in any way be connected with (i) the physical condition of the Property including, without limitation, all structural and seismic elements, all mechanical, electrical, plumbing, sewage, heating, ventilating, air conditioning and other systems, the environmental condition of the Property and Hazardous Materials on, under or about the Property, or (ii) any Law applicable to the Property. Notwithstanding the foregoing, Buyer does not release Seller or any of the Seller Related Parties from any fraud or intentional misrepresentation. 4.4.2 Buyer expressly waives the benefits of Section 1542 of the California Civil Code, which provides as follows: "A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR." 4.5 SURVIVAL. The provisions of this Section 4 shall survive the Closing. The covenants of the Lease, including, without limitation, the indemnification obligations set forth in Section 18.1 of the Lease, shall survive the termination of the Lease and shall be fully enforceable thereafter. -4- 5. RISK OF LOSS. Buyer shall be bound to purchase the Property for the full Purchase Price as required by the terms hereof, without regard to the occurrence or effect of any damage to the Property or destruction of any improvements thereon or condemnation of any portion of the Property, provided that all insurance proceeds or condemnation awards collected by Seller as a result of any such damage or destruction or condemnation shall be paid to Buyer at Closing. However, if the proceeds or awards have not been collected as of the Closing, then all such proceeds or awards shall be assigned to Buyer. 6. CLOSING. 6.1 ESCROW INSTRUCTIONS. Upon execution of this Agreement, Seller and Buyer shall deposit an executed counterpart of this Agreement with the Title Company, and this instrument shall serve as the instructions to the Title Company as the escrow holder for consummation of the purchase and sale of the Property in accordance with this Agreement. Seller and Buyer agree to execute such reasonable additional and supplementary escrow instructions as may be appropriate to enable the Title Company to comply with the terms of this Agreement; provided, however, that in the event of any conflict between the provisions of this Agreement and any supplementary escrow instructions, the terms of this Agreement shall control. Seller and Purchaser hereby designate Title Company as the "Reporting Person" for the transaction pursuant to Section 6045(e) of the Internal Revenue Code (the "Code") and the regulations promulgated thereunder and agree to execute such documentation as is reasonably necessary to effectuate such designation. 6.2 CLOSING. The Closing (which shall occur when the deed conveying the Property to Buyer is recorded and the Purchase Price is disbursed to Seller) shall be held and delivery of all items to be made at the Closing under the terms of this Agreement shall be made at the offices of the Title Company on a date mutually acceptable to Seller and Buyer, but no later than August 15, 2003 (the "Closing Date"). Such date and time may not be extended without the prior written approval of both Seller and Buyer. In addition to the other conditions set forth in this Agreement, Buyer's obligation to purchase the Property is subject to the satisfaction, on or before the Closing Date, of each of the following conditions: 6.2.1 At Closing, the Title Company shall have committed to issue to Buyer the title insurance policy described in Section 6.4.2 of this Agreement; and 6.2.2 Seller having complied with, fulfilled, and performed in all material respects, each covenant, term, and condition to be complied with, fulfilled, or performed by Seller under this Agreement. 6.3 DEPOSIT OF DOCUMENTS. 6.3.1 At or before the Closing, Seller shall deposit into escrow the following items: (a) a duly executed and acknowledged deed (the "Deed") in the form attached as Exhibit B conveying the Real Property to Buyer subject to the Conditions of Title; -5- (b) an affidavit pursuant to Section 1445(b)(2) of the Code, and on which Buyer is entitled to rely, that Seller is not a "foreign person" within the meaning of Section 1445(f)(3) of the Code; (c) a Form 593-W from Seller certifying the information required by ss.ss. 18662 of the California Revenue and Taxation Code and the regulations issued thereunder to establish that the transaction contemplated by this Agreement is exempt from the tax withholding requirements of such provisions (the "California Certificate"); and (d) an assignment to Buyer of any claims and causes of action against any third parties, if any, arising out of or relating to defective design, defective construction, or other physical defects (including, without limitation, environmental contamination) relating to the Property (the "Claims"); provided, however, notwithstanding anything to the contrary in this Agreement, Seller reserves and retains all of its rights, title, and interest in and to any Claims applicable to or covering any part of the Property relating to any matter for which Seller may have liability; and provided, further, said rights, title, and interest reserved and retained by Seller shall exist jointly with Buyer's rights, title, and interest in and to the Claims to be assigned to Buyer, and such rights, title, and interest in and to the Claims may be enforceable by each of Seller and Buyer to the extent of their respective liability or damages for any matters relating thereto. 6.3.2 At or before Closing, Buyer shall deposit into escrow the funds necessary to close this transaction. 6.4 PRORATIONS AND TITLE INSURANCE. 6.4.1 Rents paid by Buyer pursuant to the Lease for the month in which Closing occurs shall be prorated as of the date the Deed is recorded, on the basis of the number of calendar days in the month in question. No other amounts shall be prorated because Buyer is obligated to pay all expenses pertaining to the Property under the Lease. If Closing occurs on or before the expiration date of the term of the Lease, the term of the Lease shall expire as of the actual Closing Date. 6.4.2 Seller shall pay the cost of furnishing to Buyer a standard owner's policy of title insurance (an Owner's CLTA 1990 form), issued by the Title Company, insuring fee simple title to the Property held by Buyer in the amount of the Purchase Price, subject only to the Conditions to Title and the usual preprinted exceptions. Buyer shall pay the costs of obtaining extended title insurance coverage; the cost of any endorsements; any transaction fees and excise taxes applicable to the sale; and one-half the escrow fee. Seller shall pay one-half the escrow fee. Recording charges, transfer and documentary taxes, and any other expenses of the escrow for the sale shall be paid by Buyer and Seller in accordance with customary practice in the city, county and state in which the Property is located, as determined by the Title Company. If Buyer elects to obtain an extended coverage title policy, Seller shall execute and deliver to the Title Company at Closing a certificate and indemnity in a form approved by Seller and reasonably required by the Title Company, but only containing information with respect to which Seller has actual knowledge. -6- 7. SELLER DELIVERIES. At or prior to Closing, Seller shall deliver to Buyer, to the extent not previously provided to Buyer and only to the extent in Seller's possession (a) copies of all architectural drawings, construction plans and specifications, "as-built" records of the improvements, environmental studies, inspection reports, and all topographical surveys and soil tests for or relating to the Property in Seller's possession, (b) all other documents relating to the condition of title to or use of the Property that are in Seller's possession. 8. MISCELLANEOUS PROVISIONS. 8.1 NOTICES. Any notices required or permitted to be given hereunder shall be given in writing and shall be delivered (a) in person, (b) by certified mail, postage prepaid, return receipt requested, or (c) by facsimile with confirmation of receipt, and such notices shall be addressed as follows: To Buyer: Schnitzer Steel Industries, Inc. 3200 NW Yeon Avenue Portland, OR 97210 Attention: Mr. Kelly Lang Fax No.: (503) 321-2648 With a copy to: Miller Nash LLP 3400 U.S. Bancorp Tower 111 SW Fifth Avenue Portland, OR 97204 Attention: James F. Dulcich Fax No.: (503) 224-0155 To Seller: Schnitzer Investment Corp. 3200 NW Yeon Avenue Portland, OR 97210 Attention: Susan J. Davidson Fax No.: (503) 323-2804 And with a copy to: Ball Janik LLP 101 SW Main Street, Suite 1100 Portland, OR 97204 Attention: Barbara W. Radler Fax No.: (503) 295-1058 or to such other address as either party may from time to time specify in writing to the other party. 8.2 ENTIRE AGREEMENT. The Lease and this Agreement contains all representations, warranties and covenants made by Buyer and Seller and constitutes the entire understanding between the parties hereto with respect to the subject matter hereof of this Agreement. -7- 8.3 TIME. Time is of the essence in the performance of each of the parties' respective obligations contained in this Agreement. 8.4 ATTORNEYS' FEES. If either party hereto fails to perform any of its obligations under this Agreement or if any dispute arises between the parties to this Agreement concerning the meaning or interpretation of any provision of this Agreement, then the defaulting party or the party not prevailing in such dispute, as the case may be, shall pay any and all costs and expenses incurred by the other party on account of such default and/or in enforcing or establishing its rights hereunder, including, without limitation, court costs and reasonable attorneys' fees and disbursements. 8.5 ASSIGNMENT. Buyer's rights and obligations under this Agreement shall not be assignable without the prior written consent of Seller which consent shall not be unreasonably withheld, conditioned or delayed. Buyer shall in no event be released from any of its obligations or liabilities under this Agreement in connection with any assignment. Subject to the provisions of this Section, this Agreement shall inure to the benefit of and be binding upon Buyer and Seller and their respective successors and assigns. 8.6 COUNTERPARTS. This Agreement may be executed in two counterparts, each of which shall be deemed an original, but both of which taken together shall constitute one and the same instrument. 8.7 GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of California. 8.8 INTERPRETATION OF AGREEMENT. The section and other headings of this Agreement are for convenience of reference only and shall not be construed to affect the meaning of any provision contained in this Agreement. Where the context so requires, the use of the singular shall include the plural and vice versa and the use of the masculine shall include the feminine and the neuter. The term "person" shall include any individual, partnership, joint venture, corporation, trust, unincorporated association, limited liability company, any other entity and any government or any department or agency thereof, whether acting in an individual, fiduciary or other capacity. 8.9 AMENDMENTS. This Agreement may be amended or modified only by a written instrument signed by Buyer and Seller. 8.10 NO RECORDING. This Agreement shall not be recorded. At Buyer's request, a memorandum or short form of this Agreement will be acknowledged by Buyer and Seller and recorded by Buyer. 8.11 SURVIVAL. All representations, warranties, covenants and agreements of Seller and Buyer contained in this Agreement and in the Lease shall survive the Closing. -8- The parties to this Agreement have executed this Agreement as of the date first written above. Seller: SCHNITZER INVESTMENT CORP., an Oregon corporation By: /s/ K. Novack ------------------------------------- Its: CEO ------------------------------------- Buyer: SCHNITZER STEEL INDUSTRIES, INC., an Oregon corporation By: /s/ R. Philip ------------------------------------- Its: CEO ------------------------------------- -9- LIST OF EXHIBITS Exhibit A Real Property Description Exhibit B Grant Deed EXHIBIT A REAL PROPERTY DESCRIPTION ORDER NUMBER: NCS-25991-SC PAGE NUMBER: 5 LEGAL DESCRIPTION REAL PROPERTY in the unincorporated area of the County of Sacramento, State of California, described as follows: ALL THAT CERTAIN RECORD OF SURVEY FILED IN BOOK 12 OF SURVEYS, PAGE 29, TOGETHER WITH ALL THAT PORTION OF THAT CERTAIN RECORD OF SURVEY FILED IN BOOK 52 OF SURVEYS, PAGE 16, OFFICIAL RECORDS OF SACRAMENTO, COUNTY, DESCRIBED AS FOLLOWS: BEGINNING AT THE NORTHWEST CORNER OF THE AFOREMENTIONED RECORD OF SURVEY FILED IN BOOK 12 OF SURVEYS, PAGE 29; THENCE, FROM SAID POINT OF BEGINNING ALONG THE NORTHERLY AND EASTERLY LINES OF SAID RECORD OF SURVEY AND ALONG THE SOUTHERLY PROLONGATION OF THE EASTERLY LINE OF SAID RECORD OF SURVEY THE FOLLOWING TWO (2) COURSES: (1) NORTH 63(degree)52'45" EAST 440.83 FEET TO THE NORTHEAST CORNER OF SAID RECORD OF SURVEY; AND (2) SOUTH 01(degree)15'55" EAST 759.33 FEET; THENCE SOUTH 63(degree)52'45" WEST 440.83 FEET; THENCE ALONG THE WESTERLY LINE OF SAID RECORD OF SURVEY AND THE SOUTHERLY PROLONGATION OF SAID WESTERLY LINE, NORTH 01(degree)15'55" WEST 759.33 FEET TO THE POINT OF BEGINNING. APN: 069-0040-080-000 A-1 EXHIBIT B RECORDING REQUESTED BY FIRST AMERICAN TITLE INSURANCE COMPANY NATIONAL COMMERCIAL SERVICES AND WHEN RECORDED MAIL TO: SCHNITZER STEEL INDUSTRIES, INC. POST OFFICE BOX 10047 PORTLAND, OR 97296-0047 ATTENTION: KELLY E. LANG - -------------------------------------------------------------------------------- SPACE ABOVE THIS LINE FOR RECORDER'S USE ONLY A.P.N.: 069-0040-080-000 FILE NO.: NCS-28991-SC (RS) THE UNDERSIGNED GRANTOR(S) DECLARE(S): DOCUMENTARY TRANSFER TAX $; CITY TRANSFER TAX $; SURVEY MONUMENT FEE $ [ ] COMPUTED ON THE CONSIDERATION OR FULL VALUE OF PROPERTY CONVEYED, OR [ ] COMPUTED AO THE CONSIDERATION OR FULL VALUE LESS VALUE OF LIENS AND/OR ENCUMBRANCES REMAINING AT TIME OF SALE. [ ] UNINCORPORATED AREA;[ ] CITY OF, AND CORPORATION GRANT DEED FOR A VALUABLE CONSIDERATION, RECEIPT OF WHICH IS HEREBY ACKNOWLEDGED, SCHNITZER INVESTMENT CORPORATION, AN OREGON CORPORATION HEREBY GRANTS TO SCHNITZER STEEL INDUSTRIES, INC., AN OREGON CORPORATION THE FOLLOWING DESCRIBED PROPERTY IN THE UNINCORPORATED AREA OF, COUNTY OF SACRAMENTO, STATE OF CALIFORNIA; ALL THAT CERTAIN RECORD OF SURVEY FILED IN BOOK 12 OF SURVEYS, PAGE 29, TOGETHER WITH ALL THAT PORTION OF THAT CERTAIN RECORD OF SURVEY FILED IN BOOK 52 OF SURVEYS, PAGE 16, OFFICIAL RECORDS OF SACRAMENTO, COUNTY, DESCRIBED AS FOLLOWS: BEGINNING AT THE NORTHWEST CORNER OF THE AFOREMENTIONED RECORD OF SURVEY FILED IN BOOK 12 OF SURVEYS, PAGE 29; THENCE, FROM SAID POINT OF BEGINNING ALONG THE NORTHERLY AND EASTERLY LINES OF SAID RECORD OF SURVEY AND ALONG THE SOUTHERLY PROLONGATION OF THE EASTERLY LINE OF SAID RECORD OF SURVEY THE FOLLOWING TWO (2) COURSES: (1) NORTH 63(DEGREE)52'45" EAST 440.83 FEET TO THE NORTHEAST CORNER OF SAID RECORD OF SURVEY; AND (2) SOUTH 01(DEGREE)15'55" EAST 759.33 FEET; THENCE SOUTH 63(DEGREE)5245" WEST 440.83 FEET; THENCE ALONG THE WESTERLY LINE OF SAID RECORD OF SURVEY AND THE SOUTHERLY PROLONGATION OF SAID WESTERLY LINE, NORTH 01(DEGREE)15'55" WEST 759.33 FEET TO THE POINT OF BEGINNING. DATED: __________________ MALL TAX STATEMENTS TO: SAME AS ABOVE - -------------------------------------------------------------------------------- B-1 A.P.N.: 069-0040-080-000 GRANT DEED - CONTINUED FILE NO.:NCS-28991-SC (RS) DATE: 07/21/2003 SCHNITZER INVESTMENT CORP., AN OREGON CORPORATION ______________________________ BY:___________________________ ___________________________ STATE OF_______________________________)SS COUNTY _______________________________) OF ON__________________________________________________, BEFORE ME,__________________________________________________________PERSONALLY APPEARED ___________________________________________________________, PERSONALLY KNOWN TO ME (OR PROVED TO ME ON THE BASIS OF SATISFACTORY EVIDENCE) TO BE THE PERSON(S) WHOSE NAME(S) IS/ARE SUBSCRIBED TO THE WITHIN INSTRUMENT AND ACKNOWLEDGED TO ME THAT HE/SHE/THEY EXECUTED THE SAME IN HIS/HER/THEIR AUTHORIZED CAPADTY(IES), AND THAT BY HIS/HER/THEIR SIGNATURES) ON THE INSTRUMENT THE PERSON(S), OR THE ENTITY UPON BEHALF OF WHICH THE PERSON(S) ACTED, EXECUTED THE INSTRUMENT. WITNESS MY HAND AND OFFICIAL SEAL. THIS AREA FOR OFFICIAL NOTARIAL SEAL SIGNATURE ________________________________________ MY COMMISSION EXPIRES:________________________________ PAGE 2 OF 2 SCHEDULE 1 ---------- DISCLOSURE ITEMS Natural hazards described in the following California code sections (the "Natural Hazard Laws") may affect the Property: (A) Govt. Code Section 8589.3 (Special Flood Hazard Area); (B) Govt. Code Section 8589.4 (Inundation Area); (C) Govt. Code Section 51183.5 (Fire Hazard Severity Zone); (D) Public Resource Code Section 2621.9 (Earthquake Fault Zone); (E) Public Resource Code Section 2694 (Seismic Hazard Zone); and (F) Public Resource Code Section 4136 (Wildland Area). Seller shall execute and deliver to Buyer a Natural Hazards Disclosure Statement with respect to the foregoing matters (the "Natural Hazards Disclosure Statement"). Buyer acknowledges and agrees that Buyer will independently evaluate and investigate whether any or all of such Natural Hazards affect the Property, and Seller shall have no liabilities or obligations with respect thereto. Buyer shall execute and deliver to Seller the Natural Hazards Disclosure Statement. BUYER ACKNOWLEDGES AND REPRESENTS THAT BUYER HAS EXTENSIVE EXPERIENCE ACQUIRING AND CONDUCTING DUE DILIGENCE REGARDING COMMERCIAL PROPERTIES. THIS PROVISION IS AN ESSENTIAL ASPECT OF THE BARGAIN BETWEEN THE PARTIES. EX-21.1 8 exh21-1_12345.txt SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21.1 ------------ SCHNITZER STEEL INDUSTRIES, INC. List of Subsidiaries Subsidiary State of Incorporation ---------- ---------------------- Alaska Steel Co. Oregon Arion Shipping Co. Delaware Cascade Steel Rolling Mills, Inc. Oregon Crawford Street Corporation Oregon Edman Corp. Oregon General Metals of Alaska, Inc. Oregon General Metals of Tacoma, Inc. Washington Joint Venture Operations, Inc. Delaware Karileen LLC Washington Levi's Iron and Metal, Inc. Oregon Manufacturing Management, Inc. Oregon SSI International Far East Ltd. Korea Mormil Corp. Oregon MRI Corporation Delaware Norprop, Inc. Oregon Oregon Rail Marketing Co. Oregon Pick and Pull Auto Dismantling, Inc. California Proler Environmental Services, Inc. Delaware Proler Industries, Inc. Delaware Proler International Corp Delaware Proler Properties, Inc. Texas Proler Recycling, Inc. Delaware Proler Steel, Inc. Delaware Proleride Transport Systems, Inc. Delaware Schnitzer Leasing, Inc. Oregon SD&G, Inc. Nevada SSI International, Inc. Guam SSP Arion Corp. Oregon SSP Reclamation Company Oregon White Top Properties, L.L.C. Washington Willamette Forge & Machine Works, Inc. Oregon EX-23.1 9 exh23-1_12345.txt CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 ------------ CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-87008, 333-21895, and 333-100511) of Schnitzer Steel Industries, Inc. of our reports dated October 1, 2003 relating to the financial statements and financial statement schedule, which appear in this Form 10-K. PricewaterhouseCoopers LLP - -------------------------- Portland, Oregon November 24, 2003 - ----------------- EX-31.1 10 exh31-1_12345.txt CERTIFICATION OF CEO PURSUANT TO SECTION 302 EXHIBIT 31.1 ------------ CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES OXLEY ACT OF 2002 I, Robert W. Philip, certify that: 1. I have reviewed this annual report on Form 10-K of Schnitzer Steel Industries, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d - 15(e) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared, (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. November 24, 2003 /s/ ROBERT W. PHILIP - ------------------------------------- Robert W. Philip President and Chief Executive Officer EX-31.2 11 exh31-2_12345.txt CERTIFICATION OF CFO PURSUANT TO SECTION 302 EXHIBIT 31.2 ------------ CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES OXLEY ACT OF 2002 I, Barry A. Rosen, certify that: 1. I have reviewed this annual report on Form 10-K of Schnitzer Steel Industries, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d - 15(e) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. November 24, 2003 /s/BARRY A. ROSEN - ------------------------------------- Barry A. Rosen Vice President, Finance and Treasurer, and Chief Financial Officer EX-32.1 12 exh32-1_12345.txt CERTIFICATION OF CEO PURSUANT TO SECTION 906 EXHIBIT 32.1 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Schnitzer Steel Industries, Inc. (the "Company") on Form 10-K for the year ended August 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert W. Philip, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ ROBERT W. PHILIP - ------------------------------------- Robert W. Philip President and Chief Executive Officer November 24, 2003 EX-32.2 13 exh32-2_12345.txt CERTIFICATION OF CFO PURSUANT TO SECTION 906 EXHIBIT 32.2 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Schnitzer Steel Industries, Inc. (the "Company") on Form 10-K for the year ended August 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Barry A. Rosen, Vice President, Finance and Treasurer, and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: (1) The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ BARRY A. ROSEN - ------------------------------------- Barry A. Rosen Vice President, Finance and Treasurer, and Chief Financial Officer November 24, 2003 -----END PRIVACY-ENHANCED MESSAGE-----