UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

xQuarterly Report UnderPursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the QuarterQuarterly Period Ended November 30, 2008February 28, 2009

Or

¨    Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Transition Period from              to             

Commission file number 0-22496

SCHNITZER STEEL INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

(503) 224-9900

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitionthe definitions of “large accelerated filer,” “accelerated filer, “” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No  x

The Registrant had 21,744,71621,837,500 shares of Class A common stock, par value of $1.00 per share, and 6,344,569 shares of Class B common stock,Common Stock, par value of $1.00 per share, outstanding at December 30, 2008.March 27, 2009.

SCHNITZER STEEL INDUSTRIES, INC.

INDEX

SCHNITZER STEEL INDUSTRIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)thousands, except per share amounts)

The accompanying notes to the unaudited condensed consolidated financial statements

are an integral part of these statements.

SCHNITZER STEEL INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)

The accompanying notes to the unaudited condensed consolidated financial statements

are an integral part of these statements.

SCHNITZER STEEL INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

The accompanying notes to the unaudited condensed consolidated financial statements

are an integral part of these statements.

SCHNITZER STEEL INDUSTRIES, INC.

Note 1 - Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Schnitzer Steel Industries, Inc. (the “Company”) have been prepared pursuant to generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and the rules and regulations of the United States Securities and Exchange Commission (“SEC”) for Form 10-Q, including Article 10 of Regulation S-X. The year-end condensed consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP for annual financial statements. Certain information and note disclosures normally included in annual financial statements have been condensed or omitted pursuant to those rules and regulations. In the opinion of management, all normal, recurring adjustments considered necessary for a fair presentation have been included. Although management believes that the disclosures made are adequate to ensure that the information presented is not misleading, management suggests that these unaudited condensed consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s annual report on Form 10-K for the fiscal year ended August 31, 2008. The results for the three and six months ended November 30,February 28, 2009 and February 29, 2008 and 2007 are not necessarily indicative of the results of operations for the entire year.

Cash and Cash Equivalents

Cash and cash equivalents include short-term securities that are not restricted by third parties and have an original maturity date of 90 days or less. Included in accounts payable are book overdrafts of $18$28 million and $51 million as of November 30, 2008February 28, 2009 and August 31, 2008, respectively.

Accounts Receivable, net

Accounts receivable represent amounts due from customers on product and other sales. These accounts receivable, which are reduced by an allowance for doubtful accounts, are recorded at the invoiced amount and do not bear interest. The Company evaluates the collectibility of its accounts receivable based on a combination of factors.factors including whether sales were made pursuant to letters of credit. In cases where management is aware of circumstances that may impair a specific customer’s ability to meet its financial obligations, management records a specific allowance against amounts due and reduces the net recognized receivable to the amount the Company believes will be collected. For all other customers, the Company maintains a reserve that considers the total receivables outstanding, historical collection rates and economic trends. The allowance for doubtful accounts was $4$11 million at November 30, 2008February 28, 2009 and $3 million at August 31, 2008.

Goodwill and Other Intangible Assets

The Company evaluates goodwill and intangibles with an indefinite life annually during the second fiscal quarter and upon the occurrence of certain triggering events or substantive changes in circumstances that indicate that the fair value of goodwill or indefinite lived intangible assets may be impaired, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Impairment of goodwill is tested at the reporting unit level. The Company’s reporting units, for which goodwill has been allocated, are equivalent to the Company’s operating segments, as all of the components of the respective segments have similar economic characteristics.

The goodwill impairment test follows a two step process as defined in SFAS 142. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. This allocation is similar to a purchase price allocation. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of goodwill, an impairment loss will be recognized in an amount equal to that excess.

SCHNITZER STEEL INDUSTRIES, INC.

The Company estimates the fair value of the reporting segments using an income approach based on the present value of expected future cash flows utilizing a risk adjusted discount rate. To estimate the cash flows that extend beyond the final year of the discounted cash flow model, the Company employs a terminal value technique, whereby the Company uses estimated operating cash flows minus capital expenditures and adjusts for changes in working capital requirements in the final year of the model, then discounts it by the risk adjusted discount rate to establish the terminal value. The Company includes the present value of the terminal value in the fair value estimate. Given that market prices of the Company’s reporting units are not readily available, the Company makes various estimates and assumptions in determining the estimated fair values of the reporting units. Forecasts of future cash flows are based on management’s best estimate of future sales and operating costs, pricing expectations and general market conditions.

In addition, the Company tests indefinite-lived intangibles for impairment by either comparing the carrying value of the intangible to the projected discounted cash flows from the intangible or by using the relief from royalties method. If the carrying value exceeds the projected discounted cash flows attributed to the intangible asset, the carrying value is no longer considered recoverable and the Company will record an impairment. Refer to Note 5 – Goodwill and Acquired Intangibles for further detail.

Accrued Workers’ Compensation Costs

The Company is self-insured up to a maximum amount for workers’ compensation claims and as such, a reserve for the estimated costs of unpaid claims and the estimated costs of incurred but not reported claims has been estimated as of the balance sheet date. The Company’s exposure to claims is protected by various stop-loss insurance policies. The estimate of this reserve is based on historical claims experience. At November 30, 2008February 28, 2009 and August 31, 2008, the Company accrued $7 million and $6 million respectively, for the estimated cost of workers’ compensation claims.

Comprehensive Income (Loss)

The following table sets forth the reconciliation of comprehensive income (loss) (in thousands):

SCHNITZER STEEL INDUSTRIES, INC.

Changes in Shareholders’ Equity

During the first quartersix months of fiscal 2009, the Company’s shareholders’ equity decreased $34 million. The decrease was primarily$43 million, comprised of a net loss of $34 million.$41 million, a foreign currency translation adjustment of $3 million and a net unrealized loss on cash-flow hedges of $1 million, partially offset by $2 million related to share-based compensation plan activity.

SCHNITZER STEEL INDUSTRIES, INC.

Net Income and Dividends per Share

The following table sets forth the reconciliation from basic net income (loss) per share to diluted net income (loss) per share (in thousands, except per share amounts):

The Company accounts for earnings per share in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings per Share.” Basic earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the periods presented, including vested deferred stock units (“DSUs”) and restricted stock units (“RSU”RSUs”). Diluted earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding, assuming dilution. Potentially dilutive common shares include the assumed exercise of stock options and assumed vesting of performance shares andshare, DSU and RSU awards using the treasury stock method. For the three months ended November 30, 2008, 1,340,913As of February 28, 2009, 1,219,861 common stock equivalent shares were considered antidilutive and were excluded from the calculation of diluted earnings per share. For the three months ended November 30, 2007,As of February 29, 2008, all of thestock options, LTIP performance shares, DSUsDSU and RSUsRSU awards issued through and outstanding as of November 30, 2007February 29, 2008 were considered to be dilutive.

Fair Value Measurements

On September 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”) which defines fair value. In accordance with SFAS No. 157, fair value is measured using inputs from the three levels of the fair value hierarchy. Classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The three levels are described as follows:

The Company uses quoted market prices whenever available, or seeks to maximize the use of observable inputs and minimize the use of unobservable inputs when quoted market prices are not available, when developing fair value measurements. The Company’s only financial instrumentsinstrument subject to fair value measurement areis its outstanding derivative contracts,contract, which areis measured at fair value using models or other market accepted valuation methodologiesa model derived from observable market data. These models considerThis model considers various inputs including:

SCHNITZER STEEL INDUSTRIES, INC.

(a) quoted futures prices for commodities, (b) time value, and (c) the Company’s credit risk, as well as other relevant economic measures. The impact of this statement is reflected in the Company’s condensed consolidated financial statements for the first quartersix months of fiscal 2009 (refer to Note 10 – Derivative Financial Instruments and Fair Value Measurements for further detail).

SCHNITZER STEEL INDUSTRIES, INC.

Recent Accounting Pronouncements

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their risks and impact on an entity’s financial position, financial performance and cash flows. The provisions of SFAS 161 are effective for the Company as of the second quarter of fiscal 2009. The adoption of SFAS No. 161 will enhance and provide more visibility over the Company’s footnote disclosure surrounding derivative instruments and hedging activities.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS 141, and issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”), an amendment of ARB No. 51. These two new standards will change the accounting and reporting for business combination transactions and noncontrolling (minority) interests in the consolidated financial statements, respectively. SFAS 141(R) will change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. These two standards will be effective for the Company in the first quarter of fiscal 2010. SFAS 141(R) will be applied prospectively. SFAS 160 requires retrospective application of most of the classification and presentation provisions. All other requirements of SFAS 160 shall be applied prospectively. Early adoption is prohibited for both standards. Management is currently evaluating the requirements of SFAS 141(R) and SFAS 160 and has not yet determined the impact on the Company’s consolidated financial statements.

In February 2008, the FASB issued FASB Staff Position No. 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”). FSP 157-2, which delays the effective date of SFAS 157 for non-recurring non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until the beginning of the Company’s first quarter of fiscal 2010. The Company’s significant non-financial assets and liabilities that could be impacted by this deferral include assets and liabilities initially measured at fair value in a business combination and goodwill tested annually for impairment. The Company is currently evaluating the requirements of SFAS 157 as it relates to FSP 157-2 for non-recurring non-financial assets and liabilities and has not yet determined the impact, if any, on the Company’s consolidated financial position, results of operations or cash flows.

In April 2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142,“Goodwill “Goodwill and Other Intangible Assets.” FSP 142-3 must be applied prospectively to all intangible assets acquired as of and subsequent to fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. This standard will be effective for the Company on September 1, 2009. Early adoption is prohibited. FSP 142-3 willis not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In December 2008, the FASB issued FASB Staff Position No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP 132(R)-1”), which provides guidance on an employer’s disclosures about the plan assets of a defined benefit pension or postretirement plan and will require additional disclosure regarding investment policies and strategies, fair value of each major asset category based on risks of the assets, inputs and valuations techniques used to estimate fair value, fair value measurement hierarchy levels under SFAS 157 for each asset category, and significant concentration of risk information. The provisions of FSP 132(R)-1 will be effective for the Company in its fiscal 2010 Form 10-K filing. FSP 132(R)-1 will enhance and provide more visibility over the Company’s footnote disclosures surrounding the plan assets of the Company’s defined benefit pension plan.

Reclassifications

Certain prior year amounts have been reclassified within operating expenses and cash flows from operating activities to conform to the current year presentation. These changes had no impact on previously reported operating income, net income or total cash flows from operating activities.

SCHNITZER STEEL INDUSTRIES, INC.

Note 2 - Inventories, net

The Company’s inventories primarily consist primarily of ferrous and nonferrous processed and unprocessed scrap metal, used and salvaged vehicles and finished steel products, consisting primarily of rebar, merchant bar and wire rod. Inventories are stated at the lower of cost or market for all periods presented.

Inventories, net, consisted of (in thousands):

The Company makes certain assumptions regarding future demand and net realizable value in order to assess that inventory is properly recorded at the lower of cost or market. The assumptions are based on both historical experience and current information. DueIn addition, due to declines inreduced production levels during the anticipated future selling pricesfirst six months of scrap metal and finished steel products, the Company recorded non-cash net realizable value (“NRV”) inventory adjustments of $52 million at November 30 to reduce the value of its inventory (and increase cost of goods sold) to the lower of cost or market. In addition,fiscal 2009, the Company recognized $10$6 million and $16 million of expense during the first quarter of fiscalthree and six months ended February 28, 2009, respectively, for production costs that could not be capitalized in inventory.

Note 3 - Property, Plant and Equipment, net

Property, plant and equipment, net consisted of (in thousands):

In the second quarter of fiscal 2009, management performed impairment testing of long-lived assets within its APB operating segment related to certain asset groupings that continued to generate operating losses. As a result, the Company recorded an impairment charge that was not material.

Note 4 - Business Combinations

Metals Recycling Business

InDuring the first quarter of fiscalsix month period ended February 28, 2009, the Company signedcompleted the acquisition of three entities and an additional 16.67% equity interest in an entity that the Company maintains operating control over, for a purchase and sale agreement for the following acquisitions:total consideration of $90 million. These acquisitions are as follows:

These acquisitions are not expected to be material, individually or in the aggregate, toexpanded the Company’s financial position or resultspresence into a new region, increased the Company’s processing capability and provided new sources of operations.scrap metal and access to international export facilities.

SCHNITZER STEEL INDUSTRIES, INC.

These acquisitions were accounted for under the purchase method of accounting in accordance with SFAS No. 141 “Business Combinations” and are included in the Company’s financial statements from the date of acquisition. The purchase price was allocated to tangible and identifiable intangible assets acquired and liabilities assumed based on their respective estimated fair values on the date of acquisition. The excess of the aggregate purchase price over the fair value of the identifiable net assets acquired of $55 million was recorded as goodwill. The purchase price allocation has been prepared on a preliminary basis, and changes may occur as additional information, such as final valuation reports, becomes available. The following is a summary of the aggregate fair values of assets acquired and liabilities assumed for acquisitions completed during the six months ended February 28, 2009 (in thousands):

SCHNITZER STEEL INDUSTRIES, INC.

The following table presents the aggregate of intangible assets and their related lives associated with the purchase of the acquisitions discussed above:

The Company recorded goodwill of $55 million related to acquisitions completed during the six-month period ended February 28, 2009, of which $11 million is expected to be deductible for tax purposes.

The following unaudited pro forma summary presents the effect of the businesses acquired during fiscal 2009 as though the businesses had been acquired as of the beginning of the periods presented (in thousands):

SCHNITZER STEEL INDUSTRIES, INC.

These pro forma results are not necessarily indicative of what actual results would be had these acquisitions occurred for the periods presented. In addition, the pro forma results are not intended to be a projection of future results and do not reflect any synergies that may be achieved from combining operations.

Note 5 - Goodwill and Acquired Intangibles

As discussed in more detail in Note 2 to the Company’s consolidated financial statements in the Company’s 2008 Annual Report on Form 10-K,1, Summary of Significant Accounting Policies, goodwill and other intangible assets with an indefinite life are tested annually for impairment during the second quarter and upon the occurrence of certain triggering events or substantive changes in circumstances. During partcircumstances that indicate the fair value of goodwill or intangible assets may be impaired. Impairment of goodwill is tested at the firstreporting unit level. The Company’s reporting units, for which goodwill has been allocated, are equivalent to the Company’s operating segments. The Company performed its goodwill impairment testing by comparing the fair value of each reporting unit with the carrying value, including goodwill. Based on the Company’s impairment testing completed in the second quarter of fiscal 2009, it was determined that the market valuefair values of each of the Company’s Class A common stock traded below its book value. Givenreporting segments was greater than their respective carrying values and the goodwill balances and indefinite lived intangible assets were not impaired as of February 28, 2009. Due to the current adverse economic conditions deterioration in the financial markets and stock market volatility,in which the Company evaluated whether a triggering event had occurred inoperates, the quarter ended November 30, 2008, which would have required itCompany will continue to perform an interim impairment test ofmonitor its goodwill, and indefinite-livedindefinite – lived intangible assets in accordance with SFAS No. 142. The Company determined that no triggering event had occurred, as the long-term fundamentals of the Company’s business have not changed. The market value of the Company’s Class A common stock was below book valueand long-lived assets for only a portion of the quarter, and subsequent to period end the Company’s stock traded above book value.possible future impairment.

The changes in the carrying amount of goodwill by reportable segments during the first threesix months of fiscal 2009 were (in thousands):

The following table presentsgross carrying amount and accumulated amortization of the Company’s identifiable intangible assets and their related liveswere (in thousands):

SCHNITZER STEEL INDUSTRIES, INC.

Intangible assets with finite useful lives are amortized over their useful lives using methods that reflect the pattern over which the economic benefits are expected to be consumed or on a straight-line basis based on estimated lives. Amortization expense for identifiable intangible assets for the three and six months ended November 30, 2008 and November 30, 2007February 28, 2009 was $1 million.million and $2 million, respectively. Amortization expense related to identifiable intangible assets with a definite life for the three and six months ended February 29, 2008 was $1 million and $2 million, respectively.

Note 6 - Environmental Liabilities and Other Contingencies

The Company evaluates the adequacy of its environmental reservesliabilities on a quarterly basis in accordance with Company policy. Adjustments to the liabilities are made when additional information becomes available that affects the estimated costs to study or remediate any environmental issues or expenditures are made for which reserves were established.

SCHNITZER STEEL INDUSTRIES, INC.

Changes in the Company’s environmental liabilities for the first threesix months of fiscal 2009 were (in thousands):

Metals Recycling Business (“MRB”)

At November 30, 2008,February 28, 2009, MRB’s environmental reserves of $24$25 million consisted primarily of the reserves established in connection with potential future clean-up of MRB locations at which the Company or its subsidiaries have conducted business or allegedly disposed of certain materials and various sites acquired through acquisitions.

Portland Harbor

In fiscal 2006, the Company was notified by the EPAU.S. Environmental Protection Agency (“EPA”) under CERCLAthe Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) that it was one of at least 69 PRPspotentially responsible parties (“PRPs”) that own or operate or formerly owned or operated sites adjacent to the Portland Harbor Superfund site. The precise nature and extent of any clean-up of the Portland Harbor, the parties to be involved, the process to be followed for any clean-up and the allocation of any costs for the clean-up among responsible parties have not yet been determined. It is unclear whether or to what extent, if any, the Company will be liable for environmental costs or damages associated with the Portland Harbor Superfund site. It is also unclear to what extent natural resource damage claims or third party contribution or damage claims will be asserted against the Company. While the Company participated in certain preliminary Portland Harbor study efforts, it is not party to the consent order entered into by the EPA with other certain PRPs, referred to as the “Lower Willamette Group” (“LWG”), 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.

During fiscal 2006, the Company received letters from the LWG and one of its members with respect to participating in the LWG Remedial Investigation/Feasibility Study (“RI/FS”) and demands from various parties in connection with environmental response costs allegedly incurred in investigating contamination at the Portland Harbor Superfund site. In an effort to develop a coordinated strategy and response to these demands, the Company joined with more than twenty other newly-noticed parties to form the Blue Water Group (“BWG”). All members of the BWG declined to join the LWG. As a result of discussions between the BWG, LWG, EPA and Oregon Department of Environmental Quality (“DEQ”) regarding a potential cash contribution to the RI/FS, certain members of the BWG, including the Company, have agreed to an interim settlement with the LWG under which the Company would contributecontributed toward the BWG’s total settlement amount.

SCHNITZER STEEL INDUSTRIES, INC.

The DEQ is performing investigations involving the Company sites, which are focused on controlling any current releases of contaminants into the Willamette River. In January 2008, the Natural Resource Damages Trustee Council (“Trustees”) for Portland Harbor invited the Company and other PRPs to participate in funding and implementing the Natural Resource Injury Assessment for the site. Following meetings among the Trustees and the PRPs, a funding and participation agreement was negotiated under which the participating PRPs agreed to fund the first phase of natural resource damage assessment. The Company joined in that agreement and agreed to pay $100,000 of those costs. The cost of the investigations and remediation associated with these properties is not reasonably estimable until the completion of the data review and further investigations now being conducted by the LWG and the Natural Resource Damage trustees.Trustees. In fiscal 2006, the Company recorded a liability for its estimated share of the costs of the investigation incurred by the LWG to date. The Company’s estimated share of these costs is not considered to be material. As of November 30, 2008,February 28, 2009, the Company has reserved $1 million for investigation costs of the Portland Harbor.

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Harbor Superfund site.

Hylebos Waterway

In fiscal 1982, the Company was notified by the U.S. Environmental Protection Agency (“EPA”)EPA under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”)CERCLA that it was one of 60 potentially responsible parties (“PRPs”)PRPs for the investigation and clean-up of contaminated sediment along the Hylebos Waterway. On March 25, 2002, the EPA issued Unilateral Administrative Orders to the Company and another party (the “Other Party”) to proceed with Remedial Design and Remedial Action (“RD/RA”) for the head of the Hylebos and to two other parties to proceed with the RD/RA for the balance of the waterway. The Unilateral Administrative Order for the head of the Hylebos Waterway was converted to a voluntary consent decree in 2004, pursuant to which the Company and the Other Party agreed to remediate the head of the Hylebos Waterway.

During the second phase of the dredging in the head of the Hylebos Waterway, which began in July 2004, the Company incurred remediation costs of $16 million during fiscal 2005. The Company’s cost estimates were based on the assumption that dredge removal of contaminated sediments would be accomplished within one dredge season, from July 2004 to February 2005. However, due to a variety of factors, including dredge contractor operational issues and other dredge related delays, the dredging was not completed during the first dredge season. As a result, the Company recorded environmental charges of $14 million in fiscal 2005, primarily to account for additional estimated costs to complete this work during a second dredging season. The Company and the Other Party then incurred additional remediation costs of $7 million during fiscal 2006. The Company and the Other Party filed a complaint in the U.S. District Court for the Western District of Washington at Tacoma against the dredge contractor to recover damages and a significant portion of cost overruns incurred in the second dredging season to complete the project. Following a trial that concluded in February 2007, a jury awarded the Company and the Other Party damages in the amount of $6 million. In the first quarter of fiscal 2009, the judgment was affirmed on appeal, and the Company relieved a liability in the amount of $2 million related to the dredge contractor’s claim for unpaid invoices and recorded a gain in the amount of $4 million with respect to the damages award. As of November 30, 2008,February 28, 2009, environmental liabilities for the Hylebos Waterway aggregated less than $1 million.

Other Metals Recycling Business Sites

The Company’s environmental reserves include approximately $22$23 million for potential future clean-up of other MRB locations at which the Company or its subsidiaries have conducted business or allegedly disposed of other materials. No environmental compliance enforcement proceedings are currently pending related to these sites.

Auto Parts Business (“APB”)

The Company’s environmental reserves include $17 million for potential future clean-up of APB locations at which the Company or its subsidiaries have conducted business or allegedly disposed of other materials. No environmental compliance enforcement proceedings are currently pending related to these sites.

SCHNITZER STEEL INDUSTRIES, INC.

Steel Manufacturing Business (“SMB”)

SMB’s electric arc furnace generates dust (“EAF dust”) that is classified as hazardous waste by the EPA because of its zinc and lead content. As a result, the Company captures the EAF dust and ships it viain specialized rail cars to a domestic firm that applies a treatment that allows the EAF dust to be delisted as hazardous waste so it can be disposed of as a non-hazardous solid waste.

SMB has an operating permit issued under Title V of the Clean Air Act Amendments of 1990, which governs certain air quality standards. The permit was first issued in fiscal 1998 and has since been renewed through fiscal 2012. The permit allows SMB to produce up to 950,000 tons of billets per year and allows varying rolling mill production levels based on levels of emissions.

SCHNITZER STEEL INDUSTRIES, INC.

Contingencies - Other

On October 16, 2006, the Company finalized settlements with the DOJ and the SEC resolving an investigation related to a past practice of making improper payments to the purchasing managers of the Company’s customers in Asia in connection with export sales of recycled ferrous metal. Under the settlement, the Company agreed to a deferred prosecution agreement with the DOJ (the “Deferred Prosecution Agreement”) and agreed to an order issued by the SEC, instituting cease-and-desist proceedings, making findings and imposing a cease-and-desist order pursuant to Section 21C of the Securities Exchange Act of 1934 (the “Order”). Under the Deferred Prosecution Agreement, the DOJ will not prosecute the Company if the Company meets the conditions of the agreement for a period of three years including, among other things, that the Company engage a compliance consultant to advise its compliance officer and its Board of Directors on the Company’s compliance program. Under the settlement, the Company has agreed to cooperate fully with any ongoing, related DOJ and SEC investigations. The Company does not expect to pay any future material amounts associated with this settlement.

Note 7 - Short-Term Borrowings

The Company’s short-term borrowings consist primarily of a one year unsecured uncommitted credit line with Wells Fargo Bank, N.A. The term of this credit line expiresfacility was recently extended to March 1, 2009; however, the Company believes it will be able to renew the facility.2010. Interest rates on outstanding indebtedness under the unsecured line of credit are set by the bank at the time of borrowing. The weighted average interest rate on this line was 2.57%2.05% at November 30, 2008.February 28, 2009. As of November 30, 2008February 28, 2009 and August 31, 2008 the Company had $19 million and $25 million, respectively, outstanding under this agreement. The credit agreement contains various representations and warranties, events of default and financial and other covenants, including covenants regarding maintenance of a minimum fixed charge coverage ratio and a maximum leverage ratio. As of November 30, 2008February 28, 2009 and August 31, 2008, the Company was in compliance with all such covenants.

Note 8 - Long-Term Debt

In July 2007, the Company amended its unsecured committed bank credit agreement with Bank of America, N.A., as administrative agent, and the other lenders party thereto. The revised agreement provides for a five-year, $450 million revolving credit facility maturing in July 2012. Interest rates on outstanding indebtedness under the amended agreement are based, at the Company’s option, on either the London Interbank Offered Rate (“LIBOR”) plus a spread of between 0.50% and 1.00%, with the amount of the spread based on a pricing grid tied to the Company’s leverage ratio, or the greater of the prime rate or the federal funds rate plus 0.50%. In addition, annual commitment fees are payable on the unused portion of the credit facility at rates between 0.10% and 0.25% based on a pricing grid tied to the Company’s leverage ratio. As of November 30, 2008February 28, 2009 and August 31, 2008 the Company had borrowings outstanding under the credit facility of $97$121 million and $150 million, respectively.

The bank credit agreement contains various representations and warranties, events of default and financial and other covenants, including covenants regarding maintenance of a minimum fixed charge coverage ratio and a maximum leverage ratio. As of November 30,February 28, 2009 and August 31, 2008, the Company was in compliance with all such covenants.

SCHNITZER STEEL INDUSTRIES, INC.

As of November 30, 2008February 28, 2009 the Company had capital lease obligations for the use of equipment that expire at various dates through November 2014.February 2015. As of November 30, 2008,February 28, 2009 and August 31, 2008 the Company had $2 million and $1 million, respectively, of assets that were accounted for as capital leases whichthat were included in property, plant and equipment on the condensed consolidated balance sheets. Additionally, as of November 30, 2008February 28, 2009 and August 31, 2008, the Company had $8 million of long-term bonded indebtedness that matures in January 2021.

SCHNITZER STEEL INDUSTRIES, INC.

Note 9 - Related Party Transactions

The Company purchases recycled metal from its joint venture operations at prices that approximate fair market value. These purchases totaled $5$3 million and $6$7 million in the second quarter of fiscal 2009 and 2008, respectively, and $8 million and $13 million for the first quartersix months of fiscal 2009 and 2008, respectively. Advances to (payments from) these joint ventures were $1$2 million and ($3) million as of November 30, 2008February 28, 2009 and August 31, 2008, respectively.

Thomas D. Klauer, Jr., President of the Company’s Auto Parts Business, is the sole shareholder of a corporation that is the 25% minority partner in a partnership with the Company. This partnership operates four self-service stores in Northern California. Mr. Klauer’s 25% share of the profits (loss) of this partnership totaled ($155,000)$105,000 and $377,000$320,000 in the second quarter of fiscal 2009 and 2008, respectively and ($50,000) and $697,000 for the first quartersix months of fiscal 2009 and 2008, respectively. Mr. Klauer also owns the property at one of these stores which is leased to the partnership under a lease providing for annual rent of $235,000,$236,000, subject to annual adjustments based on the Consumer Price Index, and has a term that expires in December 2010. The partnership has the option to renew the lease upon its expiration for a five-year period. In addition, during fiscal 2008, the Company loaned this partnership $5 million to fund the exercise of an option to purchase property occupied by the partnership. The loan bears interest at a market rate, and the partnership is prohibited from making distributions to its partners until the loan is repaid. At November 30, 2008February 28, 2009 the loan balance was $3 million.

Members of the Schnitzer family own significant interests in the Company and may exercise voting control by virtue of their ownership of Class B common stock. As such, Schnitzer family employees are considered related parties for financial reporting purposes. Gary Schnitzer, Gregory Schnitzer and Joshua Philip, each a member of the Schnitzer family, are employed by the Company. Gary Schnitzer, also a member of the Schnitzer family, was employed by the Company until his retirement effective December 31, 2008, and he continues to provide services to the Company under a consulting agreement. For the second quarter and first quartersix months of fiscal 2009, these members of the Schnitzer family collectively earned total compensation of $292,000$76,000 and $368,000, respectively, compared to $247,000$467,000 and $714,000 for the first quartersame periods of fiscal 2008.

Note 10 - Derivative Financial Instruments and Fair Value Measurements

TheNatural gas price risk management

On December 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” which requires enhanced disclosures about the Company’s derivative and hedging activities, as discussed below.

Natural gas represented 2% of SMB’s cost of goods sold for the first six months of fiscal 2009 and 2008. SMB has entered into a take-or-pay natural gas contract which obligates it to supplypurchase a minimum of 3,500 million British Thermal Units (“BTU”) per day, whether or not the SMB mini-millamount is utilized. The contract will expire on October 30, 2010. This contract is considered a derivative instrument for accounting purposes.

The Company designated the entire remaining portion of the natural gas contract as a cash flow hedge on September 1, 2008. According to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted hedged transaction will not occur. Deferred gains and losses in other comprehensive income associated with such derivative instruments are immediately reclassified into earnings to

SCHNITZER STEEL INDUSTRIES, INC.

the extent the forecasted transaction will not occur. Due to changes in the expectation of the Company’s future production as a result of changes in market conditions, the Company de-designated the contract as a hedge and re-designated only a portion, 20,000 million BTU per month, as a cash flow hedge in October 2008. The remaining portion of the contract is accounted for as a derivative not designated as a hedge under SFAS 133.

Derivative designated as a hedging instrument under SFAS 133

Changes in the fair value of the cash flow hedge are recorded in other comprehensive income (“OCI”) to the extent the hedge is effective in offsetting changes in future cash flows for forecasted natural gas purchase transactions. Amounts included in accumulated other comprehensive income (“AOCI”) are reclassified to cost of goods sold when the forecasted purchase transaction is recognized in earnings and when ineffectiveness arises out of the hedge. Included in other accrued liabilities is the fair value of the designated hedge portion of the derivative of $2 million as of February 28, 2009. Included in OCI, net of tax, for the effective portion of the hedge is an unrealized loss of $1 million for the three and six months ended February 28, 2009, respectively. The effective portion of losses reclassified into cost of goods sold was not material for the three and six months ended February 28, 2009. The ineffective portion of losses included in cost of goods sold was not material for the three and six months ended February 28, 2009. Upon de-designation of the cash flow hedge in October 2008, $1 million was reclassified from AOCI to cost of goods sold. Existing unrealized losses, net of tax, of $1 million currently recorded in AOCI are expected to be reclassified into cost of goods sold within the next 12 months. No derivatives were designated as hedges in fiscal 2008.

Please also refer to Note 1 – Summary of Significant Accounting Policies – Comprehensive Income (Loss) for the impact of gains and losses from cash flow hedges on Comprehensive Income (Loss).

Derivative not designated as a hedging instrument under SFAS 133

For the portion of the natural gas contract not designated as a hedge, the Company recognizes the change in fair value in cost of goods sold in the period of change. Included in other accrued liabilities is the fair value of the derivative not designated as a hedge of $7 million and $4 million as of February 28, 2009 and August 31, 2008, respectively. Losses of $2 million and $3 million were recognized in cost of goods sold for the three and six months ended February 28, 2009, respectively, compared to $1 million and $2 million of net gains for the three and six months ended February 29, 2008.

Fair value measurement

SMB’s natural gas contract is classified as a derivative instrument and carried at fair value. Fair value for the Company’s natural gas derivativethis instrument, the only instrument impacted by the adoption of SFAS No. 157, is determined using a forward price curve based on observable market price quotations at a major natural gas trading hub. In accordance with SFAS No. 157, the Company considers nonperformance risk in calculating fair value adjustments. This includes a credit risk adjustment based on the credit spreads of the counterparty when the Company is in an unrealized gain position or on the Company’s own credit spread when the Company is in an unrealized loss position. This assessment of nonperformance risk is generally derived from the credit default swap market or from bond market credit spreads. The impact of the credit risk adjustments for the Company’s outstanding derivative was not material to the fair value calculation at November 30, 2008.February 28, 2009. Mark-to-market adjustments on this instrument resulted in a derivative liability of $6$9 million at November 30, 2008,February 28, 2009, an increase of $2$5 million from August 31, 2008. This amount is classified as a Level 2 fair value measurement under the SFAS 157 fair value hierarchy described in Note 1 above.

SCHNITZER STEEL INDUSTRIES, INC.

Note 11 - Share-based Compensation

ThePursuant to provisions of the Company’s 1993 Stock Incentive Plan (“the Plan”), the Company recognized $4was previously authorized to issue up to 7.2 million shares of Class A Common Stock for any awards issued under the Plan. At the Annual Meeting of Shareholders on January 28, 2009, the Company’s shareholders approved an amendment to the Plan to increase the number of shares reserved for issuance under the Plan from 7.2 million shares to 12.2 million shares.

Due to the weakened economic conditions and $3 millionresulting decline in the aggregateCompany’s operating results, the Company’s estimated payout on performance share plans for share-based compensation expensethe fiscal 2007-2009 and fiscal 2008-2010 awards was significantly reduced, and for the three months ended November 30,February 28, 2009, the Company recorded a $3 million credit to share-based compensation expense and for the six months ended February 28, 2009, share-based compensation expense was $1 million, compared to $4 million and $7 million of expense for the three and six months ended February 29, 2008, and 2007, respectively. A detailed description of the awards under the Company’s 1993 Stock Incentive Plan and the respective accounting treatment is included in the “Notes to the Consolidated Financial Statements” included in the Company’s Annual Report on Form 10-K for the year ended August 31, 2008.

SCHNITZER STEEL INDUSTRIES, INC.

In connection with John Carter’s appointment as Chairman of the Board effective December 1, 2008, the Company entered into an amended and restated employment agreement which granted Mr. Carter stock awards having an aggregate grant date fair value of $2 million which fully vested on the grant date.

Fiscal 2009-2011 Long-Term Incentive Awards

On November 24, 2008, the Company’s Compensation Committee approved performance-based awards under the Company’s 1993 Stock Incentive Plan (“the Plan”) and the entry by the Company into Long-Term Incentive Award Agreements evidencing the award of these performance shares. The Compensation Committee established performance targets based on the Company’s average growth in earnings per share (weighted at 50%) and the Company’s average return on capital employed (weighted at 50%) for the three years of the performance period, with award payouts ranging from a threshold of 50% to a maximum of 200% for each portion of the target awards. A participant generally must be employed by the Company on the October 31 following the end of the performance period to receive an award payout, although adjusted awards will be paid if employment terminates earlier on account of death, disability, retirement, termination without cause after the first year of the performance period or on a sale of the Company. Awards will be paid in Class A common stock as soon as practicable after October 31 following the end of the performance period. The grant date for the fiscal 2009–2011 performance-based awards was November 24, 2008. Compensation expense for the fiscal 2009–2011 performance-based awards during the quarterthree and six months ended November 30, 2008February 28, 2009 was immaterial.not material.

Deferred Stock Units

On January 28, 2009, each of the Company’s non-employee directors received a DSU award equal to $120,000, divided by the closing market price of the Class A common stock on January 28, 2009. Mr. Carter, the Chairman, and Tamara Lundgren, the President and Chief Executive Officer, receive compensation pursuant to their employment agreements and do not receive DSUs. The DSUs granted on January 28, 2009 were for a total of 24,681 shares. The DSUs will become fully vested on the day before the 2010 annual meeting, subject to continued Board service. For the three months ended February 28, 2009, the compensation expense related to these DSU awards was not material.

SCHNITZER STEEL INDUSTRIES, INC.

Note 12 - Employee Benefits

The Company and certain of its subsidiaries have qualified and nonqualified retirement plans covering substantially all employees of these companies. These plans include a defined benefit plan, a supplemental executive retirement benefit plan (“SERBP”), defined contribution plans, and multiemployermulti-employer pension plans. These plans are more fully described in the “Notes to the Consolidated Financial Statements” included in the Company’s Annual Report on Form 10-K for the year ended August 31, 2008.

The components of net periodic pension costs for the three and six months ended February 28, 2009 and February 29, 2008, were (in thousands):

Defined Benefit Plans

Benefits under the Company’s defined benefit plan were frozen effective June 30, 2006. In general, additional contributions to the plan are not required; however, changes in the discount rate or actual investment returns that are lower than the long-term expected return on plan assets could result in the need for the Company to make additional contributions. Recently, most defined benefit plans have experienced deterioration in their funded status due to the general decline in equityinvestment values over the last two fiscal quarter.quarters. As a result, the Company may be requiredelect to make additional contributions to the defined benefit plan in fiscal 2009. The Company made nodid not make contributions to the defined benefit plan during the quartersthree and six months ended November 30, 2008February 28, 2009 or 2007.the three and six months ended February 29, 2008. Company contributions to the SERBP were $37,000not material for the first quarter of each of fiscal 2009 and 2008.all periods presented.

Multiemployer Pension Plans

The Company contributes to various multiemployer pension plans in accordance with its collective bargaining agreements. The plans are jointly managed by trustees that include representatives from both management and labor unions. Contribution rates are established by collective bargaining and benefit levels are set by a joint board of trustees based on the advice of an independent actuary regarding the level of benefits that agreed-upon contributions can be expected to support. Company is notcontributions to the sponsor or administrator of thesemultiemployer plans were $1 million and contributions are determined in accordance with$2 million, respectively, during the provisions of negotiated labor contracts. three and six months ended February 28, 2009 and February 29, 2008.

SCHNITZER STEEL INDUSTRIES, INC.

The Company has contingent liabilities for its share of the unfunded liabilities of each plan to which it contributes. Due to the general decline in equity values, the

SCHNITZER STEEL INDUSTRIES, INC.

Company believes these plans have experienced deterioration in their funded status. Should the funding status of these plans fall below certain specified levels, the Company may be required to participate in a rehabilitation plan, which could involve contribution increases, benefit reductions or a combination of the two. Company contributions to the multiemployer plans were $1 million for the first quarter of each of fiscal 2009 and 2008.

The Company also has a contingent liability for the funding of the multiemployer plan benefiting employees of SMBcontributes that would be triggered if the Company were to withdraw or partially withdraw from that plan, and such liability could be material to the Company’s results of operations and cash flows.plan. Because the Company has no current intention of withdrawing from any of the multiemployer plans in which it participates, it has not recognized a liability for this contingency.

In January 2009, the Company was notified by the plan administrator that the multiemployer plan benefiting employees of SMB has an accumulated funding deficiency (i.e., a failure to satisfy the minimum funding requirements) for the current Plan year and was therefore “in critical status.” Federal law requires pension plans in critical status to adopt a rehabilitation plan designed to restore the financial health of the plan. Rehabilitation plans may involve contribution increases, benefit reductions, or a combination of the two. The law also requires that all contributing employers pay to the plan a surcharge to help correct the Plan’s financial situation until they are signatory to a collective bargaining agreement that is consistent with the rehabilitation plan. At this time, the Company is unablenot required to determine its relative portion of any existingmake surcharge payments, as it is already signatory to an August 2008 agreement that requires annual six percent contribution increases. Any contributions that the Company would be required to make would be substantially less than the Company’s estimated withdrawal liability, or estimate its future liability, under these planswhich was calculated by the plan actuary to be $20 million as of NovemberSeptember 30, 2008. If returns on plan investments are less than amounts expected the withdrawal liability may have increased since this date.

Defined Contribution Plans

The Company has several defined contribution plans covering non-union employees. Company contributions to the defined contribution plans were $2 million and $1$4 million, respectively for the first quarter of fiscalthree months and six months ended February 28, 2009 and 2008, respectively.February 29, 2008. The Company suspended employer contributions to these plans effective in March 2009. The Company expects to make contributionscontribute $1 million to its various defined contributionthese plans of approximately $5 million forduring the remainder of fiscal 2009.

Note 13 - Segment Information

The Company operates in three reportable segments: metalmetals purchasing, processing, recycling, and selling (MRB), mini-mill steel manufacturing (SMB), and self-service and full-service used auto parts (APB) and mini-mill steel manufacturing (SMB). Additionally, the Company is a non-controlling partner in joint ventures, which are either in the metals recycling business or are suppliers of unprocessed metal.

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. Because of this unallocated expense, the operating income (loss) of each segment does not reflect the operating income (loss) the segment would have as a stand-alone business.

The following is a summary of the Company’s total assets (in thousands):

SCHNITZER STEEL INDUSTRIES, INC.

The tables below illustrate the Company’s operating results by segment for the three and six months ended November 30,February 28, 2009 and February 29, 2008, and 2007respectively (in thousands):

Note 14 - Income TaxesTax Expense (Benefit)

The effective tax ratesIncome taxes represented a benefit for the three months ended November 30, 2008 and November 30, 2007 were 33.6% and 35.9%, respectively. Sincefiscal 2009 since there was a pre-tax loss for the periodthree and six month periods ended November 30, 2008, income taxes represented a benefitFebruary 28, 2009. The effective tax rates for those periods were 60.5% and 40.3%, respectively, compared to 35.3% and 35.6% for the period.same periods in fiscal 2008. The decrease in thehigher effective tax rate was primarily duerates for fiscal 2009 were mainly attributable to state taxes and totax benefits arising from the benefitreversal of $5 million of nondeductible executive incentive compensation and the impact on the Company’s tax rate of undistributed foreign earnings. The incentive compensation of $5 million for certain executives that was awarded and includedtreated as nondeductible officers’ compensation forin fiscal 2008 but was voluntarily and irrevocably declined in November 2008.fiscal 2009, thereby providing a tax benefit. The undistributed foreign earnings from the Puerto Rico metals recycling operation acquired in February 2009 provided a tax benefit because the earnings are presumed to be indefinitely reinvested in Puerto Rico and therefore taxed at less than the statutory US Federal tax rate.