NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, AUGUST 31, 1998

1. Summary of Significant Accounting Policies

Nature of Operations
The Company manufactures, recycles and markets steel and metal products and related materials. Its manufacturing and recycling facilities and primary markets are located in the Sunbelt from the mid-Atlantic area through the Southwest. Through its global marketing offices, the Company trades primary and secondary metals and other industrial products worldwide. As more fully discussed in footnote 12, the Manufacturing segment is the most dominant in terms of capital assets and operating profit.

Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany transactions and balances are eliminated in consolidation.

Revenue Recognition
Sales are recognized when title to inventory passes to the customer based on customary industry practice.

Inventories
Inventories are stated at the lower of cost or market. Inventory cost for most domestic inventories is determined by the last-in, first-out (LIFO) method; cost of international and remaining inventories is determined by the first-in, first-out (FIFO) method.

Property, Plant and Equipment
Property, plant and equipment is recorded at cost and is depreciated at annual rates based upon the estimated useful lives of the assets using substantially the straight-line method. Provision for amortization of leasehold improvements is made at annual rates based upon the estimated useful lives of the assets or terms of the leases, whichever is shorter.

Start-Up Costs
Start-up costs associated with the acquisition and expansion of manufacturing and recycling facilities are expensed as incurred.

Income Taxes
Deferred income taxes are provided for temporary differences between financial and tax reporting. The principal differences are described in footnote 5. Benefits from tax credits are reflected currently in earnings.

Foreign Currency
The functional currency of the Company's international subsidiaries in Australia, the United Kingdom, and Germany is the local currency. The remaining international subsidiaries' functional currency is the United States dollar. Translation adjustments are reported as a separate component of stockholders' equity.

Gain or loss on foreign currency exchange contracts designated as hedges is deferred and recognized upon settlement of the related trade receivable or payable.

Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make significant estimates regarding assets and liabilities and associated revenues and expenses. Management believes these estimates to be reasonable; however, actual results may vary.

Cash Flows
For purposes of the statements of cash flows, the Company considers investments that are short-term (generally with original maturities of three months or less) and highly liquid to be cash equivalents.

Reclassifications
Certain reclassifications have been made in the 1997 and 1996 financial statements to conform to the classifications used in the current year.

Other
The Company will adopt Statement of Financial Accounting Standard No. 130, Reporting Comprehensive Income, and Standard No. 131, Disclosures About Segments of an Enterprise and Related Information, as of the quarter ending November 30, 1998. It will adopt Standard No. 133, Accounting for Derivative Instruments and Hedging Activities, as of the quarter ending November 30, 1999. Standards No. 130 and 131 are disclosure oriented and will not have an impact on reported operations. The Company has not evaluated the impact of Standard No. 133.

2. Inventories
Before reduction of LIFO reserves of $22,450,000 and $30,131,000 at August 31, 1998 and 1997, respectively, inventories valued under the first-in, first-out method approximated replacement cost.

At August 31, 1998 and 1997, 72% of total inventories were valued at LIFO. The remainder of inventories, valued at FIFO, consist mainly of material dedicated to international business.

3. Credit Arrangements
Periodically, the Company is active in the commercial paper market with a program that permits borrowings up to $40,000,000. It is the Company's policy to maintain formal bank credit lines equal to 100% of the amount of all commercial paper outstanding.

The Company has numerous informal credit facilities available from domestic and international banks. These credit facilities are priced at banker's acceptance rates or on a cost of funds basis. No compensating balances or commitment fees are required under these credit facilities.

At August 31, 1998, the Company had filed a shelf registration for $200 million of long- and medium-term notes, of which $100 million is expected to be drawn in fiscal 1999.

The Company's $100 million investment grade, unsecured notes have a coupon rate of 7.20%, which, after netting the proceeds of an interest rate hedge, results in an effective interest rate of 7.04%.

On July 30, 1997, the Company sold the remaining $50 million of notes under its $150 million shelf registration. The notes have an effective yield of 6.8%.

On August 15, 1996, the Company arranged a five-year, $40 million unsecured revolving credit loan facility with a group of four banks. The agreement provides for borrowing in United States dollars indexed to the reference rate or to the offshore dollar interbank market rate. A commitment fee of .1125% per annum is payable on the credit line. No compensating balances are required.

Long-term debt and amounts due within one year as of August 31, 1998, are as follows:

All interest is payable semiannually. The 7.20% notes are due in July 2005; the 6.80% notes in August 2007. The 8.49% notes provide for annual principal repayments beginning on December 1, 1995; all other notes are payable semiannually.

Certain of the note agreements include various covenants. The most restrictive of these requires maintenance of consolidated net current assets of $75,000,000 and net worth (as defined) of $150,000,000. At August 31, 1998, approximately $205,000,000 of retained earnings was available for cash dividends under these covenants.

The aggregate amounts of all long-term debt maturities for the five years following August 31, 1998 are (in thousands): 1999 - $11,483; 2000 - $9,332; 2001 - $7,179; 2002 - $7,163; 2003 - $21.

Interest expense is comprised of the following:

Interest of $2,290,000, $804,000 and $320,000 was capitalized in the cost of property, plant and equipment constructed in 1998, 1997, and 1996, respectively. Interest of $20,691,000, $15,578,000, and $16,467,000 was paid in 1998, 1997, and 1996, respectively.

4. Financial Instruments, Market and Credit Risk
Management believes that the historical financial statement presentation is the most useful for displaying the Company's financial position. However, generally accepted accounting principles require disclosure of an estimate of the fair value of the Company's financial instruments as of year end. These estimated fair values disregard management intentions concerning these instruments and do not represent liquidation proceeds or settlement amounts currently available to the Company. Differences between historical presentation and estimated fair values can occur for many reasons including taxes, commissions, prepayment penalties, make-whole provisions and other restrictions as well as the inherent limitations in any estimation technique. Because of this management believes that this information may be of limited usefulness in understanding the Company and minimal value in making comparisons between companies. Due to near-term maturities, allowances for collection losses, investment grade ratings and security provided, the following financial instruments' carrying amounts are considered equivalent to fair value:

• Cash and temporary investments
• Commercial paper
• Notes payable

The Company's long-term debt is both publicly and privately held. Fair value was determined for private debt by discounting future cash flows at current market yields and for public debt at indicated market values.

The notional amount of foreign currency exchange contracts outstanding at year end was $58,730,000. The fair value of these contracts effective as hedges if settled at August 31, 1998 would result in a gain of $1,332,000. The fair value of all outstanding letters of credit is not meaningful.

In 1998, the Company entered into an interest rate swap (variable to fixed) effective as a hedge for certain debt outstanding of its Australian subsidiary. The instrument's notional amount is seven million Australian dollars and terminates June 2, 2003. The variable rate at year end was 5.6% and the fixed rate 5.5%. At August 31, 1998, it had a fair value of $112,000.

The Company does not have significant off-balance-sheet risk from financial instruments. It enters into foreign exchange contracts as hedges of trade receivables and payables denominated in currencies other than the functional currency. Effects of changes in currency rates are therefore minimized. As a matter of Company policy, foreign exchange contracts are used to hedge only firm commitments, not anticipated transactions.

Pricing of certain firm sales and purchase commitments is fixed to forward metal commodity exchange quotes. The Company enters into metal commodity contracts (predominantly copper) as hedges of gross margins on these commitments. The hedges are closed when the underlying sales and purchase commitments are priced, and gain or loss is recognized when the sale or purchase is recorded.

The Company maintains both corporate and divisional credit departments. Limits are set for customers and countries. Letters of credit issued or confirmed through sound financial institutions are obtained to further ensure prompt payment in accordance with terms of sale; generally, collateral is not required. At August 31, 1998, $6,751,000 of bankers acceptances were included in accounts receivable.

In the normal course of its marketing activities, the Company transacts business with substantially all sectors of the metals industry. Customers are internationally dispersed, cover the spectrum of manufacturing and distribution, deal with various types and grades of metal, and have a variety of end markets in which they sell. The Company's historical experience in collection of accounts receivable falls within the recorded allowances. Due to these factors, no additional credit risk beyond amounts provided for collection losses is believed inherent in the Company's accounts receivable.

5. Income Taxes
The provisions for income taxes include the following:

Taxes of $21,444,000, $25,506,000 and $16,537,000 were paid in 1998, 1997 and 1996, respectively.

Deferred taxes arise from temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements. The sources and tax effects of these differences are:

The Company uses substantially the same depreciable lives for tax and book purposes. Changes in deferred taxes relating to depreciation are mainly attributable to differences in the basis of underlying assets recorded under the purchase method of accounting. As noted above, the Company provides United States taxes on unremitted foreign earnings. Such earnings have been reinvested in the foreign operations except for dividends of $6,062,000. The Company's effective tax rates were 37.2% in 1998, 36.7% in 1997, and 36.9% in 1996. Reconciliations of the United States statutory rates to the effective rates are as follows:

Net operating losses reflected as deferred tax assets consist of $4.5 million that are due to expire in 2009. These assets will be reduced as tax expense is recognized in future periods. The $1.7 million alternative minimum tax credit is available indefinitely.

6. Capital Stock
Stock Purchase Plan
Substantially all employees may participate in the Company's employee stock purchase plan. The Directors have authorized the annual purchase of up to 200 shares at a discount of 25% from the stock's price. Annual activity of the stock purchase plan was as follows:

The Company recognized compensation expense for this plan of $1,053,000, $906,000 and $844,000 in 1998, 1997 and 1996, respectively.

Stock Option Plans
The 1986 Stock Incentive Plan (1986 Plan) terminated November 23, 1996, except as to awards outstanding. Under the 1986 Plan, stock options were awarded to full-time salaried employees. The option price was the fair market value of the Company's stock at the date of grant, and the options are exercisable two years from date of grant.

The 1996 Long-Term Incentive Plan (1996 Plan) was approved in December 1996. Under the 1996 Plan, stock options, stock appreciation rights, and restricted stock may be awarded to employees. The option price for both the stock options and the stock rights will not be less than the fair market value of the Company's stock at the date of grant. Vesting periods are variable but no award may be exercised after ten years. The outstanding awards under the 1996 Plan vest 50% after one year and 50% after two years from date of grant and will expire seven years after grant.

Combined share information for the two plans is as follows:

The Company has maintained its historical method for accounting for stock options, which recognizes no compensation expense for fixed options granted at current market values. Generally accepted accounting principles require disclosure of an estimate of the weighted-average grant date fair value of options granted during the year and pro forma disclosures of the effect on earnings if compensation expense had been recorded.

The Black-Scholes option pricing model used requires the following weighted-average assumptions:

Management believes that the resulting answer has narrow reliability as characteristics of the Company's options such as nontransferability, forfeiture provisions, and long lives are inconsistent with the option model's basic purpose of valuing traded options. For purposes of pro forma earnings disclosures, the assumed compensation expense is amortized over the option's vesting period. The 1998 pro forma information includes options granted in 1996, 1997, and 1998. The 1997 pro forma information includes options granted in 1996 and 1997.

The weighted-average fair value of options granted in 1998, 1997 and 1996 was $6.06, $6.27 and $6.44, respectively.

Preferred Stock
Preferred stock has a par value of $1.00 a share, with 2,000,000 shares authorized. It may be issued in series, and the shares of each series shall have such rights and preferences as fixed by the Board of Directors when authorizing the issuance of that particular series. There are no shares of preferred stock outstanding.

7. Employees' Pension and Profit Sharing Plans
Substantially all employees of the Company and its subsidiaries are covered by profit sharing or savings plans. Company contributions, which are discretionary, to all plans were $19,448,000, $14,468,000, and $13,915,000, for 1998, 1997 and 1996, respectively.

During 1998 the Company settled its only remaining defined benefit plan, which it had terminated in 1997. Included in 1998 is pension expense of $3,310,000, substantially all of which was a settlement liability. There will be no future pension expense.

8. Postretirement Benefits Other Than Pensions/Postemployment Benefits
The Company has no significant postretirement obligations. The Company's historical costs for postemployment benefits have not been significant and are not expected to be in the future.

9. Commitments and Contingencies
Minimum rental commitments payable by the Company and its consolidated subsidiaries for noncancelable operating leases in effect at August 31, 1998, are as follows for the fiscal periods specified:

Total rental expense was $9,634,000, $8,621,000 and $7,834,000 in 1998, 1997 and 1996, respectively.

In the ordinary course of conducting its business, the Company becomes involved in litigation, administrative proceedings and governmental investigations, including environmental matters.

The Company has received notices from the U.S. Environmental Protection Agency (EPA) or equivalent state agency that it is considered a potentially responsible party (PRP) at thirteen sites, none owned by the Company, and may be obligated under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) or similar state statute to conduct remedial investigations, feasibility studies, remediation and/or removal of alleged releases of hazardous substances or to reimburse the EPA for such activities. The Company is involved in litigation or administrative proceedings with regard to several of these sites in which the Company is contesting, or at the appropriate time may contest, its PRP designation. In addition, the Company has received information requests with regard to other sites which may be under consideration by the EPA as potential CERCLA sites.

Some of these environmental matters or other proceedings may result in fines, penalties or judgments being assessed against the Company, which, from time to time, may have a material impact on earnings for a particular quarter. While the Company is unable to estimate precisely the ultimate dollar amount of exposure to loss in connection with the above-referenced matters, it makes accruals as warranted. Due to evolving remediation technology, changing regulations, possible third-party contributions, the inherent shortcomings of the estimation process and other factors, amounts accrued could vary significantly from amounts paid. Accordingly, it is not possible to estimate a meaningful range of possible exposure. It is the opinion of the Company's management that the outcome of these proceedings, individually or in the aggregate, will not have a material adverse effect on the business or consolidated financial position of the Company.

During 1998 the Company and former stockholders of Owen Steel Company, Inc. and affiliates settled litigation with regard to the Company's claims against a portion of the purchase price held in escrow since the November 1994 acquisition. The Company received approximately $3 million of the approximately $5 million escrow balance. The proceeds were substantially offset against claim payments paid and deferred pending settlement.

10. Earnings Per Share
Statement of Financial Accounting Standards No. 128, Earnings per Share, requires a reconciliation of both the numerator and denominator of the earnings per share calculations. There are no adjustments to net earnings to arrive at income for any years presented. The stock options granted June 11, 1998, with total outstanding share commitments of 364,141 at year end is antidilutive. All share data has been restated in accordance with the Standard.

12. Business Segments
Summarized data for the Company's international operations located outside of the United States (principally in Europe, Australia and the Far East) are as follows:

The Company operates in three business segments, as indicated below. Intersegment sales generally are priced at prevailing market prices. Certain corporate administrative expenses are allocated to segments based upon the nature of the expense.

13. Quarterly Financial Data (Unaudited)
Summarized quarterly financial data for 1998, 1997 and 1996 are as follows (in thousands except per share data):

The quantities and costs used in calculating cost of goods sold on a quarterly basis include estimates of the annual LIFO effect. The actual effect cannot be known until the year-end physical inventory is completed and quantity and price indices are developed. The quarterly cost of goods sold above includes such estimates. Fourth quarter 1998 net earnings increased $3,920,000 after the final determination of quantities and prices was made.

The net earnings per share (EPS) is on a diluted basis calculated in accordance with Financial Accounting Standards No. 128.