Commercial Metals Company - 10-Q quarterly report FY2011 Q3

 

(Exact name of registrant as specified in its charter)

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No þ

As of July 1, 2011 there were 115,533,540 shares of the Company’s common stock outstanding.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States on a basis consistent with that used in Commercial Metals Company’s (the “Company” or “CMC”) Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) for the year ended August 31, 2010, and include all normal recurring adjustments necessary to present fairly the consolidated balance sheets and statements of operations, cash flows and stockholders’ equity for the periods indicated. These notes should be read in conjunction with such Form 10-K. The results of operations for the three and nine month periods are not necessarily indicative of the results to be expected for a full year.

In the first quarter of 2011, the Company adopted accounting guidance related to the accounting for transfers of financial assets. The guidance clarifies the determination of a transferor’s continuing involvement in a transferred financial asset and limits the circumstances in which a financial asset should be removed from the balance sheet when the transferor has not transferred the entire original financial asset. See Note 3, Sales of Accounts Receivable, for additional details.

On April 5, 2011, the Company entered into a two year sale of accounts receivable program. The Company periodically contributes and several of its subsidiaries periodically sell without recourse certain eligible trade accounts receivable to the Company’s wholly-owned consolidated special purpose subsidiary, CMC Receivables, Inc. (“CMCRV”). CMCRV is structured to be a bankruptcy-remote entity and was formed for the sole purpose of buying and selling receivables generated by the Company. Depending on the Company’s level of financing needs, CMCRV will sell the trade accounts receivable in their entirety to a third party financial institution. The third party financial institution will advance up to a maximum of $100 million for all receivables and the remaining portion due to the Company will be deferred until the ultimate collection of the underlying receivables. The facility can be increased to a maximum of $200 million with consent of the financial institution. The Company will account for sales to the financial institution as true sales and the receivables will be removed from the consolidated balance sheet and the proceeds from the sale will be reflected as cash provided by operating activities. Additionally, the receivables program contains certain cross-default provisions whereby a termination event could occur if the Company defaulted under one of its credit arrangements. As of May 31, 2011, no receivables had been sold to the third party financial institution.

The Company’s previous accounts receivable securitization agreement of $100 million expired on January 31, 2011. As of August 31, 2010, no receivables had been sold under the expired program.

In addition to the domestic sale of accounts receivable program described above, the Company’s international subsidiaries in Europe and Australia periodically sell accounts receivable without recourse. These arrangements constitute true sales, and once the accounts are sold, they are no longer available to satisfy the Company’s creditors in the event of bankruptcy. Uncollected accounts receivable sold under these arrangements and removed from the consolidated balance sheets were $153.8 million and $103.9 million at May 31, 2011 and August 31, 2010, respectively. The Australian program contains financial covenants in which the subsidiary must meet certain coverage and tangible net worth levels, as defined. At May 31, 2011, the Australian subsidiary was in compliance with these covenants.

During the nine months ended May 31, 2011 and 2010, proceeds from the sales of receivables were $892.6 million and $604.3 million, respectively, and cash payments to the owners of receivables were $842.7 million and $575.0 million, respectively. The Company is responsible for servicing the receivables for a nominal servicing fee. Discounts on domestic and international sales of accounts receivable were $3.6 million and $2.8 million for the nine months ended May 31, 2011 and 2010, respectively. These discounts primarily represented the costs of funds and were included in selling, general and administrative expenses.

Inventories are stated at the lower of cost or market. Inventory cost for most domestic inventories is determined by the last-in, first-out method (“LIFO”). LIFO inventory reserves were $297.7 million and $230.3 million at May 31, 2011 and August 31, 2010,

respectively. Inventory cost for international inventories and the remaining domestic inventories are determined by the first-in, first-out method (“FIFO”). The majority of the Company’s inventories are in the form of finished goods, with minimal work in process. At May 31, 2011 and August 31, 2010, $114.4 million and $59.1 million, respectively, were in raw materials.

The Company tests for impairment of goodwill by estimating the fair value of each reporting unit compared to its carrying value. The Company’s reporting units are based on its internal reporting structure and represent an operating segment or a reporting level below an operating segment. Additionally, the reporting units are aggregated based upon similar economic characteristics, nature of products and services, nature of production processes, type of customers and distribution methods. The Company has determined its operating units that have a significant amount of goodwill to be in the Americas Recycling and Americas Fabrication segments. The Company uses a discounted cash flow model to calculate the fair value of its reporting units. The model includes a number of significant assumptions and estimates regarding future cash flows including discount rates, volumes, prices, capital expenditures and the impact of current market conditions. These estimates could be materially impacted by adverse changes in market conditions. The Company performs the goodwill impairment test in the fourth quarter each fiscal year and when changes in circumstances indicate an impairment event may have occurred. There were no triggering events during the third quarter of 2011.

The total gross carrying amounts of the Company’s intangible assets that were subject to amortization were $70.1 million and $73.9 million at May 31, 2011 and August 31, 2010, respectively, and are included in other noncurrent assets. Aggregate amortization expense for intangible assets for the three months ended May 31, 2011 and 2010 was $2.4 million and $2.7 million, respectively. Aggregate amortization expense for intangible assets for the nine months ended May 31, 2011 and 2010 was $7.4 million and $11.3 million, respectively.

During the three and nine months ended May 31, 2011, the Company recorded severance costs of $1.3 million and $2.6 million, respectively. During the three and nine months ended May 31, 2010, the Company recorded severance costs of $1.9 million and $18.5 million, respectively. These severance costs relate to involuntary employee terminations initiated as part of the Company’s focus on operating expense management and reductions in headcount. Additionally, during the second quarter of 2010, the Company incurred severance costs associated with exiting the joist and deck business.

On February 26, 2010, the Company’s Board of Directors approved a plan to exit the joist and deck business through the sale of those facilities. The Company determined that the decision to exit this business met the definition of a discontinued operation. As a result, this business has been presented as a discontinued operation for all periods. The Company recorded $26.8 million to impair plant, property and equipment, $4.5 million to write-off intangible assets, and $7.4 million of inventory valuation adjustments during the second quarter of 2010. During the nine months ended May 31, 2010, the Company recorded severance costs of $9.2 million in connection with exiting the business. The joist and deck business was in the Americas Fabrication segment.

During the fourth quarter of 2010, the Company completed the sale of the majority of the deck assets and during the first quarter of 2011, the Company completed the sale of the majority of the joist assets resulting in a gain of $1.9 million.

Various financial information for discontinued operations is as follows:

During the first quarter of 2011, CMC Construction Services, a subsidiary of the Company included in the Americas Fabrication segment, completed the sale of heavy forming and shoring equipment for approximately $35 million. The Company recorded a loss on sale of approximately $0.5 million in connection with this transaction.

The Company’s revolving credit facility of $400 million has a maturity date of November 24, 2012 and includes certain covenants. The Company is required to maintain a minimum interest coverage ratio of not less than 2.50 to 1.00 for the twelve month cumulative period ended May 31, 2011 and for each fiscal quarter on a rolling twelve month cumulative period thereafter. At May 31, 2011, the Company’s interest coverage ratio was 3.37 to 1.00. The agreement also requires the Company to maintain a debt to capitalization ratio covenant not greater than 0.60 to 1.00. At May 31, 2011, the Company’s debt to capitalization ratio was 0.50 to 1.00. The agreement provides for interest based on LIBOR, Eurodollar or Bank of America’s prime rate. The facility fee is 60 basis points per annum and no compensating balances are required.

It is the Company’s policy to maintain contractual bank credit lines equal to 100% of the amount of the commercial paper program. There were no amounts outstanding at May 31, 2011 and $10 million outstanding at August 31, 2010 under the commercial paper program. There were no amounts outstanding on the revolving credit facility at May 31, 2011 and August 31, 2010. The availability under the revolving credit agreement is reduced by any outstanding amount under the commercial paper program. At May 31, 2011, $400 million was available under the revolving credit agreement.

The Company has numerous uncommitted credit facilities available from domestic and international banks. No commitment fees or compensating balances are required under these credit facilities. These credit facilities are used, in general, to support import letters of credit, foreign exchange transactions and short term advances which are priced at market rates.

Long-term debt, including the net effect of interest rate swap revaluation adjustments, is as follows:

Interest on the notes, except for the CMC Zawiercie (“CMCZ”) note, is payable semiannually.

Effective May 20, 2011, the Company entered into an interest rate swap transaction on its 6.50% notes due July 2017 (“2017 Notes”). On March 23, 2010, the Company entered into two interest rate swap transactions on its 5.625% notes due November 2013 (“2013 Notes”) and 7.35% notes due August 2018 (“2018 Notes”). The swap transactions were designated as fair value hedges at inception and convert all fixed rate interest to floating rate interest on the Company’s 2013 Notes, $300 million on the 2017 Notes and $300 million on the 2018 Notes and have termination dates of November 15, 2013, July 15, 2017 and August 15, 2018, respectively. The swap transactions costs are based on the floating LIBOR plus 303 basis points with respect to the 2013 Notes, LIBOR plus 374 basis points with respect to the 2017 Notes and LIBOR plus 367 basis points with respect to the 2018 Notes.

CMCZ has a five year term note of PLN 160 million ($58.2 million) with a group of four banks. The term note is used to finance operating expenses of CMCZ and the development of a rolling mill. The note has scheduled principal and interest payments in fifteen equal quarterly installments which began in November 2009 with the final installment in May 2013. The weighted average interest rate at May 31, 2011 was 6.5%. The term note contains four financial covenants for CMCZ. At May 31, 2011, CMCZ was not in compliance with one of the financial covenants which resulted in a guarantee by Commercial Metals Company continuing to be effective. As a result of the guarantee, the financial covenant requirements became void; however, all other terms of the loan remain in effect, including the payment schedule. The guarantee will cease to be effective when CMCZ is in compliance with the financial covenant for two consecutive quarters.

CMC Sisak (“CMCS”) has a five year financing agreement of EUR 15.0 million ($21.6 million). The loan is intended to be used for capital expenditures and other uses. The note has scheduled principal and interest payments in seven semiannual installments beginning in July 2011 and ending in July 2014. The weighted average interest rate at May 31, 2011 was 5.0%.

Interest of $0.7 million and $4.2 million was capitalized in the cost of property, plant and equipment constructed for the nine months ended May 31, 2011 and 2010, respectively. Interest of $32.6 million and $40.5 million was paid for the nine months ended May 31, 2011 and 2010, respectively.

The Company’s worldwide operations and product lines expose it to risks from fluctuations in metals commodity prices, foreign currency exchange rates, natural gas prices and interest rates. One objective of the Company’s risk management program is to mitigate these risks using derivative instruments. The Company enters into metal commodity futures and forward contracts to mitigate the risk of unanticipated declines in gross margin due to the volatility of the commodities’ prices, enters into foreign currency forward contracts which match the expected settlements for purchases and sales denominated in foreign currencies and enters into natural gas forward contracts to mitigate the risk of unanticipated changes in operating cost due to the volatility of natural gas prices. When sales commitments to customers include a fixed price freight component, the Company occasionally enters into freight forward contracts to minimize the effect of the volatility of ocean freight rates. The Company enters into interest rate swap contracts to maintain a portion of the Company’s debt obligations at variable interest rates. These interest rate swap contracts, under which the Company has agreed to pay variable rates of interest and receive fixed rates of interest, are designated as fair value hedges of fixed rate debt.

The following tables provide certain information regarding the foreign exchange and commodity financial instruments discussed above.

Gross foreign currency exchange contract commitments as of May 31, 2011 (in thousands):

Commodity contract commitments as of May 31, 2011:

The Company designates only those contracts which closely match the terms of the underlying transaction as hedges for accounting purposes. These hedges resulted in substantially no ineffectiveness in the statements of operations, and there were no components excluded from the assessment of hedge effectiveness for the three months and nine months ended May 31, 2011 and 2010. Certain of the foreign currency and commodity contracts were not designated as hedges for accounting purposes, although management believes they are essential economic hedges.

The following tables summarize activities related to the Company’s derivative instruments and hedged (underlying) items recognized within the statements of operations (in thousands):

The Company’s fair value hedges are designated for accounting purposes with gains and losses on the hedged (underlying) items offsetting the gain or loss on the related derivative transaction. Hedged (underlying) items relate to firm commitments on commercial sales and purchases, capital expenditures and fixed rate debt obligations. As of May 31, 2011, fair value hedge accounting for interest rate swap contracts increased the carrying value of debt instruments by $17.3 million.

The Company recognizes the impact of actual and estimated net periodic settlements of current interest on our active interest rate swaps as adjustments to interest expense. The following table summarizes the impact of actual and estimated periodic settlements of active swap agreements on the results of operations:

The Company’s derivative instruments were recorded at their respective fair values as follows on the consolidated balance sheets (in thousands):

As of May 31, 2011, all of the Company’s derivative instruments designated to hedge exposure to the variability in future cash flows of the forecasted transactions will mature within twelve months.

All of the instruments are highly liquid, and none are entered into for trading purposes.

The Company has established a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three levels. These levels are determined based on the lowest level input that is significant to the fair value measurement.

The following table summarizes information regarding the Company’s financial assets and financial liabilities that were measured at fair value on a recurring basis:

The Company’s long-term debt is predominantly publicly held. The fair value was approximately $1.25 billion at May 31, 2011 and $1.29 billion at August 31, 2010. Fair value was determined by indicated market values.

The Company had net refunds of $72.9 million and $0.7 million in income taxes during the nine months ended May 31, 2011 and 2010, respectively.

Reconciliations of the United States federal income tax expense (benefit) from continuing operations were as follows:

The Company’s effective tax rate from discontinued operations for the three and nine months ended May 31, 2011 was 38.8% and for the three and nine months ended May 31, 2010 was 43.1% and 38.6%, respectively.

The reserve for unrecognized tax benefits relating to the accounting for uncertainty in income taxes was $20.4 million, exclusive of interest and penalties, as of May 31, 2011 and August 31, 2010.

The Company policy classifies interest recognized on an underpayment of income taxes and any statutory penalties recognized on a tax position as tax expense and the balances at the end of a reporting period are recorded as part of the current or non-current reserve for uncertain income tax positions. For the three and nine months ended May 31, 2011, before any tax benefits, the Company recorded immaterial amounts of accrued interest and penalties on unrecognized tax benefits.

During the next twelve months, it is reasonably possible that the statute of limitations may lapse pertaining to positions taken by the Company in prior year tax returns or that income tax audits in various taxing jurisdictions could be finalized. As a result, the total amount of unrecognized tax benefits may decrease, which would reduce the provision for taxes on earnings by an immaterial amount.

The following is a summary of tax years subject to examination:

U.S. Federal — 2006 and forward
U.S. States — 2006 and forward
Foreign — 2004 and forward

The federal tax returns for fiscal years 2006 to 2008 are under examination by the Internal Revenue Service. However, we believe our recorded tax liabilities as of May 31, 2011 sufficiently reflect the anticipated outcome of these examinations.

The Company recognized share-based compensation expense of $3.2 million for the three months ended May 31, 2011 and $9.2 million and $5.6 million for the nine months ended May 31, 2011 and 2010, respectively, as a component of selling, general and administrative expenses. The Company recognized no share-based compensation expense during the third quarter of 2010 due to a forfeiture adjustment of $2.3 million which offset expense for the quarter. At May 31, 2011, the Company had $23.8 million of total unrecognized pre-tax compensation cost related to non-vested share-based compensation arrangements, of which, $16.4 million related to share-based awards granted during the second quarter of 2011. This cost is expected to be recognized over the next 36 months.

Combined information for shares subject to options and stock appreciation rights (“SARs”) for the nine months ended May 31, 2011 were as follows:

Share information for options and SARs at May 31, 2011:

Of the Company’s previously granted restricted stock awards, 27,727 and 50,154 shares vested during the nine months ended May 31, 2011 and May 31, 2010, respectively.

During the second quarter of 2011, the Compensation Committee (the “Committee”) of the Board of Directors approved a grant to employees of approximately 670,000 restricted stock units. These awards vest over a three-year period in increments of one-third per year. The Committee also approved a grant of performance stock units. The performance awards will vest upon the achievement of certain target levels of the performance goals and objectives of the Company over the performance period of approximately three years. The actual number of performance awards granted will be based on the level of achievement. Upon achievement of any of the performance goals, the awards will be paid out 50% in shares of common stock of the Company and 50% in cash. The Company has accounted for the cash component of the performance award as a liability award and the value is adjusted to fair market value each period. All equity awards are valued at the fair market value at the date of grant. Prior to vesting, the restricted stock unit and the performance stock unit recipients do not receive an amount equivalent to any dividend declared on the Company’s common stock.

In calculating earnings (loss) per share, there were no adjustments to net earnings (loss) to arrive at earnings (loss) for any years presented. The reconciliation of the denominators of the earnings (loss) per share calculations was as follows:

For the three months ended May 31, 2011, SARs with total share commitments of 2.4 million were antidilutive because the exercise price was above the average market price for the quarter and therefore excluded from the calculation of diluted earnings per share. For the nine months ended May 31, 2011 and the three and nine months ended May 31, 2010, no stock options, restricted stock or SARs were included in the calculation of dilutive shares because the Company reported a loss from continuing operations. All stock options and SARs expire by 2018.

The Company’s restricted stock is included in the number of shares of common stock issued and outstanding, but omitted from the basic earnings (loss) per share calculation until the shares vest.

The Company purchased no shares during the first nine months of 2011 and had remaining authorization to purchase 8,259,647 shares of its common stock at May 31, 2011.

See Note 12, Commitments and Contingencies, to the consolidated financial statements in the Annual Report on Form 10-K for the year ended August 31, 2010 relating to environmental and other matters. There have been no significant changes to the matters noted therein. In the ordinary course of conducting its business, the Company becomes involved in litigation, administrative proceedings and governmental investigations, including environmental matters. Management believes that adequate provisions have been made in the consolidated financial statements for the potential impact of these contingencies, and that the outcomes will not significantly impact the results of operations, the financial position or the cash flows of the Company.

The Company’s reportable segments are based on strategic business areas, which offer different products and services. These segments have different lines of management responsibility as each business requires different marketing strategies and management expertise.

Effective September 1, 2010, the Company’s scrap metal processing facilities which directly support the domestic mills are included as part of the Americas Mills segment. Prior to September 1, 2010, these facilities were included as part of the Americas Recycling segment. All prior period financial information has been recast to the current segment reporting structure.

The Company structures the business into the following five segments: Americas Recycling, Americas Mills, Americas Fabrication, International Mills and International Marketing and Distribution. The Americas Recycling segment consists of the scrap metal processing and sales operations primarily in Texas, Florida and the southern United States. The Americas Mills segment includes the Company’s domestic steel mills, including the scrap processing facilities which directly support these mills, and the copper tube minimill. The copper tube minimill is aggregated with the Company’s steel mills because it has similar economic characteristics. The Americas Fabrication segment consists of the Company’s rebar fabrication operations, fence post manufacturing plants, construction-related and other products facilities. The International Mills segment includes the minimills in Poland and Croatia, recycling operations in Poland and fabrication operations in Europe, which have been presented as a separate segment because the economic characteristics of their markets and the regulatory environment in which they operate are different from that of the Company’s domestic mills and rebar fabrication operations. International Marketing and Distribution includes international operations for the sales, distribution and processing of steel products, ferrous and nonferrous metals and other industrial products. Additionally, the

International Marketing and Distribution segment includes the Company’s two U.S. based trading and distribution divisions, CMC Cometals and CMC Cometals Steel (previously CMC Dallas Trading). The international distribution operations consist only of physical transactions and not positions taken for speculation. Corporate contains expenses of the Company’s corporate headquarters and interest expense relating to its long-term public debt and commercial paper program.

The financial information presented for the Americas Fabrication segment excludes its joist and deck fabrication operations. This operation has been classified as discontinued operations in the consolidated statements of operations. See Note 7, Discontinued Operations and Dispositions, for more detailed information.

The Company uses adjusted operating profit (loss) to measure segment performance. Intersegment sales are generally priced at prevailing market prices. Certain corporate administrative expenses are allocated to segments based upon the nature of the expense. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The following is a summary of certain financial information from continuing operations by reportable segment: