Commercial Metals Company - 10-Q quarterly report FY

 

(Exact Name of registrant as specified in its charter)

6565 N. MacArthur Blvd.
Irving, Texas 75039

(Address of principal executive offices)
(Zip Code)

(214) 689-4300

(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.

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

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

Large accelerated filer  þ     Accelerated filer  o     Non-Accelerated filer  o

As of July 5, 2007, there were 119,693,752 shares of the Company’s common stock issued and outstanding excluding 9,366,912 shares held in the Company’s treasury.

See notes to unaudited condensed consolidated financial statements.

See notes to unaudited condensed consolidated financial statements.

See notes to unaudited condensed consolidated financial statements.

See notes to unaudited condensed consolidated financial statements.

See notes to unaudited condensed consolidated financial statements.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) on a basis consistent with that used in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) for the year ended August 31, 2006, and include all normal recurring adjustments necessary to present fairly the condensed consolidated balance sheets and statements of earnings, 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.

See Note 9, Capital Stock, to the Company’s consolidated financial statements for the year ended August 31, 2006 filed on Form 10-K with the SEC for a description of the Company’s stock incentive plans.

The Company adopted 123(R) effective September 1, 2005 using the modified prospective method. As a result, compensation expense was recorded for the unvested portion of previously issued awards that were outstanding at September 1, 2005. The Black-Scholes pricing model was used to calculate total compensation cost which is amortized on a straight-line basis over the remaining vesting period of previously issued awards. (See Note 1, Summary of Significant Accounting Policies, to the Company’s consolidated financial statements for the year ended August 31, 2006 for the assumptions used to estimate the fair value and the weighted average grant date fair value. The Company developed its volatility assumption based on historical data). The Company recognized after-tax stock-based compensation expense of $1.3 million and $1.7 million ($0.01 per diluted share, respectively) for the three months ended May 31, 2007 and 2006, respectively and $4.8 million and $4.6 million ($0.04 per diluted share, respectively) for the nine months ended May 31, 2007 and 2006, respectively as a component of selling, general and administrative expenses. The cumulative effect of adoption (primarily arising from the recognition of anticipated forfeitures) was not material. At May 31, 2007, the Company had $4.7 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements. This cost is expected to be recognized over the next 25 months.

Combined information for shares subject to options and SARs for the nine months ended May 31, 2007 was as follows:

Share information for options and SARs at May 31, 2007:

Of the Company’s previously granted restricted stock awards 112,833 and 16,000 shares vested during the nine months ended May 31, 2007 and 2006, respectively.

The total gross carrying amounts of the Company’s intangible assets that were subject to amortization were $31.1 million and $22.0 million at May 31, 2007 and August 31, 2006, respectively. Aggregate amortization expense for the three months ended May 31, 2007 and 2006 was $1.6 million and $0.8 million, respectively. Aggregate amortization expense for each of the nine months ended May 31, 2007 and 2006 was $3.2 million and $2.0 million, respectively.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. This statement permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 is effective for the Company’s fiscal year beginning September 1, 2008. The Company does not expect the adoption of this Standard to have a material impact on its financial statements.

In September 2006, the SEC released SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” which is effective for the Company’s fiscal year beginning September 1, 2007. The Standard requires registrants to consider the effects of the carryover or reversal of prior year misstatements in quantifying a current year misstatement and should quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. The Company does not expect the adoption of this Standard to have a material impact on its financial statements.

In September 2006, the FASB issued FASB Staff Position (FSP) No. AUG AIR-1, “Accounting for Planned Major Maintenance Activities” which is effective for the Company’s fiscal year beginning September 1, 2007. The Staff Position prohibits the use of the accrue-in-advance method of accounting for planned major maintenance activities in annual and interim financial reporting periods. The Company does not expect the adoption of this Standard to have a material impact on its financial statements.

During the nine months ended May 31, 2007, the company made the following acquisitions:

The total purchase price for these acquisitions of approximately $159.2 million consisted of $156.5 million in cash consideration and $2.8 million in liabilities assumed. The following table summarizes the preliminary allocation of the purchase prices to the assets acquired and liabilities assumed based on the fair value at the date of the acquisition (subject to change following management’s final evaluation of the fair value):

The intangible assets acquired include customer base which will be amortized over 5 years and a backlog, which will be amortized over 9 months.

The pro forma effect of these acquisitions on consolidated net earnings was not material.

On March 2, 2007, the Company purchased all of the shares of CMCZ owned by the Polish Ministry of State Treasury for approximately $59.5 million. The shares acquired represent approximately 26.8% of the total CMCZ shares outstanding. The Company intends to redeem the shares and with this purchase and subsequent redemption, CMC holds approximately 99% of the outstanding shares of CMCZ.

The Company has an accounts receivable securitization program which it utilizes as a cost-effective, short-term financing alternative. Under this program, the Company and several of its subsidiaries periodically sell certain eligible trade accounts receivable to the Company’s wholly-owned consolidated special purpose subsidiary (CMCRV). CMCRV is structured to be a bankruptcy-remote entity. CMCRV, in turn, sells undivided percentage ownership interests in the pool of receivables to affiliates of two third-party financial institutions. CMCRV may sell undivided interests of up to $200 million, depending on the Company’s level of financing needs.

At May 31, 2007 and August 31, 2006, accounts receivable of $377 million and $351 million, respectively, had been sold to CMCRV. The Company’s undivided interest in these receivables (representing the Company’s retained interest) was 100% at May 31, 2007 and August 31, 2006. The Company did not sell any undivided interests in the pool of receivables to the financial institution buyers during the three months ended May 31, 2007 and the average monthly amount of undivided interests owned by the financial institution buyers was $8.2 million and $1.1 million for the nine months ended May 31, 2007 and 2006, respectively.

In addition to the securitization program described above, the Company’s international subsidiaries periodically sell accounts receivable without recourse. Uncollected accounts receivable that had been sold under these arrangements and removed from the condensed consolidated balance sheets were $123.6 million and $61.9 million at May 31, 2007 and August 31, 2006, respectively. The average monthly amounts of outstanding international accounts receivable sold were $81.9 million and $60.6 million for the nine months ended May 31, 2007 and 2006, respectively.

Discounts (losses) on domestic and international sales of accounts receivable were $1.5 million and $0.8 million for the three months ended May 31, 2007 and 2006, respectively. For the nine months ended May 31, 2007 and 2006, these discounts were $3.8 million and $2.4 million, respectively. These losses primarily represented the costs of funds and were included in selling, general and administrative expenses.

Before deduction of last-in, first-out (LIFO) inventory valuation reserves of $249.3 million and $189.3 million at May 31, 2007 and August 31, 2006, respectively, inventories valued under the first-in, first-out method approximated replacement cost. The majority of the Company’s inventories are in finished goods, with minimal work in process. Approximately $95.9 million and $54.6 million were in raw materials at May 31, 2007 and August 31, 2006, respectively.

Borrowings outstanding under the Company’s commercial paper program were $146.9 million and none at May 31, 2007 and August 31, 2006, respectively. No borrowings were outstanding under the related revolving credit agreement at May 31, 2007 and August 31, 2006. The company was in compliance with all covenants at May 31, 2007.

The Company has numerous informal credit facilities available from domestic and international banks. These credit facilities are available to support documentary letters of credit (including those with extended terms), foreign exchange transactions and, in certain instances, short-term working capital loans and are priced at bankers’ acceptance rates or on a cost of funds basis. Amounts outstanding on these facilities relate to accounts payable settled under documentary letters of credit. The Company has $5.1 million outstanding under such facility at May 31, 2007.

Long-term debt was as follows:

In February 2007, CMCZ entered into a new revolving credit facility agreement. The credit agreement has maximum borrowings of 100 million PLN ($35.3 million) and interest rate of WIBOR plus 0.55%. The credit facility expires on July 31, 2007 and is not collateralized. The short-term credit facility contains certain financial covenants and CMCZ was in compliance with these covenants at May 31, 2007. Under this facility, 100 million PLN ($35.3 million) was outstanding at May 31, 2007.

In May 2007, CMCZ renewed its other revolving credit facility that expired on May 11, 2007. The renewed facility has maximum borrowings of 100 million PLN ($35.3 million) bearing interest at the Warsaw Interbank Offered Rate (WIBOR) plus 0.5%. This facility has an expiration date of May 9, 2008 and is not collateralized. At May 31, 2007, 22.2 million PLN ($7.8 million) was outstanding under this facility. The revolving credit facilities contain certain financial covenants. CMCZ was in compliance with these covenants at May 31, 2007. There are no guarantees by the Company or any of its subsidiaries for any of CMCZ’s debt.

CMC Poland, a wholly-owned subsidiary of the Company, owns and operates equipment at the CMCZ mill site. In connection with the equipment purchase, CMC Poland issued equipment notes under a term agreement dated September 2005 with 34.0 million PLN ($12.0 million) outstanding at May 31, 2007. Installment payments under these notes are due through 2010. Interest rates are variable based on the Poland Monetary Policy Council’s rediscount rate, plus any applicable margin. The weighted average rate as of May 31, 2007 was 4.25%. The notes are substantially secured by the shredder equipment.

Interest of $27.2 million and $22.4 million was paid in the nine months ended May 31, 2007 and 2006, respectively.

The Company paid $145.0 million and $149.4 million in income taxes during the nine months ended May 31, 2007 and 2006, respectively.

Reconciliations of the United States statutory rates to the Company’s effective tax rates were as follows:

In June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement 109,” which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FAS No. 109, “Accounting for Income Taxes.” FIN 48 requires that we recognize, in our financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. In May 2007, the FASB issued Staff Position FIN No. 48-1, “Definition of ‘Settlement’ in FASB Interpretation No. 48”. FSP FIN 48-1 provides guidance on how a company should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. The provisions of FIN 48 are effective for the Company’s fiscal year beginning September 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently assessing the impact, if any, that the adoption of FIN 48 will have on the Company’s financial statements.

In calculating earnings per share, there were no adjustments to net earnings to arrive at earnings for the three or nine months ended May 31, 2007 or 2006. The reconciliation of the denominators of the earnings per share calculations is as follows:

All of the Company’s outstanding stock options, restricted stock and Stock Appreciation Rights (SARs) with total share commitments of 6,130,725 and 8,943,368 at May 31, 2007 and 2006, were dilutive based on the average share price for the quarters then ended of $31.90 and $25.30, respectively. All stock options and SARs expire by 2013.

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

At May 31, 2007, the Company had authorization to purchase 2,642,260 of its common shares.

The Company’s worldwide operations and product lines expose it to risks from fluctuations in foreign currency exchange rates and metals commodity prices. The objective of the Company’s risk management program is to mitigate these risks using futures or forward contracts (derivative instruments). The Company enters into metal commodity forward contracts to mitigate the risk of unanticipated changes in gross margin due to the volatility of the commodities’ prices, and enters into foreign currency forward contracts, which match the expected settlements for purchases and sales denominated in foreign currencies. Also, when its 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. Forward contracts on natural gas may also be entered to reduce the price volatility of gas used in production. The Company designates only those contracts which closely match the terms of the underlying transaction as hedges for accounting purposes. These hedges resulted in an immaterial amount of ineffectiveness in the statements of earnings and there were no components excluded from the assessment of hedge effectiveness for the three or nine months ended May 31, 2007 and 2006. 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 table shows the impact on the condensed consolidated statements of earnings of the changes in fair value of these economic hedges:

The Company’s derivative instruments were recorded as follows on the condensed consolidated balance sheets:

The following table summarizes activities in other comprehensive income (losses) related to derivatives classified as cash flow hedges held by the Company during the nine months ended May 31, 2007 (in thousands):

During the twelve months following May 31, 2007, $2.7 million in losses related to commodity hedges and capital expenditures are anticipated to be reclassified into net earnings as the related transactions mature and the assets are placed into service, respectively. Also, an additional $112 thousand in gains will be reclassified as interest expense related to an interest rate lock.

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

See Note 11, Commitments and Contingencies, to the consolidated financial statements for the year ended August 31, 2006 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 provision has been made in the condensed consolidated financial statements for the potential impact of these issues, and that the outcomes will not significantly impact the results of operations or the financial position of the Company, although they may have a material impact on earnings for a particular quarter.

In February 2007, the Company entered into a guarantee agreement to assist one of the Company’s Chinese coke suppliers to obtain pre-production financing from a bank. In addition, we entered into another guarantee agreement for one of our suppliers of finished goods to obtain working capital financing from a financial institution. In the aggregate, the Company’s maximum exposure under the guarantees at May 31, 2007 is approximately $12.3 million. The fair value of the guarantees is negligible.

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.

The Company has five reportable segments: domestic mills, CMCZ, domestic fabrication, recycling and marketing and distribution.

The following is a summary of certain financial information by reportable segment:

The following table provides a reconciliation of consolidated adjusted operating profit to net earnings:

The following presents external net sales by major product and geographic area for the Company:

One of the Company’s international subsidiaries has an agreement for steel purchases with a key supplier of which the Company owns an 11% interest. The total amounts of purchases from this supplier were $273.1 million and $195.4 million for the nine months ended May 31, 2007 and 2006, respectively.

This Management’s Discussion and Analysis should be read in conjunction with our Form 10-K filed with the Securities and Exchange Commission (SEC) for the year ended August 31, 2006.

Our critical accounting policies are consistent with the information set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our Form 10-K filed with the SEC for the year ended August 31, 2006 and are, therefore, not presented herein.

In the table above, we have included a financial statement measure that was not derived in accordance with GAAP. We use EBITDA (earnings before interest expense, income taxes, depreciation and amortization) as a non-GAAP performance measure. In calculating EBITDA, we exclude our largest recurring non-cash charge, depreciation and amortization. EBITDA provides a core operational performance measurement that compares results without the need to adjust for federal, state and local taxes which have considerable variation between domestic jurisdictions. Tax regulations in international operations add additional complexity. Also, we exclude interest cost in our calculation of EBITDA. The results are, therefore, without consideration of financing alternatives of capital employed. We use EBITDA as one guideline to assess our unleveraged performance return on our investments. EBITDA is also the target benchmark for our long-term cash incentive performance plan for management. Reconciliations to net earnings are provided below:

Our EBITDA does not include interest expense, income taxes and depreciation and amortization. Because we have borrowed money in order to finance our operations, interest expense is a necessary element of our costs and our ability to generate revenues. Because we use capital assets, depreciation and amortization are also necessary elements of our costs. Also, the payment of income taxes is a necessary element of our operations. Therefore, any measures that exclude these elements have material limitations. To compensate for these limitations, we believe that it is appropriate to consider both net earnings determined under GAAP, as well as EBITDA, to evaluate our performance. Also, we separately analyze any significant fluctuations in interest expense, depreciation and amortization and income taxes.

Overview This is the strongest third quarter ever reported by the Company. We posted record net earnings and EBITDA of $99.4 million and $181.4 million, respectively, for the three months ended May 31, 2007, an increase of 27% and 19% over the same period last year. For the nine months ended May 31, 2007, net earnings increased by 10% to $250.7 million and EBITDA by 11% to $486.4 million as compared to the same period ended May 31, 2006. The Company reported net sales of $2.3 billion and $6.3 billion for the three and nine months ended May 31, 2007 an improvement of $0.3 billion and $1.0 billion, respectively over last year’s results. The record results were helped by a strong U.S. nonresidential construction market, favorable global economic conditions and relatively stable international steel prices. For the quarter just ended, four of our five operating segments set third quarter records with CMCZ, our Polish operation, and Marketing and Distribution setting all time quarterly records. Third quarter results were supported by the strong domestic and international nonresidential projects that kept demand strong for our products and sustained higher prices despite

a slight downward shift in volume shipments and margin squeeze. We expect this pricing trend to continue and to improve as the overall construction market appears to be resilient against the volatility of scrap prices, high construction material costs and softening of the housing construction market. In addition, the demand for our merchant bar and the margin squeeze experienced by our reinforcing bar segment should improve as service center destocking winds down and imports decline as a result of favorable U.S. market conditions and the stabilization of ferrous scrap prices. The following financial events were significant during the third quarter ended May 31, 2007:

See Note K — Business Segments, to the condensed consolidated financial statements.

We use adjusted operating profit (loss) to compare and evaluate the financial performance of our segments. Adjusted operating profit is the sum of our earnings before income taxes, minority interests and financing costs.

The following tables show our net sales and adjusted operating profit (loss) by business segment:

LIFO Impact on Adjusted Operating Profit — LIFO is an inventory costing method that assumes the most recent inventory purchases or goods manufactured are sold first. This results in current sales prices offset against current inventory costs. In periods of rising prices it has the effect of eliminating inflationary profits from net income. In periods of declining prices it has the effect of eliminating deflationary losses from net income. In either case the goal is to reflect economic profit. The table below reflects LIFO income or (expense) representing decreases or (increases) in the LIFO inventory reserve. CMCZ is not included in this table as it uses FIFO valuation exclusively for its inventory:

Domestic Mills We include our four domestic steel and our copper tube minimills in our domestic mills segment. Our domestic mills had an adjusted operating profit for the three months ended May 31, 2007 of $73.6 million, up by 6% and a pre-tax LIFO expense increase of 4% to $15.3 million as compared to last year’s third quarter. Net sales for the segment increased by 6% to $447 million as a result of higher average selling prices overcoming a slight decline in tons shipped.

Within the segment, adjusted operating profit for the three months ended May 31, 2007 for our steel minimills was 15% higher than the same period last year on 8% higher net sales or $382 million. Metal margins expanded over $10 a ton third quarter to third quarter though shipments dropped 4%. Rebar sales remained strong. Merchant bar tonnages were lower as buyers continued the pattern of overbuying in periods of anticipated or actual rising price increases and lowering their activity in periods of anticipated or actual price declines as occurred in this year’s third quarter. On a year-to-year basis, tonnage melted for the third quarter increased 7% to 596 thousand tons while tonnage rolled was 534 thousand tons, 7% lower than last year’s third quarter as planned outages at CMC Alabama reacted to the weaker merchant market. Shipments were 613 thousand tons or 4% lower than last year’s third quarter. Our average total selling price was up $60 per ton to $575 per ton, while the average selling price for finished goods was up by $71 per ton to $601 per ton. By product line, the price premium of merchant bar over reinforcing bar was $80 per ton, down $3 from last year. The average scrap purchase cost increased by $45 per ton a year ago to $239 per ton. Total utility costs decreased by $1.2 million compared with the third quarter last year with natural gas and electricity both declining. Year-over-year costs for ferroalloys, graphite electrodes and other supplies were up $2.9 million.

The table below reflects steel and ferrous scrap prices per ton:

The table below reflects our domestic steel minimills’ operating statistics (short tons in thousands):

Two of our domestic steel minimills were more profitable for the three and nine months ended May 31, 2007 as compared to 2006. On a year-to-year basis, our Alabama mill was more profitable with higher margins resulting in an increase in adjusted operating profit of 25% despite planned outages in reaction to a weak merchant market that contributed to a drop in tons melted and rolled of 3% and 20% from last year’s third quarter. Our Texas mill was also profitable at a 23% and 9% higher adjusted operating profit for the three and nine months ended May 31, 2007 as compared to 2006 as sales and shredder production set record highs for the quarter. Selling prices at all of our domestic steel mills were higher for the quarter just ended as compared to the same period last year.

The table below reflects our copper tube minimill’s prices per pound and operating statistics: