Commercial Metals Company — Q2 FY2016 Form 10-Q
Reporting period: Three and six months ended February 29, 2016. Unless noted, amounts are U.S. dollars; financial figures are in millions. Prior-year inventory-costing results were retrospectively adjusted where applicable.
Financial performance
- Revenue: Q2 net sales were $1,019.7 million, down 27% from $1,391.1 million. First-half sales were $2,174.6 million, down 29% from $3,071.1 million. Management attributed the declines to lower selling prices, weaker volumes in several businesses, global steel overcapacity, U.S. imports, a strong dollar and weak energy markets.
- Profit and margins: Q2 continuing-operations earnings were $10.8 million versus $13.5 million; diluted continuing-operations EPS was $0.09 versus $0.11. First-half continuing-operations earnings were $36.5 million versus $47.7 million; diluted EPS was $0.31 versus $0.40. Gross profit was $134.8 million in Q2 and $292.4 million for the first half, about 13.2% and 13.4% of sales, respectively, compared with about 10.6% in each prior-year period. GAAP net earnings were $10.5 million in Q2 and $35.6 million for the first half. Q2 adjusted EPS, a non-GAAP measure excluding debt-extinguishment costs after tax, was $0.15 versus $0.05.
- Operating measures: Adjusted operating profit, a non-GAAP measure, was $30.0 million in Q2 versus $37.9 million and $86.0 million for the first half versus $104.9 million. Adjusted EBITDA was $61.1 million and $148.8 million, respectively, compared with $70.8 million and $170.9 million.
- Cash flow: First-half operating cash flow was $332.8 million, versus cash used of $139.3 million in the prior-year period, helped by working-capital changes, including inventory reductions. Investing activities used $108.5 million, including $62.4 million of capital expenditures and $49.1 million added to restricted cash for the Durant, Oklahoma micro-mill. Financing activities used $326.8 million, largely reflecting debt repayments and tender-offer costs.
- Liquidity and debt: At February 29, cash was $381.7 million, total debt was approximately $1,082.7 million, and net debt was approximately $701.0 million. Long-term debt was $1,071.8 million. The $350 million revolving facility was undrawn; reported availability was $326.5 million. The company reported interest-coverage and debt-to-capitalization ratios of 4.53x and 0.44x, respectively, and compliance with debt covenants.
- Other metrics: Total assets were $3,043.5 million versus $3,445.6 million at August 31, 2015. The quarterly dividend was $0.12 per share. The company repurchased 1.94 million shares during Q2 and had $27.6 million of authorization remaining.
Material changes and segment trends
- Americas Recycling sales fell 43% in Q2; lower scrap prices and shipments pressured revenue, though lower input costs improved quarterly metal margins.
- Americas Mills sales fell 22% and adjusted operating profit declined, as lower selling prices outweighed lower scrap costs. Americas Fabrication adjusted operating profit improved to $14.8 million from a $5.8 million loss, supported by higher rebar shipments and improved metal margins.
- International Marketing and Distribution sales fell 40%; it recorded a $2.3 million adjusted operating loss versus $7.4 million profit, amid weaker volumes and margins and higher inventory write-downs. International Mill sales fell 22%, while adjusted operating profit rose to $2.0 million.
- Debt declined after February tender offers repurchased approximately $100 million of 2017 Notes and $100.2 million of 2018 Notes. The company recorded an $11.4 million loss on debt extinguishment.
- The company changed inventory methods effective September 1, 2015. The retrospective LIFO-method change reduced prior-year continuing-operations earnings by $48.3 million in Q2 and $52.3 million for the first half; investors should use the restated comparatives.
Outlook, risks and unusual items
- Management expected finished-steel demand to improve in fiscal Q3 as the construction season ramped up, citing strong backlogs and improving U.S. non-residential construction indicators. It also expected ongoing challenges from Chinese steel overcapacity, imports into the U.S. and Poland, and the strong U.S. dollar.
- Fiscal 2016 capital expenditures were expected to be $200–$210 million. Management said operating cash flow should cover interest and principal payments due over the next 12 months and believed it could refinance debt at maturity.
- Management identified a potential impairment risk in certain Americas Recycling long-lived assets following margin and volume pressure. Its review found no impairment for the quarter, but further deterioration in market conditions could result in impairment.
- Inventory write-downs were $7.9 million for the first half, compared with $4.1 million a year earlier. The company also exited its Australian steel distribution business, reported as discontinued operations; that business had $9.95 million of Q2 sales and a $0.35 million after-tax loss.
- Environmental liabilities totaled $3.8 million; the company said pending litigation and environmental matters were not expected to have a material adverse effect, while noting actual outcomes could differ from estimates. A tax-credit financing arrangement for the Durant micro-mill carries potential tax-credit recapture and indemnification obligations if requirements are not met; management did not anticipate recapture.
- Key risks include cyclical steel demand, metal-price swings, excess industry capacity and imports, customer credit, foreign exchange, energy and raw-material costs, debt covenants, and environmental and legal matters. No material risk-factor changes were reported.
Important facts for investors to verify
- Whether steel prices, shipment volumes and segment margins stabilize, particularly in Americas Mills, Recycling and International Marketing and Distribution.
- Whether working-capital cash generation is sustainable and how much liquidity depends on receivables-sale programs, which include cross-default provisions.
- Debt maturities, refinancing access and covenant headroom, including liquidity requirements tied to the 2017 and 2018 Notes.
- Whether further market deterioration triggers impairment or additional inventory write-downs, and whether the Durant micro-mill remains on budget and schedule.
- The impact of the inventory-accounting change when comparing periods, and progress against the stated capital-expenditure outlook.