CMC

Business Context and Reporting Period

Company: Commercial Metals Company (CMC)
Filing Type: Form 10-K (Annual Report)
Period Ended: August 31, 2009
Business Overview: CMC recycles, manufactures, fabricates, and distributes steel and metal products through a network of over 220 locations in the U.S. and internationally. Operations are organized into five segments: Americas Recycling, Americas Mills, Americas Fabrication and Distribution, International Mills, and International Fabrication and Distribution.

Key Financial Metrics

Note: Net earnings for 2009 included a significant LIFO income benefit of $208.4 million ($1.83 per share) due to declining inventory costs.

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 35% to $6.79 billion, driven by a significant reduction in both metal prices and shipment volumes across all segments.
• Profitability Impact: Net earnings dropped 91% to $20.8 million. Without the LIFO benefit, the company would have reported a significant loss.
• Segment Performance:
  • Americas Recycling: Recorded an adjusted operating loss of $89.6 million (vs. $145.8 million profit in 2008) due to weak demand and price declines.
  • Americas Mills: Adjusted operating profit increased 27% to $263.4 million, primarily due to LIFO income offsetting lower sales volumes.
  • International Mills: Reported an adjusted operating loss of $77.4 million (vs. $96.8 million profit in 2008) due to margin compression and inventory adjustments.
• Inventory Adjustments: The company recorded $127.1 million in lower-of-cost-or-market inventory adjustments and $19.3 million in charges related to contractual non-compliance.
• Workforce Reduction: Implemented global reductions in force of approximately 2,600 employees, with 2,100 in the U.S.

Guidance, Outlook, and Risks

Outlook: Management expects fiscal 2010 to be a year of two contrasting halves. The first half is expected to suffer from lingering economic downturn effects, while the second half should benefit from an improving economy and the traditional spring construction season. Domestic markets appear to be stabilizing at modest levels, while Asian markets (particularly China) remain encouraging.

Capital Expenditures: Total capital spending for 2010 is expected to be approximately $150 million, down from $370 million in 2009.

Key Risks and Contingencies:

• Credit Availability: Uncertainty regarding the solvency of financial institutions and access to credit facilities remains a primary risk.
• Customer Defaults: Increased risk of bad debts and contract renegotiations due to the recession. Bad debt expense was $33.7 million in 2009.
• Environmental Liability: The company is a named Potentially Responsible Party (PRP) at ten federal Superfund sites. While $2.2 million is accrued for eight sites, the ultimate cost for two sites cannot be reasonably estimated.
• Antitrust Litigation: Subject to class action lawsuits alleging price-fixing in the steel industry; management believes these are without merit.
• Debt Covenants: The Polish subsidiary (CMCZ) was not in compliance with financial covenants as of August 31, 2009, triggering a guarantee by the parent company.

Investor Verification Checklist

• LIFO Impact: Verify the sustainability of the $208.4 million LIFO income benefit, which significantly masked operating losses in 2009.
• Inventory Valuation: Assess the adequacy of the $127.1 million inventory write-down and the risk of further write-downs if metal prices continue to fluctuate.
• Debt Covenants: Monitor the status of the CMCZ (Poland) subsidiary's compliance with financial covenants and the duration of the parent company guarantee.
• Environmental Exposure: Review the potential liability exposure for the two Superfund sites where costs are currently unestimable.
• Customer Credit Quality: Evaluate the $773 million accounts receivable balance and the $42 million allowance for doubtful accounts in the context of ongoing economic weakness.