CMC

Business Context and Reporting Period

Company: Commercial Metals Company (CMC)
Filing Type: Form 10-K (Annual Report)
Period Ended: August 31, 2008
Business Overview: CMC recycles, manufactures, fabricates, and distributes steel and metal products through a network of over 200 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 were significantly impacted by a $209.1 million LIFO expense in 2008 compared to $33.3 million in 2007.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 25% to a record $10.4 billion, driven by higher metal prices and favorable foreign exchange rates.
• Profitability Decline: Net earnings decreased 35% primarily due to a massive increase in LIFO expense ($209.1M vs $33.3M) and margin compression in the Americas Fabrication segment.
• Segment Performance:
  • Americas Recycling: Record sales and adjusted operating profit ($145.8M) driven by a 56% increase in ferrous scrap prices.
  • Americas Mills: Sales up 28%, but adjusted operating profit down 20% due to LIFO charges and rising energy/alloy costs.
  • Americas Fabrication: Reported an adjusted operating loss of $67.5M (vs $100M profit in 2007) due to fixed-price contracts and LIFO charges.
  • International Fabrication: Set an all-time record for adjusted operating profit ($124.3M), up 69%.
• Debt Increase: Long-term debt increased by approximately $491 million following the issuance of $500 million in senior unsecured notes in August 2008.
• Cash Flow Reversal: Operating cash flow swung from a $461 million inflow in 2007 to a $43.5 million outflow in 2008, largely due to increased working capital requirements (higher inventory and receivables costs).

Guidance, Outlook, and Risks

Outlook: Management expects Fiscal 2009 to be challenging due to global financial market turmoil, credit constraints, and declining metal prices. The company anticipates lower volumes as customers withhold orders. However, fabrication operations may benefit from lower finished goods prices, and long-term demand remains strong due to global urbanization.

Key Risks & Contingencies:

• Antitrust Litigation: In September 2008, CMC was named in a class-action antitrust lawsuit alleging price-fixing in the steel industry. Management believes the claims are without merit.
• Environmental Liability: CMC is a Potentially Responsible Party (PRP) at 13 Superfund sites. While $14.7 million is accrued for environmental liabilities, ultimate costs are uncertain.
• ERP Implementation: The company is in the midst of a global SAP implementation ($172 million spent to date). Risks include cost overruns, delays, or potential impairment of capitalized costs if the project fails.
• Commodity Volatility: Rapid fluctuations in scrap metal, energy, and currency prices continue to impact margins and working capital.

Investor Verification Checklist

• LIFO Impact: Verify the sustainability of earnings by analyzing results excluding the $209 million LIFO charge, which significantly distorted 2008 profitability.
• Working Capital Trends: Monitor the $409 million increase in cash used for working capital; assess if inventory levels are appropriate given the anticipated market downturn.
• Debt Covenants: Confirm continued compliance with debt covenants (maximum debt-to-capitalization and interest coverage ratios) given the increased debt load and potential earnings volatility.
• Antitrust Exposure: Track the progress of the September 2008 antitrust lawsuit and potential settlement costs or legal fees.
• SAP Project Status: Review updates on the ERP implementation to ensure no further capitalization of costs or impairment charges are required.