CMC

Business Context and Reporting Period

Company: Commercial Metals Company (CMC)
Filing Type: Form 10-K (Annual Report)
Period Ended: August 31, 2002
Business Overview: CMC manufactures, recycles, markets, and distributes steel and metal products through over 130 locations in the U.S. and internationally. Operations are organized into three segments: Manufacturing (steel minimills, fabrication, copper tubing), Recycling (secondary metals processing), and Marketing & Distribution (global trading of metals and industrial products).

Key Financial Metrics

Note: 2001 and 2000 figures have been restated due to the discovery of accounting fraud and errors (see Material Changes).

Material Changes vs. Prior Period

• Restatement of Prior Periods: In August 2002, the company discovered a theft and accounting fraud at a South Carolina rebar fabrication facility ($2.7 million pre-tax) and accounting errors at a California facility ($1.9 million pre-tax). These adjustments reduced prior period earnings and assets.
• Net Earnings Growth: Net earnings increased 70% to $40.5 million in 2002 compared to $23.8 million in 2001. This improvement was driven by the non-recurrence of an $8.3 million litigation accrual in 2001, a $5.2 million gain on the sale of SMI-Owen assets, and improved minimill profitability.
• Segment Performance:
  • Manufacturing: Operating profit rose 26% to $71.4 million. Steel minimill shipments increased 14% to 2.17 million tons, offsetting lower selling prices and higher scrap costs.
  • Recycling: Returned to profitability with $5.1 million operating profit, up from a $2.3 million loss in 2001, due to improved ferrous scrap markets.
  • Marketing & Distribution: Operating profit surged 82% to $14.2 million, largely due to the acquisition of Coil Steels Group in Australia.
• Liquidity: The company repaid all short-term borrowings during 2002. Temporary investments increased to $91.1 million from $23.0 million in 2001.

Guidance, Outlook, and Risks

Management Outlook:

• Fiscal 2003 Forecast: Management expects fiscal 2003 to be weaker than 2002 due to a slowing global economy and soft demand in construction markets. Diluted earnings per share are expected to decrease due to a rise in average shares outstanding.
• Capital Expenditures: Planned capital spending for 2003 is $88 million, focused on downstream rebar fabrication and concrete-related products, as well as an acquisition in Australia.
• Dividends: The company increased its quarterly cash dividend to $0.08 per share (post-split) in the fourth quarter of 2002, marking the 151st consecutive quarterly dividend.

Risks and Contingencies:

• Legal Proceedings: Significant disputes remain regarding the Aladdin Gaming project, including a $27 million claim against the general contractor and a $144 million counter-claim filed against CMC. A $15 million insurance settlement was received in 2002, but final resolution is pending.
• Environmental Liability: CMC is named a Potentially Responsible Party (PRP) at 14 Superfund sites. While management believes outcomes will not materially affect financial position, costs could impact quarterly earnings. Environmental expenses totaled $12.1 million in 2002.
• Market Volatility: The company faces risks from fluctuating metal commodity prices, energy costs, and import tariffs. While U.S. steel tariffs (15-30%) were implemented in 2002, management noted they have not yet resulted in significant price increases due to constant competitor production.

Investor Verification Checklist

• Restatement Impact: Verify the full extent of the $4.6 million pre-tax adjustment related to fraud and errors in the South Carolina and California facilities and its effect on historical comparability.
• Legal Exposure: Monitor the status of the $144 million arbitration claim filed by Aladdin Gaming and the general contractor against CMC.
• Environmental Accruals: Review the $5.0 million accrued for environmental liabilities and the potential for future costs at the 14 identified Superfund sites.
• Debt Covenants: Confirm continued compliance with the interest coverage ratio (>3x) and debt-to-capitalization ratio (<55%) covenants, especially given the forecasted weaker earnings for 2003.
• Minimill Margins: Assess the sustainability of minimill profitability given the combination of lower selling prices, higher scrap costs, and the temporary nature of import tariffs.