CMC

Business Context and Reporting Period

Company: Commercial Metals Company (CMC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: May 31, 2009 (Third Quarter of Fiscal Year 2009)
Business Overview: CMC operates in five segments: Americas Recycling, Americas Mills, Americas Fabrication and Distribution, International Mills, and International Fabrication and Distribution. The company processes scrap metal, operates steel and copper minimills, and distributes metal products globally.

Key Financial Metrics

Note: EBITDA is a non-GAAP measure. Working Capital calculated as Current Assets ($2,078,997) minus Current Liabilities ($838,860).

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 54% in the quarter and 27% for the nine-month period compared to the prior year, driven by a global economic downturn, reduced demand, and lower metal prices.
• Profitability Shift: The company reported a net loss of $13.1 million for the quarter, compared to net earnings of $59.5 million in the same period last year. For the nine months, net earnings were $13.6 million, down 92% from $168.4 million.
• LIFO Impact: A significant factor in the results was the Last-In, First-Out (LIFO) inventory method. The company recorded $45.3 million in pre-tax LIFO income for the quarter (due to falling prices), compared to $127.2 million in LIFO expense in the prior year quarter.
• Inventory Reduction: Inventories decreased by approximately $654 million from the prior year-end ($1.4 billion to $746 million) as the company reduced stock levels to match lower demand.
• Segment Performance:
  • Americas Recycling: Sales down 76%; operating loss of $6.7 million vs. profit of $50.4 million prior year.
  • Americas Mills: Sales down 47%; operating profit increased 24% to $42.1 million, aided by LIFO income.
  • International Mills: Sales down 57%; operating loss of $17.7 million vs. profit of $30.7 million prior year.

Guidance, Outlook, and Risks

Outlook: Management expects market conditions in the U.S. to remain difficult for the fourth quarter and the remainder of calendar 2009. They anticipate prices will stabilize near current levels, negating the need for further significant inventory valuation adjustments. Domestic mills are expected to operate around 65% capacity in the fourth quarter. Overall, fourth-quarter results are anticipated to be similar to the third quarter.

Liquidity: The company maintains a strong balance sheet with $441 million in cash and cash equivalents. It has access to committed credit facilities, including a $400 million commercial paper program and various international receivables facilities.

Risks and Contingencies:

• Customer Non-Compliance: Significant risk of customers breaching contracts due to the recession, leading to renegotiations, cancellations, and litigation.
• Market Volatility: Exposure to fluctuations in metal commodity prices, foreign currency exchange rates, and natural gas prices.
• Discontinued Operations: A division involved in nonferrous metals (copper, aluminum, stainless steel) is classified as discontinued and is being liquidated or absorbed, incurring closure costs.
• Inventory Valuation: Continued risk of lower-of-cost-or-market adjustments if prices decline further, though management expects stabilization.

Investor Verification Checklist

• LIFO Reserve Impact: Verify the sustainability of the $45.3 million LIFO income benefit; this is a non-cash accounting gain resulting from falling prices, not operational efficiency.
• Customer Contract Defaults: Assess the magnitude of "contractual noncompliance" charges ($8.9 million in Q3) and potential future litigation recoveries.
• Inventory Levels: Confirm that inventory reductions are sufficient to prevent future write-downs as the company moves to a lower price environment.
• Debt Covenants: Review compliance with debt covenants, particularly for international subsidiaries (CMCZ and CMCP), given the volatility in foreign exchange rates.
• Capital Expenditures: Monitor the $395 million planned capital spending for 2009, specifically the $113 million for the Arizona micro mill and international upgrades, to ensure cash flow can support these outlays.