COMMERCIAL METALS Co annual report, FY2011

Commercial Metals Company — FY2011 Form 10-K

Reporting period: Fiscal year ended August 31, 2011. The filing also reports fourth-quarter results for the three months ended August 31, 2011; this is an annual report, not a standalone quarterly filing. CMC recast prior-period segment information after moving certain domestic scrap-processing facilities into Americas Mills.

Business context and results

CMC recycles, manufactures, fabricates, markets and distributes steel and other metals through five segments: Americas Recycling, Americas Mills, Americas Fabrication, International Mills and International Marketing and Distribution. Its markets include construction, manufacturing, energy and metals trading, making results sensitive to economic conditions, metal prices and demand.

Metric	FY2011	FY2010
Net sales	$7.918 billion	$6.306 billion
Gross profit	$616.6 million	$395.0 million
Gross margin	7.8%	6.3%
Net loss attributable to CMC	$129.6 million	$205.3 million
Diluted loss per share	$1.13	$1.81
Adjusted EBITDA	$237.3 million	$14.9 million
Cash from operating activities	$27.7 million	$44.9 million

Gross margin is calculated from reported sales and cost of goods sold. Adjusted EBITDA is a non-GAAP measure; CMC reported $238.9 million from continuing operations and $(1.6) million from discontinued operations. Continuing-operations net loss was $129.4 million. Interest expense was $70.8 million, down from $75.5 million.

Financial position, liquidity and debt

• At year end, cash was $222.4 million, total assets $3.683 billion, and CMC-attributable equity $1.160 billion. Cash declined from $399.3 million in FY2010.
• Long-term debt was $1.167 billion, with total debt including current maturities of $1.226 billion. The $400 million revolving credit facility was undrawn and available; there was no commercial paper outstanding. Management reported covenant ratios of 3.35x interest coverage (2.50x minimum) and 0.54x debt to capitalization (0.60x maximum).
• Current assets were $2.326 billion and current liabilities $1.199 billion, a current ratio of approximately 1.94x. The filing lists $1.021 billion of contractual cash obligations due within one year, including ordinary-course purchase obligations.
• Capital expenditures were $73.2 million; investing activities used $61.5 million and financing activities used $147.0 million. CMC paid $55.2 million in dividends, or $0.48 per share. Management forecast FY2012 capital spending of approximately $139 million.
• CMC sold receivables through domestic and international programs. The domestic program had $50 million advanced at year end against $557 million of receivables sold; the remainder was deferred purchase price. An Australian subsidiary was not in compliance with receivables-facility covenants, but CMC’s guarantee resulted in a waiver at year end.

Material changes and unusual items

• Sales rose approximately 26% year over year. Higher volumes and prices improved recycling and domestic mills: Americas Recycling adjusted operating profit was $43.1 million, up from $11.4 million; Americas Mills was $161.7 million, up from $37.3 million.
• Americas Fabrication remained loss-making, with adjusted operating loss widening to $129.1 million from $107.8 million amid weak construction demand. International Mills’ adjusted operating loss widened to $100.1 million from $73.5 million, chiefly due to Croatia’s CMCS operation.
• CMC recorded $118.8 million of impairment charges. Fourth-quarter actions to close or exit facilities also involved severance, inventory write-downs, lease termination and other closure costs. CMC cited approximately $110.6 million of restructuring and impairment charges at CMCS and announced its exit from the Croatian steel-pipe business after year end; it expected $25 million to $40 million of additional closure and severance costs in FY2012.
• CMC decided to close four domestic and one international rebar fabrication locations and eight construction-services locations; it also planned to close or sell its German fabrication operation. It acquired Australian distributor G.A.M. Steel for $48.4 million.
• Pre-tax LIFO expense was $77.0 million, versus LIFO income of $11.4 million in FY2010; management said LIFO increased the FY2011 net loss by approximately $50 million versus an approximately $5 million increase in FY2010.
• Fourth-quarter sales were $2.268 billion, gross profit $171.0 million and net loss attributable to CMC $120.3 million. The quarter included substantial impairment and closure charges.

Outlook, risks and contingencies

Management expected the U.S. non-residential construction recovery to extend beyond FY2012 and described the global macroeconomic environment as likely to remain stagnant. It anticipated continued strength in recycling and domestic mills, ongoing challenges in fabrication, and support for the Polish mill from economic growth and product mix. CMC expected the Croatian exit to begin benefiting operations in the second half of FY2012 and said it would continue cost reduction and cash-flow improvement efforts. These are management expectations, not guarantees.

• Key exposures include economic and construction cycles, customer credit and contract defaults, volatility in scrap and finished-metal prices, imports and excess steel capacity, and energy costs.
• International operations add currency, political, trade and regional economic risks. The filing also identifies potential effects of environmental and climate regulation, equipment failures, and access to financing.
• CMC disclosed a steel-industry antitrust class action and environmental matters, including potentially responsible-party claims at multiple sites. It accrued $1.0 million for CERCLA-site cleanup and reported total environmental liabilities of $16.3 million. Management said provisions were adequate and did not expect the matters to materially affect the company overall, while acknowledging estimation uncertainty.
• The company disclosed an activist shareholder’s notice nominating three directors and proposing other matters for the 2012 annual meeting. A shareholder rights plan adopted in July 2011 generally becomes exercisable at a 10% ownership trigger and expires August 1, 2014.
• Management reported effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

• Whether cash generation, margins and segment performance improve as expected, especially in Americas Fabrication and International Mills.
• The remaining cash costs, timing and operational impact of CMCS’s wind-down and other facility closures; compare realized costs with the $25 million to $40 million FY2012 estimate.
• Liquidity and covenant headroom, including the revolving facility’s November 2012 maturity, receivables-sale dependence, and resolution of the Australian subsidiary’s covenant issue.
• Customer receivable quality and concentration: year-end receivables were $956.9 million, and the filing reported $16.7 million of receivables charged off during FY2011.
• Potential developments in antitrust and environmental proceedings, and whether accrued amounts remain adequate as facts and remediation costs evolve.
• Progress on the FY2012 capital budget and restructuring plans, and the impact of metal prices, LIFO accounting and the weak construction outlook on reported results.