Commercial Metals Company - 10-Q quarterly report FY

 

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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

As of July 6, 2006, there were 119,834,106 shares of the Company’s common stock issued and outstanding excluding 9,226,558 shares held in the Company’s treasury.

See notes to unaudited condensed consolidated financial statements.

See notes to unaudited condensed consolidated financial statements.

See notes to unaudited condensed consolidated financial statements.

See notes to unaudited condensed consolidated financial statements.

See notes to unaudited condensed consolidated financial statements.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The basis is consistent with that used in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) for the year ended August 31, 2005 with the exception of the Company’s adoption of Financial Accounting Standards Board (FASB) Statement No.123(R), Share-Based Payment as described below. They include all normal recurring adjustments necessary to present fairly the condensed consolidated balance sheets and statements of earnings, cash flows and stockholders’ equity for the periods indicated. These Notes should be read in conjunction with such Form 10-K. The results of operations for the three and nine month periods are not necessarily indicative of the results to be expected for a full year.

See Note 9, Capital Stock, to the Company’s consolidated financial statements for the year ended August 31, 2005 filed on Form 10-K with the SEC for a description of the Company’s stock incentive plans.

In December 2004, the FASB issued 123(R), requiring that the compensation cost relating to share-based compensation transactions be recognized at fair value in financial statements. The Company adopted 123(R) effective September 1, 2005 using the modified prospective method. As a result, compensation expense was recorded for the unvested portion of previously issued awards that were outstanding at September 1, 2005. The Black-Scholes pricing model was used to calculate total compensation cost which is amortized on a straight-line basis over the remaining vesting period of previously issued awards. (See Note 1, Summary of Significant Accounting Policies, to the Company’s consolidated financial statements for the year ended August 31, 2005 for the assumptions used to estimate the fair value and the weighted average grant date fair value. The Company developed its volatility assumption based on historical data). The Company recognized pre-tax stock-based compensation expense of $2.6 million ($.01 per diluted share) and $7.0 million ($.04 per diluted share) as a component of selling, general and administrative expenses for the three and nine months ended May 31, 2006, respectively. The cumulative effect of adoption (primarily arising from the recognition of anticipated forfeitures) was not material. At May 31, 2006, the Company had $13.1 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements. This cost is expected to be recognized over the next 35 months.

Prior to the adoption of 123(R), the Company accounted for stock options and stock appreciation rights (SARs) granted to employees and directors using the intrinsic value-based method of accounting. If the Company had used the fair value-based method of accounting, net earnings and earnings per share for the three and nine months ended May 31, 2005 would have been adjusted to the pro forma amounts listed in the table below.

Combined information for shares subject to options and SARs for the nine months ended May 31, 2006 was as follows:

Share information for options and SARs at May 31, 2006:

Of the Company’s previously granted restricted stock awards, 16,000 shares vested during the nine months ended May 31, 2006.

The total gross carrying amounts of the Company’s intangible assets that were subject to amortization were $18.6 million and $15.7 million at May 31, 2006 and August 31, 2005, respectively. Aggregate amortization expense for the three months ended May 31, 2006 and 2005 was $807 thousand and $331 thousand, respectively. Aggregate amortization expense for the nine months ended May 31, 2006 and 2005 was $2.0 million and $1.4 million, respectively.

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, Inventory Costs, which specifies that certain abnormal costs must be recognized as current period charges. The Company adopted this Statement, which is effective for inventory costs incurred after September 1, 2005, and it did not materially affect the Company’s results of operations or financial position as of and for the three and nine months ended May 31, 2006.

In March 2005, the FASB issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations—an interpretation of FASB Statement No. 143 (FIN 47). FIN 47 clarifies that an asset retirement obligation for which the timing and (or) the method of settlement are conditional on a future event that may or may not be within the Company’s control must be recognized as a liability incurred or acquired if it can be reasonably estimated. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Company adopted FIN 47 effective September 1, 2005 and its adoption did not materially impact the Company’s financial position as of May 31, 2006 or its results of operations for the three or nine months then ended.

During the nine months ended May 31, 2006, the Company acquired 3 businesses:

The total purchase price of $18.0 million ($11.0 million in cash, $.4 million in notes payable, and $6.6 million in liabilities assumed) for these acquisitions was allocated to the acquired assets and assumed liabilities based upon estimates of their respective fair values. The following is a summary of the preliminary allocation of the total purchase price as of the date of the respective acquisitions presented in conformity with U.S. GAAP, subject to change following management’s final evaluation of the fair value:

The intangible assets acquired include customer base and non-compete agreements, which will be amortized over 5 years and a backlog, which will be amortized over 12 months.

On June 7, 2006, the Company purchased substantially all of the operating assets of Yonack Iron & Metal Co. and related companies, which operate scrap and metal processing facilities in Dallas and Forney, Texas; Stroud, Oklahoma and Lonoke, Arkansas and a plastic scrap recycling facility in Grand Prairie, Texas. The acquisition is expected to strengthen the Company’s metal recycling presence in the Southwestern United States. The purchase price of $31.3 million ($31.2 million in cash, $.06 million in liabilities assumed) will be allocated to the acquired assets and assumed liabilities based upon estimates of their respective fair values. The following is a summary of the preliminary allocation of the purchase price as of the date of the acquisition presented in conformity with U.S. GAAP, subject to change following management’s final evaluation of the fair value:

The pro forma impact of these acquisitions on consolidated net earnings would not have been materially different than reported net earnings.

The Company has an accounts receivable securitization program which it utilizes as a cost-effective, short-term financing alternative. Under this program, the Company and several of its subsidiaries periodically sell certain eligible trade accounts receivable to the Company’s wholly-owned consolidated special purpose subsidiary (CMCRV). CMCRV is structured to be a bankruptcy-remote entity. CMCRV, in turn, sells undivided percentage ownership interests in the pool of receivables to affiliates of two third-party financial institutions. CMCRV may sell undivided interests of up to $130 million, depending on the Company’s level of financing needs.

At May 31, 2006 and August 31, 2005, accounts receivable of $384 million and $275 million, respectively, had been sold to CMCRV. The Company’s undivided interest in these receivables (representing the Company’s retained interest) was 100% at May 31, 2006 and August 31, 2005. The Company did not sell any undivided interests in the pool of receivables to the financial institution buyers during the three months ended May 31, 2006. The average monthly amount of undivided interests owned by the financial institution buyers was $1.1 million and $34.9 million for the nine months ended May 31, 2006 and 2005, respectively.

In addition to the securitization program described above, the Company’s international subsidiaries periodically sell accounts receivable without recourse. Uncollected accounts receivable that had been sold under these arrangements and removed from the condensed consolidated balance sheets were $73.5 million and $63.2 million at May 31, 2006 and August 31, 2005, respectively. The average monthly amounts of outstanding international accounts receivable sold were $60.6 million and $63.8 million for the nine months ended May 31, 2006 and 2005, respectively.

Discounts (losses) on domestic and international sales of accounts receivable were $787 thousand and $1.2 million for the three months ended May 31, 2006 and 2005, respectively. For the nine months ended May 31, 2006 and 2005, these discounts were $2.4 million and $3.0 million, respectively. These losses primarily represented the costs of funds and were included in selling, general and administrative expenses.

Before deduction of last-in, first-out (LIFO) inventory valuation reserves of $173.1 million and $111.4 million at May 31, 2006 and August 31, 2005, respectively, inventories valued under the first-in, first-out method approximated replacement cost. The majority of the Company’s inventories are in finished goods, with minimal work in process. Approximately $61.4 million and $39.9 million were in raw materials at May 31, 2006 and August 31, 2005, respectively.

At May 31, 2006 and August 31, 2005, no borrowings were outstanding under the Company’s commercial paper program or the related revolving credit agreement. The Company was in compliance with all covenants at May 31, 2006.

The Company has numerous informal credit facilities available from domestic and international banks. These credit facilities are available to support documentary letters of credit (including those with extended terms), foreign exchange transactions and, in certain instances, short-term working capital loans and are priced at bankers’ acceptance rates or on a cost of funds basis. Amounts outstanding on these facilities relate to accounts payable settled under documentary letters of credit.

Long-term debt was as follows:

Interest on CMCZ’s term note is accrued at the Warsaw Interbank Offered Rate (WIBOR) plus 1.1% and was fixed at 5.22% for the three months ended May 31, 2006. The term note has scheduled semi-annual payments beginning in September 2005 and is collateralized by CMCZ’s property, plant and equipment. On May 12, 2006, CMCZ entered into a revolving credit facility agreement

with maximum borrowings of 100 million PLN ($32.7 million) and secured by CMCZ receivables. It has an expiration date of May 11, 2007 and interest is accrued at the WIBOR plus 0.55%. At May 31, 2006, 50.4 million PLN ($16.5 million) was outstanding under this facility. The term note and the revolving credit facility contain certain financial covenants for CMCZ. CMCZ was in compliance with these covenants at May 31, 2006. There are no guarantees by the Company of CMCZ’s debt.

CMC – Poland, a wholly-owned subsidiary of CMC, owns and operates equipment at the CMCZ mill site. In connection with the equipment purchase, CMC – Poland issued equipment notes under a term agreement dated September 2005 with 40.0 million PLN ($13.1 million) outstanding at May 31, 2006. Installment payments under these notes are due from 2006 through 2010. Interest rates are variable based on the Poland Monetary Policy Council’s rediscount rate, plus an applicable margin. The weighted average rate as of May 31, 2006 was 4.25%. The notes are substantially secured by the shredder equipment.

Interest of $22.4 million and $23.7 million was paid in the nine months ended May 31, 2006 and 2005, respectively.

The Company paid $149.4 million and $85.2 million in income taxes during the nine months ended May 31, 2006 and 2005, respectively.

Reconciliations of the United States statutory rates to the Company’s effective tax rates were as follows:

The American Jobs Creation Act of 2004 (AJCA) would allow the Company a one-time opportunity to repatriate undistributed foreign earnings by August 31, 2006 at a 5.25% tax rate (without consideration of possible foreign withholding taxes) rather than the normal U.S. tax rate of 35%, provided that certain criteria, including qualified U.S. reinvestment, are met. Available tax credits related to the repatriation would be reduced under provisions of the AJCA. The Company continues to evaluate whether it will repatriate foreign earnings under this provision of the AJCA. Up to $20 million is being considered for possible repatriation. The Company estimates that the U.S. tax liability incurred on the possible repatriation could range up to $1.8 million for which the Company has recorded $3 million of deferred taxes. On May 18, 2006 the State of Texas passed a bill to replace the current franchise tax with a new margin tax to be effective January 1, 2008. The Company estimates the new margin tax will not have a significant impact on tax expense or deferred tax assets and liabilities.

On April 24, 2006, the Company declared a two-for-one stock split in the form of a 100% stock dividend on the Company’s common stock payable May 22, 2006 to shareholders of record on May 8, 2006. The stock dividend resulted in the issuance of 64,530,332 additional shares of common stock and a transfer of $0.6 million from additional paid-in capital at the record date. All per share and weighted average share amounts in the accompanying condensed consolidated financial statements have been restated to reflect the stock split. The Company also instituted a quarterly cash dividend of six cents per share on the increased number of shares resulting from the stock dividend effective with the July, 2006 dividend payment.

On January 26, 2006 the shareholders of the Company voted to increase the authorized shares of common stock from 100,000,000 to 200,000,000 shares. The shareholders also voted to change the par value of the Company’s common stock from $5.00 to $.01 per share. As a result, $322 million was transferred from common stock to additional paid-in capital.

In calculating earnings per share, there were no adjustments to net earnings to arrive at earnings for the three or nine months ended May 31, 2006 or 2005. The reconciliation of the denominators of the earnings per share calculations is as follows:

All of the Company’s outstanding stock options, restricted stock and Stock Appreciation Rights (SARs) with total share commitments of 8,943,368 and 10,214,404 at May 31, 2006 and 2005, were dilutive based on the average share price for the quarters then ended of $25.30 and $15.05, respectively. All stock options and SARs expire by 2013.

The Company’s restricted stock is included in the number of shares of common stock issued and outstanding, but omitted from the basic earnings per share calculation until the shares vest as required by Financial Accounting Standards.

At May 31, 2006, the Company had authorization to purchase 1,811,000 of its common shares.

The Company’s worldwide operations and product lines expose it to risks from fluctuations in foreign currency exchange rates and metals commodity prices. The objective of the Company’s risk management program is to mitigate these risks using futures or forward contracts (derivative instruments). The Company enters into metal commodity forward contracts to mitigate the risk of unanticipated changes in gross margin due to the volatility of the commodities’ prices, and enters into foreign currency forward contracts, which match the expected settlements for purchases and sales denominated in foreign currencies. Also, when its sales commitments to customers include a fixed price freight component, the Company occasionally enters into freight forward contracts to minimize the effect of the volatility of ocean freight rates. The Company designates only those contracts which closely match the terms of the underlying transaction as hedges for accounting purposes. These hedges resulted in an immaterial amount of ineffectiveness recorded in the statements of earnings; and additionally, there were no components excluded from the assessment of hedge effectiveness for the three or nine months ended May 31, 2006 and 2005. Certain of the foreign currency and commodity contracts were not designated as hedges for accounting purposes, although management believes they are essential economic hedges.

The following chart shows the impact on the condensed consolidated statements of earnings of the changes in fair value of these economic hedges:

The Company’s derivative instruments were recorded as follows on the condensed consolidated balance sheets:

The following table summarizes activities in other comprehensive income (losses) related to derivatives classified as cash flow hedges held by the Company during the nine months ended May 31, 2006 (in thousands):

During the twelve months following May 31, 2006, $114 thousand in losses related to commodity hedges and capital expenditures are anticipated to be reclassified into net earnings as the related transactions mature and the assets are placed into service, respectively. Also, an additional $112 thousand in gains will be reclassified as interest expense related to an interest rate swap.

All of the instruments are highly liquid, and none are entered into for trading purposes.

See Note 11, Commitments and Contingencies, to the consolidated financial statements for the year ended August 31, 2005 relating to environmental and other matters. There have been no significant changes to the matters noted therein. In the ordinary course of conducting its business, the Company becomes involved in litigation, administrative proceedings and governmental investigations, including environmental matters. Management believes that adequate provision has been made in the condensed consolidated financial statements for the potential impact of these issues, and that the outcomes will not significantly impact the results of operations or the financial position of the Company, although they may have a material impact on earnings for a particular quarter.

The Company has refined its method of overhead allocation. Prior year period overhead costs of $3.6 million and $10.1 million for the three and nine months ended May 31, 2005, respectively, were reclassified from the domestic mills to the domestic fabrication segment to ensure comparability with current year amounts reported.

The following is a summary of certain financial information by reportable segment:

The following table provides a reconciliation of consolidated adjusted operating profit to net earnings:

The following presents external net sales by major product and geographic area for the Company:

Net sales for Europe and the United States for the nine months ended May 31, 2005 have been changed to properly reflect the net sales in those geographic areas.

One of the Company’s international subsidiaries has an agreement for steel purchases with a key supplier of which the Company owns an 11% interest. The total amounts of purchases from this supplier were $195.4 million and $188.8 million for the nine months ended May 31, 2006 and 2005, respectively.

This Management’s Discussion and Analysis should be read in conjunction with our Form 10-K filed with the Securities and Exchange Commission (SEC) for the year ended August 31, 2005.

Our critical accounting policies are consistent with the information set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our Form 10-K filed with the SEC for the year ended August 31, 2005 and are, therefore, not presented herein.

In the table above, we have included a financial statement measure that was not derived in accordance with GAAP. We use EBITDA (earnings before interest expense, income taxes, depreciation and amortization) as a non-GAAP performance measure. In calculating EBITDA, we exclude our largest recurring non-cash charge, depreciation and amortization. EBITDA provides a core operational performance measurement that compares results without the need to adjust for federal, state and local taxes which have considerable variation between domestic jurisdictions. Tax regulations in international operations add additional complexity. Also, we exclude interest cost in our calculation of EBITDA. The results are, therefore, without consideration of financing alternatives of capital employed. We use EBITDA as one guideline to assess our unleveraged performance return on our investments. EBITDA is also the target benchmark for our long-term cash incentive performance plan for management. Reconciliations to net earnings are provided below:

Our EBITDA does not include interest expense, income taxes and depreciation and amortization. Because we have borrowed money in order to finance our operations, interest expense is a necessary element of our costs and our ability to generate revenues. Because we use capital assets, depreciation and amortization are also necessary elements of our costs. Also, the payment of income taxes is a necessary element of our operations. Therefore, any measures that exclude these elements have material limitations. To compensate for these limitations, we believe that it is appropriate to consider both net earnings determined under GAAP, as well as EBITDA, to evaluate our performance. Also, we separately analyze any significant fluctuations in interest expense, depreciation and amortization and income taxes.

Overview Reported net earnings of $78.0 million or $0.62 per diluted share for the third quarter ended May 31, 2006, ranks it as the strongest third quarter ever reported for the Company. The following financial events were significant during our 2006 third quarter compared to last year’s third quarter:

See Note K — Business Segments, to the condensed consolidated financial statements.

We use adjusted operating profit (loss) to compare and evaluate the financial performance of our segments. Adjusted operating profit is the sum of our earnings before income taxes, minority interests and financing costs. The following tables show our net sales and adjusted operating profit (loss) by business segment:

LIFO Impact on Adjusted Operating Profit — LIFO is an inventory costing assumption that assumes the most recent inventory purchases or goods manufactured are sold first. This results in current sales prices offset against current inventory costs. In periods of rising prices it has the effect of eliminating inflationary profits from net income. In periods of declining prices it has the effect of eliminating deflationary losses from net income. In either case the goal is to reflect economic profit. The table below reflects LIFO income or (expense) representing decreases or (increases) in the LIFO inventory reserve. CMCZ is not included in this table as it uses FIFO valuation exclusively for its inventory:

Domestic Mills We include our four domestic steel and our copper tube minimills in our domestic mills segment. Adjusted operating profit was higher due to higher selling prices, higher tons shipped and relatively stable scrap prices. Increases in steel metal margins (our average selling price less our average cost of scrap used in production) of 8% and 9% for the three and nine months ended May 31, 2006, respectively, more than offset an increase of 19% in energy costs.

Selling prices for our domestic steel minimills increased for the three and nine months ended May 31, 2006 as compared to 2005 due to strong domestic demand for steel including public works and commercial construction. Our average total mill selling price for the third quarter was $39 per ton above last year’s level. By product line, the price premium of merchant bar over reinforcing bar remained unchanged at $81 per ton.

The table below reflects steel and ferrous scrap prices per ton:

Our mills’ shipments increased for the three and nine months ended May 31, 2006 as compared to 2005 due to increased orders from distributor and end-user customers with strong demand and lower inventories. The table below reflects our domestic steel minimills’ operating statistics (short tons in thousands):

Three of our domestic steel minimills were more profitable for the three and nine months ended May 31, 2006 as compared to 2005; CMC Steel Arkansas recorded a loss before tax and a 39% reduction of profit before tax, respectively, primarily due to LIFO expense and higher material cost. Selling prices at all domestic steel mills were higher for the same periods in 2006. Tons shipped were higher for all domestic steel minimills for the three and nine months ended May 31, 2006 as compared to 2005, except for CMC Steel Texas where tons shipped were down slightly due to the successful start up of the new continuous caster during the third quarter of 2006. The commissioning of the caster will continue over the next several months. During the three and nine months ended May 31, 2005, the domestic steel mills reported gains of $4.5 million and $8.5 million from business interruption insurance recovery.

Overall our domestic steel mills had pretax LIFO expense of $10.9 million during the three months and $18.1 million for the nine months ended May 31, 2006 as compared to $6.3 million LIFO income and $19.7 million LIFO expense for the three and nine months ended May 31, 2005, respectively. Our total utility costs increased by $3.6 million (19%) and $20.0 million (38%) for the three and nine months ended May 31, 2006, respectively, as compared to 2005. Year-over-year costs for ferroalloys and graphite electrodes were mixed, while transportation rates rose significantly.

     The table below reflects our copper tube minimill’s prices per pound and operating statistics:

Our copper tube minimill’s adjusted operating profit was $8.4 million and $18.7 million for the three and nine months ended May 31, 2006, respectively, as compared to $1.7 million and $4.9 million, respectively, in 2005. Better market conditions in the industry, particularly stronger commercial demand, resulted in an increased average selling price for the third quarter of $3.32 per pound and metal spreads widened to $1.21 per pound, up from 56 cents, more than offsetting the pronounced rise in the cost of scrap. Pounds shipped were up 13% and 4% for the three and nine months ended May 31, 2006, respectively, as compared to 2005; however, sales revenue increased 94% and 60% for the same periods in 2006 as compared to 2005 caused mainly by selling price increases. Our copper tube mill recorded $3.9 million and $7.1 million LIFO expense for the three and nine months ended May 31, 2006 as compared to $1.7 million LIFO income and $0.4 million LIFO expense in 2005, respectively.

CMCZ Operating levels and shipments were up significantly from those of third quarter and year-to-date of fiscal 2005, including higher exports, while prices and margins improved markedly. The end result is that CMCZ went from an adjusted operating loss in the third quarter of 2005, a period of inventory overhang, to an operating profit in 2006. CMCZ reported an adjusted operating profit of $13.9 million and an adjusted operating profit of $14.8 million for the three and nine months ended May 31, 2006 as compared to adjusted operating losses of $9.8 million and $2.0 million in 2005, respectively. The change in foreign currency exchange rates had nominal impact on the reported sales for the aforementioned periods in 2006. During May, 2006 we began the operation of the new mega-shredder; commissioning will continue throughout the fourth quarter with expected benefits of higher melt yields and lower furnace operating costs beginning in fiscal 2007. The following table reflects CMCZ’s operating statistics and average prices per short ton: