Commercial Metals Company (CMC) purchases and processes scrap metals for use as raw materials by manufacturers of new metal products. CMC produces finished long steel products, including rebar and merchant bar, as well as semi-finished billets and wire rod.
1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED AUGUST 31, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO _________ COMMISSION FILE NO. 1-4304 COMMERCIAL METALS COMPANY (Exact name of registrant as specified in its Charter) DELAWARE 75-0725338 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 7800 STEMMONS FREEWAY, DALLAS, TEXAS 75247 (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) (214) 689-4300 Securities registered pursuant to Section 12(b) of the Act: NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- --------------------- Common Stock, $5 par value New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: NONE 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. YES [X] NO [ ] INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. [ X ] THE AGGREGATE MARKET VALUE OF THE COMMON STOCK ON NOVEMBER 19, 1998, HELD BY NON-AFFILIATES OF THE REGISTRANT BASED ON THE CLOSING PRICE OF $25.625 PER SHARE ON NOVEMBER 19, 1998, ON THE NEW YORK STOCK EXCHANGE WAS APPROXIMATELY $373,000,000. INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE REGISTRANT'S CLASSES OF COMMON STOCK, AS OF NOVEMBER 19, 1998: COMMON STOCK, $5.00 PAR -- 14,584,816. DOCUMENTS INCORPORATED BY REFERENCE PORTIONS OF THE FOLLOWING DOCUMENT ARE INCORPORATED BY REFERENCE INTO THE LISTED PART OF FORM 10-K: REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE ANNUAL MEETING OF SHAREHOLDERS TO BE HELD JANUARY 28, 1999 -- PART III. ================================================================================
2 PART I ITEM 1. BUSINESS Commercial Metals Company was incorporated in 1946 in Delaware as a successor to a secondary metals recycling business in existence since approximately 1915. The Company maintains executive offices at 7800 Stemmons Freeway, Dallas, Texas 75247 (telephone 214/689-4300). The terms "Company" or "registrant" as used herein include Commercial Metals Company and its consolidated subsidiaries. The Company's fiscal year ends August 31 and all references to years refer to the fiscal year ended August 31 of that year unless otherwise noted. The Company considers its businesses to be organized into three segments - (i) Manufacturing, (ii) Recycling and (iii) Marketing and Trading. The Company's activities are primarily concerned with metals related activities. Financial information for the last three fiscal years concerning the segments is incorporated herein by reference from "Note 12 Business Segments," of the Notes to Consolidated Financial Statements at Part II, Item 8. THE MANUFACTURING SEGMENT The Manufacturing segment is the registrant's dominant and most rapidly expanding segment in terms of assets employed, capital expenditures, operating profit and number of employees. It consists of two entities, the CMC Steel Group and the Howell Metal Company subsidiary, a manufacturer of copper tubing. The Steel Group is by far the more significant entity in this segment with subsidiaries operating four steel minimills, twenty steel fabrication plants, four steel joist manufacturing facilities, four steel fence post manufacturing plants, a heat treating plant, eight metals recycling plants, a railcar rebuilding facility, twelve concrete related product warehouses, two industrial products supply facilities and a railroad salvage company. The Company endeavors to operate all four minimills at full capacity in order to minimize product costs. Increases in capacity and productivity are continuously emphasized through both operating and capital improvements. The steel minimill business is capital intensive with substantial capital expenditures required on a regular basis to remain competitive as a low cost producer. Over the past three fiscal years, approximately $173 million or 72% of the Company's total capital expenditures have been for minimill projects. This emphasis on productivity improvements is reflected in a generally increased number of tons of steel melted, rolled and shipped from the minimills during each of the last three years as follows: <TABLE> <CAPTION> 1996 1997 1998 --------- --------- --------- <S> <C> <C> <C> Tons Melted 1,561,000 1,755,000 1,932,000 Tons Rolled 1,477,000 1,581,000 1,693,000 Tons Shipped 1,730,000 1,926,000 2,008,000 </TABLE> The Company's largest steel minimill, operated by Structural Metals, Inc. ("SMI Texas") is located at Seguin, Texas, near San Antonio. SMI Steel, Inc. ("SMI Alabama"), a steel minimill in Birmingham, 1
3 Alabama, was acquired in 1983. This mill now known as SMI Steel South Carolina ("SMI South Carolina"), located in Cayce, South Carolina, was acquired in November, 1994 as part of the acquisition of Owen Steel Company, Inc., and affiliates. A fourth, much smaller mill, has been in operation since 1987 and is located near Magnolia, Arkansas ("SMI Arkansas"). The SMI Texas, Alabama, and South Carolina mills consist of melt shops with electric arc furnaces that melt the steel scrap, continuous casting facilities to shape the molten metal into billets, reheating furnaces, rolling mills, mechanical cooling beds, finishing facilities and supporting facilities. The mills utilize both a Company-owned fleet of trucks and private haulers to transport finished products to customers and Company-owned fabricating shops. Mill capacity at SMI Texas is approximately 900,000 tons per year melted and 800,000 rolled. SMI Alabama's annual capacity is approximately 600,000 tons melted and 500,000 rolled and SMI South Carolina's annual capacity is approximately 550,000 tons melted and, before full operation of the new rolling mill, approximately 350,000 tons rolled. The new rolling mill at SMI South Carolina should increase capacity to approximately 700,000 tons when fully operational. SMI Texas manufactures steel reinforcing bars, angles, rounds, channels, flats, and special sections used primarily in highways, reinforced concrete structures and manufacturing. SMI Texas sells primarily to the construction, service center, energy, petrochemical, and original equipment manufacturing industries. Its primary markets are located in Texas, Louisiana, Arkansas and Oklahoma although products are shipped to approximately 30 states and Mexico. SMI Texas melted 847,000 tons during 1998 compared to 802,000 tons the prior year and rolled 757,000 tons, up 50,000 tons from 1997. Both were production records. A substantial program to modernize and improve productivity at SMI Alabama following its 1983 acquisition has resulted in approximately $121 million of capital expenditures through 1998. During 1998 work on improvements to the mill finishing area including a new cooling bed, straighteners and stackers commenced with completion scheduled for the first calendar quarter of 1999. During 1998 the melt shop recorded record production of 570,000 and 456,000 tons were rolled. SMI Alabama manufactures primarily larger size products than the other three Steel Group mills such as mid-size structural including angles, channels, up to eight inch wide flange beams and special bar quality rounds and flats. Customers include primarily service centers as well as the construction, manufacturing, and fabricating industries in the primary market areas of Alabama, Georgia, Tennessee, North and South Carolina, and Mississippi. Facilities at SMI South Carolina are similar but on a generally smaller capacity scale than the SMI Texas and SMI Alabama mills. SMI South Carolina manufactures primarily steel reinforcing bars with limited but increasing production of angles, rounds and squares. Its primary market area includes the Southeast and mid-Atlantic area south through Florida and north into southern New England. During 1998 SMI South Carolina melted 515,000 tons and rolled 346,000 tons. The largest single expenditure project in the Company's history, in excess of $100 million, will replace SMI South Carolina's existing rolling mill with a new state-of-the-art rolling mill. Construction began in July, 1997, and is anticipated to be finished in the first calendar quarter of 1999 with start up beginning upon completion. When fully operational the new rolling mill will have a capacity of at least 700,000 tons with a substantially broader product line than SMI South Carolina is presently capable of rolling. The primary raw material for SMI Texas, Alabama and South Carolina is secondary (scrap) ferrous metal purchased primarily from suppliers generally within a 300 mile radius of each mill. A portion of the ferrous raw material, generally less than half, is supplied from Company owned recycling plants. The 2
4 supply of scrap is believed to be adequate to meet future needs but has historically been subject to significant price fluctuations. All three minimills also consume large amounts of electricity and natural gas, both of which are believed to be readily available at competitive prices. No melting facilities are located at SMI Arkansas since this mill utilizes as its raw material rail salvaged from abandoned railroads for rerolling and, on occasion, billets from Company minimills or other suppliers. The rail or billets are heated in a reheat furnace and processed on a rolling mill and finished at facilities similar to, but on a smaller scale, the other mills. SMI Arkansas' finished product is primarily metal fence post stock, small diameter reinforcing bar and sign posts with some high quality round and flat products being rolled. Fence post stock is fabricated into studded "T" metal fence posts at Company owned facilities at the Magnolia mill site, San Marcos, Texas, Brigham City, Utah, and West Columbia, South Carolina. Because of this mill's lack of melting capacity, it is dependent on an adequate supply of competitively priced billets or used rail, the availability of which fluctuates with the pace of railroad abandonments, rate of rail replacement by railroads and demand for used rail from domestic and foreign rail rerolling mills. Capacity at SMI Arkansas is approximately 150,000 tons rolled per year. The Steel Group's downstream processing facilities are engaged in the fabrication of reinforcing and structural steel, steel warehousing, joist manufacturing, fence post manufacturing and railcar repair and rebuilding. Steel fabrication capacity now exceeds 850,000 tons with a record 839,000 tons of fabricated steel shipped in 1998. Steel for fabrication may be obtained from unrelated vendors as well as Company owned mills. Fabrication activities are conducted at various locations in Texas in the cities of Beaumont, Buda (near Austin), Corpus Christi, Dallas, Houston, San Marcos, Seguin, Victoria, and Waco; Baton Rouge and Slidell, Louisiana; Magnolia and Hope, Arkansas; Brigham City, Utah; Starke and Whitehouse, Florida; Fallon, Nevada; Cayce, Columbia, and Taylors, South Carolina; Lawrenceville, Georgia; Gastonia, North Carolina and Fredericksburg, Virginia. Fabricated steel products are used primarily in the construction of commercial and non-commercial buildings, including high-rise office or hotel towers, hospitals, convention centers, industrial plants, power plants, highways, arenas, stadiums, and dams. Sales of fabricated steel are generally made in response to bid solicitation from construction contractors or owners on a competitive bid basis and less frequently on a negotiated basis. Safety Railway Service in Victoria, Texas, repairs, rebuilds and provides custom maintenance with some manufacturing of railroad freight cars owned by railroad companies and private industry. That work is obtained primarily on a bid and contract basis and may include maintenance of the cars. During 1998 a second location operated by Safety Railway Service in Tulsa, Oklahoma was closed. Secondary metals recycling plants in Austin and at the SMI Texas mill in Seguin, Texas, and Cayce, South Carolina, together with five smaller feeder facilities nearby operate as part of the Steel Group due to the predominance of secondary ferrous metals sales to the nearby SMI minimills. The Cayce recycling plant installed and began operating a new automobile shredder during 1997 at a cost of approximately $5 million and the Seguin recycling facility began operating a new automobile shredder in late 1998 at a cost of approximately $9 million. SMI Joist Company, headquartered in Hope, Arkansas, manufactures steel joists and decking for roof supports using steel obtained primarily from the Steel Group's minimills at locations in Hope, Starke, Florida, Cayce, South Carolina, and Fallon, Nevada. Joist consumers are typically construction contractors or large chain store owners. Joists are generally made to order and sales, which may include custom design and fabrication, are primarily obtained on a competitive bid basis. The Company sells concrete related supplies including the sale or rental of equipment to the concrete installation trade at eleven warehouse locations in Texas and one location opened in 1998 in Atlanta, Georgia. Two smaller operations which emphasize a broader industrial product supply are located in Columbia and Cayce, South Carolina. 3
5 The operating assets of Allegheny Heat Treating, Inc., of Chicora, Pennsylvania, were purchased in January, 1997. AHT, Inc. is the Steel Group's entry into the steel heat treating business. AHT works closely with SMI Alabama and other steel mills that sell specialized heat treated steel for customer specific use, primarily in original or special equipment manufacturing. AHT's operating capacity is approximately 30,000 tons per year. The copper tube minimill operated by Howell Metal Company is located in New Market, Virginia. It manufactures primarily copper water tube as well as air conditioning and refrigeration tubing in straight lengths and coils for use in commercial, industrial and residential construction. Its customers, largely equipment manufacturers and wholesale plumbing supply firms, are located primarily east of the Mississippi river. High quality copper scrap supplemented occasionally by virgin copper ingot, is the raw material used in the melting and casting of billets. Copper scrap is readily available subject to rapid price fluctuations generally related to the price or supply of virgin copper. A small portion of the scrap is supplied by the Company's metal recycling yards. Howell's facilities include melting, casting, piercing, extruding, drawing, finishing and other departments. Capacity is approximately 55,000,000 pounds per year. Demand for copper tube is dependent mainly on the level of new residential construction and renovation. No single customer purchases ten percent or more of the manufacturing segment's production. The nature of certain stock products sold in the manufacturing segment are, with the exception of the steel fabrication and joist jobs, not characteristic of a long lead time order cycle. Orders for other stock products are generally filled promptly from inventory or near term production. As a result the Company does not believe backlog levels are a significant factor in evaluating most operations. Backlog in the CMC Steel Group at 1998 year-end was approximately $300,221,000. Backlog at 1997 year-end was approximately $261,506,000. Because most of the segment's sales are to consumers located in the sunbelt where construction activity generally continues throughout the year, demand for the Company's products is not considered seasonal although adverse weather can slow shipments. THE RECYCLING SEGMENT The Recycling segment is engaged in processing secondary (scrap) metals for further recycling into new metal products. This segment consists of the Company's 40 secondary metals processing divisions's recycling plants (excluding eight such facilities operated by the CMC Steel Group as a part of the Manufacturing segment). During the past year the secondary metals division purchased operating assets of recycling facilities in Houston, Texas; Joplin, Missouri; Miami, Oklahoma and Frontenac and Independence, Kansas. In addition the operating assets and inventory of three automobile salvage yards located in Ocala, Leesburg and Gainesville, Florida, were purchased in 1998 and constitute the recycling division's entry into the automobile salvage business. The Company's metal recycling plants purchase ferrous and nonferrous secondary or scrap metals, processed and unprocessed, in a variety of forms. Sources of metals for recycling include manufacturing and industrial plants, metal fabrication plants, electric utilities, machine shops, factories, railroads, refineries, shipyards, ordinance depots, demolition businesses, automobile salvage and wrecking firms. Numerous small secondary metals collection firms are also, in the aggregate, major suppliers. These plants processed and shipped approximately 1,469,000 tons of scrap metal during 1998, up from 1,367,000 the prior year. Ferrous metals comprised the largest tonnage of metals recycled at approximately 1,280,940 tons - - approximately 126,000 tons more than the prior year - followed by 4
6 approximately 188,055 tons compared to 212,000 in 1997, of non-ferrous metals, primarily aluminum, copper and stainless steel. The Company also purchased and sold an additional 187,000 tons of metals processed by other metal recycling facilities. With the exception of precious metals, practically all metals capable of being recycled are processed by these plants. The CMC Steel Group's eight metals recycling facilities processed and shipped an additional 360,000 tons of primarily ferrous scrap metal during 1998. The metal recycling plants generally consist of an office and warehouse building equipped with specialized equipment for processing both ferrous and nonferrous metal. Most of the larger plants are equipped with scales, shears, baling presses, briquetting machines, conveyors and magnetic separators. Two locations have extensive equipment for mechanically processing large quantities of insulated wire to segregate metallic content. All ferrous processing centers are equipped with either presses, shredders or hydraulic shears, locomotive and crawler cranes and railway tracks to facilitate shipping and receiving. The segment operates six large shredding machines capable of pulverizing obsolete automobiles or other ferrous metal scrap with the addition in 1998 of a new shredder in Jacksonville, Florida. Two additional shredders are operated by the Manufacturing segment's recycling facilities. A typical recycling plant includes several acres of land used for receiving, sorting, processing and storage of metals. Several recycling plants devote a small portion of their site or a nearby location for display and sales of metal products considered reusable for their original purpose. The auto salvage operations in Gainesville, Ocala and Leesburg, Florida, assist in the supply of crushed auto bodies, an important feed stock, to the new Jacksonville shredder. These operations purchase wrecked or inoperable motor vehicles at prices related to estimated recovery value of usable parts prior to ultimate sale to scrap metal processors, usually shredding facilities. The operating assets of scrap processing facilities in Joplin, Missouri, Miami, Oklahoma and Independence and Frontenac, Kansas, acquired during 1998 extend the geographic area served by the Company's Springfield, Missouri facility. Recycled metals are sold to steel mills and foundries, aluminum sheet and ingot manufacturers, brass and bronze ingot makers, copper refineries and mills, secondary lead smelters, specialty steel mills, high temperature alloy manufacturers and other consumers. Sales of material processed through the Company's recycling plants are coordinated through the recycling segment's office in Dallas. Export sales are negotiated through the Company's network of foreign offices as well as the Dallas office. No single source of material or customer of the Recycling segment represents a material part of purchases or revenues. The Recycling segment competes with other secondary processors and primary nonferrous metals producers, both domestic and foreign, for sales of nonferrous materials. Consumers of nonferrous scrap metals often have the capability to utilize primary or "virgin" ingot processed by mining companies interchangeably with secondary metals. The prices for nonferrous scrap metals are normally closely related to but generally less than, the prices of the primary or "virgin" metal producers. Ferrous scrap is the primary raw material for electric arc furnaces such as those operated by the Company's steel minimills. Relatively high prices and the need for low residual elements in the melting process have recently caused some minimills to supplement purchases of scrap metal with direct reduced iron and pig iron for certain product lines. THE MARKETING AND TRADING SEGMENT The Marketing and Trading segment buys and sells primary and secondary metals and other industrial products through a network of trading offices located around the globe. Steel, nonferrous metals, specialty metals, chemicals, industrial minerals, ores, concentrates, ferroalloys, and other basic 5
7 industrial materials are purchased primarily from producers in domestic and foreign markets. On occasion these materials are purchased from trading companies or industrial consumers with surplus supplies. Long-term contracts, spot market purchases and trading or barter transactions are all utilized to obtain materials. A large portion of these transactions involve fabricated semi-finished or finished product. Customers for these materials include industrial concerns such as the steel, nonferrous metals, metal fabrication, chemical, refractory and transportation sectors. Sales are generally made directly to consumers through and with coordination of offices in Dallas; New York City; Englewood Cliffs, New Jersey; Los Angeles; Hurstville near Sydney, Australia; Singapore; Zug, Switzerland; Hong Kong, and Surrey, and Sandbach, United Kingdom and Bergisch Gladbach, Germany. The Company also maintains representative offices in Moscow, Seoul, and Beijing, as well as agents in other significant international markets. These offices form a network for the exchange of information on the materials marketed by the Company as well as servicing sources of supply and purchasers. In most transactions the Company acts as principal and often as a marketing representative. The Company utilizes agents when appropriate and occasionally acts as broker. The Company participates in transactions in practically all major markets of the world where trade by American-owned companies is permitted. This segment focuses on the marketing of physical products as contrasted to traders of commodity futures contracts who frequently do not take delivery of the commodity. Sophisticated global communications and the development of easily accessible, although not always accurate, quoted market prices for many products has resulted in the Company emphasizing creative service functions for both sellers and buyers. Actual physical market pricing and trend information, as contrasted with sometimes more speculative metal exchange market information, technical information and assistance, financing, transportation and shipping (including chartering of vessels), storage, warehousing, just in time delivery, insurance, hedging and the ability to consolidate smaller purchases and sales into larger, more cost efficient transactions are examples of the services offered. The Company attempts to limit its exposure to price fluctuations by offsetting purchases with concurrent sales and entering into foreign exchange contracts as hedges of trade receivables and payables denominated in foreign currencies. The Company does not, as a matter of policy, speculate on changes in the markets and hedges only firm commitments not anticipated transactions. During the past year over 1.4 million tons of steel products were sold by the Marketing and Trading segment. The Australian operations maintain three warehousing facilities for just in time delivery of steel and industrial products and operate a heat treating facility for special steel products. COMPETITION The Company's steel manufacturing, steel fabricating, and copper tube manufacturing businesses compete with regional, national and foreign manufacturers and fabricators of steel and copper. Price, quality and service are the primary methods of competition. The Company does not produce a significant percentage of the total national output of most of its products but is considered a substantial supplier in the markets near its facilities. The large job structural steel capacity and expertise resulting from the acquisition of Owen Steel Company, Inc. enables the Company to compete throughout the United States for large structural steel projects. SMI Joist is believed to be the second largest manufacturer of joist in the United States although significantly smaller than the largest joist supplier. The Company's Southern Post operations are believed to be the largest manufacturer of steel fence posts in the United States. The Company believes the Recycling segment is among the larger entities recycling nonferrous secondary metals and is also a major regional processor of ferrous scrap. The past two years have brought 6
8 active consolidation in the scrap processing industry with aggressively priced acquisitions of significant operations by several relatively new industry members. Poor markets for secondary metals and poor results for many scrap processors in late 1998 resulted in an abrupt halt to acquisitions by most of these competitors and attempts to sell some recently acquired facilities. The secondary metals business is subject to cyclical fluctuations depending upon the availability and price of unprocessed scrap metal and the demand in steel and nonferrous metals consuming industries. The Company will continue with selective acquisitions at prices consistent with the cyclical nature of the metals recycling industry. All phases of the Company's marketing and trading business are highly competitive. Many of the marketing and trading segment's products are standard commodity items. The principal elements of competition are price, quality, reliability, financing alternatives, and additional services. This segment competes with other domestic and foreign trading companies, some of which are larger and may have access to greater financial resources or be able to pursue business without regard for the laws and regulations governing the conduct of corporations subject to the jurisdiction of the United States. The Company also competes with industrial consumers who purchase directly from suppliers and importers and manufacturers of semi-finished ferrous and nonferrous products. ENVIRONMENTAL MATTERS Compliance with environmental laws and regulations is a significant factor in the Company's business. The Company is subject to local, state, federal and supranational environmental laws and regulations concerning, among other matters, solid waste disposal, air emissions, waste and storm water effluent and disposal and employee health. The Company's manufacturing and recycling operations produce significant amounts of by-products, some of which are handled as industrial waste or hazardous waste. For example, the electric arc furnace ("EAF") dust generated by the Company's minimills is classified as a hazardous waste by the Environmental Protection Agency (EPA) because of lead, cadmium and chromium content and requires special handling and recycling for recovery of zinc or disposal. Additionally the Company's scrap metal recycling facilities operate eight shredders for which the primary feed materials are automobile hulks and obsolete household appliances. Approximately twenty percent (20%) of the weight of an automobile hulk consists of material (shredder fluff) which remains after the segregation of ferrous and saleable non-ferrous metals. Federal environmental regulations require shredder fluff to pass a toxic leaching test to avoid classification as a hazardous waste. The Company endeavors to have hazardous contaminants removed from the feed material prior to shredding and as a result the Company believes the shredder fluff generated is properly not considered a hazardous waste. Should the laws, regulations or testing methods change with regard to EAF dust processing or shredder fluff disposal, the Company may incur additional significant expenditures. To date, the Company has not experienced difficulty in contracting for recycling of EAF dust or disposing of shredder fluff in municipal or private landfills. The Company may also be required from time to time to clean up or take certain remediation action with regard to sites formerly used in connection with its operations. Furthermore, the Company may be required to pay for a portion of the costs of clean up or remediation at sites the Company never owned or on which it never operated if it is found to have arranged for treatment or disposal of hazardous substances on the sites. (See Item 3. Legal Proceedings). The Company has been named a potentially responsible party (PRP) at several Superfund sites because the EPA contends that the Company and other PRP scrap metal suppliers are liable for the cleanup of those sites solely as a result of having sold scrap metal to unrelated manufacturers for recycling as a raw material in the manufacture of new products. The 7
9 Company's position is that an arms length sale of valuable scrap metal for use as a raw material in a manufacturing process over which the Company exercises no control should not, contrary to EPA's assertion, constitute "an arrangement for disposal or treatment of hazardous substances" within the meaning of federal law. If the EPA's position is consistently upheld by the courts and no clarification or amendment of the law is provided by legislative bodies, the Company believes the possible liability arising from the sale of secondary metals may reduce recycling rates for metals and other recyclable materials in general. In particular, the Company believes that sellers of secondary or recycled metals could be at material disadvantage compared to sellers of "virgin" ingot from mining operations because the EPA's position apparently excludes suppliers of virgin metals with the same levels of hazardous substances from liability for sales of those materials to the same manufacturers for use, often interchangeably with secondary metals, in the same manufacturing process. The Company believes this result is contrary to public policy objectives and federal and state legislation encouraging recycling and promoting the use of recycled materials. New federal, state and local laws, regulations and changing interpretations, together with uncertainty regarding adequate control levels, testing and sampling procedures, new pollution control technology and cost benefit analysis based on market conditions are all factors which impact the Company's future expenditures to comply with environmental requirements. It is not possible to predict the total amount of capital expenditures or increases in operating costs or other expenses or whether such costs can be passed on to customers through product price increases. During 1998, the Company incurred environmental costs including disposal, permit, license fees, tests, studies, remediation, consultant fees and environmental personnel expense of approximately $10.9 million. In addition the Company estimates that approximately $1.4 million of capital expenditures put in service during 1998 were for environmental projects. The Company believes that it is in material compliance with currently applicable environmental laws and regulations and does not presently anticipate material capital expenditures for new environmental control facilities during 1999 other than a new baghouse at SMI Texas which will be put in service during 1999 at an estimated cost of approximately $6 million, of which $1.3 million remains to be spent in 1999. EMPLOYEES As of October, 1998, the Company had approximately 7,350 employees. Approximately 5,993 were employed by the manufacturing segment, 1,019 by the recycling segment, 270 by the marketing and trading segment, 38 in general corporate management and administration with 30 employees providing service functions for divisions and subsidiaries. Production employees at one metals recycling plant are represented by a union for collective bargaining. The Company believes that its labor relations are generally good to excellent and its work force highly motivated. ITEM 2. PROPERTIES The SMI Texas steel minimill is located on approximately 600 acres of land owned by the Company. Facilities including buildings occupying approximately 760,000 square feet, are used for manufacturing, storage, office and related uses. SMI Alabama's steel mill in Birmingham is located on approximately 36 acres with buildings occupying approximately 435,000 square feet used for manufacturing, storage, office and related use. The SMI South Carolina mill in Cayce, South Carolina is located on approximately 81 acres, all owned, with buildings occupying approximately 372,000 square feet. The SMI Arkansas facility at Magnolia is located on approximately 113 acres with buildings occupying approximately 194,000 square feet. Approximately 30 acres of the Alabama mill property and all Arkansas 8
10 mill property is leased in conjunction with revenue bond financing and may be purchased by the Company at the termination of the leases for a nominal sum. The steel fabricating operations including the fabrication plants, fence post and joist operations own approximately 929 acres of land and lease approximately 44 acres of land at various locations in Texas, Louisiana, Arkansas, Utah, South Carolina, Florida, Virginia, Georgia, North Carolina and Nevada. Howell Metal owns approximately 21 acres of land with buildings occupying about 228,000 square feet in New Market, Virginia. The Company's recycling plants occupy in the aggregate approximately 450 acres owned by the Company located at Austin, Beaumont, Dallas, Galveston, Houston, Lubbock, Midland, Odessa, Victoria and Vinton, all in Texas; as well as the Jacksonville, Ocala, Leesburg, Gainesville, Lake City, Orlando, and Tampa, Florida; and Shreveport, Louisiana; Chattanooga, Tennessee; Springfield and Joplin, Missouri; Burlington, North Carolina and Frontenac, Kansas plants. It leases the real estate at Clute, Edinburg, and Laredo,Texas; Ocala, Port Sutton (Tampa) and Casselberry, Florida; East Ridge, Tennessee. The smaller of two locations at Beaumont and Victoria, Texas, and Shreveport, Louisiana, are leased. The Fort Worth, Corpus Christi, and smaller Houston, Texas, Miami, Oklahoma and Independence, Kansas, recycling plants are partially owned and partially leased. Most small feeder yard locations are leased. The corporate headquarters, all domestic marketing and trading offices and all foreign offices occupy leased premises. The leases on the leased properties described above will expire on various dates within the next ten years. Several of the leases have renewal options and the Company has had little difficulty in renewing such leases as they expire. The minimum annual rental obligation of the Company for real estate operating leases in effect at August 31, 1998, to be paid during fiscal 1999 is approximately $4,272,000. The Company also leases a portion of the equipment used in its plants. The minimum annual rental obligation of the Company for equipment operating leases in effect at August 31, 1998, to be paid during fiscal 1999, is approximately $4,684,000. ITEM 3. LEGAL PROCEEDINGS As of August 31, 1998, the Company or its affiliates has received notices from the United States Environmental Protection Agency (EPA) or state agency with similar responsibility that the Company and numerous other parties are considered potentially responsible parties (a PRP) and may be obligated under the Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA) or similar state statute to pay for the cost of remedial investigation, feasibility studies and ultimately remediation to correct alleged releases of hazardous substances at approximately thirteen locations. The Company is contesting or intends to contest its designation as a PRP with regard to several sites, while at other sites the Company is participating with other named PRPs in agreements or negotiations expected to result in agreements to remediate the sites. The locations, none of which involve real estate ever owned or on which operations were conducted by the Company, are commonly referred to by the EPA or state agency as the Peak Oil Site (Tampa, FL), the Metcoa Site (Pulaski, PA), the NL Industries/Taracorp Site (Granite City, IL), the Sapp Battery Site (Cottondale, Florida), the Interstate Lead Company ("ILCO") Site (Leeds, Alabama), the Poly-Cycle Industries Site (Techula, Texas), the Taylor Road Site (Tampa, Florida), the Jensen Drive Site (Houston, TX), the Houston Lead Site (Houston, TX), the SoGreen/Parramore Site (Tifton, GA), the Stoller Site (Jericho, SC), the RSR Corporation Site (Dallas, TX), the Sandoval Zinc Company Site (Marion County, IL) and the Ross Metals Site (Rossville, TN). The Company has periodically received information requests with regard to other sites which are apparently under consideration by the EPA as existing or potential CERCLA clean-up sites. It is not known if any demand 9
11 will ultimately be made against the Company as a result of those inquiries. The EPA has notified the Company and other alleged PRPs that under Sec. 106 of CERCLA it could be subject to a maximum penalty fine of $25,000 per day and the imposition of treble damages if they refused to clean up the Peak Oil, Sapp Battery, NL/Taracorp, SoGreen/Parramore and Stoller sites as ordered by the EPA. The Company is presently participating in a PRP organization at the Peak Oil, Sapp Battery, SoGreen/Parramore and Stoller sites, although reserving the right to contest its PRP status, and does not believe that the EPA will pursue any fine against it so long as it continues to participate in the PRP groups. The Company is evaluating a de minimis settlement offer at the NL/Taracorp Site and believes it has adequate defenses to any attempt by the EPA to impose fines in that matter. CMC Oil Company (CMC Oil), a wholly-owned subsidiary which has been inactive since 1985, is subject to a final judgment resulting from an order entered in 1993 by the Federal Energy Regulatory Commission (the "FERC Order"). Judgment upholding the FERC Order was entered by Federal District Court in November, 1994 and affirmed by the Court of Appeals in November, 1995. The FERC Order found CMC Oil liable for overcharges constituting violations of crude oil reseller regulations from December, 1977 to January, 1979, in joint venture transactions with RFB Petroleum, Inc. The overcharges total approximately $1,330,000 plus interest from the transaction dates calculated under the Department of Energy's interest rate policy to the date of the District Court judgment with interest thereafter at 6.48% per annum. Although CMC Oil accrued a liability on its books during 1995 it does not have sufficient assets to satisfy the judgment. No claim has ever been asserted against Commercial Metals Company arising out of the CMC Oil litigation. Commercial Metals Company will vigorously contest liability should any such claim be asserted. In August, 1998, the Company and former stockholders of Owen Steel Company, Inc. ("Owen Steel") and affiliates settled litigation with regard to the Company's claims against a portion of the purchase price held in escrow following the Company's November, 1994, acquisition of Owen Steel. The Company received approximately $3,000,000 of the $5,000,000 escrow balance with the former Owen Steel stockholders receiving the remainder. Dorothy G. Owen, a director of the Company and former stockholder of Owen Steel was one of four designated representatives of former Owen Steel stockholders and received a portion of the escrowed funds equivalent to her pro rata ownership interest of Owen Steel. The settlement terminates all disputes related to the acquisition. While the Company is unable to estimate the ultimate dollar amount of exposure to loss in connection with the above-described environmental matters, government proceedings, and disputes that could result in additional litigation, some of which may have a material impact on earnings and cash flows for a particular quarter, it is the opinion of the Company's management that the outcome of the suits and proceedings mentioned, and other miscellaneous litigation and proceedings now pending, will not have a material adverse effect on the business or the consolidated financial position of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS. Not Applicable. 10
12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The table below summarizes the high and low sales prices reported on the New York Stock Exchange for the Company's common stock and cash dividends paid for the past two fiscal years. <TABLE> <CAPTION> 1998 Price Range Fiscal of Common Stock Cash Quarter --------------- Dividends High Low ------------------------------------------------------------------------------- <S> <C> <C> <C> 1ST $33 9/16 $30 1/16 13(cent) 2ND 33 13/16 29 3/8 13(cent) 3RD 36 30 1/2 13(cent) 4TH 32 11/16 24 1/8 13(cent) <CAPTION> 1997 Price Range Fiscal of Common Stock Cash Quarter --------------- Dividends High Low ------------------------------------------------------------------------------- <S> <C> <C> <C> 1ST $33 1/2 $29 5/8 13(cent) 2ND 30 28 13(cent) 3RD 30 3/8 27 1/8 13(cent) 4TH 32 1/2 28 3/4 13(cent) </TABLE> Since August 3, 1982, the Company's common stock has been listed and traded on the New York Stock Exchange. Prior to that date and since 1959 the Company's common stock was traded on the American Stock Exchange. The number of shareholders of record of the registrant's common stock at November 17, 1998, was approximately 2,634. 11
13 ITEM 6. SELECTED FINANCIAL DATA The table below sets forth a summary of selected consolidated financial information of the Company for the periods indicated: <TABLE> <CAPTION> FOR THE YEARS ENDED AUGUST 31, 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS) <S> <C> <C> <C> <C> <C> Net Sales 2,367,569 2,258,388 2,322,363 2,116,779 1,666,234 Net Earnings 42,714 38,605 46,024 38,208 26,170 Net Income Per 2.82 2.54 3.01 2.51 1.75 Diluted Share Total Assets 1,002,617 839,061 766,756 748,103 604,877 Stockholders' Equity 381,389 354,872 335,133 303,164 242,773 Long-term Debt 173,789 185,211 146,506 158,004 72,061 Cash Dividend Per Share .52 .52 .48 .48 .46 </TABLE> 12
14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE CONSOLIDATED FINANCIAL STATEMENTS <TABLE> <CAPTION> Consolidated Results (in millions except share data) Year ended August 31, - ------------------------------------------------------------------ 1998 1997 1996 --------------------------------- <S> <C> <C> <C> Net sales $2,368 $2,258 $2,322 Net earnings 42.7 38.6 46.0 Cash flow 93.5 83.2 89.9 International sales 752 739 892 As % of total 32% 33% 39% LIFO effect on net earnings 5.0 (.2) 2.9 Per share .33 (.01) .19 LIFO reserve 22.5 30.1 29.8 % of inventory on LIFO 72% 72% 79% </TABLE> SIGNIFICANT EVENTS AFFECTING THE COMPANY THIS YEAR: / Second-best net earnings year ever; fourth quarter was the highest quarterly earnings in history. / Manufacturing segment achieved record profits, sales, and shipments. / Recycling segment's record four-year period of operating profits came to an abrupt end. / Marketing and Trading performed remarkably in spite of demise of Far East markets. Segments Net sales and operating profit by business segment are shown in the following table: <TABLE> <CAPTION> (in millions) Year ended August 31, - -------------------------------------------------------------- 1998 1997 1996 ------------------------------- <S> <C> <C> <C> Net sales: Manufacturing $1,234 $1,083 $1,018 Recycling 415 485 464 Marketing and Trading 788 758 890 Operating profit: Manufacturing 74.8 54.8 61.8 Recycling (1.4) 7.6 12.1 Marketing and Trading 20.6 17.6 17.7 </TABLE> MANUFACTURING The Manufacturing segment includes the CMC Steel Group and Howell Metal Company. With revenues up 14% and operating profit increasing 36%, the segment set all-time records for the year. The Steel Group led the way ending the fourth quarter with all-time record quarterly sales and record fourth quarter shipments. The Copper Tube Division's annual operating profit was down slightly from last year. <TABLE> <CAPTION> August 31, ---------------------- 1998 1997 ---------------------- <S> <C> <C> Average mill selling price $ 322 $ 314 Average fab selling price 660 650 Average scrap purchase price 113 114 </TABLE> Selling prices were lower at the beginning of the year but recovered, and combined with record shipments produced a 42% increase in annual operating profit for the Steel Group. Mill tonnage shipped at 2,008,000 was 4% ahead of last year. The four mills showed a 22% increase in operating profit led by SMI-Alabama and SMI-Arkansas, each with increases in excess of 24%; particularly notable is the turnaround in profitability of SMI-South Carolina which was profitable all fiscal year. Its results were all the more noteworthy as they were attained in the midst of construction of a new rolling mill. SMI-Texas operating profit was 7% ahead of the prior year, a strong performance as last year's results included a $1.7 million nonrecurring insurance recovery. By year end the Company's newest and largest shredder was in successful operation at SMI-Texas. Operating profit in the Company's steel fabrication businesses more than doubled with record results in virtually all product areas. Fabricated shipments of 839,000 tons were well ahead of the previous year of 690,000 tons. SMI Owen Steel, the large structural fabrication facility in Columbia, South Carolina, had operating profit $4.4 million ahead of the prior year. A similar gain was accomplished by the combined joist plants. As of August 31, 1998, the Company ceased operations at its railcar rebuilding facility in Tulsa, Oklahoma. Substantially all employees were released and accruals raised for liabilities including severance, warranties, and facility costs. Steel Group computer migration project expense totaled $8.6 million compared with $6 million last year. Final pension settlement cost of $3.3 million was incurred as the Company's only major defined benefit plan was terminated. The Company had a record $120 million in capital spending for fiscal 1998, primarily at the steel mills. Construction of the new rolling mill and ancillary equipment at SMI-South Carolina will ultimately double capacity, reduce costs, and broaden the product line. The finishing upgrade at SMI-Alabama (replacement of the mill cooling bed, straighteners and stackers) will improve quality, enhance efficiency and also broaden the product line. Start up of both projects is scheduled to begin during the first calendar quarter of 1999. Attractive interest rates continue to strengthen residential construction markets, maintaining demand for plumbing tube. Margins were weak in the early months of the year, but improved to moderate proportions by the fourth quarter. Copper tube shipments increased 11% over the prior year to 51 million pounds. Annual production was 4% ahead of last year's rate. RECYCLING The Asian economic crisis brought the Recycling segment's four-year period of record operating profits to an abrupt end. Scrap normally exported by competitors was diverted for domestic consumption. Selling prices were decimated, falling to their lowest levels in many years. Margins eroded while total processing costs increased due to acquisitions; 13
15 however, the new capacity failed to bring in sufficient margin increases. All of these factors resulted in a moderate operating loss - the first in six years in this cyclical industry. The fourth quarter saw ferrous scrap markets in full retreat with scrap sales especially difficult. Nonferrous markets had weakened earlier and remained soft. For the year the average copper and brass scrap price dropped 22%, aluminum fell 6%, and steel scrap was unchanged; at year end this left prices 20% below the previous year. Ferrous scrap shipped increased 11% to 1.28 million tons; however, nonferrous shipments declined 11% to 188,000 tons, due to a drop in copper and brass shipments. Total volume of scrap processed, including the Steel Group processing plants, reached 1,948,000 tons. During the year the Company made several small acquisitions within existing geographic areas, none of which were significant to the overall operations of the Company. In the fourth quarter a new shredder in Jacksonville, Florida and a new shear in Odessa, Texas came online. The Division restructured its management into five autonomous profit centers, which should provide better coordination of processing equipment, personnel, marketing strength, sourcing and management. MARKETING AND TRADING Revenues for the Marketing and Trading segment increased 4%, and operating income rose 17% over the prior year. This was a remarkable performance given the demise of traditional Far East markets and a higher LIFO credit in the previous year. Most of the Asian markets did a complete reversal and induced a shift in trade flows. Purchases from new sources in the Far East increased significantly while sales were sharply reduced. Shipments into North America were brisk for most product lines and business in Europe increased. Operating profits from steel marketing and distribution increased; however, profitability in steel trading decreased because of reduced volume and margins. Nonferrous metal product tonnage increased particularly in semi-finished aluminum products. Activity for ores, minerals and industrial materials continued solid; meanwhile, new marketing channels were added. Near-Term Outlook Despite the global weakness and import surge of low-priced steel into the U.S.A., the Company's domestic steel markets are relatively firm and manufacturing margins should remain at a good level. It is likely that in the long products that the Company produces the market can better absorb the quantities that will be imported and the effect on prices will be more limited while raw material costs decline further. The outlook for steel fabrication also is favorable. Demand for copper tube is good, but the supply is adequate. Activity in the Company's important end-use construction markets in the U.S., including private nonresidential, public, and residential, is robust, although it has diminished from the frenzied pace earlier in the year. Manufacturing sector and distributor demand are somewhat softer as service centers continue to reduce inventories. Ferrous scrap prices have continued to fall and nonferrous prices remain very weak; consequently, the first part of fiscal 1999 will be very difficult for the Recycling segment. Nevertheless, some improvement in Recycling profits should be expected in the second half of the year with some restoration of margins beginning in the second quarter. Marketing and Trading anticipates reasonably good sales in North America, Western Europe, and Australia. The sharply lower global demand and prices for steel and nonferrous metals will persist, and it appears that any recovery in Asia will be slow; however, the Company plans to continue to capitalize on new marketing opportunities as a result of the dislocations throughout the world. Profitability in fiscal 1999 will be affected by the major project start ups in the Steel Group, higher depreciation, and increased interest expense. Conversely, some recoveries from the graphite electrode anti-trust litigation settlements are anticipated. Computer migration costs will be lower, and the Company's only major pension plan was terminated. This year the $217 billion six-year transportation bill, known as The Transportation Equity Act for the 21st Century, was enacted. This legislation will help restore the nation's infrastructure and will substantially increase highway spending. Additionally, it includes especially large increases for the states of Texas and South Carolina. The Company should benefit considerably from this program. Long-Term Outlook Near term the Asian crisis has altered the nature of U.S. economic growth away from capital investment, manufacturing and exports toward personal consumption, housing, and services. Commodity-based industries have been impacted significantly in the short run. The Company's long-term prospects remain encouraging. Some of the reasons for optimism include: first-class capable people are spread throughout the Company; expected continued high growth rates in the Sunbelt; capital projects that will contribute significant incremental profits; major computer migration costs will be completed by the end of fiscal 1999; high-cost producers will be compelled to reduce output on account of the prevailing low prices; a number of planned capacity increases around the world in steel and metal production will be canceled or delayed; European economies appear set to grow more strongly while Asia will recover and contribute to higher consumption; there is likely to be a concerted effort by the industrialized countries to tackle the global economic and financial problems and to combat deflation; the new transportation act will boost demand for steel long products in the U.S. The sections regarding near- and long-term outlook contain forward-looking statements regarding the outlook for the Company's financial results including estimated expenses, shipments, pricing, demand and general market conditions. There is inherent risk and uncertainty in any 14
16 forward-looking statements. Variances will occur and some could be materially different from management's current opinion. Developments that could impact the Company's expectations include interest rate changes, construction activity, unanticipated start-up expenses and delays, metals pricing, over which the Company exerts little influence, new capacity and product availability from competing steel minimills and other steel suppliers including import quantities and pricing, global factors including credit availability, currency fluctuations, timing of litigation settlements and decisions by governments impacting the level and pace of overall economic activity. 1997 Compared to 1996 SEGMENTS MANUFACTURING The Steel Group achieved record sales and tons melted, rolled and shipped; however, operating profits were held back by computer migration costs, termination of a defined benefit plan, and the start-up costs of a new joist facility. Shipments by the four minimills increased 11% to 1.93 million tons while fabricated shipments increased 6% to 690 thousand tons. A decrease of $4 per ton to $321 for average mill prices combined with slightly higher fabrication prices of $656 per ton resulted in a 7% increase in revenues to over $1 billion. Steel Group revenues were $1.0 billion compared with $949 million in the prior year. Operating profit for the Steel Group was $48.6 million or 15% lower. Computer migration costs totalled $6 million, and pension expense included a $541,000 curtailment loss for termination of the Company's last defined benefit plan. The Company's fourth joist plant, which opened in Nevada in June 1997, had start-up costs of $2.8 million, all of which were expensed as incurred. SMI-Texas set new records for shipments and production, and SMI Alabama had record profits. Most notable was SMI South Carolina's turnaround from a very weak performance last year to break even this year. Steel fabrication profits were only half of last year's strong results due to delays on larger structural jobs, generally lower margins, and the joist plant start up. In January 1997 the Company acquired the assets of a heat treating plant in Pennsylvania. The purchase price was not significant to the Company. The operation has been profitable since the acquisition. The Copper Tube Division operating profit was up 40% from last year based on 6% higher shipments and increased productivity. Late in the year, margins came under pressure due to imports from Mexico and reduced housing starts. RECYCLING Although revenues increased 4%, the Recycling segment reported a 37% decrease in operating profit compared to last year. The largest single factor was a LIFO charge this year versus a credit the prior year resulting in a change in LIFO expense of $4.7 million. Gross margins on nonferrous scrap improved, but ferrous margins were less because of lower volume. Shipments amounted to 1.15 million tons of ferrous scrap and 212 thousand tons of nonferrous scrap, down 2% in total from last year (excludes scrap tons processed by the six Steel Group processing plants). Rail service disruption, especially in the Southwest, was a problem. Domestic demand for scrap was good, while exports were slack except for Mexico. Average steel scrap prices were down slightly from last year. Aluminum prices were a bit higher while copper prices were 9% lower. 15
17 1997 Compared to 1996 (continued): The consolidation within the scrap industry accelerated during the past year with major acquisitions pursued at what the Company believes are overvaluations. The Company made an acquisition in 1997 of a complementary processing facility in Midland/Odessa, Texas, which was not significant to its overall operations. The synergism of the combined operations fueled a turnaround in profitability for the location. MARKETING AND TRADING Operating income for the Marketing and Trading segment was consistent with last year although revenues were down 15%. For the year, the segment had pretax LIFO income of $2,006,000 compared to an expense of $324,000 last year. Steel trading margins were pressured by intensely competitive global markets, diminished buying by China and continuing exports from the CIS. The Southeast Asian markets, wracked in the latter stages of the year with severe financial downturns, were particularly weak. The steel and nonferrous marketing and distribution businesses achieved good results with just-in-time delivery and other warehousing programs, especially in Australia. Similar programs in the United Kingdom reversed the poor results of the prior year. Trading operations located in the U.S., which import substantial quantities into North America, had excellent results. Semi-fabricated metals and minerals and chemicals had equivalent results to the prior year. New steel products surpassed last year. In the second half of the year, a steel supply contract was consummated with Essar Steel in India, and CMC Trading AG will market over $100 million of steel products for Essar during the next three years. At year end, a similar but smaller arrangement was concluded with a mill in China for performance over the next year. The Tokyo office was converted to an exclusive representative agency arrangement, and a small office was opened in Germany to facilitate steel imports. Liquidity and Capital Resources Cash flow from operations (before changes in operating assets and liabilities) for fiscal 1998 was the highest in the Company's history. Strong Company earnings and record depreciation expense generated the cash flow. Cash flow from operating activities was used to fund increases in accounts receivable in the Manufacturing segment (particularly fabrication operations) and Marketing and Trading. The Recycling segment had a significant decrease in accounts receivable. Inventories increased in all segments. Other assets increased due to almost $22 million in advances to suppliers for inventory commitments. Accounts payable increased due to normal seasonal commercial activity in the Manufacturing segment. Due to expanded operations, strong sales activity in the fourth quarter, and a record capital expenditure program, short-term borrowings increased $101 million over the prior year. Net working capital was $247 million as of August 31, 1998, compared to $307 million last year. The current ratio was lower at 1.6. The Company's sources of short-term funds include a commercial paper program of $40 million. The Company's commercial paper is rated in the second highest category by both Standard & Poor's Corporation (A-2) and Fitch IBCA, Inc. (F-2). Formal bank credit lines equal to 100% of the amount of all commercial paper outstanding are maintained. The Company's $150 million long-term notes issued in July 1997 ($50 million) and July 1995 ($100 million) are rated investment grade by Standard & Poor's Corporation and Fitch IBCA, Inc. (BBB+) and by Moody's Investors Service (Baa1). The Company has numerous informal credit facilities available from domestic and international banks. These credit facilities are priced at banker's acceptance rates or on a cost of funds basis. At August 31, 1998, the Company had filed a shelf registration of $200 million of long- and medium-term notes, of which $100 million is expected to be drawn in fiscal 1999. Management believes it has adequate capital resources available from internally generated funds and from short-term and long-term capital markets to meet anticipated working capital needs, planned capital expenditures, dividend payments to shareholders, stock repurchases and to take advantage of new opportunities requiring capital. Capital investments in property, plant and equipment were a record $120 million in 1998 compared to $71 million the prior year. Capital spending for fiscal 1999 is projected to be the largest plan in Company history at $150 million. The most important projects to be completed are the rolling mill at SMI-South Carolina and the finishing upgrade at SMI-Alabama. These expenditures are expected to be funded from internally generated funds and existing credit facilities. 16
18 Total capitalization was $577 million at the end of fiscal 1998. The ratio of long-term debt to capitalization was 30%, down from 33% last year. Stockholders' equity was $381 million or $26.18 per share. During the fiscal year, the Company repurchased 496,000 shares of Company stock at an average cost of $29.70 per share. The Company has authorized an additional 585,081 for repurchase. On August 31, 1998, 1,562,972 treasury shares were held by the Company. There were 14,569,611 million shares outstanding at year end. Contingencies In the ordinary course of conducting its business, the Company becomes involved in litigation, administrative proceedings and governmental investigations, including environmental matters. The Company's origin and one of its core businesses for over three quarters of a century has been metals recycling. In the present era of conservation of natural resources and ecological concerns, the Company has a continuing commitment to sound ecological and business conduct. Certain governmental regulations regarding environmental concerns, however well intentioned, are presently at odds with goals of greater recycling and expose the Company and the industry to potentially significant risks. Such exposures are causing the industry to shrink, leaving fewer but more well-financed operators as survivors to face the challenge. The Company believes that materials that are recycled are commodities that are neither discarded nor disposed. They are diverted by recyclers from the solid waste streams because of their inherent value. Commodities are materials that are purchased and sold in public and private markets and commodities exchanges every day around the world. They are identified, purchased, sorted, processed and sold in accordance with carefully established industry specifications. Environmental agencies at various federal and state levels would classify certain recycled materials as hazardous substances and subject recyclers to material remediation costs, fines and penalties. Taken to extremes, such actions could cripple the recycling industry and undermine any national goal of material conservation. Enforcement, interpretation, and litigation involving these regulations are not well developed. The Company has received notices from the U.S. Environmental Protection Agency (EPA) or equivalent state agency that it is considered a potentially responsible party (PRP) at thirteen sites, none owned by the Company, and may be obligated under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) or similar state statute to conduct remedial investigation, feasibility studies, remediation and/or removal of alleged releases of hazardous substances or to reimburse the EPA for such activities. The Company is involved in litigation or administrative proceedings with regard to several of these sites in which the Company is contesting, or at the appropriate time may contest, its PRP designation. In addition, the Company has received information requests with regard to other sites which may be under consideration by the EPA as potential CERCLA sites. Some of these environmental matters or other proceedings may result in fines, penalties or judgments being assessed against the Company which, from time to time, may have a material impact on earnings and cash flows for a particular quarter. While the Company is unable to estimate precisely the ultimate dollar amount of exposure to loss in connection with the above-referenced matters, it makes accruals as warranted. It is the opinion of the Company's management that the outcome of these proceedings, individually or in the aggregate, will not have a material adverse effect on the business or consolidated financial position of the Company. In fiscal 1998, the Company incurred environmental expense of $10.9 million. This included the cost to staff environmental personnel at various divisions, permit and license fees, accruals and payments for studies, tests, assessment, and remediation, consultant fees, baghouse dust removal and various other expenses. The Company estimates that approximately $1.4 million of its capital expenditures for fiscal 1998 related to costs directly associated with environmental compliance. The nature and timing of these environmental costs is such that it is not practical for the Company to estimate their magnitude in future periods. At August 31, 1998, $5.7 million remained in accrued expenses for environmental liabilities. The November 22, 1994 Final Order of the United States District Court for the Southern District of Texas against CMC Oil Company, a subsidiary of the Company, is a final, non-appealable order. This liability has been accrued in the financial statements of CMC Oil Company. CMC Oil does not have sufficient assets to satisfy the judgment. No claim has been asserted against Commercial Metals Company in connection with this litigation. Commercial Metals Company will vigorously contest liability should any such claim be asserted. During 1998, the Company and former stockholders of Owen Steel Company, Inc. and affiliates settled litigation with regard to the Company's claims against a portion of the purchase price held in escrow since the November 1994 acquisition. The Company received approximately $3 million of the approximately $5 million escrow balance. The proceeds were substantially offset against claim payments paid and deferred pending settlement. Dividends Quarterly cash dividends have been paid in each of the past 34 consecutive years. The annual dividend in 1998 was 52 cents a share paid at the rate of 13 cents each quarter. 17
19 Year 2000 The Company's three operating segments, Manufacturing, Recycling, and Marketing and Trading (combined with Corporate), have undertaken management information system initiatives that address a broad spectrum of functionalities including the Year 2000 issue, the ability of computer software to correctly interpret dates at the turn of the century. The following is a discussion by segment of the status of each of these initiatives. MANUFACTURING Since fiscal year 1995, the Steel Group has been in preparation and implementation of a Year 2000 compliant enterprise resource planning system. This system will cover all traditional financial systems and, in addition, cover sales, raw material usage, transportation management, purchasing, maintenance and other functional areas. Each of the four mills in the Steel Group, SMI-Texas, SMI-Alabama, SMI-South Carolina, and SMI-Arkansas, have Year 2000 task teams that meet periodically. Non-mill operations have less formalized structures as the effect is significantly reduced. Each of these teams is charged with identifying, analyzing, implementing, and validating a plan that will address the impact of the Year 2000 on the following areas: 1. State of readiness of key suppliers and vendors. 2. Conversion or changes necessary to any programs developed by the internal information systems. 3. Verifying and validating the embedded electronic control systems in equipment. An infrastructure migration completed in July 1998 upgraded all personal computer hardware and software to common compliant platforms. Major modules of the enterprise system, e.g., general ledger, have been successfully rolled out at every location. Remaining modules are being phased in so that the complete system will be functioning by August 1999. There are other niche software programs in use at various rebar and structural fabrication operations, scrap yards, and concrete related products locations. Some software vendors have already issued written letters of compliance; the rest will be sought before the end of calendar 1998. Systems in place at the Steel Group scrap yards, a relatively small portion of the Steel Group, will need to be upgraded to a current release. RECYCLING The Recycling segment is completing a multi-year transition of its systems for Year 2000 compliance. The segment is evaluating, determining alternatives, implementing solutions, and testing the applications in each of the following categories: 1. Mainframe computer hardware - All current computers have been certified by the manufacturer as compliant. Outside of Year 2000 issues, some older machines are being retired and replaced by certified compliant hardware. 2. Workstation hardware - Personal computer testing software has been acquired and based on random sampling, perhaps 50% of the installed base of 200 PC's will require chip replacements; of those, 20% may be more cost effective to replace. All PC's should be compliant by April 1999. 3. Business application software - Core applications developed in-house have had conversion processes completed and are fully compliant. Outside package software (general ledger, payroll, and fixed assets), is being upgraded with completion expected by March 1999. 4. Systems software - The mainframe replacements discussed in point 1 above will bring all operating systems up to a certified compliant version. It is believed that all PC's have had Year 2000 patches installed; however, this will be confirmed by the audit discussed in point 2. 5. User level software and applications - Standard spreadsheet and word processing software has been upgraded to current versions. There may remain pockets of applications that will be discovered during the audit process, which will be addressed as uncovered. 6. Communication equipment and software - The segment-wide communications equipment will be compliant by December 1998. Individual branches will then need to assess local phone and messaging systems. 7. Non-computer automated systems - Although considered a minor risk, processing equipment, security systems, and other equipment will be evaluated on a branch-by- branch basis. MARKETING AND TRADING, INCLUDING CORPORATE The Marketing and Trading segment, combined with the Corporate functions, represent the most geographically dispersed operations of the Company. Several systems were in place to address both financial applications and marketing information needs. Compliance evaluations begun two years ago indicated that generally the international divisions were compliant but reaching capacity constraints and that the domestic operations had sufficient size but were not compliant. Therefore, a joint program was developed to address both the functional marketing requirements and the financial systems with the goal to have the entire segment on a common platform with Corporate. Separate teams have been established for completing the upgrade process for both marketing and financials. To date, the committees have evaluated and purchased software. Training is in process concurrently with implementation. Both systems are expected to be rolled out, tested, and online by May 1999. A common PC hardware and software platform has been established. All locations are in substantial compliance with these requirements; however, there may be some remaining individual PC's requiring upgrade. SUMMARY The area of greatest risk is the readiness of the Company's suppliers and vendors. A letter requesting notice of their plans will be circulated in November 1998 requesting a response before year end. Regardless of the response, there will be a factor of the unknown until January 1, 2000. 18
20 The Company has implemented the program described above with the use of internal personnel and outside consultants. Resources are considered available and adequate to meet the Company's goals. If necessary, contingency plans will be developed by the end of March 1999 to address any anticipated shortfall. The Steel Group's migration project has a remaining estimated expense of $6 million, all to be incurred in fiscal 1999. The Recycling segment should have minimal costs (less than $100,000) to meet its plans. The Marketing and Trading plus Corporate project has an estimated budget of $4 million, which will be capitalized and amortized over five years. The section titled "Year 2000" contains forward-looking statements regarding the Company's expectations regarding addressing the Year 2000 computer problem. These plans among other factors include the timing of implementation phases, reallocation of in-house resources, use of outside personnel, third-party hardware and software, and reliance on representations of third parties. There is inherent risk and uncertainty in any forward-looking statements. Variances will occur and could be materially different from management's current opinion. Developments that could impact the Company's expectations include the availability of Company personnel, malfunctions of third-party software and hardware, over which the Company has no control, availability of outside consultants, and the inability to fully assess the readiness of key vendors and suppliers. 19
21 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Market Risk APPROACH TO MINIMIZING MARKET RISK The Company's product lines and its worldwide operations expose it to risks associated with fluctuations, sometimes volatile, in exchange and interest rates and commodity prices. It employs various strategies to mitigate the effects of this volatility. None of the instruments used are entered into for trading purposes or speculation; all are effected as hedges of underlying physical transactions. The accompanying information mandated by the Securities and Exchange Commission should be read in conjunction with footnotes 1 and 4 to the annual financial statements with particular attention to the limitations on its usefulness. Foreign Exchange The Company enters into foreign exchange contracts as hedges of trade receivables and payables denominated in currencies other than the functional currency. Effects of changes in currency rates are therefore minimized. No single currency poses a primary risk to the Company; fluctuations that cause temporary disruptions in one market segment tend to open opportunities in other segments. As a matter of Company policy, foreign exchange contracts are used to hedge only firm commitments, not anticipated transactions. Certain information in the accompanying chart assumes that the foreign exchange contracts were settled at August 31, 1998; this would defeat their purpose as hedges on transactions that will not occur for some period after year end. Due to customary weight and quality settlements on physical transactions, small gains and losses do occur upon close of the foreign exchange contracts. Interest Rates Substantially all of the Company's short- and long-term debt is denominated in United States dollars. The Company's financial results as affected by interest rates are most vulnerable to swings in short-term commercial borrowing rates. At August 31, 1998, approximately $7 million Australian dollars notional amount of debt was covered by an interest rate swap. The swap is variable to fixed, terminating June 2, 2003, intending to match physical asset lives with debt provisions in one foreign subsidiary. The variable rate at year end was 5.6% and the fixed rate 5.5%. At August 31, 1998, it had a fair value of $112,000. Commodity Prices Pricing of certain firm sales and purchase commitments is fixed to forward metal commodity exchange quotes. The Company enters into metal commodity contracts for copper, aluminum, and zinc as hedges of gross margins on these commitments. Of these, copper is the most predominant. The hedges are closed when the underlying sales and purchase commitments are priced, and gain or loss is recognized when the sale or purchase is recorded. In general the Company is most affected in periods of declining commodity prices as spreads narrow and sources withhold recycled metals from the market. The settlement values expressed in the accompanying chart as of August 31, 1998, should be read with caution as the offsetting physical transactions for which the commodity futures are effective as hedges are not quantified. Physical transaction quantities will not match exactly with standard commodity lot sizes, leading to small gains and losses at settlement. The following table provides certain information regarding the financial instruments discussed above. 20
22 FOREIGN CURRENCY EXCHANGE CONTRACT COMMITMENTS AS OF AUGUST 31, 1998 <TABLE> <CAPTION> Range of U.S. $ Amount Currency Hedge Rates Equivalent - ------------- ---------------- ------------- ------------- <S> <C> <C> <C> 27,886,000 German mark 1.829 - 1.757 $ 15,634,000 681,000 ECU 1.086 739,000 1,276,953,000 Italian lira 1749.25 730,000 5,950,000 Swiss franc 1.516 - 1.441 4,093,000 300,000 Singapore dollar 1.642 168,000 9,485,000 British pound .620 - .602 15,520,000 34,966,539 Australian dollar .6696 - .5662 21,399,000 3,642,000 Swedish krona 8.230 - 8.026 446,000 - ------------- ---------------- ------------- ------------- 58,729,000 Revaluation as of August 31, 1998, at quoted market 57,398,000 ------------- Settlement gain (loss) $ 1,331,000 </TABLE> / All foreign currency exchange contracts mature within one year. / Foreign currency exchange contracts effective as hedges have no book carrying value until maturity; they are considered reductions in otherwise available bank credit lines. METAL COMMODITY CONTRACT COMMITMENTS AS OF AUGUST 31, 1998 <TABLE> <CAPTION> Range of Total Contract Long/ # of Standard Total Hedge Rates Value at Terminal Exchange Metal Short Lots Lot Size Weight Per MT Inception - -------------------- -------- ----- --- ----------- ----------- -------------- -------------- <S> <C> <C> <C> <C> <C> <C> <C> London Metal Exchange (LME) Copper Long 62 25 MT 1550 MT $ 1617-2180 $ 2,676,000 Zinc Long 23 25 MT 575 MT 1069-1320 641,000 Aluminum Long 7 25 MT 175 MT 1349-1375 238,000 Aluminum Short 24 25 MT 600 MT (1360-1345) (813,000) New York Mercantile Per 100/wt. Exchange Copper Long 221 25,000 lbs. 5.5 MM lbs. 88.25-72.15 4,526,000 Commodities Division (Comex) Copper Short 165 25,000 lbs. 4.1 MM lbs. (80.80-71.10) (3,081,000) - -------------------- -------- ----- --- ----------- ----------- -------------- ------------ 4,187,000 Revaluation as of August 31, 1998, at quoted market 3,577,000 ------------ Settlement gain (loss) $ (610,000) </TABLE> / Thirty-four lots mature after one year / MT = Metric Tons / Metal commodity contracts effective as hedges have no book carrying value until maturity; a two million dollar letter of credit stands as margin requirement for Comex transactions. 21
23 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA. COMMERCIAL METALS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS <TABLE> <CAPTION> (in thousands, except share data) Year ended August 31, - --------------------------------- ---------------------------------------- 1998 1997 1996 ---------------------------------------- <S> <C> <C> <C> Net sales $2,367,569 $2,258,388 $2,322,363 Costs and expenses: Cost of goods sold 2,083,036 2,004,155 2,068,534 Selling, general and administrative expenses 178,961 164,173 151,171 Interest expense 18,055 14,637 15,822 Employees' pension and profit sharing plans (Note 7) 19,448 14,468 13,915 ---------- ---------- ---------- 2,299,500 2,197,433 2,249,442 ---------- ---------- ---------- Earnings before income taxes 68,069 60,955 72,921 Income taxes 25,355 22,350 26,897 ---------- ---------- ---------- Net earnings $ 42,714 $ 38,605 $ 46,024 ========== ========== ========== Net earnings per share basic $ 2.88 $ 2.59 $ 3.06 ========== ========== ========== Net earnings per share diluted $ 2.82 $ 2.54 $ 3.01 ========== ========== ========== </TABLE> See notes to consolidated financial statements 22
24 COMMERCIAL METALS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> (in thousands, except share data) August 31, - --------------------------------- ---------------------------- 1998 1997 ----------- ----------- <S> <C> <C> Assets Current assets: Cash $ 30,985 $ 32,998 Accounts receivable (less allowance for collection losses of $8,120 and $6,116) 318,655 289,735 Inventories 257,231 220,644 Other 66,629 41,899 ----------- ----------- Total current assets 673,500 585,276 Other assets 10,655 6,524 Property, plant and equipment: Land 24,967 17,844 Buildings 67,505 55,700 Equipment 499,899 447,553 Leasehold improvements 26,084 19,666 Construction in process 61,946 29,841 ----------- ----------- 680,401 570,604 Less accumulated depreciation and amortization (361,939) (323,343) ----------- ----------- 318,462 247,261 ----------- ----------- $ 1,002,617 $ 839,061 =========== =========== </TABLE> 23
25 <TABLE> <CAPTION> August 31, ---------------------------- 1998 1997 ----------- ----------- <S> <C> <C> LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Commercial paper $ 40,000 $ -- Notes payable 60,809 -- Accounts payable 156,389 136,988 Other payables and accrued expenses 150,512 129,036 Income taxes payable 6,870 618 Current maturities of long-term debt 11,483 11,502 ----------- ----------- Total current liabilities 426,063 278,144 Deferred income taxes 21,376 20,834 Long-term debt 173,789 185,211 Commitments and contingencies Stockholders' equity: Capital stock: Preferred stock -- -- Common stock, par value $5.00 per share: authorized 40,000,000 shares; issued 16,132,583 shares; outstanding 14,569,611 and 14,760,930 shares 80,663 80,663 Additional paid-in capital 14,285 13,627 Cumulative translation adjustment (1,596) -- Retained earnings 328,597 293,600 ----------- ----------- 421,949 387,890 Less treasury stock 1,562,972 and 1,371,653 shares at cost (40,560) (33,018) ----------- ----------- 381,389 354,872 ----------- ----------- $ 1,002,617 $ 839,061 =========== =========== </TABLE> See notes to consolidated financial statements 24
26 COMMERCIAL METALS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> (in thousands) August 31, - -------------- --------------------------------------- 1998 1997 1996 --------- --------- --------- <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net Earnings $ 42,714 $ 38,605 $ 46,024 Adjustments to earnings not requiring cash: Depreciation and amortization 47,460 43,720 41,599 Provision for losses on receivables 2,898 1,433 2,535 Deferred income taxes 542 (210) (6) Other (164) (353) (258) --------- --------- --------- Cash Flows from Operations Before Changes in Current Assets and Liabilities 93,450 83,195 89,894 Changes in Current Assets and Liabilities: Decrease (increase) in accounts receivable (33,104) 3,443 (29,063) Decrease (increase) in inventories (36,587) (34,443) 21,913 Decrease (increase) in other assets (30,457) (9,449) 1,601 Increase (decrease) in accounts payable, accrued expenses, and income taxes 47,129 14,063 2,253 --------- --------- --------- Net Cash Flows from Operating Activities 40,431 56,809 86,598 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment (119,915) (70,955) (50,781) Sales of property, plant and equipment 1,418 3,037 1,805 --------- --------- --------- Net Cash Used by Investing Activities (118,497) (67,918) (48,976) CASH FLOWS FROM FINANCING ACTIVITIES: Commercial paper - net change 40,000 -- -- Notes payable - net change 60,809 -- -- Financial services notes payable -- -- (5,189) New long-term debt -- 50,000 -- Payments on long-term debt (11,441) (11,287) (14,112) Stock issued under stock option, purchase, and bonus plans 8,239 5,989 5,225 Tax benefits related to stock option plan 895 649 407 Treasury stock acquired (14,732) (17,727) (13,465) Dividends paid (7,717) (7,777) (7,246) --------- --------- --------- Net Cash Provided (Used) by Financing Activities 76,053 19,847 (34,380) Increase (Decrease) in Cash and Cash Equivalents (2,013) 8,738 3,242 Cash and Cash Equivalents at Beginning of Year 32,998 24,260 21,018 --------- --------- --------- Cash and Cash Equivalents at End of Year $ 30,985 $ 32,998 $ 24,260 ========= ========= ========= </TABLE> See notes to consolidated financial statements 25
27 COMMERCIAL METALS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY <TABLE> <CAPTION> Common Stock Treasury Stock -------------------- Additional Cumulative ---------------------- Number of Paid-In Translation Retained Number of (in thousands, except share data) Shares Amount Capital Adjustment Earnings Shares Amount - --------------------------------- ---------- --------- ----------- ----------- --------- ---------- --------- <S> <C> <C> <C> <C> <C> <C> <C> Balance, September 1, 1995 16,132,583 $ 80,663 $ 11,946 $ 223,994 (762,991) $ (13,439) Net earnings 46,024 Cash dividends - $.48 per share (7,246) Treasury stock acquired (557,600) (13,465) Additional treasury stock issued for Owen acquisition 552 37,196 472 Stock issued under stock option, purchase and bonus plans 288 246,776 4,937 Tax benefits related to stock option plan 407 ---------- --------- --------- -------- --------- ---------- --------- <CAPTION> Balance, August 31, 1996 16,132,583 80,663 13,193 262,772 (1,036,619) (21,495) Net earnings 38,605 Cash dividends - $.52 per share (7,777) Treasury stock acquired (628,993) (17,727) Stock issued under stock option, purchase and bonus plans (215) 293,959 6,204 Tax benefits related to stock option plan 649 ---------- --------- --------- -------- --------- ---------- --------- Balance, August 31, 1997 16,132,583 80,663 13,627 293,600 (1,371,653) (33,018) Net earnings 42,714 Cash dividends - $.52 per share (7,717) Treasury stock acquired (496,000) (14,732) Stock received from escrow upon settlement of Owen lawsuit (47,316) (1,286) Stock issued under stock option, purchase and bonus plans (237) 351,997 8,476 Tax benefits related to stock option plan 895 Translation adjustment (1,596) ---------- --------- --------- -------- --------- ---------- --------- Balance, August 31, 1998 16,132,583 $ 80,663 $ 14,285 $ (1,596) $ 328,597 (1,562,972) $ (40,560) ========== ========= ========= ======== ========= ========== ========= </TABLE> See notes to consolidated financial statements. 26
28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, AUGUST 31, 1998 1. Summary of Significant Accounting Policies NATURE OF OPERATIONS The Company manufactures, recycles and markets steel and metal products and related materials. Its manufacturing and recycling facilities and primary markets are located in the Sunbelt from the mid-Atlantic area through the Southwest. Through its global marketing offices, the Company trades primary and secondary metals and other industrial products worldwide. As more fully discussed in footnote 12, the Manufacturing segment is the most dominant in terms of capital assets and operating profit. CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany transactions and balances are eliminated in consolidation. REVENUE RECOGNITION Sales are recognized when title to inventory passes to the customer based on customary industry practice. INVENTORIES Inventories are stated at the lower of cost or market. Inventory cost for most domestic inventories is determined by the last-in, first-out (LIFO) method; cost of international and remaining inventories is determined by the first-in, first-out (FIFO) method. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is recorded at cost and is depreciated at annual rates based upon the estimated useful lives of the assets using substantially the straight-line method. Provision for amortization of leasehold improvements is made at annual rates based upon the estimated useful lives of the assets or terms of the leases, whichever is shorter. START-UP COSTS Start-up costs associated with the acquisition and expansion of manufacturing and recycling facilities are expensed as incurred. INCOME TAXES Deferred income taxes are provided for temporary differences between financial and tax reporting. The principal differences are described in footnote 5. Benefits from tax credits are reflected currently in earnings. FOREIGN CURRENCY The functional currency of the Company's international subsidiaries in Australia, the United Kingdom, and Germany is the local currency. The remaining international subsidiaries' functional currency is the United States dollar. Translation adjustments are reported as a separate component of stockholders' equity. Gain or loss on foreign currency exchange contracts designated as hedges is deferred and recognized upon settlement of the related trade receivable or payable. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make significant estimates regarding assets and liabilities and associated revenues and expenses. Management believes these estimates to be reasonable; however, actual results may vary. CASH FLOWS For purposes of the statements of cash flows, the Company considers investments that are short-term (generally with original maturities of three months or less) and highly liquid to be cash equivalents. RECLASSIFICATIONS Certain reclassifications have been made in the 1997 and 1996 financial statements to conform to the classifications used in the current year. OTHER The Company will adopt Statement of Financial Accounting Standard No. 130, Reporting Comprehensive Income, and Standard No. 131, Disclosures About Segments of an Enterprise and Related Information, as of the quarter ending November 30, 1998. It will adopt Standard No. 133, Accounting for Derivative Instruments and Hedging Activities, as of the quarter ending November 30, 1999. Standards No. 130 and 131 are disclosure oriented and will not have an impact on reported operations. The Company has not evaluated the impact of Standard No. 133. 2. Inventories Before reduction of LIFO reserves of $22,450,000 and $30,131,000 at August 31, 1998 and 1997, respectively, inventories valued under the first-in, first-out method approximated replacement cost. At August 31, 1998 and 1997, 72% of total inventories were valued at LIFO. The remainder of inventories, valued at FIFO, consist mainly of material dedicated to international business. 3. Credit Arrangements Periodically, the Company is active in the commercial paper market with a program that permits borrowings up to $40,000,000. It is the Company's policy to maintain formal bank credit lines equal to 100% of the amount of all commercial paper outstanding. The Company has numerous informal credit facilities available from domestic and international banks. These credit facilities are priced at banker's acceptance rates or on a cost of funds basis. No compensating balances or commitment fees are required under these credit facilities. At August 31, 1998, the Company had filed a shelf registration for $200 million of long- and medium-term notes, of which $100 million is expected to be drawn in fiscal 1999. The Company's $100 million investment grade, unsecured notes have a coupon rate of 7.20%, which, after netting the proceeds of an interest rate hedge, results in an effective interest rate of 7.04%. 27
29 On July 30, 1997, the Company sold the remaining $50 million of notes under its $150 million shelf registration. The notes have an effective yield of 6.8%. On August 15, 1996, the Company arranged a five-year, $40 million unsecured revolving credit loan facility with a group of four banks. The agreement provides for borrowing in United States dollars indexed to the reference rate or to the offshore dollar interbank market rate. A commitment fee of .1125% per annum is payable on the credit line. No compensating balances are required. Long-term debt and amounts due within one year as of August 31, 1998, are as follows: <TABLE> <CAPTION> Long-Term Current (in thousands) Debt Maturities Total - -------------------- --------- ---------- -------- <S> <C> <C> <C> 7.20% notes due 2005 $100,000 $ -- $100,000 6.80% notes due 2007 50,000 -- 50,000 8.49% notes due 2001 21,428 7,143 28,571 8.75% note due 1999 2,141 4,286 6,427 Other 220 54 274 -------- -------- -------- $173,789 $ 11,483 $185,272 ======== ======== ======== </TABLE> All interest is payable semiannually. The 7.20% notes are due in July 2005; the 6.80% notes in August 2007. The 8.49% notes provide for annual principal repayments beginning on December 1, 1995; all other notes are payable semiannually. Certain of the note agreements include various covenants. The most restrictive of these requires maintenance of consolidated net current assets of $75,000,000 and net worth (as defined) of $150,000,000. At August 31, 1998, approximately $205,000,000 of retained earnings was available for cash dividends under these covenants. The aggregate amounts of all long-term debt maturities for the five years following August 31, 1998 are (in thousands): 1999 - $11,483; 2000 - $9,332; 2001 - $7,179; 2002 - $7,163; 2003 - $21. Interest expense is comprised of the following: <TABLE> <CAPTION> (in thousands) Year ended August 31, - -------------- ---------------------------------- 1998 1997 1996 -------- -------- -------- <S> <C> <C> <C> Long-term debt $11,568 $10,894 $11,903 Commercial paper 1,547 731 360 Notes payable 4,940 3,012 3,559 -------- -------- -------- $18,055 $14,637 $15,822 ======== ======== ======== </TABLE> Interest of $2,290,000, $804,000 and $320,000 was capitalized in the cost of property, plant and equipment constructed in 1998, 1997, and 1996, respectively. Interest of $20,691,000, $15,578,000, and $16,467,000 was paid in 1998, 1997, and 1996, respectively. 4. Financial Instruments, Market and Credit Risk Management believes that the historical financial statement presentation is the most useful for displaying the Company's financial position. However, generally accepted accounting principles require disclosure of an estimate of the fair value of the Company's financial instruments as of year end. These estimated fair values disregard management intentions concerning these instruments and do not represent liquidation proceeds or settlement amounts currently available to the Company. Differences between historical presentation and estimated fair values can occur for many reasons including taxes, commissions, prepayment penalties, make-whole provisions and other restrictions as well as the inherent limitations in any estimation technique. Because of this management believes that this information may be of limited usefulness in understanding the Company and minimal value in making comparisons between companies. Due to near-term maturities, allowances for collection losses, investment grade ratings and security provided, the following financial instruments' carrying amounts are considered equivalent to fair value: o Cash and temporary investments o Commercial paper o Notes payable The Company's long-term debt is both publicly and privately held. Fair value was determined for private debt by discounting future cash flows at current market yields and for public debt at indicated market values. <TABLE> <CAPTION> (in thousands) - ----------------------------------------------- Long-Term Debt 1998 1997 - -------------- -------- -------- <S> <C> <C> Carrying Amount $185,272 $196,713 Estimated Fair Value $186,796 $196,494 ======== ======== </TABLE> The notional amount of foreign currency exchange contracts outstanding at year end was $58,730,000. The fair value of these contracts effective as hedges if settled at August 31, 1998 would result in a gain of $1,332,000. The fair value of all outstanding letters of credit is not meaningful. In 1998, the Company entered into an interest rate swap (variable to fixed) effective as a hedge for certain debt outstanding of its Australian subsidiary. The instrument's notional amount is seven million Australian dollars and terminates June 2, 2003. The variable rate at year end was 5.6% and the fixed rate 5.5%. At August 31, 1998, it had a fair value of $112,000. The Company does not have significant off-balance-sheet risk from financial instruments. It enters into foreign exchange contracts as hedges of trade receivables and payables denominated in currencies other than the functional currency. Effects of changes in currency rates are therefore minimized. As a matter of Company policy, foreign exchange contracts are used to hedge only firm commitments, not anticipated transactions. Pricing of certain firm sales and purchase commitments is fixed to forward metal commodity exchange quotes. The Company enters into metal commodity contracts (predominantly copper) as hedges of gross margins on these commitments. The hedges are closed when the underlying sales and purchase commitments are priced, and gain or loss is recognized when the sale or purchase is recorded. 28
30 The Company maintains both corporate and divisional credit departments. Limits are set for customers and countries. Letters of credit issued or confirmed through sound financial institutions are obtained to further ensure prompt payment in accordance with terms of sale; generally, collateral is not required. At August 31, 1998, $6,751,000 of bankers acceptances were included in accounts receivable. In the normal course of its marketing activities, the Company transacts business with substantially all sectors of the metals industry. Customers are internationally dispersed, cover the spectrum of manufacturing and distribution, deal with various types and grades of metal, and have a variety of end markets in which they sell. The Company's historical experience in collection of accounts receivable falls within the recorded allowances. Due to these factors, no additional credit risk beyond amounts provided for collection losses is believed inherent in the Company's accounts receivable. 5. Income Taxes The provisions for income taxes include the following: <TABLE> <CAPTION> (in thousands) Year ended August 31, - -------------- ---------------------------------- 1998 1997 1996 ------- ------- ------- <S> <C> <C> <C> Current: United States $21,651 $19,986 $22,356 Foreign 782 680 1,364 State and local 2,558 2,065 2,880 ------- ------- ------- 24,991 22,731 26,600 Deferred 364 (381) 297 ------- ------- ------- $25,355 $22,350 $26,897 ======= ======= ======= </TABLE> Taxes of $21,444,000, $25,506,000 and $16,537,000 were paid in 1998, 1997 and 1996, respectively. Deferred taxes arise from temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements. The sources and tax effects of these differences are: <TABLE> <CAPTION> (in thousands) August 31, - -------------- -------------------- 1998 1997 ------- ------- <S> <C> <C> U.S. taxes provided on foreign income and foreign taxes $11,595 $11,524 Tax on difference between tax and book depreciation 19,165 19,294 Net operating losses (2,660) (6,692) Alternative minimum tax credit (1,713) (1,713) Other accruals (2,030) (754) Other (2,981) (825) ------- ------- Total $21,376 $20,834 ======= ======= </TABLE> The Company uses substantially the same depreciable lives for tax and book purposes. Changes in deferred taxes relating to depreciation are mainly attributable to differences in the basis of underlying assets recorded under the purchase method of accounting. As noted above, the Company provides United States taxes on unremitted foreign earnings. Such earnings have been reinvested in the foreign operations except for dividends of $6,062,000. The Company's effective tax rates were 37.2% in 1998, 36.7% in 1997, and 36.9% in 1996. Reconciliations of the United States statutory rates to the effective rates are as follows: <TABLE> <CAPTION> Year ended August 31, -------------------------- 1998 1997 1996 ------ ------ ------ <S> <C> <C> <C> Statutory rate 35.0% 35.0% 35.0% Tax credits (.5) (.5) (.5) State and local taxes 2.6 2.2 2.6 Other .1 -- (.2) ----- ----- ----- Effective tax rate 37.2% 36.7% 36.9% ===== ===== ===== </TABLE> Net operating losses reflected as deferred tax assets consist of $4.5 million that are due to expire in 2009. These assets will be reduced as tax expense is recognized in future periods. The $1.7 million alternative minimum tax credit is available indefinitely. 6. Capital Stock Stock Purchase Plan Substantially all employees may participate in the Company's employee stock purchase plan. The Directors have authorized the annual purchase of up to 200 shares at a discount of 25% from the stock's price. Annual activity of the stock purchase plan was as follows: <TABLE> <CAPTION> 1998 1997 1996 ------- ------- ------- <S> <C> <C> <C> Shares subscribed 161,130 165,300 158,490 Price per share $ 24.59 $ 23.80 $ 17.80 Shares purchased 138,640 152,260 138,180 Price per share $ 23.80 $ 17.80 $ 18.41 Shares available 501,191 </TABLE> The Company recognized compensation expense for this plan of $1,053,000, $906,000 and $844,000 in 1998, 1997 and 1996, respectively. Stock Option Plans The 1986 Stock IncentivePlan (1986Plan) terminated November 23, 1996, except as to awards outstanding. Under the 1986 Plan, stock options were awarded to full-time salaried employees. The option price was the fair market value of the Company's stock at the date of grant, and the options are exercisable two years from date of grant. The 1996 Long-Term Incentive Plan (1996 Plan) was approved in December 1996. Under the 1996 Plan, stock options, stock appreciation rights, and restricted stock may be awarded to employees. The option price for both the stock options and the stock rights will not be less than the fair market value of the Company's stock at the date of grant. Vesting periods are variable but no award may be exercised after ten years. The outstanding awards under the 1996 Plan vest 50% after one year and 50% after two years from date of grant and will expire seven years after grant. 29
31 Combined share information for the two plans is as follows: <TABLE> <CAPTION> Weighted Price Average Range Number Exercise Price Per Share --------- -------------- ------------- <S> <C> <C> <C> September 1, 1995 Outstanding 1,430,293 $20.81 $ 8.72-27.61 Granted 435,050 27.29 26.25-27.31 Exercised (119,362) 17.92 8.72-27.61 Forfeited (31,486) 24.57 12.61-27.61 Exercisable 1,003,670 20.02 8.72-27.61 --------- ------ ------------- August 31, 1996 Outstanding 1,714,495 $22.58 $ 8.72-27.61 Granted 390,251 28.00 28.00 Exercised (161,879) 18.60 8.72-27.61 Forfeited (23,559) 26.46 18.42-28.00 Exercisable 1,108,337 21.32 8.72-27.61 --------- ------ ------------- August 31, 1997 Outstanding 1,919,308 $23.99 $ 8.72-28.00 Granted 364,841 29.81 29.81 Exercised (229,277) 19.05 8.72-28.00 Forfeited (9,859) 27.35 8.72-29.81 Exercisable 1,454,626 24.14 12.61-28.00 --------- ------ ------------- August 31, 1998 Outstanding 2,045,013 $25.56 $ 12.61-29.81 Authorized Shares Remaining 3,052 ========= ====== ============= </TABLE> Share information for options at August 31, 1998: <TABLE> <CAPTION> Outstanding Exercisable - ------------------------------------------------------------------------- Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Price Outstanding Life Price Outstanding Price - ------------ ----------- ----------- -------- ----------- -------- <S> <C> <C> <C> <C> <C> $12.61-18.42 257,027 2.8 years $16.48 257,027 $16.48 $20.20-24.50 420,526 5.5 years $22.51 420,526 $22.51 $26.25-29.81 1,367,460 6.5 years $28.21 777,073 $27.55 - ------------ ----------- ----------- -------- ----------- -------- $12.61-29.81 2,045,013 5.8 years $25.56 1,454,626 $24.14 </TABLE> The Company has maintained its historical method for accounting for stock options, which recognizes no compensation expense for fixed options granted at current market values. Generally accepted accounting principles require disclosure of an estimate of the weighted-average grant date fair value of options granted during the year and pro forma disclosures of the effect on earnings if compensation expense had been recorded. The Black-Scholes option pricing model used requires the following weighted-average assumptions: <TABLE> <CAPTION> 1998 1997 1996 ---------- ---------- ---------- <S> <C> <C> <C> Risk-free interest rate 5.44% 6.22% 6.74% Expected life 4.60 YEARS 4.85 years 4.85 years Expected volatility .170 .160 .160 Expected dividend yield 1.8% 1.7% 1.7% </TABLE> Management believes that the resulting answer has narrow reliability as characteristics of the Company's options such as nontransferability, forfeiture provisions, and long lives are inconsistent with the option model's basic purpose of valuing traded options. For purposes of pro forma earnings disclosures, the assumed compensation expense is amortized over the option's vesting period. The 1998 pro forma information includes options granted in 1996, 1997, and 1998. The 1997 pro forma information includes options granted in 1996 and 1997. <TABLE> <CAPTION> 1998 1997 1996 ---- ---- ---- <S> <C> <C> <C> Net Earnings (in thousands) As reported $42,714 $38,605 $46,024 Pro Forma 41,120 37,584 45,667 Net Earnings per share As reported $ 2.82 $ 2.53 $ 3.01 Pro Forma 2.72 2.47 $ 2.98 </TABLE> The weighted-average fair value of options granted in 1998, 1997 and 1996 was $6.06, $6.27 and $6.44, respectively. Preferred Stock Preferred stock has a par value of $1.00 a share, with 2,000,000 shares authorized. It may be issued in series, and the shares of each series shall have such rights and preferences as fixed by the Board of Directors when authorizing the issuance of that particular series. There are no shares of preferred stock outstanding. 7. Employees' Pension and Profit Sharing Plans Substantially all employees of the Company and its subsidiaries are covered by profit sharing or savings plans. Company contributions, which are discretionary, to all plans were $19,448,000, $14,468,000, and $13,915,000, for 1998, 1997 and 1996, respectively. During 1998 the Company settled its only remaining defined benefit plan, which it had terminated in 1997. Included in 1998 is pension expense of $3,310,000, substantially all of which was a settlement liability. There will be no future pension expense. 8. Postretirement Benefits Other Than Pensions/Postemployment Benefits The Company has no significant postretirement obligations. The Company's historical costs for postemployment benefits have not been significant and are not expected to be in the future. 9. Commitments and Contingencies Minimum rental commitments payable by the Company and its consolidated subsidiaries for noncancelable operating leases in effect at August 31, 1998, are as follows for the fiscal periods specified: <TABLE> <CAPTION> Real (in thousands) Equipment Estate - ------------------ --------- -------- <S> <C> <C> 1999 $ 4,684 $ 4,272 2000 2,996 4,109 2001 3,212 2,394 2002 2,122 1,638 2003 and thereafter 1,415 2,721 -------- -------- $ 14,429 $ 15,134 ======== ======== </TABLE> Total rental expense was $9,634,000, $8,621,000 and $7,834,000 in 1998, 1997 and 1996, respectively. 30
32 In the ordinary course of conducting its business, the Company becomes involved in litigation, administrative proceedings and governmental investigations, including environmental matters. The Company has received notices from the U.S. Environmental Protection Agency (EPA) or equivalent state agency that it is considered a potentially responsible party (PRP) at thirteen sites, none owned by the Company, and may be obligated under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) or similar state statute to conduct remedial investigations, feasibility studies, remediation and/or removal of alleged releases of hazardous substances or to reimburse the EPA for such activities. The Company is involved in litigation or administrative proceedings with regard to several of these sites in which the Company is contesting, or at the appropriate time may contest, its PRP designation. In addition, the Company has received information requests with regard to other sites which may be under consideration by the EPA as potential CERCLA sites. Some of these environmental matters or other proceedings may result in fines, penalties or judgments being assessed against the Company, which, from time to time, may have a material impact on earnings for a particular quarter. While the Company is unable to estimate precisely the ultimate dollar amount of exposure to loss in connection with the above-referenced matters, it makes accruals as warranted. Due to evolving remediation technology, changing regulations, possible third-party contributions, the inherent shortcomings of the estimation process and other factors, amounts accrued could vary significantly from amounts paid. Accordingly, it is not possible to estimate a meaningful range of possible exposure. It is the opinion of the Company's management that the outcome of these proceedings, individually or in the aggregate, will not have a material adverse effect on the business or consolidated financial position of the Company. During 1998 the Company and former stockholders of Owen Steel Company, Inc. and affiliates settled litigation with regard to the Company's claims against a portion of the purchase price held in escrow since the November 1994 acquisition. The Company received approximately $3 million of the approximately $5 million escrow balance. The proceeds were substantially offset against claim payments paid and deferred pending settlement. 10. Earnings Per Share Statement of Financial Accounting Standards No. 128, Earnings per Share, requires a reconciliation of both the numerator and denominator of the earnings per share calculations. There are no adjustments to net earnings to arrive at income for any years presented. The stock options granted June 11, 1998, with total outstanding share commitments of 364,141 at year end is antidilutive. All share data has been restated in accordance with the Standard. <TABLE> <CAPTION> August 31, -------------------------------------- 1998 1997 1996 ---------- ---------- ---------- <S> <C> <C> <C> Shares outstanding for basic earnings per share 14,829,515 14,910,771 15,032,343 Effect of dilutive securities: Stock options/purchase plans 291,271 308,956 243,815 Shares outstanding for dilutive earnings per share 15,120,786 15,219,727 15,276,158 </TABLE> 11. Other Payables and Accrued Expenses <TABLE> <CAPTION> (in thousands) August 31, - -------------- ----------------------- 1998 1997 --------- --------- <S> <C> <C> Salaries, wages and commissions $ 32,685 $ 29,330 Advance billings on contracts 15,585 5,306 Pension and profit sharing 21,882 17,028 Insurance 11,202 9,516 Accrual for contract losses 2,379 1,163 Environmental 5,718 4,477 Litigation accrual 6,650 6,650 Freight 4,936 5,593 Taxes other than income taxes 7,558 6,044 Interest 3,348 3,732 Other accrued expenses 38,569 40,197 --------- --------- $ 150,512 $ 129,036 ========= ========= </TABLE> 12. Business Segments Summarized data for the Company's international operations located outside of the United States (principally in Europe, Australia and the Far East) are as follows: <TABLE> <CAPTION> (in thousands) Year ended August 31, - -------------- ---------------------------------- 1998 1997 1996 --------- --------- --------- <S> <C> <C> <C> Revenues-unaffiliated customers $ 335,036 $ 360,283 $ 505,255 ========= ========= ========= Operating profit $ 4,491 $ 3,469 $ 6,731 ========= ========= ========= Identifiable assets $ 107,422 $ 95,358 $ 108,492 ========= ========= ========= </TABLE> Export sales from the Company's United States operations are as follows: <TABLE> <CAPTION> (in thousands) Year ended August 31, - -------------- ---------------------------------- 1998 1997 1996 --------- --------- --------- <S> <C> <C> <C> Far East $ 19,627 $ 39,863 $ 60,008 Canada and Mexico 40,330 38,883 40,565 Other 3,014 4,590 3,414 --------- --------- --------- Total $ 62,971 $ 83,336 $ 103,987 ========= ========= ========= </TABLE> The Company operates in three business segments, as indicated below. Intersegment sales generally are priced at prevailing market prices. Certain corporate administrative expenses are allocated to segments based upon the nature of the expense. 31
33 12. Business Segments (Continued): <TABLE> <CAPTION> Adjustments Marketing and 1998 (in thousands) Manufacturing Recycling and Trading Corporate Eliminations Consolidated - ---------------------------------- ------------- --------- ----------- --------- ------------ ------------ <S> <C> <C> <C> <C> <C> <C> Net sales - unaffiliated customers $ 1,229,016 $ 386,002 $ 752,501 $ 50 $ -- $ 2,367,569 Intersegment sales 4,925 28,884 35,991 (69,800) ------------- --------- ----------- --------- ------------ ------------ Total sales 1,233,941 414,886 788,492 50 (69,800) 2,367,569 ============= ========= =========== ========= ============ ============ Operating profit (loss) 74,766 (1,354) 20,582 (7,870) 86,124 Interest expense (18,055) Earnings before income taxes 68,069 ============= ========= =========== ========= ============ ============ Depreciation and amortization 35,364 10,925 939 232 47,460 ============= ========= =========== ========= ============ ============ Capital expenditures 90,036 27,391 1,360 1,128 119,915 ============= ========= =========== ========= ============ ============ Identifiable assets $ 622,694 $ 118,905 $ 236,968 $ 24,050 $ -- $ 1,002,617 ============= ========= =========== ========= ============ ============ <CAPTION> 1997 (in thousands) - ------------------- Net sales - unaffiliated customers $ 1,077,296 $ 453,436 $ 727,532 $ 124 $ -- $ 2,258,388 Intersegment sales 5,703 31,182 30,672 (67,557) ------------- --------- ----------- --------- ------------ ------------ Total sales 1,082,999 484,618 758,204 124 (67,557) 2,258,388 ============= ========= =========== ========= ============ ============ Operating profit (loss) 54,782 7,615 17,636 (4,441) 75,592 Interest expense (14,637) Earnings before income taxes 60,955 ============= ========= =========== ========= ============ ============ Depreciation and amortization 32,915 9,926 669 210 43,720 ============= ========= =========== ========= ============ ============ Capital expenditures 50,773 15,885 4,023 274 70,955 ============= ========= =========== ========= ============ ============ Identifiable assets $ 510,951 $ 112,875 $ 192,224 $ 23,011 $ -- $ 839,061 ============= ========= =========== ========= ============ ============ <CAPTION> 1996 (in thousands) - ------------------- Net sales - unaffiliated customers $ 1,008,231 $ 443,825 $ 869,646 $ 661 $ -- $ 2,322,363 Intersegment sales 9,625 20,348 20,394 (50,367) ------------- --------- ----------- --------- ------------ ------------ Total sales 1,017,856 464,173 890,040 661 (50,367) 2,322,363 ============= ========= =========== ========= ============ ============ Operating profit (loss) 61,818 12,091 17,680 (2,846) 88,743 Interest expense (15,822) Earnings before income taxes 72,921 ============= ========= =========== ========= ============ ============ Depreciation and amortization 31,319 9,410 614 256 41,599 ============= ========= =========== ========= ============ ============ Capital expenditures 37,315 8,727 1,611 329 47,982 ============= ========= =========== ========= ============ ============ Identifiable assets $ 457,939 $ 91,885 $ 195,042 $ 21,890 $ -- $ 766,756 ============= ========= =========== ========= ============ ============ </TABLE> 32
34 13. Quarterly Financial Data (Unaudited) Summarized quarterly financial data for 1998, 1997 and 1996 are as follows (in thousands except per share data): <TABLE> <CAPTION> Three Months Ended 1998 ---------------------------------------------- Nov. 30 Feb. 28 May 31 Aug. 31 ---------------------------------------------- <S> <C> <C> <C> <C> Net sales $550,501 $568,178 $606,099 $642,791 Gross profit 63,801 66,284 73,836 80,375 Net earnings 8,053 8,348 11,391 14,922 EPS basic .55 .57 .77 1.01 EPS diluted .54 .56 .75 1.00 </TABLE> <TABLE> <CAPTION> Three Months Ended 1997 ---------------------------------------------- Nov. 30 Feb. 28 May 31 Aug. 31 ---------------------------------------------- <S> <C> <C> <C> <C> Net sales $530,961 $525,755 $589,646 $612,026 Gross profit 61,654 58,411 66,009 68,159 Net earnings 9,177 7,201 9,510 12,717 EPS basic .61 .48 .64 .87 EPS diluted .60 .47 .63 .85 </TABLE> <TABLE> <CAPTION> Three Months Ended 1996 ---------------------------------------------- Nov. 30 Feb. 28 May 31 Aug. 31 ---------------------------------------------- <S> <C> <C> <C> <C> Net sales $590,219 $518,181 $639,144 $574,819 Gross profit 59,937 60,954 66,238 66,700 Net earnings 10,832 10,010 12,012 13,170 EPS basic .71 .67 .80 .88 EPS diluted .70 .67 .79 .86 </TABLE> The quantities and costs used in calculating cost of goods sold on a quarterly basis include estimates of the annual LIFO effect. The actual effect cannot be known until the year-end physical inventory is completed and quantity and price indices are developed. The quarterly cost of goods sold above includes such estimates. Fourth quarter 1998 net earnings increased $3,920,000 after the final determination of quantities and prices was made. The net earnings per share (EPS) is on a diluted basis calculated in accordance with Financial Accounting Standards No. 128. INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders Commercial Metals Company Dallas, Texas We have audited the consolidated balance sheets of Commercial Metals Company and subsidiaries at August 31, 1998 and 1997 and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended August 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Commercial Metals Company and subsidiaries at August 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 1998, in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE, LLP Dallas, Texas October 14, 1998 33
35 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE No event reportable herein took place. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Certain of the information required in response to this Item with regard to directors is incorporated herein by reference from the registrant's Definitive Proxy Statement for the annual meeting of shareholders to be held January 28, 1999, which will be filed no later than 120 days after the close of the Registrant's fiscal year. The following is a listing of employees believed to be considered "Executive Officers" of the registrant as defined under Rule 3b-7 as of August 31, 1998: <TABLE> <CAPTION> NAME CURRENT TITLE & POSITION AGE OFFICER SINCE - ---- ------------------------ --- ------------- <S> <C> <C> <C> Lawrence A. Engels Vice President, Treasurer and 65 1977 Chief Financial Officer Hugh M. Ghormley Vice President and 69 1981 CMC Steel Group - President Fabrication Plants Harry J. Heinkele Vice President and Secondary Metals 66 1981 Processing Division - President A. Leo Howell Vice President and 77 1977 Howell Metal Company - President; Director and Chairman of the Executive Committee William B. Larson Controller 45 1995 Murray R. McClean Vice President and 50 1995 International Division - President Stanley A. Rabin President and Chief Executive 60 1974 Officer; Director </TABLE> 34
36 <TABLE> <S> <C> <C> <C> Bert Romberg Senior Vice President 68 1968 Marvin Selig CMC Steel Group - Chairman 75 1968 and Chief Executive Officer; Director Clyde P. Selig Vice President and 66 1981 CMC Steel Group - President and Chief Operating Officer David M. Sudbury Vice President, Secretary and 53 1976 General Counsel </TABLE> The Executive Officers are employed by the Board of Directors of the registrant or the respective subsidiary usually at its first meeting after the registrant's Annual Shareholders Meeting and continue to serve for terms set from time to time by the registrant's Board of Directors in its discretion. All of the Executive Officers of the Company have served in the positions indicated above or in positions of similar responsibility for more than five years except for Mr. Larson. Mr. Larson was employed by the Company in June, 1991 as Assistant Controller and was named Controller in March, 1995. Marvin Selig is the brother of Clyde P. Selig. There are no other family relationships among the officers of the registrant or among the Executive Officers and Directors. ITEM 11. EXECUTIVE COMPENSATION Information required in response to this Item is incorporated herein by reference from the Registrant's Definitive Proxy Statement for the annual meeting of shareholders to be held January 28, 1999, which will be filed no later than 120 days after the close of the Registrant's fiscal year. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required in response to this Item is incorporated herein by reference from the Registrant's Definitive Proxy Statement for the annual meeting of shareholders to be held January 28, 1999, which will be filed no later than 120 days after the close of the Registrant's fiscal year. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS To the extent applicable, information required in response to this Item is incorporated herein by reference from the Registrant's Definitive Proxy Statement for the annual meeting of shareholders to be held January 28, 1999, which will be filed no later than 120 days after the close of the Registrant's fiscal year. 35
37 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this report: 1. All financial statements are included at Item 8 above. 2. Commercial Metals Company and Subsidiaries Consolidated Financial Statement Schedules Independent Auditors' Report as to Schedules Valuation and qualifying accounts (Schedule VIII) All other schedules have been omitted because they are not applicable, are not required, or the required information is shown in the financial statements or notes thereto. 3. The following is a list of the Exhibits and Index required to be filed by Item 601 of Regulation S-K: (3)(i) Restated Certificate of Incorporation (Filed as Exhibit (3)(i) to the Company's Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). (3)(i)a- Certificate of Amendment of Restated Certificate of Incorporation dated February 1, 1994 (Filed as Exhibit 3(i)a to the Company's Form 10-K for the fiscal year ended August 31, 1995, and incorporated herein by reference). (3)(i)b- Certificate of Amendment of Restated Certificate of Incorporation dated February 17, 1995 (Filed as Exhibit 3(i)b to the Company's Form 10-K for the fiscal year ended August 31, 1995, and incorporated herein by reference). (3)(ii) By-Laws (Filed as Exhibit (3)(ii) to the Company's Form 10-K for the fiscal year ended August 31, 1993 and incorporated hereby by reference). (4) Indenture between the Company and Chase Manhattan Bank dated as of July 31, 1995 (Filed as Exhibit 4.1 to the Company's Registration Statement No. 33-60809 on July 18, 1995 and incorporated herein by reference). (21) Subsidiaries of Registrant...................................E1 (23) Independent Auditors' consent to incorporation by reference of report dated October 14, 1998 accompanying the consolidated financial statements of Commercial Metals Company and subsidiaries for the year ended August 31, 1997 into previously filed Registration Statements No. 033-61073, No. 033-61075, and 333-27967 on Form S-8 and Registration Statements No. 33-60809 and 333-61379 on Form S-3............................................................E2 36
38 (27) Financial Data Schedules......................................E3 (b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of the period covered by this report. 37
39 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. COMMERCIAL METALS COMPANY /s/ Stanley A. Rabin -------------------------------------- By: Stanley A. Rabin President and Chief Executive Officer Date: November 23, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: /s/ Albert A. Eisenstat /s/ Dorothy G. Owen - -------------------------------------- -------------------------------------- Albert A. Eisenstat, November 23, 1998 Dorothy G. Owen, November 23, 1998 Director Director /s/ Moses Feldman /s/ Charles B. Peterson - -------------------------------------- -------------------------------------- Moses Feldman, November 23, 1998 Charles B. Peterson, November 23, 1998 Director Director /s/ Stanley A. Rabin - -------------------------------------- -------------------------------------- Laurence E. Hirsch, November 23, 1998 Stanley A. Rabin, November 23, 1998 Director President, Chief Executive Officer and Director /s/ A. Leo Howell /s/ Marvin Selig - -------------------------------------- -------------------------------------- A. Leo Howell, November 23, 1998 Marvin Selig, November 23, 1998 Vice President and Director Chairman and Chief Executive Officer Steel Group and Director /s/ Walter F. Kammann /s/ Lawrence A. Engels - -------------------------------------- -------------------------------------- Walter F. Kammann, November 23, 1998 Lawrence A. Engels, November 23, 1998 Director Vice President and Chief Financial Officer /s/ Ralph E. Loewenberg /s/ William B. Larson - -------------------------------------- -------------------------------------- Ralph E. Loewenberg, November 23, 1998 William B. Larson November 23, 1998 Director Controller 38
40 INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders of Commercial Metals Company Dallas, Texas We have audited the consolidated financial statements of Commercial Metals Company and subsidiaries as of August 31, 1998 and 1997, and for each of the three years in the period ended August 31, 1998, and have issued our report thereon dated October 14, 1998; such financial statements and report are included in Item 8 herein. Our audits also included the consolidated financial statement schedule of Commercial Metals Company listed in Item 14. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ DELOITTE & TOUCHE, LLP Dallas, Texas October 14, 1998
41 SCHEDULE VIII COMMERCIAL METALS COMPANY AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED AUGUST 31, 1998, 1997 AND 1996 (In thousands) Allowance for collection losses deducted from notes and accounts receivable: <TABLE> <CAPTION> Charged to Charged Deductions Balance, profit and to other from Balance beginning loss or accounts reserves end Year of year income (A) (B) of year - ----- --------- ---------- -------- ---------- ------- <S> <C> <C> <C> <C> <C> 1996 4,743 2,535 269 2,046 5,501 1997 5,501 1,433 354 1,172 6,116 1998 6,116 2,898 261 1,155 8,120 </TABLE> (A) Recoveries of accounts written off. (B) Write-off of uncollectible accounts.
42 EXHIBIT INDEX <TABLE> <CAPTION> EXHIBIT NUMBER DESCRIPTION - -------------- ----------- <S> <C> (3)(i) Restated Certificate of Incorporation (Filed as Exhibit (3)(i) to the Company's Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). (3)(i)a -- Certificate of Amendment of Restated Certificate of Incorporation dated February 1, 1994 (Filed as Exhibit 3(i)a to the Company's Form 10-K for the fiscal year ended August 31, 1995, and incorporated herein by reference). (3)(i)b -- Certificate of Amendment of Restated Certificate of Incorporation dated February 17, 1995 (Filed as Exhibit 3(i)b to the Company's Form 10-K for the fiscal year ended August 31, 1995, and incorporated herein by reference). (3)(ii) By-Laws (Filed as Exhibit (3)(ii) to the Company's Form 10-K for the fiscal year ended August 31, 1993 and incorporated hereby by reference). (4) Indenture between the Company and Chase Manhattan Bank dated as of July 31, 1995 (Filed as Exhibit 4.1 to the Company's Registration Statement No. 33-60809 on July 18, 1995 and incorporated herein by reference). (21) Subsidiaries of Registrant ........................................E1 (23) Independent Auditors' consent to incorporation by reference of report dated October 14, 1998 accompanying the consolidated financial statements of Commercial Metals Company and subsidiaries for the year ended August 31, 1997 into previously filed Registration Statements No. 033-61073, No. 033-61075, and 333-27967 on Form S-8 and Registration Statements No. 33-60809 and 333-61379 on Form S-3 .........................................E2 (27) Financial Data Schedules ..........................................E3 </TABLE>