TO OUR STOCKHOLDERS
Consolidated Results - Fiscal year 1998 was our second strongest year in history and the fourth quarter was the best quarter ever despite the adverse effects from the global financial crisis. For the year ended August 31, 1998, your company reported an 11% increase in net earnings to $42.7 million or $2.82 per diluted share on sales of $2.4 billion. This compares with net earnings of $38.6 million or $2.54 per diluted share on sales of $2.3 billion for the year ended August 31, 1997. Cash flow from operations for the year was a record $93 million or $6.18 per diluted share compared with $83 million or $5.47 per diluted share last year. Earnings for the fourth quarter were $14.9 million or $1.00 per diluted share, highlighted by a record quarter for the CMC Steel Group. Our fourth quarter frequently is our strongest period. Segment results were highly skewed, however, and the year ended in differing directions, a key factor being that scrap prices fell to the lowest level in years.
Demand in our most important North American markets generally was robust, and we benefited particularly from strong construction activity. Europe was stronger while most other markets were considerably weaker. The financial crisis in Asia spread during the year and continued to affect our profitability because of its major impact on consumption in the Pacific Rim as well as on prices around the world. The recessions in Japan and South Korea were the biggest negative factors, and China continued its cautious buying. On a global basis the oversupply conditions in steel and nonferrous metals increased throughout the year.
Manufacturing Segment - Fiscal 1998 was a record year for our Manufacturing segment - led by our CMC Steel Group - in profits, sales and shipments. This segment again provided the bulk of our earnings. Operating profit for the segment was 59% above last year's comparable fourth quarter on 16% higher sales of $350 million, and for the year profit was up 36%. The fourth quarter was the best in history for the Steel Group with record sales for any quarter and record shipments for a fourth quarter; operating profit was up 54% versus last year's same period. For the year Steel Group operating profit increased by 42% on a sales increase of 15%, and total assets rose above $600 million.
All of our four steel minimills had very satisfactory results. Annual records were achieved for steel mill profits, production and shipments, and our mills showed a 22% increase in operating profit. Mill shipments in the fourth quarter totaled 525,000 tons, which was 2% below last year's fourth quarter. Our average mill selling price increased $6 per ton to $323 per ton, including billet sales, while the average scrap purchase price was down by $11 per ton to $105 per ton (our average mill selling price for finished goods was up $13 per ton). For the year mill shipments were 2.01 million tons versus 1.93 million tons last year, and the average selling price was $322 per ton compared with $314 per ton in fiscal 1997. The full year average scrap purchase price declined only $1 per ton. There were numerous process improvements at the mills.
At our steel mills the major capital projects for fiscal 1999 are completion of the new rolling mill and ancillary equipment at SMI-South Carolina and the finishing upgrade (replace mill cooling bed, straighteners and stackers) at SMI-Alabama. Start up of both is scheduled to begin during the first calendar quarter of 1999. The South Carolina project ultimately will more than double capacity, reduce costs, and broaden the product range. At Alabama we will improve quality, enhance efficiency and broaden the product line. Combined these capital investments will materially strengthen our position in the Southeast and South Central U.S.A.
Fiscal 1998 also was a record year in steel fabrication. Operating profit in our steel fabrication businesses was substantially above last year's fourth quarter with strong results in almost all product areas. Fabricated shipments of 237,000 tons were a record for any quarter and compared with 190,000 tons in the same period the prior year. Shipments for the year were a record 839,000 tons against 690,000 tons last year. The average fab selling price rose $14 per ton for the quarter and $10 per ton for the year, but the mean price is also a function of product mix. We anticipate that growth will continue for rebar fabrication, joists, structural steel, posts, concrete related products and heat treating of steel.
The Steel Group computer migration project tax effected expense was $5.6 million compared with $3.8 million last year. We also incurred final pension settlement costs of $2.2 million after tax. Computer migration costs will be much lower in fiscal 1999.
We are seeing some evidence of stepped up consolidation and rationalization in the steel producing and steel fabrication industries. This should be beneficial.
The Copper Tube Division operating profit was above the comparable quarter last year, but down slightly for the year. Demand for plumbing tube was good, although spreads remained tight because of increased supply in the market. Margins were "moderate" in the fourth quarter. Annual production was up 4%. Our copper tube shipments increased 11% over the fourth quarter last year, and for fiscal 1998 were 11% higher at 51 million pounds. The internal focus will continue on process control, automation and productivity gains along with increased output of refrigeration tube.
Recycling Segment - Four consecutive years of good results in the Secondary Metals Processing Division (SMPD) came to an abrupt end in fiscal 1998, mainly due to the Asian economic crisis. Selling prices were decimated - both ferrous and nonferrous - and fell to their lowest levels in many years. Shipments also were affected. Scrap normally exported by competitors was diverted to domestic consumers. All of this caused margins to erode while total processing costs increased mainly due to acquisitions. The net effect was a moderate loss compared with a profitable fiscal 1997, and results were weakest in the fourth quarter. Depreciation also rose, but the corollary to this was that cash flow from operations remained positive.
Sales in the fourth quarter fell 33% and a loss was incurred. Ferrous scrap markets were in full retreat during the quarter and ferrous scrap sales were especially difficult. Nonferrous markets, which weakened earlier in the year, remained soft and the intake of scrap dropped. For the year the average copper and brass scrap price dropped 22%, aluminum fell 6% and steel scrap was unchanged; but in the fourth quarter all prices were about 20% below the previous year. Compared with last year the volume of ferrous scrap shipped increased 11% to 1.28 million tons; however, nonferrous shipments declined 11% to 188,000 tons, mostly because of a drop in copper and brass shipments. Total volume of scrap processed, including our CMC Steel Group processing plants, reached 1.95 million tons.
During the year we made several relatively small acquisitions within our existing geographic areas. In the fourth quarter we started up a new shredder in Jacksonville, Florida and a new shear in Odessa, Texas.
Toward the end of the year the SMPD reorganized into five regions, each being autonomous and a profit center. This structure should provide better coordination of processing equipment, personnel, marketing strength, sourcing and management.
Although the near-term market outlook is poor, our goal is to improve profits in fiscal 1999 to at least breakeven based on aligning costs with margins, a modest tonnage increase and stabilized product prices. An improvement in gross margins could begin during the second quarter. The key to an increase in profitability will be turnarounds at the plants that performed poorly last year.
The long-term outlook for ferrous scrap demand remains positive. Additional electric arc furnaces requiring scrap as a raw material are under construction. We also expect the long-term nonferrous scrap markets to grow, stemming from rising consumption in developed and emerging countries. On the other hand, competition in the scrap processing industry will remain keen.
It appears that the extensive consolidation that had begun within the industry has abated. One of the major consolidators already has announced that it plans to divest its metal operations. Many of the consolidators' acquisitions were made at what we considered high valuations. Our strategy is to make only very selective acquisitions that significantly help our competitive position in a region and capital expenditures that markedly improve productivity and quality; simultaneously, we will consider divesting certain assets at favorable prices and will continue to consider ventures that improve our market position and return on net assets.
Marketing and Trading Segment - Our results in this segment have been consistently good. Operating income was 17% higher than last year while revenues were up 4%, and the fourth quarter was strong on higher sales. This was a remarkable performance given the demise of our traditional Far East markets. Purchases from new sources in the Far East, meanwhile, increased significantly. Shipments into North America were brisk for most product lines, and business in Europe increased; however, our sales to Asian markets were sharply reduced.
Operating profits from steel marketing and distribution increased; however, profitability in steel trading decreased because of reduced volume and margins. We achieved further growth for nonferrous metal products including aluminum, copper and copper alloy semis. It was another successful year in ores, minerals, special metals and industrial products; meanwhile, we added several new marketing channels. We continued to diversify our sourcing and customers in all product lines, and we have achieved notable growth in higher value added products. Overall we benefited from our ongoing effort to expand our marketing and distribution businesses. Last year we commissioned our steel heat treating venture in Australia, which should be profitable this year.
In spite of constant volatility around the world, our various divisions in this segment have developed a variety of trading relationships and strategic alliances that form the base of the business. Further, the divisions constantly have developed new suppliers and customers to replace those that inevitably disappear. The key to CMC's success in this segment is to be compensated for performing diverse important functions for producers and consumers depending on the nature of the specific business. We continue to avoid speculation and to emphasize integrity, reliability and risk management.
Capital Plan - Capital expenditures in fiscal 1998 were $120 million including acquisitions. The capital plan for fiscal 1999 is $150 million, $113 million of which is related to carryover projects. Over 90% of the budget is allocated to our Manufacturing segment. As previously indicated, the focus of our capital plan is on operating efficiencies, lower costs, higher quality products and broader product lines.
Financial Analysis - Commercial Metals Company's financial condition remains sound. At the end of fiscal 1998 our stockholders' equity was $381 million or $26.18 per share. Net working capital was $247 million and the current ratio was 1.6. Long-term debt as a percentage of total capitalization declined to 30%, and the ratio of total debt to total capitalization plus short-term debt stood at 42%. Total assets exceeded $1 billion for the first time. The cash flow return on beginning equity was 26%.
On August 13, 1998, we filed a shelf registration for $200 million of unsecured debt securities with a plan to consummate in the near future the sale of $100 million of ten year notes. Our outstanding public long-term debt is investment grade, rated Baa1 by Moody's and BBB+ by Standard & Poor's and Fitch.
Near-Term Outlook - Despite the global weakness and import surge of low-priced steel into the U.S.A., our domestic steel markets are relatively firm and manufacturing margins should remain at a good level. It is likely that in the long products that we produce 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 our 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 in Recycling. Nevertheless, we anticipate an improvement in Recycling profits in the second half of the year, with some restoration of margins beginning in the second quarter.
We are cautiously optimistic for Marketing and Trading and anticipate 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, we plan to continue to capitalize on new marketing opportunities as a result of the dislocations throughout the world.
Our profit in fiscal 1999 will be affected by the two major project startups in the CMC Steel Group, higher depreciation and increased interest expense. On the other hand, we anticipate recoveries from the graphite electrode anti-trust litigation settlements. Also, our computer migration costs will be lower, and our only major pension plan was terminated. Cash flow from operations will, of course, benefit from the increase in depreciation.
This past spring the U.S. Congress passed and the President signed the new $217 billion six-year transportation bill known as The Transportation Equity Act for the 21st Century (TEA-21). 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. Consequently, your 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.
Our long-term prospects remain encouraging. Some of the reasons for optimism include:
/ first-class capable people are spread throughout our company
/ we expect to see continued high growth rates in the Sunbelt
/ our capital projects will contribute significant incremental profits, particularly at the South Carolina mill
/ major computer migration costs will be behind us by the end of fiscal 1999
/ high cost producers will be compelled to reduce output on account of the low prices prevailing
/ 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 aforementioned TEA-21 Federal spending in the U.S. will boost demand for steel long products.The sections regarding near and long-term outlook in the President and Chief Executive Officer's letter to stockholders in this report 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 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.
 |
 |