Commercial Metals Co (CMC) 2014 Q3 法說會逐字稿

Hello, and welcome, everyone, to today's Commercial Metals Company's third-quarter fiscal 2014 earnings call. Today's call is being recorded. After the Company's remarks, we will have a question and answer session, and we'll have a few instructions at that time.

I would like to remind all participants that during the course of this conference call, the Company will make statements that provide information other than historical information, and will include expectations regarding political and economic conditions, future events, and the Company's future results, prospects, operations, and capital spending. These statements are considered forward-looking and may involve speculation and are subject to risks and uncertainties that could cause actual results to differ materially from those expectations. These statements reflect the Company's beliefs based on current conditions, but are subject to certain risks and uncertainties, including those that are described in the Company's latest 10-K.

Although these statements are based on management's current expectations and assumptions, CMC offers no assurance that events or facts will happen as expected. All statements are made only as of this date. Except as required by law CMC does not assume any obligation to update them in connection with future events, new information, or otherwise.

Some numbers presented will be non-GAAP financial measures, and reconciliations can be found on the Company's earning release or on the Company's website. And now, for opening remarks and introductions, I will turn the call over to the Chairman of the Board, President, and Chief Executive Officer of Commercial Metals Company, Mr. Joe Alvarado. Please go ahead, sir.

Good morning. And thank you for joining us to review the results of CMC's fiscal 2014 third quarter. I will begin this session with highlights from the quarter. Barbara will then provide further financial details and I will conclude our prepared remarks of comments on our outlook for the fourth quarter of fiscal 2014, after which we will open the call to questions.

As detailed in our earnings release this morning, we reported net sales of $1.8 billion for the third quarter of fiscal 2014, which was 3% higher than our net sales for the third quarter of fiscal 2013. This increase in net sales is noteworthy, as it marks the first quarter over quarter topline growth in over two fiscal years.

For our third quarter of fiscal 2014, we reported earnings from continuing operations of $23.8 million or $0.20 per diluted share, which is an increase of $0.04 per diluted share when compared to the same quarter in the prior year. The results for the third quarter mark our 11th consecutive quarter of profitability, and as anticipated, results from the third quarter improved over results for the second quarter by $0.11 per diluted share.

As indicated in the earnings release, the Board of Directors declared a dividend of $0.12 per share for shareholders of record on July 10, 2014. The dividend will be paid on July 24, 2014. There were a number of factors influencing our third quarter results, and I would like to make a few comments on market conditions as well as comment on some of our strategic themes.

The US economy has been trending up in recent months with strong job growth, further reduction in the budget deficit, and improvements in construction and manufacturing activity. American manufacturing grew in May at the fastest rate of calendar 2014 with the Institute for Supply Management Index posting 55.7 points. 17 of the 18 sectors tracked by ISM reported growth in May compared to 11 in January.

In light of these encouraging trends, we believe that projected GDP growth of 2.4% for 2014 appears achievable. Many of the key US economic indicators that are relevant to our businesses remain strong. Construction spending increased in April, primarily due to growth in nonresidential construction.

As it relates to the renewal of federal funding of transportation programs, we are encouraged by the dialogue currently taking place in Washington, D.C. to find a long-term solution for the necessary rebuild of the US infrastructure system, we anticipate another short-term extension of the existing building while Congress debates the various funding alternatives.

The Highway Trust Fund is running a deficit. However, we anticipate that Congress will make a one-time transfer out of the general fund into the Highway Trust Fund prior to the expiration of the current bill at the end of September 2014.

As an update on the anti-dumping and countervailing cases before the U.S. Commerce Department, a preliminary ruling was issued on anti-dumping duties for Turkish and Mexican importers of reinforcing bar. The department ruled against instituting any meaningful anti-dumping duties on Turkish producers. We were disappointed with the ruling, as Turkish imports into the US continue to negatively impact our business and capture market share in the markets in which we operate.

However, this was only a preliminary decision. We were hopeful that upon further review by the US Commerce Department, Turkish margins will increase in the final determination. On the other hand, the preliminary ruling instituted significant anti-dumping duties on Mexican importers. Mexico has since essentially pulled out of the US market.

On June 13, 2014, we completed the purchase of substantially all of the assets of a small recycling facility in San Antonio, Texas. This acquisition supports our vertical integration model by protecting the raw material supply for our CMC Steel Texas mill location. It also establishes a larger recycling presence in San Antonio and provides an opportunity for continued growth of our recycling operations in the Central Texas area.

The Texas market is seeing increased competition, with scrap exports to Mexico and offshore. In addition to our acquisition of the recycling facility, we purchased a new shredder. And we are in the process of strategically evaluating alternatives for the location of this shredder.

At our South Carolina mill, we experienced a 12-day unplanned outage in May. We were able to continue shipping during the outage due to safety stock as we were ramping up for the busy summer months. However, we depleted critical inventory stocks to support the busy summer season and we will be working hard to replenish safety stocks in the months ahead.

Shifting to our international markets, during the third quarter we successfully commissioned the new modern electric arc furnace in Poland. We are pleased with the performance of the furnace thus far, which has met all certified performance targets to date. We were able to leverage our knowledge from the start of the electric arc furnace in South Carolina and during the fall of 2012 to facilitate the startup in Poland.

With this implementation, we expect to realize efficiencies and improvement of the overall cost performance of our melt shop in Poland in fiscal 2015.

Poland's economic growth has accelerated to the fastest pace in two years due to record low borrowing costs. While this improvement has revived the investment in consumer spending, political uncertainty in the region has impeded business confidence and margin recovery. We continue to monitor the situation in the region as well as the turmoil in the Middle East.

Meanwhile, eurozone growth is at a three-year peak, and the recent allocation of eurozone funding to Poland will help support strong activity levels for the next several years.

We remain focused on reducing costs and improving working capital efficiencies, with particular emphasis on our Australian operations, which have faced difficult market conditions for the past year. We were making solid progress and our Australian operations have reported improvements in profitability. Anticipated economic stimulus by the new Australian government has been slow to materialize and we anticipate low levels of demand to continue.

With that overview, I will now turn the discussion over to Barbara Smith, Senior Vice President and Chief Financial Officer. Barbara?

Thank you, Joe, and good morning, everyone. As Joe mentioned, for the third quarter of fiscal 2014, we reported earnings from continuing operations of $23.8 million or $0.20 per diluted share, which compares to earnings from continuing operations of $18.4 million or $0.16 per diluted share for the third quarter of the prior year.

This year's third quarter results included after-tax LIFO income of $5.3 million or $0.04 per diluted share, compared with after-tax LIFO income of $10.7 million or $0.09 per diluted share during last year's third quarter.

Turning to our results by segment, our Americas recycling segment reported an adjusted operating loss of $1.1 million in the third quarter of fiscal 2014 compared to adjusted operating profit of $3.2 million in the third quarter of fiscal 2013. Although ferrous to nonferrous shipments increased 1% and 4%, respectively, an unfavorable change in pretax LIFO income and an increase in employee-related expenses accounted for the decline in adjusted operating profit when compared to the third quarter of fiscal 2013.

Our Americas mill segment recorded adjusted operating profit of $74.1 million for this year's third quarter compared to $46.6 million during the same period last year. As noted in our earnings release, this segment recorded its highest quarterly adjusted operating profit in over five years. Average selling prices for this segment increased 2% and tons shipped increased 15%. Additionally, the average cost of ferrous scrap consumed decreased 1%, which contributed to a $15 per short ton, or 5% increase, in the average metal margin.

Americas mill segment, also recorded and $8.8 million favorable impact to pretax LIFO income when compared to the third quarter of fiscal 2013.

Our Americas fabrication segment recorded reported adjusted operating profit of $1.2 million for this year's third quarter compared to the prior year's third quarter adjusted operating profit of $13.5 million. The average selling price for this segment decreased 3% over last year's third quarter average selling price while tons shipped increased 12%.

Although net sales were up in the third quarter of fiscal 2014 when compared to the third quarter of fiscal 2013, adjusted operating profit declined due to margin compression from increased input cost prices. Despite continued import activity, we were able to increase volumes. As of the end of the third quarter of fiscal 2014, this segment's backlog was up 16% over the third quarter of fiscal 2013.

Our international mill segment continued to show improvement over fiscal 2013. Adjusted operating profit for the third quarter of fiscal 2014 was $2 million compared to adjusted operating loss of $3.8 million for the same period last year. This segment's average selling price increased 5% over the third quarter of fiscal 2013 with volumes remaining steady at 322,000 tons shipped.

Additionally, the cost of ferrous scrap consumed decreased 1% over the third quarter of fiscal 2013, contributing to a $31 per short ton increase in metal margin. However, adjusted operating profit from our international mill segment declined $6.3 million over the second quarter of fiscal 2014, due to margin increases and margin pressures, regional competitors attempted to grab market share, as well as the shift in product mix from merchant products to rebar, due to normal seasonality.

Our international marketing and distribution segment reported adjusted operating profit of $1.5 million for the third quarter of fiscal 2014 compared to adjusted operating profit of $7.7 million during the third quarter of fiscal 2013. The primary driver of the decrease in adjusted operating profit for these divisions was an $11.2 million unfavorable change in pretax LIFO income from the third quarter of fiscal 2013.

Our Australian operations reported an improved performance year-over-year, partially offset by a decline in performance at our European operations. Despite continuing aggressive competition in Australia, cost improvements have resulted in the improved operating results for this division.

Turning to our balance sheet and liquidity, our balance sheet remained strong. Cash and short-term investments totaled $437.2 million as of May 31, 2014, an increase of $58.4 million over the balance as of August 31, 2013. [$94.3 million] of this increase came from operations.

As the spring construction season moved into full swing during the third quarter, our previous inventory build over the winter months began to convert to sales and receivables. Over the remainder of the fiscal year, we anticipate these receivables will convert to cash. Total liquidity was approximately $1 billion as of May 31, 2014.

For added flexibility, we continue to maintain significant unused credit lines. Yesterday we amended the terms of our US revolving credit agreement, which increased its capacity under this agreement to $350 million, and extended the maturity date to June 2019. Additionally, the amended agreement provides for more favorable covenant terms.

Capital expenditures were $31.5 million for the third quarter of fiscal 2014. That is compared to $21.2 million in the prior year's third quarter. We estimate that our capital spending for fiscal 2014 will be in the range of $130 million to $140 million.

Thank you very much and now I will turn it back to Joe for the outlook.

Thank you, Barbara. We anticipate that our operational results for the fourth quarter of fiscal 2014 will remain consistent with results for our fiscal 2014 third quarter.

The American Institute of Architectural Building Index -- ABI -- for May, rose a full 3 points over April to 52.6, indicating positive directional growth in the US construction markets.

On the rebar import front, we saw a slowdown from Mexico during the third quarter of fiscal 2014 and we plan to continue monitoring the volume of rebar imports from Turkey and other European and Asian countries until the pending countervailing and anti-dumping decisions are finalized by the US Commerce Department, which we expect to take place in the latter part of 2014.

Lastly, as a result of the new electric arc furnace at our Polish operations successfully commissioned during the third quarter of fiscal 2014, we anticipate that our international segment will begin to benefit from productivity and cost improvements in fiscal 2015.

Thank you very much for your attention. We will now open the call to questions.

(Operator Instructions) Sal Tharani, Goldman Sachs.

Thank you. A couple of things on your guidance; when you say operational performance will be the same, do you generally talk ex-LIFO, because LIFO could change quarter to quarter, or you include that in your outlook?

Yes. Typically, Sal, we don't include LIFO in the outlook unless we have a pretty good sense of what direction it is going to move. And it is a little too early to have a good indication of that. And so that is without considering any impact of LIFO.

Okay. And, how is -- I don't know if you made a comment. I'm sorry I missed the earliest part of your prepared remarks. In terms of backlog, at your downstream business, have you seen any change is coming out of the winter going into the summer over the last few months and the order rate and so forth?

Last quarter, we reported record backlogs. And backlogs have remained steady. One of the things that we are doing, Sal, is obviously to shore up the business and take advantage of demand is we are being more discriminating about the kinds of businesses or projects that we are booking. So, we are good with the backlog and our objective is to continue to improve the quality of the backlog.

Evan Kurtz, Morgan Stanley.

My first question is on the trade case. So I guess it is kind of a parallel situation right now with OCTG in Korea. And a lot of the petitioners here in the US have dug through the details on the questionnaires and kind of uncovered that they have been quite aggressive with what they are using for home market pricing, using other products at much lower quality and that sort of thing.

I was wondering if you guys have done any sort of analysis. And have you been working with the Department of Commerce at all to try to help them work through the questionnaires with regards to rebar in Turkey?

Well, the DOC is in the discovery phase, so we had our chance to respond to the preliminary determination and, yes, we gave them a lot of input on what we believe to also be some discretionary calculations, which didn't seem to be consistent with past precedent. So yes, we have given guidance and we have commented and we have worked through our lawyers on that.

And of course the DOC, through their discovery process, will hopefully take some of that into consideration. And that is one of the reasons why we anticipate that there could be some adjustments to the Turkish preliminary, because of concerns we had about some of the calculations, particularly -- I will use as an example -- on energy.

Great. Thanks. And, second question is maybe also on fab. It seems like back logs are up. Nonres seems to be showing a little bit of improvement and the profitability is down year-on-year in fab, and we are pretty far away from pre-crisis levels. It seems like in rebar, on the steel mill side we are almost kind of back to pre-crisis levels and profit per ton.

Is there anything that has changed in that business? And what it is going to take -- what it is what is it going to take to get back to the $50 a ton type of profitability levels in that business?

Evan, I would answer that question by saying that it is going to take stronger demand across the board. We see -- we are particularly fortunate in Texas to see an awful lot of construction activity and projects. Initially, or for most of the time recently, that has been restricted to North Texas. But the Eastern market has picked up considerably.

California market has picked up, and I have mentioned before, South Florida and the Beltway. But there are still a lot of points in between where there aren't as many projects or there isn't as much construction activity, particularly in the desert states, for example. So it takes stronger demand overall for margin expansion.

And that is why I commented that we are holding steady on our backlog, because we are being more discriminating and trying to cull through projects that make more economic sense for us to fill our facilities with those kinds of activities as opposed to taking marginal business.

So that demand is improving, but as you said, Evan, it is incremental. And it is not across the board, but all the indicators in terms of non-residential construction forecasts, as well as the ABI index, would suggest that there is continued demand and growth for construction activity.

I would further add, Evan, that as the demand materialized and you have stronger market conditions, fab is going to be chasing higher rebar prices up. And that will pressure them initially, but with stronger demand, they will be able to then catch up to the higher rebar prices and expand margins.

Luke Folta, Jefferies.

I am having trouble understanding something on the international mill business. It looks like shipments are up, prices are up, metal margins are up. And there is no LIFO issue, obviously, there.

So I guess what has changed in terms of -- I mean, is or something on the cost side, maybe to ramp up the new furnace or something, that is impacting profitability there sequentially?

Yes, so let me just distinguish between startup of the mill, which has really gone very well, and startup-related costs. Prior to the build up -- or prior to the shutdown of the furnace, we built inventory. And, unfortunately, concurrent with that inventory build, there is very competitive pricing on rebar in the Eastern European regions. So we didn't have any chance for margin expansion.

We had -- our costs were buried or sunk in prior period. And there was also a mix element associated with what we call seasonal activity. Rebar shipments increased as a percentage of our total shipments, and so that is what we absorbed most of the margin compression.

Market activity is good and, as you know, year-on-year, much better in Eastern Europe. Certainly we reversed the losses from a year ago. And the market continues to strengthen. But the economic uncertainty is what creates, I'll say, hesitancy and a lack of confidence.

So it is a very aggressive market. The iron ore prices tend to influence thinking, as do scrap prices, and regionally there is a mix of competitors that have become more aggressive on supplying rebar. And we just have to deal with that competitively.

And, as the market strengthens, or confidence improves, we will see and expect increased margin. But, not sitting still; part of the reason for the upgrade in the furnace was to improve our cost efficiency and effectiveness.

Luke, last quarter I tried to indicate, when you have that long outage, our conversion costs, bottom line this quarter, is up substantially over the prior quarter. And you have a lot of unabsorbed burden when you have in the melt shop down for an extended period of time. So it is really, in a lot of ways, related to the installation of the new furnace, not, as Joe pointed out, due to any difficulty with the installation, but just the sheer fact that the melt shop was not operating. And our conversion cost, consequently, was higher. We do expect that to come back in line in the coming quarters.

Okay. But, to dig in a little bit on that, so if we look sequentially -- and I hear what you're saying on the competitive side -- but the metal spread as reported was up $12 a ton quarter over quarter. EBIT was down from [eight and change to two]. Should we think of virtually all the deterioration in margin there being related to that conversion cost, which should ultimately kind of reverse? Or was there any other factor there, or is that kind of $6 million sort of the number to think about or something beyond that, because metal spreads are actually higher?

Yes. Basically, conversion costs were up some $25, $26 a ton, quarter over quarter. We may not get all of that back in the fourth quarter, but over time it will come back down in line.

Understood. Okay. And then, any color on what is happening with the international trading -- or the marketing distribution segment? FIFO margins there are also a bit lower than what we have seen in a while. Was there any sort of -- was there any one-time factors there or is it just a more competitive situation? Any color there would be helpful.

No. There is no one-time factor. We have commented in the past about tighter and tighter margins in Asia, in particular, and trading activity really throughout the world is really very competitive. So I think it is common to any trading business in this kind of environment, when there is excess capacity or supply and short lead times in domestic markets, that it become markets a more competitive business not only in price, but in margin.

So there is nothing extraordinary. It is a one time. This is something that we have been working with for really the last two years, maybe exacerbated a little bit by the situation in China continuing to -- well, not improve, I'll say, as opposed to deteriorate.

Timna Tanners, Bank of America.

I just want to clarify on the guidance. Maybe this wasn't clear to me. It is Friday. But, it seems to me like you are talking about an ex-LIFO kind of similar fourth fiscal quarter from the third quarter. But, at the same time, maybe some of these outage costs in the international mill side are going to roll over.

I know more about is going to show up in your fiscal 2015 environment, but you are also talking about non-res improving. So, why wouldn't it be an improvement quarter over quarter? What are you seeing that might impede that?

Well, I think -- I will make a comment and then Joe can embellish. We are not suggesting that it is not going to be precisely a $0.20 quarter and that there might not be some improvement. But, clearly, I think the Street expectations have gotten out a little bit ahead of the true recovery, and clearly the import situation is continuing to pressure margins. And until this is ultimately resolved, and if Turkey is allowed to continue at the pace that they have been, that is going to be a headwind in the future.

Yes. I guess what I would add to that, Timna, is that the growth in rebar demand, while we have seen some growth ourselves, growth in rebar demand overall in the US has mostly been absorbed by imports. So I think everyone in the rebar business is challenged to grow market share because of the sheer volume of imports.

And while the licensing is down, presently, imports are kind of lumpy anyway. They don't come in consistently month after month. Sometimes it is just a timing issue.

So we don't anticipate there is any difference to be expected from Turkish imports. We monitor it, but with the preliminary orders, there is no reason for them not to ship product.

Okay. That's super helpful. And then, my other question was really on CapEx just because the guidance maintains $140 million for your fiscal year, and on the run rate we would need to see a big increase in the fourth quarter. So if you can just remind us of your CapEx plans and your vision for growth there? Thanks.

Yes. Well, we are anticipating higher expense in the fourth quarter and we have struggled to spend our CapEx guidance over the last couple of years. And it is a function of two things. One, just building the momentum of getting the projects moving and keeping that spending sustained quarter over quarter. And second is being very discriminating on the projects.

And one major project that was in our 2014 CapEx plan was a similar project to the downstream recycling project that we installed in last year, which has been highly successful and we are generating a number of benefits from that.

However, as you know, non-ferrous prices have fallen off dramatically. And so we slowed that project down to assure ourselves that it made good economic sense. So that is an example of a project that probably would have started earlier in the year.

We still think it is a good project. It is still part of our plan, but it is one that we have delayed the actual start of the project to rerun the economic analysis and make sure the returns are up to our expectations.

Okay. So, is that saying you might not spend it all or that there's projects that we have to wait and see what happens to them? I'm sorry. I'm not following.

So, let me just try and build upon that a little bit, Timna. We reprioritize projects all the time. And the downstream project that Barbara is referring to in South Carolina was in our plan and we have deferred that. And, in all likelihood, we would do that at a later date. But it was a significant project and we didn't throw other projects right behind it, so that would moderate some of our spending.

So it is really a function of timing and prioritization as well as recognition of market conditions. And so what we are really successful with the Texas operation in building and starting it up in about an eight- or nine-month period, so within one calendar year, we deferred that project.

So we have lots of projects, but we don't go at them willy-nilly. They have got to be prioritized. They have got to be justified, and there was nothing the same size or magnitude. There were other smaller projects.

So we continue to spend capital as required and continue to believe in the business and growing the business. Our capital spending is up year on year and has each year, and our plans for next year would be at or above current projected levels even if we don't make them, at least above the $150 million level.

Phil Gibbs, KeyBanc Capital Markets.

First question was just on Joe's prepared remarks. Joe, was the safety stock piece just related to Poland? Or were you referring to the domestic business as well? I think I missed part of your comments.

Yes. That was referring to safety stock in South Carolina. We had an extended outage in South Carolina. It was equipment-related in the melt shop. And so we depleted what is essentially a safety stock for the summer.

And so we are continuing to work hard to replenish that stock, but when you lose two weeks' production, it just makes things tight. So I don't we have had any issues with delivery or maintaining good performance with our customers. It is just a comment that we had an outage. And, obviously when you work through inventory, it is more hand to mouth in the mill, especially when the mill was busy as it normally is in the summer season.

Okay. Barbara, in IM&D any reason why there was a LIFO charge in the quarter? I thought that was just a bit unusual for that segment.

We have had fairly significant LIFO movements in M&D in the past. So it is not unusual and it is just a function of the inventory evaluation method that we have selected. If you look at M&D on a FIFO basis, year-over-year the segment is up quarter over quarter and it is about flat or even. So when we look at it on a FIFO basis, that is where we expected it to be.

And I think as Joe said earlier, there is parts of that business where activity level is good, such as our steel trading. And then there is parts of the business that are weaker, like our Australian piece of the business. But the reason for the improvement year-over-year on a FIFO basis is the work that is being done to improve the business in Australia.

Okay. Just have a real quick one. I appreciate that, Barbara. The nonferrous scrap business in recycling, how much of that would be stuff like the byproduct coming out of the separation downstream equipment versus other metals, meaning how much is stuff like zorba versus maybe some of the cleaner stuff you pick out on the front end? Thanks.

Phil, I am shaking my head because I am not sure I could measure the difference -- or I can give you data on the measured difference. I know we have data that we could look at, but it would be the increment over what we have been processing before we had the downstream. Perhaps we can get back to you on that one. I would rather give you good information than guess. And we would be guessing right now.

I was just curious on not even the split, but is it, call it a mild portion in things like zorba versus a major portion? And if you had just any general color, that would be fine. Thanks.

Yes. The general color -- the best way I would describe it generally is that the downstream allowed us to pick up another 8% to 9% in metallic recovery from what we had been collecting. Hence, that was the justification for the investment. So we think of it incrementally as the additional recovery and the economics associated with that recovery, as opposed to the separation to zorba or other categorizations. At the end, there is always some material left over that ends up going to landfill. We will recover as much of the metallics as conceivably possible. So if you have more questions, we can follow up on that, Phil.

Nathan Littlewood, Credit Suisse.

Just wanted to ask a point of clarification of the guidance. Am I correct in saying that the embedded expectation with the guidance that you have given is that the Turkish import volumes in rebar will continue at current levels? And, therefore, by implication, the guidance is based on an unfavorable final assessment on those anti-dumping duties?

Well, I haven't thought of it in those specific terms, Nathan. Our guidance is really to give an indication of where we think the market is and, today, the Turks are a significant importer. I guess what I would say is that, if the Turks were not in the market, there would certainly be a different opportunity for margin spread.

But there is always inventory, Nathan, and inventory needs to be worked off. So I can't tell you where some of the distributors are with their Turkish inventory. I don't know that we would see something have an immediate impact with the different ruling, and the final ruling doesn't come until later in the year. I believe -- well, September is the next hearing, but the final ruling is late October, early November timetable. So we are already talking about 2015 fiscal year.

So, with the preliminary determinations, we expect to see imports at a high level and we expect them to be disruptive.

We are not making any indication of where we think the final ruling will come out. It is hard to predict, as you know, and we are doing everything we can to present the facts.

Sure. Absolutely. And you guys usually have pretty good insight through your international marketing business on trade flows and that sort of stuff. What can you see heading here on rates at the moment in terms of long product tonnage?

So what I will do is talking a little bit more general terms about trade flows. Obviously, and this pertains to flat products as well as long products.

Import activity has picked up considerably and a lot of that owing to the fact that there is significant margin opportunities in North America where business activities seem to be more stable and level. And prices have tended to be higher. That is particularly true in flat products, whereas in long products I think market was -- reflected more of our cost structure and competitive nature in North American long products including rebar.

Generally speaking, the excess supply and availability in Japan is -- I'm sorry; in China -- is disruptive to overall trade flows and it continues to show up in different markets. But at the same time, lead times from China are quite long. So there is a risk associated with those leadtimes.

There is still excess availability in Europe. And, while demand is improving and forecasts for general economic growth are also improving in Europe, the excess supply would not reflect that same sort of improvement in operating rates. And, availability and lead time is much, much shorter on a domestic basis. In Europe, including deliveries from Russia, 1 to 6 weeks is what has been reported, so depending on product.

I guess a positive note is in our raw materials trading activities. There are some indications of improved demand on discrete products. Some products in particular are stronger than others.

And so, for the first time in quite a long time, we are seeing a little bit longer -- a little bit stronger demand and longer lead time on some products, which to us is always an encouraging sign of increased or improved business activity. And, certainly, continues to improve in North America at maybe a little bit better rate than the rest of the world.

Nick Jarmoszuk, Royal Bank of Canada.

Hi, most of my questions have been answered. I just had one remaining about inventory. It came in a little higher than I was looking. Can you talk about what is going on there and whether it is indication of increased demand in terms of how you are looking at the market, or how we should look think about inventories going forward? Thanks.

Yes. I think as we indicated in our prepared remarks, first of all, inventory levels are higher because activity levels are higher in certain parts of the business. And so, that will naturally make your inventory levels drift up. We are still in the process of working down inventory that we built up in Poland for the outage and they did see a decrement this past quarter, but we expect that to continue on into the fourth quarter.

And we do expect a nice working capital release between now and late fall, when the business activity level drops seasonally and then again it will pick back up going into the new year.

Brian Yu, Citigroup.

First question is just on the Fab business. I think you had mentioned that there was some margin compression and some pricing lags, and that impacted profitability. Would you help us quantify or something to think about what that pricing lag impact is?

Well, I am trying to make sure I give you a good answer. In each of the regions in which we operate, there are different economic conditions and scenarios.

Where you sit in San Francisco, business activity levels are strong and we have seen increased construction in fab bidding activity. There was a freight component associated with what we do in Northern California, but in general, the fab market has picked up in the -- stronger on the West Coast than it might be on the East Coast.

The central regions remain strong. So if you could rephrase the question, maybe I can give you a little bit better answer, but I am not sure what you are asking, Brian.

Sorry. You guys talked about the fab profitability, despite the volume improvement, it did not increase much. And I think mentioned in there was two things, one of them which is just the impact on margins from higher input costs. And I took that to mean increase in steel prices while your selling prices on an average basis actually declined. So I thought there was a negative margin impact from those two components -- input prices up, while your selling prices came down a little bit.

Yes. Well, absolutely, therein lies the margin squeeze. So, as Joe indicated, it is still really competitive out there. And we found it harder to continue to maintain the progress that we have been making in raising fab prices on an overall average basis. So you see average fab pricing is down some $25 a ton.

At the same time, for a portion of the quarter, you saw rising rebar prices. So you get a fairly significant margin squeeze associated with that.

So Brian, maybe one other thing to add is, when we are booking fab business, some of that -- those projects can be booked a year out. And we live with that cost. And part of the bitter scenario as we see it looking forward is the fact that the level of our private bidding activity, which normally has a much shorter leadtime from order intake to order delivery, thus less exposure, continues to expand. Bidding activity in the private sector as well as our booking activity is stronger, and that mix has shifted significantly towards a better mix.

It takes time for all of that to work its way through the system. And, at the same time, we are chasing the raw material cost across some rebar into the fab shop. So, some of the degradation in scrap pricing or the change in scrapped pricing creates some uncertainty in the fab business and can cause margins to be a little bit upset one way or the other. And the same is true when the prices are going up. There is a little bit of a chase, but in the aggregate, those margins can expand.

We are in favor of rising rebar prices. Right? And you can see the effect of that in the mill segment. It is just -- it takes fab a while to catch up to that rising price environment.

Yes. And that is what I was trying to separate, is there is the competitive pressure on margins and there is also just a lag affect where you might be bidding projects with greater profits built into it, but because rebar prices are going up, it takes time to -- for that business to catch.

Yes.

So in this quarter result, would you say most of it was just due to that timing and lag effect? Or it almost sounded, Barbara, that you mentioned maybe there is even additional competitive pressures, more than maybe we saw last few quarters.

Yes. There is additional pressure of all the rebar imports that we talked about end up in fabricators' hands. And so those fabricators will bid projects more aggressively because they have a price advantage. So when we talk about rebar imports, it is not just the rebar, but the fab business that is impacted.

And that is part of why we have been more discerning about the order book, because we are not going to chase orders that are based on import pricing, as that takes us nowhere. But there are plenty of fabricators who would use imported rebar as their raw material and have an advantage. And in those cases where we have had to meet situations, it causes compression. But that is why we will continue to work the order book in our fab business to be more discerning as activity picks up.

Okay. Can I get one more question in on fab?

Sure.

In the results, there was a very meaningful pick up in volumes, about 12%. And in the press release, you'd called out a 14% increase in labor costs. And I was wondering, the slight mismatch, is that because you are ramping up on the labor force, given the increase in backlog, so you got some negative short-term fixed cost leverage? Or is that maybe a reflection of additional overtime and catching up from the polar vortexes during the winter?

I am sure it is a combination of both, depending on the shop, but we have had to add personnel to recover the backlog and to take care of our customers. So I would say a significant portion of the increase is related to adding staff and manpower to meet the demand.

Frank Duplak, Prudential.

Just one for me. Barbara, can you give us any more detail on what that covenant changes were on the revolver?

There is some relief on -- I think we were pledging the stock of some of our subs, and that was removed, and some lightening on the interest coverage ratio. So, not significant, the biggest being no longer pledging the stock of the subs.

What is the new level for interest coverage in the document?

It flexes, but I think it goes to 2.5 from 3.

And then the debt to cap number stayed the same?

Yes.

Alyssa Johnson, D.A. Davidson.

Within the slot volume number for Poland, can you talk about the demand trend internally within Poland versus the region you export to from the mill?

Demand in Poland is strong. Typically, as we go into summer months there, starting with the spring, demand does increase significantly, particularly for rebar product. Merchant is a little bit less volatile, but this is a typical season when demand picks up. We are seeing good order demand.

We haven't had the same problem that we had a year ago when Latvian imports were a prevalent problem and consuming large market share. So we are not seeing anything abnormal. There is good business activity. There is lots of projects and good funding from eurozone money to continue to support infrastructure projects in Poland.

So we are confident that the Polish economy will continue to expand and grow and that we will have a significant role in supporting that construction activity.

Okay. Then just one more; can you talk about how volumes in the Americas mill developed during the quarter, particularly month-to-month? Do you think there was some pent-up demand following the difficult winter or more so than you seasonally tend to see?

Well, on account of the fact that there is more shipments in the aggregate, on a month-to-month basis, I am looking at it right now -- Barbara is getting the numbers. But, traditionally, well, there are two things. One is overall demand. The other thing that influenced monthly shipments is amount of shipping days that we have in any given month.

I will say that -- and this is not an uncommon phenomenon that shipments are also being impacted by transportation availability and transportation costs. So that is something we are working through and can also cause fluctuation. But generally speaking, our third quarter will be stronger on a volume basis than our second-quarter has been, because of the outages and because of the winter issues.

So I think we don't are seeing anything extraordinary. Barbara has the month-to-month numbers or she could give you an indication, directionally.

Yes. The total tons shipped did increase each month within the quarter, and it is very difficult for us to distinguish if there are -- how much of that was catch-up from the difficult winter. I guess I would say that we are not seeing a downward shift in the current month shipping rate, so think it is reflective of continued good demand.

John Tumazos, John Tumazos Research.

Thank you for taking my questions. I apologize in advance if there is two that are too much to the point. First question, why do you think US scrap prices are not something like $100 lower, given that iron ore has fallen about $100 over two years in spot markets and met coal has fallen $200 in three years. And second, do you think that your business would be healthier if scrap was lower and the finished steel price lower, reflecting world markets?

So, no need to apologize, John, for asking good questions. We will just try to answer them as best we can. First, on the iron ore and scrap relationship, there is no doubt there is a correlation in metallic pricing over time. And some of that is influenced, in fact, obviously, by availability. And, remember that scrap pricing can be very regionally different and there are significant regional differences.

So, what I expect that with ore prices at low levels or continued to decline that there wouldn't be a correlation, of course not. There would be continued movement. I guess the question is expectation of what happens with ore pricing. And there are arguments both ways that will improve, that will weaken, and I guess time will tell. And over time, iron scrap prices would reflect that metallic cost.

From a spread perspective in terms of whether it is $100 a ton or $100 a ton lower or higher, we price our product according to our cost. And at least in North America, there is a strong correlation between raw material costs in scrap and the electric furnaces and selling prices. And I don't anticipate that that is going to change dramatically, except that there could be some expansion in margin when demand increases.

So we are all for higher scrap prices and higher selling prices in rebar and higher selling prices of fab. But it is incumbent upon us to manage our margins and manage our costs. And that is one of the reasons that we have improved our EBITDA margin per ton is because we are working to shop hard to improve our cost competitiveness. And whether it is in raw material or alloys or labor costs or productivity, a lot of the CapEx that we invest is intended to keep us cost competitive.

At this time, there appear to be no further questions. Mr. Alvarado, I will turn the call back over to you.

Okay. Well, thank you, Betty, for moderating this for us. And thank you, everyone, for joining us on today's conference call. We appreciate your interest and your questions, and we look forward to speaking with many of you during the weeks ahead as we schedule investor visits and/or calls with individuals.

Thank you very much for your attention and time and wish you a safe and happy holiday season.

This concludes today's Commercial Metals Company conference call. You may now disconnect your lines.