Description
Filed with the SEC from April 12 to April 18:
Texas Industries (TXI)
NNS Holding owns 6,575,056 shares, (23.5%) after buying 332,597 from March 29 through April 11 at $33.40 to $35.37 each.
BUSINESS OVERVIEW
General
We are a leading supplier of heavy construction materials in the southwestern United States through our three business segments: cement, aggregates and consumer products. Our cement segment produces gray portland cement and specialty cements. Our cement production and distribution facilities are concentrated primarily in Texas and California, the two largest cement markets in the United States. Based on production capacity, we are the largest producer of cement in Texas with a 24% share in that state. Our aggregates segment produces natural aggregates, including sand, gravel and crushed limestone, and specialty lightweight aggregates. Our consumer products segment produces primarily ready-mix concrete and, to a lesser extent, packaged products. We are a major supplier of natural aggregates and ready-mix concrete in Texas and northern Louisiana and, to a lesser extent, in Oklahoma and Arkansas. For financial information about our business segments, see Note 10 of Notes to Consolidated Financial Statements in Item 8 of this Report.
As of May 31, 2011, we had 107 manufacturing facilities in six states. In fiscal year 2011, our net sales were $621.8 million, of which 39% was generated by our cement segment, 24% by our aggregates segment, and 37% by our consumer products segment. During the year, we shipped 3.3 million tons of finished cement, 12.1 million tons of natural aggregates, 1.1 million cubic yards of lightweight aggregates and 2.4 million cubic yards of ready-mix concrete.
Even though the national economy experienced some growth during fiscal year 2011, construction activity has remained at low levels. As a consequence, throughout fiscal year 2011 we continued with many of the steps that we began taking in fiscal year 2009 in response to the recession. We also continued to assess other actions that may help us reduce costs, conserve cash or improve our sales or operations. These steps and others are indicative of our intense focus on cost reduction, management of our cash position and management of production levels, which we believe had a significant positive impact on our operating results in the last two fiscal years.
During October 2007, we commenced construction on a project to expand our Hunter, Texas cement plant. In May 2009 we temporarily halted construction on the project because we believed that economic and market conditions made it unlikely that cement demand levels in Texas at that time would permit the new kiln to operate profitably if the project was completed as originally scheduled. We resumed construction in October 2010. The total capital cost of the project is expected to be between $365 million and $375 million, excluding capitalized interest, and commissioning is expected to begin within 24 months of the restart of construction. As of May 31, 2011, we have incurred approximately $310.5 million, excluding capitalized interest of approximately $35.0 million related to the project, of which $303.8 million has been paid.
In April 2011 we entered into an asset exchange transaction in which we acquired the ready-mix operations of Transit Mix Concrete and Materials Company, a subsidiary of Trinity Industries, Inc., that serve the central Texas market from north of San Antonio to Hillsboro, Texas. In exchange for the ready-mix facilities, we transferred to Trinity Materials, Inc., also a subsidiary of Trinity Industries, Inc., our aggregate operations at the Anacoco sand and gravel plant, which serves the southwest Louisiana and southeast Texas markets, and the Paradise and Beckett sand and gravel plants, which both serve the north Texas market.
We expect our capital expenditures in fiscal year 2012 to be approximately $35 million to $45 million, excluding those related to the construction of the Hunter cement plant expansion.
Our Competitive Strengths and Strategies
We believe the following competitive strengths and strategies are key to our ability to grow and compete successfully:
Leading Market Positions. We strive to be a major supplier in markets that have attractive characteristics, such as large market size, above average long-term projected population growth, strong economic activity and a year-round building season. Based on production capacity, we are the largest producer of cement in Texas (with a 24% share of total production capacity), and the second largest producer of cement in southern California. We believe we are also the largest supplier of expanded shale and clay specialty aggregate products west of the Mississippi River, the second largest supplier of stone, sand and gravel natural aggregate products in North Texas, one of the largest suppliers of ready-mix concrete in North Texas and one of the largest suppliers of sand and gravel aggregate products and ready-mix concrete in northern Louisiana. We believe our leadership in these markets enhances our competitive position.
Integrated Operations . Historically, a significant part of our operating approach has focused on the synergies available from operating in the cement, aggregate and ready-mix businesses. Our most recent acquisitions of aggregate and ready-mix plants in central Texas were aimed at improving our competitive position in that region. We plan to continue to assess opportunities to enhance our operations in similar ways.
Low Cost Supplier. We strive to be a low cost supplier in our markets. We believe we have some of the most efficient cement capacity in the industry. We focus on optimizing the use of our equipment, enhancing our productivity and exploring new technologies to further improve our unit cost of production at each of our facilities. Efficient plant designs, high productivity rates and innovative manufacturing processes are all results of our focus on being a low cost supplier.
Strategic Locations and Markets. The strategic locations of our facilities near our customer base and sources of raw materials allow us to access the largest cement consuming markets in the United States. Our cement manufacturing facilities are located in Texas and California, the two largest U.S. cement markets. During calendar year 2010, Texas and California accounted for approximately 11.4 million and 6.9 million tons, respectively, of cement consumption or approximately 15% and 9%, respectively, of total U.S. cement consumption. California and Texas have also been the largest beneficiaries of federal transportation funding during the last several years. Funds distributed under multi-year federal highway legislation historically have comprised a majority of California and Texas’ public works spending. Additionally, Texas utilizes private sources of funds for highway construction through public-private partnerships.
Diversified Product Mix and Broad Range of End-User Markets. Our revenue streams are derived from multiple end-user markets, including the public works, residential, commercial, retail, industrial and institutional construction sectors, as well as the oil and gas industry. Accordingly, we have a broad and diverse customer base. Our diversified mix of products provides access to this broad range of end-user markets and helps mitigate the exposure to cyclical downturns in any one product or end-user market. No one customer accounted for more than 10% of our net sales in fiscal year 2011.
Long-Standing Customer Relationships. We have established a solid base of long-standing customer relationships. For example, our ten largest customers during fiscal year 2011 have done business with us for an average of over 18 years. We strive to achieve customer loyalty by delivering superior customer service and maintaining an experienced sales force with in-depth market knowledge. We believe our long-standing relationships and our leading market positions help to provide additional stability to our operating performance and make us a preferred supplier.
Experienced Management Team. Mel Brekhus, our chief executive officer, Ken Allen, our chief financial officer, Jamie Rogers, our chief operating officer, and the vice presidents for the cement, aggregates and consumer products segments have an average of almost 23 years of industry experience. Our management team has led our company through several industry cycles and has demonstrated the ability to successfully complete and operate major expansion projects.
Products
Cement Segment
Our cement segment produces gray portland cement as its principal product. We also produce specialty cements such as masonry and oil well cements.
Our cement production facilities are located at three sites in Texas and California: Midlothian, Texas, south of Dallas/Fort Worth, the largest cement plant in Texas; Hunter, Texas, between Austin and San Antonio; and Oro Grande, California, near Los Angeles. The limestone reserves used as the primary raw material are located on property we own adjacent to each of the plants. Additional information about our cement production facilities and associated limestone reserves is provided in Item 2, Properties, of this Report.
Due to the recent recession, we modified our operating processes in order to reduce costs and more closely match cement production to demand in our markets. We temporarily idle each of our dry process gray cement kilns from time to time in order to control inventories. We shut down the four wet process kilns at our Midlothian, Texas plant which were less efficient than the large dry kiln at that plant. Finally, the white cement production facility at our Crestmore plant near Riverside, California remains idled. We continue to operate a cement terminal and packaging facility at the Crestmore plant, and we operate its gray portland cement grinding facility on an as needed basis.
In July 2010 we decided to surrender the operating permits for the four wet kilns at our Midlothian plant, which had a rated annual production capacity of 600,000 tons of clinker. We plan to replace the production capacity of the wet kilns by increasing the much more efficient capacity of the large modern dry process kiln at the plant. Closing the four wet kilns is expected to allow us to obtain the permits needed to enhance and optimize the dry kiln. We do not know when market conditions will support the enhancements. As a consequence, we cannot yet estimate the cost or schedule for the enhancements.
The primary fuel source for all of our facilities is coal. At our Hunter, Texas plant we also use alternative fuels. Our facilities also consume large amounts of electricity. We believe that adequate supplies of both fuel and electricity are available.
We produced approximately 3.3 million tons of finished cement during fiscal year 2011. We shipped approximately 3.3 million tons during the year, of which 2.7 million tons were shipped to outside trade customers. At May 31, 2011, our backlog was approximately 551,000 tons, approximately 161,000 tons of which we do not expect to fill in fiscal year 2012. At May 31, 2010, our backlog was approximately 509,000 tons.
We market our cement products in the southwestern United States. Our principal marketing area includes the states of Texas, Louisiana, Oklahoma, California, Nevada and Arizona. Sales offices are maintained in the marketing area and sales are made primarily to numerous customers in the construction industry, no one of which would be considered material to our business.
Cement is distributed by rail or truck to 8 distribution terminals located throughout the marketing area. Transportation costs vary depending on the mode of transportation utilized.
Aggregates Segment
Natural Aggregates. Our natural aggregate operations produce sand, gravel and crushed limestone. These operations are conducted from facilities primarily serving the Dallas/Fort Worth, Austin and Houston areas in Texas; the southern Oklahoma area; and the Alexandria and Monroe areas in Louisiana. On April 1, 2011, in an asset exchange transaction we transferred to Trinity Materials, Inc. our Anacoco sand and gravel plant, which served the southwest Louisiana and southeast Texas markets, and our Paradise and Beckett sand and gravel plants, which served the north Texas market. Additional information about our natural aggregates production facilities and associated reserves is provided in Item 2, Properties, of this Report.
We produced approximately 13.2 million tons of natural aggregates during fiscal year 2011. We shipped approximately 12.1 million tons of natural aggregates during fiscal year 2011, of which 9.5 million tons were shipped to outside trade customers. At May 31, 2011, our backlog was approximately 1.6 million tons, approximately half of which will be shipped in 2012. At May 31, 2010, our backlog was approximately 1.5 million tons.
The cost of transportation limits the marketing of aggregate products to the areas within approximately 100 miles of the plant or terminal sites. Sales are therefore related to the level of construction activity near the plants and terminals. The products are marketed by our sales organization located in the areas served by the plants and terminals and are sold to numerous customers, no one of which would be considered material to our business.
Products are distributed to trade customers principally by contract or customer-owned haulers or through rail distribution facilities. To enhance our efficiency and competitiveness, particularly in sales of crushed stone, we strive to establish direct rail links between production facilities and our key markets, reducing the cost of transportation. We have installed rail capacity at our crushed stone plants and 6 rail terminals close to major markets, which allow rapid loading and unloading of product. In local areas surrounding our rail terminals, we believe we have a transportation cost advantage over some competing suppliers who rely to a greater extent on truck transportation.
Lightweight Aggregates. Expanded shale and clay, a specialty lightweight aggregate product, is manufactured from facilities serving the Dallas/Fort Worth, Austin and Houston areas in Texas; the Oakland/San Francisco and Los Angeles areas in California; and the Denver area in Colorado. Additional information about our lightweight aggregates production facilities and associated reserves is provided in Item 2, Properties, of this Report.
We produced approximately 1.0 million cubic yards of lightweight aggregates during fiscal year 2011. We shipped approximately 1.1 million cubic yards of lightweight aggregates during fiscal year 2011, of which approximately 0.9 million cubic yards were shipped to outside trade customers. At May 31, 2011, our backlog was approximately 110,000 cubic yards, the majority of which will be shipped in 2012. At May 31, 2010, our backlog was approximately 125,000 cubic yards.
The cost of transportation limits the marketing of most lightweight aggregate products to the areas within approximately 200 miles of the plant or terminal sites. Sales are therefore related to the level of construction activity near the plants and terminals. The products are marketed by our sales organization located in the areas served by the plants and terminals and are sold to numerous customers, no one of which would be considered material to our business.
Products are distributed to trade customers principally by contract or customer-owned haulers and, to a lesser extent, by rail. Certain specialty products we have developed from our expanded shale and clay, such as DiamondPro ® baseball infield conditioner, have developed a geographically dispersed customer base and are shipped to a significant portion of the continental United States.
Consumer Products Segment
Ready-mix Concrete. Our ready-mix concrete operations are situated in four areas in Texas (Dallas/Fort Worth/Denton, Houston, central Texas and east Texas), in north and central Louisiana, and at one location in southern Arkansas. On April 1, 2011, in an asset exchange transaction we acquired from Transit Mix Concrete and Materials Company 26 ready-mix plants located on 23 sites in central Texas stretching from north of San Antonio to Hillsboro. Additional information about our ready-mix concrete production facilities and associated equipment is provided in Item 2, Properties, of this Report.
We shipped approximately 2.4 million cubic yards of ready-mix concrete during fiscal year 2011. At May 31, 2011, our backlog was approximately 2.5 million cubic yards, approximately half of which will be shipped in 2012. At May 31, 2010, our backlog was approximately 1.4 million cubic yards.
We manufacture and supply a substantial amount of the cement and aggregates raw materials used by the ready-mix plants. The remainder is purchased from outside suppliers. Ready-mix concrete is sold to various contractors in the construction industry, no one of which would be considered material to our business. We believe that we are a significant participant in the Texas and Louisiana concrete products markets in which we operate. Because we are a producer of cement and aggregates, the primary components of concrete, we believe that our customers view us as a reliable supplier of quality concrete, particularly during times that the supply of raw materials is tight.
Other Products. We manufacture and market packaged concrete mix, mortar, sand and related products from plant or distribution sites we own in the Dallas/Fort Worth, Austin and Houston areas in Texas. We also market our Maximizer packaged concrete mix in southern California. The products are marketed by our sales force in each of these locations, and are delivered primarily by contract haulers direct to retailers. Since the cost of delivery is significant to the overall cost of most of these products, the market area is generally restricted to within approximately 100 miles of the packaging locations. These products are sold by the retailers to contractors, distributors and property owners.
Competition
All of the product segments and markets in which we participate are highly competitive. These markets are also generally regional because transportation costs are high relative to the value of the product. Ready-mix concrete also competes in relatively small geographic areas due to delivery time constraints associated with pre-mixed concrete after the addition of water. As a result, in our aggregates and consumer products markets, there is little competition from imported products. However, our cement segment does compete with imported cement because of the higher value of the product and the existence of major ports in some of our markets.
The nature of our competition varies among our product lines due to the widely differing amounts of capital necessary to build production facilities. Construction of cement production facilities is highly capital intensive and requires long lead times to complete engineering design, obtain regulatory permits, acquire equipment and construct a plant. Most domestic producers of cement are owned by large foreign companies operating in multiple international markets. Many of these producers maintain the capability to import cement from foreign production facilities.
Sand and gravel production by dredging, or crushed stone production from stone quarries, is moderately capital intensive. Our major competitors in the aggregates markets are typically large vertically integrated companies.
Ready-mix concrete production requires relatively small amounts of capital to build a concrete batching plant and acquire delivery trucks. As a result, in each local market we face competition from numerous small producers as well as large vertically integrated companies with facilities in many markets.
Due to the lack of product differentiation, competition for all of our products is based largely on price and, to a lesser extent, quality of product and service. As a result, the prices that we charge our customers are not likely to be materially different from the prices charged by other producers in the same markets. Accordingly, our profitability is generally dependent on the level of demand for cement, aggregates and concrete products in the local markets we serve, and on our ability to control operating costs.
Employees
At May 31, 2011, we had approximately 2,020 employees. Approximately 98 employees at our Oro Grande, California cement plant are covered by a collective bargaining agreement that expires in June 2012. Approximately 12 employees at our Crestmore plant near Riverside, California are covered by a collective bargaining agreement that expires in August 2013.
We believe our relationship with our employees is good.
CEO BACKGROUND
Mel G. Brekhus , age 62, has been a director since 2004. He has been President and Chief Executive Officer of the Company since June 1, 2004. He has been with the Company for over 20 years, rising through various management positions in the cement, aggregate and concrete business until attaining his current position. Mr. Brekhus has over 38 years of experience in engineering, operating and management roles in the cement industry. He held positions as technical services engineer, cement plant chemist, cement plant process engineer and cement plant manager at plants in four different states before joining the management team of the Company.
His professional affiliations include the Portland Cement Association, where he is Past Chairman and presently a Director.
As a result of the positions and experience described above, Mr. Brekhus has leadership experience with our Company and with other large, complex and diverse organizations, a long history of experience in the cement, aggregates and concrete industry, and experience in strategic planning.
Eugenio Clariond , age 67, has been a director since 2009. He also served as a director from 1998 until 2005. He has been Chairman of Grupo Cuprum (aluminum products), Monterrey, Mexico, since November 2010. He was Chairman of Verzatec, S.A. (aluminum and plastic construction products), Monterrey, Mexico, from 2004 until November 2010. He was Chairman of the Board and Chief Executive Officer of Grupo IMSA, S.A. (steel processor, auto parts, aluminum and plastic construction products), Monterrey, Mexico, from 1981 until his retirement in December 2006. He is currently a director of Johnson Controls, Inc., Navistar (International) Corp., Grupo Financiero Banorte S.A., and Mexichem, S.A. During the last five years, Mr. Clariond has also been a director of Chaparral Steel Company and The Mexico Fund Inc. Mr. Clariond has been Chairman of the Mexican Fund for Nature Conservancy, and a founding member and past Vice-Chairman of the World Business Council for Sustainable Development. He is Chairman of the United States-Mexico Business Committee of the Mexican Business Council for Foreign Trade. He is also a director of Monterrey Tech, the Center of Studies from the Private Sector for Sustainable Development, and Bat Conservation International. He is on the Advisory Board of the McCombs School of Business at the University of Texas at Austin, the Harte Research Institute for Gulf of Mexico Studies and the Jacobs School of Engineering of the University of California at San Diego.
As a result of the positions and experience described above, Mr. Clariond has leadership experience with large, complex and diverse organizations, and in strategic planning. His years of service on other public company boards provide him with additional perspectives from which to view the Company’s operations and the Board’s activities.
Sam Coats , age 70, has been a director since 2005. He has been a business and aviation consultant since March 2006. He was President and Chief Executive Officer of Schlotzsky’s, Inc. (fast casual dining restaurants) and S.I. Restructuring, Inc. from June 2004 until March 2006. Schlotzsky’s, Inc. recruited Mr. Coats to restructure the company and, as a part thereof, it filed under chapter 11 of the Bankruptcy Code in August 2004, from which it has emerged as a successful, growing company. During his career, Mr. Coats has been President and Chief Executive Officer of several companies, including Sammons Travel Group (package tour operator), PROS Revenue Management, Inc. (the world’s leading provider of airline revenue management software systems), and Trinity Texas Corporation (real estate development, quick lubrication centers, oil and gas). Mr. Coats has also served as President of Muse Air Corporation until its acquisition by Southwest Airlines Company, and he has held senior management positions with Southwest Airlines Company, Continental Airlines, Inc., Braniff Airways, Inc. and Texas International Airlines, Inc. He has also practiced law with a major Dallas law firm and served as a member of the Texas legislature. During the last five years, Mr. Coats has also been a director of Safety-Kleen, Inc. Mr. Coats is active in civic affairs and serves on the boards of a number of non-profit organizations, including the Valley International Airport in Harlingen, Texas, the Dallas Central Appraisal District, The Plan Fund (a micro lender to clients without access to traditional sources of capital) and Central Dallas Community Development Corporation (dedicated to providing affordable housing to low-income clients and permanent housing to the homeless).
As a result of the positions and experience described above, Mr. Coats has leadership experience with several large, complex and diverse organizations, experience in strategic planning and governmental and political matters. His years of service on the boards of other public companies provide him with additional perspectives from which to view the Company’s operations and the Board’s activities.
Thomas R. Ransdell , age 69, has been a director since 2005. He has managed private investments since July 2004. He has over 37 years of experience in engineering, operating and management roles in the aggregates industry. He served in various management positions with Vulcan Materials Company (largest domestic producer of aggregates) for over 26 years until his retirement in 2004, rising from the position of Vice President/Texas to President of the Southwest Division. During his tenure with Vulcan, he also served as President and Chief Executive Officer of two international joint venture companies, Calizas Industriales del Carmen and Vulica Shipping Company, which marketed high quality limestone products and provided deep water shipping services. He also spent eleven years in various engineering and management positions in the aggregate operations of Texas Industries, Inc. from 1967 through 1978. His professional affiliations include serving as past Chairman of the National Slag Association and the Texas Aggregate and Concrete Association. He is currently a director of the Cancer Therapy and Research Center Foundation.
As a result of the positions and experience described above, Mr. Ransdell has leadership experience with our Company and another large, complex and diverse organization, a long history of experience in the aggregates industry, and experience in strategic planning.
Robert D. Rogers , age 75, has been a director since 1970. He has been Chairman of the Board of the Company since October 2004. He was President and Chief Executive Officer of the Company for over 34 years until his retirement from that position on May 31, 2004. He is currently a director of Adams Golf, Inc. During the last five years, Mr. Rogers has also been a director of Con-Way Inc. He is also a director of the National Recreation Foundation and a member of the Executive Board of the SMU Cox School of Business. Mr. Rogers is a former Chairman of the Federal Reserve Bank of Dallas, Chairman of the Greater Dallas Chamber of Commerce and director of the American Business Conference.
As a result of the positions and experience described above, Mr. Rogers has leadership experience with our Company and other large, complex and diverse organizations, a long history of experience in the cement, aggregates and concrete industry, and experience in strategic planning. His years of service on other public company boards provide him with additional perspectives from which to view the Company’s operations and the Board’s activities.
Ronald G. Steinhart , age 71, has been a director since 2007. He retired in 2000 as Chairman and Chief Executive Officer of the Commercial Banking Group of Bank One Corporation (commercial banking), a position he had held since 1996. He has over 37 years of experience in the financial services industry. He led a group of investors that established Team Bank (commercial banking) in 1988 and served as its Chairman and Chief Executive Officer until it merged with Bank One Texas in 1992. He was President and Chief Operating Officer of Bank One Texas through 1996. He is also a former President and Chief Operating Officer of InterFirst Corporation (commercial bank holding company), prior to which he teamed with investors to charter or purchase six other banks. He is a current director of Penske Automotive Group, Inc.and Susser Holdings Corporation, and a trustee of the MFS/Compass Group of mutual funds. During the last five years, Mr. Steinhart has been a director of Animal Health International, Inc.and Penson Worldwide, Inc. Mr. Steinhart is an Advisory Board Member of the McCombs School of Business at the University of Texas at Austin. Among the civic positions in which he has served are Chairman of the Board of Trustees of the Teacher Retirement System of Texas, Chairman of the Housing Authority of the City of Dallas, Chairman of the United Way of Metropolitan Dallas, President of the Federal Advisory Council of the Federal Reserve System, Chairman of the Dallas Citizens Council, and Regent of the Lamar University System.
As a result of the positions and experience described above, Mr. Steinhart has leadership experience with several large, complex and diverse organizations, a strong background in financial and accounting matters, experience in strategic planning and governmental and political matters. His years of service on the boards of other public companies provide him with additional perspectives from which to view the Company’s operations and the Board’s activities.
John D. Baker, II , age 63, has been a director since 2010 and is serving a term of office that expires in 2012. He has been Executive Chairman of Patriot Transportation Holding, Inc. (a motor carrier of liquid and dry bulk commodities and real estate management and investment company) since October 1, 2010. He was Chief Executive Officer and President of Patriot from February 2008 until October 1, 2010. He was President and Chief Executive Officer of Florida Rock Industries, Inc. (an aggregates, ready-mix concrete and cement company) from 1996 until November 2007. He is currently a director of Patriot Transportation Holding, Inc., Progress Energy, Inc. and Wells Fargo & Company. During the last five years, Mr. Baker has also been a director of Vulcan Materials Company, Hughes Supply, Inc., Wachovia Corp. and Florida Rock Industries, Inc. His professional affiliations include the Florida Concrete and Products Association, where he was a former Chairman.
As a result of the positions and experience described above, Mr. Baker has leadership experience with large, complex and diverse organizations, a long history of experience in the cement, aggregates and concrete industry, and experience in strategic planning. His years of service on other public company boards provide him with additional perspectives from which to view the Company’s operations and the Board’s activities.
Gary L. Pechota , age 61, has been a director since 2009 and is serving a term of office that expires in 2012. He has been President and CEO of DT-Trak Consulting, Inc. (a medical coding, billing and data entry services company) since December 2007. From May 2005 until December 2007, Mr. Pechota was a private investor. Mr. Pechota was the Chief of Staff of the National Indian Gaming Commission from August 2003 until April 2005. Mr. Pechota has 18 years of experience in the cement industry, serving as President and CEO of Dacotah Cement from January 1983 until May 1992, President of Keystone Cement Company from May 1992 until September 1994, President of Giant Cement Company from January 1993 until September 1994, President, CEO and Chairman of Giant Cement Holding, Inc. from September 1994 until November 1999 and President and CEO of Giant Cement Holding, Inc. from November 1999 until December 2001. Mr. Pechota is a former Chairman and member of the Finance Committee of the Portland Cement Association. He is currently a director of Insteel Industries, Inc. and Black Hills Corporation. Mr. Pechota was nominated as a director by Shamrock Activist Value Fund (Shamrock), which owned over 10% of our common stock at the time of the nomination. Pursuant to a written agreement with Mr. Pechota, Shamrock agreed to (a) provide Mr. Pechota $50,000 as compensation for acting as a Shamrock nominee, (b) reimburse Mr. Pechota for the out-of-pocket expenses incurred by him in connection with serving as a Shamrock nominee, (c) indemnify Mr. Pechota in connection therewith, subject to certain limitations, and (d) pay the reasonable fees and expenses of one legal counsel (up to $20,000 unless Shamrock consented to pay any additional amounts).
As a result of the positions and experience described above, Mr. Pechota has leadership experience with large, complex and diverse organizations, a long history of experience in the cement, aggregates and concrete industry, a strong background in financial and accounting matters and experience in strategic planning. His years of service on other public company boards provide him with additional perspectives from which to view the Company’s operations and the Board’s activities.
Dorothy C. Weaver , age 64, has been a director since 2010 and is serving a term of office that expires in 2012. She has been Chairman and Chief Executive Officer of Collins Capital Investments, LLC (an investment management company managing multi-manager, multi-strategy funds of hedge funds) since 1995. Prior to that she was President of Intercap Investments, Inc. (a residential and commercial real estate investment firm) for approximately six years. Ms. Weaver is a director of Austin Industries and was formerly a director of Coldwell Banker. She is a former Chairman of the Board of the Federal Reserve Bank of Miami. She has also served as Chairman of the Governor’s Council of Economic Advisors for the State of Florida, and was a founding director of Enterprise Florida, a public-private partnership that replaced Florida’s Department of Commerce. Among the many other civic positions in which she has served are Chairman of the Greater Miami Chamber of Commerce, Chairman of the Strategic Planning Committee of Workforce Florida, Inc., Chairman of the Workforce Development Committee of the Governor’s Blue Ribbon Commission on Education and a member of the board of trustees and the executive committee of Wellesley College.
As a result of the positions and experience described above, Ms. Weaver has a strong background in financial and accounting matters, and experience in strategic planning and governmental and political matters.
MANAGEMENT DISCUSSION FROM LATEST 10K
GENERAL
We are a leading supplier of heavy construction materials in the southwestern United States through our three business segments: cement, aggregates and consumer products. Our principal products are gray portland cement, produced and sold through our cement segment; stone, sand and gravel, produced and sold through our aggregates segment; and ready-mix concrete, produced and sold through our consumer products segment. Other products include expanded shale and clay lightweight aggregates, produced and sold through our aggregates segment, and packaged concrete mix, mortar, sand and related products, produced and sold through our consumer products segment.
Our facilities are concentrated primarily in Texas, Louisiana and California. We own long-term reserves of the primary raw materials for the production of cement and aggregates. Our business requires large amounts of capital investment, energy, labor and maintenance.
During fiscal year 2009 and into fiscal year 2010, the economy in all of our operating regions was in recession. Declining home values, investor losses on mortgage related securities, tight credit conditions, state budget shortfalls, rising unemployment and other factors led to declines in all segments of construction activity in our markets. These conditions impacted all segments of our business. In response, we took numerous steps to manage our production to more closely match market demand, reduce costs and manage our cash position. We significantly reduced both capital and non-capital spending, including delaying construction of the expansion of our Hunter, Texas cement plant. We idled plants where necessary and reduced our employee and contract labor force by approximately 30%. We also significantly reduced overtime pay, implemented a salary freeze for non-union employees and renegotiated a number of supply and service agreements. Our president and chief executive officer voluntarily reduced his salary by 10% and other executive officers similarly reduced their salaries by 5%. We negotiated amendments to our senior secured revolving credit facility to reduce the risk that the market decline would cause our operating results to fall below levels required by financial covenants.
Even though the national economy experienced slow growth during fiscal year 2011, construction activity has remained at low levels. As a consequence, throughout fiscal year 2011 we continued with many of the steps that we began taking in fiscal year 2009 in response to the recession. We also continued to assess other actions that may help us reduce costs, conserve cash or improve our sales or operations. These steps and others are indicative of our intense focus on cost reduction, management of our cash position and management of production levels, which we believe had a significant positive impact on our operating results in the last two fiscal years.
In October 2007 we commenced construction on a project to expand our Hunter, Texas cement plant. In May 2009 we temporarily halted construction on the project because we believed that economic and market conditions made it unlikely that cement demand levels in Texas at that time would permit the new kiln to operate profitably if the project was completed as originally scheduled. We resumed construction in October 2010. The total capital cost of the project is expected to be between $365 million and $375 million, excluding capitalized interest, and commissioning is expected to begin within 24 months of the restart of construction. As of May 31, 2011, we have incurred approximately $310.5 million, excluding capitalized interest of approximately $35.0 million related to the project, of which $303.8 million has been paid.
In April 2011 we entered into an asset exchange transaction in which we acquired the ready-mix operations of Transit Mix Concrete and Materials Company, a subsidiary of Trinity Industries, Inc., that serve the central Texas market from north of San Antonio to Hillsboro, Texas. In exchange for the ready-mix facilities, we transferred to Trinity Materials, Inc., also a subsidiary of Trinity Industries, Inc., our aggregate operations at the Anacoco sand and gravel plant, which serves the southwest Louisiana and southeast Texas markets, and the Paradise and Beckett sand and gravel plants, which both serve the north Texas market. The exchange resulted in the recognition of a gain of $12.0 million and an increase in ready-mix property, plant and equipment of $17.4 million. The operating results of the acquired ready-mix operations are reported in our consumer products segment.
RESULTS OF OPERATIONS
Management uses segment operating profit as its principal measure to assess performance and to allocate resources. Business segment operating profit consists of net sales less operating costs and expenses that are directly attributable to the segment. Corporate includes non-operating income and expenses related to administrative, financial, legal, human resources, environmental and real estate activities.
During fiscal year 2011, construction activity remained at low levels in both our California and Texas market areas. We have continued to focus on cost reduction, management of our cash position and management of production levels, which we believe has had a significant positive impact on our operating results.
Consolidated sales for fiscal year 2011 were $621.8 million, an increase of $0.7 million from the prior fiscal year. Consolidated cost of products sold was $596.5 million, an increase of $34.4 million from the prior fiscal year. Consolidated gross profit was $25.3 million, a decrease of $33.7 million from the prior fiscal year. Lower sales prices offset in part by higher shipments reduced consolidated gross profit approximately $31 million.
Consolidated sales for fiscal year 2010 were $621.1 million, a decrease of $218.1 million from the prior fiscal year. Consolidated cost of products sold was $562.1 million, a decrease of $164.1 million from the prior fiscal year. Consolidated gross profit was $59.0 million, a decrease of $54.1 million from the prior fiscal year. Lower shipments and sales prices reduced consolidated gross profit approximately $92 million. The effect of lower shipments and sales prices was offset in part by lower costs including approximately $14 million lower supplies and maintenance costs related to plant shutdowns for maintenance at our three cement plants, $16 million lower aggregate production costs and $10 million lower ready-mix concrete raw material costs.
Consolidated selling, general and administrative expense for fiscal year 2011 was $76.4 million, a decrease of $3.0 million from the prior fiscal year. Consolidated selling, general and administrative expense for fiscal year 2010 was $79.4 million, an increase of $7.3 million from the prior fiscal year. In 2011, we recognized $1.3 million in expenses associated with the acquisition of ready-mix operating assets through an asset exchange transaction. In addition, insurance expense increased $1.7 million in 2011 and decreased $1.0 million in 2010 and bad debt expense increased $1.4 million in 2011 and $0.5 million in 2010 from the prior fiscal years. Our stock-based compensation includes awards expected to be settled in cash, the expense for which is based on their fair value at the end of each period until the awards are paid. The impact of changes in our stock price on the fair value of these awards increased expense $0.3 million in 2011 and $8.9 million in 2010 from the prior fiscal years. Our financial security plan postretirement benefit obligations are determined using assumptions as of the end of the year. In 2010, it was discovered that our actuarial assumptions for certain participants failed to consider that these participants will receive their defined benefit for a minimum of 15 years or life. Previously, our calculations had incorrectly assumed that the payments to these participants ceased after 15 years. We recomputed the defined benefit liability for these participants and accordingly recognized a charge of $4.4 million in 2010 to record the additional liability. Management estimated that $3.4 million of this additional liability related to years prior to 2010. This $3.4 million would have accumulated over time since the year 2000. The $1.0 million increase related to 2010 was primarily a function of the decreased discount rate in 2010 compared to the discount rate in 2009. Management determined that the amount related to prior years was not material to the financial statements and the entire change has been recognized in selling, general and administrative expense in 2010. Financial security plan postretirement benefit expense excluding this adjustment decreased $1.0 million in 2011 and increased $3.1 million in 2010 from the prior fiscal years. Our focus on reducing controllable costs lowered overall other expenses $2.3 million in 2011 and $8.6 million in 2010 from the prior fiscal years.
Consolidated other income for fiscal year 2011 was $21.5 million, an increase of $10.8 million from the prior fiscal year. Consolidated other income for fiscal year 2010 was $10.7 million, a decrease of $10.5 million from the prior fiscal year. The exchange of aggregate operating assets for ready-mix operating assets resulted in the recognition of a gain of $12.0 million in 2011. Sales of emission credits associated with our Crestmore cement plant in Riverside, California resulted in gains of $1.7 million in 2011, $3.4 million in 2010 and $1.7 million in 2009. Routine sales of surplus operating assets and real estate resulted in gains of $1.7 million in 2011, $1.4 million in 2010 and $6.8 million in 2009. In addition, we have entered into various oil and gas lease agreements on property we own in north Texas. The terms of the agreements include the payment of a lease bonus and royalties on any oil and gas produced. Lease bonus payments and royalties on oil and gas produced resulted in income of $3.1 million in 2011, $1.1 million in 2010 and $6.2 million in 2009.
Interest
Interest expense incurred for fiscal year 2011 was $66.3 million, of which $18.7 million was capitalized in connection with our Hunter, Texas cement plant expansion project and $47.6 million was expensed. Interest expense incurred for fiscal year 2010 was $52.2 million, all of which was expensed. Interest expense incurred for fiscal year 2009 was $47.7 million, of which $14.4 million was capitalized in connection with our Hunter, Texas cement plant expansion project and $33.3 million was expensed.
Interest expense incurred for fiscal year 2011 increased $14.1 million from the prior fiscal year. The increase was primarily the result of higher average outstanding debt at higher interest rates due to the August 2010 refinancing of our 7.25% senior notes.
Interest expense to be capitalized in connection with our Hunter, Texas cement plant expansion project during fiscal year 2012 is currently estimated at approximately $35 million.
Loss on Debt Retirements
On July 27, 2010, we commenced a cash tender offer for all of the outstanding $550 million aggregate principal amount of our 7.25% senior notes due 2013 and a solicitation of consents to amend the indenture governing the 7.25% notes. Pursuant to the tender offer and consent solicitation, we purchased $536.6 million aggregate principal amount of the 7.25% notes, and paid an aggregate of $547.7 million in purchase price and consent fees. On September 9, 2010, we redeemed the remaining $13.4 million aggregate principal amount of the 7.25% notes at a price of 101.813% of the principal amount thereof, plus accrued and unpaid interest on the 7.25% notes to the redemption date. We used the net proceeds from the issuance and sale of $650 million aggregate principal amount of our 9.25% senior notes to pay the purchase or redemption price of the 7.25% notes and the consent fees and to increase working capital. We recognized a loss on debt retirement of $29.6 million representing $11.4 million in consent fees, redemption price premium and transaction costs and a write-off of $18.2 million of unamortized debt discount and original issuance costs associated with the 7.25% notes in fiscal year 2011.
On August 18, 2008, we sold $300 million aggregate principal amount of additional 7.25% senior notes due in 2013 at an offering price of $93.25. The net proceeds were used to repay our $150 million senior term loan and borrowings outstanding under our senior revolving credit facility in the amount of $29.5 million. We recognized a loss on debt retirement of $0.9 million representing a write-off of debt issuance costs associated with the mandatory prepayment of the term loan in fiscal year 2009.
Income Taxes
Our effective tax rate was 39.2% in 2011, 37.3% in 2010 and 42.0% in 2009. The primary reason that the effective tax rate differed from the 35% statutory corporate rate was due to additional percentage depletion that is tax deductible, the effect of qualified domestic production activities, state income taxes and nondeductible stock compensation.
As of May 31, 2011, we had an alternative minimum tax credit carryforward of $28.8 million. The credit, which does not expire, is available for offset against future regular federal income tax. We had a $46.4 million federal net operating loss carryforward. The federal net operating loss may be carried forward twenty years and offset against future federal taxable income. We also had a tax benefit of $3.5 million from state net operating losses that may be carried forward from five to twenty years. Management believes it is more likely than not that the deferred tax assets will be realized.
Management reviews our deferred tax position and in particular our deferred tax assets whenever circumstances indicate that the assets may not be realized in the future and would record a valuation allowance unless such deferred tax assets were deemed more likely than not to be recoverable. The ultimate realization of these deferred tax assets depends upon various factors including the generation of taxable income during future periods. The Company’s deferred tax assets exceeded deferred tax liabilities as of May 31, 2011, primarily as a result of the recent losses. Management believes the positive evidence relating to the Company’s existing deferred tax liabilities and its ability to execute prudent and feasible tax planning strategies exceeds the negative evidence from the recent losses. We have concluded based on all available evidence that the Company will more-likely-than-not realize its deferred tax assets, and that a valuation allowance is not required at this time. Should the Company continue to experience losses, a valuation allowance may become necessary.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and accompanying notes in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported. Changes in the facts and circumstances could have a significant impact on the resulting financial statements. We believe the following critical accounting policies affect management’s more complex judgments and estimates.
Receivables. Management evaluates the ability to collect accounts receivable based on a combination of factors. A reserve for doubtful accounts is maintained based on the length of time receivables are past due or the status of a customer’s financial condition. If we are aware of a specific customer’s inability to make required payments, specific amounts are added to the reserve.
Environmental Liabilities. We are subject to environmental laws and regulations established by federal, state and local authorities, and make provision for the estimated costs related to compliance when it is probable that an estimable liability has been incurred.
Legal Contingencies. We are defendants in lawsuits which arose in the normal course of business, and make provision for the estimated loss from any claim or legal proceeding when it is probable that an estimable liability has been incurred.
Inventories. Inventories are stated at the lower of cost or market. We use the last-in, first out (“LIFO”) method to value finished products, work in process and raw material inventories excluding natural aggregate inventories. Natural aggregate inventories and parts and supplies inventories are valued using the average cost method. Our natural aggregate inventory excludes volumes in excess of an average twelve-month period of actual sales.
Long-lived Assets. Management reviews long-lived assets on a facility by facility basis for impairment whenever changes in circumstances indicate that the carrying amount of the assets may not be recoverable and would record an impairment charge if necessary. Such evaluations compare the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset and are significantly impacted by estimates of future prices for our products, capital needs, economic trends and other factors. Estimates of future cash flows reflect Management’s belief that it operates in a cyclical industry and that we are at a low point in the cycle.
In the fourth quarter of our 2011 fiscal year, management evaluated the Hunter, Texas cement plant, including the capitalized construction and interest costs associated with the expansion. We expect the Texas market to recover to pre-recession levels and to complete the expansion project. Based on historical margins, we believe the undiscounted cash flows over the remaining life of the Hunter plant after completion of the expansion will significantly exceed the current investment in the plant as well as the remaining costs of the expansion and future capital expenditures necessary to achieve these cash flows.
Goodwill and Goodwill Impairment . Management tests goodwill for impairment annually by reporting unit in the fourth quarter of our fiscal year using a two-step process. The first step of the impairment test identifies potential impairment by comparing the fair value of a reporting unit to its carrying value including goodwill. In applying a fair-value-based test, estimates are made of the expected future cash flows to be derived from the reporting unit. Similar to the review for impairment of other long-lived assets, the resulting fair value determination is significantly impacted by estimates of future prices for our products, capital needs, economic trends and other factors. If the carrying value of the reporting unit exceeds its fair value, the second step of the impairment test is performed to measure the amount of impairment loss, if any. The second step of the impairment test compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying value of the reporting unit goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
RESULTS OF OPERATIONS
We are a leading supplier of heavy construction materials in the southwestern United States through our three business segments: cement, aggregates and consumer products. Our principal products are gray portland cement, produced and sold through our cement segment; stone, sand and gravel, produced and sold through our aggregates segment; and ready-mix concrete, produced and sold through our consumer products segment. Other products include expanded shale and clay lightweight aggregates, produced and sold through our aggregates segment, and packaged concrete mix, mortar, sand and related products, produced and sold through our consumer products segment. Our facilities are concentrated primarily in Texas, Louisiana and California.
Management uses segment operating profit as its principal measure to assess performance and to allocate resources. Business segment operating profit consists of net sales less operating costs and expenses that are directly attributable to the segment. Corporate includes non-operating income and expenses related to administrative, financial, legal, human resources, environmental and real estate activities.
During the three-month and nine-month periods ended February 29, 2012, construction activity remained at low levels in both our California and Texas market areas. We have continued to focus on cost reduction, management of our cash position and management of production levels, which we believe has had a significant positive impact on our operating results.
In April 2011 we entered into an asset exchange transaction in which we acquired the ready-mix operations of Transit Mix Concrete and Materials Company, a subsidiary of Trinity Industries, Inc., that serve the central Texas market from north of San Antonio to Hillsboro, Texas. In exchange for the ready-mix facilities, we transferred to Trinity Materials, Inc., also a subsidiary of Trinity Industries, Inc., our aggregate operations at the Anacoco sand and gravel plant, which serves the southwest Louisiana and southeast Texas markets, and the Paradise and Beckett sand and gravel plants, which both serve the north Texas market. In July 2011 we entered into an asset exchange transaction in which we acquired the ready-mix and aggregate operations of CEMEX USA that serve the Austin, Texas metropolitan market. In exchange for the three ready-mix plants and one sand and gravel plant, we transferred to CEMEX USA certain of our ready-mix operations in Houston, Texas. With the completion of this transaction we have exited the Houston, Texas ready-mix market. The operating results of the acquired ready-mix and sand and gravel operations are reported in our consumer products and aggregate segments, respectively.
In November 2011 we entered into a joint venture agreement with a ready-mix operator based in Waco, Texas to which we contributed seven of our central Texas ready-mix plants and certain related assets and guaranteed 50%, or $13.0 million, of the joint venture’s debt which matures November 18, 2013. In addition to our 50% guarantee of the joint venture’s debt, 100% of the debt is guaranteed by the other partner and secured by the underlying assets of the joint venture. The joint venture was in compliance with all the terms of the debt as of February 29, 2012. Subject to a final determination of the fair value, our 40% equity interest in the joint venture was recorded at the $3.9 million carrying amount of the assets contributed, and therefore no gain or loss was recognized in the three-month and nine-month periods ended February 29, 2012. Because the assets contributed were recently acquired any future gain or loss is not expected to be significant. The day to day business operations are managed by the 60% partner in the venture. The joint venture will operate a total of nineteen ready-mix and two sand and gravel plants serving the central Texas market. We will continue to supply cement to the joint venture. The joint venture operations are reported in our consumer products segment using the equity method of accounting.
Consolidated sales for the three-month period ended February 29, 2012 were $134.6 million, an increase of $8.8 million from the prior year period. Consolidated cost of products sold for the three-month period ended February 29, 2012 was $133.9 million, a decrease of $1.3 million from the prior year period. Sales increased $0.2 million and cost of products sold increased $0.2 million due to the net effect of the exchanges of ready-mix concrete and aggregate operating assets completed in April and July 2011. Sales increased $8.6 million, excluding the effect of the exchanges, primarily due to higher shipments for all of our major products and higher cement and ready-mix concrete sales prices. Cost of products sold, excluding the effect of the asset exchanges, decreased $1.5 million primarily due to higher clinker production which offset the effect of higher shipments. Consolidated gross profit for the three-month periods ended February 29, 2012 was $0.7 million. Consolidated gross loss for the three-month period ended February 28, 2011 was $9.4 million.
Consolidated sales for the nine-month period ended February 29, 2012 were $472.4 million, an increase of $26.4 million from the prior year period. Consolidated cost of products sold for the nine-month period ended February 29, 2012 was $455.1 million, an increase of $27.9 million from the prior year period. Sales increased $8.0 million and cost of products sold increased $8.3 million due to the net effect of the exchanges of ready-mix concrete and aggregate operating assets completed in April and July 2011. Sales increased $18.4 million, excluding the effect of the exchanges, primarily due to higher cement shipments and sales prices. Cost of products sold, excluding the effect of the asset exchanges, increased $19.6 million primarily due to higher cement shipments offset in part by higher clinker production. Consolidated gross profit for the nine-month periods ended February 29, 2012 and February 28, 2011 was $17.3 million and $18.8 million, respectively.
Consolidated selling, general and administrative expense for the three-month period ended February 29, 2012 was $18.4 million, an increase of $1.1 million from the prior year period primarily due to $1.0 million higher stock-based compensation expense. Our stock-based compensation includes awards expected to be settled in cash, the expense for which is based on their fair value at the end of each period until the awards are paid. The impact of changes in our stock price on the fair value of these awards increased expense $1.7 million and $0.7 million for the three-month periods ended February 29, 2012 and February 28, 2011, respectively.
Consolidated selling, general and administrative expense for the nine-month period ended February 29, 2012 was $50.1 million, a decrease of $1.9 million from the prior year period primarily due to $2.6 million lower stock-based compensation expense and $1.2 million lower provisions for bad debts offset in part by $1.7 million higher provisions for insurance claims. Our stock-based compensation includes awards expected to be settled in cash, the expense for which is based on their fair value at the end of each period until the awards are paid. The impact of changes in our stock price on the fair value of these awards decreased expense $2.1 million for the nine-month period ended February 29, 2012 and increased expense $0.8 million for the nine-month period ended February 28, 2011.
Consolidated restructuring charges of $3.2 million were recorded in the nine-month period ended February 29, 2012, of which $2.5 million has been paid. These charges consist primarily of severance and benefit costs associated with various workforce reduction initiatives.
Consolidated other income for the three-month period ended February 29, 2012 was $1.3 million, an increase of $0.2 million from the prior year period. The increase was primarily due to $1.1 million higher gains from routine sales of surplus operating assets offset in part by $0.3 million equity in losses of joint venture and $0.5 million lower royalties and oil and gas lease bonus payments.
Consolidated other income for the nine-month period ended February 29, 2012 was $8.7 million, an increase of $0.8 million from the prior year period. The July 2011 asset exchange resulted in the recognition of a gain of $2.1 million in the nine-month period ended February 29, 2012. Sales of emission credits associated with our Crestmore cement plant in Riverside, California resulted in gains of $2.5 million and $1.7 million in the nine-month periods ended February 29, 2012 and February 28, 2011, respectively. These gains were offset in part by $0.3 million equity in losses of joint venture and $1.7 million lower royalties and oil and gas lease bonus payments.
Total segment operating loss for the three-month periods ended February 29, 2012 and February 28, 2011 was $6.4 million and $17.2 million, respectively. Total segment operating loss for the nine-month periods ended February 29, 2012 and February 28, 2011 was $5.2 million and $4.4 million, respectively. The following is a summary of operating results for our business segments and certain other information related to our principal products and non-operating income and expenses.
Three months ended February 29, 2012
Aggregate operating profit for the three-month period ended February 29, 2012 was $0.2 million. Aggregate operating loss for the three-month period ended February 28, 2011 was $0.1 million.
Total segment sales for the three-month period ended February 29, 2012 were $36.6 million compared to $34.9 million for the prior year period. Stone, sand and gravel sales decreased $1.4 million from the prior year period. The effect of the disposition of aggregate operating assets through the asset exchange transaction completed in April 2011 decreased sales $1.8 million, shipments 8% and average prices 2% from the prior year period. Stone, sand and gravel sales from current operations increased $0.4 million from the prior year period on 4% higher shipments and 2% lower average prices.
Cost of products sold for the three-month period ended February 29, 2012 increased $2.9 million from the prior year period. The effect of the disposition of aggregate operating assets through the asset exchange transaction completed in April 2011 decreased stone, sand and gravel cost of products sold $1.8 million which was offset in part by higher freight costs. Stone, sand and gravel unit costs increased 3% from the prior year period primarily due to the effect of the disposition of aggregate operating assets through the asset exchange transaction completed in April 2011 on unit costs.
Selling, general and administrative expense for the three-month period ended February 29, 2012 decreased $0.2 million from the prior year period primarily due to lower compensation expense.
Other income for the three-month period ended February 29, 2012 increased $1.2 million from the prior year period primarily due to higher gains from routine sales of surplus operating assets.
Nine months ended February 29, 2012
Aggregate operating profit for the nine-month periods ended February 29, 2012 and February 28, 2011 was $6.2 million and $8.4 million, respectively.
Total segment sales for the nine-month period ended February 29, 2012 were $121.7 million compared to $126.0 million for the prior year period. Stone, sand and gravel sales decreased $7.4 million from the prior year period. The effect of the disposition of aggregate operating assets through the asset exchange transaction completed in April 2011 decreased sales $6.3 million, shipments 8% and average prices 2% from the prior year period. Stone, sand and gravel sales from current operations decreased $1.1 million from the prior year period on comparable shipments and 1% lower average prices.
Cost of products sold for the nine-month period ended February 29, 2012 decreased $1.7 million from the prior year period. The effect of the disposition of aggregate operating assets through the asset exchange transaction completed in April 2011 decreased stone, sand and gravel cost of products sold $6.4 million which was offset in part by higher freight costs. Stone, sand and gravel unit costs decreased 1% from the prior year period due to the effect of the disposition of aggregate operating assets through the asset exchange transaction completed in April 2011 on unit costs.
Interest
Interest expense incurred for the three-month period ended February 29, 2012 was $17.0 million, of which $8.5 million was capitalized in connection with our Hunter, Texas cement plant expansion project and $8.5 million was expensed. Interest expense incurred for the three-month period ended February 28, 2011 was $17.3 million, of which $7.6 million was capitalized in connection with our Hunter, Texas cement plant expansion project and $9.7 million was expensed.
Interest expense incurred for the nine-month period ended February 29, 2012 was $51.4 million, of which $24.6 million was capitalized in connection with our Hunter, Texas cement plant expansion project and $26.8 million was expensed. Interest expense incurred for the nine-month period ended February 28, 2011 was $49.0 million, of which $11.0 million was capitalized in connection with our Hunter, Texas cement plant expansion project and $38.0 million was expensed.
Interest expense incurred for the three-month period ended February 29, 2012 decreased $0.3 million from the prior year period primarily as a result of lower credit facility fees. Interest expense incurred for the nine-month period ended February 29, 2012 increased $2.4 million from the prior year period primarily as a result of higher average outstanding debt at higher interest rates due to the August 2010 refinancing of our senior notes.
An additional $10 million of interest expense is estimated to be capitalized in connection with our Hunter, Texas cement plant expansion project during the remainder of our current fiscal year.
Loss on Debt Retirements
On July 27, 2010, we commenced a cash tender offer for all of the outstanding $550 million aggregate principal amount of our 7.25% senior notes due 2013 and a solicitation of consents to amend the indenture governing the 7.25% notes. Pursuant to the tender offer and consent solicitation, we purchased $536.6 million aggregate principal amount of the 7.25% notes, and paid an aggregate of $547.7 million in purchase price and consent fees. On September 9, 2010, we redeemed the remaining $13.4 million aggregate principal amount of the 7.25% notes at a price of 101.813% of the principal amount thereof, plus accrued and unpaid interest on the 7.25% notes to the redemption date. We used the net proceeds from the issuance and sale of $650 million aggregate principal amount of our 9.25% senior notes to pay the purchase or redemption price of the 7.25% notes and the consent fees and to increase working capital. As of February 28, 2011, we recognized a loss on debt retirement of $29.6 million representing $11.4 million in consent fees, redemption price premium and transaction costs and a write-off of $18.2 million of unamortized debt discount and original issuance costs associated with the 7.25% notes.
Income Taxes
Income taxes for the interim periods ended February 29, 2012 and February 28, 2011 have been included in the accompanying financial statements on the basis of an estimated annual rate. The tax rate differs from the 35% federal statutory corporate rate primarily due to percentage depletion that is tax deductible, state income taxes and valuation allowances against deferred tax assets. The estimated annualized rate does not include the tax impact of the loss on debt retirements which was recognized as a discrete item in the nine-month period ended February 28, 2011. The estimated annualized rate excluding this charge is 2.5% for fiscal year 2012 compared to 40.2% for fiscal year 2011. We received income tax refunds of less than $0.1 million and made income tax payments of $0.1 million in the nine-month period ended February 29, 2012. We received income tax refunds of $13.1 million and made income tax payments of less than $0.1 million in the nine-month period ended February 28, 2011.
Net deferred tax assets totaled $16.3 million at February 29, 2012 and $15.0 million at May 31, 2011, of which $15.0 million at February 29, 2012 and $12.3 million at May 31, 2011 were classified as current. Management reviews our deferred tax position and in particular our deferred tax assets whenever circumstances indicate that the assets may not be realized in the future and would record a valuation allowance unless such deferred tax assets were deemed more likely than not to be recoverable. The ultimate realization of these deferred tax assets depends upon various factors including the generation of taxable income during future periods. The Company’s deferred tax assets exceeded deferred tax liabilities as of February 29, 2012 primarily as a result of the recent losses. Management has concluded that the sources of taxable income we are permitted to consider do not assure the realization of the entire amount of the increase in our net deferred tax assets expected during the year. Accordingly, a valuation allowance is required due to the uncertainty of realizing the deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
In addition to cash and cash equivalents of $27.2 million at February 29, 2012, our sources of liquidity include cash from operations and borrowings available under our senior secured revolving credit facility.
Senior Secured Revolving Credit Facility . On August 25, 2011, we amended and restated our credit agreement and the associated security agreement. The credit agreement continues to provide for a $200 million senior secured revolving credit facility with a $50 million sub-limit for letters of credit and a $15 million sub-limit for swing line loans. The credit facility matures on August 25, 2016. Amounts drawn under the credit facility bear annual interest either at the LIBOR rate plus a margin of 2.0% to 2.75% or at a base rate plus a margin of 1.0% to 1.75%. The base rate is the higher of the federal funds rate plus 0.5%, the prime rate established by Bank of America, N.A. or the one-month LIBOR rate plus 1.0%. The interest rate margins are determined based on the Company’s fixed charge coverage ratio. The commitment fee calculated on the unused portion of the credit facility ranges from 0.375% to 0.50% per year based on the Company’s average daily loan balance. We may terminate the credit facility at any time.
The amount that can be borrowed under the credit facility is limited to an amount called the borrowing base. The borrowing base may be less than the $200 million stated principal amount of the credit facility. The borrowing base is calculated based on the value of our accounts receivable, inventory and mobile equipment in which the lenders have a security interest. In addition, by mortgaging tracts of its real property to the lenders, the Company may increase the borrowing base by an amount beginning at $20 million and declining to $10.7 million at the maturity of the credit facility.
The borrowing base under the agreement was $135.3 million as of February 29, 2012. We are not required to maintain any financial ratios or covenants unless an event of default occurs or the unused portion of the borrowing base is less than $25 million, in which case we must maintain a fixed charge coverage ratio of at least 1.0 to 1.0. At February 29, 2012, our fixed charge coverage ratio was (.62) to 1.0. Given this ratio, we may use only $110.3 million of the borrowing base as of such date. No borrowings were outstanding at February 29, 2012; however, $25.5 million of the borrowing base was used to support letters of credit. As a result, the maximum amount we could borrow as of February 29, 2012 was $84.8 million.
All of our consolidated subsidiaries have guaranteed our obligations under the credit facility. The credit facility is secured by first priority security interests in all or most of our existing and future consolidated accounts, inventory, equipment, intellectual property and other personal property, and in all of our equity interests in present and future domestic subsidiaries and 66% of the equity interest in any future foreign subsidiaries, if any.
CONF CALL
Kenneth Allen
Thanks. Before we begin, Linda English would like to make some introductions. Linda please go ahead.
Linda English
Thank you Ken. Good afternoon and thank you for joining us today for TXI’s first quarter results conference call and webcast. We appreciate your time and interest in TXI. I am Linda English, Manager of Investor Communications. Joining me today are President and CEO, Mel Brekhus and CFO, Ken Allen. Gentlemen, thank you.
We will follow a similar format as in previous presentations. Mel and Ken will first provide comments for the quarter and follow with Q&A. Before I turn the call over to our speakers, I would like to remind you that certain statements contained in this press release are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to risk, uncertainties and other factors which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements.
Potential risk and uncertainties include but are not limited to the impact of competitive pressures and changing economic and financial conditions on our business, the cyclical and seasonal nature of our business, the level of construction activity in our markets at normal periods of inclement weather, unexpected periods of equipment downtime, unexpected operational difficulties, changes in the cost of raw materials, fuel and energy, changes in the cost or availability of transportation, changes in interest rates, the timing and amount of federal, state and local funding for infrastructure, delays in announced capacity expansions, ongoing volatility and uncertainty in the capital or credit markets, the impact of environmental laws and regulations and claims and changes in governmental and public policy and the risk and uncertainties described in our reports on Forms 10K, 10Q and 8K.
Forward-looking statements speak only as of the date hereof and we assume no obligation to publicly update these statements. Now, for opening comments, Mel please go ahead.
Melvin Brekhus
Thank you Linda. Good afternoon from Dallas, Texas. I am very pleased to be here today discussing the positive earnings we reported this morning. While meager from a historical perspective, our results are impressive in light of the current market conditions and directly attributable to the actions we began to take a year ago.
Recall that a year ago Lehman had collapsed, the depth of the credit crisis was not yet known and we were recognizing the reality of a recession in California and had not had seen much impact in Texas. In light of this uncertainty, we had already begun an aggressive process of thoroughly reviewing our businesses to ensure that we operated as cost effectively as possible.
At the same time, we were focused on our liquidity and took a number of steps to generate cash and to preserve and strengthen our financial position. Through the past 12 months we have reported our actions to you. We idled our less efficient small kilns at our Midlothian cement plant in order to maximize the efficiencies inherent in our large, modern kiln and to manage our clinker inventory levels.
We idled our cement grinding operations at our Crestmore plant because we were able to meet demand with the grinding capacity at our Oro Grand cement plant. We decided to operate our Oro Grand plant in California at high production rates in order to maximize our cost efficiencies by building inventory and then taking the kiln down for extended times while selling out of inventory. We suspended operations at two central Texas aggregate plants. We adjusted shifts and reduced overtime hours to match production to demand. We improved our maintenance practices on mobile equipment in order to expand major component rebuilds.
During the summer we shifted our zone production to off-peak hours in order to avoid force production interruptions during peak power consumption. Our Ready Mix operations which are particularly susceptible to inefficiencies related to volume declines, have idled trucks, reduced headcount and made a number of other operational changes to preserve margins and remain profitable. All of our operations have made dramatic changes and significantly reduced their headcount over the past year.
Our headcount is down 28% compared to the beginning of calendar year 2008. These and other actions are the reason our consolidated cash gross margins actually improved compared to a year ago despite shipments being off 25-35% for our major products. Ken will provide additional details with his comments.
On the fiscal front, we have also taken a number of actions to proactively manage our financial condition. In August 2008 we issued senior notes to add over $100 million of cash. In November 2008 we modified our debt terms to give us more room on our covenants. In June 2009 we converted our credit facility to an asset backed loan to secure by the value of our accounts receivable, our inventory and our mobile equipment; all of this in order to give us further flexibility.
We delayed the expansion of our central Texas cement plant which conserved $40-60 million of capital spending. We pared back our regular CapEx spending by approximately $20 million. We declared a companywide salary freeze for non-union employees and the board of directors, executive officers and I voluntarily chose to reduce our compensation in fiscal year 2010.
Looking forward, predicting the future continues to be a difficult task. We are preparing for a challenging winter but we are also encouraged by the fact that the Portland Cement Association forecast for our markets indicate that cement consumption will hit bottom in 2009 and that recovery will start to occur in 2010. The PCAs conclusions are in line with our current outlook and I am pleased that the recovery prospects appear to bet getting clearer for calendar 2010 and beyond.
Let me now turn my attention to the elephant in the room, the Shamrock’s proxy play. Needless to say, I am disappointed by their actions and I strongly disagree with the conclusions they have reached about the performance of our board of directors and management team. Ken and I have been on the road visiting with a number of shareholders and these conversations will continue over the coming months. As I have already discussed, we have taken a number of aggressive and proactive measures in response to an economic event that surprised virtually everyone. We have expanded our earnings capacity in the two most attractive long-term markets in the United States and this board has demonstrated its commitment to shareholder value by initiating and completing an extraordinarily successful spin off of Chaparral Steel Company.
We are very proud of these accomplishments and we strive to exceed them for the benefit of our shareholders every day. In spite of this distraction, we are focused on running our business as effectively as possible. The good work of our employees is delivering results to our shareholders and I am grateful for their efforts.
With that I will turn it over to Ken.
Kenneth Allen
Thanks Mel and good afternoon. As Mel mentioned earlier, results from TXI’s first quarter though down from a year ago reflect the continued successful efforts of employees to control costs in an environment of significantly reduced demand for construction materials.
Consolidated net sales declined 28% compared to last year’s first quarter primarily due to lower product shipments. Wet weather in the last half of July in our Texas markets also had a negative impact on shipments but the recession driven decline in overall construction activity was clearly the primary reason for the decrease in sales.
Despite the decline in shipments gross margins increased compared to last year moving from 12.7% to 18.5%. After removing $11 million of expenses for major cement plant maintenance that were incurred a year ago in order to get more of an apples-to-apples comparison, gross margin still improved from 17% last year to this quarter’s 18.5%.
Now let’s take the comparison one more step and look at cash gross margins. When you add back depreciation and amortization expenses, cash gross margins actually increased from 23.5% a year ago to 27.4% for the current quarter. I will go into more detail on the segment discussions but these results in the face of a 28% decline in sales just underscore Mel’s earlier comments about the good job TXI’s employees are doing to control and manage costs.
Looking at SG&A expenses they were up $2.9 million compared to last year and this was due to a $6.7 million increase in stock based compensation. Taking out the stock based component which is primarily a function of changes in the company stock price, SG&A expenses were actually down $3.8 million or 18% again reflecting additional success in focusing on costs throughout the company.
Interest expense in the quarter increased by $6 million compared to a year ago. This increase reflects a higher level of debt and the fact that $1.8 million of interest related to the Hunter Cement Plant expansion was capitalized and therefore reduced interest expense in last year’s quarter. Other income declined by $5.6 million as last year’s quarter benefited from emission credit sales and oil and gas lease transactions.
As a result of all of the above, net income declined $8.9 million compared to last year but our focus on cash conservation paid large dividends in the quarter. We started the quarter with $20 million in cash. During the quarter we made a semi-annual interest payment of $20 million and still ended the quarter with a cash balance of $32 million. Again, we have our eye on the ball and continue to block and tackle.
Turning to the cement segment, operating profit for the quarter of $12.4 million was 26% below that of a year ago. Both the Texas and California operations registered 25% declines in cement shipments compared to last year. Average realized prices were down 6% as Texas pricing declined 3% and California prices were down 13%. Cement unit costs declined 13% compared to last year. As I mentioned earlier though, last year’s first quarter had approximately $11 million of scheduled maintenance expense for our Hunter, Texas and California plants and we have no major scheduled maintenance in the recent quarter.
Adjusting for the scheduled maintenance, unit costs were down 2% and unit cash costs were down 7% and this is a remarkable result given that shipments declined 25% and also that the cost per ton of coal increased 29% as we encountered our new coal contracts since last winter. The increased coal cost was offset by the positive results we have experienced in substituting other fuels for coal and by lower power costs.
Electricity prices declined 38% on a per kilowatt hour basis and natural gas prices were down 66% from last year’s very high levels. In other areas such as labor, material costs and maintenance as well as SG&A expenses, the operations did a remarkable job in controlling costs. Other income for the cement segment declined by $3.5 million. Last year’s quarter included income from the sale of emissions credits as I mentioned earlier and also the oil and gas lease bonus payments. The emission sales credit number was $1.7 million and the bonus payments were $2.8 million.
Turning to TXI’s aggregate operations, quarterly operating profit for the segment of $8.6 million was only 3% below that of a year ago even though stone, sand and gravel shipments declined 34%. Average realized prices for stone, sand and gravel products were up 4%. Average unit costs were stable and cash unit costs actually declined by 8%.
Lower [inaudible] diesel costs also helped to reduce cash costs but the clear takeaway from these results is that the aggregate employees are doing a great job of managing through this challenging time. As an added example, segment SG&A expenses declined by $1.1 million, again as the result of the continued focus on cost reductions.
For the consumer products segment, operating profit moved from a loss of $500,000 a year ago to a profit of $4.8 million in this year’s quarter. A 6% price improvement combined with a 2% unit cost decline offset the 35% drop in shipments. Raw material costs including the transportation costs of getting raw materials to the plants, declined by 8%. Diesel prices were off by approximately 50% compared to a year ago as well. Maintenance and SG&A expenses also declined while solid delivery efficiencies were achieved even with the significant drop in shipments. Again, the results reflect the good blocking and tackling the consumer product segment has done to show improved results in spite of the steep decline in construction activity.
In the corporate section, other income declined by $1.8 million. In last year’s quarter we had $1.6 million in oil and gas bonus payment income and that accounts for the decline. Corporate SG&A expense increased $5.9 million and this was driven by the $6.7 million increase in stock based compensation that I mentioned earlier. Taking the stock based compensation out, corporate SG&A actually declined by 9% compared to a year ago.
As we look forward you can see from the results in our press release that depreciation expense is running at an annual rate of about $66 million a year. With regard to capital spending in July we mentioned that capital spending for fiscal year 2010 should be between $30-40 million. Today though we expect capital spending for fiscal year 2010 to be somewhat lower, between $20-30 million and this is just another action we are taking to conserve cash.
Now that we are not capitalizing interest for projects, the interest expense run rate is approximately $13.2 million per quarter or about $52 million per year. The tax rate for the quarter of 47% was high by historical standards but as we mentioned in July at these low levels of pre-tax income the tax rates can become highly variable. I would use that rate in modeling for the rest of the year.
Now for a couple of notes for the November quarter. First, our Texas markets have been subject to extended and continuous rainfall during September and this has negatively impacted shipments for the month. Secondly, remembering last year’s November quarter our Midlothian, Texas cement plant was down for scheduled maintenance and we estimated that the maintenance added about $8 million to expense for the quarter. Now we expect to bring the Midlothian plant down for maintenance late in the current quarter and the downtime will extend into December.
Estimating the cost impact to the November quarter related to the downtime is difficult because of the timing but we do expect the cost of the maintenance in the November quarter itself will be less than the $8 million incurred last year.
Finally, with regard to TXI’s financial standing, we ended the quarter with $30 million in cash and the ability to borrow approximately $100 million under the asset base line before we encounter any maintenance [projects]. With the good discipline that is being applied to capital spending we believe the company is well positioned to get through the recession and are looking forward to the beginning of a recovery in the coming year.
Now with that, operator, I will turn things back over to you as we move into the Q&A session.
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Fund Letters
