ITEM 1. BUSINESS
(a) General Development of Business
Texas Industries, Inc. and subsidiaries (unless the context indicates otherwise, collectively, the “Registrant”, the “Company” or “TXI”), is a leading supplier of construction materials through two business segments: cement, aggregate and concrete products (the “CAC” segment); and structural steel and steel bar products (the “Steel” segment). Through the CAC segment, TXI produces and sells cement, stone, sand and gravel, ready-mix concrete, and other products. Through the Steel segment, TXI produces and sells structural steel and special bar quality and other products. Demand for structural steel, cement, aggregate and concrete products is driven primarily by construction activity, while special bar quality products supply original equipment manufacturers and oil related markets.
TXI believes it is the largest producer of cement in Texas, a major cement producer in California and the second largest supplier of structural steel products in North America. TXI is the only North American producer of both cement and steel.
Incorporated April 19, 1951, TXI began its cement operations in 1960 with the opening of its Midlothian, Texas facility and added its steel operations in 1975 with the construction of a plant in Midlothian. On December 31, 1997, TXI acquired Riverside Cement Company, the owner of a 1.3 million ton per year portland cement plant and a 100,000 ton per year white cement plant. The acquisition increased TXI’s capacity at the time by 60% and opened the California regional cement market to the Company. During the May 2001 quarter TXI completed the expansion of its Midlothian, Texas cement plant. This expansion added approximately 1.5 million tons of capacity, which increased the Company’s total capacity by over 40% to 4.9 million tons. TXI’s structural steel facility in Virginia began operations during the August 1999 quarter expanding TXI’s steel capacity by over 60% to 3.0 million tons.
(b) Financial Information about Industry Segments
Financial information for the Registrant’s two industry segments, is presented in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages 12 and 13, incorporated herein by reference.
(c) Narrative Description of Business
CEMENT, AGGREGATE AND CONCRETE
The CAC business segment includes the manufacture and sale of cement, aggregates, ready-mix concrete and other related products. Production and distribution facilities are concentrated primarily in Texas, Louisiana and California, with markets extending into contiguous states. The Company does not place heavy reliance on patents, franchises, licenses or concessions related to its CAC operations.
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Cement
TXI’s cement operations produce gray portland cement as its principal product. Also produced are specialty cements such as white portland, masonry and oil well.
Cement production facilities are located at four sites in Texas and California: Midlothian, Texas, south of Dallas/Fort Worth, the largest cement plant in Texas; Hunter, Texas, south of Austin; and Oro Grande and Crestmore, California, both near Los Angeles. Except for the Crestmore facility, the limestone reserves used as the primary raw material are located on fee-owned property adjacent to each of the plants. Raw material for the Crestmore facility is purchased from multiple outside suppliers. Information regarding each of the Company’s facilities is as follows:
The Company uses its patented CemStarSM process in both of its Texas facilities and its Oro Grande, California facility to increase combined annual production by approximately 6%. The CemStarSM process adds “slag,” a co-product of steel-making, into a cement kiln along with the regular raw material feed. The added slag serves to increase the production of clinker with little additional cost. The primary fuel source for all of the Company’s facilities is coal; however, the Company displaces approximately 15% of its coal needs at its Midlothian plant and approximately 8% of its coal needs at its Hunter plant by utilizing alternative fuels such as waste-derived fuels and tires. The Company’s facilities also consume large amounts of electricity obtained primarily under variable-price firm supply contracts of short duration. The Company believes that adequate supplies of both fuel and electricity are readily available.
The Company produced approximately 5.1 million tons of finished cement in 2004, 4.8 million tons in 2003 and 4.7 million tons in 2002. Total annual shipments of finished cement were approximately 5.3 million tons in 2004, 4.9 million tons in 2003 and 4.9 million tons in 2002, of which 4.4 million tons in 2004, 4.0 million tons in 2003 and 3.9 million tons in 2002 were shipped to outside trade customers.
The Company markets its cement products in the southwestern United States. The principal marketing area includes the states of Texas, Louisiana, Oklahoma, California, Nevada, Arizona and Utah. Sales offices are maintained throughout the marketing area and sales are made primarily to numerous customers in the construction industry, no one of which accounted for more than ten percent of the trade sales volume in 2004.
Cement is distributed by rail or truck to eight distribution terminals located throughout the marketing area.
The cement industry is highly competitive with suppliers differentiating themselves based on price, service and quality.
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Aggregates
TXI’s aggregate operations, which produce sand, gravel, and crushed limestone, are conducted from facilities primarily serving the Dallas/Fort Worth, Austin and Houston areas in Texas; the southern Oklahoma area; and the Alexandria, New Orleans, Baton Rouge and Monroe areas in Louisiana. The following table summarizes certain information about the Company’s aggregate production facilities.
Reserves identified with the facilities shown above and additional reserves available to support future plant sites are contained on approximately 39,000 acres of land, of which approximately 25,000 acres are owned in fee and the remainder leased. The plants operated at 82 percent of rated annual productive capacity for 2004 and sales for the year totaled 22.9 million tons, of which approximately 17.7 million tons were shipped to outside trade customers. In addition, the Company owns and operates three industrial sand plants and an aggregate blending facility.
The cost of transportation limits the marketing of aggregate products to the areas within approximately one hundred miles of the plant sites, therefore, sales are related to the level of construction activity near the plants. The products are marketed by the Company’s sales organization located in the areas served by the plants and are sold to numerous customers, no one of which would be considered significant to the Company’s business. Products are distributed to trade customers principally by contract or customer-owned haulers or through Company-owned rail distribution facilities.
Ready-mix Concrete
TXI’s ready-mix concrete operations are situated in three areas in Texas (Dallas/Fort Worth/Denton, Houston and East Texas), in north and central Louisiana, and at one location in southern Arkansas. The following table summarizes various information concerning these facilities.
The plants listed above are located on sites owned or leased by the Company. TXI manufactures and supplies a substantial amount of the cement and aggregates used by the ready-mix plants with the remainder being purchased from outside suppliers. Ready-mix concrete is sold to various contractors in the construction industry, no one of which would be considered significant to the Company’s business. The Company believes that it is a significant participant in each of the Texas and Louisiana concrete products markets. The principal methods of competition in concrete products markets are quality and service at competitive prices.
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Other Products
Expanded shale and clay, a specialty 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. The following table summarizes certain information about the Company’s expanded shale and clay production facilities.
The expanded shale and clay plants operated at 80 percent of rated annual productive capacity for 2004 and sales for the year totaled approximately 1.6 million cubic yards, of which approximately 1.4 million cubic yards were shipped to outside trade customers.
The cost of transportation limits the marketing of expanded shale and clay products to the areas within approximately one hundred miles of the plant sites, therefore, sales are related to the level of construction activity near the plants. The products are marketed by the Company’s sales organization located in the areas served by the plants and are sold to numerous customers, no one of which would be considered significant to the Company’s business. Products are distributed to trade customers principally by contract or customer-owned haulers, and to a lesser extent by rail.
The Company manufactures and markets prepackaged concrete and related products from plant or distribution sites owned by the Company in the Dallas/Fort Worth, Austin and Houston areas in Texas and Bossier City, Louisiana.
The products are marketed by the Company’s sales force in each of these locations, and are delivered primarily by contract haulers. Because the cost of delivery is significant to the overall cost of most of these products, the market area is generally restricted to within approximately one hundred miles of the plant locations. These products are sold to various contractors, owners and distributors, no one of which would be considered significant to the Company’s business.
During 2004, the Company sold its clay brick and concrete block production facilities in Texas and Louisiana.
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STEEL
TXI’s steel facilities, located in Midlothian, Texas and Dinwiddie County, Virginia, produce a broad array of steel products. TXI uses its patented near net shape casting technology at both facilities. The process involves casting molten steel into a shape that is closer to a product’s final shape than traditional casting methods. This technology provides energy and capital cost savings in the making of wide flange beams and other structural steel products. The Texas facility has two electric arc furnaces with continuous casters that feed melted steel to a bar mill, a structural mill and a large beam mill. Finished (rolled) products produced include beams up to twenty-four inches wide, special bar quality products, merchant bar quality rounds, reinforcing bar and channels. The Virginia facility has one electric arc furnace and in-line processing units consisting of two near net shape casters and a sophisticated rolling mill. Finished products produced include beams up to thirty-six inches wide, sheet piling and H-piling.
The rated annual capacities of the operating facilities are as follows:
The bar and structural mills produced approximately 2.1 million tons of finished products in 2004, 1.8 million tons in 2003 and 1.9 million tons in 2002.
The principal raw material is recycled steel scrap. Shredded steel represents approximately 40% of the raw material mix. A major portion of the shredded steel requirements of the Texas facility is produced by an on-site shredder operation utilizing primarily crushed auto bodies purchased on the open market. The Company purchases shredded steel on the open market to meet the requirements of the Virginia facility. Another grade of recycled steel scrap, #1 Heavy, representing approximately 30% of the raw material mix is also purchased on the open market. The purchase price of recycled steel scrap is subject to market forces largely beyond the Company’s control. The supply of recycled steel scrap is expected to be adequate to meet future requirements.
Steel mills with electric arc furnaces consume large amounts of electricity and natural gas. Electricity for the Texas facility is obtained under variable-price supply contracts typically of short duration. Electricity for the Virginia facility is obtained from a local utility under an interruptible supply contract with price adjustments that reflect increases or decreases in the utility’s fuel costs. Natural gas is obtained under supply contracts. The Company believes that adequate supplies of both electricity and natural gas are readily available.
The Company’s steel products are marketed by the Company’s sales organization throughout North America. Sales are primarily to steel service centers and steel fabricators for use in the construction industry, as well as to cold finishers, forgers and original equipment manufacturers for use in the railroad, defense, automotive, mobile home and energy industries. The Company does not place heavy reliance on franchises, licenses or concessions. None of TXI’s customers accounted for more than ten percent of the Steel segment’s sales in 2004. Sales to affiliates are minimal. Orders are generally filled within 45 days and are cancelable. Delivery of finished products is accomplished by common-carrier, contract or customer-owned haulers, rail or barge.
The Company competes with steel producers, including foreign producers, on the basis of price, quality and service. Certain of the foreign and domestic competitors, including both large integrated steel producers and mini-mills, have substantially greater assets and larger sales organizations than TXI. Intense sales competition exists for substantially all of TXI’s steel products.
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RISKS RELATING TO THE COMPANY
Competition
All of the markets in which the Company participates are highly competitive. The Company competes in each of its cement, aggregate and concrete products markets with several other domestic suppliers of these products as well as with importers of foreign cement. The Company competes in its steel markets with national and international producers of steel products. Some of the Company’s competitors are larger, have greater financial resources and have less financial leverage than the Company. The Company competes on the basis of, among other things, competitive prices, prompt availability, customer service and quality products.
Sensitivity to Economic Cycles; Seasonality and Weather
A significant percentage of the Company’s sales of both CAC and Steel products is attributable to the level of construction activity, which is affected by such cyclical factors as general economic conditions, availability of public funds, interest rates, inflation, consumer spending habits and employment. The Company’s CAC operating profit is generally lower in its fiscal quarter ended February 28 as compared to the other three fiscal quarters due to the impact of winter weather on construction activity. Extended periods of inclement weather can adversely impact construction activity at other times of the year as well. Steel results are also affected by the Company’s shut-downs scheduled every twelve to twenty-four months to refurbish its steel production facilities.
Growth Strategy
A significant element of the Company’s operating strategy is to pursue strategic acquisitions that either expand or complement the Company’s products or markets or to build new or expand existing production facilities. There can be no assurance that the Company will be able to identify and make acquisitions on acceptable terms, that the Company will be able to obtain the permits necessary to build new or expand existing production facilities, that the Company will be able to obtain financing for such acquisitions or expansions on acceptable terms or that the Company will be able successfully to integrate such acquisitions into existing operations.
Availability and Pricing of Raw Materials and Energy
The Company is dependent upon purchased recycled scrap steel as a raw material and upon the availability of energy sources, including electricity and fossil fuels. Accordingly, the Company’s results of operations and financial condition have in the past been, and may again in the future be adversely affected by increases in raw material costs or energy costs, or their lack of availability.
Status of Certain Tariffs
CAC Segment. A group of domestic cement producers, including the Company, filed antidumping petitions that have resulted in the imposition of significant antidumping duty cash deposits on gray portland cement and clinker imported from Mexico and Japan. In addition, the U.S. Department of Commerce has signed agreements with the Venezuelan Government and Venezuelan cement producers, which are designed to eliminate the dumping and illegal subsidization of gray portland cement and clinker from Venezuela. On an annual basis, the antidumping duties are subject to review by the Department of Commerce to determine whether the current antidumping duty deposit rates should be adjusted upward or downward. A substantial reduction or elimination of the existing antidumping duties could lower the Company’s results of operations.
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In 1995, the Antidumping Code of General Agreement on Tariffs and Trade was substantially altered pursuant to the Uruguay Round of multilateral trade negotiations. U.S. legislation approving and implementing the Uruguay Round agreements requires the Department of Commerce and the U.S. International Trade Commission (“ITC”) to conduct “sunset” reviews of all outstanding antidumping and countervailing duty orders and suspension agreements, including the antidumping orders against gray portland cement and clinker from Mexico and Japan and the suspension agreements on gray portland cement and clinker from Venezuela, to determine whether they should be terminated or remain in effect. In 2000, the Department of Commerce and the ITC conducted “sunset” reviews of the antidumping orders and suspension agreements and determined that they should remain in effect until 2005 when the ITC is scheduled to conduct another sunset review. However, the ITC determined that the suspension agreements with Venezuela were no longer necessary. Mexican cement producers have appealed the ITC sunset determination regarding imports from Mexico to a dispute panel established under the North American Free Trade Agreement. The Government of Mexico has also requested consultations with the United States regarding the Mexican cement antidumping order under World Trade Organization (“WTO”) dispute settlement rules. The consultations could lead to Mexico filing a WTO complaint challenging the Department of Commerce’s and the ITC’s determinations in sunset reviews and the annual determination of the amount of duties. In addition, the Government of Mexico has filed a request with the WTO to form a dispute resolution panel regarding the United States antidumping order on Mexican cement. The exact schedule of the WTO preceding is not yet established. Domestic cement producers have appealed the ITC sunset review determinations regarding imports from Venezuela to the U.S. Court of International Trade. Although to date Venezuelan imports have not competed in the Company’s markets to any significant degree, they may do so in the future.
Independently owned cement operations could undertake to construct new import facilities and begin to purchase large quantities of low-priced cement from countries not yet subject to antidumping orders, such as those in Asia, which could not compete with domestic producers. An influx of low-priced cement or clinker products from countries not subject to antidumping orders could lower the Company’s results of operations.
Steel Segment. Excessive imports of steel into the United States have, and may again in the future, exert downward pressure on U.S. steel prices and significantly reduce the Company’s sales, margins and profitability. Some foreign steel producers are owned, controlled or subsidized by foreign governments. As a result, decisions by these producers with respect to their production, sales and pricing are often influenced to a greater degree by political and economic policy considerations than by prevailing market conditions, realities of the marketplace or consideration of profit or loss.
In July 1999, complaints were filed with the ITC and the U.S. Department of Commerce by the Company, Northwestern Steel & Wire Co., Nucor-Yamato Steel Co. and the United Steelworkers of America seeking to impose antidumping and countervailing duties against imports of structural steel beams from Germany, Japan, South Korea and Spain. In June and July 2000, the ITC made respective determinations that an industry in the United States is materially injured or threatened with material injury by reason of such imports from Japan and Korea that the Department of Commerce has determined are subsidized and sold in the United States at less than fair value. As a result of the ITC’s affirmative determinations, the Department of Commerce directed the U.S. Customs Service to impose countervailing and antidumping duties on imports of certain structural steel beams from these two countries. However, imports of structural steel beams from other countries increased significantly and the Committee for Fair Beam Imports (composed of Northwestern Steel & Wire Co., Nucor Corp., Nucor-Yamato Steel Co. and the Company) again petitioned the ITC and the U. S. Department of Commerce concerning imports of certain structural steel beams from China, Germany, Luxembourg, Russia, South Africa, Spain and Taiwan. On June 17, 2002, the ITC determined that, although the Department of Commerce had determined that these imports were being sold in the United States at less than fair value, such imports did not materially injure or threaten with material injury an industry in the United States, and no antidumping duties were imposed on imports of structural steel beams from these countries.
Existing duties are subject to annual review upon request. A substantial reduction or elimination of the existing antidumping duties, or an influx of low-priced steel products from countries not subject to antidumping orders, could again create downward pressure on U.S. steel prices and, in turn, lower the Company’s results of operations.
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Impact of Environmental Laws
The Company’s operations and those of its subsidiaries are subject to various federal, state and local environmental, health and safety laws and regulations. These laws and regulations govern the generation, use, handling, storage, transportation and disposal of hazardous substances and wastes, and provide for the investigation and remediation of contamination existing at current and former properties, and at third-party waste disposal sites. They have tended to become increasingly stringent over time. As with others in its business, the Company expends substantial amounts to comply with these laws and regulations, including amounts for pollution control equipment required to monitor and regulate wastewater discharges and air emissions. The U.S. Environmental Protection Agency (“EPA”) and state agencies are charged with enforcing these laws and regulations, and these agencies can impose substantial fines and penalties, as well as curtail and/or suspend the Company’s operations, for violations and non-compliance. Moreover, certain of these laws and regulations permit private parties to bring actions against the Company for injuries to persons and damages to property allegedly caused by its operations. Changes in environmental laws may interrupt production, increase the cost of compliance and hinder the Company’s ability to build new or expand production facilities.
Emissions sources at the Company’s facilities are regulated by a combination of permit limitations and emission standards of national and statewide application. The Company believes it is in substantial compliance with its permit limitations and emission standards and regulations applicable to its existing facilities. Future changes in permit limitations and emission standards, however, may result in prolonged production interruption, significant costs of compliance or a hindrance of ability to build new or expand existing production facilities.
Many of the raw materials, products and by-products associated with the operation of any industrial facility, including those for the production of steel, cement or concrete products, contain chemical elements or compounds that can be designated as hazardous. Such raw materials, products and by-products may also exhibit characteristics that result in their being classified as a hazardous substance or waste. Some examples are the metals present in cement kiln dust (“CKD”), electric arc furnace dust (“EAF dust”) generated by the Company’s steel facilities and the ignitability of the waste derived fuels that the Company uses as a primary or supplementary fuel substitute for nonrenewable coal and natural gas to fire certain of its cement kilns.
Currently, CKD is exempt from hazardous waste management standards under the Resource Conservation and Recovery Act (“RCRA”) if certain tests are satisfied. The Company has demonstrated that the CKD it generates satisfies these tests. However, the EPA plans to apply site-specific waste-management standards to CKD under the Clean Air Act and RCRA to assure that the environment is protected. The Company has established operating practices and is implementing waste management programs that it believes will comply with these anticipated standards, but such practices and programs may not continue to comply in the future if regulations become more restrictive.
The Company utilizes hazardous materials such as gasoline, acids, solvents and chemicals as well as materials that have been designated or characterized as hazardous waste by the EPA, which it utilizes for energy recovery. This requires the Company to familiarize its work force with the more exacting requirements of applicable environmental laws and regulations with respect to human health and the environment related to these activities. The failure to observe these exacting requirements could jeopardize the Company’s hazardous waste management permits and, under certain circumstances, expose it to significant liabilities and costs of cleaning up releases of hazardous substances into the environment or claims by employees or others alleging exposure to hazardous substances.
The Company’s steel facilities generate, in the same manner as other similar steel plants in the industry, EAF dust that contains lead, chromium and cadmium. The EPA has listed this EAF dust, which is collected in baghouses, as hazardous waste. The Company has contracts with reclamation facilities in the United States and Mexico pursuant to which such facilities receive the EAF dust generated by the Company and recover the metals from the dust for reuse, thus rendering the dust non-hazardous. In addition, the Company is continually investigating alternative reclamation technologies and has implemented processes for diminishing the amount of EAF dust generated.
The Company intends to comply with all legal requirements regarding the environment and health and safety matters, but since many of these requirements are subjective and therefore not quantifiable, are presently not determinable, or are likely to be affected by future legislation or rule making by government agencies, it is not possible to accurately predict the aggregate future costs of compliance and their effect on the Company’s operations, future net income or financial condition. Notwithstanding the Company’s intentions to comply with all legal requirements, if injury to persons or damage to property or contamination of the environment has been or is caused by the conduct of its business or hazardous substances or wastes used in, generated or disposed of by it, the Company may be liable for such injuries and damages, and be required to pay the cost of investigation and remediation of such contamination. The amount of such liability could be material and the Company may incur material liability in connection with possible claims related to its operations and properties under environmental, health and safety laws.
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Equipment Failure
Due to the high fixed cost nature of the Company’s business, interruptions in its production capabilities may cause the Company’s productivity and results of operations to decline significantly during the affected period. The Company’s manufacturing processes are dependent upon critical pieces of equipment, such as its cement kilns, grinding mills, stone crushers, steel furnaces, continuous casters and rolling equipment, as well as electrical equipment, such as transformers. This equipment may, on occasion, be out of service as a result of unanticipated failures or damaged during accidents, which may lead to production curtailments and shutdowns. In addition to equipment failures, its facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or violent weather conditions.
Earthquakes
The Company’s operations in California are susceptible to damage from earthquakes. Any significant earthquake damage could materially adversely affect the Company’s results of operations. The Company maintains only a limited amount of earthquake insurance and, therefore, is not fully insured against earthquake risk.
OTHER ITEMS
Employees
TXI has approximately 4,100 employees: 2,500 employed in CAC operations, 1,400 employed in Steel operations and the balance employed in corporate resources.
Intellectual Property
While the Company maintains trademarks such as TXI ® and Maximizer ® and process patents such as CemStar SM and near net shape casting, the Company does not believe any of its active trademarks or patents are essential to the Company’s business as a whole.
Real Estate
The Company is involved in the development of its surplus real estate and real estate acquired for development of high quality industrial and multi-use parks in the metropolitan areas of Dallas/Fort Worth and Houston, Texas.
Available Information
TXI files annual, quarterly and special reports, proxy statements and other information with the SEC. You may read and copy any reports, statements and other information filed by TXI at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call (800) SEC-0330 for further information on the Public Reference Room. The SEC maintains an internet web site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. TXI’s filings are also available to the public at the website maintained by the SEC, http://www.sec.gov.
TXI makes available, free of charge, through its investor relations website its reports on Forms 10-K, 10-Q and 8-K, and amendments to those reports, as soon as reasonably practicable after they are filed with the SEC. The URL for TXI’s investor relations website is www.txi.com.
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ITEM 2.
ITEM 2. PROPERTIES
The information required by this item is included in Item 1.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The information required by this item is included in the section of the Notes to Consolidated Financial Statements entitled “Legal Proceedings and Contingent Liabilities” presented in Part II, Item 8 on page 37 and incorporated herein by reference.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table presents certain information about the executive officers of the Registrant.
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PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The shares of common stock, $1 par value, of the Registrant are traded on the New York Stock Exchange (ticker symbol TXI). As of August 2, 2004 , there were 2,535 holders of record of the Company’s common stock. Common stock market prices, dividends and certain other items are presented in the Notes to Consolidated Financial Statements entitled “Quarterly Financial Information” on page 46, incorporated herein by reference. The restriction on the payment of dividends described in the Notes to Consolidated Financial Statements entitled “Long-term Debt” on pages 32 and 33 is incorporated herein by reference. The Company’s quarterly cash dividend at $.075 per common share has remained unchanged since January 1997.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
TEXAS INDUSTRIES, INC. AND SUBSIDIARIES
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Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company is a leading supplier of construction materials through two business segments: cement, aggregate and concrete products (the “CAC” segment); and structural steel and steel bar products (the “Steel” segment). Through the CAC segment, the Company produces and sells cement, stone, sand and gravel, ready-mix concrete, expanded shale and clay aggregate, and other products. Through the Steel segment, the Company produces and sells structural steel, piling products, special bar quality products, merchant bar quality rounds, reinforcing bar and channels.
The Company’s CAC facilities are concentrated primarily in Texas, Louisiana and California, with several products marketed throughout the United States. The Company owns long-term reserves of limestone, the primary raw material for the production of cement.
The Company’s steel facilities produce a broad array of steel products, utilizing recycled steel scrap obtained from crushed automobiles and other sources as the principal raw material. Steel products, sold principally to steel service centers, fabricators, cold finishers, forgers and original equipment manufacturers, are distributed primarily to markets in North America.
Both the CAC and Steel businesses require large amounts of capital investment, energy, labor and maintenance.
Corporate Resources include administration, financial, legal, environmental, human resources and real estate activities which are not allocated to operations and are excluded from operating profit. Assets identified with Corporate Resources include cash and cash equivalents, real estate and investments, debt issuance costs and deferred tax assets.
BUSINESS SEGMENTS
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RESULTS OF OPERATIONS
Operating Profit - Fiscal 2004 Compared to Fiscal 2003
CAC Operations
CAC operating profit at $122.8 million increased $42.1 million from 2003. The sale of the Company’s brick production facilities in Texas and Louisiana contributed $34.7 million to other income. Higher shipments for all major CAC products also contributed to the increased operating profit. The Company has experienced improving overall demand for its CAC products throughout the year.
Net Sales. CAC net sales at $767.2 million increased 7%. Total cement sales increased $25.2 million on 8% higher shipments. Ready-mix sales increased $3.0 million on somewhat higher volume. Aggregate sales increased $15.5 million on 17% higher shipments. Average trade prices for the major CAC products were comparable to the prior year.
Operating Costs. CAC cost of products sold at $637.3 million, including depreciation, depletion and amortization, increased $40.6 million on higher shipments and aggregate production. Cement unit costs were comparable to the prior year.
Selling, general and administrative expense at $46.2 million, including depreciation and amortization, increased $4.2 million primarily due to higher incentive compensation and general expenses.
Other income includes $34.7 million from the sale of the Company’s brick production facilities in Texas and Louisiana.
Steel Operations
Steel operating profit at $44.1 million increased $92.8 million from 2003. Higher selling prices and shipments, and improved production rates and efficiencies at the Virginia facility, contributed to the improvement. During the year rapidly escalating raw material costs affected results. Beginning in January 2004 margins began to recover due to increased selling prices and the implementation of a raw material surcharge.
Net Sales. Steel sales at $905.3 million increased 40%. Structural steel sales increased $182.8 million on 12% higher shipments and 25% higher average realized prices. Bar mill sales increased $61.7 million on 25% higher shipments and 23% higher realized prices.
Operating Costs. Steel cost of products sold at $842.3 million, including depreciation and amortization, increased $169.0 million. The increased costs were the result of higher shipments and the effect of higher raw material costs on unit costs partially offset by improved operating efficiencies at the Virginia facility due to increased production levels.
The Company has experienced unprecedented increases in the cost of steel scrap, the principal raw material used in its steel production. As a result of these increases in scrap costs the Company incurred a charge to value inventories using the last-in, first-out (“LIFO”) method of accounting of $26.9 million in 2004 compared to $8.5 million in the prior year.
Selling, general and administrative expense at $26.5 million increased $5.5 million primarily due to higher incentive compensation and bad debt expense.
Other income includes $4.2 million obtained from the Company’s litigation against certain graphite electrode suppliers.
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Operating Profit-Fiscal 2003 Compared to Fiscal 2002
CAC Operations
CAC operating profit at $80.7 million declined $38.5 million from 2002. Softening demand due to the decline in non-residential construction and abnormal inclement weather in Texas during the winter months reduced ready-mix and aggregate shipments. Higher energy and maintenance costs reduced cement margins.
Net Sales. CAC net sales at $718.1 million decreased 6%. Total cement sales decreased $11.7 million on comparable shipments as average trade prices declined 2%. Ready-mix sales declined $28.2 million on 10% lower volume at 2% lower average prices. Aggregate sales decreased $12.2 million on 10% lower shipments.
Operating Costs. CAC cost of products sold at $596.7 million, including depreciation, depletion and amortization, was unchanged from the prior year as lower ready-mix volume offset the impact of higher energy and maintenance costs on cement unit costs.
Selling, general and administrative expense at $41.9 million, including depreciation and amortization, decreased $6.8 million primarily due to lower incentive compensation and bad debt expense.
Other income decreased due to lower gains from the disposal of surplus operating assets.
Steel Operations
Steel operating profit at $48.6 million loss declined $80.0 million from 2002. The lower operating profit included a $9.1 million decrease in other income from the Company’s litigation against certain graphite electrode suppliers. The decline in non-residential construction resulted in a very competitive structural steel market. Realized prices for structural steel declined significantly from the prior year as the Company sought to maintain market share. Increased raw material and energy costs also contributed to reduce margins.
Net Sales. Steel sales at $646.0 million were $39.2 million below the prior year. Structural steel average realized prices for the year were down 6% on 2% lower shipments. Bar sales were comparable to the prior year as 6% lower shipments were offset by 8% higher realized prices.
Operating Costs. Steel cost of products sold at $673.4 million, including depreciation and amortization, increased $33.2 million. Lower shipments that reduced costs $10.8 million were offset by higher unit production costs resulting from increased raw material and energy costs.
Selling, general and administrative expense at $20.9 million decreased $6.7 million primarily due to lower bad debt and general expenses.
Other income included $500,000 from the Company’s litigation against certain graphite electrode suppliers compared to $9.6 million in 2002.
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Corporate Resources
Selling, general and administrative expense at $30.7 million in 2004, including depreciation and amortization, increased $600,000. Increased incentive compensation and retirement expenses of $6.0 million were offset by decreased bad debt and general expenses, and the effect of the termination of the Company’s agreement to sell receivables. Other income in 2004 decreased $2.2 million primarily due to lower real estate income.
Selling, general and administrative expense at $30.1 million in 2003, including depreciation and amortization, decreased $2.7 million on lower incentive compensation and costs associated with the Company’s agreement to sell receivables. Other income in 2003 decreased $4.9 million primarily due to lower real estate income.
Interest Expense
Interest expense at $73.7 million in 2004 increased $27.8 million. The increase was the result of the June 2003 refinancing which increased the Company’s outstanding debt $114.8 million and the effective interest rate on fixed rate debt 3%. The Company has entered into interest rate swaps on $300 million of the senior notes such that the interest payable effectively becomes variable based on six-month LIBOR, currently 7.26%.
Interest expense at $45.9 million in 2003 decreased $7.8 million from the prior year as a result of lower average outstanding debt in the period.
Loss on Early Retirement of Debt
As a result of the June 2003 refinancing, the Company recognized an ordinary loss on early retirement of debt of $11.2 million. The loss represents $8.5 million in premium or consent payments to holders of the existing senior notes and a write-off of $2.7 million of debt issuance costs associated with the debt repaid. Effective May 27, 2004, the Company lowered the available borrowings under the new senior secured credit facility from $200 million to $100 million. The Company recognized an ordinary loss on early retirement of debt of $1.1 million, representing a termination fee of $100,000 and a write-off of $1.0 million of debt issuance costs associated with the portion of the facility terminated.
Income Taxes
The Company’s effective tax rate was 27.4% in 2004, 40.1% in 2003 and 29.3% in 2002. The primary reason that the current tax rate differs from the 35% statutory corporate rate is due to percentage depletion that is tax deductible and state income tax expense. Deferred taxes include a $13.0 million alternative minimum tax credit carryforward that is available for offset against future regular income taxes. In addition, the Company has $80.4 million in federal net operating loss carryforwards, which expire in 2023.
Cumulative Effect of Accounting Change-Net of Income Taxes
Effective June 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations,” which applies to legal obligations associated with the retirement of long-lived assets. The Company incurs legal obligations for asset retirement as part of its normal CAC and Steel operations related to land reclamation, plant removal and Resource Conservation and Recovery Act closures. Application of the new rules resulted in a cumulative charge of $1.1 million, net of income taxes of $600,000.
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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. The Company believes the following critical accounting policies affect its 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 the Company is aware of a specific customer’s inability to make required payments, specific amounts are added to the reserve.
Environmental Liabilities. The Company is subject to environmental laws and regulations established by federal, state and local authorities, and makes provision for the estimated costs related to compliance when it is probable that a reasonably estimable liability has been incurred.
Legal Contingencies. The Company and its subsidiaries 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 a reasonably estimable liability has been incurred.
Long-lived Assets. Management reviews long-lived assets 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 the Company’s products, capital needs, economic trends and other factors.
Goodwill. Management tests goodwill for impairment at least annually. If the carrying amount of the goodwill exceeds its fair value an impairment loss is recognized. In applying a fair-value-based test, estimates are made of the expected future cash flows to be derived from the applicable 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 the Company’s products, capital needs, economic trends and other factors.
LIQUIDITY AND CAPITAL RESOURCES
To improve liquidity and provide more financial and operating flexibility, the Company on June 6, 2003 issued $600 million of 10.25% senior notes maturing June 15, 2011. A portion of the net proceeds was used to repay $473.5 million of the outstanding debt at May 31, 2003. The remaining proceeds were used to repurchase the entire outstanding interest in the defined pool of trade receivables previously sold. To replace the terminated revolving credit facility and agreement to sell receivables, the Company entered into a new senior secured credit facility expiring June 6, 2007. The Company recognized a loss on early retirement of debt of $11.2 million, representing $8.5 million in premium or consent payments to holders of the existing senior notes and a write-off of $2.7 million of debt issuance costs associated with the debt repaid.
Senior Secured Credit Facility. Available borrowings under the senior secured credit facility were lowered from $200 million to $100 million effective May 27, 2004. The Company recognized a loss on early retirement of debt of $1.1 million, representing a termination fee of $100,000 and a write-off of $1.0 million of debt issuance costs related to the portion of the facility that was terminated. Borrowings under the facility are limited based on the net amounts of eligible accounts receivable. Borrowings bear annual interest at either the LIBOR rate plus 2.25% or the prime rate plus .25%. These interest rate margins are subject to performance price adjustments. Commitment fees at an annual rate of .375% are to be paid on the unused portion of the facility. The Company may terminate the facility at any time, and under certain circumstances may be required to pay a termination fee.
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The senior secured credit facility is collateralized by first priority liens on substantially all of the Company’s existing and future acquired accounts receivable, inventory, deposit accounts, and certain of its general intangibles. The agreement contains covenants restricting, among other things, prepayment or redemption of notes, distributions, dividends and repurchases of capital stock and other equity interests, acquisitions and investments, indebtedness, liens and affiliate transactions. In addition, there is the requirement to meet certain financial tests and to maintain certain financial ratios if the excess availability under the senior secured credit facility falls below $30 million, including maintaining a fixed charge coverage ratio and meeting a minimum tangible net worth test.
No borrowings were outstanding under the senior secured credit facility at May 31, 2004; however, $29.8 million of the facility was utilized to support letters of credit and hedge obligations.
The Company’s ability to incur additional debt is currently limited to $70.2 million of available borrowings under the senior secured credit facility. The payment of cash dividends on common stock is currently limited to an annual amount of $7.0 million.
Senior Notes. The senior notes represent general unsecured senior obligations of the Company. The senior notes were issued by Texas Industries, Inc. (the parent company), which has no independent assets or operations, excluding amounts related to its investments in its subsidiaries and financing activities. All consolidated subsidiaries of the Company are 100% owned and, excluding minor subsidiaries without operations or material assets, have provided a joint and several, full and unconditional guarantee of the securities. The terms of the notes contain covenants that among other things provide for restrictions on the payment of dividends or repurchasing common stock, making certain investments, incurring additional debt or selling preferred stock, creating liens, and transferring assets. The Company is also required to reinvest through capital expenditures the net proceeds from asset sales within 360 days of their receipt. To the extent that the amount not reinvested exceeds $10 million, the Company must make an offer to all note holders to purchase the maximum principal amount of notes that may be purchased out of the remaining proceeds at an offer price equal to 100% of principal amount plus accrued and unpaid interest and liquidated damages, if any, to the date of purchase. The Company has a requirement to reinvest through capital expenditures approximately $24.6 million prior to February 2005. These capital expenditures may be funded, if necessary, from borrowings under the Company’s long-term senior secured credit facility. At any time prior to June 15, 2006, the Company may redeem up to 35% of the aggregate principal amount of the notes at a redemption price of 110.25% of the principal amount thereof, plus accrued interest, with the net cash proceeds from certain equity offerings. In addition, at any time on or prior to June 15, 2007, the Company may redeem all or part of the notes at a redemption price equal to the sum of the principal amount thereof, plus accrued interest and a make-whole premium. After June 15, 2007, the Company may redeem all or a part of the notes at a redemption price of 105.125% in 2007, 102.563% in 2008 and 100% in 2009 and thereafter.
Interest Rate Swaps. The Company has outstanding interest rate swap agreements that have the economic effect of modifying the interest obligations associated with $100 million and $200 million of the senior notes, effective January 30, 2004 and April 6, 2004, respectively, such that the interest payable effectively becomes variable based on six-month LIBOR, set on June 15th and December 15th of each year. The interest rate swaps have been designated as fair value hedges and have no ineffective portion. The notional amounts and the termination dates match the principal amounts and maturities of the $300 million portion of the outstanding senior notes. As a result of the interest rate swaps, the current effective interest rate on the hedged portion of the senior notes was reduced to 7.26%.
On March 11, 2004, the Company terminated its August 5, 2003 interest rate swap agreements associated with $200 million of the senior notes resulting in a gain of $8.4 million. The gain was recorded as an increase in the carrying value of the Company’s long-term debt and is being amortized as an offset to interest expense over the remaining term of the senior notes.
The Company historically has financed major capital expansion projects with cash from operations and long-term borrowings. Working capital requirements and capital expenditures for normal replacement and technological upgrades of existing equipment and expansions of its operations are funded with cash from operations. The fiscal year 2005 capital expenditure budget for these activities is estimated currently at approximately $75 million. In addition, the Company leases certain mobile and other equipment used in its operations under operating leases that in the normal course of business are renewed or replaced by subsequent leases.
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The Company’s estimated future payments under its material contractual obligations are summarized, as follows:
Future payments under leases exclude mineral rights which are insignificant and are generally required only for products produced. Outstanding letters of credit generally only collateralize payment of recorded liabilities.
As discussed in Notes to Consolidated Financial Statements entitled “Retirement Plans” on pages 37 through 39, the Company contributed $1.5 million to a defined benefit pension plan in 2004 and expects to make a contribution of $4.1 million in 2005. The Company paid benefits under a health benefit plan of $500,000 in 2004 and expects to pay a similar amount in 2005. The Company paid benefits under a series of non-qualified defined benefit plans of $2.3 million in 2004 and expects to pay a similar amount in 2005.
We expect cash from operations and available borrowings under the senior secured credit facility to be sufficient to provide funds for capital expenditure commitments, scheduled debt repayments and working capital needs for at least the next year.
Cash Flows
Net cash provided by operations was $16.9 million, compared to $56.9 million in the prior year. Operating cash flows excluding repurchases of trade receivables increased $66.0 million primarily as a result of increased net income and the related effect on deferred taxes. Changes in working capital items were primarily the result of higher Steel prices and shipments that increased net receivables $37.5 million and the Company’s June 2003 refinancing that increased accrued interest $23.6 million. In addition, the Company funded the repurchase of $115.5 million of trade receivables out of the proceeds of the June 2003 refinancing.
Net cash provided by investing activities was $13.3 million, compared to $42.1 million used in the prior year. Capital expenditures for normal replacement and technological upgrades of existing equipment and expansions of the Company’s operations excluding major plant expansions were $29.8 million, down $25.0 million from the prior year. Proceeds from disposal of assets result from the routine sale of surplus operating assets, which in 2004 includes the proceeds from the sale of the Company’s brick production facilities in Texas and Louisiana and in 2003 includes the collection of notes receivable related to disposals in 2001.
Net cash provided by financing activities was $105.3 million, compared to $16.0 million used in the prior year. The proceeds from the June 2003 refinancing net of issuance and retirement costs funded the repurchase of trade receivables. The Company terminated its August 2003 interest rate swap agreements resulting in a gain of $8.4 million and entered into new interest rate swap agreements. The Company’s quarterly cash dividend of $.075 per common share remained unchanged from the prior year.
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OTHER ITEMS
Litigation
In November 1998, Chaparral Steel Company, a 100% owned subsidiary, filed an action in the District Court of Ellis County, Texas against certain graphite electrode suppliers seeking damages for illegal restraints of trade in the sale of graphite electrodes. The Company has now obtained settlements from all the major producers named in the action and does not anticipate any material future settlements.
Environmental Matters
The Company is subject to federal, state and local environmental laws and regulations concerning, among other matters, air emissions, furnace dust disposal and wastewater discharge. The Company believes it is in substantial compliance with applicable environmental laws and regulations; however, from time to time the Company receives claims from federal and state environmental regulatory agencies and entities asserting that the Company is or may be in violation of certain environmental laws and regulations. Based on its experience and the information currently available to it, the Company believes that such claims will not have a material impact on its financial condition or results of operations. Despite the Company’s compliance and experience, it is possible that the Company could be held liable for future charges which might be material but are not currently known or estimable. In addition, changes in federal or state laws, regulations or requirements or discovery of currently unknown conditions could require additional expenditures by the Company.
Market Risk
The Company has not historically entered into derivatives or other financial instruments for trading or speculative purposes. Because of the short duration of the Company’s investments, changes in market interest rates would not have a significant impact on their fair value.
As noted under Liquidity and Capital Resources, the Company on June 6, 2003, issued $600 million of 10.25% senior notes maturing June 15, 2011. The refinancing increased the amount of fixed rate debt outstanding, and added approximately 3% to its average effective interest rate. The fair value of the debt will vary as interest rates change. At May 31, 2004, the fair value of long-term debt, estimated based on broker/dealer quoted market prices, is approximately $630.6 million compared to the carrying amount of $599.1 million and the fair value of convertible subordinated debentures, estimated based on NYSE quoted market prices, is approximately $178.3 million compared to the carrying amount of $199.9 million.
The Company has outstanding interest rate swap agreements that change the characteristics of the interest payments on $300 million of the underlying fixed rate debt from fixed rate payments to short-term LIBOR-based variable rate payments in order to achieve a mix of interest rates on the Company’s long-term debt which, over time, is expected to moderate financing costs. The swap is sensitive to interest rate changes. For example, if short-term interest rates increase (decrease) by one percentage point from the date of the refinancing, annual pretax interest expense would increase (decrease) by $3 million.
Change in Principles of Consolidation
Effective February 29, 2004, the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” Prior to its adoption the Company consolidated all majority owned subsidiaries. FIN 46 provides that a variable interest entity is to be consolidated by its primary beneficiary. The Company has a variable interest in a subsidiary trust that has mandatorily redeemable preferred securities outstanding with a liquidation value of $199.9 million. These securities were previously reported on the Company’s balance sheet as Company-obligated Mandatorily Redeemable Preferred Securities of Subsidiary Holding Solely Company Convertible Debentures. The trust is a variable interest entity under FIN 46 because the Company has a limited ability to make decisions about its activities. However, the Company is not the primary beneficiary of the trust, and therefore, the trust and the mandatorily redeemable preferred securities issued by the trust are no longer reported on the Company’s balance sheet. Instead, the convertible subordinated debentures held by the trust which previously were eliminated in the Company’s consolidated financial statements are reported on its balance sheet. Distributions on the mandatorily redeemable preferred securities are no longer reported on the Company’s statements of operations, but interest on the debentures is recorded as interest expense. These reclassifications are reflected for all periods presented and have no overall effect on the Company’s results of operations or financial position.
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Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the
Private Securities Litigation Reform Act of 1995
Certain statements contained in this annual report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Potential risks and uncertainties include, but are not limited to, the impact of competitive pressures and changing economic and financial conditions on the Company’s business, construction activity in the Company’s markets, abnormal periods of inclement weather, changes in the cost of raw materials, fuel and energy, and the impact of environmental laws and other regulations (see Part I, Item 1 under the caption “Risks Relating to the Company” on pages 6 through 9).
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ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is included in Item 7.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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CONSOLIDATED BALANCE SHEETS
TEXAS INDUSTRIES, INC. AND SUBSIDIARIES
See notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
TEXAS INDUSTRIES, INC. AND SUBSIDIARIES
See notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
TEXAS INDUSTRIES, INC. AND SUBSIDIARIES
See notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
TEXAS INDUSTRIES, INC. AND SUBSIDIARIES
See notes to consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Texas Industries, Inc. and subsidiaries (unless the context indicates otherwise, collectively, the “Company” or “TXI”) is a leading supplier of construction materials through two business segments: cement, aggregate and concrete products (the “CAC” segment); and structural steel and steel bar products (the “Steel” segment). Through the CAC segment, the Company produces and sells cement, stone, sand and gravel, ready-mix concrete, expanded shale and clay aggregate, and other products from facilities concentrated in Texas, Louisiana and California, with several products marketed throughout the United States. Through the Steel segment, the Company produces and sells structural steel, piling products, special bar quality products, merchant bar quality rounds, reinforcing bar and channels from facilities located in Texas and Virginia, for markets in North America.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. The consolidated financial statements include the accounts of Texas Industries, Inc. and all subsidiaries except a subsidiary trust in which the Company has a variable interest but is not the primary beneficiary.
Effective February 29, 2004, the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” Prior to its adoption the Company consolidated all majority owned subsidiaries. FIN 46 provides that a variable interest entity is to be consolidated by its primary beneficiary. The Company has a variable interest in a subsidiary trust that has mandatorily redeemable preferred securities outstanding with a liquidation value of $199.9 million. These securities were previously reported on the Company’s balance sheet as Company-obligated Mandatorily Redeemable Preferred Securities of Subsidiary Holding Solely Company Convertible Debentures. The trust is a variable interest entity under FIN 46 because the Company has a limited ability to make decisions about its activities. However, the Company is not the primary beneficiary of the trust, and therefore, the trust and the mandatorily redeemable preferred securities issued by the trust are no longer reported on the Company’s balance sheet. Instead, the convertible subordinated debentures held by the trust which previously were eliminated in the Company’s consolidated financial statements are reported on its balance sheet. Distributions on the mandatorily redeemable preferred securities are no longer reported on the Company’s statements of operations, but interest on the debentures is recorded as interest expense. These reclassifications are reflected for all periods presented and have no overall effect on the Company’s results of operations or financial position.
Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation.
Estimates. 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. Actual results could differ from those estimates.
Fair Value of Financial Instruments. The estimated fair value of each class of financial instrument as of May 31, 2004 approximates its carrying value except for long-term debt having fixed interest rates and convertible subordinated debentures. The fair value of long-term debt at May 31, 2004, estimated based on broker/dealer quoted market prices, is approximately $630.6 million compared to the carrying amount of $599.1 million. The fair value of convertible subordinated debentures at May 31, 2004, estimated based on NYSE quoted market prices, is approximately $178.3 million compared to the carrying amount of $199.9 million.
Cash and Cash Equivalents. Investments with maturities of less than 90 days when purchased are classified as cash equivalents and consist primarily of money market funds and investment grade commercial paper issued by major corporations and financial institutions.
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 the Company is aware of a specific customer’s inability to make required payments, specific amounts are added to the reserve.
Environmental Liabilities. The Company is subject to environmental laws and regulations established by federal, state and local authorities, and makes provision for the estimated costs related to compliance when it is probable that a reasonably estimable liability has been incurred.
Legal Contingencies. The Company and its subsidiaries 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 a reasonably estimable liability has been incurred.
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Long-lived Assets. Management reviews long-lived assets 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 the Company’s products, capital needs, economic trends and other factors.
Property, plant and equipment is recorded at cost. Provisions for depreciation are computed generally using the straight-line method. Provisions for depletion of mineral deposits are computed on the basis of the estimated quantity of recoverable raw materials. Useful lives for the Company’s primary operating facilities range from 10 to 20 years. Maintenance and repairs are charged to expense as incurred. Costs incurred for scheduled shut-downs to refurbish the Steel facilities are amortized over the benefited period, typically 12 to 24 months.
Goodwill. Management tests goodwill for impairment at least annually by each reporting unit. If the carrying amount of the goodwill exceeds its fair value an impairment loss is recognized. In applying a fair-value-based test, estimates are made of the expected future cash flows to be derived from the applicable 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 the Company’s products, capital needs, economic trends and other factors. Goodwill identified with CAC’s California cement operations resulted from the acquisition of Riverside Cement Company. Goodwill identified with Steel’s Texas operations resulted from the acquisition of Chaparral Steel Company. In each case the fair value of the respective reporting unit exceeds its carrying value. At both May 31, 2004 and 2003, the carrying value of CAC goodwill was $61.3 million and the carrying value of Steel goodwill was $85.2 million.
Real Estate and Investments. Surplus real estate and real estate acquired for development of high quality industrial, office or multi-use parks totaled $11.2 million and $11.6 million at May 31, 2004 and 2003, respectively.
Investments are composed primarily of life insurance contracts that may be used to fund certain Company benefit agreements. The contracts, recorded at their net cash surrender value, totaled $34.2 million (net of distributions of $52.5 million) at May 31, 2004 and $30.1 million (net of distributions of $50.2 million) at May 31, 2003. Subsequent to May 31, 2004 substantially all distributed amounts were repaid. Charges incurred on the distributions of $3.3 million in 2004, $3.6 million in 2003 and $3.6 million in 2002 were included in interest expense.
Deferred Charges and Intangibles. Deferred charges are composed primarily of debt issuance costs that totaled $19.7 million and $9.7 million at May 31, 2004 and 2003, respectively. The costs are associated with various debt issues and amortized over the term of the related debt.
Intangibles are composed of non-compete agreements and other intangibles with finite lives being amortized on a straight-line basis over periods of 5 to 15 years. Their carrying value, adjusted for write-offs, totaled $2.1 million at May 31, 2004 and $2.5 million at May 31, 2003, net of accumulated amortization of $3.8 million at May 31, 2004 and $3.6 million at May 31, 2003. Amortization expense incurred was $400,000 in 2004, $900,000 in 2003 and $1.2 million in 2002. Estimated amortization expense for each of the five succeeding years is $400,000 in 2005 and $300,000 per year thereafter.
Other Credits. Other credits of $68.5 million at May 31, 2004 and $44.8 million at May 31, 2003 are composed primarily of liabilities related to the Company’s retirement plans, deferred compensation agreements and asset retirement obligations.
Asset Retirement Obligations. Effective June 1, 2003, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations,” which applies to legal obligations associated with the retirement of long-lived assets.
SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The fair value of the liability is added to the carrying amount of the associated asset and this additional carrying amount is depreciated over the life of the asset. The liability is accreted at the end of each period through a charge to operating expense. If the obligation is settled for other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement.
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The Company incurs legal obligations for asset retirement as part of its normal CAC and Steel operations related to land reclamation, plant removal and Resource Conservation and Recovery Act closures. Prior to the adoption of SFAS No. 143, the Company generally accrued for land reclamation obligations related to its aggregate mining process on the unit of production basis and for its other obligations as incurred. Determining the amount of an asset retirement liability requires estimating the future cost of contracting with third parties to perform the obligation. The estimate is significantly impacted by, among other considerations, management’s assumptions regarding the scope of the work required, labor costs, inflation rates, market-risk premiums and closure dates. The initial application of the new rules resulted in an increase in net property, plant and equipment of $500,000, a net increase in asset retirement obligation liabilities of $2.2 million and a pretax cumulative charge of $1.7 million.
Changes in asset retirement obligations for the year ended May 31, 2004 are as follows (in thousands):
The pro forma effect of assuming that the adoption of SFAS No. 143 was applied retroactively was not material to net income (loss) or the related per-share amounts for 2003 and 2002.
Pension Liability Adjustment. The pension liability adjustment to shareholders’ equity of $4.5 million at May 31, 2004 (net of tax of $2.4 million) compared to $5.9 million at May 31, 2003 (net of tax of $3.2 million) relates to a defined benefit retirement plan covering approximately 600 employees and retirees of an acquired subsidiary. Comprehensive income or loss consists of net income or loss and the pension liability adjustment to shareholders’ equity. In 2004, comprehensive income was $37.8 million. In 2003, comprehensive loss was $30.1 million. In 2002, comprehensive income was the same as net income.
Net Sales. Sales are recognized when title has transferred and products are delivered. The Company includes delivery fees in the amount it bills customers to the extent needed to recover the Company’s cost of freight and delivery. Net sales are presented as revenues including these delivery fees.
Other Income. Other income in 2004 includes a gain of $34.7 million resulting from the sale of the Company’s Texas and Louisiana brick production facilities. Additional routine sales of surplus operating assets and real estate resulted in gains of $3.8 million in 2004, $300,000 in 2003 and $8.6 million in 2002. Also included in other income was $4.2 million in 2004, $500,000 in 2003 and $9.6 million in 2002 resulting from the Company’s litigation against certain graphite electrode suppliers.
Income Taxes. Accounting for income taxes uses the liability method of recognizing and classifying deferred income taxes. The Company joins in filing a consolidated return with its subsidiaries. Current and deferred tax expense is allocated among the members of the group based on a stand-alone calculation of the tax of the individual member.
Earnings Per Share (“EPS”). Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding during the period including certain contingently issuable shares.
Contingently issuable shares relate to deferred compensation agreements in which directors elected to defer annual and meeting fees or executives elected to defer incentive compensation and vested shares under the Company’s former stock awards program. The shares are considered contingently issuable because the director or executive has an unconditional right to the shares to be issued. The deferred compensation is denominated in shares of the Company’s common stock and issued upon retirement or at such earlier date as approved by the Company. Vested stock award shares are issued in the year in which the employee reaches age 60.
Diluted EPS adjusts net income and the outstanding shares for the dilutive effect of convertible subordinated debentures, stock options and awards.
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Basic and Diluted EPS are calculated as follows:
Stock-based Compensation. The Company accounts for employee stock options using the intrinsic value method of accounting prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees” as allowed by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” Generally, no expense is recognized related to the Company’s stock options because each option’s exercise price is set at the stock’s fair market value on the date the option is granted.
In accordance with SFAS No. 123, the Company discloses the compensation cost based on the estimated fair value at the date of grant recognizing compensation expense ratably over the vesting period. The fair value of each option grant was estimated on the date of grant for purposes of the pro forma disclosures using the Black-Scholes option-pricing model. No options were granted in 2004. In 2003, the weighted-average fair value of options granted was $8.20 based on weighted average assumptions for dividend yield of 1.33%, volatility factor of .361, risk-free interest rate of 3.38% and expected life in years of 6.4. In 2002, the weighted-average fair value of options granted was $14.57 based on weighted average assumptions for dividend yield of .83%, volatility factor of .350, risk-free interest rate of 4.77% and expected life in years of 6.4.
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If the Company had recognized compensation expense for the stock option plan based on the fair value at the grant dates for awards, the Company’s net income (loss) and earnings (loss) per share would have been reduced to the following pro forma amounts:
WORKING CAPITAL
Working capital totaled $466.7 million at May 31, 2004, compared to $209.6 million at May 31, 2003.
Accounts receivable are presented net of allowances for doubtful receivables of $5.3 million at May 31, 2004 and $4.4 million at May 31, 2003. Provisions for bad debts charged to expense were $4.6 million in 2004, $2.9 million in 2003 and $9.6 million in 2002. Uncollectible accounts written off amounted to $3.7 million in 2004, $3.2 million in 2003 and $7.5 million in 2002.
In March 1999, the Company entered an agreement to sell, on a revolving basis, an interest in a defined pool of trade receivables of up to $125 million. Sales were reflected as reductions of accounts receivable and as operating cash flows. At May 31, 2003 the interest sold totaled $115.5 million. Fees and expenses of $2.8 million in 2003 and $4.2 million in 2002 were included in selling, general and administrative expense. On June 6, 2003, the Company entered into an agreement whereby the entire outstanding interest in the defined pool of trade receivables previously sold was repurchased and the agreement to sell receivables was terminated. The repurchase was reflected as an increase in accounts receivable and a reduction in operating cash flows.
Inventories consist of:
Inventories are stated at cost (not in excess of market) with approximately 63% of inventories using the last-in, first-out (“LIFO”) method. If the average cost method (which approximates current replacement cost) had been used, inventory values would have been higher by $49.7 million in 2004 and $16.5 million in 2003. During 2004 certain inventory quantities were reduced, which resulted in a liquidation of LIFO inventory layers carried at lower costs prevailing in prior years. The effect of the liquidation was to decrease cost of products sold by approximately $4.4 million.
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Accrued interest, wages and other items consist of:
LONG-TERM DEBT
Long-term debt is composed of the following:
Maturities of long-term debt for each of the five succeeding years are $700,000 per year through 2007, $1.1 million for 2008 and none for 2009.
Refinancing. On June 6, 2003, the Company issued $600 million of 10.25% senior notes maturing June 15, 2011. A portion of the net proceeds was used to repay $473.5 million of the outstanding debt at May 31, 2003. The remaining proceeds were used to repurchase the entire outstanding interest in the defined pool of trade receivables previously sold. To replace the terminated revolving credit facility and agreement to sell receivables, the Company entered into a new senior secured credit facility expiring June 6, 2007. The Company recognized a loss on early retirement of debt of $11.2 million, representing $8.5 million in premium or consent payments to holders of the existing senior notes and a write-off of $2.7 million of debt issuance costs associated with the debt repaid.
Senior Secured Credit Facility. Available borrowings under the senior secured credit facility were lowered from $200 million to $100 million effective May 27, 2004. The Company recognized a loss on early retirement of debt of $1.1 million, representing a termination fee of $100,000 and a write-off of $1.0 million of debt issuance costs related to the portion of the facility that was terminated. Borrowings under the facility are limited based on the net amounts of eligible accounts receivable. Borrowings bear annual interest at either the LIBOR rate plus 2.25% or the prime rate plus .25%. These interest rate margins are subject to performance price adjustments. Commitment fees at an annual rate of .375% are to be paid on the unused portion of the facility. The Company may terminate the facility at any time, and under certain circumstances may be required to pay a termination fee.
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The senior secured credit facility is collateralized by first priority liens on substantially all of the Company’s existing and future acquired accounts receivable, inventory, deposit accounts, and certain of its general intangibles. The agreement contains covenants restricting, among other things, prepayment or redemption of notes, distributions, dividends and repurchases of capital stock and other equity interests, acquisitions and investments, indebtedness, liens and affiliate transactions. In addition, there is the requirement to meet certain financial tests and to maintain certain financial ratios if the excess availability under the senior secured credit facility falls below $30 million, including maintaining a fixed charge coverage ratio and meeting a minimum tangible net worth test.
No borrowings were outstanding under the senior secured credit facility at May 31, 2004; however, $29.8 million of the facility was utilized to support letters of credit and hedge obligations.
The Company’s ability to incur additional debt is currently limited to $70.2 million of available borrowings under the senior secured credit facility. The payment of cash dividends on common stock is currently limited to an annual amount of $7.0 million.
Senior Notes. The senior notes represent general unsecured senior obligations of the Company. The senior notes were issued by Texas Industries, Inc. (the parent company), which has no independent assets or operations, excluding amounts related to its investments in its subsidiaries and financing activities. All consolidated subsidiaries of the Company are 100% owned and, excluding minor subsidiaries without operations or material assets, have provided a joint and several, full and unconditional guarantee of the securities. The terms of the notes contain covenants that among other things provide for restrictions on the payment of dividends or repurchasing common stock, making certain investments, incurring additional debt or selling preferred stock, creating liens, and transferring assets. The Company is also required to reinvest through capital expenditures the net proceeds from asset sales within 360 days of their receipt. To the extent that the amount not reinvested exceeds $10 million, the Company must make an offer to all note holders to purchase the maximum principal amount of notes that may be purchased out of the remaining proceeds at an offer price equal to 100% of principal amount plus accrued and unpaid interest and liquidated damages, if any, to the date of purchase. The Company has a requirement to reinvest through capital expenditures approximately $24.6 million prior to February 2005. These capital expenditures may be funded, if necessary, from borrowings under the Company’s long-term senior secured credit facility. At any time prior to June 15, 2006, the Company may redeem up to 35% of the aggregate principal amount of the notes at a redemption price of 110.25% of the principal amount thereof, plus accrued interest, with the net cash proceeds from certain equity offerings. In addition, at any time on or prior to June 15, 2007, the Company may redeem all or part of the notes at a redemption price equal to the sum of the principal amount thereof, plus accrued interest and a make-whole premium. After June 15, 2007, the Company may redeem all or a part of the notes at a redemption price of 105.125% in 2007, 102.563% in 2008 and 100% in 2009 and thereafter.
Interest Rate Swaps. The Company has outstanding interest rate swap agreements that have the economic effect of modifying the interest obligations associated with $100 million and $200 million of the senior notes, effective January 30, 2004 and April 6, 2004, respectively, such that the interest payable effectively becomes variable based on six-month LIBOR, set on June 15th and December 15th of each year. The interest rate swaps have been designated as fair value hedges and have no ineffective portion. The notional amounts and the termination dates match the principal amounts and maturities of the $300 million portion of the outstanding senior notes. As a result of the interest rate swaps, the current effective interest rate on the hedged portion of the senior notes was reduced to 7.26%.
On March 11, 2004, the Company terminated its August 5, 2003 interest rate swap agreements associated with $200 million of the senior notes resulting in a gain of $8.4 million. The gain was recorded as an increase in the carrying value of the Company’s long-term debt and is being amortized as an offset to interest expense over the remaining term of the senior notes.
The amount of interest paid was $47.8 million in 2004, $33.7 million in 2003, and $43.6 million in 2002. No interest was capitalized in the three-year period ended May 31, 2004.
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CONVERTIBLE SUBORDINATED DEBENTURES
On June 5, 1998, the Company issued $206.2 million aggregate principal amount of 5.5% convertible subordinated debentures due June 30, 2028 (the “Debentures”). TXI Capital Trust I (the “Trust”), a Delaware business trust 100% owned by the Company, issued 4,000,000 of its 5.5% Shared Preference Redeemable Securities (“Preferred Securities”) to the public for gross proceeds of $200 million. The combined proceeds from the issuance of the Preferred Securities and the issuance to the Company of the common securities of the Trust were invested by the Trust in the Debentures. At May 31, 2004, 3,998,744 Preferred Securities representing an undivided beneficial interest in $199.9 million of the $206.1 million aggregate principal amount of Debentures issued were outstanding.
The Debentures are redeemable for cash, at par, plus accrued and unpaid interest, under certain circumstances relating to federal income tax matters or in whole or in part at the option of the Company. Upon any redemption of the Debentures, a like aggregate liquidation amount of Preferred Securities will be redeemed. Debentures are convertible at any time prior to the close of business on June 30, 2028, at the option of the holder of the Preferred Securities into shares of the Company’s common stock at a conversion rate of .72218 shares of the Company’s common stock for each Preferred Security.
Holders of the Preferred Securities are entitled to receive cumulative cash distributions at an annual rate of $2.75 per Preferred Security (equivalent to a rate of 5.5% per annum of the stated liquidation amount of $50 per Preferred Security). The Company has guaranteed, on a subordinated basis, distributions and other payments due on the Preferred Securities, to the extent the Trust has funds available therefor and subject to certain other limitations (the “Guarantee”). The Guarantee, when taken together with the obligations of the Company under the Debentures, the Indenture pursuant to which the Debentures were issued, and the Amended and Restated Trust Agreement of the Trust (including its obligations to pay costs, fees, expenses, debts and other obligations of the Trust [other than with respect to the Preferred Securities and the common securities of the Trust]), provide a full and unconditional guarantee of amounts due on the Preferred Securities. The Preferred Securities do not have a stated maturity date, although they are subject to mandatory redemption upon maturity of the Debentures on June 30, 2028, or upon earlier redemption.
OPERATING LEASES
The Company leases certain mobile and other equipment, office space and other items which in the normal course of business are renewed or replaced by subsequent leases. Total expense for such operating leases (other than for mineral rights) amounted to $28.6 million in 2004, $26.2 million in 2003 and $29.0 million in 2002. Non-cancelable operating leases with an initial or remaining term of more than one year totaled $64.5 million at May 31, 2004. Estimated lease payments for each of the five succeeding years are $18.9 million, $9.4 million, $6.7 million, $6.3 million and $5.8 million.
SHAREHOLDERS’ EQUITY
Common stock at May 31 consists of:
There are authorized 100,000 shares of Cumulative Preferred Stock, no par value, of which 20,000 shares are designated $5 Cumulative Preferred Stock (Voting), redeemable at $105 per share and entitled to $100 per share upon dissolution. An additional 25,000 shares are designated Series B Junior Participating Preferred Stock. The Series B Preferred Stock is not redeemable and ranks, with respect to the payment of dividends and the distribution of assets, junior to (i) all other series of the Preferred Stock unless the terms of any other series shall provide otherwise and (ii) the $5 Cumulative Preferred Stock. Pursuant to a Rights Agreement, in November 1996, the Company distributed a dividend of one preferred share purchase right for each outstanding share of the Company’s Common Stock. Each right entitles the holder to purchase from the Company one two-thousandth of a share of the Series B Junior Participating Preferred Stock at a price of $122.50, subject to adjustment. The rights will expire on November 1, 2006 unless the date is extended or the rights are earlier redeemed or exchanged by the Company pursuant to the Rights Agreement.
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STOCK OPTION PLAN
The Company’s stock option plan as approved by shareholders provided that non-qualified and incentive stock options to purchase Common Stock may be granted to directors, officers and key employees at market prices at date of grant. Outstanding options become exercisable in installments beginning one year after date of grant and expire ten years later.
A summary of option transactions for the three years ended May 31, 2004, follows:
Options exercisable as of May 31 were 2,025,428 shares in 2004, 1,803,933 shares in 2003 and 1,567,983 shares in 2002 at a weighted-average option price of $30.42, $30.12 and $29.04, respectively. The following table summarizes information about stock options outstanding as of May 31, 2004.
Outstanding options expire on various dates to May 15, 2013.
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INCOME TAXES
The provisions (benefit) for income taxes are composed of:
A reconciliation from income taxes at the federal statutory rate to the preceding provisions (benefit) follows:
The components of the net deferred tax liability at May 31 are summarized below.
The Company received income tax refunds of $400,000 in 2004 and $2.8 million in 2003 and made income tax payments of $1.6 million, $2.8 million and $2.2 million in 2004, 2003 and 2002, respectively.
As of May 31, 2004, the Company has $13.0 million of alternative minimum tax credit. The credit does not expire and is available for offset against future regular income tax. In addition, the Company has $80.4 million in federal net operating loss carryforwards that expire in 2023. Management believes it is more likely than not that these deferred tax assets will be realized.
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LEGAL PROCEEDINGS AND CONTINGENT LIABILITIES
The Company is subject to federal, state and local environmental laws and regulations concerning, among other matters, air emissions, furnace dust disposal and wastewater discharge. The Company believes it is in substantial compliance with applicable environmental laws and regulations; however, from time to time the Company receives claims from federal and state environmental regulatory agencies and entities asserting that the Company is or may be in violation of certain environmental laws and regulations. Based on its experience and the information currently available to it, the Company believes that such claims will not have a material impact on its financial condition or results of operations. Despite the Company’s compliance and experience, it is possible that the Company could be held liable for future charges which might be material but are not currently known or estimable. In addition, changes in federal or state laws, regulations or requirements or discovery of currently unknown conditions could require additional expenditures by the Company.
A California subsidiary of the Company operates a cement kiln in Oro Grande, California that became subject to new air quality testing and reporting requirements in June 2002. The Mojave Desert Air Quality Management District believes that the Oro Grande facility did not provide the necessary proof of compliance with these new requirements until September 2003, when it completed a high-temperature stack test. Due to the delay in providing proof of compliance, the District has stated that it intends to fine the Oro Grande facility an amount which exceeds $100,000, although the fine is not expected to be an amount that is financially material to the Company.
The Company and subsidiaries are defendants in lawsuits which arose in the normal course of business. In management’s judgment (based on the opinion of counsel) the ultimate liability, if any, from such legal proceedings will not have a material effect on the consolidated financial position or results of operations of the Company.
In November 1998, Chaparral Steel Company, a 100% owned subsidiary, filed an action in the District Court of Ellis County, Texas against certain graphite electrode suppliers seeking damages for illegal restraints of trade in the sale of graphite electrodes. The Company has now obtained settlements from all the major producers named in the action and does not anticipate any material future settlements.
RETIREMENT PLANS
Substantially all employees of the Company are covered by a series of defined contribution retirement plans. The amount of pension expense charged to costs and expenses for these plans was $4.6 million in 2004, $6.1 million in 2003 and $6.2 million in 2002. It is the Company’s policy to fund the plans to the extent of charges to income.
Approximately 600 employees and retirees of Riverside Cement Company are covered by a defined benefit pension plan and a postretirement health benefit plan. The amount of the defined benefit pension plan and postretirement health benefit plan expense charged to costs and expenses was as follows:
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The Company contributes amounts sufficient to meet minimum funding requirements as set forth in employee benefit and tax laws plus such additional amounts considered appropriate. An additional 2004 contribution of $4.1 million is expected to be made in 2005.
Obligation and asset data for the defined benefit pension plan and health benefit plan at May 31, 2004 were as follows:
The plan fiduciaries set the long-term strategic investment objectives for the defined benefit pension plan assets. The objectives include preserving the funded status of the trust and balancing risk and return. The fiduciaries engaged external consultants to conduct an asset and liability study in order to determine the most appropriate investment strategy and asset mix for the plan assets. The expected long-term rate of return on plan assets of 8.5% for 2004 was determined by considering historical and expected returns for each asset class as identified in the asset and liability study and the effect of periodic target asset allocation rebalancing. The long-term rate of inflation was assumed to average 4%. Fixed income returns are expected to exceed the inflation rate by 2% and equity security returns are expected to exceed fixed income returns by 5%.
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The actual defined benefit pension plan asset allocation at May 31, 2004 and 2003, and the target asset allocation for 2005, by asset category were as follows:
The health benefit plan provisions were amended in the prior year for non-union active employees such that a non-union active employee who did not retire on or before December 31, 2003 is no longer eligible for any postretirement medical and/or life insurance benefits. Additional plan changes effective January 1, 2005 and January 1, 2007 reduce the percentage of the annual cost of the retiree’s and dependent’s health insurance to be paid by the Company and set a limit on the total annual cost the Company will incur.
The assumed health care cost trend rates attributed to all participant age groups were 12% for 2004 and 11% for 2005, declining to an ultimate trend rate of 6% in 2009. Increasing or decreasing health care cost trend rates by one percentage point would have increased or decreased the health benefit obligation at May 31, 2004 by approximately $400,000 and $300,000, respectively, and the 2004 plan expense by approximately $200,000 and $100,000, respectively.
The U.S. Medicare Prescription Drug, Improvement and Modernization Act of 2003 provides a new federal prescription drug benefit effective in 2006. In accordance with Financial Accounting Standards Board Staff Position No. 106-1, the Company has elected to defer the recognition of the effects of the Act on the May 31, 2004 accumulated health benefit obligation.
The Company has a series of financial security plans (“FSP”) that are non-qualified defined benefit plans providing death and retirement benefits to substantially all of the Company’s executive and key managerial employees. The plans are contributory but not funded.
Life insurance contracts have been purchased that may be used to fund the FSP payments. These insurance contracts, recorded at their net cash surrender value, totaled $34.2 million (net of distributions of $52.5 million) at May 31, 2004 and $30.1 million (net of distributions of $50.2 million) at May 31, 2003.
The amount of FSP benefit expense and the projected FSP benefit obligation are determined using assumptions as of the end of the year. The weighted-average discount rate used was 7% in 2004. Actuarial gains or losses are recognized when incurred, and therefore, the end of year benefit obligation is the same as the accrued benefit costs recognized in the balance sheet. The amount of FSP benefit expense charged to costs and expenses was as follows:
The following provides a reconciliation of the FSP benefit obligation.
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INCENTIVE PLANS
All personnel employed as of May 31 and not subject to production-based incentive awards share in the pretax income of the Company for the year then ended based on predetermined formulas. The duration of most of the plans is one year. Certain executives are additionally covered under a three-year plan. All plans are subject to annual review by the Company’s Board of Directors. Incentive compensation included in selling, general and administrative expense was $8.5 million in 2004, $1.3 million in 2003 and $3.5 million in 2002.
BUSINESS SEGMENTS
The Company has two reportable segments: cement, aggregate and concrete products (the “CAC” segment) and steel (the “Steel” segment). The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because of significant differences in manufacturing processes, distribution and markets served. Through the CAC segment, the Company produces and sells cement, stone, sand and gravel, ready-mix concrete, expanded shale and clay aggregate, and other products. Through the Steel segment, the Company produces and sells structural steel, piling products, special bar quality products, merchant bar quality rounds, reinforcing bar and channels. Operating profit is net sales less operating costs and expenses, excluding general corporate expenses and interest expense. Identifiable assets by segment are those assets that are used in the Company’s operation in each segment. Corporate assets consist primarily of cash and cash equivalents, real estate and other financial assets not identified with a major business segment. Operating results and certain other financial data for the Company’s business segments are presented on pages 12 and 13 under “Business Segments” of Management’s Discussion and Analysis of Financial Condition and Results of Operations, and are incorporated herein by reference.
CONDENSED CONSOLIDATING FINANCIAL INFORMATION
The Company’s senior notes were issued by Texas Industries, Inc. (the parent company), which has no independent assets or operations, excluding amounts related to its investments in its subsidiaries and financing activities. All consolidated subsidiaries of the Company are 100% owned and, excluding the Company’s accounts receivable subsidiary and other minor subsidiaries without operations or material assets, provided a joint and several, full and unconditional guarantee of the securities. There are no significant restrictions on the parent company’s ability to obtain funds from any of the guarantor subsidiaries in the form of a dividend or loan. Additionally, there are no significant restrictions on the various guarantor subsidiaries’ ability to obtain funds from its direct or indirect subsidiaries.
The Company’s accounts receivable subsidiary was established in March 1999 to facilitate the Company’s agreement to sell, on a revolving basis, an undivided interest in a defined pool of trade receivables. At May 31, 2003, the subsidiary had total assets of $54.1 million. However, on June 6, 2003, in connection with the issuance of the senior notes, the Company repurchased the entire outstanding interest in the defined pool of trade receivables previously sold and terminated the agreement to sell trade receivables. The repurchased trade receivables were subsequently transferred to the respective operating entities. Effective May 27, 2004, the subsidiary was merged into the parent company.
The following condensed consolidating balance sheets, statements of operations and statements of cash flows are provided for the parent company, all guarantor subsidiaries and all non-guarantor subsidiaries. The information has been presented as if the parent company accounted for its ownership of the guarantor and non-guarantor subsidiaries using the equity method of accounting.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Texas Industries, Inc.
We have audited the accompanying consolidated balance sheets of Texas Industries, Inc. and subsidiaries (the Company) as of May 31, 2004 and 2003, the business segment information on pages 12 and 13 of the Annual Report on Form 10-K, and the related consolidated statements of operations, cash flows, and shareholders’ equity for each of the three years in the period ended May 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Texas Industries, Inc. and subsidiaries at May 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended May 31, 2004, in conformity with U.S. generally accepted accounting principles.
As discussed in the “Summary of Significant Accounting Policies” footnote to the consolidated financial statements, in fiscal year 2004 the Company changed its method of accounting for asset retirement obligations.
Ernst & Young LLP
June 30, 2004
Dallas, Texas
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QUARTERLY FINANCIAL INFORMATION (Unaudited)
The following is a summary of quarterly financial information (in thousands except per share).
On February 29, 2004, the Company sold its Texas and Louisiana brick production facilities for a total pretax gain of $34.7 million.
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ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the specified time periods. As of the end of the period covered by this Annual Report on Form 10-K, the Company’s Chief Executive Officer and Chief Financial Officer evaluated, with the participation of the Company’s management, the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on the evaluation, which disclosed no significant deficiencies or material weaknesses, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective. There were no significant changes in the Company’s internal controls over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information with respect to the executive officers of the Company, see “Executive Officers of the Registrant” included as a separate item at the end of Part I of this Report. For information with respect to the directors of the Company, see the “Election of Directors” section of the Proxy Statement for the 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission not later than 120 days after May 31, 2004, which is incorporated herein by reference. For information with respect to Section 16 reports, see “Section 16(a) Beneficial Ownership Reporting Compliance” section of the Proxy Statement for the 2004 Annual Meeting of Shareholders, which is incorporated herein by reference. For information with respect to the Audit Committee and the status of each member as an audit committee financial expert, see “Board of Directors, Board Committees, Meetings, Attendance and Fees” section of the Proxy Statement for the 2004 Annual Meeting of Shareholders, which is incorporated herein by reference.
The Company has a code of ethics applicable to all employees and its directors. In addition, the Company’s principal executive, financial and accounting officers are subject to the provisions of the Code of Ethics of Texas Industries, Inc. for the CEO and Senior Financial Officers adopted by the Company, a copy of which will be available on the Company’s website. In the event that the Company amends or waives any of the provisions of these codes of ethics applicable to our principal executive, financial and accounting officers, the Company intends to disclose the same on the Company’s website at www.txi.com.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
For information with respect to executive and director compensation, see the “Executive Compensation,” “Report of the Compensation Committee on Executive Compensation,” and “Board of Directors, Board Committees, Meetings, Attendance and Fees” sections of the Proxy Statement for the 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission, which are incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
For information with respect to security ownership of certain beneficial owners and management, see the “Security Ownership of Certain Beneficial Owners” and “Security Ownership of Management” sections of the Proxy Statement for the 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission, which are incorporated herein by reference.
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EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes the Company’s equity compensation plans as of May 31, 2004.
(1) The Company’s stock option plan is described in the Notes to Consolidated Financial Statements entitled “Stock Option Plan” on page 35.
(2) Includes 65,921 shares of Common Stock issuable under deferred compensation agreements in which directors elected to defer annual and meeting fees or executives elected to defer incentive compensation. Compensation so deferred is denominated in shares of the Company’s Common Stock determined by reference to the average market price as specified by the terms of the individual agreement. Dividends are credited to the account denominated in shares of the Company’s Common Stock at a value equal to the fair market value of the stock on the date of payment of such dividend.
(3) Includes 13,514 shares of Common Stock issuable under the Company’s former stock award program in which certain employees were granted stock awards at no cost. Subject to continued employment, the 20 remaining participants are to be issued shares in five-year installments until age 60. The program was discontinued in 1990.
All shares of Common Stock issuable under the Company’s compensation plans are subject to adjustment to reflect any increase or decrease in the number of shares outstanding as a result of stock splits, combination of shares, recapitalizations, mergers or consolidations.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information with respect to certain relationships and related transactions, see caption “Other Transactions” of “Board of Directors, Board Committees, Meetings, Attendance and Fees” section of the Proxy Statement for the 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission, which is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
For information with respect to principal accountant fees and services, see “Report of the Audit Committee” and “Fees Paid to Independent Auditors” sections of the Proxy statement for the 2004 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission, which are incorporated herein by reference.
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PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as a part of this report.
(1) Financial Statements and Supplementary Data
Consolidated Balance Sheets-May 31, 2004 and 2003
Consolidated Statements of Operations-Years ended May 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows-Years ended May 31, 2004, 2003 and 2002
Consolidated Statements of Shareholders’ Equity-Years ended May 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Quarterly Financial Information
(2) Financial Statement Schedules
Financial statement schedules have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto.
(3) Listing of Exhibits
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(3) Listing of Exhibits-Continued
The Registrant agrees to furnish to the Commission, upon request, copies of all instruments with respect to long-term debt not being registered where the total amount of securities authorized thereunder does not exceed 10% of the total assets of Registrant and its subsidiaries on a consolidated basis.
The remaining exhibits have been omitted because they are not applicable or the information required therein is included elsewhere in the financial statements or notes thereto.
(b) Reports on Form 8-K
The Registrant filed the following reports on Form 8-K during the three-month period ended May 31, 2004:
(1) March 25, 2004, furnishing the Company’s press release dated March 25, 2004 announcing results for the fiscal third quarter ended February 29, 2004;
(2) April 22, 2004, furnishing the Company’s press release dated April 21, 2004 announcing the appointment of a new Chief Executive Officer; and
(3) May 13, 2004, furnishing the Company’s press release dated May 11, 2004 updating its fourth quarter earnings.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the issuer has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 9th day of August, 2004.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
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INDEX TO EXHIBITS
Index to Exhibits-(Continued)
* Previously filed and incorporated herein by reference.
** Electronically filed only.