| The Monarch Cement Company and Subsidiaries |
| Item 2. Management's Discussion and Analysis |
| of Financial Condition and Results of Operations |
FORWARD-LOOKING STATEMENTS
Certain statements under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this Form 10-Q report filed with the Securities and Exchange Commission, constitute "forward-looking statements". Except for historical information, the statements made in this report are forward-looking statements that involve risks and uncertainties. You can identify these statements by forward-looking words such as "should", "expect", "anticipate", "believe", "intend", "may", "hope", "forecast" or similar words. In particular, statements with respect to variations in future demand for our products in our market area or the future activity of federal and state highway programs and other major construction projects, the timing, scope, cost and benefits of our proposed and recently completed capital improvements and expansion plans, including the resulting increase in production capacity, our forecasted cement sales, the timing and source of funds for the repayment of our revolving line of credit, our ability to pay dividends at the current level, the timing and/or collectability of retainage, our anticipated expenditures for benefit plans, and our anticipated increase in solid fuels and electricity required to operate our facilities and equipment are all forward-looking statements. You should be aware that forward-looking statements involve known and unknown risks, uncertainties, and other factors that may affect the actual results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others:
general economic and business conditions;
competition;
raw material and other operating costs;
costs of capital equipment;
changes in business strategy or expansion plans;
demand for our Company's products;
cyclical and seasonal nature of our business;
the effect of weather on our business;
the effect of environmental and other government regulations;
the availability of credit at reasonable prices; and
the effect of federal and state funding on demand for our products.
We have described under the caption "Risk Factors" in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010, and in other reports that we file with the SEC from time to time, additional factors that could cause actual results to be materially different from those described in the forward-looking statements. You are cautioned not to put undue reliance on any forward-looking statements, which speak only as of the date they were made.
RESULTS OF OPERATIONS - CRITICAL ACCOUNTING POLICIES
Reference is made to the Management's Discussion and Analysis of Financial Condition and Results of Operations - Accounting Policies incorporated herein by reference to Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2010 for accounting policies which are considered by management to be critical to an understanding of the Company's financial statements.
RESULTS OF OPERATIONS - OVERVIEW
Our products are used in residential, commercial and governmental construction. In recent years, the Company has spent substantial sums on major plant modifications designed to increase our cement production capacity to meet our customers' needs and to improve our production processes. Improvements are planned over the next few years to further enhance our production processes and to meet emission limitations included in the latest regulations issued by the Environmental Protection Agency (EPA).
The residential and commercial construction slowdown, which began during 2008 and continued into 2011, has resulted in a declining demand for cement and ready-mixed concrete. Recent economic forecasts from the Portland Cement Association (PCA) indicate the construction industry is likely to remain weak until 2013. They indicate the negative drag on construction activity is due to uncertainty regarding highway spending and government policy related to the debt crisis. This weakness in the industry is putting downward pressure on the pricing of cement and ready-mixed concrete. The decline in volume and pricing pressure in the industry has adversely impacted our revenues, gross margins, and net profits. The impact of these adverse economic conditions was greater in the first nine months of 2011 than in the corresponding period of 2010.
Based on sales forecasts and inventory levels, the Company elected to reduce cement production in both the first quarter of 2010 and of 2011 to undertake plant repairs and maintenance, largely using our own production personnel. The Company normally performs repairs and maintenance every winter, but the decision to use employees or outside contractors is determined by anticipated sales demand, by whether we have the internal expertise and by our inventory target levels. During the remainder of the year, the Company evaluates inventory levels and sales forecasts to determine if reductions in cement production are warranted and can be scheduled around maintenance needs. In addition to costs that vary with the volume of production, our cost of sales includes certain fixed costs that do not vary with the volume of production. We have extremely limited ability to reduce these fixed costs in the short term. As a result, lower production levels which result from extended shutdowns generally have, and in 2010 and 2011 have had, a negative impact on our gross profit margins.
The Company plans to shut down its cement production facility and lay off the majority of its cement production employees during the first quarter of 2012 due to the continued weakness in the construction industry. The layoff is anticipated to last from four to ten weeks depending on cement shipments, and the resulting reduction in cement inventory, during the layoff period.
RESULTS OF OPERATIONS - THIRD QUARTER OF 2011 COMPARED TO THIRD QUARTER OF 2010
Consolidated net sales, for the three months ended September 30, 2011, increased by $1.4 million when compared to the three months ended September 30, 2010. Sales in our Cement Business increased by $0.1 million and sales in our Ready-Mixed Concrete Business increased by $1.3 million. Cement Business sales increased $0.4 million due to a 3.0% increase in volume sold and decreased $0.3 million due to price decreases. The acquisition of Kay Concrete resulted in an increase in cubic yards of ready-mixed concrete sold. Sales increased by $2.1 million due to a 14.9% increase in cubic yards sold and increased $0.1 million due to price increases. These ready-mixed concrete sales increases were partially offset by a decrease of $0.7 million in construction contract sales and a decrease of $0.2 million in sales of brick, block, aggregates and other sundry items.
Consolidated cost of sales, for the three months ended September 30, 2011, increased by $2.0 million when compared to the three months ended September 30, 2010. Cost of sales in our Cement Business was higher by $1.8 million and cost of sales in our Ready-Mixed Concrete Business was higher by $0.2 million. Cement Business cost of sales increased $0.3 million primarily due to the 3.0% increase in volume sold in addition to a $1.5 million increase related to higher production costs primarily resulting from the continuation of fixed costs during production shutdowns and the inefficiencies of lower production levels. Ready-Mixed Concrete Business cost of sales increased $1.9 million primarily due to the 14.9% increase in cubic yards of ready-mixed concrete sold which was partially offset by declines in direct material costs of $0.7 million. Cost of sales for brick, block, aggregates and other sundry items declined $0.5 million in addition to a $0.5 million decline in cost of sales for construction contracts.
As a result of the above sales and cost of sales factors, our overall gross profit rate declined from 17.4% for the three months ended September 30, 2010 to 15.2% for the three months ended September 30, 2011. The gross profit rate for the Cement Business declined from 31.7% for the three months ended September 30, 2010 to 20.7% for the three months ended September 30, 2011. The gross profit rate for the Ready-Mixed Concrete Business improved from 7.4% for the three months ended September 30, 2010 to 11.5% for the three months ended September 30, 2011.
The Company recorded $0.4 million less for impairment loss on equity investments due to impairments that were other-than-temporary for the three months ended September 30, 2011 compared to the three months ended September 30, 2010. The impairment loss for both years were for investments in the general building materials industry.
The effective tax rate for the three months ended September 30, 2011 and 2010 was 28.0%. The Company's effective tax rate differs from the federal and state statutory income tax rate primarily due to the effects of percentage depletion, domestic production activities deduction and valuation allowance. Taxes for the current year are estimated based on prior years' effective tax rates.
RESULTS OF OPERATIONS - FIRST NINE MONTHS OF 2011 COMPARED TO THE FIRST NINE MONTHS OF 2010
Consolidated net sales, for the nine months ended September 30, 2011, decreased by $2.0 million when compared to the nine months ended September 30, 2010. Sales in our Cement Business were lower by $1.7 million and sales in our Ready-Mixed Concrete Business were lower by $0.3 million. Cement Business sales decreased $1.1 million due to a 3.1% decrease in volume sold and decreased $0.6 million due to price decreases. The acquisition of Kay Concrete resulted in an increase in cubic yards of ready-mixed concrete sold. Sales increased $0.6 million due to the 1.8% increase in cubic yards sold and increased $0.1 million due to price increases. Sales brick, block, aggregates and other sundry items decreased $0.9 million and construction contract sales decreased $0.1 million.
Consolidated cost of sales, for the nine months ended September 30, 2011, increased by $3.1 million when compared to the nine months ended September 30, 2010. Cost of sales in our Cement Business was higher by $4.3 million and cost of sales in our Ready-Mixed Concrete Business was lower by $1.2 million. Cement Business cost of sales decreased $0.8 million due to the 3.1% decrease in volume sold which was more than offset by a $5.1 million increase related to higher production costs primarily resulting from the continuation of fixed costs during production shutdowns and the inefficiencies of lower production levels. Ready-Mixed Concrete Business cost of sales increased $0.6 million due to the $1.8% increase in cubic yards of ready-mixed concrete sold and decreased $0.4 million primarily due to declines in direct material costs. Cost of sales for brick, block, aggregates and other sundry items declined $0.7 million in addition to a $0.7 million decline in cost of sales for construction contracts.
Our overall gross profit rate declined from 12.9% for the nine months ended September 30, 2010 to 7.3% for the nine months ended September 30, 2011. The gross profit rate for the Cement Business declined from 25.9% for the nine months ended September 30, 2010 to 9.7% for the nine months ended September 30, 2011. The gross profit rate for the Ready-Mixed Concrete Business improved slightly from 4.0% for the nine months ended September 30, 2010 to 5.7% for the nine months ended September 30, 2011.
Gain on sale of equity investments increased by $5.2 million for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010. The Company recorded $0.4 million less for impairment loss on equity investments due to impairments that were other-than-temporary for the first nine months ended September 30, 2011 compared to the nine months ended September 30, 2010. The impairment loss for both years were for investments in the general building materials industry.
Other, net decreased by $0.5 million for the nine months ended September 30, 2011 from the nine months ended September 30, 2010 primarily due to a $0.7 million gain related to the sale of a non-operating asset during the first nine months of 2010 while Other, net during the first nine months of 2011 primarily consisted of $0.1 million proceeds from scrap metal sales.
The effective tax rates for the nine months ended September 30, 2011 and 2010 were 28.0% and (150.5)%, respectively. The Company's effective tax rate differs from the federal and state statutory income tax rate primarily due to the effects of percentage depletion, domestic production activities deduction and valuation allowance. Taxes for the current year are estimated based on prior years' effective tax rates. The change in the effective tax rate for 2010 was primarily due to an income tax charge of $685,000 recorded during the first quarter of 2010 as a result of the Patient Protection and Affordable Care Act, as modified by the Health Care and Education Reconciliation Act of 2010.
LIQUIDITY
The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At September 30, 2011 and December 31, 2010, cash equivalents consisted primarily of money market investments and repurchase agreements with various banks. The FDIC, through the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), has permanently raised the standard maximum deposit insurance amount (SMDIA) to fully guarantee all deposit accounts up to $250,000. In addition, the FDIC has adopted section 343 of the Dodd-Frank Act, effective December 31, 2010, which provides for unlimited deposit insurance for noninterest-bearing transaction accounts for two years starting December 31, 2010. This temporary unlimited coverage is in addition to, and separate from, the coverage of at least $250,000 available to depositors under the FDIC's general deposit insurance rules.
We are able to meet our cash needs primarily from a combination of operations, the sale of equity investments and bank loans.
Operating activities provided $4.0 million less cash for the nine months ended September 30, 2011 compared to the same period in 2010. For the nine months ended September 30, 2011 and September 30, 2010, cash provided by operating activities was $1.2 million and $5.3 million, respectively. Net losses were $0.6 million lower in the first nine months of 2011 compared to the corresponding period in 2010 despite 2011's decline in overall sales volume and decline in gross profit margins. This improvement is primarily the result of the $5.2 million gain on the sale of equity investments. The Company did not have any gain on the disposal of other assets in the first nine months of 2011, but the corresponding period in 2010 had a gain on the disposal of a non-operating asset of $0.7 million. Accrued postretirement benefits and pension expense used $1.0 million less cash in the first nine months of 2011 when compared to the corresponding period of 2010 primarily as a result of postretirement benefits using $0.8 million less cash in during 2011. The net result of production levels and sales volumes in the first nine months of 2011 and 2010 resulted in inventories decreasing $1.7 million more in the first nine months of 2011 than the corresponding period of 2010. Net Receivables increased $0.7 million more in the nine months ended September 30, 2011 than the corresponding period of 2010 primarily due to a greater increase in September 2011 over December 30, 2010 sales compared to the increase in September 2010 over December 30, 2009 sales. Refundable income taxes increased $0.9 million more in the nine months ended September 30, 2011 than the corresponding period of 2010 due to the net losses incurred during 2011 and the sale during 2011 of previously other-than-temporarily impaired equity securities which resulted in $0.9 million of associated deferred tax becoming refundable. Accounts payable and accrued liabilities excluding acquisitions of property, plant and equipment purchases provided $1.4 million more cash in the nine months ending September 2011 primarily as a result of accrued liability for prepaid cement sales which decreased less during the nine months ended September 2011 than the corresponding period in 2010.
Net cash used for investing activities totaled $0.4 million in the first nine months of 2011 while $4.7 million was used in the first nine months months of 2010. The $4.4 million decrease in net cash used for investing activities for the first nine months of 2011 compared to the corresponding period of 2010 is principally due to the $6.1 million increase in proceeds from disposals, net of purchases, of equity investments in the first nine months of 2011 over the corresponding period of 2010. The Company used $1.2 million more cash for the net acquisition and disposal of property, plant and equipment and disposals of other assets in the first nine months of 2011 than in the corresponding period of 2010. The acquisition of Kay Concrete used $0.5 million in cash, net of cash acquired, in the first nine months of 2011 while no such acquisitions were made in the first nine months of 2010.
Net cash used for financing activities totaled $2.6 million and $1.2 million for the nine months ending September 30, 2011 and September 30, 2010, respectively. The $1.4 million increase in cash used in 2011 compared to 2010 was primarily the result of an increase in capital stock purchases of $2.2 million. Our line of credit, net of payments on long term debt, provided $0.8 million more through the third quarter of 2011 compared to the same period in 2010.
In December 2010, Monarch entered into an amendment to the loan agreement with its current lender, Bank of Oklahoma, N.A., to, among other things, renew and modify the terms of Monarch's term loan and revolving line of credit. The amendment added a financial covenant that requires the Company to pledge its investment account to the Bank of Oklahoma, N.A. as collateral for the term loan and revolving line of credit. The fair value of the investment account pledged as collateral was $13.5 million as of September 30, 2011. The proceeds of the sale of any assets held in the investment account would be paid to the Bank of Oklahoma, N.A. to be applied to the balance of the revolving line of credit and then to the term loan, at the lender's discretion. Monarch's secured credit commitment consists of a $17.8 million term loan maturing December 31, 2014 and a $15.0 million line of credit maturing December 31, 2011. Under the amended loan agreement, interest rate terms were not changed. The interest rate on the Company's line of credit remains variable and based on the lender's national prime rate less 0.50% with a 3.50% interest rate minimum or floor. The interest rate on the Company's term loan remains variable and based on the lender's national prime rate less 0.75% with a 3.00% interest rate minimum or floor. The loan agreement contains a financial covenant related to net worth which the Company was in compliance with at the end of the third quarter of 2011.
As of September 30, 2011, we had $9.7 million outstanding on the term loan and $6.4 million outstanding on the line of credit leaving a balance available on the line of credit of $8.6 million. The annual weighted average interest rate we paid on the term loan during the third quarter and first nine months of 2011 and 2010 was 3.25%. The annual weighted average interest rate we paid on the line of credit during the third quarter and first nine months of 2011 and 2010 was 3.50%. As of September 30, 2011, the applicable interest rate was 3.25% on the term loan and 3.50% on the line of credit. The term loan was used to help finance the expansion project at our cement manufacturing facility. The line of credit was used during the year to fund temporary operating expenses. Our Board of Directors has given management the authority to borrow a maximum of $50 million. We have not discussed additional financing with any banks or other financial institutions; therefore, no assurances can be given that we will be able to obtain this additional borrowing on favorable terms, if at all.
The Company has projects in the planning and design phases in addition to projects already in progress. For discussion of these projects, see "Capital Resources" below. We anticipate capital expenditures for 2011 to exceed 2010 levels, but we do not anticipate the need for additional bank financing other than that available under the existing line of credit.
For several years the Company has paid a dividend in January, March, June and September. At the August 2011 Board of Directors' meeting, the Board declared a dividend of $0.23 per share payable in September. Under the terms and conditions of our loan agreement, the Company's ability to pay dividends is subject to its satisfaction of a requirement to maintain a tangible net worth of $90 million and an adjusted tangible net worth, which is tangible net worth before other comprehensive income, of $95 million. The Company was in compliance with these requirements at the end of the third quarter of 2011. The minimum net worth requirements could impact the Company's ability to pay dividends in the future. Although dividends are declared at the Board's discretion and could be impacted by the minimum net worth requirements of the Company's loan agreement, we project future cash flow will support the continued payment of dividends at the current level.
The Company has been required to make a pension contribution each of the past two years. In 2010 and 2009, the Company contributed approximately $2.3 million and $2.1 million, respectively, to the pension fund. The decline in the bond and stock markets in 2008 significantly reduced the value of our pension funds at December 31, 2008. By December 31, 2010, actual returns on plan assets had increased the value of our pension funds enough to recover approximately 80% of the 2008 year reductions. Based on the pension laws currently in effect, any resulting increases in minimum funding requirements could cause a negative impact to our liquidity. See Note 7 for disclosures about 2011 pension contributions.
FINANCIAL CONDITION
Total assets as of September 30, 2011 were $174.6 million, an increase of $0.5 million since December 31, 2010. The acquisition of Kay Concrete plus higher sales in September 2011 compared to December 2010 led to a $6.2 million increase in receivables. From year-to-year the weather conditions in these two months can vary significantly which impacts sales and resulting receivables at month-end. Increases in receivables are common during the first nine months of the year due to the seasonality of our business (see"Seasonality" below). Total inventories decreased $2.7 million primarily due to a $3.3 million decrease in finished cement and $0.7 million decrease in work in process inventories resulting from reduced production during the year in addition to the shutdowns of the production facilities during the first quarter of 2011. Fuel, gypsum, paper sacks and other inventory increased $1.3 million primarily as a result of purchases of coal and petroleum coke exceeding amounts consumed in the production process, increases related to the acquisition of Kay Concrete, and smaller increases from various other subsidiaries in preparation for seasonal increased demand.
Refundable income taxes increased $1.1 million compared to December 31, 2010. Our quarterly estimated tax payments are based on annualized income and the net loss we experienced during the first nine months resulted in refundable income taxes. In addition, equity securities which had previously been other-than-temporarily impaired were sold and the $0.9 million deferred tax associated with them as a result of their book/tax basis difference became refundable. Prepaid expenses increased by $0.9 million primarily due to insurance deposits. Property, plant and equipment net of depreciation and depletion increased by $2.5 million primarily due to routine expenditures for property, plant and equipment plus the acquisition of Kay Concrete which increased property, plant and equipment by $5.3 million. Investments decreased $7.5 million primarily due to the $5.5 million sale, net of purchases, of available-for-sale equity securities in addition to decreases in the market value of remaining equities held. The $1.5 million increase in other assets was primarily a result of the Kay Concrete acquisition which added $0.6 million and $0.9 million to goodwill and noncompete agreements, respectively.
Accounts payable increased by $0.8 million primarily due to increases related to the acquisition of Kay Concrete and increases in the Ready-Mixed Concrete Business segment related to increased sales volume in September 2011 over December 2010. Accrued liabilities decreased from December 31, 2010 to September 30, 2011 by $1.8 million primarily due to a $1.8 million decrease in cash dividends liability resulting from the timing of when dividends are declared and paid.
Indebtedness increased $5.8 million during the first nine months of 2011 primarily due to increased utilization of our line of credit to fund the $5.8 million increase in receivables and approximately $5.6 million for cash expenditures for property, plant and equipment.
Accrued postretirement and pension liabilities increased by $1.3 million and $0.4 million, respectively, due to net periodic expense exceeding contributions.
Additional-paid-in-capital increased by $2.5 million as a result of the purchase of Kay Concrete on April 15, 2011, and the resulting issuance of 105,750 shares of the Company’s capital stock with a market value on that date of $26.00 per share compared to a $2.50 per share par value.
Unrealized holding gain, which is included in accumulated other comprehensive loss, decreased by $4.1 million during the first nine months of 2011 primarily due to the realization of previously unrealized gains of $5.2 million through the sale of $7.9 million of available-for-sale equity securities in addition to decreases in the market value of remaining equities held.
CAPITAL RESOURCES
The Company regularly invests in miscellaneous equipment and facility improvements in both the Cement Business and Ready-Mixed Concrete Business. Capital expenditures included routine equipment purchases during the first nine months of 2011, equally in the Cement Business and in the Ready-Mixed Concrete Business. During the first nine months of 2011, cash expenditures for property, plant and equipment totaled approximately $5.6 million, excluding the amounts that are included in accounts payable.
The Company does not currently meet certain emission limitations included in the latest regulations issued by the EPA. For discussion on the regulations, see NESHAP discussed below under "Environmental Regulations". To comply with these new regulations, the Company will need to install additional pollution control equipment in its Cement Business. There is no proven technology that enables us to give 100% assurance that we can reach the limits required by the new regulations; however, we feel compliance is possible at our modern facility through the installation of additional pollution control equipment. We plan to use a step approach, beginning with the installation of additional dust collectors on one of our two kilns. Once they are installed, we will test for compliance to determine if other pollution control equipment is needed. If we are not in compliance, we will continue to install pollution control equipment, testing for compliance after each installation, until our emissions are within limits. Once we have successfully modified one kiln to meet the new emission standards, we will proceed with our second kiln. We have also initiated plans to modify our roller mill and related equipment at an estimated cost of $6.0 million dollars. Supplemental equipment (and estimated cost) which may be required include additional dust collectors on both kilns ($4.0 million), upgraded dust collectors on both clinker coolers ($4.0 million), hydrated lime injection system ($0.4 million), and a chloride by-pass system ($7.0 million). Cost estimates will be updated as the modifications are engineered and priced for our facility. We are hopeful that we can comply with the new regulations without having to install a chloride by-pass system. We have until September 2013 to comply and may be able to get a one year extension if we have shown continuous progress toward becoming compliant. Various court challenges and legislative actions are pending against the NESHAP regulations issued by the EPA. If any of these court challenges or legislative actions are successful in delaying or overruling the regulation, we will evaluate whether or not to complete the projects currently in process.
NESHAP regulations also require us to install analyzers capable of continuously monitoring certain pollutants. Analyzers capable of continuously monitoring these pollutants at the extremely low levels (i.e. emissions of particulate matter are limited to 3 parts per million) specified in the regulation do not currently exist. We are partnering with an analyzer manufacturer to assist in the development of the required technology and estimate we will spend approximately $0.8 million for these analyzers.
The Company plans to invest in other miscellaneous equipment and facility improvements in both the Cement Business and Ready-Mixed Concrete Business in 2011. These expenditures, including the ones discussed in the above paragraphs related to NESHAP compliance, are expected to reach approximately $10.1 million during 2011 and will be funded with a mixture of cash from operations and temporary bank loans. We do not anticipate the need for additional bank financing beyond the amount available through our existing revolving line of credit.
MARKET RISK
Market risks relating to the Company's operations result primarily from changes in demand for our products. Construction activity, particularly in the residential market, has been adversely impacted by the global financial crisis even though interest rates continue to be at low levels. A continuation of the financial crisis, including a scarcity of credit, or a significant increase in interest rates could lead to a further reduction in construction activities in both the residential and commercial market. Budget shortfalls during economic slowdowns could cause money to be diverted away from highway projects, schools, detention facilities and other governmental construction projects. Reduction in construction activity lowers the demand for cement, ready-mixed concrete, concrete products and sundry building materials. As demand decreases, competition to retain sales volume could create downward pressure on sales prices. The manufacture of cement requires a significant investment in property, plant and equipment and a trained workforce to operate and maintain this equipment. These costs do not materially vary with the level of production. As a result, by operating at or near capacity, regardless of demand, companies can reduce per unit production costs. The continual need to control production costs encourages overproduction during periods of reduced demand.
INFLATION
Inflation directly affects the Company's operating costs. The manufacture of cement requires the use of a significant amount of energy. The Company burns primarily solid fuels, such as coal and petroleum coke, and to a lesser extent natural gas, in its kilns. Increases above the rate of inflation in the cost of these solid fuels, natural gas, or in the electricity required to operate our cement manufacturing equipment could adversely affect our operating profits. Prices of the specialized replacement parts and equipment the Company must continually purchase tend to increase directly with the rate of inflation with the exception of equipment and replacement parts containing large amounts of steel. In recent years, steel prices have tended not to follow inflationary trends, but rather have been influenced by worldwide demand. Prices for diesel fuel used in the transportation of our raw materials and finished products also vary based on supply and demand and in some years exceed the rate of inflation adversely affecting our operating profits.
ENVIRONMENTAL REGULATIONS
The Company's cement plant emissions are regulated by the Kansas Department of Health and Environment (KDHE) and the EPA. KDHE is responsible for the administration and enforcement of Kansas environmental regulations, which typically mirror national regulations.
A ruling promulgated by the EPA in 2009 required us to install carbon dioxide (CO2) Continuous Emission Monitors (CEMs) to track various aspects of the production process to effectively establish a Greenhouse Gas (GHG) inventory for our cement manufacturing facility.
The EPA Administrator has made two important findings clearing the way for EPA to regulate greenhouse gases under the Clean Air Act. The "Endangerment Finding" clarifies EPA's belief that current and projected concentrations of six key greenhouse gases in the atmosphere pose a threat to human health and welfare. Further, the "Cause or Contribute Finding," associates the emissions of the six named GHGs with the threat to public health and welfare. At this time it is difficult to determine if the EPA will act on the "Endangerment Finding", what that action may involve, and when it might be put into place.
We are currently not aware of any proposed or pending climate change regulations. There are many variables making it difficult to predict the overall cost of carbon legislation. It is equally difficult to determine when those costs will be realized, or even the feasibility of legislation being passed. There is consensus in the industry that the costs of CO2 limits required through regulation or legislation could be substantial enough to fundamentally change the cement manufacturing business.
On September 9, 2010, the EPA published modifications to the National Emission Standard for Hazardous Air Pollutants (NESHAP) regulation in the Federal Register. The compliance date for all U.S. cement plants is September 9, 2013. The final rule differs from the proposed rule by requiring more stringent emission limitations on mercury (Hg), total hydrocarbons (THC), hydrochloric acid (HCL), and particulate matter less than 10 microns in diameter (PM 10). Our current emission levels are below the proposed limitations for mercury and THC so additional control equipment is not required for these pollutants; however, we expect to incur increased costs for control equipment for PM 10 & HCL. There will also be additional costs for monitoring, testing, and increased maintenance labor. Initial costs to comply are discussed above under "Capital Resources". H. R. 2681, The Cement Sector Regulatory Relief Act, which would extend the compliance date for NESHAP to September 9, 2015, was passed by the House of Representatives, and The Portland Cement Association (PCA) filed legal briefs with the District of Columbia Circuit Court of Appeals addressing numerous challenges to NESHAP. It is uncertain when and if companion legislation to H. R. 2681 will pass the Senate and be acceptable to President Obama. It is also unknown when the D. C. Circuit Court will rule on PCA's briefs. Management has elected to proceed with modifications to the roller mill rather than risk non-compliance with NESHAP should legislative or judicial relief not materialize.
On September 9, 2010 the EPA published New Source Performance Standards (NSPS) for nitrous oxide (NOx), sulphur dioxide (SO2), and particulate matter (PM 10). The rule applies to new or modified sources. At this time, management does not anticipate that modifications necessitated to comply with NESHAP will trigger application of NSPS.
Although there are presently no proposed or pending climate change regulations, climate change regulation could result in (1) increased energy costs, (2) a shift toward carbon neutral fuels or carbon neutral offset strategies, and (3) increased labor costs to acquire the specialized technical expertise needed to comply with the environmental regulations. Demand for our products could decrease due to increased pollution control costs. Conversely, demand could increase as others try to meet their government environmental mandates by using concrete products known for their sustainability benefits and energy efficiency.
In management's opinion, the physical impact of a warmer climate in our market area will increase the number of days with weather conducive for work to proceed on construction projects which in turn will create the potential for greater profitability. Conversely, legislation and regulatory attempts to interfere with natural warming and cooling cycles will, if successful, have an adverse affect on profitability. In addition, differences in environmental regulations in the United States from those of other cement producing countries could affect our ability to continue to compete with the cost of cement imported from other countries.
SEASONALITY
Portland cement is the basic material used in the production of ready-mixed concrete that is used in highway, bridge and building construction. These construction activities are seasonal in nature. During winter months when the ground is frozen, groundwork preparation cannot be completed. Cold temperatures affect concrete set-time, strength and durability, limiting its use in winter months. Dry ground conditions are also required for construction activities to proceed. During the summer, winds and warmer temperatures tend to dry the ground quicker creating fewer delays in construction projects.
Variations in weather conditions from year-to-year significantly affect the demand for our products during any particular quarter; however, our Company's highest revenue and earnings historically occur in its second and third fiscal quarters, April through September.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company invests in equity investments which are subject to market fluctuations. The Company had $16.5 million of equity securities, primarily of publicly traded entities, as of September 30, 2011. The aggregate amount of securities carried at cost, for which the Company has not elected the fair value option, was $2.5 million as of September 30, 2011. The remaining $14.0 million in equity investments, which are stated at fair value, are not hedged and are exposed to the risk of changing market prices. The Company classifies all securities as "available-for-sale" for accounting purposes and marks them to fair value on the balance sheet at the end of each period unless they are securities for which the Company has not elected the fair value option. Securities carried at cost are adjusted for impairment, if conditions warrant. Management estimates that its publicly traded investments will generally be consistent with trends and movements of the overall stock market excluding any unusual situations. An immediate 10% change in the fair value of our equity securities would have a $0.8 million effect, net of deferred tax, on comprehensive income. At September 30, 2011, the Company evaluated all of its equity investments for impairment. The results of those evaluations are discussed in Note 6 of Notes to the Condensed Consolidated Financial Statements.
The Company also has $16.1 million of bank loans as of September 30, 2011. Interest rates on the Company's term loan and line of credit are variable, subject to interest rate minimums or floors, and are based on the lender's National Prime rate less 0.75% and lender's National Prime rate less 0.50%, respectively.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures (as defined in Rules 13a-5(e) and 15d-15(e) under the Securities Exchange Act of 1934) that are designed to ensure that information required to be disclosed in the Company's reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to the Company's management, including its President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
As of the end of the period covered by this report, an evaluation was carried out by the Company's management, including its President and Chairman of the Board of Directors and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures (as defined in Rules 13a-5(e) or 15d-15(e) under the Exchange Act). Based upon that evaluation, the Company's President and Chairman of the Board of Directors and Chief Financial Officer concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report.
There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company self-reported potential violations of certain permitting requirements of the Kansas Department of Health and Environment (KDHE). As a result, the Company was notified by letter dated April 27, 2009 of allegations by KDHE that the Company has performed multiple modifications and alterations at the Company’s facility for which the Company did not apply for or obtain the KDHE construction permits required by the Kansas Air Quality Act and related regulations. KDHE also alleged that the Company did not apply for or obtain from KDHE the necessary permits for modifications or alterations to a facility that are significant for Prevention of Significant Deterioration (PSD). Based on these allegations, KDHE proposes to assess a civil penalty of $351,000, and to require the Company to submit a new, complete PSD permit application, including therein a proposal by the Company for installation of air emission controls to achieve Best Available Control Technology (BACT) as provided in applicable regulations. The Company does not agree with certain of KDHE’s factual and legal allegations, and is attempting to resolve these issues through negotiation and mutual agreement between the Company and KDHE. The Company reserves all legal rights in the event such a resolution cannot be reached. As of September 30, 2011, it is probable that losses may result, but such losses are estimated to be insignificant.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table summarizes the purchases made by or on behalf of our Company or certain affiliated purchasers of shares of our capital stock during the third quarter ended September 30, 2011:
| Period | | (a) Total Number of Shares (or Units) Purchased | | | (b) Average Price Paid per Share (or Unit) | | | (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | | | (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs | |
| Beginning repurchase authority | | | | | | | | | | | | | | | 98,328 | |
| July 1-31, 2011 | | | - | | | | - | | | | - | | | | 98,328 | |
| Additional authorization of 101,672 shares from August 5, 2011 Board of Directors' meeting | | | | 200,000 | |
| August 1-31, 2011 | | | 8,700 | | | | 24.04 | | | | 8,700 | | | | 191,300 | |
| September 1-30, 2011 | | | 2,500 | | | | 24.06 | | | | 2,500 | | | | 188,800 | |
| Total | | | 11,200 | | | $ | 24.05 | | | | 11,200 | | | | 188,800 | |
| | | | | | | | | | | | | | | | | |
On August 5, 2011, our Board of Directors authorized the purchase, through open market or private transactions, of 101,672 shares of our Company's capital stock in addition to the existing 98,328 shares remaining from the Board's 1996 authorization for a total repurchase authority of 200,000 shares. Management's authorization has no expiration. Management was given discretion to determine the number and pricing of shares to be purchased as well as the timing of any such purchases.
Item 5. Other Information
Under Section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, each operator of a coal or other mine is required to include disclosures regarding certain mine safety results in its periodic reports filed with the SEC. The operation of the Company's quarries is subject to regulation by the federal Mine Safety and Health Administration ("MSHA") under the Federal Mine Safety and Health Act of 1977. The information required under Section 1503(a) regarding certain mining safety and health matters is presented in Exhibit 95 to this report.
Item 6. Exhibits
| 31.1 | Certificate of the President and Chairman of the Board pursuant to Section 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934. |
| Certificate of the Chief Financial Officer pursuant to Section 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934. |
| 18 U.S.C. Section 1350 Certificate of the President and Chairman of the Board dated November 9, 2011. |
| 18 U.S.C. Section 1350 Certificate of the Chief Financial Officer dated November 9, 2011. |
| Dodd-Frank Act Section 1503(a) Disclosures of Mine Safety and Health Administration Safety Data. |
| The following financial statements from the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2011, formatted in XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Income (Loss) and Retained Earnings, (iii) Condensed Consolidated Statements of Comprehensive Income (Loss), (iv) Condensed Consolidated Statements of Cash Flows, and (v) Notes to the Condensed Consolidated Financial Statements. |
* Pursuant to Rule 406T of Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be "filed" for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filings.
S I G N A T U R E S
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | | | The Monarch Cement Company | |
| | | | | (Registrant) | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| Date November 9, 2011 | | | | /s/ Walter H. Wulf, Jr. | |
| | | | | Walter H. Wulf, Jr. | |
| | | | | President and | |
| | | | | Chairman of the Board | |
| | | | | (principal executive officer) | |
| | | | | | |
| | | | | | |
| Date November 9, 2011 | | | | /s/ Debra P. Roe | |
| | | | | Debra P. Roe, CPA | |
| | | | | Chief Financial Officer and | |
| | | | | Assistant Secretary-Treasurer | |
| | | | | (principal financial officer and | |
| | | | | principal accounting officer) | |
Exhibit
Number Description
31.1 Certificate of the President and Chairman of the
Board pursuant to Section 13a-14(a)/15d-14(a)
of the Securities Exchange Act of 1934.
31.2 Certificate of the Chief Financial Officer pursuant
to Section 13a-14(a)/15d-14(a) of the
Securities Exchange Act of 1934.
32.1 18 U.S.C. Section 1350 Certificate of the President
and Chairman of the Board dated November 9, 2011.
32.2 18 U.S.C. Section 1350 Certificate of the
Chief Financial Officer dated November 9, 2011.
95 Dodd-Frank Act Section 1503(a) Disclosures of Mine
Safety and Health Administration Safety Data.
101 The following financial statements from the Company’s
Quarterly Report on Form 10-Q for the fiscal quarter
ended September 30, 2011, formatted in XBRL: (i) Condensed
Consolidated Balance Sheets, (ii) Condensed Consolidated
Statements of Income (Loss) and Retained Earnings,
(iii) Condensed Consolidated Statements of Comprehensive
Income (Loss), (iv) Condensed Consolidated Statements
of Cash Flows, and (v) Notes to the Condensed
Consolidated Financial Statements.
