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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

x      Annual Report on Form 10-K pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934,

 

For the fiscal year ended February 28, 2013

 

or

 

o         Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934,

 

For the transition period from                to                

 

Commission File Number 333-176538

 

NEW ENTERPRISE STONE & LIME CO., INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

23-1374051

(State or other jurisdiction

of incorporation or organization)

 

(IRS employer

identification number)

 

3912 Brumbaugh Road

P.O. Box 77

New Enterprise, PA

 

16664

(Address of principal executive offices)

 

(Zip code)

 

Registrant’s telephone number, including area code:  (814) 766-2211

 

Securities registered pursuant to Section 12(b) of the Act:  None

 

Securities registered pursuant to Section 12(g) of the Act:  None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.  Yes o  No x

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No x

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K:  x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of 1934. (Check one):

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes o  No x

 

As of February 28, 2013, there was no established public market for the registrant’s Class A Voting and Class B Non-Voting Common Stock and therefore the aggregate market value of the voting and non-voting common equity held by non-affiliates is not determinable.

 

As of May 17, 2013, the number of outstanding shares of the registrant’s Class A Voting Common Stock, $1.00 par value was 500 shares and the number of outstanding shares outstanding of the registrant’s Class B Non-Voting Stock, $1.00 par value, was 273,285.

 

DOCUMENTS INCORPORATED BY REFERENCE

None

 

 

 



Table of Contents

 

Explanatory Note

 

Except as otherwise specifically noted, all information contained herein is as of February 28, 2013 and does not reflect any events or changes in information that may have occurred subsequent to that date.

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K for our fiscal year ended February 28, 2013 (“fiscal year 2013”) includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with respect to our financial condition, results of operations and business and our expectations or beliefs concerning future events. Such statements include, in particular, statements about our plans, strategies and prospects under the headings “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” You can identify certain forward-looking statements by our use of forward-looking terminology such as, but not limited to, “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “targets,” “likely,” “will,” “would,” “could” and similar expressions that identify forward-looking statements. All forward-looking statements involve risks and uncertainties. Many risks and uncertainties are inherent in our industry and markets. Others are more specific to our operations. The occurrence of the events described and the achievement of the expected results depend on many events, some or all of which are not predictable or within our control. Actual results may differ materially from the forward-looking statements contained in this Annual Report on Form 10-K.  Factors that could cause actual results to differ materially from those expressed or implied by the forward-looking statements include:

 

·            material weaknesses and significant deficiencies in our internal controls over financial reporting;

 

·            risks associated with the cyclical nature of our business and dependence on activity within the construction industry;

 

·            declines in public sector construction and reductions in governmental funding which continue to adversely affect our operations and results;

 

·            our reliance on private investment in infrastructure and a slower than normal recovery which continue to adversely affect our results;

 

·            a decline in the funding of the Pennsylvania Department of Transportation, which we refer to as PennDOT, the Pennsylvania Turnpike Commission, the New York State Thruway Authority or other state agencies;

 

·            difficult and volatile conditions in the credit markets may adversely affect our financial position, results of operations and cash flows;

 

·            the potential for our lender to modify the terms of our asset-based loan facility;

 

·            the potential to inaccurately estimate the overall risks, requirements or costs when we bid on or negotiate a contract that is ultimately awarded to us;

 

·            the weather and seasonality;

 

·            operation in a highly competitive industry within our local markets;

 

·            our dependence upon securing and permitting aggregate reserves in strategically located areas;

 

·            risks related to our ability to acquire other businesses in our industry and successfully integrating them with our existing operations;

 

·            risks associated with our capital-intensive business;

 

·            risks related to our ability to meet schedule or performance requirements of our contracts;

 

·            changes to environmental, health and safety laws;

 

·            our dependence on our senior management;

 

·            our ability to recruit additional management and other personnel and our ability to grow our business effectively or successfully implement our growth plans;

 

·            the potential for labor disputes to disrupt operations of our businesses;

 

·            special hazards related to our operations that may cause personal injury or property damage;

 

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·            unexpected self-insurance claims and reserve estimates;

 

·            material costs and losses as a result of claims that our products do not meet regulatory requirements or contractual specifications;

 

·            cancellation of significant contracts or our disqualification from bidding for new contracts;

 

·            general business and economic conditions, particularly an economic downturn; and

 

·            the other factors discussed in the section of this Annual Report on Form 10-K titled “Item 1A—Risk Factors.”

 

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We caution you that the foregoing list of important factors may not contain all of the material factors that are important to you. In addition, in light of these risks and uncertainties, the matters referred to in the forward-looking statements contained in this Annual Report on Form 10-K may not in fact occur. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.

 

TABLE OF CONTENTS

 

PART I

 

 

 

 

Item 1.

BUSINESS

5

 

Item 1A.

RISK FACTORS

22

 

Item 1B.

UNRESOLVED STAFF COMMENTS

30

 

Item 2.

PROPERTIES

30

 

Item 3.

LEGAL PROCEEDINGS

34

 

Item 4.

MINE SAFETY DISCLOSURES

34

 

 

 

 

PART II

 

 

 

 

Item 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

34

 

Item 6.

SELECTED FINANCIAL DATA

35

 

Item 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

36

 

Item 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

56

 

Item 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

57

 

Item 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

98

 

Item 9A.

CONTROLS AND PROCEDURES

98

 

Item 9B.

OTHER INFORMATION

101

 

 

 

 

PART III

 

 

 

 

Item 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

102

 

Item 11.

EXECUTIVE COMPENSATION

105

 

Item 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

110

 

Item 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

112

 

Item 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

114

 

 

 

 

PART IV

 

 

 

 

Item 15.

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

115

 

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PART I

 

Item 1.                                    BUSINESS.

 

Overview

 

We are a leading privately held, vertically integrated construction materials supplier and heavy/highway construction contractor in Pennsylvania and western New York and a national traffic safety services and equipment provider. Founded in 1924, we are one of the top 10 construction aggregates producers based on tonnage of crushed stone produced and one of the top 50 highway contractors based on revenues in the United States, according to industry surveys.

 

We operate in three segments based upon the nature of our products and services: construction materials, heavy/highway construction and traffic safety services and equipment. Our construction materials operations are comprised of: aggregate production, including crushed stone and construction sand and gravel; hot mix asphalt production; ready mixed concrete production; and the production of concrete products, including precast/prestressed structural concrete components and masonry blocks. Another of our core businesses, heavy/highway construction, includes heavy construction, blacktop paving and other site preparation services. Our heavy/highway construction operations are primarily supplied with construction materials from our construction materials operation. Our third core business, traffic safety services and equipment, consists primarily of sales, leasing and servicing of general and specialty traffic control and work zone safety equipment and devices to industrial construction end-users.

 

Our core businesses operate primarily in Pennsylvania and western New York, except for our traffic safety services and equipment business, which maintains a national sales network for our traffic safety products and provides traffic maintenance and protection services primarily in the eastern United States.

 

Our revenue is derived from multiple end-use markets, including highway construction and maintenance, residential and non-residential construction and energy production, including operators in the coal and natural gas industries. We are a heavy/highway contractor that offers a diversity of construction materials and services. As a result, we are able to meet a wide range of customer requirements on a local scale. A significant portion of our revenues, both through direct and indirect sales, are generated from PennDOT, the Pennsylvania Turnpike Commission, the New York State Thruway Authority and other agencies in the Commonwealth of Pennsylvania.

 

Through four generations of family management, we have grown both organically and by acquisitions and now operate 52 quarries and sand deposits, 30 hot mix asphalt plants, 19 fixed and portable ready mixed concrete plants, four concrete products production plants, three lime distribution centers and seven construction supply centers. Our traffic safety services and equipment business operates five manufacturing facilities and has sales facilities throughout the continental United States. We believe our extensive operating history and industry expertise, combined with strategically located operations and substantial aggregate reserves throughout Pennsylvania and western New York, enable us to be a low-cost supplier, as well as an operator with an established execution track record.

 

Corporate Information

 

New Enterprise Stone & Lime Co., Inc. (which we refer to as NESL) is a Delaware corporation initially formed as a partnership in 1924. Our principal executive offices are located at 3912 Brumbaugh Road, P.O. Box 77, New Enterprise, PA 16664, and our telephone number is (814) 766-2211.

 

Our Markets

 

Our vertically integrated construction materials and heavy/highway construction businesses operate in competitive regional markets. Many of our contracts are awarded based on a “sealed bid” process, which dictates that the lowest price bidder must be chosen. This dynamic forces us to compete against major, national suppliers and smaller, local operators. We believe that our extensive operational footprint and local market knowledge allow us to bid effectively on jobs, to obtain a unique understanding of our customers’ evolving needs and, most critically, to maintain favorable positions in the markets for our products and services, enabling us to submit lower price bids while maintaining our profitability.

 

We maintain strategically located construction materials operations across Pennsylvania and western New York. We also provide heavy/highway construction services, primarily in Pennsylvania and, to a lesser degree, into Maryland, West Virginia and Virginia. We operate traffic safety equipment manufacturing facilities and sell these products across the United States and we provide maintenance and traffic protection services primarily in the eastern United States.

 

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Pennsylvania and Western New York

 

We operate primarily throughout Pennsylvania and western New York. The geography and natural resources of this area contribute to this region being one of the largest consumers of construction aggregates in the United States.

 

Pennsylvania, which was the third largest producer of construction aggregates and the sixth largest producer of concrete in the United States in 2012, is located between the major consumer markets of the eastern United States and the large agricultural and industrial regions of the Midwestern United States, with an extensive and heavily utilized interstate system connecting the two. In addition, the state has a widely dispersed and dense rural population that requires approximately 120,000 miles of paved roads throughout the state that must be maintained on a regular basis. A high percentage of the state’s roads are built in frost susceptible areas which, when subject to the typical freeze-thaw cycles of Pennsylvania’s climate, create excess pavement stresses, deformation and surface degradation, all requiring road maintenance.

 

The Appalachian ridge, located in the central part of the state and close to many of our facilities, contains expansive coal strip mining production and Marcellus Shale’s gas well drilling and pipeline expansion, all of which require extensive road networks, and related road maintenance, that provide an additional market for our construction materials and heavy/highway construction. This same area has been the site of recent wind farm expansion. The construction of wind farms and the associated power generation facilities consume substantial amounts of aggregates and ready mixed concrete.

 

The geography and natural resources of Pennsylvania, western New York and the surrounding states provide a robust market for our product offerings. Geographically, the locations of our quarries allow us to reach a large market area in Pennsylvania and the western part of New York. Our highway construction division can perform work throughout Pennsylvania and is able to respond to this market with aggregates, concrete, blacktop paving and highway construction services. Furthermore, our geographically diverse facilities are situated to maximize the consumption trends in this region. The higher growth areas of eastern Pennsylvania have slowed during the recession. Conversely, our western and central Pennsylvania and New York locations are focused on the less cyclical core highway maintenance and heavy/highway construction, as well as the more stable residential and agricultural needs in these areas.

 

Public Sector

 

Public sector construction includes spending by federal, state and local governments for highways, bridges and airports, as well as other infrastructure construction for sewer and waste disposal systems, water supply systems, dams, reservoirs and other public construction projects. Generally, public sector construction spending is more stable than private sector construction. Public sector spending is less sensitive to interest rates and often is supported by multi-year legislation and programs. A significant portion of our revenue is from public highway construction projects. As a result, the funding for public highway construction significantly impacts our market.

 

The level of state spending on infrastructure varies across the United States and depends on the needs and economies of individual states. However, a large part of any state’s public expenditure on transportation infrastructure is a factor of the amount of federal funds it receives for such purposes. During its fiscal year ended June 30, 2012, PennDOT spent approximately $7.0 billion on transportation projects and administration, which includes its federal funds allocation of approximately $1.5 billion. In addition, the Pennsylvania Turnpike Commission, the roads of which are located near many of our facilities, receives toll revenue less susceptible to variations in state funding which it utilizes for its maintenance and construction operations. The Pennsylvania Turnpike Commission’s Ten-Year Capital Plan for the fiscal year ending May 31, 2013 is $6.8 billion, approximately 90% of which amount is allocated to the cost of resurfacing, replacing or reconstructing the existing turnpike system. The New York Thruway, also in our market area, is a toll road with dedicated funding outside of the New York Department of Transportation.

 

Private Sector

 

This market includes both non-residential and residential construction and is more cyclical than public construction.

 

Private non-residential construction includes a wide array of project types. Overall demand in private non-residential construction is generally driven by job growth, vacancy rates, private infrastructure needs and demographic trends. The growth of the private workforce creates a demand for offices, hotels and restaurants. Likewise, population growth generates demand for stores, shopping centers, warehouses and parking decks as well as hospitals, schools and entertainment facilities. Large industrial projects, such as a new manufacturing facility, can increase the need for other manufacturing plants to supply parts and assemblies, as well as the need for additional residential construction. Construction activity in this end-market is influenced by the ability to finance a project and the cost of such financing.

 

The majority of residential construction is for single-family houses with the remainder consisting of multi-family construction (i.e., two family houses, apartment buildings and condominiums). Public housing comprises a small portion of housing demand. Construction activity in this end-market is influenced by the cost and availability of mortgage financing. Demand for our products

 

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generally occurs early in the infrastructure phase of subdivision development and residential construction, and later as part of driveways or parking lots.

 

United States housing starts peaked in 2005 at just over 2.0 million units. From 2007 to 2009, housing starts declined approximately 25% to 40% in each year.  Housing starts began to increase modestly in 2010 and 2011, with an approximate 6% and 4%, increase, respectively, and then increased significantly in 2012, with a 25% improvement, according to the National Association of Homebuilders. The housing starts in the Pennsylvania market in which we operate had a similar decline and rebound. We believe lower home prices and attractive mortgage interest rates are positive factors that should continue to impact single-family housing construction in 2013 and beyond.

 

Consistent with past cycles of private sector construction, private non-residential construction remained strong after residential construction peaked in 2006. However, in late 2008, contract awards for non-residential buildings in the United States peaked. By April 2011, contract awards for non-residential construction had declined approximately 40% from its peak in 2008 and then began to rise modestly at the end of 2011 and into 2012.

 

Our Competitive Strengths

 

The following characteristics provide us with competitive advantages relative to others that operate in our markets. While our competitors may possess one or more of these strengths, we believe we are a leader in our markets because of our full complement of these attributes. Our strengths include:

 

Leading Market Positions

 

We are one of the top 10 construction aggregates producers based on tonnage of crushed stone produced and one of the top 50 largest highway contractors based on revenues in the United States, according to industry surveys. These leading market positions are driven by our regionally focused operational footprint, which facilitates efficient, low-cost product delivery and responsiveness to customer demands, which are essential to maintaining existing customers and securing new business.

 

Vertically Integrated Business Model

 

We generate revenue across a spectrum of related products and services. We are able to mine our quarries to extract aggregates that we use to produce ready mixed concrete and hot mix asphalt materials, which may be utilized by our heavy/highway construction business to service end customers. Our vertically integrated business model enables us to operate as a single source provider of materials and construction capabilities, creating economic, convenience and reliability advantages for our customers, while at the same time creating significant cross-marketing opportunities among our interrelated businesses. Our vertical integration model, combined with the breadth of our construction materials offerings, enhances our position as a construction materials supplier and as a bidder on complex multi-discipline construction projects. In instances where we may not win a local construction contract, for example, we may often serve as a subcontractor or significant supplier to the winning bidder, creating additional revenue opportunities.

 

Favorable Market Fundamentals

 

We work extensively for PennDOT and other governmental entities within Pennsylvania which are responsible for the state’s roads and highways. Pennsylvania’s diversified economy is heavily reliant on the state’s approximately 120,000 miles of interstate, state and local roads, and approximately 22,000 state and local bridges. Pennsylvania has the nation’s sixth largest gross state product and the nation’s eleventh largest road network, which serves as a critical highway transportation route connecting Midwestern manufacturing centers and the northeast corridor. The Pennsylvania State Transportation Advisory Committee, in its report dated May 2010, identified over $3.5 billion of annual unmet state and local highway and bridge funding needs in excess of currently available funding levels. In a recent Pennsylvania Senate Transportation Committee Report, approximately 23% of the state owned roads were rated poor and 18% and 34% of the state and local owned bridges, respectively, were rated structurally deficient.  In February 2013, Governor Corbett announced a plan to increase annual transportation funding by $1.8 billion. In April 2013, several Pennsylvania state senators, including the Chairman of the Senate Transportation Committee, proposed a senate bill that would add approximately $2.5 billion to be utilized for state and local highway and bridge maintenance and repair. While there is no assurance that such a bill will be enacted, the market for highway and bridge construction in Pennsylvania will be favorably impacted if the state legislature ultimately approves additional highway and bridge funding.  We believe our construction materials locations, understanding of various specifications, project management and skilled labor position us to take advantage of these favorable dynamics and enable us to provide competitive bids on most public sector projects in Pennsylvania.

 

Substantial Reserve Life

 

We estimate that we currently own or have under lease approximately 2.1 billion tons of proven and probable aggregate reserves,

 

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with an average estimated useful life of 115 years at current production levels. These reserves are located across our market area, creating a balanced distribution of reserves to serve customers across our markets. With our long operating experience and local knowledge, we believe we are highly qualified to efficiently identify and develop new quarry opportunities or quarries that become available for acquisition.

 

High Barriers to Entry

 

We benefit from barriers to entry that affects both potential new market entrants and existing competitors operating within or near our markets. The high weight-to-value ratio of aggregates and concrete products and the time in which hot mix asphalt and ready mixed concrete begin to set limit the efficient distribution range for these products to roughly a one-hour haul time. Our regionally focused operational footprint allows us to maintain lower transportation costs and compete effectively against large and small players in our local markets.

 

Quarry and construction operations are inherently asset intensive and require significant investments in land, high-cost equipment and machinery, resulting in significant start-up costs for a new business. We own most of the equipment and machinery used at our facilities, creating an advantage over potential market entrants. The complex regulatory environment and time-consuming permitting process, especially for opening new quarries, add further start-up costs and uncertainty for new market entrants.

 

Our regional focus and local knowledge, acquired through decades of operating experience, enhance our ability to bid effectively and win profitable contracts. We believe our experience allows us to distinguish ourselves from other competitors in this regard.

 

Experienced and Dedicated Management Team

 

Our senior management team includes certain third and fourth generation members of our founding family, the Detwiler family, who have spent a significant portion of their professional careers in the aggregate and heavy construction businesses and are complemented and supported by highly trained and experienced senior managers who came to us through various acquisitions and internal advancement. Our Chairman, Paul Detwiler, Jr., and our Vice Chairman, Donald Detwiler, have spent their entire careers working at NESL (54 and 47 years, respectively), with Paul’s expertise centered on the operation of the plants and quarries and Donald’s focused on the heavy/highway construction business. Two of Paul, Jr.’s sons, Paul Detwiler, III and Steven Detwiler, and Donald’s son-in-law, James W. Van Buren, hold executive officer positions and serve on our Board of Directors and Executive Committee. Our Chief Executive Officer and President, Paul Detwiler, III, joined us in 1981. Our Executive Vice President and Chief Operating Officer, James W. Van Buren, joined us in 1991. Steven Detwiler joined us in 1990 and currently serves as our Senior Vice President-Construction Materials and President of our Buffalo Crushed Stone Division. Albert Stone became our Chief Financial Officer on March 22, 2013. Mr. Stone has been in the aggregates and heavy/highway construction business since 1986.  G. Dennis Wiseman joined us in 1984 and currently serves as our Chief Accounting Officer and Assistant Secretary. The senior management team is complemented and supported by a large number of talented, highly trained and experienced senior managers with an average of approximately 34 years of experience. Our senior management team makes joint decisions on all major operating issues including capital deployments, acquisitions and expansions. Other corporate responsibilities are divided among the senior management group to ensure adequate contingency planning and leadership across all of our business lines and divisions. We continue to focus on succession planning and focus on growing our company management from our internal ranks. Accordingly, we believe our management team has served and will continue to serve a critical role in our growth and profitability. Management remains dedicated to continuing to develop our operations and executing our business strategy as we continue to grow the business. We have management and leadership training programs in place and have trained hundreds of employees over the years so that we are not dependent on the outside market place to fill open positions. Members of the Detwiler family, who control all of the voting equity of NESL, have demonstrated a commitment to continued reinvestment in NESL. With the exception of certain tax-related dividends, we have not issued a dividend to any of our equity holders in 20 years.

 

Our Business Strategy

 

We are focused on growing our sales, profitability and cash flow and strengthening our balance sheet by capitalizing on our competitive strengths and reinvesting in our core businesses. Key elements of our business strategy include:

 

Leverage Our Vertically Integrated Business Model

 

We generate revenue across a spectrum of related products and services, many of which comprise a vertically integrated business that provides both raw materials and construction services. By maintaining production and cost control over this vertically integrated supply chain, we believe we are better able to serve our customers and be a low-cost supplier. We intend to leverage this vertical integration to continue to minimize our costs, improve our customer service and win profitable new business.

 

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Maintain a Competitive Position in Our Markets

 

We are competitive in the areas we serve due to our extensive network of quarries and related operations that facilitate efficient distribution throughout our geographical market area. We believe that our vertically integrated model, including our network of operational facilities, as well as our tightly managed costs, project management, safety and educational training, technological improvements and value engineering focus all further drive our low-cost position. We continuously work to exploit new technologies, such as implementing improved global positioning systems to monitor truck delivery activity and increase precision in construction projects. These technological improvements, coupled with our comprehensive employee training program and health and safety training programs and policies, allow us to make optimal use of our employees and equipment, operate safely and lower our insurance claims. Our extensive operating experience allows us to identify value engineering opportunities on certain projects, allowing us to propose enhancements to project specifications which we believe save our customers money and enhance our profitability. The mechanics of the “sealed bid” process that govern many of our contract awards require that we submit a bid that is low enough to win the business, but also includes a margin sufficient to maintain profitability. We will continue to manage our business aggressively to minimize costs to ensure that we are positioned to continue to win competitive, profitable new business in our markets.

 

Capitalize on Our Strategically Located Operations to Expand Market Share

 

We believe our existing operational footprint places us in proximity to some of the strongest market opportunities in the mid-Atlantic and western New York regions. Our proximity to areas of high construction activity, including the extensive Pennsylvania and western New York road networks and the Pennsylvania coal and gas industries, creates attractive revenue opportunities for which we are particularly well positioned relative to both major, national and smaller, local competitors. We believe our strategically situated construction materials locations create an inherent competitive advantage for us in our markets. We intend to continue to capitalize on these advantages to increase revenues and drive profitability. In those instances where our construction materials locations do not create an inherent competitive advantage, we remain competitive through our local knowledge of required specifications and industry expertise.

 

Drive Profitable Growth Through Reinvestment

 

Through over 86 years of operations, we have developed significant experience and expertise in identifying and executing new growth opportunities. We expect to continue to enhance our overall competitive position and customer base by reinvesting in our business. We also anticipate that we will leverage our experience to develop more greenfield quarry locations within or adjacent to our current markets.

 

Our Industry

 

Our core construction materials, heavy/highway construction and traffic safety services and equipment businesses are organized to deliver customers products and services from six interrelated industry sectors:

 

·            aggregates;

 

·            hot mix asphalt;

 

·            ready mixed concrete;

 

·            concrete products;

 

·            heavy/highway construction; and

 

·            traffic safety services and equipment.

 

Competitors in these industries range from small, privately held firms that produce a single product, to multinational corporations that offer a comprehensive suite of construction materials and services, including design, engineering, construction and installation. However, day-to-day execution for construction materials for all competitors remains local or regional in nature based upon typical value-to-weight ratios which limit the distance construction materials can be transported in a cost effective manner.

 

Transportation infrastructure projects represent a substantial portion of the overall U.S. infrastructure market. These projects are driven by both state and federal funding programs. During 2012, the U.S. Congress passed a two year funding bill, Moving Ahead for Progress, or MAP-21, which provides relatively flat infrastructure funding for Pennsylvania as compared to the previous federal

allocation. With approximately 120,000 miles of interstate, state and local roads and approximately 22,000 state and local bridges,

 

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Pennsylvania currently has the fifth largest allocation of the Federal Highway Trust Fund budget, receiving approximately $1.5 billion annually.

 

In addition to federal funding, highway construction and maintenance funding is also available through state agencies. In Pennsylvania, new highway and bridge construction and maintenance is coordinated by PennDOT. During its fiscal year ended June 30, 2012, PennDOT spent approximately $7.0 billion on transportation projects and administration, which includes its federal funds allocation. Typically the federal government funds a portion of PennDOT’s annual budget, while Pennsylvania funds the balance through the Motor License Fund, which we refer to as MLF. MLF funds are mandated per the state constitution to fund expenditures on highways and bridges and may not be reallocated to other state funding needs in the annual budgeting process. The Pennsylvania Turnpike Commission has a budget that is currently separate from PennDOT. The Pennsylvania Turnpike Commission’s Ten-Year Capital Plan for the fiscal year ending May 31, 2013 was $6.8 billion, approximately 90% of which amount is allocated to the cost of resurfacing, replacing or reconstructing the existing turnpike system.

 

PennDOT and the Pennsylvania Turnpike Commission have historically provided consistent demand for construction materials and projects in our markets. In addition, we also bid on purchase order contracts for hot mix asphalt and aggregates supplied directly to PennDOT maintenance districts and municipalities.

 

Construction Materials

 

Aggregates

 

The aggregates industry generated over $17.7 billion in sales through the production and shipment of 2.0 billion metric tons in 2012 in the United States, according to the United States Geological Survey, which we refer to as USGS. Aggregates include materials such as gravel, crushed stone, limestone and sand, which are primarily incorporated into construction materials, such as hot mix asphalt, cement and ready mixed concrete. Aggregates are also used for various applications and products, such as railroad ballast, filtration, roofing granules and in solutions for snow and ice control. The U.S. aggregate industry is highly fragmented with numerous participants operating in localized markets. The USGS reported that a total of 1,550 companies operating 4,000 quarries and 91 underground mines produced or sold crushed stone valued at $11.0 billion in 2012 in the United States.

 

Transportation cost is a major variable in determining aggregate pricing and marketing radius. The cost of transporting aggregate products from the plant to the market often equates to or exceeds the sale price of the product at the plant. As a result of the high transportation costs and the large quantities of bulk material that have to be shipped, finished products are typically marketed locally. High transportation costs are responsible for the wide dispersion of production sites. Where possible, construction material producers maintain operations adjacent to highly populated areas to reduce transportation costs and enhance margins.

 

The demand for aggregates is a function of several factors, including transportation infrastructure spending and changes in population density. In the past few years, the recession in the United States has led to a decrease in overall private construction activity. Despite the increase in federal stimulus spending, public construction activity has also suffered a decline over this period. Crushed stone production was approximately 1.24 billion tons in 2012, a 7% increase compared with that of 2011. Apparent consumption also increased to approximately 1.28 billion tons. Demand for crushed stone was slightly higher in 2012 because of the apparent end of the slowdown in activity that some of the principal construction markets have experienced during the last 6 years. Long-term increases in construction aggregates demand will be influenced by activity in the public and private construction sectors, as well as by construction work related to security measures being implemented around the nation. The underlying factors that would support a rise in prices of crushed stone are expected to be present in 2013, especially in and near metropolitan areas. With U.S. economic activity slowly improving, construction sand and gravel output for 2012 increased about 5% compared with that of 2011. The total number of employees in the U.S. construction sand and gravel industry increased by 6% in 2012 compared with that of 2011. Growth in housing starts in 2012 is increasing demand for construction sand and gravel in many states. Growth was also seen in some nonresidential construction, especially within the sectors of communications, power generation, and non-highway transportation.

 

We believe that the long-term growth of the market for aggregates is largely driven by growth in population, jobs and households. While short-term and medium-term demand for aggregates fluctuates with economic cycles, the declines have historically been followed by strong recovery, with each peak establishing a new historical high.

 

A significant portion of our aggregates is utilized in heavy/highway construction projects. Highways located in our markets are particularly vulnerable to freeze-thaw conditions that lead to excessive pavement stress and surface degradation conditions. The highway pavement deterioration in our markets is accelerated by the large volume of intrastate and interstate trucking in Pennsylvania given its location between the eastern United States consumer markets and other agricultural and industrial regions of the United States. Surface maintenance repairs, as well as general highway construction and repair, occur in the warmer months. Heavy/highway construction in our target markets tends to be similarly seasonal. As a result, our aggregate business is seasonal in nature as the

majority of production and sales occur in the eight months between April and November.

 

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Hot Mix Asphalt

 

Hot mix asphalt is the most commonly utilized pavement surface. Hot mix asphalt is produced by mixing asphalt cement and aggregate. The asphalt cement is heated to increase its viscosity and the aggregate is dried to remove moisture from it prior to mixing. Paving and compaction must be performed while the asphalt is sufficiently hot, typically within a one-hour haul from the production facility. In many parts of the country, including the market in which we operate, paving is generally not performed in the winter months because of cold temperatures.

 

Asphalt pavement is one of the building blocks of the United States. The United States has more than two million miles of paved roads and highways, 94% of which are surfaced with asphalt.

 

The United States has approximately 4,000 asphalt plants. Each year, these plants produce 500 million tons of asphalt pavement material worth in excess of $30 billion. Asphalt pavement material is a precisely engineered product composed of approximately 95% stone, sand and gravel by weight, and approximately 5% asphalt cement, a petroleum product. Asphalt cement acts as the glue to hold the pavement together.

 

Asphalt is the United States’ most recycled material. Reclaimed asphalt pavement is reusable as an aggregate mixture. In addition, the asphalt cement in the reclaimed pavement when reheated is reactivated to become an integral part of the new pavement. The recycled asphalt pavement replaces part of the new liquid asphalt cement required for the mixture, thereby reducing costs for asphalt mixtures.

 

Ready Mixed Concrete

 

Demand for ready mixed concrete is driven by its highly versatile end use applications. The ready mixed concrete industry generated approximately $30 billion in sales in 2012, according to the National Ready Mixed Concrete Association. Ready mixed concrete is created through the combination of coarse and fine aggregates with water, various chemical admixtures and cement. Given the high weight-to-value ratio, delivery of ready mixed concrete is typically limited to a one-hour haul from a production plant location and is further limited by a 90 - minute window in which newly mixed concrete must be poured to maintain quality and desired performance characteristics. Most industry participants produce ready mixed concrete in batch plants and use concrete mixer trucks to deliver the concrete to customers’ job sites. Ready mixed concrete, which is poured in place at a construction site, can compete with other precast concrete products and concrete masonry block products.

 

According to the National Ready Mixed Concrete Association, it is estimated that that there are approximately 5,500 ready mixed concrete plants in the United States. The North American ready mixed concrete industry is highly fragmented. Given that the concrete industry has historically consumed approximately 75% of all cement produced annually in the United States, many cement companies choose to be vertically integrated. Additionally, we face competition from precast concrete manufacturers.

 

Concrete Products

 

Precast and prestressed concrete products are utilized in highway construction to build bridges and decks and in non-residential construction to build a broad range of large structures such as parking garages, prison cells and sports stadium risers. Precast and prestressed concrete products offer many building advantages, including flexibility in design, speed to completion and low maintenance.

 

Masonry blocks are widely used in the construction of buildings, such as foundations, arches and retaining walls, due to their durability and relative low cost. Most of the companies that produce masonry blocks, such as ours, also produce other concrete-related products, including architectural block, pavers and franchised building systems such as Anchor ® Segmental Retaining Walls, which can be manufactured centrally and shipped to the point of installation.

 

Heavy/Highway Construction

 

Heavy/highway construction businesses provide a broad range of transportation and site preparation construction services, including grading and drainage, building bridge structures and concrete and blacktop paving services. While we provide services for a range of projects from driveway construction to the construction of new interstate highways, our business is primarily focused on structures, road construction and maintenance and blacktop/concrete paving. In general, the highway construction industry’s growth rate is directly related to federal and state transportation agencies’ funding of road, highway and bridge maintenance and construction. While public sector spending for highway construction has increased over the past two years, primarily as a result of federal stimulus money released under the American Recovery and Reinvestment Act, the simultaneous decrease in private sector spending has resulted in a contraction of the overall market. In Pennsylvania, public spending on third-party highway construction in 2012 was approximately $2.0 billion due to reallocation of funds by the state that shifted funds from certain other existing projects. Public spending on third-party highway construction for 2013 is budgeted at approximately $1.7 billion.

 

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We stand to benefit from the additional federal investments in our core Pennsylvania and western New York markets as municipal, state, and federal agencies represent our largest customer base. We believe we will also benefit from the renewed emphasis on investments in Pennsylvania’s transportation and highway systems at the state level. Along with the rest of the country, Pennsylvania has decreased its highway construction, but it has not kept pace with its growing investment needs.

 

The Pennsylvania Transportation Advisory Committee finalized a Transportation Funding Study in May 2010 which concluded that Pennsylvania needs to invest an additional $3.5 billion annually from federal, state and local sources, which investment must grow with inflation, if Pennsylvania is going to upgrade its infrastructure and maintain it in a state of good repair. The recommended funding needs for highways and bridge construction and maintenance in the study for 2010 were $2.6 billion in additional funds for state-owned facilities and $432 million for local government projects. To address these needs, the Governor appointed the Transportation Funding Advisory Committee, or TFAC, in 2011.  TFAC provided a final recommendation in its report dated August 2011 that is a partial solution to the $3.5 billion annual shortfall by developing additions to the existing revenue stream equal to $2.7 billion annually. The majority of the income comes by incrementally increasing the cap on the state’s Oil Company Franchise Tax.

 

In February 2013, Pennsylvania Governor Corbett unveiled a plan to raise $1.8 billion annually for transportation needs. The increased spending would occur incrementally over a 5-year period. More recently, in April 2013, Senate Transportation Committee Chairman John Rafferty announced his plan which would raise $2.5 billion annually over a 3-year period. Both plans rely on the Pennsylvania Oil Company Franchise Tax limit being lifted over time. The senator’s plan also includes increasing fees and fines. There can be no assurance that either these plans will be enacted or, if enacted, the extent of the funding provided by such legislation.

 

Traffic Safety Services and Equipment

 

The traffic safety services and equipment industry comprises companies that produce, sell and set up traffic safety equipment in the United States. Traffic safety products generally consist of portable products such as message boards, arrow boards and speed awareness monitors, as well as traffic cones, barrels and signs. Demand for traffic safety services and equipment is particularly sensitive to changes in activity in the highway construction end-market. While significant challenges to the traffic safety equipment industry remain due to the recent economic downturn, we believe that the long-term growth prospects for the industry are favorable, given increasingly stringent highway and workplace safety regulations and standards, in addition to an anticipated cyclical recovery in highway spending.

 

Our Operations

 

We operate our construction materials, heavy/highway construction and traffic safety services and equipment businesses through local operations and marketing teams, which work closely with our end customers in the local markets where we operate. We believe that this strong local presence gives us a competitive advantage by keeping our costs low and allows us to obtain a unique understanding for the evolving needs of our customers.

 

We have construction material operations across Pennsylvania and western New York. We provide heavy/highway construction services in these markets and, to a lesser degree, Maryland, West Virginia and Virginia. We operate traffic safety equipment manufacturing facilities and sell these products across the United States. Additionally, we provide maintenance and traffic protection services primarily in the eastern United States.

 

Construction Materials

 

We are a leading provider of construction materials in Pennsylvania and western New York. Our construction materials operations are comprised of aggregate production, including crushed stone and construction sand and gravel; hot mix asphalt production; ready mixed concrete production; and the production of concrete products, including precast/prestressed structural concrete components and masonry blocks. We also operate transportation facilities complete with deep water port facilities for bulk cargo storage, railroad transportation and other transportation and distribution at the Port of Buffalo.

 

Our largest construction materials customer is our heavy/highway construction operations which are almost wholly supplied with our construction materials.  Additionally, our largest external customer is PennDOT.

 

Our Aggregate Operations

 

Aggregate Products

 

We mine limestone, sandstone, dolomite, clay, gravel, white quartzite and other natural resources from 52 quarries and sand

 

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deposits throughout Pennsylvania and western New York. Aggregates are produced mainly from blasting hard rock from quarries and then crushing and screening it to various sizes to meet our customers’ needs. The production of aggregates also involves the extraction of sand and gravel, which requires less crushing, but still requires screening for different sizes. Aggregate production utilizes capital intensive heavy equipment which includes the use of loaders, large haul trucks, crushers, screens and other heavy equipment at quarries.  According to the USGS, we were the tenth largest crushed stone producer in the United States in 2011.

 

Once extracted, the minerals are processed and/or crushed on site into crushed stone, concrete and masonry sand, specialized sand, pulverized lime or agricultural lime. The minerals are processed to meet customer specifications or to meet industry standard sizes. Crushed stone is used in ready mixed concrete, hot mix asphalt, the construction of road base for highways, ditch and pipe bedding, drainage channels, retaining walls and backfill. Our sand products are used in the production of masonry grout, ready mixed concrete and hot mix asphalt as well as sand traps on golf courses, baseball fields and landfill cover. Pulverized limestone is primarily used as an absorbent for sulfur dioxide gases in power generation. Farmers use agricultural lime to reduce the acidity level in soil and enhance crop growth.

 

Transportation cost is a major variable in determining aggregate pricing and marketing radius. The cost of transporting aggregate products from the plant to the market often equates to or exceeds the sale price of the products at the plant. As a result of high transportation costs and the large quantities of bulk material that have to be shipped, finished products are typically marketed locally. High transportation costs are responsible for the wide dispersion of production sites. Where possible, construction material producers maintain operations adjacent to highly populated areas to reduce transportation costs and enhance margins. Our operations near Allentown, Pennsylvania are located in a strategic position of the densely populated eastern Pennsylvania corridor and our Buffalo, New York operations are also in an area of high population density.

 

However, more recently, rising land values combined with local environmental concerns are forcing production sites to move further away from the end-use locations. Our extensive network of quarries, plants and facilities, located throughout Pennsylvania, New York and Delaware ensures that we have a nearby operation to meet the needs of customers in Pennsylvania, New York, Delaware, Maryland, West Virginia, Virginia and New Jersey.

 

Aggregate Markets

 

The shipping distance from each quarry and the proximity to competitors are key factors that determine the geographic market area for each quarry. Each quarry location is unique in that demand for each product, proximity to competition and truck availability are different. Accordingly, our aggregate customers are generally located within Pennsylvania, Delaware, northern Maryland and western New York.

 

Aggregate Reserves

 

Through acquisitions of raw land and existing quarries, we have assembled significant operating reserves throughout our geographic market area. We estimate that we currently own or have under lease approximately 2.10 billion tons of proven and probable aggregate reserves, with an average estimated useful life of 115 years at current production levels.  See “Item 2 — Properties.”

 

Aggregate Sales and Marketing

 

Each of our aggregate operations is responsible for the sale and marketing of its aggregate products. The method that each entity employs to sell aggregates is similar and varies by customer type. Standard price lists are developed for each construction season. This list is used to establish a list price and is typically discounted for contractors or special customers. Large orders are quoted to each contractor in a bidding process and pricing is established based on plant and haul costs, plus appropriate margins.

 

Most bids to non-governmental agencies are either accepted or negotiated with the end result being a purchase order at a fixed price for a specified amount during a given period of time. Bids submitted directly to a governmental agency generally utilize the low bid process. The low bidder is responsible for providing the material within specifications at a specific location for the bid price. We will also negotiate long-term (greater than one year) supply contract agreements at predetermined prices.

 

Aggregate Competition

 

The U.S. aggregate industry is highly fragmented with numerous participants operating in localized markets. The USGS reported that a total of 1,550 companies operating 4, 000 quarries and 91 underground mines produced or sold crushed stone in 2012 in the United States. This fragmentation is a result of the cost of transporting aggregates, which limits producers to a market area within 100 miles of their production facilities.

 

Lehigh Hanson Building Materials America, PLC (a unit of Heidelberg Cement Group), Oldcastle, Inc. and Lafarge Corporation are our largest aggregate producer competitors across all of our market areas.

 

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Our Hot Mix Asphalt Operations

 

Hot Mix Asphalt Products

 

Our hot mix asphalt products are produced by heating asphalt cement to increase its viscosity and drying the aggregate to remove moisture from it prior to mixing. Hot mix asphalt consists of approximately 95% stone, sand and gravel by weight, and approximately 5% of asphalt cement that serves as a binder. The aggregates used for our production of these products are generally supplied from internal sources through our construction materials division and through purchases of bitumen from third party suppliers. Since bitumen is a by-product of petroleum refining, the price of this material is aligned with the price of oil. The asphalt and aggregates mixture is heated to a temperature of approximately 300 degrees Fahrenheit. While still hot, the paving mixture is transported by truck to a mechanical spreader where it is placed in a smooth layer and compacted by rollers.

 

As part of our vertically integrated structure, we operate 30 hot mix asphalt plants and seven blacktop paving divisions.

 

Hot Mix Asphalt Markets

 

Our hot mix asphalt businesses operate independent paving crews that service various markets. Our Pennsylvania hot mix asphalt plants generate the majority of their revenue through sales to our heavy/highway construction division, which then places the material under contract with the owner, typically a governmental agency such as PennDOT or the Pennsylvania Turnpike Commission. Our New York operation does not operate any paving crews, but does sell hot mix asphalt to paving contractors.

 

Each hot mix asphalt plant is unique in that demand for hot mix asphalt, proximity to competition; transportation costs and supply of aggregates are different. Most of our hot mix asphalt operations use a combination of company- owned and hired haulers to deliver materials. Hauling costs can range from 5% to 20% of the total cost of the materials. To optimize crew demand and costs, each hot mix asphalt operation has a fleet manager and plant dispatchers. Our New York operations contract for delivery and do not have their own delivery trucks.

 

Aggregates are another major factor in the cost of producing hot mix asphalt. In an effort to reduce cost, we have located the majority of our hot mix asphalt plants in our aggregate quarries. This is the most efficient production method because costs associated with transporting the raw materials are minimized. However, we do operate facilities that are not at quarries. These facilities are situated to meet market demand due to the constraint that the hot mix asphalt material can only be in a truck for one hour before it cools too much to compact correctly on the job site.

 

The preparation and placement of the hot mix asphalt is also a major cost. Most of our hot mix asphalt operations operate paving crews. The management of these crews is regionalized and is typically located near a plant. We operate seven blacktop paving divisions throughout Pennsylvania, Maryland and West Virginia. In addition to paving crews, each hot mix asphalt operation also operates a number of grading/preparation crews. Depending on project size, we will hire subcontractors or, in certain cases, will utilize our heavy/highway construction division to prepare a site for paving.

 

We also generate revenue by selling material freight on board plant or quarry. On many Pennsylvania highway projects, we will quote hot mix asphalt freight on board, or in place to the competition, as well as bid a project directly as the prime contractor.

 

Hot Mix Asphalt Sales and Marketing

 

Hot mix asphalt customers include our own heavy/highway construction, other heavy/highway contractors and state and federal agencies, building contractors and homeowners. One of our largest hot mix asphalt customers is PennDOT. Each individual hot mix asphalt operation estimates, markets and performs its own work. The sales and marketing process is divided into two categories: PennDOT and other government projects and private projects. Our hot mix asphalt operations will bid on state, township, county or other governmental entities’ projects under the “sealed” bid system. Each project is estimated and quoted to the requesting municipality. This is most often the case for hot mix asphalt put in place, however, some municipalities and department of transportation maintenance districts have their own paving crews and in those instances, the project is bid freight on board plant or delivered to PennDOT crews.

 

Sales to private entities are typically submitted to the owner as a quoted price. Key factors for obtaining sales from private entities are the relationship with the owner or contractor and price. Our sales and estimating staff are responsible for maintaining and enhancing customer relationships and prospecting new customers and projects.

 

Our New York hot mix asphalt business is based predominantly on its relationships with paving contractors and pricing projects competitively. It also provides material quotes directly to those government agencies that have their own paving crews.

 

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There are approximately 4,000 asphalt plants in the United States, and in each year these plants collectively product approximately 500 to 550 million tons of asphalt pavement material.

 

Our Ready Mixed Concrete Operations

 

Ready Mixed Concrete Products

 

We are one of the leading suppliers of ready mixed concrete in Pennsylvania and western New York according to the most recent industry surveys. We produce ready mixed concrete by blending aggregates, cement, chemical admixtures in various ratios and water at our concrete production plants and placing the resulting product in ready mixed concrete trucks where it is then delivered to our customers. Our construction aggregates region serves as the primary source of the raw materials for our concrete production, functioning essentially as a supplier to our ready mixed concrete operations. Aggregates are a major component in ready mixed concrete, comprising approximately 60%-75% of ready mixed concrete by volume. Our wide variety of mixes, which are certified for use by PennDOT, the New York Department of Transportation and other state and federal agencies, are used in activities ranging from building construction to highway paving.

 

We operate 19 fixed and portable ready mixed concrete plants for highway paving and bridge construction.

 

Each plant’s capacity is determined, to a large degree, by the local plants production capacity and the number of ready mixed concrete trucks dispatched out of each location. However, trucks can be re-routed to accommodate demand fluctuations at a given plant. Currently, we operate a fleet of approximately 178 ready mixed concrete trucks.

 

Ready Mixed Concrete Markets

 

Due to the finite time before concrete hardens, our market area is limited to an approximate one-hour hauling radius around a plant. Portable ready mixed concrete plants allow for an extended marketing area, but are only cost effective for larger projects in excess of 5,000 cubic yards. Our ready mixed concrete customers are generally located within Pennsylvania, northern Maryland and western New York. One of our largest ready mixed concrete customers is our precast concrete products division, which employs ready mixed concrete for the production of structural precast concrete structures such as bridge beams, double tee beams, modular prison cells and stadium risers.

 

Ready Mixed Concrete Sales and Marketing

 

Each of our ready mixed concrete operations is responsible for the sale and marketing of its ready mixed concrete products.    The method that each operation employs to sell ready mixed concrete is similar and varies by customer type. Standard price lists are developed for each construction season. This list is used to establish a list price and is typically discounted for contractors or special customers. The majority of direct bids are either accepted or negotiated with the end result being a purchase order at a fixed price for a specified amount during a given period of time. Larger projects with multi-year construction phases have price increases built into the bids.

 

Our Concrete Products Operations

 

Our Precast/Prestressed Products Operations

 

We produce precast/prestressed concrete components for highway bridges and various commercial structures, including I-beams, box beams, double tee beams, stadium risers, prison cells and wall panels. Each of these products is manufactured pursuant to unique specifications for each particular job. Prestressed concrete units can then be used in the construction of bridges, modular correctional facilities, parking structures and sports facilities. Our ready mixed concrete operations supply the high strength mixes used in the precast/prestressed beams, stadium risers, prison cells and wall panels we produce. Our sales staff work with our engineers and production staff to maximize value and reduce overall construction time. Our precast/prestressed manufacturing and sales facility is located in Roaring Spring, Pennsylvania with an additional sales office in Center Valley, Pennsylvania. Our manufacturing facility produces prestressed concrete bridge beams and a number of commercial structural building components.

 

Precast/Prestressed Concrete Products Markets

 

The two primary factors that influence market size for bridge and commercial products are the distance from our facilities to the project and the proximity of the competition to the project. Our non-residential market area encompasses Pennsylvania, northern Maryland, western New York and New Jersey. Our bridge beam market encompasses Pennsylvania, New York and Maryland. The hauling cost of these products can be quite expensive, in some cases requiring 13 axle tractor-trailers.

 

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Precast/Prestressed Concrete Products Sales and Marketing

 

The sale of bridge beams to contractors is typically based on price and delivery schedule. Most beams are sold to a bridge contractor and integrated into their bridge construction quote. Generally, if we are the low bidder at the time of bid and are able to accommodate the contractor’s schedule, the sale will be made.

 

In an effort to influence project designs to be compatible with our manufacturing standards and specifications, commercial products are marketed directly to architects and engineers. Once a private project has been designed and bid, the purchase decision/negotiations can extend for months until an owner or general contractor makes a decision and awards the contract. For publicly owned projects, the low bidder is typically awarded the project.

 

Precast/Prestressed Concrete Products and Purchasers

 

Bridge products include prestressed concrete I-beams, box beams and precast box culverts. The largest purchasers of bridge beams are state departments of transportation, which we refer to as DOTs, through a general contractor or erector. The second largest purchasers are port authorities for airport runways, shipping ports and bridges. Commercial products include parking garages, prison cells and sports stadium risers. Parking garage owners vary from private developers to parking authorities to governmental agencies. Stadiums and prisons are typically owned by a state, county, city or the federal government. We generally sell these products, erected, to a general contractor, but will also contract directly with the owner.

 

Our Masonry Block Operations

 

We operate our masonry block operation from three facilities located in Pennsylvania. We sell directly to customers within an approximately 60-mile radius of each production facility and indirectly through broker/dealers within an approximately 100-mile radius.

 

Masonry Block Markets

 

The market for a block plant is dependent upon transportation costs and product mix. The product mix for masonry block has changed considerably over the past 20 years, expanding from a predominantly gray block offering to a range of architectural blocks for buildings and landscaping blocks for retaining walls. Architectural blocks are generally colored with a textured outer surface. Many blocks are also produced with a waterproofing feature or an interlocking feature to allow retaining wall construction. New products offer expanded market potential until competition develops a similar product. Although we can produce masonry products in any color, we have a number of standard colors, allowing us to deliver quickly, minimize inventory and reduce wasted customized blocks. This has reduced product lead time and contractor costs, since the contractor can now return any unused blocks.

 

Masonry Block Sales and Marketing

 

We market directly to architects and designers in an attempt to influence plans to incorporate our product offerings. This marketing strategy provides us with a competitive edge in the sales process because the customer has less flexibility to choose alternative products once our products have been incorporated into the design. In an effort to add greater value to the block package, our Construction Supply Centers will quote a package to the contractors for most of their building supply needs on a project.

 

Our Heavy/Highway Construction Operations

 

Heavy/Highway Construction

 

Our heavy/highway operations are separated into two basic categories: (i) large heavy/highway projects, which are typically complex roadway and bridge rehabilitation or new construction projects that incorporate all or most of our construction operation disciplines, including grading, drainage, paving, structure work and civil engineering and project management, and (ii) private and non-residential blacktop paving projects or small- and mid-size maintenance projects, which are typically less complex roadway and bridge rehabilitation projects and involve minor bridgework, roadway patching and blacktop paving. In addition, we also provide gas and fiber optic line installation and repair services. These combined operations made us one of the top 50 largest highway contractors in the United States, according to a survey of contractors and design firms published by the Engineering News Record in May 2012.

 

Heavy/highway projects are managed by our contract division located at our New Enterprise, Pennsylvania headquarters. This division manages projects across the state ranging in size up to $90.0 million.  This division typically manages 15 to 25 projects at any given time. Our seasoned contract division management team is comprised of project managers, estimators, production supervisors and field superintendents and foremen. These projects may or may not be located near our construction material locations. The construction teams operate competitively both with our construction materials as well as with materials purchased from third parties when the projects are not within the economic reach of our construction materials production facilities.

 

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Our blacktop paving and maintenance projects are located within the economic shipping radius of our hot mix asphalt plants and quarries as they are generally very highly construction materials-dependent projects. These projects include driveways, parking lots, race tracks and roadways and are typically one construction season in duration, although some of the larger projects may span two seasons. Our blacktop paving and maintenance projects are all bid and managed across our markets through our regional offices. These operations manage projects in their localities, ranging in size from tens of thousands of dollars to upwards of several million dollars. The largest and most construction materials-intense projects can exceed $10.0 million. Collectively, there are hundreds of projects per year ranging from driveways to large maintenance projects that we perform. The number of these projects for governmental agencies typically ranges from 50 to 100 per year. Management teams for these projects generally consist of salesmen, production supervisors, estimators and field foremen.

 

The bulk of our contracted jobs are public projects, which have replaced some of the private spending shortfall. The procedures and bid documents governing the contracts with our public sector customers typically allow the customers to terminate the project at their discretion. Cancellation of a few of our very large contracts could have a materially adverse impact on our revenues and results of operations. See “Item 1A—Risk Factors—The Cancellation Of Significant Contracts Or Our Disqualification from Bidding for New Contracts Could Reduce Revenues and Have a Material Adverse Effect On Our Results Of Operations.”

 

Heavy/Highway Construction Markets

 

Our largest heavy/highway construction customer is PennDOT. We also work with municipalities, state and national parks, the Army Corps of Engineers, industrial facilities, other contractors and private customers. Along with the local county and municipal governments, PennDOT controls and maintains its approximately 40,000 mile system, with the remaining approximately 80,000 miles maintained by local county and municipal governments. Our extensive network of quarries, hot mix asphalt plants, paving crews and traffic safety services and equipment sales, in combination with our unlimited prequalification bid capacity for PennDOT projects, ensures a broad marketing area. Our core heavy construction market extends throughout Pennsylvania. Our core blacktop paving and maintenance and highway construction market is located within an approximately 50 mile radius from each hot mix asphalt plant, which covers a large portion of Pennsylvania.

 

For our heavy construction market we operate with a non-union workforce that will travel to each project. This enables construction project staffing with a predictable stable workforce. It also allows predictable production rates when market forces require us to look for work beyond our core market. The hot mix asphalt and maintenance markets also operate with non-union workforces throughout our market area, as well as a small union operation in the heavily unionized Delaware Valley market. These projects are generally local crews, so overnight stays are unnecessary.

 

We act as the prime contractor on the majority of our projects, with 15% to 20% of a project performed by subcontractors. We will subcontract larger pieces of a project if necessary to manage labor and equipment costs. Subcontractors typically perform specialized services such as line stripping, guide rail installation, clearing, signing, lighting and providing traffic protection services.

 

For our blacktop paving and maintenance operations we will serve either as the prime contractor when we are the low bidder or as a subcontractor for another general contractor when we are either not the low bidder or we chose not to bid on the project.

 

Heavy/Highway Construction Sales and Marketing

 

All public work is awarded in a “sealed bid.” Estimators and engineers review the work to be performed and estimate the cost to complete the project. On heavy/highway construction projects, teams of three to six people under the direction of a chief estimator, develop the estimate. The majority of our estimators are also project managers, which allows for greater accuracy in estimating crew sizes and production capabilities. Typically, each project has approximately four to eight bidders.

 

With respect to blacktop paving and maintenance work, the sales effort varies significantly depending on the project scope. All projects are staffed with an estimating or sales person or team, depending on the size, and generally reviewed by a manager. For private and subcontracted public work, salesmen will negotiate both the project scope and price. For low bid public work, the estimating team will submit a sealed bid.

 

Heavy/Highway Construction Competition

 

The competition for our heavy/highway work is complex. On the heavy side, competition varies by the work discipline on the project, the amount of each discipline on the project and the location. Our competition for blacktop paving and maintenance work is much more localized, since these projects are typically material-intensive and the competition is generally vertically integrated construction materials suppliers and local contractors that specialize in roadway rehabilitation, site development or paving.

 

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Our Traffic Safety Services and Equipment Operations

 

Traffic Safety Services and Equipment

 

Our traffic safety services and equipment business consists primarily of traffic cones, barricades, plastic drums, arrow boards, construction signs and crash attenuators, which are sold and rented throughout the United States through our safety products operations.

 

We manufacture, sell and install a complete line of traffic control devices, including traffic cones, plastic drums, channelizers, barricades, arrow boards, crash attenuators, construction/permanent signs and posts, message boards, speed awareness monitors and strobe/warning lights. Traffic cones are produced using a polyvinyl chloride material that enhances the cone’s durability and coloring. The cones are differentiated by size, wall thickness and weight in order to meet customer specifications and state safety requirements. Our plastic drums and drum bases are used in a variety of roadwork settings. The drum’s design features a snap-locking mechanism that connects the drum and the base to assure a sturdy connection. The drums are made from flexible low-density polyethylene plastic and can be used with plastic or rubber bases. We offer a wide range of drum sizes that are used in highway or residential road construction. We also offer a complete line of traffic channelizers for the work zone environment, including barricades, channelizers and vertical panels. Our crash attenuators are designed to enhance driver safety and to reduce maintenance and repair costs. We manufacture a complete line of traffic control signs for use in long and short term construction patterns, as well as for temporary roadway use.

 

We manufacture solar powered traffic safety devices. Our products include a full line of arrow boards, message centers and speed awareness monitors. These are powered by batteries that are recharged through the use of solar panels, making the units environmentally friendly, convenient to locate and cost efficient to operate.

 

We also provide intelligent transportation systems equipment and a proprietary Computerized Highway Information Processing System, which we refer to as CHIPS, to DOTs, universities and paving and construction companies. Our products include queue detectors, over-height vehicle detectors, flooded roadway detectors, trailer mounted cameras and variable speed limits systems. The information collected from sensors along the highways is stored and processed through the CHIPS traffic management software program.

 

We purchase products from third party manufacturers and resell them to a network of independent distributors. A third party manufactures the barrels and channelizers and the reflective striping is applied at our facilities. The channelizers are produced by a third party vendor on a verbal contract or on a purchase order basis. The attenuators are manufactured by third parties in Salt Lake City, Utah, Somerset, Pennsylvania and Texas.

 

Traffic Safety Services and Equipment Markets and Sales and Marketing

 

Our traffic safety equipment is sold nationwide through a network of distributors as well as through our own sales force. Distributors include highway traffic control companies, “Do-It-Yourself” home centers, safety supply, industrial supply, telecommunication supply, contractor equipment and supply. One of our largest customers for this business is Lowes.

 

We have a dedicated team of sales professionals for our traffic safety equipment including sales managers, territory managers, customer service representatives and products specialists. Each territory manager is responsible for marketing to end-users and DOTs in our geographic regions. Customer service representatives are responsible for providing customers with product information, entering orders and developing relationships with distributors. The sales force is managed from our St. Charles, Illinois office.

 

In addition to product sales, we provide maintenance and traffic protection services primarily in the eastern United States, to highway contractors, DOTs and municipal government agencies. Under traffic pattern management contracts, we provide all aspects of management and maintenance of traffic control patterns for work sites. We maintain an inventory of products used for our rental business and traffic pattern management contracts. The contracts are bid based on a “Daily Rental Rate” or a “Lump Sum Price.” Sales are primarily the result of competitive bidding.

 

We have 37 branch offices and sub-offices in the eastern United States. Each location varies slightly in the services they provide so as to best compete in the local market. Generally all regions sell products and install traffic patterns or rent equipment to contractors so they can set their own traffic patterns. Branch offices are overseen by three regional managers who report to our Harrisburg, Pennsylvania office.

 

For traffic safety services, we compete with many local maintenance and traffic protection contractors, many of which are small businesses or minority-owned firms that get bidding preference through various government programs.

 

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Other Operations

 

We operate several additional non-core businesses, including port operations, clay fillers and retail construction supply sales.

 

Gateway Trade Center

 

We operate the Port of Buffalo under the trade name Gateway Trade Center. The port is comprised of an approximately 3,900-foot long shipping canal with a depth of approximately 27 feet and approximately 71 acres of storage. The primary product through the port is de-icing salt, which is unloaded in the summer and fall and stored at the port until it is used throughout the winter. Other materials that are unloaded and transported to their final destination include: limestone, coal, coke, steel and specialty products.

 

Construction Supply Centers

 

We operate a chain of construction supply centers in Pennsylvania, which sell retail construction supplies to contractors and homeowners. The four primary product lines sold are masonry, grading and drainage, small tools and rentals and highway contractor supplies.

 

Bonding

 

We generally are required to provide various types of surety bonds that provide an additional measure of security for our performance under certain public and private sector contracts as well as for various regulatory requirements. We obtain bonding for highway work, any bonding required for precast and prestressed product projects and certain blacktop paving projects, workers compensation in the Commonwealth of Pennsylvania, reclamation bonds for quarries and other miscellaneous bonds. Our ability to obtain surety bonds depends upon our working capital, financial performance, past performance on projects, management expertise and external factors, including the capacity of the overall surety market. Surety companies consider such factors in light of the amount of our contract backlog that we have currently bonded and their current underwriting standards, which may change from time to time. We use multiple surety providers to provide our surety bonding program. Additionally, in order to better manage the fluctuations in the surety market, we may utilize a co-surety structure on certain projects.  Although we do not believe that fluctuations in surety market capacity have significantly affected our ability to manage our business, there is no assurance that it will not significantly affect our ability to obtain new contracts in the future.  See “Item 1A. Risk Factors.”

 

Construction Backlog

 

Backlog is our estimate of the revenue that we expect to earn in future periods on projects performed by our heavy construction civil business.  We generally include a project in our contract backlog at the time a contract is awarded.  At February 28, 2013, our backlog was $155.7 million, as compared to $133.4 million at February 29, 2012. Approximately, $101.2 million of the February 28, 2013 backlog is expected to be completed during fiscal year 2014.

 

Substantially all of the contracts in our backlog may be canceled or modified at the election of the customer; however, we have not been materially adversely affected by contract cancellations or modifications in the past. Backlog measures all remaining work; and as such, a rise or fall in backlog is not a true measure of work to be performed in a fiscal year as some projects will span multiple fiscal years while other projects will be added and completed within the same fiscal year.

 

Seasonality

 

Almost all of our products are produced and consumed outdoors. Our financial results for any quarter do not necessarily indicate the results expected for the year because seasonal changes and other weather-related conditions can affect the production and sales volumes of our products. Normally, the highest sales and earnings are in the second and third quarters and the lowest are in the first and fourth quarters.

 

Employment

 

We had approximately 3,114 employees of which approximately 18% are full time salary employees and approximately 82% are hourly. Since most of our work is seasonal, many of our hourly and certain of our full time employees are subject to seasonal layoffs. Since layoffs are determined by the type of work and weather in the late fall through early spring, they vary greatly.

 

Approximately 31% of our total hourly employees are union members. We have no unionized full time salary employees. We believe that we enjoy an excellent working relationship with all of our employees and unions. The following is a list of all our unions and their contract status as of February 28, 2013:

 

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Union

 

Contract Status

 

Number of
Employees

New Enterprise Stone & Lime Co., Inc.

 

 

 

 

 

 

 

 

 

The International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America Local 110 and 453. Select quarries, hot mix asphalt and ready mixed concrete plants

 

Expires April 30, 2014.

 

323

 

 

 

 

 

United Steelworkers Union—Local 00504, Roaring Spring Newcrete plant

 

Expires March 15, 2014.

 

72

 

 

 

 

 

Truck Drivers Local Union No. 449, affiliated with the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America

 

Expires June 30, 2014.

 

3

 

 

 

 

 

International Union of Operating Engineers—Local 17

 

Como Park contract expires March 31, 2015, Franklinville contract expires March 31, 2016, Gateway contract expires June 30, 2014 and ABC Paving contract expires March 31, 2014.

 

41

 

 

 

 

 

Cement, Lime, Gypsum and Allied Workers Division of International Brotherhood of Boilermakers, Iron Ship Builders, Blacksmiths, Forgers and Helpers

 

Wehrle Drive and Barton Road contract expires May 31, 2015.

 

40

 

 

 

 

 

Cement, Lime, Gypsum and Allied Workers Division of International Brotherhood of Boilermakers, Iron Ship Builders, Blacksmiths, Forgers and Helpers

 

Olean and Como blacktop and quarry contract expires May 15, 2015.

 

24

 

 

 

 

 

International Brotherhood of Electrical Workers and Northeastern Line Constructors Chapter, NECA

 

Expires December 31, 2014.

 

24

 

 

 

 

 

Laborers International Union of North America Upstate New York Laborers District Council No. 210

 

Expires June 30, 2013.

 

9

 

 

 

 

 

Kutztown & Oley Quarries, United Steelworkers

 

Expires May 31, 2015.

 

13

 

 

 

 

 

Oley Quarries, United Steelworkers

 

Expires May 31, 2015.

 

11

 

 

 

 

 

Little Gap, Whitehall, Ormrod and Nazareth Quarries, Teamster

 

Expires December 31, 2014.

 

21

 

 

 

 

 

Kutztown, Wescosville, Ormrod and Bethlehem Blacktop, Teamster

 

Expires January 31, 2016.

 

6

 

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Wescosville Block, Building and Forms, Teamster

 

Expires December 31, 2014.

 

19

 

 

 

 

 

Service Division and Eastern Trucking, Teamster

 

Expires May 31, 2014.

 

20

 

 

 

 

 

Elco-Hausman Construction, International Union of Operating Engineers Local Union 542

 

Expires April 30, 2014.

 

13

 

 

 

 

 

Elco-Hausman Construction, Teamsters Local 773

 

Expires May 31, 2014.

 

4

 

 

 

 

 

Elco-Hausman Construction, Laborers Local 158

 

Expires April 30, 2016.

 

7

 

 

 

 

 

Clifford, Towanda, Sheshequin and Towanda (concrete, Block and Delivery), Unaffiliated Company Collective Bargaining Unit

 

Expires December 31, 2015.

 

58

 

 

 

 

 

Harrisburg Plant, Unaffiliated Company Collective Bargaining Unit

 

Expires November 3, 2013.

 

11

 

 

 

 

 

Lake City Plant, Unaffiliated Company Collective Bargaining Unit

 

Expires November 3, 2013.

 

13

 

 

 

 

 

Oreland, Unaffiliated Company Collective Bargaining Unit

 

Expires November 2, 2013.

 

16

 

 

 

 

 

Pittsburgh, Unaffiliated Company Collective Bargaining Unit

 

Expires November 2, 2013.

 

7

 

 

 

 

 

Teamsters Local 110 (Cleveland)

 

No stated expiration date.

 

2

 

 

 

 

 

Teamsters Local 110 (Columbus)

 

Expires December 31, 2013.

 

3

 

Intellectual Property

 

We own trademarks and trade names related to our construction materials, concrete and construction businesses. We also own pending patent applications, issued patents, trademarks and trade names related to our construction materials business and our traffic safety services business, with specific patents relating to our attenuators and our CHIPS program. We believe that these patent applications, issued patents, trademarks and trade names are material to our traffic safety services and equipment business.

 

Environmental and Government Regulation

 

Our operations are subject to federal, state and local laws and regulations relating to the environment and to health and safety, including noise, discharges to air and water, waste management, remediation of contaminated sites, mine reclamation, dust control, zoning and permitting. While we believe our operations are in substantial compliance with applicable requirements, there can be no assurance that compliance costs will not be significant.

 

We regularly monitor and review our operations, procedures, and policies for compliance with existing environmental laws and regulations, changes in interpretations of existing laws and enforcement policies, new laws that are adopted, and new requirements that we anticipate will be adopted that could affect our operations.

 

We are frequently required by state and local regulations or contractual obligations to reclaim our former mining sites. These

 

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reclamation liabilities are recorded in our financial statements as a liability at the time the obligation arises. The fair value of such obligations is capitalized and depreciated over the estimated useful life of the owned or leased site. The liability is accreted through charges to operating expenses. To determine the fair value, we estimate the cost for a third party to perform the legally required reclamation, adjusted for inflation and risk and including a reasonable profit margin. All reclamation obligations are reviewed at least annually. Reclaimed quarries often have potential for use in non-residential or residential development or as reservoirs or landfills. However, no projected cash flows from these anticipated uses have been considered to offset or reduce the estimated reclamation liability. As of February 28, 2013, we have accrued approximately $13.7 million to cover our mine reclamation obligations.

 

Worker Health and Safety

 

Our operations are subject to a variety of worker health and safety requirements, particularly those administered by the federal Mine Safety and Health Administration and the Occupational Safety and Health Administration, which are likely to become stricter in the future. Failure to comply with these requirements can result in fines and penalties and claims for personal injury and property damage. These requirements may also result in increased operating and capital costs in the future. We believe we are in substantial compliance with such requirements but cannot guarantee that violations will not occur which could result in significant costs. We conduct approximately 20,000 hours of annual Mine Safety and Health Administration and Occupational Safety and Health Administration training sessions, as well as weekly tool box talks. Finally, we have safety professionals on staff, as well as a corporate risk manager.

 

Insurance

 

We use a combination of third-party insurance and self-insurance to provide for potential liabilities for workers’ compensation, general liability, vehicle accident, property and medical benefit claims. We utilize an actuary to assist us with estimating the liabilities associated with the risks retained by us, in part, by considering historical claims experience, demographic and severity factors and other actuarial assumptions which, by their nature, are subject to a high degree of variability. Any projection of losses concerning workers’ compensation and general liability is subject to a high degree of variability. Among the causes of this variability are unpredictable external factors affecting future inflation rates, discount rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns.

 

Although we have minimized our exposure on individual claims, for the benefit of costs savings we have accepted the risk of a large amount of independent multiple material claims arising, which could have a significant impact on our earnings. Our Pennsylvania workers compensation claims are self insured for up to $1.0 million per occurrence. We maintain a wholly-owned captive insurance company, Rock Solid Insurance Company, which we refer to as RSIC, for workers’ compensation (non-Pennsylvania employees), general liability and property coverage. Our general automobile and liability and other states workers compensation coverages are currently fully insured in the primary layer, the first $5.0 million, through a deductible reimbursement program with one of our insurance carriers and our subsidiary, RSIC.  We are liable for up to $0.3 million per year per member for health care claims and RSIC is responsible for amounts in excess of our $0.3 million deductible up to $1.0 million for each health care claim, with coverage from insurance carriers after the $1.0 million retention. This layer is additionally insured for a maximum annual aggregated loss for $10.0 million and has clash protection for $2.5 million. We are responsible for the first $0.3 million for each property and casualty claim and RSIC is responsible for amounts in excess of our $0.3 million deductible up to the first $2.0 million of every property and casualty claim.  Our property and casualty insurance coverage then carries a $15.0 million limit per occurrence. Our pollution liability coverage is a three year program with an aggregate $15.0 million limit and a $1.0 million deductible. RSIC is subject to the insurance rules and regulations of the state of South Carolina. The premiums paid annually to RSIC from the Company are determined by a third party actuary.

 

In addition to the $5.0 million primary insurance coverage, we have an additional $95.0 million of insurance coverage, which is insured by several non-affiliated insurance companies.

 

Item 1A.                           RISK FACTORS.

 

Risks Related to Our Business and Industry

 

Our business depends on activity within the construction industry.

 

We sell most of our construction materials and traffic safety equipment, and provide all of our heavy/highway construction services, to the construction industry, so our results depend on the strength of the construction industry. Demand for our products, particularly in the non-residential and residential construction markets, could remain weak and continue to fall if companies and consumers continue to struggle to obtain credit for construction projects or if the slow pace of economic activity continues to delay or cancel capital projects. State and federal budget issues continue to hurt the funding available for infrastructure spending, particularly heavy/highway construction and traffic safety, which constitute a significant portion of our business. Many states, including

 

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Pennsylvania, have reduced their construction spending because of budget shortfalls caused by lower tax revenues and uncertainty relating to long-term federal highway funding. There has been a reduction in many states’ investment in highway maintenance. These factors resulted in a continued reduction in our sales during fiscal years 2012 and 2013 which, combined with a decline in pricing in many of our business units, continues to hurt our business. Our earnings depend on the strength of the local economies in which we operate because of the high cost to transport our products relative to their price. If economic conditions and construction remain low in our top revenue-generating markets of Pennsylvania and western New York, our business and results of operations continue to be materially adversely affected and there is no assurance that this will not continue to affect our business in the future.

 

Our business is cyclical and requires significant working capital to fund operations.

 

The cyclicality of our business requires that we maintain significant working capital to fund our operations. Our ability to generate sufficient cash flow depends on future performance, which will be subject to general economic conditions, industry cycles and financial, business, and other factors affecting our operations, many of which are beyond our control. If we are unable to generate sufficient cash to operate our business and service our outstanding debt and other obligations, we may be required, among other things, to further reduce or delay planned capital or operating expenditures, sell assets or take other measures, including the restructuring of all or a portion of our debt, which may only be available, if at all, on unsatisfactory terms.

 

Our lender has the right to add or modify certain terms of our revolving credit facility that would negatively impact our financial position, cash flows and results of operations

 

We have an asset-based secured revolving credit facility, which we refer to as our ABL Facility, with Manufacturers and Traders Trust Company, which we refer to as M&T.  The ABL Facility provides for maximum borrowings on a revolving basis of up to $145.0 million.  As a result of amendments to the terms of the ABL Facility, the maximum availability is subject to restriction if our Fixed Charge Coverage Ratio is less than 1.0 to 1.0, which it was as of February 28, 2013. In addition, our borrowing availability would be further restricted after November 30, 2014 if our Fixed Charge Coverage Ratio is less than 1.0 to 1.0. In such case, the limited availability could impact our ability to borrow for working capital purposes which could, in turn, negatively impact our financial position, cash flows and results of operations. In addition, since M&T was unable to reduce its final participation in the ABL Facility to no more than $75.0 million by December 15, 2012, M&T may add or modify terms of the ABL Facility that were previously prohibited from being added or modified, including but not limited to the advance rates, certain covenants and the interest and fees payable.  As of the date of this Annual Report on Form 10-K, the terms of the ABL Facility have not been modified as a result of M&T’s inability to syndicate the ABL Facility.  However, should M&T choose to exercise its right to add or modify terms of the ABL Facility, borrowings under the ABL Facility may be subject to terms less favorable than the current terms of the ABL Facility which could negatively impact our financial position, cash flows and results of operations. Furthermore, such modifications may require us to renegotiate the terms of our ABL Facility or obtain additional financing.  We may not be able to obtain such modifications or additional financing on commercially reasonable terms or at all.   If we are unable to obtain such modifications or additional financing, we would have to consider other options, such as the sale of certain assets, sales of equity, and negotiations with our lenders to restructure our debt.  The terms of our indebtedness may restrict, or market or business conditions may limit, our ability to do any or all of these things.

 

A decline in public sector construction and reductions in governmental funding could adversely affect our operations and results.

 

A significant portion of our revenue is generated from publicly funded construction projects. If, because of reduced federal or state funding or otherwise, spending on publicly funded construction continues to remain low, our earnings and cash flows will remain negatively affected.  In 2012, the U.S. Congress passed a two year funding bill, Moving Ahead for Progress, or MAP-21, which provides relatively flat infrastructure funding for Pennsylvania as compared to the previous federal allocation. The lack of a long term bill increases the uncertainty of many state departments regarding funding for highway projects. This uncertainty could result in federal, state or local governing bodies being reluctant to undertake large projects which could, in turn, negatively affect our revenues.

 

As a result of the foregoing, we cannot be assured of the existence, amount and timing of appropriations for spending on federal, state or local projects. The federal support for the cost of highway maintenance and construction is dependent on congressional action. In addition, each state funds its infrastructure spending from specially allocated amounts collected from various taxes, typically gasoline taxes and vehicle fees, along with voter-approved bond programs. Shortages in state tax revenues can reduce the amounts spent on state infrastructure projects, even below amounts awarded under legislative bills. Nearly all states are now experiencing state-level funding pressures caused by lower tax revenues and an inability to finance approved projects. Delays or cancellations of state infrastructure spending have in the past hurt, and we anticipate in the immediate future will continue to hurt, our business because a significant portion of our business is dependent on state infrastructure spending.

 

A decline in the funding of PennDOT, the Pennsylvania Turnpike Commission, the New York State Thruway or other state agencies could adversely affect our operations and results.

 

A significant portion of our revenues, both through direct and indirect sales, are generated from PennDOT, the Pennsylvania Turnpike Commission, the New York State Thruway and other Pennsylvania state agencies. The spending of these agencies is governed

 

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by an annual budget which is approved by the relevant state. Our revenues have in the past been adversely affected and will continue to be adversely affected by any decreases by these entities in their annual budgets.

 

Our business relies on private investment in infrastructure and a slower than normal recovery will adversely affect our results.

 

A portion of our sales are for projects with non-public owners. Construction spending is affected by developers’ ability to finance projects. The current credit environment has negatively affected the United States economy and demand for our products. Non-residential and residential construction could continue to decline if companies and consumers are unable to finance construction projects or if the economic slowdown continues to cause delays or cancellations of capital projects.  If housing starts and non-residential projects do not begin to rise steadily with the slow economic recovery as they normally do when recessions end, our construction materials and contracting services sales may fall further and our business and results of operations may continue to be materially adversely affected.

 

Difficult and volatile economic conditions continue to affect our financial position, results of operations and cash flows.

 

Demand for our products is primarily dependent on the overall health of the economy, and federal, state and local public funding levels. The stagnant, and at times declining, economy continues to put pressure on the demand for our construction materials and increases competition and aggressive pricing for private and public sector projects as companies migrate from bidding on scarce private sector work to projects in the public sector. In addition, a stagnant or declining economy tends to produce less tax revenue for public agencies, thereby decreasing a source of funds available for spending on public infrastructure improvements, which constitute a substantial part of our business.  We expect that the challenges to our business environment will persist throughout the next twelve months, and will continue to affect for some time our heavy/highway construction and traffic safety services and equipment businesses, which constitute a significant portion of our overall business. We expect that these conditions will continue to negatively impact our financial position, results of operations, cash flows and liquidity at least throughout the next twelve months.

 

With the slow pace of economic recovery, there is also a likelihood that we will not be able to collect on certain of our accounts receivable from our customers, many of which are still struggling. Although we are protected in part by payment bonds posted by some of our customers, we have in the past and continue to experience payment delays from some of our customers during this economic downturn.

 

These adverse economic factors have in the past, and in the immediate future could continue to, materially adversely affect our financial condition, results of operations, cash flows and liquidity. These factors have also in the past resulted in our inability to meet our covenants under our debt facilities and necessitated our seeking numerous amendments and waivers. As a result of several refinancing transactions which occurred on March 15, 2012, we have recapitalized our debt structure. While our 13% senior secured notes due 2018 and our 11% senior notes due 2018, which we refer to collectively as our notes, do not contain financial maintenance covenants, depending on the amount borrowed under our asset-based revolving loan facility, which we refer to as ABL Facility, we may have to maintain certain financial maintenance covenants in order to be able to borrow the full amount available under that facility. Our ability to make payments on, or repay or refinance, our debt and to fund planned capital expenditures will depend largely upon the availability of financing and our future operating performance.

 

We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our ABL Facility or from other sources in an amount sufficient to pay our debt or to fund our other liquidity needs. If we are unable to generate sufficient cash flow to meet our debt service requirements, we may have to renegotiate the terms of our indebtedness and obtain additional financing. We cannot assure you that we will be able to refinance any of our debt or obtain additional financing on commercially reasonable terms or at all. If we were unable to meet our debt service requirements or obtain new financing under these circumstances, we would have to consider other options, such as the sales of certain assets, sales of equity, and negotiations with our lenders to restructure our debt. The terms of our indebtedness may restrict, or market or business conditions may limit, our ability to do any or all of these things.

 

If we are unable to accurately estimate the overall risks, requirements or costs when we bid on or negotiate a contract that is ultimately awarded to us, we may achieve a lower than anticipated profit or incur a loss on the contract.

 

Even though the majority of our governmental contracts contain certain raw material escalators to protect us from certain price increases, a portion of the contracts are on a fixed cost basis. The fixed cost basis portion of these contracts requires us to perform the contract for a fixed unit price based on approved quantities irrespective of our actual costs. Lump sum contracts require that the total amount of work be performed for a single price irrespective of our actual costs. We realize a profit on our contracts only if: (i) we successfully estimate our costs and then successfully control actual costs and avoid cost overruns and (ii) our revenues exceed actual costs. If our cost estimates for a contract are inaccurate, or if we do not execute the contract within our cost estimates, then cost overruns may cause us to incur losses or cause the contract not to be as profitable as we expected. The final results under these types of contracts could negatively affect our cash flow, earnings and financial position. The costs incurred and gross profit realized, if any, on our

 

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contracts can vary, sometimes substantially, from our original projections due to a variety of factors, including, but not limited to:

 

·            failure to include materials or work in a bid, or the failure to estimate properly the quantities or costs needed to complete a lump sum contract;

 

·            delays caused by weather conditions;

 

·            contract or project modifications creating unanticipated costs not covered by change orders;

 

·            changes in availability, proximity and costs of materials, including steel, concrete, aggregates and other construction materials (such as stone, gravel, sand and oil for asphalt paving), as well as fuel and lubricants for our equipment;

 

·            to the extent not covered by contractual cost escalators, variability and inability to predict the costs of purchasing diesel, asphalt and cement;

 

·            availability and skill level of workers;

 

·            failure by our suppliers, subcontractors, designers, engineers or customers to perform their obligations;

 

·            fraud, theft or other improper activities by our suppliers, subcontractors, designers, engineers, customers or our own personnel;

 

·            mechanical problems with our machinery or equipment;

 

·            costs associated with 104 (a) citations issued by any governmental authority, including the Occupational Safety and Health Administration and Mine Safety and Health Administration;

 

·            difficulties in obtaining required governmental permits or approvals;

 

·            changes in applicable laws and regulations; and

 

·            uninsured claims or demands from third parties for alleged damages arising from the design, construction or use and operation of a project of which our work is part.

 

Public sector customers may seek to impose contractual risk-shifting provisions more aggressively, and we could face increased risks, which may adversely affect our cash flow, earnings and financial position.

 

Weather can materially affect our business and we are subject to seasonality.

 

Nearly all of the products used by us, and by our customers, in the public or private construction industry are used outdoors. In addition, our heavy/highway operations and production and distribution facilities are located outdoors. Therefore, seasonal changes and other weather-related conditions can adversely affect our business and operations through a decline in both the demand for our services and use of our products. Adverse weather conditions such as extended rainy and cold weather in the spring and fall can reduce demand for our products by contractors and reduce sales or render our contracting operations less efficient.

 

Occasionally, major weather events such as hurricanes, tropical storms and heavy snows with quick rainy melts adversely affect sales in the short term.

 

The construction materials business production and shipment levels follow activity in the construction industry, which typically occurs in the spring, summer and fall. Warmer and drier weather during the second and third quarters of our fiscal year typically result in higher activity and revenue levels during those quarters. The last quarter of our fiscal year has typically lower levels of activity due to the weather conditions. Our first quarter varies greatly with the spring rains and wide temperature variations. A cool wet spring increases drying time on projects, possibly delaying sales until the second quarter, while a warm dry spring may enable earlier project startup.

 

Within our local markets, we operate in a highly competitive industry.

 

The U.S. aggregate industry is highly fragmented with numerous participants operating in localized markets. However, in most markets, we also compete against large private and public companies, some of which are as vertically integrated as we are. This results in intense competition in a number of markets in which we operate. Significant competition leads to lower prices and lower sales volumes, which can negatively affect our earnings and cash flows.

 

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Our long-term success is dependent upon securing and permitting aggregate reserves in strategically located areas.

 

Construction aggregates are bulky and heavy and, therefore, difficult to transport efficiently. Because of the nature of the products, the freight costs can quickly surpass the production costs. Therefore, except for geographic regions that do not possess commercially viable deposits of aggregates and are served by rail, barge or ship, the markets for our products tend to be very localized around our quarry sites. New quarry sites often take a number of years to develop, so our strategic planning and new site development must stay ahead of actual growth. As is the case with the broader industry, we acquire existing quarries and, where practical, extend the permit boundaries at existing quarries and open greenfield sites to continue to grow our reserves. In a number of urban and suburban areas in which we operate, it is increasingly difficult to permit new sites or expand existing sites due to community resistance. Therefore, our future success is dependent, in part, on our ability to accurately forecast future areas of high growth in order to locate optimal facility sites and on our ability to either acquire existing quarries or secure operating and environmental permits to open new quarries. If we are unable to accurately forecast areas of future growth, acquire existing quarries or secure the necessary permits to open new quarries, our business and results of operations may be materially adversely affected.

 

Our future growth may depend in part on acquiring other businesses in our industry and successfully integrating them with our existing operations.

 

In the past, we have made acquisitions to strengthen our existing locations, expand our operations, grow our reserves and grow our market share. We expect to continue to make selective acquisitions in contiguous locations and geographic markets or other business arrangements we believe will help our company. However, the success of our acquisition program will depend on our ability to find and buy other attractive businesses at a reasonable price, the availability of financing and our ability to successfully integrate acquired businesses into our existing operations. We cannot assure you that there will be attractive acquisition opportunities at reasonable prices, that financing will be available or that we can successfully integrate such acquired businesses into our existing operations. In addition, acquisitions may require us to take an impairment charge in our financial statements. We had to take certain impairment charges in the past due to acquisitions and cannot assure you that we will not do it again in the future in connection with new acquisitions.

 

Our business is a capital-intensive business.

 

The property and machinery needed to produce our products can be very expensive. Therefore, we need to spend a substantial amount of money to purchase and maintain the equipment necessary to operate our business. We believe that our current cash balance, along with our projected internal cash flows and our available financing resources, will be enough to give us the cash we need to support our currently anticipated operating and capital needs and service our outstanding debt and other obligations. If we are unable to generate sufficient cash to purchase and maintain the property and machinery necessary to operate our business, we may be required to reduce or delay planned capital expenditures, sell assets or take other measures, including restructuring all or a portion of our debt, which may only be available, if at all, on unsatisfactory terms.

 

Our failure to meet schedule or performance requirements of our contracts could adversely affect us.

 

In most cases, our contracts require completion by a scheduled acceptance date. Failure to meet any such schedule could result in additional costs, penalties or liquidated damages being assessed against us, and these could exceed projected profit margins on the contract. Performance problems on existing and future contracts could cause actual results of operations to differ materially from those anticipated by us and could cause us to suffer damage to our reputation within the industry and among our customers, which may have a material adverse effect on our business and results of operations.

 

Environmental, health and safety laws and any changes to such laws may have a material adverse effect on our business, financial condition and results of operations.

 

We are subject to a variety of environmental, health and safety laws, and the cost of complying and other liabilities associated with such laws may have a material adverse effect on our business, financial condition and results of operations.

 

We are subject to a variety of federal, state and local environmental laws and regulations relating to: (i) the release or discharge of materials into the environment; (ii) the management, use, processing, handling, storage, transport or disposal of hazardous materials; and (iii) the protection of public and employee health, safety and the environment. These laws and regulations expose us to liability for the environmental condition of our current or formerly owned or operated facilities, and may expose us to liability for the conduct of others or for our actions that complied with all applicable laws at the time these actions were taken. In particular, we may incur remediation costs and other related expenses because: (i) our facilities were constructed and operated before the adoption of current environmental laws and the institution of compliance practices and (ii) certain of our processes are regulated. These laws and regulations may also expose us to liability for claims of personal injury or property or natural resource damage related to alleged exposure to regulated materials.

 

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Despite our compliance efforts, there is the inherent risk of liability in the operation of our business, especially from an environmental standpoint. These potential liabilities could have an adverse impact on our operations and profitability. In many instances, we must have government approvals and certificates, permits or licenses in order to conduct our business, which often require us to make significant capital and maintenance expenditures to comply with zoning and environmental laws and regulations. Our failure to maintain required certificates, permits or licenses or to comply with applicable governmental requirements could result in substantial fines or possible revocation of our authority to conduct some of our operations. Governmental requirements that impact our operations also include those relating to air quality, waste management, water quality, mine reclamation, remediation of contaminated sites and worker health and safety. These requirements are complex and subject to frequent change. They impose strict liability in some cases without regard to negligence or fault and expose us to liability for the conduct of, or conditions caused by, others, or for our acts that may otherwise have complied with all applicable requirements when we performed them. Stricter laws and regulations, more stringent interpretations of existing laws or regulations or the future discovery of environmental conditions may impose new liabilities on us, reduce operating hours, require additional investment by us in pollution control equipment or impede our opening new or expanding existing plants or facilities.

 

We depend on our senior management and we may be materially harmed if we lose any member of our senior management.

 

We are dependent upon the services of our senior management, especially Paul Detwiler, Jr., Donald Detwiler, Paul Detwiler, III, Steven Detwiler and James W. Van Buren. Because these members of our senior management team have been with us for approximately 30 years on average and have contributed greatly to our growth, their services would be very difficult, time consuming and costly to replace. We maintain a key man insurance policy for each of Paul Detwiler, Jr., Donald Detwiler, Paul Detwiler, III, James W. Van Buren, Steven Detwiler and Jeffrey Detwiler. The loss of key management personnel or our inability to attract and retain qualified management personnel could have a material adverse effect on us. A decision by any of these individuals to leave us, to compete against us or to reduce his involvement could have a material adverse effect on our business.

 

We may not be able to grow our business effectively or successfully implement our growth plans if we are unable to recruit additional management and other personnel.

 

Our ability to continue to grow our business effectively and successfully implement our growth strategy is partially dependent upon our ability to attract and retain qualified management employees and other key employees. We believe there is a limited number of qualified people in our business and the industry in which we compete. As such, there can be no assurance that we will be able to identify and retain the key personnel that may be necessary to grow our business effectively or successfully implement our growth strategy. Our inability to attract and retain talented personnel could limit our ability to grow our business.

 

Labor disputes could disrupt operations of our businesses.

 

As of February 28, 2013, labor unions represent approximately 31% of our total employees. Our collective bargaining agreements for employees generally expire between 2013 and 2016. Although we have good relations with our employees and unions, disputes with our trade unions, or the inability to renew our labor agreements, could lead to strikes or other actions that could disrupt our business, raise costs, and reduce revenues and earnings from the affected locations.

 

Our operations are subject to special hazards that may cause personal injury or property damage, subjecting us to liabilities and possible losses which may not be covered by insurance.

 

Operating hazards inherent in our business can cause personal injury and loss of life, damage to or destruction of property, plant and equipment and environmental damage. We maintain insurance coverage in amounts and against the risks we believe are consistent with industry practice, but this insurance may not be adequate or available to cover all losses or liabilities we may incur in our operations. Our insurance policies are subject to varying levels of deductibles. Losses up to our deductible amounts are accrued based upon our estimates of the ultimate liability for claims incurred and an estimate of claims incurred but not reported. However, liabilities subject to insurance are difficult to assess and estimate due to unknown factors, including the severity of an injury, the determination of our liability in proportion to other parties, the number of incidents not reported and the effectiveness of our safety programs. If we were to experience insurance claims or costs above our estimates, we might also be required to use working capital to satisfy these claims rather than using working capital to maintain or expand our operations.

 

Unexpected factors affecting self-insurance claims and reserve estimates could adversely affect our business.

 

We use a combination of third-party insurance and self-insurance to provide for potential liabilities for workers’ compensation, general liability, vehicle accident, property and medical benefit claims. Although we believe we have minimized our exposure on individual claims, for the benefit of costs savings we have accepted the risk of a large amount of independent multiple material claims

 

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arising, which could have a significant impact on our earnings. We have a wholly-owned captive insurance company, RSIC, for workers’ compensation, general liability, automobile and property coverage. We are liable for up to $0.3 million per year for health care claims and RSIC is responsible for amounts in excess of our $0.3 million deductible up to $1.0 million for each health care claim, with coverage from insurance carriers after the $1.0 million retention. We are responsible for the first $0.3 million for each property and casualty claim and RSIC is responsible for amounts in excess of our $0.3 million deductible up to the first $2.0 million of every property and casualty claim.

 

We estimate the liabilities associated with the risks retained by us, in part, by considering historical claims experience, demographic and severity factors and other actuarial assumptions which, by their nature, are subject to a high degree of variability. Any projection of losses concerning workers’ compensation and general liability is subject to a high degree of variability. Among the causes of this variability are unpredictable external factors affecting future inflation rates, discount rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns.

 

We may incur material costs and losses as a result of claims that our products do not meet regulatory requirements or contractual specifications.

 

We provide to our customers specified product designs that meet building code or other regulatory requirements and contractual specifications for measurements such as durability, compressive strength, weight-bearing capacity and other characteristics. If we fail or are unable to provide products meeting these requirements and specifications, material claims may arise against us and our reputation could be damaged. Additionally, if a significant uninsured, non-indemnified or product-related claim is resolved against us in the future, that resolution may increase our costs and reduce our profitability and cash flows.

 

We identified material weaknesses and significant deficiencies in our internal control over financial reporting during the years ended February 28, 2013 and February 29, 2012 and have a history of material weaknesses and significant deficiencies in our internal control in prior years as well. If we fail to maintain an effective system of internal control over financial reporting, the accuracy and timing of our financial reporting may be adversely affected. In addition, if we are unable to implement methods to document, review and test our control policies, procedures and systems, we may fail to comply in the future with our SEC reporting obligations, including the requirement to provide management’s assessment of our internal control on financial reporting.

 

Effective internal controls are necessary for us to provide timely and reliable financial reports and effectively prevent fraud. Any inability to provide reliable financial reports or prevent fraud could harm our business. If we fail to maintain the adequacy of our internal controls, our financial statements may not accurately reflect our financial condition. We have identified certain material weaknesses in our internal control over financial reporting in current and prior years, including those described in Item 9A of this Annual Report on Form 10-K and the following:

 

·            identification by our independent auditors of misstatements in internal drafts of our financial statements, disclosures and accounting records that were not initially identified by our internal control process, indicating weaknesses with respect to our ability to properly monitor and account for both routine and non-routine transactions;

 

·            the absence of an internal audit function;

 

·            the need to enhance the skill set within our tax department and associated processes;

 

·            the need to enhance the consistency and application of our systems and internal controls which are highly manual and inconsistent across divisions and locations;

 

·            the insufficiency of documentation of financial policies and procedures;

 

·            the need to enhance our budgeting and forecasting capabilities;

 

·            the need for policies and procedures related to our consolidation process which is a time-intensive process requiring multiple adjustments to prepare and present accurate and complete financial data; and

 

·            general data security and restricted access controls of information systems.

 

In addition, we recently implemented a new enterprise resource planning system (“ERP”), which is not yet operational across all of our business units. As previously disclosed in our filings with the SEC, we have in the past experienced and are experiencing significant delays and other issues stemming from our initial implementation which we have been and are continuing to actively resolve.

 

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Any impact from the issues we are currently experiencing or additional delays in the implementation of this system could cause further disruption of our internal control over financial reporting and cause delays in our ability to adequately assess our internal control over financial reporting. Any delay in documenting, reviewing and testing our internal control could cause us to fail to comply with our SEC reporting obligations related to our management’s assessment of our internal control over financial reporting and, if we do so, we would be in violation of our obligations under the Sarbanes-Oxley Act, the Exchange Act and the applicable SEC rules and regulations.  Our ABL Facility contained a covenant that required us to deliver our fiscal year 2012 annual financial statements to the lender by May 29, 2012. On September 7, 2012 we entered into an amendment to the ABL Facility, and subsequent letters on September 28, 2012, November 9, 2012 and December 7, 2012 to change the required delivery date of the audited February 29, 2012 financial statements and the required delivery date of our first and second quarter results and financial statements to December 15, 2012, January 1, 2013, and February 15, 2013, respectively. Additionally, on December 7, 2012 we entered into a second amendment to our ABL Facility to change the required delivery date of our third quarter results and financial statements to March 31, 2013.  On February 14, 2013, we received additional extensions of time to issue our Quarterly report on Form 10-Q for the second quarter of fiscal year 2013 to February 28, 2013 and to issue our Quarterly report on Form 10-Q for the third quarter of fiscal year 2013 to April 1, 2013.

 

There can be no guarantee the Company will not need to obtain similar amendments in the future. A failure to obtain such amendment could result in an acceleration of our indebtedness under our ABL loan facility and a cross-default under our other indebtedness, including our $250.0 million 11% senior notes due 2018 (the “Notes”) and our $265.0 million 13% senior secured notes due 2018 (the “Secured Notes”).

 

If we fail to remediate any material weakness or significant deficiency, maintain effective internal control over our financial reporting or comply with the federal securities rules and regulations applicable to us, including the Sarbanes-Oxley Act and our SEC reporting obligations related to our internal control over financial reporting, our financial statements may be inaccurate, our ability to report our financial results on a timely and accurate basis may be adversely affected, we may be unable to obtain an unqualified audit opinion, and our access to the capital markets may be restricted. In addition, we may, in the future, identify further material weaknesses or significant deficiencies in our internal control over financial reporting. Each of the foregoing could impact the reliability and timeliness of our financial reports and could cause investors to lose confidence in our reported financial information, which could have a negative effect on our business and the value of our securities. We may also be required to restate our financial statements from prior periods.

 

Implementation of plans to document and remediate our internal control system may divert management’s attention from other aspects of our business and place a strain on our management, operational and financial resources. In addition, we may, in the future, identify further material weaknesses or significant deficiencies in our internal control over financial reporting.

 

The cancellation of significant contracts or our disqualification from bidding for, or being awarded, new contracts could reduce revenues and have a material adverse effect on our results of operations.

 

Contracts that we enter into with governmental entities can usually be canceled at any time by them with payment only for the work already completed. In addition, we could be prohibited from bidding on or being awarded certain governmental contracts and other contracts if we fail to maintain qualifications required by those entities, including failing to post required surety bonds or meet disadvantaged business or minority business requirements, bidding on an amount outside of the government entity’s estimate or including a bid item which the government entity determines is unacceptable. A cancellation of an unfinished contract or our disqualification from the bidding process could cause our equipment to be idled for a significant period of time until other comparable work became available, which could have a material adverse effect on our business and results of operations.

 

We may incur increased costs due to fluctuation in commodity prices.

 

We are subject to commodity price risk with respect to price changes in energy, including fossil fuels, electricity and natural gas for production of hot mix asphalt and cement and diesel fuel for distribution and production related vehicles. See “Item 7A —Quantitative and Qualitative Disclosures About Market Risk.”

 

We may incur increased costs due to fluctuation in interest rates.

 

We are exposed to risks associated with fluctuations in interest rates in connection with our variable rate debt, including under the ABL Facility. Any material and untimely changes in interest rates could result in significant losses to us. See “Item 7A —Quantitative and Qualitative Disclosures About Market Risk.”

 

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We are dependent on information technology and our systems and infrastructure face certain risks, including cybersecurity risks and data leakage risks.

 

We are dependent on information technology systems and infrastructure. Any significant breakdown, invasion, destruction or interruption of these systems by employees, others with authorized access to our systems, or unauthorized persons could negatively impact operations. There is also a risk that we could experience a business interruption, theft of information, or reputational damage as a result of a cyber-attack, such as an infiltration of a data center, or data leakage of confidential information either internally or at our third-party providers. While we have invested in the protection of our data and information technology to reduce these risks and periodically test the security of our information systems network, there can be no assurance that our efforts will prevent breakdowns or breaches in our systems that could adversely affect our business. Management is not aware of a cybersecurity incident that has had a material impact on our operations.

 

Item 1B.                           UNRESOLVED STAFF COMMENTS.

 

Not applicable.

 

Item 2.                                    PROPERTIES.

 

Our headquarters are located in a 70,000 square foot building which we lease in New Enterprise, Pennsylvania, under a lease expiring in 2023. See “Item 13—Certain Relationships and Related Transactions, and Director Independence.”

 

We also operate 52 quarries and sand deposits, 30 hot mix asphalt plants, 19 fixed and portable ready mixed concrete plants, four concrete products production plants, three lime distribution centers and seven construction supply centers. For our safety services and equipment business, we conduct operations through five manufacturing facilities and 37 branch offices.

 

Through acquisitions of raw land and existing quarries, we have assembled significant operating reserves throughout our geographic market area. We estimate that we currently own or have under lease approximately 2.1 billion tons of proven and probable aggregate reserves, with an average estimated useful life of 115 years at current production levels.

 

Proven reserves are determined through the testing of samples obtained from closely spaced subsurface drilling and/or exposed pit faces. Proven reserves are sufficiently understood so that quantity, quality, and engineering conditions are known with sufficient accuracy to be mined without the need for any further subsurface work. Actual required spacing is based on geologic judgment about the predictability and continuity of each deposit.

 

Probable reserves are determined through the testing of samples obtained from subsurface drilling, but the sample points are too widely spaced to allow detailed prediction of quantity, quality, and engineering conditions. Additional subsurface work may be needed prior to mining the reserve.

 

Our reserve estimates were made by our geologists and engineers. Reserve estimates are based on various assumptions and any material inaccuracies in these assumptions could have a material impact on the accuracy of our reserve estimates. All of our quarries are open pit and are primarily accessible by road.

 

The following map shows the approximate locations of our permitted construction materials properties in New York, Pennsylvania and Delaware as of February 28, 2013:

 

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The following chart sets forth specifics of our production and distribution facilities:

 

Property

 

Owned /
Leased

 

Type of
Aggregates

 

Hot
Mix
Asphalt

 

Ready
Mixed
Concrete

 

Masonry
Blocks

 

Lime
Distribution /
CSC(1)

 

Precast / 
Prestressed
Concrete

 

Alfred Station, NY

 

Owned

 

Sand and gravel

 

 

 

 

 

 

Aschom, PA

 

Owned

 

Limestone

 

X

 

X

 

 

 

 

Ashford, NY

 

Owned

 

 

X

 

 

 

 

 

Bakersville, PA

 

Owned

 

Limestone

 

X

 

 

 

 

 

Bath, PA

 

Owned

 

 

X

 

 

 

 

 

Bedford, PA

 

Owned

 

 

 

 

 

X

 

 

Bethlehem, PA

 

Owned

 

 

X

 

 

 

 

 

Burkholder, PA

 

Owned

 

Limestone

 

X

 

 

 

 

 

Central City, PA

 

Owned

 

Sandstone

 

 

 

 

 

 

Chambersburg, PA (Blacktop)

 

Owned

 

 

X

 

 

 

 

 

Chambersburg, PA (Quarry)

 

Owned

 

Limestone

 

 

X

 

 

 

 

Clayton, DE

 

Owned

 

 

 

 

 

X

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Clifford, PA

 

Owned

 

Sandstone

 

X

 

 

 

 

 

Como Park, NY

 

Owned

 

Limestone

 

X

 

 

 

 

 

Cowlesville, NY(2)

 

See footnote.

 

 

 

X

 

 

 

 

Delmar, DE

 

Owned

 

 

 

 

 

X

 

 

Denver, PA

 

Owned

 

Limestone

 

X

 

X

 

 

X

 

 

Derry, PA

 

Owned

 

Limestone

 

 

 

 

 

 

Dry Run, PA

 

Leased/Owned(3)

 

Limestone

 

 

X

 

 

 

 

Ebensburg, PA (Batch)

 

Owned

 

 

 

X

 

 

 

 

Ebensburg, PA (Pulverizing)

 

Leased(4)

 

Processing Facility

 

 

 

 

 

 

Egypt, PA

 

Leased (5)

 

Limestone

 

 

 

 

 

 

Elizabethville, PA

 

Owned

 

Sandstone

 

X

 

 

 

 

 

Fairfield, PA

 

Owned

 

Limestone

 

 

 

 

 

 

 

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Franklinville, NY

 

Owned

 

Sand and gravel

 

 

 

 

 

 

Gettysburg, PA

 

Owned

 

Traprock

 

X

 

 

 

 

 

Greencastle, PA

 

Owned

 

 

 

X

 

 

 

 

Honey Brook, PA

 

Owned

 

Sand

 

 

 

 

 

 

Jayne Bend, PA

 

Leased(6)

 

Sand and Gravel

 

 

 

 

 

 

Kutztown, PA

 

Owned/Leased(7)

 

Dolomite

 

X

 

 

 

 

 

Lackawanna, NY

 

Owned

 

Port

 

 

X

 

 

 

 

Ledge, NY

 

Owned

 

Limestone

 

 

 

 

 

 

Lewisburg, PA

 

Owned

 

Limestone and High Calcium

 

X

 

 

 

 

 

Limeville, PA

 

Owned

 

Limestone

 

 

 

 

 

 

Little Gap, PA

 

Owned

 

Sandstone

 

 

 

 

 

 

Liverpool, PA

 

Leased(8)

 

Sandstone

 

 

 

 

 

 

Martins Creek, PA

 

Owned

 

Limestone, and Dolomite

 

 

 

 

 

 

McConnellstown, PA

 

Owned

 

Limestone

 

 

 

 

 

 

Mount Cydonia 1, PA

 

Owned

 

Sandstone

 

 

 

 

 

 

Mount Cydonia 2, PA

 

Owned

 

Sand and gravel

 

 

 

 

 

 

Mount Cydonia III, PA

 

Owned

 

Sandstone

 

 

 

 

 

 

Naginey, PA

 

Owned/Leased(9)

 

Limestone and High Calcium

 

X

 

 

 

 

 

Narvon, PA

 

Owned

 

Clay and Limestone

 

 

 

 

 

 

Nazareth, PA

 

Owned

 

Limestone and Dolomite

 

 

 

 

 

 

New Holland, PA

 

Owned

 

 

 

X

 

X

 

X

 

 

New Paris, PA

 

Owned

 

Limestone

 

 

 

 

 

 

Nottingham, PA

 

Owned

 

 

 

X

 

 

X

 

 

Ogletown, PA

 

Owned/Leased(10)

 

Limestone

 

 

 

 

 

 

Olean, NY

 

Owned

 

 

X

 

 

 

 

 

Oley, PA

 

Owned

 

Limestone, Dolomite

 

X

 

 

 

 

 

Orbisonia, PA

 

Owned

 

Limestone

 

 

 

 

 

 

Ormrod, PA

 

Owned/Leased(11)

 

Limestone, Dolomite

 

X

 

 

 

 

 

Riverton, PA

 

Leased(12)

 

Sand and gravel

 

 

 

 

 

 

Roaring Spring, PA

 

Owned

 

Dolomite, Limestone

 

X

 

X

 

 

X

 

X

 

Schoeneck, PA

 

Owned

 

Limestone, Dolomite, High Calcium

 

 

 

 

 

 

Shamokin, PA

 

Owned/Leased(13)

 

Sandstone

 

X

 

 

 

 

 

Sheshequin, PA

 

Owned/Leased(14)

 

Sand and Gravel

 

 

 

 

 

 

Shippensburg, PA

 

Owned

 

Limestone

 

X

 

X

 

 

 

 

Somerset, PA

 

Owned

 

 

 

X

 

 

 

 

Sproul, PA

 

Leased(15)

 

Limestone

 

 

 

 

 

 

Strodes Mill, PA

 

Owned

 

Sandstone

 

 

 

 

 

 

Tioga, PA

 

Leased(16)

 

Sandstone

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Towanda, PA

 

Owned

 

 

X

 

X

 

X

 

X

 

 

 

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Tyrone Forge, PA

 

Owned

 

Limestone

 

X

 

X

 

 

 

 

Union Furnace, PA

 

Owned

 

Limestone

 

 

 

 

 

 

Viola, DE

 

Owned

 

 

 

 

 

X

 

 

Weaverland, PA

 

Owned

 

Limestone

 

 

 

 

 

 

Wehrle Drive, NY

 

Owned

 

Limestone

 

X

 

 

 

 

 

 

Wescosville, PA

 

Owned

 

 

X

 

 

X

 

X

 

 

Whitehall, PA

 

Owned

 

Limestone, Dolomite

 

 

 

 

 

 

Williamson, PA

 

Owned

 

Limestone

 

 

 

 

 

 

Winfield, PA

 

Owned

 

Limestone

 

 

 

 

 

 

 


(1)                     Construction Supply Centers

 

(2)                     Cowlesville, NY is owned by a third party who leases the concrete batch plant to the Company.  Pursuant to a batch agreement, Area Ready-Mix provides batching services at this plant.

 

(3)                      The term of this lease is April 4, 1996 through April 4, 2016. There are no renewal rights.

 

(4)                      The term of this lease expires December 31, 2021. The lease may be renewed for up to an additional five (5) years.

 

(5)                      The term of this lease is January 1, 2010 through January 1, 2020.  The lease shall automatically renew for five (5) additional periods of five (5) years each.

 

(6)                      The term of this lease is September 8, 1992 through September 8, 2042. There are no renewal rights.

 

(7)                      The term of this lease is November 19, 1976 through November 19, 2056. There are no renewal rights.

 

(8)                      The terms for the two leases at this site are both January 1, 2009 through December 31, 2018. Both leases will automatically renew for an additional ten (10) year term.

 

(9)                      The terms for the two leases at this site will continue until all commercially recoverable limestone has been recovered and removed from the premises. There is no option to renew.

 

(10)               The term of this lease is January 1, 1999 through January 1, 2019. The lease may be renewed for three (3) additional terms of five (5) years each after the expiration of the initial term.

 

(11)               The term of this lease is March 1, 2002 through February 28, 2020. After the expiration of the term, the lease will continue on a year-to-year basis.

 

(12)               The term of this lease is November 1, 2004 through October 31, 2024. There are no renewal rights.

 

(13)               The initial term of this lease was May 1, 1989 through May 1, 1990, but the lease automatically renews on a year-to-year basis.

 

(14)               The term of the lease is May 23, 1996 until all materials subject to the lease have been completely mined or removed from the premises. There are no renewal rights.

 

(15)               The term of this lease is March 5, 1999 through March 5, 2024. The lease may be renewed for an additional twenty-five (25) year term.

 

(16)               The initial term of this lease was June 1, 1986 through June 1, 1991. The lease may be renewed for successive periods of five (5) years. The current term of this lease will expire on May 31, 2016.

 

In addition, we operate three portable ready mixed concrete plants.

 

The following chart sets forth specifics of our traffic safety equipment manufacturing facilities:

 

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Facility

 

Owned/Leased

 

Square Footage

 

St Charles, Illinois manufacturing facility, warehouse and office space

 

Owned

 

49,000 sq. ft.

 

Harrisburg, Pennsylvania manufacturing facility

 

Owned

 

28,000 sq. ft.

 

Lake City, Florida manufacturing facility

 

Owned

 

28,632 sq. ft.

 

New Castle, Delaware facility and office space

 

Leased

 

12,110 sq. ft.

 

Garland, Texas manufacturing facility

 

Leased

 

40,050 sq. ft.

 

 

Item 3.                                    LEGAL PROCEEDINGS.

 

We are a party from time to time to legal proceedings relating to our operations. Our ultimate legal and financial liability in respect to all legal proceeding in which we are involved at any given time cannot be estimated with any certainty. However, based upon examination of such matters and consultation with counsel, management currently believes that the ultimate outcome of these contingencies, net of liabilities already accrued on our consolidated balance sheet, will not have a material adverse effect on our consolidated financial position, although the resolution in any reporting period of one or more of these matters could have a significant impact on our results of operations and/or cash flows for that period.

 

The information concerning mine safety violations or other regulatory matters required by Section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Item 104 of Regulation S-K is included in Exhibit 95 of this report.

 

Item 4.                                    MINE SAFETY DISCLOSURES.

 

The information concerning mine safety violations or other regulatory matters required by Section 1503(a) of the Dodd Frank Wall Street Reform and Consumer Protection Act and Item 104 of Regulation S-K is included in Exhibit 95 of this Annual Report on Form 10-K.

 

PART II

 

Item 5.                                    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

There is no established public trading market for any class of common stock of NESL. All of the issued and outstanding common stock of NESL is held by members or trusts established by and for members of the Detwiler family. See “Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” As of May 17, 2013, there were approximately 16 beneficial holders of the common stock.

 

With the exception of certain tax-related dividends, we have not issued a dividend to any of our equity holders in over ten years. The indentures governing our notes and our ABL Facility contain covenants that limit our ability to pay dividends. See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

We have no equity compensation plans.

 

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Item 6.                                    SELECTED FINANCIAL DATA.

 

The following table presents our selected historical consolidated financial data for the periods indicated. The following information should be read in conjunction with, and is qualified by reference to, the section entitled “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the notes thereto included elsewhere herein.

 

The consolidated balance sheet data of NESL as of February 28, 2013 and as of February 29, 2012 and the related consolidated statements of comprehensive loss data of NESL for each of the fiscal years ended February 28, 2013, February 29, 2012 and February 28, 2011 are derived from our audited consolidated financial statements and the notes thereto included in “Item 8—Financial Statements and Supplementary Data.” The consolidated balance sheet data of NESL as of February 28, 2011, February 28, 2010 and February 28, 2009 and the related consolidated statements of operations data of NESL for the fiscal years ended February 28, 2010 and February 28, 2009 has been derived from the audited consolidated financial statements of NESL not included herein.

 

 

 

February 28,
 2009

 

February 28,
 2010

 

February 28,
 2011

 

February 29,
 2012

 

February 28,
 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Statement of Operations Data: (in thousands)

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

785,180

 

$

736,857

 

$

725,399

 

$

705,934

 

$

677,090

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

Costs of revenue

 

620,145

 

580,612

 

578,611

 

575,486

 

557,503

 

Depreciation, depletion and amortization

 

42,279

 

43,742

 

45,917

 

51,674

 

50,942

 

Intangible asset impairment

 

44,873

 

 

 

1,100

 

4,704

 

Pension and profit sharing

 

8,895

 

9,690

 

8,907

 

7,622

 

8,325

 

Selling, administrative and general expenses

 

59,223

 

64,779

 

61,547

 

64,511

 

77,138

(5)

(Gain) loss on disposals of property, equipment and software

 

(595

)

(261

)

(600

)

808

 

323

 

Operating income (loss)

 

10,360

 

38,295

 

31,017

 

4,733

 

(21,845

)

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

667

 

593

 

318

 

343

 

140

 

Interest expense

 

(40,185

)

(29,536

)(1)

(41,586

)(2)

(46,902

)

(75,987

)(3)

Total other expense

 

(39,518

)

(28,943

)

(41,268

)

(46,559

)

(75,847

)

(Loss) income before income taxes

 

(29,158

)

9,352

 

(10,251

)

(41,826

)

(97,692

)

Income tax expense (benefit)

 

1,060

 

392

 

(4,478

)

(16,397

)

(41,558

)

Net (loss) income

 

(30,218

)

8,960

 

(5,773

)

(25,429

)

(56,134

)

Noncontrolling interest in net (income) loss

 

(1,214

)

(1,165

)

(1,195

)

(820

)

(1,384

)

Net (loss) income attributable to stockholders

 

$

(31,432

)

$

7,795

 

$

(6,968

)

$

(26,249

)

$

(57,518

)

Other Financial Data:

 

 

 

 

 

 

 

 

 

 

 

Cash capital expenditures (4)

 

28,263

 

24,571

 

32,706

 

43,954

 

42,417

 

Consolidated Balance Sheet Data (end of period):

 

 

 

 

 

 

 

 

 

 

 

Cash, restricted cash and cash equivalents

 

$

18,219

 

$

12,573

 

$

21,916

 

$

25,354

 

$

19,657

 

Accounts receivable, net

 

61,780

 

60,087

 

67,372

 

76,841

 

52,271

 

Inventories

 

118,745

 

127,214

 

129,422

 

132,195

 

125,144

 

Property, plant, and equipment

 

408,590

 

390,530

 

382,965

 

371,574

 

371,868

 

Total assets

 

764,511

 

750,234

 

768,078

 

776,322

 

$

734,188

 

Long-term debt, including current portion

 

518,080

 

484,896

 

500,846

 

529,013

 

577,987

 

Total liabilities

 

688,904

 

665,788

 

690,907

 

726,454

 

741,778

 

Total equity (deficit) and redeemable common stock

 

$

75,607

 

$

84,446

 

$

77,171

 

$

49,868

 

$

(7,590

)

 

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(1)                     The decrease in interest expense from fiscal year 2009 to fiscal year 2010 was primarily the result of lower interest rates year over year.

 

(2)                     The increase in interest expense during fiscal year 2011 was a result of an overall increase in borrowings and interest rates primarily related to the issuance of our 11% senior notes due 2018 in August 2010.

 

(3)                     The increase in interest expense during fiscal year 2013 was a result of an overall increase in borrowings and interest rates primarily related to the issuance of our 13% senior secured notes due 2018 and the write-off of $6.4 million of unamortized deferred financing fees associated with the debt repaid.

 

(4)                     Cash paid for expenditures includes capitalized software expenditures.

 

(5)                     The increase in expense from fiscal year 2012 to fiscal year 2013 was attributable to costs associated with the remediation of our ERP system of approximately $4.3 million and higher legal and accounting fees of $7.1 million.

 

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Item 7.                                    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

General

 

We are a leading privately held, vertically integrated construction materials supplier and heavy/highway construction contractor in Pennsylvania and western New York and a national traffic safety services and equipment provider.  Founded in 1924, we are one of the top 10 construction aggregates producers based on tonnage of crushed stone produced and one of the top 50 highway contractors based on revenues in the United States, according to industry surveys.

 

We operate in three segments based upon the nature of our products and services: construction materials, heavy/highway construction and traffic safety services and equipment. Our construction materials operations are comprised of aggregate production (crushed stone and construction sand and gravel), hot mix asphalt production, ready mixed concrete production and the production of concrete products, including precast/prestressed structural concrete components and masonry blocks.  Another of our core businesses, heavy/highway construction, includes heavy construction, blacktop paving and other site preparation services. Our heavy/highway construction operations are primarily supplied with construction materials from our construction materials operation. Our third core business, traffic safety services and equipment, consists primarily of sales, leasing and servicing of general and specialty traffic control and work zone safety equipment and devices to industrial construction end-users.

 

Our core businesses operate primarily in Pennsylvania and western New York, except for our traffic safety services and equipment business, which maintains a national sales network for our traffic safety products and provides traffic maintenance and protection services primarily in the eastern United States.

 

Our revenue is derived from multiple end-use markets, including highway construction and maintenance, residential and non-residential construction and energy production, including operators in the coal and natural gas industries. Because of the diversity of construction materials and services that we offer, we are able to meet a wide range of customer requirements on a local scale.  A significant portion of our revenues, both through direct and indirect sales, are generated from PennDOT, the Pennsylvania Turnpike Commission, the New York State Thruway Authority and other agencies in the Commonwealth of Pennsylvania.

 

The majority of our construction contracts are obtained through competitive bidding in response to advertisements and as a result of following the letting schedule provided by PennDOT. Our bidding activity is affected by such factors as the nature and volume of available jobs to bid, contract backlog, available personnel, current utilization of equipment and other resources, and competitive considerations. Bidding activity, contract backlog and revenue resulting from the award of new contracts may vary significantly from period to period.

 

Our typical construction project begins with the preparation and submission of a bid to a customer. If selected as the successful bidder, we generally enter into a contract with the customer that provides for payment upon completion of specified work or units of work as identified in the contract. Our contracts frequently call for retention; a specified percentage withheld from each payment until the contract is completed and the work accepted by the customer.

 

Demand for our products is primarily dependent on the overall health of the economy, and federal, state and local public funding levels. The primary end uses for our products include infrastructure projects such as highways, bridges, and other public institutions, as well as private residential and non-residential construction. A stagnant or declining economy will generally result in reduced demand for construction and construction materials in the private sector. This reduced demand increases competition for private sector projects and will ultimately also increase competition in the public sector as companies migrate from bidding on scarce private sector work to projects in the public sector. Greater competition can reduce our revenues and/or have a downward impact on our gross profit margins. In addition, a stagnant or declining economy tends to produce less tax revenue for public agencies, thereby decreasing a source of funds available for spending on public infrastructure improvements. Some funding sources that have been specifically earmarked for infrastructure spending, such as diesel and gasoline taxes, are not as directly affected by a stagnant or declining economy, unless actual consumption is reduced.  While some states and localities may seek to redirect funds related to diesel and gasoline taxes in an effort to balance their budgets, the Commonwealth of Pennsylvania currently does not allow for such activities.  Funds earmarked for infrastructure purposes in the Commonwealth of Pennsylvania are constitutionally required to be used for that purpose.

 

Market conditions remained challenging throughout fiscal year 2013. Our business continues to be impacted by the slow pace of economic recovery and the continued pressure on state budgets which has limited state spending on public highway construction projects. The overall housing market remains weak and private non-residential construction is still experiencing a slow recovery. Competition remains strong as a result of the weak public and private sector demand, with residential and commercial contractors bidding aggressively on projects, which continues to affect our profitability. Our margins also remain under pressure as a result of higher fuel and liquid asphalt costs. We expect that the challenges to our business environment will persist throughout fiscal year 2014, which will continue to affect our heavy/highway construction and traffic safety services and equipment businesses, which constitute a significant portion of our overall business. We expect that these conditions will continue to negatively impact our financial position, results of operations, cash flows and liquidity throughout fiscal year 2014. To address these challenges, we are continuing our efforts to monitor and adjust our cost structure in our operating plants and control administrative and general spending. We also actively review our assets and properties on an ongoing basis for strategic disposals of lesser performing or non-core assets.

 

Seasonality and Cyclical Nature of Our Business

 

Almost all of our products are produced and consumed outdoors. Our financial results for any quarter do not necessarily indicate

 

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the results expected for the year because seasonal changes and other weather-related conditions can affect the production and sales volumes of our products. Normally, the highest sales and earnings are in the second and third quarters and the lowest are in the first and fourth quarters. Our sales and earnings are sensitive to national, regional and local economic conditions and particularly to cyclical swings in construction spending, especially in the private sector.  Our primary balance sheet accounts, such as accounts receivable and accounts payable, vary greatly during these peak periods, but return to historical levels as our operating cycle is completed each fiscal year.

 

Components of Operating Results

 

Revenue

 

We derive our revenues predominantly from the operations of our three core businesses: construction materials, heavy/highway construction and traffic safety services and equipment. Our construction materials business consists of aggregate production (crushed stone and construction sand and gravel), hot mix asphalt production, ready mixed concrete production and concrete products including precast/prestressed structural concrete components and masonry blocks. Our heavy/highway construction business primarily relates to heavy construction, blacktop paving and other site preparation services. Our traffic safety services and equipment business consists primarily of sales, leasing and servicing of general and specialty traffic control and work zone equipment and devices, including traffic cones, flashing lights, barricades, plastic drums, arrow boards, construction signs and crash attenuators.

 

The following is a summary of how we recognize revenue in our core businesses:

 

·            Construction materials. We generally recognize revenue on the sale of construction materials and concrete products, other than specialized concrete beams, when they are shipped and the customer takes title and assumes risk of loss.  We account for the sale of specialized concrete beams under the units-of-production method. Under this method, the revenue is recognized as the units are produced under firm contracts.

 

·            Heavy/highway construction.  The Company recognizes revenue on construction contracts under the percentage-of-completion method of accounting, as measured by the cost incurred to date over estimated total cost. The typical contract life cycle for these projects can be up to two to four years in duration. Changes in job performance, job conditions, estimated profitability and final contract settlements may result in revisions to revenues and costs, which are recognized during the period in which the revisions are identified. Amounts attributable to contract claims are included in revenues when realization is probable and the amounts can be reasonably estimated. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are identified. Contract costs include all direct material, labor, subcontract and other costs and those indirect costs related to contract performance, such as indirect salaries and wages, equipment repairs and depreciation, insurance and payroll taxes. Administrative and general expenses are charged to expense as incurred.  Costs and estimated earnings in excess of billings on uncompleted contracts represent the excess of contract revenue recognized to date over billings to date. Billings in excess of costs and estimated earnings on uncompleted contracts represent the excess of billings to date over the amount of revenue recognized to date.

 

·            Traffic safety services and equipment. Our rental contract periods for our traffic safety products are daily, weekly or monthly and are recognized on a straight-line basis. We recognize revenues from the sale of rental equipment and new equipment at the time of delivery to, or pick-up by, the customer. We also recognize sales of contractor supplies at the time of delivery to, or pick-up by, the customer.

 

Operating Costs and Expenses

 

The key components of our operating costs and expenses consist of the following:

 

·            Cost of revenue. Cost of revenue consists of all production and delivery costs related to our revenue and primarily includes all labor, raw materials, subcontractor costs, equipment rental and maintenance and manufacturing overhead. Our cost of revenue is directly impacted by fluctuations in commodity prices. As a result, our operating profit margins can be significantly impacted by the underlying cost of raw materials. We attempt to limit our exposure to changes in commodity prices by entering into purchase commitments when appropriate. In addition, we have sales price escalators in place for most public contracts and we aggressively seek to obtain escalators on private and commercial contracts.

 

·            Depreciation, depletion, and amortization. Our business is relatively capital-intensive.  We carry property, plant and equipment at cost on our balance sheet and assets under capital leases are stated at the lesser of the present value of minimum lease payments or the fair value of the leased item. Provision for depreciation is generally computed over estimated service lives by the straight-line method.

 

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The average depreciable lives by fixed asset category are as follows:

 

Land improvements

 

20 years

 

Buildings, improvements and capitalized software

 

8 - 40 years

 

Crushing, prestressing and manufacturing plants

 

5 - 33 years

 

Contracting equipment

 

3 - 12.5 years

 

Trucks and autos

 

3 - 8 years

 

Office equipment

 

5 - 10 years

 

 

Depletable limestone deposits are reduced by cost depletion estimated on the basis of recoverable quantities of each quarry. Amortization expense is the periodic expense related to our other intangible assets, which were primarily acquired as part of the Stabler acquisition and the amortization of software cost related to our ERP.

 

·            Pension and profit sharing. We participate in several multiemployer pension plans, which provide defined benefits to certain employees covered by labor union contracts. These amounts were determined by the union contracts and we do not administer or control the funds. We also maintain, for certain salaried and hourly employees, an investment plan under which eligible employees can invest various percentages of their earnings, matched by an employer contribution of up to 6.0%. We may make special voluntary contributions to all employees eligible to participate in the investment plan, regardless of whether they contributed during the year. Additionally, we have two defined benefit pension plans covering certain union employees of one of our divisions located in Buffalo, New York.

 

·            Selling, administrative and general expenses. Selling, administrative and general expenses consist primarily of salaries and personnel costs for our sales and marketing, administration, finance and accounting, legal, information systems and human resources employees. Additional expenses include marketing programs, consulting and professional fees, travel, insurance and other corporate expenses.

 

Results of Operations

 

The following table summarizes our operating results on a consolidated basis:

 

 

 

Year Ended

 

 

 

February 28,

 

February 29,

 

February 28,

 

(In thousands)

 

2013

 

2012

 

2011

 

 

 

 

 

 

 

 

 

Revenue

 

$

677,090

 

$

705,934

 

$

725,399

 

Cost of revenue (exclusive of items shown separately below)

 

557,503

 

575,486

 

578,611

 

Depreciation, depletion and amortization

 

50,942

 

51,674

 

45,917

 

Intangible asset impairment

 

4,704

 

1,100

 

 

Pension and profit sharing

 

8,325

 

7,622

 

8,907

 

Selling, administrative and general expenses

 

77,138

 

64,511

 

61,547

 

Loss (gain) on disposals of property, equipment and software

 

323

 

808

 

(600

)

Operating (loss) income

 

(21,845

)

4,733

 

31,017

 

Interest income

 

140

 

343

 

318

 

Interest expense

 

(75,987

)

(46,902

)

(41,586

)

Loss before income taxes

 

(97,692

)

(41,826

)

(10,251

)

Income tax benefit

 

(41,558

)

(16,397

)

(4,478

)

Net loss

 

$

(56,134

)

$

(25,429

)

$

(5,773

)

 

The tables below disclose revenue and operating data for our reportable segments on a gross basis. We include inter-segment and certain intra-segment sales in our comparative analysis of revenue at the product line level and this presentation is consistent with the basis on which we review results of operations.  Revenue and operating income exclude inter-segment sales and delivery revenues and costs.  We also operate ancillary port operations and certain rental operations, which are included in our other non-core business operations line items presented below. All non-allocated operating costs are reflected in the corporate and unallocated line item presented below.

 

The Company’s segment revenue presentation for fiscal years 2012 and 2011 has been revised to conform to the current presentation.  The revisions resulted in decreases to heavy/highway construction revenue and eliminations of $29.8 million and $30.8

 

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million for fiscal years 2012 and 2011, respectively.  These revisions were made to align with the current management approach related to this segment.

 

 

 

Year Ended

 

 

 

February 28,

 

February 29,

 

February 28,

 

(In thousands)

 

2013

 

2012

 

2011

 

 

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

 

 

Construction materials

 

$

505,026

 

$

529,838

 

$

512,143

 

Heavy/highway construction

 

248,188

 

268,160

 

306,795

 

Traffic safety services and equipment

 

84,463

 

82,929

 

78,181

 

Other revenues

 

15,264

 

15,592

 

15,220

 

Segment totals

 

852,941

 

896,519

 

912,339

 

Eliminations

 

(175,851

)

(190,585

)

(186,940

)

Total revenue

 

$

677,090

 

$

705,934

 

$

725,399

 

 

The following tables summarize the percentage of revenue and operating income (loss) by our primary lines of business:

 

 

 

Year Ended

 

 

 

February 28,

 

February 29,

 

February 28,

 

 

 

2013

 

2012

 

2011

 

Revenue:

 

 

 

 

 

 

 

Construction materials

 

59.2

%

59.1

%

56.1

%

Heavy/highway construction

 

29.1

%

29.9

%

33.6

%

Traffic safety services and equipment

 

9.9

%

9.3

%

8.6

%

Other revenues

 

1.8

%

1.7

%

1.7

%

Segment totals

 

100.0

%

100.0

%

100.0

%

 

 

 

Year Ended

 

 

 

February 28,

 

February 29,

 

February 28,

 

(In thousands)

 

2013

 

2012

 

2011

 

 

 

 

 

 

 

 

 

Operating (loss) income:

 

 

 

 

 

 

 

Construction materials

 

$

27,567

 

$

36,192

 

$

36,108

 

Heavy/highway construction

 

(6,800

)

(5,103

)

6,454

 

Traffic safety services and equipment

 

(5,769

)

(209

)

3,377

 

Other non-core business operations

 

747

 

674

 

2,811

 

Segment totals

 

15,745

 

31,554

 

48,750

 

Corporate and unallocated

 

(37,590

)

(26,821

)

(17,733

)

Total operating (loss) income

 

$

(21,845

)

$

4,733

 

$

31,017

 

 

Fiscal Year 2013 Compared to Fiscal Year 2012

 

Revenue

 

Revenue for our construction materials business decreased $24.8 million, or 4.7%, to $505.0 million for fiscal year 2013 compared to $529.8 million for fiscal year 2012. The decrease in revenue in our construction materials business was primarily attributable to decreased sales of aggregates, hot mix asphalt, and precast/prestressed structural concrete in the amount of $13.4  million, $5.2 million and $4.2 million, respectively. Sales volumes of aggregates decreased 6.9% to 16.7 million tons shipped and consumed while the average price per ton shipped and consumed remained consistent for fiscal year 2013. The decrease in volumes of

 

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aggregates shipped and consumed was attributable to an 8.4% decrease in external sales volumes and a 5.2% decrease in internal sales volumes. Sales volumes of hot mix asphalt decreased 3.8% to 3.6 million tons shipped and consumed, offset by an increase in the average price per ton shipped and consumed of 1.2% to $54.70  Sales volumes of precast/prestressed structural concrete products decreased 40.9% offset by an increase in the average price per ton shipped and consumed of 45.8% for fiscal year 2013. The price and demand for our materials is largely based upon local markets and varies across the Company.  The table below represents sales volumes and average prices of our primary products (units in thousands):

 

 

 

2013

 

2012

 

 

 

Construction materials

 

 

 

Units

 

Price per unit

 

% Sales*

 

Units

 

Price per unit

 

% Sales*

 

Units Shipped and Consumed:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stone, sand and gravel (tons)

 

16,726

 

$

11.30

 

37

%

17,972

 

$

11.27

 

38

%

Hot mix asphalt (tons)

 

3,592

 

$

54.70

 

39

%

3,734

 

$

54.03

 

38

%

Ready mixed concrete (cubic yards)

 

539

 

$

116.43

 

12

%

550

 

$

113.66

 

12

%

 


* Remaining percentage of sales are from precast/prestressed structural concrete, block and construction supplies.

 

Revenue for our heavy/highway construction business decreased $20.0 million, or 7.5%, to $248.2 million for fiscal year 2013 compared to $268.2 million for fiscal year 2012.  We continue to experience strong competition in the public and commercial markets.  Further, we believe that the lack of a federal multi-year surface transportation bill over the past several construction seasons has caused the number of larger, heavy, multidiscipline, multiyear highway and bridge construction projects to decrease in favor of smaller, shorter jobs such as road resurfacing and bridge replacement and rehabilitation.

 

Revenue for our traffic safety services and equipment sales businesses increased $1.6 million, or 1.9%, to $84.5 million for fiscal year 2013 compared to $82.9 million for fiscal year 2012. The increase was the result of an increase in highway safety equipment revenue, which was offset by a decrease in rental activity. The increase in revenue for fiscal year 2013 compared to fiscal year 2012 can be attributed primarily to a recent enhancement of our product offerings of trailer products and a redesigned barrel product which has allowed us to enter the market at varying price points. Included in traffic safety service and equipment revenue for fiscal year 2012 is a refund of excess taxes of approximately $1.1 million. Overall rental service activity decreased for fiscal year 2013 compared to fiscal year 2012 primarily as the result of decline in transportation and infrastructure spending in our rental service regions.

 

Cost of Revenue

 

Cost of revenue decreased $18.0 million, or 3.1%, to $557.5 million for fiscal year 2013 compared to $575.5 million for fiscal year 2012. Cost of revenue as a percentage of revenue increased to 82.3% for fiscal year 2013 from 81.5% in fiscal year 2012.  The decrease in cost of revenue for fiscal year 2013 was attributable primarily to lower revenue in the current fiscal year. The increase in cost of revenue as a percentage of revenue was due to reduced profitability in all three of our businesses.

 

Depreciation, Depletion and Amortization

 

Depreciation, depletion and amortization decreased $0.8 million, or 1.5% to $50.9 million for fiscal year 2013 compared to $51.7 million for fiscal year 2012. Depreciation expense recognized on capitalized asset retirement costs associated with a change in the timing and amount of our mining reclamation costs decreased approximately $1.4 million which was offset by increased amortization expense during fiscal year 2013 of approximately $0.9 million related to our capitalized software.

 

Intangible Asset Impairment

 

Intangible asset impairment increased $3.6 million to $4.7 million during fiscal year 2013 compared to $1.1 million in fiscal year 2012. In fiscal year 2013, we recorded trademark impairments of $2.0 million related to our Traffic Safety Services and Equipment reporting unit and $2.7 million related to our Construction Materials reporting unit primarily due to declining revenue in those reporting units.

 

Pension and Profit Sharing

 

Pension and profit sharing expense increased $0.7 million, or 9.2%, to $8.3 million during fiscal year 2013 compared to $7.6 million in fiscal year 2012. The increase is attributable primarily to higher contributions to certain benefit programs.

 

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Selling, Administrative and General Expenses

 

Selling, administrative and general expenses increased $12.6 million, or 19.5%, to $77.1 million for fiscal year 2013 compared to $64.5 million for fiscal year 2012. The increase was primarily attributable to costs associated with the remediation of our ERP system of approximately $4.3 million and higher legal and accounting fees of $7.1 million.

 

Operating (Loss) Income

 

Operating income for our construction materials business decreased $8.6 million, or 23.8%, to $27.6 million for fiscal year 2013 compared to $36.2 million for fiscal year 2012. Operating profit as a percentage of revenue for our construction materials business was 5.5% for fiscal year 2013 compared to 6.8% for fiscal year 2012. Operating income related to the sale of aggregates decreased $4.9 million, or 25.8%, to $14.1 million for fiscal year 2013 compared to $19.0 million for fiscal year 2012. The decrease was attributable primarily to decreased sales volumes without a commensurate reduction in operating costs. Additionally, variations in internal and external sales mix can cause changes in profitability period over period. Operating income related to our ready mixed concrete products for fiscal year 2013 decreased $1.0 million to operating income of $1.3 million compared to $2.3 million for fiscal year 2012. The decline in operating performance in fiscal year 2013 compared to fiscal year 2012 for our ready mixed concrete products is primarily attributable to decreased volumes in the overall markets in which we operate, partially offset by improved prices. The overall decrease in operating profit was offset by a $1.8 million increase in hot mix asphalt operating profit. Hot mix asphalt profit increased 11.9% to $16.9 million for fiscal year 2013 as compared to $15.1 million for fiscal year 2012. The improvement in hot mix asphalt profit is attributed to higher selling prices, while maintaining consistent operating costs, primarily those for liquid asphalt.  Contributing to the decrease in operating income was a $2.7 million impairment charge on our indefinite lived intangible asset.

 

Operating loss for our heavy/highway construction business increased $1.7 million to $6.8 million for fiscal year 2013 compared to $5.1 million for fiscal year 2012.  Operating loss as a percentage of revenue for the heavy/highway construction business was an operating loss of 2.7% for fiscal year 2013 compared to an operating loss of 1.9% for fiscal year 2012. Our multiyear jobs from 2009 and 2010 wrapped-up in fiscal year 2013 and we filled capacity with additional, albeit shorter projects such as road resurfacing and bridge replacement and rehabilitation.  These types of projects have lower margins and we have experienced greater competition than with the larger, heavy, multidisciplinary, multiyear highway and bridge construction projects. The extensive competition we are currently experiencing is the result of a continual increase in the number of residential and commercial contractors bidding on public sector projects, resulting in continuing low margins on projects as these contractors tend to bid at or below our historic bid levels. If we are unable to maintain our market share and continue to be aggressive in our bidding to maintain our market share, profitability may be negatively impacted in future periods.

 

Operating loss for our traffic safety services and equipment sales businesses increased $5.6 million to an operating loss of $5.8 million during fiscal year 2013 compared to an operating loss of $0.2 million during fiscal year 2012. Operating loss as a percentage of revenue for traffic safety services and equipment was 6.9% for fiscal year 2013 compared to an operating loss of 0.2% for fiscal year 2012.  The decrease in profitability was attributable primarily to declining rental service revenue, as well as $2.0 million of impairment charges related to our intangible assets. Additionally, fiscal year 2012 reflects a $1.1 million refund from a state use tax audit. The use tax settlement resulted in a refund of taxes remitted to the Commonwealth of Pennsylvania by the Company. Overall profit from rental service activity decreased as we experienced an overall decrease in transportation and infrastructure spending in our rental service regions.

 

Interest Expense

 

Interest expense increased $29.1 million, or 62.0%, to $76.0 million for fiscal year 2013 compared to $46.9 million for fiscal year 2012.  This increase is primarily attributable to the increase in our net effective interest rate as a result of our Secured Notes outstanding for most of fiscal year 2013 as well as an overall increase in the average debt outstanding for fiscal year 2013 as compared to fiscal year 2012.  Interest expense for fiscal year 2013 also included the write off of $6.4 million of unamortized deferred debt issuance costs related to the debt repaid on March 15, 2012.

 

Income Tax Benefit

 

During fiscal year 2013, we recorded $41.6 million of income tax benefit, which resulted in an annual effective rate of 42.5%. The benefit consists of a $35.9 million federal tax benefit and a $5.7 million state tax benefit. Our annual effective tax rate differs from the U.S. federal statutory rate of 35% primarily due to the current year state income taxes, permanent differences, most significantly percentage depletion and an increase in the valuation allowance on deferred tax assets. Included in the fiscal year 2013 state tax benefit is a discrete out-of-period tax benefit of $1.2 million due to differences in our state apportionment calculation when we finalized our tax returns for fiscal year 2012 in November 2012.  Also included in the fiscal year 2013 deferred federal and state tax benefit, net of federal benefit amounts,  is a $0.5 million of expense related to the tax treatment of certain leases.  The Company understated the deferred tax liability in prior periods by $1.1 million. The out-of-period adjustments are not material to the prior or current consolidated

 

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financial statements.

 

During fiscal year 2012, we recorded $16.4 million of income tax benefit, which resulted in an annual effective rate of 39.2%. The benefit consists of a $17.6 million federal tax benefit offset by $1.2 million of state income tax expense. Our annual effective tax rate differs from the U.S. federal statutory rate of 35% primarily due to the current year state income taxes, permanent differences, most significantly percentage depletion and an increase in the valuation allowance on deferred tax assets.

 

Our future effective tax rate may be materially impacted by the timing and extent of the realization of deferred tax assets and changes in the tax laws. Further, our effective tax rate may fluctuate within a fiscal year, including from quarter-to-quarter, due to items arising from discrete events, including the resolution or identification of tax uncertainties, or due to the changes in the valuation allowance.

 

Fiscal Year 2012 Compared to Fiscal Year 2011

 

Revenue

 

Revenue for our construction materials business increased $17.7 million, or 3.5%, to $529.8 million for fiscal year 2012 compared to $512.1 million for fiscal year 2011. The increase in revenue in our construction materials business was primarily attributable to the increase in sales of aggregates, hot mix asphalt, and precast/prestressed structural concrete in the amount of $10.4 million, $5.5 million and $3.3 million, respectively. Sales volumes of aggregates increased 3.3% to 18.0 million tons shipped and consumed while the average price per ton shipped and consumed increased 1.8% to $11.27 for fiscal year 2012. The increase in volumes of aggregates shipped and consumed was attributable to a 6.9% increase in external sales volumes, offset by a 3.8% decrease in internal sales volumes. Sales volumes of hot mix asphalt decreased 7.3% to 3.7 million tons shipped and consumed, offset by an increase in the average price per ton shipped and consumed of 10.9% to $54.03.  Sales volumes of precast/prestressed structural concrete products increased 18.1% to 0.07 million tons shipped and consumed, offset by a decrease in the average price per ton shipped and consumed of 5.0% to $460.14 for fiscal year 2012. The price and demand for our materials is largely based upon local markets and varies across the Company.  The table below represents sales volumes and average prices of our primary products (units in thousands):

 

 

 

2012

 

2011

 

 

 

Construction materials

 

 

 

Units

 

Price per unit

 

% Sales*

 

Units

 

Price per unit

 

% Sales*

 

Units Shipped and Consumed:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stone, sand and gravel (tons)

 

17,972

 

$

11.27

 

38

%

17,401

 

$

11.07

 

38

%

Hot mix asphalt (tons)

 

3,734

 

$

54.03

 

38

%

4,026

 

$

48.74

 

38

%

Ready mixed concrete (cubic yards)

 

550

 

$

113.66

 

12

%

566

 

$

112.12

 

12

%

 


* Remaining percentage of sales are from precast/prestressed structural concrete, block and  construction supplies.

 

Revenue for our heavy/highway construction business decreased $38.6 million, or 12.6%, to $268.2 million for fiscal year 2012 compared to $306.8 million for fiscal year 2011. The decrease was attributable to the overall decrease in highway and infrastructure spending at the federal, state and local levels, which we anticipate to continue into fiscal year 2013.  Further, we believe that the lack of a federal multi-year surface transportation bill over the past several construction seasons, has caused the number of larger, heavy, multidisciplinary, multiyear highway and bridge construction projects to decrease in favor of smaller, shorter jobs such as road resurfacing and bridge replacement and rehabilitation. This change in the mix of infrastructure spending has resulted in a reduced number of larger, heavy, multidisciplinary, multiyear highway and bridge construction projects in our backlog.

 

Revenue for our traffic safety services and equipment sales businesses increased $4.7 million, or 6.0%, to $82.9 million for fiscal year 2012 compared to $78.2 million for fiscal year 2011. The increase was the result of an increase in highway safety equipment revenue, which was offset by a decrease in rental activity. The increase in revenue for fiscal year 2012 compared to fiscal year 2011 can be attributed primarily to a recent enhancement of our product offerings of trailer products and a redesigned barrel product which has allowed us to enter the market at varying price points. Included in traffic safety service and equipment revenue is a refund of excess taxes previously recorded as a reduction of revenue of approximately $1.1 million remitted to the Commonwealth of Pennsylvania by the Company. Overall rental service activity decreased for fiscal year 2012 compared to fiscal year 2011 primarily as the result of the conclusion of three large service jobs that were completed during fiscal year 2011 and the decline in transportation and infrastructure spending in our rental service regions.

 

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Cost of Revenue

 

Cost of revenue decreased $3.1 million, or 0.5%, to $575.5 million for fiscal year 2012 compared to $578.6 million for fiscal year 2011. Cost of revenue as a percentage of revenue increased to 81.5% for fiscal year 2012 from 79.8% in fiscal year 2011.  The decrease in cost of revenue for fiscal year 2012 was attributable primarily to lower revenue in the current fiscal year. The increase in cost of revenue as a percentage of revenue was attributable primarily to our heavy/highway construction business.  The heavy/highway construction business experienced an overall decrease in the amount of work available during the current fiscal year. Our multiyear jobs from 2009 and 2010 wrapped-up and were filled with additional, albeit shorter projects such as road resurfacing and bridge replacement and rehabilitation. Additionally, the heavy/highway business experienced a loss contract for one job due to unanticipated site conditions for approximately $1.0 million.

 

Depreciation, Depletion and Amortization

 

Depreciation, depletion and amortization increased $5.8 million, or 12.6% to $51.7 million for fiscal year 2012 compared to $45.9 million for fiscal year 2011. We placed $35.4 million of new assets in use in fiscal year 2012 compared to $31.8 million in fiscal year 2011 accounting for approximately $1.8 million of the increase. The remaining increase was attributable to depreciation expense recognized on capitalized asset retirements costs associated with a change in the timing and amount of our mining reclamation activities.

 

Intangible Asset Impairment

 

Intangible asset impairment increased $1.1 million during fiscal year 2012 compared to fiscal year 2011. In fiscal year 2012, we recorded a trademark impairment of $1.1 million related to our Traffic Safety Services and Equipment reporting primarily due to declining revenue.

 

Pension and Profit Sharing

 

Pension and profit sharing expense decreased $1.3 million, or 14.6%, to $7.6 million during fiscal year 2012 compared to $8.9 million in fiscal year 2011. The decrease is attributable primarily to an overall reduction of our work force as well as overall lower operating performance which decreased the amount of our contribution to certain benefit programs.

 

Selling, Administrative and General Expenses

 

Selling, administrative and general expenses increased $3.0 million, or 4.9%, to $64.5 million for fiscal year 2012 compared to $61.5 million for fiscal year 2011. The increase for fiscal year 2012 compared to fiscal year 2011 is attributable primarily to $2.1 million in Hire Tax Credits in fiscal year 2011 that reduced prior fiscal year and which were not received in fiscal year 2012. The remaining increase is primarily attributable to an increase in the allowance for doubtful accounts of approximately $0.8 million and increased public company compliance and ERP costs of approximately $1.7 million which were offset by a decrease in administrative and general costs for fiscal year 2012 compared to fiscal year 2011.

 

Operating Income

 

Operating income for our construction materials business increased $0.1 million, or 0.3%, to $36.2 million for fiscal year 2012 compared to $36.1 million for fiscal year 2011. Operating income as a percentage of revenue for our construction materials business was 6.8% for fiscal year 2012 compared to 7.0% for fiscal year 2011. Income related to the sale of aggregates decreased $0.4 million, or 2.1%, to $19.0 million for fiscal year 2012 compared to $19.4 million for fiscal year 2011. The decrease was attributable primarily to increased depreciation expense of approximately $4.0 million related to the timing of mine reclamation activities offset by an increase in outside sales, including increased fourth quarter sales, due to the open winter as well as a favorable sales mix. Variations in internal and external sales mix can cause changes in profitability period over period. Operating loss related to our precast/prestressed concrete products for fiscal year 2012 decreased $2.5 million to an operating loss of $0.7 million compared to an operating loss of $3.2 million for fiscal year 2011. The improved operating performance in fiscal year 2012 compared to fiscal year 2011 for our precast/prestressed concrete products is primarily attributable to improved selling margins in the overall markets in which we operate and to a lesser extent a more beneficial product mix as we are producing and selling larger beams which typically carry higher overall margins than the smaller beams and other commercial work that we completed in the prior year. The overall increase in operating income was offset by a $3.4 million decrease in hot mix asphalt operating profit. Hot mix asphalt profit decreased 18.4% to $15.1 million for fiscal year 2012 as compared to $18.5 million for fiscal year 2011. The decline in hot mix asphalt profit is attributed to decreased sales volume and increased material costs, primarily those for liquid asphalt.

 

Operating profit for our heavy/highway construction business decreased $11.6 million to an operating loss of $5.1 million for fiscal year 2012 compared to operating income of $6.5 million for fiscal year 2011.  Operating loss as a percentage of revenue for the heavy/highway construction business was 1.9% for fiscal year 2012 compared to an operating income of 2.1% for fiscal year 2011. Our multiyear jobs from 2009 and 2010 completed and were filled with additional, albeit shorter projects such as road resurfacing and bridge

 

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replacement and rehabilitation.  These types of projects have lower margins and we have experienced greater competition than with the larger, heavy, multidisciplinary, multiyear highway and bridge construction projects. The extensive competition we are currently experiencing is the result of a continual increase in the number of residential and commercial contractors bidding on public sector projects, resulting in continuing low margins on projects as these contractors tend to bid at or below our historic bid levels. If we are unable to maintain our market share and continue to be aggressive in our bidding to maintain our market share, profitability may be negatively impacted in future periods. The heavy/highway construction business also experienced a loss contract for one job due to unanticipated site conditions for approximately $1.0 million.

 

Operating profit for our traffic safety services and equipment sales businesses decreased $3.6 million to an operating loss of $0.2 million during fiscal year 2012 compared operating income of $3.4 million during fiscal year 2011. Operating loss as a percentage of revenue for traffic safety services and equipment was 0.2% for fiscal year 2012 compared to operating income of 4.3% for fiscal year 2011.  The decrease in profitability was attributable primarily to a $1.7 million decrease in profit as the result of declining rental service revenue, $0.7 million in increased healthcare costs, $0.5 million increase in bonus expense and the impairment of an indefinite lived trademark for $1.1 million, offset by a $1.1 million refund from a state use tax audit. The use tax settlement resulted in a refund of taxes remitted to the Commonwealth of Pennsylvania by the Company. Overall profit from rental service activity decreased as we concluded three large high margin service jobs in the prior year and we experienced an overall decrease in transportation and infrastructure spending in our rental service regions.

 

Interest Expense

 

Interest expense increased $5.3 million, or 12.7%, to $46.9 million for fiscal year 2012 compared to $41.6 million for fiscal year 2011.  This increase is primarily attributable to the increase in our net effective interest rate as a result of our Notes being outstanding for a full year as well as an overall increase in the average debt outstanding for fiscal year 2012 as compared to fiscal year 2011.

 

Income Tax Benefit

 

During fiscal year 2012, we recorded $16.4 million of income tax benefit, which resulted in an annual effective rate of 39.2%. The benefit consists of a $17.6 million federal tax benefit offset by $1.2 million of state income tax expense. Our annual effective tax rate differs from the U.S. federal statutory rate of 35% primarily due to the current year state income taxes, permanent differences, most significantly percentage depletion and an increase in valuation allowance on deferred tax assets.

 

Our effective tax rate for the year ended February 28, 2011 resulted in a benefit of 43.7%. Our effective tax rate differs from the U.S. federal statutory rate of 35% primarily due to the establishment of the valuation allowance on certain federal and state deferred tax assets, state income taxes and permanent differences, primarily percentage depletion. The benefit from income taxes for the year ended February 28, 2011 consisted of a $4.8 million federal income tax benefit, partially offset by $0.3 million of state income tax expense.

 

Our future effective tax rate may be materially impacted by the timing and extent of the realization of deferred tax assets and changes in the tax laws. Further, our effective tax rate may fluctuate within a fiscal year, including from quarter-to-quarter, due to items arising from discrete events, including the resolution or identification of tax uncertainties, or due to the changes in the valuation allowance.

 

Liquidity and Capital Resources

 

Our sources of liquidity include cash and cash equivalents, cash from operations and amounts available for borrowing under our ABL Facility with Manufacturers and Traders Trust Company (“M&T”).  As of February 28, 2013, we had borrowed $24.3 million under the ABL Facility.  As of such date, the borrowing base was $109.7 million; provided, however, there was $84.7 million available to borrow because we were required to maintain at least $25 million of excess availability so that we do not trigger the fixed charge coverage ratio based covenant discussed in “Our Indebtedness - Asset-Based Loan Facility - Covenants”, included in this Item.  We recently amended our ABL Facility to, among other things, reduce the overall commitment to $145.0 million and provide that through November 30, 2014 we are no longer required to maintain minimum excess availability (as defined in the ABL Facility).  As of February 28, 2013, we had $9.5 million in cash and cash equivalents and working capital of $131.8 million compared to $15.0 million in cash and cash equivalents and working capital of $171.5 million as of February 29, 2012.  Cash balances of $10.1 million and $10.3 million as of February 28, 2013 and February 29, 2012, respectively, were restricted in certain consolidated subsidiaries for bond sinking fund and insurance requirements, as well as collateral on outstanding letters of credit or rentals.  We maintain company owned life insurance policies with cash surrender values (“CSV”).  During fiscal year 2012 we obtained $3.0 million of cash in the form of a loan against the $4.0 million of CSV which was used for general corporate needs and working capital purposes. This amount was subsequently repaid in fiscal year 2013, however we plan to draw against the CSV in fiscal year 2014.

 

On March 15, 2012, we completed the sale of $265.0 million in 13.0% senior secured notes due 2018 (the “Secured Notes”).  In connection with the sale of the Secured Notes, we also entered into the ABL Facility.  We utilized the proceeds from the sale of the