Hello I'm Professor Brian Bushee, welcome back. This is our final video of our financial statement analysis of Vulcan Materials Company in 2010. In this video we're going to look for off-balance sheet items which are not a problem today, but are things that can turn into big problems down the road. Lets get started. Okay the last stop on our financial statement analysis road map is the question of whether there are significant off-balance sheet items that we should be concerned about with Vulcan materials. So the first that we're going to look at is the operating leases. So if you remember from earlier in the course, these are long term non-cancelable contracts to rent building or equipment. And there were those four criteria that determine whether it's capital or operating. And we talked about how these could be structured in a way where these really should be capital leases and be on-balance sheet, but you can just get around the criteria a little bit. And, in doing so keep a lot of assets and liabilities off your balance sheet. So we're going to take a look at how big these are for Vulcan. So I'm on page 74 of the Vulcan report, this is footnote seven, operating leases. First thing they show is his total rent expense for the last few years. So in 2010, total rent expense was about $61 million. And then they show the future minimum operating lease payments under all leases with noncancelable leases and here's the payment schedule going forward. Remember, future minimum operating leases means that this assumes these are, or this is only for the leases that are in place. And it assumes when they expire, they wouldn't be renewed, and so these are the only payments that are now contractually obligated under lease terms. But as we talked about, that, that can be somewhat misleading, because oftentimes, companies have to renew the lease to keep the equipment, and so the, the actual lease payments may be higher. So why don't we go and take these numbers into Excel and see what kind of liability and amount of assets could be kept off-balance sheet by using operating leases. So, I brought over the future minimum lease payments that Vulcan discloses in their report. And one of the first problems we run into is the thereafter. It's hard to take the present value of a thereafter payment, so we have to make some assumption on what's going to happen in the thereafter. So just sort of carrying these over we have to do something with the thereafter. And what I'm going to do is just split it into five equal payments of about 5 million which is where the leases send, seem to be going. So I it's a crude assumption but at least get us close. So now we can take the present value of each of these streams and we're going to need an interest rate assumption. So I'm going to assume 6% because if you go back a couple pages in the Vulcan report that's about the interest that they have on their medium term debt instruments. So I'm going to bring up the formula and tie it to the 6% interest rate. So I can vary it if I want. Number of periods will be whatever the year is minus 2010. There's no payment because we're going to take the individual present value of a future value and then the future value is in cell E2. So, we figure that out and we get 25,060. I'm going to do that for all the years and come up with a present value of 84,406. Which, I think, is really on the low end. Again, because Vulcan would have to shrink their company substantially if they're only going to be paying 5 million in lease payments going forward given that their rent expense was about 60 million. And so, that's what I'm going to look at next, is what if we did 8 times rent expense. So, rent expense was about 61 million. If we take 8 times that then we'd have 487. So their liability is somewhere between 84 and 487. Now, another technique you could use is use the present value technique that we did here, but instead of having the payment decline, assume that the rent expense is going to continue around this level. And just discount it using the formula. And here, you get about 450 million. So my guess is the liability is probably closer to something like 400 million than 84 million that Vulcan's keeping off-balance sheet. Their total liabilities are 4.3 billion, or 4,372. So basically, what would be 10% of their liabilities are kept off-balance sheets through these operating leases. So, it doesn't look like there are any questions from the virtual students on the operating lease, I guess they remember that from earlier in the course. So let's go ahead and move onto the next topic which is pension plans. Now, pension plan accounting is incredibly complicated. You think deferred taxes were bad, I'd probably need two weeks of videos to take care of pension plans. But what I'll do is I'm going to go to footnote 10 for Vulcan and try to give you just enough knowledge to be dangerous on pension plans and show you one thing that you should always look for. Even if you tot, totally understand everything that's going on with pensions. Okay so I'm at note 10 on page 79 of the Vulcan report where they talk about their pension plans. Now where the accounting comes in is for what are called defined benefit pension plans. A defined benefit plan is where the company promises to pay its employees a certain monthly amount after they return until they die. And that monthly amount is based on what their salary is just before they retire. So defined benefit means that when you retire, you're guaranteed to get a check from Vulcan materials every month with a certain pension plan. So, what you have to do to account for this is first of all show how big the liability is for these future pension payments. So this projected benefit obligation of $761 million, this represents the present value of all the expected payments they have to make to retirees after they retire. So, what would they do is they get an actuary. The actuary would forecast out how many more years people will work until they retire. How much their salary will increase until then to figure out what the payment would be when they retire. Then they'll try to guess how long people will live before they pass away and the payments stop. They'll take all of those and future dollars, discount them back to present value. The total obligation in present value terms is $761 million. Now, to meet this obligation companies have to put assets into the pension plan, and the idea is that those assets are going to grow to pay off the obligation. So they'll put money into stocks, bonds, mutual funds. And hopefully, those assets will grow to meet the pension benefits. So at the end of 2010, Vulcan had 630 million of assets set aside to meet 761 million of expected benefits. oh. That means their pension plan is underfunded by $131 million. So, they don't have enough in assets to cover all of the expected payments their going to make to retirees when they retire. Now, this 13101, 081 does show up on the balance sheet. So this part is technically not off-balance sheet, there is a liability for $131 million that Vulcan has on the balance sheet. But here's where this is something to look for. So these pension benefits or this pension obligation is guaranteed by the federal government. So there's an agency called the pension benefit guarantee corporation, which will step in and make the payments to the retire's if Vulcan goes bankrupt and can't do it. But because the government is provided this essential insurance against default for these payments, the government charges Vulcan insurance premium, in order to, to provide this insurance coverage. And the government also has some influence on making Vulcan put enough assets into their pension plans, so that they're not severely underfunded. Where we could get into the problem where they can't pay their pension benefits. And if you notice, in 2009, Vulcan was underfunded by 216 million. That's gone down to only 131 million. What happened, a big part of that is that Vulcan put more cash into it's pension plan, they put more assets aside. And so, here's the big thing to look for. If this net amount recognized, this underfunding is big and negative, there's a good chance that Vulcan's going to have to put more cash into their pension plan in the future. So, instead of taking their operating cash flow and investing it in buying new property, plant and equipment or using it to pay that substantially big dividend, my guess is, in the future, because of this underfunding, Vulcan's going to have to take some of their cash flow and divert it into their pension plan. So just find this net amount recognized, which is also called funded status. If that funded status is big and negative it's a good indication that the companies going to have to divert cash from running the business into it's pension plan in the future. So, surely the virtual students must have some questions about this right? Huh. There are no virtual students here. Are they caught in traffic? Did they go out for coffee? Are they studying for the final? Hm. I guess we'll carry on without them. Next thing we're going to look at are contingent liabilities that Vulcan has. Contingent liabilities are things that are not liabilities today. So they're not on the balance sheet today, but they're items that could turn into liabilities at some point in the future. So it'll be things like purchase commitments, lawsuits, guarantees, and so forth. So let's go to Vulcan's note 12 to take a look at those. Okay, so I'm on page 90 of the Vulcan report. These are commitments and contingencies. So the first thing to have are some commitments in terms of contracts they've signed, which obligate them to purchase things in the future. So there, they've signed commitments to buy about $10 million of PP&E, and about $68 million of other stuff. And then you can see how this shows out into the future. So this is not on the balance sheet yet because there's been no transaction. There's been no exchange of cash, goods, or services. But the assumption is in the normal course of business, Vulcan will probably spend this cash to buy the property planned equipment and other stuff. They also have commitments to pay out under royalties for mineral leases. Which are about 227 million. Again, this is not a liability now because there's been no obligation or transaction that's been triggered yet. But in the normal course of business Vulcan will have to payout approximately 227 million over the next few years under, under these mineral leases. Next thing is they provide guarantees, standby letters of credit. So that's about 65 million that they're potentially on the hook for. That they could borrow up and then owe to banks. And then what is a big deal for Vulcan, for Vulcan actually is getting into government proceedings pertaining to occupational self, safety and health. So, no surprise, you're digging up stones from the ground, you have plants where you're making asphalt, you have to worry about employee safety and pollution. And so they talk about all the issues that they've run into. So there's some notices from the US Environmental Protection Agency about some problems. Maybe superfund sites, that's where you have a big spill of some kind of chemical or pollutant into the ground that then has to be cl, cleaned up. And what they say is, based on the information currently available, the ultimate resolution of those claims will not have a material adverse effect on our operations. Now, that's as of what they know right now. But of course things could change and all the sudden, you know, the superfi, fund site they could find even more bad chemicals. And this could turn into a big liability at some point in the future, so this is something you want to keep an eye on. Then Vulcan has been subject to lawsuits so there's Florida anti trust litigation regarding Florida rock. There's a problem with the IDOT/Jouliet road in Illinois where they may have damaged it with some of their operations. There's the lower Passaic River clean-up in New Jersey. There is the usual per, perchloroethylene cases that all companies seem to run into. And there's just a number of places in California Suffolk County, I think that's Long Island, US Virgin Islands that are suing them. West Virginia's suing them over this. There's West Virginia Coal Sink Lab litigation and so forth and so on. And they say it's, it's not possible to predict with certainty the ultimate outcome of these legal proceedings, no liability was accorded at this point, because they could not reasonably estimate it. So essentially what happens is, until Vulcan gets to the point where they can reasonably estimate a lawsuit loss, they don't have to record a liability. Now that doesn't mean that there's no potential obligation down the road. What you want to do with these is know that they exist and keep an eye on them, because these are things that could be not a liability today, but they could turn into a big liability in the future if Vulcan loses a court case or if they decide to settle out of court. So keep an eye on the commitments and contingencies as things that could turn into big liabilities or obligations down the road. And the last thing to keep an eye out for in general are variable interest entities. Now as it turns out Vulcan doesn't have any, but these are something you want to look at in general. So let me bring up this section of their 10-K where they talk about these. Okay I'm on page 40 of the Vulcan MDNA a required disclosure or any off-balance sheet arrangements for things like variable interest entities. So I don't know if you heard about Enron, it was one of the biggest bankruptcies in US history back in believe it was 2001. And a big part of what caused the bankruptcy is that investors could not see some of their risky activities because they were in these variable interest entities that are were off-balance sheet. Now again I would need two weeks of videos to talk through all of the issues with variable interest entities, but in a nutshell here's what it is. You set up a corporation that only exists on paper. So it's not a corporation that has a headquarters or buildings or people. But it's all documents where you set up a legal corporation that can do something. And this, this variable interest entity this, this off-balance sheet legal corporation is set up to do like one purpose. Like securitize loans or finance a acquisition of a building or finance research and development or whatever. And basically there's this series of rules where if you structure this correctly you can take things that normally would be on your balance sheet and move them off your balance sheet. Basically hiding any debt involved in these variable interest entities. Then any assets from your balance sheet. So, as a result if you do these activities you have to disclose them in your financial statements and it turns out Volkan doesn't do them or if they do them I guess they say I guess they say no off-balance sheet arrangements that would have a current material effects. So we don't know if they have no arrangements or none that are a big deal. But if they did you would see a disclosure here about how those off-balance sheet arrangements might effect their assets, liabilities, income statement if they were on-balance sheet. So, it's not here for Vulcan but in general you always want to go and look for these kind of arrangements. Okay, to sort of wrap up our comprehensive look at Vulcan Materials. What we've learned is that Vulcan's business is largely driven by large construction projects. Really driven by highways, federal spending on infrastructure, especially highways. And for Vulcan to turn around, they need recovery of public spec-, sector spending so government spending as well as the residential and non-residential building segment. Big thing is they need a new highway bill. They need Congress to get into gear. Pass a new highway bill. Build some more highways so they can sell some more stones for those highways. Their acquisition of Florida Rock in 2007 greatly increased the scale of the company. But the problem is Vulcan hasn't grown into that new scale yet. They're not covering all their fixed costs. They really need more aggregate shipments. The aggregates, again, are the stones, to cover all those fixed costs. And we see they're cutting back on capital investment. And part of the reason is, they're over capacity with Florida Rock. They need to get up to capacity for Florida Rock and then start building up their investment to grow even further. Through all of the problems with this recession they're managing their short-term cash position very well. So the management team is doing a great job of managing their cash through these tough times. But as we saw, there is a looming issue ahead with debt principal payments. And having this big dividend on top of these $300 million a year principle payments that come up, is going to be a challenge for managing their cash. And it's going to require them to probably keep their borrowing high and try to roll this debt over. But it's going to make the company very risky. So bottom line is if we can just get the government to start building new highways, everything will take care of itself. If not, this is a company that's probably in trouble. So this was the 2010 Vulcan report that we looked at. It's obviously not 2010 anymore, so what happened? Well I'm not going to tell you. And I'm not going to tell you because I'd like to use this video for the next ten years if I can get away with it. So if I told you where the company was right now, then this video would be outdated years from now. So, what I want you to do is since you're going to have all this free time now because the course is ending. Why don't you go on the internet, download the current Vulcan annual report, and see how they're doing. See what's been going well for them, see if there's anything that's continue to go bad for them. See if they're still around. And, you know, try to do your own analysis sort of like the, like the one that we've done here you now have the tools and techniques to do it. And that wraps up our look at financial statement analysis. So hopefully you're at a point right now where you could pick up any companies financial statement, go through it, and try to pick up the things that we've been talking about this week and learn a lot about what's going on with the company now. It has some impression of what might be happening between you and the company in the future. My only regret as we wrap this week up, is that the virtual students weren't here for this last video. I wonder where they are? >> Thank you so much for taking the course with us. We hope that you enjoyed it and learned a lot. >> [FOREIGN]
