IRS Dispute...
The IRS has completed examination of EXP’s tax returns for fiscal years 2001, 2002, and 2003. It is challenging the depreciation deductions EXP claimed with respect to acquisition of Republic in November 2000. These deductions have been substantial; for the three years under question they amounted to $44M. If the IRS challenge is sustained, EXP will be required to pay $27.6M in back taxes plus $5.7M penalties and interest. Moreover, the $37M in deductions claimed on the federal returns after 2003 are in jeopardy. The IRS is currently examining tax returns for fiscal years 2004, 2005, and 2006.
The deductions on state tax forms have been about 20% of those claimed on the federal form putting an additional $7.5M at risk.
In other words, this dispute could cost EXP close to $2/share. The actual effect on the stock price, however, may not be noticeable. It will be deemed a one time event and EXP has sufficient cash flow to absorb the shock of an adverse ruling.
EXP believes that they have a substantial basis supporting their original depreciation deduction. On December 7, 2007, EXP filed an administrative appeal of the proposed adjustments. In the event that the appeal is denied, EXP intends to resort to the courts for a final determination. These legal maneuvers might take some time to resolve themselves. In the interim, EXP paid the IRS $45.8M in Q3 2007 to minimize additional interest and penalty charges that would accrue in the event that the IRS’s claims are upheld. This tax payment represented about 40% of the 50% reduction in net cash provided by operating activities during the nine months ending on December 31, 2007.
Related to this tax dispute, EXP recorded an increase in liability for unrecognized tax benefits on its books; $27.6 million of the unrecognized tax benefit as an increase in federal income taxes payable and $53.1 million as an increase in long-term deferred taxes. This was balanced by an increase of $80.7 million to other assets relating to unrecognized tax benefits. Upon resolution, any tax ultimately not recognized will be reclassified to goodwill. Additionally, EXP reduced the April 1, 2007 retained earnings balance by $34.6 million, which represents potential interest and penalties related to unrecognized tax benefits. During the three and nine month periods ended December 31, 2007 EXP accrued an additional $1.6 million and $5.4 million, respectively, of interest on the unrecognized tax benefit. They classify interest expense related to unrecognized tax benefits as a component of interest expense, while penalties related to unrecognized tax benefits are classified as a component of income tax expense.
Background:
Centex Construction Products, the predecessor of EXP, paid $392M to purchase assets from Republic Group Incorporated on November 10, 2000. The assets acquired were: a 1.1 billion square foot gypsum wallboard plant located in Duke, Oklahoma; a short line railroad and railcars linking the Duke plant to adjacent railroads; a 220,000 ton-per-year lightweight paper mill in Lawton, Oklahoma; a 50,000 ton-per-year Commerce City (Denver, Colorado) paper mill; and three recycled paper fiber collection sites.
On January 30, 2004 Centex divested EXP to its stockholders on a tax-free basis.
The first SEC filling reporting an IRS audit of the 2001-2003 tax returns was the 10-Q filed February 6, 2007 (EXP’s Q3 2007). In May 2007, the IRS informally indicated that it intended to impose statutory civil penalties. On June 26, 2007, the IRS issued a Notice of Proposed Adjustment incorporating the Company’s comments and included a separate Notice of Proposed Adjustment for statutory civil penalties. The 10-Q filled February 5, 2008 reported that the IRS has completed examination of the 2001, 2002, and 2003 returns and was starting to examine the 2004, 2005, and 2006 returns.
