FORTERRA, INC. The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included in Item 8. "Financial Statements and Supplementary Data".
This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under the heading Item 1A. "Risk Factors" and elsewhere in this Annual Report on Form 10-K. See the section entitled "Cautionary Statement Concerning Forward-Looking Statements." Overview Our Company We are a manufacturer of ductile iron pipe and concrete pipe and precast products inthe United States andEastern Canada for a variety of essential water-related infrastructure applications, including water transmission, distribution and drainage. Our manufacturing and distribution network allows us to serve most majorU.S. and Eastern Canadian markets. We operate 80 active manufacturing facilities and currently have additional manufacturing capacity available in both of our segments, providing room to increase production to meet short-cycle demand with minimal incremental investment. These facilities and our distribution network provide us with a local presence and the necessary proximity to our customers to minimize delivery time and distribution costs to the markets we serve.
Quikrete Merger Agreement and the Related Divestitures
OnFebruary 19, 2021 , we entered into an Agreement and Plan of Merger, or the Merger Agreement, withQuikrete Holdings, Inc. , aDelaware corporation, or Quikrete, andJordan Merger Sub, Inc. , aDelaware corporation and a wholly-owned subsidiary of Quikrete, or Merger Sub. Pursuant to the Merger Agreement, subject to the satisfaction or waiver of specified conditions, Merger Sub will merge with and into the Company, or the Merger, with us surviving the Merger as a wholly-owned subsidiary of Quikrete. Pursuant to the Merger Agreement, at the effective time of the Merger, or the Effective Time, each issued and outstanding share of common stock of ours (other than (i) any shares held in the treasury of us or owned, directly or indirectly, by Quikrete, Merger Sub or any wholly-owned subsidiary of us immediately prior to the Effective Time, (ii) shares that are subject to any vesting restrictions, or the Company Restricted Shares, granted under our stock incentive plans, or the Company Stock Plans, and (iii) any shares owned by stockholders who have properly exercised and perfected appraisal rights underDelaware law) will be automatically canceled and converted into the right to receive$24.00 in cash, without interest, or Merger Consideration, subject to deductions for any required withholding tax. Each party's obligation to consummate the Merger is subject to certain conditions, including, among others: (i) expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; (ii) the absence of any order issued by any court of competent jurisdiction, other legal restraint or prohibition or any law enacted or deemed applicable by a governmental entity that prohibits or makes illegal the consummation of the Merger; (iii) the passing of twenty (20) days from the date on which we mail to our stockholders the Information Statement (as defined below) in definitive form; (iv) subject to certain qualifications, the accuracy of representations and warranties of the other party set forth in the Merger Agreement; and (v) the performance by the other party in all material respects of its obligations under the Merger Agreement. Quikrete's obligation to consummate the Merger is also conditioned on, among other things, the absence of any Material Adverse Effect (as defined in the Merger Agreement).
Entry into the Merger Agreement was unanimously approved by our board of directors.
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The Merger Agreement includes customary representations, warranties and covenants of us, Quikrete and Merger Sub. Among other things, we have agreed to use commercially reasonable efforts to conduct its business in the ordinary course of business consistent with past practice and use commercially reasonable efforts to preserve intact its businesses until the Merger is consummated. We and Quikrete have also agreed to use their respective reasonable best efforts to obtain any approvals from governmental authorities for the Merger, including all required antitrust approvals, on the terms and subject to the conditions set forth in the Merger Agreement, provided that Quikrete and its affiliates will not be required to take, or agree to take, certain actions with respect to assets, businesses or product lines of Quikrete or any of its subsidiaries, or we or any of its subsidiaries, accounting for more than$80 million of EBITDA (as defined in the Merger Agreement) for the 12 months endedDecember 31, 2020 , measured in accordance with the Merger Agreement. The Merger Agreement contains certain provisions giving each of Quikrete and us rights to terminate the Merger Agreement under certain circumstances, including the right for either Quikrete or us to terminate the Merger Agreement if the Merger has not been consummated on or beforeNovember 19, 2021 , which date will be automatically extended for up to two additional 60-day periods in specified circumstances as described in the Merger Agreement, or the Outside Date. Upon termination of the Merger Agreement under specified circumstances, we will be required to pay Quikrete a termination fee of$50 million . The Merger Agreement further provides that Quikrete will be required to pay us a reverse termination fee of$85 million under certain circumstances if the Merger Agreement is terminated due to the failure of the parties to obtain required approvals under Antitrust Laws (as defined in the Merger Agreement) prior to the Outside Date or as a result of a Restraint (as defined in the Merger Agreement) arising under applicable Antitrust Laws. If the Merger is consummated, the shares of Common Stock will be delisted from theNasdaq Stock Market LLC and deregistered under the Securities Exchange Act of 1934, as amended or the Exchange Act. In order to address some of the divestitures anticipated to be required by theDOJ to satisfy the HSR Condition, onNovember 24, 2021 ,Forterra Pipe & Precast, LLC , aDelaware limited liability company and wholly owned subsidiary of us, or FP&P, entered into a Membership Interest Purchase Agreement, or the Eagle Purchase Agreement, withEagle Corporation , aVirginia corporation, or Eagle, and Quikrete. Pursuant to the terms and subject to the conditions set forth in the Eagle Purchase Agreement, contemporaneously with the closing of the Merger and the other transactions contemplated by the Merger Agreement, Eagle will purchase FP&P's 50% equity interest inConcrete Pipe & Precast, LLC , or CP&P, a joint venture with Eagle, or the CP&P Sale, for a purchase price of$105,000,000 (subject to certain adjustments as described in the Eagle Purchase Agreement). Consummation of the CP&P Sale is subject to customary closing conditions, including, among others, the consummation of the Merger and approval by theDOJ . The Eagle Purchase Agreement contains certain termination rights for FP&P and Eagle, including, among others, the right to terminate the Eagle Purchase Agreement (i) by either party if the CP&P Sale has not occurred byMarch 22, 2022 , which date may be extended under certain circumstances described in the Eagle Purchase Agreement, (ii) by either party in the event of the issuance of a final and non-appealable governmental order that prohibits the CP&P Sale or if FP&P notifies Eagle that (x) the Merger is not occurring or (y) the Merger Agreement has been terminated and (iii) by FP&P if FP&P determines in good faith in its reasonable discretion that theDOJ is not likely to approve the CP&P Sale and the Merger. In addition, in order to address some of the divestitures anticipated to be required by theDOJ to satisfy the HSR Condition, onDecember 13, 2021 , FP&P entered into an Asset Purchase Agreement, or the Foley Asset Purchase Agreement, withHydro Conduit, LLC d/b/a Rinker Materials, aDelaware limited liability company and an affiliate of Quikrete, or Rinker, andFoley Products Company, Inc. , aGeorgia corporation, or Foley. Pursuant to the terms and subject to the conditions set forth in the Foley Asset Purchase Agreement, contemporaneously with the closing of the Merger and the other transactions contemplated by the Merger Agreement, FP&P and Rinker will each sell to Foley certain assets and liabilities associated with reinforced concrete pipe and precast plants, or the Asset Sale, for an aggregate purchase price of$95,000,000 (subject to certain adjustments described in the Asset Purchase Agreement). The assets being sold by FP&P include FP&P's 46
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reinforced concrete pipe and precast plant located in
The Asset Purchase Agreement contains specified termination rights for the FP&P and Rinker, or the Asset Sellers, and Foley, including, among others, the right to terminate the Asset Purchase Agreement (i) by either the Foley or the Asset Sellers if the Asset Sale has not occurred byMarch 22, 2022 , which date may be extended under certain circumstances described in the Asset Purchase Agreement, (ii) by either Foley or the Asset Sellers in the event of the issuance of a final and non-appealable governmental order that prohibits the Asset Sale or if the Asset Sellers notify Foley that (x) the Merger is not occurring or (y) the Merger Agreement has been terminated and (iii) by the Asset Sellers if they determine in good faith in its reasonable discretion that theDOJ is not likely to approve the Asset Sale and the Merger. Additionally, onFebruary 16, 2022 , the Company announced that Rinker had entered into an Asset Purchase Agreement, or the Oldcastle Asset Purchase Agreement, withOldcastle Infrastructure, Inc. , aWashington corporation, or Oldcastle, in order to address some of the divestitures anticipated to be required by theDOJ to satisfy the HSR Condition for the consummation of the Merger and the other transactions contemplated by the Merger Agreement. Pursuant to the terms and subject to the conditions set forth in the Oldcastle Asset Purchase Agreement, contemporaneously with or shortly after the closing of the Merger and the other transactions contemplated by the Merger Agreement, Rinker will sell to Oldcastle certain assets and liabilities associated with three reinforced concrete pipe plants located in theDallas/Fort Worth ,Houston , andSan Antonio metropolitan areas, or the Oldcastle Asset Sale. Consummation of the Oldcastle Asset Sale is subject to customary closing conditions, including, among others, the consummation of the Merger and approval by theDOJ . The Company and Quikrete continue to work with theDOJ to obtain the necessary consent to allow the parties to complete the Merger by the outside date ofMarch 22, 2022 , but whether such consent is obtained by the outside date is outside of the Company's control. If such consent has not been obtained by the outside date, the parties will have the rights set forth in the Merger Agreement. For additional detail regarding the risks associated with the failure to close the Merger prior to the outside date, please refer to the "Risks Related to the Proposed Merger" set forth in "Risk Factors" in Part I, Item 1A of this Form 10-K. Our Segments
Our operations are organized into the following reportable segments:
•Drainage Pipe & Products - We are a producer of concrete drainage pipe and precast products and concrete pressure pipe products.
•Water Pipe & Products - We are a producer of ductile iron pipe, or DIP.
•Corporate and Other - Corporate, general and administrative expenses not allocated to our revenue-generating segments such as certain shared services, executive and other administrative functions.
In the fourth quarter of 2020, we reclassified our pressure pipe business from Water segment to Drainage segment to better align with our organizational structure.
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COVID-19 Pandemic
Beginning inmid-March 2019 , local, state, provincial and federal authorities began issuing stay at home orders in response to the spread of the coronavirus disease 2019, or COVID-19, which has quickly spread throughoutthe United States and worldwide. These government-instituted restrictions, together with the economic volatility and uncertainty caused by the pandemic, have had a significant impact onthe United States economy in general and certain parts of our end-markets in particular. Despite these events and the related uncertainty, we have continued to operate as an essential business under the government orders, and the COVID-19 pandemic has not materially affected our liquidity, financial results or business operations thus far. During the initial phase of the pandemic in the early part of the second quarter, we experienced temporary delays in certain projects, primarily related to governmental stay-at-home orders in place at that time and the reactions of certain customers to those orders, specifically in our residential end-markets. Late in the second quarter and continuing through 2020 and into 2021, as most states started gradually resuming their normal economic activities, there was some correction in these trends in the residential housing market. Since the onset of the COVID-19 pandemic, we have focused on protecting the health and safety of our team members while maintaining our operations, which have been deemed essential under relevant pandemic-related government regulations, and continuing to meet our customers' needs. Although some of our team members have tested positive for COVID-19, and we encountered temporary closures of a small number of our manufacturing facilities in the second quarter of 2020 due to such cases or due to government mandate, these events have not had a significant impact on our operations or our ability to serve our customers' needs. We did however utilize the option under the CARES Act to defer the employer portion of the social security taxes that would otherwise have been due in 2020, with 50% paid in the third quarter of 2021 and the remaining 50% due byDecember 31, 2022 . During 2021, we saw improvements in our business conditions, however, we continued to see supply chain challenges as well as higher raw material, labor, and freight costs. The situation around the COVID-19 pandemic remains fluid because of the evolution of COVID-19 variants, and the extent of the ongoing impact on our business may be significant. However, due the fluidity and unprecedented and uncertain nature of the pandemic, we cannot predict the future impact of the COVID-19 pandemic may have on our business, or that of our customers, and participants in our supply chain, or on economic conditions generally, including the effects on infrastructure spending and other construction activity. The ultimate scope and extent of the effects of the COVID-19 pandemic are highly uncertain and will depend on future developments, and such effects could exist for an extended period of time even after the pandemic may end.
For additional information on risk factors that could impact our results, please refer to "Risk Factors" in Part I, Item 1A of this Form 10-K.
Principal Factors Affecting Our Results of Operations
Our financial performance and results of operations are influenced by a variety of factors, including conditions in the residential, non-residential and infrastructure construction markets, general economic conditions, changes in cost of goods sold, competitive behavior in the markets we serve, and seasonality and weather conditions. Some of the more important factors are discussed below, as well as in the section Item 1A. "Risk Factors," with the exception of the impacts of the COVID-19 pandemic, which are discussed above.
Infrastructure Spending and Residential and Non-Residential Construction Activities
A large proportion of our net sales in our Drainage Pipe & Products segment is generated through public infrastructure projects, which are driven by federal, state and provincial funding programs. In theU.S. , federal funds are allocated to the states, which are required to match a portion of the federal funds they receive. According to theFederal Reserve Bank , public investment in theU.S. infrastructure as a share of Gross Domestic Product has fallen by more than 40% since the 1960s. TheWorld Economic Forum ranked theU.S. 13th when it comes to overall quality of infrastructure. In terms of the transportation infrastructure, more than 45,000U.S. 48
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bridges and 1 in 5 miles of roads are in poor condition, according to the
A large proportion of our net sales in our Water Pipe & Products segment is generated through municipal infrastructure projects. TheU.S. potable water infrastructure, especially the underground pipes that deliver drinking water to homes and businesses, is aging and in need of significant reinvestment. Like many of the roads, bridges, and other public assets on which theU.S. relies, most of the underground drinking water infrastructure was built 50 or more years ago, in the post-World War II era of rapid demographic change and economic growth. In some older urban areas, many water mains have been in the ground for a century or longer. Given its age, a large proportion of theU.S. water infrastructure is approaching, or has already reached, the end of its useful life. In some locations, improvements to water infrastructure are needed to comply with standards for drinking water quality. The ASCE estimates 240,000 water main breaks per year in theU.S. due to aging pipelines, wasting over two trillion gallons of treated drinking water. The underlying demand for municipalities to repair or replace their water systems depends on the status of the water systems and the availability of funding. With people spending more time at their homes in order to reduce the spread of the COVID-19 virus, it is even more critical to ensure the uninterrupted supply of clean water. InNovember 2021 ,President Biden signed into law theInfrastructure Investment and Jobs Act, a$1.2 trillion investment inU.S. infrastructure, of which more than$100 billion is dedicated to upgrading aging bridges, highways and roads. In addition, more than$50 billion of the contemplated spending is dedicated to upgrading water infrastructure in theU.S. The law's increased federal funding for highways, roads, bridges, transit and water systems is expected to benefit the state and local governments, which undertake the bulk of public-sector investment in theU.S. The funding will allow these entities to maintain aging assets and clear project backlogs especially for projects which were delayed during the initial outbreak of the COVID-19 pandemic, as well as supporting economic activity and revenue growth. A relatively smaller proportion of our products has been closely tied to residential construction and non-residential construction activity inthe United States andEastern Canada . Activity levels in these markets can be materially affected by general economic and global financial market conditions. In addition, residential construction activity levels are influenced by and sensitive to mortgage availability, the cost of financing a home (in particular, mortgage and interest rates), unemployment levels, household formation rates, residential vacancy and foreclosure rates, existing housing prices, rental prices, housing inventory levels, consumer confidence and government policy and incentives. During 2021, the residential construction activities continued recovering from the brief downturn during the initial outbreak of the pandemic in 2020, driven by improvements in economic activities, increased demand for single-family housing as more people work remotely, as well as historically low mortgage interest rates. Non-residential construction activity is primarily driven by levels of business investment, availability of credit and interest rates, as well as many of the factors that impact residential construction activity levels. See Item 1 "Business."
Mix of Products
We derive our revenues from both the sale of products manufactured to
inventory, such as concrete drainage pipe and DIP, and highly engineered
products which are made to order, such as precast concrete products and concrete
pressure pipe. These two product categories differ in their dynamics. The mix of
products our customers order is project driven and varies from period to period.
We generally recognize revenue at the time of shipment of our products; however,
for some of our highly engineered structural precast products, we recognize
revenue on a percentage of completion method, which accounted for 1.7% of our
total sales in 2021.
Most of our products are sold on a one-off basis, with volumes and prices
determined frequently based on market participants' perceptions of short-term
supply and demand factors. A shortage of capacity or excess capacity in the
industry, or in the regions where we have operations, or the behavior of our
competitors, can each result in significant increases or decreases in market
prices for these products, often within a short period of time. By contrast, our
project-driven business involves highly engineered and customized products with
a wide range of contract values. The products for these projects are engineered,
manufactured and delivered on the basis of contracts that tend to extend over
periods of several months or, in some cases, several years. The timing of the
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commencement of a project and the progress and completion of work under a contract, therefore, can have a significant effect on our results of operations for a particular period.
Average Selling Prices The average selling prices we are able to obtain for our products affect our results of operations and our margins. Our average selling price can vary by market location, particularly in our Drainage Pipe and Products segment, product mix, factors relating to supply and demand, and the actions of our customers and competitors. The average selling prices for our products increased in 2021 over the average selling prices we received in 2020 in both our Water and Drainage segments. For a discussion of changes to average selling price see the discussion by segment in "Results of Operations" below.
Cost of Goods Sold
Costs of raw material and other inputs, supplies, labor (including contract labor), freight and energy constitute a large portion of our cost of goods sold, and fluctuations in the prices of these materials and inputs affect our results of operations and, in particular, our margins. Our primary raw materials in our Drainage Pipe and Products segment are cement, aggregates, and steel. We typically negotiate contracts with suppliers of these materials for one to three years, with prices subject to annual revisions. The primary input in our Water business is scrap steel, which we purchase on the spot market, and its costs can vary significantly from period to period. We do not generally hedge our raw material purchases but rather utilize our product pricing strategy to manage our exposure to fluctuations in our raw material costs. The costs of our raw materials increased significantly during 2021 over 2020, in particular the costs of steel and scrap steel.
Seasonality and Weather Conditions
The construction industry, and therefore demand for our products, is typically seasonal and highly dependent on weather conditions, with periods of snow or heavy rain negatively affecting construction activity. Because the majority of our products are buried underground, we experience lower demand for our products in periods of cold weather, particularly during winter, and periods of excessive rain or flooding. These types of conditions or other unfavorable weather conditions generally lead to seasonal fluctuations in our quarterly financial results. Historically, our net sales in the second and third quarters have been higher than in the other quarters of the year, particularly the first quarter. In addition, unfavorable weather conditions, such as hurricanes or severe storms, or public holidays during peak construction periods can result in temporary cessation of projects and a material reduction in demand for our products and consequently have an adverse effect on our net sales. Results of a fiscal quarter may therefore not be a reliable basis for the expectations of a full fiscal year and may not be comparable with the results in the other fiscal quarters in the same year or prior years.
Our Business Strategy
Our strategy is focused on continued execution of our five improvement pillars:
health and safety of our team members, plant-level operational discipline,
enhanced commercial capabilities, working capital efficiency, and general and
administrative effectiveness. See Item 1 "Business" These pillars are designed
to expand our product margin so that we can earn a full and fair return on the
products we produce and the capital we deploy. We are also committed to
strengthening our capital structure through a combination of working capital
improvement, debt repayment and prudent investment in the business. Prudent
investment in the business includes growth capital expenditures in projects and
smaller acquisitions. Our near-term goal is to reduce our net leverage ratio to
3x-3.5x. After achieving that, we will cautiously evaluate our capital
allocation plans going forward to maximize values to our stakeholders.
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Principal Components of Results of Operations
Net sales consist of the consideration received or receivable for the sale of products in the ordinary course of business and include the billable costs of delivery of our products to customers, net of discounts given to the customer. Net sales include any outbound freight charged to the customer. Revenue on certain long-term engineering and construction contracts for our structural precast and products that are designed and engineered specifically for the customer is recognized under the percentage-of completion method. See Note 2 to our consolidated financial statements.
Cost of Goods Sold
Cost of goods sold includes raw materials and other inputs (cement, aggregates, scrap, and steel) and supplies, labor (including contract labor), freight (including outbound freight for delivery of products to end users and other charges such as inbound freight), energy, depreciation and amortization, repairs and maintenance and other cost of goods sold.
Selling, General and Administrative Expenses
Selling, general and administrative expenses include expenses for sales, marketing, legal, accounting and finance services, human resources, customer support, treasury and other general corporate services. Selling, general and administrative expenses also include transaction costs directly related to business combinations.
Earnings from Equity Method Investee
Earnings from equity method investee represents our share of the income of the CP&P joint venture we entered into withAmericast, Inc. CP&P is engaged primarily in the manufacture, marketing, sale and distribution of concrete pipe and precast products inVirginia ,West Virginia ,Maryland ,North Carolina ,Pennsylvania andSouth Carolina with sales to contiguous states. See Note 6 to the consolidated financial statements for additional information on CP&P.
Other Operating Income
The remaining categories of operating income and expenses consist of scrap income (associated with scrap from the manufacturing process or remaining scrap after plants are closed), insurance gains, rental income, as well as net gain or loss on the sale of assets including property, plant and equipment.
Interest Expense
Interest expense represents interest on the indebtedness.
Income Tax Expense
Income tax expense consists of federal, state, provincial, local and foreign taxes based on income in the jurisdictions in which we operate.
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Results of Operations
Year Ended
The following table summarizes certain financial information relating to our operating results for the years endedDecember 31, 2021 andDecember 31, 2020 (in thousands). Year ended Year ended December 31, December 31, Statements of Income Data: 2021 2020 % Change Net sales$ 1,858,270 $ 1,594,506 16.5% Cost of goods sold 1,437,872 1,217,833 18.1% Gross profit 420,398 376,673 11.6% Selling, general and administrative expenses (216,146) (221,770) (2.5)% Impairment and exit charges (645) (2,511) (74.3)% Other operating income, net 13,763 1,409 876.8% (203,028) (222,872) (8.9)% Income from operations 217,370 153,801 41.3% Other income (expenses) Interest expense (74,976) (79,890) (6.2)% Gain (loss) on extinguishment of debt - (12,256) * Earnings from equity method investee 12,592 11,291 11.5% Income before income taxes 154,986 72,946 * Income tax expense (38,669) (8,460) * Net income$ 116,317 $ 64,486 80.4%
* Represents positive or negative change in excess of 100%
Net sales for the year endedDecember 31, 2021 were$1,858.3 million , an increase of$263.8 million or 16.5% from$1,594.5 million for the year endedDecember 31, 2020 . The increase was the combination of a$157.7 million increase in our in our Water Pipe & Products segment due to both higher average selling prices and higher shipment volumes, and a$106.1 million increase in our Drainage Pipe & Products segment mostly driven by higher shipment volumes.
Cost of Goods Sold
Cost of goods sold for the year endedDecember 31, 2021 were$1,437.9 million , an increase of$220.1 million or 18.1% from$1,217.8 million for the year endedDecember 31, 2020 . The increase in cost of goods sold was the combination of a$156.4 million increase in our Water Pipe & Products segment due to both higher raw material, labor, and freight costs and higher shipment volumes, and a$63.5 million increase in our Drainage Pipe & Products segment primarily due to higher shipment volumes. Specifically, for our Water Pipe & Products segment, the industry average cost of scrap metal increased by more than 50% year-over-year. In addition, unit freight and labor costs increased by more than 25% and 5% year-over-year, respectively. 52
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Gross profit in the year ended
Selling, General and Administrative Expenses
Selling, general and administrative expenses in the year endedDecember 31, 2021 were$216.1 million , a slight decrease compared to$221.8 million in the year endedDecember 31, 2020 .
Impairment and Exit Charges
Impairment and exit charges in the year ended
Other Operating Income, net
Other operating income, net increased to$13.8 million in the year endedDecember 31, 2021 , compared to$1.4 million in the year endedDecember 31, 2020 . The increase was primarily due to$10.3 million of gains from disposal of properties, plant and equipment during the year as we continue optimizing our asset portfolio. Interest Expense Interest expense in the year endedDecember 31, 2021 was$75.0 million , a decrease of$4.9 million , or 6.2%, from$79.9 million in the year endedDecember 31, 2020 . Lower LIBOR and lower average outstanding term loan balances year-over-year contributed a$12.3 million decrease in interest expenses, which was partially offset by$6.3 million impact of a full year of interest expense on the$500 million senior secured notes that were issued inJuly 2020 .
Gain (loss) on extinguishment of debt
Loss on extinguishment of debt in the year endedDecember 31, 2020 was$12.3 million . There was no loss on extinguishment of debt in the year endedDecember 31, 2021 . The loss in 2020 was primarily driven by the write-off of the deferred debt issuance cost of$13.1 million associated with our$612.5 million term loan prepayment at par with the proceeds from the offering of our Senior Notes and cash on hand, slightly offset by a gain from our$83.5 million open-market term loan repurchases at small discounts.
Income Tax Expense
Income tax expense in the year endedDecember 31, 2021 was$38.7 million , an increase of$30.2 million from an income tax expense of$8.5 million in the year endedDecember 31, 2020 . The change is primarily due to the improvement of our operating income in 2021 to$155.0 million , compared to$72.9 million in 2020. In addition, the prior year income tax expense was offset by an$11.5 million reversal of valuation allowance. 53
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Segment Results of Operations
(in thousands) For the year ended December 31,
2021 2020(2) % Change
Net sales:
Drainage Pipe & Products $ 993,464 $ 887,420 11.9 %
Water Pipe & Products 864,806 707,086 22.3 %
Corporate and Other - -
Total $ 1,858,270 $ 1,594,506 16.5 %
Gross profit (loss):
Drainage Pipe & Products 254,076 211,568 20.2 %
Water Pipe & Products 166,378 165,078 0.8 %
Corporate and Other (56) 27 *
Total $ 420,398 $ 376,673 11.6 %
Segment EBITDA(1):
Drainage Pipe & Products 239,860 187,547 27.9 %
Water Pipe & Products 150,412 145,451 3.4 %
Corporate and Other (77,754) (90,666) (14.2) %
Key Operational Statistics % Change
Drainage Pipe & Products(2)
Shipment Volumes +11%
Average Selling Prices +2%
Water Pipe & Products(3)
Shipment Volumes +12%
Average Selling Prices +10%
(1) For purposes of evaluating segment performance, the Company's chief
operating decision maker reviews earnings before interest, taxes, depreciation
and amortization, or EBITDA, as a basis for making the decisions to allocate
resources and assess performance. Our discussion below includes the primary
drivers of EBITDA. See Note 21, Segment Reporting, to the condensed consolidated
financial statements for segment EBITDA reconciliation to income (loss) before
income taxes.
(2) Operational statistics only pertain to pipe and precast products and do
not include other services, non-volume-based products, or non-core products.
Pipe and precast products revenue accounted for more than 87% of Drainage
segment revenue.
(3) Operational statistics only pertain to ductile iron pipe products and do
not include other services, non-volume-based products, or non-core products.
Ductile iron pipe products revenue accounted for more than 88% of Water segment
revenue.
* Represents positive or negative change in excess of 100%.
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Table of Contents Drainage Pipe & ProductsNet Sales Net sales in the year endedDecember 31, 2021 were$993.5 million , an increase of$106.0 million , or 12.0%, from$887.4 million in the year endedDecember 31, 2020 . The increase was primarily driven by higher shipment volumes in our pipe and precast products as the economy continued to recover from the COVID-19 pandemic. Pipe and precast products revenues accounted for more than 85% of the net sales in this segment. Gross Profit
Gross profit in the year ended
Water Pipe & Products
Net sales in the year endedDecember 31, 2021 were$864.8 million , an increase of$157.7 million or 22.3% from$707.1 million in the year endedDecember 31, 2020 . The increase was primarily the combination of$68.0 million driven by higher shipment volumes and$63.3 million driven by higher average selling prices of our ductile iron pipe products. Ductile-iron pipe sales accounted for more than 85% of the net sales in this segment.
Gross Profit
Gross profit in the year ended
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Year Ended
The following table summarizes certain financial information relating to our operating results for the years endedDecember 31, 2020 andDecember 31, 2019 (in thousands). Year ended Year ended December 31, December 31, Statements of Income Data: 2020 2019 % Change Net sales$ 1,594,506 $ 1,529,752 4.2 % Cost of goods sold 1,217,833 1,233,370 (1.3) % Gross profit 376,673 296,382 27.1 % Selling, general and administrative expenses (221,770) (221,770) - % Impairment and exit charges (2,511) (3,520) (28.7) % Other operating income, net 1,409 1,094 28.8 % (222,872) (224,196) (0.6) % Income from operations 153,801 72,186 * Other income (expenses) Interest expense (79,890) (94,970) (15.9) % Gain (loss) on extinguishment of debt (12,256) 1,708 * Earnings from equity method investee 11,291 10,466 7.9 % Income (loss) before income taxes 72,946 (10,610) * Income tax (expense) benefit (8,460) 3,279 * Net income (loss)$ 64,486 $ (7,331) *
* Represents positive or negative change in excess of 100%
Net sales for the year endedDecember 31, 2020 were$1,594.5 million , an increase of$64.7 million or 4.2% from$1,529.8 million for the year endedDecember 31, 2019 . The increase was the net effect of a$90.3 million increase in our in our Water Pipe & Products segment mostly due to higher average selling prices; partially offset by a decrease of$25.6 million in our Drainage Pipe & Products segment primarily driven by lower shipment volumes, partially offset by higher average selling prices.
Cost of Goods Sold
Cost of goods sold for the year endedDecember 31, 2020 were$1,217.8 million , a decrease of$15.6 million or 1.3% from$1,233.4 million in the year endedDecember 31, 2019 . The small decrease in cost of goods sold was the net effect of a$36.2 million decrease in our Drainage Pipe & Products segment primarily driven by lower shipment volumes, partially offset by an increase of$20.8 million in our Water Pipe & Products segment primarily due to a slight year-over-year increase in shipment volumes while unit cost of sales remained relatively flat. 56
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Table of Contents Gross Profit Gross profit in the year endedDecember 31, 2020 was$376.7 million , an increase of$80.3 million , or 27.1%, from$296.4 million in the year endedDecember 31, 2019 . Gross profit in both our Water Pipe & Products segment and our Drainage Pipe & Products segment increased by$69.5 million and$10.6 million , respectively, primarily due to higher average selling prices in both businesses, partially offset by the volume decline in our Drainage Pipe & Products segment.
Selling, General and Administrative Expenses
Selling, general and administrative expenses in the year endedDecember 31, 2020 were$221.8 million , the same as$221.8 million in the year endedDecember 31, 2019 . Higher incentive compensation expenses of$6.1 million driven by better results were partially offset by lower travel expenses of$3.1 million , and lower executive severance expenses of$2.5 million in 2020 compared to 2019.
Impairment and Exit Charges
Impairment and exit charges in the year endedDecember 31, 2020 were$2.5 million , compared to$3.5 million in the year endedDecember 31, 2019 . The exit charges in both years primarily related to plant closings undertaken for the purpose of achieving operating efficiencies.
Interest Expense
Interest expense in the year endedDecember 31, 2020 was$79.9 million , a decrease of$15.1 million , or 15.9%, from$95.0 million in the year endedDecember 31, 2019 . The decrease in interest expense was primarily driven by both the impact of lower LIBOR of$12.3 million and the impact of lower average outstanding debt balance of$4.0 million as we continued voluntarily prepaying our term loan, partially offset by$6.3 million impact of higher interest rate on the$500 million senior secured notes that were issued inJuly 2020 . In addition,$5.4 million of the change was related to the decrease of mark-to-market loss on the interest rate swaps year over year.
Gain (loss) on extinguishment of debt
Loss on extinguishment of debt in the year endedDecember 31, 2020 was$12.3 million , compared to a gain of$1.7 million in the year endedDecember 31, 2019 . The loss in 2020 was primarily driven by the write-off of the deferred debt issuance cost of$13.1 million associated with our$612.5 million term loan prepayment at par with the proceeds from the offering of our Senior Notes and cash on hand, slightly offset by a gain from our$83.5 million open-market term loan repurchases at small discounts. The gain in 2019 primarily related to our open-market purchases of term loan at discounts.
Income Tax (Expense) Benefit
Income tax expense in the year endedDecember 31, 2020 was$8.5 million , a change of$11.8 million from an income tax benefit of$3.3 million in the year endedDecember 31, 2019 . The change is primarily due to the improvement of our operating income in 2020 to$72.9 million , compared to an operating loss of$10.6 million in 2019. The increase in income tax expense was partially offset by an$11.8 million reversal of valuation allowance in 2020 as our operating income improved over the prior year. 57
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Segment Results of Operations
(in thousands) For the year ended December 31,
2020 2019(2) % Change
Net sales:
Drainage Pipe & Products $ 887,420 $ 913,033 (2.8) %
Water Pipe & Products 707,086 616,719 14.7 %
Corporate and Other - -
Total $ 1,594,506 $ 1,529,752 4.2 %
Gross profit (loss):
Drainage Pipe & Products 211,568 201,015 5.2 %
Water Pipe & Products 165,078 95,581 72.7 %
Corporate and Other 27 (214) *
Total $ 376,673 $ 296,382 27.1 %
Segment EBITDA(1):
Drainage Pipe & Products 187,547 173,006 8.4 %
Water Pipe & Products(2) 145,451 82,831 75.6 %
Corporate and Other (90,666) (74,219) 22.2 %
Key Operational Statistics % Change
Drainage Pipe & Products(3)
Shipment Volumes -11%
Average Selling Prices +8%
Water Pipe & Products(4)
Shipment Volumes +3%
Average Selling Prices +14%
(1) For purposes of evaluating segment performance, the Company's chief
operating decision maker reviews earnings before interest, taxes, depreciation
and amortization, or EBITDA, as a basis for making the decisions to allocate
resources and assess performance. Our discussion below includes the primary
drivers of EBITDA. See Note 21, Segment Reporting, to the condensed consolidated
financial statements for segment EBITDA reconciliation to income (loss) before
income taxes.
(2) During the fourth quarter of 2020, we reclassified the pressure pipe
business from Water segment to Drainage segment to better align with our
organizational structure. The US and Canadian Pressure Pipe businesses were
formerly managed by the Water segment management team, however Forterra changed
its internal management structure to include the remaining Canadian Pressure
Pipe plant under the same management team that oversees the Canadian Pipe &
Precast operations. As a result, historical segment data reported in our 2019
Form 10-K was updated to reflect the current segment compositions.
(3) Operational statistics only pertain to pipe and precast products and do
not include other services, non-volume-based products, or non-core products.
Pipe and precast products revenue accounted for more than 85% of Drainage
segment revenue.
(4) Operational statistics only pertain to ductile iron pipe products and do
not include other services, non-volume-based products, or non-core products.
Ductile iron pipe products revenue accounted for more than 85% of Water segment
revenue.
* Represents positive or negative change in excess of 100%.
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Table of Contents Drainage Pipe & ProductsNet Sales Net sales in the year endedDecember 31, 2020 was$887.4 million , a decrease of$25.6 million , or 2.8%, from$913.0 million in the year endedDecember 31, 2019 . The decrease was primarily the net effect of a$91.3 million decrease due to lower shipment volumes in our pipe and precast products driven by less favorable weather in 2020 compared to 2019, temporary project delays related to the COVID-19 pandemic, as well as our margin-enhancing "value before volume" commercial strategy; partially offset by a$53.7 million increase driven by higher average selling price in our pipe and precast products. Pipe and precast products revenues accounted for more than 85% of the net sales in this segment. The remaining increase in net sales was primarily related to our structural precast business and was driven by higher shipment volumes.
Gross Profit
Gross profit in the year ended
Water Pipe & ProductsNet Sales Net sales in the year endedDecember 31, 2020 were$707.1 million , an increase of$90.4 million or 14.7% from$616.7 million in the year endedDecember 31, 2019 . The increase was primarily the combination of$76.2 million driven by higher average selling prices and$13.9 million driven by higher shipment volumes of our ductile iron pipe products. Ductile-iron pipe sales accounted for more than 85% of the net sales in this segment.
Gross Profit
Gross profit in the year ended
Liquidity and Capital Resources
Our available cash and cash equivalents, borrowing availability under our$350.0 million Revolver, and funds generated from operations are our most significant sources of liquidity. While we believe these sources will be sufficient to finance our working capital requirements, planned capital expenditures that are essential, debt service obligations, lease payment obligations and other cash requirements for at least the next 12 months, our long-term future liquidity requirements will depend in part upon our operating performance, which will be affected by prevailing economic conditions, including those related to the COVID-19 pandemic, and financial, business and other factors, some of which are beyond our control. See "Risk Factors" in Part I, Item 1A of this Form 10-K. Other long-term liquidity requirements may include strategic transactions. As ofDecember 31, 2021 and 2020, we had approximately$56.8 million and$25.7 million of cash and cash equivalents, respectively, of which$19.0 million and$12.5 million , respectively, were held by foreign subsidiaries. All of the cash and cash equivalents as ofDecember 31, 2021 and 2020 were readily convertible as of such dates into currencies used in the Company's operations, including theU.S. dollar. As a result of recent tax reform legislation, we can repatriate the cumulative undistributed foreign earnings back to theU.S. when needed with minimal additional taxes other than state income and foreign withholding tax. 59
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In connection with the IPO, we entered into a tax receivable agreement withLone Star that provides for the payment by us toLone Star of specified amounts in respect of any cash savings as a result of the utilization of certain tax benefits. The actual utilization of the relevant tax benefits as well as the timing of any payments under the tax receivable agreement will vary depending upon a number of factors, including the amount, character and timing of our and our subsidiaries' taxable income in the future. However, we expect that the payments we make under the tax receivable agreement could be substantial. The tax receivable agreement also includes provisions that restrict the incurrence of debt and require that we make an accelerated payment toLone Star equal to the present value of all future payments due under the tax receivable agreement, in each case under certain circumstances. Because of the foregoing, our obligations under the tax receivable agreement could have a substantial negative impact on our liquidity and could have the effect of delaying, deferring or preventing certain mergers, asset sales, other forms of business combinations or other changes of control. The passage of the TCJA significantly reduced the Company's anticipated liability under the tax receivable agreement. Our liability recorded for the tax receivable agreement atDecember 31, 2021 andDecember 31, 2020 was$55.9 million and$64.2 million , respectively, with$7.7 million and$8.3 million , respectively, being classified as short-term. For the years endedDecember 31, 2021 andDecember 31, 2020 , we paid$8.3 million and$13.1 million , respectively, toLone Star under the tax receivable agreement. Our forecast for payments under the tax receivable agreement in 2022 is expected to be in the range of$7 million to$9 million . We expect that future annual payments under the tax receivable agreement will decline each year in accordance with our tax basis depreciation and amortization schedule unless future transactions result in an acceleration of our tax benefits under the agreement. See Item 1A, Risk Factors and Note 16 to the consolidated financial statements. Financing Arrangements During the year endedDecember 31, 2020 , we voluntarily prepaid$203.5 million of our Term Loan and prepaid$492.5 million of our Term Loan using the net proceeds from the offering of the senior secured notes, as further described below. No voluntary debt prepayments were made during the year endedDecember 31, 2021 . As ofDecember 31, 2021 , we had$402.4 million outstanding balance under our Term Loan. AtDecember 31, 2021 , we had no borrowings under our Revolver and our available borrowing capacity under the Revolver was$317.9 million . The Revolver provides for an aggregate principal amount of up to$350.0 million , with up to$330.0 million to be made available to theU.S. borrowers and up to$20.0 million to be made available to the Canadian borrowers. Subject to the conditions set forth in the revolving credit agreement, the Revolver may be increased by up to the greater of (i)$100.0 million and (ii) such amount as would not cause the aggregate borrowing base to be exceeded by more than$50.0 million . Borrowings under the Revolver may not exceed a borrowing base equal to the sum of (i) 100% of eligible cash, (ii) 85% of eligible accounts receivable and (iii) the lesser of (a) 75% of eligible inventory and (b) 85% of the orderly liquidation value of eligible inventory, with theU.S. and Canadian borrowings being subject to separate borrowing base limitations. The Revolver bears interest at a rate equal to LIBOR or CDOR plus a margin ranging from 1.75% to 2.25% per annum, or an alternate base rate, Canadian prime rate or Canadian base rate plus a margin ranging from 0.75% to 1.25% per annum, in each case, based upon the average excess availability under the Revolver for the most recently completed calendar quarter and our total leverage ratio as of the end of the most recent fiscal quarter for which financial statements have been delivered. The Revolver matures onJune 17, 2025 , subject to earlier maturity if greater than$75.0 million of our Term Loan remains outstanding 91 days prior to the scheduled maturity of the term loan credit facility or any refinancing thereof. The Term Loan, as amended, provides for a$1.25 billion senior secured term loan. Subject to the conditions set forth in the term loan agreement, the Term Loan may be increased by (i) up to the greater of$285.0 million and 1.0x consolidated EBITDA ofForterra, Inc. and its restricted subsidiaries for the four quarters most recently ended prior to such incurrence plus (ii) the aggregate amount of any voluntary prepayments, plus (iii) an additional amount, provided certain financial tests are met. See Note 11 to our consolidated financial statements. The Term Loan matures onOctober 25, 2023 and is subject to quarterly amortization equal to 0.25% of the initial principal amount. Interest will accrue on outstanding borrowings thereunder at a rate equal to LIBOR 60
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(with a floor of 1.0%) or an alternate base rate, in each case plus a margin of 3.00% or 2.00%, respectively. Our credit agreement does not provide a mechanism to facilitate the adoption of an alternative benchmark rate for use in place of LIBOR. We plan to monitor the expected phase-out of LIBOR and may seek to renegotiate the benchmark rate with our lenders in the future. See Item 1A. "Risk Factors." The Revolver and the Term Loan contain customary representations and warranties, and affirmative and negative covenants, that, among other things, restrict our ability to incur additional debt, incur or permit liens on assets, make investments and acquisitions, consolidate or merge with any other company, engage in asset sales and pay dividends and make distributions. The Revolver contains a financial covenant restrictingForterra from allowing its fixed charge coverage ratio to drop below 1.00:1.00 during a compliance period, which is triggered when the availability under the Revolver falls below a threshold. The fixed charge coverage ratio is the ratio of consolidated earnings before interest, depreciation, and amortization, less cash payments for capital expenditures and income taxes to consolidated fixed charges (interest expense plus scheduled payments of principal on indebtedness). The Term Loan does not contain any financial covenants. Obligations under the Revolver and the Term Loan may be accelerated upon certain customary events of default (subject to grace periods, as appropriate). As ofDecember 31, 2021 , we were in compliance with all applicable covenants under the Revolver and the Term Loan. OnJuly 16, 2020 , two of our subsidiaries,Forterra Finance, LLC andFRTA Finance Corp. , completed the issuance of$500 million senior secured notes, or the Notes, that are dueJuly 15, 2025 . The Notes have a fixed annual interest rate of 6.50%. Obligations under the Notes are guaranteed by us and our existing and future subsidiaries (other than the issuers) that guarantee the Term Loan and the obligations of theU.S. borrowers under the Revolver. The Notes and the related guarantees are secured by first-priority liens on the collateral that secures the Term Loan on a first-priority basis (which is generally all assets other than those that secure the Revolver on a first-priority basis as set forth below) and second-priority liens on the collateral that secures the Revolver on a first-priority basis (which is generally inventory, accounts receivable, deposit accounts, securities accounts, certain intercompany loans and related assets), which second-priority liens is ratable with the liens on such assets securing the obligations under the Term Loan and junior to the liens on such assets securing the Revolver. Upon closing onJuly 16, 2020 , we used the net proceeds from this offering to repay$492.5 million of the principal amount of the Term Loan at par, plus accrued interest.
Parent Issuer and Subsidiary Guarantor Summarized Financial Information
The following information contains the summarized financial information for the
parent (
This consolidated summarized financial information has been prepared from the Company's financial information on the same basis of accounting as the Company's consolidated financial statements. Transactions between the parent and subsidiary guarantors presented on a combined basis have been eliminated. The principal elimination entries relate to investments in subsidiaries and intercompany balances and transactions. Certain costs have been partially allocated to all of the subsidiaries of the Company.
The subsidiary guarantors are 100% owned by the Company. All guarantees are full
and unconditional and are joint and several. There are no significant
restrictions on the ability of the Company to obtain funds from its
Summarized financial information for the two most recent annual periods was as follows (in thousands):
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Parent - Forterra, Inc. and Subsidiary
Guarantors
December 31, 2021 December 31, 2020
Current assets $ 566,907 $ 443,839
Intercompany payable to non-guarantor subsidiaries 7,334 8,384
Non-current assets 1,085,017 1,115,191
Current liabilities 277,093 267,672
Non-current liabilities 1,153,624 1,176,492
Parent - Forterra, Inc. and Subsidiary
Guarantors
Year ended December Year ended December
31, 2021 31, 2020
Net sales $ 1,752,627 $ 1,514,556
Gross profit 374,792 347,854
Income before taxes 123,513 58,880
Net income 91,277 52,273
Cash Flows
The following table sets forth a summary of the net cash provided by (used in)
operating, investing and financing activities for the periods presented (in
thousands).
Year ended Year ended Year ended
December 31, December 31, December 31,
2021 2020 2019
Statement of Cash Flows data:
Net cash provided by operating activities$ 100,514
Net cash used in investing activities (48,008) (18,373) (42,295) Net cash used in financing activities (21,236) (234,272) (106,181)
Net Cash Provided by Operating Activities
Changes in operating cash flows between the periods are primarily due to the change in income from operations, timing of collections and payments, as well as the change in our inventory as compared to the prior year periods. Operating cash flow decreased to$100.5 million in 2021 as compared to$243.2 million in 2020 primarily due to$159.2 million changes in net working capital items as compared to the prior year, partially offset by a$35.9 million increase in cash income from operations. Operating cash flow increased to$243.2 million in 2020 as compared to$146.8 million in 2019 primarily due to higher income from operations and better working capital management. 62
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Net cash used in investing activities was$48.0 million for the year endedDecember 31, 2021 primarily due to capital expenditures of$65.6 million and acquisition ofBarbour of$7.3 million , partially offset by proceeds from the sale of fixed assets of$24.9 million . Net cash used in investing activities was$18.4 million for the year endedDecember 31, 2020 primarily due to capital expenditures of$34.0 million , partially offset by proceeds from the sale of fixed assets of$15.6 million . Net cash used in investing activities was$42.3 million for the year endedDecember 31, 2019 primarily due to capital expenditures of$42.9 million and the acquisition ofBuckner assets of$10.8 million , partially offset by proceeds from the sale of fixed assets of$11.4 million .
Net cash used in financing activities was$21.2 million for the year endedDecember 31, 2021 primarily due to$12.5 million repayments of principal on the Term Loan and$8.3 million payment pursuant to the tax receivable agreement. Net cash used in financing activities was$234.3 million for the year endedDecember 31, 2020 due primarily to$707.6 million repayments of principal on the Term Loan,$13.1 million payment pursuant to the tax receivable agreement, and$11.4 million payment of debt issuance costs, partially offset by proceeds from senior secured notes of$500.0 million . Net cash used in financing activities was$106.2 million for the year endedDecember 31, 2019 due primarily to$95.7 million of repayments of principal on the Term Loan and a$11.4 million payment pursuant to the tax receivable agreement. The$8.3 million payment under the tax receivable agreement in 2021 was pertaining to the 2020 tax year. The$13.1 million payment under the tax receivable agreement in 2020 was pertaining to the 2019 tax year. Capital Expenditures Under normal circumstances, our annual sustaining capital expenditures would average$45.0 million to$55.0 million . Our capital expenditures were$65.6 million for the year endedDecember 31, 2021 ,$34.0 million for the year endedDecember 31, 2020 , and$42.9 million for the year endedDecember 31, 2019 . Our capital expenditures in 2021 were higher than usual due to certain pandemic-delayed projects originally planned for 2020 that were completed during 2021. The majority of our planned capital spending now is related to equipment, such as plant and mobile equipment, upgrade and expansion of existing facilities, and environmental and permit compliance projects.
Off-Balance Sheet Arrangements
In the ordinary course of our business, we are required to provide surety
bonds and standby letters of credit to secure performance commitments. As of
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Contractual Obligations and Other Long-Term Liabilities
The following table summarizes our significant contractual obligations as ofDecember 31, 2021 . Non-cancelable operating leases are presented net of non-cancelable subleases. Some of the amounts included in the table are based on management's estimate and assumptions about these obligations, including their duration, the possibility of renewal, anticipated actions by third parties and other factors. Because these estimates and assumptions are necessarily subjective, our actual payments may vary from those reflected in the table. Payment Due by Period Total 2022 2023 2024 2025 2026 Thereafter (In thousands) Term loan$ 402,357 $ 12,510 $ 389,847 $ - $ - $ - $ - Notes 500,000 - - - 500,000 - - Interest on indebtedness (1) 28,797 16,084 12,713 - - -
-
Operating leases 145,167 11,381 11,887 11,144 10,320 8,808 91,627 Finance leases 709,129 18,245 18,372 18,605 18,809 18,531 616,567 Total Commitments$ 1,785,450 $ 58,220 $ 432,819 $ 29,749 $ 529,129 $ 27,339 $ 708,194
(1) The interest rate on the Term loan is 4.0%; the interest rate on the Notes is 6.5%.
Additionally, we have accrued approximately$48.2 million associated with the tax receivable agreement in long-term liabilities and$27.3 million of other long-term liabilities as ofDecember 31, 2021 . The risks and uncertainties associated with the tax receivable agreement are discussed above and in Note 16 to the consolidated financial statements.
Application of Critical Accounting Policies and Estimates
Business Combinations
Assets acquired and liabilities assumed in business combination transactions, as defined by ASC 805, Business Combination, are recorded at fair value using the acquisition method of accounting. We allocate the purchase price of acquisitions based upon the fair value of each component which may be derived from various observable and unobservable inputs and assumptions. Initial purchase price allocations are preliminary and subject to revision within the measurement period, not to exceed one year from the date of the transaction. The fair value of property, plant and equipment and intangible assets may be based upon the discounted cash flow method that involves inputs that are not observable in the market (Level 3).Goodwill assigned represents the amount of consideration transferred in excess of the fair value assigned to identifiable assets acquired and liabilities assumed.
Use of estimates
The preparation of our financial statements in conformity withU.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the reporting date, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. These estimates are based on management's best knowledge of current events and actions that the Company may undertake in the future. The more significant estimates made relate to fair value estimates for assets and liabilities acquired in business combinations; accrued liabilities for environmental cleanup, bodily injury and insurance claims; estimates for commitments and contingencies; and estimates for the realizability of deferred tax assets, the tax receivable agreement obligation, inventory reserves, allowance for doubtful accounts and impairment of goodwill and long-lived assets. 64
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Inventories
Inventories are valued at the lower of cost or net realizable value. Our inventories are valued using the average cost and first-in-first-out methods. Inventories include materials, labor and applicable factory overhead costs. The value of inventory is adjusted for damaged, obsolete, excess and slow-moving inventory. Market value of inventory is estimated considering the impact of market trends, an evaluation of economic conditions, and the value of current orders relating to the future sales of each respective component of inventory.
Goodwill represents the excess of costs over the fair value of identifiable assets acquired and liabilities assumed. We evaluate goodwill and intangible assets in accordance with ASC 350,Goodwill and Other Intangible Assets which requires goodwill to be either qualitatively or quantitatively assessed for impairment annually (or more frequently if impairment indicators arise) for each reporting unit. We perform our annual impairment testing of goodwill as ofOctober 1 of each year and in interim periods if events occur that would indicate that it is more likely than not the fair value of a reporting unit is less than carrying value. We first assess qualitative factors to evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as the basis for determining whether it is necessary to perform a quantitative goodwill impairment test. We may bypass the qualitative assessment for any reporting unit in any period and proceed directly with the quantitative analysis. The quantitative analysis compares the fair value of the reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds the fair value, impairment is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. We determine the fair value of our reporting units using a weighted combination of the discounted cash flow method (income approach) and the guideline company method (market approach). Determining the fair value of a reporting unit requires judgment and the use of significant estimates and assumptions. Such estimates and assumptions include future revenue growth rates, gross profit margins, EBITDA margins, future capital expenditures, weighted average costs of capital and future market conditions, among others. We believe the estimates and assumptions used in our impairment assessments are reasonable; however, variations in any of the assumptions could result in materially different calculations of fair value and determinations of whether or not an impairment is indicated. Under the discounted cash flow method, we determine fair value based on estimated future cash flows of each reporting unit including estimates for capital expenditures, discounted to present value using the risk-adjusted industry rate, which reflect the overall level of inherent risk of the reporting unit. Cash flow projections are derived from one year budgeted amounts and five year operating forecasts plus an estimate of later period cash flows, all of which are evaluated by management. Subsequent period cash flows are developed for each reporting unit using growth rates that management believes are reasonably likely to occur. Under the guideline company method, we determine the estimated fair value of each of our reporting units by applying valuation multiples of comparable publicly-traded companies to each reporting unit's projected EBITDA and then averaging that estimate with similar historical calculations using a three-year average. In addition, we estimate a reasonable control premium representing the incremental value that accrues to the majority owner from the opportunity to dictate the strategic and operational actions of the business. Key assumptions for the measurement of an impairment include management's estimate of future cash flows and EBITDA. The estimates of future cash flows and EBITDA are subjective in nature and are subject to impacts from the business risks described in "Item 1A. Risk Factors." Therefore, the actual results could differ significantly from the amounts used for goodwill impairment testing, and significant changes in fair value estimates could occur, resulting in potential impairments in future periods.
For the years ended
Leases Accounting Policy
We determine if an arrangement is a lease at inception. Leases with an initial term of 12 months or less are not recorded on the balance sheet. Operating leases are included in operating lease right-of-use, or ROU,
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assets, accrued liabilities, and long-term operating lease liabilities in the
consolidated balance sheets. Finance leases are included in property, plant and
equipment, accrued liabilities, and long-term finance lease liabilities in the
consolidated balance sheets.
ROU assets represent our right to use an underlying asset for the lease term
and lease liabilities represent our obligation to make lease payments arising
from the lease. Operating lease ROU assets and liabilities are recognized at
commencement date based on the present value of lease payments over the lease
term. As most of our leases do not provide an implicit rate, we use our
incremental borrowing rate based on the information available at commencement
date in determining the present value of lease payments. We use the implicit
rate when readily determinable. The lease terms may include options to extend or
terminate the lease when it is reasonably certain that we will exercise that
option. Lease expense for lease payments is recognized on a straight-line basis
over the lease term.
We have lease agreements with lease and non-lease components, which are
generally accounted for separately. For machinery and equipment leases, such as
forklifts, we account for the lease and non-lease components as a single lease
component.
Income Taxes
The Company computes the provision for income taxes using the asset/liability
method. Deferred tax assets and liabilities are recorded for temporary
differences between the tax basis of assets and liabilities and their reported
amounts in the consolidated financial statements using the statutory tax rates
in effect for the year in which the differences are expected to reverse. The
Company uses the period cost method for Global Intangible Low-taxed Income
("GILTI") provisions, and therefore, has not recorded deferred taxes for basis
differences expected to reverse in future periods.
The Company evaluates the recoverability of its deferred tax assets quarterly
to determine if valuation allowances are required or should be adjusted. In
assessing the need for a valuation allowance, the Company considers all
available evidence for each jurisdiction, including past operating results,
future reversal of taxable and deductible temporary differences, estimates of
future taxable income, and the feasibility of ongoing tax planning strategies.
The measurement of a deferred tax asset is reduced, if necessary, by a valuation
allowance if, based on all available evidence, it is more likely than not that
some portion or all of the deferred tax assets will not be realized.
The Company recognizes a tax benefit for uncertain tax positions only if it
believes it is more-likely-than-not that the position will be sustained upon
examination based solely on the technical merits of the tax position. The
Company evaluates whether a tax position meets the more-likely-than-not
recognition threshold using the assumption that the position will be examined by
the appropriate taxing authority. The tax benefits recognized in the financial
statements from such positions are measured based upon the largest amount that
is more than 50% likely to be realized upon ultimate settlement. Penalties and
interest related to income tax uncertainties, should they occur, are included in
income tax expense in the period in which they are incurred.
Revenue recognition
Revenues are recognized when the risks and rewards associated with the transaction have been transferred to the purchaser, which is demonstrated when all the following conditions are met: evidence of a binding arrangement exists, products have been delivered or services have been rendered, there is no future performance required, fees are fixed or determinable and amounts are collectible under normal payment terms. Sales represent the net amounts charged or chargeable in respect of services rendered and goods supplied, excluding intercompany sales. Sales are recognized net of any discounts given to the customer.
A portion of our sales revenue is derived from sales to distributors. Distributor revenue is recognized when all of the criteria for revenue recognition are met, which is generally the time of shipment to the distributor. All returns and credits are estimable and recognized as contra-revenue.
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We incur shipping costs to third parties for the transportation of building products and bill such costs to customers. For the years endedDecember 31, 2021 , 2020 and 2019, we recorded freight costs of approximately$153.9 million ,$122.7 million , and$131.8 million , respectively, on a gross basis within net sales and cost of goods sold in the accompanying consolidated statements of operations. For certain engineering and construction contracts and building contracting arrangements, we recognize revenue using the percentage of completion method, based on total contract costs incurred to date compared to total estimated cost at completion for each contract. Changes to total estimated contract cost or losses, if any, are recognized in the period in which they are determined. Pre-contract costs are expensed as incurred. If estimated total costs on a contract indicate a loss, the entire loss is provided for in the financial statements immediately. To the extent we have invoiced and collected from customers more revenue than has been recognized as revenue using the percentage of completion method, we record the excess amount invoiced as deferred revenue. Revenue recognized in excess of amounts billed, and balances billed but not yet paid by customers under retainage provisions are classified as a current asset within receivables, net on the balance sheet. For the years endedDecember 31, 2021 ,December 31, 2020 , andDecember 31, 2019 , revenue recognized in continuing operations using the percentage of completion method amounted to 2%, 3%, and 2% of total net sales, respectively. We generally provide limited warranties related to our products which cover manufacturing in accordance with the specifications identified on the face of our quotation or order acknowledgment and to be free of defects in workmanship or materials. The warranty periods typically extend for a limited duration of one year. We estimate and accrue for potential warranty exposure related to products which have been delivered.
Recent Accounting Guidance Adopted
The information set forth under Note 2 to the consolidated financial statements under the caption "Recent Accounting Guidance Adopted" is incorporated herein by reference.
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