FORTERRA, INC. The following discussion and analysis should be read in conjunction with our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 filed with theSEC onFebruary 27, 2020 , or the 2019 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. See the section entitled "Cautionary Statement Concerning Forward-Looking Statements" for a discussion of the risks, uncertainties and assumptions associated with those statements.
Unless otherwise specified or where the context otherwise requires, references
in this Report to "our," "we," "us," "Forterra", the "Company" and "our
business" refer to
Overview
Our Company
We are a manufacturer of pipe and precast products in the United States and
Eastern Canada for a variety of water-related infrastructure applications,
including water transmission, distribution and drainage. We provide critical
infrastructure components for a broad spectrum of construction projects across
infrastructure, residential and non-residential markets. Our suite of products
ranges from large diameter pipe that transports water to and from treatment
centers and manages drainage along major transportation corridors, to smaller
diameter pipe that delivers potable water to, and removes wastewater from, end
users in residential and commercial settings.
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.
• Water Pipe & Products - We are a producer of ductile iron pipe, or
DIP, and concrete pressure pipe.
• 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.
COVID-19 Pandemic
The emergence of the coronavirus disease 2019, or COVID-19, has adversely
affected many industries as well as the economies and financial markets of many
countries, including the United States and Canada , and caused a significant
deceleration of economic activity. While the COVID-19 pandemic did not
materially adversely affect our financial results and business operations in our
first fiscal quarter ended March 31, 2020 , economic and health conditions in the
United States and eastern Canada have changed rapidly since the end of the
quarter. In the short-term, we anticipate demand for our products could
decrease. Some of the decrease in demand will likely be driven by the slowdown
in our end-markets, especially the residential housing market. How long this
decrease in demand lasts will depend on the duration and severity of the
COVID-19 pandemic, the length of time it takes for normal economic and operating
conditions to resume, any additional governmental actions that may be taken,
including extensions of restrictions that are currently in place, and numerous
other uncertainties.
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-------------------------------------------------------------------------------- Under the various local and state orders restricting business operations in response to the COVID-19 pandemic, our operations have been exempted as essential business or critical infrastructure, and our manufacturing facilities have continued to operate. In connection with continuing to operate our manufacturing facilities, we have taken a number of actions designed to safeguard the health of our employees, implementing enhanced safety and health protocols consistent with guidelines promulgated by theUnited States Center for Disease Control andthe World Health Organization , as well as applicable orders from local and state authorities. However, all employees whose jobs allow them to work from home are doing so, and all non-essential business travel has been eliminated. We have also increased the availability of paid leave for our employees to encourage them to stay home if they are ill, both for their own protection and the protection of their coworkers. In addition, in response to the COVID-19 pandemic, we have taken proactive steps to enhance our financial flexibility, liquidity and cash flow, including, but not limited to, limiting capital expenditures to essential maintenance and projects that have the ability to pay for themselves in the short term; temporarily reducing cash compensation for the executive management team and independent members of our board of directors; implementing a hiring freeze and deferring annual employee compensation increases; minimizing overtime hours worked; and drawing down$180.0 million of cash under our revolving credit facility. Looking ahead, we have also formulated contingency plans that would allow us to further decrease costs and cash expenditures in the event that demand for our products declines meaningfully. The COVID-19 pandemic is expected to affect our operations in the second quarter of 2020 and may continue to do so thereafter. The impacts of COVID-19 on our end markets have largely been related to project delays on residential and non-residential projects, as well as a few delays on municipal and infrastructure projects in localized areas that have been heavily impacted by the COVID-19 pandemic. To date in the second quarter, we have experienced a continuation of the demand we saw in the first quarter in our Water Pipe & Products segment, with shipment volumes at or above the same period in 2019. We expect Water Pipe & Products volumes to remain at or slightly below those levels into some or all of May. In our Drainage Pipe & Products segment, volumes to date in the second quarter are approximately 13% below the same period in the prior year, a decrease we believe is driven primarily by continued poor weather inTexas and secondarily by COVID-19 related residential project delays. We expect volumes to remain at or slightly above these levels into some or all of May. At this time, we are unable to project demand and shipment levels beyond May due to the longer-term uncertainty surrounding the direct and indirect impacts of the pandemic. Due to the above circumstances and as described generally in this Form 10-Q, our results of operations for the three month period endedMarch 31, 2020 were not significantly impacted by the COVID-19 pandemic and are, therefore, not necessarily indicative of the results to be expected in future quarters or for the full fiscal year. Due to the fluidity and unprecedented and uncertain nature of the pandemic, we cannot predict the full impact of the COVID-19 pandemic on our business or that of our customers and participants in our supply chain, or on economic conditions generally, including the effects on infrastructure and related construction activity. The ultimate scope and extent of the effects of the COVID-19 pandemic is highly uncertain and will depend on future developments, and such effects could exist for an extended period of time even after the pandemic might end.
For additional information on risk factors that could impact our results, please refer to " Risk Factors " in Part II, Item 1A of this Form 10-Q.
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, and seasonality and weather conditions. Some of the more
important factors are discussed in the 2019 10-K, to which there were no
material changes during the period covered by this report with the exception of
the impacts of the COVID-19 pandemic, which are discussed above.
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--------------------------------------------------------------------------------Principal Components of Results of Operations
Net sales consist of the consideration which we expect to be entitled to for the sale of products in the ordinary course of business and include the billable costs of delivery of our products to customers. Net sales include any outbound freight charged to the end user. Revenue for certain contracts related to our structural precast products that are designed and engineered specifically for the customer is recognized over time using an acceptable input method which utilizes our cost incurred to date relative to total estimated costs at completion to measure progress.
Cost of Goods Sold
Cost of goods sold includes raw materials (cement, aggregates, scrap, steel and clay) 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 any business combinations and other costs incurred with respect to cost savings initiatives.
Impairment and Exit Charges
Impairment and exit charges are primarily comprised of severance and other charges incurred to consolidate certain plants in an effort to optimize our portfolio, as well as asset impairment charges.
Other Operating Income, Net
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 and the gain or loss generated on the sale of assets including property, plant and equipment.
Interest Expense
Interest expense represents interest on indebtedness, including finance lease obligations, the amortization of deferred financing costs, as well as the gain and loss associated with our interest rate swaps.
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, Investment in Equity Method Investee, to the condensed consolidated financial statements for additional information on CP&P.
Income Tax Benefit
Income tax benefit 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
Three Months Ended
Total Company The following table summarizes certain financial information relating to our operating results for the three months endedMarch 31, 2020 andMarch 31, 2019 (in thousands). Three months ended Three months ended Statements of Income Data: March 31, 2020 March 31, 2019 % Change Net sales$ 330,876 $ 291,858 13.4 % Cost of goods sold 272,134 250,053 8.8 % Gross profit 58,742 41,805 40.5 % Selling, general and administrative expenses (54,240 ) (51,391 ) 5.5 % Impairment and exit charges (824 ) (231 ) * Other operating income, net 330 579 (43.0 )% (54,734 ) (51,043 ) 7.2 % Income from operations 4,008 (9,238 ) * Other income (expenses) Interest expense (20,745 ) (24,665 ) (15.9 )% Loss on extinguishment of debt (50 ) - * Earnings from equity method investee 2,799 1,567 78.6 % Loss before income taxes (13,988 ) (32,336 ) (56.7 )% Income tax (expense) benefit (78 ) 7,297 * Net loss$ (14,066 ) $ (25,039 ) *
* Represents positive or negative change in excess of 100%
Net sales for the three months endedMarch 31, 2020 were$330.9 million , an increase of$39.0 million , or 13.4%, from$291.9 million in the three months endedMarch 31, 2019 . The increase primarily came from the Water Pipe & Products segment driven by both higher average selling prices and higher shipments compared to prior year.
Cost of Goods Sold
Cost of goods sold were
Gross Profit
Gross profit increased by$16.9 million , or 40.5%, to$58.7 million in the three months endedMarch 31, 2020 from$41.8 million in the three months endedMarch 31, 2019 . Most of the increase in gross profit related to our Water Pipe & Products segment driven by higher average selling prices, higher shipments, as well as a slight decline in raw material cost compared to prior year. 28 --------------------------------------------------------------------------------
Selling, General and Administrative Expenses
Selling, general and administrative expenses were$54.2 million for the three months endedMarch 31, 2020 , an increase of$2.8 million , or 5.5%, from$51.4 million in the three months endedMarch 31, 2019 . The year-over-year increase is due primarily to higher staff costs as we expand our sales and marketing teams as well as production support teams in both businesses.
Interest Expense
Interest expense for the three months endedMarch 31, 2020 was$20.7 million , a decrease of$4.0 million or 15.9% from$24.7 million in the three months endedMarch 31, 2019 . The decrease was primarily due to lower LIBOR in the first quarter of 2020 compared to prior year.
Income Tax (Expense) Benefit
Income tax expense in the three months endedMarch 31, 2020 was$0.1 million , a change of$7.4 million from an income tax benefit of$7.3 million in the three months endedMarch 31, 2019 . The change is primarily due to the smaller pretax loss during the three months endedMarch 31, 2020 , as well as additional expense related to the federal and state valuation allowance. Segments For the three months ended March 31, (in thousands) 2020 2019 % Change Net sales: Drainage Pipe & Products $ 170,234$ 163,734 4.0 % Water Pipe & Products 160,642 128,124 25.4 % Corporate and Other - - * Total $ 330,876$ 291,858 13.4 % Gross profit (loss): Drainage Pipe & Products 32,555 31,433 3.6 % Water Pipe & Products 26,160 10,735 * Corporate and Other 27 (363 ) * Total $ 58,742$ 41,805 40.5 % Segment EBITDA(1): Drainage Pipe & Products 26,052 25,066 3.9 % Water Pipe & Products 22,873 8,741 * Corporate and Other (19,667 ) (17,086 ) 15.1 %
(1) For the purposes of evaluating segment performance, the Company's chief
operating decision maker reviews earnings before interest, taxes,
depreciation and amortization ("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 17, Segment
Reporting, to the condensed consolidated financial statements for segment
EBITDA reconciliation to income (loss) before income taxes.
* Represents positive or negative change in excess of 100%.
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Drainage Pipe & Products
Net sales in the three months endedMarch 31, 2020 were$170.2 million , an increase of$6.5 million or 4.0% from$163.7 million in the three months endedMarch 31, 2019 . The increase was driven by higher average selling prices partially offset by lower shipments due primarily to unfavorable weather in the first quarter of 2020 as compared to 2019, as well as a sales volume decline in theHouston residential market due primarily to regulatory changes and lower crude oil price. Gross Profit Gross profit in the three months endedMarch 31, 2020 was$32.5 million , a slight increase of$1.1 million or 3.6% from$31.4 million in the three months endedMarch 31, 2019 . The increase was primarily due to higher average selling prices, partially offset by slightly increased input costs such as freight and labor. Water Pipe & ProductsNet Sales Net sales in the three months endedMarch 31, 2020 was$160.6 million , an increase of$32.5 million or 25.4% from$128.1 million in the three months endedMarch 31, 2019 . The increase was due primarily to higher average selling prices, as well as higher shipment volume.
Gross Profit
Gross profit in the three months ended
Liquidity and Capital Resources
We believe our available cash and cash equivalents, borrowing availability under our$300.0 million asset-based revolving credit facility, or the 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 and other cash requirements for at least the next 12 months, our future liquidity 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. As a result, inMarch 2020 we borrowed approximately$180.0 million under the Revolver as a precautionary measure to strengthen our liquidity position and provide financial flexibility during the COVID-19 pandemic. Additionally, we have also delayed some non-essential capital expenditures to preserve liquidity. See " Risk Factors " in Part II, Item 1A of this Form 10-Q. We are currently engaged in a dispute with HeidelbergCement regarding the earnout provision in the purchase agreement entered into in connection with the original acquisition of our business. HeidelbergCement has asserted that a payment should be made in the amount of$100.0 million . Resolution is expected to be determined by a neutral accountant pursuant to the terms of the purchase agreement. If it is determined that we are required to make a significant payment to HeidelbergCement, we may not have sufficient cash to make such payment and may be required to incur additional indebtedness. This dispute is discussed in greater detail in Note 14, Commitments and contingencies, to the condensed consolidated financial statements. As ofMarch 31, 2020 andDecember 31, 2019 , we had approximately$182.4 million and$34.8 million of cash and cash equivalents, respectively, of which$3.1 million and$12.6 million , respectively, were held by foreign subsidiaries. All of the cash and cash equivalents as ofMarch 31, 2020 andDecember 31, 2019 were readily convertible as of such dates into currencies used in the Company's operations, including theU.S. dollar. 30 -------------------------------------------------------------------------------- We have 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 which restrict the incurrence of debt and that 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. See Note 14, Commitments and contingencies, to the condensed consolidated financial statements for additional information regarding the tax receivable agreement. Our forecasted payments under the tax receivable agreement in 2020, pertaining to the 2019 tax year, are expected to be in the range of$8 to$10 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 unplanned transactions result in an acceleration of our tax benefits under the agreement. During the three months endedMarch 31, 2020 , we voluntarily prepaid$5.0 million of our senior term loan and as ofMarch 31, 2020 , we had$1.1 billion outstanding balance under our senior term loan, or, as amended, the Term Loan, and$180.0 million in borrowings outstanding under the Revolver. Availability under the Revolver, based on draws, outstanding letters of credit of$15.4 million , as well as allowable borrowing base as ofMarch 31, 2020 , was$72.1 million . The Revolver provides for an aggregate principal amount of up to$300.0 million , with up to$280.0 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 matures onOctober 25, 2021 . The Term Loan 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. 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 (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. 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 restricting us 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 31
-------------------------------------------------------------------------------- accelerated upon certain customary events of default (subject to grace periods, as appropriate). As ofMarch 31, 2020 , we were in compliance with all applicable covenants under the Revolver and the Term Loan.
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):
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