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 statement 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 pipe and precast products inthe United States andEastern Canada for a variety of 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 77 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.
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 products.
• 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.
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 infrastructure, residential, and non-residential 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."
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. Federal highway spending uses funds predominantly from theFederal Highway Trust Fund , which derives its revenue from taxes on diesel fuel, gasoline and other user fees. The dependability of federal funding allows the state departments of transportation to plan for their long term highway construction and maintenance needs. Funding for the existingU.S. federal transportation funding program extends through 2020. With the nation's infrastructure aging, there is increased demand by states and municipalities for long-term federal funding to support the 40
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construction of new roads, highways and bridges in addition to the maintenance of the existing infrastructure. In addition to federal funding, state, county and local agencies provide highway construction and maintenance funding through various sources such as gas taxes. 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 buried 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 underlying demand for municipalities to repair or replace their water systems depends on the status of the water systems and the availability of funding. 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. 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 amounted to$31.8 million in 2019. 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 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. 41
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Table of Contents 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. 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.
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 commercial and operational excellence programs in both our businesses aimed at expanding unit margins for our products as well as a commitment 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. We are focused on generating cash flow in 2020, a portion of which is expected be utilized to make voluntary repayments on our term loan.
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.
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Table of Contents Cost of Goods Sold Cost of goods sold includes raw materials and other inputs (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 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.
Gain on Sale of Property, Plant and Equipment, Net
Gain on sale of property, plant and equipment, net includes the net gain or loss on the sale of assets including property, plant and equipment.
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, and rental income.
Interest Expense
Interest expense represents interest on the indebtedness.
Income Tax (Expense) Benefit
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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Table of Contents Results of Operations
Year Ended
The following table summarizes certain financial information relating to our operating results for the years endedDecember 31, 2019 andDecember 31, 2018 (in thousands). Year ended Year ended Statements of Income Data: December 31, 2019 December 31, 2018 % Change Net sales$ 1,529,752 $ 1,479,712 3.4% Cost of goods sold 1,233,370 1,234,143 (0.1)% Gross profit 296,382 245,569 20.7% Selling, general and administrative expenses (221,770 ) (209,877 ) 5.7% Impairment and exit charges (3,520 ) (4,336 ) (18.8)% Other operating income, net 1,094 9,523 (88.5)% (224,196 ) (204,690 ) 9.5% Income from operations 72,186 40,879 76.6% Other income (expenses) Interest expense (94,970 ) (78,337 ) 21.2% Gain on extinguishment of debt 1,708 - * Earnings from equity method investee 10,466 10,162 3.0% Other income, net - 6,016 * Loss before income taxes (10,610 ) (21,280 ) (50.1)% Income tax (expense) benefit 3,279 (3,085 ) * Net loss $ (7,331 ) $ (24,365 ) (69.9)%
* Represents positive or negative change in excess of 100%
Net sales for the year endedDecember 31, 2019 were$1,529.8 million , an increase of$50.1 million or 3.4% from$1,479.7 million for the year endedDecember 31, 2018 . The increase was primarily due to higher shipment volumes in our Drainage Pipe & Products segment and higher average selling prices in both segments, partially offset by lower shipment volumes in our Water Pipe & Products segment.
Cost of Goods Sold
Cost of goods sold for the year endedDecember 31, 2019 were$1,233.4 million , a decrease of$0.7 million or 0.1% from$1,234.1 million for the year endedDecember 31, 2018 . Lower shipment volumes and lower cost of scrap metal in our Water Pipe & Products segment, were mostly offset by higher shipment volumes in our Drainage Pipe & Products segment.
Gross Profit
Gross profit in the year endedDecember 31, 2019 was$296.4 million , an increase of$50.8 million , or 20.7%, from$245.6 million in the year endedDecember 31, 2018 . Gross profit increased primarily due to higher shipment volumes in our Drainage Pipe & Products segment, higher average selling prices in both segments, and lower raw material costs in our Water Pipe & Products segment. 44
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Selling, General and Administrative Expenses
Selling, general and administrative expenses in the year endedDecember 31, 2019 were$221.8 million , an increase of$11.9 million or 5.7% from$209.9 million in the year endedDecember 31, 2018 . The increase was primarily due to higher IT costs as we invest in our systems and processes, increased expenses related to various disputes and claims in the ordinary course of our business, increased reserves for credit losses, as well as a$3.7 million executive severance charge primarily related to the change in CEO in 2019.
Impairment and Exit Charges
Impairment and exit charges in the year ended
Other Operating Income
Other operating income for the year endedDecember 31, 2019 was$1.1 million , compared to$9.5 million in the prior year period. The income in the 2018 period primarily related to gains from the disposition of certain property, plant and equipment. Interest Expense Interest expense in the year endedDecember 31, 2019 was$95.0 million , an increase of$16.7 million , or 21.2%, from$78.3 million in the year endedDecember 31, 2018 . The interest expense in 2019 included$7.8 million resulting from the change in the classification of certain leases from operating lease to finance lease as the result of the amendment and restatement of our sale-leaseback transaction completed inJune 2018 . In addition,$7.8 million of the change related to the increase in interest expense due to the mark-to-market on the interest rate swaps year over year. The remainder of the interest expense increase was primarily due to the impact of higher average interest rates.
Other Income, net
Other income, net of
Income Tax (Expense) Benefit
Income tax benefit in the year endedDecember 31, 2019 was$3.3 million , a change of$6.4 million from an income tax expense of$3.1 million in the year endedDecember 31, 2018 . The change is primarily due to the benefit of the favorable valuation allowance movement between the two years that was partially offset with the tax expense recorded on the greater pre-tax earnings in the year endedDecember 31, 2019 compared to the prior year. 45
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Table of Contents Segment Results of Operations
(in thousands) For the year ended December 31,
2019 2018 % Change
Net sales:
Drainage Pipe & Products $ 894,722 $ 811,477 10.3 %
Water Pipe & Products 635,030 668,235 (5.0 )%
Corporate and Other - -
Total $ 1,529,752 $ 1,479,712 3.4 %
Gross profit (loss):
Drainage Pipe & Products 200,321 174,786 14.6 %
Water Pipe & Products 96,275 71,471 34.7 %
Corporate and Other (214 ) (688 ) (68.9 )%
Total $ 296,382 $ 245,569 20.7 %
Segment EBITDA(1):
Drainage Pipe & Products 171,413 156,735 9.4 %
Water Pipe & Products(2) 84,424 64,547 30.8 %
Corporate and Other (74,219 ) (58,802 ) 26.2 %
(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 to our
consolidated financial statements, for segment EBITDA reconciliation to
income (loss) before income taxes.
Drainage Pipe & Products
Net Sales
Net sales increased in the year ended December 31, 2019 was $894.7 million , an
increase of $83.2 million , or 10.3%, from $811.5 million in the year ended
December 31, 2018 . The increase was primarily due to higher shipment volumes as
well as higher average selling prices.
Gross Profit
Gross profit in the year endedDecember 31, 2019 was$200.3 million , an increase of$25.5 million or 14.6% from$174.8 million in the year endedDecember 31, 2018 . The increase was primarily due to higher shipment volumes and higher average selling prices, slightly offset by a higher cost of raw materials.
Water Pipe & Products
Net sales in the year endedDecember 31, 2019 were$635.0 million , a decrease of$33.2 million or 5.0% from$668.2 million in the year endedDecember 31, 2018 . The decrease was due primarily to a decline in sales volumes, partially offset by higher average selling prices. 46
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Table of Contents Gross Profit
Gross profit in the year ended
Year Ended
The following table summarizes certain financial information relating to our operating results for the years endedDecember 31, 2018 andDecember 31, 2017 (in thousands). Year ended Year ended Statements of Income Data: December 31, 2018 December 31, 2017 % Change Net sales$ 1,479,712 $ 1,580,413 (6.4 )% Cost of goods sold 1,234,143 1,327,305 (7.0 )% Gross profit 245,569 253,108 (3.0 )% Selling, general and administrative expenses (209,877 ) (255,034 ) (17.7 )% Impairment and exit charges (4,336 ) (13,220 ) (67.2 )% Other operating income, net 9,523 5,197 83.2 % (204,690 ) (263,057 ) (22.2 )% Income (loss) from operations 40,879
(9,949 ) *
Other income (expenses)
Interest expense (78,337 )
(59,408 ) 31.9 %
Change in tax receivable agreement liability -
46,180 *
Earnings from equity method investee 10,162 12,360 (17.8 )% Other income (expense), net 6,016 (31,915 ) * Loss before income taxes (21,280 ) (42,732 ) (50.2 )% Income tax (expense) benefit (3,085 ) 40,672 * Net loss $ (24,365 ) $ (2,060 ) *
* Represents positive or negative change in excess of 100%
Net sales for the year endedDecember 31, 2018 were$1,479.7 million , a decrease of$100.7 million or 6.4% from$1,580.4 million for the year endedDecember 31, 2017 . The decrease is primarily due to the divestiture of ourU.S. concrete and steel pressure pipe business inJuly 2017 , which contributed$72.7 million in net sales in 2017, and the Foley Transaction, which resulted in a$42.3 million decline in net sales. Excluding the impact of these two transactions, our net sales grew approximately$14.3 million , or 0.9% due primarily to higher average selling prices. Cost of Goods Sold Cost of goods sold were$1,234.1 million for the year endedDecember 31, 2018 , a decrease of$93.2 million or 7.0% from$1,327.3 million in the year endedDecember 31, 2017 . The decrease is due to the divestiture of ourU.S. concrete and steel pressure pipe business, which resulted in a$80.2 million decline in cost of goods sold, as well as the Foley Transaction, which resulted in a$33.2 million decline in cost of goods sold. Costs of 47
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goods sold in our existing businesses increased by
Gross Profit
Gross profit decreased by$7.5 million , or 3.0%, to$245.6 million in the year endedDecember 31, 2018 from$253.1 million in the year endedDecember 31, 2017 . Gross profit decrease was attributed to lower profitability in the Water Pipe and Products segment due primarily to the impact of higher scrap steel, labor and freight costs that were not fully offset by higher average selling prices.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were$209.9 million in the year endedDecember 31, 2018 , a decrease of$45.1 million or 17.7% from$255.0 million in the year endedDecember 31, 2017 . The decrease was due primarily to lower professional fees associated with various cost saving initiatives implemented in 2018 and savings from our divestitures of$5.1 million .
Impairment and Exit Charges
Impairment and exit charges decreased by$8.9 million to$4.3 million in the year endedDecember 31, 2018 from$13.2 million in the year endedDecember 31, 2017 . The decrease was primarily due to a 2017 goodwill impairment of$3.0 million related to our Canadian concrete pressure pipe reporting unit and$7.5 million of long-lived asset impairment related to the sale of ourU.S. concrete and steel pressure pipe business in 2017. See Notes 3 and 8 to the consolidated financial statements. Other Operating Income Other operating income for the year endedDecember 31, 2018 was$9.5 million , compared to$5.2 million in the prior year period. The income in the 2018 period primarily related to gains from the disposition of certain property, plant and equipment deemed not core to our operations.
Interest Expense
Interest expense increased by$18.9 million , or 31.9%, to$78.3 million in the year endedDecember 31, 2018 from$59.4 million in the year endedDecember 31, 2017 . The increase included$10.2 million in higher interest expense related to the change in the classification of certain leases from operating lease to capital lease as the result of the amendment and restatement of our sale-leaseback transaction completed inJune 2018 . Additionally, the mark-to-market gain on the interest rate swaps in the year endedDecember 31, 2018 was$1.4 million as compared to$5.3 million in the prior year. The remainder of the interest expense increase was primarily due to the impact of higher average interest rates.
Change in Tax Receivable Agreement Liability
The passage of the TCJA in 2017 significantly reduced the Company's anticipated liability under the tax receivable agreement. The reduction in the tax receivable agreement resulted in$46.2 million recognized in the Company's statement of operations for the year endedDecember 31, 2017 due primarily to the decrease in the federal corporate tax rate from 35% to 21%. The Company did not have a comparable charge for the year endedDecember 31, 2018 . See Note 16 to the consolidated financial statements.
Other Income (Expense), net
Other income was$6.0 million for the year endedDecember 31, 2018 due primarily to the gain resulting from the Foley Transaction. Other expense of$31.9 million for the year endedDecember 31, 2017 was primarily due to the$32.3 million loss generated by theU.S. Pressure Pipe Divestiture duringJuly 2017 . See Note 3 to the consolidated financial statements. 48
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Table of Contents Income Tax (Expense) Benefit Income tax (expense) benefit changed by$43.8 million to an income tax expense of$3.1 million in the year endedDecember 31, 2018 from an income tax benefit of$40.7 million in the year endedDecember 31, 2017 . The change is due largely to the impact of the lower corporate tax rates enacted inDecember 2017 as a result of the TCJA, the smaller loss before income taxes recorded for the year endedDecember 31, 2018 compared to 2017, inclusion of the global intangible low-tax income, the foreign tax rate differential and the change in valuation allowance. See Note 20 to the consolidated financial statements. OnDecember 22, 2017 , theU.S. government enacted comprehensive tax reform legislation commonly known as the Tax Cuts and Jobs Act, or TCJA. Changes included, but were not limited to, a marginal corporate tax rate decrease from 35% to 21% effective for tax years beginning afterDecember 31, 2017 , the transition ofU.S international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as ofDecember 31, 2017 . During 2017, we provisionally calculated our best estimate of the impact of the TCJA in the year end income tax provision in accordance with our understanding of the TCJA and guidance available at that time and as a result recorded$26.9 million as additional income tax benefit in the fourth quarter of 2017.
Segment Results of Operations
(in thousands) For the year ended December 31,
2018 2017 % Change
Net sales:
Drainage Pipe & Products $ 811,477 $ 834,810 (2.8 )%
Water Pipe & Products 668,235 745,555 (10.4 )%
Corporate and Other - 48 (100.0 )%
Total $ 1,479,712 $ 1,580,413 (6.4 )%
Gross profit (loss):
Drainage Pipe & Products 174,786 147,741 18.3 %
Water Pipe & Products 71,471 108,320 (34.0 )%
Corporate and Other (688 ) (2,953 ) (76.7 )%
Total $ 245,569 $ 253,108 (3.0 )%
Segment EBITDA(1):
Drainage Pipe & Products 156,735 129,618 20.9 %
Water Pipe & Products(2) 64,547 47,587 35.6 %
Corporate and Other (58,802 ) (44,870 ) 31.0 %
(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, for segment EBITDA reconciliation to income (loss) before
income taxes.
(2) For the 2017 period, segment EBITDA included a $32.3 million loss as a
result of the U.S. Pressure Pipe Divestiture in July 2017 .
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Table of Contents Drainage Pipe & ProductsNet Sales Net sales decreased by$23.3 million , or 2.8%, to$811.5 million in the year endedDecember 31, 2018 from$834.8 million in the year endedDecember 31, 2017 . Excluding net sales of$42.3 million associated with the Foley Transaction, net sales increased by$19.0 million or 2.3%. The increase was due primarily to higher average selling prices that offset the impact of a decline in shipments.
Gross Profit
Gross profit was$174.8 million in the year endedDecember 31, 2018 , an increase of$27.1 million , or 18.3%, from$147.7 million in the year endedDecember 31, 2017 . The increase was primarily due to higher average selling prices that more than offset higher cost of goods sold including labor, freight, and raw materials. Water Pipe & ProductsNet Sales For the year endedDecember 31, 2018 , net sales were$668.2 million , a decrease of$77.4 million or 10.4% from$745.6 million for the year endedDecember 31, 2017 . The decrease was primarily attributable to the sale of theU.S. concrete and steel pressure pipe business inJuly 2017 that contributed net sales of$72.7 million . Excluding the impact of the divestiture, net sales declined by 1% due to lower sales of fabrication, fittings and large diameter concrete pressure pipe inCanada that were not fully offset by the growth in sales of ductile iron pipe. The sales growth for ductile iron pipe was due to higher average selling prices. Gross Profit Gross profit was$71.5 million in the year endedDecember 31, 2018 , a decrease of$36.8 million or 34.0% from$108.3 million in the year endedDecember 31, 2017 . The decrease was due primarily to the impact of higher scrap steel, labor and freight costs that were not fully offset by higher average selling prices.
Other
For the year endedDecember 31, 2017 , EBITDA included a$32.3 million loss generated by theU.S. Pressure Pipe Divestiture inJuly 2017 . In addition, for the year endedDecember 31, 2017 , EBITDA included$3.0 million for a goodwill impairment and$7.5 million for long-lived asset impairment charges. See Note 8 to the consolidated financial statements.
Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash from operations and borrowings under our credit agreements. We believe these sources will be sufficient to fund our planned operations and capital expenditures in the next 24 months.
We are currently engaged in a dispute with HeidelbergCement regarding the earnout provision in the purchase agreement entered into in connection with the Acquisition. HeidelbergCement has asserted that a payment should be made in the amount of$100.0 million . Resolution will be determined by a neutral accounting arbitrator 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. See Item 1A. "Risk Factors" and Note 16 to our consolidated financial statements. 50
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As ofDecember 31, 2019 and 2018, we had approximately$34.8 million and$35.8 million of cash and cash equivalents, respectively, of which$12.6 million and$18.1 million , respectively, were held by foreign subsidiaries. All of the cash and cash equivalents as ofDecember 31, 2019 and 2018 were readily convertible as of such dates into currencies used in the Company's operations, including theU.S. dollar. As a result of the TCJA, 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. 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, 2019 andDecember 31, 2018 was$77.4 million and$88.8 million , respectively, with$13.1 million and$15.5 million , respectively, being classified as short-term. For the years endedDecember 31, 2019 andDecember 31, 2018 , we paid$11.4 million and$30.4 million , respectively, toLone Star under the tax receivable agreement. Our forecast for payments under the tax receivable agreement in 2020 is expected to be in the range of$13 to$15 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.
Credit Agreements
During the year endedDecember 31, 2019 , we voluntarily prepaid$87.0 million of our Term Loan and as ofDecember 31, 2019 , we had$1.1 billion outstanding balance under our Term Loan. AtDecember 31, 2019 , we had no borrowings under our Revolver and our available borrowing capacity under the Revolver was$257.7 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, 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. 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 51
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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, 2019 , we were in compliance with all applicable covenants under the Revolver and the Term Loan.
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, 2019 Statement of Cash Flows data:
Net cash provided by operating activities$ 146,786 $
27,196
Net cash used in investing activities (42,295 ) (51,052 ) (66,023 )
Net cash (used in) provided by financing activities (106,181 )
(43,451 ) 86,250
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 increased to$146.8 million in 2019 as compared to$27.2 million in 2018 primarily due to higher income from operations and a decrease in ending inventory. Operating cash flow declined to$27.2 million in 2018 as compared to$42.3 million in the prior year period. Higher income from operations and lower cash taxes in 2018 as compared to 2017 was offset by higher cash interest payments and higher cash utilization associated with changes in assets and liabilities. Excluding the impact of changes in tax-related receivables and payables that resulted in a cash inflow of$12.8 million in 2018 and cash outflow of$43.3 million in 2017, the changes in assets and liabilities in 2018 was a cash use of$52.2 million , compared to a cash use of$14.3 million in the prior year, due primarily to an increase in ending inventory.
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 investing activities was$51.1 million for the year endedDecember 31, 2018 due to capital expenditures of$48.7 million , final net working capital settlement related toU.S. Pressure Pipe Divestiture of$8.5 million , settlement on derivative contracts of$5.0 million , business acquisitions of$4.5 million and other asset acquisitions of$1.9 million , partially offset by cash received from the Foley Transaction of$9.1 million and proceeds from sale of fixed assets of$8.4 million . Net cash 52
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used in investing activities was$66.0 million for the year endedDecember 31, 2017 primarily due to capital expenditures of$52.5 million and Royal acquisition of$35.5 million , partially offset by$23.2 million cash proceeds from theU.S. Pressure Pipe Divestiture.
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. Net cash used in financing activities was$43.5 million for the year endedDecember 31, 2018 due primarily to the payment of$30.4 million under our tax receivable agreement. The$30.4 million payment under the tax receivable agreement in 2018, pertaining to the 2017 tax year, included the impact of accelerated payments as a result of certain transactions completed in 2017, including the sale of theU.S. concrete and steel pressure pipe business, that caused an acceleration of tax benefits subject to the tax receivable agreement. The$11.4 million payment under the tax receivable agreement in 2019 was pertaining to the 2018 tax year. Net cash provided by financing activities was$86.3 million for the year endedDecember 31, 2017 due primarily to proceeds from additional borrowing under the Term Loan.
Capital Expenditures
Our capital expenditures were$42.9 million for the year endedDecember 31, 2019 ,$48.7 million for the year endedDecember 31, 2018 , and$52.5 million for the year endedDecember 31, 2017 . Capital expenditures primarily related to equipment, such as plant and mobile equipment, expansion of existing facilities and environmental and permit compliance projects.
Off-Balance Sheet Arrangements
In the ordinary course of our business, we are required to provide surety bonds
and standby letters of credit to secure performance commitments. As of
Contractual Obligations and Other Long-Term Liabilities
The following table summarizes our significant contractual obligations as ofDecember 31, 2019 . Non-cancelable operating leases are presented net of non-cancelable subleases. Some of the amounts included in the table are based on management's estimate and assumptions about these obligations, including their duration, the possibility of renewal, anticipated actions by third parties and other factors. Because these estimates and assumptions are necessarily subjective, our actual payments may vary from those reflected in the table. Payment Due by Period Total 2020 2021 2022 2023 2024 Thereafter (In thousands) Senior term loan$ 1,123,358 $ 12,510 $ 12,510 $ 12,510 $ 1,085,828 $ - $ - Interest on indebtedness (1) 204,282 54,532 53,774 53,165 42,811 - - Operating leases 160,218 11,858 9,682 9,380 10,127 9,561 109,610 Finance leases 738,967 16,894 17,049 17,300
17,516 17,841 652,367
Total Commitments
(1) The interest rate on the Term loan is 5.52%.
Additionally, we have accrued approximately$64.2 million associated with the tax receivable agreement in long-term liabilities and$21.9 million of other long-term liabilities as ofDecember 31, 2019 . The risks and uncertainties associated with the tax receivable agreement are discussed above and in Note 16 to the consolidated financial statements. 53
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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.
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 54
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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 less than 12 months are not recorded on the balance sheet. Operating
leases are included in operating lease right-of-use, or ROU, 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
Deferred tax assets generally represent items that can be used as a tax
deduction or credit in our tax returns in future years for which a tax benefit
has already been recorded in our income statement. The measurement of a deferred
tax asset is reduced, if necessary, by a valuation allowance if, based on the
available evidence, it is more likely than not that some portion or all of the
deferred tax assets will not be realized. Deferred tax liabilities generally
represent tax expense recognized in the financial statements for which payment
has been deferred, or expense for which we have already taken a deduction in its
tax return but have not yet recognized as expense in the financial statements.
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We finalized our policy and elected to use the period cost method for GILTI provisions, and therefore, have not recorded deferred taxes for basis differences expected to reverse in future periods.
We recognize a tax benefit for uncertain tax positions only if we believe it is more likely than not that the position will be upheld on audit based solely on the technical merits of the tax position. We evaluate uncertain tax positions after the consideration of all available information. Penalties and interest related to income tax uncertainties, should they occur, would be 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.
We incur shipping costs to third parties for the transportation of building products and bill such costs to customers. For the years endedDecember 31, 2019 , 2018 and 2017, we recorded freight costs of approximately$131.8 million ,$127.0 million , and$132.3 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, 2019 ,December 31, 2018 , andDecember 31, 2017 , revenue recognized in continuing operations using the percentage of completion method amounted to 2%, 1%, and 3% 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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