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YoY shift: Neutral
Year-over-year tone shift - average net-tone change across Risk Factors and MD&A vs the prior 10-K. This filing is -0.05pp more bearish than last year's.
Why YoY instead of absolute: the LM lexicon has ~6.6× more negative words than positive (legal/risk-disclosure language is heavy on hedging), so every 10-K reads bearish on raw tone. Year-over-year change strips that bias and surfaces the actual shift in management's framing.
Tone shift by section
The two components the gauge averages: how Risk Factors and MD&A each shifted in net tone versus last year's 10-K. The headline above is their average, so a green needle over a soft section just means the other section carried it.
Risk Factors
+0.05pp
Flat
Net-tone change vs last year's 10-K.
MD&A
-0.15pp
Flat
Net-tone change vs last year's 10-K.
Per-snippet highlights
Sentence-level sentiment highlighting with category and subcategory filters is coming once the snippet-scoring pipeline lands. For now, dig into the actual section text on the Sections tab.
Language change vs prior 10-K
Risk Factors (Item 1A) - words with the biggest YoY frequency increase
Negative rising
adversely+4
divestiture+4
disruptions+3
adverse+2
termination+2
Positive rising
achieve+4
favorable+1
efficiently+1
improvements+1
satisfied+1
Risk Factors (Item 1A)
21,251 words
Item 1A. RISK FACTORS
Our business, operations and financial condition are subject to various risks and uncertainties. We have described below significant factors that may adversely affect our business, operations, financial performance and condition or industry. Additionally, the COVID-19 pandemic has amplified many of the other risks discussed below to which we are subject and, given the unpredictable, unprecedented, and fluid nature of the pandemic, it may also materially and adversely affect our business, financial condition, and operating results in ways that are not currently anticipated by or known to us or that we do not currently consider to present material risk.
Additionally, the COVID-19 pandemic has amplified many of the other risks discussed below to which we are subject and, given the unpredictable, unprecedented, and fluid nature of the pandemic, it may also materially and adversely affect our business, financial condition, and operating results in ways that are not currently anticipated by or known to us or that we do not currently consider to present material risk. You should carefully consider these factors, together with all of the other information in this Annual Report on Form 10-K and in other documents that we file with the SEC, before making any investment decision about our securities. These risks and uncertainties are not the only ones we face. Additional risk and uncertainties presently unknown to us or currently deemed immaterial also may our business operations. developments or changes related to any of the factors listed below or others could materially and affect our business, financial condition, results of operations, future prospects and growth.
Language change vs prior 10-K
MD&A (Item 7) - words with the biggest YoY frequency increase
Negative rising
closing+6
divestitures+4
loss+3
termination+2
negative+2
Positive rising
satisfy+3
good+2
gain+1
positive+1
improvement+1
MD&A (Item 7)
12,026 words
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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 in the United States and Eastern 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 major U.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.
This risk factor summary contains a high-level overview of certain of the principal factors and uncertainties that make an investment in our securities risky, including risks related to our industry and end markets; risks related to our business; production, supply chain and systems related risks; employee specific risks; miscellaneous business risk; indebtedness and liquidity related risks; risks related to the proposed merger; risks related to ownership of our common stock; and risks related to our tax receivable agreement. The following summary is not complete and should be read together with the more detailed discussion of these and the other factors and uncertainties that follows before making an investment decision regarding our securities. The principal factors and uncertainties that makes an investment in our securities risky include:
Risks Related to Our Industry and End Markets
• Our business is based in significant part on government-funded infrastructure projects and building activities, and any reductions or re-allocation of spending or related subsidies in these areas could have a material adverse effect on us.
• Residential and non-residential construction activity is cyclical and influenced by many factors, and any reduction in the activity in one or both of these markets could have a material adverse effect on us.
• We engage in a highly competitive business and any failure to effectively compete could have a material adverse effect on us.
• Changes in construction activity levels in Texas could have a material adverse effect on us.
Risks Related to Our Business
• Our business, results of operations, financial condition, cash flows and stock price have been and in the future may be adversely affected by the COVID-19 pandemic.
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• Our dependence on key customers with whom we do not have long-term contracts and consolidation within our customers’ industries could have a material adverse effect on us.
• The seasonality of our business and its susceptibility to severe and prolonged periods of adverse weather and other conditions could have a material adverse effect on us.
Production, Supply Chain and Systems Related Risks
• Decreased availability or increases in the cost of raw materials could have a material adverse effect on us.
• A material disruption or capacity constraints at one or more of our manufacturing facilities or in our supply chain could have a material adverse effect on us.
• Delays in construction projects and any failure to manage our inventory could have a material adverse effect on us.
Employee Specific Risks
• Labor disruptions and other union activity could have a material adverse effect on us.
• We depend on the services of key executives and any inability to attract and retain key management personnel could have a material adverse effect on us.
• Any failure by us or the contractors with which we work to retain and attract necessary personnel or contract labor could have a material adverse effect on us.
Miscellaneous Business Risks
• Cybersecurity attacks may threaten our confidential information, disrupt operations and result in harm to our reputation and adversely impact our business and financial performance.
• We are subject to increasingly stringent environmental laws and regulations, and any failure to comply with any current or future laws or regulations could have a material adverse effect on us.
• Climate change and climate change legislation or regulations may adversely impact our business.
• Legal and regulatory claims and proceedings could have a material adverse effect on us.
• Any inability to successfully acquire businesses in the future could have a material adverse effect on us.
Indebtedness and Liquidity Related Risks
• The terms of our debt could have a material adverse effect on us.
• Our current indebtedness and any future indebtedness we may incur could have a material adverse effect on us.
• Credit and non-payment risks of our customers could have a material adverse effect on us.
Risks Related to the Proposed Merger
• We may not complete the proposed merger within the time frame we anticipate or at all, which could adversely affect our business.
• Our business is subject to restrictions while the merger is pending.
• The announcement and pendency of the merger may disrupt business relationships, lead to employee departures, or otherwise adversely affect our business.
Risks Related to Ownership of Our Common Stock
• The trading price of our common stock has been and may in the future be volatile and could decline substantially.
• The coverage of our business or our common stock by securities or industry analysts or the absence thereof could adversely affect our stock price and trading volume.
Risks Related to Our Tax Receivable Agreement
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• We will be required to pay Lone Star for certain tax benefits, and these amounts are expected to be material.
• We will not be reimbursed for any payments made to Lone Star under the tax receivable agreement in the event that the tax benefits are disallowed.
Risks Related to Our Industry and End Markets
Our business is based in significant part on government-funded infrastructure projects and building activities, and any reductions or re-allocation of spending or related subsidies in these areas could have a material adverse effect on us.
Our business depends heavily on government spending for infrastructure and other similar building activities. As a result, demand for many of our products is heavily influenced by U.S. and Canadian federal government fiscal policies and tax incentives and other subsidies, as well as state and municipal funding of projects. The infrastructure projects in which we participate are typically funded directly by governments and/or privately-funded but are otherwise tied to or impacted by government policies and spending measures. Government infrastructure spending and governmental policies with respect thereto depend primarily on the availability of public funds, which is influenced by many factors, including governmental budgets, public debt levels, interest rates, existing and anticipated and actual federal, state, provincial and municipal tax revenues, government leadership and the general political climate, as well as other general macroeconomic and political factors. In addition, U.S. federal government funds may only be available based on states’ willingness to provide matching funding, and state funding may not be available, particularly in light of the negative impact of the COVID-19 pandemic on state budgets. Government spending is often approved only on a short-term basis and some of the projects in which our products are used require longer-term funding commitments. If government funding is not approved or funding is lowered, whether as a result of poor economic conditions, lower than expected revenues, competing spending priorities or other factors, it could limit infrastructure projects available, increase competition for projects, result in excess inventory and decrease sales, any of which could adversely affect the profitability of our business.
Additionally, certain regions or states may require or possess the means to finance only a limited number of large infrastructure projects and periods of high demand may be followed by years of little to no activity. There can be no assurances that governments will sustain or increase current infrastructure spending and tax incentive and other subsidy levels, and any reductions thereto or delays therein could have a material adverse effect on our business, financial condition and results of operations.
Residential and non-residential construction activity is cyclical and influenced by many factors, and any reduction in the activity in one or both of these markets could have a material adverse effect on us.
Historically, demand for our products has been closely tied to residential construction and non-residential construction in the United States and Eastern Canada. Our success and future growth prospects depend, to a significant extent, on conditions in these two markets and the degree to which these markets are strong in the future.
The construction industry and related markets are cyclical and have in the past been, and may in the future be, materially and adversely affected by general economic and global financial market conditions. These factors impact not only our business, but those of our customers and suppliers as well. This influence is true with respect to macroeconomic factors within North America, particularly within our geographic footprint in the United States and Eastern Canada. For example, in 2008, residential construction and non-residential construction activity dipped to historically low levels during the financial crisis. As a result, demand for many of our products dropped significantly. More recently, the COVID-19 pandemic has impacted global supply chains, including pricing and availability of many of the materials used in residential construction. Continued supply chain issues within the construction industry could adversely affect demand for our products.
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The markets in the construction industry in which we operate are also subject to other more specific factors. Residential construction activity levels are influenced by and sensitive to a number of factors, including mortgage availability, the cost of financing a home (in particular, mortgage terms and interest rates), unemployment levels, household formation rates, gross domestic product, residential vacancy and foreclosure rates, demand for second homes, existing housing prices, rental prices, housing inventory levels, building mix between single- and multi-family homes, consumer confidence, seasonal weather factors, the available labor pool and government regulation, 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.
We cannot control the foregoing factors, we cannot be certain that residential and non-residential construction activity will remain at current levels, and there can be no assurances regarding whether any growth in these markets can be sustained. If construction activity in our markets, and more generally, does remain at current levels, or if there are future downturns, whether locally, regionally or nationally, it could have a material adverse effect on our business, financial condition and results of operations.
We engage in a highly competitive business and any failure to effectively compete could have a material adverse effect on us.
The markets in which we sell our products are highly competitive. We face significant competition from, depending on the segment or product, domestic and imported products produced by local, regional, national and international building product manufacturers, as well as privately owned single-site enterprises. Due in part to the costs associated with transporting our products to our customers, many of our sub-markets are relatively fragmented and include a number of regional competitors. Our competitors include Rinker Materials (a division of QUIKRETE) and Oldcastle Infrastructure (a division of CRH plc), as well as numerous regional and local competitors, in our Drainage Pipe & Products segment, and McWane, Inc. and American Cast Iron Pipe Company in our Water Pipe & Products segment.
Competition among manufacturers in our markets is based on many factors with significant emphasis on price. Our competitors may sell their products at lower prices because, among other things, they possess the ability to manufacture or supply similar products and services more efficiently or at a lower cost or have built a superior sales or distribution network. Some of our competitors may have access to greater financial or other resources than we do, which may afford them greater purchasing power, greater production efficiency, increased financial flexibility or more capital resources for expansion and improvement. In addition, some of our competitors are vertically integrated with suppliers or distributors and can leverage this structure to their advantage to offer better pricing to customers. Furthermore, our competitors’ actions, including restoring idled or expanding manufacturing capacity, or the entry of new competitors into one or more of our markets, particularly in the Drainage business where there are low barriers to entry, could cause us to lower prices in an effort to maintain our customer base. Certain of our products, including gravity pipe, are volume manufacturing products that are widely available from other manufacturers or distributors, with prices and volumes determined frequently based on participants’ perceptions of short-term supply and demand. Competitive factors, including industry overcapacity, could also lead to pricing pressures. For example, competitors may choose to pursue a volume policy to continue utilizing their manufacturing facilities or in attempt to gain market share, each to the detriment of maintaining prices. Excess product supply can result in significant declines in the market prices for these products, often within a short period of time. As a result, at times, to remain competitive, we may lower the price for any one or more of our products to or below our production costs, requiring us to sacrifice margins or incur losses. Alternatively, we may choose to forgo product sales or cease production at one or more of our manufacturing facilities. Conversely, at times when prices are maintained at higher levels, there is greater risk that foreign competitors may enter one or more of our markets, particularly with respect to DIP.
In addition to pricing, we also compete based on service, quality, range of products and product availability. Our competitors may be positioned to provide better service, including faster delivery time on products, and thereby establish stronger relationships with customers and suppliers. Our competitors may also sell preferred products, improve the design and performance of their products, develop a more comprehensive product portfolio, be better positioned to influence end-user product specifications or introduce new products with competitive
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prices and performance characteristics. While the majority of our products are not subject to frequent or rapid stylistic changes, trends do evolve over time, and our competitors may do a better job of predicting market developments or adapt more quickly to new technologies or evolving customer requirements.
We also face competition from substitute and newly designed building products. For example, storm water pipe can be manufactured from concrete, steel, high-density polyethylene (HDPE), polypropylene (PP) or polyvinyl chloride (PVC) and potable water transmission infrastructure can be manufactured using HDPE or PVC. The market share of HDPE and PP pipe, which compete with gravity pipe and concrete pressure pipe for certain applications, and HDPE and PVC pipe, which compete with DIP for certain applications, have increased in recent years. Governments in the past have provided, and may continue in the future, to provide incentives that support or encourage, or in certain instances pass regulations that require, the consideration or use of substitute products with which we compete. Lower costs and pricing of substitute products may challenge our ability to achieve pricing for our products at a level that is consistent with our business plans. Some of the substitute products with which we compete may also offer longer warranties than our typical product warranty, and we may face competitive pressures to offer longer warranties on our products, which could increase our exposure to claims in future years or cause us to lose business. Additionally, new construction techniques and materials will likely be developed in the future. Increases in customer or market preferences for any of these products could lead to a reduction in demand for our products, limit our ability to raise prices or otherwise adversely impact our competitive position.
Any failure by us to compete on price or service, to develop successful products and strategies or to generally maintain and improve our competitive position could have a material adverse effect on our business, financial condition and results of operations.
Changes in construction activity levels in Texas could have a material adverse effect on us.
We currently conduct a significant portion of our business in Texas, which we estimate represented approximately 18% and 18% of our 2021 and 2020 net sales, respectively. Government-funded infrastructure spending, as well as residential and non-residential construction activity in each of these areas has declined from time to time, particularly as a result of slow economic growth, whether in the energy industry or otherwise. Local economic conditions depend on a variety of factors, including national economic conditions, local and state budgets, infrastructure spending and the impact of federal cutbacks. In addition, Texas is susceptible to severe weather and flooding, which can interrupt, delay or otherwise impact the timing of projects. Any decrease in construction activity in Texas could have a material adverse effect on our business, financial condition and results of operations.
A tightening of mortgage lending or mortgage financing requirements or other reductions in the availability of consumer credit or increases in its cost could have a material adverse effect on us.
We depend on net sales generated from residential construction activity. Most home sales in the U.S. and Eastern Canada are financed through mortgage loans, and a significant percentage of renovation and other home repair activity is financed either through mortgage loans or other available credit. To the extent that the economy experiences a cyclical downturn, the financial position of many consumers may be impacted and financial institutions may tighten their lending criteria, as occurred after the 2008 financial crisis, each of which can and did contribute to a significant reduction in the availability of consumer credit and result in a significant reduction in total new housing starts in the U.S. and consequently, a reduction in demand for our products in the residential sector. Similarly, the rate of interest payable on any mortgage or other form of credit will have an impact on the cost of borrowing. While base rates have remained relatively low in recent years, U.S. central bank authorities have indicated an intent to raise such rates in response to inflationary pressures on the economy during 2022, which would increase the cost of borrowing, making the purchase of a home less attractive, which could reduce the number of new housing starts in the U.S. and Eastern Canada. Any future tightening of mortgage lending or other reductions in the availability of consumer credit or increases in its cost, including as a result of rising interest rates and inflation, could have a material adverse effect on our business, financial condition and results of operations.
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Risks Related to Our Business
Our business, results of operations, financial condition, cash flows and stock price have been and in the future may be adversely affected by the COVID-19 pandemic.
Our operations and business have been adversely affected and could in the future be materially and adversely affected, whether directly or indirectly, by the COVID-19 pandemic and the resulting weakening of economic conditions in the United States and eastern Canada. Local, state, provincial and federal governmental authorities initially responded to the pandemic by implementing increasingly stringent measures in geographies where we operate to help control the spread of the virus, including restrictions on movement such as quarantines, “shelter in place,” “stay at home” orders, and travel restrictions, as well as restricting or prohibiting outright some or all forms of commercial and business activity, and other restrictions, including closures of school and childcare facilities. Certain states also enacted regulations that authorize local officials to close businesses where there if a lack of safety precautions in place or signs that transmission of the virus at the workplace has occurred. Although we were and have continued to be categorized as “essential” and therefore permitted to operate our facilities consistent with applicable local, state, provincial and federal orders, any changes in these governmental orders, including the imposition of new orders, changes to the extent or the duration thereof, or any further, more severe, actions taken by governmental authorities or that we may choose to take whether required or not could have a material adverse effect on our operations.
Our customers have been and could continue to be negatively impacted by the COVID-19 pandemic, including as a result of project delays and other adverse impacts on demand, which could result in adverse impacts on our sales and have a material adverse effect on our business, results of operations and financial condition. Similarly, our suppliers and other parts of our supply chain have experienced and could continue to experience disruptions and other adverse impacts as a result of the pandemic that could cause us to be unable to obtain key raw materials and supplies on a timely or cost-effective basis, or in some cases, at all, any of which could result in our being unable to service our customers’ demands, and adversely affect our business and results of operations. For example, prices for certain of our raw material costs, including costs for scrap metal, steel, cement, as well as other key materials needed in smaller amounts to produce and sell our products, such as coke, nitrogen gas, rubber gaskets, and magnesium ferrosilicon, which have historically fluctuated depending on, among other things, overall market supply and demand and general business conditions, were negatively impacted by both global and industry-wide supply chain disruptions, resulting in increases to our costs of goods sold and disruption in supply for some materials in certain of our areas. We have also encountered issues regarding timely receipt and in some cases availability of certain of these raw materials.
The COVID-19 pandemic, including any actions we have taken in response, has disrupted our internal operations, including by heightening the risk that a significant portion of our workforce will suffer illness or otherwise not be permitted or be unable to work, and required that certain of our employees work remotely, which has heightened certain risks, including those related to cybersecurity and internal controls. For example, during the second quarter of 2020, a small number of employees tested positive for COVID-19, which required us to temporarily close a small number of our manufacturing facilities, and throughout 2021 we experienced increasing numbers of employees who tested positive for COVID-19 and were required to quarantine, which impacted our ability to operate our facilities efficiently. Additionally, we cannot predict whether these conditions and concerns will continue or whether we will experience more significant or frequent disruptions in the future, including the complete closure of one or more of our facilities, which could cause delays in our ability to produce and deliver products to our customers and cause us to suffer reputational harm and incur penalties and other types of damages if we are not able to meet contractual obligations. In addition, in the event demand for our products is significantly reduced as a result of the COVID-19 pandemic and related economic impacts, we may need to assess different corporate actions and cost-cutting measures, including reducing our workforce or closing one or more facilities, and these actions could cause us to incur costs and expose us to other risks and inefficiencies, including whether we would be able to rehire our workforce or recommence operations at a given facility if our business experiences a subsequent recovery. A prolonged period of generating lower cash from operations or other pressures on our liquidity could adversely affect our financial condition, the achievement of our strategic objectives or require us to seek additional capital, which may not be available on favorable terms or at all.
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The COVID-19 pandemic also adversely affected economies worldwide and significantly disrupted financial and other capital markets, causing a significant deceleration of economic activity. The continuing impact of this outbreak on the U.S. and world economies is uncertain and, depending on the severity of future strains, the impact of responsive government measures and the efficacy of vaccines and vaccine roll-outs, these adverse impacts could worsen, impacting all segments of the global economy, and result in a significant recession or worse. Although we initially took certain precautionary measures to preserve liquidity, including borrowing under our ABL Facility and suspending non-essential capital expenditures, we have since ended these measures, repaid the amounts borrowed under the ABL Facility and caught up on capital projects that were initially delayed early in the pandemic.
Considerable uncertainty still surrounds the COVID-19 virus and the pandemic's potential effects, and the extent and effectiveness of responses taken on local, national and global levels. While we expect the pandemic and related events will continue to have a negative effect on us, the unpredictable and unprecedented nature and fluidity of current circumstances makes it impractical to identify all potential risks or estimate the full extent and scope of the impact on our business and industry, as well as national, regional and global markets and economies. However, our ability to conduct our business in the manner previously or currently expected could be materially and adversely affected, and any of the foregoing risks and uncertainties as well as those that have not yet manifested themselves or been identified could have a material adverse impact on our business, financial condition, results of operations and cash flows.
Our dependence on key customers with whom we do not have long-term contracts and consolidation within our customers’ industries could have a material adverse effect on us.
Our business is dependent on certain key customers. In 2021 and 2020, Core & Main, our largest customer accounted for 18% and 16% of our net sales, respectively. As is customary in our industry, we do not enter into long-term contracts with many of our customers. As a result, our customers could stop purchasing our products, reduce their purchase levels or request reduced pricing structures at any time. We may therefore need to adapt our manufacturing, pricing and marketing strategies in response to a customer who may seek concessions in return for its continued or increased business. In addition, a macroeconomic downturn or any other cause of consolidation in the U.S. homebuilding industry or among our other customers, as occurred in the aftermath of the 2008 financial crisis when a number of smaller businesses went out of business or were acquired, can significantly increase the market share and bargaining power of a limited number of customers and give them significant additional leverage to negotiate more favorable terms and place greater demands on us. A loss of one or more customers or a meaningful reduction in their purchases from us or further consolidation within our end markets could have a material adverse effect on our business, financial condition and results of operations.
The seasonality of our business and its susceptibility to severe and prolonged periods of adverse weather and other conditions could have a material adverse effect on us.
Demand for our products in some markets is typically seasonal, with periods of snow or heavy rain negatively affecting construction activity. For example, sales of our products in Canada and the Northeast and Midwest regions of the United States are somewhat higher from spring through autumn when construction activity is greatest. Construction activity declines in these markets during the winter months in particular due to inclement weather, frozen ground and fewer hours of daylight. Construction activity can also be affected in any period by adverse weather conditions such as hurricanes, severe storms, torrential rains and floods, natural disasters such as fires and earthquakes and similar events, any of which could reduce demand for our products, push back existing orders to later dates or lead to cancellations. Furthermore, our ability to deliver products on time or at all to our customers can be significantly impeded by such conditions and events, such as those described above. Public holidays and vacation periods constitute an additional factor that may exacerbate certain seasonality effects, as building projects or industrial manufacturing processes may temporarily cease. These conditions, particularly when unanticipated, can leave both equipment and personnel underutilized. Additionally, the seasonal nature of our business has led to variation in our quarterly results in the past and may continue to do so in the future. This general seasonality of our business and any severe or prolongedadverse weather conditions or other similar events could have a material adverse effect on our business, financial condition and results of operations.
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The use of our products is often affected by various laws and regulations in the markets in which we operate, any of which may have a material adverse effect on us.
The use of many of our products is subject to approvals by municipalities, state departments of transportation, engineers and developers. These approvals and specifications, including building codes, may affect the products our customers or their customers (the end users) are allowed or choose to use, and, consequently, failure to obtain or maintain such approvals or changes in building codes may affect the saleability of our products. Changes in applicable regulations governing the sale of some of our products or the failure of any of our products to comply with such requirements could increase our costs of doing business, reduce sales or otherwise have a material adverse effect on our business, financial condition and results of operations.
We are subject to increasingly stringent environmental laws and regulations, and any failure to comply with any current or future laws or regulations could have a material adverse effect on us.
We are subject to federal, state, provincial, local and foreign laws and regulations governing the protection of the environment and natural resources, including those governing air emissions, wastewater discharges and the use, storage, discharge, handling, disposal, transport and cleanup of solid and hazardous materials and wastes. We are required to obtain permits from governmental authorities for certain operations, and if we expand or modify our facilities or if environmental laws change, we could be required to obtain new or modified permits.
Environmental laws and regulations, including those related to energy use and climate change, tend to become more stringent over time, and any future laws and regulations could have a material impact on our operations or require us to incur material additional expenses to comply with any such future laws and regulations. Future environmental laws and regulations may cause us to modify how we manufacture and price our products or require that we make significant capital investments to comply. For example, our manufacturing processes use a significant amount of energy, and increased regulation of energy use to address the possible emission of greenhouse gases could materially increase our manufacturing costs or require us to install emissions control or other equipment at some or all of our manufacturing facilities.
If we fail to comply with any existing or future environmental laws, regulations or permits, we could incur fines, penalties or other sanctions and suffer reputational harm. In addition, we could be held responsible for costs and damages arising from claims or liabilities under environmental laws and regulations, including with respect to any exposure to or release of hazardous materials or contamination at our facilities, whether presently or previously leased, operated, or owned, or at third-party waste disposal sites. We could also be subject to third-party claims from individuals for property damage, personal injury or nuisance if any releases from our property were to cause contamination of the air, soil or groundwater of areas near our facilities. These laws and regulations may also require us to investigate and, in certain instances, remediate contamination. Some of our sites have a history of industrial use, and while we apply strict environmental operating standards and undertake extensive environmental due diligence in relation to our facilities and acquisitions, some soil and groundwater contamination has occurred in the past at a limited number of sites.
As of December 31, 2021, we had accrued approximately $1.3 million for environmental liabilities. Additionally, we cannot completely eliminate the risk of future contamination. Any costs or other damage related to existing or future environmental laws, regulations or permits or any violations thereof could expose us to significant financial losses as well as civil and criminal liabilities, any of which could have a material adverse effect on our business, financial condition and results of operations.
Climate change and climate change legislation or regulations may adversely impact our business.
Many of our products, particularly in our Drainage Pipe & Products segment, are made from or use concrete, which utilizes Portland cement as a raw material, a material whose manufacturing process involves the emission of carbon dioxide, a greenhouse gas that scientists have attributed as a cause of climate change. Our products are also heavy and require transportation from our facilities to the site where they are used, which consumes energy. A number of governmental bodies have finalized, proposed or are contemplating legislative
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and regulatory changes in response to the potential effects of climate change, which could lead to additional legislative and regulatory changes in those countries, including by means of required reporting of greenhouse gas emissions, the use of alternative fuels, the use of carbon credits (including a "cap and trade" system) and/or a carbon tax. The U.S and Canada have agreed to the Paris Agreement, in connection with the United Nations Framework Convention on Climate Change, in which the signatories aim to reduce greenhouse gas emissions, or GHGs, as soon as possible and achieve a position of net zero GHGs by 2050. In the U.S., President Biden has stated his commitment to taking action to address climate change, including by rejoining the Paris Agreement, announcing goals to achieve a 50-52% reduction in GHGs from 2005 levels by 2030, a whole-of-government initiative supported by his National Climate Task Force, and by issuing various executive orders addressing climate change policy, including an executive order in December 2021 directing the federal government to achieve net-zero greenhouse gas emissions by 2050. Based on this focus, it is possible that environmental regulators and other agencies may use their rule-making authority and procurement decisions to further address climate change Although it is uncertain at this time precisely what actions various governmental bodies will take early to address the effects of climate change and to achieve the goals outlined in various agreements, including in what timeframe those actions would be implemented, it seems clear that changes to regulate carbon emissions are a key focus for the Biden Administration and other governmental entities, including California, which has had a cap and trade system in place since 2012. In light of the uncertainty around what regulations will be implemented, we cannot at this time reasonably predict what the costs of any future compliance requirements may be, but it is likely our costs will increase in relation to any climate change legislation and regulation concerning greenhouse gases, which could have an adverse effect on our future financial position, results of operations or cash flows.
Climate change may also have adverse physical or financial impacts on our business to the extent that it causes more severe or more frequent major storm events, flooding, drought-induced wildfires, or other shifts in weather patterns. Increases in the intensity and frequency of acute weather events have been linked to climate change, and this risk may increase to the extent global warming continues or is unabated. These types of extreme weather events may include disruptions to operations or production, disruptions to supply chains or damage to our physical plants, which could lead to reduced financial performance of our business.
In addition, regardless of whether governmental bodies enact legislation to address climate change and reduce GHGs, the public perception of carbon-intensive industries may change adversely over time and additional focus on environmental, social and governance issues by the public and/or investors may harm our business as it could damage our reputation, require us to expend resources in reducing our net carbon emissions, or reduce demand for our products, which could adversely impact our results of operations and cash flows.
We are subject to health and safety laws and regulations, and the costs to comply with, or any failure to comply with, any current or future laws or regulations could have a material adverse effect on us.
Manufacturing sites are inherently dangerous workplaces. Our sites often put our employees and others in close proximity with large pieces of mechanized equipment, moving vehicles, chemical and manufacturing processes, heavy products and items and highly regulated materials. As a result, we are subject to a variety of health and safety laws and regulations dealing with occupational health and safety. Unsafe work sites have the potential to increase employee turnover and raise our operating costs. Our safety record can also impact our reputation. We maintain functional groups whose primary purpose is to ensure we implement effective work procedures throughout our organization and take other steps to ensure the health and safety of our work force, but there can be no assurances these measures or other measures we may take in the future will be successful in preventinginjuries, including severeinjuries and fatalities, or violations of health and safety laws and regulations. Any failure to maintain safe work sites or violations of applicable law could expose us to significant financial losses and reputational harm, as well as civil and criminal liabilities, any of which could have a material adverse effect on our business, financial condition and results of operations.
Warranty and related claims could have a material adverse effect on us.
We generally provide warranties on our products againstdefects in materials and workmanship, the costs of which could be significant. Many of our products such as gravity pipe are buried underground and incorporated
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into a larger infrastructure system, such as a city’s or municipality’s water transmission system, or built into the fabric of a building or dwelling. In most cases, it is difficult to access, repair, recall or replace these products. Additionally, some of our products, such as our pressure pipe, which is used in nuclear and coal-fired power generation factories, are used in applications where a product failure or construction defect could result in significant project delay, property damage, personal injury or death or could require significant remediation expenses. Because our products, including discontinued products, are long lasting, claims can also arise many years after their manufacture and sale. In certain cases, we may also offer warranties for longer periods now for certain products to compete with certain substitutes, which could increase the number, size, and frequency of warranty claims in the future. Product failures may also arise due to the quality of the raw materials we purchase from third-party suppliers or the quality of the work performed by our customers, including installation work, matters for which we have little to no control, but which may still subject us to a warranty claim. We may also assume product warranty or other similar obligations in acquisition transactions regarding the products sold by the acquired businesses prior to the transaction date for which we are not indemnified pursuant to the terms of the relevant transaction documentation. Our quality control systems and procedures and those of our suppliers and customers cannot test for all possible conditions of use or identify all defects in the design, engineering or specifications of one of our products or the raw materials we use before they are put to their intended purpose. Therefore, there can be no assurances that we will not supply defective or inferior products that cause product or system failure, which could give rise to potentially extensive warranty and other claims for damages, as well as negatively impact our reputation and the perception of our product quality and reliability. While we have established reserves for warranty and related claims that we believe to be reasonable, these claims may exceed our reserves and any such excess and any negative publicity and other issues related to such claims could have a material adverse effect on our business, financial condition and results of operations.
Sharing our brand name and logo could have a material adverse effect on us.
We share the “Forterra” brand with the operator of HeidelbergCement's former building products business in the United Kingdom, or Forterra UK, a public company listed on the London FTSE. Forterra UK is no longer affiliated with us and, to our knowledge, operates solely in the United Kingdom. We have no control over Forterra UK’s use of the “Forterra” name and logo in Europe. Any actions or negative publicity related to Forterra UK and its products could have a material adverse effect on our business, financial condition and results of operations.
Production, Supply Chain and Systems Related Risks
Decreased availability or increases in the cost of raw materials could have a material adverse effect on us.
Our ability to offer our products to our customers is dependent upon our ability to obtain adequate supplies of raw materials at reasonable costs, such as cement, aggregate, steel and scrap iron. Raw material prices for certain raw materials that are key to our products, such as steel and scrap metal, have been volatile in recent years, and the cost of some of our most critical raw materials was significantly increased in 2021 over prior years as the demand for such raw materials was significantly inflated. Increased demand for these materials could lead to the continued In addition, changes in trade policy can also impact the price and availability of raw materials. In particular, changes in U.S. trade policy, including the imposition of any tariffs by the U.S. or foreign governments, may negatively impact the availability and price of raw materials used in our production. In particular, in 2018 and 2019, the U.S. government imposed tariffs and quotas on certain imported steel articles, and other countries, such as Canada, have implemented retaliatory tariffs on certain U.S. imports, including steel. These actions resulted in increased prices for both U.S. and non-U.S. steel, one of our main raw material inputs, and the continued imposition of these tariffs, increases in tariff rates, additional tariffs on other goods, or further retaliatory actions from other governments may result in higher costs for us, and there can be no assurance we will be able to pass any of the increases in raw material costs directly resulting from the tariff to our customers. Such actions may also result in more difficulty or the inability to obtain needed materials.
Suppliers are also subject to their own viability concerns from economic, market and other pressures. In particular, many suppliers may decrease capacity during financial downturns or due to other market factors such as depressed prices. This decreased capacity, along with strong global demand for certain raw materials, has at
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times caused and may continue to cause tighter supply and significant price increases. Factors such as adverse weather conditions and other natural disasters, as well as political and other social instability, have and will continue to disrupt raw material supplies and impact prices.
Although we have agreements with our raw material suppliers, these agreements are generally terminable by either party on limited notice or contain prices that are based upon the volume of our total purchases. To the extent agreements with any of our raw material suppliers are terminated or we need to purchase additional raw materials in the open market, there can be no assurance that we could timely find alternative sources in reasonable quantities or at reasonable prices. Furthermore, given the global issues with supply chains caused by the ongoing COVID-19 pandemic, certain raw materials may be difficult to acquire at all or may be delayed in their delivery, which may cause delays in our ability to meet production schedule for our customers and timely deliver our products. In addition, sudden or unanticipated changes in sources for certain raw materials, such as cement, may require us to engage in testing of our products for quality assurance, which also could cause delays in our ability to meet our production schedule and timely deliver products. Changes in U.S. trade policy and reactions of other governments to those changes could also negatively impact the availability of certain raw materials, such as steel, as the demand for U.S. steel could increase as a result of these changes. The inability to obtain any raw materials or unanticipated changes with respect to our suppliers could negatively impact our ability to manufacture or deliver our products and to meet customer demands.
We are susceptible to raw material price fluctuations. In recent years, prices of the raw materials we use have at times fluctuated and may be susceptible to significant price fluctuations in the future. For example, in 2021, according to industry average prices, the costs of our scrap steel, a major input in DIP, were on average at least 50% higher than in 2020 and much higher than the average price of each of the prior five years. Because of the volatility of these prices, we cannot predict whether the trend of inflation will continue during 2022 and beyond. We have hedged our positions with respect to certain raw materials in the past and may do so in the future, but we currently have no hedging in place regarding our raw material needs and are therefore more susceptible to any short-term price fluctuations. We generally attempt to pass increased costs, including higher raw material prices and government imposed costs, on to our customers, but the timing between acceptance of a customer order and the purchase of raw materials needed to fulfill such order, pricing pressure from our competitors, the market power of our customers or other pricing factors may limit our ability to pass on such price increases. If we cannot fully-offset increases in the cost of raw materials through other cost reductions, or recover these costs through price increases or otherwise, we could experience lower margins and profitability, which could have a material adverse effect on our business, financial condition and results of operations.
A material disruption or capacity constraints at one or more of our manufacturing facilities or in our supply chain could have a material adverse effect on us.
We own and operate manufacturing facilities of various ages and levels of automated control and rely on a number of third parties as part of our supply chain, including for the efficient distribution of products to our customers. Any disruption at one of our manufacturing facilities or within our supply chain could prevent us from meeting demand or require us to incur unplanned capital expenditures. Older facilities and equipment are generally less energy efficient and are at an increased risk of breakdown or equipment failure, resulting in unplanneddowntime. Any unplanneddowntime at our facilities may cause delays in meeting customer timelines, result in damagesclaims, including liquidateddamages, or cause us to lose or harm customer relationships. Additionally, we require specialized equipment to manufacture certain products, and if any of our manufacturing equipment fails, the time required to repair or replace this equipment could be lengthy, which could result in extended downtime at the affected facility. Any unplanned repair or replacement work can also be very expensive. Moreover, manufacturing facilities can unexpectedly stop operating because of events unrelated to us or beyond our control, including fires and other industrial accidents, floods and other severe weather events, natural disasters, environmental incidents or other catastrophes, utility and transportation infrastructure disruptions, shortages of raw materials, and acts of war or terrorism. Work stoppages, whether union-organized or not, can also disrupt operations at manufacturing facilities. Furthermore, we are generally responsible for delivering products to the customer and, while we deliver a small percentage of our products directly to the customer using our own fleet, we outsource this function and depend on third parties to deliver the vast majority of our products, primarily by truck with some reliance on rail where possible. Any shortages in trucking or rail capacity or any
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increase in the cost thereof, whether as a result of strikes, slowdowns, a shortage of drivers, other disruption to the highway or rail systems, or other unrelated transportation issues could limit our ability to deliver our products in a timely and cost-effective manner or at all. Any material disruption at one or more of our facilities or those of our customers or suppliers or otherwise within our supply chain, whether as a result of downtime, facility damage, an inability to deliver our products or otherwise, could prevent us from meeting demand, require us to incur unplanned capital expenditures or cause other material disruption to our operations, any of which could have a material adverse effect on our business, financial condition and results of operations.
Delays in construction projects and any failure to manage our inventory could have a material adverse effect on us.
Many of our products are used in water transmission and distribution projects and other large-scale construction projects which generally require a significant amount of planning and preparation before construction commences. However, construction projects can be delayed and rescheduled for a number of reasons, including unanticipated soil conditions, adverse weather or flooding, changes in project priorities, financing issues, difficulties in complying with environmental and other government regulations or obtaining permits and additional time required to acquire rights-of-way or property rights. These delays or reschedulings may occur with too little notice to allow us to replace those projects in our manufacturing schedules or to adjust production capacity accordingly, creating unplanneddowntime, increased costs and inefficiencies in our operations and increased levels of excess or obsolete inventory. Additionally, we maintain an inventory of certain products that meet standard specifications and are ultimately purchased by a variety of end users. However, our demand forecasts are not always accurate and unexpected changes in demand for these products, whether project-driven, because of a change in preferences or otherwise, can lead to increased levels of excess or obsolete inventory. Any delays in construction projects and our customers’ orders or any inability to manage our inventory, which can lead to impairment charges, could have a material adverse effect on our business, financial condition and results of operations.
Increased costs of energy could have a material adverse effect on us.
We use significant amounts of energy, including electricity, natural gas and gasoline, in the manufacturing, transportation, distribution and sale of our products, and the related expense is significant. While we have benefited from the relatively low cost of electricity and natural gas in recent years, energy prices have been and may continue to be volatile and these reduced prices may not continue. Prices for such energy products may also increase due to global conflicts and actions taken in response to them. In addition, proposed or existing government policies, including those to address climate change by reducing greenhouse gas emissions or the effects of hydraulic fracturing could result in increased energy costs. In addition, factors such as international political and military instability, adverse weather conditions and other natural disasters may disrupt fuel supplies and increase prices in the future. Additionally, because we and other manufacturers in our industry are often responsible for delivering products to the customer, we are further exposed to increased energy prices as a component of our transportation costs. While we generally attempt to pass increased costs, including higher energy costs, on to our customers, pricing pressure from our competitors, the market power of our customers or other pricing factors may limit our ability to do so, and any increases in energy prices could have a material adverse effect on our business, financial condition and results of operations.
Our business and financial performance could be adversely impacted based on disruptions, delays, outages of our information technology systems and computer networks.
Our manufacturing facilities as well as our sales and service activities depend on the efficient and uninterrupted operation of complex and sophisticated information technology systems and computer networks, which are subject to failure and disruption. These and other problems may be caused by system updates, natural disasters, malicious attacks, human error, accidents, power disruptions, telecommunications failures, acts of terrorism or war, computer viruses, physical or electronic break-ins or other similar events. Additionally, because we have grown through various acquisitions, we have integrated and are integrating a number of disparate information technology systems across our organization, certain of which may be outdated and due for replacement, further increasing the likelihood of problems. We may in the future replace and integrate systems or
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implement new technology systems, but these updates may not be successful, they may create new issues we currently do not face, or significantly exceed our cost estimates.
We outsource certain portions of the operations of our information technology systems to a third party. Any failure of us or of our third party provider to effectively operate such systems could cause a disruption in our information technology systems. Any disruption in our information technology systems could interrupt or damage our operations and our ability to meet customer needs as well as our ability to maintain effective controls. These events could damage our reputation and cause us to incur unanticipated liabilities, including financial losses from remedial actions, business interruptions, loss of business and other unanticipated costs which may not be covered by insurance. Despite the defensive measures we have taken to protect our data and information technology, our systems could be vulnerable to disruption and any such disruption and the resulting fallout could have a material adverse effect on our business, financial condition and results of operations.
Employee Specific Risks
Labor disruptions and other union activity could have a material adverse effect on us.
As of December 31, 2021, approximately 33% of our workforce was covered by collective bargaining agreements, and approximately 46% of these employees were included in collective bargaining agreements that are due to expire within one year. If negotiations to renew expiring collective bargaining agreements are not successful or become unproductive, the union could take actions such as strikes, work slowdowns or work stoppages. Such actions at any one of our facilities could lead to a plant shut down or a substantial modification to employment terms, thereby causing us to lose net sales or incur increased costs. We have not had any recent union-organized work stoppages in the United States, Canada or Mexico; however, we have experienced one union organizing effort directed at our non-union employees in the past ten years. There can be no assurances there will not be additional union organizing efforts, strikes, work slowdowns or work stoppages in the future. Any such disruption, or other issue related to union activity, could have a material adverse effect on our business, financial condition and results of operations.
We depend on the services of key executives and any inability to attract and retain key management personnel could have a material adverse effect on us.
Our key management personnel, including our Chief Executive Officer and Chief Financial Officer, are important to our success because they are instrumental in setting our strategic direction, operating our business and identifying expansion opportunities. Additionally, as our business grows, we may need to attract and hire additional management personnel. We have employment agreements with some members of senior management; however, we cannot prevent our executives from terminating their employment with us, and any replacements we hire may not be as effective. While we strive to mitigate the negative impact associated with changes our senior management team, there may be uncertainty among investors, employees, customers and others concerning our future direction and performance. Our ability to retain our key management personnel or to attract additional management personnel or suitable replacements when needed is dependent on a number of factors, including the competitive nature of the employment market. Any failure to retain key management personnel or to attract additional or suitable replacement personnel could have a material adverse effect on our business, financial condition and results of operations.
Any failure by us or the contractors with which we work to retain and attract necessary personnel or contract labor could have a material adverse effect on us.
Competition for hiring new and retaining existing qualified personnel is intense and our success depends in part on our ability to retain, attract and train necessary personnel, including engineering and other skilled technical personnel. Our experienced sales team has also developed a number of meaningful customer relationships that would be difficult to replace. We compete with other companies for many employees in hourly positions, which have historically had high turnover rates. Without a sufficient number of qualified employees in each of these areas, the productivity and profitability of our operations and manufacturing quality could suffer.
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Additionally, our business relies on the ability of the contractors who install our products to obtain qualified employees, including experienced supervisors and foreman, and a shortage in the supply of these skilled personnel could cause delays in customer’s ability to take shipments of our products.
Labor shortages may impact our ability to hire skilled or unskilled workers with the necessary experience. For example, the reduction in demand for products in our industry during the financial crisis led to a number of both skilled and unskilled workers leaving our industry permanently, reducing an already limited pool of available and qualified personnel. In addition, the COVID-19 pandemic led to a decreased labor force size and participation rates, and we have observed an overall tightening and increasingly competitive labor market in many of our geographies, which causes increased costs to attract and retain qualified workers. Furthermore, if new or more restrictive immigration legislation is enacted at the federal level or in states in which we do business, or if existing regulations are interpreted or enforced differently, these changes could further tighten certain labor markets.
If we are unsuccessful in hiring and retaining the necessary workforce, we may incur additional costs to run our business. Many of these positions have historically had high turnover rates, which can lead to increased training and retention costs. Our ability to control labor costs is also subject to numerous external factors, including prevailing wage rates, the impact of legislation or regulations governing wages, regulations governing payment of workers.
There can be no assurances the labor pool from which we or the contractors with whom we work hire will increase or remain stable, nor that we will be able to control labor costs. Any failure by us or the contractors with which we work to retain our existing personnel or attract and train additional qualified personnel at reasonable costs could have a material adverse effect on our business, financial condition and results of operations.
Miscellaneous Business Risks
Cybersecurity attacks may threaten our confidential information, disrupt operations and result in harm to our reputation and adversely impact our business and financial performance.
Cybersecurity attacks across industries, including ours, are increasing in sophistication and frequency and may range from uncoordinated individual attempts to measures targeted specifically at us. These attacks include but are not limited to, malicious software or viruses, attempts to gainunauthorized access to, or otherwise disrupt, our information systems, attempts to gainunauthorized access to business, proprietary or other confidential information, and other electronic security breaches that could lead to disruptions in critical systems, unauthorized release of confidential or otherwise protected information and corruption of data. Cybersecurity failures may be caused by employee error, malfeasance, system errors or vulnerabilities, including vulnerabilities of our vendors, suppliers, and their products. We have been subject to cybersecurity attacks in the past, including breaches of our IT systems that exposed certain confidential business information as well as ransomware attacks on non-critical business systems. Based on information known to date, past attacks have not had a material impact on our business, financial condition or results of operations. We may experience these and different types of attacks in the future, potentially with more frequency or sophistication.
Failures of our IT systems as a result of cybersecurity attacks or other disruptions could result in a breach of critical operational or financial controls and lead to a disruption of our operations, commercial activities or financial processes. Cybersecurity attacks or other disruptions impacting significant customers and/or suppliers could also lead to a disruption of our operations or commercial activities. Despite our attempts to safeguard our systems and mitigate potential risks, there is no assurance that such actions will be sufficient to prevent cyberattacks or security breaches that manipulate or improperly use our systems or networks, compromise confidential or otherwise protected information, destroy or corrupt data, or otherwise disrupt our operations. The occurrence of such events could have a material adverse effect on our business, financial condition and results of operations.
Legal and regulatory claims and proceedings could have a material adverse effect on us.
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We are subject to claims, litigation and regulatory proceedings in the normal course of business and could become subject to additional claims in the future, some of which could be material. For example, we have been, and may in the future be, subject to claims for product liability, construction defects, project delay, personal injury, property and other damages as well as allegations regarding compliance with mandated product specifications. Claims and proceedings, whether or not they have merit and regardless of the outcome, are typically expensive and can divert the attention of management and other personnel for significant periods of time. Additionally, claims and proceedings can impact customer confidence and the general public’s perception of our company and products, even if the underlying assertions are proven to be false.
We are also currently a defendant, together with several of our current and former officers and directors, in a shareholder derivative suit, and in the past have been a defendant in other similar suits, each filed by plaintiffs seeking damagesagainst the Company for allegations of violations of United States laws regulating securities, as discussed in greater detail in Item 3, "Legal Proceedings," and Note 16 to our consolidated financial statements. Lawsuits involving us, or our current or former officers and directors, could result in significant expense and divert attention and resources of our management and other key employees. In addition to any damages we may be required to pay, we are generally obligated to indemnify our current and former directors and officers in connection with lawsuits and related settlement amounts. Such amounts could exceed the coverage provided under our insurance policies.
While we have established reserves we believe to be reasonable under the facts known, the outcomes of litigation and similar disputes are often difficult to reliably predict and may result in decisions or settlements that are contrary to, or in excess of, our expectations, and losses may exceed our reserves. In addition, various factors and developments could lead us to make changes in our current estimates of liabilities and related insurance receivables or make new or modified estimates as a result of a judicial ruling or judgment, settlement, regulatory development or change in applicable law. Any claims or proceedings, particularly those in which we are unsuccessful or for which we did not establish adequate reserves, could harm our reputation and could have a material adverse effect on our business, financial condition and results of operations.
Any inability to successfully acquire businesses in the future could have a material adverse effect on us.
Historically we have grown in large part as a result of acquisitions and our business plan continues to provide for growth in part through acquisitions and joint ventures. Although we expect to regularly consider additional strategic transactions in the future, there can be no assurances that we will identify suitable acquisition, joint venture or other investment opportunities or, if we do, that any transaction can be consummated on acceptable terms. Antitrust or other competition laws may also limit our ability to acquire, or work collaboratively with, certain businesses or to fully realize the benefits of a prospective acquisition or joint venture. Furthermore, changes in our business or the economy, an unexpected decrease in our cash flows or any restrictions imposed by our debt may limit our ability to obtain the necessary capital or otherwise impede our ability to complete a transaction. Regularly considering strategic transactions can also divert management’s attention and lead to significant due diligence and other expenses regardless of whether we pursue or consummate any transaction. Failure to identify suitable transaction partners and to consummate transactions on acceptable terms, as well as the commitment of time and resources in connection with such transactions, could have a material adverse effect on our business, financial condition and results of operations.
The consummation of an acquisition also exposes us to significant risks and additional costs. We may not accurately assess the value, strengths, weaknesses or potential profitability of an acquisition target. Furthermore, we may not be able to fully or successfully integrate an acquired business or realize the expected benefits and synergies following an acquisition. Business and operational overlaps may lead to hidden costs. These costs can include unforeseen pre-acquisition liabilities or the impairment of customer relationships or certain acquired assets such as inventory and goodwill. We may also incur costs and inefficiencies to the extent an acquisition expands the industries, markets or geographies in which we operate due to our limited exposure to and experience in a given industry, market or region. Significant acquisitions may also require that we incur additional debt to finance the transaction, which could be substantial and limit our flexibility in using our cash flow from operations for other purposes. Acquisitions can also involve post-transaction disputes with the counterparty regarding a number of matters, including a purchase price or other working capital adjustment or liabilities for
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which we believe we were indemnified under the relevant transaction agreements, such as environmental liabilities or pension or benefit obligations retained by the seller, including certain environmental and benefit obligations in connection with our U.S. Pipe Acquisition and certain pension obligations we assumed pursuant to the Acquisition and our acquisition of Cretex. We are also engaged in other indemnification and other post-closingdisputes with certain of our transaction counterparties. Our inability to realize the anticipated benefits of an acquisition as well as other transaction-related issues could have a material adverse effect on our business, financial condition and results of operations.
In July 2012, we entered into a joint venture agreement with Americast, Inc., now known as Eagle Corporation, to form Concrete Pipe & Precast LLC. From time to time, we may enter into additional joint ventures as part of our growth strategy. The nature of a joint venture requires us to share control with unaffiliated third parties. If our joint venture partners do not fulfill their contractual and other obligations, the affected joint venture may be unable to operate according to its business plan, and we may be required to increase our level of commitment. Differences in views among joint venture participants could also result in delays in business decisions or otherwise, failures to agree on major issues, operational inefficiencies and impasses, litigation or other issues. Third parties may also seek to hold us liable for the joint ventures’ liabilities. These issues or any other difficulties that cause a joint venture to deviate from its original business plan could have a material adverse effect on our business, financial condition and results of operations.
Any inability to protect our intellectual property or claims that we infringe on the intellectual property rights of others could have a material adverse effect on us.
We rely on a combination of patents, trademarks, trade names, confidentiality and nondisclosure clauses and agreements, and other unregistered rights to define and protect our rights to our brand and the intellectual property used in certain of our products, including the innovative technologies relating to storm water management acquired in the Bio Clean Acquisition. We also rely on product, industry, manufacturing and market “know-how” that cannot be registered and may not be subject to any confidentiality or nondisclosure clauses or agreements. However, we cannot guarantee that any of our registered or unregistered intellectual property rights or our know-how, or claims thereto, will now or in the future successfully protect our intellectual property , or that our rights will not be circumvented or successfullyopposed or otherwise challenged. We also cannot guarantee that applications filed will be approved. To the extent that our intellectual property rights are not sufficient, third parties, including competitors, may be able to commercialize our innovations or products or use our know-how. Additionally, we have faced in the past and may in the future face claims that we are infringing the intellectual property rights of others, including with respect to both existing and new technologies we use. If any of our products are found to infringe the patents or other intellectual property rights of others, our manufacture and sale of such products could be significantly restricted or prohibited and we may be required to pay substantial damages or on-going licensing fees. Any inability to protect our intellectual property rights or any misappropriation of the intellectual property of others could have a material adverse effect on our business, financial condition and results of operations.
Our foreign operations could have a material adverse effect on us.
We operate production facilities in Canada and Mexico and we are therefore subject to a number of risks specific to these countries. These risks include social, political and economic instability, unexpected changes in regulatory requirements, tariffs and other trade barriers, currency exchange fluctuations, acts of war or terrorism and import/export requirements. In addition, we have a limited number of sales to other foreign jurisdictions, primarily concentrated in the Dominican Republic and Bolivia. Our consolidated financial statements are reported in U.S. dollars with international transactions being translated into U.S. dollars. If the U.S. dollar strengthens in relation to the Canadian dollar, our U.S. dollar reported net sales and income will decrease. Additionally, since we incur costs in foreign currencies, fluctuation in those currencies’ value can negatively impact manufacturing and selling costs. See Item 7A, “Quantitative and Qualitative Disclosures about Market Risk.” There can be no assurances that any of these factors will not materially impact our production cost or otherwise have a material adverse effect on our business, financial condition and results of operations.
Changes in tax laws could adversely affect us.
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We regularly assess our future ability to utilize tax benefits, including those in the form of net operating loss, tax credit and other tax carryforwards, that are recorded as deferred income tax assets on our balance sheets to determine whether a valuation allowance is necessary. A reduction in, or disallowance of, these tax benefits resulting from a legislative change or adverse determination by a taxing jurisdiction could have an adverse impact on our financial results and liquidity.
Changes in corporate tax rates, the realizability of the net deferred tax assets relating to our U.S. operations, the taxation of foreign earnings and the deductibility of expenses contained in the Tax Cuts and Jobs Act of 2017, or the TCJA, or other tax reform legislation, including the Coronavirus Aid, Relief, and Economic Security Act of 2020, (“CARES Act”), could have a material impact on the value of our deferred tax assets, could result in significant one-time charges and could increase our future U.S. tax expense. See Note 20 to our consolidated financial statements.
Significant judgment is required in determining our domestic and international provision for income taxes, deferred tax assets or liabilities and in evaluating our tax positions on a worldwide basis. While we believe our tax positions are consistent with the tax laws in the jurisdictions in which we conduct our business, it is possible these positions may be contested or overturned by jurisdictional tax authorities, which may have a significant impact on our tax provision for income taxes. Tax laws are dynamic and subject to change as new laws are passed and new interpretations of the laws are issued or applied.
Insufficient insurance coverage could have a material adverse effect on us.
We maintain property, business interruption, counterparty and liability insurance coverage that we believe is consistent with industry practice. However, our insurance program does not cover, or may not adequately cover, every potential risk associated with our business and the consequences thereof. In addition, market conditions or any significant claim or a number of claims made by or against us could cause our premiums and deductibles to increase substantially and, in some instances, our coverage may be reduced or become entirely unavailable. In the future, we may not be able to obtain meaningful coverage at reasonable rates for a variety of risks, including certain types of environmental hazards and ongoing regulatory compliance. In addition, we self-insure a portion of our exposure to certain matters, including employee health care claims of up to $500,000 per covered individual per year and wage-payment obligations for short-term disability. If our insurance coverage is insufficient, if we are not able to obtain sufficient coverage in the future, or if we are exposed to significant losses as a result of the risks for which we self-insure, any resulting costs or liabilities could have a material adverse effect on our business, financial condition and results of operations.
Our internal control over financial reporting may not be effective, and our independent registered public accounting firm may not be able to certify as to their effectiveness, which could have a material adverse effect on our business and reputation.
As a public company, we are required to comply with the SEC’s rules implementing Sections 302 and 404 of the Sarbanes-Oxley Act, which require management to certify financial and other information in our quarterly and annual reports and provide an annual management report on the effectiveness of our control over financial reporting. Our independent registered public accounting firm is also required to formally attest to the effectiveness of our internal control over financial reporting pursuant to Section 404.
Although we currently do not have any material weaknesses in our internal control over financial reporting, we have historically experienced such material weaknesses. To remediate our prior material weaknesses, we have needed to undertake various actions, such as implementing additional internal controls and procedures and hiring additional accounting or internal audit staff, and we may need to do so in the future to maintain the effectiveness of our internal control over financial reporting and other controls. Testing and maintaining internal control can divert our management’s attention from other matters that are important to the operation of our business. If we identify material weaknesses in our internal control over financial reporting or are unable to comply with the requirements of Section 404 of the Sarbanes-Oxley Act or assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion as to the
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effectiveness of our internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be negatively affected, and we could become subject to investigations by the SEC or other regulatory authorities, which could require additional financial and management resources.
We are a holding company and depend on the cash flow of our subsidiaries.
We are a holding company with no material assets other than the equity interests of our subsidiaries. Our subsidiaries conduct substantially all of our operations and own substantially all of our assets and intellectual property. Consequently, our cash flow and our ability to meet our obligations and pay any future dividends to our stockholders depends upon the cash flow of our subsidiaries and their ability to make payments, directly or indirectly, to us in the form of dividends, distributions and other payments. Any inability on the part of our subsidiaries to make payments to us could have a material adverse effect on our business, financial condition and results of operations.
Risks Relating to our Indebtedness and Liquidity
The terms of our debt could have a material adverse effect on us.
We have substantial debt and may incur additional debt. As of December 31, 2021, we had approximately $902.4 million of total debt. Our credit facility contains a number of significant restrictions and covenants that generally restrict our business and limit our ability to, among other things:
• dispose of certain assets;
• incur or guarantee additional indebtedness;
• enter into new lines of business;
• make investments, intercompany loans or certain payments in respect of indebtedness;
• incur or maintain certain liens;
• enter into transactions with affiliates;
• engage in certain sale and leaseback transactions;
• declare or pay dividends and make other restricted payments, including the repurchase or redemption of our stock; and
• engage in mergers, consolidations, liquidations and certain asset sales.
In addition, our ability to borrow under the Revolver is limited by the amount of the borrowing base applicable to U.S. dollar and Canadian dollar borrowings. Any negative impact on the elements of our borrowing base, such as eligible accounts receivable and inventory, will reduce our borrowing capacity under the Revolver. Moreover, the Revolver provides discretion to the agent bank acting on behalf of the lenders to impose additional requirements on what accounts receivable and inventory may be counted toward the borrowing base availability, and to impose other reserves, which could materially impair the amount of borrowings that would otherwise be available to us. The credit facility also requires us to maintain certain financial ratios. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information regarding the terms of our credit facility and the indenture governing our senior secured notes dues due 2025. We are also party to a U.S. and a Canadian master lease under which we currently pay an aggregate of $17.1 million and $1.2 million (CAD) per annum, respectively, to lease certain properties through June 30, 2043. Each of these master lease agreements contain certain restrictions and covenants that limit, among other things, our use of and ability to sublease or discontinue use of the leased properties, our ability to consider strategic divestitures of properties that are leased and our ability to consolidate operations as may be appropriate in order to minimize operating costs. See Note 15 in our consolidated financial statements.
These and other similar provisions in these and other documents could have adverse consequences on our business and to our investors because they limit our ability to take these actions even if we believe that it would contribute to our future growth or improve our operating results. For example, these restrictions could limit our flexibility in planning for or reacting to changes in our business and our industry, thereby inhibiting our ability to
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react to markets and potentially making us more vulnerable to downturns. These restrictions could also require that, based on our level of indebtedness, a significant portion of our cash flow from operations be used to make interest payments, thereby reducing the cash flow available for working capital, to fund capital expenditures or other corporate purposes and to generally grow our business. Furthermore, these restrictions could prevent us from pursuing a strategic transaction that we believe would benefit our company.
Our ability to comply with these provisions may be affected by events beyond our control. A breach of any of these provisions or any inability to comply with mandated financial ratios could result in a default, in which case the counterparties may have the right to declare all borrowings or other amounts due thereunder to be immediately due and payable. If we are unable to pay any amounts when due, whether periodic payments, at maturity or if declared due and payable following a default, the counterparties would have the right to proceed against the pledged collateral securing the indebtedness. Therefore, the restrictions under these agreements and any breach of the covenants or failure to otherwise comply with the terms thereof could have a material adverse effect on our business, financial condition and results of operations.
Our current indebtedness and any future indebtedness we may incur could have a material adverse effect on us.
We expect that we will depend primarily on cash generated by our operations to pay our expenses and any amounts due under our credit facility and any other indebtedness we may incur. However, our business may not generate sufficient cash flows from operations in the future and any anticipated growth in revenues and cash flows may not be realized, either or both of which could result in us being unable to repay indebtedness or our inability to fund other liquidity or strategic needs. Our ability to make these payments depends on our future performance, which will be affected by financial, business, economic and other factors, many of which are beyond our control. If we do not have sufficient liquidity, we may be required to refinance all or part of our then existing debt, sell assets or borrow more money.
If we incur additional indebtedness, the risks related to our indebtedness that we currently face could intensify. In addition to the risk of higher interest rates and fees, the non-economic terms of any additional indebtedness may contain covenants and other terms restricting our financial, operating and strategic flexibility to an equal or greater extent as those imposed by our credit facility, the indenture governing our senior secured notes dues due 2025 and the master leases. Additional indebtedness may also include cross-default provisions such that, if we breach a restrictive covenant with respect to any of our indebtedness, or an event of default occurs, lenders may be entitled to accelerate all amounts owing under other outstanding indebtedness.
If we are required to refinance our indebtedness or otherwise incur additional indebtedness to fund strategic transactions or otherwise, any additional financing may not be available on terms favorable to us or at all. If, at such time, market conditions are materially different or our credit profile has deteriorated, the cost of refinancing our debt may be significantly higher than our indebtedness existing at that time, or we may not be able to refinance our debt at all. For example, our senior term loan matures in 2023 and, if interest rates continue to rise in the short- and longer-term, it could be more difficult and more expensive for us to refinance that debt as compared to the options that we would currently have. Any failure to meet any future debt service obligations or any inability to obtain any additional financing on terms acceptable to us or to comply therewith could have a material adverse effect on our business, financial condition and results of operations.
Credit and non-payment risks of our customers could have a material adverse effect on us.
As is customary in our industry, the majority of our sales are to customers on an open credit basis, with standard payment terms of 30 days. While we generally monitor the ability of our customers to pay these open credit arrangements and limit the credit we extend to what we believe is reasonable based on an evaluation of each customer’s financial condition and payment history, we may still experience losses because of a customer’s inability to pay. As a result, while we maintain what we believe to be a reasonable allowance for doubtful receivables for potential credit losses based upon our historical trends and other available information, there is a risk that our estimates may not be accurate, particularly in times of economic uncertainty and tight credit markets.
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Any inability to collect customer receivables or inadequate provisions for doubtful receivables could have a material adverse effect on our business, financial condition and results of operations.
Our project-based business requires significant liquidity, and any inability to ensure adequate financing or guarantees for large projects in the future could have a material adverse effect on us.
The projects in which we participate, particularly in our pressure pipe business, can be capital-intensive and often require substantial liquidity levels. In line with industry practice, we receive prepayments from our customers as well as milestone payments. However, a change in prepayment patterns or our inability to obtain third-party guarantees in respect of such prepayments could force us to seek alternative financing sources, such as bank debt or in the capital markets, which we may not be able to do on terms acceptable to us or at all, any of which could have a material adverse effect on our business, financial condition and results of operations.
Certain of the contracts in our backlog may be adjusted, canceled or suspended by our customers and, therefore, our backlog is not necessarily indicative of our future revenues or earnings or a good indicator of our future margins, even if performed.
As of December 31, 2021, our backlog totaled approximately $882.9 million. I n accordance with industry practice, many of our contracts are subject to cancellation, reduction, termination or suspension at the discretion of the customer in respect of work that has not yet been performed. In the event of a project cancellation, we would generally have no contractual right to the total revenue reflected in our backlog, but instead would collect revenues in respect of all work performed at the time of cancellation as well as all other costs and expenses incurred by us through such date. Projects can remain in backlog for extended periods of time because of the nature of the project, delays in execution of the project and the timing of the particular services required by the project. Additionally, the risk of contracts in backlog being canceled, terminated or suspended generally increases at times, including as a result of periods of widespread macroeconomic and industry slowdown, weather, seasonality and many of the other factors impacting our business. Many of the contracts in our backlog are subject to changes in the scope of services to be provided as well as adjustments to the costs relating to the contracts. The revenue for certain contracts included in backlog are based on estimates. Therefore, the timing of performance on our individual contracts can affect greatly our margins and hence, future profitability. There is no assurance that backlog will actually be realized as revenues in the amounts reported or, if realized, will result in any estimated profits.
As is customary in some of our markets, we provide our customers with performance guarantees and other guarantee instruments, such as surety bonds, that guarantee the timely completion of a project pursuant to defined contractual specifications. We also enter into contractual obligations to pay liquidateddamages to our customers for project delays. We are required to make payments under these contracts, guarantees and instruments if we fail to meet any of the specifications. Some customers require the performance guarantees to be issued by a reputable and credit worthy financial institution in the form of a letter of credit, surety bond or other financial guarantee. Financial institutions consider our credit ratings and financial position in the guarantee approval process. Our credit ratings and financial position could make the process of obtaining guarantees from financial institutions more difficult and expensive. If we cannot obtain such guarantees from reputable and credit-worthy financial institutions on reasonable terms or at all, we could face higher financing costs or even be prevented from bidding on or obtaining new projects, and any of these or other related obstacles could have a material adverse effect on our business, financial condition and results of operations.
Our ability to raise capital in the future may be limited.
Our business and operations may consume resources faster than we anticipate. In the future, we may need to raise additional funds through the issuance of new equity securities, debt or a combination of both. However, any sale or perception of a possible sale by Lone Star, and any related decline in the market price of our common stock, could impair our ability to raise capital. Separately, additional financing may not be available on favorable terms, or at all. If adequate funds are not available on acceptable terms, we may be unable to fund our capital requirements. If we issue new debt securities, the debt holders would have rights senior to common stockholders to make claims on our assets, and the terms of any debt could restrict our operations, including our ability to pay
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dividends on our common stock. If we issue additional equity securities, existing stockholders will experience dilution, and the new equity securities could have rights senior to those of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future securities offerings reducing the market price of our common stock and diluting their interest.
The phase-out of LIBOR could increase our interest expense and have a material adverse effect on us.
LIBOR is the basic rate of interest used in lending between banks on the London interbank market.
Borrowings under our senior term loan and revolver use the London Interbank Offering Rate, or LIBOR, as a benchmark for establishing the applicable interest rate. The Financial Conduct Authority of the United Kingdom has announced that it plans to phase out LIBOR by the end of 2021. It is unclear if LIBOR will cease to exist at that time or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with a new index, the Secured Overnight Financing Rate, or SOFR, calculated using short-term repurchase agreements backed by Treasury securities. Whether or not SOFR, or another alternative reference rate, attains market traction as a LIBOR replacement tool remains in question. Although our borrowing arrangements provide for alternative base rates, , those alternative base rates historically would often have led to increased interest rates, in some cases significantly higher, than those we paid based on LIBOR, and may similarly be higher in the future. Therefore, if LIBOR ceases to exist, we will likely need to agree upon a replacement index with our lenders, which would require an amendment to our borrowing arrangements, and the interest rate thereunder will likely change.
The consequences of the phase out of LIBOR cannot be entirely predicted at this time. For example, we may not be successful in amending our borrowing arrangements to provide for a replacement rate. If any new or alternative base rate for calculating interest with respect to our outstanding indebtedness may not be as favorable or perform in the same manner as LIBOR and could lead to an increase in our interest expense or could impact our ability to refinance some or all of our existing indebtedness. In addition, the transition process may involve, among other things, increased volatility or illiquidity in financial markets, which could also have an adverse effect on us whether or not any replacement rate applicable to our borrowings is affected. Any such effects of the transition away from LIBOR, as well as other unforeseen impacts, may result in increased interest expense and other expenses, difficulties, complications or delays in connection with future financing efforts or otherwise have a material adverse impact on our business, financial condition, and results of operations.
Risks Related to the Proposed Merger
We may not complete the proposed merger within the time frame we anticipate or at all, which could adversely affect our business.
Completion of the merger is subject to a number of closing conditions, including, among others, the expiration or termination of the waiting period under the Hart-Scot-Rodino AntitrustImprovements Act of 1976, as amended, or the HSR Act, including any agreement with the United States Department of Justice, or the DOJ, to delay the Merger, or the HSR Condition. The DOJ has indicated that it will require conditions on the proposed transaction, including requiring the disposition of certain assets held by us and/or Quikrete. We and Quikrete have each entered into definitive agreements with various third parties to dispose of certain assets in order to secure the DOJ's approval of the merger, or the Divestiture Agreements. There can be no assurances that the dispositions contemplated by the Divestiture Agreements will be acceptable to the DOJ or sufficient to obtain the DOJ's approval of the merger prior to the outside date contained in the merger agreement or by the outside dates contemplated in each of the Divestiture Agreements. Further, while the parties have agreed to use their respective reasonable best efforts to obtain the required regulatory approvals, 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 the Company or any of its subsidiaries, accounting for more than $80 million of EBITDA for the 12 months ended December 31, 2020, as defined in and measured in accordance with the merger
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agreement. Therefore, Quikrete may not be required to agree to additional divestitures the extent that the DOJ requires divestitures beyond those currently contemplated by the Divestiture Agreements.
Each party’s obligation to consummate the merger is also subject to 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; subject to certain qualifications, the accuracy of representations and warranties of the other party set forth in the merger agreement; and 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. In addition, the merger agreement may be terminated under certain specified circumstances, including if the merger has not been consummated on or before March 22, 2022, or the Outside Date. There is currently no assurance that the HSR Condition will be satisfied by the Outside Date. As a result, we cannot assure you that the merger will be completed, or that, if completed, it will be exactly on the terms set forth in the merger agreement or within the expected time frame.
If the merger is not completed within the expected time frame or at all, we may be subject to a number of material risks and our business, financial condition and results of operations will be harmed. The price of our common stock may decline to the extent that current market prices reflect a market assumption that the merger will be completed. We could be required to reimburse certain expenses of Quikrete or pay Quikrete a termination fee of $50.0 million if the merger agreement is terminated under specific circumstances described in the merger agreement. The failure to complete the merger may result in negative publicity and could negatively affect our relationship with our stockholders, employees, customers, suppliers and strategic partners. We may also be required to devote significant time and resources to litigation related to any failure to complete the merger or related to any enforcement proceeding commenced against us to perform our obligations under the merger agreement.
The merger agreement provides us with limited remedies in the event of a breach by Quikrete that results in termination of the merger agreement, including the right to a reverse termination fee payable under certain specified circumstances, as described in the merger agreement. We cannot assure you that a remedy will be available to us in the event of such a breach or that the damages we incur in connection with such breach will not exceed the amount of the reverse termination fee.
Our business is subject to restrictions while the merger is pending.
The merger agreement restricts the conduct of our business prior to the completion of the merger or termination of the merger agreement, generally requiring us to conduct our business in the ordinary course and subjecting us to a variety of specified limitations absent Quikrete’s prior written consent. The restrictions on our business activities include, among other things, restrictions on our ability to acquire other businesses and assets, dispose of our assets, make investments, enter into certain contracts, repurchase or issue securities, pay dividends, make capital expenditures above specified levels, amend our organizational documents and incur indebtedness above specified levels. These restrictions could prevent us from pursuing strategic business opportunities, taking actions with respect to our business that we may consider advantageous and responding in a timely and effective manner to competitive pressures and industry developments, any of which could adversely affect our business, and financial condition and results of operations.
The pendency of the merger may disrupt business relationships, lead to employee departures, or otherwise adversely affect our business.
The pendency of the merger and our efforts to complete the merger could create uncertainty surrounding and significantly disrupt our business. Uncertainty regarding our future could adversely affect our relationship with existing and potential customers, suppliers, vendors, strategic partners or others that deal with us. For example, clients and other counterparties may delay or defer decisions concerning entering into contracts or otherwise working with us, seek to change our existing business relationships or consider doing business with other companies rather than us. Competitors may also target our customers by highlighting potential uncertainties and other risks related to the merger. The pendency of the merger may also divert management’s attention and
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resources towards completing the merger and preparing for integration actives and away from ongoing business and operations. Uncertainty as to whether the merger will be completed may also affect our ability to recruit prospective employees or to retain and motivate existing employees. Employee retention may be particularly challenging while the merger is pending because employees may experience uncertainty about their roles following the merger. These risks and the resulting adverse effects on business, financial condition and results of operations could be exacerbated by any delays in completion of the merger or termination of the merger agreement.
We have incurred, and will continue to incur, significant costs as a result of the merger.
We have incurred, and will continue to incur, significant direct and indirect costs and expenses in connection with the merger. These costs and expenses include fees for financial, legal and accounting advisors, facilities and systems costs in anticipation of consolidation, severance other potential employment-related costs and other transaction costs. We must pay substantially all of these amounts regardless of whether the merger is completed. There are a number of factors beyond our control that could affect the total amount or the timing of these costs and expenses, including the length of time required to obtain the required regulatory approvals and satisfy the other conditions to closing the merger. If the merger is not completed, we will have incurred significant costs for which we will have received little or no benefit, which could adversely affect our business, financial condition and results of operations.
Merger-related legal proceedings could delay or prevent the completion of the merger or otherwise adversely affect us.
Litigation by purported stockholder plaintiffs and others is common in connection with public company acquisitions, regardless of the merits of these claims. While certain lawsuits with respect to the merger were previously filed by stockholder plaintiffs and subsequently dismissed, any additional legal proceedings filed in connection with the merger could delay or prevent the merger from becoming effective. For example, the conditions to closing the merger include the absence of any order, injunction or other judgment 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 and, if a settlement or other resolution is not reached in any merger-related lawsuit in which a claimant secures injunctive or other relief having the effect of making the merger illegal or otherwise prohibiting completion of the merger, then the merger may not be completed in a timely manner or at all. Moreover, any litigation could be time consuming and expensive and could divert management’s attention away from our regular business, any of which could adversely affect our business, financial condition and results of operations.
The merger agreement prohibits us from affirmatively seeking other acquisition proposals that may be superior to the merger.
The merger agreement prohibits us from engaging in any further discussions or solicitations regarding an alternative potential acquisition of the Company. This provision prevents us from affirmatively seeking offers from other possible acquirers that may be superior to the pending merger. Further, under the terms of the merger agreement, we may be required to pay Quikrete a termination fee of $50.0 million under specified conditions, including in the event Quikrete terminates the merger agreement for specified reasons and, within 12 months thereafter, we have consummated an acquisition proposal, as defined in the merger agreement, or entered into a definitive agreement regarding an acquisition proposal that is ultimately consummated. If the merger agreement is terminated under circumstances where the termination fee is potentially payable by the Company, this payment could affect the structure, pricing and terms proposed by a third party seeking to acquire or merge with us, and could discourage a third party from making a competing acquisition proposal following the termination of the merger agreement.
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Risks Related to Ownership of Our Common Stock
The trading price of our common stock has been and may in the future be volatile and could decline substantially.
The market price of our common stock may be highly volatile and subject to wide fluctuations. Some of the factors that could negatively affect the market price of our common stock or result in significant fluctuations in price, regardless of our actual operating performance, include:
• actual or anticipated variations in our quarterly operating results;
• changes in market valuations of similar companies;
• changes in the markets in which we operate;
• additions or departures of key personnel;
• actions by stockholders, including the sale by Lone Star of any of its shares of our common stock;
• speculation in the press or investment community;
• general market, economic and political conditions, including an economic slowdown;
• uncertainty regarding economic events, including in Europe in connection with the United Kingdom’s departure from the European Union;
• changes in interest rates;
• our operating performance and the performance of other similar companies;
• our ability to accurately project future results and our ability to achieve those and other industry and analyst forecasts;
• new legislation or other regulatory developments that adversely affect us, our markets or our industry; and
• the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger agreement or delay in consummating the Merger.
Furthermore, at times, the stock market has experienced significant price and volume fluctuations. This volatility has had a significant impact on the market price of securities issued by many companies, including companies in our industry, and often occurs without regard to the operating performance of the affected companies. Therefore, factors that have little or nothing to do with us could cause the price of our common stock to fluctuate, and these fluctuations or any fluctuations related to our company could cause the market price of our common stock to decline materially.
The coverage of our business or our common stock by securities or industry analysts or the absence thereof could adversely affect our stock price and trading volume.
The trading market for our common stock is influenced in part by the research and other reports that industry or securities analysts may publish about us or our business. We currently have, but may not be able to continue, research coverage by industry or financial analysts. If analysts do not continue coverage of us, the trading price and volume of our stock would likely be negatively impacted. Even if analyst coverage continues, if we fail to meet analyst expectations or one or more of the analysts who cover us downgrade our stock, or if analysts issue other unfavorable commentary or inaccurate research, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
Lone Star may have conflicts of interest with other stockholders and may limit your ability to influence corporate matters.
Lone Star beneficially owns approximately 51.9% of our outstanding common stock. As a result of this concentration of stock ownership, Lone Star acting on its own has sufficient voting power to effectively control all matters submitted to our stockholders for approval, including director elections and proposed amendments to our bylaws or certificate of incorporation. Five of the nine members of our board of directors are employees or affiliates of Lone Star.
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In addition, this concentration of ownership may delay or prevent a merger, consolidation or other business combination or change in control of our company and make some transactions that might otherwise give investors the opportunity to realize a premium over the then-prevailing market price of our common stock more difficult or impossible without the support of Lone Star. Because we have opted out of Section 203 of the Delaware General Corporation Law, or the DGCL, regulating certain business combinations with interested stockholders, Lone Star may transfer control of us to a third party by transferring its common stock without the approval of our board of directors or other stockholders, which may limit the price that investors are willing to pay in the future for shares of our common stock. The interests of Lone Star may not always coincide with our interests as a company or the interests of other stockholders. Accordingly, Lone Star could cause us to enter into transactions or agreements of which investors would not approve or make decisions with which investors would disagree. This concentration of ownership may also adversely affect our share price.
Lone Star is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us, although it does not currently hold any such interests. Lone Star may also pursue acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. In recognition that principals, members, directors, managers, partners, stockholders, officers, employees and other representatives of Lone Star and its affiliates and investment funds may serve as our directors or officers, our amended and restated certificate of incorporation provides, among other things, that none of Lone Star or any principal, member, director, manager, partner, stockholder, officer, employee or other representative of Lone Star has any duty to refrain from engaging directly or indirectly in the same or similar business activities or lines of business that we do. In the event that any of these persons or entities acquires knowledge of a potential transaction or matter which may be a corporate opportunity for itself and us, we will not have any expectancy in such corporate opportunity, and these persons and entities will not have any duty to communicate or offer such corporate opportunity to us and may pursue or acquire such corporate opportunity for themselves or direct such opportunity to another person. These potential conflicts of interest could have a material adverse effect on our business, financial condition and results of operations if, among other things, attractive corporate opportunities are allocated by Lone Star to themselves or their other affiliates.
Lone Star may also have conflicts of interest with the Company and other stockholders as a result of its status as a party to the tax receivable agreement. For example, the tax receivable agreement entered into with Lone Star at the time of our initial public offering gives us the right to terminate the tax receivable agreement with approval of a majority of our independent directors and with Lone Star’s consent by making a payment equal to the present value of future payments under the tax receivable agreement (based on certain assumptions and deemed events in the agreement, including those relating to our and our subsidiaries’ future taxable income). Lone Star may determine to withhold its consent to terminate the tax receivable agreement at a time when such a termination would be favorable to us and the other stockholders. Furthermore, the tax receivable agreement prohibits us from settling any tax audit without Lone Star’s consent (not to be unreasonably withheld, conditioned or delayed) if the outcome of the audit is reasonably expected to affect Lone Star’s rights under the tax receivable agreement. Therefore, Lone Star may determine to withhold consent to a settlement that reduces the payments Lone Star will receive under the tax receivable agreement, even though the settlement might be favorable to us and our stockholders.
We are a “controlled company” within the meaning of Nasdaq rules and, as a result, qualify for, and are relying on, exemptions from certain corporate governance requirements.
Lone Star controls a majority of the voting power of our outstanding common stock. As a result, we are a “controlled company” within the meaning of the Nasdaq corporate governance standards. Under the relevant Nasdaq rules, a company of which more than 50% of the voting power is held by a person or group is a “controlled company” and need not comply with certain requirements, including the requirement that a majority of the board of directors consist of independent directors and the requirements that the compensation and nominating and corporate governance committees be composed entirely of independent directors. We are utilizing these exemptions and, for so long as Lone Star controls a majority of the voting power of our outstanding common stock, we intend to continue to utilize these exemptions. As a result, among other things, we do not have a majority of independent directors and our compensation and nominating and corporate governance committees
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do not consist entirely of independent directors. Accordingly, investors will not have the same protections afforded to stockholders of companies that are subject to all of the applicable Nasdaq corporate governance requirements.
Future sales of our common stock in the public market could cause our stock price to fall.
Lone Star beneficially owns approximately 51.9% of our outstanding shares of common stock. The shares held by Lone Star and all shares held by our affiliates are eligible for resale in the public market, subject to applicable securities laws, including the Securities Act of 1933, as amended, or the Securities Act. In December 2019 we registered the shares of common stock beneficially owned by Lone Star pursuant to the terms of a registration rights agreement and these shares are now generally freely tradeable in the public market, subject to applicable securities laws. Unless the shares owned by any of our other affiliates are registered under the Securities Act, these shares may only be resold into the public markets in accordance with the requirements of an exemption from registration or safe harbor, including Rule 144 and the volume limitations, manner of sale requirements and notice requirements thereof. Any sale by Lone Star or other affiliates or any perception in the public markets that such a transaction may occur could cause the market price of our common stock to decline materially.
We have issued, and in the future we expect to issue, options, restricted stock and other forms of stock-based compensation, which have the potential to dilute stockholder value and cause the price of our common stock to decline.
We have issued, and in the future expect to issue, stock-based awards, including stock options, restricted stock and other forms of stock-based compensation to our independent directors, officers and employees. If any options that we have issued or may issue are exercised, or any restricted stock or other awards that we have issued or may issue vests, and the shares of common stock are sold into the public market, the market price of our common stock may decline. In addition, the availability of shares of common stock for award under our equity incentive plan, or the grant of stock options, restricted stock or other forms of stock-based compensation, may adversely affect the market price of our common stock.
We have no present intention to pay dividends on our common stock.
We have no present intention to pay dividends on our common stock. Any determination to pay dividends to holders of our common stock will be at the discretion of our board of directors and will depend upon many factors, including our financial condition, results of operations, projections, liquidity, earnings, legal requirements, restrictions in our credit facility and agreements governing any other indebtedness we may enter into and other factors that our board of directors deems relevant. Accordingly, holders of our common stock may need to sell their shares to realize a return on their investment and may not be able to sell their shares at or above the price they paid.
Provisions of our amended and restated governing documents, Delaware law and other documents could discourage, delay or prevent a merger or acquisition at a premium price.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws may have the effect of delaying or preventing a change of control or changes in our management. For example, our amended and restated certificate of incorporation and amended and restated bylaws include provisions that:
• permit us to issue, without stockholder approval, preferred stock in one or more series and, with respect to each series, fix the number of shares constituting the series and the designation of the series, the voting powers, if any, of the shares of the series and the preferences and other special rights, if any, and any qualifications, limitations or restrictions, of the shares of the series;
• prevent stockholders from calling special meetings;
• restrict the ability of stockholders to act by written consent after such time as Lone Star owns less than a majority of our common stock;
• limit the ability of stockholders to amend our certificate of incorporation and bylaws;
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• require advance notice for nominations for election to the board of directors and for stockholder proposals;
• do not permit cumulative voting in the election of our directors, which means that the holders of a majority of our common stock may elect all of the directors standing for election; and
• establish a classified board of directors with staggered three-year terms (which will be phased out over the next 3 annual meetings of stockholders).
These provisions may discourage, delay or prevent a merger or acquisition of our company, including a transaction in which the acquirer may offer a premium price for our common stock.
Our amended and restated certificate of incorporation includes an exclusive forum clause, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us.
Our amended and restated certificate of incorporation provides that, unless we consent in writing to the selection of an alternative forum, the sole and exclusive forum for any stockholder (including any beneficial owner) to bring (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, or employees to us or to our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the DGCL, or our certificate of incorporation or bylaws, or (iv) any action asserting a claim governed by the internal affairs doctrine, will be a state court located within the State of Delaware (or, if no state court located within the State of Delaware has jurisdiction, the federal district court for the District of Delaware); in all cases subject to such court having personal jurisdiction over the indispensable parties named as defendants. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock is deemed to have notice of and consented to the foregoing provisions. The exclusive forum clause may limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us. It is also possible that, notwithstanding such exclusive forum clause, a court could rule that such a provision is inapplicable or unenforceable.
Risks Related to Our Tax Receivable Agreement
We will be required to pay Lone Star for certain tax benefits, and these amounts are expected to be material.
We entered into a tax receivable agreement with Lone Star that provides for the payment by us to Lone Star of 85% of the amount of cash savings, if any, in U.S. federal, state, local and non-U.S. income tax that we and our subsidiaries realize (or in some circumstances are deemed to realize) as a result of the utilization of certain tax benefits, together with interest accrued at a rate of LIBOR plus 100 basis points from the date the applicable tax return is due (without extension) until paid. These tax benefits, which we collectively refer to as the Covered Tax Benefits, include: (i) all depreciation and amortization deductions, and any offset to taxable income and gain or increase to taxable loss, resulting from the tax basis that we have in our assets as of the time of the consummation of our initial public offering, (ii) the utilization of our and our subsidiaries’ net operating losses and tax credits, if any, attributable to periods prior to our initial public offering, (iii) deductions in respect of payments made, funded or reimbursed by an initial party to the tax receivable agreement (other than us or one of our subsidiaries) or an affiliate thereof to participants under the LSF9 Concrete Holdings Ltd Long Term Incentive Plan, or the LTIP, (iv) deductions in respect of transaction expenses attributable to the acquisition of U.S. Pipe and (v) certain other tax benefits attributable to payments made under the tax receivable agreement. The tax receivable agreement will remain in effect until all Covered Tax Benefits have been used or expired, unless the agreement is terminated early, as described below.
We expect that the payments we make under the tax receivable agreement could be substantial. For the years ended December 31, 2021 and December 31, 2020, we paid $8.3 million and $13.1 million, respectively, on our tax receivable agreement to Lone Star. Assuming no material changes in the relevant tax law, and that we and our subsidiaries earn sufficient income to realize the full tax benefits subject to the tax receivable agreement, we currently estimate that future payments under the agreement will aggregate to approximately $55.9 million. This amount excludes any payments that may be made to Lone Star under the tax receivable agreement as a
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result of tax benefits recognized in connection with payments under the LTIP and, thus, the actual payments we ultimately are required to make under the tax receivable agreement could be greater, potentially materially greater, than these amounts. These payment obligations are our obligations and are not obligations of any of our subsidiaries. Furthermore, these payment obligations are not conditioned upon Lone Star maintaining a continued direct or indirect ownership interest in us. The actual utilization of Covered 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.
We will not be reimbursed for any payments made to Lone Star under the tax receivable agreement in the event that the tax benefits are disallowed.
Lone Star will not reimburse us for any payments previously made under the tax receivable agreement if such benefits are subsequently disallowed upon a successfulchallenge by the Internal Revenue Service, although future payments under the agreement would be adjusted to the extent possible to reflect the result of such disallowance. As a result, in certain circumstances, payments could be made under the tax receivable agreement in excess of our cash tax savings if any, from the Covered Tax Benefits, and we may not be able to recoup those payments, which could adversely affect our liquidity.
In certain cases, payments made by us under the tax receivable agreement may be accelerated and/or significantly exceed the actual benefits we realize in respect of the Covered Tax Benefits.
The term of the tax receivable agreement will continue until all Covered Tax Benefits have been utilized or expired, unless we exercise our right to terminate the agreement with Lone Star’s consent, we breach any of our material obligations under the agreement or certain credit events occur with respect to us, in any of which cases we will be required to make an accelerated payment to Lone Star equal to the present value of future payments under the tax receivable agreement. Such payment would be based on certain assumptions, including, among others, that we and our subsidiaries would generate sufficient taxable income and tax liability to fully utilize all Covered Tax Benefits. The tax receivable agreement also provides that upon certain mergers, asset sales, other forms of business combinations or other changes of control, our (or our successor’s) payments under the tax receivable agreement for each taxable year after any such event would be based on certain valuation assumptions, including the assumption that we and our subsidiaries have sufficient taxable income to fully utilize the Covered Tax Benefits. Accordingly, payments under the tax receivable agreement may be made years in advance of the actual realization, if any, of the anticipated future tax benefits and may be significantly greater than the benefits we realize in respect of the Covered Tax Benefits.
Even if the payments under the tax receivable agreement are not accelerated as described above, such payments may be significantly greater than the benefits we realize in respect of the Covered Tax Benefits, due to the manner in which payments are calculated under the tax receivable agreement. For example, for purposes of calculating the payments to be made to Lone Star:
• it is assumed that we will pay effective state and local taxes at a rate of 5%, even though our actual effective state and local tax rate may be materially lower;
• tax benefits existing at the time of our initial public offering are deemed to be utilized before any post-closing/after-acquired tax benefits and, as a result, we could be required to make payments to Lone Star for a particular tax year even if our tax liability for such year would have been materially reduced or eliminated by reason of our utilization of the post-initial public offering/after-acquired tax benefits;
• a non-taxable transfer of assets by us to a non-consolidated entity is treated under the tax receivable agreement as a taxable sale at fair market value and, as a result, we could be required to make payments to Lone Star even though such non-taxable transfer would not generate any actual tax benefits to us or our non-consolidated entity; and
• a taxable sale or other taxable transfer of subsidiary stock by us (in cases where the subsidiary’s tax basis in its assets exceeds our tax basis in the subsidiary’s stock) is treated under the tax receivable agreement as a taxable sale of the subsidiary’s assets and, as a result, we could be required to make payments to Lone Star that materially exceed the actual tax benefit we realize from such stock sale.
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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.
Certain provisions of the tax receivable agreement limit our ability to incur additional indebtedness, which could adversely affect our business and growth strategy.
For so long as the tax receivable agreement remains outstanding, without the prior written consent of Lone Star (not to be unreasonably withheld, conditioned or delayed), we will be prohibited from (a) entering into any agreement that would be materially more restrictive with respect to our ability to make payments under the tax receivable agreement than the terms of our credit agreement and (b) incurring any indebtedness for borrowed money if, immediately after giving effect to such incurrence and the application of proceeds therefrom, our consolidated net leverage ratio - the ratio of consolidated funded indebtedness for borrowed money less unrestricted cash to consolidated EBITDA - would exceed a certain specified ratio, in each case as calculated pursuant to the tax receivable agreement, unless the incurrence of such indebtedness is permitted by the terms of our credit agreement or any replacement credit agreements to the extent the terms thereof are no less restrictive in this regard than the applicable credit agreement it replaced. These restrictions on the incurrence of debt could adversely affect our business, including by preventing us from pursuing an acquisition or other strategic transaction that we believe is in the best interests of our company and our stockholders, thereby impeding our growth strategy. Lone Star has no fiduciary duties to us when deciding whether to enforce these covenants under the tax receivable agreement. Furthermore, the provision in the tax receivable agreement that requires that we make an accelerated payment to Lone Star equal to the present value of all future payments due under the tax receivable agreement if we breach any of our material obligations under the agreement or certain credit events occur with respect to us might make it harder for us to obtain financing from third party lenders on favorable terms.
We would be required to make tax gross-up payments to Lone Star if we consummate a corporate inversion or similar transaction that causes payments under the tax receivable agreement to be subject to withholding taxes.
If we were to consummate a change of control transaction that causes us (or our successor) to become a non-U.S. person (e.g., a corporate inversion transaction), and such transaction causes payments under the tax receivable agreement to become subject to withholding taxes, we would be required under the tax receivable agreement to make tax gross-up payments to Lone Star in respect of such withholding taxes in amounts that may exceed the tax savings realized by the Company from the Covered Tax Benefits. Any such tax gross-up payments could have a negative impact on our liquidity and our ability to finance our growth.
Divestitures
On February 19, 2021, we entered into an Agreement and Plan of Merger, or the Merger Agreement, with Quikrete Holdings, Inc., a Delaware corporation, or Quikrete, and Jordan Merger Sub, Inc., a Delaware 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 under Delaware 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 AntitrustImprovements 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 ended December 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 before November 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 the Nasdaq 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 the DOJ to satisfy the HSR Condition, on November 24, 2021, Forterra Pipe & Precast, LLC, a Delaware limited liability company and wholly owned subsidiary of us, or FP&P, entered into a Membership Interest Purchase Agreement, or the Eagle Purchase Agreement, with Eagle Corporation, a Virginia 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 in Concrete 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 the DOJ.
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 by March 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 the DOJ 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 the DOJ to satisfy the HSR Condition, on December 13, 2021, FP&P entered into an Asset Purchase Agreement, or the Foley Asset Purchase Agreement, with Hydro Conduit, LLC d/b/a Rinker Materials, a Delaware limited liability company and an affiliate of Quikrete, or Rinker, and Foley Products Company, Inc., a Georgia 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
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reinforced concrete pipe and precast plant located in St. Martinville, Louisiana. Consummation of the Asset Sale is subject to customary closing conditions, including, among others, the consummation of the Merger and approval by the DOJ.
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 by March 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 the DOJ is not likely to approve the Asset Sale and the Merger.
Additionally, on February 16, 2022, the Company announced that Rinker had entered into an Asset Purchase Agreement, or the Oldcastle Asset Purchase Agreement, with Oldcastle Infrastructure, Inc., a Washington corporation, or Oldcastle, in order to address some of the divestitures anticipated to be required by the DOJ 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 the Dallas/Fort Worth, Houston, and San 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 the DOJ.
The Company and Quikrete continue to work with the DOJ to obtain the necessary consent to allow the parties to complete the Merger by the outside date of March 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 in mid-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 throughout the United States and worldwide. These government-instituted restrictions, together with the economic volatility and uncertainty caused by the pandemic, have had a significant impact on the 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 by December 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 the U.S., federal funds are allocated to the states, which are required to match a portion of the federal funds they receive. According to the Federal Reserve Bank, public investment in the U.S. infrastructure as a share of Gross Domestic Product has fallen by more than 40% since the 1960s. The World Economic Forum ranked the U.S. 13 th when it comes to overall quality of infrastructure. In terms of the transportation infrastructure, more than 45,000 U.S.
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bridges and 1 in 5 miles of roads are in poor condition, according to the American Society of Civil Engineers, or the ASCE.
A large proportion of our net sales in our Water Pipe & Products segment is generated through municipal infrastructure projects. The U.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 the U.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 the U.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 the U.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.
In November 2021, President Biden signed into law the Infrastructure Investment and Jobs Act, a $1.2 trillion investment in U.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 the U.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 the U.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 in the United States and Eastern 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
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 with Americast, Inc. CP&P is engaged primarily in the manufacture, marketing, sale and distribution of concrete pipe and precast products in Virginia, West Virginia, Maryland, North Carolina, Pennsylvania and South 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 December 31, 2021 as Compared to the Year Ended December 31, 2020
Total Company
The following table summarizes certain financial information relating to our operating results for the years ended December 31, 2021 and December 31, 2020 (in thousands).
Statements of Income Data:
Year ended
December 31, 2021
Year ended
December 31, 2020
% Change
Net sales
Cost of goods sold
Gross profit
Selling, general and administrative expenses
Impairment and exit charges
Other operating income, net
Income from operations
Other income (expenses)
Interest expense
Gain (loss) on extinguishment of debt
Earnings from equity method investee
Income before income taxes
Income tax expense
Net income
* Represents positive or negative change in excess of 100%
Net Sales
Net sales for the year ended December 31, 2021 were $1,858.3 million, an increase of $263.8 million or 16.5% from $1,594.5 million for the year ended December 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 ended December 31, 2021 were $1,437.9 million, an increase of $220.1 million or 18.1% from $1,217.8 million for the year ended December 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.
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Gross Profit
Gross profit in the year ended December 31, 2021 was $420.4 million, an increase of $43.7 million, or 11.6%, from $376.7 million in the year ended December 31, 2020. Most of the increase in gross profit came from our Drainage Pipe and Products segment primarily driven by higher shipment volumes
Selling, General and Administrative Expenses
Selling, general and administrative expenses in the year ended December 31, 2021 were $216.1 million, a slight decrease compared to $221.8 million in the year ended December 31, 2020.
Impairment and Exit Charges
Impairment and exit charges in the year ended December 31, 2021 were $0.6 million, compared to $2.5 million in the year ended December 31, 2020. These charges in both years primarily related to plant closings undertaken for purposes of achieving operating efficiencies.
Other Operating Income, net
Other operating income, net increased to $13.8 million in the year ended December 31, 2021, compared to $1.4 million in the year ended December 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 ended December 31, 2021 was $75.0 million, a decrease of $4.9 million, or 6.2%, from $79.9 million in the year ended December 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 in July 2020.
Gain (loss) on extinguishment of debt
Loss on extinguishment of debt in the year ended December 31, 2020 was $12.3 million. There was no loss on extinguishment of debt in the year ended December 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 ended December 31, 2021 was $38.7 million, an increase of $30.2 million from an income tax expense of $8.5 million in the year ended December 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.
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Segment Results of Operations
(in thousands)
For the year ended December 31,
% Change
Net sales:
Drainage Pipe & Products
Water Pipe & Products
Corporate and Other
Total
Gross profit (loss):
Drainage Pipe & Products
Water Pipe & Products
Corporate and Other
Total
Segment EBITDA (1) :
Drainage Pipe & Products
Water Pipe & Products
Corporate and Other
Key Operational Statistics
% Change
Drainage Pipe & Products (2)
Shipment Volumes
Average Selling Prices
Water Pipe & Products (3)
Shipment Volumes
Average Selling Prices
(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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Drainage Pipe & Products
Net Sales
Net sales in the year ended December 31, 2021 were $993.5 million, an increase of $106.0 million, or 12.0%, from $887.4 million in the year ended December 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 December 31, 2021 was $254.1 million, an increase of $42.5 million or 20.1% from $211.6 million in the year ended December 31, 2020. The increase was primarily due to higher shipment volumes of our pipe and precast products.
Water Pipe & Products
Net Sales
Net sales in the year ended December 31, 2021 were $864.8 million, an increase of $157.7 million or 22.3% from $707.1 million in the year ended December 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 December 31, 2021 was $166.4 million, a slight increase of $1.3 million or 0.8% from $165.1 million in the year ended December 31, 2020. Higher average selling prices were offset by higher raw material, labor and freight costs.
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Year Ended December 31, 2020 as Compared to the Year Ended December 31, 2019
Total Company
The following table summarizes certain financial information relating to our operating results for the years ended December 31, 2020 and December 31, 2019 (in thousands).
Statements of Income Data:
Year ended
December 31, 2020
Year ended
December 31, 2019
% Change
Net sales
Cost of goods sold
Gross profit
Selling, general and administrative expenses
Impairment and exit charges
Other operating income, net
Income from operations
Other income (expenses)
Interest expense
Gain (loss) on extinguishment of debt
Earnings from equity method investee
Income (loss) before income taxes
Income tax (expense) benefit
Net income (loss)
* Represents positive or negative change in excess of 100%
Net Sales
Net sales for the year ended December 31, 2020 were $1,594.5 million, an increase of $64.7 million or 4.2% from $1,529.8 million for the year ended December 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 ended December 31, 2020 were $1,217.8 million, a decrease of $15.6 million or 1.3% from $1,233.4 million in the year ended December 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 remain ed relatively flat.
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Gross Profit
Gross profit in the year ended December 31, 2020 was $376.7 million, an increase of $80.3 million, or 27.1%, from $296.4 million in the year ended December 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 ended December 31, 2020 were $221.8 million, the same as $221.8 million in the year ended December 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 ended December 31, 2020 were $2.5 million, compared to $3.5 million in the year ended December 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 ended December 31, 2020 was $79.9 million, a decrease of $15.1 million, or 15.9%, from $95.0 million in the year ended December 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 in July 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 ended December 31, 2020 was $12.3 million, compared to a gain of $1.7 million in the year ended December 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 ended December 31, 2020 was $8.5 million, a change of $11.8 million from an income tax benefit of $3.3 million in the year ended December 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.
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Segment Results of Operations
(in thousands)
For the year ended December 31,
% Change
Net sales:
Drainage Pipe & Products
Water Pipe & Products
Corporate and Other
Total
Gross profit (loss):
Drainage Pipe & Products
Water Pipe & Products
Corporate and Other
Total
Segment EBITDA (1) :
Drainage Pipe & Products
Water Pipe & Products (2)
Corporate and Other
Key Operational Statistics
% Change
Drainage Pipe & Products (3)
Shipment Volumes
Average Selling Prices
Water Pipe & Products (4)
Shipment Volumes
Average Selling Prices
(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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Drainage Pipe & Products
Net Sales
Net sales in the year ended December 31, 2020 was $887.4 million, a decrease of $25.6 million, or 2.8%, from $913.0 million in the year ended December 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 December 31, 2020 was $211.6 million, an increase of $10.6 million or 5.3%, from $201.0 million in the year ended December 31, 2019. The increase was primarily due to higher average selling prices, partially offset by lower shipment volumes of our pipe and precast products.
Water Pipe & Products
Net Sales
Net sales in the year ended December 31, 2020 were $707.1 million, an increase of $90.4 million or 14.7% from $616.7 million in the year ended December 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 December 31, 2020 was $165.1 million, an increase of $69.5 million or 72.7% from $95.6 million in the year ended December 31, 2019. The increase was primarily due to both higher average selling prices and higher shipment volumes.
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 of December 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 of December 31, 2021 and 2020 were readily convertible as of such dates into currencies used in the Company’s operations, including the U.S. dollar. As a result of recent tax reform legislation, we can repatriate the cumulative undistributed foreign earnings back to the U.S. when needed with minimal additional taxes other than state income and foreign withholding tax.
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In connection with the IPO, we entered into a tax receivable agreement with Lone Star that provides for the payment by us to Lone 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 to Lone 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 at December 31, 2021 and December 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 ended December 31, 2021 and December 31, 2020, we paid $8.3 million and $13.1 million, respectively, to Lone 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 ended December 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 ended December 31, 2021. As of December 31, 2021, we had $402.4 million outstanding balance under our Term Loan. At December 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 the U.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 the U.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 on June 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 of Forterra, 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 on October 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
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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 restricting Forterra 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 of December 31, 2021, we were in compliance with all applicable covenants under the Revolver and the Term Loan.
On July 16, 2020, two of our subsidiaries, Forterra Finance, LLC and FRTA Finance Corp., completed the issuance of $500 million senior secured notes, or the Notes, that are due July 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 the U.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 on July 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 (Forterra, Inc.) and subsidiary guarantors.
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 U.S. subsidiaries, including the guarantors.
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
Intercompany payable to non-guarantor subsidiaries
Non-current assets
Current liabilities
Non-current liabilities
Parent - Forterra, Inc. and Subsidiary Guarantors
Year ended December 31, 2021
Year ended December 31, 2020
Net sales
Gross profit
Income before taxes
Net income
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 December 31, 2021
Year ended December 31, 2020
Year ended December 31, 2019
Statement of Cash Flows data:
Net cash provided by operating activities
Net cash used in investing activities
Net cash used in financing activities
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.
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Net Cash Used in Investing Activities
Net cash used in investing activities was $48.0 million for the year ended December 31, 2021 primarily due to capital expenditures of $65.6 million and acquisition of Barbour 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 ended December 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 ended December 31, 2019 primarily due to capital expenditures of $42.9 million and the acquisition of Buckner 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
Net cash used in financing activities was $21.2 million for the year ended December 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 ended December 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 ended December 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 ended December 31, 2021, $34.0 million for the year ended December 31, 2020, and $42.9 million for the year ended December 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 December 31, 2021, outstanding stand-by letters of credit amounted to $18.8 million.
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Contractual Obligations and Other Long-Term Liabilities
The following table summarizes our significant contractual obligations as of December 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
Thereafter
(In thousands)
Term loan
Notes
Interest on indebtedness (1)
Operating leases
Finance leases
Total Commitments
(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 of December 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 with U.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.
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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 and other intangible assets, net
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 of October 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 December 31, 2021, December 31, 2020 and December 31, 2019, no impairment charge was recorded for goodwill and intangible assets.
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 ended December 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 ended December 31, 2021, December 31, 2020, and December 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.
