ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and the accompanying notes contained in this Annual Report.
OVERVIEW
As a vertically integrated organization, we manufacture, recycle and fabricate steel and metal products, related materials and services through a network including seven EAF mini mills, two EAF micro mills, two rerolling mills, steel fabrication and processing plants, construction-related product warehouses and metal recycling facilities in the U.S. and Poland. Our operations are conducted through two reportable segments: North America and Europe. See Part I, Item 1, "Business", for further information regarding our business and reportable segments.
When considering our results for the period, we evaluate our operating performance by comparing our net sales, in the aggregate and for both of our segments, in the current period to net sales in the corresponding period in the prior year. In doing so, we focus on changes in average selling price per ton and tons shipped for each of our product categories as these are the two variables that typically have the greatest impact on our results of operations. We group our products into three categories: raw materials, steel products and downstream products. Raw materials include ferrous and nonferrous scrap, steel products include rebar, merchant and other steel products, such as billets and wire rod, and downstream products include fabricated rebar and steel fence post.
We use adjusted EBITDA from continuing operations to compare and evaluate the financial performance of our segments. Adjusted EBITDA is the sum of the Company's earnings from continuing operations before interest expense, income taxes, depreciation and amortization expense and impairment expense. Although there are many factors that can impact a segment’s adjusted EBITDA and, therefore, our overall earnings, changes in metal margin of our steel products and downstream products period-over-period is a consistent area of focus for our Company and industry. Metal margin is an important metric used by management to monitor the results of our vertically integrated organization. For our steel products, metal margin is the difference between the average selling price per ton of rebar, merchant and other steel products and the cost of ferrous scrap per ton utilized by our steel mills to produce these products. An increase or decrease in input costs can impact profitability of these products when there is no corresponding change in selling prices due to competitive pressures on prices. The metal margin for our downstream products is the difference between the average selling price per ton of fabricated rebar and steel fence post products and the cost of material utilized by our fabrication facilities to produce these products. The majority of our downstream products selling prices per ton are fixed at the beginning of a project and these projects last one to two years on average. Because the selling price generally remains fixed over the life of a project, changes in input costs over the life of the project can significantly impact profitability.
Impact of COVID-19
In March 2020, the World Health Organization characterized the outbreak of COVID-19 as a pandemic, and the President of the United States declared the COVID-19 pandemic a national emergency. COVID-19 resulted in various government actions globally, including governmental actions in both the U.S. and Poland designed to slow the spread of the virus. Shelter-in-place or stay-at-home orders ("COVID-19 restrictions") were implemented in many of the jurisdictions where we operated in 2020. However, because we operate in a critical infrastructure industry, our facilities were allowed to remain open in the U.S in 2020. Our facilities in Poland also remained open. Accordingly, COVID-19 had limited impact on our operations. Due to the impact of COVID-19 on the broader economy, average selling prices per ton and volumes decreased for certain product categories in 2020 compared to 2019. However, net sales and volumes in the second half of 2020 were relatively consistent with, or higher than, net sales and volumes in the first half of 2020. While we implemented new procedures to support the safety of our employees, the costs were not material.
While COVID-19 may negatively impact our results of operations, cash flows and financial position in the future, the current level of uncertainty over the economic and operational impacts of COVID-19 and the actions to contain the outbreak or treat its impact means the related financial impact cannot be reasonably estimated at this time.
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RESULTS OF OPERATIONS SUMMARY
The following discussion of our results of operations is based on our continuing operations and excludes any results of our discontinued operations.
Year Ended August 31,
2020 Compared to 2019
Net sales for 2020 decreased $0.4 billion, or 6%, compared to 2019. Net sales in our North America segment decreased in 2020, as compared to the same period in 2019, primarily due to a year-over-year decrease in raw material shipments and a year-over-year decline in steel products average selling prices. This decrease was partially offset by two additional months of shipments from the Acquired Businesses in 2020 compared to 2019. Net sales in our Europe segment also decreased due to a decline in steel products average selling prices in 2020 compared to 2019.
Earnings from continuing operations for 2020 increased by $79.5 million, or 40%, compared to 2019. Earnings increased in 2020 compared to 2019 primarily due to a year-over-year increase in downstream products metal margin in our North America segment. This increase was partially offset by a year-over-year decrease in steel products metal margin in our Europe segment.
Selling, General and Administrative Expenses
Selling, general and administrative expenses in 2020 increased $41.3 million compared to 2019. The year-over-year increase was driven primarily by a $49.2 million year-over-year increase in employee-related expenses due, in part, to two additional months of employee-related expenses related to the Acquired Businesses, and a $32.1 million charge recorded in 2020 due to a working capital adjustment related to the Acquisition, which was recorded subsequent to the end of the allowable one-year measurement period. This increase was partially offset by a $23.3 million year-over-year decrease in professional fees and legal expenses, primarily related to the Acquisition, a $5.3 million year-over-year decrease in lease expense as we have closed certain facilities in 2020 as part of the integration of the Acquired Businesses, as described in Note 3, Changes in Business, in Part II, Item 8 of this Annual Report, and a $3.2 million year-over-year decrease in travel-related expenses primarily due to COVID-19 restrictions which limited travel in 2020.
Interest Expense
Interest expense in 2020 decreased $9.5 million compared to 2019. The year-over-year decrease was the result of a reduction in interest on long-term debt primarily due to total prepayments of $210.1 million in 2020 on the Term Loan (as defined in Note 10, Credit Arrangements, in Part II, Item 8 of this Annual Report).
Income Taxes
Our effective income tax rate for 2020 was 24.9% compared to 26.0% for 2019. The year-over-year decrease was primarily due to tax expense recorded during 2019 as a result of the TCJA which did not recur during 2020. See Note 14, Income Tax, in Part II, Item 8 of this Annual Report, for further discussion of our effective tax rate.
2019 Compared to 2018
Net sales for 2019 increased $1.2 billion, or 26%, compared to 2018 due to the successful execution of our growth strategy and strength in our core markets. The Acquisition, which was completed in the first quarter of 2019, contributed net sales of $1.4 billion in 2019. See Note 3, Changes in Business, in Part II, Item 8 of this Annual Report, for further information related to the Acquisition. Net sales in our North America segment increased in 2019, as compared to the same period in 2018, primarily due to increased shipments from the Acquired Businesses and an increase in year-over-year steel products and downstream products average selling prices. This increase was partially offset by a reduction in net sales in our Europe segment as steel products average selling prices and volumes were down in 2019, as compared to 2018.
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Earnings from continuing operations for 2019 increased by $63.5 million, or 47%, compared to 2018. The increase in earnings was primarily due to the Acquired Businesses.
Selling, General and Administrative Expenses
Selling, general and administrative expenses in 2019 increased $61.8 million compared to 2018, due to $51.0 million of costs associated with the Acquisition and with the expenses related to the operation of the Acquired Businesses.
Interest Expense
Interest expense in 2019 increased $30.4 million compared to 2018. The increase was primarily the result of financing activities in connection with the Acquisition, including issuance of the 2026 Notes and a draw under the 2018 Term Loan (both defined in Note 10, Credit Arrangements, in Part II, Item 8 of this Annual Report), which increased interest expense by $19.8 million in 2019 as compared to 2018. Also contributing to the increase was a year-over-year reduction in capitalized interest of $6.9 million in 2019 compared to 2018.
Income Taxes
Our effective income tax rate for 2019 was 26.0% compared to 18.2% for 2018. Our effective tax rate for 2019 included non-recurring expense of approximately $7.4 million related to the final measurement of our U.S. federal tax expense associated with repatriation tax provisions of the TCJA.Excluding the impacts of the TCJA, the year-over-year increase was primarily due to certain tax benefits recorded during 2018 which did not recur during 2019. See Note 14, Income Tax, in Part II, Item 8 of this Annual Report, for further discussion of our effective tax rate.
SEGMENTS
All amounts are computed and presented in a manner that is consistent with the basis in which we internally disaggregate financial information for the purpose of making operating decisions. See Note 21, Business Segments, in Part II, Item 8 of this Annual Report, for further information on how we evaluate financial performance of our segments.
2020 Compared to 2019
North America
Year Ended August 31,
External tons shipped (in thousands)
Average selling price per ton
Cost of ferrous scrap utilized per ton $ 238 $ 284
Steel products metal margin per ton 380 397
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Net sales in 2020 decreased $231.2 million, or 5%, compared to 2019. The net sales decrease for 2020 compared to 2019 was due, in part, to a 433 thousand ton decrease in raw materials shipped due to (i) lower availability of raw materials as a result of the declining price environment, (ii) COVID-19 restrictions, which resulted in the temporary idling of many industrial accounts, such as auto manufacturers and (iii) reduced demand from certain of our customers, many of which produce flat rolled steel. A $63 per ton year-over-year decline in steel products average selling prices also contributed to the net sales decrease. This decrease was partially offset by a 117 thousand ton year-over-year increase in steel products shipped due to two additional months of shipments from the Acquired Businesses, and a $70 per ton year-over-year increase in downstream products average selling prices. Net sales for 2020 and 2019 included amortization benefit of $29.4 million and $74.8 million, respectively, related to the unfavorable contract backlog of the Acquired Businesses.
Adjusted EBITDA in 2020 increased $204.9 million compared to 2019. The year-over-year increase in adjusted EBITDA was due to significant expansion in downstream products metal margin. As the majority of the downstream products are fixed price, the project backlog reflects a lag between current market prices and average selling prices of material shipped. This is beneficial during a time of economic slowdown as the average selling prices per ton fixed at the beginning of a project are typically higher than current market input costs, resulting in metal margin expansion for downstream products. The expansion in downstream products metal margin in 2020 compared to 2019 was partially offset by the year-over-year decrease in raw material volumes discussed above and a $17 per ton year-over-year decrease in steel products metal margin. Adjusted EBITDA did not include the $29.4 million or $74.8 million benefit of the amortization of the unfavorable contract backlog in 2020 or 2019, respectively. Adjusted EBITDA included non-cash stock compensation expense of $12.4 million and $9.4 million in 2020 and 2019, respectively.
Europe
Year Ended August 31,
External tons shipped (in thousands)
Average selling price per ton
Cost of ferrous scrap utilized per ton $ 246 $ 288
Steel products metal margin per ton 202 240
Net sales in 2020 decreased $117.9 million, or 14%, compared to 2019. The decrease in net sales was primarily driven by an $80 per ton decline in steel products average selling price primarily due to continued pricing pressure as a result of high levels of imports. Net sales were also impacted by an unfavorable foreign currency translation adjustment of $25.1 million due to the increase in the average value of the U.S. dollar relative to the Polish zloty in 2020, as compared to 2019.
Adjusted EBITDA in 2020 decreased $38.1 million compared to 2019, primarily driven by a $38 per ton, or 16%, compression in steel products metal margin as the input cost of ferrous scrap utilized has not decreased as much as the average selling price of steel products. This decrease was partially offset by a $10.7 million carbon credit received in the fourth quarter of 2020. The impact of foreign currency translation to adjusted EBITDA for 2020 compared to 2019 was immaterial. Adjusted EBITDA included non-cash stock compensation expense of $2.0 million and $1.2 million in 2020 and 2019, respectively.
Corporate and Other
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Year Ended August 31,
Corporate and Other adjusted EBITDA loss in 2020 increased by $14.3 million compared to 2019. The year-over-year increase was driven by a $32.1 million charge recorded in 2020 due to a working capital adjustment related to the Acquisition, which was recorded subsequent to the end of the allowable one-year measurement period and an $11.7 million increase in employee-related expenses in 2020 compared to 2019. These increases were partially offset by a $25.1 million year-over-year decrease in professional services and legal fees, primarily due to the Acquisition in 2019, coupled with a $2.9 million year-over-year increase in other revenue primarily due to an increase in gains on Benefit Restoration Plan ("BRP") assets year-over-year. Adjusted EBITDA included non-cash stock compensation expense of $17.5 million and $14.4 million for 2020 and 2019, respectively.
Discontinued Operations
See Note 3, Changes in Business, in Part II, Item 8 of this Annual Report, for information regarding discontinued operations.
2019 Compared to 2018
North America
Year Ended August 31,
External tons shipped (in thousands)
Average selling price per ton
Cost of ferrous scrap utilized per ton $ 284 $ 303
Steel products metal margin per ton 397 337
Net sales in 2019 increased $1.3 billion, or 34%, compared to 2018. The year-over-year increase in net sales was driven by a 991 thousand and 518 thousand ton increase in steel products and downstream products shipped, respectively, due to shipments by the Acquired Businesses. Year-over-year increases in downstream products and steel products average selling prices of $105 per ton and $41 per ton, respectively, also contributed to the increase in net sales in 2019 compared to 2018, as the Section 232 trade actions implemented in the U.S., aimed at unfairly priced steel imports, favorably impacted the pricing environment in 2019. These increases were partially offset by a 215 thousand ton decrease in raw material shipments, coupled with a decrease in raw materials average selling prices year-over-year. Net sales for 2019 included amortization benefit of $74.8 million related to the unfavorable contract backlog of the Acquired Businesses.
Adjusted EBITDA in 2019 increased $132.3 million compared to 2018. This increase was due, in part, to the Acquired Businesses, which contributed $98.2 million to adjusted EBITDA in 2019. Adjusted EBITDA in 2019 also increased, compared to 2018, due to an 18% expansion in steel products metal margin. Partially offsetting steel products metal margin expansion were increases in conversion costs due to increased electrode prices and repairs and maintenance expenses in 2019 compared to
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2018, as well as increases due to the Acquired Businesses. The increase in adjusted EBITDA was partially offset by downstream products metal margin compression in 2019 compared to 2018, as the implementation of Section 232 trade actions resulted in increased input costs, while the projects included in our downstream products backlog were fixed at lower average selling prices agreed upon when the projects began. Adjusted EBITDA did not include the $74.8 million benefit related to the amortization of the unfavorable contract backlog in 2019. Adjusted EBITDA included$4.2 million of costs related to the closure of certain facilities in 2019 and also included non-cash stock compensation expense of $9.4 million and $8.7 million in 2019 and 2018, respectively.
Europe
Year Ended August 31,
External tons shipped (in thousands)
Average selling price per ton
Cost of ferrous scrap utilized per ton $ 288 $ 314
Steel products metal margin per ton 240 246
Net sales in 2019 decreased $70.0 million, or 8%, compared to 2018. The decrease in net sales was primarily related to an unfavorable foreign currency exchange rate impact of $53.9 million due to the increase in the average value of the U.S. dollar relative to the Polish zloty in 2019, as compared to 2018. Excluding the foreign exchange impact, net sales decreased by approximately 2% on a year-over-year basis due to a high volume of steel imports into the European Union which drove prices down.
Adjusted EBITDA in 2019 decreased $31.6 million compared to 2018, primarily driven by a $6 per ton, or 2%, decrease in steel products metal margin and a $7 per ton, or 4%, increase in conversion costs. Adjusted EBITDA for 2019 included an unfavorable foreign currency exchange rate impact of approximately $6.4 million in 2019, as compared to 2018. Adjusted EBITDA included non-cash stock compensation expense of $1.2 million and $1.4 million in 2019 and 2018, respectively.
Corporate and Other
Year Ended August 31,
Corporate and Other adjusted EBITDA loss in 2019 increased by $28.8 million compared to 2018. The increase in adjusted EBITDA loss in 2019 was driven by a $10.2 million decrease in other revenue primarily as a result of a decrease in gains on BRP assets year-over-year and a $12.2 million increase in acquisition and integration-related costs arising from the Acquisition.
Discontinued Operations
See Note 3, Changes in Business, in Part II, Item 8 of this Annual Report, for information regarding discontinued operations.
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LIQUIDITY AND CAPITAL RESOURCES
Sources of Liquidity and Capital Resources
Our cash and cash equivalents position remained strong in 2020 with $542.1 million at August 31, 2020 compared to $192.5 million at August 31, 2019. Our cash flows from operations result primarily from sales of steel products and downstream products as described in Part I, Item 1, "Business". Historically, our North America operations have generated the majority of our cash. Our foreign operations generated approximately 13% of our net sales in 2020. At August 31, 2020, cash and cash equivalents of $27.4 million were held by our non-U.S. subsidiaries. From time to time, we use futures or forward contracts to mitigate the risks from fluctuations in metal commodity prices, foreign currency exchange rates, interest rates and natural gas, electricity and other energy commodity prices. See Note 12, Derivatives, in Part II, Item 8 of this Annual Report for further information.
We have a diverse and generally stable customer base, and regularly maintain a substantial amount of accounts receivable. We actively monitor our accounts receivable and, based on market conditions and customers' financial condition, record allowances when we believe accounts are uncollectible. We use credit insurance internationally to mitigate the risk of customer insolvency. We estimate that the amount of credit-insured receivables (and those covered by export letters of credit) was approximately 13% of total receivables at August 31, 2020.
The table below reflects our sources, facilities and availability of liquidity as of August 31, 2020. See Note 10, Credit Arrangements, in Part II, Item 8 of this Annual Report, for additional information.
(in thousands) Total Facility Availability
__________________________________
* We believe we have access to additional financing and refinancing, if needed.
COVID-19 has not had a material impact on our operations to date. We anticipate our current cash balances, cash flows from operations and our available sources of liquidity will be sufficient to meet our cash requirements, including our scheduled debt repayments, payments for our contractual obligations, capital expenditures, working capital needs, dividends and other prudent uses of our capital, as needed, for the next twelve months. However, as the impact of COVID-19 on the economy, and our operations, evolves, we will continue to assess our liquidity needs. In the event of sustained market deterioration, we may need additional liquidity, which would require us to evaluate available alternatives and take appropriate actions.
Stock Repurchase Program
During the first quarter of 2015, our Board of Directors authorized a share repurchase program under which we may repurchase up to $100.0 million of outstanding common stock. As of August 31, 2020, $27.6 million of our common stock was available to be purchased under this program. We may repurchase shares from time to time for cash in the open market or privately negotiated transactions in accordance with applicable federal securities laws. The timing and the amount of repurchases, if any, will be determined by management based on an evaluation of market conditions, capital allocation alternatives and other factors. The share repurchase program does not require us to purchase any dollar amount or number of shares of our common stock and may be modified, suspended, extended or terminated at any time without prior notice. We did not purchase any shares of common stock during 2020, 2019 or 2018.
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2020 Compared to 2019
Operating Activities
With the adoption of Accounting Standards Update ("ASU") 2016-15 effective September 1, 2018, cash receipts related to the collection of the deferred purchase price ("DPP") from our accounts receivable programs in the U.S. and Poland (the "Programs"), previously recorded as cash flows from operating activities, were recorded as cash flows from investing activities in the statement of cash flows. Upon the adoption of ASU 2016-15, coupled with amendments made to the Programs as described in Note 6, Accounts Receivable Programs, in Part II, Item 8 of this Annual Report, cash collections related to our outstanding DPP balance at August 31, 2018 were reflected as cash flows from investing activities. As a result of the amendments to the Programs, excluding collections related to the outstanding DPP balance at August 31, 2018, cash collections of trade receivables under the Programs are classified as operating activities, and cash advances, including repayment of such advances, are classified as financing activities.
Net cash flows from operating activities were $791.2 million during 2020 compared to $37.0 million in 2019. Due to the adoption of ASU 2016-15 described above, $367.5 million of cash collections of the Programs were reflected in investing activities in 2019 rather than operating activities. Also contributing to the increase in net cash flows from operating activities in 2020 compared to 2019 was an $81.4 million year-over-year increase in net earnings, a $237.4 million year-over-year increase in cash from operating assets and liabilities ("working capital"), and a $45.4 million year-over-year decrease in amortization of acquired unfavorable contract backlog. The increase in cash from working capital was primarily due to lower volumes and values of steel inventory and lower selling prices reflected in accounts receivable as of August 31, 2020 compared to 2019. For continuing operations, operating working capital days decreased 4 days year-over-year.
Investing Activities
Net cash flows used by investing activities were $192.9 million and $462.0 million during 2020 and 2019, respectively. Cash used by investing activities during 2020 was lower than the corresponding period primarily due to cash used for the Acquisition in 2019 of $700.9 million, as described in Note 3, Changes in Business, in Part II, Item 8 of this Annual Report, partially offset by $367.5 million in cash collections of the Programs in 2019, as described above.
We estimate that our 2021 capital spending will range from $200 million to $225 million. We regularly assess our capital spending based on current and expected results.
Financing Activities
Net cash flows used by financing activities were $247.8 million during 2020 compared to $13.2 million during 2019. During 2020, we had net debt repayments of $187.3 million, compared to net borrowings of $45.2 million in the corresponding period which were used to fund the Acquisition. See Note 10, Credit Arrangements, in Part II, Item 8 of this Annual Report, for additional information regarding long-term debt transactions.
2019 Compared to 2018
Operating Activities
Net cash flows from operating activities increased by $470.9 million during 2019 compared to 2018. Working capital generated $48.7 million net cash inflows in 2019 compared to $89.6 million of net cash outflows in 2018. This was primarily due to $89.7 million of cash inflows related to inventories in 2019, excluding the inventory purchased as part of the Acquisition which is reflected in investing activities, compared to $43.2 million of cash outflows in 2018, due to decreases in the raw materials pricing environment and inventory levels at August 31, 2019. The adoption of ASU 2016-15 on September 1, 2018, as described above, also contributed to the increase in net cash flows from operating activities as the beneficial interest in securitized accounts receivable decreased $302.9 million year-over year. For continuing operations, operating working capital days increased one day on a year-over-year basis.
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Investing Activities
Net cash flows used by investing activities increased by $984.0 million during 2019 compared to 2018. The year-over-year increase in cash used by investing activities was primarily due to the $700.9 million cash outflows related to the Acquisition. Also contributing to the net increase in cash flows used by investing activities, the adoption of ASU 2016-15, and subsequent amendment to the Programs, resulted in a $302.9 million decrease in cash inflows related to the cash collections of the DPP from the Programs. These increases in cash flows used by investing activities were partially offset by a $35.8 million decrease in cash outflows related to capital expenditures in 2019 compared to 2018.
Financing Activities
Net cash flows used by financing activities increased $272.7 million during 2019 compared to 2018. In 2019, we borrowed $180.0 million of long-term debt to fund the Acquisition and repaid $127.7 million, compared to 2018 when we borrowed $350.0 million in long-term debt and repaid $20.0 million.
Contractual Obligations
The following table represents our contractual obligations as of August 31, 2020:
Payments Due By Period
__________________________________
(1)Total amounts are included in the August 31, 2020 consolidated balance sheet. See Note 10, Credit Arrangements, in Part II, Item 8 of this Annual Report, for more information regarding scheduled maturities of our long-term debt. These amounts exclude any obligation related to finance leases as those are disclosed separately.
(2)Excludes imputed interest related to operating and finance leases.
(3)Includes maturities of lease liabilities, including imputed interest, for real property and equipment leases in effect as of August 31, 2020. See Note 9, Leases, in Part II, Item 8 of this Annual Report for additional information.
(4)Approximately 28% of these purchase obligations are for inventory items to be sold in the normal course of business. Purchase obligations include all enforceable, legally binding agreements to purchase goods or services that specify all significant terms, regardless of the duration of the agreement. Agreements with variable terms are excluded because we are unable to estimate the minimum amounts. We have not discounted the contractual obligations related to purchase obligations included in the table.
We provide certain eligible employees benefits pursuant to our nonqualified BRP equal to amounts that would have been available under our tax qualified plans under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), but for limitations of ERISA, tax laws and regulations. We did not include estimated payments related to the BRP in the above contractual obligation table. Refer to Note 16, Employees' Retirement Plans, in Part II, Item 8 of this Annual Report, for more information on the BRP.
Other Commercial Commitments
We maintain stand-by letters of credit to provide support for certain transactions that governmental agencies, our insurance providers and suppliers request. At August 31, 2020, we had committed $27.4 million under these arrangements, of which $3.0 million reduced availability under the Credit Agreement (as defined in Note 10, Credit Arrangements, in Part II, Item 8 of this Annual Report).
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Off-Balance Sheet Arrangements
As of August 31, 2020 and 2019, we had no off-balance sheet arrangements that may have a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
CONTINGENCIES
In the ordinary course of conducting our business, we become involved in litigation, administrative proceedings and governmental investigations, including environmental matters. We may incur settlements, fines, penalties or judgments because of some of these matters. Liabilities and costs associated with litigation-related loss contingencies require estimates and judgments based on our knowledge of the facts and circumstances surrounding each matter and the advice of our legal counsel. We record liabilities for litigation-related losses when a loss is probable and we can reasonably estimate the amount of the loss. We evaluate the measurement of recorded liabilities each reporting period based on the current facts and circumstances specific to each matter. The ultimate losses incurred upon final resolution of litigation-related loss contingencies may differ materially from the estimated liability recorded at a particular balance sheet date. Changes in estimates are recorded in earnings in the period in which such changes occur. We do not believe that any currently pending legal proceedings to which we are a party will have a material adverse effect, individually or in the aggregate, on our results of operations, cash flows or financial condition. See Note 19, Commitments and Contingencies, in Part II, Item 8 of this Annual Report, for more information.
Environmental and Other Matters
The information set forth in Note 19, Commitments and Contingencies, in Part II, Item 8 of this Annual Report is hereby incorporated by reference.
General
We are subject to federal, state and local pollution control laws and regulations in all locations where we have operating facilities. We anticipate that compliance with these laws and regulations will involve continuing capital expenditures and operating costs.
Metals recycling was our original business, and it has been one of our core businesses for over a century. In the present era of conservation of natural resources and ecological concerns, we are committed to sound ecological and business conduct. Certain governmental regulations regarding environmental concerns, however well-intentioned, may expose us and our industry to potentially significant risks. We believe that recycled materials are commodities that are diverted by recyclers, such as us, from the solid waste streams because of their inherent value. Commodities are materials that are purchased and sold in public and private markets and commodities exchanges every day around the world. They are identified, purchased, sorted, processed and sold in accordance with carefully established industry specifications.
Solid and Hazardous Waste
We currently own or lease, and in the past we have owned or leased, properties that have been used in our operations. Although we have used operating and disposal practices that were standard in the industry at the time, wastes may have been disposed of or released on or under the properties or on or under locations where such wastes have been taken for disposal. We are currently involved in the investigation and remediation of several such properties. State and federal laws applicable to wastes and contaminated properties have gradually become more strict over time. Under new laws, we could be required to remediate properties impacted by previously disposed wastes. We have been named as a PRP at a number of contaminated sites, none of which involve real estate we ever owned or upon which we have ever conducted operations. There is no guarantee that the EPA or individual states will not adopt more stringent requirements for the handling of, or make changes to the exemptions upon which we rely for, the wastes that we generate. Any such change could result in an increase in our costs to manage and dispose of waste which could have a material adverse effect on our business, results of our operations and financial condition.
We generate wastes, including hazardous wastes, that are subject to the Federal Resource Conservation and Recovery Act and comparable state and local statutes where we operate. These statutes, regulations and laws may limit our disposal options with respect to certain wastes.
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Superfund
The EPA, or an equivalent state agency, has notified us that we are considered a PRP at several sites, none of which involve real estate we ever owned or upon which we have ever conducted operations. We may be obligated under CERCLA, or similar state statutes, to conduct remedial investigation, feasibility studies, remediation and/or removal of alleged releases of hazardous substances or to reimburse the EPA for such activities and pay costs for associated damages to natural resources. We are involved in litigation or administrative proceedings with regard to several of these sites in which we are contesting, or at the appropriate time may contest, our liability. In addition, we have received information requests with regard to other sites which may be under consideration by the EPA as potential CERCLA sites. Because of various factors, including the ambiguity of the regulations, the difficulty of identifying the responsible parties for any particular site, the complexity of determining the relative liability among them, the uncertainty as to the most desirable remediation techniques and the amount of damages and cleanup costs and the extended time periods over which such costs may be incurred, we cannot reasonably estimate our ultimate costs of compliance with CERCLA. Based on currently available information, which is in many cases preliminary and incomplete, we had $0.7 million accrued as of August 31, 2020 and 2019 in connection with CERCLA sites. We have accrued for these liabilities based upon our best estimates. The amounts paid and the expenses incurred on these sites for 2020, 2019 and 2018 were not material. Historically, the amounts that we have ultimately paid for such remediation activities have not been material.
Clean Water Act
The Clean Water Act ("CWA") imposes restrictions and strict controls regarding the discharge of wastes into waters of the U.S., a term broadly defined, or into publicly owned treatment works. These controls have become more stringent over time, and it is probable that additional restrictions will be imposed in the future. Permits must generally be obtained to discharge pollutants into federal waters or into publicly owned treatment works and comparable permits may be required at the state level. The CWA and many state statutes provide for civil, criminal and administrative penalties for unauthorized discharges of pollutants. In addition, the EPA's regulations and comparable state statutes may require us to obtain permits to discharge storm water runoff. In the event of an unauthorized discharge or non-compliance with permit requirements, we may be liable for penalties, costs and injunctive relief.
Clean Air Act
Our operations are subject to regulations at the federal, state and local level for the control of emissions from sources of air pollution. New and modified sources of air pollutants are often required to obtain permits prior to commencing construction, modification or operations. Major sources of air pollutants are subject to more stringent requirements, including the potential need for additional permits and to increase scrutiny in the context of enforcement. The EPA has been implementing its stationary emission control program through expanded enforcement of the New Source Review Program. Under this program, new or modified sources may be required to construct emission sources using what is referred to as the Best Available Control Technology, or in any areas that are not meeting NAAQS, using methods that satisfy requirements for the Lowest Achievable Emission Rate. Additionally, the EPA has implemented, and is continuing to implement, new, more stringent standards for NAAQS, including fine particulate matter. Compliance with new standards could require additional expenditures.
We incurred environmental expenses of $46.6 million, $42.5 million and $32.0 million for 2020, 2019 and 2018, respectively. The expenses included the cost of disposal, environmental personnel at various divisions, permit and license fees, accruals and payments for studies, tests, assessments, remediation, consultant fees, baghouse dust removal and various other expenses. In addition, during 2020, we spent approximately $2.7 million in capital expenditures related to costs directly associated with environmental compliance. Our accrued environmental liabilities were $3.4 million and $3.6 million, of which $2.7 million and $1.8 million, respectively, were classified as other long-term liabilities, as of August 31, 2020 and 2019, respectively.
DIVIDENDS
We have paid quarterly cash dividends for 224 consecutive quarters. We paid quarterly dividends in 2020 and 2019 at the rate of $0.12 per share of CMC common stock.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preceding discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent liabilities. We evaluate the appropriateness of these estimates and assumptions, including those related to revenue recognition, income taxes, carrying value of inventory, acquisitions, goodwill, long-lived assets and contingencies, on an ongoing basis. Estimates and assumptions are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Accordingly, actual results in future periods could differ materially from these estimates. Judgments and estimates related to critical accounting policies used in the preparation of the consolidated financial statements include the following.
Revenue Recognition
Revenue from contracts where the Company provides fabricated product and installation services is recognized over time using an input method based on costs incurred compared to estimated total costs. Revenue from contracts where the Company does not provide installation services is recognized over time using an output method based on tons shipped compared to estimated total tons. Significant judgment is required to evaluate total estimated costs used in the input method and total estimated tons in the output method. If estimated total consolidated costs on any contract are greater than the net contract revenues, the Company recognizes the entire estimated loss in the period the loss becomes known. The cumulative effect of revisions to estimates related to net contract revenues, costs to complete or total planned quantity is recorded in the period in which such revisions are identified. The Company does not exercise significant judgment in determining the transaction price. See Note 5, Revenue Recognition, in Part II, Item 8 of this Annual Report, for further details.
Income Taxes
We periodically assess the likelihood of realizing our deferred tax assets based on the amount of deferred tax assets that we believe is more likely than not to be realized. We base our judgment of the recoverability of our deferred tax assets primarily on historical earnings, our estimate of current and expected future earnings, prudent and feasible tax planning strategies and current and future ownership changes.
Our effective income tax rate may fluctuate on a quarterly basis due to various factors, including, but not limited to, total earnings and the mix of earnings by jurisdiction, the timing of changes in tax laws and the amount of income tax provided for uncertain income tax positions. We establish income tax liabilities to reduce some or all of the income tax benefit of any of our income tax positions at the time we determine that the positions become uncertain based upon one of the following: (i) the tax position is not "more likely than not" to be sustained, (ii) the tax position is "more likely than not" to be sustained, but for a lesser amount or (iii) the tax position is "more likely than not" to be sustained, but not in the financial period in which the tax position was originally taken. Our evaluation of whether or not a tax position is uncertain is based on the following: (i) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information, (ii) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position and (iii) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. We adjust these income tax liabilities when our judgment changes as a result of new information. Any change will impact income tax expense in the period in which such determination is made.
Inventory Cost
We state inventories at the lower of cost or net realizable value, which is defined as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. Adjustments to inventory may be due to changes in price levels, obsolescence, damage, physical deterioration and other causes. Any adjustments required to reduce the carrying value of inventory to net realizable value are recorded as a charge to cost of goods sold.
Acquisitions
The Company accounts for business combinations under the acquisition method of accounting, which requires assets acquired and liabilities assumed to be recorded at their estimated fair value at the date of acquisition. The fair value is estimated by the Company using valuation techniques and Level 3 inputs, including expected future cash flows and discount rates. The excess of
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purchase price over the fair value amounts assigned to the assets acquired and liabilities assumed, if any, is recorded as goodwill. Determining the fair value of assets acquired and liabilities assumed involves the use of significant estimates and assumptions.
Goodwill
Goodwill is tested for impairment at the reporting unit level annually and whenever events or circumstances indicate that the carrying value may not be recoverable.
Our reporting units represent an operating segment or one level below an operating segment. Additionally, the reporting units are aggregated based on similar economic characteristics, nature of products and services, nature of production processes, type of customers and distribution methods. We use an income and a market approach to calculate the fair value of our reporting units. To calculate the fair value of our reporting units using the income approach, management uses a discounted cash flow model which includes a number of significant assumptions and estimates regarding future cash flows such as discount rates, volumes, prices, capital expenditures and the impact of current market conditions. These estimates could be materially impacted by adverse changes in market conditions.
For 2020 and 2019, the annual goodwill impairment analysis did not result in any impairment charges. Management does not believe that it is reasonably likely that our reporting units will fail the goodwill impairment test in the near term, as the determined fair value of the reporting units with goodwill substantially exceeded their carrying value.
See Note 8, Goodwill and Other Intangible Assets, in Part II, Item 8 of this Annual Report, for additional information.
Long-Lived Assets
We evaluate the carrying value of property, plant and equipment and finite-lived intangible assets whenever a change in circumstances indicates that the carrying value may not be recoverable from the undiscounted future cash flows from operations. Events or circumstances that could trigger an impairment review of a long-lived asset or asset group include, but are not limited to: (i) a significant decrease in the market price of the asset, (ii) a significant adverse change in the extent or manner that the asset is used or in its physical condition, (iii) a significant adverse change in legal factors or in the business climate that could affect the value of the asset, (iv) an accumulation of costs significantly in excess of original expectation for the acquisition or construction of the asset, (v) a current period operating or cash flow loss combined with a history of operating or cash flow losses or a forecast of continuing losses associated with the use of the asset and (vi) a more-likely-than-not expectation that the asset will be sold or disposed of significantly before the end of its previously estimated useful life. If an impairment exists, the net book values are reduced to fair values. Our operations are capital intensive. Some of the estimated values for assets that we currently use in our operations are based upon judgments and assumptions of future undiscounted cash flows that the assets will produce. If these assets were for sale, our estimates of their values could be significantly different because of market conditions, specific transaction terms and a buyer's perspective on future cash flows. Also, we depreciate property, plant and equipment on a straight-line basis over the estimated useful lives of the assets. Depreciable lives are based on our estimate of the assets' economical useful lives. To the extent that an asset's actual life differs from our estimate, there could be an impact on depreciation expense or a gain/loss on the disposal of the asset in a later period. We expense major maintenance costs as incurred.
Contingencies
In the ordinary course of conducting our business, we become involved in litigation, administrative proceedings and governmental investigations, including environmental matters. We may incur settlements, fines, penalties or judgments in connection with some of these matters. While we are unable to estimate the ultimate dollar amount of exposure or loss in connection with these matters, we make accruals when a loss is probable and the amount can be reasonably estimated. The amounts we accrue could vary substantially from amounts we pay due to several factors including the following: evolving remediation technology, changing regulations, possible third-party contributions, the inherent uncertainties of the estimation process and the uncertainties involved in litigation. We believe that we have adequately provided for these contingencies in our consolidated financial statements. We also believe that the outcomes will not materially affect our results of operations, our financial position or our cash flows.
Other Accounting Policies and New Accounting Pronouncements
See Note 2, Summary of Significant Accounting Policies, in Part II, Item 8 of this Annual Report.
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FORWARD-LOOKING STATEMENTS
This Annual Report contains "forward-looking statements" within the meaning of the federal securities laws with respect to general economic conditions, key macro-economic drivers that impact our business, the effects of ongoing trade actions, the effects of continued pressure on the liquidity of our customers, potential synergies and organic growth provided by our recent acquisitions and strategic investments, demand for our products, metal margins, the effect of COVID-19 and related governmental and economic responses thereto, the ability to operate our steel mills at full capacity, future supplies of raw materials and energy for our operations, share repurchases, legal proceedings, the undistributed earnings of our non-U.S. subsidiaries, U.S. non-residential construction activity, international trade, capital expenditures, our liquidity and our ability to satisfy future liquidity requirements, estimated contractual obligations and our expectations or beliefs concerning future events. These forward-looking statements can generally be identified by phrases such as we or our management "expects," "anticipates," "believes," "estimates," "intends," "plans to," "ought," "could," "will," "should," "likely," "appears," "projects," "forecasts," "outlook" or other similar words or phrases. There are inherent risks and uncertainties in any forward-looking statements. We caution readers not to place undue reliance on any forward-looking statements.
Our forward-looking statements are based on management's expectations and beliefs as of the time this Annual Report is filed with the SEC. Although we believe that our expectations are reasonable, we can give no assurance that these expectations will prove to have been correct, and actual results may vary materially. Except as required by law, we undertake no obligation to update, amend or clarify any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, new information or circumstances or any other changes. Important factors that could cause actual results to differ materially from our expectations include those described in Part I, Item 1A, "Risk Factors" of this Annual Report as well as the following:
•changes in economic conditions which affect demand for our products or construction activity generally, and the impact of such changes on the highly cyclical steel industry;
•rapid and significant changes in the price of metals, potentially impairing our inventory values due to declines in commodity prices or reducing the profitability of our downstream products contracts due to rising commodity pricing;
•impacts from COVID-19 on the economy, demand for our products and on our operations, including the responses of governmental authorities to contain COVID-19;
•excess capacity in our industry, particularly in China, and product availability from competing steel mills and other steel suppliers including import quantities and pricing;
•compliance with and changes in environmental laws and regulations, including increased regulation associated with climate change and greenhouse gas emissions;
•involvement in various environmental matters that may result in fines, penalties or judgments;
•potential limitations in our or our customers' abilities to access credit and non-compliance by our customers with our contracts;
•activity in repurchasing shares of our common stock under our repurchase program;
•financial covenants and restrictions on the operation of our business contained in agreements governing our debt;
•our ability to successfully identify, consummate and integrate acquisitions, and the effects that acquisitions may have on our financial leverage;
•risks associated with acquisitions generally, such as the inability to obtain, or delays in obtaining, required approvals under applicable antitrust legislation and other regulatory and third party consents and approvals;
•lower than expected future levels of revenues and higher than expected future costs;
•failure or inability to implement growth strategies in a timely manner;
•impact of goodwill impairment charges;
•impact of long-lived asset impairment charges;
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•currency fluctuations;
•global factors, including trade measures, political uncertainties and military conflicts;
•availability and pricing of electricity, electrodes and natural gas for mill operations;
•ability to hire and retain key executives and other employees;
•competition from other materials or from competitors that have a lower cost structure or access to greater financial resources;
•information technology interruptions and breaches in security;
•ability to make necessary capital expenditures;
•availability and pricing of raw materials and other items over which we exert little influence, including scrap metal, energy and insurance;
•unexpected equipment failures;
•losses or limited potential gains due to hedging transactions;
•litigation claims and settlements, court decisions, regulatory rulings and legal compliance risks;
•risk of injury or death to employees, customers or other visitors to our operations;
•civil unrest, protests and riots;
•new and clarifying guidance with regard to interpretation of certain provisions of the Tax Cuts and Jobs Act that could impact our assessment; and
•increased costs related to health care reform legislation.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Approach to Mitigating Market Risk
See Note 12, Derivatives, in Part II, Item 8 of this Annual Report, for disclosure regarding our approach to mitigating market risk and for summarized market risk information by year. Also, see Note 2, Summary of Significant Accounting Policies, in Part II, Item 8 of this Annual Report, for additional information. We utilized the following types of derivative instruments during 2020 in accordance with our risk management program. None of the instruments were entered into for trading purposes.
Currency Exchange Forward Contracts
The Company's global operations expose it to risks from fluctuations in foreign currency exchange rates. We enter into currency exchange forward contracts as economic hedges of trade commitments denominated in currencies other than the functional currency of CMC or its subsidiaries. No single foreign currency poses a material risk to us.
Commodity Futures Contracts
The Company's product lines expose it to risks from fluctuations in metal commodity prices and natural gas, electricity and other energy commodity prices. We base pricing in some of our sales and purchase contracts on metal commodity futures exchange quotes, which we determine at the beginning of the contract. Due to the volatility of the metal commodity indices, we enter into metal commodity futures contracts for copper and aluminum. These futures contracts mitigate the risk of unanticipated declines in gross margin due to the price volatility of the underlying commodities. We also enter into energy derivatives to mitigate the risk of unanticipated declines in gross margin due to the price volatility of electricity and natural gas.
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The following tables provide certain information regarding the foreign exchange forward contracts and commodity futures contracts discussed above.
The fair value of our foreign currency exchange forward contract commitments as of August 31, 2020 were as follows:
Functional Currency Foreign Currency
__________________________________
(1) Most foreign currency exchange forward contracts mature within one year. The range of hedge rates represents functional to foreign currency conversion rates.
The fair value of our commodity futures contract commitments as of August 31, 2020 were as follows:
__________________________________
MT = Metric ton
MW(h) = Megawatt hour
(1) All commodity futures contract commitments mature within one year, except for the electricity contract commitment which has a maturity date of December 31, 2030.
(2) There is no terminal exchange for electricity as it is a bilateral agreement with a counterparty.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of Commercial Metals Company
Opinion on Internal Control Over Financial Reporting
We have audited the internal control over financial reporting of Commercial Metals Company and subsidiaries (the “Company”) as of August 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of August 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended August 31, 2020, of the Company and our report dated October 15, 2020, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Deloitte & Touche LLP
Dallas, Texas
October 15, 2020
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of Commercial Metals Company
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Commercial Metals Company and subsidiaries (the “Company”) as of August 31, 2020 and 2019, the related consolidated statements of earnings, comprehensive income, stockholders’ equity, and cash flows, for each of the three years in the period ended August 31, 2020, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of August 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended August 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of August 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated October 15, 2020, expressed an unqualified opinion on the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Revenue Recognition — Revenue from Fabricated Product Contracts with Customers in the
North America Segment — Refer to Notes 2 and 5 to the Financial Statements
Critical Audit Matter Description
The Company has certain fabricated product contracts with customers in its North America segment for delivering fabricated steel products, which may also include providing installation services. Each fabricated product contract represents a single performance obligation and revenue is recognized over time as fabricated steel products are delivered and installation services are provided, if applicable. Revenue from contracts where the Company provides fabricated product and installation services is recognized over time using an input method in which the measure of progress is based on contract costs incurred to date compared to total estimated contract costs. Revenue from contracts where the Company provides fabricated product only is recognized over time using an output method in which the measure of progress is based on tons shipped compared to total estimated tons.
The accounting for these contracts involves significant judgment by management to estimate total costs used in the input method and total tons used in the output method. For the year ended August 31, 2020, North America segment revenue was $4.8 billion; of which 12% represents revenue recognized over time using an input method and 11% represents revenue
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recognized over time using an output method. The remaining 77% of revenue in the North America segment was recognized concurrent with the transfer of control or as amounts are billed to the customer.
We identified revenue recognized over time for certain fabricated product contracts in the North America segment as a critical audit matter because of the significant judgments made by management to estimate total costs for the input method and total tons for the output method. Auditing such estimates required extensive audit effort due to the volume and complexity of contracts and required a high degree of auditor judgment to evaluate the reasonableness of management’s estimates used to recognize revenue over time.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s estimates of total costs and total tons used to recognize revenue over time for certain fabricated product contracts in the North America segment included the following, among others:
•We tested the effectiveness of management’s controls over the calculation of contract costs incurred to date compared to total estimated contract costs for the input method, and management’s controls over the calculation of tons shipped compared to total estimated tons for the output method.
•We selected a sample of fabricated product contracts with customers that were recognized over time, for both the input method and the output method, and we performed the following:
◦Obtained the contracts, including any change orders, management’s estimated contract costs or tons, including any revisions to date, and evaluated whether the contracts were properly included in management’s calculation of revenue based on the terms and conditions of each contract.
◦Obtained a schedule of costs or tons incurred to date by contract and tested such schedule for completeness and accuracy by obtaining supporting documents for fabricated steel products delivered and installation services provided, if applicable, and evaluated whether the costs or tons were properly included in the costs incurred to date.
◦Evaluated management’s estimated cost to complete the contract, including remaining quantities and costs, by comparing the estimates to management’s job cost forecasts, and performing corroborating inquiries with the Company’s project managers.
◦Tested the mathematical accuracy of management’s calculation of revenue recognized over time for each selection.
•For a sample of contracts, we evaluated management’s ability to accurately estimate total costs and total tons by comparing actual costs and actual tons at completion to management’s previous estimates for such contracts.
Goodwill — A Reporting Unit within the North America Segment — Refer to Notes 2 and 8 to the Financial Statements
Critical Audit Matter Description
The Company has goodwill of $64.3 million, of which $61.9 million relates to the North America segment. Goodwill is tested for impairment at the reporting unit level annually and whenever events or circumstances indicate that the carrying value may not be recoverable. The Company’s goodwill impairment assessment involves comparing the fair value of each reporting unit to its carrying value. The Company estimates the fair value of its reporting units using a weighting of fair values derived from the income and market approaches. The determination of fair value using the income approach is based on the present value of estimated future cash flows, which requires management to make significant estimates and assumptions of revenue growth rates and operating margins, and selection of the discount rate. The determination of the fair value using the market approach requires management to make significant assumptions related to market multiples of revenue and earnings derived from comparable publicly-traded companies with similar operating and investment characteristics as the reporting unit.
At August 31, 2020, based on the results of the Company’s annual impairment testing, no impairment was recognized as the fair value of this reporting unit exceeded its carrying value.
We identified the Company’s goodwill impairment assessment for this reporting unit as a critical audit matter because of the significant estimates and assumptions management makes to estimate the fair value of this reporting unit. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists, when performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions of future cash flows based on estimates of revenue growth rates and operating margins and selection of the discount rate for the income approach, and multiples of revenue and earnings for the market approach.
How the Critical Audit Matter Was Addressed in the Audit
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Our audit procedures related to the goodwill impairment assessment for the reporting unit within the North America segment included the following, among others:
•We tested the effectiveness of controls over the goodwill impairment assessment, including management’s controls over forecasts of future cash flows based on estimates of revenue growth rates and operating margins and the selection of the discount rate for the income approach, and determination of multiples of revenue and earnings for the market approach.
•We evaluated the reasonableness of management’s forecasts of future cash flows based on revenue growth rates and operating margins by comparing the forecasts to (1) historical revenues and operating margins, (2) internal communications to management and the Board of Directors, and (3) forecasted information included in analyst and industry reports for the Company and certain of its peer companies.
•With the assistance of our fair value specialists:
◦We evaluated the reasonableness of the valuation methodologies.
◦We evaluated the reasonableness of the discount rate used in the income approach by testing the underlying source information and the mathematical accuracy of the calculations, and developing an independent range of estimated discount rates and comparing that range to the discount rate used in the Company’s valuation.
◦We evaluated the multiples of revenue and earnings used in the market approach, including testing the underlying source information and mathematical accuracy of the calculations.
/s/ Deloitte & Touche LLP
Dallas, Texas
October 15, 2020
We have served as the Company’s auditor since 1959.
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COMMERCIAL METALS COMPANY AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF EARNINGS
Year Ended August 31,
Costs and expenses:
Earnings (loss) from discontinued operations 1,201 (686) 3,269
Basic earnings (loss) per share(1)
Earnings from continuing operations $ 2.34 $ 1.69 $ 1.16
Earnings (loss) from discontinued operations 0.01 (0.01) 0.03
Diluted earnings (loss) per share(1)
Earnings from continuing operations $ 2.31 $ 1.67 $ 1.14
Earnings (loss) from discontinued operations 0.01 (0.01) 0.03
See notes to consolidated financial statements.
__________________________________
(1) Earnings Per Share ("EPS") is calculated independently for each component and may not sum to Net EPS due to rounding
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Year Ended August 31,
Other comprehensive income (loss), net of income taxes:
Foreign currency translation adjustment:
Net unrealized gain (loss) on derivatives:
Unrealized holding gain (loss) (12,136) (6) 48
Reclassification for gain included in net earnings (304) (244) (279)
Defined benefit obligation:
Amortization of net loss 86 — 126
Amortization of prior services (53) (25) (62)
Reclassification for settlement losses — 1,316 —
See notes to consolidated financial statements.
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COMMERCIAL METALS COMPANY AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS
(in thousands, except share data) 2020 2019
Assets
Current assets:
Property, plant and equipment:
Liabilities and stockholders' equity
Current liabilities:
Acquired unfavorable contract backlog 6,035 35,360
Current maturities of long-term debt and short-term borrowings 18,149 17,439
Commitments and contingencies (Note 19)
Stockholders' equity:
Stockholders' equity attributable to noncontrolling interests 212 196
See notes to consolidated financial statements.
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COMMERCIAL METALS COMPANY AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended August 31,
Cash flows from (used by) operating activities:
Amortization of acquired unfavorable contract backlog (29,367) (74,784) —
Net gain on sales of a subsidiary, assets and other (4,213) (2,281) (1,322)
Loss on debt extinguishment 1,778 — —
Provision for losses on receivables, net 578 388 2,510
Changes in operating assets and liabilities, net of acquisitions:
Accounts payable, accrued expenses and other payables 45,718 (15,315) (20,163)
Beneficial interest in securitized accounts receivable — (367,521) (670,457)
Cash flows from (used by) investing activities:
Proceeds from the sale of property, plant and equipment 11,843 3,910 8,103
Advances under accounts receivable programs — — 226,325
Repayments under accounts receivable programs — — (304,178)
Beneficial interest in securitized accounts receivable — 367,521 670,457
Cash flows from (used by) financing activities:
Repayments under accounts receivable programs (237,828) (296,033) —
Debt issuance costs — — (5,254)
Effect of exchange rate changes on cash 759 (598) (703)
See notes to consolidated financial statements.
Year Ended August 31,
Supplemental information:
Noncash activities:
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Common Stock Additional AccumulatedOther Treasury Stock Non-
Contribution of noncontrolling interests 13 13
Reclassification of share-based liability awards 15,248 15,248
Contribution of noncontrolling interests 10 10
Reclassification of share-based liability awards 2,927 2,927
Contribution of noncontrolling interests 16 16
Reclassification of share-based liability awards 2,510 2,510
See notes to consolidated financial statements.
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COMMERCIAL METALS COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF OPERATIONS
Nature of Operations
Commercial Metals Company ("CMC") and its subsidiaries (collectively, the "Company," "we," "our" or "us") manufacture, recycle and fabricate steel and metal products, related materials and services through a network of facilities that includes seven electric arc furnace ("EAF") mini mills, two EAF micro mills, two rerolling mills, steel fabrication and processing plants, construction-related product warehouses and metal recycling facilities in the United States ("U.S.") and Poland.
The Company has two reportable segments: North America and Europe.
North America
The North America segment is a vertically integrated network of recycling facilities, steel mills and fabrication operations located in the U.S. The recycling facilities process ferrous and nonferrous scrap metals (collectively known as "raw materials") for use by manufacturers of new metal products. The steel mills manufacture finished long steel products including reinforcing bar ("rebar"), merchant bar, light structural and other special sections as well as semi-finished billets for rerolling and forging applications (collectively known as "steel products"). The fabrication operations primarily manufacture fabricated rebar and steel fence posts (collectively known as "downstream products"). The strategy in North America is to optimize the Company's vertically integrated value chain to maximize profitability by obtaining the lowest possible input costs and highest possible selling prices. The Company operates the recycling facilities to provide low-cost scrap to the steel mills and the fabrication operations to optimize the steel mill volumes. The North America segment's products are sold primarily to steel mills and foundries, construction, fabrication and other manufacturing industries.
Europe
The Europe segment is a vertically integrated network of recycling facilities, an EAF mini mill, and fabrication operations located in Poland. The steel products manufactured by this segment include rebar, merchant bar and wire rod as well as semi-finished billets. In addition, the downstream products manufactured by this segment's fabrication operations include fabricated rebar, fabricated mesh, assembled rebar cages and other fabricated rebar by-products. The Europe segment's products are sold primarily to fabricators, manufacturers, distributors and construction companies.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned and majority owned subsidiaries and certain variable interest entities ("VIEs") for which the Company is the primary beneficiary. Intercompany account balances and transactions have been eliminated.
Use of Estimates
The preparation of the Company's consolidated financial statements in accordance with accounting principles generally accepted in the United States ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of net sales and expenses during the reporting period. Significant items subject to such estimates and assumptions include revenue recognition, income taxes, carrying value of inventory, acquisitions, goodwill, long-lived assets and contingencies. Actual results could differ significantly from these estimates and assumptions.
Cash and Cash Equivalents
Cash and cash equivalents include cash on deposit and short-term, highly-liquid investments with original maturities of three months or less at the date of purchase.
Revenue Recognition and Allowance for Doubtful Accounts
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Revenue is recognized when control of the promised goods or services is transferred to the customer in an amount that reflects the consideration received or expected to be received in exchange for those goods or services. The Company's performance obligations arise from (i) sales of raw materials, steel products and downstream products and (ii) services such as steel fabrication and installation by its fabrication operations. The shipment of products to customers is considered a fulfillment activity and amounts billed to customers for shipping and freight are included in net sales, and the related costs are included in cost of goods sold. Net sales are presented net of taxes. Revenue related to raw materials and steel products is recognized at a point in time concurrent with the transfer of control, which usually occurs, depending on shipping terms, upon shipment or customer receipt. Revenue related to steel fence posts and other downstream products not described below is recognized equal to billing under an available practical expedient.
Each fabrication product contract sold by the North America segment represents a single performance obligation and revenue is recognized over time. For contracts where the Company provides fabricated product and installation services, revenue is recognized over time using an input measure of progress based on contract costs incurred to date compared to total estimated contract costs ("input measure"). This input measure provides a reasonable depiction of the Company’s progress towards satisfaction of the performance obligation as there is a direct relationship between costs incurred by the Company and the transfer of the fabricated product and installation services. Revenue from contracts where the Company does not provide installation services is recognized over time using an output measure of progress based on tons shipped compared to total estimated tons ("output measure"). This output measure provides a reasonable depiction of the transfer of contract value to the customer, as there is a direct relationship between the units shipped by the Company and the transfer of the fabricated product. If estimated total consolidated costs on any contract are greater than the net contract revenues, the Company recognizes the entire estimated loss in the period the loss becomes known. The cumulative effect of revisions to estimates related to net contract revenues, costs to complete or total planned quantity is recorded in the period in which such revisions are identified.
The timing of revenue recognition may differ from the timing of invoicing to customers. The Company records an asset when revenue is recognized prior to invoicing and a liability when revenue is recognized subsequent to invoicing. Payment terms and conditions vary by contract type, although the Company generally requires customers to pay 30 days after the Company satisfies the performance obligations. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined the contracts do not include a significant financing component.
The Company maintains an allowance for doubtful accounts to reflect its estimate of the uncollectability of accounts receivable. These reserves are based on historical trends, current market conditions and customers' financial condition. The Company reviews and sets credit limits for each customer. The Europe segment uses credit insurance to ensure payment in accordance with the terms of sale. Generally, collateral is not required. Approximately 13% of total receivables at August 31, 2020 and 2019 were secured by credit insurance.
Inventories
Inventories are stated at the lower of cost or net realizable value determined by the weighted average cost method.
Elements of cost in finished goods inventory in addition to the cost of material include depreciation, amortization, utilities, consumable production supplies, maintenance, production, wages and transportation costs. Additionally, the costs of departments that support production, including materials management and quality control, are allocated to inventory.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Maintenance is expensed as incurred. Leasehold improvements are amortized over the shorter of their estimated useful lives or the lease term. Depreciation and amortization is recorded on a straight-line basis over the following estimated useful lives:
Buildings 7 to 40 years
Land improvements 3 to 25 years
Leasehold improvements 3 to 15 years
Equipment 3 to 25 years
The Company evaluates impairment of its property, plant and equipment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. For each asset or group of assets held for use with indicators of impairment, the Company compares the sum of the expected future cash flows generated by the asset or group of assets with its associated net
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carrying value. If the net carrying value of the asset or group of assets exceeds expected undiscounted future cash flows, the excess of the net book value over estimated fair value is charged to impairment loss. Properties held for sale are reported at the lower of their carrying amount or their estimated sales price, less estimated costs to sell.
Leases
The Company's leases are primarily for real property and equipment. The Company determines if an arrangement is a lease at inception of a contract if the terms state the Company has the right to direct the use of, and obtain substantially all the economic benefits from, a specific asset identified in the contract. The right-of-use ("ROU") assets represent the Company's right to use the underlying assets for the lease term, and the lease liabilities represent the obligation to make lease payments arising from the leases. The Company records its ROU assets in other noncurrent assets, its current lease liabilities in accrued expenses and other payables and its noncurrent lease liabilities in other noncurrent liabilities. ROU assets and lease liabilities are recognized at commencement date based on the present value of lease payments to be made over the lease term. Certain of the Company's lease agreements contain options to extend the lease. The Company evaluates these options on a lease-by-lease basis, and if the Company determines it is reasonably certain to be exercised, the lease term includes the extension. The Company uses its incremental borrowing rate at lease commencement to determine the present value of lease payments, and lease expense is recognized on a straight-line basis over the lease term. The incremental borrowing rate is the rate of interest the Company could borrow on a collateralized basis over a similar term with similar payments. The Company does not record leases with an initial term of twelve months or less (“short-term leases”).
Certain of the Company's lease agreements include payments for certain variable costs not determinable upon lease commencement, including mileage, utilities, fuel and inflation adjustments. These variable lease payments are recognized in cost of goods sold and selling, general and administrative expenses, but are not included in the ROU asset or lease liability balances. The Company's lease agreements do not contain any material residual value guarantees, restrictions or covenants.
Government Assistance
Government assistance, including non-monetary grants, herein collectively referred to as grants, are not recognized until there is reasonable assurance that the Company will comply with the conditions of the grant and the Company will receive the grant.
Generally, government grants fall into two categories: grants related to assets and grants related to income. Grants related to assets are government grants for the purchase, construction or other acquisition of long-lived assets. The Company accounts for grants related to assets as deferred income with the offset to an asset account, such as fixed assets, on the consolidated balance sheets. Non-monetary grants are recognized at fair value. The Company recognizes the deferred income in profit or loss on a systematic basis over the useful life of the asset, which, consistent with the Company's fixed assets policy, is straight-line. The period over which grants are recognized depends on the terms of the agreement. Grants related to specific expenses already incurred are recognized in profit or loss in the period in which the grant becomes receivable. A grant related to depreciable assets is recognized in profit or loss over the life of the depreciable asset. Grants related to non-depreciable assets may require the fulfillment of certain obligations. In such cases, these grants are recognized in profit or loss over the periods that bear the cost of meeting the obligations.
Grants related to income are any grants that are not considered grants related to assets, such as grants to compensate for certain expenses. Grants related to income are recognized as a reduction in the related expense in the period that the recognition criteria are met. See Note 11, New Markets Tax Credit Transactions.
Goodwill and Other Intangible Assets
Goodwill is tested for impairment at the reporting unit level annually and whenever events or circumstances indicate that the carrying value may not be recoverable.
To evaluate goodwill for impairment, the Company utilizes a quantitative test that compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is indicated in the amount that the carrying value exceeds the fair value of the reporting unit, not to exceed the goodwill value for the reporting unit. The Company's reporting units represent an operating segment or one level below an operating segment.
The Company estimates the fair value of its reporting units using a weighting of fair values derived from the income and market approaches. Under the income approach, the Company determines the fair value of a reporting unit based on the present value of estimated future cash flows. Cash flow projections are based on management's estimates of revenue growth rates and
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operating margins, taking into account industry and market conditions. The discount rate is based on a weighted average cost of capital adjusted for the relevant risk associated with the characteristics of the reporting unit. The market approach estimates fair value based on market multiples of revenue and earnings derived from comparable publicly-traded companies with similar operating and investment characteristics as the reporting unit. See Note 8, Goodwill and Other Intangible Assets, for additional information on the Company's annual goodwill impairment analysis.
Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Impairment charges are recorded on finite-lived intangible assets when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts.
Contingencies
The Company accrues for claims and litigation, including environmental investigation and remediation costs, when they are both probable and the amount can be reasonably estimated. Environmental costs are based upon estimates regarding the sites for which the Company will be responsible, the scope and cost of work to be performed at each site, the portion of costs that will be shared with other parties and the timing of remediation. Where timing and amounts cannot be reasonably determined, a range is estimated and the lower end of the range is recorded.
Stock-Based Compensation
The Company recognizes stock-based equity and liability awards at fair value. The fair value of each stock-based equity award is estimated at the grant date using the Black-Scholes or Monte Carlo pricing model. Total compensation cost of the stock-based equity award is amortized over the requisite service period using the accelerated method of amortization for grants with graded vesting or the straight-line method for grants with cliff vesting. Stock-based liability awards are measured at fair value at the end of each reporting period and will fluctuate based on the price of CMC common stock and performance relative to the targets.
Income Taxes
CMC and its U.S. subsidiaries file a consolidated federal income tax return. Deferred income taxes are provided for temporary differences between financial statement and income tax bases of assets and liabilities. The principal differences are described in Note 14, Income Tax. Benefits from income tax credits are reflected currently in earnings. The Company records income tax positions based on a more likely than not threshold that the tax positions will be sustained on examination by the taxing authorities having full knowledge of all relevant information. The Company classifies interest and any statutory penalties recognized on a tax position as income tax expense.
Foreign Currencies
The functional currency of the Company's Polish operations is the local currency, the Polish zloty ("PLN"). Translation adjustments are reported as a component of accumulated other comprehensive income or loss. Transaction gains (losses) from transactions denominated in currencies other than the functional currency related to continuing operations were immaterial for 2020, 2019 and 2018.
Derivative Financial Instruments
The Company recognizes derivatives as either assets or liabilities in the consolidated balance sheets and measures those instruments at fair value. Derivatives that are not designated as hedges are adjusted to fair value through net earnings. Changes in the fair value of derivatives that are designated as hedges are recognized depending on the nature of the hedge. In the case of fair value hedges, changes are recognized as an offset against the change in fair value of the hedged balance sheet item. When the derivative is designated as a cash flow hedge and is highly effective, changes are recognized in other comprehensive income. The ineffective portion of a change in fair value for derivatives designated as hedges is recognized in net earnings.
When a derivative instrument is sold, terminated, exercised or expires, the gain or loss is recorded in the consolidated statement of earnings for fair value hedges, and the cumulative unrealized gain or loss, which had been recognized in the statement of comprehensive income, is reclassified to the consolidated statement of earnings for cash flow hedges. Additionally, when hedged items are sold or extinguished, or the anticipated transaction being hedged is no longer expected to occur, the Company recognizes the gain or loss on the designated hedged financial instrument.
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Fair Value
The Company has established a fair value hierarchy which prioritizes the inputs to the valuation techniques used to measure fair value into three levels. These levels are determined based on the lowest level input that is significant to the fair value measurement. Level 1 represents unadjusted quoted prices in active markets for identical assets and liabilities. Level 2 represents quoted prices for similar assets and liabilities in active markets (other than those included in Level 1) which are observable, either directly or indirectly. Level 3 represents valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
Recently Adopted Accounting Pronouncements
On September 1, 2019, the Company adopted Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), as amended, (“ASU 2016-02”), using the modified retrospective transition approach. ASU 2016-02 requires a lessee to recognize a ROU asset and a lease liability on its balance sheet for all leases with terms longer than twelve months. The Company’s financial statements for periods prior to September 1, 2019 were not modified for the application of this ASU. Upon adoption of ASU 2016-02, the Company recorded the following amounts associated with operating leases in its consolidated balance sheet at September 1, 2019: $113.4 million of ROU assets in other noncurrent assets, $30.9 million of lease liabilities in accrued expenses and other payables and $84.9 million of lease liabilities in other noncurrent liabilities. There was no impact to the opening balance of retained earnings as a result of implementing ASU 2016-02. The Company elected the package of three practical expedients available under the ASU. Additionally, the Company implemented appropriate changes to internal processes and controls to support recognition, subsequent measurement and disclosures.
Recently Issued Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes ("ASU 2019-12"). ASU 2019-12 eliminates certain exceptions to the general principles in Accounting Standards Codification 740 and also clarifies and amends existing guidance to improve consistent application. This standard is effective for annual periods beginning after December 15, 2020, including interim periods therein. The Company currently does not expect ASU 2019-12 to have a material effect on its consolidated financial statements; however, the Company will continue to evaluate the impact of this guidance.
NOTE 3. CHANGES IN BUSINESS
2019 Acquisition
On November 5, 2018 (the "Acquisition Date"), the Company completed the acquisition (the "Acquisition") of 33 rebar fabrication facilities in the U.S., as well as four EAF mini mills located in Knoxville, Tennessee, Jacksonville, Florida, Sayreville, New Jersey and Rancho Cucamonga, California from Gerdau S.A., hereinafter collectively referred to as the "Acquired Businesses." The total cash purchase price, including working capital adjustments made within the allowable one-year measurement period, was $701.2 million, and was funded through a combination of domestic cash on-hand and borrowings under the Term Loan (as defined in Note 10, Credit Arrangements).
The results of operations of the Acquired Businesses were reflected in the Company’s consolidated financial statements from the Acquisition Date. The Acquired Businesses' net sales and earnings before income taxes included in the Company's consolidated statement of earnings and consolidated statement of comprehensive income in 2019 were $1.4 billion and $132.7 million, respectively.
The purchase price paid was allocated between the acquired mills and fabrication facilities' assets acquired and liabilities assumed at fair value and was finalized on November 5, 2019. The table below presents the allocation of the fair value to the Acquired Businesses' assets and liabilities as determined by the Company:
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(in thousands) Fair Value
Cash and cash equivalents $ 6,399
Other current assets 26,290
Property, plant and equipment 421,969
Deferred income taxes 9,155
Accounts payable-trade, accrued expenses and other payables (134,702)
Acquired unfavorable contract backlog (110,166)
Other long-term liabilities (9,920)
Pension and other post retirement employment benefits (6,365)
Total assets acquired and liabilities assumed $ 701,201
The Company recorded a $32.1 million charge due to a working capital adjustment related to the Acquisition. This charge was recorded subsequent to the end of the allowable one-year measurement period in selling, general and administrative expenses on the consolidated statements of earnings in 2020. The related liability was recorded in accrued expenses and other payables as of August 31, 2020.
Pro Forma Supplemental Information
Supplemental information on an unaudited pro forma basis is presented below as if the Acquisition occurred on September 1, 2017. The pro forma financial information is presented for comparative purposes only, based on significant estimates and assumptions, which the Company believes to be reasonable, but not necessarily indicative of future results of operations or the results that would have been reported if the Acquisition had been completed on September 1, 2017. These results were not used as part of management analysis of the financial results and performance of the Company or the Acquired Businesses. These results are adjusted, where possible, for transaction and integration-related costs.
Year Ended August 31,
__________________________________
(1) Pro forma net sales for the year ended August 31, 2018 includes estimated fair value adjustments related to amortization of unfavorable contract backlog. The impact of the amortization of unfavorable contract backlog has been removed from the pro forma net sales for the year ended August 31, 2019.
(2) Pro forma net earnings for the year ended August 31, 2018 reflects the impact of fair value adjustments related to the amortization of unfavorable contract backlog described above and includes estimated fair value adjustments related to inventory step-up, as well as non-recurring acquisition and integration costs of approximately $51.7 million.
Other Acquisitions
On July 21, 2020, the Company acquired substantially all of the assets of AZZ's Continuous Galvanized Rebar business ("GalvaBar") located in Tulsa, Oklahoma. GalvaBar manufactures galvanized rebar with a zinc alloy coating produced through a proprietary process to provide corrosion protection and post-fabrication formability. This acquisition complements the Company's existing concrete reinforcement capabilities. The operating results of GalvaBar are included in the North America segment.
On February 3, 2020, the Company's subsidiary CMC Poland Sp. z.o.o. ("CMCP") acquired P.P.U. Ecosteel Sp. z.o.o. ("Ecosteel"), a steel mesh producer located in Zawiercie, Poland. This acquisition complements CMCP's existing mesh production and increases sales to other markets in Europe. The operating results of Ecosteel are included in the Europe segment.
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On October 26, 2017, the Company completed the purchase of substantially all of the assets of MMFX Technologies Corporation ("MMFX"). MMFX markets, sells and licenses the production of proprietary specialty steel products. The operating results of MMFX are included in the North America segment.
The acquisitions of GalvaBar, Ecosteel and MMFX were not material individually, or in the aggregate, to the Company's financial position or results of operations; therefore pro-forma operating results and other disclosures for the acquisitions are not presented as the results would not be significantly different than reported results.
Facility Closures and Dispositions
In October 2019, the Company closed the melting operations at its Rancho Cucamonga facility, which is part of the North America segment. In August 2020, the Company announced plans to sell its Rancho Cucamonga facility. This disposition does not meet the criteria for discontinued operations or held for sale accounting. Due to these announcements, the Company recorded $9.8 million of expense related to severance, pension curtailment and vendor agreement terminations.
In 2020, the Company idled six facilities in its North America segment and recorded $6.2 million of expense related to severance and ROU and other long-lived asset impairments.
In the third quarter of 2018, the Company sold substantially all of the assets of its structural steel fabrication operations, which were part of the North America segment. The disposition did not meet the criteria for discontinued operations. Proceeds associated with the sale were $20.3 million. As a result of the sale of these assets, the Company recorded impairment charges of $13.7 million. The signed definitive asset sale agreement and subsequent post-closing adjustments (Level 2) were the basis for the determination of fair value of these operations.
Discontinued Operations
In 2018, the remaining operations related to the Company's steel trading businesses in the U.S. and Asia were substantially wound down and the Company sold certain assets and liabilities of its Australian steel trading business. As a result of the Company's exit of its trading and distribution businesses in Australia, the Company prepared an impairment analysis on the asset disposal groups. Indicators of value from other recent sales of similar businesses within the segment (Level 3) were the basis for the determination of fair value of this component. As a result of this analysis, the Company recorded impairment charges of $2.1 million in 2018 resulting in an overall transaction loss, including selling costs, of $5.3 million. This loss was primarily due to accumulated foreign currency translation losses. The results of these activities are included in discontinued operations in the consolidated statements of earnings.
The major classes of line items constituting earnings from discontinued operations in the consolidated statements of earnings for 2018 are presented in the table below. Earnings (loss) from discontinued operations in the consolidated statements of earnings were immaterial in 2020 and 2019.
(in thousands) Year Ended August 31, 2018
Costs and expenses:
Selling, general and administrative expenses 25,317
Interest expense (86)
Earnings before income taxes 3,235
Income taxes benefit (34)
Earnings from discontinued operations $ 3,269
There were no material non-cash operating or investing items related to discontinued operations for the periods ended August 31, 2020, 2019 and 2018.
The Company recorded $6.7 million of severance expense related to discontinued operations for 2018. These costs related to the Company's closure of marketing and distribution offices that resulted in involuntary employee termination benefits. Severance expense recorded in 2020 and 2019 related to discontinued operations was immaterial.
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NOTE 4. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Accumulated other comprehensive income (loss) ("AOCI") was comprised of the following:
Other comprehensive loss before reclassifications (29,718) (7) (3,346) (33,071)
Amounts reclassified from AOCI 6 (375) — (369)
The items reclassified out of AOCI were not material for 2020, 2019 and 2018.
NOTE 5. REVENUE RECOGNITION
Revenue from Contracts with Customers
Each fabricated product contract sold by the North America segment represents a single performance obligation. Revenue from contracts where the Company provides fabricated product and installation services is recognized over time using an input measure and these contracts represented approximately 12% of net sales in the North America segment in 2020 and 2019. Revenue from contracts where the Company does not provide installation services is recognized over time using an output measure and these contracts represented approximately 11% and 9% of net sales in the North America segment in 2020 and 2019, respectively. The remaining 77% and 79% of net sales in the North America segment were recognized at a point in time concurrent with the transfer of control or as amounts were billed to the customer under an available practical expedient in 2020 and 2019, respectively.
The following table provides information about assets and liabilities from contracts with customers.
Year Ended August 31,
Contract assets (included in accounts receivable) $ 53,275 $ 103,805
The decrease in contract assets was primarily due to timing of invoicing in 2020 compared to 2019. The entire contract liability as of August 31, 2019 was recognized in 2020.
Remaining Performance Obligations
As of August 31, 2020, a total of $723.4 million has been allocated to remaining performance obligations in the North America segment, related to those contracts where revenue is recognized using an input or output measure. Of this amount, the Company estimates the remaining performance obligations will be recognized as revenue as follows: 40% in the first twelve months, 48% in the following twelve months, and 12% thereafter. The duration of all other contracts in the North America and Europe segments are typically less than one year.
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NOTE 6. ACCOUNTS RECEIVABLE PROGRAMS
As an additional source of liquidity, the Company sells certain trade accounts receivable both in the U.S. and Poland (hereinafter referred to as the "Programs"). Prior to September 1, 2018, the Company accounted for transfers of the trade accounts receivable under the Programs as sales of financial assets, and the trade accounts receivable balances sold were removed from the consolidated balance sheets. On September 1, 2018, the Company amended certain terms of the Programs, disqualifying the sale of such receivables from being accounted for as sales of financial assets. For activity in the Programs occurring prior to the September 1, 2018 amendment, disclosures required under ASC 860-20-50 are provided below. See Note 10, Credit Arrangements for further details regarding the Programs after September 1, 2018.
Prior to September 1, 2018, in exchange for trade receivables transferred into the Programs, the Company received either cash (referred to as a cash purchase prior or "CPP") or a deferred purchase price ("DPP"). Upon adoption of ASU 2016-15, the CPP received was reflected as cash provided by operating activities in the Company's consolidated statements of cash flows, and cash received to settle the DPP related to the transfer of receivables was included as part of investing activities in the Company's consolidated statement of cash flows.
(in thousands) Total U.S. Poland
Deferred purchase price
At August 31, 2018, the Company transferred $381.1 million of trade accounts receivable to the financial institutions and had no advance payments outstanding under the U.S. Facility and $12.1 million outstanding under the Poland Facility (as defined in Note 10, Credit Arrangements).
NOTE 7. INVENTORIES
The majority of the Company's inventories are in the form of semi-finished and finished goods. Under the Company’s business
model, products are sold to external customers in various stages, from semi-finished billets through fabricated steel, leading these categories to be combined. As such, at August 31, 2020 and 2019, work in process inventories were not material. At August 31, 2020 and 2019, the Company's raw materials inventories were $123.9 million and $143.7 million, respectively.
Inventory write-downs were immaterial for 2020, 2019 and 2018.
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NOTE 8. GOODWILL AND OTHER INTANGIBLE ASSETS
The following table details the changes in the carrying amount of goodwill by reportable segment:
(in thousands) North America Europe Consolidated
Goodwill, gross
Foreign currency translation — (184) (184)
Foreign currency translation — 195 195
Accumulated impairment losses
Foreign currency translation — 12 12
Foreign currency translation — (12) (12)
Goodwill, net
Foreign currency translation — (172) (172)
Foreign currency translation — 183 183
As of August 31, 2020 and 2019, the excess of the fair value over the carrying value of each reporting unit was substantial. There were no goodwill impairment charges in 2020, 2019, or 2018.
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The following intangible assets subject to amortization are included in other noncurrent assets on the Company's consolidated balance sheets:
In connection with the Acquisition, the Company recorded an unfavorable contract backlog liability of $110.2 million. At August 31, 2020 and 2019, the net carrying amount of the liability was $6.0 million and $35.4 million, respectively. Amortization of the unfavorable contract backlog was $29.4 million and $74.8 million for the twelve months ended August 31, 2020 and 2019, respectively, and was recorded as an increase to net sales in the Company's consolidated statements of earnings.
Perpetual lease rights at August 31, 2020 have an estimated useful life of 85 years. All other intangible assets with definitive lives are amortized over estimated useful lives ranging from 3 to 15 years. Excluding goodwill, the Company does not have any other significant intangible assets with indefinite lives. Amortization expense for intangible assets was $2.1 million for 2020 and $2.2 million for 2019 and 2018. Estimated amounts of amortization expense for the next five years are as follows.
Year Ended August 31, (in thousands)
NOTE 9. LEASES
The following table presents the components of the total leased assets and lease liabilities and their classification in the Company's consolidated balance sheet at August 31, 2020:
(in thousands) Classification in Consolidated Balance Sheet August 31, 2020
Assets:
Operating assets Other noncurrent assets $ 114,905
Finance assets Property, plant and equipment, net 50,642
Liabilities:
Operating lease liabilities:
Current Accrued expenses and other payables $ 27,604
Long-term Other noncurrent liabilities 95,810
Total operating lease liabilities 123,414
Finance lease liabilities:
Current Current maturities of long-term debt and short-term borrowings 14,373
Long-term Long-term debt 35,851
Total finance lease liabilities 50,224
Total lease liabilities $ 173,638
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The components of lease cost were as follows:
(in thousands) Year Ended August 31, 2020
Operating lease expense $ 35,611
Finance lease expense:
Amortization of assets 11,445
Interest on lease liabilities 1,792
Total finance lease expense 13,237
Variable and short term-lease expense 17,020
Total lease expense $ 65,868
The weighted average remaining lease term and discount rate for operating and finance leases are presented in the following table:
Weighted average remaining lease term (years)
Operating leases 6.3
Finance leases 3.8
Weighted average discount rate
Operating leases 4.283 %
Finance leases 4.270 %
Cash flow and other information related to leases is included in the following table:
(in thousands) Year Ended August 31, 2020
Cash paid for amounts included in the measurement of lease liabilities
Operating cash outflows from operating leases $ 36,063
Operating cash outflows from finance leases 1,720
Financing cash outflows from finance leases 12,774
ROU assets obtained in exchange for lease obligations:
Maturities of lease liabilities at August 31, 2020 are presented in the following table:
(in thousands) Operating Leases Finance Leases
Future maturities of lease liabilities at August 31, 2019, prior to adoption of ASU 2016-02, are presented in the following table:
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Twelve Months Ended August 31,
NOTE 10. CREDIT ARRANGEMENTS
Long-term debt was as follows:
Weighted AverageInterest Rate as of August 31, 2020 Year Ended August 31,
In July 2017, the Company issued $300.0 million of 5.375% Senior Notes due July 2027 (the "2027 Notes"). Interest on these notes is payable semiannually.
In May 2018, the Company issued $350.0 million of 5.750% Senior Notes due April 2026 (the "2026 Notes"). Interest on the 2026 Notes is payable semiannually.
In May 2013, the Company issued $330.0 million of 4.875% Senior Notes due May 2023 (the "2023 Notes"). Interest on these notes is payable semiannually.
The Company has a $350.0 million revolving credit facility (the "Revolver") pursuant to the Fourth Amended and Restated Credit Agreement (as amended, the "Credit Agreement"). The Credit Agreement has a maturity date in June 2022. The maximum availability under the Revolver can be increased to $600.0 million with bank approval. The Company's obligations under the Credit Agreement are collateralized by its North America inventory and certain of its North America receivables. The Credit Agreement's capacity includes a $50.0 million sub-limit for the issuance of stand-by letters of credit. The Company had no amounts drawn under the Revolver at August 31, 2020 or 2019. The availability under the Revolver was reduced by outstanding stand-by letters of credit of $3.0 million at August 31, 2020 and 2019.
The Company also had a term loan (the "Term Loan") contemplated under the Credit Agreement. The Term Loan was funded in two tranches: one drawn on July 13, 2017 with an original principal amount of $150.0 million, and one drawn on November 1, 2018 with an original principal amount of $180.0 million. The Company repaid the remaining Term Loan balance in 2020, and recognized $1.8 million of expense related to early extinguishment of this debt, which is included in selling, general and administrative expenses in the Company's consolidated statement of earnings for the year ended August 31, 2020.
Under the Credit Agreement, the Company is required to comply with certain financial and non-financial covenants, including covenants to maintain: (i) an interest coverage ratio (consolidated EBITDA to consolidated interest expense, as each is defined in the Credit Agreement) of not less than 2.50 to 1.00 and (ii) a debt to capitalization ratio (consolidated funded debt to total capitalization, as each is defined in the Credit Agreement) that does not exceed 0.60 to 1.00. Loans under the Credit Agreement
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bear interest based on the Eurocurrency rate, a base rate, or the LIBOR rate. At August 31, 2020, the Company's interest coverage ratio was 9.36 to 1.00 and the Company's debt to capitalization ratio was 0.37 to 1.00.
In August 2020, the Company entered into an agreement through its subsidiary, CMCP, which allowed for a delayed draw Term Loan facility ("Poland Term Loan") in the maximum aggregate principal amount of up to PLN 250.0 million, or $67.9 million at August 31, 2020. The proceeds of the Poland Term Loan will be used to finance the third rolling mill in Poland. At August 31, 2020, PLN 150.0 million, or $40.7 million, was outstanding. CMCP is required to make quarterly interest and principal payments on the Poland Term Loan with interest based on the Warsaw Interbank Offer Rate ("WIBOR") plus a margin. The Poland Term Loan has a maturity date of August 2026.
The Company also has credit facilities in Poland, through its subsidiary, CMCP, available to support working capital, short-term cash needs, letters of credit, financial assurance and other trade finance-related matters. At August 31, 2020 and 2019, CMCP's credit facilities totaled PLN 275.0 million, or $74.6 million and $69.0 million, respectively. These facilities expire in March 2022. At August 31, 2020 and 2019, no amounts were outstanding under these facilities. In 2020, CMCP had $22.4 million borrowings and $22.4 million repayments under its credit facilities. CMCP had no borrowings or repayments under its credit facilities in 2019 and 2018. The available balance of these credit facilities was reduced by outstanding stand-by letters of credit, guarantees and/or other financial assurance instruments, which totaled $0.8 million and $1.1 million at August 31, 2020 and August 31, 2019, respectively.
At August 31, 2020, the Company was in compliance with all of the covenants contained in its credit arrangements.
The scheduled maturities of the Company's long-term debt, excluding obligations related to finance leases, are included in the table below. See Note 9, Leases, for scheduled maturities of finance leases.
Year Ended August 31, (in thousands)
Total long-term debt, excluding finance leases 1,042,042
Less debt issuance costs 8,581
Total long-term debt outstanding, excluding finance leases $ 1,033,461
The Company capitalized $2.5 million, $0.3 million and $7.3 million of interest in the cost of property, plant and equipment during 2020, 2019 and 2018, respectively.
Accounts Receivable Facilities
CMC has a $200.0 million U.S. trade accounts receivable facility (the "U.S. Facility"), which expires in November 2021. Under the U.S. Facility, CMC contributes, and certain of its subsidiaries transfer without recourse, certain eligible trade accounts receivable to CMC Receivables, Inc. ("CMCRV"), a wholly-owned subsidiary of CMC. CMCRV is structured to be a bankruptcy-remote entity formed for the sole purpose of facilitating transfers of trade accounts receivable generated by the Company. CMCRV transfers the trade accounts receivable in their entirety to two financial institutions. Under the U.S. Facility, with the consent of both CMCRV and the program's administrative agent, the amount advanced by the financial institutions can be increased to a maximum of $300.0 million for all trade accounts receivable. The remaining portion of the purchase price of the trade accounts receivable takes the form of subordinated notes from the respective financial institutions. These notes will be satisfied from the ultimate collection of the trade accounts receivable after payment of certain fees and other costs. The U.S. Facility contains certain cross-default provisions whereby a termination event could occur if the Company defaulted under certain of its credit arrangements. The covenants contained in the receivables purchase agreement are consistent with the Credit Agreement. Advances taken under the U.S. Facility incur interest based on LIBOR plus a margin. The Company had no advance payments outstanding under the U.S. Facility at August 31, 2020 and August 31, 2019.
In addition to the U.S. Facility, the Company's subsidiary in Poland transfers trade accounts receivable to financial institutions without recourse (the "Poland Facility"). The Poland Facility has a facility limit of PLN 220.0 million ($59.7 million and $55.2 million as of August 31, 2020 and 2019, respectively) and allows the Company's Polish subsidiaries to obtain an advance of up
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to 90% of eligible trade accounts receivable transferred under the terms of the arrangement. Advances taken under the Poland Program incur interest based on the WIBOR plus a margin. The Company had no advance payments outstanding under the Poland Facility at August 31, 2020, compared to $3.9 million at August 31, 2019.
The transfer of receivables under the U.S. and Poland Facilities do not qualify to be accounted for as sales. Therefore, any advances outstanding under these programs are recorded as debt on the Company's consolidated balance sheets.
NOTE 11. NEW MARKETS TAX CREDIT TRANSACTIONS
During 2016 and 2017, the Company entered into three New Markets Tax Credit (“NMTC”) transactions with U.S. Bancorp Community Development Corporation, a Minnesota corporation ("USBCDC"). The NMTC transactions relate to the construction and equipping of the micro mill in Durant, Oklahoma, as well as a rebar spooler and automated T-post shop located on the same site.
The transactions qualified through the New Markets Tax Credit program provided for in the Community Renewal Tax Relief Act of 2000 (the "NMTC Program"), as the micro mill, spooler and T-post shop are located in an eligible zone designated by the Internal Revenue Service ("IRS") and are considered eligible business activities for the NMTC Program. Under the NMTC Program, an investor that makes a capital investment, which, in turn, together with leverage loan sources, is used to make a Qualifying Equity Investment (a "QEI") in an entity that (i) qualifies as a Community Development Entity ("CDE"), (ii) has applied for and been granted an allocation of a portion of the total federal funds available to fund the credits (an "NMTC Allocation") and (iii) uses a minimum specified portion of the QEI to make a Qualified Low Income Community Investment up to the maximum amount of the CDE’s NMTC Allocation will be entitled to claim, over a period of seven years, federal nonrefundable tax credits in an amount equal to 39% of the QEI amount. NMTCs are subject to 100% recapture for a period of seven years as provided in the Internal Revenue Code.
In general, the three NMTC transactions were structured similarly. USBCDC made a capital contribution to an investment fund and Commonwealth Acquisition Holdings, Inc., a wholly-owned subsidiary of the Company (“Commonwealth”), made a loan to the investment fund. The investment fund used the proceeds from the capital contribution and the loan to make a QEI into a CDE, which, in turn, makes loans of the QEIs to the operating subsidiaries of the Company with terms similar to the loans by Commonwealth.
The following table summarizes the key terms and conditions for each of the three NMTC transactions ($ in millions):
By its capital contributions to the investment funds (exclusive of Twain Investment Fund 222) (collectively the "Funds"), USBCDC is entitled to substantially all the benefits derived from the NMTCs. These transactions include a put/call provision whereby the Company may be obligated or entitled to repurchase USBCDC’s interest in the Funds at the end of a seven-year period, in the case of the USBCDC Investment Fund 156, LLC and Twain Investment Fund 249, LLC or an eight-year period, in the case of Twain Investment Fund 219, LLC (each of such periods, an "Exercise Period"). The Company believes USBCDC will exercise the put options following the end of the respective Exercise Periods. The value attributed to the put/call is immaterial. The Company is required to follow various regulations and contractual provisions that apply to the NMTC transactions. Non-compliance with applicable requirements could result in unrealized projected tax benefits and, therefore, could require the Company to indemnify USBCDC for any loss or recapture of NMTCs related to the financing until the Company's obligation to deliver tax benefits is relieved. The Company does not anticipate any credit recaptures will be required in connection with these transactions.
The Company has determined that the Funds are VIEs, of which the Company is the primary beneficiary and has consolidated them in accordance with ASC Topic 810, Consolidation. USBCDC’s contributions are included in other noncurrent liabilities in
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the accompanying consolidated balance sheets. Direct costs incurred in structuring the transactions were deferred and are recognized as expense over each Exercise Period. Incremental costs to maintain the structures during the compliance periods are recognized as incurred.
The Company has determined that Twain Investment Fund 222 is a VIE, of which the Company is not the primary beneficiary and has therefore treated the QEI of $2.1 million as debt. The obligation represents the Company's maximum exposure to loss and is included in long-term debt in the accompanying consolidated balance sheets.