NORTHWEST PIPE CO Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)

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The following is management's discussion and analysis of certain significant
factors that have affected our consolidated financial condition and results of
operations during the periods included herein. This discussion should be read in
conjunction with our historical Consolidated Financial Statements and Notes to
Consolidated Financial Statements in Part II - Item 8. "Financial Statements and
Supplementary Data" of this 2021 Form 10­K. This discussion contains
forward-looking statements based upon current expectations that involve risks
and uncertainties. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of various factors,
including those set forth under Part I - Item 1A. "Risk Factors" or in other
parts of this 2021 Form 10­K. For discussion related to the changes in financial
condition for the year ended December 31, 2020 compared to the year ended
December 31, 2019, refer to Part II - Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources" in our 2020 Form 10­K, which was filed with the SEC on
March 4, 2021, and which is incorporated herein by reference.



Overview



Northwest Pipe Company is a leading manufacturer for water related
infrastructure products. In addition to being the largest manufacturer of
engineered steel water pipeline systems in North America, we manufacture
high-quality precast and reinforced concrete products; water, wastewater, and
stormwater equipment; steel casing pipe, bar-wrapped concrete cylinder pipe, and
one of the largest offerings of pipeline system joints, fittings, and
specialized components. Strategically positioned to meet growing water and
wastewater infrastructure needs, we provide solution-based products for a wide
range of markets under the ParkUSA, Geneva Pipe and Precast, Permalok®, and
Northwest Pipe Company lines. Our diverse team is committed to quality and
innovation while demonstrating our core values of accountability, commitment,
and teamwork. We are headquartered in Vancouver, Washington, and have
13 manufacturing facilities across North America.



Our water infrastructure products are sold generally to installation
contractors, who include our products in their bids to federal, state, and
municipal agencies, privately-owned water companies, or developers for specific
projects. We believe our sales are substantially driven by spending on urban
growth and new water infrastructure with a recent trend towards spending on
water infrastructure replacement, repair, and upgrade. Within the total range of
products, our steel pipe tends to fit the larger-diameter, higher-pressure
pipeline applications, while our precast concrete products mainly serve
stormwater and sanitary sewer systems.



In October 2021 we acquired Park Environmental Equipment, LLC, a precast
concrete and steel fabrication-based company in Texas that develops and
manufactures water, wastewater, and environmental solutions. In January 2020, we
acquired Geneva Pipe and Precast Company (fka Geneva Pipe Company, Inc.), a
concrete pipe and precast concrete products manufacturer based in Utah.
Effective in the fourth quarter of 2021, as a result of the acquisition of
ParkUSA, we revised our historical one segment position and identified the new
operating segments, Engineered Steel Pressure Pipe (SPP) and Precast
Infrastructure and Engineered Systems (Precast), to align with changes made in
our internal management structure and our reporting structure of financial
information used to assess performance and allocate resources. For detailed
descriptions of these segments, see the "Our Segments" discussion in Part I -
Item 1. "Business" of this 2021 Form 10­K.



Our current economic environment



We operate our business with a long-term time horizon. Projects are often
planned for many years in advance, and are sometimes part of 50­year build-out
plans. Long-term demand for water infrastructure projects in the United States
appears strong. However, in the near term, we expect that strained governmental
and water agency budgets and financing along with increased manufacturing
capacity from competition could impact the business. Additionally, we have
started to experience effects of a current labor shortage at certain
manufacturing facilities, for which we are mitigating the impact through the use
of overtime and third-party outsourcing as warranted. It is possible that a
prolonged shortage of qualified, available workers could result in a further
increase in labor costs that could impact our business.



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Fluctuating steel costs will also be a factor, as the ability to adjust our
selling prices as steel costs fluctuate depends on market conditions. Purchased
steel represents a substantial portion of our cost of sales of steel pipe
products, and changes in our selling prices often correlate directly to changes
in steel costs. Recently, steel markets have been extremely volatile, and the
cost of steel introduced into the manufacturing process increased 67% in 2021
compared to 2020. Due to production and delivery lead times for steel, these
costs in 2021 were not always indicative of the current market prices.



Impact of the COVID19 pandemic on our business



While the COVID­19 pandemic did cause indirect financial impacts associated with
project bidding, execution, and delivery delays during the year ended
December 31, 2021, we are unable to predict the ultimate impact that the
COVID­19 pandemic may have on our business, future results of operations,
financial position, or cash flows. For additional details, refer to the
information set forth under the caption "Impact of the COVID­19 Pandemic on Our
Business" in Part I - Item 1. "Business" and discussions in Part I -
Item 1A. "Risk Factors" of this 2021 Form 10­K.



Results of Operations



The following table sets forth, for the periods indicated, certain financial
information regarding costs and expenses expressed in dollars (in thousands) and
as a percentage of total net sales.



                        Year Ended December 31, 2021        Year Ended December 31, 2020        Year Ended December 31, 2019
                                           % of Net                                                                % of Net
                            $               Sales             $             % of Net Sales          $               Sales
Net sales:
Engineered Steel
Pressure Pipe           $  259,823               78.0 %   $  241,690                   84.5 %   $  279,317              100.0 %
Precast
Infrastructure and
Engineered Systems          73,490               22.0         44,217                   15.5              -                  -
Total net sales            333,313              100.0        285,907                  100.0        279,317              100.0
Cost of sales:
Engineered Steel           228,542               68.6        197,397                   69.0        232,133               83.1
Pressure Pipe
Precast
Infrastructure and
Engineered Systems          60,517               18.1         37,991                   13.3              -                  -
Total cost of sales        289,059               86.7        235,388                   82.3        232,133               83.1
Gross profit:
Engineered Steel            31,281                9.4         44,293                   15.5         47,184               16.9
Pressure Pipe
Precast
Infrastructure and
Engineered Systems          12,973                3.9          6,226                    2.2              -                  -
Total gross profit          44,254               13.3         50,519                   17.7         47,184               16.9
Selling, general, and
administrative
expense                     28,222                8.5         24,954                    8.8         18,495                6.6
Operating income            16,032                4.8         25,565                    8.9         28,689               10.3
Other income                   328                0.1            953                    0.3          4,383                1.6
Interest income                  -                  -             49                      -             40                  -
Interest expense            (1,202 )             (0.4 )         (933 )                 (0.2 )         (472 )             (0.2 )
Income before income
taxes                       15,158                4.5         25,634                    9.0         32,640               11.7
Income tax expense           3,635                1.0          6,584                    2.3          4,738                1.7
Net income              $   11,523                3.5 %   $   19,050                    6.7 %   $   27,902               10.0 %



Year ended December 31, 2021 Compared to the year ended December 31, 2020

Net sales. Net sales increased by 16.6% to $333.3 million in 2021 compared to
$285.9 million in 2020.



SPP net sales increased 7.5% to $259.8 million in 2021 compared to
$241.7 million in 2020 driven by a 15% increase in selling price per ton due to
increased materials costs and changes in product mix, partially offset by a 6%
decrease in tons produced resulting from changes in project timing. Bidding
activity, backlog, and production levels may vary significantly from period to
period affecting sales volumes.



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Precast net sales increased 66.2% to $73.5 million in 2021 compared to
$44.2 million in 2020 primarily due to the ParkUSA operations acquired in
October 2021, which contributed $18.0 million in net sales during the fourth
quarter of 2021, as well as a 26% increase in net sales at the Geneva operations
acquired in January 2020 due to an 18% increase in shipments and a 6% increase
in selling prices.


Gross profit. Gross margin decreased by 12.4% for $44.3 million (13.3% of sales) in 2021 vs. $50.5 million (17.7% of turnover) in 2020.



SPP gross profit decreased 29.4% to $31.3 million (12.0% of SPP net sales) in
2021 compared to $44.3 million (18.3% of SPP net sales) in 2020 due to the
combination of changes in product mix and pressure on project pricing.
Additionally, as a result of the fire at our Saginaw facility in April 2019,
$1.4 million of business interruption insurance recovery (net of incremental
production costs) was recorded in 2020.



Precast gross profit increased 108.4% to $13.0 million (17.7% of Precast net
sales) in 2021 compared to $6.2 million (14.1% of Precast net sales) in 2020 due
to contributions from the ParkUSA operations acquired in October 2021, as well
as higher prices and production volume at the Geneva operations. Precast gross
profit in 2021 was reduced by $2.1 million in higher acquisition-related fair
value inventory charges.



Selling, general, and administrative expense. Selling, general, and
administrative expense increased 13.1% to $28.2 million (8.4% of net sales) in
2021 compared to $25.0 million (8.8% of net sales) in 2020. The increase in
selling, general, and administrative expense was primarily due to $1.8 million
in higher compensation-related expense, $0.6 million in higher
acquisition-related transaction costs, and $0.8 million in higher depreciation
and amortization expense, all primarily due to the acquisition of ParkUSA in
October 2021.


Other income. In 2020, we recorded gains on insurance products from $1.0 million
for material damage resulting from the fire of our Saginaw establishment.



Income taxes. Income tax expense was $3.6 million in 2021 (an effective income
tax rate of 24.0%) compared to $6.6 million in 2020 (an effective income tax
rate of 25.7%). The effective income tax rate for 2021 was primarily impacted by
estimated changes in our valuation allowance. The effective income tax rate for
2020 was primarily impacted by costs associated with the acquisition of Geneva
that were non-deductible for tax purposes. The effective income tax rate can
change significantly depending on the relationship of permanent income tax
deductions and tax credits to estimated pre-tax income or loss and the changes
in valuation allowances. Accordingly, the comparison of effective income tax
rates between periods is not meaningful in all situations.



Year ended December 31, 2020 Compared to the year ended December 31, 2019

Net sales. Net sales increased by 2.4% to $285.9 million in 2020 compared to
$279.3 million in 2019.



SPP net sales decreased 13.5% to $241.7 million in 2020 compared to
$279.3 million in 2019 driven by a 28% decrease in tons produced resulting from
changes in project timing, partially offset by a 20% increase in selling price
per ton due to a change in product mix. Additionally, the pandemic-related
shut-down of our San Luis Río Colorado, Mexico facility negatively impacted our
sales in the second quarter of 2020. Bidding activity, backlog, and production
levels may vary significantly from period to period affecting sales volumes.



Net prefab sales increased to $44.2 million in 2020 compared to $0 in 2019 thanks to the contribution of the Geneva activities acquired in January 2020.

Gross profit. Gross margin increased by 7.1% for $50.5 million (17.7% of sales) in 2020 vs. $47.2 million (16.9% of turnover) in 2019.



SPP gross profit decreased 6.1% to $44.3 million (18.3% of SPP net sales) in
2020 compared to $47.2 million (16.9% of SPP net sales) in 2019 due to lower
production volume, partially offset by improved product pricing. Additionally,
as a result of the fire at our Saginaw facility in April 2019, $1.4 million of
business interruption insurance recovery (net of incremental production costs)
was recorded in 2020, compared to $1.6 million of incremental production costs
(net of business interruption insurance recovery) in 2019.



Precast gross profit increased to $6.2 million (14.1% of Precast net sales) in
2020 compared to $0 in 2019 due to the contribution from the Geneva operations
acquired in January 2020.



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Selling, general, and administrative expense. Selling, general, and
administrative expense increased 34.9% to $25.0 million (8.8% of net sales) in
2020 compared to $18.5 million (6.6% of net sales) in 2019. The increase in
selling, general, and administrative expense was primarily due to the addition
of Geneva, including $2.7 million in higher compensation-related expense,
$2.0 million in higher acquisition-related transaction costs, and $0.9 million
in higher intangible amortization expense. In addition, we incurred $0.8 million
in higher administrative expense.



Other income. In 2020 and 2019, we recognized gains on insurance proceeds of
$1.0 million and $1.6 million, respectively, for property damage resulting from
the fire at our Saginaw facility. In August 2019, we received $2.3 million of
proceeds related to a favorable legal settlement involving certain pipe produced
at our former Houston, Texas and Bossier City, Louisiana facilities.



Income taxes. Income tax expense was $6.6 million in 2020 (an effective income
tax rate of 25.7%) compared to $4.7 million in 2019 (an effective income tax
rate of 14.5%). The effective income tax rate for 2020 was primarily impacted by
costs associated with the acquisition of Geneva that were non-deductible for tax
purposes. The effective income tax rate for 2019 was primarily impacted by the
estimated changes in our valuation allowance. The effective income tax rate can
change significantly depending on the relationship of permanent income tax
deductions and tax credits to estimated pre-tax income or loss and the changes
in valuation allowances. Accordingly, the comparison of effective income tax
rates between periods is not meaningful in all situations.



Cash and capital resources


Sources and Uses of Cash



Our principal sources of liquidity generally include operating cash flows and
the Amended Credit Agreement. From time to time our long-term capital needs may
be met through the issuance of long-term debt or additional equity. Our
principal uses of liquidity generally include capital expenditures, working
capital, organic growth initiatives, acquisitions, and debt service. Information
regarding our cash flows for the years ended December 31, 2021, 2020, and 2019
are presented in our Consolidated Statements of Cash Flows contained in
Part II - Item 8. "Financial Statements and Supplementary Data" of this 2021
Form 10­K, and are further discussed below.



As we cannot predict the duration or scope of the COVID­19 pandemic and its
impact on our customers and suppliers, the potential negative financial impact
to our results cannot be reasonably estimated, but could be material. We are
actively managing the business to maintain cash flow and believe we have
liquidity to meet our anticipated funding requirements and other near-term
obligations.



As of December 31, 2021, our working capital (current assets minus current
liabilities) was $164.1 million compared to $146.1 million as of December 31,
2020. Cash and cash equivalents totaled $3.0 million and $37.9 million as of
December 31, 2021 and 2020, respectively. The decrease is primarily attributable
to the repayment of long-term debt and changes in working capital in 2021.



Fluctuations in SPP working capital accounts result from timing differences
between production, shipment, invoicing, and collection, as well as changes in
levels of production and costs of materials. We typically have a relatively
large investment in working capital, as we generally pay for materials, labor,
and other production costs in the initial stages of a project, while payments
from our customers are generally received after finished product is delivered. A
portion of our revenues are recognized over time as the manufacturing process
progresses; therefore, cash receipts typically occur subsequent to when revenue
is recognized and the elapsed time between when revenue is recorded and when
cash is received can be significant. As such, our payment cycle is a
significantly shorter interval than our collection cycle, although the effect of
this difference in the cycles may vary by project, and from period to period.



As of December 31, 2021, we had $86.8 million of outstanding revolving loan
borrowings, $98.4 million of operating lease liabilities, and $2.2 million of
finance lease liabilities. For future maturities of these obligations, see
Notes 7 and 8 of the Notes to Consolidated Financial Statements in Part II -
Item 8. "Financial Statements and Supplementary Data" of this 2021 Form 10­K.



Due to the uncertainty with respect to the timing of future cash flows
associated with our approximately $4.4 million in unrecognized tax benefits as
of December 31, 2021, we are unable to make reasonably reliable estimates of the
period of cash settlement with the respective taxing authorities. For further
information, see Note 15 of the Notes to Consolidated Financial Statements in
Part II - Item 8. "Financial Statements and Supplementary Data" of this 2021
Form 10­K.



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Net cash provided by (used in) operating activities



Net cash provided by (used in) operating activities was $(5.8) million in 2021
compared to $56.1 million in 2020. Net income, adjusted for non-cash items,
provided $28.7 million of operating cash flow in 2021 compared to $40.3 million
of operating cash flow in 2020. The net change in working capital provided
(used) $(34.5) million of operating cash flow in 2021 compared to $15.8 million
of operating cash flow in 2020.



Net cash used in investment activities



Net cash used in investing activities was $100.2 million in 2021 compared to
$61.4 million in 2020. Acquisitions of businesses, net of cash acquired, were
$87.2 million in 2021 compared to $48.7 million in 2020. Capital expenditures
were $13.3 million in 2021 compared to $14.0 million in 2020, which was
primarily for standard capital replacement. We currently expect capital
expenditures in 2022 to be approximately $26 million to $30 million, which
includes an approximately $13 million of additional investment in a new
reinforced concrete pipe mill and the remainder primarily for standard capital
replacement.


Net cash provided by financing activities



Net cash provided by financing activities was $71.0 million in 2021 compared to
$12.3 million in 2020. Net borrowings on the line of credit were $86.8 million
in 2021 compared to $0 in 2020. Net borrowings (repayments) on long-term debt
were $(13.8) million in 2021 compared to $13.8 million in 2020.



We anticipate that our existing cash and cash equivalents, cash flows expected
to be generated by operations, and additional borrowing capacity under the
Amended Credit Agreement will be adequate to fund our working capital, debt
service, and capital expenditure requirements for at least the next twelve
months. To the extent necessary, we may also satisfy capital requirements
through additional bank borrowings, senior notes, term notes, subordinated debt,
and finance and operating leases, if such resources are available on
satisfactory terms. We have from time to time evaluated and continue to evaluate
opportunities for acquisitions and expansion. Any such transactions, if
consummated, may necessitate additional bank borrowings or other sources of
funding. As previously discussed, we acquired ParkUSA in October 2021 which was
funded primarily by borrowings on the line of credit.



On November 3, 2020, our registration statement on Form S­3 (Registration
No. 333­249637) covering the potential future sale of up to $150 million of our
equity and/or debt securities or combinations thereof, was declared effective by
the SEC. This registration statement, which replaced the registration statement
on Form S­3 that expired on September 15, 2020, provides another potential
source of capital, in addition to other alternatives already in place. We cannot
be certain that funding will be available on favorable terms or available at
all. To the extent that we raise additional funds by issuing equity securities,
our shareholders may experience significant dilution. As of the date of this
2021 Form 10­K, we have not yet sold any securities under this registration
statement, nor do we have an obligation to do so. Please refer to the factors
discussed in Part I - Item 1A. "Risk Factors" of this 2021 Form 10­K.



Credit Agreement



The Amended Credit Agreement provides for a revolving loan, swingline loan, and
letters of credit in the aggregate amount of up to $125 million ("Revolver
Commitment"). The Amended Credit Agreement will expire, and all obligations
outstanding will mature, on June 30, 2024. We may prepay outstanding amounts in
our discretion without penalty at any time, subject to applicable notice
requirements. As of December 31, 2021 under the Amended Credit Agreement, we had
$86.8 million of outstanding revolving loan borrowings, $1.6 million of
outstanding letters of credit, and additional borrowing capacity of
approximately $37 million. Based on our business plan and forecasts of
operations, we expect to have sufficient credit available to support our
operations for at least the next twelve months.



Revolving loans under the Amended Credit Agreement bear interest at rates
related to, at our option and subject to the provisions of the Amended Credit
Agreement including certain LIBOR transition provisions, either: (i) Base Rate
(as defined in the Amended Credit Agreement) plus the Applicable Margin;
(ii) LIBOR plus the Applicable Margin; or (iii) the daily one month LIBOR plus
the Applicable Margin. The "Applicable Margin" is 1.75% to 2.25%, depending on
our Senior Leverage Ratio (as defined in the Amended Credit Agreement). Interest
on outstanding revolving loans is payable quarterly. Swingline loans under the
Amended Credit Agreement bear interest at the Base Rate plus the Applicable
Margin. The Amended Credit Agreement requires the payment of a commitment fee of
between 0.30% and 0.40%, based on the amount by which the Revolver Commitment
exceeds the average daily balance of outstanding borrowings (as defined in the
Amended Credit Agreement). Such fee is payable quarterly in arrears. We are also
obligated to pay additional fees customary for credit facilities of this size
and type.



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Letters of credit outstanding in December 31, 2021 relate to insurance against accidents at work. Given the nature of these agreements and our historical experience, we do not expect to make any material payments under these agreements.



The Amended Credit Agreement contains customary representations and warranties,
as well as customary affirmative and negative covenants, events of default, and
indemnification provisions in favor of the Lenders. The negative covenants
include restrictions regarding the incurrence of liens and indebtedness, annual
capital expenditures, certain investments, acquisitions, and dispositions, and
other matters, all subject to certain exceptions. The Amended Credit Agreement
requires us to regularly provide financial information to Wells Fargo and to
maintain a consolidated senior leverage ratio no greater than 2.50 to 1.00
(subject to certain exceptions) and a minimum consolidated earnings before
interest, taxes, depreciation, and amortization (as defined in the Amended
Credit Agreement) of at least $31.5 million for the four consecutive fiscal
quarters most recently ended. Pursuant to the Amended Credit Agreement, we have
also agreed that we will not sell, assign, or otherwise dispose or encumber, any
of our owned real property. The occurrence of an event of default could result
in the acceleration of the obligations under the Amended Credit Agreement. We
were in compliance with our financial covenants as of December 31, 2021. Based
on our business plan and forecasts of operations, we believe we will remain in
compliance with our financial covenants for the next twelve months.



Our obligations under the Amended Credit Agreement are secured by a first ranking lien on substantially all of our assets and those of our subsidiaries.

Recent accounting pronouncements



For a description of recent accounting pronouncements affecting our company,
including the dates of adoption and estimated effects on financial position,
results of operations, and cash flows, see Note 2 of the Notes to Consolidated
Financial Statements in Part II - Item 8. "Financial Statements and
Supplementary Data" of this 2021 Form 10­K.



Critical Accounting Estimates



Management Estimates



The preparation of our Consolidated Financial Statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues, and expenses, and disclosure of contingent assets and liabilities. We
base our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances. On an ongoing basis,
we evaluate all of our estimates including those related to revenue recognition,
business combinations, goodwill, inventories, property and equipment, including
depreciation and valuation, share-based compensation, income taxes, allowance
for doubtful accounts, and litigation and other contingencies. Actual results
may differ from these estimates under different assumptions or conditions. We
believe the following critical accounting policies and related judgments and
estimates affect the preparation of our Consolidated Financial Statements.



Revenue Recognition



SPP revenue for water infrastructure steel pipe products is recognized over time
as the manufacturing process progresses because of our right to payment for work
performed to date plus a reasonable profit on cancellations for unique products
that have no alternative use to us. Revenue is measured by the costs incurred to
date relative to the estimated total direct costs to fulfill each contract
(cost-to-cost method). Contract costs include all material, labor, and other
direct costs incurred in satisfying performance obligations. The cost of steel
material is recognized as a contract cost when the steel is introduced into the
manufacturing process. Estimated total costs of each contract are reviewed on a
monthly basis by project management and operations personnel for all active
projects. All cost revisions that result in a material change in gross profit
are reviewed by senior management personnel. Significant judgment is required in
estimating total costs and measuring the progress of project completion, as well
as whether a loss is expected to be incurred on the contract. We use certain
assumptions and develop estimates based on a number of factors, including the
degree of required product customization, our historical experience, the project
plans, and an assessment of the risks and uncertainties inherent in the contract
related to implementation delays or performance issues that may or may not be
within our control. Changes in job performance, job conditions, and estimated
profitability, including those arising from contract change orders, contract
penalty provisions, foreign currency exchange rate movements, changes in raw
materials costs, and final contract settlements may result in revisions to
estimates of revenue, costs, and income, and are recognized in the period in
which the revisions are determined. Provisions for losses on uncompleted
contracts are estimated by comparing total estimated contract revenue to the
total estimated contract costs and a loss is recognized during the period in
which it becomes probable and can be reasonably estimated.



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Precast revenue for water infrastructure concrete pipe and precast concrete
products is recognized at the time control is transferred to customers, in an
amount that reflects the consideration we expect to be entitled to in exchange
for the products. All variable consideration that may affect the total
transaction price, including contractual discounts, returns, and credits, is
included in net sales. Estimates for variable consideration are based on
historical experience, anticipated performance, and management's judgment. Our
contracts do not contain significant financing.



We do not recognize revenue on a contract until the contract has approval and
commitment from both parties, the contract rights and payment terms can be
identified, the contract has commercial substance, and its collectability is
probable.



Business Combinations



Business combinations are accounted for under the acquisition method which
requires identifiable assets acquired and liabilities assumed in the business
acquired be recognized and measured at fair value on the acquisition date, which
is the date that the acquirer obtains control of the acquired business. The
amount by which the fair value of consideration transferred as the purchase
price exceeds the net fair value of assets acquired and liabilities assumed is
recorded as goodwill. The amount by which the net fair value of assets acquired
and liabilities assumed exceeds the fair value of consideration transferred as
the purchase price is recorded as a bargain purchase gain. Acquisition-related
costs are expensed as incurred.



Accounting for business combinations requires management to make significant
estimates and assumptions in the determination of the fair value of assets
acquired and liabilities assumed in order to allocate purchase price
consideration properly. These assumptions and estimates include a market
participant's use of the asset and the appropriate discount rates for a market
participant. Our estimates are based on historical experience, information
obtained from the management of the acquired companies and, when appropriate,
include assistance from independent third-party appraisal firms. Our significant
assumptions and estimates can include, but are not limited to, the cash flows
that an asset is expected to generate in the future, the appropriate
weighted-average cost of capital, and the cost savings expected to be derived
from acquiring an asset. These estimates are inherently uncertain and
unpredictable. In addition, unanticipated events and circumstances may occur
which may affect the accuracy or validity of such estimates. As a result, during
the measurement period, which may be up to one year from the acquisition date,
we may record adjustments to the assets acquired and liabilities assumed with
the corresponding offset to goodwill or bargain purchase gain.



Goodwill



Goodwill is reviewed for impairment annually as of December 31, or whenever
events occur or circumstances change that indicate goodwill may be impaired.
Goodwill is tested for impairment at the reporting unit level. A reporting unit
is an operating segment or one level below an operating segment (also known as a
component).



In testing goodwill for impairment, we have the option to perform a qualitative
assessment to determine whether the existence of events or circumstances
indicate that it is more-likely-than-not (more than 50%) that the fair value of
a reporting unit is less than its carrying amount. When performing a qualitative
assessment, we evaluate factors such as industry and market conditions, cost
factors, overall financial performance, and other relevant entity specific
events and changes. In the evaluation, we look at the long-term prospects for
the reporting unit and recognize that current performance may not be the best
indicator of future prospects or value, which requires management judgment.



If the qualitative assessment indicates that it is more-likely-than-not that the
fair value of the reporting unit is less than its carrying amount, or if we
choose not to perform the qualitative assessment, then a quantitative assessment
is performed to determine the reporting unit's fair value. The fair value
calculation uses a combination of income and market approaches. The income
approach is based upon projected future after-tax cash flows discounted to
present value using factors that consider the timing and risk associated with
the future after-tax cash flows. The market approach is based upon historical
and/or forward-looking measures using multiples of revenue or earnings before
interest, tax, depreciation, and amortization. We utilize a weighted average of
the income and market approaches. If the reporting unit's carrying value exceeds
its fair value, then an impairment loss is recognized for the amount of the
excess of the carrying amount over the reporting unit's fair value, not to
exceed the total amount of goodwill allocated to the reporting unit.



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Inventories



Inventories are stated at the lower of cost and net realizable value.
Determining net realizable value of inventories involves judgments and
assumptions, including projecting selling prices and cost of sales. To estimate
net realizable value, we review recent sales and gross profit history, existing
customer orders, current contract prices, industry supply and demand, forecasted
steel prices, replacement costs, seasonal factors, general economic trends, and
other information, as applicable. If future market conditions are less favorable
than those projected by us, inventory write-downs may be required. The cost of
raw material inventories of steel is either on a specific identification basis
or on an average cost basis. The cost of materially all other raw material
inventories, as well as work-in-process and supplies, is on an average cost
basis. The cost of finished goods uses the first-in, first-out method of
accounting.



Property, plant and equipment and intangible assets



Property and equipment are recorded at cost, and are depreciated using either
the units of production method or the straight-line method depending on the
classification of the asset. Depreciation expense calculated under the units of
production method may be less than, equal to, or greater than depreciation
expense calculated under the straight-line method. We evaluate historical and
projected units of production at each facility to reassess the units of
production expected on an annual basis.



Intangible assets consist primarily of customer relationships, trade names and
trademarks, patents, and backlog recorded as the result of acquisition activity.
Intangible assets are amortized using the straight-line method over estimated
useful lives.



We assess impairment of property and equipment and intangible assets whenever
changes in circumstances indicate that the carrying values of the asset or asset
group(s) may not be recoverable. The recoverable value of a long-lived asset
group is determined by estimating future undiscounted cash flows using
assumptions about our expected future operating performance. Estimates of future
cash flows used in the recoverability test incorporate our own assumptions about
the use of the asset group and shall consider all available evidence. Our
estimates of undiscounted cash flows may differ from actual cash flow due to,
among other things, technological changes, economic conditions, or changes to
our business operations. If we determine the carrying value of the property and
equipment and intangible assets will not be recoverable, we calculate and record
an impairment loss.



Share-based Compensation



We recognize the compensation cost of employee and director services received in
exchange for awards of equity instruments based on the grant date estimated fair
value of the awards. We estimate the fair value of restricted stock units and
performance share awards using the value of our stock on the date of grant.
Share-based compensation cost is recognized over the period during which the
employee or director is required to provide service in exchange for the award
and, as forfeitures occur, the associated compensation cost recognized to date
is reversed. For awards with performance-based payout conditions, we recognize
compensation cost based on the probability of achieving the performance
conditions, with changes in expectations recognized as an adjustment to earnings
in the period of change. Any recognized compensation cost is reversed if the
conditions are ultimately not met.



Income Taxes



Income taxes are recorded using an asset and liability approach that requires
the recognition of deferred income tax assets and liabilities for the expected
future tax consequences of events that have been recognized in our Consolidated
Financial Statements or income tax returns. Valuation allowances are established
when necessary to reduce deferred income tax assets to the amount expected to be
realized. The determination of our provision for income taxes requires
significant judgment, the use of estimates, and the interpretation and
application of complex tax laws. Our provision for income taxes primarily
reflects a combination of income earned and taxed in the various United States
federal, state, local, and to a lesser extent, foreign jurisdictions.
Jurisdictional tax law changes, increases or decreases in permanent differences
between book and tax items, accruals or adjustments of accruals for unrecognized
income tax benefits or valuation allowances, and our change in the mix of
earnings from these taxing jurisdictions all affect the overall effective income
tax rate.



We record income tax reserves for federal, state, local, and international
exposures relating to periods subject to audit. The development of reserves for
these exposures requires judgments about tax issues, potential outcomes and
timing, and is a subjective estimate. We assess our income tax positions and
record income tax benefits for all years subject to examination based upon
management's evaluation of the facts, circumstances, and information available
at the reporting dates. For those income tax positions where it is
more-likely-than-not that an income tax benefit will be sustained, we have
recorded the largest amount of income tax benefit with a greater than 50%
likelihood of being realized upon settlement with a tax authority that has full
knowledge of all relevant information. For those income tax positions where it
is not more-likely-than-not that an income tax benefit will be sustained, no
income tax benefit has been recognized in the Consolidated Financial Statements.



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Contents

Allowance for doubtful accounts



We maintain allowances for estimated losses resulting from the inability of our
customers to make required payments or from contract disputes. The amounts of
such allowances are based on historical experience and management's judgment.
The extension and revision of credit is determined by obtaining credit rating
reports or financial information on the customer. An allowance is recorded based
on a variety of factors, including our historical collection experience and our
historical product quality claims. At least monthly, we review past due balances
to identify the reasons for non-payment. We will write down or write off a
receivable account once the account is deemed uncollectible for reasons such as
customer quality claims, a contract dispute, deterioration in the customer's
financial position, a bankruptcy filing, or other events. If the customer's
financial conditions were to deteriorate resulting in their inability to make
payments, or if contract disputes were to escalate, additional allowances may
need to be recorded which would result in additional expenses being recorded for
the period in which such determination was made.

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