WOR Worthington Enterprises Inc

CONDENSED Notes to Consolidated Financial Statements

(Unaudited)

NOTE A – Basis of Presentation

The consolidated financial statements include the accounts of Worthington Industries, Inc. and consolidated subsidiaries (collectively, “we,” “our,” “Worthington,” or the “Company”).  Investments in unconsolidated affiliates are accounted for using the equity method.  Significant intercompany accounts and transactions have been eliminated.

The Company owns controlling interests in the following four joint ventures: Spartan Steel Coating, LLC (“Spartan”) (52%), TWB Company, L.L.C. (“TWB”) (55%), Worthington Samuel Coil Processing LLC (“Samuel” or “Samuel joint venture”) (63%), and Worthington Specialty Processing (“WSP”) (51%).  These joint ventures are consolidated with the equity owned by the other joint venture members shown as noncontrolling interests in our consolidated balance sheets, and their portions of net earnings (loss) and other comprehensive income (loss) (“OCI”) shown as net earnings or comprehensive income attributable to noncontrolling interests in our consolidated statements of earnings (loss) and consolidated statements of comprehensive income (loss), respectively.  Investments in unconsolidated affiliates are accounted for using the equity method.  See further discussion of our unconsolidated affiliates in “NOTE D – Investments in Unconsolidated Affiliates”.  On December 31, 2019, we acquired an additional 31.75% interest in Samuel, increasing our ownership to a 63% controlling interest, with Samuel’s results being consolidated within the Steel Processing operating segment since the acquisition date.  

These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the United States Securities and Exchange Commission (the “SEC”).  Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements.  In the opinion of management, all adjustments, which are of a normal and recurring nature except those which have been disclosed elsewhere in this Quarterly Report on Form 10-Q, necessary for a fair presentation of the consolidated financial statements for these interim periods, have been included.  Operating results for the three months ended August 31, 2020 are not necessarily indicative of the results that may be expected for the fiscal year ending May 31, 2021 (“fiscal 2021”). For further information, refer to the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the fiscal year ended May 31, 2020 (“fiscal 2020”) of Worthington Industries, Inc. (the “2020 Form 10-K”).

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes.  Actual results could differ from those estimates.

Deconsolidation of Engineered Cabs:  On November 1, 2019, we closed on an agreement with an affiliate of Angeles Equity Partners, LLC by which we contributed substantially all of the net assets of the Company’s Engineered Cabs business to a newly-formed joint venture, Taxi Workhorse Holdings, LLC (the “Cabs joint venture”), in which the Company retained a 20% noncontrolling interest.  Immediately following the contribution, the Cabs joint venture acquired the net assets of Crenlo Cab Products, LLC (“Crenlo”).  The investment in the Cabs joint venture is accounted for under the equity method, due to lack of control as more fully described in “NOTE D – Investments in Unconsolidated Affiliates”.

The Company’s contribution to the Cabs joint venture consisted of the net assets of our primary Engineered Cabs manufacturing facilities located in Greeneville, Tennessee and Watertown, South Dakota.  As a result of the contribution, an impairment charge of $35,194,000 was recognized during the first quarter of fiscal 2020 when the disposal group met the criteria as assets held for sale.  Certain non-core assets of the Engineered Cabs business, including the fabricated products facility in Stow, Ohio, and the steel packaging facility in Greensburg, Indiana, were retained.  Refer to “NOTE E – Impairment of Long-Lived Assets” for additional information on the retained assets.

Upon closing of the transaction, the contributed net assets were deconsolidated, resulting in a net gain of $258,000 during fiscal 2020, as summarized below:

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Recently Adopted Accounting Standards

On June 1, 2020, the Company adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326):  Measurement of Credit Losses on Financial Instruments and additional related ASUs which introduced an expected credit loss model for impairment of financial assets measured at amortized cost, including trade receivables.  The model replaces the probable, incurred loss model for those assets and broadens the information an entity must consider when developing its expected credit loss estimate for assets measured at amortized cost.  The adoption of the new accounting standard did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.  Additionally, there have been no changes to our significant accounting policies as disclosed in our 2020 Form 10-K as a result of the adoption of this new accounting guidance.

We recognize revenue at a point in time, with the exception of the toll processing revenue stream and certain contracts within the oil & gas equipment revenue streams, which are recognized over time. The following table summarizes the over time revenue for the periods presented:

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The following table summarizes the unbilled receivables and contract assets for the periods indicated:

The Company has elected the optional exemption, which allows for the exclusion of the amounts for remaining performance obligations that are part of contracts with an expected duration of one year or less.  There are no unsatisfied or partially satisfied performance obligations related to contracts with an expected duration greater than one year.

NOTE C – Investment in Nikola

On June 3, 2020 (the “Effective Date”), Nikola Corporation (“Nikola”) became a public company through a reverse merger with a subsidiary of VectoIQ Acquisition Corporation, a NASDAQ listed publicly traded company.  At the Effective Date, the Company owned 19,048,020 shares of Nikola common stock.  During the first quarter of fiscal 2021, the Company recognized a $796,141,000 pre-tax gain consisting of $508,511,000 of realized gains from the sale or contribution of 12,000,000 of its Nikola shares, and an unrealized mark-to-market gain of $287,630,000 related to the shares the Company continues to own.  The Company also recognized in operating income $49,511,000 of incremental expenses related to the Nikola gains, $28,858,000 for discretionary profit sharing and bonus expenses and $20,653,000 for the contribution of 500,000 shares of Nikola common stock to the Worthington Industries Foundation to establish a charitable endowment focused on the communities in which it operates.  The 7,048,020 shares of Nikola common stock that the Company continues to own are subject to a lock-up agreement that restricts our ability to sell, transfer or otherwise monetize these shares until early December 2020.  Going forward, the value of these shares will change according to the fluctuations in the market price of the stock and the change in fair value of this investment will be reflected in the statement of earnings as an unrealized gain or loss.  

NOTE D – Investments in Unconsolidated Affiliates

Investments in affiliated companies that we do not control, either through majority ownership or otherwise, are accounted for using the equity method.  At August 31, 2020, the Company held investments in the following affiliated companies:  ArtiFlex Manufacturing, LLC (“ArtiFlex”) (50%), the Cabs joint venture (20%), Clarkwestern Dietrich Building Systems LLC (“ClarkDietrich”) (25%), Serviacero Planos, S. de R. L. de C.V. (“Serviacero Worthington”) (50%), and Worthington Armstrong Venture (“WAVE”) (50%).

During the first quarter of fiscal 2020, the Company began the process of exploring the potential exit of its ownership interest in Nisshin, its former joint venture in China.  As a result, the Company evaluated its investment for potential impairment and concluded the remaining book value of the investment was fully impaired, resulting in an impairment charge of $4,236,000 within equity in net income of unconsolidated affiliates in our consolidated statement of loss for the three months ended August 31, 2019.  On December 19, 2019, the Company finalized an agreement to transfer the risks and rewards related to its 10% interest to the other joint venture partners. As a result, from that point on the Company has no further rights or obligations related to the Nisshin joint venture.

On December 31, 2019, the Company contributed the operating net assets, excluding working capital, of its Cleveland facility, (which the Company had previously acquired on October 7, 2019 from Heidtman Steel Products, Inc.) to the Samuel joint venture in exchange for an incremental 31.75% ownership interest in the joint venture.  This increased our total ownership interest to 63% and the joint venture’s results have been consolidated within Steel Processing since that time.  

On November 1, 2019, we closed on an agreement with an affiliate of Angeles Equity Partners, LLC by which we contributed substantially all of the net assets of our Engineered Cabs business to a newly-formed joint venture, in which we retained a 20% noncontrolling interest.  Immediately following the contribution, the Cabs joint venture acquired the net assets of Crenlo.  Our contribution to the Cabs joint venture consisted of the net assets of our primary Engineered Cabs manufacturing facilities located in Greeneville, Tennessee and Watertown, South Dakota.  Our investment in the Cabs joint venture is accounted for under the equity method, due to lack of control.

We received distributions from unconsolidated affiliates totaling $16,877,000 during the three months ended August 31, 2020.  We have received cumulative distributions from WAVE in excess of our investment balance, which resulted in an amount recorded within other liabilities on our consolidated balance sheets of $101,865,000 at August 31, 2020.  In accordance with the applicable accounting guidance, we reclassified the negative investment balance to the liabilities section of our consolidated balance sheet.  We will continue to record our equity in the net income of WAVE as a debit to the investment account, and if the investment balance becomes positive, it will again be shown as an asset on our consolidated balance sheet.  If it becomes probable that any excess

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distribution may not be returned (upon joint venture liquidation or otherwise), we will recognize any negative investment balance classified as a liability as income immediately.

We use the “cumulative earnings” approach for determining cash flow presentation of distributions from our unconsolidated joint ventures.  Distributions received are included in our consolidated statements of cash flows as operating activities, unless the cumulative distributions received, less distributions received in prior periods that were determined to be returns of investment, exceed our portion of the cumulative equity in the net earnings of the joint venture, in which case the excess distributions are deemed to be returns of the investment and are classified as investing activities in our consolidated statements of cash flows.

The following tables summarize combined financial information for our unconsolidated affiliates as of the dates, and for the periods presented:  

The amount presented within the “Net earnings from discontinued operations” caption in the table above reflects the international operations of our WAVE joint venture prior to their sale on September 30, 2019. The sale was part of a broader transaction between the joint venture partner, Armstrong World Industries, Inc. (“AWI”), and Knauf Ceilings and Holding GmbH (“Knauf”), a family-owned manufacturer of building materials headquartered in Germany.  As of August 31, 2020, WAVE has a $5,900,000 receivable from AWI ($2,950,000 of which is Worthington’s portion), related to the remaining proceeds of the sale which are subject to post-closing adjustments as provided by the purchase agreement.  In September 2020, we received a cash distribution for the full amount of the remaining proceeds of the sale.  The Company corrected certain amounts in the table above for the three months ended August 31, 2019, to reflect the international operations of our WAVE joint venture within discontinued operations prior to their sale on September 30, 2019, as those amounts were previously included in net sales, gross margin, operating income, and income tax expense.    

NOTE E – Impairment of Long-Lived Assets

Fiscal 2021:  During the first quarter of fiscal 2021, management determined indicators of impairment were present with regard to the cryogenics business primarily operated out of Theodore, Alabama with European distribution in Austria.  As a result, property, plant and equipment with a carrying value of $13,526,000 were written down to their estimated fair value of $9,193,000 (determined using Level 2 inputs), resulting in an impairment charge of $4,333,000.  Additionally, the customer list intangible assets with a carrying value of $3,662,000 were deemed to be fully impaired and written off.  The fair value of the customer list intangible assets was determined using unobservable Level 3 inputs.  

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During the first quarter of fiscal 2021, the Company decided to discontinue its operation of the manufacturing line for alternative fuel cylinders at the Jefferson, Ohio facility.  As a result, long-lived assets with a carrying value of $1,823,000 were written down to their estimated fair market value of $400,000 (determined using Level 2 inputs), resulting in an impairment charge of $1,423,000.

During the first quarter of fiscal 2021, the Company recognized a $506,000 impairment charge related to the Superior Tools business that was acquired as part of Magna Industries, Inc. in fiscal 2019 and subsequently sold.

Fiscal 2020:  During the first quarter of fiscal 2020, the Company committed to plans to sell substantially all of the net assets of its Engineered Cabs business with the exception of the fabricated products facility in Stow, Ohio, and the steel packaging facility in Greensburg, Indiana.  As the disposal group met the criteria for classification as assets held for sale as of August 31, 2019, those net assets were presented separately as assets held for sale in our consolidated balance sheet as of August 31, 2019.  In accordance with the applicable accounting guidance, such net assets were recorded at the lower of net book value or fair value less costs to sell.  The book value of the disposal group exceeded its estimated fair market value of $12,860,000 (determined using Level 2 inputs), resulting in an impairment charge of $35,194,000 during the three months ended August 31, 2019.  Included in the impairment charge were lease ROU assets with a net book value of $905,000 that were deemed fully impaired and written off.  The Company also identified an impairment indicator for the long-lived assets of the fabricated products business as the planned sale would have an adverse impact on the manner and extent in which these assets were used.  As a result, fixed assets with a net book value of $1,469,000 and lease ROU assets with a net book value of $3,938,000 were deemed to be fully impaired and written off during the first quarter of fiscal 2020.      

NOTE F – Restructuring and Other Expense, Net

We consider restructuring activities to be programs whereby we fundamentally change our operations, such as closing and consolidating manufacturing facilities or moving manufacturing of a product to another location.  Restructuring activities may also involve substantial realignment of the management structure of a business unit in response to changing market conditions.

A progression of the liabilities associated with our restructuring activities, combined with a reconciliation to the restructuring and other expense, net financial statement caption, in our consolidated statement of earnings is summarized below for the period presented:

The total liability associated with our restructuring activities as of August 31, 2020 is expected to be paid in the next twelve months.

NOTE G – Contingent Liabilities and Commitments

Legal Proceedings

We are defendants in certain legal actions.  In the opinion of management, the outcome of these actions, which is not clearly determinable at the present time, would not significantly affect our consolidated financial position or future results of operations.  We also believe that environmental issues will not have a material effect on our capital expenditures, consolidated financial position or future results of operations.

Voluntary Tank Replacement Program

In February 2019, our Structural Composites Industries, LLC subsidiary (“SCI”) agreed to participate in a tank replacement program for specific design sizes of its composite hydrogen fuel tanks, which are integrated into a customer’s hydrogen fuel cells used to fuel material handling equipment, primarily rider pallet jacks in warehouses.  As of August 31, 2020, the Company has a reserve of $4,950,000 related to this matter, which we believe is sufficient to absorb our remaining direct costs related to the replacement program.  The actual cost incurred by the Company related to this matter may vary from the initial estimate.

NOTE H – Guarantees

We do not have guarantees that we believe are reasonably likely to have a material current or future effect on our consolidated financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. We had in place $15,050,000 of outstanding stand-by letters of credit issued to third-party service providers at August 31, 2020.  No amounts were drawn against them at August 31, 2020.

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NOTE I – Debt

On August 23, 2019, two of our European subsidiaries issued a €36,700,000 principal amount unsecured 1.56% Series A Senior Note due August 23, 2031 (the “2031 Note”) and €55,000,000 aggregate principal amount of unsecured 1.90% Series B Senior Notes due August 23, 2034 (the “2034 Notes”), (collectively, the “Senior Notes”).  The 2031 Note is to be repaid in the principal amount of €30,000,000, together with accrued interest, on August 23, 2029, with the remaining €6,700,000 principal amount payable on August 23, 2031, together with accrued interest.  The 2034 Notes are to be repaid in the aggregate principal amount of €23,300,000, together with accrued interest, on August 23, 2031, with the remaining €31,700,000 aggregate principal amount payable on August 23, 2034, together with accrued interest.  Debt issue costs of $134,000 were incurred in connection with the issuance of the Senior Notes and have been recorded on the consolidated balance sheets within long-term debt as a contra-liability.  They will be amortized, through interest expense, in our consolidated statements of earnings (loss) over the term of the respective Senior Notes.  The unamortized portion of the debt issuance costs was $123,000 at August 31, 2020.

The Senior Notes were issued in a private placement and the proceeds thereof were used in the redemption of $150,000,000 aggregate principal amount of unsecured 6.50% senior notes that were set to mature on April 15, 2020 (the “2020 Notes”).  The 2020 Notes were redeemed in full on August 30, 2019.  In connection with the early redemption, the Company recognized a loss of $4,034,000, which has been presented separately in our consolidated statements of earnings (loss).

We maintain a $500,000,000 multi-year revolving credit facility (the “Credit Facility”) with a group of lenders which matures in February 2023.  Borrowings under the Credit Facility have maturities of up to one year.  We have the option to borrow at rates equal to an applicable margin over the LIBOR, Prime Rate or Overnight Bank Funding Rate.  The applicable margin is determined by our credit rating.  There were no borrowings or letters of credit outstanding under the Credit Facility at August 31, 2020.

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The following tables summarize the changes in accumulated other comprehensive loss for the periods presented:

(a)  The statement of earnings (loss) classification of amounts reclassified to income include:

(1)  Foreign currency translation – result of $7,454,000 related to the sale of the cryogenics business in Turkey; and $1,042,000 related to the impairment of Nisshin, the Company’s former joint venture in China.

(2)  Pension liability adjustment – result of the settlement of certain participant balances within the pension plan maintained by WAVE.

(3)  Cash flow hedges – disclosed in “NOTE P – Derivative Instruments and Hedging Activities”.

NOTE L – Stock-Based Compensation

Non-Qualified Stock Options

During the three months ended August 31, 2020, we granted non-qualified stock options covering a total of 116,300 common shares under our stock-based compensation plans.  The weighted average option price of $36.93 per share was equal to the market price of the underlying common shares at the grant date.  The fair value of these stock options, based on the Black-Scholes option-pricing model, calculated at the grant date, was $10.43 per share.  The calculated pre-tax stock-based compensation expense for these stock options is $1,213,000 and will be recognized on a straight-line basis over the three-year vesting period, net of any forfeitures.  The following assumptions were used to value these stock options:

Expected volatility is based on the historical volatility of our common shares and the risk-free interest rate is based on the U.S. Treasury strip rate for the expected term of the stock options.  The expected term was developed using historical exercise experience.

Service-Based Restricted Common Shares

During the three months ended August 31, 2020, we granted an aggregate of 203,000 service-based restricted common shares under our stock-based compensation plans.  The fair value of these restricted common shares was equal to the closing market price of the underlying common shares on the date of grant, or $36.93 per share. The calculated pre-tax stock-based compensation expense for these restricted common shares is $7,497,000 and will be recognized on a straight-line basis over the three-year service-based vesting period.

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Market-Based Restricted Common Shares

On June 25, 2020, we granted an aggregate of 45,000 restricted common shares to three key employees under one of our stock-based compensation plans.  Vesting of these restricted common share awards is contingent upon the price of our common shares reaching $65.00 per share and remaining at or above that price for 90 consecutive days during the five-year period following the date of grant and the completion of a three-year service vesting period.  The grant-date fair value of these restricted common shares, as determined by a Monte Carlo simulation model, was $20.87 per share.  The following assumptions were used to determine the grant-date fair value and the derived service period for these restricted common shares:

The calculated pre-tax stock-based compensation expense for these restricted common shares is $939,000 and will be recognized on a straight-line basis over the three-year service vesting period.

Performance Share Awards

We have awarded performance shares to certain key employees under our stock-based compensation plans.  These performance shares are earned based on the level of achievement with respect to corporate targets for cumulative corporate economic value added, earnings per share growth and, in the case of business unit executives, business unit operating income targets for the three-year periods ending May 31, 2021, 2022 and 2023.  These performance share awards will be paid, to the extent earned, in common shares of Worthington Industries, Inc. in the fiscal quarter following the end of the applicable three-year performance period.  The fair values of our performance shares are determined by the closing market prices of the underlying common shares at the respective grant dates of the performance shares and the pre-tax stock-based compensation expense is based on our periodic assessment of the probability of the targets being achieved and our estimate of the number of common shares that will ultimately be issued.  During the three months ended August 31, 2020, we granted performance share awards covering an aggregate of 65,400 common shares (at target levels).  The calculated pre-tax stock-based compensation expense for these performance shares is $2,415,000. The ultimate pre-tax stock-based compensation expense to be recognized over the three-year performance period will vary based on our periodic assessment of the probability of the targets being achieved.

NOTE M – Income Taxes

Income tax expense for the three months ended August 31, 2020 and 2019 reflected estimated annual effective income tax rates of 21.6% and 25.1%, respectively. The annual effective income tax rates exclude any impact from the inclusion of net earnings attributable to noncontrolling interests in our consolidated statements of earnings (loss). Net earnings attributable to noncontrolling interests are primarily a result of our WSP, Spartan, Samuel and TWB consolidated joint ventures. The earnings attributable to the noncontrolling interests in WSP, Spartan, Samuel and TWB’s U.S. operations do not generate tax expense to Worthington since the investors in WSP, Spartan, Samuel and TWB’s U.S. operations are taxed directly based on the earnings attributable to them. The tax expense of TWB’s wholly-owned foreign corporations is reported in our consolidated income tax expense (benefit).  Management is required to estimate the annual effective income tax rate based upon its forecast of annual pre-tax income for domestic and foreign operations. Our actual effective income tax rate for fiscal 2021 could be materially different from the forecasted rate as of August 31, 2020.    

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