Notes to Consolidated Financial Statements

(Unaudited)

NOTE A – Basis of Presentation

The unaudited consolidated financial statements include the accounts of Worthington Industries, Inc. and consolidated subsidiaries (collectively, “we,” “our,” “Worthington,” or the “Company”).  They have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and 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.  

At February 29, 2020, the Company owned 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”) (63%), and Worthington Specialty Processing (“WSP”) (51%).  These joint ventures are consolidated in the Company’s financial statement, and the equity owned by the other joint venture members shown as noncontrolling interests in our consolidated balance sheets, and their portions of net earnings and other comprehensive income (“OCI”) shown as net earnings or comprehensive income attributable to noncontrolling interests in our consolidated statements of earnings and consolidated statements of comprehensive income, respectively.  Investments in unconsolidated affiliates are accounted for using the equity method.  See further discussion on unconsolidated affiliates in “NOTE C – Investments in Unconsolidated Affiliates”.  As more fully described in “NOTE P – Acquisitions,” 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.  The transaction resulted in a one-time net pre-tax gain of $6,055,000 within miscellaneous income in our consolidated statement of earnings for the three and nine months ended February 29, 2020.

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.  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 and significant intercompany accounts and transactions have been eliminated.

Operating results for the three and nine months ended February 29, 2020 are not necessarily indicative of the results that may be expected for the fiscal year ending May 31, 2020 (“fiscal 2020”), particularly in light of the novel coronavirus (“COVID-19”) and its effects on the domestic and global economies. To limit the spread of COVID-19, governments have taken various actions including the issuance of stay-at-home orders and social distancing guidelines, causing  some businesses to suspend operations and a reduction in demand for many products from direct or ultimate customers.  Accordingly, businesses have adjusted, reduced or suspended operating activities.  This has negatively impacted several of the markets we serve, including the North American automotive market, which shut down production in mid-March 2020.  While a number of our plants are operating as essential businesses, some of our plants have suspended or cut back on operating levels and shifts, and additional suspensions and cutbacks may occur as the impacts from COVID-19 and related responses continue to develop.  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, 2019 (“fiscal 2019”) of Worthington Industries, Inc. (the “2019 Form 10-K”) and “Part II – Item 1A – Risk Factors” of this 10-Q.

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 C – Investments in Unconsolidated Affiliates”.

The Company’s contribution to the Cabs joint venture consisted of the net assets of its two primary manufacturing facilities located in Greeneville, Tennessee and Watertown, South Dakota.  In anticipation of the transaction for substantially all the net assets of the Engineered Cabs business, an impairment charge of $35,194,000 was recognized when the disposal group met the criteria as assets held for sale as of August 31, 2019.  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.  The Company is in the process of evaluating strategic alternatives for the retained assets.  Refer to “NOTE E – Impairment of Goodwill and Long-Lived Assets” for additional information.

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Upon closing of the transaction, the contributed net assets were deconsolidated, resulting in a one-time net gain of $50,000 within restructuring and other expense (income), net in our consolidated statements of earnings for the three months ended November 30, 2019, as summarized below.

  In accordance with the applicable accounting guidance, our minority ownership interest in the Cabs joint venture was recorded at fair value as of the closing date.  The Company’s estimate of fair value was based on a preliminary valuation of the net assets of the Cabs joint venture.  For additional information regarding the fair value of our minority ownership interest in the Cabs joint venture, refer to “NOTE R – Fair Value”.

Recently Adopted Accounting Standards

On June 1, 2019, the Company adopted Accounting Standards Update 2016-02, Leases (“Topic 842”), which replaces most existing lease accounting guidance under U.S. GAAP.  See “NOTE D – Leases” for additional information regarding the Company’s adoption of Topic 842, including newly-required disclosures. 

On June 1, 2019, the Company adopted ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (“Topic 815”), which amended the existing hedge accounting guidance under U.S. GAAP.  The ASU is intended to simplify and clarify the accounting and disclosure requirements for hedging activities by more closely aligning the results of cash flow and fair value hedge accounting with the underlying risk management activities.  The adoption of the standard had no current or historical impact on our consolidated financial position or results of operations.   See “NOTE Q – Derivative Instruments and Hedging Activities” for additional information.

Recently Issued Accounting Standards

In June 2016, amended accounting guidance was issued related to the measurement of credit losses on financial instruments. The amended accounting guidance changes the impairment model for most financial assets to require measurement and recognition of expected credit losses for financial assets held.  The amended accounting guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.  We are in the process of evaluating the effect this amended accounting guidance will have on our consolidated financial position and results of operations; however, we do not expect the amended accounting guidance to have a material impact on our ongoing financial reporting.  

Reclassification

Certain prior period amounts have been reclassified within the operating section of the consolidated statements of cash flows for consistency with the current period presentation.

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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 stream, which are recognized over time.  The following table summarizes the over time revenue for the periods presented:

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

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NOTE C – 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 February 29, 2020, the Company held investments in the following affiliated companies:  ArtiFlex Manufacturing, LLC (“ArtiFlex”) (50%), Clarkwestern Dietrich Building Systems LLC (“ClarkDietrich”) (25%), Serviacero Planos, S. de R. L. de C.V. (“Serviacero Worthington”) (50%), Worthington Armstrong Venture (“WAVE”) (50%) and the Cabs joint venture (20%).  

During the first quarter of fiscal 2020, the Company began the process of exploring the potential exit of its interest in the Nisshin joint venture in China.  As a result, the Company evaluated its investment for potential impairment.  The Company concluded the remaining book value of the investment was fully impaired, resulting in an impairment charge of $4,236,000 within equity income during 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, the Company has no further rights or obligations related to the Nisshin joint venture.

During the second quarter of fiscal 2020, the Company’s exploration of strategic alternatives relating to its investment in ArtiFlex resulted in the need to evaluate this investment for potential impairment.  Based on the analysis performed, the Company concluded its investment was not impaired, as then current and projected cash flows were deemed sufficient to recover the remaining book value of $54,566,000.  However, it is possible the Company’s estimate of future cash flows could decline to a level that no longer supports the current book value of the investment.  Factors which could have an adverse impact on the current cash flow projections, include, but are not limited to deteriorating market conditions as well as potential outcomes that may result from management’s review of strategic alternatives.  

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 contributions to the Cabs joint venture consisted of the net assets of its primary 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.

On December 31, 2019, the Company contributed the recently acquired operating net assets related to Heidtman Steel Products, Inc.’s Cleveland facility (“Heidtman”) to the Samuel joint venture in exchange for an incremental 31.75% ownership interest in the Samuel joint venture, bringing our total ownership interest to 63%.  The Samuel joint venture’s results have been consolidated within Steel Processing since that date.  Refer to “NOTE P – Acquisitions” for additional information.

We received distributions from unconsolidated affiliates totaling $78,321,000 during the nine months ended February 29, 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 $95,291,000 at February 29, 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 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.

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

The amounts presented within the discontinued operations captions in the tables above reflect the international operations of our WAVE joint venture prior to their sale on September 30, 2019.  Upon closing of the transaction, the related net assets were deconsolidated resulting in a pre-tax gain within net earnings from discontinued operations of $46,238,000, which is subject to certain post-closing adjustments. The sale of these operations was closed as 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.   Our portion of the net gain was $23,119,000 and has been recognized within equity in net income of unconsolidated affiliates.  The Company corrected certain amounts in the above table during the quarter ended February 29, 2020, to reflect the international operations of our WAVE joint venture within discontinued operations prior to their sale on September 30, 2019.  Those amounts were previously included in net sales, gross margin, operating income, and income tax expense for the three month and year-to-date periods ended February 28, 2019, August 31, 2019, and November 30, 2019.  Additionally, the Company reclassified to discontinued operations $50,948,000 for the gain related to the sale of the WAVE international operations that was previously reported in net earnings from continuing operations for the three and six month periods ended November 30, 2019.  The amounts reported in our consolidated financial statements were not impacted.

Worthington has invested and continues to invest in other companies which are generally pursuing innovative products.  The amount invested by Worthington in these companies is generally smaller and accounted for using the cost method.  One of these investments is in Nikola Corporation, a designer and manufacturer of electric and hydrogen trucks and powertrains, in which the Company owns approximately a 5-6% interest.   

NOTE D – Leases

On June 1, 2019, the Company adopted the new lease accounting standard under U.S. GAAP, Topic 842, which among other things, requires right-of-use (“ROU”) assets and liabilities be recognized upon lease commencement for operating leases based on the present value of lease payments over the lease term.  Topic 842 was adopted using the modified retrospective approach as of the effective date of the new standard.  As such, comparative financial information for reporting periods beginning prior to June 1, 2019,

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has not been restated and continues to be reported under the previous accounting standard.   As allowed, we elected to carry forward the historical lease classification and to apply the short-term lease measurement and recognition exemption whereby ROU assets and lease liabilities are not recognized for short-term leases.  Adoption of the new standard resulted in the recognition of $42,200,000 of net operating lease ROU assets and $43,400,000 of corresponding operating lease liabilities.  The net ROU asset includes the effect of reclassifying deferred rent as an offset in accordance with the transition guidance.  The impact of the new standard was immaterial to the Company’s results of operations and cash flows.  

The Company determines if an arrangement is a lease at inception.  Operating lease ROU assets include any initial direct costs and prepayments less lease incentives.  Lease terms include options to renew or terminate the lease when it is reasonably certain the Company will exercise such options.  As most of our leases do not include an implicit rate, we use our collateralized incremental borrowing rate based on the information available at the lease commencement date, in determining the present value of lease payments.  Operating lease expense is recognized on a straight-line basis over the lease term and is included in cost of goods sold or selling, general and administrative expense depending on the underlying nature of the leased assets.  

We lease certain property and equipment from third parties under non-cancellable operating lease agreements.  Certain lease agreements provide for payment of property taxes, maintenance and insurance by the Company.  Under Topic 842, we elected the practical expedient to account for lease and non-lease components as a single component for all asset classes.  Certain leases include variable lease payments based on usage or an index or rate.  

During the second quarter of fiscal 2020, we entered into a non-cancellable financing lease agreement for land and a building which was paid as part of the cash consideration in connection with the acquisition of certain operating assets of Heidtman.  Refer to “NOTE P – Acquisitions” for additional information.  In the consolidated balance sheets, the financing lease ROU assets are recorded in other assets and the current and long-term portion of the financing lease ROU liabilities are recorded in other accrued items and other liabilities, respectively.

The components of lease expense were as follows:

During the first quarter of fiscal 2020, ROU assets within the Engineered Cabs operating segment with a book value of $4,843,000 were deemed to be fully impaired and written off.  Refer to “NOTE E – Impairment of Goodwill and Long-Lived Assets” for additional information.

Other information related to the Company’s leases, as of and for the nine-month period ended February 29, 2020, is provided below:

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Future minimum lease payments for non-cancelable leases having an initial or remaining term in excess of one year at February 29, 2020, were as follows:

As previously disclosed in our 2019 Form 10-K, under the prior accounting guidance, future minimum lease payments for non-cancelable operating leases having an initial or remaining term in excess of one year at May 31, 2019, were as follows:

NOTE E – Impairment of Goodwill and Long-Lived Assets

Fiscal 2020:  

On February 12, 2020, the Company announced a plan to consolidate its oil & gas equipment manufacturing operations in Wooster, Ohio, into its existing manufacturing facility in Bremen, Ohio.  The closure is expected to be complete by the end of fiscal 2020.  As a result, the Company tested the long-lived assets of the combined asset group, consisting of fixed assets and customer list intangible assets with net book values of $14,274,000 and $6,577,000, respectively, for impairment. The book value of the fixed assets was determined to be in excess of fair value, resulting in an impairment charge of $4,679,000 during the third quarter of fiscal 2020.  Additionally, the customer list intangible assets were deemed to be fully impaired and written off. Fair value of the fixed assets was determined using observable Level 2 inputs and the fair value of the customer list intangible assets was determined using unobservable Level 3 inputs.  The land and building of the Wooster facility met the criteria for classification as assets held for sale and, accordingly, have been presented separately as assets held for sale in our consolidated balance sheet.  

As a result of the impairment charges noted above, the Company also performed an interim goodwill impairment test of its oil & gas equipment reporting unit.  The results of the analysis indicated that the fair value of the reporting unit no longer supported the book value of the corresponding goodwill, resulting in an impairment charge of $22,097,000 during the third quarter of fiscal 2020.  The key assumptions used in the fair value calculation were projected cash flows and the discount rate, which represent unobservable, Level 3 inputs.  

During the third quarter of fiscal 2020, the Company’s consolidated joint venture, WSP committed to a plan to sell the Canton, Michigan facility and some of the production equipment at that facility.  The land and building related to the facility were determined to not be impaired and the book value of $6,312,000 has been presented separately as assets held for sale in the consolidated balance sheet.  The production equipment was determined to be below fair market value therefore, the net assets were written down to their estimated fair value less cost to sell of $700,000 (determined using Level 2 inputs), resulting in an impairment charge of $1,274,000.  These assets have also been presented separately as assets held for sale in the consolidated balance sheet at February 29, 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 of August 31, 2019, the disposal group met the criteria for classification as assets held for sale and the net assets were

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recorded at the lower of net book value or fair value, less costs to sell, and presented separately as assets held for sale in our consolidated balance sheet.  The book value of the disposal group exceeded its estimated fair market value of $12,860,000 (determined using Level 2 inputs), which resulted in the recording of a $35,194,000 impairment charge during the first quarter of fiscal 2020.  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.  On November 1, 2019, the assets of the disposal group were contributed to the Cabs joint venture.  For additional information, refer to “NOTE C – Investments in Unconsolidated Affiliates”.  The Company also identified an impairment indicator for the long-lived assets of the Engineered Cabs fabricated products business as the sale will have an adverse impact on the manner and extent in which the remaining assets are 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 ended August 31, 2019.      

NOTE F – Restructuring and Other Expense (Income), 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 (income), net financial statement caption, in our consolidated statement of earnings is summarized below for the period presented:

During the nine months ended February 29, 2020, the following actions were taken related to the Company’s restructuring activities:

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The total liability associated with our restructuring activities as of February 29, 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.  During the third quarter of fiscal 2020, a favorable adjustment was recorded related to lower than expected freight.   

A progression of the liabilities recorded in connection with this matter during fiscal 2020 is summarized in the following table:

We believe these liabilities are sufficient to absorb our remaining direct costs related to the replacement program, which are expected to be paid in the next twelve months.  The actual costs 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.  However, as of February 29, 2020, we were party to an operating lease for an aircraft in which we have guaranteed a residual value at the termination of the lease. The maximum obligation under the terms of this guarantee was approximately $6,667,000 at February 29, 2020.  Based on current facts and circumstances, we have estimated the likelihood of payment pursuant to this guarantee is not probable and, therefore, no amount has been recognized in our consolidated financial statements.

We also had in place $15,300,000 of outstanding stand-by letters of credit issued to third-party service providers at February 29, 2020.  No amounts were drawn against these stand-by letters of credit at February 29, 2020.

NOTE I – Debt and Receivables Securitization

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 issuance costs of $134,000 were incurred in connection with the issuance of the Senior Notes and have been recorded on the consolidated balance sheet within long-term debt as a contra-liability.  They will continue to be amortized, through interest expense, in our consolidated statements of earnings over the term of the respective Senior Notes.  The unamortized portion of the debt issuance costs was $128,000 at February 29, 2020.

The Senior Notes were issued in a private placement and the proceeds thereof were used to redeem $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 on extinguishment of debt of $4,034,000, which has been presented separately in our consolidated statements of earnings.

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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 outstanding under the Credit Facility at February 29, 2020.  As discussed in “NOTE H – Guarantees,” we provided $15,300,000 in stand-by letters of credit for third-party beneficiaries as of February 29, 2020.  While not drawn against at February 29, 2020, $450,000 of these letters of credit were issued against availability under the Credit Facility, leaving $499,550,000 available at February 29, 2020.

We also maintain a revolving trade accounts receivable securitization facility (the “AR Facility”). On January 13, 2020, the Company extended the maturity of the AR Facility by one year to January 2021 and reduced the borrowing capacity from $50,000,000 to $10,000,000.  Pursuant to the terms of the AR Facility, certain of our subsidiaries sell their accounts receivable without recourse, on a revolving basis, to Worthington Receivables Corporation (“WRC”), a wholly-owned, consolidated, bankruptcy-remote subsidiary.  In turn, WRC may sell without recourse, on a revolving basis, up to $10,000,000 of undivided ownership interests in this pool of accounts receivable to a third-party bank.  We retain an undivided interest in this pool and are subject to risk of loss based on the collectability of the receivables from this retained interest.  Because the amount eligible to be sold excludes receivables more than 90 days past due, receivables offset by an allowance for doubtful accounts due to bankruptcy or other cause, concentrations over certain limits with specific customers and certain reserve amounts, we believe additional risk of loss is minimal.  As of February 29, 2020, no undivided ownership interests in this pool of accounts receivable had been sold.