Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risks from adverse changes in interest rates and nickel prices.
Changes in United States interest rates affect the interest earned on the Company's cash and cash equivalents as well as interest paid on its indebtedness. Except as described below, the Company does not engage in speculative or leveraged transactions, nor does it hold or issue financial instruments for trading purposes. The Company is exposed to changes in interest rates primarily as a result of its borrowing activities used to maintain liquidity and fund business operations.
Fair value of the Company's debt obligations as of December 31, 2020, which approximated the recorded value, consisted of:
• $49.0 million under a revolving line of credit with an availability of $11.0 million, maturing December 20, 2021 with a variable interest rate of 1.81 percent;
• $12.3 million under a term loan, maturing February 1, 2024 with a variable interest rate of 2.06 percent; and
• An interest rate swap contract with a notional amount of $3.8 million which fixes the term loan interest rate at 3.74 percent. The fair value of the interest rate swap contract was a liability to the Company of $45,041.
On January 15, 2021, the Company and its subsidiaries entered into a new Credit Agreement with BMO Harris Bank N.A. providing the Company with a new four-year revolving credit facility. See Note 18 for additional details on this new agreement.
The Company occasionally hedges its nickel exposure to provide coverage against extreme downside product pricing exposure related to the content of nickel alloy contained in purchased stainless steel inventory. The sales price of stainless steel product (containing nickel alloy) is subject to a variable pricing component for alloys (nickel, chrome, molybdenum and iron) contained in the product. As of December 31, 2020, the Company had no such hedge contracts in place.
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Management's Annual Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control involves maintaining records that accurately represent our business transactions, providing reasonable assurance that receipts and expenditures of Company assets are made in accordance with management authorization and providing reasonable assurance that unauthorized acquisition, use or disposition of Company assets that could have a material effect on our financial statements would be detected or prevented on a timely basis.
Because of innate limitations, internal control over our financial statements is not intended to provide absolute guarantee that a misstatement can be detected or prevented in the statements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies may deteriorate.
Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 COSO framework). A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Based on this evaluation, and those criteria, the Company's CEO and CFO concluded that the Company's internal control over financial reporting was effective as of December 31, 2020.
This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit us to provide only management's report in this Annual Report as a non-accelerated filer.
Changes in Internal Control Over Financial Reporting
Other than the actions taken as described below under "Remediation Efforts to Address Material Weakness," there were no changes in the Company's internal control over financial reporting during the fourth quarter of 2020, which were identified in connection with management's evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Remediation Efforts to Address Material Weakness
In response to the material weakness identified in Management’s Report on Internal Control Over Financial Reporting as set forth in item 4 “Controls and Procedures” in the second quarter 2020 Form 10-Q filing, management, with oversight from the Audit Committee of the Board of Directors, developed and fully executed a plan to remediate the material weakness at Synalloy. The remediation actions included the following:
• Conducted executive coaching and mentoring sessions with select executives to reinforce their responsibility in maintaining effective internal control over financial reporting;
• Performed activities to identify, evaluate, and align job descriptions with job responsibilities;
• Reaffirmed communication protocols and refreshed policies related to the transition process for new finance executives and Audit Committee members; and
• Implemented an independent third-party Ethics and Compliance Hotline service for the receipt and timely reporting to the Audit Committee.
During our fourth fiscal quarter of 2020, we completed our testing of the operating effectiveness of the controls and found them to be effective. As a result, we have concluded the material weakness has been remediated as of December 31, 2020.
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Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Synalloy Corporation:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Synalloy Corporation and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations and comprehensive loss, shareholders’ equity, and cash flows for the years then ended, and the related notes and financial statement Schedule II (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Earn-out liabilities
As discussed in Notes 1 and 3 to the consolidated financial statements, the Company has recorded a liability for the quarterly earn-out payments to be made to the previous owners of acquired businesses, which included MUSA-Galvanized and ASTI. The earn-out payments are based on actual revenues earned over the respective earn-out periods pursuant to the asset purchase agreements. The fair value of the earn-out liabilities was estimated by applying the probability-weighted expected return method using management’s revenue projections, which required an estimation of pounds to be shipped and future price per unit. The fair value of the earn-out liabilities as of December 31, 2020 was $3.7 million, of which $3.3 million related to the MUSA-Galvanized and ASTI acquisitions. The liabilities are classified as Level 3 in the fair value hierarchy.
We identified the earn-out liabilities for the MUSA-Galvanized and ASTI acquisitions as a critical audit matter. Significant auditor judgment was required in evaluating management’s revenue projections used in the fair value estimation of the related earn-out liabilities due to the unobservable nature of management’s projections of pounds to be shipped and the future price per unit.
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The following are the primary procedures we performed to address this critical audit matter. We compared the Company’s historical revenue forecasts to actual results to assess the Company’s ability to accurately forecast and we performed sensitivity analyses over the Company’s revenue projections (pounds and price) to assess the impact on the Company’s determination of the fair value of the earn-out liabilities. We involved valuation professionals with specialized skills and knowledge, who utilized third-party market research tools to assist in the evaluation of the revenue projections by comparing third-party market data to the Company’s revenue projections.
/s/ KPMG LLP
We have served as the Company’s auditor since 2015.
Richmond, Virginia
March 9, 2021
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