Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis summarizes the significant factors affecting our consolidated operating results, financial condition, liquidity, and capital resources during the fiscal years ended December 31, 2023 and 2022. Unless otherwise noted, all references herein for the years 2023 and 2022 represent the fiscal years ended December 31, 2023 and 2022, respectively. We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements. This discussion should be read in conjunction with our consolidated financial statements and notes to the consolidated financial statements included in this Annual Report that have been prepared in accordance with accounting principles generally accepted in the United States of America. This discussion and analysis is presented in five sections:
• Executive Overview
• Results of Operations and Non-GAAP Financial Measures
• Liquidity and Capital Resources
• Material Cash Requirements from Contractual and Other Obligations
• Critical Accounting Policies and Estimates
Executive Overview
There have been a number of strategic changes that have occurred throughout 2023, including the permanent cessation of operations and closure of the Munhall facility and the sale of substantially all of assets of Specialty Pipe & Tube, Inc. ("SPT"), which are discussed below. These strategic changes have been implemented to allow the Company to focus on core competencies that drive growth and long-term value creation for our shareholders. As a result of these decisions, Munhall and SPT results have been reclassified from the Tubular Products segment and are reflected as discontinued operations in all periods presented. The discussion and analysis of our results of operations refers to continuing operations only unless noted.
Consolidated net sales decreased 26.3%, or $68.8 million, compared to 2022 driven by decreases in average selling price and pounds shipped.
Consolidated net loss increased to $34.2 million in 2023, compared to net income of $17.6 million in 2022. Diluted loss per share increased to $3.37 for the full-year 2023 compared to diluted earnings per share of $1.69 for the full-year 2022.
For 2023, cash flows from operating activities were $6.6 million, with $2.9 million used for capital expenditures.
During the year, we also repurchased 143,108 shares for $1.3 million through our share repurchase program as part of our continued efforts to create sustainable value for our shareholders.
Munhall Closure
During the second quarter of 2023, the Board of Directors of the Company made the decision to permanently cease operations at Munhall effective on or around August 31, 2023. This strategic decision is part of the Company’s ongoing efforts to consolidate manufacturing to drive an increased focus on its core operations and to improve profitability while driving operational efficiencies. As a result of this decision, the Company incurred asset impairment charges of $8.8 million related to the write down of inventory to net realizable value and the impairment of long-lived assets as well as $2.8 million in increased reserves on accounts receivable and other current assets at the facility during the year ended December 31, 2023.
Divestiture of Specialty Pipe & Tube, Inc.
On December 22, 2023, the Company and its wholly-owned subsidiary Specialty Pipe & Tube, Inc. (“SPT”) entered into an Asset Purchase Agreement pursuant to which Ascent and SPT sold substantially all of the assets primarily related to SPT to Specialty Pipe & Tube Operations, LLC, a Delaware limited liability company. The consideration for the transaction was approximately $55 million of cash proceeds subject to certain closing adjustments. The transaction closed on December 22, 2023. The sale of SPT is a tremendous value-creating outcome for Ascent shareholders while greatly reducing the complexity associated with our tubular operations and allowing our tubular leadership and operational teams to focus on core competencies that best position the Company for long-term growth. The transaction also provided the Company the ability to significantly reduce its debt, while providing additional available capital to pursue growth opportunities within our focused businesses. The Company recognized a pre-tax gain on the sale of the SPT assets of $26.3 million.
14
Table of Contents
Goodwill Impairment Review
During the third quarter of 2023, as described in Note 1 - Summary of Significant Accounting Policies , we tested our goodwill for impairment. The Company determined potential indicators of impairment existed within the Specialty Chemicals reporting unit. Macroeconomic conditions and pressures, increased risks within the broader specialty chemicals business, reporting unit operating losses and a decline in the reporting unit's net sales compared to forecast, collectively, indicated that the reporting unit had experienced a triggering event and the need to perform a quantitative evaluation of goodwill. The Company performed a discounted cash flow analysis and a market multiple analysis for the Specialty Chemicals reporting unit to determine the reporting unit's fair value. The discounted cash flow analysis included management assumptions for expected sales growth, capital expenditures and overall operational forecasts while the market multiple analysis included historical and projected performance, market capitalization, volatility and multiples for industry peers. Determining the fair value of the reporting unit and allocation of that fair value to individual assets and liabilities within the reporting unit to determine the implied fair value of the goodwill is judgmental in nature and requires the use of significant management estimates and assumptions. Any changes in the judgments, estimates, or assumptions could produce significantly different results. As a result of the goodwill impairment evaluation, it was concluded that the estimated fair value of the Specialty Chemicals reporting unit was below its carrying value by 27.6% resulting in a goodwill impairment charge of $11.4 million for the year ended December 31, 2023.
Macroeconomic Events
We experienced challenges in 2023 related to ongoing economic factors driving volatility in global markets. Inflationary pressures have negatively impacted our revenue, operating margins and net income in 2023, including increased costs of labor, raw materials and freight. During the year, we also experienced reduced demand from inventory management measures being pursued by our customers driving reductions in volume. The ongoing factors driving volatility in global markets that could impact our business' earnings and cash flows include, but are not limited to, the misalignment of supply and demand for labor, energy, raw materials and other inputs, the inflation of (or unavailability of) raw material inputs and transportation and logistics services, currency fluctuations, rising interest rates and extreme weather, the purchasing of commodities and relative commodity prices. The Company continues efforts to offset these inflationary pressures and continues to take action to improve working capital and evaluate other opportunities to maintain and improve financial performance in the short and long term, however, if these inflationary and demand pressures continue, our revenue, gross and operating margins and net income will be impacted in 2024.
In February 2022, the United States announced targeted economic sanctions on Russia in response to the military conflict in Ukraine. This conflict and the associated sanctions have disrupted the global economy, causing heightened cybersecurity risks, supply chain challenges, higher energy costs, and an exacerbation of existing inflationary pressures. As our operations are located in North America, we have no direct exposure to Russia and Ukraine, however, we are actively monitoring the broader economic impact of the crisis, especially the potential impact on commodity and fuel prices, and the potential decreased demand for our products.
Results of Operations
Comparison of 2023 to 2022 – Consolidated
Consolidated net sales for the full-year 2023 decreased $68.8 million, or 26.3%, over the full-year 2022 to $193.2 million. The decrease in net sales was primarily driven by a 8.5% decrease in average price coupled with a 18.7% decrease in pounds shipped.
Full-year 2023 consolidated gross profit decreased 96.5% to $1.5 million, or 0.8% of sales, compared to $43.3 million, or 16.5% of sales, in the full-year 2022. The decrease in dollars and percentage of sales for the full-year 2023 were attributable to the decrease in pounds shipped and average selling price.
Consolidated selling, general and administrative expense (SG&A) for the full-year 2023 decreased $0.9 million to $26.7 million compared to $27.6 million for the full-year 2022. SG&A as a percentage of sales was 13.8% of sales for 2023 and 10.6% of sales for 2022. The changes in SG&A expense were primarily driven by:
• decrease in incentive bonus driven by lower attainment of performance goals in the current year over the prior year;
• decrease in repair and maintenance expenses; and,
15
Table of Contents
• decreases in other expenses primarily driven by decreases in salaries, wages and benefits, share-based compensation, amortization expense, bad debt expense and utilities
The full-year decreases were partially offset by:
• Increases in professional fees; and,
• Increases and taxes and licenses.
Consolidated operating loss for the full-year 2023 totaled $37.4 million compared to operating income of $14.5 million for the full-year 2022. The operating loss increase for the full-year 2023 was primarily driven by aforementioned decrease in pounds shipped and average selling price.
Comparison of 2023 to 2022 - Tubular Products
Net sales for the Tubular Products segment totaled $109.5 million for the full year of 2023, a decrease of 28.9% compared to the full-year 2022. The decrease in net sales was primarily driven by a 21.4% decrease in pounds shipped and a 9.2% decrease in average selling price.
SG&A expense decreased $0.6 million, or 7.3%, for the full-year 2023 when compared to 2022. SG&A as a percentage of sales was 6.9% of sales for 2023 and 5.3% of sales for 2022. The changes in SG&A expense were primarily driven by decreases in salaries, wages and benefits and lower travel expense partially offset by increases in taxes and licenses expense.
Operating loss for the full-year 2023 totaled $11.2 million compared to operating income of $22.2 million for the full-year 2022. The operating loss increase for the full-year 2023 was primarily driven by aforementioned decreases in pounds shipped and lower selling price as well as higher material costs.
The following table summarizes operating results for the two years indicated. Reference should be made to Note 13 to the consolidated financial statements included in Item 8 of this Form 10-K.
2023 2022
(in thousands) Amount % Amount %
Net sales $ 109,513 100.0 % $ 154,040 100.0 %
Cost of goods sold 113,187 103.4 % 123,726 80.3 %
Gross profit (3,674) (3.4) % 30,314 19.7 %
Selling, general and administrative expense
7,536 6.9 % 8,132 5.3 %
Operating (loss) income $ (11,210) (10.2) % $ 22,182 14.4 %
Comparison of 2023 to 2022 – Specialty Chemicals
Net sales for the Specialty Chemicals segment decreased 22.2%, or $23.9 million, to $83.6 million for 2023 compared to $107.5 million in 2022. The decrease in net sales was primarily driven by a 17.3% decrease in pounds shipped and a 4.3% decrease in average selling prices.
SG&A expense increased by $0.1 million, or 1.1%, to $7.0 million in 2023 compared to $6.9 million in 2022. SG&A as a percentage of sales increased to 8.3% in 2023 from 6.4% in 2022. The changes in SG&A expense were primarily driven by increases in salaries, wages and benefits and professional fees partially offset by lower incentive bonus and amortization expense.
Operating loss for the full-year 2023 totaled $12.6 million compared to operating income of $7.0 million for the full-year 2022. The increase in operating loss was primarily driven by aforementioned decreases in pounds shipped and lower selling price
16
Table of Contents
The following tables summarize operating results for the two years indicated. Reference should be made to Note 13 to the consolidated financial statements included in Item 8 of this Form 10-K.
2023 2022
(in thousands) Amount % Amount %
Net sales $ 83,616 100.0 % $ 107,542 100.0 %
Cost of goods sold 77,807 93.1 % 93,680 87.1 %
Gross profit 5,809 6.9 % 13,862 12.9 %
Selling, general and administrative expense
6,966 8.3 % 6,891 6.4 %
Acquisition costs and other 12 — % — — %
Goodwill impairment 11,389 13.6 % — — %
Operating (loss) income $ (12,558) (15.0) % $ 6,971 6.5 %
Comparison of 2023 to 2022 - Corporate
Corporate expenses decreased $1.1 million to $12.9 million in 2023 down from $13.9 million in 2022. The full-year decrease resulted primarily from decreases in salaries, wages and benefit, stock-based compensation, incentive bonuses due to lower attainment of performance goals, as well as decreases in other corporate overhead. The decreases were partially offset by increases in professional fees related to accounting, tax and other advisory related costs, taxes and licenses and insurance expenses.
Interest expense was $4.2 million and $2.7 million for the full-years of 2023 and 2022, respectively. The increase was primarily driven by higher interest rates in 2023 compared to 2022. As discussed in Note 6 , the Company used the proceeds from the SPT divestiture to prepay in full the term loan in the original principal amount of $5 million under the Company's credit facility and used the remaining proceeds to prepay in part the revolving loans under the credit facility. The Company has no debt outstanding as of December 31, 2023.
The Company's effective tax rate for 2023 was less than the U.S. statutory rate of 21% primarily driven by tax benefits associated with non-deductible goodwill impairment. The Company's effective tax rate for 2022 was less than the U.S. statutory rate of 21% primarily driven by tax benefits associated with the closure of Palmer and the release of valuation allowances on certain deferred tax assets, partially offset by state taxes.
Non-GAAP Financial Measures
To supplement our consolidated financial statements, which are prepared and presented in accordance with accounting principles generally accepted in the United States ("GAAP"), we use the following non-GAAP financial measures: EBITDA and Adjusted EBITDA. Management believes that these non-GAAP measures are useful because they are key measures used by our management team to evaluate our operating performance, generate future operating plans and make strategic decisions as well as allow readers to compare the financial results between periods. Non-GAAP measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the Company's performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company's results or financial condition as reported under GAAP.
17
Table of Contents
EBITDA and Adjusted EBITDA
We define "EBITDA" as earnings before interest, income taxes, depreciation and amortization. We define "Adjusted EBITDA" as EBITDA further adjusted for the impact of non-cash and other items we do not consider in our evaluation of ongoing performance. These items include: goodwill impairment, asset impairment, gain on lease modification, stock-based compensation, non-cash lease cost, acquisition costs and other fees, shelf registration costs, loss on extinguishment of debt, earn-out adjustments, retention costs and restructuring and severance costs from net (loss) income. We caution investors that amounts presented in accordance with our definitions of EBITDA and Adjusted EBITDA may not be comparable to similar measures disclosed by other companies because not all companies calculate EBITDA and Adjusted EBITDA in the same manner. We present EBITDA and Adjusted EBITDA because we consider them to be important supplemental measures of our performance and investors' understanding of our performance is enhanced by including these non-GAAP financial measures as a reasonable basis for comparing our ongoing results of operations.
Consolidated EBITDA and Adjusted EBITDA from continuing operations are as follows:
Year Ended December 31,
($ in thousands) 2023 2022
Consolidated
Net (loss) income from continuing operations $ (34,151) $ 17,578
Adjustments:
Interest expense 4,238 2,742
Income taxes (6,924) (5,568)
Depreciation 6,161 6,421
Amortization 1,505 1,853
EBITDA (29,171) 23,026
Acquisition costs and other 856 1,104
Shelf registration costs — 12
Goodwill impairment 11,389 —
Gain on lease modification — (2)
Stock-based compensation 594 962
Non-cash lease expense 242 414
Retention expense 26 —
Restructuring and severance costs 130 74
Adjusted EBITDA $ (15,934) $ 25,590
% sales (8.2) % 9.8 %
18
Table of Contents
Tubular Products EBITDA and Adjusted EBITDA from continuing operations are as follows:
Year Ended December 31,
($ in thousands) 2023 2022
Tubular Products
Net (loss) income from continuing operations $ (11,210) $ 22,182
Adjustments:
Depreciation 2,274 2,500
Amortization 871 951
EBITDA (8,065) 25,633
Stock-based compensation 58 46
Non-cash lease expense 118 —
Retention expense 8 —
Restructuring and severance costs 84 20
Tubular Products Adjusted EBITDA $ (7,797) $ 25,699
% of segment sales (7.1) % 16.7 %
Specialty Chemicals EBITDA and Adjusted EBITDA are as follows:
Year Ended December 31,
($ in thousands) 2023 2022
Specialty Chemicals
Net (loss) income $ (12,619) $ 6,935
Adjustments:
Interest expense 74 36
Depreciation 3,798 3,846
Amortization 634 903
EBITDA (8,113) 11,720
Acquisition costs and other 12 —
Goodwill impairment 11,389 —
Stock-based compensation 8 41
Non-cash lease expense 88 2
Restructuring and severance costs 40 8
Specialty Chemicals Adjusted EBITDA $ 3,424 $ 11,771
% of segment sales 4.1 % 10.9 %
19
Table of Contents
Liquidity and Capital Resources
We closely manage our liquidity and capital resources. Our liquidity requirements depend on key variables, including level of investment required to support our business strategies, the performance of our business, capital expenditures, credit facilities and working capital management. Capital expenditures and share repurchases are a component of our cash flow and capital.
Sources of Liquidity
Funds generated by operating activities supplemented by our available cash and cash equivalents and our credit facilities are our most significant sources of liquidity. As of December 31, 2023, we held $1.9 million of cash and cash equivalents, as well as $61.8 million of remaining available capacity on our revolving line of credit. Our existing cash, cash equivalents, and credit facilities balances may fluctuate during 2024. Cash from operations could also be affected by various risks and uncertainties detailed in Item 1A - Risk Factors of this report. We believe our sources of liquidity will be sufficient to fund operations and anticipated capital expenditures as well as repay our debt obligations as they become due over the next 12 months and beyond.
Cash Flows
Cash flows from continuing operations were as follows:
Year ended December 31,
(in thousands) 2023 2022
Total cash provided by (used in):
Operating activities 6,644 (5,262)
Investing activities (2,885) (3,295)
Financing activities (73,169) (374)
Net decrease in cash and cash equivalents $ (69,410) $ (8,931)
Operating Activities
The increase in cash provided by operating activities for the year ended December 31, 2023 compared to cash used in operating activities in the year ended December 31, 2022 was primarily driven by changes in working capital. Changes in working capital can vary significantly depending on factors such as the timing of inventory production and purchases, customer payments of accounts receivable and payments to vendors in the regular course of business. Inventory increased operating cash flows for the year ended December 31, 2023 by approximately $12.2 million compared to a decrease of approximately $13.7 million for 2022, while accounts payable increased operating cash flows by approximately $1.6 million for the year ended December 31, 2023 compared to an decrease of approximately $6.3 million for the year ended December 31, 2022. The increase in operating cash flows from inventory is primarily due to lower inventory turns year over year while the increase in accounts payable is primarily driven by a slight increase in days payables outstanding. Accounts receivable increased operating cash flow by approximately $6.8 million compared to a decrease of $0.3 million driven by lower sales in the current year partially offset by slightly higher days sales outstanding. In addition to the working capital changes, changes in income taxes increased cash flows by approximately $3.1 million compared to cash used in operations of approximately $7.9 million in 2022. This was driven by the receipt of a cash refund from the Company's 2022 tax return.
Investing Activities
Net cash used in investing activities primarily consists of transactions related to capital expenditures, proceeds from the disposal of property, plant and equipment and acquisitions. The decrease in cash used in investing activities for the full-year 2023 compared to cash used in investing activities for the full-year 2022 was primarily driven by a decrease in capital expenditures in the current year over the prior year.
Financing Activities
Net cash used in financing activities primarily consist of transactions related to our long-term debt. The increase in net cash used in financing activities for the full-year 2023 compared to the full-year 2022 was primarily due to the repayment of the Company's asset backed line of credit and delayed draw term loan in the fourth quarter of 2023 driven by the sale of substantially all of the assets of SPT.
20
Table of Contents
Short-term Debt
The Company has a note payable in the amount of $0.9 million with an annual interest rate of 3.70% maturing April 1, 2024, associated with the financing of the Company's insurance premium in the current year. As of December 31, 2023, the outstanding balance was $0.4 million.
Long-term Debt
During the fourth quarter of 2023, the Company entered into a Limited Consent, Second Amendment to Credit Agreement and Omnibus Amendment to Loan Documents with BMO Bank N.A. and the other lenders under the Company’s credit facility (the “Credit Facility Amendment”). The Credit Facility Amendment contained a consent for the SPT divestiture, released the lien on the assets of SPT and removed SPT as a loan party. The Credit Facility Amendment also reduced the maximum revolving loan commitment under the credit facility from $105 million to $80 million, and increased the interest rate for the credit facility from SOFR plus an interest rate margin of between 1.60% and 1.70% to SOFR plus an interest rate margin of between 1.85% and 2.10%, depending on average availability under the credit facility and the Company’s consolidated fixed charge coverage ratio. As required by the Credit Facility Amendment, the Company used the proceeds from the SPT divestiture to prepay in full the term loan in the original principal amount of $5 million under the credit facility and used the remaining proceeds to prepay in part the revolving loans under the credit facility.
As of December 31, 2023, the Company had no borrowings outstanding with its lender due to the repayment of the Company's asset backed line of credit and delayed draw term loan in the fourth quarter of 2023 driven by the sale of substantially all of the assets of SPT. As of December 31, 2023, the Company had $61.8 million of remaining availability under its credit facility.
The Facility contains covenants requiring the maintenance of a minimum consolidated fixed charge coverage ratio if excess availability falls below the greater of (i) $7.5 million and (ii) 10% of the revolving credit facility (currently $8.0 million). As of December 31, 2023, the Company was in compliance with all financial debt covenants. See Note 6 in the notes to the consolidated financial statements for additional information on the Company's line of credit.
Stock Repurchases and Dividends
We may repurchase common stock and pay dividends from time to time pursuant to programs approved by our Board of Directors. The payment of cash dividends is also subject to customary legal and contractual restrictions. Our capital allocation strategy is to first fund operations and investments in growth and then return excess cash over time to shareholders through share repurchases and dividends.
The share repurchase program allows for repurchase of up to 790,383 shares of the Company's outstanding common stock and expires on February 17, 2025. The shares will be purchased from time to time at prevailing market prices, through open market or privately negotiated transactions, depending on market conditions. Under the program, the purchases will be funded from available working capital, and the repurchased shares will be returned to the status of authorized, but unissued shares of common stock or held in treasury. There is no guarantee as to the exact number of shares that will be repurchased by the Company, and the Company may discontinue purchases at any time that management determines additional purchases are not warranted. As of December 31, 2023, the Company has 536,871 shares of its share repurchase authorization remaining.
Shares repurchased for the year ended December 31, 2023 and 2022 were as follows:
Year ended December 31,
2023 2022
Number of shares repurchased 143,108 110,404
Average price per share $ 8.97 $ 12.16
Total cost of shares repurchased $ 1,287,416 $ 1,345,540
At the end of each fiscal year, the Board reviews the financial performance and capital needed to support future growth to determine the amount of cash dividend, if any, which is appropriate. In 2023 and 2022, no dividends were declared or paid by the Company.
21
Table of Contents
Other Financial Measures
Below are additional financial measures that we believe are important in understanding the Company's liquidity position from year to year. The metrics are defined as:
Liquidity Measure:
• Current ratio = current asset divided by current liabilities. The current ratio will be determined by the Company using generally accepted accounting principles, consistently applied.
Leverage Measure:
• Debt to capital = Total debt divided by total capital. The debt to capital ratio will be determined by the Company using generally accepted accounting principles, consistently applied.
Profitability Ratio:
• Return on average equity ("ROAE") = net (loss) income divided by the trailing 12-month average of equity. The ROAE will be determined by the Company using generally accepted accounting principles, consistently applied.
Results of these additional financial measures are as follows:
Year ended December 31,
2023 2022
Current ratio 3.7 4.6
Debt to capital —% 49%
Return on average equity (38.6)% 29.7%
Material Cash Requirements from Contractual and Other Obligations
As of December 31, 2023, our material cash requirements for our known contractual and other obligations were as follows:
• Operating and Finance Leases - The Company enters into various lease agreements for real estate and manufacturing equipment used in the normal course of business. Operating and finance lease obligations were $32.5 million, with $1.4 million payable within 12 months. See Note 7 for further detail of our lease obligations and the timing of expected future payments.
The Company has no off-balance sheet arrangements that are reasonably likely to have a material current or future effect on the Company's financial position, revenues, results of operations, liquidity, or capital expenditures. We expect capital spending in fiscal 2024 to be as much as $6.5 million.
Critical Accounting Policies and Estimates
The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments based on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies are described in Note 1 to the consolidated financial statements included herein. We believe the following accounting policies affect the most significant estimates and management judgments used in the preparation of the Company's consolidated financial statements.
Business Combinations
Description
Business combinations are accounted for using the acquisition method of accounting in accordance with GAAP. Under this method, the total consideration transferred to consummate the business combination is allocated to the identifiable tangible and intangible assets acquired and liabilities assumed based on their respective fair values as of the closing date of the transaction.
22
Table of Contents
Judgments and uncertainties involved in the estimate
The acquisition method of accounting requires extensive use of estimates and judgments to allocate the consideration transferred to the identifiable tangible and intangible assets acquired, if any, and liabilities assumed. Fair value determinations involve significant assumptions about highly subjective variables, including future cash flows, discount rates, and expected business performance. There are also different valuation models and inputs for each component, the selection of which requires considerable judgment. Our estimates and assumptions may be based, in part, on the availability of listed market prices or other transparent market data. These determinations will affect the amount of amortization expense recognized in future periods as well the allocation of goodwill, if any, attributable to the transaction.
Effect if actual results differ from assumptions
We base our fair value estimates on assumptions we believe are reasonable, but recognize the assumptions are inherently uncertain. Depending on the size of the purchase price of a particular acquisition, the mix of intangible assets acquired and expected business performance, the purchase price allocation could be materially impacted by applying a different set of assumptions and estimates. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.
Goodwill
Description
Goodwill is the excess of the purchase price over the fair value of identifiable assets acquired, less fair value of liabilities assumed, in a business combination. The Company reviews goodwill for impairment at the reporting unit level, which is the operating segment level or one level below the operating segment level. A reporting unit is an operating segment or a business unit one level below that operating segment, for which discrete financial information is prepared and regularly reviewed by segment management. Goodwill is not amortized but is evaluated for impairment at least annually on October 1 or whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount may not be recoverable. The evaluation begins with a qualitative assessment to determine whether a quantitative impairment test is necessary. If, after assessing qualitative factors, we determine it is more likely than not that the fair value of the reporting unit is less than the carrying amount, then the quantitative goodwill impairment test is performed.
Judgments and uncertainties involved in the estimate
We make various estimates and assumptions about our goodwill, including whether any potential impairment events have occurred. Examples of such events or changes in circumstances, many of which are subjective in nature, include the following:
• Significant negative industry or economic trends;
• A significant change in the use of the acquired assets or our strategy;
• A significant divestiture or other disposition activity;
• A significant decrease in the market value of the asset;
• A significant change in legal factors or the business climate that could affect the value of the asset; and
• A change in segment by one or more reporting unit
Additionally, we make estimates and assumptions regarding the inputs used to perform a quantitative assessment of our goodwill, if necessary, and the Company will perform a discounted cash flow analysis and a market multiple analysis. The discounted cash flow analysis includes management assumptions for expected sales growth, capital expenditures and overall operational forecasts. The market multiple analysis includes historical and projected performance, market capitalization, volatility and multiples for industry peers.
Effect if actual results differ from assumptions
We have not made any material changes in our methodology used to determine whether potential impairment events have occurred or any material changes in the estimates and assumptions used in our quantitative goodwill impairment testing. In the third quarter of 2023, the Company determined potential indicators of impairment within the Specialty Chemicals segment and performed a quantitative evaluation of goodwill. As a result, it was concluded that the estimated fair value of the Specialty Chemicals reporting unit was below its carrying value by 27.6% resulting in a goodwill impairment charge of $11.4 million. As of December 31, 2023, the Company's goodwill balance is $0. See Note 1 for further discussion on the Company's goodwill.
23
Table of Contents
Inventory
Description
Inventory is stated at the lower of cost or net realizable value. Cost is determined by either specific identification or weighted average methods. At the end of each quarter, all facilities review recent sales reports to identify sales price trends that would indicate products or product lines that are being sold below our cost. This would indicate that an adjustment would be required.
We record an obsolete inventory reserve for identified aged inventory items with slow or no sales activity for finished goods or slow or no usage for raw materials for a certain period of time. For those inventory items, a reserve is established for a percentage of the inventory cost less any estimated scrap proceed and is based on our current knowledge with respect to inventory levels, sales trends and historical experience. During 2023, our reserve increased approximately $2.8 million to $5.6 million as of December 31, 2023.
We also record an inventory reserve for the estimated shrinkage (quantity losses) between physical inventories. This reserve is based upon the most recent physical inventory results. During 2023, the inventory shrink reserve had a $0.4 million increase in response to estimated shrinkage rates based on results from previous physical inventories. Our inventory reserve for estimated shrinkage was $0.5 million as of December 31, 2023.
Judgments and uncertainties involved in the estimate
We do not believe that our inventories are subject to significant risk of obsolescence in the near term and we have the ability to adjust purchasing practices based on anticipated sales trends and general economic conditions. However, changes in demand, product life cycle, cost trends, product pricing or a deterioration in product quality could result in the need for additional reserves. Likewise, changes in the estimated shrink reserve may be necessary, based on the timing and results of physical inventories. We also apply judgment in the determination of levels of obsolete inventory and assumptions about net realizable value.
Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to establish our reserves for obsolete inventory or inventory shrinkage during the past two fiscal years. However, it is possible that actual results could differ from recorded reserves. For instance, a 10% change in the amount of products considered obsolete would have decreased net earnings by $0.6 million for 2023. A 10% change in the estimated shrinkage rate would not have had a material impact on net earnings for 2023.
Income Taxes
Description
In determining income for financial statement purposes, we must make certain estimates and judgments in the calculation of tax expense, the resultant tax liabilities and the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of revenue and expense. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. In addition, deferred tax assets are also recorded with respect to net operating losses and other tax attribute carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when realization of the benefit of deferred tax assets is not deemed to be more likely than not. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
We recognize net tax benefits under the recognition and measurement criteria of FASB ASC Topic 740, Income Taxes, which prescribes requirements and other guidance for financial statement recognition and measurement of positions taken or expected to be taken on tax returns. We record interest and penalties, if any, related to uncertain tax positions as a component of income tax expense.
Judgments and uncertainties involved in the estimate
We assess on a tax jurisdictional basis the likelihood that our deferred tax assets can be recovered. If recovery is not more likely than not (a likelihood of less than 50 percent), the provision for taxes must be increased by recording a reserve in the form of a valuation allowance for the deferred tax assets that are estimated not to ultimately be recoverable. In this process, certain relevant criteria are evaluated including: the amount of income or loss in prior years, the existence of deferred tax
24
Table of Contents
liabilities that can be used to absorb deferred tax assets, the taxable income in prior carryback years that can be used to absorb net operating losses and credit carry backs, future expected taxable income and prudent and feasible tax planning strategies. Changes in taxable income, market conditions, tax laws and other factors may change our judgment regarding whether we will be able to realize the deferred tax assets. These changes, if any, may require material adjustments to the net deferred tax assets and an accompanying reduction or increase in income tax expense which will result in a corresponding increase or decrease in net income in the period when such determinations are made. The utilization of certain deferred tax assets is dependent on the amount and timing of taxable income that we will ultimately generate in the future and other factors, such as changes in tax laws.
We also assess the likelihood that our tax reporting positions will ultimately be sustained. To the extent it is determined it is more likely than not (a likelihood of more than 50 percent) that some portion, or all, of a tax reporting position will ultimately not be recognized and sustained, a provision for unrecognized tax benefit is provided by either reducing the applicable deferred tax asset or accruing an income tax liability. Our judgment regarding the sustainability of our tax reporting positions may change in the future due to changes in tax laws and other factors. These changes, if any, may require material adjustments to the related deferred tax assets or accrued income tax liabilities and an accompanying reduction or increase in income tax expense which will result in a corresponding increase or decrease in net income in the period when such determinations are made.
We have provided valuation allowances as of December 31, 2023, aggregating to $1.6 million, net of federal benefit, against certain state and local net operating loss carryforwards and other deferred tax assets. As of December 31, 2023, the Company has no liability for unrecognized income tax benefits.
Effect if actual results differ from assumptions
Although management believes that the estimates and judgments discussed herein are reasonable, actual results could differ, which could result in income tax expense or benefits that could be material.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company is a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and is not required to provide the information required by this Item.
25
Table of Contents