Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis is intended to assist the reader in understanding our results of operations and financial condition. Management’s Discussion and Analysis is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements that are included in Item 8 . " Financial Statements and Supplementary Data ".
Background
The Company has one reportable segment, Industrial Tools & Service ("IT&S"). This segment is primarily engaged in the design, manufacture and distribution of branded hydraulic and mechanical tools, as well as providing services and tool rental to the industrial, maintenance, infrastructure, oil & gas, energy and other markets. Financial information related to the Company's reportable segment is included in Note 15, "Business Segment, Geographic and Customer Information" in the notes to the consolidated financial statements.
Business Update
Our businesses provide an array of products and services across multiple markets and geographies which results in significant diversification. The IT&S segment operates within thirteen vertical markets. We continue to execute our strategy to drive best in class returns for our shareholders, our focus on improving commercial effectiveness, optimizing our global facility footprint and our heavy emphasis on new product development.
We remain focused on our long-term strategy of pursuing both organic and acquisition-related growth opportunities aligned with our strategic objectives. This includes the advancement of our commercial effectiveness initiatives along with new product development efforts. We also remain focused on our safety, quality, cost and delivery metrics across our manufacturing, assembly and service operations. Our IT&S segment is focused on accelerating global sales growth through new product introductions, a continued emphasis on sales effectiveness and more focused retail and wholesale marketing efforts. In addition, we remain focused on reducing our concentration in the oil & gas vertical markets by growing sales of critical products, rentals, and services with new and existing customers in other attractive vertical markets including power generation/alternative energy, aerospace, infrastructure and industrial maintenance, repair and operation.
COVID-19 Update
During largely the second half of fiscal 2020 and through the first two quarters of fiscal 2021, our business, like many others around the world, experienced significant negative financial impacts from the COVID-19 pandemic. In the third and fourth quarters of fiscal 2021, we returned to year-over-year core growth in all regions. We saw strong growth in the Americas and Europe, however, there are still portions of our business, particularly in our Middle East and Asia Pacific regions, that remain challenged by reduced demand conditions, pandemic-related lockdowns or the lingering economic effects of the pandemic. Our key manufacturing facilities continue to operate with additional precautions in place to ensure the safety of our employees and prevent production disruptions. Though lead times have been difficult to predict due to the current supply chain and logistics environment, we generally have been able to meet our customers' demand for the products and services they require, although our product backlogs and lead times have grown in recent quarters. The Company is well-positioned to execute our strategic growth initiatives as the markets we serve continue to recover across the globe. With our strong balance sheet, we remain focused on new product development, driving organic growth and pursuing disciplined acquisition opportunities.
General Business Update
On October 31, 2019, the Company completed the previously announced sale of its former EC&S segment to wholly owned subsidiaries of BRWS Parent LLC, a Delaware limited liability company and affiliate of One Rock Capital Partners II, LP, for a purchase price of approximately $216 million (inclusive of final working capital adjustments), with approximately $3 million which was due in four equal quarterly installments, the last of which was received in the first quarter of 2021.
On March 21, 2019, the Company announced a restructuring plan focused on (i) the integration of the Enerpac and Hydratight businesses (IT&S segment), (ii) the strategic exit of certain commodity-type services in our North America Services operations (IT&S segment), and (iii) driving efficiencies within the overall corporate structure. In the third quarter of fiscal 2020, the Company announced the expansion and revision of this plan, which further simplifies and flattens the corporate structure through elimination of redundancies between the segment and corporate functions, while enhancing our commercial and marketing processes to become even closer to our customers. Total restructuring charges associated with this restructuring plan were $2 million and $7 million for the year ended August 31, 2021 and 2020 , respectively, r elated primarily to headcount reductions and facility consolidations. We anticipate achieving annual savings of $12 million to $15 million from the first phase of the plan and anticipate an additional annual savings of $12 million to $15 million from the expansion and revision of the
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plan. The annual benefit of these gross cost savings may be impacted by a number of factors, including annual incentive compensation differentials.
Historical Financial Data (in millions)
Year Ended August 31,
2021 2020 2019
Statements of Earnings Data: (1)
Net sales $ 529 100 % $ 493 100 % $ 655 100 %
Cost of products sold 286 54 % 276 56 % 362 55 %
Gross profit 243 46 % 217 44 % 293 45 %
Selling, general and administrative expenses 175 33 % 181 37 % 209 32 %
Amortization of intangible assets 8 2 % 8 2 % 9 1 %
Restructuring charges 3 1 % 7 1 % 4 1 %
Impairment & divestiture charges (benefit) 6 1 % (3) (1) % 23 4 %
Operating profit 51 10 % 24 5 % 48 7 %
Financing costs, net 5 1 % 19 4 % 28 4 %
Other expense (income), net 2 0 % (3) (1) % 1 0 %
Earnings before income tax expense 44 8 % 8 2 % 19 3 %
Income tax expense 4 1 % 2 0 % 11 2 %
Net earnings $ 40 8 % $ 6 1 % $ 8 1 %
Other Financial Data: (1)
Depreciation $ 13 $ 12 $ 11
Capital expenditures 12 12 15
(1) Results are from continuing operations and exclude the financial results of previously divested businesses reported as discontinued operations.
Fiscal 2021 compared to Fiscal 2020
Consolidated net sales from continuing operations in fiscal 2021 were $529 million, 7% higher than the prior-year sales of $493 million. Core sales increased $27 million (5%) and divested product lines and the strategic exits of certain service offerings, net of sales from acquisitions, decreased net sales $2 million (1%), while the impact from foreign currency rates favorably impacted sales by 2%. The COVID-19 pandemic had a detrimental impact on our core sales in the third and fourth quarter of fiscal 2020. Sales in the first and second quarter of fiscal 2021 still were COVID-19 impacted, however, not to the same extent as we saw in the third and fourth quarters of fiscal 2020. The third and fourth quarter of fiscal 2021 saw more of a return to normalcy in our core product sales, driving the overall increase in core sales from fiscal 2020 to fiscal 2021. Gross profit margins increased 2% year over year as a result of the increase in volumes, leading to greater absorption of overhead, and a strong mix of product and service sales. Operating profit was $27 million higher in fiscal 2021 as compared to fiscal 2020 predominantly as a resul t of the $26 million increase in gross profit. Selling, general and administrative expenses ("SG&A") also decreased approximately $6 million on leading to the increase in operating profit as a result of the recognition of a gain on the sale of a manufacturing facility in China. Restructuring savings realized in fiscal 2021 were able to offset the short term cost reduction actions taken in the third and fourth quarter of fiscal 2020 in response to the COVID-10 pandemic (termination of our fiscal 2020 bonus program and furloughs and other temporary wage reduction programs. The savings in SG&A were nearly offset by an increase in impairment and divestiture charges recorded in fiscal 2021, specifically the $6 million Goodwill impairment charge recorded associated with the Cortland Industrial reporting unit (Other Segment). Financing costs also decreased in fiscal 2021 due to continued benefit from the cash pay off of our outstanding term loan in fiscal 2020, the rate benefit from the retirement of our Senior Notes in the fourth quarter of fiscal 2020 through drawing on our revolving credit facility, and the paydown of $80 million of principal on our outstanding credit facility in fiscal 2021 through utilization of cash from operations.
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Fiscal 2020 compared to Fiscal 2019
Consolidated sales from continuing operations in fiscal 2020 were $493 million, 25% lower than the prior-year sales of $655 million. Core sales decreased $117 million (20%), while strategic exits and divestitures of non-core product lines, net of current year acquisitions, accounted for a $38 million (6%) decrease in net sales. Changes in foreign currency exchange rates favorably impacted sales comparisons by 1%. The 20% decrease in core sales predominantly was a result of the significant declines in volume in the third and fourth quarter due to impacts of the COVID-19 pandemic and volatile oil prices. In addition, global economic uncertainty, predominantly in North America, caused slight year over year declines from volume in the first half of the fiscal year, and there were lower year-over-year service sales in the fiscal year as large projects in the Middle East and Asia in fiscal 2019 did not repeat in fiscal 2020. Gross profit margins remained relatively consistent year-over-year despite the substantial volume decrease as we benefited from the strategic exit of certain low-profit product and service lines in fiscal 2020 , executed certain temporary cost-reduction actions such as furloughs and other temporary wage reduction measures, and we saw a greater impact from the COVID-19 pandemic to our service revenue stream, which generally has lower gross profit margins than our product sales. Operating profit was $24 million lower in fiscal 2020 as compared to fiscal 2019 as a result of the $76 million decrease in gross profit driven by the decline in net sales volume, offset by cost reduction actions to reduce SG&A, and impairment & divestiture benefits in the current year as opposed to charges in the prior year. SG&A decreased $28 million, predominantly due to the benefit from restructuring actions and a decrease in commissions expense as a result of the reduction in sales volumes, as well as temporary cost reduction measures in response to the COVID-19 pandemic including the termination of our fiscal 2020 bonus plan, furloughs and other temporary wage reduction programs, and other discretionary spending initiatives. In addition, we received approximately $1.1 million of COVID-19 relief governmental support in certain foreign jurisdictions. With respect to impairment and divestiture charges, in fiscal 2020, we incurred a net benefit of $3 million due to the benefit from the divestitures of our Connectors and UNI-LIFT product lines, partially offset by the impairment and divestiture charges associated with the divestiture of our Milwaukee Cylinder business. In fiscal 2019, we incurred $14 million of goodwill impairment charges associated with triggering events impacting Cortland U.S., $6 million of impairment & divestiture charges associated with the impairment of a customer relationship intangible in connection with the strategic exit of certain North America service offerings and $3 million of trade name impairment & divestiture charges associated with a re-branding strategy to eliminate the use of certain secondary brands within the IT&S segment that were previously determined to be indefinite-lived. Financing costs also decreased in fiscal 2020 as we utilized the proceeds from the sale of EC&S in the first quarter of the fiscal year to pay off the remaining $175 million principal on our term loan and in the fourth quarter of fiscal 2020, we redeemed our 5.625% Senior Notes by drawing on our revolving credit facility which provided modest interest savings during our fourth quarter. These savings were partially offset as we expensed $2 million of capitalized debt issuance costs associated with the accelerated repayment of our term loan and redemption of our Senior Notes. Our income tax expense decreased for reasons discussed in the Income Tax Expense section below.
Segment Results
IT&S Segment
The IT&S segment is a global supplier of branded hydraulic and mechanical tools and services to a broad array of end markets, including infrastructure, industrial maintenance, repair, and operations, oil & gas, mining, alternative and renewable energy and construction markets. Its primary products include branded tools, cylinders, hydraulic torque wrenches, highly engineered heavy lifting technology solutions and other tools (Product product line). On the service and rental side, the segment provides maintenance and manpower services to meet customer-specific needs and rental capabilities for certain of our products (Service & Rental product line). The following table sets forth the results of operations for the IT&S segment (in millions):
Year Ended August 31,
2021 2020 2019
Net Sales $ 493 $ 455 $ 610
Operating Profit 82 66 101
Operating Profit % 16.6 % 14.4 % 16.6 %
Fiscal 2021 compared to Fiscal 2020
Fiscal 2021 IT&S segment net sales increased by $38 million (8%) from fiscal 2020 to $493 million. Core sales increased $29 million (7%) year-over-year. The net sales increase included a $2 million (1%) decrease from strategic exits and divestitures of non-core product lines, net of current-year acquisitions, and a 2% favorable impact on sales due to changes in foreign currency exchange rates. The 7% increase in core sales was predominantly a result of broad-based market recovery, as our largest regions of the world returned to more normalized levels of activity in the second half of fiscal 2021.
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Fiscal 2021 operating profit increased $16 million (25%) from the prior year. The operating profit increase was a result of a $24 million increase in gross profit as a result of the increased sales volumes, offset by the $8 million increase in selling, general, and administrative expenses ("SG&A"). The increase in SG&A expenses resulted from increased sales commissions, the cost of our fiscal 2021 bonus plan (the fiscal 2020 bonus plan was eliminated in response to the COVID-19 pandemic) and other discretionary spending cuts and government subsidy programs that provided a benefit in fiscal 2020, partially offset by the benefit of the restructuring plan first announced in March 2019 and expanded in fiscal 2020.
Fiscal 2020 compared to Fiscal 2019
Fiscal 2020 IT&S segment net sales decreased by $155 million (25%) from fiscal 2019 to $455 million. Core sales decreased $110 million (20%) year over year, while strategic exits and divestitures of non-core product lines, net of current-year acquisitions, accounted for $38 million (6%) of the decrease. Changes in foreign currency exchange rates favorably impacted sales comparisons by 1%. The 20% decrease in core sales predominantly was a result of the significant declines in volume in the third and fourth quarter due to impacts of the COVID-19 pandemic and volatile oil prices. In addition, global economic uncertainty, predominantly in North America, caused slight year-over-year declines from volume in the first half of the fiscal year, and there were lower year-over-year service sales in the fiscal year as large projects in the Middle East and Asia in fiscal 2019 did not repeat in fiscal 2020.
Fiscal 2020 operating profit decreased $36 million (35%) from the prior year. The operating profit decrease was a result of the $72 million decrease in gross profit as a result of the sales volume decline, partially offset by a $23 million decrease in SG&A and a $12 million decrease in impairment and divestiture charges. The $23 million decrease in SG&A was predominantly due to the benefit from restructuring actions and a decrease in commissions expense as a result of the reduction in sales volumes, in addition to cost-reduction measures in response to the COVID-19 pandemic including the termination of our fiscal 2020 bonus plan, furloughs and other temporary wage reduction programs, and other discretionary spending initiatives. We also received approximately $1.1 million of COVID-19 relief governmental support in certain foreign jurisdictions. With respect to impairment and divestiture charges, in fiscal 2020, we incurred a net benefit of $3 million due to the benefit from the divestitures of our Connectors and UNI-LIFT product lines, partially offset by the impairment and divestiture charges associated with the divestiture of our Milwaukee Cylinder business. In fiscal 2019, we incurred $6 million of impairment & divestiture charges associated with the impairment of a customer relationship intangible in connection with the strategic exit of certain North America service offerings and $3 million of trade name impairment & divestiture charges associated with a re-branding strategy to eliminate the use of certain secondary brands within the IT&S segment that were previously determined to be indefinite lived.
Corporate
Corporate consists of selling, general and administrative costs and expenses, including executive, legal, finance, human resources, and technology, that are not allocated to the segments based on their nature. Corporate expenses were $20 million in fiscal 2021 compared to $38 million in fiscal 2020. The decrease of $18 million is a result of the realization of savings from restructuring actions, the elimination of costs retained after the EC&S divestiture that were required to support the transition services agreement entered into as part of that sale, the reduction in business development costs and the gain, net of transaction costs and value-added taxes, resulting from the sale of our facility in China.
Corporate expenses were $38 million in fiscal 2020 as compared to $42 million in fiscal 2019. The decrease of $4 million is a result of the benefit from restructuring actions, positive experience in medical claims, and temporary cost-reduction actions in response to the COVID-19 pandemic, including the termination of our fiscal 2020 bonus plan, furloughs and other temporary wage reduction programs, and restrictions on travel and other discretionary spend. These were partially offset by $2 million of restructuring expenses associated with our strategic efforts to drive efficiency in the overall corporate structure (there were no restructuring charges in fiscal 2019) and an increase in business development costs, specifically costs associated with the acquisition of HTL Group.
Net financing costs were $5 million, $19 million and $28 million in fiscal 2021, 2020 and 2019, respectively. Fiscal 2021 financing costs decreased as a result of the cash pay off of our outstanding term loan in November 2019 and, in the fourth quarter of fiscal 2020, the retirement of the 5.625% Senior Notes through drawing on our revolving line of credit, which maintains a lower interest rate in the current interest rate environment. We have also reduced the principal on our outstanding credit facility by $80 million in fiscal 2021 through utilization of cash from operations. Fiscal 2020 net financing costs decreased from fiscal 2019 primarily as a result of the repayment of the term loan and retirement of 5.625% Senior Notes. These actions were partially offset due to $2 million of additional interest expense recorded due to the accelerated write off of the remaining capitalized debt issuance costs associated with the early payoff of the term loan and redemption of the Senior Notes.
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Income Tax Expense
The Company's income tax expense or benefit is impacted by a number of factors, including, among others, the amount of taxable earnings generated in foreign jurisdictions with tax rates that are different than the U.S. federal statutory rate, permanent items, state tax rates, changes in tax laws, acquisitions and divestitures and the ability to utilize various tax credits and net operating loss carryforwards. Income tax expense also includes the impact of provision to tax return adjustments, changes in valuation allowances and reserve requirements for unrecognized tax benefits. Pre-tax earnings, income tax expense and effective income tax rate from continuing operations for the past three fiscal years were as follows (in thousands):
Year Ended August 31,
2021 2020 2019
Earnings before income tax expense $ 43,975 $ 7,849 $ 18,724
Income tax expense 3,763 2,292 10,657
Effective income tax rate 8.6 % 29.2 % 56.9 %
The comparability of pre-tax earnings, income tax expense and the related effective income tax rates are impacted by impairment and other divestiture charges (benefits) as well as the Tax Cuts and Jobs Act (“TCJA”), which was enacted on December 22, 2017, and the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which was enacted on March 27, 2020. Fiscal 2021, 2020 and fiscal 2019 results included $6 million (expense), $3 million (benefit) and $23 million (expense) of impairment and divestiture charges, respectively. A substantial portion of these charges (benefits) do not result in a tax expense or benefit. The fiscal 2021 tax provision included a tax benefit of $8 million related to the lapse of statute of limitations on uncertain tax positions and a tax benefit $ 4 million related to the net operating loss carryback provision of the CARES Act. The fiscal 2020 tax provision included a tax benefit of $3 million related to legislative changes and additional guidance related to the TCJA compared to a tax benefit of $2 million from fiscal 2019.
Both the fiscal 2021 and prior-year income tax provisions were impacted by the mix of earnings in foreign jurisdictions with income tax rates different than the U.S. federal income tax rate and income tax benefits from global tax planning initiatives. The fiscal 2021 effective tax rate was 8.6%, which is significantly lower than the fiscal 2020 effective tax rate of 29.2%. The decrease in the fiscal 2021 effective tax rate from the statutory 21% is largely driven by the lapse of the statute of limitations on uncertain tax positions and the one-time tax benefits related to the CARES Act in fiscal 2021 that will not repeat in future periods.
Items Impacting Comparability
On January 7, 2020, the Company acquired the stock of HTL Group ("HTL"), a provider of controlled bolting products, calibration and repair services, and tool rental services, which contributed net sales of $14 million and $6 million in fiscal 2021 and 2020, respectively. During fiscal 2020, the Company completed the sale of the UNI-LIFT and Connectors product lines, as well as the Milwaukee Cylinder business, which contributed combined net sales of $3 million and $18 million for the years ended August 31, 2020 and 2019, respectively.
Liquidity and Capital Resources
At August 31, 2021, cash and cash equivalents were $140 million, comprised of $128 million of cash held by foreign subsidiaries and $12 million held domestically. The following table summarizes the cash flow attributable to operating, investing and financing activities (in millions):
Year Ended August 31,
2021 2020 2019
Net cash provided by (used in) operating activities $ 54 $ (3) $ 54
Net cash provided by investing activities 13 176 11
Net cash used in financing activities (82) (239) (100)
Effect of exchange rate changes on cash 3 7 (5)
Net decrease in cash and cash equivalents $ (12) $ (59) $ (40)
Cash flow provided by operations was $54 million in fiscal 2021, an increase of $57 million from the prior year due to a $20 million increase in cash flows from discontinued operations driven by the timing of the divestiture of the EC&S segment in fiscal 2020 and an increase in net earnings from continuing operations of $35 million year over year. We generated $13 million of cash from investing activities in the current year as compared to $176 million in the prior-year period. The cash provided in fiscal 2020 was primarily generated from the sale of our EC&S segment as well as our Connectors and UNI-LIFT product lines, slightly offset by cash used for capital expenditures. In fiscal 2021, we sold our manufacturing facility in China for approximately $22 million and received approximately $3 million in proceeds associated with the death benefit for life
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insurance on legacy officers of the Company, which was offset by approximately $12 million of capital expenditures in the fiscal year. In fiscal 2021, our cash used in financing activities was primarily from the paydown of $80 million of principal on our outstanding credit facility with cash from operations and excess cash on hand.
Cash flow provided by operations was a use of $3 million in fiscal 2020, a decrease of $57 million from the prior year due to a $34 million decrease in cash flows from discontinued operations driven by the timing of the divestiture of the EC&S segment in the first quarter and a decrease in net earnings from continuing operations, exclusive of the impacts of impairment & divestiture (benefit) charges, of $26 million year over year. We generated $176 million of cash from investing activities in the fiscal 2020 from the divestiture of the EC&S business ($211 million, net, comprised of the sales price of $216 million, less closing costs of $3 million and $2 million of capital expenditures in fiscal 2020 prior to the divestiture date) and the divestiture of other non-core product lines ($10 million), offset by the HTL Group acquisition ($33 million) and capital expenditures ($12 million). In fiscal 2020, we utilized the proceeds of the sale of our EC&S segment to repay the remaining $175 million of outstanding principal on our term loan, utilized free cash flow and excess cash on hand to reduce the outstanding principal on our remaining debt by $33 million and also repurchased approximately 1 million shares of our outstanding common stock for $28 million.
The Company's senior credit facility is comprised of a $400 million revolving line of credit and a $200 million term loan both scheduled to mature in March 2024 (see Note 7, "Debt" in the notes to the consolidated financial statements for further details of the senior credit facility). As previously noted, the Company paid off the outstanding principal balance on the term loan in November 2019. Further, as noted in Note 7, "Debt", on June 15, 2020, the Company borrowed $295 million under the senior credit facility revolving line of credit to fund the redemption of all of the outstanding Senior Notes at par, plus the remaining accrued and unpaid interest, to reduce interest costs. Outstanding borrowings under the senior credit facility revolving line of credit were $175 million as of August 31, 2021. The unused credit line and amount available for borrowing under the revolving line of credit was $220 million at August 31, 2021.
We believe that the revolver, combined with our existing cash on hand and anticipated operating cash flows, will be adequate to meet operating, debt service, acquisition and capital expenditure funding requirements for the foreseeable future.
Primary Working Capital Management
We use primary working capital as a percentage of sales as a key metric for working capital efficiency. We define this metric as the sum of net accounts receivable and net inventory less accounts payable, divided by the past three months' sales annualized. The following table shows the components of our primary working capital (in millions):
August 31, 2021 August 31, 2020
$ PWC % $ PWC %
Accounts receivable, net $ 103 18 % $ 84 19 %
Inventory, net 75 13 % 69 16 %
Accounts payable (62) (11) % (45) (10) %
Net primary working capital $ 116 20 % $ 108 25 %
Total primary working capital was $116 million at August 31, 2021, which increased from $108 million at August 31, 2020. The primary working capital increase related to increased accounts receivable as a result of the substantial increase in net sales in the fourth quarter of fiscal 2021 as a result of the return towards normalcy, as compared to fiscal 2020 where the fourth quarter was severely impacted by the COVID-19 pandemic. In response to the increased volume, we have increased inventory levels and purchases of inventory (Accounts Payable) which partially offset the increase in net primary working capital from the increase in accounts receivable.
Capital Expenditures
The majority of our manufacturing activities consist of assembly operations. We believe that our capital expenditure requirements are not as extensive as other industrial companies given the nature of our operations. Capital expenditures associated with continuing operations were $12 million for both fiscal 2021 and 2020, respectively, and $15 million in fiscal 2019. Capital expenditures for fiscal 2022 are expected to be $12 to $15 million, but could vary depending on business performance, changes in foreign currency exchange rates, the timing and extent of the impact from the COVID-19 pandemic and the amount of assets leased instead of purchased.
Commitments and Contingencies
Given our desire to allocate cash flow and revolver availability to fund growth initiatives, we have historically leased most of our facilities and some operating equipment. We lease certain facilities, computers, equipment and vehicles under various operating lease agreements, generally over periods ranging from one to twenty years. Under most arrangements, we pay the property taxes, insurance, maintenance and expenses related to the leased property. Many of our leases include provisions that
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enable us to renew the leases at contractually agreed rates or, less commonly, based upon market rental rates on the date of expiration of the initial leases.
We are contingently liable for certain lease payments under leases within businesses we previously divested or spun-off. If any of these businesses do not fulfill their future lease payment obligations under a lease, we could be liable for such obligations, however, the Company does not believe it is probable that it will be required to satisfy these obligations. Future minimum lease payments for these leases at August 31, 2021 were $5 million with monthly payments extending to fiscal 2025.
We had outstanding letters of credit totaling $12 million at both August 31, 2021 and 2020, the majority of which relate to commercial contracts and self-insured workers' compensation programs.
Contractual Obligations
Our predominant sources of contractual obligations include the payment of interest and principal on our outstanding line of credit, our operating lease portfolio, certain employee-related benefit plans and agreements with certain suppliers related to the procurement of inventory.
The timing of principal payments associated with our revolving line of credit are disclosed in N ote 7 , " Debt . " We pay interest monthly based on prevailing interest rates at the time and the balance outstanding on our revolving line of credit.
Our lease contracts are primarily for real estate leases, vehicle leases, IT and manufacturing leases, information technology services and telecommunications services. See Note 10 , " Leases " for future minimum lease payments associated with our lease portfolio.
We have long-term obligations related to our deferred compensation, pension and postretirement plans that are summarized in Note 11, “Employee Benefit Plans” in the notes to the consolidated financial statements.
As part of our global sourcing strategy, we have entered into agreements with certain suppliers that require the supplier to maintain minimum levels of inventory to support certain products for which we require a short lead time to fulfill customer orders. We have the ability to notify the supplier that they no longer need to maintain the minimum level of inventory should we discontinue manufacturing a product during the contract period, however, we must purchase the remaining minimum inventory levels the supplier was required to maintain within a defined period of time. These contracts allow for us to terminate with appropriate notice so long as we utilize the remaining inventory on hand at the supplier and there are no overall minimum volumes in these contracts other than what the supplier is required to maintain on hand at any given point in time.
Critical Accounting Estimates
We prepare our consolidated financial statements in conformity with GAAP. This requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. The following estimates are considered by management to be the most critical in understanding judgments involved in the preparation of our consolidated financial statements and uncertainties that could impact our results of operations, financial position and cash flow.
Accounts receivable, net: Accounts receivable, net is recorded based on the contractual value of our accounts receivable, net of an estimated allowance for doubtful accounts representing management’s best estimate of the amount of receivables that are not probable of collection. Accounts receivable, net was $103 million as of August 31, 2021 , which is net of a $4 million allowance for doubtful accounts. Our customer base generally consists of financially reputable distributors, agents, OEMs, and other customers with whom we have long standing relationships, and we have not experienced significant write off of accounts receivables as a percentage of our annual net sales (accounts receivable written off as a percentage of net sales was 0.1% for each the years ended August 31, 2021 , 2020 , and 2019, respectively). Recently, however, an agent through which we conduct a significant amount of business in an international jurisdiction, and which has historically been a slow but consistent payer, has delayed its payments to us beyond its customary practices and, in fact, failed to make any payment to us in the three month periods ended May 31, 2021 and August 31, 2021. At August 31, 2021 , the agent, for whom we have outstanding receivables of $11 million as of August 31, 2021 , has indicated it is temporarily unable to remit required payments to us because of disputes with tax authorities in its jurisdiction but intends to honor its payment obligations when it is able. Management's estimate of the allowance for doubtful accounts as of August 31, 2021 considered various factors associated with this agent, including, but not limited to (i) the lack of payment received in the six-month period ended August 31, 2021, (ii) our due diligence on balances due to the agent from their end customers related to sales of our product and the known markup on those sales from agent to end customer and (iii) the status of ongoing negotiations with the agent to secure payments. Actual collections from the agent may differ from our estimate, which could impact our financial position and results of operations.
Inventories: Inventory cost is determined using the last-in, first-out (“LIFO”) method for a portion of U.S. owned inventory (approximatel y 48% and 44% of total inventories at August 31, 2021 and 2020, respectively). If the LIFO method were not used, inventory balances would be higher than amounts presented in the consolidated balance sheet b y $16 million and
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$10 million at August 31, 2021 and 2020, respectively. We perform an analysis on historical sales usage of individual inventory items on hand and record a reserve to adjust inventory cost to net realizable value. The inventory valuation assumptions used are based on historical experience. We believe that such estimates are made based on consistent and appropriate methods; however, actual results may differ from these estimates under different assumptions or conditions.
Goodwill and Long-lived Assets:
Goodwill Impairment Review and Estimates: A considerable amount of management judgment is required in performing the impairment tests, principally in determining the fair value of each reporting unit and the indefinite-lived intangible assets. While we believe our judgments and assumptions are reasonable, different assumptions could change the estimated fair values and, therefore, impairment charges could be required. Significant negative industry or economic trends, disruptions to the Company's business, loss of significant customers, inability to effectively integrate acquired businesses, unexpected significant changes or planned changes in use of the assets or in entity structure and divestitures may adversely impact the assumptions used in the valuations and ultimately result in future impairment charges.
In estimating the fair value of a reporting unit, we generally use a discounted cash flow model, which calculates fair value as the sum of the projected discounted cash flows over a discrete seven-year period plus an estimated terminal value. Significant assumptions include forecasted revenues, operating profit margins, and discount rates applied to the future cash flows based on the respective reporting unit's estimated weighted average cost of capital. In certain circumstances, we also review a market approach in which a trading multiple is applied to either forecasted EBITDA (earnings before interest, income taxes, depreciation and amortization) or anticipated proceeds of the reporting unit to arrive at the estimated fair value. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded. The estimated fair value represents the amount we believe a reporting unit could be bought or sold for in a current transaction between willing parties on an arms-length basis.
Fiscal 2021 Impairment Charges : In the fourth quarter of fiscal 2021, the Cortland Industrial business lagged behind our IT&S segment with respect to recovery in demand from the COVID-19 pandemic. Further, though volumes did increase from previous quarters, it became clear that we were not on track to realize the annual savings from our footprint optimization actions at the pace initially projected. Therefore, in conjunction with our annual goodwill impairment assessment, we recorded a $6 million goodwill impairment charge associated with the Cortland Industrial reporting unit. See Note 6, "Goodwill, Intangible Assets, and Long-Lived Assets" in the notes to the consolidated financial statements for further discussion. The fiscal 2021 annual review of other reporting units performed in the fourth quarter did not result in any reporting units having an estimated fair value that exceeded the carrying value (expressed as a percentage of the carrying value) by less than 100%.
The fiscal 2020 annual review of the reporting units performed in the fourth quarter resulted in all reporting units having an estimated fair value that exceeded the carrying value.
Fiscal 2019 Impairment Charges : As a result of a triggering event in fiscal 2019, we recorded a $14 million goodwill impairment charge associated with the Cortland U.S. reporting unit. See Note 6, "Goodwill, Intangible Assets, and Long-Lived Assets" in the notes to the consolidated financial statements for further discussion.
In addition, as a result of the EC&S reporting unit being held for sale as of August 31, 2019, we recorded a $210 million impairment charge representing the excess of the net book value of the net assets of the reporting unit as compared to the anticipated proceeds less costs to sell which is recorded within "Loss from discontinued operations, net of Income Taxes" within the Consolidated Statements of Operations.
Indefinite-lived intangibles (tradenames): Indefinite-lived intangible assets are also subject to annual impairment testing. On an annual basis or more frequently if a triggering event occurs, the fair value of indefinite-lived intangible assets, based on a relief of royalty valuation approach, are evaluated to determine if an impairment charge is required.
No material impairments were recorded in fiscal 2021 or fiscal 2020 as a result of triggering events or the annual impairment review of indefinite-lived intangible assets.
We recognized an impairment charge of $3 million in the fourth quarter of fiscal 2019 as a result of our determination that two secondary tradenames which were previously assumed to have an indefinite life would be phased out over the next 12-15 months and be re-branded with the Enerpac tradename.
A considerable amount of management judgment is required in performing impairment tests, principally in determining the fair value of each reporting unit and the indefinite-lived intangible assets. While we believe our judgments and assumptions are reasonable, different assumptions, including the duration and severity of the impacts from the COVID-19 pandemic, could change the estimated fair values and, therefore, future additional impairment charges could be required. Prolonged weakening industry or economic trends, disruptions to our business, loss of significant customers, inability to effectively integrate acquired businesses, unexpected significant changes or planned changes in the use of the assets or in entity structure and divestitures may adversely impact the assumptions used in the valuations and ultimately result in future impairment charges.
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Long-lived assets (fixed assets and amortizable intangible assets): We also review long-lived assets for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. If such indicators are present, we perform undiscounted operating cash flow analyses to determine if impairment exists. If impairment is determined to exist, any related impairment loss is calculated based on fair value.
No long-lived asset impairment charges were recorded in fiscal 2021. The fact that the fair value of the Cortland Industrial reporting unit was less than its net book value was considered a triggering event, however, no impairments were recorded on the long-lived assets based on the results of the undiscounted cash flow analyses performed.
In the first quarter of fiscal 2020, in connection with the held-for sale-treatment of the Milwaukee Cylinder business, we recognized a $3 million impairment charge, representing the excess of the net book value of assets held for sale over anticipated proceeds. See Note 5, "Discontinued Operations and Other Divestiture Activities" in the notes to the consolidated financial statements for further discussion.
In the fourth quarter of fiscal 2019, in connection with our North America service restructuring within the IT&S segment, we identified one customer relationship intangible asset associated with the component of the service business we intended to exit. As a result of our assessment, for which the primary assumption is the anticipated revenues associated with those customers, we determined that the fair value of the intangible asset was less than its carrying value, and therefore, recorded a $6 million impairment charge. See Note 6, "Goodwill, Intangible Assets, and Long-Lived Assets" in the notes to the consolidated financial statements for further discussion.
Also in the fourth quarter of fiscal 2019, in connection with the held-for-sale treatment of the remaining businesses within the EC&S segment, we recognized a $54 million impairment charge related to the recognition in earnings of the cumulative effect of foreign currency rate changes since acquisition of those businesses which is recorded in "Loss from discontinued operations" within the Consolidated Statements of Operations. See Note 5, "Discontinued Operations and Other Divestiture Activities" in the notes to the consolidated financial statements for further discussion.
Significant management judgment is required in performing impairment tests, principally in determining the fair value of long-lived assets. While we believe our judgments and assumptions are reasonable, different assumptions could change the estimated fair values and, therefore, future additional impairment charges could be required. Prolonged weakening industry or economic trends, disruptions to our business, loss of significant customers, inability to effectively integrate acquired businesses, unexpected significant changes or planned changes in the use of the assets or in entity structure and divestitures may adversely impact the assumptions used in the valuations and ultimately result in future impairment charges.
Business Combinations and Purchase Accounting: Business combinations are accounted for using the acquisition method of accounting, and accordingly, the assets and liabilities of the acquired business are recorded at their respective fair values. The excess of the purchase price over the estimated fair value is recorded as goodwill. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires knowledge of current market values and the values of assets in use, and often requires the application of judgment regarding estimates and assumptions. While the ultimate responsibility resides with management, for certain acquisitions we retain the services of certified valuation specialists to assist with assigning estimated values to certain acquired assets and assumed liabilities, including intangible assets and tangible long-lived assets. Acquired intangible assets, excluding goodwill, are valued using discounted cash flow methodology based on future cash flows specific to the type of intangible asset purchased. This methodology incorporates various estimates and assumptions, the most significant being projected revenue growth rates, profit margins and forecasted cash flows based on discount rates and terminal growth rates.
Employee Benefit Plans: We provide a variety of benefits to employees and former employees including, in some cases, pensions and postretirement health care. Plan assets and obligations are recorded based on an August 31 measurement date utilizing various actuarial assumptions such as discount rates, assumed rates of return on plan assets and health care cost trend rates. We determine the discount rate assumptions by referencing high-quality, long-term bond rates that are matched to the duration of our benefit obligations, with appropriate consideration of local market factors, participant demographics and benefit payment forecasts. At August 31, 2021 and 2020, the discount rates on domestic benefit plans were 2.55% and 2.40%, respectively. In estimating the expected return on plan assets, we consider historical returns, forward-looking considerations, inflation assumptions and the asset-allocation strategy in investing such assets. Domestic benefit plan assets consist primarily of participating units in mutual funds with equity based strategies, mutual funds with fixed income based strategies, and U.S treasury securities. The expected return on domestic benefit plan assets was 4.2% and 4.6% for the fiscal years ended August 31, 2021 and 2020, respectively. A 25 basis point change in the assumptions for the discount rate or expected return on plan assets would not have materially changed the fiscal 2021 domestic benefit plan expense.
We review actuarial assumptions on an annual basis and make modifications based on current rates and trends, when appropriate. As required by GAAP, the effects of any modifications are recorded currently or amortized over future periods. Based on information provided by independent actuaries and other relevant sources, we believe that the assumptions used are
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reasonable; however, changes in these assumptions could impact our financial position, results of operations or cash flow. See Note 11, “Employee Benefit Plans” in the notes to the consolidated financial statements for further discussion.
Income Taxes: Judgment is required to determine the annual effective income tax rate, deferred tax assets and liabilities, reserves for unrecognized tax benefits and any valuation allowances recorded against net deferred tax assets. Our effective income tax rate is based on annual income, statutory tax rates, tax planning opportunities available in the various jurisdictions in which we operate and other adjustments. Our annual effective income tax rate includes the impact of discrete income tax matters including adjustments to reserves for uncertain tax positions and the benefits of various income tax planning activities. Tax regulations require items to be included in our tax returns at different times than these same items are reflected in our consolidated financial statements. As a result, the effective income tax rate in our consolidated financial statements differs from that reported in our tax returns. Some of these differences are permanent, such as expenses that are not tax deductible, while others are temporary differences, such as amortization and depreciation expenses.
Temporary differences create deferred tax assets and liabilities, which are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We establish valuation allowances for our deferred tax assets when the amount of expected future taxable income is not large enough to utilize the entire deduction or credit. Relevant factors in determining the realizability of deferred tax assets include future taxable income, the expected timing of the reversal of temporary differences, tax planning strategies and the expiration dates of the various tax attributes.