INSTEEL INDUSTRIES INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
Caution Regarding Forward-Looking Statements
This report contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, particularly under the caption "Outlook" below. When used in this report, the words "believes," "anticipates," "expects," "estimates," "appears," "plans," "intends," "continue," "outlook," "may," "should," "could" and similar expressions are intended to identify forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, they are subject to numerous risks and uncertainties and involve certain assumptions. Actual results may differ materially from those expressed in forward-looking statements, and we can provide no assurances that such plans, intentions or expectations will be implemented or achieved. Many of these risks and uncertainties are discussed in detail, and where appropriate, updated in our filings with theU.S. Securities and Exchange Commission ("SEC"), in particular in our Annual Report on Form 10-K for the fiscal year endedOctober 2, 2021 (our "2021 Annual Report"). You should carefully review these risks and uncertainties. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. All forward-looking statements speak only to the respective dates on which such statements are made and we do not undertake any obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events, except as may be required by law. It is not possible to anticipate and list all risks and uncertainties that may affect our business, future operations or financial performance; however, they include, but are not limited to, the following: ? the impact of COVID-19 on the economy, demand for our products and our operations, including the measures taken by governmental authorities to address it, which may precipitate or exacerbate other risks and/or uncertainties; ? general economic and competitive conditions in the markets in which we operate;
? changes in spending levels for non-residential and residential construction
and the impact on demand for our products;
? changes in the amount and duration of transportation funding provided by
federal, state and local governments and the impact on spending for
infrastructure construction and demand for our products;
? the cyclical nature of the steel and building material industries;
? credit market conditions and the relative availability of financing to us,
our customers and the construction industry as a whole;
? fluctuations in the cost and availability of our primary raw material,
hot-rolled carbon steel wire rod, from domestic and foreign suppliers;
? competitive pricing pressures and our ability to increase selling prices to
to recover increases in raw material or operating costs;
? changes in
wire rod or our products;
? unexpected changes in customer demand, order patterns and inventory levels;
? the impact of fluctuations in demand and capacity utilization levels on our
unit manufacturing costs;
? our ability to further develop the engineered structural truss market
("ESM") and expand our shipments of ESM;
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? legal, environmental, economic, geopolitical or regulatory developments that
significantly impact our business or operating costs;
? unplanned production stoppages, equipment failures or labor difficulties; and
? the “risk factors” discussed in our 2021 Annual Report and other filings
made by us with theSEC . OverviewInsteel Industries, Inc. ("we," "us," "our," "the Company" or "Insteel") is the nation's largest manufacturer of steel wire reinforcing products for concrete construction applications. We manufacture and market prestressed concrete strand ("PC strand") and welded wire reinforcement, including ESM, concrete pipe reinforcement and standard welded wire reinforcement. Our products are sold primarily to manufacturers of concrete products that are used in nonresidential construction. We market our products through sales representatives who are our employees. We sell our products nationwide across theU.S. and, to a much lesser extent, intoCanada ,Mexico , and Central andSouth America , delivering them primarily by truck, using common or contract carriers. Our business strategy is focused on: (1) achieving leadership positions in our markets; (2) operating as the lowest cost producer in our industry; and (3) pursuing growth opportunities within our core businesses that further our penetration of the markets we currently serve or expand our footprint. Impact of COVID-19 Despite the significant disruption in theU.S. and global economies, including supply chain challenges and labor market obstacles, COVID-19 has had a limited impact on our financial position and results of operation to date. We continue to closely monitor the impact of the COVID-19 pandemic on all aspects of our business and the potential effect on our financial position, results of operations, and cash flows. There are many uncertainties regarding the future and ultimate impact that COVID-19 will have on all aspects of our business. We will continue to assess and make adjustments as necessary. Results of Operations Statements of Operations - Selected Data (Dollars in thousands) Three Months Ended Six Months Ended April 2, April 3, April 2, April 3, 2022 Change 2021 2022 Change 2021 Net sales$ 213,209 53.4 %$ 138,999 $ 391,668 51.5 %$ 258,604 Gross profit 57,069 88.8 % 30,228 99,433 98.6 % 50,079 Percentage of net sales 26.8 % 21.7 % 25.4 % 19.4 % Selling, general and administrative expense$ 7,202 (30.3 %)$ 10,330 $ 19,483 3.2 %$ 18,883 Percentage of net sales 3.4 % 7.4 % 5.0 % 7.3 % Restructuring charges (recoveries), net$ (365 ) (167.0 %)$ 545 $ (318 ) (126.5 %)$ 1,202 Other expense (income), net (11 ) (114.7 %) 75 (16 ) (118.2 %) 88 Interest expense 23 (4.2 %) 24 45 (8.2 %) 49 Interest income (10 ) 100.0 % (5 ) (24 ) 140.0 % (10 ) Effective income tax rate 22.3 % 22.5 % 22.6 % 22.8 % Net earnings$ 39,017 161.5 %$ 14,920 $ 62,146 169.5 %$ 23,063
Second Quarter of Fiscal 2022 vs. Second Quarter of Fiscal 2021
Net Sales Net sales for the second quarter of 2022 increased 53.4% to$213.2 million from$139.0 million in the prior year quarter, reflecting a 65.4% increase in average selling prices partially offset by a 7.2% decrease in shipments. The increase in average selling prices was driven by price increases implemented to recover the escalation in raw material costs together with strong demand for our products. The decrease in shipments was due to the impact of sustained tight supply conditions for raw materials during the current year quarter. Shipments in the current and prior year quarter were not materially impacted by the COVID-19 pandemic. 18
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Gross Profit Gross profit for the second quarter of 2022 increased 88.8% to$57.1 million , or 26.8% of net sales, from$30.2 million , or 21.7% of net sales, in the prior year quarter due to higher spreads between average selling prices and raw material costs ($31.7 million ) partially offset by higher manufacturing costs ($2.9 million ) and a decrease in shipments ($2.0 million ). The increase in spreads was driven by higher average selling prices ($84.2 million ) partially offset by higher raw material costs ($51.2 million ) and freight expense ($1.3 million ).
Selling, general and administrative expenses
Selling, general and administrative expense ("SG&A expense") for the second
quarter of 2022 decreased 30.3% to $7.2 million , or 3.4% of net sales, from
$10.3 million , or 7.4% of net sales, in the prior year quarter primarily due to
lower compensation ($3.6 million ), legal ($631,000 ) and employee benefits
($502,000 ) expense partially offset by the relative year-over-year changes in
the cash surrender value of life insurance policies ($1.4 million ). The decrease
in compensation expense was largely driven by lower incentive plan expense due
to previously achieving the maximum incentive plan benefit during the first
quarter due to our strong financial results. The decrease in employee benefits
expense was due to a net gain on the settlement of life insurance policies
($364,000 ) as well as lower employee health insurance costs in the current year
quarter. The decrease in legal expense was due to costs associated with trade
matters incurred in the prior year quarter. The cash surrender value of life
insurance policies decreased $566,000 in the current year quarter compared with
an increase of $804,000 in the prior year quarter due to the corresponding
changes in the value of the underlying investments.
Restructuring costs (recoveries), net
Net restructuring recoveries of$365,000 were incurred in the second quarter of 2022 related to the closure of theSummerville, South Carolina facility, which had been acquired through theStrand-Tech Manufacturing, Inc. acquisition, and consolidation of our PC strand operations. Net restructuring recoveries for the current quarter included a gain on sale of theSummerville facility ($622,000 ) partially offset by facility closure ($257,000 ) costs. Net restructuring charges of$545,000 were incurred in the prior year quarter for equipment relocation ($286,000 ) and facility closure ($259,000 ) costs. Income Taxes Our effective tax rate for the second quarter of 2022 decreased to 22.3% from 22.5% for the prior year quarter primarily due to changes in book versus tax difference. Net Earnings Net earnings for the second quarter of 2022 increased to$39.0 million ($1.99 per diluted share) from$14.9 million ($0.76 per diluted share) in the prior year quarter primarily due to the increase in gross profit and lower SG&A expense.
First Half of Fiscal 2022 vs. First Half of Fiscal 2021
Net Sales Net sales for the first half of 2022 increased 51.5% to$391.7 million from$258.6 million in the same year-ago period, reflecting a 67.5% increase in average selling prices partially offset by a 9.5% decrease in shipments. The increase in average selling prices was driven by price increases implemented to recover the escalation in raw material costs together with strong demand for our products. The decrease in shipments was due to the impact of sustained tight supply conditions for raw materials during the current year period. Shipments for both periods were not materially impacted by the COVID-19 pandemic. Gross Profit Gross profit for the first half of 2022 increased 98.6% to$99.4 million , or 25.4% of net sales, from$50.1 million , or 19.4% of net sales, in the same year-ago period. The year-over-year increase was primarily due to higher spreads between average selling prices and raw material costs ($58.7 million ) partially offset by higher manufacturing costs ($5.5 million ) and a decrease in shipments ($4.4 million ). The increase in spreads was driven by higher average selling prices ($157.4 million ) partially offset by higher raw material costs ($95.9 million ) and freight expense ($2.8 million ). 19 --------------------------------------------------------------------------------
Selling, general and administrative expenses
SG&A expense for the first half of 2022 increased 3.2% to$19.5 million , or 5.0% of net sales, from$18.9 million , or 7.3% of net sales, in the same year-ago period primarily due to the relative year-over-year changes in the cash surrender value of life insurance policies ($1.6 million ), higher compensation ($260,000 ) and travel ($223,000 ) expense partially offset by lower legal ($1.3 million ) and employee benefit ($422,000 ) expense. The cash surrender value of life insurance policies decreased$451,000 in the current year period compared with an increase of$1.2 million in the prior year period due to the corresponding changes in the value of the underlying investments. The decrease in legal expense was primarily related to costs associated with trade matters incurred in the prior year period. The decrease in employee benefits expense was due to a net gain on the settlement of life insurance policies ($364,000 ) as well as lower employee health insurance costs in the current year period.
Restructuring costs (recoveries), net
Net restructuring recoveries of$318,000 were incurred in the first half of 2022 related to the closure of theSummerville, South Carolina facility, which had been acquired through theStrand-Tech Manufacturing, Inc. acquisition, and consolidation of our PC strand operations. Net restructuring recoveries for the current period included a gain on sale of theSummerville facility ($622,000 ) partially offset by facility closure ($304,000 ) costs. Net restructuring charges of$1.2 million were incurred in the prior period for facility closure ($811,000 ), equipment relocation ($374,000 ), employee separation ($13,000 ) costs and asset impairment charges ($4,000 ). Income Taxes
Our effective tax rate for the first half of 2022 decreased to 22.6% from 22.8% for the same period of the prior year, mainly due to changes in the accounting difference compared to the tax difference.
Net Earnings Net earnings for the first half of 2022 increased to$62.1 million ($3.17 per diluted share) from$23.1 million ($1.18 per diluted share) in the same year-ago period primarily due to the increase in gross profit partially offset by higher SG&A expense. 20
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Cash and capital resources
Selected Financial Data
(Dollars in thousands)
Six Months Ended
April 2, April 3,
2022 2021
Net cash provided by operating activities $ 20,066 $ 29,239
Net cash used for investing activities (86 ) (8,923 )
Net cash used for financing activities (40,139 ) (30,064 )
Net working capital 208,988 133,049
Total debt - -
Percentage of total capital - -
Shareholders' equity $ 325,147 $ 258,736
Percentage of total capital 100.0 % 100.0 %
Total capital (total debt + equity)
Operating Activities Operating activities provided$20.1 million of cash during the first half of 2022 primarily from net earnings adjusted for non-cash items together with a net decrease in working capital. Working capital used$54.0 million of cash due to a$48.0 million increase in inventories and a$12.8 million increase in accounts receivable partially offset by a$6.8 million increase in accounts payable and accrued expenses. The increase in inventories was the result of higher raw material purchases near the end of the period together with higher average unit costs. The increase in accounts receivable was due to the seasonal increase in shipments together with higher average selling prices. The increase in accounts payable and accrued expenses was largely due to the timing of payments related to raw material purchases. Operating activities provided$29.2 million of cash during the first half of 2021 primarily from net earnings adjusted for non-cash items together with a net decrease in working capital. Working capital used$1.3 million of cash due to a$4.3 million increase in accounts receivable partially offset by a$2.7 million increase in accounts payable and accrued expenses and a$0.3 million decrease in inventories. The increase in accounts receivable was largely driven by the seasonal increase in shipments together with higher average selling prices. The increase in accounts payable and accrued expenses was largely related to higher raw material purchases near the end of the period together with an increase in accrued salaries, wages and related expenses partially offset by decreases in the contingent earnout liability andStrand-Tech Manufacturing Inc. acquisition holdback and lower accrued customer rebates. The decrease in inventories was due to higher shipments during the period partially offset by higher unit costs. We may elect to adjust our operating activities as there are changes in our construction end-markets, which could materially impact our cash requirements. While a downturn in the level of construction activity adversely affects sales to our customers, it generally reduces our working capital requirements. Investing Activities Investing activities used$0.1 million of cash during the first half of 2022 compared to$8.9 million during the prior year period primarily due to the receipt of proceeds from the sale of assets held for sale ($6.9 million ) and life insurance claims ($1.5 million ). Capital expenditures decreased to$8.6 million from$8.8 million in the prior year period and are expected to total up to$25.0 million for fiscal 2022, which include expenditures to advance the growth of our engineered structural mesh business and support cost and productivity improvement initiatives in addition to recurring maintenance requirements.
Our investing activities are largely discretionary, allowing us to significantly reduce expenses when warranted by economic conditions.
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Financing Activities Financing activities used$40.1 million of cash during the first half of 2022 compared to$30.1 million during the prior year period. During the first half of 2022, we declared and paid a special dividend totaling$38.8 million , or$2.00 per share, and regular quarterly dividend totaling$1.2 million , or$0.06 per share. During the first half of 2021, we declared and paid a special dividend totaling$29.0 million , or$1.50 per share, and a regular quarterly dividend totaling$1.2 million , or$0.06 per share. Cash Management
Our cash is primarily concentrated in a single financial institution, which sometimes exceeds federally insured limits. We invest our excess cash primarily in money market funds, which are highly liquid securities with minimal risk.
Credit Facility We have a$100.0 million revolving credit facility (the "Credit Facility") that is used to supplement our operating cash flow and fund our working capital, capital expenditure, general corporate and growth requirements. InMay 2019 , we entered into a new credit agreement, which amended and restated in its entirety the previous agreement pertaining to the revolving credit facility that had been in effect sinceJune 2010 . The new credit agreement, among other changes, extended the maturity date of the Credit Facility fromMay 13, 2020 toMay 15, 2024 and provided for an accordion feature whereby its size may be increased by up to$50.0 million , subject to our lender's approval. Advances under the Credit Facility are limited to the lesser of the revolving loan commitment amount (currently$100.0 million ) or a borrowing base amount that is calculated based upon a percentage of eligible receivables and inventories. As ofApril 2, 2022 , no borrowings were outstanding on the Credit Facility,$98.6 million of borrowing capacity was available and outstanding letters of credit totaled$1.4 million (see Note 10 to the consolidated financial statements). We believe that, in the absence of significant unanticipated funding requirements, cash and cash equivalents, net cash generated by operating activities and the borrowing availability provided under the Credit Facility will be sufficient to satisfy our expected requirements for working capital, capital expenditures, dividends and share repurchases, if any. We expect to have access to the amounts available under the Credit Facility as required. However, should we experience future reductions in our operating cash flows due to weakening conditions in our construction end-markets and reduced demand from our customers, we may need to curtail capital and operating expenditures, cease dividend payments, delay or restrict share repurchases and/or realign our working capital requirements. Should we determine, at any time, that we require additional short-term liquidity, we would evaluate the alternative sources of financing that would be potentially available to provide such funding. There can be no assurance that any such financing, if pursued, would be obtained, or if obtained, would be adequate or on terms acceptable to us. However, we believe that our strong balance sheet and borrowing capacity available to us under our Credit Facility position us to meet our anticipated liquidity requirements for the foreseeable future, including the next 12 months. Seasonality and Cyclicality Demand in our markets is both seasonal and cyclical, driven by the level of construction activity, but can also be impacted by fluctuations in the inventory positions of our customers. From a seasonal standpoint, shipments typically reach their highest level of the year when weather conditions are the most conducive to construction activity. As a result, assuming normal seasonal weather patterns, shipments and profitability are usually higher in the third and fourth quarters of the fiscal year and lower in the first and second quarters. From a cyclical standpoint, construction activity and demand for our products is generally correlated with general economic conditions, although there can be significant differences between the relative strength of nonresidential and residential construction for extended periods. 22 --------------------------------------------------------------------------------
Impact of Inflation We are subject to inflationary risks arising from fluctuations in the market prices for our primary raw material, hot-rolled carbon steel wire rod, and, to a much lesser extent, freight, energy and other consumables that are used in our manufacturing processes. We have generally been able to adjust our selling prices to pass through increases in these costs or offset them through various cost reduction and productivity improvement initiatives. However, our ability to raise our selling prices depends on market conditions and competitive dynamics, and there may be periods during which we are unable to fully recover increases in our costs. During the first half of 2022, we were successful in implementing price increases sufficient to recover the escalation in our raw material costs that occurred over the course of the period. The timing and magnitude of any future increases in our raw material costs and the selling prices for our products is uncertain at this time. Contractual Obligations
There have been no material changes to our contractual obligations and commitments, as disclosed in our 2021 Annual Report, other than those that arise in the normal course of business.
Critical Accounting Estimates Our Management's Discussion and Analysis of Financial Condition and Results of Operations is based on our unaudited financial statements, which have been prepared in accordance with accounting principles generally accepted in theU.S. for interim financial information. The preparation of our financial statements requires the application of these accounting principles in addition to certain estimates and judgments based on current available information, actuarial estimates, historical results and other assumptions believed to be reasonable. These estimates, assumptions and judgments are affected by our application of accounting policies, which are discussed in our 2021 Annual Report. Estimates are used for, but not limited to, determining the net carrying value of trade accounts receivable, inventories, recording self-insurance liabilities and other accrued liabilities. Estimates are also used in establishing opening balances in relation to purchase accounting. Actual results could differ from these estimates. Please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates" included in our 2021 Annual Report for further information regarding our critical accounting policies and estimates. As ofApril 2, 2022 , none of our accounting estimates were deemed to be critical for the accounting periods presented, which is consistent with our assessment of critical accounting estimates disclosed in our 2021 Annual Report.
Recent accounting pronouncements
Refer to Note 2 of the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report for recently adopted and issued accounting pronouncements including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements. Outlook
Our trading conditions remain positive thanks to robust demand from our customers. Looking ahead to the remainder of our fiscal year, we expect strong financial results driven by underlying strength in all of our non-residential construction markets, in addition to the usual seasonal upturn in demand that is occurring over our third and fourth trimesters.
Inadequate supplies of domestically produced hot rolled steel wire rod, our
principal raw material, continue to be a concern. As a result, we have
increasingly supplemented our raw material requirements with foreign sources,
which should support anticipated demand and mitigate any plant operational
disruptions for the balance of the fiscal year. In addition, while we have been
successful in recovering the rapidly increasing prices for steel wire rod,
record high steel prices remain a concern, yet they have not demonstrated any
impact to demand to date.
We will continue to focus on those factors that we can reasonably control
including closely managing expenses; aligning our production schedules with
demand to minimize our cash operating costs; and pursuing further improvements
in the productivity and effectiveness of all our manufacturing, selling and
administrative activities. We also expect gradually increasing contributions
from the substantial investments we have made in recent years, and expect to
continue to make in our facilities in the form of reduced operating costs and
additional capacity to support future growth. Also, we will continue to pursue
acquisitions opportunistically to expand our penetration of markets we currently
serve or to expand our footprint.
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