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INSTEEL INDUSTRIES, INC.

(IIIN)
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INSTEEL INDUSTRIES INC Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-K)

10/27/2022 | 11:22am EST

The matters discussed in this section include forward-looking statements that are subject to numerous risks. You should carefully read the "Cautionary Note Regarding Forward-Looking Statements" and "Risk Factors" in this Form 10-K.



Overview


Our operations are entirely focused on the manufacture and marketing of concrete reinforcing products for the concrete construction industry. 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.




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On March 16, 2020, we, through our wholly-owned subsidiary, IWP, purchased substantially all of the assets of STM for an adjusted purchase price of $19.4 million, which reflects certain post-closing adjustments. STM was a leading manufacturer of PC strand for concrete construction applications. We acquired, among other assets, STM's accounts receivable, inventories, production equipment and facility located in Summerville, South Carolina and assumed certain of its accounts payable and accrued liabilities. Subsequent to the acquisition, we elected to consolidate our PC strand operations with the closure of the Summerville facility.



Impact of COVID-19


Despite the significant disruption in the U.S. and global economies, including supply chain challenges and labor market obstacles, COVID-19 has had a limited impact on our operations 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.



Critical Accounting Estimates


Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. Our discussion and analysis of our financial condition and results of operations are based on these consolidated financial statements. The preparation of our consolidated financial statements requires the application of these accounting principles in addition to certain estimates and judgments based on currently 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 Note 2, "Summary of Significant Accounting Policies", and elsewhere in the accompanying consolidated financial statements. 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. Actual results could differ from these estimates.

Accounting estimates are considered critical if both of the following conditions are met: (1) the nature of the estimates or assumptions is material because of the levels of subjectivity and judgment needed to account for matters that are highly uncertain and susceptible to change and (2) the effect of the estimates and assumptions is material to the financial statements.

We have reviewed our accounting estimates, and none were deemed to be considered critical for the accounting periods presented.

Recent Accounting Pronouncements.

The nature and impact of recent accounting pronouncements is discussed in Note 3 to our consolidated financial statements and incorporated herein by reference.



Results of Operations


The following discussion and analysis of our financial condition and results of operations is for the year ended October 1, 2022 compared with the year ended October 2, 2021. Discussions of our financial condition and results of operations for the year ended October 2, 2021 compared to October 3, 2020 that have been omitted under this item can be found in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the fiscal year ended October 2, 2021 , which was filed with the SEC on October 27, 2021.




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The table below presents a summary of our results of operations for fiscal 2022 and fiscal 2021.

Statements of Operations - Selected Data

(Dollars in thousands)



                                                              Year Ended
                                               October 1,                     October 2,
                                                  2022          Change           2021
Net sales                                     $    826,832          40.0 %   $    590,601
Gross profit                                       197,310          62.3 %        121,548
Percentage of net sales                               23.9 %                         20.6 %

Selling, general and administrative expense $ 36,048 11.3 % $ 32,388 Percentage of net sales

                                4.4 %                          5.5 %
Restructuring (recoveries) charges, net       $       (318 )     (111.1% )   $      2,868
Effective income tax rate                             22.7 %                         22.6 %
Net earnings                                  $    125,011          87.7 %   $     66,610






2022 Compared with 2021



Net Sales


Net sales increased 40.0% to $826.8 million in 2022 from $590.6 million in 2021, reflecting a 51.9% increase in selling prices partially offset by a 7.8% decrease in shipments. The increase in average selling prices was driven by price increases implemented in the current year to recover the escalation in raw material costs. The decrease in shipments was due to tight supply conditions for raw materials during the first half of the current year followed by inventory management measures pursued by our customers and weakness in residential construction activity in the latter half of the year.



Gross Profit


Gross profit increased 62.3% to $197.3 million, or 23.9% of net sales, in 2022 from $121.5 million, or 20.6% of net sales, in 2021. The year-over-year increase was primarily due to higher spreads between average selling prices and raw material costs ($94.2 million) partially offset by higher manufacturing costs ($9.2 million) and a decrease in shipments ($9.2 million). The increase in spreads was driven by higher average selling prices ($282.0 million) partially offset by higher raw material costs ($181.9 million) and freight expense ($5.9 million).

Selling, General and Administrative Expense

Selling, general and administrative expense ("SG&A expense") increased 11.3% to $36.0 million, or 4.4% of net sales, in 2022 from $32.4 million, or 5.5% of net sales, in 2021 primarily due to relative year-over-year changes in the cash surrender value of life insurance policies ($3.4 million), higher compensation ($948,000), travel ($423,000) and insurance ($265,000) expense partially offset by the lower legal ($1.8 million) and employee benefit ($321,000) expense. The cash surrender value of life insurance policies decreased $1.9 million in the current year compared with an increase of $1.5 million in the prior year due to the corresponding changes in the value of the underlying investments. The increase in compensation expense was largely driven by higher incentive and stock-based compensation expense. The decrease in legal expense was primarily related to costs associated with trade matters incurred in the prior year. The decrease in employee benefits expense was due to a net gain on the settlement of life insurance policies ($364,000) in the current year.

Restructuring (Recoveries) Charges, Net

Net restructuring recoveries of $318,000 were incurred in 2022 related to the closure of the Summerville, South Carolina facility, which had been acquired through the STM Acquisition, and the consolidation of our PC strand operations. Net restructuring recoveries in 2022 included a gain on sale of the Summerville facility ($622,000) partially offset by facility closure costs ($304,000). Net restructuring charges of $2.9 million were incurred in the prior year which included asset impairment charges ($1.4 million), facility closure costs ($1.0 million), equipment relocation costs ($423,000) and employee separation costs ($13,000).




Income Taxes



Our effective income tax rate for 2022 increased to 22.7% from 22.6% in 2021 due to changes in book versus tax differences.




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Net Earnings


Net earnings increased to $125.0 million ($6.37 per diluted share) in 2022 from $66.6 million ($3.41 per diluted share) in 2021 primarily due to the increase in gross profit and the change in net restructuring (recoveries) charges partially offset by higher SG&A expense.

Liquidity and Capital Resources



Overview


Our sources of liquidity include cash and cash equivalents, cash generated by operating activities and borrowing availability provided under our $100.0 million revolving credit facility (the "Credit Facility"). Our principal capital requirements include funding working capital, capital expenditures, dividends and any share repurchases. As of October 1, 2022, our cash and cash equivalents totaled $48.3 million compared with $89.9 million as of October 2, 2021.

We believe that, in the absence of significant unanticipated cash demands, cash and cash equivalents, 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, in both the short- and long-term. We also expect to have access to the amounts available under our 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, delay or restrict share repurchases, cease dividend payments 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 were 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, flexible capital structure and borrowing capacity available to us under our Credit Facility position us to meet our anticipated liquidity requirements for the foreseeable future.

Selected Liquidity and Capital Resources Data

(Dollars in thousands)



                                                             Year Ended
                                                     October 1,       October 2,
                                                        2022             2021
Net cash provided by operating activities           $      5,670     $     69,878
Net cash used for investing activities                    (6,039 )        (17,805 )
Net cash used for financing activities                   (41,199 )        (30,877 )

Cash and cash equivalents                                 48,316           89,884
Net working capital                                      272,736          178,057
Total debt                                                     -                -
Percentage of total capital                                    -                -
Shareholders' equity                                $    389,744     $    302,038
Percentage of total capital                                  100 %            100 %

Total capital (total debt + shareholders' equity) $ 389,744 $ 302,038




Operating Activities


Operating activities provided $5.7 million of cash in 2022 primarily from net earnings adjusted for non-cash items partially offset by an increase in working capital. Working capital used $134.3 million of cash due to a $118.6 million increase in inventories, a $13.7 million increase in accounts receivable and a $2.0 million decrease in accounts payable and accrued expenses. The increase in inventories was the result of higher raw material purchases during 2022 together with higher average unit costs. The increase in accounts receivable was due to higher average selling prices. The decrease in accounts payable and accrued expenses was primarily related to lower raw material purchases near the end of the current year.




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Operating activities provided $69.9 million of cash in 2021 primarily from net earnings adjusted for non-cash items partially offset by an increase in working capital. Working capital used $12.3 million of cash due to a $14.1 million increase in accounts receivable and a $10.1 million increase in inventories partially offset by an $11.9 million increase in accounts payable and accrued expenses. The increase in accounts receivable and inventories were due to the escalation in raw material costs and average selling prices during 2021. The increase in accounts payable and accrued expenses was primarily related to raw material purchases with higher unit costs near the end of the period and, to a lesser extent, increases in accrued salaries, wages and related expenses and income taxes.

We may elect to adjust our operating activities as there are changes in the conditions in our construction end-markets, which could materially impact our cash requirements. While a downturn in the level of construction activity affects sales to our customers, it generally reduces our working capital requirements.




Investing Activities



Investing activities used $6.0 million of cash in 2022 primarily due to capital expenditures ($15.9 million) partially offset by the receipt of proceeds from the sale of assets held for sale ($6.9 million), life insurance claims ($1.5 million) and a decrease in cash surrender value of life insurance policies ($1.4 million). Investing activities used $17.8 million of cash in 2021 primarily due to capital expenditures ($17.5 million) and an increase in the cash surrender value of life insurance policies ($0.4 million). Capital expenditures for both years focused on cost and productivity improvement initiatives in addition to recurring maintenance requirements. Capital expenditures are expected to total up to approximately $30.0 million in 2023, which include expenditures primarily to advance the growth of our engineered structural mesh business and to support cost and productivity improvement initiatives as well as recurring maintenance requirements. Our investing activities are largely discretionary, providing us with the ability to significantly curtail outlays should future business conditions warrant that such actions be taken.



Financing Activities


Financing activities used $41.2 million of cash in 2022 and $30.9 million of cash in 2021. In 2022, $41.2 million of cash was used for dividend payments (including a special cash dividend of $38.8 million, or $2.00 per share, and regular cash dividends totaling $2.4 million) and $1.2 million for the repurchase of common stock, which was partially offset by $1.7 million of proceeds from the exercise of stock options. In 2021, $31.3 million of cash was used for dividend payments (including a special cash dividend of $29.0 million, or $1.50 per share, and regular cash dividends totaling $2.3 million), which was partially offset by $1.1 million of proceeds from the exercise of stock options.



Cash Management


Our cash is principally concentrated at one financial institution, which at times exceeds federally insured limits. We invest excess cash primarily in money market funds, which are highly liquid securities that bear minimal risk.



Credit Facility


We have a Credit Facility that is used to supplement our operating cash flow and fund our working capital, capital expenditure, general corporate and growth requirements. In May 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 since June 2010. The new credit agreement, among other changes, extended the maturity date of the Credit Facility from May 13, 2020 to May 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 of October 1, 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 8 to the consolidated financial statements). As of October 2, 2021, there were no borrowings outstanding on the Credit Facility.

Off-Balance Sheet Arrangements

We do not have any material transactions, arrangements, obligations (including contingent obligations), or other relationships with unconsolidated entities or other persons, as defined by Item 303(a)(4) of Regulation S-K of the SEC, that have or are reasonably likely to have a material current or future impact on our financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses.




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Contractual Obligations


In addition to our discussion and analysis surrounding our liquidity and capital resources, our contractual obligations and commitments as of October 1, 2022, include:



  ? Raw Material Purchase Commitments - See Note 12, "Commitments and
    Contingencies," within our consolidated financial statements for further
    details concerning our non-cancelable raw material purchase commitments.


  ? Supplemental Employee Retirement Plan Obligations - See Note 11, "Employee
    Benefit Plans," within our consolidated financial statements for further
    detail of our obligations and the timing of expected future payments under our
    supplemental employee retirement plan.


  ? Operating Leases - See Note 13, "Leases," within our consolidated financial
    statements for further detail of our obligations and the timing of expected
    future payments, including a five-year maturity schedule.


  ? Debt Obligations and Interest Payments - See Note 8, "Long-Term Debt," within
    our consolidated financial statements for further detail of our debt and the
    timing of expected future principal and interest payments. As of October 1,
    2022, there were no borrowings outstanding.


  ? Capital Expenditures - As of October 1, 2022, we had contractual commitments
    for capital expenditures of $31.9 million.






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, labor, 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 2022 and 2021, we were successful in implementing price increases sufficient to recover the escalation in our raw material costs that occurred over the course of each year. The timing and magnitude of any future increases in raw material costs and the impact on selling prices for our products is uncertain at this time.



Outlook


Looking ahead to fiscal 2023, we are optimistic about demand in both our private and public nonresidential construction markets. Backlogs across our customer base remain solid and widely monitored leading market indicators in private nonresidential construction point to continued expansion. Public nonresidential construction markets should benefit from incremental demand from both the strong financial position of state budgets and funding by the Infrastructure Investment and Jobs Act. Weakness in the residential construction market and heightened uncertainty regarding the future direction of the overall economy are areas we are closely monitoring, but we believe our strong balance sheet and flexible operating model position us to navigate challenges we may encounter.

Regardless of the market dynamics, we continue to focus on those factors we control: closely managing and controlling our expenses; aligning our production schedules with demand in a proactive manner as there are changes in market conditions to minimize our operating costs; pursuing further improvements in the productivity and effectiveness of all our manufacturing, selling and administrative activities: and furthering our human capital strategy. We also expect gradually increasing contributions from the substantial investments we have made in our facilities in the form of reduced operating costs and additional capacity to support future growth. Finally, we will continue to pursue acquisitions opportunistically in our existing businesses that expand our penetration of markets we currently serve or expand our footprint.

The statements contained in this section are forward-looking statements. See "Cautionary Note Regarding Forward-Looking Statements" and "Risk Factors".

© Edgar Online, source Glimpses

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