Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis summarizes the significant factors affecting our consolidated operating results, liquidity, and capital resources during the fiscal years ended December 31, 2021 and December 31, 2020. Unless otherwise noted, all references herein for the years 2021 and 2020 represent the fiscal years ended December 31, 2021 and 2020, respectively. We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements. This discussion should be read in conjunction with our consolidated financial statements and notes to the consolidated financial statements included in this Annual Report that have been prepared in accordance with accounting principles generally accepted in the United States of America. This discussion and analysis is presented in five sections:
• Executive Overview
• Results of Operations and Non-GAAP Financial Measures
• Liquidity and Capital Resources
• Material Cash Requirements from Contractual and Other Obligations
• Critical Accounting Policies and Estimates
Executive Overview
Fiscal 2021 Highlights
Consolidated net sales increased 30.7%, or $78.7 million, compared to 2020 driven by increases in average selling price and pounds shipped as well as the Company's acquisition of DanChem, which is discussed in more detail below and in Note 2 of the notes to the consolidated financial statements. Excluding the DanChem acquisition, net sales increased 28.5%, or $73.0 million, over 2020.
Consolidated net income increased to $20.2 million in 2021, compared to a net loss of $27.3 million in 2020. Earnings per share increased to $2.14 diluted earnings per share for the full-year 2021 compared to $2.98 diluted loss per share in 2020. Excluding the DanChem acquisition, consolidated net income increased to $19.6 million and earnings per share increased to $2.08 diluted earnings per share.
For 2021, cash flows from operating activities were $19.1 million, with $1.5 million used for capital expenditures.
Throughout 2021, the Company experienced profitable growth across both business segments. In our Metals Segment, robust commodity pricing and improved throughput drove strong growth while in our Specialty Chemicals Segment customer demand and increased volumes helped to offset labor and raw materials constraints and drive growth in the segment.
During the fourth quarter of 2021, the Company announced it acquired DanChem, a leading full-service specialty chemicals contract manufacturing organization located on an owned 55-acre campus in Danville, Virginia. The DanChem facility boasts the largest fleet of horizontal reactors in the industry and produces a broad array of diversified products with a stable customer base. The addition of DanChem will enable the Company to bolster its chemical operations while providing significant opportunities to grow into new end-markets with a wide array of commercial offerings. DanChem positions the Company as one of the largest specialty chemical contract manufacturers in the U.S. and enhances the Company’s ability to be a preferred acquirer for companies within the industry while continuing to strategically grow the specialty chemicals business through:
• The Acceleration of Product Development Capabilities – DanChem brings leading engineering and process development capabilities with a demonstrated track record of rapidly developing products for commercialization.
• The Expansion of Process Offerings – DanChem’s production plants and horizontal reactors drastically accelerate the long-term investment plans of Synalloy Chemicals, providing differentiated assets, rail access and meaningful site acreage for continued expansion.
• A Larger Presence in Target End-Markets and Applications – DanChem brings additional customer relationships in target markets, including CASE (coatings, adhesives, sealants and elastomers), additives, industrial and agricultural chemistries.
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Full-year 2021 results include $5.7 million in net sales and $0.6 million in operating income attributable to the DanChem operations acquired in the fourth quarter of 2021.
COVID-19 Update
The COVID-19 pandemic has had, and continues to have, a significant impact around the world, prompting governments and businesses to take unprecedented measures, such as restrictions on travel and business operations, temporary closures of businesses, and quarantine and shelter-in-place orders. The COVID-19 pandemic has at times significantly curtailed global economic activity and caused significant volatility and disruption in global financial markets. The COVID-19 pandemic and the measures taken in response have affected and could future materially impact the Company's business, results of operations and financial condition, as well as the Company's stock.
The Company has seen wide ranging impacts partially attributable to COVID-19 to date, including an adverse impact on our reported results and operations in 2020 and impacts to our supply chain in 2021. However, throughout 2021, economic conditions have improved, leading to increased demand for our products and positive operating results. The Company has also taken a number of steps to continue to improve its financial position throughout 2021 including :
• refinancing and expanding its revolving line of credit with a new lender to give the Company more favorable terms and increased liquidity;
• making the decision to permanently cease operations at the curtailed Palmer facility as of December 31, 2021 and to sublease the facility; and
• divesting the Company's ownership interest in N845BB Partners, LLC.
The extent of the continuing impact of the COVID-19 pandemic on the Company's operational and financial performance is uncertain and will depend on many factors outside the Company's control, including the timing, extent, trajectory and duration of the pandemic, the emergence of new variants, the development, availability, distribution and effectiveness of vaccines and treatments and the imposition of protective public safety measures. See Part I - Item 1A , "Risk Factors," included herein for updates to our risk factors regarding risks associated with the COVID-19 pandemic.
Results of Operations
Comparison of 2021 to 2020 – Consolidated
Consolidated net sales for the full-year 2021 increased $78.7 million, or 30.7%, over the full-year 2020 to $334.7 million. The increase in net sales was primarily driven by a 19.5% increase in average price and a 9.1% increase in pounds shipped. Excluding DanChem, net sales increased $73.0 million, or 28.5%, to $329.0 million driven by a 18.5% increase in average selling price and a 8.1% increase in pounds shipped.
Full-year 2021 consolidated gross profit increased 168.3% to $60.8 million, or 18.2% of sales, compared to $22.7 million, or 8.8% of sales, in the full-year 2020. The increase in dollars and percentage of sales for the full-year 2021 were attributable to increased selling prices and a continued favorable surcharge market environment partially offset by increasing raw material and freight costs.
Consolidated selling, general and administrative expense (SG&A) for the full-year 2021 increased by $1.4 million to $30.1 million compared to $28.7 million for the full-year 2020. SG&A as a percentage of sales was 9.0% of sales for 2021 and 11.2% of sales for 2020. The changes in SG&A expense were primarily driven by:
• Increases in incentive bonus expense of $1.3 million primarily driven by higher attainment of performance goals in the current year over the prior year;
• Increases in personnel costs related to salaries, commissions and employee benefit costs of $1.1 million;
• Increases in professional fees of $0.2 million primarily driven by acquisition related costs; and,
• Increases in other expenses of $0.4 million primarily driven by increases in taxes, licenses and insurance.
The full-year increases were partially offset by:
• Decreases in share-based payment expense of $1.0 million primarily driven by a reduction of awards outstanding in the current year;
• Increases on gains recognized on the sale of assets of $0.8 million primarily driven by wind down activities at the Palmer facility; and,
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• Decreases in bad debt expense of $0.2 million due to lower levels of uncollectible accounts in the current year.
Consolidated operating income for the full-year 2021 totaled $27.4 million compared to an operating loss of $31.1 million for the full-year 2020. The operating income increase for the full-year 2021 was primarily driven by increased demand driven sales, increases in average selling prices, a continued favorable surcharge market environment and goodwill and asset impairment expenses in 2020 that did not occur in 2021.
Comparison of 2021 to 2020 - Metals Segment
The following table summarizes operating results for the two years indicated. Reference should be made to Note 13 to the consolidated financial statements included in Item 8 of this Form 10-K.
2021 2020
(in thousands) Amount % Amount %
Net sales $ 267,238 100.0 % $ 204,459 100.0 %
Cost of goods sold 215,841 80.8 % 189,103 92.5 %
Gross profit 51,397 19.2 % 15,356 7.5 %
Selling, general and administrative expense
17,836 6.6 % 17,538 8.6 %
Asset impairment — — % 6,214 3.0 %
Goodwill impairment — — % 16,203 7.9 %
Operating income (loss) $ 33,561 12.6 % $ (24,599) (12.0) %
Net sales for the Metals Segment totaled $267.2 million for the full year of 2021, an increase of 30.7% compared to the full-year 2020. The increase in net sales was primarily driven by a 15.7% increase in average selling prices and a 12.5% increase in pounds shipped.
The net sales increase (decrease) for the full-year 2021 compared to the full-year 2020 is summarized as follows:
(in thousands) $ % Average Selling Price (1)
Units Shipped
Fiberglass and steel liquid storage tanks and separation equipment $ (4,159) (75.6) % (29.7) % (62.6) %
Heavy wall seamless carbon steel pipe and tube 16,869 71.3 % 14.7 % 49.3 %
Stainless steel pipe and tube 31,676 20.4 % 14.0 % 5.6 %
Galvanized pipe and tube 18,393 90.6 % 65.9 % 14.9 %
Total increase $ 62,779
(1) Average price increases (decreases) for the full-year 2021 as compared to the full-year 2020 relate to the following:
• Fiberglass and steel liquid storage tanks and separation equipment - due to the curtailment of Palmer operations and decision to sublease facility;
• Heavy wall seamless carbon steel pipe and tube - increase due to demand driven price increases and raw material availability;
• Stainless steel pipe and tube - increase due to demand driven price increases and raw material availability, and;
• Galvanized pipe and tube - increase due to improvement in indexed pricing.
SG&A expense increased $0.3 million, or 1.7%, for the full-year 2021 when compared to 2020. SG&A as a percentage of sales was 6.7% of sales for 2021 and 8.6% of sales for 2020. The changes in SG&A expense were primarily driven by:
• Increases in personnel costs related to salaries, commissions and employee benefit costs of $1.5 million; and,
• Increases in incentive bonus of $1.0 million primarily driven by higher attainment of performance goals in the current year over the prior year.
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The full-year increases were partially offset by:
• Increases on gains recognized on the sale of assets of $1.0 million related to wind down activities at the Palmer facility;
• Decreases in bad debt expense of $0.6 million due to lower levels of uncollectible accounts in the current year; and,
• Decreases in share-based payment expense of $0.2 million primarily driven by a reduction of awards outstanding in the current year.
Operating income increased to $33.6 million for the full-year 2021 compared to an operating loss of $24.6 million for the full-year 2020. The current year operating income increase was primarily driven by increased demand driven sales, increases in average selling prices, a continued favorable surcharge market environment and goodwill and asset impairments in the full-year 2020 that did not occur in the full-year 2021.
Comparison of 2021 to 2020 – Specialty Chemicals Segment
The following tables summarize operating results for the two years indicated. Reference should be made to Note 13 to the consolidated financial statements included in Item 8 of this Form 10-K.
2021 2020
(in thousands) Amount % Amount %
Net sales $ 67,477 100.0 % $ 51,541 100.0 %
Cost of goods sold 57,627 85.4 % 43,736 84.9 %
Gross profit 9,850 14.6 % 7,805 15.1 %
Selling, general and administrative expense
5,961 8.8 % 3,772 7.3 %
Asset impairment 233 0.3 % — — %
Operating income $ 3,656 5.4 % $ 4,033 7.8 %
Net sales for the Specialty Chemicals Segment increased 30.9%, or $15.9 million, to $67.5 million for 2021 compared to $51.5 million in 2020. The increase in net sales was primarily driven by a 26.7% increase in average selling prices and a 3.8% increase in pounds shipped. Excluding DanChem, net sales increased $10.2 million, or 19.9%, to $61.8 million driven by a 18.9% increase in average selling prices and a 1.3% increase in pounds shipped.
SG&A expense increased $2.2 million or 58.0%, to $6.0 million in 2021 when compared to 2020. Excluding the DanChem acquisition, SG&A expense increased $1.3 million, or 35.2% compared to 2020. SG&A as a percentage of sales increased to 8.8% in 2021 from 7.3% in 2020. The changes in SG&A expense were primarily driven by:
• Increases in personnel costs related to salaries, commissions and employee benefit costs of $1.4 million;
• Increases in bad debt expense of $0.3 million primarily driven by an increase in uncollectible accounts in the current year;
• Increases in travel expense of $0.1 million; and,
• Increases in professional fees of $0.1 million.
The full-year increases were partially offset by:
• Decreases in incentive bonus of $0.2 million primarily driven by lower attainment of performance goals in the current year over the prior year; and,
• Decreases in share-based payment expense of $0.1 million primarily driven by a reduction of awards outstanding in the current year.
Operating income decreased to $3.7 million for the full-year 2021 compared to operating income of $4.0 million for the full-year 2020. The decrease in operating income was primarily driven by the aforementioned increases in SG&A expense.
Comparison of 2021 to 2020 - Corporate
Corporate expenses decreased $1.1 million to $6.8 million, or 2.0% of sales, in 2021 down from $7.9 million, or 3.1% of sales, in 2020. The full-year decrease resulted primarily from:
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• Decreases in personnel costs related to salaries, wages and employee benefits of $1.7 million driven by a reduction in severance expense in the current year over the prior year;
• Decreases in share-based compensation of $0.8 million over the prior year driven by a reduction in awards outstanding; and,
• Decreases in travel expense of $0.3 million due to continued reductions in non-essential travel in response to the on-going COVID-19 pandemic.
The full-year decreases were partially offset by increases in :
• Incentive bonus expense of $0.6 million as a result of higher attainment of performance goals in the current year over the prior year; and,
• Other corporate overhead expenses of $0.8 million driven primarily by increases in taxes and licenses and insurance expense.
Interest expense was $1.5 million and $2.1 million for the full-years of 2021 and 2020, respectively. The decrease was primarily driven by more favorable interest rates associated the Company's debt refinance in the first quarter of 2021.
Non-GAAP Financial Measures
To supplement our consolidated financial statements, which are prepared and presented in accordance with accounting principles generally accepted in the United States ("GAAP"), we use the following non-GAAP financial measures: EBITDA, Adjusted EBITDA, Adjusted Net Income (Loss), and Adjusted Diluted Earnings (Loss) Per Share. Management believes that these non-GAAP measures provide additional useful information to allow readers to compare the financial results between periods. Non-GAAP measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the Company's performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company's results or financial condition as reported under GAAP.
EBITDA and Adjusted EBITDA
We define "EBITDA" as earnings before interest (including change in fair value of interest rate swap), income taxes, depreciation and amortization. We define "Adjusted EBITDA" as EBITDA further adjusted for the impact of non-cash and other items we do not consider in our evaluation of ongoing performance. These items include: goodwill impairment, asset impairment, gain on lease modification, stock-based compensation, non-cash lease cost, acquisition costs and other fees, proxy contest costs and recoveries, loss on extinguishment of debt, earn-out adjustments, realized and unrealized (gains) and losses on investments in equity securities and other investments, retention costs and restructuring and severance costs from net income. We caution investors that amounts presented in accordance with our definitions of EBITDA and Adjusted EBITDA may not be comparable to similar measures disclosed by other companies because not all companies calculate EBITDA and Adjusted EBITDA in the same manner. We present EBITDA and Adjusted EBITDA because we consider them to be important supplemental measures of our performance and investors' understanding of our performance is enhanced by including these non-GAAP financial measures as a reasonable basis for comparing our ongoing results of operations.
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Consolidated EBITDA and Adjusted EBITDA are as follows:
Year Ended December 31,
($ in thousands) 2021 2020
Consolidated
Net income (loss) $ 20,245 $ (27,267)
Adjustments:
Interest expense 1,486 2,110
Change in fair value of interest rate swap (2) 51
Income taxes 5,253 (4,706)
Depreciation 7,547 7,572
Amortization 2,794 3,028
EBITDA 37,323 (19,212)
Acquisition costs and other 1,001 861
Proxy contest costs and recoveries 168 3,105
Loss on extinguishment of debt 223 —
Earn-out adjustments 1,872 (1,195)
Loss (gain) on investments in equity securities and other investments 363 (170)
Asset impairment 233 6,214
Goodwill impairment — 16,203
Gain on lease modification — (171)
Stock-based compensation 799 1,791
Non-cash lease expense 481 510
Retention expense 500 235
Restructuring and severance costs 1,345 1,076
Adjusted EBITDA $ 44,308 $ 9,247
% sales 13.2 % 3.6 %
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Metals Segment EBITDA and Adjusted EBITDA are as follows:
Year Ended December 31,
($ in thousands) 2021 2020
Metals Segment
Net income (loss) $ 31,893 $ (22,388)
Adjustments:
Interest expense — 11
Depreciation 5,485 5,855
Amortization 2,721 3,028
EBITDA 40,099 (13,494)
Acquisition costs and other — 16
Earn-out adjustments 1,872 (1,195)
Asset impairment — 6,214
Goodwill impairment — 16,203
Stock-based compensation 129 303
Retention expense 500 —
Restructuring and severance costs 363 —
Metals Segment Adjusted EBITDA $ 42,963 $ 8,047
% of segment sales 16.1 % 3.9 %
Specialty Chemicals Segment EBITDA and Adjusted EBITDA are as follows:
Year Ended December 31,
($ in thousands) 2021 2020
Specialty Chemicals Segment
Net income $ 3,589 $ 4,046
Adjustments:
Interest expense 11 9
Depreciation 1,932 1,552
Amortization 73 —
EBITDA 5,605 5,607
Acquisition costs and other 61 —
Asset impairment 233 —
Stock-based compensation 165 207
Restructuring and severance costs 484 —
Specialty Chemicals Segment Adjusted EBITDA $ 6,548 $ 5,814
% of segment sales 9.7 % 11.3 %
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Liquidity and Capital Resources
Summary
We closely manage our liquidity and capital resources. Our liquidity requirements depend on key variables, including level of investment required to support our business strategies, the performance of our business, capital expenditures, credit facilities and working capital management. Capital expenditures and share repurchases are a component of our cash flow and capital.
Cash Flows
Cash flows were as follows:
Year ended December 31,
(in thousands) 2021 2020
Total cash provided by (used in):
Operating activities 19,055 17,978
Investing activities (32,661) 994
Financing activities 15,391 (19,362)
Net increase (decrease) in cash and cash equivalents $ 1,785 $ (390)
Operating Activities
The increase in net cash provided by operating activities for the full-year 2021 compared to the full-year 2020 was primarily driven by higher net earnings partially offset by changes in working capital. Accounts receivable decreased operating cash flow for 2021 by approximately $21.7 million over 2020 driven by an increase in net sales partially offset by a decrease in days sales outstanding to 43 days as of December 31, 2021 from 45 days as of December 31, 2020. The decrease in days sales outstanding was driven by increased collection efforts in the current year. Inventory decreased operating cash flow for 2021 by approximately $28.0 million over 2020 driven by higher purchases to meet increased customer demand partially offset by increases in inventory turns to 2.91 turns as of December 31, 2021 from 2.55 turns as of December 31, 2020. The increases in cash used from accounts receivable and inventory were partially offset by an increase in cash provided by accounts payable due to an increase in days payables outstanding to 35 days as of December 31, 2021 from 32 days as of December 31, 2020, as well as changes in accrued income taxes driven in part by tax benefits received as part of the CARES Act.
Investing Activities
Net cash used in investing activities primarily consists of transactions related to capital expenditures, proceeds from the disposal of property, plant and equipment and acquisitions. The increase in cash used in investing activities for the full-year 2021 compared to cash provided by investing activities for the full-year 2020 was primarily driven by an increase in cash outflows related to the DanChem acquisition in the current year partially offset by a decrease in capital expenditures in the current year over the prior year.
Financing Activities
Net cash used in financing activities primarily consist of transactions related to our long-term debt. The increase in net cash provided by financing activities for the full-year 2021 compared to net cash used in financing activities in the full-year 2020 was primarily due to increased borrowings against the Company's asset backed line of credit driven by the acquisition of DanChem and proceeds received from the Company's Rights Offering in the fourth quarter of 2021.
Sources of Liquidity
Funds generated by operating activities, available cash and cash equivalents and our credit facilities are our most significant sources of liquidity. Our existing cash, cash equivalents, and credit facilities balances may fluctuate during 2022. Cash from operations could also be affected by various risks and uncertainties, including, but not limited to, continued effects of the pandemic and other risks detailed in Item 1A - Risk Factors of this report. We believe our current sources of liquidity will be sufficient to fund operations, debt obligations and anticipated capital expenditures over the next 12 months.
On January 15, 2021, the Company and its subsidiaries entered into a new Credit Agreement with BMO Harris Bank N.A. ("BMO"). The new Credit Agreement provides the Company with a new four-year revolving credit facility with up to
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$150.0 million of borrowing capacity (the "Facility"). The Facility refinances and replaces the Company's previous $100.0 million asset based revolving line of credit with Truist (the "Truist Line"), which was scheduled to mature on December 20, 2021, and the remaining portion of the Company's five-year $20 million term loan with Truist (the "Truist term loan"), which was scheduled to mature on February 1, 2024.
The initial borrowing capacity under the Facility totals $110.0 million consisting of a $105.0 million revolving line of credit and a $5.0 million delayed draw term loan. The revolving line of credit includes a $17.5 million machinery and equipment sub-limit which requires quarterly payments of $0.4 million with a balloon payment due upon maturity of the Facility in January 2025. The term loan requires quarterly payments of $0.2 million with a balloon payment due upon maturity of Facility in January 2025.
We have pledged all of our accounts receivable, inventory, and certain machinery and equipment as collateral for the Credit Agreement. Availability under the Credit Agreement is subject to the amount of eligible collateral as determined by the lenders' borrowing base calculations. Amounts outstanding under the revolving line of credit portion of the Facility currently bear interest, at the Company's option, at (a) the Base Rate (as defined in the Credit Agreement) plus 0.50%, or (b) LIBOR plus 1.50%. Amounts outstanding under the delayed draw term loan portion of the Facility bear interest at LIBOR plus 1.65%. The Facility also provides an unused commitment fee based on the daily used portion of the Facility.
Pursuant to the Credit Agreement, the Company was required to pledge all of its tangible and intangible properties, including the stock and membership interests of its subsidiaries. The Facility contains covenants requiring the maintenance of a minimum consolidated fixed charge coverage ratio if excess availability falls below the greater of (i) $7.5 million and (ii) 10% of the revolving credit facility (currently $10.5 million). As of December 31, 2021, the Company was in compliance with all debt covenants.
As of December 31, 2021, the Company has $39.4 million of remaining availability under it credit facility.
Stock Repurchases and Dividends
We may repurchase common stock and pay dividends from time to time pursuant to programs approved by our Board of Directors. The payment of cash dividends is also subject to customary legal and contractual restrictions. Our capital allocation strategy is to first fund operations and investments in growth and then return excess cash over time to shareholders through share repurchases and dividends.
On February 17, 2021, the Board of Directors re-authorized the Company's share repurchase program. The previous share repurchase program had a term of 24 months and terminated on February 21, 2021. The share repurchase program allows for repurchase of up to 790,383 shares of the Company's outstanding common stock over 24 months. The shares will be purchased from time to time at prevailing market prices, through open market or privately negotiated transactions, depending on market conditions. Under the program, the purchases will be funded from available working capital, and the repurchased shares will be returned to the status of authorized, but unissued shares of common stock or held in treasury. There is no guarantee as to the exact number of shares that will be repurchased by the Company, and the Company may discontinue purchases at any time that management determines additional purchases are not warranted. As of December 31, 2021, the Company has 790,383 shares of its share repurchase authorization remaining.
Stock repurchase activity was as follows:
Year ended December 31,
2021 2020
Number of shares repurchased — 59,617
Average price per share $ — $ 10.65
Total cost of shares repurchased $ — $ 636,940
At the end of each fiscal year, the Board reviews the financial performance and capital needed to support future growth to determine the amount of cash dividend, if any, which is appropriate. In 2021 and 2020, no dividends were declared or paid by the Company.
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Other Financial Measures
Below are additional financial measures that we believe are important in understanding the Company's liquidity position from year to year. The metrics are defined as:
Liquidity Measure:
• Current ratio = current asset divided by current liabilities. The current ratio will be determined by the Company using generally accepted accounting principles, consistently applied.
Leverage Measure:
• Debt to capital = Total debt divided by total capital. The debt to capital ratio will be determined by the Company using generally accepted accounting principles, consistently applied.
Profitability Ratio:
• Return on average equity ("ROAE") = net income divided by the trailing 12-month average of equity. The ROAE will be determined by the Company using generally accepted accounting principles, consistently applied.
Results of these additional financial measures are as follows:
Year ended December 31,
2021 2020
Current ratio 3.3 4.1
Debt to capital 39% 43%
Return on average equity 21.1% (29.2)%
Material Cash Requirements from Contractual and Other Obligations
As of December 31, 2021, our material cash requirements for our known contractual and other obligations were as follows:
• Debt Obligations and Interest Payments - Outstanding obligations on our revolving credit facility and term loan were $65.6 million and $4.8 million, respectively, with $2.5 million payable within 12 months. The interest payments on our remaining borrowings will be determined based upon the average outstanding balance of our borrowings and the prevailing interest rate during that time. See Note 6 for further detail of our debt and the timing of expected future payments.
• Operating and Finance Leases - The Company enters into various lease agreements for real estate and manufacturing equipment used in the normal course of business. Operating and finance lease obligations were $34.8 million, with $1.3 million payable within 12 months. See Note 7 for further detail of our lease obligations and the timing of expected future payments.
The Company has no off-balance sheet arrangements that are reasonably likely to have a material current or future effect on the Company's financial position, revenues, results of operations, liquidity, or capital expenditures. We expect capital spending in fiscal 2022 to be as much as $10.0 million.
Critical Accounting Policies and Estimates
The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments based on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies are described in Note 1 to the consolidated financial statements included herein. We believe the following accounting policies affect the most significant estimates and management judgments used in the preparation of the Company's consolidated financial statements.
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Business Combinations
Description
Business combinations are accounted for using the acquisition method of accounting in accordance with GAAP. Under this method, the total consideration transferred to consummate the business combination is allocated to the identifiable tangible and intangible assets acquired and liabilities assumed based on their respective fair values as of the closing date of the transaction.
Judgments and uncertainties involved in the estimate
The acquisition method of accounting requires extensive use of estimates and judgments to allocate the consideration transferred to the identifiable tangible and intangible assets, if any, acquired and liabilities assumed. Fair value determinations involve significant assumptions about highly subjective variables, including future cash flows, discount rates, and expected business performance. There are also different valuation models and inputs for each component, the selection of which requires considerable judgment. Our estimates and assumptions may be based, in part, on the availability of listed market prices or other transparent market data. These determinations will affect the amount of amortization expense recognized in future periods as well the allocation of goodwill, if any, attributable to the transaction.
Effect if actual results differ from assumptions
We base our fair value estimates on assumptions we believe are reasonable, but recognize the assumptions are inherently uncertain. Depending on the size of the purchase price of a particular acquisition, the mix of intangible assets acquired and expected business performance, the purchase price allocation could be materially impacted by applying a different set of assumptions and estimates. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.
Earn-Out Liabilities
Description
Our acquisitions may include earn-out liabilities (contingent consideration) as part of the purchase price. In connection with the American Stainless, MUSA-Galvanized and MUSA-Stainless acquisitions, we are required to make quarterly earn-out payments based on certain performance metrics determined at the time of the acquisition. These quarterly earn-out payments end in 2022. The fair value of the earn-out liabilities is estimated as of the acquisition date based on the present value of the contingent payments to be made using the probability-weighted expected return method. Each quarter-end, the Company re-evaluates its assumptions for all earn-out liabilities and adjusts to reflect the updated fair values.
Judgments and uncertainties involved in the estimate
Our earn-out liability evaluations require us to apply judgment surrounding the unobservable inputs used in the determination of the fair value of the earn-out liabilities. The calculations require us to apply judgment in estimating expected pounds to be shipped and future price per pound. We apply judgment in estimating future payments, including the selection of an appropriate discount rate to determine the present value of the contingent payments to be made and liability balance at a period end.
Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to establish our earn-out liabilities in the past two fiscal years. This approach reasonably estimates future payments related to the earn-out liabilities, however, it is possible that actual results could differ from recorded earn-out liabilities. Changes in the estimated fair value of the earn-out liabilities are reflected in the results of operations in the periods in which they are identified. Changes in the fair value of the earn-out liabilities may materially impact and cause volatility in the Company's operating results. For instance, a 10% change in estimated pounds shipped or future price per pound used in our earn-out liability calculation would not have had a material effect on earnings for 2021.
Goodwill
Description
Goodwill is the excess of the purchase price over the fair value of identifiable assets acquired, less fair value of liabilities assumed, in a business combination. The Company reviews goodwill for impairment at the reporting unit level, which is the operating segment level or one level below the operating segment level. A reporting unit is an operating segment or a business unit one level below that operating segment, for which discrete financial information is prepared and regularly reviewed by segment management. Goodwill is not amortized but is evaluated for impairment at least annually on October 1
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or whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount may not be recoverable. The evaluation begins with a qualitative assessment to determine whether a quantitative impairment test is necessary. If, after assessing qualitative factors, we determine it is more likely than not that the fair value of the reporting unit is less than the carrying amount, then the quantitative goodwill impairment test is performed.
Judgments and uncertainties involved in the estimate
We make various estimates and assumptions about our goodwill, including whether any potential impairment events have occurred. Examples of such events or changes in circumstances, many of which are subjective in nature, include the following:
• Significant negative industry or economic trends;
• A significant change in the use of the acquired assets or our strategy;
• A significant divestiture or other disposition activity;
• A significant decrease in the market value of the asset;
• A significant change in legal factors or the business climate that could affect the value of the asset; and
• A change in segment by one or more reporting unit
Additionally, we make estimates and assumptions regarding the inputs used to perform a quantitative assessment of our goodwill, if necessary. The Company performed a discounted cash flow analysis and a market multiple analysis. The discounted cash flow analysis included management assumptions for expected sales growth, capital expenditures and overall operational forecasts. The market multiple analysis included historical and projected performance, market capitalization, volatility and multiples for industry peers.
Effect if actual results differ from assumptions
We have not made any material changes in our methodology used to determine whether potential impairment events have occurred or any material changes in the estimates and assumptions used in our quantitative goodwill impairment testing. During 2021, goodwill was allocated to the Company's Specialty Chemicals Segment and as of December 31, 2021, we determined that no impairment of the carrying value of goodwill for this reporting unit was required. During the third and fourth quarter of 2020, the Company determined potential indicators of impairment existed within our Welded Pipe and Tube reporting unit existed and quantitatively tested the goodwill assigned to the reporting unit for impairment. As a result of the quantitative analysis, the Company incurred goodwill impairment expenses of $16.2 million. In the event that our estimates vary from actual results, we may record additional impairment losses, which could be material to our results of operations.
Inventory
Description
Inventory is stated at the lower of cost or net realizable value. Cost is determined by either specific identification or weighted average methods. At the end of each quarter, all facilities review recent sales reports to identify sales price trends that would indicate products or product lines that are being sold below our cost. This would indicate that an adjustment would be required.
We record an obsolete inventory reserve for identified finished goods with no sales activity and raw materials with no usage. This reserve is based on our current knowledge with respect to inventory levels, sales trends and historical experience. During 2021, our reserve increased approximately $0.9 million to $1.1 million as of December 31, 2021.
We also record an inventory reserve for the estimated shrinkage (quantity losses) between physical inventories. This reserve is based upon the most recent physical inventory results. During 2021, the inventory shrink reserve decreased approximately $0.3 million to $0.2 million as of December 31, 2021, in response to estimated shrinkage rates based on results from previous physical inventories.
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Judgments and uncertainties involved in the estimate
We do not believe that our inventories are subject to significant risk of obsolescence in the near term and we have the ability to adjust purchasing practices based on anticipated sales trends and general economic conditions. However, changes in demand, product life cycle, cost trends, product pricing or a deterioration in product quality could result in the need for additional reserves. Likewise, changes in the estimated shrink reserve may be necessary, based on the timing and results of physical inventories. We also apply judgment in the determination of levels of obsolete inventory and assumptions about net realizable value.
Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to establish our reserves for obsolete inventory or inventory shrinkage during the past two fiscal years. However, it is possible that actual results could differ from recorded reserves. For instance, a 10% change in the amount of products considered obsolete or the estimated shrinkage rate would not have had a material impact on net earnings for 2021.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company is a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and is not required to provide the information required by this Item.
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