IIIN Insteel Industries Inc

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Note 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 the U.S. Securities and Exchange Commission (“SEC”), in particular in our Annual Report on Form 10-K for the fiscal year ended October 1, 2022 (our “2022 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:

Overview

Insteel 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 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 the U.S. and, to a much lesser extent, into Canada, Mexico and Central and South 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.

Second Quarter of Fiscal 2023 Compared to Second Quarter of Fiscal 2022

Net Sales

Net sales for the second quarter of 2023 decreased 25.4% to $159.1 million from $213.2 million in the prior year quarter, reflecting a 14.5% decrease in average selling prices along with a 12.8% decrease in shipments. The decrease in average selling prices was driven by competitive pricing pressures. The decline in shipments was due to adverse weather conditions in many of our markets during the current quarter, which limited construction activity, and reduced demand resulting from inventory management measures pursued by our customers.

Gross Profit

Gross profit for the second quarter of 2023 decreased 76.8% to $13.3 million, or 8.3% of net sales, from $57.1 million, or 26.8% of net sales, in the prior year quarter due to lower spreads between average selling prices and raw material costs ($30.8 million) along with a decrease in shipments ($7.5 million) and higher manufacturing costs ($5.5 million). The decrease in spreads was driven by lower average selling prices ($26.0 million), higher raw material costs ($4.3 million) and freight expense ($480,000).

Selling, General and Administrative Expense

Selling, general and administrative expense (“SG&A expense”) for the second quarter of 2023 increased 4.2% to $7.5 million, or 4.7% of net sales, from $7.2 million, or 3.4% of net sales, in the prior year quarter primarily due to higher compensation ($647,000) and employee benefit expense ($583,000) partially offset by the relative year-over-year change in the cash surrender value of life insurance policies ($935,000). The increase in compensation expense was primarily due to higher incentive plan expense in the current quarter in comparison to achieving the maximum plan expense during the first quarter of the prior fiscal year. The increase in employee benefits expense was due to a net gain on the settlement of life insurance policies ($364,000) in the prior year quarter along with higher employee health insurance costs in the current year quarter. The cash surrender value of life insurance policies increased $369,000 in the current year quarter compared with a decrease of $566,000 in the prior year quarter due to the corresponding changes in the value of the underlying investments.

Interest Income

Interest income increased to $747,000 due to an increase in cash and higher average interest rates.

Income Taxes

Our effective tax rate for the second quarter of 2023 decreased to 22.0% from 22.3% for the prior year quarter primarily due to changes in book versus tax differences.

Net Earnings

Net earnings for the second quarter of 2023 decreased to $5.1 million ($0.26 per share) from $39.0 million ($1.99 per diluted share) in the prior year quarter primarily due to the decrease in gross profit.

First Half of Fiscal 2023 Compared to First Half of Fiscal 2022

Net Sales

Net sales for the first half of 2023 decreased 16.8% to $325.9 million from $391.7 million in the same year-ago period, reflecting an 11.4% decrease in shipments along with a 6.0% decrease in average selling prices. The decline in shipments was due to adverse weather conditions in many of our markets during the current year period, which limited construction activity, and reduced demand resulting from inventory management measures pursued by our customers. The decrease in average selling prices was driven by competitive pricing pressures.

Gross Profit

Gross profit for the first half of 2023 decreased 68.8% to $31.0 million, or 9.5% of net sales, from $99.4 million, or 25.4% of net sales, in the same year-ago period. The year-over-year decrease was primarily due to lower spreads between average selling prices and raw material costs ($46.9 million) along with a decrease in shipments ($11.8 million) and higher manufacturing costs ($9.7 million). The decrease in spreads was driven by higher raw material costs ($26.6 million), lower average selling prices ($18.7 million) and an increase in freight expense ($1.6 million).

Selling, General and Administrative Expense

SG&A expense for the first half of 2023 decreased 24.9% to $14.6 million, or 4.5% of net sales, from $19.5 million, or 5.0% of net sales, in the same year-ago period primarily due to lower compensation expense ($4.2 million) and the relative year-over-year changes in the cash surrender value of life insurance policies ($1.2 million) partially offset by higher employee benefit expense ($581,000). The decrease in compensation expense was largely driven by lower incentive plan expense due to a decline in financial results in the current year period. The cash surrender value of life insurance policies increased $732,000 in the current year period compared with a decrease of $451,000 in the prior year period due to the corresponding changes in the value of the underlying investments. The increase in employee benefits expense was due to a net gain on the settlement of life insurance policies ($364,000) in the prior year along with higher employee health insurance costs in the current year period.

Other Income, net

Other income of $3.4 million for the first half of 2023 was primarily related to a net gain from the sale of property, plant and equipment ($3.3 million).

Interest Income

Interest income increased to $1.2 million due to an increase in cash and higher average interest rates.

Income Taxes

Our effective tax rate for the first half of 2023 was unchanged from the prior year period at 22.6%.

Net Earnings

Net earnings for the first half of 2023 decreased to $16.2 million ($0.83 per share) from $62.1 million ($3.17 per diluted share) in the same year-ago period primarily due to the decrease in gross profit partially offset by lower SG&A expense.

Operating Activities

Operating activities provided $79.6 million of cash during the first half of 2023 primarily from net earnings adjusted for non-cash items together with a net decrease in working capital. Working capital provided $57.5 million of cash due to a $61.2 million decrease in inventories and a $15.8 million reduction in accounts receivable partially offset by a $19.5 million decrease in accounts payable and accrued expenses. The decrease in inventories was primarily due to lower raw material purchases along with lower average unit costs. The decrease in accounts receivable was largely driven by the decrease in shipments and lower average selling prices. The decrease in accounts payable and accrued expenses was largely due to lower raw material purchases during the period.

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.

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 $5.5 million of cash during the first half of 2023 compared to using $0.1 million during the prior year period primarily due to higher capital expenditures ($6.8 million) partially offset by the increased receipt of proceeds from the sale of property, plant and equipment and assets held for sale ($3.0 million). Capital expenditures increased to $15.4 million from $8.6 million in the prior year period and are expected to total up to approximately $30.0 million for fiscal 2023. Capital expenditures for fiscal 2023 are 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, providing us with the ability to significantly curtail outlays when warranted based on business conditions.

Financing Activities

Financing activities used $42.3 million of cash during the first half of 2023 compared to $40.1 million during the prior year period. During the first half of 2023, $40.1 million of cash was used for dividend payments (including a special dividend of $38.9 million, or $2.00 per share, and regular quarterly dividend totaling $1.2 million, or $0.06 per share) and $1.9 million for the repurchase of common stock. 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 dividends totaling $1.2 million, or $0.06 per share.

Cash Management

Our cash is principally concentrated at one major 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 $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. In March 2023, we amended our credit agreement to extend the maturity date of the Credit Facility from May 15, 2024, to March 15, 2028 and replaced the London Inter-Bank Offered Rate with the secured overnight financing rate. The Credit Facility provides 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 April 1, 2023, 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 9 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.

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 2023, selling prices for our products declined in response to the softening in demand as a result of inventory management measures being pursued by our customers, which negatively impacted our financial results as we consumed higher cost inventory that was purchased in prior periods. 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 in our contractual obligations and commitments as disclosed in our 2022 Annual Report other than those which occur in the ordinary 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 the U.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 2022 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. 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 2022 Annual Report for further information regarding our critical accounting policies and estimates. As of April 1, 2023, 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 2022 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

As we move into the second half of the fiscal year, we expect to regain momentum as we enter our busy season, and the weather-related headwinds subside. Additionally, we believe the customer destocking activities that have unfavorably impacted our results over the first half of the year are mostly complete. Customer sentiment remains positive, and we are encouraged by the outlook for shipment volumes and margins. We anticipate favorable market conditions driven by continued strong activity in our private nonresidential construction markets, along with a gradual recovery in residential construction. These conditions should support widening spreads, higher operating levels and lower unit cost at our facilities. Additionally, while there currently has been little impact on our business from the Infrastructure Investment and Jobs Act, we do expect this federal spending to stimulate demand during the second half of fiscal 2023.

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.