Insteel Industries Inc: Form 10-Q for the period ended Dec 30, 2023

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 September 30, 2023 (our “2023 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:

• general economic and competitive conditions in the markets in which we operate;
• changes in the spending levels for nonresidential 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 for us, our customers and the construction industry as a whole;
• the impact of rising interest rates on the cost of financing for our customers;
• 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 raise selling prices in order to recover increases in raw material or operating costs;
• changes in U.S. or foreign trade policy affecting imports or exports of steel wire rod or our products;
• unanticipated 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 market for engineered structural mesh (“ESM”) and expand our shipments of ESM;
• legal, environmental, economic or regulatory developments that significantly impact our business or operating costs;
• unanticipated plant outages, equipment failures or labor difficulties; and
• the “Risk Factors” discussed in our 2023 Annual Report and in other filings made by us with the SEC.

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.

Results of Operations

Statements of Operations – Selected Data

(Dollars in thousands)

"N/M" = not meaningful

First Quarter of Fiscal 2024 Compared to First Quarter of Fiscal 2023

Net Sales

Net sales for the first quarter of 2024 decreased 27.1% to $121.7 million from $166.9 million in the prior year quarter as relatively flat shipments were offset by a 27.1% decrease in average selling prices. The decrease in average selling prices was driven by competitive pricing pressures and a decline in raw material costs.

Gross Profit

Gross profit for the first quarter of 2024 decreased 64.7% to $6.3 million, or 5.2% of net sales, from $17.8 million, or 10.7% of net sales, in the prior year quarter due to lower spreads between average selling prices and raw material costs ($11.0 million) and higher manufacturing costs ($499,000). The decrease in spreads was driven by lower average selling prices ($45.8 million) partially offset by lower raw material costs ($34.6 million) and freight expense ($201,000).

Selling, General and Administrative Expense

Selling, general and administrative expense (“SG&A expense”) for the first quarter of 2024 decreased 10.7% to $6.4 million, or 5.2% of net sales, from $7.1 million, or 4.3% of net sales, in the prior year quarter primarily due to lower compensation expense ($674,000) and the relative year-over-year change in the cash surrender value of life insurance policies ($312,000) partially offset by higher legal expense ($147,000). The decrease in compensation expense was primarily driven by a decrease in incentive plan expense due to a decline in financial results. The cash surrender value of life insurance policies increased $675,000 in the current year quarter compared with an increase of $363,000 in the prior year quarter due to the corresponding changes in the value of the underlying investments.

Other Income, net

Other income for the first quarter of 2024 decreased to $22,000 from $3.3 million in the prior year quarter. The decrease was primarily due to the prior year period including a $3.3 million net gain from the sale of property, plant and equipment.

Interest Income

Interest income increased $1.2 million from the prior year quarter due to an increase in cash and higher average interest rates.

Income Taxes

Our effective tax rate for the first quarter of 2024 increased to 27.2% from 22.9% for the prior year quarter primarily due to permanent book versus tax differences for stock-based compensation which were treated as discrete in the current period.

Net Earnings

Net earnings for the first quarter of 2024 decreased to $1.1 million ($0.06 per share) from $11.1 million ($0.57 per share) in the prior year quarter primarily due to the decrease in gross profit and other income partially offset by the increase in interest income and lower SG&A expense.

Liquidity and Capital Resources

Selected Financial Data

(Dollars in thousands)

16

Operating Activities

Operating activities provided $21.8 million of cash during the first quarter of 2024 primarily from net earnings adjusted for non-cash items together with a net decrease in working capital. Working capital provided $16.3 million of cash due to a $20.1 million reduction in accounts receivable and a $9.2 million decrease in inventories partially offset by a $12.9 million decrease in accounts payable and accrued expenses. The decrease in accounts receivable was largely driven by the decrease in shipments in the quarter combined with lower average selling prices. The decrease in inventories was primarily due to lower average unit costs. The decrease in accounts payable and accrued expenses was largely due to lower raw material purchases near the end of the period, lower raw material unit costs and decreases in accrued salaries, wages and related expenses.

Operating activities provided $33.0 million of cash during the first quarter of 2023 primarily from net earnings adjusted for non-cash items together with a net decrease in working capital. Working capital provided $17.8 million of cash due to a $26.5 million decrease in inventories and a $12.9 million reduction in accounts receivable partially offset by a $21.5 million decrease in accounts payable and accrued expenses. The decrease in inventories was primarily due to lower raw material purchases during the quarter along with lower average unit costs. The decrease in accounts receivable was largely driven by the decrease in shipments in the quarter combined with lower average selling prices. The decrease in accounts payable and accrued expenses was largely due to lower raw material purchases during the period.

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 $12.4 million of cash during the first quarter of 2024 compared to providing $1.6 million during the prior year period primarily due the decreased receipt of proceeds from the sale of property, plant and equipment ($9.9 million) partially offset by higher capital expenditures ($4.1 million). Capital expenditures increased to $12.3 million from $8.2 million in the prior year period and are expected to total up to approximately $30.0 million for fiscal 2024. Capital expenditures for fiscal 2024 are to support costs and productivity initiatives, modernize our facilities and information systems, advance the growth of our engineered structural mesh business and 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 $49.5 million of cash during the first quarter of 2024 compared to $40.3 million during the prior year period. During the first quarter of 2024, $49.2 million of cash was used for dividend payments (including a special dividend of $48.6 million, or $2.50 per share, and regular quarterly dividend totaling $583,000, or $0.03 per share) and $539,000 for the repurchase of common stock. During the first quarter of 2023, $39.5 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 $584,000, or $0.03 per share) and $916,000 for the repurchase of common stock.

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 December 30, 2023, no borrowings were outstanding on the Credit Facility, $96.7 million of borrowing capacity was available and outstanding letters of credit totaled $1.5 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, labor rates, 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 quarter of 2024, selling prices for our products declined in response to the softening demand and competitive pricing pressures which negatively impacted our financial results as we consumed higher cost inventory. The timing and magnitude of any future increases in our raw material costs and the selling prices for our products are uncertain at this time.

Contractual Obligations

There have been no material changes in our contractual obligations and commitments as disclosed in our 2023 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 2023 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 2023 Annual Report for further information regarding our critical accounting policies and estimates. As of December 30, 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 2023 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 issued accounting pronouncements including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements.

Outlook

As we look ahead to the remainder of fiscal 2024, we anticipate stronger market fundamentals and improving financial results. Customer sentiment remains mostly positive, and the macroeconomic outlook is improving with the apparent end of the recent rising interest rate cycle. Furthermore, the outlook for infrastructure construction remains favorable as federal spending from the Infrastructure Investment and Jobs Act is expected to increase demand as we progress through the fiscal year.

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.

Our cash flows and earnings are subject to fluctuations resulting from changes in commodity prices, interest rates and foreign exchange rates. We manage our exposure to these market risks through internally established policies and procedures and, when appropriate, the use of derivative financial instruments. We do not use financial instruments for trading purposes and are not a party to any leveraged derivatives. We monitor our underlying market risk exposures on an ongoing basis and believe we can modify or adapt our hedging strategies as necessary.

Commodity Prices

We are subject to significant fluctuations in the cost and availability of our primary raw material, hot-rolled carbon steel wire rod, which we purchase from both domestic and foreign suppliers. We negotiate quantities and pricing for both domestic and foreign wire rod purchases for varying periods (most recently monthly for domestic suppliers), depending upon market conditions, to manage our exposure to price fluctuations and to ensure adequate availability of material consistent with our requirements. We do not use derivative commodity instruments to hedge our exposure to changes in prices as such instruments are not currently available for wire rod. Our ability to acquire wire rod from foreign sources on favorable terms is impacted by fluctuations in foreign currency exchange rates, foreign taxes, duties, tariffs, quotas and other trade actions. Although changes in our wire rod costs and selling prices tend to be correlated, in weaker market environments, we may be unable to fully recover increased wire rod costs through higher selling prices, which would reduce our earnings and cash flows. Additionally, when raw material costs decline, our financial results may be negatively impacted if the selling prices for our products decrease to an even greater extent and if we are consuming higher cost material from inventory. Based on our shipments and average wire rod cost reflected in cost of sales for the first quarter of 2024, a 10% increase in the price of wire rod would have resulted in a $7.9 million decrease in our pre-tax earnings (assuming there was not a corresponding change in our selling prices).

Interest Rates

Although we did not have any balances outstanding on our Credit Facility as of December 30, 2023, future borrowings under the facility are subject to a variable rate of interest and are sensitive to changes in interest rates.

Foreign Exchange Exposure

We have not typically hedged foreign currency exposures related to transactions denominated in currencies other than U.S. dollars, as such transactions have not been material historically. We will occasionally hedge firm commitments for certain equipment purchases that are denominated in foreign currencies. The decision to hedge any such transactions is made by us on a case-by-case basis. There were no forward contracts outstanding as of December 30, 2023.

We have conducted an evaluation of the effectiveness of our disclosure controls and procedures as of December 30, 2023. This evaluation was conducted under the supervision and with the participation of management, including our principal executive officer and our principal financial officer. Based upon that evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Further, they concluded that our disclosure controls and procedures were effective to ensure that information is accumulated and communicated to management, including our principal executive officer and our principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

There has been no change in our internal control over financial reporting that occurred during the quarter ended December 30, 2023, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

During the quarter ended December 30, 2023, there have been no material changes from the risk factors set forth under Part I, Item 1A. “Risk Factors” in our 2023 Annual Report. You should carefully consider these factors in addition to the other information set forth in this report which could materially affect our business, financial condition or future results. The risks and uncertainties described in this report and in our 2023 Annual Report, as well as other reports and statements that we file with the SEC, are not the only risks and uncertainties facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also have a material adverse effect on our financial position, results of operations or cash flows.