INSTEEL INDUSTRIES INC (IIIN) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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.

14

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 September 30, 2023 compared with the year ended October 1, 2022. Discussions of our financial condition and results of operations for the year ended October 1, 2022 compared to October 2, 2021 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 1, 2022, which was filed with the SEC on October 27, 2022.

The table below presents a summary of our results of operations for fiscal 2023 and fiscal 2022.

Statements of Operations – Selected Data

(Dollars in thousands)

2023 Compared with 2022

Net Sales

Net sales decreased 21.5% to $649.2 million in 2023 from $826.8 million in 2022, reflecting a 17.1% decrease in selling prices along with a 5.3% decrease in shipments. The decrease in average selling prices was driven by competitive pricing pressures resulting from weakening demand for our products and declining raw material costs. The decrease in shipments was due to reduced demand resulting from inventory management measures pursued by our customers during the fiscal year and a decrease in new project activity.

15

Gross Profit

Gross profit decreased 66.9% to $65.4 million, or 10.1% of net sales, in 2023 from $197.3 million, or 23.9% of net sales, in 2022. The year-over-year decrease was primarily due to lower spreads between average selling prices and raw material costs ($105.7 million) along with a decrease in shipments ($11.8 million) and higher manufacturing costs ($14.4 million). The decrease in spreads was driven by lower average selling prices ($129.7 million) and an increase in freight expense ($1.4 million) partially offset by lower raw material costs ($25.4 million).

Selling, General and Administrative Expense

Selling, general and administrative expense (“SG&A expense”) decreased 14.9% to $30.7 million, or 4.7% of net sales, in 2023 from $36.0 million, or 4.4% of net sales, in 2022 primarily due to lower compensation ($2.9 million), the relative year-over-year changes in the cash surrender value of life insurance policies ($2.4 million) and depreciation expense ($577,000) partially offset by higher employee benefit expense ($489,000). The decrease in compensation expense was largely driven by lower incentive plan expense due to a decline in financial results in the current year. The cash surrender value of life insurance policies increased $531,000 in the current year compared with a decrease of $1.9 million in the prior year 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) Expense, net

Other income of $3.4 million for 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 $3.7 million due to an increase in cash and higher average interest rates.

Income Taxes

Our effective income tax rate for 2023 decreased to 22.4% from 22.7% in 2022 due to changes in book versus tax differences.

Net Earnings

Net earnings decreased to $32.4 million ($1.66 per share) in 2023 from $125.0 million ($6.37 per diluted share) in 2022, primarily due to the decrease in gross profit partially offset by lower SG&A expense and increased other income and interest income.

16

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 September 30, 2023, our cash and cash equivalents totaled $125.7 million compared with $48.3 million as of October 1, 2022.

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)

Operating Activities

Operating activities provided $142.2 million of cash in 2023 primarily from net earnings adjusted for non-cash items together with a net decrease in working capital. Working capital provided $95.6 million of cash due to a $94.3 million decrease in inventories and an $18.2 million reduction in accounts receivable partially offset by a $16.9 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 lower average selling prices. The decrease in accounts payable and accrued expenses was largely due to lower raw material purchases, lower unit costs and a reduction in accrued incentive plan expense.

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.

17

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 $20.9 million of cash in 2023 primarily due to capital expenditures ($30.7 million) partially offset by the receipt of proceeds from the sale of property, plant and equipment ($9.9 million). 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). 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 2024, including expenditures to support costs and productivity initiatives, modernize our facilities and information systems and 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 $44.0 million of cash in 2023 and $41.2 million of cash in 2022. In 2023, $41.3 million of cash was used for dividend payments (including a special cash dividend of $38.9 million, or $2.00 per share, and regular cash dividends totaling $2.4 million) and $2.3 million for the repurchase of common stock. 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.

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 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 September 30, 2023, no borrowings were outstanding on the Credit Facility, $98.5 million of borrowing capacity was available and outstanding letters of credit totaled $1.5 million (see Note 8 to the consolidated financial statements). As of October 1, 2022, 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.

Contractual Obligations

In addition to our discussion and analysis surrounding our liquidity and capital resources, our contractual obligations and commitments as of September 30, 2023, include:

18

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 2023, we experienced a decline in wire rod prices primarily due to reductions in the cost of scrap for wire producers and a concurrent weakening in demand. Selling prices for our products fell in response to the softening demand and competitive pricing pressure. Consequently, our financial results were adversely affected as we consumed higher cost inventory that was purchased in prior periods. During 2022, we were successful in implementing price increases sufficient to recover the escalation in our raw material costs that occurred over the course of the 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 2024, we are aware of the risks associated with higher interest rates and the implications for the broader U.S. economy and, ultimately, our end markets. Nevertheless, we remain optimistic about demand in our private and public nonresidential construction markets as customer sentiment is mostly positive. Furthermore, the outlook for infrastructure construction remains favorable as federal spending associated with the Infrastructure Investment and Jobs Act is expected to accelerate as we progress through fiscal 2024 and help drive demand.

Regardless of the market dynamics, we continue to focus on those factors we control, including 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 increasing contributions from the substantial investments we have made in our facilities in recent years and expect to continue to make in the form of reduced operating costs and additional capacity to support future growth. Finally, we will continue to pursue acquisitions opportunistically to 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”.