10-Q 1 iiin20160626_10q.htm FORM 10-Q iiin20160626_10q.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

[X]

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended July 2, 2016

 

OR

 

[  ]

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period From ________ to ________

 

Commission File Number: 1-9929

 

Insteel Industries, Inc.

(Exact name of registrant as specified in its charter)

 

North Carolina

(State or other jurisdiction of incorporation or organization)

 

56-0674867

(I.R.S. Employer Identification No.)

     

1373 Boggs Drive, Mount Airy, North Carolina

(Address of principal executive offices)

 

27030

(Zip Code)

 

Registrant’s telephone number, including area code: (336) 786-2141

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes [X]

No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X]

No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ]

Accelerated filer [X]

Non-accelerated filer   [  ] (Do not check if a smaller reporting company)

Smaller reporting company [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes [  ]

No [X]

 

The number of shares outstanding of the registrant’s common stock as of July 20, 2016 was 18,903,899.

 

 
 

 

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION

  

Item 1.

Unaudited Financial Statements

 
 

Consolidated Statements of Operations and Comprehensive Income

3

 

Consolidated Balance Sheets

4

 

Consolidated Statements of Cash Flows

5

 

Consolidated Statements of Shareholders' Equity

6

 

Notes to Consolidated Financial Statements

7

     

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

17

     

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

24

     

Item 4.

Controls and Procedures

24

     

PART II – OTHER INFORMATION

     

Item 1.

Legal Proceedings 

25

     

Item 1A.

Risk Factors

25

     

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

25

     

Item 6.

Exhibits

25

     
SIGNATURES 26
     
EXHIBIT INDEX 27

  

 
2

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(In thousands, except per share amounts)

(Unaudited)

 

   

Three Months Ended

   

Nine Months Ended

 
   

July 2,

2016

   

June 27,

2015

   

July 2,

2016

   

June 27,

2015

 
                                 

Net sales

  $ 115,629     $ 117,016     $ 315,434     $ 329,411  

Cost of sales

    88,082       101,322       252,849       292,972  

Gross profit

    27,547       15,694       62,585       36,439  

Selling, general and administrative expense

    6,849       6,427       20,820       18,054  

Restructuring charges, net

    58       345       83       678  

Other expense (income), net

    223       601       138       (1,038 )

Interest expense

    40       65       121       273  

Interest income

    (53 )     (1 )     (103 )     (5 )

Earnings before income taxes

    20,430       8,257       41,526       18,477  

Income taxes

    6,899       2,865       14,135       6,391  

Net earnings

  $ 13,531     $ 5,392     $ 27,391     $ 12,086  
                                 
                                 

Net earnings per share:

                               

Basic

  $ 0.72     $ 0.29     $ 1.47     $ 0.66  

Diluted

    0.71       0.29       1.44       0.64  
                                 

Weighted average shares outstanding:

                               

Basic

    18,867       18,438       18,690       18,407  

Diluted

    19,135       18,828       19,011       18,823  
                                 

Cash dividends declared per share

  $ 0.03     $ 0.03     $ 1.09     $ 0.09  
                                 

Comprehensive income

  $ 13,531     $ 5,392     $ 27,391     $ 12,086  

 

See accompanying notes to consolidated financial statements.

 

 
3

 

 

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

 

   

(Unaudited)

         
   

July 2,

2016

   

October 3,

2015

 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 53,838     $ 33,258  

Accounts receivable, net

    49,426       46,782  

Inventories

    63,914       66,009  

Other current assets

    2,208       5,309  

Total current assets

    169,386       151,358  

Property, plant and equipment, net

    85,779       84,178  

Intangibles, net

    9,352       10,220  

Goodwill

    6,965       6,965  

Other assets

    7,935       7,518  

Total assets

  $ 279,417     $ 260,239  
                 

Liabilities and shareholders' equity

               

Current liabilities:

               

Accounts payable

  $ 39,738     $ 32,182  

Accrued expenses

    13,376       13,644  

Total current liabilities

    53,114       45,826  

Other liabilities

    13,212       14,198  

Commitments and contingencies

               

Shareholders' equity:

               

Common stock

    18,904       18,466  

Additional paid-in capital

    66,303       60,967  

Retained earnings

    130,030       122,928  

Accumulated other comprehensive loss

    (2,146 )     (2,146 )

Total shareholders' equity

    213,091       200,215  

Total liabilities and shareholders' equity

  $ 279,417     $ 260,239  

 

See accompanying notes to consolidated financial statements.

 

 
4

 

 

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

   

Nine Months Ended

 
   

July 2,

2016

   

June 27,

2015

 

Cash Flows From Operating Activities:

               

Net earnings

  $ 27,391     $ 12,086  

Adjustments to reconcile net earnings to net cash provided by operating activities:

               

Depreciation and amortization

    8,529       8,704  

Amortization of capitalized financing costs

    48       72  

Stock-based compensation expense

    1,521       1,502  

Deferred income taxes

    597       546  

Asset impairment charges

    20       237  

Excess tax benefits from stock-based compensation

    (1,244 )     (150 )

Loss (gain) on sale and disposition of property, plant and equipment

    15       (1,755 )

Increase in cash surrender value of life insurance policies over premiums paid

    (268 )     (233 )

Net changes in assets and liabilities (net of assets and liabilities acquired):

               

Accounts receivable, net

    (2,644 )     2,833  

Inventories

    2,095       11,106  

Accounts payable and accrued expenses

    7,981       (19,409 )

Other changes

    1,613       786  

Total adjustments

    18,263       4,239  

Net cash provided by operating activities

    45,654       16,325  
                 

Cash Flows From Investing Activities:

               

Capital expenditures

    (9,077 )     (6,767 )

Acquisition of intangible asset

    -       (1,460 )

Proceeds from fire loss insurance

    -       1,713  

Acquisition of business

    -       480  

Proceeds from sale of assets held for sale

    180       -  

Proceeds from sale of property, plant and equipment

    60       104  

Proceeds from surrender of life insurance policies

    134       40  

Increase in cash surrender value of life insurance policies

    (324 )     (284 )

Net cash used for investing activities

    (9,027 )     (6,174 )
                 

Cash Flows From Financing Activities:

               

Proceeds from long-term debt

    273       60,872  

Principal payments on long-term debt

    (273 )     (60,872 )

Cash dividends paid

    (20,289 )     (1,657 )

Cash received from exercise of stock options

    4,312       200  

Excess tax benefits from stock-based compensation

    1,244       150  

Payment of employee tax withholdings related to net share transactions

    (1,303 )     (254 )

Financing costs

    (11 )     (207 )

Net cash used for financing activities

    (16,047 )     (1,768 )
                 

Net increase in cash and cash equivalents

    20,580       8,383  

Cash and cash equivalents at beginning of period

    33,258       3,050  

Cash and cash equivalents at end of period

  $ 53,838     $ 11,433  
                 

Supplemental Disclosures of Cash Flow Information:

               

Cash paid during the period for:

               

Interest

  $ -     $ 119  

Income taxes, net

    12,166       4,198  

Non-cash investing and financing activities:

               

Purchases of property, plant and equipment in accounts payable

    460       182  

Restricted stock units and stock options surrendered for withholding taxes payable

    1,303       254  

 

See accompanying notes to consolidated financial statements.

 

 
5

 

 

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY 

(In thousands)

(Unaudited)

 

                                   

Accumulated

         
                   

Additional

           

Other

   

Total

 
   

Common Stock

   

Paid-In

   

Retained

   

Comprehensive

   

Shareholders'

 
   

Shares

   

Amount

   

Capital

   

Earnings

   

Loss

   

Equity

 

Balance at October 3, 2015

    18,466     $ 18,466     $ 60,967     $ 122,928     $ (2,146 )   $ 200,215  

Net earnings

                            27,391               27,391  

Stock options exercised, net

    408       408       3,904                       4,312  

Vesting of restricted stock units

    30       30       (30 )                     -  

Compensation expense associated with stock-based plans

                    1,521                       1,521  

Excess tax benefits from stock-based compensation

                    1,244                       1,244  

Restricted stock units and stock options surrendered for withholding taxes payable

                    (1,303 )                     (1,303 )

Cash dividends declared

                            (20,289 )             (20,289 )

Balance at July 2, 2016

    18,904     $ 18,904     $ 66,303     $ 130,030     $ (2,146 )   $ 213,091  

 

See accompanying notes to consolidated financial statements.

 

 
6

 

 

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

(1) Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements of Insteel Industries, Inc. (“we,” “us,” “our,” “the Company” or “Insteel”) have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q. Certain information and note disclosures normally included in the audited financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. The October 3, 2015 consolidated balance sheet was derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should therefore be read in conjunction with the consolidated financial statements and notes for the fiscal year ended October 3, 2015 included in the Company’s Annual Report on Form 10-K filed with the SEC.

 

The accompanying unaudited interim consolidated financial statements reflect all adjustments of a normal recurring nature that the Company considers necessary for a fair presentation of results for these interim periods. The results of operations for the nine-month period ended July 2, 2016 are not necessarily indicative of the results that may be expected for the fiscal year ending October 1, 2016 or future periods.

 

On August 15, 2014, the Company through its wholly-owned subsidiary, Insteel Wire Products Company (“IWP”), purchased substantially all of the assets associated with the prestressed concrete strand (“PC strand”) business of American Spring Wire Corporation (“ASW”) (see Note 3 to the consolidated financial statements).

 

The Company has evaluated subsequent events through the time of filing this Quarterly Report on Form 10-Q and has concluded that there are no significant events that occurred subsequent to the balance sheet date but prior to the filing of this report that would have a material impact on the consolidated financial statements.

 

(2) Recent Accounting Pronouncements

 

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-09 “Compensation – Stock Compensation Topic 718: Improvements to Employee Share-Based Payment Accounting,” which is intended to simplify the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU No. 2016-09 will become effective for the Company in the first quarter of fiscal 2018. The Company is evaluating the future effects of the adoption of this update on its consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02 “Leases,” which will replace the guidance in Accounting Standards Codification (“ASC”) Topic 840. ASU No. 2016-02 was issued to increase transparency and comparability among organizations by recognizing all lease transactions (with terms in excess of 12 months) on the balance sheet as a lease liability and a right-of-use asset. ASU No. 2016-02 will become effective for the Company in the first quarter of fiscal 2020. The Company is evaluating the potential effects of the adoption of this update on its consolidated financial statements.

 

In July 2015, the FASB issued ASU No. 2015-11 “Simplifying the Measurement of Inventory,” which requires that an entity measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. ASU No. 2015-11 will become effective for the Company in the first quarter of fiscal 2018. The Company does not expect the adoption of this update will have a material effect on its consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09 “Revenue from Contracts with Customers,” which will supersede nearly all existing revenue recognition guidance under GAAP. ASU No. 2014-09 provides that an entity recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. ASU No. 2014-09 allows for either full retrospective or modified retrospective adoption and will become effective for the Company in the first quarter of fiscal 2019. The Company is evaluating the alternative transition methods and the potential effects of the adoption of this update on its consolidated financial statements.

 

 
7

 

  

(3) Business Combination

 

On August 15, 2014, the Company purchased substantially all of the assets associated with the PC strand business of ASW for a final adjusted purchase price of $33.5 million, net of post-closing adjustments of $480,000 (the “ASW Acquisition”).

 

ASW manufactured PC strand at facilities located in Houston, Texas and Newnan, Georgia. The Company acquired, among other assets, the accounts receivable and inventories related to ASW’s PC strand business, the production equipment at its facility in Houston and its production equipment and facility in Newnan. Pursuant to an agreement with ASW, the Company is leasing the Houston facility from ASW with an option to purchase it in the future. In addition, the Company assumed certain of ASW’s accounts payable and accrued liabilities related to its PC strand business.

 

Following is a summary of the Company’s final allocation of the adjusted purchase price to the fair values of the assets acquired and liabilities assumed as of the date of the ASW Acquisition:

 

(In thousands)

       

Assets acquired:

       

Accounts receivable

  $ 7,854  

Inventories

    6,292  

Other current assets

    786  

Property, plant and equipment

    8,638  

Intangibles

    8,530  

Total assets acquired

  $ 32,100  
         

Liabilities assumed:

       

Accounts payable

  $ 3,240  

Accrued expenses

    2,362  

Total liabilities assumed

    5,602  

Net assets acquired

    26,498  

Purchase price

    33,463  

Goodwill

  $ 6,965  

 

In connection with the ASW Acquisition, the Company acquired intangible assets consisting of customer relationships, developed technology and know-how, and a non-competition agreement. The ASW Acquisition was accounted for as a business purchase pursuant to ASC Topic 805, Business Combinations. Under the provisions of ASC Topic 805, acquisition and integration costs are not included as components of consideration transferred, but are recorded as expenses in the period in which such costs are incurred.

 

Restructuring charges. Subsequent to the ASW Acquisition, in fiscal 2014, the Company incurred employee separation costs for staffing reductions associated with the acquisition. In February 2015, the Company elected to consolidate its PC strand operations with the March 2015 closure of the Newnan, Georgia facility that had been acquired through the ASW Acquisition.

 

 
8

 

  

Following is a summary of the restructuring activities and associated costs that were incurred during the three- and nine-month periods ended July 2, 2016 and June 27, 2015:

 

           

Severance and

                   

Asset

         

(In thousands)

 

Equipment

   

Other Employee

   

Facility

   

Gain on Sale

   

Impairment

         
   

Relocation Costs

   

Separation Costs

   

Closure Costs

   

of Equipment

   

Charges

   

Total

 

2016

                                               

Liability as of October 3, 2015

  $ -     $ 735     $ -     $ -     $ -     $ 735  

Restructuring charges (recoveries)

    75       -       30       (180 )     -       (75 )

Cash receipts (payments)

    (75 )     (72 )     (30 )     180       -       3  

Liability as of January 2, 2016

    -       663       -       -       -       663  

Restructuring charges

    21       -       59       -       20       100  

Cash payments

    (21 )     (59 )     (39 )     -       -       (119 )

Non-cash charges

    -       -       -       -       (20 )     (20 )

Liability as of April 2, 2016

    -       604       20       -       -       624  

Restructuring charges

    58       -       -       -       -       58  

Cash payments

    -       (51 )     (20 )     -       -       (71 )

Liability as of July 2, 2016

  $ 58     $ 553     $ -     $ -     $ -     $ 611  
                                                 

2015

                                               

Liability as of September 27, 2014

  $ -     $ 1,208     $ -     $ -     $ -     $ 1,208  

Cash payments

    -       (53 )     -       -       -       (53 )

Liability as of December 27, 2014

    -       1,155       -       -       -       1,155  

Restructuring charges

    -       75       21       -       237       333  

Cash payments

    -       (58 )     (4 )     -       -       (62 )

Non-cash charges

    -       -       -       -       (237 )     (237 )

Liability as of March 28, 2015

    -       1,172       17       -       -       1,189  

Restructuring charges

    18       -       327       -       -       345  

Cash payments

    -       (101 )     (312 )     -       -       (413 )

Liability as of June 27, 2015

  $ 18     $ 1,071     $ 32     $ -     $ -     $ 1,121  

 

As of July 2, 2016, the Company recorded restructuring liabilities of $0.6 million in accounts payable and accrued expenses on its consolidated balance sheet. As of October 3, 2015, the Company recorded restructuring liabilities of $0.7 million on its consolidated balance sheet, including $0.5 million in accrued expenses and $0.2 million in other liabilities.

 

The Company does not currently expect to incur any significant restructuring charges during the remainder of fiscal 2016.

 

(4) Fair Value Measurements

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The authoritative guidance for fair value measurements establishes a three-level fair value hierarchy that encourages an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs used to measure fair value are as follows:

 

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets.

 

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities, including certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

 

 
9

 

 

As of July 2, 2016 and October 3, 2015, the Company held financial assets that are required to be measured at fair value on a recurring basis. The financial assets held by the Company and the fair value hierarchy used to determine their fair values are as follows:

 

(In thousands)

 

Total

   

Quoted Prices

in Active

Markets

(Level 1)

   

Observable

Inputs

(Level 2)

 

As of July 2, 2016:

                       

Current assets:

                       

Cash equivalents

  $ 52,050     $ 52,050     $ -  

Other assets:

                       

Cash surrender value of life insurance policies

    7,652       -       7,652  

Total

  $ 59,702     $ 52,050     $ 7,652  
                         

As of October 3, 2015:

                       

Current assets:

                       

Cash equivalents

  $ 32,843     $ 32,843     $ -  

Other assets:

                       

Cash surrender value of life insurance policies

    7,194       -       7,194  

Total

  $ 40,037     $ 32,843     $ 7,194  

 

Cash equivalents, which include all highly liquid investments with original maturities of three months or less, are classified as Level 1 of the fair value hierarchy. The carrying amount of the Company’s cash equivalents, which consist of investments in money market funds, approximates fair value due to their short maturities. Cash surrender value of life insurance policies are classified as Level 2. The fair value of the life insurance policies was determined by the underwriting insurance company’s valuation models and represents the guaranteed value the Company would receive upon surrender of these policies as of the reporting date.

 

As of July 2, 2016 and October 3, 2015, the Company did not have any nonfinancial assets that were required to be measured at fair value on a nonrecurring basis other than the assets and liabilities that were acquired from ASW at fair value (see Note 3 to the consolidated financial statements). The carrying amounts of accounts receivable, accounts payable and accrued expenses approximates fair value due to the short-term maturities of these financial instruments.

 

(5) Intangible Assets

 

The primary components of the Company’s intangible assets and the related accumulated amortization are as follows:

 

(In thousands)

 

Gross Amount

   

Accumulated Amortization

   

Net Book Value

 

As of July 2, 2016:

                       

Customer relationships

  $ 6,500     $ (613 )   $ 5,887  

Developed technology and know-how

    1,800       (169 )     1,631  

Non-competition agreements

    3,577       (1,743 )     1,834  
    $ 11,877     $ (2,525 )   $ 9,352  
                         

As of October 3, 2015:

                       

Customer relationships

  $ 6,500     $ (369 )   $ 6,131  

Developed technology and know-how

    1,800       (102 )     1,698  

Non-competition agreements

    3,577       (1,186 )     2,391  
    $ 11,877     $ (1,657 )   $ 10,220  

 

Amortization expense for intangibles was $289,000 for the three-month periods ended July 2, 2016 and June 27, 2015, and $868,000 and $745,000 for the nine-month periods ended July 2, 2016 and June 27, 2015, respectively.

 

(6) Stock-Based Compensation

 

Under the Company’s equity incentive plans, employees and directors may be granted stock options, restricted stock, restricted stock units and performance awards. Effective February 17, 2015, the shareholders of the Company approved the 2015 Equity Incentive Plan of Insteel Industries, Inc. (the “2015 Plan”), which authorizes up to 900,000 shares of Company common stock for future grants under the plan. The 2015 Plan, which expires on February 17, 2025, replaces the 2005 Equity Incentive Plan of Insteel Industries, Inc., which expired on February 15, 2015. As of July 2, 2016, there were 614,000 shares of Company common stock available for future grants under the 2015 Plan, which is the Company’s only active equity incentive plan.

 

 
10 

 

 

Stock options. Under the Company’s equity incentive plans, employees and directors may be granted options to purchase shares of the Company’s common stock at the fair market value on the date of the grant. Options granted under these plans generally vest over three years and expire ten years from the date of the grant. Compensation expense associated with stock options for the three- and nine-month periods ended July 2, 2016 and June 27, 2015 is as follows:

 

   

Three Months Ended

   

Nine Months Ended

 

(In thousands)

 

July 2,

2016

   

June 27,

2015

   

July 2,

2016

   

June 27,

2015

 

Stock options:

                               

Compensation expense

  $ 97     $ 78     $ 563     $ 633  

 

As of July 2, 2016, the remaining unamortized compensation cost related to unvested stock option awards was $278,000, which is expected to be recognized over a weighted average period of 1.35 years.

 

The fair value of each option award granted is estimated on the date of grant using a Monte Carlo valuation model. The estimated fair values of stock options granted during the nine-month periods ended July 2, 2016 and June 27, 2015 was $8.69 and $7.75 per share, respectively, based on the following assumptions:

 

   

Nine Months Ended

 
   

July 2,

2016

   

June 27,

2015

 

Risk-free interest rate

    1.39 %     1.77 %

Dividend yield

    0.53 %     0.55 %

Expected volatility

    39.23 %     37.39 %

Expected term (in years)

    5.75       5.67  

 

The assumptions utilized in the Monte Carlo valuation model are evaluated and revised, as necessary, to reflect market conditions and actual historical experience. The risk-free interest rate for periods within the contractual life of the option was based on the U.S. Treasury yield curve in effect at the time of the grant. The dividend yield was calculated based on the Company’s annual dividend as of the option grant date. The expected volatility was derived using a term structure based on historical volatility and the volatility implied by exchange-traded options on the Company’s common stock. The expected term for options was based on the results of a Monte Carlo simulation model, using the model’s estimated fair value as an input to the Black-Scholes-Merton model, and then solving for the expected term.

 

The following table summarizes stock option activity for the nine-month period ended July 2, 2016:

 

                             

Contractual

   

Aggregate

 
   

Options

   

Exercise Price Per Share

   

Term - Weighted

   

Intrinsic

 
   

Outstanding

             

Weighted

   

Average

   

Value

 
   

(in thousands)

   

Range

   

Average

   

(in years)

   

(in thousands)

 

Outstanding at October 3, 2015

    923     $7.55 - $21.96     $ 15.14                  

Granted

    56      23.95 - 23.95       23.95                  

Exercised

    (580 )    7.55 - 21.96       13.68             $ 7,429  

Outstanding at July 2, 2016

    399      9.16 - 23.95       18.50       7.68       4,082  
                                           

Vested and anticipated to vest in the future at July 2, 2016

    392                 18.47       7.67       4,027  
                                           

Exercisable at July 2, 2016

    146                 15.19       5.94       1,983  

 

Stock option exercises include “net exercises,” pursuant to which the optionee received shares of common stock equal to the intrinsic value of the options (fair market value of common stock on the date of exercise less exercise price) reduced by any applicable withholding taxes.

 

 
11

 

 

Restricted stock units. Restricted stock units (“RSUs”) granted under the Company’s equity incentive plans are valued based upon the fair market value on the date of the grant and provide for a dividend equivalent payment which is included in compensation expense. The vesting period for RSUs is generally one year from the date of the grant for RSUs granted to directors and three years from the date of the grant for RSUs granted to employees. RSUs do not have voting rights. RSU grants and compensation expense for the three- and nine-month periods ended July 2, 2016 and June 27, 2015 are as follows:

 

   

Three Months Ended

   

Nine Months Ended

 

(In thousands)

 

July 2,

2016

   

June 27,

2015

   

July 2,

2016

   

June 27,

2015

 

Restricted stock unit grants:

                               

Units

    -       -       43       36  

Market value

  $ -     $ -     $ 1,027     $ 790  

Compensation expense

    148       151       958       869  

 

As of July 2, 2016, the remaining unrecognized compensation cost related to unvested RSUs was $576,000, which is expected to be recognized over a weighted average vesting period of 1.59 years.

 

The following table summarizes RSU activity during the nine-month period ended July 2, 2016:

 

(Unit amounts in thousands)

 

Restricted

Stock Units

Outstanding

   

Weighted

Average

Grant Date

Fair Value

 

Balance, October 3, 2015

    157     $ 18.96  

Granted

    43       23.95  

Released

    (38 )     18.50  

Forfeited

    (2 )     23.95  

Balance, July 2, 2016

    160       20.34  

 

(7) Income Taxes

 

Effective income tax rate. The Company’s effective income tax rate was 34.0% for the nine-month period ended July 2, 2016 compared with 34.6% for the nine-month period ended June 27, 2015. The effective income tax rates for both periods were based upon the estimated rate applicable for the entire fiscal year adjusted to reflect any significant items related specifically to interim periods.

 

Deferred income taxes. In November 2015, the FASB issued ASU No. 2015-17 “Income Taxes (Topic 740) - Balance Sheet Classification of Deferred Taxes” to simplify the presentation of deferred income taxes. Under this update, all deferred tax assets and liabilities, along with any related valuation allowance, are required to be classified as noncurrent on the balance sheet. Effective January 2, 2016, the Company early adopted ASU No. 2015-17 on a prospective basis, which resulted in the reclassification of the Company’s current deferred tax asset as a non-current deferred tax liability on its consolidated balance sheet. No prior periods were retrospectively adjusted.

 

As of July 2, 2016, the Company recorded a non-current deferred tax liability (net of valuation allowance) of $5.2 million in other liabilities on its consolidated balance sheet. The Company has $7.5 million of state net operating loss carryforwards (“NOLs”) that begin to expire in 2017, but principally expire between 2017 and 2031. The Company has also recorded $178,000 of gross deferred tax assets for various state tax credits that begin to expire in 2016, but principally expire between 2016 and 2020.

 

The realization of the Company’s deferred tax assets is entirely dependent upon the Company’s ability to generate future taxable income in applicable jurisdictions. GAAP requires that the Company periodically assess the need to establish a reserve against its deferred tax assets to the extent the Company no longer believes it is more likely than not that they will be fully realized. As of July 2, 2016 and October 3, 2015, the Company recorded a valuation allowance of $334,000 and $492,000, respectively, pertaining to various state NOLs and tax credits that were not expected to be utilized. The valuation allowance established by the Company is subject to periodic review and adjustment based on changes in facts and circumstances and would be reduced should the Company utilize the state NOLs and tax credits against which an allowance had previously been provided or determine that such utilization was more likely than not.

 

 
12

 

  

Uncertainty in income taxes. As of July 2, 2016, the Company has no material, known tax exposures that require the establishment of contingency reserves for uncertain tax positions.

 

The Company files U.S. federal income tax returns as well as state and local income tax returns in various jurisdictions. Federal and various state tax returns filed by the Company subsequent to 2011 remain subject to examination.

 

(8) Employee Benefit Plans

 

Retirement plans. The Company has one defined benefit pension plan, the Insteel Wire Products Company Retirement Income Plan for Hourly Employees, Wilmington, Delaware (the “Delaware Plan”). The Delaware Plan provides benefits for eligible employees based primarily upon years of service and compensation levels. The Company’s funding policy is to contribute amounts at least equal to those required by law. The Delaware Plan was frozen effective September 30, 2008 whereby participants no longer earn additional service benefits.

 

During the second quarter of fiscal 2016, the Company notified plan participants of its intent to terminate the Delaware Plan effective May 1, 2016 and settle plan liabilities through either lump sum distributions to plan participants or annuity contracts that cover vested benefits. The Company expects to contribute such additional amounts as may be necessary to fully fund the Delaware Plan (currently estimated to be approximately $1.9 million) concurrent with the settlement of the liabilities, which is expected to be completed by September 30, 2016.

 

The Company made contributions totaling $70,000 and $155,000 to the Delaware Plan during the three- and nine-month periods ended July 2, 2016, respectively.

 

Net periodic pension costs for the Delaware Plan for the three- and nine-month periods ended July 2, 2016 and June 27, 2015 include the following components:

 

   

Three Months Ended

   

Nine Months Ended

 

(In thousands)

 

July 2,

2016

   

June 27,

2015

   

July 2,

2016

   

June 27,

2015

 

Interest cost

  $ 37     $ 32     $ 111     $ 98  

Expected return on plan assets

    (44 )     (46 )     (132 )     (136 )

Recognized net actuarial loss

    19       14       57       40  

Net periodic pension cost

  $ 12     $ -     $ 36     $ 2  

 

Supplemental employee retirement plan. The Company maintains supplemental employee retirement plans (each, a “SERP”) with certain of its employees (each, a “Participant”). Under the SERPs, if the Participant remains in continuous service with the Company for a period of at least 30 years, the Company will pay to the Participant, for the 15-year period following the later of the Participant’s retirement date or the Participant’s attainment of age 65, a supplemental retirement benefit equal to 50% of the Participant’s highest average annual base salary for five consecutive years in the 10-year period preceding the Participant’s retirement. If the Participant retires prior to the completion of 30 years of continuous service with the Company, but has completed at least 10 years of continuous service with the Company and is at least 55 years of age, the amount of the supplemental retirement benefit will be reduced by 1/360th for each month short of 30 years that the Participant was employed by the Company.

 

Net periodic pension costs for the SERPs for the three- and nine-month periods ended July 2, 2016 and June 27, 2015 include the following components:

 

   

Three Months Ended

   

Nine Months Ended

 

(In thousands)

 

July 2,

2016

   

June 27,

2015

   

July 2,

2016

   

June 27,

2015

 

Service cost

  $ 66     $ 72     $ 198     $ 216  

Interest cost

    81       81       243       243  

Recognized net actuarial loss

    21       29       63       87  

Net periodic pension cost

  $ 168     $ 182     $ 504     $ 546  

 

 
13

 

 

(9) Long-Term Debt

 

Revolving Credit Facility. The Company has a $100.0 million revolving credit facility (the “Credit Facility”) that is used to supplement its operating cash flow and fund its working capital, capital expenditure, general corporate and growth requirements. In May 2015, the Company amended the Credit Facility to, among other changes, extend its maturity date from June 2, 2016 to May 13, 2020. 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 July 2, 2016, no borrowings were outstanding on the Credit Facility, $81.5 million of borrowing capacity was available and outstanding letters of credit totaled $1.8 million.

 

Interest rates on the Credit Facility are based upon (1) an index rate that is established at the highest of the prime rate, 0.50% plus the federal funds rate or the LIBOR rate plus the excess of the then-applicable margin for LIBOR loans over the then-applicable margin for index rate loans, or (2) at the election of the Company, a LIBOR rate, plus in either case, an applicable interest rate margin. The applicable interest rate margins are adjusted on a quarterly basis based upon the amount of excess availability on the Credit Facility within the range of 0.25% to 0.75% for index rate loans and 1.25% to 1.75% for LIBOR loans. In addition, the applicable interest rate margins would be increased by 2.00% upon the occurrence of certain events of default provided for under the terms of the Credit Facility. Based on the Company’s excess availability as of July 2, 2016, the applicable interest rate margins on the Credit Facility were 0.25% for index rate loans and 1.25% for LIBOR loans.

 

The Company’s ability to borrow available amounts under the Credit Facility will be restricted or eliminated in the event of certain covenant breaches, events of default or if the Company is unable to make certain representations and warranties provided for under the terms of the Credit Facility. The Company is required to maintain a fixed charge coverage ratio of not less than 1.10 at the end of each fiscal quarter for the twelve-month period then ended when the amount of liquidity on the Credit Facility is less than $12.5 million. In addition, the terms of the Credit Facility restrict the Company’s ability to, among other things: engage in certain business combinations or divestitures; make investments in or loans to third parties, unless certain conditions are met with respect to such investments or loans; pay cash dividends or repurchase shares of the Company’s stock subject to certain minimum borrowing availability requirements; incur or assume indebtedness; issue securities; enter into certain transactions with affiliates of the Company; or permit liens to encumber the Company’s property and assets. The terms of the Credit Facility also provide that an event of default will occur with respect to the Company upon the occurrence of, among other things: defaults or breaches under the loan documents, subject in certain cases to cure periods; defaults or breaches by the Company or any of its subsidiaries under any agreement resulting in the acceleration of amounts above certain thresholds or payment defaults above certain thresholds; certain events of bankruptcy or insolvency with respect to the Company; certain entries of judgment against the Company or any of its subsidiaries, which are not covered by insurance; or a change of control of the Company. As of July 2, 2016, the Company was in compliance with all of the financial and negative covenants under the Credit Facility and there have not been any events of default.

 

Amortization of capitalized financing costs associated with the Credit Facility was $16,000 and $21,000 for the three-month periods ended July 2, 2016 and June 27, 2015, respectively, and $48,000 and $72,000 for the nine-month periods ended July 2, 2016 and June 27, 2015, respectively. Accumulated amortization of capitalized financing costs was $4.5 million as of July 2, 2016 and October 3, 2015.

 

(10) Earnings Per Share

 

The computations of basic and diluted earnings per share attributable to common shareholders for the three- and nine-month periods ended July 2, 2016 and June 27, 2015 are as follows:

 

   

Three Months Ended

   

Nine Months Ended

 

(In thousands, except per share amounts)

 

July 2,

2016

   

June 27,

2015

   

July 2,

2016

   

June 27,

2015

 

Net earnings available to common shareholders

  $ 13,531     $ 5,392     $ 27,391     $ 12,086  
                                 

Basic weighted average shares outstanding

    18,867       18,438       18,690       18,407  

Dilutive effect of stock-based compensation

    268       390       321       416  

Diluted weighted average shares outstanding

    19,135       18,828       19,011       18,823  
                                 

Net earnings per share:

                               

Basic

  $ 0.72     $ 0.29     $ 1.47     $ 0.66  

Diluted

  $ 0.71     $ 0.29     $ 1.44     $ 0.64  

 

 
14 

 

 

Options representing 19,000 and 88,000 shares for the three-month periods ended July 2, 2016 and June 27, 2015, respectively, were antidilutive and not included in the diluted earnings per share calculation. Options representing 54,000 and 67,000 shares for the nine-month periods ended July 2, 2016 and June 27, 2015, respectively, were antidilutive and not included in the diluted earnings per share calculation.

 

(11) Share Repurchases

 

On November 18, 2008, the Company’s board of directors approved a share repurchase authorization to buy back up to $25.0 million of the Company’s outstanding common stock (the “Authorization”). Under the Authorization, repurchases may be made from time to time in the open market or in privately negotiated transactions subject to market conditions, applicable legal requirements and other factors. The Company is not obligated to acquire any particular amount of common stock and the program may be commenced or suspended at any time at the Company’s discretion without prior notice. The Authorization continues in effect until terminated by the Board of Directors. As of July 2, 2016, there was $24.8 million remaining available for future share repurchases under this authorization. No repurchases of common stock were made during the three- and nine-month periods ended July 2, 2016 and June 27, 2015.

 

 
15

 

 

(12) Other Financial Data

 

Balance sheet information:

 

(In thousands)

 

July 2,

2016

   

October 3,

2015

 

Accounts receivable, net:

               

Accounts receivable

  $ 50,061     $ 47,420  

Less allowance for doubtful accounts

    (635 )     (638 )

Total

  $ 49,426     $ 46,782  
                 

Inventories:

               

Raw materials

  $ 39,470     $ 38,457  

Work in process

    2,875       2,968  

Finished goods

    21,569       24,584  

Total

  $ 63,914     $ 66,009  
                 

Other current assets:

               

Prepaid insurance

  $ 1,108     $ 2,519  

Deferred tax asset

    -       1,492  

Other

    1,100       1,298  

Total

  $ 2,208     $ 5,309  
                 

Other assets:

               

Cash surrender value of life insurance policies

  $ 7,652     $ 7,194  

Capitalized financing costs, net

    187       227  

Other

    96       97  

Total

  $ 7,935     $ 7,518  
                 

Property, plant and equipment, net:

               

Land and land improvements

  $ 9,619     $ 9,279  

Buildings

    43,435       43,016  

Machinery and equipment

    143,628       142,662  

Construction in progress

    7,418       1,715  
      204,100       196,672  

Less accumulated depreciation

    (118,321 )     (112,494 )

Total

  $ 85,779     $ 84,178  
                 

Accrued expenses:

               

Salaries, wages and related expenses

  $ 6,300     $ 5,455  

Income taxes

    2,316       2,187  

Customer rebates

    1,178       1,760  

Pension plan

    1,143       1,263  

Property taxes

    902       1,507  

Restructuring liabilities

    532       505  

Workers' compensation

    287       294  

Other

    718       673  

Total

  $ 13,376     $ 13,644  
                 

Other liabilities:

               

Deferred compensation

  $ 8,027     $ 7,765  

Deferred income taxes

    5,162       6,057  

Other

    23       376  

Total

  $ 13,212     $ 14,198  

 

 
16

 

 

(13) Business Segment Information

 

The Company’s operations are entirely focused on the manufacture and marketing of concrete reinforcing products for the concrete construction industry. The Company’s concrete reinforcing products consist of welded wire reinforcement and PC strand. Based on the criteria specified in ASC Topic 280, Segment Reporting, the Company has one reportable segment.

 

(14) Contingencies

 

Insurance recoveries. On January 21, 2014, a fire occurred at the Company’s Gallatin, Tennessee PC strand manufacturing facility, damaging a portion of the facility and requiring the temporary curtailment of operations until the necessary repairs were completed. The Company reassigned a portion of its production requirements to its PC strand facility located in Sanderson, Florida, which was operating at a reduced utilization level. During the first quarter of fiscal 2015, the Company completed the remainder of the repairs and the Gallatin facility was fully operational.

 

The Company maintained general liability, business interruption and replacement cost property insurance coverage on its facilities that was sufficient to cover the losses incurred from the fire. During the three- and nine-month periods ended June 27, 2015, the Company received $0.1 million and $2.0 million of insurance proceeds, respectively, related to the expenses that were incurred and capital outlays that were required to replace property and equipment damaged in the fire. During the nine-month period ended June 27, 2015, the insurance proceeds attributable to the additional expenses incurred were recorded in cost of sales ($244,000) and selling, general and administrative expense ($69,000) on the consolidated statement of operations and comprehensive income. The insurance proceeds attributable to the property and equipment damaged in the fire were reported in cash flows from investing activities and all other insurance proceeds received were reported in cash flows from operating activities on the consolidated statement of cash flows. The Company reached a final settlement with its insurance carrier on this claim during the third quarter of fiscal 2015.

 

Customer dispute. During the three- and nine-month periods ended June 27, 2015, the Company settled a dispute with a customer resulting in a $0.7 million charge that was recorded in other expense (income) on the consolidated statement of operations and comprehensive income.

 

Legal proceedings. The Company is involved in lawsuits, claims, investigations and proceedings, including commercial, environmental and employment matters, which arise in the ordinary course of business. The Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its financial position, results of operations or cash flows.

 

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,” “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 a number of risks and uncertainties, 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 periodic and other reports and statements filed with the U.S. Securities and Exchange Commission (“SEC”), in particular in our Annual Report on Form 10-K for the year ended October 3, 2015. 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 and specifically decline 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.

 

 

 
17

 

 

It is not possible to anticipate and list all risks and uncertainties that may affect our future operations or financial performance; however, they would include, but are not limited to, the following:

 

 

general economic and competitive conditions in the markets in which we operate;

 

 

reduced spending 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;

 

 

fluctuations in the cost and availability of our primary raw material, hot-rolled steel wire rod, from domestic and foreign suppliers;

 

 

competitive pricing pressures and our ability to raise selling prices in order to recover increases in wire rod costs;

 

 

changes in United States 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 weak demand and reduced 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 operating costs;

 

 

unanticipated plant outages, equipment failures or labor difficulties;

 

 

continued escalation in certain of our operating costs; and

 

 

the “Risk Factors” discussed in our Annual Report on Form 10-K for the year ended October 3, 2015 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 (“PC 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. Our products are sold nationwide as well as into Canada, Mexico, and Central and South America, and delivered 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; and (3) pursuing growth opportunities within our core businesses that further our penetration of the markets we currently serve or expand our geographic footprint.

 

On August 15, 2014, we, through our wholly-owned subsidiary, Insteel Wire Products Company (“IWP”), purchased substantially all of the assets associated with the PC strand business of American Spring Wire Corporation (“ASW”) for a final adjusted purchase price of $33.5 million (the “ASW Acquisition”). ASW manufactured PC strand at facilities located in Houston, Texas and Newnan, Georgia (see Note 3 to the consolidated financial statements). We acquired, among other assets, the accounts receivable and inventories related to ASW’s PC strand business, the production equipment at its facility in Houston and its production equipment and facility in Newnan. We also entered into an agreement to lease the Houston facility from ASW with an option to purchase it in the future. Subsequent to the acquisition, we elected to consolidate our PC strand operations with the March 2015 closure of the Newnan facility.

 

 
18

 

  

Results of Operations

 

Statements of Operations – Selected Data

(Dollars in thousands)

 

   

Three Months Ended

   

Nine Months Ended

 
   

July 2,

2016

   

Change

   

June 27,

2015

   

July 2,

2016

   

Change

   

June 27,

2015

 
                                                 

Net sales

  $ 115,629       (1.2% )   $ 117,016     $ 315,434       (4.2% )   $ 329,411  

Gross profit

    27,547       75.5 %     15,694       62,585       71.8 %     36,439  

Percentage of net sales

    23.8 %             13.4 %     19.8 %             11.1 %

Selling, general and administrative expense

  $ 6,849       6.6 %   $ 6,427     $ 20,820       15.3 %   $ 18,054  

Percentage of net sales

    5.9 %             5.5 %     6.6 %             5.5 %

Restructuring charges, net

  $ 58       (83.2% )   $ 345     $ 83       (87.8% )   $ 678  

Other expense (income), net

    223       (62.9% )     601       138       N/M       (1,038 )

Interest expense

    40       (38.5% )     65       121       (55.7% )     273  

Interest income

    (53 )     N/M       (1 )     (103 )     N/M       (5 )

Effective income tax rate

    33.8 %             34.7 %     34.0 %             34.6 %

Net earnings

  $ 13,531       150.9 %   $ 5,392     $ 27,391       126.6 %   $ 12,086  

 

"N/M" = not meaningful

 

Third Quarter of Fiscal 2016 Compared to Third Quarter of Fiscal 2015

 

Net Sales

 

Net sales for the third quarter of 2016 decreased 1.2% to $115.6 million from $117.0 million in the prior year quarter as a 9.8% increase in shipments was offset by a 10.0% decrease in average selling prices. The increase in shipments was primarily due to improved market conditions and increased demand for products relative to the prior year. Shipments for both periods were unfavorably impacted by the excessive rainfall and flooding in the south central region of the country, particularly during April and May. The decrease in average selling prices was driven by competitive pricing pressures.   

 

Gross Profit

 

Gross profit for the third quarter of 2016 increased 75.5% to $27.5 million, or 23.8% of net sales, from $15.7 million, or 13.4% of net sales, in the same year-ago period. The year-over-year increase was primarily due to higher spreads between average selling prices and raw material costs ($9.7 million), lower unit conversion costs ($0.4 million) and the increase in shipments ($1.6 million). The increase in spreads was driven by lower raw material costs ($22.6 million) partially offset by lower average selling prices ($12.9 million).

 

Selling, General and Administrative Expense

 

Selling, general and administrative expense (“SG&A expense”) for the third quarter of 2016 increased 6.6% to $6.8 million, or 5.9% of net sales, from $6.4 million, or 5.5% of net sales, in the same year-ago period as higher compensation expense ($0.9 million) was partially offset by lower employee benefit costs ($0.2 million) and the relative year-over-year change in the cash surrender value of life insurance policies ($0.2 million). The increase in compensation expense was largely driven by higher incentive plan expense due to our improved financial results in the current year quarter. The decrease in employee benefit costs was primarily related to lower employee health insurance expense. The cash surrender value of life insurance policies increased $173,000 in the current year quarter compared with a decrease of $50,000 in the prior year quarter due to changes in the value of the underlying investments.

 

Restructuring Charges, Net

 

Net restructuring charges of $58,000 were incurred in the third quarter of 2016 for equipment relocation costs related to the consolidation of our PC strand facilities. Net restructuring charges of $345,000 were incurred in the third quarter of 2015 related to the closure of the Newnan, Georgia PC strand facility, which included facility closure ($327,000) and equipment relocation costs ($18,000).

 

 
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Other Expense

 

Other expense for the third quarter of 2016 was $0.2 million compared to $0.6 million in the same year-ago period. Other expense for the current year quarter was largely related to losses on the disposal of equipment. Other expense for the third quarter of 2015 was primarily due to a $0.7 million charge related to the settlement of a customer dispute.

 

Interest Expense

 

Interest expense for the third quarter of 2016 decreased 38.5% to $40,000 from $65,000 in the same year-ago period primarily due to the borrowings on our revolving credit facility during the prior year period.

 

Income Taxes

 

Our effective income tax rate for the third quarter of 2016 decreased to 33.8% from 34.7% for the same year-ago period due to changes in permanent book versus tax differences.

 

Net Earnings

 

Net earnings for the third quarter of 2016 increased to $13.5 million ($0.71 per diluted share) from $5.4 million ($0.29 per share) in the same year-ago period primarily due to the increase in gross profit partially offset by the increase in SG&A expense.

 

First Nine Months of Fiscal 2016 Compared to First Nine Months of Fiscal 2015

 

Net Sales

 

Net sales for the first nine months of 2016 decreased 4.2% to $315.4 million from $329.4 million in the same year-ago period as a 6.8% increase in shipments was offset by a 10.3% decrease in average selling prices. The increase in shipments was primarily due to improved market conditions relative to the prior year. The decrease in average selling prices was driven by competitive pricing pressures.

 

Gross Profit

 

Gross profit for the first nine months of 2016 increased 71.8% to $62.6 million, or 19.8% of net sales, from $36.4 million, or 11.1% of net sales, in the same year-ago period. The year-over-year increase was primarily due to higher spreads between average selling prices and raw material costs ($18.9 million), lower unit conversion costs ($3.9 million) and the increase in shipments ($2.7 million). The increase in spreads was driven by lower raw material costs ($54.7 million) and freight costs ($0.8 million) partially offset by lower average selling prices ($36.6 million).

 

Selling, General and Administrative Expense

 

SG&A expense for the first nine months of 2016 increased 15.3% to $ 20.8 million, or 6.6% of net sales, from $18.1 million, or 5.5% of net sales, in the same year-ago period as higher compensation expense ($3.2 million) was partially offset by lower employee benefit costs ($0.6 million). The increase in compensation expense was largely driven by higher incentive plan expense due to our improved financial results in the current year period. The decrease in employee benefit costs was primarily related to lower employee health insurance expense.

 

Restructuring Charges, Net

 

Net restructuring charges of $83,000 were incurred in the first nine months of 2016 related to the consolidation of our PC strand facilities, which included equipment relocation costs ($154,000), facility closure costs ($89,000) and impairment charges related to the decommissioning of equipment ($20,000) partially offset by a gain on the sale of equipment previously associated with the Newnan, Georgia PC strand facility ($180,000). Net restructuring charges of $678,000 were incurred in the prior year period related to the closure of the Newnan, Georgia facility, which included facility closure costs ($348,000), impairment charges related to the decommissioning of equipment ($237,000), employee separation costs ($75,000) and equipment relocation costs ($18,000).

 

 
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Other Expense (Income)

 

Other expense for the first nine months of 2016 was $138,000 compared with other income of $1.0 million in the same year-ago period. Other income for the prior year period was primarily related to a $1.7 million net gain from insurance proceeds attributable to the replacement of property and equipment damaged in the fire at our Gallatin, Tennessee PC strand facility in 2014 partially offset by a $0.7 million charge related to the settlement of a customer dispute.

 

Interest Expense

 

Interest expense for the first nine months of 2016 decreased 55.7% to $121,000 from $273,000 in the same year-ago period primarily due to the borrowings on our revolving credit facility during the prior year period.

 

Income Taxes

 

Our effective income tax rate for the first nine months of 2016 decreased slightly to 34.0% from 34.6% for the same year-ago period due to changes in permanent book versus tax differences.

 

Net Earnings

 

Net earnings for the first nine months of 2016 increased to $27.4 million ($1.44 per diluted share) from $12.1 million ($0.64 per diluted share) in the same year-ago period primarily due to the increase in gross profit partially offset by the increase in SG&A expense.

 

Liquidity and Capital Resources

 

Selected Financial Data

(Dollars in thousands)

 

   

Nine Months Ended

 
   

July 2,

2016

   

June 27,

2015

 

Net cash provided by operating activities

  $ 45,654     $ 16,325  

Net cash used for investing activities

    (9,027 )     (6,174 )

Net cash used for financing activities

    (16,047 )     (1,768 )
                 

Net working capital

    116,272       91,277  

Total debt

    -       -  

Percentage of total capital

    -       -  

Shareholders' equity

  $ 213,091     $ 190,910  

Percentage of total capital

    100.0 %     100.0 %

Total capital (total debt + shareholders' equity)

  $ 213,091     $ 190,910  

 

Operating Activities

 

Operating activities provided $45.7 million of cash during the first nine months of 2016 primarily from net earnings adjusted for non-cash items and a reduction in the net working capital components of accounts receivable, inventories, and accounts payable and accrued expenses. Net working capital provided $7.4 million of cash due to an $8.0 million increase in accounts payable and accrued expenses and a $2.1 million decrease in inventories partially offset by a $2.6 million increase in accounts receivable. The increase in accounts payable and accrued expenses was principally related to higher raw material purchases near the end of the period. The decrease in inventories was largely due to lower average raw material costs partially offset by higher raw material levels. The increase in accounts receivable was primarily related to higher sales near the end of the period.

 

Operating activities provided $16.3 million of cash during the first nine months of 2015 primarily from net earnings adjusted for non-cash items partially offset by an increase in the net working capital components of accounts receivable, inventories, and accounts payable and accrued expenses. Net working capital used $5.5 million of cash due to a $19.4 million decrease in accounts payable and accrued expenses partially offset by an $11.1 million decrease in inventories and a $2.8 million decrease in accounts receivable. The decrease in accounts payable and accrued expenses was largely due to lower raw material purchases near the end of the period and lower unit costs. The decrease in inventory was primarily driven by lower raw material purchases and unit costs. The decrease in accounts receivable was primarily related to lower selling prices.

 

 
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We may elect to make adjustments in our operating activities as changes occur in our construction end-markets, which could materially impact our cash requirements. While a downturn in the level of construction activity would adversely affect sales to our customers, it would generally reduce our working capital requirements.

 

Investing Activities

 

Investing activities used $9.0 million of cash during the first nine months of 2016 compared to $6.2 million during the same period last year. Capital expenditures increased to $9.1 million for the first nine months of 2016 from $6.8 million in the prior year period and are expected not to exceed $18.0 million for fiscal 2016, including outlays related to expansion of our Houston PC strand facility. Investing activities for the prior year included the $1.5 million acquisition of an intangible asset from a competitor, which was offset by the receipt of $1.7 million of insurance proceeds related to the Gallatin fire and $0.5 million of post-closing adjustments associated with the ASW Acquisition. Our investing activities are largely discretionary, providing us with the ability to significantly curtail outlays should business conditions warrant that such actions be taken.

 

Financing Activities

 

Financing activities used $16.0 million of cash during the first nine months of 2016 compared to $1.8 million during the same period last year. Cash dividends used $20.3 million of cash during the first nine months of 2016, including a special cash dividend totaling $18.6 million, or $1.00 per share, which was partially offset by $4.3 million of cash provided by stock option exercises and $1.2 million of related excess tax benefits. Financing activities for the prior year included the payment of $1.7 million of cash dividends and $0.2 million of financing costs incurred in connection with the amendment of our credit facility partially offset by $0.2 million of cash provided by stock option exercises.

 

Cash Management

 

Our cash is concentrated primarily 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 $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 May 2015, we amended the Credit Facility to, among other changes, extend its maturity date from June 2, 2016 to May 13, 2020. 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 July 2, 2016, no borrowings were outstanding on the Credit Facility, $81.5 million of borrowing capacity was available and outstanding letters of credit totaled $1.8 million.

 

We believe that, in the absence of significant unanticipated cash demands, 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, delay or restrict share repurchases, cease dividend payments and/or realign our working capital requirements.

 

Should we determine, at any time, that we required 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 the Credit Facility position us to meet our anticipated liquidity requirements for the foreseeable future.

 

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, the highest level of sales within the year typically occurs when weather conditions are the most conducive to construction activity. As a result, sales 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, the level of construction activity tends to be correlated with general economic conditions although there can be significant differences between the relative performance of nonresidential versus residential construction for extended periods.

 

 
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Impact of Inflation

 

We are subject to inflationary risks arising from fluctuations in the market prices for our primary raw material, hot-rolled 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. Inflation did not have a material impact on our sales or earnings during the third fiscal quarter of 2016. The timing and magnitude of any future changes in the prices for wire rod and the impact on selling prices for our products is uncertain at this time.

 

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

 

There have been no material changes in our contractual obligations and commitments as disclosed in our Annual Report on Form 10-K as of October 3, 2015 other than those which occur in the ordinary course of business.

 

Critical Accounting Policies

 

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 United States (“GAAP”) for interim financial information. The preparation of our financial statements requires the application of accounting policies in addition to certain estimates and judgments based on current available information, actuarial estimates, historical results and other assumptions believed to be reasonable. Actual results could differ from these estimates. Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” included in our Annual Report on Form 10-K for the year ended October 3, 2015 for further information regarding our critical accounting policies and estimates. As of July 2, 2016, there were no changes in the nature of our critical accounting policies or the application of those policies from those reported in our Annual Report on Form 10-K for the year ended October 3, 2015.

 

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 since the filing of our Form 10-K for the year ended October 3, 2015, 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 2016, we expect our financial results will continue to be favorably impacted by the ongoing improvement in our construction end-markets, which should support higher shipment volumes and operating levels, and reduced unit conversion costs at our facilities. Spreads between average selling prices and raw material costs are likely to narrow from the third quarter as we consume higher cost inventory, but should remain at improved levels. The recent passage of a new five-year federal transportation funding authorization provides greater funding certainty for states and municipalities that should spur increased infrastructure construction in the coming years.

 

We continue to focus on the operational fundamentals of our business: 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 cash operating costs; and pursuing further improvements in the productivity and effectiveness of all of our manufacturing, selling and administrative activities. We expect that our financial results will be favorably impacted by the realization of additional operating synergies associated with the ASW Acquisition and the related reconfiguration of our PC strand operations. As market conditions improve, we also expect gradually increasing contributions from the substantial investments we have made in our facilities in the form of reduced operating costs and additional capacity to support future growth (see “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors”). In addition, we will continue to pursue further acquisitions in our existing businesses that expand our penetration of markets we currently serve or expand our geographic footprint. 

 

 
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Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

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 deemed appropriate, through 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 that 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 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 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 and other trade actions. Although changes in wire rod costs and our selling prices may be correlated over extended periods of time, depending upon market conditions and competitive dynamics, there may be periods during which we are unable to fully recover increased wire rod costs through higher selling prices, which would reduce our gross profit and cash flow from operations. Additionally, should wire rod costs decline, our financial results may be negatively impacted if the selling prices for our products decrease to an even greater degree and to the extent that we are consuming higher cost inventory. Based on our shipments and average wire rod cost reflected in cost of sales for the first nine months of 2016, a 10% increase in the price of wire rod would have resulted in a $16.6 million decrease in our pre-tax earnings for the nine months ended July 2, 2016 (assuming there was not a corresponding change in our selling prices).

 

Interest Rates 

 

Although we did not have any balances outstanding on our revolving credit facility as of July 2, 2016, 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 July 2, 2016.

 

Item 4. Controls and Procedures

 

We have conducted an evaluation of the effectiveness of our disclosure controls and procedures as of July 2, 2016. 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 (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Further, we 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 July 2, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 
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PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

We are involved in various lawsuits, claims, investigations and proceedings, including commercial, environmental and employment matters, which arise in the ordinary course of business. We do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our financial position, results of operations or cash flows.

 

Item 1A. Risk Factors

 

During the quarter ended July 2, 2016, there were no material changes from the risk factors set forth under Part I, Item 1A., “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended October 3, 2015. 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 Annual Report on Form 10-K for the year ended October 3, 2015, 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.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

On November 18, 2008, our Board of Directors approved a share repurchase authorization to buy back up to $25.0 million of our outstanding common stock (the “Authorization”). Under the Authorization, repurchases may be made from time to time in the open market or in privately negotiated transactions subject to market conditions, applicable legal requirements and other factors. We are not obligated to acquire any particular amount of common stock and the program may be commenced or suspended at any time at our discretion without prior notice. The Authorization continues in effect until terminated by the Board of Directors. As of July 2, 2016, there was $24.8 million remaining available for future share repurchases under this authorization. No repurchases of common stock were made during the three- and nine-month periods ended July 2, 2016 and June 27, 2015.

 

Item 6. Exhibits

 

31.1

 

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

 

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

 

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101

 

The following financial information from the Quarterly Report on Form 10-Q of Insteel Industries, Inc. for the quarter ended July 2, 2016, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended July 2, 2016 and June 27, 2015, (ii) the Consolidated Balance Sheets as of July 2, 2016 and October 3, 2015, (iii) the Consolidated Statements of Cash Flows for the nine months ended July 2, 2016 and June 27, 2015, (iv) the Consolidated Statements of Shareholders’ Equity as of July 2, 2016 and October 3, 2015, and (v) the Notes to Consolidated Financial Statements.

 

 
25

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

INSTEEL INDUSTRIES, INC.

Registrant

 

 

 

Date: July 21, 2016

 

By:

/s/ Michael C. Gazmarian

     

     Michael C. Gazmarian

     

     Vice President, Chief Financial Officer and Treasurer

 

 

 

(Duly Authorized Officer and Principal Financial Officer)

   

 

 

 

 
26

 

 

EXHIBIT INDEX

 

Exhibit

Number

 

 

Description

     
     

31.1

 

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

 

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

 

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101

 

The following financial information from the Quarterly Report on Form 10-Q of Insteel Industries, Inc. for the quarter ended July 2, 2016, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended July 2, 2016 and June 27, 2015, (ii) the Consolidated Balance Sheets as of July 2, 2016 and October 3, 2015, (iii) the Consolidated Statements of Cash Flows for the nine months ended July 2, 2016 and June 27, 2015, (iv) the Consolidated Statements of Shareholders’ Equity as of July 2, 2016 and October 3, 2015, and (v) the Notes to Consolidated Financial Statements.

 

 

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