10-K 1 iiin20160817_10k.htm FORM 10-K iiin20160817_10k.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934  

     

For the fiscal year ended October 1, 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 27030

(Address of principal executive offices) (Zip Code)

 

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

 

Securities registered pursuant to Section 12(b) of the Act: 

Title of Each Class

Name of Each Exchange on Which Registered

Common Stock (No Par Value) (Preferred Share Purchase 

The NASDAQ Stock Market LLC

Rights are attached to and trade with the Common Stock) (NASDAQ Global Select Market)
   

Securities registered pursuant to Section 12(g) of the Act:

Preferred Share Purchase Rights (attached to and trade with the Common Stock)

Title of Class

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [  ] No [X]

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes [  ] No [X]

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K. [X]

 

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. (Check one):

 

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 Act). Yes [  ] No [X]

 

As of April 2, 2016 (the last business day of the registrant’s most recently completed second quarter), the aggregate market value of the common stock held by non-affiliates of the registrant was $507,817,830 based upon the closing sale price as reported on the NASDAQ Global Select Market. As of October 27, 2016, there were 18,975,641 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain portions of the registrant’s proxy statement to be delivered to shareholders in connection with the 2017 Annual Meeting of Shareholders are incorporated by reference as set forth in Part III hereof.

 

 
 

 

 

TABLE OF CONTENTS

 

 

 

Cautionary Note Regarding Forward-Looking Statements  

3

 

PART I

 

Item 1.

Business

4

     

Item 1A.

Risk Factors

6

     

Item 1B.

Unresolved Staff Comments

9

     

Item 2.

Properties

9

     

Item 3.

Legal Proceedings

9

     

Item 4.

Mine Safety Disclosures

9

     
Executive Officers of the Company 10
     

PART II

     

Item 5.

Market for the Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

10

     

Item 6.

Selected Financial Data

12

     

Item 7.

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

12

     

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

20

     

Item 8.

Financial Statements and Supplementary Data

20

     

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

48

     

Item 9A.

Controls and Procedures

48

     

Item 9B.

Other Information

50

     

PART III

     

Item 10.

Directors, Executive Officers and Corporate Governance

50

     

Item 11.

Executive Compensation

50

     

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

50

     

Item 13.

Certain Relationships and Related Transactions, and Director Independence

50

     

Item 14.

Principal Accounting Fees and Services

50

     

PART IV

     

Item 15.

Exhibits, Financial Statement Schedules

50

       

SIGNATURES

52

       

EXHIBIT INDEX

53

 

 
2

 

 

Cautionary Note Regarding Forward-Looking Statements

 

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly in the “Business,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of this report. 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 the “Risk Factors” section of this report and are updated from time to time in our filings with the United States (“U.S.”) Securities and Exchange Commission (“SEC”).

 

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.

 

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

 

 

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

 

 

changes in the spending levels for nonresidential and residential construction and the impact on demand for our products;

 

 

changes in the amount and duration of transportation funding provided by federal, state and local governments and the impact on spending for infrastructure construction and demand for our products;

 

 

the cyclical nature of the steel and building material industries;

 

 

credit market conditions and the relative availability of financing for us, our customers and the construction industry as a whole;

 

 

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

 

 

competitive pricing pressures and our ability to raise selling prices in order to recover increases in raw material or operating costs;

 

 

changes in U.S. or foreign trade policy affecting imports or exports of steel wire rod or our products;

 

 

unanticipated changes in customer demand, order patterns and inventory levels;

 

 

the impact of fluctuations in demand and capacity utilization levels on our unit manufacturing costs;

 

 

our ability to further develop the market for engineered structural mesh (“ESM”) and expand our shipments of ESM;

 

 

legal, environmental, economic or regulatory developments that significantly impact our operating costs;

 

 

unanticipated plant outages, equipment failures or labor difficulties; and

 

 

the risks and uncertainties discussed herein under the caption “Risk Factors.”

 

 

 
3

 

 

PART I

 

Item 1. Business

 

General

 

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 (“WWR”), including ESM, concrete pipe reinforcement (“CPR”) and standard welded wire reinforcement (“SWWR”). Our products are sold primarily to manufacturers of concrete products that are used in nonresidential construction. For fiscal 2016, we estimate that approximately 85% of our sales were related to nonresidential construction and 15% were related to residential construction.

 

Insteel is the parent holding company for two wholly-owned subsidiaries, Insteel Wire Products Company (“IWP”), an operating subsidiary, and Intercontinental Metals Corporation, an inactive subsidiary. We were incorporated in 1958 in the State of North Carolina.

 

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 in our core businesses that further our penetration of the markets we currently serve or expand our footprint. Headquartered in Mount Airy, North Carolina, we operate ten manufacturing facilities that are all located in the U.S. in close proximity to our customers and raw material suppliers. Our growth strategy is focused on organic opportunities as well as acquisitions in existing or related markets that leverage our infrastructure and core competencies in the manufacture and marketing of concrete reinforcing products.

 

On August 15, 2014, we, through our wholly-owned subsidiary, 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 4 to the consolidated financial statements). We acquired, among other assets, the accounts receivable and inventories related to ASW’s PC strand business, production equipment at its facilities in Houston, Texas and Newnan, Georgia, and the Newnan facility. We also entered into an agreement with ASW to lease the Houston facility with an option to purchase it in the future. Subsequent to the acquisition, we elected to consolidate our PC strand operations with the closure of the Newnan facility, which was completed in March 2015.

 

Products

 

Our operations are entirely focused on the manufacture and marketing of steel wire reinforcing products for concrete construction applications. Our concrete reinforcing products consist of two product lines: PC strand and WWR. Based on the criteria specified in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 280, Segment Reporting, we have one reportable segment.

 

PC strand is a high strength, seven-wire strand that is used to impart compression forces into precast concrete elements and structures, which may be either pretensioned or posttensioned, providing reinforcement for bridges, parking decks, buildings and other concrete structures. Its high tensile strength allows for the casting of longer spans and thinner sections. Pretensioned or “prestressed” concrete elements or structures are primarily used in nonresidential construction while posttensioned concrete elements or structures are used in both nonresidential and residential construction. For fiscal years 2016, 2015 and 2014, PC strand sales represented 39%, 43% and 38%, respectively, of our net sales.

 

WWR is produced as either a standard or a specially engineered reinforcing product for use in nonresidential and residential construction. We produce a full range of WWR products, including ESM, CPR and SWWR. ESM is an engineered made-to-order product that is used as the primary reinforcement for concrete elements or structures, frequently serving as a lower cost reinforcing solution than hot-rolled rebar. CPR is an engineered made-to-order product that is used as the primary reinforcement in concrete pipe, box culverts and precast manholes for drainage and sewage systems, water treatment facilities and other related applications. SWWR is a secondary reinforcing product that is produced in standard styles for crack control applications in residential and light nonresidential construction, including driveways, sidewalks and various slab-on-grade applications. For fiscal years 2016, 2015 and 2014, WWR sales represented 61%, 57% and 62%, respectively, of our net sales.

 

Marketing and Distribution

 

We market our products through sales representatives who are our employees. Our outside sales representatives are trained on the technical applications for our products and sell multiple product lines in their respective territories. We sell our products nationwide across the U.S. and, to a much lesser extent, into Canada, Mexico, and Central and South America, delivering them primarily by truck, using common or contract carriers. The delivery method selected is dependent upon backhaul opportunities, comparative costs and customer service requirements.

 

 
4

 

 

Customers

 

We sell our products to a broad range of customers that includes manufacturers of concrete products, and to a lesser extent, distributors, rebar fabricators and contractors. In fiscal 2016, we estimate that approximately 70% of our net sales were to manufacturers of concrete products and 30% were to distributors, rebar fabricators and contractors. In many cases we are unable to identify the specific end use for our products as most of our customers sell products that are used for both nonresidential and residential construction, and the same products can be used for different end uses. We did not have any customers that represented 10% or more of our net sales in fiscal years 2016, 2015 and 2014, and are not dependent upon a single customer or a few customers, the loss of which would have a material adverse effect on our business.

 

Backlog 

 

Backlog for our business is minimal due to the relatively short lead times that are required by our customers. We believe that the majority of our firm orders as of the end of fiscal 2016 will be shipped during the first quarter of fiscal 2017.

 

Seasonality and Cyclicality

 

Demand in our markets is both seasonal and cyclical, driven by the level of construction activity, but can also be impacted by fluctuations in the inventory positions of our customers. From a seasonal standpoint, shipments typically reach their highest level of the year when weather conditions are the most conducive to construction activity. As a result, shipments and profitability are usually higher in the third and fourth quarters of the fiscal year and lower in the first and second quarters. From a cyclical standpoint, construction activity and demand for our products is generally correlated with general economic conditions, although there can be significant differences between the relative strength of nonresidential and residential construction for extended periods.

 

Raw Materials

 

The primary raw material used to manufacture our products is hot-rolled carbon steel wire rod, which we purchase from both domestic and foreign suppliers. Wire rod can generally be characterized as a commodity product. We purchase several different grades and sizes of wire rod with varying specifications based on the diameter, chemistry, mechanical properties and metallurgical characteristics that are required for our products. High carbon grades of wire rod are required for the production of PC strand while low carbon grades are used to manufacture WWR.

 

Wire rod prices tend to fluctuate based on changes in scrap and other metallic prices for steel producers together with domestic and global market conditions. In most economic environments, domestic demand for wire rod exceeds domestic production capacity and imports of wire rod are necessary to satisfy the supply requirements of the U.S. market. Trade actions initiated by domestic wire rod producers can significantly impact the pricing and availability of imported wire rod, which during fiscal years 2016 and 2015 represented approximately 30% and 29%, respectively, of our total wire rod purchases. We believe that our substantial wire rod requirements, desirable mix of sizes and grades, and strong financial condition represent a competitive advantage by making us a relatively more attractive customer to our suppliers.

 

Our ability to source wire rod from overseas suppliers is limited by domestic content requirements generally referred to as “Buy America” or “Buy American” laws that exist at both the federal and state levels. These laws generally prescribe a domestic “melt and cast” standard for purposes of compliance. Certain segments of the PC strand market and the majority of our CPR and ESM products are certified to customers to be in compliance with the domestic content regulations.

 

Selling prices for our products tend to be correlated with changes in wire rod prices. However, the timing and magnitude of the relative price changes varies depending upon market conditions and competitive factors. Ultimately the relative supply - demand balance in our markets and competitive dynamics determine whether our margins expand or contract during periods of rising or falling wire rod prices.

 

Competition

 

We are the nation’s largest manufacturer of steel wire reinforcing products for concrete construction applications. Our markets are highly competitive based on price, quality and service. Some of our competitors, such as Nucor Corporation, Keystone Consolidated Industries, Inc. (“Keystone”), Oklahoma Steel and Wire, and Gerdau Long Products North America, are vertically integrated companies that produce both wire rod and concrete reinforcing products and offer multiple product lines over broad geographic areas. Other competitors are smaller independent companies that offer limited competition in certain markets. Our primary competitors for WWR products are Nucor Corporation, Gerdau Ameristeel Corporation, Engineered Wire Products, Inc. (a subsidiary of Keystone), Davis Wire Corporation, Oklahoma Steel & Wire Co., Inc., Concrete Reinforcements Inc. and Wire Mesh Corporation. Our primary competitors for PC strand are Sumiden Wire Products Corporation, Keystone and Wire Mesh Corporation. Import competition is also a significant factor in certain segments of the PC strand market that are not subject to “Buy America” requirements.

 

 
5

 

 

In response to irrationally-priced import competition from offshore PC strand suppliers, we have pursued trade cases when necessary as a means of ensuring that foreign producers were complying with the applicable trade laws and regulations. In 2003, we joined together with a coalition of domestic PC strand producers and filed petitions with the U.S. Department of Commerce (the “DOC”) alleging that imports of PC strand from Brazil, India, Korea, Mexico and Thailand were being “dumped” or sold in the U.S. at a price that was lower than fair value and had injured the domestic PC strand industry. The DOC ruled in our favor and imposed anti-dumping duties ranging from 12% up to 119%, which had the effect of limiting the participation of these countries in the domestic market. In 2010, we joined together with a coalition of domestic PC strand producers and filed petitions with the DOC alleging that imports of PC strand from China were being “dumped” or sold in the U.S. at a price that was lower than fair value and that subsidies were being provided to Chinese PC strand producers by the Chinese government, both of which had injured the domestic PC strand industry. The DOC ruled in our favor and imposed final countervailing duty margins ranging from 9% to 46% and anti-dumping margins ranging from 43% to 194%, which had the effect of limiting the continued participation of Chinese producers in the domestic market.

 

Quality and service expectations of customers have risen substantially over the years and are key factors that impact their selection of suppliers. Technology has become a critical competitive factor from the standpoint of manufacturing costs, quality and customer service capabilities. In view of our strong market positions, broad product offering and national footprint, technologically advanced manufacturing facilities, low-cost production capabilities, sophisticated information systems and financial strength and flexibility, we believe that we are well-positioned to compete favorably with other producers of our concrete reinforcing products.

 

Employees

 

As of October 1, 2016, we had 848 employees, none of which were represented by labor unions. In the event of production disruptions, we believe that our contingency plans would enable us to continue serving our customers, although there can be no assurances that a work slowdown or stoppage would not adversely impact our operating costs and financial results.

 

Product Warranties

 

Our products are used in applications that are subject to inherent risks, including performance deficiencies, personal injury, property damage, environmental contamination or loss of production. We warrant our products to meet certain specifications. Although actual or claimed deficiencies from these specifications may give rise to claims, we do not maintain a reserve for warranties as the historical claims have been immaterial. We maintain product liability insurance coverage to minimize our exposure to such risks.

 

Environmental Matters

 

We believe that we are in compliance in all material respects with applicable environmental laws and regulations. We have experienced no material difficulties in complying with legislative or regulatory standards and believe that these standards have not materially impacted our financial position or results of operations. Although our future compliance with additional environmental requirements could necessitate capital outlays, we do not believe these expenditures would ultimately have a material adverse effect on our financial position or results of operations. We expect to make capital outlays for environmental control processes associated with our expansion of the Houston facility during fiscal 2017, but do not expect these expenditures will have a material effect on our financial position or results of operations.

 

Available Information

 

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to these reports, are available at no cost on our web site at http://investor.insteel.com/sec.cfm and the SEC’s web site at www.sec.gov as soon as reasonably practicable after we file these reports electronically with, or furnish them to, the SEC. The information available on our web site and the SEC’s web site is not incorporated into this report or any of our filings with the SEC.

 

Item 1A. Risk Factors

 

An investment in our common stock involves risks and uncertainties. You should carefully consider the following risk factors, in addition to the other information contained in this annual report on Form 10-K, before deciding whether an investment in our common stock is suitable for you. The risk factors described below are not the only ones we face. There may be other risks and uncertainties that are currently unknown to us or that we currently consider to be immaterial that could adversely affect our business, results of operations, financial condition and cash flows.

 

 
6

 

 

Our business is cyclical and can be negatively impacted by prolonged economic downturns or tightening in the financial markets that reduce the level of construction activity and demand for our products.

 

Demand for our products is cyclical in nature and sensitive to changes in the economy and in the financial markets. Our products are sold primarily to manufacturers of concrete products that are used for a broad range of nonresidential and residential construction applications. Demand for our products is driven by the level of construction activity, which tends to be correlated with conditions in the general economy as well as other factors beyond our control. Tightening in the financial markets could adversely impact demand for our products by reducing the availability of financing to our customers and the construction industry as a whole and increasing the risk of payment defaults on our outstanding customer balances. Future prolonged periods of economic weakness or reduced availability of financing could have a material adverse impact on our business, results of operations, financial condition and cash flows.

 

Our business can be negatively impacted by reductions in the amount and duration of government funding for infrastructure projects that reduce the level of construction activity and demand for our products.

 

Certain of our products are used in the construction of highways, bridges and other infrastructure projects that are funded by federal, state and local governments. Reductions in the amount of funding for such projects or the period for which it is provided could have a material adverse impact on our business, results of operations, financial condition and cash flows.

 

Our operations are subject to seasonal fluctuations that may impact our cash flows.

 

Our shipments are typically lower in the first and second fiscal quarters due to the unfavorable impact of winter weather on construction activity during these periods and customer plant shutdowns associated with holidays. As a result, our cash flows may fluctuate from quarter to quarter due to these seasonal factors.

 

Demand for our products is highly variable and difficult to forecast due to our minimal backlog and unanticipated changes that can occur in customer order patterns or inventory levels.

 

Demand for our products is highly variable. The short lead times for customer orders and minimal backlog that characterize our business make it difficult to forecast the future level of demand for our products. In some cases, unanticipated softening in demand can be exacerbated by inventory reduction measures pursued by our customers, which may cause significant fluctuations in our sales, profitability and cash flows.

 

Our financial results can be negatively impacted by the volatility in the cost and availability of our primary raw material, hot-rolled carbon steel wire rod.

 

The primary raw material used to manufacture our products is hot-rolled carbon steel wire rod, which we purchase from both domestic and foreign suppliers. We do not use derivative commodity instruments to hedge our exposure to changes in the price of wire rod as such instruments are currently unavailable in the financial markets. Beginning in fiscal 2004, a tightening of supply in the rod market together with fluctuations in the raw material costs of rod producers resulted in increased price volatility which has continued through fiscal 2016. In response to the increased pricing volatility, wire rod producers have resorted to increasing the frequency of price adjustments, typically on a monthly basis as well as unilaterally changing the terms of prior commitments.

 

Although changes in our wire rod costs and selling prices tend to be correlated, we may be unable to fully recover increased rod costs through higher selling prices during weaker market environments, which would reduce our earnings and cash flows. Additionally, when raw material costs decline, our financial results may be negatively impacted if the selling prices for our products decrease to an even greater extent and if we are consuming higher cost material from inventory.

 

Our financial results can also be significantly impacted if raw material supplies are inadequate to satisfy our purchasing requirements. In addition, trade actions by domestic wire rod producers against offshore suppliers can have a considerable impact on the availability and cost of imported wire rod. The imposition of anti-dumping or countervailing duty margins by the DOC against exporting countries can have the effect of reducing or eliminating their activity in the domestic market, which is of increasing significance in view of the reductions in domestic wire rod production capacity that have occurred in recent years. If we were unable to obtain adequate and timely delivery of our raw material requirements, we may be unable to manufacture sufficient quantities of our products or operate our manufacturing facilities in an efficient manner, which could result in lost sales and higher operating costs.

 

 
7

 

 

Foreign competition could adversely impact our financial results.

 

Our PC strand business is subject to offshore import competition on an ongoing basis in that domestic production capacity is insufficient to satisfy domestic demand in most market environments. If we are unable to purchase raw materials and achieve manufacturing costs that are competitive with those of foreign producers, or if the margin and return requirements of foreign producers are substantially lower, our market share and profit margins could be negatively impacted. In response to irrationally-priced import competition from offshore PC strand suppliers, we have pursued trade cases when necessary as a means of ensuring that foreign producers were complying with the applicable trade laws and regulations. These trade cases have resulted in the imposition of duties which have had the effect of limiting the continued participation of certain countries in the domestic market. Trade law enforcement is critical to our ability to maintain our competitive position against foreign PC strand producers that engage in unlawful trade practices.

 

Our manufacturing facilities are subject to unexpected equipment failures, operational interruptions and casualty losses.

 

Our manufacturing facilities are subject to risks that may limit our ability to manufacture and sell our products, including unexpected equipment failures and catastrophic losses due to other unanticipated events such as fires, explosions, accidents, adverse weather conditions and transportation interruptions. For example, during fiscal 2014, a fire at our Gallatin, Tennessee PC strand manufacturing facility damaged a portion of the plant and required the temporary curtailment of operations until the necessary repairs were completed. Any such equipment failures or events can subject us to material plant shutdowns, periods of reduced production or unexpected downtime. Furthermore, the resolution of certain operational interruptions may require significant capital expenditures. Although our insurance coverage could offset the losses or expenditures relating to some of these events, our results of operations and cash flows could be negatively impacted to the extent that such claims were not covered or only partially covered by our insurance.

 

We are increasingly dependent on information technology systems that are susceptible to certain risks, including cybersecurity breaches and data leaks, which could adversely impact our business.

 

Our increasing reliance on technology systems and infrastructure heightens our potential vulnerability to system failure and malfunction, breakdowns due to natural disasters, human error, unauthorized access, power loss and other unforeseen events. Data privacy breaches by employees and others with or without authorized access to our systems poses risks that sensitive data may be permanently lost or leaked to the public or other unauthorized persons. With the growing use and rapid evolution of technology, not limited to cloud-based computing and mobile devices, there are additional risks of unintentional data leaks. There is also the risk of the theft of confidential information, intentional vandalism, industrial espionage, and a variety of cyber-attacks that could compromise our internal technology system and infrastructure, or result in data leaks in-house or at our third-party providers and business partners. Failures of technology or related systems, or an improper release of confidential information, could adversely impact our business or subject us to unexpected liabilities.

 

Our financial results could be adversely impacted by the escalation of our operating costs.

 

Consistent with the experience of other employers, our medical and workers’ compensation costs have increased substantially in recent years and are expected to continue to rise. The Patient Protection and Affordable Care and Education Reconciliation Act of 2010 will have a significant impact on employers, health care providers, insurers and others associated with the health care industry and increase our employee health care costs. This legislation requires certain large employers like us to offer health care benefits to full-time employees or face potential annual penalties. To avoid these penalties, employers must offer health benefits providing a minimum level of coverage and limit the amount that employees are charged for the coverage. Provisions of this law have become and will become effective at various dates over the next several years and many of the regulations and guidance for the law have not been implemented. Due to the breadth and complexity of this law, the lack of implementing regulations and interpretive guidance and the phased-in nature of the requirement, we cannot predict the future effect of this law on our results. Any significant increases in the costs attributable to our self-insured health and workers’ compensation plans could adversely impact our business, results of operations, financial condition and cash flows.

 

In addition, increasing prices for natural gas, electricity, fuel and consumables would adversely affect our manufacturing and distribution costs. For most of our business, we incur the fuel costs and surcharges associated with the delivery of products to our customers. Although we have previously implemented numerous measures to offset the impact of increases in these costs, there can be no assurance that such actions will be effective. If we are unable to pass these additional costs through by raising our selling prices, our financial results could be adversely impacted.   

 

Our financial results could be adversely impacted by the impairment of goodwill.

 

Our balance sheet includes intangible assets, including goodwill and other separately identifiable assets primarily related to the ASW Acquisition, and we may acquire additional intangible assets in connection with future acquisitions. We are required to review goodwill for impairment on an annual basis, or more frequently if certain indicators of permanent impairment arise such as, among other things, a decline in our stock price and market capitalization and lower than projected operating results and cash flows. If our review determines that goodwill has been impaired, the impaired portion would have to be written-off during that period which could have an adverse effect on our business and financial results.

 

 
8

 

 

Our capital resources may not be adequate to provide for our capital investment and maintenance expenditures if we were to experience a substantial downturn in our financial performance. 

 

Our operations are capital intensive and require substantial recurring expenditures for the routine maintenance of our equipment and facilities. Although we expect to finance our business requirements through internally generated funds or from borrowings under our $100.0 million revolving credit facility, we cannot provide any assurances these resources will be sufficient to support our business. A material adverse change in our operations or financial condition could limit our ability to borrow funds under our credit facility, which could further adversely impact our liquidity and financial condition. Any significant future acquisitions could require additional financing from external sources that may not be available on favorable terms, which could adversely impact our operations, growth plans, financial condition and results of operations.

 

Environmental compliance and remediation could result in substantially increased capital investments and operating costs.

 

Our business is subject to numerous federal, state and local laws and regulations pertaining to the protection of the environment that could require substantial increases in capital investments and operating costs. These laws and regulations, which are constantly evolving, are becoming increasingly stringent and the ultimate impact of compliance is not always clearly known or determinable because regulations under some of these laws have not yet been promulgated or are undergoing revision.

 

Our stock price can be volatile, often in connection with matters beyond our control.

 

Equity markets in the U.S. have been increasingly volatile in recent years. During fiscal 2016, our common stock traded as high as $37.22 and as low as $16.19. There are numerous factors that could cause the price of our common stock to fluctuate significantly, including: variations in our financial results; changes in our business outlook and expectations for the construction industry; changes in market valuations of companies in our industry; and announcements by us, our competitors or industry participants that may be perceived to impact us or our operations.

 

Item 1B. Unresolved Staff Comments.

 

None.

 

Item 2. Properties.

 

Our corporate headquarters and IWP’s sales and administrative offices are located in Mount Airy, North Carolina. At October 1, 2016, we operated ten manufacturing facilities located in Dayton, Texas; Gallatin, Tennessee; Hazleton, Pennsylvania; Hickman, Kentucky; Houston, Texas; Jacksonville, Florida; Kingman, Arizona; Mount Airy, North Carolina; Sanderson, Florida; and St. Joseph, Missouri.

 

We own all of our real estate except for the facility located in Houston, which we currently lease from ASW with an option to purchase in the future. We believe that our properties are in good operating condition and that our machinery and equipment have been well maintained. We also believe that our manufacturing facilities are suitable for their intended purposes and have capacities adequate to satisfy the current and projected demand for our products.

 

Item 3. Legal Proceedings. 

 

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

 

Item 4. Mine Safety Disclosures.

 

Not applicable.

 

 
9

 

 

Executive Officers of the Company

 

Our executive officers are as follows:

 

Name

 

Age

 

Position

H.O. Woltz III

 

60

 

President, Chief Executive Officer and Chairman of the Board

Michael C. Gazmarian

 

57

 

Vice President, Chief Financial Officer and Treasurer

James F. Petelle

 

66

 

Vice President - Administration and Secretary

Richard T. Wagner

 

57

 

Vice President and General Manager of IWP

 

H. O. Woltz III, 60, was elected Chief Executive Officer in 1991 and has been employed by us and our subsidiaries in various capacities since 1978. He was named President and Chief Operating Officer in 1989. He served as our Vice President from 1988 to 1989 and as President of Rappahannock Wire Company, formerly a subsidiary of our Company, from 1981 to 1989. Mr. Woltz has been a Director since 1986 and also serves as President of Insteel Wire Products Company. Mr. Woltz served as President of Florida Wire and Cable, Inc., formerly a subsidiary of our Company, until its merger with Insteel Wire Products Company in 2002. Mr. Woltz serves on the Executive Committee of our Board of Directors and was elected Chairman of the Board in 2009.

 

Michael C. Gazmarian, 57, was elected Vice President, Chief Financial Officer and Treasurer in February 2007. He had previously served as Chief Financial Officer and Treasurer since 1994, the year he joined us. Before joining us, Mr. Gazmarian had been employed by Guardian Industries Corp., a privately-held manufacturer of glass, automotive and building products, since 1986, serving in various financial capacities.

 

James F. Petelle, 66, joined us in October 2006. He was elected Vice President and Assistant Secretary on November 14, 2006 and Vice President - Administration and Secretary on January 12, 2007. He was previously employed by Andrew Corporation, a publicly-held manufacturer of telecommunications infrastructure equipment, having served as Secretary from 1990 to May 2006, and Vice President - Law from 2000 to October 2006.

 

Richard T. Wagner, 57, joined us in 1992 and has served as Vice President and General Manager of the Concrete Reinforcing Products Business Unit of our subsidiary, Insteel Wire Products Company, since 1998. In February 2007, Mr. Wagner was appointed Vice President of the parent company, Insteel Industries, Inc. From 1977 until 1992, Mr. Wagner served in various positions with Florida Wire and Cable, Inc., a manufacturer of PC strand and galvanized strand products that was later acquired by us in 2000.

 

The executive officers listed above were elected by our Board of Directors at its annual meeting held February 11, 2016 for a term that will expire at the next annual meeting or until their successors are elected and qualify. The next meeting at which officers will be elected is expected to be February 7, 2017.

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.

 

Our common stock is listed on the NASDAQ Global Select Market under the symbol “IIIN” and has been trading on NASDAQ since September 28, 2004. As of October 25, 2016, there were 675 shareholders of record. The following table summarizes the high and low sales prices as reported on the NASDAQ Global Select Market and the cash dividends per share declared in fiscal 2016 and 2015:

  

   

Fiscal 2016

   

Fiscal 2015

 
   

High

   

Low

   

Cash

Dividends

   

High

   

Low

   

Cash

Dividends

 

First Quarter

  $ 25.78     $ 16.19     $ 1.03     $ 24.85     $ 19.05     $ 0.03  

Second Quarter

    32.05       18.72       0.03       24.44       18.60       0.03  

Third Quarter

    32.11       25.40       0.03       22.85       18.15       0.03  

Fourth Quarter

    37.22       28.33       0.03       19.79       14.61       0.03  

 

We currently pay a quarterly cash dividend of $0.03 per share. In addition to the regular quarterly cash dividend, we paid a special cash dividend of $1.00 per share in the first quarter of fiscal 2016. While we intend to pay regular quarterly cash dividends for the foreseeable future, the declaration and payment of future dividends, if any, are discretionary and will be subject to determination by our Board of Directors each quarter after taking into account various factors, including general business conditions and our financial condition, operating results, cash requirements and expansion plans. See Note 8 of the consolidated financial statements for additional discussion with respect to restrictions on our ability to make dividend payments under the terms of our revolving credit facility.

 

 
10

 

 

Stock Performance Graph

 

The graph below compares the cumulative total shareholder return on our common stock with the cumulative total return of the Russell 2000 Index and the S&P Building Products Index for the five years ended October 1, 2016. The graph and table assume that $100 was invested on October 1, 2011 in our common stock and in each of the two indices and the reinvestment of all dividends. Cumulative total shareholder returns for our common stock, the Russell 2000 Index and the S&P Building Products Index are based on our fiscal year.

 

 

Comparison of Five-Year Cumulative Return for Insteel Industries, Inc.,

the Russell 2000 Index and the S&P Building Products Index

 

 

 

 

   

Fiscal Year Ended

 
   

10/1/11

   

9/29/12

   

9/28/13

   

9/27/14

   

10/3/15

   

10/1/16

 

Insteel Industries, Inc.

  $ 100.00     $ 117.74     $ 165.21     $ 217.81     $ 168.23     $ 398.19  

Russell 2000

    100.00       131.91       171.55       178.30       180.52       208.44  

S&P Building Products

    100.00       217.28       312.58       359.14       434.90       564.12  

 

Issuer Purchases of Equity Securities

 

Information regarding our share repurchase authorization is discussed in Note 19 to our consolidated financial statements and incorporated herein by reference.

 

Rights Agreement 

 

Information regarding our Rights Agreement is discussed in Note 17 to our consolidated financial statements and incorporated herein by reference.

 

 
11

 

 

Item 6. Selected Financial Data.

 

Financial Highlights

(In thousands, except per share amounts)

 

   

Year Ended

 
   

(52 weeks)

   

(53 weeks)

   

(52 weeks)

   

(52 weeks)

   

(52 weeks)

 
   

October 1,

   

October 3,

   

September 27,

   

September 28,

   

September 29,

 
   

2016

   

2015

   

2014

   

2013

   

2012

 

Net sales

  $ 418,547     $ 447,504     $ 408,978     $ 363,896     $ 363,303  

Net earnings

    37,245       21,710       16,641       11,735       1,809  

Net earnings per share (basic)

    1.99       1.18       0.91       0.65       0.10  

Net earnings per share (diluted)

    1.95       1.15       0.89       0.64       0.10  

Cash dividends declared

    1.12       0.12       0.12       0.37       0.12  

Total assets

    292,892       260,239       256,795       212,649       208,552  

Total debt

    -       -       -       -       11,475  

Shareholders’ equity

    224,566       200,215       178,883       161,056       149,500  

 

As summarized more fully in Item 7 below, on August 15, 2014, we, through our wholly-owned subsidiary, IWP, purchased substantially all the assets associated with the PC strand business of ASW. This transaction may materially affect the comparability of the information reflected in the selected financial data presented in this Item 6.

 

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; and (3) pursuing growth opportunities within our core businesses that further our penetration of the markets we currently serve or expand our footprint.

 

On August 15, 2014, we, through our wholly-owned subsidiary, IWP, purchased substantially all of the assets associated with the PC strand business of ASW for a final adjusted purchase price of $33.5 million. ASW manufactured PC strand at facilities located in Houston, Texas and Newnan, Georgia (see Note 4 to the consolidated financial statements). We acquired, among other assets, the accounts receivable and inventories related to ASW’s PC strand business, production equipment at its facilities in Houston, Texas and Newnan, Georgia, and the Newnan facility. 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 closure of the Newnan facility, which was completed in March 2015.

 

Critical Accounting Policies

 

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). 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 current available information, actuarial estimates, historical results and other assumptions believed to be reasonable. Actual results could differ from these estimates.

 

The following critical accounting policies are both important to the depiction of our financial condition and results of operations and require judgments, assumptions and estimates.

 

Revenue recognition. We recognize revenue from product sales when products are shipped and risk of loss and title has passed to the customer. Sales taxes collected from customers are excluded from revenues and recorded on a net basis.

 

Concentration of credit risk. Financial instruments that subject us to concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. Our cash is concentrated primarily at one financial institution, which at times exceeds federally insured limits. We are exposed to credit risk in the event of default by institutions in which our cash and cash equivalents are held and by customers to the extent of the amounts recorded on the balance sheet. We invest excess cash primarily in money market funds, which are highly liquid securities that bear minimal risk.

 

 
12

 

 

Most of our accounts receivable are due from customers that are located in the U.S. and are generally not secured by collateral depending upon the creditworthiness of the account. We provide an allowance for doubtful accounts based upon our assessment of the credit risk of specific customers, historical trends and other information. There is no disproportionate concentration of credit risk.

 

Allowance for doubtful accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the potential inability of our customers to make required payments on outstanding balances owed to us. Significant management judgments and estimates are used in establishing the allowances. These judgments and estimates consider such factors as the financial position, cash flows and payment history of our customers as well as current and expected business conditions. It is reasonably likely that actual collections will differ from our estimates, which may result in increases or decreases in the allowances. Adjustments to the allowances may also be required if there are significant changes in the financial condition of our customers.

 

Inventory valuation. We periodically evaluate the carrying value of our inventory. This evaluation includes assessing the adequacy of allowances for losses in the normal course of operations, providing for excess and obsolete inventory, and ensuring that inventory is valued at the lower of cost or estimated net realizable value. Our evaluation considers such factors as the cost of inventory, future demand, our historical experience and market conditions. In assessing the realization of inventory values, we are required to make judgments and estimates regarding future market conditions. Because of the subjective nature of these judgments and estimates, it is reasonably likely that actual outcomes will differ from our estimates. Adjustments to these reserves may be required if actual market conditions are substantially different than the assumptions underlying our estimates.

 

Long-lived assets. We review long-lived assets, which consist principally of property, plant and equipment and finite-lived intangibles, for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be fully recoverable. Recoverability of long-lived assets to be held and used is measured based on the future net undiscounted cash flows expected to be generated by the related asset or asset group. If it is determined that an impairment loss has been incurred, the impairment loss is recognized in the period in which it is incurred and is calculated based on the difference between the carrying value and the present value of estimated future net cash flows or comparable market values. Assets to be disposed of by sale are recorded at the lower of carrying value or fair value less selling cost when we have committed to a disposal plan, and are reported separately as assets held for sale on our balance sheet. Unforeseen events and changes in circumstances and market conditions could negatively affect the value of assets and result in an impairment charge.

 

Goodwill. Goodwill is tested annually for impairment and whenever events or circumstances change that would make it more likely than not that an impairment may have occurred. We perform our annual impairment analysis as of the first day of the fourth quarter each fiscal year, which involves comparing the current estimated fair value of the reporting unit to its recorded value, including goodwill.

 

We perform a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. It may be necessary to perform a quantitative analysis where a discounted cash flow model is used to determine the current estimated fair value of the reporting unit. Key assumptions used to determine the fair value of the reporting unit as part of our annual testing (and any required interim testing) include: (a) expected cash flows for the five-year period following the testing date; (b) an estimated terminal value using a terminal year growth rate based on the growth prospects of the reporting unit; (c) a discount rate based on our estimated after-tax weighted average cost of capital; and (d) a probability-weighted scenario approach by which varying cash flows are assigned to alternative scenarios based on their likelihood of occurrence. In developing these assumptions, we consider historical and anticipated future results, general economic and market conditions, the impact of planned business and operational strategies and all available information at the time the fair value of the reporting unit is estimated.

 

We monitor our operating results throughout the year to determine if events or changes in circumstances warrant any interim impairment testing. Otherwise, goodwill will be subject to the required annual impairment test during our fourth quarter. Changes in the judgments and estimates underlying our analysis of goodwill for possible impairment, including the expected future operating cash flows and discount rate, could reduce our estimated fair value in the future and result in an impairment of goodwill. There was no goodwill impairment loss recognized in fiscal 2016.

 

Self-insurance. We are self-insured for certain losses relating to medical and workers’ compensation claims. Self-insurance claims filed and claims incurred but not reported are accrued based upon our estimates of the discounted ultimate cost for uninsured claims incurred using actuarial assumptions followed by the insurance industry and historical experience. These estimates are subject to a high degree of variability based upon future inflation rates, litigation trends, changes in benefit levels and claim settlement patterns. Because of uncertainties related to these factors as well as the possibility of changes in the underlying facts and circumstances, future adjustments to these reserves may be required.

 

 
13

 

  

Litigation. We are involved in claims, lawsuits and other proceedings, which arise in the ordinary course of business. The eventual outcome of such matters and the potential losses that we may ultimately incur are subject to a high degree of uncertainty. We record expenses for litigation when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We estimate the probability of such losses based on the advice of legal counsel, the outcome of similar litigation, the status of the lawsuits and other factors. Due to the numerous factors that enter into these judgments and assumptions, it is reasonably likely that actual outcomes will differ from our estimates. We monitor our potential exposure to these contingencies on a regular basis and may adjust our estimates as additional information becomes available or as there are significant developments.

 

Stock-based compensation. We account for stock-based compensation arrangements, including stock option grants and restricted stock units, in accordance with the provisions of ASC Topic 718, Compensation - Stock Compensation. Under these provisions, compensation cost is recognized based on the fair value of equity awards on the date of grant and amortized on a straight-line basis over the vesting period. We use the Monte Carlo valuation model to determine the fair value of stock options at the date of grant, which requires us to make assumptions for the expected term, volatility, dividend yield, risk-free interest rate and forfeiture rates. These assumptions are based on historical information and judgment regarding market factors and trends. If actual results differ from our assumptions and judgments used in estimating these factors, future adjustments to these estimates may be required.

 

Assumptions for employee benefit plan. We account for our supplemental employee retirement plans (each, a “SERP”) in accordance with ASC Topic 715, Compensation - Retirement Benefits. Under the provisions of ASC Topic 715, we recognize net periodic pension cost and value liabilities based on certain actuarial assumptions, principally the assumed discount rate.

 

The discount rate we utilize for determining net periodic pension cost and the related benefit obligation for the SERPs is based, in part, on current interest rates earned on long-term bonds that receive one of the two highest ratings assigned by recognized rating agencies. Our discount rate assumptions are adjusted as of each valuation date to reflect current interest rates on such long-term bonds. The discount rate is used to determine the actuarial present value of the benefit obligations as of the valuation date as well as the interest component of the net periodic pension cost for the following year. The discount rate for the SERPs was 3.75% for fiscal 2016 and 4.25% for fiscal years 2015 and 2014.

 

The assumed discount rate is reevaluated annually. Changes in this assumption can result in the recognition of a materially different pension cost over different periods and a materially different liability amount in our consolidated financial statements. A reduction in the assumed discount rate generally results in an actuarial loss, as the actuarially-determined present value of estimated future benefit payments will increase. Conversely, an increase in the assumed discount rate generally results in an actuarial gain.  However, any actuarial gains generated in future periods reduce the negative amortization effect of any cumulative unamortized actuarial losses, while any actuarial losses generated in future periods reduce the favorable amortization effect of any cumulative unamortized actuarial gains.

 

The projected benefit obligations and net periodic pension cost for the SERPs are based in part on expected increases in future compensation levels. Our assumption for the expected increase in future compensation levels is based upon our average historical experience and our intentions regarding future compensation increases, which generally approximates average long-term inflation rates.

  

We currently expect net periodic pension cost for fiscal 2017 to be $856,000 for the SERPs. Cash contributions to the SERPs during fiscal 2017 are expected to be $290,000.

 

 A 0.25% decrease in the assumed discount rate for our SERPs would have increased our projected and accumulated benefit obligations as of October 1, 2016 by approximately $290,000 and $224,000, respectively, and our expected net periodic pension cost for fiscal 2017 by approximately $30,000.

 

See Note 11 to our consolidated financial statements for the related accounting and disclosures surrounding our terminated pension plan, the Insteel Wire Products Company Retirement Income Plan for Hourly Employees, Wilmington, Delaware (the “Delaware Plan”).

 

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.

 

 
14

 

 

Results of Operations

 

Statements of Operations – Selected Data

(Dollars in thousands)

 

 

   

Year Ended

 
   

October 1,

           

October 3,

           

September 27,

 
   

2016

   

Change

   

2015

   

Change

   

2014

 

Net sales

  $ 418,547       (6.5% )   $ 447,504       9.4 %   $ 408,978  

Gross profit

    85,188       46.0 %     58,333       19.6 %     48,773  

Percentage of net sales

    20.4 %             13.0 %             11.9 %

Selling, general and administrative expense

  $ 26,069       0.9 %   $ 25,824       10.5 %   $ 23,371  

Percentage of net sales

    6.2 %             5.8 %             5.7 %

Pension plan settlement loss

  $ 2,539    

N/M

    $ -       -     $ -  

Restructuring charges, net

    115       (67.0% )     349       (72.0 %)     1,247  

Acquisition costs

    -       -       -       (100.0 %)     612  

Other expense (income), net

    183    

N/M

      (1,113 )  

N/M

      (1,907 )

Interest expense

    158       (50.6% )     320       27.0 %     252  

Interest income

    (166 )  

N/M

      (11 )     10.0 %     (10 )

Effective income tax rate

    33.8 %             34.1 %             34.0 %

Net earnings

  $ 37,245       71.6 %   $ 21,710       30.5 %   $ 16,641  
                                         

"N/M" = not meaningful

                                       

  

2016 Compared with 2015

 

Net Sales

 

Net sales decreased 6.5% to $418.5 million in 2016 from $447.5 million in 2015 as a 2.6% increase in shipments was offset by an 8.8% reduction in average selling prices. Shipments for the prior year benefited from an extra week based on our fiscal calendar. On a pro forma basis adjusting both years to reflect the same 52-week period as 2016, the year-over-year shipment increase was 4.8%. The increase in shipments was primarily due to improved market conditions and increased demand for our products relative to the prior year. The decrease in average selling prices was driven by competitive pricing pressures.

 

Gross Profit

 

Gross profit increased 46.0% to $85.2 million, or 20.4% of net sales, in 2016 from $58.3 million, or 13.0% of net sales, in 2015. The year-over-year increase was primarily due to higher spreads between average selling prices and raw material costs ($22.3 million), lower unit conversion costs ($2.3 million) and the increase in shipments ($1.6 million). The increase in spreads was driven by lower raw material costs ($62.4 million) and freight expense ($0.5 million) partially offset by lower average selling prices ($40.6 million).

 

Selling, General and Administrative Expense

 

Selling, general and administrative expense (“SG&A expense”) increased 0.9% to $26.1 million, or 6.2% of net sales, in 2016 from $25.8 million, or 5.8% of net sales, in 2015 primarily due to higher compensation expense ($1.8 million) which was partially offset by lower employee benefit ($657,000), bad debt ($250,000) and legal expense ($114,000), together with the relative year-over-year change in the cash surrender value of life insurance policies ($441,000). The increase in compensation expense was largely driven by higher incentive plan expense due to our improved financial results in the current year. The decrease in employee benefit costs was primarily related to a reduction in high-dollar health insurance claims. The decrease in bad debt expense was due to favorable collections experience. The cash surrender value of life insurance policies increased $480,000 in the current year period compared with $39,000 in the prior year period due to the changes in the value of the underlying investments.

 

Pension Plan Settlement Loss

 

A pension plan settlement loss of $2.5 million was incurred in 2016 related to the termination of the Delaware Plan.

 

Restructuring Charges, Net

 

Net restructuring charges of $115,000 were incurred in 2016 related to the consolidation of our PC strand facilities, including equipment relocation costs ($186,000), 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 $349,000 were incurred in 2015 related to the closure of the Newnan facility, which included facility closure costs ($547,000), impairment charges related to the decommissioning of equipment ($543,000), equipment relocation costs ($79,000) and employee separation costs ($75,000). These charges were partially offset by an $895,000 gain on the sale of the real estate and certain of the equipment associated with the Newnan facility.

 

 
15

 

  

Other Expense (Income)

 

Other expense for 2016 was $0.2 million compared with other income of $1.1 million in 2015. The other income for 2015 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 decreased 50.6% to $158,000 in 2016 from $320,000 in 2015 primarily due to borrowings on our revolving credit facility during the prior year.

 

Income Taxes

 

Our effective income tax rate for 2016 decreased slightly to 33.8% from 34.1% in 2015 due to changes in permanent book versus tax differences.

 

Net Earnings

 

Net earnings increased to $37.2 million ($1.95 per diluted share) in 2016 from $21.7 million ($1.15 per diluted share) in 2015 primarily due to the increase in gross profit partially offset by higher SG&A expense and the pension settlement loss.

 

2015 Compared with 2014

 

Net Sales

 

Net sales increased 9.4% to $447.5 million in 2015 from $409.0 million in 2014 as a 10.0% increase in shipments was partially offset by a 0.5% reduction in average selling prices from the prior year levels. The increase in shipments was primarily driven by the additional business provided by the ASW Acquisition and the extra week in 2015 based on our fiscal calendar. On a pro forma basis adjusting both years to reflect the same 52-week period as 2014, the year-over-year shipment increase was 7.7%.

 

Gross Profit

 

Gross profit increased 19.6% to $58.3 million, or 13.0% of net sales, in 2015 from $48.8 million, or 11.9% of net sales, in 2014. The year-over-year increase was primarily due to wider spreads between average selling prices and raw material costs ($11.4 million) and higher shipments ($5.3 million) partially offset by higher unit conversion costs ($7.0 million). The increase in spreads was driven by lower raw material costs ($13.2 million) and freight expense ($0.9 million) partially offset by lower average selling prices ($2.7 million).

 

Selling, General and Administrative Expense

 

SG&A expense increased 10.5% to $25.8 million, or 5.8% of net sales, in 2015 from $23.4 million, or 5.7% of net sales, in 2014 primarily due to higher compensation expense ($650,000), amortization expense associated with intangible assets ($619,000) and employee benefit costs ($435,000) together with the relative year-over-year change in the cash surrender value of life insurance policies ($474,000). The increase in compensation expense was largely driven by higher incentive plan expense due to our improved financial results in 2015. The increase in amortization expense was primarily associated with the intangible assets that were acquired in connection with the ASW Acquisition. The increase in employee benefit costs was primarily due to higher employee health insurance and supplemental retirement plan expense. The cash surrender value of life insurance policies increased $39,000 in the current year period compared with $513,000 in the prior year period due to the changes in the value of the underlying investments.

 

Restructuring Charges, Net

 

Net restructuring charges of $349,000 were incurred in 2015 compared with $1.2 million in 2014. The net restructuring charges for 2015 were related to the closure of the Newnan, Georgia PC strand facility that was acquired through the ASW Acquisition, including $547,000 for facility closure costs, $543,000 for impairment charges related to the decommissioning of equipment, $79,000 for equipment relocation costs and $75,000 for employee separation costs. These charges were partially offset by an $895,000 gain on the sale of the real estate and certain of the equipment associated with the Newnan facility. The net restructuring charges for 2014 were for employee separation costs associated with staffing reductions that were implemented in connection with the ASW Acquisition.

 

 
16

 

  

Acquisition Costs

 

Acquisition costs of $0.6 million were incurred in 2014 for legal, accounting and other professional fees related to the ASW Acquisition, which were expensed as required under the provisions of ASC Topic 805, Business Combinations.

 

Other Expense (Income)

 

Other income for 2015 was $1.1 million compared to $1.9 million in 2014. The other income for 2015 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. The other income for 2014 was largely related to a net gain from insurance proceeds attributable to the replacement of property and equipment damaged in the Gallatin fire.

 

Interest Expense

 

Interest expense increased 27.0% to $320,000 in 2015 from $252,000 in 2014 primarily due to higher average borrowings on our revolving credit facility during 2015.

 

Income Taxes

 

Our effective income tax rate for 2015 was essentially unchanged at 34.1% compared with 34.0% in 2014.

 

Net Earnings

 

Net earnings increased to $21.7 million ($1.15 per diluted share) in 2015 from $16.6 million ($0.89 per diluted share) in 2014 primarily due to the increase in gross profit partially offset by higher SG&A expense.

 

Liquidity and Capital Resources

 

Selected Financial Data

(Dollars in thousands)

 

   

Year Ended

 
   

October 1,

   

October 3,

   

September 27,

 
   

2016

   

2015

   

2014

 

Net cash provided by operating activities

  $ 54,536     $ 35,774     $ 29,232  

Net cash used for investing activities

    (12,972 )     (3,039 )     (40,375 )

Net cash used for financing activities

    (15,949 )     (2,527 )     (1,247 )
                         

Cash and cash equivalents

    58,873       33,258       3,050  

Net working capital

    126,704       105,532       79,407  

Total debt

    -       -       -  

Percentage of total capital

    -       -       -  

Shareholders' equity

  $ 224,566     $ 200,215     $ 178,883  

Percentage of total capital

    100 %     100 %     100 %

Total capital (total debt + shareholders' equity)

  $ 224,566     $ 200,215     $ 178,883  

 

Operating Activities

 

Operating activities provided $54.5 million of cash in 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 $3.2 million of cash due to a $9.0 million increase in accounts payable and accrued expenses partially offset by a $5.2 million increase in inventories and a $0.6 million increase in accounts receivable. The increases in accounts payable and accrued expenses and inventories were largely related to higher raw material purchases near the end of the period. The increase in accounts receivable was primarily due to an increase in days sales outstanding partially offset by lower selling prices.

 

Operating activities provided $35.8 million of cash in 2015 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 $2.3 million of cash due to a $15.9 million decrease in inventories and a $4.3 million decrease in accounts receivable partially offset by a $17.9 million decrease in accounts payable and accrued expenses. The decrease in inventories and accounts payable and accrued expenses was primarily due to lower raw material purchases and unit costs. The decrease in accounts receivable was related to lower selling prices.

 

 
17

 

  

Operating activities provided $29.2 million of cash in 2014 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 $2.4 million of cash due to a $21.3 million increase in accounts payable and accrued expenses partially offset by a $16.8 million increase in inventories and a $2.1 million increase in accounts receivable. The increases in accounts payable and accrued expenses and inventories were largely related to higher raw material purchases driven by the increase in sales. The increase in accounts receivable was primarily due to the increase in sales.

 

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 $13.0 million of cash in 2016, $3.0 million in 2015 and $40.4 million in 2014. In 2016, $13.0 million of cash was used for capital expenditures. In 2015, $7.2 million of cash was used for capital expenditures and $1.5 million for the acquisition of an intangible asset from a competitor, which was partially offset by $3.5 million of proceeds from the sale of the real estate and certain of the equipment associated with the Newnan facility, $1.7 million of insurance proceeds related to the Gallatin fire and $0.5 million of post-closing adjustments associated with the ASW Acquisition. In 2014, $33.9 million of cash was used to fund the ASW Acquisition and $9.0 million for capital expenditures (including $4.5 million to replace property and equipment damaged in the fire at the Gallatin facility), which was partially offset by $2.7 million of insurance proceeds related to the Gallatin fire. 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 $15.9 million of cash in 2016, $2.5 million in 2015 and $1.2 million in 2014. In 2016, $20.9 million of cash was used for dividend payments (including a special cash dividend of $18.6 million, or $1.00 per share, and regular cash dividends totaling $2.3 million), which was partially offset by $5.1 million of proceeds from the exercise of stock options. In 2015, $2.2 million of cash was used for dividend payments and $0.2 million for financing costs that were incurred in connection with the amendment of our revolving credit facility. In 2014, $2.2 million of cash was used for dividend payments, which was partially offset by $1.1 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 $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 October 1, 2016, no borrowings were outstanding on the Credit Facility, $83.5 million of borrowing capacity was available and outstanding letters of credit totaled $1.8 million (see Note 8 to the consolidated financial statements). As of October 3, 2015, there were no borrowings outstanding on the Credit Facility.

 

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. 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 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 our Credit Facility position us to meet our anticipated liquidity requirements for the foreseeable future.

 

 
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, freight, energy and other consumables that are used in our manufacturing processes. We have generally been able to adjust our selling prices to pass through increases in these costs or offset them through various cost reduction and productivity improvement initiatives. However, our ability to raise our selling prices depends on market conditions and competitive dynamics, and there may be periods during which we are unable to fully recover increases in our costs.

 

During the second half of 2016, wire rod prices escalated over most of the period due to increasing scrap costs for wire rod producers which we were generally able to recover through price increases for our products. During 2015 and through the first half of 2016, wire rod prices declined through most of the period due to reductions in scrap costs for wire rod producers which favorably impacted our margins after the higher cost inventory we had purchased in earlier periods was consumed. During 2014, wire rod prices fluctuated within a narrower range, and inflation did not have a material impact on our sales or earnings. The timing and magnitude of any future increases 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 

 

Our contractual obligations and commitments at October 1, 2016 are as follows: 

 

Payments Due by Period

(In thousands)

 

           

Less Than

                   

More Than

 
   

Total

   

1 Year

   

1 - 3 Years

   

3 – 5 Years

   

5 Years

 
Contractual obligations:                                        

Raw material purchase commitments(1)

  $ 26,805     $ 26,805     $ -     $ -     $ -  

Supplemental employee retirement plan obligations

    20,938       290       680       482       19,486  

Operating leases

    2,416       1,364       1,002       50       -  

Trade letters of credit

    1,766       1,766       -       -       -  

Commitment fee on unused portion of credit facility

    1,149       313       626       210       -  

Other unconditional purchase obligations(2)

    11,638       11,638       -       -       -  

Total

  $ 64,712     $ 42,176     $ 2,308     $ 742     $ 19,486  

 

(1)Non-cancelable purchase commitments for raw materials.

(2)Contractual commitments for capital expenditures. 

 

Outlook

 

As we look ahead to 2017, the recent macro indicators for our construction end-markets have been mixed and it is unclear whether the softening in shipments we experienced during the latter part of the year will persist. Customer sentiment for the coming year remains positive and we expect to benefit from the higher degree of funding certainty provided by the FAST Act together with increased infrastructure spending at the state and local level.

 

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 following the anticipated completion of the expansion of our Houston plant by the end of the first quarter of fiscal 2017. 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 footprint.

 

 
19

 

  

Item 7A. 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 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 we can modify or adapt our hedging strategies as necessary.

 

Commodity Prices

 

We are subject to significant fluctuations in the cost and availability of our primary raw material, hot-rolled carbon steel wire rod, which we purchase from both domestic and foreign suppliers. We negotiate quantities and pricing for both domestic and foreign wire rod purchases for varying periods (most recently monthly for domestic suppliers), depending upon market conditions, to manage our exposure to price fluctuations and to ensure adequate availability of material consistent with our requirements. We do not use derivative commodity instruments to hedge our exposure to changes in prices as such instruments are not currently available for wire rod. Our ability to acquire wire rod from foreign sources on favorable terms is impacted by fluctuations in foreign currency exchange rates, foreign taxes, duties, tariffs and other trade actions. Although changes in our wire rod costs and selling prices tend to be correlated, in weaker market environments, we may be unable to fully recover increased rod costs through higher selling prices, which would reduce our earnings and cash flows. Additionally, when raw material costs decline, our financial results may be negatively impacted if the selling prices for our products decrease to an even greater extent and if we are consuming higher cost material from inventory. Based on our 2016 shipments and average wire rod cost reflected in cost of sales, a 10% increase in the price of wire rod would have resulted in a $21.7 million decrease in our annual pre-tax earnings (assuming there was not a corresponding change in our selling prices).

 

Interest Rates

 

Although we did not have any balances outstanding on our Credit Facility as of October 1, 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 October 1, 2016. During 2016, a 10% increase or decrease in the value of the U.S. dollar relative to foreign currencies to which we are typically exposed would not have had a material impact on our financial position, results of operations or cash flows.

 

 

Item 8. Financial Statements and Supplementary Data. 

 

(a) Financial Statements  
     
 

Consolidated Statements of Operations for the years ended October 1, 2016, October 3, 2015 and September 27, 2014

22

 

Consolidated Statements of Comprehensive Income for the years ended October 1, 2016, October 3, 2015 and September 27, 2014

23

 

Consolidated Balance Sheets as of October 1, 2016 and October 3, 2015

24

 

Consolidated Statements of Shareholders’ Equity for the years ended October 1, 2016, October 3, 2015 and September 27, 2014

25

 

Consolidated Statements of Cash Flows for the years ended October 1, 2016, October 3, 2015 and September 27, 2014

26

 

Notes to Consolidated Financial Statements

27

 

Report of Independent Registered Public Accounting Firm – Consolidated Financial Statements

46

 

Schedule II – Valuation and Qualifying Accounts for the years ended October 1, 2016, October 3, 2015 and September 27, 2014

47

 

Report of Independent Registered Public Accounting Firm – Internal Control Over Financial Reporting

49

  

 
20

 

 

(b) Supplementary Data

 

Selected quarterly financial data for 2016 and 2015 is as follows:

 

Financial Information by Quarter (Unaudited)

(In thousands, except per share and price data)

 

   

Quarter Ended

 
   

January 2

   

April 2

   

July 2

   

October 1

 

2016

                               

Operating results:

                               

Net sales

  $ 92,391     $ 107,414     $ 115,629     $ 103,113  

Gross profit

    16,423       18,615       27,547       22,603  

Net earnings

    6,708       7,152       13,531       9,854  

Net earnings per share:

                               

Basic

    0.36       0.38       0.72       0.52  

Diluted

    0.36       0.38       0.71       0.51  

 

   

Quarter Ended

 
   

December 27

   

March 28

   

June 27

   

October 3

 

2015

                               

Operating results:

                               

Net sales

  $ 110,628     $ 101,767     $ 117,016     $ 118,093  

Gross profit

    12,043       8,702       15,694       21,894  

Net earnings

    4,150       2,544       5,392       9,624  

Net earnings per share:

                               

Basic

    0.23       0.14       0.29       0.52  

Diluted

    0.22       0.14       0.29       0.51  

 

 
21

 

 

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

 

 

   

Year Ended

 
   

October 1,

   

October 3,

   

September 27,

 
   

2016

   

2015

   

2014

 

Net sales

  $ 418,547     $ 447,504     $ 408,978  

Cost of sales

    333,359       389,171       360,205  

Gross profit

    85,188       58,333       48,773  

Selling, general and administrative expense

    26,069       25,824       23,371  

Pension plan settlement loss

    2,539       -       -  

Restructuring charges, net

    115       349       1,247  

Acquisition costs

    -       -       612  

Other expense (income), net

    183       (1,113 )     (1,907 )

Interest expense

    158       320       252  

Interest income

    (166 )     (11 )     (10 )

Earnings before income taxes

    56,290       32,964       25,208  

Income taxes

    19,045       11,254       8,567  

Net earnings

  $ 37,245     $ 21,710     $ 16,641  
                         
                         

Net earnings per share:

                       

Basic

  $ 1.99     $ 1.18     $ 0.91  

Diluted

    1.95       1.15       0.89  
                         

Cash dividends declared

    1.12       0.12       0.12  
                         

Weighted average shares outstanding:

                       

Basic

    18,754       18,418       18,257  

Diluted

    19,055       18,803       18,665  

 

See accompanying notes to consolidated financial statements.

 

 
22

 

 

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

 

 

   

Year Ended

 
   

October 1,

   

October 3,

   

September 27,

 
   

2016

   

2015

   

2014

 
                         

Net earnings

  $ 37,245     $ 21,710     $ 16,641  
                         

Pension plan settlement, net of income taxes of ($733)

    1,197       -       -  

Adjustment to defined benefit plan liability, net of income taxes of $363, $218 and $140

    (592 )     (356 )     (228 )

Other comprehensive income (loss)

    605       (356 )     (228 )
                         

Comprehensive income

  $ 37,850     $ 21,354     $ 16,413  

 

See accompanying notes to consolidated financial statements.

 

 
23

 

 

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 

 

   

October 1,

   

October 3,

 
   

2016

   

2015

 

Assets:

               

Current assets:

               

Cash and cash equivalents

  $ 58,873     $ 33,258  

Accounts receivable, net

    47,389       46,782  

Inventories

    71,186       66,009  

Other current assets

    3,039       5,309  

Total current assets

    180,487       151,358  

Property, plant and equipment, net

    88,193       84,178  

Intangibles, net

    9,063       10,220  

Goodwill

    6,965       6,965  

Other assets

    8,184       7,518  

Total assets

  $ 292,892     $ 260,239  
                 

Liabilities and shareholders’ equity:

               

Current liabilities:

               

Accounts payable

  $ 42,759     $ 32,182  

Accrued expenses

    11,024       13,644  

Total current liabilities

    53,783       45,826  

Other liabilities

    14,543       14,198  

Commitments and contingencies

               

Shareholders’ equity:

               

Preferred stock, no par value

               

Authorized shares: 1,000

               

None issued

    -       -  

Common stock, $1 stated value

               

Authorized shares: 50,000

               

Issued and outstanding shares: 2016, 18,976; 2015, 18,466

    18,976       18,466  

Additional paid-in capital

    67,817       60,967  

Retained earnings

    139,314       122,928  

Accumulated other comprehensive loss

    (1,541 )     (2,146 )

Total shareholders’ equity

    224,566       200,215  

Total liabilities and shareholders’ equity

  $ 292,892     $ 260,239  

 

See accompanying notes to consolidated financial statements.

 

 
24

 

 

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(In thousands)

 

                                   

Accumulated

         
                   

Additional

           

Other

   

Total

 
   

Common Stock

   

Paid-In

   

Retained

   

Comprehensive

   

Shareholders'

 
   

Shares

   

Amount

   

Capital

   

Earnings

   

Income (Loss)(1)

   

Equity

 

Balance at September 28, 2013

    18,185     $ 18,185     $ 55,452     $ 88,981     $ (1,562 )   $ 161,056  

Net earnings

                            16,641               16,641  

Other comprehensive loss(1)

                                    (228 )     (228 )

Stock options exercised

    129       129       1,000                       1,129  

Vesting of restricted stock units

    63       63       (63 )                     -  

Compensation expense associated with stock-based plans

                    2,661                       2,661  

Excess tax benefits from stock-based compensation

                    575                       575  

Restricted stock units and stock options surrendered for withholding taxes payable

                    (758 )                     (758 )

Cash dividends declared

                            (2,193 )             (2,193 )

Balance at September 27, 2014

    18,377       18,377       58,867       103,429       (1,790 )     178,883  

Net earnings

                            21,710               21,710  

Other comprehensive loss(1)

                                    (356 )     (356 )

Stock options exercised

    24       24       176                       200  

Vesting of restricted stock units

    65       65       (65 )                     -  

Compensation expense associated with stock-based plans

                    2,298                       2,298  

Excess tax benefits from stock-based compensation

                    169                       169  

Restricted stock units and stock options surrendered for withholding taxes payable

                    (478 )                     (478 )

Cash dividends declared

                            (2,211 )             (2,211 )

Balance at October 3, 2015

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

Net earnings

                            37,245               37,245  

Other comprehensive income(1)

                                    605       605  

Stock options exercised

    463       463       4,602                       5,065  

Vesting of restricted stock units

    47       47       (47 )                     -  

Compensation expense associated with stock-based plans

                    2,439                       2,439  

Excess tax benefits from stock-based compensation

                    1,717                       1,717  

Restricted stock units and stock options surrendered for withholding taxes payable

                    (1,861 )                     (1,861 )

Cash dividends declared

                            (20,859 )             (20,859 )

Balance at October 1, 2016

    18,976     $ 18,976     $ 67,817     $ 139,314     $ (1,541 )   $ 224,566  

 

(1)Activity within accumulated other comprehensive income (loss) is reported net of related income taxes: 2014 $140, 2015 $218 and 2016 ($370).

 

See accompanying notes to consolidated financial statements.

 

 
25

 

  

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

   

Year Ended

 
   

October 1,

   

October 3,

   

September 27,

 
   

2016

   

2015

   

2014

 

Cash Flows From Operating Activities:

                       

Net earnings

  $ 37,245     $ 21,710     $ 16,641  

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

                       

Depreciation and amortization

    11,544       11,934       10,274  

Amortization of capitalized financing costs

    65       89       102  

Stock-based compensation expense

    2,439       2,298       2,661  

Deferred income taxes

    536       333       41  

Pension plan settlement loss, net of cash contributed

    620       -       -  

Asset impairment charges

    20       543       -  

Excess tax benefits from stock-based compensation

    (1,717 )     (169 )     (575 )

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

    61       (2,652 )     (1,629 )

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

    (480 )     (39 )     (512 )

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

                       

Accounts receivable, net

    (607 )     4,266       (2,084 )

Inventories

    (5,177 )     15,890       (16,814 )

Accounts payable and accrued expenses

    9,009       (17,861 )     21,333  

Other changes

    978       (568 )     (206 )

Total adjustments

    17,291       14,064       12,591  

Net cash provided by operating activities

    54,536       35,774       29,232  
                         

Cash Flows From Investing Activities:

                       

Capital expenditures

    (12,977 )     (7,153 )     (8,955 )

Acquisition of intangible asset

    -       (1,460 )     -  

Acquisition of business

    -       480       (33,943 )

Proceeds from sale of assets held for sale

    180       3,537       -  

Proceeds from fire loss insurance

    -       1,713       2,732  

Proceeds from sale of property, plant and equipment

    60       132       1  

Proceeds from surrender of life insurance policies

    140       40       205  

Increase in cash surrender value of life insurance policies

    (375 )     (328 )     (415 )

Net cash used for investing activities

    (12,972 )     (3,039 )     (40,375 )
                         

Cash Flows From Financing Activities:

                       

Proceeds from long-term debt

    328       60,978       19,215  

Principal payments on long-term debt

    (328 )     (60,978 )     (19,215 )

Cash dividends paid

    (20,859 )     (2,211 )     (2,193 )

Cash received from exercise of stock options

    5,065       200       1,129  

Excess tax benefits from stock-based compensation

    1,717       169       575  

Payment of employee tax withholdings related to net share transactions

    (1,861 )     (478 )     (758 )

Financing costs

    (11 )     (207 )     -  

Net cash used for financing activities

    (15,949 )     (2,527 )     (1,247 )
                         

Net increase (decrease) in cash and cash equivalents

    25,615       30,208       (12,390 )

Cash and cash equivalents at beginning of period

    33,258       3,050       15,440  

Cash and cash equivalents at end of period

  $ 58,873     $ 33,258     $ 3,050  
                         

Supplemental Disclosures of Cash Flow Information:

                       

Cash paid during the period for:

                       

Interest

  $ -     $ 143     $ 30  

Income taxes, net

    19,184       7,805       7,889  

Non-cash investing and financing activities:

                       

Purchases of property, plant and equipment in accounts payable

    1,746       570       680  

Restricted stock units and stock options surrendered for withholding taxes payable

    1,861       478       758  

Post-closing purchase price adjustment for business acquired

    -       -       45  

 

See accompanying notes to consolidated financial statements.

 

 
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INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED OCTOBER 1, 2016, OCTOBER 3, 2015 AND SEPTEMBER 27, 2014

 

(1) Description of Business

 

Insteel Industries, Inc. (“we,” “us,” “our,” “Insteel” or “the Company”) is the nation’s largest manufacturer of steel wire reinforcing products for concrete construction applications. Insteel is the parent holding company for two wholly-owned subsidiaries, Insteel Wire Products Company (“IWP”), an operating subsidiary, and Intercontinental Metals Corporation, an inactive subsidiary. We manufacture and market prestressed concrete strand (“PC strand”) and welded wire reinforcement (“WWR”), including engineered structural mesh, concrete pipe reinforcement and standard welded wire reinforcement. Our products are primarily sold to manufacturers of concrete products and, to a lesser extent, distributors, rebar fabricators and contractors. We sell our products nationwide across the U.S. and, to a much lesser extent, into Canada, Mexico, and Central and South America.

 

On August 15, 2014, we, through our wholly-owned subsidiary, IWP, purchased substantially all of the assets associated with the PC strand business of American Spring Wire Corporation (“ASW”) (see Note 4 to the consolidated financial statements).

 

We have evaluated all subsequent events that occurred after the balance sheet date through the time of filing this Annual Report on Form 10-K and concluded there were no events or transactions during this period that required additional recognition or disclosure in our financial statements.

 

(2) Summary of Significant Accounting Policies

 

Fiscal year. Our fiscal year is the 52 or 53 weeks ending on the Saturday closest to September 30. Fiscal years 2016 and 2014 were 52-week periods and fiscal year 2015 was a 53-week period. All references to years relate to fiscal years rather than calendar years.     

 

Principles of consolidation. The consolidated financial statements include the accounts of Insteel and our subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation.

 

Use of estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S.” and such accounting principles, “GAAP”) requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. There is no assurance that actual results will not differ from these estimates.

 

Cash equivalents. We consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.

 

Concentration of credit risk. Financial instruments that subject us to concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. Our cash is principally concentrated at one financial institution, which at times exceeds federally insured limits. We are exposed to credit risk in the event of default by institutions in which our cash and cash equivalents are held and by customers to the extent of the amounts recorded on the balance sheet. We invest excess cash primarily in money market funds, which are highly liquid securities.

 

The majority of our accounts receivable are due from customers that are located in the U.S., and are generally not secured by collateral depending upon the creditworthiness of the account. We provide an allowance for doubtful accounts based upon our assessment of the credit risk of specific customers, historical trends and other information. We write off accounts receivable when they become uncollectible. There is no disproportionate concentration of credit risk.

 

Stock-based compensation. We account for stock-based compensation in accordance with the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718, Compensation – Stock Compensation, which requires stock-based compensation expense to be recognized in net earnings based on the fair value of the award on the date of the grant. We determine the fair value of stock options issued by using a Monte Carlo valuation model at the grant date, which considers a range of assumptions including the expected term, volatility, dividend yield and risk-free interest rate.

 

 
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Revenue recognition. We recognize revenue from product sales when products are shipped and risk of loss and title has passed to the customer. Sales taxes collected from customers are excluded from revenues and recorded on a net basis.

 

Shipping and handling costs. We include all of the outbound freight, shipping and handling costs associated with the shipment of products to customers in cost of sales. Any amounts paid by customers to us for shipping and handling are recorded in net sales on the consolidated statements of operations.

 

Inventories. Inventories are valued at the lower of weighted average cost (which approximates computation on a first-in, first-out basis) or market (net realizable value or replacement cost). The valuation of inventory includes the costs for material, labor and manufacturing overhead.

 

Property, plant and equipment. Property, plant and equipment are recorded at cost or fair market value in the case of the assets acquired through acquisitions, or otherwise at reduced values to the extent there have been asset impairment write-downs. Expenditures for maintenance and repairs are charged directly to expense when incurred, while major improvements are capitalized. Depreciation is computed for financial reporting purposes principally by use of the straight-line method over the following estimated useful lives: machinery and equipment, 3 - 15 years; buildings, 10 - 30 years; and land improvements, 5 - 15 years. Depreciation expense was approximately $10.4 million in 2016, $10.9 million in 2015 and $9.8 million in 2014 and reflected in cost of sales and selling, general and administrative expense (“SG&A expense”) in the consolidated statements of operations. Capitalized software is amortized over the shorter of the estimated useful life or 5 years and reflected in SG&A expense in the consolidated statements of operations. No interest costs were capitalized in 2016, 2015 and 2014.

 

Goodwill. Goodwill is the excess of cost over the fair value of net assets of businesses acquired. Goodwill is not amortized but is tested annually for impairment and whenever events or circumstances change that would make it more likely than not that an impairment may have occurred. We perform our annual impairment analysis as of the first day of the fourth quarter each year. The evaluation of impairment involves comparing the current estimated fair value of the reporting unit to its recorded value, including goodwill. We perform a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. It may be necessary to perform a quantitative analysis where a discounted cash flow model is used to determine the current estimated fair value of the reporting unit. Key assumptions used to determine the fair value of the reporting unit as part of our annual testing (and any required interim testing) include: (a) expected cash flows for the five-year period following the testing date; (b) an estimated terminal value using a terminal year growth rate based on the growth prospects of the reporting unit; (c) a discount rate based on our estimated after-tax weighted average cost of capital; and (d) a probability-weighted scenario approach by which varying cash flows are assigned to alternative scenarios based on their likelihood of occurrence. In developing these assumptions, we consider historical and anticipated future results, general economic and market conditions, the impact of planned business and operational strategies and all available information at the time the fair value of the reporting unit is estimated. Assumptions in estimating future cash flows are subject to a high degree of judgment and complexity. Changes in assumptions and estimates may affect the fair value of goodwill and could result in impairment charges in future periods. Based on the results of our impairment analysis, no goodwill impairment losses were recognized in the consolidated statements of operations for 2016. Subsequent to the analysis, there have been no events or circumstances that indicate any potential impairment of goodwill.

 

Other assets. Other assets consist principally of capitalized financing costs and the cash surrender value of life insurance policies. Capitalized financing costs are amortized using the straight-line method, which approximates the effective interest method over the term of the related credit agreement, and reflected in interest expense in the consolidated statements of operations.      

 

Long-lived assets. Long-lived assets include property, plant and equipment and identifiable intangible assets with definite useful lives. Finite-lived intangible assets are amortized over their estimated useful lives. Our intangible assets consist of customer relationships, developed technology and know-how and non-competition agreements that are being amortized on a straight-line basis over their finite useful lives (see Note 7 to the consolidated financial statements). We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. When we determine that the carrying value of such assets may not be recoverable, we measure recoverability based on the undiscounted cash flows expected to be generated by the related asset or asset group. If it is determined that an impairment loss has occurred, the loss is recognized in the period in which it is incurred and is calculated as the difference between the carrying value and the present value of estimated future net cash flows or comparable market values.

 

 
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During 2016 and 2015, we recorded $20,000 and $0.3 million, respectively, of impairment charges related to long-lived assets resulting from the consolidation of our PC strand operations with the closure of the Newnan, Georgia facility (see Note 5 to the consolidated financial statements). There were no impairment losses in 2014

 

Fair value of financial instruments. The carrying amounts for cash and cash equivalents, accounts receivable, and accounts payable and accrued expenses approximate fair value because of their short maturities.

 

Income taxes. Income taxes are based on pretax financial accounting income. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. We assess the need to establish a valuation allowance against deferred tax assets to the extent we no longer believe it is more likely than not that the tax assets will be fully realized.

 

Earnings per share. Basic earnings per share (“EPS”) are computed by dividing earnings available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted EPS are computed by dividing earnings available to common shareholders by the weighted average number of shares of common stock and other dilutive equity securities outstanding during the period. Securities that have the effect of increasing EPS are considered to be antidilutive and are not included in the computation of diluted EPS.

 

(3) Recent Accounting Pronouncements

 

Future Adoptions

 

In August 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-15 “Statement of Cash Flows Topic 230: Classification of Certain Cash Receipts and Cash Payments.” ASU No. 2016-15 addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows with the objective of reducing existing differences in the presentation of these items. The amendments in ASU No. 2016-15 are to be adopted retrospectively and will become effective for us in the first quarter of fiscal 2019. The adoption of this update is not expected to have a material impact on our consolidated financial statements.

 

In March 2016, the FASB issued 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 us in the first quarter of fiscal 2018. We are evaluating the future effects of the adoption of this update on our consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02 “Leases,” which will replace the guidance in 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 us in the first quarter of fiscal 2020. We are evaluating the potential effects of the adoption of this update on our 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 us in the first quarter of fiscal 2018. We do not expect the adoption of this update will have a material effect on our consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09 “Revenue from Contracts with Customers,” which will replace 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 us in the first quarter of fiscal 2019. We are continuing to evaluate the potential effects of the adoption of this update on our consolidated financial statements and have not yet selected a transition method.

 

(4) Business Combination

 

On August 15, 2014, we 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”).

 

 
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ASW manufactured PC strand at facilities located in Houston, Texas and Newnan, Georgia. We acquired, among other assets, the accounts receivable and inventories related to ASW’s PC strand business, the production equipment at its facilities in Houston and Newnan, and its facility in Newnan. We also entered into an agreement with ASW to lease the Houston facility with an option to purchase it in the future. In addition, we assumed certain of ASW’s accounts payable and accrued liabilities related to its PC strand business.

 

Following is a summary of our 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, we 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 (See Note 5 to the consolidated financial statements).

 

Following the ASW Acquisition, net sales of the ASW facilities in 2014 were approximately $7.3 million. The actual amount of net sales specifically attributable to the ASW Acquisition, however, cannot be quantified due to the actions that we took to integrate ASW’s facilities with our existing operations, which involved the reassignment of business across locations. We have determined that the presentation of ASW’s earnings for 2014 is impractical due to the integration of ASW’s facilities with our existing operations following the ASW Acquisition.

 

The following unaudited supplemental pro forma financial information reflects our combined results of operations had the ASW Acquisition occurred at the beginning of 2013. The pro forma information reflects certain adjustments related to the ASW Acquisition, including adjusted amortization and depreciation expense based on the fair value of the assets acquired, interest expense related to the borrowings on our revolving credit facility and an appropriate adjustment for the acquisition-related costs. The pro forma information does not reflect any operating efficiencies or potential cost savings that may result from the ASW Acquisition. Accordingly, this pro forma information is for illustrative purposes and is not intended to represent or be indicative of the actual results of operations of the combined company that may have been achieved had the ASW Acquisition occurred at the beginning of 2013, nor is it intended to represent or be indicative of future results of operations. The pro forma combined results of operations for the comparative prior year period are as follows:

 

(In thousands)

 

Year Ended

September 27,

2014

 

Net sales

  $ 469,079  

Earnings before income taxes

    27,225  

Net earnings

    18,928  

 

 
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(5) Restructuring Charges and Acquisition Costs

 

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

 

Following is a summary of the restructuring activities and associated costs that were incurred during 2016, 2015 and 2014:

 

(In thousands)  

Asset

Impairment

Charges

   

Equipment

Relocation Costs

   

Severance and

Other Employee

Separation Costs

   

Facility

Closure Costs

   

Gain on Sale

of Property

and Equipment

   

Total

 

2016

                                               

Liability as of October 3, 2015

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

Restructuring charges (recoveries)

    20       186       -       89       (180 )     115  

Cash payments

    -       (155 )     (496 )     (89 )     -       (740 )

Non-cash charges

    (20 )     -       -       -