INSTEEL INDUSTRIES INC - Quarter Report: 2011 July (Form 10-Q)

     Ivy was one of the nation’s largest producers of welded wire reinforcement and wire products for concrete construction applications. The Company believes the addition of Ivy’s facilities will enhance the Company’s competitiveness in its Northeast, Midwest and Florida markets, in addition to providing a platform to serve the West Coast markets more effectively. The assets purchased included Ivy’s production facilities in Arizona, Florida, Missouri and Pennsylvania; production equipment in Texas; and certain related inventories. In addition, the Company assumed certain of Ivy’s accounts payable and employee benefit obligations.

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

(In thousands)
Assets acquired:
Inventories		$	20,585
Property, plant and equipment			37,211
Total assets acquired		$	57,796
Liabilities assumed:
Accounts payable		$	6,263
Accrued expenses			725
Total liabilities assumed			6,988
Net assets acquired			50,808
Purchase price			50,308
Bargain purchase gain		$	500

     Accounting standards require that when the fair value of the net assets acquired exceeds the purchase price, resulting in a bargain purchase gain, the acquirer must reassess the reasonableness of the values assigned to all of the assets acquired, liabilities assumed and consideration transferred. The Company has performed such a reassessment and has concluded that the values assigned for the Ivy Acquisition are reasonable. Consequently, the Company has recorded a $500,000 bargain purchase gain on the Ivy Acquisition.

     The Ivy Acquisition was accounted for as a business purchase pursuant to ASC Topic 805, Business Combinations. Acquisition and integration costs are not included as components of consideration transferred, but are accounted for as expenses in the period in which the costs are incurred (See Note 4 to the consolidated financial statements).

     Following the Ivy Acquisition, net sales for the Ivy facilities for the three- and nine-month periods ended July 2, 2011 were approximately $26.8 million and $50.2 million, respectively. The actual amount of net sales specifically attributable to the Ivy Acquisition, however, cannot be quantified due to the integration actions that have been taken by the Company involving the transfer of business between the former Ivy facilities and the Company’s existing facilities. The Company has determined that the presentation of Ivy’s earnings for the three- and nine-month periods ended July 2, 2011 is impractical due to the integration of Ivy’s operations into the Company following the Ivy Acquisition.

     The following unaudited supplemental pro forma financial information reflects the combined results of operations of the Company had the Ivy Acquisition occurred at the beginning of fiscal 2010. The pro forma information reflects certain adjustments related to the Ivy Acquisition, including adjusted depreciation expense based on the fair value of the assets acquired, interest expense related to the secured subordinated promissory note and an appropriate adjustment in the current period for the acquisition-related costs. The pro forma information does not reflect any operating efficiencies or potential cost savings which may result from the Ivy 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 Ivy Acquisition occurred at the beginning of fiscal 2010, nor is it intended to represent or be indicative of future results of operations. The pro forma combined results of operations for the current and comparative prior year periods are as follows:

		Three Months Ended								Nine Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands)		2011				2010				2011				2010
Net sales		$	98,579			$	91,146			$	254,529			$	226,524
Earnings (loss) from continuing operations before income taxes			5,397				694				(1,003	)			(12,758	)
Net earnings (loss)			3,650				32				(786	)			(8,334	)

(4) Restructuring Charges and Acquisition Costs

     Restructuring charges. Subsequent to the Ivy Acquisition, the Company elected to consolidate certain of its welded wire reinforcement operations in order to reduce its operating costs, which involved the closure of facilities in Wilmington, Delaware and Houston, Texas. These actions were taken in response to the close proximity of Ivy’s facilities in Hazleton, Pennsylvania and Houston, Texas to the Company’s existing facilities in Wilmington, Delaware and Dayton, Texas. The Houston plant closure was completed in December 2010 and the Wilmington plant closure was completed in May 2011.

     Following is a summary of the restructuring activities and associated costs that were incurred during the nine-month period ended July 2, 2011:

		Severance
		and other				Asset				Facility				Equipment
(In thousands)		employee costs				impairment				closure costs				relocation				Total
Restructuring charges		$	979			$	2,868			$	533			$	10			$	4,390
Cash payments			(310	)			—				(75	)			(10	)			(395	)
Non-cash charges			—				(2,868	)			—				—				(2,868	)
Liability as of January 1, 2011		$	669			$	—			$	458			$	—			$	1,127
Restructuring charges			1,176				584				224				229				2,213
Cash payments			(1,486	)			—				(367	)			(145	)			(1,998	)
Non-cash charges			—				(584	)			—				—				(584	)
Liability as of April 2, 2011		$	359			$	—			$	315			$	84			$	758
Restructuring charges			118				683				615				554				1,970
Cash payments			(152	)			—				(758	)			(579	)			(1,489	)
Non-cash charges			—				(683	)			—				—				(683	)
Liability as of July 2, 2011		$	325			$	—			$	172			$	59			$	556

     As of July 2, 2011, the Company recorded a liability of $556,000 on its consolidated balance sheet for restructuring liabilities, including $59,000 in accounts payable and $497,000 in accrued expenses. The Company currently expects to incur approximately $1.0 million of additional restructuring charges in connection with the remaining anticipated equipment relocation and facility closure costs through the first quarter of fiscal 2012 and that substantially all of the cash payments related to the restructuring charges will be made before the end of the first quarter of fiscal 2012.

     Acquisition costs. During the nine-month period ended July 2, 2011, the Company recorded $3.5 million of acquisition-related costs associated with the Ivy Acquisition for advisory, accounting, legal and other professional fees. The Company did not record any acquisition costs during the three-month period ended July 2, 2011 and does not expect to incur any additional acquisition costs related to the Ivy Acquisition over the remainder of the fiscal year.

(5) Fair Value Measurements

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

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

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

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

     As of July 2, 2011, the Company held financial assets that are required to be measured at fair value on a recurring basis. The financial assets held by the Company and the fair value hierarchy used to determine their fair values are as follows:

						Quoted Prices
						in Active				Observable
						Markets				Inputs
(In thousands)		Total				(Level 1)				(Level 2)
Current assets:
Cash equivalents		$	3,540			$	3,540			$	—
Other assets:
Cash surrender value of life insurance policies			4,676				—				4,676
Total		$	8,216			$	3,540			$	4,676

     Cash equivalents, which include all highly liquid investments with original maturities of three months or less, are classified as Level 1 of the fair value hierarchy. The carrying amount of the Company’s cash equivalents, which consist of investments in money market funds, approximates fair value due to their short maturities. Cash surrender value of life insurance policies are classified as Level 2. The fair value of the life insurance policies was determined by the underwriting insurance company’s valuation models and represents the guaranteed value the Company would receive upon surrender of these policies as of July 2, 2011.

     As of July 2, 2011, the Company had no nonfinancial assets that are required to be measured at fair value on a nonrecurring basis other than the assets and liabilities acquired from Ivy (see Note 3 to the consolidated financial statements) that were acquired at fair value. The carrying amount for accounts receivable, accounts payable and accrued expenses approximates fair value due to the short-term maturities of these financial instruments. The Company believes that the carrying amount of the $13.5 million secured subordinated promissory note payable to Ivy approximates fair value based on comparable debt with similar terms, conditions and proximity to the issuance date, which would be considered a level 2 input.

(6) Discontinued Operations

     In April 2006, the Company decided to exit the industrial wire business with the closure of its Fredericksburg, Virginia facility, which manufactured tire bead wire and other industrial wire for commercial and industrial applications. The Company’s decision was based on the weakening in the business outlook for the facility and the expected continuation of difficult market conditions and reduced operating levels. Manufacturing activities at the Virginia facility ceased in June 2006 and the Company liquidated the remaining assets of the business in fiscal 2010. The results of operations and related non-recurring closure costs associated with the industrial wire business have been reported as discontinued operations for the prior year period.

     Liabilities of discontinued operations as of October 2, 2010 are as follows:

		October 2,
(In thousands)		2010
Current liabilities:
Accrued expenses		$	210
Total current liabilities			210
Other liabilities			280
Total liabilities		$	490

(7) Stock-Based Compensation

     Under the Company’s equity incentive plans, employees and directors may be granted stock options, restricted stock, restricted stock units and performance awards. As of July 2, 2011, there were 277,000 shares available for future grants under the plans.

     Stock option awards. Under the Company’s equity incentive plans, employees and directors may be granted options to purchase shares of the Company’s common stock at the fair market value on the date of the grant. Options granted under these plans generally vest over three years and expire ten years from the date of the grant. Compensation expense and excess tax benefits associated with stock options for the three- and nine-month periods ended July 2, 2011 and July 3, 2010 are as follows:

		Three Months Ended								Nine Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands)		2011				2010				2011				2010
Stock options:
Compensation expense		$	266			$	214			$	773			$	695
Excess tax benefits			—				6				81				3

     As of July 2, 2011, the remaining unamortized compensation cost related to unvested stock option awards was $537,000, which is expected to be recognized over a weighted average period of 1.32 years.

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

     The estimated fair value of stock options granted during the nine-month periods ended July 2, 2011 and July 3, 2010 was $5.86 and $4.62, respectively, based on the following assumptions:

		Nine Months Ended
		July 2,				July 3,
		2011				2010
Risk-free interest rate			2.40	%			2.69	%
Dividend yield			0.97	%			1.29	%
Expected volatility			56.49	%			60.68	%
Expected term (in years)			5.11				5.71

     The following table summarizes stock option activity for the nine-month period ended July 2, 2011:

																						Contractual				Aggregate
		Options				Exercise Price Per Share																Term -				Intrinsic
		Outstanding																Weighted				Weighted				Value
		(in thousands)				Range												Average				Average				(in thousands)
Outstanding at October 2, 2010			847			$	0.18				-			$	20.27			$	10.63
Granted			77				12.43				-				12.43				12.43
Expired			—				—				-				—				—
Forfeited			(10	)			11.15				-				11.15				11.15
Exercised			(13	)			1.06				-				7.55				1.60
Outstanding at July 2, 2011			901				0.18				-				20.27				10.91			6.95 years				$	2,335
Vested and anticipated to vest in the future at July 2, 2011			883																10.92			6.91 years					2,294
Exercisable at July 2, 2011			560																11.16			5.85 years					1,574

     Restricted stock awards. Under the Company’s equity incentive plans, employees and directors may be granted restricted stock awards (“RSAs”) which are valued based upon the fair market value on the date of the grant. Restricted stock granted under these plans generally vests one to three years from the date of the grant. There were no restricted stock grants during the three- and nine-month periods ended July 2, 2011 and July 3, 2010. Amortization expense for restricted stock for the three- and nine-month periods ended July 2, 2011 and July 3, 2010 is as follows:

		Three Months Ended								Nine Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands)		2011				2010				2011				2010
Amortization expense		$	33			$	96			$	149			$	364

     As of July 2, 2011, the remaining unrecognized compensation cost related to unvested restricted stock awards was $17,000, which is expected to be recognized over a weighted average vesting period of 0.13 years.

     During the nine-month periods ended July 2, 2011 and July 3, 2010, 40,580 and 26,620 shares, respectively, of employee restricted stock awards vested. Upon vesting, employees have the option of remitting payment for the minimum tax obligation to the Company or net-share settling such that the Company will withhold shares with a value equivalent to the respective employee’s minimum tax obligation. A total of 6,757 and 5,225 shares were withheld during the nine-month periods ended July 2, 2011 and July 3, 2010, respectively, to satisfy employees’ minimum tax obligations.

     The following table summarizes restricted stock activity during the nine-month period ended July 2, 2011:

						Weighted
		Restricted				Average
		Stock Awards				Grant Date
(Share amounts in thousands)		Outstanding				Fair Value
Balance, October 2, 2010			67			$	13.37
Granted			—				—
Released			(40	)			11.15
Balance, July 2, 2011			27			$	16.69

     Restricted stock units. On January 21, 2009, the Executive Compensation Committee of the Board of Directors approved a change in the equity compensation program such that awards of restricted stock units (“RSUs”) to employees and directors would be made in lieu of awards of restricted stock. RSUs granted under these plans are valued based upon the fair market value on the date of the grant and provide for a dividend equivalent payment which is included in compensation expense. The vesting period for RSUs is generally one to three years from the date of the grant. RSUs do not have voting rights. RSU grants and amortization expense for the three- and nine-month periods ended July 2, 2011 and July 3, 2010 are as follows:

		Three Months Ended								Nine Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands)		2011				2010				2011				2010
Restricted stock unit grants:
Units			19				—				71				78
Market value		$	276			$	—			$	928			$	732
Amortization expense			417				193				976				545

     As of July 2, 2011, the remaining unrecognized compensation cost related to unvested RSUs was $1.1 million, which is expected to be recognized over a weighted average vesting period of 1.43 years.

     The following table summarizes RSU activity during the nine-month period ended July 2, 2011:

						Weighted
		Restricted				Average
		Stock Units				Grant Date
(Unit amounts in thousands)		Outstanding				Fair Value
Balance, October 2, 2010			239			$	9.23
Granted			71				12.99
Released			(30	)			9.39
Balance, July 2, 2011			280			$	10.17

(8) Income Taxes

     The Company has recorded the following amounts for deferred income taxes and accrued income taxes on its consolidated balance sheet as of July 2, 2011: a current deferred tax asset (net of valuation allowance) of $2.6 million in other current assets, a non-current deferred tax liability of $1.3 million in other liabilities, accrued non-current income taxes payable of $55,000 in other liabilities, and income taxes receivable of $1.3 million in other current assets. As of July 2, 2011, the Company has $27.3 million of gross state operating loss carryforwards (“NOLs”) that principally expire during 2017 to 2030. The Company has also recorded deferred tax assets for various state tax credits of $300,000, which principally expire during 2014 to 2019. The effective income tax rate for the three-month period ended July 2, 2011 was 32.4% compared with 50.8% in the same year-ago period as a result of changes in permanent book versus tax differences together with $150,000 of net reserves that were recorded in the prior year period for known tax exposures.

     The realization of the Company’s deferred income tax assets is entirely dependent upon the Company’s ability to generate future taxable income in applicable jurisdictions. GAAP requires that the Company periodically assess the need to establish a valuation allowance against its deferred income tax assets to the extent that it no longer believes it is more likely than not they will be fully utilized. As of July 2, 2011 and October 2, 2010, the Company recorded a valuation allowance of $708,000 and $461,000, respectively, pertaining to various state NOLs and tax credits that were not expected to be utilized. The valuation allowance established by the Company is subject to periodic review and adjustment based on changes in facts and circumstances and would be reduced should the Company utilize the state NOLs and tax credits against which an allowance had been provided or determine that such utilization is more likely than not. The increase in the valuation allowance for the nine-month period ended July 2, 2011 is primarily due to a change in the Company’s expectations regarding the future realization of deferred tax assets related to certain state NOLs and tax credits.

     The Company has established contingency reserves for material, known tax exposures, including potential tax audit adjustments. The Company’s tax reserves reflect management’s judgment as to the estimated liabilities that would be incurred in connection with the resolution of these matters. As of July 2, 2011, the Company had approximately $15,000 of gross unrecognized tax benefits classified in other current assets and $33,000 of gross unrecognized tax benefits classified as other liabilities on its consolidated balance sheet, of which $37,000, if recognized, would reduce its income tax rate in future periods. The Company anticipates the gross unrecognized tax benefit of $15,000 will be resolved within the next twelve months.

     The Company recognizes interest and penalties related to unrecognized tax benefits as a component of income tax expense. As of July 2, 2011, the Company had accrued interest and penalties related to unrecognized tax benefits of $91,000.

     The Company files U.S. federal income tax returns as well as state and local income tax returns in various jurisdictions. Federal and certain state tax returns filed by the Company subsequent to fiscal year 2007 remain subject to examination together with certain state tax returns filed by the Company subsequent to fiscal year 2003.

(9) Employee Benefit Plans

     Retirement plans. The Company has one defined benefit pension plan, the Insteel Wire Products Company Retirement Income Plan for Hourly Employees, Wilmington, Delaware (the “Delaware Plan”). The Delaware Plan provides benefits for eligible employees based primarily upon years of service and compensation levels. The Delaware Plan was frozen effective September 30, 2008 whereby participants will no longer earn additional service benefits. The Company’s funding policy is to contribute amounts at least equal to those required by law. The Company made contributions totaling $33,000 and $444,000 to the Delaware Plan during the three- and nine-month periods ended July 2, 2011, respectively, and expects to contribute an additional $34,000 during the remainder of the current fiscal year.

     In February 2011, as part of the planned closure of the Wilmington, Delaware facility, the Company amended the Delaware Plan granting certain participants additional service credit. The amendment resulted in a one-time charge of $306,000 that was recorded in the second quarter of this fiscal year and is included within the restructuring charges for the nine-month period ended July 2, 2011.

     Net periodic pension costs and related components for the Delaware Plan for the three- and nine-month periods ended July 2, 2011 and July 3, 2010 are as follows:

		Three Months Ended								Nine Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands)		2011				2010				2011				2010
Interest cost		$	48			$	52			$	144			$	156
Expected return on plan assets			(52	)			(50	)			(156	)			(150	)
Recognized net actuarial loss			58				49				174				147
Net periodic pension cost		$	54			$	51			$	162			$	153

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

     Net periodic benefit costs and related components for the SERPs for the three- and nine-month periods ended July 2, 2011 and July 3, 2010 are as follows:

		Three Months Ended								Nine Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands)		2011				2010				2011				2010
Service cost		$	44			$	41			$	132			$	123
Interest cost			71				70				213				210
Amortization of prior service cost			65				64				195				192
Net periodic benefit cost		$	180			$	175			$	540			$	525

(10) Long-Term Debt

     Revolving Credit Facility. On June 2, 2010, the Company and each of its wholly-owned subsidiaries entered into the Second Amended and Restated Credit Agreement (the “Credit Agreement”) which amends and restates in its entirety the previous agreement pertaining to its revolving credit facility that had been in effect since January 2006. The Credit Agreement, which matures on June 2, 2015, provides the Company with up to $75.0 million of financing on the credit facility to supplement its operating cash flow and fund its working capital, capital expenditure, general corporate and growth requirements. As of July 2, 2011, no borrowings were outstanding on the credit facility, $73.9 million of additional borrowing capacity was available and outstanding letters of credit totaled $1.1 million.

     Advances under the credit facility are limited to the lesser of the revolving credit commitment or a borrowing base amount that is calculated based upon a percentage of eligible receivables and inventories. Interest rates on the revolver are based upon (1) an index rate that is established at the highest of the prime rate, 0.50% plus the federal funds rate or the LIBOR rate plus the excess of the then-applicable margin for LIBOR loans over the then-applicable margin for index rate loans, or (2) at the election of the Company, a LIBOR rate, plus in either case, an applicable interest rate margin. The applicable interest rate margins are adjusted on a quarterly basis based upon the amount of excess availability on the revolver within the range of 0.75% — 1.50% for index rate loans and 2.25% — 3.00% for LIBOR loans. In addition, the applicable interest rate margins would be increased by 2.00% upon the occurrence of certain events of default provided for in the Credit Agreement. Based on the Company’s excess availability as of July 2, 2011, the applicable interest rate margins on the revolver were 0.75% for index rate loans and 2.25% for LIBOR loans.

     The Company’s ability to borrow available amounts under the revolving credit facility will be restricted or eliminated in the event of certain covenant breaches, events of default or if the Company is unable to make certain representations and warranties provided for in the Credit Agreement.

     Financial Covenants

     The terms of the Credit Agreement require the Company to maintain a Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of not less than 1.10 at the end of each fiscal quarter for the twelve-month period then ended when the amount of excess availability on the revolving credit facility is less than $10.0 million. As of July 2, 2011, the Company was in compliance with all of the financial covenants under the Credit Agreement.

     Negative Covenants

     In addition, the terms of the Credit Agreement restrict the Company’s ability to, among other things: engage in certain business combinations or divestitures; make investments in or loans to third parties, unless certain conditions are met with respect to such investments or loans; pay cash dividends or repurchase shares of the Company’s stock subject to certain minimum borrowing availability requirements; incur or assume indebtedness; issue securities; enter into certain transactions with affiliates of the Company; or permit liens to encumber the Company’s property and assets. As of July 2, 2011, the Company was in compliance with all of the negative covenants under the Credit Agreement.

     Events of Default

     Under the terms of the Credit Agreement, an event of default will occur with respect to the Company upon the occurrence of, among other things: defaults or breaches under the loan documents, subject in certain cases to cure periods; defaults or breaches by the Company or any of its subsidiaries under any agreement resulting in the acceleration of amounts above certain thresholds or payment defaults above certain thresholds; certain events of bankruptcy or insolvency with respect to the Company; certain entries of judgment against the Company or any of its subsidiaries, which are not covered by insurance; or a change of control of the Company.

     Amortization of capitalized financing costs associated with the credit facility was $20,000 and $93,000 for the three-month periods ended July 2, 2011 and July 3, 2010, respectively, and $61,000 and $342,000 for the nine-month periods ended July 2, 2011 and July 3, 2010, respectively. Accumulated amortization of capitalized financing costs was $4.1 million and $4.0 million as of July 2, 2011 and October 2, 2010, respectively.

     Subordinated Note. As part of the consideration for the Ivy Acquisition, on November 19, 2010 (see Note 3 to the consolidated financial statements) the Company entered into a $13.5 million secured subordinated promissory note (the “Note”) payable to Ivy over five years. The Note requires semi-annual interest payments in arrears, and annual principal payments payable on November 19 of each year during the period 2011 — 2015. The Note bears interest on the unpaid principal balance at a fixed rate of 6.00% per annum and is collateralized by certain of the real property and equipment acquired from Ivy. Based on the terms of the Note, the Company expects to make cash payments of approximately $335,000 for interest and no principal payments during fiscal 2011. As of July 2, 2011, $675,000 of the outstanding balance on the Note is recorded as the current portion of long-term debt on the Company’s consolidated balance sheet.

     As of July 2, 2011, the aggregate maturities of the Note are as follows:

Fiscal years(s)		(In thousands)
2012		$	675
2013			675
2014			675
2015			5,737
2016			5,738
Total future maturities		$	13,500
Less: Current portion			(675	)
		$	12,825

     The scheduled principal payments will become immediately due and payable together with interest in the event of certain covenant breaches, events of default or if the Company is unable to make certain representations and warranties provided for in the Note. Additionally, there are certain non-financial covenants associated with the Note that require the Company to effect its corporate existence and all material rights and grant a perfected, first priority security interest in all of the real and personal property representing collateral for the Note. The terms of the Note provide that an event of default will occur with respect to the Company upon the occurrence of, among other things: defaults or breaches under the loan document, subject in certain cases to cure periods; certain events of bankruptcy or insolvency with respect to the Company; or a change of control of the Company. As of July 2, 2011, the Company was in compliance with all of the covenants under the Note.

(11) Earnings (Loss) Per Share

     Effective October 4, 2009, the Company adopted certain provisions of ASC Topic 260, Earnings Per Share, which requires unvested share-based payment awards that contain non-forfeitable rights to dividends (whether paid or unpaid) to be treated as participating securities and included in the computation of basic earnings per share. The Company’s participating securities are its unvested RSAs. Because the Company’s unvested RSAs do not contractually participate in its losses, the Company has not allocated such losses to the unvested RSAs in computing basic earnings per share, using the two-class method, for the nine-month period ended July 2, 2011.

     The computations of basic and diluted earnings (loss) per share attributable to common shareholders for the three- and nine-month periods ended July 2, 2011 and July 3, 2010 are as follows:

		Three Months Ended								Nine Months Ended
		July 2,				July 3,				July 2,				July 3,
(In thousands except per share amounts)		2011				2010				2011				2010
Earnings (loss) from continuing operations		$	3,650			$	1,624			$	(1,359	)		$	2,145
Less allocation to participating securities			(6	)			(8	)			—				(12	)
Available to Insteel common shareholders		$	3,644			$	1,616			$	(1,359	)		$	2,133
Loss from discontinued operations net of income taxes		$	—			$	(19	)		$	—			$	(42	)
Less allocation to participating securities			—				—				—				—
Available to Insteel common shareholders		$	—			$	(19	)		$	—			$	(42	)
Net earnings (loss)		$	3,650			$	1,605			$	(1,359	)		$	2,103
Less allocation to participating securities			(6	)			(8	)			—				(12	)
Available to Insteel common shareholders		$	3,644			$	1,597			$	(1,359	)		$	2,091
Basic weighted average shares outstanding			17,587				17,492				17,550				17,454
Dilutive effect of stock-based compensation			268				203				—				207
Diluted weighted average shares outstanding			17,855				17,695				17,550				17,661
Per share basic:
Earnings (loss) from continuing operations		$	0.21			$	0.09			$	(0.08	)		$	0.12
Loss from discontinued operations			—				—				—				—
Net earnings (loss)		$	0.21			$	0.09			$	(0.08	)		$	0.12
Per share diluted:
Earnings (loss) from continuing operations		$	0.20			$	0.09			$	(0.08	)		$	0.12
Loss from discontinued operations			—				—				—				—
Net earnings (loss)		$	0.20			$	0.09			$	(0.08	)		$	0.12

     Options and RSUs representing 348,000 and 465,000 shares for the three-month periods ended July 2, 2011 and July 3, 2010, respectively, were antidilutive and were not included in the diluted earnings per share calculation. Options and RSUs representing 496,000 and 486,000 shares for the nine-month periods ended July 2, 2011 and July 3, 2010, respectively, were antidilutive and were not included in the diluted earnings per share calculation. Options, RSAs and RSUs representing 236,000 shares for the nine-month period ended July 2, 2011 were not included in the diluted earnings per share calculation due to the net losses that were incurred.

(12) Share Repurchases

     On November 18, 2008, the Company’s board of directors approved a new share repurchase authorization to buy back up to $25.0 million of the Company’s outstanding common stock in the open market or in privately negotiated transactions (the “New Authorization”). Repurchases may be made from time to time in the open market or in privately negotiated transactions subject to market conditions, applicable legal requirements and other factors. The Company is not obligated to acquire any particular amount of common stock and the program may be commenced or suspended at any time at the Company’s discretion without prior notice. The New Authorization continues in effect until terminated by the Board of Directors. As of July 2, 2011, there was $24.8 million remaining available for future share repurchases under this authorization. No purchases of common stock were made during the three-month periods ended July 2, 2011 and July 3, 2010. During the nine-month periods ended July 2, 2011 and July 3, 2010, the Company repurchased $86,000 or 6,757 shares and $51,000 or 5,225 shares, respectively, of its common stock through restricted stock net-share settlements.

(13) Other Financial Data

     Balance sheet information:

		July 2,				October 2,
(In thousands)		2011				2010
Accounts receivable, net:
Accounts receivable		$	44,513			$	27,266
Less allowance for doubtful accounts			(822	)			(2,296	)
Total		$	43,691			$	24,970
Inventories, net:
Raw materials		$	39,782			$	23,817
Work in process			3,782				1,899
Finished goods			26,890				18,203
Total		$	70,454			$	43,919
Other current assets:
Current deferred tax asset		$	2,625			$	2,612
Income taxes receivable			1,315				547
Capitalized financing costs, net			82				82
Other			1,677				690
Total		$	5,699			$	3,931
Other assets:
Cash surrender value of life insurance policies, net of loans of $446 and $505		$	4,676			$	4,525
Assets held for sale			794				—
Capitalized financing costs, net			239				300
Other			368				272
Total		$	6,077			$	5,097
Property, plant and equipment, net:
Land and land improvements		$	8,586			$	5,571
Buildings			40,763				32,433
Machinery and equipment			119,493				97,813
Construction in progress			603				239
			169,445				136,056
Less accumulated depreciation			(79,427	)			(77,403	)
Total		$	90,018			$	58,653
Accrued expenses:
Salaries, wages and related expenses		$	2,070			$	1,210
Pension plan			1,321				1,263
Deferred revenues			1,143				321
Property taxes			836				846
Customer rebates			592				506
Dividends payable			529				—
Restructuring			497				—
Worker’s compensation			333				683
Interest			164				—
Legal settlement			—				600
Other			782				500
Total		$	8,267			$	5,929
Other liabilities:
Deferred compensation		$	6,009			$	5,688
Deferred income taxes			1,317				1,778
Other			55				55
Total		$	7,381			$	7,521

(14) Business Segment Information

     Following the Company’s exit from the industrial wire business (see Note 6 to the consolidated financial statements), the Company’s operations are entirely focused on the manufacture and marketing of concrete reinforcing products for the concrete construction industry. The Company’s concrete reinforcing products consist of welded wire reinforcement and PC strand. Based on the criteria specified in ASC Topic 280, Segment Reporting, the Company has one reportable segment. The results of operations for the industrial wire products business have been reported as discontinued operations for the prior year periods presented.

(15) Contingencies

     Legal proceedings. On November 19, 2007, Dwyidag Systems International, Inc (“DSI”) filed a third-party lawsuit in the Ohio Court of Claims alleging that certain epoxy-coated strand sold by the Company to DSI in 2002, and supplied by DSI to the Ohio Department of Transportation (“ODOT”) for a bridge project, was defective. The third-party action sought recovery of any damages which could have been assessed against DSI in the action filed against it by ODOT, which allegedly could have been in excess of $8.3 million, plus $2.7 million in damages allegedly incurred by DSI. In 2009, the Ohio court granted the Company’s motion for summary judgment as to the third-party claim against it on the grounds that the statute of limitations had expired, but DSI filed an interlocutory appeal of that ruling. In addition, the Company previously filed a lawsuit against DSI in the North Carolina Superior Court in Surry County seeking recovery of $1.4 million (plus interest) owed for other products sold by the Company to DSI, which action was removed by DSI to the U.S. District Court for the Middle District of North Carolina.

     On October 7, 2010, the Company participated in a structured mediation with ODOT and DSI which led to settlement of all of the above legal matters. The parties dismissed the action in the Middle District of North Carolina on December 23, 2010, and the Ohio Court of Claims action was dismissed on January 21, 2011. Pursuant to the settlement agreement, which was approved by the Ohio Court of Claims on January 5, 2011, the parties have released each other from all liability arising out of the sale of strand for the bridge project. In connection with the settlement, the Company reserved the remaining outstanding balance that it was owed by DSI and agreed to make a cash payment of $600,000 to ODOT. In the second quarter of fiscal 2011, the Company paid $600,000 to ODOT and wrote off the DSI receivables against the previously established reserve. The resolution of this matter has enabled the Company to reinstate its commercial relationship with DSI that had existed prior to the initiation of the legal proceedings. The Company’s fourth quarter fiscal 2010 results reflect a pre-tax charge of $1.5 million relating to the net effect of the settlement.

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

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

Cautionary Note Regarding Forward-Looking Statements

     This report contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, particularly under the caption “Outlook” below. When used in this report, the words “believes,” “anticipates,” “expects,” “estimates,” “intends,” “may,” “should” 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, such forward-looking statements 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. All forward-looking statements are based on information that is current as of the date of this report. Many of these risks and uncertainties are discussed in detail, and where appropriate, updated in our periodic and other reports and statements, in particular under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended October 2, 2010, filed with the U.S. Securities and Exchange Commission. You should carefully review these risks and uncertainties.

     All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. All forward-looking statements speak only to the respective dates on which such statements are made and we do not undertake and specifically decline any obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events, except as may be required by law.

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

	•		potential difficulties that may be encountered in integrating the Ivy Acquisition into our existing business;
	•		potential difficulties in realizing synergies, including reduced operating costs, with respect to the Ivy Acquisition;
	•		competitive and customer responses to our expanded business following the Ivy Acquisition;
	•		general economic and competitive conditions in the markets in which we operate;
	•		credit market conditions and the relative availability of financing for us, our customers and the construction industry as a whole;
	•		the continuation of reduced spending for nonresidential construction, particularly commercial construction, and the impact on demand for our products;
	•		the duration and magnitude of a new federal transportation funding authorization and the amount of infrastructure-related funding provided for that requires the use of our products;
	•		the severity and duration of the downturn in residential construction activity and the impact on those portions of our business that are correlated with the housing sector;
	•		the cyclical nature of the steel and building material industries;
	•		fluctuations in the cost and availability of our primary raw material, hot-rolled steel wire rod, from domestic and foreign suppliers;
	•		competitive pricing pressures and our ability to raise selling prices in order to recover increases in wire rod costs;
	•		changes in United States (“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 weak demand and reduced capacity utilization levels on our unit manufacturing costs;
	•		our ability to further develop the market for engineered structural mesh (“ESM”) and expand our shipments of ESM;
	•		legal, environmental, economic or regulatory developments that significantly impact our operating costs;
	•		unanticipated plant outages, equipment failures or labor difficulties;
	•		continued escalation in certain of our operating costs; and
	•		the “Risk Factors” discussed in our Annual Report on Form 10-K for the year ended October 2, 2010 and in other filings that we make with the SEC.

Overview

     Insteel Industries, Inc. is the nation’s largest manufacturer of steel wire reinforcing products for concrete construction applications. We manufacture and market PC strand and welded wire reinforcement, including ESM, concrete pipe reinforcement and standard welded wire reinforcement. Our products are sold primarily to manufacturers of concrete products that are used in nonresidential construction. We market our products through sales representatives who are our employees. Our products are sold nationwide as well as into Canada, Mexico, and Central and South America, and delivered primarily by truck, using common or contract carriers. Our business strategy is focused on: (1) achieving leadership positions in our markets; (2) operating as the lowest cost producer; and (3) pursuing growth opportunities within our core businesses that further our penetration of current markets served or expand our geographic reach.

     On November 19, 2010, we, through our wholly-owned subsidiary, Insteel Wire Products Company, purchased certain of the assets of Ivy for approximately $50.3 million, after giving effect to post-closing adjustments. Ivy was one of the nation’s largest producers of welded wire reinforcement and wire products for concrete construction applications (see Note 3 to the consolidated financial statements). Among other assets, we acquired certain of Ivy’s inventories and its production facilities located in Pennsylvania, Florida, Arizona and Missouri, in addition to the production equipment located at a leased facility in Texas. We also entered into a short-term sublease with Ivy for the Texas facility. Subsequent to the acquisition, we elected to consolidate certain of our welded wire reinforcement operations in order to reduce our operating costs, which involved the closure of facilities in Wilmington, Delaware and Houston, Texas. These actions were taken in response to the

close proximity of Ivy’s facilities in Hazleton, Pennsylvania and Houston, Texas to our existing facilities in Wilmington, Delaware and Dayton, Texas.

     Following our exit from the industrial wire business (see Note 6 to the consolidated financial statements), our operations are entirely focused on the manufacture and marketing of concrete reinforcing products. The results of operations for the industrial wire products business have been reported as discontinued operations for all periods presented.

Results of Operations

Statements of Operations – Selected Data
(Dollars in thousands)

		Three Months Ended												Nine Months Ended
		July 2,								July 3,				July 2,								July 3,
		2011				Change				2010				2011				Change				2010
Net sales		$	98,579				59.1	%		$	61,956			$	237,818				53.0	%		$	155,425
Gross profit			12,529				62.9	%			7,690				23,997				53.3	%			15,651
Percentage of net sales			12.7	%							12.4	%			10.1	%							10.1	%
Selling, general and administrative expense		$	4,947				14.6	%		$	4,317			$	13,638				11.4	%		$	12,241
Percentage of net sales			5.0	%							7.0	%			5.7	%							7.9	%
Restructuring charges		$	1,970				N/M			$	—			$	8,573				N/M			$	—
Acquisition costs			—				N/M				—				3,518				N/M				—
Bargain purchase gain			—				N/M				—				(500	)			N/M				—
Interest expense			260				124.1	%			116				664				61.6	%			411
Interest income			(18	)			(60.0	%)			(45	)			(37	)			(47.9	%)			(71	)
Effective income tax rate			32.4	%							50.8	%			22.9	%							35.4	%
Earnings (loss) from continuing operations		$	3,650				124.8	%		$	1,624			$	(1,359	)			N/M			$	2,145
Loss from discontinued operations			—				N/M				(19	)			—				N/M				(42	)
Net earnings (loss)			3,650				127.4	%			1,605				(1,359	)			N/M				2,103