INSTEEL INDUSTRIES INC - Quarter Report: 2016 July (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended July 2, 2016

OR

For the Transition Period From ________ to ________

Commission File Number: 1-9929

Insteel Industries, Inc.

(Exact name of registrant as specified in its charter)

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

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

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).

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.

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

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

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes to consolidated financial statements.

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands)

See accompanying notes to consolidated financial statements.

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes to consolidated financial statements.

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY 

(In thousands)

(Unaudited)

See accompanying notes to consolidated financial statements.

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Cautionary Note Regarding Forward-Looking Statements

This report contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, particularly under the caption “Outlook” below. When used in this report, the words “believes,” “anticipates,” “expects,” “estimates,” “appears, “plans,” “intends,” “may,” “should,” “could” and similar expressions are intended to identify forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, they are subject to a number of risks and uncertainties, and we can provide no assurances that such plans, intentions or expectations will be implemented or achieved. Many of these risks and uncertainties are discussed in detail, and where appropriate, updated in our periodic and other reports and statements filed with the U.S. Securities and Exchange Commission (“SEC”), in particular in our Annual Report on Form 10-K for the year ended October 3, 2015. You should carefully review these risks and uncertainties.

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

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:

Overview

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

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

Results of Operations

Statements of Operations – Selected Data

(Dollars in thousands)

"N/M" = not meaningful

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

Net Sales

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

Gross Profit

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

Selling, General and Administrative Expense

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

Restructuring Charges, Net

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

Other Expense

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

Interest Expense

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

Income Taxes

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

Net Earnings

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

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

Net Sales

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

Gross Profit

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

Selling, General and Administrative Expense

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

Restructuring Charges, Net

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

Other Expense (Income)

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

Interest Expense

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

Income Taxes

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

Net Earnings

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

Liquidity and Capital Resources

Selected Financial Data

(Dollars in thousands)

Operating Activities

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

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

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

Investing Activities

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

Financing Activities

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

Cash Management

Our cash is concentrated primarily at one financial institution, which at times exceeds federally insured limits. We invest excess cash primarily in money market funds, which are highly liquid securities that bear minimal risk.

Credit Facility

We have a $100.0 million revolving credit facility (the “Credit Facility”) that is used to supplement our operating cash flow and fund our working capital, capital expenditure, general corporate and growth requirements. In May 2015, we amended the Credit Facility to, among other changes, extend its maturity date from June 2, 2016 to May 13, 2020. Advances under the Credit Facility are limited to the lesser of the revolving loan commitment amount (currently $100.0 million) or a borrowing base amount that is calculated based upon a percentage of eligible receivables and inventories. As of July 2, 2016, no borrowings were outstanding on the Credit Facility, $81.5 million of borrowing capacity was available and outstanding letters of credit totaled $1.8 million.

We believe that, in the absence of significant unanticipated cash demands, cash and cash equivalents, net cash generated by operating activities, and the borrowing availability provided under the Credit Facility will be sufficient to satisfy our expected requirements for working capital, capital expenditures, dividends and share repurchases, if any. We expect to have access to the amounts available under the Credit Facility as required. However, should we experience future reductions in our operating cash flows due to weakening conditions in our construction end-markets and reduced demand from our customers, we may need to curtail capital and operating expenditures, delay or restrict share repurchases, cease dividend payments and/or realign our working capital requirements.

Should we determine, at any time, that we required additional short-term liquidity, we would evaluate the alternative sources of financing that were potentially available to provide such funding. There can be no assurance that any such financing, if pursued, would be obtained, or if obtained, would be adequate or on terms acceptable to us. However, we believe that our strong balance sheet, flexible capital structure and borrowing capacity available to us under the Credit Facility position us to meet our anticipated liquidity requirements for the foreseeable future.

Seasonality and Cyclicality

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

Impact of Inflation

We are subject to inflationary risks arising from fluctuations in the market prices for our primary raw material, hot-rolled steel wire rod, and, to a much lesser extent, freight, energy and other consumables that are used in our manufacturing processes. We have generally been able to adjust our selling prices to pass through increases in these costs or offset them through various cost reduction and productivity improvement initiatives. However, our ability to raise our selling prices depends on market conditions and competitive dynamics, and there may be periods during which we are unable to fully recover increases in our costs. Inflation did not have a material impact on our sales or earnings during the third fiscal quarter of 2016. The timing and magnitude of any future changes in the prices for wire rod and the impact on selling prices for our products is uncertain at this time.

Off-Balance Sheet Arrangements

We do not have any material transactions, arrangements, obligations (including contingent obligations), or other relationships with unconsolidated entities or other persons, as defined by Item 303(a)(4) of Regulation S-K of the SEC, that have or are reasonably likely to have a material current or future impact on our financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses.

Contractual Obligations

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

Critical Accounting Policies

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

Recent Accounting Pronouncements 

Refer to Note 2 of the Notes to Consolidated Financial Statements in Item 1 of this Quarterly Report for recently adopted and issued accounting pronouncements since the filing of our Form 10-K for the year ended October 3, 2015, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements.

Outlook

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Commodity Prices

We are subject to significant fluctuations in the cost and availability of our primary raw material, hot-rolled steel wire rod, which we purchase from both domestic and foreign suppliers. We negotiate quantities and pricing for both domestic and foreign wire rod purchases for varying periods (most recently monthly for domestic suppliers), depending upon market conditions, to manage our exposure to price fluctuations and ensure adequate availability of material consistent with our requirements. We do not use derivative commodity instruments to hedge our exposure to changes in prices as such instruments are not currently available for wire rod. Our ability to acquire wire rod from foreign sources on favorable terms is impacted by fluctuations in foreign currency exchange rates, foreign taxes, duties, tariffs and other trade actions. Although changes in wire rod costs and our selling prices may be correlated over extended periods of time, depending upon market conditions and competitive dynamics, there may be periods during which we are unable to fully recover increased wire rod costs through higher selling prices, which would reduce our gross profit and cash flow from operations. Additionally, should wire rod costs decline, our financial results may be negatively impacted if the selling prices for our products decrease to an even greater degree and to the extent that we are consuming higher cost inventory. Based on our shipments and average wire rod cost reflected in cost of sales for the first nine months of 2016, a 10% increase in the price of wire rod would have resulted in a $16.6 million decrease in our pre-tax earnings for the nine months ended July 2, 2016 (assuming there was not a corresponding change in our selling prices).

Interest Rates 

Although we did not have any balances outstanding on our revolving credit facility as of July 2, 2016, future borrowings under the facility are subject to a variable rate of interest and are sensitive to changes in interest rates.

Foreign Exchange Exposure

We have not typically hedged foreign currency exposures related to transactions denominated in currencies other than U.S. dollars, as such transactions have not been material historically. We will occasionally hedge firm commitments for certain equipment purchases that are denominated in foreign currencies. The decision to hedge any such transactions is made by us on a case-by-case basis. There were no forward contracts outstanding as of July 2, 2016.

Item 4. Controls and Procedures

We have conducted an evaluation of the effectiveness of our disclosure controls and procedures as of July 2, 2016. This evaluation was conducted under the supervision and with the participation of management, including our principal executive officer and our principal financial officer. Based upon that evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Further, we concluded that our disclosure controls and procedures were effective to ensure that information is accumulated and communicated to management, including our principal executive officer and our principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

There has been no change in our internal control over financial reporting that occurred during the quarter ended July 2, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings