INSTEEL INDUSTRIES INC - Quarter Report: 2018 March (Form 10-Q)

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2018

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, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 April 20, 2018 was 19,063,470.

PART I – FINANCIAL INFORMATION

Item 1. 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 filings with the United States (“U.S.”) Securities and Exchange Commission (“SEC”), in particular in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017 (our “2017 Annual Report”). 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 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:

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. 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. Our business strategy is focused on: (1) achieving leadership positions in our markets; (2) operating as the lowest cost producer in our industry; and (3) pursuing growth opportunities within our core businesses that further our penetration of the markets we currently serve or expand our footprint.

Results of Operations

Statements of Operations – Selected Data

(Dollars in thousands)

Second Quarter of Fiscal 2018 Compared to Second Quarter of Fiscal 2017

Net Sales

Net sales for the second quarter of 2018 increased 6.2% to $107.4 million from $101.2 million in the prior year quarter, reflecting a 2.4% increase in shipments and a 3.7% increase in average selling prices. The increase in shipments was primarily due to improved market conditions and strengthening demand for our products relative to the prior year quarter. The increase in average selling prices was driven by price increases that were implemented in the current quarter to recover higher raw material costs.

Gross Profit

Gross profit for the second quarter of 2018 decreased 15.7% to $15.4 million, or 14.4% of net sales, from $18.3 million, or 18.1% of net sales, in the prior year quarter. The year-over-year decrease was due to lower spreads between average selling prices and raw material costs ($3.6 million) partially offset by higher shipments ($0.4 million) and lower manufacturing costs ($0.2 million). The reduction in spreads was driven by higher raw material costs ($7.3 million), partially offset by higher average selling prices ($3.6 million) and lower freight expense ($0.1 million).

Selling, General and Administrative Expense

Selling, general and administrative expense (“SG&A expense”) for the second quarter of 2018 increased 6.0% to $7.5 million, or 7.0% of net sales, from $7.1 million, or 7.0% of net sales in the prior year quarter primarily due to higher employee benefit expense ($0.5 million) and the relative changes in the cash surrender value of life insurance policies ($0.3 million), partially offset by a decrease in compensation expense ($0.5 million). The increase in employee benefit expense was primarily related to higher employee health insurance costs in the current year quarter. The cash surrender value of life insurance policies was essentially unchanged in the current year quarter compared with an increase of $0.3 million in the prior year quarter due to the corresponding changes in the value of the underlying investments. The decrease in compensation expense was largely driven by lower incentive plan costs.

Restructuring Charges, Net

Net restructuring charges of $25,000 were incurred in the second quarter of 2017 for equipment relocation costs related to the consolidation of our PC strand facilities. We did not incur any restructuring charges during the second quarter of 2018.

Other Expense

Other expense for the second quarter of 2018 was $0.2 million and primarily related to losses on the disposition of property, plant and equipment.         

Income Taxes

Our effective tax rate for the second quarter of 2018 decreased to 24.7% from 33.9% for the prior year quarter largely due to the reduction in the federal statutory tax rate to 21% from 35% enacted under the Tax Cuts and Jobs Act in December 2017.

Net Earnings

Net earnings for the second quarter of 2018 decreased to $5.9 million ($0.31 per share) from $7.4 million ($0.39 per share) in the prior year quarter primarily due to the decrease in gross profit together with the increase in SG&A expense, partially offset by the reduction in income tax expense.

First Half of Fiscal 2018 Compared to First Half of Fiscal 2017

Net Sales

Net sales for the first half of 2018 increased 5.2% to $205.2 million from $195.0 million in the same year-ago period, reflecting a 1.8% increase in shipments and a 3.3% increase in average selling prices. The increase in shipments was primarily due to improved market conditions and strengthening demand for our products relative to the prior year period. The increase in average selling prices was driven by price increases that were implemented to recover higher raw material costs.

Gross Profit

Gross profit for the first half of 2018 decreased 13.5% to $27.1 million, or 13.2% of net sales, from $31.3 million, or 16.0% of net sales, in the same year-ago period. The year-over-year decrease was primarily due to lower spreads between average selling prices and raw material costs ($7.1 million), partially offset by lower manufacturing costs ($1.6 million) and higher shipments ($0.6 million). The reduction in spreads was driven by higher raw material costs ($13.2 million) and freight expense ($0.1 million), partially offset by higher average selling prices ($6.2 million).

Selling, General and Administrative Expense

SG&A expense for the first half of 2017 decreased 0.6% to $13.2 million, or 6.5% of net sales, from $13.3 million, or 6.8% of net sales, in the same year-ago period primarily due to lower compensation expense ($0.7 million), partially offset by higher employee benefit ($0.3 million) and labor expense ($0.1 million). The decrease in compensation expense was largely driven by lower incentive plan costs. The increase in employee benefit expense was primarily related to higher employee health insurance costs in the current year period. The cash surrender value of life insurance policies increased $0.3 million in the current year period compared with $0.4 million in the prior year period due to the changes in the value of the underlying investments.

 Restructuring Charges, Net

Net restructuring charges of $73,000 were incurred in the first half of 2017 for equipment relocation costs related to the consolidation of our PC strand facilities. We did not incur any restructuring charges during the first half of 2018.

Other Expense

Other expense for the first half of 2018 was $0.2 million and primarily related to losses on the disposition of property, plant and equipment.

Income Taxes

Our effective tax rate for the first half of 2018 decreased to (1.9%) from 33.8% for the prior year period. The current year rate benefited from a $3.7 million gain on the remeasurement of deferred tax liabilities related to the lower corporate tax rate enacted under the Tax Cuts and Jobs Act in December 2017. Excluding the deferred tax gain, our effective tax rate decreased to 24.7% from 33.8% in the prior year period reflecting the reduction in the federal statutory rate to 21% from 35% for three quarters of fiscal 2018.

Net Earnings

Net earnings for the first half of 2018 increased to $14.0 million ($0.73 per share) from $11.9 million ($0.62 per diluted share) in the same year-ago period primarily due to the deferred tax gain and reduction in our effective tax rate related to enactment of the Tax Cuts and Jobs Act, partially offset by the decrease in gross profit.

Liquidity and Capital Resources

Selected Financial Data

(Dollars in thousands)

Operating Activities

Operating activities provided $24.5 million of cash during the first half of 2018 primarily from net earnings adjusted for non-cash items together with a decrease in the net working capital components of accounts receivable, inventories, and accounts payable and accrued expenses. Net working capital provided $4.3 million of cash due to an $18.7 million decrease in inventories, partially offset by a $10.2 million increase in accounts receivable and a $4.2 million decrease in accounts payable and accrued expenses. The decrease in inventories and increase in accounts receivable were primarily related to the increasing sales during the latter part of the period. The decrease in accounts payable and accrued expenses was principally due to the payment of accrued incentive compensation and accrued property taxes for the prior year.

Operating activities provided $17.6 million of cash during the first half of 2017 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 $1.3 million of cash due to an $11.1 million decrease in accounts payable and accrued expenses and a $2.2 million increase in accounts receivable, partially offset by a $12.0 million decrease in inventories. The decrease in accounts payable and accrued expenses was principally due to lower raw material purchases during the period together with the payment of accrued incentive compensation for the prior year. The increase in accounts receivable was primarily related to the increase in sales in the latter part of the period. The decrease in inventories was largely due to lower raw material purchases.

We may elect to adjust our operating activities as there are changes in our construction end-markets, which could materially impact our cash requirements. While a downturn in the level of construction activity adversely affects sales to our customers, it generally reduces our working capital requirements.

Investing Activities

Investing activities used $12.7 million of cash during the first half of 2018 compared to $10.9 million during the same period last year primarily due to the acquisition of a business, partially offset by lower capital expenditures in the current year. Capital expenditures decreased to $9.3 million from $10.7 million in the prior year period and are expected to total up to $21.0 million for fiscal 2018 largely related to additional investments in ESM manufacturing capabilities, the purchase of the leased Houston facility and further upgrades of production technology and information systems. 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 $20.4 million of cash during the first half of 2018 while using $25.4 million during the same period last year primarily due to a lower special cash dividend payment in the current year period. Cash dividends used $20.2 million of cash during the first half of 2018, including a special cash dividend totaling $19.0 million, or $1.00 per share. In the prior year period, cash dividends used $24.9 million of cash, including a special cash dividend totaling $23.7 million, or $1.25 per share.

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 March 31, 2018, no borrowings were outstanding on the Credit Facility, $84.4 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 require additional short-term liquidity, we would evaluate the alternative sources of financing that were potentially available to provide such funding. There can be no assurance that any such financing, if pursued, would be obtained, or if obtained, would be adequate or on terms acceptable to us. However, we believe that our strong balance sheet, flexible capital structure and borrowing capacity available to us under our Credit Facility position us to meet our anticipated liquidity requirements for the foreseeable future, including the next 12 months.

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, assuming normal seasonal weather patterns, 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.

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 quarter of fiscal 2018, the year-over-year escalation in our raw material costs exceeded the increase in our selling prices due to competitive pricing pressures. 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

There have been no material changes in our contractual obligations and commitments as disclosed in our 2017 Annual Report 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 U.S. for interim financial information. The preparation of our 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. Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” included in our 2017 Annual Report for further information regarding our critical accounting policies and estimates. As of March 31, 2018, there were no changes in the nature of our critical accounting policies or the application of those policies from those reported in our 2017 Annual Report.

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 2017 Annual Report, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements.

Outlook

Looking ahead to the remainder of 2018, we expect our financial results will be favorably impacted by the usual seasonal upturn in demand together with continued growth in our construction end-markets. Customer sentiment remains positive and we believe the infrastructure-related portion of our business will benefit from the recent passage of the federal omnibus spending bill and higher state and local funding in many of our markets. The leading indicators and industry forecasts for nonresidential construction remain positive as well with the potential for additional growth resulting from the new tax law.

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 resulting from our acquisition of the assets associated with the PC strand business of American Spring Wire Corporation and the related reconfiguration of our PC strand operations as we ramp up the new raw material cleaning and production lines at our Houston plant. 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.

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 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 wire rod costs and our 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 shipments and average wire rod cost reflected in cost of sales for the first half of 2018, a 10% increase in the price of wire rod would have resulted in a $12.2 million decrease in our 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 March 31, 2018, 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 March 31, 2018.

Item 4. Controls and Procedures

We have conducted an evaluation of the effectiveness of our disclosure controls and procedures as of March 31, 2018. 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, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Further, they 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 March 31, 2018 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

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 costs to resolve these matters will have a material adverse effect on our financial position, results of operations or cash flows.

Item 1A. Risk Factors

During the quarter ended March 31, 2018, there were no material changes from the risk factors set forth under Part I, Item 1A., “Risk Factors” in our 2017 Annual Report. You should carefully consider these factors in addition to the other information set forth in this report which could materially affect our business, financial condition or future results. The risks and uncertainties described in this report and in our 2017 Annual Report, as well as other reports and statements that we file with the SEC, are not the only risks and uncertainties facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also have a material adverse effect on our financial position, results of operations or cash flows.

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

On November 18, 2008, our Board of Directors approved a share repurchase authorization to buy back up to $25.0 million of our outstanding common stock (the “Authorization”). Repurchases may be made from time to time in the open market or in privately negotiated transactions subject to market conditions, applicable legal requirements and other factors. We are not obligated to acquire any particular amount of common stock and may commence or suspend the program at any time at our discretion without prior notice. The Authorization continues in effect until terminated by our Board of Directors. As of March 31, 2018, there was $24.8 million remaining available for future share repurchases under the Authorization. There were no share repurchases during the three- and six-month periods ended March 31, 2018 and April 1, 2017.

Item 6. Exhibits

SIGNATURES

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

INSTEEL INDUSTRIES, INC.

Registrant

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