UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________ COMMISSION FILE NUMBER 1-9929 INSTEEL INDUSTRIES, INC. (Exact name of registrant as specified in its charter) NORTH CAROLINA 56-0674867 -------------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1373 BOGGS DRIVE, MOUNT AIRY, NORTH CAROLINA 27030 -------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (336) 786-2141 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The number of shares outstanding of the registrant's common stock as of May 13, 2002 was 8,460,187.
PART I - - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INSTEEL INDUSTRIES, INC. CONSOLIDATED BALANCE SHEETS (In thousands) (Unaudited) <TABLE> <CAPTION> MARCH 30, SEPTEMBER 29, 2002 2001 --------- ------------- <S> <C> <C> Assets Current assets: Cash and cash equivalents $ 1,764 $ 4,183 Accounts receivable, net 38,984 43,912 Inventories 36,524 34,576 Prepaid expenses and other 2,688 4,645 --------- --------- Total current assets 79,960 87,316 Property, plant and equipment, net 60,489 74,234 Other assets 18,467 37,296 --------- --------- Total assets $ 158,916 $ 198,846 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 27,049 $ 32,293 Accrued expenses 7,876 9,692 Current portion of long-term debt 5,720 2,920 --------- --------- Total current liabilities 40,645 44,905 Long-term debt 89,145 97,785 Other liabilities 4,593 6,092 Shareholders' equity: Common stock 16,920 16,920 Additional paid-in capital 38,327 38,327 Retained deficit (28,040) (1,562) Accumulated other comprehensive loss (2,674) (3,621) --------- --------- Total shareholders' equity 24,533 50,064 --------- --------- Total liabilities and shareholders' equity $ 158,916 $ 198,846 ========= ========= </TABLE> 2
INSTEEL INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except for per share data) (Unaudited) <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED --------------------------- -------------------------- MARCH 30, MARCH 31, MARCH 30, MARCH 31, 2002 2001 2002 2001 --------- --------- --------- --------- <S> <C> <C> <C> <C> Net sales $ 64,900 $ 70,834 $ 127,614 $ 139,773 Cost of sales 59,903 67,756 117,549 133,780 --------- --------- --------- --------- Gross profit 4,997 3,078 10,065 5,993 Selling, general and administrative expense 2,784 4,863 6,106 10,298 Restructuring charges 12,802 -- 12,923 -- --------- --------- --------- --------- Operating loss (10,589) (1,785) (8,964) (4,305) Interest expense 2,984 4,544 6,127 7,931 Other income (66) (40) (1,023) (234) --------- --------- --------- --------- Loss before income taxes and accounting change (13,507) (6,289) (14,068) (12,002) Benefit for income taxes (1,776) (2,102) (1,948) (4,255) --------- --------- --------- --------- Loss before accounting change (11,731) (4,187) (12,120) (7,747) Cumulative effect of accounting change -- -- (14,358) -- --------- --------- --------- --------- Net loss $ (11,731) $ (4,187) $ (26,478) $ (7,747) ========= ========= ========= ========= Weighted average shares outstanding (basic and diluted) 8,460 8,460 8,460 8,460 ========= ========= ========= ========= Per share (basic and diluted): Loss before accounting change $ (1.39) $ (0.49) $ (1.43) $ (0.92) Cumulative effect of accounting change -- -- (1.70) -- --------- --------- --------- --------- Net loss $ (1.39) $ (0.49) $ (3.13) $ (0.92) ========= ========= ========= ========= </TABLE> 3
INSTEEL INDUSTRIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) <TABLE> <CAPTION> SIX MONTHS ENDED ----------------------------- MARCH 30, MARCH 31, 2002 2001 ---------- --------- <S> <C> <C> Cash Flows From Operating Activities: Net loss $(26,478) $ (7,747) Adjustments to reconcile net loss to net cash provided by (used for) operating activities: Cumulative effect of accounting change 14,358 -- Depreciation and amortization 4,564 7,125 Gain on sale of assets (131) (55) Restructuring charges 12,923 -- Deferred income taxes 768 (5,620) Net changes in assets and liabilities: Accounts receivable, net 4,688 1,656 Inventories (1,948) 2,159 Accounts payable and accrued expenses (7,060) (6,799) Other changes 1,784 926 -------- -------- Total adjustments 29,946 (608) -------- -------- Net cash provided by (used for) operating activities 3,468 (8,355) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (337) (1,589) Proceeds from (issuance of) notes receivable 240 (47) Proceeds from sale of property, plant and equipment 50 82 -------- -------- Net cash used for investing activities (47) (1,554) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term debt 2,100 66,900 Principal payments on long-term debt (7,940) (59,850) -------- -------- Net cash provided by (used for) financing activities (5,840) 7,050 -------- -------- Net decrease in cash (2,419) (2,859) Cash and cash equivalents at beginning of period 4,183 3,230 -------- -------- Cash and cash equivalents at end of period $ 1,764 $ 371 ======== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 5,228 $ 6,536 Income taxes -- 5 </TABLE> 4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION The consolidated unaudited financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in the audited financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended September 29, 2001. The unaudited consolidated financial statements included herein reflect all adjustments (consisting only of normal recurring accruals) that the Company considers necessary for a fair presentation of the financial position, results of operations and cash flows for all periods presented. The results for the interim periods are not necessarily indicative of the results to be expected for the entire fiscal year. (2) RESTRUCTURING CHARGES The Company recorded restructuring charges totaling $12.8 million (pre-tax) in the quarter. During the quarter, the Company exited the bulk and collated nail business with the closure of the nail manufacturing operations located in Andrews, South Carolina and disposed of most of the nail-related assets as well as certain of the remaining assets of the galvanized strand business, which the Company exited in May 2001. The restructuring charges consisted of: (1) losses on the sale of certain assets associated with the Company's nail business and write-downs in the carrying value of the remaining assets to be disposed of totaling $5.7 million; (2) estimated costs related to the closure of the Company's nail operations amounting to $0.2 million; (3) losses on the sale of certain assets associated with the Company's galvanized strand business and write-downs in the carrying value of the remaining assets to be disposed of totaling $2.9 million; and (4) an impairment loss on the long-lived assets associated with the industrial wire business amounting to $4.0 million. Approximately $12.6 million of the restructuring charges were non-cash charges related to asset write-downs or losses on asset sales and the remaining $0.2 million were cash charges associated with the closure of the nail business. Total net proceeds from the asset sales amounted to $1.6 million and were received by the Company subsequent to the end of the quarter. The $4.0 million impairment loss recorded on the long-lived assets related to the industrial wire business was primarily related to the impact of the closure of the nail business and related reduction in wire requirements together with unfavorable changes in the market. In determining the impairment loss, the Company considered historical performance and future estimated results in the evaluation of potential impairment. This analysis indicated that the carrying amount of the assets was not recoverable through the future undiscounted cash flows expected to result from the use of the assets. The impairment charge reflects a reduction in the carrying value of the property, plant and equipment to their estimated fair market value based on estimates of current selling prices less the associated selling costs. (3) GOODWILL AND INTANGIBLE ASSETS In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). Under SFAS 142, the Company will no longer amortize goodwill and intangibles which have indefinite lives. SFAS 142 requires that the Company assess goodwill and certain intangible assets with indefinite useful lives for impairment upon adoption at the beginning of the fiscal year (September 30, 2002) and at least annually thereafter. The Company has determined that it will perform its annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of fiscal 2002. Under SFAS 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. For purposes of the impairment testing, the Company determined that the goodwill asset to be tested was entirely related to the continuing operations of Florida Wire and Cable, Inc. ("FWC"), a subsidiary of the Company that was acquired in January 2000. In calculating the impairment charge, the fair value of the impaired reporting unit, FWC, was estimated using a multiple of earnings before interest, taxes, depreciation and amortization ("EBITDA") based on recent comparable transactions and using a discounted cash flow methodology based on estimated future cash flows. Based on the impairment testing, the Company recorded a non-cash charge of $14.4 million, or $1.70 per share, as the cumulative effect of a change in accounting principle to write off the entire goodwill balance associated with FWC as of 5
the beginning of the fiscal year. Including the cumulative effect of the accounting change, the first quarter net loss was $14.7 million, or $1.74 per share, compared with a net loss of $0.4 million, or 5 cents per share as previously reported (prior to the charge). The Company's fiscal 2001 results reflect goodwill amortization expense (pre-tax) of $0.3 million for the second quarter and $0.5 million for the six-month period. A reconciliation of the previously reported fiscal 2001 statement of operations information to pro forma amounts that reflect the elimination of goodwill amortization is presented below: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, 2001 MARCH 31, 2001 ------------------------------ ------------------------------ NET LOSS PER NET LOSS PER SHARE (BASIC) SHARE (BASIC) NET LOSS AND DILUTED) NET LOSS AND DILUTED) -------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> Net loss, as reported $(4,187) $(0.49) $(7,747) $(0.92) Add back goodwill amortization 168 0.02 329 0.04 ------- ------ ------- ----- Net loss, pro forma $(4,019) $(0.47) $(7,418) $(0.88) ======= ====== ======= ===== </TABLE> (4) DEFERRED TAX ASSET As of March 30, 2002, the Company recorded a deferred tax asset of $7.6 million, net of valuation allowance of $7.5 million. The realization of the Company's deferred tax assets is entirely dependent upon the Company's ability to generate future taxable income. Generally accepted accounting principles ("GAAP") require that the Company periodically assess the need to establish a valuation allowance against its deferred tax assets to the extent the Company no longer believes it is more likely than not that the tax assets will be fully utilized. Based on the Company's projections of future operations, the Company believes that it will generate sufficient taxable income to utilize all of its NOLs. Under GAAP, however, projected financial performance alone is not sufficient to warrant the recognition of a deferred tax asset to the extent the Company has had cumulative losses in recent years. Rather, the presumption exists that absent recent historical evidence of the Company's ability to generate taxable income, a valuation reserve against deferred tax assets should be established. Accordingly, in connection with the loss incurred for the quarter, the Company established a valuation allowance of $7.5 million against its deferred tax assets, $6.7 million of which relates to non-current tax assets. The provision to establish this valuation allowance is included in the benefit for income taxes reported for the quarter ended March 30, 2002. The valuation allowance established by the Company is subject to periodic review and adjustment based on changes in facts and circumstances. (5) CREDIT FACILITIES The Company has a senior secured credit facility with a group of banks, consisting of a $50.0 million revolving credit loan and a $57.5 million term loan. In May 2002, the Company and its senior lenders agreed to an amendment to the credit agreement that extended the previously amended maturity date of the credit facility from January 15, 2003 to October 15, 2003. The amendment also provided for certain other terms and conditions, including: (1) changes in the applicable margin that allow the Company to lower its borrowing rates through improvements in the ratio of debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") or future reductions in the term loan outstandings; (2) a reduction in the amount of the revolving credit commitment from $50.0 million to $42.0 million that is to occur no later than July 31, 2002 based on decreases in the borrowing base resulting from the Company's divestitures and expected reductions in the Company's borrowing requirements; (3) the deferral of certain scheduled fee payments and increases in the fee amounts payable; (4) annual limitations on the amount of capital expenditures; and (5) mandatory prepayments of the term loan should actual EBITDA exceed certain thresholds. Under the amended terms of the credit agreement, interest rates on the credit facility are determined based upon a base rate that is established at the higher of the prime rate or 0.5% plus the federal funds rate, plus, in either case, an 6
applicable interest rate margin. As of March 30, 2002, the interest rate on the credit facility was 8.00%. In addition, a commitment fee is payable on the unused portion of the revolving credit facility. Advances under the revolving 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. At March 30, 2002, approximately $7.6 million was available under the revolving credit facility. Under the amended terms of the credit agreement, the Company is subject to financial covenants that require the maintenance of EBITDA and net worth above specified levels. The senior secured credit facility is collateralized by all of the Company's assets. The Company and its senior lenders have agreed to certain modifications in the credit facility through a series of amendments to the credit agreement. The previous amendments had the effect of increasing the Company's interest expense from the amounts that would have been incurred under the original terms of the credit agreement as a result of: (1) increases in the applicable interest rate margins; (2) additional fees, a portion of which are calculated based upon the Company's stock price, payable to the lenders on certain dates and in increasing amounts based upon the timing of the completion of a refinancing of the credit facility; and (3) a reduction in the term of the credit facility and the period over which the capitalized financing costs are amortized, resulting in higher amortization expense. Upon an event of default, the lenders would be entitled to the right to payment of that portion of the fees that are calculated based upon the Company's stock price. The Company intends to refinance the senior secured credit facility prior to its amended maturity date of October 15, 2003. In the event that such efforts are unsuccessful, the Company believes that it would likely experience a material adverse impact on its financial condition, liquidity and results of operations. As required by its lenders under the terms of the credit facility, in April 2000, the Company entered into interest rate swap agreements to reduce the financial impact of future interest rate fluctuations on its earnings and cash flows. These agreements effectively converted $50.0 million of the Company's variable rate debt to fixed rate debt. The Company has designated its interest rate swap agreements as cash flow hedges and formally assesses on an ongoing basis whether these agreements are highly effective in offsetting the changes in the fair values of the interest cash flows under its senior secured credit facility. Interest rate differentials paid or received under these swap agreements are recognized in income over the life of the agreements as adjustments to interest expense. Changes in the fair value of the swap agreements are recorded as a component of "accumulated other comprehensive income." As of March 30, 2002, the fair value of the swap agreements was ($3.5 million) and was recorded in other liabilities on the Company's consolidated balance sheet. (6) EARNINGS PER SHARE The reconciliation of basic and diluted earnings per share ("EPS") is as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED -------------------------- -------------------------- MARCH 30, MARCH 31, MARCH 30, MARCH 31, (Amounts in thousands, except per share data) 2002 2001 2002 2001 --------- ---------- ---------- --------- <S> <C> <C> <C> <C> Net loss $(11,731) $ (4,187) $(26,478) $ (7,747) Weighted average shares outstanding: Weighted average shares outstanding (basic) 8,460 8,460 8,460 8,460 Dilutive effect of stock options -- -- -- -- -------- -------- -------- -------- Weighted average shares outstanding (diluted) 8,460 8,460 8,460 8,460 ======== ======== ======== ======== Net loss (basic and diluted) $ (1.39) $ (0.49) $ (3.13) $ (0.92) ======== ======== ======== ======== </TABLE> Options to purchase 1,169,000 shares and 846,000 shares for the three months ended March 30, 2002 and March 31, 2001, respectively, were antidilutive and were not included in the diluted EPS computation. 7
(7) COMPREHENSIVE INCOME (LOSS) The components of comprehensive income (loss), net of tax, for the three months ended March 30, 2002 and March 31, 2001 are as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ------------------------- ---------------------------- MARCH 30, MARCH 31, MARCH 30, MARCH 31, (Amounts in thousands) 2002 2001 2002 2001 -------- -------- ---------- --------- <S> <C> <C> <C> <C> Net loss $(11,731) $ (4,187) $(26,478) $ (7,747) Change in fair market value of financial instruments 525 (378) 947 (1,569) -------- -------- -------- -------- Total comprehensive loss $(11,206) $ (4,565) $(25,531) $ (9,316) ======== ======== ======== ======== </TABLE> The components of the change in the accumulated other comprehensive loss for the six months ended March 30, 2002 are as follows: <TABLE> (Amounts in thousands) <S> <C> Balance, September 29, 2001 $(3,621) Change in fair market value of financial instruments 947 ------- Balance, March 30, 2002 $(2,674) ======= </TABLE> (8) OTHER FINANCIAL DATA Balance sheet information: <TABLE> <CAPTION> MARCH 30, SEPTEMBER 29, 2002 2001 --------- ------------- <S> <C> <C> Accounts receivable, net: Accounts receivable $ 37,277 $ 41,810 Other receivables (income tax refund) 2,816 3,034 Less allowance for doubtful accounts (1,109) (932) --------- --------- Total $ 38,984 $ 43,912 ========= ========= Inventories: Raw materials $ 15,588 $ 16,514 Supplies 1,145 1,901 Work in process 1,163 1,791 Finished goods 18,628 14,370 --------- --------- Total $ 36,524 $ 34,576 ========= ========= Other assets: Non-current deferred taxes, net $ 5,370 $ 5,806 Equity investment 3,250 3,401 Cash surrender value of life insurance policies 2,480 2,380 Assets held for sale 1,764 4,724 Capitalized financing costs, net 1,355 1,771 Goodwill, net -- 14,358 Other 4,248 4,856 --------- --------- Total $ 18,467 $ 37,296 ========= ========= Property, plant and equipment, net: Land and land improvements $ 5,788 $ 6,708 Buildings 34,376 40,239 Machinery and equipment 76,481 97,446 Construction in progress 1,483 1,444 --------- --------- 118,128 145,837 Less accumulated depreciation (57,639) (71,603) --------- --------- Total $ 60,489 $ 74,234 ========= ========= </TABLE> 8
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 that reflect the Company's current assumptions and estimates of future performance and economic conditions. Such statements are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements contain words such as "expects," "plans," "believes," "will," "estimates," "intends," and other words of similar meaning that do not relate strictly to historical or current facts. Forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those projected, stated or implied by the statements. Such risks and uncertainties include, but are not limited to, general economic and competitive conditions in the markets in which the Company operates; unanticipated changes in customer demand, order patterns and inventory levels; fluctuations in the cost and availability of the Company's primary raw material, hot rolled steel wire rod from domestic and foreign suppliers; the Company's ability to raise selling prices in order to recover increases in wire rod prices; legal, environmental or regulatory developments that significantly impact the Company's operating costs; continuation of good labor relations; the Company's ability to avoid events of default with respect to its indebtedness, particularly under its senior secured credit facility, as amended; and the Company's ability to refinance its current indebtedness in a timely manner and on favorable terms. RESULTS OF OPERATIONS STATEMENTS OF EARNINGS - - SELECTED DATA ($ in thousands) <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED ---------------------------------------- ---------------------------------------- MARCH 30, MARCH 31, MARCH 30, MARCH 31, 2002 CHANGE 2001 2002 CHANGE 2001 ------------ -------- ------------ ------------ -------- ------------- <S> <C> <C> <C> <C> <C> <C> Net sales $ 64,900 (8%) $ 70,834 $ 127,614 (9%) $ 139,773 Gross profit 4,997 62% 3,078 10,065 68% 5,993 Percentage of net sales 7.7% 4.3% 7.9% 4.3% Selling, general and administrative expense $ 2,784 (43%) $ 4,863 $ 6,106 (41%) $ 10,298 Percentage of net sales 4.3% 6.9% 4.8% 7.4% Restructuring charges $ 12,802 N/M $ -- $ 12,923 N/M $ -- Operating loss $ (10,589) N/M $ (1,785) $ (8,964) N/M $ (4,305) Percentage of net sales (16.3%) (2.5%) (7.0%) (3.1%) Interest expense $ 2,984 (34%) $ 4,544 $ 6,127 (23%) $ 7,931 Percentage of net sales 4.6% 6.4% 4.8% 5.7% Effective income tax rate 13.1% 33.4% 13.8% 35.5% Cumulative effect of accounting change $ -- -- $ -- $ (14,358) N/M $ -- Net loss $ (11,731) 180% $ (4,187) $ (26,478) 242% $ (7,747) Percentage of net sales (18.1%) (5.9%) (20.7%) (5.5%) </TABLE> N/M = Not meaningful SECOND QUARTER OF FISCAL 2002 COMPARED TO SECOND QUARTER OF FISCAL 2001 Net Sales Net sales for the quarter decreased 8% to $64.9 million from $70.8 million in the same year-ago period primarily due to the Company's exit from the galvanized strand and nail businesses. On a comparable basis, excluding the revenues from these discontinued product lines, sales rose 1%. Sales of the Company's concrete reinforcing products (welded wire fabric and PC strand) declined 4% from the year-ago quarter, but rose to 68% of consolidated sales from 65%. Sales of wire products (industrial wire and tire bead wire, excluding nails) increased 19% from the year-ago quarter and rose to 25% of consolidated sales from 20%. The changes in product mix were primarily due to increased sales of welded wire fabric and tire bead wire together with the elimination of galvanized strand sales and the reduction in nail sales in the current year. 9
Following the Company's exit from the galvanized strand business in the third quarter of fiscal 2001 and from the nail business during the current quarter, the Company no longer generates revenues from these product lines. For fiscal 2001, sales of bulk and collated nails were $24.3 million, or 8% of the Company's consolidated sales. Gross Profit Gross profit rose 62% to $5.0 million, or 7.7% of net sales in the quarter compared with $3.1 million, or 4.3% of net sales in the same year-ago period. The 3.4 point improvement in gross margins was due to manufacturing cost reductions and higher productivity levels at the Company's facilities, which served to more than offset lower spreads between average selling prices and raw material costs. Selling, General and Administrative Expense Selling, general and administrative expense ("SG&A expense") fell 43% to $2.8 million, or 4.3% of net sales in the quarter from $4.9 million, or 6.9% of net sales in the same year-ago period. The decrease in SG&A expense was largely driven by the Company's exit from the galvanized strand and nail businesses together with the favorable impact of the cost reduction measures that have been implemented. Restructuring Charges During the quarter, the Company recorded pre-tax restructuring charges totaling $12.8 million ($11.1 million after-tax, or $1.31 per share), for losses on the sale of assets associated with the nail and galvanized strand businesses, write-downs in the carrying value of the remaining assets to be disposed of, closure costs associated with the nail business, and an impairment loss on the long-lived assets of the industrial wire business. Approximately $12.6 million of the restructuring charges were non-cash charges related to asset write-downs or losses on asset sales and the remaining $0.2 million were cash charges associated with the closure of the nail business (see Note 2 - Restructuring Charges). Operating Loss The Company's operating loss increased to $10.6 million for the quarter from $1.8 million in the same year-ago period due to the restructuring charges that were recorded in the current year quarter. On a comparable basis, excluding restructuring charges in the current year and goodwill amortization expense in the prior year, the Company's operating income was $2.2 million for the quarter, compared with an operating loss of $1.5 million in the same year-ago period. Interest Expense Interest expense for the quarter fell $1.5 million to $3.0 million from $4.5 million in the same year-ago period. The decrease was primarily due to reductions in amortization expense associated with capitalized financing costs ($1.0 million), average borrowing levels ($0.4 million) and average interest rates ($0.1 million). Income Taxes The Company's effective income tax rate decreased to 13.1% for the quarter compared to 33.4% in the same year-ago period. The decrease was due to the establishment of a $7.5 million valuation allowance against the Company's deferred tax assets related to the tax benefit generated by the loss incurred for the current quarter. Net Loss The Company's net loss for the quarter increased to $11.7 million, or $1.39 per share, from $4.2 million, or 49 cents per share, in the same year-ago period. On a comparable basis, excluding restructuring charges in the current year and goodwill amortization expense in the prior year, the Company's net loss was $0.6 million, or 7 cents per share, for the quarter, compared with a net loss of $4.0 million, or 48 cents per share, in the same year-ago period. 10
FIRST SIX MONTHS OF FISCAL 2002 COMPARED WITH FIRST SIX MONTHS OF FISCAL 2001 Net Sales Net sales for the first six months of fiscal 2002 decreased 9% to $127.6 million from $139.8 million in the same year-ago period primarily due to the Company's exit from the galvanized strand and nail businesses. On a comparable basis, excluding the revenues from these discontinued product lines, sales were essentially flat. Sales of the Company's concrete reinforcing products (welded wire fabric and PC strand) declined 4% from the year-ago period, but rose to 69% of consolidated sales from 66%. Sales of wire products (industrial wire and tire bead wire, excluding nails) increased 16% from the year-ago quarter and rose to 24% of consolidated sales from 19%. The changes in product mix were primarily due to increased sales of welded wire fabric and tire bead wire together with the elimination of galvanized strand sales and reduction in nail sales in the current year. Following the Company's exits from the galvanized strand business in the third quarter of fiscal 2001 and from the nail business during the current quarter, the Company no longer generates revenues from these product lines. For fiscal 2001, sales of bulk and collated nails were $24.3 million, or 8% of the Company's consolidated sales. Gross Profit Gross profit rose 68% to $10.1 million, or 7.9% of net sales for the first six months of fiscal 2002 compared with $6.0 million, or 4.3% of net sales in the same year-ago period. The 3.6 point improvement in gross margins was due to manufacturing cost reductions and higher productivity levels at the Company's facilities, which served to more than offset lower spreads between average selling prices and raw material costs. Selling, General and Administrative Expense Selling, general and administrative expense ("SG&A expense") fell 41% to $6.1 million, or 4.8% of net sales for the first six months of fiscal 2002 from $10.3 million, or 7.4% of net sales in the same year-ago period. The decrease in SG&A expense was largely driven by the Company's exit from the galvanized strand and nail businesses together with the favorable impact of the cost reduction measures that have been implemented. Restructuring Charges During the current year, the Company recorded pre-tax restructuring charges totaling $12.9 million ($11.1 million after-tax, or $1.32 per share), for losses on the sale of assets associated with the nail and galvanized strand businesses, write-downs in the carrying value of the remaining assets to be disposed of, closure costs associated with the nail business, an impairment loss on the long-lived assets of the industrial wire business, and separation costs associated with other selling and administrative staffing reductions. Approximately $12.6 million of the restructuring charges were non-cash charges related to asset write-downs or losses on asset sales and the remaining $0.3 million were cash charges associated with the closure of the nail business and employee separation costs (See Note 2-Restructuring Charges). Operating Loss The Company's operating loss increased to $9.0 million for the first six months of fiscal 2002 from $4.3 million in the same year-ago period due to the restructuring charges that were recorded in the current year. On a comparable basis, excluding restructuring charges in the current year and goodwill amortization expense in the prior year, the Company's operating income was $4.0 million for the first six months of the current year, compared with an operating loss of $3.8 million in the same year-ago period. Interest Expense Interest expense for the first six months of fiscal 2002 fell $1.8 million to $6.1 million from $7.9 million in the same year-ago period. The decrease was primarily due to reductions in amortization expense associated with capitalized financing costs ($1.0 million), average borrowing levels ($0.6 million) and average interest rates ($0.2 million). 11
Other Income The Company's results for the first six months of fiscal 2002 reflect a pre-tax gain of $1.0 million that was recorded in other income in connection with an insurance settlement. The settlement was related to a property damage and business interruption claim resulting from an accident that occurred at the Fredericksburg, Virginia facility in August 1999. Income Taxes The Company's effective income tax rate decreased to 13.8% for the first six months of fiscal 2002 compared with 35.5% in the same year-ago period. The decrease was due to the establishment of a $7.5 million valuation allowance against the Company's deferred tax assets related to the tax benefit generated by the loss incurred for the current year. Cumulative Effect of Accounting Change The Company's results for the first six months of fiscal 2002 reflect a non-cash charge of $14.4 million resulting from an accounting change. During the current year, the Company completed the goodwill impairment testing required in connection with its adoption of Statement of Financial Accounting Standards 142 ("SFAS 142") effective September 30, 2001. Based on the results of the testing, the Company determined that goodwill had been impaired and that a charge should be recorded as of the date of adoption at the beginning of the current fiscal year. In accordance with generally accepted accounting principles, the Company's fiscal 2001 results reflect charges for the amortization of goodwill of $0.3 million for the second quarter and $0.5 million for the six-month period. Goodwill is no longer amortized in the current year with the adoption of SFAS 142. Including the cumulative effect of the accounting change in the first quarter of fiscal 2002, the net loss was $14.7 million, or $1.74 per share, compared with a net loss of $0.4 million, or 5 cents per share as previously reported (prior to the charge) (See Note 3-Goodwill and Intangible Assets). Net Loss The Company's net loss for the first six months of fiscal 2002 increased to $26.5 million, or $3.13 per share, from $7.7 million, or 92 cents per share, in the same year-ago period. On a comparable basis, excluding restructuring charges and the gain on the insurance settlement in the current year, and goodwill amortization expense in the prior year, the Company's net loss was $1.9 million, or 22 cents per share, for the first six months of the current year, compared with a net loss of $7.4 million, or 88 cents per share, in the same year-ago period. LIQUIDITY AND CAPITAL RESOURCES SELECTED FINANCIAL DATA ($ in thousands) <TABLE> <CAPTION> SIX MONTHS ENDED ----------------------------- MARCH 30, MARCH 31, 2002 2001 ----------- --------- <S> <C> <C> Net cash provided by (used for) operating activities $ 3,468 $ (8,355) Net cash used for investing activities (47) (1,554) Net cash provided by (used for) financing activities (5,840) 7,050 Total long-term debt 94,865 112,050 Percentage of total capital 79% 62% Shareholders' equity $ 24,533 $ 67,518 Percentage of total capital 21% 38% Total capital (total long-term debt + shareholders' equity) $ 119,398 $ 179,568 </TABLE> CASH FLOW ANALYSIS Operating activities provided $3.5 million of cash for the first six months of fiscal 2002 while using $8.4 million in the same year-ago period. The year-to-year increase was primarily due to the improvement in the Company's cash operating performance in the current year, after adjusting for the non-cash accounting change and restructuring charges, compared with 12
the prior year net loss and the associated change in deferred income taxes. The net change in the working capital components of receivables, inventories and accounts payable and accrued expenses used $4.3 million in the current year while using $3.0 million in the prior year. Depreciation and amortization declined by $2.6 million, or 36%, compared to the prior year primarily due to: (1) lower amortization expense associated with capitalized financing costs; (2) the elimination of goodwill amortization in the current year in connection with the adoption of SFAS 142; (3) the reduced depreciation in the current year resulting from the impairment losses and write-downs in the carrying values of the Company's tire bead wire and galvanized strand facilities in the third quarter of fiscal 2001; and (4) the closure and sale of the assets of the nail business and write-down of the carrying value of the Company's industrial wire assets in the second quarter of fiscal 2002. Investing activities were essentially breakeven for the first six months of fiscal 2002 while using $1.6 million in the same year-ago period. The decrease was principally due to the Company's curtailment of capital outlays in connection with its debt reduction efforts. The Company expects capital expenditures to be below $2.0 million in fiscal 2002 and $3.0 million in fiscal 2003. Financing activities used $5.8 million of cash for the first six months of fiscal 2002 while providing $7.1 million in the same year-ago period. The reduction in financing requirements was primarily due to the Company's debt reduction efforts. As required by its lenders under the terms of the credit facility, in April 2000, the Company entered into interest rate swap agreements to reduce the financial impact of future interest rate fluctuations on its earnings and cash flows. These agreements effectively converted $50.0 million of the Company's variable rate debt to fixed rate debt. The Company has designated its interest rate swap agreements as cash flow hedges and formally assesses on an ongoing basis whether these agreements are highly effective in offsetting the changes in the fair values of the interest cash flows under its senior secured credit facility. Interest rate differentials paid or received under these swap agreements are recognized in income over the life of the agreements as adjustments to interest expense. Changes in the fair value of the swap agreements are recorded as a component of "accumulated other comprehensive income." As of March 30, 2002, the fair value of the swap agreements was ($3.5 million) and was recorded in other liabilities on the Company's consolidated balance sheet. The Company's total debt to capital ratio increased to 79% at March 30, 2002 compared with 62% at March 31, 2001 primarily due to the net losses incurred over the prior twelve-month period and the resulting reduction in shareholders' equity. CREDIT FACILITIES The Company has a senior secured credit facility with a group of banks, consisting of a $50.0 million revolving credit loan and a $57.5 million term loan. In May 2002, the Company and its senior lenders agreed to an amendment to the credit agreement that extended the previously amended maturity date of the credit facility from January 15, 2003 to October 15, 2003. The amendment also provided for certain other terms and conditions, including: (1) changes in the applicable margin that allow the Company to lower its borrowing rates through improvements in the ratio of debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") or future reductions in the term loan outstandings; (2) a reduction in the amount of the revolving credit commitment from $50.0 million to $42.0 million that is to occur no later than July 31, 2002 based on decreases in the borrowing base resulting from the Company's divestitures and expected reductions in the Company's borrowing requirements; (3) the deferral of certain scheduled fee payments and increases in the fee amounts payable; (4) annual limitations on the amount of capital expenditures; and (5) mandatory prepayments of the term loan should actual EBITDA exceed certain thresholds. Under the amended terms of the credit agreement, interest rates on the credit facility are determined based upon a base rate that is established at the higher of the prime rate or 0.5% plus the federal funds rate, plus, in either case, an applicable interest rate margin. As of March 30, 2002, the interest rate on the credit facility was 8.00%. In addition, a commitment fee is payable on the unused portion of the revolving credit facility. Advances under the revolving 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. At March 30, 2002. approximately $7.6 million was available under the revolving credit facility. Under the amended terms of the credit agreement, the Company is subject to financial covenants that require the maintenance of EBITDA and net worth above specified levels. The senior secured credit facility is collateralized by all of the Company's assets. 13
The Company and its senior lenders have agreed to certain modifications in the credit facility through a series of amendments to the credit agreement. The previous amendments had the effect of increasing the Company's interest expense from the amounts that would have been incurred under the original terms of the credit agreement as a result of: (1) increases in the applicable interest rate margins; (2) additional fees, a portion of which are calculated based upon the Company's stock price, payable to the lenders on certain dates and in increasing amounts based upon the timing of the completion of a refinancing of the credit facility; and (3) a reduction in the term of the credit facility and the period over which the capitalized financing costs are amortized, resulting in higher amortization expense. Upon an event of default, the lenders would be entitled to the right to payment of that portion of the fees that are calculated based upon the Company's stock price. The Company intends to refinance the senior secured credit facility prior to its amended maturity date of October 15, 2003. In the event that such efforts are unsuccessful, the Company believes that it would likely experience a material adverse impact on its financial condition, liquidity and results of operations. OUTLOOK The Company believes that the overall weakening in the economy will continue to create challenging business conditions through the remainder of fiscal 2002. In addition, reduced domestic capacity together with the "tariff-rate-quota" framework that is in effect and pending antidumping and countervailing duty actions could adversely impact the supply of hot rolled carbon steel wire rod, the Company's primary raw material, leading to higher prices. In the event that it was unsuccessful in recovering these higher costs in its markets, the Company's financial performance would be negatively impacted. In view of the Company's recent financial performance and the expected continuation of difficult market conditions, it is continuing to pursue a range of initiatives to reduce operating costs and debt. Over the prior year, the Company focused on improving the performance of its core operations, divested non-core operations, completed related staffing reductions, curtailed discretionary spending, and achieved higher productivity levels at its manufacturing facilities in reducing operating costs. The Company anticipates that the reductions in operating costs together with the suspension of its cash dividend, curtailment of capital outlays, improved management of working capital, disposal of under performing businesses and excess assets will facilitate further reductions in its debt. Although there can be no assurances, the Company believes that these actions will have a favorable impact on its financial performance for the remainder of 2002 (see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Cautionary Note Regarding Forward-Looking Statements"). ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK The Company's cash flows and earnings are subject to fluctuations resulting from changes in commodity prices, interest rates and foreign exchange rates. The Company manages its exposure to these market risks through internally established policies and procedures and, when deemed appropriate, through the use of derivative financial instruments. The Company does not use financial instruments for trading purposes and is not a party to any leveraged derivatives. The Company monitors its underlying market risk exposures on an ongoing basis and believes that it can modify or adapt its hedging strategies as necessary. Commodity Prices The Company does not generally use derivative commodity instruments to hedge its exposures to changes in commodity prices. The principal commodity price exposure is hot rolled carbon steel wire rod, the Company's primary raw material, which is purchased from both domestic and foreign suppliers. The Company has purchasing procedures and arrangements in place with customers to manage its exposure to changes in wire rod prices. Interest Rates The Company has debt obligations that are sensitive to changes in interest rates under its senior secured credit facility. As required by its lenders under the terms of its senior secured credit facility, in April 2000, the Company entered into interest rate swap agreements to reduce the financial impact of future interest rate fluctuations on its earnings and cash flows. These agreements effectively converted $50.0 million of the Company's floating rate debt to fixed rate debt. Interest 14
rate differentials paid or received under these swap agreements are recognized in income over the life of the agreements as adjustments to interest expense. Foreign Exchange Exposure The Company has not typically hedged foreign currency exposures related to transactions denominated in currencies other than U.S. dollars, although such transactions have not been material in the past. The Company 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 the Company on a case-by-case basis. There were no forward contracts outstanding as of March 30, 2002. PART II -- OTHER INFORMATION ITEM 5. OTHER MATTERS. In January 2002, the Company was notified by the New York Stock Exchange ("NYSE") that it would initiate procedures to suspend trading and delist the common stock of the Company in view of the fact that it had fallen below the following NYSE continued listing standards: (1) average global market capitalization over a consecutive 30 trading-day period less than $15.0 million, and (2) average closing price of the Company's common stock less than $1.00 over a consecutive 30 trading-day period. In February 2002, the Company's common stock began trading on the OTC bulletin board. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits: 4.1(f) Amendment Agreement No. 6 dated May 10, 2002 to Credit Agreement between Insteel Industries, Inc., Bank of America, N.A. and Lenders dated January 31, 2000 as amended January 12, 2001, May 21, 2001, August 9, 2001, November 16, 2001 and January 28, 2002. (Portions of this exhibit have been omitted pursuant to a request for confidential treatment). b. Reports of Form 8-K On February 12, 2002, the Company filed a Form 8-K under Item 5 regarding delisting of its common stock on the NYSE and the commencement of trading on the OTC bulletin board. 15
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INSTEEL INDUSTRIES, INC. ------------------------ Registrant Date: May 14, 2002 By: /s/ H.O. Woltz III -------------------------------------- H.O. Woltz III President and Chief Executive Officer Date: May 14, 2002 By: /s/ Michael C. Gazmarian -------------------------------------- Michael C. Gazmarian Chief Financial Officer and Treasurer 16