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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended June 28, 2003

OR

For the Transition Period From ________ to ________

Commission File Number 1-9929

Insteel Industries, Inc.

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 [   ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes [   ]                         No [X]

     The number of shares outstanding of the registrant’s common stock as of August 12, 2003 was 8,460,187.

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

See accompanying notes to consolidated financial statements.

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INSTEEL INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands except for per share data)
(Unaudited)

See accompanying notes to consolidated financial statements.

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INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

See accompanying notes to consolidated financial statements.

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INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation

     The unaudited consolidated 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 in the United States (“GAAP”) 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 28, 2002.

     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) Recent Accounting Pronouncements

     In April 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections.” As a result of rescinding SFAS No. 4, “Reporting Gains and Losses from Extinguishments of Debt,” gains and losses from extinguishments of debt are to be classified as extraordinary items only if they meet the criteria specified in Accounting Principles Board (“APB”) Opinion No. 30. This statement also amends SFAS No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions. Additional amendments include changes to other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. The Company adopted the provisions of SFAS No. 145 during the first quarter of fiscal 2003, which did not have a material impact on its results of operations or financial position.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This statement requires the recognition of a liability for the costs associated with an exit or disposal activity when the liability is incurred instead of at the date an entity commits to an exit plan. The statement is effective for exit and disposal activities entered into after December 31, 2002. The adoption of this statement did not have a material impact on the Company’s results of operations or financial position.

     In November 2002, the FASB issued FASB Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a guarantee is issued, an entity must recognize an initial liability for the fair value, or market value, of the obligations assumed and disclose such information in its interim and annual financial statements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of this Interpretation did not have a material impact on the Company’s financial statements.

     In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities (VIE).” In general, FIN 46 clarifies how an enterprise should determine if it should consolidate a VIE. FIN 46 is effective immediately for variable interests in VIEs created after January 31, 2003. Additionally, for a variable interest in a VIE created before February 1, 2003, FIN 46 is required to be applied no later than the beginning of the Company’s fourth quarter of fiscal 2003. The Company does not expect that the adoption of this Interpretation will have a material impact on its financial statements.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – An Amendment to FASB Statement No. 123.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” providing entities with alternative transition methods should they elect to change to the fair value method of accounting for stock-based compensation prescribed by SFAS No. 123. As amended by SFAS No. 148, SFAS No.

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123 also requires additional disclosure regarding stock-based compensation in annual and condensed interim financial statements. The new disclosure requirements are effective immediately.

     As allowed under SFAS No. 123, the Company accounts for stock-based compensation using the intrinsic value method in accordance with APB No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Stock options granted for the three months and nine months ended June 28, 2003 and June 29, 2002, respectively, were exercisable at prices equal to the fair market value of the Company’s common stock on the dates the options were granted; accordingly, no compensation expense has been recognized for the stock options granted.

     If the Company accounted for stock-based compensation using the fair market value recognition provisions of SFAS No. 123, the net earnings (loss) and basic and diluted net earnings (loss) per share would have changed to the pro forma amounts indicated below:

     The fair value of the options at the date of grant were estimated using the Black-Scholes option-pricing model based on the following weighted average assumptions:

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003, and should be applied prospectively. The Company does not expect that the adoption of this Interpretation will have a material impact on its financial statements.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity, requiring that an issuer classify instruments that are within its scope as liabilities (or assets in some circumstances). The statement is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company is currently evaluating the impact of this statement, but does not expect that its adoption will have a material impact on its financial statements.

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(3) Restructuring Charges

     In the prior year quarter, the Company recorded restructuring charges amounting to $23,000, which consisted of a loss on the sale of certain assets associated with its industrial wire business less a reduction in the reserves that were previously recorded related to its exit from the galvanized strand business. In May 2002, the Company sold certain assets related to its industrial wire business for net proceeds of $10.2 million, subject to a final purchase price adjustment, and recorded a loss on the sale of $360,000. Also during the prior year quarter, the Company determined that certain of the reserves that were previously established in connection with its May 2001 exit from the galvanized strand business exceeded the estimated remaining closure-related costs to be incurred. Accordingly, the Company recorded a $337,000 reduction in the reserve balances and a corresponding benefit to restructuring charges.

     In the prior year nine-month period, the Company recorded restructuring charges totaling $12.9 million related to its exit from certain product lines. 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. Additionally, the Company disposed of certain of the remaining assets of the galvanized strand business, which the Company had previously 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 $225,000; (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; (4) an impairment loss on the long-lived assets associated with the industrial wire business amounting to $4.0 million; and (5) separation costs totaling $121,000 associated with selling and administrative staffing reductions. Approximately $11.7 million of the restructuring charges were non-cash charges related to asset write-downs or losses on asset sales and the remaining $1.2 million were cash charges associated with the closure of the nail business and the selling and administrative staffing reductions.

     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 evaluating the potential impairment and determining the impairment loss, the Company considered historical performance and future estimated results. 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 was recorded to reduce the carrying value of the property, plant and equipment to its estimated fair market value based on estimated selling prices less the associated selling costs.

(4) Goodwill and Intangible Assets

     The Company adopted the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” as of September 30, 2001, the first day of fiscal 2002. In accordance with this statement, the Company no longer amortizes goodwill and intangible assets which have indefinite lives. SFAS No. 142 requires that the Company assess goodwill and certain intangible assets with indefinite useful lives for impairment upon adoption and at least annually thereafter. The Company performs its annual impairment review during the fourth quarter of each year.

     Under SFAS No. 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 as of the implementation date, 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, in the prior year nine-month period as the cumulative effect of a change in accounting principle to write off the entire goodwill balance associated with FWC as of the beginning of fiscal year 2002.

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(5) Deferred Tax Asset

     The Company has recorded the following amounts for deferred tax assets on its consolidated balance sheet as of June 28, 2003, a current deferred tax asset of $2.2 million in prepaid expenses and other, and a noncurrent deferred tax asset of $5.1 million (net of valuation allowance of $7.5 million) in other assets. The realization of the Company’s deferred tax assets is entirely dependent upon the Company’s ability to generate future taxable income. 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 net operating loss carryforwards. 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 fiscal year 2002, the Company established a valuation allowance of $7.5 million against its deferred tax assets. The valuation allowance established by the Company is subject to periodic review and adjustment based on changes in facts and circumstances. No adjustments to the valuation allowance have been recorded during fiscal 2003.

(6) Credit Facilities

     The Company has a senior secured credit facility with a group of banks, consisting of a $42.0 million revolving credit facility, a $28.5 million term loan and a $11.7 million term loan. In February 2003, 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 October 15, 2003 to March 31, 2004. The amendment also provided for certain other terms and conditions, including: (1) changes in the applicable margins that allow the Company to lower its interest rates through future reductions in the term loan; (2) additional fees which become payable to the lenders on certain dates unless a refinancing of the credit facility is completed before such dates; (3) the deferral of the payment dates of other contingent fees consistent with the period of time for which the maturity date was extended; (4) adjustments to the financial covenants that are applicable under the credit agreement; (5) limitations on the amount of capital expenditures to $1.8 million for each fiscal year; and (6) 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 0.50% plus the federal funds rate, plus, in either case, an applicable interest rate margin. As of June 28, 2003, interest rates on the credit facility were as follows: 6.50% on the revolver and 8.00% on the term loans. In addition, a commitment fee is payable on the unused portion of the revolving credit facility and a utilization fee is payable on the $11.7 million term loan.

     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 June 28, 2003, approximately $6.7 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 Company was in compliance with all of the financial covenants as of June 28, 2003. 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 March 31, 2004. In the event that such efforts are unsuccessful, the Company believes that it will likely experience a material adverse impact on its financial condition, liquidity and results of operations.

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     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 a fixed rate of 7.08% plus the applicable margin under the credit facility. 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 loss.” As of June 28, 2003, the fair value of the swap agreements was ($4.6 million) and was recorded in other liabilities on the Company’s consolidated balance sheet.

(7) Stock Option Plans

     In order to enable employees to acquire or increase their holdings of the Company’s common stock and to promote a closer identification of their interests with those of the Company and its shareholders, on November 12, 2002, the Board of Directors approved a one-time exchange program under the 1994 Employee Stock Option Plan. Under the terms of the exchange, participants that elected to surrender eligible options prior to December 9, 2002 were issued one option for every three options surrendered on June 13, 2003. The new options were issued at an exercise price equal to the market price of the Company’s stock on the grant date. Pursuant to the exchange program, 535,000 options with an average exercise price of $5.58 per share were surrendered on or prior to December 9, 2002 and 178,000 options with an average exercise price of $0.65 per share were issued on June 13, 2003. The Company’s Chief Executive Officer, Chairman, and all of its Directors elected not to participate in the exchange program.

(8) Earnings Per Share

     The reconciliation of basic and diluted earnings per share (“EPS”) is as follows: