Insteel Industries
Annual Report 2007

Plain-text annual report

Insteel IndustrIes 2007 AnnuAl report rebuilding America’s Infrastructure FI nAnc IAl H IgHlIgHts (In thousands, except for per share amounts) 2007 2006 2005 operating results: Net sales Gross profit % of net sales Earnings from continuing operations % of net sales Net earnings per share data: Basic: Earnings from continuing operations Net earnings Diluted: Earnings from continuing operations Net earnings Cash dividends declared returns: Return on capital(1) Return on equity(2) Financial position: Total assets Total long-term debt Shareholders’ equity cash Flows: $ 297,806 56,061 $ 329,507 70,871 $ 309,320 57,898 18.8% 21.5% 18.7% $ 24,284 $ 34,377 $ 24,499 8.2% 10.4% 7.9% $ 24,162 $ 33,040 $ 25,045 $ 1.34 1.33 1.33 1.32 0.12 $ 1.88 1.80 1.86 1.79 0.12 $ 1.31 1.34 1.29 1.32 0.06 18.2% 18.2% 29.7% 31.3% 21.1% 29.1% $ 173,529 — 143,850 $ 166,596 — 122,438 $ 138,276 11,860 97,036 Net cash provided by operating activities of continuing operations Capital expenditures Depreciation and amortization Repurchase of common stock Cash dividends paid $ 17,065 17,013 6,209 — 2,176 $ 42,650 18,959 5,107 8,529 2,222 $ 41,830 6,302 5,627 — 566 (1) Earnings from continuing operations/(average total long-term debt + average shareholders’ equity). (2)Earnings from continuing operations/(average shareholders’ equity). Net Sales (in millions) $329.5 $309.3 $297.8 Diluted Earnings Per Share From Continuing Operations $1.86 $1.29 $1.33 Return on Equity(2) 31.3% 29.1% 18.2% 0 0.0 ’05 ’06 ’07 ’05 ’06 ’07 ’05 ’06 ’07 350000 300000 250000 200000 150000 100000 50000 2.0 1.5 1.0 0.5 35 30 25 20 15 10 5 0 Insteel Industries is one of the nation’s largest manufacturers of steel wire reinforcing products for concrete construction applications. We manufacture and market prestressed concrete strand (“pc strand”) and welded wire reinforcement, including concrete pipe reinforcement, engineered structural mesh and standard welded wire reinforcement. our products are sold primarily to manufacturers of concrete products that are used in nonresidential construction. Headquartered in Mount Airy, north carolina, we operate six manufacturing facilities located in the u nited states. Welded WIre reInForceMent prefabricated reinforcement consisting of high-strength, cold-drawn or cold-rolled longitudinal and transverse wires welded together in square or rectangular grids according to customer requirements. Wire intersections are electrically resistance-welded by a computer-controlled continuous automatic welder which uses pressure and heat to fuse all wires in their proper position, creating a consistent high-quality reinforcing product. CoNCrete PIPe reINforCemeNt Engineered made-to-order product that is used as the primary reinforcement in concrete pipe and box culverts for drainage and sewage systems, water treatment facilities and other related applications. PLANT LOCATIONS Dayton, Texas Mount Airy, North Carolina Wilmington, Delaware CuSTO meR SegmeNTS eND uSe S Concrete Pipe and Precast Producers Nonresidential Construction Residential Construction eNgINeered StruCtural meSh Engineered made-to-order product that is used as the primary reinforcement in concrete elements or structures, frequently serving as a replacement for hot-rolled rebar. PLANT LOCATIONS Dayton, Texas Mount Airy, North Carolina CuSTO meR SegmeNTS Precast and Prestressed Producers Rebar Fabricators Distributors eND uSe S Nonresidential Construction StaNdard Welded WIre reINforCemeNt Secondary reinforcing product that is produced in standard styles for crack control applications in residential and light nonresidential construction, including driveways, sidewalks and a wide range of slab-on-grade applications. PLANT LOCATIONS Dayton, Texas Hickman, Kentucky Mount Airy, North Carolina Wilmington, Delaware CuSTO meR SegmeNTS Rebar Fabricators Distributors eND uSe S Nonresidential Construction Residential Construction prestressed concrete strAnd High-strength seven-wire reinforcement consisting of six cold-drawn wires that are continuously wrapped around a center wire forming a strand. the strand is heat-treated while under tension, which imparts low relaxation characteristics and increases the working range of the product, providing engineers with greater flexibility in its application and the ability to better utilize its reinforcing properties. pc strand is used to impart compression forces into prestressed concrete elements and structures, which may be either pretensioned or posttensioned. pretensioned means that the strands are tensioned to their design load and anchored at the ends of a form. After concrete has been placed and allowed to cure to sufficient strength, the load on the strand is transferred from the external anchors to the cured member, creating compression forces within the element, or “prestressing” it. posttensioned means that the strands are tensioned after the concrete has been placed and allowed to cure. PLANT LOCATIONS Gallatin, Tennessee Sanderson, Florida CuSTO meR SegmeNTS Precast Prestress Producers Posttension Suppliers eND uSe S Nonresidential Construction Residential Construction America faces a growing infrastructure crisis. Deterioration. Congestion. Reduced reliability. A projected funding gap of $1.6 trillion over the next five years. After years of neglect, the warning signs are becoming increasingly apparent across all sectors of our nation’s infrastructure. Nearly 30% of the bridges in the U.S. are structurally deficient or functionally obsolete. Our interstate highway system is reaching the end of its 50-year life cycle and will require substantial rebuilding and maintenance. A recent study indicates that 83% of our transportation infrastructure is incapable of meeting the country’s needs over the next 10 years. In its most recent report card on America’s infrastructure, the American Society of Civil Engineers gave our system an overall “D” which included 4 Cs and 10 Ds. Our roads are becoming increasingly congested as the number of miles driven rose 23% from 1995 to 2005 while the length of roads increased only 2%. The average metropolitan driver spends 46 hours a year stuck in traffic which doubles for daily rush-hour commuters in large cities. The lack of comprehensive and coordinated long-term strategies and financing solutions has left us playing catch-up to other nations. Addressing these needs will require substantial increases in funding at the federal, state and local level, which are likely to come from higher taxes and user fees in addition to various forms of public/private partnerships and bond issues funded by user fees and general tax revenues. 2 2 How does our nation’s infrastructure strategy impact Insteel? Through the intensive use of our concrete reinforcing products in highway and infrastructure construction…PC strand and ESM in bridges and overpasses, concrete pipe reinforcement in road drainage systems and ESM in concrete barrier medians. We believe the heightened interest in addressing our nation’s infrastructure needs will ultimately yield financing solutions that represent a substantial growth opportunity for Insteel. Insteel IndustrIes, Inc. and subsIdIarIes 3 Insteel IndustrIes, Inc. and subsIdIarIes 3 Insteel Industries A name largely unfamiliar outside of the building materials industry. A company that is one of the largest manufacturers of steel wire reinforcing products for concrete construction applications. A leader in its markets with state-of-the-art facilities and manufacturing capabilities. A provider of concrete reinforcing solutions ideally positioned to capitalize on the critical infrastructure needs of our nation. us82—Greenville bridge The new Greenville Bridge on I-82 crossing the Mississippi River which incorporated Insteel’s concrete reinforcing products and was previously featured on the cover of our 2005 annual report. Engineered structural mesh A welded wire reinforcing product manufactured to customer specifications that frequently serves as a replacement for hot-rolled rebar. A product produced as prefabricated sheets that offers significant labor savings versus the time-intensive placing and tying inherent to rebar and requires less steel due to its superior strength. A product gaining momentum in penetrating the rebar market in response to: (1) increasing construction labor constraints and costs; and (2) improvements in welding equipment technology that have made small batch production and quick delivery feasible. A product that can serve as 6 6 new esM production line at our Mount airy, nc plant a substitute for rebar sizes representing approximately 80% of domestic rebar consumption. A market for Insteel that could double in volume on just a few percentage points of market share growth. A product frequently used with PC strand to provide a comprehensive concrete reinforcing solution. With the two new production lines that started up during 2007 in our North Carolina and Texas facilities, each with the capacity to generate $16–$20 million of revenues annually (at current average selling prices), we are well-positioned to capitalize on the growing acceptance of ESM as a superior reinforcing solution for many concrete construction applications. Insteel IndustrIes, Inc. and subsIdIarIes 7 Insteel IndustrIes, Inc. and subsIdIarIes 7 $2.9 $6.3 2003 2004 2005 $19.0 2006 $17.0 2007 0 Investing for the future During 2006 and 2007, we’ve invested $36 million in our manufacturing facilities. Adding new ESM production lines in our North Carolina and Texas plants. Upgrading the equipment and reconfiguring the process flow of our Tennessee and Florida PC strand facilities. Adding a new standard welded wire reinforcement line in our Delaware plant. These projects share common characteristics by providing additional capacity to satisfy future growth in demand and facilitating substantial improvements in our labor productivity and unit conversion costs. When fully ramped up, they should add over $70 million of revenue-generating capacity annually (at current average selling prices) and advance our ongoing initiatives to operate as the lowest cost producer. 30 40 10 20 50 0 10 20 30 40 50 Let t er to Sh a r ehoLderS In 2007, Insteel posted solid financial results coming off the record highs that were achieved in 2006 despite facing increasing headwinds in our markets. We contin- ued to make strategic investments that position us for future growth and enhance our manufacturing capabili- ties. our business strategy remains focused on generating returns that exceed our cost of capital by (1) achieving leadership positions in our markets and operating as the lowest cost producer, and (2) pursuing growth opportunities in our core businesses that further our penetration of existing markets or expand our geo- graphic footprint. FInancIal HIgHlIgHts Sales for 2007 decreased 9.6% to $297.8 million from $329.5 million in 2006 as an 11.4% drop-off in shipments offset a 2.0% increase in average selling prices. Earnings from continuing operations fell to $24.3 million ($1.33 per diluted share) from $34.4 million ($1.86 per diluted share) in the prior year due to the reduced shipments, increasing raw material costs and higher unit conversion costs resulting from lower production levels. Business conditions continued to be mixed during the year, characterized by strong demand for concrete reinforcing products that are primarily used in nonresidential construction and weak demand from customers with significant exposure to the housing market. During the second half of the year, our sales of PC strand to commercial posttension accounts focused on residential construction applications declined due to the elevated level of irrationally priced import competition, primarily from China. As a result, shipments to posttensioners, which represented 14% of our total shipments in 2006 were minimal during the second half of 2007. We ended the year debt-free with $8.7 million of cash on hand. Our strong balance sheet and flexible capital structure position us to enhance value for our shareholders by investing in the growth of our core businesses through capital expenditures and acquisitions, paying cash dividends and utilizing our share repurchase program on an opportunistic basis. capItal ExpE ndItur E program Capital expenditures were $17.0 million in 2007 as we continued to invest in a wide range of important initiatives to expand revenues and drive cost improvements at our manufacturing facilities. When fully operational, these projects have the capability of generating over $70.0 million of incremental revenues annually (at current average selling prices) in addition to significantly reducing our unit conversion costs through higher productivity and increased throughput. 10 With most of the outlays for these projects behind us, we plan on significantly scaling back capital expenditures in 2008 as we assess the uncertainty in our markets and in the economy in general. At the same time, our financial flexibility will allow us to capitalize on any growth opportunities that may develop. Engineered Structural Mesh (“ESM”). We started up a new ESM production line in our North Carolina facility during the first quarter and a second new line at our Texas plant during the fourth quarter. These expansions position us to benefit from the growing market acceptance for ESM as a replacement for hot-rolled rebar due to the inherent labor, cycle time and material cost advantages it offers for many concrete reinforcing applications. With total domestic consumption of ESM representing less than 5% of the rebar volume it could potentially replace, the product is still early in its life cycle where just a few percentage points of market share growth translate into a substantial increase in demand. We expect each of the new lines to generate $16.0 to $20.0 million of annual revenues (at current average selling prices) when ramped up to capacity. PC strand. During the first quarter, we completed the reconfiguration and expansion of our Tennessee PC strand operation which entailed the consolidation of manufacturing processes previously performed in two adjacent facilities together with the installation of a new production line. We also began work on the upgrading of our Florida PC strand facility which is expected to be completed during the third quarter of 2008. These projects add a combined $30.0 million of annual revenue capacity (at current average selling prices)—$25.0 million at the Tennessee facility and $5.0 million at the Florida plant. While the timing of these additions may not coincide with robust market conditions, we view them as critical to extending our leadership position in the North American market. Standard welded wire reinforcement. During the fourth quarter, we started up a new standard welded wire reinforcement line in our Delaware plant that adds $7.0 million of annual revenue capacity (at current average selling prices). lookI ng aHEad As we move into 2008, we face significant near-term challenges in the form of rising raw material costs, PC strand import competition and the continuation of mixed market conditions. Raw materials. Prices for hot-rolled steel wire rod, our primary raw material, are on the rise and are likely to continue trending up until the pricing for imports into the U.S. becomes more competitive with domestic producers. These additional costs may be difficult to recover in our markets depending upon the strength of demand and competitive dynamics, although we are hopeful that the increased discipline that has been evident in our markets since 2004 continues going forward. PC strand imports. Imports of PC strand from China continue to enter the U.S. market at unrealistically low prices reflecting the dysfunctional nature of China’s non-market economy. It is clear that Chinese producers lack any inherent manufacturing cost advantage relative to state-of-the-art domestic producers such as Insteel. The Chinese pursuit of the U.S. market is largely a result of distorted economics resulting Insteel IndustrIes, Inc. and subsIdIarIes 11 from the availability of low-cost financing and government subsidies that have resulted in an explosion of capacity well in excess of China’s home market requirements. In July 2007, the Chinese government took the first step towards leveling the competitive playing field by reducing the VAT rebate for exported PC strand from 13% to 5%. This reduction, together with recent escalation in wire rod costs and ocean freight rates, has made exporting to the U.S. substantially less attractive for Chinese producers, forcing them to raise their selling prices. Although it would be premature to assume that these favorable trends will continue, we believe the unfair trade practices of the Chinese will ultimately be resolved—either through further proactive changes on the part of the Chinese government that allow true economics to prevail or through the filing of trade actions on the part of U.S. strand producers should market conditions deteriorate to the point where we can demonstrate injury. Under either scenario, Insteel will be well-positioned to capitalize through the expansion and upgrading of our Tennessee and Florida PC strand facilities and our world-class cost structure. Market outlook. We expect market conditions to remain mixed in 2008 with some moderation in the growth rate for nonresidential construction from the elevated level of recent years due to the anticipated softening in commercial construction. Other categories within nonresidential construction, however, are expected to remain strong driven by continued growth in infrastructure-related spending and post-hurricane reconstruction in the Gulf region. Longer term, we believe the heightened focus on addressing the critical infrastructure needs that exist will yield creative financing solutions that favorably impact demand for our concrete reinforcing products for an extended period. In view of the inventory overhang of unsold homes and tightening in the credit markets, we expect the weakness in residential construction to persist through 2009 and continue to adversely affect shipments to customers that have greater exposure to the housing sector. Despite these challenges, we anticipate gradually increasing returns from the substantial investments we have made in our facilities over the past two years through reduced operating costs and additional revenues, particularly for ESM as we further our penetration of the rebar market. In addition, we will continue to evaluate and pursue other growth opportunities—organic as well as through acquisitions—that strengthen our competitive position and create value for our shareholders. We wish to thank our customers, employees and shareholders for their continued trust, confidence and support. As we move into 2008, we are well-positioned to capitalize on the opportunities and respond to the challenges that lie ahead. Sincerely, H.O. Woltz III President and Chief Executive Officer 12 Contents 14 Management’s Discussion and Analysis of Financial Condition and Results of Operations 21 Management’s Report on Internal Control Over Financial Reporting 22 23 24 25 26 28 29 44 45 46 Report of Independent Registered Public Accounting Firm Consolidated Financial Statements Report of Independent Registered Public Accounting Firm Internal Control Over Financial Reporting Consolidated Statements of Operations Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareholders’ Equity and Comprehensive Income Notes to Consolidated Financial Statements Stock Performance Graph Financial Information by Quarter (Unaudited) Selected Financial Data—Five-Year History F i n a n c i a l R e v i e w ManageMent’s Discussion anD analysis of financial conDition anD Results of ope Rations Forward-Looking StatementS This annual report contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. When used in this report, the words “believes,” “anticipates,” “expects,” “estimates,” “plans,” “intends,” “may,” “should” and similar expressions are intended to identify forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, such forward-looking statements are subject to a number of risks and uncertainties, and we can provide no assurances that such plans, intentions or expectations will be achieved. All forward- looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. All forward-looking statements speak only to the respective dates on which such statements are made and we do not undertake and specifically decline any obligation to publicly release the results of any revisions to these forward- looking statements that may be made to reflect any future events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. 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 risks discussed below and in our Form 10-K for the year ended September 29, 2007 under the caption “Risk Factors” which includes the following:   •  Our business is cyclical and prolonged economic declines,  particularly in the level of construction activity, could have a material adverse effect on our financial results.   •  Demand for our products is highly variable and difficult  to forecast due to our minimal backlog and the unanticipated changes that can occur in customer order patterns or inventory levels.   •  Our financial results can be negatively impacted by the  volatility in the cost and availability of our primary raw mate- rial, hot-rolled carbon steel wire rod.   •  Foreign competition could adversely impact our financial  results.   •  Our  manufacturing  facilities  are  subject  to  unexpected  equipment failures, operational interruptions and casualty losses.   •  Our financial results could be adversely impacted by the  continued escalation in certain of our operating costs.   •  Our  capital  resources  may  not  be  adequate  to  provide  for our capital investment and maintenance expenditures if we were to experience a substantial downturn in our financial performance.   •  Environmental compliance and remediation could result  in substantially increased capital investments and operating costs.   •  Our production and earnings could be reduced by strikes  or work stoppages by our unionized employees.   •  Our stock price can be volatile, often in connection with  matters beyond our control. overview Following our exit from the industrial wire busi- ness (see Note 7 to the consolidated financial state- ments), our operations are entirely focused on the manufacture and marketing of concrete reinforcing products for the concrete construction industry. The results of operations for the industrial wire business have been reported as discontinued operations for all periods presented. Our business strategy is focused on: (1) achieving leadership positions in our markets and operating as the lowest cost producer; and (2) pursuing growth opportunities within our core businesses that further our penetration of current markets served or expand our geographic reach. CritiCaL aCCounting PoLiCieS Our financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. Our discussion and analysis of our financial condition and results of operations are based on these financial statements. 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 assump- tions believed to be reasonable. Actual results could differ from these estimates. The following critical accounting policies are used in the preparation of the financial statements: Revenue recognition and credit risk. We recognize revenue from product sales in accordance with Staff Accounting Bulletin (“SAB”) No. 104 when products are shipped and risk of loss and title has passed to the customer. Substantially all of our accounts receivable are due from customers that are located in the United States and we generally require no collateral depending 14                     upon the creditworthiness of the account. We provide an allowance for doubtful accounts based upon our assessment of the credit risk of specific customers, historical trends and other information. There is no disproportionate concentration of credit risk. Allowance for doubtful accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the potential inability of our customers to make required payments. If the financial condition of our customers were to change significantly, adjust- ments to the allowances may be required. While we believe our recorded trade receivables will be collected, in the event of default in payment of a trade receivable, we would follow normal collection procedures. Excess and obsolete inventory reserves. We write down the carrying value of our inventory for estimated obsolescence to reflect the lower of the cost of the inventory or its estimated net realizable value based upon assumptions about future demand and market conditions. If actual market conditions for our products are substantially different than our projections, adjust- ments to these reserves may be required. Accruals for self-insured liabilities and litigation. We accrue estimates of the probable costs related to self-insured medical and workers’ compensation claims and legal matters. These estimates have been devel- oped in consultation with actuaries, our legal counsel and other advisors and are based on our current under- standing of the underlying facts and circumstances. Because of uncertainties related to the ultimate out- come of these issues as well as the possibility of changes in the underlying facts and circumstances, adjustments to these reserves may be required in the future. Recent accounting pronouncements. In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncer- tainty in Income Taxes” (“FIN No. 48”) which clarifies the criteria for the recognition of tax benefits under Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” FIN No. 48 specifies how tax benefits for uncertain tax positions are to be recognized, measured and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncer- tain tax positions should be classified on the balance sheet; and provides transition and interim period guid- ance, among other provisions. FIN No. 48 is effective for us beginning in fiscal 2008 and requires that the cumulative effect of applying its provisions be disclosed separately as a one-time, non-cash charge against the opening balance of retained earnings in the year of adoption. Based on our preliminary analysis, the adoption of FIN No. 48 is expected to result in an estimated charge to retained earnings of approximately $260,000. The actual amount of the adjustment will be recorded in the first quarter of 2008 upon the finaliza- tion of our analysis. In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for us beginning in fiscal 2009. At this time, we have not determined what effect, if any, the adoption of SFAS No. 157 will have on our financial position or results of operations. In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” SFAS No. 158 requires that an employer recognize the overfunded or underfunded status of a defined benefit postretire- ment plan in its statement of financial position and changes in the funded status through other compre- hensive income in the year in which the changes occur. SFAS No. 158 also requires the measurement of defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position. The provisions regarding the recog- nition of a plan’s funding status were effective for us in fiscal 2007 and resulted in a $2.1 million decrease in shareholders’ equity, net of tax. The provisions regard- ing the change in the measurement date are effective for us beginning in fiscal 2009. The adoption of SFAS No. 158 is further discussed in Note 8 to the consoli- dated financial statements. insteel industRies, inc. and subsidiaRies 15 ManageMent’s Discussion anD analysis of financial conDition anD Results of opeRations (continued) reSuLtS oF oPerationS Statements of Operations—Selected Data (Dollars in thousands) Net sales Gross profit Percentage of net sales Selling, general and administrative expense Percentage of net sales Other expense (income), net Interest expense Effective income tax rate Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings “N/M” = not meaningful 2007 ComPared with 2006 Net Sales Net sales decreased 9.6% to $297.8 million in 2007 from $329.5 million in 2006 as lower shipments more than offset higher average selling prices. Shipments for the year decreased 11.4% while average selling prices rose 2.0% from the prior year. The reduction in shipments was driven by a combination of factors including: (1) the continuation of weak demand and inventory reduction measures pursued by customers that have been negatively impacted by the downturn in residential construction activity; (2) our decision to solicit minimal new business from posttension custom- ers in the PC strand market due to low-priced import competition; and (3) less favorable weather conditions in certain of our markets relative to the prior year which reduced the level of construction activity. Gross Profit Gross profit decreased 20.9% to $56.1 million, or 18.8% of net sales in 2007 from $70.9 million, or 21.5% of net sales in 2006. The decrease was primarily due to the reduction in shipments, higher unit manufacturing costs resulting from lower operating levels and higher raw material costs which were partially offset by the increase in average selling prices. september 29, 2007 $297,806 56,061 18.8% $ 17,583 5.9% $ 4 592 36.6% $ 24,284 (122) 24,162 Year Ended September 30, 2006 $329,507 70,871 21.5% $ 16,996 5.2% $ (446) 669 36.2% $ 34,377 (1,337) 33,040 Change (9.6%) (20.9%) 3.5% N/M (11.5%) (29.4%) N/M (26.9%) Change 6.5% 22.4% October 1, 2005 $ 309,320 57,898 18.7% 5.1% $ 16,175 N/M (80.5%) $ 5.2% (73) 3,427 36.1% 40.3% N/M 31.9% $ 24,499 546 25,045 Selling, General and Administrative Expense Selling, general and administrative expense (“SG&A expense”) increased 3.5% to $17.6 million, or 5.9% of net sales in 2007 from $17.0 million, or 5.2% of net sales in 2006. The increase was primarily due to higher compensation expense ($989,000) which was partially offset by lower employee benefit costs ($387,000). Other Expense (Income), Net Other expense was $4,000 in 2007 compared with income of $446,000 in 2006. The income for the prior year was primarily related to a $247,000 litigation settlement and $128,000 of duties related to the dumping and countervailing duty cases that were filed by a coalition of domestic PC strand producers which included us. Interest Expense Interest expense decreased $77,000, or 11.5%, to $592,000 in 2007 from $669,000 in 2006. The decrease was primarily due to lower average outstanding bal- ances on the revolving credit facility in the current year together with lower amortization expense associ- ated with capitalized financing costs. Income Taxes Our effective income tax rate was relatively flat for 2007 at 36.6% compared with 36.2% in 2006. 16 Earnings From Continuing Operations Gross Profit Earnings from continuing operations for 2007 decreased to $24.3 million, or $1.33 per diluted share, compared to $34.4 million, or $1.86 per diluted share in 2006 primarily due to the lower sales and gross profit. Earnings (Loss) From Discontinued Operations The loss from discontinued operations for 2007 was $122,000, or $0.01 per diluted share compared to $1.3 million, or $0.07 per diluted share in 2006. The current year loss reflects the closure costs incurred to exit the industrial wire business and close our Fredericksburg, Virginia manufacturing facility. The prior year loss reflects the operating losses incurred by the industrial wire business together with the closure costs which were partially offset by a $1.3 million pre- tax gain on the sale of certain machinery and equip- ment associated with the industrial wire business for $6.0 million. Net Earnings Net earnings for 2007 decreased to $24.2 million, or $1.32 per diluted share, compared to $33.0 million, or $1.79 per diluted share in 2006 primarily due to the lower sales and gross profit which was partially offset by the reduction in the loss from discontinued opera- tions associated with our exit from the industrial wire business and closure of our Fredericksburg, Virginia manufacturing facility. 2006 ComPared with 2005 Net Sales Net sales increased 6.5% to $329.5 million in 2006 from $309.3 million in 2005 as higher shipments more than offset lower average selling prices. Shipments for the year increased 11.0% while average selling prices decreased 4.0% from the prior year. The increase in shipments was primarily due to the continued improve- ment in nonresidential construction activity and demand for our concrete reinforcing products together with the completion of the inventory reduction mea- sures pursued by customers during the prior year. The decrease in average selling prices was due to compe- titive activity in our markets which was offset by reduc- tions in raw material costs. Gross profit increased 22.4% to $70.9 million, or 21.5% of net sales in 2006 from $57.9 million, or 18.7% of net sales in 2005. The increase in gross profit was driven by higher shipments together with wider spreads between average selling prices and raw material costs. In addition, gross profit for 2005 was negatively impacted by the sale of higher cost inventory as raw material costs and selling prices declined over the course of the year. Selling, General and Administrative Expense SG&A expense increased 5.1% to $17.0 million, or 5.2% of net sales in 2006 from $16.2 million, or 5.2% of net sales in 2005. We adopted SFAS No. 123(R) as of the beginning of fiscal 2006 which required all share-based payments to be recognized as expense over the requisite service period based upon their fair values as of the grant dates. Under the provisions of SFAS No. 123(R), total stock-based compensation expense for 2006 amounted to $1.2 million comprised of $535,000 of stock option expense and $638,000 of restricted stock amortization. Although we elected to adopt SFAS No. 123(R) using the modified prospective method, the 2005 amounts also reflect stock option expense due to certain previous option plans that were required to be accounted for as variable plans. Under variable plan accounting, compensation expense was recognized for the excess of the market price over the exercise price and adjusted to reflect changes in market valuation. As a result, total stock-based compensation expense for 2005 amounted to $805,000 comprised of $571,000 of stock option expense resulting from the increase in our share price that occurred during 2005 and $234,000 of restricted stock amortization. Excluding the stock-based compensation expense from both peri- ods, SG&A expense increased $453,000 primarily due to increases in compensation expense ($445,000), allowance for doubtful accounts ($299,000), employee benefit costs ($295,000), and travel-related expenses ($211,000) partially offset by lower legal expenses ($556,000) and consulting fees ($244,000). insteel industRies, inc. and subsidiaRies 17 ManageMent’s Discussion anD analysis of financial conDition anD Results of opeRations (continued) Other Expense (Income), Net Other income was $446,000 in 2006 compared with $73,000 in 2005. The income for 2005 was pri- marily related to a $247,000 litigation settlement and $128,000 of duties related to the dumping and coun- tervailing duty cases that were filed by a coalition of domestic PC strand producers which included us. Interest Expense Interest expense decreased $2.8 million, or 80.5%, to $669,000 in 2006 from $3.4 million in 2005. The decrease was primarily due to the reduction in average borrowing levels on our senior secured credit facility ($1.8 million) and lower amortization expense associ- ated with capitalized financing costs and the unreal- ized loss on the terminated interest rate swaps which was fully amortized in 2005 ($959,000). Income Taxes Our effective income tax rate was relatively flat for 2006 at 36.2% compared with 36.1% in 2005. Earnings From Continuing Operations Earnings from continuing operations for 2006 increased to $34.4 million, or $1.86 per diluted share, compared to $24.5 million, or $1.29 per diluted share in 2005 primarily due to the higher sales and gross profit together with the reduction in interest expense in 2006. Liquidity and CaPitaL reSourCeS Selected Financial Data Earnings (Loss) From Discontinued Operations The loss from discontinued operations for 2006 was $1.3 million, or $0.07 per diluted share com- pared with earnings from discontinued operations of $546,000, or $0.03 per diluted share in 2005. The 2006 loss related to the operating losses and closure costs associated with our exit from the industrial wire busi- ness and closure of our Fredericksburg, Virginia manu- facturing facility. In 2006, we completed the sale of certain machinery and equipment associated with the industrial wire business for $6.0 million and recorded a pre-tax gain of $1.3 million. The 2005 earnings con- sisted of a $793,000 gain on the disposal of real estate, the collection of a note receivable and the settlement on the release of an equipment lien associated with Insteel Construction Systems, a discontinued operation that we had previously exited in 1997, partially offset by a loss of $247,000 from the operations of the indus- trial wire business. Net Earnings Net earnings for 2006 increased to $33.0 million, or $1.79 per diluted share, compared to $25.0 million, or $1.32 per diluted share in 2005 primarily due to the higher sales and gross profit together with the reduc- tion in interest expense during 2006 which was par- tially offset by the loss from discontinued operations. (Dollars in thousands) Net cash provided by operating activities of continuing operations Net cash used for investing activities of continuing operations Net cash used for financing activities of continuing operations Net cash provided by (used for) operating activities of discontinued operations Net cash provided by investing activities of discontinued operations Net cash used for financing activities of discontinued operations Working capital Total long-term debt Percentage of total capital Shareholders’ equity Percentage of total capital Total capital (total long-term debt + shareholders’ equity) Year Ended september 29, 2007 September 30, 2006 October 1, 2005 $ 17,065 (17,062) (1,842) (147) — — 70,697 — — $143,850 $ 42,650 (19,472) (22,008) 2,185 5,963 — 56,938 — — $122,438 100% 100% $ 41,830 (6,036) (40,931) 2,630 2,120 (560) 51,662 11,860 11% $ 97,036 89% $143,850 $122,438 $ 108,896 18 CaSh FLow anaLySiS Operating activities of continuing operations pro- vided $17.1 million of cash in 2007 compared with $42.7 million in 2006 and $41.8 million in 2005. The year-over-year decrease in 2007 was largely due to the $10.1 million reduction in earnings from continuing operations and $18.9 million decrease in cash provided by working capital. In 2007, the net change in receiv- ables, inventory and accounts payable and accrued expenses used $14.6 million of cash while providing $4.3 million and $7.9 million in 2006 and 2005, respec- tively. The cash used by working capital in the current year was primarily due to the $17.0 million decrease in accounts payable and accrued expenses resulting from the sharp reduction in raw material purchases during the fourth quarter together with changes in the mix of vendor payment terms. Depreciation and amortization rose $1.1 million, or 24.7%, primarily due to the increase in capital expenditures during the current and prior years and related asset additions. Deferred income taxes provided $2.0 million of cash during 2007 while using $1.6 million in 2006 primarily due to higher tax basis gains on the sale of fixed assets in the prior year. Investing activities of continuing operations used $17.1 million of cash in 2007 compared with $19.5 mil- lion in 2006 and $6.0 million in 2005. Capital expen- ditures amounted to $17.0 million, $19.0 million and $6.3 million in 2007, 2006 and 2005, respectively, with the higher levels in the current and prior years primar- ily related to capital outlays for the expansions of the ESM and PC strand businesses. Capital expenditures are expected to be $10.0 million in 2008 primarily related to the upgrading of our Florida PC strand facil- ity. The actual timing of these expenditures as well as the amounts are subject to change based on adjust- ments in the project timelines or scope, future market conditions, our financial performance and additional growth opportunities that may arise. In 2007, we sold an idle facility which had been classified as assets held for sale and realized net proceeds of $590,000. Investing activities from discontinued operations did not provide or utilize cash in 2007 while providing $6.0 million in 2006 from the net proceeds on the sale of certain machinery and equipment associated with our discon- tinued industrial wire business. Financing activities of continuing operations used $1.8 million of cash in 2007 compared with $22.0 mil- lion in 2006 and $40.9 million in 2005. The year-over- year decrease in 2007 was due to the $16.0 million reduction in long-term debt and the $8.5 million of share repurchases in the prior year. Credit FaCiLitieS As of September 29, 2007, we had a $100.0 mil- lion revolving credit facility in place to supplement our operating cash flow in funding our working capital, capital expenditure and general corporate require- ments. No borrowings were outstanding on the credit facility as of September 29, 2007 and September 30, 2006 and outstanding letters of credit totaled $1.9 mil- lion and $1.4 million, respectively. As of September 29, 2007, $54.7 million of borrowing capacity was available on the credit facility (see Note 4 to the consolidated financial statements). Our balance sheet was debt-free as of September 29, 2007 and September 30, 2006. We believe that, in the absence of significant unanticipated cash demands, net cash generated by operating activities and amounts available under our revolving credit facility will be sufficient to satisfy our expected requirements for work- ing capital, capital expenditures, dividends and share repurchases, if any. oFF-BaLanCe Sheet arrangementS We do not have any material transactions, arrangements, obligations (including contingent obli- gations), 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 reason- ably likely to have a material current or future impact on our financial condition, results of operations, liquid- ity, capital expenditures, capital resources or significant components of revenues or expenses. insteel industRies, inc. and subsidiaRies 19 ManageMent’s Discussion anD analysis of financial conDition anD Results of opeRations (continued) ContraCtuaL oBLigationS Our contractual obligations and commitments at September 29, 2007 are as follows: Contractual Obligations (In thousands) Operating leases Raw material purchase commitments(1) Other unconditional purchase obligations(2) Pension benefit obligations Supplemental employee retirement plan Total (1) Non-cancelable fixed price purchase commitments for raw materials. (2) Contractual commitments for equipment purchases. outLook We expect continued growth in nonresidential construction, our primary demand driver, in 2008, but at a reduced rate from the elevated levels of recent years. The outlook for commercial construction has weakened due to the ongoing housing downturn and recent tightening in the credit markets. However, other segments within nonresidential construction are expected to remain strong supported by: (1) higher spending for infrastructure-related construction asso- ciated with the recently enacted federal transporta- tion funding authorization, the improved fiscal positions of most states and the heightened focus on addressing the critical infrastructure needs that exist; and (2) post-hurricane reconstruction in the Gulf region of the U.S. At the same time, the drop-off in residential con- struction is expected to continue through 2008, which will adversely affect shipments to customers that have greater exposure to the housing sector. We now believe that a recovery in the housing market is unlikely to occur until sometime in 2009, although the exact tim- ing remains highly uncertain. In addition, increasing imports of PC strand and escalating raw material costs could compress margins depending upon the strength of demand, competitive dynamics and our ability to recover these additional costs in our markets. Despite these near-term challenges, we expect gradually increasing contributions during 2008 from the substantial investments that have been made in our facilities over the past two years to expand and reconfigure our Tennessee PC strand facility, add new ESM production lines in our North Carolina and Texas plants and a new standard welded wire reinforcing line at our Delaware facility, and upgrade our Florida PC 20 Payments Due by Period Less Than 1 Year $ 781 31,831 3,843 428 80 1–3 Years $ 658 — — 864 160 3–5 Years $ 27 — — 642 418 More Than 5 Years $ — — — 8,270 17,654 Total $ 1,466 31,831 3,843 10,204 18,312 $ 65,656 $ 36,963 $ 1,682 $ 1,087 $ 25,924 strand operation which is expected to be completed in the third quarter of 2008. As we ramp up production on the new equipment, we anticipate dual benefits in the form of reduced operating costs and additional capacity to support future growth. In addition to these organic growth and cost reduction initiatives, we are continually evaluating potential acquisitions in our existing businesses that further our penetration in current markets served or expand our geographic reach. We anticipate that these actions, together with the positive overall outlook for our nonresidential construction-related markets, should have a favorable impact on our financial performance in 2008 (see “Forward-Looking State ments”). quantitative and quaLitative diSCLoSureS aBout market riSk Our cash flows and earnings are subject to fluc- tuations resulting from changes in commodity prices, interest rates and foreign exchange rates. We manage our exposure to these market risks through internally established policies and procedures and, when deemed appropriate, through the use of derivative financial instruments. We do not use financial instruments for trading purposes and we are not a party to any lever- aged derivatives. We monitor our underlying market risk exposures on an ongoing basis and believe that we can modify or adapt our hedging strategies as necessary. Commodity Prices We have not generally used derivative commodity instruments to hedge our exposures to changes in com- modity prices. Our principal commodity price exposure is hot-rolled carbon steel wire rod, our primary raw material, which we purchase from both domestic and foreign suppliers and is denominated in U.S. dollars. Prior to 2004, we typically negotiated quantities and pricing on a quarterly basis for both domestic and foreign steel wire rod purchases to manage our expo- sure to price fluctuations and to ensure adequate avail- ability of material consistent with our requirements. However, beginning in 2004, a tightening of supply in the rod market together with fluctuations in the raw material costs of rod producers resulted in increased price volatility which has continued through 2007. In some instances, wire rod producers have resorted to increasing the frequency of price adjustments, typically on a monthly basis as well as unilaterally changing the terms of prior commitments. Our ability to acquire steel wire rod from foreign sources on favorable terms is impacted by fluctuations in foreign currency exchange rates, foreign taxes, duties, tariffs and other trade actions. Although changes in wire rod costs and our selling prices may be correlated over extended periods of time, depending upon market conditions, there may be periods during which we are unable to fully recover increased rod costs through higher selling prices, which reduces our gross profit and cash flow from operations. Interest Rates Although we were debt-free as of September 29, 2007, future borrowings under our senior secured credit facility are sensitive to changes in interest rates. Foreign Exchange Exposure We have not typically hedged foreign currency exposures related to transactions denominated in cur- rencies other than U.S. dollars and any such trans- actions have not been material in the past. We will occasionally hedge firm commitments for 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 September 29, 2007. ManageMent’s RepoRt on inte Rnal cont Rol oV eR financial RepoRting Insteel’s management is responsible for establish- ing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Insteel’s internal control over financial reporting is designed to provide reason- able assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s inter- nal control over financial reporting includes those written policies and procedures that: (1) pertain to maintaining records that in reasonable detail accu- rately and fairly reflect the transactions and disposi- tions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit prepa- ration of financial statements in accordance with gen- erally accepted accounting principles, and that receipts and expenditures are made in accordance with autho- rizations of management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposi- tion of assets that could have a material effect on the financial statements. Because of its inherent limitations, internal con- trol over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compli- ance with the policies or procedures may deteriorate. Management assessed the effectiveness of Insteel’s internal control over financial reporting as of Sep- tember 29, 2007. In making this assessment, manage- ment used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commis- sion in Internal Control—Integrated Framework. Based on its assessment, management believes that, as of September 29, 2007, Insteel’s internal control over financial reporting was effective based on those criteria. Grant Thornton LLP, an independent registered public accounting firm, has audited management’s assessment of the effectiveness of Insteel’s internal con- trol over financial reporting and has issued an attesta- tion report concurring with management’s assessment which is on page 23. insteel industRies, inc. and subsidiaRies 21 RepoRt of in DepenDent RegisteReD pu Blic accounting fi RM consoliDateD financial stateM ents The Board of Directors and Shareholders Insteel Industries, Inc.: We have audited the accompanying consolidated balance sheets of Insteel Industries, Inc. and subsidiary (a North Carolina corporation) as of September 29, 2007 and September 30, 2006 and the related consoli- dated statements of operations, shareholders’ equity and comprehensive income and cash flows for each of the three years in the period ended September 29, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Over- sight Board (United States). Those standards require that we plan and perform the audit to obtain reason- able assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by man- agement, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial state- ments referred to above present fairly, in all material respects, the financial position of Insteel Industries, Inc. and subsidiary as of September 29, 2007 and September 30, 2006 and the results of their opera- tions and their cash flows for each of the three years in the period ended September 29, 2007, in conformity with accounting principles generally accepted in the United States. As discussed in Note 8 to the financial statements, the Company has adopted Financial Accounting Standards Board Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” as of September 29, 2007. In addition, as discussed in Note 1, the Company adopted Financial Accounting Standards Board Statement No. 123(R), “Share-Based Payment” on October 2, 2005. We also have audited, in accordance with the standards of the Public Company Accounting Over- sight Board (United States), the effectiveness of Insteel Industries, Inc. and subsidiary’s internal control over financial reporting as of September 29, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated November 19, 2007 expressed an unqualified opinion. Greensboro, North Carolina November 19, 2007 22 RepoRt of in DepenDent RegisteReD pu Blic accounting fi RM inteRnal cont Rol oV eR financial RepoRting To the Board of Directors and Shareholders Insteel Industries, Inc.: We have audited Insteel Industries, Inc. and sub- sidiary’s (a North Carolina corporation) internal con- trol over financial reporting as of September 29, 2007, based on criteria established in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commis- sion (COSO). Insteel Industries, Inc. and subsidiary’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on Insteel Industries, Inc. and subsidiary’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Over- sight Board (United States). Those standards require that we plan and perform the audit to obtain reason- able assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understand- ing of internal control over financial reporting, assess- ing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial report- ing and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit prepa- ration of financial statements in accordance with gen- erally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal con- trol over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compli- ance with the policies or procedures may deteriorate. In our opinion, Insteel Industries, Inc. and sub- sidiary maintained, in all material respects, effective internal control over financial reporting as of Sep- tember 29, 2007 based on criteria established in Internal Control—Integrated Framework issued by the Com- mittee of Sponsoring Organizations of the Treadway Commission (COSO). We have also audited, in accordance with the standards of the Public Company Accounting Over- sight Board (United States), the consolidated balance sheets of Insteel Industries, Inc. and subsidiary as of September 29, 2007 and September 30, 2006 and the related consolidated statements of operations, share- holders’ equity and comprehensive income and cash flows for each of the three years in the period ended September 29, 2007, and our report dated November 19, 2007, expressed an unqualified opinion on those financial statements and contains an explanatory para- graph relating to the adoption of Financial Account- ing Standards Board Statement (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” In addition, as dis- cussed in Note 1, the Company adopted SFAS No. 123(R), “Share-Based Payment” on October 2, 2005. Greensboro, North Carolina November 19, 2007 insteel industRies, inc. and subsidiaRies 23 consoliDateD stateMents of opeRations (In thousands, except for per share amounts) Net sales Cost of sales Gross profit Selling, general and administrative expense Other expense (income), net Interest expense Interest income Earnings from continuing operations before income taxes Income taxes Earnings from continuing operations Earnings (loss) from discontinued operations net of income taxes of ($77), ($851) and $330 Net earnings Per share amounts: Basic: Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Diluted: Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Cash dividends declared Weighted shares outstanding: Basic Diluted See accompanying notes to consolidated financial statements. Year Ended september 29, 2007 September 30, 2006 October 1, 2005 $297,806 241,745 $329,507 258,636 $309,320 251,422 56,061 17,583 4 592 (415) 38,297 14,013 24,284 70,871 16,996 (446) 669 (255) 53,907 19,530 34,377 57,898 16,175 (73) 3,427 — 38,369 13,870 24,499 (122) (1,337) 546 $ 24,162 $ 33,040 $ 25,045 $ 1.34 (0.01) $ 1.33 $ $ $ 1.33 (0.01) 1.32 0.12 $ 1.88 (0.08) $ 1.31 0.03 $ 1.80 $ 1.34 $ $ $ 1.86 (0.07) 1.79 0.12 $ $ $ 1.29 0.03 1.32 0.06 18,142 18,314 18,307 18,473 18,656 18,954 24 consoliDateD Balance sH eets (In thousands, except for per share amounts) Assets: Current assets: Cash and cash equivalents Accounts receivable, net Inventories Prepaid expenses and other Current assets of discontinued operations Total current assets Property, plant and equipment, net Other assets Non-current assets of discontinued operations Total assets Liabilities and shareholders’ equity: Current liabilities: Accounts payable Accrued expenses Current liabilities of discontinued operations Total current liabilities Other liabilities Long-term liabilities of discontinued operations Commitments and contingencies Shareholders’ equity: Preferred stock, no par value Authorized shares: 1,000 None issued Common stock, $1 stated value Authorized shares: 40,000 Issued and outstanding shares: 2007, 18,303; 2006, 18,213 Additional paid-in capital Deferred stock compensation Retained earnings Accumulated other comprehensive loss Total shareholders’ equity Total liabilities and shareholders’ equity See accompanying notes to consolidated financial statements. september 29, 2007 September 30, 2006 $ 8,703 34,518 47,401 4,640 — 95,262 67,147 7,485 3,635 $ 10,689 37,519 46,797 2,675 411 98,091 55,217 9,653 3,635 $ 173,529 $ 166,596 $ 16,705 7,613 247 24,565 4,862 252 $ 30,691 9,819 643 41,153 2,713 292 — — 18,303 48,939 (1,132) 79,859 (2,119) 143,850 $ 173,529 18,213 47,005 (662) 57,882 — 122,438 $ 166,596 insteel industRies, inc. and subsidiaRies 25 consoliDateD state Ments of cas H floW s (In thousands) Cash Flows From Operating Activities: Net earnings Earnings (loss) from discontinued operations Earnings from continuing operations Adjustments to reconcile earnings from continuing operations to net cash provided by operating activities of continuing operations: Depreciation and amortization Amortization of capitalized financing costs Amortization of unrealized loss on financial instruments Stock-based compensation expense Excess tax benefits from exercise of stock options Loss on sale of property, plant and equipment Deferred income taxes Increase in cash surrender value of life insurance over premiums paid Net changes in assets and liabilities: Accounts receivable, net Inventories Accounts payable and accrued expenses Other changes Total adjustments Net cash provided by operating activities— continuing operations Net cash provided by (used for) operating activities— discontinued operations Net cash provided by operating activities Cash Flows From Investing Activities: Capital expenditures Proceeds from sale of assets held for sale Proceeds from sale of property, plant and equipment Premium payments on life insurance policies Net cash used for investing activities— continuing operations Net cash provided by investing activities— discontinued operations Net cash used for investing activities Year Ended september 29, 2007 September 30, 2006 October 1, 2005 $ 24,162 122 24,284 $ 33,040 1,337 $ 25,045 (546) 34,377 24,499 5,711 498 — 1,258 (122) 301 2,003 (277) 3,001 (604) (17,019) (1,969) (7,219) 4,578 529 — 1,173 (459) 82 (1,627) (193) 1,082 (15,228) 18,456 (120) 8,273 4,139 651 837 805 — 63 2,004 — 481 6,753 640 958 17,331 17,065 42,650 41,830 (147) 16,918 (17,013) 590 — (639) 2,185 44,835 (18,959) — 52 (565) 2,630 44,460 (6,302) 904 27 (665) (17,062) (19,472) (6,036) — (17,062) 5,963 (13,509) 2,120 (3,916) (continued) 26 (In thousands) Cash Flows From Financing Activities: Proceeds from long-term debt Principal payments on long-term debt Financing costs Cash received from exercise of stock options Excess tax benefits from exercise of stock options Repurchase of common stock Cash dividends paid Other Net cash used for financing activities— continuing operations Net cash used for financing activities— discontinued operations Net cash used for financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Supplemental Disclosures of Cash Flow Information: Cash paid during the period for: Interest Income taxes Non-cash financing activity: Cashless exercise of stock options Purchases of property, plant and equipment in accounts payable Issuance of restricted stock Declaration of cash dividends to be paid Other See accompanying notes to consolidated financial statements. Year Ended september 29, 2007 September 30, 2006 October 1, 2005 16,999 (16,999) — 162 122 — (2,176) 50 135,219 (147,079) (307) 360 459 (8,529) (2,222) 91 329,562 (370,070) (23) 175 — — (566) (9) (1,842) (22,008) (40,931) — (1,842) (1,986) 10,689 — (560) (22,008) (41,491) 9,318 1,371 (947) 2,318 $ 8,703 $ 10,689 $ 1,371 $ 93 16,785 $ 202 17,489 $ 3,531 12,001 — 937 1,215 544 — — — 792 543 — 338 — 742 565 105 insteel industRies, inc. and subsidiaRies 27 consoliDateD stateMents of sH aReHol De Rs ’ eQuity anD coMpReHensiVe incoMe (In thousands) Balance at October 2, 2004 Comprehensive income: Net earnings Amortization of loss on financial instruments included in net earnings Recognition of additional pension plan liability Comprehensive income(1) Stock options exercised Restricted stock granted Restricted stock shares from dividend Compensation expense associated with stock- based plans Retirement of shares held within grantor trust Cash dividends declared Excess tax benefits from exercise of stock options Balance at October 1, 2005 Comprehensive income: Net earnings Reduction in pension liability Comprehensive income(1) Stock options exercised Restricted stock granted Restricted stock shares from dividend Compensation expense associated with stock- based plans Excess tax benefits from exercise of stock options Repurchase of common stock Cash dividends declared Common Stock Shares Amount Additional Paid-In Capital Deferred Compensation Retained Earnings Accumulated Other Comprehensive Income (Loss)(1) Total Shareholders’ Equity 18,244 $ 18,244 $ 43,677 $ — $ 10,927 $ (1,637) $ 71,211 25,045 656 (111) 570 82 570 83 (36) (36) (395) 659 3 571 488 (742) 234 (69) (1,131) 25,045 656 (111) 25,590 175 — 3 805 (105) (1,131) 488 18,860 $ 18,861 $ 45,003 $ (508) $ 34,772 $ (1,092) $ 97,036 33,040 1,092 101 51 1 101 50 1 (800) (800) 259 742 7 535 459 (792) 638 (7,729) (2,201) 33,040 1,092 34,132 360 — 8 1,173 459 (8,529) (2,201) Balance at September 30, 2006 18,213 $ 18,213 $ 47,005 $ (662) $ 57,882 $ — $ 122,438 Comprehensive income: Net earnings Recognition of additional pension plan liability Adjustment to adopt SFAS No. 158 Comprehensive income(1) Stock options exercised Restricted stock granted Restricted stock shares from dividend Compensation expense associated with stock- based plans Excess tax benefits from exercise of stock options Cash dividends declared 24,162 (9) (2,110) 23 67 23 67 139 1,148 12 513 122 (1,215) 745 (2,185) 24,162 (9) (2,110) 22,043 162 — 12 1,258 122 (2,185) Balance at September 29, 2007 18,303 $ 18,303 $48,939 $(1,132) $79,859 $(2,119) $143,850 (1) Components of accumulated other comprehensive income (loss) are reported net of related income taxes. See accompanying notes to consolidated financial statements. 28 notes to consoli DateD financial state Ments Years Ended September 29, 2007, September 30, 2006 and October 1, 2005 (1) deSCriPtion oF BuSineSS Insteel Industries, Inc. (“Insteel” or “the Com- pany”) is one of the nation’s largest manufacturers of steel wire reinforcing products for concrete construc- tion applications. Insteel is the parent holding com- pany for a wholly-owned operating subsidiary, Insteel Wire Products Company (“IWP”). The Company manufactures and markets PC strand and welded wire reinforcement products, including concrete pipe rein- forcement, engineered structural mesh and standard welded wire reinforcement. The Company’s products are primarily sold to manufacturers of concrete prod- ucts and to a lesser extent to distributors and rebar fabricators that are located nationwide as well as into Canada, Mexico, and Central and South America. The Company’s exit from the industrial wire business in June 2006 (see Note 7 to the consolidated financial statements) narrowed its strategic and opera- tional focus to concrete reinforcing products. The results of operations for the industrial wire products business have been reported as discontinued operations for all periods presented. (2) Summary oF SigniFiCant aCCounting PoLiCieS Fiscal year. The Company’s fiscal year is the 52 or 53 weeks ending on the Saturday closest to September 30. Fiscal years 2007, 2006 and 2005 were 52-week fis- cal years. All references to years relate to fiscal years rather than calendar years. Principles of consolidation. The consolidated finan- cial statements include the accounts of the Company and its subsidiaries. All significant intercompany bal- ances and transactions have been eliminated. Use of estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. There is no assurance that actual results will not differ from these estimates. Cash equivalents. The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Stock options. Effective October 2, 2005, the Company began recording compensation expense asso- ciated with stock options and other forms of equity compensation in accordance with Statement of Finan- cial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment” as interpreted by Staff Accounting Bulletin (“SAB”) No. 107. Previously the Company had accounted for stock option plans under the intrinsic value method prescribed by Accounting Principals Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and therefore no related compensation expense was recorded for awards granted with no intrinsic value. The Company adopted the modified prospective transition method provided for under SFAS No. 123(R) and consequently, has not ret- roactively adjusted results from prior periods. Under this transition method, (1) stock compensation expense associated with options granted on or after October 2, 2005 is recorded in accordance with the provisions of SFAS No. 123(R); and (2) stock compensation expense associated with the remaining unvested portion of stock options granted prior to October 2, 2005 is recorded based on the grant date fair value of the options estimated in accordance with the original provisions of SFAS No. 123, “Accounting for Stock- Based Compensation.” Under the provisions of SFAS No. 123(R), the Company recorded $513,000 and $535,000 of compen- sation expense for stock options within selling, general and administrative expense for the years ended September 29, 2007 and September 30, 2006, respec- tively. The Company recorded $571,000 of compensa- tion expense for the year ended October 1, 2005 for stock options associated with certain previous option plans that were required to be accounted for as vari- able plans under the provisions of APB No. 25. Under variable plan accounting, compensation expense was recognized for the excess of the market price over the exercise price and adjusted each reporting period to reflect changes in market valuation. Under the pro- visions of SFAS No. 123(R), these options are now accounted for as equity awards and, since the options were fully vested as of October 2, 2005, no compensa- tion expense was recorded in 2006 and 2007. insteel industRies, inc. and subsidiaRies 29 notes to consoliDateD financial stateMents (continued) Years Ended September 29, 2007, September 30, 2006 and October 1, 2005 Prior to the adoption of SFAS No. 123(R), the benefit of tax deductions in excess of recognized stock compensation expense was reported as a reduction of taxes paid within operating cash flow. SFAS No. 123(R) requires that such benefits be reported as a financing cash flow. For the years ended September 29, 2007 and September 30, 2006, $122,000 and $459,000 of excess tax benefits were generated from option exer- cises, respectively. The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to options granted under the Company’s option plans for the year ended October 1, 2005: (In thousands, except for per share amounts) Net earnings—as reported Stock-based compensation expense included in reported net earnings, net of related tax effects Total stock-based compensation expense determined under fair-value based method for all awards, net of related tax effects Net earnings—pro forma Basic net earnings per share—as reported Basic net earnings per share—pro forma Diluted net earnings per share—as reported Diluted net earnings per share—pro forma Basic shares outstanding—as reported and pro forma Diluted shares outstanding—as reported Diluted shares outstanding—pro forma Year Ended October 1, 2005 $25,045 (214) (141) $24,690 $ 1.34 1.32 1.32 1.30 18,656 18,954 18,940 Revenue recognition and credit risk. The Company recognizes revenue from product sales in accordance with SAB No. 104 when the products are shipped and risk of loss and title has passed to the customer. Sub- stantially all of the Company’s accounts receivable are due from customers that are located in the U.S. and the Company generally requires no collateral depend- ing upon the creditworthiness of the account. The Company provides an allowance for doubtful accounts based upon its assessment of the credit risk of specific customers, historical trends and other information. The Company writes off accounts receivable when they become uncollectible and payments subsequently received are credited to the allowance for doubtful accounts. There is no disproportionate concentration of credit risk. Shipping and handling costs. The Company includes all of the outbound freight, shipping and han- dling costs associated with the shipment of products to customers in cost of sales. Any amounts paid by customers to the Company for shipping and handling are recorded in net sales on the consolidated statement of operations. Inventories. Inventories are valued at the lower of average cost (which approximates computation on a first-in, first-out basis) or market (net realizable value or replacement cost). Property, plant and equipment. Property, plant and equipment are stated at cost or otherwise at reduced values to the extent there have been asset impairment write-downs. Expenditures for maintenance and repairs are charged directly to expense when incurred, while major improvements are capitalized. Depreciation is computed for financial reporting purposes principally by use of the straight-line method over the following estimated useful lives: machinery and equipment, 3–15 years; buildings, 10–30 years; land improvements, 5–15 years. Depreciation expense was approximately $5.7 million in 2007, $4.6 million in 2006 and $4.1 million in 2005. Capitalized software is amortized over the shorter of the estimated useful life or 5 years. No inter- est costs were capitalized in 2007, 2006 or 2005. Other assets. Other assets consist principally of non-current deferred tax assets, capitalized financing costs, the cash surrender value of life insurance policies and assets held for sale. Capitalized financing costs are amortized using the straight-line method, which approximates the effective interest method over the life of the related credit agreement. Long-lived assets. Long-lived assets include prop - erty, plant and equipment and identifiable intangible assets with definite useful lives. The Company assesses the impairment of long-lived assets whenever events or changes in circumstance indicate that the carrying value may not be fully recoverable. When the Company determines that the carrying value of such assets may not be recoverable, it measures recoverability based on the undiscounted cash flows expected to be generated by the related asset or asset group. If it is determined that an impairment loss has occurred, the loss is recog- nized during the period incurred. An impairment loss is calculated as the difference between the carrying 30 value and the present value of estimated future net cash flows or comparable market values. There were no impairment losses in 2007, 2006 or 2005. Fair value of financial instruments. The carrying amounts for cash and cash equivalents, accounts receiv- able, and accounts payable and accrued expenses approximate fair value because of their short maturities. Income taxes. Income taxes are based on pretax financial accounting income. Deferred tax assets and liabilities are recognized for the expected tax conse- quences of temporary differences between the tax bases of assets and liabilities and their reported amounts. The Company assesses the need to establish a valua- tion 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. Earnings per share. Basic earnings per share (“EPS”) are computed by dividing net earnings by the weighted average number of common shares outstand- ing during the period. Diluted EPS are computed by dividing net earnings by the weighted average number of common shares and other dilutive equity securities outstanding during the period. Securities that have the effect of increasing EPS are considered to be anti- dilutive and are not included in the computation of diluted EPS. Recent accounting pronouncements. In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncer- tainty in Income Taxes” (“FIN No. 48”) which clarifies the criteria for the recognition of tax benefits under SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 specifies how tax benefits for uncertain tax positions are to be recognized, measured and derecog- nized in financial statements; requires certain disclo- sures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions. FIN No. 48 is effective for the Company beginning in fiscal 2008 and requires that the cumulative effect of applying its provisions be disclosed separately as a one-time, non-cash charge against the opening balance of retained earnings in the year of adoption. Based on the Company’s preliminary analysis, the adoption of FIN No. 48 is expected to result in an estimated charge to retained earnings of approximately $260,000. The actual amount of the adjustment will be recorded in the first quarter of 2008 upon the finalization of the Company’s analysis. In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for the Company beginning in fiscal 2009. At this time, the Company has not determined what effect, if any, the adoption of SFAS No. 157 will have on its financial position or results of operations. In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” SFAS No. 158 requires that an employer recognize the overfunded or underfunded status of a defined benefit postretire- ment plan in its statement of financial position and changes in the funded status through comprehensive income in the year in which the changes occur. SFAS No. 158 also requires the measurement of defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position. The provisions regarding the recognition of a plan’s funding status were effective for the Company in fiscal 2007 and resulted in a $2.1 million decrease in shareholders’ equity, net of tax. The provisions regarding the change in the measurement date are effective for the Company beginning in fiscal 2009. The adoption of SFAS No. 158 is further discussed in Note 8 to the consolidated financial statements. (3) StoCk SPLit On May 16, 2006, the Board of Directors approved a two-for-one split of the Company’s common stock payable in the form of a stock dividend. The stock split entitled each shareholder of record on June 2, 2006 to receive one share of common stock for each outstanding share of common stock held on that date and was distributed on June 16, 2006. Unless other- wise indicated, the capital stock accounts and all share and earnings per share amounts in this report give effect to the stock split, applied retroactively, to all periods presented. insteel industRies, inc. and subsidiaRies 31 notes to consoliDateD financial stateMents (continued) Years Ended September 29, 2007, September 30, 2006 and October 1, 2005 (4) Credit FaCiLitieS Financial Covenants As of September 29, 2007, the Company had a $100.0 million revolving credit facility in place to sup- plement its operating cash flow in funding its working capital, capital expenditure and general corporate requirements. No borrowings were outstanding on the credit facility as of September 29, 2007 and September 30, 2006 and outstanding letters of credit totaled $1.9 million and $1.4 million, respectively. As of September 29, 2007, $54.7 million of borrowing capacity was avail- able on the credit facility. Advances under the credit facility are limited to the lesser of the revolving credit commitment or a bor- rowing base amount that is calculated based upon a percentage of eligible receivables and inventories plus, upon the Company’s request and subject to certain conditions, a percentage of eligible equipment and real estate. Interest rates on the revolver are based upon (1) a base rate that is established at the higher of the prime rate or 0.50% plus the federal funds rate, or (2) at the election of the Company, a LIBOR rate, plus in either case, an applicable interest rate margin. The applicable interest rate margins are adjusted on a quar- terly basis based upon the amount of excess availability on the revolver within the range of 0.00%–0.50% for the base rate and 1.25%–2.00% for the LIBOR rate. In addition, the applicable interest rate margins would be adjusted to the highest percentage indicated for each range upon the occurrence of certain events of default provided for under the credit facility. Based on the Company’s excess availability as of September 29, 2007, the applicable interest rate margins were 0.00% for the base rate and 1.25% for the LIBOR rate on the revolver. In connection with the refinancing of the pre- vious credit facility, the Company terminated interest rate swap agreements for payments totaling $2.1 mil- lion and recorded a corresponding unrealized loss for hedging instruments in fiscal 2004 which, in accor- dance with generally accepted accounting principals (“GAAP”) was amortized and recorded as interest expense through the original termination date of the swap agreement of January 31, 2005. The Company’s ability to borrow available amounts under the revolving credit facility will be restricted or eliminated in the event of certain cove- nant breaches, events of default or if the Company is unable to make certain representations and warranties. 32 The terms of the credit facility require the Company to maintain a Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of not less than: (1) 1.10 at the end of each fiscal quarter for the twelve- month period then ended when the amount of excess availability on the revolving credit facility is less than $10.0 million and the applicable borrowing base only includes eligible receivables and inventories; or (2) 1.15 at the end of each fiscal quarter for the twelve-month period then ended when the amount of excess avail- ability on the revolving credit facility is less than $10.0 million and the applicable borrowing base includes eligible receivables, inventories, equipment and real estate. As of September 29, 2007, the Company was in compliance with all of the financial covenants under the credit facility. Negative Covenants In addition, the terms of the credit facility restrict the Company’s ability to, among other things: engage in certain business combinations or divestitures; make investments in or loans to third parties, unless certain conditions are met with respect to such investments or loans; pay cash dividends or repurchase shares of the Company’s stock subject to certain minimum bor- rowing availability requirements; incur or assume indebtedness; issue securities; enter into certain trans- actions with affiliates of the Company; or permit liens to encumber the Company’s property and assets. As of September 29, 2007, the Company was in compli- ance with all of the negative covenants under the credit facility. Events of Default Under the terms of the credit facility, an event of default will occur with respect to the Company upon the occurrence of, among other things: a default or breach by the Company or any of its subsidiaries under any agreement resulting in the acceleration of amounts due in excess of $500,000 under such agree- ment; certain payment defaults by the Company or any of its subsidiaries in excess of $500,000; certain events of bankruptcy or insolvency with respect to the Company; an entry of judgment against the Company or any of its subsidiaries for greater than $500,000, which amount is not covered by insurance; or a change of control of the Company.  Amortization of capitalized financing costs asso- ciated with the senior secured facility was $498,000 in 2007, $529,000 in 2006 and $651,000 in 2005. Accumulated amortization of capitalized financing costs was $2.6 million and $2.1 million as of September 29, 2007 and September 30, 2006, respectively. The Company expects the amortization of capitalized financing costs to approximate the following amounts for the next five fiscal years: Fiscal year 2008 2009 2010 2011 2012 In thousands $499 499 345 — — (5) StoCk-BaSed ComPenSation Under the Company’s stock option plans, employ- ees and directors may be granted options to purchase shares of common stock at the fair market value on the date of the grant. Options granted under these plans generally vest over three years and expire ten years from the date of the grant. The fair value of each option award granted prior to October 1, 2005 was estimated on the date of grant using a Black-Scholes option-pricing model. With the adoption of SFAS No. 123(R), the Company determined that it would use a Monte Carlo valuation model for options that are granted subsequent to October 1, 2005. The weighted average estimated fair values of stock options granted during 2007, 2006, and 2005 were $8.69, $8.82 and $7.74 per share, respectively, based on the following weighted average assumptions: Year Ended september 29, 2007 September 30, 2006 October 1, 2005 3.16 4.70% 3.20 7.00 4.82% 4.14% 65.84% 74.72% 180.40% 0.65% 0.70% 0.79% Expected term (in years) Risk-free interest rate Expected volatility Expected dividend yield The assumptions utilized in the model are evalu- ated and revised, as necessary, to reflect market condi- tions and actual historical experience. The risk-free interest rate for periods within the contractual life of the option was based on the U.S. Treasury yield curve in effect at the time of the grant. The dividend yield was calculated based on the Company’s annual divi- dend as of the option grant date. The expected vol- atility was derived using a term structure based on historical volatility and the volatility implied by exchange-traded options on the Company’s stock. The expected term for options was based on the results of a Monte Carlo simulation model, using the model’s estimated fair value as an input to the Black-Scholes- Merton model, and then solving for the expected term. At September 29, 2007, there were 1,340,000 shares available for future grants under the Company’s equity incentive plans. The following table summarizes stock option activity during 2005, 2006 and 2007: (Share amounts in thousands) Outstanding at October 2, 2004 Granted Exercised Outstanding at October 1, 2005 Granted Exercised Outstanding at September 30, 2006 Granted Exercised Forfeited Outstanding at September 29, 2007 Vested and anticipated to vest in future at September 29, 2007 Exercisable at September 29, 2007 Options Outstanding 938 96 (706) 328 55 (101) 282 79 (23) (2) 336 327 196 Exercise Price Per Share Range $ 0.18 – $ 5.43 9.12 5.43 6.89 – 0.18 – 9.12 0.18 – 15.64 – 20.26 9.12 0.18 – 0.18 – 20.26 17.11 – 20.27 4.56 – 15.64 20.26 – 20.26 0.18 – 20.27 Weighted Average $ 2.36 8.24 2.17 4.48 17.54 3.56 7.37 18.54 7.12 20.26 9.95 Contractual Term— Weighted Average Aggregate Intrinsic Value (in thousands) $4,762 1,396 228 6.70 years 2,179 9.79 5.41 6.64 years 5.08 years 2,165 1,989 insteel industRies, inc. and subsidiaRies 33 notes to consoliDateD financial stateMents (continued) Years Ended September 29, 2007, September 30, 2006 and October 1, 2005 The remaining unrecognized compensation cost related to unvested awards at September 29, 2007 was $582,000 which is expected to be recognized over a weighted average period of 1.26 years. Restricted stock awards. During the years ended September 29, 2007, September 30, 2006 and October 1, 2005, the Company granted 67,000, 51,000 and 82,000 shares of restricted stock, respectively, to key employees and directors which had a total market value of $1.2 million, $792,000 and $742,000, respectively, as of the grant date. The following table summarizes restricted stock activity during 2005, 2006 and 2007: (Share amounts in thousands) Balance, October 2, 2004 Granted Released Balance, October 1, 2005 Granted Released Balance, September 30, 2006 Granted Released Balance, September 29, 2007 Restricted Stock Awards Outstanding Weighted Average Grant Date Fair Value — 82 — 82 51 (30) 103 67 (28) 142 $ — 8.98 — 8.98 15.64 8.72 12.27 18.18 12.51 15.00 The Company recorded amortization expense of $745,000, $638,000 and $234,000 pertaining to the restricted stock for the years ended September 29, 2007, September 30, 2006 and October 1, 2005, respectively. The Company will continue to amortize the remaining unamortized balance of $1.1 million over the vesting period of one to three years. (6) inCome taxeS The components of the provision for income taxes on continuing operations are as follows: (Dollars in thousands) Provision for income taxes: Current: Federal State Deferred: Federal State Year Ended september 29, 2007 September 30, 2006 October 1, 2005 $10,801 1,209 12,010 1,821 182 2,003 $18,603 2,554 21,157 (1,437) (190) (1,627) $10,457 1,409 11,866 1,802 202 2,004 Income taxes $14,013 $19,530 $13,870 Effective income tax rate 36.6% 36.2% 36.1% The reconciliation between income taxes computed at the federal statutory rate and the provision for income taxes on continuing operations is as follows: (Dollars in thousands) Provision for income taxes at federal statutory rate State income taxes, net of federal tax benefit Qualified production activities deduction Other permanent book and tax differences, net Stock option expense (benefit) Valuation allowance Revisions to estimates based on filing of final tax return Other, net september 29, 2007 $13,403 904 (374) — 126 — (32) (14) 35.0% 2.4 (1.0) — 0.3 — (0.1) (0.0) Year Ended September 30, 2006 $18,867 1,381 (490) — 151 (37) (21) (321) 35.0% 2.6 (0.9) — 0.3 (0.1) (0.1) (0.6) October 1, 2005 $13,429 1,166 — 77 (575) (227) — — 35.0% 3.0 — 0.2 (1.5) (0.6) — — Provision for income taxes $14,013 36.6% $19,530 36.2% $13,870 36.1% 34  The components of deferred tax assets and liabili- ties are as follows: (In thousands) Deferred tax assets: Accrued expenses or asset reserves for financial statements, not yet deductible for tax purposes State net operating loss carryforwards Goodwill, amortizable for tax purposes Defined benefit plans Nonqualified stock options not deductible in current year Valuation allowance Gross deferred tax assets Deferred tax liabilities: Plant and equipment principally due to differ- ences in depreciation and impairment charges Other reserves Gross deferred tax liabilities Net deferred tax asset september 29, 2007 September 30, 2006 $ 2,492 $ 2,440 601 2,346 1,299 239 (601) 6,376 944 2,686 — 204 (599) 5,675 (3,001) (671) (1,467) (800) (3,672) (2,267) $ 2,704 $ 3,408 The Company has recorded the following amounts for deferred taxes on its consolidated balance sheets as of September 29, 2007 and September 30, 2006: a current deferred tax asset (net of valuation allowance) of $1.2 million for both years in prepaid expenses and other, and a non-current deferred tax asset (net of val- uation allowance) of $1.5 million and $2.2 million, respectively, in other assets. The Company has $9.6 million of gross state operating loss carryforwards that begin to expire in six years, but principally expire in 13–17 years. The realization of the Company’s deferred tax assets is entirely dependent upon the Company’s abil- ity to generate future taxable income in applicable jurisdictions. GAAP requires that the Company peri- odically assess the need to establish a valuation allow- ance against its deferred tax assets to the extent the Company no longer believes it is more likely than not that they will be fully utilized. As of September 29, 2007, the Company had recorded a valuation allow- ance of $601,000 pertaining to various state NOLs that were not anticipated to be utilized. The valuation allowance established by the Company is subject to periodic review and adjustment based on changes in facts and circumstances and would be reduced should the Company utilize the state net operating loss carry- forwards against which an allowance had been pro- vided or determine that such utilization is more likely than not. (7) diSContinued oPerationS In April 2006, the Company decided to exit the industrial wire business with the closure of its Fredericksburg, Virginia facility which manufactured tire bead wire and other industrial wire for commer- cial and industrial applications. The Company’s deci- sion was based on the weakening in the business outlook for the facility and the expected continua- tion of difficult market conditions and reduced operat- ing levels. Manufacturing activities at the Virginia facility ceased in June 2006 and the Company is cur- rently in the process of liquidating the remaining assets of the business. The Company has determined that the exit from the industrial wire business meets the criteria of a discontinued operation in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Accordingly, the results of opera- tions and related non-recurring closure costs associated with the industrial wire business have been reported as discontinued operations for all periods presented. Additionally, the assets and liabilities of the discontin- ued operations have been segregated in the accompa- nying consolidated balance sheets. The following table summarizes the results of dis- continued operations for the years ended September 29, 2007, September 30, 2006 and October 1, 2005, respectively: (In thousands) Net sales Earnings (loss) before income taxes Income taxes Net earnings (loss) Year Ended september 29, 2007 September 30, 2006 October 1, 2005 $ — $22,544 $36,216 (199) (77) (122) (2,188) 851 (1,337) 876 (330) 546 Included within results from discontinued opera- tions is an allocation of interest expense which was calculated based on the net assets of the industrial wire business relative to the consolidated net assets of the Company. Interest expense allocated to discontinued insteel industRies, inc. and subsidiaRies 35 notes to consoliDateD financial stateMents (continued) Years Ended September 29, 2007, September 30, 2006 and October 1, 2005 operations was $64,000 and $802,000 for the years ended September 30, 2006 and October 1, 2005, respectively. The net loss from discontinued operations for the year ended September 30, 2006 includes a pre-tax gain of $1.3 million on the sale of certain machinery and equipment associated with the industrial wire business. The net earnings from discontinued operations for the year ended October 1, 2005 includes a pre-tax gain of $1.3 million relating to the disposal of real estate, the collection of a note receivable, and the settlement on the release of an equipment lien associated with Insteel Construction Systems (“ICS”), a discontinued opera- tion that the Company had previously exited in 1997. Assets and liabilities of discontinued operations as of September 29, 2007 and September 30, 2006 are as follows: (In thousands) Assets: Current assets: Accounts receivable, net Prepaid expenses and other Total current assets Other assets Total assets Liabilities: Current liabilities: Accounts payable Accrued expenses Total current liabilities Other liabilities Total liabilities september 29, 2007 September 30, 2006 $ — — — 3,635 $3,635 $ 4 243 247 252 $ 499 $ 407 4 411 3,635 $4,046 $ 25 618 643 292 $ 935 As of September 29, 2007, there was approximately $285,000 of accrued expenses and other liabilities related to ongoing lease obligations and closure-related liabilities incurred as a result of the Company’s exit from the industrial wire business. (8) emPLoyee BeneFit PLanS Adoption of SFAS No. 158. On September 29, 2007, the Company adopted the recognition and disclosure provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” Prior to the adoption of SFAS No. 158, the Company accounted for its defined benefit postretire- ment plans under SFAS No. 87, “Employers’ Account- ing for Pensions” and SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other than Pensions.” SFAS No. 158 requires an employer to rec- ognize the funded status of its defined benefit plans in its statement of financial position, with a correspond- ing adjustment to accumulated other comprehensive income, net of tax. The adjustment to accumulated other comprehensive income at adoption represents the net unrecognized actuarial gains and unrecognized prior service costs which were previously netted against the funded status of the plans in the Company’s state- ment of financial position. These amounts will subse- quently be recognized as net benefit cost consistent with the Company’s historical accounting policy for amortizing such amounts. In addition, actuarial gains and losses that arise in subsequent periods and are not recognized as net periodic benefit cost in the same periods will be recognized as a component of net periodic benefit cost on the same basis as the amount recognized in accumulated other comprehensive income at the adoption of SFAS No. 158. SFAS No. 158 affects the accounting for the Company’s defined benefit pension plan and its supple- mental employee retirement plan, both of which are discussed below. The effects of adopting the provisions of SFAS No. 158 on the Company’s consolidated bal- ance sheet as of September 29, 2007 are presented in the following table. The adoption of SFAS No. 158 had no effect on the Company’s consolidated statement of operations for the year ended September 29, 2007 or for any prior period presented, and will not affect the Company’s operating results in future periods. (In thousands) Prepaid expenses and other Deferred tax asset Other non-current liabilities Accumulated other com- prehensive income Before Application of SFAS No. 158 $5,960 1,410 2,779 9 Adjustments $(1,320) 1,294 2,083 2,110 After Application of SFAS No. 158 $4,640 2,704 4,862 2,119 36  Retirement plans. The Company has one defined benefit pension plan, the Insteel Wire Products Company Retirement Income Plan for Hourly Employees, Wilmington, Delaware (“the Delaware Plan”). The Delaware Plan provides benefits for eligible employees based primarily upon years of service and compensation levels. The Company’s funding policy is to contribute amounts at least equal to those required by law. No contributions were made to the Delaware Plan during 2007. The Company expects to contribute $200,000 to the Delaware Plan in 2008. The reconciliation of the projected benefit obligation, plan assets, funded status of the plan and amounts recognized in the Company’s consolidated balance sheets at September 29, 2007, September 30, 2006 and October 1, 2005 is as follows: (In thousands) Change in benefit obligation: Benefit obligation at beginning of year Service cost Interest cost Actuarial loss (gain) Distributions Benefit obligation at end of year Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Distributions Fair value of plan assets at end of year Reconciliation of funded status to net amount recognized: Funded status Unrecognized net loss Unrecognized prior service cost Net amount recognized Amounts recognized in the consolidated balance sheet consist of: Current prepaid pension asset Non-current prepaid pension asset Accrued benefit liability Intangible asset related to prior service cost Accumulated other comprehensive loss (net of tax) Net amount recognized Amounts recognized in accumulated other comprehensive income: Unrecognized net loss Unrecognized prior service cost Net amount recognized Other changes in plan assets and benefit obligations recognized in other comprehensive income: Net gain Amortization of prior service cost Total recognized in other comprehensive income Year Ended september 29, 2007 September 30, 2006 October 1, 2005 $ 4,702 82 253 (306) (204) $4,527 $3,334 79 1,318 (204) $4,527 $ — 1,476 2 $ 1,478 $ 236 1,242 — — — $ 1,478 $ 4,036 91 268 512 (205) $ 4,702 $ 2,633 350 556 (205) $ 3,334 $(1,368) 1,762 2 $ 396 $ 396 — (1,764) 2 1,092 $ (274) $ 4,527 78 269 203 (642) $4,435 $ 4,527 536 — (642) $4,421 $ (14) — — $ (14) $ — — (14) — 827 $ 813 $1,333 1 $1,334 $ (143) (1) $ (144) insteel industRies, inc. and subsidiaRies 37 notes to consoliDateD financial stateMents (continued) Years Ended September 29, 2007, September 30, 2006 and October 1, 2005 Net periodic pension cost includes the following components: (In thousands) Service cost Interest cost Expected return on plan assets Amortization of prior service cost Recognized net actuarial loss Net periodic pension cost The estimated net loss and prior service cost that will be amortized from accumulated other comprehen- sive income into net periodic pension cost over the next fiscal year is $96,000 and $1,000, respectively. The assumptions used in the valuation of the plan are as follows: Measurement Date september 29, 2007 September 30, 2006 October 1, 2005 Assumptions at year-end: Discount rate Rate of increase in compensa- tion levels Expected long- term rate of return on assets 6.50% 6.25% 6.00% n/a N/A N/A 8.00% 8.00% 8.00% The projected benefit payments under the plan are as follows: Fiscal year(s) 2008 2009 2010 2011 2012 2013–2017 In thousands $ 428 428 436 437 205 1,617 The Delaware Plan has a long-term target asset mix of 65% equities and 35% fixed income. The ranges for the long-term allocation are: equities 60% to 80%, fixed income 20% to 40% and cash reserves 0 to 10%. The investment strategy for equities emphasizes U.S. large cap equities with the portfolio’s performance Year Ended september 29, 2007 September 30, 2006 October 1, 2005 $ 78 269 (324) 1 134 $ 158 $ 82 253 (243) 1 143 $ 236 $ 91 268 (217) 3 151 $ 296 measured against the S&P 500 index or other applica- ble indices. The investment strategy for fixed income investments is focused on maintaining an overall port- folio with a minimum credit rating of A-1 as well as a minimum rating of any security at the time of purchase of Baa/BBB by Moody’s or Standard & Poor’s, if rated. The total fund has an expected return of 8.0% based on the overall policy allocation and historical market returns, compared to the expected long-term rate of return of 8.0% used to develop the plan’s net periodic pension cost. Supplemental employee retirement plan. The Company has Retirement Security Agreements (each, a “SERP”) with certain of its employees (each, a “Participant”). Under the SERP, if the Participant remains in continuous service with the Company for a period of at least 30 years, the Company will pay to the Participant a supplemental retirement benefit for the 15-year period following the Participant’s retirement equal to 50% of the Participant’s highest average annual base salary for five consecutive years in the 10-year period preceding the Participant’s retirement. If the Participant retires prior to the later of age 65 or the completion of 30 years of continuous service with the Company, but has completed at least 10 years of continuous service with the Company, the amount of the supplemental retirement benefit will be reduced by 1/360th for each month short of 30 years that the Participant was employed by the Company. In 2005, the Company amended the SERP to add Participants and increase benefits to certain Participants already included in the plan. 38  The reconciliation of the projected benefit obligation, plan assets, funded status of the plan and amounts recognized in the Company’s consolidated balance sheets for the SERP at September 29, 2007, September 30, 2006 and October 1, 2005 is as follows: (In thousands) Change in benefit obligation: Benefit obligation at beginning of year Service cost Interest cost Actuarial loss Distributions Benefit obligation at end of year Change in plan assets: Actual employer contributions Actual distributions Plan assets at fair value at end of year Reconciliation of funded status to net amount recognized: Funded status Unrecognized net loss Unrecognized prior service cost Net amount recognized Amounts recognized in accumulated other comprehensive loss: Unrecognized prior service costs Net amount recognized Other changes in plan assets and benefit obligations recognized in other comprehensive loss: Net loss Prior service costs Total recognized in other comprehensive loss Net periodic pension cost includes the following components: (In thousands) Service cost Interest cost Prior service cost Recognized net actuarial loss Net periodic pension cost Year Ended september 29, 2007 (Revised) September 30, 2006 (Revised) October 1, 2005 $ 3,574 106 207 61 (80) $ 3,868 $ 80 (80) $ — $(3,868) 510 1,588 $ (1,770) $ 3,315 103 196 — (40) $ 3,574 $ 40 (40) $ — $ (3,574) 451 1,815 $(1,308) $ 3,868 163 230 11 (80) $ 4,192 $ 80 (80) $ — $(4,192) — — $(4,192) $ 2,083 $ 2,083 $ 1 (227) $ (226) Year Ended september 29, 2007 September 30, 2006 October 1, 2005 $ 163 230 227 10 $ 630 $ 106 207 227 2 $ 542 $ 103 196 227 11 $ 537 The estimated net loss and prior service costs that will be amortized from accumulated other comprehensive income into net periodic pension cost over the next fiscal year is $8,000 and $227,000, respectively. insteel industRies, inc. and subsidiaRies 39 notes to consoliDateD financial stateMents (continued) Years Ended September 29, 2007, September 30, 2006 and October 1, 2005 The assumptions used in the valuation of the SERP are as follows: Measurement Date september 29, 2007 December 1, 2005 December 1, 2004 Assumptions at year-end: Discount rate Rate of increase in compensa- tion levels 6.25% 5.60% 5.60% 3.00% 3.00% 3.00% The projected benefit payments under the SERP are as follows: Fiscal year(s) 2008 2009 2010 2011 2012 2013–2017 In thousands $ 80 80 80 169 249 1,375 As noted above, the SERP was amended in 2005 to add Participants and increase benefits to certain Participants already included in the plan. However, for certain Participants the Company still maintains the benefits of the SERP that were in effect prior to the 2005 amendment. These Participants are entitled to fixed cash benefits upon retirement at age 65, payable annually for 15 years. This plan is supported by life insurance polices on the Participants purchased and owned by the Company. The cash benefits paid under this plan were $74,000 in 2007, 2006 and 2005, respec- tively. The plan expense was $11,000 in 2007, $10,000 in 2006 and $3,000 in 2005. Retirement savings plan. In 1996, the Company adopted the Retirement Savings Plan of Insteel Industries, Inc. (“the Plan”) to provide retirement ben- efits and stock ownership for its employees. The Plan is an amendment and restatement of the Company’s Employee Stock Ownership Plan (“ESOP”). As allowed under Sections 401(a) and 401(k) of the Internal Revenue Code, the Plan provides for tax-deferred salary deductions for eligible employees. Employees may contribute up to 15% of their annual compensation to the Plan, limited to a maxi- mum annual amount as set periodically by the Internal Revenue Code. The Plan allows for discretionary con- tributions to be made by the Company as determined by the Board of Directors. Such contributions to the Plan are allocated among eligible participants based on their compensation relative to the total compensation of all participants. In 2007, the Company matched employee contributions up to 50% of the first 7% of eligible compensation that was contributed by employ- ees. In 2006 and 2005, the Company matched employee contributions up to 50% of the first 5% of eligible com- pensation that was contributed by employees. Company contributions to the Plan were $402,000 in 2007, $351,000 in 2006 and $265,000 in 2005. Voluntary Employee Beneficiary Associations (“VEBA”). The Company has a VEBA. Under the plan, both employees and the Company may make contribu- tions to pay for medical costs. Company contributions to the VEBA were $2.4 million in 2007, $3.1 million in 2006 and $2.5 million in 2005. The Company is pri- marily self-insured for employee’s healthcare costs, car- rying stop-loss insurance coverage for individual claims in excess of $150,000. The Company’s self-insurance liabilities are based on the total estimated costs of claims filed and claims incurred but not reported, less amounts paid against such claims. Management reviews current and historical claims data in developing its estimates. (9) CommitmentS and ContingenCieS Leases and purchase commitments. The Company leases a portion of its equipment under operating leases that expire at various dates through 2010. Under most lease agreements, the Company pays insurance, taxes and maintenance. Rental expense for operating leases was $920,000 in 2007, $836,000 in 2006 and $701,000 in 2005. Minimum rental commitments under all non- cancelable leases with an initial term in excess of one year are payable as follows: 2008, $781,000; 2009, $445,000; 2010, $213,000; 2011, $27,000; 2012 and beyond, $0. 40  As of September 29, 2007, the Company had $31.8 million in non-cancelable fixed price purchase commitments for raw material extending as long as approximately 120 days. In addition, the Company has contractual commitments for the purchase of certain equipment. Portions of such contracts not completed at year-end are not reflected in the consolidated finan- cial statements and amounted to $3.8 million as of September 29, 2007. Legal proceedings. On November 19, 2007, Dywidag Systems International, Inc. (“DSI”) filed a third-party lawsuit in the Ohio Court of Claims alleging that certain epoxy-coated strand sold by the Company to DSI in 2002, and supplied by DSI to the Ohio Department of Transportation (“ODOT”) for a bridge project, was defective. The third-party action seeks recovery of any damages which may be assessed against DSI in the action against it filed by ODOT, which allegedly could be in excess of $8.3 million, plus $2.7 million in damages allegedly incurred by DSI. The Company had previously filed a lawsuit in North Carolina against DSI seeking recovery of $1.4 million (plus interest) owed for other products sold to DSI and a judgment declaring that the Company had no liability to DSI arising out of the bridge project. The Company believes North Carolina is the appropriate venue for these proceedings and otherwise intends to vigorously defend the claims asserted against it by DSI in addition to pursuing full recovery of the amounts owed to it by DSI. The Company also is involved in other lawsuits, claims, investigations and proceedings, including com- mercial, environmental and employment matters, which arise in the ordinary course of business. The Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its financial position, results of operations or cash flows. Severance and change of control agreements. The Company has entered into severance agreements with its Chief Executive Officer and Chief Financial Officer that provide certain termination benefits to these executives in the event that an executive’s employment with the Company is terminated without cause. The initial term of each agreement is two years and the agreements provide for an automatic renewal of one year unless the Company or the executive provides notice of termination as specified in the agreement. Under the terms of these agreements, in the event of termination without cause, the executives would receive termination benefits equal to one and one-half times the executive’s annual base salary in effect on the termination date and the continuation of health and welfare benefits for eighteen months. In addition, all of the executive’s stock options and restricted stock would vest immediately and outplacement services would be provided. The Company has also entered into change in control agreements with key members of management, including its executive officers, which specify the terms of separation in the event that termination of employ- ment followed a change in control of the Company. The initial term of each agreement is two years and the agreements provide for an automatic renewal of one year unless the Company or the executive provides notice of termination as specified in the agreement. The agreements do not provide assurances of contin- ued employment, nor do they specify the terms of an executive’s termination should the termination occur in the absence of a change in control. Under the terms of these agreements, in the event of termination within two years of a change of control, the Chief Executive Officer and Chief Financial Officer would receive severance benefits equal to two times base compensation, two times the average bonus for the prior three years and the continuation of health and welfare benefits for two years. The other key members of management, including the Company’s other two executive officers, would receive severance benefits equal to one times base compensation, one times the average bonus for the prior three years and the con- tinuation of health and welfare benefits for one year. In addition, all of the executive’s stock options and restricted stock would vest immediately and outplace- ment services would be provided. insteel industRies, inc. and subsidiaRies 41 notes to consoliDateD financial stateMents (continued) Years Ended September 29, 2007, September 30, 2006 and October 1, 2005 (10) earningS Per Share The reconciliation of basic and diluted earnings per share (“EPS”) is as follows: (In thousands, except for per share amounts) Net earnings Weighted average shares outstanding: Weighted average shares outstanding (basic) Dilutive effect of stock-based compensation Weighted average shares outstanding (diluted) Per share (basic): Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Per share (diluted): Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Year Ended september 29, 2007 September 30, 2006 October 1, 2005 $24,162 $33,040 $25,045 18,142 172 18,314 $ 1.34 (0.01) $ 1.33 $ 1.33 (0.01) $ 1.32 18,307 166 18,473 $ 1.88 (0.08) $ 1.80 $ 1.86 (0.07) $ 1.79 18,656 298 18,954 $ 1.31 0.03 $ 1.34 $ 1.29 0.03 $ 1.32 Options to purchase 67,000 shares in 2007, 42,000 shares in 2006 and 34,000 shares in 2005 were anti- dilutive and were not included in the diluted EPS computation. (11) BuSineSS Segment inFormation Following the Company’s exit from the industrial wire business (see Note 7 to the consolidated financial statements), the Company’s operations are entirely focused on the manufacture and marketing of concrete reinforcing products for the concrete construction industry. Based on the criteria specified in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” the Company has one reportable segment. The results of operations for the industrial wire products business have been reported as discon- tinued operations for all periods presented. (12) reLated Party tranSaCtionS In connection with the Company’s stock repur- chase program, on January 30, 2006, the Company repurchased approximately 400,000 shares of its com- mon stock held by the Chairman of the Company’s Board of Directors and his wife. The purchase price for the shares repurchased was $21.322 per share based on a predetermined formula, which represented a 15% discount from the closing price on January 27, 2006. The number of shares repurchased and purchase price per share are prior to the effect of the two-for-one split of the Company’s common stock that was distributed as a stock dividend on June 16, 2006. Sales to a company affiliated with one of the Company’s directors amounted to $967,000 in 2007, $929,000 in 2006 and $701,000 in 2005. Purchases from a company affiliated with one of the Company’s directors amounted to $418,000 in 2007 and $1.5 mil- lion in 2006. (13) ComPrehenSive LoSS The components of accumulated other compre- hensive loss are as follows: (In thousands) Adjustment to adopt SFAS No. 158 Additional pension plan liability Accumulated other compre- hensive loss september 29, 2007 September 30, 2006 $(2,110) (9) $(2,119) $ — — $ — 42 (14) other FinanCiaL data (15) rightS agreement Balance sheet information: (In thousands) Accounts receivable, net: Accounts receivable Less allowance for doubtful accounts september 29, 2007 September 30, 2006 $ 35,128 $ 38,183 (610) (664) Total $ 34,518 $ 37,519 Inventories: Raw materials Work in process Finished goods Total Other assets: Cash surrender value of life insurance policies Non-current deferred tax assets Capitalized financing costs, net Prepaid pension cost Assets held for sale Other $ 25,443 2,083 19,875 $ 47,401 $ 27,160 1,657 17,980 $ 46,797 $ 4,367 $ 3,500 1,480 1,342 — — 296 2,176 1,841 1,242 583 311 Total $ 7,485 $ 9,653 Property, plant and equipment, net: Land and land improvements Buildings Machinery and equipment Construction in progress Less accumulated depreciation Total Accrued expenses: Salaries, wages and related expenses Customer rebates Property taxes Cash dividends Worker’s compensation Sales allowance reserve Income taxes Other Total Other liabilities: Deferred compensation Deferred revenues Total $ 5,621 31,981 86,560 3,955 128,117 (60,970) $ 67,147 $ 4,278 840 749 544 499 236 — 467 $ 7,613 $ 4,584 278 $ 4,862 $ 5,345 28,473 60,090 18,013 111,921 (56,704) $ 55,217 $ 4,084 758 641 543 119 236 2,805 633 $ 9,819 $ 2,147 566 $ 2,713 On April 26, 1999, the Company’s Board of Directors adopted a Rights Agreement and declared a dividend distribution of one right per share of the Company’s common stock to shareholders of record as of May 17, 1999. In addition, the Rights Agreement provides that one right will attach to each share of the Company’s common stock issued after May 17, 1999 until the tenth business day following a public announcement that a person or group has acquired, obtained the right to acquire or made a tender or exchange offer for 20% or more of the outstanding shares of the Company’s common stock (such tenth business day, the “Distribution Date”). Currently, the rights are not exercisable but trade automatically with the Company’s common stock shares. The rights become exercisable on the Distri- bution Date. Each right will entitle the holder, other than the acquiring person or group, to purchase one one-hundredth of a share (a “Unit”) of the Company’s Series A Junior Participating Preferred Stock at a pur- chase price of $80 per Unit, subject to adjustment as described in the Rights Agreement (the “Purchase Price”). All rights beneficially owned or acquired by the acquiring person or group will become null and void as of the Distribution Date. If an acquiring person or group acquires 20% or more of the Company’s out- standing common stock, each rights holder, other than the acquiring person or group, upon exercise of his or her rights and payment of the Purchase Price, will severally have the right to receive shares of the Company’s common stock having a value equal to two times the Purchase Price or, at the discretion of the Board of Directors, upon exercise and without payment of the Purchase Price, will have the right to purchase the number of shares of the Company’s common stock having a value equal to two times the Purchase Price at a 50% discount. In addition, each rights holder, other than an acquiring person or group, upon exercise of his or her rights will have the right to receive shares of the com- mon stock of the acquiring corporation having a value equal to two times the Purchase Price for such holder’s rights if the Company engages in a merger or other business combination where it is not the surviving entity or where it is the surviving entity and all or part of the Company’s common stock is exchanged for the stock or other securities of the other company, or if 50% or more of the Company’s assets or earning power is sold or transferred. insteel industRies, inc. and subsidiaRies 43 6,000 5,000 4,000 3,000 2,000 1,000 0 notes to consoliDateD financial stateMents (continued) Years Ended September 29, 2007, September 30, 2006 and October 1, 2005 The rights will expire on April 26, 2009, and may be redeemed by the Company at any time prior to the Distribution Date at a price of $0.01 per right. (16) ProduCt warrantieS The Company’s products are used in applications which are subject to inherent risks including perfor- mance deficiencies, personal injury, property damage, environmental contamination or loss of production. The Company warrants its products to meet certain specifications and actual or claimed deficiencies from these specifications may give rise to claims. The Company does not maintain a reserve for warranties as the historical claims have been immaterial. The Company maintains product liability insurance cover- age to minimize its exposure to such risks. stock peRfoRMance gRapH totaL return to SharehoLderS The following graph compares the total returns (including the reinvestment of dividends) of the Company, the S&P 500 Index and the S&P Building Products Index. The graph assumes $100 invested on September 28, 2002 in the Company’s stock and September 30, 2002 in each of the indices. Total returns for the indices are calculated on a month-end basis. Insteel Industries S&P 500 S&P Building Products $6,000 5,000 4,000 3,000 2,000 1,000 0 9/28/02 9/27/03 10/2/04 10/1/05 9/30/06 9/29/07 (In dollars) Insteel Industries S&P 500 S&P Building Products 9/28/02 9/27/03 10/2/04 10/1/05 9/30/06 9/29/07 100.00 100.00 100.00 110.29 124.40 130.00 2,136.62 141.65 184.61 2,267.65 159.01 186.79 5,938.86 176.17 171.61 4,619.25 205.13 172.86 44 financial infoRMation By QuaRteR (unauDiteD) (In thousands, except for per share and price data) december 30 March 31 June 30 september 29 Quarter ended 2007 Operating results: Net sales Gross profit Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Per share data: Basic: Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Diluted: Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Stock prices(1) High Low Cash dividends declared 2006 Operating results: Net sales Gross profit Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Per share data: Basic: Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Diluted: Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Stock prices(1) High Low Cash dividends declared (1) Prices adjusted to reflect 2-for-1 stock split on June 16, 2006. $69,716 13,624 5,931 (152) 5,779 $74,766 12,358 4,944 (31) 4,913 $ 78,966 17,352 8,344 (37) 8,307 $74,358 12,727 5,065 98 5,163 0.33 (0.01) 0.32 0.32 — 0.32 21.97 16.58 0.03 0.27 — 0.27 0.27 — 0.27 19.06 15.89 0.03 0.46 — 0.46 0.46 (0.01) 0.45 19.66 16.43 0.03 0.28 — 0.28 0.28 — 0.28 23.00 15.35 0.03 Quarter Ended December 31 April 1 July 1 September 30 $ 75,604 17,113 8,013 (335) 7,678 $ 79,776 16,979 7,845 (444) 7,401 $ 91,644 18,486 9,066 (1,184) 7,882 $ 82,483 18,293 9,453 626 10,079 0.43 (0.02) 0.41 0.42 (0.02) 0.40 8.68 6.89 0.03 0.43 (0.02) 0.41 0.42 (0.02) 0.40 29.70 8.13 0.03 0.50 (0.07) 0.43 0.50 (0.07) 0.43 30.00 18.77 0.03 0.52 0.04 0.56 0.52 0.03 0.55 24.85 16.33 0.03 insteel industRies, inc. and subsidiaRies 45 selecteD financial Data—fiVe-yeaR HistoRy (In thousands, except for per share amounts) Operating Results: Net sales Gross profit % of net sales Selling, general and administrative expense Interest expense Earnings from continuing operations % of net sales Earnings (loss) from discontinued operations Net earnings Per Share Data: Per share (basic): Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Per share (diluted): Earnings from continuing operations Earnings (loss) from discontinued operations Net earnings Cash dividends declared Returns: Return on capital(1) Return on equity(2) Financial Position: Total assets Total long-term debt Shareholders’ equity Cash Flows: Net cash provided by operating activities Capital expenditures Depreciation and amortization Repurchase of common stock Cash dividends paid Other Data: Number of employees at year-end Year Ended (52 weeks) september 29, 2007 (52 weeks) September 30, 2006 (52 weeks) October 1, 2005 (53 weeks) October 2, 2004 (52 weeks) September 27, 2003 $ 297,806 56,061 $ 329,507 70,871 $309,320 57,898 $ 298,754 78,956 $184,868 19,632 18.8% 21.5% 18.7% 26.4% 10.6% $ 17,583 592 24,284 $ 16,996 669 34,377 $ 16,175 3,427 24,499 $ 21,194 5,832 32,035 $ 11,165 4,126 9,512 8.2% 10.4% 7.9% 10.7% 5.1% $ (122) 24,162 $ (1,337) 33,040 $ 546 25,045 $ (546) 31,489 $ (2,790) 6,722 $ 1.34 $ 1.88 $ 1.31 $ 1.85 $ 0.56 (0.01) 1.33 1.33 (0.01) 1.32 0.12 (0.08) 1.80 1.86 (0.07) 1.79 0.12 0.03 1.34 1.29 0.03 1.32 0.06 (0.03) 1.82 1.78 (0.03) 1.75 — (0.16) 0.40 0.55 (0.16) 0.39 — 18.2% 18.2% 29.7% 31.3% 21.1% 29.1% 28.6% 62.5% 9.7% 34.8% $173,529 — 143,850 $ 16,918 17,013 6,209 — 2,176 $166,596 — 122,438 $ 44,835 18,959 5,108 8,529 2,222 $ 138,276 11,860 97,036 $ 44,460 6,302 5,627 — 566 $151,291 52,368 71,211 $ 28,122 2,921 6,209 — — $132,930 69,453 31,272 $ 5,290 933 5,143 — — 559 621 655 669 677 (1) Earnings from continuing operations/(average total long-term debt + average shareholders’ equity). (2) Earnings from continuing operations/(average shareholders’ equity). 46 corpor Ate InForMAtIon Board of directors louis e. hannen (1) Retired Senior Vice President Wheat, First Securities, Inc. Charles B. Newsome (2) Executive Vice President Johnson Concrete Company gary l. Pechota (1) Retired Chairman, President and Chief Executive Officer Giant Cement Holding, Inc. W. allen rogers II (1) Principal Ewing Capital Partners, LLC William J. Shields (2) Retired Chairman and Chief Executive Officer Co-Steel, Inc. C. richard Vaughn (2,3) Chairman John S. Clark Company, Inc. howard o. Woltz, Jr.(3) Chairman of the Board Insteel Industries, Inc. h.o. Woltz III (3) President and Chief Executive Officer Insteel Industries, Inc. (1) Member of the Audit Committee (2) Member of the Executive Compensation Committee (3) Member of the Executive Committee executive officers h.o. Woltz III President and Chief Executive Officer michael C. gazmarian Vice President, Chief Financial Officer and Treasurer James f. Petelle Vice President—Administration and Secretary richard t. Wagner Vice President and General Manager—Insteel Wire Products Company shareholder information corporate headquarters 1373 Boggs Drive Mount Airy, North Carolina 27030-2148 (336) 786-2141 independent Public accountants Grant Thornton LLP Greensboro, North Carolina annual meeting Insteel shareholders are invited to attend our annual meeting which will be held at 10:00 A.M. on Tuesday, February 19, 2008, at the Cross Creek Country Club, 845 Greenhill Road, Mount Airy, North Carolina. common stock The Common Stock of Insteel Industries, Inc. is traded on the NASDAQ Global Select Market under the symbol IIIN. At November 27, 2007, there were 1,142 shareholders of record. shareholder services For change of name, address, ownership of stock; to replace lost stock certificates; or to consolidate accounts, please contact: American Stock Transfer & Trust Company 59 Maiden Lane New York, New York 10038 (866) 627-2704 www.amstock.com investor relations For information on the Company, additional copies of this report, Form 10-K, or other financial infor- mation, contact Michael C. Gazmarian, Vice President, Chief Financial Officer and Treasurer, at the Company’s head- quarters. You may also visit the Investor Information section on the Company’s Web site at www.investor.insteel.com. m o c . s r o n n o c - n a r r u c . w w w / . c n i , s r o n n o c & n a r r u c y b d e n g i s e d Insteel IndustrIes, Inc. 1373 Boggs Drive, Mount Airy, North Carolina 27030-2148 phone (336) 786-2141 www.insteel.com ListeD oN uNDer the syMBoL “IIIN” 

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