Insteel Industries
Annual Report 2009

Plain-text annual report

2009 AnnuAl RepoRt 2009 AnnuAl RepoRt  Leadership Positions in Attractive Markets State-of-the-Art Facilities and Manufacturing Capabilities Financial Strength and Flexibility 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 engineered structural mesh, concrete pipe reinforcement and stan- dard 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 seven manufacturing facilities located in the United States. Financial Highlights (In thousands, except for per share amounts) 2009 2008 2007 operating Results: Net sales Gross profit (loss) % of net sales Earnings (loss) from continuing operations % of net sales Net earnings (loss) per Share Data: Basic: Earnings (loss) from continuing operations Net earnings (loss) Diluted: Earnings (loss) from continuing operations Net earnings (loss) Cash dividends declared Returns: Return on total capital (1) Return on shareholders’ equity(2) Financial position: Cash and cash equivalents Total assets Total long-term debt Shareholders’ equity Cash Flows: Net cash provided by operating activities of continuing operations Capital expenditures Depreciation and amortization Repurchases of common stock Cash dividends paid $ 230,236 (15,093) $ 353,862 86,755 $ 297,806 56,061 (6.6%) 24.5% 18.8% $ (20,940) $ 43,717 $ 24,284 (9.1%) 12.4% 8.2% $ (22,086) $ 43,752 $ 24,162 $ (1.20) (1.27) $ (1.20) (1.27) 0.12 2.49 2.49 2.47 2.47 0.62 $ 1.34 1.33 1.33 1.32 0.12 (13.2%) (13.2%) 27.9% 27.9% 18.2% 18.2% $ 35,102 182,117 — 147,070 $ 26,493 228,220 — 169,847 $ 8,703 173,529 — 143,850 $ 22,092 2,377 7,377 — 11,381 $ 36,808 9,456 7,271 8,691 2,141 $ 17,065 17,013 5,711 — 2,176 (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) $353.9 $297.8 Diluted Earnings (Loss) Per Share From Continuing Operations Return on Total Capital(1) $2.47 27.9% $230.2 $1.33 18.2% $(1.20) (13.2%) 2007 2008 2009 2007 2008 2009 2007 2008 2009 400 350 300 250 200 150 100 50 0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 30 25 20 15 10 5 0 -5 -10 -15 weLded wire reinForCeMent (% oF totAL net SALeS: 2009—53%, 2008—55%, 2007—56%) Prefabricated reinforcement consisting of high-strength, cold-drawn or cold-rolled wires that are welded into square or rectangular grids according to customer requirements. Wire intersections are electrically resistance-welded by com- puter controlled continuous automatic welding lines that use pressure and heat to fuse wires in their proper positions. The technology used by Insteel allows for production of sheets and rolls of high-strength reinforcing products with exacting dimensional tolerances. 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 customer segments Precast and Prestressed Producers Rebar Fabricators Distributors end uses Nonresidential Construction 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 customer segments Concrete Pipe and Precast Producers end uses Nonresidential Construction Residential 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 customer segments Rebar Fabricators Distributors end uses Nonresidential Construction Residential Construction PreStreSSed ConCrete StrAnd (% oF totAL net SALeS: 2009—47%, 2008—45%, 2007—44%) High-strength seven-wire reinforcement consisting of six cold-drawn wires that are continuously wrapped around a center wire forming a strand, which is heat-treated while under tension to impart low relaxation characteristics and increase the working range of the product. 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 the 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 customer segments Precast Prestress Producers Posttensioning Suppliers end uses Nonresidential Construction Residential Construction We market our products through sales representatives that are our employees and through a sales agent. Our sales force is organized by product line and trained in the technical applications of our products. Our products are sold nationwide as well as into Canada, Mexico, and Central and South America, and delivered primarily by truck, using common or contract carriers. Letter to Shareholders 2009 was a year of unprecedented change for nearly all industrial companies, including Insteel following the record financial results that we achieved in 2008. The recessionary conditions in the economy coupled with the ongoing tightness in credit markets spurred a heightened focus on liquidity throughout our supply chain. Demand for our products plummeted through the first nine months of the year as the decline in end use consumption was compounded by dramatic inventory destocking across our customer base. Prices for our primary raw material, hot-rolled steel wire rod, as well as for our concrete reinforcing products, which had surged to record high levels in the prior year, abruptly reversed course, spiraling downward through most of 2009. In our PC strand business, these macro factors were exacerbated by the glut of Chinese imports that had accumulated in various distribution channels towards the end of the prior year, which created substantial downward pressure on shipments and pricing through the first three quarters of 2009. We responded aggressively to these challenges by realigning our operating schedules with the depressed level of demand, reducing staffing by 16% over the course of the year, ratcheting down our discretionary spending, intensifying our focus on process improvements and closely managing working capital while continuing to meet the expectations of our customers. Financial Results Net sales for 2009 fell 34.9% to $230.2 million from $353.9 million in 2008 on a 29.7% decrease in shipments and a 7.5% decrease in average selling prices. We incurred a loss from continuing operations of $20.9 million ($1.20 per diluted share), which included a pre-tax charge of $25.9 million ($16.6 million after- tax or $0.96 per share) for inventory write-downs to reduce the carrying value of inventory to the lower of cost or market resulting from the decline in selling prices. In comparison, earnings from continuing opera- tions were $43.7 million ($2.47 per diluted share) in 2008. On a positive note, we returned to profitability in our fourth fiscal quarter following three consecutive quarterly losses. Despite the loss, operating activities generated $22.1 million of cash in 2009, which was primarily used to pay $11.5 million of dividends, fund $2.4 million of capital expenditures and increase our cash balance by $8.6 million. We ended the year with a debt-free balance sheet and $35.1 million of cash. In connection with the loss that was incurred for the year, we also have an estimated tax refund of $13.0 million that we expect to receive during 2010, which will further strengthen our financial position. Pc stR and tR ade cases In May 2009, Insteel together with two other U.S. producers of PC strand filed antidumping and countervailing duty petitions, alleging that imports of PC strand from China were injuring the domestic PC strand industry. The trade cases were in response to a surge in imports in recent years that resulted in Chinese producers representing 92% of total PC strand imports entering the U.S. in 2008 and capturing 41% of the domestic market. We believe that these extraordinary results were achieved through commercial practices that are 1 While the short-term environment is formidable, we remain confident about our long-term prospects. We will continue to focus on generat- ing returns that exceed our cost of capital by: (1) maintaining and building upon our market leadership positions; (2) operating as the lowest cost producer; and (3) pursuing growth opportunities in our core businesses that further our penetration of existing markets or expand our geographic footprint. inconsistent with U.S. trade law rather than by exploiting any legitimate strategic or cost advantage. The pricing tactics employed by the Chinese to undersell domestic producers have severely impacted Insteel’s shipping volumes and selling prices, resulting in significant margin erosion. On a level playing field, we are confident that our manufacturing costs for PC strand compare favorably with any other producer, domestic or foreign. The trade cases allege that imports of PC strand from China were being “dumped” or sold in the U.S. at less than fair value and that subsidies were being provided to Chinese PC strand producers by the Chinese government. The alleged dumping margins range from 140% to 315%, with an average margin of 223%. Fortunately, we have already benefited from the trade cases as Chinese producers have practically aban- doned the U.S. market while they run their course, providing us an opportunity to restore our participation with customers that had been relying heavily on Chinese sources of supply. The entire investigative process is anticipated to take approximately one year, with the final determinations of injury, dumping and subsidies expected to occur in mid-2010. looking ahe ad As we move into 2010, our level of visibility remains limited in view of the ongoing uncertainty regarding future economic conditions, the relative availability of financing in the credit markets, and the timing and magnitude of the infrastructure-related funding provided for under the American Recovery and Reinvestment Act (“ARRA”) and the next federal highway funding authorization. The seasonal downturn that we typically experience during our first and second fiscal quarters is likely to be exacerbated by the actions taken by certain of our competitors and customers to minimize inventories. We expect market conditions to remain challenging for the near-term, particularly in the commercial construction sector, where backlogs have eroded due to the drop-off in new projects. Although the infrastructure spending provided for under ARRA is expected to ramp up during 2010 and 2011, the extent to which it offsets the anticipated decline in other categories of nonresidential construction is unknown at this time. In the residential construction sector, we expect that market conditions will remain weak, but gradually improve over the course of the year. Following the extended downturn that occurred during 2009, wire rod prices appear to have leveled out and are expected to be influenced by changes in steel scrap prices in the coming months. The closures of two 2 U.S. rod mills in July and September 2009 that represented over 20% of total domestic capacity could potentially tighten availability and drive prices higher as market conditions improve, particularly if imports remain at reduced levels. However, the impact of the plant closures has been minimal up to this point due to the depressed level of demand. Insteel has weathered difficult times in the past. While the short-term environment is formidable, we remain confident about our long-term prospects. We will continue to focus on generating returns that exceed our cost of capital by: (1) maintaining and building upon our market leadership positions; (2) operating as the lowest cost producer; and (3) pursuing growth opportunities in our core businesses that further our penetration of existing markets or expand our geographic footprint. Insteel’s strength and stability lie in our commitment to operating the Company as efficiently and effectively as possible. Our highly skilled workforce is dedicated to finding new ways to best meet our customers’ requirements by improving efficiencies, reducing costs and right-sizing our business on a continuous basis. Following the completion of our three-year $45.4 million capital investment program in 2008, we believe that our state-of-the-art facilities and manufacturing capabilities are unsurpassed in our industry. We anticipate gradually increasing contributions from these investments in the form of reduced operating costs and additional capacity to satisfy future growth in demand. Finally, our strong balance sheet and financial flexibility position us to capitalize on any attractive growth opportunities that may arise in this difficult environment. As we navigate our way through this challenging period, we wish to thank our employees, customers and shareholders for their continued trust, confidence and support. Sincerely, h.o. Woltz iii Chairman, President and Chief Executive Officer 3 Leadership Positions in Attractive Markets Insteel is the largest manufacturer of welded wire reinforcement and PC strand in the United States. We are also the only domestic producer that manufactures both of these products, which are used in combination for a broad range of concrete reinforcing applications. Our strategically located facilities place us in close proximity to our customers and provide us with a national presence—a significant advantage relative to single location producers. We sell into attractive markets that offer considerable growth potential and a diverse customer base with minimal concentration. Demographic trends and the ongoing deterioration in our nation’s infra- structure are expected to spur long-term growth in construction spending and demand for our Precast/prestressed and posttensioned concrete technologies, which rely on PC strand, are being used in the construction of Hoover Dam Bypass, which will be the longest single-arch concrete crossing in North America, spanning the Colorado River between Nevada and Arizona. 4 products. In addition, concrete continues to gain market share in the construction sector relative to competing building materials due to its lower life cycle cost and superior performance with respect to durability and safety. Engineered structural mesh (“ESM”) is undergoing a similar growth dynamic as it has gradually penetrated the rebar market where it can serve as a higher strength, less labor intensive and lower cost reinforcing solution for many applications. We have found that as rebar users initially convert projects to ESM and experience first-hand the advantages that it offers, they tend to become repeat ESM customers going forward. As market conditions improve, we plan on pursuing additional investments in ESM to capitalize on the growing acceptance for the product. 5 State-of-the-Art Facilities and Manufacturing Capabilities Given the highly competitive nature of our markets, a key element of our business strategy is to operate as the lowest cost producer. From 2006 to 2008, we invested $45.4 million in our facilities, adding two new ESM production lines, reconfiguring and expanding our two PC strand facilities, and upgrading and expanding our standard welded wire reinforcement operations. These projects provide dual benefits in the form of operating cost reductions together with additional capacity that can be ramped up as market conditions improve. Although the unprecedented collapse in demand that we experienced over the past year has negated any contribution from the incremental capacity that was added, we have achieved sizable improvements in efficiencies and productivity as we have shifted volume over to the new equipment. These improvements are largely a result of the The long span beams used in highway construction are frequently reinforced with both PC strand and ESM. 6 technological advancements in equipment that have occurred in recent years, particularly for the production of ESM, and have favorably impacted our unit conversion costs. Our world-class manufacturing facilities are supported by a sophisticated information systems infrastructure that provides us with real-time data on our business processes and a broad range of performance metrics and decision-support tools. Through the sizable investments that we have made, we believe that our state-of-the-art facilities and systems infrastructure are second-to-none in our industry, placing us in a strong competitive position across all our product lines. Box culverts, which are used for water drainage applications, are typically reinforced with ESM. 7 Financial Strength and Flexibility We are committed to preserving a capital structure that provides us with the flexibility to pursue future growth opportunities while maintaining sufficient liquidity to withstand economic or cyclical downturns and the inherent volatility in our working capital requirements. Despite the recessionary conditions in our markets over the past year, we ended fiscal 2009 with a debt-free balance sheet and $35.1 million of cash. Our strong balance sheet and flexible capital structure allow us to create value for our shareholders through capital expenditures, acquisitions, regular quarterly cash dividends and the repurchase of shares on an opportunistic basis. A recent study indicated that more than 25% of the bridges in the U.S. are estimated to be either structurally deficient or functionally obsolete. The eventual upgrading and replacement of these structures together with the ongoing construction of new bridges to alleviate the growing congestion on our roadways should favorably impact demand for Insteel’s concrete reinforcing products in the coming years. 8 We believe the ongoing weakness in business conditions and tightness in the credit markets could serve as a catalyst for potential acquisition candidates to become available at attractive valuations. There may be growth opportunities in our core welded wire reinforcement and PC strand businesses that further our penetration of the markets that we currently serve or expand our geographic footprint. Such opportunities would offer substantial synergies and value-creation potential, typically in the form of operating cost reductions through improved efficiencies and the elimination of redundant expenses, reduced freight costs and additional purchasing leverage. Our primary focus, however, is to maintain our strong financial position, and we will be disciplined in pursuing any growth opportunities to ensure that the anticipated returns meet the expectations of our shareholders. 9 contents 12 21 22 23 24 25 26 27 28 30 48 48 49 50 Management’s Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures About Market Risk Management’s Report on Internal Control Over Financial Reporting 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 Shareholders’ Equity and Comprehensive Income (Loss) Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Stock Price and Dividend Data Supplementary Quarterly Financial Data (Unaudited) Stock Performance Graph Selected Financial Data—Five-Year History 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, particularly in the “Letter to Shareholders” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” When used in this report, the words “believes,” “anticipates,” “expects,” “estimates,” “intends,” “may,” “should” and similar expressions are intended to identify forward-looking statements. Although we believe that our plans, inten- tions and expectations reflected in or suggested by such forward-looking statements are reasonable, they are subject to a number of risks and uncertainties, and we can provide no assurances that such plans, intentions or expectations will be achieved. Many of these risks and uncertainties are discussed in detail in our periodic and other reports and statements that we file with the U.S. Securities and Exchange Commission (the “SEC”), in particular in our Annual Report on Form 10-K for the year ended October 3, 2009. You should carefully review these risks and uncertainties. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. All forward-looking statements speak only to the respective dates on which such statements are made and we do not undertake and specifically decline any obligation to publicly release the results of any revisions to these forward-looking state- ments 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 would include, but are not limited to, the following: general economic and competitive conditions in the markets in which we operate; credit market conditions and the impact of the measures that have been taken by the federal government on the relative availability of financing for us, our customers and the construction industry as a whole; the timing and magnitude of the impact of the additional federal infrastructure-related funding provided for under the American Recovery and Reinvestment Act; the anticipated reduction in spending for nonresidential construction, particularly commercial construction, and the impact on demand for our concrete reinforcing products; the severity and duration of the downturn in residential construction activity and the impact on those portions of our business that are correlated with the housing sector; the cyclical nature of the steel and building material industries; fluctuations in the cost and availability of our primary raw material, hot-rolled steel wire rod, from domestic and foreign suppliers; our ability to raise selling prices in order to recover increases in wire rod costs; changes in United States or foreign trade policy affecting imports or exports of steel wire rod or our products, including the outcome of the trade cases that have been filed by domestic producers of prestressed concrete strand (“PC strand”) regarding imports of PC strand from China; unanticipated changes in customer demand, order patterns or inventory levels; the impact of weak demand and reduced capacity utilization levels on our unit manufacturing costs; our ability to further develop the market for engineered structural mesh (“ESM”) and expand our shipments of ESM; the actual net proceeds realized and closure costs incurred in connection with our exit from the industrial wire business; legal, environmental or regulatory developments that significantly impact our operating costs; unanticipated plant outages, equipment failures or labor dif- ficulties; continued escalation in certain of our operating costs; and the “Risk Factors” discussed in our Annual Report on Form 10-K for the year ended October 3, 2009. 10 2009 Financial ReviewManageMent’s Discussion anD analysis of financial conDition anD Results of opeRations Overview Following our exit from the industrial wire busi- ness (see Note 8 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; (2) operating as the lowest cost producer; and (3) pur- suing growth opportunities within our core busi- nesses 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 United States (“GAAP”). Our discus- sion and analysis of our financial condition and results of operations are based on these financial statements. The preparation of our financial state- ments requires the application of these accounting principles in addition to certain estimates and judgments based on current available information, actuarial estimates, historical results and other assumptions believed to be reasonable. Actual results could differ from these estimates. Following is a discussion of our most critical accounting policies, which are those that are both important to the depiction of our financial condition and results of operations and that require judgments, assumptions and estimates. Revenue recognition. We recognize revenue from prod- uct sales in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition when products are shipped and risk of loss and title has passed to the customer. Sales taxes collected from customers are recorded on a net basis and as such, are excluded from revenue. Concentration of credit risk. Financial instruments that subject us to concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. We are exposed to credit risk in the event of default by institutions in which our cash and cash equivalents are held and by customers to the extent of the amounts recorded on the balance sheet. We invest excess cash primarily in money market funds, which are highly liquid securities that bear minimal risk. Our cash is concentrated primarily at one financial institution, which at times exceeds fed- erally insured limits. Most of our accounts receivable are due from customers that are located in the U.S. and we gener- ally require no collateral depending upon the credit- worthiness of the account. We utilize credit insurance on certain accounts receivable due from customers located outside of the U.S. 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 on outstanding balances owed to us. Significant management judgments and esti- mates are used in establishing the allowances. These judgments and estimates consider such factors as cus- tomers’ financial position, cash flows and payment history as well as current and expected business con- ditions. It is reasonably likely that actual collections will differ from our estimates, which may result in increases or decreases in the allowances. Adjustments to the allowances may also be required if there are significant changes in the financial condition of our customers. Inventory valuation. We periodically evaluate the carry- ing value of our inventory. This evaluation includes assessing the adequacy of allowances to cover losses in the normal course of operations, providing for excess and obsolete inventory, and ensuring that inventory is valued at the lower of cost or estimated net realizable value. Our evaluation considers such factors as the cost of inventory, future demand, our historical experience and market conditions. In assessing the realization of inventory values, we are required to make judgments and estimates regarding 12 future market conditions. Because of the subjective nature of these judgments and estimates, it is reason- ably likely that actual outcomes will differ from our estimates. Adjustments to these reserves may be required if actual market conditions for our products are substantially different than the assumptions underlying our estimates. Self-insurance. We are self-insured for certain losses relating to medical and workers’ compensation claims. Self-insurance claims filed and claims incurred but not reported are accrued based upon management’s estimates of the discounted ultimate cost for uninsured claims incurred using actuarial assumptions followed by the insurance industry and historical experience. These estimates are subject to a high degree of variability based upon future inflation rates, litigation trends, changes in benefit levels and claim settlement patterns. Because of uncertainties related to these factors as well as the possibility of changes in the underlying facts and circumstances, future adjustments to these reserves may be required. Litigation. From time to time, we may be involved in claims, lawsuits and other proceedings. Such matters involve uncertainty as to the eventual outcomes and the potential losses that we may ultimately incur. We record expenses for litigation when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We estimate the probability of such losses based on the advice of legal counsel, the outcome of similar litigation, the status of the lawsuits and other factors. Due to the numerous factors that enter into these judgments and assumptions, it is reasonably likely that actual out- comes will differ from our estimates. We monitor our potential exposure to these contingencies on a regular basis and may adjust our estimates as addi- tional information becomes available or as there are significant developments. Assumptions for employee benefit plans. We account for our defined employee benefit plans, the Insteel Wire Products Company Retirement Income Plan for Hourly Employees, Wilmington, Delaware (the “Delaware Plan”) and the supplemental employee retirement plans (each, a “SERP”) in accordance with FASB ASC Topic 715, Compensation—Retire- ment Benefits. Under the provisions of ASC Topic 715, we recognize net periodic pension costs and value pension assets or liabilities based on certain actuarial assumptions, principally the assumed dis- count rate and the assumed long-term rate of return on plan assets. The discount rates we utilize for determining net periodic pension costs and the related benefit obligations for our plans are based, in part, on current interest rates earned on long-term bonds that receive one of the two highest ratings assigned by recognized rating agencies. Our discount rate assumptions are adjusted as of each valuation date to reflect current interest rates on such long-term bonds. The discount rates are used to determine the actuarial present value of the benefit obligations as of the valuation date as well as the interest component of the net periodic pension cost for the following year. The dis- count rate for the Delaware Plan was 5.5%, 7.0% and 6.5% for 2009, 2008 and 2007, respectively. The dis- count rate for the SERPs was 5.5%, 7.0% and 6.25% for 2009, 2008 and 2007, respectively. The assumed long-term rate of return on plan assets for the Delaware Plan represents the estimated average rate of return expected to be earned on the funds invested or to be invested in the plan’s assets to fund the benefit payments inherent in the projected benefit obligations. Unlike the discount rate, which is adjusted each year based on changes in current long- term interest rates, the assumed long-term rate of return on plan assets will not necessarily change based upon the actual short-term performance of the plan assets in any given year. The amount of net peri- odic pension cost that is recorded each year is based on the assumed long-term rate of return on plan assets for the plan and the actual fair value of the plan assets as of the beginning of the year. We regu- larly review our actual asset allocation and, when appropriate, rebalance the investments in the plan to more accurately reflect the targeted allocation. For 2009, 2008 and 2007, the assumed long-term rate of return utilized for plan assets of the Delaware Plan was 8%. We currently expect to use the same assumed rate for the long-term return on plan assets in 2010. In determining the appropriateness of this INSTEEL INDUSTRIES, INC. // 2009 annual report 13 ManageMent’s Discussion anD analysis of financial conDition anD Results of opeRations (continued) assumption, we considered the historical rate of return of the plan assets, the current and projected asset mix, our investment objectives and information provided by our third-party investment advisors. The projected benefit obligations and net peri- odic pension cost for the Delaware Plan are based in part on expected increases in future compensation levels. Our assumption for the expected increase in future compensation levels is based upon our average historical experience and management’s intentions regarding future compensation increases, which gen- erally approximates average long-term inflation rates. Assumed discount rates and rates of return on plan assets are reevaluated annually. Changes in these assumptions can result in the recognition of materially different pension costs over different periods and materially different asset and liability amounts in our consolidated financial statements. A reduction in the assumed discount rate gener- ally results in an actuarial loss, as the actuarially- determined present value of estimated future benefit payments will increase. Conversely, an increase in the assumed discount rate generally results in an actuar- ial gain. In addition, an actual return on plan assets for a given year that is greater than the assumed return on plan assets results in an actuarial gain, while an actual return on plan assets that is less than the assumed return results in an actuarial loss. Other actual outcomes that differ from previous assumptions, such as individuals living longer or shorter lives than assumed in the mortality tables that are also used to determine the actuarially-determined present value of estimated future benefit payments, changes in such mortality tables themselves or plan amendments will also result in actuarial losses or gains. Under GAAP, actuarial gains and losses are deferred and amortized into income over future periods based upon the expected average remaining service life of the active plan participants (for plans for which benefits are still being earned by active employees) or the average remaining life expectancy of the inactive participants (for plans for which bene- fits are not still being earned by active employees). However, any actuarial gains generated in future periods reduce the negative amortization effect of any cumulative unamortized actuarial losses, while any actuarial losses generated in future periods reduce the favorable amortization effect of any cumulative unamortized actuarial gains. The amounts recognized as net periodic pension cost and as pension assets or liabilities are based upon the actuarial assumptions discussed above. We believe that all of the actuarial assumptions used for determining the net periodic pension costs and pension assets or liabilities related to the Delaware Plan are reasonable and appropriate. The funding requirements for the Delaware Plan are based upon applicable regulations, and will generally differ from the amount of pension cost recognized under ASC Topic 715 for financial reporting purposes. No contri- butions were required to be made to the Delaware Plan during 2009, 2008 and 2007. We currently expect to record net periodic pen- sion costs totaling $199,600 during 2010, although we do not expect any cash contributions to the Delaware Plan will be required during the year. Contributions to the SERPs are expected to total $155,000 during 2010, matching the required benefit payments. A 0.25% decrease in the assumed discount rate for the Delaware Plan would have increased our projected and accumulated benefit obligations as of October 3, 2009 by approximately $90,200 and the expected net periodic pension cost for 2010 by approx- imately $3,400. A 0.25% decrease in the assumed dis- count rate for our SERPs would have increased our projected and accumulated benefit obligations as of October 3, 2009 by approximately $182,000 and $137,000, respectively, and increased the net periodic pension cost for 2010 by approximately $16,000. A 0.25% decrease in the assumed long-term rate of return on plan assets for the Delaware Plan would have increased the expected net periodic pension cost for 2010 by approximately $7,100. reCent aCCOunting PrOnOunCements Current Adoptions In June 2009, FASB issued Accounting Standards Update (ASU) No. 2009-01, the FASB Accounting Standards Codification™ (“Codification”) and the Hierarchy of Generally Accepted Accounting Prin- ciples (“ASU 2009-01”). This update established the Codification as the source of authoritative accounting 14 principles recognized by the FASB in the preparation of financial statements in conformity with GAAP. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered non- authoritative. As the Codification was not intended to change or alter existing GAAP, the adoption of ASU 2009-01 did not have an impact on our consolidated financial statements. In August 2009, the FASB issued ASU No. 2009- 05, Measuring Liabilities at Fair Value (“ASU 2009- 05”). This update provides amendments to ASC Topic 820, Fair Value Measurement and Disclosure, for the fair value measurement of liabilities. The purpose of this amendment is to reduce ambiguity in financial reporting when measuring the fair value of liabilities. The adoption of ASU 2009-05 did not have an impact on our consolidated financial statements. Future Adoptions In December 2007, the FASB amended certain provisions of ASU Topic 805, Business Combina- tions (previously reported as Statement of Financial Accounting Standards “SFAS” No. 141R, “Business Combinations”). This amendment requires the acquir- ing entity in a business combination to recognize all the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose all of the information required to evaluate and understand the nature and financial effect of the business combination. This amendment is effective for acquisition dates on or after the beginning of the first annual reporting period beginning after December 15, 2008 and is not expected to have a mate- rial effect on our consolidated financial statements to the extent that we do not enter into business com- binations subsequent to adoption. In December 2007, the FASB amended certain provisions of ASU Topic 810, Consolidation (previ- ously reported as SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements”). This amendment establishes accounting and reporting standards for non-controlling interests in subsidiaries and for the deconsolidation of subsidiaries. This amendment also clarifies that a non-controlling inter- est in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This amend- ment is effective for fiscal years beginning after December 15, 2008 and is not expected to have a mate- rial effect on our consolidated financial statements to the extent that we do not obtain any minority interests in subsidiaries subsequent to adoption. In June 2008, the FASB amended certain provi- sions of ASU Topic 260, Earnings per Share (previ- ously reported as FASB Staff Position “FSP” Emerging Issues Task Force “EITF” No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Pay- ment Transactions are Participating Securities”). This amendment requires that unvested share-based pay- ment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. This amendment is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years, and requires that all prior period earnings per share data presented (including interim financial statements, summaries of earnings and selected financial data) be adjusted retrospec- tively to conform to its provisions. We are currently evaluating the impact, if any, that the adoption of this amendment will have on our consolidated financial statements. In December 2008, the FASB amended certain provisions of ASU Topic 715, Compensation—Retire- ment Benefits (previously reported as FSP No. FAS 132(R)-1, “Employers’ Disclosures about Postretire- ment Benefit Plan Assets”). This amendment requires objective disclosures about postretirement benefit plan assets including investment policies and strate- gies, categories of plan assets, fair value measure- ments of plan assets and significant concentrations of risk. This amendment is effective, on a prospective basis, for fiscal years ending after December 15, 2009. We are currently evaluating the impact, if any, that the adoption of this amendment will have on our con- solidated financial statements. INSTEEL INDUSTRIES, INC. // 2009 annual report 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 (loss) Percentage of net sales Selling, general and administrative expense Percentage of net sales Other expense (income), net Interest expense Interest income Effective income tax rate Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) “N/M” = not meaningful October 3, 2009 $230,236 (15,093) (6.6%) Change (34.9%) (117.4%) Year Ended September 27, 2008 $353,862 86,755 24.5% Change 18.8% 54.8% September 29, 2007 $297,806 56,061 18.8% $ 17,243 (7.4%) $ 18,623 5.9% $ 17,583 7.5% (135) 641 (144) 36.0% $ (20,940) (1,146) (22,086) N/M 7.9% (80.0%) (147.9%) N/M (150.5%) 5.3% 85 594 (721) 35.9% $ 43,717 35 43,752 N/M 0.3% 73.7% 80.0% N/M 81.1% 5.9% 4 592 (415) 36.6% $ 24,284 (122) 24,162 2009 COmPared with 2008 Net Sales Net sales decreased 34.9% to $230.2 million in 2009 from $353.9 million in 2008. Shipments for the year decreased 29.7% while average selling prices declined 7.5% from the prior year levels. The reduc- tion in shipments was primarily due to the general economic downturn, the tightening in credit markets and the surge in low-priced imports of PC strand during 2008, which resulted in customer inventory destocking through most of the year. The decline in average selling prices was driven by the collapse in steel prices that occurred through most of the current year together with weakening demand following the unprecedented escalation in raw material costs and selling prices that occurred during the prior year. Gross Profit (Loss) The gross loss for 2009 was $15.1 million, or 6.6% of net sales compared to gross profit of $86.8 million, or 24.5% of net sales in 2008. The gross loss for the year reflects a pre-tax charge of $25.9 million for inventory write-downs to reduce the carrying value of inventory to the lower of cost or market resulting from the decline in selling prices for certain products during the year relative to higher raw mate- rial costs under the first-in, first-out (“FIFO”) method of accounting. The gross loss for the current year also reflects the unfavorable impact of the reductions in shipments and selling prices, the consumption of higher cost inventory that was purchased prior to the recent collapse in steel prices and the escalation in unit conversion costs resulting from reduced operat- ing schedules at our manufacturing facilities. Selling, General and Administrative Expense Selling, general and administrative expense (“SG&A expense”) decreased 7.4% to $17.2 million, or 7.5% of net sales in 2009 from $18.6 million, or 5.3% of net sales in 2008 primarily due to reductions in employee incentive plan expense ($2.6 million), supplemental employee retirement plan expense ($246,000), travel expense ($201,000) and bad debt expense ($139,000). The reduction in employee incen- tive plan expense was related to the decline in our financial performance during the current year. The reduction in travel expense was primarily due to the implementation of various cost reduction meas- ures. These reductions were partially offset by the net gain on a life insurance settlement in the prior year ($661,000), and increases in stock-based compen- sation expense ($375,000), legal expense ($257,000), employee benefit costs ($231,000) and consulting expense ($138,000). The increase in legal expense was primarily associated with the trade cases that have been filed regarding imports of PC strand from China. The increase in employee benefit expense was largely due to higher employee medical costs. Interest Expense Interest expense for 2009 increased $47,000, or 7.9% to $641,000 from $594,000 in 2008 primarily due to higher average outstanding balances on the revolv- ing credit facility in the current year. 16 Interest Income Gross Profit Interest income for 2009 decreased $577,000, or 80.0%, to $144,000 from $721,000 in 2008 primarily due to lower rates of return on cash investments in the current year. Income Taxes Our effective income tax rate for 2009 was rela- tively flat at 36.0% compared with 35.9% in 2008. Earnings (Loss) From Continuing Operations The loss from continuing operations for 2009 was $20.9 million ($1.20 per share) compared with earn- ings from continuing operations of $43.7 million ($2.47 per diluted share) in 2008 due to the decreases in net sales and gross profit. Earnings (Loss) From Discontinued Operations The loss from discontinued operations for 2009 was $1.1 million ($0.07 per share) compared with earnings of $35,000 in 2008, which had no effect on earnings per share. The current year loss is pri- marily due to a pre-tax impairment charge of $1.8 million ($1.1 million or $0.06 per share after-tax) to write down the carrying value of the real estate held for sale associated with the industrial wire business, which we exited in 2006. The earnings in 2008 resulted from escrow payments we received that were forfeited by a prospective buyer of the industrial wire facility. Net Earnings (Loss) The net loss for 2009 was $22.1 million ($1.27 per share) compared to net earnings of $43.8 million ($2.47 per diluted share) in 2008 primarily due to the decreases in net sales and gross profit. 2008 COmPared with 2007 Net Sales Net sales increased 18.8% to $353.9 million in 2008 from $297.8 million in 2007. Average selling prices for the year increased 28.7% while shipments decreased 7.7% from the prior year levels. The increase in average selling prices was driven by price increases that were implemented during the year to recover the unprecedented escalation in our raw material costs. The reduction in shipments was pri- marily due to the continuation of weak demand from customers that have been negatively impacted by the downturn in residential construction activity. Gross profit increased 54.8% to $86.8 million, or 24.5% of net sales in 2008 from $56.1 million, or 18.8% of net sales in 2007 primarily due to higher spreads between average selling prices and raw material costs, which more than offset lower shipments and higher unit conversion costs. The widening in spreads during the current year was primarily driven by the price increases that were implemented together with the consumption of lower cost inventory under the first-in, first-out (“FIFO”) method of accounting. Selling, General and Administrative Expense Selling, general and administrative expense (“SG&A expense”) increased 5.9% to $18.6 million, or 5.3% of net sales in 2008 from $17.6 million, or 5.9% of net sales in 2007 primarily due to increases in employee benefit costs ($812,000), bad debt expense ($630,000), compensation expense ($370,000) and supplemental employee retirement plan expense ($291,000), which were partially offset by the net gain on life insurance settlements ($661,000) and decreases in consulting expense ($204,000), travel expense ($167,000) and legal fees ($79,000). Interest Expense Interest expense for 2008 was relatively flat at $594,000 compared to $592,000 in 2007, primarily con- sisting of non-cash amortization expense associated with capitalized financing costs. Interest Income Interest income for 2008 increased $306,000, or 73.7%, to $721,000 from $415,000 in 2007 primarily due to higher average cash balances. Income Taxes Our effective income tax rate decreased to 35.9% in 2008 from 36.6% in 2007 due to an increase in per- manent differences resulting from higher tax credits attributable to domestic production activities and nontaxable proceeds associated with life insurance settlements. Earnings From Continuing Operations Earnings from continuing operations for 2008 increased to $43.7 million ($2.47 per diluted share) compared to $24.3 million ($1.33 per diluted share) in 2007 primarily due to the increases in sales and gross profit which more than offset the increase in SG&A expense. INSTEEL INDUSTRIES, INC. // 2009 annual report 17 ManageMent’s Discussion anD analysis of financial conDition anD Results of opeRations (continued) Earnings (Loss) From Discontinued Operations Earnings from discontinued operations for 2008 were $35,000, which had no effect on earnings per share, compared with a loss of $122,000 ($0.01 per share) in 2007. The earnings in 2008 resulted from escrow payments we received that were forfeited by a prospective buyer of our Fredericksburg, Virginia manufacturing facility, which we had closed in 2006 in connection with our exit from the indus- trial wire business. Net Earnings Net earnings for 2008 increased to $43.8 million ($2.47 per diluted share) compared to $24.2 million ($1.32 per diluted share) in 2007 primarily due to the increases in sales and gross profit which more than offset the increase in SG&A expense. liquidity and CaPital resOurCes Selected Financial Data (Dollars in thousands) Year Ended October 3, 2009 September 27, 2008 September 29, 2007 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 $ 22,092 (2,166) (11,347) $ 36,808 (8,249) (10,710) $ 17,065 (17,062) (1,842) Net cash provided by (used for) operating 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) 30 (59) (147) 82,252 — — $147,070 97,566 — — $169,847 70,697 — — $143,850 100% 100% 100% $147,070 $169,847 $143,850 Cash flOw analysis Operating activities of continuing operations provided $22.1 million of cash during 2009 compared to $36.8 million in 2008 and $17.1 million in 2007. The year-over-year change in 2009 was primarily due to the loss that was incurred in the current year, which was partially offset by the cash provided by the net working capital components of accounts receiv- able, inventories, and accounts payable and accrued expenses. The current year loss reflects a pre-tax charge of $25.9 million for inventory write-downs. Net working capital provided $20.3 million of cash in the current year largely due to the $28.3 million decrease in accounts receivable resulting from the reductions in shipments and selling prices, and the $6.7 million decrease in inventories (excluding the impact of the inventory write-downs) resulting from our inventory reduction initiatives. These decreases were partially offset by the $14.8 million decrease in accounts payable and accrued expenses that was pri- marily due to the payment of $10.9 million of accrued income taxes payable and lower raw material pur- chases. In addition to these changes in working capi- tal, the $14.2 million of other changes in assets and liabilities in the current year includes $13.0 million of estimated income taxes receivable that were recorded in prepaid expenses and other resulting from the current year loss. Net working capital used $20.2 mil- lion and $14.6 million in 2008 and 2007, respectively. The cash used by working capital in 2008 was due to the $23.8 million increase in inventories and the $15.1 million increase in accounts receivable resulting from the escalation in raw material costs and selling prices, which were partially offset by an $18.7 million increase in accounts payable and accrued expenses largely related to higher raw material purchases. The cash used by working capital in 2007 was primarily due to the $17.0 million decrease in accounts payable and accrued expenses resulting from the sharp reduc- tion in raw material purchases together with changes in the mix of vendor payments. Additionally, depre- ciation and amortization expense increased $1.6 mil- lion from 2007 to 2008 as a result of the elevated level 18 of capital expenditures and related asset additions. As the impact and duration of the current economic slowdown become clearer, we may make additional adjustments in our operating activities, which could materially impact our cash requirements. While an economic slowdown adversely affects sales to our customers, it generally reduces our working capital requirements. Investing activities used $2.2 million of cash dur- ing 2009 compared to $8.2 million during 2008 and $17.1 million in 2007. Capital expenditures amounted to $2.4 million, $9.5 million and $17.0 million in 2009, 2008 and 2007, respectively, with the higher levels in the prior years primarily related to the expansion and upgrading of our manufacturing facilities. Capital expenditures are expected to total less than $5.0 mil- lion for fiscal 2010. Current year investing activities also include $413,000 of proceeds from the surrender of life insurance policies compared to $170,000 in the prior year and a $215,000 increase in the cash surren- der value of life insurance policies resulting from the increase in the value of the underlying investments compared to $190,000 in 2008 and $639,000 in 2007. Investing activities in 2008 also include $1.1 million of proceeds from claims on life insurance policies. Investing activities are largely discretionary and future outlays could be reduced significantly or elim- inated should economic conditions warrant. Financing activities used $11.3 million of cash during 2009 compared to $10.7 million and $1.8 million during 2008 and 2007, respectively. During the current year, $11.4 million of cash dividends were paid compared to $2.1 million and $2.2 million dur- ing 2008 and 2007, respectively. Additionally, $8.7 million of shares were repurchased during 2008. Credit faCility We have a $100.0 million revolving credit facility in place, which matures in June 2010 and supplements our operating cash flow in funding our working capital, capital expenditure and general corporate requirements. No borrowings were outstanding on the credit facility as of October 3, 2009 and September 27, 2008 and outstanding letters of credit totaled $1.1 million and $1.2 million, respectively. As of October 3, 2009, $38.7 million of borrowing capacity was avail- able on the credit facility (see Note 5 to the consoli- dated financial statements). During the year ended October 3, 2009, ordinary course borrowings on our revolving credit facility were as high as $10.0 million. We believe that, in the absence of significant unanticipated cash demands, cash and cash equiva- lents, and net cash generated by operating activities will be sufficient to satisfy our expected requirements for working capital, capital expenditures, dividends and share repurchases, if any. We can also access the amounts available under our revolving credit facility, which we expect to either extend or replace prior to the June 2010 maturity date. In the event that we elected not to extend or replace the existing revolving credit facility or if we were unable to do so, we believe that cash and cash equivalents, and net cash gen- erated by operating activities will be sufficient to meet our expected funding requirements. However, further deterioration in general economic conditions could result in additional reductions in demand from our customers, which would likely reduce our oper ating cash flows. Under such circumstances, we may need to curtail capital and operating expen- ditures, delay or restrict share repurchases, cease dividend payments and/or realign our working capi- tal requirements. Should we determine, at any time, that we require additional short-term liquidity, we would evaluate the alternative sources of financing that are potentially available to provide such funding. There can be no assurance that any such financing, if pursued, would be obtained, or if obtained, would be adequate or on terms acceptable to us. However, we believe that our strong balance sheet and capital structure as of October 3, 2009 positions us to meet our anticipated liquidity requirements for the fore- seeable future. Our liquidity position is further supported by the borrowing capacity available to us under our existing credit facility. imPaCt Of inflatiOn We are subject to inflationary risks arising from fluctuations in the market prices for our primary raw material, hot-rolled steel wire rod, and, to a much lesser extent, freight, energy and other consumables that are used in our manufacturing processes. We have generally been able to adjust our selling prices to pass through increases in these costs or offset them through various cost reduction and productivity improvement initiatives. However, our ability to raise INSTEEL INDUSTRIES, INC. // 2009 annual report 19 ManageMent’s Discussion anD analysis of financial conDition anD Results of opeRations (continued) our selling prices depends on market conditions and competitive dynamics, and there may be periods dur- ing which we are unable to fully recover increases in our costs. During 2009, selling prices for our prod- ucts declined dramatically in response to softening demand and the inventory destocking measures pur- sued by our customers, which negatively impacted our financial results as we consumed higher cost inventory that was purchased prior to the collapse in steel prices. In contrast, during 2008, we implemented price increases in response to the unprecedented escalation in wire rod costs, which materially increased our net sales and earnings as we consumed lower cost inventory. During 2007, inflation did not have a material impact on our sales or earnings. 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, liquidity, capital expenditures, capital resources or significant components of revenues or expenses. COntraCtual OBligatiOns Our contractual obligations and commitments at October 3, 2009 are as follows: (In thousands) Contractual obligations: Raw material purchase commitments(1) Supplemental employee retirement plan obligations Pension benefit obligations Operating leases Trade letters of credit Other unconditional purchase obligations(2) Commitment fee on unused portion of credit facility Total (1) Non-cancelable fixed price purchase commitments for raw materials. (2) Contractual commitments for capital expenditures. Payments Due by Period Total Less Than 1 Year 1–3 Years 3–5 Years More Than 5 Years $28,389 19,260 7,391 1,595 1,118 298 197 $28,389 155 399 615 1,118 298 197 $ — $ — 487 469 69 — — — 487 494 508 — — — $ — 18,131 6,029 403 — — — $58,248 $31,171 $ 1,489 $ 1,025 $24,563 OutlOOk Our visibility for business conditions in 2010 is clouded by the continued uncertainty regarding future global economic conditions, the availability of financing in the credit markets and the timing and magnitude of the impact of the federal infrastructure- related funding provided for under the American Recovery and Reinvestment Act (“ARRA”) as well as the next federal highway funding authorization. Although we expect nonresidential construction, our primary demand driver, to decrease from the levels of recent years, particularly for commercial projects which have been the most severely impacted by the economic downturn, the additional infrastructure funding provided for under ARRA should serve to at least partially mitigate this decline. We anticipate that residential construction will remain weak, but gradually improve over the course of the year, favor- ably impacting shipments to customers that have greater exposure to the housing sector. Following an extended downward trend that began in September 2008, prices for our primary raw material, hot-rolled steel wire rod, appear to have leveled out in recent months, although their future direction remains highly uncertain. The recent closures of two U.S. rod mills that represented over 20% of total domestic capacity has the potential to drive prices higher, although the impact is likely to be minimized to the extent that demand for wire rod remains at depressed levels. 20 In response to the challenges facing us, we will continue to focus on the operational fundamentals of our business: closely managing and controlling our expenses; aligning our production schedules with demand in a proactive manner as there are changes in market conditions to minimize our cash operating costs; and pursuing further improvements in the productivity and effectiveness of all of our manufac- turing, selling and administrative activities. We also expect gradually increasing contributions from the substantial investments we have made in our facili- ties in recent years in the form of reduced operating costs and additional capacity to support future growth when market conditions improve (see “Forward-Looking Statements”). In addition to these organic growth and cost reduction initiatives, we are continually evaluating potential acquisitions in our existing businesses that further our penetra- tion in current markets served or expand our geo- graphic reach. quantitative and qualitative disClOsures aBOut market risk Our cash flows and earnings are subject to fluctuations resulting from changes in commodity prices, interest rates and foreign exchange rates. We manage our exposure to these market risks through internally established policies and procedures and, when deemed appropriate, through the use of deriva- tive financial instruments. We do not use financial instruments for trading purposes and we are not a party to any leveraged derivatives. We monitor our underlying market risk exposures on an ongoing basis and believe that we can modify or adapt our hedging strategies as necessary. Commodity Prices We are subject to significant fluctuations in the cost and availability of our primary raw material, hot- rolled carbon steel wire rod, which we purchase from both domestic and foreign suppliers. We negotiate quantities and pricing for both domestic and foreign steel wire rod purchases for varying periods (most recently monthly for domestic suppliers), depending upon market conditions, to manage our exposure to price fluctuations and to ensure adequate availability of material consistent with our requirements. We do not use derivative commodity instruments to hedge our exposure to changes in prices as such instru- ments are not currently available for steel wire rod. Our ability to acquire steel wire rod from foreign sources on favorable terms is impacted by fluctua- tions 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, depend- ing upon market conditions and competitive dynam- ics, there may be periods during which we are unable to fully recover increased rod costs through higher selling prices, which would reduce our gross profit and cash flow from operations. Additionally, should wire rod costs decline, our financial results may be negatively impacted if the selling prices for our prod- ucts decrease to an even greater degree and to the extent that we are consuming higher cost material from inventory. Based on our 2009 shipments and average rod cost reflected in cost of sales, a 10% increase in the price of steel wire rod would have resulted in a $19.1 million decrease in our annual pre- tax earnings (assuming there was not a correspond- ing change in our selling prices). Interest Rates Although we were debt-free as of October 3, 2009, 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 currencies other than U.S. dollars and any such trans- actions historically have not been material. We will occasionally hedge firm commitments for equipment purchases that are denominated in foreign curren- cies. 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 October 3, 2009. During fiscal 2009, a 10% increase or decrease in the value of the U.S. dollar relative to foreign curren- cies to which we are typically exposed would not have had a material impact on our financial position, results of operations or cash flows. INSTEEL INDUSTRIES, INC. // 2009 annual report 21 ManageMent’s RepoRt on inteRnal contRol oVeR financial RepoRting Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process to provide reasonable assur- ance regarding the reliability of our financial report- ing for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes: (1) main- taining records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets; (2) providing reasonable assurance that trans- actions are recorded as necessary for preparation of financial statements, and that receipts and expendi- tures are made in accordance with authorizations of management and directors; and (3) providing reason- able assurance that unauthorized acquisition, use or disposition of assets that could have a material effect on financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of financial statements would be pre- vented or detected. Also, projections of any evalua- tion 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 our internal control over financial reporting based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework. Based on this assessment, management concluded that our internal control over financial reporting was effective as of October 3, 2009. Our independent registered public accounting firm has issued an audit report on the effectiveness of our internal control over financial reporting as of October 3, 2009 which is on page 24. 22 RepoRt of inDepenDent RegisteReD puBlic accounting fiRM consoliDateD financial stateMents To the Board of Directors and Shareholders Insteel Industries, Inc.: We have audited the accompanying consolidated balance sheets of Insteel Industries, Inc. and subsid- iaries (a North Carolina corporation) as of October 3, 2009 and September 27, 2008, and the related consoli- dated statements of operations, shareholders’ equity and comprehensive income (loss) and cash flows for each of the three years in the period ended October 3, 2009. 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 prin- ciples 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 subsidiaries as of October 3, 2009 and September 27, 2008, and the results of their operations and their cash flows for each of the three years in the period ended October 3, 2009 in conformity with accounting principles generally accepted in the United States. As discussed in Note 2 to the financial state- ments, the Company adopted certain provisions of ASC Topic 740, “Income Taxes” (previously reported as Financial Accounting Standards Board Interpre- tation No. 48, “Accounting for Uncertainty in Income Taxes”) at the beginning of 2008. In addition, as dis- cussed in Note 9, the Company adopted certain provi- sions of ASC Topic 715, Compensation—Retirement Benefits (previously reported as Financial Accounting Standards Board Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”) on September 29, 2007. We also have audited, in accordance with the standards of the Public Company Accounting Over- sight Board (United States), Insteel Industries, Inc. and subsidiaries’ internal control over financial report ing as of October 3, 2009, based on criteria established in Internal Control—Integrated Frame work issued by the Committee of Sponsoring Organiza- tions of the Treadway Commission (COSO) and our report dated November 9, 2009 expressed an unquali- fied opinion. Greensboro, North Carolina November 9, 2009 INSTEEL INDUSTRIES, INC. // 2009 annual report 23 RepoRt of inDepenDent RegisteReD puBlic accounting fiRM inteRnal contRol oVeR financial RepoRting To the Board of Directors and Shareholders Insteel Industries, Inc.: We have audited Insteel Industries, Inc. and sub- sidiaries’ (a North Carolina corporation) internal con- trol over financial reporting as of October 3, 2009, based on criteria established in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Com- mission (COSO). Insteel Industries, Inc. and subsid- iaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on Insteel Industries, Inc. and sub- sidiaries’ 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 con- trol over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operat- ing 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 poli- cies and procedures that (1) pertain to the mainte- nance 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 preparation of financial statements in accordance with generally accepted accounting prin- ciples, 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 unau- thorized acquisition, use, or disposition of the com- pany’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- sidiaries maintained, in all material respects, effective internal control over financial reporting as of October 3, 2009, based on criteria established in Internal Control—Integrated Framework issued by 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 subsidiaries as of October 3, 2009 and September 27, 2008 and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss) and cash flows for each of the three years in the period ended October 3, 2009, and our report dated Novem ber 9, 2009, expressed an unqualified opinion on those financial statements and contains an explanatory paragraph relating to the adoption of cer- tain provisions of ASC Topic 740, “Income Taxes” (previously reported as Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”) at the beginning of 2008. In addition, as discussed in Note 9, the Company adopted certain provisions of ASC Topic 715, “Compensation—Retirement Benefits” (previously reported as Financial Account ing Standards Board Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”) on September 29, 2007. Greensboro, North Carolina November 9, 2009 24 consoliDateD stateMents of opeRations (In thousands, except for per share amounts) Net sales Cost of sales Inventory write-downs Gross profit (loss) Selling, general and administrative expense Other expense (income), net Interest expense Interest income Earnings (loss) from continuing operations before income taxes Income taxes Earnings (loss) from continuing operations Earnings (loss) from discontinued operations net of of income taxes of ($729), $23 and ($77) Net earnings (loss) Per share amounts: Basic: Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) Diluted: Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) Cash dividends declared Weighted shares outstanding: Basic Diluted See accompanying notes to consolidated financial statements. Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $230,236 219,388 25,941 $353,862 267,107 — $297,806 241,745 — (15,093) 17,243 (135) 641 (144) (32,698) (11,758) (20,940) 86,755 18,623 85 594 (721) 68,174 24,457 43,717 56,061 17,583 4 592 (415) 38,297 14,013 24,284 (1,146) 35 (122) $ (22,086) $ 43,752 $ 24,162 $ (1.20) (0.07) $ 2.49 — $ (1.27) $ 2.49 $ (1.20) (0.07) $ 2.47 — $ (1.27) $ 2.47 $ 0.12 $ 0.62 $ 1.34 (0.01) $ 1.33 $ 1.33 (0.01) $ 1.32 $ 0.12 17,380 17,380 17,547 17,712 18,142 18,314 INSTEEL INDUSTRIES, INC. // 2009 annual report 25 consoliDateD Balance sHeets (In thousands, except for per share amounts) Assets: Current assets: Cash and cash equivalents Accounts receivable, net Inventories Prepaid expenses and other 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: 20,000 Issued and outstanding shares: 2009, 17,525; 2008, 17,507 Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total shareholders’ equity October 3, 2009 September 27, 2008 $ 35,102 21,283 38,542 16,724 111,651 64,204 4,382 1,880 $ 26,493 49,581 71,220 3,122 150,416 69,105 5,064 3,635 $182,117 $228,220 $ 23,965 5,215 219 29,399 5,465 183 $ 23,581 29,081 188 52,850 5,306 217 — — 17,525 43,774 88,291 (2,520) 147,070 17,507 41,746 112,479 (1,885) 169,847 Total liabilities and shareholders’ equity $182,117 $228,220 See accompanying notes to consolidated financial statements. 26 consoliDateD stateMents of sHaReHolDeRs’ eQuity anD coMpReHensiVe incoMe (loss) (In thousands) Common Stock Shares Amount Additional Paid-In Capital Retained Earnings Accumulated Other Comprehensive Income (Loss)(1) Total Shareholders’ Equity Balance at September 30, 2006 18,213 $18,213 $46,343 $ 57,882 $ — $122,438 Comprehensive income: Net earnings Recognition of additional pension plan liability(1) Adjustment to adopt certain provisions of ASC Topic 715 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 stock-based compensation Cash dividends declared 24,162 (9) (2,110) 23 67 23 67 139 (67) 12 1,258 122 (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 $47,807 $ 79,859 $(2,119) $143,850 Comprehensive income: Net earnings Adjustment to defined benefit plan liability(1) Comprehensive income(1) Stock options exercised Restricted stock granted Compensation expense associated with stock-based plans Adjustment to adopt certain provisions of ASC Topic 740 Excess tax benefits from stock-based compensation Repurchases of common stock Restricted stock surrendered for withholding taxes payable Cash dividends declared 43,752 234 24 93 24 93 (906) (906) 96 (93) 1,759 31 (7,785) (7) (7) (69) (256) (10,876) 43,752 234 43,986 120 — 1,759 (256) 31 (8,691) (76) (10,876) Balance at September 27, 2008 17,507 $17,507 $41,746 $112,479 $(1,885) $169,847 Comprehensive loss: Net loss Adjustment to defined benefit plan liability(1) Comprehensive loss(1) Stock options exercised Compensation expense associated with stock-based plans Excess tax deficiencies from stock-based compensation Restricted stock surrendered for withholding taxes payable Cash dividends declared Balance at October 3, 2009 (22,086) (635) 20 20 46 2,036 (32) (22) (2,102) (2) (2) (22,086) (635) (22,721) 66 2,036 (32) (24) (2,102) 17,525 $17,525 $43,774 $ 88,291 $(2,520) $147,070 (1) Activity within accumulated other comprehensive income (loss) is reported net of related income taxes: 2007–$1,299, 2008–($143), 2009–$389. See accompanying notes to consolidated financial statements. INSTEEL INDUSTRIES, INC. // 2009 annual report 27 consoliDateD stateMents of casH floWs (In thousands) Cash Flows From Operating Activities: Net earnings (loss) Loss (earnings) from discontinued operations Earnings (loss) from continuing operations Adjustments to reconcile earnings (loss) from continuing operations to net cash provided by operating activities of continuing operations: Depreciation and amortization Amortization of capitalized financing costs Stock-based compensation expense Excess tax deficiencies (benefits) from stock-based compensation Inventory write-downs Loss on sale of property, plant and equipment Deferred income taxes Gain from life insurance proceeds 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 Proceeds from surrender of life insurance policies Increase in cash surrender value of life insurance policies Proceeds from life insurance claims Net cash used for investing activities— continuing operations Net cash used for investing activities Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $(22,086) 1,146 (20,940) $ 43,752 (35) 43,717 $ 24,162 122 24,284 7,377 508 2,036 32 25,941 24 997 — — 28,298 6,737 (14,761) (14,157) 43,032 7,271 498 1,759 (31) — 289 484 (661) — (15,063) (23,819) 18,699 3,665 (6,909) 5,711 498 1,258 (122) — 301 2,003 — (277) 3,001 (604) (17,019) (1,969) (7,219) 22,092 36,808 17,065 30 22,122 (2,377) — 13 413 (215) — (2,166) (2,166) (59) 36,749 (9,456) — 116 170 (190) 1,111 (8,249) (8,249) (147) 16,918 (17,013) 590 — — (639) — (17,062) (17,062) (continued) 28 (In thousands) Cash Flows From Financing Activities: Proceeds from long-term debt Principal payments on long-term debt Cash received from exercise of stock options Excess tax benefits (deficiencies) from stock-based compensation Repurchases of common stock Cash dividends paid Other Net cash used for financing activities— continuing operations Net cash used for financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Year Ended October 3, 2009 September 27, 2008 September 29, 2007 22,920 (22,920) 66 (32) — (11,381) — (11,347) (11,347) 8,609 26,493 951 (951) 120 31 (8,691) (2,141) (29) (10,710) (10,710) 17,790 8,703 16,999 (16,999) 162 122 — (2,176) 50 (1,842) (1,842) (1,986) 10,689 Cash and cash equivalents at end of period $ 35,102 $ 26,493 $ 8,703 Supplemental Disclosures of Cash Flow Information: Cash paid during the period for: Interest Income taxes Non-cash financing activity: $ 133 11,454 $ 95 11,563 $ 93 16,785 Purchases of property, plant and equipment in accounts payable Issuance of restricted stock Declaration of cash dividends to be paid Restricted stock surrendered for withholding taxes payable 136 — — 24 178 1,185 9,279 76 937 1,215 544 — See accompanying notes to consolidated financial statements. INSTEEL INDUSTRIES, INC. // 2009 annual report 29 notes to consoliDateD financial stateMents Years Ended October 3, 2009, September 27, 2008 and September 29, 2007 (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 two wholly-owned subsidiaries, Insteel Wire Products Company (“IWP”) and Intercontinental Metals Corporation. The Company manufactures and markets PC strand and welded wire reinforcement products, including concrete pipe reinforcement, engineered structural mesh and standard welded wire reinforcement. The Company’s products are pri- marily sold to manufacturers of concrete products and to a lesser extent to distributors and rebar fabri- cators that are located nationwide as well as in Canada, Mexico, and Central and South America. In 2006, the Company exited the industrial wire business in order to narrow its strategic and opera- tional focus to concrete reinforcing products (see Note 8 to the consolidated financial statements). The results of operations for the industrial wire business have been reported as discontinued operations for all periods presented. The Company has evaluated all subsequent events that occurred after the balance sheet date through November 9, 2009, the date its financial state- ments were issued, and concluded there were no events or transactions occurring during this period that required recognition or disclosure in its financial statements. (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 year 2009 was a 53-week fiscal year, and fiscal years 2008 and 2007 were 52-week fiscal years. All references to years relate to fiscal years rather than calendar years. Principles of consolidation. The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated. Use of estimates. The preparation of financial state- ments in conformity with accounting principles generally accepted in the United States 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 maturi- ties of three months or less to be cash equivalents. Concentration of credit risk. Financial instruments that subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. The Company is exposed to credit risk in the event of default by these institutions and customers to the extent of the amounts recorded on the balance sheet. The Company invests excess cash primarily in money market funds, which are highly liquid securities. The Company’s cash is con- centrated primarily at one financial institution, which at times exceeds federally insured limits. The majority of the Company’s accounts receiv- able are due from customers that are located in the United States and the Company generally requires no collateral depending upon the creditworthiness of the account. The Company utilizes credit insurance on certain accounts receivable due from customers located outside of the United States. The Company provides an allowance for doubtful accounts based upon its assessment of the credit risk of specific cus- tomers, 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. Stock-based compensation. The Company accounts for stock-based compensation in accordance with the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718, Compensation— Stock Compensation, which requires stock-based compensation expense to be recognized in net earn- ings based on the fair value of the award on the date of the grant. The Company determines the fair value of stock options issued by using a Monte Carlo valuation model at the grant date. The Monte Carlo valuation model considers a range of assumptions including the expected term, volatility, dividend yield and risk-free interest rate. Excess tax deficiencies (benefits) generated from option exercises during 2009, 2008 and 2007 were $32,000, ($31,000) and ($122,000), respectively. 30 Revenue recognition. The Company recognizes revenue from product sales in accordance with FASB ASC Topic 605, Revenue Recognition, when the products are shipped and risk of loss and title has passed to the customer. Sales taxes collected from customers are recorded on a net basis and as such, are excluded from revenue. Shipping and handling costs. The Company includes all of the outbound freight, shipping and handling costs associated with the shipment of products to cus- tomers in cost of sales. Any amounts paid by custom- ers 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 weighted average cost (which approximates computa- tion on a first-in, first-out basis) or market (net realiz- able value or replacement cost). Property, plant and equipment. Property, plant and equip- ment are recorded at cost or otherwise at reduced values to the extent there have been asset impair- ment 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 pur- poses 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 $7.4 million in 2009, $7.3 million in 2008 and $5.7 million in 2007 and reflected in cost of sales and selling, general and administrative expense (“SG&A expense”) in the consolidated statement of operations. Capitalized software is amortized over the shorter of the estimated useful life or 5 years and reflected in SG&A expense in the consolidated state- ment of operations. No interest costs were capitalized in 2009, 2008 or 2007. Other assets. Other assets consist principally of non- current deferred tax assets, capitalized financing costs, the cash surrender value of life insurance poli- cies 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, and reflected in interest expense in the consolidated state- ment of operations. Long-lived assets. Long-lived assets include property, plant and equipment and identifiable intangible assets with definite useful lives. The Company assesses the impairment of long-lived assets when- ever 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 impair- ment loss has occurred, the loss is recognized during the period incurred and is calculated as the differ- ence between the carrying value and the present value of estimated future net cash flows or compara- ble market values. The Company recorded a pre-tax impairment loss of $1.8 million during 2009 for the write-down to fair value of an idle manufacturing facility currently classified as held for sale. The impairment loss is included within the results of dis- continued operations (see Note 8 to the consolidated financial statements). There were no impairment losses in 2008 or 2007. Fair value of financial instruments. The carrying amounts for cash and cash equivalents, accounts receivable, and accounts payable and accrued expenses approxi- mate fair value because of their short maturities. Income taxes. Income taxes are based on pretax finan- cial 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 valuation allowance against its deferred tax assets to the extent the Company no longer believes it is more likely than not that the tax assets will be fully utilized. The Company adopted certain provisions of FASB ASC Topic 740, Income Taxes (formerly reported as FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” “FIN No. 48”) effective September 30, 2007, the beginning of fiscal year 2008. The cumulative effect of adopting these provisions resulted in a $256,000 increase in tax reserves and a corresponding decrease in the Company’s retained earnings balance as of September 30, 2007. Earnings per share. Basic earnings per share (“EPS”) are computed by dividing net earnings by the weighted average number of common shares outstanding INSTEEL INDUSTRIES, INC. // 2009 annual report 31 notes to consoliDateD financial stateMents (continued) Years Ended October 3, 2009, September 27, 2008 and September 29, 2007 during the period. Diluted EPS are computed by dividing net earnings by the weighted average num- ber of common shares and other dilutive equity secu- rities outstanding during the period. Securities that have the effect of increasing EPS are considered to be antidilutive and are not included in the computation of diluted EPS. (3) reCent aCCOunting PrOnOunCements Current Adoptions In June 2009, FASB issued Accounting Standards Update (ASU) No. 2009-01, the FASB Accounting Standards Codification™ (“Codification”) and the Hierarchy of Generally Accepted Accounting Prin- ciples (“ASU 2009-01”). This update established the Codification as the source of authoritative accounting principles recognized by the FASB in the preparation of financial statements in conformity with GAAP. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered non- authoritative. As the Codification was not intended to change or alter existing GAAP, the adoption of ASU 2009-01 did not have an impact on the Company’s consolidated financial statements. In August 2009, the FASB issued ASU No. 2009- 05, Measuring Liabilities at Fair Value (“ASU 2009- 05”). This update provides amendments to ASC Topic 820, Fair Value Measurement and Disclosure, for the fair value measurement of liabilities. The purpose of this amendment is to reduce ambiguity in financial reporting when measuring the fair value of liabilities. The adoption of ASU 2009-05 did not have an impact on the Company’s consolidated financial statements. Future Adoptions In December 2007, the FASB amended certain provisions of ASU Topic 805, Business Combinations (previously reported as Statement of Financial Accounting Standards “SFAS” No. 141R, “Business Combinations”). This amendment requires the acquiring entity in a business combination to recog- nize all the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose all of the information required to evaluate and understand the nature and financial effect of the business combination. This amendment is effective for acquisition dates on or after the beginning of the first annual reporting period begin- ning after December 15, 2008 and is not expected to have a material effect on the Company’s consolidated financial statements to the extent that it does not enter into business combinations subsequent to adoption. In December 2007, the FASB amended certain provisions of ASU Topic 810, Consolidation (previ- ously reported as SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements”). This amendment establishes accounting and reporting standards for non-controlling interests in subsidiaries and for the deconsolidation of subsidiaries. This amendment clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consoli- dated entity that should be reported as equity in the consolidated financial statements. This amendment is effective for fiscal years beginning after December 15, 2008 and is not expected to have a material effect on the Company’s consolidated financial statements to the extent that it does not obtain any minority inter- ests in subsidiaries subsequent to adoption. In June 2008, the FASB amended certain provi- sions of ASU Topic 260, Earnings per Share (previ- ously reported as FASB Staff Position “FSP” Emerging Issues Task Force (“EITF”) No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Pay- ment Transactions are Participating Securities”). This amendment requires that unvested share-based pay- ment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. This amendment is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years, and requires that all prior period earnings per share data presented (including interim financial statements, summaries of earnings and selected financial data) be adjusted retrospec- tively to conform to its provisions. The Company is currently evaluating the impact, if any, that the adop- tion of this amendment will have on its consolidated financial statements. In December 2008, the FASB amended certain provisions of ASU Topic 715, Compensation—Retire- ment Benefits (previously reported as FSP No. FAS 132(R)-1, “Employers’ Disclosures about Post- retire ment Benefit Plan Assets”). This amendment requires objective disclosures about postretirement benefit plan assets including investment policies 32 and strategies, categories of plan assets, fair value measurements of plan assets and significant concen- trations of risk. This amendment is effective, on a pro- spective basis, for fiscal years ending after December 15, 2009. The Company is currently evaluating the impact, if any, that the adoption of this amendment will have on its consolidated financial statements. at the measurement date. ASC Topic 820 also estab- lishes a three-level fair value hierarchy that priori- tizes the inputs used to measure fair value. This hierarchy requires that the Company maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: (4) fair value measurements Effective September 28, 2008, the Company adopted ASC Topic 820, Fair Value Measurements and Disclosures, (previously reported as “SFAS No. 157” as amended by “FSP No. 157-2”) for financial assets and liabilities. The Company will adopt the non-financial assets and liabilities provisions in the first quarter of fiscal 2010. ASC Topic 820 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and expands disclosures about fair value measure- ments. The fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants Level 1—Quoted prices in active markets for identical assets or liabilities. Level 2—Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, similar assets and liabilities in markets that are not active or can be corroborated by observable market data. Level 3—Unobservable inputs that are supported by little or no market activity and that are signifi- cant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. As of October 3, 2009, the Company held assets that are required to be measured at fair value on a recurring basis. The financial assets held by the Company and the fair value hierarchy used to determine their fair values are as follows: (In thousands) Current assets: Cash equivalents Other assets: Cash surrender value of life insurance policies Total Quoted Prices in Active Markets (Level 1) Observable Inputs (Level 2) Total $35,391 $35,391 3,739 $39,130 — $35,391 $ — 3,739 $3,739 Cash equivalents, which include all highly liquid investments with original maturities of three months or less, are classified as Level 1 of the fair value hier- archy. The carrying amount of the Company’s cash equivalents, which consist of money market funds, approximates fair value due to the short maturities of these investments. Cash surrender value of life insur- ance policies are classified as Level 2. The value was determined by the underwriting insurance compa- ny’s valuation models and represents the guaranteed value the Company would receive upon surrender of these policies as of October 3, 2009. The carrying amounts of accounts receivable, accounts payable and accrued expenses approximates fair value due to the short-term maturities of these financial instruments. (5) Credit faCility The Company has a $100.0 million revolving credit facility in place, which matures in June 2010 and supplements its operating cash flow in funding its working capital, capital expenditures and general corporate requirements. No borrowings were out- standing on the credit facility as of October 3, 2009 INSTEEL INDUSTRIES, INC. // 2009 annual report 33 notes to consoliDateD financial stateMents (continued) Years Ended October 3, 2009, September 27, 2008 and September 29, 2007 and September 27, 2008 and outstanding letters of credit totaled $1.1 million and $1.2 million, respec- tively. As of October 3, 2009, $38.7 million of borrow- ing capacity was available on the credit facility. Advances under the credit facility are limited to the lesser of the revolving credit commitment or a borrowing base amount that is calculated based upon a percentage of eligible receivables and inventories plus, upon the Company’s request and subject to cer- tain 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 quarterly 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 per- centage indicated for each range upon the occurrence of certain events of default provided for under the credit facility. Based on the Company’s excess avail- ability as of October 3, 2009, the applicable interest rate margins were 0.00% for the base rate and 1.25% for the LIBOR rate on the revolver. The Company’s ability to borrow available amounts under the revolving credit facility will be restricted or eliminated in the event of certain covenant breaches, events of default or if the Com- pany is unable to make certain representations and warranties. Financial Covenants 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 availability 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 October 3, 2009, 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 invest- ments or loans; pay cash dividends or repurchase shares of the Company’s stock subject to certain mini- mum borrowing availability requirements; incur or assume indebtedness; issue securities; enter into cer- tain transactions with affiliates of the Company; or permit liens to encumber the Company’s property and assets. As of October 3, 2009, the Company was in compliance 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 $508,000 in 2009 and $498,000 in 2008 and 2007, respectively. Accumulated amortization of capitalized financing costs was $3.6 million and $3.1 million as of October 3, 2009 and September 27, 2008, respectively. The Company expects the amortization of capitalized financing costs to approximate the following amounts for the next five fiscal years: Fiscal year (In thousands) 2010 2011 2012 2013 2014 $336 — — — — (6) stOCk-Based COmPensatiOn Under the Company’s equity incentive plans, employees and directors may be granted stock options, restricted stock, restricted stock units and performance awards. As of October 3, 2009 there 34 were 739,000 shares available for future grants under the plans. respectively, based on the following weighted- average assumptions: Stock option awards. Under the Company’s equity incentive plans, employees 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. Compensation expense and excess tax ben- efits associated with stock options are as follows: (In thousands) Stock options: Compensation expense Excess tax deficien- cies (benefits) Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $937 32 $898 $ 513 (31) (122) The remaining unrecognized compensation cost related to unvested options at October 3, 2009 was $939,000 which is expected to be recognized over a weighted average period of 1.53 years. The fair value of each option award granted is estimated on the date of grant using a Monte Carlo valuation model. The weighted-average estimated fair values of stock options granted during 2009, 2008 and 2007 were $5.43, $6.00 and $8.69 per share, Year Ended October 3, 2009 September 27, 2008 September 29, 2007 4.92 2.64% 74.53% 4.03 2.65% 66.62% 3.16 4.70% 65.84% Expected term (in years) Risk-free interest rate Expected volatility Expected dividend yield 1.31% 1.01% 0.65% The assumptions utilized in the Monte Carlo val- uation model are evaluated and revised, as necessary, to reflect market conditions 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 dividend as of the option grant date. The expected volatility 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. The following table summarizes stock option activity: (Share amounts in thousands) Outstanding at September 30, 2006 Granted Exercised Forfeited Outstanding at September 29, 2007 Granted Exercised Outstanding at September 27, 2008 Granted Exercised Forfeited Outstanding at October 3, 2009 Vested and anticipated to vest in future at October 3, 2009 Exercisable at October 3, 2009 Options Outstanding 282 79 (23) (2) 336 219 (24) 531 171 (20) (9) 673 657 331 Exercise Price Per Share Range $ 0.18–$20.26 17.11– 20.27 4.56– 15.64 20.26– 20.26 0.18– 20.27 11.15– 16.69 3.19– 9.12 0.18– 20.27 7.55– 11.60 3.28– 3.28 15.64– 20.27 0.18– 20.27 Weighted Average $ 7.37 18.54 7.12 20.26 9.95 12.37 4.96 11.17 9.27 3.28 18.07 10.83 10.81 10.38 Contractual Term— Weighted Average Aggregate Intrinsic Value (in thousands) $ 228 148 120 7.43 years 1,575 7.40 years 5.85 years 1,554 1,114 INSTEEL INDUSTRIES, INC. // 2009 annual report 35 notes to consoliDateD financial stateMents (continued) Years Ended October 3, 2009, September 27, 2008 and September 29, 2007 Restricted stock units. On January 21, 2009, the Executive Compensation Committee of the Board of Directors approved a change in the equity compensation pro- gram such that awards of restricted stock units (“RSUs”) to employees and directors would be made in lieu of awards of restricted stock. RSUs granted under these plans are valued based upon the fair market value on the date of the grant and provide for a dividend equivalent payment which is included in compensation expense. The vesting period for RSUs is generally one to three years from the date of the grant. RSUs do not have voting rights. RSU grants and amortization expense are as follows: (In thousands) Restricted stock unit grants: Units Market value Amortization expense Year Ended October 3, 2009 September 27, 2008 September 29, 2007 136 $1,185 343 — $— — — $— — The remaining unrecognized compensation cost related to unvested RSUs on October 3, 2009 was $801,000 which is expected to be recognized over a weighted average period of 2.13 years. The following table summarizes RSU activity: (Unit amounts in thousands) Balance, September 30, 2006 Granted Released Balance, September 29, 2007 Granted Released Balance, September 27, 2008 Granted Released Balance, October 3, 2009 Restricted Stock Units Outstanding Weighted Average Grant Date Fair Value — — — — — — — 136 — 136 $ — — — — — — — 8.71 — 8.71 Restricted stock awards. Under the Company’s equity incentive plans, employees and directors may be granted restricted stock awards which are valued based upon the fair market value on the date of the grant. Restricted stock granted under these plans generally vests one to three years from the date of the grant. Restricted stock grants and amortization expense for restricted stock are as follows: (In thousands) Restricted stock grants: Shares Market value Amortization expense Year Ended October 3, 2009 September 27, 2008 September 29, 2007 — $ — 756 93 $1,185 861 67 $1,215 745 The remaining unrecognized compensation cost related to unvested restricted stock awards at October 3, 2009 was $579,000 which is expected to be recog- nized over a weighted average period of 1.42 years. For the years ended October 3, 2009 and Sep- tember 27, 2008, 25,254 and 44,533 shares, respectively, of employee restricted stock awards vested with a fair value of $238,000 and $489,000, respectively. Upon vesting, employees have the option of remitting payment for the minimum tax obligation to the Company or net-share settling such that the Com- pany will withhold shares with a value equivalent to the employees’ minimum tax obligation. During 2009 and 2008, a total of 2,497 and 6,870 shares, respec- tively, were withheld to satisfy employees’ minimum tax obligations. No shares vested during 2007. The following table summarizes restricted stock activity: (Share amounts in thousands) Balance, September 30, 2006 Granted Released Balance, September 29, 2007 Granted Released Balance, September 27, 2008 Granted Released Balance, October 3, 2009 Restricted Stock Awards Outstanding 103 67 (28) 142 93 (70) 165 — (50) 115 Weighted Average Grant Date Fair Value $12.27 18.18 12.51 15.00 12.77 11.68 15.16 — 14.40 15.50 36 (7) 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 Income taxes Effective income tax rate Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $(12,708) (47) (12,755) 1,686 (689) 997 $21,720 2,253 23,973 440 44 484 $10,801 1,209 12,010 1,821 182 2,003 $(11,758) $24,457 $14,013 36.0% 35.9% 36.6% 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) Year Ended October 3, 2009 September 27, 2008 September 29, 2007 Provision for income taxes at federal statutory rate State income taxes, net of federal tax benefit Qualified production activities deduction Stock option expense benefit Revisions to estimates based on filing of final tax return Other, net $(11,444) (479) — 203 33 (71) 35.0% 1.5 — (0.6) (0.1) 0.2 $23,861 1,886 (1,322) 240 293 (501) 35.0% $13,403 904 2.8 (374) (1.9) 126 0.3 (32) 0.4 (14) (0.7) 35.0% 2.4 (1.0) 0.3 (0.1) (0.0) Provision for income taxes $(11,758) 36.0% $24,457 35.9% $14,013 36.6% The components of deferred tax assets and liabil- ities are as follows: (In thousands) Deferred tax assets: October 3, 2009 September 27, 2008 Accrued expenses, asset reserves and state tax credits State net operating loss carryforwards Goodwill, amortizable for tax purposes Defined benefit plans Stock-based compensation Valuation allowance Gross deferred tax assets Deferred tax liabilities: Plant and equipment Other reserves Gross deferred tax liabilities $ 3,048 $ 3,524 1,419 602 1,690 1,545 465 (602) 7,565 (5,161) (361) (5,522) 2,004 1,156 328 (602) 7,012 (4,489) (445) (4,934) Net deferred tax asset $ 2,043 $ 2,078 The Company has recorded the following amounts for deferred taxes on its consolidated balance sheet as of October 3, 2009: a current deferred tax asset (net of valuation allowance) of $1.7 million in prepaid expenses and other, and a non-current deferred tax asset (net of valuation allowance) of $375,000 in other assets. As of September 27, 2008, the Company recorded a current deferred tax asset (net of valuation allowance) of $2.5 million in prepaid expenses and other, and a non-current deferred tax liability (net of valuation allowance) of $435,000 in other liabilities. The Company has $28.4 million of gross state operat- ing loss carryforwards that begin to expire in 2013, but principally expire in 2018–2029. The realization of the Company’s deferred tax assets is entirely dependent upon the Company’s ability to generate future taxable income in appli- cable jurisdictions. GAAP requires that the Company periodically assess the need to establish a valuation allowance against its deferred tax assets to the extent INSTEEL INDUSTRIES, INC. // 2009 annual report 37 notes to consoliDateD financial stateMents (continued) Years Ended October 3, 2009, September 27, 2008 and September 29, 2007 the Company no longer believes it is more likely than not that they will be fully utilized. As of October 3, 2009, the Company had recorded a valuation allow- ance of $602,000 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 car- ryforwards against which an allowance had been provided or determine that such utilization is more likely than not. The Company adopted certain provisions of ASC Topic 740 (previously reported as “FIN No. 48”) effec- tive September 30, 2007. The cumulative effect of adopting these provisions was a $256,000 increase in tax reserves and a corresponding decrease in the Company’s retained earnings balance as of September 30, 2007. As of October 3, 2009, the Company had no unrecognized tax benefits. As of September 27, 2008, the Company had approximately $48,000 of gross unrecognized tax benefits classified as other liabili- ties on its consolidated balance sheet. The reduction in gross unrecognized tax benefits was due to the lapse of the statute of limitations for outstanding tax issues. We do not anticipate any unrecognized bene- fits in the next 12 months that would result in a mate- rial change in our financial position. A reconciliation of the beginning and ending balance of total unrecognized tax benefits for 2009 is as follows: (Dollars in thousands) Balance at September 27, 2008 Increase in tax positions of prior years Reductions for tax positions of prior years Lapse of statute of limitations Balance at October 3, 2009 $ 48 — — (48) $ — The Company classifies interest and penalties as part of income tax expense. The Company did not have any accrued interest and penalties related to unrecognized tax benefits as of October 3, 2009 com- pared to $15,000 as of September 27, 2008. The reduc- tion in accrued interest and penalties is due to the settlement of outstanding tax issues. For the year ended October 3, 2009, the Company recorded $36,000 of expense related to interest and penalties. The Company files U.S. federal income tax returns as well as state and local income tax returns in various jurisdictions. Federal and various state tax returns filed by the Company subsequent to tax year 2004 remain subject to examination together with certain state tax returns filed by the Company subse- quent to tax year 2002. The Company’s 2007 tax year is currently under examination by the U.S. Internal Revenue Service. (8) 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 continuation of difficult market conditions and reduced operating levels. Manufacturing activities at the Virginia facil- ity ceased in June 2006 and the Company is currently in the process of liquidating the remaining assets of the business. The results of operations 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 discontinued operations have been segregated in the accompanying consoli- dated balance sheets. The Company reviews its assets for impairment whenever events or changes in circumstances indi- cate that the carrying amount of an asset may not be recoverable. During 2009, the recessionary conditions in the economy together with the deterioration in the commercial real estate market have significantly reduced the valuation of commercial properties. In recognition of these developments, the Company recorded a pre-tax impairment charge of $1.8 million during the year ended October 3, 2009 to write down the carrying value of the real estate associated with the industrial wire business. The results of discontinued operations are as follows: (In thousands) Earnings (loss) before income taxes Income taxes Net earnings (loss) Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $(1,875) 729 $(1,146) $ 58 (23) $ 35 $(199) 77 $(122) 38  Assets and liabilities of discontinued operations are as follows: (In thousands) Assets: Other assets Total assets Liabilities: Current liabilities: Accounts payable Accrued expenses Total current liabilities Other liabilities October 3, 2009 September 27, 2008 $1,880 $1,880 $3,635 $3,635 $ 2 217 219 183 $ 1 187 188 217 Total liabilities $ 402 $ 405 As of October 3, 2009 and September 27, 2008 there was approximately $217,000 and $251,000, respectively, 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. (9) emPlOyee Benefit Plans On September 29, 2007, the Company adopted the recognition and disclosure provisions of FASB ASC Topic 715, Compensation—Retirement Benefits. ASC Topic 715 requires that an employer recognize the overfunded or underfunded status of a defined benefit postretirement plan on its balance sheet and changes in the funded status through other compre- hensive income in the year in which the changes occur. As a result of adopting the recognition and dis- closure provisions of ASC Topic 715, the Company recorded a $2.1 million reduction in shareholders’ equity, net of tax, as of September 29, 2007. The Company adopted the measurement date provisions of ASC Topic 715 in the current fiscal year. As the Company already measured plan assets and benefit obligations as of its fiscal year-end, the adoption of the measurement date provision of ASC Topic 715 did not have an impact on its consolidated financial statements. 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 employ- ees based primarily upon years of service and com- pensation levels. The Company’s funding policy is to contribute amounts at least equal to those required by law. The Company did not make any contributions to the Delaware Plan in 2009 and it does not expect to make any contributions in 2010. The Delaware Plan was frozen effective September 30, 2008 whereby participants will no longer earn additional benefits. 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 Delaware Plan 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 Distributions Fair value of plan assets at end of year Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $ 4,377 — 250 150 (488) $ 4,289 $ 3,764 (223) (488) $ 3,053 $4,435 65 257 (171) (209) $4,377 $4,421 (448) (209) $3,764 $4,527 78 269 203 (642) $4,435 $4,527 536 (642) $4,421 (continued) INSTEEL INDUSTRIES, INC. // 2009 annual report 39 notes to consoliDateD financial stateMents (continued) Years Ended October 3, 2009, September 27, 2008 and September 29, 2007 (In thousands) Reconciliation of funded status to net amount recognized: Funded status Net amount recognized Amounts recognized in the consolidated balance sheet: Accrued benefit liability Accumulated other comprehensive loss (net of tax) Net amount recognized Amounts recognized in accumulated other comprehensive loss: Unrecognized net loss Unrecognized prior service cost Net amount recognized Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss): Net loss (gain) Amortization of prior service cost Total recognized in other comprehensive income (loss) Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $(1,236) $(1,236) $(1,236) 1,336 $ 100 $ 2,155 — $ 2,155 $ 396 — $ 396 $ (613) $ (613) $ (613) 1,091 $ 478 $1,759 — $1,759 $ 426 (1) $ 425 $ (14) $ (14) $ (14) 827 $ 813 $1,333 1 $1,334 $ (143) (1) $ (144) Net periodic pension cost for the Delaware Plan The assumptions used in the valuation of the includes the following components: Delaware Plan are as follows: (In thousands) Service cost Interest cost Expected return on plan assets Amortization of prior service cost Recognized net actuarial loss Net periodic pension cost Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $ — 250 $ 65 257 $ 78 269 (262) (325) (324) — 113 1 67 1 134 $ 101 $ 65 $ 158 The Company incurred settlement losses of $126,000 and $109,000 during the year ended October 3, 2009 and September 27, 2008, respectively, for lump- sum distributions to plan participants. The estimated net loss that will be amortized from accumulated other comprehensive income into net periodic pension cost over the next fiscal year is $189,000. Measurement Date October 3, 2009 September 27, 2008 September 29, 2007 Assumptions at year-end: Discount rate Rate of increase in compensa- tion levels Expected long- term rate of return on assets 5.50% 7.00% 6.50% N/A N/A N/A 8.00% 8.00% 8.00% The projected benefit payments under the Del- aware Plan are as follows: Fiscal year(s) 2010 2011 2012 2013 2014 2015–2019 (In thousands) $ 399 297 197 268 201 1,474 40  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 perfor- mance measured against the S&P 500 index or other applicable indices. The investment strategy for fixed income investments is focused on maintaining an overall portfolio 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 Delaware Plan’s net periodic pen- sion cost. Supplemental employee retirement plan. The Company has Retirement Security Agreements (each, a “SERP”) with certain of its employees (each, a “Participant”). Under the SERPs, if the Participant remains in con- tinuous service with the Company for a period of at least 30 years, the Company will pay to the Par- ticipant 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 revised the SERPs to add Participants and increase benefits to existing Participants. 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 SERPs 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: Actual employer contributions Actual distributions Plan assets at fair value at end of year Reconciliation of funded status to net amount recognized: Funded status Net amount recognized Amounts recognized in accumulated other comprehensive loss: Unrecognized net loss Unrecognized prior service cost Net amount recognized Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss): Net loss (gain) Prior service costs Total recognized in other comprehensive income (loss) Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $ 4,121 123 279 855 (160) $ 5,218 $ 160 (160) $ — $(5,218) $(5,218) $ 1,002 908 $ 1,910 $ 855 (227) $ 628 $ 4,192 155 266 (352) (140) $ 4,121 $ 140 (140) $ — $(4,121) $(4,121) $ 147 1,135 $ 1,282 $ (363) (438) $ (801) $ 3,868 163 230 11 (80) $ 4,192 $ 80 (80) $ — $(4,192) $(4,192) $ — 2,083 $ 2,083 $ 1 (227) $ (226) INSTEEL INDUSTRIES, INC. // 2009 annual report 41 notes to consoliDateD financial stateMents (continued) Years Ended October 3, 2009, September 27, 2008 and September 29, 2007 Net periodic pension cost for the SERPs includes the following components: (In thousands) Service cost Interest cost Prior service cost Recognized net actuarial loss Net periodic pension cost Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $123 278 227 — $154 266 227 12 $163 230 227 10 $628 $659 $630 The estimated prior service costs that will be amortized from accumulated other comprehensive income into net periodic pension cost over the next fiscal year is $33,000. The assumptions used in the valuation of the SERPs are as follows: Measurement Date October 3, 2009 September 27, 2008 September 29, 2007 Assumptions at year-end: Discount rate Rate of increase in compensa- tion levels 5.50% 7.00% 6.25% 3.00% 3.00% 3.00% The projected benefit payments under the SERPs are as follows: Fiscal year(s) 2010 2011 2012 2013 2014 2015–2019 (In thousands) $ 155 244 244 244 244 1,486 As noted above, the SERPs were revised in 2005 to add Participants and increase benefits to certain existing Participants. However, for certain Participants the Company still maintains the benefits of the respective SERPs that were in effect prior to the 2005 changes, which entitles them to fixed cash benefits upon retirement at age 65, payable annually for 15 years. These SERPs are supported by life insurance policies on the Participants purchased and owned by the Company. The cash benefits paid under these SERPs were $76,000 in 2009, $74,000 in 2008 and 2007, respectively. The expense attributable to these SERPs was $12,000 in 2009 and 2008, respectively, and $11,000 in 2007. Retirement savings plan. In 1996, the Company adopted the Retirement Savings Plan of Insteel Industries, Inc. (“the Plan”) to provide retirement benefits and stock ownership for its employees. The Plan is an amend- ment 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. In 2009 employees could contribute up to 75% of their annual compensation to the Plan, limited to a maximum annual amount as set periodically by the Internal Revenue Code. In 2008 and 2007 employees could contribute up to 15% of their annual compen- sation to the Plan, limited to a maximum annual amount as set periodically by the Internal Revenue Code. The Plan allows for discretionary contributions 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 2009, the Company matched employee contributions up to 100% of the first 1% and 50% of the next 5% of eligible compensation that was contrib- uted by employees. In 2008 and 2007, the Company matched employee contributions up to 50% of the first 7% of eligible compensation that was contrib- uted by employees. Company contributions to the Plan were $465,000 in 2009, $407,000 in 2008 and $402,000 in 2007. Voluntary Employee Beneficiary Associations (“VEBA”). The Company has a VEBA under which both employees and the Company may make contributions to pay for medical costs. Company contributions to the VEBA were $2.9 million in 2009, $1.7 million in 2008 and $2.4 million in 2007. The Company is primarily self- insured for employees’ healthcare costs, carrying stop-loss insurance coverage for individual claims in excess of $150,000 per benefit plan year. 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 his- torical claims data in developing its estimates. 42 (10) COmmitments and COntingenCies Leases and purchase commitments. The Company leases a portion of its equipment under operating leases that expire at various dates through 2012. Under most lease agreements, the Company pays insurance, taxes and maintenance. Rental expense for operating leases was $939,000 in 2009, $977,000 in 2008 and $920,000 in 2007. Minimum rental commitments under all non- cancelable leases with an initial term in excess of one year are payable as follows: 2010, $615,000; 2011, $412,000; 2012, $96,000; 2013, $34,000; 2014 and beyond, $438,000. As of October 3, 2009, the Company had $28.4 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 consoli- dated financial statements and amounted to $298,000 as of October 3, 2009. Legal proceedings. On November 19, 2007, Dywidag Systems International, Inc. (“DSI”) filed a third-party lawsuit in the Ohio Court of Claims alleging that cer- tain 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 filed against it 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 against DSI in the North Carolina Superior Court in Surry County on July 25, 2007 seeking recovery of $1.4 million (plus interest) owed for other products sold by the Company to DSI and a judgment declaring that it had no liabil- ity to DSI arising out of the ODOT bridge project. The Company’s North Carolina lawsuit was subsequently removed by DSI to the U.S. District Court for the Middle District of North Carolina and on July 28, 2009, the federal district court denied the Company’s motion to remand the matter to the Surry County Court. The parties continue to contest the appropriate jurisdiction in which this litigation should proceed. With regard to DSI’s third-party action, the Company filed a motion for summary judgment in the Ohio Court of Claims lawsuit on June 25, 2009 and discov- ery has commenced on a limited basis. The Company 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 has concluded that a loss is not yet probable with respect to this matter, and therefore no liability has been recorded. In the event the ultimate resolution of the case is unfavorable, the Company has estimated that the potential loss could range up to $11.0 million. The Company also is involved in various other lawsuits, claims, investigations and proceedings, including commercial, environmental and employ- ment matters, which arise in the ordinary course of business. The Company does not expect that the ulti- mate cost to resolve these other matters will have a material adverse effect on its financial position, results of operations or cash flows. Severance and change of control agreements. The Com- pany 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 employ- ment 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 pro- vides notice of termination as specified in the agree- ment. 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 out- placement services would be provided. The Company has also entered into change in control agreements with key members of manage- ment, including its executive officers, which specify the terms of separation in the event that termination of employment 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 execu- tive provides notice of termination as specified in the agreement. The agreements do not provide assur- ances of continued employment, nor do they specify the terms of an executive’s termination should the termination occur in the absence of a change in con- trol. Under the terms of these agreements, in the INSTEEL INDUSTRIES, INC. // 2009 annual report 43 notes to consoliDateD financial stateMents (continued) Years Ended October 3, 2009, September 27, 2008 and September 29, 2007 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 con- tinuation 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 continuation of health and welfare benefits for one year. In addition, all of the executive’s stock options and restricted stock would vest immediately and outplacement services would be provided. (11) earnings Per share The reconciliation of basic and diluted earnings per share (“EPS”) is as follows: (In thousands, except for per share amounts) Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) Weighted average shares outstanding: Weighted average shares outstanding (basic) Dilutive effect of stock-based compensation Weighted average shares outstanding (diluted) Per share (basic): Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) Per share (diluted): Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $(20,940) (1,146) $(22,086) 17,380 — 17,380 $ (1.20) (0.07) $ (1.27) $ (1.20) (0.07) $ (1.27) $43,717 35 $43,752 17,547 165 17,712 $ 2.49 — $ 2.49 $ 2.47 — $ 2.47 $24,284 (122) $24,162 18,142 172 18,314 $ 1.34 (0.01) $ 1.33 $ 1.33 (0.01) $ 1.32 Options and restricted stock awards represent- ing 668,000 shares in 2009, 180,000 shares in 2008 and 67,000 shares in 2007 were antidilutive and were not included in the diluted EPS computation. Options and restricted stock awards representing 130,000 shares were not included in the diluted EPS calcula- tion in 2009 due to the net loss that was incurred. (12) Business segment infOrmatiOn Following the Company’s exit from the indus- trial wire business (see Note 8 to the consolidated financial statements), the Company’s operations are entirely focused on the manufacture and marketing of concrete reinforcing products for the concrete con- struction industry. The Company’s concrete reinforc- ing products consist of welded wire reinforcement and PC Strand. Based on the criteria specified in FASB ASC Topic 280, Segment Reporting, the Com- pany has one reportable segment. The results of oper- ations for the industrial wire business have been reported as discontinued operations for all periods presented. 44  The Company’s net sales and long-lived assets for continuing operations by geographic region are as follows: (15) Other finanCial data Balance sheet information: Year Ended (In thousands) (In thousands) Net sales: United States Foreign October 3, 2009 September 27, 2008 September 29, 2007 $ 225,286 4,950 $337,801 16,061 $287,202 10,604 Total $ 230,236 $353,862 $297,806 Long-lived assets: United States Foreign $ 67,943 — $ 73,043 — $ 71,514 — Accounts receivable, net: Accounts receivable Less allowance for doubtful accounts Total Inventories: Raw materials Work in process Finished goods Total $ 67,943 $ 73,043 $ 71,514 Total The Company’s net sales for continuing opera- tions by product line are as follows: (In thousands) Net sales: Welded wire reinforcement PC strand Year Ended October 3, 2009 September 27, 2008 September 29, 2007 $122,942 107,294 $193,307 160,555 $167,896 129,910 Total $230,236 $353,862 $297,806 There were no customers that accounted for 10% or more of the Company’s net sales in 2009, 2008 or 2007. (13) related Party transaCtiOns Sales to a company affiliated with one of the Company’s directors amounted to $585,000 in 2009, $1.0 million in 2008 and $967,000 in 2007. Purchases from another company affiliated with one of the Company’s directors amounted to $5,800 in 2008 and $418,000 in 2007. There were no such purchases in 2009. (14) COmPrehensive lOss The components of accumulated other compre- hensive loss are as follows: Prepaid expenses and other: Income taxes receivable Current deferred tax asset Capitalized financing costs, net Other Total Other assets: Cash surrender value of life insurance policies Non-current deferred tax assets Capitalized financing costs, net Other Total Property, plant and equipment, net: Land and land improvements Buildings Machinery and equipment Construction in progress Less accumulated depreciation Total Accrued expenses: Pension plan Salaries, wages and related expenses Property taxes Customer rebates Worker’s compensation Sales allowance reserves Cash dividends Income taxes (In thousands) Adjustment to defined benefit plan liability Total accumulated other compre- hensive loss October 3, 2009 September 27, 2008 September 29, 2007 Other Total $(2,520) $(1,885) $(2,119) Other liabilities: Deferred compensation Deferred income taxes Deferred revenues $(2,520) $(1,885) $(2,119) Total October 3, 2009 September 27, 2008 $ 22,340 $ 50,487 (1,057) (906) $ 21,283 $ 49,581 $ 17,649 1,780 19,113 $ 30,793 3,161 37,266 $ 38,542 $ 71,220 $ 13,049 1,668 336 1,671 $ — 2,513 — 609 $ 16,724 $ 3,122 $ 3,739 375 — 268 $ 3,938 — 844 282 $ 4,382 $ 5,064 $ 5,571 32,437 96,411 695 $ 5,631 31,819 96,638 2,195 135,114 (70,910) 136,283 (67,178) $ 64,204 $ 69,105 $ 1,236 $ 613 1,228 1,023 752 378 236 — — 362 4,128 794 840 673 1,493 9,279 10,861 400 $ 5,215 $ 29,081 $ 5,465 — — $ 4,476 435 395 $ 5,465 $ 5,306 INSTEEL INDUSTRIES, INC. // 2009 annual report 45 notes to consoliDateD financial stateMents (continued) Years Ended October 3, 2009, September 27, 2008 and September 29, 2007 (16) rights agreement On April 26, 1999, the Company’s Board of Directors declared a dividend distribution of one right per share of the Company’s outstanding com- mon stock as of May 17, 1999 pursuant to a Rights Agreement, dated as of April 27, 1999. The Rights Agreement also provides that one right will attach to each share of the Company’s common stock issued after May 17, 1999. On April 21, 2009, effective April 25, 2009, the Company’s Board of Directors amended the Rights Agreement to, among other changes, extend the final expiration date and adjust the pur- chase price payable upon exercise of a right. The rights are not currently exercisable but trade with the Company’s common stock shares and become exercisable on the distribution date. The dis- tribution date will occur upon the earliest of 10 busi- ness days following a public announcement that either a person or group of affiliated or associated persons (an “acquiring person”) has acquired, or obtained the right to acquire, beneficial ownership of 20% or more (after adjustment for certain derivative transactions) of the outstanding shares of common stock (the “stock acquisition date”), or of a tender offer or exchange offer that would, if consummated, result in an acquiring person beneficially owning 20% or more of such outstanding shares of common stock, subject to certain limitations. Each right will entitle the holder, other than the acquiring person or group, to purchase one two- hundredths of a share (a “Unit”) of the Company’s Series A Junior Participating Preferred Stock (“Preferred Stock”) at a purchase price of $46 per Unit, subject to adjustment as described in the Rights Agreement (the “purchase price”). At the time speci- fied each holder of a right will have the right to receive in lieu of Preferred Stock, upon exercise and payment of the purchase price, common stock (or, in certain circumstances, cash, property or other securi- ties of the Company) having a value equal to two times the purchase price or, at the discretion of the Board, upon exercise and without payment of the purchase price, common stock (or, in certain circum- stances, cash, property or other securities of the Company) having a value equal to the difference between the purchase price and the value of the con- sideration which a person exercising the right and paying the purchase price would receive. Rights that are or (under specified circumstances) were, benefi- cially owned by any acquiring person will be null and void. The purchase price payable, and the num- ber of Units of Preferred Stock or other securities or property issuable upon exercise of the rights are sub- ject to adjustment from time to time. At any time after any person becomes an acquiring person, the Company may exchange all or part of the rights for shares of common stock at an exchange ratio of one share per right, as appropriately adjusted to reflect any stock dividend, stock split or similar transaction. In addition, each rights holder, other than an acquiring person, upon exercise of rights will have the right to receive shares of the common 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. The rights will expire on April 24, 2019, and may be redeemed by the Company at any time prior to the distribution date at a price of $0.005 per right. (17) PrOduCt warranties The Company’s products are used in applications which are subject to inherent risks including per- formance deficiencies, personal injury, property damage, environmental contamination or loss of pro- duction. The Company warrants its products to meet certain specifications and actual or claimed deficien- cies from these specifications may give rise to claims. The Company does not maintain a reserve for war- ranties as the historical claims have been immaterial. The Company maintains product liability insurance coverage to minimize its exposure to such risks. 46 (18) share rePurChases On November 18, 2008, the Company’s board of directors approved a new share repurchase authori- zation to buy back up to $25.0 million of the Com- pany’s outstanding common stock in the open market or in privately negotiated transactions (the “New Authorization”). The New Authorization replaces the previous authorization to repurchase up to $25.0 mil- lion of the Company’s common stock which was to expire on December 5, 2008. Repurchases may be made from time to time in the open market or in privately negotiated transactions subject to market conditions, applicable legal requirements and other factors. The Company is not obligated to acquire any particular amount of common stock and the program may be commenced or suspended at any time at the Company’s discretion without prior notice. The New Authorization continues in effect until terminated by the Board of Directors. During the year ended October 3, 2009, the Company repurchased $24,000 or 2,497 shares of its common stock through restricted stock net-share settlements. During the year ended September 27, 2008, the Company repurchased 913,268 shares or $8.7 million of its common stock, which included 6,870 shares or $76,000 through restricted stock net-share settlements. INSTEEL INDUSTRIES, INC. // 2009 annual report 47 stocK pRice anD DiViDenD Data The common stock of Insteel Industries, Inc. is traded on the NASDAQ Global Select Market under the sym- bol IIIN. The following table summarizes the quarterly high and low sales prices as reported on the NASDAQ Global Select Market and the cash dividend per share declared for the periods indicated: First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal 2009 Fiscal 2008 High Low $14.72 12.47 9.26 12.58 $7.00 4.76 6.24 7.53 Cash Dividends $0.03 0.03 0.03 0.03 High Low $16.35 12.45 19.14 20.17 $10.00 7.36 9.96 13.77 Cash Dividends $0.03 0.03 0.03 0.53 While we intend to pay regular quarterly cash dividends for the foreseeable future, the declaration and pay- ment of future dividends, if any, are discretionary and will be subject to determination by the board of directors each quarter after taking into account various factors, including general business conditions and our financial condition, operating results, cash requirements and expansion plans. See Note 5 of the consolidated financial statements for additional discussion with respect to dividend payments. suppleMentaRy QuaRteRly financial Data (unauDiteD) (In thousands, except for per share amounts) October 3, 2009 June 27, 2009 March 28, 2009 December 27, 2008 September 27, 2008 June 28, 2008 March 29, 2008 December 29, 2007 Quarter Ended $61,070 9,047 $56,963 1,176 $ 50,404 (21,040) $61,799 (4,276) $106,290 29,463 $104,332 30,885 $77,260 15,787 $65,980 10,620 2,778 (1,737) (16,382) (5,599) 15,646 16,948 6,892 4,231 (1,085) 1,693 (12) (1,749) (13) (16,395) (36) (5,635) 37 15,683 (21) 16,927 26 6,918 (7) 4,224 0.16 (0.10) (0.94) (0.33) 0.90 0.98 0.40 0.23 (0.06) 0.10 — (0.10) — (0.94) — (0.33) — 0.90 — 0.98 — 0.40 — 0.23 0.16 (0.10) (0.94) (0.33) 0.89 0.97 0.39 0.23 (0.06) 0.10 — (0.10) — (0.94) — (0.33) — 0.89 — 0.97 — 0.39 — 0.23 Operating results: Net sales Gross profit (loss) Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) Per share data: Basic: Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) Diluted: Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) 48 300 250 200 150 100 50 0 stocK peRfoRMance gRapH The following graph compares the total returns (including the reinvestment of dividends) of the Company, the Russell 2000 and the S&P Building Products Index. The graph assumes $100 invested on October 2, 2004 in the Company’s stock and September 30, 2004 in each of the indices. Total returns for the indices are calculated on a month-end basis. Insteel Industries, Inc. Russell 2000 S&P Building Products $300 250 200 150 100 50 0 October 2, 2004 October 1, 2005 September 30, 2006 September 29, 2007 September 27, 2008 October 3, 2009 (In dollars) Insteel Industries, Inc. Russell 2000 S&P Building Products October 2, 2004 October 1, 2005 September 30, 2006 September 29, 2007 September 27, 2008 October 3, 2009 100.00 100.00 100.00 106.13 117.95 101.18 277.96 129.66 92.96 216.19 145.65 93.64 205.94 124.56 96.79 173.38 112.67 73.70 INSTEEL INDUSTRIES, INC. // 2009 annual report 49 selecteD financial Data—fiVe-yeaR HistoRy (In thousands, except for per share amounts) Operating Results: Net sales Gross profit (loss) % of net sales Selling, general and administrative expense Interest expense Earnings (loss) from continuing operations % of net sales Earnings (loss) from discontinued operations Net earnings (loss) Per Share Data: Per share (basic): Year Ended (53 weeks) October 3, 2009 (52 weeks) September 27, 2008 (52 weeks) September 29, 2007 (52 weeks) September 30, 2006 (52 weeks) October 1, 2005 $230,236 (15,093) $353,862 86,755 $297,806 56,061 $329,507 70,871 $309,320 57,898 (6.6%) 24.5% 18.8% 21.5% 18.7% $ 17,243 641 (20,940) (9.1%) $ (1,146) (22,086) $ 18,623 594 43,717 $ 12.4% 35 43,752 $ 17,583 592 24,284 $ 16,996 669 34,377 8.2% 10.4% $ (122) 24,162 $ (1,337) 33,040 $ 16,175 3,427 24,499 $ 7.9% 546 25,045 Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) $ Per share (diluted): Earnings (loss) from continuing operations Earnings (loss) from discontinued operations Net earnings (loss) Cash dividends declared (1.20) (0.07) (1.27) (1.20) (0.07) (1.27) 0.12 $ 2.49 — 2.49 2.47 — 2.47 0.62 $ 1.34 (0.01) 1.33 1.33 (0.01) 1.32 0.12 $ 1.88 (0.08) 1.80 1.86 (0.07) 1.79 0.12 $ 1.31 0.03 1.34 1.29 0.03 1.32 0.06 Returns: Return on total capital(1) Return on shareholders’ equity(2) Financial Position: Cash and cash equivalents Total assets Total long-term debt Shareholders’ equity Cash Flows: (13.2%) (13.2%) 27.9% 27.9% 18.2% 18.2% 29.7% 31.3% 23.9% 40.7% $ 35,102 182,117 — 147,070 $ 26,493 228,220 — 169,847 $ 8,703 173,529 — 143,850 $ 10,689 166,596 — 122,438 $ 1,371 138,276 11,860 97,036 Net cash provided by operating activities of continuing operations Capital expenditures Depreciation and amortization Repurchases of common stock Cash dividends paid Other Data: Number of employees at year-end $ 22,092 2,377 7,377 — 11,381 $ 36,808 9,456 7,271 8,691 2,141 $ 17,065 17,013 5,711 — 2,176 $ 42,650 18,959 4,578 8,529 2,222 $ 41,830 6,302 4,139 — 566 438 523 559 621 655 (1) Earnings from continuing operations/(average total long-term debt + average shareholders’ equity). (2) Earnings from continuing operations/(average shareholders’ equity). 50 Corporate Information Board of directors Louis e. Hannen(1) Retired Senior Vice President Wheat, First Securities, Inc. charles B. Newsome(2,3) Executive Vice President Johnson Concrete Company Gary L. Pechota(1,3) President and Chief Executive Officer DT-Trak Consulting, Inc. W. allen rogers ii(1,3) Principal Ewing Capital Partners, LLC William J. shields(2) Retired Chairman and Chief Executive Officer Co-Steel, Inc. c. richard Vaughn(2,4) Chairman and Chief Executive Officer John S. Clark Company, Inc. Howard o. Woltz, Jr.(4) Chairman Emeritus Insteel Industries, Inc. H.o. Woltz iii(4) Chairman, 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 Nominating and Governance Committee (4) Member of the Executive Committee executiVe officers H.o. Woltz iii Chairman, 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— Concrete Reinforcing Products Business Unit, Insteel Wire Products Company sHareHoLder iNforMatioN corporate Headquarters 1373 Boggs Drive Mount Airy, North Carolina 27030-2148 (336) 786-2141 independent registered Public accounting Firm Grant Thornton LLP Greensboro, North Carolina annual meeting Insteel shareholders are invited to attend our annual meeting, which will be held on Tuesday, February 9, 2010 at 9:00 a.m. ET at the Cross Creek Country Club, 1129 Greenhill Road, Mount Airy, North Carolina 27030 common stock The common stock of Insteel Industries, Inc. is traded on the NASDAQ Global Select Market under the symbol IIIN. At November 6, 2009, there were 1,076 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 Plaza Level New York, New York 10038 (866) 627-2704 www.amstock.com investor relations For information on the Company, addi- tional copies of this report, Form 10-K or other financial information, contact Michael C. Gazmarian, Vice President, Chief Financial Officer and Treasurer, at the Company’s headquarters. You may also visit the Investor Information section on the Company’s web site at http://investor.insteel.com/. s r i a f f A c i l b u P T O D V , n o t y a r W r o v e r T o t o h p 9 – 8 e g a P 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 n g i s e D t r o p e R l a u n n A Insteel IndustrIes, Inc. 1373 Boggs Drive, Mount Air y, Nor th Carolina 27030-2148 phone ( 336 ) 786-2141 www.insteel.com 

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