UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended September 27, 2003

Commission File Number 1-9929

INSTEEL INDUSTRIES, INC.

1373 Boggs Drive, Mount Airy, North Carolina 27030
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (336) 786-2141

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Title of Each Class

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ ] No [X]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K. [X]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]

     The aggregate market value of the common stock held by non-affiliates of the registrant as of March 29, 2003 was $4,641,244.

     The number of shares outstanding of the registrant’s common stock as of June 11, 2004 was 8,602,492.

DOCUMENTS INCORPORATED BY REFERENCE

     None.

PART I

Cautionary Note Regarding Forward-Looking Statements

     This report contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. When used in this report, the words “believes,” “anticipates,” “expects,” “plans” and similar expressions are intended to identify forward-looking statements. Although the Company believes that its plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, such forward-looking statements are subject to a number of risks and uncertainties, and the Company can provide no assurances that such plans, intentions or expectations will be achieved. All forward-looking statements attributable to the Company or persons acting on its 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 the Company does not undertake and specifically declines any obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

     It is not possible to anticipate and list all risks and uncertainties that may affect the future operations or financial performance of the Company; however, they would include, but are not limited to, the following:

	•		general economic and competitive conditions in the markets in which the Company operates;
	•		the cyclical nature of the steel industry;
	•		changes in U.S. or foreign trade policy affecting steel imports or exports;
	•		fluctuations in the cost and availability of the Company’s primary raw material, hot-rolled steel wire rod from domestic and foreign suppliers;
	•		the Company’s ability to raise selling prices in order to recover increases in wire rod prices;
	•		interest rate volatility;
	•		unanticipated changes in customer demand, order patterns and inventory levels;
	•		legal, environmental or regulatory developments that significantly impact the Company’s operating costs;
	•		unanticipated plant outages, equipment failures or labor difficulties; and
	•		continuing escalation in medical costs that affect employee benefit expenses.

Risks Related to the Company’s Business

The Company’s business is seasonal and cyclical where prolonged economic declines could have a material adverse effect on its financial performance.

     Demand for most of the Company’s products is both seasonal and cyclical and sensitive to general economic conditions. The Company’s concrete reinforcing products are used for a broad range of commercial, residential and infrastructure construction applications. Demand in these markets is driven by the level of construction activity, which generally is highest in the third and fourth quarters of its fiscal year when weather conditions are conducive to construction activity. As a result of the seasonal nature of the construction industry, sales and profitability generally are lower in the first and second fiscal quarters.

     The Company’s industrial wire products are used in the manufacture of tires and other industrial applications where the seasonal changes are not as pronounced as they are for concrete reinforcing products. However, demand for these products is cyclical based on general economic conditions in the markets served and the overall level of manufacturing activity. As a result, a prolonged slowdown in the economy or weakening market conditions for any of the industries that it serves could have a material adverse impact on the Company’s results of operations, financial condition and cash flows.

Fluctuations in the cost and availability of the Company’s primary raw material from domestic and foreign suppliers may increase its production costs which it may not be able to pass through to its customers.

     The primary raw material used to manufacture the Company’s products is hot-rolled carbon steel wire rod, which is purchased from both domestic and foreign suppliers. During 2003, imported wire rod represented approximately 33% of the Company’s total wire rod purchases compared with 45% in 2002. Demand for hot-rolled steel wire rod in the U.S. contracted

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between 2000 and the first half of 2003. Beginning during the last half of 2003, however, demand began to recover and that recovery has continued into 2004. Wire rod prices have risen sharply since July 2003 due to reductions in domestic capacity related to mill closures, the impact on pricing of the lower value of the U.S. dollar, and anti-dumping duties imposed in 2002 by the U.S. Department of Commerce on seven wire rod producing countries. While favorable market conditions have enabled the Company to raise its selling prices to recover higher wire rod cost, there can be no assurance that future cost increases could be recovered. In addition, the lower value of the dollar has made the U. S. market less desirable to certain offshore suppliers which when combined with the reduction in domestic wire rod capacity has led to spot shortages of material. The Company has lost production time at certain of its facilities due to delayed deliveries of offshore purchases and the inability to backfill its requirements through replacement orders with domestic suppliers. The Company expects to experience intermittent raw material related production outages through the balance of the year.

Unexpected equipment failures or operational interruptions may lead to curtailments in production or shutdowns.

     If the Company were to experience operational interruptions for any reason, it would be negatively impacted by increased production costs as well as reduced sales and earnings. In addition to equipment failures, the Company’s manufacturing facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or adverse weather conditions. The manufacturing processes depend on critical pieces of equipment, which may be out of service on occasion because of unanticipated failures. In the future, any such equipment failures could subject the Company to material plant shutdowns or periods of reduced production. Furthermore, any operational interruptions may require capital expenditures to remedy the situation, which could have a negative effect on the Company’s profitability and cash flows. Although the Company maintains business interruption insurance, any recoveries for such claims could potentially be insufficient to offset the lost revenues or increased costs that may be experienced. In addition to the revenue losses, which may be recoverable under the policy, longer-term business disruption could result in a loss of customers. If this were to occur, future sales, profitability and cash flow could be adversely affected.

The Company’s production costs may increase should commodity prices continue to rise because it does not hedge its exposure to price fluctuations for its raw materials.

     The Company does not use derivative commodity instruments to hedge its exposures to changes in commodity prices, including prices of hot-rolled carbon steel wire rod. Historically, the Company has typically negotiated quantities and pricing on a quarterly basis for both domestic and foreign steel wire rod purchases to manage its exposure to price fluctuations and to ensure adequate availability of material consistent with its requirements. However, the recent tightening of supply in the rod market together with the rising costs of rod producers has resulted in increased price volatility. In some instances, wire rod producers have resorted to increasing the frequency of price adjustments, typically on a monthly basis as well as unilaterally changing the terms of prior commitments. Because the Company generally does not hedge against price fluctuations, it may be forced to purchase wire rod at higher than anticipated prices. Although changes in its wire rod costs and selling prices tend to be correlated, depending upon market conditions, there may be periods during which the Company is unable to fully recover increased rod costs through higher selling prices, which would reduce gross profit and cash flow from operations.

The Company’s variable rate indebtedness subjects it to interest rate risk, which could cause its annual debt service obligations to increase significantly.

     All of the Company’s debt obligations under its senior secured credit facility are at variable rates of interest which exposes it to interest rate risk. In connection with the refinancing of its senior secured credit facility in June 2004, the Company terminated certain interest rate swap agreements which were entered as required under the terms of its previous credit facility to reduce the future impact of interest rate fluctuations on earnings and cash flows. Because the Company has not entered into interest rate hedging instruments relating to its refinanced credit facility, if interest rates rise, the increased interest expense on its variable rate indebtedness would decrease earnings and cash flow.

The Company could have difficulty meeting its funding requirements for debt service, capital investment and maintenance expenditures if there was a substantial downturn in its financial performance.

     As of September 27, 2003, the Company had approximately $70.3 million of long-term debt, consisting of approximately $69.5 million outstanding under its senior secured credit facility and $840,000 outstanding under its industrial revenue refunding bonds. On June 3, 2004, the Company refinanced its senior secured credit facility by closing on a new $82.0 million senior secured credit facility consisting of a $60.0 million revolver, a $17.0 million term loan and a $5.0 million term loan with one lender which matures in 2008. The Company’s operations are capital intensive and require substantial recurring

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expenditures for routine maintenance of its equipment and facilities. Although the Company expects the cash requirements for its business needs to be financed by internally generated funds or from borrowings under the new credit facility, it cannot provide any assurances this will be the case.

The Company’s ability and the ability of some of its subsidiaries to engage in some business transactions may be limited by the terms of its debt.

     The Company’s new senior secured credit facility contains a number of financial covenants requiring it to meet certain financial ratios and financial condition tests, as well as other covenants that restrict or limit its ability to:

	•		incur additional debt;
	•		pay dividends on, redeem or repurchase capital stock;
	•		allow its subsidiaries to issue new stock to any person other than itself or any of its other subsidiaries;
	•		make investments;
	•		incur or permit to exist liens;
	•		enter into transactions with affiliates;
	•		guarantee the debt of other entities, including joint ventures;
	•		merge or consolidate or otherwise combine with another company; and
	•		transfer or sell its assets.

     The Company’s ability to borrow under its credit facility will depend upon its ability to comply with these covenants and borrowing base requirements. The Company’s ability to meet these covenants and requirements may be affected by events beyond its control which may result in the inability to meet these obligations. The Company’s failure to comply with these covenants and requirements could result in an event of default under its credit facility that, if not cured or waived, could terminate its ability to borrow further, permit acceleration of the relevant debt and permit foreclosure on any collateral granted as security under its credit facility.

Environmental compliance and remediation could result in substantially increased capital requirements and operating costs.

     The Company’s businesses are subject to numerous federal, state and local laws and regulations relating to the protection of the environment that could result in substantially increased capital, operating and compliance costs. These laws are constantly evolving and becoming increasingly stringent. The ultimate impact of complying with existing laws and regulations is not always clearly known or determinable because regulations under some of these laws have not yet been promulgated or are undergoing revision.

The Company’s production and earnings could be significantly reduced by strikes or work stoppages by its unionized employees.

     As of September 27, 2003, the Company employed 677 people, of which approximately 68 were union members (approximately 61 employees at its Wilmington, Delaware facility and 7 employees at its Jacksonville, Florida facility). The Company has collective bargaining agreements in place with each union, which expire in November 2006 for the Wilmington facility and April 2005 for the Jacksonville facility. Although the Company believes that its current relations with the labor unions and its unionized employees are satisfactory, any strikes or work stoppages organized by the unions, particularly the union representing certain employees at its Wilmington facility, could reduce production and negatively affect its profitability.

The Company’s operating costs and earnings could be negatively impacted by the continued escalation in medical costs.

     Although the Company has implemented a number of measures to offset the impact of the ongoing escalation in medical costs, there can be no assurance that such actions will be effective going forward. Continued increases in medical costs could potentially be substantial enough to significantly increase the Company’s operating costs and reduce its earnings.

Anti-takeover provisions in the Company’s organizational documents and North Carolina law make any change in control more difficult. This could have an adverse affect on the price of the Company’s common stock.

     The Company’s articles of incorporation and bylaws contain provisions that may delay or prevent a change in control,

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may discourage bids at a premium over the market price of its common stock and may have an adverse affect on the market price of its common stock as well as the voting and other rights of the holders of its common stock. These provisions include:

	•		the division of its Board of Directors into three classes servicing staggered three-year terms;
	•		prohibiting its shareholders from calling a special meeting of shareholders;
	•		the ability to issue additional shares of its common stock preferred stock without shareholder approval;
	•		the existence of a rights agreement, or “poison pill,” that results in the dilution of the value of its common stock held by a potential acquirer and forces any acquirer to negotiate the potential acquisition of the Company with its Board of Directors;
	•		prohibiting its shareholders from amending its articles of incorporation or bylaws except with 66 2/3% shareholder approval; and
	•		advance notice requirements for raising matters of business or making nominations at shareholder meetings.

Risks Related to Its Common Stock

Shareholder’s ability to sell shares of the Company’s common stock may be limited.

     In February 2004, the Company’s common stock ceased trading on the OTC Bulletin Board (the “OTCBB”) and began trading on the Pink Sheets because of its noncompliance with the OTCBB’s filing requirement which requires that an issuer’s filings with the SEC are current (subject to a 30-day grace period). The OTCBB and the Pink Sheets are thinly traded markets and as a result, the shareholder may not receive pricing and order execution similar to that received if the Company’s common stock were traded on other securities exchanges. Because trading activity in its common stock is thin and shares of its common stock may at times be illiquid; the Company’s common stock is subject to significant price fluctuations based upon the trading activity of its shareholders. The Company anticipates that its common stock will resume trading on the OTCBB following the filing of this report together with its Form 10-Qs for the periods ended December 27, 2003 and March 27, 2004. However, continued listing on the OTCBB requires market-maker sponsorship and there can be no assurance that its common stock will continue to be traded or that liquidity for its common stock will not be adversely affected.

The Company may not pay dividends for the foreseeable future.

     In November 2000, the Company suspended its quarterly cash dividend in connection with the terms of a covenant waiver with its lenders under its senior secured credit facility. Under the terms of its new credit facility the Company is currently prohibited from paying dividends and it does not anticipate doing so in the near future. The payment of any future dividends, to the extent permitted under the terms of the credit facility, will be at the discretion of its board of directors after taking into account various factors, including its financial condition, operating results, cash needs, and expansion plans. In addition, the terms of the Company’s new senior secured credit facility restrict its ability to pay dividends or make any distributions or payments with respect to its capital stock. Accordingly, investors must rely on sales of their common stock after price appreciation (which may never occur) as the only way to realize income on their investment.

Item 1. Business

General

     Insteel Industries, Inc. (“Insteel” or “the Company”) is one of the nation’s largest manufacturers of wire products. Insteel is the parent holding company for a wholly-owned operating subsidiary, Insteel Wire Products Company (“IWP”), which manufactures and markets concrete reinforcing products, including welded wire fabric (“WWF”) and prestressed strand (“PC Strand”), and industrial wire products, including tire bead and other industrial wire products for a broad range of construction and industrial applications. Insteel’s business strategy is focused on achieving leadership positions in its markets and operating as the lowest cost producer. The Company pursues growth opportunities in existing or related product lines sold to the same customers that leverage off of its infrastructure and core competencies in the manufacture and marketing of wire products.

Internet Access to Company Information

     Additional information about the Company and its filings with the U.S. Securities and Exchange Commission (“SEC”) are available on the Company’s web site at www.insteel.com. The information available on the Company’s web site is not part of this report and shall not be deemed incorporated into any of its SEC filings.

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Products

     Concrete Reinforcing Products. The Company’s concrete reinforcing products consist of welded wire fabric and prestressed concrete strand (“PC strand”).

     Welded wire fabric (“WWF”) is produced as either a commodity or a specially engineered reinforcing product for use in infrastructure, residential, and commercial construction. Insteel produces a full range of WWF products, including pipe mesh, building mesh and engineered structural mesh (“ESM”). Pipe mesh is an engineered made-to-order product that is used as the primary reinforcement in concrete pipe, box culverts and precast manholes for drainage and sewage systems, water treatment facilities and other related applications. Building mesh is a secondary reinforcing product that is produced in standard styles for crack control applications in residential and light nonresidential construction, including driveways, sidewalks and a variety of slab-on-grade applications. ESM is an engineered made-to-order product that is used as the primary reinforcement for concrete elements or structures serving as a replacement for rebar. For 2003, WWF sales represented 52% of the Company’s consolidated net sales.

     PC strand is a high carbon seven-wire strand that is used to impart compression forces into precast concrete elements and structures, which may be either prestressed or posttensioned, providing reinforcement for bridges, parking decks, buildings and other concrete structures. For 2003, PC strand sales represented 35% of the Company’s consolidated net sales.

     Industrial Wire Products. In addition to its concrete reinforcing products, the Company also produces tire bead wire and other industrial wire.

     Tire bead wire is a bronze-plated steel wire that is used by tire manufacturers to reinforce the inside diameter of a tire and hold the tire to the wheel. The bronze coating serves to provide the product with rubber adhesion properties, which is critical to its application. For 2003, tire bead wire sales represented 11% of the Company’s consolidated net sales.

     Other industrial wire is specialty small diameter wire sold as an intermediate product to manufacturers for a broad range of industrial and commercial applications. Industrial wire is produced to customer specifications based upon the specific requirements of their manufacturing processes and the end use of the finished product. Product attributes vary with the specific application and can include intermediate heat-treating as well as stringent dimensional tolerance specifications and mechanical properties. For 2003, industrial wire sales represented 2% of the Company’s consolidated net sales.

Marketing and Distribution

     Insteel markets its products through sales representatives that are employees of the Company and a sales agent. The Company’s sales force is organized by product line and trained in the technical applications of its products. The Company’s products are sold directly to users as well as through numerous wholesalers and distributors located nationwide as well as into Canada, Mexico, and Central and South America.

     Insteel delivers its products primarily by truck, using common or contract carriers. The delivery method selected is dependent upon backhaul opportunities, comparative costs and scheduling requirements.

Customers

     The Company sells its products to a broad range of customers including manufacturers, distributors and wholesalers. There were no customers that represented 10% or more of the Company’s net sales in 2003, 2002 or 2001.

Product Warranties

     The Company’s products are used in applications, which are subject to inherent risks including performance deficiencies, personal injury, property damage, environmental contamination, or loss of production. The Company warrants its products to meet certain specifications and actual or claimed deficiencies from these specifications may give rise to claims. The Company does not maintain a reserve for warranties due to immateriality. The Company maintains product liability insurance coverage to minimize its exposure to such risks.

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Seasonality and Cyclicality

     The Company’s concrete reinforcing products are used for a broad range of nonresidential, infrastructure and residential construction applications. Demand in these markets is both seasonal and cyclical, driven by the level of construction activity, which significantly impacts the sales and profitability of the Company. From a seasonal standpoint, the highest level of sales within the year typically occurs when weather conditions are the most conducive to construction activity. As a result, sales and profitability are usually higher in the third and fourth quarters of the fiscal year and lower in the first and second quarters. Demand for the Company’s concrete reinforcing products was adversely impacted in 2001 and 2002 by the decline in spending for commercial and industrial construction. In addition, a new domestic entrant into the PC strand market in 2001 negatively impacted PC strand margins.

     The Company’s tire bead wire and industrial wire products are used in the manufacture of tires and for a broad range of other industrial applications. Demand for these products tends to be cyclical based on changes in general economic conditions, sales of new vehicles as well as replacement tires, and the overall level of manufacturing activity. As a result, seasonality in demand does not tend to be as pronounced as it is for concrete reinforcing products.

Raw Materials

     The primary raw material used to manufacture Insteel’s products is hot-rolled carbon steel wire rod, which the Company purchases from both domestic and foreign suppliers. Wire rod can generally be characterized as a commodity-type product. The Company purchases several different grades and sizes of wire rod with varying specifications based on the diameter, chemistry, mechanical properties, and metallurgical characteristics that are required for its various end products. In spite of recent reductions in supply, the Company believes that alternative sources of wire rod are available in sufficient quantities to meet its requirements.

     Pricing for wire rod tends to fluctuate with domestic market conditions as well as the global economic environment. Domestic demand for wire rod exceeds domestic production, and as such, imports of wire rod are essential to provide adequate supply to U.S. consumers of wire rod. In recent years, the Company has relied on imported wire rod to satisfy between 20% and 45% of its total requirements. During 2003, imported wire rod represented approximately 33% of the Company’s total wire rod purchases compared with 45% in 2002. The Company believes that the substantial volume and desirable mix of products represented by its wire rod requirements makes it an attractive customer to suppliers thereby providing it with the opportunity to purchase rod at more favorable pricing relative to its competitors. As the Company’s purchases are dollar denominated, there are no exchange rate risks.

     In recent years, trade actions initiated by domestic rod producers have impacted the balance of supply and demand in the market as well as pricing. In January 1999, domestic rod producers initiated a Section 201 filing with the U.S. International Trade Commission (“ITC”) alleging that rising import levels had resulted in serious injury to the domestic industry. In response to the ITC’s report, in February 2000, President Clinton announced import relief for the domestic industry in the form of a “tariff-rate-quota” (“TRQ”), under which imported rod would be subject to duties once the imported quantities exceeded certain levels. The TRQ framework that was implemented provided for a gradual increase in the annual tonnage that may enter the domestic market each year as well as a gradual reduction in the applicable tariff for imports in excess of the quota. In November 2001, President Bush amended the terms of the TRQ by changing the administration of the quota system to a regional approach from the previous worldwide structure. In addition, administrative changes were made intended to balance the entry of imported material into the market. For the final year of the quota program, which was March 2002 to February 2003, the duty rate for imports in excess of the quota decreased to 5.0% from 7.5%.

     In addition to the TRQ limitations, in August 2001, four domestic producers of wire rod filed anti-dumping and countervailing duty complaints against twelve wire rod exporting countries. These countries accounted for over 80% of the imported wire rod that entered the domestic market during the year preceding the filing. In October 2002, the ITC determined that domestic producers were materially injured by imports of carbon steel wire rod from seven countries. The Department of Commerce (“DOC”) found that wire rod had been sold in the United States at less than fair value and imposed anti-dumping duty margins ranging from 4% to 369%.

     In 2002, demand for wire rod in the United States was curtailed by the continued weakness in economic conditions. In spite of the reduced demand, wire rod prices rose primarily due to the decreasing supply of foreign rod resulting from trade restrictions as well as reductions in domestic capacity related to mill closures. Although alternative sources of foreign rod were available to meet the Company’s requirements, prices increased as a result of the uncertainty caused by the pending anti-dumping

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and countervailing duty cases. In 2003, demand for wire rod remained at depressed levels due to the continuation of weak economic conditions. Additional reductions in domestic capacity, including the closure of a major rod mill that was previously one of the Company’s primary suppliers, significantly curtailed the domestic supply alternatives available to wire rod consumers. Prices escalated due to the combined impact of the decrease in domestic supply and the reduced availability of rod from foreign countries that were subject to the anti-dumping and countervailing duty orders. Additionally, the weakening in the value of the dollar made the domestic market less attractive to foreign producers and drove import prices higher.

     Selling prices for the Company’s products tend to move closely with changes in rod prices - typically within a three-month period - although the timing varies based on market conditions and competitive factors. The balance of supply and demand in the Company’s markets for its finished products determines whether its margins expand or contract during periods of rising or falling wire rod prices. Depending upon the relative strength of demand, the Company can be negatively impacted when rod prices are rising if it is unable to pass through offsetting increases in selling prices to its customers while the contrary holds true when raw material costs are falling.

     During the recent rapid rise in wire rod costs, the Company adopted a pricing policy with respect to its wire products to consider replacement costs of wire rod rather than inventory costs. The rapidly increasing cost environment together with the Company’s modified pricing policy favorably impacted its profit margins beginning in January 2004.

Competition

     The markets in which Insteel’s business is conducted are highly competitive, including competition from other manufacturers of wire products whose revenues and financial resources are much larger than the Company’s. Some of its competitors are integrated steelmakers that produce both wire rod and wire products and offer multiple product lines over broad geographical areas. Other competitors are smaller independent wire mills that offer limited competition in certain markets. Market participants compete on the basis of price, quality and service. Quality and service expectations of customers have risen substantially over the years and are key factors that impact their selection of suppliers. Technology has become a critical factor in maintaining competitive levels of conversion costs and quality. The Company believes that it is one of the leading low cost producers of wire products based upon its technologically-advanced manufacturing facilities and production capabilities. In addition, the Company believes that it offers a broader range of products through more diverse distribution channels than any of its competitors. The Company believes that it is well positioned to compete favorably with other producers of wire products.

Employees

     As of September 27, 2003, the Company employed 677 people. The Company has a collective bargaining agreement with a labor union at its Wilmington, Delaware facility, which expired in November 2003. Following the expiration of the agreement, the union members elected to continue working without a contract until April 2004, when the Company and the union agreed to a new labor contract that expires in November 2006. Approximately 61 employees at the Wilmington plant are union members. The Company also has a collective bargaining agreement in effect for 7 remaining employees at its Jacksonville, Florida facility, which expired in April 2004 and was replaced by a new contract that is effective through April 2005. The Company believes that its relations with the labor unions and its employees are satisfactory.

Environmental Matters

     The Company believes that it is in compliance in all material respects with applicable environmental laws and regulations. The Company has experienced no material difficulties in complying with legislative or regulatory standards and believes that these standards have not materially impacted its financial position or results of operations. Compliance with future additional environmental requirements could necessitate capital outlays. However, the Company does not believe that these expenditures should ultimately result in a material adverse effect on its financial position or results of operations.

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Executive Officers of the Company

     The executive officers of the Company are as follows:

     Howard O. Woltz, Jr., has been a Director and Chairman of the Board since 1958 and has served in various capacities for more than 50 years. He had been President of the Company from 1958 to 1968 and from 1974 to 1989. He previously served as Vice President, General Counsel and a director of Quality Mills, Inc., a publicly held manufacturer of knit apparel and fabrics, for more than 35 years prior to its acquisition in 1988 by Russell Corporation.

     H. O. Woltz III, a son of Howard O. Woltz, Jr., was elected Chief Executive Officer in 1991 and has served in various capacities for more than 25 years. He was named President and Chief Operating Officer in 1989. He had been Vice President of the Company since 1988 and, previously, President of Rappahannock Wire Company, formerly a subsidiary of the Company, from 1981 to 1989. Mr. Woltz has been a director of the Company since 1986 and also serves as President of IWP. Mr. Woltz serves on the Executive Committee of the Company’s Board of Directors.

     Michael C. Gazmarian joined Insteel as Chief Financial Officer and was elected Treasurer in 1994. He had been with Guardian Industries Corp., a privately held glass manufacturer, since 1986, serving in various financial capacities.

     Gary D. Kniskern was elected Vice President - Administration in 1994 and has served in various capacities for more than 23 years. He had been Secretary and Treasurer since 1984 and, previously, internal auditor since 1979.

     The executive officers listed above were elected by the Board of Directors at its annual meeting held February 25, 2003 for a term that will expire at the next annual meeting of the Board of Directors or until their successors are elected and qualify. The next meeting at which officers will be elected is scheduled for July 20, 2004.

Item 2. Properties.

     Insteel’s corporate headquarters and Insteel Wire Products’ sales and administrative offices are located in Mount Airy, North Carolina. The Company operates seven manufacturing facilities located in Dayton, Texas; Fredericksburg, Virginia; Gallatin, Tennessee; Hickman, Kentucky; Mount Airy, North Carolina; Sanderson, Florida; and Wilmington, Delaware. In connection with its exits from certain businesses, the Company is pursuing a sale of idle facilities located in Jacksonville, Florida, Brunswick, Georgia and Andrews, South Carolina.

     The Company owns all of its real estate, all of which is pledged as security under long-term financing agreements. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. The Company’s manufacturing facilities are suitable for their intended purposes and have capacities adequate for current and projected needs for existing products.

Item 3. Legal Proceedings.

     At the time of the Company’s acquisition of Florida Wire and Cable, Inc. (“FWC”), FWC was a party to a Rod Supply Agreement (the “Agreement”) with its then parent, GS Industries, Inc. (“GSI”) which was to remain in effect through its termination date of December 31, 2004. The Agreement required FWC to purchase and GSI to supply 80% of FWC’s requirement for certain grades of wire rod subject to a minimum purchase and supply quantity of 99,000 tons per year and a maximum purchase and supply quantity of 150,000 tons per year. On October 1, 2002, FWC was merged into IWP.

     In February 2001, GSI and certain of its subsidiaries, including Georgetown Steel Corporation, filed for bankruptcy protection. During GSI’s bankruptcy proceeding, the Agreement was assigned to Georgetown Steel Corporation. Georgetown Steel Corporation emerged from bankruptcy in July 2002 as Georgetown Steel Company LLC (“GSC”). In October 2003, GSC

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filed for bankruptcy protection and permanently discontinued operations at its steel mill.

     Following the closure of its steel mill, GSC breached the terms of the Agreement by failing to supply wire rod to the Company and the Company was forced to cover its requirements in the open market at prices in excess of the prices as defined in the Agreement. Due to its immediate need for raw materials, the Company incurred substantial excess costs in covering its wire rod requirements for the first quarter of fiscal 2004. In response, the Company elected to defer the payment of the outstanding balances owed to GSC pending a settlement for the recovery of the excess costs it had incurred.

     On December 4, 2003 GSC filed suit against the Company in United States Bankruptcy Court for the District of South Carolina seeking payment by the Company of its pre-petition obligation to GSC (approximately $4.9 million) and alleging that (i) the Agreement had been disregarded by the parties and was not effective, (ii) the Company wrongfully withheld payments for material that was not subject to the terms of the Agreement, and (iii) the Company wrongfully withheld payments for material that it claimed was defective. The Company answered the complaint on January 9, 2004. On April 22, 2004, the Company and GSC agreed to a settlement which resulted in a $0.8 million gain ($1.1 million settlement offset by $0.3 million rod claim) for the Company that will be recorded in other income in the third quarter of fiscal 2004. Under the terms of the agreement, the Company will pay GSC the amount of $3.8 million over a period of six months ending in October 2004.

     Other than as noted above, there are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or which any of their property is a subject.

Item 4. Submission of Matters to a Vote of Security Holders.

     No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2003.

PART II

Item 5. Market for the Registrant’s Common Stock and Related Shareholder Matters.

     In January 2002, the Company was notified by the New York Stock Exchange (“NYSE”) that it would initiate procedures to suspend trading and delist the common stock of the Company in view of the fact that it had fallen below the following NYSE continued listing standards: (1) average global market capitalization over a consecutive 30 trading-day period less than $15.0 million, and (2) average closing price of the Company’s common stock less than $1.00 over a consecutive 30 trading-day period. In February 2002, the Company’s common stock began trading on the OTC bulletin board (“OTCBB”). In February 2004, the Company’s common stock ceased trading on the OTCBB and began trading on the Pink Sheets (www.pinksheets.com) under the symbol “IIIN” due to the Company’s noncompliance with the OTCBB’s filing requirement which requires that an issuer’s filings with the U.S. Securities and Exchange Commission (“SEC”) are current (subject to a 30-day grace period). The Company anticipates that its common stock will resume trading on the OTCBB following the filing of this report together with its Form 10-Qs for the periods ended December 27, 2003 and March 27, 2004. The Company continues to be subject to all applicable periodic reporting requirements of the SEC.

     At June 7, 2004, there were 1,601 shareholders of record. For information regarding the Company’s stock price and dividend history, see “Item 8(b) - Supplementary Data” in this report.

     In November 2000, the Company suspended its quarterly cash dividend in connection with the terms of a covenant waiver with its senior lenders under its credit facility. Pursuant to the restrictions of its new credit facility, the Company is subject to limitations on the payment of dividends (see Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Credit Facilities”) and it does not intend to pay cash dividends in the foreseeable future.

     In April 1999, the Company’s Board of Directors adopted a Rights Agreement between the Company and First Union National Bank, as Rights Agent. In connection with adopting the Rights Agreement, the Company declared a dividend of one right per share of the Company’s common stock to shareholders of record as of May 17, 1999. Generally, the Rights Agreement provides that one right will attach to each share of the Company’s common stock issued after that date. Each right entitles the registered holder to purchase from the Company on certain dates described in the Rights Agreement one one-hundredth of a share of the Company’s Series A Junior Participating Preferred Stock. For more information regarding the Company’s Rights Agreement, see Note 17 under “Item 8(a) - Financial Statements” in this report.

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Equity Compensation Plan Information
Year Ended September 27, 2003
(In thousands, except exercise price amounts)

Item 6. Selected Financial Data.

Financial Highlights

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies

     The Company’s financial statements have been prepared in accordance with accounting policies generally accepted in the United States. The Company’s discussion and analysis of its financial condition and results of operations are based on these financial statements. The preparation of the Company’s financial statements requires the application of these accounting policies in addition to certain estimates and judgments by the Company’s management. The Company’s estimates and judgments are based on current available information, actuarial estimates, historical results and other assumptions believed to be reasonable. Actual results could differ from these estimates.

     The following critical accounting policies are used in the preparation of the financial statements:

     Revenue recognition and credit risk. The Company recognizes revenue from product sales when the product is shipped

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and risk of loss and title has passed to the customer. Substantially all of the Company’s accounts receivable are due from customers that are located in the U.S. and the Company generally requires no collateral depending upon the creditworthiness of the account. The Company provides an allowance for doubtful accounts based upon its assessment of the credit risk of specific customers, historical trends and other information. There is no disproportionate concentration of credit risk.

     Allowance for doubtful accounts. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company’s customers were to change significantly, adjustments to the allowances may be required. While the Company believes its recorded trade receivables will be collected, in the event of default in payment of a trade receivable, the Company would follow normal collection procedures.

     Excess and obsolete inventory reserves. The Company writes down the carrying value of its inventory for estimated obsolescence to reflect the lower of the cost of the inventory or its estimated net realizable value based upon assumptions about future demand and market conditions. If actual market conditions for the Company’s wire products are substantially different than those projected by management, adjustments to these reserves may be required.

     Valuation allowances for deferred income tax assets. The Company has recorded valuation allowances related to a portion of its deferred income tax assets for which it cannot support the presumption that expected realization meets a “more likely than not” criteria. If the timing or amount of future taxable income is different than management’s current estimates, adjustments to the valuation allowances may be necessary.

     Accruals for self-insured liabilities and litigation. The Company has accrued its estimate of the probable costs related to self-insured medical and workers’ compensation claims and legal matters. These estimates have been developed in consultation with actuaries, the Company’s legal counsel and other advisors and are based on management’s current understanding of the underlying facts and circumstances. Because of uncertainties related to the ultimate outcome of these issues as well as the possibility of changes in the underlying facts and circumstances, adjustments to these reserves may be required in the future.

     Recent accounting pronouncements. In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment and Disposal of Long-Lived Assets.” This statement replaced certain aspects of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and APB No. 30, “Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 144 retains the basic provisions from both SFAS No. 121 and APB No. 30 but incorporates changes to improve financial reporting and comparability among entities. The Company adopted the provisions of SFAS No. 144 during the first quarter of fiscal 2003, which did not have a material impact on its results of operations or financial position.

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

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

     In November 2002, the FASB issued FASB Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a guarantee is issued, an entity must recognize an initial liability for the fair value, or market value, of the obligations

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assumed and disclose such information in its interim and annual financial statements. The initial recognition and measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of this Interpretation did not have a material impact on the Company’s financial statements.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – An Amendment to FASB Statement No. 123.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” providing entities with alternative transition methods should they elect to change to the fair value method of accounting for stock-based compensation prescribed by SFAS No. 123. As amended by SFAS No. 148, SFAS No. 123 also requires additional disclosure regarding stock-based compensation in annual and condensed interim financial statements. The new annual disclosure requirements have been applied in fiscal 2003 and will be applied in interim disclosures beginning with the first quarter of fiscal 2004.

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

     In January 2003, the Financial Accounting Standards Board (“FASB”) issued FIN 46, “Consolidation of Variable Interest Entities - An Interpretation of Accounting Research Bulletin (“ARB”) No. 51”. This Interpretation is intended to clarify the application of the majority voting interest requirement of ARB No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The controlling financial interest may be achieved through arrangements that do not involve voting interests.

     Subsequent to issuing FIN 46, the FASB issued FIN 46 (revised) (“FIN 46R”), which replaces FIN 46. Among other things, FIN 46R clarified and changed the definition and application of a number of provisions of FIN 46 including de facto agents, variable interests and variable interest entity (“VIE”). FIN 46R also expanded instances when FIN 46 should not be applied. FIN 46R was issued December 23, 2003 and, for the Company, is effective no later than the end of the second quarter of 2004. FIN 46R may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The Company has not identified any significant variable interests that would have a material impact on its financial statements upon adoption of FIN 46 at the end of the second quarter of fiscal 2004.

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

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Results of Operations

Statements of Operations – Selected Data
(Dollars in thousands)

2003 Compared with 2002

Net Sales

     Net sales decreased 15% to $212.1 million in 2003 from $251.0 million in 2002 primarily due to the elimination of revenues from the product lines that the Company has exited, including certain segments of the industrial wire business and the nail business, together with lower sales of concrete reinforcing products. On a comparable basis, excluding the revenues from the discontinued product lines, sales decreased 3%. Shipments for the year decreased 20% while average selling prices rose 5% from the prior year levels. Excluding the discontinued product lines, shipments fell 7% while average selling prices rose 4%.

     Sales of the Company’s concrete reinforcing products (welded wire fabric and PC strand) declined 5% from a year ago, but rose to 87% of consolidated sales from 77%. Demand for the Company’s concrete reinforcing products was unfavorably impacted by the reduced level of nonresidential construction activity. Pricing pressure for standard styles of welded wire fabric remained intense during the period. Sales of industrial wire products (tire bead wire and other industrial wire excluding revenues from the industrial wire and nail businesses that the Company has exited) rose 10% from the prior year, increasing to 13% of consolidated sales from 10%. Sales of the product lines that the Company has exited represented 13% of consolidated sales in 2002. The changes in product mix were primarily due to increased sales of industrial wire products and reduced sales of concrete reinforcing products in the current year together with the impact of the Company’s exit from certain segments of the industrial wire business and the nail business in the prior year.

Gross Profit

     Gross profit decreased 12% to $21.3 million, or 10.0% of net sales in 2003 from $24.1 million, or 9.6% of net sales in 2002. The decrease in gross profit was largely driven by the reduction in sales and compression in spreads between average selling prices and raw material costs in certain product lines together with the unfavorable impact of reduced schedules and downtime on the operating costs of the Company’s manufacturing facilities.

Selling, General and Administrative Expense

     Selling, general and administrative expense (“SG&A expense”) decreased 2% to $11.3 million, or 5.3% of net sales in 2003 from $11.6 million, or 4.6% of net sales in 2002. The decrease in SG&A expense was primarily due to the elimination of selling and administration costs associated with the product lines that the Company exited as well as the savings generated from previously implemented cost reduction measures. These decreases were partially offset by legal fees related to the dumping and

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countervailing duty cases that were filed by a coalition of domestic PC strand producers, including the Company, against certain countries exporting into the U.S. markets and higher selling expenses in support of the development of the Company’s engineered structural mesh business.

Restructuring Charges

     In 2002, the Company recorded restructuring charges totaling $13.0 million for losses on the sale of certain assets associated with the Company’s nail business and write-downs in the carrying value of the remaining assets to be disposed of ($5.0 million), estimated costs related to the closure of the Company’s nail operations ($854,000), losses on the sale of certain assets associated with the Company’s galvanized strand business and write-downs in the carrying value of the remaining assets to be disposed of ($3.1 million), an impairment loss on the long-lived assets and closure reserves associated with the industrial wire business ($4.3 million) and separation costs associated with other selling and administration staffing reductions ($114,000). These charges were partially offset by the benefit from a $361,000 reduction in the reserves that were previously recorded related to the Company’s exit from the galvanized strand business. Approximately $11.4 million of the restructuring charges were non-cash charges related to asset write-downs or losses on asset sales and the remaining $1.6 million were cash charges associated with the sale of the industrial wire and nail businesses and employee separation costs.

Other Expense (Income)

     Other expense was $7,000 in 2003 compared with other income of $797,000 in 2002. In 2002, the Company recorded a $1.0 million gain in other income in connection with an insurance settlement, which was partially offset by $215,000 of other expense. The insurance settlement was related to a property damage and business interruption claim resulting from an accident that occurred at the Fredericksburg, Virginia facility in August 1999.

Earnings Before Interest, Income Taxes and Accounting Change

     The Company’s earnings before interest, income taxes and accounting change was $9.9 million in 2003 compared with $343,000 in 2002. Excluding restructuring charges and the gain on an insurance settlement in the prior year, the Company’s earnings before interest, income taxes and accounting change was $12.3 million.

Interest Expense

     Interest expense decreased $1.7 million, or 15%, to $10.1 million in 2003 from $11.8 million in 2002. The decrease was primarily due to reductions in the average borrowing levels on the Company’s senior secured credit facility ($2.3 million) and amortization expense associated with capitalized financing costs ($216,000), partially offset by higher average interest rates ($786,000).

Income Taxes

     The Company’s effective income tax rate increased substantially in 2003 due to a reduction of the valuation allowance on deferred income tax assets from $7.5 million to $1.3 million. The reduction in the valuation allowance was due to management’s determination that the realization of certain net operating loss carryforwards was more likely than not in view of the taxable income generated during fiscal 2004 but prior to this Filing. This reduction accounts for $6.2 million of the $6.8 million benefit for income taxes that was recorded in 2003. Due to the near breakeven pre-tax earnings of the Company (a pre-tax loss of $112,000), the changes in the valuation were amplified in the calculation of the effective income tax rates. The Company anticipates that the rate will return to historical levels near 38% when it has taxable income.

Cumulative Effect of Accounting Change

     In 2002, the Company recorded a non-cash charge of $14.4 million, or $1.70 per share, for the cumulative effect of an accounting change. During the second quarter of fiscal 2002, the Company completed the testing of the goodwill associated with Florida Wire and Cable, Inc. (“FWC”), required in connection with its adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142 effective September 30, 2001, the first day of fiscal year 2002. Based on the results of the testing, the Company determined that goodwill had been impaired and that a charge should be recorded as of the date of adoption at the beginning of fiscal 2002. Following the adoption of SFAS No. 142, no goodwill amortization was recorded in 2003 or 2002 (see Note 4 to Consolidated Financial Statements – Goodwill and Intangible Assets in Item 8 below).

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Net Earnings (Loss)

     The Company’s net earnings for 2003 were $6.7 million, or $0.79 per share, compared to a loss of $25.7 million, or $3.04 per share, in 2002.

2002 Compared with 2001

Net Sales

     Net sales decreased 16% to $251.0 million in 2002 from $299.8 million in 2001 primarily due to the elimination of revenues from the product lines that the Company has exited, including galvanized strand, nails and certain segments of the industrial wire business. On a comparable basis, excluding the revenues from these discontinued product lines, sales decreased 2%. Sales of the Company’s concrete reinforcing products (welded wire fabric and PC strand) declined 5% from a year ago, but rose to 77% of consolidated net sales from 67%. Sales of wire products (tire bead wire and industrial wire, excluding revenues from the industrial wire and nail businesses which the Company has exited) increased 34% from a year-ago, rising to 10% of consolidated sales from 8%. The changes in product mix were primarily due to increased sales of welded wire fabric and tire bead wire in the current year together with the impact of the Company’s exit from the galvanized strand, nail and certain segments of the industrial wire business. Sales from discontinued product lines represented 13% of the Company’s consolidated sales in 2002.

Gross Profit

     Gross profit rose 13% to $24.1 million, or 9.6% of net sales in 2002 from $21.3 million, or 7.1% of net sales in 2001. The 2.5 point increase in gross margin was due to higher productivity levels and favorable costs achieved by the Company’s manufacturing facilities, which reduced average unit conversion costs. These improvements served to more than offset the compression in spreads between average selling prices and raw material costs from prior year levels.

Selling, General and Administrative Expense

     Selling, general and administrative expense (“SG&A expense”) fell 33% to $11.6 million, or 4.6% of net sales in 2002 from $17.1 million, or 5.7% of net sales in 2001. The decrease in SG&A expense was primarily related to the elimination of selling and administration costs associated with the product lines that the Company has exited as well as the savings generated from previously implemented cost reduction measures. In addition, $863,000 of the decrease resulted from the elimination of goodwill amortization expense in 2002 in connection with the Company’s adoption of Statement of Financial Accounting Standards No. 142.

Restructuring Charges

     The Company recorded restructuring charges totaling $13.0 million in 2002 for losses on the sale of certain assets associated with the Company’s nail business and write-downs in the carrying value of the remaining assets to be disposed of ($5.0 million), estimated costs related to the closure of the Company’s nail operations ($854,000), losses on the sale of certain assets associated with the Company’s galvanized strand business and write-downs in the carrying value of the remaining assets to be disposed of ($3.1 million), an impairment loss on the long-lived assets and closure reserves associated with the industrial wire business ($4.3 million) and separation costs associated with other selling and administration staffing reductions ($114,000). These charges were partially offset by the benefit from a $361,000 reduction in the reserves that were previously recorded related to the Company’s exit from the galvanized strand business. Approximately $11.4 million of the restructuring charges were non-cash charges related to asset write-downs or losses on asset sales and the remaining $1.6 million were cash charges associated with the sale of the industrial wire and nail businesses and employee separation costs.

     In 2001, the Company recorded restructuring charges totaling $28.3 million consisting of $26.2 million of impairment losses associated with the write-downs in the carrying values of the Company’s tire bead wire and galvanized strand manufacturing facilities, and $2.1 million for the estimated plant closure costs associated with the sale of its galvanized strand business. The $16.1 million impairment loss recorded on the tire bead wire facility was primarily related to unfavorable changes in the market that have occurred since the Company entered the business. The $10.1 million impairment loss recorded on the galvanized strand facility was due to the change in circumstances resulting from the sale of certain assets of the galvanized strand business and the planned closure and liquidation of the remaining assets of the facility.

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Other Income

     Other income rose to $797,000 in 2002 from $436,000 in 2001. In 2002, the Company recorded a $1.0 million gain in other income in connection with an insurance settlement, which was partially offset by $215,000 of other expense. The insurance settlement was related to a property damage and business interruption claim resulting from an accident that occurred at the Fredericksburg, Virginia facility in August 1999.

     In 2001, the Company recorded a $622,000 gain in other income in connection with the sale of assets associated with its galvanized strand and nail businesses, which was partially offset by $185,000 of other expense.

Earnings (Loss) Before Interest, Income Taxes and Accounting Change

     The Company’s earnings before interest, income taxes and accounting change was $343,000 in 2002 compared with a loss before interest, income taxes and accounting change of $23.7 million in 2001.

Interest Expense

     Interest expense decreased $3.0 million, or 20%, to $11.8 million in 2002 from $14.8 million in 2001. The decrease was primarily due to reductions in the average borrowing levels on the Company’s senior secured credit facility ($1.6 million) and amortization expense associated with capitalized financing costs ($1.4 million).

Income Taxes

     The Company’s effective income tax rate decreased to 0.1% in 2002 from 37.7% in 2001. The decrease was primarily due to the establishment of a $7.5 million valuation allowance against the Company’s deferred tax assets related to the tax benefit generated by the loss incurred for the current year.

Cumulative Effect of Accounting Change

     In 2002, the Company recorded a non-cash charge of $14.4 million, or $1.70 per share, for the cumulative effect of an accounting change. During the second quarter of fiscal 2002, the Company completed the testing of the goodwill associated with Florida Wire and Cable, Inc. (“FWC”), required in connection with its adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142 effective September 30, 2001, the first day of fiscal year 2002. Based on the results of the testing, the Company determined that goodwill had been impaired and that a charge should be recorded as of the date of adoption at the beginning of the current fiscal year. In accordance with generally accepted accounting principles, the Company’s 2001 results reflect charges for the amortization of goodwill of $863,000. Following the adoption of SFAS No. 142, no goodwill amortization was recorded in 2002 (see Note 4 to Consolidated Financial Statements – Goodwill and Intangible Assets in Item 8 below).

Net Earnings (Loss)

     The Company’s net loss for 2002 increased to $25.7 million, or $3.04 per share, from $23.8 million, or $2.81 per share, in 2001. Excluding the cumulative effect of an accounting change, the loss in 2002 was $11.4 million, or $1.34 per share.

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Liquidity and Capital Resources

Selected Financial Data
(Dollars in thousands)

Cash Flow Analysis

     Operating activities provided $3.8 million of cash in 2003 compared to $7.8 million in 2002 while using $1.5 million in 2001. The decrease in 2003 was primarily due to the decline in the Company’s financial performance (after adjusting for the non-cash accounting change ($14.4 million) and restructuring charges ($13.0 million) in the prior year), the increase in the cash used for working capital, and the reduction in depreciation and amortization. The net change in the working capital components of receivables, inventories and accounts payable and accrued expenses used $5.2 million in 2003 compared to $4.0 million in 2002. Depreciation and amortization declined by $1.3 million, or 16%, compared to the prior year primarily due to the sale of certain assets of the industrial wire and nail businesses in 2002 together with lower amortization expense associated with capitalized financing costs. In 2003, the amount recorded for other changes reflects the receipt of a $3.0 million federal tax refund.

     Investing activities used $716,000 of cash in 2003 while providing $18.2 million of cash in 2002 and $6.0 million in 2001. The cash provided in 2002 was principally related to the $16.4 million of proceeds generated from the sale of the South Carolina industrial wire business, the Company’s investment in Structural Reinforcing Products and certain assets of the Company’s galvanized strand and nail businesses. In 2001, the cash provided included $8.1 million of proceeds from the sale of certain assets of the Company’s galvanized strand and nail businesses. Capital expenditures amounted to $1.0 million, $528,000 and $2.3 million in 2003, 2002 and 2001, respectively. The decreases in capital expenditures were primarily related to the curtailment of the Company’s capital outlays in connection with its debt reduction efforts. The Company expects that capital expenditures will remain at reduced levels in 2004 in comparison to the recent historical levels prior to 2001.

     Financing activities used $3.0 million, $26.7 million and $6.5 million of cash in 2003, 2002 and 2001, respectively. The reduction in financing requirements in 2003, 2002 and 2001 was primarily related to the Company’s debt reduction efforts. In 2003, principal payments reflect the application of a $3.0 million federal tax refund, which was used to pay down term debt on the credit facility.

     The Company’s total debt to capital ratio decreased to 69% at September 27, 2003 compared with 76% at September 28, 2002 and 67% at September 29, 2001. The decrease was due to the combined impact of a $3.3 million net reduction in debt and a $7.9 million increase in shareholders’ equity in the current year. The Company believes that, in the absence of significant unanticipated cash demands, net cash generated by operating activities and amounts available under its revolving credit facility will be sufficient to satisfy its working capital and capital expenditure requirements.

Credit Facilities

Previous Facility

     As of September 27, 2003, the Company had a senior secured credit facility with a group of banks, consisting of a $42.0 million revolving credit facility, a $28.5 million term loan and a $10.3 million term loan. In February 2003, the Company and its senior lenders agreed to an amendment to the credit agreement that extended the previously amended maturity date of the credit facility from October 15, 2003 to March 31, 2004. The amendment also provided for certain other terms and conditions, including: (1) changes in the applicable margins that allow the Company to lower its interest rates through future reductions in

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the term loan; (2) additional fees which become payable to the lenders on certain dates unless a refinancing of the credit facility is completed before such dates; (3) the deferral of the payment dates of other contingent fees consistent with the period of time for which the maturity date was extended; (4) adjustments to the financial covenants that are applicable under the credit agreement; (5) limitations on the amount of capital expenditures to $1.8 million for each fiscal year; and (6) mandatory prepayments of the term loan should actual EBITDA exceed certain thresholds.

     Under the amended terms of the credit agreement, interest rates on the credit facility are determined based upon a base rate that is established at the higher of the prime rate or 0.50% plus the federal funds rate, plus, in either case, an applicable interest rate margin. As of September 27, 2003, interest rates on the credit facility were as follows: 7% on the revolver and 8% on the term loans. In addition, a commitment fee is payable on the unused portion of the revolving credit facility and a utilization fee is payable on the $10.3 million term loan.

     Advances under the revolving credit facility are limited to the lesser of the revolving credit commitment or a borrowing base amount that is calculated based upon a percentage of eligible receivables and inventories. At September 27, 2003, approximately $6.5 million was available under the revolving credit facility. Under the amended terms of the credit agreement, the Company is subject to financial covenants that require the maintenance of EBITDA and net worth above specified levels. The Company was in compliance with all of the financial covenants as of September 27, 2003. The senior secured credit facility is collateralized by all of the Company’s assets.

     The Company and its senior lenders have agreed to certain modifications in the credit facility through a series of amendments to the credit agreement. The previous amendments had the effect of increasing the Company’s interest expense from the amounts that would have been incurred under the original terms of the credit agreement as a result of: (1) increases in the applicable interest rate margins; (2) additional fees, a portion of which are calculated based upon the Company’s stock price, payable to the lenders on certain dates and in increasing amounts based upon the timing of the completion of a refinancing of the credit facility; and (3) a reduction in the term of the credit facility and the period over which the capitalized financing costs are amortized, resulting in higher amortization expense. Upon an event of default, the lenders would be entitled to the right to payment of that portion of the fees that are calculated based upon the Company’s stock price.

     As required by its lenders under the terms of the credit facility, in April 2000, the Company entered into interest rate swap agreements to reduce the financial impact of future interest rate fluctuations on its earnings and cash flows. These agreements effectively converted $50.0 million of the Company’s variable rate debt to a fixed rate of 7.08% plus the applicable margin under the credit facility. The Company has designated its interest rate swap agreements as cash flow hedges and formally assesses on an ongoing basis whether these agreements are highly effective in offsetting the changes in the fair values of the interest cash flows under its senior secured credit facility. The amount of hedge ineffectiveness associated with these agreements was not material for the years ended September 27, 2003, September 28, 2002, or September 29, 2001. Interest rate differentials paid or received under these swap agreements are recognized in income over the life of the agreements as adjustments to interest expense. Changes in the fair value of the swap agreements are recorded as a component of “accumulated other comprehensive loss.” The fair value of the swap agreements was ($4.1 million) as of September 27, 2003, ($5.6 million) as of September 28, 2002 and ($5.0 million) as of September 29, 2001and was recorded in other liabilities on the Company’s consolidated balance sheet. As discussed below in Item 7A., these interest rate swap agreements were terminated in May 2004.

New Facility

     In March 2004, the Company reached preliminary agreements with new lenders for the refinancing of its senior secured credit facility. In order to facilitate the anticipated refinancing, the Company’s existing lenders agreed to an extension in the maturity date of the current credit facility from March 31, 2004 to May 17, 2004 and a subsequent extension from May 17, 2004 to June 4, 2004. On June 3, 2004, the Company entered into a new $82.0 million senior secured debt facility with one lender, consisting of a $60.0 million revolver, a $17.0 million Term Loan A and a $5.0 million Term Loan B, which has a four-year term maturing on June 2, 2008. Proceeds from the financing were used to pay off the Company’s existing credit facility (approximately $62.4 million outstanding as of the closing date) and will support its working capital, capital expenditure and general corporate requirements going forward. The credit facility is secured by all of the Company’s assets.

     Advances under the revolving credit facility are limited to the lesser of the revolving credit commitment or a borrowing base amount that is calculated based upon a percentage of eligible receivables and inventories. As of June 3, 2004, approximately $42.2 million was outstanding on the revolver and excess availability was $10.9 million. The Term Loan A amortizes over 47 months, beginning on July 1, 2004, at $283,000 per month with the remaining principal balance due on June 2, 2008. The Term Loan B does not amortize and the entire principal balance is due in a single payment on June 2, 2008.

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     Interest rates on the revolver and Term Loan A 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. Interest rates on the Term Loan B are based upon the higher of the prime rate or 0.50% plus the federal funds rate plus an applicable interest rate margin. The applicable interest rate margins are initially 1.50% for the base rate and 3.00% for the LIBOR rate on the revolver, 2.25% for the base rate and 3.75% for the LIBOR rate on Term Loan A, and 7.00% for the base rate on Term Loan B. Beginning on April 2, 2005, the applicable interest rate margins will be adjusted within the following ranges on a quarterly basis based upon the Company’s leverage ratio: 1.00% - 1.75% for the base rate and 2.50% - 3.25% for the LIBOR rate on the revolver, 1.50% - 2.25% for the base rate and 3.00% - 3.75% for the LIBOR rate on Term Loan A, and 5.00% - 7.00% for the base rate on Term Loan B. In addition, the applicable interest rate margins may be adjusted further based on the amount of excess availability on the revolver and the occurrence of certain events of default provided for under the credit facility.

     The Company’s ability to borrow available amounts under the credit facility will be restricted or eliminated in the event of certain covenant breaches, events of default or if the Company is unable to make certain representations and warranties, including that a Material Adverse Change (as defined in the Credit Agreement) has not occurred with respect to the Company.

     Financial Covenants

     The terms of the credit facility require the Company to maintain certain fixed charge coverage and leverage ratios during the term of the credit facility. Commencing with the fiscal quarter ending on October 2, 2004, the Company must have a Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of not less than 1.15 at the end of each fiscal quarter for the 12-month period then ended (or, for the fiscal quarters ending on or before July 2, 2005, the period commencing on June 1, 2004 and ending on the last day of such fiscal quarter). In addition, the Company must maintain a Leverage Ratio (as defined in the Credit Agreement) of not more than 3.25 as of the last day of each quarter through July 1, 2006, and not more than 3.00 thereafter. The Company is also required to have consolidated EBITDA equal to at least $15.0 million for the quarter ending June 26, 2004.

     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 capital expenditures;
	•		make investments in or loans to third parties, unless certain conditions are met with respect to such investments or loans;
	•		incur or assume indebtedness;
	•		issue securities;
	•		enter into certain transactions with affiliates of the Company; or
	•		permit liens to encumber the Company’s property and assets.

     The Company is limited to Capital Expenditures (as defined in the Credit Agreement) of not more than $5.0 million for the period beginning on May 30, 2004 and ending on October 2, 2004, and not more than $7.0 million for each fiscal year thereafter through the year ended September 29, 2007, and for the period beginning on September 30, 2007 and ending on June 2, 2008, plus for any of these periods, up to a $2.0 million carryover of the amount by which actual Capital Expenditures are less than the applicable limitation for the prior period.

     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 other agreement;
	•		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;

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	•		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.

Off Balance Sheet Arrangements

     The Company has no material transactions, arrangements, obligations (including contingent obligations), or other relationships with unconsolidated entities or other persons, that have or are reasonably likely to have a material current or future impact on its financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenues or expenses.

Aggregate Contractual Obligations

     The Company’s aggregate contractual obligations are as follows:

Payments Due by Period
(in thousands)

     These aggregate maturities represent amounts due under the new facility. The difference between the total of these amounts and long-term debt reflected on the accompanying balance sheet at September 27, 2003 is due to payments of $4.0 million made by the Company related to the previous revolving credit facility prior to the closing of the new facility on June 3, 2004. The current portion of long-term debt reflected on the accompanying balance sheet at September 27, 2003 represents principal payments made related to the old facility during fiscal 2004 and scheduled principal payments to be made on the new facility during fiscal 2004

Outlook

     The Company believes that a gradual recovery in nonresidential construction spending from the depressed levels of recent years will lead to increased demand for its concrete reinforcing products. Additionally, limited supplies of wire rod, the Company’s primary raw material, have caused the Company, and many of its competitors, to adjust their product offerings and the relative availability of products based upon profitability. The recovery of demand and the Company’s more favorable cost structure together with rapidly rising costs of raw materials and changes in its selling practices have caused margins to expand significantly in fiscal 2004. The Company’s ability to continue to pass through higher raw material costs in its markets will be dependent on the competitive environment and the willingness of other producers to accept lower margins to retain volume at the expense of profitability. In the event that it is unsuccessful in recovering higher costs in its markets, the Company’s financial performance would be negatively impacted as a result of the compression in gross margin.

     The Company is continuing to pursue a broad range of initiatives to improve its financial performance and reduce debt. Over the prior year, the Company focused on increasing the productivity levels and reducing the operating costs of its manufacturing facilities as well as its selling and administrative activities. Additional resources were directed towards the development of the Company’s engineered structural mesh business as well as other niche products and these efforts will be intensified in fiscal 2004. The Company anticipates that these actions together with the disposal of excess assets will facilitate further reductions in debt and favorably impact its financial performance for fiscal 2004 (see “Cautionary Note Regarding Forward-Looking Statements”).

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

     The Company’s cash flows and earnings are subject to fluctuations resulting from changes in commodity prices, interest rates and foreign exchange rates. The Company manages its exposure to these market risks through internally established policies

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and procedures and, when deemed appropriate, through the use of derivative financial instruments. The Company does not use financial instruments for trading purposes and is not a party to any leveraged derivatives. The Company monitors its underlying market risk exposures on an ongoing basis and believes that it can modify or adapt its hedging strategies as necessary.

Commodity Prices

     The Company does not generally use derivative commodity instruments to hedge its exposures to changes in commodity prices. The principal commodity price exposure is hot-rolled carbon steel wire rod, the Company’s primary raw material, which is purchased from both domestic and foreign suppliers and denominated in U.S. dollars. Historically the Company has typically negotiated quantities and pricing on a quarterly basis for both domestic and foreign steel wire rod purchases to manage its exposure to price fluctuations and to ensure adequate availability of material consistent with its requirements. The recent tightening of supply in the rod market together with the rising costs of rod producers has resulted in increased price volatility. In some instances, rod producers have resorted to increasing the frequency of price adjustments, typically on a monthly basis. The Company’s ability to acquire steel wire rod from foreign sources on favorable terms is impacted by fluctuations in foreign currency exchange rates, foreign taxes, duties, tariffs, and other trade actions. Although changes in wire rod costs and the Company’s selling prices tend to be correlated, depending upon market conditions, there may be periods during which it is unable to fully recover increased rod costs through higher selling prices, which reduces its gross profit and cash flow from operations.

Interest Rates

     The Company has debt obligations that are sensitive to changes in interest rates under its senior secured credit facility. As required by its lenders under the terms of its senior secured credit facility, in April 2000, the Company entered into interest rate swap agreements to reduce the financial impact of future interest rate fluctuations on its earnings and cash flows. These agreements effectively converted $50.0 million of the Company’s floating rate debt to a fixed rate of 7.08% plus the applicable margin under the credit facility. Interest rate differentials paid or received under these swap agreements are recognized in income over the life of the agreements as adjustments to interest expense. Based on the Company’s interest rate exposure and floating rate debt levels as of September 27, 2003, and considering the effect of the interest rate swap, a 100 basis point change in interest rates would have an estimated $0.2 million impact on pre-tax earnings over a one-year period. In connection with the refinancing that was completed on June 3, 2004, the Company terminated the interest rate swap agreements in May 2004 for payments totaling $2.1 million.

Foreign Exchange Exposure

     The Company has not typically hedged foreign currency exposures related to transactions denominated in currencies other than U.S. dollars, although such transactions have not been material in the past. The Company will occasionally hedge firm commitments for certain equipment purchases that are denominated in foreign currencies. The decision to hedge any such transactions is made by the Company on a case-by-case basis. There were no forward contracts outstanding as of September 27, 2003.

Item 8. Financial Statements and Supplementary Data.

(a) Financial Statements

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(b) Supplementary Data

     Selected quarterly financial data is as follows:

Financial Information by Quarter (Unaudited)
(In thousands, except for per share and price data)

23

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

See accompanying notes to consolidated financial statements.

24

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

See accompanying notes to consolidated financial statements.

25

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands)

See accompanying notes to consolidated financial statements.

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

See accompanying notes to consolidated financial statements

27

INSTEEL INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 27, 2003, SEPTEMBER 28, 2002 AND SEPTEMBER 29, 2001

(1) Description of Business

     Insteel Industries, Inc. (“Insteel” or “the Company”) is one of the nation’s largest manufacturers of wire products. The Company’s wholly-owned subsidiary, Insteel Wire Products Company (“IWP”), manufactures and markets concrete reinforcing and industrial wire products for a broad range of construction and industrial applications. The Company’s products are sold directly to users as well as through numerous wholesalers and distributors located nationwide as well as into Canada, Mexico, and Central and South America.

(2) Summary of Significant Accounting Policies

     Fiscal year. The Company’s fiscal year is the 52 or 53 weeks ending on the Saturday closest to September 30. Fiscal years 2003, 2002 and 2001 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 statements 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 maturities of three months or less to be cash equivalents.

     Stock options. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, “Stock-Based Compensation,” the Company has continued to measure compensation expense for its stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” Pro forma disclosures of net income are presented as if the fair value-based method prescribed by SFAS No. 123 had been applied in measuring compensation expense for the periods required by the statement.

     The Company has elected to follow APB No. 25, “Accounting for Stock Issued to Employees,” in accounting for its stock option plans. APB No. 25 specifies that no compensation expense is recognized when the exercise price of the stock options equals the market value of the underlying stock at the grant date, as in the case of options granted under the Company’s plans. SFAS No. 123, “Accounting for Stock-Based Compensation,” specifies the use of certain option valuation models to calculate estimated compensation expense to be reflected in pro forma net earnings and net earnings per share. The Company’s pro forma net earnings for year ended September 27, 2003 are greater than its reported earnings due to the cancellation of certain options. The Company’s pro forma information is as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

     The weighted average estimated fair values of options granted during 2003, 2002 and 2001 were $0.54, $0.29 and $1.64 per share, respectively.

     Revenue recognition and credit risk. The Company recognizes revenue from product sales when the product is shipped and risk of loss and title has passed to the customer. Substantially all of the Company’s accounts receivable are due from customers that are located in the U.S and the Company generally requires no collateral depending upon the creditworthiness of the account. The Company provides an allowance for doubtful accounts based upon its assessment of the credit risk of specific customers, historical trends and other information. There is no disproportionate concentration of credit risk. The allowance for doubtful accounts balance was reduced in 2003 due to write-offs of fully reserved accounts.

     Inventories. Inventories are valued at the lower of average cost (which approximates computation on a first-in, first-out basis) or market (net realizable value or replacement cost).

     Property, plant and equipment. Property, plant and equipment are stated at cost or otherwise at reduced values to the extent there have been asset impairment write-downs. Expenditures for maintenance and repairs are charged directly to expense when incurred, while major improvements are capitalized. Depreciation is computed for financial reporting purposes principally by use of the straight-line method over the following estimated useful lives: machinery and equipment, 3 - 15 years; buildings, 10 - 30 years; land improvements, 5 - 15 years. Depreciation expense was approximately $5.3 million, $6.3 million, and $9.2 million for the years ended September 27, 2003, September 28, 2002 and September 29, 2001, respectively. Capitalized software is amortized over the shorter of the estimated useful life or 5 years. No interest costs were capitalized in 2003, 2002 or 2001.

      Other assets. Other assets consist principally of non-current deferred tax assets, the cash surrender value of life insurance policies, assets held for sale and capitalized financing costs. Amortization of intangible assets is computed using the straight-line basis over the economic lives of the respective assets. Capitalized financing costs are amortized on a straight-line basis over the remaining term of the associated debt.

     Long-lived assets. Long-lived assets include property, plant and equipment and identifiable intangible assets with definite useful lives. Long-lived assets are periodically reviewed for impairment by comparing the carrying value of the assets with their estimated future undiscounted cash flows. If it is determined that an impairment loss has occurred, the loss is recognized during the period incurred. An impairment loss is calculated as the difference between the carrying value and the present value of estimated future net cash flows or comparable market values.

     Fair value of financial instruments. The carrying amounts for cash and cash equivalents, accounts and notes receivable, accounts payable and accrued expenses approximate fair value because of their short maturities. The estimated fair value of long-term debt is primarily based upon quoted market prices as well as borrowing rates currently available to the Company for bank loans with similar terms and maturities. The carrying amount of long-term debt approximates its estimated fair value under the amended terms of the Company’s senior secured credit facility (see Note 5 – Credit Facilities).

     Income taxes. Income taxes are based on pretax financial accounting income. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. The Company periodically 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.

     Earnings per share. Basic earnings per share (“EPS”) are computed by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted EPS are computed by dividing net earnings by the weighted average number of common shares and other dilutive equity securities outstanding during the period. Securities that have the effect of increasing EPS are considered to be antidilutive and are not included in the computation of diluted EPS.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

     Recent accounting pronouncements. In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment and Disposal of Long-Lived Assets.” This statement replaced certain aspects of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and APB No. 30, “Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 144 retains the basic provisions from both SFAS No. 121 and APB No. 30 but incorporates changes to improve financial reporting and comparability among entities. The Company adopted the provisions of SFAS No. 144 during the first quarter of fiscal 2003, which did not have a material impact on its results of operations or financial position.

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

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

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

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – An Amendment to FASB Statement No. 123.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” providing entities with alternative transition methods should they elect to change to the fair value method of accounting for stock-based compensation prescribed by SFAS No. 123. As amended by SFAS No. 148, SFAS No. 123 also requires additional disclosure regarding stock-based compensation in annual and condensed interim financial statements. The new annual disclosure requirements have been applied in fiscal 2003 and will be applied in interim disclosures beginning with the first quarter of fiscal 2004.

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

     In January 2003, the Financial Accounting Standards Board (“FASB”) issued FIN 46, “Consolidation of Variable Interest Entities - An Interpretation of Accounting Research Bulletin (“ARB”) No. 51”. This Interpretation is intended to clarify the application of the majority voting interest requirement of ARB No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The controlling financial interest may be achieved through arrangements that do not involve voting interests.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

     Subsequent to issuing FIN 46, the FASB issued FIN 46 (revised) (“FIN 46R”), which replaces FIN 46. Among other things, FIN 46R clarified and changed the definition and application of a number of provisions of FIN 46 including de facto agents, variable interests and variable interest entity (“VIE”). FIN 46R also expanded instances when FIN 46 should not be applied. FIN 46R was issued December 23, 2003 and, for the Company, is effective no later than the end of the second quarter of 2004. FIN 46R may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The Company has not identified any significant variable interests that would have a material impact on its financial statements upon adoption of FIN 46 at the end of the second quarter of fiscal 2004.

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

     Reclassifications. Certain amounts within the accompanying consolidated statement of cash flows for the year ended September 29, 2001 have been revised to reflect the following reclassifications for consistency with the September 27, 2003 and September 28, 2002 presentation: (1) the reclassification of $3.2 million of cash and cash equivalents to accounts payable to more appropriately state bank overdrafts; and (2) the reclassification of $3.2 million from accounts receivable to prepaid expenses and other current assets ($4.1 million) and accrued expenses ($928,000) to more appropriately classify certain non-trade receivables and accruals for sales rebates to customers.

(3) Divestitures and Restructuring Charges

     Divestiture of investment in Structural Reinforcement Products. In July 2002, the Company sold its 25% ownership interest in Structural Reinforcement Products, Inc. (“SRP”), a manufacturer of welded wire fabric products, and liquidated other related investments, generating net proceeds of $6.6 million. The Company had accounted for its investment in SRP on an equity basis and, accordingly, reflected its proportionate share of SRP’s earnings in its consolidated earnings. The Company recorded an equity loss of $151,000 in 2002 and equity income of $160,000 in 2001 in other expense (income) on its consolidated statement of operations.

     Divestiture of industrial wire business. In May 2002, the Company sold certain assets related to its industrial wire business located in Andrews, South Carolina for net proceeds of $10.2 million. Sales of this business were $24.6 million in 2002 and $37.3 million in 2001. The loss on the sale of the business was immaterial.

     Divestiture of nail business. In January 2002, the Company exited the bulk and collated nail business with the closure of its nail manufacturing operations located in Andrews, South Carolina. The assets associated with the nail business were sold in March 2002 generating net proceeds of $1.6 million. Sales of this business were $7.5 million in 2002 and $24.3 million in 2001. The loss on the sale of the business was immaterial.

     Divestiture of galvanized strand business. In May 2001, the Company sold certain assets related to its galvanized strand business located in Jacksonville, Florida for $8.1 million and recorded a gain of $262,000 in other income on its consolidated statement of operations. Sales of this business were $14.6 million in 2001 and $10.6 million in 2000.

     Under the terms of the agreement, the Company agreed to continue to manufacture galvanized strand for the acquirer of the business through a transition period, which ended in October 2001. Following the completion of the transition period, the operations of the facility were ceased and the Company is pursuing a sale of the remaining assets.

     Restructuring charges. The Company recorded restructuring charges totaling $13.0 million in 2002 for losses on the sale of certain assets associated with the Company’s nail business and write-downs in the carrying value of the remaining assets to be disposed of ($5.0 million), estimated costs related to the closure of the Company’s nail operations ($854,000), losses on the sale of certain assets associated with the Company’s galvanized strand business and write-downs in the carrying value of the remaining assets to be disposed of ($3.1 million), an impairment loss on the long-lived assets and closure reserves associated with the industrial wire business ($4.3 million) and separation costs associated with other selling and administration staffing reductions ($114,000). These charges were partially offset by the benefit from a $361,000 reduction in the reserves that were previously recorded related to the Company’s exit from the galvanized strand business. Approximately $11.4 million of the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

restructuring charges were non-cash charges related to asset write-downs or losses on asset sales and the remaining $1.6 million were other charges associated with the sale of the industrial wire and nail businesses and employee separation costs.

     In 2001, the Company recorded non-cash restructuring charges totaling $28.3 million consisting of $26.2 million of impairment losses associated with the write-downs in the carrying values of the Company’s tire bead wire and galvanized strand manufacturing facilities, and $2.1 million for the estimated plant closure costs associated with the sale of its galvanized strand business. The $16.1 million impairment loss recorded on the tire bead wire facility was primarily related to unfavorable changes in the market that have occurred since the Company entered the business. The $10.1 million impairment loss recorded on the galvanized strand facility was due to the change in circumstances resulting from the sale of certain assets of the galvanized strand business and the planned closure and liquidation of the remaining assets of the facility.

     In determining the impairment losses, the Company considered historical performance and future estimated results in the evaluation of potential impairment. This analysis indicated that the carrying amount of the assets was not recoverable through the future undiscounted cash flows expected to result from the use of the assets.

     A reconciliation of the restructuring charge activity associated with the plant closure costs as of September 27, 2003 September 28, 2002, and September 29, 2001 is as follows:

(4) Goodwill and Intangible Assets

     In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” Under SFAS No. 142, the Company no longer amortizes goodwill and intangibles, which have indefinite lives. SFAS No. 142 requires that the Company assess goodwill and certain intangible assets with indefinite useful lives for impairment upon adoption at the beginning of the fiscal year (September 30, 2001) and at least annually thereafter. The Company performed the initial impairment review required by SFAS No. 142 during the second quarter of fiscal year 2002 and determined that it will perform its annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of fiscal 2002.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

     Under SFAS No. 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. For purposes of the impairment testing, the Company determined that the goodwill asset to be tested was entirely related to the continuing operations of FWC, a subsidiary of the Company that was acquired in January 2000. In calculating the impairment charge, the fair value of the impaired reporting unit, FWC, was estimated using a multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”) based on recent comparable transactions and using a discounted cash flow methodology based on estimated future cash flows.

     Based on the impairment testing performed during the second quarter of fiscal 2002, the Company recorded a non-cash charge of $14.4 million, or $1.70 per share, as the cumulative effect of a change in accounting principle to write off the entire goodwill balance associated with FWC as of the beginning of the fiscal year. As a result, the Company has no goodwill recorded on its consolidated balance sheet as of September 27, 2003 or September 28, 2002.

     The Company’s fiscal 2001 results reflect goodwill amortization expense (pre-tax) of $936,000. A reconciliation of the previously reported fiscal 2001 results to pro forma amounts that reflect the elimination of goodwill amortization is presented below:

(5) Credit Facilities

       Long-term debt as of September 27, 2003 and September 28, 2002 consisted of the following:

     As of September 27, 2003, the Company had a senior secured credit facility with a group of banks, consisting of a $42.0 million revolving credit facility, a $28.5 million term loan and a $10.3 million term loan. In February 2003, the Company and its senior lenders agreed to an amendment to the credit agreement that extended the previously amended maturity date of the credit facility from October 15, 2003 to March 31, 2004. The amendment also provided for certain other terms and conditions, including: (1) changes in the applicable margins that allow the Company to lower its interest rates through future reductions in the term loan; (2) additional fees which become payable to the lenders on certain dates unless a refinancing of the credit facility is completed before such dates; (3) the deferral of the payment dates of other contingent fees consistent with the period of time for which the maturity date was extended; (4) adjustments to the financial covenants that are applicable under the credit agreement; (5) limitations on the amount of capital expenditures to $1.8 million for each fiscal year; and (6) mandatory prepayments of the term loan should actual EBITDA exceed certain thresholds.

     Under the amended terms of the credit agreement, interest rates on the credit facility are determined based upon a base rate that is established at the higher of the prime rate or 0.50% plus the federal funds rate, plus, in either case, an applicable interest rate margin. As of September 27, 2003, interest rates on the credit facility were as follows: 7% on the revolver and 8% on the term loans. In addition, a commitment fee is payable on the unused portion of the revolving credit facility and a utilization

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

fee is payable on the $10.3 million term loan.

     Advances under the revolving credit facility are limited to the lesser of the revolving credit commitment or a borrowing base amount that is calculated based upon a percentage of eligible receivables and inventories. At September 27, 2003, approximately $6.5 million was available under the revolving credit facility. Under the amended terms of the credit agreement, the Company is subject to financial covenants that require the maintenance of EBITDA and net worth above specified levels. The Company was in compliance with all of the financial covenants as of September 27, 2003. The senior secured credit facility is collateralized by all of the Company’s assets.

     The Company and its senior lenders have agreed to certain modifications in the credit facility through a series of amendments to the credit agreement. The previous amendments had the effect of increasing the Company’s interest expense from the amounts that would have been incurred under the original terms of the credit agreement as a result of: (1) increases in the applicable interest rate margins; (2) additional fees, a portion of which are calculated based upon the Company’s stock price, payable to the lenders on certain dates and in increasing amounts based upon the timing of the completion of a refinancing of the credit facility; and (3) a reduction in the term of the credit facility and the period over which the capitalized financing costs are amortized, resulting in higher amortization expense. Upon an event of default, the lenders would be entitled to the right to payment of that portion of the fees that are calculated based upon the Company’s stock price.

     As required by its lenders under the terms of the credit facility, in April 2000, the Company entered into interest rate swap agreements to reduce the financial impact of future interest rate fluctuations on its earnings and cash flows. These agreements effectively converted $50.0 million of the Company’s variable rate debt to a fixed rate of 7.08% plus the applicable margin under the credit facility. The Company has designated its interest rate swap agreements as cash flow hedges and formally assesses on an ongoing basis whether these agreements are highly effective in offsetting the changes in the fair values of the interest cash flows under its senior secured credit facility. The amount of hedge ineffectiveness associated with these agreements was not material for the years ended September 27, 2003, September 28, 2002, or September 29, 2001. Interest rate differentials paid or received under these swap agreements are recognized in income over the life of the agreements as adjustments to interest expense. Changes in the fair value of the swap agreements are recorded as a component of “accumulated other comprehensive loss.” The fair value of the swap agreements was ($4.1 million) as of September 27, 2003, ($5.6 million) as of September 28, 2002 and ($5.0 million) as of September 29, 2001and was recorded in other liabilities on the Company’s consolidated balance sheet. In connection with the refinancing that was completed on June 3, 2004, the Company terminated the interest rate swap agreements in May 2004 for payments totaling $2.1 million.

New Facility

     In March 2004, the Company reached preliminary agreements with new lenders for the refinancing of its senior secured credit facility. In order to facilitate the anticipated refinancing, the Company’s existing lenders agreed to an extension in the maturity date of the current credit facility from March 31, 2004 to May 17, 2004 and a subsequent extension from May 17, 2004 to June 4, 2004. On June 3, 2004, the Company entered into a new $82.0 million senior secured debt facility with one lender, consisting of a $60.0 million revolver, a $17.0 million Term Loan A and a $5.0 million Term Loan B, which has a four-year term maturing on June 2, 2008. Proceeds from the financing were used to pay off the Company’s existing credit facility (approximately $62.4 million outstanding as of the closing date) and will support its working capital, capital expenditure and general corporate requirements going forward. The credit facility is secured by all of the Company’s assets.

     Advances under the revolving credit facility are limited to the lesser of the revolving credit commitment or a borrowing base amount that is calculated based upon a percentage of eligible receivables and inventories. As of June 3, 2004, approximately $42.2 million was outstanding on the revolver and excess availability was $10.9 million. The Term Loan A amortizes over 47 months, beginning on July 1, 2004, at $283,000 per month with the remaining principal balance due on June 3, 2008. The Term Loan B does not amortize and the entire principal balance is due in a single payment on June 2, 2008.

     Interest rates on the revolver and Term Loan A 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. Interest rates on the Term Loan B are based upon the higher of the prime rate or 0.50% plus the federal funds rate plus an applicable interest rate margin. The applicable interest rate margins are initially 1.50% for the base rate and 3.00% for the LIBOR rate on the revolver, 2.25% for the base rate and 3.75% for the LIBOR rate on Term Loan A, and 7.00% for the base rate on Term Loan B. Beginning on April 2, 2005, the applicable interest rate margins will be adjusted within the following ranges on a quarterly basis based upon the Company’s leverage ratio: 1.00% - 1.75% for the base rate and

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2.50% - - 3.25% for the LIBOR rate on the revolver, 1.50% - 2.25% for the base rate and 3.00% - 3.75% for the LIBOR rate on Term Loan A, and 5.00% - 7.00% for the base rate on Term Loan B. In addition, the applicable interest rate margins may be adjusted further based on the amount of excess availability on the revolver and the occurrence of certain events of default provided for under the credit facility.

     The Company’s ability to borrow available amounts under the credit facility will be restricted or eliminated in the event of certain covenant breaches, events of default or if the Company is unable to make certain representations and warranties, including that a Material Adverse Change (as defined in the Credit Agreement) has not occurred with respect to the Company.

     Financial Covenants

     The terms of the credit facility require the Company to maintain certain fixed charge coverage and leverage ratios during the term of the credit facility. Commencing with the fiscal quarter ending on October 2, 2004, under the terms of the credit facility the Company must have a Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of not less than 1.15 at the end of each fiscal quarter for the 12-month period then ended (or, for the fiscal quarters ending on or before July 2, 2005, the period commencing on June 1, 2004 and ending on the last day of such fiscal quarter). In addition, the Company must maintain a Leverage Ratio (as defined in the Credit Agreement) of not more than 3.25 as of the last day of each quarter through July 1, 2006, and not more than 3.00 thereafter. The Company is also required to have consolidated EBITDA equal to at least $15.0 million for the quarter ending June 26, 2004.

     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 capital expenditures;
	•		make investments in or loans to third parties, unless certain conditions are met with respect to such investments or loans;
	•		incur or assume indebtedness;
	•		issue securities;
	•		enter into certain transactions with affiliates of the Company; or
	•		permit liens to encumber the Company’s property and assets.

     The Company is limited to Capital Expenditures (as defined in the Credit Agreement) of not more than $5.0 million for the period beginning on May 30, 2004 and ending on October 2, 2004, and not more than $7.0 million for each fiscal year thereafter through the year ended September 29, 2007, and for the period beginning on September 30, 2007 and ending on June 2, 2008, plus for any of these periods, up to a $2.0 million carryover of the amount by which actual Capital Expenditures are less than the applicable limitation for the prior period.

     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 other agreement;
	•		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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

     Aggregate scheduled maturities of long-term debt (reflecting the amended terms of the senior secured credit facility) for the next five fiscal years are as follows: 2004, $2.7 million; 2005,$3.7 million; 2006, $3.7 million; 2007, $3.4 million; 2008, $52.8 million. Capitalized financing costs associated with the senior secured facility were $1.5 million at September 27, 2003, $1.7 million at September 28, 2002 and $1.8 million at September 29, 2001. These aggregate maturities represent amounts due under the new facility. The difference between the total of these amounts and long-term debt reflected on the accompanying balance sheet at September 27, 2003 is due to payments of $4.0 million made by the Company related to the previous revolving credit facility prior to the closing of the new facility on June 3, 2004. The current portion of long-term debt reflected on the accompanying balance sheet at September 27, 2003 represents principal payments made related to the old facility during fiscal 2004 and scheduled principal payments to be made on the new facility during fiscal 2004.

(6) Shareholders’ Equity

     Shares of common stock outstanding are as follows:

(7) Stock Option Plans

     The Company has stock option plans under which 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 five years and expire ten years from the date of the grant. The options granted during 2003 vest over two years and expire ten years from the date of the grant.

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

     A summary of stock option activity follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The weighted average characteristics of outstanding stock options at September 27, 2003 for various price ranges are as follows:

     At September 27, 2003, 522,000 shares were available for future grants under the plans. Options exercisable were 842,000 at September 27, 2003, 957,000 at September 28, 2002 and 697,000 at September 29, 2001. The weighted average exercise price for these shares was $3.33 for 2003, $5.14 for 2002 and $6.37 for 2001.

(8) Income Taxes

     The benefit for income taxes consisted of:

“N/M” = not meaningful

     The benefit for income taxes differs from the amount computed by applying the federal statutory rate to the Company’s loss before taxes as a result of the following differences:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

     Deferred tax assets and liabilities are recognized for the differences between the tax basis of assets and liabilities and their reported financial statement amounts. Significant components of deferred tax assets and liabilities are as follows:

     The Company has recorded the following amounts for deferred tax assets and tax refunds receivable on its consolidated balance sheets as of September 27, 2003 and September 28, 2002: a current deferred tax asset of $7.1 million (net of valuation allowance) and $1.4 million, respectively, in prepaid expenses and other; a noncurrent deferred tax asset of $5.9 million (net of valuation allowance) and $5.5 million, respectively, in other assets; and a current income tax refund receivable of $3.0 million on the balance sheet as of September 28, 2002 in prepaid expenses and other. The Company has gross federal operating loss carryforwards of $18.0 million that will expire in 19 - 20 years and gross state operating loss carryforwards of $37.2 million that begin to expire in six years, but principally expire in 14 - 20 years. The Company also has federal alternative minimum tax credit carryforwards of $360,000 that do not expire.

     The realization of the Company’s deferred tax assets is entirely dependent upon the Company’s ability to generate future taxable income. Generally accepted accounting principles (“GAAP”) require that the Company periodically assess the need to establish a valuation allowance against its deferred tax assets to the extent the Company no longer believes it is more likely than not that the tax assets will be fully utilized. Based on the Company’s projections of future operations, the Company believes that it will generate sufficient taxable income to utilize all of its federal net operating loss carryforwards. Under GAAP, however, projected financial performance alone is not sufficient to warrant the recognition of a deferred tax asset to the extent the Company has had cumulative losses in recent years. Rather, the presumption exists that absent recent historical evidence of the Company’s ability to generate taxable income, a valuation reserve against deferred tax assets should be established. Accordingly, in connection with the losses incurred for fiscal 2001 and 2002, the Company established a valuation allowance of $7.5 million against its deferred tax assets in 2002. The valuation allowance was reduced during the fourth quarter of 2003 from $7.5 million to $1.3 million eliminating the valuation allowance on all federal net operating losses (“NOLs”) due to their anticipated utilization in 2004. The remaining $1.3 million valuation allowance is to offset various state NOLs that are not anticipated to be utilized during 2004. The valuation allowance established by the Company is subject to periodic review and adjustment based on changes in facts and circumstances.

(9) Employee Benefit Plans