ITEM 1B.
UNRESOLVED STAFF COMMENTS
None
Encore maintains its corporate office and manufacturing plant in McKinney, Texas, approximately 35 miles north of Dallas. The Company’s facilities are located on a combined site of approximately 115 acres and consist of buildings containing approximately 1,285,000 square feet of floor space, of which approximately 24,000 square feet is used for office space and 1,261,000 square feet is used for manufacturing and warehouse operations. The Company is in the process of constructing a new office building on the McKinney site. This building will have approximately 60,000 square feet and is being built to allow further plant expansions that are blocked by the current office. The plant and equipment are owned by the Company and are not mortgaged to secure any of the Company’s existing indebtedness. Encore believes that its plant and equipment are suited to its present needs, comply with applicable federal, state and local laws and regulations, are properly maintained and adequately insured.
There are no material pending proceedings to which the Company is a party or of which any of its property is the subject. However, the Company is a party to litigation and claims arising out of the ordinary business of the Company. While the results of these matters cannot be predicted with certainty, the Company does not believe the final outcome of such litigation and claims will have a material adverse effect on its financial condition, the results of operations or cash flows of the Company, in part because the Company believes that it has adequate insurance to cover any damages that may ultimately be awarded.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE COMPANY
Information regarding Encore’s executive officers including their respective ages as of March 7, 2007 is set forth below:
Mr. Jones has served as President and Chief Executive Officer of the Company since May 2005, after serving as President and Chief Operating Officer of the Company since May 1998. In May 1997, Mr. Jones was named Executive Vice President of the Company, and in October 1997, he was named Chief Operating Officer. He previously held the position of Vice President-Sales and Marketing of Encore from 1992 to May 1997, after serving as Director of Sales since joining the Company in November 1989. He also serves as a member of the Board of Directors.
Mr. Bilban has served as Vice President-Finance, Treasurer, Secretary and Chief Financial Officer of Encore since June 2000. From 1998 until joining the Company in June 2000, Mr. Bilban was Executive Vice President and Chief Financial Officer of Alpha Holdings, Inc., a plastics manufacturing conglomerate. From 1996 until 1998, Mr. Bilban was Vice President and Chief Financial Officer of Wedge Dia-Log Inc., an oil field services company. From 1991 until 1996, Mr. Bilban held financial positions, including Division Controller, with the CT Film Division of Rexene Corporation. From 1978 until 1991 he was employed in various financial capacities with several divisions of Outboard Marine Corporation.
All executive officers are elected annually by the Board of Directors to serve until the next annual meeting of the Board or until their respective successors are chosen and qualified.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company’s Common Stock is traded and quoted on the NASDAQ Stock Market’s Global Select Market under the symbol “WIRE.” The following table sets forth the high and low closing sales prices per share for the Common Stock as reported by NASDAQ for the periods indicated.
As of March 2, 2007, there were 72 record holders of the Company’s Common Stock.
The Company paid its first cash dividend in January 2007. Aside from periodic dividends, management intends to retain the majority of future earnings for the operation and expansion of the Company’s business. The Company did not repurchase any shares of its common stock during the year ended December 31, 2006. For further information see Note 8 of the Consolidated Financial Statements under “Item 8, Financial Statements and Supplementary Data.”
Equity Compensation Plan Information
The following table provides information about the Company’s equity compensation plans as of December 31, 2006.
Performance Graph
The following graph is not “soliciting material,” is not deemed filed with the SEC, and is not to be incorporated by reference into any of the Company’s filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, as amended, respectively.
The following graph sets forth the cumulative total stockholder return, which assumes reinvestment of dividends, of a $100 investment in the Company’s Common Stock, the Peer Group1 and CRSP Total Return Index for The Nasdaq Stock Market (U.S. companies).
The Company believes that although the companies included in the Peer Group are not entirely representative of the Company’s business in the building wire and cable industry, they are the only companies available that are representative of the Company’s business, and they reasonably reflect the Company’s peers in the wire and cable industry.
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
AMONG THE COMPANY, PEER GROUP AND CRSP TOTAL RETURN INDEX
FOR THE NASDAQ STOCK MARKET (U.S.)
A.
The lines represent monthly index levels derived from compounded daily returns that include all dividends.
B.
The indexes are reweighted daily, using the market capitalization on the previous trading day.
C.
If the monthly interval, based on the fiscal year-end, is not a trading day, the preceding trading day is used.
D.
The index level for all series was set to $100.00 on 12/31/2001.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANICAL CONDITION AND RESULTS OF OPERATIONS
Introduction
The following management’s discussion and analysis is intended to provide a better understanding of key factors, drivers and risks regarding the Company and the building wire industry.
Executive Overview
Encore Wire, as stated throughout this report, sells a commodity product in a highly competitive market. Management strongly believes that the historical strength of the Company’s growth and earnings is attributable to the following main factors:
•
Industry leading order fill rates and responsive customer service.
•
Product innovations based on listening to and understanding customer needs.
•
Low cost manufacturing operations, resulting from a state of the art manufacturing plant.
•
A focused management team leading an incentivized work force.
•
Low general and administrative overhead costs.
•
A team of experienced independent manufacturers’ representatives with strong customer relationships across the United States.
These factors, and others, have allowed Encore Wire to grow from a startup in 1989 to $1.25 billion in net sales in 2006. Encore has built a loyal following of customers throughout the lower 48 United States. These customers have developed a brand preference for Encore Wire in a commodity product line, due to the reasons noted above, among others. The Company prides itself on striving to grow sales only where profit margins are acceptable. Senior management monitors gross margins daily, frequently extending down to the individual order level. Management strongly believes that this focused approach to the building wire business has produced success thus far and will lead to continued success.
In 2006, the Company completed the construction of a new 160,000 square foot building on its McKinney, Texas campus to manufacture armored (MC & AC) cable. Armored cable contains copper conductors currently manufactured by the Company, with an aluminum or steel flexible outer jacket. The new facility houses armoring machines the Company purchased. The Company markets the armored cable to its existing customer base, the majority of whom are currently buying this product from other suppliers. Sales of this product line started in the third quarter of 2006.
The construction and remodeling industries drive demand for building wire. Housing construction activity in the U.S.A. softened significantly in 2006. Nationally, commercial construction, which had been down in the first half of the decade picked up in the last two years and according to industry forecasts, may stay strong over the next several years. Data on remodeling is not readily available, however remodeling activity can trend up when new construction slows down.
General
Price competition for electrical wire and cable is intense, and the Company sells its products in accordance with prevailing market prices. Copper, a commodity product, is the principal raw material used by the Company in manufacturing its products. Copper accounted for approximately 82.3%, 76.8%, 73.0%, 67.1%, and 63.9% of the Company’s cost of goods sold during fiscal 2006, 2005, 2004, 2003, and 2002, respectively. The price of copper fluctuates, depending on general economic conditions and in relation to supply and demand and other factors, which causes monthly variations in the cost of copper purchased by the Company. The price of copper rose gradually in 2003 and then accelerated its rise in the fourth quarter. In 2004, copper prices trended upward in the first quarter and then traded in a range during the remainder of 2004. In 2005, copper prices rose slowly and steadily through the first half of the year and then more rapidly in the second half of the year. In 2006, copper prices rose quickly from January through May and then slowly descended throughout the rest of the year. The Company cannot predict copper prices in the future or the effect of fluctuations in the cost of copper on the Company’s future operating results.
Results of Operations
The following table presents certain items of income and expense as a percentage of net sales for the periods indicated.
The following discussion and analysis relates to factors that have affected the operating results of the Company for the years ended December 31, 2006, 2005 and 2004. Reference should also be made to the Consolidated Financial Statements and the related notes included under “Item 8. Financial Statements and Supplementary Data” of this Annual Report.
Net sales were $1.249 billion in 2006, compared to $758.1 million in 2005 and $603.2 million in 2004. The 65% increase in net sales in 2006 versus 2005 was primarily the result of a 73% increase in the average selling price of product sold along with a change in the mix of product sold offsetting a 4.5% decrease in the volume of copper pounds of product sold. The 26% increase in net sales in 2005 versus 2004 was primarily the result of a 28% increase in the average selling price of product sold along with a slight change in the mix of product sold. The large increases in average price in 2006 and 2005 were primarily driven by the increase in raw copper prices. Changes in the mix of product sold also impacted the average prices to a lesser extent. Sales volume increases are generally due to several factors, including increased customer acceptance and product availability. Also in 2006, 2005 and 2004, the Company realized an increase in the spread between the sales price of wire and the price of raw copper for the years as a whole, although the quarterly spreads varied widely. This spread was high in the first quarter of 2004, with the intense price competition in the building wire industry compressing the Company’s spread during the succeeding three quarters. This margin compression continued even further into the first five months of 2005. The margins rebounded sharply in the second half of the year resulting in higher spreads, particularly in the fourth quarter of 2005. Margins during 2006 were volatile. The first quarter of 2006 had lower spreads. However, during the second quarter as copper ran to a record high COMEX price of $4.07 on May 23, 2006, spreads rose to a record high. Margins and spreads slowly declined in the third quarter and then accelerated their decline in the fourth quarter of 2006.
Cost of goods sold was $1.005 billion in 2006, compared to $632.8 million in 2005 and $506.8 million in 2004. Copper costs increased to $826.8 million in 2006 from $486.1 million in 2005 and $370.1 million in 2004. Copper costs as a percentage of net sales increased to 66.2% in 2006 from 64.2% in 2005 and 61.4% in 2004. The increase as a percentage of net sales was due to copper costs rising more than other costs and more than the price of copper wire sold, in percentage terms as discussed above. Other raw material costs as a percentage of net sales were 5.0%, 8.3% and 9.7%, in 2006, 2005, and 2004, respectively. The decrease is due primarily to the Company’s cost of other raw materials per pound of copper sold increasing less than the price of copper wire sold. Depreciation, labor and overhead costs as a percentage of net sales were 5.5% in 2006, compared to 8.1% in 2005 and 10.9% in 2004. The percentage decreases in 2006 and 2005 were due to these costs containing significant fixed components versus the elastic nature of the price of copper wire sold.
Inventories consist of the following at December 31:
Copper prices trended upward dramatically in the first half of 2006, particularly in the second quarter and then slowly descended in the third quarter, accelerating their decrease in the fourth quarter of 2006. However, the 2006 year-end price of copper was still above the beginning of the year price. As of December 31, 2006, the value of all inventories using the LIFO method was less than the FIFO value by $82.3 million. This differential increased $45.8 million versus the December 31, 2005 differential of $36.4 million, resulting in a corresponding increase of $45.8 million in cost of goods sold for the year.
Copper prices trended upward slowly in the first half of 2005, then accelerated their increase during the remainder of 2005. As of December 31, 2005, the value of all inventories using the LIFO method was less than the FIFO value by $36.4 million. This differential increased $21.8 million versus the December 31, 2004 differential of $14.6 million, resulting in a corresponding increase of $21.8 million in cost of goods sold for the year.
Copper prices trended upward in the first quarter of 2004, then traded in a more stable range during the remainder of 2004. As of December 31, 2004, the value of all inventories using the LIFO method was less than the FIFO value by $14.6 million. This differential increased $12.0 million versus the December 31, 2003 differential of $2.6 million, resulting in a corresponding increase of $12.0 million in cost of goods sold. Due to the management of inventory levels during the third and fourth quarters of 2004, the Company liquidated the LIFO inventory layers established in 2003, 2002, 2001, 1999 and a portion of the inventory layer established in 1998. As a result, under the LIFO method, these inventory layers were liquidated at historical costs that were less than current costs, which favorably impacted cost of goods sold by $11.7 million for the full year and net income for the full year by $7.5 million. As of December 31, 2004, the LIFO cost basis of inventory was less than the market value resulting in no lower of cost or market adjustment being required.
Gross profit increased to $244.3 million, or 19.6% of net sales in 2006 from $125.2 million, or 16.5% of net sales in 2005 and from $96.4 million, or 16.0% of net sales in 2004. The changes in gross profit were due to the factors discussed above.
Selling expenses, which include freight and sales commissions, were $51.2 million in 2006, $38.5 million in 2005 and $34.4 million in 2004. As a percentage of net sales, selling expenses dropped to 4.1% in 2006, versus 5.1% in 2005 and 5.7% in 2004. The percentage drop in 2006 and 2005 was due to freight expenses dropping in relation to sales, which increased dramatically in 2006 and 2005. General and administrative expenses, as a percentage of net sales, were 0.7% in 2006, 1.0% in 2005 and 1.3% in 2004. In 2006 and 2005, general and administrative costs decreased as a percent of net sales due to the semi-fixed nature of many of these costs.
Interest expense increased to $7.7 million in 2006 from $3.9 million in 2005 and $2.9 million in 2004. The increases in the last two years are due to the higher average debt levels in 2006 and 2005. The Company capitalized interest expense relating to the construction of assets in the amounts of approximately $657,000 in 2006, $213,000 in 2005 and $165,000 in 2004.
The Company’s effective tax rate was 34.9% in 2006, 33.2% in 2005 and 35.6% in 2004. The decrease in the effective tax rate in 2005 is primarily due to the Company adjusting deferred tax liabilities by $0.8 million in the first quarter, lower overall state tax expense and realizing an approximate 1% reduction from the benefits of the American Jobs Creation of Act of 2004. The Jobs Creation Act of 2004 also reduced the 2006 rate approximately 1.2% versus 2005 and a cumulative 2.24% from 2004.
The American Jobs Creation Act of 2004 provides a deduction from income for qualified domestic production activities that generally will be phased in from 2005 through 2010. Subsequently, the Financial Accounting Standards Board (“FASB”) passed FSP FAS 109-1, which indicates that the available qualified domestic production activity deduction will be treated as a “special deduction” as described in SFAS No. 109. Accordingly, the impact of any deductions is being reported in the period for which the deduction will be claimed on the Company’s tax return.
As a result of the foregoing factors, the Company’s net income was $115.1 million in 2006, $50.1 million in 2005 and $33.4 million in 2004.
Off-Balance Sheet Arrangements
The Company does not currently have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Liquidity and Capital Resources
The following table summarizes the Company’s cash flow activities:
The Company maintains a substantial inventory of finished products to satisfy customers’ prompt delivery requirements. As is customary in the industry, the Company provides payment terms to most of its customers that exceed terms that it receives from its suppliers. Therefore, the Company’s liquidity needs have generally consisted of operating capital necessary to finance receivables and inventory. Capital expenditures have historically been necessary to expand the production capacity of the Company’s manufacturing operations. The Company has historically satisfied its liquidity and capital expenditure needs with cash generated from operations, borrowings under its various debt arrangements and sales of its common stock.
The Company, through its indirectly wholly-owned subsidiary, Encore Wire Limited, a Texas limited partnership (“Encore Wire Limited”), is party to a Financing Agreement with two banks, Bank of America, N.A., as Agent, and Wells Fargo Bank, National Association (the “Financing Agreement”). The Company is the guarantor of the indebtedness under the Financing Agreement. In 2006, the Financing Agreement was amended twice. The Financing Agreement was first amended May 16, 2006, to expand the Company’s line of credit from $85,000,000 to
$150,000,000, as disclosed in previous filings with the SEC. The Financing Agreement was amended a second time on August 31, 2006, to expand the Company’s line of credit from $150,000,000 to $200,000,000, as disclosed in previous filings with the SEC. The Financing Agreement, as amended, extends through August 27, 2009 and provides for maximum borrowings of the lesser of $200,000,000 or the amount of eligible accounts receivable plus the amount of eligible finished goods and raw materials, less any reserves established by the banks. The calculated maximum borrowing amount available at December 31, 2006, as computed under the Financing Agreement, as amended, was $200,000,000.
Encore Wire Limited and the Company, through their agent bank, are also parties to a Note Purchase Agreement (the “2004 Note Purchase Agreement) with Hartford Life Insurance Company, Great-West Life & Annuity Insurance Company, London Life Insurance Company and London Life and Casualty Reinsurance Corporation (collectively, the “2004 Purchasers”), whereby Encore wire Limited issued and sold $45,000,000 of 5.27% Senior Notes, Series 2004-A, due August 27, 2011 (the “Fixed Rate Senior Notes”) to the 2004 Purchasers, the proceeds of which were used to repay a portion of the Company’s outstanding indebtedness under its previous financing agreement. Through its agent bank, the Company is also a party to an interest rate swap agreement to convert the fixed rate on the Fixed Rate Senior Notes to a variable rate based on LIBOR plus a fixed adder for the seven-year duration of these notes. As of December 31, 2006, the Company recorded a liability and a corresponding unrealized reduction to notes payable on the balance sheet of $1,025,709 to account for the fair value of the interest rate swap.
On September 28, 2006, Encore Wire Limited and the Company, through its agent bank, entered into another Note Purchase Agreement (the “2006 Note Purchase Agreement”) with Metropolitan Life Insurance Company, Metlife Insurance Company of Connecticut and Great-West Life & Annuity Insurance Company, whereby Encore Wire Limited issued and sold $55,000,000 of Floating Rate Senior Notes, Series 2006-A, due September 30, 2011 (the “Floating Rate Senior Notes”), the proceeds of which were used to repay a portion of the Company’s outstanding indebtedness under its Financing Agreement.
Obligations under the Financing Agreement, the Fixed Rate Senior Notes and the Floating Rate Senior Notes are unsecured and contain customary covenants and events of default. The Company was in compliance with these covenants as of December 31, 2006. Under the Financing Agreement, the 2004 Note Purchase Agreement and the 2006 Note Purchase Agreement, the Company is allowed to pay cash dividends. At December 31, 2006, the total balance outstanding under the Financing Agreement, the Fixed Rate Senior Notes and the Floating Rate Senior Notes was $100,000,000. Amounts outstanding under the Financing Agreement are payable on August 27, 2009, with interest payments due quarterly. Interest payments on the Fixed Rate Senior Notes are due semi-annually, while interest payments on the Floating Rate Senior Notes are due quarterly.
On November 10, 2006, the Board of Directors of the Company approved a new stock repurchase program covering the purchase of up to 1,000,000 additional shares of its common stock dependent upon market conditions. Common stock purchases under this program were authorized through December 31, 2007 on the open market or through privately negotiated transactions at prices determined by the President of the Company. There were no repurchases of stock in 2004, 2005 or 2006. This new stock repurchase plan replaces the prior stock repurchase plan.
Cash provided by operations was $14.3 million in 2006 compared to cash used in operations of $5.0 million in 2005 and cash provided by operations of $24.9 million in 2004. The increase in cash flows provided in 2006 versus 2005 was due primarily to the $65.0 million increase in net income and a $23.5 million positive swing in prepaid expenses offset by a $61.9 million negative swing in taxes receivable. The taxes receivable swing is due to the Company being required to make high estimated tax payments to the I.R.S. based on the record earnings trend early in 2006. The Company is now owed a $17.8 million tax refund. The decrease in cash in 2005 was due primarily to a $56.5 million increase in accounts receivable and a $28.8 million increase in inventories, offset by $16.7 million increase in net income, a $23.7 million increase in taxes payable and a $7.8 million increase in accounts payable and accrued liabilities. The increases in cash required for accounts receivable and inventories were primarily due to the rise in raw material prices during 2005 that drove sales higher as discussed above, and in the case of inventories, an increase in the quantity of inventory on hand at year-end. Increases in taxes payable and accounts payable are primarily due to timing issues at year-end. In 2004 cash flow from operations was due primarily to a $19.0 million increase in net income, as well as a $20.2 million decrease in inventory, offset by a $27.6 million increase in accounts receivable. Inventory quantities at December 31, 2004 versus December 31, 2003 were cut in raw materials and finished goods, as the Company worked to increase inventory turns while maintaining order fill rates. This was accomplished by pressuring suppliers to be more responsive as well as utilizing the flexibility in receiving copper with the additional railroad tracks and utilizing the flexibility of the new machinery put in service in the wire mills to respond quickly to changes in product demand.
Cash used in investing activities increased to $22.1 million in 2006 from $16.9 million in 2005 and $21.3 million in 2004. During 2006 and 2005, capital expenditures were made primarily in conjunction with the building of the new
armored cable plant and machinery that will be used in the manufacture of this new product line. During 2004, capital expenditures increased to expand the distribution center, expand railroad access and selectively add machinery to address bottlenecks in the wire mills.
The cash provided by financing activities of $29.8 million in 2006 was used primarily to fund increased working capital requirements and capital expenditures as discussed above. The cash provided by financing activities of $21.9 million in 2005 was used primarily to fund capital expenditures and increased working capital requirements. The relatively high level of capital expenditures in 2004 was funded by the strong operating cash flow discussed above, which also funded cash used in financing activities of $1.4 million. Cash provided by financing activities was increased by $0.7 million in 2006, $0.5 million in 2005 and $2.8 million in 2004, as the result of the issuance of common stock, primarily related to employee option exercises.
During 2007, the Company expects its capital expenditures will consist of maintaining and adding manufacturing equipment for its building wire operations as well as the construction of the new office building. The Company also expects its working capital requirements may increase during 2007 as a result of continued increases in sales and potential increases in the price of copper. The Company believes that the cash flow from operations and the financing available from its revolving credit facility will satisfy working capital and capital expenditure requirements for the next twelve months.
Contractual Obligations
As shown below, the Company had the following contractual obligations as of December 31, 2006.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. See Note 1 to the Consolidated Financial Statements. Management believes the following critical accounting policies affect its more significant estimates and assumptions used in the preparation of its consolidated financial statements.
Inventories are stated at the lower of cost, using the last-in, first out (LIFO) method, or market. The Company maintains only one inventory pool for LIFO purposes as all inventories held by the Company generally relate to the Company’s only business segment, the manufacture and sale of copper electrical building wire products. As permitted by U.S. generally accepted accounting principles, the Company maintains its inventory costs and cost of goods sold on a first-in, first-out (FIFO) basis and makes a quarterly adjustment to adjust total inventory and cost of goods sold from FIFO to LIFO. The Company applies the lower of cost or market test by comparing the LIFO cost of its raw materials, work-in-process and finished goods inventories to estimated market values, which are based primarily upon the most recent quoted market price of copper and finished wire prices as of the end of each reporting period. As of December 31, 2006, a $0.20 reduction in the fair market value of copper per pound would not have resulted in any lower of cost or market reserve for the year ended December 31, 2006. However, larger decreases in copper prices could necessitate establishing an LCM reserve in future periods. Additionally, future reductions in the quantity of inventory on hand could cause copper that is carried in inventory at costs different from the cost of copper in the period in which the reduction occurs to be included in costs of goods sold for that period at the different price.
Revenue from the sale of the Company’s products is recognized when goods are shipped to the customer, title and risk of loss are transferred, pricing is fixed or determinable and collection is reasonably assured. A provision for payment discounts and customer rebates is estimated based upon historical experience and other relevant factors and is recorded within the same period that the revenue is recognized.
The Company has provided an allowance for losses on customer receivables based upon estimates of those customers’ inability to make required payments. Such allowance is established and adjusted based upon the makeup of the current receivable portfolio, past bad debt experience and current market conditions. If the financial condition of our customers was to deteriorate and impair their ability to make payments to the Company, additional allowances for losses might be required in future periods.
Recent Accounting Pronouncements
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of Statement of Financial Accounting Standards No. 109 (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of FIN 48, but does not expect it to have a material impact on its consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). This statement establishes a framework for fair value measurements in the financial statements by providing a single definition of fair value, provides guidance on the methods used to estimate fair value and increases disclosures about estimates of fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and is generally applied prospectively. The Company is currently evaluating the impact of this statement on its consolidated financial statements.
In September 2006, the FASB issued FSPAUG AIR-1, Accounting for Planned Major Maintenance Activities (FSPAUG AIR-1). This FSP addresses the planned major maintenance of assets and prohibits the use of the “accrue-in-advance” method of accounting for these activities. This FSP is effective for the first fiscal year beginning after December 15, 2006. The Company is currently evaluating the impact of this FSP, but does not expect it to have a material impact on its consolidated financial statements.
Information Regarding Forward Looking Statements
This report contains various forward-looking statements and information that are based on management’s belief as well as assumptions made by and information currently available to management. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Such statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those expected. Among the key factors that may have a direct bearing on the Company’s operating results and stock price are:
•
Fluctuations in the global and national economy.
•
Fluctuations in the level of activity in the construction and remodeling industries.
•
Demand for the Company’s products.
•
The impact of price competition on the Company’s margins.
•
Fluctuations in the price of copper and other key raw materials.
•
The loss of key manufacturers’ representatives who sell the Company’s product line.
•
Fluctuations in utility costs, especially electricity and natural gas.
•
Fluctuations in insurance costs of various types.
•
Weather related disasters at the Company’s and/or key vendor’s operating facilities.
•
Stock price fluctuations due to “stock market expectations.”
•
Unforeseen future legal issues and/or government regulatory changes.
•
Fluctuations in the Company’s financial position or national banking issues that impede the Company’s ability to obtain reasonable financing.
This list highlights some of the major factors that could affect the Company’s operations or stock price, but cannot enumerate all the potential issues that management faces on a daily basis, many of which are totally out of management’s control. For further discussion of the factors described herein and their potential effects on the Company, see “Item 1. Business,” “Item 1A. Risk Factors,” “Item 7. Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and “Item 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not engage in metal futures trading or hedging activities and does not enter into derivative financial instrument transactions for trading or other speculative purposes. However, the Company is generally exposed to commodity price and interest rate risks. In order to take advantage of the relatively large difference between prevailing interest rates in 2004 and the fixed rate on the Company’s $45 million seven-year notes, the Company entered into an interest rate swap agreement on this fixed portion of its long-term debt. This arrangement was entered into to float the interest rate on that portion of the debt until August 2011.
The Company purchases copper cathode primarily from producers and merchants at prices determined each month based on the average daily COMEX closing prices for copper for that month, plus a negotiated premium. As a result, fluctuations in copper prices caused by market forces can significantly affect the Company’s financial results.
Interest rate risk is attributable to the Company’s long-term debt. The Company and its wholly owned subsidiaries are guarantors of the indebtedness under the Financing Agreement, the 2004 Note Purchase Agreement and the 2006 Note Purchase Agreement. Amounts outstanding under the Financing Agreement, as amended, are payable on August 27, 2009, with interest payments due quarterly. Amounts outstanding under the $45 million 2004 Note Purchase Agreement are payable on August 27, 2011, with interest only payments due semi-annually. Amounts outstanding under the $55 million 2006 Note Purchase Agreement are payable on September 30, 2011, with interest only payments due quarterly. At December 31, 2006, the balance outstanding under the Financing Agreement was zero and the collective balance outstanding collectively under the 2004 and 2006 Note Purchase Agreements was $100 million, and the average interest rate was 6.65%. There is inherent rollover risk for borrowings under the Financing Agreement as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and the Company’s future financing requirements. Holding borrowing levels at December 31, 2006 constant, an average 1% interest rate increase in 2007 would increase interest expense by $1,000,000.
For further information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Item 1A. Risk Factors.”
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and the notes thereto appear on the following pages.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Encore Wire Corporation
We have audited the accompanying consolidated balance sheets of Encore Wire Corporation (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Encore Wire Corporation at December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share Based Payment, in accounting for equity-based compensation.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Encore Wire Corporation’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 7, 2007 expressed an unqualified opinion thereon.
Dallas, Texas
March 7, 2007
Encore Wire Corporation
Consolidated Balance Sheets
See accompanying notes.
Encore Wire Corporation
Consolidated Statements of Income
See accompanying notes.
Encore Wire Corporation
Consolidated Statements of Stockholders’ Equity
See accompanying notes
Encore Wire Corporation
Consolidated Statements of Cash Flows
See accompanying notes.
Encore Wire Corporation
Notes to Consolidated Financial Statements
December 31, 2006
1. Significant Accounting Policies
Business
The Company conducts its business in one segment - the manufacture of copper electrical wire, principally NM-B cable, for use primarily as interior wiring in homes, apartments, and manufactured housing, and THWN-2 cable and armored cable for use primarily as wiring in commercial and industrial buildings. The Company sells its products primarily through approximately 31 manufacturers’ representatives located throughout the United States and, to a lesser extent, through its own direct marketing efforts. The principal customers for Encore’s building wire are wholesale electrical distributors.
Copper, a commodity product, is the principal raw material used in the Company’s manufacturing operations. Copper accounted for 82.3%, 76.8%, and 73.0% of its cost of goods sold during 2006, 2005, and 2004, respectively. The price of copper fluctuates, depending on general economic conditions and in relation to supply and demand and other factors, and has caused monthly variations in the cost of copper purchased by the Company. The Company cannot predict copper prices in the future or the effect of fluctuations on the cost of copper on the Company’s future operating results.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Encore Wire Limited, a Texas limited partnership (“Encore Wire Limited”). Significant intercompany accounts and transactions have been eliminated upon consolidation.
Reclassifications
Certain reclassifications have been made to prior periods’ financial statements to conform to the current presentation.
Recent Accounting Pronouncements
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of Statement of Financial Accounting Standards No. 109 (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of FIN 48, but does not expect it to have a material impact on its consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). This statement establishes a framework for fair value measurements in the financial statements by providing a single definition of fair value, provides guidance on the methods used to estimate fair value and increases disclosures about estimates of fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and is generally applied prospectively. The Company is currently evaluating the impact of this statement on its consolidated financial statements.
In September 2006, the FASB issued FSPAUG AIR-1, Accounting for Planned Major Maintenance Activities (FSPAUG AIR-1). This FSP addresses the planned major maintenance of assets and prohibits the use of the “accrue-in-advance” method of accounting for these activities. This FSP is effective for the first fiscal year beginning after December 15, 2006. The Company is currently evaluating the impact of this FSP, but does not expect it to have a material impact on its consolidated financial statements.
1. Significant Accounting Policies (continued)
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Revenue Recognition
Revenue from the sale of the Company’s products is recognized when goods are shipped to the customer, title and risk of loss are transferred, pricing is fixed or determinable and collection is reasonably assured. A provision for payment discounts and customer rebates is estimated based upon historical experience and other relevant factors and is recorded within the same period that the revenue is recognized.
Freight Expenses
The Company classifies shipping and handling costs as a component of selling, general and administrative expenses. Shipping and handling costs were approximately $18.1 million, $18.6 million, and $16.5 million for the fiscal years ended December 31, 2006, 2005 and 2004, respectively.
Financial Instruments and Concentrations of Credit Risk
Cash, accounts receivable, trade accounts payable, accrued liabilities, notes payable and other long-term liabilities are stated at amounts which approximate fair value.
Accounts receivable represent amounts due from customers (primarily wholesale electrical distributors, manufactured housing suppliers and retail home improvement centers) related to the sale of the Company’s products. Such receivables are uncollateralized and are generally due from a diverse group of customers located throughout the United States. The Company establishes an allowance for losses based upon the makeup of the current portfolio, past bad debt experience and current market conditions.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
Inventories
Inventories are stated at the lower of cost, using the last-in, first-out (LIFO) method, or market. The Company evaluates the market value of its raw materials, work-in-process and finished goods inventory primarily based upon current raw material and finished goods prices at the end of each period.
Property, Plant, and Equipment
Depreciation of property, plant and equipment for financial reporting is provided on the straight-line method over the estimated useful lives of the respective assets as follows: buildings and improvements, 15 to 30 years; machinery and equipment, 3 to 10 years; and furniture and fixtures, 3 to 5 years. Accelerated cost recovery methods are used for tax purposes. Repairs and maintenance costs are expensed as incurred.
Stock-Based Compensation
Prior to January 1, 2006, the Company applied the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). In accordance with the provisions of
1. Significant Accounting Policies (continued)
SFAS 123, the Company applied Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related interpretations in accounting for its plan and, accordingly, did not recognize compensation expense for the plan because stock options were issued at exercise prices equal to the market value of its stock on the date of grant.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which supersedes SFAS 123 and APB 25. SFAS 123R requires all share-based payments to employees to be recognized in the financial statements based on their fair values using an option-pricing model, such as the Black-Scholes model, at the date of grant. The Company elected to use the modified-prospective method for adoption, which requires compensation expense to be recorded for all unvested stock options beginning in the first quarter of adoption. For all unvested options outstanding as of January 1, 2006, compensation expense previously measured under SFAS No. 123, but unrecognized, will be recognized using the straight-line method over the remaining vesting period, net of forfeitures. For share-based payments granted subsequent to January 1, 2006, compensation expense, based on the fair value on the date of grant, as defined by SFAS 123R, will be recognized using the straight-line method from the date of grant over the related service period of the employee receiving the award.
The adoption of SFAS 123R reduced pre-tax income by $420,524, reduced net income by $273,340, and did not appreciably impact basic and diluted earnings per common share for the year ended December 31, 2006. The Company also recognized $805,244 of excess tax benefits on stock based compensation which have been included in cash flows from financing activities upon adoption of SFAS 123R.
The following table illustrates the pro forma effect on net income and earnings per share for 2005 and 2004 as if the Company had applied the fair value recognition provisions of SFAS 123R to stock-based employee compensation (in thousands, except for earnings per common share information):
Earnings Per Share
Earnings per common and common equivalent share are computed using the weighted average number of shares of common stock and common stock equivalents outstanding during each period. The dilutive effects of stock options, which are common stock equivalents, are calculated using the treasury stock method.
Income Taxes
Income taxes are provided for based on the liability method, resulting in deferred income tax assets and liabilities arising due to temporary differences. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years.
2. Inventories
Inventories consist of the following as of December 31:
During the third and fourth quarters of 2004, the Company liquidated the LIFO inventory layers established in 2003, 2002, 2001, 1999 and a portion of the inventory layer established in 1998. As a result, under the LIFO method, these inventory layers were liquidated at historical costs, that were less than current costs, which favorably impacted net income for the full year by $7.5 million. During 2006 and 2005, there were liquidations of inventory quantities.
3. Accrued Liabilities
Accrued liabilities consist of the following as of December 31:
4. Long-Term Notes Payable
Long-term notes payable consist of the following as of December 31:
The Company, through its indirectly wholly-owned subsidiary, Encore Wire Limited, a Texas limited partnership (“Encore Wire Limited”), is party to a Financing Agreement with two banks, Bank of America, N.A., as Agent, and Wells Fargo Bank, National Association (the “Financing Agreement”). The Company is the guarantor of the indebtedness under the Financing Agreement. In 2006, the Financing Agreement was amended twice. The Financing Agreement was first amended May 16, 2006, to expand the Company’s line of credit from $85,000,000 to $150,000,000, as disclosed in previous filings with the SEC. The Financing Agreement was amended a second time on August 31, 2006, to expand the Company’s line of credit from $150,000,000 to $200,000,000, as disclosed in previous filings with the SEC. The Financing Agreement, as amended, extends through August 27, 2009, and provides for maximum borrowings of the lesser of $200,000,000 or the amount of eligible accounts receivable plus the amount of eligible finished goods and raw materials, less any reserves established by the banks. The calculated maximum borrowing amount available at December 31, 2006, as computed under the Financing Agreement, as amended, was $200,000,000. Borrowings under the line of credit bear interest, at the Company’s option at either (1) LIBOR plus a margin that varies from 0.875% to 1.75% depending upon the ratio of debt outstanding to adjusted earnings or (2) the base rate (which is the higher of the federal funds rate plus 0.5% or the prime rate) plus 0% to 0.25%. A commitment fee ranging from 0.20% to 0.375% (depending upon the ratio of debt outstanding to adjusted earnings) is payable on the unused line of credit.
Encore Wire Limited and the Company, through their agent bank, are also parties to a Note Purchase Agreement (the “2004 Note Purchase Agreement) with Hartford Life Insurance Company, Great-West Life & Annuity Insurance Company, London Life Insurance Company and London Life and Casualty Reinsurance Corporation (collectively, the “2004 Purchasers”), whereby Encore wire Limited issued and sold $45,000,000 of 5.27% Senior Notes, Series 2004-A, due August 27, 2011 (the “Fixed Rate Senior Notes”) to the 2004 Purchasers, the proceeds of which were used to repay a portion of the Company’s outstanding indebtedness under its previous financing agreement. Through its agent bank, the Company is also a party to an interest rate swap agreement to convert the fixed rate on the Fixed Rate Senior Notes to a variable rate based on LIBOR plus a fixed adder for the seven-year duration of these notes. As of December 31, 2006, the Company recorded a liability and a corresponding unrealized reduction to notes payable on the balance sheet of $1,025,709 to account for the fair value of the interest rate swap.
On September 28, 2006, Encore Wire Limited and the Company, through its agent bank, entered into another Note Purchase Agreement (the “2006 Note Purchase Agreement”) with Metropolitan Life Insurance Company, Metlife Insurance Company of Connecticut and Great-West Life & Annuity Insurance Company, whereby Encore Wire Limited issued and sold $55,000,000 of Floating Rate Senior Notes, Series 2006-A, due September 30, 2011 (the “Floating Rate Senior Notes”), the proceeds of which were used to repay a portion of the Company’s outstanding indebtedness under its Financing Agreement.
Obligations under the Financing Agreement, the Fixed Rate Senior Notes and the Floating Rate Senior Notes are unsecured and contain customary covenants and events of default. The Company was in compliance with these covenants, as of December 31, 2006. Under the Financing Agreement, the 2004 Note Purchase Agreement and the 2006 Note Purchase Agreement, the Company is allowed to pay cash dividends. At December 31, 2006, the total balance outstanding under the Financing Agreement, the Fixed Rate Senior Notes and the Floating Rate Senior Notes was $100,000,000. Amounts outstanding under the Financing Agreement are payable on August 27, 2009, with interest payments due quarterly. Interest payments on the Fixed Rate Senior Notes are due semi-annually, while interest payments on the Floating Rate Senior Notes are due quarterly.
The Company paid interest totaling $7,686,014, $3,928,906 and $2,978,845 in 2006, 2005 and 2004, respectively. The Company capitalized $656,674, $213,142 and $165,048 of interest in 2006, 2005 and 2004, respectively.
5. Income Taxes
The provisions for income tax expense are summarized as follows for the year ended December 31:
The differences between the provision for income taxes and income taxes computed using the federal income tax rate are as follows for the year ended December 31:
The tax effect of each type of temporary difference giving rise to the net deferred tax liability at December 31, 2006 and 2005, is as follows:
The Company made income tax payments of $99.5 million in 2006, $3.9 million in 2005 and $22.3 million in 2004.
In October 2004, the American Jobs Creation Act of 2004 (“the Act”) was passed, which provides a deduction for income from qualified domestic production activities which generally will be phased in from 2005 through 2010. Subsequently, the Financial Accounting Standards Board (“FASB”) passed FSP FAS 109-1, which indicates that the available qualified domestic production activity deduction will be treated as a “special deduction” as described in SFAS No. 109. This deduction lowered the Company’s effective tax rate by $1,867,862, or approximately 1.2%, for 2006.
6. Stock Options
The Company has one stock option plan that provides for the grant of stock options to its directors, officers and key employees. The Company grants stock option awards at prices equal to the market value of its stock on the date of grant. These options vest ratably over a period of five years from the time the options are granted with maximum terms of ten years.
The following presents a summary of stock option activity for the year ending December 31, 2006 (aggregate intrinsic value in thousands):
The fair value of stock options granted during the years ended December 31, 2006, 2005, and 2004, was estimated on the date of grant using a Black-Scholes options pricing model and the following weighted average assumptions:
We base expected volatilities on historical volatilities of our common stock. The expected life represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting periods and management’s consideration of historical exercise patterns. The risk free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding to the expected life of the option.
SFAS 123R requires the estimation of forfeitures when recognizing compensation expense and adjustment of the estimated forfeiture rate over the requisite service period should actual forfeitures differ from such estimates. Changes in estimated forfeitures are recognized through a cumulative catch-up adjustment, which is recognized in the period of change and impacts the amount of un-recognized compensation expense to be recorded in future periods.
During the years ended December 31, 2006, 2005, and 2004, the weighted average grant date fair value of options granted was $19.63, $6.39, and 9.74, respectively, and the total intrinsic value of options exercised was $2.3 million, $1.2 million, and $5.5 million, respectively. As of December 31, 2006, total unrecognized compensation cost related to nonvested stock options of $979,726 was expected to be recognized over a weighted average period of 4.46 years.
7. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share for the year ended December 31:
Stock options and warrants to purchase common stock at exercise prices in excess of the average actual stock price for the period that were anti-dilutive and that were excluded from the determination of diluted earnings per share are as follows:
8. Stockholders’ Equity
On November 10, 2006, the Board of Directors of the Company approved a new stock repurchase program covering the purchase of up to 1,000,000 additional shares of its common stock dependent upon market conditions. Common stock purchases under this program were authorized through December 31, 2007 on the open market or through privately negotiated transactions at prices determined by the President of the Company. There were no repurchases of stock in 2006, 2005 or 2004.
In November of 2006, the Board of Directors declared a two-cent per share cash dividend payable in January of 2007.
9. Contingencies
There are no material pending proceedings to which the Company is a party or of which any of its property is the subject. However, the Company is a party to litigation and claims arising out of the ordinary business of the Company. While the results of these matters can not be predicted with certainty, the Company does not believe the final outcome of such litigation and claims will have a material adverse effect on the financial condition, the results of operations or the cash flows of the Company, in part because the Company believes that it has adequate insurance to cover any damages that may ultimately be awarded.
10. Encore Wire 401-K Plan
The Company sponsors an employee savings plan (the “401-K Plan”) that is intended to provide participating employees with additional income upon retirement. Employees may contribute between 1% and 15% of eligible
compensation to the 401-K Plan. The Company matches 50% of the first 6% deferred by employees. Employees are eligible to participate in the 401-K Plan and related Company matching contributions after one year of service. Employer matching contributions are vested at a rate of 20% per year and are fully vested after five years of employment. The Company’s contribution expense was $327,007, $280,082 and $279,003 in fiscal years 2006, 2005 and 2004, respectively .
11. Related Party Transactions
The Company purchases certain finished goods inventory components from a company that is partially owned by a family member of an individual serving on its Board of Directors. The Company believes such purchases, which totaled approximately $6.1 million, $6.6 million and $5.6 million in fiscal years 2006, 2005 and 2004, respectively, were made at prices that are no less favorable than are available from non-affiliated parties. Additionally, for a minor portion of its freight requirements, the Company uses a freight carrier that is owned by a family member of one of the Company’s executive officers. During fiscal years 2006, 2005 and 2004, amounts paid to the affiliated freight carrier were not significant.
12. Quarterly Financial Information (Unaudited)
The following is a summary of the unaudited quarterly financial information for the two years ended December 31, 2006 and 2005 (in thousands, except per share amounts):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains controls and procedures designed to ensure that it is able to collect the information it is required to disclose in the reports it files with the SEC, and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Based on an evaluation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report conducted by the Company’s management, with the participation of the Chief Executive and Chief Financial Officers, the Chief Executive and Chief Financial Officers believe that these controls and procedures are effective to ensure that the Company is able to collect, process and disclose the information it is required to disclose in the reports it files with the SEC within the required time periods.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on our assessment, we believe that, as of December 31, 2006, the Company’s internal control over financial reporting is effective based on those criteria.
Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, has been audited by Ernst & Young LLP, the independent registered public accounting firm who also audited the Company’s consolidated financial statements. Ernst & Young LLP’s attestation report on management’s assessment of the Company’s internal control over financial reporting appears directly below.
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
Board of Directors and Stockholders
Encore Wire Corporation
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Encore Wire Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Encore Wire Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Encore Wire Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Encore Wire Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Encore Wire Corporation as of December 31, 2006 and 2005 and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2006. Our report dated March 7, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Dallas, Texas
March 7, 2007
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The section entitled “Election of Directors” and “Section 16 (a) Beneficial Ownership Reporting Compliance” appearing in the Company’s proxy statement for the annual meeting of stockholders to be held on May 1, 2007 sets forth certain information with respect to the directors of the Company, with respect to Section 16 (a) reporting obligations of directors and officers, with respect to the Company’s audit committee, and with respect to the Company’s code of ethics that is incorporated herein by reference. Certain information with respect to persons who are or may be deemed to be executive officers of the Company is set forth under the caption “Executive Officers of the Company” in Part I of this report.
In connection with Company’s long-standing commitment to conduct its business in compliance with applicable laws and regulations and in accordance with its ethical principles, the Board of Directors has adopted a Code of Business Conduct and Ethics applicable to all employees, officers, directors, and advisors of the Company. The Code of Business Conduct and Ethics of the Company is available under the “Investor Relations - Corporate Governance” section of the Company’s website at http://www.encorewire.com, and is incorporated herein by reference.
The section entitled “Executive Compensation” appearing in the Company’s proxy statement for the annual meeting of stockholders to be held on May 1, 2007, sets forth certain information with respect to the compensation of management of the Company and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The section entitled “Security Ownership of Certain Beneficial Owners, Directors and Executive Officers” appearing in the Company’s proxy statement for the annual meeting of stockholders to be held on May 1, 2007 sets forth certain information with respect to the ownership of the Company’s common stock, and is incorporated herein by reference. Certain information with respect to the Company’s equity compensation plans that is required to be set forth in this Item 12 is set forth under the caption “Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.”
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The section entitled “Executive Compensation - Certain Relationships and Related Transactions” and “Corporate Governance and Other Board Matters - Board Independence” appearing in the Company’s proxy statement for the annual meeting of stockholders to be held on May 1, 2007 sets forth certain information with respect to certain relationships and related transactions, and director independence, and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Section entitled “Proposal Two - Ratification of Appointment of Independent Public Accountants” appearing in the Company’s proxy statement for the annual meeting of stockholders to be held on May 1, 2007, sets forth certain information with respect to certain fees paid to accountants, and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
The following documents are filed as a part of this report:
(1)
Consolidated Financial Statements included in Item 8 above are filed as part of this annual report.
(2)
Consolidated Financial Statement Schedules included in Item 8 herein:
All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.
(3)
Exhibits:
The information required by this Item 15(a)(3) is set forth in the Index to Exhibits accompanying this Annual Report on Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Encore Wire Corporation has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.
ENCORE WIRE CORPORATION
Date: March 9, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed by the following persons in the capacities and on the dates indicated.
Signature
Title
Date
/s/ DANIEL L. JONES
Daniel L. Jones
President, Chief Executive Officer and Director (Principal Executive Officer)
March 9, 2007
/s/ FRANK J. BILBAN
Frank J. Bilban
Vice President-Finance, Treasurer, Secretary and Chief Financial Officer (Principal Financial and Accounting Officer)
March 9, 2007
INDEX TO EXHIBITS**
*
Management contract or compensatory plan