Insteel Industries Inc (IIIN) 2005 Q3 法說會逐字稿

Good day, everyone, and welcome to the Insteel Industries' third-quarter earnings conference call. As a reminder, today's call is being recorded. For opening remarks and introductions, I would like to turn the conference over to Insteel's President and Chief Executive Officer, H.O. Woltz, III. Please go ahead, sir.

H.O. Woltz, III: Thank you, Kim. Thank you for your interest in Insteel and welcome to our conference call, which will be conducted by Mike Gazmarian, our CFO and Treasurer, and me.

Earlier this morning, you should have received our press release announcing our financial results for the third fiscal quarter of 2005. Mike will walk you through our financial performance for the quarter, and I will follow with some comments on business conditions and our future outlook. Following our presentation, we will take your questions.

Before we begin, let me remind you that some of the comments that are made in our presentation are considered to be forward-looking statements. Forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those projected. These risk factors are described in our most recent Form 10-K.

Now, I will turn it over to Mike to provide you with more details on the Company's financial results.

Thank you, H.

As reported in this morning's press release, Insteel posted strong results for its third quarter ended July 2, as we benefited from the seasonal upturn that we typically experience during the period associated with the rise in the level of construction activity.

Net earnings for the quarter were 8.5 million, or $0.90 per diluted share, compared with 15.3 million, or $1.70 per diluted share, for the prior-year quarter. Excluding the 0.1 million extraordinary gain on the disposal of an additional asset associated with Insteel Construction Systems, a discontinued operation that we exited back in fiscal 1997, earnings from continuing operations for the current-year quarter were 8.4 million or $0.89 per diluted share.

Sales for the third quarter declined 2% to 94.4 million from 96.8 million in the year-ago period due to lower average selling prices on flat shipments. You may recall that, during the prior-year period, the Company's selling prices were escalating dramatically, largely due to the run-up in rod costs and supply constraints, whereas in the current year, both rod costs and selling prices have trended down.

On a sequential basis, average selling prices were down 7% relative to the second quarter with the highest degree of erosion occurring in our standard welded-wire fabric product line, consistent with our experience last quarter.

Shipments for the third quarter, which were unchanged from a year ago, were up 24% on a sequential basis as we moved into our busy season. However, the increase was not of a magnitude that would indicate a broader recovery in demand above and beyond the usual seasonal rise. As H. will discuss later in the call, many of our customers continue to be in inventory reduction mode for the quarter with their actual rates of consumption higher than what would be indicated by our order book.

Sales of concrete reinforcing products, which includes our welded-wire fabric and PC Strand product lines, decreased 1% for the third quarter from a year ago. Welded-wire fabric sales were down 4% as compared with year-ago levels due to lower selling prices, particularly for standard mesh, while PC Strand sales were up 2% on higher selling prices.

In our industrial wire business, which includes tire bead wire and other complementary wire products, sales were down 9% for the quarter due to lower shipments. Although shipments were weaker than anticipated for the quarter, our customers are generally bullish about their business prospects for the remainder of fiscal 2005, as well as for fiscal 2006, and the outlook for the demand drivers of our products appears to be favorable.

Gross profit for the third quarter was down 14.9 million from the year-ago level, falling to 17.8 million from 32.7 million with gross margins decreasing to 18.8% from 33.8% last year. You may recall that the year-ago quarter marked an all-time high for gross margins and earnings, as we benefited from record spreads largely resulting from lower-cost rod purchases matched against sharply increasing selling prices.

On a promising note, in spite of the weak shipments, margins and spreads increased relative to the second quarter, even with the continued compression that we experienced in our standard mesh product lines with gross margins rising 4.5% from the 14.3% that we posted for the previous quarter.

SG&A expense for the third quarter decreased 2.4 million, or 39%, to 3.7 million or 3.9% of net sales from 6.1 million or 6.3% of net sales a year ago, driven by the year-to-year swing in stock-based compensation expense. In that prior-year quarter, we recorded 2.7 million of option-related expense due to the impact of the increase in our share price during the quarter on the valuation of the unexercised options subject to variable accounting treatment, whereas in the current-year quarter we recognized 0.4 million of income due to the increase in price. Excluding the stock-based compensation expense, SG&A expense would have actually been up 0.8 million, primarily due to the costs associated with our SOX 404 compliance efforts and increases in healthcare and other benefit costs.

Interest expense for the third quarter decreased 1.5 million or 68% to less than a third of the year-ago level due to lower average borrowing levels, decreased amortization of financing-related fees and lower average borrowing rates on our credit facility.

The Company's expected (indiscernible) income tax rate for the second quarter was 37.1% versus 40.4% in the prior year, largely due to book tax differences associated with incentive stock options in the prior year. Going forward, we expect the effective rate to trend in the 36 to 37% range.

In addition to our strong earnings performance for the quarter, we generated substantial operating cash flow, which enabled us to make a sizable reduction in our debt level. Operating activities generated 23.4 million of cash for the third quarter compared with 17.2 million in the year-ago period, primarily due to a 12.9 million decrease in net working capital in the current quarter compared against a 5.3 million increase in the prior-year quarter. The reduction in net working capital in the current-year quarter was largely driven by an 11.3 million increase in Accounts Payable and accrued expenses, a large portion of which was due to the restoration of traditional payment terms with their primary suppliers to the previous arrangements that were in existence prior to the tight supply conditions of a year ago and the recovery in the Company's financial performance.

Inventories were down 3 million for the quarter with finished goods declining 3.3 million, whip remaining flat and raw material inventories up about 0.3 million. On a forward-looking basis, our total inventory quantities on hand as of the quarter end represented about 68 days of shipments based on our anticipated run-rate for the next few months. We are comfortable with our quarter-end position and expect a further reduction in inventories over the remainder of the year unless changes in rod market conditions dictate otherwise.

The strong operating cash flow for the quarter enabled us to reduce our total debt to 24.3 million as of the end of the quarter, down 21 million from the second quarter and 28.7 million from the beginning of the fiscal year. As of July 2, outstanding borrowings on our revolving credit facility were down to 19.4 million, leaving 42.9 million of unused borrowing capacity, and our term loan balance was 4.9 million. Under the terms of our credit agreement, following the delivery of our third-quarter financials, the applicable margins will remain at the same levels based on our quarter-end leverage ratio, and we were in compliance with all of the financial covenants.

Capital expenditures for the first nine months were 5 million compared to 1.9 million in the prior year, primarily due to outlays related to our ESM and PC Strand expansions and upgrades to our information systems infrastructure. As we had indicated in our previous quarterly report, we anticipate that the capital expenditures will rise over the 2005 to 2007 period to support the expansion of our ESM and PC Strand businesses, in addition to covering recurring maintenance-type requirements. We continue to believe that the three-year total will be in the neighborhood of 28 million with 9 million of outlays in the current year, 12 million in fiscal 2006 and 7 million in 2007, although the timing between the years as well as the amounts are subject to change based on any further adjustments in our project timelines, future market conditions or the Company's financial performance. We suspect that some of the CapEx previously anticipated to occur in 2005 may slip over into early 2006, although we would be hesitant to provide a precise amount at this time.

H. will now comment on some of the factors driving our results for the quarter, market conditions and our business outlook.

H.O. Woltz, III: Thank you, Mike.

We're pleased with our financial results for the third quarter, particularly in view of the continued weakness in our markets. We reported, in our second-quarter conference call, that April bookings were showing signs of a recovery in volume but unfortunately, that upward trend was not sustained through the quarter or for that matter past the month of April. Although we benefited from our usual seasonal upturn that resulted in a flat year-over-year comparison for Quarter Three, the increase was not of a magnitude that would indicate an overall recovery in demand. You might recall that last year here in the third quarter, we lost about 24 plant operating days due to rod supply constraints, so while we are glad to have ended the year-over-year unfavorable shipping comparisons, the Q3 performance should probably not be interpreted as a sign that our markets are finally recovering from the doldrums we've experienced for the last four quarters.

Shipments of concrete-reinforcing products for the quarter were under our expectations by about 10%, and our forecast was not particularly robust. Despite this weakness, we've believed for several months that the underlying level of consumption of our products was stronger than our order entry rate would indicate and that our order book would begin to reflect that strength when customers had accomplished their inventory reduction objectors. Based on conversations with our customers concerning their backlogs and quotation activity, we still believe that this is the case.

The U.S. Dept. of Census Construction Spending data support the view that we're past the bottom of the trough and that spending levels are beginning to rise, although Census reports put in place data that is retrospective and is of limited value to forecasting.

If our view of consumption of reinforcing products is correct, we have to attribute the depressed level of activity in our markets to inventories, both the quantity of material on hand as well as the perceived carrying risk in an environment of softening prices that contributes to heightened purchasing conservatism among customers.

In spite of this depressed shipment in production levels that have persisted for an extended period of time, margins have held up relatively well, after giving consideration to both lower raw material costs and the downward drift in selling prices. The exception to this statement, as Mike pointed out, would be our standard welded wire fabric product line where we've experienced reductions in selling prices that exceed raw material costs. There is evidence, however, of increasing competitive pricing activity in the marketplace across other welded wire fabric products as well as PC Strand.

I sense restlessness among some competitors who have been patient with lackluster volume for a number of months and who now may be becoming more concerned about the subdued pace of business activity here in the height of the construction season. I also sense, however, that the industry has experienced the beneficial effect of maintaining margins and I don't foresee a downward spiral on the horizon.

Our CapEx plan for our concrete-reinforcing business remains essentially unchanged from our last update. Although given that we are in the fourth fiscal quarter of 2005, it's possible that expenditures originally planned for the current fiscal year will slip into fiscal 2006, due to the late deliveries of equipment from offshore suppliers. Nevertheless, our CapEx plan continues to call for expenditures of slightly over $28 million for the 2005 through 2007 period.

In addition to routine maintenance-type requirements, the bulk of the expenditures will be used to complete the installation of our engineered welded-wire fabric production line in Texas during 2005 to expand and configure reconfigure our Tennessee PC Strand plant, a project which is now underway and will extend into the middle of 2006 -- and to add two additional engineered welded-wire fabric production lines, one in 2006 and the other in 2007.

Looking forward, we are optimistic about the prospect for recovering shipping performance and strong financial results, driven by the completion of inventory reduction measures by our customers, the anticipated recovery in nonresidential construction spending, and resolution of the successor legislation to T-21, which will provide for a substantial increase in highway spending levels. We believe that we're well positioned financially, strategically and operationally to capitalize on the improving market conditions for our reinforcing products.

Turning to our industrial wire business, we're coming off a difficult quarter where shipments declined 15% from last year and we incurred unusual maintenance costs of approximately $400,000. The combination of these circumstances resulted in a loss for the quarter. The weak shipping performance was exacerbated by extended customer plant outages around the July 4 holiday that were intended to reduce inventory levels. Capacity utilization of our industrial wire facility was only about 70% for the quarter, which is insufficient to generate satisfactory financial results. We've taken cost-reduction measures at the plant that should restore profitable operations until such time as shipments recover, but over the longer term, to achieve acceptable financial performance, the plant must operate at a higher level of capacity utilization.

On a positive note, during the quarter, the plant made some significant improvements that appear to have solved package-related quality problems that have plagued us for several months. The elimination of the negative cost and efficiency impact of these problems should support our commercial efforts to improve the operating level of the plant. But no doubt, 2005 has been a disappointment in our industrial wire business, coming off an improving trend in 2004. The industrial wire operation should serve as an important balance to the more cyclical and volatile concrete reinforcing products business. Provided that we achieve and sustain a reasonable level of profitability from the operation, there are opportunities for growth in the industrial wire market. Ultimately, though, our future direction for this business will be driven off its actual results relative to performance expectations that are consistent across all of our businesses.

That concludes my prepared remarks. We will now open it up to questions. Kim, would you explain the procedure for questions, please?

Thank you. (OPERATOR INSTRUCTIONS). I have no questions at this time. (OPERATOR INSTRUCTIONS). We have a question from Walt Glasier (ph), a private investor.

Good morning, gentlemen. H., I was wondering if you could comment a little bit more on something that was in the release. You talk about your get reduction and the opportunity you have for continued reduction and then also some opportunities for growth in the future. I'm just wondering if you would expand upon that a little bit.

H.O. Woltz, III: Well, we do expect our debt level to continue to fall. I think, consistent with our prior statements on this matter, we believe that continuing to strengthen the balance sheet just opens up all kinds of alternatives for the Company. You saw, of course, that we reinstituted the quarterly dividend; we also see that there are opportunities for growth on the horizon, and we believe that all of our opportunities to move the Company forward will be enhanced by the additional flexibility that comes with the stronger balance sheet.

Other than that, Walt, there's nothing specific that we can say at this time.

Okay. As I look at the balance sheet, it looks like I would guess that you probably have the opportunity, by the end of the year, to maybe reduce perhaps 10 million in inventory. Does that seem unrealistic?

H.O. Woltz, III: That might be a little unrealistic. I would also point out that our intentions and desire to reduce inventory will be impacted by our assessment of market conditions in the wire rod market. If we have seen a low ebb in wire rod prices, we might elect actually to move those inventories up some, but that's not saying that we plan to do that at this point in time; it's only saying that it's possible that those events would play out so that we want to move them up.

Okay. One last -- on a related question -- based on the improved financial condition, I know you've done some things with your banks to kind of fine-tune your credit agreements. Has there been any change in the quarter, any anticipated change in the next couple of quarters?

H.O. Woltz, III: We've spent quite a bit of time in reviewing what our options are, and as you would expect, our options are numerous. We're going to continue evaluating what the best course of action is, of course trying to give the proper weight of consideration to our long-term objectives, but we are fully engaged in that process and fully aware of market conditions and the opportunities that are out there.

Okay, great. Well, it looks like you had a -- you did well in a somewhat-challenging environment, and good luck.

(OPERATOR INSTRUCTIONS). We have a question from John Wigman (ph) from Speedwell (ph) Securities.

Hello. In terms of collections, should this be construed as actually -- because it is a peak sales quarter, actually one of the slower collections quarters, meaning that, later on in the calendar year, we will see further reduction of debt?

Well, typically with the third and fourth quarters being our high point, the receivables tend to maintain at a higher plateau during the period. I'd say the collections run-rate is up, but then as we get further into the year, from a seasonal standpoint, typically receivables will wind down where you are correct, where we would see a reduction in working capital, which would facilitate further debt reductions.

Okay. Did this quarter's cost of sales incorporate any inventory losses?

Well, in order to avoid any confusion or misinterpretation, we are going to reference spreads on an all-in basis, which is what I did in my comments, where we alluded to the fact that spreads had actually increased from the previous quarter on a sequential basis. That included the impact of any inventory revals (ph). But based on some follow-up calls after previous releases and conference calls, we would just like to reference it on an all-in basis just to make sure it's viewed consistently and that there isn't any misinterpretation. I mean, the inventory reval (ph) would tend to trend with the direction of rod prices.

Okay, thank you.

(OPERATOR INSTRUCTIONS). Gentlemen, it appears there are no further questions at this time.

H.O. Woltz, III: Okay. In that case, we appreciate your interest in the Company and your time this morning. Thank you very much.

That does conclude our conference call for today. Thank you all for your participation.