Insteel Industries Inc (IIIN) 2005 Q4 法說會逐字稿

Good day, everyone, and welcome to the Insteel Industries' fourth-quarter fiscal-year 2005 earnings conference. As a reminder, today's call is being recorded. For opening remarks and introductions, I would like to the conference over to Insteel's President and Chief Executive Officer, H.O. Woltz III. Please go ahead, sir.

Thank you, Jessica. Good morning and thank you for your interest in Insteel. Welcome to our fourth-quarter 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 fourth 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 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 fourth quarter ended October 1, in spite of the continuation of soft market conditions. Net earnings for the quarter were $6.4 million or $0.67 per diluted share compared with $9.9 million or $1.06 per diluted share for the prior-year quarter.

For the fiscal year, net earnings were $35 million or $2.64 per diluted share compared with $31.5 million or $3.51 per diluted share in 2004. Excluding the extraordinary gain on the disposal of assets associated with the discontinued operations that we exited back in fiscal 1997, earnings from continuing operations for the year were $24.3 million or $2.56 per share.

In order to put the prior-year comparisons in perspective, our 2004 results for the fourth fiscal quarter and for the year as a whole represented all-time highs for both periods and also benefited from having an extra week based on our fiscal calendar.

Sales for the fourth quarter declined 10% to $94.8 million from $105.8 million in the year-ago period, as an 11% decrease in average selling prices more than offset a slight rise in shipments. Although the volume increase only amounted to 1%, it marked the first time since the second quarter of fiscal 2004 that shipments were up on a year-over-year basis; and as I indicated earlier, the increase was in spite of the extra week of shipments in the prior year.

In view of recent indications that the customer inventory rebalancing which plagued us through most of the year is largely behind us, we are hopeful that the increase in Q4 shipments is an indicator of a more pronounced upturn in demand in 2006.

With regard to the decrease in selling prices, you may recall that during the prior year 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, at least up until September when rod prices began to turn up, largely driven by cost pressures experienced by steel producers as well as outages in domestic capacity.

On a sequential basis, average selling prices were down 3% relative to the third quarter, with most of the erosion occurring in our standard welded wire fabric product line, consistent with our experience over the past few quarters.

Shipments for the fourth quarter were up 3% on a sequential basis from the third quarter, driven by higher sales of PC strand. As we move into the first quarter, I wanted to remind participants on the call that from a seasonal standpoint our third and fourth fiscal quarters typically represent the peak shipping periods within the year, driven by the increased level of construction activity which tends to be correlated with weather conditions.

Sales of concrete reinforcing products, which includes our welded wire fabric and PC strand product lines, decreased 10% for the fourth quarter from a year ago. Welded wire fabric sales were down 13% as compared with the prior year, due to lower selling prices, particularly for standard mesh; while PC strand sales were down 6% on lower shipments and selling prices.

As a side note, in spite of the weak market conditions we made substantial progress ramping up our engineered structural mesh business over the course of the year. ESM shipments were up 25% from the prior-year levels, and we expect to build on this momentum through the expansions that are underway and the additional capacity planning to come online over the next two years.

In our industrial wire business, which includes tire bead wire and other complementary wire products, sales are down 17% for the quarter due to lower shipments and selling prices.

Gross profit for the fourth quarter was down $9.5 million from the prior year, falling to $15.2 million from $24.8 million with gross margins decreasing to 16.1% from 23.4%. The gross margin in the prior year represented a record high for the fourth fiscal quarter, where we benefited from record spreads due to the favorable matching of lower-cost rod purchases with escalating selling prices. In addition to the difficult prior-year comparison, with rod pricing on the decline during the quarter, current-year margins were negatively impacted by the consumption of higher-cost inventory.

Finally unit conversion costs were higher in the current year quarter as production levels were 13% lower than a year ago, primarily due to our inventory rebalancing efforts. With these measures behind us, we expect that our operating levels should correspond more closely with the actual consumption rates of our customers going forward.

On a promising note, in spite of the weak market conditions, average spreads remained stable on a sequential basis relative to the third quarter, even with the continued compression that we experienced in our standard mash product line.

The decrease in gross margins from the previous quarter's 18.8% to 16.1% was primarily due to the impact of the higher-cost inventory that I alluded to earlier flowing through cost of sales. With rod prices now on the rise, we do not expect to see a similar inventory-related impact on our first-quarter results.

SG&A expense for the fourth quarter decreased $2.3 million or 33% to $4.5 million or 4.8% of net sales, from $6.8 million or 6.4% of net sales a year ago, driven by a $2.5 million decrease in stock-based compensation expense. The prior-year quarter reflected $2.8 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 $0.3 million of expense.

Excluding the stock-based compensation expense, SG&A costs would have been up $0.2 million, primarily due to higher control [team] and professional service fees related to our SOX 404 compliance efforts.

Interest expense for the fourth quarter increased $1.3 million or 73%, to $0.5 million from $1.8 million a year ago, due to lower amortization expense associated with financing-related fees and lower average borrowing levels, partially offset by higher average borrowing rates.

The Company's effective income tax rate for the fourth quarter remained relatively flat at 40.2% versus 39.8% in the prior year, bringing the total year rate to 36.7%, which is about where we would expect it to trend going forward, barring any significant changes in our tax position.

In addition to the solid earnings performance, the strong operating cash flow for the quarter enabled us to make another sizable reduction in our debt level. Operating activities generated $13.7 million in cash for the fourth quarter, compared with $4.5 million in the year-ago period. The increase was due to a net $15.4 million year-over-year improvement in the cash provided by net working capital, which more than offset the reduced earnings.

The reduction in net working capital in the current-year quarter was driven by a $17.7 million or 35% decrease in inventories from $50.9 million at the end of the third quarter to $33.2 million as of year-end. Finished goods inventories declined $10.1 million. Raw material inventories were down $7.4 million, and WIP was slightly lower than the previous quarter-end levels. On a forward-looking basis, our total inventory quantities on hand represented about two months of shipments based on our anticipated run rate for the first quarter.

As a result of the strong operating cash flow, we were able to reduce our total debt level to $11.9 million as of the end of the year, down $12.4 million from the third quarter and $41.1 million from the beginning of the fiscal year. As of October 1, outstanding borrowings on our revolving credit facility were $9.5 million, leaving $43.7 million of unused borrowing capacity. Our term loan balance was $2.4 million.

Capital expenditures for the year rose to $6.6 million from $3 million in the prior year, primarily due to outlays related to our ESM and PC strand expansion and upgrades to our information systems infrastructure. The current-year expenditures actually came in $2.4 million lower than we had anticipated, as the timing of certain of the outlays shifted over into fiscal 2006.

We now expect that capital expenditures will rise to $13 million in each of the next two years, or $26 million in total, versus the $19 million that we had previously forecast, due to some additional equipment upgrades in our PC strand operations that we plan on pursuing in 2007 and the deferral of a portion of the 2005 spending into 2006. The actual timing of these expenditures as well as the amounts are subject to change based on adjustments in our project timelines, future market conditions, and the Company's financial performance.

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

Thank you, Mike. We're pleased with our financial results for the fourth quarter. On any basis other than a comparison to last year, the Company's 2005 financial performance was excellent, particularly in view of market conditions that failed to meet expectations.

While the shipping performance for the fourth quarter was certainly not robust, shipments were slightly higher than a year ago, even though the prior-year quarter benefited from having extra week. This favorable trend appears to have accelerated in October, as we have seen a continuing upturn in shipments over the past three weeks.

At this point, it is difficult to determine whether the improved environment should be attributed to the urgency of customers to finish projects before winter weather conditions set in, or whether it represents the beginning of a long-awaited rebound in demand. So while we are glad to report the improvement in conditions, it remains to be seen whether the trend will be sustained.

I reported last quarter that we had seen evidence of increasing competitive pricing activity in both our welded wire fabric and PC strand markets. This pricing activity continued through most of the fourth fiscal quarter, but tailed off measurably in September following the announcement of significant price increases by domestic wire rod producers for the fourth calendar quarter. It is now clear that these increases will stick and will force our industry to seek to recover the escalation in raw material costs through higher selling prices.

While we are on the subject of wire rod, I would point out that availability has tightened up significantly over the past two months, at least in part due to ongoing labor disputes at two of the largest mills serving the U.S. market. One mill has been down since the end of May, and the other went on strike during the middle of September. We have heard no news that would lead us to believe the either of these work stoppages will be resolved in the near term.

The substantial price increases that the North American rod producers have implemented place them on uncompetitive footing with the world market, and we believe that the widening domestic versus import pricing differential could serve as a catalyst for increasing wire rod imports in 2006.

As Mike indicated earlier, our CapEx spending is anticipated to rise over the 2006/2007 period, primarily in support of our ESM and PC strand expansions. In addition to routine maintenance type requirements, the bulk of the expenditures will go toward adding two additional production lines for engineered structural mesh, which will expand our capacity and reduce operating costs associated with that product.

We are also well along the expansion of our Tennessee PC strand plant, which entails the installation of a new production line in a larger facility owned by the Company that had only been partially utilized for the past few years. Following the startup of the new line, we will relocate the equipment from the existing strand operation to the larger facility. Although there will be significant cost incurred in relocating the existing equipment and ramping up the new line, we expect significant benefits from lower operating costs and higher volume levels going forward.

Since the last update on our capital spending plans, we have moved forward with planning improvements to our Florida PC strand plant. The Florida plant, which is a highly efficient operation with a capable group of management personnel, was originally constructed in the 1970s. Incremental facility improvements have been made over the years, but we have run the course of efficiency and cost improvements that we can expect employing the technology the plant currently has at its disposal. We are confident that we will obtain substantially lower operating costs following investment in the facility and expect to complete planning for the project during 2006, with implementation during 2007.

Turning to the outlook for our reinforcing business, we are optimistic that there will be favorable market developments in 2006 and we believe Insteel's prospects are excellent in an improving environment. The most significant driver of demand for our reinforcing products is nonresidential construction spending, which is beginning to show a favorable trend after several down years. The recently enacted Federal Transportation Spending Bill and the reconstruction in hurricane-affected zones should also spur additional demand for our products, although it is not possible to quantify the potential impact of these things.

All factors considered, we believe that the demand environment is shaping up nicely for us, and we are well positioned financially, strategically, and operationally to capitalize on the favorable outlook.

Turning to our industrial wire business, we are coming off another difficult quarter where shipments declined 8.5% from the prior year, resulting in breakeven results for the quarter. The weak shipping performance was exacerbated by extended customer plant outages around the July 4th holiday that were intended to manage inventory levels, as well as shortages of certain commodities following Hurricane Katrina that caused certain customers to curtail operating rates.

Capacity utilization of our facility was only about 70% for the quarter, which is insufficient to generate satisfactory financial results. Longer term, achieving acceptable financial performance is dependent upon operating the plant at a higher level of capacity utilization.

On a positive note, our people demonstrated over the course of the fourth quarter that the solutions implemented earlier in the year to solve some packaging-related quality issues have been successful. Customer rejections and complaints have fallen substantially; and reports from the plants using our material indicate processability has improved markedly. The improvement in the performance of our products should increase our value as a supplier and support our commercial efforts to improve the operating level of the plant.

Conceptually the industrial wire business should serve as an important counterbalance to the more cyclical nature of our concrete reinforcing business. Provided that we achieve and sustain a reasonable level of profitability from the operation, there are opportunities for growth in these markets. Ultimately, though, our future direction for the business will be driven off its actual results relative to performance expectations that are consistent across all of our businesses.

That concludes our prepared remarks, and we will now open it for questions. Jessica, would you please explain the procedure for asking questions?

(OPERATOR INSTRUCTIONS) [Peter Reed], [Mass Capital Management].

Congratulations on a great quarter and a great year. Can you comment a little more on the expansion in PC strand and ESM? How much capacity are you adding on that? Is there a percentage or tonnage basis?

Each of those expansions has a component of cost reduction as well as a component of capacity expansion to it. We have really focused on justifying these investments primarily through the operating cost improvements that can be expected following the implementation of these projects. So we don't have specific capacity increase statistics at hand for you.

Okay, thanks.

Jeremy Hellman, Thompson Davis.

A quick question for Mike. I was wondering; in terms of your total revenue breakdown between the concrete reinforcing and the industrial wire side, do you have a percentage breakdown available?

Yes, for the quarter or --?

Yes, for the quarter.

For the quarter I can actually give you the revenue amounts. For concrete reinforcing products, net sales were $86.6 million; and for industrial wire, sales were $8.2 million.

Thanks. Getting back to capacity utilization, you guys said in industrial wire you are running about 70%. What about the other side of the business? What is the utilization there?

In terms of the way that the operations are staffed today, certain operations are staffed 24/7 and certain are not. But given the staffing that we would say is sort of base level staffing, we are running between 80% and 85%. There are plants that we could take from five days to seven days, but that would really leave the analysis on a noncomparable basis.

Okay, thanks. I'll get back in the queue and let someone else have a turn.

(OPERATOR INSTRUCTIONS) [Jim Winchester], [Quantified Value].

I have two questions. The first one is, based on what you know today about the timing and projects in the highway bill, could you walk us through what you anticipate -- how you anticipate that feeding into and then starting projects for next year? What the timing is, and how quickly you'll actually start to see any benefits from that, based on where demand in these contracts -- the biggest -- develop for reinforcing products? That is the first question.

The second one is, based in your comments on raw material prices for rod tightening up and firming in the fourth quarter, and also lessening of competitive aggressive competition on pricing of strand and whatnot, net-netting it all, if you look at margins, gross margin over the next couple of quarters -- and again, taking into account seasonality of margins and whatnot -- but could you give us a sense of whether you expect margins to be higher, lower, about the same? Any sort of color on that, what your expectation would be.

Okay, answering the second question first, there have been a series of price increases announced in the industry for wire rod. There are two significant producers that are not operating at this point. So domestically certainly the supply and demand balance has tightened up and favors the producers at this point in time; and we fully expect the price increases that they have announced to go through.

With that said, as we have looked out for the next couple of quarters, we have not forecast any significant deterioration in our margins. Implied in that is that we will be able to recover these costs; or potentially that through more offshore purchases we do not incur some of the higher costs.

But it is not possible to give you a real breakdown of how we plan to deal with the higher material costs that are coming our way, because these announcements are relatively new and we are still feeling our way through the market impact.

In answer to your first question concerning the impact of the transportation bill, I think our position on the transportation bill as well as on the impact to our business of hurricane-related construction is that these are nice underpinnings for our market; but they are not the most substantial drivers of demand for our products.

We estimate that in transportation-related markets that are federal government and state government funded, we see 20 to 25% of our business. So certainly we are glad to see the transport bill; but it really is, as I say, a good underpinning but not the main driver.

We believe that the actual purchases of reinforcing products that are driven by the transportation bill, we will begin to see here in the last half of 2006. Our understanding from our interaction with various Departments of Transportation is that there are a lot of projects on the drawing board and in engineering; but these things are not quickly moved into the market. It takes time for the states to prioritize and get these things ready to be bid out.

Okay. In respect to work in the Southeast for reconstruction, as compared to government I presume that that is actually more of a near-term and immediate -- there is a real effort to try to get that going next year and early in the spring. What kind of feedback are you getting from customers on things of that nature? Just generally what they are seeing as the fallout from what has happened down there.

Certainly the reconstruction will have as stimulative impact on our business, but realize that first it has a depressing impact on our business. We had several customers that were adversely impacted directly by the storms. Those customers were out of business for a period of time; and then as they started their operations back up they obviously did not start up full. They had to find their people. They had to repair their plants. My guess is that there are several of them that are not up to full power yet.

Actually some of our customers have decided to take extended periods down and actually relocate facilities. So my guess is that the overall impact through the end of our first fiscal quarter will be negative.

There is emergency work going on with quick delivery times, but that is not enough to offset the customers who really had significant damage and have to repair their facilities. As we get into calendar 2006, I do think that you'll see the pace of some of these emergency repairs pick up and actually have a favorable impact on our business.

But if you take the cement industry's view of this whole thing, I think the last thing I read was they expected a 2% to 3% increase in demand for cement during 2006 as a result of reconstruction efforts. So while 2% to 3% is pretty significant, it is not enough in itself to turn a mediocre year into a robust year. I would expect the same is going to be true in our products.

Okay. You did comment briefly on seeing some improvement in commercial construction activity, and trying to weigh whether that is just sort of a catch-up at the end of the season or the beginning of something more prolonged or sustainable. Can you comment as to what kind of feedback your major commercial customers are giving you for next year, what their outlook is?

I think almost without exception the outlook is positive among our customers. For most of the current year, it seems that our customers have been much busier than we have; and we attribute a big part of that to inventory reductions that have occurred throughout the year.

We think that most of those inventory corrections are past us now, so that the more favorable level of demand that we have seen and activity rates that we have seen on the part of our customers should be reflected in our business going forward.

What we are weighing right now is whether our recent upturn in shipments is in fact that we are catching up with the activity level of our customers or whether there is just a rush to finish projects ahead of winter weather. I wish we had a way to really give you a definitive answer on which it is; but unfortunately we are only going to know as we look back at this experience and judge it.

Final question. What do you think the odds are that we go actually in the opposite direction, where as rod prices start increasing you folks start pushing through some -- try to push through some improve -- or pass-through at least of the costs. And your customer sees pricing going up on strand and whatnot, that you start to see a little bit, perhaps, swing back toward the interest in the customers on having extra inventory on hand. Did they learn their lesson or will they try (multiple speakers)?

I think there has been heightened sensitivity to the risk of carrying inventory as prices essentially doubled on many of our products and then they came off pretty significantly. My guess is that availability is going to drive this more than announced price increases. It is perfectly clear to us that our products are readily available to our customers.

My guess is that after they size up the events of the last 16 or 18 months, that they will elect to manage their inventories conservatively in view of the availability of the products, and that they will see no reason to hoard the product.

I'm sorry; I apologize in advance. I need to ask one last question. That is, in some of the basic building materials, like plywood and whatnot down in the Southeast and Midwest, there has been a tremendous run-up in the price at the retail level because of scarcity issues.

What I am asking is have you gotten any feedback from maybe not directly your products but related products, like fencing and whatnot that use some of the same materials? Have you seen any of that or gotten a sense that maybe some of the product lines that are ancillary to what you are selling have tightened at all?

I am not sure that I have great insight into that, Jim, except I would venture to say that if it is made out of steel wire, it has not been in short supply and the price has not risen significantly due to the hurricane.

Okay, fair enough. Thank you very much. I appreciate your comments.

John Wegmann, Speedwell.

Congratulations on your quarter. Question. On a sequential basis and on a year-on-year comp basis, what do you expect the current quarter's selling prices to be, or the change in selling price?

I don't know that we can really provide guidance on that at this point. As we indicated, both our selling prices and rod costs had trended down through the year; and in September we began to see rod pricing turning back in the other direction.

As H. indicated, we are in the process of pursuing price increases in certain of our product lines; but we are in the early stages of those activities. I don't know if we would really be able to give you much in the way of guidance.

Okay, thank you.

A follow-up from Jeremy Hellmann, Thompson Davis.

Yes, I was wondering -- considering one thing that H. had said in terms of some of your customers relocating operations and the like -- do you see anything out there in the aftermath of the hurricanes, or otherwise even, giving your healthy cash flow the ability to add anything strategically, capital investment side of things?

We're certainly interested, and we are looking, and we have a process under way to methodically evaluate what the opportunities may be. I think the reality is in our business that the valuations could be a significant issue at this point in time. But Insteel is definitely interested in growing, and we are looking for the right opportunities strategically and also from a valuation point of view.

Okay, thank you.

(OPERATOR INSTRUCTIONS) It appears there are no further questions. Mr. Woltz, I will turn the conference back over to you for any additional or closing remarks.

Okay. We appreciate your interest in the Company and your taking the time to call in today. If you have further questions, feel free to follow up with us directly. Thank you.

That concludes today's conference. Thank you for your participation.