Insteel Industries Inc (IIIN) 2006 Q1 法說會逐字稿

Good day, everyone, and welcome to the Insteel Industries' first-quarter 2006 earnings release conference. 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.

Good morning and 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 first fiscal quarter of 2006. 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 the 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'll 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's financial results rose to a new record high for the first quarter, driven by strong demand for our products during what is typically one of the slower periods of the year.

For the quarter ended December 31st, net earnings increased 50% to 7.7 million, or $0.81 per diluted share, compared with the previous first-quarter high of 5.1 million, or $0.54 per diluted share, in the year-ago period. The first-quarter results are past our Q4 2005 earnings, which is highly unusual from a seasonal standpoint, as our first- and second-quarter performance has historically been significantly weaker than our results for the third and fourth quarters due to the usual drop-off in construction activity related to weather conditions. We are pleased by the strong start to fiscal 2006 and hopeful that the improved market conditions will continue as we move further into the year.

Sales for the first quarter rose 12%, or 8.9 million, from a year ago, as a 24% increase in shipments more than offset a 10% decrease in average selling prices. The increase in shipments marked the second straight quarter that we have posted year-over-year improvement, following five consecutive quarters of declines.

We believe that the upturn in volume for the quarter was driven by the combination of the long-awaited recovery in the private nonresidential construction sector and the completion of the inventory reduction measures within our customer base, which reduced shipments through most of fiscal 2005.

At this point, we have not seen much benefit yet from the anticipated increase in infrastructure-related construction activity. We expect that higher spending for roadways and bridges at both the federal and state level, together with the posthurricane reconstruction requirements, will have an increasingly favorable impact on the demand for our concrete reinforcing products going forward.

On a sequential basis, shipments for the first quarter were down 14% from the fourth quarter, but this compares with a 30% dropoff between the same two periods last year, which indicates the strength of the current quarter shipments. We were also encouraged by the increase in the year-over-year growth in volume for each month as we proceeded through the quarter.

Although average selling prices were down 10% relative to last year, they were up 2% on a sequential basis from Q4, following three consecutive quarterly declines amounting to 12% on a cumulative basis.

Sales for our concrete reinforcing products business unit, which includes our welded wire reinforcement and PC strand product lines, increased 16%, or 10.5 million, for the first quarter from a year ago. PC strand sales were up 30% as compared with the prior year, while welded wire reinforcement sales increased 5%, both on higher shipments.

In our industrial wire products business unit, which includes tire bead wire and other specialty wire products, sales were down 17%, or 1.7 million, from last year due to lower shipments and selling prices.

Gross profit for the first quarter increased 21%, or 2.9 million, from the prior year, with gross margins widening to 19.9% from 18.4% due to the higher shipments, together with lower unit conversion costs, largely driven by the increase in production levels. Although spreads between selling prices and raw material costs were slightly lower than the prior year, they widened on a sequential basis from Q4.

Gross profit for our concrete reinforcing products business unit increased 30% to 17.1 million from 13.2 million last year, with gross margins rising to 22.6% from 20.2%, primarily due to the higher shipments.

Our industrial wire products business unit had a disappointing quarter, posting a gross loss of 0.5 million compared with gross profit of 0.6 million last year, largely due to lower shipments as well as narrower spreads resulting from competitive pricing pressures.

SG&A expense for the first quarter was flat on a year-over-year basis at 4.2 million, representing 5% of net sales in the current year versus 5.6% last year.

The Company adopted FAS 123R as of the beginning of fiscal 2006, which required the cost of all forms of stock-based compensation, including stock options, restricted stock and employee stock purchase plans, to be recognized as expense over the requisite service period based upon their fair values.

Under the new pronouncement, total stock-based compensation expense for the first quarter amounted to 0.5 million, which was recorded as SG&A expense. Since we elected to adopt FAS 123R using the modified perspective method, no expense was recorded related to options that were fully vested as of the implementation date, including options that were issued under certain plans previously required to be accounted for as variable plans.

Under variable plan accounting, compensation expense is recognized over the vesting period for the excess of the market price over the exercise price and adjusted to reflect changes in market valuation. As a result, SG&A expense for the prior year included 1.2 million of stock-based compensation expense.

Both the current and prior year amounts for stock-based compensation expense, which are non-cash, are reflected as a separate line item on the cash-flow statement. Excluding stock-based compensation expense from both periods, SG&A expense would have been up 0.7 million from last year, largely due to higher benefit costs.

Interest expense for the first quarter decreased 86%, or 1.5 million, from a year ago due to lower average borrowing levels on the credit facility and reduced amortization expense associated with terminated interest rate swaps incurred in the prior year.

The Company's effective income tax rate for the first quarter rose to 38.4% from 33.6% in the prior year. The lower rate in the prior year was primarily due to higher compensation expense for tax purposes versus book related to incentive stock options and a reduction in the valuation allowance that had been established for state tax loss carryforwards.

Moving to the balance sheet and cash-flow statement, operating activities generated 20.5 million of cash for the first quarter, while using 2.9 million in the same year-ago period. The year-over-year change was largely due to a 22.3 million net improvement in cash provided by net working capital, together with the increase in earnings.

In the current quarter, net working capital decreased from the beginning of year, generating 9.4 million of cash in comparison to the prior-year quarter, when it had increased, consuming 12.9 million in cash. The reduction in net working capital in the current year was driven by a 6.1 million decrease in receivables resulting from the seasonal drop-off in sales, together with a 13.7 million increase in payables and accrued expenses, primarily due to higher purchases, a more favorable mix of underpayment terms as of quarter end, and an increase in accrued income taxes. These sources of cash more than offset a 10.3 million increase in inventories during the quarter.

In the prior-year quarter, the increase in working capital was due to a 24.3 million increase in inventories resulting from the combined impact of the customer inventory reduction measures, which reduced shipments below expected levels, and imported rod orders placed during the latter part of fiscal 2004 that were received during the first quarter.

Raw material inventories increased 8.5 million for the quarter. Finished goods inventories rose 1.6 million, which is much lower than a typical first quarter increase due to be higher shipments, and [whip] was slightly higher. On a forward-looking basis, our total inventory quantities on hand represented about 2.5 months of shipments based on our anticipated run rate for the second quarter. As a point of comparison, our inventories as of the end of the quarter were approximately 21.2 million lower than the prior-year level.

Capital expenditures for the quarter rose to 2.4 million from 0.8 million in the prior year, primarily due to outlays related to the PC strand and ESM expansions. We continue to believe that capital expenditures will [rest] at 13 million in 2006 as well as in 2007, with the largest outlays earmarked for the completion of the expansion and reconfiguration of our PC strand operation in 2006, the addition of another ESM line in 2006, a third ESM line in 2007 and various upgrades to our PC strand operation in Florida in 2007, in addition to recurring maintenance-type requirements. 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.

As a result of the strong operating cash flow for the quarter, we were able to not only repay the remaining 11.9 million that was outstanding on our credit facility, but increased our cash position by 5.1 million to 6.5 million as of the quarter end.

As of December 31st, there were no borrowings outstanding on our credit facility and our balance sheet was debt-free. In comparison, we had 55.9 million in total debt outstanding a year ago.

Following the end of the quarter, we completed a comprehensive amendment to our credit facility in order to capitalize on the favorable conditions in the credit markets and the Company's improved financial performance. The amendment increased the revolver commitment amount from 75 million to 100 million and extended the maturity date two years to June 2010. In addition, the initial LIBOR-based borrowing rates on the revolver was reduced by 100 basis points to 125 over LIBOR, and the unused fee was reduced by 12.5 basis points to 37.5.

In addition to the reductions in borrowing costs and fees, the amendment also provides us with a much greater degree of flexibility going forward by eliminating the annual capital expenditure limitation and the leverage ratio covenant, as well as the restrictions on dividends and share repurchases and the fixed charge ratio covenant, subject to the maintenance of certain excess borrowing availability thresholds.

Also following the end of the quarter, we announced that our Board of Directors had authorized a repurchase of up to 15 million of the Company's common stock over a period of up to 12 months, ending January 12, 2007. We believe that the Board's action sends a strong message regarding our confidence in the future performance of Insteel and our commitment to delivering value to our shareholders without compromising our growth prospects.

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 are pleased with our record financial results for the first quarter of 2006. During the quarter, we experienced a welcomed rebound in shipments and we hope that it proves to be a precursor to strong market conditions for the balance of the year.

We've reported in the past that backlog data for Insteel was of minimal value for forecasting purposes in view of the short leadtimes for most of our products, so we are unable to provide any assurance that the improved market environment will continue.

At this point, though, we can make two observations about 2006. First, we believe the macro outlook for demand for our products is favorable, driven by the rebound in nonresidential construction activity that began about a year ago, together with increased public infrastructure spending and reconstruction work associated with the recent hurricanes. And second, order entry through this point in January has been robust, continuing the favorable trend that began last September.

We reported in the last two quarterly conference calls that we had seen increasing competitive pricing activity in both our welded wire reinforcing and PC strand markets. This activity with respect to domestic competitors tailed off during the last part of the fourth fiscal quarter following the announcement of price increases by domestic wire rod suppliers.

The pricing environment for our products remained relatively stable through the first fiscal quarter and up to this point in the second quarter. Offshore competitors in PC strand, however, have steadily reduced prices in spite of increasing demand, which has had an unfavorable impact on spreads in this part of our business.

During the first quarter, these pricing pressures were more than offset by the 30% increase in strand sales that Mike mentioned previously. One of the unknowns concerning our future financial performance is the net impact of the continuation of low-priced imports of strand relative to the anticipated improvement in demand.

Conditions in the wire rod market are important to the outlook for our performance also, so I'll provide a brief update on developments since the last conference call. As you may recall, last quarter we reported that labor disputes at two North American producers had significantly affected the availability of wire rod, particularly for higher quality grades. Now, however, it appears that these labor issues are well on the way to being resolved.

Effective January 16, workers returned to their jobs at a major Canadian producer that had been on strike since September, and we understand that workers are returning to a U.S. producer that had locked out workers last May, although a labor agreement has not been finalized at that facility. Based on our understanding of the circumstances, it sounds like production at the U.S. plant will ramp up over the next few months.

The supply curtailments that resulted from these labor disputes allowed North American wire rod pricing to escalate over the past six months to levels that were increasingly noncompetitive with the world market.

In November, the domestic wire rod producers filed antidumping cases against China, Germany and Turkey. Generally, the filing of these cases results in a Department of Commerce investigation that takes place over the course of 10 to 12 months. In response to the filings, wire rod producers in the subject countries typically withdraw from the market due to the potential for incurring onerous duties during the course of the investigation.

This time, however, the cases were terminated on December 23rd following a ruling by the International Trade Commission that there was insufficient evidence of injury to the domestic industry caused by these imports. I read in a trade publication that this was the first negative determination at the preliminary stage of a steel case in 20 years.

The termination of the investigation should mean that adequate quantities of wire rod are available for the foreseeable future and that pricing should not be distorted by artificial supply constraints. It remains to be seen whether adequate import availability, together with the restart of the two mills that had experienced labor problems, results in pricing from North American sources becoming more competitive with the world market. If the gap remains wide, we will continue to increase our purchases of offshore material as a percentage of our total requirement.

Regardless of how events develop in the wire rod market, it's worth noting that Insteel has one of the most desirable wire rod requirements in the market in terms of our volume and our mix, which should position us to purchase favorably in almost any market environment. Our tonnage requirement is one of the largest in the industry, and importantly, we purchase a mix of sizes and grades and that's highly attractive to wire rod producers.

We use high value-added, metallurgically sophisticated products for PC strand and our industrial wire products, as well as lower end grades for our welded wire reinforcing products. With nearly 50% of our requirement in the high-value end of the market, our needs are quite attractive to most suppliers.

As we indicated previously, our CapEx spending will rise over the 2006, 2007 period, primarily in support of our engineered structural mesh and PC strand expansions. The bulk of the expenditures will go toward adding two additional ESM production lines, which will expand our capacity and reduce operating costs. The first of these lines has been ordered and should be delivered to us during the fourth fiscal quarter of 2006. Commissioning is planned for the latter part of the fourth fiscal quarter and early into the first fiscal quarter of 2007.

We're also well along with the expansion of our Tennessee PC strand plant, which entails the installation of a new strand production line in a larger facility owned by the Company that has been only partially utilized for the past few years. Following commissioning of the new line, which is expected to begin in late March, we will relocate the equipment from the existing strand operation to the larger facility. In addition to providing us with additional strand capacity, this project will have a favorable impact on operating cost. Completion is expected [before] the fourth fiscal quarter.

Turning to the outlook for our concrete reinforcing business, the first 16 weeks of fiscal 2006 have been encouraging. Shipments have recovered from the doldrums and, by and large, margins have remained attractive. We believe that the demand improvement that we've seen since September 2005 is largely attributable to the end of the inventory correction cycle that began in late 2004 and negatively impacted shipment levels through most of 2005, together with the strengthening market fundamentals resulting from growth of nonresidential construction spending, which has finally reversed the unfavorable trend that began in 2001.

During 2006, we should also begin to see an increasing benefit from higher public infrastructure spending, along with reconstruction requirements in the areas that were affected by the hurricanes. The combined impact of these macro factors should support healthy demand for our products, and we believe that we are well positioned to capitalize on the favorable outlook.

Turning to our industrial wire business, we're coming off another difficult quarter, where shipments declined 8% from the prior year. The facility operated at approximately 65% of capacity during the quarter. To make matters worse, costs have increased substantially, particularly for energy and transportation. The combination of the low capacity utilization and cost escalation resulted in an operating loss for the quarter.

As we reported previously, achieving acceptable financial performance is dependent upon operating the plant at higher levels of capacity utilization. Based on the recent improvements in our product performance and the likelihood of a more competitive raw material environment, we believe the prospects are good that the plant will return to profitability during the second or third quarter.

Provided that the operation can achieve and sustain an acceptable return on capital, there are opportunities for growth going forward. Ultimately, though, our future direction for this business will be driven off its actual results relative to the performance expectations that we apply to all of our businesses.

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

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

Congratulations on another great quarter. Do you have any -- I think the outlook has been kind of hazy as to when the public infrastructure spending might start to kick. Do you have any better visibility into that at this point, or not yet?

Not, really, Peter. Anecdotally, I think that we believe that we should see some impact of that during 2006. But I would expect it to be in the latter part of 2006 rather than earlier.

Got you. One other housekeeping item, I guess. Have you repurchased any shares yet under the agreement?

No, we haven't. We are subject to the normal insider trading regulations, so we have a blackout period.

Great. Thank you very much and congratulations on another great quarter.

(OPERATOR INSTRUCTIONS) Jeremy Hellman with Thompson, Davis.

Good morning, guys. Nice quarter. Like to see it. Just wondering, Mike, if you can go back and run through the revenue breakdown again. I just couldn't keep up with you taking notes, breaking it all out.

Okay. In particular the business segments?

Yes.

Okay. For the quarter, sales for our concrete reinforcing products business unit were 75.6 million this year versus 65.1 million a year ago. And the gross profit was 17.1 million versus 13.2 million last year.

And how did that break down between ESM and wire -- or PC strand, sorry?

We don't disclose that separately.

Okay.

And then for industrial wire products, revenues for the quarter were 7.9 million versus 9.6 million last year. And the gross loss for the current quarter was about 0.5 million versus gross profit of 0.6 million last year.

Okay. On to other things. Looking at gross margin, I was very pleased you guys had real healthy gross margin this quarter. Is that something that you see as being sustainable heading into the rest of the year or something that could even improve from these levels overall?

In the end, a lot of it is going to depend on the demand conditions, which, as we indicated, appear to be favorable. But in terms of the margins for the quarter and the year-over-year improvement, the biggest driver by far was the higher shipments level. And we would think that continued improvement in demand going forward would support maintenance of existing spreads or possibly higher spreads. But difficult to say much more than that at this point.

Okay, got you. I'll get back into queue.

Leanne Karns with Singular Research.

Great quarter. I had a question on inventory, the uptick there appears to be related substantially to increases in raw materials. I was anticipating that maybe next quarter in anticipation of the third and fourth quarter. Is there a story there or why did you increase so early?

Generally, there is an increase during this quarter simply due to the seasonal nature of the business, and the increase is actually lower than what we've seen in the past. We also, as I mentioned, had the trade actions that were filed in November which causes, to the extent that we could, to accelerate some deliveries because availability can become a concern under the backdrop of antidumping cases.

Okay, great. Thank you.

Steve (indiscernible) with [Strickland Advisory Services].

I wonder if you could kind of give me a sense here, you're talking about increased availability of raw material inputs. I was wondering if you can comment a little bit on the competitive side, the user site, your competitors, as to whether or not they may have some excess capacity which could ultimately result in spreads for your products becoming narrowed. What is your sense on the capacity utilization availability for your competitors at this point?

Well, while we like to think that we're running our business well, I think the reality is that our experience is probably not a lot different than what we see from our competitors. I would expect that business levels have been favorable for both our welded wire reinforcing and our PC strand competitors, and that everyone has enjoyed the benefits of a stronger market.

And so you are saying so far you think spreads should sort of remain stable -- plus or minus a little bit, is your feeling at this point?

Yes, I think that at this point. But I would just remind you that delivery cycles are short in our business and we really don't have firm commitments that go out any distance that would allow us to say unequivocally that spreads are going to do one thing or the other.

Is there someone out there operating at 60% utilization -- at 50%, which would make them want to take advantage of potentially increasing raw material availability at this point -- that you are aware of?

I don't have any facts on it, but I would be surprised if there is anyone out there operating at that lower level.

In terms of the hurricanes that we have had, have you seen any sort of activity related to that yet at this point?

Probably not, judged by or measured by actual shipments of products. But there has been considerable quotation activity on the part of our customers for some of the fast-track projects that you may have read about relating to the reconstruction of I-10 and I think it's U.S. 90. There is really quite a bit of work that will be coming out on a fast-track basis to solve some of those problems.

Now when I say a fast-track business, keep in mind that is fast-track for this industry and fast-track in view of the normal leadtimes, which sometimes are measured in years. So when I say fast-track, I think that we will see some of those shipments actually made during 2006, but very little of that has occurred at this point.

In terms of your content of these pretty sizable projects, can you give any indication of what you think your content might be for projects like this?

Unfortunately, it's really impossible to project the times or the units of our product that will be consumed. But just based on the activity and the nature of the some of the reconstruction, I'm confident that this will be a positive impact on demand for our industry, both in PC strand as well as welded wire reinforcing.

Can you talk a little bit about the reduction in cement tariffs from Mexico and sort of if you think that has any impact one way or another on your business?

I think it could have any impact. Last year particularly we received reports of spot cement shortages in the coastal areas, primarily. And the elimination of duties or the reduction in duties and the increased availability would certainly help to stem those issues going forward in 2006.

With that said, I don't believe that we lost significant business in 2005 due to cement shortages, but it certainly was a bottleneck that caused scheduling issues and it certainly did slow down certain projects that our customers had.

Just one more, if I may. On your working capital, I was certainly very pleased to see the large working capital benefit here in Q1. Is there any feeling as to whether or not this could be reversed going forward based on your mix or growth inventories or what not?

(indiscernible) just due to the number of factors, actually. I don't know if we can really speculate on that. I mean, generally, as you would expect, the receivables would tend to follow our seasonal pattern, where during the quarter we benefited cash-wise from the reduction, but --.

The payables are sort of what, you know, jumps out.

Pardon?

The payables line.

And then the payables, there is quite a bit of fluctuation there as well, depending upon conditions in the raw material markets and our mix of imported versus domestic material, where I don't know that I could really speculate on it. I would say that we wouldn't anticipate there being, I guess, a sizable swing, barring any significant changes in the market environment, where we change our mix in one direction or the other. But I don't know if I could give you a more precise response.

No, I appreciate it. Thanks so much for your time, guys.

(indiscernible)

Who is the price leader in the market? What essentially I'm saying, what can we anticipate in terms of pricing?

Well, I think what I'd be comfortable saying there is that certainly in PC strand, the imports are the price leaders and have significant influence on that marketplace.

Okay, great. And in industrial wire, other than tire bead, what are the principal end markets?

Springs, products that are driven by residential housing. Really, the market is quite broad, there are innumerable end uses. But springs, strapping, ducts, those are certainly large parts of the market.

Great, thank you.

(OPERATOR INSTRUCTIONS) [John Evans] with Coker & Palmer.

Can you talk to us a little bit about your outlook for CapEx this year, I guess what that total will be? And then can you give us any insight into D&A?

Sure. For CapEx, we're -- and this is consistent with what we had indicated -- at the end of the fiscal year, we're looking for outlays to increase to 13 million in the current year as well as in 2007.

And the largest components of that would be for our expansion efforts in PC strand and ESM, the expansion and reconfiguration of the strand operation, the addition of another ESM line this year, a third line in 2007. And then beyond that, various upgrades to our PC strand operation in Sanderson, Florida in 2007. Beyond that, it would be a combination of recurring maintenance type expenditures.

I guess at the highest level, we're looking at CapEx of 13 million for 2006 and 13 million in 2007.

John Evans; Okay. And D&A, this year, you expect -- will it change much?

We wouldn't anticipate much of a change there.

Okay, thank you.

Jim Winchester with [Quantified Value].

Good morning. Just had a quick question on the ESM. If you look at the two new lines that are coming up and assume that the third line is on full production -- and maybe we're looking out to '08 before that actually occurs -- but could you quantify or just give us a sense of what the volumetric increase would represent versus your existing capacity or capacity, if you want to look at sort of the aggregate volume of ESM that you sold in the '05 fiscal year, what that expansion would represent in volume terms when it is all online?

I don't know if we can drill down to that level of detail. I guess at a higher level, you may have noticed that in our annual report we had indicated that on an incremental basis, each ESM line could potentially generate 16 to 20 million of revenues based on a number of assumptions, the existing average selling prices and existing mix, which is obviously subject to the fluctuation. So I guess in assessment of the impact of the lines, you could probably approximate it on that basis.

There is, Jim, though, a component of cost reduction associated with certainly the first two lines, where we expect to produce much of what we are now producing at a far lower cost. So there is that impact also.

And when you say far lower cost, could you give us a sense of what that represents percentagewise or what the impact might be on gross margin or on your --?

We really have -- we have avoided disclosing to that detail, Jim.

Where do those cost benefits come from? Is it in purchasing, is it at the overhead level or --?

It's labor and yield.

Okay, labor and yield, good. Okay, great. Thanks.

Jeremy Hellman with Thompson, Davis.

Two quick parts. First thing is just a bookkeeping, back to the options. Would you say that your rate of annual issuance is changing at all with the new options expense or -- I mean, it's always been, I think, compared to other industries a nominal amount. But have you guys made any changes to the rate of option issuance?

We don't anticipate any significant changes.

Okay. And then secondly, going back to the industrial wire division. Is there anything you guys are doing on the sales side to try and either find new end uses or anything to really try and drive additional orders in that regard? Or is it you're looking at trying -- [sort of] back around and be a cost recovery and just some increased capacity utilization?

We are working as diligently as we can to address the volume side of the equation, which is really the essence of the problem that we have there. The plant is quite an excellent facility with low operating costs and high standing costs. So we are diligently pursuing the business that is required for us to attain the plant's inherent cost advantages. And it comes from both looking at new products as well as existing products.

Okay. Thanks, guys.

Gentlemen, it appears there are no further telephone questions. I'll now turn the conference back over to you for any additional or closing remarks.

Okay, thank you. We appreciate your interest in the Company. We're available for follow-up calls if you'd like. Thank you and we will sign off.

That does conclude today's teleconference. We would like to thank everyone again for their participation and have a wonderful day.