Insteel Industries Inc (IIIN) 2006 Q2 法說會逐字稿

Good day, everyone. Welcome to the Insteel Industries' second-quarter 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, HO Woltz III. Please go ahead, sir.

Thank you, Allen. Thank you for your interest in Insteel. Welcome to our second-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 quarter ended April 1st. Mike will walk you through our financial performance for the quarter, and I will follow up 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 periodic reports with the SEC.

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

Thank you, H. As we reported in this morning's press release, Insteel's financial results rose to a new record high for the second quarter, driven by the continuation of strong demand for our concrete reinforcing products during what is typically one of the slower periods of the year.

For the quarter ended April 1st, net earnings increased 47% to 7.4 million or $0.80 per diluted share compared with 5 million or $0.53 per diluted share in the year-ago period and the previous second-quarter high of 5.5 million or $0.63 per diluted share that we posted back in fiscal 2004. Excluding the gain from a discontinued operation that was recorded in the prior year, earnings from continuing operations were up 70% from the year-ago quarter. The strong performance for the quarter was in spite of the fact that our first and second-quarter results have historically been significantly weaker than our results for the second half of the year due to the usual seasonal drop-off in construction activities that occurs during the winter months. For the 6-month period, net earnings increased 48% to 15.1 million or $1.61 per diluted share compared with 10.2 million or $1.07 per diluted share for the same period last year. Excluding the prior-year gain from the discontinued operation, earnings from continuing operations for the 6 months rose 59% from a year ago.

Sales for the second quarter rose 9% from a year ago, as a 20% increase in shipments more than offset a 9% decrease in average selling prices. The increase in shipments marked the third straight quarter that we posted year-over-year improvement, following five consecutive quarters of decline, providing further evidence of the favorable trends that we're seeing in our markets.

We believe that the upturn in volume for the quarter was driven by the continuation of the recovery in the non-residential construction sector. As we previously reported, shipments of concrete reinforcing products in the prior year were negatively impacted by inventory-reduction measures within our customer base that were pursued in response to weaker-than-anticipated demand. We believe that these inventory imbalances were corrected around the end of our fiscal year to where our first-quarter shipment levels were more closely aligned with the actual rates of consumption for our products.

At this point, we do not believe that we have realized 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 post-hurricane reconstruction work in the Gulf region will have an increasingly favorable impact on the demand for our concrete reinforcing products later in the year and into 2007.

On a sequential basis, shipments for the second quarter were up 8% from the previous quarter, which is encouraging when you consider the volume improvement that was achieved in the first quarter where we were up 24% from the prior year. 9% decrease in average selling prices from a year ago was largely due to the reduction in the cost of steel wire rod, our primary raw material, which occurred over the same period.

Sales of concrete reinforcing products, which includes our welded wire reinforcement and PC strand product lines increased 11% for the second quarter from a year ago on a 22% increase in shipments, which more than offset the 9% decrease in average selling prices. PC strand sales were up 17% as compared with the prior year, while welded wire reinforcement sales increased 4%, both driven by higher shipments. Sales of industrial wire products, which includes tire bead wire and other specialty wire products, decreased 5% from last year due to lower selling prices.

Gross profit for the second quarter increased 39% from the prior year with gross margins widening to 18.3% from 14.3% due to the increase in shipments together with lower unit conversion costs, primarily driven by higher production levels. Gross profit for concrete reinforcing products increased 46% from last year with gross margins rising to 21.3% from 16.1%, primarily due to the higher shipments and lower unit conversion costs. Our industrial wire products business unit had a disappointing quarter, posting a gross loss of 0.7 million compared with gross profit of 0.1 million last year due to lower average selling prices and higher unit conversion costs.

SG&A expense for the second quarter increased 14% or 0.6 million to 4.5 million or 5.1% of net sales in the current year versus 3.9 million or 4.8% of net sales last year. Most of the increase was driven by the year-over-year change in stock-based compensation expense. As we have previously reported, the Company adopted FAS 123R as of the beginning of fiscal 2006, which requires that the fair value of stock-based compensation, such as stock options or restricted stock, be established as of the grant date and recognized as expense over the requisite service period.

Under the provisions of 123R, 0.2 million of stock-based compensation expense was recorded as SG&A expense for the second quarter. In the prior year, options issued under certain plans were previously subject to variable plan accounting, where compensation expense was recognized for the excess of market over exercise price over the vesting period and adjusted for changes in market valuation. As a result of the decrease in the Company's share price that occurred during the prior-year quarter, last year's SG&A expense reflected a 0.4 million reduction in stock-based compensation expense. So, excluding stock-based compensation expense from both periods, SG&A expense would have been flat year over year at 4.3 million. On a sequential basis, SG&A expense was up 0.3 million from Q1, primarily due to higher incentive plan expense.

Interest expense for the second quarter decreased 86% or 1.1 million from a year ago due to lower average borrowing levels on the credit facility and reduced amortization expense, largely associated with terminated interest rate swaps incurred in the prior year. The Company's effective tax rate for the second quarter rose to 36.8% from 34.4% in the prior year. The lower rate in the prior year was primarily due to higher compensation expense for tax versus book purposes related to incentive stock options, an increase in favorable book to tax differences and a reduction in valuation allowance for deferred tax assets that had been established for state tax loss carry-forwards.

Moving to the balance sheet and cash flow statement, operating activities generated 4.1 million of cash for the second quarter versus 11.2 million in the same year-ago period. The 7.1 million decrease was largely due to a 9.9 million swing in the changes in net working capital, which more than offset the increase in earnings. In the current quarter, net working capital rose as it typically does with the seasonal increase in sales consuming 3.7 million in cash. While in the prior-year quarter, net working capital decreased as a result of the inventory-reduction measures that were being pursued, providing 6.2 million in cash. For the 6-month period, operating activities have provided 24.6 million in cash compared with 8.3 million in the prior-year period, primarily due to a 17.6 million increase in payables and accrued expenses in the current year together with the increase in earnings. The payables increase was driven by higher purchases and a more favorable mix of vendor payment terms.

On a forward-looking basis, our total inventory quantities on-hand as of the end of the quarter represented a little over 2 months of shipments based on our anticipated run rate for the third quarter. As a point of comparison, our quarter-end inventory level was approximately 6.9 million lower than the prior year. Capital expenditures for the quarter rose to 5.7 million from 1.6 million in the prior year, bringing the 6-month year-to-date total to 8.1 million versus 2.4 million a year ago. The increases were primarily due to expenditures for the PC strand and ESM expansions.

As previously reported, we expect that capital expenditures will rise to 13 million in 2006 and 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 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 significant cash outflows that occurred during the quarter for CapEx and share repurchases, we ended the quarter with 3.8 million outstanding on our revolving credit facility, leaving 57.4 million of unused borrowing capacity. In comparison, we had 45.3 million of total debt outstanding a year ago.

In addition to the quarterly financial results, we also announced that following the end of the quarter, we determined that we would exit the industrial wire business and proceed with the closure of our Fredericksburg, Virginia plant. Our decision was driven by further weakening in the business outlook for the plant, since the end of the quarter, with no indications of a future recovery insight. With the deterioration in expected performance coming in the wake of the 1.1 million gross loss that was incurred through the first half of the year, we concluded that the best course of action would be to close the plant and redeploy the capital. Although we are still in the process of finalizing the details of our closure plans, we expect the plant shutdown to be completed during our third quarter, ending July 1st.

In connection with the plant closure, we currently estimate that we will record pretax charges totaling approximately 4 million during the third quarter, comprised of 2.7 million non-cash impairment losses to write down the carrying amount of the PP&E to fair value and 1.3 million in cash outlays for contractual obligations and employee termination benefits. As indicated in the release, these estimates should be reviewed as preliminary, as the actual charges recorded will not be known until we have finalized the details of the closure plan and the assets to be sold and prepared or obtained updated estimates of the related fair values. From a strategic standpoint, the completion of the plant closure will narrow the Company's focus entirely to concrete reinforcing products. The industrial wire business will be accounted for as a discontinued operation in the Company's financial reporting, beginning with the third quarter.

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 record financial results for the second quarter, which were driven by a continuation of the rebound in shipments that began in the fourth fiscal quarter of 2005. We attribute the recovery in unit volume primarily to improved conditions in the private non-residential construction sector. From all indications, it appears the favorable environment is likely to persist at least into 2007. The primary risk we see at the health of this market segment is increasing interest rates, which at this point in time seems manageable.

Another primary source of demand for Insteel's products is the infrastructure sector, which is comprised of government-funded projects, such as highways, bridges, and transit programs. We view the fundamentals of this market sector to be favorable in view of the Federal Highway Bill that was passed last August together with the stimulative impact on demand that we expect to see from rebuilding activities related to the 2005 hurricane season. Importantly, though, we do not believe that there has yet been a growth of unit volume that is attributable to increasing public sector demand. While we are quoting more work that is directly related to the Highway Bill and to hurricane rebuilding, it appears to us that actual shipments and revenues related to these projects will be recognized, beginning in late 2006 and in 2007.

We have reported in the past that backlog data for Insteel is of minimal value for forecasting purposes in view of the short lead-times for most of our products. So, we are unable to provide any assurance that the improved market environment will continue, but we believe that the macro demand drivers for our reinforcing products are favorable.

The pricing environment for our reinforcing products with respect to domestic competitors was relatively stable during the second quarter, and margins generally reflect the favorable business conditions we are experiencing. 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 second quarter, these pricing pressures were more than offset by a sharp increase in shipments. One of the variables that will affect our future financial performance is the net impact of the continuation of low-priced imports of PC strand relative to changes in demand.

Conditions in the market for our primary raw material, hot-rolled steel, wire rod are important to the outlook for our performance, so I will update you on developments since our last conference call. As expected, domestic supply increased following the resolution of labor problems that persisted in the industry through the December/January period. Availability is adequate with reasonable lead-times, and producers appear to be satisfied with the level of orders booked at their facilities. Through our second fiscal quarter, domestic wire rod pricing remained well above world market levels, providing incentive for Insteel to import a significant portion of its requirement.

Over the last few weeks, the international market for wire rod has strengthened due to rising scrap prices and improving demand in other parts of the world. At this point, offshore availability is adequate for our needs, but we would expect higher prices when we go to market for our next deliveries. Regardless of developments in the wire rod market, we believe we will purchase competitively due to the desirability of Insteel's requirements to wire rod producers from both the volume and mix standpoint. Approximately half our requirement is comprised of higher value-added, metallurgically-sophisticated products, which are attractive to our suppliers.

As we previously indicated and as Mike pointed out, our CapEx spending will rise over 2006 and 2007 to support the growth of our engineered structural mesh and PC strand expansions. We plan to add two additional ESM production lines, which will expand our capacity and contribute to reduced 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 expected to take place during the first quarter of 2007. We expect to place orders for the second line during the fourth fiscal quarter of 2006, with startups scheduled for later in 2007.

Also, we are winding up the first phase of our Tennessee PC strand plant expansion, which entails the installation of two new strand production lines in a larger facility owned by the Company that has only been partially utilized for the last few years. Commissioning of the first new production line will begin later this month or in early May, followed by commissioning of the second new line during the latter part of our fourth fiscal quarter. Following the commissioning of the new equipment, we will relocate some existing equipment to the larger facility. We expect for these activities to be substantially complete during our fourth fiscal quarter. In addition to increasing capacity by approximately 25%, we expect to realize substantial operating cost reductions from this project.

We've also moved forward with design and engineering related to the modernization of our Florida PC strand plant and expect to complete that project during fiscal 2007. As with the Tennessee project, we are looking for substantial operating cost reductions from this initiative. We have previously indicated that our CapEx over 2006 and 2007 would approximate $26 million. While the timing may shift between periods due to equipment availability and scheduling issues, this estimate of our aggregate investment plan is still reasonable. Based on what we see now, we are encouraged that our expansion initiatives appear to be well-timed with respect to market demand for our products.

Turning to our industrial wire business, as we announced this morning, we plan to close our Virginia industrial wire plant during the current quarter. Those of you who have followed the Company for a while are aware that the facility had suffered for the past five or six quarters from low operating rates and more recently from significantly rising costs that we have been unable to recover in the marketplace. After evaluating every possible option to turn the operation around, we eventually determined that it was unlikely we would meet our minimum return on capital requirements and that closure was our best option. We regret the necessity of the closing and its impact on our people and the Fredericksburg community. We plan to offer extensive support and transition assistance that includes continuation of compensation and benefits, preferential consideration for positions elsewhere in the Company and outplacement assistance. We are fortunate that the plant is located in an area where unemployment is extremely low and job opportunities are plentiful. There are excellent prospects for our people to transition to good jobs, either within the Company or in new fields, and for Insteel to strengthen its focus on its core markets and redeploy the capital that was invested in this business.

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

(Operator Instructions). Jeremy Hellmann, Thompson Davis.

It looks like a good quarter to me. Congratulations. I got questions on a couple fronts. First off, in terms of the CapEx expenditures, would you say that those outlays have come kind of on the timeline you were expecting or have they come any sooner due to availability such that things are coming about quicker than maybe you originally thought?

I think spending has occurred just right in line with our expectations.

Okay, (multiple speakers) --

No, no, today's indicator was still looking at 26 million in total over the 2-year period. But there may be some movement between the years, particularly as we get into the fourth quarter.

That makes sense. Next, moving on to gross margins and I'm just going to focus on concrete reinforcing going forward. Q2 margin in that business was 21.3% versus 16.1 last year. Q1 was 22%. What was margins for that business Q1 of '05 just for comparison purposes?

I will have to follow up with you on that. I don't have that readily available.

What I was kind of getting into kind of based on whatever that number might be is, you've had year-over-year improvements -- it looks like Q1 and Q2, assuming that Q1 was an improvement over '05, can we look for similar improvements in Q3 and Q4 over '05 levels as well?

That is a big question, and I'm not sure we can deal with it with the information we have in our hands right at this moment.

One comment I will make -- not a question but a comment in terms of industrial wire. I know it's a difficult decision to tell your people that you're closing the facility and everything, but I think it is worth applauding you guys for making a decision in a prompt fashion the way you have. Last question and then I will get out of the queue is in terms of capacity utilization with what -- the lines you do have right now, where is your capacity utilization running in concrete reinforcing and broken out between the ESM and PC strand if you could.

It's running at a relatively high rate, Jeremy, across-the-board. I would say in the low 90s probably across all of the product lines.

So it looks like which is I think the new -- been assumption for everyone involved that some of these expansions are coming on just at the right time, which is something that you guys point out as well, right?

Yes, we certainly -- we certainly think so.

I will jump out and let someone else take their turn.

(Operator Instructions). John Wegmann, Speedwell.

On the PC strand business, can you name who the foreign competition is coming from?

It's primarily Chinese competition at this point in time. If my memory serves me right, the Chinese are accounting for somewhere between 60 and 70% of total imports. That is up from 0 in 2003.

Thank you. Again, congratulations on a great quarter and great performance with the Company.

(Operator Instructions). Leanne Karns, Singular Research.

I had a question on the closure of the industrial wire business. How many people are you expecting to be affected?

That business unit employs approximately 87 people, which would represent about 13% of our total workforce. The number actually impacted will depend on the outcome of the process that we're going through right now in evaluating other opportunities within the Company to redeploy some of those people.

So, it's too early to really have an estimate on the long-term cost reduction, especially in the SG&A?

Well, we've provided -- I guess in the release, we've provided an indication of what the estimated closure costs would be that would be recorded in the third quarter. You know, we expect to have the closure completed within that period. Then from that point forward, that would imply that the gross loss that has been incurred would be eliminated.

(Operator Instructions). Trey Snow, Priority Capital.

With regards to the industrial wire business, were there thoughts or efforts to try to sell that rather than shutter it?

Absolutely. We looked at a number of different alternatives over an extended period of time and a sale of the facility certainly was one of them.

But just no fires at the --

Correct.

Current level? Okay and seeing recently I guess Nucor and Gerdau acquiring in the last 6 months or so a couple of companies in the rebar space in the WWR arena. Are you concerned at all about capacity and/or competition sort of increasing over the next year?

With respect to Gerdau, the acquisitions that I'm familiar with are -- have been primarily either steelmaking acquisitions or Rebar fabrication acquisitions and in either case would not affect Insteel one way or the other. The Nucor acquisition of Connecticut Steel certainly puts them in the welded wire reinforcing business. We perceive no threat from that. Connecticut Steel has been an established competitor for an extended period of time. We also know that Nucor likes to make money, and we like to have competitors who are concerned about the returns on their investment. So, we perceive no threat from that acquisition.

(Operator Instructions). It appears there are no further questions at this time. Mr. Woltz, I would like to turn the conference back over to you for any additional or closing remarks.

Okay, thank you, Allen. We appreciate your interest in the Company. If you have follow-up items, please don't hesitate to call us. Thank you very much.

Ladies and gentlemen, that does conclude today's call. Thank you for your participation and you may disconnect at this time.