Insteel Industries Inc (IIIN) 2006 Q3 法說會逐字稿

Good day everyone and welcome to the Insteel third quarter earnings release 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.

Think you Kim and thank you for your interest in Insteel and welcome to our third quarter 2006 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 July 1. 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 than 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 more details on the Company's financial results.

Thank you, H. As we reported in this morning's press release, Insteel posted solid results for the third quarter, driven by the continuation of strong demand for our concrete reinforcing products as we moved into our busy season. For the quarter ended July 1, diluted earnings per share from continuing operations rose 9% to $0.50 from $0.46 in what was a strong year-ago period and earnings from continuing operations were up 5% from the prior year. Including the results of discontinued operations, diluted earnings per share for the quarter was $0.38 versus $0.45 a year ago. For the nine-month period, diluted earnings per share from continuing operations increased 41% to $1.35 from $0.96 last year and earnings from continuing operations were up 38% from the prior year. Including the results of discontinued operations, diluted earnings per share for the nine-month period was $1.19 versus $0.99 a year ago.

Before I commented on sales for the quarter, I wanted to touch on some of the recent macro indicators that impact demand for our product. With roughly 80% of Insteel's revenues driven by nonresidential and infrastructure-related construction and 20% by residential construction, we are ideally positioned to benefit from the current trends that are underway in the construction sector. Although certain construction indicators have reflected some weakening in recent months, we believe that the declines are reflective of the front loading of construction activity earlier in the year due to the unusually mild winter and early spring weather, rather than the beginning of a downward trend. A recent report by the U.S. Geological Survey indicated that the increased shipments of cement for the first four months of the year were at least partially driven by record high temperatures in January in April, which allowed earlier concrete placing than in most years. This may have served to accelerate some of the business that would have otherwise fallen within the second half of the year into the first six months, which is consistent with the unusually strong demand that we experienced in Q1 and Q2. The double-digit year-over-year growth in Q3 shipments, in spite of the shifting of volume, attest to the strength of demand in our market.

In the most recent construction spending report from the Census Bureau for the month of May, private nonresidential spending fell slightly from the previous month by 0.3% but was up 13% on a year-to-date basis and public spending, which is primarily infrastructure-related, was up 0.7% for the month and 10% year-to-date. In spite of the monthly decline, all of the nonresidential spending categories were higher than the prior-year levels on a year-to-date basis. Within the public spending category, highway and street spending for the January to May period was up 15% from last year. In comparison, residential construction was down 0.8% from April and up 6% on a year-to-date basis.

Another recent indicator, the June monthly report from the Bureau of Labor Statistics, reflected similar trends for the nonresidential and residential construction sectors where on an overall basis, construction employment was relatively flat for June as a decrease of jobs in residential building, especially trade construction, was offset by increases in the same categories for the nonresidential sector.

Other recent reports indicate further declines in office vacancy rates, which have now fallen for nine consecutive quarters, and increases in hotel occupancy rates, which have risen to an all-time high, surpassing the previous decrease in February 2001. We believe that the expansion and demand for both these sectors should continue, spurring additional growth in office and hotel construction over the next couple of years.

Finally, another recent data point, the architecture billings index, posted a drop in June billings from the previous month, which was the second straight monthly decline following the positive trend that had extended over 19 consecutive months and 28 out of the previous 29 months. The ADI serves as a leading indicator in nonresidential construction activity based on the typical six to nine-month lag time between architecture billings and construction spending, although it can also be impacted to a lesser extent by residential activity. At this point, because the index only indicated slight easing over the past few months and new project inquiries continued to be strong, we view the declines as being isolated in nature, rather than signaling a future downturn.

We continue to believe that higher infrastructure spending, together with post-hurricane reconstruction work, will have a gradual increasing impact on the demand for our products later in the year and into 2007. However, we will continue to monitor these indicators as well as other relevant data points to determine if longer-term trends develop that could become cause for concern.

Insteel's sales from continuing operations for the third quarter rose 7% from a year ago on an 11% increase in shipments which more than offset a 3% decline in average selling prices. The increase in shipments marked the fifth consecutive quarter we posted year-over-year improvement and the third consecutive quarter we've achieved double-digit growth versus the prior year.

On a sequential basis, shipments for the third quarter increased 16% from Q2 in spite of the shifting of business that I alluded to and the substantial upturn that occurred during the first half of the year when shipments were up 25% from the same period as last year. The 3% decrease in average selling prices from year ago paralleled the reduction in the cost of a primary raw material steel wire rod which occurred over the same period. On a sequential basis, average selling prices are relatively stable, declining slightly by about the same amount as the reduction in rod costs that occurred from Q2.

Sales of PC strand were up 15% from the quarter from a year ago while welded wire reinforcement sales increased a percent, both driven by higher shipments. On a sequential basis, welded wire reinforcement sales were up 27% from the second quarter while PC strand sales, which were unusually strong earlier in the year, increased 3% from the second quarter, again, driven primarily by higher shipments.

Gross profit from continuing operations for the third quarter was up 3% from a year ago, driven by the higher shipments, while gross margins declined to 20.2% from 21%, primarily due to increasing manufacturing costs, together with the sale of inventories value at higher costs, reflecting raw materials purchased in prior period. Spread between selling prices and raw material costs are relatively stable compared with the prior year, as well as on a sequential basis relative to Q2.

In response to the recent escalation in rod cost, which is expected to continue through the remainder of the year, we implemented price increases in most of our markets in late June. Due to the timing of the increases, they had a minimal effect on third quarter margins, which should have a more pronounced impact on Q4 where they will be in effect for the entire quarter and could be followed with additional increases.

SG&A expense for the third quarter increased 8%, or 0.3 million from a year ago, to 4 million versus 3.7 million, which is flat as a percentage of net sales at 4.3% in both years. The increase was primarily driven by the year-over-year change in stock-based compensation expense. Under the provisions of FAS 123(R) which we adopted as of the beginning of fiscal 2006, we recorded 0.2 million of stock-based compensation expense for the third quarter.

In the prior year, options issued under certain plans were subject to variable plan accounting. 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 reflects the 0.3 million reduction in stock-based compensation expense. So excluding it from both periods, SG&A expense would have declined 0.2 million to 3.8 from 4 million last year.

Interest expense for the third quarter decreased 75%, or 0.5 million from a year ago, primarily due to lower average borrowing levels on the credit facility in addition to lower amortization expense. The Company's effective income tax for the third quarter, including the disk ops component, was relatively flat at 36.6% versus 37.1% a year ago.

Moving to the balance sheet and cash-flow statement, operating activities of continuing ops generated 9.5 million of cash for the quarter, versus 21.2 million in the same quarter year-ago period. The 11.7 million decrease was largely due to the 12.8 million year-over-year change in net working capital, which more than offset the increase in earnings from continuing operations. In the current quarter, net working capital rose with the seasonal increase in sales, consuming 0.8 million of cash, while in the prior-year quarter, net working capital decreased by 12 million, primarily due to the 11.4 million increase in accounts payable in accrued expenses. This prior year increase was largely related to the reinstatement of traditional payment terms by vendors from the reduced terms that had been instituted in 2004 in connection with the tight supply conditions that existed in the market at that time. For the nine-month period, operating activities of continuing operations provided 32.4 million in cash, compared with 28.3 million in the prior-year period, primarily due to the 6.8 million increase in earnings from continuing operations.

On a forward-looking basis, total inventory quantities on hand as of the end of the quarter represented a little over two months of shipments based on our anticipated run rate for Q4. Total inventories were down 3.1 million from the prior quarter end with raw materials increasing 1.3 million for the quarter to 25.8 million; finished goods inventories declining 4.5 million to 14.6 million and [WIP] rising slightly by 0.1 million to 1.6 million. As a point of comparison, our quarter end inventory level was approximately 6.8 million lower than the prior year.

Capital expenditures for the quarter rose to 3.7 million from 2.5 million in the prior year, bringing the nine-month year-to-date total to 11.7 million versus 5 million a year ago. The increases were primarily related to outlays for the PC strand and ESM expansion. As indicated in the release, we have revised our previous capital expenditure plan in order to accelerate certain outlays and the related expected benefits, as well as to reflect increases in the cost of certain equipment addition. We now expect that CapEx will rise to 18 million in 2006 and 13 million 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 an ESM line at our North Carolina facility in 2006 and an additional 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 time lines, future market conditions and the Company's financial performance.

In view of the fact that we are at 11.7 million of CapEx through the first nine months, we may wind up coming in under 18 million for the year with any shortfall becoming a 2007 expenditure.

As a result of the strong operating cash flow for the quarter, we paid off the 3.8 million balance that was outstanding under our revolving credit facility at the end of Q2 and increased our cash balance to 2.7 million as of the end of the quarter.

As reported in the release, we proceeded as planned during the quarter with our previously announced exit from the industrial wire business. Operations at our Fredericksburg, Virginia plant were seized in June and we're in the process of liquidating the assets of the facility. The industrial wire business has been accounted for as a discontinued operation and reclassified from continuing operations in both the current and prior-year periods. From a strategic standpoint, the completion of the plant closure narrows Insteel's focus entirely to its core concrete reinforcing products business.

In connection with the plant closure, we recorded an after-tax loss from disc ops of approximately 2.1 million, or $0.12 per diluted share during the quarter, which included 1 million of non-cash impairment losses to write down the carrying value of the Virginia plants PT&E to its estimated fair value. The remainder of the loss related to operating losses incurred prior to the closure of the plant, as well as the closure related costs.

As indicated in the release, these amounts are subject to adjustment based upon the final net proceeds realized from the liquidation of the assets of the facility and the actual closure costs incurred.

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 the financial results for the third quarter, which were driven by a continuation of the favorable market demand that we have experienced for the past several quarters. We attribute the growth in unit volume primarily to improved conditions in private nonresidential construction sector, and to a lesser extent, public infrastructure spending. As Mike indicated earlier, we continue to believe that the demand outlook for our products is favorable, meaning that we should be able to expect a continuation of the favorable environment at least into 2007.

Concerning the publicly financed infrastructure segment of our market, we believe that the longer-term outlook is favorable. But as we have stated previously, it appears to us that this market will begin to gain momentum late in 2006 and 2007, driven by increase highway spending derived from the 2005 Federal Transportation Bill, improving fiscal health of the states and post-hurricane related construction. Up to this point though, activity in the infrastructure market continues at about the level we have seen in the recent past without any noticeable uptick in activity. The primary risks we perceive to the continuation of strong demand for our products are rising interest rates, which seem manageable at this point and global political instability, which could potentially undermine confidence in the economy.

Domestically, the pricing environment for our reinforcing products was relatively stable during the third quarter and margins reflect the favorable business climate we are experiencing. As I recorded last quarter, however, offshore competitors in PC strand continued to exert downward pressure on pricing and import quantities have risen to unprecedented levels with China supplying the overwhelming majority of imported material. The impact on our selling prices has been minimal up to this point due to robust demand, but the ability of the market to continue absorbing Chinese imports at these levels will ultimately be driven by the growth of supplying relative to demand.

Turning to the market for our primary raw material, hot-rolled steel wire rod, prices have turned upward from domestic suppliers as well as offshore. Availability of wire rod is adequate at this time, and we don't foresee it tightening over the next few months, absent labor disputes or other events that may cause disruptions in production. Early indications of offshore pricing for deliveries during our first fiscal quarter of 2007 were sharply higher as compared to the Company's earlier commitments. In view of this, we have elected to minimize future purchases until we have a clearer view of the competitive conditions and future direction of the market.

As mentioned previously, we were successful in adjusting selling prices by an amount sufficient to offset the increases in domestic rod pricing that were effective in June and July. An additional increase from domestic sources has been announced for August and our ability pass these added costs through will be determined by future market conditions for our reinforcing products and the balance of supply and demand.

Regardless of the developments in the wire rod market, we believe we're well positioned to purchase competitively due to the desirability of our high-volume purchases and our product mix. Approximately half of our requirement is comprised of higher value-added metallurgically sophisticated products which are attractive to wire rod producers with the balance being less sophisticated products that are widely available both domestically and from producers around the globe.

The critical issue for us is the timing of purchases where we try to avoid holding excessive inventories during periods of declining prices and we elevate our inventories somewhat when we believe pricing will rise.

Turning our capital investment program, we have quite a bit of activity scheduled for the next 120 days. Based on current market expectations, we're comfortable with the timing of these CapEx initiatives. During the current quarter, we'll be commissioning our Tennessee PC strand expansion which is a little behind our initial plan due to glaze and receiving certain materials and normal start-up issues. The project will expand our strand production capacity and yield operating costs reductions through the consolidation of all our Tennessee production activities in a single facility. We expect to debug the lines for a period of three to four weeks, which should allow for full operations by the end of this quarter. During this process, we do not expect to lose production as we'll not take equipment off-line at the existing plant until the newly consolidated facility is operating satisfactorily.

The next major startup event for us will be the engineered structural mesh production line at our North Carolina plant which is expected to come online during the first fiscal quarter of 2007 with another production line scheduled to start up in the third fiscal quarter. I would plan out, as we have in previous calls, that improved operating costs constitute an important component of the financial return calculation for these projects. The same will be true for any new projects that we elect to undertake. We do not plan to justify investments, assuming perpetually increasing demand. We're focused on significant improvements in operating costs, as well as selective capacity expansions in certain markets in order to further improve our cost competitiveness and support our growth initiatives for the next several years.

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

(OPERATOR INSTRUCTIONS). Jeremy Hellman, Thompson Davidson Company.

Good morning guys. Very thorough conversation so far by you guys, I appreciate the color. First question I have is around average selling prices. Is it reasonable to assume with the price increase coming in late this quarter that average selling prices for Q4 are going to be up year-over-year and reverse that negative trend we have seen in the first three quarters of this year?

You mean sequentially?

Well, year-over-year. Average selling prices were down 3% Q3 versus last year, 9% Q2, 10% Q1 -- is that going to turn positive in Q4 on a year-over-year comparison?

Jeremy, it certainly will sequentially. I have a difficult time doing the math in my head here to know how it will compare year-over-year.

Right. I'm looking at where shipments have been nicely in the double-digit range, but it had that drag by the average selling price. And so I'm hoping going forward if you can say that shipments will continue at a good rate and then with some increase in average selling prices, just trying to build the top line from there.

Secondly, was I correct in understanding when you were talking about the CapEx, H, that the larger number -- you bumped up what was originally 13 to 18. How much of that quantifiably due to increased cost of equipment versus accelerating the program and so forth?

Primarily it's related to accelerating the program, which includes the third engineered structural mesh production line that has been accelerated somewhat.

Another point that you've hammered on a number of times is the cost improvement of running these new lines. Is there any way to really quantify what that will mean in terms of margins and so forth?

Obviously, we quantify it as we're doing our justifications, Jeremy, but it is sensitive to product mix. There are so many variables that it would be, it would be difficult for us to lay out a firm number and tell you that we're confident that any particular dollars per ton will come out of our manufacturing costs for one, because the product mix as we go further into engineered structural mesh, the cost of production for that product varies substantially from the cost of some of our more repetitive manufacturing operations. So we just get into a situation where it's very difficult to give you comparable numbers.

Understandable. And then one last thing and then I will step out of the queue and let someone else have a turn. You give some context about how much additional revenues could be realized from this capacity expansions. Is there kind of a target utilization that you think we could kind of look for with the new lines?

We debated providing the revenue numbers. I know we've done it a couple of times. The part that is difficult about that is that we are currently producing a substantial amount of engineered structural mesh on equipment that's really not all that highly productive. So we know for a fact that we will shift those products to the new equipment, and then the amount of capacity that is left over and incremental, let's say, is hard to project. So we expect to operate the lines full between the existing business that we have in those product lines and the growth in those markets that we expect to see over the next couple of years. Now, when will those lines be fully utilizes? It's hard to say. 2007, 2008 would be a reasonable guess.

Last quarter, I had a utilization running around 90% give or take -- is that still a fair number?

Yes, I think --.

For existing operations?

Yes.

Yes.

Thanks guys.

[Jose Miguel], [Tiger] Management.

Long-term, once the new capacity shakes out, what is your expect -- what is your best guess for the return on that new investment?

As a minimum threshold, we justify investments based on our cost of capital and we fully expect that we will attain returns that exceed our cost of capital for all of our projects.

Now what would be the figure you would put on that?

I would say on an overall blended basis, it would be in the 15% plus range. We risk adjust that, depending on the specific project. But I would use that as an approximation, 15% after-tax.

So long-term normal returns on the new investment you expect to be 15% to equity, after tax?

Yes. That's the minimum threshold that we use.

Is that also what you expect on the new ESM PC strand, or do you see that being actually higher than that?

We've really talked about the floor, not the ceiling, Jose. I think we're comfortable that they will be value-adding investments. As far as how favorable the return could become, it's pretty speculative.

Fair enough, that's all I have, thanks.

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

Thank you, Kim. We appreciate your interest in the Company and your participation in the call. If you'd like to follow-up with us, don't hesitate to do so. Thank you.

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