Insteel Industries Inc (IIIN) 2006 Q4 法說會逐字稿

Good day, everyone, and welcome to the Insteel Industries fourth-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, H.O. Woltz, III. Please go ahead, sir.

Thank you, Connie. Thank you for your interest in Insteel. Welcome to our fourth-quarter 2006 conference call, which will be conducted by Mike Gazmarian, our CFO and Treasurer, and me.

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.

I want to start today's presentation by stating that we are extremely pleased by Insteel's strong financial performance for the fourth quarter and fiscal year. For the year, the Company earned an after-tax return on capital of 30%, ending the year debt free with nearly $11 million cash on the balance sheet after repurchasing 800,000 shares of Company stock and investing $19 million in cost reduction and capacity expansion initiatives. We believe it was an exceptional performance.

We plan to follow up in 2007 with capital expenditures in the range of $18 million that will further strengthen our position in each of our markets from a cost as well as a volume standpoint. Additionally, during 2007, we would like to grow through acquisition where warranted based on strategic considerations and targeted return thresholds. We will also continue to evaluate further share repurchases.

All factors considered, we couldn't be more pleased by the Company's strategic and financial position. We're optimistic about our prospects for 2007 in spite of a more challenging environment.

Now, I will turn it over to Mike to provide you with more details on the Company's financial results. And then, I will pick it back up to comment on our outlook.

Thank you, H. As we reported in this morning's press release, Insteel posted solid results for the fourth quarter, despite a substantial and abrupt drop-off in housing-related demand. For the quarter ended September 30, diluted earnings per share from continuing operations rose 53% to $0.52 from $0.34 in the year-ago period and earnings from continuing operations were up 47% from the prior year.

Including the results of discontinued operations, net earnings per diluted share were $0.55 versus $0.34 a year ago. For the fiscal year, diluted earnings per share from continuing operations increased 44% to $1.86 from $1.29 last year and earnings from continuing operations were up 40% from the prior year. Including the results of disc ops, net earnings per diluted share were $1.79 for the year versus $1.32 a year ago.

Our markets continued to be characterized by divergent trends, which became even more pronounced during the fourth quarter. Sales into non-residential and infrastructure-related markets, which represent about 80% of Insteel's revenues, remained relatively strong. In contrast, the other 20% of our business that is more closely related with residential construction suffered from deteriorating market conditions, as a downturn in housing activity was compounded by inventory reduction measures pursued by customers in this sector.

Insteel sales from continuing operations for the quarter declined 5% from a year ago on an 8% decrease in shipments, which was partially offset by a 4% increase in average selling prices. On a sequential basis, shipments decreased 14% from the third quarter, while average selling prices rose 5% following two consecutive quarters of declines.

Sales for both our product families were down from the prior year and on a sequential basis. Sales of welded wire reinforcement decreased 4% from last year and 13% from the third quarter, while PC strand sales declined 6% from a year ago as well as from the third quarter.

Our sales performance for the quarter appears to be consistent with recent macro indicators from our markets, which depict continued strength for non-residential and infrastructure construction and further weakening in the residential construction sector. In the most recent construction spending report from the Census Bureau, which is for the month of August, private non-residential spending was up 3.4% from the prior month and 16.5% for the first eight months of the year, while public construction spending which is primarily infrastructure related was up 1.1% from the prior month and 10% year to date. In comparison, private residential construction was down 1.5% from the prior month and up 2.5% year to date but only due to the higher spending levels earlier in the year.

McGraw-Hill Construction, which compiles data on new construction, starts recently -- reported that in August, the non-residential building category was up 7% from the prior month and 13% year to date and non-building construction was up 4% from the prior month and 14% year to date, while residential construction was unchanged and down 5% year to date.

Another recent data point, the Architecture Billings Index posted modest growth in September following an upward spike in August that had raised it to its highest level since July 2005. The ABI serves as a leading indicator of non-residential construction activity based on the typical 9 to 12-month lag time between architecture billings and construction spending.

The increase for September was again driven by strong demand for commercial industrial and institutional projects, while the residential sector reflected a decline in billings for the sixth consecutive month. Also encouraging in the report was the increase in new project inquiries, which rose to its highest level since December 2005, implying increased demand for architectural services and ultimately construction projects in future months.

Finally, this week's report on residential construction for September indicated that housing starts were up 5.9% from the prior month, which appears to be an anomaly, but down 17.9% from a year ago and 9.1% on a year-to-date basis, while building permits were down 6.3% from the prior month, 27.7% from a year ago and 11.5% on a year-to-date basis. In view of the weakness reflected in this data and historically high inventory of unsold homes on the market, it appears that builders will be forced to continue scaling back on new home construction for the near term.

I should point out that the spending comparisons I referenced have not been adjusted to constant dollars to eliminate the impact of the inflation in construction material costs, which had the effect of making the increases appear to be larger than actual growth from a unit consumption standpoint. For some projects, these cost increases have been significant enough to result in delays, redesigns, or cancellations as contractor bids have come in substantially higher than initial estimates.

We're hopeful that the recent moderation in inflationary pressures will serve to reduce these bottlenecks going forward. Taken together, these reports clearly illustrate the variations between the non-residential infrastructure and residential construction sectors that we're currently experiencing in our markets.

Gross profit from continuing operations for the fourth quarter was up 20% from a year ago, and gross margins widened to 22.2% from 17.6% due to increasing spreads between average selling prices and raw material costs, which more than offset the impact of the reduced shipments and higher unit conversion costs. Spreads were also up on a sequential basis relative to the third quarter.

SG&A expense for the fourth quarter was flat relative to a year ago at $4.5 million, increasing as a percentage of net sales to 5.4% from 5.2% due to the lower sales. Interest expense for the fourth quarter decreased 67% or $0.3 million from a year ago, primarily due to the reduction in our debt level.

Our effective income tax rate for the fourth quarter, including the disc ops component, fell to 33.2% versus 38.2% in the prior year. The decrease for the quarter was primarily due to higher compensation expense for tax versus book purposes related to stock option activities, the recognition of additional tax credits, and the favorable resolution of state tax audits. For the total year, our effective rate was relatively flat at 36.1% versus 36.2% last year.

In July, we completed the sale of the equipment associated with our industrial wire business for $6 million and recorded a pre-tax gain of $1.3 million from disc ops, which is partially offset by $0.2 million of closure-related costs during the quarter. We had exited the industrial wire business in June following the closure of our Fredericksburg, Virginia facility and are currently in the process of liquidating the remaining assets of the business; the largest component of which is real estate.

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. The amounts recorded in connection with the sale of the assets and closure of the plant are subject to future adjustment based on the net proceeds realized from the liquidation of the remaining assets and the actual closure costs that are incurred.

At this time, we do not expect that such adjustments will result in significant charges or losses from discontinued operations. From a strategic standpoint with the plant closure behind us, we're now fully focused on our concrete reinforcing products business.

Moving to the balance sheet and cash flow statement, operating activities of continuing ops generated $9.7 million in cash for the fourth quarter versus $13.5 million in the same year-ago period, primarily due to the inventory reduction measures that were pursued in the prior year. For the year, net cash provided by operating activities of continuing ops increased to $42.7 million compared with $41.8 million a year ago.

As a result of the strong operating cash flow and the proceeds from the sale of the industrial wire equipment, we remain debt free as of year-end and increased our cash balance by $8 million from the end of Q3 to $10.7 million. In comparison, a year ago, we had $11.9 million in total debt outstanding and $1.4 million in cash.

Capital expenditures for the quarter rose to $7.3 million from $1.6 million in the prior year, bringing the total for the year to $19 million versus $6.3 million a year ago. The increases were primarily related to outlays for the PC strand and ESM expansions.

We've revised our CapEx plan for 2007 in order to accelerate certain outlays and the related anticipated benefits and now expect that CapEx will total $18 million this year. Following the completion of the projects that are planned or currently underway, we anticipate a substantial reduction in CapEx in 2008 with our maintenance requirements falling to $3 to $5 million per year. 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 our financial performance.

Our inventory levels rose $4.8 million during the quarter due to the weak shipping performance. On a forward-looking basis, total inventory quantities on hand as of the end of the year represented about three months of shipments based on our anticipated run rate for Q1. We expect inventory levels to gradually decrease over the first half of the year.

H. will now comment on market conditions, our capital investment plan and our business outlook.

Thank you, Mike. As Mike pointed out, the well-publicized downturn in housing has had a disproportionate impact on our business, as customers who operate in this market space adopted an aggressive inventory reduction mode during the quarter. Given that we're heading into the seasonally slower time of year, it seems inevitable that this trend will continue for the next few months, which will continue to negatively impact shipments.

There is a forecast to suit every mood concerning the magnitude of the housing duration -- downturn and its duration. But most experts agree that the correction will be regional with California and the Midwest likely to suffer more than other geographic markets. If this proves to be true, Insteel's favorable location relative to areas that are less impacted by the correction should serve as a mitigating factor. Nevertheless, the downturn is a reality that we will have to contend with.

Fortunately, we estimate that about 80% of our revenues are derived from non-residential construction, which continues to be strong and subject to favorable underlying influences, including falling office vacancy rates, historically-low interest rates and growth across a broad spectrum of construction markets including retail, institutional, industrial and commercial. The breadth of the recovery together with these favorable fundamentals should serve to sustain market growth for the non-residential sector through 2007 and into 2008.

The pricing environment for our reinforcing products has become more competitive over the past couple of months as volumes have contracted. Pricing pressures have been particularly significant in the standard welded wire reinforcing market, which is ironic in view of rising offshore raw material costs for this product line. It remains to be seen whether competitors will continue trying to create demand with lower pricing or whether they will adjust their volume expectations to reflect the lower level of market activity that will persist until seasonal and cyclical factors in the housing market improve.

Up to this point, pricing has been more stable in the markets for our other welded wire product lines. Overall, higher raw material costs and pricing pressures in certain markets will likely cause spreads to narrow somewhat over the next few months. Although, the drop-off is impossible to quantify and we will refrain from guessing at the amount of compression that we may experience.

The same macro factors that are driving the economics of our welded wire fabric business are at work in the PC strand market. Generally, the non-residential portion of the market is strong. Most strand consumers have large backlogs and are optimistic that market conditions will be favorable for 2007.

Over the last five years however, there has been strong growth in single-family residential applications for PC strand, primarily for post-tensioning slab on grade construction in areas with expansive soils. States where this construction technique have grown rapidly include California, Arizona, New Mexico, Texas, and Louisiana. Not surprisingly, this market segment is feeling the full impact of the housing downturn and we don't expect to see signs of recovery before our third fiscal quarter due to both cyclical and seasonal influences.

The other dynamic affecting the PC strand market is increasing imports, particularly from China. Year to date through July, import tonnage has risen by 65% from last year. Up to this point, market growth has dampened the impact of imports. But as volumes fall due to the housing slump, the risk is higher that escalating imports will cause an imbalance between supply and demand, resulting in spread compression for domestic producers including Insteel. As is the case for welded wire reinforcing, we are unable to quantify the potential spread compression we may experience in the PC strand market and we will refrain from guessing.

Turning to our capital investment program, we are starting up the expanded Tennessee PC strand plant at this time. Our schedule was set back due to the receipt of defective cooling towers that had to be replaced and a delay in the delivery of some electronic components. We've debugged the individual components of the line and have completed our initial runs with most of the line components working together. While the delays have been frustrating, we've not run into significant debugging issues. And we expect the line to operate as designed upon receipt and installation of the missing components that are expected next week.

The next major startup event for us will be the structural mesh production line at our North Carolina plant. Most of this equipment has been received at the plant, and the erection of the line is underway. We currently expect to begin startup activities in late December or early January with production ramping up through the second and third fiscal quarters.

Following the North Carolina startup, we expect to commission a second structural mesh production line to be located at our Texas facility early in the third fiscal quarter. We are moving as rapidly as possible to bring these new facilities online, as they will facilitate reductions in our operating costs and provide the capacity for growth.

We have indicated that we expect CapEx for fiscal 2007 to approximate $18 million following expenditures of $19 million in 2006. I want to point out though that we have not established a new, higher run rate of CapEx for the Company. Rather, our activities through 2007 will complete the process of upgrading and expanding our facilities so that we are assured of the lowest operating cost capabilities and are prepared to meet demand in growing markets. We expect our base level of CapEx to be in the range of $3 million to $5 million beginning in 2008.

In wrapping up our prepared comments, I would acknowledge the difficult comparisons that we face for the next couple of quarters, brought about by the Company's strong performance last year and the margin pressures we may experience for the next couple of quarters. We are optimistic, on the other hand, that housing will level off or begin to recover during the year and that non-residential construction will continue to expand through 2007 and into 2008. We are comfortable that the actions we've taken over the past two years to strengthen our balance sheet and invest in our facilities position us to deliver solid results for our investors, despite the more challenging environment that we may face.

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

(Operator Instructions). Jaime Lester, Soundpost Partners.

Can I just get a sense -- I know you were looking to give guidance on this -- but if you were to characterize the nature of the import competition and where you think they could profitably sell the business, where would that leave margins if the imports really began dictating the price and I suppose the domestic industry on the strand side I guess?

I'm not sure there is any way to give you a good answer to that question. I think we've reported for the last several quarters that the growth of imports of PC strand has been a concern. Of course, the market has grown dramatically. And as I mentioned just a minute ago, that market growth has served to dampen the influence of imports in the market.

It is really speculative to try to project what may happen if imports continue at the current rate and to assume any given level of the falloff in demand. We just don't have enough data to give you an intelligent answer to that.

Got it. Okay, if you had to -- I don't know if this even makes sense -- but if you had to think about kind of how far they could go -- and obviously this is -- it's kind of a doomsday scenario maybe. But if you think back to 2003 and where margins were there, are there enough structural changes in the business itself and in the competitive environment that you think there's no way that margins could return to those levels? Or is it theoretically possible if let's say the perfect storm hits, residential stays soft, non-residential doesn't grow as people think and there's nothing done on imports on the -- and certainly, there's potentially some benefit on the tariff side.

But is there a way that you could go down to the mid-single digit operating margin side or are those days completely gone -- there's no way we'd go back there?

I think the most fundamental change since the period of time that you reference is the dramatic growth of the market. And beyond that, I think your guess is probably as good as mine about what is theoretically possible.

And then just -- can you quantify on a -- maybe on a ton basis where -- if we go back two years ago, what domestic production was, what imports were and what total demand was and where we are today just so we can get a sense of the magnitude and tonnage?

Most of those numbers are available, particularly on the import side. I don't happen to have at my fingertips that data for multiple years. What I did confirm and what I mentioned in my presentation a moment ago was that imports are up 65% from last year. I happen also to know that China accounts for 77% of total imports year to date, and China is the story. It is somewhat reminiscent of the issue that we had back around 2000 or 2001 with India, Korea, Mexico, Thailand, and Brazil where imports escalated dramatically. And we were ultimately effective in dealing with that through anti-dumping and countervailing duty cases.

As it stands now, is there -- I guess is there a risk that any duties that are applied or applied to just the raw material itself for you guys would you still import and not to the finished product? Or you think any duties that would be applied would be applied equally to both the wire and the strand?

At this point in time, there are duties in place on wire rod from several different origins. Those duties were imposed through the anti-dumping and countervailing duty process. There are other countries that of course have no duties because they have not been on the losing end of anti-dumping and countervailing cases.

And at this point in time, there are no cases underway and we don't suspect that there will be any cases filed in the near-term. But of course, that is subject to change at a moment's notice.

(Operator Instructions). Jeremy Hellman, Thompson Davis.

Wondering is it possible to break out the non-res and residential by unit growth or loss where shipments were down 8% overall? Can you break that down between non-res and res for me at all?

No, we really don't -- we really don't have that visibility to drill it down to that level. We don't always have a clear view of the exact end use for the products. But as we indicated in our comments on an overall basis, our estimate would be a 80%/20% split.

The drop-off in residential there would be like -- I would say there are two components to it where you have this overall decline in activity that has occurred. And then beyond that, it was amplified by the inventory reduction measures that were taken by customers in that segment. It has compounded it, but it is difficult to really quantify how much of the drop-off each of those factors is responsible for.

Right. To try and push you a little bit on it, could you say anecdotally that ex-residential/non-residential shipments might have been up or were those -- was there enough of a backup at the distributor level where the equipment that might have -- or goods that might have been going that way were backed up at that level where both were down?

I think there are a couple of things going on here, Jeremy. First, with respect to whether our products wind up in residential or non-residential applications, keep in mind that most of our customers participate in both of those market segments. So, when they order product from us, it is really impossible for us to have the visibility of what the split in our customers' mix is. So we just don't see it.

Yes, that's exactly what I was thinking. If you've got a distributor that had stuff that they might have taken on, thinking that they were going to sell it into residential and that dried up a little bit and that left them oversupplied into non-res (multiple speakers).

But the thing I would tell you about non res is that Mike cited chapter and verse on what the spending numbers look like for the year. And he also mentioned that those numbers were not inflation-adjusted. So, the unit growth is not as great as what you may first think just looking at the raw spending numbers.

And I would tell you that the non-residential portion of the market has been pretty solid. But it's not been gangbusters robust.

I think that a lot of that has to do with the extremely strong first six months of our fiscal year 2006 that we experienced, which were driven by nearly perfect weather conditions. I think a lot of the business that was going to be done in that 12-month period was seasonally of a different character than what is typical. We just saw more of the 12 months' business done in the first 6 than in the last 6.

Then a question for Mike. Just looking at the inventory number, is -- it sounded to me -- I just want to make sure I understood that correctly -- that the total inventory value is up. You've got about three months' worth of shipments. And as of last quarter, it was a little over two. So, it's more a function of additional units than additional average prices in inventory?

It would actually be a combination of both of those factors and units were up. And then, our unit values were up as well because rod costs were up slightly for the quarter.

(Operator Instructions). Robert Kelly, Sidoti & Company.

Congratulations on a good quarter. I'm not sure if anyone has said that yet.

Thank you. We appreciate it.

Just help me out with something. It sounds like demand I guess softened sequentially year over year. Yet, your pricing held up. It looks like average pricing benefited top line a little bit. Should we expect that to reverse as we enter the first half of '07 of your fiscal '07?

It's really hard to say that we have seen more pricing activity in the marketplace. As I mentioned specifically, we have seen it in our standard welded wire reinforcing. I am reluctant to project what's going to happen on prices because of the day-to-day and week-to-week nature of our competition.

Keep in mind that the other dynamic is what happens to raw material cost. And while we've made commitments at higher pricing levels that we'll have in the first fiscal quarter, we don't know what's going to happen to raw material costs beyond that. So, it's possible that there could be some offset there. Or if that market gains strength, it's possible that costs could actually rise. So we need to talk about both of those items rather than just the selling value.

You may recall from our last release that we had implemented price increases in late June. So, we only got a partial quarter's benefit in Q3 and a full benefit in Q4. So, there is a timing element at play as well.

I guess what I was trying to get my head around was if demand is slowing, will that pricing kind of hold up with the import competition and your competitors and whatnot?

I think it's safe to say that if you look at the historical results of the industry and not just ours but most others that I'm familiar with, if demand slackens up, then we are certainly subject to increased pricing activity. We're not real anxious to go there though.

Understood. You had mentioned early in your comments about some strategic acquisitions. Are valuations compelling at this point in your space? Are you finding attractive assets?

No, we're not. But we are interested and we believe that the condition that we are seeing now is subject to change going forward. But I think it is more of a recognition on the part of the Company that we want to grow more than just organically.

Could you maybe -- I know you don't give a whole lot of information on it. Could you touch on maybe the trends throughout the quarter? Was July strong? Did it all kind of fall apart in September? Or was it just kind of consistently softer month to month versus last year? Was there something about the housing that kind of took you by surprise I guess is what I'm trying to get at?

It was a little softer toward the end of the quarter than it was at the beginning of the quarter. But, I wouldn't characterize it as robust during any of the three months.

Then, finally, on some of the Hurricane Katrina New Orleans rebuild, have your customers mentioned that they are feeling demand from that? Is that in your projections internally at this point, or is that still a longer-term--?

There's quite a bit of activity on the part of our customer base. Most of it at this point is related to gearing up to satisfy that demand. I still don't believe that we have seen in our order book any impact of the hurricane-rebuilding activity. But, we do see customers setting up new facilities to satisfy that demand. I think that in 2007 sometime that we will begin to see the impact of it. But there really is quite a bit of activity underway in terms of setting up production facilities to satisfy the rebuilding requirement.

(Operator Instructions). Jaime Lester, Soundpost Partners.

I guess my understanding on this is wrong. But on the welded wire side, I would imagine pretty local business. So, can you just talk about are there certain regions that are more competitive than others? Or are across-the-board, there's too much capacity and everyone is aggressive on the pricing?

Well, I think we have stated before that the more volatile and price-sensitive part of our business is the standard welded wire reinforcing product line where it is much more commodity like than the higher value and more specialized engineered parts of the product mix. But (multiple speakers) --

I guess how local is that competition in the sense of you produce it at a plant? How far away can that be shipped economically?

300 to 500 miles from a plant would not be abnormal at all. Certain products can go much further than that. And I don't think -- I would not characterize the market as just suffering from gross overcapacity. I don't think that's the case at all.

But there is pricing in the welded wire side, right -- pricing competition?

Correct.

So, what is the -- when you say it's not suffering from gross overcapacity, you would say it is suffering from mild overcapacity -- and you know good point?

Yes, I think that the downturn in volume, which is a relatively new phenomenon, has left some producers with a less robust order book than they would like to see. And that is over the last 30 to 60 days.

Great. Sorry for the follow-up.

At this time, we have no further questions. I would like to turn the conference back over to Mr. Woltz for any additional or closing remarks.

Thank you, Connie. We appreciate your interest in the Company and your participation on the call today. Thank you very much.

That concludes today's conference. We thank you for your participation.