Insteel Industries Inc (IIIN) 2007 Q1 法說會逐字稿

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

Thank you, Evelyn. Good morning and thank you for your interest in Insteel and welcome to our first-quarter conference call which is being 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 filings with the SEC.

I want to start today's presentation by saying that we're placed with Insteel's financial performance for the first quarter which was the second strongest first quarter performance in the company's history and was achieved despite less hospitable market conditions. We feel good about the start that we have for fiscal 2007 and we look forward to another successful year.

I'm going to turn the presentation over to Mike to provide you with more details on our 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's first-quarter sales and earnings were the second highest in the company's history in spite of the continued weakness in housing related demand. For the quarter ended December 30th, earnings from continuing operations were $5.9 million or $0.32 per diluted share compared with $8 million or $0.42 per diluted share in the prior year which represented our all-time high for the first quarter.

Including the results of our discontinued industrial wire business which we exited in June net earnings were $5.8 million or $0.32 per diluted share compared with $7.7 million or $0.41 per diluted share a year ago. During the quarter we continued to experience radically different business conditions across our markets. The 80% of our business related to nonresidential construction continued to be strong. The other 20% that is more closely correlated with the housing sector remained weak due to the drop-off in new housing construction together with the related inventory reduction measures pursued by customers selling into this market.

Before I walk through our results for the quarter I wanted to summarize the most recent report for a couple of the macro indicators of our market and provide some added perspective to our performance for the quarter and our outlook for the remainder of the year.

The most recent construction spending report by the Census Bureau which is for the month of November indicated that total construction spending rose only 0.1% from a year ago and declined 0.2% from the revised October estimate. The total spending data continued to match the dramatic differences in the trends for nonresidential versus residential construction. Private nonresidential construction for November increased 18% from last year and 1.4% from October and public construction was up 10.6% from a year ago and 1% from October.

In comparison, private residential construction was down 11.1% from last year and 1.6% from October due to the drop-off in single-family housing which fell 20.4% from last year and 3.1% from October more than offsetting the continued strength in multi-family housing construction. Through the first 11 months of the year private nonresidential and public construction were up 16.7% and 10.1% respectively from the prior year while private residential construction was down 0.8%.

Yesterday the American Institute of Architects reported that the Architecture Billings Index, or ABI, rose to 59.5 in December finishing 2006 at its highest reading for the year. The ABI serves as a leading indicator of nonresidential construction activity based on the typical nine to 12-month lifetime between architecture billing and construction spending.

Also encouraging were the increases reported for the commercial industrial sector index which rose to 63, a record high for the survey since it originated in 1995 and the Institutional Sector Index which improved to 60.2, its highest reading since October of 2005. Although billings for the residential sector remained weak with the index and in the year at 49.3, the December reading was the highest in nine months and represented the third consecutive monthly increase.

In addition to the positive billing indicators, the new project inquiries index ended the year at 58.5 implying increased demand for architectural services and ultimately construction projects in future months.

Moving back to Insteel's financial results for the first quarter, sales from continuing operations were down 8% from a year ago on an 8% decrease in shipments partially offset by a 1% increase in average selling prices. On a sequential basis, shipments decreased 15% from the fourth quarter which was about the same seasonal percentage decline that we experienced a year ago while average selling prices were down by less than a percent from the fourth quarter.

Sales for both our product lines were lower than the prior year as well as on a nonsequential basis. Welded wire reinforcement sales decreased 2% from last year and 16% from the fourth quarter while PC strand sales which have been more severely impacted by the housing downturn declined 14% from a year ago and 15% from the fourth quarter.

Gross profit from continuing operations for the quarter fell to $13.6 million or 19.5% of net sales from $17.1 million or 22.6% of net sales in the prior year due to be reduced shipments, lower spreads between average selling prices and raw material costs and higher unit conversion costs. Spreads were also lower on a sequential basis relative to the fourth quarter due to higher raw material costs combined with a slight decrease in average selling prices.

SG&A expense for the quarter was relatively stable at $4.2 million which was our average quarterly run rate for the prior year. The reduction in interest expense and increase in interest income were driven by our debt free position throughout the period and the increase in our cash balance in the current year.

Our effective income tax rate for the first quarter including the discontinued ops component fell to 37.2% versus 38.4% in the prior year. The reduction in the effective rate was primarily due to a higher permanent book versus tax differences in the prior year.

Moving to the cash flow statements and balance sheet. Operating activities of continuing ops generated $4.2 million in cash for the quarter versus $19.9 million in the year-ago period primarily due to the $12.9 million increase in accounts payable on accrued expenses in the prior year which was related to higher purchases and favorable changes in the mix of venture payment terms.

Operating cash flow for the quarter was primarily used to fund $2.7 million of capital expenditures and $0.6 million in dividends. Our cash balance increased $0.9 million to $11.6 million as of the end of the quarter. Total asset additions for the quarter including the $0.9 million of accounts payable related to PP&E which is reflected at the bottom of the cash flow statement were $3.6 million compared with $2.3 million last year. The increases were primarily related to outlays for the PC strand and ESM expansions.

We continue to expect CapEx to total $18 million this year and fall to a range of $3.5 million -- $3 million to $5 million -- beginning in 2008. However, 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.

Inventories rose $9.9 million during the quarter due to the weak shipping performance together with increased import purchases. On a forward-looking basis, total inventory quantities on hand as of the end of the quarter represented around 3.5 months of shipments based on our anticipated run rate for Q2.

In view of the recent reports that rising raw material costs for steel producers and the likelihood of future increases in wire rod prices, a higher inventory level should work to our advantage from a comparative cost standpoint as we move into our third quarter. At this time we expect inventories levels will begin to gradually decrease following our second quarter over the remainder of the year.

H will now comment on market conditions and our business outlook for the remainder of the year.

Thank you, Mike. From the construction industry data Mike provided it is apparent that the downturn in housing has a disproportionate impact on our business as customers in this market have dramatically scaled back purchases in response to their increasingly conservative outlooks.

Looking back at our first quarter, the impact of the housing downturn on our business was in line with expectations communicated in our fourth quarter 2006 conference call last October. Inventories in housing related markets are still excessive relative to the reduced run rates for demand and the process of rebalancing will continue to have a negative impact on our order book during the second quarter. Personally I don't believe the housing market has reached a low point and I'd not be surprised to see unfavorable trends in this segment persist into our third quarter.

The effect of the housing downturn is magnified in the PC strand market by an unprecedented surge of imports which has occurred without regard for this steep decline in demand. Through 11 months ended November 2006, PC strand imports rose 71% compared to 2005 and the average unit value of imported material fell 21% or $185 per ton. During this period China accounted for over 80% of total imports.

In contrast to the rather bleak scenario in the housing sector, we believe all indications are favorable for the nonresidential construction market in 2007 and that continued growth in spending will drive healthy demand for our products. While spending in demand should be favorable, we've witnessed some spill-over pricing pressure in our nonresidential markets as origins in the weak housing sector. We need to acknowledge the potential for spread compression driven by reduced demand in the housing market but up to this point fortunately it has not been as severe as we expected.

Turning to CapEx, we've reported over the last several calls on expansion and cost reduction initiatives that are underway. Our Tennessee strand project and our North Carolina structural mesh production line are now essentially complete and ramping up. From a CapEx standpoint, we have three significant projects that we'll focus on over the remainder of the fiscal year. Each of these projects will contribute to lower operating cost and will therefore produce a return even during this period where demand is weaker than we'd like to see it.

As Mike pointed out, we expect total expenditures for the year to approximate $18 million but there is a chance that a portion of the outlays could slip into fiscal 2008 depending on the timing of equipment deliveries. After we complete these upcoming initiatives, we expect CapEx to fall back to the 3 to $5 million range which we would view as a maintenance level. Any additional expansion or cost reduction initiatives would be evaluated on their own merits and could potentially increase CapEx above the maintenance level in 2008 and beyond.

In wrapping up our prepared comments, we acknowledged last quarter that we were facing difficult comparisons particularly during the first half of fiscal 2007 brought about by the company's strong performance last year and the margin compression that may result from the housing market correction that is underway.

While we continue to feel these pressures, we believe that our outlook for nonresidential construction is at least as favorable as it was three months ago. Overall we are confident that our markets will support solid financial performance for 2007 and that the actions that we've taken to grow, improve our infrastructure and incorporate the latest technology into our manufacturing facilities have strengthened our best-of-class status in our markets.

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

(OPERATOR INSTRUCTIONS) Trey Snow with Priority Capital.

Good morning. You gave us some color on imports. I was wondering if you could maybe look in your crystal ball and see what you think imports may do over the next three to six months? Are there signs that they are going to weaken? I know they were with weaker in November and indicated in December. But do you have anything you can see ahead?

Nothing but intuition and market experience. Unfortunately imports of PC strand are not covered under the early reporting mechanism to the Department of Commerce. So we really only know what the numbers are after they are finally published. As I mentioned 80% of the imports are coming from China or slightly over 80%. And quite honestly I've seen nothing in the numbers that leads me to believe that we should expect a reduction in those numbers.

The material seems to be coming in at a rate of 19,000 to 23,000 tons per month without regard to what final demand is in the U.S. It is really -- it's an ugly picture. But I can't really point to any real facts that would lead to a conclusion that it is going to slow down.

Okay. And based on that, the rise in imports and also I guess there's been some capacity additions planned or in place at the moment with some of your larger competitors and that is mostly I guess on just on the commercial rebar stuff. But does any of this change your return expectations for your growth projects, these three growth projects you've talked about?

No, I don't think so. And when you mention capacity additions, are you referring to in PC strand?

Again more in the general rebar and structural market.

Any capacity expansions in rebar really would have no impact on our expectations for our business. In PC strand specifically I'm unaware other than our own initiatives of capacity expansions in the domestic market and in fact we have one competitor who has decided to move his equipment out of the country. So you classify that I guess as a reduction of capacity.

So at this point I think we are comfortable with the return expectations that we have on the projects that are complete or underway at Insteel recognizing the fact that these investments are not made for a quarter, they are made for a longer term than that. And I'm entirely comfortable with what we've done.

The ESM expansions aren't subject on any import competition so there has been no change whatsoever in our outlook for the returns on those.

Okay, great. Thanks, guys.

Jeremy Hellman with Thompson Davis & Co.

Good morning everybody. A couple questions for you guys. Looking at the inventory levels can you give us any kind of granularity in terms of how much inventory is PC strand versus welded wire fabric?

No, we don't have that data readily available.

Okay. Then and I know this is maybe asking you guys to go somewhere you can't go in terms of forecasting, but looking at shipments for the rest of the year is it pretty much appropriate to think that this quarter Q2 in the fiscal gear will be down versus last year and then Q3 and Q4 will be up or flat versus last year? Judging on H's comments about positioning regarding your inventory that would seem to kind of be the curve that you are looking at? Is that a fair thing to ascertain?

I think from a macro point of view we've said previously that we believe the first two quarters of our fiscal year are going to represent the most challenging part of the year for us and that we would see more recovery in the second half where we benefit both from seasonality and potentially from some beginnings of a correction or recovery in the housing market. So based on that I think those expectations are still valid and based on that I think it is not unreasonable to assume that shipments would follow that pattern also.

Okay. And then one last thing just going back to the inventory number and I wasn't able to dig it out quickly enough in my notes, but a year ago this time how many months worth of inventories did you have on hand in terms of sales?

From a dollar standpoint as of this quarter and where at $56.7 million --

Right.

-- last year we were at around $41 million. I would expect it would be relatively proportional or it would be somewhere in the 2.5 months.

Okay. So you in effect have ramped inventory a little bit more aggressively than you did last year at this time?

And keep in mind when you compare to last year it was one of the only first quarters that I recall where our plants basically ran and shipped as hard as they could through the winter months in the first and second quarters. So our inventories last year were probably a little under where we really would have liked them.

Okay, got you. Okay, that is it for me. Just stay warm down there guys.

Thanks, Jeremy.

[Vic Kumar] with Soundpost Partners.

Hi guys. I have a question for you around your gross margins. It looks like your margins have held up very well despite the housing decline. I was just wondering if that is normal for this part of the cycle or if anything is different? Any thoughts on that?

Well, I don't know if I would really I guess attribute or I guess relate it to the housing cycle in particular. I think it really goes all the way back to the question of what our sustainable margins are going back to the initial ramp up that occurred in 2004. And we would contend that there does appear to be in spite of some of these factors that we've mentioned the softening in demand and the import competition and other areas of our business, there does appear to be more pricing discipline in place where our competitors are focusing more on margins and returns rather than purely chasing volume. So I think that is a longer-term trend that has been underway over the past couple of years that is at least partially responsible for the margins being where they are at now.

Okay. So you don't really expect I guess the further any further housing declines or imports to --?

Well, the other factor that we're contending with going in this and we have the same concerns heading into the second quarter as far as the combination of the weak housing related demand together with continued increases in raw material costs so to the extent that we are unable to pass those additional costs through that could put some additional pressure on margins. But as we look out into the second half of the year we would expect the trends return for the better just in terms just with our volume picking up from a seasonal standpoint and hopefully some improvement in demand as well.

Got it. That was my only question. Thanks.

Robert Kelly with Sidoti & Co.

Good morning. Question on the gross margin year-over-year decline. Can you give us maybe an order of magnitude as far as volumes, spreads and unit conversion costs that led to the decline?

I would say that of those factors the conversion cost represented the smallest component and that the reduction in spreads and the volume impact were at about the same level as far as order of magnitude.

And what is the PC strand side, despite that being weak, it sounds like in Q1 your average pricing was up versus last year. Is that just an easy comparison? Is that partially makes? How do we kind of reconcile that?

I think it was related to mix where when you look at the housing sector, the post tension segment of the market that has been the most severely impacted generally the pricing is lower for that segment. So in spite of the volume impact it has had a favorable affect on our average selling prices.

Great. The question also on inventories, you guys you said you are about 3.5 months. Are you running, will you give us a little indication as far as your capacity utilization 1Q and maybe even 2Q versus where you would be normally given seasonality?

We have taken some time out of our schedules to control inventories of finished goods. We really take a look at this over week to week or every two weeks cycle so we don't have a firm plan for all of Q2 at this point. But around the holidays and in January we have taken some time out of the production schedules.

Okay. And then as far as some of the import issues and the pressure on pricing, it sounds like it is more related to PC strand. The gross margins that we saw in Q1, should we expect sequentially a little more pressure on spreads given what we are seeing on the PC strand side and the weakness in housing or do you begin to ramp up a little more as far as volume in the 2Q months?

It is really harder to give a precise answer to the question just in view of the constant changes that occur both on the order book side and the pricing side. It's very difficult to give you a good answer to that question.

From a seasonal standpoint when you look at our historical performance, there has typically been an increase in the second quarter but at the same time we are looking at higher raw material costs that will be flowing through the P&L. So it really gets back to the pricing question and just how much pricing pressure we experience in the quarter that will determine where margins net out at.

Okay. Have you seen any relief as far as the raw material costs as we progress through 1Q?

Yes, we have after seeing a blip up in the world market during -- I'd say for deliveries during our first and early second quarter, pricing has come off for deliveries that would be later in our second quarter. But as we look to our next round of delivers, we see again upward pressure in raw material cost. So it is always changing but yes we expect some relief going forward.

And the supply as far as domestic and imports on raw materials, that remains adequate, as far as you can tell?

Yes, it is adequate. The domestic producers almost without exception are running well below capacity at this point in time. There is material available on the world market. China is dominating that picture right now and is the source of most of the offshore material.

Okay, great. And I guess you guys talk about the 80-20 mix, is that a pretty good rule of thumb to still work off of, at the end of the last quarter? You talked about 80-20, is that how we should think about your end market still going forward?

Yes, I think that is still a pretty accurate depiction of our mix. However, that 20% impact if you take the general changes in construction spending and compare that against our shipping performance, those aren't necessarily going to be in tandem just due to inventory impact. And that is what has really affected us in the segment or business related to the housing sector not only just a general decline but the inventory reduction measures that are being pursued by customers in that segment, that has really compounded it.

Are the reduction measures still underway or have they softened a little bit?

Yes, I think particularly in these areas that have been most severely impacted by the decline in housing starts to the extent that some of these customers were importing material, there is a 60 to 90 day reaction time before they can realize any reduced inflow of material. So I think those inventory rebalancing acts are still underway and probably have some way to go.

Okay, thank you.

[Steve Rainier] with Franklin Advisory Services.

Hi. Good morning. I'm just trying to understand the statement you made regarding inventory. You said you had higher inventory and you thought that would ultimately help your costs because raw material prices were headed higher. Is that what you said?

Yes, that is what we said.

Okay. But at the same time we have imports which are priced lower and therefore placing pressure on spreads. And at the same time you said there is excess capacity in terms of domestic raw materials. And I'm just trying to reconcile all these statements together as to understanding how this would be a positive for you.

Okay, let me try to explain. Looking at the raw material side of our business it is pretty clear to us that we are going to see rising prices for wire rod because the international price is rising. There is little motivation for the domestics to undercut import prices and I think that as we look into late first calendar quarter, the quarter that we are in, we are going to see that the domestic quarter books begin to fill up and that they also will be under rising steel scrap cost pressure and the domestics will find the opportunity to raise their prices in tandem with what is going on in the international market.

For that reason I'm not at all uncomfortable with the inventory position that we have today which is of course higher than -- higher inventory investment than the previous quarter. I think that those purchases will look very favorable by the time we get to the end of the current quarter. The domestic wire rod producing industry has consolidated significantly over the last two to three years and I think the reason that they are not running full is that they don't want to compromise their pricing so they've elected to curtail production as a result. So I think that is where they are right now.

Okay. I guess I'm a little surprised given the drop in energy prices and the fact that imports are rising so much here. I'm surprised that landed costs are rising. I would imagine if we're importing more it's because there is less need abroad and therefore their prices would be dropping. Otherwise if they didn't send this stuff over here. Right? Okay.

In terms of the PC strand market, can you just give me a bigger sense of at this point what imports represent, what share they represent of the PC strand market versus what they have been maybe a year ago?

I can give you a general feel for it but unfortunately I don't have the data in front of me. The Chinese are really the story in PC strand imports. And it looks to me like they will finish total imports of PC strand for the calendar year 2006 will wind up being in the range of 240,000 tons. And my estimate of the market for 2006 is in the range of 500,000 to 520,000 tons in that range somewhere. So if you do the mathematics, the Chinese are accounting for in the range of half the market. And that is just not sustainable. It is just a wildly absurd amount of Chinese strand in this market.

Okay. And normally the number is much lower?

Well, when you say normally it has been, it has been lower. This Chinese phenomenon has been with us now since 2003 and just of interest there were zero Chinese imports until about July of 2003. So this explosion is really unprecedented. They have ramped up since 2003 though on a consistent and continual basis. So fortunately the market has grown fast enough during 2003, 2004, 2005 and most of 2006 so that while they were out there and they were certainly noticeable in the market in many instances we could ignore them.

Okay. All right, thank you very much for your time.

Trey Snow with Priority Capital.

Did you mention what impact weather might have had on your shipments? Given the quarter was a little bit warmer and construction may have been accelerated.

I don't really know any positive nor negative impact on shipments from weather this year. I think it is pretty much a nonfactor.

Okay. Thank you.

(OPERATOR INSTRUCTIONS) Sir, it appears that we have no further questions at this time.

Okay. We appreciate your interest in Insteel and we welcome any follow-up calls that you may have. Thank you very much.

That does conclude today's audio conference. Thank you for your participation and have a nice day.