Insteel Industries Inc (IIIN) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Insteel Industries second quarter earnings release conference. As a reminder, today's call is being recorded.

And now 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 for your interest in Insteel and welcome to our second quarter 2007 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 pointing out that our Q2 results were achieved in spite of significant challenges on a number of fronts. As we had anticipated in our previous call, that housing sector remained anemic during the second quarter. Imports of PC Strand continued to affect us. Raw material costs were on the rise and the year-over-year comparisons were difficult in view of the record performance turned in by the Company last year. In view of all these factors, we're pleased with the results for the quarter and we look forward to significant improvement during the second half of the year.

I'm going to turn the presentation over to Mike to provide you with more details on the 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, despite continued weakness in housing related demand, higher raw material costs and adverse weather conditions in certain of our markets, Insteel boasted solid financial results for its second quarter ended March 31. Earnings from continuing operations were $4.9 million or $0.27 per diluted share compared with $7.8 million or $0.42 per diluted share in the prior year.

Including the results for discontinued industrial wire business, which we exited last June, net earnings were $4.9 million or $0.27 per diluted share compared with $7.4 million or $0.40 per diluted share a year ago. For the six month period, earnings from continuing operations were $10.9 million or $0.59 per diluted share compared with $15.9 million or $0.85 per diluted share in the prior year. Including discontinued operations, net earnings were $10.7 million or $0.58 per diluted share compared with $15.1 million or $0.81 per diluted share a year ago.

The core was again characterized by the continuation of favorable trends for nonresidential construction and soft demand from those portions of our customers business impacted by the weakening in the housing sector. These trends appear to be consistent with the most recently reported macro indicators for the construction sector.

Just to highlight a couple of the indices that we monitor, in the most recent Commerce Department report, which is for the month of February, a seasonally adjusted annual rate of total construction spending was .3% above the revised January estimate, but down 2.4% from a year ago. There continue to be sharp differences between construction categories. Private nonresidential construction for February increased 2.3% from the previous month and 15.9% from last year, and public construction was up .4% from January and 10.4% from a year ago.

In contrast, private residential construction was down 1% from January and 15.1% from last year due to the drop-off in single family housing, which fell 27.6% from last year, more than offsetting the continued strength in multifamily housing construction. Spending for single family housing has now fallen for 11 straight months.

Yesterday, the American Institute of Architects reported that the Architectural Billings Index remained stable and large with the rating of 52.6; virtually identical to the 52.5 reported for February with any score above 50 indicating an increase in billings from the previous month. The overall index has now been positive for 37 out of the previous 40 months. The ABI serves as a leading indicator of nonresidential construction activity based on a typical 9 to 12 month lag time between architecture billings and construction spending.

Breaking down the overall index by sector, the commercial industrial sector index was 51.7 and the institutional sector index was 54.8, both relatively flat compared to February. Another positive with the New Projects Inquiries Index which was 61.8 in March, implying increased demand for architectural services and ultimately construction projects in future months.

Moving back to Insteel's financial results for the second quarter, sales from continuing operations were down 6.3% from a year ago due to the weakness in housing related demand and severe winter weather conditions that we experienced in some of our markets during the quarter. In addition, we faced difficult prior year comps with our 2006 results representing record high sales and earnings for the second fiscal quarter. You may recall that last year we benefited from the unusually mild weather which served to extend the construction season and boost shipments for the first half.

Shipments for the quarter fell 6.4% while average selling prices were relatively flat, increasing by .2% from a year ago. On a sequential basis, shipments for Q2 were up 9.8% from the first quarter, which was slightly higher than the 7.5% increase we experienced between the same period a year ago, while average selling prices fell 2.3%.

Sales of welded wire reinforcement rose 2.1% from last year, and 11.1% for the first quarter while PC Strand sales, which have been more severely impacted by the downturn in the housing sector as well as import competition, declined 14.7% from a year ago, but were up 3% from the first quarter.

Gross profit from continuing operations for the quarter fell to $12.4 million or 16.5% of net sales from $17 million or 21.3% of net sales in the prior year due to the lower shipment, higher raw material costs, and higher unit conversion costs largely driven by the reduced operating schedules. On a sequential basis, gross profit fell by $1.3 million and gross margins were down 3% from Q1 due to lower spreads resulting from the combination of the lower average selling price that I alluded to earlier and higher raw material costs together with higher unit conversion costs, which more than offset the increase in shipments in Q1.

SG&A expense for the quarter rose 3.2% from a year ago from $4.5 million to 4.6 million. Excluding the 387,000 of stock based compensation that was recorded in the current year quarter, [and 185,000] a year ago, SG&A expense would have actually fallen slightly from the prior year. Interest expense for the quarter was relatively flat year-over-year primarily consisting of non-cash amortization associated with capitalized financing costs while interest income was up, driven by the higher average cash balances in the current year.

Our overall effective income tax rate for the quarter, including the (inaudible) component fell to 35.9% versus 36.8% in the prior year due to a reduction in permanent book tax differences related to stock options and a decrease in our effective state tax rate.

Moving to the cash-flow statement and balance sheet, operating activities and continuing operations used $10 million of cash for the quarter while providing $3 million in the year-ago period, primarily due to the increase in cash used for net working capital together with the lower earnings. In the current year quarter, net working capital used $15.7 million in cash, $10.7 million higher than the $5 million that was used in the prior year. This increase was largely driven by the $14.6 million reduction in Accounts Payable and accrued expenses in the current year quarter resulting from payments related to the higher raw material purchases made during Q1 and early in Q2 in anticipation of future price increases.

As a result of the cash used by operating activities and the funding requirements for CapEx and cash dividends, we ended the quarter with $4.3 million of borrowings outstanding on our revolving credit facility as compared to a year ago when we had $3.8 million outstanding.

Total asset additions for the quarter including the portion of Accounts Payable related to [TCD] reflected at the bottom of the cash-flow statement were $5.3 million compared with $5.7 million last year. The majority of the $9 million of asset additions for the first half of the year was related to outlays for the PC Strand and ESM expansion together with various upgrades to our PC Strand operation in Florida and our welded wire reinforcement facility in Delaware in addition to recurring maintenance type requirements.

We continue to expect CapEx to total $18 million this year and fall to a range of $3 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. Depending upon the timing of anticipated equipment received later in the year, a portion of the $18 million projected for this year could potentially spill over into 2008.

Total inventory fell $5.4 million from the prior quarter end following the $9.9 million inventory build that occurred in the first quarter in anticipation of rising prices for steel wire rods, our primary raw material. On a forward-looking basis, total inventory quantities on hand as of the end of the quarter represented about 2.8 months of shipments based on our anticipated shipment run rate for Q3.

At this point, we expect an inventory to gradually decrease over the remainder of the year subject to any adjustments that we elect to make in response to future changes in the rod market. As a point of comparison, our quarter end inventory level was approximately $6.2 million higher than a year ago.

Looking forward, in view of the recent series of price increases announced by the domestic rod producers, the higher inventory levels that we are carrying should work to our advantage from a comparative cost standpoint; with demand improving as we head into our busy season, recently announced price increases for all of our product lines, which should alleviate the compression and spreads that we experienced in Q2 and favorably impact our third quarter results.

I'll now turn it back over to H. for an update on our capital projects and our business outlook.

Thank you, Mike. First, I want to briefly comment on the status of our CapEx initiatives. The Tennessee PC Strand project is essentially complete with only a few loose ends to be tied up. We expect to complete the remaining equipment relocations during the current quarter along with some operating refinements related to new processes, but our experience thus far with the reconfigured facility has validated our productivity improvement assumptions.

The ramp up of our engineered structural mesh production line at the North Carolina facility has gone smoothly. We are currently operating the line at approximately 60% of capacity with improvements coming daily. The sophistication and technology of the line are unlike any other equipment we operate, and our people have done a good job so far ramping up production.

Delivery of the Texas line, which is essentially a clone of the North Carolina line, is expected in early May and startup should take place during the fourth fiscal quarter. The extensive knowledge that we've gained during the North Carolina startup should work to our benefit in the Texas startup.

The remaining significant projects that are scheduled for 2007 are the installation of a standard welded wire reinforcing line at our Delaware facility and the upgrading of our Florida PC Strand manufacturing plant. The startup of the Delaware line is expected to begin toward the end of the current quarter. Delivery of equipment for the Florida project is not expected until late in the fiscal year with the startup of that project expected to occur late in Q1 of fiscal 2008 or early in Q2, depending on the timing of receipt of machinery.

Before we open it for questions, I want to comment on three issues that will affect our performance going forward -- expectations for market demand, the prospects for recovering increasing raw material costs, and the impact of PC Strand imports on the Company.

First, let me interest demand expectations for the balance of the year. We continue to believe that the outlook is favorable for our nonresidential construction markets. Customer backlogs in this segment are strong and there seems to be a large volume of work available to bid. In addition to this anecdotal evidence, spending data and the ABI support a bullish outlook for the nonresidential sector.

The housing sector, on the other hand, is expected to remain weak through the calendar year with a recovery unlikely to begin until sometime in 2008. We had been hopeful for an earlier recovery in this market, but based on the most recent indicators, it's abundantly clear that housing activity will remain depressed for several more quarters.

Assuming that these trends develop as expected, it's likely that demand for Insteel's products for the balance of the year will resemble demand over the past two quarters, which I would characterize as reasonably good, but certainly not as favorable as previous quarters when the level of activity in both sectors of the construction market were strong. Our bookings so far in April indicate that the expected seasonal upturn is materializing, which should support improvement in our second half results.

The second issue I want to comment on is our ability to recover rising raw material costs in our markets. Since March 1, wire rod price increases in the amount of $125 to $130 per ton have been announced by domestic suppliers. These increases were driven by the sharp escalation in scrap prices since January and supported by rising wire rod prices from offshore producers driven by increasing consumption in other parts of the world.

In the absence of significant cost increases, we doubt that price increases would have been announced, since our domestic suppliers have experienced the same orderbook lethargy that we have experienced up to this point. With pricing rising from offshore suppliers, however, it's likely that U.S. wire rod consumers are redirecting some purchases to domestic suppliers, which would cause orderbooks to firm over the next few months. Firmer orderbooks could create more resolve to collect the announced increases and perhaps to initiate increases beyond those that have already been published.

The question for Insteel that we can't definitively answer yet is whether we'll be able to pass these increases through in a mixed market environment. Our initial experience in welded wire reinforcing has been favorable. Assuming that our raw material costs continue to rise, it's likely that we will announce additional price increases for these products in the near future.

The initial PC Strand price increases are effective April 30. We'll discuss strand imports in a minute, but as you might suspect, there's concern about the widening gap between domestic and import strand prices. Nevertheless, at this point, we're cautiously optimistic about the prospects for our margins during the third quarter. Looking out into Q4 and beyond, we're unable to make a definitive statement about margins which will ultimately be determined by the strength of demand and developments with imports.

The third topic that I want to comment on is the implication for Insteel of continued high levels of PC Strand imports. For calendar 2006, imports of PC Strand totaled 242,000 tons, up 69% from 2005, with imports from China rising 133% to 196,000 tons and accounting for 81% of total import volume. On an overall basis, the average unit value of imports for the year fell 14% or $125 per ton, while the AUV for imports from China fell 19% or $152 per ton. These data are highly concerning with respect to the magnitude of the rise in volume and the decline in average unit value.

Unfortunately, recent changes by the Chinese government in export rebate tax policies could serve to exacerbate the problem of Chinese strand imports in the short-term. Longer-term, however, the lack of any compelling Chinese cost advantage and the related reliance on government subsidies to support a massive export program should result in the pendulum swinging back in favor of U.S. production. And we will be well positioned to capitalize on this following the investments that we've made in our facilities. And I would point out that we have successfully navigated this cycle previously.

In view of rising prices for wire rod and indications of declining prices for Chinese strand deliveries during our third and fourth fiscal quarters, we've elected to back away from a significant amount of business in the commercial posttension segment of the market, which has been most seriously impacted by the housing downturn and import competition. We are evaluating the possibility of servicing this market segment, which accounts for approximately one-third of domestic PC Strand consumption, with sourced material beginning in our fourth quarter and continuing until such time as the economics for domestic production yield acceptable returns.

During the second quarter, we adjusted our operating configuration and schedule to reflect our revised commercial posture. Until circumstances change, we will not fully utilize our expanded PC Strand production facilities, but our recent and planned investments will facilitate significant reductions in our cash cost of production. We're confident that a time will come in the near future when we will fully deploy our expanded production capacity, but that time will only come when market-based economics prevail with respect to Chinese participation in the U.S. market.

I would emphasize that these comments are focused on the one-third of our strand business going into the commercial posttension market. Overall, PC Strand continues to be a highly desirable product line delivering attractive returns on the capital that we've invested. We expect to build on our market position and compete more aggressively with imports as we experiment with our sourcing program for the balance of 2007. Longer-term, we will be well positioned with substantial domestic production capability to serve the continued growth of this market.

That concludes our prepared remarks, and we'll now open it for questions. Would you please explain the procedure for asking questions?

Absolutely, gentlemen. The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS). Casey Flavin, CJS Securities.

Your accounts payable and accrued expenses were down substantially in the quarter. Could you give us some more details if this is due just to the inventory build or if there are other factors?

Can you please repeat the question?

Yes, we can barely hear you.

Your accounts payable and accrued expenses were down substantially in the quarter. Can you give us some detail if this is due just to the inventory build or if there's some other factors there?

It's primarily related to the inventory build and the drop-off in raw material purchasing volumes from Q1. You'll recall back in the first quarter we were in inventory build with our inventories rising by $9.9 million. In addition we made significant broad purchases earlier in the second quarter and then as we progressed through the quarter, the purchasing activity dropped off pretty significantly, so that -- it's the payment on those previous purchases really, and I guess a reduction in outstanding payables that's driven that balance lower. As purchases pick back up again in Q3, we would expect that balance to rise again.

And you previously mentioned having to work off higher cost inventory and purchasing commitments. Are those done or should we expect those to impact the second half of the year?

Well, the reference there was to the higher cost -- it's been, I guess, a gradual increase -- the reference was to the higher cost on rod purchase in the first quarter that was blowing through cost of sales in the second quarter. Now our purchases have dropped off here recently and for a period we would expect to be favorably impacted by the lower cost of material currently in inventory. Assuming that we're successful on these price increases, that should widen the spreads in the third quarter. And then going forward, further out, just in the wake of these recent price increase announcements, the net impact will ultimately be driven by demand and whether the future price increases that we implement are in excess of these recent rod price increases. It's a little more difficult to predict as we look out beyond the third quarter.

And then in terms of your expansion ESM in PC Strand and the related expenses there, at what point do you expect them to operate in line with [firm] margins?

On both the strand and ESM, with ESM as we indicated in our comments, we made substantial progress ramping up in North Carolina line and we would expect to see further increase this quarter which would, I think would eventually get us up close to -- on the overall averages. I don't know that we can really predict it with precision as far as the timing, but we would expect the volume to continue to ramp up this quarter.

Gary Lenhoff, Ironworks Capital.

Could you just expand a little bit on your comments about the unlikely recovery of the housing related part of your business prior to year end? Maybe if you could broaden or provide some color on what geographies or what you're seeing in the marketplace that has caused you to push back the expectation.

I wouldn't want to hold out our expertise as particularly in lighting -- enlightening with respect to the housing market, but just from everything that we read, it seems that the momentum continues to be negative and we see that inventory issues continue to exist with our customers and I guess it's just a reasonably pessimistic view that we have of the timeline for recovery. But there's not a lot of original analysis underpinning those comments.

Thanks very much.

(OPERATOR INSTRUCTIONS). Trey Snow, Priority Capital.

I believe in your closing statements, you mentioned that you might begin to source some PC Strand for -- was it pretension?

It's for the commercial posttension segment of the industry primarily. That is a lot of residential work where slab-on-grade construction is posttensioned in areas with expansive soils. That is -- that would be one target market.

And is there material to source there? There's something available?

Yes, there is.

And would that be domestic or foreign suppliers?

Foreign.

And second question, it seems like the timetable for Tennessee has slipped a little bit the last few quarters. Is there anything major going on there, something you didn't predict or machinery not being available? What's going on with the startup there?

That's a very complex project that is composed of several distinct pieces; one of which was the relocation of existing machinery. And it is those pieces that are being finished up now that the nature of this project was that we were consolidating into one manufacturer facility activities that had been occurring at two separate facilities on the same site, and we both installed and started up proprietary technology. We purchased and installed some conventional technology that represented new hardware, new equipment, and we relocated existing equipment. In connection with the relocation of existing equipment, we also hold that equipment apart to thoroughly overhaul and refurbish it, and we have run into some extensive timelines on finishing up that work that are due to internal resource constraints as well as finding some things that we didn't expect when we got into the equipment. So it has dragged out longer than we expected it to, but there are no significant underlying issues that should concern you.

And I think you mentioned earlier, but you don't really see any cost escalation on that project?

About all the spending has been complete for a good period of time. The spending that's going on now is minor.

Thank you very much.

Robert Kelly, Sidoti and Company.

Thanks for taking my call. You guys mentioned wire rod costs are up $125 a ton since March. The price increases that you are looking to get, does that look to recover all of them or partially?

Well, at this point, there have been, depending on the vendor, there have been at least three separate price increase announcements, and I don't recall the exact numbers, the way that they rolled out, but they would total $125 to $130 per ton. The first was effective the middle of March. The second was effective April 1, and the third one is effective May 1. The first two rounds of price increases from a domestic point of view I would say that those are solidly in place. And it is those two increases totaling $70 or $75 per ton that we have recovered in our welded wire reinforcing market and that we are attempting to recover through the price increase in PC Strand that is effective April 30. The remaining outstanding price increase that's effective May 1, we are arm wrestling over with our vendors.

Understood.

On the raw material side, in view of the inventory build that occurred in Q1 and early Q2, we should be pretty well-positioned, where the carrying costs of the material in the inventory would be lower than what would be implied by those recent price increases. And as I indicated in my comments, we have about 2.8 months of raw material on supply as of quarter end, so we should be pretty well-positioned from a spread standpoint with the matching of those price increases against the lower-cost material. When we get further out past that period, which would be near the end of Q3 or Q4, when we begin to see the impact from those cumulative increases that H. mentioned and that will be just a question of where we stand on additional selling price increases.

The utilization in 2Q, where were we on that?

It really varies by product line. As a general statement, I would say that we're in the '70s, probably the lower '70s.

And it's -- assuming the seasonal upturn for Q3, I mean, where do we get to? I know Q3 last year was a pretty tough comparison as far as utilization. Is it normally in the '80s? 85 or do we stay in the '70s?

It will certainly rise but I don't know that we can provide a specific figure. We just don't have the backlog to be able to tell you with any confidence where we expect it. We are seeing the seasonal upturn that we had expected, but on an overall basis with our pullback during third quarter from some of our strand market, clearly, we're not going to attain the same levels that we did last year.

Right. I guess another way, should we assume coverage and costs decrease sequentially with the seasonal uptick or --?

Yes, we would expect that. Yes.

And then you did mention you're backing off the commercial posttension. How much of your overall capacity does that affect?

Well, we would say that it's roughly one-third of the overall market and it's also roughly one-third of Insteel's PC Strand business.

All right. Thank you.

Gentlemen, there are no further questions in our queue at this time. Mr. Woltz, I'll turn the conference back over to you, sir.

Well, we appreciate your interest in the Company and your participation in the call today. And we'll talk to you next quarter. Thank you.

That does conclude today's conference call. Thank you for your participation. Have a great day.