Insteel Industries Inc (IIIN) 2008 Q1 法說會逐字稿

Good day, everyone and welcome to the Insteel Industries' first-quarter 2008 conference call. At this time, I would like to turn the call over to Mr. H.O. Woltz III, President and CEO. Please go ahead, sir. 1.

Thank you, Craig. Good morning and thank you for your interest in Insteel and welcome to our first-quarter 2008 conference call, which will be conducted by Mike Gazmarian, our Vice President and Chief Financial Officer 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.

During our first quarter, which is seasonally our slowest period of the year, we continued to experience weak conditions across most of our markets that adversely affected shipments and resulted in inefficiencies related to curtail production schedules at our plants. Further, during the second half of the quarter, we began to experience an escalation in raw material costs that is proving to be without historical precedent in its magnitude. In view of the considerable challenges posed by these external factors, I am pleased with the Company's strong financial performance and particularly encouraged by the strength of our balance sheet at the end of the quarter.

I am going to turn the presentation over to Mike to comment on our financial results for the quarter and then I will pick it back up to comment on our business outlook.

Thank you, H. As we reported in this morning's press release, despite the continuation of soft demand in certain of our markets, together with increasing raw material costs, Insteel posted solid results for the first quarter ended December 29. Considering the challenging business conditions that we experienced, we are pleased with the Company's financial performance during what has historically been our weakest shipment period of the year.

Net earnings for the quarter were $4.2 million or $0.23 per diluted share compared with $5.8 million or $0.32 per diluted share in the prior year. We continued to experience wide variations in market conditions across productlines during the quarter that were consistent with the most recent monthly construction spending data reported by the U.S. Census Bureau. In the most recent report, which is for the month of November, the seasonally adjusted annual rate of total construction spending rose 0.1% from the revised October estimate, but was down 0.1% from a year ago due to the weakness in the housing market.

Private nonresidential construction for November increased 1.7% from the previous month and 19.5% from last year and public construction is up 2.5% from October and 16.3% from a year ago. Conversely private residential construction was down 2.5% from October and 17.8% from last year. It has now fallen for 21 straight months, dropping 30% from the February 2006 peak with construction spending for new single-family homes falling 44% over the same period. The 11-month year-to-date spending totals reflect the same trends with private nonresidential construction, up 18.1% from last year, public construction up 12.7% and private residential construction down 17.8%.

Insteel's net sales for the quarter were down 5.4% from a year ago due to a 6.1% decrease in shipments. The reduction in shipments was primarily driven by the same factors that have impacted us in recent quarters, our limited solicitation of PC strand business from post-tension accounts in view of the depressed pricing levels and weak demand from customers with greater exposure to the housing sector.

On a sequential basis, shipments were down 11.8% from the fourth quarter, which was slightly lower than the 14.9% seasonal decrease that we experienced between the same period for each of the past two years. Our year-over-year shipment comparisons across productlines continued to vary depending upon the relative correlation with nonresidential versus residential construction. On a combined basis, shipments of PC strand to precasters and ESM shipments, which are both strictly used for nonresidential construction applications, were up 13.4% from last year due to the continuation of strong demand and the ramp up of the new ESM line in our North Carolina facility.

Average selling prices for the quarter were slightly higher, rising 0.7% from last year and 0.6% on a sequential basis as a result of the price increases that were implemented in certain of our productlines during the quarter. Gross profit for the quarter decreased to $10.6 million from $13.6 million last year due to the escalation in raw material costs, lower shipments, and higher unit conversion costs with gross margins narrowing to 16.1% from 19.5%.

SG&A expense was down $0.2 million from a year ago and $0.5 million from the fourth quarter as the gain on an insurance settlement and lower incentive compensation expense offset increases in bad debt and employee retirement plan expense. Interest expense, which primarily consists of non-cash amortization and capitalized financing costs and interest income, were both relatively flat compared with last year.

Our overall effective income tax rate for the quarter, including the disc ops component, decreased to 35.9% from 37.2% in the prior year, primarily due to book versus tax differences relating to the insurance gain and higher tax credits, which were amplified by the lower pretax earnings in the current year.

Moving to the cash flow statement and balance sheet, operating activities of continuing operations provided $17.3 million of cash for the quarter compared with $4.2 million a year ago as a result of the year-over-year changes in working capital, which offset the reduction in earnings. The network and capital components of receivables, inventories and accounts payable and accrued expenses provided $8.9 million in cash while using $3.8 million last year, largely due to the $9.9 million increase in inventory that occurred in the prior year.

The strong operating cash flow for the quarter enabled us to fund $4.9 million of capital expenditures, repurchase $2.5 million of common stock under our previous share repurchase authorization, pay $0.5 million of dividends and end the quarter debt free with $17.7 million of cash, an increase of $9 million from the fourth quarter.

In view of our debt-free balance sheet, the increase in our cash position and the borrowing capacity available under our $100 million revolving credit facility, we believe that Insteel is ideally positioned to capitalize on any growth opportunities that may develop and weather future economic downturns.

Our quarter-end inventories were down $2 million from the previous quarter and $11.3 million from a year ago, representing around three months of shipments based on our forecasted run rate for Q2. Total additions to property plant and equipment, including the accounts payable related to PP&E reflected at the bottom of the cash flow statement, were $5.3 million for the quarter compared with $3.6 million last year. The bulk of the current year outlays were related to the equipment upgrades at our Florida PC strand plant, which are expected to be completed during the third fiscal quarter.

We continue to expect CapEx to total $10 million for fiscal 2008; although the actual timing is subject to change based on adjustments and project timelines or scope, future market conditions, the Company's financial performance and additional growth opportunities that may arise.

As previously announced, on December 5, our Board authorized a new 25 million share repurchase program that runs through December 5, 2008. Going forward, we will continue to evaluate the potential repurchase of additional shares based upon the expected timing and funding requirements for any growth opportunities that arise, as well as evaluation of our shares relative to our business outlook and cash flow expectations.

As we move further into 2008, we expect some moderation in the growth in nonresidential construction. Although the most recent Architectural Billings Index, or ABI report, for the month of November remained positive. The ABI serves as a leading indicator for nonresidential construction based on the typical nine to 12-month lag time between architectural billings and construction spending with any score above 50 indicating an increase in billings from the previous month. In November, the ABI rose more than two points to 55.3 from 53.2 in October, implying the continuation of strong demand for nonresidential construction projects well into the year. I will now turn it back over to H.

Thank you, Mike. Market conditions have become increasingly challenging in recent months as there are growing indications that the ongoing weakness in the housing market has begun to affect commercial construction. In addition, the continued growth in other nonresidential construction categories could be jeopardized if the economy enters recession or a protracted period of no growth that affects demand for new projects or the ability of state and federal government agencies to adequately fund transportation and infrastructure initiatives.

In addition to these demand-related risks, recent developments in the market for our primary raw material -- hot rolled steel wire rod -- contribute to our uncertain outlook as it appears that prices are poised to rise approximately 30% on a cumulative basis between October and March, an increase of unprecedented magnitude that is driven by the weak dollar and strong worldwide demand for steel products.

While the potential for short supplies should support our efforts to pass through these additional costs in our markets, the resulting inflationary impact could at some point begin to impact the level of construction activity, particularly considering the escalation in costs of other building materials.

In response to these challenges, we will continue to carefully control our operating expenses, closely align production schedules at our facilities with demand to reflect changes in market conditions and defer discretionary spending to the full extent possible.

Before opening it up for questions, let me comment on import competition in the PC strand market. Through 11 months of calendar 2007, strand imports have declined 19% from the prior year with 89% of the volume entering the US from China. While the reduction is somewhat encouraging, we believe market demand has declined by a similar amount. The average unit value of imports has risen $80 per ton from the 2007 low point, but the Chinese have continued to undersell the domestic industry by more than $200 per ton in recent months.

Beginning in 2006, the Chinese government took steps to curb exports of a variety of steel products by reducing or eliminating export tax rebates and imposing new taxes on exports of many lower value products. While we were hopeful that PC strand would be among the products slated for the imposition of export taxes, this has not yet occurred.

Instead, it appears that the Chinese government has embraced a policy that encourages downstreaming of steel products by taxing exports of lower value products such as steel wire rod while rebating VAT taxes applicable to finished products such as PC strand. Such a taxation scheme serves to favor exports of PC strand over exports of wire rod by approximately $150 per ton. The use of tax policy for this purpose is clearly contrary to WTO rules and our industry trade coalition is in discussions with the Office of the US Trade Rep regarding this matter. The outcome of these efforts may not be known for several months.

Meanwhile, Chinese prices for delivery in the April/May period are rising significantly, but rapidly rising costs in the US market could dilute, if not eliminate, any relative competitive advantage that domestic producers may have otherwise gained. We should get a clearer view as to the impact of these changes on the net domestic versus import price differential over the next few months.

In summary, there are some encouraging trends with respect to import competition, but Chinese activity in the market will continue to be a source of concern for us. This concludes our prepared remarks and we will now take your questions. Craig, would you please explain the procedure for asking questions?

(OPERATOR INSTRUCTIONS). Chris Haberlin, Davenport & Co.

Good morning. I just had a quick question on the conversion costs. You all had said in the release that they increased year-over-year and we noticed there has been I guess four facility expansions and upgrades that have come online since then. When do you all expect to see year-over-year improvements in your conversion costs as a result of these expansions?

There are actually a few different answers to the question, but let me first say that the overall reason for the unfavorable comparison relates to the downtime that was scheduled in the facilities, which is related to just weak order patterns and our desire to control inventories. Some of the investments that we have made for instance in engineered structural mesh have in fact reduced our productline conversion costs on a comparable basis; although the depreciation load that we are carrying has contributed to an overall higher conversion cost on an average basis at the facility. But if you were to look at product-for-product engineered structural mesh that was produced prior to our investments and after, we have clearly significantly reduced the labor content of that productline.

Moving to PC strand, the payback that we will realize from our PC strand investments in the near term is really solely related to the lower labor content component of conversion costs as we will not see overall benefits on the cost side until we are able to realize fuller utilization of these facilities.

One other comment to add on the Q1 increase year-over-year and on the scaling back of our production schedules. Our production volumes for the quarter were down about 14% from the prior year just to kind of put it in perspective as far as -- that was really the primary factor driving the increase.

(OPERATOR INSTRUCTIONS). [Walt Glazer], Parthenon.

Good morning. H., you mentioned that you thought rod prices were poised to go up about 30%. I want to make sure I understood that. Is that based on announced price increases or trends that you see or what leads you to --

Actually both, Walt. The cumulative increases that have been announced in the industry would support that 30%, but also these increases are being collected; there is no question about it. So it is happening.

It is. And historically, higher rod prices would translate into better margins for you guys, but it sounds like this time, it is different.

Well, I think our comment on steel prices has been in the past that it is difficult to generalize as to whether higher rod prices are good or bad for our business, that if we're -- in markets where demand is strong for our products then we are generally able to pass those increases through and increase our margins. When demand for our products is weak, of course, it is much more difficult to pass on raw material increases.

The thing that is different this time and really where we have no experience is the magnitude of these increases. At round numbers, $150 to $200 a ton of increase in raw material costs, there is not a producer or a competitor in the marketplace that can reasonably consider absorbing this. So I think that the shock value of the size and the magnitude of these increases, together with the prospect that domestic wire rod may be in short supply, are going to support our ability to pass these through. So time is only going to tell, but at this point, one of my top concerns is not that we will not be able to -- that we will not be able to pass these through. I think we will get the increases.

Okay. And currently, your rod purchases are pretty much evenly split domestic and overseas or how would you characterize that?

No, it is really almost exclusively domestic today, Walt. We have, over time, we have been as much as 60% or 65% offshore and generally, we are at least 20% offshore, but the thing that has caused this run-up in large part is the absence of import material in the marketplace and that absence is driven by strong worldwide demand and the weak dollar. So I would guess we will certainly be under 10% offshore material as we look at the next few months.

Okay, great. Well, thanks for the info and look forward to talking to you next time.

Thanks, Walt.

Casey Flavin, CJS Securities.

Hi, Mike and H. To give us a better understanding of your business, can you give us a breakdown of the welded wire segment, PC strand by revenue and margin?

No, we don't disclose that information.

How about by revenue?

We haven't disclosed that on a quarterly basis previously and I don't know that we'd want to set a precedent.

Okay. Well then given that your shipments were down 6% in units in the quarter and inventories were also reduced, were clients reducing their inventories in the quarter versus actually building heading into a higher priced environment?

It is a timing matter, Casey. We did begin building inventories when we saw what was happening in the market and I think that you will see we probably didn't receive all that we had ordered for our first quarter. The balance of that will be received in our second quarter and we have taken measures to protect ourselves from short supply by arranging to build some inventories during the current quarter.

Okay, H., the question was actually regarding your clients and not your own view of the inventories.

Oh, I apologize. I didn't understand that. We have seen little or no activity by our customers in terms of building inventory. Many of them are still reeling from the reduction in their own order books and it just does not appear that this has been on their radar screen as a priority.

Got it. And then to recover 30% increase in costs over I guess a four to six-month time period here, how much do you anticipate you will raise prices?

Well, the rod increases are variously, but that have been announced so far are variously between $150 and $200 a ton. So to stay even, we certainly have to pass through that amount. Through the month of January, we have announced increases in welded wire fabric of $80 per ton and approximately $40 in PC strand and you will see additional increases being announced by the Company in the very near future.

Great. And then given current utilization demand and higher costs, are the 16% gross margins reported in the current quarter achievable in Q2?

Typically, we would see some seasonal benefit moving into Q2 where the volumes would increase some from the first quarter. So we should see some benefit from that and then just from a timing standpoint and a rising rod cost environment, there is typically some interim benefit where to the extent that we are getting increases through, those would be matched up against lower cost material and inventory over an interim period and as I indicated, we had about three months worth of inventory on hand as of the end of the quarter. At the end of that period, then rod costs would be elevated to those higher levels and there would be an offset, but just from a timing standpoint, we would expect some benefit.

Thank you. I will hop back in the queue.

(OPERATOR INSTRUCTIONS). [Scott Arnold], The Clinton Group.

Good morning. Congrats on a relatively strong quarter in what I am sure has been a challenging period. I have one question just about what was said earlier. There was a lot of double negatives in the sentence. H., you said you were not concerned that you would not be able to pass on costs. If I could turn that around, that means you are relatively sanguine and positive about your ability to recoup some of your higher raw material costs, is that correct?

That is correct and I apologize for the twisted --

No, that's fine. I just want to make sure that we are on the same page. And second of all, relative to kind of your future forecast of demand, I looked at the ABI index from the architectural people and I have actually spent some time with them going over the trends and whatnot and both, from a geographic basis and from a kind of sector basis, the areas you guys are active in actually look to be pretty strong and look to probably continue to be pretty strong. Could you comment on that?

I think we would agree with that. The point that I would make is that you can't view the nonresidential and residential as totally independent of one another in our marketplace. Keep in mind that Insteel and all of Insteel's competitors are vying for business and the products that we produce that go nonres and res are going across, in many cases, the same production lines, the same people and the dramatic fall-off that residential has seen definitely impacts competitive activity in those productlines that are primary nonresidential. So these things work independent events.

And then historically, you have been about 85% nonresidential, is that still the case?

Yes, it would be right in that range -- (technical difficulty)