Insteel Industries Inc (IIIN) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to the Insteel Industries conference call to announce second quarter 2008 earnings. Today's conference is being recorded. At this time I would like to turn the conference over to Mr. H.O. Woltz III, President and CEO of Insteel Industries.

Thank you for your interest in Insteel, and welcome to our second quarter 2008 conference call, which will be conducted by Mike Gazmarian, our Vice President, 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.

During our second quarter we continued to face weak conditions in certain of our markets, which reduced shipments and resulted in curtailed operating schedules at most of our facilities. We also experienced unprecedented increases in our raw material costs, a trend which has continued into our third fiscal quarter. Considering these significant challenges, we're pleased with the Company's strong financial performance for the quarter.

I'm going to turn the call over to Mike to comment on our financial results, and then I will pick it back up to discuss our business outlook.

Thank you, H. As we reported in this morning's press release, Insteel posted strong financial results for the second quarter ended March 29, despite the continuation of soft demand in housing-related markets and unprecedented escalation in raw material costs.

Net earnings rose to 6.9 million from 4.9 million, with diluted earnings per share increasing 44% to $0.39 from $0.27 a year ago. Market conditions continued to vary across product lines during the quarter, consistent with the latest construction spending data reported by the US Census Bureau. In the most recent report, which was for the month of February, the seasonally adjusted annual rate of total construction spending decreased 0.3% on a sequential basis, the fifth consecutive month it has fallen, and was down 3.5% from a year ago due to the continued weakness in the housing market.

After rising 14 straight months through last November, private nonresidential construction has now fallen for three consecutive months, decreasing 0.1% from January. In spite of the recent drop-off, it was still up 13.2% from the prior year, while public construction was up 0.4% from January and 8.2% from a year ago. Private residential construction dropped 0.9% from January and 18.8% from last year, and has now fallen for 24 straight months. February spending was down 34% from its peak level two years ago, while spending for new single-family homes fell 53% over the same period.

Insteel's net sales for the quarter rose 3.3% from a year ago on a 10.6% increase in average selling prices, which more than offset a 6.5% decrease in shipments. The reduced shipments were primarily driven by the same factors impacting us in recent quarters -- our limited solicitation of PC strand business from post-tension accounts due to the impact of irrationally-priced Chinese imports, and weak demand from customers with greater exposure to the housing sector.

On a sequential basis, shipments are up 9.2% from the first quarter, which was about in line with the 9.8% seasonal increase that we experienced between the same periods last year. Average selling prices for the quarter were up 7.2% on a sequential basis as a result of the price increases that were implemented during the quarter. Our year-over-year product line shipment comparisons varied depending upon the extent to which they were related to nonresidential versus residential construction.

On a combined basis, shipments of PC strand to precasters, and ESM shipments, which are both used almost entirely for nonresidential construction applications, were up 15.1% from last year due to the continuation of strong demand and the increasing contributions of our two new ESM lines. On the other hand, shipments of concrete pipe reinforcement and standard welded wire reinforcement, which have both been significantly impacted by the drop-off in housing, were down a combined 20.9% from the prior year.

Gross profit for the quarter rose 28% to 15.8 million from 12.4 million a year ago due to the increase in average selling prices, which more than offset higher raw material costs, lower shipments, and higher unit conversion costs. Gross margins improved to 20.4% from 16.5% a year ago and 16.1% in the first quarter.

SG&A expense was up 0.6 million from a year ago, rising to 5.2 million from 4.6 million due to increases in incentive plan expense, employee benefit costs, and selling expense. The increase in incentive plan expense was driven by the improvement in our Q2 financial results and outlook for the year from the forecast on which we based the amount recorded for the first quarter. On a sequential basis, SG&A expense rose 1.1 million from the first quarter, largely due to the same factors. If Q1 and Q2 SG&A expense were adjusted on a pro forma basis to reflect the same amounts for incentive plan expense, the sequential increase would have been from 4.4 million to 4.8 million instead of 4.1 million to 5.2 million. Going forward, we expect SG&A expense to fall somewhere between the Q1 and Q2 levels, in the range of 4.6 to 4.7 million per quarter, although this line item is always subject to period-to-period fluctuation.

Interest expense, which primarily consists of non-cash amortization of capitalized financing costs, was relatively flat compared with last year, while interest income rose 0.2 million due to higher average cash balances in the current year. Our overall effective income tax rate for the quarter including the disc-ops component was relatively flat at 36% versus 35.9% last year.

Moving to the cash flow statement and balance sheet, operating activities of continuing operations provided 6.8 million of cash for the quarter while using 10 million a year ago as a result of the year-over-year changes in working capital and, to a lesser extent, the 1.9 million increase in earnings. The net working capital components of receivables, inventories accounts payable, and accrued expenses used 3.1 million of cash during the quarter, versus 15.7 million a year ago, largely due to the 14.6 million decrease in accounts payable and accrued expenses in the prior year from the reduction in raw material purchases relative to the levels earlier in the year.

The strong operating cash flow for the quarter enabled us to repurchase 6.2 million of common stock under a share repurchase authorization, fund 1.3 million of capital expenditures, pay 0.5 million of dividend, and end the quarter debt-free with 17.7 million in cash, unchanged from the previous quarter-end. Through the first six months of the year, our total outlays for share repurchases were 8.7 million for 906,000 shares, which represented about 5% of shares outstanding as of the beginning of the year. As of the end of the quarter we had 18.8 million remaining on our current repurchase authorization, which runs through December 5, 2008.

Inventories at the end of Q2 were up 9.9 million from the previous quarter and 4 million from a year ago, representing just under three months of shipments based on our forecasted run rate for Q3. In view of the additional price increases that we plan on implementing to offset the continued escalation in raw material costs, we expect to benefit from additional widening in spreads during the third quarter, as these higher selling prices are matched against lower-cost material released from inventory. When we reach a period where pricing for our products as well as for wire rod flattens out, we would expect spreads to narrow as the higher-cost material in inventory gradually flows through cost of sales.

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 1.5 million for the quarter compared with 5.3 million last year. The bulk of the current-year outlay is related to the equipment upgrades at our Florida PC strand facility, the majority of which started up late in the quarter, with the remainder of the project expected to be completed during the current quarter. Capital expenditures through the first six months of the year were 6.2 million and are currently expected to total 10 million for fiscal 2008, although the actual amount is subject to change based on adjustments in project timelines or scope, future market conditions, our financial performance, and additional growth opportunities that may arise.

As we move further into 2008, the most recent Architectural Billings Index -- or ABI -- report for the month of February implies future softening in nonresidential construction activity. The ABI serves as the 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 February, the ABI dropped by almost 9 points, to 41.8 from 50.7 in January, its lowest level in more than six years. In view of our debt-free balance sheet and cash position, and the borrowing capacity available under our 100 million revolving credit facility, we believe that Insteel is well-positioned to withstand future market downturns that may develop and capitalize on any growth opportunities that may arise.

I will now turn it back over to H.

Thank you, Mike. During the quarter we moved closer to completing our two-year capital investment program, which has been focused on the upgrading and expansion of our manufacturing facilities. To recap, during fiscal 2007, we started up new ESM production lines at our North Carolina and Texas facilities, completed the reconfiguration and expansion of our Tennessee PC strand facility, and started up a new standard welded wire reinforcement line at our Delaware plant.

The last component of this program is the upgrading of our Florida PC strand facility. During the second quarter, we started up two of the wiredrawing machines and one stranding line. We expect to wrap up the remainder of the project in the current quarter with the start-up of a second stranding line and the relocation of remaining wiredrawing equipment.

All of the projects we've undertaken offer dual benefits in the form of cost reductions as well as additional capacity to satisfy future growth and demand. Although the soft market environment will limit our ability to fully ramp up our new capacity in the near term, we begin to -- we expect to begin realizing a portion of the expected returns on these investments through the favorable impact on our operating costs and increased sales of ESM as we further penetrate the rebar market.

Moving to market conditions, as Mike commented earlier, some of the macro indicators for nonresidential construction are beginning to reflect weakness, and we believe this will begin to have an unfavorable impact on demand for our products as we move further into the year. Commercial construction in particular is expected to soften, due to the ongoing downturn in housing and tightening in the credit markets, coupled with the overall weakening in the economy.

Other categories of nonresidential construction which have remained relatively strong up to this point could begin to be affected depending upon the duration of the economic downturn. The reduced tax revenues at all levels of government could result in budgetary constraints which curtail the availability of funding for infrastructure construction. At this point we expect the downturn to be much less severe and extend for a shorter duration than the meltdown that's occurred in the housing sector.

Turning to PC strand imports, during the quarter we continued to find ourselves uncompetitive with low-priced Chinese imports in the post-tension PC strand market. For calendar year 2007, total imports of PC strand into the US fell 18% from the prior year, largely due to the housing downturn, representing 42% of apparent consumption versus 45% in the prior year. Imports from China represented 89% of total imports at an average unit value that was 38% under the average for all other countries. The Chinese have yet to address the inconsistency in their export tax policy for steel products that we have alluded to on previous calls, under which exports of steel wire rod are subject to a 15% tax, while exports of PC strand receive the benefit of a 5% VAT rebate. This policy, which serves to promote the downstreaming of Chinese hotrolled steel into value-added markets, is inconsistent with WTO rules, and our industry trade coalition is continuing to pursue remedies through the office of the US trade rep and the Department of Commerce. Despite these ongoing concerns, we're encouraged by the recent upturn in Chinese pricing and anecdotal information indicating that the supply of Chinese strand into the US may be tightening up. However, the recent surge in raw material costs in the US makes it difficult to determine the extent to which the net domestic versus import price differential will narrow over the next few months, which impacts the time horizon for the domestic industry to regain competitiveness in the post-tension market.

Moving to raw materials, in addition to the challenging market environment, we also face increasing cost pressures as a result of the unprecedented escalation in raw material costs that we have witnessed since the beginning of the fiscal year. These increases have been driven by the upward surge in scrap and other input costs for steel producers, together with the drop-off in import competition, as offshore suppliers of rod have redirected material from the US to other more attractive markets. This condition has been aggravated by the decline in the dollar.

Domestic wire rod producers recently announced additional price increases, ranging from 150 to $190 per ton for the April/May timeframe, bringing the cumulative increase since October to more than $400 per ton, or an increase of over 70% in an eight-month period. We intend to continue passing these additional costs through in our markets, although the anticipated softening in demand could make it more challenging to do so.

At the same time, in view of the limited availability of imports, the wire rod market has tightened significantly, raising the prospect for insufficient supplies as we move through the year. While a shortage of wire rod could unfavorably impact shipments depending on the strength of demand, it would tend to instill added pricing discipline on the part of our competitors, which would have a favorable impact on margins, similar to the environment that we experienced in 2004.

In response to these challenges, we'll continue to focus on the operational fundamentals of our business, closely managing and controlling our expenses, aligning our production schedules with demand as there are changes in market conditions in a proactive manner to minimize our cash operating costs, and pursuing further improvements in the productivity and effectiveness of all of our manufacturing, selling and administrative activities.

This concludes our prepared remarks and we'll now take your questions. Kim, would you please explain the procedure for asking questions?

(OPERATOR INSTRUCTIONS). Casey Flavin, CJS Securities.

If I heard you correctly, I believe you mentioned that you increased your prices 10% during the quarter. However, raw materials, obviously, were up much more significantly than that. Could you just clarify how you fully recovered your costs, and how much you're going to have to increase prices going forward?

Our approach on recovering our costs up to this point has been to patch through all of the price increases that we are receiving from our wire rod vendors through to our markets. It is a fact that we were behind during the quarter that just recently closed. Also, the momentum of price increases has picked up dramatically from the late February/March time period through now. So, we have had some catching up to do, and have more aggressively moved up our timeline for passing these increases through.

Can you just give us a sense of what the timing of your price increases were, and how has the customer demand been since?

There have been so many price increases, I can't remember the date of each one. Suffice it to say that they match and mirror for the most part the wire rod increases. Our customers are in a state of shock, as we are. Many of them have commitments that extend out for a period of time, and, obviously, the developments in the steel market were not anticipated, and come as quite a shock. So, I think there is a sense of resignation to the current environment that there is not -- it's beyond the control of Insteel, or Insteel's suppliers, or our customers. So there is resignation to it, and a determination to get through it. But the price increases are becoming effective at every stage of the supply chain.

Just given your outlook on widening spreads and the volume uncertainty going forward, do you anticipate next quarter's gross margins to be higher than the gross margins you currently just reported?

I would say it's possible that that could occur.

Through the anticipated widening in spreads, and assuming that we realize the typical seasonal increase in volume, it should have a favorable impact.

Thank you.

Robert Kelly, Sidoti & Co.

Do you have a sense of how much your customers might have bought in 2Q ahead of the spring price increases?

Only in an anecdotal sense. I think that when customers returned from the holiday season, and saw the price increase announcements that had piled up on their desks, I think that there was some accelerated purchasing in January and in February. By March, I think, fatigue had set in, and we really didn't detect too much of this hedge-type purchasing. So, there was some acceleration of purchases, but it's impossible for us to accurately identify the extent of it.

That's helpful. You guys talked about low utilization; where are you running during 2Q?

In our strand business, probably in the vicinity of 60% of capacity. In our welded wire reinforcing business, somewhat higher than that, probably closer to 70.

Are we fully ramped on the new ESM capacity at this point?

We are right on plan at our North Carolina production line. We have seen a weakening in the market environment in Texas that has become the constraint for the ramp-up of that line.

Has it pushed the timeline very far out?

It's hard to say. It's such a week-to-week environment right now that I don't know that I can make a good estimate. As we look at the year, we think that, clearly, these lines are going to have a significant positive impact on our shipments; it's just not going to be -- it's not going to be as dramatic as we may have once forecast.

Just a couple questions on the pricing. First, you alluded to shortage in wire possibly instilling discipline in your competitors. Can we read into some improved discipline during Q2? We show some pretty heavy cost increases thus far in fiscal '08.

I think for the most part, our competitors have viewed this environment just as we have. The urgency and the absolute requirement to pass these costs through is out there. So, as a general statement, I think that the industry is moving in one direction.

And then, on the price increases that you are instituting to relieve the cost pressure, is this -- is the step function dollar for dollar? As your suppliers go up 150 a ton, are you going up 150 a ton in one shot? Do you do it -- gradually ease into it? Counterintuitively, your profitability at this level of utilization and the cost increases you're talking about shouldn't have been this good in 2Q. That's what I'm trying to reconcile.

Clearly, the inventory phenomenon helped us in Q2. There's no doubt about that. The price increases have come at us with such frequency that every time that we believe we have put out into the marketplace increases sufficient to recover our increased costs, yet another wire rod price increase is announced. So it's a constant. It's constant activity of announcing increases and passing through the cost increases.

How about up to this point, have you recovered all cost increases? (multiple speakers)

No, because we haven't incurred all of the cost increases that have been announced yet. As I mentioned, I can't remember the effective date, but somewhere between 150 and $190 per ton of new cost increases have been pushed our way just in the last few days, and those increases are effective toward the end of April. So we're in the process of getting our increases out to recover those big jumps.

Up until that (multiple speakers) increase of 150 to 190 by -- I guess by the end of April, I think, we would have gone up by enough to recover the cumulative rod increase. The timing's been a little different across product lines, but we would be about in line as of April. Now we're looking at additional increases to recover this latest announcement.

Thanks.

Nat Kellogg, Next Generation Equity Research.

Just on the inventory, obviously, we saw inventory -- you probably like to have more inventory than less right now. But, on a quarter-over-quarter basis, how much is the increase due to price and how much is due to tonnage? Do you guys have more inventory on the ground, or is it about the same and just increased in price? Or do you have less?

Let me see if we have a breakout on that. I think it was split relatively equal between the two. Our units were up. Our units were actually up slightly from -- up slightly from the third quarter, right in the 10% vicinity. And the remainder would have been from the valuation increase.

So units are up about 10% from Q1?

Yes.

(inaudible)

It's about 50/50; half units, and half from the valuation increase.

How do you guys feel about your inventory position right now, given (inaudible) pricing increases? And talk about sort of shortage on the wire rod? Are you guys happy with your inventory position, would like to have more, would like to have less?

We planned to have more. In conjunction with this rapidly rising market, we've seen our suppliers increasingly willing to walk away from commitments. And actually, that had a serious negative effect on Insteel through the March quarter. We understand it's a seller's market, and that's the way it is at this point. We would have liked to have been able to execute the plan that we put in place last October, but just were prevented from doing so.

On the numbers you guys gave for 15% increase in precast PC strand and the ESM lines, and the 20.9% drop in welded wire and the concrete pipe reinforcement, are those -- is that volume, or is that revenue?

Those were volume changes, which were pretty consistent with the latest construction spending data, as far as the distinctions between non-res versus res.

I'm just trying to get a sense on the ESM; 15% on the volume is pretty impressive. With a 10% price increase, obviously, the volume is less impressive. But that's a volume increase.

It is in units.

On the discontinued ops side, I assume that's just the old -- that's the facility from the old industrial wire business you guys used to have?

That's the only remaining component, the real estate associated with that facility.

Where do you guys stand on getting -- you talked about selling that. Where does that stand?

Actually, it's been under contract for quite a period of time. We just had to extend the contract because the purchaser is having some difficulties arranging financing, as might not come as a surprise. But, we believe that the purchaser is for real, and that we will be successful in moving the facility.

I think you guys said at the beginning of the year you expected to spend about $10 million on CapEx, and it looks like you've -- were you expecting $2 million a quarter for the next two quarters in CapEx? Or is that high, or is that low?

It's probably right in line. We have a balance left on this Florida project, and then the remaining outlays would just be routine maintenance-type expenditures. I think that would be a good assumption, just splitting it equally.

That is helpful. I think this is now -- if I look at -- it was Q3 last year -- if I look just sort of year-over-year, you guys got out of the business -- this is the last quarter where you're basically comping against year-over-year where you're in the PC strand on the post-tensioner side, right?

That is correct. It was in Q3 last year that we opted out of that market. So, as we move into Q3 this year, the year-over-year comparison should be on an apples-to-apples basis.

Okay. I'm assuming you're still dealing with weakness in the standard welded wire reinforcement and the concrete reinforced pipe, but you don't have the added sort of headwind of the post-tensioners on the PC strand side.

Right.

I know you guys have sort of talked about acquisitions in the past, and, obviously, your balance sheet is in great shape. The issues that you guys are seeing in the market, this, I would assume, is affecting smaller employers even more so. Or are the spreads so good that they're happy and that they're making money, and no one is interested in selling?

I think the environment has changed really radically, to where wire rod consumers who relied almost exclusively on imports are probably feeling quite a pinch at this point in time as the domestics have really not been willing under these circumstances to take on a lot of new customers. So, I suspect that there are some rod consumers, in the welded wire reinforcing business particularly, that are seeing a real supply crunch. And there could be some favorable opportunities that open up for us.

And you guys really want to stick to either the PC strand or the welded wire business. I assume there's not another product line that would make sense to fold in.

We've made the commitment, and believe that it's based on solid reasoning, that we need to stick to our knitting. And I'm not sure that means that we wouldn't consider any other product, but it would have to be highly comparable and compatible with the markets that we're serving now.

I think this is the seventh straight quarter of year-over-year volume decline for you guys. Obviously, there's a lot of concern about the rollover in commercial construction and whatnot, but if I go back to sort of 2003, when the business was not -- was just starting to pick up, can you give a sense of how much your volume levels are today versus in the businesses that you still have -- I realize you have to strip out sort of some of the industrial wire businesses. But, are you guys up that substantially over sort of where you guys were in 2003 when things weren't that great?

It's difficult to really get that on an apples-to-apples basis just because of the changes that have occurred in our operations through some of the investments that have been made, particularly in ESM. So, to really get that on a comparable basis, I don't know that we could give you a response on this call.

That's fair enough. I appreciate the time. And obviously, nice quarter, and good luck going forward.

(OPERATOR INSTRUCTIONS). [Walt Glaser], Parthenon Capital.

I was wondering if you could talk a little bit about CapEx over the next two to three years.

We generally believe that the run rate of base CapEx for maintenance purposes is in the 3 to 5 million range. I don't think that we have ever been that low, except maybe in 2001 and 2002. So I wouldn't expect that you would see 3 to 5 million, for instance, in 2009. It's going to be 3 to 5 million, plus some increment that reflects the growth or the cost reduction opportunities that we find that make sense for us. I know that's a mushy answer, but I'm not sure we can give you a better one.

No, that's helpful. So 3 to 5 million would be pure maintenance; anything above that you'd expect to get a good return on, either through capacity or cost reduction.

I think that's a good assumption.

Just going back to your comment about whether or not there could be some similarities with '04, of course, we'd love to see that. But I'm wondering if you could talk just a little bit about what feels the same and what feels different with that period.

Absolutely. I think that's a real good question. In 2004 we were basically pressed to produce and sell everything that we possibly could. Demand was really solid, and we had the tailwind of rising prices in the steel market. As we look at the environment today, it's certainly dramatically different, where business conditions as measured by demand for our products are not particularly good, and the outlook is not particularly favorable in many of our market segments. But at the same time, we do detect a shortage in the marketplace for our raw material. And to the extent that short supply is real, it will have the same impact of limiting the output of our products as favorable demand characteristics would. So, I think as we look at our business plan over the next six months, we're concerned about having adequate supplies of wire rod. And that certainly gives us a lot of commitment to be sure that we price our products appropriately.

Thanks very much.

[Chris Haberlin], Davenport & Company.

First, I think I missed your sequential change in volume.

Sequentially, Q2 shipments were up 9.2% from Q1, and that compared to a 9.8% increase last year. So, pretty much in line.

You said that you expect the spread to widen Q3. Is that -- are you looking year-over-year, or sequentially, or versus both (multiple speakers)

Sequentially.

Finally, I know that you all have some other revenue included in your revenues, such as scrap sales and so forth. And with scrap prices rising so much, can you give us an idea of how much that other revenue was as a percentage, or an absolute dollar amount?

Actually, it isn't reflected in revenues; it's netted out against our scrap costs and would be reflected in cost of sales. It wouldn't have impacted the top-line.

It wouldn't have impacted the top-line, just COGS?

Right.

Thank you.

(OPERATOR INSTRUCTIONS). It appears there are no further questions today. Gentlemen, I'll turn the conference back to you.

Thank you. We appreciate your interest in the Company and look forward to the call next quarter. Thank you.

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