Insteel Industries Inc (IIIN) 2008 Q3 法說會逐字稿

Good day, everyone, and welcome to the Insteel Industries third-quarter earnings conference call. Today's call is being recorded. At this time, I would like to turn the conference over to Mr. H.O Woltz III, President and CEO. Mr. Woltz, please go ahead, sir.

Good morning and thank you for your interest in Insteel and welcome to our third-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 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 third 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. Raw material costs rose at unprecedented rates during the quarter and all indications point to a further escalation through the fourth quarter, although the magnitude of the increases appears to be moderating somewhat.

The Company's results were favorably impacted by the implementation of price increases sufficient to cover the higher replacement cost for our raw materials together with the consumption of lower-cost material from inventory under first-in, first-out accounting. Overall we are pleased with the quarterly results and particularly encouraged that operating cash flow remained positive despite the significant increase in net working capital that was driven by the escalation in raw material costs and selling prices.

I'm going to turn the call over to Mike to comment on our financial results for the quarter and the macroenvironment, 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, despite the continuation of soaring raw material costs and soft demand in certain of our markets, Insteel posted solid financial results for the third quarter ended June 28. Earnings from continuing operations increased to $16.9 million from $8.3 million a year ago with diluted earnings per share rising to $0.97 from $0.46. Net sales for the quarter rose 32.1% from a year ago as a 37.6% increase in average selling prices driven by the escalation in raw material costs and tightening supply more than offset a 4% reduction in shipments.

Shipments fluctuated throughout the quarter as customers adjusted their purchasing in response to the price increases and to manage inventories to desired levels. PC strand sales to post tensioners remained at minimal levels due to irrationally priced Chinese import competition and the ongoing weakness in housing-related demand.

On a sequential basis, average selling prices for the quarter were up 31.7% as a result of the price increases that were implemented while shipments rose 2.6% from the second quarter, which was weaker than the usual seasonal increase between these periods.

Gross profit for the quarter increased to $30.9 million from $17.4 million a year ago and gross margins rose to 29.6% from 22% due to higher spreads between average selling prices in raw material costs, which more than offset the reduction in shipments and higher unit conversion costs.

Most of our facilities operated on reduced schedules during the quarter, with capacity utilization levels ranging from around 65% for our PC strand operations to about 70% for our welded wire reinforcement facilities.

SG&A expense was up $0.3 million for the quarter, rising to $4.5 million from $4.2 million a year ago due to higher bad debt expense largely associated with increases in receivables and our general reserve and higher stock-based compensation expense.

Interest expense, which primarily consists of non-cash amortization and capitalized financing costs, was essentially flat compared with last year while interest income rose due to higher average cash balances in the current year.

Our overall effective income tax rate for the quarter including the discontinued operations component was relatively flat at 35.7% versus 36.1% in the prior year.

Moving to the cash flow statement and balance sheet, the sharp escalation in raw material costs and selling prices resulted in significant increases in our working capital investments in inventory and accounts receivable with a net working capital components of accounts receivable, inventory, accounts payable, and accrued expenses consuming $17.3 million of cash during the quarter.

Inventories at the end of Q3 were up $17.7 million or 32% from the March quarter, which was primarily driven by a 29.7% increase in average unit values with units up 1.8%. As compared to the beginning of the year, inventories were up $25.6 million or 54%, with unit values rising 43% and units increasing 7.7%.

Our quarter-end inventory position represented a little over three months of shipments based on our forecasted run rate and we were favorably positioned in terms of the carrying value of inventory relative to its replacement cost. However, assuming that price increases for wire rod and our products moderates in the fourth quarter which it appears they will, we expect margins to narrow from the Q3 levels as the reduced increases in selling prices are matched against the higher increases in raw material costs that were incurred over the previous few months and begin to be reflected in cost of sales under FIFO accounting.

Accounts receivable rose $12.2 million during the quarter, which essentially mirrored the percentage increase in average selling prices with Days Sales Outstanding remaining relatively stable. Despite the substantial increase in our working capital requirement, operating activities of continuing operations still managed to provide $2.6 million of cash for the quarter largely due to the increase in earnings, which was primarily used to fund $2.2 million of capital expenditures and pay $0.5 million in dividends, leaving us debt-free at the end of the quarter with $17.5 million of cash.

Total additions of property, plant, and equipment for the quarter including the accounts payable related to PP&E reflected at the bottom of the cash flow statement were $1.9 million compared with $5.1 million last year.

Capital expenditures through the first nine months of the year totaled $8.7 million and are currently expected to come in at $10 million for fiscal 2008 with the bulk of the outlays related to the upgrades at our Florida PC strand facility, which were essentially completed during the quarter.

Although we opted not to repurchase any shares during the quarter through the first nine months of the year, total outlays for share repurchases were $8.7 million or 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 in our current repurchase authorization, which runs through December 5, 2008.

Moving to the macro indicators for our markets, we are seeing increasing signs of weakness in the near-term outlook for non-residential construction. In May, the Architectural Billings Index dropped to 43.4 from 45.5 in April, marking the fourth consecutive month that it has fallen. Inquiries for new projects also declined following the 46.5 in May from 53.9 in April.

Yesterday the American Institute of Architects announced the results of its semiannual consensus construction forecast for nonresidential construction, which represents a survey of six of the nation's leading construction forecasters. On an overall basis, nonresidential construction was forecasted to decrease 1.2% adjusted for inflation in 2008 and 6.7% in 2009. The steepest declines were anticipated for the commercial construction sector, particularly retail, office, and hotel construction.

Institutional construction was projected to remain relatively stable with its two largest categories, healthcare and education, potentially offsetting some of the decreases in other categories. I should mention that for most construction categories, the firm's estimates vary across a wide range, which speaks to the difficulty of forecasting in the current environment.

Finally another recent report indicated that at last count at least 29 states faced or are facing an estimated $48 billion in combined budget shortfalls for fiscal 2009, largely due to the drop-off in tax revenues which could have negative implications for the funding of infrastructure projects. Since the vast majority of states are restricted from operating at a deficit, these budget gaps are likely to spur more movement toward public/private partnerships and other alternative financing approaches to address the glaring needs that exist.

I will now turn it back over to H.

Thank you, Mike. During the quarter, we essentially completed the upgrading of our Florida PC strand facility, which entailed the installation of new wire [drilling] and stranding equipment together with the reconfiguration of the operation. This project represents the last component of our two-year capital investment program under which we have added two new engineered structural mesh production lines, modernized and expanded our standard welded wire reinforcing manufacturing capabilities, and reconfigured and expanded our PC strand facilities. All of these projects are expected to generate dual benefits, enabling us to achieve further operating cost reductions in providing additional capacity to satisfy future growth in demand.

Although the weaker market environment will limit our ability to fully ramp up our new capacity in the near term, we are beginning to realize a portion of the expected returns on these investments through their favorable impact on labor productivity and increased sales of engineered structural mesh.

Looking ahead to 2009, we expect to incur $3 million to $5 million of routine base level CapEx with total outlays coming in at a higher level that reflects other cost reduction, infrastructure, or expansion initiatives that we are still in the process of evaluating. We will provide an updated estimate during our fourth-quarter earnings conference call.

Moving to market conditions, as Mike commented earlier, nonresidential construction is expected to soften later in the year and into 2009, which could have an unfavorable impact on demand for our products. The most severe weakening is expected in the commercial construction sector due to the protracted downturn in housing, the continuation of turmoil in the credit markets, and the potential for weakening in the economy. In addition, the budgetary constraints that Mike alluded to earlier at the state level together with the looming insolvency of the Federal Highway Trust Fund could negatively impact funding for infrastructure projects.

The otherwise concerning outlook for infrastructure spending is alleviated somewhat by the remarkable growth of private infrastructure investment and public/private partnerships that are beginning to have a meaningful impact on infrastructure development. We believe this is an encouraging trend and one that will gain momentum as politicians weigh the magnitude of our infrastructure deficiencies and funding alternatives against the risk of continuing to ignore substandard bridges, roads, airports, and other infrastructure components.

Turning to PC strand imports, those of you who have followed the company in recent years are aware of our ongoing concerns about PC strand imports from China, which represent over 90% of total strand imports entering the US. Unfortunately there is no positive news to report on this matter. Through the first five months of the year, Chinese imports have risen over 12% from last year despite declining demand in the US and the average unit values of Chinese imports for the month of May remained at levels that were lower than the world market price for hot rolled wire rod, our primary raw material.

It is apparent that the Chinese have implemented through taxation policies and other means a strategy of promoting exports of higher value downstream products and we are convinced that these policies are inconsistent with their World Trade Organization obligations. Our industry trade group continues to evaluate various alternatives to address their irresponsible market tactics. As their actions have become more egregious, our commitment to identify strategies to obtain redress has intensified. While there are no apparent quick resolutions for these issues, we are determined to pursue every alternative available to restore reasonable conditions of competition in the PC strand market.

Moving to developments within our raw material markets, the cost pressures we referenced during the second-quarter conference call continue, although the monthly price increases for wire rod appear to have moderated from the triple digit levels that we experienced late in the second quarter and during the third quarter. The primary driver of the extraordinary pricing power possessed by our suppliers is the higher world market price for wire rod that persists despite the significant run-up that has occurred in the US market.

The US has been a net importer of wire rod for decades and will continue to be for the foreseeable future. As long as purchasers like Insteel are faced with higher prices for imported material, our domestic suppliers will be able to continue ratcheting their prices up.

Having resolved ourselves for the near term to the lack of competitively priced alternative sources of supply, we plan to continue passing these higher costs through in our markets although the anticipated softening in demand can make it more challenging to do so. At the same time, the prospect for insufficient supplies of domestic rod together with the significant premium paid for imports that are required to round out the sourcing plans for most domestic rod consumers impose harsh economic realities which should continue to promote discipline in our markets.

In response to these challenges, we plan to continue focusing on the operational fundamentals of our business, closely managing and controlling our expenses, and proactively aligning our production schedules with market demand to minimize our cash operating costs. We will pursue further improvements in the productivity and effectiveness of all of our manufacturing, selling, and administrative activities.

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

(OPERATOR INSTRUCTIONS) Robert Kelly, Sidoti.

Good morning, guys. Thanks for taking my call. First off, the volume decline 4% year-over-year -- in the past you had given us your non-res pure play product growth versus I guess residential units. Would you provide that again, please?

I think we had carved out a couple of our product lines that were more closely correlated with nonresidential, our shipments of PC strand or precasters and ESM shipments. Those are up a little over 6% from the prior year. Then when you rolled up shipments of concrete pipe reinforcement and standard welded wire reinforcement, which were more closely related to the housing sector, those were down by about 13% from a year ago.

So the trend for the non-res pure play is decelerating a little bit and is the stuff that goes into housing, is that improving a little bit or --?

I would not say it is improving, but it is not getting worse any longer either.

Okay, somewhat stabilizing.

We are at the bottom.

The intra-quarter I guess price increase with the FIFO convention, what was -- can you give us any help as to what the current spread would be? Is it more in line with your 2Q results or 1Q? Just a little more help as to what we're actually looking at when (multiple speakers) moderate?

The situation is highly fluid as you can imagine with the movement in both rod costs and our selling prices. There are indications that we will see additional increases in rod costs and we plan on raising our selling prices as well during the current quarter so that favorable dynamics should continue. But at the same time with the size of those increases declining from the previous quarter, that would imply that our margins would come down some.

I guess we are somewhat hesitant to throw out a number as far as the impact of the FIFO inventory, where it is subject to misinterpretation in view of how fluid the environment is with our price, selling prices changing, and fluctuating by such large amounts on a regular basis. To get a clear picture you would also have to pro forma our selling prices to reflect the corresponding increases. We really don't want to set a precedent by providing any guidance for normalized spreads or margins, but suffice it to say up to this point our cumulative price increases have exceeded the cumulative increases in wire rod costs.

So you are -- by the time we hit 4Q you might actually be up a little bit on the rod costs or the next round of rod costs catches up to you? Is that a way to think about it?

What we are seeing monthly -- we are seeing monthly increases, and I think Mike's point was that we are a late second quarter and early third quarter we saw increases that were well in excess of $100 per ton. To the extent that those increases moderate going forward, which we expect, then the gap narrows or it has that impact on spreads.

I guess what I'm trying to get a sense of is the cumulative price increase that you guys have announced, does that -- has that risen step for step with the raw material price increase or are you somewhat ahead of that because your raw materials are not 100% of your costs?

We are ahead of it. Keeping in mind that while raw material costs is the most obvious increase in costs that we are experiencing, we have huge networking capital additions, all of our energy and transportation costs are rising. So I guess I would say that while our cumulative price increases exceed the cumulative rod price increases to do otherwise would be backing up because of all of the other cost increases that we are incurring.

I'm with you. As far as your exposure to the commercial market, where the pain seems to be expected for '09, do you have any idea of what your exposure there for office and retail, some of the areas that are supposed to be considerably weaker than, say, institutional or industrial that are looking at mid-single digit declines?

It is really difficult to quantify that precisely. Just due to the nature of those applications, they tend not to be as intensive users as some of the infrastructure related work, but I don't know that we could really give a specific percentage.

I understand. Some of the -- last question. Some of the points you made on federal highway spending and your expectations for budgetary constraints may be hurting infrastructure, are these things that you are seeing now or you expect -- you see as a risk that could come to fruition in '09? Or is this something that you felt already?

It is a risk that we foresee from what we read and from the data that we collect. At the same time, I would tell you that I am specifically familiar with a lot of customers who are actively bidding and see a lot of work coming out, so it is the prospect for these things more than the reality of them at this point.

Okay. Thanks, guys. I appreciate it.

Matthew Wiger, Monness, Crespi.

Good morning, gentlemen. You mentioned reduced utilization for the facilities during the quarter. How does that compare to the prior quarter and year-ago quarter?

We are on about the same volume track that we have been on for the last couple of quarters. I wouldn't say there is any significant change. For the year-ago quarter, I really can't speak to that. I don't have the information in front of me.

Okay, at current prices and full utilization, what would you estimate to be your full revenue capacity?

I don't know that we would want to throw out a number on that. There would have to be some assumptions made. It gets more complicated at certain of our facilities just from a mix standpoint. So I don't know that we would want to throw out an amount for that.

Okay, understood. You guys mentioned a little bit with the ongoing import situation. Do you have any update on the effort to secure a tariff on Chinese imports?

Well, we are really in the process of just evaluating the options that a traditional dumping kind of -- dumping and countervailing case is probably not in the cards, but to the extent that the Chinese are really not honoring their WTO obligations, there could be other approaches for us to take. So I did not mean to imply that there is anything pending in the near term that would help us resolve this, only that we are taking a much more detailed look at what the options might be.

Just moving back to your previous question on revenue potential, when we are fully tapped out, you could ballpark that just based on those utilization percentages that we indicated, but (multiple speakers)

Yes, I got that, Mike. I was just implying exactly what you were getting at in terms of with the mix shift and everything else. Elaborating on the Chinese thing, any sense as to when the orders that came in this quarter were booked and whether or not a weak dollar environment and higher freight costs might sort of effectively create a tariff going forward?

The pipeline is roughly 90 days long from placing an order to it showing up here in the US, so the numbers that we saw for May were certainly booked in the January/February timeframe. And the numbers are rising and our customers tell us that the Chinese quotations for September/October kinds of deliveries have risen, pricing has risen sharply, and that availability is more questionable. There actually have been some purchase orders turned back or refused, but I tell you that we have heard these kinds of things before and when we look at the official statistics, all we see is a relentless assault of low-priced material on the markets. So what we are hearing may or may not actually turn out to be reflected in the data.

Okay, great. That's helpful. Finally I just want to reiterate Bob's last question in reference to the anticipated slowing that you guys are seeing and you are basing it largely off the ABI and the architectural forecasts. You are saying that you've not seen any specific weakness yourself.

I think we are hearing anecdotal evidence and we read forecasts and data that is published industry wide, but it is not a case of where it is the reality for us at this point.

Okay. Thanks, gentlemen.

[Chris Havilland], Davenport & Co.

Good morning. It's Tim Hayes. First, thanks for all the prepared remarks and the detail. That answered a lot of our questions. I did have a couple, though. You mentioned that you are passing through the increases in wire rod prices. And maybe passing on a little bit more than the increase so far this year. But what about more recently? Say, increases in June, maybe the increases in July, are you now just matching those increases or still staying ahead of them? How are you doing on the pricing side there?

No, we are staying ahead of them.

So passing a little bit more than the wire rod increases?

That's correct.

In terms of your outlook for wire rod imports say by year-end or as we get into '09, do you see any pickup from these almost scarce levels?

It's a good question and I think it's really going to be driven by demand in the rest of the world and the value of the dollar. The level of construction activity elsewhere in the world, particularly the Middle East is remarkably high. I think that most producers in the US have export opportunities if they would really like to take advantage of them, so my sense is that we are going to see a continued tight environment at least through the rest of 2008. These things when they change sometimes change fast, but I am not sensing at this point that the conditions that would drive that change are really mounting.

Okay, regarding the mills, I remain surprised that their utilization rates are not much higher. These prices are so high domestically, add to that export opportunities, why aren't the mills running more like 90%, 95% capacity higher than what they seem to be doing not just for all products but specifically for wire rod products?

I think there is a reluctance to upset what is a very desirable condition for the mills right now. I know that there are some mills that are attempting to increase their output incrementally. Some of them are having hiring problems in actually bringing the workforce together that would result in the extra operating hours. But I just don't sense that there is a great desire to work harder and make less money. I think they are pretty happy with the situation that exists.

Okay. Thanks again for all the detail.

(OPERATOR INSTRUCTIONS) Robert Kelly, Sidoti.

A question I guess on the wire rod market as you see it. Is the product basically still on allocation? Is there any type of opportunity for you to kind of buy ahead of the price increases?

It is on allocation, Bob, and one thing I should have mentioned in response to the previous question is that's there have been some relatively serious unplanned production outages at at least a couple mills recently that have taken the mills down or in one case a week, one case two weeks so this is not an unusual situation either. It seems to happen every summer, but it is unplanned. So that has served to just exacerbate the tightness in the market. But yes, we are clearly still on allocation and I don't see that situation changing in the near-term.

Then as far as your markets and your distribution channel, is there the same amount of tightness? Are your customers able to kind of hedge, buy and pull demand forward ahead of your announced price increases?

We saw a lot of that when we were announcing increases of the triple digit magnitude. I think there is a certain amount of fatigue that may have settled over the market, where your typical $80 or $90 per ton price increase is generating less fear than it did some months ago and therefore generating less hedge buying. So -- and it also varies within product line in terms of how tight things are.

So certain product lines are tight based on the pricing, but not necessarily your entire product line?

That's correct, yes.

Okay, is there --? With the working capital investment that you have, the rising wire rod, is there any plans to go back and look at share repurchases, do something with your cash flow and excess cash?

Yes there is. That as we have stated on a number of occasions that our foremost objective is to keep the company positioned to execute on growth initiatives that come our way or that we are able to develop. At the same time, we recognize that the balance sheet is -- probably should not stay in its current condition indefinitely. So we are evaluating all of the appropriate uses of cash.

Thanks, guys.

With that, ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Woltz, I will turn the conference back over to you for any closing remarks.

Thank you, Rufus. We appreciate your interest in the company and encourage any follow-up questions that you have. Thank you very much.

Ladies and gentlemen, this does conclude the Insteel Industries third-quarter earnings conference call. We do appreciate your participation and you may disconnect at this time.