Insteel Industries Inc (IIIN) 2008 Q4 法說會逐字稿

Good day, everyone, and welcome to today's Insteel Industries' first quarter conference call. Today's call is being recorded. At this time for opening remarks I would like to turn the call over to H. O. Woltz III, President and CEO. Please go ahead.

Thank you, Gwen. Good morning and thank you for your interest in Insteel and welcome to our fourth 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.

Before Mike reviews our financial results for the quarter, I want to comment on Insteel's performance in 2008 and the important investment initiatives that were wrapped up during the year. 2008 was a record year from both a revenue and earning standpoint. Return on capital, which is the Company's primary financial performance metric, came in at 27.9% which -- while not a record -- is quite respectable, considering the challenges we encountered over the course of the year.

All factors considered, we are extremely pleased with our 2008 financial performance. Those of you who have followed the Company recently are aware of the comprehensive capital investment program that has been underway at Insteel. Over a three-year period, the Company has invested approximately $45 million in its manufacturing facilities to support growth opportunities in promising markets, and to ensure an unrivaled operating cost structure across all plants and product lines. We emerge from this program at the end of fiscal 2008 debt-free with a cash balance of $26 million.

Going forward, our financial flexibility will be greatly enhanced by minimal routine CapEx requirements and a balance sheet that will support the pursuit of growth initiatives that may emerge from the more difficult business environment we see.

We readily acknowledge the favorable market environment that contributed to the Company's 2008 performance, including rapidly rising prices and tight supplies of hot rolled steel wire rod. We are fortunate to have been well-positioned to benefit from these developments, and believe that Insteel's long-term earnings potential has been materially enhanced by the investment program that was just completed.

But now 2008 is behind us. And we face challenges of unknown magnitude for 2009, as the world abruptly changed over the past few weeks.

I will turn it over to Mike to review the drivers of our fourth quarter financial results. And then I will follow up to comment more on market conditions and our business outlook.

Thank you, H. As we reported in this morning's press release, despite increasingly difficult market conditions and higher raw material costs, Insteel posted strong financial results for the fourth quarter ended September 27.

Earnings from continuing operations increased to $15.6 million or $0.89 per diluted share from $5.1 million or $0.28 per diluted share a year ago. For the year, earnings from continuing operations rose to a record high $43.7 million or $2.47 per diluted share, from $24.3 million or $1.33 per diluted share last year.

Net sales for the quarter rose 42.9% from a year ago, as a 66.6% increase in average selling prices -- largely driven by the dramatic escalation in raw material costs during the year -- more than offset 14.2% decrease in shipments.

After getting off to a solid start to the quarter with July shipments coming in above forecast, order levels dropped off considerably over the next two months in response to initial indications of softening steel prices in August, compounded by the financial market meltdown in September and heightened level of uncertainty regarding the future direction of the economy. Average selling prices for the quarter were up 17.3% on a sequential basis in Q3 as result of the price increases that were implemented during the first two months of the quarter, while shipments were down 13.2% from the third quarter due to the factors that I alluded to earlier.

Gross profit for the quarter increased to $29.5 million from $12.7 million a year ago, with gross margins rising to 27.7% from 17.1% due to higher spreads between average selling prices and raw material costs which more than offset the reduction of shipments. Our facilities continue to operate on reduced schedules during the quarter with capacity utilization levels ranging from around 67% for our PC Strand operations to about 62% for our welded wire reinforcement facilities.

On a sequential basis, gross profit was down $1.4 million from the third quarter, with gross margins decreasing 1.9% due to the lower shipments, which is partially offset by higher spreads.

SG&A expense for the quarter increased $0.3 million from a year ago, primarily due to reductions in the cash surrender values and life insurance policies related to the downturn in the financial markets.

Our overall effective income tax rate for the year including the [discount] component wound up at 35.9% versus 36.6% last year.

Moving to the cash-flow statement and balance sheet, continuing operating activities generated $10.2 million in cash during the quarter, compared with $6.4 million a year ago, primarily due to the higher earnings which more than offset the increased investment in working capital in the current year quarter. Operating cash flow for the quarter was primarily used to fund $1.1 million in capital expenditures and pay $0.5 million of dividends.

For the year, continuing operating activities generated $36.8 million of cash, which was primarily used to fund $9.5 million of capital expenditures, repurchase $8.7 million of our common stock, pay $2.1 million in dividends and increase our cash balance by $17.8 million, leaving us debt-free at the end of the year with $26.5 million in cash. Following the end of the year, we returned an additional $9.3 million in cash to our shareholders in the form of a $0.50 special dividend and $0.03 regular quarterly dividend that was paid out earlier this month.

Inventories at the end of Q4 were down $1.8 million or 2.4% from the previous quarter end, which [matched] offsetting changes in inventory units versus average unit values. [Unit] inventories dropped 24.5% from the previous quarter, due to our inventory reduction efforts, while average unit values rose 29.2% as a result of the escalation in raw material costs and a higher proportion of finished goods in our inventory mix.

On a year-over-year basis, inventories are up 50.3% from a total dollar standpoint, with units down 18.7% and unit values up 84.7%. Based on our current forecasted run rate for Q1, our quarter end inventory position represents around three months of shipments and reflects average unit carrying values that are relatively close to replacement costs.

As we indicated in today's earnings release, we expect spreads and margins for the first quarter to narrow from the Q4 levels as the higher cost of raw material's purchased in recent months are reflected in cost of sales, in contrast to the previous two quarters where we've benefited from the consumption of lower-cost inventory under FIFO accounting.

Capital expenditures for the quarter were $1.1 million compared with $3.7 million a year ago with CapEx for the year coming in at $9.5 million, which was under our previous forecast of 10 million. The bulk of the outlays for the year related to the upgrades at our Florida PC strand facility. For 2009, we currently estimate maintenance-related CapEx to total less than $5 million, although the actual amount will depend on future market conditions; our financial performance; and other investment opportunities that may arise.

At the end of the quarter, we had $18.8 million remaining on our current share buyback program, which runs through December 5. Going forward, we will continue to evaluate the repurchase of shares, based on the expected timing and funding requirements for any growth opportunities that make arise, as well as the valuation of our shares relative to our business outlook and cash-flow expectations.

From a financial and operational standpoint, Insteel has never been better positioned. And we are hopeful that the more difficult market environment we are entering serves as a catalyst for some strategic growth opportunities to become available.

I will now turn it back over to H.

Thank you, Mike. Typically, when we discuss our business outlook we focus on macro factors like the architectural buildings index and construction spending trends. Given recent events however, these macro indicators are somewhat irrelevant, at least for the near-term, having been eclipsed by the inflection point in steel prices that was recently reached and the credit market crisis.

During 2008, steel supplies tightened up over the course of the year and pricing rose on a monthly or sometimes weekly basis, which required us to scramble to cover our requirements, and to fully utilize supply allocations that more favorable pricing levels than would exist for subsequent orders. Conditions changed rapidly however with the news in August that ferrous scrap prices were expected to be flat or down for September, representing the first break from a relentless year-long run-up.

In our view, the prospect for lower steel prices followed by the heightened level of concern and uncertainty about the impact of credit market turmoil on the general economy caused purchasing activity to grind to a halt throughout the supply chain. While the pain of unprecedented price increases took its toll over the course of the year, [perchers] were acutely aware that it would be even more painful to enter a period of declining prices with high inventory levels.

The result of these developments for Insteel was that in September, customers moved to the sidelines and curtailed their purchases to the full extent possible. While October shipping activity has risen from the September lows, it's still running well below expectations.

Not surprisingly, our selling prices are under pressure although they've held up relatively well, considering the drop-off in demand. We've experienced the most significant pressure in our more commodity-like standard welded wire reinforcing product line, where pricing always tends to be more volatile.

We are making adjustments on a number of fronts to address the challenges and sudden change in the business environment. First, we are taking actions to minimize our inventories to the point that when we resume raw material purchases, it will be at new market pricing levels, which have declined significantly and could weaken further. Although we are fortunate to have entered the period with a favorable inventory position, the time line for reducing our inventories will be extended to the extent that shipments remain at depressed levels.

Second, we are reducing the operating hours and staffing at each of our manufacturing facilities, to closely align production schedules and costs with the lower level of demand we are forecasting for the next few months. Even at this reduced level of activity, we expect to benefit from the recent capital investments in our manufacturing facilities in the form of our higher productivity and our cash operating costs.

Third, we are intensifying our scrutiny of all capital outlays in the context of the market environment.

And fourth, we are pursuing additional improvements in the productivity and effectiveness of all of our sales and administrative activities.

Turning to PC strand imports, on previous calls, we've expressed concerns about searching imports of Chinese strand. Unfortunately, there is no positive news to report on this issue. Through eight months of 2008, Chinese imports have risen over 19% from last year, despite declining demand, and now represent 93% of total strand imports entering the US.

In August, average unit values per Chinese imports were at about 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 is are inconsistent with their World Trade Organization obligations.

Our industry trade group is working closely with USTR to hold the Chinese accountable for their actions. Later this month we will participate in the Steel Dialog trade talks in Beijing, at which time Chinese policies with respect to downstream markets -- including PC strand -- will be specifically discussed with authorities.

While we don't expect a quick resolution of these issues, we are determined to pursue every alternative available to restore reasonable conditions of competition in the PC strand market, in view of Chinese tactics that are increasingly injurious to the domestic industry.

To wrap up our prepared comments, I risk stating the obvious to say that, in the wake of the events that have unfolded in the US economy over the past few weeks, we are in uncharted territory, making forecasting even more difficult. The silver lining in this uncertain environment is Insteel's strong competitive position and financial flexibility, which should enable our pursuit of growth opportunities even in the difficult environment that has emerged.

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

(Operator Instructions). Nate Kellogg with Next Generation Equity.

Obviously a nice quarter. Just a couple of questions. Can you give -- I mean, I guess you gave us a little [peephole] but can you guys give us a little bit more detail on about sort of the deceleration in the quarter? Can you give us a sense of maybe what volumes look like in September compared to July and August?

As Mike said, we were actually ahead of plan for shipments in the month of July, and it did decelerate through the quarter. But it just basically came to a halt in September.

And October continues to be slow. But at least you are shipping some stuff now?

That's correct.

Okay. It sounds like pretty much all of the FIFO gains from the last couple of quarters from in inventory have been pretty much used up. So we will go back to sort of a more traditional spread, metal spread going forward. Is that correct?

Yes. As of the end of the quarter, the carrying value of our inventory was relatively close to the replacement cost at that time. So --.

Okay. And you guys are comfortable -- I mean, obviously it sounded like unit volumes were down significantly in inventory, but obviously the cost is up -- but you guys are comfortable with where your inventory is right now more or less?

Well, I don't think we're comfortable with anything. The environment has just changed so radically that, obviously, the lower your inventory, the better.

I would say that we could have been in much, much worse position, but are pretty -- let's say reasonably happy with where we are.

Okay. That's helpful. And then like accrued expenses look pretty high in the quarter. I was just wondering what was on the balance sheet on the liability side. Just wondering if there is anything particular in there? Or what -- I assume that will probably come down going forward?

Yes. A big component of that was the dividend that was declared that was paid earlier in October. That was around $9.3 million. So --.

Okay. So that will come out of the accrued expenses when we see that December quarter.

Right.

Okay. That you. That's helpful. And then tax rate for '09 should be around 36%?

Yes. I think that would be reasonable.

And is there any risk -- I realize on the PC strand side it actually sounds like your utilization rates on the PC strand were -- I heard you guys (inaudible) a little bit higher on the welded wire reinforcement side.

Is there any risk -- obviously the posttension is where you guys are seeing the Chinese competition. Is there any risk that they move into and compete with you throughout the full PC strand market?

There is that risk. And there really always has been that, while the Chinese have completely dominated the posttension part of the market, I don't think we have ever implied that they haven't tried to enter the precast market -- and in fact, have, over the last couple of years, particularly in some of the coastal markets like around Texas and Florida. They have had a foothold there for sometime.

But obviously, I mean they haven't -- obviously they haven't completely penetrated that business because you guys are still doing some decent business to the precasters. I guess is that -- do you expect that dynamic to change at all or --?

No. I expect it to continue down the path that we've been on for the last two or three years which is where the importers and the Chinese are certainly pursuing that market segment. And we are fighting them as hard as we can.

Okay. Then I guess, obviously, you guys are in a great position as far as your cash flow and balance sheet. No matter how tough next year gets real -- you know, provided we don't go into sort of a worldwide depression. But I know you guys will probably generate some free cash flow in '09.

I'm just sort of -- you know, if you guys could prioritize for us where your thinking is, as far as use of free cash flow for acquisitions and what that market maybe looks like now versus three to six months ago; or a buyback given where your stock price is or all the rest or additional dividends? I mean, I'm just curious what you guys are thinking internally.

I think the thinking and the rationale is consistent from the last time that this subject came up on a conference call, where our first priority is looking for reasonable growth opportunities that fit within our core business. It is probably more likely, looking forward, that some of those will emerge that meet our hurdles and fit with our Company than over the past couple of years.

Past the growth opportunities that we want to be in the position to execute, I think you'll see us evaluate using our cash flow for both share repurchases, if we believe that the valuation is attractive. And I would say we could potentially consider future special dividends.

But we are also going to be pretty conservative on the capital structure in view of just the tremendous unknowns that are out there. So I don't think you are going to see us do anything rash.

Okay. Fair enough, and then just last question, you guys didn't talk at all about ESM. I'm just wondering you know that has been a bright spot for you guys. Just wondering how that business is holding up and any color you can give us there would be great.

It is holding up better than the more traditional businesses, as we have put our heads together to alter our planning horizon and forecast. Certainly, the ESM market has been affected, but our view is that not merely to the degree that the other more traditional markets have been affected.

Okay. Great. Thanks very much. Thanks for the question. I will let somebody else hop in here, but nice quarter, guys. And, always, good luck, given these tough times.

Robert Kelly with Sidoti & Company.

Good morning. Thanks for taking my questions. Let's start with the volumes. And with September being very weak and then, you said October was better than September, but still down pretty much, what is spurring the sequential monthly increase there? Have you dropped prices significantly or is the market starting to come back a little bit? Maybe just a little help there.

Well, maybe start out first by saying that I don't think the drop in price is going to stimulate demand in this kind of environment. The market will set the price and Insteel is going to be competitive. But we are not panicking.

I think that, to some extent, inventory liquidations were probably accomplished in the month of September. And we may be seeing customers who are really buying what they need and have depleted inventories to some extent. But I don't claim to really have a good explanation for it.

I would also point out that we are only halfway through the month. So it could be early to make any call on what October ultimately winds up looking like.

More, I was trying to get at, do you get the sense that customer inventories are as tight as they were maybe a few months ago?

I think our sense would be that customer inventories are heavier than we would like to see them or probably than our customers would like also.

So you got your inventories downstream running out. You guys are doing the same. Some of the things you are doing here, in response here, you know -- minimizing the inventory, taking some plants down, taking some people out -- it sounds like you are girding up for something pretty prolonged as far as [weak] demand.

Is this -- I mean, is that accurate?

We have a couple of different things at play right now. We have all of the negative macro factors that you are well aware of. We also have seasonal issues that are confronting us just in terms of the normal seasonal downturn that we see in our first and second quarters. And I would be surprised that we see this as less than a two quarter sort of hunkering down that we are doing.

Fair. You talked about your strategic initiatives. Does it make more sense rather than do a possible acquisition and maybe to let some of your competitors fall by the wayside should this prove more than a two quarter hunkering down period?

I think it all depends on what the opportunity is and what the circumstances are specific to that opportunity. I'm not sure I can give you a good answer.

Has industry pricing -- you guys had talked about for most of F '08 and even some leaner times in F '07, the industry largely behaving themselves. Is that still the case?

Yes, I would say it is early to really be able to make that call. But generally I would lean toward saying yes, that is right.

Great. That is encouraging. Then finally just on wire rod, we've heard about steel prices weakening. It's more -- the chatter we see is more in response to flatroll.

Has wire rod behaved similar to the way the flatroll steel costs have? Have you seen the weakness?

Certainly prices went down for October. I think it's publicly acknowledged that a couple of the producers put out price decrease letters in the amount of about $70 per ton.

We are still looking at November, and don't really know what November will be.

Is there a chance that you get to a point where your spreads aren't enough to keep you above breakeven is kind of what I am getting at.

I just say I don't expect Insteel to lose money.

Great. Okay. Thank you.

[Walt Glaser] with Parthenon LLC.

Good morning. I was wondering if you could provide a little more detail on rod pricing? Kind of where it is right now, where it's been, where it peaked and where you -- if you have a view, where you think it might go?

Other than what I previously indicated, Walt, that prices were announced at down $70 per ton for October, I'm not really sure that I want to comment further on it, partly because we don't know for sure where they're going.

The dramatic reductions in scrap costs are driving part of this and we are working to understand those dynamics ourselves right now. But I would say that there's got to be significant weakness in the market. We also are seeing interest from offshore sources who have not been active in this market in quite some time.

So I think the competitive dynamics have just changed radically in the last two or three weeks.

As far as the pricing fluctuations within the fourth quarter, you probably saw the announcements that went out earlier where, in July, pricing was up around $60 a ton and then another $60 in August. Then September was basically sideways, followed by the $70 ton reduction in October.

So we got close to $200 in total? From the (multiple speakers) --.

No. The first two -- the first two $60s were movements upward.

Those are increases.

Those were increases.

September flat and then down $70. So net of $50.

So if I were buying rod today, what would I pay for a ton?

What I would do is I would direct you to the American Metal Market. They have a chart in there that would give you the benchmark price for about four different grades of wire rod. And I would point you toward the mesh quality and the high carbon quality numbers as the two grades that Insteel purchases.

Okay. Thank you very much.

(Operator Instructions). Tim Hayes with Davenport & Company.

Good morning. Actually all my questions have been asked and answered. Thank you.

There are no more questions in the queue. (Operator Instructions).

It appears there are no further questions. I'd like to turn the conference back over to Mr. Woltz for any closing remarks.

Thank you. We appreciate your interest and your time in participating in the call today, and we'll talk to you next quarter. Thanks.

Thank you, everyone. That does conclude today's conference. You may now disconnect.