Insteel Industries Inc (IIIN) 2009 Q1 法說會逐字稿

Good day, everyone. Welcome to today's Insteel Industries first quarter 2009 conference call. Just as a reminder, today's call is being recorded.

At this time, I'd like to turn the conference over to Mr. H.O. Woltz, III, President and CEO. Please go ahead, sir.

Thank you, Christina. Good morning and thank you for your interest in Insteel and welcome to our first quarter 2009 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. I'm going to turn it over to Mike to review the drivers of our first quarter financial results and then I'll follow-up to comment more on market conditions and our business outlook.

Thank you, H. As we reported in this mornings press release, Insteel incurred a net loss of $5.6 million or $0.32 per diluted share for the first quarter ended December 27, which included a pre-tax charge of $6.8 million or $0.24 per diluted share after-tax for inventory writedowns as compared with earnings of $4.2 million, or $0.23 per diluted share a year ago. In addition to the inventory writedowns, Insteel's financial results for the quarter were unfavorably impacted by reductions in shipments and operating levels. Together with the consumption of higher cost inventory that had been purchased earlier in the year. Net sales for the quarter increased 6.3%, decreased 6.3% from a year ago, as a 38% decline in shipments more than offset a 51.2% increase in average selling prices. On a sequential basis, shipments for the first quarter were down 36.3% from the fourth quarter due to the continuation of inventory destocking measures by our customers in addition to the usual seasonal downturn.

The magnitude of the Q4 to Q1 decline was much more severe than the 12 to 15% decrease that we've experienced in recent years. Average selling prices for the quarter were down 8.8% on a sequential basis from Q4 as a were down 8.8% on a sequential basis from Q4 as a result of the softening in demand but have not fallen nearly as much as the prices for our primary raw material, steel wire rod. The gross loss for the quarter was $4.3 million compared with gross profit of $10.6 million a year ago. As I alluded to earlier, the gross loss reflects a $6.8 million charge to cost of sales for inventory writedowns to estimated net realizable value resulting from a decline in selling prices for certain products during the quarter relative to the higher raw material costs under FIFO accounting. In addition, spreads between average selling prices and raw material costs narrowed from the Q4 levels as a result of the matching of higher cost material and inventory with lower selling prices. In response to the softening in demand, we implemented further reductions in operating schedules in our manufacturing facilities which reduced our overall capacity utilization level for the quarter to 42% from 63% in Q4. SG&A expense increased $0.6 million for the quarter from a year ago rising to $4.7 million from $4.1 million, primarily due to reductions in the cash surrender values of the life insurance policies, resulting from the downturn in the financial markets, which more than offset decreases in bad debt and incentive compensation expense.

In addition, the prior year amount for SG&A expense was reduced by the net gain on an insurance settlement. Despite the significant year-over-year increase for the quarter, the Q1 amount is relatively close to our average quarterly run rate for the previous fiscal year and we expect it to moderate going forward. Interest expense which primarily consists of non-cash amortization of capitalized financing costs was relatively flat compared with last year while the decline in interest income was due to lower returns on our cash investments in the current year. Our overall effective income tax rate for the quarter, including the disc ops component increased to 38.3% from 35.9% last year, due to the amplified impact of permanent book versus tax differences on the weaker results for the current year together with the reduction in estimated tax credits.

Moving to the cash flow statement and balance sheet, operating activities used $15.8 million of cash for the first quarter while providing $17.2 million a year ago primarily due to the year-over-year changes in working capital, which used $8.7 million in the current year quarter while providing $8.9 million last year, together with a loss that was incurred in the current year. Accounts payable and accrued expenses dropped $21.9 million during the quarter primarily due to the payment of $10.9 million of accrued income taxes and lower raw material purchases. Accounts receivable decreased $24 million largely due to the reduction in shipments and selling prices during the quarter while inventories increased $10.9 million as a result of the lower shipments and receipts of imported material that had been committed to earlier in the year.

In addition to the cash used by working capital, we paid a cash dividend to shareholders totaling $9.3 million in aggregate or $0.53 per share during the quarter, which included a special cash dividend of $8.8 million or $0.50 per share and a regular quarterly cash dividend of $0.5 million or $0.03 per share. Capital expenditures for the quarter were $0.9 million and are expected to total less than $5 million for fiscal 2009. We did not repurchase any shares of our stock during the quarter, leaving the full $25 million remaining on our current share repurchase authorization, which went into effect in November. Going forward, we will continue to be opportunistic in repurchasing shares after taking into consideration our business outlook, cash flow expectations, and expected timing and funding requirements for any growth opportunities that may arise.

Looking ahead to the second quarter, we expect spreads and margins to remain at depressed levels as the remainder of the higher cost material is consumed and then gradually rebound as we move into the second half of the year and the lower replacement costs begin to be reflected in cost of sales. Based on our current forecasted run rate for the next few months, our quarter end inventory position represents about 4.5 months of shipment. Although the average unit carrying values in inventory as of the end of the quarter are significantly lower than the costs we incurred in Q1, they are still significantly higher than current replacement costs and as we work our way through this destocking process, we could incur additional inventory writedowns depending upon future pricing trends.

Turning to the macro indicators for non-residential construction, the primary driver of demand for our products, last week's construction spending report for November reflected surprising strength with total non-res spending up 1% from October, and 9.2% from a year ago; however this strength is expected to be short lived as the ongoing credit crunch, the economic downturn and budget shortfalls at the state and local level began to have an increasing impact, which is implied by the most recent architectural building index report. In November, the ABI dropped to its lowest level since the survey began for the second month in a row, falling to 34.7 from 36.2 in October, and has now remained below the 50 threshold that constitutes growth for 10 consecutive months. On a positive note it is appearing increasingly likely that a federal economic stimulus package will be enacted this year that provides for substantial increases in infrastructure related funding, although the overall amount and break out by category has yet to be determined.

In the November construction spending report, total construction spending was estimated at a seasonally adjusted annual rate of about $1.1 trillion with private non- residential construction representing around 40% of the total and private residential and public construction each representing around 30%. Within public construction, spending for highways and streets which includes bridges was at about $84 billion. Although the stimulus package is far from being finalized in assessing the potential impact on Insteel, if a 50 to $100 billion increase in highway and street funding were provided for over a two year period, the spending level for this category would rise by 30 to 60% in each year over the current run rate. With highways and bridges estimated to represent around 35% of the end use demand for our products, an increase of this size would potentially offset the anticipated weakening and other categories of non-residential construction over the next few years until a recovery began to take hold.

Historically there has been a significant time lag between when government funding of this nature was approved and actual spending occurred, which could easily extend out 18 months or longer. The package under consideration however is specifically targeting shovel-ready projects where the design and permitting have been completed and construction could begin within 90 to 120 days of the approval of funding. In addition, the new administration has indicated that they intend to pursue the use it or lose it approach where the states would potentially lose project funding if construction didn't begin promptly after the funds were appropriated.

Finally, should the additional infrastructure-related funding that is approved wind up being close to speculated levels, its mere passage has the potential to have immediate effect on our market dynamics by placing a significant increase in demand on the horizon. For these reasons, assuming that a stimulus package is enacted, we believe the typical timeline required for the additional funding to begin to impact demand for our products would be significantly compressed from our previous experience. I'll now turn the call back over to H.

Thank you, Mike. During our fourth quarter conference call in October, we reported that Insteel shipments declined precipitously in September from the run rate of prior months and compared to the previous year. As reported today, the trend of severely depressed activity in our markets persisted throughout the first quarter and has continued thus far in the second quarter. Customers continue to be highly conservative as they seek to work down inventory levels and maximize liquidity in response to tight credit markets and the heightened level of uncertainty regarding the outlook for the construction sector this year. Mike pointed out that at current run rates, we have about four and a half months of inventory which is more than desired. Our timing was unfortunate with respect to import transactions that we committed to earlier in the year during a period of tight supply conditions and at a time when a primary supplier had announced plans for an extended maintenance outage during our first fiscal quarter.

While we were successful in unwinding some of these commitments, others were at an advanced state and irreversible. We've responded by significantly scaling back our domestic purchases in recent months. Going forward, we expect a gradual recovery in margins as lower cost material begins to flow through cost of sales later in the year. In response to the deterioration in business conditions, we undertook a series of actions to align our cost and production levels with the reduced level of demand. During the first quarter, we eliminated approximately 70 positions or 13% of our workforce, we've also focused on minimizing cash operating expenses by scheduling extensive downtime at each of our manufacturing facilities and maximizing our operating efficiencies when we do operate. This strategy is reflected in the dismal quarterly capacity utilization figure of 42% that Mike mentioned earlier.

In addition, we've curtailed discretionary spending on a company-wide basis. We're fortunate that we have minimal CapEx requirements for the foreseeable future, following the completion of a three year, $45 million program in September. As we look ahead through the balance of the fiscal year, our visibility is minimal with respect to demand for our products. It's clear that our markets are undergoing significant inventory liquidations, but we're unable to project the exact timing for the conclusion of this process. At this point, we expect the end of inventory destocking to coincide with usual seasonal improvements in our business during the second half of the year, which should serve to boost volumes from the unprecedented low levels we've recently experienced. Nonetheless, demand is likely to be disappointing throughout 2009 in view of the adverse macro factors that are affecting our markets. Although the weak demand environment has given rise to significant pricing competition across all of our products, spreads have actually widened in certain product lines on a replacement cost basis as raw material costs have fallen further and faster than our selling prices.

It's difficult to project whether this positive trend will continue, hover, given the uncertain outlook for demand over the next few quarters, the potential for rising steel scrap and wire rod costs, and the competitive pricing environment that we are experiencing in our markets. Imports of Chinese PC strand continue to undersell domestic producers by a wide margin, exacerbating spread concerns in this market. In addition, the volume of Chinese strand entering the US continues at highly elevated levels, particularly in view of the weakening demand over the course of 2008. Through nine months, which is the most current data available to us, Chinese imports rose 20% from the prior year, representing 43% of apparent construction and 93% of total imports entering the US. Given the many challenges that we face during 2009, we take some comfort in knowing that we've built a highly variable cost structure at Insteel, and that our state-of-the-art facilities clearly position us as a low cost producer. These attributes give rise to the prospect for reasonable profitability even during challenging market environments.

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

Absolutely. (Operator Instructions). Our first question will come from Tim Hayes with Davenport & Company.

Good morning.

Good morning, Tim.

Good morning.

Two questions. Just wanted to clarify, when you use the term "net realizable value" for the inventory, excuse me, when you do take a writedown, do you write that down to the value that you can replace the inventory at or do you write that down to what you could sell it for after you process the inventory?

Yeah, after you process the inventory, not all the way down to replacement costs. To derive the net realizable value, we're estimating the net selling price is less freight, less conversion costs and any other costs incurred complete and sell the product and if that amount is higher, is lower than our inventory carrying value, then it's written down to that level.

So I'm sorry, could you repeat that? You take the, sort of a net --

The net realizable value is derived by estimating the net selling price, less freight, less any conversion costs required to complete the product, transform the product in the finished product and then any variable manufacturing or selling expenses, so if that net realizable value amount that you derived is lower than your inventory carrying value, then you write it down to that level, but replacement costs can in the current environment, can be significantly lower just due to the drop off in wire rod pricing.

Right. Now, how do you account for any shifts in mix when you have to make this estimate? Wouldn't that be a factor given that maybe say higher value products are sold versus lower margin product?

It could have a potential impact but in completing the analysis, we look back over an extended period and then forward as well, considering our forecast and generally, our mix has been relatively stable.

Okay. And then on some of the import figures that you gave from China, it was up 20% year-to-date, 43% on the parent consumption, et cetera. Was that just for PC strand or was that a broader category?

That's just PC Strand.

Okay, thank you.

Virtually no import competition in wiring reinforcement.

Okay, that's all my questions. Thanks.

Our next question will come from Nate Kellogg with Next Generation Equity.

Hi, guys, how are you doing?

Good morning.

Thanks for taking my question. I think you may have touched on it briefly in the opening comments but I may have missed it. It looked like SG&A expense was a little bit higher than I had been expecting for the quarter and I was just curious if that's the run rate we were expecting going forward or if there was any items that pushed it up a little bit.

We would expect it to moderate going forward. There are a couple of significant factors at play. There was a sizeable gain on an insurance settlement in the prior year that was around $0.5 million that reduced that amount and then the current year, we had a significant increase in expense resulting from the reduction in cash surrender values on life insurance policies just related to the downturn in the financial market, so that kind of spiked it up in the current year. The year-over-year increase looks like it's pretty significant but if you compare the 4.7 million to our average quarterly run rate for last year, it's about in line. I think it's up a little less than 2% and going forward, barring any unforeseens, we would expect it to moderate some.

Right. I mean in theory it should be lower year-over-year going forward just because obviously there was a lot of compensation expense because you guys were hitting all your bonuses last year because of the good returns obviously this year that's probably less likely to happen; correct?

Right.

Okay, and then just as far as your customers, I mean, do you guys have any customer, I mean I know you aren't going to call out specific customers in the call but if you could talk generally if you have any customer-specific concerns about going concerns in liability and any issues they are seeing. Obviously there are tough times and you guys have positioned yourself well to weather them but I'm wondering if you have any concerns in your customer base sort of how they are doing?

It's always a concern, Nate, but at this point, it appears that the situation is pretty stable and of course we're watching it closely but so far so good.

Okay, and then on the China issue, I mean, I know previously you guys have just sort of the industry whole has been too profitable to really have much of an effective trade case but I guess that's no longer the case so I just wondered if you could sort of walk us through what that looks like and what the timeline might be to get some relief and how that might sort of unfold in the next six or 12 or 18 months?

It's probably too early to really comment with any specificity. I think suffice it to say at this point, that we have been evaluating our options on a quarterly basis and certainly we'll continue to do that, but it's a pretty highly complex analysis and we just need, we need some more time before we can say anything that really is responsible.

Okay. And then just on the raw material prices going forward, I mean I know we've seen scrap has sort of moved up since very low levels in December, and sounds like some of the mills are getting back. Do you guys see that wire rod prices are stabilizing at all or do you expect them to continue to fall throughout the first six months of this year?

It's real hard to tell particularly in view of just the lack of activity in the marketplace over the last 60 or 90 days, but I would tell you that it appears to me that there is a new model emerging among the wire rod supply industry and that is that they are going to closely align their pricing practices with movements in steel scrap, and they are willing to dramatically curtail production to match up with demand at whatever level it falls out at, so I think it's entirely possible that if steel scrap moves up as many of the forecasts are indicating that it will, that we'll also see wire rod costs move up despite the fact that the industry is really not doing very much business.

Okay, that's helpful, and then I guess obviously at some point though imports would have to put a cap on those types of movements; correct?

That's correct, but I think certainly, here and elsewhere in the industry, the length of the pipeline for imports just is viewed as a pretty risky situation and so that could have some impact on the willingness of people to bring material in.

Okay, that's helpful. All right, guys, listen that's all I've got, and obviously, good luck going forward and appreciate the time as always.

Thanks, Nate.

(Operator Instructions).

Okay, sounds like we're wrapped up, Christina. We appreciate everyone's interest in Insteel and your participation in the call today. Thank you.

That does conclude our teleconference for today. We would like to thank everyone for your participation and have a wonderful day.