Insteel Industries Inc (IIIN) 2009 Q2 法說會逐字稿

Good day, everyone and welcome to today's Insteel Industries' second-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. Please go ahead, sir.

Thank you, Gwen. Good morning. Thank you for your interest in Insteel and welcome to our second-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 will turn it over to Mike to review the drivers of our second-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, Insteel incurred a net loss of $16.4 million, or $0.94 per share for the second quarter ended March 28 compared with net earnings of $6.9 million, or $0.39 per diluted share for the same period last year. The loss for the quarter includes a pretax charge of $16.1 million, or $0.58 per share after tax for inventory write-downs to reduce the carrying value of inventory to the lower cost to market.

In addition to the inventory write-downs, our financial results for the quarter were unfavorably impacted by the consumption of higher-cost inventory that was purchased prior to the collapse in steel prices that has occurred since September, together with the continuation of depressed shipment and operating levels.

Net sales for the quarter decreased 34.8% from a year ago as a 45.5% decline in shipments was partially offset by a 19.7% increase in average selling prices. On a sequential basis, shipments for the quarter were down 3.9% from the first quarter. The current year decline is a stark contrast from the seasonal increase that we typically experience moving from Q1 to Q2, which has ranged from 8% to 13% over the previous five years. We believe that the bulk of the current year decline was driven by the continuation of customer inventory destocking during the quarter.

Average selling prices for the quarter were down 15.1% on a sequential basis from Q1 due to the softening in demand. On a positive note, selling prices for our products have not declined by nearly as much as the prices for steel wire rod, our primary raw material, from the peak levels that were reached last August. Unfortunately, this widening in spreads has not been reflected in our current year results due to the inventory write-downs and consumption of higher-cost inventory, which should become more apparent as we move into the second half of the year assuming that pricing pressures do not intensify.

The gross loss for the quarter was $21 million compared with gross profit of $15.8 million a year ago. The gross loss reflects the $16.1 million charge that I mentioned earlier for inventory write-downs to estimated net realizable value resulting from the sequential decline in selling prices and receipt of the remainder of the higher-cost purchase commitments early in the quarter. In addition, spreads between average selling prices and raw material costs narrowed from the Q1 levels as a result of the matching of higher-cost material and inventory with lower selling prices.

We implemented further reductions in the operating schedules of our manufacturing facilities during the quarter in order to minimize our cash operating costs, which reduced our overall capacity utilization level for the quarter to 35% from 42% in Q1. Our total unit production for the quarter was down 46.5% from a year ago and 16.8% on a sequential basis from the first quarter, also as a result of the schedule reductions.

On an overall basis, close to three quarters of the year-over-year reduction in gross profit was driven by the inventory write-downs and narrowing in spreads. About 20% was from reduced shipments and the remainder was due to higher unit conversion costs resulting from the reduced production volumes.

If we were to pro forma our Q2 results to reflect current selling prices for our products and replacement costs for wire rod, our gross margins would have approached the levels of recent years and we would have been profitable for the quarter, even at the depressed level of shipments.

SG&A expense for the quarter decreased $0.8 million from a year ago following the $4.4 million from $5.2 million, primarily due to the drop-off in incentive compensation expense in the current year and to a much lesser extent lower travel expense, which were partially offset by increases in bad debt expense and employee benefit costs. Q2 SG&A expense was about $0.3 million lower than our average quarterly run rate for the previous fiscal year and we expect it to remain at reduced levels over the remainder of the year.

The year-over-year changes in interest expense and interest income were primarily driven by the changes in our balance sheet as we were in borrowing mode on our revolver during the current year quarter versus debt free with a sizable cash balance during the same period last year. About two-thirds of the quarterly interest expense amount was for non-cash amortization of capitalized financing costs. Our overall effective income tax rate for the quarter, including the disc ops component was relatively flat at 35.8% versus 36% last year.

Moving to the cash flow statement and balance sheet, operating activities used $0.7 million of cash for the second quarter while providing $6.8 million a year ago, primarily due to the current year loss, which was partially offset by the year-over-year changes in working capital. Working capital provided $6.8 million in the current year quarter while using $3.1 million last year, primarily due to the reduced operating levels and declining prices during the current year.

The other changes line item within the operating activities section of our cash flow statement, which reflects the use of $9.6 million in cash for the quarter and $13.9 million year to date, is primarily related to the increase in income taxes receivable within prepaid expenses and other on our balance sheet, resulting from the current year loss.

Capital expenditures for the six-month period were $1.4 million compared with $6.2 million for the same period last year and are expected to total less than $5 million for fiscal 2009. We did not repurchase any shares of our stock during the quarter under our 25 million share repurchase authorization. Going forward, we will continue to be opportunistic in repurchasing shares based on our business outlook, our cash flow expectations and the expected timing and funding requirements for any growth opportunities that may arise. We ended the quarter with $0.4 million of borrowings outstanding on our $100 million revolving credit facility.

Looking ahead to the second half of the fiscal year, we expect spreads and margins to gradually improve as the remainder of the higher-cost inventories consumed and the lower replacement costs began to be reflected in cost of sales. Based on our current forecasted run rate for the third quarter, our inventory position as of the end of Q2 represents around four months of shipments.

To the extent that we experience further reductions in selling prices in the coming months, we could incur additional inventory write-downs; although we believe that the worst is behind us. We are targeting substantial reductions in our inventory levels between now and the end of our fiscal year, which when combined with the anticipated improvement in our financial results should translate into strong operating cash flow through the next few quarters.

Turning to one of the primary demand drivers of our business, infrastructure construction, following our last quarterly call, the American Recovery and Reinvestment Act of 2009 was enacted, which provides for around $130 billion of construction spending. Although the final amount targeted for highways and bridges, $28 billion, is disappointing in view of the higher levels that were being floated earlier in the deliberations, it still represents a substantial increase relative to the current $78 billion annual spending rate for this category.

With highways and bridges estimated to represent around 35% of the end-use demand for our products, the additional funding should serve to at least partially offset the anticipated weakness in other categories of non-residential construction over the next few years, particularly for commercial projects. Although a portion of the stimulus spending is already underway, we do not expect it to have a significant impact on the demand for our products until 2010.

In addition to the federal stimulus package, the other significant driver of infrastructure-related spending for the next few years will be the new federal highway spending authorization that will have to be pursued later in the year as the current five-year $286 billion authorization known as SAFETEA-LU is set to expire in September. We hope to get better clarity on the new authorization over the next few months. I will now turn the call back over to H.

Thank you, Mike. As indicated by our second-quarter results and Mike's comments, the environment we have contended with over the past few months has been harsh and unforgiving. The collapse in market prices for steel that has affected the entire supply chain and the related adjustments to the carrying value of inventory have precluded profitable operations as measured by accounting convention.

Given these circumstances together with tight credit markets and an uncertain business outlook, we are focused on preserving our flexibility, which means maximizing our liquidity. Viewed from this perspective, we are reasonably pleased with the Company's second-quarter performance and we expect further improvement over the remainder of fiscal 2009.

During our first-quarter conference call in January, we reported that Insteel's shipments had continued at the depressed rate we experienced beginning in September. As reported today, the trend of severely depressed activity in our markets persisted through the second quarter, which was expected given the many headwinds facing our economy and more specifically construction markets.

Customer purchasing patterns are expected to continue to reflect conservatism, driven by the difficult market outlook, the exposure created by inventories and tight credit markets. While Mike pointed out that we still have about four months of inventory, down from about 4.5 months at the end of the first quarter, the timing of raw material receipts masked the significant progress that was made during the second quarter toward realigning our inventories with the reduced level of demand.

Unit inventories peaked at the end of January following the receipt of the remainder of import purchase commitments that were made last summer. As of the end of the second quarter, our unit inventories were down 21% from the January high and we will be pursuing further reductions in the range of 25% to 50% over the remainder of the fiscal year depending on how our markets develop in coming months relative to forecasts.

Operationally, we reported last quarter that we had reduced our employment level to reflect the downturn in business conditions. During the second quarter, we made no further significant changes to our employment levels. Although we took out of the schedule large blocks of production time at each of our manufacturing facilities, resulting in the record low capacity utilization rate of 35% that Mike mentioned earlier.

Looking ahead, we expect to ramp up somewhat as destocking trends subside and favorable seasonal influences gather momentum in the coming months. Our expectations are modest however and it would not be surprising if capacity utilization remained under 60% through the balance of the fiscal year.

Although weak demand environments have given rise to significant pricing competition across all of our products, spreads have actually widened in certain products on a replacement cost basis as raw material costs have fallen further and faster than our selling prices. It is difficult to project whether this positive trend will continue however given the uncertain outlook for demand over the next few quarters, the potential for rising steel scrap and wire rod costs and the intense competitive pricing environment that we are experiencing.

Imports of Chinese PC strand continued to undersell the domestic industry by a wide margin, exacerbating spread concerns in that market. While the volume of Chinese imports subsided over the last four reported months, it is apparent that large quantities of unsold Chinese strand are warehoused around the country, which is resulting in continued pricing pressure and lost sales even as reported import volumes taper off.

Despite the tumultuous nature of the first two quarters of fiscal 2009 and the prospect for continued low capacity utilization rates, we are expecting significant improvement in our financial results and healthy operating cash flow during the second half of the fiscal year. We have confidence in our market positioning and we believe we have world-class operating costs in each of our productlines. These attributes, together with our strong financial condition, should provide us considerable flexibility over the next few quarters.

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

(Operator Instructions). Robert Kelly, Sidoti.

Good morning, guys. Thanks for taking my question.

Good morning. You had referenced the worst was behind you as far as inventory write-downs. Does that presume you are seeing stabilizing pricing or you have written off the highest-cost stuff?

Well, I think I alluded -- in my comments, I alluded to the fact that we had received the remainder of those previous higher-cost purchase commitments early in the quarter, so any activity since then would reflect the lower current replacement costs. So from that standpoint, as well as in view of the write-downs that have occurred and in looking at inventory carrying value versus replacement costs, we are clearly in a much better position than we were a quarter ago and believe the bulk of it is behind us. The unknown is what happens with selling prices going forward. To the extent that we see significant declines in selling prices, there is the potential for further write-downs. But again, we believe that the worst of it is behind us.

Well, how have selling prices trended in this early part of April?

It has continued to be highly competitive, Bob. It is just that kind of environment. It is very difficult to project where it is going to go. I think a considerable influence is going to be what happens with steel scrap and wire rod pricing. And there are some indications out there that prices for those materials may have bottomed out and actually may begin heading up.

That's encouraging. Mike, you had spoken to what the pro forma margins would look like. Had you used current replacement costs? Is there any way to quantify that or give us some intuition as far as a quarter that you might have reported to get an idea of what the current numbers, the pro forma number would look like?

Yes, those assumptions are pretty dynamic depending on fluctuations in rod and selling prices. I wouldn't want to drill down into those details, but I guess in my statement, I referenced that, on a pro forma basis, our margin for the quarter would have been back up at the level in recent years, which would have been in the high teens, low 20 range. But I don't know that I would want to give more detail than that.

And that assumes selling prices, current selling prices versus what you would be buying wire rod for?

That assumes current selling prices and replacement costs, current replacement costs for rod, if you just adjusted those two variables for the quarter. It assumes shipments remained at the depressed levels or our margins would have been back up at those prior-year levels.

So assuming the replacement costs stabilize at the current level, given the four-month inventory you have for shipments, does that imply you need four months of stable pricing and demand to get to current replacement costs? Is that how long it would take to finally reflect what the pro forma numbers would be? I am just trying to get a sense of the timing.

It wouldn't be quite that long because -- I guess under FIFO, the four months worth of inventory is layered, so you have some of those older layers that would reflect higher costs and then any of the more recent activity would be relatively close to replacement costs. So I would view four months as being at the high end.

Thanks for that. And just finally, April shipments, have you seen anything beyond the normal seasonal uptick in activity?

Well, let's say we have seen some normal seasonal uptick in activity, which is certainly welcome. But I would caution against assuming that that means a return to historical levels of shipments. We are running much closer to forecast than we have in recent months and it is somewhat better.

But you will still be running low utilization --.

Yes, as I mentioned in my comments, it is unlikely that we would ever hit 60% capacity utilization during the current fiscal year given our current outlook.

Do you stay at 35 in 2H or do we move higher from what you saw in 2Q?

Well, I mean it should be higher than Q2.

Right, but still --.

Part of that is a function of our inventory reduction and focus. I mean obviously that has some scheduling implications.

Okay. Thanks, guys.

Nat Kellogg, Next Generation.

Hi, guys. How are you doing?

Good morning, Nat.

Good morning. The four months in inventory for shipments, is that based on the shipment levels of Q2 or is that forecast shipment levels?

That is a going-forward view.

Okay, okay. So that sort of includes some seasonal uptick?

Right.

And then I noticed there is a fairly decent increase in prepaid expenses, the other assets on the balance sheet. I am just wondering if you could give a little more detail on what is in there just because it is a pretty material increase.

Yes, that is actually related to the increase and the income tax receivable balance, which is reflected in prepaid expenses and other on the balance sheet. If you look at our beginning-of-the-year balance sheet versus quarter-end, you see a substantial increase there. And that really corresponds with the other changes. That is the bulk of it. And that is just a function of the loss that was incurred through the first half of the year.

Okay. And then just help me out, do you guys -- is that an asset that you need to generate profit? Is it like an NOL where you need to generate profits and then you write it off as you basically don't pay cash taxes or is that a situation where we get to the end of the year and you guys will have a loss, so you could actually get a cash refund from the government?

Right, if we were still in a loss position as of the end of the year, you are right. Whatever that receivable balances would translate into a refund. It would be a carryback.

Okay. And there's nothing -- I mean you would get -- on the inventory write-down just because those are non-cash (inaudible), you would still get a refund for those types of losses, correct?

Yes.

Okay, okay. So that will be on there until we get to the end of the year and you guys file your taxes?

That will just be a function of where that year-end balance comes in at, which will obviously be driven by our second-half results.

Sure. All right. I guess that is fine. In a sense, you hope to get as small a refund as possible, right?

Correct.

The inventory situation at your customers, I mean I know this is sort of anecdotal, but can you just give us a sense of where you think that is today versus maybe six months ago or three months ago really and then what you see it looking like maybe going forward?

It varies considerably, Nat. But as a general statement, I think if you look at inventories of finished goods together with inventories of raw material and in-process at the customer level, it is still higher than desirable. And I think also there is just gathering concern about the amount of work being quoted out in the marketplace that is contributing to the highly conservative approach that customers are taking.

Okay, so I mean if quote activity picked up, you guys would probably have to build inventory, but given that things are pretty tepid right now, nobody feels the need to have much on the ground?

That would be certainly my feeling.

Okay. And then on the Chinese import situation, as far as sort of taking steps as far as trade case type of things, just curious how that stands and given the drop in import levels, does that change how you guys might approach that type of thing? I am just curious on any updates on that front.

It is always a moving target and highly dynamic, but suffice it to say that we are constantly analyzing the position of the industry and if we thought we had a case, we wouldn't be hesitant to move forward.

Okay, okay. So I guess that means that you haven't started a case that means that you don't feel like there is enough evidence to really make a push there yet?

Yes, that would be an accurate statement.

Okay. And then you guys have talked about spreads widening given the rapid drop in wire rods costs. If I look going forward -- I mean I understand the dynamics going on right now, but if I look going forward, why wouldn't spreads narrow? I mean I would think just if it is a competitive environment out there, at some point once wire rod costs hit bottom that you would go back to sort of more normalized spreads or maybe even depressed spreads.

I think it is anybody's guess, Nat. I just don't think you can accurately project it. Another school of thought would be that the downward spiral in our selling prices is really driven by the prospect for lower steel scrap prices and therefore, lower rod prices and if that trend were to halt or to reverse, the psychology forever decreasing prices for raw material could change dramatically and could have some impact on the behavior of competitors for wire products in the marketplace. At the end of the day, these things are always driven by supply and demand and it is just very difficult to understand how the competitors are going to react.

Okay. And then I think you guys mentioned in your release that wire rod costs haven't fallen as much as flat-rolled, but I know flat-rolled sort of took obviously a big header and then I think, in February, people thought maybe they had reached the bottom and then it sort of took another leg down in March and was just curious on sort of how wire rod costs -- do you see that type of thing on the wire rod cost side?

All I know about the flat-rolled market is what I read in the various trade rags and I wouldn't want to really draw a comparison between wire rod and the flat products because I don't know enough about the flat market. Suffice it to say that the rod mills are still operating at highly depressed levels of capacity utilization and their input costs have continued to retreat. So it has been a pretty competitive picture out there.

But as I mentioned earlier, I do see signs that that is changing, that scrap prices may have bottomed and are heading up and I would expect to see a fairly high degree of discipline from our supplier community if their cost structures begin to turn around that way.

Yes, okay, all right. All right, guys. Well, I appreciate the color as always and that is all I have got for now.

Okay, thank you, Nat.

Gary Lenhoff, Ironworks Capital.

Thank you, guys. All my questions actually have been answered. Thank you.

John Kohler, Oppenheimer & Close.

Good morning, gentlemen. I was wondering if you had a breakout for inventory of finished goods, in-process or raw material or rough estimates.

Yes, we will actually be filing our Q next week, which will have the breakout there, but I can -- let me go ahead and give you the breakout here. Bear with me a minute.

Sure.

Raw material inventories were at about $24.9 million, finished goods at $28.4 million and WIP at about $1.7 million.

Okay, great. And then if I look at some historical sales inventory levels, is it fair to assume that 15% to 20% is a safe estimate of where inventory should be in relation to sales given that you would be operating at a fairly low level?

(inaudible) basis. That might be a little light. Just looking at it from a month inventory standpoint, we would kind of ballpark that range at two to three months. A little higher than the 15% I guess. And I guess in our comments, we indicated that we were pursuing inventory reductions in the 25% to 50% range from the quarter-end levels. I guess where we land on that spectrum will be determined on how market conditions play out over the next couple of months relative to our forecast.

Okay. Excellent. All right, thank you very much.

Thank you.

Tim Hayes, Davenport.

Good morning.

Good morning, Tim.

Just one question. A lot of our questions have already been answered from your prepared remarks. But in terms of the inventory write-downs, can you put in perspective or how much in terms of percentage of your inventory have been written down over the last quarter?

We need to give that some thought just in view of the layering that is involved.

Right, and of course, that is a percentage based on units of inventory.

Right, right. Well, as I mentioned, we received the remainder of those higher-priced commitments earlier in the quarter, so January was a pretty high receipts month. We have obviously curtailed our purchasing activity pretty dramatically over -- really going back to the last quarter. So I don't know that I would be able to throw a precise percentage out, but I would say a relatively high proportion of the inventory would have been written down just given that our recent purchasing activity has been pretty minimal.

Have you had to write down any of the tonnage of inventory twice?

Yes, just in view of the selling price declines, we have and there was a portion of the inventory that would have been adjusted last quarter that was also adjusted this quarter as well.

And I am not sure if I am reading into your question the right thing, but if we had been able to write the inventory down to replacement value then it would have been done, but that is just not the mechanic that we have to use to do this.

Right. Okay, thank you.

(Operator Instructions). Robert Kelly, Sidoti.

Yes, thanks for taking my question. If you could just talk about the different products in your lineup there and the relative pain you are feeling top to bottom. You had talked in the past, engineered structural mesh, some of the more value-add products, we are seeing less price pressure. Is that still the case? I mean are most of the write-downs here or the selling price pressure related to the lower-end commodity type products? Maybe just some help on the degree within your product lineup.

I think despite the fact that the end uses of these products and the drivers are different, there is a remarkable similarity in the degree to which the markets are all for each of our productlines. And as you would expect, the price competition in some of the more commodity-like products has been more severe than in the more custom and engineered products. But the price competition has been intense across the board if you just had to put a label on it. But just circling back, I would say that the productlines are remarkably similar in terms of how far off they are relative to previous experience.

So as far as the 15% decline sequentially you saw in pricing, that is pretty much what all your product groups look like? They are all about down that 15%? I'm trying to get the sense -- are the commodity price, the commodity-type products dragging you down more or is it across-the-board price pressure?

Well, I think there has been a little more pressure in the standard products, which tend to be more price-sensitive.

But the engineered and custom are not really insulated right now?

I mean there is some pricing pressure there as well. And from a volume standpoint, as H indicated, there has been an across-the-board downturn. But generally, the ESM volume has held up somewhat better than the other productlines.

And then how about the --?

And then just the other part of your question about the inventory write-downs, as you would expect with the standard product experiencing more of the pricing pressure, that is where -- up to this point, that is where the majority of the write-downs have occurred.

Okay. And then in respect to the spread that you are able to maintain between the commercial construction, PC strand and residential PC strand, has that been --?

Post-tension versus precast?

Yes. Has that been widening, shrinking? What are the dynamics?

We have essentially been out of the commercial post-tension market for a pretty significant period of time. It is a very small part of what we are doing.

Understood, but there is a premium that precasters pay relative to the post-tension product?

Are you wondering whether that has narrowed or --?

Has it maintained, has it widened, has it narrowed?

Well, I guess what you are asking is the relationship between the Chinese price for PC strand --.

Yes, has that spilled over into the precast market?

Well, it has been in the precast market for a couple of years and the importers continue to knock on those doors and press their case. Chinese prices have fallen dramatically. The spread between the import price and the domestic price is still wide and about what it has been over the past few quarters.

Okay, great. Thanks, guys.

And there are no further questions at this time. I would like to turn the conference back to Mr. Woltz for any closing remarks.

Okay, thank you, Gwen. We appreciate your interest in the Company and your time today. If you would like to follow up with us, feel free to do so. Thank you.

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