Insteel Industries Inc (IIIN) 2009 Q4 法說會逐字稿

Good day, everyone, and welcome to this Insteel Industries fourth quarter 2009 conference call. Just a reminder that today's call is being recorded. At this time I would like to turn the call over to President and CEO, Mr. H.O. Woltz, III. Please go ahead, sir.

Thank you, Lisa. Good morning and thank you for your interest in Insteel. Welcome to our fourth 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 now turn it over to Mike to review our fourth quarter financial results, and then I'll follow up to comment more on market conditions, the PC strand trade cases and our business outlook.

Thank you, H.

As we reported in this morning's earnings release, Insteel returned to profitability in the fourth quarter, posting strong results considering the ongoing weakness and market conditions. Earnings from continuing operations were $2.8 million, or $0.16 per share, for the quarter compared with the loss from continuing operations of $1.7 million, or $0.10 per share, in the third quarter of fiscal 2009. In the fourth quarter of fiscal 2008, earnings from continuing operations were $15.6 million, or $0.89 per share.

Net earnings for the quarter, including the results of discontinued operations, were $1.7 million, or $0.10 per share. The loss from disc-ops for the quarter was primarily related to a pretax impairment charge of $1.8 million to writedown the carrying value of the real estate held for sale associated with the industrial wire business, which we exited in 2006.

Our results for the quarter were favorably impacted by higher shipments, widening spreads between selling prices and raw material costs, and lower unit conversion costs as compared to the third quarter. In addition, the current quarter also benefited from having one additional week than the third quarter in the prior year period, based on our fiscal calendar.

Net sales for the quarter increased 7.2% from the third quarter, driven by a 16.4% increase in shipments, which more than offset the 7.9% decline in average selling prices. The sequential increase in shipments between the quarters was significantly more favorable than the decreases we have experienced between the same periods over the past three years, which have ranged from 3% to 14%. We believe this year's increase was largely driven by reduced imports of PC strand and the completion of the customer inventory destocking that had been underway since the beginning of the fiscal year.

On a year-over-year basis, net sales decreased 42.5% from the fourth quarter of fiscal 2008 due to a 39.9% decline in average selling prices and a 4.4% decrease in shipments.

Gross profit for the quarter rose to $9 million, or 14.8% in net sales, from $1.2 million or 2.1% in the third quarter.

Inventory writedowns for the quarter were minimal as compared to the $25.9 million incurred during the first nine months of the fiscal year. Barring any unforeseen deterioration in market conditions and selling prices, we believe this issue is behind us.

We would attribute a little over half of the $7.9 million sequential improvement in gross profit for the quarter to the widening in spreads, with the balance split about equally between higher shipments and lower unit conversion costs resulting form the higher operating levels.

In the fourth quarter of 2008, gross profit was $29.5 million, or 27.7% of net sales. The year-over-year decline was primarily due to wider spreads and higher shipments in the prior year quarter.

Our overall capacity utilization for the quarter rose to 56% from 42% in the third quarter, reaching the highest level since the prior year quarter when we operated at 63%.

Total unit production for the quarter was up 41.8% on a sequential basis from the third quarter, when we were in inventory reduction mode and operating on reduced schedules, but down 5.7% from a year ago.

SG&A expense for the quarter increased slightly from the third quarter, but was down $0.7 million from a year ago. The year-over-year decrease was primarily due to reduction in incentive compensation and bad debt expense, together with an increase in the cash surrender value of life insurance policies.

Our overall effective income tax rate for the quarter, including disc-ops, rose to 45.4% from 41.5% in Q3 and 36% in the fourth quarter of last year. The increase was primarily due to changes in our estimated book tax differences for the current year, which had an amplified impact on the effective rate for the quarter as a result of the shift to pretax earnings from the large pretax losses we incurred earlier in the year.

For the fiscal year 2009, our overall effective rate wound up at 36.1%. If we were to adjust our fourth quarter results to reflect the effective rate for the year, earnings from continuing ops would have risen to $3.1 million, or $0.18 per share.

In connection with the current year loss, we have an estimated income tax refund of $13 million as of the end of the year that we expect to receiving during 2010, which is reflected in Prepaid Expenses and Other on the balance sheet.

Moving to the cash flow statement and balance sheet, cash provided by continuing operating activities remained strong for the quarter at $14.9 million, following the $23.1 million that was generated in the third quarter. The sequential decrease was due to the larger reductions in working capital that occurred in the previous quarter, primarily related to inventories, which was partially offset by the improvement in the current quarter results. Cash provided by continuing ops was $10.2 million in the prior year quarter.

Inventories at the end of Q4 were up $3.4 million, or 9.6% from the previous quarter end, with unit inventories increasing 5.9% and average unit values rising 3.5% due to the recent increases in wire rod costs. On an overall basis, average unit values for inventory as of the end of the quarter were below current replacement costs.

Based on our current forecasted run rate for the first quarter, which has historically been the seasonal low point of the year from a volume standpoint, our inventory position at the end of Q4 represented around 3.7 months of shipments. We will continue to reassess our optimum inventory levels based on our business outlook and expected conditions in the wire rod market.

Capital expenditures for the year fell to $2.4 million compared with $9.5 million last year. Looking ahead to fiscal 2010, we expect CapEx to come in at less than $5 million.

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 and cash flow expectations. We will also ensure that we maintain ample borrowing capacity and the financial flexibility to pursue any growth opportunities that may arise.

We ended the year debt free with $35.1 million of cash and cash equivalents, a $13.5 million increase from the end of the third quarter and $8.6 million above where we started the fiscal year.

As we look ahead to the first quarter, our visibility remains limited due to the ongoing uncertainty regarding the future direction of the economy and the mixed outlook for the construction sector.

Up to this point, the infrastructure spending provided for under the federal stimulus plan has not had an appreciable impact on demand for our products. Based on a recent analysis, a higher percentage of the funding targeted for highways and bridges has been designated for pave-way improvement projects, which would not require the use of our reinforcing products.

As we move into 2010, we are hopeful that a higher proportion of the spending will be directed towards other infrastructure applications, such as new roads and bridges, that represent more intense uses for our products, and that the significant amount of funding targeted for buildings will begin to have a favorable impact on demand.

In addition to the stimulus, the other significant driver of infrastructure-related spending will be the next Federal Highway Spending Authorization. The current five-year authorization, known as SAFETEA-LU, expired in September and the one-month extension is currently in effect, which maintains funding at the previously authorized levels.

Unfortunately, it is difficult to predict what the ultimate outcome will be at this time as there are wide differences in the alternative approaches that are being considered. We are hoping for a timely resolution of a new multi-year authorization in order to avoid the project delays and cancellations that may otherwise result from the uncertainty regarding future funding levels.

I will now turn the call back over to H.

Thank you, Mike.

As you've heard, business conditions strengthened somewhat during our fourth quarter, resulting in rising shipments and operating volumes from the severely depressed levels of the previous three quarters. We believe the increased activity was driven by the winding down of destocking as we have yet to see any compelling evidence of a recovery in end-use demand for our products.

Operationally, we ramped up hours at several facilities during the fourth quarter in response to moderate strengthening in our order flow, which increased our capacity utilization levels from the third quarter. Unfortunately, we don't expect a continuation of this favorable trend as we foresee near-term weakness that is both cyclical and seasonal in nature.

The shock to the supply chain that occurred over the past four quarters has instilled a heightened level of conservatism that has potential to exacerbate the normal seasonal downturn our industry experiences. Accordingly, we are making plans to curtail operating hours as appropriate to minimize cash costs and control inventories.

As we enter the seasonally weakest period of the year, we've begun to experience elevated levels of competitive pricing activity. Apparently, we have some competitors that are acting out of desperation to increase their operating levels or reduce inventories, and others that are struggling with quality and service problems that have resulted in lost market share. Both groups seem to believe that lower pricing will resolve their problems.

While we don't understand the business case for these tactics, Insteel is well positioned to provide quality products at competitive prices and we plan to be a consistent and reliable partner for our customers.

Concerning developments in the wire rod market, as previously announced, two US rod production facilities were closed in recent months. The market appears to have taken these events in stride as weak demand has muted the impact of lower production capacity, at least for the near term.

Supply concerns could materialize, however, should a recovery of any significant magnitude develop. Steel scrap prices appear to be headed down for the next couple of months, which should have a moderating impact on wire rod pricing. In view of the uncertainty surrounding steel markets and demand for our products, we plan to mitigate our risk by closely managing inventories.

As mentioned in our earnings release, we continue to pursue the PC strand dumping and countervailing duty cases that were initiated against China in May, 2009 by Insteel and two other domestic producers. We expect the Department of Commerce to make its preliminary determination with respect to countervailing duty margins by October 26th and dumping margins by December 3rd.

The deadline for the preliminary determinations in the dumping case is now 20 days earlier than we had previously communicated due to schedule modifications at the Department of Commerce. The cases will continue through next spring, with the International Trade Commission's final injury determination expected in June or July, 2010.

While no one can predict the eventual outcome of the China cases, they unquestionably have had a positive impact on our market. Chinese imports have fallen precipitously since the cases were filed.

As we've been confronted with lower quantities of dumped Chinese strand, we've successfully renewed our participation with customers that had previously relied heavily or even exclusively on low-priced Chinese imports. Unfortunately, the potential volume of business with these customers reflects the overall erosion in market demand, but we're once again competitive and our future prospects with these customers have improved considerably.

Predictably, as low-priced Chinese import quantities have dropped off due to the trade cases, other countries have ramped up exports to the US. This comes as no surprise to us and we feel confident in our ability to compete effectively with imports that are traded in accordance with US laws.

Coincidentally, at the same time we're pursuing the China cases, we are also participating in the sunset review process for dumping orders that were entered in 2004 against Brazil, India, Korea, Mexico and Thailand, and a countervailing duty order that was entered against India. The results of the sunset reviews should be known by the middle of November.

As with the new China cases, we're unable to predict the outcome but believe that we've made compelling arguments supporting the continuation of the orders against these countries.

In summary, we're relieved to have 2009 behind us. It's difficult to envision a more hostile environment than the one we experienced during the first three quarters of the fiscal year. As our fourth quarter performance indicates, there is evidence that the market has stabilized at severely depressed levels but, nevertheless, at levels that will support profitable operations.

Despite the high level of forecasting uncertainty, it's clear to us that our markets are unlikely to recover to pre-recession levels until our economy grows, businesses return to hiring mode and investor confidence is restored. Given these realities, the country's fiscal condition and the policies being pursued by the administration and congress are worrisome, to say the least.

As we enter 2010, we expect market demand for our products to remain at depressed levels, particularly during the first two quarters of the fiscal year, when the seasonal downturn that we typically experience is likely to be compounded by ongoing weakness in the economy and heightened conservatism throughout the supply chain.

We're fortunate to have emerged from 2009 in a strong competitive position, with world-class operating costs and formidable financial strength and flexibility.

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

Absolutely. (OPERATOR INSTRUCTIONS.) We'll take our first question today from Lloyd O'Carroll of Davenport & Company.

Good morning. This is actually Chris for Lloyd. I wanted to see if you could kind of give us an update on your breakout of cost of sales given the recent writedowns in wire rod prices or wire rod costs and in your fallen conversion costs?

Yes. I don't know that we have that data readily available for the fourth quarter. Needless to say, we would -- you would expect that raw material percentage to be increasing from the prior year as a percentage of cost of sales in view of the higher cost material that was consumed earlier in the year and the writedowns. So, I think we were at 73% last year. And for the year as a whole, I would guess it's probably up closer to the 77% range, somewhere in that vicinity.

Okay. Thank you.

Up next is Robert Kelly, Sidoti & Company.

Hey, H., Mike.

Good morning, Bob.

Good morning.

Just a quick question. The tax rate in the quarter you said cost you $0.02 on the--?

Yes.

Okay, thanks.

Yes.

I was interested in the commentary you had regarding the PC strand market. Imports were down and you were able to supply that market a little bit. At what level of pricing were you there in that market, and how does that compare to when you were still competing against Chinese strand?

Well, when the Chinese were dominating the market, I mean, we were basically out and had concluded that we couldn't compete and be profitable. The level of pricing today, suffice it to say, is sufficient for us to generate profitability and is more of what we would consider a world market level as opposed to just the unrealistic and clearly dumped level that the Chinese persisted with for many quarters.

No, I understand that. I'm just trying to get a sense of pricing in 4Q versus pricing prior to you pulling out of the market.

Gosh, Bob.

Are you referring more to the -- I guess the spread between that--?

Either selling price or a spread. Just trying to get a sense of how much them being out of the market helps your story in PC strand.

I don't -- I honestly don't recall where the levels were when we determined that we needed to exit some of these accounts.

Okay. Alright, great. As far as the outlook, volume's down 4% year on year. Any reason to believe that you shouldn't have -- you shouldn't see in fiscal '10 a much gentler decline for volumes, just given you've been through the destocking cycle? Are you suggesting that there's another destocking cycle about to start?

Well, I'd say that the bar is relatively low for the first half of the year in particular, just given what we experienced in 2009. I mean, if you're just looking at the year-over-year comparisons. But when you get beyond that, the level of uncertainty is still pretty high. And I guess as we go into the slow time of the year, we do have some concerns, as H. indicated, just with the heightened level of conservatism where our customers are still managing their inventories pretty closely, and that can lead to some volatility in order flow, so--.

Okay. That's fair. Now, as far as what you're seeing on spread across the board, are you able to go out because of your financial position and get lower priced steel, similar to what you had done in previous years ahead of -- we saw an increase off the bottom in July. Were you able to buy a lot at the low?

Yes. I think our whole inventory philosophy, Bob, is one of managing that risk. That demand for wire rod is maybe at an all time low in North America but, at the same time, significant capacity has exited the market. So, I think there's still a settling out of what all that means in terms of the relative power of producers versus consumers. But we're just not of a mind to roll the dice on steel prices. I think that there's just a lot of risk there and we want to avoid it.

Okay. Fair enough. And then, as far as the PC strand actions, do you think the improvement you saw in strand demand during 4Q, was that a function of you filing the case or is that a function of demand actually improving somewhat from the trough in 2Q and 3Q?

I guess they are probably multiple underlying drivers, but I would say that the most significant is the dumping and countervailing case against China. For all intents and purposes, they're out of the market. We have restored position in areas where they had caused us to exit and I feel real good about that.

I think, clearly, that Insteel can compete with world market prices that aren't dumped. And the guys who are coming into the market now, the other offshore sources, if they trade here in accordance with US law, I think Insteel's going to be fine.

Okay. And then in the past you've talked about the pre-stress versus the post-tension. There's a certain ratio you need to keep and a lot of it depends on where the low-end strand is priced. Are you seeing an improvement in the higher kind of value products because of the improvement in strand kind of discipline, I guess I'd call it?

Well, let me -- to be more specific, when I mentioned the participation that has been restored for us with the Chinese leaving, it is primarily in the post-tension arena. So, in case I confused you, let me clear that up.

Certainly, the Chinese influence was not limited to just the post-tension market. They had made inroads into the pre-cast market as well. And their exit, I think, is going to help the entire market.

Okay, great. Thanks, guys.

Our next question today will come from Tyson Bauer, Wealth Monitors, Inc.

Good morning, gentlemen.

Good morning, Tyson.

Good morning.

A couple of quick questions. We've gone through many quarters here where a lot of the results have been determined by destocking inventory, trade issues, those types of items. Is it really going to be second half of the next fiscal year or fiscal '10 before we get results that are going to be generated based on the end customer activity and demand, as opposed to maybe some of these side events or underlying factors that are creating some of this product movement?

I think, particularly to the extent that we believe the destocking process has run its course, I think we're probably there now. I think that what you see for fiscal 2010 is likely to reflect underlying rates of utilization of our products without too much noise in the background. There's always some noise of some variety, but I think it's minimal going forward.

Okay. Is there tangible evidence or activity that you're seeing that gives you or reinforces your hope that these infrastructure projects geared for the next calendar year will be more of that bridge, new road projects, or items that will utilize your products as opposed to, say, fresh, shiny blacktops that get you reelected?

Well, we have seen some recent references to the product mix potentially changing as we get further out in the stimulus, where there's such a heavy emphasis on the shovel-ready work and some of these projects, the heavier infrastructure projects that have higher lead times, that those would tend to get pushed out further. So, we have seen some references to that effect, but still isn't real clear.

Yes. I'd say there's an absence of facts to support the contention that we're going to see a real robust sort of impact on our products. There's a lot of hope, but not many facts.

And the last one for me, you talked about, H., being able to have your business, that now with the cost structure, with your components in place, to be profitable going forth. Is that an absolute profitability on a quarterly basis going forward, or does some of the lows and your seasonality and still the cyclical nature -- see there in these next couple of quarters?

Well, look, you keep in mind that I prefaced that statement by acknowledging our inability to forecast. And I really think there's so much uncertainty out there that I really wouldn't want to speculate on it now. That we're tooled up here to be lean and mean and low cost and we know how to operate in this environment, but we can't predict the top line. We just can't do it. And if we can't do that, then we can't give you very much credible information on profitability.

Okay. Thanks a lot, gentlemen.

Okay. Thank you.

(OPERATOR INSTRUCTIONS.) Up next is Nat Kellogg, Next Generation Equity Research.

Good morning, guys. How you doing?

Good morning, Nat.

Good morning, Nat.

Just a couple. Mike, any guidance on what you think a tax rate will be next year?

The difficulty is that it's somewhat skewed just by the absolute level of pretax earnings. But, I mean, we would generally expect it to run a little bit higher next year, but I don't know that I could get any more precise than that right now. Because it does get impacted pretty significantly when you hit certain thresholds based on the book tax differences. And this past quarter was distorted by that factor, as well as just by the swing between the high pretax losses to the relatively low pretax earnings. It just impacts the math that way. So, I don't know that I'd want to throw out a percentage right now.

Okay. Fair enough. But it's somewhere in the 35 to -- or 36% to 39% range. It's not going to be in the low 40's?

Yes. I wouldn't think so. Again, barring any real significant fluctuations.

Right. Right. Right. Okay, that's somewhat helpful. And then -- oh, the writedown that you guys took on the -- I assume that that's the building in Virginia?

Correct. That's just really a function -- it's just a function of the current commercial real estate market environment and the decline in value.

And is that something that, because it was a discontinued op that you can only carry it on your books for a certain amount of time and that's why you had to write it down, or is this just because year-end cleaning up your books and the real estate market's weak and that's why you decided to write it down?

No. I mean, we're actually continually reassessing the carrying value. And just based on some additional analysis and updates based on the current market environment, we just thought it was appropriate.

Okay. And you guys -- do you guys get -- does that go against your taxable earnings or -- from a tax cash perspective?

No.

No. Okay.

No.

That won't be until you actually sell the building.

Correct.

Okay. And then share count looked like it was up a little bit in the quarter. I was just curious if there was -- if that's just driven the prices up a little bit and higher options in the money, or is there anything else that I'm missing there?

No, it's just -- I think it's just a function of the timing. We're under an equity incentive plan. There are two grants that are typically made during the year, in February and in August. So, I think the increase is a function of those August grants.

Okay. Okay. And then, what kind of lead times are you guys getting quoted right now from your suppliers? And I'm just sort of curious about whether, with the shutdowns that we've seen on wire rod side domestically, going -- as you guys look going forward, if the status quo will hold, how much will you expect to be sourced? I mean, obviously place matters, right? But how much would you expect to be sourcing domestically versus internationally? I mean, I guess my question is, can you get everything domestically if the price is right or will you need to go internationally because of the supply that's been taken out of the market?

We're actually still trying to understand all of those dynamics since it is relatively recent that these two steel mills have closed. And we're trying to really understand what the impact on lead times is going to be. But I'd tell you that an initial observation is that lead times are unexpectedly long compared to the anemic level of demand that we see in the market and it is an area of concern.

We don't plan to return to the foreign market unless we see a compelling economic reason to do so. At this point, I don't think we have great concerns about being able to source domestically if we decide that's the right way to go. But I would say that this is a work in progress because we're only about a month or six weeks into having both of these mills down.

And the one -- one of them might come back, correct?

Yes. Yes, I think there's a good chance that it will. But I guess the way that some of the unemployment benefits were structured, there's little reason for the union to be interested in working until some time next spring.

I hope they have a nice vacation in the time off. Now, you guys -- I think that months on hand was about 3.7 -- inventory was about 3.7 months on hand?

Yes. It generally tends to run a little higher around this time of the year due to the seasonality, because that was calculated on a going-forward basis, reflecting an anticipated drop-off in volume.

Okay. So, that's not the months -- you guys just shipped the last couple months. That's going forward, what you might--.

Yes--.

Expect to see given the seasonal slowdown.

Yes. Yes.

And I think you said inventory right now is below what replacement cost in the market would be?

Yes, as of the end of the quarter.

Yes. As of the end of the quarter. And--.

Which is a change from where we were at through the first nine months of the year when we were experiencing those writedowns, where we were behind the curve and the comparison was in the other direction.

Sure. Absolutely. And then I'm just curious whether -- on the wire rod pricing side. I mean, given the fact that it sounds like scrap's going to be down here in November, and maybe December as well. But obviously, countervailing against that is the lead times that you guys are seeing. I mean, are wire rod prices holding steady or do you expect they'll see a little bit of slack as we get towards the end of the year as well?

I think they'll come under some pressure, although the reduced capacity is certainly an offsetting factor. It's just hard to say how far down are scrap prices going to go and how weak do the order books get as we hit the real bad holiday and weather periods. It's just difficult to say. But certainly, I mean, all of these factors tend to have a moderating impact on our expectations for wire rod costs.

Right. Right. Okay. And I guess last, but not least, I mean, I know you guys don't give guidance and it's hard to forecast. But I mean, given the year we just came through, I mean, shipments and the fact that shipment data you guys were able to put in this quarter was pretty darn good, especially provided if you win the PC strand case. I would expect shipments would have a good chance of being actually up next year year-over-year. I mean, is that a fair guess?

Well, the hurdle's so low going through the first part of the year that it's certainly not impossible that that's the case. And we would hope so. We would hope that the underlying level of consumption of our products is, on balance, greater in fiscal 2010 than it was in 2009.

Right. Right. Okay. Alright. Listen, that's all I've got. I appreciate the time, guys, and I'll hop back in the queue.

Thank you.

Thanks.

(OPERATOR INSTRUCTIONS.) We'll go next to Gary Lenhoff of Ironworks Capital.

Good morning. I just want to take maybe a smaller bite at that last question. Q1 are you guys comfortable that volumes will be up year-over-year over last year's quarter?

Yes. I really don't know that we'd want to state that at this point in time. I mean, as we said earlier, the bar's relatively low during the first half of the year.

I'd say we're really not comfortable at all with knowing what's going to happen on the top line. There is a significant sense of conservatism out there. And I expect that we're going to see customers force their inventories down as low as possible for both pricing risk reasons, as well as cash flow reasons. So, it's just very difficult to say.

Okay.

It's a combination of those factors with the usual seasonal forces that makes it real difficult to forecast at this time.

Can you tell us where -- how you feel about -- where is pricing and spreads in October versus the third -- the fourth fiscal quarter?

Well, let's say volume is about on expectation. Spreads are no worse than expectation. So, nothing's fallen off the cliff at this point.

And can you share -- directionally, is that better, worse or about the same as you saw in Q4 with respect to pricing and spreads?

I would say it's about the same although, as I mentioned in my comments, we are detecting a ramp up in competitive pricing opportunity--.

Right--.

Or activity. So, it's difficult to know where that goes over the balance of the quarter.

Okay, great. Thanks much.

Thank you.

Gentlemen, at this time there are no further questions. I'll turn the conference back over to you for any additional or closing remarks.

Okay. Thank you. We appreciate your interest in Insteel and encourage you to call us to follow up if you have further questions. Thank you.

Everyone, that does conclude today's conference. Thank you all for your participation.