Insteel Industries Inc (IIIN) 2010 Q1 法說會逐字稿

Good day, everyone, and welcome to the Insteel Industries first-quarter 2010 conference call. Today's call is being recorded. At this time, I would like to turn the call over to Insteel's President and CEO, H. O. Woltz III. Please go ahead, sir.

Good morning. Thank you for your interest in Insteel and welcome to our first-quarter 2010 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'll turn it over to Mike to review our first-quarter financial results and the macro environment that we are contending with, and then I will follow up to comment on market conditions, the PC strand trade cases, and our business outlook, and then we'll take your questions.

Thank you, H. As we reported earlier this morning, Insteel incurred a net loss of $1.1 million, or $0.07 a share, for the first quarter of fiscal 2010, compared with a net loss of $5.6 million, or $0.33 a share, for the same period last year.

The net losses in both the current- and prior-year periods include charges for inventory write-downs amounting to $1.9 million pretax, or $0.07 a share after tax, in the current-year quarter, and $6.8 million pretax, or $0.24 a share after tax, in the prior-year quarter. Excluding these write-downs from both periods, we would've essentially been at a breakeven level for the current-year quarter versus a loss of $0.09 a share in the same period last year.

Insteel's first-quarter financial results were unfavorably impacted by depressed shipment volumes, narrowing spreads between selling prices and raw material costs, and elevated unit conversion costs due to reduced operating levels.

Net sales for the first quarter decreased 33.3% from the prior year, due to a 35.2% decline in average selling prices, which was partially offset by a 2.9% increase in shipments. On a sequential basis, shipments fell 31.4% from the fourth quarter of fiscal 2009, which benefited from having one additional week based on our fiscal calendar. The sequential decline was significantly higher than the typical seasonal drop-off that we experienced from Q4 to Q1, which prior to 2008 had generally been in the low teens from a percentage standpoint.

We believe the more pronounced decline this year was driven by the ongoing weakness in non-residential construction, together with adverse weather conditions in many of our markets, which hampered construction activity.

Average selling prices for the first quarter were down 1.7% from the fourth quarter, due to competitive pricing pressures in our markets, particularly for standard welded wire reinforcing products, where pricing was down 45% year over year and 8.2% on a sequential basis.

Gross profit for the first quarter was $1.7 million, or 4.2% of net sales, compared with a gross loss of $4.3 million, or 6.9% of net sales, in the prior year. Gross profit for the current-year quarter includes the $1.9 million charge that I referenced earlier to write down inventories to the lower of cost or market. These write-downs resulted from the pricing erosion for standard welded wire reinforcing products that occurred during the quarter, largely due to certain competitors that appeared to be focused on liquidating excess inventories regardless of the impact on margins.

Excluding the inventory write-downs from both years, gross margins would've been 8.9% for the current-year quarter and 4.1% for the same period last year.

Virtually all of the $6 million year-over-year improvement in gross profit was due to the reduction in inventory write-downs and widening in spreads and, to a much lesser extent, lower unit conversion costs.

Our overall capacity utilization for the quarter dropped to 33% from 56% in the fourth quarter and 42% in the prior-year quarter, primarily due to the scaled-down operating schedules that we implemented at all of our facilities, particularly during December, in response to the extended year-end shutdowns that were taken by customers. As a result, our total unit production for the quarter was down 14.5% from the severely depressed levels of a year ago and 39.7% on a sequential basis from Q4, which adversely impacted our unit conversion costs.

SG&A expense for the quarter decreased $1 million, or 20.9%, from the prior year and $0.4 million, or 9.3%, from the fourth quarter. Approximately $836,000 of the year-over-year decrease was due to the relative changes in the cash surrender value of insurance policies. Cash surrender values rose $111,000 in the current-year quarter, due to the appreciation in the value of the underlying investments, as compared to a $725,000 decrease in the prior year resulting from the collapse in the financial markets.

The remainder of the decrease in SG&A expense was driven by reductions in payroll taxes, salaries, and travel expense.

The $153,000 of other income for the quarter was primarily related to the settlement of a dispute with an equipment vendor.

Our effective income tax rate for the quarter rose to 43.4% from 38.3% in the prior-year quarter, primarily due to changes in the federal tax regulations enacted in November 2009 regarding the carryback of net operating losses, which increased the anticipated tax refund related to the prior-year loss, together with the change in permanent book versus tax differences. Adjustments of this nature tend to have an amplified impact on the effective tax rate when pretax income or losses are relatively low.

Moving to the cash flow statement and balance sheet, operating activities used $9.8 million of cash for the quarter, compared with $15.8 million for the prior-year quarter. The cash used by operating activities in the current-year quarter was primarily attributable to the reduction in raw material purchases.

Inventories at the end of the first quarter were relatively flat on a sequential basis compared with the previous quarter-end, as unit inventories increased 2.1% while average unit values declined 2.3%. Based on our current forecasted run rate for shipments through the remainder of fiscal 2010, our inventory position at the end of Q1 represented about 3.3 months of shipments.

Accounts Payable dropped by $15.1 million from the previous quarter-end to $8.8 million, due to the reduction in raw material purchases during the quarter. The $16.5 million of prepaid expenses and other as of the end of the quarter includes a $13.3 million receivable for the income tax refund that we expect to receive during the second quarter relating to our prior-year loss.

Capital expenditures for the current-year quarter fell to $0.3 million from $0.9 million last year. Looking ahead through the remainder of the year, we continue to expect that CapEx will come in at less than $5 million for fiscal 2010.

We did not repurchase any shares of our stock during the quarter under a 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 quarter debt free with $24.3 million of cash and cash equivalents, a $10.8 million decrease from the end of the fourth quarter, but $23.1 million above the prior-year level.

As we move into the second quarter, we expect business conditions to remain challenging due to continuing weakness in construction markets. In the latest monthly report from the Department of Commerce, which is for November, total construction spending fell to $900 billion, the lowest level in over six years. Private non-residential construction spending, the primary demand driver for our products, was down 20.6% year over year and has now fallen for eight consecutive months, with every category reflecting year-over-year decreases, other than power construction.

Public construction was only up 2.7% year over year as any favorable impact from the federal stimulus has largely been offset by reduced funding at the state and local level due to budget constraints. The Architectural Billings Index, or ABI, which serves as a leading indicator for non-residential construction, increased slightly in December to 43.4 from 42.8 in November, but has now remained in negative territory for 23 consecutive months.

Based on the approximate nine- to 12-month lag time between architectural billings and construction spending, the steepest portion of the downturn in construction spending should be occurring in late 2009.

Earlier this month, American Institute of Architects also issued its semiannual Consensus Construction Forecast in which it surveys the nation's six leading construction forecasting firms. Non-residential construction was projected to decline another 13.4% in 2010 in inflation-adjusted dollars. The steepest declines were forecasted for commercial and industrial construction, moderated by smaller declines for institutional construction.

Although we remain bullish about the long-term prospects for infrastructure construction, our near-term outlook is clouded by the uncertainty regarding federal funding levels and the growing budget shortfalls at the state and local level. The $154 billion jobs bill that was narrowly passed by the House in mid-December provides $48 billion for public works projects, including $27.5 billion for highways and $8.4 million for mass transit. However, the prospects for passage in the Senate appear to be increasingly bleak at this time.

Although the Obama administration is working with Congress on a new multiyear transportation bill that is expected to total somewhere in the neighborhood of $500 billion, the timing for its passage remains uncertain due to the difficulty in arriving at a palatable funding solution, which will likely require increases in the federal fuel tax as well as other revenue sources. As a temporary fix, funding levels provided for under the previous SAFETEA-LU authorization, which expired in September, have been extended through February.

I will now turn the call back over to H.

Thank you, Mike. Those of you who listened to our fourth-quarter call last October may recall that the sales and earnings improvement we posted for the fourth quarter was overshadowed by concerns regarding the upcoming seasonal downturn and the potential for it to be more pronounced, given the severe cyclical slump in our markets. As you can see from our first-quarter results, our concerns were well-founded as shipments and production for the quarter were only slightly higher than the prior-year quarter, which was the weakest on record.

Operationally, we reduced operating hours or simply idled facilities for extended periods of time during the quarter as we focused on minimizing our cash costs of operation. The outages that we implemented were draconian, resulting in a capacity utilization rate of only 33% for the quarter. While such a low rate is a sobering reminder of the weakness that we are experiencing in our markets, we are also mindful of the strain that curtailed schedules cause for our people.

As market conditions recover, we look forward to ramping up our manufacturing facilities and getting our people back to work on full schedules.

In our call last quarter, we mentioned that we'd begun to experience heightened levels of price competition. This activity continued into our first quarter, especially in our standard welded wire reinforcing market, which has always tended to be more volatile from a pricing standpoint. Prices were in a freefall for much of the quarter, giving rise once again to the inventory write-downs that Mike alluded to earlier.

Competitive pricing activity in other product lines was less pronounced, but nonetheless a source of concern. In the wake of the recent escalation in steel scrap prices and ensuing increases in the prices for steel wire rod, our primary raw material, pricing momentum has changed across all our product lines to where it now appears that the next moves will be upward.

In addition to a firm scrap market, we believe that wire rod producers are benefiting from higher capacity utilization rates following the plant closures that occurred in 2009, together with the impact of restocking that's occurring in all markets and particularly in the automotive sector. We are aware of rod mills that are operating on nearly full schedules, which raises the prospect for tight supplies and rising prices as the seasonally weak winter months for construction activity give way to the typical spring upturn.

Here in our second quarter thus far, we have received price increase announcements from our rod vendors ranging from $115 to $128 per ton effective between January and February, and given recent market trends, additional increases may materialize for March.

We plan price increases for each of our product lines that are at least sufficient to recover these cost increases. The success of our efforts will be determined by competitive dynamics and the balance of supply and demand. We are hopeful that these cost pressures serve to reinstitute a greater degree of rationality in our markets than what we experienced during the first quarter.

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 are pleased by the preliminary determinations of the Department of Commerce with respect to countervailing duties and dumping margins, and are now focused on the culmination of the process, which includes final determinations by the Department of Commerce with respect to countervailing and anti-dumping duty margins and a final determination of injury by the International Trade Commission, which is expected next June or July.

While no one can predict the eventual outcome of the China cases, they unquestionably have had positive impact on the domestic market for strand. Chinese imports have fallen precipitously since the cases were filed to where the Chinese have essentially been out of the market in recent months.

As the quantities of dumped Chinese strand have diminished, we have successfully renewed our participation with customers that previously relied heavily or even exclusively on low-priced Chinese imports. Although the potential volume of business with these customers has been unfavorably impacted by the overall erosion in market demand, we are once again competitive and our future prospects with these customers have improved considerably.

Predictably, as low-priced Chinese import quantities have declined in response to the trade cases, other countries have ramped up exports to the U.S.. 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 U.S. law.

As we look forward through the balance of 2010, we expect demand for our products to remain at depressed levels, although we should experience a favorable seasonal upturn. Our efforts to recover rising costs through increased selling prices will be played out against cyclically low demand, but the sheer magnitude of steel scrap and wire rod increases is such that competitors, both integrated and independent, will likely be compelled to recover them through price increases.

Longer term, we realize that our markets are unlikely to recover to pre-recession levels until our economy grows and businesses return to hiring mode, and we've taken the necessary steps to deal with this reality. Given these facts, the country's fiscal and political challenges are sobering. We are fortunate to remain in a strong competitive position with world-class operating costs and ample financial flexibility. We remain hopeful that the difficult business conditions we are experiencing will serve as a catalyst for attractive growth opportunities.

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

(Operator Instructions). Nat Kellogg, Next Generation Equity Research.

Just a couple of things. On the Chinese side of things, I'm just curious how much benefit or lack thereof that you guys -- I mean, how much were they out of the market during the quarter, and obviously I would've expected that your potential and new customers would have some inventory that they need to work through first, so I guess I'm sort of -- did you guys see any benefit from that in the quarter or would you -- . Just a little more color there would be great.

We did, Nat, and we have for the last couple of quarters as the Chinese volumes have really ramped down over the last six or eight months. The Chinese, for all intents and purposes, are really out of this market now, and while there is no objective data that we can provide, all appearances are that the substantial inventories that overhung for many months have by and large been worked off, so we're really not seeing them as a factor.

So, I mean, I guess, but going forward it's not like there is any more incremental improvement there. You guys have -- during the quarter, you saw most of the benefit you're going to get from pushing them out of the market.

Yes, I think that, as I said in my comments, that the good news is that we are competitive and we're back to a regular business relationship with many of these customers that relied on Chinese product. The bad news is that many of those customers have very little business, particularly given the fact that many of them focus on the residential segment of the construction market, and I don't need to tell you what's going on there.

Then just on the cost side. On the write -- inventory write-down. Was that inventory that you guys have purchased that is still sort of overhanging from the high-priced steel purchased late last year or was that just stuff that you purchased more recently, but it's just the price in wire rod was -- sorry, in welded wire was falling fast enough that that was what caused the inventory write-down? I guess I'm just surprised. I thought we'd worked through most of that, and so I'm just trying to get a little color on what sort of drove that.

It was really the latter, that -- it's not inventory overhang from surplus quantities that we had when things started to fall apart last year. In fact, this whole write-down problem is driven by collapsing selling prices. So, it's not overhang of the old problem.

Obviously, I'd imagine you guys feel pretty good about where your inventory is priced today, though, going into the March quarter, given the fact that we've seen some upward pricing on wire rod costs.

I think we feel good about where we are. And I think we are also very cognizant of the volatility in this market, and it's surprising to us that we are seeing the dramatic escalations in costs that are taking place. We are very mindful of the fact that this thing could turn around rapidly the other direction. So, we are taking a conservative position.

Okay, and I mean, I guess if you guys start to see -- I mean, if folks started raising prices in -- for your products, given the fact that input costs have gone up or is that still yet to play out?

There are price increasement -- price increase announcements that are operative in certain product lines already. There is widespread anticipation, not just among producers like Insteel, but also consumers of our products, widespread expectations for significant price increases coming up shortly, and I think probably everyone is on track that -- that's going to be what happens.

Okay. Okay, and I know -- were you guys looking at sort of a $50 a ton or is this $100 a ton?

For?

The price increases. I realize it varies a little bit by product line.

On our selling prices, you are referring to?

Yes.

No, it would be definitely more than that (multiple speakers)

More than that.

Yes, because wire rod increases range from $115 to $128, and that's only through February. So it's very possible we may see something additional in March.

I can tell you that the existing price increase announcement that does exist in one of our product lines is $100 per ton.

All right, that's helpful. I appreciate the color, as always, and I'll hop back in the queue. Thank you.

Robert Kelly, Sidoti & Company.

If we adjust for the inventory write-down on your gross margin and compare 1Q 2010 to 1Q 2009, can you just give us, like, the push and pull -- what helped you, if you could quantify it, and what hurt you? To the degree that utilization hurt you in the quarter and how much that was offset by the improvement in volume or better pricing -- or better spreads, sorry.

Are you referring to a year-over-year comparison?

Yes, the year-over-year change.

The shipments were relatively flat. We were up 2%, somewhere in that vicinity, so that really wasn't much of an impact. So, the bulk of it would really be just the year-over-year swing in the write-downs. That accounted for, I guess -- the gross profit change was about $6 million and the bulk of that could be accounted for by the change in the write-downs, and also (multiple speakers)

Yes, if we were to just ignore the write-downs.

Strip that out. The widening, yes, there was some widening in spreads year over year, and then to a much lesser extent, lower unit conversion costs in the current year even with -- even given the reduced operating schedules that -- although that was much -- that was a less significant factor than the widening in spreads.

So what did your spread look like compared to 4Q?

It's narrowed relative to 4Q, just due to the competitive pricing pressures, particularly in the standard product line.

How much of the sequential decline in gross margin was due to spread versus utilization?

On a sequential basis, we would attribute about half of the decrease to -- in gross profit to the reduction in shipments, and then the balance would be split between narrowing spreads and higher unit conversion costs.

So now, the spreads are hanging in there pretty well, despite the seasonality. You're talking about your vendors increasing prices for -- I guess, your 2Q time period. Forever you've been able to match that inflation with your own price increases. Any reason why that should change now?

I don't know that there are any fundamental reasons that it should change, Bob. But at the same time, every time we go through this it's a unique and independent event.

I would tell you that the magnitude of these cost increases actually increases my confidence that we'll be able to pass through the rising costs because they're just of a magnitude -- I can't imagine anyone really feeling like they could absorb it or even a meaningful part of it.

Now, you guys had gone through a destocking cycle for much of 2009, and it sounds like a little bit from 4Q to 1Q. What is your outlook relative to the close of 1Q into the rest of F2010? Are you seeing your sales match end-user demand?

Actually, I think right now the picture is clouded somewhat by just the obvious fact that prices are going to rise substantially. We've actually seen a flurry of purchasing activity that is surprisingly strong.

But I don't think it reflects -- it doesn't reflect any change in underlying demand. It more reflects just the impending price increases.

Now, the utilization you are in after 1Q, should we expect that depressed level for the balance of the year, or by the time we hit 2H are we seeing something similar to what we saw in your 2H fiscal 2009?

I think you certainly won't see it persist at the depressed levels of the first quarter. It will rise, and we really have stayed away from forecasting utilization rates, but I guess I don't see that we are going to remain anywhere near the first-quarter level.

Now, as far as -- just following on with this strand question, the Chinese strand is really no longer a factor in the market. It hasn't been for a couple of quarters.

Correct.

And to really leverage, I guess, that newfound opportunity there, what needs to happen? Do you need to see residential markets bounce back or some sort of destocking take place within the supply chain?

I think -- as I said earlier, there's no real good objective data available to us about inventory levels. But just from talking with customers and being in the market, I think our people feel like that's run its course. There's not more destocking to take place certainly of any meaningful amount.

What we need to see is a recovery in consumption, and as you'll probably recall from prior discussions, a disproportionate amount of the imported material has wound up in residential markets over the past few years and, in fact, those residential markets have accounted for a large percentage of the growing consumption of PC strand in the U.S.. So, probably more in terms of benefits to us of lower Chinese participation is going to be a recovering housing market and, to a lesser extent, recovering in other commercial markets.

Okay, great. And then, just on the balance sheet, the tax refund is due to you in 2Q. (multiple speakers)

Yes, we expect to receive it during the second quarter.

And then, as far as your inventory position and, I guess, your raw materials, are you in build mode for the balance of F2010 where you are using cash or do you still expect to generate cash from working capital?

At this time, we'd expect inventories to remain relatively flat, possibly decline slightly, although that's subject to change depending on changes in the rod market.

Yes, but if prices are going up, all things outstanding, should be, do you think, working capital?

Yes, I was referring just from a unit standpoint (multiple speakers)

Finished goods. Oh, okay, got you. Thanks, Mike; thanks, H.

(Operator Instructions). Gary Lenhoff, Ironworks Capital Management.

Just real quickly, H., would you be comfortable sharing with us where is your operating rate today?

We really don't -- we don't release the data and the specifics concerning our operating rates.

Okay, that's fine. Thanks very much, guys.

At this time, there are no further questions in the queue. I would like to turn the call back over to Mr. Woltz for his closing comments.

We appreciate your interest in the Company. Feel free to follow up with us if you have further questions. Thank you.

That does conclude today's conference. We thank you for your participation.