Insteel Industries Inc (IIIN) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Insteel Industries first quarter 2011 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will be given at that time. (Operator instructions.) As a reminder, today's conference call is being recorded.

I would like to the conference your host, Mr. H. O. Woltz, President and CEO. Please go ahead.

Thank you, Ally. Good morning. Thank you for your interest in Insteel and welcome to our first quarter 2011 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 then follow up to comment more on market conditions, our business outlook, and the status of our Ivy Steel & Wire integration activities.

Thank you, H. As we reported earlier this morning, Insteel incurred a loss of $7.6 million, or $0.44 a share, for the first quarter ended January 1st, compared with a net loss of $1.1 million, or $0.07 a share, for the same period last year.

Our results for the quarter were unfavorably impacted by acquisition-related costs and restructuring charges associated with our November 2010 acquisition of certain of the assets of Ivy Steel & Wire.

Ivy was previously the second largest producer of welded wire reinforcement products in the US, behind only Insteel, operating five manufacturing facilities located in Arizona, Florida, Missouri, Pennsylvania and Texas.

The timing for brining the Ivy facilities online during the second half of the first quarter correspond with the seasonal low point of our fiscal year, which was ideal from a transition and integration standpoint, but negated any immediate financial contribution.

We are confident, however, that the aggressive actions we have already taken to realize our targeted synergies through the plant consolidations that have been announced, and the elimination of staffing redundancies, will yield the estimated cost reductions indicated in today's release, which amount to $9 million in total on an annualized basis when fully implemented.

The net loss for the current year quarter includes $2.8 million of acquisition related costs, or $0.10 a share after tax, for advisory, audit, legal, and other professional fees, and $4.4 million of restructuring charges, or $0.16 a share after tax, for asset impairment charges, employee separation costs, and future lease obligations for the Houston facility that was closed.

The net loss for the prior year quarter includes $1.9 million of inventory writedowns, or $0.07 a share after tax, to reduce the carrying value of inventory to the lower of cost or market.

On a comparable basis, excluding these charges from both periods, the net loss for the current year quarter would have been $0.18 a share versus essentially a breakeven level in the same period last year.

Despite the significant year-over-year improvement in sales that was posted for the quarter, demand for concrete-reinforcing products continued to trend at depressed levels due to the ongoing recession in our construction end markets.

Net sales for the first quarter were up 27% from the prior year due to the addition of the Ivy facilities, together with higher sales at our existing facilities, driving by a 15.9% increase in shipments and a 9.5% increase in average selling prices. However, even with the double-digit increase in shipments, our first quarter volume was still close to 40% under the peak levels for Q1 that were reached during 2004 to 2008, prior to the onset of the construction downturn.

On a sequential basis, shipments declined 7.7% from the fourth quarter of fiscal 2010, reflecting the usual seasonal downturn, while average selling prices were relatively flat, rising 0.9%.

We incurred a gross loss of about $0.2 million for the first quarter, compared with gross profit of $1.7 million in the prior year, due to reduced spreads between selling prices and raw material costs, driven by the weak market conditions and competitive pricing pressures, and elevated unit conversion costs resulting from the seasonal slowdown and extended down time at our facilities.

Gross margins were also unfavorably impacted by the sale of the higher-cost inventory acquired from Ivy as valued under the purchase accounting regs.

Our overall capacity utilization level for the quarter, including the additional Ivy facilities, was 35% compared with 49% in the fourth quarter and 33% a year ago.

SG&A expense for the first quarter increased $0.4 million, or 11.4%, from the prior year, primarily due to increases in staffing and other transition related costs, largely related to the Ivy acquisition.

Interest expense for the first quarter was relatively flat at about $0.2 million as the higher interest expense from the seller note related to the Ivy acquisition was offset by reduced amortization of capitalized financing costs resulting from the June 2010 amendment of our credit facility.

Our overall effective income tax rate for the first quarter was 34.1%, compared with 43.3% a year ago, primarily due to an increase in our tax valuation allowance relating to the Wilmington plant closure, and changes in permanent book versus tax differences.

Going forward, our effective tax rate will continue to be subject to fluctuations, depending upon the level of future earnings, which could skew the impact of permanent differences and for any adjustments that are made in our estimates that enter into our tax provision calculation.

Moving to the cash flow statement and balance sheet, continuing operating activities used $5.1 million of cash for the first quarter, compared with $9.8 million in the prior-year quarter, as net working capital provided $2 million in cash during the current-year quarter, while using $12.9 million in the prior-year quarter, largely due to the $14.5 million decrease in payables that occurred from Q4 to Q1 of last year as a result of reduced raw material purchases.

Q1 inventories are up $17.1 million on a sequential basis from the fourth quarter of 2010 due to the Ivy acquisition, with close to the entire amount of the unit inventory increase attributable to Ivy.

On an overall basis, average unit values for inventory at the end of the quarter were lower than current replacement costs in the wake of the recent price increases for wire rod, which should favorably impact our Q2 gross margins to the extent that the price increases we have implemented stick in our markets.

Based on our forecasted run rate for Q2, our inventory position at the end of the quarter represented about 3.5 months of shipments, with raw materials at about 65 days, whip at 8 days, and finished goods at 34 days.

We ended the quarter with $2.8 million of cash and cash equivalents, $13.5 million of total debt, and no borrowings outstanding on our $75 million revolving credit facility, which had approximately $58 million of unused borrowing capacity.

As we move into our second fiscal quarter, the primary macro drivers for construction activity imply continued weakness, although the rate of descent that we have experienced over the past few years appears to be moderating.

Yesterday, the American Institute of Architects issued its semi-annual Consensus Construction Forecast, in which it surveyed six of the nation's leading construction forecasting firms. Non-residential construction was projected to bottom out during 2011, declining another 2% in inflation-adjusted dollars before posting a modest increase of 5% in 2012.

At an individual sector level, the latest forecast for 2011 projected a 4.2% reduction for the commercial sector, an 11.8% decrease for manufacturing, and flat spending for institutional construction.

The Architectural Billings Index, which is a leading indicator for non-residential construction activity, ha s moved into positive territory for two consecutive months, rising in December to 54.2% from 52% the previous month, to its highest level since November of 2007.

If these two positive scores prove to be reflective of the beginning of a sustained recovery in design billings for architectural firms, it would imply that we are likely to see an upturn in construction activity begin in the latter part of the year, as construction spending has traditionally lagged behind a design recovery by 9 to 12 months.

I will now turn the call back over to H.

Thank you, Mike. I want to focus my comments first on current market conditions, our outlook for demand over the next few quarters, and developments in our raw material markets. Then, I'll provide some information on our integration activities with respect to our recent purchase from Ivy Steel & Wire.

As we discussed on our Q4 conference call, heightened competitive pricing activity had begun to adversely impact margins across each of Insteel's product lines. We mentioned that spreads between selling prices and raw material costs had declined to levels that severely impacted the operating results of our industry, and were likely to challenge the survival of less cost competitive producers. These conditions persisted through our first quarter, resulting in the margin compression Mike alluded to earlier.

The primary challenge posed by the current macro-environment is the severely depressed level of demand for concrete-reinforcing products, driven by the persistent weakness in the construction sector.

Employment growth, which is essential to a recovery in private non-residential construction, is not yet evident. And considering the dire fiscal positions at the federal, state and local levels, a rebound in demand from the public infrastructure sector appears to be unlikely.

These realities cause us to maintain our conservative outlook for 2011, and to focus our efforts on minimizing cash operating costs, maintaining our market share, and preserving our financial flexibility.

Turning to our raw material markets, after tempering our pricing expectations early in the first fiscal quarter, circumstances changed dramatically later in the quarter with the spike in steel scrap prices, which translated into a $60-per-ton increase in hot rolled wire rod prices, effective with January transactions.

Further escalation in steel scrap prices during the month of January resulted in another round of price increase announcement by our wire rod suppliers, ranging from $75 to $90 per ton for February deliveries.

As is frequently the case, consumers of wire rod tend to increase their order rates in a rising price environment, and the ensuring increase in demand results in extended lead times at the mill, thereby reinforcing the belief that the market is capable of absorbing additional increases.

We've seen this cycle repeat itself in recent weeks, which will drive our raw material costs higher during the current quarter. We have responded to these cost pressures by raising selling prices across all of our product lines by amounts that are sufficient to recover the rod price increases that have been announced. Our first round of price increases went into effect between December 15th and January 7th, and our second round of increases will become effective, depending on the product line, between January 31st and February 7th.

Up to this point, we've been pleased by the market's response to our increases. It appears that the extremely compressed spread environment that existed last quarter has served to instill some discipline on the part of our competitors to recover higher raw material costs. Competitive dynamics will ultimately determine whether the second round of increases will be fully implemented; however, at this point we are optimistic that they will stick.

Wrapping up my comments on the raw material market, in our last conference call we reported that the ArcelorMittal's wire rod mill in South Carolina had been scheduled to restart during January 2011. The commissioning is on schedule and we expect to be sourcing material from the mill during the current quarter.

I'll now turn my comments to our recent acquisition of certain assets of Ivy Steel & Wire, reviewing the strategic rationale for the transaction and providing an update on the status of our integration activities.

Ivy was a long-time leader in the welded wire reinforcing industry, having pioneered the development of the market for engineered structural mesh over the last 20 years. And up until the last couple of years, was the largest producer of welded wire reinforcing in the country.

Through its purchase, Insteel achieved a number of important strategic objectives. First, our footprint is now truly national as we gain more competitive access to markets west of the Rocky Mountains and strengthened our position in both the Midwest and Florida markets.

Second, the transaction significantly enhanced our product mix as Ivy had strong positions in both engineered structural mesh and concrete pipe reinforcing markets, with minimal presence in the more commodity-like market for standard welded wire reinforcing. On a comparative basis, Insteel's mix had much more heavily weighted toward standard products.

Finally, there were significant cost reduction opportunities achievable through the leveraging of our SG&A infrastructure and our manufacturing assets. Insteel is highly sophisticated in its application of information technology to operate its business, and we expect to deploy new tools in the former Ivy plants that will facilitate the availability of enhanced product cost and customer profitability data, as well as improved customer service performance.

From a manufacturing point of view, both Ivy and Insteel had invested heavily in state-of-the-art production technology over the last five years. The facility consolidations we have announced, together with the realignments of product mix capabilities that will occur over the next two quarters, should position the Company as the clear industry leader from the standpoint of manufacturing and customer service capabilities and operating costs.

Our integration activities have moved rapidly and we're pleased with our progress roughly 70 days after close. Our efforts have focused primarily on information systems, people and facilities.

We elected to implement Insteel information systems immediately upon closing, relying only minimally on transition services from the seller. Because the transaction was a simultaneous sign-and-close, we were required to implement temporary hardware solutions until such time as we could provide full access to Insteel networks in the office and on the shop floor of each plant.

At this point, two of the four plants have been fully transitioned away from temporary solutions to permanent, new IT configurations, and the other two plants are projected to be complete in February. The IT infrastructure and training work is on budget and on schedule.

Looking forward, the introduction of new systems and procedures will represent a considerable learning curve to traverse, but the progress made has been satisfactory up to this point and the new tools that are being provided are well received by the former Ivy employees.

From a people point of view, we're pleased with the caliber of employees that joined Insteel through the transaction. Ivy was staffed by professionals who had substantial industry and market expertise and the desire to succeed.

For consistency purposes, we immediately transitioned the new plants to Insteel operating policies and benefit plans. Over the next 90 days we expect to implement Insteel incentive systems at the new plants, migrating compensation to a more variable structure driven off the effectiveness of plant operations, with emphasis on safety, quality and productivity.

Another critical aspect of our integration and transition activities is facility realignments that will assure proper product mix capabilities and optimum equipment configurations and capacities at each facility. Over the next two quarters we expect to relocate several production lines with the objectives of improving quality, elevating our customer service level, lowering operating costs, and minimizing inbound and outbound freight costs.

As you can appreciate, the integration process is a huge undertaking that is highly demanding. We've asked a great deal of our people and they've been stepping up to the challenge.

At this point, I couldn't be more pleased with the planning and execution of this transition. We are solidly on track toward realizing the synergies we identified as critical to meeting our strategic and financial objectives.

Following completion of our transition and integration activities, we should be positioned to operate profitably, even in the weak demand environment that is expected to persist.

We should be able to better demonstrate our increased earning power as our markets begin to show signs of recovery, and the capacity utilization rates start to increase to more reasonable levels.

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

(Operator instructions.) Tim Hayes, Davenport & Company.

A few questions. On the margin from the purchase and accounting with Ivy, can you quantify how much that hurt the December quarter, and then how much it may continue to hurt the March quarter?

I don't know that I could quantify the precise impact for this quarter. In terms of the gross margin, it was really a combination of the two factors I alluded to, the compressed spreads and then just the inflated conversion costs relating to the down time.

But, just on the higher cost of inventory issue, I mean, just based on their inventory levels and projected shipments looking out over Q2, we believe we have the bulk of that behind us by the end of next quarter.

By the end of next quarter being the June quarter or this current quarter?

No, I'm sorry, this quarter, the March quarter end.

Right, right.

Yes.

And then, how much of the sales can you provide me? Is that something that we'll see in the Q, sales related to acquisitions?

It's a good question. Unfortunately, it's difficult to quantify due to the movement in business that has already occurred where a distinct connection with the plant consolidations and other operational efficiency moves that we've taken. And we've already been moving business from their locations to Insteel locations. So, unfortunately, there isn't a lot of clarity that -- where we can breakout their revenue contribution versus ours at this point.

Okay. And then my final question is, on the restart of the mill that you mentioned, do you know how much of the total wire rod market that this restart will be? Just trying to get a sense of how much additional supply is coming online as a percent of what's currently running.

Well, my understanding is that they intend to bring the facility up to about 50% of capacity over the next 90 days. And that would result in somewhere in the neighborhood of 10% to 12% increase in domestic production, roughly.

(Operator instructions.) Gary Lenhoff, Wintrust.

Mike, can you maybe -- the $9 million in annual savings that you allude to, what's the baseline that we should be comparing that to, or going from?

I think there'll be better clarity on that once we've completed the filing on Ivy's historical financials, which will -- which should occur within the next week. Because the majority of those cost savings would be attributable to their financials, I guess you could -- I guess, to some extent, the Wilmington facility would obviously impact the Insteel side, but I think there'll be better clarity once that filing has occurred.

Okay. And it looks like, for this fiscal year at least, CapEx relating to the new -- or the Ivy facilities and the consolidation efforts have increased from about $5 million to $10 million. Can you add a little color in terms of what we should expect maybe longer term? Is that a good number to think about, or are there some special projects this year that might have elevated that number?

I would view that number as being somewhat fluid right now. It's a high level estimate just based on what we're aware of at this point in time. But, we're going through some pretty detailed analysis in connection with the plant consolidations and movement of equipment across locations, which could significantly impact that going forward.

Robert Kelly, Sidoti.

Just on the cost savings that you outlined, do you need volume to recover to a certain level to leverage those savings, or do we start getting the benefit of them right away?

We should get the benefit right away.

So, that $9 million annualized, is that the current level of demand?

Yes. We broke out the components where about $4 million was related to staffing reduction and $5 million on the plant consolidations. That $5 million for the plant rollup would be based on current operating levels. If we were to increase our schedules, ramp up to higher levels, then that amount would likely increase the amount of the savings.

And the staffing reductions have largely been implemented. The plant consolidation, we completed the closure of the Houston facility and we're expecting the Wilmington plant to be closed by the end of this quarter. So, I would generally say, by the end of the quarter and heading into Q3, we should be realizing the entire amount of those savings.

Great. As far as the price increases that you put through, does having Ivy Steel & Wire under the Insteel banner help you all in achieving the price increase?

It certainly doesn't hurt us.

Is the new-found discipline you're seeing in the market, is it a function of the steepness of the price increases, or the pain that the industry has undergone for the last year and a half or so, or the fact that there's glimmers of hope with the AVI pointing to better conditions within the next year or so?

I think it's really a function, Bob, of spreads having been so depressed for the last couple of quarters, as I pointed out in my comments, that I believe that the survival of certain producers was actually threatened. And as the industry was faced with these substantial steel increases, I think it's just out of the question that any producer would not try to collect those increases and even more if possible. The economics, it just -- they were just upside-down up until recently.

Okay. One final one on the balance sheet. Getting pretty skinny on your cash balance. If these price increases continue to escalate as far as your raw material is concerned, do you think you'll need to dip into the revolver to fund operations for a period of time during F'11?

That could potentially occur over the course of this quarter and then we would expect cash flows to improve as we head into the busy season in the second part of the year. I mean, a lot will be dependent on the future raw material market conditions and what happens with pricing, because that'll obviously impact the working capital requirements.

John Kohler, Oppenheimer.

A couple of questions. Did you see any significant industry capacity reductions in the latest round of spread compression?

We did see some exits on the part of higher-cost producers, mainly of standard welded wire reinforcing products. I don't think that that is necessarily played itself all the way out yet; conditions are still pretty difficult. So, we have seen some, but probably not as much as I would have expected given the difficult economic conditions the industry's facing.

And then, did you see any particular areas of geographic strength, whether it be in the West or maybe in Florida?

No, I couldn't point to any particular geography that is running well ahead of others. Texas is always a significant consuming state, and I believe it's had fewer budget difficulties than some of the other areas. And they have had a larger backlog of work in Texas. So, it's probably not as depressed as some of the other areas, but it's definitely feeling some pain.

Gary Lenhoff, Wintrust.

Mike, could you repeat your comment on Q1 inventory? I think you said that the $61 million is about three-and-a-half months of inventory. Is that correct?

Yes, that's correct. That's based on -- that's on a forward-looking basis based on our expected run rates for Q2.

Okay. So, just to make sure I understand this correctly, that would suggest -- if that was your forward-looking view for the rest of the year, that would suggest revenues about even with fiscal 2010. Is that about right?

No, I mean, that's just strictly based on our Q2 shipment run rate and not for the period beyond that, for the busy season of the year. So, I don't know that it would imply -- it really wouldn't imply an annualized sales level.

Tyson Bauer, Wealth Monitors.

Just a quick one from me, more ideological in nature. And that is, with Ivy in tow, do you have the critical mass and capacity when things start to improve that would allow you to give some serious consideration to kind of controlling the front end of your business; and that is, having a small wire rod facility where we can take out some of the volatility here?

Well, the volume of consumption may be sufficient to justify evaluation of that. But, keep in mind the nature of the volatility is coming from the steel scrap market. And it is volatility that all of the steel producers are subject to. And I think it's driven by forces that are much greater than those that affect our industry only. So, I think the volatility is with us and I don't really see a way around it absent some hedging mechanism.

So, you don't necessarily see a value in having your own rod facility?

I'm not convinced that the returns that have come from the wire rod producing industry have been sufficient to make it attractive.

And I am showing no further questions at this time and would like to turn the call back over to Mr. H. Woltz.

Thank you, Ally. We appreciate your interest in the Insteel. Welcome any follow-up calls. And we look forward to talking to you again next quarter. Thank you.

Ladies and gentlemen, that does conclude today's conference. You may all disconnect and have a wonderful day.