Insteel Industries Inc (IIIN) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Insteel Industries third-quarter 2011 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 follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Mr. H.O. Woltz, Insteel's President and CEO. You may begin.

Thank you, Mimi. Good morning, thank you for your interest in Insteel, and welcome to our third-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.

Before I turn the call over to Mike, let me say that we are pleased with our Q3 financial performance which was achieved in an environment of anemic demand for our products, rising costs, and intense competitive conditions. The former Ivy facilities contributed meaningfully to earnings during the quarter, which is a tribute to the effective execution of our integration plan by our manufacturing, administrative, and sales groups.

There is much more to accomplish, but we are solidly on track toward realizing the synergies that form the strategic and financial rationale for the transaction. I extend my sincere appreciation and compliments to all of the Insteel employees who have contributed to our progress up to this point.

I will now turn it over to Mike to review our third-quarter financial results and then follow-up to comment more on market conditions, our business outlook, and the status of our Ivy integration activities.

Thank you, H. As we reported earlier this morning, despite the continuation of weak market conditions, Insteel's earnings for the third quarter ended July 2 rose to the highest level since fiscal 2008, more than doubling the $3.7 million or $0.20 a share from $1.6 million or $0.09 a share for the same period last year.

Our results for the quarter include $2 million or $0.07 a share after-tax of restructuring charges related to the November 2010 acquisition of certain of the assets of Ivy Steel & Wire. Excluding the restructuring charges, net earnings for the quarter were $0.27 a share.

During the quarter we make continued progress with the integration of the four production facilities and incremental business that were added through the Ivy acquisition and we remain on track to realize the anticipated synergies from the transaction. In May, we completed the second of the regional plant consolidations with the closure of the Wilmington, Delaware, facility.

Demand in our construction end-markets continued to trend at depressed levels during the quarter, as evidenced by the most recent construction spending data reported by the Department of Commerce. Total construction spending for May declined for the sixth consecutive month, falling to its lowest level in over 11 years.

Private non-residential construction, our primary demand driver, was down 5.1% from a year ago and 40% from its January 2008 high. Public construction dropped to its lowest level since February 2007 and private residential construction was down 6.6% year over year and 66.2% from its March 2006 high. We believe that the comparative strength of our third-quarter results in such a challenging macro environment attests to the improvement in our earnings power through the Ivy acquisition and our ongoing performance improvements efforts.

Net sales for the third quarter were up 66.3% from the prior year, primarily due to the addition of the Ivy business and higher average selling prices, with shipments rising 41.9% and average selling prices increasing 12.1%. On a sequential basis, shipments rose 7.5% from Q2, reflecting the usual seasonal upturn we experienced moving between the quarters which was in line with the 8% sequential increase of a year ago.

Average selling prices were up 5.5% sequentially due to the additional price increases that were implemented during the quarter to recover the escalation in our raw material costs since December.

Gross profit for the third quarter rose $4.8 million to $12.5 million from $7.7 million in the prior year, with gross margins improving to 12.7% of net sales from 12.4%. The year-over-year improvement was driven by the incremental contribution from the Ivy facilities and wider spreads between selling prices and raw material costs, which more than offset the elevated unit conversion costs resulting from the depressed utilization levels at our facilities.

SG&A expense for the third quarter increased $0.6 million from the prior year, primarily due to staffing increases in our sales and administration functions to support the additional Ivy volume together with higher health insurance costs and stock-based compensation expense. These increases were partially offset by the relative changes in the cash surrender value of life insurance policies and reduced legal expenses where we were incurring the fees associated with the PC strand trade cases in the prior year.

Our effective income tax rate for the third quarter was 32.4% compared with 50.8% a year ago. The effective rates for both periods were impacted by changes in permanent book versus tax differences, which has an amplified impact when pretax earnings or losses are at relatively low levels and the prior year effective rate was skewed higher by tax reserve adjustments. Excluding the impact of permanent differences in tax credits, we would estimate our marginal effective rate to be around 38%.

Moving to the cash flow statement and balance sheet, operating cash flow was essentially at a breakeven level for the third quarter while using $6.8 million in the prior year quarter with the year-over-year improvement largely due to the increases in earnings and add-backs for depreciation and asset impairment charges in the current year quarter together with the relative changes in deferred taxes in net working capital.

Net working capital used $8.8 million of cash during the current year quarter and $10.7 million in the prior year quarter, primarily due to the seasonal increase in sales volume together with the increases in average selling prices and raw material costs. Accounts receivable increased $6.3 million during the quarter due to the sequential increases in shipments and average selling prices, while inventories rose $8.7 million from the second quarter due to a 9.9% increase in average unit values and a 3.9% increase in units.

Our inventory position at the end of the quarter represented around 2.5 months of shipments on a forward-looking basis calculated off the forecasted volume for Q4 with raw materials at 48.9 days, WIP at 4.5 days, and finished goods at 28 days.

Capital expenditures were $6.3 million for the nine-month period and we continue to expect that it will come in at less than $10 million for the fiscal year. We ended the quarter with $2 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 $73.9 million of unused borrowing capacity.

As we move into the second half of the calendar year, there continues to be a high degree of uncertainty regarding the timing and trajectory of a recovery in the construction sector. After showing steady improvement and moving back into positive territory above the 50 growth threshold during 2010, the Architectural Billings Index, a leading indicator of non-residential construction activity, has now fallen for four consecutive months, dropping to 46.3 in June from 47.2 in May.

The outlook for infrastructure spending and the prospects for a new federal highway funding bill have grown increasingly unclear due to the political dynamics in Washington and heightened deficit concerns. Since the previous SAFETEA-LU funding authorization expired in September of 2009 there have been eight temporary extensions with the latest extension scheduled to expire at the end of September. These interim measures have resulted in project delays and cancellations at the state and local level due to the uncertainty regarding future funding levels.

Recently, competing bills have been proposed in the House and Senate that reflect dramatic differences in both the amount of funding and the period for which it would be provided. In the House, the Transportation and Infrastructure Committee has introduced a $230 billion, six-year bill that would reduce spending by around one-third from 2011 enacted funding or about 20% from the previous SAFETEA-LU authorization. The House bill would essentially reduce the level of funding to where it was aligned with the projected revenues coming into the Federal Highway Trust Fund from fuel taxes and withdraw any supplemental support from the Treasury's general fund.

In the Senate, a two-year bill is in the works that would provide for $109 billion of funding, which would represent a continuation of current spending levels adjusted for inflation but require a $12 billion infusion from other revenue sources yet to be identified. At this point it is difficult to predict the timeframe of resolving these differences and the eventual outcome.

Despite the limited visibility regarding future market conditions, we expect that our financial results will be favorably impacted by the increasing contribution provided by the Ivy acquisition and the realization of additional synergies as we complete the remainder of our integration activities.

I will now turn the call back over to H.

Thank you, Mike. As I mentioned in my introductory comments, we continue to operate in an environment of weak demand and intense competitive pressures. Despite the fact that this downturn has persisted for 12 quarters, we have yet to see any signs of recovery in our markets.

Over the past two years, the leading construction forecasters have pushed out the projected timeline for a recovery in their periodic updates to where some of the most recent forecasts are projecting ongoing weakness to persist through 2012 with a recovery not taking hold until 2013. In view of the high degree of uncertainty regarding future market conditions, our focus remains on cost and productivity improvements and the pursuit of additional growth opportunities that would significantly strengthen our competitive position.

We plan to maintain a conservative posture with respect to our balance sheet, thereby preserving our flexibility to navigate through any unexpected developments in our markets and the economy and to capitalize on any acquisition opportunities that may become available.

During our last two conference calls we discussed the margin pressures we were experiencing due to heightened competitive pricing activity in our markets and increasing raw material costs. These trends continued to affect our business during the third quarter and are expected to persist in the fourth quarter as well. The competitive pricing pressures that we are experiencing across all of our product lines reflect the low level of capacity utilization throughout the industry and resulting aggressive tactics employed by competitors seeking to minimize further deterioration in operating rates and cash flow.

Given the acceleration of these trends over the past few quarters together with depressed demand, it's unlikely that the margin environment will improve materially in the fourth quarter. In view of these realities, we maintain our conservative outlook and our focus on achieving further improvements in our productivity levels, minimizing our cash operating costs, maintaining our market share, and preserving our financial flexibility.

Our raw material markets have been somewhat more stable in recent months due to lower volatility in the market for steel scrap and softening demand. As we have seen over time however, it would be a mistake to assume that the recent stability will continue into the future. Conditions in the wire rod market require continuous tactical shifts and short-term planning horizons.

Turning to the Ivy integration, we continue to be pleased with our progress. During the quarter we completed the closure of our Delaware plant and the transition of that business to our Pennsylvania and North Carolina facilities, one of the final remaining milestones in the implementation of our synergy plan. Going forward our activities will be increasingly centered on achieving operational improvements at the newly acquired plants and completing the remaining equipment relocations which should be wrapped up by the end of the first fiscal quarter of 2012.

At this point we have commissioned production lines at the Pennsylvania, Florida, and Arizona plants and are in the process of ramping up their operating levels. The remaining capacity redeployments at the Florida facility will take place during the current quarter and Q1 of 2012.

Following the completion of the capacity realignments we will positioned to focus additional resources on closing the productivity gap that exists at the recently acquired Ivy facilities relative to our existing plants. The gap is largely attributed to equipment configurations, product mix management, and differences in operating culture. As we resolve these issues, we will be transitioning the former Ivy facilities to a compensation structure that is more variable in nature and driven off the effectiveness of plant operations with emphasis on safety, quality, and productivity.

I am glad to report that over the past seven months the management teams at the newly acquired facilities have made considerable strides in cost control and developing more performance-oriented cultures. We expect to realize significant productivity improvements once we have provided enhanced production technology to these groups.

In summary, while we are reassigned to the likely continuation of weak market conditions, we are determined to capitalize on opportunities created by the downturn to significantly increase the Company's future earnings potential. The solid progress that we have made on integrating Ivy favorably positions us for an additional growth.

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

(Operator Instructions) Tim Hayes, Davenport & Company.

Good morning. Couple questions. In terms of the wire rod price, can you remind me what -- in terms of additional supply that has come on this year and maybe any thoughts on why that price seems to be as well supported as it has been? Has there been demand for wire rod coming from other markets that has helped support it?

Given that we see construction as weak as it is, it doesn't seem like it would be coming from that end market.

In terms of new supply, the (inaudible) facility in Georgetown, South Carolina, is up and running, which has occurred during this current Insteel fiscal year. We are glad to see that plant come back into the supply chain.

And you are correct that there are other wire rod consuming sectors that are experiencing robust demand, certainly relative to the construction sector. And I would point out automotive in particular. The producers of automotive fasteners and other parts have been running at elevated levels of capacity utilization really for almost two straight years.

That together with a decline in capacity to produce wire rod over the last few years has really left a reasonably tight market. And, of course, that would pose some concerns for us as the construction industry eventually recovers.

Okay. Then given that the wire rod prices have been pretty stable the last, say, three months or so, have you implemented any more price increases over the last three months or what you did earlier in the year was that what you have -- all that you have done so far? And how well are those -- the price increases that you have put forth, how well have those been received by the marketplace?

As a general statement, I would say it has been a struggle. There is significant price competition in the market. We, depending on product line, are either trying to recover price increases that were announced in previous months or, in the case of certain welded wire reinforcing markets, we had an increase that was effective on July 18 that we are in the process of collecting.

But overall, the environment is highly competitive. It's difficult to collect these increases, certainly in the magnitude of the rod increases that we have taken.

The price increase on the 18th, was that one that was announced earlier or was that one that was announced on the 18th?

No, it was announced the end of June to be effective July 18.

And how much was that for?

$40 per ton.

Okay. Very good, thank you.

(Operator Instructions) John Kohler, Oppenheimer.

Good morning, gentlemen. A couple of questions. I was wondering if you could give us an idea of the magnitude of the productivity gap between Ivy facilities and your older Insteel facilities.

It's hard to make a general statement and I would point out that part of the gap is related to production technology that is employed, part of it is related to product mix that has been put across the equipment, but it's double digit in nature.

Okay. And then my follow-up question there is have you quantified the cost for the production technology improvement? And I am wondering if you could sort of ballpark that.

Yes. Just let me be clear about the tactics we are using there. Given the extremely depressed state of our markets, Insteel had in its factories several production lines that were grossly underutilized. Our initial tactic has been to reposition these, some of these surplus production lines to the Ivy facilities.

So you are not looking at a situation where we are expending vast amounts of capital on new equipment and the costs that we are incurring to make these changes are basically covered in the restructuring numbers that you see.

Mike, do you want to elaborate on that?

No, I think that is really one of the primary drivers of the equipment relocation cost component of the restructuring charges, these equipment moves that we are making.

Excellent. I know it's a difficult environment, you know that better than anybody else, but it's impressive to see that -- your cost control and your ability to still deliver here. So congratulations and thanks.

Jeremy Hellman, Divine Capital Markets.

Just wanted to -- obviously you know what is going on at the federal level funding wise is the tail that wags the dog, but can you speak to what is going on at the state level? Just where you see some states that seem to be in a bit of a better position and the ones that are lagging kind of in your coverage area.

I would tell you the only place that we see any sort of activity that is at all encouraging is in Texas. There seems to be a reasonable amount of activity there, particularly given the sad state of affairs in others states and at the federal level.

Okay. And then if you -- maybe in the back halls and back rooms do you hear any dialog or chatter that the public-private partnership model is gaining any quiet support? Obviously what is going on with the debt ceiling is occupying everyone right now. But once that is resolved and people look to solving other problems down the line, do you think that private money will come into this as a longer-term solution going forward or maybe more tolling instances, which is really the fairest tax there is, to support a lot of us what is required in terms of investment in infrastructure?

Well, as you are probably aware, there is quite a bit of press activity in talking through the public-private partnership approach to this. And I do think that it will be growing, because I think the need creates such a vacuum that it will eventually be filled. If not through the typical historical ways, it will be filled in new ways and public-private is certainly going to play a role there.

The same is true with tolling. I believe that tolls are going to be another tactic that are used by the state governments and federal governments to try to generate some revenue to address the needs that are out there. The real question is what is the timeline and what is the magnitude of all of this.

Sure. Okay, thanks a lot, guys.

Tyson Bauer, Wealth Monitors.

Just a quick follow-up on the previous questions and that is you have explained the Mica and the Boxer bills very well, Mike. Is there a preference of which one you would like to see passed, giving the spending levels but the longer duration, or as long as something gets passed is better than what we have seen the last three years?

I guess there are trade-offs between the two. We would like to blend them together and wind up with at least an extension of the current funding but for a longer period. There may likely be a middle ground struck; it's still unclear at this point.

But I think to the extent that a multi-year fix is put in place that should serve to -- I mean even if it was at the same or reduced funding that would serve to eliminate some of the uncertainty. I don't know that two years is sufficient, but just getting a longer fix in place I think would have a favorable impact.

Are we seeing any trends continuing in regards to any shifts between the use of concrete and obviously some of your products, as opposed to slapping on an inch and a half of blacktop to make things look pretty?

I have read a considerable amount of the impact of oil prices on the asphalt market and the relative increasing competitiveness of concrete. Recently though, particularly in the stimulus area, a lot of the asphalt work that you have seen has been just strictly overlays and not related to new construction.

So I guess I would tell you that I think the potential is there for concrete to gain market share against asphalt in new construction, but there has to be some new construction to make that happen. Concrete is not likely, in my opinion, to make any inroads on just this overlay work.

Okay. And the last question is have you seen any differences in the spending and projects? Obviously you got the federal, the matching with the states, but more on the ground level at the municipal level has that taken a bigger hit than some of these larger state projects or federal-oriented projects?

I don't know that we have a lot of insight into the municipally-funded sector. I can't really comment, because I don't have enough knowledge to give you a good answer, except that municipalities seemed to be in at least as much trouble as the other levels of government.

Okay. Thanks a lot, gentlemen.

(Operator Instructions) I am showing no further questions in the queue at this time.

Okay. We appreciate your participation in the call today. We thank you for your interest and look forward to talking to you next quarter.

Thank you. Ladies and gentlemen, this concludes the conference for today. You may all disconnect and have a wonderful day.