Insteel Industries Inc (IIIN) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Insteel Industries' second-quarter 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 call is being recorded.

I would now like to turn the conference over to your host Mr. H.O. Woltz, President and CEO. You may begin.

Good morning. Thank you for your interest in Insteel and welcome to our second-quarter 2012 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 second-quarter financial results. Then I'll follow up to comment more on market conditions and our business outlook.

Thank you, H. As we reported earlier this morning, Insteel's net earnings for the second quarter ended March 31, which is typically one of the seasonally weaker periods of our fiscal year, were $0.3 million, or $0.01 a share, compared with $2.6 million, or $0.15 a share, in the year-ago period. Excluding the Ivy related restructuring charges from both years and the acquisition costs and bargain purchase gain from the prior-year period, net earnings were $0.02 for the current year quarter versus $0.23 a year ago.

Although we are beginning to see signs of improvement on the horizon for our construction end markets, demand for our products remained at depressed levels during the quarter. The latest construction spending data reported by the Department of Commerce reflected a similar lull in activity following five consecutive monthly increases over the latter part of 2011 with total construction and private non-res construction spending declining in February for the second straight month. On a year-over-year basis, however, total construction spending was up 5.8% while private non-res construction, our primary demand driver, was up 14.5% from last year and has now risen year-over-year for nine consecutive months.

Insteel's net sales for the second quarter were relatively flat compared with the prior year as the 7% increase in average selling prices was largely offset by a 6.4% decrease in shipments. The year-over-year drop off in volume was a relative to a prior-year period in which shipments were favorably impacted to some extent by customer hedge buying in response to the escalation in our selling prices which rose 10% from December to March of last year while declining 1% over the same period last year.

We believe the unusually mild winter weather accelerated construction activity earlier into the year in some of our markets, although we are unable to quantify the impact at this time or the extent to which it affected Q2 versus Q1 shipments.

On a sequential basis, shipments for the quarter were up 3% from Q1, reflecting the usual seasonal improvement, while average selling prices were down 0.4% as a result of competitive pricing pressures.

Gross profit for the second quarter fell to $5.5 million from $11.6 million in the year-ago quarter with gross margins narrowing to 6.3% of net sales from 13.3% due to reduced spreads between selling prices and raw material costs, the drop off in shipments, and higher unit conversion costs. Gross profit for the quarter was also unfavorably impacted by disruptions related to the relocation and reinstallation of equipment at two of the former Ivy plants. We are currently in the process of ramping up operating volumes at both facilities and expect substantial improvement in their financial results over the remainder of the year.

SG&A expense for the second quarter increased $0.4 million from a year ago, primarily due to a gain on the settlement of life insurance policies that reduced prior-year expense, together with higher compensation costs in the current year largely from the staffing additions required to support the incremental Ivy volume. These factors are partially offset by a larger increase in the cash surrender value of life insurance policies in the current year.

Interest expense for the second quarter fell to less than (technical difficulty) the prior-year level primarily due to lower interest rates in our revolving credit facility relative to the $13.5 million note related to the Ivy acquisition that was outstanding in the prior-year quarter and prepaid in December.

Our effective income tax rate (technical difficulty) the second quarter was 36.3% compared with 40.6% a year ago due to the impact of book versus tax differences which are amplified at lower levels of pretax earnings. Going forward, our effective rate will continue to be subject to fluctuations based upon future earnings, changes in permanent book versus tax differences and adjustments to the other assumptions and estimates that enter into our (technical difficulty) calculation.

Moving to the cash flow statement and balance sheet, operating activities provided $12.3 million of cash for the (technical difficulty) quarter compared with $5.1 million in the year-ago period. The year-over-year improvement was largely driven by the relative changes in the networking capital components of Accounts Receivable, inventories and Accounts Payable and accrued expenses which provided $8.6 million of cash in the current-year quarter while using $2.3 million in the prior year, primarily due to the impact of the Ivy acquisition in the prior-year period.

Accounts Receivable rose $0.4 million during the quarter due to the sequential increase in sales, while inventories fell $4.2 million from Q1 on a $5.4 million reduction in units and a 0.3% decline in average unit values.

Our inventory position at the end of the quarter represented 84 days of shipment or about 2.75 months on a forward-looking basis calculated off of a forecast of shipments for Q3 with raw materials at 40 days, WIP at four days and finished goods at 40 days.

Capital expenditures came in at $3 million for the quarter, largely due to the initial payments related to the two new ESM (technical difficulty) that were referenced in today's release which H will discuss in more detail later in this call. Even after including the outlays related to these projects, we do not expect CapEx to exceed $10 million in fiscal 2012 or 2013.

As previously reported, we completed the amendment of our revolving credit facility during the quarter which incorporated a number of favorable changes for the Company, including an extension in the maturity date by one year to June 2016, an increase in the commitment amount from $75 million to $100 million, and reductions in the LIBOR margins and unused fee. We ended the quarter with $8 million outstanding on the facility, down $8.4 million from the end of Q1 and had $68.6 million of additional borrowing availability.

Looking ahead to the remainder of the fiscal year, we expect gradual but modest improvement in our nonresidential construction end markets following the unprecedented drop-off in demand that we have experienced since 2008. Business conditions are likely to remain challenging, however, until there is higher sustained growth in both the economy and the labor market.

The architectural (technical difficulty) leading economic indicator for non-res construction activity has been reflecting positive trends since late last year led by improving conditions in the commercial sector. Yesterday's March report marked the fifth consecutive month that it has exceeded the 50 growth threshold.

Unfortunately, the outlook for infrastructure construction, which drives an estimated 35% of the demand for our products, remains uncertain due to the continued lack of clarity regarding a new multi-year federal highway funding bill.

Following the expiration of the previous SAFETEA-LU authorization in September 2009, there have been nine temporary funding extensions, the most recent of which expires on June 30. This continued lack of visibility at the state and local level has the effect of shifting the project mix away from longer-term new build projects that are heavier consumers of our concrete reinforcing products to resurfacing and repair type work.

Yesterday, the House passed a further extension that runs through the end of September which will serve as a springboard to enter into negotiations with the Senate on a new bill. Given the current political dynamics, it is unclear what the outcome of these negotiations will be at this time.

As we move into the second half of the year, we expect that our financial results will be favorably impacted by the usual seasonal upturn in volume and the anticipated benefits from the reconfiguration of our welded wire reinforcement operations.

I will now turn the call back over to H.

Thank you, Mike. Our Q2 results reflect the continuation of the depressed market conditions that we have experienced since the fourth quarter of fiscal 2008, together with competitive pricing pressures that have compressed spreads across all our product lines. Although we are encouraged by the recent improvement in private nonresidential construction indicators and the reports by some customers of a definite uptick in both quotation activity and bookings in the commercial market, we expect business conditions to remain challenging through the remainder of the year. As Mike pointed out, the outlook for infrastructure related portion of our business continues to be clouded by the uncertainty regarding a new federal highway funding bill given the election year politics that are likely to persist.

As reported in today's release, during the quarter, we committed to the purchase of additional production lines for engineered structural mesh that will affect our Texas, Missouri, and North Carolina facilities. These investments in state-of-the-art technology will expand our capacity, broaden our product offering, reduce our conversion costs, and enhance our customer service capabilities.

You may recall that, shortly after we completed the Ivy acquisition, we closed Ivy's Houston manufacturing facility and absorbed the volume at our Dayton, Texas plant without any equipment additions. Consequently, the Dayton plant and our ESM business as a whole have (technical difficulty) higher capacity utilization levels than implied by the overall rates referenced in our release to the point that we will soon require additional capacity to ensure satisfactory customer service levels and accommodate an eventual recovery in the Texas market.

In addition to providing incremental capacity, the new production line will be nearly twice as productive as more conventional technology, which is expected to favorably impact our unit conversion costs.

Additionally, we plan to add a production line for specialty ESM products at our North Carolina plant. This line is oriented towards small batch production for highly specialized reinforcements typically fabricated by customers from Rebar using labor-intensive manual processes. The line will produce practically any geometric shape required by a customer, including circles, trapezoids and rhomboids, and will minimize the need for off-line processing when fabricating voids within our reinforcement. The new technology should enable us to expand our present (technical difficulty) sector of the market while reducing yield loss and minimizing the substantial labor costs that are associated with off-line fabrication activities. Taken together, these new lines have incremental revenue generating capacity of $15 million to $2 million per year and are expected to be commissioned during the second quarter of fiscal 2013.

Turning to our raw material markets, following the volatility in steel scrap prices that occurred during the last few weeks of December, market conditions have remained relatively stable since early in the second quarter. Pricing has flattened out and availability is reasonable, consistent with normal leadtimes. Of course, we are accustomed to rapid changes in the metallics market, and we have no reason to believe that the recent stability is indicative of a fundamental change in the market.

In February, Nucor Corporation announced an investment initiative that includes a significant broadening of the product range of its Darlington, South Carolina steel mill. It is our understanding that the expansion includes a new wire rod rolling mill with a target date for commissioning during the second half of 2013. The addition of this capacity would relieve some of our concern about the potential for inadequate supplies of (technical difficulty) produced wire rod at the point in time when construction markets begin to recover.

In summary, although we're encouraged to see some signs of a construction market recovery on the horizon, we expect the balance of 2012 to be difficult with only marginal improvements in demand and the continuation of a highly competitive pricing environment. While these conditions are not welcome, we believe this environment could yield additional growth opportunities that would further strengthen our competitive position and our earnings potential.

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

(Operator Instructions). Robert Kelly, Sidoti & Company.

Hey Mike, hey H. Good morning. Could you just maybe order of magnitude walk through the margin compression year-on-year in 2Q? Was it primarily the raw material spread? How much did the reconfiguration hurt you?

I would say on a comparative basis, the spread compression was a lot more significant where -- despite the year-over-year increase in sell-in prices which were up 7%, the increase in raw materials exceeded that amount, so we experienced some compression in spreads.

Then there are two facilities in particular that have suffered through disruptions related to our reconfiguration activities, the movement and reinstallation of equipment, but as we indicated, we are in the process of ramping up both plants and are expecting significant improvement in their costs over the remainder of the year. But overall, the spread compression would've been the more significant factor.

What did -- can you quantify what the disruption cost you in the two facilities?

I don't know if we could quantify that precisely.

Okay. As far as the competitive pricing, has that eased as you moved into April and saw the signs, or the way you characterized it in your release, the signs increasing quoting and bidding activity in the commercial market?

No, Bob, there has been really no improvement. It's still a real food fight out there as everyone scrambles for available orders. So I wish I could tell you that there has been a significant improvement, but unfortunately, it's just not the case.

Okay. Then as far as what you are holding in inventory, how does that relate to where the market price for wire rod is?

We feel pretty comfortable with where we're at. There really isn't a significant gap in terms of our inventory carrying values versus current market prices.

You are at the market now. Okay. As far as the commentary for the new capacity in wire rod, does that necessarily help your cause? One of the benefits that you guys have discussed in the past is having a wire rod market be tight and using that as a basis for getting price increases from your customer. How does a looser wire rod market help Insteel (multiple speakers)?

I think really was we were referring to is that with the construction industry operating at such a terribly low level of capacity utilization, if you would project a recovery in the construction market, I think there is clearly the possibility that there would be shortages of wire rod in the marketplace, which would obviously give us some concern relative to our ability to service our customers, and it would also give us some concern relative to our competitiveness with integrated suppliers of wire products. So, overall, we believe this is a positive development for Insteel.

Okay, I follow. Then just finally on the ESM line expansion, the need for more production capacity there indicates that demand levels still are pretty strong there. So, what is dragging down Company-wide utilization? Is it all strand? Is it the standard welded?

Clearly, if you go back and look at the Ivy product mix, it was much more heavily oriented toward engineered structural mesh than Insteel's product mix. So bringing over those volumes and particularly the way we did it in Texas where we closed a facility and consolidated that production at our Dayton, Texas plant without any addition of equipment caused a significant ramp up in capacity utilization at Dayton.

As we look out, I pointed out in my comments that a commissioning is at least a year away from the (technical difficulty) of an order. So as we look down the road to the future, it's clear to us that, to maintain our customer service capabilities and our market share in any kind of a recovering environment, we had to go ahead and move on these opportunities.

So, engineered structural mesh is definitely operating at a higher level of capacity utilization in Texas and elsewhere for that matter, as compared to either of our other welded wire reinforcing product lines and also relative to PC strand.

Okay. Thanks a lot guys.

Alan Brochstein, AB Analytical.

Thank you for taking the call. I'm just wondering. The competitive environment, it's kind of challenging that your competition is that dropping and this has been going on for a while. What do you think is going on here?

Well, it is, we certainly note the same thing. I think that there are subsistence levels of spreads between wire rod cost and sell-in values for our finished products that allow people to barely make it. That is what we're facing in the marketplace on a daily basis. Why there hasn't been more dropout, I can't really answer.

So, with that said, obviously Ivy, the timing with the question, it looks like great long-term investment. I'm glad to see you guys extending upon that acquisition. But are there other potential acquisitions? What is your appetite for that?

Well, we think one of the silver linings of this environment could be the opportunity for further acquisitions that would fit well within our existing product lines, and we are very interested and active in searching out those opportunities. We believe that both financially, operationally and from an infrastructure point of view internally that we are very capable of doing further acquisitions.

Are any of your competitors open to that at this point or is this prospective?

No, I would say it is prospective.

Okay. Then just lastly, I see you have capped your CapEx expectations at $10 million. Mike, I assume, even with these investments, D&A will continue to run about $10 million a year. Is that accurate?

Yes, they should be relatively close to one another.

Okay, thank you and good luck guys.

(Operator Instructions) Tyson Bauer, KC Capital.

Good morning, gentlemen. Are we looking at similar capacity utilization then to last year as we kind of muddle our way through here?

I think that is probably accurate.

You talked about the industry and some of the weakness obviously in some of the competitive aspects. Is there just an overcapacity because of the current demand, or is there an absolute overcapacity in which there needs to be attrition either through those folks falling off or through consolidation efforts in which plants are then combined and that taken out of capacity?

I think, if you were to look back before the downturn -- and Mike, you might need to help me some here -- but Insteel generally ran in the 70s and low 80s as a percentage of utilization. Today, we are running far below that.

I think the question is really, the question is really when does the market begin to grow again and at what rate? I don't think that, at least in Insteel's view, we have resisted the more draconian consolidation kinds of activities, are under the belief that there will be a recovery in demand for the product and with the objective of maintaining our geographic diversity and our ability to operate on a nationwide scale. So, I think it's just a matter of timing, but I don't think anyone's forecast would be for a rapid return to 2006, 2007, 2008 kinds of volumes, and that would definitely imply that consolidation, in terms of business combinations among some of the producers in this industry, would be a good idea.

Okay. You talked about some of the geographic divergence that is going on in Texas a little stronger than some of your other areas. That is probably propping up your utilization that we are seeing overall. What conditions are you seeing, say, on the East Coast or the Atlantic as opposed to some of these other areas that are really causing a little more pain than, say, where Texas is a little bit stronger?

Yes, Texas is clearly the strongest for Insteel, both because of the consolidation of manufacturing facilities as well as our fiscal situation in the state that is better than what we see generally. The West Coast is clearly the weakest geography that we serve, and it is concerningly weak. The East Coast is some better than the West Coast but not as -- certainly not as robust as what we see in Texas.

When you attempted to do the price increase at the beginning of February, was that just a complete failure to get those prices because nobody would follow suit, so that some of your volumes go away, or did you abandon it early just to maintain some of your utilization in the volumes?

It really -- the circumstances are different between product lines. For instance, we reported in the call last time that we never even attempted to raise prices for PC strand in view of the obvious waste of time that it would've represented. We were successful more or less in other product lines to certain degrees. In some of these product lines, we are quoting now for a period of time -- that a price is good for a period of time, but we are quitting on a job-by-job basis. You can see pretty quickly the direction that competitors are taking as these individual jobs are quoted out in the market. And so in areas where there was some opportunity to raise prices, we did. But to a larger extent, prices remained flat or even fell in some cases.

Okay, thank you guys.

Thank you. Ladies and gentlemen, I'm showing no further questions in the queue at this time. I will hand the call back to management for closing remarks.

Okay. We appreciate your interest in the Company and your participation in the call today and feel free to call us for follow-up as you would like. Thank you.

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