Insteel Industries Inc (IIIN) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Insteel Industries third-quarter 2014 conference call. (Operator Instructions). As a reminder, this conference is being recorded.

Now I would like to turn the call over to H. Woltz, President and CEO of Insteel Industries. Mr. Woltz, you may begin.

Thank you, Kevin. Good morning. Thank you for your interest in Insteel, and welcome to our third-quarter 2014 conference call, which will we 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 on today's call are considered to be forward-looking statements, which 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.

All forward-looking statements are based on our current expectations and information that is currently available. We do not assume any obligation to update these statements in the future to reflect the occurrence of anticipated or unanticipated events or new information.

I'll now turn the call over to Mike to review our third-quarter financial results and the macro indicators for our construction end markets. Then I will follow up to comment more on market conditions and our business Outlook.

Thank you, H. As we reported earlier this morning, Insteel posted strong results for the third quarter of fiscal 2014, with net earnings rising to $5.8 million or $0.31 a diluted share from $3.3 million or $0.19 a share in the second quarter and $3.3 million or $0.18 a share in the prior-year quarter.

Excluding a net gain from insurance proceeds related to the fire at our Gallatin manufacturing facility, net earnings for the third quarter were $5.3 million or $0.28 a diluted share, the highest level since fiscal 2008 before the onset of the recession in the nonresidential construction sector.

Net sales for the quarter rose 16.8% from last year to a record high of $113 million, driven by a 16% increase in shipments, which also reached an all-time high, and a 0.7% increase in average selling prices. The previous highs, however, were not on a comparable basis, as they were achieved prior to our November 2010 acquisition of Ivy Steel & Wire. Since Ivy was generating over $200 million of revenues on a stand-alone basis in 2008, our pro forma combined revenues were approaching $600 million, which is still significantly higher than our current run rate.

Although demand in our markets remains well under prerecession levels, we are encouraged by the continued recovery in shipments, which have now risen year over year for five consecutive quarters and in seven of the previous eight quarters.

On a sequential basis, net sales were up 23.8% from the second quarter on a 25.2% increase in shipments, partially offset by a 1.1% reduction in average selling prices driven by a less favorable product mix relative to Q2.

Gross profit for the quarter improved to $14.3 million from $10.9 million a year ago, with gross margins widening 130 basis points to 12.6% from 11.3% due to the increase in shipments, higher spreads between selling prices and raw material costs, and lower unit conversion costs and higher operating volumes relative to the prior-year quarter.

Our overall capacity utilization for the quarter improved to 58%, its highest level since 2008. The Gallatin fire and insurance claim did not impact our operating costs for the quarter or nine-month period, as the out-of-pocket expenses recorded in cost of sales and SG&A expense were offset by insurance proceeds. Other income for the quarter includes a net gain that I alluded to earlier of $0.8 million, representing the excess of the insurance proceeds attributable to the replacement of property and equipment over the carrying value of the assets that were destroyed in the fire.

SG&A expense for the quarter rose $0.8 million from a year ago, primarily due to higher incentive compensation expense driven by our improved results, partially offset by an increase in the cash surrender value of life insurance policies.

Our effective income tax rate for the quarter fell to 34.4% versus 35.5% in the prior year, primarily due to changes in permanent tax differences. Going forward, our effective rate will continue to be subject to fluctuations based upon the level of future earnings, changes in permanent tax differences, and adjustments to the other assumptions and estimates entering into the tax provision calculation.

Moving to the cash flow statement and balance sheet, cash provided by operating activities improved to $14.2 million for the quarter due to $6.9 million of cash provided by net working capital and the increase in earnings. Accounts receivable rose $5.5 million, driven by the sequential increase in sales. Inventories rose $7.8 million, and accounts payable and accrued expenses increased $20.1 million, largely due to higher raw material purchases and a higher proportion of import receipts during the quarter.

Our inventory position at the end of Q3 represented about 3.4 months of shipments on a forward-looking basis, calculated off of forecasted shipments for the fourth quarter. Capital expenditures through the first nine months of the year total $5.8 million, which includes $1.9 million in outlays related to the Gallatin fire. We have scaled down our CapEx estimate for the year to less than $5 million, excluding the fire-related outlays, largely due to changes in the anticipated timing of certain payments previously forecasted for Q4 into early next year.

We ended the quarter with $31.4 million of cash on hand, up $12.3 million from the previous quarter, and no borrowings outstanding on our $100 million revolving credit facility, providing us with plenty of liquidity.

As we move into the last quarter of our fiscal year, the macro indicators for our construction end markets are reflecting continued improvement. After dropping into negative territory for two straight months, the Architectural Billings Index moved back into positive territory in May, rebounding to 52.6. It is now remained above the 50 growth threshold for 17 of the previous 22 months, its longest positive streak since 2007, implying increased construction spending for nonresidential buildings in the coming months.

Private nonresidential construction spending through the first five months of the year was up 12.5% from last year, and the seasonally adjusted annual rate has now risen year over year for 10 straight months and at a double-digit rate over the past five months. Public construction spending, however, has remained relatively weak on an overall basis. The May year-to-date total fell about 1% from last year, although the highway and street and transportation categories were up around 4%.

The outlook for federal transportation infrastructure construction spending continues to be clouded by uncertainty, in view of the upcoming expiration of the current MAP-21 funding authorization in September, and recent forecasts indicating that the Federal Highway Trust Fund could be depleted by the end of August. As we had anticipated on our last call, it now appears likely that a short-term extension will be enacted that provides additional time for the development of a longer-term funding plan.

You may recall that following the expiration in the previous SAFETEA-LU highway bill in September 2009, a series of nine short-term extensions were required before MAP-21 was enacted almost three years later in July of 2012. Although the limited duration of the extension that is likely to be passed is disappointing, we are encouraged by the increased dialogue in Washington regarding longer-term funding solutions, particularly the bipartisan Corker/Murphy proposal, which would increase the gas and diesel tax by $0.12 over a two-year period and then index the taxes to inflation.

The resulting revenue infusion has been estimated to range from $160 billion to over $200 billion over a 10-year period, which would be sufficient to offset the anticipated shortfall in the Highway Trust Fund that has required over $54 billion of transfers from the General Fund to the Treasury since 2008.

I will now turn the call back over to H.

Thank you, Mike. As reflected in our release and in Mike's comments, we are encouraged by the continued improvement in market conditions during the third quarter. These favorable trends are largely consistent with the various macro indicators and forecasts for the construction sector and our previously stated view that demand for our reinforcing product should improve over the next few quarters.

While our capacity utilization improved to 58% in Q3, it remains depressed on an absolute basis relative to prerecession levels, and we suspect that competitors are operating at comparable rates. Taken together, slow growth, capacity additions by certain competitors, and concerns about the resilience of the construction recovery have contributed to a highly competitive pricing environment that prevails in our markets.

We expect that these conditions will persist until there are further meaningful improvements in demand. With that said, the pricing environment during our third quarter was relatively stable, reflecting growing demand for reinforcing products and lower volatility in pricing for our principal raw material, hot rolled wire rod. Contributing to the more stable pricing environment has been reduced volatility in the steel scrap markets, which have traded at a narrow range over the past few months.

We welcome this stability and would like to see it continue. Ultimately, we would expect to see the opportunity to expand margins as market conditions continue to improve and capacity utilization rates rise, providing the industry with the opportunity to sell more selectively.

As we reported previously, last January a group of domestic wire rod producers filed antidumping and countervailing duty cases against China, which has been the current primary source of imported wire rod to the US market for the last two years. On July 8, the Department of Commerce published its preliminary determination in the CVD case, indicating subsidy rates between 10% and 81%. Commerce is scheduled to make its preliminary determination in the antidumping case on August 29.

We expect that the antidumping duties will be substantial and that domestic producers will prevail in their injury argument, causing China to exit the US wire rod market. The final determinations in the cases are expected sometime between November and January.

In anticipation of successful Chinese trade cases, we elevated our import purchases and inventory levels to bridge the transition from China to other offshore sources for the portion of our material requirement that is imported -- which can vary, depending on market conditions, from about 15% to 30%. In assessing the attractiveness of offshore purchases, we consider the working capital implications and pricing exposure that are inherent due to the longer lead times and larger order quantities relative to domestic purchases.

Predictably, other foreign sources have replaced Chinese producers, and we expect a continuation of ample availability. Transaction prices for imported material have risen by approximately $60 per ton, implying the need for us to increase selling prices for our product lines that consume foreign rod, in order to avoid margin compression. And that process is currently underway. Although it is too soon to comment on the likelihood that we'll recover these additional costs, cyclical and seasonal factors cause us to be optimistic.

Mike mentioned that we scaled down our CapEx forecast due to timing issues associated with payments for machinery commitments. Going forward, CapEx will continue to be focused on maintaining our facilities and our information systems infrastructure, expanding capacity where warranted, improving quality, and reducing operating costs. We continue to view maintenance CapEx to be in the range of $5 million to $6 million annually.

Finally, Mike touched on the financial impact of the fire that we experienced in January at the Gallatin, Tennessee, PC strand facility. The repair work on the facility is approximately 60% complete, and we continue to expect the startup of the reconstructed cleaning operation will occur during the fourth fiscal quarter. Our people, working in cooperation with the responsive group of outside toll processors, have done an excellent job of making this unfortunate incident a nonevent for our customers.

To summarize, the recovery in nonresidential construction markets has accelerated somewhat, resulting in an uptick in our capacity utilization rate, although the market environment remains highly competitive. Our most immediate external concern relates to the looming crisis with the Federal Highway Trust Fund. An unfavorable outcome of discussions to shore up federal infrastructure funding could begin negatively impacting certain Insteel customers late in the first fiscal quarter or early in second fiscal quarter of 2015.

Consistent with prior periods, we will continue to focus on achieving further improvements in the effectiveness of our manufacturing operations and identifying additional opportunities to broaden our product offering and grow through acquisition.

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

(Operator Instructions). Tim Moore, Rutabaga Capital.

Congratulations on the quarter's top-line growth acceleration and the nice rise in utilization. But I was just wondering, with so much net cash now, and your untapped revolver, as well as with interest rates low, can you kind of share with us if you have given consideration to maybe doing a buyback; and how you weigh that against maybe a strategic tack-on acquisition?

I think our view on that is consistent with past periods, where we view the number one objective of the Company for use of its resources to be finding growth opportunities going forward. Once we believe that we have adequate liquidity to accommodate those, as you know, we have a buyback resolution in place. We also have a history of returning cash to shareholders through special dividends, as warranted.

So I don't think the Company's position has changed at all -- that those are the priorities, or the continuing priorities. And I think you can expect us to act in the future as we have in the past on those issues.

Great. Thank you.

Tyson Bauer, KC Capital.

Good job, gentlemen, and hopefully better quarters ahead. A couple quick questions. We talked about the private or nonpublic activity on the construction side. Do you have a sense of any pockets of greater strength in others -- maybe in the commercial, or institutional, or industrial segments -- that you have seen a greater benefit, given the location of your manufacturing facilities?

I would say that disparity is more geographic than by construction segment. And I don't know that we have tremendous visibility into each construction segment, except for the data that is Department of Commerce oriented. Geographically, we continue to see Texas and related -- the surrounding areas as the strongest market, but recovery elsewhere, as well.

Okay. And a nice segue with Texas you mentioned on your answer; we are seeing more states independently -- not basically counting on the federal government to provide funding for infrastructure needs, and doing special activities, raising funds, doing their own bills that are more state-oriented instead of looking for matching federal funds.

They seem to be the leader in the country of doing that. You are ideally located in Texas. Is that going to be a growing theme, if the best that we are hoping for on the federal policy is just to maintain previous spending levels? And they may do add-on bills that are specific to bridges or otherwise, but the general highway funding seems to be, best-case scenario, just maintaining. Will we see a greater percentage, then, going onto the states and the local municipalities to meet their infrastructure needs?

Yes. I mean, we would expect that to be an ongoing theme, where just in a lot of situations the states really don't have a choice, because they can no longer defer certain outlays. So you are seeing a lot of alternative approaches being pursued to raise revenues through the various means. And to the extent there is continued uncertainty at the federal level, we expect the states will get more aggressive.

We are also seeing a trend in the oil energy markets having to provide funding for states, as they use the infrastructure for a lot of their trucking needs in the fracking operations and otherwise. Is that a pocket of strength that you are also participating in?

We believe we are benefiting from that, but it's difficult for us to get that granular and pinpoint how much demand or consumption is driven by that specifically.

Tyson, I'm sure you've read about some of the mega-chemical projects that are underway in the shale oil geographies. And those facilities do require a lot of underground infrastructure that consume our product. So to the extent that those facilities wouldn't be built were it not for the fracking and shale oil phenomenon, then we are definitely benefiting, although it is impossible to quantify it.

Okay. The higher shipments (technical difficulty)

Yes, that sequential shipment increase of 25% -- that is significantly higher than what we would typically experience. So it is a combination of factors, where there is definitely some effect from pent-up demand, just due to the adverse weather in the previous quarter. But the increase was, above and beyond that, reflecting continued improvement in activity.

Okay. And last question: you talked about some of the industrial -- the chemical plants and some of the other growth areas. Are you seeing a better adoption rate and better reception to your ESM product line? And do you think that will facilitate better margins as we go forward?

Yes, we continue to make good progress with state DOTs and individual customers to adopt ESM as alternative means of reinforcing. And we expect growth out of that sector, and I'd say we are proceeding on the expected schedule.

Sounds great. Thanks a lot, gentlemen.

(Operator Instructions). Jon Evans, JWest.

This may be a silly question, but especially in Texas, it seems like the cement companies and the ready-mix guys are getting pretty aggressive on pricing and starting to push pricing. Does that give you any ability to have cover to push price for your product in Texas as opposed to other markets? Or could you give us any insights into that?

I would say it doesn't really give us any cover. I think the same market forces that are allowing the cement-related industries to raise prices are positively affecting in our business, but there's no direct linkage. So I would take that as a positive underlying fundamental of the market, but I wouldn't infer anything about our ability to price our product from it.

Relative to spreads, with what you see relative to scrap pricing, would you think spreads get better in Q3 as opposed to Q2 relative (technical difficulty)?

Well, it is hard to say. And we make a habit of not forecasting spreads in margins. But if you go back to the comment that I made on what is going to take for us to see that opportunity to expand our margin, we are really going to need to see the industry operating at better levels of capacity utilization, and I think that just implies the need for continued market improvement.

Got it. Great.

I'm not showing any further questions at this time.

Okay. In that case, we appreciate your interest in Insteel, and we look forward to talking to you next quarter. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.