Insteel Industries Inc (IIIN) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Insteel Industries' third-quarter 2015 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, today's conference is being recorded.

I would like to introduce for this conference call Mr. H. Woltz, Insteel President and CEO. You may begin.

Thank you. Good morning. Thank you for your interest in Insteel and welcome to our third-quarter 2015 earnings 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 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 will now turn the call over to Mike to review our third-quarter financial results and the macro indicators for our end markets. 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 third quarter of fiscal 2015 were $5.4 million or $0.29 a share compared with $5.8 million or $0.31 a diluted share a year ago. On a pro forma basis, however, excluding the nonrecurring charges and gains that were noted in today's release, our net earnings for the quarter rose to the highest level since 2008, increasing to $6 million or $0.32 a share from $5.3 million or $0.28 a share a year ago.

The improved results were achieved in spite of the record rainfall and flooding that occurred in the central region of the US during the quarter, particularly in our largest market, Texas, which brought construction activity and customer operations to a standstill for extended periods. The NOAA reported that average rainfall in Texas for the April to June period reached an all-time high of 17 inches, almost double the historical average. And the total for the contiguous US was the second wettest on record at 11 inches or almost 30% above average. We expect the resulting deferral of shipments will have a favorable impact on future business levels and potentially extend our busy season later into the year.

Net sales for the quarter rose 3.3% from last year on a 5.1% increase in shipments, driven by the additional business provided by the ASW acquisition, partially offset by a 1.7% reduction in average selling prices. On a comparable basis, however, adjusting prior-year shipments to include ASW's preacquisition volume, shipments for the quarter were down 8.8% year-over-year, largely due to the adverse weather.

Shipments were up 19.1% sequentially from the second quarter, driven by the usual seasonal factors, as compared to a 25.2% increase between the same periods a year ago, again reflecting the weather-related impact. Gross profit for the quarter benefited from widening spreads, as the drop-off in raw material costs exceeded the decrease in average selling prices, and gross margins improved each month within the quarter, rising to a high point in June.

We expect this favorable trend will continue during our fourth quarter, as lower-cost inventory is consumed, reflecting further reductions in wire rod costs, assuming that selling prices for our products remain flat or decline to a lesser extent. With our inventory valued on a FIFO basis, the raw material costs reflected in cost of sales are largely associated with purchases made in the previous quarter, since we are typically carrying the equivalent of around three months of shipments.

Our inventory position at the end of the third quarter represented 91 days of shipments on a forward-looking basis, calculated off of our Q4 forecasts. Unit conversion costs for Q3 improved sequentially from the second quarter, but were higher than the prior year, as a result of the lower-than-expected production volume, together with higher medical and Workers' Compensation insurance costs. Looking ahead to our fourth quarter, we expect to make further progress in reducing our conversion costs, assuming that operating volumes increase to anticipated levels.

SG&A expense for the quarter was up $0.2 million from a year ago, due to increases in health insurance costs and amortization expense associated with acquired intangible assets, together with the relative changes in the cash surrender value of life insurance policies. We recorded an additional $0.3 million of restructuring charges during the quarter for closure and equipment relocation costs associated with the March shutdown of our Newnan, Georgia PC strand facility. And, at this time, we expect to incur $0.2 million of additional closure-related costs.

We are currently in the process of relocating the strand-related equipment to other facilities and will be selling the real estate. Other expense for the current-year quarter includes the $0.7 million charge associated with the settlement of a customer dispute, net of the $0.1 million gain from insurance recoveries related to the Gallatin fire, while other income for the prior-year quarter includes a $0.8 million gain also related to the Gallatin insurance claim.

Our effective income tax rate for the quarter rose slightly to 34.7% from 34.4% in the prior year, primarily due to changes in permanent book versus tax differences. In May, we completed an amendment to our existing $100 million revolving credit facility that extended the maturity date to 2020, and reduced the applicable LIBOR margins and unused fee. As a result of our strong cash flow for the period, we ended the quarter with $11.4 million of cash on-hand and no borrowings outstanding, providing us with plenty of liquidity to meet our funding needs and pursue additional growth opportunities.

As we move into our fourth fiscal quarter, we expect a recovery in nonresidential construction will regain momentum following the increment weather of the past two quarters, and benefit from the pent-up demand resulting from the related shipment delays. Although the leading indicators for our end markets have shown some signs of softening in the recent months, the outlook remains positive.

After dropping into negative territory in April, the Architectural Billings Index rebounded to 51.9 in May, and has remained above the 50 growth threshold for 12 of the previous 14 months. The Index for the Institutional sector, which has recently been the strongest performing segment, rose to 55.2 in May, its 12th straight monthly increase following a string of negative readings that ran from late-2013 to mid-2014.

The Dodge Momentum Index, another leading indicator for nonresidential building construction, has moderated through the first half of the year, with the June prior-three-month average up 5.4% from the same period last year. In its latest report, Dodge data and analytics indicated that the recent softening was likely related to the economic weakness in the first quarter, and that real estate market fundamentals remain favorable, and should support a pickup in commercial building activity later this year.

The outlook for infrastructure construction continues to be unclear in view of the upcoming expiration of the stopgap federal highway funding bill at the end of this month. There appears to be growing support for a repatriation proposal that would impose a tax on offshore corporate earnings, and use the proceeds to cover the estimated $90 billion to $100 billion that would be required to fund a six-year bill.

Considering there are only 15 days left in the month, it appears that another short-term extension will be enacted, along the lines of the bill that was passed yesterday in the House, to provide additional time to arrive at a longer-term funding solution. Under this bill, federal transportation spending would be extended another five months, and the $8.1 billion of additional funding that would be required would be provided by various tax compliance measures, and the two-year extension of a TSA fee increase.

On a positive note, the ongoing delays and uncertainty at the federal level have spurred a number of states to step up their efforts to generate additional funding on their own to meet their infrastructure requirements through fuel tax increases, new or increased fees, private public partnerships, and bond financings.

I will now turn the call back over to H.

Thank you, Mike. During the third quarter, demand for our reinforcing products benefited from favorable seasonal influences, partially offset by adverse weather conditions in some regions of the country, which delayed construction projects and unfavorably affected production schedules at some of our customers, particularly in the central part of the country.

Normalizing for these conditions, demand for our products reflects the continuing recovery in construction markets. Capacity utilization for the quarter was 54% compared with 58% last year. Macro indicators, as well as customer sentiment, indicate continued growth, as we look ahead to the next few quarters.

During the Q2 earnings call, we mentioned the prospect for expanding spreads resulting from declining prices for metallic units and steel wire rod, together with the potential for stable selling prices resulting from the cyclical recovery in construction markets and the usual seasonal upturn. Our Q3 results reflect some benefit from this confluence of market conditions, although weaker-than-expected demand contributed to more competitive pricing activity than we had initially anticipated.

Based on current conditions, we expect our fourth-quarter financial performance to be favorably impacted by a continuation of these trends. As we've mentioned previously, however, it's difficult to forecast our selling prices and volume with a high degree of precision, given the dynamic nature of our markets, short order lead-times, and minimal backlog. Looking ahead, there does not appear to be a significant catalyst on the horizon for recovery in the metallics markets, which implies that our raw material pricing may fluctuate within a reasonably narrow range, resulting in a rather long and flat bottom.

China continues to exert enormous influence on the world market, depressing prices throughout the supply chain. We expect that the pending permanent closure of a domestic wire rod production facility will contribute to some strengthening of the market for our raw materials. We had anticipated this mill closure, and believe we are well-positioned to transition our requirements to other suppliers without negatively impacting our customers or our financial performance. As we reported in Q2, we proceeded with the closure of the Newnan, Georgia PC strand plant that was acquired in August 2014 as part of the ASW transaction.

Following the cessation of manufacturing activities in March, the remaining inventory was shipped during Q3, and customer requirements were shifted to other Insteel facilities. We are in the process of relocating the production equipment from Newnan, and plan to ramp up production rates significantly at the Houston, Texas PC strand facility that was also part of the ASW transaction. We've begun to realize cost reductions that are expected to amount to approximately $3 million per year.

Turning to CapEx, we initially expected that capital outlays would range between $11 million and $13 million for fiscal 2015. Factoring in timing issues for various projects that are underway or anticipated, we now estimate that CapEx will come in at less than $11 million, as changes in project timelines have pushed certain expenditures into 2016.

The new, high-volume standard welded wire reinforcing production line at our Pennsylvania facility replaces obsolete technology, and provides increased capacity to produce certain SKUs for which we've been routinely short on capacity. The line is now staffed for two operating shifts per day. And we plan to ramp up the third shift as operator training and technical considerations allow. We expect this line to be fully operational during the current quarter.

We are also commissioning a new wire production line at our Florida welded wire reinforcing facility that is expected to be fully functional during the current quarter. The

new line rounds out capacity and allows for reduced operating costs.

Finally, as we mentioned previously, we plan to expand the manufacturing capabilities of our Houston PC strand facility with funding requirements falling primarily into 2016. We have completed a considerable amount of engineering and design work, and have navigated most of the permitting requirements for the project.

Other capital outlays will be focused on maintaining our facilities, lowering our operating costs, and improving our information technology infrastructure. We'll provide an overview of our expectations for 2016 CapEx during our fourth-quarter call in October.

To summarize, we believe the recovery in nonresidential construction markets will continue to gain traction through 2015. In addition, we expect to benefit from enhanced spreads and margins, assuming that selling prices for our reinforcing products remain relatively stable, which appears likely, considering that seasonal and cyclical trends should drive capacity utilization levels higher across our industry. Consistent with prior periods, we'll continue to focus on achieving further improvements in the effectiveness of our manufacturing operations, and identifying additional opportunities to broaden our product offering and growth through acquisition.

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

(Operator Instructions) Michael Conti, Sidoti.

Yes, so I guess to start, I mean, you cited weather as a drag. I was hoping if you could comment on how monthly sales progressed throughout the quarter? And then just maybe comment on the month of July. I know we are only two weeks in, but what are you seeing so far in terms of order flow?

Well, I think the normal seasonal upturn is in play, Mike. Certainly, the weather conditions that we referred to in the release and in the call affected the momentum during Q3. But I don't think that -- certainly, there is no carryover of that into Q4, and we would expect for volumes to be about as expected going forward. So, if you are wondering whether there is a continuing lag, there is not.

The bulk of the weather-related impacts seems to be in the month of May and then through the early part of June.

Okay, thanks. And then, secondly, I guess your comment just regarding the increased traction. I mean, is that optimism on your part or your customers? Or are you seeing increased order flow or pipeline, expected shipments hitting their books? I just want to be able to (multiple speakers) --.

Well, I think most of our expectations are driven by the macro projections that we read for the industry, as well as the anecdotal sentiments expressed to us by our customers. We really aren't tapped into any other sort of proprietary information loop.

Sure, okay. AND I guess just building on that, H., I mean you've been in the business a long time, and just given the estimates out there, you know we all look at the same macro data -- just given the estimates for non-res, I mean, does this feel like a single -- a high-single-digit construction recovery here? I mean, what's your take on that?

Yes, I think you can make that case, Mike, that all along, we've -- or up until the last quarter or two, we've referred to this recovery as somewhat subdued. There's certainly been no breakout from the downturn. It's been sort of plodding and steady. But I think the mid to high-single-digits is a reasonable characterization of where we are.

Okay, good. And then lastly -- I mean, you generate nice free cash flow. And Mike, you talked about eliminating your debt in the quarter, and -- what's your latest thinking on potential M&A opportunities in the space? Are you seeing any financially distressed companies out there? Or, I mean, what's the strategy behind it (multiple speakers) --?

No, I think the time where you would've expected to see a lot of distress has passed, that -- we're not seeing that. We are continually looking for acquisition opportunities, and believe that we are very well-positioned to effectively assimilate additional acquisitions. And you can rest assured that it's near the top of our priority list.

Okay, great. I'll hop back in queue.

All right. Thank you.

Tyson Bauer, KC Capital.

You touched on this a little bit, the weather situation, primarily Texas, some of the Southern tier that you typically have a better strength early in the warmer weather season. Historically, we don't necessarily play catch-up, per se, with pent-up demand, that all of a sudden we get a big rush going through the following quarter. But we have, in cases, seen that you have a seasonal benefit that gets prolonged.

Do you think because of where the weather situation occurred, that you may see greater strength that may last a little longer through Q4, into Q1, that maybe we wouldn't see otherwise, that we'd just get a prolonged benefit?

Yes, I suspect that's exactly what we'll see, Tyson. I can tell you that I am unaware of any project that has been permanently canceled because of weather consideration. So, what we will see is a little more frenzy on -- during our normal up-season. We'll see a little more frenzy on the part of customers to complete more work. And it is likely to go further into the fall than typical. So -- but I don't think this thing has affected -- or the adverse weather situation -- has affected overall consumption of our products at all.

Correct. Which also means we may not necessarily get the benefit on ASP's, per se, either because we're not dealing with a situation where we are going to increase capacity, say, 10 points.

You mean we're not going to see capacity utilization ratchet up significantly?

(multiple speakers) -- emphatically, yes.

Yes. No, I think that's fair to say.

Okay. Steel costs, obviously, you talked about should get some benefit the way you manage your raw materials going forward. Obviously, we see some changes. Anything that's more long-term or more in length and duration that would create some visibility on where those costs should stay? Or is it really just going to continue to fluctuate?

Well, I would expect that we'll see fluctuations, Tyson, but I think worldwide, the overall pressure from the Chinese in our industry today, it's coming in the form of extremely low-priced steel billets that are being shipped around the world to re-rollers, and are making a lot of wire rod available at very low costs for many countries.

And I don't see a catalyst for that changing in the near-term. So I think that we'll see some -- we'll continue to see some volatility, but in a relatively narrow $10 to $30 per ton range, rather than some of these huge swings that we've seen over time in the $50 to $100 range.

Okay. In regards to the transportation bill, obviously some different rhetoric coming out of the Senate versus the House. Overall, would you anticipate that the size on any long-term bill may be lower than previous funding levels? But the overall funding, if we include state contributions and local municipality contributions, may either be the same, if not greater, in spending, especially if we add in the private contributions?

I think it's difficult to say at the federal level, because there's still a high degree of uncertainty. It seems that with this repatriation approach that they are targeting to generate enough funds to maintain the spending at current levels. And then you have the President's proposal, which reflects a substantial increase.

I don't know that we have clarity on that. But we would agree that we have seen some upside at the state level, where it's gotten to the point where they can no longer defer their needs, and they are moving ahead on other fronts through increases in the fuel tax and other revenue-generating measures. So I think you are likely to see that trend continue going forward.

And is there any movement in regards to allocation of those federal monies, as some of the larger states squawk in regards to their disproportionate contribution into those funds, as opposed to what they get back on federal matching?

I think that jousting always is going on, but I am unaware of any significant change in that circumstance.

Okay. H., given your years in doing this, I know the tongue-in-cheek comment in California is there are obviously more infrastructure projects in election years. That's how they know the election is coming up. More politicians with names on bridges than otherwise. Do you or have you seen that to be the case, that we typically see a little more activity in those time periods?

Well, I'm certainly aware of the sentiment. And I would tell you that when we have seen those kinds of shenanigans, it mainly takes the form of road paving with asphalt, because it can be done quickly and it's visible to voters. I can tell you it will have no impact on our business one way or the other.

Okay. So let's say an inch-and-a-half of pretty black asphalt to get votes?

That's exactly right.

(laughter) All right. Thanks a lot, gentlemen.

Thank you.

(Operator Instructions) And I'm not showing any further questions at this time.

Okay. Well, thank you for your time today. We appreciate your interest in the Company, and look forward to talking with you next quarter.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.