Insteel Industries Inc (IIIN) 2016 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Insteel Industries' first quarter 2016 conference call. (Operator Instructions). As a reminder to our audience, this conference is being recorded. Now, I would like to turn the conference over to H. Woltz, Insteel's President and CEO. Sir, you have the floor.

Thank you, Bryan. Good morning. Thank you for your interest in Insteel and welcome to our first quarter 2016 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'll now turn it over to Mike to review our first quarter financial results and the macro indicators for our construction end-markets, then I'll follow-up to comment more on market conditions and our business outlook.

Thank you, H. As reported in this morning's press release, Insteel posted strong results for the first quarter of fiscal 2016, driven by continued margin expansion. Net earnings grew 62% from a year ago to $6.7 million, or $0.36 per share, from $4.2 million or $0.22 per diluted share, rising to the second highest level in our history for the first quarter.

Net sales for the quarter fell 16.5% from last year on a 9% decrease in shipments and an 8.3% reduction in average selling prices. On a sequential basis, net sales were down 21.8% from the fourth quarter due to a 19.9% drop off in shipments and a 2.3% decrease in average selling prices. Around half of the year-over-year and sequential shipment decreases were driven by our fiscal calendar and the inclusion of an extra week in our fourth-quarter, which last occurred in fiscal 2009.

The additional week had the effect of extending the end of the first quarter from December 26 to January 2 and eliminating the week ended October 3, in effect adding one of the seasonally slowest weeks of the year and dropping a stronger week that fell within our busy season. On a pro forma basis, adjusting both quarters to reflect the same dates and duration as the prior years, the year-over-year shipment decrease was 4.6% instead of the 9% that was reported, and the sequential decrease from Q4 to Q1 was 8.9% rather than 19.9%, which is actually lower than the seasonal reduction we typically experience between the periods.

Over the past few weeks, our order book has strengthened and shipments have trended above expected levels, although I would caution that we're still early in the second quarter and our volume over the remainder of the period can be significantly impacted by the relative severity of the winter weather, as we've seen in prior years.

Gross profit for the quarter improved to $16.4 million from $12 million a year ago, with gross margins widening 690 basis points to 17.8% from 10.9%, due to higher spreads as the continued reduction in raw material costs exceeded a smaller decrease in average selling prices and more than offset the impact of the lower shipments. As we've indicated on prior calls, considering that we're typically carrying around three months of inventory valued on a FIFO basis, the raw material costs reflected in cost of sales for any given quarter are largely associated with purchases made in the previous quarter.

In the declining price environment, as we've experienced over most of the past year, this time-lag has the effect of deferring the favorable impact of the reduction in raw material costs until the higher cost inventory purchased in earlier periods is sold. At the end of the first quarter, our inventory position represented around 3 1/2 months of shipments on a forward-looking basis calculated off of our Q2 forecast. So as we move into our second quarter our spreads and margins should be favorably impacted as the more recent lower-cost purchases are gradually reflected in cost of sales, assuming that our selling prices remain flat or fall to a lesser extent.

For those of you that may have noticed, we elected to drop the capacity utilization metric that was previously reported in our earnings release, as it was subject to misinterpretation when there were changes in our product mix. We believe the percentage change in shipment serves as a more accurate indicator of our volume trends.

SG&A expense for the quarter rose $0.7 million from a year ago to $6.3 million, primarily due to higher accrued incentive compensation expense driven by the improvement in our results over last year. As a result of the strong operating cash flow for the quarter, our cash balance increased by $12.4 million to $45.6 million. Following the end of the quarter we paid the special cash dividend of $1 per share that we had declared in December, which totaled $18.6 million. We ended the quarter debt-free with no borrowings outstanding on our credit facility, providing us with the liquidity to meet our funding needs and the flexibility to pursue additional growth opportunities.

As we look ahead to the remainder of fiscal 2016, the leading indicators for nonresidential construction are pointing to continued improvement. Yesterday the American Institute of Architects reported that the Architecture Billings Index ended the year in positive territory, rising to 50.9 in December. Over the course of 2015, the ABR remained above the 50 growth threshold for 8 of the 12 months, implying further improvement in nonresidential building construction in the coming year.

The institutional sector continued to be the strongest performer, as it has now posted increases for 19 straight months. The Dodge Momentum Index, another leading indicator for nonresidential building construction, rebounded 4.1% in December after reflecting some softening over the prior two months. On a year-over-year basis the overall index was up 2.4%, driven by the strength in institutional projects, which were up 15.8% and more than offset a 6.7% decrease in commercial projects. In its latest release, Dodge indicated that strong industry fundamentals should drive renewed growth in commercial project planning activity during 2016 and attributed increase in institutional project activity to the recent passage of construction bond measures and the improved fiscal health of state and local governments.

The outlook for infrastructure construction has brightened with the recent passage of the FAST Act, which provides $305 billion of funding over a five-year period for our nation's surface transportation programs. Of this total, $207.4 billion will be targeted at the federal highway system and apportioned among the states based on formula. The average annual funding level of nearly $41.5 billion represents about a 10% increase in nominal dollars over the duration of the Bill, reflecting a 5% increase in 2016, followed by 2% increases in the subsequent years that should essentially hold real dollars spending constant.

The longer five-year duration represents a significant improvement over the 36 short-term extensions that had been passed since the last bill extending more than two years expired in September 2009. The higher degree of funding certainty should shift the project mix towards larger, longer-term projects that generally require greater usage of our concrete reinforcing products, as compared to the repaving and maintenance work that consumed the bulk of the funding provided by the stimulus package of 2009.

A recent analysis by the Portland Cement Association regarding the impact of the FAST Act on cement consumption estimated that 25% of the spending authorized for a given year would occur in the year appropriated, 50% in the subsequent year, 15% in the third year, and 10% in the fourth year, following the initial authorization. In addition to the positive developments at the federal level, since 2012, 23 states have raised new revenue to fund their transportation needs, with 12 states successfully passing bills in 2015 alone. I'll now turn to call back over to H.

Thank you, Mike. During the first quarter, demand for our reinforcing products reflected the usual seasonal downturn related to winter weather conditions and holiday schedules. As we look ahead to the remainder of fiscal 2016, macro indicators and customer sentiment remain positive, pointing to continued growth. We're also encouraged by the more robust rate of order entry and our shipping trends less far in January, which have exceeded expectations. We believe the normal positive seasonal influences that should begin to become evident in a few weeks will sustain a favorable market environment for Insteel as we head into the balance of the fiscal year.

In our last few earnings calls, we commented on the potential for expanding spreads driven by declining prices for steel scrap, our primary raw material -- steel wire rod -- together with stable or more slowly declining selling prices resulting from the cyclical recovery in the construction sector. Our Q3 2015 results reflected the initial impact of these favorable trends, which became more pronounced during the fourth quarter and continued to benefit us during the first quarter of fiscal 2016.

There are indications that the trend of sharply declining steel scrap and wire rod pricing may have run their course for the near-term in view of the $30 per ton spike in January's scrap prices. We believe, however, that the seasonal factors constricting scrap supply during the winter months are primarily responsible for the uptick rather than higher demand, since steel mill capacity utilization remains weak almost across the board. Also, softening economic conditions in many regions of the world argue against a near-term recovery in steel demand sufficient to reverse the weak pricing trends for iron ore, steel scrap, and wire rod.

China and Russia are struggling with poor home market demand and capitalizing on the depressed metallics market by exporting substantial volumes of finished and semifinished steel, which has depressed prices throughout the supply chain. Fortunately, demand trends in our markets are more favorable, which has allowed us to benefit from the drop off in our raw material costs. Toward the end of our second quarter or early in our third quarter we expect a competitor to start up a new PC strand production line that is being installed in South Carolina. We expect the additional capacity will have minimal impact on our PC strand business, assuming the market continues to grow.

Turning to CapEx, despite the modest level of expenditures reflected during Q1, we expect outlays to rise to approximately $20 million in 2016, which includes a $9 million investment in our Houston PC strand facility to upgrade equipment and install a new state-of-the-art wire rod cleaning process comparable to our Gallatin and Sanderson strand plants. The addition of new cleaning capabilities at the Houston facility will eliminate a high cost process that constrains the capacity of the plant and adversely affects its yield and productivity.

Coincident with construction of the new cleaning operation, we're removing antiquated PC strand production lines from the plant and replacing them with modern equipment that was previously operating at the Newnan plant, thereby increasing the capacity at Houston by approximately 40%. Construction is underway and is proceeding on schedule. We expect to commission the cleaning facility and the relocated equipment by the end of the first fiscal quarter of 2017.

As we approach the completion of the first phase of the Houston project, we expect to add a third PC strand production line at the facility to align our capacity with the requirements of the Texas market. The addition of the third line, which would likely fall within fiscal 2017, is expected to require a $4 million to $5 million investment over and above the outlays for the current improvements. The economies of scale that are attainable through ramping up the volume of the facility are significant and represent a considerable competitive advantage for Insteel relative to other domestic PC strand producers.

We have reported in recent conference calls that we were commissioning a new, high-volume standard welded wire reinforcement production line at our Hazleton facility to replace obsolete technology and allow us to increase production of certain SKUs for which we have routinely experienced capacity constraints. While we originally expected the line to be operational during the third fiscal quarter of 2015, our equipment vendor experienced technical difficulties that delayed the ramp up of the line, which contributed to higher operating costs, poor customer service, and lost sales during the second half of fiscal 2015 and the first quarter of 2016.

During the third quarter of 2015, the new line achieved approximately 40% to 50% of expected output, rising to 70% to 80% of expected output during the fourth quarter of 2015. Design modifications completed during the first quarter of 2016 allowed us to ramp up production to approximately 90% of expectations during the latter part of Q1. We have recently achieved output levels that are between 90% and 100% of expectations. Importantly, as we head into the seasonally strong selling season of 2016, we expect to have adequate inventories and the required mix of SKUs to provide our customers with the high level of service they were accustomed to receiving from Insteel prior to the unfortunate events of 2015.

To conclude our prepared remarks, we believe the recovery in nonresidential construction markets will continue through 2016. In addition, we expect to benefit from favorable business conditions created by improved demand for our products, together with weaker commodities markets. 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. Bryan, would you please explain the procedure for asking questions?

(Operator Instructions). Chris Olin, Rosenblatt Securities.

Good morning. I just had two follow-up questions regarding non-res demand. I guess, Mike, first you talked a little bit about -- sounded like shipments were running ahead of expectations for the quarter. guess I was curious how much of that would be attributed to weather versus better spending dollars flowing through?

I don't know that we can get that granular at this point as far as segregating those drivers, but we have seen a pretty significant rebound over the first few weeks of this quarter. Although as I indicated, this quarter is always sensitive to weather conditions, as we've seen in prior years. But considering the positive macro indicators and favorable customer sentiment, we're optimistic about the prospects for the remainder of the year.

Okay. Also, can you talk a little bit about what you may be seeing in the Texas market? And I'm familiar with demand being good there, but since the oil correction has started there's been some talk of potential weakness in some of these regions that have benefited from that. Have you seen any kind of indicator where there could be some weakness going forward in those areas?

I would say we have read about the prospect for weakness in the Texas market. Up to this point, the oil weakness has really not had an adverse impact on our business.

Okay. Great. Thank you.

Tyson Bauer, KC Capital Management.

Good morning, gentlemen. You talked about the steel costs and raw materials somewhat stabilizing or expected to remain more within a range. Does that make your ability to maintain spreads more likely to hold as we go through this fiscal year, than having a volatile raw material price spiking and hitting troughs?

It's really hard to generalize, Tyson. I think that, as we pointed out previously, that the primary driver of any pricing power that we may have in the market is based on demand for our products. Raw material costs are a secondary consideration and my guess is that if demand continues to improve then we will maintain attractive margins. If demand were to substantially fall off then I think it's a different ballgame.

Given the weather issues we had last year in fiscal Q2 and Q3 as far as snowfall in the Northeast and then the wet weather that followed in the Texas market and the South, it would appear you had some very favorable -- or the opportunity for some very favorable comps over the next couple of quarters. Given that and the budgetary increase we've seen with the states and the federal level, do you have a general volume outlook or shipment outlook that you're targeting for fiscal 2016?

When we did our forecast for fiscal 2016, it included a rather modest unit shipment improvement. And that actually came to pass, more or less, during our first quarter. And as Mike pointed out, we've started out the second quarter on a much healthier pace. But as you know our insight is very limited.

Last question. Give us a little bit of color on that PC strand market. You do have some of the protections in place from imports coming in, although the dollar would suggest that's more difficult to compete against. But you have a new competitor in South Carolina. You yourself have described putting in a third line in Houston. Give us a little sense of what your position is in that Texas market for PC strand? And overall why we're starting to see a recovery and people putting dollars into that area?

Wow, that was a lot. Let me start at the end and try to answer your last question first. And that just addresses the new investments and new competitors and new capacity during a period where it's not clearly justified. And as we've pointed out many times, this is a phenomenon that has recurred in this marketplace really over the course of my career. Even through the 2009 and 2010 downturn, we saw investments made in new capacity that really would be hard to justify from a supply and demand point of view. And so, we can't explain it but it's nothing new.

In terms of Insteel's position in the Texas market in PC strand, as you know, that was a driving force behind the acquisition of the American Spring Wire PC strand assets. It is the largest consuming market, and what we saw there was the ability to acquire the ASW assets, which were high-cost assets from a conversion and operating cost point of view, but we had -- between our market share at Insteel and ASW's market share, we had enough scale to transform that manufacturing facility into a highly cost-effective facility and to effectively serve the Texas market. So that's the plan that we're executing on.

And then finally in terms of PC strand imports, yes, we have been active over the years in pursuing anti-dumping and countervailing duty cases, as may be warranted under the circumstances. And generally in PC strand we have been successful with all the cases that we have pursued, and those countries and those sources continue to be out of the US market. But as is always the case, new countries replace those who have been closed out by trade actions, and we see that now.

We see the volume of PC strand imports ramping up, and I think it's driven largely by just the unattractive economics worldwide in terms of supply and demand, and the US remains an attractive spot. So, we are accustomed to PC strand imports coming into the market and we're accustomed to competing with them in the marketplace and to pursuing trade actions when they are warranted.

Thank you, gentlemen.

Michael Conti, Sidoti.

Hi, good morning. Could you just go into a bit more detail on the decline in shipments? Is that a function of just weaker -- I guess which one of your targeted end markets just saw a greater year-over-year decline? And just geographically speaking, are you seeing any pockets of weakness anywhere in the country?

I wouldn't say that any particular geography stands out as weak or as declining, other than weather related. Certainly the Northern tier is not very active these days and won't be until the weather improves. But otherwise the volume trends that you see in our numbers I think are more a function of just holiday schedules and winter weather up to this point.

Okay. And then with the recent passing of the FAST Act, can you just talk about how that may impact your product mix going forward? Should we start to see a greater adoption of a particular product line? And then, assuming that raw material stay flat from here, how should we think of margins going forward?

Well, I would say that in the infrastructure segment of our market the primary product lines that benefits for Insteel are PC strand engineered structural mesh and pipe reinforcing. And to the extent that FAST is stimulative of infrastructure construction, you would see those three product lines benefit the most here at Insteel. Although it's very difficult for us to delve down into the level of detail that would allow us to quantify it.

Okay. But I'm assuming the engineered structural mesh, that comes at a higher selling price, just given that it's more of an engineered type product?

Higher than what, Mike?

Higher than some of your other product lines of pipe reinforcing -- of the three that you just mentioned?

I don't really think you can generalize that way. Typically that is the case, but each job is different.

Okay. Great. Thank you.

Steve Marascia, Capitol Securities.

Good morning, gentlemen. Just more of a micro -- a macro question, I should say. Given what's going on in China and what they are trying to do to keep themselves, whatever -- moving forward in a positive direction; whatever the numbers may be. What do you anticipate their movements might do to various prices of the metals going forward, if any?

I think they are largely responsible for the disruptions that you're seeing in the steel market worldwide, not to mention other markets. But the Chinese have been somewhat out of control for years. And I think as their markets have turned down, their steel production has not turned down proportionately, and they've actually flooded the entire world with unrealistically priced finished product and semifinished product. And I think they are the driver of most of this weakness. And I see nothing on the horizon that would cause me to believe there's going to be a significant change.

Okay. Thank you very much.

(Operator Instructions). Arthur Winston, Pilot Advisors.

Thank you and great quarter. What percentage of your sales ordinarily come from the business of the new legislation -- the FAST program that you alluded to?

We've estimated that around 35% of our revenues are infrastructure related for roads and bridges. And when you consider the funding sources, historically federal funding has represented around 50% of the spending at the state level.

So that's about 15% to 20%, probably. Okay. That's good. My next question is from what you said, no particular customer could result in having a lower spread because the spread is a function, as you put it, of the demand, the aggregate demand, and then what's going on with the cost of raw materials. So that basically if demand and raw materials continue on the path they are on, it's your best guess or your best estimate or feel that the spreads would more or less stay the same -- is what you're saying?

Selling prices and steel wire rod prices are correlated over the longer term, but a spike in raw material cost doesn't entitle us to raise our selling prices, nor does a collapse in raw material prices obligate us to reduce our selling prices. Our selling prices are really more a function of THE conditions of supply and demand at our level of the supply chain.

Okay. One other question, which I don't know if you want to comment, but can you give any color on why the Board of Directors chose to give out this $1 dividend rather than store it for future acquisitions, or actually raise the quarterly dividend? What were they thinking, in your mind?

I can give you a pretty good idea.

Okay.

That we had accumulated a cash balance that was above and beyond the needs of business. As we were looking forward, we have an unused credit facility. We have plenty of liquidity. We can grow our business the way that we want to without the cash that was paid out, and we have a history of returning excess cash to our shareholders. And it was as simple as that. That was the motivation behind it.

Thank you for answering all my questions.

Fran Okoniewski, Friess Associates.

I just wanted to circle back on the shipments. I'm just curious where the shipments came in in the quarter relative to your internal plan. And would the distribution channel be a factor in the shipment decline, or any of the utilizations at any of your facilities? I'm just curious about the decline in shipments in the quarter?

Yes, I would say that the shipments were softer than we had anticipated for the quarter, but the Q4 has been notoriously difficult for us to forecast just due to the seasonal factors that are at play, between the weather and holiday schedules. We're hopeful that the weakness that we experienced will prove to be short-lived considering the rebound that we've seen so far in January. In the past we've gone through similar stretches where there may be lulls in demand that appear to be out of sync with some of the macro indicators.

But over the longer-term there tends to be a closer correlation. So it's difficult for us to really -- when we go through a short stretch like that where demand softens, it's difficult to really pinpoint what's driving it. And I think you generally have to look out over a longer period to really come to some conclusions.

So we should expect to see some improvement here in your fiscal second quarter, perhaps?

Well, we're off to a strong start, which is encouraging. But, again, we would just caution that weather is a pretty significant factor. Last year it was to the negative, and it can obviously go in the other direction, but we're encouraged by what we've seen so far.

And what are inventories in terms of the distribution channel like? How is their appetite?

(multiple speakers) supply chain at our customers, or --?

Yes.

We don't sense that there's been any movement in either direction. I think just in the current environment our customers are playing it generally closer; not speculating in either direction.

Yes, and I would add that customer sentiment is almost universally positive. So, I don't detect that there's been any sort of unplanned inventory build in the supply chain downstream from us.

Okay. Terrific. Nice quarter. Thanks.

Thank you. There are no further questions. I would now like to turn the call back to H. Woltz, Insteel's President and CEO, for closing comments.

Thank you, Bryan. We appreciate your interest in Insteel and would encourage you to call and check in with us if you have further questions. Thank you.

Ladies and gentlemen, this does conclude today's program and you may all disconnect. Everybody have a wonderful day.