Insteel Industries, Inc.
Q1 2008 Earnings Call Transcript

Published: 15 Apr 2008

[Operator:]

Good day, everyone, and welcome to the Insteel Industries Conference Call to announce Second Quarter 2008 Earnings. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. H.O. Woltz III, President and CEO of Insteel Industries. Please go ahead, sir.

[H.O. Woltz III:]

Thank you, Kim. Thank you for your interest in Insteel and welcome to our Second Quarter 2008 Conference Call which will be conducted Michael Gazmarian, our Vice President, CFO, and Treasurer, and me. Before we begin, let me remind you that some of the comments that are 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. During our second quarter, we continued to face weak conditions in certain of our markets which reduced shipments and resulted in curtailed operating schedules at most of our facilities. We also experienced unprecedented increases in our raw materials costs, a trend which has continued into our third fiscal quarter. Considering these significant challenges, we’re pleased with the Company’s strong financial performance for the quarter. I’m going to turn the call over to Michael to comment on our financial results, and then I’ll pick it back up to discuss our business outlook.

[Michael Gazmarian:]

Thank you, H. As we reported in this morning’s press release, Insteel posted strong financial results for the second quarter ended March 29th despite the continuation of soft demand in housing-related markets and unprecedented escalation in raw material costs. Net earnings rose to $6.9 million from $4.9 million with diluted earnings per share increasing 44% to $0.39 from $0.27 a year ago. Market conditions continued to vary across product lines during the quarter, consistent with the latest construction spending data reported by the U.S. Census Bureau. In the most recent report, which is for the month of February, the seasonally adjusted annual rate of total construction spending decreased 0.3% on a sequential basis, the fifth consecutive month it has fallen, and was down 3.5% from a year ago due to the continued weakness in the housing market. After rising 14 straight months through last November, private non-residential construction has now fallen for three consecutive months, decreasing 0.1% from January. In spite of the recent drop off, it was still up 13.2% from the prior year while public construction was up 0.4% from January and 8.2% from a year ago. Private residential construction dropped 0.9% from January and 18.8% from last year and has now fallen for 24 straight months. February spending was down 34% from its peak level of two years ago while spending for new single family homes fell 53% over the same period. Insteel’s net sales for the quarter rose 3.3% from a year ago on a 10.6% increase in average selling prices which more than offset a 6.5% decrease in shipment. The reduced shipments were primarily driven by the same factors impacting us in recent quarters, our limited solicitation of PC stand business from post-tension accounts due to the impact of irrationally priced Chinese imports and weak demand from customers of greater exposure to the housing sector. On a sequential basis, shipments are up 9.2% from the first quarter which was about in line with the 9.8% seasonal increase that we experienced between the same period as last year. Average selling prices for the quarter were up 7.2% on a sequential basis as a result of the price increases that were implemented during the quarter. Our year-over-year product line shipment comparisons vary depending upon the extent to which they were related to non-residential versus residential construction. On a combined basis, shipments of PC strand to pre-casters and ESM shipments, which are both used almost entirely for non-residential construction applications were up 15.1% from last year due to the continuation of strong demand and the increase in contributions of our two new ESM line. On the other hand, shipments of concrete pipe reinforcement and standard welded wire reinforcement, which have both been significantly impacted by the drop off in housing, were down a combined 20.9% from the prior year. Gross profit for the quarter rose 28% to $15.8 million from $12.4 million a year ago due to the increase in average selling prices which more than offset higher raw material costs, lower shipments, and higher unit conversion costs. Gross margins improved to 20.4% from 16.5% a year ago and 16.1% in the first quarter. SG&A expense was up $0.6 million from a year ago, rising to $5.2 million from $4.6 million due to increases in incentive plan expense, employee benefit costs, and selling expense. The increase in incentive plan expense was driven by the improvement in our Q2 financial results and outlook for the year from the forecast in which we had based the amount recorded for the first quarter. On a sequential basis, SG&A expense rose $1.1 million from the first quarter largely due to the same factors. If Q1 and Q1 SG&A expense were adjusted on a pro forma basis to reflect the same amounts for incentive plan expense, the sequential increase would’ve been from $4.4 million to $4.8 million instead of $4.1 million to $5.2 million. Going forward, we expect SG&A expense to fall somewhere between the Q1 and Q2 levels in the range of $4.6 to $4.7 million per quarter; although, this line item is always subject to period-to-period fluctuations. Interest expense which primarily consists of non-cash amortization of capital financing costs was relatively flat compared with last year, while interest income rose $0.2 million due to higher average cash balances in the current year. Our overall effective income tax rate for the quarter, including the discounts component was relatively flat at 36% versus 35.9% last year. Moving to the cash flow statement and balance sheet

[H.O. Woltz III:]

Thank you, Michael. During the quarter, we moved closer to completing our 2-year capital investment program which has been focused on the upgrading and expansion of our manufacturing facilities. To recap

[Operator:]

Thank you. (Operator Instructions) Our first question is from Casey Flavin from CJS Securities.

[Casey Flavin:]

Good morning, Michael and H. If I heard you correctly, I believe you mentioned that you increased your prices 10% during the quarter; however, raw materials obviously were up much more significantly than that. Could you just clarify how you fully recovered your costs, and how much you’re going to have to increase prices going forward?

[H.O. Woltz III:]

Our approach on recovering our costs up to this point has been to patch through all of the price increases that we are receiving from our wire rod vendors through to our markets. It is a fact that we were behind during the quarter that just recently closed. Also, the momentum of price increases has picked up dramatically from the late February/March time period through now, so we have had some catching up to do and have more aggressively moved up our timeline for passing these increases through.

[Casey Flavin:]

Can you just give us a sense of what the timing of your price increases were, and how has the customer demand been since?

[H.O. Woltz III:]

Casey, there have been so many price increases, I can’t remember the date of each one. Suffice it to say that they match and mirror for the most part the wire rod increases. Our customers are in a state of shock as we are. Many of them have commitments that extend out for a period of time and obviously the developments in the steel market were not anticipated and come as quite a shock. So I think there is a sense of a resignation to the current environment that there’s not, it’s beyond the control of Insteel or Insteel suppliers or our customers, so there’s resignation to it and a determination to get through it. But the price increases are becoming effective at every stage of the supply chain.

[Casey Flavin:]

Just given your outlook on widening spreads and the volume of uncertainty going forward, do you anticipate next quarter’s gross margins to be higher than the gross margins you currently just reported?

[H.O. Woltz III:]

I would say it’s possible that that could occur.

[Michael Gazmarian:]

Through the anticipated widening and spreads and assuming that we realize that the typical seasonal increase in volume, that should have a favorable impact.

[Casey Flavin:]

Thank you.

[Operator:]

Our next question today will come from Robert Kelly from Sidoti & Company.

[Robert Kelly:]

Hey guys. Good morning. Do you have a sense of how much your customers might have bought in 2Q ahead of the spring price increases?

[H.O. Woltz III:]

Only in an anecdotal sense. I think that when customers return from the holiday season and so the price increase announcements that had piled up on their desks, I think that there was some accelerated purchasing in January and in February. By March, I think fatigue had set in and we really didn’t detect too much of this hedge-type purchasing. So there was some acceleration of purchases, but it’s impossible for us to accurately identify the extent of it.

[Robert Kelly:]

That’s helpful. You guys talked about low utilization, where are you running during 2Q?

[H.O. Woltz III:]

In our strand business, probably in the vicinity of 60% of capacity. In our welded wire reinforcing business, somewhat higher than that, probably closer to 70%.

[Robert Kelly:]

Are we fully ramped on the new ESM capacity at this point?

[H.O. Woltz III:]

We are right on plan at our North Carolina production line. We have seen a weakening in the market environment in Texas that has become the constraint of the ramp up of that line.

[Robert Kelly:]

Does it push the timeline very far out or?

[H.O. Woltz III:]

It’s hard to say, Bob. It’s week-to-week environment right now that I don’t know that I can make a good estimate. As we look at the year, we think that clearly these lines are going to have a significant positive impact on our shipments. It’s just not going to be as dramatic as we may have once forecast.

[Robert Kelly:]

Then just a couple questions on the pricing. First, you alluded to shortage in wire possibly instilling discipline in your competitors. I mean can we read into some improved discipline during 2Q? We’ve seen some pretty heavy cost increases thus far in fiscal ’08.

[H.O. Woltz III:]

I think for the most part, our competitors have viewed this environment just as we have. The urgency and the absolute requirement to pass these costs through is out there. So as a general statement, I think that industry is moving in one direction.

[Robert Kelly:]

Then on the price increases that you are instituting to relieve the cost pressure, is this… I mean is the step function dollar-for-dollar as your suppliers go up $150 a ton, are you going up $150 a ton in one shot? I mean do you do it gradually ease into it? Counter intuitively your profitability at this level of utilization and the cost increases you’re talking about, shouldn’t have been this good in 2Q, that’s what I’m just trying to reconcile.

[H.O. Woltz III:]

It’s clearly the inventory phenomenon helped us in Q2; there’s no doubt about that. The price increases have come at us with such frequency that every time that we believe we have put out it into the marketplace increases sufficient to recover our increase cost yet another wire rod price increase is announced, so it’s a constant. It’s constant activity of announcing increases and passing through the cost increases.

[Robert Kelly:]

How about up to this point, have you recovered all cost increases?

[H.O. Woltz III:]

Well no because we haven’t incurred all of the cost increases that have been announced yet.

[Robert Kelly:]

Right.

[H.O. Woltz III:]

As I mentioned, I can’t remember the effective date, but somewhere between $150 and $190 per ton of new costs increases have been pushed our way just in the last few days and those increases are effective toward the end of April, so we’re in the process of getting our increases out to recover those big jumps.

[Michael Gazmarian:]

I guess up until that (inaudible)…

[Robert Kelly:]

Your price into April.

[Michael Gazmarian:]

…increase of $150 to $190 by, I guess by the end of April, I think we would’ve gone up by enough to recover the accumulative rod increase. The timing’s been a little different across product lines, but we’d be about in line as of April but now we’re looking at additional increases to recover this last announcement.

[Robert Kelly:]

All right, great. Thanks guys.

[Operator:]

Moving on, we have a question from Nat Kellogg from Next Generation Equity Research.

[Nat Kellogg:]

Hi guys. Nice quarter. A couple of questions

[Michael Gazmarian:]

Let me see if a breakout on that. I think it was split relatively equal between the two. Our units are actually up slightly from the third quarter right in the 10% vicinity and then the remainder would’ve been from the valuation increase.

[Nat Kellogg:]

So units were up about 10% from Q1?

[Michael Gazmarian:]

Yeah.

[Nat Kellogg:]

I got you, so about half from pricing.

[Michael Gazmarian:]

Yeah, it’s about 50/50, half units and half from the valuation increase.

[Nat Kellogg:]

How do you guys feel about your inventory position right now given the pricing increases and the talk about of shortage on the wire rods? I mean are you guys happy with your inventory position, would like to have more, would like to have less?

[H.O. Woltz III:]

We planned to have more. In conjunction with this rapidly rising market, we’ve seen our suppliers increasingly willing to walk away from commitments and actually that had a serious negative effect on Insteel through the March quarter. We understand it’s a sellers’ market and that’s the way it is at this point. We would’ve liked to have been able to execute the plan that we put in place last October, but just were prevented from doing so.

[Nat Kellogg:]

Then on the numbers you guys gave for 15% increase in pre cash PC strand in the ESM lines and the 20.9% drop in welder wire and the concrete pipe enforcement, are those, is that volume or is that revenue?

[Michael Gazmarian:]

Those were volume changes which were pretty consistent the latest construction spending data as far as the distinctions between non-res versus res.

[Nat Kellogg:]

No, I’m just trying to get a sense of on the ESM, 15% on the volume is pretty impressive. With a 10% price increase, obviously the volume’s less impressive. But that’s a volume increase.

[Michael Gazmarian:]

Right, it is in units.

[Nat Kellogg:]

All right. That’s helpful. Then just one the discontinued op side, I assume that’s just the old, that’s the facility from the old industrial wire business you guys used to have?

[Michael Gazmarian:]

Yes, that’s the only remaining component, the real estate associated with that facility.

[Nat Kellogg:]

Where do you guys stand on getting… You talked about selling that; where does that stand?

[H.O. Woltz III:]

Actually it’s been under contract for quite a period of time. We just had extended the contract because the purchaser is having some difficulties arranging financing, as might not come as a surprise.

[Nat Kellogg:]

Great.

[H.O. Woltz III:]

But we believe that the purchaser is for real and that we will be successful in moving the facility.

[Nat Kellogg:]

Then I think you guys said at the beginning of the year you expected to spend about $10 million on cap ex, and it looks like you’ve… I mean you were expecting a couple 2 million bucks a quarter for the next two quarters on cap ex or is that high or is that low?

[Michael Gazmarian:]

It’s probably right in line. We have a balance left on this Florida project and then the remaining outlays will be just routine maintenance-type expenditures. I think that’d be a good assumption just splitting equally.

[Nat Kellogg:]

That is helpful. Then I think this is now, if I look at… It was Q3 last year…Let’s just sort of year-over-year, you guys got out of the business… This is the last quarter we’re you’re basically comping against year-over-year where you were in the PC strand on the post-tensioned side, right?

[Michael Gazmarian:]

That’s correct. It was in Q3 last year that we opted out of that market. So as we move into Q3 this year, the year-over-year comparison should be on an apples-to-apples basis.

[Nat Kellogg:]

So I’m assuming you’re still done with weakness in the standard welded wire reinforcement and the concrete reinforced pipe, but you don’t have the added sort of lag or added headwind of the post-tensioners on the PC strand side?

[Michael Gazmarian:]

Right.

[Nat Kellogg:]

Then just, I know you guys have sort of talked about acquisitions in the past and obviously your balance sheet’s in great shape. The issues that you guys are seeing in the market, I mean this I would assume is affecting smaller players even more so or that the spreads so good that they’re happy and that they’re making money and no ones interested in selling?

[H.O. Woltz III:]

I think that environment has changed really radically to where wire rod consumers who relied almost exclusively on imports are probably feeling quite a pinch at this point and time as the domestics have really not been willing under these circumstances to take on a lot of new customers. So I suspect that there are some rod consumers in the welded wire reinforcing business particularly that are seeing a supply crunch and there could be some favorable opportunities that open up for us.

[Nat Kellogg:]

You guys really want to stick sort of either the PC strand or the welded wire businesses I assume. There’s not another product line that would make sense to fold in?

[H.O. Woltz III:]

We’ve made the commitment and believe that it’s based on solid reasoning that we need to stick to our knitting; and I’m not sure that means that we wouldn’t consider any other product, but it would have to be highly comparable and compatible with the markets that we’re serving now.

[Nat Kellogg:]

Then just last question

[Michael Gazmarian:]

It’s really difficult to really get that on an apples-to-apples basis just because of the changes that have occurred in our operation through some of the investments that have been made, particularly in ESM, so to really get that on a comparable basis I don’t know that we can give you a response on this call.

[Nat Kellogg:]

All right, that’s fair enough. All right, well that’s all I get, appreciate the time and obviously nice quarter guys and good luck going forward.

[Operator:]

(Operator Instructions) I’ll take our next question from Walt Glazer from Parthenon Capital.

[Walt Glazer:]

Good morning. Most of my questions have been answered, but I was wondering if you could just talk a little bit about cap ex over the next two to three years?

[H.O. Woltz III:]

We generally believe that the run rate based cap ex for maintenance purposes in the $3 to $5 million range. I don’t think that we’ve ever been that low except maybe in 2001 and 2002, so I wouldn’t expect that you’d see $3 to $5 million for instance in 2009. It’s going to be $3 to $5 million plus some increment that reflects the growth or the cost reduction opportunities that we find that make sense for us, Walt. I know that’s a mushy answer, but I’m not sure we can give you a better one.

[Walt Glazer:]

That’s helpful. So $3 to $5 million would be pure maintenance, anything above that you’d expect to get a good return on either through capacity or cost reduction.

[H.O. Woltz III:]

Yeah, I think that’s a good assumption.

[Walt Glazer:]

Just going back to your comments about whether or not there could be some similarities with ‘04, of course we’d love to see that, but I’m wondering if you could just talk a little bit about what feels the same and what feels different to that period?

[H.O. Woltz III:]

Absolutely, and I think that’s a real good question. In 2004, we were basically pressed to produce and sell everything that we possibly could. Demand was really solid and we had the tailwind of rising prices in the steel market. As we look at the environment today, it’s certainly dramatically different where business conditions as measured by demand for our products are not particularly good and the outlook is not particularly favorable in many of our market segments. But at the same time, we do detect a shortage in the marketplace for our raw material and to the extent that that short supply is real, it will have the same impact of limit in the output of our products as favorable demand characteristics would. So I think as we look at our business plan over the next 6 months, we’re concerned about having adequate supplies of wire rod and that certainly gives us a lot of commitment to be sure that we price our products appropriately.

[Walt Glazer:]

Great. Thanks very much.

[Operator:]

Moving on, we’ll from Chris Haverland from Davenport & Company.

[Chris Haverland:]

Good morning. I just got a couple quick questions here

[Michael Gazmarian:]

Yeah, sequentially Q2 shipments are up 9.2% from Q1 and that compared to a 9.8% increase last year so pretty much in line.

[Chris Haverland:]

Then you said that you expect the spread to widen Q3, are you looking year-over-year or sequentially or both sequentially year-over-year?

[Michael Gazmarian:]

Sequentially.

[Chris Haverland:]

Sequentially, okay. Then finally, I know that you all had some other revenue included in your revenues such as scrap sales and so forth; and with scrap prices rising so much, can you just give us an idea of how much that other revenue was as a percentage or an absolute dollar amount?

[Michael Gazmarian:]

Actually it isn’t reflected in revenues. It’s netted out against our scrap costs and would be reflected in cost of sales, so it wouldn’t have impacted the top line.

[Chris Haverland:]

Okay, it wouldn’t have impacted the top line, just cogs?

[Michael Gazmarian:]

Right.

[Chris Haverland:]

All right. Thank you.

[Operator:]

(Operator Instructions) It appears there are no further questions today. Gentlemen, I’ll turn the conference back to you.

[H.O. Woltz III:]

Thank you. We appreciate your interest in the Company and look forward to the call next quarter. Thank you.

[Operator:]

That does conclude our conference call today. Thank you all for your participation.