Insteel Industries, Inc.
Q4 2008 Earnings Call Transcript

Published: 16 Oct 2008

[Operator:]

Welcome to today’s Insteel Industries Fourth Quarter Conference Call. Today’s call is being recorded. At this time, for opening remarks, I would like to turn to call over to H.O. Woltz III, President and CEO.

[H.O. Woltz:]

Good morning and thank you for your interest in Insteel and welcome to our Fourth Quarter 2008 Conference Call, which will be conducted by Mike Gazmarian our Vice President, CFO, and Treasurer, and me. Before we begin, let me remind you that some of the comments made in our presentation are considered to be forward looking statements. Forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those projected. These risk factors are described in our periodic filings with the SEC. Before Mike reviews our financial results for the quarter, I want to comment on Insteel’s performance in 2008 and the important investment initiatives that were wrapped up during the year. 2008 was a record year from both a revenue and earnings standpoint. Return on capital, which is the company's primary financial performance metric, came in at 27.9 percent, which while not a record is quite respectable considering the challenges we encountered over the course of the year. All factors considered we are extremely pleased with our 2008 financial performance. Those of you who have followed the company recently are aware of the comprehensive capital investment program that’s been underway at Insteel. Over a three-year period, the company has invested approximately $45 million in its manufacturing facilities to support growth opportunities in promising markets and to insure an unrivaled operating cost structure across all plants and product lines. We emerge from this program at the end of fiscal 2008 debt-free with a cash balance of $26 million. Going forward, our financial flexibility will be greatly enhanced by minimal routine CapEx requirements and a balance sheet that will support the pursuit of growth initiatives that may emerge from the more difficult business environment we see. We readily acknowledge the favorable market environment that contributed to the company’s 2008 performance including rapidly rising prices and tight supplies of hot-rolled steel-wired rod. We are fortunate to have been well positioned to benefit from these developments and believe that Insteel’s long-term earnings potential has been materially enhanced by the investment program that was just completed. But now, 2008 is behind us and we face challenges of unknown magnitude for 2009 as the world abruptly changed over the past few weeks. I'll turn it over to Mike to review the driver’s of our fourth quarter financial results and then I will follow up to comment more on market conditions and our business outlook.

[Michael C. Gazmarian:]

As we reported in this morning’s press release despite increasingly difficult market conditions and higher raw material costs, Insteel posted strong financial results for the fourth quarter ended September 27. Earnings from continuing operations increased to $15.6 million or $0.89 per diluted share from $5.1 million or $0.28 per diluted share a year ago. For the year, earnings from continuing operations rose to a record high $43.7 million or $2.47 per diluted share from $24.3 million or $1.33 per diluted shared last year. Net sales for the quarter rose 42.9% from a year ago as a 66.6% increase in average selling prices largely driven by the dramatic escalation in raw material costs during the year more than offset a 14.2% decrease in shipments. After getting off to a solid start to the quarter, with July shipments coming in above forecasts, order levels dropped off considerably over the next two months in response to initial indications of softening steel prices in August compounded by the financial market meltdown in September and heightened level of uncertainty regarding the future direction of the economy. Average selling prices for the quarter were up 17.3% on a sequential basis from Q3 as a result of the price increases that were implemented during the first two months of the quarter while shipments were down 13.2% from the third quarter due to the factors that I alluded to earlier. Gross profit for the quarter increased to $29.5 million from $12.7 million a year ago, with gross margins rising to 27.7% from 17.2% due to higher spreads between average selling prices and raw material costs, which more than offset the reduction in shipments. Our facilities continue to operate on reduced schedules during the quarter with capacity utilization levels ranging from around 67% for our PC strand operations to about 62% for our welded wire reinforcement facilities. On a sequential basis, gross profit was down $1.4 million from the third quarter with gross margins decreasing 1.9% due to the lower shipments, which is partially offset by higher spreads. SG&A expense, for the quarter, increased $0.3 million from a year ago primarily due to reductions in the cash surrender values and life insurance policies related to the downturn in the financial markets. Our overall effective income tax rate for the year including the [disk ops] component wound up at 35.9% versus 36.6% last year. Moving to the cash flow statement and balance sheet, continuing operating activities generated $10.2 million of cash during the quarter compared with $6.4 million a year ago primarily due to the higher earnings which more than offset the increased investment in working capitol in the current year quarter. Operating cash flow for the quarter was primarily used to fund $1.1 million of capital expenditures and pay $0.5 million of dividends. For the year, continuing operating activities generated $36.8 million of cash, which was primarily used to fund $9.5 million of capital expenditures, repurchase $8.7 million of our common stock, pay $2.1 million of dividends, and increase our cash balance by $17.8 million leaving us debt-free at the end of the year with $26.5 million in cash. Following the end of the year, we returned an additional $9.3 million of cash to our shareholders in the form of a $0.50 special dividend and $0.03 regular quarterly dividend that was paid out earlier this month. Inventories at the end of Q4 were down $1.8 million or 2.4% from the previous quarter end, which masked offsetting changes in inventory units versus average unit values. Unit inventories dropped 24.5% from the previous quarter due to our inventory reduction efforts, while average unit values rose 29.2% as a result of the escalation raw material costs and a higher proportion of finished goods in our inventory mix. On a year-over-year basis, inventories are up 50.3% from a total dollar standpoint with units down 18.7% and unit values up 84.7%. Based on our current forecasted run rate for Q1, our quarter end inventory position represents around three months of shipments and reflects average unit carrying values that are relatively close to replacement costs. As we indicated today at earnings release, we expect spreads and margins for the first quarter to narrow from the Q4 levels as the higher cost of raw materials purchased in recent months are reflected in cost of sales in contrast to the previous two quarters where we have benefited from the consumption of lower cost inventory under FIFO accounting. Capital expenditures for the quarter were $1.1 million compared with $3.7 million a year ago with CapEx for the year coming in at $9.5 million, which was under our previous forecast of $10 million. The bulk of the outlays for the year related to the upgrades at our Florida PC strand facility. For 2009, we currently estimate maintenance related CapEx to total less than $5 million although the actual amount will depend on future market conditions, our financial performance and other investment opportunities that may arise. At the end of the quarter, we had $18.8 million remaining on our current share buy back program, which runs through December 5. Going forward, we will continue to evaluate the repurchase of shares based on the expected timing and funding requirements for any growth opportunities that may arise, as well as evaluation of our shares relative to our business outlook and cash flow expectations. From a financial and operational standpoint, Insteel has never been better positioned and we are hopeful that the more difficult market environment that we are entering serves as a catalyst for some strategic growth opportunities to become available. I will now turn it back over the H.

[H.O. Woltz:]

Typically, when we discuss our business outlook we focus on macro factors like the architectural billings index and construction spending trends. Given recent events; however, theses macro indicators are somewhat irrelevant at least for the near term having been eclipsed by the inflection point in steel prices that was recently reached and the credit market crisis. During 2008 steel supplies tightened up over the course of the year and pricing rose on a monthly or sometimes weekly basis, which required us to scramble to cover our requirements and to fully utilize supply allocations at more favorable pricing levels than would exist for subsequent orders. Conditions changed rapidly; however, with the news in August that [inaudible] scrap prices were expected to be flat or down for September representing the first break from a relentless year-long run up. In our view, the prospect for lower steel pricing followed by the heightened level of concern and uncertainty about the impact of credit market turmoil on the general economy caused purchasing activity to grind to a halt throughout the supply chain. While the pain of unprecedented price increases took its toll over the course of the year, purchasers were acutely aware that it would be even more painful to enter a period of declining prices with high inventory levels. The result of these developments for Insteel was that in September customers moved to the sidelines and curtailed their purchases to the full extent possible. While October shipping activity has risen from the September lows, it’s still running well below expectations. Not surprisingly, our selling prices are under pressure although they have held up relatively well considering the drop off in demand. We've experience the most significant pressure in our more commodity-like standard welded wire reinforcing product line where pricing always tends to be more volatile. We are making adjustments on a number of fronts to address the challenges and the sudden change in the business environment. First, we are taking actions to minimize our inventories to the point than when we resume raw material purchases, it will be at new market pricing levels, which have declined significantly and could weaken further. Although we are fortunate to have entered the period with a favorable inventory position, the timeline for reducing our inventories will be extended to the extent that shipments remain at depressed levels. Second, we are reducing the operating hours and staffing at each of our manufacturing facilities to closely align production schedules and costs with the lower level of demand we’re forecasting for the next few months. Even at this reduced level of activity, we expect to benefit from the recent capital investments in our manufacturing facilities in the form of higher productivity and lower cash operating costs. Third, we are intensifying our scrutiny of all capital outlays in the context of the market environment. And fourth, we are pursuing additional improvements in the productivity and effectiveness in all of our sales and administrative activities. Turning to PC strand imports, on previous calls we have expressed concerns about surging imports of Chinese strand. Unfortunately, there is no positive news to report on this issue. Through eight months of 2008, Chinese imports have risen over 19% from last year despite declining demand and now represent 93% of total strand imports entering the U.S. In August, average unit values for Chinese imports were at about the world market price for hot-rolled wire rod, our primary raw material. It is apparent that the Chinese have implemented, through taxation policies and other means, a strategy of promoting exports of higher value downstream products. And we are convinced that these policies are inconsistent with their World Trade Organization obligations. Our industry trade group is working closely with USTR to hold the Chinese accountable for their actions. Later this month, we will participate in the steel dialogue trade talks in Beijing at which time Chinese policies with respect to downstream markets including PC strand will be specifically discussed with authorities. While we don’t expect a quick resolution of these resolutions, we are determined to pursue every alternative available to restore reasonable conditions of competition in the PC strand market in view of Chinese tactics that are increasingly injurious to the domestic industry. To wrap up our prepared comments, I risk stating the obvious to say that in the wake of the events that have unfolded in the U.S. economy over the past few weeks we are in uncharted territory making forecasting even more difficult. The silver lining in this uncertain environment is Insteel’s strong competitive position and financial flexibility, which would enable our pursuit of grown opportunities even in the difficult environment that has emerged. This concludes our prepared remarks and we will now take your questions. [Gwen], would you please explain the procedure for asking questions. [Gwen], are you with us?

[Operator:]

(Operator Instructions) And we’ll go first to Nat Kellogg – Next Generation Equities.

[Nat Kellogg:]

Hi, guys, how are you doing? You know, obviously a nice quarter. Just a couple of questions, can you, I mean, I guess you gave us a little bit, but can you guys give us a little bit more about sort of the deceleration in the quarter? I mean, can you give us a sense of what volumes looked like in September compared to July and August?

[H.O. Woltz:]

Well, as Mike said, we were actually ahead of plan for shipments in the month of July and it did decelerate through the quarter but it just basically came to a halt in September, Nat.

[Nat Kellogg:]

And October continues to be slow but at least your shipping stuff now.

[H.O. Woltz:]

That’s correct.

[Nat Kellogg:]

Okay. It sounds like you know pretty much all the FIFO gains from the last couple of quarters from the end inventory have been pretty much used up, so we'll go back to sort of a more traditional spread, metal spread going forward. Is that correct?

[H.O. Woltz:]

Yes, as of the end of the quarter the carrying value of our inventory is relatively close to the replacement cost at that time, so –

[Nat Kellogg:]

– Okay, and you guys are comfortable I mean obviously it sounded like unit volumes were down significantly in inventory but obviously the cost is up. But you guys are comfortable with where your inventory as right now more or less?

[H.O. Woltz:]

Well, I don’t think we are comfortable with anything, Nat, I mean the environment’s just changed so radically that obviously the lower your inventory the better. I would say that we could have been in much, much worse position but we are pretty you know let’s say reasonably happy with where we are.

[Nat Kellogg:]

Okay, that’s helpful. And then, Mike, your current expenses look pretty high in the quarter. I was just wondering what was you know on the balance sheet on the liabilities side. I'm just wondering if there is anything in particular in there or what I assume that will all probably come down going forward?

[Michael C. Gazmarian:]

Yes, a big component of that was the dividend that was declared that was paid earlier in October that was around 9.3 million so.

[Nat Kellogg:]

Okay. So that will come out of the expenses when we see the December quarter?

[Michael C. Gazmarian:]

Right.

[Nat Kellogg:]

Okay got you. That’s helpful. And then the tax rate for '09 should be around 36%?

[Michael C. Gazmarian:]

Yes, I think that would be reasonable.

[Nat Kellogg:]

Okay, and is there any risk I mean I realize on the PC Strand side I mean it actually sounds like your utilization rates on the PC Strand were I’ve heard yes for it was a little bit higher on the welded wire reinforcement side. I mean, is there any risk? Obviously the post tension is where you guys are seeing the Chinese competition. Is there any risk that they move into and compete with you guys so were out of the full PC strand market?

[Michael C. Gazmarian:]

While there is that risk, Nat, and there really always has been that while the Chinese have completely dominated the post tension part of the market I don’t think we have ever implied that, they haven’t tried to enter the pre-cast market and in fact have over the last couple of years particularly, in some of the coastal markets of like around Texas and Florida. They’ve had a foothold there for some time.

[Nat Kellogg:]

But obviously I mean they haven’t completely penetrated that business because you guys are still doing some decent business so you know the pre-castors. I mean, I guess it's that do you expect that dynamic to change it all or –

[Michael C. Gazmarian:]

– No, I expect it to continue down the path that we’ve been on for the last two or three years which is where the importers and the Chinese are certainly pursuing that market segment and were fighting them as hard as we can.

[Nat Kellogg:]

Okay. And then I guess you know obviously you guys are in a great position as far as your cash flow and balance sheet and you know no matter how tough next year gets you know provided we don’t go into sort of a worldwide depression but you know you guys will probably generate some free cash flow in '09. I'm just sort of you know if you guys could sort of prioritize for us where your thinking is as far use of free cash flow for you know acquisitions and what that market maybe looks like now versus maybe three to six months ago, or a buy back given where your stock prices are and all the rest or additional dividends. And I’m just like curious what you guys are thinking internally?

[Michael C. Gazmarian:]

Well I think the thinking and the rationale is consistent form the last time that this subject came up on a conference call where our first priority is looking for reasonable growth opportunities that fit within our core business. And its probably more likely looking for some of those will emerge that meet our hurdles and fit with our company than over the past couple of years. Past the growth opportunities if we want to be in the position to execute, I think you’ll see us evaluate using our cash flow for both share repurchases if we believe that the valuation is attractive and I would say we could potentially consider future special dividends, but were also going to be pretty conservative on the capital structure, in view of just the tremendous unknowns that are out there. So I don’t think you are going to see us do anything rash.

[Nat Kellogg:]

Okay, good, fair enough. And just the last question, you know, you guys didn’t talk at all about sort of ESM. I’m just wondering that has been a bright spot for you guys. I'm just wondering how that business is holding up and any call you can give us would be great?

[Michael C. Gazmarian:]

Nat, it's holding up better than the more traditional businesses as we have put our heads together to alter planning horizon, and forecast. Certainly the ESM market has been affected, but our view is not nearly to the degree that the other more traditional markets have been affected.

[Nat Kellogg:]

Okay great. Well thanks very much. Thanks for the questions. I well let somebody else talk in here, but nice quarter guys and always good luck given these tough times.

[Operator:]

And we'll go next to Robert Kelly – Sidoti & Company.

[Robert Kelly:]

Thanks for taking my questions. Just you know let’s start with the volumes, with September being very weak and then you said October was a better than September but still down pretty much. I mean what is spurring kind of the sequential monthly increase there? Have you dropped prices significantly or is the market starting to come back a little bit – maybe just a little help there?

[Michael C. Gazmarian:]

Well, let me start out first by saying that I don’t think the drop in prices is gong to stimulate demand in this kind of environment. The market will set the price and any steel is going to be competitive but were not panicking. I think that to some extent inventory liquidations were probably accomplished in the month of September and we may be seeing customers who are really buying what they need and have depleted inventories to some extent, but I don’t claim to really have a good explanation for it. And I would also point out that we are only half way through the month so it could be early to make any call on what October ultimately winds up looking like.

[Robert Kelly:]

More I was trying to get at do you is do you get the sense that customer inventory is – are tight as they were maybe a few months ago?

[Michael C. Gazmarian:]

I think our sense would be that customer inventories are heavier than we would like to see and probably that our customers would like also.

[Robert Kelly:]

So you’ve got your inventory downstream running up; you guys are doing the same. Some of the you know some of the things your doing here in response here you know minimizing the inventory, taking some plants down, taking some people out. It sounds like you are gearing up for something pretty prolonged as far as you know weak demand is this, I mean, is that accurate?

[Michael C. Gazmarian:]

Well we have a couple different things play right now. We have all the negative macro factors that you're well aware of. We also have seasonal issues that are confronting us just in terms of the normal seasonal downturn that we see in our first and second quarters. And I would be surprised that we see this as less than a two quarter sort of hunkering down that were doing.

[Robert Kelly:]

You talked about kind of your strategic initiatives. Does it make more sense rather than do possible acquisitions maybe to let some of your competitors fall by the wayside should this prove more than a few quarter you know hunkering down period?

[Michael C. Gazmarian:]

Well I think it all depends on, on what the opportunity is and what the circumstances are specific to that opportunity I am not sure I can give you a good answer.

[Robert Kelly:]

All right. Has industry pricing, you guys have talked about for most of F08 and even some leaner times in F07, the industry largely behaving themselves. Is that still the case?

[Michael C. Gazmarian:]

Yes, I would say it’s early really to be able to make that call; but generally I would lean towards saying yes, that’s right.

[Robert Kelly:]

Great. That’s encouraging. And finally, just on wire rod you know we’ve heard about steel prices weakening. It’s more the chatter we see is more in response to flat roll. Has wire rod behaved similar to the way the flat roll steel costs have? Have you seen the weakness?

[Michael C. Gazmarian:]

Well, certainly prices went down for October. I think it’s publicly acknowledged that a couple of the producers put out price decrease letters in the amount of about $70.00 per ton. We’re still looking at November and don’t really know what November will be.

[Robert Kelly:]

Right, I mean, is there a chance that you got to a point where your spreads aren’t you know enough to keep you above breakeven – that’s kind of what I’m getting at?

[Michael C. Gazmarian:]

Well, I mean, I just say I don’t expect Insteel to lose money.

[Robert Kelly:]

Great.

[Operator:]

We’ll go next to Walt Glazer with Parthenon LLC.

[Walt Glazer:]

I was wondering if you could provide a little more detail on rod pricing you know kind of where it is right now, where it’s been, and where it peaked and if you have a view, where you think it might go.

[Michael C. Gazmarian:]

Oh gosh, other than what I’ve previously indicated, Walt, that prices were announced at down $70.00 per ton for October, I’m not really sure that I want to comment further on it, partly because we don’t know for sure where they’re going. The dramatic reductions in scrap costs are driving part of this and we’re working to understand those dynamics ourselves right now; but I would say that there’s got to be significant weakness in the market. We also are seeing interests from offshore sources who have not been active in this market in quite some time. So, I mean, I think the competitive dynamics have just changed radically in the last two or three weeks.

[H.O. Woltz:]

Part of the pricing fluctuations within the fourth quarter, you probably saw the announcements that went out earlier, wherein July pricing was up around $60 a ton, then another $60 in August, then September was basically sideways, followed by the $70 ton reduction in October.

[Walt Glazer:]

Well we got close to $200, I mean total.

[Michael C. Gazmarian:]

The first two $60s were movements upward.

[Michael C. Gazmarian:]

Those were increases.

[Walt Glazer:]

Oh, those were increases.

[Unidentifiable Corporate Participant:]

They were flat and then down $70; so a net of $50.

[Walt Glazer:]

So if I were buying rod today, what would I pay per ton?

[H.O. Woltz:]

You know what I would do is I’d direct you to the American Metal Market. They have a chart in there that would give you the benchmark price for about four different grades of wire rod, and I would point you toward the mesh quality and the high carbon quality numbers as the two grades that Insteel purchases.

[Operator:]

(Operator Instructions) We’ll go next to Tim Hayes – Davenport & Company.

[Tim Hayes:]

Actually all my questions have been asked and answered.

[Operator:]

(Operator Instructions) I would like to turn the conference back over to Mr. Woltz for any closing remarks.

[H.O. Woltz:]

We appreciate your interest and your time in participating in the call today, and we’ll talk to you next quarter.

[Operator:]

Thank you everyone. That does conclude today's conference. You may now disconnect.