H.O. Woltz - Chairman, President, Chief Executive Officer Michael Gazmarian - Vice President, Chief Financial Officer.

Tyson Bauer - KC Capital Michael Conti - Sidoti.

Good morning and welcome to Insteel Industries’ Second 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. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone.

As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, H. Woltz, Insteel’s President and CEO. Mr. Woltz, you may begin..

Good morning. Thank you for your interest in Insteel and welcome to our second 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’ll now turn it over to Mike to review our second quarter financial results and the macro indicators for our 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, our earnings for the second quarter were weaker than anticipated due to the combination of the unusually severe winter weather, higher unit conversion costs, and to a lesser extent lower spreads.

Excluding the net effect of a gain from insurance proceeds related to the Gallatin fire and restructuring charges associated with the Newnan plant closure, pro forma net earnings for the quarter came in at $0.10 a share compared with $0.19 a share a year ago.

After getting off to an unexpectedly slow start, our financial results improved during the latter part of the quarter with the bulk of our Q2 earnings generated in March as gross margins returned to double-digit levels.

Net sales for the quarter rose 11.3% from last year on a 10.6% increase in shipments driven by the additional business provided through the ASW acquisition and a 0.7% increase in average selling prices.

On a comparable basis, however, shipments for the quarter were down 3.8% from the prior year, excluding the former ASW plants, reflecting the impact of the adverse weather in many of our markets.

On a sequential basis, shipments dropped 6.7% from the first to the second quarter this year as compared to a 2% increase between the same period last year, again reflecting the weather-related impact.

Gross profit for Q2 was unfavorably affected by the lower than expected shipments and production, higher unit conversion costs, and lower spreads as we consumed higher cost inventory.

The increase in conversion costs was primarily driven by the lower than anticipated production together with the spike in medical and workers compensation insurance costs, amounting to $1.5 million that reduced our gross margin for the quarter by 140 basis points and earnings per share by about $0.05.

We expect this increase will prove to be non-recurring in nature as it related to an unusual number of high dollar claims that were incurred within a relatively short period of time.

The reduction in spreads during the quarter resulted from the consumption of higher cost inventory under our FIFO inventory accounting that was largely purchased in the previous quarter prior to the recent drop-off in raw material costs, coupled with a 1.4% sequential reduction in average selling prices.

SG&A expense for the quarter was flat relative to a year ago at $6 million as lower incentive plan compensation offset increases in other compensation, health insurance, and intangible amortization expense.

The $0.3 million of restructuring charges that were recorded for the quarter included asset impairment, severance and closure costs associated with the previously announced closure of our Newnan, Georgia facility, which was completed in March.

We currently expect to incur an additional $0.5 million of charges related to the closure for equipment relocation and facility closure costs. As we move into the second half of the year, we believe the actions we have taken to consolidate our PC strand operations will generate annualized cost savings of approximately $3 million.

Other income for the quarter included the $1.6 million gain from insurance recoveries related to the January 2014 fire at our Gallatin, Tennessee facility. Our effective income tax rate for the quarter rose slightly to 34.5% from 34% in the prior year, primarily due to changes in permanent book versus tax differences.

Our inventory position at the end of the quarter represented about three months of shipments, or 87 days on a forward-looking basis calculated off of forecasted Q3 shipments, and reflected significantly lower raw material costs than Q2 cost of sales as a result of the recent reductions in wire rod pricing.

So as we move into our third quarter, we should benefit from a substantial widening in spreads and margins as these lower costs begin to be reflected in cost of sales.

Looking ahead to the remainder of fiscal 2015, we expect the recovery in non-residential construction will regain momentum as we enter a busy season and the weather-related headwinds subside.

After dropping into negative territory for the first time in 10 months, the Architectural Billings Index posted a nominal increase in February, rising to 50.4, and has remained above the 50 growth threshold for 10 of the previous 12 months.

The institutional sector has been the strongest performing segment in recent months, which is encouraging considering that it’s been the last non-residential building category to recover from the recession.

In March, the Dodge Momentum Index, another leading indicator for non-residential building construction, fell slightly to 122.3 but was up 13.6% year-over-year and 11.8% for the first three months of this year versus the same period last year.

Considering these leading indicators for non-residential construction as well as construction starts have all rebounded recently and are still pointed at continued improvement, we believe that the softening in demand we experienced during Q2 will prove to be of short duration.

The outlook for infrastructure construction, however, remains unclear in view of the upcoming May expiration of the current federal transportation funding authorization.

Although we’re encouraged by the increasing dialog regarding a longer term bill, there is still far from a consensus regarding a funding solution to cover the ongoing shortfall in the Highway Trust Fund.

The six-year, $478 billion Grow America Act recently proposed by the Obama Administration would increase highway funding by 29% and annual funding by almost $25 billion from current levels.

The bill would largely be funded by requiring companies to pay a 14% tax on their offshore earnings, which would generate an estimated $238 billion of revenue to pay for infrastructure improvements.

Although some Republicans are receptive to using repatriated funds to pay for a transportation bill, they would prefer that such payments be voluntary through a one-time tax holiday rather than mandatory, as the administration has proposed.

At this time, there appears to be an increasingly likelihood that a short-term funding extension will be enacted in order to buy additional time to arrive at a longer term fix. I will now turn the call back over to H..

Thank you, Mike. As reflected in our earnings release and in Mike’s comments, our financial performance for the quarter was disappointing, particularly during the first two months of the period in view of the momentum that had been building in our markets over the previous few quarters.

Despite the weaker than anticipated results, we remain optimistic about our prospects for the remainder of 2015. Considering the positive macro indicators and customer sentiment, we believe that Insteel is well positioned to capitalize on the continued recovery of the construction sector and report strong financial results for the year.

Consistent with the headwinds we encountered during Q2, our overall capacity utilization was about flat year-over-year at 52%, and down from 54% in Q1.

In recent earnings calls, we’d indicated our belief that significantly improving capacity utilization rates industry-wide that would drive increased pricing discipline were a prerequisite for meaningful margin improvement.

Recent developments in steel scrap and wire rod markets have changed the environment, however, creating the prospect for widening spreads in gross margins, driven by declining raw material costs coupled with stable selling prices.

Over the next couple of quarters, the seasonal uptick in demand together with cyclical market improvements should result in stronger order books industry-wide and expanding margins, assuming a reasonable level of pricing stability.

As we’ve mentioned previously, though, it’s difficult to forecast our selling prices and volume with a high degree of precision, given the dynamic nature of our markets, our short order lead times, and minimal backlog.

While predictions of future steel scrap and wire rod prices are inherently risky, we believe that both markets may have bottomed in April, and without an obvious catalyst for a pricing recovery on the horizon, the bottom may prove to be rather long and flat.

As reflected in the release and in Mike’s comments, conversion costs for Q2 were adversely impacted by difficult weather conditions and lower production volumes, together with unusually high employee healthcare and workers comp costs that we do not expect to be recurring in nature.

Going forward, we expect the usual seasonal upturn and ongoing construction recovery will complement our efforts to lower unit conversion costs through higher productivity and tight control of operating expenses.

As we’ve reported previously, we spent much of fiscal 2014 recovering from the fire that destroyed the cleaning house at our Gallatin, Tennessee PC strand facility. During Q1, the rebuilt facility was commissioned and ramped up to where it was self-sufficient.

During Q2, we continued to optimize procedures to the point that we were comfortable proceeding with the closure of the Georgia strand plant that was acquired in August 2014 as part of the ASW transaction.

A significant portion of the production volume will be transitioned to the Tennessee plant with the balance moving to the Florida and Texas facilities.

The anticipated $3 million of annualized cost savings that Mike mentioned earlier is largely driven by minimal incremental operating costs we expect to incur at the plants that will be receiving the volume previously produced at the Georgia facility.

While the Georgia plant was highly efficient, its scale was not sufficient to meet our expectations with respect to unit conversion costs.

Turning to capex, as reflected in our earnings release, we expect to invest between $11 million and $13 million in our facilities and technology infrastructure over the course of 2015, subject to the timing of payments for various projects which could move into next year.

Two of the most significant projects that are currently underway are focused on reducing our operating cost and rounding out capacity in our standard welded wire reinforcing product line.

We are commissioning a new high volume production line at our Pennsylvania facility that will replace obsolete technology and provide increased capacity to produce certain SKUs for which we have routinely experienced capacity constraints.

While we had initially expected the line to be in production by the end of our second quarter, the timeline has extended somewhat as our equipment vendor resolved some technical issues. We continue to expect the production line to contribute to earnings during the second half of the fiscal year.

During the current quarter, we expect to commission a new wire production line at our Florida welded wire reinforcing facility that will round out capacity and allow for reduced operating costs.

Other capital outlays will be focused on maintaining our facilities, improving our quality, lowering our operating costs, and improving our information technology infrastructure.

Finally, as we mentioned follow the ASW acquisition, we plan to significantly expand the manufacturing capabilities of our Houston facility, which will entail initial capital expenditures during fiscal 2015 and additional expenditures during fiscal 2016.

To summarize, despite weaker than anticipated demand during Q2, we believe the recovery in non-residential construction markets will regain traction in the coming quarters.

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 improve capacity utilization levels across our industry.

Consistent with prior period, 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 grow through acquisitions. This concludes our prepared remarks, and we’ll now take your questions.

Will, will you please explain the procedure for asking questions?.

[Operator instructions] Our first question comes from the line of Tyson Bauer from KC Capital. Your line is now open..

Good morning, gentlemen. A quick question on the weather impact on the quarter. Last you announced was the middle of January and you were fairly positive at that point in time. Obviously we’re well aware February was very difficult in the northeast and the Atlantic states.

Walk us through that progression - if we started the quarter fairly decent in January, had the big lull as we went through February and picked it back up in March, given that 20% of your revenue is Texas and some of the southern states, where do we find the trouble spots and did we just experience complete shutdowns in some of those regions that made it more impactful for the quarter?.

Well, let me address the answer this way. Both January and February were affected by weather conditions, and certainly regionally there were different levels of impact. But even in the southern tier, in Texas and even on the west coast, we saw weather interfering with customers’ production and, as a result, interfering with order flow to our plants.

So both months were adversely affected, with March returning to some semblance of normality and closer to meeting expectations. So it was just a difficult quarter in all regions for the first two months of the quarter..

Obviously this is a hypothetical - without those weather impacts, you had the volume decrease of 6.7%.

Going into the quarter, were you anticipating that to be more equivalent to the Q1 volume levels?.

Our shipments for the quarter came in close to 11% under expected levels, and it’s difficult to precisely quantify the weather-related impact, but just as a point of comparison, as I mentioned, in prior years we typically see a slight increase moving from Q1 to Q2, where last year that amounted to 2% versus that 6.7% drop-off, so I think that clearly reflects the weather-related impact..

Okay. In Texas specifically, obviously a lot of headlines regarding capital expenditures, energy markets, whether that would reduce some developments. You were fairly--didn’t believe that was going to be the case for yourselves. We’re three months now removed.

Do you still share that same thought process that your markets will be less impacted due to, say, the energy spending declines?.

Yes, we still feel that way, Tyson. We’re watching the effect of the energy downturn. It’s definitely out there, but to the extent that we’re so strongly focused in non-res construction, we’re really not seeing a direct linkage to our business..

Okay. I guess in summary, should we treat Q2 then as an isolated quarter that really should not have much, if any, impact as we go into the second half of your fiscal year, given the medical, the $0.05 shouldn’t recur, the weather shouldn’t recur, and we saw the recovery already in March.

Does that put you back on track from your view for the last half?.

We believe that 2015, when we look back at it, will have been a strong year for the company.

Our backlog, our order cycle is so short that it’s difficult for us to make any statements that are based on objective facts right now about future level of revenues, but we don’t see anything that causes us to question the cyclical recovery of the construction markets, and we don’t see anything internally that impairs our ability to capitalize on that.

We feel very well positioned, and hopefully we look back at Q2, as you say, as just an isolated event..

All right, thank you, gentlemen..

Thank you. [Operator Instructions]. Michael Conti from Sidoti, your line is now open..

Hi, good morning.

With the ASW, now that you’ve had the asset for more than six months or so, what cost savings or synergies were you guys able to achieve as part of that integration?.

The most significant synergies, Mike, are the ones we’ve discussed in the call here, where we consolidate our manufacturing assets and basically reduce our footprint by one plant. It’s a significant synergy, and one that we couldn’t really pursue. The timing was unfortunate with respect to the rebuilding of our Tennessee cleaning house.

It put the realization of that synergy on hold until we were confident that our other facilities could accommodate the volume from the Georgia plant. So that’s the most significant synergy. The other synergies that we had surrounding SG&A and purchasing and logistics had pretty well already been realized..

On the consolidation-related synergies, since that occurred toward the end of the quarter, we really didn’t realize any benefit from that in Q2, but we will going forward beginning in Q3. That’s when we should begin realizing that annualized reduction of around $3 million..

Okay, great.

You talked about March, how volumes started to pick up, but did you see any pullback from federal projects, just given the uncertainty regarding the Highway Trust Fund? Has that impacted some of your customers’ buying patterns?.

We read some about it in call reports, but I would not say that it’s had a tremendous impact at this point because it’s been so transparently visible to the marketplace that there’s certainly no unexpected ramifications of it. So at this point, I would say that if there was any impact on the federal side, it was minimal..

The other favorable impact in March was from the lower cost raw materials, where we always have a time lag given our FIFO inventory accounting and the fact that we’re typically carrying around three months worth of inventory. So to a large extent, the raw material costs reflected in cost of sales for Q2 reflect purchases from the prior quarter.

But within the quarter, we did see some gradual improvement leading up to March to where at a gross margin level, we were back in that double digit range. We should see additional benefit from that as we move into the next quarter and those lower costs begin to be reflected..

Okay, great.

Then just given the deflated wire rod pricing that you guys are seeing and your confidence in non-residential construction outlook for the rest of the year, why wouldn’t you guys purchase more raw material now at a cheaper price and experience a longer period of spread expansion - you know, six to nine, maybe 12 months out from now?.

Traditionally we really don’t speculate in the raw material markets. There is so much volatility and the consequences of being wrong are dire in some respects, so it’s just not our style to speculate in the markets. I would also say that there is no indication that steel markets are going to recover in the near term.

As I pointed out in my prepared comments, we expect that this could be a long, flat bottom, and we’d just prefer to have our inventories in shape and be flexible and stick with our conservative policy of not speculating..

Sure, okay. That makes sense. H, you talked about acquisitions.

Are you seeing more willing sellers now compared to the last up cycle? How is the selling field playing out right now?.

We’re still vitally interested in growing our business through acquisition, but I wouldn’t say that there’s been a change one way or the other in terms of willing sellers..

Okay, great. That’s all the questions I had. Thanks..

Thank you. Our next question comes from the line of Tyson Bauer from KC Capital. Your line is now open..

A couple quick follow-up questions. You talked about steel being at a bottom, and we’ve seen a fairly robust steel import market coming into the U.S. probably related to that strong dollar that’s existing in the marketplace.

Does that give you that benefit, and have you experienced that in the past where in a strong dollar market, you’re able to control those raw material costs better because you have that luxury of a lot of steel coming in from Turkey or other countries?.

There is some precedent that would indicate that those market environment components result in a favorable environment for us.

You really have to go back to the late 90s to see that, where the strong dollar combined with weakness in economies elsewhere in the world resulted in pressure on our raw material prices without the same level of pressure on our selling prices.

So it’s very difficult to predict where this thing is going to go, but I think it’s safe to say that steel markets are weak and it’s not surprising that that tends to favor steel consumers..

Well, hopefully history will repeat itself for your sake and your shareholders.

The $3 million of cost that you talked about getting out of the system by shutting down the Georgia facility, is that isolated just for those fixed costs that were associated with that facility, or are you including the benefits of better efficiencies at Tennessee by combining them? Is that a combined benefit number, or is the $3 million isolated to just eliminating Georgia and we will see a benefit above and beyond because of the better efficiencies in Tennessee?.

There’s no speculative component to realizing that synergy. It’s primarily the fixed cost that we shed. We’ll add minimal incremental costs at the receiving plants, so we’re not counting on dramatic changes in the effectiveness of the other operations..

Okay.

Since we’re doing a little history lesson, the Tennessee, before the fire in January of ’14, what was that running capacity level, and now that we’re combining two plants into that one with expanded capacity, as you ramp that up and we get into the second half, where do you anticipate that capacity utilization being, so we can kind of gauge where you were and where you think you’ll be in the second half..

Well, that calls for a level of detail that I don’t have at my fingertips, Tyson, but I can tell you that our strand operations have run at slightly higher levels of capacity utilization than our welded wire reinforcing operations.

We will redeploy the equipment from the Georgia plant to another facility, so we’re really not changing the overall capacity. So there shouldn’t be--as we look company-wide at our PC strand manufacturing footprint, there shouldn’t really be a lot of change in overall capacity utilization resulting from this shutdown..

Okay. Last one - we know at the federal level likely you’re going to get another stop-gap spending measure for the infrastructure, like we’ve seen time and time again.

What impact are you seeing at the state and municipality levels? Is it status quo because they’ve never had really certainty for so long, or are we starting to see that crack where they’re getting a little bit more cautious in their own right? So I guess basically have states and municipalities given up on that support from the federal level, so they’ve changed their mentality that they’re going to have to foot the bill more themselves and will proceed accordingly, or is there still this lag that they’re hoping they get that matching funds and it’s just a waiting game to get a real policy from the feds?.

Well, there have been a handful of states that have reverted, deferring or canceling projects over the past month. I’ve seen some references to it - I don’t have the exact dollar amount, but there have been some indications of that.

But flipside is at the state level, you’re continuing to see more aggressive movement in tapping into new revenue streams, increasing a fuel tax or taking other actions to offset that anticipated shortfall, so there is somewhat of an offset there at the state and local level because it has gotten to the point where some of these needs just can’t be deferred any longer..

All right, thank you, gentlemen..

Thank you. Ladies and gentlemen, if you have a question, please press star then the number one key on your touchtone phone. At this time, I’m showing no further questions. I would like to turn the call back over to H. Woltz for closing remarks..

Thank you. We appreciate your interest in Insteel. We look forward to updating you in the next quarter, and in the meantime if you’d like to call and talk through any issues, don’t hesitate. Thank you..

Ladies and gentlemen, thank you for your participation on today’s conference. This concludes the program. You may now disconnect..