H.O. Woltz - President & CEO Michael Gazmarian - VP & CFO.

Michael Conti - Sidoti Tyson Bauer - KC Capital.

Welcome to the Insteel Industries Fourth Quarter 2015 Conference Call. [Operator Instructions]. I would now like to turn the conference over to your host for today H.O. Woltz, President & CEO. Sir, you may begin..

Good morning. Thank you for your interest in Insteel and welcome to our fourth quarter 2015 earnings call. which will be conducted by Michael Gazmarian, 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 fourth quarter financial results and the macro indicators for our construction end markets then I will follow up to comment more on market conditions and our business outlook..

Thank you H, as reflected in this morning's earnings release Insteel posted strong results for the fourth quarter fiscal 2015 with net earnings rising to the highest level in seven years.

On a pro forma basis excluding the non-recurring charges and gains that were referenced in the release net earnings nearly doubled 9.4 million to 9.4 million or $0.50 to diluted share from 4.9 million or $0.26 a diluted share a year ago due to wider spreads between selling prices in raw material costs and higher shipment.

Our current year quarter also benefited from having an extra week than the prior year based on our fiscal calendar. Net sales for the quarter rose 0.9% from last year on a 6% increase in shipments. That was driven by the additional business provided by the ASW acquisition and the extra week in the current your quarter.

Our results for the quarter were unfavorably impacted by continued delays, with the ramp up of the new standard velvet wire reinforcement production line at the Hazelton facility.

We estimate the volume shortfall at Hazelton reduced Q4 net sales by approximately 4 million and the year-over-year growth in shipments by about 400 basis points, aside from the equipment issues at Hazelton shipments for the quarter did not accelerate to the same extent as certain of the macro indicators for construction end markets are reflect as much of a weather related deferral of business from Q3 as we had anticipated which is difficult to reconcile.

Based on the most recent construction forecast and the prevailing sentiment of our customers. We continue to expect improved market conditions and favorable demand trends in the coming year.

Gross profit for the quarter rose to 21.9 million from 13.8 million a year ago with gross margins widening 670 basis points to 18.5% from 11.8% largely due to higher spreads as the drop off in raw material costs exceeded a much smaller reduction in average selling prices.

Gross margins improved each month within the quarter rising to a high for the year in September. As we've alluded to on previous calls since we're typically carrying around three months of inventory valued on a FIFO basis, the raw material costs reflected in cost of sales are largely associated with purchases made in the previous quarter.

This time lag had the effect of delaying the favorable impact of the reduction in our material costs through a large portion of the year. As of the end of the fourth quarter our inventory position represented a little over three months of shipments at 97 days on a forward looking basis calculated off of our Q1 forecast.

Unit conversion costs for the quarter improved slightly both on a sequential and year over year basis or remained higher than anticipated due to the equipment issues that Hazleton and lower than projected operating volumes.

SG&A expense for the quarter was up 1.3 million from a year ago at 7.8 million primarily due to a 0.8 million increase in incentive plan expense driven by or improved results for the quarter and to a much lesser extent the relative changes in the cash surrender value of life insurance policies and higher labor costs from the extra week in the current year quarter.

Net restructuring recoveries for the quarter amounted to 0.3 million reflecting a 0.9 million gain on the sale of the real estate and certain of the equipment associated with Newnan facility that was closed in March less asset impairment closure and equipment relocation costs also related to the shutdown of the plant and the reconfiguration of our PC strand operations.

As a result of the strong operating cash flow for the quarter and the 3.5 million of proceeds from the sale of the Newnan assets, our cash balance increased by 21.8 million during the quarter to 33.3 million and we ended the quarter debt free with no borrowings outstanding on our credit facility, providing us with ample liquidity to meet our funding needs and pursue additional growth opportunities.

As we head into fiscal 2016 the macro indicators for nonresidential construction remain positive. In the most recent monthly report.

Total construction spending through the first eight months of the year was up 9.8% from last year with private non-residential up 12.1%, public up 5.8% and private residential up 10.7 and the seasonally adjusted annual rate of total non-residential construction spending rose for the 7th straight month increasing by 11.4% from January to August.

The leading indicators for nonresidential building construction imply continued growth in the coming year. After dropping into negative territory in August the Architectural Billings index rebounded to 53.7 in September and has remained above the 50 growth threshold for 15 of the previous 18 months and 6 of the 9 months this year.

The favorable trend for the institutional sector index which we alluded to on our last call has continued as it has now posted increases for 16 straight months following a string of negative readings that ran from late 2013 to mid-2014.

The Dodge Momentum Index another leading indicator for nonresidential building construction which had remained relatively flat through the first half of the year has shown significant improvement over the past three months.

In September the index rose to its highest level since January 2009 and the prior three month average was up 14.6% from a year ago. Unfortunately the outlook for infrastructure construction remains mixed with the latest stopgap federal highway funding bill expiring a week from now.

Today the House is scheduled to mark up a six year bill with the funding sources yet to be determined that will have to be reconciled with the six year bill passed by the senate this summer that only provided for three years of funding. Considering the minimal amount of time remaining before the expiration date.

It appears likely that yet another short term funding extension will be enacted in order to buy additional time to arrive at a longer term fix.

In contrast to the impasse at the federal level, state and local spending has been on the rise as budgets have gradually recovered from the recession and additional funding has been generated through fuel tax increases, new or increased fees, private public partnerships and bond financings. I will now turn the call back over to H..

Thank you, Mike.

During the fourth quarter, demand for our reinforcing products benefited from favorable seasonal influences and the continuation of the cyclical recovery, as indicated by our year over year and sequential shipment comparisons however growth in demand was moderate, relative to recent construction industry data and it's difficult to reconcile these differences considering that we do not believe we have ceded market share to competitors.

As indicated in the release capacity utilization for the quarter was 51% compared to 54% last year. As we look ahead to 2016 macro indicators and customer sentiment remain optimistic and point to continued growth.

During the Q3 earnings call we commented on the prospect for expanding spreads resulting from declining prices for steel scrap and our primary raw material, steel wire rod together with the potential for stable selling prices resulting from the cyclical recovery in construction markets as well as the usual seasonal upturn.

Our Q3 results reflected some impact from these favorable trends which became more pronounced during the fourth quarter and should continue to benefit us during the first quarter of fiscal 2016.

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

Looking ahead, there does not appear to be a significant catalyst on the horizon that would lead to strengthening pricing for the steel industry.

Weakening economic conditions in most regions of the world including China argue against a near term recovery and demand that would be required to mitigate the downward pricing pressure for iron ore, steel scrap and wire rod.

China continues to struggle with anemic home market demand and is capitalizing on the depressed metallic's market by exporting substantial volumes of finished and semi-finished steel to most regions of the world, depressing 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 cost. Turning to CapEx. During our last earnings call we indicated that capital outlays would come in at less than 11 million for fiscal 2015.

Due to timing issues for various projects that shifted certain outlays into fiscal 2016 we actually came in considerably lower at 7.2 million.

We expect CapEx to rise to approximately 20 million in 2016 which includes a $9 million investment in our Houston PC strand facility to install a new state of the art wire rod cleaning process and upgrade production equipment together with other investments and advanced manufacturing technology and in our information systems infrastructure.

The new cleaning facility for which we have recently completed permitting will be similar to the facilities currently in operation at our Gallatin and Sanderson PC strand plants.

You may recall that we recently rebuilt the cleaning facility at the Gallatin plant after it had been destroyed in a fire in January 2014 leveraging a recent experience at Gallatin should allow us to minimize the technical and timeline risks associated with the Houston project.

The addition of new cleaning capabilities will eliminate a high cost process that constrains the capacity of the plant and adversely affects it's yield and productivity. While we're installing the new cleaning process.

We plan to remove antiquated PC strand production lines from the plant and replace them with equipment that was previously operating at the Newnan plant which will increase the capacity of Houston by approximately 40%. 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 cleaning and equipment relocation projects. We expect to move forward with the addition of a third PC strand production line at the facility that will serve 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 reinforcing production line at our Hazelton 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 technical issues on the part of the equipment supplier have delayed the ramp up of the line which we now expect to occur during the current quarter.

These delays resulted in excess operating cost during the fourth quarter as we were forced to operate both the old production line. And the new line throughout the period.

While the delays are regrettable we've made significant progress in recent weeks as the output of the line has risen to approximately 70% to 80% of expected rates from 40% to 50% in prior months.

The unanticipated delays in ramping up the line adversely impacted our shipments during the fourth quarter and our customer service capabilities due to inadequate quantities of product and poor visibility of product availability. As Mike indicated we estimate these delays reduced our quarterly revenues by approximately 4 million.

Additionally we need to regain the confidence of customers that were unfavorably impacted from the limitations that we experienced at the plant.

To conclude our prepared remarks, we believe the recovery on non-residential 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. We will now take your questions. Ben would you please explain the procedure for asking questions..

[Operator Instructions]. And our first question comes from the line of Michael Conti of Sidoti. Your line is open. Please go ahead..

Yes, so I just want to get a better idea on I guess the outlook on some of your volume shipments, just hearing from a few companies in the space that there is a lack of capacity from the end customer in terms of a labor shortage etcetera, I mean is that playing a role in your shipment..

It's a good question, we certainly have heard that it is a factor for our customers. But I have not heard of any specific case where a labor shortage prevented a job from moving forward..

And then I guess can you just. I mean just go into some detail on the decision to expand the Houston facility in terms of end market demand and particularly in that region, are you seeing more in terms of you know infrastructure or commercial. Any color there would be great..

I don't think that there has been any change in the mix of the end markets and I don't detect that there's been an acceleration or deceleration with any of our market in any of our downstream markets it just seems like business has rocked along at about the pace that we have seen earlier in the year..

And then Mike, with SG&A that stuck out to me, would this be a good run rate, you know a model for the rest of the fiscal 2016?.

It's going to fluctuate quarter to quarter depending on our results which drive that incentive plan, compensation components.

So this quarter was skewed higher by the increase, but for the year overall I think it probably be pretty representative recognizing that there's probably on the upside if our results were to continue to improve to where we maxed out on the incentive plan there would probably be as much as another million dollars of expense. on the upside..

And then I guess when you guys expand the Houston facility should we anticipate a pick-up in cost in terms of training new employees or would that be offset by the reduction on the fixed side of the conversion cost?.

There is really very little impact on the employment level of the facility related to this project that there been some very labor intensive and high cost processes operating at the plant that we plan to eliminate and so the impact on employment will be negligible..

Just one other point on the Houston expansion the comment we made about realigning its capacity. Just to be clear as it stands now.

The capacity of the plant falls short of meeting the requirements of its markets where we're incurring some additional freight expense shipment from the other strand locations so this will, you know this will realign the volume of the plant to meet those needs and reduce some expense as well..

Our next question comes from the line of Tyson Bauer of KC Capital. Your line is open. Please go ahead..

You alluded to this briefly in your prepared remarks, the expectations that we might see some demand pushed into this quarter also pushed into fiscal Q1 that really didn't materialize as we first thought, any ideas that may have happened there and does that erode some of those expectations for Q1 that we're currently, that maybe we didn't have that pent up demand that's going to flow through the system..

It's a good question and it's been the subject of quite a bit of introspection here over the last few weeks that there does seem to be a mismatch between what appears to be pretty strong data coming out of the construction industry and we're just not see it in our order book.

So it's not that that business is bad in any way, it's just not meeting the expectations that we had of accelerating unit volume.

So I think it's too early, it's too early to say that it's going to continue to run at a low growth rate I think there are some upside there but we just have to wait and see as we've described a few times over the course of these calls, our insight into the future volume levels is just pretty low relative to the backlogs that we maintain and the short lead times that we're required to fulfill.

So we're optimistic that 2016 is going to represent further growth and we're hopeful that we see that the acceleration in unit volume that we've expected..

And just a follow on to that, the expectation was for favorable comps at least for the next three quarters due to events whether as Mother Nature driven or whether it was your own internal difficulties getting things ramped up, moved around from facility to facility.

Do you still maintain that outlook at least in a broad sense that given some of those external factors that occurred a year ago, the elimination of those should provide some lift as we go forward?.

Yes I mean I think our expectation is for continued growth and to the extent that materializes, I mean it would provide some additional upside if we're going against those prior year periods that were depressed due to the weather other factors.

So I think that's correct and if you know if you look at the most recent construction industry forecasts for nonres, they're still clustered in that high single-digit range for growth rates for 2016..

In your prepared remarks, you talked about the expectations for steel stabilization and pricing. They didn't see a lot of factors that would create the volatility we've seen in years past.

Any effect that has on your cash management strategies in regards to billing inventories or just going maybe a shorter timetable on those turns?.

We're not speculators, Tyson. We will continue to back the product that we need on the timeline that's required to adequately service our plants. But we don't plan to take any inventory positions above and beyond what's required for normal operations..

Given the low-cost steel environment more globally, in that retrospect, have you seen any unusual or atypical countries trying to export into the U.S.

that maybe you hadn't seen before?.

Well, I think at one time or the other, we've seen nearly every wire rod producing country in the world that's not under a dumping order interested in shipping to the U.S.. So no, there are no new countries, but there is considerable interest really worldwide in the U.S. market and for the obvious reasons..

Okay.

Last question for me, given the expansion in Houston, moving product down in that area, Texas as the representative strong area for the Company, how does that -- how do your other regions compare relative to Texas and is this what we should expect going forward, a greater concentration in that area?.

I wouldn't say that there's been any change in the relative strength of the Texas market area to the other areas. Texas has always been the largest consumer of products and we have always serviced the Texas market from afar.

The difference that having the Houston strand plant makes for us is that we should be able to service the bulk of our participation in that market from a much closer location that will help our service and it will also reduce our freight costs. So we have not seen a large acceleration or deceleration in other regions relative to Texas.

It just continues to be the largest consuming area for us..

Our next question comes from the line of Keenan Murray of Forge First Asset Management. Your line is open. Please go ahead..

I was just wondering in layman's terms if you could kind of explain the impacts at the Houston facility and -- sorry, the Hazelton plant in this quarter and you said the 400 basis point impact and how much was that versus just weaker than expected shipments in the quarter?.

The amount that we referenced, the $4 million in lost revenues and the 400 basis point drop-off in shipment growth, those would be directly attributed to the production issues where we believe we would've been able to ship that material out that the demand was there. So it represented a lost opportunity for the quarter.

And then in addition, just with the lower operating level, it had an unfavorable conversion cost impact as well..

Yes, so can you just kind of explain what -- kind of explain more of the production issues and are those kind of alleviated going forward now?.

Do you mean the nature of the difficulties that our supplier had commissioning the loan?.

Yes, I guess so and kind of what you --.

Multiple component failures and repeated component failures, downtime required to replace these components, along with some redesigns of certain systems on the machine. It's a big machine, it is a highly productive and highly automated machine and we've had a disappointing trip out of the gate with it.

As I referenced in my comments, we were dragging along 40% to 50% of expected output rates for many months and we're now up to 70% to 80% of expected rates which represents a significant improvement. So I think we will get there and I think we will get there in the current quarter, but it's been a very disappointing experience for us.

We have a long record with the supplier of quick and efficient startups of new production lines and this certainly is anything but that. But I think we will get there and I think we will get there during the current quarter..

And then I'm just wondering if you can comment at all on what you may think of your uses of cash above and beyond the $20 million expected CapEx for next year? Is that primarily for acquisitions or maybe do you think about any other priorities of these of that cash?.

think our priorities remain unchanged in that our first priority is looking for continued opportunities to grow either organically or through acquisition and we want to maintain plenty of financial flexibility to do so.

After that, we have, over history, generated a record of returning cash to shareholders through both special dividends, dividends and share repurchases and we would consider all of those options going forward if we thought that it was prudent and wouldn't interfere with our growth aspirations..

[Operator Instructions]. Our next question comes from the line of Arthur Winston of Pilot Advisors. Your line is open. Please go ahead..

Two questions about the disparity between the economic statistics and the demand for your shipments. The first part is, was the disparity the greatest in regions where oil is explored and produced? That's my first question.

And the second part, was there a disparity in a certain class or type of construction project more than the other kinds of projects that you serve?.

Let me try to answer it this way, saying that across our two product families of welded wire reinforcing and PC strand, we have three distinct welded wire reinforcing product lines and we have two areas of participation in PC strand.

And I would tell you that we saw similar characteristics in each of those market areas and product segments and geographically there is not a great deal of difference in what we're seeing. So I would say just to say it's an overall phenomenon would be a proper characterization..

Does your product come in at the beginning of a project or more towards the end?.

It would be more toward the front end generally..

Thank you and I am showing no additional questions. I would like to turn the conference back over to Mr. Woltz for any closing remarks..

Thank you. We appreciate your interest in Insteel and encourage you to follow up with us later if additional questions come up. Thank you very much..

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the programming. You may all disconnect. Have a great rest of your day..