H. Woltz - President and CEO Mike Gazmarian - Vice President, CFO and Treasurer.

Michael Conti - Sidoti Tyson Bauer - KC Capital.

Good day, ladies and gentlemen, and welcome to Insteel Industries’ Second Quarter 2016 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. [Operator Instructions] As a reminder, today’s conference is being recorded.

I would like to introduce your host for today’s conference call Mr. H. Woltz, President and CEO. You may begin..

Thank you, Kevin. Good morning. Thank you for your interest in Insteel and welcome to our second quarter 2016 earnings call, which will be conducted by Mike Gazmarian, our Vice President, CFO and Treasurer and me.

Before we begin, let me remind you that some of the comments made on today's call are considered to be forward looking statements, which are subject to various risks and uncertainties that could cause actual results to differ materially from those projected. These risk factors are described in our periodic filings with the SEC.

All forward-looking statements are based on our current expectations and information that is currently available. We do not assume any obligation to update these statements in the future, to reflect the occurrence of anticipated or unanticipated events or new information.

I'll now turn it over to Mike to review our second quarter financial results and the macro indicators for our markets. Then I will follow up to comment more on market conditions and our business outlook..

Thank you, H. As we reported earlier this morning, Insteel's net earnings for the second quarter of fiscal 2016 close to tripled from a year ago rising to $7.2 million or $0.38 a share driven by higher shipments in spreads and lower conversion costs.

Shipments for the quarter rebounded strongly from the weaker than expected levels of Q1 benefiting from improved market conditions, the relatively mild winter weather, and the year-over-year differences in our fiscal calendar.

Net sales for the quarter were up 16.3% from the first quarter and 5.5% from last year driven by a 23.1% sequential increase in shipments from Q1 and a 20.1% year-over-year increase which more than offset lower average selling prices.

About half of the sequential shipment increase and a third of the year-over-year increase were driven by our fiscal calendar and the extra week in Q4 of fiscal 2015 which extended the end dates for the first and second quarters by a week as compared to last year.

This had the effect of moving one of the seasonally slowest weeks of the year, the week ended January 2nd from the second to the first quarter and adding the week ended April 2nd which falls around the beginning of our busy season to the second quarter.

On a pro forma basis, adjusting both quarters to reflect the same periods as last year, the sequential shipment increase from Q1 to Q2 would have been 11.8% instead of the 23.1% that was reported which is still significantly higher than the seasonal change we typically experience between the periods and the year-over-year increase would have been 14.3% instead of 20.1%.

Although we're still early in the third quarter, our order book has remained strong and shipments have continued to trend above expected levels as we move into our busy season.

Gross profit for the quarter rose to $18.6 million with gross margin more than doubling to 17.3% from 8.5% year-ago due to higher spreads, the increase in shipments and lower conversion costs.

The year-over-year improvement in spreads was driven by a continued reduction in raw material costs that exceeded the decrease in selling prices for our products.

On a sequential basis, gross profit was up $2.2 million from Q1 on the increase in shipments and lower conversion costs, our gross margin declined slightly by 50 basis points due to narrower spreads relative to the first quarter.

Since we typically carry around three months of inventory valued on a FIFO basis, the raw material costs reflected in cost of sales for any given quarter are largely representative of purchases made in the previous quarter and a declining price environment as we've experienced over most of the past year.

This time lag has the effect of deferring the favorable impact of the reduction in raw material costs until the higher cost inventory purchased in prior periods is sold.

At the end of the second quarter, our inventory position represented about 81 days or a little over two and half months of shipments on a forward-looking basis calculated off of our Q3 forecast.

So as we move into our third quarter our spreads and gross margins should continue to benefit from the consumption of lower cost inventory purchased prior to the recent price increases for wire rod.

SG&A expense for the quarter rose $1.7 million from a year ago to $7.6 million primarily due to higher accrued expenses under our return on capital incentive compensation plans driven by our improved results which was partially offset by a $0.3 million in employee health insurance costs related to the high dollar medical claims that were incurred last year.

On a sequential basis, SG&A expense was up $1.3 million from Q1 largely due to higher stock-based compensation expense associated with options and RSUs that were granted during the quarter.

Equity awards under our plan is typically granted on a semiannual basis in our second and fourth fiscal quarters which drives SG&A expense higher in these periods.

After funding the $18.6 million or $1 a share special dividend that was paid in January, our strong operating cash flow for the period left us with $36.4 million of cash as of the end of the quarter and no borrowings outstanding on our $100 million credit facility, providing us with plenty of liquidity and the financial flexibility to pursue additional growth opportunities.

Looking ahead to the remainder of fiscal 2016, we expect continued strength in our non-residential construction end markets as we enter our busy season.

In the most recent monthly construction spending report, total spending through the first two months of the year was up 11.2% from last year with private non-residential up 12.6%, public up 8.4% and private residential up 11.6%.

Over half of the increase in public spending was driven by a sharp rise in highway and street construction, one of the largest consumers of our welded wire and PC strand products which was up 24.1% from a year ago benefiting from this year's milder winter weather.

As you move later into the year we expect the federal highway funding provided for under the recently passed FAST Act will begin to have a favorable impact on infrastructure construction activity and demand for our products.

Construction employment, another indicator for end markets was up 301,000 in March from a year ago rising to its highest level since December 2008 while the construction unemployment rate was at 8.7%, a 10-year low for March. The most recent reports for a couple of the leading indicators for nonresidential building construction were mixed.

Yesterday the American Institute of Architects reported that Architectural Billings Index rose to 51.9% in March from 50.3% the prior months, entering the traditionally busy spring season.

The index has remained above the 50 growth threshold for 10 of the previous 12 months implying further improvement in non-residential building construction based on the approximate 9 to 12 months lead time between architectural billings and construction spending.

Following three months of gains the Dodge Momentum Index another leading indicator for non-residential building construction fell 7.1% in March from the prior month but was essentially unchanged from last year.

Considering the volatility in the DMI over the past year it's uncertain whether the drop-off from RX was isolated or the beginning of a trend. I'll now turn the call back over to H..

Thank you, Mike. As reflected in our release and Mike's comments, demand for reinforcing products exceeded our expectations for Q2, driven by the ongoing cyclical recovery in construction markets and generally favorable weather conditions in most areas of the country.

As we look ahead to the remainder of fiscal 2016, most macro indicators remain positive and customer sentiment points to strong demand for reinforcing products through the balance of our fiscal year.

In our last few earnings calls, we commented on the potential for widening spreads driven by declining prices for steel scrap and our primary raw material steel wire rod together with stable or more slowly declining selling prices for our products resulting from the cyclical recovery in the construction sector.

Our Q3 2015 results reflected the initial impact of these favorable trends which became more pronounced during the fourth and first quarters and continued to benefit us during the second quarter of fiscal 2016.

During our Q1 conference call, we mentioned that the declining trends for steel scrap and wire rod pricing may have run their course in view of the $30 per ton spike in January. Since then, scrap prices have climbed an additional $70 per ton driven by reduced collection of obsolete scrap and a rebound in exports.

The sudden move out which totals approximately $100 per ton since January appears to be a supply side phenomenon since overall steel demand continues to be unimpressive and steel mill capacity utilization remains stuck at around 70%, down from 71.5% last year.

Nevertheless, the sharp uptick in steel scrap prices has been reflected in the transaction prices for wire rod and other hot rolled products and the market appears to have the momentum to support another increase in May.

We're seeking to recover these higher costs through a series of price increase announcements driven off the market conditions and competitive dynamics for each of our product lines. Strong demand and increasing backlog should in most cases provide a favorable environment for recovering higher raw material costs.

We mentioned in the Q1 call that a PC strand competitor would begin their startup of a New South Carolina manufacturing plant during our second quarter and that we expected minimal impact over time from the new capacity provided market demand continued to grow.

Events have unfolded substantially as we expected as we've experienced some pricing pressure as the ramp up activities have commenced. In addition to new domestic capacity, importers are more aggressively soliciting business at prices that are significantly lower than the prevailing domestic market level.

We are carefully monitoring this activity and we plan to move quickly to address any tactics that are inconsistent with US trade laws. We continue to believe that further growth in the PC strand market will be adequate to mitigate the impact on Insteel of new domestic capacity and more aggressive importers.

Turning to CapEx, despite the modest level of expenditures through our second quarter, we expect outlays to rise to approximately $20 million in 2016 which includes $9 million investment in our Houston PC strand facility to upgrade equipment and install a new state of the art wire rod cleaning process comparable to our Gallatin and Sanderson strand plants.

The addition of new cleaning capabilities at the Houston facility will eliminate a high cost process that constrains the capacity of the plant and adversely affects its yield and productivity.

Coincident with the construction of the new cleaning operation, we have removed most of the adequate equipment from the plant and are replacing it with modern equipment that was previously operating at the Newnan plant there by increasing the capacity at Houston by approximately 40%.

We expect this first phase of the project will be completed by the end of the first quarter of fiscal 2017 and generate approximately $5 million of annualized cost savings.

As we approach the completion of the first phase of the Houston project, we expect to add a third PC strand production line at the facility to align our capacity with the requirements of the Texas market.

The addition of the third line which would likely fall within fiscal 2017 is expected to require a $4 million to $5 million investment over and above the outlays for the current improvements.

The economies of scale that are attainable through ramping up the volume of the facility are significant and represent a considerable competitive advantage for Insteel relative to other domestic producers.

We've reported in recent earnings calls that we were commissioning a new high volume standard welded wire reinforcement 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.

The timeline for the ramp up had been affected by vendor technical difficulties which adversely affected our customer service performance and operating cost during the third and fourth quarters of 2015.

I'm glad to report that most of these matters appear to have been resolved and that we expect the line to meet our performance expectations going forward.

Importantly, the volume contributions from the new line here in our first and second quarters have positioned us to restore the service level our customers have become accustomed to prior to the unfortunate experience during the second half of last year.

To conclude our prepared remarks, we are pleased by the strength our markets were showing and by our Q2 financial performance and we believe we're well-positioned to deliver strong results over the course of the next two quarters which represent the seasonally strongest period of the year.

Consistent with prior periods, we'll continue our efforts to further improve the effectiveness of our manufacturing operations, identify additional opportunities to broaden our product offering and grow through acquisition. This concludes our prepared remarks and we'll now take your questions.

Kevin would you please explain the procedure for asking questions..

[Operator Instructions] Our first question comes from Michael Conti with Sidoti..

So with the unit shipment growth, can you just give us an idea on the trend in shipments throughout the quarter and then just looking at the adjusted growth rates and looking at the inventory position, I’m just curious as to how much of that was tied to end market demand versus a pull-forward effect, so that customers can buy ahead of any announced price increases?.

Well, let me start, I’d say, when we finished up our first quarter, volume expectations had not been met or we did not meet our forecast during the first fiscal quarter and it seemed that there was a dramatic change when we returned from the Christmas and New Year holidays, we began booking strongly in January and we were consistently above forecast throughout the second quarter.

So, January did see that first spike in steel scrap prices, but I think at the time, there was not sufficient concern about that and the market too have generated any sort of hedge buying or preneed buying that contemplated further scrap increases. I really don’t think anyone for what would unfold over the course of the quarter in steel scrap prices.

So I guess I would summarize by saying from our perspective, from what we see, customers needed the material, they purchased it and they used it..

Okay. That makes sense.

And then just given the price increases by some of the wire rod producers and then your own announced selling price increase, it looks like the effective dates are about a month apart or so, so should we anticipate some spread pressure, just given that time lag?.

Well, actually, benefit for an interim period, just due to the usual timing issues associated with our inventory where we’re carrying around three month the dimension we’re carrying around, usually carrying around three months’ worth on [indiscernible], so with that quarter lag, we should actually benefit on an interim basis as the price increases are matched against the lower cost inventory and then as we’d indicated, I mean our future direction on pricing would just be a function on just on how the market evolves over the next few months..

Our next question comes from Tyson Bauer with KC Capital..

Good morning, gentlemen. Great quarter. Following up, obviously, margins are going to be the key topic here.

It does sound like you’re more confident on your volume expectations going forward than the margins, once we get beyond kind of the latter part of your fiscal Q3, would that inventory rolling through that gives you a little bit of buffer, what -- it sounds like we may see that dissipate once we get in Q4, when you will have a better idea of price increases sticking or whether or not we’re going to see a little bit of pressure as we get into the last part of the fiscal year..

It’s a good question, Tyson. We operate in a competitive environment. I think the magnitude of the steel scrap and wire rod increases actually works in our favor as it would be unthinkable for any of our competitors to absorb those increases and I think it creates motivation to recover the cost increases in the marketplace.

But exactly how it unfolds and whether there turns out to be any timing issue in recovering the cost, it’s just really hard to say right now, but I would just comment that our markets are strong, our backlogs are far out on the office to be somewhat uncomfortable from a service level point of view and the market is strong and I think it will support these increases.

So as these things go, the environment couldn’t have been -- couldn’t be more favorable for us..

Last year, we had a day loss of weather events in the Texas, Louisiana, Oklahoma, this year, we have a more isolated shorter in duration should provide you a favorable comp situation in those areas, which is a key area for you.

How have the recent, what we’re seeing in Houston, Louisiana, from some of the rail guys having problems and moving product and activities and construction, have you seen anything that would be material to you this year as opposed to last year?.

I guess that’s still unfolding. In terms of its direct impact on our Houston area plants, we lost 32 hours of production at our PC Strand plant and we lost part of one shift at our welded wire reinforcing plant.

The impact on customers is harder to ascertain at this point, but I think over the course of Q3, you probably won’t notice it that the orders that have been in place produced and shipped during the quarter, I don’t believe would be affected by the events of earlier this week..

Okay.

And last question from me, it seems like kind of the mental gymnastics you went through in going ahead with a third line for the PC side, when we have a new competitor entering the marketplace, you talked about imports creating some additional pressure in volumes, what was kind of that impetus that said, yeah, we’re going to go ahead and increase that, is it that strong in that marketplace and the new competitor is far enough away, is not going to impact you or just give us a little, what you went through to make that decision?.

Well, we took -- we go through an exercise that we refer to as optimum mill exercise, which quantifies the inbound and outbound freight impact of serving our customers from various plants. And for us to align our customer service requirements with our supply and demand in the Texas market, the third line is justified.

So, overtime, this market has grown what we believe it will continue to grow and one of the major thrusts of our company over the last five years has been to put our capacity and our product capabilities in optimum geography relative to our suppliers and our customers, there are huge cost implications of doing so and there are huge customer service implications of doing so.

And it’s just -- it’s really just quite an important fundamental of our business..

[Operator Instructions] And I’m not showing any further questions at this time. Actually, one moment, we did have someone just queue up. We have another follow up question from Michael Conti with Sidoti..

Yeah.

Just wanted to touch upon maybe the M&A pipeline, what you’re seeing out there in terms of multiples or areas of growth that you’re seeking to expand to?.

Mike, we continue to be focused on our core markets, looking for opportunities in every geography and every product lines. So I believe that’s really specific as I’d want to be..

And I’m not showing any further questions at this time. I would like to turn the call back over to H..

Okay. Thank you. We appreciate your interest in Insteel and encourage your follow-up if you have further questions. Thank you..

Ladies and gentlemen that does conclude today’s presentation. You may now disconnect and have a wonderful day..