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#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 <UNK> <UNK>, 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 <UNK> 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, <UNK>
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 and 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 2 ---+ from the second to the first quarter, and adding the week ended April 2, which follows 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% a year ago due to higher spreads, the increase in shipments, and the 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, while 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.
In 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 around 81 days or a little over 2 1/2 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 expense under our return on capital incentive compensation plan, driven by our improved results which was partially offset by a $0.3 million reduction 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 the options and RSUs that were granted during the quarter.
Equity awards under our plan are 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 $1.00 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 nonresidential 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 nonresidential 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 we 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 the Architectural Billings Index rose to 51.9 in March from 50.3 the prior month, 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 nonresidential building construction based on the approximate 9- to 12-month lead time between architectural billings and construction spending.
Following three months of gains, the Dodge Momentum Index, another leading indicator for nonresidential 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 for March was isolated or the beginning of a trend.
I will now turn the call back over to <UNK>
Thank you, <UNK>.
As reflected in our release and <UNK>'s comments, demand for our 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 up, 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 backlogs 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 a $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 antiquated equipment from the plant and are replacing it with modern equipment that was previously operating at the Newnan plant, thereby increasing the capacity of 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 advantages 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 Hazleton 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 are 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 will 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.
Well, let me start by saying that when finished up our first quarter, volume expectations had not been met.
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 in the market to have generated any sort of hedged buying or pre-need buying that contemplated further scrap increases.
I really don't think anyone foresaw 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.
We'll actually benefit for an interim period, just due to the usual timing issues associated with our inventory where we are carrying around three months ---+ as I mentioned, we are carrying around ---+ usually carrying around three months worth [on viapost].
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 had indicated, our future direction on pricing would just be a function on how the market evolves over the next few months.
That's a good question, <UNK>.
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, is just really hard to say right now.
But I would just comment that our markets are strong.
Our backlogs are far out enough as 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 be more favorable for us.
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 placed, produced, and shipped during the quarter ---+ I don't believe will be affected by the events of earlier this week.
Well, we took ---+ we go through an exercise that we refer to as an 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 over time, this market has grown.
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 really just quite an important fundamental of our business.
Thank you, <UNK>.
We continue to be focused on our core markets, looking for opportunities in every geography and every product line.
So I believe that's really as specific as I would want to be.
Okay.
Thank you.
We appreciate your interest in Insteel, and encourage your follow-up if you have further questions.
