Insteel Industries, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the InSteel Industries first quarter 2020 conference call. At this time, all participants' lines are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star, then 1 on your telephone keypad. Please be advised that today's conference is being recorded. If you require any further assistance, please press star, then 0 to reach an operator. I'd now like to hand the conference over to your speaker today, Mr. H. Woltz, President and CEO. Please go ahead, sir.

Thank you. Good morning, and thank you for your interest in InSteel. Welcome to our first quarter 2020 earnings call, which will be conducted by Mike Gasmarian, 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 the call over to Mike to review the first quarter financial results and outlook for our construction markets, and then I'll follow up and comment more on business conditions.

Thank you, H, and good morning to everyone joining us on the call. As we reported earlier today, the first quarter of fiscal 2020 proved to be another challenging period for InSteel as we continue to contend with low-priced import competition and the consumption of higher-cost inventory. Earnings per share for the quarter dropped to 3 cents from 19 cents a year ago, excluding last year's 2-cent-a-share non-recurring gain related to the disposition of fixed assets. As we've conveyed on previous calls, our import competition is centered and certain of our PC strand and standard welded wire reinforcement markets, where pricing pressure has intensified in the wake of the Section 232 tariffs on imported steel. The tariffs, which apply to imports of our primary raw material, hot-rolled steel wire rod, but not to our finished products, have driven domestic prices for wire rod substantially higher than global market levels, and foreign competitors have leveraged this cost advantage to expand their market share. Weather conditions for the corridor were generally more conducive for construction activity as compared to a year ago, when the near-record precipitation across our largest markets resulted in construction delays and deferred orders. Shipments for the quarter were up 11.7% from last year, but down 10.9% sequentially from Q4, reflecting the usual seasonal slowdown in demand. Average selling prices continued to decline during the quarter, falling another 3.4% from Q4, reflecting the impact of the import-related pricing pressure, together with domestic competitors' efforts to backfill lost volume as well as retain existing business. The price erosion was more pronounced in markets subject to import competition, which represented around 30% of our sales for the quarter, with ASPs for these markets dropping 8.3% sequentially from Q4 as compared to only a 2.1% decrease for the rest of our business. Gross profit for the quarter fell $4.7 million from a year ago, and gross margin narrowed 410 basis points to 6.4%, primarily due to lower spreads between ASPs and raw material costs. While on a sequential basis, gross profit rose $2.4 million from the fourth quarter and gross margin widened 300 basis points, driven by higher spreads relative to the depressed levels of Q4, which represented the low point over the past year. As I alluded to earlier, the spread compression we experienced during fiscal 2019 and in the first quarter of this year has been compounded by the continued consumption of higher cost inventory in a declining price environment. Considering that we're typically carrying around three months of inventory valued on a FIFO basis, our spreads and margins have been adversely affected by the matching of higher cost inventory purchased in prior periods with lower ASPs for our products. Fortunately, it appears this unfavorable trend could be coming to an end in view of the growing indications that steel prices may have reached a bottom, with scrap prices rising now for three straight months by a total of $80 a ton since October. Our wire rod suppliers have followed suit, announcing price increases in November, December, and January, and we've rolled out an initial increase across most of our product lines that went into effect earlier this month. Should these increases mark the beginning of an upward trend or an eventual leveling out of prices, it would eliminate a significant headwind that has been weighing on our results since early last year. SG&A expense for the quarter fell $0.8 million to $5.7 million from $6.5 million, or 5.9% of net sales from 6.3 last year, largely due to a favorable $0.9 million year-over-year change in the cash surrender value of life insurance policies, which increased $0.3 million this year as compared to a half million decrease last year. Our effective tax rate for the quarter fell to 22.7% from 23.5% last year, primarily due to changes in permanent book tax differences. Looking ahead to the remainder of the year, we expect our effective rate will run around 23%, subject to the level of pre-tax earnings, book tax differences, and the other assumptions and estimates entering into our tax provision calculation. Moving to the balance sheet and cash flow statements, Cash flow from operations for the quarter improved to $29.6 million, largely due to a $24.6 million decrease in working capital. The reduction in working capital was driven by an increase in payables resulting from higher raw material purchases in the latter part of the quarter, a reduction in receivables reflecting the usual seasonal slowdown in sales, and a reduction in inventories due to lower average unit carrying values. Based on our sales forecast for Q2, our quarter-end inventories represented 2.9 months of shipments compared with 3.1 months at the end of the fourth quarter. Our ending inventories were valued at an average unit cost that was lower than the beginning average in the amount reflected in Q1 cost of sales, which will favorably impact our spreads and margins during the second quarter. We ended the quarter with $67.1 million of cash on hand are just under $3.50 a share, and no borrowing is outstanding on our $100 million revolving credit facility, providing us with ample financial flexibility and the ability to pursue any attractive growth opportunities that may develop. In allocating our cash flow and managing the cyclical nature of our business, we continue to focus on three objectives, reinvesting in the business for growth and to improve our costs and productivity, maintaining adequate financial strength and flexibility, and returning capital to our shareholders in a disciplined manner. Going forward, we will continue to balance these objectives in deploying capital and any excess cash balances. As we move into the second quarter of fiscal 2020, our market outlook for the remainder of the year remains positive with higher growth in the infrastructure segment expected to offset further moderation and non-res activity. Through November, public construction spending was up 6.8% from the prior year, with highway and street construction, one of the largest end-use applications for our products, rising 8.8%. We expect this favorable trend will continue in 2020, driven primarily by higher state and local spending supported by fuel tax increases and the availability of low-cost debt financing and other ballot measures, together with the improved fiscal positions of states and municipalities. Following two short-term continuing resolutions, on December 20th, a federal transportation spending bill for fiscal 2020 was enacted, which eliminates the cloud of uncertainty that it threatened to curtail project commitments and allow states to receive their full-year spending authority. The new spending package increases federal highway funding another 2.4% up to the level authorized under the FAST Act and provides for an additional $2.2 billion of supplemental funding from the general fund. This marks the first time in five years that state DOTs will have their full spending authority prior to January 1st and provides a clear path for Congress to pursue a successor highway funding bill to the FAST Act, which expires at the end of fiscal 2020. In its annual forecast for 2020, the ARTBA is projecting at least 5% growth in the U.S. transportation infrastructure market after adjusting for project costs and inflation, which reflects 6% growth in the real value of public highway, street, and related construction investment by state DOTs and local governments, the largest market sector, and 3% growth in bridge and tunnel construction. After remaining relatively flat through most of the year, the architectural billings and Dodge Momentum Indexes, both leading indicators for non-residential building construction, have reflected recent improvement with the ABI rising to 51.9 in November, the second straight month of modest growth, and the DMI increasing 14.9% over the past four months. I will now turn the call back over to Age.

Thank you, Mike. As Mike indicated, our first quarter results reflect improving shipment trends relative to the prior year resulting from favorable underlying demand for our reinforcing products and a return to more normalized weather patterns. Looking forward, we expect construction market conditions will support continued growth in the demand for our products during fiscal 2020. While we're less than three weeks into our second fiscal quarter, we're pleased with the strength of our order book and the robust pace of shipments. As Mike indicated, steel scrap prices have rebounded for three consecutive months, rising nearly $80 a ton from the October low. This upward momentum together with stronger conditions in our markets has led us to announce a price increase with an effective date earlier this month. Assuming the favorable market environment persists, we expect to take the appropriate actions necessary to recover our rising raw material costs and restore spreads in certain of our markets. Importantly, we believe the cycle of continually declining steel prices has run its course for now, which implies the opportunity for spreads to return to normalized levels. Not surprisingly, our first quarter financial performance was negatively impacted by the elevated level of import competition we've contended with following the imposition of the Section 232 tariffs. and this will limit our ability to recover higher costs in markets that have been most severely affected. Foreign competitors continue to underprice the domestic market to capitalize on the market distortions that have been created by U.S. trade policy. Since it appears the administration is firmly committed to the use of tariffs as a policy tool, the only reasonable resolution of these distortions is to extend the 232 tariff to downstream products. We've continued our dialogue with the administration and believe they understand the unintended consequences of the tariff program and are evaluating options to address the matter, although it's not possible to predict whether they will take action to correct the distortions that have been created. In the interim, we'll continue to assess our operating strategy and determine the appropriate adjustments that are warranted in response to increased import competition. Our current plans are to continue to compete in these markets and aggressively pursue additional improvements in our manufacturing efficiencies and costs while we work toward a satisfactory resolution with the administration. Turning to CapEx, we continue to expect outlays to come in at approximately $17 million for fiscal 2020, subject to revisions as we move through the year. Our capital plan is focused on investments that will broaden our product capabilities in certain markets, expand our engineered structural mesh capacity, lower our production costs, and update our information systems technology. During Q1, we continued commissioning activities for the new ESM production line at our North Carolina facility that will increase capacity for certain niche products as well as substantially reduce our operating costs. While the line has performed well across a limited range of products, our equipment supplier has identified additional modifications that need to be made in order for it to achieve its full range of capabilities. We expect this work will be completed during the current quarter and allow for the line to ramp up to projected operating rates during the balance of the fiscal year. Market conditions remain favorable, and we're confident we'll attain our investment objectives once the line has attained its full range of capabilities. So in summary, we expect continued growth in demand for our products during 2020. We're optimistic that the robust shipping trim that emerged in Q1 will continue, and it appears that the cycle of steel price weakness that has adversely affected our results in 2019 is behind us. We will remain focused on improving all aspects of our manufacturing operations and continue our dialogue with the administration to address the challenges created by steel trade policy and will continue to be vigilant in pursuing attractive growth opportunities, both organic and through acquisition. This concludes our prepared remarks and we'll now take your questions. Liz, would you please explain? explain the procedure for asking questions.

Certainly. Ladies and gentlemen, if you'd like to ask a question at this time, please press the star, then the number one key on your touchtone telephone. To withdraw your question, press the pound key. Again, that's star, then one, if you'd like to ask a question at this time. Our first question comes from the line of Julio Romero with Sidoti. Your line is now open.

Hey, good morning, everyone. I wanted to ask what your sense is for industry inventory levels. As I understand it, they were pretty elevated as recently as last quarter. Do you have a sense as if to your competitors' inventory levels have maybe flushed out as well?

And, Holy, are you referring at our level of the supply chain or our customers?

At your level of the supply chain in terms of your competitors and, you know, having some elevated inventory levels.

Okay. Yeah, I mean, I think that inventory reduction cycle has run its course. We actually receive some pretty solid data on inventories in the industry, and it would indicate that inventories have reduced markedly over the last three quarters.

Okay, great. On your capital expenditures, I saw you did maybe less than a million in CapEx in the quarter. Can you maybe remind us what you expect maintenance CapEx to be, and would the $17 million in total that you expect for the year be sort of back-weighted towards the back half of the year?

Yeah, well, we've remarked in previous calls that we tend to be slower in deploying capital than we initially think we will be when we look at a multi-year capital expenditure plan. It really has as much to do with internal resources as it does anything else. But we've laid out these projects, and we know the path we're pursuing is simply a question of lead times and our ability to execute on it internally. So, yes, it would be back-ended, and there's always a chance that spending comes up a little short of this estimate.

Okay, excellent. And just last one, and I'll hop back into the queue, is could you comment on the leadership change that you announced in December, you know, maybe some color on where you are in your search for a successor, and do you expect any material change in the company strategy?

Well, right now I'm still in mourning that Mike's going to depart the company. But we are engaged in finding his successor. and we've had a tremendous amount of interest in the position, as we expected we would. But, really, there's nothing else to say at this point other than that it's a high priority for us.

Understood. And, Mike, thanks for your help and your success over the years at Insteel. And I'll hop back into the queue. Thank you. Thanks, Julio.

As a reminder, ladies and gentlemen, that is star then one if you'd like to ask a question at this time. Our next question comes from the line of Tyson Bauer with KC Capital. Your line is now open.

Good morning, gentlemen.

Hi, Tyson.

From the comments in your press release, is it safe to say that when you went into your budgeting for this year, you have considered the tariffs and the import pressure to be persistent throughout the year? And if those things were to change, that may change some of your business operations. But for right now, heading into the year, you're running the business as if those will be present throughout the year.

Yeah, that's correct. But we really haven't changed our operations at all. We've sort of just tucked through the import competition and And I assume that that will continue, absent some dramatic change in the landscape that we see.

Okay. Regarding the price increase, then, if we're viewing the imports are going to be present, does that mean that the price increase is targeted to the non-import affected areas and on certain product lines? And also, the implementation of that during your weakest seasonal quarter, We've had mixed results in the history of the company in doing that. When do you think you'll start to see evidence of that working or not working?

Well, it's hard to say, Tyson. It's a day-by-day exercise. You are correct, and as we acknowledged in the prepared comments, it's going to be difficult where import competition is already substantially under our pricing level. So our expectations, I think, are realistic there. But I would tell you that one of the more relevant factors in whether price increases can become effective or not is the strength of the order book, and it's strong. So I think that this is certainly not a fantasy that we're working right now. I think that the conditions are conducive to our recovery, and we've experienced just substantial margin compression. So I think it's also realized or it's fair to expect that those spreads normalize at some point in time, and that has to happen when market conditions are stronger.

Would it be fair to say that 70% of the business will likely have a positive benefit from those price increases and spreads widening, while 30% may – remain at constant levels or may have more challenges as far as their spreads, depending on the level of imports then?

Well, all of those things are at work, Tyson. I'd rather address that question next quarter.

Okay. Mike, SG&A, very favorable level. Is that something you're looking at to be consistent as we go through the year, obviously depending on sales levels, but where do you see SG&A landing this year?

Yeah, I would expect it to bounce back up in the coming quarters. As I mentioned, we benefited from a favorable swing in the cash surrender life insurance policy that tends to be correlated with fluctuations in the financial market. So, I mean, going forward, it would be a question of whether that continues to be a significant positive. That's always a factor. And then also the other significant variable cost of the incentive comp pay, which would fluctuate with our results and going forward over the remainder of the year, performance continues to improve, then you may see a pickup in expense for that component.

Okay. Working capital outlook, if we're going to have some increase in some of our raw materials there, obviously we had the benefit in this past quarter Where do you see working capital needs for the year?

Yeah, I think we've probably bottomed out as of the end of the quarter, and you're likely to see an increase both in inventory levels, modest increase there, as well as the usual seasonal pickup in receivables as we move into the busy season.

Okay. And last question for me. H on the prepared remarks are in the press release you talk about strategic acquisitions is the environment with a stronger end market in non-import affected areas and given your cash and balance sheet presence are you looking for an industry shakeout to take advantage of this year or why the specific mention that we could see more activity than what we've seen in the past I don't I don't

I think we meant to imply that you would see more than you've seen in the past, only that we're constantly looking for opportunities. And certainly down cycles typically present some opportunities that up cycles don't. And we're attuned to that, but we've been attuned to it every quarter that we've held a call. So there's no change there. Okay. Thank you, gentlemen.

And I'm showing no further questions in queue at this time. I'd like to turn the call back to Mr. Waltz for closing remarks.

Okay. Thank you for your interest in the company, and we look forward to talking to you next quarter. Have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.