Insteel Industries, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the InSteel Industries third quarter 2020 conference call. At this time, all participants' lines are in a 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 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. Today's call is being hosted by H. Waltz President and Chief Executive Officer, and Mark Carano, Vice President, CFO, and Treasurer. I would now like to hand the conference over to your first speaker today, Mr. H. Waltz. Thank you. Please go ahead, sir.

Good morning. Thank you for your interest in InSteel, and welcome to our third quarter 2020 earnings call, which will be conducted by Mark Carano, our Vice President, CFO, and Treasurer, and me. This is Mark's first earnings call with the company, and we welcome him to the InSteel team. Before we begin today, I'd like those on the call to be aware that Mike Gazmarian, who faithfully and competently served as InSteel's CFO for 25 years, will leave the company effective July 31st. On behalf of our entire management team and the board of directors, I would like to thank Mike for his performance orientation, leadership, and integrity that were instrumental in transforming InSteel into the premier competitor in its markets. He was strongly focused on making our company a good place to work and shareholder-friendly for investors. Mike, we wish you the very best going forward. Pertaining to the call today, 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 current expectations and information that's 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 Mark to review our third quarter financial results. Then I'll follow up to comment more on business conditions and other recent developments.

Great. Thank you, H. And good morning to everyone joining us on the call. I'm pleased to be here participating in my first earnings call with the CFO of InSeal. As we reported earlier today, the recovery in spreads between selling prices and raw materials from the depressed levels of a year ago was the key driver in our strong results for the third quarter of fiscal 2020. Additionally, our performance also benefited from strong shipment growth relative to the prior year period. Excluding the non-recurring charges and gain that were referenced in our release, net earnings rose to $0.30 a share from $0.11 a share last year. Shipments for the quarter rose 9.5% from last year and 7.4% sequentially from Q2, which represented the second highest quarter of shipments in the last 10 years, a level that was only exceeded in the third quarter of 2016. The strong shipping performance was driven by increased construction activity across most of our markets, the benefit of incremental tonnage from the Strandtec manufacturing acquisition, and a return to generally more favorable weather conditions for construction activities this year as compared to the prior period. Partially offsetting the benefit of these increased shipments, though, was the impact of declining average selling prices, which fell sequentially for the sixth straight quarter, declining 11.7% from last year and 1.2% sequentially from Q2. And in those markets susceptible to import competition, the pricing pressure was more pronounced. In certain of our PC strand and standard welded wire reinforcement markets susceptible to import competition, which represents about 30% of our overall sales for the quarter, average selling prices in these markets declined 20% year over year, which was more than double the 8% decline for the remainder of our business. As we've conveyed on previous calls, low-priced import competition in the PC strand and standard welded wire markets, respectively, remains intense and continues to have a negative impact on our average selling prices. To level the playing field in those markets, we are aggressively pursuing actions with the U.S. government and international trade authorities and remain optimistic that our efforts will be successful in remedying these market inequities through duties or other mechanisms. Gross profit for the quarter increased $6.6 million to $14.8 million from a year ago, and gross margin widened 560 basis points the 12.1% from 6.5%, primarily due to the wider spreads and, to a lesser extent, the increase in shipments. While on a sequential basis, gross profit decreased $477,000 from the second quarter and gross margin declined 117 basis points. Spreads in the quarter expanded to more historically normal levels from a year ago as we benefited from the consumption of low-priced rod inventory that exceeded the negative impact from a decline in average selling prices from the prior quarter. Current spread levels over the last two fiscal quarters have been consistently above these historically depressed levels experienced during our first quarter of fiscal 2020 and the last two quarters of fiscal 2019. Scrap pricing trends, which can affect our raw material comps, remain under downward pressure as signaled by the benchmark Chicago Shredded Index declining from $297 per ton in January 2020 to $235 per ton in July 2020. SG&A expense for the quarter rose $1.2 million to $6.7 million, or 5.5% of net sales from 4.4% last year. The increase was primarily driven by accruals for incentive comp and legal costs, that were partially offset by a favorable $589,000 year-over-year change in the cash surrender value of life insurance policies due to the rebound in the financial markets over the last few months. Our effective tax rate through the first nine months of the year decreased to 21.7% from 22.4% last year due to a $224,000 benefit recorded in the quarter related to the NOL carryback provisions of the CARES Act. Excluding this benefit, our effective tax rate for the first nine months of the year would have been 23.2% as compared to last year's 22.4%. 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 other assumptions and estimates factored into our tax provision calculation. Moving to the balance sheet and cash flow statement, Operating activities provided $17.9 million of cash for the quarter due to a combination of earnings, and an $8.4 million reduction in working capital driven largely by the timing of accounts payable related to raw material purchases. Based on our sales forecast for Q4, our quarter-end inventories represented 2.4 months of shipments compared with 2.5 months at the end of the second quarter, and on an overall basis, average unit carrying value is relatively close to the amounts reflected in Q3 cost of sales. We concluded the quarter with $61.4 million of cash on hand, or over $3 a share, and no borrowings outstanding on our $100 million revolving credit facility, for which we have almost 100% availability today. As we look ahead to the fourth quarter of this fiscal year, we expect our markets to be strong as customers remain busy working through their backlogs. but our visibility in the fiscal 2021 remains limited due to the sustained uncertainty resulting from the COVID-19 outbreak. Fortunately, our financial flexibility, owing to our strong liquidity position mentioned earlier, combined with our flexible operating model positions us well to navigate through today's uncertain marketplace and act opportunistically as and if opportunities arise. Our capital deployment strategies remain focused on maintaining adequate financial strength while balancing the pursuit of our three objectives, reinvesting in the business to improve our operating model through cost and productivity improvements or capital expenditures to accelerate our organic growth, executing on strategic opportunities that meet our return parameters to support inorganic growth, and returning capital to shareholders in a disciplined manner.

I will now turn the call back over to H. As Mark indicated, our third quarter results reflect strong shipment growth relative to the prior year, driven by favorable underlying demand for our concrete reinforcing products and a return to more normalized seasonal weather patterns. We also benefited from the closer alignment between our raw material costs and average selling prices. We were pleased with the solid underlying demand for our products and our Q3 three, financial performance. In response to the COVID-19 outbreak, we are observing CDC recommended procedures for managing exposure to the virus and its transmission at our plants as well as our administrative offices. With our industry deemed essential, none of our manufacturing facilities was materially affected by COVID-related operating restrictions during the third quarter. Order entry has remained robust. although we saw some moderation in the Northeast and Midwest during the quarter, reflecting COVID-related regulatory responses, which have now largely abated. Through the beginning of this week, the company had 29 confirmed COVID-19 cases affecting six plants and our administrative offices. Fortunately, there's been only one hospitalization, and 18 employees have recovered and returned to work. Our hospitalized employee is recovering and we look forward to welcoming him back to the plant. Although we're unable to predict the ultimate impact of the virus on our business, as a general statement, customers are adhering to normal operating schedules and the impact on our operations has been minimal. We remain committed to fulfilling customer requirements, provided that we can do so without compromising the safety of our people. Should we eventually experience a precipitous drop-off in demand, we're prepared to make the appropriate adjustments to our operating plans. While pandemic concerns did not materially affect our operations during Q3, we elected to schedule two weeks of downtime during the quarter at two plants producing standard reinforcing products where finished goods inventories were trending toward excessive levels due to the impact of Mexican imports on this product line. I'll comment more on imports later in the presentation. As you know, we completed the acquisition of certain assets of Strandtech Manufacturing in March. Integration activities have proceeded smoothly and the closure plan for the Somerville site is on schedule. Customer service and order fulfillment responsibilities were transferred to in-skew facilities immediately upon closing. and our people delivered a practically seamless transition for Strandtech customers. Since closing, our engineering team has been onsite in the Somerville facility, continuously updating and renovating equipment that will be deployed at other in-steel plants. The first equipment transfers are now underway, beginning a process which will continue into Q2 of fiscal 2021. we expect to realize significant operating leverage from the strand tech production assets, which will be used to eliminate process bottlenecks at the Tennessee, Texas, and Florida PC strand plants. The Somerville real property has been listed for sale, and we're pleased with the level of interest that's received. We're also working through the process of disposing of equipment that will not be utilized by other instilled facilities. In summary, Up to this point, we're very pleased with the strand tech transaction, including customer retention and the status of our integration efforts. As we mentioned during the Q2 call, on April 16th, InSteel, together with two other domestic PC strand producers, filed anti-dumping petitions against 15 countries representing 89% of total PC strand imports entering the U.S. in 2019. in addition to a countervailing duty petition against Turkey alleging illegal subsidies. The scope of the filings, which allege dumping margins ranging from 24% to 194%, reflects the egregious behavior of PC strand producers from these countries in the U.S. market over the 2017-2019 investigation period. On June 1st, the International Trade Commission issued its affirmative preliminary injury determination and the investigation shifted over to the Department of Commerce. Additional milestones are tentatively scheduled for September and November 2020 and April and May 2021. I should point out, however, that the timeline for the cases could be impacted by procedural considerations at the Department of Commerce and the International Trade Commission. On June 30th, InSteel and four other domestic producers of standard welded wire reinforcing filed an anti-dumping petition against Mexico, alleging dumping margins from 56% to 161% of value. For a protracted period of time, imports of Mexican standard welded wire reinforcement has substantially undersold the domestic market, and consequently, Mexican import penetration has increased significantly. This case will follow a similar timeline as PC Strand cases, although it will be somewhat compressed since only one country is involved in the filing. We expect the International Trade Commission to render its preliminary determination of injury by the middle of August. As with any litigation, it's not possible to predict the outcome of these cases, but we believe the allocations made in the cases are strongly supported by the underlying facts and extensive analysis, and we expect the cases to be successful. Turning to CapEx, we had initially estimated 2020 expenditures of approximately $17 million, subject to revisions as we move through the year. Last quarter, we indicated that 2020 CapEx would likely be substantially under $17 million due to delays in committing to an investment for our engineered structural mesh business. Subsequently, questions surrounding that project were resolved, and we committed to move forward during Q3. While we're unable to predict with certainty the timing of outlays, We now believe that 2020 CapEx will come in at approximately 12 million. Our CapEx strategy continues to be focused on reducing cash costs of production, improving the quality of our products, supporting the growth of our engineered structural mesh business, and improving our information technology infrastructure and capabilities. As we head further into Q4, We expect another quarter of solid shipments and reasonable financial performance. Looking out to 2021, however, market conditions are uncertain in view of the impact of the pandemic on funding sources for public construction and the increased risks it has created for private non-residential construction. We would not be surprised to see some softening as the consequences of this significant downturn in economic activity are felt in our markets. We'll continue to closely monitor market conditions and aggressively pursue the appropriate actions to optimize our costs. We'll also continue to be vigilant in pursuing growth opportunities, both organic and through acquisition. This concludes our prepared remarks and we'll now take your questions. Daniel, would you please explain the procedure for asking questions?

As a reminder, to ask a question, you'll need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Julio Romero with Sedodian Company, your line of jokes.

Hey, good morning, Mark. Good morning, H. Good morning, Julio. I guess to start... Can you maybe talk about, you know, COVID-19 response? I appreciate the comments and the prepared remarks, but maybe just talk about more broadly what's been the biggest impact in your view. You know, it sounds like, again, minimal impact, but, you know, would you say the biggest impact would be maybe customer uncertainty or any changes in the competitive environment or anything else that these were highlighting?

Yeah, well, so... While the impact has been minimal on our operations, the concern has been high. We have customers who have difficulty predicting their operating rates based on the impact of infections in their manufacturing facilities. We have had disruptions in our own manufacturing facilities as we've been conservative in quarantine procedures and testing. being sure that people get the right attention if they've been exposed, which means that we wind up with vacancies in our operations and shifts that aren't completely staffed, and clearly that's been a problem for us to work around. But overall, I'd say the uncertainty that's been created may be the most significant impact at this point because Neither In-Steel nor In-Steel's customers can say exactly what operating configurations and conditions will be next week or next month or in the fall. So I'd say that while we typically don't have a long view of demand in our markets, that's particularly true right now because everything is subject to change on a daily basis.

That's helpful. And I guess on that point, as you talk to your customers, as you talk to the concrete manufacturers, can you just talk to what areas, you know, within residential or non-residential are holding up well? I know you have a couple of steps removed from the end project, but maybe any sense of, you know, public, private, and kind of areas within that would be helpful.

Yeah, well, I think public construction has continued to be pretty robust, as you're well aware. most of those projects were funded prior to all the uncertainties that have developed. We've also seen on the private non-REIT side a tremendous amount of work in the distribution center market, which has been quite robust and appears to continue to have a long glide path for us. So I can't point out any significant area of weakness at this point.

Got it. And then, you know, on the volumes, really strong quarter there. I was really impressed there. I mean, I was hoping you'd maybe quantify the incremental tonnage from Sprint Tech in the quarter.

Yeah, Julio, that's actually a number that we haven't disclosed historically with respect to more broadly, but also with respect to the acquisition.

Yeah, and the other part of it is, Julio, that it's difficult for us to know precisely since in certain cases we were splitting business with StrandTech at certain accounts, and we've really focused on just taking good care of those accounts that StrandTech was servicing, but it's really difficult for us to pin down the incremental tonnage.

Fair enough. I guess just maybe to ask another way, I guess you mentioned the customer retention has been pretty good. If you could speak to maybe the customer retention efforts that, you know, with Stratax, maybe that would be helpful.

Yeah, well, that was key. Customer retention is a key driver of making this transaction successful, and And it probably won't surprise you to know that our focus has been on making good on our commitments for delivery, being competitive with market pricing with these accounts, and to the extent that we can make their lives easier, they'll stick with us. And we've done that, and we're pleased with the retention that we've seen up to this point.

Really helpful. I'll hop back into Q. Thanks very much.

Thank you. Thank you. As a reminder, ladies and gentlemen, that star then won to ask a question. Our next question comes from Tyson Bauer with KC Capital. Your line is now open.

Good morning, gentlemen, and excellent quarter.

Good morning, Tyson.

Can you give us a sense, reading a lot of headlines regarding state bonding activity, it would appear that municipalities, states, outside of their general fund typically do a lot of bonding that is project oriented or for the Department of Transportation and they're taking advantage of the availability of lower rates at this current time. Does that help insulate or help out your particular business if they are to continue that pattern of increasing that bonding?

Yeah, I mean, absolutely. And I think this is a trend that is not new as DOTs have become more strapped for funds and localities and municipalities have been strapped for funds over the last few years. We've seen at the local and state level that many of these entities have turned to bond financing or they have dealt with their own fuel tax issues in a local or statewide basis. to try to replace some of the funding that in prior years may have come out of the federal government. So, yeah, I think that the trend is positive for us, although I don't know that it would be sufficient to offset what we believe will be a pretty serious downturn in federal fuel receipts and distributions in 2021. I think it remains to be seen.

Doesn't the Highway Trust Fund technically run out of money? I think it's September. So the action must be taken in some regard just to maintain. Is that your understanding?

It is, yes.

Would you anticipate minimally maintenance funding for that that we've seen the past two years, or do you buy into the fact they may try to increase that? availability of the stimulus?

Well, good questions. I think the context of the election in November has to be considered in all of these scenarios. And with the emphasis and focus on minimizing the COVID damage to our economy, I fully expect that there will be some sort of infrastructure action at the federal level. Whether that comes before the election or after is hard to say. But I would be very surprised if infrastructure funding isn't wrapped up into this whole stimulus and recovery program that seems to be popular in Washington.

Okay. Would you say when referencing your 21 outlook, which obviously it's early 2020, that the most uncertainty is probably isolated or focused in on the private non-res portion of your business on whether or not that can backfill current activity?

I would say both private non-res and public construction are concerns, Tyson. And when we talk to customers who have backlogs that go six to eight months out, We're trying to keep our ear to the ground on bidding activity that's occurring for 2021, and there's mixed news on that at this point. But I think there are risks in both sectors.

Okay. It appears we're getting into an economy that's going to be more delivery-based, people taking it at home as opposed to going to the stores, whether that's groceries or otherwise, which puts a much greater focus on DCs that has been what Amazon's been doing, some of the other big companies in that area. Tilt-up buildings typically are those kind of manufacturing or that kind of construction. Is that a key area for you and something that you excel at and provide that cost-saving equation for those construction companies and that type of design?

Absolutely. It's a sweet spot for us, and we have capitalized on it to a great degree this year. We also believe that that trend has a long way to run for exactly the reason that you pointed out in the comment you made in opening your question. So it's very robust, and we expect it to continue.

Okay. Last one so I don't take up too much time. You've got a significant amount of cash built up. years past you have at the board level examined a possible special dividend at the end of the year. Is your 21 outlook too uncertain to put that under consideration, or are you more focused in on being conservative, having the cash there, and M&A opportunities should they arise?

Well, our position hasn't really changed, Tyson, that our first objective is to find attractive growth opportunities for the business on both organic, and by acquisition. We will continue to be conservative with respect to our balance sheet because we believe it's a real strategic advantage in times of uncertainty. But with all that said, we're not going to hoard cash. That if we have cash that is beyond that that we believe on a conservative basis is required to operate the business, then we'll seriously consider returning it to shareholders.

All right. Thank you, gentlemen, and thank you, Mike, for all your years of service and dealing with you. It was a real pleasure, and I hope things go well in Michigan.

Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to H. Woltz for any closing remarks.

Okay. Thank you. We appreciate your interest in the company and encourage you to call us back with questions if they arise, and we look forward to speaking with you at the Q4 call.

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