Insteel Industries, Inc.

Good morning, ladies and gentlemen, and welcome to the InSteel Industries' fourth quarter 2020 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. If anyone should require assistance during the conference, please press star, then zero on your touchscreen telephone. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. H. Waltz, President and CEO of InSteel. Please go ahead, sir.

Good morning. Thank you for your interest in InSteel, and welcome to our fourth quarter 2020 earnings call, which will be conducted by Mark Carano, our Senior Vice President, CFO, and Treasurer, and me. 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 Mark to review our financial results, then I'll follow up to comment more on business conditions and other recent developments.

Thank you, H, and good morning to everyone joining us on the call. As we reported earlier today, the fourth quarter of fiscal 2020 proved to be a strong quarter for InSteel. Robust demand in our construction end markets, in addition to a sustained recovery in spreads from depressed levels of a year ago, were the key drivers in our performance. Excluding the non-recurring charges referenced in our release, net earnings rose to 38 cents per share as compared to a net loss of 9 cents per share last year. To note, the current year quarter also benefited from having an extra week as compared to the prior year based on our fiscal calendar. Shipments for the quarter increased 27.7% from last year and 12.1% sequentially from Q3. The fourth quarter of fiscal 2020 was our highest quarterly shipment level in the company's history, even excluding the extra week in the quarter and exceeding our previous high watermark in the third quarter of 2016. The fourth quarter shipping performance was driven by continued strength in construction activity across all our end markets as compared to last year, with engineered structural mesh and PC strand leading the growth in the quarter. Average selling prices, though, remained under pressure and declined 4.6% from last year. But there are signs of improvement as sequentially average selling prices increased 1.1%, which represented the first increase in seven sequential quarters. As we've communicated in previous calls, low-priced import competition in the PC strand and standard welded wire markets, respectively, remain intense and continues to have a negative impact on our average selling prices. Combined, they represented approximately 30 percent of our fourth quarter revenue and experienced an average selling price decline of 8 percent as compared to a decline of 3 percent for the balance of the business relative to last year. This does represent an improvement from our third quarter 2020 levels, though. As we highlighted during that quarter, these products also represented 30 percent of revenue, but they experienced a 20 percent decline in average selling prices as compared to an 8 percent decline for the balance of the business. While this positive trend may prove to be temporary, we do believe that the anti-dumping and countervailing duty cases we have filed have had a positive impact on the market. Gross profit for the quarter rose $15.6 million from a year ago to $19.5 million, and gross margin expanded over 1,000 basis points to 14.1 percent due to the impact of incremental volume and the recovery in spreads between selling prices and raw material costs. On a sequential basis, gross profit increased $4.7 million from the third quarter and gross margin widened 200 basis points, primarily due to shipment volume and, to a lesser extent, a widening in spreads. Spreads over the last two sequential fiscal quarters of 2020 have been consistently above the depressed levels experienced during the last two comparable quarters of fiscal 2019. as we benefited from the consumption of lower-priced rod inventory that exceeded the negative impact from a steady decline in average selling prices. Given current market rod pricing and stabilizing average selling prices, we would expect to maintain these more normalized spread levels into Q1 of fiscal 2021. FG&A expense for the quarter rose $3.4 million to $9.4 million, or 6.7% of net sales, from $5.9 million, or 5.2% of net sales, last year. This increase was largely driven by three areas. First, we experienced higher incentive compensation expense under our return on capital-based incentive plan due to our strong financial results this year. You may recall that we did not incur any incentive compensation expense in the fourth quarter of last year or for the full fiscal year of 2019, given our performance during that reporting period. Next, we incurred higher legal expenses relative to our normal run rate solely in support of our trade case initiatives. And finally, we revalued the earn-out liability related to an acquisition given measurement of its performance. This is the conclusion of the measurement period, so no future expenses will be incurred with respect to it. Our effective tax rate for the year decreased to 21.4 percent for the fiscal year 2020 from 24.9 percent last year due to the benefit of an NOL carryback provision of the CARES Act and the utilization of selected state NOLs. Excluding the CARES Act benefit, our effective tax rate would have been 22.3 percent. Looking ahead to next year, we expect our effective tax rate will continue to run around 23 percent, subject to the level of pre-tax earnings, book tax differences, and other assumptions and estimates that factor into our tax provision calculations. Moving to the balance sheet and cash flow statement, cash flow from operations for the quarter generated 11.4 million, largely from earnings, with a minimal change in working capital. as compared to $32.5 million in cash flow last year, which was primarily the result of a $31.4 million reduction in working capital due to a rebalancing of our inventories during that quarter from the elevated levels experienced during much of last year. Based on our sales forecast for Q1, our year-end inventories represented three months of shipments compared with two and a half months at the end of the third quarter and were valued at an average unit cost that was lower than the beginning quarter average and the amount reflected in Q4 cost of sales. These lower costs should favorably impact our margins during the first quarter, assuming average selling prices remain stable. Capital expenditures were $7.1 million for the year, down $3.4 million from last year, and remain largely focused on cost and productivity improvement initiatives, in addition to recurring maintenance requirements. Looking ahead to 2021, We expect CapEx to total up to $20 million, including important initiatives related to relocating and upgrading the STM assets and investments to further the growth in our engineered structural mess business, as well as our customary recurring maintenance needs. We concluded the quarter with $68.7 million of cash on hand, or approximately $3.50 a share, and no borrowings outstanding on our $100 million revolving credit facility. Looking ahead to fiscal 2021, we continue to experience steady demand in the early weeks of Q1 as our customer base executes existing project backlogs. But the lingering impact of COVID-19 on the U.S. economic recovery remains a risk to our business. As we progress through the fiscal year, we expect our financial results will remain vulnerable to the path of these evolving market conditions and their impact on both non-residential and infrastructure markets. While recent third-party forecasts for non-residential construction spending indicate a bottoming or modest improvement from trends earlier in the year, we are cautious on the demand outlook. The Architectural Billings Index and the Dodge Momentum Index, leading indicators for non-residential construction, support these trends. ABI has rebounded from a multi-year low of 29.5 in April. After stalling at 40 during the summer, ABI registered an increase to 47 yesterday. but it has remained below the 50 threshold for seven consecutive months. Dodge, which hit a low point in June of this year, has posted three sequential increases in July, August, and September, gaining 2.2 percent over that period. These, along with other indicators, typically would signal a slowdown broadly across non-residential construction activity, but the drivers behind the economic weakness make the magnitude and timing of any impact unclear. Turning to public infrastructure, spending has yet to experience the level of weakness forecast at the beginning of the pandemic, but the impact varies by state and region. Certain large markets for our business, like Texas, have remained steady relative to historical levels. In addition, through the first eight months of the year, public construction spending increased 6.1% from a year ago, with highway and street construction, one of the largest end applications for our products, increased 2%. Despite these economic uncertainties, we continue to focus on optimizing our operations, safeguarding our employees, and advancing our key growth and market initiatives. Our success in the engineered structural mesh market in fiscal 2020 should position us for continued expansion of that product in 2021. Additionally, the trade cases alleging illegal activity by importers in certain of our markets, which are expected to be resolved in fiscal 2021, have progressed favorably and we believe the facts supporting the cases are strong. Finally, we will continue to evaluate acquisitions opportunistically in our existing business that may arise in this challenging environment. These initiatives remain consistent with our capital deployment strategy that balances maintaining appropriate financial strength for pursuit of our three objectives. Reinvesting in the business to improve our operating model through cost and productivity improvements or capital expenditures to accelerate 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'll now turn the call back over to H. Thank you, Mark.

As Mark indicated, our fourth quarter results reflect strong shipment growth relative to the prior year driven by resilient non-residential construction markets. We also benefited from the closer alignment between raw material costs and average selling prices as reflected in the recovery of our gross margin, which was distorted in the prior year by the downward spiral in steel prices and unexpected weak demand. Gross margin is trending closer to a normalized level following the relative stability we've seen recently in steel prices. We're pleased with the solid underlying demand for our products and our financial performance, and we thank our instilled teammates for their focus on working safely and execution excellence. During Q4, we continued to observe CDC-recommended procedures for managing exposure to COVID-19 and its transmission at our plants and administrative offices. While we had staffing disruptions during the quarter related to quarantines, none of our locations was materially affected by operating restrictions and most customers also experienced normal operations subject to the same quarantine-related staffing complications that affected InSteel. As of now, we expect to continue fulfilling customer requirements and do not expect a surge of infections to affect our operating plans. During Q4, we completed the customer integration activities related to our Q2 acquisition of certain assets of Strandtec Manufacturing. We appreciate the confidence placed in InSteel by former Strand Tech customers and are gratified that practically all of these relationships are ongoing and mutually beneficial. Our engineering team has been on site at the Strand Tech plant continuously, updating and renovating equipment that will be deployed at other InSteel facilities. Commissioning activities are presently underway for the first two production lines that were relocated. These capacity additions will relieve process bottlenecks and contribute to significant improvements in the unit cost of production, in addition to playing an important role in accommodating our anticipated TC strand growth. The renovation and relocation process is a substantial undertaking, which has absorbed a significant portion of our internal engineering capacity and will continue to do so into our second fiscal quarter. I'd like to express my appreciation to the engineering group and those supporting the group for the truly remarkable progress they've made up to this point. We look forward to completing this initiative and moving on to promising opportunities in other parts of the business. The Strandtec real property has been listed for sale and has generated a great deal of interest among prospective buyers. Our continued presence on site while renovating equipment is not particularly helpful to the marketing process, so we're focused on expediting completion of these activities to advance the sale process without delay. Turning to our trade case initiatives, in April, InSteel, together with two other domestic PC strand producers, filed anti-dumping petitions against 15 countries representing 89 percent of total PC strand imports that entered the U.S. in 2019, in addition to a countervailing duty petition against Turkey alleging illegal subsidies. The scope of the filings, which alleged dumping margins ranging from 24 to 194 percent of value, reflects the irresponsible behavior of respondents in the U.S. market over the 2017 to 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. It now appears that about half of the cases will wrap up in early January with the balance concluding during our third fiscal quarter. As Mark indicated previously, dependency of these cases has had a favorable impact on the market, which is certainly welcome after years of import-driven downward pricing pressure. We must win the cases, however, to level the playing field with these parties on an ongoing basis. While we can't forecast the outcomes, we're pleased with developments up to this point, and we believe the facts support our allegations and that we'll be successful. At the end of June, InSteel and four other domestic producers of standard welded wire reinforcing filed anti-dumping and counter-failing duty petitions against Mexico, alleging dumping margins ranging from 56 to 161 percent of value and illegal government subsidies of the Mexican industry. Import penetration has risen consistently as Mexican producers have persisted in dramatically underselling the U.S. market. We received a favorable preliminary determination of injury from the International Trade Commission in August, which shifted the investigation to the Department of Commerce. It now appears that these cases will wrap up during our third fiscal quarter or early in the fourth quarter. As with the PC Strand cases, we can't predict the outcome, but we are pleased with the developments up to now, and we believe we will ultimately obtain anti-dumping and countervailing duty orders with respect to Mexican producers. Turning to CapEx, as reported, we came in at just over $7 million for 2020, which was substantially under our prior estimates. The shortfall is purely timing related, largely connected with a significant project supporting our engineered structural mesh growth that was delayed, but which is now moving ahead at a rapid pace. Given the momentum of this project and other ESM initiatives, significant investments related to the renovation and relocation of the strand tech assets, and further upgrades to our information technology, we expect 2021 CapEx to come in at approximately $20 million. We view the 2020 CapEx shortfall as an opportunity cost, and we look forward to improving our competitive position and our growth prospects by successfully completing a number of attractive investments across our product portfolio. Our CapEx strategy continues to be focused on reducing cash costs of production, improving the quality of our products, supporting growth initiatives, and improving our information technology infrastructure and capabilities. Turning to our outlook for 2021, during the Q3 call, we indicated that we expected a strong fourth quarter in view of the momentum in our markets. While momentum is still favorable, numerous uncertainties affect our ability to accurately forecast 2021. Primary among those are the impact of the downturn on funding sources for public construction and the increased risk profile of the private non-residential construction market and, in fact, the entire economy. We would not be surprised to see some softening as the consequences of the pandemic-driven downturn ripple through our markets, although recent macro forecasts are more encouraging than those made three or four months ago. We're optimistic that once we're past the upcoming election, bipartisan support will emerge for increased infrastructure spending, which would provide economic stimulus promoted by many politicians, while also generating long-term investment returns for taxpayers. We'll continue to closely monitor market conditions and aggressively pursue the appropriate actions to optimize our costs 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. Ming, would you please explain the procedure for asking questions?

Ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Julio Romero of Suduti. Your line is open.

Hey, good morning, Mark. Good morning, H. Good morning. So I guess I wanted to start off with... you know, what you're hearing from customers in regards to maybe their level of concern about state and local funding and a potential drop-off there? And when does the timing of that potentially affect in steel?

I think that's a $64 question for sure. And as you might expect, there's a wide range of expectations among our customers from certain customers who have strong backlogs going through what would be our second fiscal quarter, to certain customers wondering what they're going to do in January. I would say that's also been the circumstance for the last few months. So at this point, I'm not sure that we can give real good, insightful guidance on how funding is going to impact the order book going forward. I think it's going to be more of a month-to-month evaluation process.

Got it. I guess maybe asked another way, I mean, is assuming no benefit from some type of stimulus or whatever, I mean, you know, can they get through three, six, nine months, you know, without some type of stimulus for them?

I mean, it sounds like the question is really how long is that pipeline? And, you know, I would say it probably goes well into our second quarter, but I don't know that it would go into the third or fourth. And that's one man's opinion, okay? That's not the result of any objective data analysis.

Okay. I appreciate it. That's helpful. On the engineered structural mesh side, can you talk about how much Did ESM make up as a portion of your portfolio in fiscal 20, and maybe how much growth do you expect in 21, either from a unit perspective or percentage perspective?

No, I mean, we don't disclose that level of detail, but I can tell you that we're growing in solid double digits and expect to continue doing so.

Okay, got it. And I guess on the $20 million in CapEx for 21, would any of that, like, be necessarily catch-up in terms of, you know, things missed out in fiscal 20 or just any color there?

Yeah, well, I mean, we've reported for the last three or four quarters at least that we had a delayed project in support of our ESM business where we had to work with with an OEM vendor to resolve some unanticipated problems with a production line that we installed at our North Carolina facility, and that took quite a while. It set us back a year. So those problems have been resolved, and we're moving ahead with full force to put another line in that is we're preparing foundations now and expect that we'll see a Q2 or Q3 startup of that line in 2021. So we've stayed on top of all routine customary sort of recurring maintenance needs. We did have a significant hole in our growth initiatives relative to this unanticipated delay. And certainly, as I said in the prepared comments, it's an opportunity cost, but Right now, we're looking forward. We're not looking behind, and we're going to move with dispatch to bring this line up and get its product into the market.

Got it. That's helpful. I'll hop back into queue. Thank you.

Our next question comes from Tyson Bauer of KC Capital. Your line is open.

Good morning, gentlemen.

Morning, Tyson. Good morning.

Just to follow up on the previous questioner's topic, do you have any hard numbers on the state and local muni bond activity as far as relative to maybe a year ago for seeing them take advantage of the lower interest rates and doing more principal bonds or any sense of any industry data that you have that you could give us a reference point?

I don't think there's any � we don't have any hard data, Tyson, but we are aware of increased activity at the state and local level in financing infrastructure projects with bond proceeds, and actually it's been ongoing for at least a couple of years. We view it as a very positive development, but unfortunately I don't think we can tack down those numbers at this point.

You see individual headlines of certain states and that that seem like they're growing that activity and taking advantage, but no real composite data that I've seen. You mentioned that you're starting to get some positive impact because of the trade actions due to typically there's a retroactive date that importers would have to make a difference if there's an injury that is taken by domestic producers. As we go into 21, that should grow depending on if you get a favorable result or not. Do you know what the retroactive dates are?

Well, that question would require a very, very lengthy answer. Suffice it to say that the retroactivity is generally associated with critical circumstances filings And as of this week, we have made those filings on approximately 12, 10 or 12 of the 15 countries where we could support a critical circumstances finding or filing. The critical circumstances allegations will not be finally acted on until the very last part of the case in our third or fourth quarter. So, I think that the impact of the cases is that the market risk has been elevated significantly for importers of record. The uncertainty is significant and the potential financial consequences are meaningful. So, I think that's the backdrop that that has created some more favorable market circumstances for us. But as I said in the prepared comments, we have to win these cases for any of this to make any difference on an ongoing basis.

Correct. But by your actions, you've kind of made the shot across the bow this past week.

Actually, I would say that we fired a torpedo below the water line. Okay.

We'll go with that. Depending on how the election turns out, there could be immense consequences for capital gains for private entities, companies raising their tax obligations for sale of their entities. Do you think that opens up or potentially opens up some more M&A opportunities before year-end pending the election results?

Honestly, I don't. I don't think so, Tyson. I don't think that the M&A opportunities that are out there for us are so much dependent upon those kinds of considerations. I think they're longer term than that.

Okay. In the past, when the weather has been poor, whether it's winter weather or wet weather and those, we've always kind of used that as a push things to the right or otherwise. your fiscal fourth quarter pretty much was ideal weather for most of the country. Did that help the quarter results, having that kind of favorable weather?

Yeah, I think what we would say is that weather patterns have more normalized. I'm not so sure that we've had all kinds of hurricane activity that's disrupted the Gulf Coast and Texas markets, but But relative to last year, certainly, it's a tremendous improvement. So, yeah, I'm always dubious of the weather excuse, and I know that we've proffered that on numerous occasions. But, yeah, we would certainly acknowledge that we welcome the return to normalized weather patterns, and there's no doubt it helped us, although we can't quantify it and haven't really attempted to quantify it.

Last question. As we look at the uncertainty and some of the sectors impacted by those, is it more the non-res commercial construction that gives you a little more pause on what's going to transpire in the next three, six, nine months, or is it really the public spending aspect that is more of a wild card for you?

Right now, I would tell you that the public side of it is a larger question mark for us. As we're seeing on private non-res, we believe that a lot of the e-commerce-driven construction that we have benefited from in 2020 will continue well in or through 2021. So I would say the bigger wild card is on the public side.

All right. Thank you, gentlemen.

Again, ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your touchstone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. I am showing no further question. At this time, I would like to turn the conference back to Mr. H. Waltz.

We appreciate your interest in steel. We thank you for your time this morning, and we welcome your contacts going forward. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation, and have a wonderful day. You may disconnect.