Insteel Industries Inc (IIIN) Q1 2021 Earnings Call Transcript

Ladies and gentlemen, thank you for standing by and welcome to the Insteel Industries First Quarter 2021 Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would like to hand the conference over to one of your speakers today, Mr. H. Woltz. Sir, please go ahead.

Good morning. Thank you for your interest in Insteel and welcome to our first quarter 2021 earnings call, which will be conducted by Mark Carano, our Senior 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 Mark to review our first quarter financial results and current market conditions.

Thank you, H, and good morning to everyone joining us on the call. As we reported earlier this morning, the first quarter of fiscal 2021 was another strong quarter for Insteel. Our markets continued to experience solid demand throughout the fall, as the momentum we experienced in the fourth quarter continued at a seasonally strong pace, which coupled with a rebound in spreads from their depressed levels last year restored gross margin to more normalized levels. Earnings per share for the quarter increased to $0.42 per share as compared to $0.03 per share a year ago. Shipments for the quarter were up 21.6% from last year, but down 15.2% sequentially from Q4 reflecting both the usual seasonality in our demand and as you recall, Q4 2020 benefited from the inclusion of an extra week in that quarter based on the fiscal 2020 calendar. Q1, though, was the highest first quarter shipment level in the company's history exceeding a previous first quarter high in 2018. Robust demand in our markets compared to last year led to broad-based shipment growth across virtually all our products, and it remained consistently strong across all three months of the quarter. Average selling prices increased 1% from last year and 2% sequentially from Q4, due in part to price increases implemented in the latter half of the quarter, to offset the rising cost of raw materials. Gross profit for the quarter increased $13.6 million from a year ago and gross margin expanded over 1,000 basis points to 16.6%, primarily due to the sustained recovery in spreads between selling prices and raw material costs, in addition to the impact of incremental volume and marginally lower conversion costs. On a sequential basis, gross profit increased $0.4 million and gross margin widened 250 basis points, primarily due to an incremental widening of spreads. SG&A expense for the quarter increased $2.8 million to $8.6 million from $5.7 million last year, or 7.2% of net sales from 5.9% last year. The increase was attributed to two areas: first, accruals for incentive compensation expense under our return on capital-based incentive plan, due to our strong results in the first quarter. As you may recall, we did not incur any incentive compensation expense in the first quarter of last year. And second, higher legal expenses relative to our normal run rate in support of our ongoing trade cases. Our effective tax rate for the quarter increased marginally to 23.2% from 22.7% last year, due to changes in permanent book tax differences. Looking ahead to the remainder of the year, we expect our effective tax rate will run around 23%, subject to the level of pretax earnings, book tax differences, and other assumptions and estimates that compose our tax provision calculation. Moving to the balance sheet and cash flow statement. Cash flow from operations for the quarter generated $14 million, largely due to earnings with a minimal increase in working capital given the strong quarterly performance as compared to $29.6 million in cash flow generated last year, which was primarily the result of a $24.6 million reduction in working capital. Based on our sales forecast for the second quarter of 2021, our quarter-end inventories represented 2.4 months of shipments compared with three months at the end of the fourth quarter. Our inventories at the end of the first quarter of 2021 were valued at an average unit cost that was higher than our fourth quarter cost of sales, but favorable relative to current replacement cost. In December, we returned $29 million of capital to our shareholders through the payment of $1.50 per share special cash dividend in addition to our regular quarterly dividend marking the fourth year over the last five years we've paid a special dividend. We ended the quarter with $50.2 million of cash on hand, or just over $2.50 a share, and no borrowings outstanding on our $100 million revolving credit facility, providing us with ample financial flexibility to support our strategic initiatives. As we look ahead to the balance of the year, we are cautiously optimistic that demand will remain steady across our markets. Our near-term shipment trends and market sentiment supports this perspective. In addition, we have announced price increases during the first quarter to offset the impact of rising raw material costs and all have largely been accepted by the market in a further indication of construction end market strength. These increases should exhibit a more pronounced effect on our average selling prices in Q2 helping to maintain our profitability levels. As H. will describe in more detail, we received favorable final determinations with respect to several of the PC Strand trade cases, which should finally resolve some of the illegal activity that has adversely affected this market. Despite the forecast of a substantial decline in infrastructure-related spending due to the financial strain from COVID-19, those dire predictions have not materialized to date. Through the first 11 months of 2020, public construction remained resilient with spending up 4.3% from the prior year. Highway and street construction, one of the largest end-use applications for our products, generally remained level with last year. And the last three months of highway and street construction spending has exceeded the same three-month period last year by almost 4%. But uncertainties do remain that underpin our cautious outlook. The impact of COVID-19 remains a risk to our markets and our operations. The recent rapid escalation in our raw material costs is a concern that has not impacted demand to date as we've been successful mitigating through price increases. But as was the case in past cycles, these high-velocity increases in rod costs can create a volatile environment as supply and demand seek an equilibrium over the coming months, and third-party forecast for non-residential construction spending remain a cause for concern. Bottoming in the mid-summer of 2020 followed by modest improvements in the early fall, they appear to have lost their upward momentum and have remained stagnant at their current levels, levels which are below the expansionary levels experienced before the impact of the economic slowdown in March of 2020.

Thank you, Mark. As reflected in the release, our strong first quarter results were driven by resilient non-residential construction markets and late in the quarter by expectations for rising steel prices. We're pleased with the solid underlying level of demand for our products and our financial performance and we thank our Insteel teammates for their focus on working safely and execution excellence. During Q1, 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 we do not expect a surge of infections to affect our operating plants. Over the course of the last three earnings calls, we have reported that Insteel along with other U.S. producers had filed anti-dumping and countervailing duty trade cases to address illegally traded imports of PC Strand and standard welded wire reinforcement. The PC Strand cases were filed in April 2020 against 15 countries that represented 89% of PC Strand imports during 2019. On January 8, the International Trade Commission issued its affirmative final injury determination with respect to Argentina, Colombia, Egypt, Netherlands, Saudi Arabia, Taiwan, Turkey, and United Arab Emirates resulting in the implementation of duties ranging from 24% to 194% of value, which we believe are sufficient to address the injurious behavior of these countries. It now appears that the cases against Indonesia, Italy, Malaysia, South Africa, Spain, Tunisia, and Ukraine will conclude during our third fiscal quarter. We are delighted to have prevailed conclusively with respect to eight of the 15 respondent countries. We're now focused on obtaining similar outcomes in the remaining seven cases. We previously reported that the pendency of the cases had favorably impacted the market and we expect the imposition of these anti-dumping duties to contribute to improved long-term market fundamentals. At the end of June 2020, Insteel and four other domestic producers of standard welded wire reinforcement filed anti-dumping and countervailing duty petitions against Mexico alleging dumping margins ranging from 56% to 161% of value and illegal government subsidies of the Mexican industry. We received a favorable preliminary injury determination in August and the final injury hearing is scheduled for February 12. We expect to know the outcome of these cases before the end of the current quarter. The Department of Commerce found a preliminary dumping margin of between 64% and 153% of value for the largest Mexican producer but has not concluded margin determinations for the other producers. As with the PC Strand cases, the pendency of the Mexico cases has had a favorable impact on the market but we must win the cases to address the illegal activity for the long term. Turning to CapEx. We continue to expect 2021 to come in at approximately $20 million. The ESM project underway at our Dayton Texas plant is on track for commissioning during our third fiscal quarter and we expect to pursue additional investments in 2021 to support our growth in this market. During the quarter we also continued the process of updating and relocating the major production equipment we acquired through the Strand-Tech Manufacturing acquisition in March 2020. We expect commissioning to begin for the remaining production lines by the end of the current quarter and have already realized a favorable impact on unit conversion costs at the plants where relocated equipment is up and running. The renovation and relocation process, which is drawing to a close, has been a substantial undertaking that consumed a significant portion of our internal engineering capacity. We look forward to turning the attention of this talented group to other important projects which are scheduled for fiscal 2021. I'd like to express my appreciation to the engineering group and to those supporting the group for their outstanding performance on the STM project. The Strand-Tech real property has been listed for sale and it's generated a great deal of interest among prospective buyers. Our continued presence on-site while renovating equipment has not been helpful to the marketing process, so we're focused on expediting completion of these activities to advance the sale process without delay. 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 the balance of 2021. Our markets have considerable momentum that we believe will continue at least into our third fiscal quarter, although numerous uncertainties affect our ability to provide an accurate forecast of business conditions through the end of the year. 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. With that said, we expect strong financial performance over the next few months driven by current robust demand trends for our products and rapid significant escalations in steel costs, which we are passing through the supply chain. We also expect the new administration in Congress to come to terms on a long-term infrastructure investment program which should inspire confidence in our markets and drive increased consumption of our products, although the timing of any positive impact is unknown. Going forward, we'll closely monitor market conditions and aggressively pursue the appropriate actions to maximize our shipments and optimize our costs, and we're well positioned to pursue attractive growth opportunities both organic and through acquisition. This concludes our prepared remarks, and we'll now take your questions. Michelle, would you please explain the procedure for asking questions?

Thank you. Our first question comes from the line of Julio Romero with Sidoti. Your line is open. Please go ahead.

Hey, good morning. Happy New Year.

Good morning, Julio.

Good morning.

My first question is about the impressive tonnage and shipment data you reported. Mark, you mentioned that some sub-categories of non-residential highway and street were up 4% over the last few months, and while revisions have been strong, the switch has been okay. Could you discuss this in relation to the 20% year-over-year increase in shipments? Are there specific areas where you're seeing notable strength?

Yes, Julio. I mean the strength is actually pretty broad-based across all our end markets. We haven't seen any particular weakness. Highway and street construction is one area that we follow closely just because it's a large market for us, and as I mentioned that stayed level throughout the year. And then over the last three months, it's actually up over where it was over that same period last year, but there really wasn't a particular market that jumped out as being stronger than usual or weaker than usual.

Yes. And Julio, I would add that, I think you're aware that we have a very difficult time actually demonstrating a causal linkage between any of those components of construction spending that are reported and our shipments. It's very difficult for us to point to definitive drivers.

I would like to revisit that point. Instead of focusing on the sub-sectors, could you clarify if public construction is becoming a larger percentage of overall activity compared to previous years, or if perhaps residential construction has seen better performance? I'm not sure if you have any insights on that.

I would tell you, we don't detect any shifts in the drivers of our order entry. As Mark indicated, the business has been strong across the board. There are no laggards.

Got it. And just 20% was really impressive there. And I guess, H, you talked about you do expect strength in the end markets just to kind of support through at least your third quarter. Does that expectation kind of factor in the same kind of backdrop you've seen in this quarter and in the last two quarters in that public construction continues to be robust kind of those projects are previously funded and that all kind of dries up potentially in maybe the third or fourth quarter of the year?

Well, as you know, we're notorious for our lack of visibility out beyond a few weeks in the business. And so, I would say no. There are no specifics that would cause me to suggest that our fourth quarter is not going to be strong, but just in view of the overall uncertainty that's present all around us, I would just be hesitant to make any observation past what we can see pretty clearly, which is through this quarter and into the third quarter.

Yes. No, understood. I guess, maybe just last one for me is can you talk about the ability of the industry to kind of absorb any further price increases if steel prices kind of continue on the current trajectory?

It's a good question. What we're seeing in recent weeks is likely unprecedented. We have experienced consecutive triple-digit price increases per ton. Historically, these trends don't last long, but there are factors in today's market that differ from past cycles where we've observed price increases. As you know, we've been frequently asked what drives our ability to pass cost increases to the market, and we consistently respond that it is the strong demand for our products. We certainly see that now. While I wouldn't welcome further increases in raw material or scrap costs that would require us to raise prices again, I believe that if that were to happen, the market is strong enough for us to implement those increases, and the risk of failing to do so is quite low. Another current factor is that hot-rolled steel wire rod is in very tight supply. In the past, we've mentioned that tight supply conditions impact pricing ability in our markets similarly to having a strong order book for our products. Since wire rod isn't available in unlimited quantities, this situation further strengthens our ability to achieve price increases in the marketplace. I want to emphasize that we really don't want to see this continue, but many factors are beyond our control. If the price increases persist, I believe the market will remain strong enough that we won't face any negative impact on our margins.

That’s helpful. I'll hop back into the queue. Good start to the year. Thanks.

Thank you.

Thank you.

Our next question comes from the line of Tyson Bauer with KC Capital. Your line is open. Please go ahead.

Good morning, gentlemen.

Good morning, Tyson.

Just to add on to what you're saying H, given your position within your markets being either the top or the second manufacturer as far as market share and prominence, do you not get a competitive advantage when you do see some tight supply or the growing demand that you're able to react and push through more favorable actions than your competitors? So, in this environment, are you not strengthening your competitive advantage in showing that might over your smaller competitors?

It's hard for me to give you a straight answer on that, Tyson. But I would tell you that, in the current environment, we're less worried about competitors and what they're doing with their pricing than we may normally be. We understand the economics of our business, and we understand that in a market environment like this, we should be expected to perform well. And I think all the stars are aligned, so that we will.

Okay. Given your scale of economies, are you able to source better? And in the past where you've been able to bring in large quantities of imported steel that was kind of shut off to you, is that reopening, or is that an option still there, where you can get more favorable front-end cost?

With regard to domestic purchases, we aren't certain how our buying compares to that of our competitors. We do our best, and that's the essence of the situation. One significant difference in today's market, compared to previous tight wire rod markets where prices have surged, is that there is practically no imported product available to ease supply. While imports are accessible, they would come at prices even higher than current domestic prices. I believe this restriction on availability and supply will likely sustain this price increase more than in previous situations.

Okay. Based on the comments, it seems that the margin outlook for the short-term, especially heading into Q3, appears to be fairly stable. You're managing to maintain a similar level to what we just observed. As we approach the seasonally stronger quarters, do you expect that the performance we witnessed in Q1 can be duplicated and sustained for the remainder of the year?

It's always hard to make a definitive statement, Tyson. But, I don't see why that would not be the case right now. Of course, things could change. But right now, I'd say that it's pretty good.

Okay.

Pretty good chance that margins will continue strong.

Working capital needs obviously the higher input cost AR, those kind of cash conversion cycles, what are we anticipating here for working capital needs this year?

I mean, I think, Tyson, depending on the cost of rod and this pricing environment I suspect we'll be using working capital or building it over the period of into Q2 and the balance of the year.

Okay. Is there any given trade action that has already occurred or pending that is more beneficial to Insteel and that pendency of those actions being partially felt already? This is kind of an open-ended question but, how much benefit have we already seen? And how much more is there to be received, should things continue to be finalized in your favor?

Well, it's the case with both the standard welded wire reinforcement and PC Strand cases that just their pendency has strengthened the market to try to quantify that is impossible. But certainly the offshore, or across the border suppliers become much more cautious, due to potential adverse consequences there and the dependency of the cases. So that has helped. But what really helps is winning the cases, as we've done with eight of the 15 countries in the PC Strand arena. So, I expect that we will adequately address the illegal activity of the remaining seven PC Strand countries and Mexico, in standard welded wire reinforcement and that there will be improved market fundamentals long-term because of that. And I would hasten to say that we will see other countries come into the market, particularly in PC Strand, probably less so in welded wire reinforcement, but this is the nature of it. We've been through the cycle many times but, dealing with 15 bad actors is nothing but highly positive for the long-term fundamentals of this market.

Okay. For my last question, we've seen previous administrations that controlled both houses and the presidency all discuss the need for infrastructure. Initially, there's a sense of hope, but over time we tend to become desensitized as the funding mechanisms remain unresolved. Is this situation any different, or are we still in a hopeful phase, expecting to see long-term solutions at the federal level? As time goes on, will we become desensitized again? Is there anything different this time?

Well, I think the difference this time around is that the entire country is practically immune to deficit spending and funding things seems to be of no real importance to anyone Republican or Democrat. And that is largely why I expect to see a big infrastructure program approved. With that said, if you think back to the Obama infrastructure program, it is also important to know what the money will be spent for. And history would tell us that infrastructure and the definition of infrastructure tends to expand to cover anything that they want to spend money on. So the details will be very important when we start to see information on how an infrastructure program is put together.

Got it. Thank you, gentlemen.

Thank you.

Thank you. And I'm showing no further questions at this time. I would like to turn the conference back over to the company for any further remarks.

Okay. Thank you. We appreciate your interest in Insteel. We look forward to talking to you in the next quarterly call. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone, have a great day.