Insteel Industries Inc (IIIN) Q1 2022 Earnings Call Transcript

Hello, and welcome to the Insteel Industries First Quarter 2022 Earnings Call. My name is Alex, and I'll be your coordinator today. I will now hand over to your host H Woltz, President and CEO of Insteel.

Thank you, Alex. Good morning. Thank you for your interest in Insteel and welcome to our first quarter 2022 conference 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 in our presentation are considered to be forward-looking statements that are subject to various risks and uncertainties which could cause actual results to differ materially from those projected. These risk factors are described in our periodic filings with the SEC. We're pleased with our first quarter results that were driven by surging demand for our reinforcing products and escalating steel prices. We believe the outlook for our markets is highly positive and has been materially enhanced by the passage of the infrastructure investment and jobs act. I'm going to turn the call over to Mark to comment on our financial results for the quarter and the macro environment, and then I'll pick it back up to discuss our business outlook.

Good morning to everyone joining us on the call. As we noted in our release earlier today, the first quarter of 2022 was another period of outstanding results. In fact, we reported record quarterly revenue of $178.5 million or an increase of 49.2% from $119.6 million in the prior year, and we reported record first quarter net earnings of $23.1 million or $1.18 per diluted share, as compared to $8.1 million or $0.42 per diluted share in the prior year, representing a 181% increase in EPS. These historically strong results were achieved, thanks to a robust demand environment for our concrete reinforcing products that remains broad-based across all our regions and markets. Much like our last two sequential quarters, this environment allows us to raise average selling prices to recover rapidly increasing raw material costs, as well as increased labor and other manufacturing costs. This in turn delivered an expansion in our spread between average selling prices and raw materials relative to the prior year quarter. But the inadequate supply of domestic steel wire rod remained a challenge and impacted our ability to fully meet our customer demand. As a result, we increasingly turn to the international steel markets to supplement our raw material inventories as much as practical. Average selling prices in the first quarter increased 69.4% relative to the prior year. Sequentially, average selling prices increased 10.7% from Q4 2021, which was our fourth sequential quarter of a price increase greater than 10%. Shipments for the quarter decreased 11.9% from last year due to ongoing domestic rod availability issues and not due to any weakness in our end market demand. On a sequential basis, shipments declined 5.9% from Q4 2021, largely reflecting the usual seasonality in our demand. Gross profit for the quarter increased $22.5 million to $42.2 million from a year ago, and gross margin expanded over 700 basis points to 23.7%. This increase was due to widening spreads in average selling prices that outpaced rod cost increases during the period. As we’ve remarked in prior calls, during environments of strong demand and escalating pricing, our results typically are favorably impacted by the implementation of price increases sufficient to cover the higher replacement cost of our raw materials and the consumption of lower cost inventories under our first-in first-out accounting methodology. On a sequential basis, gross profit increased $2.3 million and gross margins remained above 23% for the second consecutive quarter. SG&A expense for the quarter increased $3.7 million to $12.3 million, but as a percentage of sales it decreased 300 basis points to 6.9%. This dollar increase was primarily a result of higher compensation expense under our return on capital-based incentive plan. This expense was partially offset by lower run rate legal expenses, given the conclusion of our trade action in the latter half of 2021. Our effective tax rate for the quarter was virtually unchanged at 23%, which is down slightly from 23.2% last year. Looking ahead to the balance of the year, we would expect our effective tax rate will remain steady at 23%, subject to the level of pre-tax earnings, book-tax differences, and the other assumptions and estimates that compose our tax provision calculation. Moving to the cash flow statement and balance sheet. Cash flow from operations for the quarter generated $13.6 million due to the record earnings performance that offset an increase in working capital. The increase in working capital is a function of both higher unit prices for inventories and a temporary timing impact stemming from year-end payment schedules. We incurred $0.8 million in capital expenditures and remain committed to our full year target of $25 million, given the many initiatives that we have underway. Based on our sales forecasts as of Q1, our quarter-end inventories represented 1.7 months of shipments, compared with 1.9 months at the end of the fourth quarter. The tight rod supply market referenced earlier continues to suppress our overall inventory levels, but particularly with respect to our finished goods inventories. And finally, our inventories at the end of the first quarter of 2022 were valued at an average unit cost that was higher than our fourth quarter cost of sales and still remains favorable relative to current replacement cost. In December, we returned $39.4 million of capital to our shareholders through the payment of $2 per share special cash dividend in addition to our regular quarterly dividend, marking the fifth year over the last six years we paid a special dividend. We ended the quarter with $63 million of cash on hand and no borrowings outstanding on our $100 million revolving credit facility. As we look ahead to the balance of the fiscal year, we expect demand to remain strong across all our markets. Our shipment trends in the current quarter and customer sentiment support this perspective. In addition, third-party leading indicators for non-residential construction spending, such as ABI and Dodge, which rebounded dramatically during much of 2021 have remained positive and reflect levels consistent with prior recovery periods. Public non-residential construction spending has also remained resilient and will clearly benefit from additional infrastructure spending following the passage of the infrastructure bill in November. H will cover this topic in more detail during his commentary. This concludes my prepared remarks. I'll now turn the call back over to H.

Thank you, Mark. As reflected in the release, our strong first quarter results were driven by robust non-residential construction markets and escalating steel prices. Above all, we thank our Insteel teammates for their perseverance through challenging circumstances and their focus on execution, excellence, and working safely. Market conditions during our first quarter closely resemble those of the previous three quarters, characterized by robust demand for our products, limited availability, and escalating prices for our primary raw material hot-rolled steel wire rod. Consistent with our recent experience, these supply bottlenecks contributed to inefficiencies at certain manufacturing facilities and customer service disruptions. As we mentioned last quarter, we've been active in the international steel market, and deliveries from offshore sources began to supplement domestic supplies during Q1. Our offshore commitments will ramp up during Q2 and Q3 to the degree that we believe operational and customer service disruptions will be eliminated by next month, provided, of course that our suppliers, both domestic and offshore, perform as agreed. We reported last quarter that it was likely the Biden administration would transition away from the Section 232 steel tariffs first with respect to the European Union and later with other trading partners. In December, the EU and US agreed to a tariff rate quota whereby certain quantities of hot-rolled steel would enter the US market tariff-free, and volumes over the quota level would be assessed a 25% tariff. With respect to steel wire rod, the transition to a tariff rate quota offers little relief for purchasers since the tariff-free volume of wire rod that can enter the US market from EU producers is minuscule relative to the supply deficit. We expect similar outcomes with other regions as the administration transitions away from Section 232, and we do not foresee that future trade deals in the pattern of the EU deal will materially affect the supply-demand imbalance experienced in the US. During fiscal Q1, Congress passed and the President signed the infrastructure investment and JOBS Act, which is arguably the most consequential infrastructure legislation and funding since the interstate highway system was conceived. At its core is the reauthorization of $304 billion of surface transportation programs and new spending of $550 billion, with the vast majority of the funds to be spent over a five-year period. We expect the stimulative impact of the legislation to become evident in our markets late in 2022 and to ramp up over the next four years. While there are many unknown details at this point, we expect the legislation to create significant positive momentum for our markets. Turning to CapEx, as we mentioned in the release. We recently reached an agreement with a group of capital equipment suppliers for purchases approximating $20 million of state-of-the-art production technology that will expand our product capabilities and favorably impact our cash cost of production. A major part of the investment package is targeted toward our Missouri and Arizona facilities with expected start-ups in fiscal 2023. Our earlier CapEx projection of $25 million for 2022 will be affected by the timing of payments and delivery schedules. We are considering additional projects that would have similar beneficial impacts on our market position and cost profile. These are exciting times for Insteel. Going forward, we plan to closely monitor market conditions and aggressively pursue the appropriate actions to maximize shipments and optimize our costs, and we are well positioned to pursue attractive growth opportunities, both organic and through acquisition. This concludes our prepared remarks and we'll now take your questions. Alex, would you please explain the procedure for asking questions.

Thank you. Our first question for today comes from Tyson Bauer from KC Capital. Tyson, your line is now open.

Good morning, gentlemen and excellent quarter.

Good morning. Tyson.

You touched on a couple of key subjects, and it seems like we're getting a sense that the pricing focus is overshadowing the underlying demand that is allowing you to have the pricing power that you exhibit. That demand that you're seeing, that is prolonged. Would you agree we're in a prolonged cycle of elevated demand that should give you better pricing power as we go forward? And given the low inventory turns, you can adjust much quicker than you have in previous cycles?

Well, Tyson, I think the current environment is really consistent with the way we've described our business over time, which is that the strength of our margins and our financial performance is really driven by the dynamics of supply and demand for the products we produce rather than so much what's going on in raw material markets. And I would say that I don't ever recall a market environment with stronger demand characteristics than we see now. And I fully believe the passage of the Bipartisan Infrastructure legislation will have a meaningful positive impact on market conditions, although there is a ramp-up period there and we wouldn't expect to see tangible benefits of that until later in 2022.

And a follow-up on that. We are seeing some of these preliminary state budgets come out with significant increases in infrastructure spending as a lot of states are having state surpluses as a result of inflows to their state coffers. That really starts to hit in 2023, but that is carried through two to three years?

I think absolutely so. And I think one of the more surprising aspects of the economy over the last year or so in the COVID environment has been the fiscal condition of states and municipalities, which has been very strong in comparison to the dire forecast that we saw at the beginning of the COVID-19 experience; the states were flushed with cash by and large even before this infrastructure legislation was passed.

Okay. So if we set aside, demand is not the issue, that's going to remain robust. You got your supply, your inputs, labor, and freight, one of those you touched on. Are you suggesting that you're going to be able to ease that supply issue with those imported steel products, so we should see or could see a recovery in those shipment volumes in the latter part of the current quarter and Q3?

Well, all of our comments have to be viewed in the context of our supply base performing as agreed. And if that happens, we believe that in the current quarter we will have eliminated the raw material supply deficit that has adversely affected our shipments over the last three quarters. Of course, it's a week-to-week and a month-to-month consideration because we are relying on our suppliers to perform as agreed. And if they don't, then we have another set of considerations. If they do, I'm sure we have adequate materials to meet the market.

Okay. And you can maintain margin profile because the demand is strong enough that you're just solving the front-end issue; the demand is still there to support the margins we've seen.

The demand is going to be there to support healthy attractive margins for Insteel. Keep in mind that we have pointed out over time and over the course of the run-up in these prices that the FIFO impact on cost of sales and the resultant gross margins has been reasonably significant as we've seen prices skyrocket for well over a year, multiple consecutive quarters. So, when prices level out and stabilize, then that tailwind will disappear. It's just a function of mathematics, but we believe that our margins will be attractive relative to historical results, and we're pleased with where we are.

Okay. And last question. Given the currency debacle in Turkey, which has been a source of steel in the past for you, has that had a positive direct or indirect impact on your ability to secure supply?

No. Turkey is under a dumping order in the US and they are really not a factor at this point.

Thank you. Tyson. Our next question comes from Julio Romero from Sidoti. Julio, your line is now open.

Thanks. Hey, good morning, Mark. Good morning, H.

Good morning.

Hey, I just had a quick one for you guys. The agreement to purchase the capital equipment of $20 million, is that incremental to your previous CapEx plans?

No, it is part of the CapEx plan. We're just a little slower out of the gate than we used to be, Julio.

Understood. And so, but you're basically securing those $20 million, you come to the agreement, and then it just comes down to how quickly they can get you the equipment?

That's right. And requisite payment schedules associated with that.

Got it. And I might have missed it on your prepared commentary, but did you mention the particular plans that that capital equipment would be targeting?

Let me say first that we have agreed to the package that I described in my prepared comments, but that doesn't mean that there won't be additional investments there; most certainly there will be. The package that I referred to in the prepared comments will be targeted primarily toward our Missouri and Arizona facilities.

Missouri and Arizona. Got it. Okay. That's all I have. Thanks very much.

Thank you.

Thank you. Julio. We now have a follow-up question from Tyson Bauer from KC Capital. Tyson, your line is now open.

Okay. In regards to that $20 million, the equipment package, is that geared toward having more labor savings and more automation? Or is it just the speed of the processing that that is going to help out and better product quality of those things? What's the new equipment package focus on resolving?

We'll expand the breadth of products that we're capable of producing. We will also reduce our cash cost of production through significant automation. So it helps us in really every aspect of both market and in our production costs.

Okay. Large part of the country really had not had winter begin until after the first of the year, which probably had some benefit towards you in the first quarter; are we going to still see that seasonal pattern muted in the current quarter, or do you just have so much demand in the southern tier states that it's business as usual?

I think it's business as usual, but being business as usual means we are definitely impacted by the winter months when it comes to shipping to job sites. Some customers produce outside, while others work in less essential spaces. So, it's still business as usual, but this does bring a level of seasonality that we can't avoid. However, I believe customer backlogs and overall optimism have never been higher. Customers are motivated to produce, and Insteel will ship as much as possible, depending on the weather conditions.

Could we see a phenomenon of people trying to build up some inventories in the seasonally weak period, so they have enough supply once we get into the warmer summer months?

I would not expect that because I don't think there is any producer that's capable of providing quantities in excess of what's being utilized in the current period.

Okay. You did an acquisition in 2017 of OEP Ortiz engineering products. It's four years after a lot of developments that happen in the tilt-up construction market. DC is being built. Has that Group performed as you thought and what technological advancements have you been able to do with them in-house for these last four years that provides you a bigger breadth of market capabilities going forward?

I think looking back at our decision to make that acquisition in 2017, we would confirm today that the rationale for the acquisition was spot on. We were slower out of the gates than we would have hoped today because we have a lot to learn about the new market that we were serving. But as we look back today, the growth has been substantial; we are significantly participating in the e-commerce build-out of DCs that is happening around the country, and we are involved in many applications and end uses for our product that we would have only been able to access through a third party had we not made the acquisition that has wound up becoming Insteel Engineered Products.

Okay. And have you seen a greater acceptance of your products for use in construction, whether non-res or in the infrastructure? Were you approved in a lot more states than you were previously?

When you say approved in a lot more states, the implication behind that is that it's a department of transportation application, and that's generally not the case for Insteel Engineered Products where most of the projects are commercial in nature and not infrastructure-related. So I think the merits of the product that we produce and the economics are realized by concrete contractors, and we're having that success because we have a reasonable value proposition.

Which has had greater acceptance in utilizing your product as opposed to maybe just straight rebar or some of the older construction methods?

Yeah, for sure. And I mean, over the course of time tight labor markets have been our friend in terms of the acceptance of engineered structural mesh on job sites, because while the industry is slow to change, it's significantly motivated to change when labor becomes a constricting factor for the amount of work that they can do. So certainly we're in one of those labor markets now, and that has definitely helped us.

All right. Thank you, gentlemen.

Thank you.

Thank you, Tyson. We have no further questions. So I will hand back over to H Woltz for any closing remarks.

Thank you, Alex. We appreciate your interest in Insteel. We look forward to talking with you next quarter. And in the meantime, don't hesitate to call us if you have questions. Thank you.