Hello, and welcome to the Insteel Industries Third Quarter 2022 Earnings Call. My name is Kate and I will be your call today. I'll now hand over to your host, H Woltz, President and CEO to begin. H, please go ahead.

Good morning. Thank you for your interest in Insteel, and welcome to our third 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 third 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.

Thank you, H. Good morning to everyone on the call. As we mentioned in our release today, the third quarter of 2022 was another exceptionally strong period for our financial performance, only surpassed by our record second quarter of this fiscal year. We reported quarterly revenue of $227.2 million, representing a 41.3% increase from $160.8 million in the same period last year, with net earnings of $38.6 million or $1.96 per diluted share, compared to $18.4 million or $0.84 per diluted share last year, reflecting a 109% growth in earnings per share. Our results have benefitted from strong demand and price increases aimed at offsetting the rising costs of raw materials and operations. Average selling prices in the third quarter rose by 53.9% compared to the previous year and saw increases across all product lines. Sequentially from Q2 2022, average selling prices went up by 6.3%, marking our eighth consecutive quarter of rising prices. These price hikes helped widen our spread between average selling prices and raw material costs from the prior year, leading to strong profitability. However, shipments for the quarter fell by 8.2% year-over-year, remaining essentially unchanged from Q2 2022. This decline was due to two unexpected challenges. Firstly, we saw a decline in demand for our standard welded wire mesh product line in the latter half of the quarter, following an unprecedented demand in the first half of the fiscal year. This product is mainly sold through distribution channels rather than direct to end customers. We believe a slowdown in homebuilding activity over the past few months has impacted demand, and distributors have begun managing their inventory down to more typical levels. The second factor affecting shipment volume was related to labor availability and turnover at our plants. With ample raw materials available from both domestic and offshore sources, we faced no production constraints, but labor issues became the main barrier to scaling up production to meet customer demand. The tight labor market, experienced across various industries in the U.S., has limited our ability to raise production levels to match demand. Regarding gross profit, for the quarter, gross profit rose to $58.1 million, an increase of $26.6 million or 84% from the previous year, with a gross margin expansion of over 600 basis points to 25.6%. This increase stemmed from the growing spread as average selling prices increased more than raw material costs during this period. Sequentially, gross profit rose by $1 million or 2%, and gross margins stayed above 20% for the fourth straight quarter. SG&A expenses for the quarter increased by $2.1 million to $8.2 million; however, as a percentage of sales, it fell slightly to 3.6%. The increase was mainly due to higher compensation and benefit costs, along with a $1.3 million change in the cash surrender value of life insurance policies, reflecting an increase in SG&A expense from an accounting perspective. These costs were partially mitigated by a decrease in legal expenses tied to our successful PC strand trade case actions concluded last year. Our effective tax rate for the quarter remained mainly unchanged at 22.7%, a slight increase from 22.4% last year. Looking forward, we anticipate our effective tax rate will hold steady around 23%, depending on pre-tax earnings and other variables affecting our tax provision calculation. In terms of cash flow and our balance sheet, cash flow from operations for the quarter showed a use of $5 million. Increased working capital due to higher inventory levels offset our strong earnings. Inventories rose as we primarily added to our raw materials and slightly to our finished goods. Based on our sales projections for Q4, our quarter-end inventories represented 3.4 months of shipments, compared to 2.2 months at the end of Q2 and 1.7 months at the end of Q1. While our raw material inventories have rebounded to more normalized levels for the strongest season of our fiscal year, our finished goods inventories remain low due to the lingering effects of constrained raw material supply during much of Q2, preventing us from building finished goods inventory as we entered the third quarter, coupled with the previously mentioned labor-related production challenges. Ultimately, our inventories at the end of the third quarter of 2022 were valued at a higher average unit cost compared to our second quarter cost of sales and align with current replacement costs. We incurred $3.6 million in capital expenditures in the third quarter, totaling $12.3 million for the first half of our fiscal year. On the liquidity front, we ended the quarter with $63 million in cash and no outstanding borrowings on our $100 million revolving credit facility. Looking towards the fourth quarter, we expect another strong financial performance. Initial shipments and pricing trends in the early weeks of the fourth quarter are aligning with our expectations. Our customers are optimistic, with extended backlogs in both private and public non-residential markets, and they have not yet felt the impact of projects funded by the infrastructure investment and JOBS Act. While the residential market appears to be shifting toward slower growth in the near to medium term, most economists still expect it to grow steadily. However, we anticipate that the residential market, which accounts for about 15% of our revenue, will not have a significant impact on our operations. Additionally, third-party leading indicators and forecasts for non-residential construction point to a robust demand outlook in our markets through 2023. That wraps up my prepared remarks. I will now hand the call back to H.

Thank you, Mark. As reflected in the release, our strong third 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. Over the past few quarters, we identified inadequate supplies of our primary raw material, hot rolled wire rod as a constraint to production and shipments and we indicated we had turned to offshore markets to supplement domestic supplies. By the end of the third quarter, receipts of imported wire rod had filled most of our supply gaps and we expect to avoid further operating disruptions related to raw material supplies over the next few months. Once our raw material shortfall was resolved, we experienced staffing-related difficulties in ramping up operating hours to meet market demand at certain facilities. We've responded by implementing more flexible work schedules and adjusting compensation, although it's too soon to know the extent to which our actions will result in a material increase in operating hours, production, and shipments. Also during the quarter, we experienced softening conditions in the market for standard welded wire reinforcing, which is our most commodity-like product line. As Mark indicated, this is the only product we produce through distribution channels rather than direct to end users and it is the product which is most heavily influenced by housing construction. For the last three or four quarters, supplies of standard welded wire reinforcing have been extraordinarily tight. Prices rose sharply and purchasing behaviors were frantic. We believe that during Q3 supply began to catch up with demand, while at the same time housing starts softened. The combination of these changes caused purchasers to become ultra-conservative and tightly managed inventories, which adversely affected our production in shipments. The condition has carried over into our fourth fiscal quarter. Customer inventories continue to be uncomfortably high, a condition which must be resolved before we can expect volumes to recover. As we stated in the release, we've experienced no softening in our other welded wire reinforcement or PC strand markets, where our customer backlogs are at near record levels and there's considerable optimism that demand will continue to be robust into calendar 2023. Our task in these markets is to ramp up operating hours and increase production and shipments. Consistent with our past practice, we do not plan to disclose or discuss additional product line details. Our offshore raw material purchases together with the slowdown in activity in the standard welded wire reinforcement market have resulted in elevated inventory balances, although not to levels that are uncomfortable, and we expect inventories to remain elevated through the end of the calendar year. As Mark pointed out, our inventory carrying values are not excessive relative to replacement cost and in reality, it's unlikely that domestic suppliers would be able to provide adequate volumes for us to sustain operations during our fourth and first quarters, making offshore supplies indispensable. In a perfect world, we would not find it necessary to participate to such an extent in the international market and we would prefer to avoid the working capital implications. Unfortunately, the domestic supply profile does not allow us this luxury. We continue to be optimistic about the impact on our markets of the infrastructure investment and JOBS Act; we believe it will create significant demand for our products beginning in late 2022 or early 2023. The need for infrastructure investment in the U.S. has been obvious for decades, but funding has consistently been inadequate to address the need. For the first time, it appears that funding shortfalls will decline in significance as obstacles to investment in view of the strong physical condition of state and local governments together with the new funding provided by the infrastructure investment and JOBS Act. Anecdotally, there's never been a time when our customer base has enjoyed the level of activity and strength of backlogs that they enjoy today. Many customers have backlogs that extend more than six months out, which is practically unprecedented. Turning to CapEx, we now project 2022 CapEx of approximately $20 million based on the timing of shipments from our vendors. The investments in state-of-the-art technology will expand our product capabilities and favorably impact our cash cost to production. We're considering additional projects that would have similar beneficial impact on our market position and our cost profile. Going forward, we plan to closely monitor market conditions and aggressively pursue the appropriate actions to maximize 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. Kate, would you please explain the procedure for asking questions?

Thank you. We will now take our first question from Julio Romero from Sidoti. Please go ahead.

Hey, good morning everyone. Thanks for taking my questions.

Good morning.

Good morning Tyson.

Could you guys maybe just dig into standard welded wire? What percentage of sales does that typically make up of overall sales? And maybe secondly, what percentage of that standard welded wire usually comes from residential?

Julio, we don't disclose product line detail like that.

Okay. Could you clarify whether the residential sales, which have usually been about 15% of your total sales, still align with that percentage or if it has deviated significantly from it?

The residential market consumes both standard welded wire reinforcement and PC strand.

Got it. Okay, I guess maybe any way to rank order what you're seeing in terms of standard welded wire, any way to rank order distribution channel, recovery versus slowing new construction as to the impact onto that product line?

I don't think we have enough insight to provide a solid answer to that. As I mentioned earlier, the activity in that market was quite intense for a long period. When the residential market showed signs of slowing down, the buying community really hit the brakes and became very conservative. However, I'm not sure we can pinpoint the exact reasons behind that change since we don't have that information.

Okay. Maybe just thinking about your inventory balance $192 million. How does that compare to maybe last quarter on a unit basis? And as you guys mentioned that the average unit cost is on par with current replacement cost?

To your latter question, that's correct. And unit volumes, I would say it's up marginally from where it was last quarter. I mean, obviously, that's a dollar value that you're seeing there and prices for the product have continued to increase.

And Julio, it really was until the latter part of the third quarter that our offshore quantities actually arrived in the volumes that we had ordered.

Okay. No that's helpful. I'll turn it over and circle back with any follow-ups. Thanks very much.

Thank you.

Here the next question comes from Tyson Bauer from KC Capital. Please go ahead, Tyson.

Good morning, gentlemen.

Good morning, Tyson.

I find it interesting that we have a record year that you’ve reported in earnings in six months and it's viewed negatively with $4 in EPS for the last six months. But that's how the market goes. Residential 8% or 15% you've made that comment a couple times already. Infrastructure, I think typically historically has been around 40%. Do we have a little timing issue where we haven't really seen that increase in spending in the infrastructure that should more than offset any current weakness that we may be experiencing on the residential that backfill as we get into ’23 should be more than adequate to overcome any kind of softness in the housing market?

Yes. I mean, we don't view the outlook negatively at all. We view the outlook as extremely bullish for reasons that you cite given the balance of our revenue stream split between residential and non-residential. And even today without the incremental spending that should come from the infrastructure investment and JOBS Act, business is extremely strong in those sectors. So I guess I would have a hard time spending a negative yarn on this at all.

Yes. When we report, you see the second highest margin ever. It may seem negative that the market has cooled down, similar to the lumber market a year ago. However, in absolute terms, the situation remains strong, indicating a robust multi-year outlook for results and cash flow.

I would agree with the statement.

The shipments decreased by 8.2%. Is this decline primarily regional? Do you have any plans to address a regional shortage by adjusting as freight conditions improve from your other facilities, or is this a challenge you need to navigate over time?

It varies by region, as each plant has its own labor market, which are all performing well. Nationally, unemployment is below 4%, and locally it ranges from about 2% to 4%. In some areas, it seems like working is becoming optional, which poses challenges. As mentioned earlier, we have adapted by making our work schedules more flexible and innovative, and we have seen success with that approach. We plan to continue these efforts. However, we are facing similar challenges as most manufacturers.

Okay. It is one of the unintended benefits, the margin level, because the product mix, if that standard welded wire has some softness that you have some flexibility and can gear some of that manufacturing toward some of those end customer, high demand items with the better margins?

There's some opportunity to do that. But in certain respects, the product is unique and the capacity may or may not be transferable to other product lines.

Did the timing of getting the raw materials in along with the staffing shortage contribute to just kind of the back of the napkin numbers, about $20 million to $30 million of revenue loss that you potentially could have done? Had you been able to fully staff?

Yes, it's hard for me to comment Tyson on the fly as to that exact calculation you've got. I will tell you that we entered, we kind of mentioned, we entered the third quarter obviously with low finished goods inventories. And in a normal operating environment, we would have entered that third and fourth quarter with much, much higher finished goods inventories. So some of that was driven by the lack of raw materials and the timing of those arriving late in the quarter if you recall from the second quarter.

Typically at the end of a calendar year, you have a big increase in your fiscal Q1 cash balances just the way the net working capital typically works out? Will we see that again this year or are you gearing up to maintain higher inventory levels? So you're well stocked as you enter in or you come out of next year's slower seasonal quarters? So you have that finished inventory available and ready to go. What's the mindset of that? How you're going to play that cash management? And also have adequate inventories?

Well, let me start by saying we want to avoid the situation we faced last year at this time, where operations were struggling due to inadequate raw material supplies. Considering the unit shortfall we experienced last year and the inflation in unit pricing, we can expect our inventory balances to remain elevated, driven by an increase in both the number of units and their higher values. However, we are comfortable with our inventory levels. We don't think we can rely solely on domestic suppliers for this quarter or the first quarter of 2023, so we plan to bring in supplies from offshore. This will be in larger quantities, which can cause fluctuations in working capital. Therefore, inventory levels will stay high, but we anticipate a working capital release in the 2022 calendar year.

And as you walk in your fiscal Q4 with the distribution adjustments from distributors adjusting some of their inventories. The impact on pricing, obviously it doesn't show up this quarter, you have a very favorable outlook being provided by one of your competitors Nucor this morning is doing well. Are we just talking in relative terms that yes, we may see some softness as far as not these, we'll take whatever product at whatever price we can get, but the pricing is still at a level that historically is extremely favorable to Insteel?

And are you referring to overall, Tyson?

Right.

Absolutely.

The majority of your products are still priced well. There's one segment that might be facing some market adjustments, but overall, even with a slight decrease, the situation remains favorable, especially when compared to previous years.

Yes. I mean, and we've made the point for the last several quarters that there has been a FIFO tailwind that we've had, although we've not trying to quantify on the end and inevitably when pricing begins to level out the tailwind dissipates. And so if that's where we are, then the tailwind will subside. But the fundamentals of the business now with spreads and volumes, I think is still extraordinarily favorable. And as I said in my comments, our mission is to get our operating hours on and to meet the demand that's available to us.

All right. Thank you, gentlemen, and keep doing it.

Thanks, Tyson.

Thank you.

We currently have no further questions registered. So H, I will hand it back to you.

Okay. Thank you, Kate. We appreciate your interest in Insteel. We look forward to talking to you next quarter and in the meantime don't hesitate to contact us if you have questions. Thank you.

Thank you all for joining. This now concludes today's call. Please disconnect your lines.