Insteel Industries, Inc. (IIIN) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Insteel Industries' Second Quarter 2018 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 be given at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference Mr. H. Woltz, President and CEO. Please go ahead Sir.

Good morning. Thank you for your interest in Insteel and welcome to our second quarter 2018 earnings call, which will be conducted by Mike Gazmarian, our 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 Mike to review our second quarter financial results and outlook for our construction markets, then follow up to comment more on business conditions.

Thank you, H. and good morning to everyone joining us on the call. As we reported earlier today, Insteel's results for the second quarter of fiscal 2018 marked the second consecutive quarter of favorable shipment trends following the disappointing volumes we experienced during the second half of last year. We believe the recent strengthening in demand will continue during our third quarter, which is typically one of the busiest periods of the year based on the usual seasonal pick up in construction activity. Spreads between selling prices and raw material costs widened sequentially from the lows of Q1 through the price increases that were implemented and we expect further improvement during our third quarter. Insteel’s earnings for the second quarter came in at $0.31 a share, which was up $0.08 sequentially from the first quarter, excluding the non-recurring gain on deferred tax liabilities, but down $0.08 from a year ago. The sequential improvement was driven by the higher spreads in shipments, while the year-over-year decrease was due to lower spreads relative to last year. The second quarter got off to a choppy start due to the intermittent stretches of cold and wet weather across our markets with shipments trending below prior year levels through the first two months of the period before rebounding strongly in March, rising over 18% from a year ago. For the quarter as a whole, shipments were up 6.8% sequentially from Q1 exceeding last year's 5.6% increase and 2.4% year-over-year. From a geographic standpoint, the volume growth was primarily driven by higher shipments into Florida and most of the Mid-Atlantic states, which offset some softening in Texas, our largest market that was likely compounded by the inclement weather. Average selling prices were up 2.9% sequentially from the first quarter and 3.7% year-over-year, reflecting a portion of the price increases that we implemented during the quarter, which should have a more pronounced impact in Q3. Gross profit for the quarter was up $3.8 million sequentially from the first quarter and gross margin increased 250 basis points due to the widening in spreads driven by the price increases and higher shipments. Gross margin improved each month within the quarter consistent with the favorable shipment trends rising to over 17% in March. On a year-over-year basis, gross profit was down $2.9 million and gross margin narrowed 370 basis points due to the lower spreads of escalation in our raw material costs, exceeded the increase in ASPs. In view of the ongoing raw material cost pressures together with the strengthening demand environment and availability concerns stemming from the Section 232 tariffs, we recently announced two additional price increases; one, that went into effect last week and the other effective May 8 which should further benefit our third quarter results. At this time we believe the pricing adjustments we've made will be sufficient to offset the higher raw material costs we will be incurring and restore spreads to more attractive levels following the compression that we experienced over the past year. SG&A expense for the quarter was up $0.4 million from a year ago due to higher employee health insurance costs and a smaller increase in the cash surrender value of life insurance policies partially offset by lower incentive compensation expense. As reflected in our historical results, our SG&A costs tend to spike higher in the second and fourth fiscal quarters based on the timing of semi-annual grants under an equity incentive plan which are typically made in February and August. Our effective income tax rate for the quarter and first half of the year dropped to 24.7%, excluding the $3.7 million re-measurement gain on deferred tax liabilities recorded in Q1 from about 34% in both periods last year, due to the reduction in the corporate tax rate under the new tax law. As we discussed in our last call, based on our September fiscal year end date, our effective rate for fiscal 2018 reflects a blended rate based upon the average of the previous 35% rate that applied to our first quarter and the lower 21% rate that applies to the remaining three quarters of the year. Going forward, our effective rate will continue to be subject to change based upon the level of future earnings, changes in permanent tax differences and adjustments to the other assumptions and estimates entering into our tax provision calculation. Moving to our balance sheet and cash flow statement, cash flow from operations for the quarter was down $4 million largely due to the $10.7 million increase in accounts receivable resulting from the acceleration in sales during the latter part of the quarter, partially offset by a reduction in days sales outstanding. Based on our sales forecast for Q3, our quarter-end inventories represented around 2.5 months of shipments compared to a little over three months at the end of the first quarter due to the strengthening in shipments and was valued at an average unit cost that was above second quarter cost of sales, but below current replacement costs. In January, we returned another $20.2 million of capital to our shareholders through the payment of $1 a share special cash dividend, in addition to two regular quarterly dividends marking the third straight year we’ve paid a special dividend of at least a $1 a share. We ended the quarter with $23.5 million of cash on hand or about $1.25 a share. We are debt free with no borrowings outstanding on our $100 million credit facility. Looking ahead to the remainder of the year, we expect continued improvement in our construction end markets, which should spur stronger demand for our products and widening spreads, together with higher operating levels and lower costs at our facilities. The latest Architectural Billings and Dodge Momentum Index reports continue to signal favorable growth trends for non-residential building construction in the coming year. On an overall basis, the ABI score for March remained positive for the sixth consecutive month. Architectural firm billings have now risen in 11 of the previous 12 months with most of the region on sector averages reflecting expansionary conditions. In its monthly report, the AIA indicated that project backlogs at architectural firms were in excess of six months, at their highest levels since the recession. The Dodge Momentum Index another leading indicator for non-residential building construction also reached a new post recession high in March and was up 16.1% from the prior year level. Dodge speculated that the 5.1% growth rate posted in the latest quarter, maybe an indication project planners were already reacting positively to the new tax law that was signed in December. We believe the infrastructure related portion of our business will be favorably impacted by the fiscal 2018 Omnibus Spending Bill that was passed last month which provides for over $21 billion increase in infrastructure investment including an 8% increase in highway funding. The bill also provides for nearly $90 billion of disaster relief funding that could potentially be used for projects requiring in the use of our concrete reinforcing products. We also expect to benefit from higher spending at the state and local level as recent funding initiatives begin to have a greater impact in the coming months. I will now turn the call back over to H.

Thank you, Mike. As we reported on our last call our Q1 shipment volumes gained momentum over the course of the quarter following the unusual weakness that we experienced during the second half of fiscal 2017. As we moved into the second quarter, our view of the underlying demand trends was obscured ‘somewhat by the impact of severe weather on the operations of seven of our plants, as well as shipments from all of our plants, particularly during January and February. Beginning in March however incoming orders and shipments accelerated dramatically driven by the usual seasonal pickup in demand together with concerns regarding the Trump Administration's Initiation of a Section 232 Tariff regime on imported steel products, including our primary raw material hot-rolled steel wire rod. These favorable demand trends have continued thus far in April as we move into what is typically our busiest season of the year. Following the completion of the DoC’s Section 232 investigation that was initiated last Spring and the delivery of its recommendations to the President. On March 9th, the administration announced that it would impose, across the board 25% tariff on steel imports, effective March 23. Subsequent to the announcement, temporary exemptions were provided to several countries deemed to be strategic allies. The exemptions could become permanent depending on the outcome of negotiations, currently underway to resolve administration trade concerns. Any such permanent exemption would likely require reductions in steel export volumes to the U.S. as was agreed with South Korea and would represent a favorable outcome for Insteel by expanding outsourcing options as compared to the across the board tariff approach that was initially announced. We should also benefit from the anticipated June restart of a previously idle wire rod mill in Georgetown, South Carolina which is strategically located to several of our plants and will add needed capacity to the marketplace. The prospect of import tariffs on imported wire rod and escalating prices for steel scrap together with expectations that pending trade cases are initiated by domestic wire rod producers will result in the imposition of significant duties have provided the impetus for a series of price increase announcements by our suppliers in excess of 30% on a cumulative basis. In-view of these continued cost pressures and the recent strengthening in demand w e have announced four price increases for reinforcing product since January. We believe these adjustments will enable us to begin recovering the spread and margin compression we've experienced over the past year. Competitive pricing pressure seemed to have diminished to some extent with customer concerns now primarily focused on ensuring adequate supply in view of the rebound in demand, tightening and availability and political uncertainty relating to the administration's trade policy. As you may recall, last November we required - we acquired certain assets of Ortiz Engineered Products in connection with our ongoing efforts to further penetrate the rebar market through the substitution of engineered structural mesh for cast in place applications. Project inquiries and shipments for OEP and its primary geographic markets have exceeded our expectations thus far, during what is typically the slower season of the year. Following the transaction, w e have deployed additional engineering and sales resources to our cast-in-place effort and intensified our focus on expanding into additional markets where we can offer a compelling value proposition relative to rebar. We believe these efforts will begin to produce results later in 2018 and build momentum as we move into 2019. Turning to CapEx, as reflected in our release capital outlays totaled 9.3 million to the first half of the year driven by the exercise of the purchase option on our previously leased Houston facility and additional investments in our ESM manufacturing capabilities. We continue to expect fiscal 2018 CapEx to approximate $21 million which includes the addition of an ESM production line and ancillary equipment, the purchase of the Houston facility and further upgrades to our PC strand manufacturing technology, and in addition investments in our information systems upgrades and other routine maintenance. We're optimistic that construction markets will strengthen in 2018 driven by growth in both private non-res and infrastructure spending and the stimulated impact of the new tax law. We’ll continue to be vigilant in pursuing attractive growth opportunities both organic and through additional acquisitions. And we remain focused on improving our operational effectiveness and realizing the anticipated benefits from the substantial investments we've made to lower manufacturing costs, reduce lead times and improve quality. This concludes our prepared remarks and will now take your questions. Christie, would you please explain the procedure for asking questions?

[Operator Instruction] Our first question is from the line of Steve Marascia of Capitol Securities. Your line is open.

Good morning, gentlemen. Just a quick question in terms of our models for this year, what would your guesstimate be that the blended expected tax rate might be going forward?

Should be right around 24.7% for the year.

Okay. No variation from quarter-to-quarter or just straight line?

It should be relatively close quarter-to-quarter.

Okay. Thank you much.

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

Good morning, gentlemen. Are you expecting to see any kind of significant recovery one of the laggers last year in the non-res construction was the public spending institutions, federal state buildings, colleges, universities that kind of area. Are we looking for a rebound this year in that area, that was kind of the lagger last year?

Yeah there has been a recent pick-up in public spending activity over the past few months and as we commented just with the recent passage of the Omnibus Spending bill that frees up the increase that was previously approved under the FAST Act and also provides another $2.5 billion of highways funding, which should have a favorable impact. And it also eliminates the uncertainty that existed through the previous continuing resolutions that were in effect. So, we are expecting some improvement at the federal level and at the state and local level. As we've discussed on previous calls just with the various funding initiatives that have been enacted or pursued over the past few years, we should see a more, more significant impact from those in the coming months as well.

Your four price increases, what would that be as a composite percentage increase?

I think, Tyson we'd like to leave it at that. At this point, they’re sufficient to cover our increasing costs and begin to help resolve the margin compression issue that we ran into in 2017.

Okay. You mentioned in March your margin would have been on a pro forma basis, 17%, are you looking at these price increases to keep that 17% steady or do you think because of the increased shipments and better leverage on those fixed assets that, that 17% can be the baseline that we can incrementally work off of?

I think it's really -- it's really hard to project at this time. There are so many moving pieces in the marketplace on both our market side and our supply side that, that, if it's typically difficult for us to see what's going to happen, it is exceedingly difficult now.

And just to clarify on your question, the 17% margin for March - in excess of 17% that was, that was actually - it wasn't a pro forma, so we were just pointing out that within the quarter there was significant improvement both in terms of margins and volumes.

So that was realized margin?

Right.

That's - I would assume your expectation at least from what you can see, which is limited of course, but we're starting out April in that same range?

As a starting point, yes.

Correct. Okay. All right. Thank you.

[Operator Instruction] Our next question is from Julio Romero of Sidoti & Company. Your line is open.

Hey, good morning H.. Good Morning Mike.

Good morning.

So did you guys call out lower shipments in Texas year over year? Was that just a function of weather or was there something else you saw going on in the region?

I think the weather clearly had an impact. It's really difficult to segregate that or quantify it precisely.

But Julio, we did lose time - manufacturing time in Texas due to ice which is – it is not unheard of, but nor is it expected. I don't think there's been a change in Texas market conditions that, that would be concerning. I think it's more a function of wet and cold weather.

Got It. Yeah. I mean everything we hear about Texas seems to be trending well and with the four announced price increases you mentioned since January, I guess I assume you see healthy appetite from your customer base to absorb these rising input costs?

Yeah, I think so far I think we're on track to do that.

Can you tell us at all what percentage of cost of sales in the quarter were raw materials versus freight and manufacturing, you know either a number or maybe if it's up at this point year over year?

I don't know that we'd want to drill down to that level of detail on for the quarter.

Got It. And then just last one for me is just, can you talk a lot about freight costs effected you at all during the quarter, availability of truckers and if you see that affecting you going forward?

It's a serious concern on the availability and the cost it just continues to be a tremendous challenge for our people across the board at all our locations. And I don't know that we see any rest that is coming in that condition. It's going to be difficult.

Got It. Thanks for taking my questions.

Thank you. Our next question is from Chris Olin of Longbow Research. Your line is open.

Hey, good morning.

Good morning, Chris.

Just want to look at the March strength that you were talking about a bit here. Do you get the sense that, any of the construction demand or I guess, let's just say you're shipping levels were impacted by the timing of the steel tariff announcements, any type of inventory adjustments, or do you get the sense that people are trying to build early before the prices started moving higher?

It's a good question. And I don't know that we necessarily have a good answer. But I could tell you that that even before the March 9 announcement of the 232 program, we had seen an acceleration in shipments. And of course, the 232 issue has been hanging over the industry since April of 2017. So where people reacting to it prior to the March 9 announcement, I assume that, it's possible that's the case. But they didn't react to it in February and they didn't react to it in January. So, it's just really hard to tell on following the announcement I would say that that concern has ramped up so that, that certainly the 232 program has had an impact on buying behaviors since that time. And, I think that's continuing, but it’s difficult for us to peel it away from, from the underlying level of demand for the product, which is pretty solid and certainly improved from last year. So, I wish we could parse it for you, but that's about all we know.

Okay. What about just in terms of your own sourcing, how should I think about your inventory costs? Or is there any margin benefit going forward since you do tend to keep a lot of inventory on hand?

Yeah we had – I think I mentioned at the end of the quarter, we had right around 2.5 months of inventory, so under a fivefold and that would get us through, most of the third quarter. Now if you go back through the most recent scrapping wire rod increases that now our inventory value is valued at higher than the amounts going through Q2 costs of sales, but still well under a replacement cost. So, I mean it's just going to be a matter of how, how that inventory carrying value compares against these additional price increases that we're implementing. But I think we're well positioned for the third quarter just from a spread and margin standpoint.

Okay, thanks a lot.

Thank you. And I'm showing no further questions. I'd like to turn the call back over to Mr. H. Woltz for any further remarks.

Okay, thank you. We appreciate your interest in the company and please don't hesitate to contact us if you have follow-up questions. Thank you.