Insteel Industries, Inc. (IIIN) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Insteel Industries' Third 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 follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to H. Woltz. Please go ahead, sir.

Good morning. Thank you for your interest in Insteel and welcome to our third 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 it over to Mike to review our third quarter financial results and outlook for construction markets and then I’ll 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 posted strong results for the third quarter fiscal 2018 driven by the continuation of strengthening demand in our markets and widening spreads between selling prices and raw material costs. Earnings per share for the quarter improved to $0.67, which is up $0.36 sequentially from the second quarter and $0.31 from a year-ago. Shipments for the quarter increased 5.3% sequentially from Q2, benefiting from the typical seasonal pickup in activity as compared to the unusual 7.5% drop-off we experienced between the same period last year. On a year-over-year basis, shipments were up 16.5%. The volume growth for the quarter was broad-based extending across our footprint with shipments into Texas, our largest market rebounding from the weather-related drop-off in Q2 and volume into the Midwestern states rising substantially as well. Average selling prices were up 12% sequentially from the second quarter and 12.2% year-over-year, reflecting the additional price increases we implemented in response to rising raw material costs and the [resulting] compression in spreads we had experienced in prior periods. These cost pressures have been driven by the Section 232 tariffs together with the duties that were imposed related to the recent trade cases initiated by domestic wire rod producers, which have eliminated certain countries from the U.S. market. Going forward, we will continue to exercise commercial discipline and pursue additional pricing adjustments when appropriate to maintain our margins at acceptable levels. Gross profit rose $8.8 million sequentially from the second quarter and gross margin widened 470 basis points due to the price increases together with the growth in shipments. On a year-over-year basis, gross profit increased $7.5 million and gross margin rose 190 basis points driven by the widening and spreads, higher shipments, and to a lesser extent, lower unit manufacturing costs, and the higher production volume. SG&A expense for the quarter was up $1.3 million from a year-ago due to higher incentive compensation costs under our return on capital plan driven by our improved results this year together with the additional resources we've deployed through the November Ortiz Engineered Products acquisition to accelerate the growth of our Engineered Structural Mesh business. Our effective income tax rate for the quarter dropped to 23.4% from 33.9% last year, largely due to the reduction in the federal rate to 21% from 35% under the new tax law. Excluding the $3.7 million re-measurement gain on deferred tax liabilities that was recorded in Q1, our effective rate through the first nine months of the year was 24% compared with 33.8% for the same period last year. Going forward, our effective rate is 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 improved to $25.3 million from $4.5 million last year, largely due to the $10.3 million of cash provided by working capital together with the increase in earnings. Inventory dropped another $8.4 million during the quarter as a result of the strengthening in shipments and tightening in the availability of wire rod from our domestic suppliers during the nine months year-to-date reduction to $27.1 million. Based on our Q4 sales forecast, our quarter-end inventories represented just under two months of the shipments compared to around two and a half months at the end of the second quarter and were valued at an average unit costs that was higher than our third quarter cost of sales, but favorable relative to current replacement costs. In allocating our cash flow and managing the cyclical nature of our business, we focused on balancing three objectives; reinvesting in the business for growth and to improve our costs and productivity, maintaining adequate financial strength and flexibility, and returning capital to our shareholders in a discipline manner. Through the first nine months of the year, we returned $20.8 million of capital to our shareholders through the payment of $1 a share special cash dividend in addition to three regular quarterly dividends, marking the third straight year we paid a special dividend of at least $1 a share. We ended the quarter with $45.2 million of cash on hand or over $2 a share and were debt-free with no borrowings outstanding on our $100 million credit facility. As we move into our fourth quarter, market conditions remain strong and the leading indicators for non-residential construction are signaling continued growth. Total construction spending through the first five months of the year was up 4.3% from a year-ago with private residential up 6.5%, private non-residential up 1.7%, and public up 4.4%. After trending negative for eight consecutive months beginning last June, the seasonally adjusted annual trending rate for private non-residential construction has now risen year-over-year for four straight months. Public highway and street construction spending is also strengthened over the last two months, rising 6.2% from the same April to May period last year. We’re also encouraged by the continued growth in state contract letting, which would translate into increased highway and bridge construction in the coming months. The latest reports for the Architecture Billings and Dodge Momentum Index implied continued growth in non-residential building construction. Yesterday, the American Institute of Architects reported that the ABI moderated to 51.3 in June, but remain positive for the ninth consecutive month. The average for the Index through the first half of the year was at 52.3, which was up slightly from 52.2 for all last year. The Dodge Momentum Index, another leading indicator for non-residential building construction, increased for the fifth straight months in June, rising to its highest level in almost 10 years. Although, the growth rate for the Index has moderated over the past few months, the prior three-month average was up 30.3% from a year-ago with similar increases in both the commercial and institutional components. Finally, we also expect the benefit from the increased infrastructure investment provided for in the recent fiscal 2018 Federal Omnibus Spending Bill together with higher spending at the state and local level in many of our markets through various funding initiatives. I’ll now turn the call back over to H.

Thank you, Mike. Our third quarter results were significantly impacted by the imposition of the Section 232 import tariffs on steel products by the Trump administration in March. The ensuing uncertainty surrounding the availability of our primary raw material, hot-rolled steel wire rod resulted in speculative purchasing throughout the supply chain and sharp price increases reflecting the 25% tariff that was eventually applied to practically all imports of carbon steel products. These supply concerns have been exacerbated by the Antidumping and Countervailing Duty Orders that were entered in April, following the conclusion of trade cases that have been filed by domestic producers in January 2017, which had already dramatically reduced the availability of offshore material. During the early part of Q3, the market reaction to these developments clouded our view of the underlying demand trends for our reinforcing products. Following the frenetic activity of March and April, market conditions began to moderate in June reflecting healthy more sustainable activity levels we expect will continue through the balance of the 2018 construction season. The tightening and wire rod availability resulted in production disruptions at several of our plants during the quarter due to poor schedule performance by certain domestic suppliers and supply chain disruptions with respect to imports. Supplier performance has improved recently to the point that we believe the production interruptions should be resolved by the end of August. We mentioned during the Q2 call that we expected the new owners of the previously idle wire rod production facility in Georgetown, South Carolina to commence operations during June. Due to delays and commissioning of the operation, we now expect regular production from the mill beginning later in our fourth fiscal quarter or during the first fiscal quarter of 2019. The mill is strategically located relative to several of our manufacturing facilities and we welcome its return to the marketplace. We have responded to tightening supply condition in our raw material markets and improving demand trends by implementing a series of price increases. We expect additional increases will be warranted in the current environment with lead times extended across the industry, which should support our efforts to selectively optimize our mix in margins. Turning to CapEx, as reflected in our earnings release, capital outlays totaled $12.5 million through nine months of the year, largely driven by the exercise of the purchase option on the 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 expected to come on line during the first fiscal quarter of 2019. The purchase of our Houston facility further upgrades to our PC strand manufacturing technology and information systems upgrades along with other routine maintenance. We will continue to be vigilant in pursuing attractive growth opportunities both organic and through additional acquisitions and remain focused on improving our operational effectiveness and realizing the anticipated benefits from the substantial investments we’ve made in our facilities to lower manufacturing costs, reduce lead times, and improve quality. This concludes our prepared remarks and we will now take your questions. George, would you please explain the procedure for asking questions?

Sure. Thank you. [Operator Instructions] And our first question comes from Julio Romero from Sidoti & Co. Your line is now open.

Yes. Good morning, gentlemen.

Good morning, Julio.

Good morning.

So how much do you guys think the investments into Houston facility translated to in the quarter in terms of EPS or maybe even a dollar amount? Is it kind of on that $0.03 to $0.04 run rate per quarter at this point?

I’m not so sure that we can quantify that precisely Julio, but suffice it to say that we continue to make the expected progress at the Houston facility and we’re on the right glide path to realize the returns from those investments.

Great. And can you just give some color on the inventory levels? I know you mentioned you had just under two months based on your Q4 forecast? Is that generally due to the tightening of supply in the industry? Or anything you can give on there would be great?

Yes. It's both on tightening of raw material supplies and the really quite poor performance that we've seen from some of our domestic vendors together with the accelerated rate of shipments that we’ve seen. I would tell you that it's probably a little lower than we are comfortable with and we will begin to see more reasonable levels restored through the next quarter.

Got it. That's all I have. Thanks for taking my questions.

[Operator Instructions] And we see no further questions. I would like now to turn the call over to H. Woltz for closing remarks.

We appreciate your interest in Insteel. We look forward to keeping up with you during the quarter and look forward to the fourth quarter call that would be coming up. Thank you.

Ladies and gentlemen, that concludes the call. Have a great day.