Insteel Industries Inc (IIIN) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Insteel Industries First Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call may be recorded for replay purposes.

It is now my pleasure to hand the conference over to H. Woltz, Chief Executive Officer. Sir, you may begin.

Good morning. Thank you for your interest in Insteel, and welcome to our first 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 first quarter financial results and the macro indicators and outlook for our markets, and then I'll follow-up to comment more on business conditions and our recent acquisition of Ortiz Engineered Products.

Thank you, H, and good morning to everyone joining us on the call. As we reported earlier today, Insteel's results for the first quarter of fiscal 2018 were favorably impacted by a rebound in shipments from the disappointing levels of the previous 2 quarters and the enactment of the Tax Cuts and Jobs Act in December.

Net earnings rose to $8.1 million or $0.42 per diluted share from $4.5 million or $0.23 per share in the prior year quarter. Excluding the nonrecurring gain on the remeasurement of deferred tax liabilities related to the reduction in the corporate tax rate under the new law, earnings per share for the quarter were unchanged from last year at $0.23, but up $0.03 sequentially from the fourth quarter.

Shipments for the quarter were up 1.3% year-over-year and 1.7% sequentially from the depressed levels of Q4, which is highly unusual considering that our volumes typically drop off from the fourth to the first quarter due to the usual seasonal downturn in construction. From a geographic standpoint, the pickup in activity during the quarter was more pronounced in the regions that were impacted by Hurricanes Harvey and Irma in August and September, with shipments into Texas and Florida both up double digits sequentially. Although it's impossible to quantify how much of the increase may have been driven by any deferral of business related to the storms.

On a year-over-year basis, shipments strengthened considerably over the course of the quarter with our December volume up almost 13% from last year. I would caution, however, that demand trends remain choppy and it would be premature to assume continued growth at these levels during our second quarter, particularly considering the weather-related uncertainty this time of the year.

Competitive pricing pressures moderated somewhat during the quarter with average selling prices falling 80 basis point sequentially from the fourth quarter, which is less than half of the 1.9% reduction that we experienced from Q3 to Q4.

Gross profit for the quarter fell $1.3 million from a year ago to $11.7 million, while gross margin narrowed 200 basis points to 11.9% due to the compression in spread, which was partially offset by lower unit manufacturing cost on the higher production volume, and to a lesser extent, the increase in shipment. On a sequential basis, gross profit fell $0.1 million from the fourth quarter and gross margin narrowed 30 basis points also due to this compression in spread, partially offset by lower unit manufacturing cost and the increase in shipments.

In response to the escalation in our raw material cost and improvement in demand, we're in the process of implementing price increases, which should favorably impact our second quarter results. Considering the additional inquiries, as it have been recently announced by our raw material suppliers, we will likely be pursuing further price increases for our products in the coming weeks.

SG&A expense for the quarter fell $0.5 million from a year ago to $5.8 million on lower incentive compensation expense under our return on capital plan, and a larger increase in the cash surrender value of life insurance policies in the current year quarter. Our tax provision for the quarter reflects the $3.7 million, or $0.19 a share gain on the remeasurement of deferred tax liabilities I alluded to earlier, together with the reduction in our effective rate related to the lower corporate tax rate that was enacted under the new law, which will be in effect for the remaining 3 quarters of the year. Excluding the deferred tax gain, our effective rate for the quarter dropped to 24.9% from 33.7% last year, which translate into a $0.5 million reduction in the provision and a $0.03 a share increase in earnings.

Looking ahead to fiscal 2019, we currently expect our effective rate to fall in the 23% to 24% range, reflecting the lower 21% corporate rate for the entire year partially offset by the elimination of the Section 199 domestic manufacturing activities deduction that is still available this year.

On a pro forma basis, we estimate that the rate reduction and other changes provided for in the new law will increase our net earnings by about 14% in 2018 and 16% beginning in 2019, relative to what they would have been at the previous fiscal 2017 rate of 34%. 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. The $10.9 million year-over-year increase in cash flow from operations was primarily driven by the relative changes in working capital and the net impact of the reduction in inventories from the fourth quarter. As you may recall, we have built inventories last year in response to the trade cases that were initiated by domestic rod producers and the tariffs and/or quotas that could result from the Section 232 investigation, which was compounded by the weaker-than-expected shipments during Q3 and Q4.

Based on our sales forecast for Q2, our quarter-end inventories represented a little over 3 months of shipment and were valued at an average unit cost that was just under the average for Q1 cost of sales, but -- and below current market prices. We ended the quarter with $37.3 million of cash on hand, or just under $2 a share, and were debt-free with no borrowings outstanding on our $100 million credit facility, providing us with ample liquidity and financial flexibility.

Earlier this month, we returned another $19.6 million of capital to our shareholders through the payment of $1 share special cash dividend, in addition to our regular $0.03 quarterly dividend, marking the third straight year we paid a special dividend of at least $1 a share.

Looking ahead to the remainder of the year, we expect continued improvement in our construction end market which should support stronger demand for our products and widening spreads, together with higher operating levels and lower cost at our facilities. The latest architectural billings in Dodge Momentum Index reports imply favorable growth trends for nonresidential building construction in the coming year.

In November, the ABI rose to 55 from 51.7 the prior month, increasing to its highest level of the year. Through the first 11 months of the year, the index has averaged 52.2 compared to 51.2 for all of last year, and 51.6 for 2015. The Dodge Momentum Index and other leading indicator for nonresidential building construction ended the year in a positive rising 3.6% in December from the prior month and 20.9% from a year ago to its highest level in over 9 years. In its report, Dodge indicated the monthly average during 2017 was up 10.7% from the prior year average with the commercial component up 11.4% and institutional up 9.7%, implying continued growth in nonresidential building activity during 2018.

The most recent construction spending data continues to reflect divergent trends for private and public construction and the need for increased infrastructure investment. Through the first 11 months of the year, total private construction spending was up 6.5% from a year ago while public construction spending was down 2.8%. Although spending for private nonresidential construction has softened in recent months, we expect modest growth in the coming year driven by the continued expansion of the economy, which should be augmented by the favorable impact of the new tax law.

November year-to-date public spending on highway and street construction, which represents close to 1/3 of public construction spending and is one of the larger end users for our products, was down 4.1% from last year and the year-over-year reduction widened to 5.8% over the most recent 3-month period. We believe the higher state and local funding that has been appropriated in many of our markets will begin to have a more pronounced impact on the infrastructure-related portion of our business, as we move into what is typically our busy season.

Although the outlook for federal infrastructure funding remains uncertain, we remain hopeful that the administration and Congress will be able to reach an agreement on the long-overdue infrastructure package that provides for meaningful funding over an extended period. We also expect to benefit from any additional incremental business that may have been deferred due to last year's rainy weather and storms. As I mentioned on our last call, longer term, the recent hurricanes could spur additional demand for our products to the extent that infrastructure repairs and improvements are required in the regions that were affected.

I'll now turn it back over to H.

Thank you, Mike. Following the unusual weakness that we experienced during the second half of fiscal 2017, we welcome the uptick in demand that gained momentum during our first fiscal quarter. Although we expect the usual seasonal factors will affect business conditions during Q2, we're hopeful the recent favorable trends will continue as implied by the largely positive macro indicators for our markets.

In November, we acquired certain assets of Ortiz Engineered Products. OEP has developed a unique market niche in providing value-engineered reinforcing solutions for the concrete construction industry converting projects that have been designed with conventional rebar to welded wire reinforcement. We believe they represent a close strategic fit with our ongoing efforts to further penetrate the rebar market through substitution of engineered structural mesh for cast-in-place applications and should accelerate the growth of our ESM business. Our newly combined sales and engineering group is focused on leveraging the substantial investments that we've made in developing our ESM manufacturing capabilities and expanding our cast-in-place business across other regions of the country.

On our last 2 calls, we indicated that we expected to experience some margin pressure due to the difficulty in recovering higher raw material costs in our markets, which is evident in our Q1 results. Over the past few months, steel markets have strengthened and wire rod costs are, again, on the rise, driven by escalating steel scrap prices, a pickup in global demand and the impact of trade cases that were filed in January 2017, which have eliminated certain countries from the domestic market.

Another factor that may potentially affect our raw material markets is the Section 232 investigation that was initiated by the Department of Commerce last spring. Last week, Commerce delivered its recommendations to the President, who is required to announce his discussion on the matter no later than April 11. In the near term, we don't believe the outcome will impact us as world market prices for wire rod have exceeded domestic prices for the last few months, which has already significantly reduced import volumes entering the U.S.

Longer term, however, it would not be in our interest for the administration to erect artificial barriers that reduce the availability of fairly traded offshore steels to domestic purchasers. In response to rising steel prices and improving market conditions, we have announced price increases, which were effective during January and expect that additional increases will be warranted in the coming weeks.

Turning to CapEx. As reflected in our release, outlays rose to $6.1 million in Q1, largely driven by the purchase of the leased Houston real estate. 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 leased facility in Houston and further upgrades to our PC strand manufacturing technology in addition to systems upgrades and other routine maintenance.

We're optimistic that construction markets will strengthen in 2018, particularly relative to the anomalous conditions we experienced during the second half of 2017, driven by growth in private non-res market, favorable trends in infrastructure spending at the state and local levels and the stimulative impact of the recent tax reform plan passed by Congress.

During 2018, we'll be vigilant in our continued pursuit of attractive growth opportunities, both organic and through additional acquisitions, and we'll continue to focus on improving our operational effectiveness and realizing the anticipated benefits from the investments we've made to substantially lower our manufacturing cost, reduce lead times and improve quality.

This concludes our prepared remarks, and we'll now take your questions. Brian, would you please explain the procedure for asking questions?

(Operator Instructions) And our first question will come from the line of Chris Olin with Longbow Research.

Just wanted to circle back on your comments regarding pricing. Have you announced price increases on both the PC strand and welded wire business? I know looking back over the past year, it was a little bit more difficult to get pricing on the PC strand side because of the supply increases. And if so, can you give us an idea of how much you're trying to get over the next month or so?

Yes. We've announced $60 per ton effective at various dates during January. And I might take exception to your comment about PC strand having been more difficult during 2017 than welded wire. It was difficult across the board. So we have another significant escalating period of wire rod transaction prices that certainly will affect all our competitors as well as they affect us. And we expect with better business conditions and plus the scale of the increases that we're facing that we'll be able to pass those increases through.

Okay. Just second to that, has there been any change in the number -- or I should say volume of PC strand imports since we started seeing global pricing move higher in the welded wire market?

Year-to-date, imports are up 7% or 8% compared to the prior year. We have seen escalating prices for imported PC strand, reflecting escalating wire rod and steel prices worldwide. But PC strand imports continue to be a problem that our industry is focused on addressing.

Okay. Just last question. Can you give us an update on the Houston facility kind of where you're at? Is it contributing to the bottom line yet?

Absolutely. Now saying that, we've had some weather disruptions in the Houston area as well as across other regions in the last few days, but the plant is operating and is well on the way to achieving the results on which our investment was based.

And our next question will come from the line of Tyson Bauer with KC Capital.

A couple of quick questions, and sorry for the road noise. The pricing you announced that you have the initial $60 in January, you're going to have another price increase shortly thereafter. Does that imply that you believe it'll be readily accepted that first increase? Otherwise, you won't have the second one, obviously. And does that help spur some of those shipment volumes coming back knowing that prices are going to go up in another 2 weeks or within another 4 weeks?

Well, let me try to take that in pieces. First, it's always unknown as to how price increase will be accepted and how effective we'll be in collecting it. And I would say that's true today with the $60 increase that has been announced to be effective in January. However, we're getting enough feedback to make us optimistic that we will put that increase in place. Future increases are driven more by our understanding of changes in the world market and changes in the availability of offshore wire rod to U.S. consumers of wire rod. Both of these things have had the impact of restricting availability and propelling the prices upward. So we don't have hard data on which to base our feeling that we'll be announcing on future price increases except the environment, certainly, clearly, indicates that we will. And as for whether the prospect of higher prices has caused front loading of demand, we really don't think so. It's hard to know exactly what's going through purchasers' minds, but we've had that discussion internally and we can't point to any significant trend where purchasers have accelerated their purchases to avoid price increases.

Is it more difficult to push through that initial price increase when you have a widespread, cooler temperatures that go all the way down to the Gulf where there's not a lot of movement or activity currently?

I think that might -- it might affect short-term psychology, but I don't think it has anything to do with the bigger picture.

Okay. Volumes expectations, obviously, you had a rough second half of '17 weather-related storms, other things that were in there. We saw some of that bounced back in the first quarter here. Should we be, as analysts, looking more on comparables to '16 where you didn't have some of those disruptions which would then lead, along with price increases this year, a much more outsized growth on the top line for the company?

Well, I'm not sure that I would characterize it exactly that way, Tyson. But I think, internally, what we would like to see is a return to the normal seasonal uptrends that have historically been evidenced during the better construction weather months. But I'm not sure that, that implies that we're going to see runaway growth in unit volume. The barring -- I'm sorry, I was going to add barring any unusual weather-related trends like we experienced last year between the rainy weather and the hurricanes, we would expect that the typical seasonal pattern to occur this year, where Q1 represents our low point and then we typically see an uptick in volume in Q2 and then Q3 and Q4 would represent our busy season at even higher volumes. And we would expect to get back to that pattern, again, assuming no weather-related anomalies.

Okay. And regarding Ortiz, is it the double effect that you're looking to drive better top line growth in addition to better margins as they're able to provide more value add on the engineering side? And is that company-wide that their services will be applied? So even though they're in kind of the rough spell day, their services can be applied company-wide, correct?

Yes. That's correct. The challenge in the underlying thesis of the acquisition is that we will be able to expand the presence of OEP from what has been Northeast-centric more to nationwide in the market areas where we have a clear value proposition that will allow us to grow.

So we should see, one, better procurement of contracts; and two, a better margin when their services are used?

That's certainly our expectation.

(Operator Instructions) Our next question will come from the line of Julio Romero with Sidoti & Company.

So I wanted to ask about Ortiz. Can you just give us additional color on maybe how the acquisition process played out? What kind of made the conversion from them being maybe a longtime customer towards being someone you're looking to acquire? And then how they can specifically accelerate the ESM adoption going forward.

Yes. So you're correct that Ortiz has been a longtime customer for us. It's a highly specialized niche that OEP occupies, where they are focusing on projects down to even the placement of reinforcing on a job site and controlling that value chain. Really, that -- from their point of view, that started with procurement from Insteel and ends with a finished concrete structure for their customer. Over the development of our ESM market, Insteel focused primarily on the precast segment of that market over the years because there was one opportunity to invest engineering resources in the conversion of rebar to ESM with a precaster, and then repetitive business followed that initial conversion of the customer. With the cast-in-place market, it's different where every project is unique and every project has its own engineering requirement and is just a much more unique and specialized segment of the market. We've been pursuing the market for the cast-in-place segment of the market for several years and saw the addition of the OEP capabilities as a way to accelerate our growth. So it's not a case where we're entering a market segment that we're unfamiliar with.

Got it. And your most recent slide deck mentions that estimated domestic production represents currently less than 5% of rebar volume you could potentially replace. I know it's a very long sales cycle, so could you speak on maybe how you see that percentage kind of playing out over the next 1-, 3-, 5-year time frame?

Yes. We really don't think about it in terms of what percentage of the rebar market we target to capture. We would rather think about the growth rates that we have in the cast-in-place market, and for that matter, in the other segments of ESM as well. There is no reason that we shouldn't expect to deliver solid double-digit unit growth from that activity going forward, and that's our expectation. But to say that we've tried to hang a number on the percentage of participation in rebar market would just not be correct. We just don't think of it in those terms.

The purpose of that reference in our slide deck was just to give an indication of the magnitude of the growth potential in that segment.

That make sense to think about it about precast versus cast in place. And then just a quick one on tax rate. So just to be clear, that 24.9% effective rate that was called out, that would be the effective rate for the full year, where the normalized rate on income earned in this first quarter would be a usual 34% type rate and then you'll be paying 23.5%-ish on the income for the remaining 3 quarters of the year? Is that accurate?

Yes. That's correct. The 24.9% represents the blended rate for the entire year. And so this year, we get the benefit of the lower rate for 3 quarters. Next year we'll, in fiscal 2019, we'll have it for the entire year.

You may begin with your closing remarks.

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

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program, and we can all disconnect. Everybody, have a wonderful day.