Insteel Industries Inc (IIIN) 2024 Q2 法說會逐字稿

Good morning. Thank you for attending the Insteel Industries' second quarter 2024 earnings call. My name is Matt, and I'll be your moderator for today's call. (Operator Instructions) I would now like to pass the conference over to our host, H. Woltz, President and Chief Executive Officer and Insteel. H, please go ahead.

Thank you, Matt. Good morning. Thank you for your interest in Insteel, and welcome to our second quarter 2024 conference call, which will be conducted by Scot Jafroodi, our Vice President, CFO, and Treasurer, and me. Before we begin, let me remind you that some of the comments made on 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 had stated in our Q1 call that we believed the headwinds of inventory liquidations and the downward recent steel prices had run its course. I can confirm that we continue to believe this and that our markets have been steadily accelerating since the first of the year. We're optimistic about the underlying level of demand for our products and the outlook for our financial performance. I'm going to turn the call over to Scott to comment on our financial results for the quarter and the macro environment, and then I'll kick it back off to discuss our business outlook.

Thank you, H, and good morning to everyone joining us on the call. As we reported in our press release earlier today, Insteel's results for the second quarter improved from a year ago, as widening spreads between selling prices and raw material costs offset the negative impact of lower shipments.

Net earnings for the quarter rose to $6.9 million from $5.1 million a year ago, and earnings per share increased to $0.35 per diluted share from $0.26 per share in the prior year. Shipments for the quarter rose 1.9% from Q1, reflecting the normal seasonal upturn in business that fell 3.2% year over year. Q2 shipments started slowly as adverse winter weather conditions during January negatively impacted construction activity. And in addition, we faced several familiar challenges during the quarter, including ongoing project delays, weakness within our commercial construction markets, and heightened competition from low-priced imports within certain of our PC strand markets.

Despite these headwinds, there was a strengthening of shipments as the quarter progressed. With February and March volumes higher than the previous year levels, although we are still early in the third quarter, our order book has remained strong and April shipments have trended above forecasted levels. Average selling prices were up 2.7% sequentially from the first quarter, reflecting a portion of the price increase we implemented in January in response to the escalation in our raw material cost during Q1.

Unfortunately, the amount realized fell short of our expectations as persistent headwinds, including competitive pricing pressures from domestic competitors and the growing impact of low-price PC strand imports gradually eroded selling prices as the quarter progressed. On a year-over-year basis, ASPs were down 17.3%, reflecting significant downward reset in selling prices experienced over March of fiscal 2023 and the first quarter of fiscal 2024.

Gross profit for the quarter increased $2.4 million from a year ago to $15.7 million, while gross margin expanded to 12.3% from 8.3%. On a sequential basis, gross profit increased $9.4 million from the first quarter and gross margin improved 710 basis points. The recovery spreads between average selling prices and raw material costs was partially offset by lower shipments.

Spreads benefited this quarter from selling price increase I mentioned earlier, along with an assumption of lower cost raw material inventory than outflows reflects replacement value. Unit conversion costs were essentially unchanged year over year, but remained elevated due to continued inventory management efforts and operating restrictions at our facilities in response to market conditions. As we move into the third quarter, we anticipate that combination of a strengthening demand environment, current raw material carrying values, and increased operating debt with operating levels at our facilities will continue to restore gross margins to more attractive levels, following the compression we experienced over the past year.

SG&A expense for the quarter increased to $7.9 million or 6.2% of net sales from $7.5 million or 4.7% of net sales last year. The dollar increase was primarily the result of increases in employee benefit costs, depreciation expense, and bad debt reserve. These increases were partially offset by lower compensation expense under our return of capital based incentive plan, which was negatively impacted by the weaker year-to-date results.

Our effective tax rate for the quarter was virtually unchanged at 22.5%, which is up slightly from 22% last year. Looking ahead to the balance of the year, we expect our effective rate will remain steady around 23%, subject to the level of pretax 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 fell to $1.4 million from $46.6 million last year. Net working capital used, $10.5 million of cash in the second quarter, due to a $12.2 million increase in receivables resulting from higher sales and an increase in average selling prices, which offset a $1.6 million decline in inventory. Our inventory position at the end of the quarter represented 2.6 month of shipments on a forward-looking basis calculated off of forecasted Q3 shipments, compared to three months at the end of the first quarter.

Additionally, our raw material inventories at the end of second quarter were valued at an average unit cost that approximates our second quarter cost of sales, remains favorable relative to current replacement costs, which should continue to favorably impact spreads and margins during the third quarter. We incurred $2 million in capital expenditures in the quarter for a total of $14.2 million during the first half of our fiscal year, and we remain committed to our full year target of $30 million. H will provide more detail on this topic in his remarks.

Finally, from a liquidity perspective, we ended the quarter with $83.9 million of cash on hand and no borrowings outstanding on our $100 million revolving credit facility, providing us ample liquidity and financial flexibility going forward.

Finally, during the second quarter, we continued our share buyback program, repurchasing $300,000 of common equity, equal to approximately 9,000 shares. Turning to the macro indicators of our construction markets, the monthly construction spending data from the US Department of Commerce continued to show strength. The latest February data revealed that total construction spending on seasonally adjusted annual basis increased by approximately 11% compared to last year.

Non-residential construction spending increased by 14%, and public highway and street construction, which is one of the largest in use applications for our products showed an increase of nearly 19%. However, leading indicators for nonresidential construction, architectural billings, and Dodge Momentum indexes remain weak and indicate easing demand. In March, the ABI fell 43.6, down from 49.5 in February, remain below 50 growth threshold and fallen to its lowest level since December 2020.

The Dodge Momentum indexes which tracks nonresidential building projects going into planning have fallen over the last several months. The market for it showed a continued decrease in planning activity, dropping 8.6% from February due to slowdowns in both commercial and institutional planning.

This concludes my prepared remarks, and I'll now turn the call back over to H.

Thank you, Scott. As we commented last quarter, the operating environment during fiscal 2024 has been difficult as we faced headwinds, including declining steel prices, inventory liquidations by customers, the need to align our finished goods inventories to reflect lower shipments, and finally, the normal seasonal downturn in construction activity. We're glad to report that these adverse conditions seem to have run their course, and we're experiencing rising demand driven by market fundamentals as well as the capital investments made by the company in recent years.

While our shipments for Q2 were slightly lower than the prior year, each month of the quarter was stronger than the prior month. And for April, month to date, shipments have increased compared to last year by more than 10%. As indicated in the release, we're ramping up operating hours at several facilities to respond to more robust demand.

Hiring continues to be difficult in view of lower unemployment rate in most markets, but conditions have improved considerably since hiring challenges peaked. As Scott mentioned and as we've stated in the last couple of earnings calls, we are increasingly affected by low price imported PC strand from producers in a variety of countries that appear to be circumventing the Section 232 tariffs on hot rolled steel by down streaming.

Continuing the trend that began last year, the average unit value of imported PC strand for February, which is much recent data, was lower than the domestic price for wire rod, the raw material from which PC strand is produced. The industry is carefully scrutinizing strand imports and will pursue any trade actions that are justified. We are also working with the administration to demonstrate that the differential treatment of possible hot rolled wire rod and PC strand with respect to the Section 232 tariff is undermining the intent of the tariff and damaging the very constituency that tariff was intended to help.

We're optimistic about the impact on our markets of the Infrastructure Investment and Jobs Act, although at this point, it's difficult to point to specific projects that have affected demand. With respect to IIJA, the Secretary of Transportation has acknowledged delays of multiple years between appropriations and increased demand for construction services and materials. The administration has also been clear that IIJA is a new way of funding infrastructure investment and is not a stimulus program.

In other words, it does not appear to surprise the administration that the impact of legislation on infrastructure spending thus far is muted. Meanwhile, of course, inflation is impacting project cost and jeopardizing the viability of some projects. Despite these obstacles, we believe that IIJA funds will ultimately be allocated to projects and spin, as intended with a beneficial impact on our industry. The question remains when, not if.

Turning to CapEx. We indicated in prior calls and press releases that CapEx for 2024 was expected to come in at approximately $30 million, and this continues to be a reasonable estimate. As we stated earlier, elevated CapEx for 2023 and 2024 does not imply a permanent step up in CapEx expectations. On an ongoing basis, we would expect CapEx to range closer to depreciation and amortization, and to be elevated in years when we elect to expand capacity or incorporate new technology into our facilities through equipment replacements.

As a reminder, the CapEx amounts for 2023 and '24 are heavily influenced by the addition of three new production lines at our welded wire reinforcement plants and the addition of our production line at a PC strand plant. The scale of these additions should be viewed as unusual and not as recurring event.

The investments that we're making in state-of-the-art technology will expand our product capabilities and favorably impact our cost -- our cash cost of production. It is clear to us that companies failing to make such investments will become increasingly uncompetitive. And as you know, Insteel continues to be debt-free and has substantial flexibility to make decisions for the long-term best interest of the business and its shareholders.

Looking ahead, we're aware of the substantial risks related to the future performance of the US economy, and we're monitoring the environment closely. In any event. We're well positioned to aggressively pursue actions to maximize shipments and optimize our costs and to pursue attractive growth opportunities both organic and through acquisition.

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

(Operator Instructions)

Julio Romero, Sidoti & Company.

Hey, good morning from my side.

Good morning, Julio.

I wanted to -- hey, good morning.

I wanted to maybe talk about pricing to start off. The price increase that was put in place January 1. I think you guys mentioned in the prepared remarks that the amount accepted fell short of expectations. And I was just hoping to kind of dig into that a little bit. What were you guys are alluding to, maybe the price increase not being accepted by the marketplace? Or was it just slower to be accepted than you would have thought of? Or was the price headwind more narrowly focused on some select product lines like the PC strand susceptible to import? Just hoping for some clarification there.

Well, the motivation for the price increase was really the dramatic escalation that we saw in the steel costs on from December and January. And as you know, if you -- I know you keep up with these things that reversed itself rather precipitously and some of the impetus throughout the industry for getting ahead of steel price increases seem to evaporate as the market change. So I would say that the level of commitment by the industry to collect in the increase waned during the quarter.

Okay, that is helpful. Because the ASPs did move up sequentially in the quarter, and I thought they were pretty good. I'm just wondering if you see the -- you talked about the volumes kind of trending upward a little bit. Wondering if you see the ASPs kind of exiting the March quarter on an upswing or do you see pricing somewhat pressured as we go into the June quarter?

Well, there's probably other so many different markets that we are serving, that it's hard to make a general statement that covers them all, because they're different levels of competition in each of them. As a general statement, I would say we're not surprised by about where we find ourselves at the end of Q2 and beginning of Q3. And this is a week-to-week matter for us. So I think the underlying level of demand will support, based on prices for our products going forward, but we only know week-to-week how that's going to shape up.

Okay, that's helpful. And then, maybe last one for me is just thinking about, you mentioned strengthening shipments as the quarter progressed. Can you maybe talk about what your -- how they trended on the non-res side, which I think has been kind of weak for a couple of quarters now versus the the residential? Are you seeing any difference there or are they kind of moving at the same kind of parallel pace?

I would say parallel is probably a good term, a good term for it. As you know, most of the products that we put into residential markets are more commodity-like and they've been more competitive. But with that said, I think parallel is probably a pretty good summation of where we are.

That's helpful, guys. I'll pass it on. Thank you.

Tyson Bauer, KC Capital.

Good morning, gentlemen.

Good morning, Tyson.

I will have to follow up on that shipment trends and increases. I guess the word that comes to my head is, finally. It seems like we've had a lot of new lines modernization and that expectation that we're finally going to get that operating leverage from increased shipments, and it just never developed as probably as timely as we had hoped. Finally, seeing that is certainly a good thing.

As we see those trends and those increased shipments going forward, how much of that is just recovering from the declines you've had the last couple of years as opposed to incremental contribution from your capacity increases you've done over the last couple of years, where we'll start to see that implication on the margin spread?

Yeah, I think most of it is a recovery in the underlying business, Tyson. And as we've stated on a number of occasions, the capital investments that we've made have two-part return. One is lowering in our internal cash cost of operation and the other is expanding capacity, really as we have moved certain product lines to new equipment and opened up capacity on older equipment. So we are seeing right now more of a recovery in the underlying business, base business and not -- it's not all incremental growth from CapEx.

Okay, Is the market -- obviously, we don't know the macro stuff, but we do anticipate improvements on the infrastructure side of those. Is there enough there in those product lines to see that contribution margin play a bigger role as we get into the seasonally stronger quarters?

Well, you would certainly think so. If -- you know that we've incurred significantly higher manufacturing costs due to inflationary trends and really everything that we purchased. But we've also had these facilities throttled back to low levels of capacity utilization, just based on market trends. And we worked diligently to maintain our finished goods inventories which has further depressed our operating rates in some cases.

So as we see volumes return to the business, you would logically expect that we would develop more pricing power and that we would see significant reduction in operating cost. And I'll quickly just add that we don't have the backlog to be able to tell you that we know that's going to happen. But certainly, the trends are positive and customers are generally optimistic, and we would expect quarters three and four to be good quarters for the company.

Okay. In regards to PC strand imports, through the years, it's kind of this game of whack-a-mole depending on what region the imports are coming from. And we've had favorable trade rulings that seem to take care of, say, India, Korea, Eastern Europe, Brazil, And then, somebody else kind of fills that void, and it's difficult to really get ahead and prevent those imports from having a impact domestically. Anything different this go around or is this just a cycle that repeats itself?

Well, let me state first that PC strand remains an attractive business for our company. And yes, there is a segment of it of that market that is subject to import competition and always has been. And Insteel has always dealt effectively with that import competition over time. And I think we'll do so again, this time. What is different about where we find ourselves today and where we found ourselves in the past is the Section 232 tariff on hot-rolled steel products, which applies to our raw material, but does not apply to imports of PC strand.

And the motivation for offshore producers to downstream that wire rod into PC strand and send it into the US is damaging to our country -- our company. And when the 232 tariff was envisioned by the Trump administration, we told them that if they apply tariffs to steal products, they needed to look at the entire supply chain and they didn't do that.

We continued to press our case. One of the fundamental thresholds of 232 was it they wanted the steel industry to operate at 80% capacity utilization. The domestic wire rod producers today are operating at under 70% of capacity, and partly is because imports of PC strand and other downstream products have reduced apparent domestic consumption of wire rod significantly. So we will continue to pursue illegal trading tactics through antidumping and countervailing duty actions.

And as I said in my prepared comments, we're also working with the administration to demonstrate to them that the intended beneficiaries of Section 232 are actually being harmed by what's going on, and that they need to seriously look at expanding the coverage of Section 232 to include PC strand. And it's a heavy lift, but we have the data on our side and the logics on our side. And it's basically irrefutable. Does that mean they'll do something? Hard to say. But certainly, all the logic is there to support it.

Does the administration trying to block the M&A activity for the steel producers exasperate that problem or has it tried to correct it?

Well, I mean, I think if you look at the US steel market, it's the highest priced steel market in the world. What produced or wouldn't covet market position and the highest price market in the world. And it is the highest price market because of Section 232. And so how the administration or why they would be surprised that Nippon would want to buy US steel, I mean, I just can't imagine. So in our space, I wouldn't see the administration as an impediment to M&A, but it's hard for me to understand that they would be surprised by the environment that exists today.

Okay. Caterpillar also announced this morning, or it came with some comments on some headwinds in the commercial construction, which matches up with the non-res. Is that something that you are also seeing at your level, that there is some working through on that side of it, but it's being overcome by the infrastructure portion of it? Or do they somewhat go hand on hand, creating this delay on recognizing that demand?

Keep in mind that it's hard for us to know for sure where our products are going, whether they would be, whether the demand is driven by residential or non-residential markets. Sometimes our customers aren't even sure of which market segment they're serving. So I think I think what we're seeing now is really decent demand from both residential and non-residential markets, and certainly, a recovery in both.

Okay. Thank you, gentlemen.

Thanks, Tyson.

(Operator Instructions) There are no additional questions waiting at this time. So I'll pass the call back to the management team for any closing remarks.

Okay. Well, we appreciate your interest in the company. We encourage you to contact us if you develop questions and we'll look forwards to the Q3 call, which will be coming up before you know it. Thank you.

That concludes the conference call and thank you for your participation. You may now disconnect your lines.