Q2 2024 Insteel Industries Inc Earnings Call

Participants

H. Woltz; Chairman of the Board, President, Chief Executive Officer; Insteel Industries Inc

Scot Jafroodi; Chief Financial Officer, Vice President, Treasurer; Insteel Industries Inc

Julio Romero; Analyst; Sidoti & Company LLC

Tyson Bauer; Analyst; Kansas City Capital Associates

Presentation

Operator

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. All lines will be muted during the presentation portion of the call, an opportunity for questions and answers. At the end.
If you'd like to ask a question, please press star one on your telephone keypad. I would now like to pass the conference over to our host, H. Woltz, President and Chief Executive Officer and steel H Please go ahead.

H. Woltz

and 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 bus capture fruity, our Vice President, CFO and Treasurer, and me before we began, 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 on our Q1 call that we believed the headwinds of inventory liquidations and the downward reset in 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 1st 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.

Scot Jafroodi

Thank you, H., and good morning, to everyone joining us on the call. As 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 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 the 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% and reflecting significant downward reset and selling prices experienced over much of fiscal 2023 and the first quarter of fiscal 2024. Gross profit for the quarter increased $2.4 million from a year ago to $16.7 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 and 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 the combination of the 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 than the other assumptions and estimates that compose our tax provision calculation movements in 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, we 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 end markets, monthly construction spending data from the U.S. 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, ABI fell 43.6, down from 49.5 in February, remain below 50 growth threshold and fallen to its lowest level since December 2020. Documentum Index, which tracks nonresidential building projects going into planning have fallen over the last several months. The market for 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.

H. Woltz

Thank you, Scott. As we commented last quarter. The operating environment during fiscal 2024 has been difficult as we face 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 low unemployment rate in most markets, but conditions have improved considerably since half hiring challenges peak, 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 and a variety of countries that appear to be circumventing the section 232 tariffs on hot rolled steel by downstreaming, 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 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 some specific projects that have affected demand with respect to RJA., 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 IDA 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 has 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 IG funds will ultimately be allocated to projects and spin up as intended with a beneficial impact on our industry.
The question remains when NADiA 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 accept 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 a production line at a PC strand plant. The scale of these additions should be viewed as unusual and not as recurring events. 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 is clear to us that companies failing to make such investments will become increasingly uncompetitive. And as you know, in steel 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 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?

Question and Answer Session

Operator

If you would like to ask a question please press star followed by one on your telephone keypad. If you would like to remove that question, please press star followed by two again to ask a question, press normal and as a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. We'll pause briefly as questions registered.
Our first question is from the line of Julio Romero with Sidoti & Company.
Your line is now open.

Julio Romero

Hey, good morning from my side.

H. Woltz

Good morning.

Julio Romero

I wanted to on.
Hey, good morning.
I wanted to maybe talk about pricing to start off on the price increase that was put in place January first.
Tom, 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 from where 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 like the PC strand susceptible to imports. Just hoping for some clarification there.

H. Woltz

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

Julio Romero

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

H. Woltz

Well
There's probably other so many different markets that we serve and that it's hard to make a general as 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 a buck where we find ourselves on it at the end of Q2 and beginning of Q3. And this is a week-to-week matter for us. So so on, I think the underlying level of demand will will support on based on prices for our products going forward. But we only know week-to-week how on how that's going to shape up.

Julio Romero

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 nonres side which I think has been kind of weak for a couple of quarters now versus the the residential? Or are you seeing any difference there? Or are they kind of moving at the same kind of ParAllele base.

H. Woltz

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

Julio Romero

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

Operator

Thank you for your question. Next question is from the line of Tyson Bauer with KC Capital.

Tyson Bauer

If you want to know, but good morning, gentlemen, monetize. I will have to follow up on that shipment trends and increases. I guess the word that comes to my head is up. Finally, it seems like we've had a lot of new lines modernization and that expectation that we're filing and I 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?

H. Woltz

Yes, 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 a two-part return. One is lowering our internal cash cost of operation and the other is expanding capacity on as really as we have moved certain product lines to new equipment and opened up capacity on older equipment. So so we are seeing right now more of a recovery in the underlying business base business on and not it's not all incremental growth from on from CapEx.

Tyson Bauer

Bucket is the market.
Obviously, we don't know the macro stuff, but we do anticipate improvements on the infrastructure side of us. 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?

H. Woltz

Well, you certainly think so if you know that we have we've incurred on significantly higher manufacturing costs due to inflationary on trends in really everything that we purchase. But we've also at these facilities throttled back on too low levels of capacity utilization just based on market trends. And and we worked on diligently to maintain our finished goods inventories and which has further depressed our operating rates in some cases. So so as we see volumes return to the business, you would logically expect that we will develop more pricing power and that we would see significant reduction in operating costs.
And I 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 certainly the trends are positive and customers are generally optimistic on and we would expect quarters three and four b. to be good quarters for the Company.

Tyson Bauer

Yes, 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, it's difficult to really get ahead and prevent those imports from have an impact domestically from anything different this go around or is this just cycle that repeats itself?

H. Woltz

Well, let let let me state first that PC strand remains an attractive business for our company. And yes, there is a segment of it, the benefit of that market that is subject to import competition and always has been and in steel has always dealt effectively with that import competition over time and will and I think we'll do so again, this time. What is different about about where we find ourselves today and where we found ourselves in the past is the Section 232 on tariffs on hot rolled 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 U.S. is damaging to our country. Our company and plan. The 232 tariffs was envisioned by the Trump administration. We we told them that if they have a plan to try to steal product. They needed to look at the entire supply chain and they didn't do that. And we continue 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 our 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 on, 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.

Tyson Bauer

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

H. Woltz

Well, I mean, I think if you look at the 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 on.
So how the administration on that it or flattening with the surprise that Nippon or want to buy U.S. steel? I mean, I just can't imagine so. So in our space on the I wouldn't say the administration is on an impediment to M&A on, but it's hard for me to understand that they would be surprised by the environment that exists today.

Tyson Bauer

If you look at Caterpillar also announced this morning or it came with some comments on some headwinds in the commercial construction, which matches up with the nonres. 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 in hand creating this delay and recognizing that demand.

H. Woltz

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

Tyson Bauer

Okay.
Thank you, gentlemen.

H. Woltz

Thanks, Tyson.

Operator

Thank you for your question. There are currently no further questions registered so as a reminder, is star one on your telephone keypad. There are no additional questions waiting at this time, so I'll pass the call back to the management team for any closing remarks.

H. Woltz

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

Operator

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