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#Thank you.
Good morning, and thank you for your interest in Insteel, and welcome to our third quarter 2017 earnings call, which will be conducted by Mike <UNK>, 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 SE<UNK>
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 the macro indicators for our end markets, and then I'll follow up to comment more on market conditions and our business outlook.
Thank you, H, and good morning to everyone joining us on the call.
As we reported earlier today, Insteel's net earnings for the third quarter of fiscal 2017 fell to $6.9 million or $0.36 a share from $13.5 million or $0.71 a diluted share last year.
Our results for the quarter were adversely affected by unusually weak shipments during what is typically one of the seasonally stronger periods of the year, together with narrower spreads due to higher raw material costs.
Shipments for the quarter were down 20.8% year-over-year and 7.5% sequentially from Q2 as compared to an 8.8% increase between the second and third quarters last year, reflecting the higher variability in demand we've experienced this year due to fluctuations in weather conditions and the timing of large projects.
We believe the volume drop off was driven by a combination of the unusually wet weather in many regions of the country, a lull in new project activity and competitive pricing pressures that were compounded by the weak demand.
Rainfall in the Southeast, Midwest and Northeast regions of the country was up 36% to 63% year-over-year for the quarter, which offset the more favorable weather in our largest market, Texas.
The resulting deferral of business from the construction delays should benefit us in future periods, although there's no way we can estimate the impact at this time.
Many of our customers were also negatively impacted by a significant slowdown in business during the quarter due to a reduction in new projects relative to work that was in process or completed.
The weakness appeared to be more prevalent in the publicly-funded infrastructure segment of the market and should subside in the coming months as the higher spending levels that have been authorized by numerous states and cities begin to have an impact.
Average selling prices for the quarter rose 3.5% sequentially from Q2 as a result of the price increases we implemented to offset the recent escalation in our raw material costs.
The amount realized was sufficient to provide for a slight sequential improvement in spread that fell short of our announced increases due to competitive pressures.
Gross profit for the quarter fell $10.9 million from a year ago to $16.7 million, while gross margin decreased 660 basis points on the lower sales to 17.2%.
More than half of the reduction was due to the drop off in shipments, about 1/3 was driven by the narrowing in spreads relative to the prior year and the balance was from higher unit manufacturing cost on the lower production volume.
On a sequential basis, gross profit fell $1.6 million from the second quarter and gross margin narrowed 90 basis points, primarily due to the reduction in shipments, and to a lesser extent, higher unit manufacturing costs, which were partially offset by the improvement in spreads.
SG&A expense for the quarter fell $0.6 million from a year ago to $6.2 million on lower compensation expense, primarily related to reduced incentive comp under our return on capital plan.
Excluding the incentive comp expense, our SG&A costs were down $0.1 million or 4.7% from last year.
Our effective income tax rate for the quarter was essentially unchanged at 33.9% versus 33.8% a year ago and 33.8% year-to-date compared to 34% for the same prior year period.
Moving to the balance sheet and cash flow statement, our inventory position rose $24.5 million from the second quarter, and was primarily responsible for the year-over-year reduction in cash flow from operations for the quarter.
Most of the increase was planned in response to the trade cases that were initiated by domestic rod producers as well as the potential tariffs and/or quotas that could result from the Section 232 investigation, with the balance resulting from the weaker than expected demand.
Based on our forecasted shipments for Q4, we ended the quarter with close to 4 months of inventory on hand valued at an average unit cost that was below the current market level but above the beginning average for the quarter as well as Q3 cost of sales.
These higher costs could pressure our margins in the fourth quarter depending on the relative strength of demand and our ability to raise prices further.
We ended the quarter with $37.8 million in cash on hand or about $2 a share and no borrowings outstanding on our $100 million credit facility, providing us with plenty of financial flexibility.
As we move into our fourth fiscal quarter, customer sentiment remains positive, project pipelines appear to be healthy and activity levels are expected to improve in the coming months.
The most recent reports for the Architectural Billings Index and Dodge Momentum Index reflect favorable trends that imply further improvement in nonresidential building construction in the coming year.
Yesterday, the American Institute of Architects reported that the ABI remained above the 50 growth threshold for the fifth consecutive month, rising to 54.2 in June from 53 the previous month.
Through the first half of the year, the index has averaged 52.1 compared to 51.2 for all of last year and 51.6 for 2015.
In June, the Dodge Momentum Index rose to its highest level in 8.5 years and the 3-month average which smooths out the usual month-to-month volatility, was up 16.7% year-over-year, reflecting similar increases in both the commercial and institutional components.
The most recent construction spending data reflects the continuing disparity between the private and public sectors and the relative weakness in infrastructure investment.
Through the first 5 months of the year, private construction spending was up 9% from a year ago, with nonresidential up 5.3% and residential up 12.4%, while public construction spending was down 3.5%.
Public highway and street construction, one of the larger end uses for our products, was down 1.3% following last year's modest 1% increase.
We expect that public sector activity will begin to pick up later in the year as the recent funding increases provided for through various ballot initiatives, fuel tax increases and other measures at the state and local level translate into higher infrastructure spending.
I will now turn it back over to H.
Thank you, Mike.
As reflected in this morning's press release, demand for our reinforcing products was weaker than expected during the quarter as well as compared to last year.
While leading indicators continue to reflect underlying strength in nonresidential construction markets with the prospect for future growth, adverse weather conditions in certain regions and project delays, particularly in the publicly-funded infrastructure segment of the market, combined to have a significant unfavorable impact on shipments during Q3.
The disappointing demand coincided with our efforts to increase prices to recover raw material costs that began escalating during our first fiscal quarter.
As we mentioned in the Q2 call, we expected the usual favorable seasonal factors would support these efforts.
Unfortunately, the seasonal pickup in demand failed to materialize and certain competitors elected to maintain or reduce their prices in the weaker environment.
Any incremental business that competitors may have gained through these tactics should prove to be short lived.
Looking forward, there are some indications that the seasonal uptick in demand may have gained some momentum following the July 4 holiday period as shipments have improved to a level closer to expectations.
However, we're likely to continue to experience some margin pressure until demand picks up to the point where the industry has additional pricing flexibility.
Turning to inventories, as Mike indicated, the pronounced build during Q3 followed the initiation of wire rod trade cases targeting 10 countries that supplied the majority of imports to the U.S. and the initiation by the Department of Commerce of a Section 232 investigation of steel imports.
We elected to increase our raw material inventories to bridge the transition to new offshore sources and to manage the risk of supply interruptions or dislocations that may result from changing conditions in the steel market.
In addition, our shipment shortfall contributed to higher inventory levels.
Based on our most recent forecast, inventories should be close to their peak level and are expected to decline through the fourth fiscal quarter.
We believe the rationale behind our decision to build inventories continues to be valid, and we're not uncomfortable with our position in view of its favorable carrying value relative to market.
Turning to CapEx, we previously indicated that we expected CapEx for 2017 to come in at approximately $25 million, while acknowledging that our estimates have tended to be on the conservative side.
While the timing of outlays is different ---+ difficult to pinpoint due to supplier and contractor schedules, we continue to forecast that 2017 expenditures will fall between $20 million and $25 million.
The scope of the anticipated projects has not changed as we continue to aggressively pursue attractive growth and cost reduction opportunities as rapidly as our internal resources allow.
Two major projects have been completed during the year, with the commissioning of new raw material, cleaning and PC strand production lines at the Houston plant and the new ESM production line at the Missouri facility.
These projects will have a beneficial impact on our operating costs, as well as expand our range of products, improve our quality and service, and increase our capacity to serve growing markets.
Looking forward to 2018, we expect to make additional investments in our ESM product line to further upgrade our technology, expand our product range and reduce operating costs.
We plan to pursue a number of other cost reduction and modernization opportunities as well, and we'll provide additional guidance on 2018 CapEx during our next conference call.
This concludes our prepared remarks, and we'll now take your questions.
Sonja, would you please explain the procedure for asking questions.
I don't know that there's any way that we could make a real valid estimation of that.
It's beyond our capability.
I wouldn't call it regional as much as it is focused on the publicly-funded sector.
We saw a slowdown in highway lettings that was reasonably widespread.
And as you know, we've also hit the end of fiscal years for governmental entities, which frequently come with funding lapses or funding slowdowns, and anecdotally, we believe that those factors were at work during this quarter.
Well, I would say really it means exactly what we said, that it is closer to expectations.
But that doesn't necessarily imply that it's robust.
No.
Yes, it's typically a timing issue where the work's deferred and we see a benefit at a later time.
Although it's always difficult to predict the timing or magnitude of the impact, especially in the current environment just with many of our customers dealing with labor constraints, it makes it more challenging to immediately ramp up.
So it could take some time for that benefit to work its way through.
That's probably a fair expectation.
I would say the biggest impact of the looming Section 232 is in combination with the trade cases that are being pursued on wire rod.
I think that there's a sense among the wire rod producers that they're going to gain some relative power through strengthening markets that are driven by these factors.
I would say that probably hasn't happened at this point.
But that would be the biggest impact on ---+ that I see on our business at this point.
There would definitely be a benefit for the ---+ from the budget being resolved in a timelier manner this year.
You may recall last year, there were a couple of short-term continuing resolutions that just created some uncertainty in terms of the FAST Act funding.
So ideally, Congress would be able to land on an annual measure this year.
In terms of the impact the FAST Act provided, just from relatively modest annual increases in the 2% range, so just in terms of the impact on our business, it would be relatively modest.
The bigger question marks the status of the additional infrastructure package where the level of uncertainty on that has obviously risen just with what's going on with the healthcare bill and tax reform and so on.
So the timing and end result on that's probably a little more uncertain than it was this time last quarter.
In answer to the first part of the question, yes, it's primarily domestic competition.
We compete with imports in one segment of our PC strand business but it's a fairly narrow and targeted segment.
So the overwhelming majority is domestic competition.
Our markets are regional and even local in nature.
And while we have competitors who are active in multiple geographies, generally we would take the view that these markets are local and regional.
Well, I would say first that no one should underestimate the competitive nature of this marketplace.
Our business is a highly competitive business, and our focus to gain advantage has been really on execution in our manufacturing opportunities and providing our people with the best possible technology both in our factories and through our information systems.
And as for what the future holds for margins, it's difficult to say, but I would point to looking over the last many years, absent the period of the Great Recession, that I don't think that there's any reason that we can't expect to continue to generate margins that are consistent with past history.
And as we continue to move our products up the value chain and add more value in markets where we can retain that value, then we would expect to see favorable margin results from that pursuit.
So despite the rather ugly comps that were reported today, we believe the future is good for the company, and that we're positioned to execute and compete very effectively in our markets.
So we're going to take advantage of the technological developments that will give us the operating edge in our manufacturing facilities, as well as to support our growth in our engineered structural mesh marketplace where there have been ongoing considerably important developments that will provide us the ability to lower cost and improve the range of products that we offer.
And then the other, of course, the other major part of CapEx that we've had during 2017 has been the expansion of our Houston facility, which is a onetime investment that will bring the cost of that facility in line with Insteel expectations.
So we have every confidence that our markets will continue to grow and support the CapEx that we need to make to maintain our competitive edge.
No.
I would say that the weakness we saw was across the board in all our product lines.
And within welded wire reinforcing and we have 3 different product families, each of which displayed weakness, as well as our PC strand displayed weakness.
The Wire Mesh Corporation expansion into South Carolina was about 15 months ago, is when they started up.
And certainly, they've had an impact on the market.
And the other expansion that is starting up as we speak is in Dayton, Texas on part of Sumiden Wire Products.
And yes, it definitely will have an impact on the market, particularly at a point in time when there's a lull in demand as we've seen.
This is not unexpected.
It's unwelcome, but it's not unexpected.
And we'll work through it.
And assuming that the PC strand market grows as it has in the past, and that there's a recovery in demand, we have every expectation that the market will absorb that capacity.
Well I think to the extent that weakness has been driven by weather, it's probably not as much Texas as it has been the rest of the country during the previous quarter.
But I wouldn't single out any particular region as an outlier.
The weakness has been somewhat across the board.
The comparisons for the quarter are all significantly impacted by the weather.
I mean, Texas ---+ in Texas, the weather conditions were actually more favorable than a year ago when we were dealing with a slowdown relating to the excessive rainfall and flooding.
So that actually moved to the positive this year.
And then in other regions of the country, it swung in the other direction.
In the Southeast in particular, the heavy rainfall, even up into Pennsylvania and the Northeast, had a pretty significant impact during stretches of the quarter.
Yes, I think we've, in the past, kind of limited that disclosure to Texas being our largest market, right in the vicinity at 20% of our shipments.
<UNK>, I would have to say it's the latter, that we haven't seen customers lay off employees and reduce operating hours during our third fiscal quarter in a long time.
And we did see some of that during the current quarter.
So ---+ and of course, while we can all read the weather statistics and we know what's going on, so much of this is anecdotal that it's difficult to quantify except we talk to our customers and we see what they're doing and we see ---+ we're aware of what they're bidding or what they're not bidding at the time.
So I think that, certainly, weather has exacerbated the situation for our third quarter, but there's also just been a lull in demand.
And I think it has been focused mostly in the publicly-funded sector and would probably have its origins around funding questions.
Again, it would be discussions with customers.
And then you have the backdrop of some improved funding on the parts of states who have taken the funding matter into their own hands to address their shortfalls.
And we've seen over the last couple of months that the level of momentum in our markets has actually begun recovering.
So if we take all of those factors and assess them as a whole, it appears that we're seeing a recovery in those markets.
And in terms of ---+ just in terms of the sequential trends, May was clearly the low point for us during the quarter in terms of the year-over-year reductions, in that it fell off some in June.
We were still down from the prior year, but it fell off from what we experienced in May.
And the same holds true for July, so far.
So I mean it's moving in the right direction, but it's still not all the way back to what you'd expect for this time of year.
No.
Other than ---+ it's difficult to precisely quantify other than just looking at the comparisons between the rainfall levels and the change in shipments.
And then you have to adjust for any customer-specific issues in either direction.
So I mean in the case of that region, we did see a reduction in shipments overall, but I don't know that we can parse it down to that level though.
Thank you for your participation in the call today.
We appreciate your interest and don't hesitate to call us back if you have follow-up questions.
Thank you.
