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Insteel Industries Inc (NASDAQ:IIIN)
Q4 2020 Earnings Call
Oct 22, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to the Insteel Industries Fourth Quarter 2020 Conference Call. [ Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. H. Woltz, President and CEO of Insteel. Please go ahead, sir.

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Good morning. Thank you for your interest in Insteel, and welcome to our fourth quarter 2020 earnings call, which will be conducted by Mark Carano, our Senior Vice President, CFO and Treasurer, and me. 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 the call over to Mark to review our financial results, then I'll follow up to comment more on business conditions and other recent developments.

Mark A. Carano -- Vice President, Chief Financial Officer and Treasurer

Thank you, H, and good morning to everyone joining us on the call. As we reported earlier today, the fourth quarter of fiscal 2020 proved to be a strong quarter for Insteel. Robust demand in our construction end markets, in addition to a sustained recovery in spreads from depressed levels of a year ago, were the key drivers in our performance. Excluding the nonrecurring charges referenced in our release, net earnings rose to $0.38 per share as compared to a net loss of $0.09 per share last year. To note, the current year quarter also benefited from having an extra week as compared to the prior year based on our fiscal calendar. Shipments for the quarter increased 27.7% from last year and 12.1% sequentially from Q3. The fourth quarter of fiscal 2020 was our highest quarterly shipment level in the company's history, even excluding the extra week in the quarter, and exceeding our previous high watermark in the third quarter of 2016. The fourth quarter shipping performance was driven by continued strength in construction activity across all our end markets as compared to last year with engineered structural mesh and PC strand leading the growth in the quarter. Average selling prices, though, remained under pressure and declined 4.6% from last year. But there are signs of improvement as sequentially average selling prices increased to 1.1%, which represented the first increase in seven sequential quarters.

As we've communicated in previous calls, low-priced import competition in the PC strand and standard welded wire markets, respectively, remained intense and continues to have a negative impact on our average selling prices. Combined, they represented approximately 30% of our fourth quarter revenue and experienced an average selling price decline of 8% as compared to a decline of 3% for the balance of the business relative to last year. This does represent an improvement from our third quarter 2020 levels, though. As we highlighted during that quarter, these products also represented 30% of revenue, but they experienced a 20% decline in average selling prices as compared to an 8% decline for the balance of the business. While this positive trend may prove to be temporary, we do believe that the anti-dumping and countervailing duty cases we have filed have had a positive impact on the market. Gross profit for the quarter rose $15.6 million from a year ago to $19.5 million and gross margin expanded over 1,000 basis points to 14.1% due to the impact of incremental volume and the recovery in spreads between selling prices and raw material costs.

On a sequential basis, gross profit increased $4.7 million from the third quarter and gross margin widened 200 basis points, primarily due to shipment volume and to a lesser extent, a widening in spreads. Spreads over the last two sequential fiscal quarters of 2020 have been consistently above the depressed levels experienced during the last two comparable quarters of fiscal 2019, as we benefited from the consumption of lower-priced rod inventory that exceeded the negative impact from the steady decline in average selling prices. Given current market rod pricing and stabilizing average selling prices, we would expect to maintain these more normalized spread levels into Q1 of fiscal 2021. SG&A expense for the quarter rose $3.4 million to $9.4 million or 6.7% of net sales from $5.9 million or 5.2% of net sales last year. This increase was largely driven by three areas: first, we experienced higher incentive compensation expense under our return on capital based incentive plan due to our strong financial results this year. You may recall that we did not incur any incentive compensation expense in the fourth quarter of last year or for the full fiscal year of 2019 given our performance during that reporting period. Next, we incurred higher legal expenses relative to our normal run rate solely in support of our trade case initiatives.

And finally, we revalued the earn-out liability related to an acquisition given measurement of its performance. This is the conclusion of that measurement period, so no future expenses will be incurred with respect to it. Our effective tax rate for the year decreased to 21.4% for the fiscal year 2020 from 24.9% last year due to the benefit of an NOL carryback provision of the CARES Act and the utilization of selected state NOLs. Excluding the CARES Act benefit, our effective tax rate would have been 22.3%. Looking ahead to next year, we expect our effective tax rate will continue to run around 23% subject to the level of pre-tax earnings, booked tax differences and other assumptions and estimates that factor into our tax provision calculations. Moving to the balance sheet and cash flow statement. Cash flow from operations for the quarter generated $11.4 million, largely from earnings, with a minimal change in working capital as compared to $32.5 million in cash flow last year, which was primarily the result of a $31.4 million reduction in working capital due to rebalancing of our inventories during that quarter from the elevated levels experienced during much of last year. Based on our sales forecast for Q1, our year-end inventories represented three months of shipments compared with 2.5 months at the end of the third quarter and were valued at an average unit cost that was lower than the beginning quarter average and the amount reflected in Q4 cost of sales.

These lower costs should favorably impact our margins during the first quarter, assuming average selling prices remained stable. Capital expenditures were $7.1 million for the year, down $3.4 million from last year and remained largely focused on cost and productivity improvement initiatives in addition to recurring maintenance requirements. Looking ahead to 2021, we expect Capex to total up to $20 million, including important initiatives related to relocating and upgrading the STM assets and investments to further the growth in our engineered structural mesh business as well as our customary recurring maintenance needs. We concluded the quarter with $68.7 million of cash on hand or approximately $3.50 a share and no borrowings outstanding on our $100 million revolving credit facility. Looking ahead to fiscal 2021, we continue to experience steady demand in the early weeks of Q1 as our customer base executes existing project backlogs. But the lingering impact of COVID-19 on the U.S. economic recovery remains a risk to our business. As we progress through the fiscal year, we expect our financial results will remain vulnerable to the path of these evolving market conditions and their impact on both nonresidential and infrastructure markets.

While recent third-party forecast for nonresidential construction spending indicate a bottoming or modest improvement from trends earlier in the year, we are cautious on the demand outlook. The Architectural Billings Index and the Dodge Momentum Index, leading indicators for nonresidential construction, support these trends. ABI has rebounded from a multiyear low of 29.5 million in April. After stalling at 40 million during the summer, ABI registered an increase to 47 million yesterday, but it has remained below the 50 million threshold for seven consecutive months. Dodge, which hit a low point in June of this year, has posted three sequential increases in July, August and September, gaining 2.2% over that period. These, along with other indicators, typically would signal a slowdown broadly across nonresidential construction activity. But the drivers behind the economic weakness make the magnitude and timing of any impact unclear. Turning to public infrastructure. Spending has yet to experience the level of weakness forecast at the beginning of the pandemic, but the impact varies by state and region. Certain large markets for our business like Texas have remained steady relative to historical levels. In addition, through the first eight months of the year, public construction spending increased 6.1% from a year ago with highway and street construction, one of the largest end applications for our products, increased 2%. Despite these economic uncertainties, we continue to focus on optimizing our operations, safeguarding our employees and advancing our key growth and market initiatives.

Our success in the engineered structural mesh market in fiscal 2020 should position us for continued expansion of that product in 2021. Additionally, the trade cases alleging illegal activity by importers in certain of our markets, which are expected to be resolved in fiscal 2021, have progressed favorably, and we believe the facts supporting the cases are strong. Finally, we will continue to evaluate acquisitions opportunistically in our existing business that may arise in this challenging environment. These initiatives remain consistent with our capital deployment strategy that balances maintaining appropriate financial strength for pursuit of our three objectives: reinvesting in the business to improve our operating model through cost and productivity improvements or capital expenditures to accelerate our organic growth, executing on strategic opportunities that meet our return parameters to support inorganic growth and returning capital to shareholders in a disciplined manner. I'll now turn the call back over to H.

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Thank you, Mark. As Mark indicated, our fourth quarter results reflect strong shipment growth relative to the prior year driven by resilient nonresidential construction markets. We also benefited from the closer alignment between raw material costs and average selling prices as reflected in the recovery of our gross margin, which was distorted in the prior year by the downward spiral in steel prices and unexpected weak demand. Gross margin is trending closer to a normalized level following the relative stability we've seen recently in steel prices. We're pleased with the solid underlying demand for our products and our financial performance, and we thank our Insteel teammates for their focus on working safely and execution excellence. During Q4, we continued to observe CDC recommended procedures for managing exposure to COVID-19 and its transmission at our plants and administrative offices. While we had staffing disruptions during the quarter related to quarantines, none of our locations was materially affected by operating restrictions, and most customers also experienced normal operations, subject to the same quarantine-related staffing complications that affected Insteel. As of now, we expect to continue fulfilling customer requirements and do not expect a surge of infections to affect our operating plans.

During Q4, we completed the customer integration activities related to our Q2 acquisition of certain assets of Strand-Tech Manufacturing. We appreciate the confidence placed in Insteel by former Strand-Tech customers and are gratified that practically all of these relationships are ongoing and mutually beneficial. Our engineering team has been on-site at the Strand-Tech plant continuously, updating and renovating equipment that will be deployed at other Insteel facilities. Commissioning activities are presently under way for the first two production lines that were relocated. These capacity additions will relieve process bottlenecks and contribute to significant improvements in the unit cost of production in addition to playing an important role in accommodating our anticipated PC strand growth. The renovation and relocation process is a substantial undertaking, which has absorbed a significant portion of our internal engineering capacity and will continue to do so into our second fiscal quarter. I'd like to express my appreciation to the engineering group and those supporting the group for the truly remarkable progress they've made up to this point. We look forward to completing this initiative and moving on to promising opportunities in other parts of the business.

The Strand-Tech real property has been listed for sale and has generated a great deal of interest among prospective buyers. Our continued presence on-site while renovating equipment is not particularly helpful to the marketing process. So we're focused on expediting completion of these activities to advance the sale process without delay. Turning to our trade case initiatives. In April, Insteel, together with two other domestic PC strand producers, filed anti-dumping petitions against 15 countries, representing 89% of total PC strand imports that entered the U.S. in 2019, in addition to a countervailing duty petition against Turkey, alleging illegal subsidies. The scope of the filings, which alleged dumping margins ranging from 24% to 194% of value, reflects the irresponsible behavior of respondents in the U.S. market over the 2017 to 2019 investigation period. On June 1, the International Trade Commission issued its affirmative preliminary injury determination and the investigation shifted over to the Department of Commerce. It now appears that about half of the cases will wrap up in early January with the balance concluding during our third fiscal quarter. As Mark indicated previously, dependency of these cases has had a favorable impact on the market, which is certainly welcome after years of import-driven downward pricing pressure.

We must win the cases, however, to level the playing field with these parties on an ongoing basis. While we can't forecast the outcomes, we're pleased with developments up to this point, and we believe the facts support our allegations and that we'll be successful. At the end of June, Insteel and four other domestic producers of standard welded wire reinforcing filed anti-dumping and countervailing duty petitions against Mexico, alleging dumping margins ranging from 56% to 161% of value and illegal government subsidies of the Mexican industry. Import penetration has risen consistently as Mexican producers have persisted in dramatically underselling the U.S. market. We received a favorable preliminary determination of injury from the International Trade Commission in August, which shifted the investigation to the Department of Commerce. It now appears that these cases will wrap up during our third fiscal quarter or early in the fourth quarter. As with the PC strand cases, we can't predict the outcome, but we are pleased with the developments up to now, and we believe we will ultimately obtain anti-dumping and countervailing duty orders with respect to Mexican producers. Turning to Capex. As reported, we came in at just over $7 million for 2020, which was substantially under our prior estimates. The shortfall is purely timing related, largely connected with a significant project supporting our engineered structural mesh growth that was delayed, but which is now moving ahead at a rapid pace.

Given the momentum of this project and other ESM initiatives, significant investments related to the renovation and relocation of the Strand-Tech assets and further upgrades to our information technology, we expect 2021 Capex to come in at approximately $20 million. We view the 2020 Capex shortfall as an opportunity cost, and we look forward to improving our competitive position and our growth prospects by successfully completing a number of attractive investments across our product portfolio. Our Capex strategy continues to be focused on reducing cash costs of production, improving the quality of our products, supporting growth initiatives and improving our information technology infrastructure and capabilities. Turning to our outlook for 2021. During the Q3 call, we indicated that we expected a strong fourth quarter in view of the momentum in our markets. While momentum is still favorable, numerous uncertainties affect our ability to accurately forecast 2021. Primary among those are the impact of the downturn on funding sources for public construction and the increased risk profile of the private nonresidential construction market and in fact, the entire economy. We would not be surprised to see some softening as the consequences of the pandemic-driven downturn ripple through our markets, although recent macro forecasts are more encouraging than those made three or four months ago.

Also, we're optimistic that once we're past the upcoming election, bipartisan support will emerge for increased infrastructure spending, which would provide economic stimulus promoted by many politicians, while also generating long-term investment returns for taxpayers. We'll continue to closely monitor market conditions and aggressively pursue the appropriate actions to optimize our costs and will continue to be vigilant in pursuing attractive growth opportunities, both organic and through acquisition. This concludes our prepared remarks, and we'll now take your questions. Maine, would you please explain the procedure for asking questions?

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Julio Romero of Sidoti. Your line is open.

Julio Romero -- Sidoti -- Analyst

Hey, good morning, Mark. Good morning, H.

Mark A. Carano -- Vice President, Chief Financial Officer and Treasurer

Good morning.

Julio Romero -- Sidoti -- Analyst

So I guess I wanted to start off with what you're hearing from customers in regards there maybe a level of concern about state and local funding and a potential drop off there? And when does the timing of that potentially affect Insteel?

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

I think that's a $64 question for sure. And as you might expect, there's a wide range of expectations among our customers from certain customers who have strong backlogs going through what would be our second fiscal quarter to certain customers wondering what they're going to do in January. I would say that's also been the circumstance for the last few months. So at this point, I'm not sure that we can give real good insightful guidance on how funding is going to impact on the order book going forward. I think it's going to be more of a month-to-month evaluation.

Julio Romero -- Sidoti -- Analyst

Got it. I guess maybe asked another way, I mean, is -- assuming no benefit from this type of stimulus or whatever, I mean can they get through three, six, nine months without some type of stimulus for them?

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

I mean it sounds like the question is really how long is that pipeline. And I would say it probably goes well into our second quarter, but I don't know that it would go into the third or fourth. And that's one man's opinion, OK? That's not the result of any objective data analysis.

Julio Romero -- Sidoti -- Analyst

Okay. Got it. I appreciate it. That's helpful. On the engineered structural mesh side, can you talk about how much did ESI make up as a portion of your portfolio in fiscal '20? And maybe how much growth do you expect in '21, either from a unit perspective or a percentage perspective?

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

No. I mean we don't disclose that level of detail, but I can tell you that we're growing in solid double digits and expect to continue doing so.

Julio Romero -- Sidoti -- Analyst

Okay. Got it. And I guess, on the $20 million in capex for '21, would any of that like be necessarily catch up in terms of things missed out in fiscal '20? Or just any color there.

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Yes. Well, I mean, we've reported, for the last three or four quarters at least, that we had a delayed project in support of our ESM business, where we had to work with an OEM vendor to resolve some unanticipated problems with a production line that we installed at our North Carolina facility. And that took quite a while. It set us back a year. So those problems have been resolved, and we're moving ahead with full force to put another line in, that is -- we're preparing foundations now and expect that we'll see a Q2 or Q3 start-up of that line in 2021. So we've stayed on top of all routine customary sort of recurring maintenance needs. We did have a significant hole in our growth initiatives relative to this unanticipated delay. And certainly, as I said in the prepared comments, it's an opportunity cost. But right now, we're looking forward. We're not looking behind, and we're going to move with this batch to bring this line up and get this product into the market.

Julio Romero -- Sidoti -- Analyst

Got it. That's helpful. I'll hop back into the queue. Thank you.

Operator

Our next question comes from Tyson Bauer of KC Capital. Your line is open

Tyson Lee Bauer -- Kansas City Capital Associates -- Analyst

Good morning, gentlemen.

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Good morning, Tyson.

Mark A. Carano -- Vice President, Chief Financial Officer and Treasurer

Good morning.

Tyson Lee Bauer -- Kansas City Capital Associates -- Analyst

Just a follow-up on previous questioner's topic. Do you have any hard numbers on the state and local muni bond activity as far as relative to maybe a year ago, if we're seeing them take advantage of the lower interest rates and doing more principal bonds? Or any sense or any industry data that you have that you could give us a reference point?

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

I don't think there's any -- we don't have any hard data, Tyson, but we are aware of the increased activity at the state and local level in financing infrastructure projects with buying proceeds. And actually, it's been ongoing for at least a couple of years. We view it as a very positive development. But unfortunately, I don't think we can tack down those numbers at this point.

Tyson Lee Bauer -- Kansas City Capital Associates -- Analyst

You see individual headlines on certain states in that, that seem like they're growing that activity and taking advantage. But no real composite data that I've seen. You mentioned that you're starting to get some positive impact because of the trade actions due to -- typically, there's a retroactive date that importers would have to make up a difference if there's an injury, that is taken by domestic producers. As we go into '21, that should grow, depending on if you get a favorable results or not. Do you know what the retroactive dates are?

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Well, that question would require a very, very lengthy answer. Suffice it to say that the retro activity is generally associated with critical circumstances filings. And as of this week, we have made those filings on approximately 12 -- 10 or 12 of the 15 countries where we could support a critical circumstances finding -- or filing. The critical circumstances allegations will not be finally acted on until the very last part of the case in our third or fourth quarter. So I think the impact of the case is that the market risk has been elevated significantly for importers of record, the uncertainty is significant and the potential financial consequences are meaningful. So I think that's the backdrop that has created some more favorable market circumstances for us. But as I said in the prepared comments, we have to win these cases for any of this to make any difference on an ongoing basis.

Tyson Lee Bauer -- Kansas City Capital Associates -- Analyst

Correct. But by your actions, you've kind of made the shot across the bow this past week.

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Actually, I would say that we fired a torpedo below the waterline.

Tyson Lee Bauer -- Kansas City Capital Associates -- Analyst

We'll go with that. Depending on how the election turns out, there could be immense consequences for capital gains, for private entities, companies raising their tax obligations for a sale of their entities. Do you think that opens up or potentially opens up some more M&A opportunities before year-end, pending the election results?

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Yeah, honestly, I don't think so, Tyson. I don't think that the M&A opportunities that are out there for us are so much dependent upon those kinds of considerations. I think they're longer term than that.

Tyson Lee Bauer -- Kansas City Capital Associates -- Analyst

Okay. In the past, you -- when the weather has been poor, whether it's winter weather or wet weather and those, we've always kind of used that as a -- push things to the right or otherwise. Your fiscal fourth quarter pretty much is ideal weather for most of the country. Did that help the quarter results having that kind of favorable weather?

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Yes. I think what we would say is that weather patterns have more normalized. I'm not so sure that we've had all kinds of hurricane activity that's disrupted on the Gulf Coast and Texas markets. But relative to last year, certainly, it's a tremendous improvement. So yes, I'm always dubious of the weather excuse. And I know that we've proffered that on numerous occasions. But yes, we would certainly acknowledge that we've welcomed the return to normalized weather patterns. And there's no doubt, it helped us, although we can't quantify it and haven't really attempted to quantify it.

Tyson Lee Bauer -- Kansas City Capital Associates -- Analyst

Okay. And last question. As we look at the uncertainty in some of the sectors impacted by those, is it more the non-res commercial construction that gives you a little more pause on what's going to transpire in the next three, six, nine months? Or is it really the public spending aspect that is more of a wildcard for you?

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Look, right now, I would tell you that the public side of it is a larger question mark for us. As we're seeing on private non-res, we believe that a lot of the e-commerce-driven construction that we have benefited from in 2020 will continue well in or through 2021. So I would say the bigger wildcard is on the public side.

Tyson Lee Bauer -- Kansas City Capital Associates -- Analyst

Thank you, gentlemen.

Operator

[Operator Instructions] I am showing no further question at this time. I would like to turn the conference back to Mr. H. Woltz.

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

We appreciate your interest in Insteel. We thank you for your time this morning, and we welcome your contacts going forward. Thank you.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

H.O. WOLTZ III -- Chairman, President and Chief Executive Officer

Mark A. Carano -- Vice President, Chief Financial Officer and Treasurer

Julio Romero -- Sidoti -- Analyst

Tyson Lee Bauer -- Kansas City Capital Associates -- Analyst

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