Insteel Industries, inc (IIIN) Q4 2021 Earnings Call Transcript

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Insteel Industries, inc (IIIN 1.76%)
Q4 2021 Earnings Call
Oct 22, 2021, 10:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and thank you for standing by. Welcome to the Insteel Industries Fourth Quarter 2021 Conference Call. [Operator Instructions]

I would now like to hand the conference over to your speaker today H. Woltz, President and Chief Executive Officer.

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 2021 conference call, which will be conducted by Mark Carano, our Senior Vice President, CFO and Treasurer and me.

Before we begin, let me remind you that some of the comments made in 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're pleased with our fourth quarter results that were driven by surging demand for our reinforcing products and escalating steel prices. We expect both trends to continue into calendar 2022. During environments of strong demand and escalating pricing, the company's results typically are favorably impacted by the implementation of price increases, sufficient to recover higher costs, together with the consumption of lower cost inventories under first in first out accounting.

I'm going to turn the call over to Mark to comment on our financial results for the quarter and the macro environment, and then I'll pick it back up to discuss our business outlook.

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

Thank you, H., and good morning to everyone joining us on the call. In our release earlier today Insteel reported record financial performance for our fourth quarter as well as our full year fiscal 2021. Our net earnings for the fourth quarter more than tripled to $25.2 million from $7.4 million a year ago, and earnings per diluted share rose to $1.28 from $0.38 per share, bringing the total for the fiscal year to $3.41 per diluted share, which is the highest level of earnings in our history.

These historically strong results were achieved despite supply chain and labor challenges that plagued not only our business but much of the U.S. economy. Like our third quarter of 2021, the robust demand environment for our concrete reinforcing products allowed us to increase prices to recover rapidly increasing raw material costs that continued unabated in our fourth quarter. As H. referenced in his opening comments these price increases often generate timing benefit in our spread. This benefit offset the negative impact of considerably lower shipments and plant operating inefficiencies resulting from inconsistent raw material availability and constrained labor markets.

Average selling prices in the fourth quarter were up 56.1% relative to the prior year, and sequentially, average selling prices increased 18.8% for Q3 2021, which was our third sequential quarter of price increases greater than 10%.

Shipments for the quarter decreased 20.6% from last year and 10.3% sequentially from Q3 2020. The decline in shipments as compared to last year and sequentially was not due to a lack of demand. It was a direct result of the tight global rod supply environment and particularly a domestic raw material market that is currently producing an insufficient supply of wire rod to meet domestic demand. To note, shipments from the prior quarter benefited from an extra week based on our fiscal calendar. On a pro forma basis adjusting the prior quarter to reflect the same 13-week period as the current quarter, the year-over-year decrease was 14.5%.

Gross profit for the quarter increased $20.5 million from a year ago and gross margin expanded to 23.3%, due primarily to a widening in spreads as average selling prices outpaced rod cost increases during the period. Our fourth quarter gross margin was above normalized our run rate levels despite the impact of plant operating inefficiencies, which led to a meaningful increase in our unit conversion costs. On a sequential basis, gross profit increased $8.4 million and gross margin expanded 370 basis points.

SG&A expense for the quarter decreased $2 million to $7.3 million, and as a percentage of sales, decreased 240 basis points to 4.3%. The decrease was primarily a result of lower compensation expense under our return on capital based incentive plan, the non-recurrence of a contingent payment related to a prior acquisition that we recorded in the fourth quarter of 2020, and lower run rate legal expenses given the completion of our successful trade case actions. To note, our annual incentive plan was fully expensed in the third quarter of this fiscal year given the strong financial results. The decrease in SG&A cost was partially offset by an unfavorable $0.4 million change in the cash surrender value of life insurance policies relative to the prior quarter.

Our effective tax rate for the quarter increased marginally to 22.7% from 20.8% last year, due primarily to changes in permanent book-tax differences. Looking ahead to next year and barring any changes in the U.S. corporate tax rate under consideration by Washington, we expect our effective tax rate will run around 23% subject to the level of pre-tax earnings, book-tax differences and other assumptions and estimates that comprise our tax provision calculation.

Based on our sales forecasts for Q1, our year-end inventories represented 1.9 months of shipments compared with 1.9 months at the end of the third quarter. The tight rod supply market referenced earlier continues to suppress our inventory levels, which has been a recurring dynamic throughout our fiscal year and we continue to trend below normalized levels of forecasted shipments at the end of the fourth quarter.

Finally, our inventories at the end of fourth quarter of 2021 were valued at an average unit cost that was higher than our third quarter cost of sales, but remain favorable relative to current replacement costs. During the year, we invested over $17.5 million in our business, which was primarily focused on completing the relocation of the STM assets and additional investments in our engineered structural mesh business.

Our free cash flow or operating cash flow less capital expenditures was $52.4 million or 8.9% of revenues. We returned $31.3 million of capital to shareholders in fiscal 2021 through the payment of $1.50 special cash dividend in addition to our regular cash dividends, marking the fourth special dividend to-date we have paid since 2016 of over $1 a share. We finished the year with $89.8 million of cash on hand or over $4.50 a share and no borrowings outstanding under our $100 million revolving credit facility.

Turning to the outlook, our construction end markets remain strong today with no signs of a slowdown and leading indicators and consensus growth estimates for construction spending signaling continued strong growth into the coming calendar year. Third-party forecasts for non-residential construction spending have rebounded dramatically since January 2021, and only recently leveled off in their rate of change in the last couple of months. But both the Architectural Billings Index and the Dodge Momentum Index are reporting levels pre the pandemic. And in fact ABI registered its highest monthly score in index history during the summer of this year.

While not all sub-segments of private non-residential construction have fully rebounded yet from the pandemic, like lodging and office, others are experienced robust growth relative to past levels. For example, some of the larger private non-residential construction sub-sectors from a dollar size perspective like warehouse and general commercial have increased at double-digit percentages of 11% and 16%, respectively, through the first eight months of the calendar year relative to the prior-year comparable period.

Public non-residential spending has remained resilient through this calendar year and should benefit from an overall strengthening economy as its impact on already healthy state and municipal finances. In addition, the Bipartisan Infrastructure Bill will add to this momentum in future years if the current administration and Congress eventually move forward with it.

And lastly on construction employment, another important measure that we track, it increased just under 3% through August of this year relative to last year, and the unemployment rate in construction declined substantially to 4.8% from 7.6%. This drop in the unemployment rate when considered relative to the overall levels of construction employment growth is an area we are monitoring for its impact on project activity. The data potentially implies the workforce may not be expanding enough to meet expected demand, resulting in increased project labor cost and reduced availability, an impact we have felt across our own plant footprint.

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

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

Thank you, Mark. As reflected in the release, our strong fourth quarter results were driven by robust non-residential construction markets and escalating steel prices. Above all, we thank our Insteel teammates for their perseverance through challenging circumstances and their focus on execution, excellence and working safely. While we're pleased with the solid underlying demand for our products and our financial performance, there have been changes in our markets that are unprecedented an unsustainable.

As we reported in the release, ASPs escalated almost 20% from the prior quarter, and nearly 60% from the fourth quarter last year. For the first time in my career both purchasers of wire rod like Insteel, and purchasers of our finished products have prioritized availability of product and subordinated pricing considerations. This trend is driven by tight supplies of hot-rolled steel rod, which is clearly underproduced domestically, resulting in substantial monthly price increases and poor performance to schedule by most of our suppliers.

The unreliability of deliveries has in turn caused inconsistencies in Insteel's customer service as we've contended with constant delivery delays and sporadic interruptions of our plant operations. While these dynamics are not constructive in the longer term for Insteel's business model or our customers' needs, current conditions will likely persist for the near term, unless there are substantial improvements in steel availability that alleviate the current short supply.

As we mentioned in the release, we turned to the international steel markets to supplement domestic supplies. Up until very recently, however, robust demand globally has resulted in limited availability for export to the U.S. as home markets have been more attractive to these steel producers. We will continue to pursue important transactions for non-buy America applications to fill voids created by the difficult domestic production and service environment. Until we develop more competitive sourcing opportunities, we expect the robust demand environment to support passing escalating costs through the supply chain.

Most of you are aware that since March 2018, the Section 232 steel tariff implemented by the Trump Administration has caused complications for wire rod purchasers, including Insteel. There are indications that the Biden Administration is pursuing alternatives that would replace the 232 tariff with another managed trade tool, most likely a tariff rate quota. While Insteel would welcome the elimination of 232, whether a tariff rate quota would constitute an improvement depends on the tariff free volumes allowed into the U.S., the tariff rate for volumes over the threshold and other administrative provisions of the program. We expect details of a new arrangement with the European Union to be available in the next few weeks, and their speculation that any new EU program could serve as a template for agreements with other regions.

Turning to capex, we finished 2021 at just under $18 million, which is slightly under the projection we communicated during the Q3 call. While commissioning our new ESM production line in Texas has taken longer than expected, we've crossed important technical thresholds and plan to move forward with additional capacity expansions during fiscal 2022. Subject to the timing of planned expenditures, we estimate capex for 2020 to come in between $20 million and $25 million, targeted toward supporting the growth of our ESM product line, improving quality, reducing the cash cost of production, and enhancing our information technology infrastructure. We plan to closely monitor market conditions and aggressively pursue the appropriate actions to maximize shipments and optimize our costs, and we're well positioned to pursue attractive growth opportunities, both organic and through acquisition.

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

Questions and Answers:

Operator

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

Julio Romero -- Sidoti & Company -- Analyst

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

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

Good morning, Julio.

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

Good morning.

Julio Romero -- Sidoti & Company -- Analyst

So my first question would be on the shipments in the quarter. Can you talk about whether there was any weather impact in any of your regions or was the decrease just solely attributable to the tight wire rod supply?

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

No, we've lost some production time when one of the hurricanes came through. But it really didn't affect shipments as much as it did production on. The shipping phenomenon is related to supply concerns.

Julio Romero -- Sidoti & Company -- Analyst

Okay. Okay, got it. And H., I think I may have heard you mention in your comments that you said that in terms of foreign wire rod availability, that's been maybe not equally as tough, but just as tough until very recently. Have you seen a -- has there been any recent changes that have kind of alleviated that somewhat?

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

Yeah, maybe at the margin, Julio, it is -- there are some opportunities out there. But it's still a fact that global markets are strong and imports are less available than you might expect.

Julio Romero -- Sidoti & Company -- Analyst

Got it. And last quarter, I believe you mentioned that there was two mills in the U.S. that could be returning to the market. Did that happen or are there any other opportunities to bring on additional domestic capacity for wire rod?

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

There was a major upgrade at a Texas steel mill and after having been down for several weeks in upgrading hardware and software, that mill has return to the market at a rather slow pace. I think they are behind on their projections in terms of ramp up volumes, which is continuing to have a negative effect on supply. The other mills that had experienced outages that were related to accidents did come back online pretty much as scheduled and are operating now.

Julio Romero -- Sidoti & Company -- Analyst

Okay. I guess just turning to pricing, I'm fascinated by the ASPs and how dramatically they've been able to to rise, and I guess, how well you've executed there. But just listening to your remarks, H., I think the way I interpret it is that the conditions that support that pricing should persist at least in the near term?

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

Certainly, I expect that, yes, Julio.

Julio Romero -- Sidoti & Company -- Analyst

Okay. It's quite surprising there. I don't think I see that anywhere when I go back historically. My model, I haven't ever seen pricing, anything like that.

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

Notably.

Julio Romero -- Sidoti & Company -- Analyst

Yeah. Okay. I'll pass it on. And I'll circle back for any follow-ups.

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

Okay. Thank you.

Julio Romero -- Sidoti & Company -- Analyst

Thank you very much.

Operator

[Operator Instructions] Our next question comes from Tyson Bauer with CK Capital. Your line is now open.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Good morning, gentlemen.

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

Good morning.

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

Good morning, Tyson.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

The benefit obviously, with the price increases as robust as it was throughout the quarter. Do we have any calculations on kind of what that FIFO benefit was in the quarter and how much of that gets muted as we get into fiscal Q1? Do we stabilize a little bit, that draws that margin down, just from the accounting aspect?

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

It's really hard to say what's going to happen in 2022, Tyson. And so far as whether steel prices stabilize or whether they continue to escalate, I think the only thing we can say for sure is that our inventory levels have fallen to about 1.9 months from about 3.5...

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Right.

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

Or more a couple of quarters ago. So the impact of the FIFO phenomenon is muted relative to earlier in the year.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Okay. So, what we've just witnessed, an experience has some staying power at least until we get into a seasonal situation, which begs the question, do you anticipate the same seasonality as we, typically, you have seen before, or does production and shipments gets shifted south of the Mason Dixon line and we really don't have that seasonality this year as we've seen in years past?

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

That's a good question, and I don't think that underlying seasonality trends have changed. They could be distorted by lack of availability of materials, and I'm not referring to only steel. But the underlying seasonality is driven by weather and I don't think that there has been any fundamental change there.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Okay. So, you don't anticipate that we'll just have more freight going south from your more northern production facilities that are unable to service projects that shut down once we get to winter?

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

There is some of that, Tyson, some of our product lines are more more seasonal than others, but I don't think you'll see a departure from the norm that you've come to expect from Insteel.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Okay. Have you quantified roughly kind of the percentage that you're short on your wire rod supply that you could be taking in, you could bring in 20%, 30% more and still just to try to meet some of the demand that you've had to turn away?

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

Maybe to answer a question you didn't ask, but it is a little less speculative, I would tell you that our entire shipments shortfalls related to wire rod availability and not demand. And on the pro forma results that was down, shipments were down about 14.5%. So all of that is related to supply concerns.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Correct.

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

That's not to say that we wouldn't have shipped more than last year had we had sufficient supplies of steel. But it's speculative as to how much more we may have shipped.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Right. Well, you talked about disruptions at the production facilities, those kinds of things. Are you -- is it always hand of foot, I mean, hand to mouth situation, as you get it in? Are with that tight or give us a little flavor on the tightness and the ability to meet your shipping schedules.

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

We've actually lost a considerable amount of manufacturing time, Tyson, when plants have been completely out of wire rod.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Okay. Would you anticipate if you have greater visibility and greater supply ease, that that pricing will soften, or is just that much demand out there in the marketplace that the pricing really would stay firm as you are able to make more shipments?

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

Yeah, I do not think that pricing would weaken if we had extra wire rod suppliers. I think the market is strong enough so that everyone would be would be glad to see an environment where our service improved, and we could completely fulfill requirements and I think we could do that at existing prices.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Okay. Do you have a calculation on kind of the wage increase, production wage increase year-over-year, as you've had to incentivize and try to retain labor?

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

Yeah. But we haven't disclosed it, Tyson. But it's a considerable on impact to our costs.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Okay. And last question, we've been running an infrastructure bill for so many years, lived through 20-plus CRs in the past, are we in a scenario right now, careful what you wish for or it's better to have that increased demand over that longer term and figure it out on the supply side, than it is not to have the infrastructure bill at this time?

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

Well, we need an infrastructure bill -- but we need an infrastructure bill that is focused on infrastructure. And not to get political about it, but I have great misgivings about the bill that is known as the Bipartisan Infrastructure Bill. And for one thing I'm not sure who thinks this industry needs to be stimulated at this point on. I have a hard time understanding that.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

So it is possibly too much of a good thing.

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

Well, I think it's just purely inflationary, yes. And that is too much of a good thing.

Tyson Bauer -- Kansas City Capital Associates -- Analyst

Okay. That's what I thought. Thank you, gentlemen.

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

Okay. Thank you.

Operator

I am not showing any further questions at this time. I would now like to turn the conference back to H. Woltz.

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

Okay. Thank you for your interest in Insteel. Feel free to contact us if you have further questions and we look forward to talking to you next quarter. Thank you.

Operator

[Operator Closing Remarks]

Duration: 26 minutes

Call participants:

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

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

Julio Romero -- Sidoti & Company -- Analyst

Tyson Bauer -- Kansas City Capital Associates -- Analyst

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