Q3 2019 Earnings Call
Michael and last thing is mckellen, rich and I see H.A.E.L. eat the I.C.H.
Yes.
Very much and lastly may I get your company name Sir.
Era A.I.E.R.A.
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Mm.
And one moment please.
Mm mm.
I'll go ahead and kind of you know okay.
Thank you.
Well at this time all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time, if anyone should require assistance. During the conference. Please press Star then zero on your Touchtone telephone as a reminder, this conference call is being recorded.
I would now like to introduce your host for today's conference mR.H. Wolf Insteels, President and CEO , Sir you may begin.
Good morning. Thank you for your interest in Insteel and welcome to our third quarter 2019 earnings call, which will be conducted by Mike Gazmarian, 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 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 will now turn the call over to Mike to review, our third quarter financial results and outlook for our markets then ill follow up to comment more on business conditions.
Thank you Amy and good morning to everyone joining us on the call.
As we reported earlier today business conditions remain challenging during the third quarter fiscal 2019, as we continue to contend with low priced import competition, resulting from the section 232 tariff on imported steel and unusually wet weather in many of our markets with earnings per share dropping to 11 cents from 67 cents a year ago.
Shipments for the quarter fell 3.9% year over year, but were up 17.5% sequentially from the depressed level to Q2 as our usual busy season got off to a slow start.
Our PC strand in standard welded wire reinforcement product lines continued to be adversely affected by increased low price import competition, resulting from the section to 30 to tear program and a substantial cost advantage. It is provided to offshore producers of these products.
The tariffs have driven domestic prices for hot rolled steel wire rod our primary raw material substantially higher than world market levels.
Foreign competitors have responded with underpricing tactics to capitalize on their lower cost and further penetration of the us market.
The unfavorable impact of the tariffs on our Q3 shipping volumes is apparent considering that shipments into markets that are susceptible to import competition, which in total represented around a third of our sales for the quarter were down 20.4% from a year ago, while the volume for the remainder our business was actually up 7.5%.
In addition to the surge in low price imports driven by the tariffs many of our customers remained in inventory reduction mode. During the quarter to the detriment of our order book due to the excessive rainfall and resulting construction delays.
The April to June period for the contiguous US was the second wettest on record impacting a significant portion of our footprint spanning across Texas, the central and upper Midwest and into the northeast.
The wet weather for Q3, followed similar conditions during our second fiscal quarter, making the January to June period, the wettest on record for the contiguous us.
The continued weather related deferral of business should benefit us going forward, although the timing and magnitude of the favorable impact is uncertain.
Average selling prices for the quarter up 3.7% from a year ago, reflecting the increases we implemented over the course of last year in response to the run up in our raw material costs, resulting from the tariffs.
On a sequential basis, however, asps dropped 4% from the second quarter due to pricing pressure driven by the increased imports as well as from domestic competitors spurred by the weather related softness in demand.
Gross profit for the quarter fell 16 million from a year ago, and gross margin dropped from 19.1% to 6.5% primarily due to the narrowing in spreads between selling prices and raw material costs and to a much lesser extent higher manufacturing costs on lower production volume and the reduction in shipments.
On a sequential basis gross profit rose $1.2 million from the second quarter and gross margin increased slightly by 20 basis points as lower manufacturing costs and the increase in shipments offset lower spreads.
The ongoing spread compression has been driven by the pricing pressures I alluded to earlier with the year over year increase in ASP is falling short of recovering the escalation in raw material costs, while a sequential reduction in average selling prices exceeded the decrease in raw material costs.
SGN expense for the quarter fell 2 million to five and a half million or 4.4% of net sales from seven and a half million or 6% last year due to lower incentive compensation expense under our return on capital plan driven by our weaker current year results.
Our effective tax rate through the first nine months of the year fell to 22.4% from 24% for the same period last year, excluding the impact of the 3.7 million deferred tax remeasurement gain on the prior year amount.
The lower rate reflects a net effect of the reduction in the statutory rate under the new tax saw the 21% from 35% for all of this year as compared to only three quarters last year plus the elimination of the section 199 domestic production deduction together with changes in book tax differences.
Looking ahead to the remainder of the year, we expect our effective rate for fiscal 2019 will wind up in the range of 22% to 23% subject to future adjustments related to the level of Q4 earnings book tax differences and the other assumptions and estimates entering into our tax provision calculation.
Moving to the balance sheet and cash flow statement cash flow from operations for the quarter fell to $14.3 million from $25.3 million last year due to the decrease in earnings and to a lesser extent a smaller reduction in net working capital in the current year.
Net working capital provided 9.2 million of cash in the current year quarter, driven by a 12.6 million reduction in inventories, which we plan on reducing to an even greater extent during the fourth quarter.
Based on our sales forecast for Q4, our quarter end inventory position represented 3.4 months the shipments essentially unchanged from the end of the second quarter and was valued at an average unit cost that was lower than the beginning average as well as the amount reflected in Q3 cost of sales.
The lower cost should favorably impact our margins during the fourth quarter and less asps fall to the same or a greater extent I will as was the case in Q3 due to continued pricing pressure.
On a pro forma basis, our gross margin for the third quarter would have been around 400 basis points higher than the reported amount if cost of sales was adjusted to reflect the lower carrying value of ending inventory and asps are unchanged.
In allocating our cash flow and managing the cyclical nature of our business. We continue to focus on three objectives.
Reinvesting in the business for growth and to improve our cost and productivity, maintaining adequate financial strength and flexibility and returning capital to our shareholders in a disciplined manner.
Going forward, we will continue to balance these objectives in deploying capital in any excess cash balances.
Capital expenditures through the first nine months of the year totaled 9.4 million down $3.1 million from last year focused on cost and productivity improvement initiatives. In addition to recurring maintenance requirements and based on our updated forecast. We now expect outlays to come in at less than $15 million for the year.
We ended the quarter with 7.4 million of cash on hand, and no borrowings outstanding on our $100 million revolving credit facility, providing us with substantial financial flexibility and the ability to be opportunistic in pursuing any growth opportunities that may arise in this difficult environment.
During the quarter, we completed an amendment to the facility, which among other favorable changes extended its maturity date to May 2024, and provided for a $50 million accordion feature that allows us to increase the size of the facility subject to our lenders approval.
As we move into the fourth quarter the outlook for our construction end markets remains positive assuming that we finally experienced normalized seasonal wetter weather patterns for the time of year.
We should also benefit to some extent from the weather related deferral of business from earlier in the year.
However, as we've indicated previously considering the ongoing tightness in the labor market and difficulty for contractors to play catch up we suspect that any favorable impact is likely to be gradual and extend out over a protracted period.
We expect the infrastructure related portion of our business, we will continue to benefit from higher state and local spending in many of our markets supported by various funding initiatives as well as the fast act funding and supplemental measures at the federal level, which is reflected in the most recent construction spending data.
Through the first five months of the year public construction spending was up 11.7% from the prior year as compared to a 3.5% decrease for the private sector, reflecting a 2% increase for nonresidential and an 8.2% decrease for residential.
Highway and street construction, which represent close to 30% of total public construction spending and is one of the larger end use applications for our products was up 18% year over year.
The most recent reports for the architectural billings and Dodge momentum index is leading indicators for nonresidential building construction reflect softening activity levels, but relatively stable conditions that are expected to continue for the near term.
Following an extended positive run the ABS has remained relatively flat or decline over the past five months. Following the 49.1 in June from 50 point to the prior month and reducing the year to date averaged to 50.5 from 52.1 for all of last year.
The Dodge momentum index, another leading indicator for non residential building construction rose 4% in June from their buys may reading, but has leveled out since the middle of last year.
On a comparable basis the average for the first half of this year was down 4.3% year over year as compared to an 18.3% increase for the first half of 2018 over the prior year level.
In its latest report Dodge indicated that the broader pullback in the index remains gradual and there is still ample projects at the planning stage to maintain stable construction spending in the near term.
I will now turn the call back over to age.
Thank you.
As Mike indicated our third quarter results continued to reflect disappointing shipping in production volumes that we attribute primarily to growing import competition and adverse weather conditions in certain of our markets. Despite our weak results. We continue to believe that the underlying market fundamentals are reasonably strong and should support a significant rebound in demand as weather patterns normalized as we mentioned on our recent earnings calls our financial performance for 2019 should be viewed in the context of the administrations section 232 tariff program initiated in March 2018, which imposed 25% import tariffs on certain steel products, including our primary raw material hot rolled steel wire rod that did not apply to most downstream steel products, including PC strand and welded wire reinforcement.
Consequently, us prices for hot rolled wire rod continue to be significantly elevated relative to the world market, which has created a highly attractive environment for offshore competitors seeking to capitalize on their tariff related cost advantage or circumvent the tariff by shifting production to products, which are not covered.
Foreign producers have taken full advantage of these unique circumstances as reflected by the surge in PC strand imports, which through the first five months of the year were up 55% from a year ago.
Average average unit values for imports has fallen to levels that are only marginally above us wire rod prices, creating an unsustainable competitive environment for domestic producers.
Similar trends have occurred in the market for standard welded wire reinforcement, we're import volumes have surged and average unit values have plummeted, particularly from Mexico.
Unfortunately, we are unaware of any knowledgeable steel trade policy analyst, who predicts that the 232 tear program will be terminated in the near future with many observers, believing the program will persist for the duration of this administration.
Assuming the Terra remains in effect, it's imperative that it be extended to include downstream products derived from wire rod in order to eliminate the harsh penalty. The current structure is imposing on producers of steel intensive downstream products.
Notably the 232 tariff has created a competitive environment, where even Turkey has shifted production downstream to low value commodity standard welded wire reinforcement exported into the us markets as a means of circumventing the terra.
This undermines the administration's clear intent in implementing the tariff which was to shore up the U.S steel industry.
Such blatant examples of gaming the system should provide strong justification to the administration for expanding coverage to downstream steel intensive products.
While we plan to continue our dialogue on this matter, it's not possible to predict whether our efforts will be successful.
We'll continue to reassess our manufacturing strategy in response to the unfavorable market channel changes, resulting from the Terra but our current plans are to continue to compete with low price imports operate our plants and obtain additional manufacturing efficiencies, while we work toward a satisfactory resolution of the matter with the administration.
Turning to Capex, we reported last quarter that our initial estimate for 2019 was 22 million subject to revisions as we move through the year with investments targeted toward expanding our product capabilities lower the cash cost of production and updating technology, including information systems, while we've not cancelled any planned investments. It now appears that certain projects will slip into fiscal 2020, resulting in 2019 capex coming in closer to $15 million.
During Q3, we continued commissioning activities for a new E assume line and our North Carolina facility that will increase capacity for certain niche products as well as substantially reduce our cash operating costs.
Market conditions for EPS and were favorable which should support an orderly ramp up following additional modifications to the line and the equipment vendors confirmation that it complies with our performance specifications.
Notwithstanding our tariff concerns we will continue to be vigilant and pursuing attractive growth opportunities, both organic and through additional acquisitions and remain focused on improving our operational effectiveness in realizing the anticipated benefits from the substantial investments we've made in our facilities to lower manufacturing costs reduce lead times and improve quality.
This concludes our prepared remarks, and we'll now take your questions. Joel would you. Please explain the procedure for asking questions.
Thank you ladies and gentlemen, if you have a question at this time. Please press the Star then the number one.
Is your question asked and answered your question.
So from the queue. Please Mr pounds.
Again, that's star then one question.
To prevent any background noise. Please please your line.
What's your question Steve.
Our first question comes from.
With Sidoti and company. Your line is now open.
Hi, good morning, everyone.
Warner Julio.
You had mentioned earlier that your customers.
Remained in inventory reduction mode throughout the quarter.
Just curious if weather aside.
Are you seeing or hearing.
Any change in the underlying demand.
From your customers regarding any of your end markets and if so.
Where do you think that they may or may not be seeing it from.
Yes, I don't think were detecting any evidence.
Of of a cyclical downturn in demand in our markets on it has been more purely weather related on where customers have literally run out of space to store finished goods on due to their inability to ship to job sites on and as always there seem to be on those who are doing better than others and in certain regional markets, but as an overall statement.
Underlying business conditions.
Appear to be reasonably strong on and we would attribute the overwhelming.
Preponderance of low shipments in weak activity to two whether at this point.
Okay, that's helpful and.
Well I just think about your your last four quarters, all being affected by weather.
And the fact that.
Steel scrap has kind of flattened out from June heading into July just how should investors think about that backdrop heading into fiscal 20 of.
Relatively.
Lighter year over year comparisons ahead, along with.
Kind of normalizing.
Raw material prices.
Well.
As we look out for the next couple of quarters, we certainly aren't forecasting a downturn in demand we're reasonably optimistic about what we see out there with the caveat being related to the 232 impact and the ramp up of imports that were seeing in a couple critical product lines, but underlying levels of demand. We believe will be solid in terms of scrap on there are a lot of there's a lot of.
Things at work in those markets were really unable to make any reasonable prediction of where that market is going to go but but clearly.
It's not just our.
Our spot in the supply chain, that's being adversely affected by by both to 32 and weather related events as as we're seeing on our supplier base also suffering from low demand taking production downtime due to due to just weak underlying conditions that that I believe are both 232 and weather related and of course, when when they take downtime, they're not buying scrap. So I think there's been pressure on the scrap market from from that perspective at least in the long products area, where where we deal.
Okay that makes sense I'll back into queue. Thank you very much.
Thank you and our next question comes from Phil Gibbs with Keybanc capital markets. Your line is now open.
Hi, good morning.
One of them, though.
You all keep referencing to 32 and the duration of that.
Initiative by the administration, but the more we see it keeps getting watered down.
Either through direct country assumptions in the case of Canada, and Mexico, and I know they produce some wire rod.
And Nucor also mention at their Investor day, a couple of weeks ago that there have been a litany of exclusions granted to to buyers and I also see that wire rod prices domestically are down.
Quite a bit I don't know if it's $100 a ton in the last year, but.
Down a lot from where they were at the highs.
So how do you square square that all up with with your own gross margins and seemingly that more favorable or more balanced supply picture on your.
Supplier side.
Yes, probably.
Should should shift that tied to you all in terms of the downstream product.
Well, you're absolutely correct that wire rod prices have fallen.
For a variety of reasons, but the real issue is that prices in the us relative to the world market and as I mentioned in my prepared comments average unit volumes of imported PC strand are only marginally higher than the domestic price of us wire rod. So falling prices is not a phenomenon limited to us markets prices fall and worldwide and I would I would argue that that the delta between us pricing and world market pricing still puts companies such as in steel at a distinct disadvantage and allows importers to have their way with our markets.
Have you Oh, Okay that makes sense have have you at all.
I tried to.
Ask for.
Exemptions have those been have those been filed and or denied if youve done so.
Yes, and it's through shifts to that and we are we are pursuing another round of exclusion request.
At this time.
And as is inevitable with any of these programs there seems to be significant inconsistency in the way that the department of Commerce has dealt with exclusion requests.
With some in our industry not directly not directly in our space, but in our industry. Some exclusions have been granted strictly based on price effects and that is the nature of the problem that in steel has on its not a supply problem at this point, it's a price problem relative to world markets.
And it's just hard to predict.
The outcome of an exclusion requests because because there is a clear lack of consistency.
Okay.
And if I could I appreciate that answer if I could just ask one more.
On the here in present, you gave some color on the end market dynamics, but.
As you look into the third quarter. The September quarter are you expecting.
Okay expecting things to be stable.
In terms of your shipments or pick up a bit and.
And then kind of sub questions that.
Is that in line with with typical seasonality or are we still seeing drags from weather. Thanks.
Yes, I mean, assuming we get to a period to normalized weather, we would expect a pickup in activity during Q4.
Usually the.
April the September period is the strongest of the year for us and.
As I indicated we should we should we just with our end markets remaining relatively strong and assuming the weather normalizes and we should should see a pickup in and also benefit to some extent for many.
Push forward of activity from from earlier in the year.
Thank you.
Thank you.
Good day, ladies and gentlemen, that's star then one to ask a question.
Our next question comes from Tyson Bauer with KC capital. Your line is now open.
Good morning, gentlemen.
Morning, guys.
You talked about a potential benefit depending obviously on market prices from the inventories flowing through.
Also if we do see increase in volume are you able to.
Gauge what kind of improvement in margins you could see just based upon better throughput on volume.
Or is that.
A little hard to.
Gauge at this point.
We we should we should see better better throughput in our plants and lower manufacturing costs. So I would tell you, though that the uncertainty the weather related deferral of business and the delay of the normal seasonal upturn has also apparently made competitors pretty nervous and there's been significant commercial activity pricing activity in the market.
Due to 232 related import concerns, but also just just related to on the obvious disappointing volumes that have materialized through this.
Suppose it seasonal upturn with other with other domestic soda.
Predict an Sps is is really difficult for us at this time.
And the factors that H. mentioned that I mean, that's really what.
What drove the compression in spreads during Q3, where we benefited from a reduction in raw material costs as anticipated, but the drop off in Sps exceeded that cost reduction and that was due to the combination of factors you alluded to the 232 pressure as well as the the soft demand that was.
Primarily weather related so to the extent.
The weather weather normalizes, and we see the usual seasonal pickup in demand then.
We could we could benefit from those lower those lower costs going into Q4.
HM repeated in the last couple of calls you ought to try to protect your market share you will compete against those imports.
By matching price are being competitive there.
Is there a point, where you start to see some pros and cons of changing that philosophy.
And if so what would.
What would cause that change.
At your level.
Well I think first.
We need to come to some conclusion about our view of the likely.
Term debt to 32 is in place if we were encouraged by bye.
The arguments that were making with the administration and we are encouraged that we might see some action there were definitely going to hang in and in.
And compete and maintain our market share. If we came to conclusion, though that that we had six more years of these can that conditions. Then we clearly start looking really hard at our cash cost of.
Production on and and began to make some longer term decisions about about whether it's in our shareholders' best interest to to continue with our current tactics.
So it's just dumb.
You know were one tweet away from anything so so it makes it difficult to plan and to strategize.
Okay.
Last year in a Mike.
Coming down is that a reversal of some accrued that you took in the first half of the year or is that a level that you're trying to maintain and just being as lean as possible.
It's really more more a function of the drop off in incentive comp based on our.
Weaker results for the current year, there's a pretty substantial variable component to SGN aided that's performance driven off our return on capital plan. So so does reflect the decrease there going into Q4, we should see it we should see an increase just due to the timing of equity grants, which occur semi annually, but otherwise we would expect that to continue to trend at the.
The reduced levels until until our performance improves.
Theres been rumblings that Secretary Ross.
Could be on the outs.
As we said one tweet away from anything.
Given his history with the steel industry.
It is.
Pushing to 30 to what his elster be viewed favorably by you and those within your industry.
I can't say that any one person in the administration is going to be a swing factor in what happens here I think that the areas at the very top of this administration I think there is.
They beliefs strenuously that tear ups are working and I don't think the departure of any one of four or five guys what would make a big difference to how the program.
Evolves from here.
Okay and last question for me, if we see some of these lower rates from the fed.
Materialize.
So you think thats enough to kick start some residential activity and to prolong the cycle on the non res.
Yes, I think I think potentially I mean, it certainly have.
Favorable impact but.
At the same time I think.
The recent the recent.
Reductions in non res fixed investments also being spurred by the.
By the uncertainty on the global economic environment as well as the these these trading issues in and.
No that the timeline for when when they will be resolved I think I think that cloud of uncertainty is work in the other direction to some extent.
Okay, Thats, certainly certainly lower rates are positive though.
Yes, Thank you gentlemen.
Thanks Tyson.
Thank you and our next question comes from.
Sidoti and company. Your line is now open.
Hey, Thank you for taking the follow up.
Can you elaborate at all on how shipments have trended through the first few weeks of July just relative to the prior year. Thanks.
Yes, I mean, certainly favorable relative to two recent disappointing shipment rates and and somewhat favorable to the prior year.
It's not running away from us at this point, but but it's definitely stronger and were glad to see that.
Thank you appreciate it.
Thank you im not showing any further questions at this time I would now like to turn the call back over to Andrew Wolf for any closing remarks.
We appreciate your interest in Insteel, we look forward to talking with you on at the end of the current quarter. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude todays program and you may all disconnect everyone have a wonderful day.