Q1 2023 Insteel Industries Inc Earnings Call

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Speaker 1: Good morning. Thank you for attending today's NCL Industries first quarter 2023 earnings call. My name is Forum and I will be your moderator for today's call. All lines will remain muted during the presentation portion of the call.

Speaker 2: with an opportunity for questions and answers at the end. If you would like to ask a question, please press star one on your telephone keypad. It is now my pleasure to pass the conference over to our host, H. Wolt, President and Chief Executive Officer of In Steel Industries. Mr. Wolt, please proceed. Thank you, Forum. Good morning. Thank you for your interest in In Steel, and welcome to our first quarter 2023 conference call, which will be conducted by Scott Giafruti, our Vice President, CFO and Treasurer, and me.

Speaker 3: to differ materially from those projected. These risk factors are described in our periodic filings with the SEC.

Speaker 4: Beginning in Q3 of 2022, residential related markets began to weaken as interest rates rose, and those markets remained weak through the first quarter of 2023. We do not expect significant recovery of residential markets.

Speaker 5: until they're signs that the interest rate environment is changing. Unlike residential markets, we believe the shipment weakness we experienced in non-residential markets is related to customer inventory management and de-stocking rather than impaired demand for our products.

Speaker 6: Following several quarters of extended lead times and inadequate supplies, customers found that excessive inventory levels and purchase commitments could be safely curtailed as lead times normalized.

Speaker 7: Notwithstanding the weakness that is apparent in Q1 results, we believe that 2023 will be a good year for our non-residential markets and for the company. I'm going to turn the call over to Scott to comment on our financial results for the quarter and the macro environment, and then I'll pick it back up to discuss our business outlook.

Speaker 8: Thank you, H, and good morning to everybody joining us on the call. I'm pleased to be here participating in my first earnings call as the CFO of InSteel.

Speaker 9: As we reported earlier today, our results for the quarter were unfavorably impacted by a decline in shipments and a narrowing of spreads between selling prices and raw material costs.

Speaker 10: Net earnings for the first quarter fell to $11.1 million from record earnings of $23.1 million a year ago, and earnings per share dropped to $0.57 from $1.18 per diluted share in the prior year.

Speaker 11: As referenced in our release, earnings for the current year quarter benefit from a $3.3 million or 13 cents per share gain on the sale of property, plant and equipment.

Speaker 12: Net sales for the quarter fell 6.5% from last year on a 10% decrease in shipments, partially offset by a 3.9% increase in average selling prices.

Speaker 13: Our shipping volume for the first quarter, which has historically been our slowest period of the year due to the onset of winter weather and holiday schedules, was adversely impacted by the previously noted inventory management and destocking measures pursued by our customers, along with the continued weakness in the residential construction market that first began in the second half of fiscal 2020.

Speaker 14: pressures eroded ASPs during the quarter with the largest decline in average selling prices from Q4 within our product line most exposed to the residential markets.

Speaker 15: Gross profit for the quarter fell $24.6 million from a year ago and gross margin narrowed to 10.7% from 23.7% due to lower spreads between average selling prices and raw material costs, along with a reduction in volume and higher overall plant operating costs resulting from lower production levels.

Speaker 16: On a sequential basis, gross profit fell $22 million from the fourth quarter and gross margins decreased 840 basis points.

Speaker 17: As we have highlighted throughout the prior year, during environments of strong demand and escalating steel prices, our results are favorably impacted by both the implementation of price increases sufficient to recover the higher replacement costs for our raw material and the consumption of lower cost inventories under first in, first out accounting methodology.

Speaker 18: However, during periods of declining steel prices, as we had during our first quarter,

Speaker 19: We experienced the opposite effect under FIFO and our gross margins narrowed due to the consumption of higher cost inventories matched against lower average selling prices for our products.

Speaker 20: As we have noted in our fourth quarter earnings call, we finished fiscal 2022 with 4.3 months of inventory on hand, valued on a FIFO basis. As such, our first quarter spreads and margins have been adversely impacted by the matching of higher cost inventory purchased in fiscal 2022 and the

Speaker 21: against lower average selling prices for our products. Going forward, we should benefit from a gradual reduction in these costs as more recent lower priced raw material purchases are consumed from inventory, assuming our selling prices remain flat or fall to a lesser extent.

Speaker 22: SGA expense for the quarter decreased $5.2 million to $7.2 million, or 4.3 percent of net sales, from $12.3 million or 6.9 percent of net sales last year, mainly due to lower compensation expense under our Return on Capital-Based Incentive Plan.

Speaker 23: … which was driven by weaker results in the current year. To note, our return on capital base incentive plan was fully expensed in the first quarter of the prior year given the record financial performance.

Speaker 24: As we've highlighted and released, other income for the corridor includes a $3.3 million net gain on the sale of property plant and equipment.

Speaker 25: Our effective tax rate was virtually unchanged at 22.9%, which is down from 23% last year. Looking ahead to the balance of the year, we expect our effective rate will remain steady at 23% subject to the level of pre-tax earnings, book tax differences, and the rate of return rate.

Speaker 26: and the other assumptions and estimates that compose our tax provision calculation.

Speaker 27: Moving to the cash flow statement and balance sheet. Cash flow from operations provided $33 million of cash in the first quarter due to a working capital reduction that was driven by a $26.5 million decrease in inventories along with a $12.9 million decrease in accounts receivable.

Speaker 28: You may recall we had ended the previous quarter with an elevated inventory balance largely due to the increase in raw material purchases.

Speaker 29: as we replenished our inventories from depressed levels earlier in 2022. Over the course of the first quarter, we scaled back our inventory purchases, particularly during December . As of the end of the first quarter, our inventory position represented 3.9 months of shipments on a forward-looking basis calculated from our Q2 sales forecast.

Speaker 30: Finally, our inventories at the end of the first quarter were valued at an average unit cost lower than the beginning of the quarter, but still unfavorable relative to current replacement costs.

Speaker 31: We incurred $8.2 million in capital expenditures in the first quarter and remain committed to our full year target of $30 million, given the many initiatives that we have underway. H will provide more detail on this topic in his remarks.

Speaker 32: In December , we returned $39.5 million of capital to our shareholders through the payment of a $2 per share of special cash dividend in addition to our regular quarterly dividend, marking the sixth year over the last seven years we have paid a special dividend and the second year in a row we paid a $2 per share of special dividend.

Also during the quarter, we repurchased $916,000 of our common equity, equal to approximately 32,000 shares.

From a liquidity perspective, we ended the quarter with $42.6 million of cash on hand and no borrowings outstanding on our $100 million revolving credit facility.

As we move into the second quarter of fiscal 2023, our market outlook for the remainder of the year remains positive as we are encouraged by continued strong demand and backlog in our nonresidential construction markets. However, the most recent reports from the third party leading indicators for nonresidential construction spending, ABI and DoDGE, have been somewhat mixed.

In November , ABI remained in negative territory for the second straight month, falling to 46.6. However, the Dodge momentum index, another leading indicator for non-residential building construction, has rebounded over the last several months, rising to 222.3 in December .

On a year-over-year basis, the overall index was up 40% driven by strength in both the commercial component, which was up 51%, and the institutional projects, that was 20% higher.

Finally, last week, the AIA released a semi-annual construction forecast for non-residential building construction.

for 2023 and 2024 reflecting continued growth for the current year. Spending on non-residential building was projected to increase 5.8% during 2023 driven by gains in industrial, institutional, and commercial sectors.

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

Thank you, Scott.

While we're not pleased by our first quarter results, we do not think our markets are deteriorating under pressure of macroeconomic weakness that jeopardizes performance for fiscal 2023. Rather, we think underlying demand from residential markets has stabilized at a lower level.

that demand is robust in non-residential markets.

Under these circumstances, inventory corrections should be expected following an extended period of constrained supply conditions when customers make purchases and commitments just in case rather than following more typical demand-pull purchasing tactics.

Our view of the market is formed by conversations with many customers focusing on their projected operating rates, backlogs, and overall expectations for business conditions during the year.

Also, recovering customer activity and internal order entry levels support the hypothesis that the inventory correction is running its course.

Scott mentioned in his comments that we have 3.9 months of inventory on hand, which is more than is required based on business conditions.

N-Steel's inventory imbalance is centered primarily in residential related markets, while inventories for non-residential construction markets are much more appropriate relative to business levels.

Recall that we turned to offshore Y-Rod markets last year beginning in fiscal Q2 when domestic sources were unable to assure us of adequate supplies for our third and fourth fiscal quarters.

As is our normal practice, we targeted imported volumes toward our housing-related markets, which are generally make-to-stop products that rarely require certification of compliance with Buy America regulations.

Our plan to supplement domestic supplies was upended when housing markets turned down sharply beginning in May 2022.

Subsequent deterioration of ASPs in these markets created significant margin pressure exacerbated by lower production volumes that extended the time horizon for resolving the inventory imbalance.

We continue to be optimistic about the impact on our markets of the Infrastructure Investment and Jobs Act and believe it will positively impact our markets during 2023.

The need for infrastructure investment in the US has been obvious for decades, but funding has consistently been inadequate. It now appears that funding shortfalls will decline in significance as obstacles to investment in view of the strong fiscal condition of state and local governments together with new funding

of the art technology will expand our product capabilities and favorably impact our cash cost of production.

As we mentioned in an earlier call, new production lines will be installed at the Missouri, Kentucky, and Arizona plants to better address market needs.

We're evaluating additional projects that would have similar beneficial impacts on our market position and cost profile.

Going forward, we are aware of rising risks related to future performance of the U.S. economy and are carefully monitoring the environment. At the same time, we plan to aggressively pursue actions to maximize shipments and optimize our costs.

and to pursue attractive growth opportunities both organic and through acquisition.

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

My pleasure. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one.

As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question.

Our first question comes from the line of Tyson Bauer with Kansas City.

Tyson, your line is now open.

Good morning gentlemen.

Good morning, Ty. Good morning, guys. Good morning, guys.

As we've seen in years past, we've kind of accustomed these kind of inventory adjustment orders that periodically take place. And typically the thought process and the question always becomes the duration of that adjustment.

to a stabilized pricing environment. And can you give us a little bit of how the quarter progressed as we got into December and was December ...

impacted more materially because of weather holidays and just the slow down these stocking at the year end for most of your customer base.

and how that kind of progresses into the fiscal second quarter.

Will we see a snapback basically as we get into the warmer months in the second half of the year or is it something more of a modest change for you?

Let me try to address it like this, Tyson, first. Q1 is always...

our lowest volume quarter. I attribute it primarily to holiday schedules more so than weather because typically October and November are not bad weather months for construction. But holiday schedules just dramatically reduce operating days. And I would say this year is not much different than any other year with respect to the weather.

In terms of inventory levels, as I mentioned in my comments, the over inventory situation that we're facing is primarily centered in our residential standard welded wire reinforcing market and

And of course, as we purchase based on forecast and when we don't meet the forecast, then the inventory pipeline lengthens in an unplanned way, which is what happened to us. And we will be.

through the second quarter and working that off, I would say that these markets, residential markets, seem to have stabilized at levels that are higher than we expected when we did our last forecast and that overall we would be cautiously optimistic about where we're going to go.

where we see those markets going. And in the non-residential markets, they just continue to percolate at nice levels. So maybe the inventory reductions in the non-residential area aren't completely...

Finished at this point, but the underlying level of demand for the product I think is robust enough so that it shouldn't be a material factor for us going forward.

Okay, and we've seen mortgage rates drop 100 basis points recently from its peak over 7% on the 30-year, so that obviously doesn't hurt our cause going forward. Every 0.9-month term you mentioned.

Are you targeting a certain level of getting it back down toward three, which implies a $30, $40 million benefit from the reduction in inventories, or just give us a little more color on where you want to be at your inventory levels by the end of Q2?

Well, of course that is highly dependent on whether we meet our shipment forecast, but whether it is February or March or April , about three months I think is a more reasonable level for the business than close to four.

And of course, that assumes that service levels from the steel producers that we do business with remain reasonable, which it appears will be the case.

Okay, are you anticipating then by the second half of this year that we'll get to more historical margin levels in those high double digits?

on a stabilized...

Yeah, we don't forecast margins.

for these purposes.

Last question for me, obviously there was no accrual for the comp in the Q1. As you hit targets, what's kind of that maximum level that would be taken this year?

if you hit those incentive comp levels for the overall year that we'll have to true up later this year.

Well, it will be on a quarter by quarter and month by month basis. There will be no big surprises.

Right. And let me just, let me say this also, Tyson. As we look at the business and we look at the spreads that are implied by contemporaneous purchases and sales of product, that the business has not been impaired.

by any kind of macroeconomic weakness or downturn that we like where we are but for a little extra inventory.

Okay, and your price, you talked about the overall average price being down 8.8%. We've never really gotten the shipments up like we wanted to see over the past year plus, due to supply constraints and otherwise.

across different product categories like PC strand versus your standard welded wire. That's more residential focus.

Give us kind of the range of what you're seeing on the pricing environment. Has PC-Strand held much more favorably than the standard welder? So that is disproportionately lowering your average price?

Well, I think what we said was that ASPs fell pretty significantly in standard welded wire reinforcing product line and not so much in other product lines. Just reflecting the state of the welded wire.

supply and demand in those various markets.

Thank you.

Okay, thank you gentlemen.

Thank you for your time today.

Thank you for your question. Our next question comes from the line of Julia Romero with Fidoti.

Mr. Romero, your line is now open.

All right, good morning, everyone.

Morning Julio. Morning.

My first question is, what is your sense for how much of the weakness you realize in non-resid shipments during the quarter was due to customer destocking versus easing supply chain constraints?

In the residential related markets, will we go...

began in last May when interest rates began to really affect that market.

we saw a significant reduction in shipments relative to our forecast to the tune of around 40%.

significant reduction in shipments relative to our forecast to the tune of around 40%.

Subsequently.

Subsequently, those markets seem to have recovered and stabilized, although at lower levels than they were running prior to the downturn. Um, but, but.

They've taken the brunt of the weakness in that marketplace.

How do you, how do you, thank you. My second question is how do you expect price to change sequentially over the next few quarters?

It's unknown and not forecastable, but typically, typically.

When demand for our products is strong, then we don't see significant price competition. Our order book and our competitors' order books are such that demand for our products is strong, then we don't see significant price competition. Our order book and our competitors' order books are such that demand for our products is strong, then we don't see significant price competition.

that pricing is not so much of an issue.

All right, thank you so much for taking my questions.

Thank you.

Thank you for your question Julio. There are currently no further questions registered, so as a brief reminder it is star 1 on your telephone keypad.

There are no further questions waiting at this time, so I will pass back for any final remarks. Thank you. We appreciate your interest in steel, and as always, we welcome your contacts and your calls for any follow-up questions that you have.

Thanks, and we'll look forward to talking to you next quarter. This concludes today's N Steel Industries first quarter 2023 earnings call. Thank you for your participation. You may now disconnect your line.