Good day, and thank you for standing by. Welcome to the Insteel Industries Third Quarter 2021 Conference Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Mr. Woltz. Please go ahead, sir..

Thank you. Good morning, and thank you for your interest in Insteel. Welcome to our third 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 and which could cause actual results to differ materially from those projected. These risk factors are described in our periodic filings with the SEC.

We are pleased with our third quarter performance that was driven by surging demand for our reinforcing products and escalating steel prices. We expect both trends to continue through the end of the calendar year.

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..

Thank you, H, and good morning to everyone joining us. As we reported in our press release earlier today, Insteel posted another quarter of exceptionally strong results. In fact, it was the highest net revenue quarter achieved in the company's history.

Net earnings for the quarter increased to $18.4 million or $0.94 per diluted share from $6.7 million or $0.34 per diluted share.

Average selling prices increased 32.9% from last year and 14.2% sequentially from Q2, reflecting the price increases we implemented in response to both strong demand across all our concrete reinforcing products and continued escalation in manufacturing costs.

Two elements provide some additional context with respect to this increase relative to the comparable period.

First, since the second quarter of 2021, steel scrap, the primary input in the production of wire rod, increased in price by 11% relative to the benchmark Chicago shredded index and has now increased 79% since the beginning of our current fiscal year.

And second, as you may recall, the third quarter of 2020 represented a 3-year low in average selling prices.

During that period, those products susceptible to import competition, which represented about 1/3 of our revenue in that quarter, or experienced pronounced pricing pressures as imports were surging while our trade case efforts in the PC strand and standard welded wire markets were underway.

Shipments for the quarter decreased 1% from last year but increased 1.2% sequentially from Q2. The largely flat volume growth as compared to last year and sequentially resulted from a tight global rod supply environment that restrained our ability to meet fully the market demand.

Gross profit for the quarter increased $16.7 million from a year ago, and gross margin expanded to 19.6% due primarily to widening in spreads as average selling prices outpaced rod cost increases during the period. On a sequential basis, gross profit was largely flat, but gross margin declined 210 basis points.

This was due to increased manufacturing costs resulting from supply-chain-driven operating inefficiencies at several of our plants. SG&A expense for the quarter decreased $0.5 million to $6.2 million. As a percentage of sales, it decreased 210 basis points to 3.8%.

The decrease was a result of $0.8 million in lower compensation expense under our return-on-capital-based incentive plan. As a result of our strong results to date, that plan has now achieved the maximum plan benefit allowable.

The decrease in incentive plan costs 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 22.4% from 21.9% last year due to changes in permanent book-tax differences.

Looking ahead to the remainder of the year, we would expect our effective tax rate will run around 23%, subject to a level of pretax earnings, book-tax differences and other assumptions and estimates that compose our tax provision calculation. Moving to the balance sheet and cash flow statement.

Cash flow from operations for the quarter generated $36.2 million due primarily to net earnings, but also due to a reduction in net working capital. The net working capital reduction was driven by an increase in accounts payable of $15.7 million, which resulted from the timing of raw material deliveries late in the month of June.

We would expect working capital balances to increase moderately as we complete our fourth quarter and fiscal year. Based on our sales forecast, as of the end of the third quarter of 2021, our quarter end inventories represented 1.9 months of shipments compared with 2 months at the end of the second quarter.

The tight rod supply market referenced earlier, continues to suppress our inventory levels which are trending below normalized levels of forecasted shipments at the end of the third quarter.

And finally, our inventories at the end of the third quarter of 2021 were valued at an average unit cost that was higher than our second quarter cost of sales but remains favorable relative to current replacement cost.

We concluded the quarter with $89.8 million of cash on hand and no borrowings outstanding on our $100 million revolving credit facility. As we look ahead to the fourth quarter, market conditions remain encouraging as the strong demand environment for our products we referenced in the second quarter continued throughout our third quarter.

Confidence in the outlook from our nonresidential construction customer base continues to gain momentum across all our sales regions.

This perspective is supported by widely monitored leading indicators which are now recording positive metrics on par with levels before the financial crisis of a decade ago and approaching all-time highs in their recorded history.

While they are leading indicators of future project activity, usually 12 to 18 months out, the optimism embedded in these levels seems to be translating into sustained activity levels today that has shown no sign of abating.

Concurrently, public nonresidential construction demand has remained durable and, in fact, never really slowed despite the concern of financial challenges with state-level budgets. Many today are in a stronger position than they were prepandemic, thanks to federal support and less dire budget outcomes than were originally forecasted a year ago.

Ongoing discussions for potential long-term infrastructure package, while encouraging, remain mired in the politics and complexity of the budget process in Washington. That said, the bipartisan proposal under consideration would provide, relatively speaking, a substantial boost to annual federal infrastructure spending.

Supply chain challenges, including both product availability and logistics issues, continue and are resulting in escalating manufacturing costs and operational inefficiencies at several of our plants. Unfortunately, we believe this dynamic will continue to be an issue for at least the remainder of the calendar year.

H will provide some additional context on these dynamics in his prepared remarks. And lastly, with respect to the uncertainties of COVID-19, our markets and operations continue to see no negative impact. We hope this risk will remain contained and soon no longer pose any mentionable risk. I'll now turn the call back over to H..

Thank you, Mark. As reflected in the release, our strong third quarter results were driven by robust nonresidential construction markets and escalating 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 execution, excellence and working safely.

Over the course of the last 16 months, our people have executed through difficult conditions, including pandemic-related uncertainties and inconveniences and then through supply chain challenges that are complicating life at our plants and our administrative offices. We are thankful for their perseverance through extraordinary circumstances.

Looking ahead, we expect continued market strength driven by significantly improved public finances at the state and local levels together with elevated private nonresidential construction activity.

While robust demand for our reinforcing products stretched lead times significantly, steel wire rod prices also rose sharply over our third quarter and supplier deliveries were unpredictable, leading to scheduling-related inefficiencies at our manufacturing facilities and customer service challenges.

We do not anticipate any meaningful supply chain performance improvement through the end of the calendar year in view of planned production outages at various steel mills over coming months and the continuing risk of unplanned outages, which seem to occur with some regularity.

Adding pressure to our cost and customer service performance is the chronic shortage of flatbed trucking capacity, which appears unlikely to abate over the course of the next few months. Until we develop more competitive sourcing opportunities, we expect the robust demand environment to support our passing escalating costs through the supply chain.

Turning to CapEx. We continue to expect 2021 to come in at approximately $20 million, subject to timing of certain planned expenditures. The new engineered structural mesh production line at our Dayton, Texas plant is being commissioned now. We began commissioning activities by producing relatively simple products, which went well.

This week, we've moved toward testing the line with more complex product complete durations. Assuming that our progress continues as expected, the line should be released to operations in August and begin a gradual ramp-up towards full capacity. We expect to pursue additional investments in 2021 to support our ESM growth.

Our CapEx strategy continues to be focused on reducing cash cost of production, improving the quality of our products, supporting growth initiatives and improving our information technology infrastructure and capabilities.

Looking through the balance of the fiscal year, we will 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.

Roche, would you please explain the procedure for asking questions?.

[Operator Instructions]. Your first question from the line of Julio Romero with Sidoti & Company..

It's Julio Romero from Sidoti here. Very nice quarter. I guess my first question is just kind of touching on wire rod.

Do you expect maybe any additional capacity of wire rod to be brought on domestically over the coming near term or maybe 12 months that could lead to some relief? Or has that shoe kind of already dropped and you've seen capacity, as much capacity as you expect to be brought online has been brought online?.

I don't expect any domestic additional capacity to come online, Julio. Operating hours could be expanded by certain mills that may not be running full out at this point.

And I guess the -- maybe the most important thing is the return to the market of 2 mills that had unplanned outages and unexpectedly curtailed market supply pretty significantly, those plants should be coming back online during this quarter.

But no, otherwise, there's no more brick-and-mortar and hardware to produce wire rod coming online to our knowledge..

Okay. Got it.

And -- this might be a silly question, but is there any substitute to wire rod that could potentially be used as an input or a different type of steel or anything of that nature?.

No, not from a practical point of view..

Okay. Okay.

And is there a risk of customers maybe turning to substitute products such as traditional rebar rather than Insteel's products, if there isn't enough wire rod to make some steel wire reinforcement on your end?.

Well, desperation will cause people to do whatever they have to, to survive. I don't think the supply situation is so dire though that we would expect to see customers revert to rebar for the long term. But I do believe that, as short-term band-aids for supply problems, you'll see some of our customers using rebar.

I would point out, though, that rebar is also in short supply. So there's no panacea on the supply side..

Okay. That's helpful. Maybe just turning to some of your CapEx commentary. It's very exciting to hear the ESM line in Dayton is underway.

When you speak to additional investments that could potentially be -- you could be doing even beyond fiscal '21, can you maybe give us a sense of how much capacity could you potentially build out for engineered structural mesh, like what's the runway there?.

Well, Julio, we're taking a pull-through approach on that, that we'll continue investing in the market as long as we like our growth prospects. But we haven't set a certain objective for unit growth. But we have put in place significant technical infrastructure and marketing infrastructure to continue our -- building our presence in the market.

So I think as we've said in the past, we believe we'll continue to see strong double-digit growth in units, and we're just going to let -- we're going to let that momentum pull our capital investment through..

Got it. And just last one from me and I'll pass it on is, on the demand side, it seems like both public and private nonres are doing very well.

What -- is there anything that keeps you up at night on the demand side?.

People. The hiring investment -- or the hiring environment is extremely, extremely difficult. And really, all of the inputs into our business are coming at premium cost with limited availability. And I'll tell you that while the results are gratifying, we're a little bit on edge around here about how we keep the momentum going..

[Operator Instructions]. Your next question, the line of Tyson Bauer with KC Capital..

Great quarter. Just to piggyback on that last question comment. There's really no areas of weakness on the demand side as far as from various sectors, public, private, nonres, res infrastructure. All of those seem to have a very robust outlook.

Would you agree that, that allows more -- allows you to have that pricing control within the market?.

Yes.

I mean I wouldn't call it pricing control, but I would say, certainly, you're correct that all sectors are hitting on all cylinders, which provides an environment where availability of the product is at a premium now the same is the case for our raw materials that we're less price-sensitive and more availability-sensitive than we've been in quite some time, and I think that carries through the supply chain..

Are you able then to be a little more choosy as far as product mix and better contribution margins and what you're willing to allocate your supply and deliver to that customer base?.

Well, you would think so. But at a point, we have to produce the products for which we have raw material. And it doesn't necessarily always match up with the products that are most desirable for us.

And it actually creates some strategic concerns and just a significant frustration because we basically are working schedules around raw material availability now rather than around more important things like customer wishes and needs..

Okay. You talked about the two mill outages, which kind of affect different geographies, more so depending on location.

Is that impact expected to be seen in greater inefficiencies in this quarter for Insteel or potentially in the fiscal first quarter?.

I'm going to tell you that I think that our fourth fiscal quarter will be the most difficult for us in terms of supply challenges..

And that gets relieved, we hope, by the time you walk into the new fiscal year?.

Well, it's day to day and week to week, but we can see out toward the end of our fourth quarter, and we have a little bit of help on the way. But we're definitely going to struggle for July and August..

Is there a point where, even with the tariff situation, that imports become an alternative given the pricing within the -- in the U.S.

market?.

Yes. I think that's one of the interesting factors that we're dealing with today, that the 232 tariff is certainly still a thorn in our side. But I don't think a reasonable argument can be made that if 232 were to go away that there would be a significant impact on available supply today. The phenomenon that we're seeing is global.

Demand for wire rod and all other carbon steel products is hitting on all cylinders in every region of the world. And I don't see that changing in the short term. So certainly, we'll continue to work for the elimination of 232 and we'll make our case.

And over time, 2 quarters or 4 quarters, pick your number I think the elimination of 232 would greatly help our sourcing situation. But right now, demand is so robust worldwide that I just wouldn't expect -- I wouldn't expect any immediate impact of the elimination of 232..

Okay. And last question.

Are you self-insured?.

For what purpose?.

For health insurance for employees and that..

We are, yes..

Are you seeing any big increases in that expense line item or as you go forward in the next 12 months?.

That one moves around a lot based on individual large claims that we may incur. But as a general statement, I could tell you that we're pleasantly surprised with the cost profile that we're experiencing right now..

Okay. And you talked about hiring difficulties. Give us a sense of what vacancies are there that you're unable to fill or the length of time to fill vacancies..

All of the above. I mean all vacancies are hard to fill, whether it's in our IS department or in our sales department or at our plants, they're all difficult to fill..

[Operator Instructions]. We do have a follow-up question from Julio Romero with Sidoti & Company..

H, I'd love to get your thoughts on a couple of ideas. Maybe given the supply constraints and the demand outlook, it seems like in regards to prices for both wire rod and your products of PC strand and welded wire on the price side, it feels like we're heading towards a new normal of higher highs and higher lows.

Would you agree with that assessment?.

I think that's likely, Julio. If you look back in time, we've seen these step moves both from metallics that work their way through all of the products downstream, both hot-rolled and fabricated products such as we produce. We saw it in 2004, we saw it 2008.

And while scrap prices and other metallics are going to be volatile up and down, generally, I think we could be in another situation where we're going to see a step-up..

Okay. And then secondly -- yes, earlier this year, I don't remember if it was the January call or the March or the April conference call, H, you gave some comments on the potential of federal infrastructure stimulus actually passing through. I think you sounded pretty confident on that.

I don't know if you have any thoughts on -- has -- on that overall and do you think that still might happen? Any thoughts there, I'd love to pick your brain on..

Yes. I have some thoughts, but I don't know that they're appropriate or inappropriate. I'm just amazed at what a mess there is in Washington. I look at it with a mix of amazement and fear. So I think Mark said that, that it's likely that something will happen on the infrastructure side. And I think that's right.

Whether and how good it is for our industry, I think, remains to be seen. I think one of the comments I made earlier is that infrastructure is a term that's been so badly abused, it's hardly recognizable today..

[Operator Instructions]. And there are no other questions at this time. I would like to turn the call back over to Mr. Woltz for any closing remarks..

Okay. Thank you, Roche. We appreciate your interest in Insteel and we look forward to talking to you next quarter. In the meantime, don't hesitate to contact us if you have questions. Thank you..

This concludes today's conference call. Thank you for participating. You may now disconnect..