H. Woltz - President and CEO Mike Gazmarian - Vice President, CFO and Treasurer

Chris Olin - Longbow Research Tyson Bauer - KC Capital Julio Romero - Sidoti & Company

Good day, ladies and gentlemen, and welcome to the Insteel Industries’ Second Quarter 2017 Conference call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will follow at that time [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Mr. H. Woltz, Insteel’s President and CEO. You may begin. H. Woltz: Thank you, Vicky. Good morning. Thank you for your interest in Insteel, and welcome to our second quarter 2017 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’ll now turn it over to Mike to review our second quarter financial results and the macro indicators for our markets. Then I will follow-up to comment more on market conditions and our business outlook.

Thank you, H. As we reported earlier this morning, despite difficult comps, Insteel’s results for the second quarter were slightly improved from year ago as widening spreads and lower operating expenses offset lower shipments. Net earnings for the quarter were up 3.7% from last year while earnings per share increased marginally to $0.39 from $0.38. After getting off to a relatively strong start in January, shipments moderated over the remainder of the quarter, resulting in 6.9% year-over-year decrease and 5.6% improvement from Q1 as compared to last year’s unusually high 23.1% sequential increase. As we have previously reported, shipments for the prior year quarter benefitted from the unusually mid weather and a carryover of pent up demand from the first quarter of fiscal 2015, which was the wettest December quarter on record for the U.S. Although, this year’s weather was also relatively mild across many regions of the country, the western states as well as Texas, experienced significantly more precipitation during January and February as did certain of our larger markets, including Pennsylvania, North Carolina and Virginia in March. Average selling prices for the quarter were up 2% sequentially from Q1 as a result of the price increases that we implemented to offset the recent escalation in our raw material costs. Unfortunately, the amount of realized fell short of our expectations and the timing for the increases occurred later in the quarter than we had anticipated due to competitive pressures that were likely exacerbated by the usual seasonal slowdown. ASPs gradually rose during the period with the March average up 3.1% from December. On a pro forma basis, assuming the higher March ASPs were in effect for the entire quarter, gross profit would have risen $1.5 million from the reported amount to $19.8 million gross margin of 120 basis points to 19.3% and earnings per share $0.05 to $0.44. Looking ahead to the third quarter, we expect further increases in ASPs, driven by the full quarter impact of the Q2 increases together with additional increases that went into effect earlier this week. Gross profit for the quarter fell $0.3 million from the year ago to $18.3 million, while gross margin increased 80 basis points on the lower sales to 18.1% as higher spreads were offset by the reduction in shipments and higher unit conversion cost and the lower production volume. On a sequential basis, gross profit rose $6.3 million from the first quarter and gross margin widened 420 basis points, also largely due to higher spreads and to a much lesser extent lower conversion cost and the increase in shipments from Q1 to Q2. We ended the quarter with less than three months inventory valued at higher average unit cost in the beginning of the quarter, reflecting the recent increases in our raw material cost. We believe the additional price increases that we’ve implemented will mitigate these cost pressures during our third quarter. SG&A expense for the quarter fell $0.6 million from a year ago to $7.1 million due to lower employee benefit and stock-based compensation costs together with the larger increase in cash surrender value of life insurance policies in the current year. Our effective income tax rate for the quarter was essentially unchanged from the prior year at 33.9% versus 34 a year ago, while the year-to-date rate fell 50 basis points to 33.8% from 34.3% due to changes in permanent book versus tax differences. We ended the quarter with $40.2 million of cash on hand or over $2 a share after paying the $1.25 a share special dividend in January. And no borrowings outstanding on our $100 million credit facility, leaving us with ample liquidity and financial flexibility. Looking ahead, the outlook for our construction end markets remains positive. The most recent reports with Architecture Billings Index and Dodge Momentum Index reflect favorable trends that imply further improvement in non-residential building construction in the coming year. Yesterday, the American Institute of Architects reported that ABI increased to 54.3 in March from 50.7 the previous month. Through the first three months of the year, the index is averaged 51.5, which is up slightly from 51.2 for all of last year. In March, the Dodge Momentum Index rose for the sixth consecutive month, increasing to its highest level in over eight years and the three months average is up 23.7% year-over-year. The monthly construction spending data continues to reflect diverging trends in private and public construction and the need for increased infrastructure investment. Through the first two months of the year, private construction spending is up 6.5% from a year ago with non-residential up 7.2% and residential up 5.7%, while public construction spending was down 8.4%. Public highway and street construction, one of the larger end uses for our products was down 9.4% after rising only 1.3% for all of last year. We continue to believe the federal funding provided were under the FAST Act will begin to have a more pronounced impact on infrastructure construction activity later in the year. We’re also encouraged by the recent funding measures approved by a number of states, providing for increased infrastructure investment in the coming years. Finally, although the timing and specifics of President Trump’s $1 trillion infrastructure proposal have yet to be firmed up, we believe the size and duration of the package that is expected to be proposed would represent a significant catalyst for increased demand for our concrete reinforcing products and favorably impact our business outlook for an extended period. At this time, it remains unclear whether it will be pursued as a standalone measure or concurrently with the tax reform or healthcare bill. I'll now turn the call back over to H. H. Woltz: Thank you, Mike. As reflected in our press release this morning, market demand for our reinforcing products was weaker than expected during the quarter, as well as compared to last year. While leading indicators continue to reflect underlying strength than in non-residential construction markets with the prospect for further growth, weather and other factors dampens demand in Q2. At the same time, the market for our raw material, hot-rolled carbon steel wire rod has remained volatile over the course of fiscal 2017, although the general pricing trajectory has been trending upward, reflecting escalating market prices for steels scrap. During Q2, we announced two price increases with the objective of recovering higher raw material costs followed by a third increase that went into effect earlier this week. While our ASPs have risen, the competitive environment has been affected by weaker demand during the seasonably slower months, resulting in a reluctance by competitors to recover rising costs at the same rate they are being incurred. We expect the favorable seasonal trends, together with positive underlying fundamentals in the non-residential construction markets, will support further upward movement of our ASPs through Q3. In late March, a group of domestic steel wire rod producers filed antidumping and countervailing duty cases against 10 countries that collectively supplied nearly 50% of the imported wire rod that entered the U.S. during 2016. These cases will run their course over the next year with final margins, if any, and final injury determinations coming in the spring of 2018. Depending on market conditions, we have typically sourced from 10% to 30% of our raw material requirements from offshore vendors due to the relative unattractiveness of certain products to domestic wire rod producers and to ensure adequate supplies. We are evaluating alternative options in the event that some traditional offshore sources elect to exit the U.S. market during dependency of these cases. Over the years, we’ve experienced several rounds of trade actions on wire rod and up to this point, has successfully navigated those events without any material adverse impact on our business. I should point out that Insteel does not act as the importer of record when it purchases material from offshore sources and therefore has no ability for assessments of antidumping or countervailing duties that maybe levied. Turnin to CapEx, following our earnings call in January, we experienced further delays with the construction and commissioning of the new raw material cleaning and PC strand production lines at our Huston plant. While we haven’t experienced any substantial technical or systems problem, the completion of required electrical, plumbing and electronics related tasks move slower than we expected. Most of these issues have been resolved and we expect to process the first coils to the new cleaning line before the end of this week, and we’ll be gradually increasing operating hours until the plant is fully satisfying its requirements. As a result of the extended timeline related to the cleaning line, we now expect the new strand production line to come online in May and ramp up by the end of the quarter. Aside from timing considerations, we’re pleased with the project and confident that we will achieve our objective of operating at the lowest production cost in the industry and realize the projected cost reductions of approximately $5 million per year. The other major project that we’ve pursued over the last two quarters is that our Missouri facility where we have installed a new ESM production line to replace older less cost effective equipment to expand our capacity and widen the range of products that we offer to the market. The project has proceeded very well, the line was commissioned and placed into service earlier than projected. The line is currently operating 16 hours per day and we expect to ramp it up further over the balance of the quarter. We previously indicated that we expected CapEx for 2017 to come in at approximately $25 million, while acknowledging that our estimates have tended to be on the conservative side in prior years. As is normally the case, the timing of outlays for certain projects could slide into next fiscal year thereby reducing CapEx during 2017. We will provide updated expectations during the third quarter call, but the scope of anticipated projects has not changed as we continue to aggressively pursue attractive growth and cost reduction opportunities as rapidly as our internal resources allow. This concludes our prepared remarks, and we’ll now take your questions. Vicky, would you please explain the procedure for asking question?

[Operator Instructions] And our first quarter comes from the line of Chris Olin with Longbow Research. Your line is now open.

So I have a question on the demand side, you are basically or you were basically, facing a difficult comp for this quarter. But it looks like the comps should get much earlier as we get into the second half of 2017. When you exclude weather and maybe timing, how do you think about real underlying demand for the reinforcing products? Is this a mid single digit growth environment, is it better than that right now? H. Woltz: I think the underlying level of demand would pretty closely match up with the spend and statistics that we see in the private sector of non-residential construction and the public sector, with the public sector continuing to drag flat or even slightly lower spending levels and the profit side being better. When you roll all that together, I wouldn’t think that it’s more than a mid single digit, high single digit market growth expectation.

Are you actually starting to see orders come from the federal funding or state level yet in terms of like the highly infrastructure demand? H. Woltz: No, I would say we’re running at the same level that we have been over the past year. There has been no surge in demand.

Switching to pricing really quickly, I know you talked a bit about your views on this wire rod trade case. I guess my question is, what is the risk that at some point in the future we see an increase in the pick up of PC strand imports as people try to navigate around these type of trade barriers? H. Woltz: Well, it’s a phenomenon that we’ve been living with for the last several years, particularly following I think it was the 2010 dumping case that the domestic wire rod producers filed and won against China. China has been the worse perpetrator in world market of pushing dump and subsidize wire rod. And when that product was shot out of the U.S., it went literally into every other market worldwide, and we think contending with PC strand imports that are produced from Chinese wire rod from many countries. So it’s a phenomenon that we’re living with Chris, and I don’t want to expect it to change neither to get significantly worse or to improve.

And our next question comes from the line of Tyson Bauer with KC Capital. Your line is now open.

Couple of quick questions, yesterday in the news, possibility of another continuing resolution for the budgetary measures for the federal government that could go to the end of the fiscal year, bringing it into October this year. Does that, in essence, delay the FAST Act price -- spending increases that were passed a year ago? H. Woltz: That is one of the reason, the continuing resolution is one other reasons why we haven’t seen a pickup in first activity, because it maintained funding at the previous levels. And just introduced some uncertainty, which has caused some delays in project work at the state and local level. So it's unfortunate where the funds -- the increased funding was approved. It was appropriate, it just hasn’t gone to work yet due to these budget issues. And that’s one of the reasons for optimism later in the year with higher funding would begin to go to work and have an impact. And then once this year’s resolution is resolved, they’re going to have to go to work pretty quickly on a resolution for 2018, which should provide for an additional increase as provided for under the act.

Lastly, I was was wondering if they do another continuing res, which sounds more likely than not at this point but that can change, total number that was in that act for increased spending. Does it just jump up to that second year level at an increase or is everything gets lift to the right? H. Woltz: I think it’s undecided, at this point. It’s yet to be determined.

Without that increase or knowing when that increase will actually come through, what are you seeing just from the local and the state levels where a lot of states have increased bonding, gas taxes those things for infrastructure spending, your overall view without the support of the federal government increased spending. What are you seeing from the state local level in aggregate that will give you an increase this year? H. Woltz: No, I would say that we haven’t seen a significant pick up at this point, but the outlook is positive, just considering some of the recent funding measures that have been approved providing for increased spending in certain markets, particularly taxes, the outlook there is real positive. And then you’re probably familiar with the funding increase that was recently approved out in California SP-1 that provides for a substantial increase over 10 year period. And that obviously hasn’t had an impact yet, but I think the outlook there is positive as well. And then there are number of other states that have implemented fuel tax increases or other fee increases that should have a favorable impact as well. But I would say at this point we really haven’t seen the upside from those.

Earlier, the comment was that the second half of the year you have easier comps, I wish I could see that on the top-line as it get price increases through and more activity. But your margins were awfully healthy last year in the second half. Are you including that with that comment of easier comps, or are we looking at a situation where we should grow the topline better but not necessarily see a better margin line in the second half than what we saw a year ago? H. Woltz: I don’t think that we can really speculate on that. There are just too many moving parts that make a reasonable answer beyond our capability.

And as far as the topline comp, it would apply in particular to our fourth quarter, which was unusually weak last year. We got off to a decent start in Q3 and then we saw volume graph off over the later part of the year.

And our next question comes from the line of Julio Romero with Sidoti & Company. Your line is now open.

Just in terms of unit shipments, can you touch on the trend of shipments throughout the quarter? Did it hold at a steady pace from January through March?

Well, there is a seasonal element at play where the volume, the absolute volume picked up over the course of the quarter where usually January is a low point and then we see gradual improvement and that was the case this year.

Right, but seasonality , like you didn’t see any peaks like in March above than expected and below than expected?

No, nothing that really stood out. I mean I think our comment that overall volumes were unimpressive to this internally would still be a fair one.

And congrats on bringing the ESM production line online early. Was there something that allowed you to bring that line earlier than expected? And can we expect additional ESM lines, going forward? H. Woltz: We’re continually evaluating the best opportunities to grow in that sector, which offers quite a bit of promise to us. So I think over the coming quarters, you’ll hear more about it.

And I’m showing no further questions, at this time. I would now like to turn the call back over to Mr. H. Woltz for closing remarks. H. Woltz: Okay, thank you. We appreciate your interest in Insteel. We’ll look forward to talking to you next quarter. Thank you.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.