Prepared remarks
Good morning, everyone. Thank you for being here for the Insteel Industries Third Quarter 2024 Earnings Call. My name is Carly, and I will be leading the call today. I will now turn it over to your host, H. Woltz, CEO of Insteel Industries, to get started.
Good morning. Thank you for your interest in Insteel, and welcome to our third quarter of 2024 conference call, which will be conducted by Scot Jafroodi, our 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. During Q3, we experienced a continuation of sluggish market conditions, although momentum increased steadily to the point that we began ramping up operating hours to manage lead times, primarily in our welded wire reinforcement business. While we're not pleased with our Q3 results, patience is the only viable strategy for us since we're unable to create demand and competitors who believe that reducing prices will stimulate demand or result in market share gains are simply mistaken.
We've noted that market lethargy is not limited to reinforcing markets following reduced estimates for producers of cement, steel, aggregates, and other construction materials. The better news is that we believe market conditions are recovering and that the longer-term outlook for demand is quite positive. We look forward to attaining higher operating rates, lower costs, improved revenue, and margins that we believe will be supported by market conditions. I'm going to turn the call over to Scot 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 on the call. As reported in our release earlier today, our third quarter results were negatively affected by the narrowing of spreads between selling prices and raw material costs relative to the prior year quarter. The reduction in spread has more than offset the favorable impact of higher shipments in the current year. As a result, Insteel's net earnings for the third quarter of fiscal 2024 fell to $6.6 million or $0.34 per share from $10.6 million or $0.54 per share a year ago. Net sales for the quarter declined 12% to $145.8 million, driven by a 16.3% decrease in average selling prices, partially offset by a 5.1% increase in shipments. On a sequential basis, average selling prices fell by 5.3% while shipments rose 20.8%. Competitive pricing pressures within our welded wire reinforcing markets and the growing impact of low-price PC strand imports continue to pressure selling prices.
Furthermore, steel scrap prices trended down during the quarter, which has created additional headwinds for AFPs. Despite the decline in selling prices, our shipments benefited this quarter from a strengthening demand environment for our products and increased activity across our construction end markets. Throughout each month of the quarter, our year-over-year shipments were higher than the prior year. However, we did experience several challenges as unfavorable weather conditions and the growing influence of low-price imports in certain of our PC strand markets negatively impacted shipments. Furthermore, we actively worked throughout the quarter to ramp up operating schedules at certain of our facilities to fully meet an improving order book and reduce delivery lead times. Gross profit decreased to $15.4 million from $20.4 million in the prior year quarter and gross margin narrowed to 10.6% from 12.3%, primarily due to lower spreads between selling prices and raw material costs, which offset the benefit of higher shipments.
After rebounding in the second quarter following a January price increase, spreads again came under pressure in the current period, with the year-over-year decline in ASPs outpacing the reduction in our inventory carrying values. As we move into the fourth quarter, we anticipate spreads to remain near current levels as selling prices continue to face downward pressure. Unit conversion costs for the third quarter improved both year-over-year and sequentially from the second quarter but remain elevated due to lower operating levels. As we enter our fourth quarter, we expect to make further progress in reducing our conversion costs as we continue ramping up operating schedules in response to improving market conditions and leveraging our recent capital investments. SG&A expense for the quarter remained unchanged at $7.9 million, representing 5.4% of net sales compared to 4.8% of net sales in the previous year.
An increase in depreciation expense combined with the relative year-over-year change in the cash rented value of life insurance policies were offset by lower compensation expense under our return on capital-based incentive plan, which was negatively impacted by weaker year-to-date results. Our effective tax rate for the quarter rose to 24.7% from 22% a year ago. The increase was largely driven by the effect of a discrete tax item, which had an amplified impact on the rate due to the lower pretax earnings. Looking ahead to the balance of the year, we expect our effective rate to run close to 23% subject to the level of pretax earnings, book tax differences, and other assumptions and estimates that compose our tax provision calculation. Moving to the cash flow statement of the balance sheet. Cash flow from operations for the quarter generated $18.7 million of cash due mainly to net earnings and reduction in net working capital.
This reduction was driven mostly by a $10.4 million increase in accounts payable and accrued expenses as well as a $3.2 million decrease in inventories. Our inventory position at the end of the quarter represented 2.5 months of shipments on a forward-looking basis, calculated off forecasted Q4 shipments, which is down slightly from 2.6 months at the end of the second quarter. In addition, the average unit cost of our inventories at the end of the third quarter was lower than our third quarter cost of sales. This is expected to have a favorable impact on spreads and margins in the fourth quarter as the lower cost materials consumed are reflected in cost of sales provided the average selling prices did not decrease to a greater extent. We incurred $3.2 million in capital expenditures in the quarter for a total of $17.5 million through the first nine months of our fiscal year. Based on our forecasted expenditures for the fourth quarter, we have reduced our full year target to $25 million from the previously communicated target of $30 million.
H will provide more detail on this topic in his remarks. We continued our share buyback during the quarter, repurchasing $1 million of our common equity equal to approximately 30,000 shares. From a liquidity perspective, we ended the quarter with $97.7 million of cash on hand and were debt-free with no borrowings outstanding on our $100 million revolving credit facility, providing us ample financial flexibility and ability to pursue any attractive growth opportunities that may develop. Turning to the macro indicators for our construction end markets. The latest reports for the Architectural Billings and Dodge Momentum Indexes, which are leading indicators for non-residential building construction, offer a mixed view of market conditions going forward. In May, the ABI declined to a score of 42.4, remaining well below the growth threshold of 50 as architectural firms report both a decrease in billings and a slowdown in new projects.
On the other hand, the Dodge Momentum Index, which tracks non-residential building projects entering the planning phase, rose by 10.4% in June to 198.6. This represents a 7% increase year-over-year. The higher June reading was largely due to a 14.5% rise in the commercial component of the index, fueled by data center planning activity. Year-over-year, the commercial segment is up 25%. The latest May report from the US Department of Commerce shows that the monthly construction spending data remains strong. Total spending on a seasonally adjusted annual basis is up 6.4% from last year. Non-residential construction is up over 6.2% and public highway and street construction, which is one of the largest end-use applications for our products, is up 9%. However, while construction spending remains elevated, US cement shipments, another measure that we track, continue to lag 2023 levels as shipments were down 8.1% in March and 4.4% for the calendar year.
Finally, this week, the AIA released its semi-annual construction forecast for non-residential building construction for 2024 and 2025. Spending on non-residential buildings is projected to increase 7% for 2024, driven by strong gains in the industrial sector. However, the forecast also indicates that spending growth is expected to slow in 2025 with only 2% growth in overall spending projected. This concludes my prepared remarks. I'll now turn the call back over to H.
Thank you, Scot. As we commented last quarter, the operating environment during fiscal 2024 has been difficult as we face headwinds, including declining steel prices, inventory liquidations by customers, the need to align our finished goods inventories to reflect lower shipments, and finally, the normal seasonal downturn in construction activity. We're glad to report that these adverse conditions seem to have run their course, and we are experiencing rising demand driven by market fundamentals as well as the capital investments made by the company in recent years. As we reported in Q2, shipments for Q3 were not impressive, but each month showed improvement as inventory positions through the supply chain improved and construction spending and employment telegraphed improving market conditions. We believe the slow and steady demand improvements we've experienced recently will continue into our fourth quarter.
Backlogs in our welded wire reinforcement business have lengthened to an uncomfortable degree due to compressed operating schedules that were dictated by weak order entry and shipments earlier in the year together with more robust order entry activity. And we're ramping up operating hours at several facilities to respond to more robust demand. Hiring continues to be difficult in view of low unemployment rates in most markets, but conditions have improved considerably since hiring challenges peaked. As Scot mentioned and as we stated in the last couple of earnings calls, we are increasingly affected by low-priced imported PC strand from producers in a variety of countries that appear to be circumventing the Section 232 tariff on hot rolled steel by downstreaming. Continuing the trend that began last year, the average unit value of imported PC strand is lower than the domestic market price for wire rod, the raw material from which we produce PC strand.
The industry is carefully scrutinizing strand imports and will pursue any trade actions that are justified. We are also working with the administration to demonstrate that the differential treatment of hot rolled wire rod and PC strand with respect to the Section 232 tariff is undermining the intent of the tariff and damaging the very constituency the tariff was intended to benefit. We're optimistic about the impact on our markets of the Infrastructure Investment and Jobs Act, although at this point, it's difficult to point to specific projects that have affected demand. With respect to IIJA, the secretary of transportation has acknowledged delays of multiple years between appropriations and increased demand for construction services and materials. The administration has also been clear that it views IIJA as a new way of funding infrastructure investment and not as a stimulus program. In other words, it does not appear to surprise the administration that the impact of the legislation on infrastructure spending thus far is muted.
Meanwhile, of course, inflation is impacting project costs and jeopardizing the viability of some projects. Despite these obstacles, we believe that IIJA funds will ultimately be allocated to projects and spent as intended, with a beneficial impact on our industry. Turning to CapEx. While we had previously indicated that CapEx for 2024 would come in at approximately $30 million, we've scaled back our view based on actual expenditures through the third quarter and expectations for the balance of the year. We have not canceled projects that have been approved previously. We expect to come in closer to $25 million based on actual experience. As we stated earlier, elevated CapEx for 2023 and 2024 does not imply a permanent step-up in our CapEx expectations. On an ongoing basis, we would expect CapEx to range closer to depreciation and amortization and to be elevated in years we elect to expand capacity or incorporate new technology into our facilities through equipment replacement.
As a reminder, the CapEx amounts for 2023 and 2024 are heavily influenced by the addition of three new production lines at our welded wire reinforcement plants and the addition of a production line at a PC strand plant. The scale of these additions should be viewed as unusual and not a recurring event. The investments we're making in state-of-the-art technology will expand our product capabilities and favorably impact our cash cost of production. We believe that companies failing to take advantage of significant technological innovations will become increasingly uncompetitive. As you know, Insteel continues to be debt-free and has substantial flexibility to make decisions for the long-term best interest of its customers and shareholders. Looking ahead, we're aware of the substantial risk related to the future performance of the US economy and are monitoring the environment. In any event, we're well positioned 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. Carly, would you please explain the procedure for asking questions?
Questions and answers
Our first question comes from Julio Romero of Sidoti. Julio, your line is now open.
Thanks. Hey, good morning, H and Scot. Maybe just to start on demand, you sound much more optimistic about improving conditions. You talked about trying to ramp up operating hours. Just maybe talk about what you're seeing across your end markets, either from inquiries or orders that kind of give you optimism that demand is indeed improving.
Well, both our forecast and our order entry rate cause us to be optimistic about where we see things going. But as I stated in my remarks, we've seen a steady and slow improvement in our order intake and conditions in the market. I don't mean to imply that we expect to see a big pop. It's more slow and steady. And as you know, we had scaled back operating hours pretty substantially to reflect earlier business conditions, which is partly a way of explaining why our backlog and lead times have expanded. It's partly due to the curtailed and truncated operating hours that we implemented earlier in the year and partly due to increasing order entry rates.
Yeah, understood. You talked about scaling hours back. You talked about the challenge of kind of retaining and attracting qualified folks. Talk about maybe how you're tackling the challenge at this point?
I think it's common in most stories about the current labor market that when you hire five or six people, only two or three of them are likely to still be with you after 60 or 90 days. We need to train these individuals and show them how to work safely, which makes this a challenging environment. I don’t know if we’re operating in any labor market with an unemployment rate above 4%. Consequently, there are fewer candidates and fewer individuals who truly appreciate or enjoy industrial work. The issue is complex and goes beyond just compensation.
Got it. You provided some preliminary thoughts for fiscal '25, which are helpful. You mentioned it's challenging to identify specific projects that have seen a demand increase due to the IIJA. Do you think that eventually, when the Infrastructure Act positively impacts Insteel, it will be clear enough for you to identify specific projects? Also, when do you anticipate that will occur? Would fiscal '25 be the year for that?
The answer to the first part, Julio, is no. I don't expect that we're going to see projects fall into the marketplace with a big banner on them that says funded by IIJA. The nature of the products that we supply just is inconsistent with that. I think that we'll begin to see impact of IIJA in 2024 and 2025. But I'm not sure that we'll be able to talk to you and say 10% of our shipments were related to IIJA. I just don't think it's that transparent.
Yeah, that makes sense. I'll pass it on at this point. Thanks so much.
Thank you.
Our next question comes from Kevin Gainey of Thompson Davis. Kevin, your line is now open.
Hey, gentlemen. Congratulations on the quarter. I wanted to discuss private demand and your thoughts on its trends over the next few months and into 2025.
I think a lot of that, Kevin, is going to be dependent on the interest rate environment that we're in. Surely, if there are cuts going forward, that could generate some demand in that private commercial segment, but it's too early to tell right now. And when you speak of private, are you also speaking of residential?
Yeah, yeah. Residential, non-res. Yeah, both.
So it seems that the outlook for residential is reasonably bullish. And I would say less uncertain than the outlook for private commercial. And if we were to get interest rate reductions, I think clearly it would be very supportive of both segments of private construction spending.
Since you guys kind of brought up the rate talk, have you found that any of your customers have changed the timing of projects for that anticipation of rate cuts?
Yes, we have seen some changes. It is evident from the number of times we have re-quoted projects that developers and owners who are hesitant about starting are considering a couple of factors. They are facing significantly increased costs over the past couple of years due to inflation, as well as rising financing costs. Some have chosen to wait for better conditions. I don't believe the projects are abandoned, but the fact that we have to re-quote a project multiple times sends a clear message, and that is something we have noticed.
That sounds exhausting. And then maybe one final one, as you guys talk about ramping up the business, what kind of confidence do you have in the ability to keep at those higher operating levels?
The business is both seasonal and cyclical. The seasonality is not going to change, especially from April through October or November, which is when construction typically reaches its peak for any given cycle. We are not expecting any changes in seasonality. The underlying demand for our products remains strong, despite going through a period of inventory correction. However, there isn't any objective data to quantify how much of our business has been impacted by these corrections. The insights we have are more qualitative, derived from reports and our general sense of the business. Nonetheless, the cyclical nature of the business will remain unchanged, and I believe we have likely seen the worst of the downcycle.
Sounds good. I appreciate you guys taking my questions.
Thank you.
Thank you so much. Our next question is from Tyson Bauer of lenders KC Capital. Tyson, your line is now open.
Good morning, gentlemen.
Good morning, Tyson.
We previously encountered the PC import issue in past years, which required us to engage in trade actions and have support from the administration to facilitate those actions. It might be challenging in an election year with potential changes ahead, particularly due to some judgments against various agencies. My primary concern is centered on the welded wire reinforcement products. Is there a domestic capacity issue in the industry causing excess slack capacity, impacting your pricing ability? Historically, you've been a price leader. Has this status changed, with competitors like Nucor potentially exerting more influence that you now need to respond to?
Well, first, let me just remind you that we have multiple product lines within our welded wire reinforcement business. It probably will come as no surprise that the more commodity-like make-to-stock products have been under more pressure than the make-to-order products. The make-to-stock products largely are light commercial and housing related, and they're highly seasonal. So the way that the business works is that producers build significant inventories of finished goods based on their outlook for demand in the busier parts of the year. And if you go through three or four months and fail to meet your shipment objectives, then there can be widespread panic in the market that results in a lot of price cutting. And that's some of what we've seen that I think some of the participants in the industry have built inventories that far exceed the needs of the market. And they've been unloading those products. That's much less a problem in the make-to-order engineered applications that we produce.
Okay. And with your new capacity lines coming online and greater automation, do you tend to focus more on your own fixed cost absorption, meaning that you're more prone to consider volume impacts and less focus on pricing yourselves?
No.
When you talk about labor increases, is that specific to certain product lines and locations or are you making a general statement company-wide?
Well, it's company-wide. But company-wide is rolled up from ten separate labor markets that we compete in. So I would say that the forces that have affected labor costs are the same nationwide. But the degree to which it has affected our company varies with each labor market that we're in. But as a general statement, all labor markets have been affected and are more costly by a wide margin today than they were previously. And actually, I don't consider that a bad thing. Okay? Our position is that we're going to be competitive in every market that we operate in. And I don't think that we're going to find that we have competitors who have substantially lower labor costs. So I think the playing field is leveled.
Okay. You talked about the somewhat disappointing volume shipments. You thought it'd be even greater, especially with seasonal impact year-over-year type metrics. As we've learned through the years, you don't necessarily ever get a catch-up quarter per se, things just kind of get pushed to the right. Is that what you're seeing in this scenario also? Is that we may be ramping up and better, but don't expect kind of that pig in the python situation where we're going to get an outsized quarter?
I don't believe there's much catching up happening. One of the issues we face, which is difficult to quantify, is that our customers' clients are also experiencing challenges in the labor market. We have clients whose products have been sold to contractors, but those contractors lack the labor needed to utilize those products. As a result, some customers have excess inventory, which impacts their ability to produce and order from Insteel since they have no space for finished goods. Even though the products on their sites are generally reserved for specific projects, I think contractors and our customers will push the season as far as possible to complete projects as weather permits. However, what we don't ship this year will simply be shipped next year. It’s not about creating a large backlog to release during slower periods; that's not how the business operates.
Okay. And last question for me. Given your outlook, given improvements in your demand metrics that you're seeing currently, as management and as a Board member, how do you go about converting that outlook and those increases in demand that you're expecting with your capacity expansion and turning that into shareholder return?
I believe, as we have mentioned before, that all the new investments we have made include both cost reduction and capacity expansion components. The reality is that if there is no market or if the market is lacking, we will not achieve the part of our returns that depends on increased demand and capacity until market conditions improve. Additionally, as I have noted several times, we cannot choose when to begin these investments. The lead time can be a year and a half to two years in some instances, and we must have confidence in the long-term implications of these investments, or we are likely in the wrong business.
You still have your dividend policy and share buybacks, considering your expectations for the next one to two years, and operating results should ultimately provide a return on capital for your shareholders based on historical multiples.
Yes. We're confident that the investments that we've made will return greater than the cost of the capital that's invested in them, or we wouldn't have made the investments.
Sounds great. Thanks a lot, gentlemen.
Thank you very much. Our next question comes from Julio Romero of Sidoti. Go ahead.
Thank you for the follow-up question. Tyson mentioned it briefly. This year is an election year, and some investors are considering the possibility of a change in administration, especially regarding the steel industry. How should we view the potential impact of either a change or stability in administration at Insteel? Is there any reason to feel optimistic that either potential outcome might lead to an expansion of Section 232 for your product?
It's uncertain what actions a new Trump administration might take regarding Section 232. Although Trump implemented 232 and showed understanding of the issues we raised, our concerns at that time were theoretical. Now, we can clearly show the tangible effects of the issues we highlighted in 2019 and 2020. Under the Biden administration, we engaged with our suppliers to communicate that the unequal treatment of PC strand and hot rolled wire rod under Section 232 has significantly harmed our suppliers, who were intended to benefit from 232. They are sympathetic to our situation. We have enough data to illustrate the actual consequences. However, it requires a presidential proclamation to include PC strand in 232, which is a challenging process regardless of the supporting facts. We believe the current situation stems from an error by the administration, and we’re framing our request as a need to correct this mistake. I firmly believe we will resolve this issue, but it's uncertain whether we can achieve this with the Biden administration or if it will be addressed by the next administration. The rationale is compelling enough that I find it hard to believe we won’t succeed in getting it resolved.
Really helpful color, H. Much appreciated. Thank you.
Thank you very much. We currently have no further questions, so I'll hand back to H. Woltz for closing remarks.
Okay, thank you, Carly. And thanks to all of you who joined the call today. We appreciate your interest in the company. And we would encourage you to give us a call back if you have any questions. And if not, we'll look forward to talking to you next quarter. Thank you.
Thank you. This concludes today's call. Thank you to everyone for joining us. You may now disconnect your lines.