Insteel Industries, Inc. — Q2 FY2018 Form 10-Q
Business and period: Insteel manufactures steel wire reinforcing products for concrete construction, including prestressed concrete strand and welded wire reinforcement. This unaudited report covers the quarter and six months ended March 31, 2018; comparisons are with the periods ended April 1, 2017. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Net sales | $107.4 | $101.2 | $205.2 | $195.0 |
| Gross profit | $15.4 | $18.3 | $27.1 | $31.3 |
| Gross margin | 14.4% | 18.1% | 13.2% | 16.0% |
| Net earnings | $5.9 | $7.4 | $14.0 | $11.9 |
| Diluted EPS | $0.31 | $0.39 | $0.73 | $0.62 |
| Operating cash flow | Not separately stated | Not separately stated | $24.5 | $17.6 |
Quarterly sales grew 6.2%, reflecting shipments up 2.4% and average selling prices up 3.7%. First-half sales grew 5.2%, with shipments up 1.8% and prices up 3.3%. Gross profit fell despite higher sales: management attributed the margin compression chiefly to raw-material costs rising faster than selling prices. Quarter gross profit was reduced by a $3.6 million spread decline; for the half, the spread decline was $7.1 million. SG&A was $7.5 million for the quarter, 7.0% of sales, and $13.2 million for the half, 6.5% of sales.
First-half operating cash flow increased to $24.5 million from $17.6 million. Working capital provided $4.3 million of cash, principally from an $18.7 million inventory reduction, partly offset by a $10.2 million receivables increase and a $4.2 million decrease in payables and accrued expenses. Investing used $12.7 million, including $9.3 million of capital expenditures and $3.3 million for a business acquisition. Financing used $20.4 million, including $20.2 million of dividends.
Balance sheet and liquidity
At March 31, 2018, cash and cash equivalents were $23.5 million, current assets $141.1 million, and current liabilities $38.1 million; reported working capital was $103.1 million. Total assets were $272.6 million and shareholders’ equity $218.0 million. The company had no debt outstanding. Its $100 million revolving credit facility had $84.4 million of borrowing availability and $1.8 million of letters of credit outstanding; it was in compliance with covenants. The facility matures May 13, 2020.
Cash declined by $8.6 million from fiscal year-end, after $24.5 million of operating cash flow, $12.7 million of investing outflows, and $20.4 million of financing outflows. Management said available cash, operating cash generation and facility capacity should meet anticipated needs, including for the next 12 months, absent significant unanticipated demands.
Material changes, outlook and risks
- Taxes: Q2 effective tax rate was 24.7%, versus 33.9% a year earlier. The first-half rate was negative 1.9%, including a $3.7 million tax benefit from remeasurement of deferred tax liabilities following the Tax Cuts and Jobs Act. Excluding that benefit, the company reported a 24.7% first-half rate. The tax benefit drove first-half earnings growth despite lower gross profit.
- Raw materials and pricing: Higher wire-rod costs outpaced price increases amid competitive pressure, compressing spreads. Management said future wire-rod cost changes and the ability to recover them through prices were uncertain. A 10% wire-rod price increase, with no corresponding selling-price change, would have reduced first-half pretax earnings by an estimated $12.2 million.
- Outlook: Management expected a seasonal demand upturn and continued construction-market growth for the remainder of fiscal 2018, citing positive customer sentiment, infrastructure funding and nonresidential construction indicators. It also anticipated benefits from PC-strand acquisition synergies, Houston plant production-line ramp-up, and prior facility investments. Fiscal 2018 capital expenditures were expected to total up to $21 million.
- Other items: The company received $0.439 million of insurance proceeds related to 2017 hurricane damage and business interruption. It completed a business acquisition during the half; purchase-price allocation effects were described as not material. No new restructuring charges were recorded. Ordinary-course legal matters were not expected to have a material adverse effect. No material risk-factor changes were reported.
- Key risks: Construction-market cyclicality and seasonality, customer demand and inventory shifts, steel-wire-rod price and availability, competitive pricing and cost pass-through, trade policy, and plant or equipment disruptions. Management noted that weaker markets could prompt reductions or delays in capital spending, dividends or repurchases.
Most important facts for investors to verify
- Whether selling-price increases can catch up with wire-rod and freight costs, and whether gross margins stabilize.
- Whether shipment growth, construction indicators and expected seasonal demand translate into sustained sales and profitability.
- Progress and returns from the acquisition, Houston production-line ramp-up, and planned capital expenditures of up to $21 million.
- The degree to which first-half earnings depended on the one-time $3.7 million tax remeasurement benefit.
- Cash conversion and working-capital trends, alongside dividend capacity and available credit-facility borrowing capacity.