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Edited Transcript of IIIN earnings conference call or presentation 17-Oct-19 2:00pm GMT

Q4 2019 Insteel Industries Inc Earnings Call

MOUNT AIRY Oct 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Insteel Industries Inc earnings conference call or presentation Thursday, October 17, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Howard Osler Woltz

Insteel Industries, Inc. - Chairman, President & CEO

* Michael C. Gazmarian

Insteel Industries, Inc. - VP, CFO & Treasurer

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Conference Call Participants

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* Julio Alberto Romero

Sidoti & Company, LLC - Equity Analyst

* Tyson Lee Bauer

Kansas City Capital Associates - Senior Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Insteel Industries fourth quarter earnings conference call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, H. Woltz, President and CEO. Thank you. Please go ahead, sir.

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [2]

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Good morning. Thank you for your interest in Insteel, and welcome to our fourth quarter 2019 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 first -- fourth quarter financial results and outlook for our markets, and I'll follow up to comment more on business conditions.

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Michael C. Gazmarian, Insteel Industries, Inc. - VP, CFO & Treasurer [3]

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Thank you, H., and good morning to everyone joining us on the call. As we reported earlier today, Insteel's results for the fourth quarter of fiscal 2019 continued to be negatively impacted by the surge in low-priced import competition spurred by the Section 232 tariffs on imported steel, resulting in a loss of $0.09 a share as compared to $0.49 a share of earnings in the prior year period. The increase in imports continued to be centered in certain of our PC strand and standard welded wire reinforcement markets where foreign competitors are leveraging the considerable cost advantage they now enjoy as a result of the tariffs, which have driven U.S. prices for hot-rolled steel wire rod, our primary raw material, substantially higher than global market levels. Not surprisingly, foreign competitors have responded by underpricing domestic producers in order to expand their market share.

Following a record rainfall we experienced through the first 9 months of the fiscal year, which resulted in construction project delays and deferred orders, the weather was largely a nonfactor during the fourth quarter with precipitation following the average or below average level across most of our markets. Despite the improvement in the weather, shipments for the quarter fell 4% sequentially from Q3 and were up only 7.2% from the depressed level of a year ago.

Drilling down into the year-over-year comp, shipments in the markets most affected by import competition, which represented around 30% of our sales for the quarter, were essentially unchanged from a year ago, reflecting the surge in imports, while the volume for the remainder of our business was up 11.9%. Average selling prices for the quarter fell another 6.5% from the third quarter and were down 12.8% year-over-year due to the import-related pricing pressure as well as domestic competitors' attempts to backfill loss volume and retain existing business.

The ASP rose and was more pronounced in markets subject to import competition where the sequential reduction from Q3 was 10%, which is more than double the 4.2% decrease for the remainder of our business.

Gross profit for the quarter fell $15.7 million from a year ago, and gross margin narrowed to 3.4% due to the compression in spreads between selling prices and raw material costs. On a sequential basis, gross profit decreased $4.4 million from the third quarter, and gross margin fell 310 basis points also due to lower spreads and, to a lesser extent, the reduction in shipments.

The spread compression that we've experienced over the course of this year has been compounded by the consumption of higher-cost inventory and the declining price environment. Considering that we're typically carrying around 3 months of inventory valued on a FIFO basis, the ongoing price pressure has resulted in a matching of lower ASPs for our products against higher-cost inventory that was purchased in earlier period, further reducing spreads and margins. This unfavorable trend has persisted during the year, following the initial run-up in pricings that occurred during the second half of fiscal 2018.

SG&A expense for the quarter fell $1.6 million to $5.9 million or 5.2% of net sales from $7.5 million or 6.2% last year due to lower incentive comp expense driven by a weaker financial results and, to a lesser extent, a reduction in the earnout liability related to OEP transactions.

Our effective tax rate for the year rose to 24.9% from 22.4% through the third quarter and 22.7% last year, excluding the impact of a $3.3 million deferred tax remeasurement gain on the prior year amount. The increase was largely driven by permanent book-tax differences, which had an amplified impact on the rate due to the lower pretax earnings, together with an increase in the overall state tax rate.

Moving to the balance sheet and cash flow statement. Cash flow from operations for the quarter rose to $32.5 million from $4.1 million last year due to a $31.4 million reduction in working capital as we made significant progress rebalancing our inventories from the elevated levels of earlier in the year. Following Q3's $12.6 million decrease, inventories dropped another $33.8 million during the fourth quarter on a 27% reduction in the quantity on hand and an 8% decrease in average unit cost, reflecting the continuing decline in wire rod prices.

Based on our sales forecast for Q1, our quarter-end inventories represented 3.1 months of shipments compared with 3.5 months at the end of the third quarter valued at an average unit cost that was lower than the beginning average in the amount reflected in Q4 cost of sales. This lower cost should favorably impact our margins during the first quarter unless ASPs fall to the same or a greater extent as was the case the last 2 quarters due to continued pricing pressure. On a pro forma basis, our gross margin for the fourth quarter would have been around 500 basis points higher than the reported amount if cost of sales was adjusted to reflect the lower carrying value of ending inventory and ASPs were unchanged.

In allocating our cash flow and managing the cyclical nature of our business, we continue to focus on 3 objectives: reinvesting in the business for growth and to improve our cost and productivity, maintaining adequate financial strength and flexibility and returning capital to our shareholders in a disciplined manner. Going forward, we will continue to balance these objectives in deploying capital in any excess cash balances. Capital expenditures came in at $10.5 million for the year, down $7.8 million from last year focused on cost and productivity improvement initiatives, in addition to recurring maintenance requirements. Looking ahead to 2020, we expect CapEx to come in at less than $17 million.

We ended the quarter with $38.2 million of cash on hand or just under $2 a share and no borrowings outstanding on our $100 million revolving credit facility, providing us with substantial financial flexibility and the ability to pursue any attractive growth opportunities that may arise in this challenging environment.

Looking ahead to fiscal 2020, we expect favorable conditions on our construction end markets with higher growth in the infrastructure segment offsetting further moderation in nonres activity as we move later into the cycle. Through the first 8 months of the year, public construction spending was up 5.7% from a year ago with highway and street construction, one of the largest end-use applications for our products, rising 10.8% year-over-year.

The favorable trends for state contract lettings over the past few years should translate into continued growth in infrastructure spending in the coming quarters, particularly in larger markets such as Texas, Florida and California supported by various funding initiatives, including fuel tax increases, bond issuances and other ballot measures. The architectural billings and Dodge Momentum Index' leading indicators for nonresidential building construction have remained flat this year, reflecting relatively stable conditions with the ABI averaging 50.1, just above the 50 growth threshold through August. The recent AIA consensus construction forecast reflects the growth in nonresidential building construction slowing in 2020, but remaining positive at 2.4%.

We should also benefit from any weather-related deferral of business from earlier this year as contractors continue to play catch-up in the coming quarters.

I will now turn the call back over to H.

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [4]

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Thank you, Mike. As Mike indicated, our fourth quarter results reflect modestly improving shipment trends relative to the prior year, resulting from reasonably favorable underlying demand for our reinforcing products and a return to more normalized weather conditions. Looking forward, we expect construction market conditions will support continued growth in the demand for our products during fiscal 2020. Not surprisingly, our fourth quarter financial performance was negatively impacted by the continuing surge of imported products that we have contended with since last year.

Through the first half of calendar 2019, PC strand imports increased by nearly 50% from the prior year, and imports of standard welded wire reinforcing from Mexico have been decreased by 60%. In both cases, foreign competitors have expanded their market share by underpricing domestic producers, which has served to displace U.S. production and U.S. workers. Average unit values for imports of have fallen into levers that only marginally above U.S. wire rod prices, creating an unsustainable competitive environment for domestic producers. Unfortunately, current conditions continued to incentivize foreign competitors to ship production downstream and capitalize on the market distortions that have been created by U.S. trade policy. So it appears the administration has firmly committed to its steel trade policy. The only reasonable resolution of these distortions is to extend the Section 232 tariff to include downstream products.

We have continued our dialogue with the administration and believe they understand the unintended consequences of current policy and are evaluating options to address the matter although it's not possible to predict whether they'll take action to correct the distortions that have been created. It's obvious, however, that the impact of current policy is antithetical to an administration that is arguably more focused than any prior administration on the strengthening of the domestic manufacturing industries. We'll continue to reassess our operating strategy in response to the unfavorable market changes resulting from the tariff, but our current plans are to continue to compete with low-priced imports, run our plants and strive for additional improvements in manufacturing efficiencies and costs, while we work towards a satisfactory resolution of trade matters with the administration.

Turning to CapEx. 2019 came in at $10.5 million, reflecting timing differences relative to our prior expectations. We're forecasting 2020 investments of approximately $17 million subject to revisions as we move through the year with investments targeted toward expanding our product capabilities, lowering the cash cost of production and updating technology, including our information systems.

During Q4, we continued commissioning activities for a new ESM production line at our North Carolina facility that will increase capacity for certain niche products as well as substantially reduce our cash operating costs. Market conditions for ESM continue to be favorable, which should support a smooth ramp-up of the line, following additional modifications in the equipment vendors' confirmation that it complies with our performance specifications.

In summary, we believe that 2020 will be another growth year in demand for our products. We will remain focused on improving all aspects of our manufacturing operations and will continue our dialogue with the administration to address the challenges created by steel trade policy. And we'll continue to be vigilant in pursuing attractive growth opportunities both organic and through acquisition. This concludes our prepared remarks. And we'll now take your questions.

Chris, would you please explain the procedure for asking questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Julio Romero of Sidoti & Company.

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Julio Alberto Romero, Sidoti & Company, LLC - Equity Analyst [2]

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I wanted to ask about your ASPs, your average selling prices. It seems like earlier in the year, they were holding up a little better than maybe I expected, even with this kind of similar backdrop, and it seems like the levies on selling prices might have kind of broken a little bit harder this quarter. Can you just try to quantify at all maybe how much industry dynamics the inventory reduction by your competitors may have affected ASPs versus, let's say, the declining fuel prices and how's that all kind of shaken out?

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [3]

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Yes. I'm not so sure that we can answer the question exactly as it was -- as you asked it, but let me say that it's been highly competitive all year. It didn't change here in our fourth quarter, and it's driven both by domestic competition and import competition. And I think one of the underlying realities is that steel prices worldwide have been under tremendous pressure during 2019. So I don't discern an uptick in the level of competitive activity. It's been pretty intense all year.

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Michael C. Gazmarian, Insteel Industries, Inc. - VP, CFO & Treasurer [4]

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Yes. And Julio, as I indicated in my comments, the pricing pressure has been more pronounced in those markets that are susceptible to import competition, or if you drill down into that 6.5% sequential reduction, the decrease for the import-sensitive portion of our business was more than double the reduction for the remainder. So it just, again, highlights the impact of the increased import competition.

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Julio Alberto Romero, Sidoti & Company, LLC - Equity Analyst [5]

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Okay. That's helpful. Mike, would you happen to have the 2019 gross profit drivers, kind of unchanged from last year or if there's any -- anything to highlight there?

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Michael C. Gazmarian, Insteel Industries, Inc. - VP, CFO & Treasurer [6]

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No. I mean in -- are you referring to just the relative impact on the quarter or?

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Julio Alberto Romero, Sidoti & Company, LLC - Equity Analyst [7]

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No. I was referring to -- typically, annually, you guys break out raw material cost of sales versus manufacturing and price.

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Michael C. Gazmarian, Insteel Industries, Inc. - VP, CFO & Treasurer [8]

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Right. Yes. We'll actually be posting an updated presentation later today that'll provide that detail. But when you look at the changes of the components, you'll see there's a shift with the raw material percentage being a little higher relative to the other components. But that will be out there later today.

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Julio Alberto Romero, Sidoti & Company, LLC - Equity Analyst [9]

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Okay. And just maybe one more, and I'll hop back in the queue, is just can you maybe talk about how weather has trended maybe throughout the first few weeks of October?

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Michael C. Gazmarian, Insteel Industries, Inc. - VP, CFO & Treasurer [10]

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Yes. I mean it's still -- it's been spotty. I mean there's been some markets that have experienced some raining stretches, but overall, I think we're still back down closer to normalized levels from what we experienced through the first 3 quarters of the year. I think if you look at the Q4 weather data just from a precipitation standpoint, it was right in line with the average level going back historically.

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Operator [11]

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And our next question comes from the line of Tyson Bauer with KC Capital.

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Tyson Lee Bauer, Kansas City Capital Associates - Senior Analyst [12]

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When we went to the period of the dollar strengthening as we saw plus the pending tariff increases by another 5%, did that create an exacerbation of the problem that you had seen in the prior quarter? And does that provide any -- some less or a little bit of a relief as we go in if those metrics are in place as they were a quarter ago?

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [13]

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Certainly, the strengthening dollar has an influence, but I would say it's moderate at best. The tariff increase you're referring to is not applicable to the Section 232 steel tariff that's affecting Insteel. It's probably the 301 tariff that is a China issue. So I'll just tell you that the dislocation of steel prices in the U.S. relative to the rest of the world continues unabated and continues to be the root cause of the pressures that we're feeling.

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Tyson Lee Bauer, Kansas City Capital Associates - Senior Analyst [14]

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Okay. Mike, you talked about 500 basis point reduction due to the inventory and pricing. Obviously, you can attribute all of that to the 30% that's affected directly by the imports. Is there a way to try to splice that to see where the true impacts came from?

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Michael C. Gazmarian, Insteel Industries, Inc. - VP, CFO & Treasurer [15]

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Yes. I don't know that we can drill down to that level. I mean I think, just getting back to my comments on the spread compression that we've experienced over the course of this year, it's really just a function of the timing being behind the curve, aside from the increased import pressures, just the matching of the higher-cost inventory versus the continued reduction in ASPs. So I think we just need to get to a point when we reach a bottom and level out at some point, I think our results will be more reflective of the current market environment and we'll get this timing issue behind us. But as long as it persists, we're likely to see that same dynamic.

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [16]

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And Tyson, just to add some context to that, the American middle market reported yesterday that wire rod prices have fallen now for 8 consecutive months. So that sort of environments is typically challenging for us.

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Tyson Lee Bauer, Kansas City Capital Associates - Senior Analyst [17]

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Okay. There have been reports of a potential clawback in the FAST Act that could be implemented July 1, 2020. Do you have any further color or commentary that you could provide in regards to those reports that possibility of $7.6 billion being taken back out of the original budget?

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Michael C. Gazmarian, Insteel Industries, Inc. - VP, CFO & Treasurer [18]

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No. We have seen some references to that action and concern about the potential impact, but I think of greater concern is just what comes out of the budget process in D.C. where we're back to operating under a continuing resolution that runs through November. And you may recall that when there was a 2-year budget agreement reached earlier that this hasn't -- the second year hasn't gone into effect yet pending an agreement on the 2020 budget. So I guess, until we have better clarity there, it's difficult to really estimate what the overall impact would be, whether -- for that decision maybe it could be reversed or there could be additional funding provided in the final budget yet to be seen.

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Operator [19]

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(Operator Instructions) And our next question comes from the line of [Tim Kero] with (inaudible).

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Unidentified Analyst, [20]

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I'm trying to get a better understanding of the tariff situation. Can you be specific on any responses you have received related to your efforts to get the 232 tariff extended?

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [21]

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Well, as I said in my prepared comments, we have been successful in providing extensive data on the impact of imports on our performance. And I think it's clear that there's an unintended consequence. I think the administration appreciates that there's an unintended consequence on the question as whether there is action to resolve it or not. And I honestly can't -- I can't opine on whether that will happen, but I do believe that there's some degree of alarm at the adverse consequences on downstream producers of the current environment. And I believe that it's very contrary to the aspirations of this administration to nurture the manufacturing industry. So the optimist in me says that there will be a resolution that's favorable to Insteel, but it's difficult to know when that might happen.

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Unidentified Analyst, [22]

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Well, I agree with your views. But when you say you've been successful, does that mean that they have acknowledged the problem in writing to you?

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [23]

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No.

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Unidentified Analyst, [24]

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And so is it just some open-ended process where there is no deadline by which a response has to be made?

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [25]

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Correct.

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Unidentified Analyst, [26]

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I mean it would seem like there would be a formal process. You file a complaint, and they're required to reply you in writing. That's just not the situation, right?

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [27]

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That's not the situation at all. This is a matter of administration prerogative, and that's how the tariff was implemented, and it will be administration prerogative to change it.

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Unidentified Analyst, [28]

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Okay. Is the problem also that you're not trying to get tariff relief, but you're trying to get tariffs applied to others, and they just -- there's just not a real mechanism to deal with that?

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [29]

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You're correct that we have not advocated for termination of the Section 232 tariff. We have advocated for recognition of interdependence of the supply chain where you can't tariff upstream products and not tariff downstream products without creating exactly the situation that we're confronting right now. And by the way, there was a 6-month investigation into the national security implications of steel imports that resulted in the implementation of the 232 tariff. And during that process, we made the point multiple times that should they find that there are national security implications of steel imports that warrant implementation of a tariff, they had to look at the entire supply chain, and that's just simply didn't happen.

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Operator [30]

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And I'm not showing any further questions at this time. I would now like to turn the call back to Mr. H. Woltz, President and CEO, for any further remarks.

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Howard Osler Woltz, Insteel Industries, Inc. - Chairman, President & CEO [31]

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We appreciate your interest in Insteel. We encourage your follow-up if you have further questions, and we look forward to talking to you next quarter. Thank you.

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Operator [32]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.