Houston Wire & Cable Company
Q3 2018 Earnings Call Transcript

Published: 9 Nov 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Houston Wire & Cable Company's Third Quarter 2018 Earnings Conference Call. My name is Sidney, and I'll be your operator for today. Joining us on the call today are Jim Pokluda, President and Chief Executive Officer; and Chris Micklas, Vice President and Chief Financial Officer. Today's call is being recorded for replay purposes and all participants are in a listen-only mode. At the end of the financial discussion, we will conduct a question-and-answer session, and instructions will be given at that time. Comments during today's call may include forward-looking statements. Any such statements are based on assumptions that the company believes are reasonable, but subject to risk factors that are summarized in press releases and SEC filings. Forward-looking statements are not guarantees and actual results could differ materially from what is indicated in such statements. Any forward-looking statements speak only as of the date of this call and the company undertakes no obligation to publicly update such statements. If you did not receive a copy of the earnings press release that was distributed earlier this morning, a copy can be found under the Investor Relations page of the company's website at www.houwire.com. At this time, I would like to turn the call over to Jim Pokluda, President and Chief Executive Officer. Please begin whenever you’re ready.

[Jim Pokluda:]

Thank you, Sidney. Good morning, everyone, and thank you for joining us on our call today. I'll begin today’s call with an update of our third quarter 2018 results, then pass the call over to our CFO, Chris Micklas, who will discuss our financial performance in additional detail. We are very pleased to report another strong quarter of revenue growth and EPS of $0.15 per diluted share. Year-over-year revenue growth of 10.9% marks our fifth consecutive quarter of growth, and was driven by excellent execution of our strategic plan, an ongoing recovery of end market activity and customer demand. Gross margin of 23.8% was also very good, and despite of a decrease of approximately 6% in the spot price per pound of copper, increased 90 basis points over our third-quarter results in the prior year. Operating expenses were little higher than we would have normally expected, which was somewhat disappointing, but not unexpected as the operations team had a very busy quarter. During the quarter, we completed two distribution center moves, expanded existing distribution centers and conducted a major upgrade to an existing distribution center. Chris Micklas will provide you some additional color on these activities and the estimated costs associated during his prepared remarks. Q3 transactional volume per day, which we measure as invoice count, decreased approximately 5.6% versus Q3 '17. We’ll keep a close eye on this trend, but negative fluctuations in this area may not necessarily be alarmed, improved fill rates, which reduce invoices from multiple shipping locations and well executed pricing discipline, which reduces the invoice count for low-margin orders are actually positive trends for our company. We estimate that the sales results in our core business with services, maintenance, repair and operations demand, increased approximately 10% from the prior year quarter, and represented approximately 79% of our total revenue. The primary drivers of this growth remain increased demand in industrial and commercial, construction end markets that was well distributed geographically across the country. Strength in oil and gas markets continued to fuel the industrial market activity. In Q3 2018, the U.S. land-based rotary rig count increased to 1,034 from 918 in Q3 2017, and the price per barrel of WTI oil increased to approximately $73 from the $52 level in Q3 2017. Our products are used extensively in applications that support oil and gas exploration, extraction, transportation, storage and production, and we’re pleased that these markets have continued to perform well. The offshore rig count of 20 at the end of Q3 was too less than the closing count in Q3 2017. Although down slightly versus the prior year, similar to Q2 of this year, we are seeing early indications of improved year-over-year activity associated with rig activation, which is positive for our business as this work creates demand for a high performance copper wire, steel wire roll, and fabricated lifting products. We estimate that project sales for the third-quarter increased 13% from 2017, and represented approximately 21% of our revenue. Our three primary end markets for projects include utility power generation and environmental compliance, industrials and infrastructure. Project sales in the utility power generation and environmental compliance market increased approximately 69% over Q3 2017, due primarily to fossil fuel plan upgrades, and environmental compliance spend associated with improved management of post-combustion products. Sequentially versus Q2 2018 sales in this market increased approximately 49%. Industrial end market project sales were flat year-over-year and down 9% sequentially. Please recall that in Q2 of this year, we experienced 126% year-over-year industrial project growth. So on a sequential basis, we had a particularly difficult comp. Q3 industrial project sales were led by ongoing activity in oil and gas and industrial manufacturing. The industrial end market is the largest of our three primary end markets. Big swings can infer for our billings in this space due to backlog timing release. And although it's certainly important to keep a keen eye on quarterly performance, we feel it's more important to focus on longer trends, which remain quite favorable. Thus far into the year, our project pipeline has continued to improve and for the first nine months of 2018, year-over-year sales growth for industrial projects has grown 24%. Project sales in the infrastructure end-market increased approximately 5% year-over-year, and 35% sequentially. Primary subcategory growth segments included projects in public works and public facilities, commercial and transportation end markets. Our Q3 book-to-bill ratio was positive at 102.2, and the positive trends experienced in the third quarter thus far continued into Q4. As we move further into the fourth quarter, we’re off to a solid start. Although end market activity has become somewhat more choppy, at some point, we will begin to experience typical fourth quarter holiday and year-end seasonality and macroeconomic -- I’d like to reread that sentence. As we move further into the fourth quarter, we’re off to a solid start although end market activity has become a bit more choppy. And at some point, we will begin to experience typical fourth quarter holiday and year-end seasonality, macroeconomic data remains positive, gross margin percent is holding steady, and revenue has increased over the prior four -- Q4 period. Accordingly, our overall outlook remains positive. Finally, I’d like to close my prepared remarks by commenting on a recent announcement that Sandy Ross has joined our Board of Directors. Sandy is another great addition to our company as he is an accomplished business professional with significant experience involving financial reporting, internal controls, risk management, mergers and acquisitions, and capital markets. I believe Sandy's multiple skill sets will serve the interests of our company and shareholders as well. I'll now turn the call over to Chris for a detailed analysis of our financial results. Chris?

[Chris Micklas:]

Thanks, Jim, and good morning. In the third quarter of 2018, HWC earned $0.15 per share, up from the loss of $0.11 per share in the same period 2017. This comparison is impacted by tax adjustments that will be discussed in more detail later. Without these adjustments, HWC earned $0.10 per share, compared with $0.06 per share in 2017. These results represent the fifth quarter in a row of year-over-year improved financial performance. We continue to believe this performance trend is indicative of an overall increase in industrial demand, improved economic conditions, as well as the company's ability to execute on initiatives from our growth plan. Sales are $91.1 million, up almost 11% from the third quarter of 2017, and benefited primarily from an increase in industrial activity and favorable product mix. Gross margin is 23.8% of sales, which represents an improvement of 90 basis points over the same period last year and remains consistent with the previous quarters. The year-over-year gross profit increased $2.8 million or 15.2%. Operating expenses are $18.3 million, an increase of 11% from the third quarter of 2017. The increase in expense is a result of improved sales volume and gross margins, which drove increases in variable operating and selling expenses. Additionally, the quarter was negatively impacted by approximately $400,000 of costs related to two distribution center moves, expanded floor space and the warehouse reorganization. These additional costs were expected, but are unusual as the activity level was significantly greater than normal for any one quarter. We view the improvements made as necessary, and we believe they put the company in a better position to maintain our competitive cost structure and to improve on our already excellent customer service levels. The quarter’s profits pull-through as defined as change in EBIT divided by change in gross margin is 35%. Although in the previously mentioned extraordinary costs are excluded, pull-through is 50%, and continues to demonstrate our strong expense control and leverage. Overall operating expenses as a percent of sales are 20.4%, which is flat compared with the third quarter of 2017. Operating income is $3 million, which is an improvement of almost 50% from $2 million in the third quarter of 2017. Interest expense decreased $34,000 from the second quarter as average debt reduced by $5.6 million, but was partially offset by a slight interest rate increase of 10 basis points from 3.7%. As mentioned earlier, our effective tax rate is a benefit of 6%, and is favorably impacted by tax adjustments that resulted from the release of $1 million valuation allowance established in 2017, and of 2017 Tax Cuts and Jobs Act. Net of the adjustments, our tax rate is 27%, and is consistent with our communicated range of 26% to 28%. While we continue to manage the relevant aspects of the 2017 Act, we do not believe there are additional material impacts to our expected range. Turning the attention to the balance sheet cash flow and liquidity. During the third quarter, we generated $7.6 million from operations and our debt ended the quarter at $73.4 million. This is down $6.7 million as compared with the second quarter and down to the levels of the third quarter last year. The majority of the reduction in debt comes from our focus on working capital. At the end of the third quarter, working capital was $126 million, a $5.5 million improvement from the previous quarter's level of $31.5 million. Cash paid for capital expenditures during the quarter is $469,000 and is $1.2 million year-to-date. We anticipate the 2018 total spend of less than $2 million, which is in line with the 2017 spend. We remain in compliance with the covenants of our $100 million asset base credit facility. At the end of the quarter, we had $26.6 million in available capacity, which is the highest level of availability in a year, and is adequate to fund ongoing operations. Our performance and results in this quarter have been encouraging. Moving forward, our top priorities remain executing the multiple components of our strategic growth plan, driving profitable growth and disciplined expense management. Multiple projects involving streamlining are order fulfillment, efficiency maximization and improving the utilization of our working capital will continue. We are pleased with the progress that we have made, and we look forward to continued success in the fourth quarter. This concludes the prepared remarks. And at this time, I'll turn the call back over to the operator.

[Operator:]

[Operator Instructions] Our first question comes from Damon Benedict with Nierenberg Investments. Your line is now open.

[Damon Benedict:]

Happy to see you reduce debt despite strong top line growth. And just, Chris if you could expand on the last point you made on the working capital management, I’d love to hear outlook for continued improvement there?

[Chris Micklas:]

Well, we’re looking at several different things. So when it comes to inventory, we’re looking to maximize the throughput on A and B, which is high volume items, and we’re looking to better stratify where we purchase products and where we store them. When it comes to payables, we’re constantly looking at the vendor terms and looking at the mix between potential rebates and the term usage. And with receivables, we continue to just monitor and stay on top of -- any of what we call hear a first-class problem, and that’s the growth in sales and additional receivables. But we stay on top of that. We have not seen any deviations in our past dues. So we just continue to push that and just stay on top of it.

[Damon Benedict:]

And Jim, on pricing discipline, happy to see that's still benefiting the gross margin. Can you talk about when you ramped up that effort in earnest? I now, it’s always a focus. But I think you have been, perhaps, more focused on at the normal in recent quarters. And just wanted to hear when that started? And how much further room for improvement is there? Or we eventually sort of lap them in bulk of that benefit?

[Jim Pokluda:]

It came through in a couple of ways, Damon. The first couple of things we did were at the very end of Q1 2017. And then we've made a couple more moves in Q2 of 2017, and one move early in Q3 of 2017. And as you've observed they have been quite successful. We’ve to be careful with gross margin though. It’s a little bit like blood pressure. You want to stay in the sweet spot. If it gets too high and that’s bad, and if it gets too low that's also too bad because there are opportunity costs associated in both of those bookings. I think, we’re in a good spot now and pleased -- relatively pleased, frankly. Where can we improve? We can do a better job in some of our end market segments that improve some of the highly customized, highly fabricated slings that we manufacture, so that’s in the steel wire rope, end of our business. Another area is in the synthetics end of our business. We have a so shop that manufactures synthetics slings. We're focusing on margin improvement there. And I believe there's still room for improvement in the faster end of our business. So the -- what we call the legacy end markets and customers Wire & Cable, I don't feel comfortable of trying to push that much further. But I believe there is room for advancement in other areas of our business. Now the next logical question would be or counter would be, thanks Jim, how much? It’s not 200 basis points, but over the next year, maybe another 20 or 30 basis points.

[Damon Benedict:]

And again, don't want to try to pin you down on quantifying copper. But if price is just sort of flat line here, you’ll start to see a bit of a headwind on a year-over-year basis. Do you think you have other areas like pricing that's been compensated for that?

[Jim Pokluda:]

Historically, the data would support your statement. However, we have been very successful with this pricing discipline, very successful. So if you’d have asked me this question 10 years ago, I would've been more inclined to immediately agree. Copper stays flat. I don't -- I have no reason to believe based on our [Audio Gap] be that much of a headwind. A major headwind would be an erosion of primary end markets, but we see no indication of that.

[Damon Benedict:]

And on the SG&A lines, a little more increase than we’ve been used to seeing. And I think it was still up maybe 8%, excluding the Eric warehouse unusual items that you called out. So I just wanted to hear on the focus there on leveraging this revenue growth going forward on that line?

[Jim Pokluda:]

Chris, I know you have thoughts on that. Let me just make a couple of quick comments. We -- you know this business well, and that makes it easier to talk to you about something like this. There are going to be periods where we have fluctuations in project revenue streams and fluctuations in price expenses. And we encourage everybody to try and exclude quarterly iterations and look over the long term. In keeping with that thought, when sales talent presents, when management talent presents, we jump on that. And we’re doing well and the good fortune from that another first-class problem is that, people want to come work for us. And if they’re good, we’re going to go after those people that talent because we will see that as a strategic investment. So there are situations where we see expense movement with salaries and variable comp that comes with salaries. Another key thing though is to never ever lose focus on the importance with providing superior operational performance and execution, and that’s just cost money. So I'm not going to shy away from investing in improvements, in distribution centers, material handling equipment, et cetera that will improve our operational performance. If you take your medicine upfront, it hurts a little bit, but our view in the long run is that it really pays off. Chris, that was very high level. You may want to add something else, but if not, we’ll just move onto the next question.

[Chris Micklas:]

No, I think that covered it well.

[Jim Pokluda:]

Anybody else in the queue that should have hop for guys?

[Damon Benedict:]

Or do you want me to keep going?

[Jim Pokluda:]

All right. There may be one more participants. Likely one more, but … okay, go ahead.

[Damon Benedict:]

Two more. So, on the long term focus, totally makes sense, and happy to note that look that on a trailing 12 months basis, your earnings growth has been absolutely phenomenal compared to the prior 12. So what do you view the main near moving drivers of continued improvement from where we are here today?

[Jim Pokluda:]

Well the macros have to hold up. And there is every indication right now that things are going well, employment, durable, nondurable goods. Industrial production is fantastic. I'm sure you've seen the most recent numbers, very, very good, capacity utilization also very, very good. On a relative basis money is still cheap. So, although capital expansion will be a little bit more expensive than it was a few years ago based on historical front, certainly not. Lots of news in the press about reserves stacks of conventional oil, and how necessary it would be for our country to continue to invest in oil extraction and infrastructure, which is important to our business. Construction markets are solid. So at a high level, my position is, and I would say most economists' position is things are quite good. Metals are holding up. We’ve seen inflation in steel. We’ve seen inflation in nickel and copper. I suppose all things being equal is similar behaving. Majority of the leading indicators out there worldwide demand et cetera, would indicate that copper probably isn't that much of a wildcard. Our credit facility is rock solid. We can finance our growth. We’ve a good management team. So borrowing any terrible, unforeseen trade war or worldwide disruption, our position is that the governing dynamics that fueled this business are good.

[Damon Benedict:]

On capital allocation, what are your updated thoughts? I mean, we’ve seen stock on back a bit despite your really strong performance. And I think it around one times book is among the cheapest in your industry, yet you’re generating good cash, you’re growing double digits, a lot of positives. And they don’t seem queue however reflected in the price. So I wanted to hear your thoughts on repurchase potential, and comparing that to other uses of capital?

[Chris Micklas:]

We always look at our capital -- our cost of capital and our capital structure, and we discussed this at the board level. We look, right now, at the opportunities, and we like the flexibility of repaying debt to give us flexibility going forward as we look at potential acquisitions or changes in structure and things that we like to do. So, we continue to monitor and look at it, and we will continue to do that. But currently, as you saw, we prefer to pay down the debt, and did see balance sheet a little stronger during the time of the interest rates to see where things play out. And then, we will look at it again and continue to look at it all the time.

[Damon Benedict:]

Okay. That makes sense. And now that we’re couple of years, I think, post the Vertex] deal. Do you feel like you’ve got that one integrated enough, and you could move onto undo deal if you found something you liked?

[Jim Pokluda:]

Vertex is certainly integrated really part of the family, and full steam ahead with being an inclusive part of our team. So we feel good about that. Mission accomplished there. However, we have a lot of work to do at Vertex. And I don't mean that to sound especially negative rather it’s a comment on the opportunity. I believe there are abundant opportunities for improved performance at Vertex, and that’s not intended to be negative either. It’s just that -- it's, in my view, a pretty blank canvas. It's just a lot we can do with that company. And yes, yes, we’re couple of years into it. And we’ve kicked the trailing wheels off, but there's a lot we can do with that. It’s a -- as we mentioned, a small-company in a $2.6 billion space, and that's very interesting to me. With respect to -- could we take on another opportunity, should it present? Absolutely. We’ve the talent to do it. We have the skill sets to do. We have the programs to do it. But to Chris’s point a moment ago, it's important that we also keep an eye on our leverage. And right now, we have a fair amount of debt. So we’re just laser focused on improving our performance and utilization of working capital to get that debt down. So when something does present, we can pull the trigger and go out and get it.

[Operator:]

Thank you. [Operator Instructions] I am not showing any further questions at this time. I would now like to turn the call back to Mr. Jim Pokluda for any closing remarks.

[Jim Pokluda:]

Thank you, Sidney. And thanks to our valued team members for their continued hard work and dedication. To our shareholders, we appreciate you joining us on the call today. And look forward to success in the period ahead. Good day, everyone.

[Operator:]

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.