Houston Wire & Cable Company
Q1 2016 Earnings Call Transcript

Published: 8 May 2016

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Houston Wire & Cable Company's First Quarter 2016 Earnings Conference Call. My name is Christie and I will be your operator for today. Joining us on the call today are Jim Pokluda, President and Chief Executive Financial -- Executive Officer, and Nic Graham, 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 when you are ready.

[James L. Pokluda III:]

Thank you, Christie. Good morning, everyone, and thank you for joining us on our call today. I will begin today's call with an overview of our first quarter 2016 results and then I will turn the call over to Nic who will discuss our financial performance in greater detail. In the first quarter, headwinds experienced in several prior quarters continued. The protracted reduction in the price of oil, significant metals deflation in copper, steel, and aluminum, and the strength of the U.S. dollar significantly impacted our industrial end markets and financial results. Sales decreased approximately 11% when adjusted for deflation in metals, which in our analysis includes copper and steel. Gross margin at 20.7% decreased 100 basis points from the first quarter of 2015 primarily due to extremely competitive pricing resulting from reduced market demand and low vendor rebates due to reduced stock purchases. Transactional volume, which we measure as invoice count, decreased 4% versus Q1 2015. We estimate that sales results in our core business with services, maintenance, repair, and operations demand decreased approximately 9% from the prior year quarter when adjusted for metals and represented approximately 72% of our total revenue. As we have experienced for some time now, MRO activity was down most significantly in geographic regions with high concentrations of oil and gas reserves. We continue to experience demand erosion in this component of the industrial market. And although the rate of decline in activity in oil and gas appears to be flattening, we believe it is still too soon to call bottom in this very important end market for our business. Partially offsetting reduced demand in oil and gas markets is a continued slow recovery along the Eastern Seaboard and micro regions with less exposure to oil and gas. Project sales decreased 18% when adjusted for metals and represented approximately 28% 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 were up approximately 3% year-over-year, driven primarily by growth in fossil fuel power generation and environmental compliance devices, and to a lesser degree, alternative fuel power generation. Projects sales in the industrials end market declined approximately 40% year-over-year. Upstream and midstream oil and gas markets were down most substantially, followed by downstream, which is the largest of the three markets, but the one most subject to volatility given the large variance in order size. Metals and minerals, agriculture, food, and beverage were positive year-over-year for the quarter. Project sales in the infrastructure end market increased approximately 23% year-over-year. Demand increases in public works and telecommunications were the primary contributors to our results in this area of our business. Moving further into 2016, we believe that although market demand appears to be stabilizing, the strong U.S. dollar and the low price of oil, copper, steel, and aluminum will remain headwinds to our business. Through April of this year, our monthly revenue per day has been inconsistent. January revenue was below expectation. Sequentially, February revenue improved double-digits, March revenue decreased mid-single digits and April revenue was flat with March revenue. Although February sales momentum did not flow through to the following months, we did begin to see the emergence of some positive trends. Monthly transactional activity in April was a six-month high, and through April transactional activity has grown steadily for the past five months. The book-to-bill ratio through April is 103% and sales transfer of products targeting non-industrial markets have gained additional traction, and in many cases are up over prior year. In a minute, I'll pass the call over to Nic who will discuss our financial results in greater detail, including several of the actions we have taken to manage the items we can truly control in this type of operating environment. Before I do that, though, I'd like to make just a few more comments on the overall marketplace and our performance during this difficult period. Reflecting on Q1, there is certainly no doubt that we are disappointed with our financial performance results. We are facing extremely difficult market conditions resulting from industrial end market demand weakness driven by the reduction in the price of oil. This situation has been created by an aberrational event, but is something we must combat nonetheless. With an estimated more than 30% of our end customers in the oil and gas market, and many more in tangentially related markets, the past several quarters have been especially difficult. Like others in the marketplace with high exposure to oil and gas, we have been hit especially hard, far worse than during the great recession when oil and gas markets actually performed much better than they are now. Just as one quick reference, the most recent U.S. rotary rig count was 420, down 54% from this time last year. As a proxy, the rig count in June 2009, during the peak of the great recession was 876. Thus we are persevering through this period and that I believe that despite the market challenges we face, they will eventually pass and we are making progress. Green shoots exist, new products are performing well, our operational excellence remains world class, morale is high, the balance sheet is strong, and our value proposition remains leverageable and in demand from our valued business partners. We believe we have taken the appropriate steps to operate in the present environment and continue to execute our business plan through a group of highly motivated and talented individuals. I will now turn the call over to Nic Graham, our Vice President, and CFO, for a detailed analysis of our financial results. Nic?

[Nicol G. Graham:]

Thanks, Jim, and good morning, ladies and gentlemen. In the latter part of 2015, we took a look at the company's 2016 financial expectations and what market performance levels we felt we might attain. We did expect demand levels in the first quarter and resulting sales volume to be the lowest of the year. However, the actual sales levels that we achieved in the first quarter fell short of our estimate. During the quarter, we were successful in reducing the level of operating expenses, which at $13.4 million were down $560,000 or 4% year-over-year from $14 million and also down sequentially excluding the fourth quarter 2015 impairment charge by $500,000 or 3.6%. The cost reduction initiative will remain an ongoing priority for the balance of 2016. However, the loss of leverage from the top line sales decrease more than offset the operating expenses savings and operating profit and net income were compressed from the levels that came in 2015. We did manage to reduce our fixed charges as interest expense at $175,000 decreased from $265,000 or 34% from the prior year period due to lower average debt levels and the 1.7% average interest rate. I'd also like to comment on our tax rate, which was impacted by share based compensation deficits of slightly less than $100,000, which arose during the quarter. These had the effect of reducing the normal tax credit for the pretax loss and resulted in a reduced tax credit at the rate of 14%. As mentioned at the Q4 2015 earnings call, we expect additional share based deficits to occur as grants issued at prices higher than the current stock price expire. These are considered discrete tax items and their impact on income tax expense will be recorded in the quarters that the deficits occur. Despite the disappointing operating results, we were able to achieve several of our first quarter 2016 financial goals, which included the reduction of the working capital investment and a decrease in the company's debt and leverage. Working capital fell by $6.6 million sequentially. The main component parts of this decrease was inventory down $5.2 million as we adjusted and improved reasonable profiles to conform to current demand levels and accounts receivable, down $3.2 million, mainly due to the collection in 2015 of the 2015 vendor incentives. The aging of our customer receivables is in line with historic norms. Our DSO decreased as collections were strong and customer delinquencies were minimal. As industrial market conditions remained depressed, we are being extremely vigilant with our customer credit line. On debt, we generated strong cash flow from operation of $7.6 million of which $5.5 million was used to reduce debt, which fell 14% from $39.2 million at December 2015 to $33.6 million at March 2016. If we look back to March 2015, debt has dropped from $47.7 million or $14.1 million, 29.5%. The reduction in debt has had a positive effect on our leverage as our debt-to-equity ratio has fallen from 39.2% at December 2015 to 34.2% at Mach 2016. We also have ample capacity under our credit facility to fund our current and near term needs as availability under our credit facility at March 2016 was $42.2 million, slightly higher than Q4 2015's $41.5 million. We continue to remain in full compliance with the availability based covenants of our loan and security agreement. Some additional closing comments, capital expenditures. The total investment for the quarter was $337,000 and we anticipate the total 2016 investment to be in the $1 million to $1.25 million range, which is a return to historical levels prior to investment in the recent Houston Wire Building -- excuse me, prior to the recent Houston Wire Rope Building consolidation. Return to shareholders, we continue to repurchase stock, 124,000 shares during the quarter and pay our shareholders a $0.06 per share dividend. Our balance sheet is strong. Leverage is low, cash flow is healthy and our cost of funds is competitive. Our model is efficient when demand and top line sales levels return to normal levels. Looking ahead at some of the current initiatives for the balance of the year, continue the reduction in the working capital investment, primarily through inventory re-profiling, reduce the level of debt, scrutinize and review new business development initiatives, including new products and markets, and ensure that requested capital allocation is prudent and provides a solid return to our shareholders, and review the efficiency of our operating expense spend, especially those expenses of a discretionary nature to ensure maximum return. That concludes our prepared remarks. At this time, I'll turn the call back over to the operator. Christie?

[Operator:]

Thank you [Operator Instructions] We do have a question from the line of Sam Darkatsh of Raymond James. Your line is open.

[Sam Darkatsh:]

Good morning, Jim, Nic. How are you?

[James L. Pokluda III:]

Fine, good morning, Sam.

[Nicol G. Graham:]

Good morning.

[Sam Darkatsh:]

Good morning. Several questions, if I might. First off, your commentary around April. You said I believe it was sequentially flat with March. What does that mean on a year-on-year basis and was there a benefit to the Easter holiday timing in the month?

[James L. Pokluda III:]

There was no benefit to the timing. Unfortunately April was a disappointment. I do not have April 2015 numbers at my fingertips. However, it hasn't been our practice in the past to provide that level of granularity, Sam. But I am happy to share with you my emotions around the month. And let's just take the entire year-to-date period for that matter. January was very difficult, as I've mentioned on this call, and on the call prior to this, especially disappointing because we never expect January to be good anyway. Budget dollars are generally exhausted in December and people come into work in January with no wind in their sail. Despite that market reality, seasonal business reality, January was a disappointment. February, however, came back really nice. Order volumes up, margin healthy, bookings up, and I really started to feel quite a bit better about market outlook. And then March was a disappointment. We had some things happen in March that typically don't, but nonetheless March was just not a month that was able to continue February's momentum. April's traditionally a busy period. It was not. Now look, we had incredible rains down in Houston, 15 inches in one day on one of the episodes, and parts of our mechanical wire business were basically out of operation for a week in Houston and other areas in Louisiana. So we had some things in April that were certainly unpleasant. But the feel for the market demand and market recovery was generally not positive, not what I hoped it would be, which in a typical year, April -- which when in a typical year, April is generally a good month.

[Sam Darkatsh:]

So I apologize if this question comes out indelicately, Jim. So you mentioned that the business you think is stabilizing. If we are looking at a quarterly sales run rate of $65 million to maybe $75 million or so, it would probably argue that your operating expense cost structure needs to be considerably lower or reevaluated. At what point do you start making really challenging decisions and what opportunities are there to take meaningful cost out of OpEx that does not impair your ability to grow at or above the market if and when it recovers?

[James L. Pokluda III:]

I think that's a very fair question, Sam. Certainly, something we think about all the time. We've had a couple of waves of expense reductions, the most significant of which occurred in the latter part of 2014, early part of 2015 when we took our 13% of our employee base. That was a pretty deep cut, didn't want to go any further into the muscle. Since then, we've been especially cautious with base rate increases and actually, the replacement of people that have either been managed out or cycled out of our business. You reach a point where, as you said, the tough decisions really have to be made because to the best of our ability, our management leadership team's ability, we need to make sure that the construct of this business, the employee base, capital investments, inventory investments are taken with a long view in mind. Let me -- I'm going to give you a pretty long answer to this question and I hope it provides some perspective and will help explain to you why we're not going to be penny wise and pound foolish in this type of operating environment. So I'm going to kind of answer a little bit of your question now and tell you that we think we have room to take some more out, but we're not going to go much deeper into the muscle, and here's why. If you look back to how this market was performing prior to this reduction in the price of oil, this business model was performing quite well. 2014 Q1 was a record revenue quarter for our company. Not only were revenues a record, so was invoice count. Q2 2014 -- record revenue quarter, record invoice count and we also rejoined the affiliated distributors buying group, and as well at that time had recruited back the president of one of our reporting units, Southern Wire and Cable. Q3 2014 -- not a record revenue quarter but very, very close and it was a record transactional count quarter as well. So through the first three quarters of 2014 and what we'll call a normal operating environment was oil at a historical quote-unquote normal price. We were gaining share. We were recruiting best-in-class talent. Order volumes were at an all-time high. Our operating leverage was good. Expenses were under control. Customer satisfaction still very high. But then market started to change and you can fill in the rest of the story and you know what's happened. We strongly believe that this operating environment we're experiencing today will pass and with that thought in mind cannot truly rationalize making cuts to the business that will impact -- harm on a long-term basis. This is a tough time to run a business. This is a tough time to have these calls. But we've just got to find the discipline to make sure that we retain our key talent, support our customers like they're accustomed to be supported by us, be wise, be prudent, and manage expenses down but not go so deep that we harm the business so we can't realize the rewards for when the market does eventually recover.

[Sam Darkatsh:]

So thank you for the full response and I understand that this is a very, very challenging environment. I imagine the unfortunately cynical retort would be in order to earn your cost of capital, at least with your balance sheet where it is now, it would imply that your EBITDA would have to be around $25 million or thereabouts. And the time where you were earning $25 million in EBITDA was when oil was at $100. So does it require that level of expectation -- and this might be an unknowable, but do we -- is that -- how concerned should we bet that we really need that level of macro in order for you folks to have a really healthy return on capital?

[James L. Pokluda III:]

Another fair question. My high-level response is no. Markets drive creative destruction. Free markets drive best-in-class performance. Another cliche is predicament drives incentive. This market shift and these market headwinds have accelerated our focus on strategic business planning and desire to assume risk for SKUs not directly associated with industrial end markets. The inventory profile of this company 15 years ago did not contain non-residential construction SKUs, commercial type products that we do distribute today. Aluminum is an item that we did not sell in a material amount before. We're selling quite a bit more today. The investments that we've made, the inventories that we've put in place for new products have bode very well for this company. And that's wonderful because I don't believe we need to have $100 oil to make $25 million in EBITDA again. When oil comes back, I think we'll do quite a bit more than that. But we have today a head of steam and wind in our sails involving commercial products touching new customers in new end markets that we didn't have prior to this significant reduction in the price of oil.

[Sam Darkatsh:]

Last question, Jim, if I could and then I'll defer to others on the call. I apologize for monopolizing it a little bit. And this is much more pleasant. The recent spike higher in copper and steel prices, at what point do we see that begin to filter through to your business and reflect itself into sequentially higher gross margins?

[James L. Pokluda III:]

We generally lag broad market commodity moves by two to three quarters because of our average cost accounting treatment for our products. So I agree with you. It's great to see that things are turning. It's certainly hasn't been a smooth assent. I mean we're back to the $2.18, $2.17 again at copper when it's touched $2.26, $2.28 [ph] in the weeks prior. But nonetheless, it appears as though it's turned. Very happy to see that. Steel as well has had a significant recovery and the market news, if we can rely on that, is that capacity will be taken out, which should help drive further gains. That remains to be seen. So we're happy to see the assent of commodities. It however, does not manifest itself immediately into our business. It relieves a little bit of pricing pressure -- to play fair, to be fair with your question. It relieves a little bit of pricing pressure, but the true benefit really won't be seen for at least two quarters.

[Sam Darkatsh:]

Very helpful. Thank you gentlemen. I appreciate it.

[James L. Pokluda III:]

Welcome Sam.

[Operator:]

Thank you. Our next question is from Ryan Merkel of William Blair. Your line is open.

[Ryan Merkel:]

Hey, good morning, everyone.

[James L. Pokluda III:]

Hey, Good morning Ryan.

[Nicol G. Graham:]

Good morning.

[Ryan Merkel:]

So wanted to start with the end markets and I know oil and gas at 30% or so is obviously in rough shape. What other end market color can you provide and I'm curious if there's any markets that are currently positive or perking up at all?

[James L. Pokluda III:]

Fossil fuel has been crawling back. However it's crawling back from a pretty low number. So the fossil fuel market that we experienced in the 2007 and 2008 period is not the fossil fuel market that we have today. Nonetheless, we did experience fossil fuel growth year-over-year and a little bit sequentially. As a surprise, because as you know mining and minerals is down broad market, but our mining and minerals business is improving. Food, beverage, agriculture is improving. Some public works projects are improving, not necessarily wastewater but schools, hospitals, public gathering centers has improved and transportation has been real choppy. One other item that we didn't have ten years ago as alternative fuels and we had growth in that area of the business as well, primarily wind and some hydro, it just is a small -- it's quite a bit smaller market for us and market opportunity than is the traditional fossil fuel end market.

[Ryan Merkel:]

Got you. And is the coal business basically done at this point? Are you doing any of that anymore?

[James L. Pokluda III:]

No, new build. The only new build out there is a project called [indiscernible] and it's a -- they've had a tough go with that. It's about $4 billion over budget and we're not involved in that project. The super majority of the retrofits and scrubber work has been done. Although we participating in SCR work each quarter, just I would say at a rate of 25% what it was in its heyday. So no, that I can think of, no new build in coal fired power generation. Some ongoing and continued work in retrofit to coal plants and scrubbing coal plants, and then of course combined cycle work is pretty good. Actually, although most market reports you read will tell you it was down 8% to 12%, power generation was down 8% to 12% last year and forecasted to be up 8% this year, we'll have to see. But the backbone power source, fossil fuel power source for a grid natural gas remains an important part of our business, and we definitely participate in those opportunities. But the environmental compliance devices and expense allocated to that is not nearly the same as it would be for a coal-fired power plant.

[Ryan Merkel:]

Got you. Okay. And then the comment in the press release here, an extremely competitive market conditions. Not that I'm surprised by that, but could you just give some anecdotes to help sort of bring that to light a little bit for us, the gross margin again in the quarter down, I think, 100 basis points year-over-year. It's going to a place I wasn't quite sure it'd get to and I'm concerned it may go a little bit lower yet. So I guess it's a two-part question, just some anecdotes and then directionally how should we think about gross margins?

[James L. Pokluda III:]

I think the gross margin still has the likelihood to go down. In the last call, I gave a range -- we finished the year at 21.4% gross margin and I gave a range of 50 basis points to 100 basis points potential decline beyond that for the 2016 period. We haven't completely exhausted that band but we're getting close. The reason I made that comment, Ryan, was although I was very proud of my coworkers' ability to hold gross margin and our company's ability to sell the value proposition, I had to be realistic. The market is tired. The market is beat up. The market is frustrated and I had a strong feeling that the likelihood of us being able to maintain margins in that sort of an operating environment wasn't practical. And regrettably, I was right and the margin did go down 100 basis points this quarter. I think we very possibly could go down to the 20% gross margin range at some point in 2016. Some anecdotes, people have more time on their hands now. So when things are really moving fast, I mean you can imagine. You've been to these distributors. You've seen the dozens of emails in their inbox and the stacks of paper on their desk, and they're trying to manage a commodity set of 300,000 SKUs and get things out on time, and keep their customers happy. And so when people are moving fast and especially [ph] wire, comes across their desk and they say, gee whiz, I'm just going to call HWC and they'll take care of this problem, and I don't have to worry anymore. That's great. We put a fair price on it and we move on. But when distributors aren't as busy as today like they are in that sort of operating environment, they have time to go out for five or six bids. So here's an anecdote. We were out in -- I won't say where -- we were at a customer's location and it was a very, very good customer, and we have one of our top sales guys showing us around the place. And we were listening to the distributor salesperson talk about how much they love working with our sales guy and our company, and how we're his number one guy. And then a 60 foot piece of cable came across his desk that he needed to buy, and he sent it out to a half a dozen people. It's like, come on, man. Thanks for saying all those nice things but I guess when you have more time on your hand and you know your competitors are going to be doing the same thing, you just have to be -- you have to do that sort of thing. And that's happening a lot. And as I said on the prior call, I felt like it was going to start happening more and indeed it is. There comes a point where you just say, I'm not going any lower, right. So this business doesn't go to 15% but I think it might go to 20%.

[Ryan Merkel:]

Got you. Well, Jim, I agree that business will come back again. It's very tough for not only you but a lot of other companies that I follow. But I appreciate your candor. You answered the questions straightforward and it's much appreciated. So best of luck.

[James L. Pokluda III:]

Okay, Ryan. Thanks so much.

[Operator:]

Thank you. And I'm not showing any further questions on the phone lines. That does conclude our Q&A session. I would now like to turn the call back over to Jim Pokluda for any further remarks.

[James L. Pokluda III:]

Okay. Thank you, Christie and thanks to all of our team members for their continued hard work and dedication to the company. We appreciate you joining us on the call today and we look forward to the success in the period ahead. Good day everyone.