Houston Wire & Cable Company
Q2 2016 Earnings Call Transcript

Published: 9 Aug 2016

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Houston Wire & Cable Company's Second Quarter 2016 Earnings Conference Call. My name is Chanel and I will be your operator for today. Joining us on the call today are Jim Pokluda, President and Chief 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.

[Jim Pokluda:]

Thank you, Chanel. Good morning, everyone, and thank you for joining us on our call today. I will begin today's call with an overview of our second quarter 2016 results and then I will turn the call over to Nic, who will discuss our financial performance in greater detail. The second quarter continued to experience significant choppiness across both MRO and project revenue streams. On a year-over-year basis sales decreased approximately 11% on adjusted for deflation in metals which in our analysis includes copper and steel. Although we did experience signs of certain industrial segment in geographic region stabilization, overall industrial end market activity remains severely depressed due to several reasons including the reduction in the price of oil and its impact on all the end markets, it touches and influences, deflation in metals including copper, steel and aluminum, and the strength of the US Dollars. Gross margin at 19.9% decreased 180 basis points from the second quarter of 2015 primarily due to extremely competitive pricing resulting from reduced market demand and slightly in increased inventory reserves. Q2, 2016 transactional volume which we measure is invoice count, was at five quarter high having increased 1.5% versus Q2, 2015 and 4.5% sequentially versus Q1, 2016. We estimate the sales results in our core business with services maintenance, repair and operations demand decreased approximately 5% from the prior year quarter when adjusted for metals and represented approximately 76% of our total revenue. MRO activity was down most significantly in geographic regions with high extraction cost, oil and gas reserves. Although demand remains depressed in this very influential component of the industrial market. We are encouraged by the slow recovery in the US land based rotary rig counts, which overtime should drive increased demand for our products in upstream and midstream end markets. The offshore rig count however remain severely depressed is at a level very similar to the low set in July 2010 following a Deepwater Horizon oil spill in April, that year. We do believe though that the rate of decline and activity in oil and gas markets is flattening. Partially offsetting reduced demand in oil and gas markets has continued growth in new products that target resident, non-residential construction. Regions with minimal exposure to oil and gas and the Eastern seaboard. Project sales decreased 26% when adjusted from metals and represented approximately 24% of our revenue. Our three primary end markets were projects include utility power generation and environmental compliance, industrials and infrastructure. Project sales in the utility power generation and environmental compliance market were down approximately 35% year-over-year driven by a reduction fossil fuel power generation and environmental compliance devices offset slightly by an increase in alternative fuel power generation. Project sales in the industrials end market declined approximately 43% year-over-year. Reduced upstream and midstream oil and gas activity drove the majority of this reduction followed by downstream oil and gas, metals and minerals and general manufacturing. Project sales in the infrastructure end market declined approximately 24% year-over-year. Revenues per day throughout the quarter were inconsistent and peaked in April, dipped in May and recovered very close to April levels in June. Monthly transactional activity increased each month during the quarter and finished in June at an eight month high. July revenue and transaction counts were below June. The book-to-bill ratio till July is 102%. As we move into the second half of 2016, our market outlook remains cautious. I think that most of us in the industrial space expected recovery by now. Although, we do believe there are indications of the recovery. We also feel it too soon to call bottom. Certainly there are abundant market headwinds and we will not fall prey to wishing the market up, as one may be tempted to do in a protracted negative market environment. Rather, we're laser focused on every key element of our business and making solid progress in several areas that should favorably impact our Company as market conditions improve. Despite our recent financial results, I'm very encouraged by the ongoing development in depth of our strategic plan and business development initiatives. I feel execution of our strategic plan, systems, processes and controls are the best in the Company's history. I will now turn the call over to Nic Graham, our Vice President and CFO for detailed analysis of our financial results, which will include a bit more color highlighting our solid capital structure, strong balance sheet and continued progress involving expense management. Nic?

[Nic Graham:]

Thanks Jim and good morning, ladies and gentlemen. The second quarter was heavily impacted by the lackluster industrial demand and sales level fell short of our expectations. The sales generated and the resulting gross profit dollars were not sufficient to cover the reduced level of operating expenses. Excluding the non-cash goodwill impairment of $2.4 million, the results of operations generate a net loss of $700,000. While we cannot control the financial impact of the reduced level of industrial demand, we did, during the quarter continue to achieve success in those areas that we can influence and control. We reduce the level of operating expenses, excluding the impact of the impairment charges from both periods; operating expenses fell by $1.1 million or 7.5% to $13.1 million in 2016 from $14.2 million in 2015. In mid-June 2016 we undertook a reduction in force, as we realigned certain duties and responsibilities in light of the current marketplace. We estimate that on a net basis we will realize approximately $500,000 on an annual basis from this action. In this current operating environment our cost reduction initiatives remains a key focus point. We also reduced our interest expense, it fell 31% to $149,000 in 2016 from $217,000 in 2015. This was achieved due to lower average debt levels, which fell by 29% to $32 million in 2016 from $45.1 million in 2015. In addition the interest rate of 1.7% in 2016 decreased from the 2% rate in the 2015 period. We also had success in several other key areas, reduction in working capital fell by $4.9 million sequentially. The main component parts of this decrease was inventory $5.9 million as our initiative to improve our regional inventory profiles to conform to current demand levels continued to gain traction. Accounts receivable fell by $1.6 million mainly due to the reduced level of sales activity. While we are still being very cautious with levels of our customers credit lines and watching closely for any signs of changes and payment patterns, which might be indicative of possible collection issues. Delinquencies through the second quarter 2016 remained minimal. Customer aging and day sales outstanding, DSO remained in line with historic norms. Cash flow despite the lower activity levels, we managed to generate cash flow from operations of $5.5 million. We also reduced the debt and improved our leverage, closing June 2016 debt was $30.1 million down $3.5 million almost 11% from the $33.6 million level at March, 2016. Over the past year debt has fallen by $10.2 million or 25% from the $40.3 million level at June, 2015. The reduction in debt has improved our leverage, as debt to equity ratio fell to 31% at June, 2016 down from 34% at March, 2016 and from 38% at June, 2015. Our asset based credit facility continues to provide adequate capacity for our current and near term needs. At June 2016, we had additional borrowing capacity of $41.6 million. Despite our success in reducing our working capital investment over the past several quarters, we maintain availability in $40 million to $42 million during that same period. Our debt agreement has availability covenants only and the remaining full compliance with these covenants. Some other comments, capital expenditures, the total investment for the quarter was $220,000 and we anticipate the total 2016 investment to be in the $1.25 million to $1.5 million range which is a return to more normalized historical CapEx levels, prior to the Houston building consolidation project. Returns to shareholders, we continue to repurchase stock 104,000 shares during the quarter and we pay our shareholders $0.03 per share dividend. On the balance sheet, we've worked hard to improve the balance sheet profile, our leverage is low, cash flow is healthy and our cost to funds is competitive. I believe our capital structure positions us well to execute both in the present environment and when demand and sales levels return to more normal level. Looking ahead of some of the current initiatives for the balance of 2016, continuing the inventory re-profiling initiative with the goal of reducing the working capital investment, generating operating cash flow and further reduce the level of debt. Search for, scrutinize and review all new business development initiatives including new products and markets that may arise to ensure an accretive return to the Company and our shareholders. Our current upping spend to ensure the expenses provide a maximum return. That concludes our prepared remarks. At this time, I'll turn the call back over to the operator. Chanel?

[Operator:]

[Operator Instructions] our first question comes from the line of Sam Darkatsh of Raymond James. Your line is now open.

[Josh Wilson:]

This is Josh filling in for Sam. Thanks for taking my questions. First question could you give us an update on your thoughts for gross margin for 2016 and what downside, if any there might be to the level that you reported in the second quarter?

[Jim Pokluda:]

Sure, Josh. If you were to dissect some of the component parts of the gross margin decrease year-over-year a high percentage of that came from purchase discounts, inventory reserve, not so much on the total gross margin side. If you were to look part of gross margin along, it was about 70 basis points that was purely a function of competitive market pressure and continued deflation in the price of metals which applies pressure to our sell process as well. So certainly not happy to see the pullback in gross margin, but again a fair percentage of that came from inventory reserve and LEDs that we get from suppliers, but since we're purchasing less this year given the present market environment, we had to pullback our accrual to some extent, it's manifested itself in the gross margin. Moving forward.

[Josh Wilson:]

[Indiscernible].

[Jim Pokluda:]

Yes, sure. Moving forward. It's certainly possible that we'll see a little bit more pressure depending on what the market does, it certainly hasn't been helpful, last time we talked, we got a little bit of head take [ph] for metals, copper was higher than it is. Today it's about $2.15 a pound and we certainly, I was hopeful there it would continue that upward path, it has not, its back down again. So if copper stays low, the market stays kind of in the doldrums, it's not unrealistic to think there will be some pricing pressure. I don't think that it's an extensive amount, maybe purely on the product gross margin side, another 20 or 30 bps. I hope nothing more than that still low Josh, there is a lot of uncertainty out there.

[Josh Wilson:]

And in regards to pricing, you talked a little bit about how the transaction activity progressed through the quarter. Could you give us a sense of whether pricing pressure got better or worse as the quarter progressed?

[Jim Pokluda:]

It worsened frankly. Summer can drive you nuts, Josh and you think to yourself, hey it's warm outside seasonality is gone, construction period should be full steam ahead and then you wake up and realize that lot of people are on vacation. So July was a disappointment for us, June was better than July was happy to see that, but July was a disappointment. I'm hoping it was more just the summer doldrums, vacation season, etc. It did apply some pricing pressure. I hope and if history repeats itself, we do get a little bit of build from this period on as we move through the third quarter. Opportunity pipeline looks pretty good actually, it's up slightly sequentially versus Q1 of this year, the amount of volume that we have in the bid and negotiation stage is consistent with what we had seen in the prior year period. So I hope that things will improve from here. We certainly would appreciate some help from the market though, both on the commodities front, with metals and certainly with the price of oil.

[Josh Wilson:]

Can you give us a sense of what July sales were like year-on-year?

[Jim Pokluda:]

We've never been that specific. So I will not do that, but I will tell you that the results in July were pretty much on par, if you were to average out what we had done in the prior year period.

[Josh Wilson:]

Okay and last one for me. You've been able to generate some cash flow by reducing inventory, is there a floor for that initiative or a limit to how far that can go.

[Jim Pokluda:]

There is a point of diminishing returns. It's simply wise to pull your inventories down when the market pulls back, so that's just good business. However, the reduction in inventory has been quite a bit more than just us buying less due to market demand. We've done a very, very good job through a lot of, [indiscernible] call proprietary processes and hard work to improve our ability to real select and move out aged inventory. So not only are we purchasing less due to market demand, we're also doing a much, much better job with respect to the way we're managing the inventory we have on hand. All that said, yes I'd say there's another $2 million available but that's about it. Our value proposition is one that provides immediate product availability to service need at now demand and we just cannot make a compromise in that front, that's why we are here. Our customers count on us for that, so there's a point at which inventory drawdowns will slow.

[Josh Wilson:]

Got it. Congratulations on improving the turns and best of luck with the next quarter.

[Operator:]

Thank you. [Operator Instructions] our next question comes from the line of Luke Young of Baird. Your line is now open.

[Luke Young:]

Maybe more of a theoretical bigger picture question around the cost structure. I guess if I look at how the business is performed since 2014, which was really the recent cyclical peak, you know TTM basis OpEx is down about 10%, versus sales in GP that are down more than 30% range. Obviously realize that this is a high fixed cost business and you're doing a lot of work in terms of discretionary expenses and things around the edges just trying to keep things lean. I guess the question is, kind of intense business pressure that you're seeing today keep up in 2017 ends up looking a lot like 2016 has so far let's say, is there some points that you would take a harder look at reducing some of those fixed cost more in a permanent basis or does that not really unchange [ph] your thinking.

[Jim Pokluda:]

I want to make sure I captured component of your question Luke, did you say OpEx was down 10% and I thought I heard you say sales were down 3%, but that I must have misheard you, did you say 30%?

[Luke Young:]

30%, yes. OpEx 10% versus 2014 and sales down about 30%.

[Jim Pokluda:]

Okay, all right. Well Luke I wish they were down 3%, yes, thank you for clarifying that. you're right this business does have high fixed cost, we lease the majority of our facilities and I have no plans, we have no plans of cutting back in any significant way on the distribution platform, we cut 95%, we touch 95% of the country with standard overnight freight and that's very important to our customers and we want to continue to deliver that feature to them. As Nic mentioned, we took some headcount out and then we estimate that we'll save about $500,000 annually with respect to that move. Cutting deeper than that, I fear would inflict significant harm into the business, we have very high tenure at this company. The average tenure for a sales person is in the order of 17 years, if you don't count the very, very new people we have in our business unit and that sort of equity is priceless in the context of customer relationships, product and market knowledge, pricing savvy application, engineering expertise and it just wouldn't be wise with the long view in mind to gut the company in that respect. So I understand why you've asked the question it's a legitimate question. It's just not practical for our business, certainly not with the long view in mind. You mentioned 2014 as a peak and that was I think it's helpful for the audience to think about 2014 period. If you go back to that period in time, I'll remind everybody that quarter one was a record revenue quarter for our company as well as record transactional account period for our company. Quarter two was also a record revenue period as well as a record transactional activity, [technical difficulty] quarter three 2014 was very, very close to a record and set a record with number of transactions, but at that time we had started to feel a little bit of the impact that began in the June, July period due to the reduction in the price of oil and then of course the fourth quarter 2014 we saw further manifestation of that. The important thing to note here, is that in a normal operating environment this company performs exceptionally well. We are well on our way to a record year in 2014 and then we had an anomaly occurred in the marketplace, kind of 50-year flood. Only amplified by the fact that commodities have continue to erode and the strength of the US dollar, all working is very significant headwinds to the business. These things will pass metals will at some point return to more normal levels, there are multiple business cases very strong arguments for how oil will recover to a point that will be more reasonable from a historical basis and allow companies to once thrive. In the interim period, we just have to have the discipline to not only retain the talent that we built over decades but also invest in talent that can carry us into the future and we've done exactly that. We have retained our best people and we've hired some great people. We now have a lift plan engineer in the heavy lift end of our business. We've recruited strategic marketing resources on electrical, new sales adds both inside and outside in the organization. We've done some, made additions to strategic marketing with respect to talent we have to manage national accounts. We've reorganized departments to be more efficient, made advances on the supply chain. We've done a lot of really, really good things that certainly overtime I have every confidence will benefit our company. The trick is just being disciplined enough not to cut too deep, cut to an extent where you can easily recover when the market returns to more normal conditions.

[Luke Young:]

Thanks for that Jim and then switching gears a little bit following up on the gross margin question from earlier. Maybe not so much thinking about the current environment in the second half this year but maybe thinking over the next year or two. Let's say if there's some kind of sales recovery out there, I would imagine that there would some kind of mix shift back towards the project business, which obviously is cyclically depressed right now. Given the gross margin levels you got today obviously knowing what's going to be happening with copper prices from here, with that mix shift you think drive you know margins potentially even lower than we see now or do you think that there would some kind of offset in terms of the competitive environment you think that would lead to some really [indiscernible] margin alignments there.

[Jim Pokluda:]

I don't think it will Luke, projects historically range from 25% to 35% of our overall revenue, now there have been periods in the past, hyper growth markets, pre-Great Recession when we were building a lot of coal plants in this country when projects represented almost 50% of our business, but those days are gone. As a project business grow, so too does the MRO end of our b business so for purposes of this conversation let's call it 70%, that is by far the most profitable of the two transaction. So I think that you're right to contemplate the fact that increased project business could add margin pressure to the business. However historically that pressure has been backfilled by the increased margins that we make on the MRO end of the business.

[Luke Young:]

Got it. That's all I had for this morning. Thanks guys.

[Operator:]

Thank you and I'm showing no further questions at this time. I would like to turn the call over to Mr. Jim Pokluda for closing remarks.

[Jim Pokluda:]

Thank you, Chanel and thanks to our valued team members for their continued hard work and dedication to the company. 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 concludes today's program. You may all disconnect. Everyone have a great day.