Houston Wire & Cable Company
Q3 2016 Earnings Call Transcript

Published: 8 Nov 2016

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Houston Wire & Cable Company's Third Quarter 2016 Earnings Conference Call. My name is Brian and I will be your operator for today. Joining us on today’s call 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, Brian. Good morning, everyone, and thank you for joining us on our call today. I will begin today's call with a brief update on the Vertex acquisition followed by an overview of our third quarter results. And then I'll turn the call over to Nick will discuss our financial performance in greater detail. As I'm sure many of you know on October 3 we completed the acquisition of Vertex Distribution. A leading master distributor of industrial fasteners specializing in corrosion resistant and specialty alloy inch and metric threaded fasteners, rivets and hose clamps. We're happy to report that the first month of sales in integration activity has gone well. Sales for October exceeded budget by approximately 2% and the facility consolidation plan is underway and on schedule. The integration of the Vertex Dow’s facility into the Vertex Houston distribution center is now complete. Vertex Atlanta will be consolidated in days HWC Atlanta in early December. And Vertex Charlotte will be consolidated into HWC Charlotte by the mid of December. After initial moving in integration expenses, we estimate the annual savings from the above facility consolidations to be approximately $200,000. Priorities over the next several months include further facility consolidation, computer system conversion, extreme focus on delivering a superior customer experience and strategic investment in inventory and digital resources. Of course we are still very, very early in integration process and significant work remains, however all key employees have been retained, our teams are motivated and morale is high. I will now move on to comments involving our base business for the third quarter 2016. Industrial market conditions including the oil and gas industry did not improve during the third quarter as demand levels remain significantly depressed on a year-over-year basis sales to decreased approximately 10% when adjusted for inflation and metals, which in our analysis includes copper and steel. Gross margin that 18.5% decrease 210 basis points from the third quarter of 2015, primarily due to extremely competitive pricing resulting from reduced market demand, increased freight and reduced vendor rebates due to the lower activity levels. Q3 2016 transactional volume, which we measure as invoice count was slightly below the 6 quarter high set in Q2 of this year and increased approximately 1% versus Q3 2015. We estimate that sales results in the core business which services maintenance repair and operations demand increased approximately 8% from the prior year quarter when adjusted for metals and represented 81% of our total revenue. Growth continued in new products to target residential and nonresidential construction and regions with minimal exposure to oil and gas and we believe several areas of the country are showing early signs of recovery. Although year-over-year MRO sales in geographic regions with high concentration oil and gas reserves were slightly negative. They continue build in U.S. based rotary rig count is encouraging with the October rig count closing at 535, which was up 135 from the 400 level at the end of Q2. Historically our oil and gas MRO revenue streams have been late cycle in broad market moves by two to three quarters. Should the rig count continue to build and historical trends prevail, we look forward to reporting increased activity in this very important area of our business at some point in the quarters ahead. Offshore rig count remained at 21 quarter-over-quarter and accordingly we expect no improvement in demand for the products used in this end market, which primarily includes specialty oil and gas cables, steel wire rope and rigging Project sales decreased 45% when adjusted for metals and represented approximately 19% of our revenue. Our three primary end markets were projects include utility power generation and environmental compliance, industrials and infrastructure. Project sales and utility power generation and environmental compliance were down approximately 57% year-over-year driven by a reduction in new construction for fossil fuel power generation, alternative fuel power generation and environmental compliance devices. Projects sales in industrial end markets declined approximately 33% year-over-year. Reduced downstream oil and gas actively drove the majority of this reduction, followed by upstream and midstream oil and gas, metals and minerals. Projects sales in the infrastructure end market decline of approximately 77% year-over-year. The majority of the decline resulted from the ongoing reduction in spend from a large telecommunications project, as well as significantly reduced spend in public works projects. Revenues per day dipped slightly in August versus July but increased significantly in September, which reached the 10 month high. Monthly transactional activity per day increased each month during the quarter and finished September at the second highest level in 22 months. The book-to-bill ratio through September was 101%. As we move into the final quarter of 2016 and our market outlook remains cautious. Although our third quarter 8% metals adjusted MRO sales growth in the higher land based rotary rig count is encouraging. We are yet to witness any increase in industrial products or material improvement in market demand from oil and gas rich geographies. As we enter traditionally slow period of the year we will continue to exercise extreme discipline with expense and working capital management, strong focus on new products and business development initiatives and integration of the Vertex acquisition. I will now turn the call over to Nic Graham, our Vice President and CFO for detailed analysis of our financial results. Nic?

[Nic Graham:]

Thanks Jim and good morning ladies and gentlemen. The third quarter was again impacted by the lower than expected level of industrial demand. While sales actively increase sequentially by 4.4%, the gross margin contribution was insufficient to cover our operating expenses and operations generated a loss of $1.8 million. These results are disappointing as we had felt at the beginning of 2016 industrial demand would by now have start to display a return to more normal demand levels. Despite the disappointing operating results we did attain success in several other financial aspects. We continue to focus on prudent expense management and again managed to reduce our operating expenses, which fell by $500,000 or 3.5% to $13.8 million in 2016 from $14.3 million in 2015. The current 2016 quarter operating expenses include approximately $100,000 in acquisition related costs. Our efforts to reduce debt levels were again successful, average debt level at 31.4% to $28.5 million in 2016 from $41.5 million in 2015. Average interest rates also declined to 1.7% in 2016 from 2.2% in 2015. Accordingly our interest expense also declined to $129,000 in 2016 from $237,000 in 2015, a decrease of 45.6%. The debt reduction has also helped reduce our leverage. Closing September 2016 debt was $28.6 million, the lowest level since 2010, down $1.5 million or almost 5% from $30.1 million level at June 2016. During the first nine months of 2016, our debt has fallen by $10.6 million or 27%. The reduction in debt has improved our leverage as our debt-to-equity ratio fell to 31.1% at September 2016. We also reduced our working capital itself by $3.4 million sequentially, main component parts of this decrease was lower accrued liabilities, a lower inventory offset by an increase in accounts receivable as sales increased sequentially. On a year-to-date basis working capital is declined by $15.4 million or 14.8% from December 2015, the largest part of which is a $12.2 million reduction in inventories, as we realigned our profiles to match the reduced level demand. We're still being very cautious with levels of customer’s credit line watching closely the signs of changes in payment patterns, which might be indicative of possible collection issues. The aging of our receivables is in line with historic norms and our DSO decreased to the lowest quarterly level of the year. Cash flow despite the lower activity levels we managed to generate cash flow from operation of $2.9 million. During the year-to-date period as we are continued to focus on reducing our working capital investment, we still maintaining borrowing availability in the $40 million to $42 million range. Our debt agreement has availability commenced only and we remain in full compliance with these covenants. Few comments on the Vertex acquisition as Jim mentioned earlier on October 3 we purchased Vertex from DXP. We financed the purchase using our existing credit facility as we had an access of availability over our current needs due to our prolonged efforts to pay down debt. The total purchase price was $32.3 million subject to a closing working capital adjustment. Vertex’s balance sheet is very similar to that of HWC in that assets are heavily concentrated in inventories and accounts receivable. These assets have been subjected to a collateral review by our lender and included in the monthly borrowing base using September 30, 2016 collateral numbers for Vertex that consolidated availability at September 30, post acquisition was $27.2 million. Some comments about the debt-to-equity ratio and capital allocation. Now the funding the Vertex acquisition our debt-to-equity ratio was increased to an estimated 67%. As mentioned in earlier calls HWC is operated with much higher ratios in early years. I believe our capital structure positions us well to execute both in the present environment and when demand in sales levels return to more normal levels. However as the business environment has not shown any clear signs and meaningful improvement, and as we go into the time of year when activity often compresses, with felt it appropriate as cost of stewards of the company's financial position to adopt a more conservative approach towards capital allocation. Accordingly the board suspended the dividend payments, and while there is still available capacity under the existing stock buyback program $9.4 million at September 2016, future buybacks will reduce or possibly temporarily cease and be closely paralleled with company's current performance, availability and stock price and will therefore be executed in the more opportunistic manner. Looking at some of the current initiatives for the balance of 2016, we continued the consolidation of the Vertex sales and distribution centers, continued the integration efforts to get Vertex onto our computer platform, identify any aspects of Vertex’s operation where it has to be consolidated and operating efficiencies obtained, for example, freight and inventory profiles. Containing the imaging – re-profiling of the base business with the goal of reducing the working capital investment and continue with our – review of our office expense and to ensure the expenses provide a maximum return. That includes the prepared remarks. At this time I'll turn the call back over to the operator. Brian?

[Operator:]

[Operator Instructions] Our first question comes from the line of Sam Darkatsh with Raymond James. Your questions please.

[Sam Darkatsh:]

Good morning Jim, good morning Nic, how are you?

[Jim Pokluda:]

Good morning Sam, thank you.

[Sam Darkatsh:]

Wanted to first hit a gross margin, clearly soft both sequentially and year-on-year and you called out a number of impacts. I wouldn't normally ask this level of quantification or granularity, but can you give us a sense of, you know with respect to pricing and freight shrinkage and vendor rebates. What each of those impacted gross margins and what you imagine the legacy business might look like in 4Q from a gross margin standpoint?

[Jim Pokluda:]

Certainly Sam, I’m glad you asked that question because 18.5% will not be the new normal. I want to be perfectly clear about that. Product gross margin went down about 23 basis points year-over-year, which was disappointing, but certainly not as bad as the 210 basis point decline would indicate. It was really a quarter where everything converged negatively. We had an abundance of freight, copper continued to be in the tank, so we are very aggressive on price markdowns to get old material off the shelf and out the door and then the continued negative impact of reduced purchases from suppliers and reduced rebates as a result of that spend, all converged in Q3. And I was extremely disappointed see the reduction in gross margin. I do not expect this to be the case in Q4 or not be the case in Q4, I would expect they return to more recent gross margin trends above 20% that's our goal. I would be happy to share additional granularity with these Sam, but I just don't have that level of detail at my fingertips right now.

[Sam Darkatsh:]

With the 20% Jim that you just referenced is that the legacy business or is that the legacy business plus Vertex which I would imagine would be accretive to gross margin?

[Jim Pokluda:]

It's the legacy business and absolutely Vertex will be accretive. We haven’t gone through that level of analysis yet, I felt the best way for you and the audience to think about gross margin would be in the historical context. So I framed my comments solely around the legacy business.

[Sam Darkatsh:]

I would imagine that the impacts of Vertex on your gross margin might be 1 point or 2 point, no. So when you actually have a reported gross margin in the fourth quarter, it might be closer to 21, 22 then it might be 20. Is that’s how to look at it?

[Nic Graham:]

Hey Sam, this is Nic, I think if you think about an annual run rate of $30 million, you know a quarter of that. You want to divide by four and take as impact of the overall base business market, it’s going to go up a little bit. But I don't think it's going to go up 2 basis points. Yeah I mean we haven't already I'm going to do it now. The gross margins for Vertex are approximately 38% so we have a definite tailwind as a result of that acquisition.

[Sam Darkatsh:]

Okay and then thank you for that. The next question I would have, are you anticipating - you actually answered the question regarding gross margin of fourth quarter. Are you anticipating a significant variable comp reset in 2017?

[Jim Pokluda:]

I would not use the word significant, but variable comp burden in 2016 will not be especially high and we didn't meet our EBITDA performance - we will not meet our EBITDA performance targets. There are other components of compensation in addition to EBITDA and we may hit some of those or – so in 2017. I would hope that the markets would recover to the point where our financial performance would improve and our variable comp and executive comp would trigger some of those levels, but we have to be realistic also. If you look at the broad market data multiple leading indicator data, although it's more positive than negative. In the highly concentrated industrial space that we participate in because of our oil and gas concentration most people are not forecasting a very impressive 2017 as well.

[Sam Darkatsh:]

Two more questions if I could and I’ll defer to others. First, it looks on a year-on-year basis. Some of the metals that you indexed against might even be up here in the fourth quarter. At what point do you think that positively impacts your sales as it relates to a metal adjusted basis.

[Jim Pokluda:]

Yeah, we're delighted to see copper hit the recent high that it has today, its 235, 236 range that's certainly good news. Aluminum has been pretty flat although that represents a rather small percentage of our sales. Steel is crawling back up to essentially where it was three or four months ago, we hope that trend continues. And now that we’re in the fastener business and nickel is a significant component part of cost for fastener stainless steel fasteners that is and nickel is above $5 a pound today, which we have seen since 2015, all bode well for our company. Having said all that, I would expect our gross margin appreciation in Q4. We can adjust prices immediately due to broad market commodity moves. We have to be careful though because everybody – all the buyers are aware of the fact that the sellers still own it at the - inexpensively priced level. So there's a little bit of a cat and mouse game played there. All in though, it's definitely more positive for our business, the most positive I've seen it in the past easily 12 months now.

[Sam Darkatsh:]

Last question where are you seeing the uptick recently in MRO specifically be it geographic or end market verticals?

[Jim Pokluda:]

Primarily the eastern seaboard, clearly less concentration in oil and gas and even Marcellus, what’s primarily gas, so although we benefited from a tailwind there, not nearly the concentration in oil and gas, so along the eastern seaboard is we have elsewhere in the country. So growth there, pockets of growth in the Midwest, pockets of growth on the west coast. Our oil and gas concentration stays though still very, very depressed.

[Sam Darkatsh:]

Thank you both. Appreciate it.

[Jim Pokluda:]

You're welcome.

[Operator:]

[Operator Instructions] Our next question comes from the line of David Mandell with William Blair. Your questions please.

[David Mandell:]

Jim, are you guys getting any feedback from your suppliers regarding your performance versus some of their other customers?

[Jim Pokluda:]

Yeah, absolutely, David, we ask that question I know somebody who pass it every day I certainly visit with them on a regular basis. Everybody that has concentrations in oil and gas is experiencing the pain right now. If you were to look at the segment data reported by some of our key suppliers, you will see down horrific numbers. I suppose it wouldn’t be good forum for me to quote them right now how, I'll direct you to look at this segment data yourself. But I'll give you a range. If you look at our key suppliers, North American suppliers; General Cable, Nexans AmerCable, folks that make products for the oil and gas base. You will see decreases in sales revenue anywhere from 30% to in one case 80%. If you look at the electrical distribution customers that we sell to the majors and the majors who report concentrations and oil and gas or even segment report data for oil and gas. You will see they're down 25% to 30%. So the brutal reality of our business is that, as I have said on the calls before we have a 30% direct concentration in oil and gas and if you count, first derivative, easily 50%. So I don't like this, I don't like obviously that sales are down and we're working exceedingly hard to correct that. What would bother me more, however, is if we were down more than our suppliers and more than our competitors and I don't believe that we are. Our challenge is to accelerate movement into markets that don't have deeper movement into markets that don't have this concentration in oil and gas. Broad the skew set to protect us in that regard. More commercial nonresidential construction skews. Then have the disciplined and courage to go out and leverage our master distribution platform into another product category like fasteners, that’s very high profit and further protects our company moving forward.

[David Mandell:]

Thanks for that color. And then looking to next year it sounds like, your outlook is cautious at best. How do you guys claim to manage operating expenses in inventory, as we enter 2017?

[Jim Pokluda:]

We still have some room to take out folks on – to take out expenses in our businesses, in our multiple businesses. So I know that we have an opportunity there. We need to be careful with the inventory we've reduced the inventory quite a bit. And that's a significant component part of our value proposition. So I think there's another $5 million or so that we could take out, maybe even a little bit more now because of Vertex. So there's some room there, but I wouldn't feel right of communicating that there's a huge opportunity for us in inventory. It's not the opportunity that we had versus where we were a couple of years ago. Our compensation programs for management and inside and outside sales are largely driven around variable comp. So if the market remains lousy, expenses in that area should not go up appreciably. Okay, all right, I just want to make sure I got all parts of your question.

[David Mandell:]

Yeah, that’s helpful. Thanks for taking my questions. Good luck with everything.

[Jim Pokluda:]

Thank you.

[Operator:]

Thank you. Ladies and gentlemen this concludes our question-and-answer session for today. So now it's my pleasure to hand the call back over to Jim Pokluda, President and Chief Executive Officer for closing comments remarks. Sir?

[Jim Pokluda:]

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

[Operator:]

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may all disconnect. Everybody have a wonderful day.