Houston Wire & Cable Company
Q2 2017 Earnings Call Transcript

Published: 9 Aug 2017

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Houston Wire & Cable Company's Second Quarter 2017 Earnings Conference Call. My name is Kevin 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 formal 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 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, Kevin. Good morning, everyone and thank you for joining us on our call today. I’ll begin with an integration update on Vertex and then move on to an overview of our second quarter 2017 results. I’ll then turn the call over to Nic who will discuss our financial performance in additional detail. It's been a little over nine months since the acquisition of Vertex and as I mentioned in May, major integration initiatives including ERP conversion, closure of one facility and consolidation of five Vertex facilities in to legacy HWC facilities are all complete. Recently in June, we completed another major milestone with the addition of Richard Megliola as President for this reporting unit. Rich is an experienced veteran of master distribution of fasteners and a dynamic leader who has a demonstrated history of creating high performance teams and operationally excellent cultures. We're delighted to have him join our team and look forward to supporting his leadership with the investments necessary to drive both near and long term results for shareholders. For the second quarter of 2017, sales of Vertex were slightly above plan and contributed 8.1 million. Now that we have the first two quarters of 2017 behind us, the aforementioned integration items and non-related recurring expenses mostly complete and amortization expenses which were unknown at the time of our original EPS accretion estimate more clearly defined, we now estimate that Vertex will be approximately $0.03 to $0.05 accretive for 2017. Moving on to our overall company performance, we were encouraged to see that the year-over-year sales increases experienced in the first quarter continued into the second quarter. Sales for the second quarter increased 21.1% over the prior year period and 8.1% organically, excluding Vertex. Market conditions remain very similar to the first quarter and given our position in the value chain continued to be largely driven by recovering activity in oil and gas end markets. Much of this year -- March of this year marked a near term peak in sales per day. In Q2, on a sequential basis, April and May sales per day pulled back slightly from the March high, however in June, the trend reversed and we finished the quarter with sales per day growth in June over May. Moving into the first month of Q3, sales per day continued to grow in July over June. We are pleased to see this improved sequential sales results in June and July, as these summer months are typically seasonally disappointing. Additionally, excluding Vertex on a year-over-year basis, June and July were up mid to near double digits respectfully versus the prior year. Although we are certainly pleased that our daily sales trends are improving, they still remain somewhat choppy and indicate to us that a continued recovery in a broad industrial market will likely be slow and inconsistent. Gross margin at 21.6% increased 170 basis points from the second quarter of 2016, primarily due to higher margins generated by Vertex, improving market conditions in metals. The balance of my year-over-year comments will exclude contributions from Vertex. Q2 2017 [ph] transactional volume per day, which we measure as invoice count increased approximately 2.5% versus Q2, 2016 and was nearly identical to the first quarter of 2017, which was the highest count since Q4, 2014. The present book to bill ratio is approximately 101%. We estimate that sales results in our core business with services, maintenance, repair and operations demand increased approximately 17% from prior year quarter or approximately 15% when adjusted for metals and represented 84% of our total revenue. Growth continued in new products that target residential and nonresidential construction and regions with exposure to oil and gas and general and industrial manufacturing improved most versus the prior year. We are encouraged to see that oil is showing signs of recovery and it's trending in the plus or minus $50 range and that the Q2 rotary rig count in the US was 919, up 507 from the closing level of 412 a year earlier, and up 117 from the second quarter of this year. Demand for products and sales have increased due to the uptick in drilling activity, primarily in upstream and midstream markets, which are the first to recover from increases in land based rig count. Upstream in midstream orders tend to be smaller in size and as I've discussed on prior calls, most often reported in our MRO revenue stream versus our project revenue stream that I will discuss momentarily. The offshore rig count at 21 remains very low by historical standards and continues to be a significant headwind for high performance copper wire, steel wire rope and fabricated lifting products used in offshore markets. Project sales for the second quarter decreased 24% from 2016 when adjusted for metals and represented approximately 16% of our revenue. Although we were disappointed with these results, we are encouraged that present macroeconomic indicators are mostly positive. Our internal pipeline data, voice of customer and business development initiatives indicate that the low level activity experienced in large projects for the past four quarters has likely bottomed and is now positioned to grow slowly moving forward. 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 39% year-over-year. The majority of the increase resulted from an increase in activity of fossil fuel power plants and substation construction offset by a reduction in activity in alternative fuel power production. Project sales in the industrials end market declined approximately 37% year-over-year. Reductions in large investments in industrial and general manufacturing and our latest cycle participation in downstream oil and gas markets contributed to the majority of the decline. Please recall that our ability to participate in the initial backbone phases of Gulf Coast mega projects is generally limited due to our position in the value chain. As these projects mature however, we anticipate an evolving growth opportunity for the next several years, because our business model becomes increasingly leverageable when supporting low profile late spend for late cycle high value demand. Although it can be frustrating that our model experiences a lag effect involving large projects, the United States outstanding progress in achieving cost reductions in land based hydrocarbon extraction has been remarkable. Today's abundant availability of readily accessible competitively sourced oil and gas continues to drive significant investment in extraction, transportation, refining and export all of what should fuel economic growth for an extended period of it. Q2 project sales in the infrastructure end market declined approximately 26% year-over-year. The majority of the decline resulted from the ongoing reduction in spend from a large telecommunications project offset to some degree by growth in public or private facilities, residential and commercial construction and waste water. We remain optimistic that this area of our business could grow substantially over the next several years, given the investment estimates communicated by the present political administration. As we move further into the second half of 2017, we believe our overall business conditions will slowly improve. As I mentioned earlier, it is encouraging to see the recent appreciation in the price per barrel of oil, the price per pound of copper has also increased and economic indicators such as industrial production, capacity utilization and durable and non-durable goods are all in the accelerating growth stage of the economic curve. We believe all these items should serve as tailwinds for our business. Finally, before I pass the call over to Nic, I would like to close my prepared remarks by commenting on our announcement last week that Roy Haley has joined our board of directors This is great news for our company and many of you may already know Roy as he is an accomplished later in industry intellectual distribution. I believe his extensive expertise in master distribution and prior experience as Chairman and CEO of one of the world's largest electrical distributors, will serve the interests of our company and shareholders well. I'll now turn the call over to Nic Graham, our Vice President and CFO for a detailed analysis of our financial results. Nic?

[Nic Graham:]

Thanks, Jim and good morning, ladies and gentlemen. As Jim mentioned, despite the slightly inconsistent sales trends, sales did increase year-over-year as did gross margins, both key performance aspects of the business, which is encouraging. An update on the Vertex acquisition. Vertex has been substantially integrated and was on our computer platform for the entire quarter. All financial functions are being handled and controlled out of our Houston, Texas corporate headquarters where the transactions of the other three legacy divisions are processed. All financial controls are likewise being handled by our corporate staff. Some comments on our operating performance. There were a few straggler integration costs during the quarter, which involved the consolidation of Vertex’s Houston location into HWC’s main hub in Houston when Vertex’s lease expired in May 2017, a reorganization and partial consolidation of Vertex’s Tampa warehouse and travel expenses of both HWC and Vertex personnel continued to work through the integration exercise. We estimate the direct cost in the $100,000 to $125,000, but that does not include the many hours spent by both HWC and Vertex management and personnel in the immersion of Vertex’s operations to conform to HWC’s business protocol through regular meetings and training. This process, which will never completely go away, including the frequency of status meetings, will diminish over the balance of the year. Comparisons on total operating in 2017 and 2016 on a quarter-over-quarter basis or for the year-to-date are not meaningful, as prior period amounts do not include Vertex. More directionally important I believe is the 2017 sequential change in consolidated operating expenses, which decreased from $17.2 million in Q1, 2017 to $16.5 million in Q2, 2017, a reduction of $700,000 or approximately 4%. The compensation spend was near flat sequentially, while almost all the sequential savings came from other operating expenses, including rent, payroll taxes and administrative expenses. We continue to look at all aspects of our operations to drive down the total cost of operations and this remains one of the key initiatives going forward. Turning to the balance sheet, as I mentioned as a goal on our Q1 call, we did manage to reduce our inventory investment by $1.8 million from Q1’s $80.3 million to $78.5 at June 2017. Reducing our inventory investment remains an integral part of our business plan for the remainder of 2017. Our working capital was near flat sequentially at $113.5 million. In addition to the decrease in inventories, the other major component parts were a decrease in accounts receivable $3.2 million and offsetting these two items was a reduction in accounts payable of $2.4 million. Our receivables days sales grandstanding increased slightly over Q1’s 49.2 days to 52.2 days at June 2017. This trend however parallels the historic practice that we experienced over the past couple of years. I like to remind our participants this morning that all credit decisions and cash collection efforts are handled by our centralized Houston credit department and the sales person do not make credit decisions. Our year-to-date bad debt expense is in line with historic norms and delinquencies from Vertex customers have been minimal. Customer receivable agings are meeting our expectations, but we continue to monitor customer credit lines and watch for change in payment patterns. We remain concerned about activity fluctuations in the oil and gas industry and its possible impact on the ability of certain of our customers to pay us in a timely manner. However, to date, we have had minimal bad debt experiences, and at this time, have no evidence to suggest undue exposure. Our debt to equity ratio and capital allocation, we did lower our debt level by $1.9 million from March 2017’s $71.8 million to $69.9 million at June 2017. Our debt to equity ratio fell from 79.9% at March 2017 to 77.6% at June 2017. As we execute our operating plan and reduce the level of working capital, principally in the reduction of the inventory investment, the primary use of the funds generated will be to reduce our debt load. Our CapEx cash outlay during the quarter was $300,000, down from the $900,000 level in Q1, 2017. Our total annual spend estimate for 2017 remains unchanged at $1.8 million. We have adequate capacity to fund our operations and at quarter end, availability under our credit facility was $20 million and we remain in full compliance with the availability covenants of our asset base credit facility. Looking ahead at some of the current initiatives for 2017, continue to execute our robust business development strategy to increase sales and improve profitability. We view all aspects of operations to generate efficiencies and reduce costs, especially where Vertex’s shipment volume may allow us to generate combined savings in such areas as freight and distribution expenses, continue the automation and streamlining of all administrative and operational functions to reduce expenses and repetitive tasks and continue the effort to reduce our working capital investment, generate funds some operations and reduce the debt level. That concludes the prepared remarks. At this time, I’ll turn the call back over to the operator. Kevin?

[Operator:]

Our first question comes from Sam Darkatsh of Raymond James.

[Unidentified Analyst:]

This is Paul on for Sam. In regard to the demand trends you're seeing, you mentioned that July is doing better than June, June improved from May. Is that what you're seeing at this point in August and kind of what are the meaningful differences you're seeing in July relative to the second quarter, what are the areas of strength?

[Jim Pokluda:]

The momentum has continued Paul and we're delighted to see that. The summer months can drive me nuts, sort of alluded to that a little bit more eloquently in my prepared remarks, but we like to think that June and July will be good months, summer, construction seasons should be robust, but many times, it's just not, it’s very frustrating. So to see those months improve was certainly a positive indicator and we believe that that portends to more flow, positive flow throughout the remainder of the year. August has been fine, the trends have continued and thanks to some metals appreciation that we've seen recently, we're getting a lift in gross margins as well and that's really, really important. Our ability to manage expenses, be thrifty with expenses is of paramount importance. So margin discipline, pricing discipline is a key component of our strategy here and we’ll continue to remain so throughout this metals appreciation period. I'm pleased with the results, excuse me, I'm pleased with the sequentially improving results on a month over month basis, admittedly plenty of room to grow and grow. But as I've also said many times, this business is sinusoidal, the supply chain has the effect of an accordion like behavior from time to time. So there will be puts and takes, ebbs and flows. But the overall governing dynamics of this business, the drivers that influence our end markets, industrial production, capacity utilization, the macros, other macros I mentioned in my prepared remarks are positive and in a growth stage of the economic curve. The hydrocarbon resources in this country are astounding. Even most recently Potential Gas Committee report came out slightly over 2.8 trillion cubic feet, up substantially from the 2.5 trillion reported in the prior report. The scoop, the stack, Permian, parts of Eagle Ford, Delaware Basin et cetera. Just an enormous supply of natural resources in these reserves and that really bodes well for our product mix in our service platform. This country is thirsty for oil. We have the proven resources now to supply oil to service that demand and then most recently you may have seen a lot of press about our export growth and the ability to bring in massive vessels, Corpus Christi is example, 2 million barrel capability vessel for exporting oil elsewhere in the world. All very, very positive things for this business model, it just doesn't happen in a binary fashion. I know this is a very long winded response to your question, but I think it's important to get this stuff out there because I really truly believe that the fundamentals that will drive our growth moving forward are continuing to firm up and we're positioned to take advantage of that.

[Unidentified Analyst:]

And then with the second quarter gross margins, you mentioned metals was aiding margin. What was the price cost benefit in the second quarter, do you have that?

[Nic Graham:]

We generally do not get that granular Paul, I do have it. So I'll be able to respond to your question. But at this point because we work off of average cost accounting treatment for inventory. There's a fairly significant lag effect into how metals inflation or deflation work their way into our system. Admittedly, copper did go up 22% year-over-year. But a lot of the big gain we've seen has come in the past couple of weeks. It will take a while for that to work its way into our system. So the benefit of that copper price appreciation has been most recently seen in the August period. Not so much in Q2. Q2 was a result - gross margin increase was a result primarily of pricing discipline on the legacy end of our business and then contributions from Vertex.

[Unidentified Analyst:]

So if the metals inflation should benefit margin even more going forward, where do you think 3Q and 4Q trends relative to the gross margin that you did in second quarter.

[Nic Graham:]

It's too soon to call Q4 given as I said the ebbs and flows of this business. But if the trends continue throughout Q3 that we've seen so far, I’d estimate 20 to 30 basis points on the entire business on a year-over-year basis.

[Unidentified Analyst:]

Okay, on a year-over-year basis.

[Nic Graham:]

Well, no, I'm sorry, let me clarify that. Let me restate that, 20 to 30 basis points sequentially.

[Unidentified Analyst:]

Yeah that makes more sense. Okay that’s all I have thank you gentlemen.

[Operator:]

[Operator Instructions] The next question comes from David Nierenberg with Nierenberg Investments.

[David Nierenberg:]

I wanted to ask you please amplify a bit on the one-time expenses of the Vertex integration in Q2, you mentioned that you thought that the range of direct costs was in the vicinity of 100,000 to 125,000. But I want to revisit that by simply asking, we added Rich, and I know we added another executive in Chicago that may not have had anything to do with Vertex. But I'm wondering whether or not we had any executive recruiting headhunting fees we also wound up paying in Q2 that also should be included in the non-recurring column number that you’ve already given us.

[Jim Pokluda:]

Yeah, which came in very late in the second quarter, David, and of course the other gentleman you referred to took a position as a regional manager on the electrical side. There were some fees for Rich and there was a very small element of amortization of those fees, but it was a very de minimis amount because Rich came on so late in the second quarter. There will be a little bit impact going forward. I mean there is always going to be some straggling costs, which are sometimes difficult to pinpoint. So there will be a little bit of those employment fees going forward that we’ll track.

[David Nierenberg:]

Other than that, is it your sense that you're pretty much done with the onetime integration expenses at this point.

[Nic Graham:]

I think for the abnormal items, David, yes. We're still fine tuning a few things here and there, some reporting issues, some reporting reports, some information that we need. So there's going to be some IT cost. But I don't think they're going to be material. I mean as Jim alluded or told us that the major cost as far as integration, closing facilities, consolidating facilities, moving product around, those are done unless something really abnormal crops up which I can’t think of. So I’d say we are done with the major costs.

[Jim Pokluda:]

And David, just to add a little bit additional color to Nic’s comments. When we - and even today, but certainly when we acquired this business we've discussed this openly. It was a business that hadn't been invested in for quite some time and we knew that going in. So that didn't come as a surprise. Had good bones, there is a lot - there were certainly a lot of positive things to consider involving the investment thesis. But one thing that we knew we were going to have to get our arms around was customer service. We had excellent customer service in some cases, but not so much the case in others. So even today and its scaling back, but in the beginning, we had to over oscillate a little bit with labor to shore up customer relationships and then go develop new customer relationships. So some of these expenses will tail for a bit, but we're winding them down as fast as we can. And additionally, as we improve our systems, processes, control measures, et cetera, automation et cetera, we’ll be able to more finely tuned operational expenses. And then just one more comment as we're on the subject. As the business was a little bit distressed or beat up, we had some making up to do, as I said plainly in a prior call. So margin was under a little bit of pressure. I had tolerance for that. I understand that. I understand the sales process and whether no one likes to admit it or say it out loud, our margin comes under pressure at times when you're rebuilding or capturing new relationships. We started whining that down a couple months ago also. So we have seen improvements in gross margin at the business and I anticipate further improvements in gross margin as we move forward.

[David Nierenberg:]

So these comments fold into what you said earlier, Jim, which is that instead of perhaps this acquisition being accretive to the extent of $0.09 or $0.10 this year which is my recollection of what you thought a year ago, now we think $0.03 to $0.05. But rather than obsessed about the near-term impact, what do you think under Rich’s leadership is the potential for this company over a longer period of time and how does that compare with what you thought at the time that you bought it?

[Jim Pokluda:]

Well, I’m extremely bullish on the company, David, I really truly am. Despite lack of investment by their former owner, they were still standing and nicely profitable. They're in a very large market space, total available markets for all fasteners is around $14 billion in North America. So a very large marketplace, still highly fragmented. The ability to move their enterprise into our legacy distribution network has significantly grossly improved their prior service platform, very excited about that. I've not changed my view at all over the long-term outlook for this company, not a single gram, very, very bullish on what we can do. Rich’s leadership and his initial contributions to the company have been wonderful. It's in his DNA, he's a super guy, he comes from this kind of stock, master distribution, he’s been doing this his entire professional career. I have every bit of confidence that he will lead us in the direction we intend to go. With respect to specifics, I'm hesitant for comparative purposes to disclose any numbers. We have numbers, I assure you we have numbers and we have business development plans that will get us to those numbers. I’m just hesitant in a public domain, Jim, get too granular for competitive purposes.

[David Nierenberg:]

Understood. If I may ask one more question to Nic. Gratifying to see in this quarter accounts receivable dollars down about 3.2, inventories down about 1.8 and net of reduction in accounts payable beginning to chip away at the debt. Could you share with us possibly at this time what you think we might be able to further do to the debt through operations and balance sheet management by the end of the calendar year?

[Nic Graham:]

David, I think that we can certainly shave the debt down by $2 million over the balance of the year, what portion that will go, more likely towards the latter part. We’re still – we’re going to take these entities down a little bit more that will be the primary source, obviously operations will generate funds too. But I think $2 million should be doable. I would like to exceed that, but certainly $2 million.

[Jim Pokluda:]

David just one more comment. I absolutely agree with Nic comment. 2 million is well within the crosshairs. The fourth quarter is a quarter that can be a bit of a wildcard depending on market conditions and a number of other factors. What I mean specifically is this, we can possibly take another 2 million out in Q4 if we decide to. But at the same time the value gained there needs to be contemplated with the opportunity available given market and customer demand and also any lucrative last minute bargains we can pick up in the marketplace. So there are some variables to consider in Q4 that could actually improve that $2 million number that Nick mentioned.

[Operator:]

Our next question comes from Damon Benedict with Nierenberg Investment.

[Damon Benedict:]

So I missed earlier when you talked about the June and July year-over-year growth in your prepared remarks. Did I hear right that it was approaching the mid teens?

[Jim Pokluda:]

No. If you exclude Vertex and just look at the legacy business, we had a sequential sales growth in June of mid-single digits and in July near double digits.

[Damon Benedict:]

So that was month over month then.

[Jim Pokluda:]

That's correct for the legacy business, which would exclude Vertex.

[Damon Benedict:]

And did that include a bottoming of projects or is that still ahead of us and could that help improve growth further?

[Jim Pokluda:]

I believe it did and I alluded to that in my prepared remarks. The comps from here do get easier. And I think we've had, I'm hopeful we've had both of those, a soft landing on our project business because of our pipeline data because of voice of customer because of the macros because of the aging of the legacy - the mega projects on the Gulf Coast, later cycle work that potentially is available to us now. All those variables indicate to me that we've experienced a soft landing and should grow from here.

[Operator:]

And I'm not showing any further questions at this time. I’d like to turn the call back over to Jim.

[Jim Pokluda:]

Thank you, Kevin and thanks to our valued team members for the 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, this does conclude today's presentation. Your may now disconnect and have a wonderful day.