Houston Wire & Cable Company
Q3 2017 Earnings Call Transcript

Published: 9 Nov 2017

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Houston Wire & Cable Company's Third Quarter 2017 Earnings Conference Call. My name is Sabrina 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 Securities Exchange Commission filings. Forward-looking statements are not guarantees of 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, Sabrina. Good morning, everyone and thanks 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 third quarter 2017 results. I'll then turn the call over to Nic who will discuss our financial performance in additional detail. The close of Q3 marks the first anniversary of our acquisition of Vertex. It was a busy year. We closed branches, consolidated branches, made organizational changes, recruited new management, fixed operational issues, converted ERP systems, substantially increase focus on supply chains and improved customer experience, lots of work, tremendous amounts of work. I'm very pleased with the considerable efforts of our team. The plan is working, sales are growing. The above wasn't accomplished without expense though, in both hard and soft dollar. So Nic in prior calls has provided you with some estimates and how this has impacted our financial performance including inventory step up charges, non-recurring integration expenses and amortization expenses that should help you understand the acquisition related cost affecting our reported results. With the first year behind us and several necessary changes executed and complete. Our top priority moving forward will be a laser focus effort to extract value from the above initiatives in the form of increasing Vertex's profitability. Moving onto our overall company performance it was encouraging to see the market strength and our financial performance results improved throughout the quarter. Sales for the third quarter increased 24.5% over the prior year period and 13.6% organically excluding Vertex. Sales of $81.2 million reached the highest levels since the acquisition of Vertex and excluding Vertex the highest since the third quarter of 2015. Industrial and infrastructure end markets led the recovery and thus far into the fourth quarter these trends have continued. Gross margin at 22.9% increased 440 basis points from the third quarter of 2016 primarily due to strong pricing discipline, metals inflation and the higher margins generated by Vertex. The balance of my year-over-year comments will exclude contributions from Vertex. Q3, 2017 transactional volume per day which we measure as invoice count increased approximately 2.7% versus Q3, 2016 and was the highest count since Q4, 2014. The present book-to-bill ratio is 104%. We estimate that sales results in core business was services maintenance repair and operations demand increased approximately 20% from the prior year quarter and represented approximately 78% of our total revenue. The primary driver of this growth resulted from increased demand in industrial construction and midstream and upstream oil and gas markets. Although the US rotary rig count has recently fallen to 880 from the Q3, high up 931 set in the second week of August. We are encouraged that the count remains significantly above last years' rig count which ended Q3 at 500. We believe that continued appreciation in the price per barrel of oil which is now trading at approximately $56 up from the approximate $50 level experienced at the end of Q2, 2017 has also been callous for increased end market activity and customer demand. The offshore rig count at 22 remains very low by historical standards and continues to be a significant headwind for certain categories of our high-performance copper wire, steel wire roll, fabricated lifting products used in offshore markets. Project sales for the third quarter decreased approximately 5% from 2016 and represented approximately 22% of our revenue. Similar to our project bottoming view mentioned on our second quarter 2017 earnings release call. We believe that on year-over-year basis present macroeconomic indicators, internal pipeline data and voice the customer feedback indicate that the low level of activity experienced in large projects for the past several quarters is likely bottomed and is now positioned to grow slowly moving forward. Project sales for the third quarter increased approximately 17% sequentially versus the second quarter, 2017. Our three primary end markets for projects include utility power generation and environmental compliance, industrials and infrastructure. Project sales in utility power generation and environmental compliance markets decreased approximately 39% year-over-year. The majority of the decrease resulted from reduced fossil fuel plant construction offset slightly by plant upgrades and modifications. Project sales in the industrials end market increased approximately 7% year-over-year and were led by recovering activity in oil and gas, metals and minerals end markets. Q3 project sales in the infrastructure end market increased approximately 70% year-over-year. The majority of the increase resulted from recently improved strength in multiple areas including transportation, public works, water, commercial and food and beverage. As we move further into the fourth quarter of 2017, we're pleased to see indications that broaden market conditions are improving, but we must remain mindful that we're entering a typically seasonally slow period of the year and that present market conditions could change. Taking a long view however, trends are positive as is our outlook for improved profitability. And I believe our third quarter results illustrate our ability to leverage our model and execute our strategic business development plan in an improving economic environment. Commodity inflation including both metals and oils appears to be mostly holding and macros overall indicate that the US economy is positioned for further growth in 2018. We believe all these items should service tailwinds for our business in the period ahead. I'll 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. As Jim mentioned some healthy indicators of improving performance were achieved in the third quarter as sales and margin increases both trend in a positive manner. Some comments on our operating performance. Comparisons on total operating expense quarter-over-quarter and year-to-date 2017 versus year-to-date 2016 are not meaningful as prior year periods do not include the cost of the Vertex operation which is acquired in early October 2016. However, we can look sequentially at the total operating expense spend, which was near flat in Q3 at $16.5 million with total operating expense spend in Q2. The increase in sales and higher gross profit helped our leverage as operating expenses to sales improved quarter-over-quarter from 21.2% in 2016 to 20.3% in 2017, a decrease of 90 basis points. In addition, the sequential operating expense to sales ratio comparing Q3's 20.3% with Q2, 2017's 21.8% ratio showed another favorable decrease of 150 basis points. Our goal to improve leverage and drive down the ratio of OpEx to sales remains a key initiative going forward. The results of operations generated pre-tax income of $1.5 million the best quarterly performance since the third quarter of 2015. We have provided non-GAAP reconciliation table as part of the earning's release to portray the impact of statutory taxes at the rate of 39.5% on pre-tax income for both the current quarter and year-to-date period. The GAAP tax rates of 213.8% for the quarter and 1,651% for the year-to-date period were inflated over the statutory rates primarily due to the change in our annual earnings estimates and the impact of the valuation allowance. On an adjusted non-GAAP basis we earned $0.06 per share for the quarter. Turning to the balance sheet the increase in demand for our products necessitated higher inventory investment. Inventory finished the quarter at $82.2 million up from the second quarter level of $78.5 million. Our operating plan for the balance of the year includes the reduction of our inventory investment which is generally being the historical trend at this time of the year. However, if sales demand continues the level achieved in the third quarter we may not be able to achieve our full goal which currently projects a decrease of approximately $2 million. Improving the efficiency of our inventory investment which includes maximizing the effect of profiles at all of our 21 distribution locations remains a major initiative of the company. As sales demand increase, so did our working capital requirements which increased from Q2's $113.5 million to $117.9 million at Q3, an increase of $4.3 million or 3.8%. the major component parts were increases in our accounts receivable of $9.2 million, inventory $3.7 million offset by a reduction of accrued liabilities and reduction in taxes and bank overdraft both for slightly more than $1 million. While our customer receivables increased as a result of the higher demand levels. Our receivables day sales outstanding was near flat at 52.8 days up from 52.2 days at Q2. Customer collections have remained strong and our overall bad debt experience remained in line with historical trends. However, our ability to monitor changing trends and customers payment patterns are identifying signs of cash flow problems remain an integral part of our success. Some comments in debt to equity. We used cash from operations during the quarter primarily to fund working capital increase and our debt level increased to $72.5 million up from $69.9 million at Q2. Our debt to equity ratio increased to 81.9% from 77.6% at Q2. Our current forecast for the balance of the year projects a decrease in our working capital investment of between $2 million to $4 million principally through inventory reduction and reduction in accounts receivables and the cash flow generated from operations will be used to reduce our debt level. Reducing this debt level remains a crucial initiative for the company going forward. Our cash requirements for capital expenditure decreased during the quarter to $100,000 down from $300,000 in Q2 and from $900,000 in Q1. We will likely close the year with a total CapEx spend slightly less than the 2017 budget total of $1.8 million. We continue to have adequate capacity from our $100 million asset base credit facility to fund our operations as we close the quarter with $24 million of availability. We remain on full compliance with the availability covenants of our asset-based credit facility. Looking ahead at some of the current initiatives for the balance of 2017. We continue to look at all aspects of our operations to generate efficiencies, reduce cost and improve leverage. Reviewing all our administrative functions with goal of further automation, gain to reduce expense and eliminate repetitive tasks. As earlier mentioned reducing our working capital investment, generating funds from operations and reduce the debt level. And continue to execute our business development strategy to increase sales and improve profitability. That concludes prepared remarks at this time I'll turn the call back over to the operator. Sabrina.

[Operator:]

[Operator Instructions] and our first question will come from the line of Paul Ryan with Raymond James. Your line is now open.

[Paul Ryan:]

I was hoping you could expand a little more in your comments about what you're seeing in regard to demand through the quarter to-date through November? And then if that will - if the demand level you're seeing will allow for further improvement in pricing sequentially in the fourth quarter.

[Jim Pokluda:]

Sure. October was a good month and the sales trends experienced in September continued in October. The build for us began in August and that was welcomed early because July was somewhat disappointing, but that reversed - it started out okay, July then it sort of lost towards the end of the month. August came in better. September good. And October continued that trend. So far November looks a lot like October. The tricky part here Paul is that, as you know and as I've commented seasonality shows up real quick obviously towards the latter part of this month and then you get some recovery pretty soon in the early weeks of December and it's sort of jump ball the last couple weeks of December. So the likelihood for what I'll call significant choppiness certainly exists. The good news is, we haven't seen any indications of that yet. With respect to demand trends that are driving this, the fundamentals are really solid. We've seen a nice lift in broad industrial markets as you could have observed infrastructure did quite well last quarter. Heavy industrial, steel, heavy industrial manufacturing, pulp and paper, plant upgrades all quite good, oil and gas good. I haven't seen any change in the macros that would change that market performance apart from seasonality. With respect to pricing, we did have a good pricing quarter and metals was a tailwind there, but the story is far from all metals. We - beginning several months ago took a strong, strong established a strong movement towards pricing improvement and it manifested itself in the third quarter very happy to see that, the results are significant. I don't feel comfortable telling you that, there's a lot more headroom from here. We've accomplished a lot very quickly and I just think it would be little out of balance for me to tell you that there is a lot more beyond this.

[Paul Ryan:]

And that's in regard to pricing reverse margin, does that imply that fourth quarter gross margin we shouldn't expect a large sequential improvement relative to third quarter?

[Jim Pokluda:]

Yes.

[Paul Ryan:]

Got it. And then what do you have gross margin thoughts beyond fourth quarter just looking into 2018 whether it will be pricing or gross margin?

[Jim Pokluda:]

It's just too far out Paul. As I said copper is a tailwind, steel is tailwind, they've all been tailwinds. We're happy to see that. I've been here in this position a lot and have been hopeful that it would stick and it didn't, so it's just too risky I think to forecast out beyond the quarter or so. You just don't know what's going to happen with metals.

[Paul Ryan:]

Fair enough and then, in regard to the project segment. What does the project backlog look like at this point in time? What is the timing of future projects and do you expect year-over-year growth to turn positive in the fourth quarter? I guess when should we expect the organic year-over-year change there to turn positive.

[Jim Pokluda:]

Project backlog is slowly growing, when I referred to the book-to-bill ratio that's mostly all projects and that's approximately 104% and that's the highest it's been in a while, so please to see that. The typical project profile we're getting today is unlike what we saw 10 years ago that was a function of what the industry call megaprojects large coal fire power plants for example with very long sale cycles some of those jobs could last a couple years, that's not what we're seeing today. The sales cycle for a project is shorter primarily because the projects we're getting are smaller. So the way to think about this is, project benefit a little carry over into Q4 and a little carryover into Q1. I wouldn't think about it beyond that. Now obviously in Q4 and Q1, we'll be working very hard to continue funding project backlog. So I'm hopeful that the markets remain solid which will allow that to occur.

[Paul Ryan:]

Okay, thanks. And then Nic just one last housekeeping question. In regard to working capital going forward into 2018 and kind of more of growth environment, how are you thinking about working capital as a percentage of sales there?

[Nic Graham:]

It's going to vary a bit Paul by quarter. Our historical - better two quarters are Q2 and Q3. It's probably going to parallel the movements we've experienced in 2017. My hope is that, when we take some more dollars out of the inventory investment. You know the AR side is really. I'll keep my DSO pretty much the same. If it goes up, it goes up no collectability problem. So really the area we've got to work on is inventory, to try and see if we can twiddle [ph] it down. Difficult to project at this point, where we're going to be out there in 2018 but it's obviously as I said my comments it's key focus area for us going forward because we've got to repair that debt down and cash flow from operations.

[Paul Ryan:]

Do you have a ballpark sense of how far you would take inventory down?

[Nic Graham:]

Probably $2 million I think would not be problematic. There's always the upside for more, depending on what the market condition has turn out to be, but certainly that $2 million is doable. Paul.

[Paul Ryan:]

Okay, thanks. That's all I have. Thanks guys.

[Jim Pokluda:]

Paul, I just now realized I didn't answer all of your questions a moment ago. You had inquired whether or not I felt we would have year-over-year growth in projects in either Q4 or Q1 and I believe, we will. It's too soon to call definitively, but my intuition is that at this point we will. So I hope that helps.

[Paul Ryan:]

That's helpful. Thank you.

[Operator:]

[Operator Instructions] and the next question will come from the line of David Nierenberg with Nierenberg Investment. Your line is now open.

[David Nierenberg:]

Nice to see you back in black, growing robustly with the whole [indiscernible] project will soon resume growth, but at least it produced nice sequential growth, so good for you, nice to see.

[Jim Pokluda:]

Yes, thanks so much.

[David Nierenberg:]

You commented in the first paragraph of the press release that the negative impact of the three major storms which is probably the worse clustering of storms in our lifetime was less than 1% on revenue. Here again congratulations because it was some heavy blows. We might imagine though that seeing as you probably had a shift where business was serviced from one warehousing area to another that you may have incurred some additional costs serving your customers as a result of the storms or cost incurred taking care of your own employees. Could you or Nic please estimate what you think the combined revenue and any additional cost impact of the storm might have been on Q3 EPS?

[Jim Pokluda:]

Well I'll do my best, Dave. Let me think about this, that's a pretty complicated question. We did shift shipping points to service customer demand but I really got a - this is difficult to contemplate I'm inclined to say that we spent more money because I know intuitively we did spend more money but I just do not believe it was material amount of money incurred for - due to alternative site shipping. So I know that's not especially helpful but that's just the reality of that situation. Where we really got hurt was order cancelations because we couldn't get the stuff out of Houston that stung quite a bit. At times we could ship from other branches, but not always because it just would have been too much time in transit so the customer had to go another route. We looked at this a couple different actually three independent analyses, the long and short of it is, in dollars loss from the storm it was slightly less than $500,000 in revenue. Prior to some of the storms there were incremental orders that I could legitimately say we wouldn't of all otherwise received, so those were orders offsetting the loss. And then following the storms, there was a little bit of bump that offset some of the loss, but all of it. Overtime we believe and overtime I mean 12 to 18 months we will be net positive in this experience but for the quarter we certainly were not. We picked up a little bit more in October, not a lot but you can see the build occurring. A couple different things happened here. The storms in Houston did not create much wind, so power lines were not down, there wasn't a lot of damage from tornadic effect etc. the damage occurred from waters in the north flowing south freshwater into residential and non-residential construction environments. There was some plant damage but not like what you've seen in the past from other storms where salt water moved north. The damage in Houston and greater area in dollars is primarily associated with residential and non-residential construction. Moving over to Florida however, there was significant amounts of high wind and tornadic activity that knocked down power lines etc. So there was some opportunity created due to that storm however the industrial environment in the Florida is not what it's like along the Texas Gulf Coast so again although there were unprecedented amounts of line men sent down to Florida the most in history ever to help those poor folks, the opportunity for revenue didn't really align with our product set. The big wild card of course is Puerto Rico, just an unprecedented amount of damage as you know and we're beginning to see some first wave opportunities. We're not the initial suppliers in that sort of situation because we're a specialty house so a lot of that just goes direct. But there is a build of opportunity we see it growing each week and this will go on for months and months. So I believe over an extended period of time there will be sales opportunities for us in Puerto Rico, it's just impossible though for me to try and quantify that at this time. I know it's a very long answer Dave. I'm trying to give you as much color as I can. I hope it was helpful.

[David Nierenberg:]

Very helpful and again, congratulations skating through what was, what could have awful - it already was awful but you guys came through remarkably well. Shifting through a completely different subject earlier this week Raymond James published a thought piece about publicly traded distribution companies in which they try to mark-to-market the value of their inventories and the value of their land and buildings and it showed a remarkable result for Houston Wire in terms of highlighting the extreme undervaluation of your shares relative to the mark-to-market book value of the company. I want to make sure everybody on the call is aware of that report and have seen it because it highlights the margin of safety investing in this company that is compliment to the upside potential that you've been talking about on this call.

[Jim Pokluda:]

Yes, that - you're right that was recently published. I'd given it a very high-level overview. As you might imagine busy time for us here, reporting season, board meetings etc. so we've been laser focused on that and preparation for this call. So following this call Nic and I are going to dig into that thought piece in far greater detail. We've also look for the read. I'm encouraged to hear your positive feedback.

[David Nierenberg:]

And I know Sam can't join us on the call today, but Paul was on. So thanks and congrats to Paul and Sam and their team because it was really good piece of work. No further questions from me. Thanks again, for a very nice quarter.

[Jim Pokluda:]

You're welcome, Dave. Thank you.

[Operator:]

[Operator Instructions] and I'm showing no further questions at this time. I would now like to turn the call back over to Mr. Pokluda for closing remarks.

[Jim Pokluda:]

Thanks Sabrina and thanks to our valued team members for their support, dedication of the company. Shareholders we appreciate you joining us on our call today and we look forward to continued success in the period ahead. Thanks a good day everyone.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude your program. You may all disconnect. Everyone have a great day.