Houston Wire & Cable Company
Q4 2017 Earnings Call Transcript

Published: 16 Mar 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Houston Wire & Cable Company's Fourth Quarter 2017 Earnings Conference Call. My name is Amanda 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 the 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, Amanda. Good morning, everyone and thank you for joining us on our call today. I'll begin today's call with an update of our fourth quarter 2017 results and then I'll provide some commentary involving present market conditions and our outlook for the first quarter 2018. I'll then turn the call over to Nic who will discuss our financial performance in additional detail. We are pleased that the positive market and customer demand trends experienced in the third quarter continued into the fourth quarter. Metals prices remained to tailwind and all three of our target end-markets including utility power generation, industrial and infrastructure showed continued signs of improvement. Sales of $82.1 million reached the highest level since the acquisition of Vertex and excluding Vertex, the highest level since the third quarter of 2015. Sales were up 18.6% from the fourth quarter of 2016, we estimate that approximately 7 percentage points of that increase were attributable to higher metal prices. Gross margin at 25.4% increased 360 basis points from the fourth quarter of 2016, primarily due to strong pricing discipline and metals inflation. Q4 2017 transactional volume per day which we measure as invoice count increased approximately 1% versus Q4 2016, and was the highest fourth quarter invoice count since 2014. We estimate that sales results in our core business with services, maintenance repair and operations demand increased approximately 16% from the prior year quarter and represented approximately 76% of our total revenue. The primary drivers of growth resulted from increased demand in industrial and commercial construction, metals and minerals, and upstream and midstream oil and gas markets. Q4 results continue to benefit from increases in the rig count and the price per barrel of oil. In Q4 2017, the U.S. land based rotary rig count increased to 911 from 635 in Q4 2016, and the price per barrel of oil increased to approximately $60 from the $53 in Q4 2016. This was good news for our company as Wire & Cable products are sold in oil and gas end markets including exploration, extraction, transportation and storage and production. The offshore rig count at '18 remains very low by historical standards, this 5 less in the closing count in Q4 2016 and continues to be a significant headwind for certain categories of our high performance copper wire, steel wire roll, and fabricated lifting products used in offshore markets. We estimate that projects sales in the fourth quarter increased 33% from 2016 and represented 24% of our revenue on a sequential basis versus Q3 2017 project sales increased 21%. We're especially pleased with this sequential growth as fourth quarter project results often decline versus Q3 due to seasonality. Our three primary end markets for projects include utility power generation, environmental compliance, industrials and infrastructure. Project sales in the utility power generation and environmental compliance markets increased approximately 47% year-over-year. The majority of the increase resulted from upgrades and modifications to existing fossil fuel power plants. Industrials end market project sales increased approximately 91% year-over-year and were led by recovering in oil and gas markets, industrial manufacturing, and metals and minerals end markets. Q4 project sales in the infrastructure end market increased approximately 170% year-over-year. The majority of the increase resulted from strength in public works projects and commercial construction. At present, our book-to-bill ratio is 101% and we're off to a good start in 2018. In 2018, on a revenue per day basis, January product sales were 7.9% above prior year; and February product sales were 14.7% above prior year. So far through March as of yesterday, sales billings are down 2% compared to March of last year. As a reminder though, March of 2017 was a very strong month and at that time it was the best billing month in 23 months. As we move further into 2018, we are pleased to see indications that broaden market conditions are improving, most macro-economic data is positive and customer and supplier feedback indicates that 2018 will be a moderate growth year. Given the above, combined with our robust operating plan, our present outlook for 2018 is one of optimism. I will 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. I'd like to first address our operating performance and then discuss the balance sheet and liquidity. I'll then close with some thoughts for 2018. 2017 quarterly sales amounts have risen over 2016 levels and our improved performance now generate a second consecutive quarter of operating profitability. Sales reached the highest level of the year which is unusual for this time when activity is normally negatively impacted by seasonality and the holidays. We believe this is a positive indicator of a market recovery. Gross margins also increased as in addition to improve pricing discipline and the impact of metals we benefited from typical year-end true-ups including vendor rebates as activity levels in the second six months of the year propelled us to higher rebate years, freight and customer incentives. Operating expenses at $17.8 million increased 7% over the prior year periods, $16.7 million. Variable compensation and commissions with the primary drivers of the increase, however, I was pleased that operating expenses as a percent of sales decreased from 2016's 24.1% to 21.8% in 2017. The results produced operating income of almost $3 million which compares favorably with last year's loss of $1.6 million. We also got some positive flow-through as operating income to sales reached 3.6%. Interest expense increased as the average interest rate moved from 2.4% in Q4 2016 to 3% in 2017 and as our debt levels rose from the prior year. We generated pretax income of $2.4 million, the best quality performance since the third quarter of 2015 and which also compares favorably on sequential basis with the $1.5 million pretax income level in Q3 2017. Our effective tax rate at approximately 16% was impacted by the effective valuation allowance on our deferred tax assets and the impact of the Tax Reform Act. I'll make some additional remarks in this issue shortly. For the year we saw two widely diverse six months operating results. The first half produced sales of $154 million and a loss before taxes of $1.4 million. In the second half, sales increased to $163 million and we generated income before taxes of $3.9 million. The improved performance can be primarily attributed to higher sales, up 6%, product margin up 118 basis points and improvement in leverage as we reduced operating expenses as a percent of sales by 82 basis points. Comparisons of year-over-year performance are not meaningful as 2016 included the three months of Vertex's operations post purchase while 2017 contained a full year. Turning to the balance sheet; the higher level of product demand required additional inventory investment which increased $88.1 million at year end, up from $82.2 million at the end of Q3 2017. As I commented on our Q3 call, our goal was to reduce the inventory investment in Q4. However, the caveat was that this was dependent on demand levels and the attractive purchase opportunities that are often present at year end. As sales demand increase, so that our working capital requirements would increase from Q3's $117.9 million to $119.6 million at year end, an increase of $1.7 million. The major component parts were increases in inventory of $5.9 million offset by reduction in income tax receivables of $2.2 million, increases in accounts payable of $1.8 million and in the bank overdraft of $1.1 million. While our customer receivables remain near flat quarter-over-quarter, days sales outstanding increased to 54.4 days for the year compared to 52.8 days at Q3. We saw no material deterioration in the composition of our receivable balances and the increase in days sales outstanding was primarily attributable to customer remittances not received until January 2018. On debt-to-equity, we drew down additional debt, primarily to fund the working capital increase and our debt level increased slightly to $73.6 million at Q4, up from $72.5 million at Q3. However, operating performance in Q4 offset a debt increase as the debt-to-equity ratio decreased slightly to 81.1% compared to 81.9% at Q3. Our cash outlays for capital expenditures during the quarter managed approximately $500,000 for a total spend in 2017 of slightly less than the budgeted level of $1.8 million. We continue to have adequate capacity from our $100 million asset based credit facility to fund our operations and we closed the year with $23 million of availability and we also remain in full compliance with the availability covenants of our asset based credit facility. I'd now like to make some comments in the recent Tax Reform Act and the estimated impact on HWC's results. Our 2017 results reflect the initial estimate of our interpretation of the recently passed tax act. As some of the provisions are not entirely quantifiable at this time, any necessary adjustments will flow through future tax revisions; however, at this time, we do not believe any such future adjustments will be material. Based on our current interpretation of the Tax Acts provisions and the information that we currently have, we are estimating that effective tax rate of approximately 30% for 2018. Please do understand this is an estimate which we want to share as a comparison to our historic effective tax rate of 39%. Looking ahead into 2018 for some current initiatives, we continue to look at all aspects of our operations including automation opportunities to maximize efficiencies and reduce operating expenses. Reducing our working capital investment will primarily focus on our inventory which involves maximizing the effectiveness of our product profiles at each of our 21 distribution locations to generate cash flow from operations and allow us to reduce the level of outstanding debt to improve the debt-to-equity ratio and our interest expense. And finally, to execute our business development strategy to increase sales and improved profitability. That concludes my prepared remarks. At this time, I'll turn the call back over to the operator. Amanda?

[Operator:]

[Operator Instructions] Our first question comes from the line of Paul Ryan of Raymond James. Your line is open.

[Paul Ryan:]

Strong gross margin for the fourth quarter; and Nic, you mentioned that you had some benefit there from vendor true-ups and rebates. How much of the 360 basis point year-over-year improvement in gross margin was specific to the billing margin; do you have that?

[Nic Graham:]

The billing margin itself -- now we had estimated Paul that the impact of the true-ups is probably in the range of about $500,000. So I'd have to nick that out to see exactly what that would be but your estimate about $500,000 -- you're looking at the difference between product gross margin and net gross margin, is that what you're referring to?

[Paul Ryan:]

Net margin, I'm thinking about $500,000 in net margin.

[Nic Graham:]

On the product gross margin basis, our policy may help you little bit more on a product gross margin basis, we're up about very similar actually and if you net out the metals impact of that, in Q4 we estimate that the impact from metals was somewhere between 110 basis points to 130 basis points.

[Paul Ryan:]

And then, looking forward into the first quarter in 2018, where do you expect gross margin to be -- what you're seeing here through in the middle of March now that first quarter is almost over already. Sequentially, do you think you'll have a similar year-over-year increase in gross margin there? Any commentary you can give on that?

[Jim Pokluda:]

Sure. We made tremendous progress in H2 of '17 with gross margin, we're grateful for that Paul but we need to be careful that we don't push it too far. Q4 '17 was a little bit higher than we expected because of some true-ups. I think it's not unreasonable that we might see a little pull back in Q1, certainly we will have -- I believe we will have gross margin improvement in Q1 of '18 over Q1 of '17 but I don't look to 2018 on an overall gross margin basis, net gross margin basis to be much higher than H2 of 2017. There is room for margin growth in certain product categories, so we are definitely laser focused on that. For the entire year, I'm comfortable estimating a 20 to 30 basis point net gross margin increase for the entire year but not that much more. We need to be careful we don't overdo this.

[Paul Ryan:]

And then looking at the salaries and commission lines, you probably are going to see bit higher there just given the growth you're seeing. All in, how do you expect that to impact your contribution margins on the operating profit line in 2018, especially with some other distributors mentioning inflation from freight costs and then some labor tightness as well? So combining that all, how do you see incremental margins in 2018 playing out? Thanks.

[Jim Pokluda:]

That's a good question; it's a complicated question because it assumes -- we have to make some broad assumptions. Let's go back a little bit; so in 2017 we did have a rather significant variable comp increase versus '16, and we estimate that increase to be around $1 million. So if you do the math and if you look at the pull-through effect, our operating profit pull-through, we estimate that in Q4 it was about 80%, if you adjust for the effect of Vertex and variable comp for Q4, it would have been another 15 approximate basis points higher, that's -- and I'll give you Q4 because we had a lot of movements in Q4. If we look at pull-through for the entire year and I'm defining pull-through as change in EBIT divided by change in gross profit dollars, pull-through for '17 was approximately 44% and then, quite a bit higher if we adjust for variable comp items and Vertex would have brought it upto approximately 80%. Those are good numbers, now recognize of course that we are -- or I will say that we recognized of course that we're coming off of a low base. Moving into '18, we have aggressive goals for the Company, we've reset our variable comp triggers, it's not unreasonable to think that we will have less of a variable comp expense for bonus purposes in the 2018 period with respect to variable comp as a function of increased sales, there will be an effect but I think it would be largely offset by a reduction in bonus variable comp otherwise described. So I hope that that helps.

[Paul Ryan:]

And lastly, just on the tax rate; Nic, you mentioned 30% -- any reason why it's not a little bit lower? Just kind of what are the different parts of that and buckets of that?

[Nic Graham:]

We've got the slightly -- federal rate is Paul 21% right off the top. We're estimating a gross takeaway to about 5.6%. And then the difference is permanent and that's a little difficult to guesstimate just because again the Tax Act has come up with some additional items that are non-deductible. So we estimate I think about 3%, 4% of -- as that best estimate there. And the other thing, we're not entire -- it's pretty difficult to kind of project this, the impact of share-based compensation, we'll have to get front-end of the year to see where that goes. That might move a little bit but it's our best guesstimate now. As I said earlier, I don't think it's going to be a whole lot of fallout from any true-up; so we're fairly comfortable with that number and we'll work through it as -- and obviously, let people know if there is any significant changes, I don't think there will be.

[Jim Pokluda:]

Paul, while Nic was chatting I was doing some quick math here. The difference between net gross margin and product gross margin in Q4 was approximately 50 basis points, so net gross margin increased Q4 year-over-year was up 360 basis points, product gross margin increased year-over-year, Q4 was up 310 basis points. For the entire year, our product gross margin increase was approximately 153 basis points, this is the product versus the net gross margin increase of 270 basis points.

[Operator:]

Thank you. [Operator Instructions] And we do have another question from the line of David Nierenberg of Nierenberg Investment Management. Your line is open.

[David Nierenberg:]

Congratulations on a sparkling fourth quarter. And the predictions that you had made in the last quarter that the fourth quarter would be a time when you would demonstrate a year-to-year recovery of the major project business, it turned out to be absolutely right and that was the substantial increase versus 2016 as well. I want to follow-up on some of these conversions about normalizing the fourth quarter result, you've already given us Jim, just a moment ago the comment about 50 basis points on gross margin which would translate into about $400,000 or so in the fourth quarter, and you've also given us some guidance about what the normalized tax rate would have been 30% as supposed to 16.4%. However, cutting the other way is this; in the fourth quarter you had a $900,000 sequential increase in revenue but you had a $1.35 million sequential increase in OpEx with no material change in depreciation which is in that category. And so that suggests to me that perhaps the second half of the year was better than you had budgeted to expected and therefore there may have been substantial catch-up accruals in compensation of various sorts during the fourth quarter to true-up for the entire year and if my hypothesis is correct, I'd like to get a sense of the dollar impact of that because what I'm trying to get us to is a sense of the extent to which we can extrapolate from the fourth quarter profit run rate into 2018.

[Jim Pokluda:]

Thank you, for that comment and there definitely are lots of moving parts and it was as Nic described, it's definitely much in H2 versus H1. There we had a catch-up on variable comp, that's for sure; other multiple variables moving around though, include rebates to customers because they are buying more. Purchase rebates from our suppliers because we're buying more. This sort of logarithmic effect of both of those rebates, in other was as you accelerate your purchase you get into heavier tranches, so you've got variables flying all over the place in your model. So lots of puts and takes. Nic has done some match and he will share with you what estimates is his best estimate, no the net result of that.

[Nic Graham:]

David, variable comp, I would estimate again because the second half is so much stronger we had some catch up to do as you might understand. So there was additional expense. So I think variable comp was probably about $500,000 in Q4 to catch-up. And the other thing we noticed too that the general management -- we did see some additional expenses on the distribution side, maybe there is lots of more expenses there as the number of cuts increased. But Jim mentioned, there was a lot of moving parts here this year which makes comparisons very, very difficult to follow.

[David Nierenberg:]

Thank you for that Nic; it basically feels to me that the impact of the catch-up on the variable comp was roughly equivalent to size to the impact -- the beneficial impact you had on gross margin. So maybe the $0.12 kind of number -- $0.11 or $0.12 is a reasonable sense of the run rate, that's great. My second question is that you had indicated in the third quarter the possibility that there always could be advantageously priced year-end buys of inventory and that even though you wanted to be in a position to take it down and pay down debt so much, you wanted to be flexible, as in fact you were because again on $900,000 increase in the sequential revenue, there was about $5 million increase in inventory but sounds like you're going to be working hard this year to try to take inventory down and to work to reduce the absolute level of indebtedness based on the comments you made in your prepared remarks.

[Nic Graham:]

David, you are absolutely right. We are laser focused on reducing our inventory investment. We're a specialty supplier obviously, and we acknowledge that our turns are not what you would see as a typical electrical distributor. So the rate at which we can release cash from the balance sheet by getting rid of aged inventory, short-linked inventory, etcetera; it can be painfully slow. However, that doesn't mean that there is a tolerance for it; we have multiple initiatives, half a dozen initiatives literally concentrating on this area of our business. I do expect that our inventory investment will go down as we move forward from here. If we have an aberrational event in the form of unforeseen customer demand increase, obviously that will pressure the balance sheet but even with our anticipated growth for 2018, we have budgeted for plans in our operating plan to reduce our inventory investment.

[David Nierenberg:]

Can you give us another update please on how Vertex is doing? And finally, which one of the 8-K the other day that one of your directors have decided not to stand for re-election; can you give us a sense as to whether you intend to reduce the size of the board or whether or not you would tend to replace the departing Director? And if you do intend to replace him, what kind of capability, what kind of person you're looking forward for the purpose?

[Jim Pokluda:]

With respect to Vertex, as you know, a year has gone by; we accomplished a great deal in that period of time. So on many levels, in many areas of the business, I'm very, very proud of all the hard work the team did. And moving on to our legacy ERP system; closing a couple of branches, consolidating several branches, bringing in new talent where new talent was needed, lots of work -- tremendous amounts of work; and so what does all that mean? Well, sales grew for the first time in 5 years, close to -- very close to our expected rate of growth for that period. So I'm generally pleased about that, thankful for that. Profitability though, did not meet expectation. Why? Because expenses were more than we had anticipated because we invested in machinery, equipment, labor, rebalancing of inventory -- so we had increased freight expense, inventory investment, travel of the CR strategic customers and suppliers. So we had a lot of -- I even was kidding around in my best Texas speak, I think a few times on the call where I said we had some making upto do, so we did; we've spend some money to get the product to the right place, rebalancing inventory and improve our operational efficiencies etcetera, and that hurt our profitability. A lot of that is behind us now and I look forward to improved financial results moving forward and we are seeing signs of that. So I'm pleased with that. With respect to Mark's departure, fantastic guy, did a wonderful job for our Company and we were sad to see him go but we certainly understand why -- his plate is getting even more full as we speak. We intend to replace Mark and we're looking at multiple skillsets in that area; distribution skillsets, manufacturing skillsets, supply chain skillsets, digital skillsets. We have a robust process in our nominating and governance committee running a good process, I'm very confident that we'll select a candidate that will contribute well to our Company.

[David Nierenberg:]

Back to where I started; excellent second half capped by a terrific Q4, and we have your positive commentary about how orders are shaping up 75 days into this quarter which is also promising in your sense for the year. So great job, thank you very much.

[Jim Pokluda:]

You're welcome, David. Thank you for that.

[Operator:]

[Operator Instructions] And I'm showing no further questions at this time. I'd like to turn the conference back over to Jim Pokluda for the closing remarks.

[Jim Pokluda:]

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

[Operator:]

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