Houston Wire & Cable Company
Q4 2016 Earnings Call Transcript

Published: 16 Mar 2017

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Houston Wire & Cable Company's Fourth Quarter 2016 Earnings Conference Call. My name is Michelle and I will be your operator for today. Joining us on the 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 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 conference over to Jim Pokluda, President and Chief Executive Officer. You may begin when you are ready sir.

[James Pokluda:]

Thank you, Michelle. Good morning, everyone, and thank you for joining us on our call today. I will begin today's call with an update on the Vertex acquisition followed by an overview of our fourth quarter 2016 results and commentary involving present market conditions and our outlook for the first quarter 2017. I will then turn the call over to Nic who will discuss our financial performance in additional detail. We are happy to report that the Vertex revenue results for the fourth quarter met expectations and our progress with the integration of the Company has continued at a brisk pace. Not unexpectedly, we incurred fair amount of integration expenses during the quarter, which in the near-term negatively affected the Company’s profitability. As we progress with the integration, these non-recurring expenses will diminish and overall profitability will improve. For the period, we estimate integration expenses were approximately $700,000. To-date we have completed consolidation of four Vertex facilities, Dallas, Atlanta, Charlotte and Los Angeles. After initial moving integration expenses, we estimated the savings from the above facility consolidations will be approximately 400,000 per year. Consolidations to be completed in Q2 of 2017 will be Houston, Tampa and Chicago. Additional integration accomplishments include inventory rebalancing, completion of the computer systems conversion, exit from majority of the transition services agreement with the seller DXP and retention of all key employees. Morale is high, strategic investment in inventory and digital resources continues and we remain laser focused on delivering a superior customer experience. Now, I will move on to comments involving our consolidated results for the fourth quarter of 2016 and provide a little color on some of the emerging optimism we are seeing in the market today. Including the acquisition of Vertex and adjusted from metals fluctuation. Sales increased 1% over 2015, 6.2% sequentially. Industrial market conditions including the oil and gas industry during the fourth quarter remained inconsistent. Encouragingly however, with the choppy results we experienced lead us to believe that the market is showing signs of recovery. Because of our product mix, we tend to be a bit later cycled than our distributor partners during the broad market recovery and we believe this is the case today as several of our channel partners are reporting at as their businesses began to moderately improve during the fourth quarter. Although We are still very early in the year, we have also begun to experience improving market conditions to January, February and early March of 2017. Sales in voice counts in overall gross margins have started to recover from the levels experienced in the fourth quarter 2016, which we believe marks the bottom four end-markets that underperform primarily due to the reduction in the price of oil and gas. Our success in the expansion of our commercial product lines continued and was a contributor to sales and operating margins in the fourth quarter and the acquisition of Vertex in early 2016 was most recent example of our efforts to broaden our product offering into the industrial market. I was also pleased that we again achieved success in reducing our working capital investment and generating operating cash flow. Gross margin at 21.8% increased 30 basis points from the fourth quarter of 2015 and 330 basis points sequential in the fourth quarter of 2016 versus a third quarter of 2016, primarily due to incrementally higher margins generated by Vertex. Excluding Vertex, sequential gross margin increased approximately 150 basis points in line with expectations I communicated in our last earnings release call. The balance of my year-over-year comments will exclude contributions from Vertex. Q4 transactional volume per day, which we measure as invoice count increased slightly over 3% versus Q4 of 2015, additionally in line with some of the recent markets improvements we are experiencing. Year-over-year January and February transactional volume per day is up 4% and 9% respectively. Bookings per day also improved in January 2017 versus December 2016 increased again in February versus January and it increased year-over-year in the early March period as well. The book-to-bill period in the January and February period of 2017 was 104%. We estimated that the sales results in our core business with services, maintenance repair and operations demand increased approximately 9% from the prior year quarter when adjusted for metals and represented 83% of our total revenue. Growth continued in new products that target residential and non-residential construction and regions with exposure to oil and gas and general manufacturing began to show varying degrees of recovery. On the last call, I mentioned that the level of US land based drilling can impact our financial performance in our largest end-market which is oil and gas. At that time, the closing October rotor rig count to U.S. was 535,, which was up 135 from a 400 level at the end of Q2. At present, the rate count is approximately 748, which is up 213 from the October level. This is good news for our business as we performed well in oil and gas markets all performed well. As I mentioned in the past, we are a later cycle participant in the oil and gas MRO revenue streams. So should the present level of drilling activity continue to improve, so to should our results necessary. The offshore rig count at 20 is down slightly versus a prior quarter and as such, we do not expect any material improvement in demand for our products used in this end-market. Project sales for the fourth quarter decreased 49% from 2015 when adjusted for metals and represented 17% of our revenue. Our three primary end-market for projects include utility power generation and environmental compliance, industrials and infrastructure. Projects sales in the utility power generation and environmental compliance market were down approximately 42% year-over-year. Very similar to the prior quarter, sales were down due to a reduction in new construction with fossil fuel power plants, alternative fuel power plants, environmental compliance devices offset slightly by an increase in substation construction. Project sales in the industrial end-market declined approximately 54% year-over-year, reduced oil and gas activity drove the majority of this decline followed by metals and minerals. Although, there are several large projects active along the Gulf Course we tend to be a second level participant in these mega projects as the initial buys were wire and cable are often purchase without aid of master distributors and instead purchase direct from cable manufactures. As these megaprojects mature however, our opportunities and levels of participation increased due to their requirements for adjacent time value proposition and specialized portfolio products and services. Q4 project sales in the infrastructure end-market decline approximately 47% year-over-year. The entirety of the decline resulted from the ongoing reduction and spend from a large telecommunications project. We are disappointed that our sales involved in this telecommunication projects have diminished; however, we are encouraged by recent pronouncements for the potential of significantly increase U.S. infrastructure spend. Should the forecasted infrastructure investments materialized, we believe this area of our business could experience nice tailwinds and growth for several years. As we move further into 2017, our near-term outlook for the market has improved. Always [indiscernible] the recent positive trends could again turn negative, which would drive return to industrial activity reduction. Reduced oil and gas exploration, transportation and production and metal inflation which would negatively impact our financial performance results. Recent positive micro trends in these areas lead us to believe that several of our target market has sound block. Although we are disappointed with our fourth quarter results, the good news is that the present macro drivers that assist us in our business are improving. Copper is at 19 month high, the price of oil has appreciate significantly from the low February of last year and at 748 U.S. rotary rig count is the highest as its been in the last 17 months. Year-over-year MRO sales have grown for two consecutive quarters and our sales funnel indicates that we are beginning to see build and project quoting activity. We are encouraged by these trends; however, as we will move forward we will continue to exercise extreme discipline with the expense in working capital management, as we realize that the macro drivers filling our sales today are still in their early stages and the lean cost structures necessary insurance policy in the market that we believe is showing signs of recovery. I will now turn the call over to Nic Graham, our Vice President and CFO for a detailed analysis of our financial results. Nic.

[Nicol Graham:]

Thanks, Jim and good morning ladies and gentlemen. It was a disappointing quarter of financial results due to the level of industrial demand, but as Jim mentioned there are some signs of recovery. I'm pleased with the Vertex acquisition as you can tell from Jim's comment we have all been working very hard on this integration at HWC. Despite the disappointing operating results, we did attained [indiscernible] in several other financial areas. For the quarter, we reduced Operating expenses, which excluding the impact the Vertex and the related acquisition expenses fell by 3.7% from 2015. On a sequential basis, operating expenses were near flat that we picked up more than 100 basis points on OpEx as a ratio to sales. We believe with the addition of Vertex that we will obtain further improvement in this ratio. I also want to remind everyone that our model has a fairly high fixed cost component, so as we push more sales volumes through the system, we gain operating leverage. For the year, excluding Vertex expenses, the acquisition expenses and the impairments from both the current year and the prior year, we reduced operating expenses by $2.4 million or 4.2%. Our focus on expense reduction will continue. Excluding Vertex's receivables we were pleased to have improved our days sales outstanding by more than 1.5 days which concerning the trend of customers to hold their cash in the current economic environment was a good achievement. Our customer agents who are in line with our expectations, but we continue to watch credit lines very closely. Our bad debt expense during the year was a little high than we would have liked principally due to certain customers who were directly tied to the oil and gas market, but write offs at 200,000 we are still less than one-tenth of 1% of sale. The aging of Vertex accounts receivable looks good and there are no obvious signs of distressed customer accounts. Cash flow, despite the lackluster activity levels is still positive in Q4 at $1.3 million and $17.3 million for the year. I want to give you a little more color on the administrative side of the Vertex acquisition. It was a subsidiary of a large Company and it had minimal traditional back office administrative or accounting support; nearly all of its being provided by its former parent for which they were charged. We got Vertex onto our computer platform in May 2017 and all of its back office functions, accounting, accounts payable, credit inflection, payrolls and HR have been consolidated in Houston, Texas. All of Vertex's bank functions have also been consolidated to Huston. We have added few more people to our staff in Houston, but we currently estimate the net savings that has changed to approximately $200,000 per year. We funded to the $32.4 million acquisition of Vertex from our existing credit facility, which was amended to accommodate the assets of Vertex to be included in the asset base facility. The facility still stands at $100 million with a $50 million accordion feature. At year-end, available borrowings under the facility were $25.6 million more than adequate to fund our operations. We remain in full compliance with the availability covenants of the facility. Some comments on debt-to-equity and capital allocation. After funding the Vertex acquisition our debt-to-equity ratio increased and stands at 67% at year end, this compares to the ratio of 40% at the end of 2015. The 2015 ratio was lower than the 49% level at the end of 2014 as we reduced debt by $14.6 million in 2015. Prior to the Vertex acquisition we had reduced debt by $10.6 million in the first nine months of 2016. Historically HWC’s [indiscernible] was much higher debt ratios and I believe our ability to generate cash flow from our operations including Vertex provides us with a capacity both manage the term debt load and reduce it going forward. As we discussed at the last earnings call, the Board suspended the dividend and has currently curtailed the stock buyback program. In line of our recent operating performance in current debt levels we believe that this action is the fiscally responsible course of action to take. Looking ahead at some of the current niches for 2017, consolidated additional Vertex sales and distribution centers in existing HWC facilities, work and [indiscernible] of Vertex operations where additional operating efficiencies can be attained including freight and inventory profiles, continue the overall inventory re-profiling initiative with the goal of reducing the working capital investment and continue with the review of our current operating expense spend to ensure that all expenses provide a maximum return. One SEC filing matter, I need to comment on, we could not complete our annual report and Form 10-K for the 2016 year including the financial statements on a timely basis due to unanticipated delays arising in connection to the preparation and inclusion of certain information related to the recent acquisition. We anticipate that we will find the annual report and Form 10-K no later than the 15th calendar date following the prescribed filing date, which is today. That concludes the prepared remarks at this time; I will turn the call back over to the Operator. Michelle.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Sam Darkatsh with Raymond James. Your line is open, please go ahead.

[Sam Darkatsh:]

Good morning Jim, good morning Nic, how are you? Three questions if I could first off, based on what you see Jim on the order book, when do you think the project business begins to grow on a year-on-year basis and how should we look at that here in the first quarter with virtually all of it having been completed already?

[James Pokluda:]

When markets recover in my experience, the MRO component comes back first, almost always. Of course, there are exceptions because we are kind of a small Company if you get a large project for a quarter, it can skew the data. But in the long run in recovering markets MRO customers, MRO spend is the first to return and that's certainly been the case here, and as you see in our data it started to come back a couple of quarters ago, so we are encouraged by that. Admittedly the project business has been slow to form, we are seeing some build in Q1, there are certainly no doubt about that, I wouldn't describe it though as anything to get excited about yet, I would like to say otherwise that that wouldn't be fair. We are seeing a build in the right areas; we are seeing more quoting activity; we are seeing less, less concern in the marketplace with the large end users worried about spend, because there is more optimism with what is going on with oil and gas. People don't seem to be quite as nervous, so there is no doubt that the buzz in the space has shifted from negative to emerging optimism and we are happy about that. We are generally and as I have also said in my prepared remarks, we are usually two or three quarters behind broad market move. So I wouldn't have look to any sort of meaningful project recovery until the middle or latter part of this year. Another tailwind of course would be what is going on with infrastructure, a lot of talk in the market about significantly increased infrastructure spend, $1 trillion plus, that would bode well for our business and that will emerge over time as well.

[Sam Darkatsh:]

Thank you for that complete answer Jim. My next couple of questions might be more so for Nic. You mentioned the high fixed cost component to OpEx, I think you were talking specifically about OpEx excluding salaries and commissions. Although, you perhaps could have been including both of them. I'm just trying to get a sense of what the organic incremental margins look like in 2017 knowing that you probably get some sort of a variable or incentive comp reset with the New Year having turned, just trying to get a sense of what the leverage might look like Nic.

[Nicol Graham:]

Yes. Sam I was back obviously starting 2016 it wasn't very great as 2015 it was just less than 2%, 6.5% in 2014 and about 4.5% in 2013. So I feel reasonably comfortable certainly looking at the average of 2013 and 2014 and that 5% range. I think that’s doable, we are still working on way through the detail on the Vertex side. But, I think 5% is probably a reasonable target.

[Sam Darkatsh:]

5% on an incremental EBITDA for organic growth is that we are referring too?

[Nicol Graham:]

I'm talking 5% overall. I think that’s the reasonable, assuming we get the sales momentum that we seemingly seen on the new orders. But, we have to get that sales momentum. Again, we have a fix cost structure, we can take more capacity through the system, if our sales increased 10% or 15%. On the support side you talk about salaries, we met have all this, they have to put some more spend on the warehouse side fill with additional throughput, but the administrative support, the sales support probably won’t fluctuate that much.

[Sam Darkatsh:]

Just so I'm clear. You are thinking that operating expenses will grow about 5% in 2017. I just want to make sure we are talking about the same numbers?

[Nicol Graham:]

No, I'm saying the ratio of operating income to sales will be about 5%, if everything pans out.

[Sam Darkatsh:]

Okay. And then my last question and I may be reeducated on this and I apologize Nic if this has been asked and answered in prior calls. But, the $26 million in available liquidity, how does that work, at some point you are need to reinvest in inventory. I think your working capital at the sales let's call it 80%, 35% or so in the way back up, which means that if you have $26 million of available liquidity you might be able to reinvest a loan and maybe a $75 million worth of sales volumes. So, how does the liquidity work when business conditions improved and you need to reinvest in inventory?

[Nicol Graham:]

Well, I think there is still some opportunity Sam to take some costs out of our current - investment. So, part of that is going to be kind of swap out one-for-one. Obviously, if we introduce more new products or broaden any existing product lines, we would have take that into account. So, I can't really give you a hard and fast answer, but I think there is a lot of - if we can free up some of the avenues we would like to free up and we could reinvest. I don’t see that $26 million moving a whole lot and obviously we have got the finance to receivable and collect that cash. So, it will be a little bit of delay there, but I don’t see it getting pressured very much.

[Sam Darkatsh:]

Okay. Thank you both gentlemen. I appreciate it.

[Operator:]

Thank you [Operator Instructions] Our next question comes from the line of [David] (Ph) [indiscernible]. Your line is open. Please go ahead.

[Unidentified Analyst:]

Hi. Guys.

[James Pokluda:]

Hi. Good morning, David.

[Nicol Graham:]

Good morning, David.

[Unidentified Analyst:]

I'm speaking about how long it's been total corporate sales have risen on metals adjusted basis. Otherwise we would have had some improvement, but when I look at the entire company has it been 10 quarters maybe 12 quarters, because this time total sales were up 1% metals adjusted, probably been 1.5%.

[James Pokluda:]

Yes, it has agreed.

[Unidentified Analyst:]

So even though its 1%, it’s a milestone because it’s black rather than red.

[James Pokluda:]

We are encouraged by that too David. It’s been a long 2.5 years and I guess I’m going to have to maybe bore the audience with a little bit of repetitive story. If you go back to the 2014 period before the oil industry cratered, we were moving right along. Q1, Q2, mostly Q3 really good records in Q1 and Q2 and almost a record in Q3 and we felt good about that. We had a lot of wind in our sail. Copper started to pull down a little bit at that point, but didn’t fall to the $2 level that we saw earlier this year. And that gives me a lot of peace of mind, it gives all of the management team a lot of peace of mind, because when the markets are behaving as they traditionally have for years and I have been here 29 years. This business does quite well, we have a lot of operating leverage, we spin-off cash make good money, good EBITDA, EPS is good, I mean we produced a buck a share in markets that were fulsome. But then the market shifted as you know and that’s where I said there has been a slow slug here for the past couple of years. We are delighted to see that the commodities inflations, steel is up, copper is up quite a bit year-over-year and that really helps us, it helps us with our inventory pricing, it helps us with bigger sales. So, these broad markets moves metals inflation, the return in strength of oil and gas, increased activity up stream with the rig count, really, really glad to see that and thank you for acknowledging that we finally had a little bit of growth here. Now, listen we are not out of the woods and we need to keep that in mind. Things are improving though, the recent market trends in Q1, great improvements over Q4 of last year. After upstream settles in, downstream follows. So you sort of start to see the dendrites that add to the backbone pipeline should allow these wells are drilling on new places, so you we have oil and gas infrastructure to bring that product to market. We have the backbone pipeline, but you have to build these little tentacles on the side that bring it to that backbone. And that’s where the pumping stations compressor stations, metering stations, tank farms, substations. That’s where that work comes in and that’s good news to. So finally we have some wind doing our sails and we are ready for it. We have the inventory, we prepared our business over the past couple of quarters to do even better when the market recovers, we have invested in people, we have invested in new products, we haven’t cut inventory, we have improved our digital platform, we have added engineering services in heavy lift, we have acquired our Company, we have paid down debt, we have returned capital to shareholders, we have worked really, really hard over these past couple of years to do what we thought was the right thing to do given the present operating environment. And now finally we are starting to see some wide at the tunnel. So I'm going to repeat myself here we are glad to see that light, we are not saying that missions accomplished absolutely not, but we think we found bottom and we are going to work very hard to do everything we can to continue to grow this business as we move forward throughout this year given the recovery in the end-markets.

[Unidentified Analyst:]

The trend is different if we say and this the recovery is positive it's good. Also I remember asking you after the third quarter, because in the third quarter there were whole bunch of small non-recurring hits to the gross margin and I remember or asking you what you thought that the combined [indiscernible] of higher gross margins and a normalizations of your own gross margin would bring Q4 gross margins to estimated 21.9% when we forced you to come up with the number and you actually did 21.8%. So it's huge improvement in gross margins as well. And then combining the comments that you made at the time of the Vertex acquisition with your comments today about the consolidation of warehouses as well as the administrative cost reduction, my recollection was you said we expect the Vertex [indiscernible] on an annualized basis and in addition to that now guys are talking about $600,000 of cost savings as 1% to $0.12 perhaps [Indiscernible]. So there is a number of things that give us some optimism Jim that while we cannot predict when this Company will return to profitability, exactly which quarters out will happen and those are the plains from a revenue point of view seems to be slightly up now, but you are still pairing away cross gross margins have risen where you expected. So there is reason to hold that this would be in the year 2017, when you will have rising organic revenue and sometimes during your referenced normalized profitability?

[James Pokluda:]

I think that was well articulated David, it's funny I was going to use an airplane matter for earlier. We are gathering some air under our wings and that's the first thing you have to do when you are pulling out, so whether the metaphors wind in our sail or air under our wings, we are feeling better. This is a good path, we have got good infrastructure, solid frame, strong field, good mass and we have some wind filling our sales. Now what we have to do is do it for two or three quarters, and we are going to work exceedingly hard to do that, there is certainly no question about that. Happy to see what we are seeing so far, not happy with our performance in Q4, but it is improving today as I said and we are not taking anything for granted. We are hunkered down, laser focused with expense management, gross margin optimization, integration of Vertex, key employee development, key employee retention, just laser focused on bare fundamentals of the business to blocking and tackling of the business that we believe will allow us to prevail as we emerge from this lousy market.

[Unidentified Analyst:]

Nic and your team are solid operator, so just do it.

[James Pokluda:]

Okay. All right. Thank you, Dave. Thank you for those questions.

[Operator:]

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

[James Pokluda:]

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

[Operator:]

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