Houston Wire & Cable Company
Q4 2015 Earnings Call Transcript

Published: 10 Mar 2016

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Houston Wire & Cable Company's Fourth Quarter 2015 Earnings Conference Call. My name is Cat [ph], 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 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 Web site 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're ready.

[Jim Pokluda:]

Thank you, Cat [ph]. Good morning everyone, and thank you for joining us on our call today. I'll begin today's call with an overview of our fourth quarter 2015 results and then I will turn the call over to Nic, who will discuss our financial performance in greater detail. In the fourth quarter, a reduction in the price of oil, deflation in copper, steel, and aluminum, and the strength of the U.S. dollar continue to be meaningful headwinds to our industrial end markets. The difficult operating environment created by these headwinds significantly affected our operating results in comparisons to the prior year period. Sales decreased approximately 10% when adjusted for deflation in metals, which in our analysis includes copper and steel. Gross margin at 21.5% decreased 160 basis points from the fourth quarter of 2014, primarily due to lower product margin, lower vendor rebates, higher freight partially offset by lower customer incentives. Product gross margin, excluding the impact of vendor rebates, customer incentives, and freight decreased approximately 100 basis points quarter-over-quarter, and decreased 20 basis points for the full year period. Transactional volume, which we measure as invoice count, decreased 7.5% versus Q4 2014. We estimate that sales results in our core business, which services maintenance repair and operations demand, decreased approximately 13% from the prior year quarter when adjusted for metals, and represented approximately 69% of our total revenue. MRO activity was down across all geographic markets, with the largest quarterly declines experienced in high-concentration oil and gas regions. We have not seen any significant sign of improvement in these regions, although we are beginning to experience improved demand in regions with less oil and gas exposure. Project sales decreased 3% when adjusted for metals, and represented approximately 31% of our revenue. 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 was up approximately 36% year-over-year. Sales in business activity improved in alternative fuel power generation and fossil fuel environmental compliance devices. Project sales in the industrials end market declined approximately 29% year-over-year. Downstream oil and gas markets were the primary contributor to the quarterly decrease, followed by upstream and midstream. General manufacturing increased significantly over the prior year period, and the mining and minerals was slightly positive. Project sales in the infrastructure end market decreased approximately 20% year-over-year. Decreases in telecommunications and transportation were slightly offset by increases in public works and wastewater end markets. For the entire year 2015, sales decreased approximately 14% on a metals adjusted basis, and transactional volume decreased approximately 9% versus 2014. For the full year, we estimate that 69% of our total revenues results from MRO activity, and approximately 31% from project activity. MRO metals adjusted sales decreased approximately 11%, driven primarily by spend reductions in oil and gas drilling, storage, transportation, and infrastructure, and petroleum petrochemical facility maintenance. Metals adjusted project sales declined approximately 19%, and was driven by decreased capital spend in telecommunications, oil and gas, and general fabrication in rigging end markets. Moving into comments involving 2016, we believe headwinds resulting from the strong U.S. dollar, and the low price of copper, steel, aluminum, and oil will remain obstacles to our business. Our results thus far for 2016 have been very inconsistent. The year began with a slower-than-expected January. February results however improved sequentially over January. And transaction activity for February returned to a level very close to that in the prior year. We believe it is certainly too soon to call it bottom, however, we do consider the flattening out of February year-over-year invoice counts a positive signal. As far as February 2016, invoice counts had been decreasing each month on a year-over-year basis for several months. We're also generating green shoots in certain areas of our business. Sales trends for our products into the non-residential construction market continue to outperform industrial sales trends, and most regions in the country with low concentrations of oil and gas exposure are beginning to deliver improved results versus the prior year. I also feel we have performed well with our ability to maintain gross margin. 2015 was an extremely difficult year for many of the reasons previously discussed. However, gross margin for the period finished at 21.4%, just 60 basis points below the prior year. Given the significant negative market forces encountered throughout the year, I believe our team did an excellent job selling the value proposition of our model, exercising price discipline, and not capitulating to pricing pressures omnipresent in our industry. As I near the end of my prepared remarks, I will highlight as I have often done on prior calls, that despite the difficult operating environment we are hyper-focused on all the areas of our business that we can control. Extreme focus on expense management, gross margin retention and optimization, strategic inventory management, prudent capital allocation, product line expansion, and superior operational excellence, all remain top priorities. We believe we've taken the appropriate steps to operate in the present environment and continue to execute our business plan through a group of highly motivated and talented individuals. 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 described, we finished up the 2015 year with a quarter which fell short of our expectations. One of the repercussions of the sales decline is the loss of leverage we normally obtain from higher sale volume. While we were able to reduce operating expenses during the quarter, we were down 4% or $600,000, excluding the impairment charge from Q4 2014. We were unable to make up for the gross profit shortfall which compresses operating income and net income. However, the financial condition of the company remained strong. As mentioned in the earlier calls, extreme emphasis has been placed on more efficient use of working capital, especially in light of the decrease in the level of demand. I would like to comment on some of these Q4 achievements and certain other metrics. We reduced working capital during the quarter. It fell by $1.8 sequentially. Customer accounts receivable aging remains in line with historical norms. Our day sales outstanding has moved up slightly, but still within our expectations, and customer delinquencies were minimal. In light of the depressed condition of the marketplace, we are taking a close look at the receivables aging and changes in the payment patterns of any customer, especially those that are influenced by activity in the oil and gas markets. Strong cash flow, operations generated $3 million in cash during the quarter. Debt compliance, availability under our credit facility at December 2015 was $41.5 million which provides ample capacity for our current and near-term needs. We remain in full compliance with the availability based covenants of our loan and security agreement. Share buyback, this initiative procured 324,000 share during the quarter. While our 2015 operating results were disappointing, we did obtain several measures of financial success during 2015, including decreased operating expenses. Excluding the impairment charge, operating expenses fell by 7% or $4 million from 60.5 million in 2014 to 56.5 million in 2015. Performance drove incentive compensation down. Salaries were reduced as we cut back on distribution, sales, and administrative salaries, and the average number of employees declined from 384 in 2014 to 360 in 2015, a decrease of 6%. The reduction in compensation cost also included lower overtime and temporary labor expenses. In addition, volume drove down operating expenses in the distribution network and we realized the savings from the facility consolidation in Houston. We also reduced our telephone expense by 25%, primarily due to the VoIP system we installed in the fourth quarter of 2014. We also decreased working capital. It fell from $130.1 million at December 2014 to $106.8 million at December 2015, a decrease of 23.3 million or almost 18%. This decrease includes the following major component parts

[Operator:]

Thank you. [Operator Instructions] And 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, Nic. How are you?

[Jim Pokluda:]

Good morning, Sam. Fine, thank you.

[Nic Graham:]

Good morning, Sam.

[Sam Darkatsh:]

Two or three questions here, if I could. First one, over the last week or so, your largest customer has talked about an initiative they have internally in which they are looking to consolidate a lot of purchasing with their top suppliers, their top 15 suppliers, in which they are going to be looking to expand purchasing by as much, you know, in the double-digits with those folks. How does this affect you? I would think, if you're named as a key supplier in that program, that could be a very positive benefit for your volumes in this year, and going forward, Jim. Could you address that?

[Jim Pokluda:]

Absolutely, Sam. If you look at -- it's our view based on our close relationships with the key large accounts that we hold the leadership position for supply, especially wire and cable at each one of those accounts. So, news like this has the potential to be very good for our company. So we're optimistic certainly that this sort of development will bode well for us. Historically, these types of developments have. We've worked hard since 1975 to earn the leadership position that I believe we have today. So when we hear things like this, we consider it good news, we think we're very well positioned to experience an enhanced relationship because of it. So we are watching this develop, and as it matures, we will be happy to discuss what we were able to discuss publicly.

[Sam Darkatsh:]

So with the commentary that as it matures, that suggests that you're not seeing it as of yet in the results in the first quarter?

[Jim Pokluda:]

That's correct.

[Sam Darkatsh:]

Okay. The second question, recently we've seen copper re-inflate, I mean, it's way too soon to obviously make a call on this, but can you talk about what you expect the metals impact to be on your sales in the first half on a year-on-year basis?

[Jim Pokluda:]

Too soon to make a call there, certainly had a large impact in 2015. Our estimate for the Q4 period was about 11.5%, and slightly over 7.5% for the full year. As you correctly have observed, it got into the high $2.20 range; $2.28, if memory serves. It's pulled back a little bit now, largely because of some bad news that came out of China. Just kind of laughing out loud here, we see news out of China on a daily basis that's all over the place. I will tell you that the data I've read most recently, long-term believes there will be a slow appreciation in the metal, but that was a very large move. The data from China very recently hasn't been particularly good. So we're happy for the move, Sam, but like you said, it's too soon to call it, and I think I just wouldn't be playing fair if I try to throw an estimate out at this point.

[Sam Darkatsh:]

But versus the down 12 points, the headwind in the fourth quarter, what might that headwind look like at least early on, based on what you can see this quarter?

[Jim Pokluda:]

Not as material.

[Sam Darkatsh:]

Okay, so it's not nearly the year-on-year headwind as you saw in the fourth quarter?

[Jim Pokluda:]

That would be my guess at this point in time, yes.

[Sam Darkatsh:]

Okay. Last question, if I could, before I'll defer to others. Just gross margin expectations, and maybe whether it's inclusive or exclusive of metals impacts, how should we look at the gross margins in the foreseeable future?

[Jim Pokluda:]

I'm glad you asked that question, Sam. And I made some comments on that area in my prepared remarks. I got to tell you, man, what this team has been able to do. The pricing discipline they have been able to execute in the marketplace, the ability they have displayed to hold their ground, and sell our products for what we believe they're worth, because they're time-sensitive, specialty type goods. I think it's just absolutely fantastic. I've been doing this coming up on 30 years here, before you know it, and been through a handful of recessions, and seen copper all over the map. And my gut would have told me, two years ago, that with this sort of protracted long-term incremental decline in copper, that our gross margins would be 300-400 basis points lower than they are today. And I'm glad I would have been wrong. So especially proud of what the team has been able to do to hold margins. Now to answer your question, I think that I also have to be realistic here. This experience that we've had, the market headwinds that we continue to face, copper at most recently a six-and-a-half year low, aluminum at a six-and-a-half year low, steel at a six-seven year low is really taking a beating on this marketplace. Goodness gracious, you know the rotary rig count in North America, 488 last week; not at a level we've seen since the late 90s, not even this bad during the great recession. So, tremendous amount of market pressure and market forces that are beyond our control. So I just have to be realistic and think that people are wearing out, and there will continue to be margin pressure. Do I think it'll be 200 basis points? No. If I already have given you a range, it may be 50 to 100 basis points. So far we've done an excellent job hauling in. I'm especially proud of the team for their efforts in that regard.

[Sam Darkatsh:]

So the 50 to 100 basis points, I just want to make sure I'm reading you correctly, Jim, so the 50 to 100 basis points would be versus what you saw for the entire year in '15?

[Jim Pokluda:]

That's correct.

[Sam Darkatsh:]

Okay, thank you. Thank you for the clear remarks and it does sound at least near-term that things are a bit more encouraging.

[Jim Pokluda:]

Yes. We try and be glass half-full folks around here. I have to balance that with some pragmatism, but we definitely see some green shoots. Making our own luck, in a lot of cases, this doesn't come without a tremendous amount of effort, but there are certainly areas for which to be optimistic and proud.

[Sam Darkatsh:]

Thank you, both.

[Jim Pokluda:]

You're welcome.

[Operator:]

Thank you. Our next question comes from the line of David Manthey with Robert W. Baird. Your line is open. Please go ahead.

[David Manthey:]

Thanks. Hi, good morning guys.

[Jim Pokluda:]

Good morning.

[Nic Graham:]

Good morning.

[David Manthey:]

So Jim, you mentioned that February transaction volume was flat year-on-year; and I don't know that you've talked recently about your average order size or what the trends have been there. I obviously assume it's been down, but could you give us an order of magnitude when you look at average order size, you know, relative to that flat transaction comment? And I'm not asking to give us a number, I'm just trending wise what does average order size look like, what's they in 2015 for the full year relative to 2014, just give us an idea of the magnitude.

[Jim Pokluda:]

My recollection, Dave, is that we haven't ever got into that level of granularity on average order size. And as just sort of thinking out loud here, it's not especially material in my mind, or for competitive reasons I wouldn't want to tell you, it's particularly difficult to calculate, because as you know, all things being equal, 70 somewhat percent of our business is MRO and 30% of it's project. And when you start working with large amounts of data and data pools that are distinctly siloed, averages can be extraordinarily misleading. A project for us could be a $150,000 if it's for compressor station, or frankly it could be $8 million if it's for a hydrocracker, half-a-dozen liquefaction trains, or even a combined cycle of power plant if it's a big plant. So I mean the size and scope and magnitude of our order flow is absolutely all over the place, and regrettably, I just don't have that data at my finger tips to give you something I don't feel good about. I could make a reasonable swag, but I don't think this is a forum for me to do that. So I'm not trying to be coy here, but I just don't feel comfortable that I have enough really solid data to give you the answer you're looking for. With respect to the transaction count, prior to February it's being going down for several months in a row, clearly not good. We're certainly down in January, we weren't happy about that, but February bounced back quite nice. So maybe that's a green shoot, it might be a little one, but we're calling it a green shoot, and obviously this will be something we're watching very closely and that we'll report really not too far from now in our Q1 results.

[David Manthey:]

Okay, and let's see, in terms of the alignment of expenses with current demand trends, are all of those actions have they been taken now, or is there more that will impact 2016, and Nic, what I'm getting at here is relative to the $14 million of SG&A in the fourth quarter, they kind of all else being equal what sort of magnitude downside to that number should we expect, or is $14 million approximately the range it's going to be in after the actions that you've already taken?

[Nic Graham:]

Yes, Dave, I think we've obviously picked all the low-hanging fruit on the expense saving side. I mean, we know our business; we've met and talked to wherever we could. There is certainly a little -- with the -- still the consolidation in Houston we're still working through some of the expenses there, so we will have a full year of comparison, but I think that number for the fourth quarter it's probably a pretty good benchmark. We might see a few things nudging around, but nothing real material, but I think we've got down -- we are still working on the few things. Obviously, we never give up, and whether it's a $1000 or $20,000, we're going to try and save it, but I think that's a pretty good benchmark going forward.

[David Manthey:]

Okay. And did you say 50% tax rate for 2016? 5-0?

[Nic Graham:]

I did.

[David Manthey:]

Okay. All right. And then, final question; in terms of the share repurchase, given that your market capital is already fairly small, could you talk to us about why the board or why do you think that share repurchase is more beneficial to shareholders than dividend at this point?

[Jim Pokluda:]

Dave, that's an excellent question. Certainly, one that's discussed often at, or certainly at every board meeting and at times even more so, and it's subject to change, okay, because market conditions change, availability changes. Our view looking back, this is not a forward comment, but an explanation of how we thought through this process prior. That given the long-term view of our company and the fact that we craft our strategy with a long-term view in mind and take into account the type of shareholder base that has invested in our company. Likely the predominant view shared by our investor group is that they would have the potential to benefit more from capital allocation into shares and the opportunity for share price appreciation over long period of time and the leverage gained from that sort of transaction versus return to shareholder in the form of a dividend. It's not something easily contemplated. There are a lot of variables, a lot of things that must be taken in mind. And it's a difficult thing to work through, but given what we are facing today, that's why we made the decision we made in the past. Moving forward, certainly a Board decision, lot of strong views on the Board and will remain an actively discussed topic moving forward.

[David Manthey:]

Okay. Thank you.

[Jim Pokluda:]

You're welcome.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Michael Conti with Sidoti & Company. Your line is open, please go ahead.

[Michael Conti:]

Hey, good morning everyone.

[Nic Graham:]

Hey, good morning, Mike.

[Jim Pokluda:]

Good morning.

[Michael Conti:]

Yes, so I guess just going back to the topic on capital allocation when you talked about repurchasing shares and then the dividend, but can you talk bit more about I guess on the M&A side? I mean is that something that you guys are looking to do over the next couple of years? I mean is that a priority for you to help accelerate growth?

[Jim Pokluda:]

Yes, Mike, it certainly is. So as we think about capital allocation, we land on four areas, okay. So priority number one would be retirement of debt. Priority number two would be return to shareholders. Priority number three would be investments in new products and services, and priority number four would be M&A. Now, just because it's number four, it doesn't mean we don't like the notion of M&A. The reason it's number four I believe is the reality of our model. We are a two-step distribution model; a distribution model that fully supports our channel of wholesale electrical distribution. And as such, we need to be very aware and sensitive to the products that our electrical distributors sell. So, you might say, geez, listen, Jim, you get these 65,000 customers you always tell me about. Why don't you sell them motors? And maybe for a second or two you might think that's a good idea, but it's not, because our electrical distributors sell motors, and lighting, and switch gear, and bulk of electrical goods. So, a lot of the things that perhaps at first flush superficially may appear to make sense for us to redistribute, just don't, because the channel partner we have already distributes them. So we're sort of encapsulated in a sense with respect to our opportunity for our acquisitions. We certainly like the idea of acquisitions, but we need to be very, very careful that in doing so, we don't create channel conflict and set up an opportunity for disappointing results, because it would conflict with our channel partner.

[Michael Conti:]

Got it, okay. And I guess can you just maybe give us your expectations for sales coming from oil and gas for 2016?

[Jim Pokluda:]

Well, as we've talked about before, we estimate that 30% of our revenue is a function of oil and gas. I think what we all found out though have come to learn is that they're first in derivate markets, coupled to oil and gas. So yes, certainly we like selling products to compressor stations and pumping stations, but where they build those pressures -- they build those stations, they also build schools and houses and churches and restaurants and stores, right? So there is the collateral erosion of tertiary markets as a result of this pullback in oil and gas, and I know you know that, but I am just trying to give you for some answers. So, 30% oil and gas and then there is additional wind down in other transcendental markets. Last year, we provided the Street an estimate of what we thought our revenues would decline as a function of oil and gas. We're not doing it this year. There has been a large pullback in the commodity as you know, we hope we're finding bottom, and just don't feel prudent to try and estimate a number like we did last year at this time. The exposure to the end market though remains the same, 30%.

[Michael Conti:]

Understood. Thanks for taking my question.

[Jim Pokluda:]

You are welcome.

[Operator:]

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

[Jim Pokluda:]

Thank you, Cat [ph], and thanks again to all our valued team members for their continued hard work and dedication to the company. To our shareholders we extend the special thanks as well. We appreciate you joining us on the call today, and looking forward to success in the period ahead. Good day everyone.

[Operator:]

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