Houston Wire & Cable Company
Q3 2014 Earnings Call Transcript

Published: 6 Nov 2014

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Houston Wire & Cable Company's Third Quarter 2014 Earnings Conference Call. My name is Eric, 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. [Operator Instructions] 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 on 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.

[James L. Pokluda:]

Thank you, Eric. Good morning, everyone, and thank you for joining us on our call today. I'll begin today's call with an overview of our third quarter 2014 performance, and then I'll turn the call over to Nic, who will discuss our financial results in greater detail. A quick housekeeping comment before we begin. Please note that we have updated our original press release from earlier this morning. The updated release corrects an error, which overstated the negative impact of metals and MRO sales for the third quarter and the first 9 months of the year. Moving on. We are pleased to report our third consecutive quarter of year-over-year revenue growth. Total sales increased 1.6% over the third quarter of 2013 and 3% when adjusted for metals. We estimate that approximately 67% of our total revenues resulted from maintenance repair and operations activity and approximately 33% from project activity. Transactional volume, which we measure as total invoice count and considered a helpful metric for gauging improvement in our market share, increased 4% over the Q3 2013 level. Largely a function of MRO sales activity, Q3's invoice count set a new company record for any single quarter period and also a new record for the year-to-date period. Continued strength in oil and gas regions, ongoing recovery in the Midwestern and Eastern regions and success from our multiple business development initiatives, including our distribution platform expansion and new aluminum specialty oil and gas product lines, were the primary drivers of these results. Despite what we consider mostly favorable market recovery trends, MRO sales decreased approximately 4% over the prior year or approximately 3% on a metals adjusted basis. Although we were disappointed to experience the year-over-year reduction in this area of our business, we were encouraged to see the continued growth of transactional activity in this space and, as such, remain confident that our disciplined execution of our business development initiatives are working and that we are continuing to increase our penetration in the available market. Third quarter sales results in the project area of our business increased 12% versus the prior year period or 14% on a metals adjusted basis. We are pleased to see these results as multiple greenfield and capital expansion projects have been frustratingly slow to materialize. When active, this space is particularly attractive to the value of our business model given our outstanding track record and extensive array of services that address complex fulfillment and logistics requirements. It is certainly a positive sign that we experienced double-digit growth in this space, although we must remain aware that the commencement dates for a substantial amount of future investments continue to be pushed back into 2015 and beyond. End markets most significantly driving the third quarter's project sales growth include upstream oil and gas, downstream oil and gas, fossil fuel power generation and general manufacturing. As we move into the final portion of the year, we're off to a solid start in the fourth quarter. The Q4 to date book-to-bill ratio is positive. October financial performance momentum was positive as well and improving upon September. And although still very early in the present month, November bookings have begun strong. The former said, we believe it is prudent to remain mindful that the project delays to which we have become accustomed and the holidays and typical year-end seasonality may negatively affect our financial performance. Overall, however, our view on the broad economy remains positive, and our end markets continue to slowly improve. Based on the above and our year-to-date results, we expect low single-digit revenue growth and mid-single-digit earnings growth for the year. I would like to close my prepared remarks by reinforcing that we believe the long-term fundamentals of our end markets are continuing to improve and the extensive value drive from strategically leveraging HWC value proposition remains increasingly important as customers focus on reducing working capital investments for the types of high-risk specialty items we supply. We believe we are gaining market share. Our new distribution centers have added incremental value to the channel. Sales of new products continue to improve, and operational performance metrics remain outstanding. 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 G. Graham:]

Thanks, Jim, and good morning, ladies and gentlemen. My comments and comparisons to the third quarter of 2013 will exclude the effect of a noncash pretax impairment charge of $7.6 million that was recorded in September 2013. Demand continues to be unpredictable and varies by region. Although we were encouraged by the year-over-year sales growth, we did fall short of our internal revenue expectations. Accordingly, the sales shortfall and resulting lower gross profit dollars did not generate the level of optimum income that we had targeted. Transactional activity, however, continues to improve, which is an encouraging sign. But we need the accompanying revenue stream to increase in order to improve sales. Our gross margin was up 10 basis points sequentially at 21.8% but down 20 basis points from last year. As we have experienced for several quarters, the marketplace remains extremely competitive across all of our regions. Operating expense as a percent of sales at 15.6% was down 10 basis points from the prior year quarter. However, the operating expense spend of $15.1 million was up 1.2% from the prior period's $14.9 million. This was primarily due to higher property taxes and the addition of the new distribution locations in Odessa and Anchorage. These higher costs were partially offset by the savings generated from our expense reduction initiative. We believe this initiative is gaining traction as Q3 operating expenses decreased by $0.5 million or 3% from the $15.6 million operating expense spend in Q2 2014. Our interest rates remain flat sequentially at 2.1%, but rates increased, as expected, in accordance with terms of our loan agreement from the 1.9% level in 2013. Interest expense was higher than the prior year period as average debt levels increased. As a full-rate taxpayer. Our tax rate of 38.4% was consistent with the recent trend in 2014 but down slightly from the prior year quarter due to slightly lower tax -- state tax rates in 2014. Net income at $3.5 million was flat with Q3 2013. Turning to the balance sheet. Our balance sheet metrics remain generally in line with our expectations. The working capital investment decreased 2.1% or $2.7 million from Q2 2014. Our receivables metrics, including aging and days sales outstanding, were consistent with recent historical trends. The net income generated and the reduction in our working capital investment combined to produce healthy cash from operations of $7 million, the highest level since 2008. Capital expenses for the quarter were $0.9 million, the majority of which related to the continuing refurbishment of the new facility for Southwest Wire Rope in Houston. This facility with will consolidate 4 existing Southwest Houston locations into one. Work is being slowed by permitting problems, and we are presently projecting the work to be completed in the first quarter of 2015. We reduced our debt levels by $2.7 million from $53.2 million at Q2 2014 to $50.5 million at Q3 2014. Our debt-to-equity ratio now stands at 45.5%, and including the bank overdraft, 48.8%. These are both very manageable levels and remain within recent norms. Availability under our $100 million credit facility was $49.5 million, more than adequate to fund our expected needs. We remain in full compliance with the covenants of our loan and security agreement, which expires in September 2016. During the quarter, we made purchases under the previously announced $25 million stock buyback program of 118,000 shares at a cost of $1.5 million. For the year-to-date period, 425,000 shares, or 2.4% of the December 2013 outstanding shares, had been bought back at a cost of $5.3 million. Interest coverage on our debt on a trailing 12-month basis was approximately 22x. We were also very pleased that the board continued the recent $0.12 per share dividend, the 30th consecutive dividend payable to shareholders on November 28, 2014. That concludes the prepared remarks. At this time, I'll turn the call back over to the operator. Eric?

[Operator:]

[Operator Instructions] And our first question comes from Ryan Merkel of William Blair.

[Ryan Merkel:]

So the first question, I just want to start with gross margin, higher freight costs. I'm assuming that you haven't been able to fully pass along the rise in the freight costs to your customers. Is that fair?

[James L. Pokluda:]

To some extent, there have been fuel charges that have tried to work -- surcharges that have tried to work their way through the system. We are doing a better job of consolidating inventory into master hubs. And at times, through that iteration process, you have to ship another bit of material from a location that might be a little bit further away. Project business picked up, as you saw, for the quarter. Freight is prepaid on projects typically because the weight is so high. We're happy to have the project business, but it's not uncommon to see freight go up as your prepaid shipments go up as a function of project business.

[Ryan Merkel:]

Okay, makes sense. And then the customer incentives, is that isolated to MRO or projects? Or is that a mix issue? Or is that just really just competitive markets continuing?

[James L. Pokluda:]

The customer incentive is accrued on all revenues realized. It is, to some extent, a mix issue because as our sales increase with certain accounts, the customers become eligible for higher rebates as a function of their spend. So we've had some customers finding themselves in more lucrative tranches due to their good growth over prior year.

[Ryan Merkel:]

Okay. Then last one for me and I'll get back in line. MRO sales is down, project business up. When I think of the MRO sales, I kind of think of smaller type projects really. Is there any reason or any themes as to why the MRO would be down but bigger projects are having some success? Is that something driven by the market? Is that driven by what you're doing?

[James L. Pokluda:]

It's both. Projects are up primarily because of a lot of hard work that we started 12 to 18 months ago. Now having said that, and we've discussed this often, the cyclicality of projects can drive you nuts. I mean, you may recall we had a very strong Q1 this year, which is typically a seasonally adjusted down performance period, but we did well because we had some projects come through that we booked 12 to 18 months prior. So projects will, I think, almost always remain or probably will always remain somewhat of a wild card in our business. They're just -- there is just some inherent choppiness in the way they flow into the business. Now having said that, we performed exceptionally well with projects. It's an area where our value proposition really gets another, say, stigma of leverage given all the special things we do. But it's a -- Ryan, to -- just really try to get to the heart of your question, they're up to some extent because of the cyclicality; they're up because we've been working hard to focus on that area; and they're also up because finally, finally, finally, we're starting to see some break-loose of the slow to come to fruition capital expansion work. With respect to the MRO end of the business, I was a little bit surprised by that as well. Quickly, I started to feel better when I saw the transaction count going up because transaction count is most largely a function of our MRO spend. We excel at MRO demand. We adopt a -- every order is important, order mindset and strategy. I think what happens -- what's happened in our business is that we've seen the market flatten, and it's been flat for some time. And others -- many others are reporting the same. And given that operating environment, we've just had to ramp our efforts up another degree more and dig deeper and deeper into the channel to get every available order that's out there for us. So I was very pleased to see the invoice count go up 4%. That tells me that we are reaching further in the channel; we are soliciting more opportunities from the channel. It just tends to be smaller bits of business in an operating environment like this.

[Ryan Merkel:]

And that really goes to the second part of my question, though. The MRO has been flattish for a while. And again, that kind of smaller projects, typically you would think those would get done and the larger projects would be more lumpy, would be pushed back, et cetera. I'm just trying to figure out why in the MRO world that small projects, people just aren't seemingly wanting to do.

[James L. Pokluda:]

Well, so MRO is Maintenance Repair and Operations, as you know. The operations pail of that prefix tends to be the little bit larger project work that you described, say, in the order of $50,000 to $60,000 -- $50,000 to $100,000. That work did slow down the past quarter, but we saw our smaller transactions pick up. It gets a little bit more complicated when you attempt to contemplate that with the bigger project work that's been on hold for some time. Well, we saw some nice pipeline infrastructure; transportation and storage work come in. Fossil fuel picked back up and projects. We started to get some downstream oil and gas work. Nice bits of work. We're happy to have them. They just really play havoc with your revenue stream.

[Operator:]

Our next question comes from David Manthey from Robert W. Baird.

[David J. Manthey:]

So relative to your statements about the full year, would you expect -- by my calculations, I've got year-to-date revenue is up about 4% and EPS flat. And if you're saying low single-digit revenue growth and mid-single-digit earnings for the year, that implies your revenues may be, I don't know, $95 million but be kind of flattish sequentially, and then EPS up sequentially to maybe $0.22. And typically, your margins are lower in the fourth quarter seasonally, I would imagine. Is there an expectation there for the mix between projects and MRO? Or why do you expect profitability to be higher in the fourth quarter than this quarter?

[James L. Pokluda:]

Well, to begin, we have an easier comp in Q4 this year. We did not have a very strong fourth quarter last year. And if you look at how we finished October, how we have begun November very strong, we're not seeing the same preliminary indications of a lousy Q4. So the data we have in hand at this point in time indicates to us that the market has improved on a Q4-over-Q4 basis this year. So our directional comments contemplate a better operating environment, certainly, versus Q4 of last year.

[David J. Manthey:]

Okay. But if you're saying low single-digit top line and you're running 4% right now, that would imply that things are going to, at least from a top line perspective, get worse to shave that down to a low single-digit number. It seems like it's mid-single digit already. Based on your comments, I would think that -- it sounds like that would be at least mid-single-digit revenue for the year.

[James L. Pokluda:]

Q4 is just -- it tends to be a wildcard, Dave. We've probably been conservative in our think. There are a lot of variables out there that have -- that just can work for you or against you. So I guess I would just have to say our posture at this point is somewhat conservative, and we expect a better earnings EPS performance in Q4 of this year.

[David J. Manthey:]

Okay. All right. It sounds like you're having good success in the energy complex as usual. And just investors out here, of course, are concerned about the 2015 CapEx environment based on sub-$80 oil. I'm just wondering, what's your view right now? As you look out at the world, obviously you're right there in the middle of it. How do you feel about the CapEx plans as we look to 2015 in the energy complex and how that relates to your business?

[James L. Pokluda:]

Right. Excellent question, Dave. I'm glad you answered it. We're not worried. At this time, we have no concerns over that issue. I've been in this business for over 27 years now. I've gone through periods of low oil in '94, in '98 and 2009. The downstream refining energy complex in Houston is very robust. So I will tell you from my personal experience I do not have a negative experience when we see pullback in oil like we're having right now. I can tell you that I've talked to a number of people in the know in the field who have also gone through this. They have not expressed concerns. The numbers vary widely depending on what hydrocarbon source one is reviewing. But Permian Basin, Eagle Ford Shale, you'll see numbers that go from, in some cases, as low as $40 a barrel to $60 a barrel, and where I'll say a concern would present, we've seen the -- where a concern may present. However, there would have to be a sustained -- basically, there would have to be a sustained environment where the oil stayed at that price for people to pull back their investments.

[David J. Manthey:]

Okay. And then last question, again on gross margin. I mean, how do you feel about it just generally? And is there any way that you can move gross margin higher outside of a spike in activity or higher copper prices? It just seems like it's been depressed for many years and I'm just wondering how you view it in the context of your business model.

[James L. Pokluda:]

How I feel about it generally is that I really don't believe it's going to get -- I really believe the bias is more towards improvement than not. Now I know that I've mentioned that on a few calls throughout the year and we've gone down a bit since I originally made those statements, but this is a statement, I hope, that can be taken with a longer view in mind. Quarter-to-quarter, there's always things that happen. People hit new rebate tranches, maybe we scalp a couple of project orders that are pretty cheap and that puts a drag on the business. If you look at the overall performance of what I'll call our "average order", we do see improvement there, and that's where we're targeting our gross profit improvement initiatives. The market has to cooperate. It's been somewhat cooperative. But I really don't fear a in perpetuity decline in our gross margins. We are doing all the right things internally to drive hyper awareness towards gross margin improvement. We are making improvements. As I said, there are some tangential events that can occur that can act as a quarter-over-quarter drag on those initiatives. But in the long run, I know that we're making improvements with our systems and our practices and our protocols to improve gross margin. So I still remain convinced that over time, given a market that doesn't do anything crazy, our gross margins will creep up.

[Operator:]

Our next question comes from Sam Darkatsh from Raymond James.

[Sam Darkatsh:]

A couple of questions here, and these are actually more follow-up related. Back to the MRO side of your business. Yes, invoices up 4%. Obviously, your MRO sales down 4% would suggest that average ticket was down pretty substantially. A part of that, maybe a point or so might be explained by the metals pricing. But what explains the rest of that average ticket decline, which again seems pretty pronounced?

[James L. Pokluda:]

I think that the market hasn't cooperated. And so there hasn't been as much quarter-over-quarter opportunity. And the reason we were able to continue to grow the invoice count was because we were even more aggressive and more diligent in our sales and marketing efforts to go get the business that was available out there. And when you operate in that sort of mindset and environment with a flat market, it's our experience that what you do get just tends to be smaller bits of opportunity.

[Sam Darkatsh:]

And that same trend is what you're seeing in Q4 also? The difference in average ticket versus invoices?

[James L. Pokluda:]

I would say it's improves -- it has improved a bit, Sam. We're still very early into this quarter. But the directional data that I've received so far indicates a slight improvement. And then just, yes. So yes, I hope that answers your question.

[Sam Darkatsh:]

And a second question related, Jim -- and thank you, yes, it did answer the question. The -- even the invoices themselves being up 4% is below that of what your -- or some of what your customers -- particularly, I guess I'll cite them by name, WESCO is bidding for their non-construction business. So if -- one explanation for that could be that you're being, to an extent, maybe disintermediated or your customers are going vertical to a greater degree than perhaps they have been in the past. What would explain the reason why the growth that you're seeing in MRO might be consistently less than that of your customers'?

[James L. Pokluda:]

That's a good question. I feel a little bit disadvantaged because I don't have all of perhaps the data that you have involving WESCO in front of me. So I can't recall, Sam, if WESCO reports project sales separately versus MRO sales. My recollection is that they do not and they just report, as you described a moment ago, industrial-type sales. WESCO has reported strong activity in the Utility Power Generation space. It's an area that they've also reported where they have a high percentage of share. One conclusion a person could draw from that bit of actual data is that success in that market has led to nice growth year-over-year. And as you've commented, they have had nice growth year-over-year.

[Sam Darkatsh:]

Well, can you remind us what the major differences are between your MRO business and, let's say, WESCO's industrial segment, which would exclude utility?

[James L. Pokluda:]

We define -- we have trigger thresholds above which we define the work as a project and below which we defined the work as an MRO order. That's sort of considered proprietary data. I can sort of color it for you. We would consider a $60,000 order an MRO order, but we would consider a $500,000 order a project order. I don't know how WESCO thinks about that same set of circumstances.

[Sam Darkatsh:]

Okay, fair point. And then last question, if I could. Nic, your prior guidance, I think, for earnings growth for the year was mid to high single digits, and now you're looking at mid-single digits. The differential there, is it primarily metals pricing? Is it the third quarter falling short of your internal sales growth expectations? What's the primary driver of that? At least at the high end of your earnings growth guidance coming down, what's the derivation of that?

[James L. Pokluda:]

I'll take that. We at midyear had forecasted a little bit stronger revenue performance in Q4, and July for us was somewhat of a disappointment and was a bit of a pullback on our Q3 performance. Now, of course, it improved a little bit in September, and I mentioned directionally in Q4 it's getting better. But I think it's just our general conservative nature, Sam, to try and as accurately report the status quo, as we know it as a given point in time. So it's our view that the original estimate for revenue in Q4 was a little bit higher than we're thinking about today and just felt it prudent to pull back that number, which sort of cut down our contribution margin leverage on the rest of the business, which pulled back our formerly communicated mid -- high single-digit earnings comment down to mid.

[Sam Darkatsh:]

Last question, if I could, and then I'll throw it to others. I apologize for monopolizing. With low single-digit to mid-single-digit sales growth-to-earnings growth this year, would you be looking at something next year -- if you were looking at a low to mid-single digit, that you would see reasonable leverage? And what might your -- either your pull-through rates or incremental margins look like at various growth rates for next year?

[James L. Pokluda:]

Yes, I think it's probably too soon to maybe get that granular. A lot of -- one of the wild cards, of course, remains projects. We do have somewhat of a high fixed cost in this business. And when we exceed that, our contribution margin in the past has been 20% and above. So I'm comfortable saying that. But I just haven't -- at this point, given the lack of visibility into 2015 and still all of this scuttlebutt about pushing these capital projects out, I don't -- I just wouldn't feel comfortable giving any higher level of detail.

[Operator:]

[Operator Instructions] And our next question comes from Michael Conti from Sidoti.

[Michael Conti:]

I just wanted to follow up on one of your comments regarding the capital projects. Were you expecting any of those projects to be seen in the fourth quarter that are now being deferred into 2015?

[James L. Pokluda:]

Yes. It's sort of an ongoing event, unfortunately, Mike. Kind of ironic -- I don't know if ironic is the right word. Frustratingly, one of the reasons some of this work is being pushed out is because of a lack of availability of labor. We had one nice project that we were in line to get several million dollars. And it's not going to go away, but they've pushed it out another 1.5 years because of the labor problem. There continues to be a lot of debate on gas-to-liquids jobs, GTL jobs. It's a proven process, but it's a process that hasn't really been extensively deployed in the United States. And there are some projects, very expensive fractionator projects that involve that component of work on-site. And so there's just ongoing delays and negotiations on permitting and approval for that type of work. On the upside, there has been some recently announced work. The Cameron LNG job is going for forward now. That's a $10 million job. There are a number of jobs that are in process along the Texas-Louisiana Gulf Coast. If you read the press, you'll probably see all the same names I do. So we're getting there, but it's really -- it's kind of 2 steps forward, 1 step back. Just one more comment. There has been some new legislation in place that will help drive the approval of these processes on the heels of conducting an extensive environmental impact. If an interested party conducts the study, they will receive expedited approval through the licensing process, and that has had a favorable impact on 2 large jobs that we've been tracking for a couple of years now. So the mechanics of -- what I would describe as the mechanics influencing the culmination of this work are improving. But again, it's probably the fourth time I'll say this, it's just been frustratingly slow to come to fruition.

[Michael Conti:]

Sure, sure. It sounds like a lot of oil and gas jobs out there. Can you give us an idea on the profitability on some of those projects in terms of gross margin? Are they usually higher than the overall projects business?

[James L. Pokluda:]

No, I would not say that they are. But I would add some color to your question. In the beginning there, all project work is somewhat unattractive, I would say, from a gross margin perspective. They're highly competitive bits of work, and they don't fall under the radar and everybody is taking a cut at them. So initial profitability of a project is very low. As you approach the tail end of a project, engineering changes occur and deadlines fast approach, and that is an opportunity to leverage a little bit more profit through the life cycle of the project. So that helps shore up some unsavory profits in the beginning. That's just, in general, profitability profile for a project. Petrochem jobs, though, we really don't have overall a different profit profile than, say, a scrubber job would have or a steel mill would have.

[Michael Conti:]

Okay, great. Now -- and my last question, just regarding, Nic, within SG&A, the operating cost. Is this more or less a level that you're comfortable with as we look into 2015, the $6.7 million?

[Nicol G. Graham:]

Yes, Mike, we've worked real hard on this cost reduction initiative. And as I said earlier, we've got some traction there. We're going to continue to press for additional savings whenever we can. But on the other hand, other aspects of the cost structure do go up. Utilities go up and property taxes go up and people get some increases. We just got to push more volume through the channel to get that leveraged. So I'm pretty comfortable with that level just now. We're still working very hard to see if we can nip and tuck it maybe a little bit further down, but that's just an ongoing process. It will continue into 2015.

[Michael Conti:]

And Jim, my last question. I just want to get an idea on how you guys are positioned to capitalize on the opportunities down there on the Gulf Coast, I mean, just given the increased competitive nature of the industry.

[James L. Pokluda:]

We have a number of things going in our favor there, Mike. This is the epicenter of our company. This is the -- where Houston Wire & Cable began. We know this market exceptionally well, the players, the customers. Every market has its own unique demand profile. This is an area of the country that we know better than any other area of the country, in fact, for that matter, all the Texas-Louisiana Gulf Coast refining -- downstream refining spaces. This is also an area of the country where we have our most significant inventory investment. We have a large investment in Houston, we've reached further into the channel in Odessa to support land-based operations and we also have our facility in Louisiana. So if you said to yourself, hey, let's start a wire and cable company, how would you do it, you probably wouldn't look at the map and say, well, let's put a place in Odessa, Houston and Baton Rouge. Yet, we've elected to do that because that's what this very substantive market requires. We touch these customers with incredible efficiency, same-day service as a standard. So that's why we've made the investment. I think it's paid off as we're doing exceptionally well in these markets. So I'm definitely convinced that we are properly positioned to get our fair share of the opportunity as it begins to come to fruition.

[Operator:]

There are no further questions at this time. I will now turn it over to Jim Pokluda for closing remarks.

[James L. Pokluda:]

Thank you, Eric. And thanks to all again and our valued team members for their continued hard work and dedication to the company. To our shareholders, we thank you as well. We appreciate you joining us on the call today and look forward to future success in the period ahead. Good day, everyone.

[Operator:]

Ladies and gentlemen, this does conclude today's conference. Thank you for your attendance. You may now disconnect. Everyone, have a great day.