Houston Wire & Cable Company
Q4 2014 Earnings Call Transcript

Published: 12 Mar 2015

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Houston Wire & Cable Company's Fourth Quarter 2014 Earnings Conference Call. My name is Shannon, 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.houwir.com [sic] 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:]

Hey. Thanks Shannon. Just a quick housekeeping note, its wire.com as the suffix on the – for our Web site. Thank you. Good morning, everyone, and thank you for joining us on our call today. I will begin this morning's call with an overview of our fourth quarter and full year 2014 results. Then I will turn the call over to Nic, who will discuss our financial performance in greater detail. We are pleased that the fourth quarter net income increased 16.5% over the prior year period and increased 4% sequentially versus the third quarter of 2014 despite sales decreasing 2% year-over-year on a metals adjusted basis. Typical year-end seasonality metals deflation and reduced demand from infrastructure in certain industrial markets including oil and gas delivered lower than expected top line sales for the quarter. Overall, we estimate that approximately 70% of our revenues resulted from maintenance repair and operations activity and approximately 30% from project activity. Transactional volume which we measure as invoice count decreased 3% versus the Q4 2013 level. We believe the reduction occurred as a result of less project activity and also from improved inventory profiling which drove more efficient inventory utilization and reduced the need to ship products for multiple branches to complete an order. Sales results in our core business which services MRO demand decreased approximately 1% from the prior year on a metals adjusted basis. Activity by geography was generally consistent when compared to the prior year with industrial manufacturing and oil and gas regions remaining primary contributors to overall results. Fourth quarter sales in the project area of our business decreased approximately 8% on a metals adjusted basis. Adjusting for a large fabricated sling order in the prior year from the heavy lift area of our business, project results were approximately flat on a metals adjusted basis. Reduced activity in infrastructure markets was offset by early quarter contributions from oil and gas markets and increased spend in the utility market encompassing power plant construction and environmental compliance. For the entire year, sales increased approximately 4% on a metals adjusted basis. And when adjusted for metals in prior year periods set a new revenue record for the company. We're pleased with the year's progress – performance progress as despite headwinds from an inconsistently performing industrial economy, metals deflation and the late year negative impact from the decline in the price of oil. The successfully increased revenue contained expenses, grew net income and continued our practice of returning earnings to shareholders through dividends and share repurchases. Full year 2014 transactional volume also closed at a record level and increased approximately 3% versus 2013. We believe growth in this metric especially given the recent invoice count reductions from our improved inventory profiling is an effective indicator of our ability to drive market share gains in a mature and highly competitive industry. For the full year, we estimate that approximately 67% of our total revenues resulted from maintenance repair and operations activity and approximately 33% from project activity. MRO metals adjusted sales grew approximately 1% and were primarily driven by increased activity in electrical cable end markets and were offset by a reduction in activity in offshore and land-based rigging demand. Metals adjusted project sales grew approximately 9% and were driven by increased activity in utility, midstream oil and gas and general rigging markets. Geographic performance continued to be led by regions with high concentrations of industrial manufacturing and oil and gas extraction, transportation and refining. Disappointing West Coast results were offset by MRO and project business in Mid-Western territories, which improved significantly over the prior year; continued growth in Eastern regions, solid activity in the major shale plays and downstream refining. Moving into comments involving 2015, we believe copper deflation and the relatively low price of oil, our potential headwinds to our business. Fortunately despite any sales reductions that may result from copper deflation, we've done a very good job maintaining gross margins, internal system changes and our extreme focus on gross margin optimization have driven success in this area. Our financial performance could also be affected by the recent decline in the price of oil and its effect on investments in exploration and production. We participate in upstream midstream and downstream markets and although most experts agree that the long-term fundamentals for all three markets remain solidly intact, we did begin to experience reduced activity in these markets in the latter part of Q4 2014. We believe the adverse effect of sustained low prices on our sales to oil and gas industry will to some degree be offset by the favorable impact on other areas of our business such as durable goods and residential construction due to increased consumer discretionary spend, but it's too early to confirm any trends. Accordingly given our present level of visibility we estimate that reduced activity in oil and gas markets could have a negative effect of 10% on our – could have a negative 10% near-term impact on our overall revenues. In closing, I would like to reinforce the fact that the long-term fundamentals of all of our markets are intact. And although oil and gas markets are presently down, many other areas of the overall economy and our business are performing well. Broad market indicators such as employment, industrial production and plant utilization continue to improve; sales growth rates of new products such as aluminum and other specialty cables remain significantly beyond that of our base business and customer satisfaction, order accuracy and on-time performance are all outstanding. 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. My comment this morning will include references to 2013 data comparisons to the full year 2013 will exclude the effect of the non-cash pretax goodwill impairment charge of $7.6 million that was recorded in September 2013. Our gross margin was up 130 basis points from 2013 and also sequentially. Despite recent metals deflation and the very competitive nature of the marketplace, we've been working hard to maximize product margins assisted by the relative growth in MRO business to project sales during the quarter. We estimate that 50 basis points of the margin increase was due to late year adjustments for customer sales incentives as sales volume declined in Q4 and also from higher than expected vendor rebates. On a year-over-year basis, gross margin at 22% fell by 10 basis points. While operating expenses as a percent of sales reached 16.2%, an increase of 10 basis points from the prior-year quarter, the total spend decreased. Q4 2014 operating expenses totaled $14.5 million, down $0.7 million or 4.7% lower than the $15.2 million level in Q4 2013. On a sequential basis, operating expenses fell from the $15.1 million level or $0.6 million since Q2 2014, which had the highest 2014 quarterly level of operating expenses of $15.6 million, operating expenses decreased by $1.1 million. We have been working very hard over the past year on our expense reduction initiative and Q4 marks the lowest level of operating expenses since Q3 of 2012. While I'm pleased with the results which indicate that we are executing on our plan, two quarters does not provide a meaningful trend. Our average interest rate for the quarter was 2.2%, up 30 basis points from Q4 2013 part of the increase was due to the ratio of LIBOR debt to total debt and the balance due to the terms of our loan agreement. Interest expense was higher than the prior year period as average debt levels increased from $46.3 million to $53.9 million. As a full rate tax payer, our tax rate of 37.9% for the quarter was slightly lower than the rates in the first three quarters due to normal year-end true-ups. For the year, the tax rate was 38.3% consistent with 2013's 38.4% and historical rates. Net income at $3.7 million increased 16.5% over Q4 2013's $3.1 million and EPS increased from $0.18 in 2013 to $0.21 in 2014. For the 2014 year net income reached $15 million generating EPS of $0.85 up from 2013's $14.6 million and EPS of $0.82. Turning to the balance sheet; balance sheet metrics remain generally in line with our expectations. Our working capital investment increased 2.9% or $3.6 million from Q3 2014 and was up 5.6% from December 2013. Receivables were up slightly from 2013 levels, but down $3.9 million from Q3 2014 as cash collections outpaced sales. Receivables metrics including aging and day sales outstanding all remained within recent historical levels. Inventory levels decreased $2.9 million or 3.2% sequentially and were down $7.1 million or 7.4% from year-end 2013. As we continue the more in-depth review and analysis to improve our regional inventory profiles. Capital expenditures for the quarter were $0.4 million, which includes the continuing refurbishment of the new facility for Southwest Wire Rope in Houston. We're making progress with the facility and are now dealing with weather delays principally rain, but still estimate that the work will be completed and the facility operational in the second quarter of 2015. Debt levels increased slightly in Q4, but our debt-to-equity ratio stands at 48.4% and including the bank overdraft at 51.2%. These are both very manageable levels and remain within recent norms. Interest coverage on our debt on a trailing 12 month basis was approximately 22x. Availability under our $100 million credit facility was $42.4 million at year-end, more than adequate to fund our expected needs. We remain in full compliance with the availability-based covenants of our loan and security agreement, which expires in September 2016. During the quarter we made purchases under the $25 million stock buyback program of 120,000 shares at a cost of $1.5 million. For 2014, since the buyback program commenced in March, a total of 545,000 shares or 3% of the December 2013 outstanding shares have been bought back at a cost of $6.9 million. During the year dividends were declared totaling $0.47 per share up from $0.42 per share in 2013. As we move into 2015, current initiatives are to continue to drive more efficient working capital utilization including the inventory profiles, prudent allocation of capital for new business development initiatives including new products and possible acquisitions and continued expense reduction initiative. That concludes the prepared remarks at this time. I will turn the call back over to the operator. Shannon?

[Operator:]

Thank you. [Operator Instructions] Our first question is from Sam Darkatsh of Raymond James. You may begin.

[Sam Darkatsh:]

Good morning, Jim. Good morning, Nic.

[Jim Pokluda:]

Good morning, Sam.

[Nic Graham:]

Good morning.

[Sam Darkatsh:]

The challenging environment, but terrific job with gross margins and inventory management candidly.

[Jim Pokluda:]

Thank you, Sam.

[Sam Darkatsh:]

Couple questions if I could. How should we look at gross margins either for the year or near term? There's an awful lot of moving parts here Jim. What with the metals and mix of MRO and some of the volume oriented rebates and discounts that are happening on both ends. I mean there's a lot of moving parts, can you help us how we should think about it?

[Jim Pokluda:]

Certainly, Sam, I will try, because to your point it is quite a complicated item. We have traditionally experienced greater gross margin pressure in periods of amplified metals deflation similar to what we are experiencing today. We proactively became very focused on gross margin optimization earlier in the year. Just in the course of trying to be prudent business managers. Fortunately, the groundwork laid at that period of time became more leverageable as copper deflation continue to accelerate throughout the year and even in today's environment, which is down over 20% in the first two months of this year. So our timing was good with respect to the extreme focus we put on gross margin. I am very, very pleased with the results we've made in that area. As you know, I've been doing this a long time. And in my experience, this is the best the company and the team has ever performed in a period of somewhat significant copper deflation. As I commented in my prepared remarks, we made some changes to our internal systems that have favorably benefited our ability to perform in this area. And everybody is very, very focused on it. With all of that said, in conservative speak would say continued pressure and decrease on copper will hurt gross margin optimization initiatives more than help. But I wouldn't expect anything extraordinary Sam. I wouldn't expect a 150 basis point decline, for example. I wouldn't expect a 200 basis point decline; would 30 or 40 basis points potentially occur, given the visibility that we have today, I would say maybe. But so far, we have done exceptionally well in holding these levels. The project component of your question is also a little bit difficult to think through because projects are very choppy and every project has a different margin profile. Generally speaking, of course, projects are more price competitive, so to the extent that projects or our ability to book a mega project in the present year occur that would likely amplify gross margin pressure to the downside.

[Sam Darkatsh:]

So to clarify Jim, the 30 to 40 basis points of pressure that you say may occur based on what you're looking at now, is that based on the fourth quarter 23% level, or is that based on the fiscal year 2014, 22% level?

[Jim Pokluda:]

Fiscal year.

[Sam Darkatsh:]

Okay. And then my follow-up question would be with respect to what you are seeing right now in demand, obviously, you've got a difficult first quarter project comparison. But, as you suggested it, it gets lumpy and I'm not sure how much comparisons really play into what quarter-to-quarter project orientation is likely to be. And obviously, you've also taken down your inventories pretty meaningfully although some of that maybe internal initiatives versus necessarily what you're seeing in the marketplace. How should we look at Q1 demand trends?

[Jim Pokluda:]

Demand trends are down over the prior year generally consistent with our take on the pressure being applied for the business in the context of the oil and gas reference that I made in my prepared remarks.

[Sam Darkatsh:]

Which was down 10%, so is that, what you're looking at right now in terms of an overall sales volume is down 10% or how do we – is that how should parse it out?

[Jim Pokluda:]

That's what we've seen through the first couple of months of 2015. Yes.

[Sam Darkatsh:]

Okay. And last question, I'll defer to others. I apologize for not [indiscernible] the call so early. Within your prepared remarks Nic, in terms of the 2015 initiatives of what is taking up your time, absent that was share repurchase activity was that by design or is that going to continue at the same general pace as what we saw in the 2014?

[Nic Graham:]

Yes. Sam that share repurchase program will continue in 2015.

[Sam Darkatsh:]

Okay, helpful. Very good. Thank you, gentlemen. I appreciate it.

[Jim Pokluda:]

You are welcome.

[Operator:]

Thank you. [Operator Instructions] Our next question is from Luke Junk of Robert W. Baird. You may begin.

[Luke Junk:]

Good morning.

[Jim Pokluda:]

Good morning.

[Nic Graham:]

Good morning.

[Luke Junk:]

Just circling back to gross margin, just wondering on the 50 basis point benefit this quarter from reduced customer sales incentives, if you could just give some color on the mechanics of how those incentives works fiscally is that a year end true-up kind of number that would be theoretically smooth out going forward, or is that kind of just an absolute terms, the benefit that you saw in the fourth quarter?

[Jim Pokluda:]

We do – every month we go through a very elaborate process and calculation that contemplates multiple variables. Expected – well, existing sales trends with the customer, expected sales trends for the remaining period. And various incentive tranches that trigger upon reaching certain performance levels. So in the beginning of the year, we don't have a lot of data to work with. So we do the best we can with limited amounts of data. As we perceive throughout the year, the dataset becomes larger and our ability to forecast improves. But there is always Luke, some uncertainty about how things will close the year because there is a convergence of a lot of events. And some of these rebate payment triggers are fairly tight. And in the event, business drops off or a particular customer has a lousy quarter, they won't reach that next lucrative rebate tranche and we experienced some of that in the fourth quarter due to the reduced volume of sales. We do the best we can to budget and forecast for what we believe will be owed or earned as a result of sales with a particular customer, but it's not an exact science. And in the fourth quarter as I said, we had some folks that didn't make it to the finish line because of reduced volumes of sales and as a result, we received a benefit towards that end.

[Luke Junk:]

Okay. That makes sense. In other words, would it be fair to characterize this someway the accounting shipment at least similar to the rebate benefit you saw in the quarter that there is accruals made through the year and then at year-end when you got all the numbers like you said, you can firm it up and put the actual number in? So there might be some benefit or drag pulled up – pulled from the first three quarters of the year, will that be fair to say?

[Jim Pokluda:]

Exactly right.

[Luke Junk:]

Okay. And then second Nic, you guys obviously did a good job of reducing costs as went through 2014. I know that continued cost actions are one of the initiatives that you highlighted in your script. I'm just wondering directionally given that this is a high-fixed cost business, are you relooking at kind of a similar pace of reductions in 2015 or is there something that would suggest the pace could accelerate or decelerate versus of what we've seen recently?

[Nic Graham:]

Luke, I think I'm real pleased with what we've done so far. I think it's a little difficult to project exactly what's going to come out in 2015. One of the areas we will get some benefit from is a little difficult to quantify is this facility consolidation in Houston. SO we might pick up a little bit more on that, but I'm pretty comfortable where we are just now. I mean we're going to continue to squeeze what we can; we got a few other things we're looking at on the operational side. But I would be really very pleased if we continued at this level. I wouldn't really feel can't say, hey, we're going to save another x percent over the trend we've seen in the last six months, but I think there is some possibility, but I'm not going to build – I wouldn't build a lot into that.

[Luke Junk:]

Okay. So maybe kind of take the last six month of the year kind of flat to maybe down a little bit, but not at the same rate as we've seen?

[Jim Pokluda:]

I would take the last six months. And use that.

[Luke Junk:]

Okay. And then last question for me, I appreciate the help in terms of the 10% potential headwind from oil and gas near term. Just wondering as you came up with that number, if there's any way to quantify your exposure to oil and gas either as a percent of revenue or maybe even just based on where your locations are at high level?

[Jim Pokluda:]

Our greatest exposure from a geography perspective would certainly be the Houston area as we've touched the Permian Basin and Eagle Ford plays there. Chicago/Minneapolis over in Bakken; Marcellus not as lucrative for us given the present price of gas and the performance dynamics of that play is less aligned towards oil and more lucrative in gas. Having said all that, yes, we generally communicate that our overall company revenues as a function of oil and gas are about 30%. Now, we're in need of now a supplier with a significant investment in inventory that ships the product the same day with extreme precision and accuracy. So that's not going to go to zero. We are shipping hundreds of orders a day in the oil and gas space. But, we all read the papers and listen to the news and there's a lot of pressure on oil and gas markets right now. About 20% of Texas State GDP is a function of oil and gas. So we have some exposure there, but again, it's not going to fall off the cliff. We have done our best to contemplate exposure and upstream markets midstream markets and downstream markets and then fair to that out between MRO demand and project demand and we have come up with a number actually slightly less than 10%. But for ease of communication we're calling it 10%. So I hope that helps. The most immediate impact has been in the upstream space we don't do a lot there, but that's where the pullback first occurs. Generally speaking the most daily activity occurs in midstream for us. Downstream somewhat choppy, but long-term that's the most fulsome of all the markets. I mean, geez, think about this. The Cameron job, the Chenier job, the Freeport job, Dominion job, just those four jobs add up to $34 billion. Those are liquefaction jobs or liquid natural gas. [Sasall] [ph] is another $10 million to $15 million if you count the fractionators and crackers for their ethylene work. And there are many more of those stories you quickly get to $80 billion and that's all on approved work. So the downstream activity, although if you heard me say frustratingly slow because it keeps getting pushed to the right, is still very material. A lot of big work funded and in process is just going to be choppy.

[Luke Junk:]

Great. That's super helpful. Thank you, Jim.

[Jim Pokluda:]

You are welcome.

[Operator:]

Thank you. Next question comes from Michael Conti of Sidoti & Company. You may begin.

[Michael Conti:]

Hey, Jim and Nic. How are you?

[Jim Pokluda:]

Good morning. Thank you, Mike. Fine.

[Nic Graham:]

Good morning.

[Michael Conti:]

Good. Just a couple of questions. Maybe if you can just comment on your share position and maybe how that changes beginning of the year just given consecutive decreases in MRO revenue?

[Jim Pokluda:]

We feel good about it Mike. This reduction invoice count is a little tricky to think about, but ironically we feel like a high percentage of that as a result of just our better inventory profiling and inventory utilization. Customer feedback has been exceptionally good at the national account count level, at the strong independent level and at the local level. Very, very good, very positive feedback from the customers and how we're performing. If you look at to the extent possible peer group data some public and some not. The conclusion we draw is that we are gaining share in a flat market. So acknowledging to your point that sales have reduced, sales did reduce through the 2014 period. We still firmly believe and have some pretty good data in evidence to support that that we are gaining share.

[Michael Conti:]

Okay. That's good to hear. In terms of some of your distribution centers located close to some of the oil and gas fields out there, what's the general feel in terms of demand, are you seeing any customer destocking or inventory pullback there?

[Jim Pokluda:]

The products that we sell are not shelf goods for the customer. So that gets to the need it now point today I made earlier. So it's not the practice of our channel to stock our products. The transactions occur on a daily basis for unexpected demand in the context of MRO of course. The wells and rigs that are stacked initially are the older rigs less productive rigs – vertical rigs. So those go first. The activity on the horizontal space haven't seen a lot of real material, real negative pullback in rig activity there. But the interest in further development of fields has stalled so no question about that. If you were to call a guy in West Texas right now or Williston, yes, they would tell you that things are different. People have lost their jobs. The market feels different. The tempo is not the same. So that's just a reality that's a function of oil and gas markets. And that's why we feel it's important to communicate to the street what we feel is potentially at risk in the oil and gas space.

[Michael Conti:]

Sure. And then just a follow-up, so that 10% number that you indicated before, is that consolidated total revenue, are you talking about 10% from your oil and gas exposure point?

[Jim Pokluda:]

Consolidated total revenue.

[Michael Conti:]

And then just last one, just given, you know the deflationary period we're in now. I mean how are you I guess combating some pricing pressure from your customers? I mean is there any strategy there to I guess maintain margins? I have the feeling that we are going to go down, but you're talking about that you are not expecting to go down 150 to 200 basis points. I guess what's your strategy behind that?

[Jim Pokluda:]

A lot of that, Mike, is – a lot of the strategy is unfortunately involves data that we consider necessary to keep private for competitive purposes, okay? So let me think about the best way to explain this to you. Without divulging anything we consider confidential, we've made some changes to our internal systems and reward systems and inventory management systems that drive greater optimization of gross margin. We embarked on this mission early last year and amplified it as we saw copper continue to deflate and then the price of oil reduce. So as I said earlier, our timing was good on this initiative. But Mike, unfortunately for competitive purposes, I'm not comfortable of sharing with you some of the granularity of these strategies. We're delighted that they are working. We have every reason to believe that they will continue to work, but beyond that I just don't think it's prudent for further discussion.

[Michael Conti:]

No, no. Understood, understood. And last one Nic, should we expect any one-time charges in the first or second quarter as the new facility comes online?

[Nic Graham:]

You broke up that last bit Mike, I'm sorry.

[Michael Conti:]

Should we expect any one-time charges over the next quarter one and quarter two as the new facility comes online?

[Jim Pokluda:]

As the new facility comes online?

[Nic Graham:]

I think we're going to have some moving costs, Mike. That's for sure. And this is a fairly significant move. It's a little difficult to quantify, we'll break that out. But that just at this point in time of the year that would be the only kind of unusual OpEx that I would see at this time.

[Michael Conti:]

Okay, great. That's all I have.

[Jim Pokluda:]

Thank you.

[Operator:]

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

[Jim Pokluda:]

Thank you, Shannon. And thanks again to all of our value team members for continued hard work and dedication to the company. To our shareholders, we extend a special thanks as well. 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, this concludes today’s conference. Thanks for your participation. And have a wonderful day.