Houston Wire & Cable Company Q3 2008 Earnings Call Transcript

Nov.10.08 | About: Houston Wire (HWCC)

Houston Wire & Cable Company (NASDAQ:HWCC)

Q3 2008 Earnings Call Transcript

November 10, 2008, 11:00 am ET

Executives

Chuck Sorrentino – President and CEO

Nick Graham – CFO, Treasurer and Secretary

Analysts

Sam Darkatsh – Raymond James

Kyle O'Meara – Robert W. Baird

Bill Dezellem – Tieton Capital Management

Holden Lewis – BB&T

Tajar Varghese – Scopia Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Houston Wire & Cable Company’s third quarter 2008 earnings conference call. My name is Beth and I will be your operator for today. This call is being recorded for replay purposes and at the end of the financial discussion; each caller will have a chance to ask one question and one follow-up question. If additional questions are necessary, the caller will be placed back in the queue, where they will be asked to wait for another opportunity.

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. Comments during today’s conference call may include forward-looking statements relating to sales, earnings, financial conditions, plans, and goals of the company.

These statements are not guarantees and actual results could differ materially from what is indicated in such statements, a complete description of risk factors may cause actual results to differ materially from statements made during the call can be found under the risk factors MD&A section of the company’s Annual Report on Form 10-K for the year ended December 31, 2007.

At this time, I would like to turn the call over to Chuck Sorrentino, President and CEO. Please go ahead.

Chuck Sorrentino

Thanks, Beth. Good morning, ladies and gentlemen. Welcome to Houston Wire & Cable’s 2008 third quarter earnings conference call. In the spirit of making our conference call as efficient as possible this morning, Nick Graham and I want to offer some select comments highlighting key notables in the third quarter of 2008. In addition to a difficult economy, we have some additional headwinds in the third quarter, so we are very pleased that we matched last year sales in the quarter.

I think this speaks well to the ability of our company to manage through adversity and continued delivering optimum performance. The 2008 hurricane season cost our corporate headquarters, which is also a national distribution center to be less than fully operational for 11 days. In addition, our Baton Rouge facility was impacted by Hurricane Gustav and was not fully functional for five days, while we were able to process some emergency shipments with a very limited staff within a few days of these storms. Sales were less than what we would expect in a normal operating environment.

Most of our customers along the Gulf Coast were equally impacted and consequently they were not generating orders or accepting goods. In addition, The Houston storm had some impact in our sales across the country as this location serves as backstop for our other ten distribution centers. As our largest facility, Houston is considered the primary distributor center as it stocks substantially more inventory and has additional real handling capabilities compared to other ten facilities.

Lost sales from the storm contributed to our lower gross margin percent in the quarter, as they were virtually all from our Repair and Replacement, which characteristically has higher margins. Historically, the third quarter of the year is our highest sales and profit quarter. Thus, business interruptions during that time can have a dramatic impact on our sales and earnings. It is impossible to estimate, how much we have lost as a result of the storm happening. It also appears that the early part of the fourth quarter of 2008, will be negatively impacted because with the slow process of returning to some level of normalcy.

As you may have noticed in our press release earlier this morning, we adjusted our annual guidance to an estimated range over $1.30 to $1.40 per share for the fiscal year 2008. The lost revenue and earnings in the third quarter coupled with what we feel is going to be a solid fourth quarter and copper volatility drove this change in our outlook. While normal fluctuations in copper have a minimal impact in our business are dramatic drop in a short period of time can have an impact.

Copper has been declining since mid-year and had a more rapid face on last few weeks. We anticipate that our stock inventory will rotate and be more closely align with market over the next few months. In the interim, we will face some gross margin pressure as most of businesses will have space because they face alike situations. In addition, I believe the Houston Wire & Cable’s primary customer appeal is the service that surrounds our product offering, thus mitigating direct commodity correlations. Also our major project business is typically copper neutral, thus reducing a large portion of the volatility associated with copper from fluctuations.

The markets and products targeted in our strategic growth plan have differentiated our revenue stream as we continue to successfully penetrate targeted macro markets that are less sensitive to the present near-term economic climate. These market’s Power Generation, infrastructure and Selected Industrials, continue to deliver above average industry growth to Houston Wire & Cable.

Estimated sales in the third quarter of 2008 from our five growth initiatives increased 5% to 10% over the third quarter of 2007. While some of the project activity was mitigated in the third quarter from storm activity, we consider these delayed sales as we would expect those projects to ramp up again and resume their schedules. LifeGuard, our proprietary low-smoke, zero halogen product offering had quarter-over-quarter and year-over-year growth that is in the solid double-digits.

As a reminder for a variety of reasons, we do not release specific information on product lines and their respective sales or margins. Therefore, I’m unable to quantify the numbers for you, but I can assure you that LifeGuard continues to outperform our company and industry growth.

A key ingredient in Houston Wire & Cable’s growth is our expanded sales for us and market development team as we continue to gain new customers and expand share with existing customers. This is a direct result of having more selling and strategic market development resources applied to the marketplace. Our growth plan is delivering meaningful results in a weekend economy. Despite the significant headwinds, we are executing on our plans and as such, our strategy remains an offensive one. Investments in organic growth play an important role in our future, so we can continue to win new customers, increase market share and improve operating leverage.

Lastly, there is a lot of doom and gloom surrounding the economy right now. However, it’s time like these that companies with solid business models and passionate management teams, which are proven they can execute, distinguish themselves from other firms. I believe that Houston Wire & Cable is such a company. I remain optimistic about out future and yes, we do face some obstacles from our economy as do nearly all firms, but please remember that we are first and foremost to service business.

Furthermore, we have a strong balance sheet, very good cash flow, excellent interest coverage, and plenty of liquidity, all of which positions us to be opportunistic with respect to acquisitions and/or other major business opportunities. In spite of the poor economic climate over the last 12 months, our return on invested capital is 26% and our return on equity is 35%. I consider both of these metrics to be top-tier results in any economic environment and particularly attractive considering the recent macroeconomic operating climate.

At this time, I would like to turn the call over to Nick Graham, our CFO, for his comments.

Nick Graham

Thanks Chuck and thanks to all our investors on the call today for your interest and support. I’m going to make some comments on our operating performance for the third quarter; follow by cash flow, liquidity and debt, and working capital. Concerning the deterioration in the economic conditions over the past few months, we were pleased to achieve sales levels in the third quarter of 2008 that match the record level set in the comparative quarter in 2007. This was despite losing several business days to storms and hurricanes. This achievement indicates the strength of our five growth initiatives, which continue to be the primary focus of our sales team.

Gross margins dropped by 200 basis points from the second quarter of 2008, due to a more competitive marketplace, driven partly by economic conditions, decreasing copper prices in the latter part of the quarter, and lower vendor rebates as sales mix changed. We do not anticipate an improvement in our margins for the next few months, primarily due to the impact of copper prices.

Operating expenses as a percent of sales, increased by 30 basis points in the quarter over the comparable 2007 period. While salaries and commissions remained fairly flat, we did experience an increase in sales support expenses and other operating expenses including higher insurance cost. Tight expenses control remains a focal point in all aspects of our operations.

However we continue to higher qualified sales personnel to support our growth initiatives. Primarily because of the compression in gross margin net income for the quarter $6.6million was lower than the comparable 2007 period. One last comment hurricanes we were very please there are business continuity plan functioned almost seamlessly during both Hurricanes Gustav and Ike.

We were able to operate our business absent the storm impacted facilities in a normal fashion, with all primary and backup systems providing the necessary support to serve our customers on our field sale force. Hurricane Ike hit the Gulf Coast of Texas and Houston in September, the site of our headquarters and our national distribution center. Our recovery plan for this facility was almost flawless.

While most of Houston and the surrounding area were absent power for two weeks, we had our 165,000 square foot facility powered by two large built in diesel generators. Hurricane Ike was the most stringent test of our business continuity plan and it’s a great comfort to workers as well as it did. Our recovery would not have been possible for the hard work of our Houston employees, many of when set aside personal issues to make the plan work.

Cash flow record quarter of an $11.5 million, which compares favorably to the competitive quarter in 2007, which cash flow $6.7 and to the sequential quarter, where we used $5 million. Capital expenditure remains inline, but historic trends at $400,000 for the year-to-date period and we estimated total 2008 capital expend of approximately $750,000. I want to remind everybody that our business model calls for minimum levels of CapEx on the year-over-year basis.

Liquidity and debt, debt levels fell by $10.2 million from the second quarter. Although readers of the financials should include approximately $4 million of bank overdraft as debt. This overdraft was caused by delays and cutting vendor checks due to the Hurricane Ike and these checks could did not clear the bank of the end of September. This adjustment makes the net reduction in debt from the prior quarter $6.2 million. At September 2008, our debt equity ratio fell to 54% from 72% at the end of the second quarter of 2008.

If include bank overdraft, the debt-to-equity ratio was 59%. While this ratio is conservative, we realize that current market conditions could deteriorate and accordingly, we will be closely watching our debt levels. The company continues to be in full compliance with all its credit facility debt covenants. We also have about $35 million of additional liquidity under the credit facility at quarter end. This facility is set for renewal in May, 2010. EBITDA levels for the quarter have provided interest coverage on the 24 times, again indicative of low leverage.

Strong cash flow availability of debt and low interest coverage provided us with the future flexibility to repurchase stock, pay dividends or fund acquisition. These actions will only be taken if they are in the shareholders best interest taken into account current economic conditions and projections and all the significant future benefit.

We adjust our working capital by $5.7 million from the second quarter 2008 and we will continue to maximize our working capital productivity including a reduction in this investment if possible. As the financial stability of many companies continues to deteriorate, we are constantly reviewing customer receivables and changes in the payment patterns.

We are also looking very closely at customers’ contract, terms and conditions to ensure that there are no potential unfavorable financial implications for HWC. Our bad debt remains close to our expectations and historic trends. In addition our DSO and receivable aging show no sign of deterioration.

This is the end of our prepared comments. At this time we will open up the call for any questions that you might have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And we will take our first question from Sam Darkatsh with Raymond James.

Sam Darkatsh – Raymond James

Good morning Chuck, good morning Nick. How are you?

Chuck Sorrentino

Good Sam. How you doing?

Sam Darkatsh – Raymond James

Couple of questions, first off the $30 to $40 it looks like you are looking for a Q4 sales down high single digits, if not low double digits if my math holds. Is that correct, and if so how much of that is due to copper deflation, how much of that is end market do you feel?

Chuck Sorrentino

It’s difficult to sort out what’s the end market. One of the problems we have Sam is the influence of storms into the fourth quarter. So, that get creates a lot of noise in the data sort to speak, but having said that your numbers of you know are minus 5% to minus 10% reserves are probably a good range to look at.

I don’t think we can comment on the copper thing that much other than to say that it’s been dropping dramatically. I mean if you look at the futures market for copper, which I did this morning, the lowest number is today’s number, which $1.82. The highest number is over $3.60, I don’t know that I remember seeing such a large swing in the value of copper and most of that is appear to me to be a biased upwards. In other words, the futures markets are stronger than the current spot markets, but we can’t predict copper, we are not going to try to predict copper; all we can do is deal with it.

Please keep in mind that, sizeable portion of our sales are copper neutral. We sell on service our appeal from customers is service. Most of what we have is readily available from other people. It’s not available from other people at the same service package, so we are able to mitigate the effects of commodity volatility as a result, but yes there is going to be some softening in the fourth quarter and there is going to copper headwinds also.

Sam Darkatsh – Raymond James

Where do your gross margins ultimately stabilize? I mean, if you had some headwinds now, again we are talking about copper, because of the severe deflation over the past few weeks which would be a detriment to gross margins and you noted in your prepared remarks that with mix you have lower rebates and such. Where do you think that, if copper stabilizes that the gross margins end up coming in around?

Chuck Sorrentino

Well, if copper stabilizes then I would revert back to what our historical margins have been. On the bandwidth of our historical margins because our cost structure then is aligned with current markets, the current replacement cost and the percentage wise I would look towards our historical bend .

Sam Darkatsh – Raymond James

The 24, 25 is still...

Chuck Sorrentino

Yes, absent other influences, which as we know nowadays that’s a pretty big absent with all of the other things we are going on, but yes.

Operator

And we will take our next question from Kyle O'Meara with Robert W. Baird.

Kyle O'Meara – Robert W. Baird

Hi, good morning. Just another copper question, could you quantify what the pricing impact was to 3Q ’08 revenue?

Chuck Sorrentino

Well I don’t think we can Kyle, again we’ve had so much noise from these storms and shutdowns, product mix variations and just a lot of things. I am afraid that whatever, we said would be at best a big guess and we probably shouldn’t do that. So, I am sorry we can’t do that.

Kyle O'Meara – Robert W. Baird

Okay, fair enough and I guess on gross margin, you broke out a couple of things and maybe this is a little bit difficult to you. I mean you talked about the storm activity, commodity inflation, pricing pressures. Are those listed in orders of importance that way it on gross margin? Could you just give us a little bit of color around that as well please?

Chuck Sorrentino

I won’t say they are listed in order of importance or in order of weight. The storms certainly had an impact because it dislocated sales that we would normally expect in our higher-margin sector, okay, so that’s a pop. The product mix also changed and then of course as Nick mentioned we started to see some deflation. Most of the deflation in the third quarter also very late in the third quarter and probably not as dramatic as it will be in the fourth quarter.

Operator

(Operator instructions) And Matt Dhane with Tieton capital Management; please go ahead.

Bill Dezellem – Tieton Capital Management

Thank you. This is Bill Dezellem sitting in with Matt, circling back to the comment about the normal gross margin range of 24% to 26%. What did you say with the timeframe that you anticipate getting back to that level?

Chuck Sorrentino

Well, the timeframe is going to be a subject to a lot of things. Primarily getting our stock inventory more closely aligned with the market. It also has an impact on what the copper prices are or what the prices are in any commodity going forward. It’s not something that we can come back and say a precise timeframe. My sense is, and this is just my sense that it’s going to be a few months before that happens, but that’s one mans opinion.

Bill Dezellem – Tieton Capital Management

So you would anticipate that clearly the fourth quarter will be below your target range and the first quarter depending on how the later part of the Q1 develops may also be below that target range. By the time we start getting into the second quarter of next calendar year, we should be gain – if nothing else changes that you don’t know about today, probably get ourselves back into that range, are we interrupting your qualitative comments correctly.

Chuck Sorrentino

I think that’s a reasonable description absent other major influences. Yes.

Operator

And will take our next question from Holden Lewis with BB&T.

Holden Lewis – BB&T

Good morning thank you. Can you just give a sense of the falling rebates comments? Are you referring – you bought less inventory or the effect of copper meant that you bought less value of inventory and therefore the rebates that you got as you sort of crossed purchasing thresholds came off or what are you referring to with rebate comment.

Chuck Sorrentino

Well, the rebates are a function of two things. Number one, thresholds which we are not in jeopardy of at this point time. Secondly, is the amount that we do buy and if we buy a less, then we get less rebates and some of them are progressive in nature. So lower sales levels sometimes can be a non-linear effect on the rebates or for that matter higher sales level can have the same effect.

Holden Lewis – BB&T

Right, but we are taking about rebates from your supplier’s right.

Chuck Sorrentino

Yes.

Holden Lewis – BB&T

Okay, because the inventory on the balance sheet, I mean it was down about $1 I guess in Q3 over Q2. It was actually down more than that sequentially, Q3 versus Q2 last year. It didn’t seem to me that the actions on the inventory were such that rebates would have been a big driver.

Chuck Sorrentino

Well, there is product mix also in there. I forget to mention that, that’s a pretty big one, but keep in mind that we also have a lot of direct which would not necessarily be reflected in the inventory. So, between the direct shipments and the other assumptions that we made, in essence we are taking nice a more conservative approach let me put that it that way to our year end rebate schedules.

Operator

(Operator instructions) We will take a follow up question from Kyle O’Meara with Robert W. Baird

Kyle O’Meara – Robert W. Baird

Hi, guys just one quicker one. Growth initiative slowed to plus 5% to 10% obviously impacted by the storms, but with the deteriorating economic environment, could you just comment on what you guys are seeing as far as backlog and whether or not you have seeing any project delays oar cancellations?

Chuck Sorrentino

We have not seen any project cancellations, any major project cancellations. Delays we see, but that is kind of normal course of events because of the weather, engineering delays a lot different things. In terms of the backlog, I think the best thing there Kyle, was to just look at what the backlog is for the Engineering and Procurement Company, EPC is the major ones.

The public ones publish that on their websites in a lot of cases, and it’s continues to be very strong. The projects that we are seeing, the projects that are in play are things that were funded likely months, if not years ago. There is still a lot of advertising that I am seeing here in Houston for engineers and procurement people for the EPCs, which suggest to me that they still have an optimistic thought process towards their backlogs in going forward. So, we have not seen anything that would suggest to us a material risk in the backlog of that business at this point in time.

Kyle O'Meara – Robert W. Baird

Okay, thanks.

Operator

And we will take the next question from Tajar Varghese; please go ahead.

Tajar Varghese – Scopia Capital

Hi guys, thanks for taking my call. I just wanted to ask a historical question. I guess from the historical context. When you guys first went public, you guys were on the uptrend of gross margin increases. I think as you guys are just secondary offering one of the reasons where you said gross margin was expanding was because of the Hurricane Katrina. There being tight supply and the fact that you guys basically earned higher gross margins and then peaked at 29% and then they have steadily been going down.

Now you guys have been hit with the hurricane again, but now you are sort of warning about gross margins going down in the future or at least staying at lower levels. It just seems somewhat of a contradiction to me. On the hand, you use it as a justification for gross margin increases, when you want public and now you guys are sort of using it as an excuse. One in fact it just seems, your gross margin are heavily levered to the price of copper and I am curious to get your comments on that.

Chuck Sorrentino

Well, let us start out first with your basic premise. I don’t recall us saying that our gross margins went up because of the hurricanes. I do recall saying that we felt, we had some positive sales influence. The gross margins that you are speaking out back in 2006 were influenced by a very strong demand from a number of different segments. In addition to that, substantial additional penetration by us in the new customers and lastly, a very substantial increase in the price of copper during the year and I believe, we did our best to quantify that.

In fact, as I recall and I am doing this off the top of my head. The 54% growth we saw in 2006, one fifth of that came from inflation, which was substantial. So, I would say that number one, if we said that then I think it may have been misunderstood, but I don’t believe we said that Tajar. In terms of using the influence of it now, keep in mind that what we are seeing now is the effects of lost sales. What you are comparing it to is the timeframe when we had replacement sales. So, the timing is not the same either.

So, you have got two things here. Number one, I don’t think your basic premise is correct and number two is that the timing is different. We are not yet in a replacement mode for this lost sale in hurricane. Not yet.

Operator

And we will take a follow up question from Matt Dhane with Tieton capital.

Bill Dezellem – Tieton Capital Management

Well, thank you. It’s Bill Dezellem again. That actually was a perfect segue for question that I had, which was when do you anticipate when the benefit the positive side of the hurricanes, the maintenance repair, when that comes through and given that this hurricane impacted this specifically being Ike impacted more of a population in industrial base than any hurricane in recent years, would it be unreasonable, or would it be appropriate to expect that the benefit ultimately could be larger than you have experienced in the past? When it does finally come through?

Chuck Sorrentino

Number one, I don’t know that we can predict when we are going to see it. I mean that’s a real wild card. Secondly to the extent that we do benefit, again I don’t think we can predict that either. The last storms that we had were large, violent, very serious, but they didn’t have a lot of rain associated with them like prior storms did or as much rains. So, you didn’t see as much flooding, I am not sure along the shoreline or close to the coast where you had the surge, but I don’t think its appropriate for us to try to predict when or how much that these things were all different.

Right now we are in a phase of having seen the impact, the negative impact and when we see the positive impact which we hope to see, but we may or may not. I would not want to project that.

Operator

And we will take a follow up question from Holden Lewis with BB&T.

Holden Lewis – BB&T

Thank you. with regard to the investments that you are making on the SG&A, can you give a sense of, how much we have been doing – I guess the primary investment is on the staffing side, can you give and then correct me if I am wrong, that may not be the case, but can you just give a sense of how much investment we’ve sort of seen in, and how much we could expect to see, and that is a follow up to that, at what point would you begin to sort of maybe reduce that level investment just to preserve the margins?

Chuck Sorrentino

Well, this year Holden, we will plan on having approximately a 5% increase in the size of the sales force. Now that could vary somewhat by year-end that is in approximation. In terms of the rate, in which we recruit people or bring people onboard, there is a balance associated with that.

We’ve been able to find productivity improvements within the company, which helps us, fund that. If, we feel that our SG&A is getting out of the line, if I can use that phrase or starting to increase more rapidly than what we’re comfortable with, then of course we can slow that down if we choose to, but keep in mind that is also a key part of our future growth, so there is a balance there.

Right now, we feel with the strong balance sheet we have for liquidity, the availability of substantially more on our credit lines, we are actually generating a lot of cash, there is a lot of positives here and we would like to think that we will remain aggressive and continue to grow and of course, if we do see our SG&A starting to deteriorate and then we can always make a quick change.

Operator

We will take the follow-up question from Sam Darkatsh with Raymond James.

Sam Darkatsh – Raymond James

A follow-up good, I thought I only had one. The last question I had for you Chuck, talk about incrementally by end market, any incremental strength or weakness that you are seeing that would be notable or that you would call out that’s interesting for us?

Chuck Sorrentino

Well, I think the targeted market that we are in, Sam, are still showing some pretty good strength. Power Generation is still reasonably strong, keep in mind that we are not on the distribution side of the power; we are only on the generation side, so that still looks good. The environmental side of that business looks good and probably even better now with the recent elections on the environmental; probably see some additional environmental requirements.

The infrastructure portion, we’ve heard, it remains pretty good. The one argument against that is the local municipalities having tax problems or tax revenue problems, but on the other side of the equation is, I know historically the federal government during times of slowness has come in with massive and infrastructure projects have both Roosevelt’s and I know, I think that currently the President-elect has begun to talk about that also. So, infrastructure to in our mind remains looks pretty good.

Then, the third area would be selected industrials, and there the energy complex still looks pretty good to us. There has been a decline in all prices, which actually helps the petrochemicals and refineries with their margins. So, all in all the energy business and let some of the other industrials, so mining has been off a little bit but still, remains what we think is going to be strong outlook. So, we are comfortable with our end markets, our targeted end markets.

There is weakness in some end markets and those probably better than I do, for the most part we are not in to many of those, I mean the automotive this week, we are not very big in the automotive markets anyway never have been. So, I would have to say right now our end markets are reasonably good.

Operator

And our final question will comes from Tajar Varghese with Scopia Capital.

Tajar Varghese – Scopia Capital

Hi guys, so just begin on the copper issue, I would encourage you to contact to your board and think about sort of disclosure going forward because, there is other companies out there annexure to limit extent was go that talked about sort of copper inflation and the impact on margins, because I think it just be very helpful for the public investor just to figure out how to value your company and you guys have been very glib about it in the past and just with the actual gross margins and how they have declined I think it is abundantly clear that it has a lot to do with your margins and to extent you guys can think about the disclosure to going forward, I think that will be a benefit to the public investment community. Thank you so much.

Chuck Sorrentino

Any other questions, operator?

Operator

There are none at this time.

Chuck Sorrentino

Hi, thank you everyone, we appreciate your time today.

Operator

That does conclude our conference for today. Thank you for your participation and have a wonderful day. You may disconnect.

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