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Houston Wire & Cable (NASDAQ:HWCC)

Q4 2012 Earnings Call

March 18, 2013 11:00 am ET

Executives

James L. Pokluda - Chief Executive Officer, President and Director

Nicol G. Graham - Chief Financial Officer, Chief Accounting Officer, Vice President, Secretary and Treasurer

Analysts

Joshua Wilson

Ryan Merkel - William Blair & Company L.L.C., Research Division

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

William J. Dezellem - Tieton Capital Management, LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Houston Wire & Cable Company's Third (sic) [Fourth] Quarter 2012 Earnings Conference Call. My name is Kate, 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. [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 under the Investor Relations page of the company's website at www.houwire.com.

At this time, I'd 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, Kate, and good morning, everyone. Today, I'll begin the call with a brief overview of our fourth quarter and total year performance, and then I'll turn the call over to Nic, who will discuss our financial results in greater detail.

2012 closed with a very solid performance, and in the fourth quarter, we had record sales of $104,400,000, which was a 19.3% increase over the prior year period and an approximate 9% increase sequentially over Q3. Our 2 revenue streams, which include project and MRO sales, experienced only minor seasonality and increased approximately 39% and 10%, respectively, versus the fourth quarter of 2011. Fourth quarter project sales were led by robust petrochemical markets and to varying degrees, continued recovery in industrial markets despite inconsistent geographic demand.

Continued strong demand from oil and gas upstream, midstream and downstream investments and multiple midsized projects to support ongoing development of hydrocarbon rich-shale geographies remained excellent, and we also benefited from increased requirements for a high-carbon steel mechanical cable used in offshore mooring applications. Our sales opportunity pipeline continued to expand, and although the average opportunity size is smaller than in the past, our project opportunity pipeline was up over 20% compared to the prior year period.

Fourth quarter MRO sales increased approximately 10% year-over-year and approximately 4% sequentially versus the third quarter of 2011. While activity continues to improve, similar to my earlier comments involving general industrial market strength, broad market activity varied by region as markets that have exited the recession performed well, whereas demand in other regions remain inconsistent and still below prerecession levels.

For the entire year of 2012, metal adjusted sales were up approximately 3% versus 2011. As a result of a strong year-end finish, we estimate project sales increased approximately 2% during the year. MRO sales, although flat year-over-year on a metal-adjusted basis, benefited from our additional sales and marketing personnel, to lead product expansions in specialty oil and gas and aluminum cable and product customization services provided from our recently completed light manufacturing facility.

Throughout the year, our target -- our largest target markets performed well, and we experienced an approximate 9% sequential revenue increase over the third quarter, thanks to solid performance in key geographic regions that support these markets. We are pleased with these results, given the ongoing inconsistency in postrecession market demand and the reduction of power generation investment in the coal-fired megaprojects, which helped produced our record sales performance in 2011.

Despite reduced activity in coal, we remained well penetrated in the power generation market and had several nice wins, supporting the industry's transition to natural gas and alternative fuel technologies. The project and MRO sales to support ongoing oil and gas investment in extraction, transportation and refining drove year-over-year increases within this key market and helped to offset revenues from prior year megaprojects.

Moving further into 2013, our outlook for the year is positive, and we believe we are well positioned to provide substantial value to our customers in a market that signals future growth. We also remain guarded, however, given the potential for seasonality often experienced at this time of the year and as such, expect the first quarter of 2013 to be flat to down slightly over the first quarter of 2012 but expect the full year to be up slightly over 2012 for both revenue and earnings.

As in the past, we will continue our practice of prudent expense and working capital management. And given our present view for the year, we'll continue with responsible allocation of capital for investments in new products and sales and marketing resources to drive increased sales and profitability.

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. Solid quarter with record fourth quarter sales, the highest level since the record of $106.6 million in Q2 of 2011 and the resulting 19.3% increase over the prior year really drove the fourth quarter performance. Gross margin at 21.1% was impacted by 2 large direct ship orders, without which would have been 22%. Margins were slightly lower than the prior 3 quarters and indicative of the continuing competitive nature of the marketplace.

The higher sales generated more leverage, as OpEx to sales of 14% fell to its lowest level since Q3 of 2011. As Jim mentioned, we did add headcount during the year, which increased 4% year-over-year, principally in sales and marketing. I do want to reemphasize Jim's comments about regional fluctuations in demand. These are very difficult to manage around, but underperforming branches still present an upside to future results should the level of industrial demand return to more normal levels in those respective regions.

Operating expenses at $14.6 million were down year-over-year by 0.2% but up 1% sequentially, primarily reflecting the investment in additional personnel. Operating margin at 7.1% increased 100 basis points from the prior year period's 6.1%, principally due to the leverage from the higher sales levels. Our cost of borrowing, 2% for the period, was in line with the earlier 2002 (sic) [2012] quarter and down from the prior year period's 2.4%. Most of this decrease was from the impact of a lower LIBOR interest spread due to improving availability under our credit facility.

HWC remains a full rate taxpayer, and the 38.6% rate was similar to the rate in the prior year period. Net income of $4.4 million was 43.2% higher than the level achieved in the comparable period, which emphasizes the leverage that we can obtain from our model from increased sales and gross profit.

Turning to the balance sheet. Our working capital investment decreased by $3 million during the quarter, primarily due to lower inventory levels and receivables. As planned, inventory levels decreased by $4.5 million from Q3 2012 as we continued to rebalance the regional profile to maintain adequate availability of product across all distribution centers. The build-out of the new product investment that we discussed in earlier calls is close to complete. Accounts receivable fell from Q3 levels principally due to the strength of collections during the quarter. The balance is up from year-end 2011 due to the higher sales levels in the fourth quarter of 2012. Customer aging and days sales outstanding metrics improved over the prior year.

Capital expenditures during the quarter was -- were $0.3 million, and for the year, we spent $1 million, down slightly from the $1.3 million spent in 2011. Debt level decreased to $58.6 million from the $65 million level at Q3 2012 as we generated $8.6 million in operating cash flow, the highest quarterly achievement of the year. The positive cash flow improved the strength of our balance sheet and one of the key ratios as debt-to-equity fell to 53.7%, the lowest level of the year.

Interest coverage on a trailing 12-month basis was more than 23x. At year-end, availability under our $100 million credit facility was $41.4 million, which still provides adequate capacity for our current needs. We remain in full compliance with the covenants of our loan and security agreement.

That concludes the prepared remarks. At this time, I'll turn the call back over to the operator. Kate?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Sam Darkatsh with Raymond James.

Joshua Wilson

This is Josh filling in for Sam. First off, I want to make sure I heard you correctly. For 1Q '13, you said flat to slightly lower versus 1Q '12, and that's both sales and EPS?

James L. Pokluda

That's our estimate at this time, yes.

Joshua Wilson

Okay. And could you talk about your thoughts on gross margin near term?

James L. Pokluda

Gross margin, Josh, is holding up pretty well. There's always a lot of pressure, of course, and that varies substantially by region. The West Coast is experiencing a lot of pressure, and the Southeast still has some margin pressure. Pricing power in the oil and gas markets in Texas, Louisiana, parts of the Southwest is not quite so apparent. There's always iterations involved given the mix of MRO to project spend. But I would say, given the general health of the markets, we would expect gross margins to remain stable and slightly improve as long as the markets stay healthy.

Joshua Wilson

And could you -- it sounds like you had 2 big projects in the quarter come in. Could you talk about what sort of tail you see in your project sales going into 1Q '13 and the full year?

James L. Pokluda

The project work we got in Q4, we got a couple of large orders involved in offshore mooring. These are the very large diameter, high-carbon steel cables that you would use to till a platform around. Those are nice pieces of business, but as we've mentioned, they tend to be lower margin, and they're very inconsistent. You may get one of those just every year or so. With respect to the overall product -- project mix in traditional markets, the very large projects that we had seen in prior years from coal-fired power plants are no longer available. However, the backfill to those projects, those in the oil and gas space, primarily in the upstream space, which on a year-over-year basis is up triple digits, has been very good. The compressor stations, the pumping stations, the substations that deliver power to those units has been incredibly active. Those projects tend to range from $200,000 to $400,000, sometimes $500,000 in cables compared to some of the megaprojects that I'd mentioned involving power generation, which could be several million dollars. Now just one more comment, with respect to power generation, we're still very active in that space and continue to participate quite a bit in the build-out of combined-cycle gas plants and alternative fuel source projects, namely solar and wind and also biomass for that matter. We wrote a couple of nice biomass jobs. Year-over-year, however, power generation has pulled back a little and is anticipated to still be good in 2013 but somewhat flat.

Joshua Wilson

So is there any remaining sales to be made in those couple of big projects this quarter or is all of that shipped?

James L. Pokluda

In the mooring cable projects?

Joshua Wilson

Yes.

James L. Pokluda

Those sales are complete.

Operator

Our next question comes from the line of Ryan Merkel with William Blair.

Ryan Merkel - William Blair & Company L.L.C., Research Division

So I want to ask about the outlook for the year, which is up slightly. Jim, can you just comment on what do you think the end market outlook is? I would think that you guys will be taking market share, just a little surprised that it's only going to be up slightly for the year. I just want a little more context on that.

James L. Pokluda

Sure. Well, it's still very early in the game here, so plenty of time left remaining throughout the year. January, for us, was actually a good month, very good. We didn't see the seasonality that we typically experience at this time of the year. February, however, did pull back a little bit, hence my guarded comment. End markets look very good. As I've mentioned, oil and gas is very active. Industrial manufacturing is solid. You'll note, and I'm sure you look at plant capacity and industrial manufacturing data on a trailing 12-month basis, the moving total is still above the line. It's starting to come off a little bit, but still in what most people would agree is Stage 3 of the growth cycle. It's just that the year-over-year change has slowed a bit. Nonetheless, industrial manufacturing, durable goods, non-durable goods, plant utilization very high and likely will remain near these peaks throughout the year. As I mentioned, utility is down a little bit but still a very active market for us. I think most would agree that we still are a nation highly dependent on power, and as we take down these coal-fired power plants, they're going to have to be replaced with alternative fuel source technologies, and fortunately, the cables that we sell are used in all of those platforms.

Ryan Merkel - William Blair & Company L.L.C., Research Division

Okay. So it sounds like maybe a bit conservative on the full year outlook, just given what you saw in February. But outside of that, it looks like most of the drivers that you look at seem to be at least stabilizing and in some cases improving.

James L. Pokluda

Yes, I would agree with that. If you'll recall, March last year was a very strong month for us, so that will be a difficult comp in the present year. All that said, we feel good. To your point about our end markets, there's stability and in some cases as in oil and gas, particularly upstream and to some extent, midstream, are improving.

Ryan Merkel - William Blair & Company L.L.C., Research Division

Yes. I wanted to ask about the oil -- your oil and gas outlook, just given the increased drilling, all the infrastructure expansion. Just looking out 2, 3 years, is that a market where Houston Wire & Cable is going to do very, very well? Is that your expectation?

James L. Pokluda

Yes, yes. In fact, we perform exceptionally well there already. It's really amazing what's going on. There was a time when, due to the price of gas, it wasn't as attractive as other hydrocarbon sources, naphtha, for example, to produce ethylenes. The ethanes that we're extracting now, as an order of magnitude to naphtha, is a factor of 1 to 5, so it's far more competitive these days for the United States to produce ethylenes from ethane. Texas is -- represents over 70% of the United States' ethylene production. Ethylene is used to make plastics, et cetera, so it's a very important item to drive economic growth. The plants that we have in the Texas and Louisiana Gulf Coast, to quite a large extent, hadn't been upgraded in several years because of the spread between ethane and naphtha. Now because ethane is so much more attractive, we're retooling these plants and upgrading these plants to process this hydrocarbon, so the feedstock that we're sourcing today is very inexpensive relative to the next best alternative, and we're working rapidly in the South to tool up to be able to process that feedstock. As an order of magnitude, what we're putting out in Texas today, if you were to look at the gas barrel equivalent plus actual crude oil, some is at an order of magnitude, 9x what it was just a few years ago. If you'll recall, in 2007, oil production and gas production in Texas was very low, and now it's at all-time highs. The products that we sell, the SKUs that we inventory on the West Coast, 22,000 plus SKUs are very specialized SKUs, very specialized cables used in caustic and complex operating environments. As you can imagine, the oil and gas space, the refinery space, these cokers -- these crackers use very specialized cables. This is clearly a space where we have a lot of attention hence the increase, as I'm sure you may have noticed, in the working capital requirements, primarily driven from our increased inventory investment in the South to support this demand.

Operator

Our next question comes from line of David Manthey with Robert W. Baird.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

First off, could you give us the revenue impact of those 2 large drop ship orders?

James L. Pokluda

Approximately -- they were between $5 million and $6 million, Dave. I don't have the orders in front of me, but I'm not too far off in that number.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Okay. That's combined?

Nicol G. Graham

Yes.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Okay, all right. And my question primarily around SG&A, which has been well controlled here. As you look to the first quarter of '13, is there anything out of the ordinary that would lead to a step-up there in the SG&A line other than sort of normal payroll taxes or anything that's typical, just as we're thinking about that? And then, apart from that, as you're looking through 2013, it sounds like you increased headcount a bit this year but still were able to really keep a lid on those costs. Is there anything that would lead to an increase as we move through this year assuming kind of flattish revenues? Or do you just continue to leverage the existing cost structure?

James L. Pokluda

David, we definitely played offense last year, primarily to help replace some of the revenues formerly booked in megaprojects. So throughout the year, there's no question we added additional resources in sales and marketing. We added market managers, we added product managers, we added outside salespeople in revenue-rich geographies. I think all in all, to your point, we did keep the ratios in check. To answer your question involving Q1, no, I don't see anything extraordinary there. Of course, we always are recruiting good sales and marketing people, but I would say that the first wave of offense is now complete. We have the people and the leadership in place to drive our investments in new products, so we're just going to continue to leverage those investments for the time being.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then, finally, could you just discuss your current sort of competitive stance within the traditional kind of MRO market? Are you aggressively targeting growth there or is your primary focus to maintain margin in that segment? A little hard to tell with these projects moving in and out, but would you say, that the core MRO margins are stable and that might be putting a damper on sales growth there? Or are you being a little bit more aggressive trying to drive faster growth?

James L. Pokluda

No. The core MRO margins are stable. We really don't chase business. We really don't chase orders on MRO. It's always a street site [ph]. There's no question about that. But at the end of the day, we have a very good service platform, we have a very good inventory, so our history of being able to support margins on MRO is good. We do not have an initiative to cut margins on MRO to drive increasing sales. With respect to the other revenue stream projects, which on average is 40% of our sales, we do get more aggressive there. Margins on projects can vary widely, and of course, margins on projects change throughout the life cycle of the project itself. Let me think here, you had another component to your question, share. Share is intact. I think we're continuing to -- I'm certain, we're continuing to gain new customers, added over 80 in Q1. David, am I leaving out any other part of your question?

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

No, Jim you got it. That's good. I'm all set.

Operator

[Operator Instructions] Our next question comes from the line of Bill Dezellem with Tieton Capital Management.

William J. Dezellem - Tieton Capital Management, LLC

A couple of question, and if they are repeats from early in the call, my apologies, I had trouble getting on. First of all, do you have any further cost savings or integration plans in 2013 relating to the mechanical businesses?

James L. Pokluda

We're always looking for ways to save money, Bill. There's no question about that, and that's really just a part of our culture. So to -- I'll get specifically to the answer to your question here in a moment, but with respect to our culture, we meet regularly to discuss cost containment strategies. Of course, we need to balance that with responsible allocation of capital towards investments, but I would describe our cost containment rigor to be very good. Specifically, addressing steel wire rope, mechanical. In some of these facilities we have manufacturing and custom fabrication. We have embarked on one initiative, recently completed in one of our facilities, to streamline flow. We're in the middle of another improvement as we speak. I would say we are in the early stages of that, Bill. I would say it's also, when complete, not going to be overly material. However, I think it just needs to be an ongoing part of our process to squeeze out cost and drive efficiencies.

William J. Dezellem - Tieton Capital Management, LLC

Okay. And am I remembering correctly, that there is still some facility consolidation that you were going to be doing with the mechanical business specifically?

James L. Pokluda

Yes. We've got a couple of places in Houston. One's better business rationale would suggest that there would be an advantage to having them all in the same place. It's not absolutely necessary. We've explored options there. I guess the reason we -- why we haven't done it yet is that the offshore markets are still in the recovery stage, marginally healthy, and I just don't think the timing is right to pull the trigger on additional investment right now, as the markets really haven't returned to pre-moratorium level. We have plans in place. We've contracted with an architect. We have secured land. We have a facility design. We've done all that. But I just don't think it's the right time to pull the trigger.

William J. Dezellem - Tieton Capital Management, LLC

That's a great segue then to the oil and gas business. You noted here on this call and in the release that the oil and gas industry has been solid for you and yet, I mean, the Gulf of Mexico activity post-moratorium, it appears, has only begun the rebound process. So you may have just answered this question, but doesn't that imply that there is, I hesitate to use the word substantial, but substantial upside still in the Gulf of Mexico for you?

James L. Pokluda

We -- yes, there's absolutely upside. Our primary market in oil and gas with electrical-type cable products is land-based. We do certainly have products that are used offshore on the rigs. But as a percentage of sales, they're not really as substantial as the products we use on land. So if I had to pick 1 of the 2, I'd rather see further growth on the land for electrical products. With respect to the mechanical products, there's a higher -- there's a greater total available market opportunity for those goods offshore. So with respect to your question, there's upside for both areas of our business. I don't -- use of the word substantial might be a bit extreme though because offshore doesn't represent the extent of opportunity for us that land-based drilling does.

William J. Dezellem - Tieton Capital Management, LLC

That is helpful. And then, one final question for now. What led to the new products that you discussed in the press release exceeding your internal expectations? Was there simply some execution in terms of the rollout that was better? Or was market demand simply better than you anticipated? Or please help us understand the backdrop.

James L. Pokluda

With respect to oil and gas cables, the market demand was very solid. So if you think about the fact that for -- in years past, we had supplied our traditional electrical cables used in drilling applications, it just made perfect sense for us to additionally package the specialty oil and gas products. So the timing was very good, and we had the foresight to stock appropriately for that demand. With respect to the aluminum product, aluminum overall has gained attention, generally speaking, because the spread between its cost and copper is somewhat attractive. But that play has been more just a general leverage of the existing business model as opposed to a substantial change in end market demand as it was with oil and gas.

Operator

I'm not showing any further questions at this time. I'd like to turn the call back over to Mr. Jim Pokluda for closing remarks.

James L. Pokluda

Thank you, Kate. Thanks, again, to all our valued team members for their continued hard work and dedication to the company. For 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, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.

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