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Houston Wire & Cable (NASDAQ:HWCC)

Q2 2013 Earnings Call

August 06, 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

David Mandell

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

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

Robert J. Kelly - Sidoti & Company, LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Houston Wire & Cable Company's Second Quarter 2013 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 the press releases and SEC filings. Forward-looking statements are not guarantees, and actual results could differ materially from what's 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're ready.

James L. Pokluda

Thank you, Kate, and good morning, everyone. And thank you for joining us on our call this morning. Today I'll begin the call with a brief overview of our second quarter performance and then I'll turn the call over to Nic who will discuss our financial results in greater detail.

During the second quarter, challenging economic conditions produced sales increases of 1.3% over the prior year period and 5.3% sequentially. More encouragingly, however, and consistent with our view that overall market conditions are continuing to slowly improve, despite varying levels of regional demand, we estimate that sales increased approximately 4% over the prior year period and 7.5% sequentially when adjusted for deflation and the price of metals.

Similar to prior quarters, continuance of strong regional demand in oil and gas territories, led by steady activity in upstream, midstream and downstream oil and gas markets and increased industrial demand in the improving southeastern region helped to offset underperformance in remaining areas of the country.

Sales of new products, including specialty oil and gas cables and aluminum cables continue to drive further penetration within existing customers and also with the top line.

Robust oil and gas markets and improving industrial manufacturing and utility power generation markets helped produce a year-over-year transactional volume increase of 3%, as well as MRO sales increase of 5%.

We believe transactional volume serves as an effective indicator of MRO sales activity, and we have experienced postrecession growth over the past 7 quarters in both transactions and MRO sales.

We consider these results a positive indication that we are gaining share, and although somewhat tepid, that the overall market remains in a slow recovery state.

Project sales decreased approximately 5% during the quarter and continued to be impacted by reduced levels of new large capital projects.

Small-scale project activity remained steady, and as in prior quarters, was composed of multiple operational upgrades in general and industrial manufacturing, ongoing capital investments and hydrocarbon extraction and transfer infrastructure and greenfield and brownfield petrochemical refining.

Although the large project market has been frustratingly slow to recover from prerecession highs, our hit ratio with the major projects that are available was consistent with prerecession performance, and we successfully booked several nice jobs. Through the second quarter, we estimate that our project opportunity pipeline, which includes identified projects in the engineering and prebid stage was up approximately 7% versus the first quarter of 2013.

As we move into the second half of the year, and although several metrics, including quarterly and year-to-date book-to-bill ratios remain positive, inconsistencies in end market and regional demand continue to persist. Should market consistency improve in the last half of the year, sales and profitability should also improve.

Given the present operating environment, however, we now expect our full year revenue to finish flat and earnings to be equal or slightly under that of the prior year.

Before I pass the call to Nic, I would like to close my prepared marks by noting that the long-term fundamentals of our markets are solidly intact, and that customers in these markets continue to require, substantially, the broad range of our products and services. Unfortunately, the large project market has been slow to recover. However, opportunity pipelines continue to grow, and our model will benefit from this expansion as these projects come to fruition.

Moving to the other end of the spectrum, MRO business is slowly improving. And we were pleased with our very solid Q2 year-over-year metals adjustment sales growth of 8%.

Finally, we continue to deliver on our promises to our customers, as customer satisfaction remained outstanding and operational excellence initiatives encompassing on-time performance and order accuracy were again superior, with both metrics exceeding 99%.

I will now turn the call over to Nic Graham, our Vice President and Chief Financial Officer, for detailed analysis of our financial results.

Nicol G. Graham

Thanks, Jim, and good morning, ladies and gentlemen. We appreciate the support of all of our investors on the call this morning. Our second quarter performance improved sequentially as the net income, but fell short of the comparable 2012 net income level.

Sales volume at $99.3 million was still impacted by varying levels of inconsistencies at the regional level. Strong in the Gulf Coast, but weaker in the other parts of the country, but sales improved 7.5% sequentially, adjusting to the impact of metal deflation, and 4% year-over-year.

Margin decreased both sequentially and year-over-year by 80 basis points, another indication of the continuing competitiveness of the market and the volatility of pricing.

Operating expenses at $14.9 million, while up 90 basis points year-over-year, fell 90 basis points from the $15 million level in Q1 2013.

As previously discussed in earlier calls, most of the op expense increase over the past 12 months were due to the additional sales and marketing headcount to support new products and services. At present, we believe we are properly staffed and will remain especially vigilant about expense management given the current operating environment, primarily due to a decreased gross margin and the more fixed nature of our operating expenses, operating margin at 6.9% fell from the prior year period 7.7%, but moved up 10 basis points from Q1 2013.

Interest expense at $0.3 million decreased 23.4% from the comparable quarter and was down 7.7% sequentially.

While our 2.1% borrowing cost was flat with the prior year period, our average borrowings decreased to $46.1 million in Q2 2013, compared to $60.9 million in Q2 2012, a 32% improvement.

Net income of $4.1 million was 8.3% lower than the level achieved in the comparable 2012 period, but increased 4.9% sequentially.

Turning to the balance sheet, fairly minimal change to our working capital investment, which increased by $1.6 million or 1.3% sequentially and decreased $1.2 million or 1% from the comparable 2012 period. Part of the increase were due to receivables, which increased $5.3 million. However, our customer aging and day sales outstanding metrics showed no negative impact and remained within acceptable historical levels. Other component parts of the working capital change were inventory levels, which increased by $2.1 million as we continue to improve our regional inventory profiles to satisfy local demand and accrued liabilities, which increased by $4.5 million as accruals built for the year-to-date period.

Expenditures on capital equipment reached $0.3 million, the same level as Q1 2013 as investments in additional warehouse and computer equipment were made. The results of operations generated positive cash flow of $3.3 million, which, after financing the capital expenditures and dividend, allowed us to pay our debt down by $1.4 million.

At quarter end, our debt was $46.6 million, the lowest quarterly level since March 2010. Very pleased we've managed to pay our debt down to this level. Our debt-to-equity ratio fell to 40.8%, and when you include the bank overdraft, to 46.5%. Interest coverage on our debt on a trailing 12-month basis was an excess of 23x.

Availability under our $100 million credit facility improved to $53.4 million, up from $41.4 million at December 31, 2012. This provides us with more than adequate capacity for our current needs. We remain in full compliance with the covenants of our loan and security agreement, which expires in September 2016. We're also very pleased to announce to our shareholders the $0.11 per share dividend for the second quarter.

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 David Mandell with William Blair.

David Mandell

So Jim, the guidance you provided for EPS, flattish to down slightly, compared to last year seems to imply somewhat of a second half pickup versus the second half of this year. First off, is that correct? And second off, kind of what's giving you confidence into that outlook?

James L. Pokluda

Well, the markets do continue to slowly improve as we've described, more so in the MRO end of the space. Nonetheless, it's a slow steady slug back. We continue to see a lot of activity across multiple markets. I think the fairest way to answer this question is to sort of dissect it by geography. The strongest markets remain the Texas and Louisiana Gulf Coast region, driven by the upstream, midstream and downstream activity. And there's no reason to believe that, that would change anytime soon. In fact, there are currently $92 billion worth of gas processing work on the horizon, very, very little of that have even begun to execute, so we look forward to that opportunity for the next several years. In the southeastern region and sort of the southeastern central region, the region that had formally been underperforming for the past several quarters. We continue to see a resurgence across multiple end markets. We've had a couple of quarters now of positive movement there, so we're encouraged to see that. With respect to major project markets, including power plant construction. Power plants, for the past year or so, have been down actually, most industry experts in the order of around 10% on a year-over-year basis. They are anticipated, though, to slowly improve from here through 2014, so we're beginning to see a pickup in combined cycle gas work and then the ongoing investment in scrubbers to remain compliant with MATS standard that reduces mercury and other dangerous exhaust products from fossil fuel combustion. So all in, the opportunity for growth, I think, is solid. The general, sort of, governing dynamics of our industrial space are intact. They are originally burdened in areas of the country like California, for example, but the overall bias, I believe, is still positive.

David Mandell

All right, and then on gross margin in the quarter, it took a step down sequentially. Is that all increased pricing pressure and metal deflation or is there mix issues there to?

James L. Pokluda

Well, they kind of go hand-in-hand. When the market's kind of flattish, people are slugging it out on orders, and we're not going to lose share. So sometimes we have to follow it down a bit. Commodity deflation acts, to some extent, as an accelerant on that state. Mix remained steady, so I wouldn't characterize it as a mix issue. I'd really just think about it in the context of a very competitive market, a flattish kind of market, and our very firm position that we will retain share and not lose it.

Operator

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

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

First off, I was wondering if you look at the sequential progression into the third quarter and fourth quarter, historically, you've had some big projects or you've had acquisitions in there that have impacted those trends. I'm just wondering if you look at what you would consider to be normal seasonality in the business, what should that look like from the second quarter to the third and into the fourth, just sort of what would a normal year look like? I understand you're maybe looking something different from that this year?

James L. Pokluda

Yes, certainly. Dave, historically, Q2 and Q3 have been our best quarters. Q3 -- Q4 and Q1, softer. At times, during the fourth quarter, we do get an end of the year rush as people look to spend budget dollars and finish up work. So in a perfect world, I would describe Q4 as likely being a little bit better than Q1, and Q2 and Q3 our best quarters. Just to give you a little bit more granularity, at times, we've seen as much of a -- as much as a 5% to 10% pullback in both Q4 and Q1.

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

Okay. All right. And then second, I guess, I'm a bit surprised that the -- you're saying you're seeing strength in upstream, midstream and downstream, particularly with what's going on rig count and the weakness there. I'm just wondering if you can talk about, approximately, the size of that business and just how do you define strong? I mean, is about double-digits, for example?

James L. Pokluda

Downstream is where we've seen the most movement, David, on a year-over-year basis. And yes, it is up double digits. Upstream is holding its head on a year-over-year basis and actually improved double digits sequentially versus the first quarter of the year. The reason that I think we're doing a little bit better -- well, I don't know, let me rephrase it. I think the reason we're holding our head in the upstream and midstream space is that our products are used extensively for maintenance, repair and operations use, as opposed to just onetime use. As they -- as the drillers and producers put these wells in, these rigs don't stay there very long, sometimes, just a few weeks, frankly. And they move them from site to site. And in doing so, their mud tanks, their power infrastructure, their machinery is never located in the same spot. So there's a nice sort of ongoing demand requirement to supply new cable, to deliver power and mud to these rigs, and that continues to be ongoing. In the downstream space, I think we're really just getting started. These fractionator jobs are very big. These NGL jobs, GTL jobs, all of the ethane and ethylene work are substantial. The $72 million that I referenced earlier is certainly a big number and 87% of that work is going to be conducted in the Texas and Louisiana region.

James L. Pokluda

Okay. And then final question, you mentioned new product, I'm not sure the magnitude of that, but if you could talk about how much growth, tailwind maybe they provide in the quarter? And just talk about the runway that you have to continue adding new SKUs?

James L. Pokluda

Yes, the most success we had in the recent quarter was in the aluminum space. The -- I would say the sequential results were flat year-over-year. I would say they were slightly positive. The products are used in a broad array of applications, actually even including oilfield, commercial, residential and industrial. These items certainly contribute to the top line. They are going to be slower growth from here, but certainly, are very valuable as we further penetrate our existing customer base with a broader SKU and service mix.

Operator

Our next question comes from the line of Sam Darkatsh with Raymond James.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

First, another follow-up on the gross margin question. I know you turn your inventory once a quarter or so and, I guess, at least copper has stabilized since mid-June. So should -- while looking at your sequential gross margins in Q3, should they rebound back higher to where Q2 was? Or is there a continuing pressure on gross margins from metal deflation and such?

James L. Pokluda

Well, there's a couple of things going on. There's a trailing effect due to commodity movement because we're -- we use an average cost accounting treatment for inventory. So there's a trailing effect, and it takes a while for moves to work their way in and out of the system. But, I think, perhaps, even more importantly, it's just the ongoing market pressure. We work very hard to service our companies. We're a value-added organization. And we're just not going to let a price cutter come in and steal customers in a market that's behaving like this. So we'll be responsible. We're not going to chase people down rabbit holes. We're going to be responsible and measured in our approach. But also we're not going to lose a customer.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

So in putting words in your mouth, and gross margin should still stay pretty much at this level even with the stability of the input cost at this point?

James L. Pokluda

Yes, absolutely.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

Okay. Second question, you've got some funky comps in the back half of 2013 in both MRO and project. When you're saying that you're expecting full year sales to be flat, could you give a color as to how that might break down project versus MRO in your view?

James L. Pokluda

The shift is -- we've made a little bit of a shift. For the past several quarters, even years, our mix of project to MRO has been 40% project, 60% MRO. Due to the reduced amount of projects, it's more in line with the 30% MRO -- excuse me, 30% project and 70% MRO. You're right, Q4 2012 was a big quarter coming in at a little bit over $104 million due to some very large mooring cable shipments -- direct shipments we had out of the steel wire rope end of our business. I would consider that an anomaly, a nonrecurring event. So if we just looked at the entire year, our guidance is indicating all-in, a topline similar to what we had last year, but less of a build in Q4 and a little bit more momentum in Q3.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

And 2 more questions, if I might. Could you give us a ballpark breakdown on the quarter of electrical versus mechanical?

James L. Pokluda

That's something we've never disclosed before, and it becomes increasingly difficult and try and track now as we, in some regions, are sharing distribution centers and management resources. The mechanical end of the business is growing. Frankly, last quarter was one of the better quarters we've had in several quarters on the mechanical end of the business. So we're encouraged by that. It's just not growing as fast as I'd like to see it growing. Nonetheless, it's still growing.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

And last question, if you allow me, Jim. You've mentioned the transactional volume being up 3%, and that's, in your eyes, an effective indicator of MRO demand. Remind us what the trends have been over the last few quarters of transactional volume? And is there typically a lag or lead in terms of what you're looking for in terms of your indicator? Or is that more of a present period indicator?

James L. Pokluda

It's primarily a function of MRO sales, so that tends to be more of a real-time indicator. On a year-over-year basis, transactional volume was up 3% and in the year-to-date period, the first 2 quarters of the year transition -- transactional volume was up approximately 1.5%. Those are pretty good numbers in our eyes. We don't have a history, for example, of seeing double-digit growth in transactional volume. It's usually in the order of 1% to 4%.

Sam Darkatsh - Raymond James & Associates, Inc., Research Division

And define transaction volume? Is that just number of invoices or tonnage? Or how do you define it?

James L. Pokluda

It's number of invoices.

Operator

[Operator Instructions] Our next question comes from the line of Robert Kelly with Sidoti.

Robert J. Kelly - Sidoti & Company, LLC

You had made a comment in your prepared remarks, Jim, that pipeline was up 7%. It sounded like sequentially. Can you tell us what the year-over-year increase was?

James L. Pokluda

I don't know if I have that immediately at my fingertips. It's here. It'd take me a couple of minutes to get it, Robert. And I have no problem sharing it with you. It's just not immediately at my fingertips. If my memory serves, it was up very slightly.

Robert J. Kelly - Sidoti & Company, LLC

Slightly, year-over-year.

James L. Pokluda

That's correct.

Robert J. Kelly - Sidoti & Company, LLC

And then just as far as the new project opportunity, it sounds like you're getting more excited about power plants picking up from here. If that is the case and that's kind of showing up in that plus 7% sequential number, when do we start to see that impact the top line and bottom line?

James L. Pokluda

The -- we've got a number of gas plants in the "mid stage" right now and we're actually on site on a few others. The most success we've had in the utility space of late has been on the operations side of the MRO piece. Upgrades to substations, for example, are up double-digit year-over-year and sequentially. We anticipate the 2014 year to be better than the 2013 year. Improvements in the nation's energy efficiency and somewhat flattish industrial demand, as I said earlier, I believe, put utility down approximately 11%, actually 10.8%. Now -- recently, on a year-over-year comparative basis, very recently, electricity demands -- power plant construction is up 10%, so we're encouraged by that. And the data source that we most often use to quantify these results estimates that 2014 will show 6% increase in power plant construction over 2013. One more comment, because of this mercury and their toxic standard, the standard that focuses on oil and gas -- oil and coal power producers in excess of 25 megawatts and they're now defined requirement to eliminate mercury, SO2 and other toxins from the air, producers are running out of time to scrub these facilities. The first sort of discussion of this issue came out in 2011, and at that time, the sort of implied deadline was 3 years with an understanding that it was going to be 4 years at the end of the day. So we're looking at the 2016-ish period of time for producers to come in compliance with this standard. So on the heels of that requirement, we are seeing a pickup in scrubber work on these aged facilities, most of which were built 35, 40 years ago.

Robert J. Kelly - Sidoti & Company, LLC

Great, great color. You mentioned the operational upgrades. Do you see -- typically see that before the larger scale upgrades take place? Or do those cycles move independently?

James L. Pokluda

Well, that's a very difficult question, Robert, because there are curveballs thrown. One would -- what you've described is a very logical scenario, and I would agree with that logic. However, an example would be the CO2 legislation that came out, and that certainly put the heels on coal-fired power plants. And you'll recall that's the requirement for new power producing units to produce the same amount of CO2 that a typical gas plant would produce in the order of magnitude of 1,000 pounds per megawatt hour and the typical coal plant is at 2,000. So when that came out, it really put the brakes on coal. So they're always these -- there's always a likelihood of some sort of broad-reaching regulation that would disrupt what you described as a very logical sequence of events.

Operator

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

James L. Pokluda

Thank you, Kate. And thanks again to our valued team members for the 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, 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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