Houston Wire & Cable Management Discusses Q3 2013 Results - Earnings Call Transcript

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 |  About: Houston Wire & Cable Company (HWCC)
by: SA Transcripts

Houston Wire & Cable (NASDAQ:HWCC)

Q3 2013 Earnings Call

November 12, 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

Joshua Wilson

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

Robert J. Kelly - Sidoti & Company, LLC

William J. Dezellem - Tieton Capital Management, LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Houston Wire & Cable Company's Third Quarter 2013 Earnings Conference Call. My name is Sam, and I'll 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 the 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.

James L. Pokluda

Thank you, Sam. Good morning, everyone, and thank you for joining us on our call this morning. I'll begin today's call with an overview of our third quarter performance, and then I'll turn the call over to Nic, who will discuss our financial results in greater detail.

Third quarter sales declined 0.9% from the prior year, and increased 1% when adjusted for deflation in the price of metals. We estimate that 70% of our total revenues resulted from maintenance, repair and operations activity, and 30% from project activity. We are pleased to see positive market recovery trends continue in MRO, which is our primary revenue stream. Sales results in this area of our business increased approximately 8% over the third quarter of 2012, and 10% on a constant-metals basis. Also on a constant-metals basis, MRO sales increased approximately 4% sequentially, and 8% for the first 9 months of 2013 versus the first 9 months of 2012.

We are encouraged by these results, as Q3 marks the fourth consecutive quarter for MRO quarter-over-quarter revenue growth and the best revenue quarter since Q1 2011. As in prior quarters, market recovery trends experienced in MRO sales were not likewise experienced in the project area of our business, and as such, Q3 project sales declined approximately 17% versus the prior-year period, and were down 9% for the first 9 months of 2013 versus the prior year period. This sales decline is mostly attributed to a reduction in large capital projects, but not smaller-scale projects, which was an area in which we continued to perform well.

Excluding investments in oil and gas refining, we continue to experience less-than-anticipated activity in large capital projects due to varying levels of geographic, economic strength and conservative budgeting in allocation of funds by end-users due to lingering fears over economic stability. As such, both bid opportunities and previously booked projects continue to be pushed into future quarters. Despite the above, our internal indices indicate that our market share is intact and our business development metrics, including project opportunity pipeline and book-to-bill ratio, remain positive, and are up through the third quarter of the year.

End-market activity varied by geographic region, and similar to the past several quarters, continued to be led by investments in petrochemical extraction, transportation and refining. Ongoing and recently completed pipeline upgrades and debottlenecking projects are improving transportation infrastructure, capacity and efficiency of feedstock transfer.

Downstream investments to support the increased availability of hydrocarbon feedstock includes new plant construction, capacity additions and upgrades required in order to process lighter crude. Activity in this space has remained consistently strong, and new project announcements indicate an ongoing positive outlook for several years. New power plant construction and environmental compliance activity was down on a year-over-year basis, and down slightly versus Q2.

We remain optimistic that activity in these areas will improve at some point in the near term, as power producers have just recently received defined standards for certain toxic air pollutants under the Mercury and Air Toxic Standard rule. Also, producers will gain additional clarity from the U.S. Environmental Protection Service on the proposed requirements of progressable [ph] CO2 output from fossil fuel power plants upon closure of the rule comment period and subsequent public hearing as it completes the rulemaking process.

Industrial and infrastructure end market strength also varied by region. Both of these markets remained challenged on the West Coast and in certain of the non-shale geographies of the Midwest. Overall activity and growth on the eastern seaboard at mid-southeast has continued in its slow ascent from the recession. Fortunately, the south and midsouth markets performed well in the above markets, and some largely-offset shortfalls in lesser-performing areas of the country.

We continue to remain pleased with the traction we are getting from our new products and services. Sales, especially oil and gas cables, aluminum cables and modified products from our recently completed light manufacturing operation, are meeting internal expectations. Given this performance, we continue to add resources and inventory investments into these initiatives, as sales of these items largely targets and supports MRO demand and have been instrumental in driving further penetration within existing customers.

Transactional volume, which is measured by invoice count, and we believe an effective measure of market share gains, increased 7% in Q3 versus the prior year quarter, and was at the highest level since Q2 2011. As we move into the final portion of the year, we are off to a solid start for the fourth quarter, and due to project delays, our booked project backlog is higher than typically experienced at this time of the year. We are hopeful that economic stability, confidence and growth will improve through the quarter. However, we remain mindful that broad market conditions are uncertain, and that the holidays and typical year-end seasonality may negatively impact our financial results. Although we believe our full year revenue will finish flat to slightly negative versus the prior year, we also believe recent expenses incurred for investments in market and business development, as well as a very competitive pricing environment, which is pressuring margins, will make it challenging to hit last year's earnings.

I'd like to close by reinforcing that the long-term fundamentals of our end markets are intact, and as in prior quarters, customer satisfaction, order accuracy and on-time performance were again outstanding. HWC's value proposition remains of significant importance to its customers as they strive to reduce working capital investments in the expensive high-risk products we provide. And we are confident that we are appropriately positioned to execute in a still-recovering environment. Finally, our practice of prudent expense management and working capital management will remain a top priority in order to ensure ample liquidity for future organic growth. Our strong balance sheet once again allowed us to provide our shareholders a dividend of $0.11 per share.

I'll now turn the call over to Nic Graham, our Vice President and Chief Financial Officer, for a detailed analysis of our results. Nic?

Nicol G. Graham

Thanks, Jim. And good morning, ladies and gentlemen. As outlined in the press release, we did a write-down -- we did write-down the value of goodwill of our Southern Wire reporting unit. We perform the annual impairment test in October each year, but during the third quarter, concluded that some impairment indicators existed.

Accordingly, we performed the normal test and determined that the carrying value of the reporting unit's goodwill was greater than the implied fair value of goodwill in the amount of $7.6 million, and the financial statements reflect this charge, which is a noncash item. We also include in the body of the press release, a reconciliation of non-GAAP measures to reflect the impact of this write-down, which moves GAAP net income to adjusted net income.

Certain of my comments this morning exclude the impact of this impairment to be comparable to prior period amounts. Our third quarter performance was impacted by the absence of top line sales growth. The competitive nature of the market and the lower-than-expected level of demand were the causes of both a shortfall in sales from what we had expected in the earlier part of 2013 and the level of gross margin and gross profit generated. Excluding the impact of the impairment, operating expenses increased 3.2% over the prior year period, principally due to a higher headcount and higher medical and dental expenses.

On a sequential basis, expenses were up 40 basis points and were flat with Q1 2013. We continue to look for ways to pare our costs and no expense item is exempt from our rigor in this regard. While we have made progress with internal expense savings and cost control measures, our expenses overall have increased slightly over prior year levels, and we feel it's important to adequately staff and fund our business development initiatives with a long-term view in mind. This approach does give us some short-term financial performance issues, but in the long term, we believe it solidifies the service capabilities of the company for its customers. Interest expense at $0.2 million decreased 31.7% from the comparable quarter, and was down 9.5% sequentially.

Our interest rate dropped to 1.9% for the period as we maximize the level of LIBOR debt that we carry, which attracts a lower interest rate. Adjusted net income was $3.5 million. Turning to the balance sheet, our working capital investment was flat with Q2 levels, and down 4.7% or $5.9 million from December 2012.

Receivables moved up slightly, however, metric sense[ph] and day sales outstanding remained within acceptable historical levels. Inventory levels fell by $3.6 million or 4.3% from Q2 2013, and by $4.4 million or 5.3% from December 2012. We remain extremely focused on improving our regional inventory profile to satisfy local demand, increase stock shipments and to maximize the effectiveness of our inventory investment. Other component parts of working capital moved minimally during the quarter. Capital expenditures for the quarter were $0.2 million, and the year-to-date spend of $0.8 million was slightly ahead of the 2012 spend of $0.7 million.

Our operations again generated positive cash flow, $4.2 million for this quarter, for a year-to-date total of $19.6 million, which compares favorably to the prior year, where we had used $11.6 million of funds through Q3 2012. After financing the capital expenditures and dividend, we paid down our debt by $2.1 million. Closing debt levels again shrunk to their lowest level since March 2010, and in the first 9 months of 2013, we've managed to shrink debt from $58.6 million at December 2012 to $44.5 million at the end of Q3, a decrease of $14.1 million or 24%, further strengthening our balance sheet.

Our debt-to-equity ratio is now 40.7%, and including the bank overdraft is 44.4%. These are historically low levels, and this is after the impact of the impairment charge, which reduced equity during the quarter. Interest coverage on our debt on a trailing 12-month basis, excluding the impairment charge, was almost 25x. Availability under our $100 million credit facility was $52.6 million, up 27% from the $41.4 million level at December 2012. This provides us with more than adequate capacity for our current needs. We also remain in full compliance with the covenants of our loan and security agreement, which expires in September 2016. We were also very pleased to announce to our shareholders the $0.11 per share dividend for the third quarter.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from David Mandell of William Blair.

David Mandell

With operating expenses up in a tough sales environment, how do you guys kind of think about managing that going forward? And how have the headcount additions over the past year or so -- how have they been performing versus kind of your expectations?

James L. Pokluda

This is Jim. Our view is that this company is a company that takes a long view in mind, and towards that end, it's just critically important we continue to invest in sales and marketing resources. We acknowledge that the project environment is not as healthy as we'd like to see. However, we do have some very good results and consistent results on the MRO end of the business. We think that's for multiple reasons, the traditional value proposition reasons involving performance, customer satisfaction, inventory profile, et cetera. But a very large accelerant to that is our commitment to adding new products to the portfolio to additionally service our customers and our reach into our customers. In order to do that, we have to take some near-term risk with adding additional cost into the business, product managers, market managers, in order to launch these products. But we think the manifestation of those results is good. Our invoice count is up, as I've commented. Our trend data is up on MRO. So with a long view in mind, we feel it's the most strategic play. I think that addresses part of your question. Was there another component of it as well?

David Mandell

Yes. If you could just discuss kind of how the headcount additions have played out versus your expectations.

James L. Pokluda

Sure. We've actually gained some recent traction on the sale of our high carbon steel and mechanical wire rope and related apparatus products, so we've been swapping some dollars around. We've had some headcount reductions on the electrical side of the business, but to a large extent, they've been reinvested into the mechanical end of the business. So from afar, at a distance, it may not appear that much is going around, but internally, we continue to fine-tune the model and add resources to support market demand.

Operator

Our next question comes from Sam Darkatsh of Raymond James.

Joshua Wilson

This is Josh filling in for Sam. I want to make sure I understood you correctly on your full year commentary. I believe you said sales flat to slightly negative, and earnings down, was that correct?

James L. Pokluda

That's correct. We're pleased that the top line is holding its head. You've seen similar economic data that we have. It seems to be a pretty sideways market. So copper-adjusted, we're up slightly, at least that's a positive indication. But due to the investments in new product development, sales and marketing resources, the expenses have gone up, and price competitiveness is very significant and gross margins are under a little bit of pressure. So given the flattish top line and expense creep, as I've just described, there will be an impact to earnings.

Joshua Wilson

And looking at the underlying assumptions for the fourth quarter and the top line. Last year in the fourth quarter of 2012, you had a pretty sizable project come through on the mechanical wire side, and so there's a pretty tough comparison, both in project and MRO. Could you -- is there enough of a backlog that's supposed to come through in the fourth quarter of '13? Or could you talk about some of the breakdown of what you're looking at for the sales by those categories in the fourth quarter?

James L. Pokluda

Certainly, Josh. Yes, you're right, we did receive 2 very large orders in Q4 of last year. They were lower margin, as you might expect for that type of work, but nonetheless, they did positively impact the top line. This year, we don't have that sort of very low-margin project business coming in to the fourth quarter. However, we do have a push of booked work from Q3 into Q4, and we estimate that, that project book, the book that was not billed in Q3 and will bill in Q4, to be approximately $5 million. Now in a traditional year, there is seasonality from quarter-to-quarter. Typically, Q4 is less than Q2 and Q3, and Q1 is the softest we experience throughout the year. That's in a typical year. We all know things are subject to change. On a more macro level, you're right, what -- or I will comment, rather, that projects are very choppy. The end users, the end-use customers appear very guarded, very cautious. Although, they have very strong balance sheets, I think there's still a little concern about the true economic stability of the environment, and for that reason, are acting in a very conservative manner. What that means is, a lot of the work that they have in process and on the books continues to get pushed out, in many cases, because of cost overruns with the work that is presently underway. So given the cost overruns of work in process -- in progress, and their still somewhat cautious outlook for the forward quarters, they have been a little hesitant to release work as quickly as we've traditionally seen. With respect to the pipeline, our opportunity pipeline looks good. Key markets, very solid; oil and gas, as you heard me comment, very good; lot of fractionator work, olefin crackers, pipeline infrastructure, all very solid in our key markets, and that's expected to last for some time.

Joshua Wilson

So what's the risk that the projects delayed from Q3 get pushed into next year?

James L. Pokluda

I feel pretty confident that, that $5 million I referenced will execute in Q4. We've seen some of the billings come through already. This tends to be faster-track work, so although they do want to procrastinate it, they don't have the luxury to do so. So it's a number that we feel good about, Josh.

Joshua Wilson

And if I could sneak just one more in, regarding the gross margin. You talked about several headwinds in the press release. Could you quantify those or at least rank them, and give us an outlook for them? And especially, given the higher mix of MRO sales this quarter that I would think would be a tailwind, could you, maybe, again, give us a sense of how big these headwinds are, and whether they persist?

James L. Pokluda

Sure. We don't quantify to the level of granularity that I believe you're requesting, but I can certainly speak about it qualitatively. When you introduce new products, you have to be competitive, so there's that very real dynamic that we have to accept. Competitors are very aggressive in their pricing strategies, so as I mentioned in prior quarters, we are not going to lose share as a result of that. We're continuing to be aggressive where we need to be in order to retain share. You're right that the MRO mix is a higher margin of profit than projects, however, given, as I said, the market competitiveness and the necessity to introduce new products at a price-competitive point, the net result is still slightly down.

Operator

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

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

If I'm understanding you right, you mentioned the seasonality of the business traditionally, and there was this $6 million mooring order in the year-ago period, which caused the fourth quarter to be greater than any other quarter of the year. But I'm trying to justify that with your comments this year. Are you saying that you could have another year this year like last year because of this $5 million backlog? Or are you saying that even with that, you should see normal seasonality in the fourth quarter?

James L. Pokluda

I think -- but so far it hasn't -- seasonality hasn't yet presented, so we're certainly encouraged by that. We had a -- having a good start -- we had a good start in the present quarter, activity levels are still very high. I don't want to be lured into a false sense of security there because I know it can change quickly, given the holiday season, but thus far, the momentum in business activity has been very good. So I guess what I'm trying to say is, Q3 would have been better to the tune of about $5 million if the stuff would have executed, which it did not. We're confident that it'll come through into Q4. Q4 was a bit of an anomaly because we did not experience seasonality, and we did have those big mooring cables that you've commented on. So we'd expect an additional, all things being equal, $5 million lift into Q4. And then the wildcard is still how Q4 will finish, a quarter which is typically less robust than Q2 and Q3.

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

Right, okay. So I guess, flat would be fairly optimistic for the year overall, given the finish -- you basically need the fourth quarter to be flat as well to get flat for the full year, which would be -- as you said, it started out okay, but it would be pretty -- have to be pretty strong to get you there, right?

James L. Pokluda

Yes, I think it's doable. I think I agree with that. It's certainly doable on the top line, it's just that the additional expenses will have a negative impact on our EPS. I'd also like to comment that the large orders last quarter -- or last year in Q4 were very low margin, and the orders that we're going to get in Q4 this year will not be at that low of a margin. They'll still be in margins typical with project-type business, but they won't be as extremely low as the ones were in the Q4 period for 2012.

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

Okay. And then, as it relates to gross margins, I'm just -- is there a point out there that you anticipate being able to stem the tide? It looks to me like if you exclude the 2010 acquisition of the mechanical wire and rope businesses, your gross margins have gone down since about '06, and probably at the lowest level in the core business that they've ever been in sort of recorded history. Is there -- I understand that they seem to be troughing here, but could you talk about, at what point they will start going up? I think the previous caller had mentioned something about the project business, and clearly, if the project business is down as much as it is, you'd think that mix would be helping you. And if that comes back, that should put additional pressure on the gross margin. So I'm just trying to get a handle on how you're thinking about GP today, and if there's a point out there where you anticipate being able to actually move it flat to higher.

James L. Pokluda

Right, right. Well, you're right. You would think that with an increased volume of MRO business, the gross margins would shift up. And I would agree with that if our operating environment wasn't so vehemently competitive. It remains a street fight. It remains very, very competitive out there. We're fighting over $100 orders, we're fighting over $1,200 orders. And it's just had an impact on our gross margin. I don't see the gross margin falling substantially from here. I mean, we provide a lot of value to our customers. We get paid for that value. It's just that the market hasn't been particularly cooperative. As mechanical wire rope end markets continue to improve, you see the Gulf of Mexico activity slowly crawling back. As those markets continue to recover, I think we'll get some lift in margins on those products. It's -- I don't think there's much additional downside from here, sans anything crazy going on in the market. And I do think that as the broad economy slowly recovers, we'll continue to -- we will begin to see an ascent in gross margins, maybe to the 23-ish percent level.

Operator

Our next question comes from Robert Kelly of Sidoti.

Robert J. Kelly - Sidoti & Company, LLC

Just a question on -- you said there -- did you quantify the expenses that we're going to hit in 4Q?

James L. Pokluda

We did not.

Robert J. Kelly - Sidoti & Company, LLC

Okay. You talked about the project business in the release being down 17% year-on-year, but you have positive commentary, I mean, regarding the oil and gas market. Just how much is the Environmental Compliance and power plant business down compared to last year?

James L. Pokluda

Well, if you look at the macro statistics, depending on which data source you review, somewhere in the order of 3%, some will say in the order of 10%. Plant usage of electricity is down slightly year-over-year, and efficiencies actually have led us to a position where we don't require as much electricity as we have required in the past. There was a time, pre-recession, in a period where the United States was very pro-coal, where Utility Power Generation and Environmental Compliance spend was as much as 40% to 45% of our business. We estimate today that that's falling substantially, likely in the 15% to 20% range. And until we get -- until the United States -- until the producers get some very clear guidance on the rules of engagement for producing power, I think the market will be somewhat flattish. Other data sources report that utility power generation and transmission infrastructure will likely grow in the order of 3% this year. That would certainly benefit us. But Power Generation and Environmental Compliance is not as significant to overall revenues, and certainly, not as significant to project revenues as oil and gas markets are. Oil and gas continues to grow. We had a nice growth quarter-over-quarter and sequentially, I believe sequentially with downstream oil and gas work. Midstream and upstream still remains very solid. And the $72 billion worth of fractionator work that I described on last quarter's conference call is a very real number. And as I said, likely to extend out for several years.

Robert J. Kelly - Sidoti & Company, LLC

Okay, great. Just one follow-on. The $5 million that you expect to hit in 4Q that moved out of 3Q, is that all oil and gas related?

James L. Pokluda

No. No, it's not. Actually a large percent of it is mechanical Wire & Cable related, I will say, coming out of the mechanical Wire & Cable end of the business for different types of lifting slings and apparatus.

Operator

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

William J. Dezellem - Tieton Capital Management, LLC

Did we hear you correctly in your opening remarks mentioning that the MRO business this quarter was the highest it has been since the first quarter of 2011?

James L. Pokluda

That's correct, Bill. And to be honest with you, it's probably even better than that, but we did not have the mechanical acquisitions fully integrated to the point where we could comfortably report MRO data until that quarter. So that's where we had to begin the measure. My intuition tells me that the numbers were -- if we have the benefit of all the analytics we'd like pre-integration, that would be even a more substantial record.

William J. Dezellem - Tieton Capital Management, LLC

And so if we have heard you correctly, your -- the MRO business has been improving, maybe not exactly every quarter, because I think you mentioned it's been 3 or 4 quarters in a row now. But if one were to draw a line, that directionally, it has been improving. And if we have heard you correctly, you would anticipate that it would continue to improve in the coming quarters. Is that an accurate assessment?

James L. Pokluda

The trend line is decidedly positive, as you've described. And, yes, I do believe that in the forward quarters, we'll continue to see recovery in that market. As I mentioned to Dave, Q4 is always a little bit of a wildcard, but so far, it started out fine. We don't know what seasonality will do to the numbers, but there's no reason to believe, nor do we have any indication that MRO will slow down. Through 2014 it looks solid. We're doing the right things, customer feed back is very positive, new products are getting traction. So we're optimistic in that regard.

William J. Dezellem - Tieton Capital Management, LLC

So ultimately, then, the question, I guess, that would bring me to is, the project business has certainly has some swings. And if we understand correctly, those swings would have been larger in the past as a result of the megaproject component, which -- I guess we should ask, do you see more megaprojects? Or does it tend to be more of the normal projects on a go-forward basis?

James L. Pokluda

The megaprojects out there today are not in power. They're in large fractionators for abundant feedstocks of ethane gas that are cracked into ethylenes. And there's a number of announced work along the Texas and Louisiana Gulf coast for that type of investment. The megaprojects, in the past, were coal-fired power plants. We wrote very large -- a couple of very large jobs, sort of pre and during the recession, massive plants, 1,600-megawatt plus power plant facilities. Just for comparative purposes, a typical gas plant is 300 to 500 megawatts. And that work is just not out there today. So there's definitely been a shift in megaproject work from coal-fired power plants to large petrochemical refining and cracking facilities. That work is -- the megaproject work in that space, the latter space, has not yet really come to fruition. We've received a few small orders as they're in early stages of development, but really the runway there is all in the out years.

William J. Dezellem - Tieton Capital Management, LLC

And so I guess -- then my question would be, in the next year or 2, as opposed to really pushing out long term, when would you anticipate the project business to turn and start showing some favorable comparisons?

James L. Pokluda

Well, on the fractionator side, most data sources would say that execution of -- or closure of front end engineering and design, closure of feed and groundbreaking will begin, if not already, in the 2014 period, and extend out through '15, '16 and '17. So there's -- we've certainly received some work in this end market, but the biggest work is yet to come.

Operator

At this time, I'm not showing any further questions. I'd like to turn the call back to management for any further remarks.

James L. Pokluda

Thank you, Sam. Thanks to our valued team members for your 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

Thank you, sir. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a wonderful day.

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