Coleman Cable Q3 2007 Earnings Call Transcript

Coleman Cable (CCIX)

Q3 2007 Earnings Call

November 14, 2007 11:00 am ET

Executives

Richard Burger- CFO

Gary Yetman – President, CEO

Analysts

Matt McCall - BB&T Capital Markets

Brett Levy - Jefferies

Tyson Bauer - Wealth Monitors

Alex Rygiel - Friedman, Billings, Ramsey

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the Coleman Cable third quarter financial results conference call. Today's call is being recorded. At this time for opening remarks and introductions, I'd like to turn things over to the Chief Financial Officer, Mr. Richard Burger. Please go ahead, sir.

Richard Burger

Thank you for joining Coleman Cable's third quarter 2007 conference call. Joining me today in the conference room is Gary Yetman, Coleman Cable's President and Chief Executive Officer; and Shari Campbell, Coleman's Vice President of Finance.

As we have detailed on slide 3, our comments today may include forward-looking statements that make assumptions about our operations, business and economic and political environment. These forward-looking statements are subject to risks and uncertainties that are detailed in the risk factors section of our annual report Form 10-K for the fiscal year ended December 31st, 2006.

We will begin our formal remarks with a review of business highlights. Then I will review the third quarter financials and we will take your questions.

I will now turn the call over to Gary.

Gary Yetman

Thanks, Rich. If you will turn to slide 4, I'm pleased to announce once again a very solid quarter for Coleman Cable. Our strategy to broaden our product offerings, strengthen relationships with distributors and increase end market diversity has produced a second consecutive quarter of record revenue.

Third quarter revenue of $253.5 million was up over 120% from last year's third quarter and up sequentially over the second quarter of 2007. We again came in at the top end of our guidance with adjusted EBITDA of $22.4 million, up nearly 37% over last year and produced adjusted EPS of $0.41, up nearly 14% over last year.

We also continue to make progress integrating Copperfield into legacy Coleman. We have recognized planned material cost savings and vertical integration initiatives during the third quarter, but a portion of these savings were negated by higher material costs, particularly the continued increase of PVC compound.

On November 8, 2007 our board approved the planned Copperfield integration strategy of streamlined manufacturing operations and cost reductions that were considered in our Copperfield acquisition. The plan involves the consolidation and closure of Copperfield manufacturing and distribution facilities located in Avilla, Indiana, Nogales, Arizona and El Paso, Texas into operations at a larger state of the art facility in El Paso, along with realignments of existing Copperfield facilities.

We expect that these measures will result in a combination of restructuring charges and purchase accounting adjustments of approximately $300,000 to $600,000 in the fourth quarter of 2007 for severance costs and approximately $3.5 million to $4.5 million in 2008 for other restructuring costs. We estimate that these measures will result in net cash expenditures of approximately $2 million to $3 million depending on various factors, including the timing of the sale of two of our own facilities and the amount of proceeds received. We expect that these measures will result in cash savings of approximately $3.5 million in 2009 and in subsequent years.

If you will turn to slide 5. Revenue for our consumer outlet segment for the three months ended September 30th increased by 9.3%. Revenues for our distribution segment, which includes our electrical wire and cable distributors as well as specialty distributors and OEMs, saw sales decline just over 4% during the quarter. Finally, Copperfield has performed to our expectations as it has contributed 123% to our revenue growth during the third period.

Slide 6. We are experiencing fluctuating market demands across a number of our channels particularly due to copper volatility and general market uncertainty. We continue to see weakness in our residential construction markets, somewhat offset by stability in our industrial OEM and commercial markets. We also continue to see inflationary cost pressures due to higher PVC costs and fuel surcharges. Labor efficiencies continue to affect a number of our facilities due to higher than normal employee turnover and tight labor markets. We have initiated expanded recruiting and retention efforts and expect to see productivity improvements in these facilities by the first quarter of 2008.

With the announced acquisition of Woods Canada, we accomplished the major objective of expanding our North American footprint. We look for the addition to significantly enhance our Canadian distribution platform. One of our initiatives with the Copperfield integration was the expansion of our industrial product offering. We are pleased with our progress and expect a number of new product introductions in the first half of 2008.

These initiatives will further expand our reach into the industrial and OEM markets and further diversify our product offering and customer base. We believe the planned integration of Coleman, Copperfield and Woods into one company provides significant opportunities to leverage our business platform and significantly enhance our value propositions to both our customers and our shareholders.

Slide 8. We previously announced last week the signing of a definitive agreement to acquire the electrical products business of Katy Industries, which operates in the United States as Woods Industries and in Canada as Woods Industries Canada.

The principal business of Woods U.S. and Woods Canada is the design and distribution of consumer electrical corded products, which are sold principally to national home improvement, mass merchant, hardware and other retailers. Through the Copperfield and Woods acquisitions, we believe we can grow our North American footprint while creating real economies of scale that will translate to true improvement in the bottom line.

Without rehashing too much from the Woods conference call, upon making the acquisition we plan an immediate, permanent reduction of working capital of $12 million to $15 million within three months of closing, which effectively lowers Coleman's investment in the Woods acquisition to $30 million to $33 million rather quickly. This will also allow us to reduce our debt by approximately $12 million to $15 million.

Coleman will utilize its current revolving credit facility to fund the purchase price. The Woods acquisition is subject to customary closing conditions and is expected to close effective November 30. Most notably, we expect this transaction to be accretive in 2008, contributing approximately $125 million in additional revenue, approximately $10 million in additional operating income and approximately $0.20 a share in additional earnings for the full year of 2008.

We believe this acquisition significantly enhances our market position in the Canadian consumer channel and also establishes a broader platform for penetrating other distribution channels and OEMs in Canada. We also solidify our position as the leading supplier of electrical wire and cable products for the U.S. consumer and industrial distribution channels, by significantly expanding our engineering and sourcing platform in Asia.

Assuming stable market conditions, we remain very optimistic about our business and the acquisition of Copperfield and the pending acquisition of Woods. We have significantly diversified our product and customer base, have a number of projects and initiatives in place and believe that we are well positioned to deliver strong operating results in 2008.

With that, I would like to turn the call over to Rich, who will provide an overview on our third quarter 2007 results.

Richard Burger

Thank you, Gary. If you'd please turn to slide 9, I will do a brief review of our GAAP financial results for the third quarter of 2007. As you can see from the slide, with the acquisition of Copperfield our new platform has produced consistent results for the past two quarters, specifically producing third quarter 2007 revenues of $254 million; EBITDA of $21.3 million; and earnings per share of $0.24.

As we noted in our second quarter conference call, several items continue to affect current period EPS versus last year, including the stock-based compensation of $1.1 million; intangible asset amortization of $2.5 million; incremental depreciation of $900,000; increased income tax expense of approximately $5.8 million since Coleman converted to a C corporation from an S corporation. As mentioned previously by Gary in talking about our planned consolidation and closure of Copperfield manufacturing and distribution facilities, we continue to drive the integration throughout the organization.

Please turn to slide 10, where I will give you an overview of a few key liquidity metrics. As evidenced by these three charts, Coleman continues to strengthen its balance sheet. We are very proud to have improved our working capital, DSOs and inventory turns. These improvements, while somewhat due to the Copperfield acquisition, have been driven by our continued focus on inventory and working capital initiatives.

Please turn to slide 11 for a discussion on various leverage metrics. The company's total debt to adjusted EBITDA remained unchanged from the second quarter at 3.9 times while our total debt to capitalization decreased 1.3 percentage points from the second quarter. As we stated in the past, Coleman has a strong history of debt reduction and while we intend to work to reduce our leverage to approximately 2 to 2.5 times, we are not uncomfortable in operating at a leverage rate at the current leverage ratio, as we have a history of successfully delivering the company from leverage ratios of greater than 6 times.

We have included our fixed charge coverage ratio as it is defined in our revolving credit facility and signifies our strength in meeting our interest and funded indebtedness. Under the revolving credit facility, the company is required to maintain a fixed charge covenant ratio of not less than 1.1:1 for any month during which the excess availability falls below $30 million. As of September 30th, 2007 our excess availability was $84.3 million.

Additionally, several investors have requested information regarding the pounds of products and copper sold as compared to other periods. Although management does not use this information as a leading metric in assessing our business, we are providing this information to investors. This information will be posted on our website and available later this morning.

Please turn to slide 12 where I will review our fourth quarter guidance. We typically experience softness in the fourth quarter as many of our end markets reduce their inventory stocking levels in conjunction with year-end holidays. Notwithstanding, we started the fourth quarter with strong operating results in October. While we continue to experience inflationary pressures from higher material and fuel costs, we have been successful in offsetting some of these pressures by implementing our cost reduction initiatives.

Finally, as stated in our press release last night, we expect our fourth quarter revenues to be between $220 million and $240 million, while we expect our adjusted EBITDA to be in the range of $17 million to $21 million.

Operator, would you please open up the line for calls?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt McCall - BB&T Markets.

Matt McCall - BB&T Capital Markets

Starting with the guidance, just so I understand what our costs are, do you have handy the pro forma numbers that we're up against in Q4 of '06 for both your revenue and your EBITDA guidance?

Richard Burger

Matt, we didn't acquire Copperfield until actually the beginning of the second quarter and I don't have that information here and I don't believe we have published it anywhere. I do believe in the conference call that we made on the Copperfield acquisition, I gave you the trailing four quarters I believe of both sales or -- at least, EBITDA.

Matt McCall - BB&T Capital Markets

I'll look back in my notes. I'm sure I have it.

Richard Burger

I just don't have it in front of me right now. I apologize.

Matt McCall - BB&T Capital Markets

That's fine. In the guidance, I know you talked about potentially closing the Woods acquisition in November. Does either your top line or EBITDA guidance include the benefit on either line from the addition of Woods in November? I guess you would get one month of benefit?

Gary Yetman

We haven't included any of the Woods numbers in our guidance.

Matt McCall - BB&T Capital Markets

Is there any seasonality in that business we should look at or is that top line number that you gave a pretty consistent pattern throughout the year for Woods?

Gary Yetman

Woods is going to have seasonality weighted towards the second half of the year.

Matt McCall - BB&T Capital Markets

From an EBITDA perspective, I know you quantified the EBIT benefit. I think I asked a similar question on the Woods call, I didn't think of it in terms of the Q4 benefit for looking at what the benefit could potentially be. I'm assuming that EBITDA could be a little bit higher than the EBIT that you forecast. I believe there was some cost savings assumed in that EBIT number. How should we look at the potential EBITDA benefit from that December period?

Richard Burger

Matt, we have not completed the fair valuation of assets, which would revolve around the allocation of purchase price. So with that said, we left it out of our guidance. As you would recognize, the requirements would be that we would step up the inventory at fair value; at the end of the transaction I would be pushing around a lot of numbers so that's why we went to the market in a conference call with we had paid $45 million for about $41 million of net working capital. I would not expect any normal EBITDA pickup in Q4 from a one-month ownership of Woods.

Matt McCall - BB&T Capital Markets

Gary, you mentioned that you are seeing some benefit from some of the efforts to improve purchasing at Copperfield. Can you give us an idea, I think you had quantified the potential for $10 million of savings. What have you recognized so far and are you expecting to see the balance of that $10 million in '08?

Gary Yetman

We are very, very pleased with the integration of the cost savings that we have been seeing out of Copperfield and are on track certainly on an annualized basis to get at least $10 million in '08. I think the offset to that, that candidly we hadn't planned on is the run-up of PVC since the first quarter of this year that has had a significant impact on that and if it continues at the current pace, will erode most of those savings.

Richard Burger

We experienced about $750,000 worth of PVC resin cost increase just in Q3.

Gary Yetman

Over Q2.

Richard Burger

Over Q2.

Gary Yetman

So it is significant.

Matt McCall - BB&T Capital Markets

Gary, you're saying that if we get the annualized benefit next year from these purchasing initiatives that carrying the current PVC costs forward would offset the majority of that?

Gary Yetman

Right now, the increase from the first quarter of this year on an annualized basis would be between $9 million and $10 million a year. Now we would hope to be able to pass some of that along, Matt, in the marketplace but right now I don't think we can quantify how much of that we will be able to pass through to the customer base. So the way we sit right now, if PVC resins remain at their same costs or continue to escalate, then I would assume that a lot of those cost savings that we are getting will be mitigated.

Matt McCall - BB&T Capital Markets

And that's despite the high levels in Q2 and Q3? You will start to annualize some easier numbers next year, so do you have to assume that the price continues to rise to see continued hit? Because again, if we just carry this number through you're going to at least in Q3 and Q4 next year, see some easier comps, if you will.

Gary Yetman

Yes, that would be true.

Matt McCall - BB&T Capital Markets

So the impact was $750,000. I think there was a similar impact in Q2. Is that correct?

Gary Yetman

Correct. In Q4, we would expect if resins stay where they are today, probably $450,000 to $500,000 increase on a quarter-over-quarter basis.

Matt McCall - BB&T Capital Markets

Sequential, so quarter to quarter from Q3?

Gary Yetman

Q3 to Q4.

Matt McCall - BB&T Capital Markets

I know copper has actually fallen. Can you quantify what the copper impact was in your guidance for Q4? I know you cited that as a source of pressure. What was the impact if copper would have held and was basically flat from last quarter, what was the impact in your EBITDA guidance?

Gary Yetman

We would expect if copper, if we look back historically, if copper stays in the $3.10 range from an average in the third quarter of about $3.47, we would expect margin compression on the legacy Coleman side again depending on our ability to lag our price decreases, someplace in the $2 million range.

Matt McCall - BB&T Capital Markets

That's the assumption that's in the guidance right now?

Gary Yetman

Yes, sir, and that would be again a one quarter impact as we work through the inventory. The other side of that, Matt, again, if you look back to last year as copper retreats, we have significant positive cash flow which we would expect if copper does stay down in the $3.10 to $3.15 range, we would expect to generate significant cash over the next three to four months.

Matt McCall - BB&T Capital Markets

The final question I had, you mentioned inefficiencies in your facilities caused by higher than expected turnover. Is something new going on there? Is it at the legacy Coleman facility? Is that legacy Coleman? Has anything changed or is that just a problem that you consistently face?

Gary Yetman

No, actually a couple of facilities, one in particular that we've always had a very strong labor pool to draw from has shifted in the last year and we've been experiencing these labor problems most of 2007. Part of it is it's just a tight labor market and we probably have in one facility 40% of our employees have less than six months experience. So getting them up and trained and efficient at running the equipment has been causing us some cost efficiency, both from a labor standpoint as well as a material standpoint. We hope and we believe that we can have most of that mitigated by the first quarter of 2008.

Operator

Your next question comes from Brett Levy - Jefferies.

Brett Levy - Jefferies

Can you talk about what the acquisition plans are from this point forward, or are you going to take a little bit of a breather here?

Gary Yetman

Our plan right now is to really focus on the operation side of our business in 2008. We think that there are some significant opportunities still to be gained from the Copperfield acquisition. As we announced with the consolidation of a number of their facilities, we see a lot of work ahead of us there this year. Certainly the Woods acquisition will not be as complicated from an integration standpoint, but our focus will be on improving the operations of those businesses and getting them integrated into Coleman Cable.

Brett Levy - Jefferies

So is it fairly safe to say that 2008 is unlikely to be the year of either acquisitions or divestitures?

Gary Yetman

I think that would probably be a good assumption. I never want to say never but it would have to be something that was very, very compelling and we would have to feel very comfortable with where we are with the two current integrations.

Brett Levy - Jefferies

The last question is with respect to the whole PVC and that type of pricing, are you guys looking to go to something that's a little bit more rapidly adjusting with your customers in terms of that or is that a nonstarter?

Gary Yetman

I'm sorry, can you ask that again?

Brett Levy - Jefferies

With respect to passing PVC prices on quickly, are you looking to change the nature of your relationship with your customers or is that a nonstarter?

Gary Yetman

I think part of the problem that we are seeing today versus a year ago is that with the market contraction that we've seen in some of our areas it is more difficult to pass along price increases. So while I think over time those prices will be able to be passed along into the marketplace, I just don't see it happening as quickly as it has happened in the past.

I would look for the first half of the next year as really a measure of how quickly they can be moved into the marketplace. Again, if those increased resin prices and plastic prices hold in the marketplace.

Operator

Your next question comes from Tyson Bauer - Wealth Monitors.

Tyson Bauer - Wealth Monitors

The distribution channel that you operate through, can you characterize the inventory levels that are being held at those locations? Also how that affects the pricing environment now that copper has shown some weakness in the last few weeks, are they more hesitant to take shipments and to hold inventory if there is a belief that copper is going to continue to be weaker?

Gary Yetman

With the volatility of copper in the last couple years, we've seen buying patterns from our customers change. And we see pushback in a lot of areas and as far as actually loading up with inventory. They will have a tendency to order more frequently on smaller orders.

The demand, which has a tendency to throw us from a forecasting standpoint, can be very, very strong one month as it was in October, and then seems to drop off. The only thing we can attribute part of that to is they are trying to play the copper market. When copper retreats and/or goes up, we see those buying patterns change even more dramatically.

Tyson Bauer - Wealth Monitors

Are you telling us that's what you've seen thus far in November?

Gary Yetman

We've seen fluctuating demands in early November, yes.

Tyson Bauer - Wealth Monitors

What would be the situation that you would like to see transpire that would certainly help you? Is that just a function of getting a tighter range on copper prices to get a more level ordering pattern?

Gary Yetman

Yes, I think if we would get stability in copper at any given level, then over time the historical order patterns would return to more normalcy.

Operator

Your next question comes from Alex Rygiel – Friedman, Billings, Ramsey.

Alex Rygiel - Friedman, Billings, Ramsey

Great press release. I love the detail you provided in it, so thank you. A couple questions here. First on a pro forma basis, if you owned Copperfield a year ago in the fourth quarter of last year, and you compare that to the fourth quarter guidance, it would appear that your sales guidance is assuming flat to up 10% year over year. Generally, does that math sound about right?

Richard Burger

Yes.

Alex Rygiel - Friedman, Billings, Ramsey

Again, I haven't found the fourth quarter '06 Copperfield EBITDA, but backing into it and doing some math, it would also appear that your EBITDA guidance year over year is sort of flat to up, despite all of these headwinds that you continue to highlight. Does that seem accurate as well?

Richard Burger

Yes, that information actually I don't have it in front of me, Alex but you could grab the press release on Woods, if you looked at EBITDA. Now, with that, I have to say, just so everybody is on the same page and it's footnoted there as well, because we never provided detailed information from Copperfield '06 because they were private and only did a review once, they were audited by PWC once a year, We just took 2006, their $35 million of EBITDA and divided it by 4.

Alex Rygiel - Friedman, Billings, Ramsey

Fair enough. That's all in the math that I did.

Richard Burger

That's what everybody else is doing, so I just did it as well.

Alex Rygiel - Friedman, Billings, Ramsey

Great. So despite the headwinds you're feeling, it would appear as if you are even more aggressive in cutting out costs despite the fact that internally you're identifying challenges. It would appear that your plan for 2008 is very similar with regards to the manufacturing consolidation and so on. Correct?

Gary Yetman

Alex as I said earlier, I think that the integration with Copperfield is going very well. We feel very good about the initiatives that are in place that we've outlined for next year. With a stable economy, we feel very positive about moving into 2008, especially with the Woods transaction at the end of this month.

Alex Rygiel - Friedman, Billings, Ramsey

Could you expand a little bit upon the Woods transaction, particularly as it relates to expanded manufacturing and sourcing in Asia?

Gary Yetman

We believe that there's some opportunities on two fronts. One, to pick up a good bit of manufacturing of what Woods was sourcing from the outside; we think we can bring that production into our facilities right away, which we believe will have a positive impact. When you combine their Asian presence with ours and their buy combined with ours, we think we will gain significant leverage in the marketplace from a purchasing standpoint throughout Asia.

Richard Burger

Just one other appendage I would put there is the Woods Canada acquisition actually creates a great distribution platform for our other channels. I know that Gary had mentioned it in our call here, but it would also give us the distribution and Canadian presence to go to other distribution channels, just not those that Woods historically participated in.

Alex Rygiel - Friedman, Billings, Ramsey

That's excellent. So that's revenue synergies driving the top line, correct?

Richard Burger

That's correct.

Alex Rygiel - Friedman, Billings, Ramsey

One last question as it relates to the seasonality of your business. Would you characterize the fourth quarter in a normal period where copper doesn't change too much throughout the year, as the fourth quarter of being the lowest or least profitable quarter? Or is it the first quarter?

Gary Yetman

Legacy Coleman, the fourth quarter would be more comparable to the third quarter but normally down. We would expect now with Copperfield, the fourth quarter to be probably the weaker quarter, especially with Copperfield because of the plant shutdowns over the holidays.

Alex Rygiel - Friedman, Billings, Ramsey

How does that fourth quarter compare to a normalized first quarter and second quarter?

Richard Burger

Alex, usually if I were going to characterize the second and third quarters are usually the strongest. First quarter depends on a lot of distribution channels. Over simplify, if you look at your irrigation channels and those things that have some climate-related activity, if you get an early spring and thawing you'll get increased expansion earlier in Q1 in some of those markets. So if you were characterizing the four quarters, Q2 and Q3 are strongest. Q4 I would still probably characterize as maybe weaker than Q1.

Operator

At this time we have no further questions. I would like to turn the program back to our speakers for any additional or closing comments.

Gary Yetman

Once again, we'd like to thank everybody for joining the call. Thank you very much and that would conclude the call.

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