Houston Wire & Cable Q4 2007 Earnings Call Transcript

Mar.17.08 | About: Houston Wire (HWCC)

Houston Wire & Cable (NASDAQ:HWCC)

Q4 2007 Earnings Call

March 17, 2008, 11:00 am ET

Executives

Charles Sorrentino – President and CEO

Nicol Graham – CFO, Treasurer and Secretary

Analysts

Jeff Germanotta

David Manthey – Robert W. Baird & Company

Michael Cox – Piper Jaffray

Sam Darkatsh – Raymond James & Associates, Inc.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Houston Wire & Cable Company’s Fourth Quarter and 2007 Year-End Conference Call. My name is Katie, and I’ll be your operator for today. This call is being recorded for replay purposes; and after the financial discussion, each caller will have a chance to ask one question and one follow-up question. If additional questions are necessary, the caller will be placed back in the queue and we’ll ask them to wait for another opportunity.

As a reminder, comments during the conference call may include forward-looking statements relating to sales, earnings, financial conditions, plans, and goals of the Company. These statements are not guaranteed and actual results could differ materially from what is indicated in forward-looking statements as a result of various important factors. Included in those set forth in the risk factor and the MD&A section of the Annual Report on Form 10-K for the year ending December 31, 2007, filed with the SEC on March 17, 2008.

At this time, I would like to turn the call over to Mr. Chuck Sorrentino, President and CEO. Sir, you may proceed.

Charles Sorrentino

Thank you, Katie; and good morning, ladies and gentlemen. Thank you for joining us today and welcome to Houston Wire & Cable’s 2007 Fourth Quarter Conference Call. My name is Chuck Sorrentino; I’m the President and Chief Executive Officer of the Company and with me today on the call is Nic Graham, our Chief Financial Officer.

Before I get started on my specific operating comments this morning, I’d like to thank you congratulate Houston Wire & Cable’s team for our achievements in 2007. Also, I want to thank our customers, suppliers, advisors, and directors as we could not have achieved, although we did, without their support and counsel. Finally, I want to thank you investors for their confidence in our team and their ongoing support for our Company in what was at best a turbulent year for the stock market in 2007.

Now let’s move to my thoughts on the fourth quarter and the year 2007. Sales growth in the fourth quarter was 7.6% over 2006. This growth rate reflected our anticipated year-end deceleration resulting from the deteriorating economy and cautious spending by end-users striving to achieve year-end financial objectives.

Estimated sales in our repair and replacement segment in the fourth quarter were slightly negative while sales from our five growth initiatives approximated in the range of 9% to 13%. As a reminder, we were rolling over a very robust quarter numbers from 2006 when we experienced nearly 26% growth over the prior quarter. Furthermore, in 2007, we faced a softer underlying economy.

For the year 2007, we achieved record sales of $359 million on 11% organic sales growth. Operating cash flow at $21 million was also a record and we acquired several new customers and launched some new products in select test markets. We also expanded our private label DataGuard product line and expanded our Armored Cable offerings. We anticipate all this product line expansion will benefit in years to come.

While we are pleased with our successes in 2007, we did fall short of our net income objective. We faced a number of headwinds from the deteriorating economic climate throughout most of 2007 caused by the turmoil in the financial markets. Furthermore, these market uncertainties reduced customer confidence and spending below the face of previous years.

Additionally, we face four difficult quarterly comparisons to our two-third 2006 organic sales growth of 51%. In spite of all these headwinds, though, we managed to post what I would consider to be our second best year, which is accomplished in a difficult economic environment, and there was a silver lining in the turmoil of 2007 as we demonstrated that Houston Wire & Cable can grow in difficult times as well as in good times, which I believe to be a critical factor in one’s investment decision.

Gross margin for the quarter was 24.3% reflecting the lower margin rate somewhat typical of our fourth quarters. In previous calls and communications we have noted that 2007 gross margin is more representative historical norms than the inflated gross margin the Company experienced in 2006. The combination of double-digit top line growth, coupled with double-digit operating income margin provided the Company with $21 million of operating cash flow in 2007.

In August of 2007, Houston Wire & Cable began repurchasing its shares in the open market. Through December 31, 2007, the Company had repurchased a total of 11.5% of its outstanding shares. This share repurchase program increased our debt to $34.5 million as of December 31, 2007. Had we not chosen to repurchase these shares, our Company would be debt free today.

Additionally, we begin a dividend in 2007 and recently increased that dividend by 13%. We are committed to managing our cash flow so that we can optimize returns to shareholder in a sensible and responsible manner while maintaining adequate reserves for acquisitions and the continued support of internal growth for our business. Our balance sheet is in great shape and we are well positioned for more growth for the many years to come.

Now I’d like to comment on some key performance metrics in 2007. According to our internal calculations, return on invested capital and return on equity were 31% and 40% respectively, which I personally consider to be top tier results. Our SG&A expense ratio to sales at 12% demonstrates our passion for expense management while we continue to invest in the growth catalyst of our business. I might add that the low level of SG&A expenses included $2.8 million of increased public company expenses this year, excuse me, in 2007 and an increase in the size of our sales force. The expenses from the sales forces’ expansions are front end loaded as new sales personnel take several quarters to become fully productive.

In spite of a daily borage of negative news in the press, our employee morale remains very high. Career paths have been bronzed, skill sets continue to be expanded through high level training and executive education and employee retention and tenure have been great. Investments in human resources have and will continue to be a critical factor in our successes as they have been a meaningful contributor, excuse me, a meaningful contributor in supporting our business expansion.

We feel strongly that we must grow our people to grow our business. Thus in 2008 will be a year when marketing and sales additions and training are a top priority. Also, today more than ever, I’m absolutely convinced that we have a great growth plan and that we are investing our resources in the right long-term markets. Please keep in mind that we are not depending on residential or commercial real estate markets.

Our five growth initiatives are targeted at power generation, industry, and infrastructure. We recognize that financial markets can influence the broad market. However, we also take comfort in knowing that the main drivers of our business, utilities, selected industrials, engineering and construction firms continue to see a robust business environment. Most engineering and construction firms, for example, are reporting backlog, record backlog activities.

Additionally, our proprietary LifeGuard Low Smoke Zero Halogen product offering, which is a key component to our strategic plan, continues to grow rapidly and at a pace that exceeded the growth of the Company in 2007. I believe this is a great time (inaudible) of Houston Wire & Cable either as a team member or as a stakeholder. As of year-end, we had over 160 sales and marketing individuals in our sales team. Thinking back just a few short years ago, we had about half that many sales persons and frankly less than half the sales dollars that we now have.

Currently the business outlook for 2008 remains mixed. We anticipate our repair and replacement business to be flat in 2008 as this activity, as this business characteristically parallels the broader near-term economy. I believe the major projects and infrastructure investments by utility end-users, federal, state, and local governments will continue with it’s brisk pace and we will likely see a similar activity level as we experienced in 2007. The data on ENC firms supports this belief as we are encouraged to see work in progress and backlogs at engineering firms at very high levels.

Thus, we expect our five growth initiatives to be the drivers of our 2008 sales growth. In line with that, we’re estimating our 2008 sales growth to be in the range of 5% to 10%. At those sales levels, we would anticipate earnings per share to come in between $1.60 and $1.75 given a like business environment.

Now let me turn it over to Nic Graham, our Chief Financial Officer, for his comments.

Nicol Graham

Thanks, Chuck. Another solid operating performance leading to double-digit top line sales growth for the year. Since we stated focusing on our new target markets in 2003, we’ve achieved double-digit sales increases in each of the last four years. This performance shows the strength of our business model and the target markets which we have made our focus points.

I’d also like to remind everyone that especially wire and cable that we inventory and sale is used across the entire spectrum of almost all industrial-based plants and facilities. Despite the impact of the anticipated declining gross margins and the increased level of operating expenses primarily due to our higher public Company, the resulting net income margin for 2007 of 8.4% was very healthy. While less than 2006 in terms of net income dollars and net income margin, the baseline 2006 amounts were impacted by inflation, hurricanes, and a partial year of public Company expenses. Despite anomaly and year-over-year operating expenses, our operating expenses of 12% of sales was slightly less in 2006, 12.1%. Again, a clear indication that we’re trying to maximize operating leverage.

During 2007, we experienced a full-year of public company expenses, including the cost of consultants, additional time by our external auditors, and internal resource hours spent on successfully obtaining our certification under Sarbox’s Section 404. This was a time-consuming and costly undertaking for the Company and going forward the cost of maintaining compliance with Sarbox will be lower.

Turning to the balance sheet, the balance sheet remains strong at year-end. Our two primary drivers in the balance sheet are our receivables and inventory. Receivables decreased from the third quarter, which is normal at this time of year. The aging of the receivables shows no weakness and our bad debt losses for the year were in line with historic trends.

Inventory levels increased as we purchased more products primarily to satisfy planned customer product demand for certain able management inventory programs. Inventory turns remain close to planned levels. Working capital requirements decreased from $100 million at the end of the third quarter to $98 million at year-end. Our cap ex spend for the year was $728,000, up slightly from 2006’s $623,000. I want to remind everyone that our business model does not require heavy cap ex demands.

Our debt increased to $34.5 million which included almost $41 million of funds used to purchase Treasury stock during the last five months of 2007. We increased our line of credit during the year to $75 million and we have plenty of available capacity to fund operations and continue the stock buyback. The buyback limit was increased by 50% by the Board of Directors in February 2008 to $75 million.

I’m very pleased with the operating cash flow that was generated in 2007, at least a historic high of $20.8 million up from 2006 less than $100,000 and the $3.8 million of funds used in 2005. This included a record $9 million of operating cash flow in the fourth quarter of 2007. We achieved this level despite increasing our investment in receivables and inventory, which together acquired another $19 million of funds. Our cash conversion efficiency was also strong as we flowed 69% of net income to operating funds, another record level for the Company.

At this time, we’ll open up the call for any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jeff Germanotta from Houston Wire & Cable. Please proceed.

Jeff Germanotta

Good morning, gentlemen. I wanted to get your thoughts on share repurchase. You’ve added a little debt to buyback shares, you’ve got a fair amount of capacity on your remaining authorization. Can you give a little more, frame for us a little bit greater detail where you’re headed there?

Charles Sorrentino

Jeff, it’s difficult to give specifics, but let me walk you through the logic and the sequencing of our logic as we think through the share repurchase program. The first thing we start out with we look at what our operating cash flow is going to be and then we also look at what our debt capacity. We also look at what he future holds in terms of possibility of near-term acquisitions or mid-term acquisitions and any other supporting requirements such as working capital for the business. On that we look at all of those things in concert with where the stock is and make a decision.

During the second half, actually from August through December we bought what I would consider to be fairly aggressively. But we had adequate cash; we had good cash reserves, operating cash flow; we had plenty of debt capacity and it made just a great deal of sense to us. In addition to the share repurchase program, I just want to remind everybody that we also have a dividend, and we increased that dividend by 13% just a few weeks ago.

So all in all we look at this thing in balance of what’s the best and most optimum way to return to the shareholders and at the same time, make sure that we have adequate resources and reserves for the needs, the immediate needs of the business and any future acquisitions.

Jeff Germanotta

This is Jeff. I’m still here. But thank you for answering my question.

Operator

Your next question comes from the line of Sam Darkatsh, please proceed.

Charles Sorrentino

Good morning, Sam. Operator, can you go to the next question?

Operator

Your next question comes from the line of David Manthey from Robert W. Baird. Please proceed.

David Manthey – Robert W. Baird & Company

Hi guys. Can you hear me?

Charles Sorrentino

Hi Dave. Yeah, sorry for the phone interruptions, but yes we can hear you.

David Manthey – Robert W. Baird & Company

Great. No problem. Thanks. When you set up the EPS guidance range relative to the top line growth that you expect in the 5% to 10%, I’m just wondering as you look down the P&L, are you expecting more favorable gross profit margin from current levels or is it SG&A leverage or what are the key drivers you’re looking at to get there? Because when I run it through my model, I’m having a hard time getting from the top line to your bottom line guidance.

Charles Sorrentino

Well there’s a number of variables. Let’s talk about the revenue side first, Dave. As we look at ’08, we’re looking for what we feel is going to be a better second half. We’ve had additional customer acceptance of LifeGuard, so we expect to have an even better this year. We’ve got some new product offerings that we’re coming out with and actually have introduced in January.

We’ve increased the size of the sales force, which I might add is also reflected in the higher SG&A expenses. We’re comfortable with our project pipeline. We’ve had sample polling with our end-user customers or markets. That’s been very positive. I mentioned the sales training which also is… We actually went through a very extensive sales training program for our entire sales force and still in the middle of that process, but that’s also reflected in the SG&A and of course there’s always stock buyback which additional stock buyback which obviously influences the EPS.

In terms of the gross margins, let me elaborate, if I may, on this because I believe there’s several points that we need to make here to bring clarity to this. In the 9 years that I’ve been with this Company, we’ve increased gross margin, we increased gross margins every year from 1999 through 2005. Now some years maybe have been flat, but essentially the trend line was up from 1999 through 2005 when we did, if I remember correctly, around 26%.

In 2007, we had 250 basis point increase in one-year. We had just an enormous increase in one year. Yeah, 2006, pardon me. In 2006, we had the 250 basis point increase in one-year. So an enormous increase in one year. Certainly well outside the normal historical trends, in fact, if you sit down and (inaudible) the gross margins for this Company for the last many years and do a bar graph and have your computer generate (inaudible) lines through that bar graph, it goes right underneath the 2006 numbers. It goes right through the bar. It simply was an anomaly and for I think for us to be compared as a baseline number to 2006 is just not correct. It’s not a fair representation; it’s not an accurate representation.

Our gross margins in 2007 returned to historical norms. 25.9%, that was close, very close to 2005 and higher than 2004 and we will expect going forward to see historical, our norm, our gross margins to be in the range of historical norms. It is not something… We just don’t feel that the 2006 numbers are representative. I might add that we did our best to make that call at the time and make that known at the time. I can remember spending a great deal of time choosing three words, three words very carefully to make sure there was absolute perfect clarity and those three words were “peak levels unsustainable,” and we use those frequently in 2006. So we have excellent, what we think is pretty good top line opportunity next year. We have historical range on gross margins.

Expenses, we expect to come down somewhat next year or excuse me in 2008. Nic can elaborate a little bit more on that. But there’s like we don’t have any, we don’t’ have a secondary offering expense, professional fees and things of that nature would be done.

Nic, why don’t you elaborate a little bit on the expense side?

Nicol Graham

Yeah, we’re going to get a decrease in the direct expenses, Dave, on the public company. Primarily the Sarbox fees are going to down significantly. We had some pretty heavy expenses last year both from our external auditor and our consultant who helped us get the Sarbox certification. So we’re going to have a pretty good saving from those two areas and we will not obviously have a, I presume not have a secondary offering expense. Those were a fairly good chunk change of last year. So we see some direct expense decrease as we go forward in 2008.

David Manthey – Robert W. Baird & Company

Thanks for the clarification.

Charles Sorrentino

You bet.

Operator

The next question comes from the line of Michael Cox from Piper Jaffray. Please proceed.

Michael Cox – Piper Jaffray

Good morning. Congratulations on the quarter, guys.

Charles Sorrentino

Thanks, Mike.

Nicol Graham

Thanks.

Michael Cox – Piper Jaffray

I have a, probably a question on the gross margin. As you talk about historical norms and I look at looking back to 2002 to 2004 timeframe and the gross margin hovered around 24% during those few years. Is that a reasonable proxy for this historical norm or should we look at 2005 as really the mark to compare it against?

Charles Sorrentino

I think if you took recent years, Michael, I would say in the range of 24% to 26%. Now some years would be more, some years might be less. But that would be given our current knowledge of our business and market conditions and things of that nature, I think that would be a reasonable estimate.

Michael Cox – Piper Jaffray

That’s great. Switching gears a little bit to the sales side, I was wondering if you could comment on seeing any delays or funding issues in the project business that you’re pursuing.

Charles Sorrentino

We’ve not seen any delays as a result of funding. We’ve seen some delays as a result of just simply not having enough engineering and enough contract laborers to do all the work, but it has… To my knowledge, there’s been no relationship between, no cut back in funding. Any delays that we’ve seen have been engineering related or there simply hasn’t been enough engineers or enough people to work on the not direct labor for the project side of the business for the laborers and also just a continuing increase in the backlog in the engineering work forum. It’s a very, very, very brisk time for them.

Michael Cox – Piper Jaffray

That’s very helpful. One last question if I could. To look at sales rev hiring plans for 2008, should we continue to see the same pace that we have in the past or perhaps some of the sales rep training initiatives that you put forth over the last six months, will that allow you to grow without adding new sales reps?

Charles Sorrentino

No, we’ll be adding new sales… Our target or our objective is to continue to add new sales people, absolutely. The reason for that I mean it’s fundamental. We feel like we’ve got five growth… We feel like we’ve got an excellent growth plan. The ability to take that growth plan to the marketplace is predicated on the number of customer touch points that we can get to. For that reason, we are absolutely convinced that we need to continue to grow our sales force and then that will be continual focus for us, not just this year, but in the years to come. I might add that the SG&A increases, some of the SG&A increased that you saw are all related to the sales force expansion and public company expenses. We’re getting a lot of productivity improvements elsewhere. But no, we will absolutely be adding to the sales force.

Michael Cox – Piper Jaffray

Great. Thank you very much.

Operator

At this time, I’m showing you have no further questions. I would now like to turn the call back over to management for closing remarks.

Charles Sorrentino

Operator, are you sure there’s no further questions?

Operator

I don’t see any further questions in the queue, sir.

Charles Sorrentino

All right, thank you everyone for joining us. Pardon me, operator?

Operator

David Manthey re-queued again, sir.

Charles Sorrentino

Okay, David.

David Manthey – Robert W. Baird & Company

Yeah. Hey, Chuck, sorry that call just seemed a little too short.

Charles Sorrentino

Yeah, I’d think so too but…

David Manthey – Robert W. Baird & Company

I figured I’d take the opportunity. Thank you. Question maybe for Nic: On the inventories with them being up over 20% year-over-year versus a 7.5% revenue growth rate, could you talk about how much of that is related to the cable management programs and how much is new products, just to give some comfort on the increase there?

Nicol Graham

Yeah, Dave, there’s some additional investment, as Chuck alluded to on the new product. As far as the overall growth, there’s a continuing demand for the cable management services that the Company provides. I think the…

Charles Sorrentino

The inventories going to fluctuate, Dave, particularly at year-end. Now sometimes at year-end, our sales are a little softer than we had anticipated and that is likely what happened, is what happens in the fourth quarter, so we had a little bit of a pop in terms of the increase in the inventory. The cable management portion of the business, the project portion of the business, is growing and growing very rapidly. In fact, most of the inventory increases are a result of that. As you may remember, that business is essentially a business that’s already committed to. It’s in our inventory but it’s sales that already committed to the customer, so it’s what I would refer to as little or no risk inventory. But we have to have the just in time delivery capability that we’ve committed to the customers.

David Manthey – Robert W. Baird & Company

Just last question: In your guidance, what type of tax rate are you using?

Nicol Graham

Dave, I think we’re at about 38.5% to 38.6%; that’s my recollection.

David Manthey – Robert W. Baird & Company

Thank you.

Charles Sorrentino

Welcome.

Operator

Your next question comes from the line of Sam Darkatsh from Raymond James. Please proceed.

Jeff for Sam Darkatsh – Raymond James & Associates, Inc.

Good morning, gentlemen. Can you hear me?

Charles Sorrentino

Hi Sam.

Jeff for Sam Darkatsh – Raymond James & Associates, Inc.

This is actually Jeff calling in for Sam. He was unable to make the call.

Charles Sorrentino

Hi Jeff.

Jeff for Sam Darkatsh – Raymond James & Associates, Inc.

My first question, you talked a little bit about the order strength or the backlog strength you’re seeing a lot of your customers on the project side, and I was wondering if you could talk a little bit about your backlog, what you’re seeing, maybe what book to bill is looking like and sequential changes there.

Charles Sorrentino

We don’t release hard numbers on the backlog, book to bill, and things like that, Jeff, because you get substantial swings in it literally quarter-to-quarter, month-to-month. I will tell you this much, that our project pipeline looks very good. It’s up. The commitments that we’ve gotten from customers, preliminary commitments that we’ve gotten from customers also looks very good, very promising. So my sense is that I believe I can tell you with some degree of confidence that the overall project business pipeline is up this year versus last year at this same point in time.

Jeff for Sam Darkatsh – Raymond James & Associates, Inc.

That’s very good. Next question would be: We’ve seen copper start to re-inflate recently. Is that a startage [sic] showing up in anywhere in pricing and do you expect that to happen?

Charles Sorrentino

Well through the fourth quarter there was not an awful lot of copper influence one way or another. The day-to-day volatility of copper is largely migrated by the fact we have an average cost inventory system. So the extent that it’s either higher or lower in any given say, it is averaged into the existing inventory part numbers. So the volatility, the day-to-day volatility is mitigated in that way. The only time, the times that it does have, begin to have an influence, if it jumps appreciably and maintains that jump over a sustained period of time. But day-to-day stuff, back and forth is not, does not have much if any affect.

Jeff for Sam Darkatsh – Raymond James & Associates, Inc.

Then just last question would be: In your EPS guidance, what are you assuming in terms of share repurchase?

Charles Sorrentino

Jeff, I don’t really want to project that. There was a number of different sensitivities that are involved with the share purchase along with all of the other line items and I think one has to look at all of that. In order to judge any of one of them, you have to look at all of them and we’re reluctant to release all of those. We’ve been in the conference call probably for the next three weeks.

Jeff for Sam Darkatsh – Raymond James & Associates, Inc.

Thanks a lot.

Charles Sorrentino

You bet. Thank you for joining us.

Operator

At this time, I’m showing you have no further questions. I’ll now like to turn the call back over to management for closing remarks.

Charles Sorrentino

All right, operator, thank you for very much. Thank you, everyone, for joining the call today and my best to you and your business in 2008.

Operator

Thank your participation in today’s conference. This concludes the presentation, and you may now disconnect. Have a great day.

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