U.S. Markets closed

Edited Transcript of HWCC earnings conference call or presentation 10-May-18 3:00pm GMT

Q1 2018 Houston Wire & Cable Co Earnings Call

HOUSTON May 15, 2018 (Thomson StreetEvents) -- Edited Transcript of Houston Wire & Cable Co earnings conference call or presentation Thursday, May 10, 2018 at 3:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Christopher Micklas

* James L. Pokluda

Houston Wire & Cable Company - President, CEO & Director

================================================================================

Conference Call Participants

================================================================================

* Damon Benedict

Nierenberg Investment Management Company, Inc. - Senior Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for standing by. Welcome to the Houston Wire & Cable Company's First Quarter 2018 Earnings Conference Call. My name is Sherry, and I'll be your operator for today.

Joining us on the call are Jim Pokluda, President and Chief Executive Officer; and Chris Micklas, Vice President and Chief Financial Officer. Today's call is being recorded for replay purposes. (Operator Instructions)

Comments during today's call may include forward-looking statements. Any such statements are based on assumptions that the company believes are reasonable, but subject to risk factors that are summarized in press releases and SEC filings. Forward-looking statements are not guarantees and actual results could differ materially from what is indicated in such statements. Any forward-looking statements speak only as of the date of this call and the company undertakes no obligation to publicly update such statements. If you did not receive a copy of the earnings press release that was distributed earlier this morning, a copy can be found under the Investor Relations page of the company's website at www.houwire.com.

At this time, I would like to turn the call over to Mr. Jim Pokluda, President and Chief Executive Officer. Please begin when you're ready.

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [2]

--------------------------------------------------------------------------------

Thank you, Sherry. Good morning, everyone, and thank you for joining us on our call today. I'll begin with an update of our first quarter 2018 results, and then I'll pass the call over to our new CFO, Chris Micklas, who will discuss our financial performance in additional detail.

We are pleased with our strong start to the new year. Revenue growth was 8% and operating income at $3.3 million was the highest Q1 performance since 2015. Year-over-year gross margin at 24.1% was outstanding, and increased 260 basis points from the first quarter of 2017, primarily due to strong pricing discipline and metals inflation. Q1 2018 transactional volume per day, which we measure as invoice count, decreased approximately 6% versus Q1 2017, which we believe was the result of increased pricing controls, which helped us cull out unprofitable orders.

Sequentially, transactional volume increased 1.7 -- increased 1%. We estimate that sales results in our core business, which services Maintenance Repair and Operations demand increased approximately 2% from the prior year quarter and represented approximately 74% of our total revenue. The primary drivers of this growth resulted from increased demand in industrial construction, metals and minerals, upstream and midstream oil and gas markets. On a sequential basis, Q4 2017 MRO sales increased 1%.

Strength in oil and gas markets continued to fuel industrial market activity. In Q1 2018, the U.S. land-based rotary rig count increased to 981 from 802 in Q1 2017. And the price per barrel of oil increased to approximately $63 per barrel from the $52 level in Q1 2017.

Our products are used extensively in applications that support oil and gas exploration, extraction, transportation, storage and production, and we're pleased that these markets performed well. The offshore rig count of 12 at the end of Q1 2018 was 10 less than the closing count in Q1 2017 and the lowest level since September 2016. The significant decline in offshore rig count continues to be a major setback for certain categories of our high-performance copper wire, steel wire rope and fabricated lifting products used in offshore markets. We estimate the project sales for the fourth quarter increased 34% from 2017 and represented 26% of our revenue. On a sequential basis versus Q4 2017, project sales increased 11%.

Our 3 primary end markets for projects include utility power generation and environmental compliance, industrials and infrastructure. Project sales in the utility generation, power generation and environmental compliance market decreased approximately 14% over Q1 2017, due primarily to a reduction in fossil fuel plant upgrades.

Sequentially versus Q4 '17, sales in this market increased approximately 7%. Industrials end market project sales increased approximately 40% year-over-year, 12% sequentially and were led by recovering activity in oil and gas and general manufacturing end markets.

Sales in the infrastructure end market increased approximately 123% sequentially. Increases in projects for public works, transportation, and commercial construction contributed to this growth. My apologies, I misspoke. Sales in the infrastructure end market increased approximately 123% year-over-year. At present, our book-to-bill ratio remains positive and sales trends experienced in the first quarter have continued into April with revenue per day in April up 15% over prior year.

May results thus far are very good with average daily sales up 39% compared to May of last year. As we move further into 2018, we are pleased that broad market conditions have improved over prior year. Project activity continues to recover and that macro -- most macroeconomic data is positive. Given the above, combined with our robust operating plan, our present outlook for 2018 remains one of optimism.

Before I pass the call over to Chris, I'd like to thank Nic Graham, HWC's recently retired CFO for his 34 years of service to the company. His tireless efforts and unwavering desire to assist in any way he could have contributed abundantly to our company, and we wish him every success in his future endeavors.

With that, I'll now turn the call over to Chris for a detailed analysis of our financial results. Chris?

--------------------------------------------------------------------------------

Christopher Micklas, [3]

--------------------------------------------------------------------------------

Thanks, Jim, and good morning. First, I'd like to tell everyone how excited I am to be at Houston Wire & Cable. During my short time with the company, I've seen the team spirit and dedication to providing top quality customer service by getting the right product to the right place at the right time. This quarter's financial performance is a result of the team's efforts. With that being said, I would like to discuss our operating performance and then cover the balance sheet and the company's liquidity.

The first quarter of 2018 is the third quarter in a row of improving operational performance and is much improved from the difficult operating environment of 2016 in the first half of 2017. We believe this trend in performance is indicative of an overall increase in industrial demand and expanding economic conditions as well as the company's ability to execute initiatives from our growth plan. As Jim mentioned, sales are up 8% and gross margin is 24.1% of sales, which is an improvement of 260 basis points over the 21.5% in the first quarter of 2017.

While the gross margin is down 130 basis points from the fourth quarter, the much improved second half of 2017 resulted in some yearly true-ups in the fourth quarter. Operating expenses are $17.2 million, which is flat to the first quarter of 2017 and down $700,000 from the fourth quarter.

Operating expenses as a percent of sales are 20.3%, which is an improvement of over 150 basis points from 21.8% in the first and fourth quarters of 2017.

Operating income is $3.3 million or 3.8% of sales, which improved materially from the operating loss of $300,000 in the first quarter of 2017, and is up 10.1% from the fourth quarter. These operating results are the strongest since the first quarter of 2015. Interest expense increased by $63 million from the fourth quarter as the average interest rate increased 25 basis points from 3% and debt ended the quarter up by $6.6 million. As a result, pretax income is $2.6 million, which is $3.3 million better than the pretax loss of the first quarter of 2017, and 10% better than the fourth quarter.

Our effective tax rate of 25.9% was favorably impacted by the 2017 Tax Act, which reduced the federal statutory rate from 35% to 21%. HWC has historically been a full rate tax payer, and we estimate, based on present information, the change in the federal rate translates into an ongoing effective rate in the range of 26% to 28%. While there are still some aspects of the 2017 Tax Act that have not yet been quantified, based on our current understanding, we do not believe these will be of a material impact.

Now to turn the attention to the balance sheet and liquidity items. At the end of the first quarter, our working capital was $128.5 million, up $8.9 million from year-end. The largest elements of the working capital change are, a $6.2 million decrease in accrued liabilities as the year-end accruals were satisfied during the first quarter; a $5.3 million increase in inventory, which was close to evenly split between commodity price increases and a build for the construction season; and lastly, a decrease in accounts receivable of $2.8 million, which consists of a decrease of other receivables of $4.6 million, mainly vendor rebates, partially offset by increased trade receivables of $1.8 million due to our increased sales activity.

Our days sales outstanding decreased by 1.8 days to 52.6 days. Cash paid for capital expenditures during the quarter is $450,000, and we have -- and we anticipate a total 2018 spend of approximately $2 million, which is in line with the 2017 spend. We remain in compliance with the covenants of our $100 million asset-based credit facility. At the end of the quarter, we have $19 million of available capacity, which is adequate to fund the ongoing operations.

As we look forward to some of the initiatives, we are focusing LEAN manufacturing techniques on our operations to maximize distribution efficiencies and to reduce our working capital with the primary focus is on inventory and improving the profitability of our various product lines.

This concludes the prepared remarks, and I'll turn the call back over to the operator.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Damon Benedict with Nierenberg Investments.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [2]

--------------------------------------------------------------------------------

Just wanted to start on downstream. Nice to see some of the project business picking up, and just wanted to hear a little more detail on what's driving that and some of the opportunities you see?

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [3]

--------------------------------------------------------------------------------

Right. What has picked up, Damon, no one is happy about it than we -- than we are likely followed you. I have said many times that because of our service model and where we fit into the value chain, we tend to be -- we are often late cycle in the project work, especially the megaproject work -- in some of these megaprojects, billion dollar-plus projects, can go on for several years. So we come in at the tail end. Instrumentation, grounding, hookup, et cetera. And that's exactly what's happening now. So delighted to see the build. It's been a long time coming. It won't surprise me if it's choppy. That's just the nature of the beast, especially when you're a smaller company. But with the long view in mind and the understanding that there is a good head of steam building, I'm optimistic for what's ahead. I'll put a little caveat in there though. I always worry about the summer doldrums. Vacation season is upon us and for every good reason why business should be fantastic, warm weather, hopefully not too much rain, full-blown construction season. There is the tendency for things to slow down in one of the next couple of months. So we have to be mindful of that. Now, having said that, we don't see any indications of it today. April was good, and May's performance through yesterday is just outstanding. So, delighted to see that. And let's hope it continues. I guess, I'll give you one more comment for your next question. Downstream is good. We are happy about that. Midstream is also good. Literally, every single day, you can pick up the paper or peruse the Internet and you'll find an article or 2 about the abundant hydrocarbon reserves in Texas, in the Permian. There's a lot there. There are abundant reasons why we need it more than ever. Even as recently as this morning, if you read what's going on in the news, and there is significant activity to get it out. Well, once you get it out, you have to get it somewhere. You have to get it to Corpus, you have to get it to Houston, you have to get it to Beaumont. You have to refine it. And although the pipeline infrastructure is okay, we completed Longhorn a few years ago, Permian I, Permian II. Those pipelines aren't enough. We need more. And we excel in that space. The pumping stations, compressor stations, substations, tank farms, et cetera, we need more pipelines. There is significant capital in the marketplace. There is significant activity in constructing these pipelines. We're set up very well to benefit from all of that in the future.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [4]

--------------------------------------------------------------------------------

Good. And on the MRO side, a little bit of a slowdown, I think. Can you just talk a little more about the reasons you saw there, and whether that could pick back up for us?

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [5]

--------------------------------------------------------------------------------

Sure. Well I think, I believe that it already has shown nice signs of improvement, as evidenced by what occurred in April and May. Those are big growth numbers, and copper in Q2 of 2017 behaved very similar to the way it did in Q1 of '17, just a few pennies off if you look at the averages. So as we move into Q2 year-over-year results, we'll probably have a similar sort of copper effect. Now the caveat there is our average cost accounting treatment trails broad market moves. So there may be some iterations in that equation that I can't quite foresee yet, but just assuming copper in Q2 of '18 has the same effect that it did in Q1 and keeping in mind those numbers I just shared with you, that's evidence to me with what I can see now that MRO would do better in Q2.

Another thing that's important to know is that we were more selective on the business that we took in Q1. The margin is up significantly. We're elated by that. 260 points is a really big deal. And that basis point increase did not come as a result of riding a wave from having low-priced inventory in our system and pricing it to market. Our inventory average cost has moved up a lot over the past year. So if you think about the inventory effect on gross margin dollars relative to our 24% plus gross margins, there was, at best, a 10% to 15% basis -- 10 to 15 basis point increase as a result of commodity inflation.

So we're happy to see that our discipline on pricing has worked. The result of that though is that you pass on unprofitable orders. That's why the invoice count's down. That's why, to some extent, the MRO sales isn't what you may -- aren't what you may have expected. Net-net though, I'm pleased with the result.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [6]

--------------------------------------------------------------------------------

Great. Absolutely happy to see that price discipline. That's fantastic. On that topic, have you seen any rationalization in the competitive set over the past couple of years during the downturn and is that helping you right now? Or is it really more internal initiatives that are driving the pricing and gross margin strength?

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [7]

--------------------------------------------------------------------------------

Very, very little. Almost nonexistent rationalization, Damon. It came as a little bit of a surprise to me, frankly. But the players there today in -- where we reside in the redistribution space, are all the same. Just nothing really meaningful to even comment about. Certainly, there has been consolidation at the manufacturer level, a major going on right now as you're well aware, but not where we reside in the value chain. So these results are not the result of a aberrational supply model chain, change or consolidation. These results are the results of our strategic efforts to execute on improved performance and getting paid for the services that we provide.

Okay, Damon, you may be the only other somebody else. I'm happy to take respite for a second and see if anybody else comes in, but -- let's do that. If they don't, just get back in.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

(Operator Instructions) I'm showing no further questions in the queue. Mr. Benedict. Okay. Thank you so much.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [9]

--------------------------------------------------------------------------------

Okay. So...

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [10]

--------------------------------------------------------------------------------

Damon.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [11]

--------------------------------------------------------------------------------

On gross margins, did you talk about how much of the increase was metals versus underlying? Sorry, if I missed that.

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [12]

--------------------------------------------------------------------------------

Yes. We estimate that the metal impact on bps relative to gross margin was minimal, 10 to 15 basis points.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [13]

--------------------------------------------------------------------------------

Great. And then did you give revenue growth, excluding metals?

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [14]

--------------------------------------------------------------------------------

You can infer it. So our year-over-year growth was 8%. The metals impact contributed to 7% of that and based on the way we do the calculation, what's essentially happening here is that because metals prices have increased, our COGS have increased. So the top line goes up with it because we keep the margin the same, but in this case, we actually raised the margin 260 basis points.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [15]

--------------------------------------------------------------------------------

Got you. And on the cost side, so freight and labor, are 2 topics we're hearing a lot about. What are you seeing there? And what are your thoughts on your ability to pass along any inflation that might come?

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [16]

--------------------------------------------------------------------------------

Haven't seen any effect -- any material effect on labor and not as much as you might expect on freight. Freight quantified in basis points came out to 14. So very minimal, almost not even noticeable. So I'd say we -- so we have clearly done a good job passing that along.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [17]

--------------------------------------------------------------------------------

Okay. And on Vertex, I'd love to hear about updates there, what you're focused on and what your outlook for the growth of that business is?

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [18]

--------------------------------------------------------------------------------

We were very pleased with the year-over-year growth in revenue at Vertex. The team is engaged. The team is far more active in the marketplace with key customers. We've done a lot of really good things in a short time to drive the top line at Vertex. That didn't come without expense. So that's really where we're laser-focused more now than we would have been a year ago at this time, Damon.

We're happy to see the top line growth, but it needs to be coincident with other things as well, so expense management, overtime, freight, everything. Everything is under significant scrutiny. That will remain a focal point going forward. And then, some of the reason why we've had this year-over-year increase in inventories is due to the very choppy nature in which product is received from overseas. So I'll remind you that over 90% of our fastener products come from Asia. Some of them have very, very long lead times, in excess of 9 months. And Murphy was working against us in Q1. We had a lot of stuff show up at the same time. I saw the storm brewing and thought, "geez, this isn't really what I thought would happen, but I'm not going to change it." So we took all the product in. It was quite a bit more than we expected. We have an active plan now to work it out in the form of revenue. So you will see an improved result in Q2 in a certain context, but there'll be other offsets about that, that I'm going to put the call to Chris here in just a minute. And so there will be some offsets to the inventory reduction that we're working on now. But nonetheless, Vertex inventory, due to the choppy nature of the supply chain, purchasing end of it, were not more than expected. Margin is okay, but it needs to be better. So we are laser-focused on that as well. Customer service, on-time performance, satisfaction. Several sigmas better than it was in the prior few years. So very happy with that. Employee development moves along briskly. We made some fairly significant changes there. I'm happy with the results. So Vertex remains a work in progress and in many ways, I'm happy with what they have done. In other ways, we have -- I'm disappointed, to say, plainly. So we have some work to do there. And we'll accomplish our goal, so I'm certain of that. Chris, I'm sort of diverging a little bit here from Damon's question, but it gives us good opportunity to talk about working capital and what you've got going on there.

--------------------------------------------------------------------------------

Christopher Micklas, [19]

--------------------------------------------------------------------------------

Yes. So, Damon, we are focusing -- I mentioned it in my script some lean manufacturing and things that I picked up in my days in GE, and we're doing some activities, looking at the profitability and looking at inventory. And the thing that I point out is, as we would be reducing inventory through the system, we're going to be increasing sales and we have had increased sales. So again, as pointed out in my script, the trade receivables were up almost $2 million in the first quarter and that's with a few days coming out of our days to sale. So you can expect, as we have strong sales, there can be an offset in the amount of working capital because we are going to be -- you'll probably see an increase in the days to pay. We don't have many past dues and we are really tight on that. So it's really a good turn of our receivables, but you can expect to see some increase.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [20]

--------------------------------------------------------------------------------

And sticking on that topic, I think in the last couple of calls, the goal was to keep inventory flattish despite the growth. And obviously, it's a happy problem if growth comes in a little stronger, but just wanted to hear an update on that and what sort of revenue growth threshold you think is the point at which you'd have to grow inventory versus being able to keep it flat?

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [21]

--------------------------------------------------------------------------------

Well, the macro goal remains keeping it flat. We didn't do a very good job this time. We're going to do better in Q2. I assure you that. This business is -- works because we have inventory, a lot of inventory. More than B school would tell you needed to have. But hopefully, if we're doing our jobs right, we get paid for it, and then we're doing a better job here recently with these gross margins at these fantastic levels. So it's a model that can have frustratingly slow turns. It's a model that, depending on how you look at it, can consume a fair amount of working capital. So we have some tolerance for that, but we're not going to use them as excuses. Sales to working capital ratios, inventory turns, et cetera, et cetera, are right in the middle of our crosshairs, very important part of our strategic plan. As I said, we didn't do a very good job in Q1. Inventory will come down in Q2. It's going to be offset by sales growth and AR, but that's not unexpected. With respect to giving you a target revenue number to support this level of inventory, I'm kind of hesitant to do that for competitive reasons, but -- so I won't, but I will tell you that it's an important subject. We're focused on it. You'll see improved results.

--------------------------------------------------------------------------------

Damon Benedict, Nierenberg Investment Management Company, Inc. - Senior Analyst [22]

--------------------------------------------------------------------------------

Great. On digital and electronic ordering, I know you've been putting some work and investments into the company there. Can you talk a little bit more about that effort and what sort of results you're seeing from it?

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [23]

--------------------------------------------------------------------------------

The opportunity for us with -- well, I need to be careful here too for competitive purposes, but I'll talk from a very high level. In our industry, every single major, everybody, frankly, is talking about digital. There hasn't been what I would call a breakout performer. And I don't say that to be disrespectful to any of the people that are in our space, not by any means. These are best-in-class organizations. I will say that the leaders in this space excel because they have the best content. But the plug-and-chug ordering hasn't -- I haven't seen anything that I'd consider Amazon-esque or what you might be accustomed to when you're buying products yourself off the Internet. The mass customization of the goods that we sell makes what you're describing really, really difficult, but there are segments of an order or the profile of an order where it does have applicability. And we are concentrating our efforts in those areas. But I just -- Damon, I don't want to overoscillate here and get on over my wheels and share with my competitors what we're doing.

So I need to be guarded and tempered in my comments. It's important that you know that we believe it's very, very important, that the team is behind it. We have capital allocated to it. The customers want it. We will deliver to our customers. It's an evolving opportunity, and I think that we are doing the appropriate things to deliver in that space, but at this point, I probably need to flatten my comments out and as I said, not get too far over my wheels.

--------------------------------------------------------------------------------

Operator [24]

--------------------------------------------------------------------------------

Thank you, ladies and gentlemen, for participating in today's question-and-answer session. I would now like to turn the call back over to management for any closing remarks.

--------------------------------------------------------------------------------

James L. Pokluda, Houston Wire & Cable Company - President, CEO & Director [25]

--------------------------------------------------------------------------------

Okay. Thank you, Sherry, and thanks to all our valued team members for their hard work and dedication to the company. To our shareholders, we appreciate you joining us today, and we look forward to success in the period ahead. Good day, everyone.

--------------------------------------------------------------------------------

Operator [26]

--------------------------------------------------------------------------------

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