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WIRE > SEC Filings for WIRE > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for ENCORE WIRE CORP

Form 10-Q for ENCORE WIRE CORP


2-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

General

Encore is a low-cost manufacturer of electrical building wire and cable. The Company is a significant supplier of building wire for interior electrical wiring in commercial and industrial buildings, homes, apartments, and manufactured housing.

The Company's operating results in any given time period are driven by several key factors, including the volume of product produced and shipped, the cost of copper and other raw materials, the competitive pricing environment in the wire industry and the resulting influence on gross margins and the efficiency with which the Company's plants operate during the period, among others. Price competition for electrical wire and cable is intense, and the Company sells its products in accordance with prevailing market prices. Copper, a commodity product, is the principal raw material used by the Company in manufacturing its products. Copper accounted for approximately 86.1%, 81.1% and 73.5% of the Company's cost of goods sold during fiscal 2011, 2010 and 2009, respectively. The price of copper fluctuates, depending on general economic conditions and in relation to supply and demand and other factors, which causes monthly variations in the cost of copper purchased by the Company. The Company cannot predict copper prices in the future or the effect of fluctuations in the cost of copper on the Company's future operating results. Wire prices can, and frequently do change on a daily basis. This competitive pricing market for wire does not always mirror changes in copper prices, making margins highly volatile. With the Company's expansion into aluminum conductors in some of its building wire products, aluminum will slowly grow its percentage share of the raw materials cost for the Company. The Company is building a plant to expand the production of aluminum building wire as announced in a December 2011 press release. Historically, the cost of aluminum is much less than copper and also less volatile. With the volatility of both raw material prices and wire prices in the Company's end market, hedging raw materials can be risky. Historically, the Company has not engaged in hedging strategies for raw material purchases. The tables below highlight the range of closing prices of copper on the Comex exchange for the periods shown.

COMEX COPPER CLOSING PRICE 2012



                 July      August       September       Quarter Ended         Year-to-Date
                 2012       2012          2012          Sept. 30, 2012       Sept. 30, 2012

      High      $ 3.53     $  3.50     $      3.85     $           3.85     $           3.97
      Low         3.35        3.29            3.47                 3.29                 3.28
      Average     3.44        3.42            3.72                 3.52                 3.61

COMEX COPPER CLOSING PRICE 2011



                 July      August       September       Quarter Ended         Year-to-Date
                 2011       2011          2011         Sept. 30,  2011      Sept. 30,  2011

      High      $ 4.47     $  4.40     $      4.14     $           4.47     $           4.62
      Low         4.29        3.89            3.15                 3.15                 3.15
      Average     4.40        4.08            3.74                 4.07                 4.20

The following discussion and analysis relates to factors that have affected the operating results of the Company for the quarterly and nine month periods ended September 30, 2012 and 2011. Reference should also be made to the audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.


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Results of Operations

Quarter Ended September 30, 2012 Compared to Quarter Ended September 30, 2011

Net sales for the third quarter of 2012 were $269.2 million compared with net sales of $319.4 million for the third quarter of 2011. This dollar decrease was primarily the result of a 15.0% decrease in the average price of wire sold and a 2.7% decrease in the unit volume of copper wire shipped. Unit volume is measured in pounds of copper contained in the wire shipped during the period. Fluctuations in sales prices are primarily a result of changing copper raw material prices and product price competition. The average cost per pound of raw copper purchased decreased 14.2% in the third quarter of 2012 compared to the third quarter of 2011, and was the principal driver of the decreased average sales price of wire. In the third quarter of 2012, aluminum wire constituted 3.1% of the Company's net sales dollars compared to 1.3% in the third quarter of 2011.

Cost of goods sold decreased to $245.0 million, or 91.0% of net sales, in the third quarter of 2012, compared to $281.5 million, or 88.2% of net sales, in the third quarter of 2011. Gross profit decreased to $24.1 million, or 9.0% of net sales, in the third quarter of 2012 versus $37.8 million, or 11.8% of net sales, in the third quarter of 2011. The decreased gross profit dollars and gross profit margin percentages were primarily the result of an increase in total raw materials cost, including the LIFO adjustment, from 81.4% to 82.4% and increased manufacturing labor, depreciation and overhead from 6.8% to 8.7% of net sales in the third quarter of 2011 versus the third quarter of 2012. The overhead percentage increased both from increased spending on machinery repairs and some gearing up for the new aluminum plant, as well as the fact that many components of overhead are semi-fixed and were being divided over a lower sales dollar denominator. The aluminum building wire plant began limited production in the third quarter of 2012 and will continue ramping up production in the fourth quarter of 2012 and the first quarter of 2013. Building wire prices and margins were impacted negatively by the competitive pricing in the building wire industry, driven in part by volatility in copper prices. This disrupted some customer buying patterns and enticed competitors to cut or hold prices, resulting in lower margins for the Company.

Inventories are stated at the lower of cost, using the last-in, first out (LIFO) method, or market. The Company maintains two inventory pools for LIFO purposes. As permitted by U.S. generally accepted accounting principles, the Company maintains its inventory costs and cost of goods sold on a first-in, first-out (FIFO) basis and makes a monthly adjustment to adjust total inventory and cost of goods sold from FIFO to LIFO. The Company applies the lower of cost or market (LCM) test by comparing the LIFO cost of its raw materials, work-in-process and finished goods inventories to estimated market values, which are based primarily upon the most recent quoted market price of copper, aluminum and finished wire prices as of the end of each reporting period. The Company performs a lower of cost or market calculation quarterly. As of September 30, 2012, no LCM adjustment was required. However, decreases in copper and other material prices could necessitate establishing an LCM reserve in future periods. Additionally, future reductions in the quantity of inventory on hand could cause copper or other raw materials that are carried in inventory at costs different from the cost of copper and other raw materials in the period in which the reduction occurs to be included in costs of goods sold for that period at the different price.


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Primarily due to increasing copper costs and an increase in copper inventory quantities on hand during the third quarter of 2012, offset somewhat by price and volume movements of other materials, a LIFO adjustment was recorded increasing cost of sales by $2.0 million during the quarter.

Selling expenses, consisting of commissions and freight, for the third quarter of 2012 were $11.4 million, or 4.3% of net sales, compared to $12.9 million, or 4.1% of net sales, in the third quarter of 2011. Commissions paid to independent manufacturers' representatives are paid as a relatively stable percentage of sales, and therefore, declined $1.8 million in concert with the decreased sales dollars. Additionally, although units shipped declined slightly, freight costs increased by $0.3 million, from 1.6% to 2.0% of net sales in 2011 to 2012 as a result of increased fuel prices, smaller customer order quantities and small shifts in demand from various areas of the country. General and administrative expenses were $4.3 million, or 1.6% of net sales, in the third quarter of 2012 compared to $3.5 million, or 1.1% of net sales, in the third quarter of 2011. The provision for bad debts was $0 for the third quarters of 2012 and 2011.

Net interest and other (income) expense was virtually zero in the third quarters of 2012 and 2011. Income taxes were accrued at an effective rate of 34.3% in the third quarter of 2012, versus an effective rate of 35.7% in the third quarter of 2011. The decrease in the effective rate was due to a moderate change in the proportional effects of permanent items on the effective rate.

As a result of the foregoing factors, the Company's net income decreased to $5.5 million in the third quarter of 2012 from $13.7 million in the third quarter of 2011.

Nine Months Ended September 30, 2012 compared to Nine Months Ended September 30, 2011

Net sales for the first nine months of 2012 were $814.3 million compared with net sales of $932.2 million for the first nine months of 2011. This dollar decrease was the result of a 12.7% decrease in the average price of wire sold and a 2.4% decrease in the unit volume of copper wire sold, measured in pounds of copper contained in the wire. The average cost per pound of raw copper purchased decreased 13.9% in the first nine months of 2012 compared to the first nine months of 2011. In comparing the first nine months of 2012 to the first nine months of 2011, the average sales price of wire that contained a pound of copper decreased more than the average price of copper purchased during the period. Margins contracted as the spread between the price of wire sold and the cost of raw copper purchased decreased by 8.8%, due primarily to deteriorating industry pricing discipline. Fluctuations in sales prices are primarily a result of changing copper raw material prices and product price competition.

Cost of goods sold decreased to $746.4 million in the first nine months of 2012, compared to $829.9 million in the first nine months of 2011. Gross profit decreased to $68.0 million, or 8.3% of net sales, in the first nine months of 2012 versus $102.2 million, or 11.0% of net sales, in the first nine months of 2011. The decreased gross profit dollars were primarily the result of the 12.6% decrease in net sales dollars and the decreased copper spreads in the first nine months of 2012 versus the same period in 2011 as discussed above.


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As a result of increasing copper costs and an increase in the amount of inventory on hand during the first nine months of 2012, a LIFO adjustment was recorded increasing cost of sales by $11.6 million during the nine month period. Based on the current copper prices, there is no LCM adjustment necessary. Future reductions in the price of copper and other materials could require the Company to record an LCM adjustment against the related inventory balance, which would result in a negative impact on net income.

Selling expenses for the first nine months of 2012 decreased to $33.6 million, or 4.1% of net sales, compared to $37.2 million, or 4.0% of net sales, in the same period of 2011. Commissions paid to independent manufacturers' representatives are calculated as a percentage of sales, and therefore, dropped $4.7 million in concert with the decreased sales dollars. Commissions were 2.3% and 2.5% of net sales in the first nine months of 2012 and 2011, respectively. Freight costs increased $1.1 million to $15.2 million or 1.9% of net sales versus $14.0 million or 1.5% of net sales as a result of increased fuel prices, smaller customer order quantities and small shifts in demand from various areas of the country. General and administrative expenses decreased to $12.5 million, or 1.5% of net sales, in the first nine months of 2012 compared to $13.5 million, or 1.4% of net sales, in the same period of 2011. The general and administrative costs declined primarily due to decreased legal and administrative costs. The provision for bad debts was zero in the first nine months of 2012 and 2011, respectively.

Net interest and other expense (income) was $32,000 of income in the first nine months of 2012 compared to $83,000 of expense in the first nine months of 2011. Income taxes were accrued at an effective rate of 33.3% in the first nine months of 2012 versus 34.3% in the first nine months of 2011 consistent with the Company's estimated liabilities.

As a result of the foregoing factors, the Company's net income decreased to $14.6 million in the first nine months of 2012 from $33.8 million in the first nine months of 2011.

Liquidity and Capital Resources

The Company maintains a substantial inventory of finished products to satisfy customers' prompt delivery requirements. As is customary in the building wire industry, the Company provides payment terms to most of its customers that exceed terms that it receives from its suppliers. Copper suppliers generally give very short payment terms, (less than 15 days) while the Company and the building wire industry give customers much longer terms. In general, the Company's standard payment terms result in the collection of a significant majority of net sales within approximately 75 days of the date of invoice. As a result of this timing difference, building wire companies must have sufficient cash and access to capital resources to finance their working capital needs, thereby creating a barrier to entry for companies who do not have sufficient liquidity and capital resources. The two largest components of working capital, receivables and inventory, and to some extent, capital expenditures are the primary drivers of the Company's liquidity needs. Generally, this will cause the cash balance to rise and fall inversely to the receivables and inventory balances. The receivables and inventories will rise and fall in concert with several factors, most notably the price of copper and other raw materials and the level of unit sales. Receivables will go up at the end of quarters with strong dollar sales and down as those sales decline. Inventory balances will rise and fall with the raw material price fluctuations and the level of units on hand at the end of any given quarter. Capital expenditures have historically been necessary to expand and update the production capacity of the Company's manufacturing operations. The Company has historically satisfied its liquidity and capital expenditure needs with cash generated from operations, borrowings under its various


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debt arrangements and sales of its common stock. The Company historically uses its revolving credit facility to manage day to day operating cash needs as required by daily fluctuations in working capital, and has the facility in place should such a need arise in the future.

The Company is party to a Credit Agreement with two banks, Bank of America, N.A., as administrative agent and letter of credit issuer, and Wells Fargo Bank, National Association as syndication agent (the "Credit Agreement"). This new Credit Agreement was executed in September 2012 and replaces the prior similar Credit Agreement the Company had with the same two banks. The Credit Agreement extends through October 1, 2017, and provides for maximum borrowings of the lesser of $150,000,000 or the amount of eligible accounts receivable plus the amount of eligible finished goods and raw materials, less any reserves established by the banks. Additionally, at our request and subject to certain conditions, the commitments under the Credit Agreement may be increased by a maximum of up to $100,000,000 as long as existing or new lenders agree to provide such additional commitments. The calculated maximum borrowing amount available at September 30, 2012, as computed under the Credit Agreement, was $145,205,006. Borrowings under the line of credit bear interest, at the Company's option, at either (1) LIBOR plus a margin that varies from 0.875% to 1.75% depending upon the Leverage Ratio (as defined in the Credit Agreement), or
(2) the base rate (which is the highest of the federal funds rate plus 0.5%, the prime rate, or LIBOR plus 1.0%) plus 0% to 0.25% (depending upon the Leverage Ratio). Prior to September 2012, borrowings under the line of credit bore interest, at the Company's option, at either (1) LIBOR plus a margin that varies from 1.0% to 1.75% depending upon the ratio of debt outstanding to adjusted earnings or (2) the base rate (which is the higher of the federal funds rate plus 0.5% or the prime rate) plus 0% to 0.25% (depending upon the ratio of debt outstanding to adjusted earnings). A commitment fee ranging from 0.15% to 0.30% (depending upon the Leverage Ratio) is payable on the unused line of credit. Prior to September 2012, the commitment fee ranged from 0.20% to 0.375%. At September 30, 2012, there were no borrowings outstanding under the Credit Agreement. Obligations under the Credit Agreement are the only contractual borrowing obligations or commercial borrowing commitments of the Company.

Obligations under the Credit Agreement are unsecured and contain customary covenants and events of default. The Company was in compliance with the covenants as of September 30, 2012.

Cash provided by operating activities was $6.5 million in the first nine months of 2012 compared to a use of cash of $78.0 million in the first nine months of 2011. The following changes in components of cash flow were notable. The Company had net income of $14.6 million in the first nine months of 2012 versus net income of $33.8 million in the first nine months of 2011. Accounts receivable increased in the first nine months of 2012 and 2011, although at much different amounts, resulting in a use of cash of $8.2 million and $69.1 million, respectively, driving a lower use of cash of $60.9 million in 2012 versus 2011. Accounts receivable generally increases in proportion to dollar sales and to a lesser extent is affected by the timing of when sales occur during a given quarter. Accounts receivable increased in the first nine months of both years, primarily due to the timing of sales in the quarters. With an average of 60 to 75 days of sales outstanding, quarters in which sales are more back-end loaded will have higher accounts receivable balances outstanding at quarter-end. In 2011, rising copper prices and a corresponding rise in sales dollars also contributed to the increase. Inventory dollars increased in 2012 and 2011, resulting in a use of cash of $3.6 million and $34.7 million, respectively, driving a $31.1 million lower use of cash in 2012 versus


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2011. Trade accounts payable and accrued liabilities resulted in a $23.3 million increase in cash provided in the first nine months of 2012 versus the first nine months of 2011 due primarily to the decrease in accounts payable, attributable primarily to the timing of inventory receipts at quarter end. These changes in cash flow were the primary drivers of the $84.6 million increase in cash provided by operations in the first nine months of 2012 versus the first nine months of 2011.

Cash used in investing activities increased to $33.0 million in the first nine months of 2012 from $10.2 million in the first nine months of 2011. The funds were used primarily for the construction of the new aluminum wire plant, including deposits on equipment for that plant in 2012 and equipment purchases in 2011. Cash used in financing activities was $67.8 million in the first nine months of 2012 versus $0.2 million in 2011. In May of 2012, the Company repurchased 2,774,250 shares of its common stock from Capital Southwest Venture Corporation for $66.6 million. As of September 30, 2012, the Company's revolving line of credit remained at $0. The Company's cash balance was $18.0 million at September 30, 2012, versus $15.2 million at September 30, 2011.

During the remainder of 2012, the Company expects its capital expenditures will consist primarily of expenditures related to the new aluminum building wire plant, including purchases of new manufacturing equipment. The total capital expenditures for all of 2012 associated with these projects are currently estimated to be between $38 million and $42 million. The Company also expects its future working capital requirements may fluctuate as a result of changes in unit sales volumes and the price of copper and other raw materials. The Company believes that the current cash balance, cash flow from operations, and the financing available from its revolving credit facility will satisfy working capital and capital expenditure requirements during 2012.

Information Regarding Forward Looking Statements

This quarterly report on Form 10-Q contains various "forward-looking statements" (within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended) and information that is based on management's belief as well as assumptions made by and information currently available to management. The words "believes", "estimates", "anticipates", "plans", "seeks", "expects", "intends" and similar expressions identify some of the forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Such statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those expected. Among the key factors that may have a direct bearing on the Company's operating results are fluctuations in the economy and in the level of activity in the building and construction industry, demand for the Company's products, the impact of price competition and fluctuations in the price of copper. For more information regarding "forward looking statements" see "Information Regarding Forward Looking Statements" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2011, which is hereby incorporated by reference.


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