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WIRE > SEC Filings for WIRE > Form 10-Q on 1-Nov-2013All Recent SEC Filings

Show all filings for ENCORE WIRE CORP

Form 10-Q for ENCORE WIRE CORP


1-Nov-2013

Quarterly Report


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

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 79.0%, 86.1% and 81.1% of the Company's cost of goods sold during fiscal 2012, 2011 and 2010, 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 the Company's purchased copper. Additionally, the SEC has recently issued an order amending a rule to allow shares of certain physically backed copper exchange traded funds ("ETFs") to be listed and publicly traded. Such funds and other copper ETFs like it hold copper cathode as collateral against their shares. The acquisition of copper cathode by copper ETFs may materially decrease or interrupt the availability of copper for immediate delivery in the United States, which could materially increase the Company's cost of copper. In addition to rising copper


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prices and potential supply shortages, we believe that ETFs and similar copper-backed derivative products could lead to increased price volatility for copper. 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, the Company expects that aluminum will slowly grow its percentage share of the raw materials cost for the Company. The Company built a plant to expand the production of aluminum building wire as previously announced. The building was completed in mid-2012, while the installation of all the machinery and equipment was completed in the second quarter of 2013. Production ramped up considerably in the first quarter of 2013, and the plant is now fully operational. In 2012, aluminum wire sales constituted less than 4% of total net sales. Historically, the cost of aluminum has been 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 2013



                 July      August       September       Quarter Ended        Year-to-Date
                 2013       2013          2013          Sept. 30, 2013       Sept. 30,2013
      High      $ 3.20     $  3.36     $      3.35     $           3.36     $          3.78
      Low         3.04        3.16            3.21                 3.04                3.03
      Average     3.14        3.28            3.27                 3.23                3.36

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

The following discussion and analysis relates to factors that have affected the operating results of the Company for the quarter and nine month periods ended September 30, 2013 and 2012. 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, 2012.


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Results of Operations

Quarter Ended September 30, 2013 Compared to Quarter Ended September 30, 2012

Net sales for the third quarter of 2013 were $309.9 million compared with net sales of $269.2 million for the third quarter of 2012. This dollar increase was primarily the result of a 15.0% increase in the unit volume of copper wire shipped offset slightly by a 4.0% decrease in the average price of copper wire sold. 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 7.5% in the third quarter of 2013 compared to the third quarter of 2012, and was the principal driver of the decreased average sales price of wire. In the third quarter of 2013, aluminum building wire constituted 7.2% of the Company's net sales dollars compared to 3.1% in the third quarter of 2012.

Cost of goods sold increased to $272.0 million, or 87.8% of net sales, in the third quarter of 2013, compared to $245.0 million, or 91.0% of net sales, in the third quarter of 2012. Gross profit increased to $37.9 million, or 12.2% of net sales, in the third quarter of 2013 versus $24.1 million, or 9.0% of net sales, in the third quarter of 2012.

The increased gross margins were driven primarily by the increased spread between the average selling price of wire containing a pound of copper and the average cost per pound of copper purchased during the quarter. As noted above, the cost of raw copper purchased per pound declined 7.5% in the third quarter of 2013 versus the third quarter of 2012, but average sales prices declined only 4.0% per copper pound sold, resulting in a 6.2% increase in the spread.

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, 2013, 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. Due primarily to increases in copper costs and an increase in copper inventory quantities on hand, offset somewhat by price and volume movements of other materials during the third quarter of 2013, a LIFO adjustment was recorded increasing cost of sales by $0.9 million during the quarter. As discussed in Note 2 to the Company's consolidated financial statements included in Item 1 to this report, during the first quarter of 2013, the Company liquidated a portion of the layer established in 2011, and then built back that layer in the second and third quarters at historical costs that were higher than current costs, which positively impacted net income for the third quarter of 2013.


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Selling expenses, consisting of commissions and freight, for the third quarter of 2013 were $12.8 million, or 4.1% of net sales, compared to $11.4 million, or 4.3% of net sales, in the third quarter of 2012. Commissions paid to independent manufacturers' representatives are paid as a relatively stable percentage of sales dollars, and therefore, exhibited little change. Freight costs were also relatively flat as a percentage of net sales. General and administrative expenses remained steady at approximately $4.3 million in the third quarters of 2013 and 2012. The provision for bad debts was $0 for the third quarters of 2013 and 2012.

Net interest and other (income) expense was virtually zero in the third quarters of 2013 and 2012. Income taxes were accrued at an effective rate of 33.6% in the third quarter of 2013, versus an effective rate of 34.3% in the third quarter of 2012. 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 increased to $13.8 million in the third quarter of 2013 from $5.5 million in the third quarter of 2012.

Nine Months Ended September 30, 2013 compared to Nine Months Ended September 30, 2012

Net sales for the first nine months of 2013 were $864.7 million compared with net sales of $814.3 million for the first nine months of 2012. This dollar increase was primarily the result of a 119.5% increase in aluminum building wire sales and a 2.5% increase in copper building wire sales. Aluminum wire sales constituted 6.5% of net sales in the first nine months of 2013 versus 3.2% in the first nine months of 2012. Copper unit sales for the first nine months of 2013, measured in pounds of copper contained in the wire were up 6.8% compared to the first nine months of 2012, but were offset by a 4.0% decrease in the average price of copper wire sold. The average cost per pound of raw copper purchased decreased 7.1% in the first nine months of 2013 compared to the first nine months of 2012. In comparing the first nine months of 2013 to the first nine months of 2012, the average sales price of wire that contained a pound of copper decreased less than the average price of copper purchased during the period. Margins expanded in the first nine months of 2013 as the spread between the price of wire sold and the cost of raw copper purchased increased by 5.5%, due primarily to improved 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 increased to $762.4 million in the first nine months of 2013, compared to $746.4 million in the first nine months of 2012. Gross profit increased to $102.4 million, or 11.8% of net sales, in the first nine months of 2013 versus $68.0 million, or 8.3% of net sales, in the first nine months of 2012. The increased gross profit dollars were primarily the result of the increased copper spreads in the first nine months of 2013 versus the same period in 2012 as discussed above.

As a result of decreasing copper costs in the first three quarters of 2013 and an increase in the amount of inventory on hand during the first nine months of 2013, a LIFO adjustment was recorded decreasing cost of sales by $8.7 million during the nine month


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period. Based on the current copper prices, there is no LCM adjustment necessary. Future reductions in the price of copper 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 2013 increased to $35.9 million, or 4.2% of net sales, compared to $33.6 million, or 4.1% of net sales, in the same period of 2012. Freight costs for the first nine months of 2013 increased $0.8 million to $16.0 million or 1.8% of net sales versus $15.2 million or 1.9% of net sales for the first nine months of 2012. Commissions paid to independent manufacturers' representatives are calculated as a percentage of sales, and therefore, increased $1.5 million, to $19.9 million in concert with the increased sales dollars. Commissions remained flat at 2.3% of net sales in the first nine months of 2013 and 2012. General and administrative expenses remained steady at approximately $12.5 million, or 1.5% of net sales, in the first nine months of both 2013 and 2012. The provision for bad debts was zero in the first nine months of 2013 and 2012, respectively.

Net interest and other expense (income) was $44,000 of income in the first nine months of 2013 compared to $32,000 of income in the first nine months of 2012. Income taxes were accrued at an effective rate of 33.8% in the first nine months of 2013 versus 33.3% in the first nine months of 2012, consistent with the Company's estimated liabilities.

As a result of the foregoing factors, the Company's net income increased to $35.7 million in the first nine months of 2013 from $14.6 million in the first nine months of 2012.

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 Company's cash balance to rise and fall inversely to the receivables and inventory balances. The Company's 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 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.


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For more information on the Company's revolving credit facility, see Note 6 to the Company's consolidated financial statements included in Item 1 to this report, which is incorporated herein by reference.

Cash provided by operating activities was $22.5 million in the first nine months of 2013 compared to cash provided of $6.5 million in the first nine months of 2012. The following changes in components of cash flow from operations were notable. The Company had net income of $35.7 million in the first nine months of 2013 versus net income of $14.6 million in the first nine months of 2012. Accounts receivable increased in the first nine months of 2013 and 2012, although at much different amounts, resulting in a use of cash of $39.0 million and $8.2 million, respectively, driving a $30.8 million larger use of cash in 2013 versus 2012. Accounts receivable generally increase in proportion to dollar sales and to a lesser extent are 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. Inventory value increased in both years, resulting in a use of cash of $9.0 million and $3.6 million for the first nine months of 2013 and 2012, respectively. The relatively small $5.4 million differential in cash used when comparing the first nine months of 2013 to the first nine months of 2012 is the result of several factors in the Company's large inventory. Trade accounts payable and accrued liabilities resulted in a $3.8 million increase in cash provided in the first nine months of 2013 versus the first nine months of 2012 attributable primarily to the timing of inventory receipts at quarter end. In the first nine months of 2013, changes in current and deferred taxes provided cash of $7.7 million versus cash used of $3.1 million in the first nine months of 2012. These changes in cash flow were the primary drivers of the $15.9 million increase in cash provided by operations in the first nine months of 2013 versus the first nine months of 2012.

Cash used in investing activities increased to $39.5 million in the first nine months of 2013 from $33.0 million in the first nine months of 2012. The funds invested in 2013 were used primarily to purchase 201 acres of land adjacent to the Company's existing campus in McKinney, Texas for $25.7 million. In 2012, the funds were used primarily for the construction of the new aluminum wire plant. Cash used in financing activities was $0.7 million in the first nine months of 2013 versus $67.8 million in the first nine months of 2012. 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, 2013, the Company's revolving line of credit remained at $0. The Company's cash balance was $16.1 million at September 30, 2013, versus $18.0 million at September 30, 2012.

During the remainder of 2013, the Company expects its capital expenditures will consist primarily of expenditures related to the purchases of manufacturing equipment throughout its facilities. The total capital expenditures for all of 2013 associated with these projects are currently estimated to be between $42 million and $45 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 2013.


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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, 2012, which is hereby incorporated by reference.

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