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WIRE > SEC Filings for WIRE > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for ENCORE WIRE CORP

Form 10-K for ENCORE WIRE CORP


28-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Introduction

The following management's discussion and analysis is intended to provide a better understanding of key factors, drivers and risks regarding the Company and the building wire industry.

Executive Overview

Encore Wire sells a commodity product in a highly competitive market. Management strongly believes that the historical strength of the Company's growth and earnings is attributable to the following main factors:

Industry leading order-fill rates and responsive customer service.

Product innovations and product line expansions based on listening to and understanding customer needs.

Low cost manufacturing operations, resulting from a state-of-the-art manufacturing complex.

Low distribution and freight costs due in large part to the "one campus" business model.

A focused management team leading an incentivized work force.

Low general and administrative overhead costs.

A team of experienced independent manufacturers' representatives with strong customer relationships across the United States.

These factors, and others, have allowed Encore Wire to grow from a startup in 1989 to what management believes is one of the largest copper electric building wire companies in the United States of America. Encore has built a loyal following of customers throughout the United States. These customers have developed a brand preference for Encore Wire in a commodity product line, due to the reasons noted above, among others. The Company prides itself on striving to grow sales by expanding its product offerings where profit margins are acceptable. Senior management monitors gross margins daily, frequently extending down to the individual order level. Management strongly believes that this "hands-on" focused approach to the building wire business has produced success thus far and will lead to continued success.

The construction and remodeling industries drive demand for building wire. Housing construction activity in the United States declined significantly in 2006 and continued its downward trend through 2010, improving slightly in 2011 and 2012 and then improving somewhat more in 2013. Nationally, commercial construction had been strong through 2007, but slowed significantly in 2008, and continued downward through 2012, before improving somewhat in 2013. The Company's unit sales volume, as measured in pounds of copper wire sold, declined 15.6% in 2009 versus 2008 and declined another 3.8% in 2010 versus 2009. In 2011, the Company's unit sales volume increased 6.2% compared to 2010. In 2012, copper unit sales declined 1.3% versus 2011. Total unit sales including pounds of aluminum wire sold increased 2.3% in 2012 versus 2011, as the Company continued to expand its building wire product line as discussed throughout this report. Total unit sales including pounds of aluminum wire sold increased 14.9% in 2013 versus 2012. In 2013, copper unit sales increased 9.5% versus 2012, while aluminum unit sales increased 116.8% versus 2012. 2013 was the first full year of sales and production from the Company's new aluminum wire plant. The Company believes that the expansion into building wire product offerings with aluminum conductors helped the increase in copper unit sales in 2013, as customers prefer to do "one stop shopping" and order from full line producers. The Company believes that the overall decline of unit volumes sold since 2006 is primarily


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the result of the slowdown in construction throughout the United States. The Company also believes that the reduced percentage decline in the Company's unit sales volume in 2010 and the increase in 2011 was caused, in large part, by the exit of a former competitor from the industry in the first quarter of 2010. According to various industry and national economic forecasts the future is unclear for the next few years. The "credit crisis" and the resulting tightening of credit could continue to negatively impact the availability of capital to fund construction projects for some time to come. Data on remodeling is not as readily available; however, remodeling activity historically trends up when new construction slows down.

General

The Company's operating results 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 77.6%, 79.0%, and 86.1% of the Company's cost of goods sold during fiscal 2013, 2012 and 2011, 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. Additionally, the SEC has recently issued an order amending a rule to allow shares of a physically backed copper exchange traded fund ("ETF") to be listed and publicly traded. Such fund 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 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, 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 ongoing as of December 31, 2012. Production ramped up considerably in the first quarter of 2013, and the plant was fully operational by mid-year. In 2012, aluminum wire sales constituted 3.6% of net sales, growing to 6.9% of net sales in 2013. 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




               October       November       December       Quarter Ended       Year-to-Date
                2013           2013           2013         Dec. 31, 2013       Dec. 31, 2013
    High      $    3.33     $     3.29     $     3.47     $          3.47     $          3.78
    Low            3.22           3.15           3.20                3.15                3.03
    Average        3.28           3.22           3.34                3.28                3.34

COMEX COPPER CLOSING PRICE 2012



               October       November       December       Quarter Ended       Year-to-Date
                2012           2012           2012         Dec. 31, 2012       Dec. 31, 2012
    High      $    3.81     $     3.63     $     3.70     $          3.81     $          3.97
    Low            3.50           3.44           3.53                3.44                3.28
    Average        3.68           3.50           3.62                3.60                3.61


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COMEX COPPER CLOSING PRICE 2011



               October       November       December       Quarter Ended       Year-to-Date
                2011           2011           2011         Dec. 31, 2011       Dec. 31, 2011
    High      $    3.70     $     3.58     $     3.60     $          3.70     $          4.62
    Low            3.05           3.27           3.26                3.05                3.05
    Average        3.34           3.44           3.43                3.41                4.00

Results of Operations

The following table presents certain items of income and expense as a percentage of net sales for the periods indicated.

                                                        Year Ended December 31,
                                                    2013         2012         2011
    Net sales                                        100.0 %      100.0 %      100.0 %
    Cost of goods sold:
    Copper                                            68.6         72.3         75.8
    Other raw materials                               11.5          9.6          7.3
    Depreciation                                       1.1          1.2          1.0
    Labor and overhead                                 8.1          7.5          5.9
    LIFO adjustment                                   (1.0 )        1.0         (2.0 )
    Lower cost or market adjustment                    0.0          0.0          0.0

                                                      88.3         91.6         88.0

    Gross profit                                      11.7          8.4         12.0
    Selling, general and administrative expenses       5.6          5.7          5.5

    Operating income                                   6.1          2.7          6.5
    Interest and other (income) expense                0.0          0.0          0.0

    Income before income taxes                         6.1          2.7          6.5
    Provision for income taxes                         2.0          0.9          2.3

    Net income                                         4.1 %        1.8 %        4.2 %

The following discussion and analysis relates to factors that have affected the operating results of the Company for the years ended December 31, 2013, 2012 and 2011. Reference should also be made to the Consolidated Financial Statements and the related notes included under "Item 8. Financial Statements and Supplementary Data" of this Annual Report.

Net sales were $1.158 billion in 2013 compared to $1.072 billion in 2012 and $1.180 billion in 2011. The 8.0% increase in net sales in 2013 versus 2012 is primarily the result of a 4.4% increase in copper wire sales driven by a 9.5% increase in copper wire pounds shipped and a 105.0% increase in aluminum wire sales driven by a 116.8% increase in aluminum wire pounds shipped, offset somewhat by decreases in average selling prices of 4.7% and 5.5% of copper and aluminum wire, respectively. Aluminum wire constituted 6.9% of total net sales in 2013. The average price of a pound of copper purchased decreased 7.5% in 2013 versus 2012, while aluminum purchase prices decreased 1.9% during the same time period. In the fourth quarter of 2013, net sales increased 13.8% versus the fourth quarter of 2012. The increase in net sales was due largely to the 10.4% increase in copper net sales and a 76.9% increase in aluminum net sales, driven by an aluminum unit volume increase of 88.5% in the fourth quarter of 2013 versus the fourth quarter of 2012. Aluminum net sales comprised 8.0% of net sales in the fourth quarter of 2013. Copper unit volume was up 18.4% in the fourth quarter of 2013 compared to the fourth quarter of 2012 while the average selling price per copper pound sold was down 6.8% between the same periods. On a sequential quarter comparison, net sales in the fourth quarter of 2013 decreased 5.3% versus the third quarter of 2013, due primarily to a 6.7% decrease in copper wire unit sales offset somewhat by a 0.6% increase in average selling prices. Margins in the fourth quarter of 2013 were down slightly versus those of the third quarter of 2013, producing $11.2 million of net income in the fourth quarter versus $13.8 million in the third quarter.

Comparing the full years of 2013 to 2012, the average sales price of wire that contained a pound of copper decreased less than the average price of a pound of copper purchased during the period. Therefore, margins expanded as the spread between the price of wire sold and the cost of raw copper purchased increased by 3.7%, due primarily to improved industry pricing discipline. Fluctuations in sales prices are primarily a result of changing copper and other raw material prices and product price competition. Margins were stronger in all four quarters of 2013 versus 2012.


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The 9.2% decrease in net sales in 2012 versus 2011 was primarily the result of a 10.4% decrease in the average price of product sold and a 1.3% decrease in the volume of copper pounds of product sold. The average price of copper purchased in 2012 decreased 10.7% versus the 2011 average price. In the fourth quarter of 2012, net sales increased 3.9% versus the fourth quarter of 2011. The small increase in net sales was due largely to the growth in aluminum net sales in the fourth quarter of 2012, which were up 196.1% versus the fourth quarter of 2011, driven by a unit volume increase of 229.9% in the fourth quarter of 2012 versus the fourth quarter of 2011. Aluminum sales, however, comprised only 5.1% of net sales in the quarter. Copper unit volume was up 2.2% in the fourth quarter of 2012 compared to the fourth quarter of 2011 while the average selling price per copper pound sold was down 1.8% between the same periods, resulting in nearly flat fourth quarter results for copper sales. On a sequential quarter comparison, net sales in the fourth quarter of 2012 decreased 4.2%, due primarily to a 9.4% decrease in copper wire unit sales offset somewhat by 3.6% increase in average prices. Margins in the fourth quarter of 2012 were consistent with those of the third quarter of 2012, producing similar results.

In 2012, the average sales price of wire that contained a pound of copper decreased more than the average price of copper purchased during the period. Therefore, margins contracted as the spread between the price of wire sold and the cost of raw copper purchased in 2012 decreased by 9.4%, as compared to 2011, due primarily to somewhat weaker industry pricing discipline. Fluctuations in sales prices are primarily a result of changing copper raw material prices and product price competition. Margins were weaker in all four quarters of 2012 versus 2011, bottoming in the second quarter of 2012.

Cost of goods sold was $1.023 billion in 2013, compared to $982.0 million in 2012 and $1.040 billion in 2011. The copper costs included in cost of goods sold were $794.4 million in 2013 compared to $775.4 million in 2012 and $895.2 million in 2011. Copper costs as a percentage of net sales decreased to 68.6% in 2013 compared to 72.3% in 2012 and 75.8% in 2011. The decrease as a percentage of net sales was due to copper costs decreasing more than or opposed to other costs. As noted above, copper costs are the largest component of costs and therefore the most significant driver of sales prices of wire. Accordingly, the decrease in copper prices in 2013 and 2012 caused most of the other costs to grow in terms of their percentage of net sales dollars. The cost of other raw materials rose from 7.3% of net sales in 2011 to 9.6% in 2012 and 11.5% in 2013 primarily due to the fact the Company increased production of aluminum wire in the second half of 2012 and throughout 2013. While much cheaper than copper, aluminum is higher in cost than the majority of the rest of the products in the other materials category, which in turn contributed to the rise in the other materials category percentage. Other lower cost materials such as plastic also rose marginally in price in 2012. Material cost percentages in 2013 were decreased by a 1.0% LIFO credit (income) and in 2012 were increased by a 1.0% LIFO debit (expense). In 2011, material costs were decreased by a 2.0% LIFO credit (income). Adding LIFO to the cost of copper and other materials, the total materials cost including LIFO in 2013 was 79.1% of net sales versus 82.9% in 2012 and 81.2% in 2011.

The increase in copper prices and the corresponding increase in net sales dollars in 2011 caused most of the other costs to shrink in terms of their percentage of net sales dollars. The cost of other raw materials, however, rose from 6.6% of net sales in 2010 to 7.3% in 2011. On a cents per pound basis, the cost of other raw materials increased by 35.7% in 2011 versus 2010, consistent with the cost of copper and other commodities and in small part due to the fact the Company began producing aluminum wire in 2011. Although the quantity of aluminum building wire sold in 2011 was insignificant compared to copper volumes, the Company did slowly increase its sales of aluminum wire during the year. The Company produced aluminum wire in its existing plants in 2011. In December of 2011, the Company announced that it was building a new 202,000 square-foot manufacturing plant on its McKinney, Texas campus, in which the Company would expand its aluminum wire and cable production.

Depreciation, labor and overhead costs as a percentage of net sales were 9.2% in 2013 compared to 8.7% in 2012 and 6.9% in 2011. The percentage increase of depreciation, labor and overhead costs in 2013 and 2012 versus 2011 was due primarily to the decrease in copper driven sales dollars trending the opposite direction of the small percentage increases in depreciation, labor and overhead costs. This disparity is due to the fact that depreciation, labor and overhead costs have fixed or semi-fixed components and do not vary directly with sales dollars or unit volumes.


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Inventories consist of the following at December 31 (in thousands):

                                             2013           2012           2011
      Raw materials                        $  28,293      $  26,013      $  18,482
      Work-in-process                         21,881         22,309         22,955
      Finished goods                          82,997         88,750         84,819

      Total                                  133,171        137,072        126,256
      Adjust to LIFO cost                    (62,391 )      (73,416 )      (62,765 )
      Lower of cost or market adjustment          -              -              -

      Inventory, net                       $  70,780      $  63,656      $  63,491

In 2013, copper traded in a narrow range, similar to 2012, while still exhibiting some volatility as shown in the copper table above. Copper prices in 2013 finished lower than at the end of 2012. In addition the quantity of total copper inventory on hand declined slightly in 2013. The other materials category, which includes a large number of raw materials, had quantity changes that included increases primarily in aluminum. These factors resulted in the 2013 year-end inventory value of all inventories using the LIFO method being $62.4 million less than the FIFO value, and the 2013 year end LIFO reserve balance being $11.0 million lower than at the end of 2012. This resulted in a LIFO adjustment decreasing cost of sales by $11.0 million.

In 2012, copper traded in a more consistent range than in 2011, but still exhibited some volatility. Copper prices in 2012 finished higher than at the end of 2011. In addition the quantity of total copper inventory on hand rose slightly in 2012. The other materials category, which includes a large number of raw materials, had quantity changes that included increases primarily in aluminum. These factors resulted in the 2012 year-end inventory value of all inventories using the LIFO method being $73.4 million less than the FIFO value, and the 2012 year end LIFO reserve balance being $10.7 million higher than at the end of 2011. This resulted in a LIFO adjustment increasing cost of sales by $10.7 million. In the fourth quarter of 2011, as part of the Company's aforementioned expansion into aluminum wire products and in anticipation of the start of production at the Company's new aluminum wire plant in 2012, the Company began a new aluminum wire inventory pool which is accounted for separately from the Company's copper wire inventory pool. The Company established this new aluminum wire pool in accordance with U.S. GAAP, which requires that new inventory items not previously present in significant quantities and having qualities significantly different from those items previously inventoried, as is the case with the physical, chemical, and cost differences between copper and aluminum metals, be accounted for separately. Based on the current copper and other raw material prices, there is no LCM adjustment necessary. Future reductions in the price of copper and other raw 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.

In 2011, copper traded in a relatively consistent range, at or near historical highs for most of the first three quarters and then made a fairly steep decline in the fourth quarter. This was offset slightly by a small increase in the amount of inventory on hand. These factors resulted in the 2011 year-end inventory value of all inventories using the LIFO method being $62.8 million less than the FIFO value, and the 2011 year end LIFO reserve balance being $24.0 million lower than at the end of 2010. This resulted in a LIFO adjustment decreasing cost of sales by $24.0 million.

Gross profit was $135.1 million, or 11.7% of net sales in 2013 compared to $90.3 million, or 8.4% of net sales in 2012 and $140.9 million, or 11.9% of net sales in 2011. The changes in gross profit were due to the factors discussed above.

Selling expenses, which include freight and sales commissions, were $48.3 million in 2013, $44.4 million in 2012 and $47.8 million in 2011. As a percentage of net sales, selling expenses remained steady at 4.2% in 2013 versus 4.1% in 2012 and 4.1% in 2011. General and administrative expenses, as a percentage of net sales, remained steady at 1.4% in 2013, 1.5% in 2012 and 1.4% in 2011. Accounts receivable write-offs were zero in 2013 and 2012, and $0.5 million in 2011. The Company did not increase the bad debt reserve in 2013, 2012 and 2011 to provide for potential bad debt expenses.

Interest expenses were $0.3 million in 2013, $0.3 million in 2012 and $0.3 million in 2011. The Company capitalized zero interest expense relating to the construction of assets in 2013, 2012 and 2011.

The Company's effective tax rate was 33.6% in 2013, 32.6% in 2012 and 34.2% in 2011, commensurate with the Company's tax liabilities. The American Jobs Creation Act of 2004 provides a deduction from income for qualified domestic production activities. Accordingly, the impact of any deduction is being reported in the period for which the deduction will be claimed on the Company's tax return. The domestic production activity deduction reduced the 2013 effective tax rate approximately 2.5%.


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As a result of the foregoing factors, the Company's net income was $46.9 million in 2013, $19.8 million in 2012 and $50.1 million in 2011.

Off-Balance Sheet Arrangements

The Company does not currently have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Liquidity and Capital Resources

The following table summarizes the Company's cash flow activities (in thousands):

                                                            Year Ended December 31,
                                                    2013             2012             2011
Net cash provided by operating activities         $  47,218        $  30,060        $  26,169
Net cash used in investing activities               (43,466 )        (40,284 )        (16,946 )
Net cash used in financing activities                  (857 )        (68,191 )           (177 )

Net increase (decrease) in cash and cash
equivalents                                       $   2,895        $ (78,415 )      $   9,046

The Company maintains a substantial inventory of finished products to satisfy customers' prompt delivery requirements. As is customary in the industry, the Company provides payment terms to most of its customers that exceed terms that it receives from its suppliers. 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 the invoice. Therefore, the Company's liquidity needs have generally consisted of working capital necessary to finance receivables and inventory. 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.

At December 31, 2013 and December 31, 2012, the Company had no debt outstanding.

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"). The Credit Agreement extends through October 1, 2017, and provides for maximum borrowings of the lesser of $150.0 million 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 $100.0 million as long as existing or new lenders agree to provide such additional commitments. The calculated maximum borrowing amount available at December 31, 2013, as computed under the Credit Agreement, was $149.5 million. 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). A commitment fee ranging from 0.15% to 0.30% (depending upon the Leverage Ratio) is payable on the unused line of credit. At December 31, 2013, 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 . . .

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