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WIRE > SEC Filings for WIRE > Form 10-Q on 1-Aug-2014All Recent SEC Filings

Show all filings for ENCORE WIRE CORP

Form 10-Q for ENCORE WIRE CORP


1-Aug-2014

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 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 the Company's purchased copper. Additionally, the SEC has 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 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 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


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grow its percentage share of the raw materials cost. In fiscal 2013, aluminum wire sales constituted less than 7.0% of 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 2014



                    April       May        June       Quarter Ended       Year-to-Date
                     2014       2014       2014       June 30, 2014       June 30, 2014
          High      $ 3.14     $ 3.19     $ 3.19     $          3.19     $          3.43
          Low         3.02       3.03       3.02                3.02                2.98
          Average     3.07       3.13       3.10                3.10                3.17

COMEX COPPER CLOSING PRICE 2013



                    April       May        June       Quarter Ended       Year-to-Date
                     2013       2013       2013       June 30, 2013       June 30, 2013
          High      $ 3.44     $ 3.38     $ 3.37     $          3.44     $          3.78
          Low         3.09       3.08       3.03                3.03                3.03
          Average     3.28       3.30       3.18                3.25                3.42

The following discussion and analysis relates to factors that have affected the operating results of the Company for the quarters ended June 30, 2014 and 2013. 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, 2013.

Results of Operations

Quarter Ended June 30, 2014 Compared to Quarter Ended June 30, 2013

Net sales were $307.1 million in the second quarter of 2014 compared to $289.5 million in the second quarter of 2013. This 6.1% increase in net sales is primarily the result of a 3.5% increase in copper wire sales driven by a 10.0% increase in copper wire unit volume shipped along with a 43.3% increase in aluminum wire sales driven by a 51.4% increase in aluminum wire unit volume shipped, offset somewhat by decreases in average selling prices of 6.0% and 5.4% of copper and aluminum wire, respectively. Unit volume is measured in pounds of copper or aluminum contained in the wire shipped during the period. Fluctuations in sales prices are primarily a result of changing copper and other raw material prices and product price competition. The Company believes that certain competitors cut prices in the second quarter of 2014 in an effort to "remain competitive" with the Company's superior service levels. The average cost per pound of raw copper purchased decreased 4.4% in the second quarter of 2014 compared to the second quarter of 2013, and was the principal driver of the decreased average sales price of copper wire. In the second quarter of 2014, aluminum building wire constituted 8.9% of the Company's net sales dollars compared to 6.6% in the second quarter of 2013.

Cost of goods sold was $273.6 million, or 89.1% of net sales, in the second quarter of 2014, compared to $249.3 million, or 86.1% of net sales, in the second quarter of 2013. Gross profit decreased to $33.5 million, or 10.9% of net sales, in the second quarter of 2014 versus $40.2 million, or 13.9% of net sales, in the second quarter of 2013.

The decrease in gross profit margin percentage was primarily the result of a decrease in the spread between the average price paid for a pound of raw copper and the average sale price for a pound of copper in the second quarter of 2014 versus the second quarter of 2013. The spread decreased 9.9% as a result of the average sales price per copper pound sold declining 6.0% while the per pound cost of raw copper decreased only 4.4%. Aluminum wire followed the same trend with the spread decreasing 8.4% in the same quarterly comparison. In 2014, total raw materials cost, including the LIFO adjustment, increased to 79.2% of net sales in the second quarter of 2014, versus 77.5% of net sales in the second quarter of 2013. This increase was compounded by an increase in the overhead expense category to 7.7% of net sales in the second quarter of 2014 versus 6.7% of net sales in the second quarter of 2013.

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


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lower of cost or market calculation quarterly. As of June 30, 2014, 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 decreases in copper costs offset somewhat by an increase in copper inventory quantities on hand, aided somewhat by price and volume movements of other materials during the second quarter of 2014, a LIFO adjustment was recorded decreasing cost of sales by $1.9 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 built some of that layer back in the second quarter of 2013. As a result, under the LIFO method, this inventory layer was liquidated at historical costs that were higher than current costs. This activity impacted net income positively in the second quarter of 2013 by $481,000.

Selling expenses, consisting of commissions and freight, for the second quarter of 2014 were $14.1 million, or 4.6% of net sales, compared to $12.1 million, or 4.2% of net sales, in the second quarter of 2013. Commissions paid to independent manufacturers' representatives are paid as a relatively stable percentage of sales dollars, and therefore, exhibited little change in percentage terms. Freight costs as a percentage of net sales increased to 2.2% of net sales in the second quarter of 2014 from 1.9% of net sales in the second quarter of 2013, primarily due to small changes in the mix of both product sold and geographical destinations of product sold. General and administrative expenses remained steady at $4.2 million, or 1.4% of net sales, in the second quarter of 2014, compared to $4.1 million, or 1.4% of net sales, in the second quarter of 2013. The provision for bad debts was $0 for the second quarters of 2014 and 2013.

Net interest and other (income) expense was virtually zero in the second quarters of 2014 and 2013. Income taxes were accrued at an effective rate of 33.5% in the second quarter of 2014, versus an effective rate of 35.3% in the second quarter of 2013. The decrease in the effective rate was due to a 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 $10.2 million in the second quarter of 2014 from $15.5 million in the second quarter of 2013.

Six Months Ended June 30, 2014 compared to Six Months Ended June 30, 2013

Net sales for the first six months of 2014 were $584.3 million compared with net sales of $554.8 million for the first six months of 2013. This 5.3% increase in net sales is primarily the result of a 44.2% increase in aluminum wire sales driven by a 53.9% increase in aluminum wire unit volume shipped along with a 2.8% increase in copper wire sales driven by a 9.6% increase in copper wire unit volume shipped, offset somewhat by a 6.3% decrease and a 6.2% decrease in the average selling price of aluminum and copper wire, respectively. Unit volume is measured in pounds of copper or aluminum contained in the wire shipped during the period. Fluctuations in sales prices are primarily a result of changing copper and other raw material prices and product price competition. The average cost per pound of raw copper purchased decreased 6.7% in the first six months of 2014 compared to the first six months of 2013, and was the principal driver of the decreased average sales price of copper wire. In the first six months of 2014, aluminum building wire constituted 8.4% of the Company's net sales dollars compared to 6.1% in the first six months of 2013.

Cost of goods sold increased to $518.6 million in the first six months of 2014, compared to $490.4 million in the first six months of 2013. Gross profit increased to $65.7 million, or 11.2% of net sales, in the first six months of 2014 versus $64.5 million, or 11.6% of net sales, in the first six months of 2013.

The decrease in gross profit margin percentage was primarily the result of a decrease in the spread between the average price paid for a pound of raw copper and the average sale price for a pound of copper in the first six months of 2014 versus the first six months of 2013 due primarily to decreased industry pricing discipline. Fluctuations in sales prices are primarily a result of changing copper raw material prices and product price competition. The spread decreased 5.0% in the first six months of 2014 versus the first six months of 2013. The spread was compressed as a result of the 6.2% decline in the average sales price per copper pound sold while the per pound cost of raw copper decreased 6.7%. (In nominal dollars, the sales price declined more than the cost of copper.) Aluminum wire followed the same trend with the spread decreasing 6.0% in the same year-to-date comparison.

Due primarily to decreases in copper costs and a slight increase in copper inventory quantities on hand, aided somewhat by price and volume movements of other materials in the first six months of 2014, a LIFO adjustment was recorded decreasing cost of sales by $6.8 million during the six month period. Based on 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 six months of 2014 increased to $25.8 million, or 4.4% of net sales, compared to $23.1 million, or 4.2% of net sales, in the same period of 2013. Commissions paid to independent manufacturers' representatives are paid as a relatively stable percentage of sales dollars, and therefore, exhibited little change in percentage terms, increasing $0.9 million in concert with the increased sales dollars. Freight costs for the first six months of 2014 increased $1.8 million to $12.2 million or 2.1% of net sales


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versus $10.4 million or 1.9% of net sales for the first six months of 2013. General and administrative expenses were $7.9 million, or 1.4% of net sales, in the first half of 2014 compared to $8.2 million, or 1.5% of net sales, in the first half of 2013. The provision for bad debts was zero in the first six months of 2014 and 2013, respectively.

Net interest and other expense (income) was virtually zero in the first half of both 2014 and 2013. Income taxes were accrued at an effective rate of 34.4% in the first six months of 2014 versus 33.9% in the first six months of 2013, consistent with the Company's estimated liabilities.

As a result of the foregoing factors, the Company's net income decreased to $21.0 million in the first half of 2014 from $21.9 million in the first half of 2013.

Liquidity and Capital Resources

The Company maintains a substantial inventory of finished products to promptly satisfy customers' 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 a lesser extent, capital expenditures are the primary drivers of the Company's liquidity needs. Generally, these needs 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. 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 and borrowings under its various debt arrangements. 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.

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 used in operating activities was $3.3 million in the first six months of 2014 compared to cash used of $0.3 million in the first six months of 2013. The following changes in components of cash flow from operations were notable. The Company had net income of $21.0 million in the first six months of 2014 versus net income of $21.9 million in the first six months of 2013. Accounts receivable increased in the first six months of both 2014 and 2013, although at different amounts, resulting in a use of cash of $22.9 million and $38.2 million, respectively, driving a $15.3 million smaller use of cash in 2014 versus 2013. 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 six months of both years, primarily due to increased sales volumes. 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 the first six months of both 2014 and 2013, resulting in a use of cash of $9.4 and $0.8 million, respectively. Trade accounts payable and accrued liabilities resulted in a $6.4 million increase in cash used in the first six months of 2014 versus the first six months of 2013 attributable primarily to the timing of inventory receipts at quarter end. In the first six months of 2014, changes in current and deferred taxes provided cash of $4.6 million versus $5.3 million in the first six months of 2013. These changes in cash flow were the primary drivers of the $2.9 million increase in cash used in operations in the first six months of 2014 versus the first six months of 2013.

Cash used in investing activities decreased to $14.1 million in the first six months of 2014 from $31.7 million in the first six months of 2013 due to the dollars spent in early 2013 to purchase 201 acres of land adjacent to the Company's campus for $25.7 million. Cash used in financing activities consisted of $0.8 million of cash dividends offset by $0.5 million of proceeds and tax benefits from exercised stock options resulting in $0.3 million of cash used in the first six months of 2014, versus $0.6 million in the first six months of 2013. As of June 30, 2014, the balance on the Company's revolving line of credit remained at $0. The Company's cash balance was $19.1 million at June 30, 2014, versus $1.2 million at June 30, 2013.

During the remainder of 2014, the Company expects its capital expenditures will consist primarily of expenditures related to the recently announced expansion of its aluminum building wire plant and purchases of manufacturing equipment throughout its facilities. The total capital expenditures for all of 2014 associated with these projects are currently estimated to be between $40 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 2014.


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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 and other raw materials. 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, 2013, which is hereby incorporated by reference.

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