AZZ Inc (AZZ) 2004 Q4 法說會逐字稿

 Good afternoon.  My name is Alexandria and I will be your conference facilitator.   At this time, I would like to welcome everyone to the AZZ Incorporated fourth quarter 2004 earnings results conference call.   All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period.  If you would like to ask a question during this time, simply press star than the number one on your telephone keypad.   If you would like to withdraw your question, please press star then the number two.   I would now like to turn the conference over to Mr. Joe Diaz of RCG Capital Markets Group.   Mr. Diaz, you may begin.

 Thank you, Alexandria, and thank all of you for joining us today to review the financial the results of AZZ Incorporated for the fourth quarter and the fiscal year ended February 29th 2004.   As the conference call operator indicated, my name is Joe Diaz.  I'm with RGC Capital Markets Group, and we are the financial license-consulting firm for AZZ Incorporated.   With us today, representing the company, are Mr. David Dingus, President and Chief Executive Officer, and Mr. Dana Perry, Vice President of Finance and Chief Financial Officer.   At the conclusion of today's prepared remarks by Mr. Dingus and Mr. Perry, we will open the call for a question and answer session.   If everyone participating on this call does not have a full text copy of the earnings release, please call RCG at 480-675-0400, and we will immediately fulfill your request or you can retrieve the release off the Internet from numerous financial sites.

Before we begin with prepared remarks from the AZZ management team, we submit for the record the following statement. This conference call may include statements that constitute forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.   The forward-looking statements involve risks and uncertainties that are detailed from time to time in documents filed by the company with the Securities and Exchange Commission.   Those risks and uncertainties include, but are not limited to, changes in customer demand and response to products and services offered by the company, including demand by the electrical power generation market, electrical transmission and distribution markets, the industrial markets, and the hot dip galvanizing markets, prices in raw material costs, including zinc and natural gas, which are used in the hot dip galvanizing process, changes in the economic conditions of the various markets the company serves, foreign and domestic, customer requested delays of shipments, acquisition opportunities, adequacy of financing, and availability of experienced management employees to implement the company's growth strategy.  The company can give no assurance that such forward-looking statements will prove to be correct.   With that having been said, we'll begin this presentation with remarks from Mr. David Dingus, President, and Chief Executive Officer.   David?

 Thank you Joe, and thanks to each of you for taking the time to join us for the conference call for the fourth quarter and fiscal year 2004.  The fourth quarter and fiscal year were completed on February 29th of 2004.   Now, consistent with what we reported at the end of the third quarter, we believe that recent market indicators suggest that our markets have stabilized and are positioned for recovery.   Our book to ship ratio exceeded 100 percent in the last three quarters. Now, prior to the three most recent quarters, the last time we achieved a book to ship ratio in excess of 100 percent was in August of 2001.

Now, despite some modest improvements in our markets, they remain extremely competitive and price sensitive, as the capacity expansion that occurred in the strong power generation market has resulted in much more capacity than can be absorbed by current market demand.   We are still seeing intense pricing pressures, as each competitor strives to maintain market share.

The operating results for the quarter and the year exceeded our internal expectations and earnings guidance that we previously provided, despite a continuation of the difficult market conditions and intense competition.   We have sized our operations to reflect these conditions and have continued our efforts to improve operating results and financial performance.  While progress has been made, we are still searching for and seeking out additional improvement opportunities.   The upcoming fiscal year we'll have a lot of emphasis on systems and procedures and sharing of best practices among our operations to further enhance operating efficiency.   We are also continuing emphasis on liquidity and continued to see reductions in our debts and improvements in our debt-to-equity ratio.

Aggressive pursuit of all domestic and international marketing opportunities has been and will continue to be an integral part of our focus as we continue to strive to expand our served markets.   With our previously announced operating structure in China, improved representation in the Middle East and Southeast Asia, we are better positioned to take advantage of these markets, which are experiencing growth.   Our efforts are also underway to improve our participation in the South and Central America markets.  The backlog at the end of the fourth quarter improved to 53.1 million from the 52.5 at the end of the third quarter.   The backlog at the end of the prior fiscal year was 49.1 million.  Our quarterly book to ship ratio was 102 percent, with incoming orders of 33.1 million and shipments of 32.5.   On a year-to-date basis, the book to ship ratio was 103 percent.

Now, our backlog is still heavily weighted toward the distribution market.   Bookings for the quarter were aided by activity in the domestic transmission grid.  Now, new orders from this market are still well below its potential favorable impact, and we will look to international opportunities for our high-voltage bust deck until such time as energy legislation provides for the operating structure and investment recovery of expenditures in the aging and outdated domestic transmission grid.   And despite continued overall favorable domestic economic news, the industrial manufacturing sector is still not showing a strong recovery. A recovery not only benefits our electrical and lighting products, but also our galvanizing services segment.

Now, with that as an overview of our results, Dana will now give us a review of the operating results for the quarter and the fiscal year.   Dana?

 Thank you David.  I would like to also welcome each of you to our fourth quarter conference call.  And at this time, I will review our unaudited consolidated rough results for the period ending February 29th 2004.   AZZ recorded revenues for the quarter ending of 32.5 million, compared to 39.8 million in the prior year.  Net income for the quarter was 1.2 million, as compared to 1.4 million.   Diluted earnings per share was 22 cents, compared to last year's 27 cents.  Revenues for the fiscal year were 136.2 million, compared to 193.4 million.   Our industrial and electrical products segment generated 65 percent of our revenues, while the galvanizing services segment generated 35 percent.   David indicated our backlog at the end of the fiscal year stored at 53.1 million, which compares favorably to the 49.1 million at the previous year-end and 52.5 million at the end of November 30 2003.   We've seen our backlogs stabilize above the $50 million mark for the past two quarters, which is very positive for us.

Our book to ship ratio, as David also indicated, which is one of our key statistics that we follow, was 102 percent for the quarter and 103 percent year-to-date.  This is our third consecutive quarter with a book to ship ratio greater than one-to-one.   As we've stated before, this is very positive, but we like to see the increases in our backlogs to be more evenly distributed across our product lines.   As in the past, our major concerns remain our ability to sustain book to ship ratio in our electrical and industrial products segment that we achieve do the last three quarters.   As everyone else is experiencing in our businesses, the rapid spike in steel prices is having an adverse effect on our businesses.   Any stabilization in the metals pricing and any improvements in the industrial market should aid both segments of our business.

At this time, David will give us an overview of our electrical and industrial products segment.

 Our electrical products have worked through the backlog that was related to the domestic power generation project, and we continue to see an increase in our international power generation quotation activity, and indications are that the long-term demand for electrical power will improve over the current level.

The power distribution and motor control center products have a broad application in the industrial and utility market.  The industrial applications product is extremely competitive marketplace, and we believe that continuing improvements in our distribution network will facilitate an increase in our participation of this market.   The specialty lighting products of the companies continues to move in concert with the industrial market.   Good profitability and excellent cash flows continue, even in these lower demand market conditions.  We've intensified our marketing efforts and our commitment to new products.   While it is not anticipated this will have a short-term impact on our operating results, it is a critical element in restoring growth to this product offering.   The metal clad outdoor Switchgear products, with their strong utility distribution substation base is operating at levels consistent with prior periods, and we continue to see excellent inquiries and a very solid and strong backlog.   The relay and control panels in industrial automation continues to be unfavorably impacted by low capital-spending levels in the industrial markets.   Manufacturing capacity utilization, which shows improvement in recent months, still remains below the 80 percent level.  Our utilization was at 76.6 at the end of February, which is up from the 75.7 at the end of November.

Now, a return to these industry statistics to the utilization level that we saw in the 1992 to 2000, which averaged 82.6 percent, would positively impact many of our operations.   In the fourth quarter, we did receive orders for our high-voltage transmission products, and quotation activity improved.  As I stated earlier, our bookings remain below the potential for this product.   We believe that we will see international market opportunities develop before we will see the upgrading of the transmission grid.

Now, Dana will now cover the operating results of this segment.

 Our electrical industrial products segment recorded revenues for the quarter of 21.5 million compared to the prior year results of 28.3 million.   Operating income was 1.7 million, as compared to 2.8 million in the prior year.   Year-to-date revenues were 88.9 million, compared to prior year results of 134.9 million, and operating income was 6.4 million compared to 14.9 million in the prior year.   Lower year over year revenue reflects reduced demand in our power generation project versus the year ago.  These results exceeded our internal projections, as David indicated earlier, in guidance for the year as well as for the fourth quarter.  It's important to note that the fourth quarter results represent the first quarter of sequential revenue growth in this segment after seven consecutive quarters of declining sales.   Although market conditions remain very challenging, we did see improvement in the fourth quarter of our quotations and booking activity related to our transmission products, as well as improvement in quotation activity associated with large international projects, primarily in the Middle East, China, Southeast Asia and India.  

Steps taken last fiscal year to improve our operating efficiencies should help improve margins as business levels return to historical levels.  The implementation of our new ERP system is on schedule and should provide numerous efficiencies once this conversion is completed during fiscal 2005.

At this time, David will give us an overview of the galvanizing segment.

 Despite the complexities brought about by the changes in the price of steel and zinc, we had another solid year in our galvanizing services segment.   The steel price increase did have an impact on many of our still fabrication customers, and some projects were delayed, which impacted our fourth quarter volume.   However, due to our broad customer base and multiple locations, we were able to minimize the impact this had on our operations.

We continue to see the benefits from sizing our operations to match market conditions.  We continue to report excellent operating margins for this business, even without the benefit of a strong market.

This segment continues to generate good operating performance and makes a very positive contribution to the overall operating results of the company.

The recent sharp increase in commodity pricing, including the cost of zinc, is of concern to us.  This increase may have an adverse impact on our operating results.   Difficult market conditions may inhibit our ability to fully recover the anticipated increase in zinc costs.   Now, it is difficult to determine at this time what the overall market reaction will be to the increased cost of zinc.  This is a critical factor an impact all participations in the hot dip galvanizing business.  

Dana will now give us a review of the key operating statistics for this segment, and cover AZZ's balance sheet.

 Revenues in our galvanizing segment for the quarter were 11 million compared to 11.5 million reported in fiscal 2003.  Volumes of steel ship were down when compared with the same quarter last year. We have seen an increase in our selling price on a quarter-to-quarter comparison, due primarily to favorable product mix.  Operating income was 2.4 million compared to 2 million in the prior year.  Operating margins for the quarter were 21.4 percent, compared to 17.1 the same quarter a year ago.   Revenues and volumes were negatively impacted for the quarter, due to increase in steel prices imposed on our customer base.  As we see steel prices stabilize, we should see volumes returned to prior levels.

Year-to-date revenues were 47.3 million compared to 48.5 in the prior year.  Operating income was 8.6 million compared to 9 million.  Year over year deterioration in operating income can be directly linked to increased cost of natural gas.   Based on current contracts, inflation, utility costs for fiscal 2005 should be consistent with fiscal 2004 levels.   Again, as we stated earlier, any improvements in the economy or the industrial markets we serve should provide additional volumes and operating income opportunities for both segments of the business.

At this time, I will cover some of the key cash flow and balance sheet items on a comparative basis.  Cash provided by operations was 15 million compared to 24.4 million in the prior year.   Our outstanding accounts receivable was 21.9 million at the end of the fiscal year, a reduction of 7 million compared to the 28.9 million at the end of the prior fiscal year.   Receivables of days outstandings remain good at 58 days.  Year-to-date inventories have been reduced by $1 million.  Capital improvements were made in the amount of approximately 3.7 million last fiscal year, and depreciation and amortization was 5.7 million.   Our debt has been reduced by 13.7 million during the year, bringing our total outstanding bank debt to 30.9 million at the end of the fiscal year.   We continue to reduce our leverage and our current long-term debt-to-equity ratio at the end of the year was .37:1, as compared to .64:1 at the end of last year.   As you can see, now focus continues to be on liquidity through debt reduction and by managing our working capital in the most efficient manner.

At this time, I'll turn the conference call over to David for closing comments, then we will open our question-and-answer session.

 Now, despite recent positive economic indicators, the uncertainty still remains in the economy and in particular the industrial manufacturing sector, which we are very reliant upon.

Now the aggressive steps that we have taken in seeking out new domestic and international marketing opportunities, improving our distribution channels, lowering our cost structure, improving operating results, enhanced management of our working capital, and significant reductions in our funded debt make us well positioned, in our opinion, for recovery.

We truly believe that when more favorable market conditions return, we'll be a much stronger, more efficient company and believe we will be able to report improved operating results.

Based upon the evaluation of information currently available to management, we are estimating fiscal 2005 earnings to be within the range of 75 to 85 cents per diluted share and revenues to be within the range of 140 to $150 million.   Now included in our earnings projection is a one-time expenditure of approximately $650 thousand to be expensed during fiscal 2005 associated with the implementation caused of our ERP system.   Now anticipated benefits from this expenditure are expected to realized in fiscal 2006.

We appreciate your support and I thank you in advance for a continuation of that support.  We appreciate your participation today.   At this time we would like to open it up for any questions that you might have.

 Certainly, sir.   [OPERATOR INSTRUCTIONS]

Your first question is from Will Lyons (ph) of Westminster Securities.  

 Hello, gentlemen.  Congratulations on a good quarter in a difficult time.

 Thank you.

 What - could you give us some details on what you've done to right size the company?  I'm going, I guess, one assumes that your employee count is down. But what have you done and is there anything left to do while you wait for the markets to turn around?

 Yes. There's in addition to what we've done, we did unfortunately have to make some reductions in our head count.  But we did it across the board, Will, so that the reductions in the payroll essentially matched the reductions in the head count.

So what that meant we had to do some management restructuring as some of our operations.  We had to consolidate them into product groups instead of individual operations.   And the, as we go forward, we believe there's some more opportunities to do that same type of thing and also to cross-utilize our capacity much better.

We had some facilities that were operating at a much higher capacity rate and were not as efficient.   And by transferring some of that production, we were able to better utilize available capacity, reduce our lead times, and better serve our customers.

So, again, as we look at that, and then we formed a number of councils for best practices.  We're looking at uniformity and how we manage our project management, our supply chain management, all aspects of the business.   And we believe that we've just scratched the surface on some of these things, Will.

 Good.  Thanks.

 You're welcome.

 Your next question is from John Franzreb of Sidoti & Co.

 Good afternoon, guys.  How are you doing?

 Doing fine, John (ph).  How are you?

 A couple of quick questions.  First, the new ERP system, could you give a sense when you expect to expense that $650 thousand?  Do you have an idea of when that would hit the P&L?

 That'll be through the course of the year as we're being billed by the company that's helping us implement that system.  So it'll be throughout the fiscal year.

 And Dana, my rates would assume it's about seven cents a share that works out to?

 Yes, sir.

 OK.  So you kind of have a penny or two here and there?

 Yes.

 OK.

Second thing is on the zinc side of the business on the cost side.  By my estimates it looks like zinc prices are up about 11% in the most recently completed quarter compared to the previous quarter.  I guess it's two questions.

How do you purchase zinc?  Are you a cash buyer in the market?  And secondly, what kind of percentage of your operating expenses is it for the services segment?

 OK.  On the first, we go out and we negotiate with the zinc suppliers a cap on it.  So we have our, a price not to exceed. And that's normally on a calendar year basis.

The second thing, John (ph), is essentially with the way that our inventory turns, you have a blended rate, so when you see a spike in the cost of zinc, then it's about six months, you gradually build up.  

So we're anticipating that the blunt of the increase will be felt more in the third and the fourth quarter than it will be felt in the first and second quarter.

 So, yes, that's six months worth of hedging if I kind of read that right?

 No.  

 On a blended ...

 On a first in, first our inventory basis.  We're expensing the oldest zinc first.

 OK.  

 So as you replenish that, it's a few months before you do that.

 OK.  And what kind of percentages is that of operating expenses for the services business?

 I think it's around 17%, John (ph).

 Seventeen percent, Dana?

 Yes.

 OK.  Thank you.

And Perry, you touched on some overseas opportunities in the Middle East.  And I think in your comments you said something about South America.  

Could you kind of just walk me through how those opportunities are arising?  Who's bringing you with them and just a little bit more color on those opportunities?

 Yes, John, what we've tried to do is to take a very rifled approach on our expansion of our international participation.

We did this in the arrangements that we did in China.  And we put the specific focus on the Middle Eastern market where we significantly upgraded our representation and local coverage there.  Someone very experienced in the business that is helping us tremendously and our participation in that market.

And we're in the early stages of doing the same thing in South America and Central America and hope in future calls we can get a little more specific as to what we're doing there.

 OK.  Good.  Thanks a lot.  Good job, guys.

 Thanks, John.

 Gentlemen, I would like to allow the participants an additional moment to pose any initial or follow up questions they may have.

[OPERATOR INSTRUCTIONS]

Your next question is from Gary Heffenun (ph) of Lord Abbott (ph).

 Good afternoon, gentlemen.  Thank you for taking the time to be here with us here today.

 Thank you.

 Could you talk about your, you gave us the incoming orders versus the ship ratio for the year.  Do you have that information for the quarter?  Did I miss that?

 Yes.  For the quarter it was 102%.

 OK.  For the quarter is was 102% and ...

 Our strongest bookings was in the third quarter.

Now, traditionally in the fourth quarter we do not see as strong a booking rate from our utility base because they normally have not got their budget approval.  So we start seeing more coming in from that than the second and third quarters.

So we were pleased that due to the holidays and the budget cycle of our utility customers at the fourth came in above the 100%.

 OK.  But due to the way the utility customers act, it is normal for the 4Q to be a step down from the 3Q?

 Yes, it is.

 OK.  And the backlog at the end of the year is at 53?

 Fifty-three point one million.

 And that's up modestly from the 52 in the third quarter, correct?

 Correct.

 Is there any change in the - in what's in that backlog? I mean the numbers are close.  Certainly it's nice to the positive delta.   Is there anything important for us to know in the current backlog number as in any way it may have changed from the third quarter to the second quarter?  Or is there any trend that you see in those orders that speaks to the general tenor of business?

 Essentially the major factor was in the fourth quarter we did finish out the balance of the some of the domestic power generation business.  So that is now all behind us.  

And so what was in there in the power generation side has now been replaced by increased orders from the transmission side.

 OK.  So you finish out most of the log that was power gen related?

 Domestic power gen, yes.

 OK.  And is there anything any overall conclusions or indications that you can draw of the general profitability of the domestic power gen business versus the, as you said it was replaced by power transmission orders?

 The power transmission and the old power generation are pretty equal in margin.  Now both of those are greater than the power distribution margins.

Most of the backlog occurred during the boom of 1998 through 2002 when there was excellent pricing going on.  So, yes, some of that was.  

But overall there's very little change in the projected margin of the backlog in the fourth quarter versus the third quarter.

 OK.  That's great.  Thank you very much for your assistance there.

 You're welcome.

 Our next question comes from the line of Jazelle Bussman (ph) with Gabelli (ph).

 Good afternoon.

Actually most of my questions have been answered regarding the backlog. Just one clarification, you said that the power gen business has been replaced by the transmission business.  Is that mostly international transmission business or is there some domestic transmission business as well?

 The fourth quarter increase in transmission is domestic.

 Oh, great.

 OK?

 And approximately how much higher would you say the domestic transmission business is quarter this quarter versus last quarter?

 Four million.

 Four million.  Percentage wise in terms of strengths?

 I'm sorry?

 I'm referring to the percentage in terms of strength like the composition in the backlog of the transmission business in the prior quarter versus this quarter.  What was the growth percentage wise for the domestic transmission business?

 Reproduced they have not given our backlog out by type of product for competitive reasons.

 OK.  That's great.  Thank you.

 Yes.

 [OPERATOR INSTRUCTIONS]

Your next question is a follow up question from Will Lyons (ph).

 You've made it pretty clear in your statements here on this call as well as on your releases recently that the international is really where you see the growth in the near term while you wait for domestic markets to really pick up again.  Would that be a fair statement?

 Absolutely.

 In an earlier caller asked for some color.  I wonder if you could at least give us some color in terms of regions if not specific countries.  But, for instance, we hear a lot about Iraq needing an entirely new electrical distribution system.  Is that a market for you?  

And what's going on with China?  Are you seeing - do you get orders from China, your new relationships there?  Or is the production in China and you get only licensing revenues?

 In China it's both.  Right now our agreement just covers our Calvert product.  So on our high voltage bus duct, we're quoting that direct into there. And we may evolve into a relationship where there's some subcontracting offered to them.  As well as there's additional quotes of other products into the China market.

The strongest area, of course, is in the Middle East is Saudi Arabia and the surrounding countries.  We're actually working on a project in Russia and in India.  And in some parts of Southeast Asia is becoming quite active.

 And would those typically be refurbishment products or project or would they be, especially in the growing countries, brand new generating facilities?

 New would be the majority.

 Interesting. Thank you.

 Yes.

 Our next question is from the line of Gary Heffenun with Lord Abbott.

 Yes, forgive me for perhaps not knowing my history well enough here.

If I look at the galvanizing business for this quarter, our revenues are down by point five million yet our operating income is up.  So it's certainly showing an improved profitability on a similar revenue basis.

Is this due to changes that you have made within the year as to, as you mentioned earlier in the press release to right size operations and does this new sell for terms business levels?   Is this due to the volatility in the prices of steel?  Or there's several other things it could be.  I'll let you answer.

 OK.  The impact on the volume was primarily the large project work that was delayed because of the increase in the steel prices.   In other words, the fabricator had to go back to the end user and get the whole project re-quoted before it could do those.  Those are large tonnage jobs.

Now we were fortunate in the fourth quarter that the - that was the margins were favorably impacted by a very positive product mix that goes through there.   A lot of the specialty work and the OEM work, which is high margin work, held up very strongly through that.  Then that was aided by the right sizing and the impact of some things that we've done on the operating efficiency plus it was a very favorable improvement in the zinc usage that occurred.

So it was a number of factors but essentially it's favorable product mix and the volume shortfall was brought about as a result of the steel price increases on our steel fabricators.

 OK.  Is it fair to say that the business that you described is the more profitable business is also going to be coming from a customer set who has a more regularly scheduled need and therefore is more likely than the ad hoc orders to be in a hedge position?   Therefore, the volatility of steel prices did not impact them as much on a shorter-term basis?

 That is a fair statement.  I, the only additional color I would add to - there's not a great disparity in the pricing side.  But it is naturally the most because in the large steel projects you have more competition fighting for the job.   And then in this down market puts more downward pressure on it. Whereas the specialty and the OEM work is more long term relationship business and they are not as volatile from the steel pricing and some of the other actions that are going on.

 OK.  And in your efforts to change, to be more efficient with the amount of zinc you use, is there a value offset here to the customer?  I mean, being completely naïve, if you're using less zinc are they getting less benefit in the - in what they're searching for as far as being corrosive, being free of corrosion and rust, et cetera?

 No, they are not getting less protection at all.  And the way there's many factors that impact the zinc usage.  It can be the way that you put it in the kettle.  It can be the way that you bind it.  It can be the way that you strap it in order to do it.

It's - the material from the customers still fully coated and it is done to a spec, so you don't do it that way but you do it and how you - your standard operating procedures.

 OK.

 But, no.  In no way do you reduce the amount that goes on the product itself.

 OK.  Not certainly I don't want to be mean spirited, but just for the purposes of a frank and fair challenge, why were you able to make these adjustments to your efficiency in zinc usage today versus say a year ago?  Has there been some changes, technology, industrial tools, whatever?

 No, sir.  We're just working harder than we used to.

 OK.  Fair enough.

 [OPERATOR INSTRUCTIONS]

Your next question is from Chip Skinner (ph) of Royce and Associates (ph).

 Hey, guys.  Could you just give me the SG&A numbers?  I didn't see those in your press release.  I'm assuming the operating income by division is pre-SG&A.

 We filed an 8-K this morning that gives all that in great detail.

 OK.  Great.

 If you don't mind I'll refer you to that.

 I can do that.  Thank you.

 It's got everything you'll ever want to see there.

 I'll find that.  Thanks.

 OK.

 Gentlemen, there are no further questions at this time.

Are there any closing remarks?

 Again, we appreciate your participation, and your support, and we look forward to continuing to report to you signs of improvement in the long-term of our business.

 Ladies and gentlemen, this does conclude our conference call for today. You may now disconnect.