AZZ Inc (AZZ) 2006 Q2 法說會逐字稿

Good morning. My name is Felicia (ph) and I will be your conference facilitator. At this time, I would like to welcome everyone to the AZZ incorporated second-quarter 2006 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) Thank you. Mr. Dorame, you may begin your conference.

Thank you, Felicia. Good morning to everyone. We would like to thank you all for taking time out of your busy schedules to join us today to review AZZ's second-quarter financial results ended August 31st, 2005.

With us today representing the Company are Mr. David Dingus, President and Chief Executive Officer, and Mr. Dana Perry, Chief Financial Officer.

Before we begin, we submit for the record that this conference call has been made available by the way of webcast technology on the Internet and direct dial via conference call service to all interested parties. This conference call includes statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Except for the statements of historical fact, this conference call may contain forward-looking statements that involve risks and uncertainties, some of which are detailed from time to time in the documents filed by the Company with the SEC.

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 markets, electrical transmission and distribution markets, the industrial markets and the hot dipped galvanizing markets; prices and raw material costs, including zinc and natural gas which are used in the hot dipped galvanizing process; changes in the economic conditions of the various markets the Company serves, foreign and domestic; customer requests (ph) delays of shipment; acquisition opportunities; adequate financing; and availability of experienced management, employees to implement the Company's growth strategy.

The Company can give no assurance of such forward-looking statements will prove to be correct. With that having been said, I'd like to turn the call over to Mr. David Dingus, President and Chief Executive Officer of AZZ. David.

Thank you, Joe, and thanks to each of you for taking the time to join us for the conference call for the second quarter of our fiscal year 2006. The second quarter was completed on August 31st, 2005.

For the second quarter, revenues increased 31% to 47.8 million; net income is up 51% to 1.4 million; and diluted earnings per share increased 50% to $.24. We are pleased to again report double-digit quarterly growth.

In general, the market indicators and quotation levels continue to suggest that our markets have shown improvement. The total dollar value of quotations outstanding at the end of the second quarter reflected a double-digit increase over the prior quarter and for the same period last year.

Despite continued aggressive competitive conditions and our decision to walk away from some opportunities due to unacceptable pricing levels, we were able to achieve an improved order level that met our minimum margin expectations. Incoming orders for the quarter were 59.4 million, while shipments for the quarter were 47.8; that results in a book-to-ship ratio of 124%. Our book to ship ratio in the second quarter of last year was 105%.

Incoming orders increased 55% over the same period of a year ago, and were 32% higher than the first quarter of fiscal year 2006. The quarterly bookings were positively impacted by a large international order for our high-voltage transmission products, currently scheduled to be completed and shipped in fiscal year 2007.

The competitive pricing pressures continued to inhibit our ability to further increase our volumes and profitability and fully recover the cost increases we've incurred over the past year. Backlog at the end of the quarter was 76.6 million, versus 53.8 million in the prior period, or an increase of 25%. We are pleased with the distribution of the backlog across our operations. We estimate that 61% of the backlog is currently scheduled to be delivered in fiscal year 2006.

We continue our efforts to improve our market coverage, expand our served markets, which should continue to result in additional bookings. Despite the improvement in our markets, competitive forces remain aggressive due to the imbalance between supply and demand, and we continue to see pricing used as a mechanism to maintain market share for improved capacity utilization.

The disruptions and loss to our employees, customers and residents of the Gulf Coast have added a complexity to our outlook for the near-term. We are extremely pleased to report that all of our employees are safe, and while many have sustained significant property loss, we are operating at all locations. We extend to all the residents and the families who suffered great loss our deep condolences and our desire to help in the recovery process. We deeply appreciate the efforts of our employees who have not only contributed monetarily, but also volunteered to assist those in need.

As of the week of October 10th, all the facilities were open and serving customer needs. While all repairs and modifications have not been completed, we have been able to begin to meet the needs of our customers.

As a Company, our accomplishments are improving and we continue to double and redouble our efforts to secure profitable business. We continue to place emphasis on systems and procedures and sharing of best practices among our operations to further enhance operating efficiency. We are also continuing our emphasis on liquidity and our current debt-to-equity ratio is 0.6 to 1.

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

Thank you, David. I would also like to welcome each of you to our second-quarter conference call. At this time, I will review our unaudited consolidated results for the period ending August 31, 2005.

We recorded revenues for the quarter ending of 47.8 million, a 31% increase as compared to 36.5 million in the prior year. Net income for the quarter increased 51% to 1.4 million, as compared to 908,000 in the comparable period. Diluted earnings per share was $0.24 as compared to last year's $0.16 per share.

Revenues for the six-month period ended August 31 were 92.6 million, an increase of 21.5% as compared to 76.2 million in the comparable period last year. Net income for the six-month period was 3.5 million, an increase of 62.6%. Diluted earnings per share was $0.63 per share as compared to $0.39 in the prior year. Our Electrical and Industrial Products segment generated 66% of our revenues, while our Galvanizing Services segment generated 34%.

Our backlog continues to improve. Backlog at the end of the second quarter was at 76.6 million, which compares to 53.8 million at the end of the second quarter last year. Our book-to-ship ratio was good at the end of the quarter at 124%.

At this time, David will give us an overview of the Electrical and Industrial Products segment.

The passage of the energy legislation has and we believe will continue to have a positive impact on our Electrical and Industrial Products segment. Though the legislation does not please everyone and there are certain areas that we wish had been more aggressive, there are incentives, reliability standards and specific alternative energy source programs which should enhance customer spending, and at least we have the benefit of the known versus the uncertainty of our customers that we had been operating in due to previously delayed energy legislation.

The long-term domestic worldwide demand for reliable electrical power is expected to increase over current levels and should create demand for our products.

Industrial demand for our Power Distribution and Motor Control Center products is showing significantly improved demand due to new projects, major renovations and expansions. We believe that increased opportunities related to refining, LNG, clean fuels initiatives will provide opportunities for additional growth. Despite the stronger demand, pricing does remain excessively competitive.

Our Specialty Lighting Program should see improved demand over the balance of the fiscal year due to new products and higher demand due to the repair and replacement of lighting for the equipment and facilities which were damaged in the recent hurricanes.

Backlog and operating results of our metal-clad outdoor switchgear products, with the strong utility distribution substation customer base and the improving mining construction base, continues at a strong pace. The second quarter saw an improved inquiry level for both our utility and our mining products.

Our relay and control panels in industrial automation services, financial performance has significantly improved over the prior period. Continued improvement in capital spending should lead to additional opportunities. Inquiries and bookings for our high-voltage transmission products, particularly international projects, continues at a very encouraging and robust level. The operating performance of this operation for fiscal 2006 should be the strongest year since our acquisition in August of 1999.

With the strong bookings in the second quarter, it appears that fiscal 2007 will meet or potentially exceed fiscal 2006. Spending in the domestic transmission grid has improved and growth in our international markets should sustain the current level of business until such time as aggressive spending on the domestic grid does occur. Orders and shipment of our tubular products to the petroleum market remain strong.

In our Electrical and Industrial Products segment, AZZ did record 32.0 million, a 37% increase as compared to the prior year results of 23.4 million. Operating income was 2.3 million, a 72.6% increase, as compared to the 1.3 million in the prior year, and the operating margins were 7.1% compared to 5.6. The increase in revenue resulted primarily from increased demand of our products in the petroleum, high-voltage transmission and industrial markets. The increased demand from these markets continues to be potentially offset by lower demand from the power generation market.

Even though margins have improved over the last year, continued pricing pressures on the market in which our products are sold to, as well as our inability to pass along many of the material price increases we have incurred, have adversely affected operating profits and margins. We continue to see improvement in our quotation activity, as well as incoming orders. The Company continues to implement cost containments and review all strategic alternatives to lower our cost structure while maintaining product quality and customer service.

Now, in review of our Galvanizing segment, revenues for the second-quarter results were on pace with the record-setting first quarter. However, the earnings were below the first quarter. As we indicated to you in our previous conference call, we were able to achieve price increases in the first quarter prior to the realization of the escalating zinc cost, which led to an unusually high and sustainable operating income level. The second quarter reflects the impact of those higher zinc and natural gas costs.

Demand remains strong across all of our served markets, particularly the telecommunications and transmission pole business. Our results do reflect the improvement in the industrial U.S. market that has resulted in increased capital spending for expansion and maintenance. Based upon our market intelligence and published data, we believe that the demand in our geographic market continues to be stronger than other markets of North America and has contributed to the outstanding results for the first six months.

Out of our 11 galvanizing facilities, Hurricanes Katrina and Rita impacted to some degree our operations and employees at 8 of the 11 facilities. Some of this was limited to the loss of power and evacuated employees and staff, and other facilities sustained significant damage. The plant in New Orleans and Beaumont, Texas sustained the most. We were, however, fortunate that the damage was limited to wind, as we are not in the heavily flooded areas.

In total, we have lost 65 production days due to the storms. With 242 production days during an average month, this represents a loss of 27% of a month's production. We do anticipate a substantial portion of the financial impact will be recovered from our business interruption insurance policy.

Additionally, our policy is to carry replacement cost insurance on our facilities and we anticipate that net insurance proceeds will approximate or exceed the carrying value of the affected sales assets. We anticipate that third-quarter operations will be impacted due to the time it will take our customers to restore operations. As I have indicated earlier, all of our operations are open; however, the two most severely damaged are running at approximately 30% of full production. Repair and restoration is in progress.

Due to the fact that offshore rigs and platforms and coastal industrial installations are extensive users of galvanized steel, we do anticipate increased demand later in fiscal 2006 and continuing into 2007 as the area rebuilds and replaces the heavily damaged infrastructure and industrial complexes. Some of our customers may have interim issues related to restaffing due to the number of evacuees and the number of people who are participating in the rebuilding efforts. This may make it difficult to fully man their operation. This is also some risk to us as well.

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

Revenues in our galvanizing segment for the quarter were 15.6 million, an increase of 19.3% as compared to 13.1 million recorded in our second quarter in fiscal 2005. Our volumes of steel shipped as well as our selling prices were up when compared to the same quarter last year.

Operating income was 2.7 million, an increase of 11.1% as compared to 2.4 million. Operating margins were at 17% on a comparative basis of 18.2 in the prior year. Increased revenues and operating leverage achieved through improved pricing and higher volumes aided our results. Increased zinc costs negatively impacted margins for the quarter by approximately $575,000.

At this time I will cover some of our key cash flow and balance sheet items on a comparative basis. For the six-month period, cash provided by operations was 6 million as compared to 5.4 million in the prior year. Our receivable days and inventory turns remain strong. Accounts receivable days outstanding were 54 days at the end of August as compared to 56 days at the end of our prior fiscal year-end. Year-to-date and capital improvements were made in the amount of 3.1 million, and depreciation and amortization was 2.8 million for the six-month period.

Total outstanding bank debt at the end of the quarter was 26.6 million, as we continue to reduce our leverage and our current long-term debt-to-equity ratio at the end of the quarter was 26 to 1. As you can see, our focus continues to be on our liquidity through debt reduction and managing our working capital in the most efficient manner.

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

Our optimism about the improvement in our markets and the potential of further improvement are definitely tempered by the tremendous escalation in the cost of key commodities and energy. The ability of our markets in the overall economy to absorb these costs is a question of major concern to us; the potential impact and probability is difficult, of course, to determine.

If the markets are currently not strong enough to absorb the pent-up cost increases that we've already absorbed, such as ourselves in the manufacturing process, it is somewhat difficult to determine our ability to pass additional increases on through increased pricing. Market conditions may inhibit our being successful in the balance of this fiscal year and into fiscal 2007.

The aggressive steps we have taken in seeking out domestic and international marketing opportunities, improving our distribution channels, lowering our cost structure, improving operating efficiencies, enhanced management of our working capital and significant reductions in our funded debt are reflected in our improved operating results for the second quarter and the first six months.

Additional improvements in volumes would further advance the gains we have made due to the leverage, but as indicated earlier, we must closely monitor the spending level of our customers to determine the overall impact of increasing cost. Our programs and services are well-positioned to benefit from the energy legislation, repair and benefit of the storm damaged infrastructure, which may provide some offset should an economic downturn occur.

Despite the improved market demand and some improvement in pricing, we believe that we will continue to see unfavorable pricing actions due to overall excess capacity. The pricing actions that we have taken may continue to inhibit our growth; however, we believe it is the correct strategy for us to follow.

Based upon the valuation of information currently available to management, we are continuing our previously issued guidance for the fiscal year 2006. Our earnings are estimated to be within the range of $1.08 to $1.18 per diluted share and revenues to be within the range of $170 to $180 million.

We continue to appreciate your support and thank you in advance for continuing that support. Thank you for your participation today, and we would like to open it up for any questions you might have at this time.

(OPERATOR INSTRUCTIONS) John Franzreb of Sidoti & Company.

Good morning, David and Dana. How are you doing? I was wondering if you could provide a little bit of color and background into that large high-voltage transmission order from China that you got. What is the size of that and how to figure (ph) that in the backlog?

John, it was an order that we worked on for some time, and it is hydro plant, new power plant, so we have to get the power from actually the existing grid. And it was in excess of $12 million.

Okay. And that is all in the backlog?

Yes, it is.

Okay. The second -- I'd just like you to elaborate. You said two comments in your prepared statements that kind of had me scratching my head. One, you just recently referenced the pricing actions that we have taken you think are the right thing. What are those pricing actions that you were referring to?

That is where we made the decision, particularly on the Electrical and Industrial Products, that we were going to establish minimum margins, John, and stick with that and not go after it, even though it might be at the risk of losing some share. And I think the improvement that we are beginning to see in the operating margins of the Electrical and Industrial Product segment says that approach is working and we are able to still get some double-digit volume increase.

Okay. I was concerned you might have been more aggressive in pricing; it that doesn't seem to be the case, though.

Secondly, you said earlier that the expectations -- and I think you are referencing the electrical side of the business -- was that next year should match or exceed maturities -- fiscal 2007 should exceed fiscal 2006. Was there any concern that it wouldn't?

Well, again, I am referring to our high-voltage products rather the entire segment, John, at this point in time. In order for us to continue to grow that year-over-year two things have got to happen. We have to improve our international market and we have to have spending in the domestic grid.

So what I was trying to convey is right now the spending that is going on in the Northeast, as well as what is going on in the international market, says we should have a record year in 2006. And with the booking of that order, that this is such a strong start on 2007, we think it may even exceed 2006.

Okay. One last question and I'll let someone else ask a question. The impact -- can you quantify the total dollar impact from disruptions, do you have a number for that?

No, because we are still in the process of calculating that, John.

John, we have, as David indicated, business interruption insurance, which should help us offset some of our operating losses. We sustained roughly three days interrupted production in the second quarter. And then the bulk of it will be sustained in our third quarter. Then we've got as well replacement cost insurance, which should cover our carrying value of our assets that were damaged. So --.

Is that three days out of the 65 that you referred to before (multiple speakers)?

Three days out of the quarter ending in August.

You referred to 65 production days earlier.

That is the total. We had, I think, 22 days in the second quarter and the balance in the third quarter.

We had 22 days in the third quarter? Only three days (indiscernible).

Okay.

So what was that breakdown, gentleman?

Pardon me?

What was that breakdown again?

22 of the 65 days occurred in the second quarter and the balance occurred in the third quarter.

Okay, thank you very much.

Greg Garabedian (ph) of Gabelli & Company.

Good morning gentlemen, how are you today?

Fine, Greg. How are you?

Good, thanks. Looking at the Company, it looks like you supply to all three end markets on the electrical industrial site. Could you just provide a little bit of color on each of the end markets and which end market you are looking to as the catalyst for the growth going into next year?

Okay, as we have indicated, we serve the power generation, the transmission distribution and the industrial. And the power generation tends to be operated at a very low level and we don't see anything in the near-term other than some international projects that will facilitate growth in that segment in the near-term.

P&D, in fiscal year 2005 was a particularly strong year for the distribution side. In fiscal 006, the distribution side has continued its pace and we've added growth in the transmission side. Also included in that is the expansion, of course, as we've talked about into the international markets with the transmission.

In the industrial, this is where we think is most impacted by the -- favorably impacted with what is going on with the mining industry is strong. Of course, refining has announced a number of projects. This is also where we classify the business that comes as a result of the clean fuels and the LNG. So we are seeing that industrial sector primarily driven by mining and petroleum.

Fantastic. Thank you.

Will Lyons of Westminster Securities.

Good morning, gentleman. I'm going to ask a question that might have actually already been answered, but I was pulled away for a second. It looked like your gross margin all-in, the segment gross income or maybe operating income the way you term it, is down relative to the last few quarters. Is that entirely due to higher costs or have you had to accept some lower pricing as well?

It is entirely due to higher costs.

Okay. My second question it was on your Oracle ERP and Sarbanes-Oxley compliance costs. In the release, there's a mention of the $1.4 million.

Yes.

Actual expense 775 so far.

No. Will, that should be -- yes, I am sorry.

Will the remainder be -- do you expect to be expensed in the next two quarters of your fiscal year?

Yes.

That is correct.

And then you'll be done with those investments?

I hope so.

I'm sure you do. Well, thanks very much.

(OPERATOR INSTRUCTIONS) Rob Longnecker (ph) of Barrington (ph).

I was wondering if you could just give a little more color on what you view your optimum debt levels as.

As a company and as we have discussed before, once our -- since we still fund the bulk of our acquisitions through cash, we believe that once that gets below 0.5 to 1 then we again start the process of looking. So we think that where it is right now. But we kind of monitor two things --where that is as in relation to that, and also what our debt level is relative to our EBITDA. And we normally measure that in the 3, 3.25 range. So we think our debt position is well below where we are very comfortable having it.

And when you guys talk about acquisitions, is there one side of the business you are more focused on?

We will look at opportunities in both.

Can you talk a little bit about your CapEx expectations over the next couple of years?

Our maintenance CapEx, primarily on the Galvanizing, essentially equals depreciation which is about $3 million a year. We are evaluating our facilities and we've been tracking at that 5 to $6 million level. And I would think that that would continue for the next two to three years.

Sorry -- so what was the difference between your maintenance and the 5 to 6, where is that money going?

Well, it could go into facilities that are needed, expansion in the electrical side. It may be new testing equipment; it may be the expenses associated with entry into a new product area. So it would be primarily expansionatory (ph) on the -- or growth oriented on the electrical side.

Okay. But in terms of your existing book of business, there is no major CapEx projects. You're just seeing businesses that you have right now; there is no major CapEx project in the future.

That is correct.

Okay, thank you.

(OPERATOR INSTRUCTIONS) Rick Fetterman of Fetterman Investments.

Good morning, how are you?

Fine, thank you.

If your run rate -- if your revenues hit the guidance range this year, is it fair to say that the pretax profit margin you experienced in the first half of this year, just a hair over 6%, is reasonable for the entire year? And is 38% a good tax rate to use?

38% is correct rate. And of course, as David indicated a while ago, our guidance is in a $1.08 to a $1.18 range.

I understand that there is no comment on the --

If you use that effective tax rate, you can back into the answer there.

Okay. All right. And would you expect there to be, going through fiscal '07, that there is going to be more benefit or continued and more benefit from the two storms next year in fiscal '07 than there will be in the balance of this year? That it should be an ongoing -- I hate to say source of revenue, but that is what it's going to amount to.

Right. And we would base that on our historical experience, where just prior to these storms we were still doing work from Ivan from the last year.

Okay. All right, thank you.

Thank you.

(OPERATOR INSTRUCTIONS) At this time there are no further questions and I will turn the call back over to the leaders at this time.

We'd like to thank everyone for taking your time out of your schedule today to join us to review AZZ's financial results for the second quarter. If you require additional information, please feel free to contact AZZ at area code 817-810-0095 and we will provide whatever information you might need. We look forward to speaking with you again at the conclusion of the next quarter. Thank you.

And this concludes today's AZZ incorporated second-quarter 2006 earnings conference call. You may now disconnect at this time.