AZZ Inc (AZZ) 2006 Q3 法說會逐字稿

At this time I would like to welcome everyone to the AZZ Incorporated third quarter 2006 earnings conference call. (OPERATOR INSTRUCTIONS). I will now turn the conference over to Mr. Joe Dorame, partner of Lytham Partners. Mr. Dorame, you may begin your conference.

Good morning. We would like to thank everyone for taking time out of your busy schedule to join us today to review AZZ's third-quarter financial results ended November 30, 2005. As Sylvia indicated, my name is Joe Dorame with Lytham Partners, the financial relations firm for AZZ Incorporated. 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 this conference call has been made available by the way of Webcast technology on the Internet and direct-to-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 include risks and uncertainties, some of which are detailed from time to time in documents filed by the Company with the SEC. Those risks and uncertainties include, but are not limited to -- changes in customer demand in 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 dip galvanizing markets; prices and 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 shipment; acquisition opportunities; adequate 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, I would like to turn the call over to Mr. David Dingus, President and Chief Executive Officer of AZZ.

Thanks to each of you for taking the time to join us for the conference call today for the third quarter of our fiscal year 2006. As Joe indicated, this is the quarter that was completed on November 30, 2005.

For the third quarter, revenues increased 16% to 44.3 million, net income is up 45% to 1.7 million, and diluted earnings per share increased 36% to $0.30. We are pleased to again report double-digit quarter-over-quarter growth.

In general, the market indicators and quotation levels suggest that some of our markets continue to show improvement, while others have stabilized at an improved level. Large international quotations are continuing, and while no new major international orders were secured in the third quarter, we continue to work to improve our participation in these markets.

Despite continued aggressive and competitive pricing conditions, and some orders being left at unacceptable pricing orders, we were able to achieve an improved order level that met our minimum margin expectations. We had a solid quarter for domestic orders. Total incoming orders for the quarter were 50.9 million, while shipments totaled 44.3, resulting in a book to ship ratio of 115%. Our book to ship ratio for the first nine months is 113%.

While our markets have strengthened over the last year, there is a continuum of excess capacity, which has put downward pressure on pricing. We do not believe that over the next few months we will see significant market increases that will absorb this excess capacity. This may inhibit our ability to significantly increase our volumes and profitability over the next few months.

Backlog at the end of the quarter was 83.1 million, versus 60.1 in the prior year, or a period-over-period increase of 38%. We are pleased with the distribution of the backlog across our operations. We estimate that approximately 40% of the backlog is scheduled to be delivered in the balance of fiscal year 2006. 50% of the backlog is scheduled for shipment in FY '07, and 10% for periods that extend beyond our next fiscal year.

During the last conference call we discussed the potential impact of the Gulf Coast hurricanes on our customers and our own operations. We anticipated that we would see more of an interim slowdown than what has occurred. This adverse impact did not materialize. Despite the loss of production days, our volumes in the third quarter were consistent with those achieved in the second quarter. And although galvanizing is enjoying good volume levels, maximization of price remains an objective and a challenge due to the continual escalation of the cost of zinc.

As a company, our accomplishments are improving and we continue to double and redouble our efforts to secure probable business. Our programs of a continual emphasis on systems and procedures and sharing of best practices among our operations to further enhance operating efficiency has, and we believe will continue to have a positive impact on our operating results. We are also continuing our emphasis on liquidity. Our current debt to equity ratio is 0.21 to 1, and this compares favorably to the 0.30 to 1 for the same period last year.

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

I would also like to welcome you to our third-quarter conference call, and at this time I will review our unaudited consolidated results for the period ending November 30, 2005.

AZZ recorded revenues for the quarter ending of 44.3 million, a 15.7% increase as compared to 38.3 million in the prior year. Net income for the quarter increased 44.6% to 1.7 million as compared to 1.2. Diluted earnings per share of $0.30 compare to last year's $0.22.

Revenues for the nine-month period ending November 30, 2005 were 136.9 million, an increase of 19.6% compared to 114.5 million. Net income for the nine-month period was 5.2 million, an increase of 56.1% as compared to 3.4 million. Diluted earnings per share was $0.93 as compared to $0.61.

Our Electrical and Industrial segment generated 66% of our revenues, while our Galvanizing Services segment generated 34%. The backlog continues to improve. While the third quarter did not include any unusual large international or domestic orders, we continue to see our book to ship ratio well in excess of 1 to 1. The increase in incoming orders during the third quarter of fiscal 2006 was primarily due to continued strong bookings in the transmission and distribution market, as well as increased orders from the domestic petroleum and industrial markets. Backlog at the end of the third quarter, again, was 83.1 million, which compares to 60.1 million at the end of our third quarter last year. As David indicated, our book to ship ratio was 1.15 for the quarter.

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

As we indicated to you last quarter, the passage of the energy legislation has and, we believe, will continue to have a positive impact on our Electrical and Industrial Products segment. There are incentives, reliability standards, and programs to promote alternative sources of energy, which should enhance customer spending. We now have the benefit of the known versus the unknown and uncertainty that we have had due to previously stalled legislation.

Industrial demand for our power distribution and motor control center products is showing improvement due to new projects, major renovations and expansions, and improved industrial capacity utilization. We believe the continued emphasis on the need for spending related to refining, LNG, and clean fuel initiatives should lead to additional opportunities. Despite the stronger demand of these markets, pricing does remain competitive.

Our specialty lighting products have seen and should continue to see improved demand due to new products and higher demand related to the repair and replacement of lighting for the offshore and onshore 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 an improved mining customer base, continues at a strong pace.

Our relay and control panels and industrial automation services financial performance has improved over the prior period. Continued improvement in capital spending and a continuation of the 80%-plus industrial utilization levels, as reported by the Federal Reserve, should sustain this improved operating level. Inquiries and bookings for our high-voltage transmission products continues at a very encouraging and robust pace. Orders and shipments of our tubular products to the petroleum market remain strong.

Dana will now cover the operating results of this segment.

In our Electrical and Industrial Products segment, we recorded revenues for the quarter of 28.8 million, a 15.3% increase as compared to the prior-year results of 24.9 million. Operating income was 2.7 million, a 56.1% increase as compared to 1.7 million. Operating margins improved to 9.3% compared to 6.9%. The increase in revenues resulted primarily from our increased demand for our products in the high-voltage transmission and industrial markets, particularly the petroleum sector. The increased demand from these markets continues to be partially offset by lower demand from the power generation market.

Improved quotations, incoming orders and shipment levels continue to be -- continued in the third quarter (indiscernible) our current fiscal year. While we have seen improved pricing levels, they are still below full recovery of our material cost increases incurred over the past 18 months. Competitive pricing pressures continue, as our industry still operates with a significant level of unused capacity. We continue to implement cost containments and review all strategic alternatives to lower our overall cost structure while maintaining product quality and customer service.

At this time, David will give us an overview of our Galvanizing Services segment.

Revenues for this segment in the third quarter were on pace with the second quarter. As we previously noted, the anticipated interim downturn as a result of the hurricanes did not occur, and allowed us to achieve levels equal to the second quarter despite the loss of production days.

While the margins for the third quarter were slightly ahead of the second quarter, we remain concerned about our ability to fully recover the escalation of zinc costs. This is a concern for the fourth quarter and for fiscal 2007. While every effort will be made, competitive forces may inhibit the accomplishment of our needed price changes.

Demand remains strong across our served markets. Our results do reflect the improvement in the industrial U.S. market that has resulted in increased capital spending for expansion and maintenance. Emergency work related to the hurricanes also positively contributed to our third-quarter volumes.

Based upon our own market intelligence and published data, we believe that the demand in our geographic markets continued to be stronger than in other areas of North America, and contributed to the excellent results for the first nine months.

Due to the fact that offshore rigs and platforms and Gulf Coast industrial installations are very extensive users of galvanized steel, we anticipate that we will see additional demand in the second quarter of fiscal year 2007 as the area rebuilds and replaces the heavily damaged infrastructure and industrial complexes.

Some of our customers continue to have interim issues related to re-staffing, due to the number of evacuees who have not returned and the number of people who are participating in the rebuilding effort, making it difficult to fully man their operations. This is also somewhat of a risk to us as well. This factor could offset the potential increase in demand for our galvanizing services.

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

Revenues in our galvanizing segment for the quarter were 15.5 million, an increase of 16.5% compared to 13.3 million. Our volumes of steel shipped, as well as our selling prices, were up when compared to the same quarter last year. Operating income was 2.8 million, an increase of 16% compared to 2.4 million in the prior year. Operating margins were 18% compared to 18.1%.

Our comparative higher operating results were achieved through increased revenues as well as operating leverage achieved through improved pricing and higher volumes. The increased revenues were due to improvements in the industrial market and the resurgence in galvanizing for the telecommunications and transmission pole market.

The settlement from our business interruption insurance from the impact of Hurricane Katrina was booked in the amount of $345,000 during the third quarter, offsetting a portion of our costs associated with lost production. Previous interruption losses associated to Hurricane Rita are currently being evaluated, and it is anticipated that business interruption insurance proceeds for the impact of the Hurricane Rita will be booked in the fourth quarter.

Property damage associated with the hurricanes resulted in a write-down of the carrying value of affected assets in the amount of 507,000, which was netted against replacement cost insurance proceeds in the amount of 550,000. This resulted in a $43,000 gain which was booked during the third quarter. Additional insurance proceeds will be booked in the future for property damage as well the -- as the amounts are determined and the proceeds are received. Increased zinc cost negatively impacted our margins for the quarter by approximately $639,000.

At this time I will cover some of our key cash flow and balance sheet items on a comparative basis. For the nine-month period, cash provided by operations was 9.7 million compared to 8.7 million in the prior year. Our receivable days outstanding and inventory change turns remained good. Accounts receivable days outstanding was 55 at the end of November '05, as compared to 56 days at the end of our last fiscal year. Year-to-date capital improvements were made in the amount of $4.6 million, and depreciation and amortization amounted to 4.3 million.

Our total outstanding bank debt at the end of the quarter was 23.3 million. We continued to reduce our leverage, and our current long-term debt to equity, as David indicated, at the end of the quarter was 0.21 to 1. As you can see, our focus continues to be on liquidity through debt reduction and by managing our working capital in the most efficient manner.

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

Our optimism about the improvement that has occurred in our markets is tempered by the potential of a slowing in the rate of growth, or reaching a plateau. The tremendous escalation in the cost of key commodities and energy remains a concern, not only in our pricing objectives, but the potential impact on our served markets.

While to date they have absorbed these cost levels, some concerns do remain as to how much more they can and will sustain. Some are projecting moderation in the cost of critical components and commodities. While we have increased pricing, market conditions may inhibit our being successful at full recovery (technical difficulty) cost increases as we continue the balance of our current fiscal year and move into fiscal year 2007.

Now, the aggressive steps we have taken in seeking out new domestic and international marketing opportunities, improving our distribution channels, the lowering of our cost structure, increasing our minimum pricing levels, improved operating efficiencies, enhanced management of our working capital, and significant reductions in our funded debt are reflected in our improved results for the third quarter and the first nine months of fiscal year 2006. Additional improvements in volume would further advance the gains that we have made due to leverage. Our products and services are well positioned to benefit from the continued strong industrial economy, the energy legislation, and the repair and the renovation of the storm-damaged Gulf Coast infrastructure.

On a year-to-date basis, our revenue and incomes are improving at a rate that exceeded our original internal targets and previously-issued guidance. This, combined with an evaluation of information currently available to management -- we are increasing our estimate of FY '06 earnings to be within the range of $1.20 to $1.30 per diluted share, and revenues to be within the range of 180 to 190 million. As we have indicated to you before, our earnings per share estimate includes the anticipated cost of completion of our Oracle ERP system implementation, and Sarbanes-Oxley compliance costs totaling some 1.4 million, which compares to an actual expense of 775,000 for fiscal year 2005. Achievement of the results that are projected within the range would result in a solid double-digit growth for revenues and earnings for fiscal 2006, when compared to fiscal 2005.

We do appreciate your support, and thank you in advance for the continuation of that support. And 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, Sidoti & Co.

The first question I have is regarding the strength you have seen in the revenue line, it seems like it's overwhelmingly been in the oil and gas market. Is that a fair assessment, or is there another end-market driver?

We've seen an improvement in our high-voltage products line, and then -- but yes, we have seen improvement, primarily from projects related to refining, clean air, clean fuels, LNG, and the general industrial pickup jobs.

You mentioned zinc; zinc is trading at an all-time high, last I checked. But don't you put in protective bands at the end of the calendar year for the full year ahead? Or correct me if I'm wrong; how do you do your zinc pricing?

That has traditionally been the method, where we would go out and negotiate with the zinc suppliers for an annual program where we would have a maximum price. Due to the volatility of the market, they're not real anxious to commit to that number. So we're having to adjust on a quarterly basis. So it's even (indiscernible) able to get that though, John. We are operating at 55% above a year ago in the cost of zinc, and 40% what the average was in zinc. We've got to recover that in price, even though we've got a cap. And that's the challenge. So we will continue to work with the zinc suppliers to get those caps. And like I said, we are operating in them. They're naturally -- and the volatility market as we indicated, they're not as willing to do them as they have in the past. Well, they're willing to do them, but we don't like the number they're willing to do them at. So that's the challenge for us is, yes, we are operating under a cap for the first calendar quarter of 2006, but our pricing will not recover that cap if we don't take some additional actions.

Fair enough. You mentioned capacity utilization industry-wide might be an issue in the industrial side of the business. What kind of capitalization rate are you running at?

We are operating at about 65 to 70%.

One last question. The tax rate seemed low to me in the quarter. What's going on with the tax rate right now?

It was an adjustment as a result of the -- just this tax credit? It was a onetime deal. And it will go back to a normal level after (inaudible). 37% is what we anticipate for the fourth quarter and next fiscal year.

Will Lyons, Westminster.

Congratulations on another fine quarter. Pardon me if I ask anything that you've already mentioned, because I pulled away from your call. You mentioned in your comments in today's press release, David, that you would like to continue to lower your internal cost structure. You guys have been working hard at that for at least three years. How much more fat do you think there is?

There's not a lot, but we can -- with being a project management and engineering (indiscernible) business, on the electrical side, we can always look for ways of doing that better. (indiscernible) we're going to be at 65% capacity for a number of years. We may have to look at another plant consolidation more than we have already done. But there's not the fat in there that we've already taken out. It's minimal. But we still believe it's something we ought to keep in front of us all the time.

And you think it's primarily on the electrical side?

Yes I do.

You also mentioned in your press release you're expecting hurricane-related work to start coming in not until Q2 '07. Could you give us a little bit of color on that? Are you looking at in terms of bidding not starting until Q2 '07, or revenues from current bids you're making now?

First of all, the fabricator and the contractors, such as a Shaw -- Shaw announced today the tremendous increase that they've had in that. It will take some time before that work is converted to the steel fabricators, and then some time for that work to then be done galvanizing. So the projects that are on there are not to the point of needing us in that cycle. So it's the life of the food chain. The projects that we see coming at us in the second quarter are either in the planning stage, the announced stage, or in the initial design and fabrication stage.

So you would start seeing revenues in Q2 '07?

That's correct.

On the galvanizing side -- and this is to give me some idea of the time span between you getting an order -- a signed order and completing the work. Your time exposure to these raw material fluctuations -- are we talking about six weeks between signing a contract and finishing the work, or three months?

It can really vary. If you take a major project that we have to quote several months in advance, we could be hanging out there for three to four months. A lot of it is a much shorter timeframe than that. So that's been difficult for us when zinc is moving at a -- even if it's moving upward at a predictable rate, we can anticipate that and price. But what made it so difficult for it now is the way that it is bouncing around. And how do you choose that? But essentially the actions -- if you're going to take a pricing action, you'll probably need to do it at least two to three months in advance of its realization.

That's quite a challenge, I'm sure. Back to the Sarb-Ox and ERP charges, do you expect any similar charges or costs in fiscal year '07, or do you have any new projects along those lines?

We do not expect a repeat of the costs associated with the ERP; that will be completed. Of course, the bulk of that 1.4 is in the Sarbanes-Oxley. So while we don't have the number finalized of what that projection is, we anticipate probably the ongoing cost of that to be in the range of 500 to 750,000. So yes, there will be less they're spending, but we'll still have a significant piece in there.

500 to 750 every year for the foreseeable future?

Yes.

Interesting. That's a heck of a drain on you, isn't it?

I know.

Despite that, you had a great quarter. We are looking forward to '07. Congratulations again.

Thanks very much. Appreciate your support.

(OPERATOR INSTRUCTIONS). Robert Palneker (ph), Barrington.

Nice quarter. I was wondering if you could just give a little more color -- how much was tonnage up in the galvanizing business for the quarter, on a volume basis?

Just a moment. On a quarter-to-quarter basis? About 11%.

And year-over-year?

Year-over-year would have been 17.7.

And you guys -- can you just give me a little more information on how much of your cost of goods sold on that side is zinc and how much of it is natural gas? Because I would have thought natural gas had an impact on you guys as well.

Natural gas -- we've been fortunate enough, as we've talked about before, that the industry adopted a surcharge for natural gas, which we employed, that has offset the increase there. So we've been more fortunate on that side than we have on the zinc. So that has -- while that has been a challenge for us through that, it has been primarily recovered through the surcharge mechanism. And when the freight companies and everyone else are doing that, it becomes more of an industry standard. So (indiscernible) comes from -- that is -- no matter how you describe it, is in price increase for the customer. And then you throw on another price increase for zinc, and we just keep pushing and pushing and pushing. And we're going to hit a point of some push-back, we think.

Hopefully not too soon.

I agree.

Are there any areas in either business that you guys have seen weakness recently?

We have not seen weakness, but we've seen some leveling. We didn't -- as we talked a little bit earlier, the increases have come more as a result of energy legislation. They've come in the high-voltage, and they've come in the petroleum refining market. But I would say that the utility market is a leveling market. Our tubular products that support the drilling effort has leveled. But they leveled at a nice level compared to a year ago. We are seeing some plateauing, but like I said, at a much improved level of where we were this time last year.

Are you guys expecting to give '07 guidance on your next call?

Yes we will, which will be in the first 10 days of April.

William Tiche (ph), Badal (ph) Capital Management.

I wanted to ask a few questions here about your capital expenditure expectations for this year, and if you could quantify it and maybe break it out for the electrical products division, as well as the galvanizing services side of the business.

Total CapEx this year is going to be somewhere around 6.2 million. 2.9 million -- 2.8 to 2.9 will be in the galvanizing portion of the business for maintenance CapEx. We'll spend about -- which is -- we'll spend about 1 million -- $2 million in our G&A. That will be the wrap-up of our Oracle of about 450, and some other computer-related items. And then the balance of that will go into our electrical and industrial part of our business. And a large portion of that electrical expenditure will be for our high-voltage transmission orders that are coming in for expansion equipment to test those kind of things in that market.

How about '07? Is there any early indicators there as far as any (multiple speakers)

We have not prepared to release those numbers.

(OPERATOR INSTRUCTIONS). Gregory Varbadian (ph), Gabelli & Co.

Could you please just elaborate a little bit on the pricing actions that you think you're going to be taking over the next quarter or two? Is it still the game plan to keep those minimum margin levels, even if you lose a little bit of share? Could you just provide some light on that?

For the Electrical and Industrial Products segment, yes, we are going to remain with our program of minimum margin levels. We believe it has worked for us. Yes, we do believe it has adversely impacted our share. But I think that the improvement that we've got in the margins of the backlog related to the industrial and electrical is better than it was this time last year. As I indicated, we some time in the very near future will be announcing what our intentions are related to price as a result of zinc cost increase. We may be going for as much as a 10% increase in the price of zinc that would be effective no later than March 1st.

And then again, on the optimum debt level, has anything changed there as far as the strategy of the Company?

No. As we've always indicated, once we get below the 0.5 to 1 we believe that we should be looking for additional opportunities, either through internal development or through acquisition. So we believe that we are totally in the range of extreme comfort, and can have a lot of dry powder that's there available for us to get a little more aggressive in looking.

Last question. As you look to do maybe a transaction down the road, is there one of the two segments that you prefer to make -- to add on, to do a bolt-on?

We're very pleased to be in both segments and we would like to acquire in both segments.

(OPERATOR INSTRUCTIONS). J.T. Ryek (ph), Crosscap (ph).

I wanted to ask about the zinc. You all mentioned that you're currently operating a maximum price for zinc, a zinc cap right now. Is that being utilized at this time, or has it -- I guess what I'm trying to figure out is how much will your zinc cost increase once that cap rolls off.

We are bumping right up against the maximum price today, for today's purchases.

Also, you mentioned in the last question that you all are going to try to increase, I guess, your galvanizing price by about 10% to cover for what the price increase is in zinc. What will that do to your operating margin in the galvanizing segment? Does that just keep it at this -- kind of the 18% where it's been running? Or will that bump it back up to maybe a 20% level?

No. It would at best keep it at the 18. And the struggle (ph) is if it goes up anymore, it would possibly slide a little below the 18.

Even with the 10% increase?

That is correct.

I'm obviously assuming that's going to come up. You saw a lot of -- I guess from kind of getting an implication that the third quarter was -- you all had some factory down-time, yet you were still able to maintain volumes about even with the prior quarter. What do you think is causing -- it doesn't seem to indicate much demand destruction. Do you think that there's some -- are people trying to kind of maybe front-load, trying to front-load some of their fabrication of zinc, trying to front-load some of their galvanizing due to the worry that zinc prices are increasing? Or is there just more demand than you see out than you all expected?

There was more emergency demand and must-do fixes in the third quarter than we had anticipated. When we talked to you last quarter about what we were projecting -- we finished this quarter with volumes right at the 15.5 million level -- we anticipated that that would drop to about the 13 to 13.5 level in the third quarter. And margins, instead of being at 18%, would possibly drop to as low as 13.5% due to the cost of lost production time, loss of leverage, and everything else. As you can tell, that didn't happen because we finished the quarter almost identical to the second, which was at that $15.5 million level and the 18% margin level. So that essentially says we got $1.5 million worth of emergency work related to the hurricane that we did not think would happen.

I see. Do you think -- obviously, you've given some guidance on the fourth quarter itself. Does that include an expectation of continued -- anymore continued emergency work, or have you found that that's basically disappeared?

There will be some level of it, but not near the level that we've already done. And like I said, the next push will come when the major rebuilding projects get started and go downstream for us.

(OPERATOR INSTRUCTIONS). I'm showing there are no further questions at this time. Gentlemen, are there any closing remarks?

Again, we would like to thank everyone for joining us today on the call. If you require additional information, please feel free to contact Lytham Partners at 602-899-9700, 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.

Ladies and gentlemen, this concludes today's AZZ Incorporated third quarter 2006 earnings conference call. You may now disconnect.