AZZ Inc (AZZ) 2007 Q1 法說會逐字稿

Good morning. My name is Cynthia and I will be your conference operator today. At this time I would like to welcome everyone to the AZZ incorporated first-quarter 2007 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 session. (OPERATOR INSTRUCTIONS) I would now like to turn today's conference over to Mr. Joe Dorame, with Lytham Partners. Please go ahead, sir.

Good morning. Thank you for joining us today to review the financial results of AZZ incorporated for the first quarter of fiscal year 2007 ended May 31, 2006. As the conference call operator indicated, my name is Joe Dorame. I am with Lytham Partners. We are the financial relations consulting 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 with prepared remarks, 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 involve 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 customers' 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 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 shipments; 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. We undertake no obligation to affirm, publicly update or revise any forward-looking statements whether as a result of information, future events or otherwise.

With that having been said, I would like to turn the call over to Mr. David Dingus, President and Chief Executive Officer of AZZ. David?

Thank you, Joe. Thanks to each of you for taking the time to join us for the conference call for the first quarter of fiscal 2007, the quarter ended on May 31, 2006. For the first quarter, revenues increased 17% to $52.5 million, another record-setting quarter. Net income is up 94% to $4.1 million, another record and diluted earnings per share increased 87% to $0.71 per share. We are again pleased to report quarter-over-quarter strong double-digit growth.

In general the market indicators are that we continue to benefit from strong market conditions. While we are beginning to see some of our markets plateau, it is at an improved level. As compared to last year, international opportunities continue to play an increasing role in our growth and expansion opportunities.

Total incoming orders for the quarter were $70.8 million while shipments for the quarter totaled $52.5 million resulting in a book to ship ratio of 135% for the first quarter. Incoming orders increased 57% over the same period of a year ago and compare favorably to the incoming orders in the fourth quarter of fiscal 2006 which represents a 73% increase. First-quarter orders were very favorably impacted by the receipt of a large international order in the amount of $16.7 million for our high-voltage electrical equipment.

While our markets have strengthened over fiscal 2006, we have been able to increase pricing, there is a continuum of excess capacity particularly for our utility generation and distribution products, which continue to inhibit our ability to maximize pricing and resulting profit. Despite the improvements in the power generation market and the potential for additional improvements as we go forward, pricing has shown little or any recovery from the depressed periods of the past and remains below our expectations and acceptable minimum margin levels.

Backlog at the end of the quarter was $92.1 million versus $65 million in the prior year or an increase of 42%. As we have indicated, the backlog was favorably impacted by the excellent incoming international orders. While we continue to work on other significant orders, we do not anticipate the receipt of them in the current fiscal year. We do not anticipate another significant increase in our backlog over the balance of the fiscal year based upon the size and scope of our current quotation activity and announced products. We do see improved conditions of our power generation opportunities and anticipate we will be quoting on these by the end of the year. Based on customer requested delivery dates, we estimate that approximately 68% of the backlog is scheduled and should be delivered in fiscal 2007.

Galvanizing demand for the quarter remains strong and tonnage of steel galvanized improved 7% on a quarter-over-quarter basis. This volume increase is spread across all of our markets and we're seeing work related to the Gulf Coast rebuilding and repair programs and anticipate that this is the potential for additional work. We continue to be amazed at the escalation of zinc costs. We have increased pricing in concert with cost increase and we'll have to continue this to offset additional cost escalation.

As we have discussed previously, there is the possibility that as we reach some point where customers begin to seek alternatives to galvanizing or delay or cancel projects. This has been very limited so far in the first quarter, but the risk does remain. The cost of zinc has been relatively stable in the last 15 days, however, worldwide demand continues to outpace its supply. As of June 23, 2006, zinc inventories have shrunk 42.4% during calendar 2006.

As a Company, our accomplishments have improved and we continue to double and redouble our efforts to secure profitable business. Our programs have continual emphasis on systems and procedures, the sharing of best practices among our operations to further enhance operating efficiency, had a very positive impact on our operating results for the first quarter of 2007. We believe that these efforts combined with pricing improvements and the leverage gained from additional volume positively impacted the first-quarter results.

As we stated in our press release, the first quarter was very favorably impacted by the realization of increased galvanizing pricing in the first quarter and we do recognize that the increased costs that we incurred for zinc purchases in the first quarter will be recognized in subsequent periods.

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

Thank you, David. AZZ recorded revenues for the quarter ending of $52.4 million, a 17.2% increase as compared to $44.7 percent million in the prior year. Net income for the quarter was $4.1 million, an increase of 93.5% which compares favorably to $2.1 million in the prior year. Diluted earnings per share was $0.71 compared to $0.38. Our first quarter was favorably impacted, as David indicated, from our continued strong demand primarily from the high-voltage transmission and petroleum markets and improved market conditions and excellent price realization required to offset the increasing cost of zinc in our Galvanizing Services segment. Our Electrical and Industrial segment generated 60% of our revenues while our Galvanizing Services segment generated 40%. We anticipate approximately the same percentage breakdown for the balance of fiscal 2007.

Backlog at the end of the first quarter again was $92.1 million, which compares to $65 million at the same period last year, a book to ship ratio of 1.35 to 1 for the quarter. The increase in coming orders during the fiscal quarter for fiscal '07 over the same quarter in '06 was favorably impacted by a large international order in the amount of $16.7 million for our high-voltage equipment.

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

As we indicated to you in our last quarterly call, 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 energy sources which should continue to enhance customer spending. We are monitoring closely the potential impact that additional utilities company mergers may have on market demand.

Industrial demand for our power and motor control centers remains strong due to new projects, major renovations and expansions, and improved industrial capacity utilization levels. Additional projects continue to be reported by the engineering procurement and construction firms and while many have not yet been released for quote, we are encouraged by these announcements and anxiously await the opportunity to quote and pursue this additional business. We believe that the emphasis on the need for spending related to refining, LNG, and clean fill initiatives as well as mining systems upgrades should lead to additional opportunities for AZZ.

Our special lighting products have seen and should continue to see improved demand due to new products and higher demand related to the strength of petroleum markets, repair and replenishment of lighting for the offshore and onshore equipment and facilities, and overall strength of the U.S. industrial market.

Operating results of our metal flat outdoor switchgear products remain solid. Utility distribution substation incoming orders in the first quarter were below our expectations and we trust this is seasonal. The mining application of this product is maintaining its strength and is anticipated to make a strong contribution to our results for fiscal year 2007.

Our relay and control panels and industrial automatic services financial performance has improved over the prior period. Continued improvement in capital spending and maintaining an 80% plus investor utilization level as reported by the Federal Reserve should sustain this improved operating level. Bookings for our high-voltage transmission products were again at a very encouraging and robust level and we now have a record level backlog for this product offering. The backlog does reflect strong domestic as well as international order activity.

Orders and shipments for our tubular products to the petroleum market remains strong and we completed another very successful quarter.

Dana will now cover the results of this product segment.

In this segment, we recorded revenues for the quarter of $31.5 million, a 9.4% increase as compared to the prior year results of $28.8 million. Operating income of $4.1 million or a 95.3% increase compares to $2.1 million in the prior year. Operating margins improved to 13% for the quarter compared to 7.3% in the prior year. As we have seen improvements in the markets we serve which allowed us to increase pricing levels, the improvement in our margins is now reflecting our consolidation efforts and the lowering of our cost structure over the last two years. We continue our emphasis on booking a business at specifically targeted margin levels and pursuing pricing actions that will recover the significant increases in the price of steel, aluminum, and copper that we have incurred over the past couple of years.

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

We remained somewhat concerned about our ability to continue to recover the escalation of zinc costs. As we stated, this was a concern in the fourth quarter of fiscal 2006 and does remain a concern for the balance of fiscal 2007. While we have been very successful to date, competitive forces may in the future inhibit accomplishment of our needed price changes. Demand remained strong across our served markets. Our results do reflect the improvement in the industrial U.S. economy that has resulted in increased capital spending for expansion as well as maintenance. The work that is related to the hurricanes also positively contributed to our quarterly volume.

Based upon our own market intelligence, we believe that demand in our geographic market continues to be stronger than in other areas of North America and contributed to the excellent results for the first quarter. Most are reporting a flat year-over-year comparison compared to our 7% increase in tonnage. We believe this extends beyond just the work that is associated with the hurricanes. While we have seen limited recurrences of customers going to another method or alternative, we are monitoring closely to see the impact of the increased cost of galvanizing and what that might do to overall demand.

Dana will give us a review of this segment as well as cover some of our key balance sheet items.

Revenues in the Galvanizing Services segment for the quarter were $20.9 million, an increase of 31.3% compared to $16 million recorded in the first quarter of fiscal 2006. Our volumes of steel shipped as well as our selling prices were up when compared to the same quarter last year. Operating income was $6.5 million, an increase of 73.8% compared to $3.7 million in the prior year. Operating margins improved to 31.1% compared to 23.5%. Our comparative higher operating results were achieved through increased revenues as well as operating leverage achieved through improved pricing and higher volumes.

Revenues for the first quarter were significantly impacted by pricing actions required to offset escalating zinc costs. Due to our first-in/first-out cost basis on zinc inventories, the higher cost for zinc purchased in the first quarter will not be recognized until subsequent quarters, so we do not believe the margins experienced -- expressed in terms of percentage of sales are sustainable for the balance of the year.

In the first quarter we were able to recover $3.3 million of additional zinc costs that we recognized -- that will be recognized in future periods through price increases in the amount of $4 million. Work related to the rebuilding of the Gulf Coast due to the hurricanes continues to increase and we expect further business from that area.

At this time I will cover some key cash flow and balance sheet items on a comparative basis as well. For the three-month period, cash provided by operations was $4 million compared to $1.8 million in the prior year. Our receivable days outstanding and inventory turns remained good. Outstanding receivable days was 54 days compared to 53 at the end of the comparative period last year.

Year-to-date capital improvements were made in the amount of $2 million and depreciation and amortization of $1.5 million. Our total outstanding bank debt at the end of the quarter was $18.1 million. We continue to reduce our leverage as our emphasis remains on liquidity. Our current long-term debt to equity ratio at the end the quarter was 0.20 to 1 as compared to 0.31 to 1 in the same period last year.

During the quarter we restructured our bank agreement replacing our existing term and revolving loan facility with a $50 million unsecured revolving line of credit with one lender. This unsecured facility will be used to refinance current outstanding borrowings, provide for working capital needs, capital improvements, future acquisitions, and other letter of credit needs.

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

Thank you, Dana. Our optimism about the improvement that has incurred our markets is tempered by the belief that there is a slowing in the rate of growth and some of our markets have reached 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 or served markets. While to date the markets have absorbed these cost increases, some concern does remain as to how much more the industrial economy can and will sustain.

The aggressive steps that we are taking in seeking out new domestic and international market opportunities, improving our distribution channels, lowering our cost structure, increasing our minimum pricing levels, improving operating efficiencies, enhanced management of our working capital, and significant reductions in our funded debt are reflected in the approved operating results. The improvement in volume has advanced the gains that we have made due to leverage.

Our products and services are well-positioned to continue to benefit from a strong industrial economy, the energy legislation, and the repair and the renovation of the storm damage to Gulf Coast infrastructure. While we anticipate that the current demand will continue, the timing of projects and release could limit our ability to recognize the full benefit of this growth in fiscal 2007. This combined with increases in commodity prices, particularly zinc, could inhibit our growth opportunities in fiscal 2007 and keep pressure on or margins. We will continue our efforts to aggressively manage our way through these conditions in order to build upon our priority and accomplishments.

Based upon the evaluation of the information currently available to management, we are increasing our estimate of 2007 earnings to be within the range of $1.85 to $1.95 per diluted share and revenues to be within the range of $205 million to $215 million. At this time we anticipate that we will continue to see improved yearly results this year when compared to the prior year, however, we do not anticipate that we will continue to see the same rate of improvement that we saw in the first quarter.

Even though our backlog has recovered, the lower bookings level in the fourth quarter of fiscal 2006 will likely adversely impact our second quarter and in some cases our third quarter operating results as we are beyond the reaction time at several of our operations to fill available production slots. This issue combined with the return of the galvanizing margins to more normalized levels as we progress through this fiscal year is anticipated to result in more quarter-to-quarter volatility than we have seen in our prior fiscal years.

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

(OPERATOR INSTRUCTIONS) John Franzreb, Sidoti & Co.

I was just wondering if you could reconcile the statement you said about unacceptable pricing in the electrical market. When I look at the revenue for the May quarter and the op margin that you recorded, it is sequentially better, at least the op margin is than the February quarter on lower revenue. That would suggest to me that you're getting better pricing. Why isn't that the case?

John, it is the case on the orders we have secured. I am referring to the orders that we have not been able to secure primarily in the utility power generation market which has been the most severe. So what we have secured, John, has and that has resulted in the improvement in the margins and we are very encouraged about that. I am referring more to our rate of growth impact than the results of what we have achieved.

Okay, so you have been willing to let jobs go at unacceptable prices?

Absolutely.

Has there been any indication that some of the competitors are increasing their pricing actions on new jobs going forward?

Not as recent as the month of June we're still not seeing it.

Okay. When can we expect the biggest impact of the zinc and FIFO inventory going forward?

Towards the end of the third quarter and throughout the fourth quarter, so essentially two months of the third quarter and all three months of the fourth quarter, John.

Okay. And can you just discuss the demand profile by end market especially in the electrical side of the business? What is the biggest driver there and if you kind of look at a pie chart, how does it look now verses maybe a year ago?

The most encouraging of course is in a high-voltage electrical transmission. Now that is not only as a result of the large international order, but we've seen strong spending in the Northeast primarily as a result of the reliability standards that were part of the energy legislation. Utility distribution has been relatively flat. It is still flat at a relatively strong level. Opportunities for generation have started to improve but like I said our order backlog hasn't because the pricing is not at our minimum levels. So then if you move to the industrial, those markets particularly related to the petrochem refining, LNG, clean fuels have been usually strong at this time, John.

How much is petrochem of your sales in the quarter?

I would have to calculate that.

One last question and I'll get back into the queue. You might have said this. Where did you end up with long-term debt in the quarter and how much cash on hand in the balance sheet, Dana?

Long-term debt was $18.1 million and we've got about $2 million in cash.

What does the cap budget look like for the full year? And are you capacity constrained given the current demand profile?

We've got $8.5 million budgeted this year and we are expanding our capacity in the high-voltage transmission part of our business primarily.

Okay, good. Thank you very much, guys.

(OPERATOR INSTRUCTIONS) Will Lyons, Westminster Securities.

Congratulations on such a strong quarter. The international order, could you give us a little detail on that, where it is from, what it was for, who the buyer was?

All I can do, I can't going go into that much detail but it was from Middle East and it did involve a significant order for our high-voltage gas insulated bus duct productline. It was a major, major expansion of a power generation facility and of course we got picked up the transmission piece of it to get it to the existing grid, Will.

Who was the primary contractor on that?

We're not allowed to disclose.

Okay, so most if not all the increase in the backlog was primarily from that order for which you shipped nothing yet?

That is correct. There was about a $19 million total increase; $16.7 million of that was related to that order, that is correct but it was when we did not have revenue recognition on it in the first quarter.

On the galvanizing segment, did I understand correctly you expect in the third and fourth quarter the FIFO cost of zinc to really flow through to your margins and so we will see a dip in galvanizing segment margins in the second half of the year?

That is correct and we are saying that our guidance our forecasting says that by the last two months of the third quarter and the fourth quarter we will return to more traditional margin as a percent of sales level when compared to the first quarter, Will.

Okay, and I'll get back in queue after this question. The blackouts in '03 really seemed to wake people up but it sure seems like it's taking a lot of time for that to flow through to orders for you guys and I'm sure others in the chain. What can we expect over the next two years? Is that finally going to pick up? Is the financing there? Is the commitment there? What is your view of how that's going?

The ultimate resolution to the infrastructure related to our grid was not addressed specifically in the last energy legislation. It was addressed indirectly in reliability standard, but until FERC or the legislation determines how you recover the investments and long-term investments in the investment grid, we will continue to have problems and continue to have pent-up demand for companies such as ourselves.

Sure. Okay, thanks. I'll get back in the queue.

(OPERATOR INSTRUCTIONS) Zahid Siddique, Gabelli & Co.

I have a couple of questions. First one on the galvanizing segment, what are the normalized margins that you would expect I guess in Q4 and beyond?

Over the last three years we have averaged in the 18.5 to 20% level.

So we should expect 18, 19 to 20 in that range, the margin?

We expect that to be the running rate. Now the effective rate for this year will naturally be higher because you have the positive contribution of the first and second quarter, but our strategy and our pricing and our manage those at is that so we exit the year at a running rate in margins very close to what we have traditionally seen. Now we had anticipated at the beginning of the year that that would be in the 17.5 to 18% range. We traditionally like we said over the last three years have been in the 18.5 to 20% range, so essentially what we are saying is that our objective is to be at that running rate and the more normalized level as we exit the current fiscal year. But again mathematically that would come back into this year being one of our better years in total for the full year, but if when you really do all the flowthrough, the FIFO, and the projections and what our strategy is, it is to get to that more normalized level.

Okay. Could you break down in percentage terms how much of your business, E&I business is high-voltage versus medium and low voltage?

No, we don't break it down that way and I do not have an update. We break it down by transmission and distribution as one number and power generation for the other.

And what is the percentage breakdown between those two?

I've got in on my desk but not in front of me.

That's something we will have to get back to you with.

It is the same as we presented to you last time we were in your office.

Great. And just one last question on your M&A strategy. You mentioned that in the past I guess that you will look for both on acquisitions. My question is what about if someone comes makes an offer for your Company? Is that something you would entertain?

Fiduciarally we have the responsibility to do that to our shareholders. There is certainly always a potential that someone sees the additional growth and expansion opportunities of AZZ and decides it wants to be part of their portfolio and of course our shareholders require us to do that and we would not hesitate to do it from a standpoint if it was in the best of interest of our shareholders.

Okay, thanks a lot.

(OPERATOR INSTRUCTIONS) Will Lyons.

Your prior FY '06 -- fiscal year '07 guidance, did that include expectations for landing this large order?

Yes, it did.

Just some back of the envelope math here, it looks like your guidance for '07 implies high single-digit low double-digit revenue growth for the rest of the year, which is well below what you're seeing for the past four quarters. I know you guys are conservative, but is that because you see no more large orders coming or can you us a little flavor for why you've -- the rest of the year the guidance on the revenue is very conservative?

Well, as I indicated, I think we're seeing some plateauing of some of our markets. They are plateauing at very encouraging levels through that and there is no doubt that we have benefited by the improvement in our international marketing efforts and international order security. As we look at those orders where we are aggressively working on right now, we don't see any of those happening in the time to impact the earnings stream for '07.

Just as I indicated also, there is some encouraging things going on in the power generation market that we don't expect to hit this year's revenue stream and I am a little more conservative than I was on what even will be in our backlog at the end of the year if we don't see some improvement in the pricing from some of our competition. But we are getting beaten double-digit percentages.

And on the power gen side you just mentioned, is that internationally or really across the board?

Across the board.

What is happening for you to in markets where we all know there's huge brownouts all the time, specifically places like China? Do you feel like you're making inroads there?

We are doing very well in China. I'm very optimistic about our long-term potential there.

I know one of your subs had a specific, a very specific partnership they were building with what I think was termed by somebody sort of one of the GEs of China. Are more of your subs looking into doing that? What is happening specifically?

If I could just (indiscernible) who we're trying to partner with we wouldn't put them into the category anywhere close to the size of GE. What our intent is of course is to maximize the local intent -- content where it makes sense but when it is limited to a one or two particular projects, it is hard to structure a long-term joint equity or even a partnership agreement going forward. Where we think that there is long-term sustainable business levels either for the supply of the China market or as an access to an export from China, then we are very interested in pursuing that. But many of our products are limited to domestic or within the Americas as opposed to the generation in transmission products, which do lend themselves very nicely for development into China and export from the U.S.

I see. Okay, thank you.

(OPERATOR INSTRUCTIONS) [Tom Zeifang], (indiscernible) Capital.

On the SG&A line, should we expect throughout this fiscal year a relatively flat absolute dollar growth?

Yes, I think if you took the first quarter, it is representative of what we do expect for the balance of this fiscal year.

Can you remind me why it is up 40% year-over-year?

Okay. Of course there has been a lot of changes and we of course had the impact of 123(R) that with the improvement in earnings you have the impact on compensation expense. You have the impact on profit-sharing expense. And also the recording of the expense associated with stock appreciation rights, which is now must be recorded into it as well as an end piece of that. Then you have the running rate of the continuum. In the first quarter of last year we had not incurred a lot of the expense related to Sarbanes-Oxley and whereas now it is more of an ongoing expense.

What is your SOX cost on an annualized basis?

We spent $1.8 million last year. We anticipate spending between $700,000 and $900,000 this year.

Okay. Then in your guidance for this calendar year of call it $1.90, can you give us a sense of what some of the margin assumptions you are using?

The margin assumption as we use were, as I went over, the biggest assumption you have to go through in your modeling of course is what is happening on the galvanizing. As we said, we anticipate those to end up the year ahead of where we traditionally have which is in the 18.5 to 20% range and we anticipate the electrical and industrial to be at the year at 10.5%

Okay, thank you.

(OPERATOR INSTRUCTIONS) At this time there are no further questions. I would like to turn the call back to David Dingus for closing remarks.

Again we appreciate the time that you took today and your interest in the Company and in gaining more knowledge on the excellent quarter that we had in the first quarter. We look forward to reporting to you again at the end of the second quarter. We certainly wish everyone a great holiday weekend. Thanks again for your participation.

Ladies and gentlemen, this concludes today's AZZ incorporated first-quarter 2007 earnings conference call. You may now disconnect.