AZZ Inc (AZZ) 2007 Q3 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 be AZZ incorporated third quarter 2007 earnings conference call. (OPERATOR INSTRUCTIONS). Thank you. Mr. Joe Dorame, you may begin your conference.

Good morning. Thank you for joining us today to review the financial results of AZZ incorporated for the third quarter of fiscal year 2007 ended November 30, 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 on the call representing the Company are Mr. David Dingus, President and Chief Executive Officer, and Mr. Dana Perry, Chief Financial Officer. At the conclusion of today's prepared remarks we will open the call for a Q&A session.

Before we begin, we submit for the record the following statements. 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 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 dip galvanizing markets, prices and raw material costs including zinc and natural gas, which are used in 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.

Thanks to each of you for taking the time to join us for the conference call for the third quarter of fiscal '07, the quarter ended on November 30, 2006.

For the third quarter revenues reached another record-setting level, increasing 48% to $65.4 million. Net income rose 248% to $8.4 million, and diluted earnings of $0.88 for the quarter. For the nine months revenues were $180.7 million, with a year-to-date diluted earnings of $2.48.

We continue to benefit from strong market conditions and expanded served markets. International opportunities continue to play an increasing role in our growth potential.

Total incoming orders for the quarter were $67.7 million, while shipments for the quarter totaled $65.4 million, resulting in book to ship ratio of 104% for the third quarter. For the first nine months of fiscal '07 orders totaled $207.9 million, while shipments totaled $180.7 million, resulting in a year-to-date book to ship ratio of 115%. Incoming orders for the first nine months increased 34% when compared to the same period of a year ago.

Our markets have strengthened over 2006 and we have been able to continue to increase pricing. We continue our efforts to achieve new business, which meets or exceeds our margin target. The increase in margin of previously booked projects, which is now being reflected in our operating results, gives a positive consequence of our strict adherence to pricing and order acceptance criteria.

We believe our backlog consists primarily of jobs with margins which approximate those that we've achieved in the third quarter and the first nine months of our fiscal year. We're not at full capacity and we do have opportunities to continue to supplement our backlog with quick turn, high margin jobs and to continue to build our backlog for further growth and expansion.

Backlog at the end of the quarter was $101 million versus $83.1 million in the prior period on an increase of 22%. The third quarter bookings remained strong despite not having a significant international order similar to that achieved in the first quarter of the current fiscal year.

We continue to work on additional significant orders outside of the U.S. and we do anticipate the receipt of these orders in the current fiscal year. Without these orders we believe our backlog over the balance of the fiscal year would remain relatively constant based upon the size and the scope of our current domestic quotation activity and announced projects.

We do see improved market conditions for our power generation products. The timing of these orders is difficult to precisely determine, but anticipate we will see an increased level of bookings by the first quarter of our new fiscal year for this power generation market.

Based upon customer requested delivery dates, we estimate that approximately 44% of the current backlog is scheduled to be delivered in FY '07. Galvanizing demand remains very strong and tonnage of steel galvanized shipments increased 24% on a quarter-over-quarter basis. This volume increase is spread across all our served markets. The quarterly results did include one month contribution from our recent acquisition of the galvanizing operations of Witt Industries in Indiana and Ohio.

For the first nine months tonnage shipped has improved a most impressive 16%. Zinc cost volatility continues, and we did see zinc increase above $2 during the quarter. With overall demand being strong, we have been able to achieve pricing that has recovered cost increases. On a year-to-date basis pricing has increased some 47%. Our stated concern about the increased cost of galvanizing and the impact this might have on customer selecting alternatives fortunately has not materialized.

We continue to closely monitor U.S. industrial market indicators to determine any anticipated change or impact upon our markets, which remain very strong. As a Company our accomplishments have improved and we continue to double and redouble our efforts to secure more profitable business and effectively and efficiently execute on that business.

Our programs of continually emphasis on systems and procedures, the sharing of best practices among our operations to further enhance operating efficiency, combined with aggressive pricing programs, have had a very positive impact on our operating results for the third quarter and the first nine months of '07. We believe that these efforts and the leveraged gained from additional volumes positively impacted the results.

As we have stated in previous discussions of our results, the third quarter and the first nine months for fiscal '07 were very favorably impacted by the realization of increased galvanizing prices. The implemented price increases should cover the costs which will be realized in subsequent quarters. Our evaluation of current pricing and current zinc costs indicate that when these increased costs are fully realized our operations margins for this segment should be in excess of 20%.

With that as an overview of our results, Dana will now give us a review of our operating results for the third quarter and the first nine months.

I would also like to welcome each of you to our third quarter conference call. And at this time I will review our unaudited consolidated results for the period ending November 30, 2006.

We recorded revenues for the quarter of $65.4 million, a 48% increase, as compared to $44.3 million in the prior year. Net income for the quarter was $5.2 million, an increase of 203%, which compared to $1.7 million in the prior year. Diluted earnings per share was $0.88 as compared to last year's $0.30.

Revenues for the nine month period ending were $180.7 million, a 32% increase, as compared to $136.9 million. Net income for the nine month period was $14.7 million, an increase of 180%, which compares to $5.2 million in the prior year. Diluted earnings per share was $2.48 compared to last year's $0.93.

Strong demand for our Electrical and Industrial Products, as well as for our Galvanizing Services continued in the third quarter. New orders were strong and balanced across our power generation transmission and distribution and industrial products as well. In our Galvanizing Services Segment our third quarter continued to be favorably impacted by positive market conditions and excellent price realizations acquired to offset the increasing cost of zinc in our Galvanizing segment.

Our Electrical and Industrial segment generated 57% of our revenues, while our Galvanizing Services Segment generated 43%. We anticipate this same percentage break down for the balance of fiscal 2007.

Backlog at the end of the quarter was $101 million, which compares favorably to $83.1 million in the same period last year. Our book to ship ratio, as David indicated, was 1.04 to 1 for the quarter. The continued strength of our markets has allowed us to increase our incoming order rate and continue our pricing programs designed to achieve cost recovery and improved margin levels. At this time David will give us an overview of the Electrical and Industrial Product Segment.

Industrial demand for our power and motor control centers remain strong due to new projects, major renovations and expansions, and industrial capacity utilization levels remaining above the 80% level. Projects continue to be reported by the engineering procurement and construction firms, and we believe that the emphasis on the need for spending related to refining, LNG, clean fuel initiatives should continue to lead to continuing strength in this market.

Our specialty lighting products have seen, and should continue to see, strong results due to new product and demand related to the strength of the petroleum market and overall strength of the U.S. industrial market. The demand for our medal clad outdoor switchgear products remains solid. Utility distribution substations, the wind energy market, and the strength of the surface mining market all contributed to the strength of the results of this product offering.

Our relay and control panels and industrial automation services' financial performance has improved over prior periods. Continued improvement in capital spending and maintaining an 80% plus industrial utilization level, as reported by the Federal Reserve, should sustain this improved operating level.

Quotations for major projects, which utilize our high-voltage transmission products, were again at a very encouraging and robust level. And our backlog in quotations reflect strong domestic and international demand.

We continue to operate at record-setting levels. As we indicated earlier, we did not book any significant orders outside of the U.S. in the third quarter, but anticipate that the fourth quarter will reflect a stronger contribution from international sales.

The increasing demand for our products that serve the power generation market is encouraging, and maintaining the build schedule of new generation plants should very positively impact our incoming order rate in future quarters. Orders and shipments of our tubular products to the petroleum market remains strong, and we completed another very successful quarter.

Dana will now cover the operating results for our Electrical and Industrial Products Segment.

In this segment of our business we recorded revenues for the quarter of $35.8 million, a 24% increase as compared to prior year results of $28.8 million. Operating income was $5.1 million, a 91% increase, as compared to $2.4 million in the prior year.

Operating margins improved to 14.3% for the quarter compared to 9.3% in the same quarter last year. Increased revenues were generated from continued strong market demand, primarily from our high-voltage transmission and petroleum markets. Improved operating margins resulted from leveraged obtained through increased revenues and improved market conditions, which allowed for more aggressive pricing to recover a portion of the material cost increases for raw materials that have occurred over the prior two years.

We continue our emphasis on booking business at specific targeted margin levels and pursuing price increases to recover increased cost of material when opportunities allow. At this time David will give us an overview of the Galvanizing segment.

We are most encouraged that we have been able to continue to recover the escalation of zinc costs in fiscal '07. Part of that success can be attributed to the overall demand for Galvanizing Services. The zinc costs did exceed $2 per pound during our third quarter. But while it has dropped back below the $2 level recently, we believe that this is related to the moderation of commodity pricing, particularly copper. The zinc demand forecast and decreasing inventory levels lead us to believe that we should not see a significant downturn in the cost of zinc in the near-term.

Demand for Galvanizing Services remains strong across all of our served markets. Our results do reflect the improvement in the industrial U.S. markets that has resulted in increased capital spending for expansion and maintenance. Demand in our traditional geographic markets continues to be strong.

We are pleased with our initial operating results and market conditions in our new Midwestern U.S. territory. While we have been -- while we have seen limited occurrences of customers going to other corrosion protection methods or materials, it has been less than we had feared. We continue to monitor it closely to see the impact of increased cost of galvanizing on demand.

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

Revenues in this segment for the quarter were $29.6 million, an increase of 91%, compared to $15.5 million recorded in our third quarter in fiscal 2006. Our volumes of steel shipped, as well as our selling prices, were up when compared to the same quarter last year. And operating income was $8.6 million, an increase of 208%, as compared to $2.8 million in the prior year. Operating and margins were 29.2% compared to 18% in the prior year. Our third quarter revenues and income include one month of operations, from the acquisition of Witt Galvanizing. This acquisition added three plants to our galvanizing operations, bringing our total galvanizing facilities to 14.

Our comparative higher operating results were achieved through increased revenues, as well as operating leverage achieved through improved pricing and higher volumes. We have seen improvements spread across all of our served markets, which are all showing strong demand.

Revenues for the third quarter were significantly impacted by pricing action required to offset escalating zinc costs. Due to the first in/first out cost basis of zinc inventories, the higher cost of zinc purchased in the first part of the year will be recognized -- will not be recognized until subsequent quarters. So we do not believe the margins experienced in terms of percentage of sales are sustainable for the balance of the year and into early next year. If last in/last out cost basis had been applied, operating profits would have been reduced by $1.1 million for the quarter, and operating margins would have been an excellent 23%.

At this time I will cover some of our key cash flow and balance sheet items on a competitive basis. For the nine-month period cash provided by operations was $7.5 million compared to $9.2 million in the prior year. Our working capital dramatically increased during the quarter, increasing by $24 million since our 2006 fiscal year-end. The acquisition of Witt Galvanizing added approximately $6.5 million to inventories and receivables, and the escalating cost of zinc has increased our galvanizing inventory carrying value by $9.4 million.

Inventories and receivables in our Electrical and Industrial segment are up as well to support our improving business leverage. Our receivable days and outstanding inventory turns remained good. Accounts receivable days outstanding were 50 days at the end of November '06 compared to 53 at the end of fiscal 2006. Year-to-date capital improvements were made in the amount of $7 million, and depreciation and amortization amounted to $4.8 million.

Our total outstanding bank debt at the end of the quarter was $30.7 million, which includes $13.5 million that was drawn down against our line of credit to finance the acquisition of Witt Galvanizing. Our current long-term debt to equity at the end of the quarter was 0.301 as compared to 0.21 to 1 the same period last year.

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

The aggressive steps that we have taken in seeking out new domestic and international marketing opportunities, improving my distribution channels, lowering our cost structure, increasing our price levels, improving our operating efficiencies, enhanced management of our working capital, and reductions in our funded debt are reflected in the improved operating results. The improvement in volumes has advanced the gains we have made due to leverage.

Our products and services are well-positioned to continue to benefit from a continuing strong industrial economy. Opportunities as a result of the energy legislation, expansions towards spending in the petrochemical market, and the beginning of a recovery in the power generation market are all positive signs for the future.

While we anticipate that the current market demand will continue, the timing of projects and release of orders will always have an impact on the quarterly recognition of bookings, revenues and earnings, and will result in quarter-to-quarter fluctuations which may be greater than through changes in our market demand and competitive successes. We will continue our efforts to aggressively manage our way through these conditions in order to build upon prior accomplishments and minimize these fluctuations.

Based upon the evaluation of information currently available to management, we are once again increasing our estimate of '07 earnings to be within the range of $3.15 to $3.25 per share, and revenues to be within the range of $250 million to $260 million. Our estimates assume that we will not have any significant customer requested delays in the delivery of our Electrical and Industrial products, and that the cost of zinc will not significantly change during the balance of the fiscal year necessitating the need to significantly adjust our pricing for galvanizing services.

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

(OPERATOR INSTRUCTIONS). John Franzreb, Sidoti & Co.

Great quarter. My first question is actually about the guidance. Just looking at it, looking at sequentially better revenues, but sequentially down EPS, you have already alluded to the fact that the backlog for the E&I business is pretty stable with the current margin novel. It kind of suggests you're looking for a significant decrease in profitability from galvanizing. Could you just walk us through what you're looking for there?

We have essentially assumed that most of that galvanizing will have worked its way through the P&L now, and then we're going to return into the 20s in the margin. As Dana stated, if we restated that, we would be at that 23, 24% level, which we are very encouraged about. But the guidance does assume that the galvanizing margins in the fourth quarter will be more normalized in that 20 to 25% range.

You're kind of assuming that 23%, that LIFO number you would have hit in Q4 compared to Q3?

Yes. We do assume that, because now we have had the full six months roll through.

That was about an $0.18 impact, if I did my mouth correctly, the FIFO versus LIFO? Does that sound right, Dana?

I haven't done the math. That's probably pretty close.

Looking to next year, could we actually have a scenario where we have negative leverage of cost of zinc, or have you made enough price increases that that won't be the case?

I'm not following you. Are you anticipating that the cost could go down so significantly that we would have the reverse situation?

Kind of like there would be a lagging effect. You're going to have so much incurred zinc prices that have to flow through the P&L that you actually have more margin pressure than you have realized or realizing right now?

Not unless there is a dramatic decrease in the cost, which is unanticipated. Because we're still monitoring the demand and inventory cycles, which we believe that won't happen. Unless you would see a significant drop in the cost of zinc, we don't believe that is a very high probability.

The last question I have, and then I will go back into queue, is the E&I business. Sequentially the revenues were modestly down. You maintained the margins. Could you talk about what is going on in that business, why the kind of the slowdown in that side? I kind of expected that to be a little bit stronger.

If you recall, the fourth quarter bookings of last year were -- we had some timing issues that they didn't come in in the first. And I previously reported that we still had some production voids -- that my recovery time was not sufficient to keep that momentum of growth in there. We didn't go out and seek low-priced business to fill up those voids. We did our calculation and said, let's stay with our strategy. Let that moderate a little bit in the third quarter and then pick back up its pace. The earnings stayed there because we picked up enough quick turn jobs to keep the margin contribution and the percentage of sales at its strong level.

And I'm actually going to tag on one more to that. What is the end market mix now look like in E&I? Can you give us a sense what that looks like, David?

I don't have the -- we have not updated that from the previous presentation, but we will when we update, and we will file [an 8-K] then.

Will Lyons, Westminster Securities.

Congratulations on another great quarter. A couple of things on the galvanizing side. That is extraordinary pricing power. I don't know of another industry that can boast of that. What is it, other than demand, or is that just flat all it is?

It is just excellent demand. We have been very fortunate that because we have got a lot of infrastructure projects going on. And it has been across all of our markets. We had some favorable impact from the rebuilding of the hurricane, but we still say that is only 1 to 1.5% of our total volume increase. But it is just a strong industrial economy, in particularly the U.S. And everything from the cellular towers to the recreational, to the stadium bleachers for NASCAR and NCAA to petrochem, highway and bridge, it has just been beautiful. It has been across every one of them which has allowed us -- to give us that pricing power from that volume.

Should we, without you giving anything specific away, should we expect to see more acquisitions in that segment?

We would love and will continue to look for acquisitions that complement us on both segments of the business. We don't have anything on the table, don't anticipate anything in the near-term, but it is our desire to do it, very much so.

Assuming that the natural market for a zinc -- for a galvanizing plant would be about a 300 mile radius, would you look outside your current market area, would it make sense to make acquisitions where you already have facilities?

If you recall, when we made the Witt acquisition into the Indiana and Ohio it is our intent to make that the focal point of geographic expansion. So we think we've got a nice footprint there, a very successful business, and that we can branch out and do the same wheel and spoke in the Midwest that we have been able to do in the South, Southwest. That would be naturally our first choice to be expansionitory in that. Now we can always look at anything that would add on to the current six state geography that we have in the South and Southwest.

Sure. Switching gears a bit to power gen and distribution, I think it is fair to say for those who have listened for a few quarters running, that you are pretty excited about the international segment. That is still fair to say, right?

That is very fair to say.

Would it be primarily the Middle East and China, or is somewhere else looking good too?

That would be the primary markets, yes. But as I said before, we were trying to do some expansion into the North American market as well as the South American market also. But the big hits are going to come from the Middle East and the China in the near-term.

How do you handle marketing in those two markets, or any international market?

Through local market representation supported by direct salesman.

Are they calling on -- for instance, in China are they calling on government entities or are they dealing with the big contractors who would actually be building the plants?

More directly with the government.

Interesting. Well, again thanks and (multiple speakers).

Will, I want to answer that question. The government has created a government-owned equivalent of EPC. Okay? So they will have created a commission or a company which functions much like the U.S. EPC would, but it is still ultimate government-owned.

(OPERATOR INSTRUCTIONS). Ned Borland, Next Generation Equity Research.

I just have a quick question here on the Galvanizing segment. You remarked that Witt contributed about a month in the results there. I'm just looking for what the dollar contribution was in the quarter, and what percentage of the tonnage, the 24% tonnage increase in that business is attributable to Witt?

Essentially the first month of operation contributed approximately about $1.5 million in dollars of revenue. Of the 24% in tonnage, I don't have that calculation in front of me, but it would be relatively consistent with the change in dollars. But for the first month it contributed roughly $1.5 million in revenue.

John Franzreb, Sidoti & Co.

I was wondering if you could give us the numbers ex Witt. How much contribution Witt added to the galvanizing business in the quarter, and what are your expectation of that change for the year ahead for Witt?

As I indicated, the volume was approximately $1.5 million in it. It did make a favorable earnings contribution, not at the same percentage level as our traditional businesses, but we're very positive with it. And very pleased about our initial first month of operation, customer acceptance and everything else. We believe that it is going to match up to our modeling and to be in that $15 million to $20 million range for its first fiscal year.

That volume number -- the sales number, what was the impact on the tonnage?

I don't have that in front of me. I should have, but I don't have what the total tonnage change was due to that. But it is a relatively consistent sales price, so we can back into the number pretty easily.

But Witt's margin contribution is it is fair to say significantly lower than AZZ's?

Yes, it is.

Yes, it is. Okay. What are you doing to improve the margins of that business? What can be done, except for taking up some back office things? Is there anything else?

Pricing actions, improved market coverage, volume leverage, operating efficiency is just what we have been able to accomplish. We have got a very enthusiastic -- a team up there that is working on it. We will hit the traditional things, base consumption and all the traditional things that we have been able to do with other acquired companies. It is just block and tackle.

To follow up to a previous question about the international market, and they've gone two quarters without any big orders there. Is there any change of dynamic that you're sensing that is going on out there?

No, it is just the timing of it. As I indicated, we really anticipate that in the fourth quarter we will be able to report some activity there. It is just with those being so large and so significant we've never anticipated those to repeat on a quarter by quarter basis.

Also, you mentioned that you let some jobs go by in the third quarter because of undesirable pricings. So in order to maintain margins you let some jobs slip. Am I correct in that statement?

What I said was when we realized we had some voids in our production cycle we did not go out and aggressively seek jobs to fill those at lower margins. I can't point to a specific job and say we rejected that because of that. We just did not say, all right, let's go fill up our plants with low-volume -- low margin business.

What I'm actually driving at there is that that means -- does that imply that that there are still jobs out there, that the pricing in your opinion is still unacceptable and that means there is still competitors being aggressive on pricing?

Absolutely.

Okay. Great. Thank you very much guys. Good job again.

(OPERATOR INSTRUCTIONS). Zahid Siddique, Gabelli & Co.

Could you comment on your negotiations with the suppliers, either for a price cap or a price floor for their zinc?

We're still in the initial discussions of that. We used to do that on a calendar basis. We have now converted that to do it on a fiscal year basis. So we have not -- don't have any further information as to what that cap would be or what that floor would be, and what negotiations.

It is obviously because demand is still strong and inventories are still weak they are not going to be any more aggressive or friendly than they were in the current fiscal year. But the premiums, which is the amount that we pay in excess of the LME, are increasing because of the demand/supply thing. As of right now we will not, but when we talk to you next in April we will definitely have our information as to what our caps are for the coming fiscal year.

Is that historically on a 100% of your zinc, or is that on a part of the zinc that you buy?

It is -- we do about 95%. The way the system works is we usually pay a premium in order to get a fixed price. We don't have to take delivery of that, but we do have to pay that premium on that committed level. So we normally try to cap about 95, 90, 95% of our anticipated volume, which gives us room for any market correction or usage adjustments that weren't anticipated at the time.

The last question I have is on your margins for the Galvanizing segment. I guess a piece of the margin improvement is coming from the FIFO. But could you walk us through the price increases, or the dynamic of the price increase, how do you pass it along to your end customers? Is it on a dollar on dollar basis or is it to keep the margins constant, or maybe somehow you increase the margins in the process?

Essentially in the broad program is that we sustain margin levels in the 20% range as if we were on a LIFO basis is our operating strategy. Now we are operating in that 23%, 24% even if we were on a LIFO basis. But that is the leverage contribution from the excellent that we've got that is doing that. But essentially what we would do is to anticipate what the LIFO impact would be of the current pricing, and then target our levels to be at the 20% range.

At this time there are no further questions. I would like to turn today's call back to David Dingus for closing remarks.

Again, we thank you for your support and your time today. And we look forward to speaking with you again when we have completed the fiscal year. Have a great and Happy New Year to everyone. Thank you.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.