AZZ Inc (AZZ) 2008 Q2 法說會逐字稿

Good morning. My name is Laurie and I will be your conference operator. At this time I would like to welcome everyone to the second quarter fiscal year 2008 earnings for AZZ 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) Thank you.

I will now turn the call over to Joe Dorame of Lytham Partners. Please go ahead, sir.

Good morning. Thank you for joining us today to review the financial results for AZZ Incorporated for the second quarter of fiscal year of 2008, ended August 31, 2007. As Laurie indicated, my name is Joe Dorame with Lytham Partners and 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. If anyone participating on this call does not have a full text copy of the earnings release, please call Lytham Partners at 602-889-9700 and we will immediately fulfill your request, or you can retrieve the release off the internet from any number of financial sites.

Before we begin, I would like to remind everyone 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 in raw material costs, including zinc and natural gas which are used in the hop 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 strategies. 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'd like to turn the call over to Mr. David Dingus, President and Chief Executive Officer of AZZ. David?

Thank you, Joe, and thanks to each of you for taking the time to join us for the conference call for the second quarter and first six months of fiscal 2008. The quarter ended on August 31, 2007. For the first six-month period that was ended August 31st, when compared to the prior year, revenues increased 36%, net income is up 30%, earnings per share increased 26%, and backlog is up 51%. We continue to benefit from strong market conditions, favorable product mix, and expanded served markets. International opportunities continue to play an increasing and an exciting role in our growth potential. Total incoming orders for the quarter were $86 million while shipments for the quarter totaled 81.6 million, resulting in a book-to-ship ratio of 105% for the second quarter. For the first six months, orders totaled $185.5 million while shipments totaled $157 million, resulting in a year-to-date book-to-ship ratio of 118%. Incoming orders for the first six months increased 32% when compared to the same period of a year ago. Based upon customer -- current customer delivery dates and our planned production schedule, 57% of our backlog is expected to ship in the current fiscal year and of the $149.2 million backlog, 29% is expected to be exported from the United States.

Our markets strengthened over FY '06 and FY '07 and this strengthening has continued into fiscal 2008. Our efforts are focused on achieving new business, which meets or exceeds our margin targets. The increase in margin on previously-booked projects, which is now being reflected in our operating results, is a positive consequence of a strict adherence to order acceptance criteria with specific margin contribution targets. We are not at full capacity and we do have opportunities to continue to supplement our backlog with quick-turn, higher-margin jobs. We do not anticipate any significant increases in our backlog during the balance of the current fiscal year and our backlog is expected to remain relatively constant with the current level based upon the size and scope of our domestic and international quotation activity and announced projects. Some of our large international quotations, which originally had been forecast to close in the fourth quarter of current fiscal year, are now projected to close in the first quarter of the new fiscal year or fiscal 2009.

Galvanizing demand remains strong and tonnage of steel galvanized shipments increased 25% for the first six months when compared to the prior fiscal year. Now, 76% of this increase is attributable to the acquisition of Witt Galvanizing. The balance of the volume increase is spread nicely across all of our served markets. As a company, our accompliments -- 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 continuous emphasis on systems and procedures, the sharing of best practices among our operations to further enhance operating efficiencies, combined with aggressive pricing programs have had a very positive impact on the operating results of AZZ for fiscal 2008. We believe that these efforts and the leverage gained from additional volume has very positively impacted our results.

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

Thank you, David. I would also like to welcome you to our second quarter conference call, and at this time I will review our unaudited consolidated results for the period ending August 31, 2007. For the second quarter, revenues remained strong and were at a record-setting level. AZZ recorded revenues for the quarter ending of $81.6 million, a 30% increase as compared to $62.9 million in the prior-year period. Net income for the quarter was$8.1 million, which compares favorably to the $5.3 million recorded in the prior year. Diluted earnings per share was $0.66 compared to $0.45. Our SG&A for the quarter returned to a more normalized level as compared to the first quarter, where there were increased expenses associated with the compensation expense for our stock appreciation rights programs that were booked during the first quarter in the amount of $4.4 million. For the first six months, this total expenditure was approximately $4.3 million and is expected to total approximately $6.2 million for the fiscal year. The stock appreciation rights program is a long-term incentive program that covers approximately 25 to 30 key management personnel.

Revenues for the six-month period ending August 31 were $157 million, a 36% increase as compared to $115.3 million in the prior year. Net income for the first six months period was $12.3 million, an increase of 30%, which compared to $9.4 million in the prior year, and diluted earnings per share was $1.01 compared to last year's $0.80. Our earnings per share calculations are stated after the affect of a two-for-one stock split in the form of 100% stock dividend paid on May 4, 2007. Current demand for our electrical and industrial products, as well as for our galvanizing services, continued in the second quarter. The orders were strong and balanced across our power generation, transmission, and distribution, as well as our industrial markets. Our improved international business and continuation of quick-turn business led to strong volume increases and improved margin performance, and our Galvanizing segment, continued strong demand allowed us the opportunity to maintain our galvanizing pricing. Our Electrical and Industrial Product segment generated 55% of our revenues, while Galvanizing Services generated 45%. We anticipate that 58% of our revenue for fiscal '08 will be generated from our Electrical and Industrial Products business and 42% will be generated from our Galvanizing segment.

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

Industrial demand for our power distribution center and motor control centers remains 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 the emphasis on the need for spending related to refining LNG, ethanol, clean fuel initiatives, combined with mining system upgrades, should lead to a continuing strength in our industrial served markets. Our specialty lighting products have seen and continue to see strong results due to new products and demand related to the petroleum market, as well as the overall strength of the industrial market. Demand for our metal-clad outdoor switch gear products is robust. Utility distribution substation orders, the strength of the wind energy market, and the surface mining market all contributed to the increases in bookings and shipments of this product offering.

Quotations and orders, which utilize our high-voltage transmission products were again at very encouraging levels and our quotations reflect strong domestic and international demand. We continue to operate at record-setting levels. The increasing demand for our products that serve the power generation product market is very encouraging and if we're able to maintain the existing build schedule of new generation plants, the favorable impact of wind energy, and the addition of scrubbers to existing facilities, should continue to possibly impact our operating results in future quarters. Orders and shipments of our tubular products to the petroleum market were essentially flat with prior periods.

Dana will now cover the operating results of the Electrical and Industrial Product segment.

In this segment of our business we recorded revenues for the quarter of $45.1 million, a 23.6% increase as compared to prior-year results of $36.5 million. Operating income was $7.9 million, a 54% increase as compared to $5.1 million. Operating margins improved to 17.6% as compared to $14.1% in the prior-year period. The increased revenues were generated as a result of continuation of improving market demand and improved pricing. The largest improvement came from our high-voltage transmission market, the power generation market, and the utility distribution market. Operating margins and profit improvement are attributable to the leverage gained from increased volumes, quick-turn jobs, and pricing actions. We continue our emphasis on booking business at a specific targeted margin levels and pursuing price increases to recover increased cost of material.

At this time David will review our Galvanizing segment.

Zinc cost reductions have occurred in the last few weeks to the $1.25 the $1.30 price range. Now the very recent trading is in the $1.35 to $1.40 range. With overall demand for galvanizing services being strong, we've been able to maintain a significant portion of our previous pricing actions. Our strategy for the third quarter will be to continue to resist downward pricing pressures and we will risk some modest market share losses to try and sustain pricing levels. If zinc remains at this current cost level, we do anticipate it will impact our operating results in the fourth quarter. We would anticipate that margins would return to the historical levels of 18% to 22%, but the revenue dollars would be reduced due to pricing adjustments due to current zinc cost levels. We do have and have embedded this outlook in our guidance.

We continue to operate in very favorable market conditions and continue to maximize the market share growth that can be achieved by providing a superior level of service and support to our customers. Operating efficiencies continue to improve and the leverage obtained from increased volumes are both reflected in our excellent year-to-date results for this segment. Our results do reflect the improvement in the industrial U.S. economy and has resulted in increased capital spending for expansion and maintenance and increased production associated with our recent acquisitions. Demand in our traditional geographic markets continues to be strong and we're extremely pleased with our operating results and market conditions in our new midwestern U.S. territory. While we have seen some limited occurrences of customers going to other corrosion protection methods or materials, it has been much less than we had feared. We continue to monitor closely to see the impact of the increased cost of galvanizing on overall demand.

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

Revenues in this segment of our business for the quarter were $36.5 million, an increase of 38.3% compared to $26.4 million recorded in the second quarter of fiscal '07. Our volumes of steel shipped as well as selling prices were up when compared to the same quarter's last year. Operating income was $9.2 million, an increase of 8.4% compared to $8.5 million in the prior-year period. Operating margins were 25.3% compared to 32.3% over the first half of fiscal 2008. We have seen higher zinc -- we have seen the higher price of zinc start to flow from our balance sheet into our P&L, which had the affect of bringing our margins in line with historical results. Our average zinc cost that is reflected in our second quarter P&L was $1.77 per pound as compared $1 per pound during the same quarter of last year.

Our second quarter includes revenues and income generated from the acquisition of Witt Galvanizing. As we have previously stated, this acquisition added three plants to our galvanizing operation, 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 shared markets, which are all showing strong demand. Revenues for the year has been significantly impacted by pricing actions required to offset the escalating cost of zinc. As David has stated, subsequent to the year en -- to the end of the second quarter, zinc prices began to decline to the $1.30 range, and as a result pricing measure could begin to occur in our fourth quarter. As we have stated before, increased volatility in our fu -- in future zinc prices could have an adverse affect on future earnings and revenues.

For the six-month period, cash provided by operations was $15.1 million compared to $8.5 million in the prior year. Our receivable days and inventory turns remain good. Accounts receivable days outstanding were 49 at the end of the second quarter compared to 51 at year end. Year-to-date capital improvements have been made in the amount of $6.1 million and our depreciation and amortization has been $4 million year to date. Our total outstanding bank debt at the end of the quarter was $20 million, which reflects a reduction in funded bank debt of $15.2 million during the first half of this fiscal year.

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

Thank you, Dana. We're very pleased -- excuse me -- with the operating results of our second quarter and the first six months for our fiscal year. The aggressive steps we have taken in seeking out new domestic and international market opportunities, improving our distribution channels, lowering of our cost structure, increasing our pricing levels, improved operating efficiencies are all related to and then reflected in our improved operating results. The improvement in volumes has advanced the gains we've made due to leverage. We continue to seek out additional products, which can be added to our products offering to our electrical and industrial customers and how we can expand our geographic coverage for our Galvanizing Services segment. Our products and services are well positioned to continue to benefit from a strong industrial economy. Opportunities as a result of energy legislation replacement, equipment for the aging distribution substation market, and the transmission grid, expansionary spending in petroleum -- petrochemical markets, and the recovery in the power generation market have enhanced and will continue to enhance these gains.

While we anticipate that 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 true changes in market demand or our competitive successes. We will continue our efforts to aggressively manage our way through these conditions in order to build upon the prior accomplishments and minimize these fluctuations. Based upon current evaluation of information currently available to management, we're increased our previously-issued guidance for fiscal '08. We are pleased to project that we believe that we will have another excellent year for AZZ in fiscal '08. With record-setting revenues of $315 million to $325 million, net income is projected to remain very strong and is estimated to be the best income year in the 51-year history of the Company. Our diluted earnings per share is estimated to be within the range of $1.95 to $2.95 -- $2.05. These projections reflect the impact of the two-for-one split effected by a 100% stock dividend distributed on May 4, 2007. We appreciate your support and thank you in advance for a continuation of that support.

Thank you for your participating today and we'd like to open it up to any questions you might have.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of John Franzreb of Sidoti & Company.

Good morning, David and Dana.

Good morning, John.

David, you threw out a cautionary note there about the timing of shipments. Is there something you're seeing in particular that we should be worried about, or could you just explain some of those cautionary statements you put forth in your commentary?

John, they're more related to the incoming order rate and the shipment rate. With the strong bookings rate that we had in the first quarter, we actually got ahead of our backlog, so we had some orders come in early. So we think that that is going to be relatively flat for the balance of this year and then pick back up in the first quarter of next year, so we would see a continuing of our domestic demand, but some of the large international projects may not close until the first quarter of next year. So I think what I'm trying to say is our backlog will be relatively flat for the balance of the year even though our demand is still going -- our quotation activity is still improving.

Okay, so you're seeing very strong quotation activity, it's just not -- closure and presumably some of that risk is associated with maybe being able to get enough people to close the jobs on the other -- on your customer's side of the business?

That is true more on the domestic side than the international side. The international side, some of the projects, there's been some modifications to the proposal that have caused some of the delays, John, rather than the project itself being at risk.

Okay. Fine, that's helpful. You said that 27% of that backlog is to be exported. How much of your total sales right now is export sales?

John, the -- and I meant to say 29%. If I said 27%, it's 29. If you recall at the end of the first quarter, I said 35% of our backlog is scheduled to be exported, so that shows that we're shipping at a little faster rate than we're booking on the international side. Again, coming back to my last comment on the timing of bookings. But I think that for the fiscal year '08, for the Electrical and Industrial Products that our exports will be between 25% and 30%, ahead of our 25% target.

Okay, excellent. Now you also threw some cautionary notes about the price of zinc and your ability to hold pricing. Can you remind me how much of your pricing is done in a surcharge mechanism versus, say, a fixed price, walk-in-the-door pricing?

Well, as I said, we -- when the price of zinc first started escalating, we did it through the surcharge and then when it leveled off there, we converted it into our base pricing. So probably 85% of our pricing is on a quoted basis and without the full surcharge mechanism.

Okay.

Okay? So now -- and then my cautionary statements were that we've been relatively stable in that $1.50, $1.60 range, $1.65. Got a little concern when it dropped down to the $1.25, $1.30, and then now that it's coming back to the $1.40, seems to match the inventory reductions that we're seeing in the LME inventories, as well as the way our suppliers are guiding us, so we then built our forecast for the balance of the year around that $1.40 -- $1.30 to $1.40 range for zinc.

Okay. So if it continues to go up, how does that impact the P&L for you?

It would increase the revenue dollars. It wouldn't significantly change the percent as revenues, but as we said before, we've been getting that 20%, 22% of a much higher revenue dollar. If it were to come back to the $1.50 to $1.60, would we be able -- we think we could sustain pretty well where we are with our pricing, but in the $1.40 range, we'll probably have to adjust.

Okay. Thank you very much. I'll let somebody else chime in.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Ned Borland of Next Generation Equity Research.

Good morning, guys.

Morning, Ned.

Just on the margins on the electrical products business, margins obviously came in way ahead of historical levels here. What was your revenue in the quarter that was associated with the quick-turn business?

We've talked among ourselves, Ned, and we've decided that we're not going to quote that number anymore, because we [don't want anymore competition now than we have.] But we not only had that, but we had some favorable efficiencies that came through, we picked up a little more leverage on the leverage side and everything else, so it was not an abnormal amount of quick-turn work. It was more predictable of what we've been seeing the last six quarters, so it was not an unusual. It was just one of those quarters where everything that could go right did go right and that's why that, again, with our guidance going forward for the full year, it is still below what we achieved in the second quarter. But it was just an outstanding quarter for us where we just hit on all cylinders.

So you wouldn't attribute the margin increase there -- you wouldn't contribute quick turn being the primary factor, it's more of your pricing to get ahead of raw materials?

That's exactly right. As far as relative volume of quick turn, it was not that much more in the second than it was in the first.

Okay, very good. And then on the industrial side in that business, you talked a little bit about the petrochem market being flat, what are some of your industrial customers doing now? How are the order trends in that side of the segment?

Well, as we've said, there's -- we don't see any reduction in the projects that are out there, but just the sheer work flow that's been placed on the industry from accommodating this number of projects, they aren't getting let as fast as we would like. So there's been some delay in not getting to the quote stage for us, but not a delay in the projects or a lessening of the number of projects, Ned. So I think it's a little bit outside of our control as to when we're seeing some of these. We'd like to see them a lot sooner, but as far as the ones out there that we're anticipating still having the opportunity to quote, that has not reduced.

Okay. And then I'm assuming these international projects, they're not booked, so they're not in the backlog, but you came in with incremental margins in the Electric Products business about 32%. Is that sustainable with some of the projects that you're looking at booking next year?

I think the pricing of our quotations that are currently on the street is consistent with the pricing of our existing backlog. So if the volume were to continue at that pace then the contribution ratio would continue at that pace, Ned, but it's -- the issue is, can we continue at that robust of a revenue growth line on the top in order to get that.

Okay. And then on galvanizing, are some of your customers -- or actually, excuse me, your competitors -- are you seeing them cutting price at the moment? Is that what -- your comments about zinc being at $1.40, are you starting to see your competitors take some pricing actions?

On an isolated basis, but not on a broad basis. I think that they're seeing the same strong demand that we are and maximizing the opportunity. So there are some isolated projects and some isolated geographic areas where we see more than the other, but we would not call our competition doing broad-based discounting of pricing.

Okay, very good. Thanks. Great quarter.

Thank you, Ned.

Your next question comes from the line of J. D. Padgett of the Boston Company.

Good morning, guys.

Morning.

Had one quick one. The types of international projects that you're looking -- and maybe there's some domestic ones as well -- but what -- is there any way to generally characterize those? Are those power gen or what types of projects are those?

Those are in the power generation side and the high-voltage transmission side.

Okay.

That's the bulk of our international business.

And is it -- what's the profile domestically? Are there other large scale projects that are on the drawing board for power gen transmission as well?

There are, but of course they're never as large as the international orders because those are -- we're seeing now strong spending in the distribution substation market, we're seeing strength in the transmission grid market, and ever improving conditions in the power generation market. So we're very pleased with all three of those on a domestic basis.

Okay. And then in order to better access the international opportunities, do you think you need to have more of a local footprint there?

We do not think it's necessary that we have to significantly change our profile as being an exporter as opposed to manufacturing on the ground. Now, when we look at the -- some of the -- expanding into some of the other products, say into the distribution substation side, that will require more of a local presence than it does on our power generation and high-voltage transmission products.

Why is there -- that distinction there?

Because you'd naturally have more local competitors in that side of the business than you do on the other.

So it doesn't necessarily have to do with production costs and lowering shipping or any of that kind of stuff?

Well, shipment is always a factor because everything that we do is bulky and we do ship a lot of air, but it's much more of a -- there are a lot more international players in the distribution substation market than there are in the generation and high-voltage transmission market.

Okay. And one other question, if I might. In the E&I business, you think revenues there continue to grow from the August quarter levels through the rest of the year?

Well, our guidance for the full year is to be between $185 million and $190 million. We did $86 million in the first six months, so you can say again it's going to be relatively consistent for the first six months, which were very strong, and a 28% improvement over the prior year.

Okay. There's not really any seasonality in that business or anything like that that we need to take into account, or is there?

Not in the traditional seasonality-type thing, but you can always hit -- in winter weather, you can always have shipment issues and site preparation issues and extra holidays, but other than that -- which everybody deals with -- we don't classify it as seasonality.

Okay. Thank you. Awesome quarter.

Thank you.

You have a follow-up question from the line of John Franzreb of Sidoti & Company.

Just to follow up some of J.D.'s thoughts, could you give us the -- what your end market revenue mix was in E&I in the quarter?

I can give you what it is projected to be for the year. Just a moment, John, while I get that. For the year, we think 20% -- now, this is E&I only.

Right.

20% will be power gen, 48% will be T&D, and industrial will be 32%. So the power gen is growing a little bit faster than the first quarter forecast, so we have a little heavier mix there. But in the second quarter we had particularly good strength in the distribution market and in the power generation and the transmission market, all three. But that's how we think the year's going turn out, John.

Can you remind me what those numbers looked like in fiscal 2007?

Yes. They were 11% in power gen, 40% in industrial, and 49% in T&D.

Okay. And one last question. The SG&A level was held down rather nicely and I recognize [SOX] kind of skewed the number in the first quarter, but is that a sustainable SG&A level that we should be thinking about?

There will be about an additional $700,000 per quarter associated with those stock depreciation right, so we had roughly $4 million in the second quarter. It ought to run $4.5 million balance of the year.

Okay, so I should be tacking on another $700,000 going forward --?

(inaudible) second quarter and that'll be consistent going out.

Okay. Okay, great. Thank you very much, enjoys.

You bet.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Eric Marshall of Hodges Capital Management.

Hey, guys. I was wondering if you could go through -- and forgive me if you've already mentioned this -- but give us the breakout on how much of the business was international and what the currency impact was in the quarter?

We did not spell that out for the quarter. We are estimating it for the full year to be between 25% and 30% for that. Now, while the devaluation of the U.S. dollar certainly doesn't hurt us, we don't attribute a big portion of that increase to the currency fluctuation. Like I said, it certainly helps us, but we think we've positioned ourselves from product selection and product solution and then naturally anytime you can add the factor in there of the favorable dollar, it just helps us that much more. So we don't attribute a significant portion of the increase. Last year we did 22.8%. We think it'll be this year, like I said, between 25% and 30% and while, like I said, that's a very favorable factor, we don't point to any particular order that we got because of the fluctuation of the dollar.

Okay. But most of your competitors in that segment are European, right?

For the most part, that is correct.

Okay, so ultimately it's likely to have put you in a good competitive position going out over the next couple of years if things persist the way they have in the currency market?

I believe that is true, particularly in the power generation market. It's not quite as true in the transmission high-voltage market, because there's simply not as many players there. But that is a favorable and I do concur with your conclusion.

Okay. All right. Well, thanks a lot, guys.

Thank you.

(OPERATOR INSTRUCTIONS) We have a follow-up question from the line of J.D. Padgett of the Boston Company.

Dana, what type of tax rate should we be using for the rest of the year?

I think we'll probably be in that 37.5%.

Okay. Thank you.

([OPERATOR INSTRUCTIONS)Thank you. At this time there are no further questions. I will now return the call to David Dingus for final remarks.

Again, we appreciate your support and participation today and we look forward to talking with you again at the end of the third quarter. Everyone have a great day and a great weekend. Thanks for your help.

Thank you. That does conclude today's second quarter fiscal year 2008 earnings for AZZ conference call. You may now disconnect.