AZZ Inc (AZZ) 2008 Q3 法說會逐字稿

Good morning. My name is Julianne and I will be your conference operator today. At this time, I would like to welcome everyone to the AZZ incorporated third-quarter 2008 financial results 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. Mr. Dorame, you may begin your conference.

Good morning. Thank you for joining us today to review the financial results for AZZ incorporated for the third quarter of fiscal-year 2008 ended November 30, 2007. As Julianne indicated, my name is Joe Dorame; I'm 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 area code 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 include 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 electrical power generation markets, electrical transmission and distribution markets, the industrial markets, and the hot dipped galvanizing markets; prices and raw material costs including zinc and natural gas which are used in the hot dipped galvanizing process; changes in the economic conditions of the various markets the Company serves, foreign and domestic; customer 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 would 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 third quarter and the first nine months of our fiscal 2008. As Joe indicated, the quarter ended on November 30, 2007.

Now for the nine-month period that ended November 30, when compared to the prior year, revenues have increased 35%; net income is up 39%; earnings per share is up 35%; and our backlog is up 46%. We continue to benefit from strong market conditions, favorable product mix, and expanded served markets. International opportunities continue to play an important role in our growth potential.

Total incoming orders for the quarter were $84.5 million, while shipments for the total quarter totaled $86.6 million, resulting in a book-to-ship ratio of 98% for the third quarter. For the first nine months, orders totaled $270.1 million while shipments totaled $243.6 million, resulting in a year-to-date book ratio of 111%. Incoming orders for the first nine months increased 30% when compared to the same period of a year ago.

Based upon customer current delivery dates and our planned production schedules, 30% of our backlog is expected to ship in the current fiscal year. Of the $147.1 million backlog, 23% is expected to be exported from the US.

The third-quarter backlog, while remaining strong, was essentially flat as compared to the second quarter and is anticipated to be at this level for the balance of the fiscal year.

Now for the past two quarters, international shipments have exceeded new international orders, as we had anticipated. Based upon our quotation activity and the significance of some of our international quotes, we would anticipate that this trend would reverse itself in the first half of fiscal 2009.

Domestic backlog has increased over the prior periods. Again, our projections based upon our quotation activity and customer-announced release dates, which are always subject to change and adjustment.

The increase in margins on previously-booked projects, which is now being reflected in our operating results, is a positive consequence of our strict adherence to order acceptance criteria with specific margin contributions. We are not at full capacity, and we do have the opportunity to continue to supplement our backlog as well as add quick-turn higher-margin jobs.

Galvanizing demand remains strong and tonnage of steel galvanized shipments increased 21% for the first nine months of the fiscal year. 82% of this increase is attributable to the acquisition of Witt Galvanizing. The balance of the volume increase is spread across all of our served markets.

As a Company, our accomplishments have improved and we continue to double and redouble our efforts to secure more profitable business and efficiently and effectively execute on that business. The strength of our balance sheet supports our efforts to find additional products and served markets that will complement our growth and expansion plans.

Our continuous improvement programs combined with aggressive marketing programs have had a very positive impact on operating results for the first nine months of fiscal 2008. We believe that these efforts and the leverage gained from additional volumes has very positively impacted our results.

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

Thank you, David. I would also like to welcome you to our third-quarter conference call. At this time, I will review our nonaudited and consolidated results for the period ending November 30, 2007. For the third quarter, revenues remained strong and were at a record-setting level. AZZ recorded revenues for the quarter ending of $86.6 million, a 33% increased as compared to $65.4 million in the prior year. Net income for the quarter was $8.1 million, which compared to $5.2 million in the prior quarter.

Diluted earnings per share was $0.66 compared to last year's $0.44. SG&A for the quarter returned to more normalized levels as compared to the first quarter where there were increased expenses associated to stock appreciation rights programs.

Revenues for the nine-month period ending November 30 were $243.5 million, a 35% increase as compared to $180.7 million in the prior year. Net income for the nine-month period was $20.4 million, an increase of 39%, which compares to $14.7 million.

Diluted earnings per share was $1.67, as compared to last year's $1.24. Earnings per share calculations are stated after the effect of a 2-for-1 stock split in the form of a 100% stock dividend paid on May 4, 2007.

Strong demand for our Electrical and Industrial Products as well as our Galvanizing Services continued through the third quarter. New orders were strong and balanced across our power generation, transmission, and distribution as well as our industrial markets. As anticipated, backlogs remained essentially flat with the second quarter.

In our Galvanizing segment the continued strong demand allowed us the opportunity to [mend] our Galvanizing pricing. Our Electrical and Industrial segment generated 56% of our revenues, while our Galvanizing Services segment generated 44%. We anticipate that 57% of our revenues for fiscal '08 will be generated from our Electrical and Industrial, and 43% will be generated from our Galvanizing segment.

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

The industrial demand for our power distribution centers and our motor control centers remains strong due to new projects, major renovations and expansions, and the strength of the industrial capacity utilization levels. Projects continue to be reported by the engineering, procurement, and construction firms, and we believe that emphasis on the need for spending related to refining, LNG, ethanol, and clean fuel initiatives, combined with mining systems upgrades, should lead to a continuing strength in this market segment for us.

Our specialty lighting products have seen and should continue to see strong results in demand due to new products and strength of the industrial market. The demand for our metal clad outdoor switchgear products is robust. Utility distribution substation orders continue to improve, and the growth in this market segment is most encouraging. Quotations which utilize our high-voltage transmission product lines were again at excellent levels and reflect strong domestic and international demand. We continue to operate at record-setting levels.

The power generation market is encouraging. The maintenance of announced build schedules of new power generation plants, the emphasis on renewables such as wind energy, and the addition of scrubbers to existing facilities should continue to positively impact our market and orders in future quarters.

Orders and shipment of our tubular products to petroleum markets were essentially flat with prior periods. Dana will now cover the operating results of this segment.

In our Electrical and Industrial Products segment we recorded revenues for the quarter of $51.5 million, a 44% increase as compared to the prior-year results of $35.8 million. Operating income was $8.3 million, a 57% increase as compared to $5.1 million. Operating margins were 15.6% for the quarter as compared to 14.3% in the prior-year period.

Increased revenues were generated as a result of a continuation of strong market demand and improving pricing. The largest improvements have come from our high-voltage transmission market, the power generation market, and the utility distribution market.

Operating margins and profit improvements are attributable to the leverage gained from increased volumes, quick-turn jobs, and pricing actions. We continue our emphases on booking business at specific targeted margin levels and pursuing price increases to recover increased cost of material.

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

Zinc cost reductions have occurred in the last few weeks in the $1.05 to $1.15 price range. With overall demand remaining strong, we have been able to maintain a significant portion of our previous pricing actions and continue to reduce our inventory of more expensive zinc. Our strategy for the fourth 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 in the fourth quarter.

We would anticipate that margins in the fourth quarter will approximate 22%, a very strong performance level for this segment. Revenue dollars will potentially be impacted in future periods as market pricing is adjusted to the reduced zinc cost levels.

We continue to operate in a very favorable market condition 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 results for the year to date.

Our results do reflect the improvement in infrastructure spending in the US market. Demand in our traditional geographic market continues to be strong. We are extremely pleased with our operating results and the market conditions in our new upper midwest territory.

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

Revenues in our Galvanizing segment for the quarter were $35.1 million, an increase of 18.9% as compared to $29.6 million recorded in our third quarter in fiscal 2007. Our volumes of steel shipped as well as our selling prices were up when compared with the same quarter last year. Operating income was $8.3 million compared to $8.6 million in the prior year.

Operating margins were 23.7% compared to 29.2%. Operating margins were lower for the compared periods due to the higher zinc cost flowing through our P&L. Over the first nine months of fiscal 2008, we have seen the higher price of zinc start to flow from our balance sheet into our P&L, which has had the effect of bringing our margins in line with historical results. Our average zinc cost that is reflected in our third-quarter P&L was $1.72 per pound as compared to $1.46 per pound during the same quarter last year.

Our third 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 operations, bringing our total Galvanizing facilities to 14.

Revenues for the year have been significantly impacted by pricing actions required to offset the escalating cost of zinc. As David stated, zinc prices have declined to the $1.05 to $1.15 range; and as a result, price pressure could begin to occur. As we have stated in prior periods, increased volatility in future zinc prices could have an adverse effect on future revenues and earnings.

At this time, I will cover some of our key cash flow and balance sheet items on a comparative basis. For the nine-month period, cash provided by operations was $20.1 million compared to $7.5 million in the prior year. Our receivable days remained strong and inventory turns remained good. Accounts receivable days outstanding were 49 days at the end of the third quarter as compared to 51 at the end of last fiscal year.

Year-to-date capital improvements have been made in the amount of $8.1 million; depreciation and amortization amounted to $6.1 million. Our total outstanding bank debt at the end of the quarter was $17 million, which reflects a reduction in bank debt of $18.2 million for the fiscal year.

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

We are very pleased with results of our third quarter and the first nine months of our fiscal year. The aggressive steps that we have taken in seeking out new domestic and international marketing opportunities, improving our distribution channels, the lowering of our cost structure, increasing our pricing levels, improved operating efficiencies are all reflected in our improved operating results. And we are setting another record year in sales and earnings.

The improvement and volume has advanced the gains that we have made due to leverage. We do continue to seek out additional products which complement our existing product offerings to the Electrical and Industrial Products customers and expansion of our geographic coverage for our Galvanizing Services segment. The strength of our balance sheet fully supports our efforts.

Our products and services are well positioned to continue to benefit from a strong industrial economy. Opportunities as a result of the replacement equipment for the aging distribution substation and transmission grid market, expansionary spending in the petrochemical market, and the recovery of the power generation market have all enhanced 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, our backlog, revenue, and earnings, and will result in quarter-to-quarter fluctuations which may be greater than true changes in market demand and conditions or competitive position and successes.

We will continue our efforts to aggressively manage our way through these conditions in order to build upon our prior accomplishments and minimize future fluctuations. Based upon evaluation of information currently available to management, we are increasing our previously-issued earnings guidance for fiscal 2008. We are pleased to project what we believe will be another excellent and record-setting year for AZZ in fiscal 2008.

With revenues of 315 to $325 million, net income is projected to grow and 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 $2.12 to $2.22. These projections reflect the impact of the 2-for-1 split effected by a 100% stock dividend on May 4, 2007.

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

(OPERATOR INSTRUCTIONS) John Franzreb with Sidoti Company.

My first question is, David, can you talk about how difficult is it for you to maintain your target margins in the Electrical and Industrial business?

John, we feel we have had pretty decent success. The growth in the market has been there, and the competitive activity has certainly not lessened, but it hasn't increased or inhibited our ability to sustain us. So we are very comfortable that we're at a very nice level, that we have got a high degree of probability of continuing that for some period of time.

Great. If I heard correctly, Dana, did you say that the margin expectation in the Galvanizing business was going to be like 22% in the final quarter?

We should average for the year around 24%.

But I did say 22% in the fourth quarter.

Okay, great. Now, the SG&A number dropped relatively significantly from Q2 to Q3. I thought Q2 was somewhat low. Can you just talk about what is going on in the SG&A line? Because I know you called it more normalized in your prepared comments.

We still had our cost associated with our SARs program in the second quarter than we did in our third quarter. Our stock price was down in the third quarter a little bit, compared to the second. So it was less of a charge going through in the third quarter.

So what is the sensitivity right now on the SG&A line as far as the stock price, so we should start building in some more SARs expense? Is it $35? When does that kind of kick back in?

We have estimated our guidance on $35 a share, which is roughly 6 to $6.2 million in expense for the entire year.

Okay. So given that you may be overestimating a little bit on the SG&A line, given where the stock is today, and that you're able to maintain the margins in the Electrical side, and the Galvanizing margins seem to be holding up, why such a sharp drop-off in your EPS forecast in the fourth quarter?

Again, as we look at it, it is just a reflection of what we think is actually going to ship in that period John, and the impact --. You know, we have some impact on Galvanizing by shorter production days. So as we look at it, traditionally, I think that flows pretty nicely with what we are expecting.

So you expect an average number about $0.51 in the fourth quarter?

Well, again within that range of $2.12 to $2.22. It could be higher if we end up on the top end of that range, of course.

Okay, it just seems very low, considering all the pieces seem to be going directly in your favor. Unless there is a sharp drop in revenues that I don't understand.

We still believe that even though our strategy will be to hang on to as much price in the Galvanizing as possible, we still run the risk, John, of some deterioration. Because we're coming out of the 25, 26 range down to the 22 on a pretty significant piece of our business. So there is always the possibility that that won't occur and we will be able to overachieve it.

David, do I understand properly that you said that price erosion could begin? That means it hasn't begun yet?

Further price erosion I should have said.

Okay, okay. That's it for now. Thanks a lot, guys.

Ned Borland with Next Generation.

First just a housekeeping question. I heard a segment margin for Galvanizing for the fourth quarter, but I did not hear one for Electrical. Did you give one out?

Yes, bear with me a second, Ned. It was for the quarter, 15.6% versus 14.3% in the same quarter last year.

Okay, all right, great. Then on the Galvanizing, I am wondering what you are seeing out there from the -- I mean, you are seeing strong demand, obviously. But is that mostly coming from the petrochemical side of the business? Or is --?

Well, even though we have seen some plateauing in the general industrial market, and there is concern about whether there will be some deterioration in that market, Ned, it's six to eight months before we see that, just based on the projects.

But there is no doubt that what is going on in petrochem as well as what is going on in power generation is significantly helping our Galvanizing business.

Okay. Then, I guess, maybe could you talk a little bit about some of your smaller galvanizing competitors? I mean generally, I think, smaller guys generally lead the price behavior in the market. What are those guys doing?

Behavior is still pretty good. I think overall demand is allowing it; and particularly in the geographic areas that we're in, they're very positively impacted by the petrochem market. We haven't seen any real deterioration in pricing from the competitive positions.

Now, they are the first ones; you are exactly right, Ned. They are the first ones to give when market demand changes. But as long as it is there, and we think it is there for a number of months, we don't think we are going to see it. Naturally, you see it on isolated situations, but not broad-based.

Okay. Then, I guess with respect to the guidance, it seems to be a little bit conservative. Is there any seasonal factors that are affecting -- that you expect are going to affect the fourth quarter?

Well, I mean you always have the potential of bad weather impacting deliveries on electrical equipment, and we have to build that in there, because that seems to hit us every year. So as far as demand, it is not seasonal. But the practicality of delivering is seasonal.

Then, on the Galvanizing business, that is a daily service business, so anytime you lose four to five days due to a holiday it is going to impact you to some degree. But we always have to build in that bad weather factor that impacts our shipments in the fourth quarter.

Okay. Then, with your assumption on the revenue for the full-year '08, does that make any assumption for the higher-margin quick-turn business or no?

It does not. That would be additive to that number.

Okay, thanks a lot.

(OPERATOR INSTRUCTIONS) Shaumo Sadhukhan.

Could you talk about the effect on both of your segments from a potentially weakening industrial economy, if that happens in the next six months? And how sensitive demand in both the segments should be to that, if that does happen?

Okay, there is absolutely no doubt that eventually we are impacted by change in industrial demand. Now, what we believe in, for the Electrical and Industrial projects, so much of that is driven by infrastructure that is related to improvements in the distribution network, it's improvements in the petrochemical market, it's improvement in the power generation market, that it will have some time before it is impacted.

But our Galvanizing business is a GDP business at the end of the day. So a change in the industrial sector, we will feel six to nine months after it occurs. But just as in the Electrical side, we believe that the strength and the length of some of the petrochem and power generation projects that are going on will help slow that, but eventually it will do a correction to the industrial outlook.

So in each of the two segments, how much of the business is petrochem and power generation related business that would be more stable? And how much of each segment is related to economically sensitive, just general industrial demand?

Now we don't breakout the petrochem as such; and I include that in the industrial. But for the total Company, power generation this year will be 13% of our volume; transmission and distribution will be 28% of our volume; and the industrial will be 59% of our volume.

So you can see a big piece of it is in there. But we still believe there is some good fundamentals buried in that overall sector of the industrial that is going to slow some reaction to a change in GDP.

Right. So if I am hearing you correctly, if I make some assumptions about what the petrochem business might be, perhaps 40% of the business is sort of sensitive to economic factors, and 60% of the business is sort of isolated or a little bit isolated because it's got exposure to sectors that just have tremendous cyclical sort of tail winds to them. Is that a fair characterization of the situation?

I don't -- would you repeat which category is 60 and which is 40?

Sorry, I am saying 60% is probably relatively isolated, meaning economically less sensitive; and 40% is more economically sensitive. Is that fair?

I think that is a fair assessment.

Okay, thank you so much. I appreciate it.

(OPERATOR INSTRUCTIONS) John Franzreb with Sidoti Company.

Could you talk a little bit about the international business? You kind of said that the order book implies that you're going to have some order flow in the first quarter of fiscal '09. What geography is that coming from and what kind of business is that?

Okay, John, it's still -- we're heavily reliant upon the China market, the Middle East market, and to a lesser extent the South American market. That is being driven by power generation, power distribution, and power transmission. So, it is the demand for power.

It may indirectly be driven by the spending ability as a result of the strength of the petrochem market. But our served markets are related primarily to power generation and power transmission.

Okay. This is I guess mostly Far East business, I guess is where you have the most -- the best opportunities in the near term? Is that --?

I would say they do not significantly surpass the opportunities in the Middle East.

Okay, okay. What is the -- percent of revenues, how much is foreign sales versus domestic?

I think that we are going to still end up the year between exporting about 25% to 30% of our Electrical and Industrial Products, John, which is right where we thought it would be.

Okay. How does that looks next year? How is that shaping up?

I would expect it to be relatively the same.

Okay, thanks a lot, David.

(OPERATOR INSTRUCTIONS) Daniel Yairi with Litmus.

Guys, was volumes in Galvanizing in the quarter, were those up, adjusted for acquisitions?

Yes. The total volume increase was 22%, of which 82% of that was acquisition related.

That was in the quarter or that was nine months to date?

That was in the quarter.

Okay, thanks a bunch.

Nathan Jacobs with Coe Capital.

Thanks for taking the question. My question is more as we look out towards '08, with these zinc prices where they are now. What type of impact will that have on your revenues as we move into '08 and on the gross profit dollars as a result?

You know, even with the price deterioration to the $1.05, $1.15 range that we think we are going to witness in the fourth quarter, margins are still going to hang in there in the 22%, which is the upper end of our historical numbers.

There is no doubt that at some point the revenue dollars will be impacted because commodity-based businesses do return to the commodity base. Now, we are -- we think that there -- as long as it were to stay above the $1 range we think we are going to get less pressure. I think there will be more psychological pressure if it were to drop into the $0.85 to $0.95 range.

But we think that it will, yes, have an impact on the top line; but as we work through our own zinc and the demand in the market, and as we look at the forecast, we think the ability to sustain our margins in the 20% range is still there.

Okay. As -- go ahead.

But as I say, it will impact the dollars; because eventually the dollars are going to reduce (multiple speakers) for that.

So the average -- I guess I'm just trying to build it for my own model here. But as we look at the price for -- the average price for all of fiscal year '08 is probably something in the $1.40 range or so?

Yes.

Okay, so as we move into '08, even if you stay at this level, it is still something like a 20% decline just from the zinc price alone. Is that the way to look at it?

I wouldn't say that the risk to the dollars is that great. There is a risk to the dollars; but remember in a normalized year zinc represents about 18% of our sales -- of our cost structure. So.

But it would be, I would believe, closer to the 10% to 15% range.

Okay, and you would see a commensurate type of drop on the Galvanizing side on the gross profit dollars as well?

In dollars, not in percent.

Yes, yes. Okay, all right. Thank you.

(OPERATOR INSTRUCTIONS) There are no further questions at this time. I would like to turn the call back over to Mr. Dingus for any closing remarks.

Again, we appreciate your participation today. We look forward to again discussing our outlook for our next fiscal year later in this month and then of course revisiting you for the final results for the year.

Again, I appreciate your support and your participation and look forward to speaking with you again. Have a great day.

This concludes today's conference call. You may now disconnect. Presenters please remain online.