AZZ Inc (AZZ) 2009 Q4 法說會逐字稿

Good afternoon. I will be your conference operator today. At this time, I'd like to welcome everyone to the AZZ fourth quarter question-and-answer session 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 day. Thank you for rejoining us today on short notice to conduct the fiscal year end 2009 Q&A session for AZZ Incorporated. Due to technical difficulties we were not able to conduct the Q&A session during our regularly scheduled conference call. We would like to apologize for any inconvenience this may have created. 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. Before we begin I'd like to remind everyone this Q&A session includes statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. With that having been said I'd like to turn the call over to Mr. David Dingus, President and Chief Executive Officer of AZZ Incorporated. David?

Thank you, Joe, and again we apologize for this problem but we would certainly like to open it up at this time to address any questions you might have.

(Operator Instructions). Your first question comes from the line of John Franzreb.

How you doing?

Good afternoon, John.

Let's start with the guidance. You pulled down your revenue numbers rather appreciably, but maintained EPS guidance. Given the backlog trends I can only assume that means that you are increasing your margin assumptions for the galvanizing business. Is that a proper assumption and if so, why are you doing that?

That is a proper assumption. There's a slight increase in our guidance, John, on the electrical industrial. We're going to come out with, we believe that's going to come in at 17 & 18 but for the same reasons we did in the fourth quarter better raw material costs, lower commodity costs and better execution. But on the galvanizing side we actually believe that this year, despite the downturn, we're going to be able to hold on to margins in that 24% range and that's up from 22 that I talked about the last time we were together. And even though the pricing has come down, our raw material content has come down more than we had anticipated. We're getting a little more efficient in some of our operations and just believe that we're going to be able to operate at that 24, 25% level despite the lower price and lower volume.

And how much of that margin degradation from the current 28 to the 24 you're thinking about, how much of that is just because of the volumes coming down, particularly I'm concerned about oil and gas volumes coming down versus pricing?

I think that it's more related to pricing because we think our volume is going to be as strong or stronger in the second half, John, because I think we're going to get enough if there is some softness that shows up in that oil and gas I think we'll pick up more than we anticipated earlier on the bridge and highway and then some of our other projects, the electrical, the solar work, the wind work is going to be stronger than we thought, so some of our markets that we looked at three months ago are not going to be as strong but there's several that are going to be even stronger than we thought.

And I'll ask one last question and I'll let someone else ask one. You refer to the fact you expect backlog to drift down through the second quarter with the potential of a rebound in Q3 of fiscal 2010. Could you talk a little bit about the quotation activity that goes into that kind of an outlook that you're hearing about?

Yes, John. The quotations are not down as much as our forecasting and my assumptions in the backlog and I'm just saying most of those things have taken 60 to 75 days longer and it's harder for us to judge which ones are going to go forward so we've got a lot more conservative in our projection of hit rate than we are saying the downturn in quotation of potential activities. The uncertainty is just things just taking longer to do that then they historically have so we're sitting here trying to forecast that backlog and trying to do that, we really don't have a good feel on how long it's going to take from the quotation to back to that cycle, so, I just believe that that will impact it on the backlog because it's just going to push those out. Now if it pushes them out too far of course it goes beyond our reaction time but I think that again, my concern is more in 2011 than it is 2010.

Okay, great. Thanks a lot, Dave. I'll let someone else in.

Thank you, John.

Your next question comes from the line of Fred Buonocore.

Yes, thank you. Just wanted to follow-up on John's question there about the backlog and about your comments on the call and the press release. So you talked about the backlog leveling off in Q3, so just to clarify, meaning to basically stop going down so you see it declining in the first half and then I guess leveling with mean and just stops declining or do you see it bouncing back up? And then if you could maybe give a sense for the magnitude of the decline that you see through the first half that might be helpful as well. Thank you.

I think what our assumptions are is that we at the end of the first quarter, the backlog will be less than it is at the fourth quarter and then you'll see another much smaller decrease at the end of the second quarter. We believe it will bottom out there and then we'll start to see some improvement in the third and the fourth quarters. Again, we want to be careful on how much of that forecast would be but we went from 195 to essentially 175. I don't think a number in the 150, 160 range is totally out of the possibility.

Great. That's helpful, and then on the galvanizing side in terms of lower volumes and weaker demand in your industrial end markets, can you give us some more granularity on the types of customers within industrial that you're seeing softness and do you think that that has bottomed? And then as part of that, is this largely AAA customers because the contribution from AAA based obviously on what you said in your press release is a bit less than what I had expected. Thank you.

Yes, Fred, it is more related to AAA than it is our traditional and it does get more into those general industrial that we've talked about before. We did a lot of work for say racking for the big box retailers. We did more work for the automotive. We did more work for the general industrial in that area, and it has bottomed out, because it's gone about as low as it can go without going away.

Right.

So we think that yes, we've seen that and it has been much more isolated in the AAA territory, than it has been in our traditional AZZ territories but we also say they have more potential from the stimulus than we do in the older AZZ territories because we'll do more bridge and highway there and any emphasis that comes from any of the more infrastructure buildouts could possibly cause a little faster rebound in that area, so we haven't forecast that but that's always the upside potential for that region of country.

Got it. Thank you. I'll jump back in queue.

Thank you, Fred.

Your next question comes from the line of Ned Borland with the Next Generation.

Good afternoon, guys. Just to follow-up on the backlog questions and your comments about pricing competition. Is it largely having to do with the large international orders, the elevated level of price competition or are you seeing it kind of across-the-board?

It has been related to the large international orders, particularly the China orders, Ned, is where we've seen it the most and we have seen some level of it in the Middle East but we've not seen anything close to that in our domestic market.

Okay, and then just a couple of housekeeping items here. Do you have the segment revenue excluding acquisitions?

Segment revenue for the quarter, galvanizing was 30.143 million, versus 34.914 million and then with the acquisitions it was 40.414 million. On the electrical side, 57.241 million versus 59.872 million.

Okay. And what were your capital spending, what's your capital spending budget for this year?

For fiscal 2010 is going to be in the $14 million range.

Okay, that's it for me for right now.

Okay.

Your next question question comes from the line of Andrew Wessel with Wessel Putnam.

How you doing?

Just fine, thank you.

Some of my questions have been answered. The one I have left just has to do with the cash balance. Looks like you guys have about $47 million on the balance sheet as of the end of the quarter; is that right?

That is correct.

That's about almost 30 times higher than the historical average over the last few years on a quarterly basis.

Correct.

Just wondering what your plans are for that cash? Are you guys looking to do another acquisition in the near term or are you just hunkering down for a tough stretch here?

I think it's some of both but naturally, the first choice of use of cash is strategic acquisitions. We think since we have a lot of borrowing power left under our current banking agreement, we got a $60 million outstanding line of credit which we're not tapping into combined with the $50 million in cash we think we can be active on the strategic market and still have plenty of cushion and liquidity for any additional tightening that may come into the banking markets but by far, our first choice will be to use that for acquisitions so we're being strategic in seeking some out and then also I believe it gives us the opportunity to be very opportunistic should something come that we're not fully anticipating at this moment.

Okay, are you looking at anything in that way right now?

We are constantly trying to add to the list. Is there something imminent? No. There isn't, but we've probably had as much activity or more activity than we've had in the last five years.

Would you be more likely to do something on the galvanizing side or the E&I side?

We're going to be very happy to do either or both.

Okay, thank you.

Thank you.

Your next question comes from the line of Brent Thielman with D.A. Davidson.

Hi, guys, good morning.

Good morning.

Just one question left for me. In terms of the galvanizing business, you guys sort of gave a projection of around 24% for operating margins. I'm just curious, what sort of range does zinc prices need to stay in between in order for you guys to meet that operating margin range?

Well, you have to make the assumption whereas if it goes up we get pricing opportunities to go up but we're in that range right now of $0.58, $0.59, that's basically where our cost of sales will work out for the next six months or so, so unless there's a $0.15, $0.20 jump in the cost of zinc that we can't recover in price and we've never had that scenario before, we don't think that we've got a lot of risk in that but essentially we're staying in the $0.60, $0.65 range is a very high comfort zone for us.

That's perfect. Thanks guys.

Thank you.

Your next question comes from the line of Eric Prouty with Canaccord.

Great. Thanks guys. Just a few follow-ups on the galvanizing side of the business. Obviously a lot of uncertainty out there in the market but if you look out there today would you say that you have some better visibility into activity than maybe you did three months ago?

I think the question is yes. I mean, three months ago, some of our customers were immensely concerned about their backlog, I think they are seeing some of that fill in. Is there still uncertainty? Absolutely but we can be a little more specific on what we think is going to happen in the Summer and in the Fall as we go in than we could three months ago. So I think we're a little more comfortable now than we were three months ago.

From a volume standpoint, again looking more industry wide, where do you think volumes are going to be versus last year and how do you think that's going to play out over the upcoming quarters, just absolute volume basis?

I think absolute volume will be anywhere from flat to down to 5%. Remember we'll gain an additional month on the, we'll have a full year of the AAA acquisition that will help us through that cycle. We've got some strong orders coming out as we know towards the end of the year from some of our customers, so I think we'll be very pleased if through our additional marketing efforts, through everything that we're doing if we can have a volume year, that's anywhere from flat to down 5%.

Okay and then what would your expectation be for organic volumes without AAA?

I'd just assume not say that. That makes me a little more vulnerable as to where my strong spots are and where my weak spots are.

Okay. That's fair enough. How about what you guys are looking at for industry wide volumes? Could you comment on that?

It just as we talked about earlier, if you go to different parts of the country, there's dramatically different results for it, so overall, the galvanizing market is going to be down. We're fortunate that we're in many areas where it is not going to occur, but I don't have a percentage of what I think the overall demand is going to be nationwide.

Sure, okay, thank you very much.

Thank you.

Your next question comes from the line of Jon Braatz with Kansas City Capital.

Good afternoon. Most of my questions were answered but when you look at the galvanizing operation, how does the galvanizing industry compare today versus maybe during the last downturn after 9/11? Fewer players? Less competitive pressure? Can you talk a little bit about the industry dynamics?

Sure. There's no question that even with the downturn, capacity utilization levels are better now than they were the 2002, 2003 time frame when this come through. The overall expansion of the market and there hasn't been a lot of new kettles come on the market during this past up cycle the way there was in the previous up cycle, so we believe that the dynamics are more favorable than they were in the last downturn. So and then I think people through as the whole industry has had a great run through this up cycle and I think they are just pleased with our higher levels of profitability and intend to try to hang on to them much longer than through the last cycle but overall the biggest driver is industry capacity utilization levels are higher than during the last downturn.

Would that suggest that given that the industry is operating more profitably during this downturn that chances are there might be fewer opportunities of some of these smaller players wanting to sell during tough times simply because the industry is more profitable and they're probably more profitable too?

As was said before, an economic cycle doesn't drive much acquisition activity on the acquisition side. These individuals are used to cycles.

Yes.

Where it does drive it though is some will just say I don't want to go through another one.

Okay.

Because it's not a heavily leveraged industry. The banks are not breathing down the necks of some of these operators so nothing drives them but as they're nearing their generational change, and something they want to come in, they may just say I just don't want to do another one, and that happens more than a real economic pressure that would drive them into selling.

Okay, all right. Thank you very much.

You bet.

(Operator Instructions). Your next question comes from the line of [Tim O'Toole] with Delta Management.

Hi. I guess one question on galvanizing first. We've talked a little bit about zinc but to what extent do you actually hedge or buy forward natural gas and are you doing anymore of that now given how kind of historically low that input is?

We, about 50% of our natural gas we will lock into contract anywhere from 6 months to 12 months. It's a factor that comes into that but we're not any more aggressive or less aggressive than we have historically been. We're just in a lot of areas where the supplier doesn't offer that option since we're in a lot of small more remote areas than some of these others, but where they are, we will go ahead and fix our price for anywhere from within 6 to 12 months.

And when you, in your pricing approach actually also, do you use some national index to lay that in and as comparative? In other words are you getting any kind of relative spread or differential pick ups as a result of kind of regional differences in kind of supply price versus NYMEX or Henry Hub or something?

With our signs we really can't do that because we serve customers from multiple facilities so we have to pretty well, our pricing approach which is very aggressive, the most aggressive in the industry will that show a lot of variant simply because one might be under contract and one won't be under contract because the customers if we may use two or three of our different facilities, we can't really price one way at one place and one place at another.

Well, no, I guess actually that's what I'm asking is if you kind of go, utilize a nationally based index as you kind of go out and price, but at a regional location you may actually have a pick up relative to NYMEX or something?

Right. I wouldn't say that that is that much of, the model is not that specific but we do know what our range of gas is and yes, we would use that to price our product.

Okay, all right, great. I won't beat that one to death. I was kind of curious maybe stepping back a little bit but really talking more on the E&I side, that, you mentioned kind of the impact of potential stimulus and kind of I think it was more in the context of galvanizing perhaps, but that there's a lot of, it seems I've heard anecdotally that the whole talk of stimulus, how big is it, where is it going to be, how is it going to be funded, when is it going to trickle through, et cetera, actually in some respects, caused some delays and some stalls in what might have been quoting activity. And on top of it I think you did allude to this, you've got some of the credit problems that have been exacerbated through the economy and it just creates uncertainty in terms of funding projects that have pretty big price tags. Could you talk a little bit about it may be anecdotal, you aren't the first line, you're a couple lines removed, but could you talk a little bit about the impact of some of those kind of overhangs and things that have stopped people in their tracks and whether or not you're seeing activity levels start to come back and I don't know if anyone thinks they have certainty but people being more comfortable with where funding is coming from or not at this juncture.

Well, I figure a good example that might answer your question. There's a lot of discussion and a lot of spending and a lot of proposals related to all of the discussion of a smart grid, all right? We at AZZ can't come and say well now our business is going to go up because of that, but we're encouraged because we're addressing the key issues facing our energy infrastructure that at some point in the future will translate into more business for us. Near term, we see very little on the stimulus bill that would help us with the exception of a continued emphasis on how much are we going to do with renewables, more on the committment side and the strategy side than the specific dollars that are going into our particular market. So overall we're encouraged. We can't point to business increases like we can on the galvanizing side when you say well if you're going to spend that much more in bridge and highway we'll get that much more opportunity, but we would like the language. We just can't point to say our business is going to be up because of it.

Well, no, and I think that some of the kind of more far reaching things like Smart Grid et cetera, I mean you're not going to see that until calendar 2010 or 2011, that takes a long time to get any momentum but I was actually thinking more of some of the transmission grid work has been talked about from 2005, 2006 and the blackouts and brownouts that we had in that time frame but meanwhile it's taken a long time to really get any momentum behind it. I don't know if some of the stimulus talk has created a bit of a stall and then that will have to be back filled and in other words, that may be a derivative effect for why -- I know there's some seasonality in order patterns anyway but a derivative effect for why the momentum may have come out of the backlog trends and kind of has to be rebuilt.

I don't think I'd draw that same conclusion.

No, okay.

No.

How much of your business, if you can identify it specifically but how much of your business in fiscal '09 would have been associated with wind projects both in terms of putting wind towers up and connecting them to a grid and then also, some specific transmission capacity has to be added to bring power from where there aren't people with lots of wind to where there's less wind and less people, if you will, do you have any figures for that?

Yes, we were probably less than 5% of our volume you could directly attribute to wind. Now, we were quite encouraged about the trend and what was going on, but those were the customers, as we talked about before that got hit so much by the credit crunch because they were more younger, start up companies and everything else but now what is happening is that industry is maturing and the large international conglomerates wind farm builders are just getting stronger and stronger. So I think we're in the transitional year here, we're still very optimistic about it but it's not going to be as strong for us in this year as we had originally hoped and I think the credit markets changed that more than anything.

Right, okay, back to one of my earlier points here. Okay, thanks, I'll jump off and maybe get back in.

All right, thank you.

Thanks.

Your next question comes from the line of John Franzreb with Sidoti & Co.

I thought I heard you say in your comments this morning something about the potential project cancellations on the E&I side. A) tell me if I'm wrong if you didn't mention it and B) if you did, what kind of historical cancellation rates do you guys typically experience?

John, I wish in that comment I would have been able to say we haven't had any, but they total probably less than $1 million, okay? And so I can't say they never happen but they are so insignificant through this whole cycle. I don't believe during the last downturn and everything else that if our total cancellation exceeded $5 million, I would be really surprised.

Okay.

I just don't think it is anything other than we've had just a couple minor ones through that. In fact, what we recovered through our cost incurred to date was almost the full amount of the contract, but I just can't make the statement that we didn't have a single cancellation, John.

Okay, that's fair, David. I just want to get a sense of what I thought the historical trends were and what we're staring at right now. One other question, you touched on the pricing environment and how it's getting a little bit tougher but you capped up your E&I margin expectations. I'm assuming the raw material recovery is significantly strong enough to offset the margin degradation that you can have a new order book. Is that a fair assessment?

That's a very fair assessment, John.

Okay, thanks a lot guys.

Thank you.

(Operator Instructions). Your next question comes from the line of Fred Buonocore with CJS Security.

Just another couple of quick follow-ups David.

Sure.

Not to beat the backlog related question, but just to make sure that I understand on the large international project side, largely in China and the Middle East, are we talking electrical infrastructure related as opposed to more oil and gas and you gave us kind of a good overview of what you think the trajectory or magnitude of the backlog change could or should look like as we move through the year and trying to gauge a confidence level on that to the extent that's possible, is this based on projects that you know are out there and that you've been working on and think you're close to or have already had a verbal committment? If you could kind of just give us a sense on the international order side, that would be helpful.

Sure. They're tied to power generation and high voltage transmission.

Right.

And there are projects that are going forward, the ones where we've had the pricing pressures where we were not successful in securing the order because we would not quote at that level were directly related to a couple of very high profile, very large jobs in the power generation side. So that, where we're seeing that pressure is where for some of our large international competitors who traditionally have had some other geographic markets such as Western Europe which were strong which are now not have had to turn to China to make up for some of that shortfall. And they are making up for it in a very aggressive fashion.

So we've not joined them at that pricing level. It will, we do anticipate and our guidance does assume we will have to make some adjustment as I was saying earlier, but we hope some rationale will return to that market pretty soon. There's a number of excellent projects still out there. But as it relates to the backlog and my not forecasting a recovery, it's just so much harder with the timing and the pricing misuse for me to say yes, we think we will secure that. Traditionally, I've made this statement, we anticipate two or three large international orders in the next six months. Today I'm not saying that, because of those issues. Are we still beating them, are we still in there trying our best? Are we still trying to get more innovative ways to quote them? Absolutely, but there have been some at a price level we just would not have accepted even if they would have been offered to it.

And you would say that this is the larger factor relative to say a slowdown in the oil and gas sector than on your backlog?

Absolutely, Fred. Absolutely.

Great and then just a quick follow-up on the discussion we were having about wind power and alternative and clean energy earlier. In terms of clean coal and the scrubbers, has that been a relatively material piece of your business? Does that continue? And just to clarify, that's on the electrical side, galvanizing side, or both on the clean coal scrubbers? Thank you.

On the clean coal, possibly impacts both sides.

Okay.

And that market is still good. It has continued to be good, and we haven't seen any significant change in that market. Again, those are the type of the projects that may get delayed 60 days so they may get delayed 90 days but they aren't coming off of the list.

Great. Thank you very much.

Thank you.

(Operator Instructions). You have a follow-up question from Tim O'Toole with Delta Management.

A couple of other dynamics that I'd love some perspective on. I actually just recently have met with a couple of utilities and one of the things that's interesting that two years ago seemed to be a log jam but seems to be freeing up in some respects now to the extent the utilities themselves have access to capital is that in order to actually create employment and put people to work, some of the utility commissions are actually more openly accepting their -- investments in their trends and their piece of the transmission grid for the capital base and for relatively attractive returns which is a bit of a change trying to undo that log jam. Are you seeing more quoting activity from that space around the transmission grid, at least sort of freeing up because obviously some of the interstate transmission grid activity can still be problematic in terms of zoning and squaring it all away but intrastate can be, one Public Utility Commission could square things up and actually get money in motion and it would be a high velocity way of putting some of the stimulus money to work. Are you seeing some of that acuity at this point?

We're seeing a conversation and a limited amount of advice on what projects are potentially there but a firm quote has not yet started. We're very pleased with those conversations and we've had experiences in the past where despite pressures from various regulatory, they just had to proceed because it was the only way to resolve the problem.

So a reliability problem, right?

It's a positive. It's a positive. I can tell you that quotes are up because of that just yet but we anticipate that the opportunity will.

Yes. What do you think the -- and this can vary a lot I'm sure, but what do you think the time constant is from the time people actually start to conceive of some of that work and activity to the time actually some of the orders get cut loose and the work really gets going? Is it six months or is it really 9 to 18 months the way these things work?

In all seriousness, we could answer that better in generation, distribution, and industrial than we could in the grid.

Okay.

I'm going to honor my forecast for five years.

No kidding. Now, the other thing was maybe you could put a little perspective on just in terms of what you're seeing out there is I guess what I would characterize is kind of more commercial applications, kind of industrial applications, tying in manufacturing capacity or whatever it maybe. I would presume that some of that activity is, and even maybe commercial tying in some commercial construction, the result of some building going up or something. Are you seeing that activity starting to wane some or is the order flow continued to be okay there?

I'm not sure I'm following you. Are you talking about distributed energy where you would build your facility closer to that or what?

Yes, I guess it would be more on what you would characterize as distribution as opposed to obviously not transmission but just some of the step-up, step-down stuff right at a manufacturing site for an individual Company or maybe -- I also envision, and maybe I'm wrong about this but if someone is building a new, if it were an office tower or some big plant that you or let's say a big hospital or something that you might be involved in the conversion of energy to high voltage down to whatever might supply that facility.

Yes, we would be in some cases involved with that but I have not seen any appreciable change in that market.

Okay, at this point. That's encouraging in a way. Okay, all right, thank you.

Thank you.

(Operator Instructions). There are no questions at this time. I would now like to turn the call back over to David Dingus for any closing remarks.

Again, we apologize for the inconvenience, the technical difficulties we had the first time. We do appreciate you taking the time to rejoin us. We enjoyed the conversation and if you have anything to follow-up don't hesitate to contact us. As I said earlier, look forward to talking to you at the end of our first quarter. Thanks again, and have a great day.

This concludes today's conference call. You may now disconnect.