AZZ Inc (AZZ) 2011 Q1 法說會逐字稿

Good morning and welcome to the AZZ Inc. first quarter fiscal year 2011 financial results conference call. All participants will be in a listen-only mode. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Joe Dorame. Please go ahead.

Good morning. Thank you for joining us today to review the financial results for AZZ Inc. for the first quarter fiscal year 2011 ended May 31, 2010. Again, my name is Joe Dorame, I'm with Lytham Partners and we are the financial relations consulting firm for AZZ Inc. With us today on the call representing the Company are Mr. David Dingus, President and Chief Executive Officer, and Mr. Dana Perry, Chief Financial Officer. At the conclusion of today's prepared remarks, we will open the call for a Q&A session.

Before we begin, I'd 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, pricing in raw material costs including zinc and natural gas which are used in the hot dip galvanizing process. Changes in the economic conditions of the various markets the Company serves, foreign and domestic, customer requested delays of shipment, acquisition opportunities, currency exchange rates, 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 time to join us for the conference call for the first quarter of our fiscal year 2011. We're pleased with the operating results for the first quarter and they did approximate what we had anticipated for the quarter. We believe it demonstrates that our markets are beginning to level off and that we have the potential for some growth in the last half of the year. Incoming order rates in our Electrical Industrial product segments are still being depressed and slower than desired due in part to the economic and regulatory uncertainty that we continue to operate in. We'll continue to closely monitor our quotation activity and customer feedback which hopefully will allow us in the future quarters to better forecast our incoming orders and backlog and confirm that we have leveled off and see signs of growth. Based upon the current customer requested delivery dates and our current production schedule, 75% of our backlog is expected to ship in the current fiscal year. Of the backlog of $111 million, 41% is to be delivered outside of the US.

The Galvanizing Services segment achieved another outstanding operating performance this quarter, considering the market conditions in which we are operating. We continue to demonstrate our commitment to quality and service during these market conditions and take advantage of all opportunities to maximize volume while maintaining price. While margins were down when compared to the prior year, we continue to operate at the higher end of our margin projection. Pricing was increased in the quarter, but did not fully offset increased costs being primarily higher cost of zinc that is flowing through our P&L.

We are very pleased that we successfully completed the tender offer for North American Galvanizing. We believe this acquisition is good for our industry, our customers, the employees of North American and the employees and shareholders of AZZ. The completion of the merger of North American is anticipated to be fully completed in the second quarter and the assimilation process has already begun. Competitive pricing actions continue to be mixed in both segments with some competitors deciding to maintain production and employment levels regardless of price and others deciding to follow a more disciplined approach. For the most part, within our served markets, the industry has remained -- has resisted massive price discounting, despite reduced demand.

As a Company, our accomplishments have continued as we double and redouble our efforts to better position the Company for a market recovery and regulatory clarity. We will strive to efficiently and effectively execute on all the business that we do have. The completion of another strong operating quarter, the financial strength of the Company, a great group of employees is reflected in our operating results and the confidence that we have in our future. We do believe we are advancing with confidence. As we continue to navigate through challenging waters in this period of market uncertainty. We continue the execution of our strategies. Now, with that as an overview of our results, Dana will now give us a review of the operating results for the first quarter of fiscal 2011. Dana.

Thank you, David. And I would also like to welcome each of you to our first quarter conference call and at this time I will review our unaudited consolidated results for the period ending May 31, 2010. As outlined in our press release, revenues for the quarter ending May 31, were $77.5 million as compared to $95.5 million in the prior year. Net income and diluted earnings per share for the quarter were $6.4 million, and $0.51, as compared to $9.9 million and $0.80 in the prior year. Transaction cost associated with the acquisition of North American Galvanizing during the first quarter amounted to approximately $1.2 million pretax dollars or $0.06 per share. Approximately $1 million pretax will be incurred in our second and third quarters for additional transaction cost related to the NGA acquisition.

As David indicated, we're pleased to report our book to ship ratio for the quarter was 101, ending the quarter with a backlog of $111 million. Our backlog at the end of our previous fiscal year end at February 28, 2010, was $109.9 million. Our Electrical and Industrial segment generated 48% of our revenues for the quarter while our Galvanizing Services segment generated 52%. With tack which significance of NGA we expect our Electrical and Industrial segment will contribute 42% of our revenues for the balance of the full fiscal year this year, while the Galvanizing segment will contribute the other 58%.

In our Electrical Industrial product segment we recorded revenues for the quarter of $37.2 million, as compared to the prior year results of $55.4 million. The decreased revenues for the quarter were the results of reduced order intake during the third and fourth quarters of fiscal 2010. The lower order intake during the second half of fiscal 2010 was a reflection of the economic and regulatory uncertainty in our served markets. Operating income was $6.6 million, as compared to $10.5 million, and operating margins were 17.8% for the quarter, compared to 19% in the prior year period. Margins were negatively impacted during the quarter as a result of loss of leverage due to reduced plant utilization as a result of lower volumes.

Revenues in the Galvanizing Services segment for the quarter were $40.3 million, essentially flat as compared to $40.1 million recorded in the first quarter in fiscal 2010. Operating income was $11.5 million, compared to $12.8 million in the prior year. Operating margins for the quarter were 28.5% compared to 31.9%. The reduction in operating income was a result of higher zinc and overhead cost that we were unable to recover through price increases. As we have indicated before, results from this segment have followed closely the condition of the Industrial sector of the general economy. For the three month period cash provided by operations was $4.2 million, compared to $13.7 million. Accounts receivable days remained strong at 62 days at the end of our first quarter as compared to 53 days at our fiscal year end. Year-to-date in capital improvements were made in the amount of $2.2 million, and depreciation and amortization amounted to $4.5 million for the quarter.

Our excellent cash flows has again allowed us to continue to pay cash dividend of $0.25 for the quarter. Our total outstanding bank debt at the end of the quarter remains at $100 million, and our cash balance was $110.2 million. We also increased our revolving line of credit during the quarter, with our primary lender from $60 million to $80 million. We utilized our cash balance at the end of the quarter to fund the tender offer of NGA during June. Our leverage ratio at the end of the first quarter was 1.45 times, which is well below our covenant requirement of 3.25 times within our Senior Credit Facility. We continue to believe that our balance sheet is one of our core strengths and along with our strong cash flow characteristics, combined with access to borrowings under the existing banking agreements, provides us with adequate flexibility to continue growth of our Company. At this time I will -- Dave will give us an overview of our two operating segments.

Industrial and petrochemical demand for our power distribution and motor control centers remained at the lower levels we saw for most of calendar 2008. Timing of new projects and release of orders related to the energy infrastructure rebuild, expansion and upgrades remains an issue and is impacting our incoming order rate. The demand for our metal clad outdoor switch gear products saw a continuation of reduced inquiry and order levels. Utility budgetary spending levels have been reduced and we do not anticipate a strong increase until calendar 2011.

Most of the demand that drove our business over the past three to four years has been more for the replacement and upgrade rather than expansion so we would anticipate that that would follow that trend once rate recovery that is connected to capital spending is granted to the utility companies and they are able to return to their upgrade programs. Therefore, we believe it is a timing issue rather than a long-term reduction in the spending for the upgrade of the distribution substation market. Our high voltage transmission bus deck products, quotation activity reflects stable demand. The quotations are made up of multiple orders rather than one or two large international orders. We are still, however, very heavily reliant on the international market which remains very competitive. Overall, we believe that power generation market has been relatively stable. Activity centers primarily around the gas, nuclear and hydroelectric power generation and the domestic emphasis on renewables such as wind and solar and environmental upgrades should positively impact our marketing opportunities in the future.

Our specialty lighting products sales did show improvement in the first quarter of fiscal '11. We traditionally see improved volume in this operation before we see it in the large project market. We will monitor closely to see if it is a leading indicator for our business levels that it has traditionally been in the past. We did also see improvement our tubular products.

For the Galvanizing Services segment our strategy to provide a premium level of service and quality to our customers has continued and will continue as we resist downward pricing pressures. Operating results will be impacted in future periods if our announced price increases do not stick as a result of sluggish demand. We still believe that the emphasis on infrastructure will have a positive long-term impact on business levels. We feel our overall marketing strategies and customer service emphasis is enhanced with the acquisition of North American Galvanizing. This acquisition will increase our geographic footprint, broaden our customer base, and increase the total facilities to 33, allowing us to provide a superior level of service and support to this market. We are anxious to get the assimilation of the two organizations completed. It has begun and should be substantially completed by the end of our current fiscal year.

In summary, the strong operating performance of the first quarter of fiscal 2011 is encouraging and we did match our internal expectations. Our primary concern, as we've shared with you and discussed previously, is the incoming order rate for Electrical products, and improved demand for Galvanizing Services. Our products and services are extremely well-positioned to benefit from any market improvement and/or increased infrastructure spending. Our lead times are shorter and should provide for more expeditious benefits of any improved market condition. The timing of the projects and release of orders will always have an impact on the quarterly recognition of bookings and backlog, revenues and earnings and will result in quarter to quarter fluctuations which may be greater than true changes in market demand and our competitive position and success.

Based upon the evaluation of information currently available to management, we are revising our guidance for revenues to be in the range of $380 million to $395 million. Our earnings guidance is anticipated to be in the range of $2.65 to $2.80. The revised guidance includes the anticipated results of the acquisition of North American Galvanizing for the balance of our fiscal year. The previously issued guidance was for revenues to be in the range of $310 million to $330 million, and that fully diluted earnings per share would be in the range of $1.85 to $2.20. We will incur as Dana indicated additional acquisition related expense during the balance of fiscal '11 of approximately $1 million, which is reflected in this guidance. We do not expect to fully realize all the synergistic benefits of the North American Galvanizing acquisition until the first quarter of fiscal '12.

Now, achievement of these projections will be our 24th consecutive year of profitability. Our estimates assume that we will not have any appreciable change in our current market conditions, competitive activity or significant delays in the delivery or timing in receipt of orders of our Electrical Industrial products and demand for our Galvanizing Services. Additionally, the Company's Board of Directors declared $0.25 per share cash dividend on common stock outstanding. The dividend will be paid at the close of business on July 26, to shareholders of record on July 9, 2010. Again, thank you for your participation today and we'd like to open it up for any questions that you might have at this time. Operator?

Yes, sir. We will now begin the question-and-answer session. (Operator Instructions) At this time we will pause momentarily to assemble our roster. Our first question comes from John Franzreb of Sidoti & Company. Please go ahead.

Good morning, David and Dana.

Good morning, John.

I guess my first question is regarding the guidance, is that entirely due to the inclusion of NGA or does it assume a change in the margin contribution from the Galvanizing business at all?

John, on the revenue side, yes, it's essentially the North American. On the earnings side, if you take the midpoint of our previous guidance and the midpoint of our current guidance, you got about a 70% -- $0.70 delta there. Of that, $0.35 or half could be attributed to North American and the other half could be attributed to higher margins in the AZZ Galvanizing business, and the little bit lower spending levels in our SG&A overall exclusive of the transition costs. So we've got improvement in both pieces of the business which we're encouraged about and that is driving the EPS side, but on the revenue side it's primarily North American.

That explains a lot. Are you seeing demand -- actually, are you seeing the prices that you're pushing through being uniformly accepted or are there pockets of strength and weaknesses, in regard on the pricing front on Galvanizing?

I would say overall, John, we've had pretty good success across the board. We did an increase back in -- announced it in February for implementation in March and we think about 70% to 80% of that is stuck across our markets and we've been pretty diligent and we get pushback naturally, but I don't think it's tied to one market more than the other. We're very pleased with how it's balanced across our operations.

Okay. And one last question and I'll let someone else in. I kind of missed that statement that you said about you view certain business as a leading indicator in Electrical. Could you just walk me through that, which business and why that's the case?

John, it is in our lighting operations. We traditionally see improvement -- that's a much faster turn business. It's not a backlog business for us. And we saw improvement in the industrial side, in the petrochemical side, in all phases of that and traditionally that has been the case every time we've come out of a recessionary period. Now, with the uncertainty that's in our overall markets I'm not bold enough to say that's what's happening. What I was trying to say was I hope that's another leading indicator that we have bottomed out and we are seeing the potential for some uptick. Again, it's a smaller piece of our business, but traditionally that's the way it's behaved. So it adds a little bit to my optimism, John.

Does that business sell mostly to distributors or does it sell mostly direct sale to an OEM customer?

Most of it goes through reps and distributors. You always have an inventory potential build-up with some of your distribution network. With it being a specialized product, it's not one that is heavily inventoried by our agent and distributors. Even though it goes through that channel, it is not necessarily an inventory management issue again. They're responding to direct demand that they get.

Thanks a lot, David.

Thank you, John.

The next question is from Ned Borland of Hudson Securities. Please go ahead.

Good morning, guys. Just staying with Galvanizing for a second here, could you give us a comparison of what your kettle cost of zinc was in the quarter versus the current spot price because zinc seems to have really dropped like a stone over the last couple of months here.

Right. In the first quarter our average cost coming through was around in that $0.78 range. Of course, it's trading in the low $0.80s now, moving up. There's no doubt that the change in the relationship, the euro versus the dollar drove that price down after the euro made its correction after the Greece, which made the price come down more than it traditionally would as a result of the case of demand and inventory. So most forecasts show it going back up, Ned, but essentially it's a match during our first quarter.

Okay. So traditionally you guys have sort of seen a six month lag between the movement of zinc and when you realize it through your P&L. So basically it's evenly matched now. We don't have to really think about a six month lag. Is that fair to say?

No. We still have some of that $90 that's going to come through over the next couple of quarters, Ned. That's why we've had to push the price through that we're pushing because the $0.78 that we had in the first quarter is actually below what we think it's going to be in the second and third quarter. And then if you have this correction, coming back to $0.80, we would see that in the fourth quarter. So yes, we have an increased rate coming through in the second and third quarter for the cost of zinc regardless of what it behaves. And for a long period of time it was in the high $0.90s, up towards a $1.00. So we'll see something approaching $1.00 in the second and third quarter which is why, again, we've had to push these price increases through to offset that, more than how the current cost of zinc is behaving.

Okay. Fair enough. I know it's early in the integration process, but outside of obvious things like corporate headquarters and things like that, what are some of the synergies you think we should be thinking about here?

Well, I mean, we -- those are the obvious ones. That's the ones that we hope to get all done by the end of this current fiscal year. The others, Ned, I think you have to just put in the overall bucket of operating performance which we've had a track record of increasing. Whether that be productivity, whether that be increased volume, whether that be increased marketing, increased sales, so it's more of molding into our model than it is your traditional elimination of cost synergies. I think the elimination of cost ones will get out by the end of the calendar year, hopefully, but definitely by the end of the fiscal year. The others are just going to be the approach that we take and the way we operate, being a little more aggressive on the top line than most of the companies that we acquire and we've just got a great starting point with North America and the way they complemented and the knowledge that we have of our customers and their operations. So we're very optimistic.

Okay. Fair enough. And then switching over to E&I, any disparity in the order picture, non-US versus US? I mean, is the non-US market even though it's more competitive, are there more opportunities available?

I don't think there's been a change really between the domestic and international. Where there has been a change, Ned, is that we haven't seen -- I mean, the distribution side of our business is just at a much lower point with no immediate or near term improvement the way we're starting to see it in generation, the way we're starting to see it in Industrial, starting to see it in the high voltage but I don't think that the mix has changed, which means our US has not picked up as much as we would like it to at the end of the day.

Okay. But--?

We're still operating in that 40%, 41% range, and that needs to be in that 30% range, not because international goes down but because domestic picks up.

Okay. Fair enough. Thanks.

Thank you.

(Operator Instructions) And the next question is from Fred Buonocore of CJS Securities. Please go ahead.

Yes, good morning.

Good morning.

It looked like you had a pretty substantial sequential increase in bookings in the quarter and can you clarify for us how much of that is real improvement in demand and potential beginning of a stabilization or strengthening trend and how much of that is really just seasonality?

Well, I think I assume you're comparing it to a year ago, as a percent and what our book to ship ratio was in the first quarter. Of course, the first quarter last year is when we saw the bulk of the downturn, had a pretty good second quarter and then down. So again, if I understand your question, it's not in any one particular point. It's not like we've traditionally reported in the past of one huge international order. It's just a gradual moving up and more of a matching. Our revenues are down so now we're matching the incoming order rate with the outgoing order rate. So I think it's more of a matching of that than it is driving that book to ship ratio than a dramatic increase in the booking side.

I'm just talking from a dollar standpoint, I guess you did $63 million in bookings in your fiscal Q4 '10 and so what you did this quarter was a pretty meaningful jump.

That is correct. When we express that. So of course our backlog was descending at that point and now we are hoping that it has leveled off so with a one to one match, so you are correct in your statement.

Great. And just sort of near term, looking at Q2, there's been a lot of bad weather in the Midwest recently, do you see any of this impacting your Galvanizing operations in the second quarter?

None to date do we anticipate through the tornado tragedies and everything else, we don't see any direct impact on us at this point.

Got it. And realizing that you provide annual, not quarterly guidance, by segment how should we sort of directionally think about revenue trends just looking into Q2? I mean, are we kind of thinking flattish in both areas or do you think you'll have another leg down to go in the Electrical products, purely on a -- go ahead.

Even with a pick-up in the Electrical and Industrial, even if that starts in the second quarter, which we don't believe it will, we believe it will be at least the third quarter before it does, that's all going to flow into next fiscal year, Fred.

Right.

And whatever the GDPs going to do in this year, we'll feel that in the Galvanizing but I really think that at the lower rates, that's going to be pretty steady going up. So I don't think you're going to see big fluctuations in the performance of the Company over the next three quarters.

Okay. So just from an organic revenue dollars standpoint, somewhat flattish on a sequential basis as we look forward?

Right. And then of course what we hope for is then we start building backlog and then we see continuing demand improvement in the Galvanizing side from the merger of the two companies.

Right. And in terms of utilization how are you sitting now in your facilities on both sides of the business?

65-ish, 70-ish, right in that area.

And what would kind of be in a stronger demand period, I mean, are you normally talking about in the mid-80s or--?

Yes, mid -- in that 80 to 85 range is a really nice place for us to be. But even at the 65 level or anything else, we're still above breakeven in all of our operations, so that's allowing us to be disciplined as we go forward and everything else. But yes, we've got a lot of room for improvement and naturally the margins in the Electrical particularly are driven by the leverage point on that and so once you get up to that 80, 85, you get a lot of leverage contribution in both segments.

Right. That's what I was getting after. Your margins have held in quite well, despite the volume declines, so it would seem like even a little uptick in demand would really increase profitability.

That is very correct.

And then just for you Dana, could you clarify what general corporate expense was in the quarter? I guess is that where these deal related expenses would have been parked and what would it have been without the deal expenses?

It was about $1.2 million associated with the deal transaction cost. If you back that out that gets us pretty much where we thought we'd be.

Got it. So somewhere in the mid-$5 million range?

Correct.

Okay. Thank you.

Thank you.

And the next question is from Rick Hoss of Roth Capital Partners. Please go ahead.

Good morning, gentlemen.

Good morning, Rick.

The Galvanizing segment, looking at operating margins and thinking about the second quarter, makes sense to me that it would be either flat to up, which from the first quarter's I think pretty impressive operating margin and then the assumption as NGA starts to contribute it will erode the operating margin for the second half of '11, is that correct?

That is correct. If you -- we believe that our AGV Galvanizing margins are going to be for the balance, are going to be in that 26%, 27% for the year. North American, because we haven't eliminated all those additional costs are going to be in that 18% to 19%. So the blended rate for the full year is going to be right at that 24%, 25% range.

Okay. And then the -- on the E&IP side, it appears that we're just sort of bumping along, leveling but bumping along on the bottom here. What sort of opportunities are there to add to revenue as in M&A?

We have probably never been more aggressive in our search for adding something in that side. Now, those naturally are -- take a little bit longer but all I can say is that we believe that there are opportunities both on the product side and as we discussed before our entry into the service side to add to that. It will be a challenge to get that done in the fiscal year, I believe, but it won't be -- but we're approaching it to really get it focused in the current fiscal year. We're devoting a considerable amount of effort to it and we've got a pretty nice list but that's just at this point a shopping list. That's not anything close to the negotiation side. But there's some real, nice strategic fits for us. We're real comfortable in what we're looking at there.

Okay. That's good news. Dana, do you have a number, just quickly, please?

Say it again. I didn't understand you.

D&A, sorry.

Depreciation and amortization was I believe $4.5 million for the quarter.

Okay. Thanks, guys. Appreciate it.

Thank you.

(Operator Instructions) The next question is from Brent Thielman of D.A. Davidson. Please go ahead.

Hi. Good morning, David. Good morning, Dana.

Good morning, Brent.

Yes, just maybe a clarification from me. As I look at the Galvanizing segment, just on a sequential basis, obviously a nice bump in terms of margins, I mean, so that's a function of better volumes, better price and flat kettle cost, I mean, can you just kind of clarify for me there on a sequential basis?

Again, what periods are we comparing? Comparing year ago?

Q1 versus Q4.

Yes, Q1 to Q4 is pretty consistent. There's nothing -- we got a little more of our price implemented in the first quarter, which helps build up in anticipation of that as we talked about earlier, the additional coming through, so nothing dramatically changed other than we just saw another quarter of stabilization which I think in this market is good news, Brent.

Dana, I'm kind of curious your thoughts. Obviously we've seen quite a bit more volatility in metals markets in the last couple years, particularly in zinc. I'm just curious, has your customers reactions to movement in spot prices changed and how is that impacting your ability to price?

Well, as we've said before, I think they understand how volatile it is. I think they understand why it's volatile. But, a customer's not going to miss any opportunity to resist your pricing action through that. But I think no one really thinks that these changes that have happened have fundamentally changed the structure of the zinc supply and I don't think anybody in the market really expect it to stay in this $0.80 range, that it's going to return back closer to where it was before.

Okay. And then on that E&I business, I think your prior margin guidance was 13.5% to 15.5%. Are you maintaining that for the full year?

We believe for the full year we're still going to be in that 15% range.

Okay. And as you're talking to people as you mentioned obviously going around with your customers, I mean, specifically with some of your oil and gas customers, I mean, are you seeing more hesitation from them now as a function of obviously what's going on in the Gulf? I mean, have attitudes changed toward capital investments there, particularly in that sector.

Absolutely. I would also package that, it's an industry that looks for excuses to delay.

Okay.

They've been given a (expletive) of a good one.

Yes, it's a big one. And I guess just in terms of a run rate for SG&A going forward with North American Galvanizing, do you have something there? I mean exclusive of obviously the acquisition cost.

It should not materially change from our run rate. If you were just -- probably you could look at when we eliminate their cost, we would probably add in the range of $0.5 million to our structure.

Okay. Perfect. Thanks a lot.

Thank you.

(Operator Instructions) Gentlemen, there are no other questions in the queue. I would like to turn the conference back over to David Dingus for any closing remarks.

Again, thank you for taking the time to join us this morning and we're going to continue hopefully to report the positive impact of the merger of the -- and the assimilation of North American and continue to look for the positive trends and the increasing of the potential to increase our backlog in the Electrical Industrial and as I said, we're still very aggressively pursuing all of our strategic plans for both segments of the Company and we're very encouraged as to where we are right now. Thank you and have a great day and we'll talk to you next quarter.

Thank you, gentlemen. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your line.