AZZ Inc (AZZ) 2011 Q3 法說會逐字稿

Good morning and welcome to the AZZ incorporated third quarter fiscal year 2011 conference call. All participants will be in a listen-only mode. (Operator instructions). After today's presentation, there will be an opportunity to ask questions. (Operator instructions). Please note, this event is being recorded. I would now like to turn the conference over to Mr. Joe Dorame. Sir, please go ahead.

Thank you, Amy. Good morning and thank all of you for joining us today to review the financial results for AZZ incorporated for the third quarter fiscal year 2011, ended November 30, 2010. As Amy indicated, my name is Joe Dorame; I'm with Lytham Partners, and we're the financial relations consulting firm for AZZ. 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 would like to remind everyone, this conference call includes statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Except for the statements of historical fact, this conference call may contain forward-looking statements that involve risks and uncertainties, some of which are detailed from time to time in documents filed by the Company. 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, the hot dip galvanizing markets, prices in raw material costs, including zinc and natural gas, which are used in the hot dip galvanizing process; changes in economic conditions of the various markets the Company serves, foreign and domestic; customer-requested delays of shipments; 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. AZZ undertakes no obligation to affirm publicly, update or revise any forward-looking statements, whether as a result of information, future events or otherwise.

With that having been said, I'd like to turn the call over to Mr. David Dingus, President and Chief Executive Officer of AZZ. David?

Thank you, Joe, and thanks to each of you for taking the time to join us for the conference call for the third quarter of our fiscal 2011.

The operating results for the third quarter did approximate what we had anticipated. We are particularly pleased that they reflect an improvement in revenues and net income when compared to the prior period. The third quarter was another quarter of effective execution of our opportunities and the positive impact of the assimilation of North American Galvanizing. The transmission, distribution and industrial markets for our Electrical and Industrial products have not shown the level of stability or the recovery that we had hoped for. The power generation market has been relatively stable. The domestic natural gas-fired power generation opportunities have improved. Based upon our quotation activity and conversations with our customers, we do not believe that our backlog will show any increases in the current fiscal year.

Our fourth quarter is traditionally our weakest bookings quarter. This, combined with economic and regulatory uncertainty and reduced utility spending, leads us to project limited opportunities for improvement in our backlog levels in the current fiscal year. We will continue to closely monitor our quotation activity and customer feedback, which hopefully will allow us in future quarters to better forecast incoming orders and backlog and confirm that we have leveled off and that we see signs of growth.

Based upon current customer-requested delivery dates in our production schedules, 40% of our backlog is expected to ship in this fiscal year. Of the backlog of $101.7 million, 40% is to be delivered outside the US.

The Galvanizing Services segment achieved another outstanding operating performance. The markets for our northern galvanizing locations showed increases, while the Gulf Coast operations continued to be adversely impacted the lower levels of petrochemical work. We continued to demonstrate our commitment to quality and service during these market conditions and take advantage of all opportunities to maximize volume and market share while maintaining and improving pricing levels.

While margins were down when compared to the prior year, we continued to operate at the higher end of our margin projections. Pricing was up 2% when compared to the prior year. However, the increase did not fully offset increased cost, being primarily higher cost of zinc. We're very pleased that we were able to acquire North American Galvanizing in this fiscal year. Results of the first few months continues to be encouraging. We believe this acquisition is good for our industry, our customers, the employees of North American and the employees and shareholders of AZZ. The assimilation process has gone extremely smoothly. 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 our more disciplined approach.

Price deterioration has become very prevalent in the utility, transmission and distribution markets due to the significant reduction in capital spending and their lower operating budgets.

The completion of another successful quarter, the financial strength of the Company and a great group of employees is reflected in our operating results, and I'm confident in our future as a Company. We continue to advance with confidence as we navigate through these challenging waters in this period of market uncertainty. We remain committed to our growth and expansion strategy.

Now, with that as an overview of our results, Dana will now give us a review of the operating results for the third quarter of fiscal 2011. Dana?

Thank you, David, and I would also like to welcome each of you to our third-quarter conference call. At this time, I will review our unaudited consolidated results for the period ended November 30, 2010.

As outlined in our press release, revenues for the quarter ending November 30, 2010, were $102.9 million as compared to $81.5 million in the prior year. Net income and diluted earnings per share for the quarter were $9.7 million and $0.77, as compared to $8.7 million and $0.70 in the prior year. Our book-to-ship ratio for the quarter was 95%, ending the quarter with a backlog of $101.7 million. Our backlog was $106.5 million at the end of our second quarter and was $109.9 million at the end of our previous fiscal year.

Our Electrical and Industrial segment generated 42% of our revenues, while our Galvanizing Services segment generated the balance at 58%. In our Electrical and Industrial products segment, we recorded revenues for the quarter of the $41.1 million as compared to results of $43.6 million in the prior year. The decreased revenues were the result of lower demand from our petrochemical and electrical transmission and distribution markets as compared to the prior years. Operating income was $6.2 million as compared to $9.1 million, and operating margins were 15.1% for the quarter compared to 20.9% in the prior-year period. Margins were negatively impacted during the quarter as results of the loss of leverage due to reduced plant utilization as well as less favorable pricing due to more competitive market conditions.

Revenues in our Galvanizing segment for the quarter were $61.8 million as compared to $37.9 million recorded in our third quarter in fiscal 2010. Operating income was $15.4 million compared to $10.5 million in the prior year. Operating margins for the quarter were 24.9% compared to 27.8% in the prior-year period. The acquisition of NGA added $18.3 million to our third-quarter revenues and $4.5 million to our operating income. The integration of NGA into AZZ's systems has actually completed at the end of our third quarter. The overall transaction cost associated with acquisition of NGA was approximately $1.8 million. The reduction in our overall operating margins in this segment was primarily a result of higher zinc and overhead costs that we were unable to recover through pricing actions to our customers.

At this time I will cover some of our key cash flow balance sheet items, as well as on a comparative basis. For the nine-month period, cash provided by operations was $25.5 million compared to $65.5 million in the prior-year period. Our decrease in our cash provided by operations was due primarily to increased working capital requirements, primarily in our Galvanizing segment. Our accounts receivable days remained strong at 48 days at the end of the third quarter as compared to 53 days at the end of our last fiscal year, and our inventory turns continued to improve.

Year-to-date capital improvements were made in the amount of $11 million, and depreciation and amortization amounted to $16.2 million. Our quarterly cash dividend will be discussed at our regularly scheduled board of directors' meeting on January 20. Our total outstanding bank debt at the end of the quarter was $100 million, and our cash balance was $6.7 million. We utilized our cash balance and drew down $12 million to fund the acquisition of NGA during our second quarter. We were able to pay down the $12 million draw during our third quarter, leaving a zero balance against our revolving line of credit.

Our leverage ratio at the end of the third quarter was 1.4 times, which is well below the ceiling on our covenant requirements of 3.25 times within our senior credit facilities. Due to the very favorable interest rate environment we are currently experiencing, we anticipate entering into an additional note purchase agreement in late January in which we will issue a $125 million unsecured senior notes due in January 2021 at a fixed rate of 5.4%. We anticipate using the proceeds from this note offering for potential future acquisitions as well as general corporate needs. The yearly carrying cost for interest associated with this note offering will be approximately $6.8 million.

We continue to believe that our balance sheet is one of our core strengths, along with our strong cash flow characteristics combined with access to borrowings under our existing banking agreements provides us with adequate flexibility to continue to grow our Company.

At this time, David will give us an overview of our two operating segments.

As I indicated earlier, overall the power generation market has been relatively stable. Most domestic activity revolves around renewals, upgrades to coal-fired plants and new natural gas-fired power facilities. Internationally, the majority is in the nuclear and hydro.

Industrial and petrochemical demand for our power distribution centers and motor control centers remained at the lower levels we saw for most of calendar 2009 and continued through 2010. Demand for our electrical distribution substation product saw a continuation of weak inquiry and order levels. Utility budgetary spending levels have been dramatically reduced and we do not anticipate an increase until overall electrical demand improves and utilities are able to get regulatory rate increases.

Our high-voltage transmission bus duct products' domestic activity was limited, and internationally it was spotty. The outlook for the international work remains positive, but the timing of the release of these orders is outside the current fiscal year. Domestic business opportunities have seen more competitors, and we have experienced price deterioration.

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. We will continue our efforts to increase our footprint and broaden our served markets.

In summary, our products and services are extremely well positioned to benefit from market improvements. Our lead times are shorter and should improve for more expeditious benefits of any improved market conditions. The timing of the projects and release of orders will always have an impact on quarterly recognition of booking, backlog, revenues and earnings and will result in quarter-to-quarter fluctuations which may be greater than true changes in market demand in our competitive position and success.

Based upon the evaluation of information currently available to management, we are maintaining our guidance for revenues to be in the range of $385 million to $395 million, and our earnings guidance is $2.70 to $2.85. Achievement of these projections would 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 delivery or timing, and the receipt of our orders of the Electrical and Industrial products and the demand for our Galvanizing Services.

As Dana indicated, we anticipate issuing guidance for fiscal 2012 on January 21, 2011. This will follow our regularly scheduled board meeting, where our operating plans and projections are approved by our Board of Directors. We anticipate entering into an additional note purchase agreement in January, and our guidance will reflect the increased interest expense associated with that note purchase agreement.

The strength of our balance sheet, the competence of our management team and strong customer acceptance of our products and services gives us the confidence to aggressively pursue additions to our products and expansion of our markets, despite current market conditions.

Thank you for your participation today, and at this time we will open it up for any questions that you might have.

(Operator instructions) Fred Buonocore, CJS Securities.

The first question relates to the new debt issuance. I wanted to see if you could elaborate any further on more specific opportunities that you're homing in on. Or, is it truly just opportunistic, given the low rates? Or, I mean, do you think you are close on some potential acquisitions?

Fred, as we've discussed before, we are committed and we are aggressively looking for those opportunities. As we model those opportunities, just as we did with North American, we know that there will be additional capital requirements for us to have in place.

And then, when you took a look at the favorable conditions we just thought strategically it was good for us to go on and develop that war chest so that we could move even more aggressively and be more opportunistic should something come up, and we could handle it with cash on hand. So, no; unfortunately, we don't have anything that near-term. But we believe strategically, again, demonstrating our commitment to continuing to expand our operations, and we believe it just was a correct decision to make.

And so it sounds like potentially opportunities more on the galvanizing side, or it's pretty, still, balanced?

It's still balanced. We still believe the larger ones will be on the electrical, Fred.

Okay. And then, in the galvanizing business, what end markets are you seeing some sort of strength or some sort of improvement? Does it look like it's starting to become meaningful improvement that could gain momentum, or still kind of shaky recovery?

Well, the one market that we are seeing some work on that we are hoping that we continue to see expansion of is just the solar market. It's begun -- our quotation activity has been strong for the last year; now we're beginning to see some of that work. And then we have been quite successful in the OEM market, converting people over to using more and more galvanizing. And then we have been favorably impacted by some of the transmission pole work, and then the bridge and highway and the transportation has been favorably impacted.

So it's been nicely spread, but the biggest opportunity that we have to see more growth that will cause it to outpace economic recovery would be tied to the solar market, probably.

Okay. Finally, Dana, you mentioned that total costs related to the integration of North American Galvanizing was $1.7 million. How much of that was in this third quarter? Was it around $1 million?

It was actually $1.8 million, and there was nothing in the third quarter.

Okay. It was all the previous quarter?

Correct.

Okay, thank you, I'll get back in line.

John Franzreb, Sidoti & Co.

My first question, I'd like to talk a little bit about the rate environment for your utility customers. You kind of implied that you really need a better environment for them, for the CapEx budgets to kind of increase. What's your thoughts about the timing of that, or what's the pushback they are receiving or not receiving at this point?

As far as we can tell, John, the pushback comes from trying to push through a rate increase when you've got 10% unemployment and you have no economic growth and no increase in demand. The regulators are just saying, we can't push that burden onto the users in this current economic condition. So it's just going to have to be part of the confidence that we do have a recovery in place and we're starting to see some reductions in the unemployment, in my opinion.

Okay. Secondly, when you borrowed the $100 million, you were willing to keep it on the balance sheet for more than a year before you did the NGA deal; kind of suggests to me that you want to get your monies in place before you make any kind of commitment. Two things -- one, should we expect one large deal, or do you expect to use this cash and a collection of smaller deals? And two, does the outlook that you're forecasting suggest that we are flat-lining, so you have a high degree of comfort level carrying this much more debt? Historically, you weren't willing to carry this much debt on the balance sheet.

Yes, I'll go to the last part. This keeps us well within our comfort levels as far as leverage related to EBITDA and as far as debt to equity. So that part was a pretty easy decision for us. Since we don't have a lot that we're looking at in very specific terms, but I'm going to answer generally to your comment on the large versus small. We think the $125 million that we're raising is more geared towards a large acquisition because the smaller add-ons that we do, particularly in the galvanizing, could be done out of free cash flow.

And one last thing, David. You mentioned something on the galvanizing sector. I don't think I've ever heard this line from you before; you said converting OEMs into galvanizing. Could you just elaborate on that point; what you're doing and how you are doing that?

Well, again, if you take, for example, some components on over-the-road highway equipment, those traditionally have not been galvanized. We have demonstrated to them how, when you galvanize that product, it extends the life of it, and then they have a positive selling point to their end-user. So it's part of our ongoing marketing efforts that we do and the AGA does and the whole industry does, is how do we demonstrate to more and more people the benefits of galvanizing versus alternatives, whether that be painting or different materials.

So some that we've seen have been in the over-the-highway equipment; that just happens to come to mind. There's been other successes in that. But that's the type thing I'm talking about.

(Operator instructions) Rick Hoss, ROTH Capital Partners.

Just to continue hitting on the potential acquisitions here, based on the size, and if I understand the galvanizing landscape at this point, it's really you and Valmont, and then just maybe other smaller guys that are maybe one or two kettles; is that correct?

There are -- I mean, Hill & Smith is a large player in the US, of course, with multiple operations in the Northeast. They are into a lot of other activities outside of the US. But the majority of the balance of the players are one and twos.

Okay, and again, as you hit that $125 million, then, it's implying that you are probably focused more on the E&IP side. And assuming that, what sort of valuations are you targeting? I know that the valuations across the industrial sectors have certainly come in and become more reasonable versus a year, two, three years ago. Do you have a specific range you are looking for, like a 5 to 7 or something like that, on EBITDA?

I think that that's a reasonable number. I think, when you look at the trailing 12 months, they're going to be nearer that 7 number simply because of everybody's optimism of their long-term potential. And they are going through a particularly weak period, but if you looked at it on a three-year basis or on a forward basis, I think it would be closer to that 6-6.5 times.

Okay, and then is there a specific region that you would hope that would give you exposure? In other words, if you would try and find products that are -- have more exposure to international markets, emerging markets, more growth-y type of areas? Or, are you really sort of geographically agnostic?

We are geographically agnostic.

Okay. And then the last question -- the NGA assimilation -- I know that the last couple of calls, you weren't quite sure how that was going to go, but it seemed to have progressed much better than expected and faster than expected. Is there anything in particular, or you were just cautious before you really had dug deeply into NGA and you were happy with what you had found? Is that accurate?

Well, I think that's accurate. I think we were just being naturally cautious because of the size of it. We knew the people and we knew the organization, but you never know all of the warts, for lack of a better word, until you get into the fold. And there's just more positive things out there than we had anticipated. And we are able, because of the tremendous acceptance of us owning the operations by the employees and the management of NGA, that they just got on board really quickly. And it just really helped us get them assimilated and achieve some of those benefits more quickly than we had thought.

Ned Borland, Hudson Securities.

Your comments about the utility market -- we started to see a little bit of life, it sounds like, over the last month domestically. It seems like there's some utility transmission projects going forward in the Northeast. And then internationally, China is talking about adding a lot of power gen capacity over the next five years. Are these opportunities for you? Are you starting to see anything, any kind of light at the end of the tunnel, in either domestic or international markets?

Yes. As indicated, Ned, the natural gas-fired power generation market is improving, and we are still participating in those markets. But I'm referring more to that substation replacement upgrade work, rather than new projects that we've been so successful at in the last three to five years, where the utility company is upgrading their equipment that is very expensive and very labor-intensive to maintain. That's where the maintenance-type budgets have hurt us more. The project-type activity has, particularly in power generation, has been more stable than that has. And then, as we indicated, we're seeing some of the benefits right now on the new transmission, more on the galvanizing side, for the erection of the poles and the towers, than we have seen. Then the increased activity in the Northeast has attracted more European competition than we would have traditionally have seen over the last few years.

Okay, well, I remember last quarter you seemed to have -- back off of your assumptions of a second-half recovery in backlog. And again, that doesn't look like it has panned out here. But was that really with regard to the international picture, or was it both markets?

I think outlook is totally consistent with what I said last quarter, Ned, that we're going to continue through the balance of this fiscal year bouncing along essentially where we are in backlog. And we didn't see the opportunity for improvement until our next fiscal year.

Okay, and switching over to galvanizing, I guess where did your zinc kettle costs come in? I think last quarter, they were about, what, $0.96 or so?

Our total consumption cost was a little over $0.91, and our purchase price was $1.06.

Okay, great, all right, thank you.

(Operator instructions) Brent Thielman, D.A. Davidson.

Obviously, the margins in the Electrical and Industrial segment are still very good. At the same time, we are obviously seeing some real rapid escalation in steel, copper prices, among other sort of potential inputs there. How comfortable are you that you are in front of these increases and can maintain these mid-teens margins in E&I?

Well, I don't think our concern and our margin deterioration is for the fact that you just stated. I think we are recovering those because all of our competitors do it. It's just that overall markup that's causing a lower price to the end-user, which is causing the margin squeeze. So indirectly, you could say it was the cost of materials. But we think our recovery of those is still pretty consistent, but we're just not getting the premium over that, that we traditionally have seen.

Okay, and then can you help me understand what is the margin profile for some of the, I guess, the power generation products relative to some of the other products you do in the Electrical and Industrial segment?

The power generation -- I'm going to say traditionally, now -- the power generation, transmission and distribution are pretty consistent on this. Currently, power generation is a little better than transmission and distribution because of the utility budget problem that we've discussed.

Okay.

The industrial market is always the toughest on the margin pressure.

Sure, sure. And then, on galvanizing, I know in previous years, you had benefits of a lot of downstream through oil and gas activity. Can you help me understand -- is there prospects for the pickup in upstream oil activity, I guess things are happening in the shale gas area, things like that?

It's conversational at this point, Brent, is how I would phrase it. It's not come to us and say, we are going forward with this project, or we're thinking about this. It's more in the embryo stage of it. And those conversations, yes, are increasing, but not anything to the point saying, we are going to do this job in X period. Now our customers, the fabricators and galvanizers -- you should anticipate this work in X time frame. We haven't seen that yet.

And I guess just up in Canada, your acquisition up there -- it's not so recent anymore, I guess. But how is that performing? Are you seeing different trends up there than what you've seen here in the US?

Well, the Canadian market was even more severely impacted because of initially what happened with the oil sands market. So you had the oil sands and then the utility. We have been pretty successful recently with repositioning ourselves, expanding our participation in markets. And we are starting to see some recovery up there that we think is more driven by some of our efforts in market recovery. But there are some positive signs we are beginning to see over there. But we are definitely behind where we thought we would be at this time, but we are making improvements.

And then lastly, on SG&A, I guess you saw a little bit of a drop from previous quarters, even though you saw some higher sales. Anything of note there?

We've just got completion of the NGA acquisition. Transition costs are behind us, predominantly. And historically, you will see our first quarter will be heavily burdened with our incentive programs for stock appreciation rights, those types of items.

Right, okay, thanks guys, good luck in the quarter.

Noelle Dilts, Stifel Nicolaus.

I'd like to speak a little bit about pricing in both Galvanizing and E&I. On the Galvanizing side, I'm curious to know if over the course of the quarter you've had any more success as the quarter has gone on pushing pricing through to customers. And then on the E&I side, I'm curious to know if there are any -- I guess, which areas you're seeing increasing pricing pressure, and then if there are any pockets of an improving pricing environment, specifically what you're seeing in international versus domestic.

On the galvanizing, I think we are having success pushing through, but not at the level we need to. So we are still behind where we would like to be, Noelle, but we are making improvement there because the cost of zinc is relevant in everybody's mind, everybody understands that. But they are still dealing in a very competitive environment, so they are resisting at that level.

I think we're going to prevail and we're going to have success because historically our customers have been very realistic as to what we were trying to accomplish through that. So we are getting improvement there, but not at the pace that we would like.

The biggest disappointment on pricing has been from our European competitors who have entered more aggressively the transmission market in the US. And then, secondly, the smaller independent companies in the distribution substation market have been very aggressive in their downward pressure on pricing.

So the market has held up pretty well through this downturn, but in the last, I would say, three to four months, we have seen more dramatic rising pressures in the transmission and distribution market than we have seen in the last 18 months.

Okay, so on the Galvanizing side, would you expect to close the cost/price gap that you saw this quarter, close that a little bit in the fourth quarter? Are you expecting that to remain consistent?

Our efforts are anticipatory of closing it, but we are going to get pushed back. But we are committed to trying to get it, yes. We need to, because we are continuing with our FIFO accounting, and the more expensive zinc is just getting closer and closer to coming to us on that. So the pressure is increasing on us. But the commitment from the organization and the staff of Galvanizing is to get it done. And I'm relying on our historical success. We don't always get it done as quickly as we'd like, but we always get it done. So if we might not get as much done in the fourth as we want, we'll just push in the first of the next year and just keep at it until we get it through.

But even in spite of that, we are still delighted that we are still operating at the very high end of our projections with this. And the early success in assimilation of North American has helped relieve some of that pricing pressure from not getting as much price recovery as we had hoped for.

Okay, great. Your tax rate in the quarter was a bit lower than in the first two quarters of the year. Can you discuss what you're expecting for the full-year tax rate?

It should be in that 37% rate, 36.5%-37%.

And then my last question -- your lighting business tends to lead some of your other businesses. Can you talk about the trends you saw in that business in the quarter?

As I indicated a couple quarters ago, when we were seeing increases -- and I attributed those to an early indicator. As we dug into it more, we are just doing a better job. And I think our improvement in our lighting business is more market share-driven because we've gotten pretty aggressive in our approach there. Pricing has been good, volume has been good, demand has been good, and our market share is improving. So we are really pleased with that business. It's a smaller piece of the total of it, but it is one of our operations that is showing nice growth on a year-over-your basis when compared to last year. But I'm not yet to the point of saying, it's the early indicator that I said, I think, at the end of the first quarter.

Great, well thanks a lot.

(Operator instructions) Fred Buonocore, CJS securities.

What utilization levels are you currently at in your electrical products facilities?

Between 65% and 70%.

Okay, and that's relative to around 80% a year or so ago?

Yes. We were right at the 80%-82% or so a year ago.

Got it, okay, thank you very much.

This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. David Dingus for any closing remarks.

Again, thank you for your participation today and we look forward to issuing our guidance for next year, as I said, around January 21, and then meeting with you again at the end of the fourth quarter. Thanks again, and we appreciate your support. Have a great day.

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