Valmont Industries Inc (VMI) 2003 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Valmont Industries second-quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. (CALLER INSTRUCTIONS) Mr. Laudin, you may begin your conference.

Thank you. and welcome to the Valmont Industries second quarter 2003 earnings call. With me today are Mogens Bay, Chairman and Chief Executive Officer; and Terry McClain, Senior Vice President, Chief Financial Officer; Robert Meaney, Senior Vice President; and Mark Jaksich, Vice President and Corporate Controller. Before we begin please note, this discussion is subject to our disclosure on forward-looking statements which applies to today's message and will be read in full at the end of the recording. The instructions for accessing a reply of this message can be found in our press release. I would like to now turn the call over to our Chairman, Mogens Bay.

Thank you for joining us. I trust that you've had an opportunity to read our earnings announcement. Let me begin by summarizing the quarter. First, net sales fell 11 percent due to much weaker utility sales and continued weakness in the wireless communication market. Second, irrigation sales internationally were strong offsetting lower sales in North America. This reaffirms the importance of our geographic diversification. Third, the combination of a sluggish U.S. economy and lower internal volumes hurt the performance of our coating segment. Fourth, operating cash flow exceeded $25 million in this quarter. At the end of the first quarter we announced that we would combine our wireless communication and toll segments. This was the first quarter where we report the combined identities as the engineered support structure segment. Our reason for combining the two segments were to pursue growth in a more cost-effective manner and streamline management.

As the wireless communication market weakened, the skills and talents of this group were underutilized. We have introduced several new products and are pleased to have gained important new customers. Examples include sign structures, low voltage substations and structures for small wind turbines. As a result of this, our communications facilities have increased production backlogs and are again in increasing employment levels. Now let me review our performance by segment starting with the engineered support structures segment.

The story here was the downturn in the utility markets. Over the past several quarters our backlog has been falling. In the same quarter sales declined 19 percent and operating income of 3.1 million was down 62 percent. There are two major reasons for our weak utility performance. First, is lower capital spending by our customers, the utilities and independent power producers. This is due to a weak U.S. economy, high debt levels that some utilities and the lack of a new energy bill. The second reason is the competitive environment. With the weakness in the wireless communication industry, participants from that market entered the utility market with very aggressive pricing. Earlier this year Valmont maintained pricing discipline. Recently, however, we have been more aggressive in our quotations and our backlog is growing, although at lower margins.

While the near-term outlook for this market is not strong, the long-term prospects remain solid. Power generation and transmission are essential to the economic growth of developed and developing nations alike. New generating capacity will be added and needed expansion and upgrades to the electrical transmission grid will take place over time. As an example, we are participating in the growing utility market in China. The utility market in general continues to represent an excellent long-term opportunity for our company. In our wireless communication business the market remains weak. Volumes were lower and pricing was very competitive reflecting the excess manufacturing capacity in the industry. Wireless service providers have postponed expanding their network and capital is constrained in this industry. Fortunately Valmont is uniquely positioned in the structures market since we are able to leverage our engineering and manufacturing across a broad range of products and markets. This flexibility has helped dampen the effect of the economic downturn, particularly in the wireless communication market.

Our lighting and tracking businesses continue to show strength. These markets are supported by strong drivers, road construction programs, commercial construction, and highway safety. Roadways have been upgraded, widened or newly constructed largely supported by state and federal funding. The construction of residential developments, shopping centers, schools and other public places, drives lighting sales. Safety is also a strong driver as people feel more secure in well lit areas. Highway safety is enhanced by more signs, lights and signals to improve traffic flow and visibility at night.

Results in our international structures businesses were comparable to 2002. In Europe sales were applied in local currency terms but higher in U.S. dollars. In China lighting sales were slightly lower, but utility and wireless communication sales were higher. Our plant in Shanghai, China is operating at capacity and solidly profitable. We are very pleased with the progress we continue to see in China. In summary, the engineered support structures segment faced mixed markets this quarter. In the long-term the drivers of these businesses are enduring and supportive of growth. The need for reliable power, the benefit lighting brings to improving traffic flow and safety, and the investment in telecommunications infrastructure that are needed to sustain economic growth.

In the coating segment, same quarter sales were 13 percent lower and operating income dropped to 1.1 million. Custom galvanizing sales are down due to weakness in the U.S. industrial economy. Internal volumes are lower due to the weakness in the utility and wireless communication market. Also, higher natural gas prices increased costs compared to last year. As this is a relatively high fixed cost to sales business, we experienced significant deleverage as the economy slowed. On the other hand, as the economy improves we fully expect (indiscernible) higher volumes to see good leverage.

In the irrigation segment sales rose 1 percent for the quarter. Operating income rose 10 percent from a combination of a salable pricing environment and strong international markets. In Brazil higher crop prices and supported government programs drove sales increases. In South Africa and Australia, dry conditions have helped sales. Our strategy of local manufacturing is enabling us to compete effectively with local competitors. Global sourcing allows us to be very competitive. We compete on better service and the advanced technology of our equipment. In North America sales were slightly lower. Wetter growing conditions in 2003 brought irrigation selling season to an early conclusion. Certain programs in the U.S. farm bill encouraged water conservation and are supportive of mechanized irrigation technology. However, delays in the implementation of these programs have caused some growers to postpone equipment purchases. Additionally, weak potato prices reduced sales in the important Pacific Northwest market.

In the tubing segment sales of 14 million were 12 percent lower due to weakness in the U.S. economy and lower pricing. Operating income of 1.4 million was 15 percent below last year's levels. Our strategy is to provide niche markets with specialty tubing and deliver high levels of customer service, and we continue to generate strong returns and invested capital in this business and pursue growth opportunities in the segment.

That summarizes the quarter in terms of sales and earnings. Turning to the balance sheet I'd like to comment about a few of the numbers. The increase in inventories is primarily a result of higher international inventory levels as that business continues to grow and the effect of currency translation. Operating cash flow exceeded $25 million for the quarter. The depreciation and amortization for the quarter was $8.6 million, and our capital expenditures continued to run at a little more than half of this number. Total debt is down 22 million from last year's second quarter.

Looking to the rest of the year, I have a few observations. In our structures business we expect higher utility lighting and traffic sales and lower wireless communication sales. However, excess capacity in the utilities sector and pricing pressures are expected to continue to hurt profitability. In our coatings business we anticipate lower sales due to the weak U.S. industrial sector. The outlook for our tubing business is for flat sales compared to last year. In the irrigation business, we'll get a better indication depending on growing conditions during the summer and the resulting crop prices.

For the Corporation as a whole, we anticipate lower sales and a decline in earnings per share for the year in the 10 to 20 percent range. We will continue to focus on improving returns and operating performance. We have capacity in place to grow our existing businesses without major capital expenditures. We continue to seek acquisitions that would leverage our products, our markets or our skill sets. And aside from acquisitions we plan to use our cash flow to fund internal growth and to pay down debt. That summarizes the results for the quarter, and at this time we will open our discussion for your questions. Thank you for listening.

(CALLER INSTRUCTIONS) Will Spedden (ph) of CJS Securities.

Can you give me an idea of what your utilization of your utility pole manufacturing facility is now compared to last year?

Well, if you just look at the quarter, our utility sales were less than half of last year, but we do move capacities around, as I talked about. So some of that may be used for high (indiscernible) lighting or sports lighting. But we can see a significant increase in volume and not have to worry about capacity.

And how much of that decline in sales is unit volume and how much is price?

Most of it is unit volume clearly, we would be in worse position than we are. But we have been substantial pricing pressure also, particularly coming from new entrants that are really hurting in the wireless communication market and are looking for other opportunities, and they have particularly gone after the tender business and the utility business.

So by lowering your pricing going forward, or being more aggressive on your pricing going forward --

What we did was -- we're probably the biggest player in the marketplace and we certainly weren't going to be the ones leading pricing down. So we watched it for a while and we kept pricing discipline, but at the other hand, we also need to make sure we defend our market share and continue to participate. So over the last quarter or so we have become more aggressive and selectively going after business at lower margin to, one, protect our market share, but also to keep plants busier than they otherwise would be.

Okay. And on the lighting and traffic side, do you see any clients differing any purchases waiting for the highway bill?

Well, no, I can't specifically say that. There's still a question as to what the next highway bill is going to look like, and whenever a current highway bill comes towards its end, that's always a big question mark. However, historically the highway bill was always getting replaced by one that is typically providing better funding than the current one. The talk is that the same thing will happen this time. Sometimes there's a small gap between the one bill expiring and the next one being put in place, but it's often covered by an extension of the current bill from a funding standpoint. At this point in time we are expecting that a new highway bill will be put in place that will have at least the funding levels we are seeing today.

And now getting to your free cash flow, where do you see -- but first starting with your inventory turns and your DSOs, where do you see those kind of trending out toward the end of the year?

Basically I think of the -- of course we're going to have a little slower inventory turn as business has declined for a while, but I think that's going to trend back to our natural average. The mix of business is important as it relates to receivables, particularly as we have more foreign sales and as we are more into the longer-term kinds of terms that we get into sometimes with some of these industrial customers. So I think receivables will probably stay about where they are today in terms of turns. Inventory has declined in terms of turns right now, I think it will improve as we go forward.

So then where do you all kind of expect your cash flow from operations to come out for the year? I noticed -- 25 is obviously pretty high for this quarter. Can you say, was there a particular working capital item?

I think over a period of a year -- a 12 month period we're still looking at around $50 million of cash flow.

Okay. And one last thing. Your minority interest was a little bit higher this quarter than it has been historically, can you just give us a little insight as to what drives that?

I think part of what you see there is that we had a very strong performance in Brazil as we talked about, and we have a 40 percent partner in that country.

Okay, great. Thank you very much, guys.

Jane Sanders from Standard & Poor's.

Quick question going on the cash flow again. You mentioned acquisitions you were looking at, any particular segment that you're looking at there?

In general we're looking at acquisitions that click right into our current businesses, that's really what we prefer. And it could be supplemental businesses, we're in our poll business, or it could be additions to our coatings businesses. In the irrigation business it's tough to think about a good acquisition of that business at the current time, so I would say that it's more likely it will happen in the infrastructure side of the business.

On a second note, any plans on dividend increases?

We did increase our dividend at the last annual meeting and our Board considers that question and will consider it again next spring.

Okay, great. Thank you.

Rick Dote (ph) of Columbia Management.

A couple of questions. One, a couple of years -- I think it's been a couple of years now, I lose track of time. But you guys started to spend some money on new initiatives, one of which was when -- I think that's been discussed periodically, my sense is it hasn't really taken off. And can you give us an update on that and then I guess maybe give us a sense of what you're spending and what you're getting for it at this point?

Thank you for the question. We have over the last two or three years been spending R&D money on wind power development, and at the end of last year we took down our first prototype which had about a 660 kW turbine on top of it for about a year. With some of the learning's from that we designed the second prototype which was installed just a couple months ago. It is designed to carry larger turbines to greater heights. The current prototype we have up is working very well. We fixed some of the vibration issues we had in the first ones and we also are generating now a significant amount of interest from the various turbine manufacturers and developers of wind power. We're deliberately going slow in developing the product-line so we don't end up with commercial sales and turbines up and then have to have fixes put in place later. We had the turbine up again in valley. The market is going toward larger turbines, one kilowatt -- 1 MW and 1.5 MW turbines are more the range you're going to see now, and they're probably going to be at least 200 feet up in the air, maybe 250 to 300 feet in the air.

We are encouraged with where we are. I would say that we're probably on average spent a couple $1 million a year on this effort. There's no doubt in our minds, the more we look at the wind power industry that is here to stay it will continue to grow. It would be a part of the U.S. energy picture although not a major part, but for us it will create great growth opportunities if we get the product line refined and ready for the marketplace. We will continue that. There's no -- we are waiting also for the new energy bill. The industry is still somewhat dependent on the production tax credit and what we hear from Washington is that there's great support and an extension -- a foreign extension of this production tax credit for another three or five or seven years. But at some point in time out in the future, this industry will be viable without a production tax credit. And we are not discouraged with what's happening in the marketplace, but like with everything else we do, we do take it one step at a time and make sure that we're doing the proper research and testing of our structures before we go into commercial production.

I would think today with the cost of alternative power, it becomes more viable without government support.

That is correct. Today -- and there are a number of numbers to look at -- but today, if you compare a good wind power development with a Greenfield startup for a fossil fuel plant, wind power is competitive. Wind power is not competitive when you compare it to the incremental cost of utilizing a current plant more.

Okay. So when does it become -- is it within 12 months of becoming a viable business, or is it still really a startup?

I think that within 12 months, we will probably have our first commercial sales. But we will probably try and get a project that has like six or eight structures in it. We would like to get some turbines up on those structures for a year or so. So it will not be as fast ramp-up of production, but I think that we are moving from the pure R&D phase to a commercial phase within the next 12 months.

Have you sized the market?

Well, yes and no. The market is huge in the sense that the world is adding thousands of megawatts a year, and each megawatt on average will need a structure. So there is plenty of room for us to participate in. We don't have to worry about the exact size of the overall market to create a meaningful business.

Last question unrelated to that, in your release you talked about on the wireless communications side with the weakness there or substituting other products to address capacity today at low level sign and support structures. Can you discuss the margins that you are looking at in that business, and if communication were to come back are you committing to long-term capacity lockups where you can't, I guess, switch back to the higher margin communication business?

Well, let me address it this way. The margins that we are expecting in the structural businesses, sign structures, etc. that we have entered into, those margins are very healthy margins. And even when wireless comes back, I think they will still look like favorable margins. We have plenty of capacity to address a return through higher level of activity in the wireless market. So I don't think it will be a question of trading off between the product lines we are developing now and allocating less capacity than we otherwise would to wireless when it comes back. I'm not concerned about our capacity in that sense.

Okay, thank you.

John Fraits (ph) from Kansas City Capital.

You've mentioned that capacity -- significant capacity that you have available when things come back. Is there maybe too much capacity? Is there any room to take some production out of capacity, reduce your fixed costs of the business, more consolidation? Are there any additional opportunities, especially as it relates to wireless?

As it relates to wireless, we don't have very expensive capacity in place now, and we have downsized the people side of that business. And as I did mention, we have started actually adding to the employment levels. I think that in that side of the business, there is really not an opportunity to take further cost out from the standpoint of closing down any more capacity.

In the pole businesses, we have a number of pole plants, and in that side of the business also we have taken as much cost out as we can. We are not at the point where it would make sense for us to mothball a plant or something like that. If you turn to the coatings business, we have at least one facility where we had more than one tank, and we may shut down one tank to better utilize the other. We have more flexibility in that side of the business to do that.

So there isn't much left from a structural standpoint to, let's say, improve the productivity of the company. I mean, little tweaks here and there.

Yes, I mean, we do not expect the business from a volume standpoint to soften much beyond where it is now. If something catastrophic would happen, and I'm not predicting that, you can shut down a plant completely and mothball it, but we are certainly not anywhere close to that stage right now.

Can you review for me the timetable on the highway bill, when it expires and so on and so forth?

It expires at the end of this year in October.

Correct me if I'm wrong, but last time when it expired there was sort of a transitional period where your business did indeed slow down because of transitional issues as it relates to the highway bill. Am I correct in that or am I thinking incorrectly?

No, you are correct in that. There was a delay in the Senate last time the highway bill expired that brought with it some uncertainty and some slowness. The expectation this time is that funding will continue even after the highway bill officially expires, because there are more safeguards in the current bill to prevent funding from going elsewhere. That was not the case in the past.

Okay, so that shouldn't be as much of a concern. The other thing is, and I know this is always difficult to answer, but as it stands right now, it looks like we are going to have a pretty good year in terms of crops, production. I mean, the yields look like they're going to be pretty good barring any unforeseen circumstances, and some people are thinking that corn is going to drop below $2 a bushel again and, of course, a lot remains to be seen. But given that type of environment, is there enough government funding at this point in terms of additional payments to farmers that would keep farm income up and keep your irrigation business moving ahead next year, even if prices do drop below $2 a bushel?

I think we have a fairly strong farm bill in place. One part of the farm bill -- under normal circumstances, when corn drops below $2, you will see some concern and some weakness. I think net farm cash income is going to stay pretty healthy. I think one aspect of the farm bill, that it is tough today to put a real number on in the sense of what it will do to our industry, is the conservation aspect of it. It has pretty significant funding and it is geared directly towards the kind of water conservation equipment that we manufacture. I think that we have yet to see the upside from that.

But as you started out by saying it is difficult to predict what farmers will do, but I am encouraged with those aspects of the farm bill and I am encouraged that net farm cash income would stay pretty healthy.

Thanks.

(CALLER INSTRUCTIONS)

While we wait for maybe for the next question, there was another issue that I often get asked about and one was wind, and I'm glad I got that question. The other is China, and we talk about China and what we have been doing, particularly in the pole businesses in our plant in Shanghai, and as I said, we have been very pleased with what is happening there. We have been there now seven or eight years, and we see improvement in sales and earnings every year, and we didn't over commit to China. We continue to be encouraged with the opportunities we see in the utility business, the continued strength of the wireless communication business, and also opportunities over time in the lighting business, particularly in the high-end lighting business, decorative lighting, etc.

Our irrigation business also in China is showing signs of opportunities that are coming their way, and we have recently established in Shanghai a procurement office, because China is becoming an ever more important manufacturing base for a number of components that we think we can utilize in our other facilities around the world. And having been there now for that number of years, we have a strong local organization, so we have good people that we trust and that we can put in place. So I think that our activity levels in China will continue to increase, and we only get more encouraged the more time we spent there and the more we learn about doing business successfully in that country. Thank you.

(CALLER INSTRUCTIONS)

If appears like there are no more question, so at this time I'll read the forward-looking statement. Included in today's discussion were forward-looking statements that involve risks and uncertainties, including operating efficiencies, availability and price of raw materials, availability and market acceptance of new product, product pricing, domestic and international competitive environment, actions and policy changes of domestic and international governments, and other risks described from time to time in our reports to the Securities and Exchange Commission. Any changes in such assumptions or factors could produce significantly different results.

In addition, the prepared materials have been copyrighted by Valmont Industries, Inc., and contain information that is protected by law. Any reproduction or retransmission of this conference call without written permission will be a violation of the applicable laws. This concludes our call. We thank you for joining us today. This message will be available for playback on the Internet or by phone for the next week. We look forward to speaking to you again next quarter.

This conclude today's conference. You may now disconnect.