Valmont Industries Inc (VMI) 2006 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the Valmont Industries fourth quarter earnings conference call. [OPERATOR INSTRUCTIONS] Thank you. Mr. Laudin, you may begin your conference.

Thank you. Welcome to the Valmont industries fourth quarter 2006 earnings conference call. With me today are Mogens Bay, Chairman and Chief Executive Officer; and Terry McClain, Senior Vice President and Chief Financial Officer; 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 talk and will be read in full at the end of the call. The instructions for accessing a replay of this call can be found in our press release. I would now like to turn the floor over to our Chairman and Chief Executive Officer, Mogens Bay.

Good morning, everyone, and thank you again for joining us. Let me begin with fourth quarter highlights. First, we had record fourth quarter sales, operating income, and net earnings. Second, our international businesses turned in another very strong performance. Third, we had strong performance in China. Fourth, Operating income as a percent of sales increased 17% and net earnings increased 39% on a 5% increase in sales. Fifth, we experienced a favorable tax rate due to our strong international performance. Before turning to performance by segment, I'd like to make a few general comments about the year end total.

A number of years ago we said leverage is our strategy for growth. That means growth would only come by using our existing products, markets, and skill sets as platforms for growth. This helped us sharpen our focus to look for opportunities where we had something to contribute other than capital. We also determined that we would pursue international expense, and since we believed our products and markets were global and that in many cases we could achieve faster growth rates in international markets. Our results in 2006 reflect our continued progress. We have many examples of international expansion in '06. The international structures business had good organize growth and operating income as a percentage of sales has steadily improved. It was not that many years ago that our European pole operations were delivering operating income percentages well below our expectations, but over the years they have grown into a solid business with much improved financial performance. Our new pole plant in the south of China which opened in June of '06 is off to a solid start and gives us the capacity to continue to grow our business in what will probably become the largest market for infrastructure products in the world.

In the international irrigation business, growth to a large part relies on missionary work by a special team of individuals. In 2006, we shipped a substantial amount of irrigation equipment for projects in Central Asia and North Africa as a result of their efforts. About a year ago we further sharpened our focus on our international businesses and created a separate international division with its own management team in charge of all international operations and sales. A few years ago we set specific goals for improved operating income and returns on invested capital. We zeroed in on three initiatives that we believed would have the most impact on Valmont's performance going forward. And they are--one, a pricing initiative that focuses on establishing better pricing discipline for our products in the markets we serve. Two, cost reduction and productivity improvement initiatives utilizing Lean principles. And third, a process to continuously improving employee engagement. These three initiatives, we believe, will drive improved financial performance.

We had seen good improvement over the last few years, and 2006 was no exception. With our initiatives, and with the help of a favorable market operating income for the year improved more than 1 percentage point, from 7.5% to 8.6% and after-tax return on invested capital reached 11.1%. We're making steady progress towards our goal of improving operating income percent to double digit levels while driving improvement in our returns on invested capital. 2006 was not without challenges. Our biggest challenge has been in our specialty structures businesses in North America. I wish I could blame soft market conditions on our disappointing performance, but unfortunately our problems were of our own doing. To address these issues we have instituted management changes that we believe will build a stronger and more responsive organization in specialty structures. We also faced performance issues in our Mexico pole joint venture which we believe will lastly resolve with our purchase of the 51% interest we did not own. We now have full operational control over the plant and will use the additional capacity for the North American utility market.

Rent prices continued to escalate during the year, peaking well above $2 a pound. This was far in excess of historical average prices which for many years were closer to $0.50 a pound. This necessity -- necessitated price increases, not only for galvanizing services, but also in many of our galvanized steel products to recover higher costs. At year end, we suspended funding for the development of our support structure for wind-powered turbines whereas the size of the wind power market will be significant, we did not see our way to the kind of profitability and returns which we would expect. In the wind power industry, the turbine manufacturers for the most part own the tower designs and the subsuppliers provide most of the material and labor. We have retained within the organization all of the technical talent involved with the wind project, engineers and drafters and if we see the market conditions change, we can re-establish this initiative at any point in time. In summary, 2006 was a very good year for Valmont. We made significant progress towards our goals and we appropriately addressed our challenges.

Let's now review results in our individual segments. You will have noticed that the revenue increase for the fourth quarter at 5% was below that of other quarters in the year. Part of the reason is that our fourth quarter and 2006 contains 13 weeks compared to 14 weeks in the fourth quarter '05. I'll begin with the engineered support structure segment. Sales increased 7% to $146.6 million. Operating income decreased 10% to 13.6 million.

In North America and Europe, sales for transportation of commercial markets were comparable to last year in China, sales were very strong, particularly for utility and wireless communication structures. Segment profitability was impacted by the disappointing results in the utility structures businesses and some restructuring costs related to parts of our European structures businesses. In the utility support structure segment, sales increased 7% from a very strong quarter in '05 to 74 million. The utility market is being driven by greater spending to improve the reliability of the transmission grid. Order rates are good and our backlog continues to build and is at record levels. Operating income increased 6% to 8.2 million or 11.1% of sales.

In the coating segment, fourth quarter sales of 30.7 million were 24% higher than last year. Largely reflecting increased pricing to recover [Inaudible] costs, operating number was 5.6 million as a result of improved pricing and lower energy costs. In the irrigation segment sales were 1.2% higher at 70.3 million. International sales more than offset a decline in North American sales. Operating income declined 2.3% to 5.1 million. While crop prices increased during the quarter, the selling season in North America was slower to develop than expected. With much talked about extended ethanol production and corn futures at $4 a bushel, one might have expected stronger results from our North American irrigation business in the fourth quarter. However, our thinking is that many farmers forward contract their corn and did not yet receive the benefit of higher crop prices.

If prices stay at current levels, our farm customers will more likely benefit from higher prices going forward which should lead to stronger sales. We are seeing currently some improvement in order flow in this business.

In the tubing segment, sales of 19.6 million were 10% lower than '05 and during the quarter, many of our service center customers were seeking to reduce their inventories on expectations that steel prices would decline. Operating income decreased 2% to 3.6 million. We continued to see solid demand from grain handling markets and increased interest in our structural steel products. This business is performing well and earns excellent returns on invested capital.

Turning to our other financial measures, increased inventories largely reflect higher utility backlogs, the Mexico coal plant purchase and increased zinc inventory and cost. In term of cash flow, the depreciation and amortization for the quarter was 8.2 million and capital expenditures were 8.1 million. Operating cash flow for the fourth quarter was 30 million. For 2007, capital expenditures are expected to be between 50 and 55 million as we add capacity in the structures businesses to meet increasing customer demand. Depreciation and amortization, we expect to be between 35 and 38 million. The decrease in the tax rate was a result of the favorable mix of International earnings at lower tax rates and a $1.1 million expense related to the repatriation of dividends from foreign subsidiaries in the fourth quarter of 2005.

In 2007, we expect further improvement in our performance. The drivers of our markets remain firm in engineered support structures, ongoing highway spending in the United States and continued investment in international infrastructure markets should provide solid support for our structure's businesses. In our utility business, we expect investment in the electrical transmission grid to continue to accelerate as reflected in our record backlog. In the irrigation business firmer crop prices should lend support to world markets along with water conservation and other traditional drivers such as weather, farm policy, and crop prices.

At the current time, we remain optimistic about the upcoming year. In our coatings and tubing businesses, improved conditions in the industrial economy should lead to solid results. This concludes our prepared remarks. And we would now like to take your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Arnie Ursaner from CJS Securities.

Hi, good morning.

Good morning, Arnie.

I would like to try to focus a little bit more on the engineered support structure piece of your business. Obviously that was the, quote, disappointment. Particularly on the margin side. Can you perhaps expand a little bit about what the issues were that you think impacted the quarter, what prompted you to make a management change, and just perhaps expand a little bit on what actually happened and what steps you're taking to fix it in '07 from a business point of view?

First of all, we made the management change earlier in the year, not in the fourth quarter.

Okay.

But so we already are seeing some traction of this new management team. The problems were mainly around the signs structure side of our business, both in Plymouth, Indiana, and in Shelbyville. And I would say that it had to do with some productivity issues, some product warranty issues and generally, getting our hands around the signs structure business which is a fairly new business for us and we must do a better job of also pricing in that industry. So, I think it was a combination of a whole host of issues that all needed to be fixed. And, as I said, new management has been in place for more than a quarter and we're confident that they'll make solid progress in '07.

Last year, in that segment, you did an 11% operating margin. Frankly, if you had done that this year, that alone would have added 70 basis points to your total operating income performance. As you look into '07, do you think you can return this or even exceed the 11% you did last year?

I made the same calculation as you did and we will focus on reverting to what should have happened.

Two more quick questions if I can. Your SG&A last year was impacted by the fact your stock had had a pretty big rise in the fourth quarter. I was is little surprised to see your SG&A dollars quite at the level they came in at. Was there anything that affected compensation or other factors that would have caused perhaps a little more SG&A than certainly we had looked for?

I can't think of anything in particular, some business units may have seen more improvement than they expected in the fourth quarter and had more maybe accruals for incentive programs but otherwise, I really don't see anything out of line. We may have added some SG&A from the Mexican joint venture. That is now part of our business. And otherwise, I would say it is just a reflection of the growth in the business.

My final question relates to your attitude towards utility support structures with the change in FERC regulation towards incenting utilities to build power transmissions. Can you comment on how you're seeing that impact the market, how your backlogs are stretching out, and perhaps if we've entered a seller's market in utility support structures.

Well, there's no doubt that there's a significant increase in activity by the utilities when it comes to upgrading and expanding distribution lines and confirmation lines and that is what is reflected in our backlog. We initiated earlier this year an expansion of our capacity. We added the Mexican coal joint venture and have allocated that capacity 100% to the utility business. We're adding capacity in our Tulsa, Oklahoma, plant. We're adding capacity in our California plant. We're adding capacity in our Jasper, Tennessee, plant. And so, I think we are taking the necessary actions to keep up with this increased demand. Now, the industry has seen a -- an extended lead time and that is probably going to be what we're going to continue to see for awhile. But we expect that this increase in utility spending is not a short-term issue. I think that the energy bill of last year created an environment where maybe underinvestment in transmission for decades is now being rectified and we see this as a long-term uptick in our business.

The capital expenditures you were supposed to have in Q4 to build up capacity, have they occurred?

Can you repeat that, the capital--?

Expenditures to increase capacity in that segment were supposed to occur in Q4. An incremental 8 million or so of investment. Did that occur?

They're in the process of happening and some happened in '06 and some will spill into '07. That's what's part of where we say that our capital expenditures in '07 are probably going to run north of $50 million.

Okay. Thank you very much.

Thank you.

Your next question comes from [James Genteel] from BB&T Capital Markets.

Good morning, gentlemen. How are you doing?

Good morning, James.

Obviously back to the USF segment. You're seeing strong backlogs, et cetera. You're adding a significant amount of capacity there. Could you comment on perhaps the incremental margin opportunity in that segment given the more accelerated growth outlook that's ahead of the business?

Well, I think that the better adsorption of SG&A and engineering overheads is what's going to help us continue to improve our operating income percentage in those businesses and therefore, in the Company going forward. So, we do expect leverage also as we add this capacity. And as we have mainly done with this capacity extension is adding capacity to existing plants which can be done more cost-effective than building brand new plants with their own overhead structure.

Then with regard to over the last couple of years or so, you've given a firmwide operating margin target of 10%.

Yes.

Are we still sticking to that?

Yes.

Or is there some upside there?

We're sticking to 10% until we get there and then we'll look around and see what should be our next target.

And then with regard to the irrigation segment, you said that order flows into the first quarter have been somewhat better. And that farmers won't realize the benefit of higher corn prices until perhaps the latter half of this year and into 2008. Obviously there is a lot of speculation with regard to higher corn prices and the sale of the incremental. center pivot irrigation system but how are you looking at that business? Are you as jazzed up as perhaps some others in the agriculture market? Sort of a different end market, so.

Well, first of all, when it comes to the ethanol side of business and what it has done to corn prices, companies like Deere who participated in 100% of agriculture will probably see more of a benefit than we will who only participate in the irrigation side of agriculture. I would have expected that we would have seen more of an uptick already now in order flow and I'm a little puzzled that we have not. But there's no doubt that solid commodity prices can only help our business. And to what extent we'll see the uptick, the future will show.

What is the absolute capacity of your McCook, Nebraska facility for the irrigation segment?

Substantially higher than what we're producing now.

Do you have any calculations on incremental margins of the next irrigation system that sold out of that facility?

Yes.

Would you like to share them with us?

No.

Thank you very much.

You're welcome.

[OPERATOR INSTRUCTIONS] Your next question comes from Jon Braatz with Kansas City Capital.

Good morning, Mogens. Going back to the irrigation side, it has been ten years since we really had a boom period in irrigation going back to '95, '96, something like that. And obviously a lot of things have changed in the agricultural business and compared to '95, '96, there is more water issues out there in Nebraska, South Dakota, wherever, in your markets. Is it possible that some of these issues are playing into the irrigation business such that, with such favorable dynamics at this time that maybe you don't see the incremental benefit that you might have seen in years ago and just spell that out. Is that a possibility?

That is a possibility. I think that where as in a macro sense, water conservation and water issues are positive drivers for our business worldwide, you can have local conditions, that way it can be a hindrance to our business. I think that the water debate, you mention Nebraska that's taking place right now, could put a damper on our business short term. We do not get in the middle of the political debate as to how water should be split between agriculture and other uses. Our purpose is to point out that whatever is available for agriculture, our technology will use that water more efficiently than any other technology. And having said that, there is, as you're aware of, a great debate going on in Nebraska, currently, as to the priority of water use and it could have a short-term negative effect on the business in this state.

Mogens, how much, for example, in Nebraska, do you think -- let's say Kansas, Nebraska, and South Dakota and so on, how much of the irrigation market has indeed been moved over to center pivot versus gravity flow? How much market share does that piece of the industry have now?

Well, without having a firm number, my feeling would be that in this central part of the country, maybe 75% of irrigation is center pivot irrigation. So, there are some opportunities to continue to improve the efficiency.

Okay. Terry, in the fourth quarter, you obviously saw a very low tax rate. How should we look at the tax rate going forward into 2007?

Well, I think we will have continued impact, positive impact for more foreign earnings. I don't know that you should take it to the level that it was in the fourth quarter necessarily at all. But I think from -- take the statutory rate down somewhat for the International mix.

Okay.

Probably 34% or so.

Okay. All right. Given the -- given the higher level of CapEx this year, do you think we'll see much debt repayment -- I think debt repayment was what, 12, 13, $14 million or something like that this year. Do we see much opportunity in terms of repaying or reducing debt in 2007?

Well, we have the ability to do it. I think we would do it on our scheduled payment plan, John.

Okay. All right. Thank you, Terry.

Your next question is a follow-up from Arnie Ursaner with CJS Securities.

Expand a little bit about in China, you have got your second facility up and running. What sort of utilization rates are you seeing? What sort of actual growth rates are you seeing in China and as you look out to that market over the next year or so, will you need additional capacity?

Let me start with the last part of your question. The answer to that is yes. We will -- it took us like eight or nine years to fill up our first plant. I think it will take us a couple three years to fill up our second plant. Which means that we already are in the planning stages for the third plant.

Okay. What are the actual revenues now and what do you think they'll be perhaps over the next year or two?

Well, the Shanghai plant can probably do about $50 million. The southern China plant will be able to do the same. I don't think we're going to get both plants filled up in 2007. But I would think they're going to be filled up in 2008. And then we need to be ready with additional capacity by the end of '08.

Okay. Shifting gears a little bit, your steel inventories, your overall inventories have remained quite high relative to past trends. Are you still assuming that we'll have pretty hefty increases in the cost of steel? And is that a reason you're running what I would view as relatively high steel inventories?

Arnie, I think first of all, the trend right now still seems to be slightly upward pressure in steel. Maybe not heavy upward pressure. And the reality is that we have a backlog that has been building in utility for which we can order the steel in advance and sometimes that's to our advantage and the structure of the steel industry, the way we purchase has led to less consignment programs and more just on the lot, if you will, quantities. We also have aluminum and zinc inventories that are going up so when you look at that inventory number, it is primarily steel. But there's other components of it. It is a price issue to a large degree.

On the acquisition front in the past, you very successfully have used your free cash flow to find and complete accretive acquisitions. What is your view of the current outlook for targets and are there particular product areas or lines that you're seeking to expand in through acquisition?

Well, we are constantly in discussion with a number of companies that we would like to acquire. And the environment today when it comes to pricing is -- prices are very rich. There is a lot of money looking out for acquisition. And often we see that strategic buyers cannot pay the prices that financial buyers are ready to pay and then get our returns. But we're looking at a number of them and we like, as you know, click acquisitions. Acquisitions that fit right into our structural businesses or other businesses and it is probably fair to say that the biggest focus is on acquisitions fitting into our structural businesses worldwide.

That's it for me. Thank you.

Thank you.

your next question is a follow-up from James Genteel from BB&T Capital Markets.

Guys, I just wanted to quiz you more on the International business as well. So, you're not currently in capacity at the second facility in China but could we speculate that you're at 50% capacity and that total China was $75 million in 2006?

You can speculate. I would repeat what I said was we only started this plant up in July or during the summer of this year and I expect that that plant will summer of this year and I expect that that plant will be more than half full in '07 and I think that it will be full in '08.

Okay. And then I guess how much of -- how much in total was then your European market as a percentage of total sales in the fourth quarter?

I'm looking but I'm not so sure that we're breaking down our International business by region by quarter. You will see it in the 10-K on an infill basis, but we had a good, solid quarter also in Europe. But the biggest improvement came from China.

All right. Thank you.

Your next question is a follow-up from the line of Jon Braatz with Kansas City Capital.

Going back to China, Beijing is going to host the Olympics I guess in 2008. Is there any reason that there might be a -- there is a surge of business in front of the Olympics and that as Beijing prepares the world for China and that following the Olympics, things slow up a little bit. Is there any reason to believe that?

As it relates to our business, the answer is no.

Okay.

Most of our business in China is utility and wireless communications. The impact that lighting projects for Olympic installations would impact our business is minor.

Okay. Thank you, Mogens.

Thank you.

Your next question is a follow-up from the line of Arnie Ursaner with CJS Securities.

Two quick questions. Regarding the irrigation business, normally, you wouldn't see any real order trends until late February but what are you hearing from your dealers going into the order season?

Well, we're actually hearing optimism from the dealers. I just attended a couple of weeks ago a dealer meeting and the dealers are optimistic that we're going into a good season. Now, we do normally see order flow already at this point of time and we have seen a positive comparison in order flow compared to last year at the same time.

Any sense of magnitude?

Yes. But I'm not going to share it.

Okay. My final question would be, as you think about financial guidance for the upcoming year, I know you didn't include it in your press release but what sort of revenue growth expectations overall do you see for your business and how close to your operating margin goal do you think you will be in '07?

I think we will see probably high single digit growth in revenue without any acquisitions. And I think we'll continue to make meaningful progress in our operating income percentage.

That's very helpful. Thank you.

At this time, we have no further questions. I will now turn the call back over to Mr. Laudin for any closing remarks.

Thank you. This concludes our call and 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. At this time, Paige will read our forward-looking disclosure.

Included in this discussion are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on assumptions that management has made in light of experience in the industries in which Belmont operates as well as management's perceptions of historical trends, current conditions, expected future developments, and other factors believed to be appropriate under the circumstances. As you listen to and consider these comments, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties, some of which are beyond Valmont's control and assumptions.

Although management believes that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect Valmont's actual financial results and would cause them to differ materially from those anticipated to forward-looking statements. These factors include among other things, risk factors described from time to time in Valmont's reports to the Securities and Exchange Commission as well as future economic and market circumstances. Industry conditions, company performance, and financial results, operating efficiencies, availability, and price of raw materials, availability, and market acceptance of new products, product pricing, domestic and International competitive environments, and actions, and policy changes of domestic and foreign governments. The Company cautions that any forward-looking statement included in this discussion is made as of the date of this discussion and the Company does not undertake to update any forward-looking statements. Thank you for joining today's conference. You may now disconnect.