Valmont Industries Inc (VMI) 2012 Q2 法說會逐字稿

My name is Holly and I'll be your conference operator today. At this time I would like to welcome everyone to the Valmont Industries' second quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) I would now like to turn the conference over to Jeff Laudin. Please go ahead, sir.

Thank you, Holly. Welcome to Valmont Industries' second quarter 2012 earnings conference call. With me today are Mogens Bay, Chairman and Chief Executive Officer; Terry McClain, Senior Vice President and Chief Financial Officer; and Mark Jaksich, Vice President and Corporate Controller. Before we begin, please note that this discussion is subject to our disclosure on forward-looking statements, which applies to today's call and will be read in full at the end of the call. The instructions for accessing a replay of the 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.

Thank you Jeff, and good morning everyone, and thank you for joining us. I trust that you have all read the press release, so I will focus on some of the highlights for the quarter. The main drivers of second quarter results were a substantial increase in Utility Support Structure Segment sales and operating income, record second quarter Irrigation Segment sales and operating income, and record Coatings operating income. The quality of our earnings improved, operating income as a percentage of the sales increasing from 10.3% to 12.7%.

We are pleased with this level of operating income, particularly considering our largest segment, the Engineer Infrastructure Product Segment continued to face very difficult market conditions in the lighting and traffic businesses, particularly in the US and in Europe. Profitability in the Utility Support Structure Segment more than doubled, and we're at 12.5% operating income as a percentage of sales. We absorbed in the quarter a significant financial penalty in connection with one large order experiencing productivity and quality issues. Absent these costs, operating income as a percentage of sales would have been in the mid teens, which is the level of operating income we expect for the balance of the year.

The outlook for our Utility business remains very strong, and we continue to get confirmation from the marketplace that this high level of activity will last for a number of years. We are adding capacity in Oklahoma, in Pennsylvania, in Texas, and in Mexico. These additions are all part of or adjacent to current facilities. We will continue to rely on some of our overseas plants when economic considerations, such as exchange rates, freight costs, et cetera, allows us to do so.

Our Irrigation business had a great quarter, exceeding last year's record second quarter, both as it relates to sales and operating income. In 2011 we had a later selling season than we experienced in 2012, where we benefited from favorable weather conditions in the first quarter of this year. Currently summer sales are following a more usual pattern, less business from storm damage but continued strong parts sales as equipment is being utilized aggressively in this very dry environment in North America. Sales in our international markets were also up as compared to the same period in 2011.

In North America we are experiencing very widespread drought conditions. Such an environment would typically indicate a strong fall selling season. At this time it is too early to determine whether revenues in the second half of the year will match or surpass last year's record performance. One concern would be that if this drought continues for much longer, it could lead to water pumping restrictions in certain parts of the country.

Our Coatings businesses continue to operate very well. Sales increases in North America basically offset lower revenue in the Asia Pacific markets. We are seeing a very high quality level of our earnings in this segment, benefiting from moderating zinc prices and lower energy costs. Going forward, we expect strong performance from this segment for the rest of the year, and we will be pleased if we can match the recent earnings quality. We have commenced operations in India of our galvanizing facility there, which is built adjacent to our new coal plant, and we expect to generate meaningful customize galvanizing in that country, but it will take time to build up volume.

The Engineer Infrastructure Product Segment had increased revenue and operating income. In the US, we welcomed the passage of a two-year Highway Bill. We would much prefer a longer Bill enabling local governments more visibility, but it is a start and demonstrates an understanding on both sides of the aisle of the importance of this funding. While the two-year Bill reduces uncertainty and probably improves the mood of the market, we do not expect much benefit in the near term.

Other areas of our North American Structures business improved. With the AT&T and T-Mobile merger off the table, our Wireless Communications Structures and Components businesses saw a meaningful improvement in revenue and earnings. We also saw some improvement in the commercial lighting market, and we added additional revenue from internal demand for Utility Structures.

In Europe the market continues very difficult with too much capacity chasing too little business, we're selling in a very competitive pricing environment. In the Asia Pacific region, on the other hand, sales and operating profits were higher, led by increased sales of access systems. In China as their economic growth rate has slowed, we are refining our business model there to put additional focus on export opportunities to some of our international markets. Those businesses categorized in Other had improved results, led by our Tubing business which benefited from improved industrial and agriculture market demand.

Turning to other financial measures, the tax rate for the quarter increased to 34.3%, reflecting a higher mix of US profits compared to the same period in 2011. Furthermore, last year we realized a one-time tax benefit in the second quarter. The impact of currency translation on operating income was a negative $1.7 million, as a result of a strengthening US currency. Inventories increased compared to last year to support the higher sales level. Depreciation and amortization for the quarter was $17 million, and capital expenditures were $19 million. We expect depreciation of about $70 million and capital spending for the year to be around $100 million, which includes capacity additions.

Looking toward the remainder of the year, we expect continued strength in Utility Support Structure Segment and the Engineer Support Structure Segment, or in the Engineer Infrastructure Products we expect improvement in the Asia Pacific region, but continued weak markets in Europe and North America. In the Irrigation business we will update you in our third quarter call on the expected impact of the drought in North America on the second half revenue. We currently maintain our expectations for full year earnings to exceed $8 per share, and believe that the existing market's consensus is achievable. We will now take your questions.

(Operator Instructions)

Julian Mitchell, Credit Suisse.

It is actually Charlie for Julian. Just wondering, we saw really strong margins in the Coatings Segment. Obviously, you mentioned lower energy costs and lower zinc prices. Just didn't know if you could kind of quantify on the $19.5 million, kind of -- in operating profit, up about $4 million or $5 million, year over year, I didn't know if you could kind of put a dollar number on what the benefit was from lower zinc prices?

I don't think I can give you a dollar amount, but I would say that the majority of the increase in the earnings quality in the quarter came from a better input environment.

Okay, great. Then you had spoken before about lower priced orders, kind of in your Utility backlog. One question on Utility is how much longer kind of will that last? Obviously you guys had a high earnings number, but just kind of from an incremental standpoint, it looked a little low. So how long will it take for the low-priced orders to kind of work through the P&L, and then also, given the capacity additions and seeing new competitors emerge, how do you see the pricing environment? I know you guys had touched on that last quarter. Thanks.

Well, let me start by saying that, over the last number of quarters, I've indicated that we would expect the earnings quality in the Utility business to be in the mid-teens on average in a good market environment, and we are seeing a good market environment. I mentioned in my prepared remarks that absent the one-time cost in connection with a big order, we would have been at the mid-teens in the second quarter, and we expect third and fourth quarter to be in the mid-teens. So basically that doesn't mean that we will never have a low-priced order, but we think we are through the period of time where the low-priced orders from '10 and '11 had such an impact that we could not reach the mid-teens.

Perfect. How about the pricing environment? I know that you had said normally in an environment where there was kind of not enough capacity to supply the market, that you would get kind of better pricing, but some of that you were not realizing just from new competitors. Has that changed?

Well, I think that as the market has continued to strengthen, we have seen a better pricing environment, which is what will take our operating income percentage to the mid-teens and hopefully stay there. Now, in a market as buoyant as the one we see in Utility, we also continue to see new players entering the market, or players from other structural businesses try their hand in the utility business. So there will be a competitive pricing environment going forward, but we expect that on balance, and with a number of orders that are probably better priced than others, that on balance we will be around the mid-teens in operating income percentage.

Schon Williams, BB&T Capital Market.

I wanted to focus here first on the EIP segment. You talked about the strength within the telecommunications structures. I'm just trying to get a sense of how much of that was that kind of pent-up demand from the AT&T merger versus how much of that is sustainable going forward? Can you just give us some indications about your thoughts in terms of growth rates accelerating, decelerating, maybe over the next couple of quarters?

I would say that we saw an improvement in the market conditions in the wireless communication part of our business, and I think we have seen a contraction as everybody was waiting to see what happened in the merger between T-mobile and AT&T. So I think we are reverting to a more sustainable level of business. So I don't think we are just seeing a pent-up demand that will go away. I think we have seen an improvement in the market condition that we think will continue.

Okay, thank you. Then when I go back and look at the last time we got an extension of the Safety -- the Highway Bill back in 2005, I mean, it looked like it took some time for that to like truly flow through to your numbers. I mean, you saw growth in 2006 but it wasn't really until 2007 to when growth really started to accelerate within that lighting and highway business. I'm just wondering, could it be end of 2013, into 2014 before we start to see some real movement from this Highway Bill, or could it be sooner than that?

I think your observation is correct, and I think I mentioned it in my prepared remarks, that we do not expect any short-term benefit from the Highway Bill. It could easily last until the end of next year. I think the general mood in the market has improved, and you may see local authorities start working on some of these projects, but this is a two-year Bill, and the timeframe you referred to back in 2006 was a five-year bill. I think the market requires and deserves a five-year bill so they can make longer term planning. We didn't get that, but we got something, and to what extent we'll see some improvement from that particular funding mechanism some time next year is yet to be seen.

Okay, thank you. Then one last question, if I could. Coatings business obviously doing very well on margins there, but I think you noted that, in the release that the international side of that business offset some of your North American demand. Could you talk about in particular, I mean, what countries would that be, and does that concern you?

Well, I think part of it has been an impact in Australia, where there's been some pressure on local industry as a result of the very strong Australian dollar, which has made import into Australia more competitive and therefore has put some dampening effect on the local industry. We have seen an affect from that. Whether that will continue, I don't know. We had one customer in Australia that was pretty significant, serving the mining industry, that have had a softer year, and we have not yet seen in general a softening in the mining industry. So I think that will correct itself. So I hope it is a temporary situation, but we did see a reduction in volume in Southeast Asia, not only in Australia, and I hope that's something that will correct itself.

Carter Shoop, Keybanc.

Good morning, and congratulations on a good quarter. I wanted to focus on the Irrigation Segments, and I appreciate the comments and the limited visibility you guys have thus far in regards to the drought, but I was hoping that we could dig into that a little bit deeper, and maybe talk about what you're seeing right now and what you're hearing right now from dealers, and then also maybe talk about how the drought in the US and the higher prices of crops is impacting your international business.

Let me start with the last part. I don't think that the drought directly is impacting our international business. Now, commodities tend to be global in their pricing dynamics. So if commodity prices globally become stronger for corn, soybeans, and other major crops, it will improve profitability of international farmers, and therefore it could translate into more business. Reverting to North America, this is the time of the year where farmers are focused on growing a crop, not on putting in new equipment. As I said, in general, when you have dry conditions, it helps irrigated farmers because they benefit from having a crop and being able to sell it at higher prices.

So that would indicate that we are going to have a strong fall season, and that usually translates into also a strong season in the first couple of quarters of next year. To what extent that environment will translate into another record season is yet to be seen. Last year was very strong, both towards the end of 2011 and into the beginning of 2012. What I can say is that, if we get an opportunity to sell more than we did last year, we'll be ready for it, but we need some traction in the marketplace later this fall to get a better feel for it. The mood in the dealer organization is good. The mood in the dealer organization was good last year. So it's a question of to what degree does it translate into a strong business.

That's helpful. In regards to margins in Irrigation, first half of the year you're at 19.5%. That compares to previous peak levels in the mid-17% range. Can you talk about if these types of margins are sustainable? I'd imagine you'd see a little bit of a decline in the second half, just due to normal seasonality, but is this kind of a reasonable way to think about margins, or are there some one-time benefits going on that we should know about?

Well, I don't think there are one-time benefits going on, but we had moderating input costs, particularly in steel. We had a fairly good pricing environment, and we get good leverage when the plants are busy. So in the third quarter, the plants won't be as busy; that's a seasonal lower quarter. But if we have another quarter like the last two with moderating input costs and busy plants, then we would expect to have the same margins.

Just a quick follow-up in regards to steel prices. How much of the benefit did you see in 2Q from that versus how much of a benefit will you see in 3Q? I mean, how quickly are you able to realize those benefits, and are you seeing any competitors lowering their prices, particularly for center pivots, given the lower steel prices?

No, I don't think the steel price change has been that significant. It's just been we haven't seen the strengthening in the second quarter that we saw in the previous couple of years. So it's not that important. We have not seen changes in the market pricing driven by steel pricing, and I don't think we're going to see any difference in quality of earnings as it relates to steel between the second and the third quarter. We will see a difference as it relates to leverage.

Brent Thielman, DA Davidson.

The question on the Coating segment, how much of your North American revenues are now tied to the Utility business?

I can't put a percentage on it. I wouldn't say that it's significant in the overall scheme of things. We have good internal loading in some of our galvanizing plants, but you saw revenue in North America was up somewhat, and some of that came from internal Utility business, and we expect that business to stay strong for a number of years going forward, but it's not like 40% or 50% of the Coatings business.

Brent, probably out of the 17 facilities, there are probably 2 or 3 that are impacted by Utility customers.

Okay. So the rest sort of driven by general industrial activity? Okay. Then just question on the, I guess, in terms of your Utility backlog, how far out does your visibility extend at this point?

Well, of all the businesses, Utility has the best visibility, and I would say that currently it extends out through the end of the year.

Arnie Ursaner, CJS securities.

Good morning. Two quick questions for Terry, if I can. Terry, can you quantify the impact of the one-time hit in Utility in dollars, and also give us a better explanation of the $2 million miscellaneous hit to earnings?

Okay. I'll let Mark handle miscellaneous, but the Utility second quarter was about $5.7 million.

Okay.

Arnie, this is Mark. The miscellaneous expense that hits in the second quarter was, the lion's share of that was foreign exchange losses as the dollar strengthened. We have had a number of locations that had US dollar based liabilities that weren't completely covered. Subsequent to the end of the quarter, we've corrected a number of those situations. So I would not expect that to reoccur going forward, but that was the lion's share of what that expense was.

Okay. Mogens, if you could -- most of the investors are looking towards 2013. I think you very broadly have spoken about your view of Utilities, of Coatings, of Irrigation. Perhaps you could sum up your views of all of those and give us kind of a big picture of how you think you're entering 2013, and how we should think about 2013?

Well, you kind of summarized it, as well. The Utility business we expect to continue to strengthen, and we are adding capacity to support that. The Irrigation business current environment is good, which would mean that the Irrigation business should continue strong, at least in North America and probably also around the world. The Coatings business is very dependent on the general economy, but if the general economy continues to improve ever so slightly, I think we'll continue to see good results there. In the Engineered Infrastructure Product Segment, I suspect that our businesses in Southeast Asia will continue to do well. We'll continue to see a difficult environment in North America as it relates to traffic and highway business, and I think we'll continue to see a tough, maybe even tougher environment in Europe, because of the financial problems that they are dealing with currently. But on balance, if all this comes to pass, we should have another record year in 2013.

Brian Drab, William Blair.

First question. Mogens, last conference call you said that you expected Irrigation to be probably modestly down in the second half, if I remember correctly, and your language today was, we are not sure whether we're going to match or exceed first half Irrigation results in the second half of this year. First of all is my memory correct, and second --

No, that's not what I said. I said I'm not sure whether we'll match or exceed last year's second half in the second half of this year.

Okay. Is my memory correct regarding what you said on the first quarter call though, that you expected that -- I guess, so in the first quarter call you said that you thought maybe the second half of 2012 would be down from the first half of 2012, is that correct?

No. I said we, at that time we currently expected the second half of 2012 to be slightly below the second half of 2011.

Right. Okay. I think that's what I meant to say. So now has your expectation improved or changed where you think that being down year-over-year in the second half of 2012 is not likely?

Well, I would say my hopefulness has changed. I'm hoping that we'll see a little more activity as a result of the current drought, but it is too early to say my expectations have changed.

Okay, got it. Then the Utility business has just been so strong over the last several quarters, but over the last three quarters it's hovered right around $200 million in revenue. Is this a business that could do $300 million a quarter in revenue? Where are we in terms of capacity utilization and the potential for this business?

Let me put it this way. We think it's going to get stronger next year. We are adding capacity, and we are adding it because we think we can fill it. So I think that would translate into more than $200 million a quarter.

Okay, and can you give us any sense, maybe you need to just remind me, but where we are in terms of capacity utilization, and how much are you adding, roughly?

I would put it this way. We are very high in capacity utilization, and I would say if you take the average capacity available in 2012 and our projected average capacity for 2013, add $100 million.

Add $100 million annually?

Yes.

Jeff Beach, Stifel Nicolaus.

Engineered Infrastructure Products -- the margin picked up somewhat. Is that a combination of cost reductions? I know you focused on that as well as volume. Then can you describe the relative profitability among the regions, North America, Europe, Asia, and then plans to move those margins up in, hopefully, all regions.

Let me start with the regions. The weakest region from a profitability standpoint is Europe. It's also the smallest region. I do not expect much improvement in European profitability until we see a changed marketplace in Europe. In North America the profitability level is higher than in Europe. It's a profitable business. I think the improvement in profitability is more a result of better margin management, or better mix, than it is a different market environment, and the highest profitability in this segment is in Southeast Asia, and they are operating at acceptable good profit level.

Are there other actions you're taking? It sounds like Europe, you have to wait on the market, but actions to move your margins up in North America and Asia, internal?

Well, in Asia, the Asia business is a good business and there are ongoing efforts through [lean], et cetera to continue to improve our profitability. In North America, we would want some help from the marketplace to see a major change in this part of the world, and in Europe, as I said, it's a question of too much capacity chasing too little business. So the price levels in the European market is the biggest impact on the profitability there, and it's very tough to predict from quarter to quarter how that pricing environment is going to be. It's not a business where you have a lot of visibility. If you have one quarter of visibility, you are pleased.

All right. My second question is, on the capacity addition in Utility. You mentioned expansion at four different states, or four different plants. Last year, I think at this time in July, you announced you were expanding capacity. Has additional capacity already come on-stream, and what you are talking about today is more capacity, and can you talk about conversion of maybe EIP lines versus added bricks and mortar?

Let me say that I think out of EIP, we are using the capacity that we probably can out of that business. We are adding capacity in several utility plants, and I made the comment that they are all either inside or adjacent to ground facilities, which allows us to leverage our SG&A better than building a new plant in a new geographic facility. I also mentioned that in total we expect that the capacity -- the average capacity available from 2012 into 2013, we will add $100 million. So we are adding capacity beyond the capacity we have talked about in the past. The biggest capacity addition is a new plant adjacent to a shipping facility in Tulsa, Oklahoma.

Jon Braatz, Kansas City Capital.

A couple questions on the Irrigation sector. When we have such a severe drought like this, and I know it goes back, the last one was really 1988, but do you see maybe new markets open up that maybe weren't typically irrigated acres? I don't know, maybe like Iowa, southern Illinois, or places like that? Do you see greater interest from farmers in the non-typical areas?

I would say yes, but it's a development we have seen over a period of time as commodity prices have been pretty strong, that we have seen more business from newly developed irrigated acres than we saw in the past. Now, one premise to have that happen is availability of underground water or water from streams, and therefore, I think we may see more new development in the Southeast than we will, for instance, in Iowa and Illinois, where the profit probably is more availability of underground water.

Okay. Going back to the water issue, I read where I think some spots in Nebraska, some farmers had to actually, if I understand this correctly, turned off their irrigation system for lack of water, or maybe restricted. Any thoughts about -- are you hearing anything about that being extended to other areas in Nebraska and elsewhere?

Well, that was one of the points I made, that one concern I have is that if the drought gets too severe, it could impact pumping of water, there'll be restrictions on it. Not only from a water issue, but we have seen it also in part of Nebraska from an availability of electricity, because of all the air-conditioning running, and farmers have been asked not to run their pivots as much.

Okay. I wasn't aware of that. Okay, thank you very much, Mogens.

(Operator Instructions)

Ryan Connors, Janney Montgomery Scott.

This is actually Tim [Veron] filling in for Ryan. My first question's just on Irrigation. I was curious to get your color on how big of a role you guys think the increasing availability and usage of crop insurance could play in the adoption of irrigation systems? Do you think that, as crop insurance starts being used more, this could be a headwind for sales of pivot systems, as farmers kind of rely on that for protection against a drought instead of installing an irrigation system, or are the drivers of irrigation sales really related to just improving productivity?

Let me say, it's a good question. I hadn't thought about it, and therefore if I tried to answer it, I'd tell you more than I know. I would say in general that productivity, and just the security of having a crop, is the main driver for our business. I have not heard from our Irrigation people a concern about crop insurance being a damper potentially on our business.

Okay, and then my next question, also on irrigation. Just curious, if there was a dip in sales in the second half of this year, do you think that would be short-lived, just given the financial health of the ag sector as a whole?

I would say that the external environment for agriculture worldwide, and therefore for irrigation, is probably as strong as we've seen it for a long time. Commodity prices continue to be high, the demand on food production as a result of improved diets around the world, the recognition around the world by governments of the importance of stretching their fresh water and protecting the quality of their fresh water, all those drivers of our business continue strong. So as I've always said, weather patterns, commodity prices, local conditions can create either peaks or valleys short-term, but in total the drivers are as strong as we've seen them.

Tim, maybe I can add. Again, when we talk about potential down from a year ago, the year ago was the abnormal year. It was -- we had a season that continued into the third quarter. We had storm damage. We had a lot of things going on. So the relative down that we talk about potentially as we were talking after the first quarter call was relative to an outstanding year, an outstanding record year for all kinds of reasons. Back to the question that Mogens just answered, I think you're seeing just a better situation for farmers in a normal pattern.

Right. So some of the decline would just be on tougher comps rather than anything fundamental?

Yes, exactly.

Holly, are there any further questions?

Yes, sir. Carter Shoop, Keybanc.

Just two quick follow-ups, if I may. On the Utility business, are we talking about a net capacity increase of $100 million, or is that assuming some business comes out of the EIP division to fill the new facilities?

Net, and actually some of that capacity was built adjacent to a part of a lighting and traffic facility.

Help me understand the reasoning behind building new capacity for Utility versus just absorbing some of the more existing capacity in the EIP business in North America. Is it more just you need to get the right facilities, some of the existing EIP facilities aren't big enough to handle some of the higher voltage, bigger towers, or how do you guys think about that trade-off?

We have already absorbed the capacity available in the North America lighting plant, because it's only the part of the EIP plant in North America that can build large structures that we can actually leverage into the Utility business. Small-pole facilities, or [regularly-pole] facilities cannot be leveraged into Utility. So we have already probably maximized what we can get from the lighting and traffic businesses.

That's helpful. Lastly, year up in the EIP division, should we expect some additional restructuring initiatives to improve the margin profile there?

It depends on what we see in the marketplace, but I would not say that is not likely.

At this time there are no further questions. I'd now like to turn the conference call back over to Jeff Laudin for closing remarks.

Thank you, Holly. This concludes our call, and we thank you for joining us today. The call 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, and at this time Holly will read our forward-looking disclosure statement.

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 Valmont 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 cause them to differ materially from those anticipated in the 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 material, 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 statement. Thank you