Valmont Industries Inc (VMI) 2017 Q3 法說會逐字稿

Good morning. My name is Kathy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Valmont Industries, Inc. Third Quarter Earnings Call. (Operator Instructions)

I would now like to turn over today's conference over to Mr. Jeff Laudin, Manager, Investor Relations. Please go ahead, sir.

Thank you. Welcome to the Valmont Industries Third Quarter 2017 Earnings Conference Call. With me today are Mogens Bay, Chairman and Chief Executive Officer; Steve Kaniewski, President and Chief Operating Officer and incoming CEO as of 12/31/17; Mark Jaksich, Executive Vice President and Chief Financial Officer; Tim Francis, Vice President and Corporate Controller and Renee Campbell who has just joined our investor relations team.

Before we begin, please note this conference call is subject to our disclosure on forward-looking statements, which applies to today's discussion 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, which you will find in the Media Room link on our website.

I would now like to turn the call over to our Chairman and Chief Executive Officer, Mogens Bay.

Thank you, Jeff, and good morning, everyone. Thank you for joining us. I trust you've all read the press release and reviewed the earnings slide deck on our website. On today's call I'll give a high-level summary of the quarter. Steve will provide the segment performance update and Mark will review the financial aspects of the quarter.

The main drivers of our results were higher utility sales and profitability and improved performance in Irrigations and Coatings. The health of most of our markets has improved over the last year. Utility demand is robust. Coatings volume has stabilized. And we have seen growth in wireless communication product demand. Irrigation demand has stabilized in North America and the international markets are strong.

The major challenges in the third quarter were primarily working through raw material price increases, particularly the spike in zinc and China steel. The shipping and production delays caused by the 2 hurricanes, which impacted 10 of our facilities and numerous customers, cost us about $0.10 a share.

I will now turn the call over to Steve, who will review the segment performance in greater detail.

Thank you, Mogens, and good morning, everyone.

At a high level, our operational results this quarter were similar to second quarter, with increased sales and muted leverage. In certain cases the cost structure was in sharp contrast with last year when steel costs were lower.

Starting with the Engineered Support Structures segment, we saw continued firm demand in global wireless communication. In lighting and traffic the markets in Europe show signs of improvement. Asia-Pacific highway safety markets have been robust all year and supported segment results. This strength more than offset moderately low North America lighting and traffic demands. Our plant in India, a greenfield startup a few years ago, is growing into a good-sized business and highlights the need for quality infrastructure as India's economy develops.

Operating income was 7.3% of sales and was negatively impacted by under-recovery of raw material inflation and an unfavorable sales mix.

In Utility Support Structures sales improved 19% year over year. Pricing has firmed and lead times are extending. The markets continue to be supported by investments in grid reliability and ongoing renewable generation projects.

Our results were impacted by the hurricanes in Texas and Florida, as our customers focused more on restoration efforts versus new construction. As can be expected, some project timelines in the fourth quarter could be moved around as a result of the disruption from the hurricanes. While the hurricanes may weigh on our near-term results, over the medium to long term they help drive overall demand. As one customer in Florida pointed out, "Not one Valmont structure failed during the hurricane." It is this kind of performance that will continue to drive hardening efforts, not just in hurricane-prone areas, but anywhere that nature could impact reliability.

Operating income for the segment was 12.3% of sales for the quarter, largely due to price recovery and favorable mix.

In the Coatings segment sales rose in North America due to higher internal demand. Notably, the Asia-Pacific region has begun to recover from depressed levels. Our coatings business benefits from a diverse customer base and is not dependent on any one market. This helps offset specific end market weakness, such as oil and gas exposure.

Segment profitability improved to 17.6% of sales, despite higher zinc costs. To provide context, zinc was $1.24 at the beginning of the quarter and $1.45 at the end. We were able to recover some costs during the quarter through price increases. We are also seeing the full benefits of our 2016 Asia-Pacific restructuring activities.

Sales in the Energy and Mining segment were lower than last year. It was a tough quarter, which we anticipated when we spoke to you in the second quarter call. In access systems we continued to benefit from our strategy to broaden our market scope with products for architectural and other applications.

Regarding the mining consumables divestiture, we are waiting for Australia's antitrust regulator to approve the transaction, notice of which could come by year-end. At that time we will quantify its financial impact, which we do not anticipate to be material.

Turning to the Irrigation segment, we had another strong quarter driven by solid international growth. North America demand was slightly higher. We have continued to be aggressive during this downturn in developing new products that assist growers in optimizing productivity.

At the summer far shows we released XTEC, a constant-drive option that allows our pivots to operate at twice the speed of a standard AC motor, which has been well received by the market. XTEC allows the grower to have greater water application precision with a larger variety of crops, and better enables chemigation applications.

Solid international demand and good operational performance led to operating income at 12.3% of sales for the quarter. Our teams have continued to manage the factories well and improved productivity.

Finally, I would like to provide an update on our operational excellence initiatives. During the year we continued to actively streamline our operations and leverage human and physical capital assets while driving better performance. Particularly in the pole production plants we have decoupled the commercial organizations from the factories.

As an example, the Utility and North America ESS plants now report to a single management team, allowing plants to be optimized to serve all the pole product lines while mitigating freight costs by better leveraging our footprint. Capital assets in inventory can now be utilized across a broader set of products, assisting us in achieving better return on invested capital and inventory turns.

We are excited about some of the early progress in this area and look forward to sharing more details at our Investor Day early next year.

I will now turn the call over to Mark.

Thank you, Steve, and good morning, everyone.

Before I begin I'd like to draw your attention to the Reg G tables at the end of the press release and slide deck, as my comments on the third quarter are based on the adjusted financials.

Third quarter earnings per share were $1.56, up 5.4% from the adjusted EPS of $1.48 last year. The 11% sales increase over 2016 was equally due to improved volume and also to pricing and sales mix, with a small positive effect from currency translation. Most of the volume increases were realized in the Irrigation and Engineered Support Structures segments, with a decrease in Energy and Mining segment volumes.

Gross profit margins for the company decreased by 170 basis points compared to last year. On a segment basis, the most notable margin compressions were in the Energy and Mining and Engineered Support Structures segments. In Energy and Mining a much less favorable steel cost environment in mining consumables contributed to most of the decrease in that segment's profitability. In Engineered Support Structures comparative pricing environments and unfavorable sales mix contributed to lower gross profit margins. In our other segments, productivity improvements and higher selling prices helped offset rising input costs.

SG&A spending was comparable to 2016, and despite the top-line growth we realized 100 basis points of improvement in SG&A as a percentage of sales.

Third quarter operating income was $59.9 million, 3% over the same period in 2016, and our operating income percentage was down about 80 basis points from last year.

Our income tax rate of 27.5% for the quarter was comparable with last year's adjusted third quarter rate of 28.3%.

Turning to cash flows, year-to-date operating cash flows totaled $134 million compared with $127 million last year. We increased our cash balance by about $94 million over year-end 2016. The increase in operating cash flows were realized despite working capital increases to support the double-digit sales growth this year. However, receivable and inventory turns have improved somewhat over 2016.

Capital spending was $40 million year-to-date as compared with $42.2 million in 2016. We expect the total year CapEx to be in the range of $55 million to $60 million.

Regarding other capital deployment activities, we did not repurchase any shares during the quarter and have $132 million remaining under the current authorization.

With that, let me now comment on our outlook for the balance of 2017. Due to the effects of the hurricanes on our third quarter results and concerns about the timing on how the aftermath of those events will affect logistics and customer delivery schedules in the fourth quarter, we are slightly lowering our total year 2017 EPS guidance from about $7.06 per share to between $6.90 and $7.04. This excludes any impact from the pending sale of the mining consumables business, which should be immaterial, or share repurchases.

We expect sales growth for the year to be in the low double digits.

We project free cash flow to be around 1x net earnings, which is dependent on timing of any potential opportunistic raw material purchases.

After-tax return on invested capital is projected to be at about 10% for the year.

While steel prices have decreased recently, we do not expect much, if any, effect on the results for the balance of this year, nor are we projecting zinc prices to decrease in the short term. We will continue our efforts on mitigating the impact of higher raw material costs through cost reduction activities, cost recovery through pricing efforts in the market and strategic material purchases when warranted.

We expect the 2017 tax rate to approximate our adjusted 2016 rate of about 30%.

Our balance sheet remains strong, with manageable leverage and solid free cash flow. Cash at the end of the quarter was $493 million, most of which is outside the United States. Our liquidity gives us ample capability to pursue growth initiatives, whether organically or via acquisitions. We remain committed to maintaining investment grade credit rating.

Our cash priorities are unchanged, and those are to support the performance and growth of our businesses with working capital and capital spending, acquire companies that strengthen or are closely adjacent to our existing businesses, paying dividends at 15% of net earnings over time and to repurchase shares opportunistically.

With that, I will now turn the call back over to Steve.

Thank you, Mark.

Our challenge this year has been getting margin performance commensurate with sales growth, primarily in the Engineered Support Structures segment. Steel costs remain stubbornly firm, zinc moved dramatically higher and even aluminum is up over last year, materials that are critical to our business. Given that inflationary pressures are muting sales growth leverage, we have taken proactive pricing actions across all of our segments to recoup these costs and enable better performance as we go forward. Our revised guidance is for full year diluted earnings per share in the range of $6.90 and $7.04.

Supporting this outlook are expectations for a strong fourth quarter in Utility. We had 130 trucks loaded and ready to go before the hurricanes interrupted shipment. Some of that product is now shipping, but project volatility will remain for some time. Our backlog supports a positive outlook.

In the Engineered Support Structures segment we expect the improving trends in international to continue into the fourth quarter. Yet a sluggish North American lighting results may persist.

The Coatings outlook is for similar results to last year.

We expect unfavorable comparisons in Energy and Mining as recovering steel costs will take time based on customer pricing arrangements.

The beginning of harvest in North America will preoccupy farmers for most of the quarter, but we expect continued solid international demand.

Our M&A teams have been active and our pipeline of appropriate candidates is robust. That said, it is always difficult to predict the timing of acquisitions. We do believe our discipline and process will result in acquisitions with solid business rationale and good returns on the invested capital deployed.

At this time I would like to turn it over to the Operator to take your questions.

(Operator Instructions) Your first question comes from the line of Julian Mitchell with Credit Suisse.

This is actually Lee Sandquist on for Julian. Regarding the hurricanes, what was the top-line impact? And also, in addition, could you give us a sense of the clean incremental margins in the quarter, adjusting for the impact of the hurricanes?

Well, the amount of revenue that we saw was approximately around the $12 million range. In terms of the overall margins, we said that it impacted us by about $0.10 a share with the majority of that being in the Utility Support segment. And then ESS and Coatings also saw effects of that, due to having plants and customers in those areas.

Understood. And the top-line guidance was increased from mid- to high single digits up to low double digits. But just adjusting for the hurricanes the EPS guidance was essentially unchanged. So is this just a function of Energy and Mining being a little bit weaker than expected and then also the input cost headwinds?

That's correct.

Got it. And in terms of Utility, lead times are extending. So can you just touch on the volume outlook for this segment as we head into the next year?

Sure. Yes, so the lead times right now we're looking at are roughly around 26 weeks. And that is due to a number of customers with good activity. As we look into the first quarter we have pretty good visibility. Obviously that, and it looks like it's pretty firm and comparable to this year. As we look beyond that it's still pretty unknown, as the utilities have to kind of reload into the new year for their spend and their projects and their capital expenditures. So we don't anticipate a significant drop-off and we don't know yet if there's going to be a significant upturn. We just know that our quoting activity remains about where it's been.

Your next question comes from the line of Mike Shlisky with Seaport Global.

Can I get more of a holistic assessment on your margins for the quarter? When you think about the prices of metals, they did impact 2 segments on the margins but you were able to kind of offset it on the other 3 segments. Kind of in total for Valmont, were metal prices a overall headwind for the company in the quarter, or as you net-net kind of make it all work when all 5 segments are taken into account?

Yes, Mike, it was a headwind. As you look in the ESS part of the business material is a significant piece of cost. Our Utility business it's more significant, but there we do have pricing mechanisms with our customers. So ESS then is the next segment that there's more impact due to raw materials. And so therefore that's a big piece. And then in the Energy and Mining segment it's very significant. And so any movement in those pricings will affect our profitability much more substantially.

Okay. I also wanted to touch briefly on Irrigation as well. One of your big competitors on their call last week said there was a kind of modest growth outlook for irrigation for the next 12 months, I guess starting in September. They have a different schedule than you, a different calendar. But is that growth outlook kind of, broadly speaking, and of course large projects excluded, is that kind of in line with your thoughts as to how that might trend next year?

You know, we don't really know, let's say from a North America perspective, how yet the market will shake out. We do believe that the market has kind of bottomed out. And we've seen commodity prices and net farm income being within a certain range. So we would expect that to continue into next year. In our international markets the pipeline and the markets that we serve look to be pretty good. And we would expect that to continue as we move into next year.

Your next question comes from the line of Jon Braatz with Kansas City Capital.

Steve, going back to the Irrigation business, the North American market has been soft here for a number of years and the international market has been pretty good. And I think historically you're sort of 2/3-1/3 international/domestic -- I mean, domestic/international. Is that percentage -- is that mix changing much? Are we approaching 40-60? And if it continues to be that way will we continue to see incremental movement towards a higher mix of international business?

Yes. We do believe over time the international business will, frankly, outgrow and be much more substantial than the domestic business. As commodity prices and as the cycles go, we may see that from time to time switch back. But the long-term prospects and the good drivers are in the international markets. So we would expect that to move towards 50% and then push over as time goes on.

Okay. And as the international business grows -- the international business is less profitable, has less margin. Would you see any change in that margin?

Well, our operational efficiencies in the international space, we've been becoming much more adept at serving that market and utilizing our footprint very effectively. So while it does have different margin pressures, on the cost side we're able to utilize plants in China, the Middle East and elsewhere to help offset some of that. So the more volume, the more leverage.

Your next question comes from the line of Nathan Jones with Stifel.

I'd like to go to ESS and the price/cost picture there. Clearly that's the big segment that has the most problems passing through the higher raw material costs to you. I know you guys at times have gone out to the market with price increases ahead of everybody else, been willing to maybe sacrifice a little share. Can you just talk about the dynamic in ESS, particularly there? Is it more difficult to push price through because that business is more fragmented? Just how you're thinking about balancing the raw material increases with price.

Sure. It is much more fragmented and there is more diversity in the product line itself. That said, we are pushing out in front with price increases on a broad-based global perspective. It takes us longer to recover those costs. And. particularly in North America, the balance between supply and demand is in favor of supply. And not by a terrible amount, because the markets have been pretty good and pretty elevated. But it's just enough that it keeps the pricing environment more muted. In Asia-Pacific, and particularly for some of the road safety, we've entertained some product lines that have a different margin profile as well that's contributing. You'll see the sales growth but not necessarily the same quality of earnings. But it is the right thing to do for both our customers and to gain some incremental margin. So long story short, we're working very diligently on price. And, as you know, we're more than willing to push out in front on the price, even if it means short-term market share loss.

I wonder then if I could be a little more blunt on the point. How should we think about the margin progression in that business as you look to recapture the steel price increases?

Well, it's hard to be completely clear. I think as we look at quarter by quarter you'll see incremental improvement as we recover the steel costs. It takes time and as we have new product introductions that will also help the margin profiles. Those are things like smart poles, small cell, camouflage, which we think the market is moving towards in a pretty aggressive way. So the drivers for the market are that the product lines will change over time and that will help the margin profile. And then really it just comes down to our quality, our delivery and overall value for the customer and making sure that we don't lose ground on any of those fronts.

(Operator Instructions) Your next question comes from the line of Craig Bibb with CJS Securities.

You guys are starting to have quite a lot of cash on the balance sheet. You have not done any share repurchasing this year. And I guess you highlighted the M&A pipeline is robust. Is that what you're saving the cash for, or --?

It's twofold. We're really pushing an organic growth agenda internally, looking at new products and services that we can offer and needing the cash for those purposes, as well as the M&A activity. And as mentioned in my comments, the funnels in all of our business are pretty strong and international in scope as well. And so therefore we believe that that's where we can utilize our cash best.

And this would be tuck-in or something larger?

I'm sorry?

So the M&A you're looking at would be more bolt-on or something larger?

It's more bolt-on in nature. But, again, the size and the scope of the acquisitions could grow in size as we look at international opportunities.

Could you maybe give us a bit more detail on the hurricane impacts, like, just where it cost you, what it cost you? And then, when do you think you'll see the positive side of the hurricane?

Well, in the short term, and I can kind of touch on this in each business, Utility you immediately see all of our customers stop taking any product and simply work on using their own storm stock that they had in place to begin with to do restoration. And so you get a major interruption and then a replanning cycle that goes on with the projects as of, say, this quarter once restoration activities. What we will see from that are certain lines that get rebuilt. We'll see storm stock inventory replenished. And you will see the hardening efforts probably take on a much more significant piece of the psyche of those utilities that were affected. So we feel good that medium to long term there's nothing but positive drivers to come out of the hurricanes. In the ESS segment, particularly in the Houston area, we have a very strong customer base there that does lighting. But it's also the -- there's a major amount of interruption in that market, both from the customers that are willing and able to take product as well as to install it until other infrastructure is fixed. And so, again, we should see some activity out of that. In Coatings it's much more of an immediate effect of lost opportunity. So you have an opportunity cost loss because your plants were -- one, you couldn't absorb your labor and most of the fabricators that we deal with in kind of the broad market perspective, they don't ramp up and run overtime to catch back up. And so you don't see a commensurate spike of dipping activity thereafter. So we really look at that as more of an opportunity cost where we just lost the potential revenue and OP that went with it.

And your next question comes from the line of Brent Thielman of D.A. Davidson.

On the consumables business, I guess close to divesture, can you remind us what's going to be kind of the key drivers for what's left in Energy and Mining going forward, and also kind of how the dynamics of raw material price fluctuations are going to impact what's left over?

Well, Energy and Mining is a mix of a number of our business -- access systems, our wind business in Denmark, as well as then the mining consumables business. And mining consumables particularly is a specialty grade of steel that is used, because it's long-lasting, inside of the mills. And so that price increase, or increases, that we saw this year, our customer dynamic is that we have fixed agreements for a period of time. And they can vary anywhere from a couple of months to close to a year. Those will be reset at given points in time. From a revenue perspective, we were fairly flat. And so the demand overall is pretty good. It's just that the cost profile has changed significantly.

Okay. And then on Irrigation, were there larger projects on the international side that moved the needle this quarter or is this -- so were results more indicative of the broader base demand outside the US?

It was much more of a broad-based market. So we saw good performance in all of our international markets, as well as the ones that we've called out previously continuing to do well. And projects do make up a piece of the international component. And so we've had projects and we'll continue to have projects, but there's nothing overly significant there.

And your next question is a follow-up from Mike Shlisky with Seaport Global.

Wanted to check in with you also on ESS. Our checks with a bunch of different road-building firms kind of suggest that in their cases their backlogs and bids are kind of rising very rapidly here, and it seems mainly on state-level funded projects like in California and Texas. So is there a sense that as people have a wait for kind of federal dollars out of DC, that some of the states are stepping in here with their own projects? And is it possible to kind of turn into a solid growth outlook next year for your domestic ESS business?

We have the seen the states doing this over the last couple of years. And California and Texas have led the way. Florida is also a pretty strong market that funds things on their own. So, yes, that part has already been kind of baked into our run rate. And really to see the pop, it's really this clarity at a federal level on who's going to fund particularly projects that go multiyear. And in one given year they may see it. They may have the funding. But they're very reluctant to take on the larger projects that last multiple years unless they have some idea that it's going to be funded their end. And so, if we see an infrastructure bill of significance, then that should help us.

Yes, Mike, this is Mark Jaksich. Just to remind you as well, when you talk about a pop in road building, our types of products tend to go in towards the tail end of projects. So there's always a bit of a lag effect. Because the last thing that goes in on a road or a highway project typically is lighting and traffic structures and the like. So it would be a case if that was -- if we saw a pop we would realize it later than some of the other players in the market.

Got it. That covers it.

Your next question is a follow-up from the line of Nathan Jones with Stifel.

Steve, you said Utility lead times are out to about 26 weeks. If I remember correctly, that's kind of the range that they were at back in the good times in '11, '12, '13 kind of timeframe. And you appear to have more than covered increased fuel costs in Utility. I know some of that's contractual. Is there an opportunity here with supply and demand tightening for you to continue to improve pricing in that business and drive margins up?

Yes, absolutely. The 26 weeks now versus then, too, to take into account, was much more added capacity into the marketplace. And so all that capacity has been absorbed up. And so we do see, particularly in our bid work, where there's opportunity to take up price. And we are taking advantage of that.

Okay. And one for Mark. The tax rate's been on a pretty steady decline over the last few years. How should we think about your tax rate going forward?

Yes, Nathan, I would still say that over the course of time, depending on the mix of course of where the earnings are made and assuming no change in tax rates, we would be around that 30% rate. And certainly if we see something come out of Washington that's favorable, we'll certainly be all over that one, whether that's being able to possibly bring money back or to take advantage of that any way we can.

Here's hoping on that front, hey? Thank you very much.

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

Just maybe curving back to the ESS margins, you guys would have blown out to the upside if the margins weren't down there. It sounds like margins are down because you have higher steel prices that you can't pass through that easily. But also you have increased competitive pressure and your mix is changing. So we're not -- will we get a full recovery in ESS margins over time? Or are we looking at kind of a lower level because of the competitive issues and the mix?

Well, we believe firmly that over time we will see the recovery. This is just part of the cycle that you go through in this business. And if it tips in favor of demand it tends to accelerate pretty quickly. So we're pretty confident with both our actions and the new products that we're introducing to keep our product line fresh, that it will have an impact.

So the lynchpin is really you need stronger North American lighting demand for the margins to recover?

Yes, that's a considerable piece of the segment. So that's true.

Okay, great.

Your next question is a follow-up from the line of Brent Thielman of D.A. Davidson.

Steve, some of the events down in Puerto Rico, pretty disastrous in terms of the impact on the grid. Is that a market you guys would serve potentially?

We do serve that. We're one of a couple of people that service, let's say, PREPA, the local utility there, so, yes. And we don't yet know what that means. I don't think any of the agencies that are working on the reconstruction know what that yet means. But we're in a good position that when there's some clarity on that that we should see something out of Puerto Rico.

All right. And then on Coatings, appreciate the commentary thus far. I guess I'm trying to understand. I mean, there's another lift kind of in zinc prices through the third quarter, thus far into the fourth quarter, yet good signs of profitability there. I know there's some lag in this, but do you think you can kind of sustain these improved margins in light of that continued lift in input prices?

Yes. I think with the restructuring activities that we undertook last year for Asia-Pacific, for the operational excellence piece that we're working across the system, and being aggressive in the zinc recovery, that we should see profitability maintained.

Okay. Thank you.

(Operator Instructions) And at this time there are no questions.

Thank you. This concludes our call. We thank you for joining us today. The message will be available for playback on the internet or by phone for the next week. And we look forward to speaking to you again next quarter.

At this time the operator 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 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.

This is the end of today's call. You may now disconnect and have a great day.