AZZ Inc. (AZZ) Q2 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the AZZ incorporated Second Quarter of Fiscal Year 2013 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. [Operator Instructions] I would now like to turn the conference over to Mr. Joe Dorame of Lytham Partners. Please go ahead, sir.

Thank you, Denise. Good morning, and thank for joining us today to review the financial results for AZZ Incorporated for the second quarter of fiscal year 2013 ended August 31, 2012. As Denise indicated, my name is Joe Dorame. I'm with Lytham Partners, and we are the investor relations consulting firm for AZZ Incorporated. With us today on the call representing the company are Mr. David Dingus, President and Chief Executive Officer; and Mr. Dana Perry, Chief Financial Officer. At the conclusion of today's prepared remarks, we will open the call for a Q&A session. Before we begin, I would like to remind everyone this conference call includes statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Except for the statements of historical fact, this conference call may contain forward-looking statements that involve risks and uncertainties, some of which are detailed from time to time in documents filed by the company with the SEC. Those risks and uncertainties include, but are not limited to, changes in customer demand and response to products and services offered by the company, including demand by the electrical power generation markets, electrical transmission and distribution markets, the industrial markets and the hot dip galvanizing markets; prices and raw material costs, including zinc and natural gas, which are used in the hot dip galvanizing process; changes in the economic conditions of the various markets the company serves, foreign and domestic; customer-requested delay of shipments; acquisition opportunities; currency exchange rates; adequate financing; and availability of experienced management employees to implement the company's growth strategies. The company can give no assurance that such forward-looking statements will prove to be correct. AZZ assumes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. With that having been said, I'd like to turn the call over to Mr. David Dingus, President and Chief Executive Officer of AZZ. David?

Thank you, Joe, and thanks to each of you for taking the time to join us for the conference call for the second quarter of our fiscal 2013, which ended on August 31 of 2012. We are extremely pleased with the results for the quarter. Our record-setting operating results reflected double-digit improvement in revenues, net income and earnings per share and backlog when we compare to the prior year. It was another quarter of effective identification and execution of opportunities and strategic initiatives. These comments apply both to the second quarter and the first 6 months of our current fiscal year. The operating results for the Electrical/Industrial segment and the Galvanizing Services segment were as anticipated and internally forecast. Nuclear Logistics made a positive contribution in the quarter for both orders, revenues and operating income. For the second quarter, year-over-year growth for the segment in revenues was 50% and operating income was 84%. Galvanizing Services segment had another outstanding quarterly operating performance. Most served markets reflect good demand. The strong second quarter results reflected 24% growth in revenues and a 26% growth in operating income when compared to the prior year. Tonnage was up 33%. Solar power generation projects, transmission line work and OEMs reflect the largest quarterly growth when compared to the prior year. We're extremely pleased that we were able to reach agreement to acquire another Canadian galvanizer, which will be effective October 1 of 2012. This continues our efforts to consolidate the Canadian market and become a leading supplier of galvanizing services to this market. Galvcast revenues will approximate $25 million on an annualized full year basis and should be accretive in the first year of our ownership of $0.12 to $0.15 per diluted share. We continue to demonstrate our commitment to quality and service and take advantage of all opportunities to maximize volumes and market share while maintaining our pricing strategies. The completion of another successful quarter, the financial strength of the company and the great group of employees is reflected in our record-setting year-to-date operating results and the confidence that we have in our future. Now with that as an overview, Dana will now give us a review of the operating results for the second quarter of fiscal 2013. Dana?

Thank you, David, and I would also like to welcome each of you as well to our second quarter conference call, and at this time, I will review our unaudited consolidated results for the period ending August 31, 2012. As outlined in our press release, revenues for the quarter ending August 31 were $153.4 million as compared to $114.7 million in the prior year. Net income and diluted earnings per share for the quarter were $15.9 million or $0.62 a share as compared to $9.6 million or $0.38 a share in the prior year. Our book-to-ship ratio for the quarter was 0.99, ending the quarter with a backlog of $213.1 million. The acquired backlog from NLI on June 1 was $78.5 million. Our backlog at the end of our previous fiscal year end was $138.6 million. Our Electrical/Industrial product segment generated 40% of our revenues for the quarter, while our Galvanizing Services generated the balance or 60%. With the acquisition of NLI, we expect at the end of the fiscal year 2013, our Electrical/Industrial segment will contribute 45% of our revenues, while the Galvanizing segment will contribute 55%. In our Electrical/Industrial product segment, we've recorded revenues for the quarter of $66.5 million as compared to our prior year results of $44.4 million. Increased revenues were results of increased order intake during the last 2 quarters of our fiscal 2012 year, as well as inclusion of the acquisition of NLI, which contributed $11.4 million to revenues for the quarter. Operating income was $9.3 million as compared to $5.1 million, and operating margins were 14% for the quarter compared to 11.4% in the prior year period. Operating profits and margins for the compared period due to the leverage obtained from increased revenues, combined with a limited amount of improved pricing. Without the acquisition -- excuse me, without the amortization of intangibles resulting from the acquisition of NLI, pro forma margins for the quarter would have been 17%. Revenues in our Galvanizing segment for the quarter were $86.9 million as compared to $70.3 million recorded in our second quarter in fiscal 2012. The increased revenues resulted from continued improved demand from the renewable energy, industrial and OEM markets. Operating income was $23.5 million compared to $18.8 million in the prior year, and operating margins for the quarter were 27.1% compared to 26.7% during the second quarter. And whilst -- during the second quarter, a loss was recorded in the amount of $1 million, which resulted from lost production associated with a fire at our Joliet facility. This loss, as well as a portion of future losses associated with this facility, will be partially offset with insurance proceeds from our business interruption policy in a future quarter. Without this loss, margins would have been 28% for the quarter on a pro forma basis. At this time, I will cover some of our key cash flow and balance sheet items on a comparative basis. For the 6-month period, cash provided by operations was $30.2 million compared to $27 million in the prior year. Earnings before interest, taxes and depreciation and amortization surpassed $68.6 million. Our accounts receivable days outstanding were 48 days at the end of the second quarter as compared to 48 days at our fiscal year end. Year-to-date capital improvements were made in the amount of $12.6 million, and depreciation amounted to $13.2 million. Our total outstanding debt at the end of the second quarter was $211 million. Our cash balance at the end of the quarter was $68.7 million. At our regular scheduled board meeting, we increased and declared our quarterly cash dividend of $0.14 per share to be paid October 26. Our leverage ratio, which is defined as our funded debt divided by our cash flow, at the end of our second quarter was 2.1x. The ceiling for our covenant requirements on our senior credit facilities is 3.25x. We continue to believe that our balance sheet is one of our core strengths, and along with our strong cash flow characteristics, combined with access to borrowings under existing banking arrangements, provides us with adequate flexibility to continue growth of our company. At this time, David will give us an overview of our 2 operating segments.

As we reported last quarter, the gas-fired power generation market has slowed domestically, but it is improving internationally. While the international opportunities are improving, the incoming order rate from the international market has not replaced the downturn in the domestic market. We remain bullish on the long-term domestic and international power generation opportunities for AZZ. NLI continued to see strong demand for their products due to the ongoing spending related to safety and license extensions for nuclear power generation. Demand for our electrical distribution substation project -- products has flattened out. Utility spending continues to be cautious in the current uncertain economic climate. Utility budgets remain strong, but the release of projects continues to lag the growth of the budgets. Over the long term, we are still encouraged with the opportunities associated with the upgrade of domestic distribution substations. Our high-voltage transmission incoming order rate improved during the second quarter. However, these projects won't impact the current fiscal year. We were also advised, during the second quarter, that a couple of projects in our backlog have been delayed due to overall site readiness delays and has moved the revenue and earnings recognition out of the current fiscal year into the next fiscal year. This will impact our third and our fourth quarters of the Electrical/Industrial Product segment. Our specialty lighting products continue to show very positive growth when compared to prior periods. For the Galvanizing Services segment, the electrical utility market remains strong and growth of our OEM business continues to be encouraging. The strength of these markets has more than offset the impact of a low national GDP rate. When compared to the prior year, quotation levels reflect only very modest improvement. We continue to see a slow release of orders, consistent with increasing concerns over the state of the economic recovery and the overall regulatory environment. This has and may continue to impact our backlog. We achieved a book-to-ship ratio in the second quarter of 99%. The slow release of orders from utility companies and the lower domestic power generation market impacted this incoming order rate. We still anticipate that the full year will be a book-to-ship of approximately 1:1. In summary, our products and services are extremely well positioned to continue to benefit from market improvement and impending improving pricing levels. The timing of projects and release of orders will always have an impact on quarterly recognition of bookings, backlog, revenue and earnings and will result in quarter-to-quarter fluctuations, which may be greater than true changes in market demand and our competitive position and successes. Based upon the evaluation of information currently available to management, we are increasing our previously issued guidance for fiscal 2013 for revenues to be in the range of $575 million to $600 million and for earnings to be within the range of $2.25 to $2.40 per diluted share. Our guidance does reflect the acquisition of NLI during the 9 -- last 9 months of the fiscal '13 and the acquisition of Galvcast effective October 1 of 2012. Both acquisitions are anticipated to be accretive to fiscal 2013 earnings. The previously issued guidance was for revenues to be in the range of $550 million to $575 million and for fully diluted earnings per share to be in the range of $2.05 to $2.15. The guidance does reflect the effects of the 2-for-1 stock split. Now we anticipate reporting strong operating results that reflect the year-over-year growth in the third and the fourth quarters of fiscal '12 -- '13. However, our current guidance does not anticipate that either quarter will be as strong as the first and second quarters. The delayed shipments discussed previously, combined with a lower GDP projection, is the primary cause of this forecast. We will look for every opportunity to offset these events and strive to maintain the current level of earnings. Achievement of these projections will be our 26th consecutive year of profitability and will be record-setting, both in terms of revenues and in terms of earnings. Our estimates assume that we will not have any appreciable change in our current market conditions, competitive activity, including pricing or significant delays in delivery or timing in the receipt of orders of our electrical and industrial products and demand for our galvanizing services. The strength of our balance sheet, the competence of our management team and the strong customer acceptance of our products and services gives us the confidence to continue to aggressively pursue additions to our products and our served markets. Thank you for your participation today, and we'd like to open it up for any questions you might have at this time.

[Operator Instructions] Our first question will come from John Franzreb of Sidoti & Company.

David, in your prepared comments, you mentioned that utility budgets are up but spending is essentially flattish. Why is that the case? And when would you expect to see any kind of improvement in the spending patterns based on what your customer feedback is?

The customer feedback, John, is that they just don't believe they have any luck in getting rate recovery in the current political environment, in the current economic environment. I think we've got to get the elections behind us and hopefully, a little rosier forecast of what the GDP is going to do and what the unemployment's going to do and the overall economic outlook before they're going to have the confidence to go before the rate regulators and start releasing these orders. I mean, they are acknowledging, I think, in the budgets, the need to do something, but the release of orders is more reflective of what they think their ability is to be successful in getting that rate recovery.

Okay. Switching to the galvanizing side of the business, strong results again in the quarter. Is there a particular geography or end market that's driving those results? And I guess are you booking any benefits from lower average zinc prices on a year-over-year basis? Can you just talk a little bit about the zinc and end-market dynamics?

Yes, the market dynamics are a continuation of what we saw in the first quarter, John. It's -- the electrical utility for the transmission lines and for the solar continues to be quite strong. OEM is doing very well. Petrochemical is picking up through that, so overall it's balanced, which is very encouraging for us through that cycle. So we think that will continue. At some point, the lower GDP numbers will start impacting us. We're concerned about that because we still do about 30% in the general industrial market, which is directly GDP-driven. Now regarding the zinc, we're still expensing zinc more expensive than we're purchasing. So in the second quarter, we averaged zinc costs on our P&L of $0.99 and average paid of $0.91, but we're starting to get to that 1:1 relationship, which should help us a little bit in the third and the fourth quarters and the beginning of next fiscal year. But right now, we're still a little bit upside down, but not bad at all.

Okay. I didn't realize that. One last question on Galvcast. Could you put some parameters on the revenue contribution from the business, how big it is? And you said it's accretive. What kind of magnitude are we thinking?

Right. The annual revenues will approximate $25 million, and we think the accretion will be between $0.12 and $0.15 for the first 12 months.

Our next question will come from Brent Thielman of D.A. Davidson.

Just the $11.4 million contribution from Nuclear Logistics, was that lower than you expected for the quarter? Because I think, previously, you guys said you were thinking $55 million, $60 million for the year from NLI, which would imply kind of a step-up here for 2H.

Even -- it was a little bit lower, Brent, than we anticipated because we did have a couple of projects that slid out, but our forecast for the full year is still the same as we had before. So the second quarter was going to be the weakest quarter to begin within our forecast. We don't see anything right now that's going to change those overall projections that we issued for it, and we're most encouraged with how the business is running. We're most encouraged with the good assimilation into it. I think most of our progress is actually ahead of schedule, and it's just proving to be just a tremendous complementary acquisition for AZZ. We’re going to probably start looking and seeing next year a little more pull-through than we initially saw for some of our other products. So it's very pleased. So it was below, but we're still hanging with our full year guidance. So the third and the fourth will be stronger for NLI than it was in the second, yes.

Got you. That's great. And then just on the Galvcast acquisition, I think you said $25 million in annual revenues. Any meaningful seasonality to that? And then I assume the margins are consistent with what you're sort of seeing today in the core AZZ business.

In the -- they're in the Toronto market, so it has some winter impact, but not to the degree that our Montréal operations have. So yes, the fourth quarter will be the weakest for all of our Canadian operations, for Galvan and Galvcast, but not to the severe level that it was. And their margins are equal to or greater than what we're overall achieving.

Okay. And then just on SG&A, $60 million, is that kind of a good quarterly run rate going forward? Or anything unusual in there this quarter?

We don't anticipate anything unusual, and that's a good assumption for running rate.

Okay. And sorry, lastly, I'm sorry if I missed this, but the cash position at the end of the quarter?

$68.7 million.

Our next question will come from Schon Williams of BB&T Capital Markets.

I wonder if you could just -- could give us a little bit more detail on what you're specifically seeing in solar? Would you couch that as -- is that a handful of projects that you see going on for the next 6, 12, 18 months? Is it -- are we talking more like 10 to 15 projects? Can you just kind of help maybe quantify what exactly you're working on within that space? And maybe how long we can expect that to be accretive to the numbers here?

Schon, on the galvanizing side, it's probably 10 to 20 different projects. On the electrical side, probably 5 to 10 different projects. We obviously know what's in the backlog, what's coming at us in this fiscal year. But as you well know, I mean, our ability to forecast beyond this current fiscal year is government policy, and it's tough as hell to do it. Now we're -- we believe long term that the solar is going to be a very favorable space for us to be in. But over the -- for our next 2 fiscal years, I think it's going to be tough. Again, it's election-driven. It's, overall, economic-driven. It's budget-deficit-driven. There's a lot of variables out there. But as we've said before, the overall cost of producing a kilowatt hour from solar is improving, which makes it more viable as we go forward. But it's still a subsidized industry, so we're very cautious in our internal forecasting on what our subsequent years are going to look like. We believe long term, maybe 3 years out, we'll be able to get -- to have a level of opportunity even greater than what we're experiencing today. So it's a big question for us, and it's a good question. And I wish I could be more specific because it would certainly help us in our internal planning, if I could be, too.

No, that's helpful. And then could you talk a little bit about -- you view the balance sheet as one of your core strengths. Can you just talk about maybe where we are historically in terms of acquisition activity and kind of debt-to-cap level? I mean, obviously, you've been very active here in the last 12 to 18 months. Debt to cap sitting around -- net debt to cap sitting around 30%. I mean, do you feel comfortable with those levels? Do you feel like you can get a bit more aggressive at this point? Or maybe should we see a little bit of a pause? Just maybe your thoughts on where we are with the balance sheet right now.

Well, since we're still expending funds that we raised from the last bond plus positive cash flow that we generated, I -- with our EBITDA running, as Dana indicated, almost $70 million in the first 6 months and that doesn't include full years for some of our acquisition, that EBITDA just continues to strengthen. So we haven't tapped the short-term term loan market. We haven't gone into our line of credit agreement. We're still expending internally generated funds and the balance of that last capital that we raised with that bond issue. And so where we are, we think we still have considerable dry powder. There's nothing in our viewing of opportunities that is slowing in the process. We're still going to monitor that we stay clearly with some breathing space between our covenants, and that -- so I don't think that we're going to have to slow the pace because we're burning through that cash we previously raised and generated because our cash -- net cash -- free cash flow is so positive and our borrowing power is positive and our untapped use of our line of credit is going to continue to support any of our working capital needs and growth needs.

Perfect. And then my last question, could you just give us an update on maybe where we stand with that Joliet facility? And then how long would you continue to recognize losses from that fire? How long would we continue to see that impacting the P&L, I guess, to the downside?

We expect to be open up for business in June of 2013. That's based upon the current construction schedule. Anything can happen with weather in that part of the country, but we do believe that. So we think we're still going to continue to have a drag on earnings of about $1 million, $1.2 million per quarter all the way through June of 2013.

[Operator Instructions] Our next question will come from Rob Longnecker of Jovetree Capital.

Could you just provide an organic tonnage growth number for the quarter, please?

Yes. Give us just a moment to look for that. We have the organic shipments -- on the galvanizing, we don't have that broken out. We didn't disclose that. Because you've only got 1 small acquisition process, which was Galvan, so on the galvanizing, it's almost all organic.

Got you. And what was the annual revenues for Galvan when you guys brought it?

We haven't disclosed that.

Okay. And then you guys said something in your commentary about shifting the projects in the next fiscal year. I didn't catch what segment that was in.

Electrical and Industrial, the high-voltage product line.

The what, I'm sorry?

In the high-voltage product line.

And our next question will come from Noelle Dilts of Stifel, Nicolaus.

So just extending on that last question, can you give us a quantification of the size of the projects that have now shifted into next year on the transmission side?

It's in excess of $10 million.

Okay, great. And then on the domestic generation -- in the domestic generation business, can you just expand upon what's really driving the slowdown there? I mean, we're hearing in the market so much about national gas peaking plants coming on and the shift toward gas. What are the dynamics that are really -- that you think are driving the slowdown?

Well, again, it's the utility companies' cautiousness on what's the price of gas 10 years from now. Are they going to do a main baseload plant in natural gas? Or are they going to wait and see? As we've talked about before, on the peaking plants, when you're shifting those from coal-fired to natural gas, the cost of compliance for EPA on a small peaking plant is pretty significant, so it's -- you have a very low risk factor in the lower megawatts. So there have been some indications that the consideration for gas-fired plants is going to move above the 400-megawatt size plant. But last year, probably 90% of what we saw was below 400 megawatts. So -- and then what we're seeing this year is less of those because more of those were completed in the prior period. So it's a viable source longer term, but the utility companies have got to get comfortable with what the price of natural gas is going to be 10 years from now because, I mean, I'm not sure anyone really expects that we're going to continue to lag the worldwide price for the next 10 years. There's going to be some recovery in that and some change in that, so it will play a role. And again, what -- to what degree it will do it in the baseload plants, we're still not sure.

Okay. And then can you give us an update on your industrial business within E&I? We're hearing a lot again about petrochemical activity picking up in the Gulf Coast. Are you starting to see -- I know you've struggled with margins or have been challenged with margins in that business in the past. Are you starting to see some improvement given that kind of petrochemical renaissance we're seeing?

Most of those projects are still below our target margins, and we continue to do less and less in that market.

Okay. And then, finally, on your guidance, just to be clear, given the full year guidance you're talking about for Galvcast in terms of revenues, can we assume that it's kind of proportionally about -- in terms of what's now included in your guidance, it's about 10 -- a little bit more than maybe $10 million in sales and $0.05 to $0.06 of EPS? Or are you forecasting more of the earnings to be back-end loaded and fall into fiscal '14?

Nicole (sic) [Noelle], if you take the $25 million and the $0.12 to $0.15 divided by 12, that's the monthly contribution and it should start the first month.

Okay. And then has there been any sort of change in terms of the accretion you're estimating from NLI or the intangibles amortization that you're expecting? Or is that still consistent with last quarter?

It's totally consistent with what we previously issued, yes.

[Operator Instructions] And our next question will be a follow-up from John Franzreb of Sidoti & Company.

I was just wondering what kind of capacity utilization are you running at in the E&I side.

Probably about 65% to 70%, John.

And what's the competitive environment been like? What's the pricing been like? And who's been most aggressive?

The Europeans continue to be the most aggressive in the international quotation activity. They're not as aggressive in the domestic or North American quotes as they were, but they're really chasing after all of the business in China, the Middle East and in Western Europe. So they are probably more aggressive in their home territories and in the Middle East and in China than they have been, but probably less price problems in the North American market.

Okay. All right. And I guess just to the project deferral, you said it was $10 million of project deferral. And you're getting roughly a $10 million to $12 million benefit from the new galvanizing purchase. I'm just surprised that your expectations are that -- and you have tailwinds from zinc, that your expectations are for maybe a much softer second half. Can you kind of reconcile those moving parts for me, David?

Sure, John. And naturally, first of all, the recognition of these delayed orders, and they came really late just in the last couple of weeks, so we really haven't had time to really dig in to what we can do to help offset that. I'm not very optimistic on that, but I know there's opportunities. On the galvanizing side, we just can't ignore a GDP of 1.3%. I mean, at some time, it's going to show up, so -- and I don't have any evidence of it right now through that other than I know our business is ultimately impacted by that. And then if solar subsidies are more at risk, we're going to start feeling a lesser amount of solar work in the fourth quarter. So I think I just have to be a little more conservative in my forecast than I would traditionally would be.

And ladies and gentlemen, that will conclude our question-and-answer session. I would now like to turn the conference back over to Mr. David Dingus for his closing remarks.

Again, we thank you for your participation today and enjoyed the opportunity to discuss our operating results and our guidance for fiscal '13, and we look forward to visiting with you on our next quarterly conference call. Have a great weekend, and thanks again.

This will conclude our conference call. Thank you for attending today's presentation. You may now disconnect your lines.