Valmont Industries, Inc. (VMI) Q2 2013 Earnings Report, Transcript and Summary

Good morning. My name is Jody and I will be your conference operator today. At this time, I would like to welcome everyone to the Valmont Industries Inc. Second Quarter Earnings Call. [Operator Instructions] I would now like to turn the conference over to Mr. Jeff Laudin, Manager, Investor Relations. Please go ahead, sir.

Thank you, Jody. Welcome to the Valmont Industries Second Quarter 2013 Earnings Conference Call. With me today are Mogens Bay, Chairman and Chief Executive Officer; Richard Heyse, Executive Vice President, Chief Financial Officer; Mark Jaksich, Vice President and Corporate Controller. 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. 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. Thank you for joining us. I trust that you have read the press release, so my commentary will focus on quarterly highlights and general trends in each of our businesses. The increase in second quarter revenue was driven by exceptionally strong sales in Irrigation, recent acquisitions made in Coatings and Engineered Infrastructure Products and increased demand in Utility Support Structures. The quality of second quarter earnings was very strong, with a 16.4% operating margin. Excluding the gain on the disposition of a Western Australian galvanizer, operating margin was 15.9%, a record for Valmont. The combination of improved project mix, moderating input costs, increased productivity and better pricing in certain businesses drove significantly higher gross margins. Strong demand across several markets allowed many of our plants to operate at very high levels of efficiency and productivity during the quarter. In addition, volume leverage drove higher operating margins, particularly in Irrigation. Let me now turn to results by segment. In Irrigation, a strong finish to the spring selling season resulted in record second quarter sales and profitability. As you know, historically high crop prices drove increased farm income during 2012. This in turn has supported North American sales of irrigation equipment in the first half of 2013. Last summer's drought in North America underscored the benefit of irrigation, spurring additional sales. International sales also benefited from a generally strong global farm economy and governmental support for water-conserving irrigation methods. Our focus on lean manufacturing over the last few years enabled us to respond well to the surge in demand. As we enter the seasonally slower third quarter in North America, farm balance sheets remain strong. Yet, many factors influencing second half demand are still unknown, making it premature to be more specific on our outlook for this segment. In our Utility business, sales exceeded last year's record second quarter results. Gains in North America more than offset the decline in international markets. Our North American business continues to benefit from the ongoing rebuild of the transmission grid, which we expect to continue. Operating margins increased as the mix of projects resulted in an improvement over last year and higher volumes drove operating efficiencies. Our previously announced capacity expansions remain on track. Construction of our second Tulsa, Oklahoma site is nearing completion and the new Columbus, Nebraska plant is ramping up. This should put us in good shape for the next couple of years. The outlook from our customers is encouraging. Discussions with them indicate a strong demand for transmission structures going forward. Second quarter revenue growth in the Engineered Infrastructure Products segment reflects the Locker acquisition in Australia and stronger North American wireless sales. Our European businesses remain challenged by government austerity measures but posted significantly better results. The contribution of Locker, improved productivity, and an improved cost structure in Engineered Infrastructure Products in North America and Europe led to operating margins of 9%. I am very pleased with this progress. The improvement is meaningful. It is a significant achievement considering austerity in Europe and the lack of a long-term U.S. Highway Bill. This could not have occurred without the cooperation of many teams throughout our organization, and much credit is due for their efforts. Coating sales increased primarily due to the contribution from recent acquisitions. Excluding the gain from the disposition of the Australian galvanizing site, margins returned to historic levels. Turning to other financial measures, the tax rate for the quarter was similar to last year's rate. Our expectation is that tax rates will continue to range between 33% and 34%. The impact of currency translation on operating income was not material in this quarter. If the current exchange rate for the Australian dollar remains, there would be a modest negative impact on second half results. However, we expect that over time, our businesses in Australia will be more competitive with the weaker Australian dollar. Second quarter corporate expense reflects an increase in incentive compensation together with planned increases in corporate cost. In the second half of the year, we expect corporate expenses in the range between $16 million and $18 million per quarter. Depreciation and amortization for the quarter was $19 million and capital expenditures were $32 million. For 2013, we expect depreciation and amortization of about $75 million, and capital expenses in excess of $100 million, as we continue to invest in capacity to support future business growth, productivity improvements and maintenance projects. We generated over $100 million in operating cash flow during the quarter. We're starting in a cash balance of $490 million, about equal to our interest-bearing debt. Looking towards the remainder of the year, we expect improved earning over year comparisons in our Utility, Engineered Infrastructure Products and Coatings. In the Irrigation segment, as is always the case, second half results will be driven by summer growing conditions, commodity prices and the expectations for farm income. For the company as a whole, we currently expect positive sales and earnings comparison each quarter, although not to the extent we saw in the first half. We will now take your questions.

[Operator Instructions] Your first question comes from the line of Arnie Ursaner from CJS.

This is actually Lee Jagoda for Arnie. So a recent Edison Electric survey cited an expectation for weakening trends in transmission for both 2014 and '15. Can you talk about some of the things that you're looking at that give you confidence in your outlook? And then whether the survey is relevant to your business or not?

Well, first of all, as I said in the prepared remarks, the indications we get from our customers is continued strength in the Utility business. When you talk about the Edison Electric survey, part of, maybe a disconnect to our business is that pure transmission companies do not report into Edison Electric or Edison Electric survey, and a good portion of our business comes from transmission companies that are not necessarily in the generating business. So maybe that's part of the disconnect. Whether that business next year will grow x percent, or stay somewhat flat, our expectations is that our Utility business in '14 will grow from 2013. And as you know, we look at it as a global business. This year, our International business is substantially weaker than it was last year because of a lack of major projects. We expect international Utility to rebound next year and we are seeing some good traction also in the Canadian market. So in total, you can't predict with any certainty what's going to happen. But our indication is that our Utility business will continue strong into next year and when you look at '15 and projects we are seeing on the drawing boards for '16, we continue to see good strength in this business.

Your next question comes from the line of Nathan Jones from Stifel. Nathan Jones - Stifel, Nicolaus & Co., Inc., Research Division: Mogens, the second quarter in Utility tends to be seasonally stronger than the first quarter, but revenues were down sequentially. Can you comment on what you think caused that sequential decline this year?

I think it's just an issue of projects, timing, et cetera, et cetera. When we look at the next 2 quarters in Utility business, we expect revenues to be up, both in the comparison to last year's equal quarter and sequentially. So I wouldn't put much into that except projects, shipping, timing. Nathan Jones - Stifel, Nicolaus & Co., Inc., Research Division: Would you be prepared to sort of quantify how much up you're expecting the second half to be over the first half? I mean, our models are forecasting a fairly significant growth in the third quarter and the fourth quarter. They tend to be seasonally stronger quarters.

Well, I think that we will see good growth in the third quarter and we will see better growth in the fourth quarter, as more capacity comes online. Nathan Jones - Stifel, Nicolaus & Co., Inc., Research Division: And while you're on that, can you talk about, I think the press release said new capacity coming online in the fourth quarter. When we should expect that, and kind of what the volume increase potential is.

Well, in the third quarter, we're going to see some volume increase. In the fourth quarter, we are going to have more of the ramp up. We're going to probably start production at the Tulsa, Oklahoma plant, and we're going to get more output out of the Nebraska plants. But as I also said in the talk up, the theoretical capacity in those 2 plants should take us through '14 and hopefully, also '15, as they ramp up completely. Once they use to get the equipment in place, but also to get people in place and get them trained. Nathan Jones - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And I'm just going to ask 1 more question on the Engineered Infrastructure Products segment. Margin there was -- improvement there was pretty exceptional. And I think in your prepared comments, you attributed most of that to coming out of Europe despite demand there still being pretty lackluster. Can you talk about why you saw that significant increase in margin, whether it's effective cost management, whether you saw some pricing improvements or anything else that might have impacted that?

Well, first of all, most of that improvement did not come from Europe. Europe, compared to their last year same quarter, had significant improvement, but so did North America and the North American numbers are bigger numbers. But the market in general has really not improved as it relates to the traffic and lighting markets. Although we have seen a little bit of traction lately in the commercial lighting market, but we have seen pretty good improvement in the wireless communication market. And our access system businesses in Southeast Asia, particularly now including the Locker acquisition, have performed as expected. So I would say, I've said quarter after quarter that I didn't think we could get to double digits operating margins without help from the marketplace, particularly a Highway Bill in North America and a better environment in Europe as it relates to government spending. Now, we are obviously getting very close and we may have an opportunity to get to double digit operating market without a Highway Bill, and that is a result of actually being much more productive, taking cost out in the areas where we could, but still be ready for an uptick when the markets come back.

Your next question comes from the line of Schon Williams from BB&T Capital. Christopher Schon Williams - BB&T Capital Markets, Research Division: I wanted to maybe spend a little bit of time on Irrigation and maybe when would we start to see more of a clearer picture on what the back half of Irrigation is going to look like. Because I mean, we've been hearing that there has been some dealer-selling kind of program-selling already, kind of the filling some of the demand for your calendar Q3. But can you talk about when will we have better sense? I mean, is there any 1 month in the quarter or in the back half of the year that tends to be kind of the signal for what the rest of the year, the back half, is going to look like?

Well, I would say that when we talk next time when we announce third quarter, which will be in the middle of October, we should have a pretty good sense for what's going to happen. When we gave the guidance we have given, we are modeling our fourth quarter down from last year's fourth quarter, which was very strong. Whether or not that will happen, it's too early to say. But to answer your question specifically, when we talk in October, we should have a good feel for the fourth quarter, and the fourth quarter is the big quarter in the second half of the year for Irrigation. Christopher Schon Williams - BB&T Capital Markets, Research Division: Do you have a good sense of how much of the capacity has already been filled for Q3? I mean, do you already have -- you've already got -- you essentially already got capacity completely filled for the quarter. Can you give us some sense of how much maybe preordering went into the quarter?

Usually this time of the year, you don't see much of that because there's enough capacity in the industry that you can have pretty short lead times. So no, the third quarter is not filled up. Christopher Schon Williams - BB&T Capital Markets, Research Division: Okay. And then just a follow-up on Utility. The incremental margins there were quite substantial in the quarter. Despite the fact that there was some delays on some projects. I'm just wondering, is that kind of year-over-year comparisons? Is that just because of an easy comp? Or what -- how should we expect margins to behave as we move forward here? Should we still be expecting kind of high teens going forward?

I would say, and I think I mentioned that at the last call, that during the cycle, we should be happy with mid-teens margins. But in the part of the cycle we are in right now, we expect to be somewhere between 15% and 20%. And around the middle of that band is probably where we expect to be for the rest of the year.

Your next question comes from the line of Brent Thielman from Davidson. Brent Thielman - D.A. Davidson & Co., Research Division: Just on the Coatings business. It looks like margins were under a little bit of pressure there versus last year when I stripped up the sale. Anything in particular there?

No. I think that if you strip up the sale of Western Australia, we are still at about 20%, 21% operating margin, which is kind of the traditional level. I would say we've seen good activity in North America. We have had a little softening -- continued softening in Australia, but all in all, I think we have reverted to the normal profitability levels in this business. Brent Thielman - D.A. Davidson & Co., Research Division: Okay. And then, I guess just, the balance sheet looks real healthy here, any commentary just on the M&A pipeline?

Well, we have an active M&A pipeline. Nothing that's imminent. We continue to look. We continue to talk. But acquisitions are difficult to predict, so we're going to continue to look.

Your next question comes from the line of Julian Mitchell from Credit Suisse. Julian Mitchell - Crédit Suisse AG, Research Division: I just had a question on the CapEx comments that you made earlier. I mean, last year, you spent just under $100 million. This year, it's forecast to be over that -- over $100 million. Can you talk maybe about how your CapEx plans have changed as we have moved through this year? Or are they pretty much set exactly the same as you were 6 or 9 months ago?

Yes. I think, we are pretty much spending to what we forecasted. We are finalizing the capacity expansion in the Utility business and I made the comment that probably next year, we are not going to see much additional. We are pretty well set up, I think, for the next couple of years. We've also had some additional capital in the Irrigation business. So I would think that for new capacity, we will probably see '14 slow down. But there's really been no change in what we expect going into the year and through the year. Julian Mitchell - Crédit Suisse AG, Research Division: Got it. And then just following up on the balance sheet question. What are your thoughts on sort of the capital allocation beyond just M&A? Or was it really a question of you want to wait for those deals to come, and so other uses of cash are not really on the agenda or outside of CapEx?

Well, I would say our priority is, one, of course, that is to fund growth of the business. It is to provide capital for productivity improvements and new capacity as we see that is necessary. And then we continue to look for acquisitions. And if over a period of time, we can't find anything to do with our cash, which I'm not predicting. But then of course, our job is to return it to shareholders, one way or the other. But I think there are enough opportunities in there that 1 of those opportunities or several should come our way one of these days.

Your next question comes from the line of Brian Drab from William Blair. Brian Drab - William Blair & Company L.L.C., Research Division: First question, just on the galvanizing operation that you divested. Can you talk little bit about the rationale for divesting that operation? And roughly how much revenue is associated with that operation and when in the quarter you divested it?

Well, it's completely insignificant. It was a small galvanizer in Western Australia that actually lost money, very little revenue. And the reason we divested of it is, and I think on several occasion, I have said that in the galvanizing business, concentration of galvanizers is more helpful to a healthy business, than having individual galvanizers spread around over a large geography. And we decided to focus on the Eastern part of Australia as opposed to expanding in the Western part of Australia. But the numbers from an earnings or revenue standpoint are completely insignificant. Brian Drab - William Blair & Company L.L.C., Research Division: Okay, great. Great. And then, again in the press release, you mentioned as is typical that there are these government programs internationally that are driving demand for your irrigation equipment. Can you talk a little bit more specifically about are there any new programs that you're seeing? What's the environment like in Russia, Ukraine, former Soviet states?

Well, if you talk about Russia, there's a lot of talk about subsidies and usually, the talk is stronger than the actual disbursement of those subsidies. But those markets are pretty healthy. In China, there's a lot of talk about large irrigation investments because of the improvement -- the necessary improvement of agriculture. And whereas China could be a significant market, my prediction is it's going to be a very difficult market from a profitability standpoint over time. I think we're going to see a lot of local manufacturers, local competitors, and I think size will -- could be more significant than contributions to the bottom line in that country for a while. Brian Drab - William Blair & Company L.L.C., Research Division: The market's taken quite a while to develop. I mean, you guys have been operating in China for how long? 30 or 40 years, is that right?

Yes. We sold our first center pivot in China in 1977, so you're right.

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

Most of my questions were just answered, but Mogens, turning on the international Irrigation side again, can you give us an idea how significant it is within the Irrigation segment? And from a longer term standpoint, everything else being equal, would you think that the international side would maybe grow faster than, let's say, the North America? I'm trying to get a sense on what you think the opportunity, especially in Africa, might be, and maybe in sort of nongovernment supported programs, private sector development of -- that would support irrigation.

Well, I would say that the international business, you say, long-term, the international business long-term is going to outgrow the North American business just because of the geography we are talking about, but we are really talking long-term. We just, at the previous question, we talked about 30-plus years of market development in China before that business starts growing in any significant way. You mentioned sub-Saharan Africa, that's going to be at least that timeframe. There may be pockets of good opportunity but it's not enough to be interested in putting in efficient irrigation equipment. You have to have all the infrastructure. You have to have roads, you have to have electricity, you have to have access to water, you have to have access to markets. And in many of the sub-Saharan African countries, those investments, which are significant, is going to take a long time to put in place. Otherwise, internationally, when you talk about countries that behave more like the U.S. market, you will look at countries like Brazil, Argentina, Australia, New Zealand, Western Europe, South Africa, they are more established markets like what we see in the U.S. And all of those markets -- now, that's not true. We're probably not going to see a lot of growth in Europe, and we may see a limited growth in the country of South Africa but sub-Saharan Africa, over time, will be. But Brazil, Argentina are potential very big markets. Argentina is -- Brazil is very strong this year. Argentina, you have some import restrictions. It was a very strong market for us, but because of current government policies, it's very difficult to get import licenses in Argentina. That does not take away from the fact that the Argentinian agriculture is very buoyant, very good and will be a very good irrigation market over time.

[Operator Instructions] Your next question comes from the line of David Rose from Wedbush Securities.

Really quickly on the international side. Can you highlight anything on international Irrigation side that really stood out for you? You mentioned Brazil. Were there some onetime projects? Or do you see a little bit more consistency for the next 6 to 12 months? And then I have a quick question on the operational side.

Okay. On the specifics of Brazil, it's not project business in the sense we normally talk project business. It is a general, strong economy throughout the farm economy in Brazil. How long it will last? Difficult to predict. But the short term outlook in Brazil is strong.

I guess, my question was really, you highlighted Brazil, were there any other markets that were exceptionally strong this quarter? Is there anything unusual that took place?

I don't think there's anything unusual. It's not like 1 large project came through in this quarter. This was broad-based improvement in the international business.

Okay, great. That's helpful. And then secondly, if we can talk about, operationally, last quarter you talked about some of the hiccups in the Coatings business as it related to the kettle. You had that fixed. Did you have that fixed middle of the quarter? Did you get the full benefit from any of the improvement there? And then were there any other challenges that might have been masked in the quarter that we may not see in Q3 or Q4?

No, I don't think so. The kettle you're talking about in Tulsa, Oklahoma came back online. I don't recall exactly when it happened during the quarter but we -- it had a positive effect on the business, but not in one that makes this quarter then particularly strong. And there's nothing out there in the current environment from a equipment standpoint, that's a particular challenge. We are in good shape in most of our facilities.

When you talk about the benefits you had in Europe in the EIP segment, were there any actions -- corporate actions you took that might have been a drag? Or are those all in the kind of -- it's already done and it's already in the numbers we've seen?

Yes, I would say that the actions we took throughout Europe was over the last couple of years, and quarter-by-quarter, I talked a little bit it. We didn't have any further restructuring actions this year in Europe, but we're seeing the benefit of what we did last year and the year before. I think our people in Europe done a good job of concentrating on the right customers and the right geographies. In Europe, as you know, the European economy is not in good shape and particularly, government spending. And yet, all our facilities in Europe are making money. And in total, they have made significant progress from last year. So I'm pretty pleased with where we sit in Europe. Do I expect a big improvement in Europe over the next couple of years? No, I don't. I think the European economy is going to stay pretty bad. But if we can hang on to the profitability we have in Europe right now, we'll be pleased.

Did you benefit at all from pricing?

No, I don't think so. I think most of it was some volume and the benefit of cost takeout and over the last couple of years, as you know, we closed a couple of facilities that were not doing well and we didn't see good opportunity. So that took those negatives out of the average and we're benefiting from that.

Sir, there are no further questions. I will turn it back over to you for closing remarks.

Thank you. This concludes our call, and we thank you for joining us today. This message will be available for playback on the Internet or by phone for the next week. We look forward to speaking to you again next quarter. And at this time, Jody will read our statement on forward-looking disclosure.

Including 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 cause -- 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 statements 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. That concludes today's conference. You may now disconnect.