Valmont Industries, Inc. (VMI) Q4 2014 Earnings Report, Transcript and Summary

Good morning. My name is Vanessa and I will be your conference operator today. At this time, I'd like to welcome everyone to the Valmont Industries Incorporated fourth quarter earnings conference call. [Operator Instructions] Thank you. I would now like to turn over today's conference to Mr. Jeff Laudin, Manager, Investor Relations. Please go ahead, sir.

Thank you, Vanessa and welcome to the Valmont Industries' fourth quarter 2014 earnings conference call. With me today are Mogens Bay, Chairman and Chief Executive Officer; Mark Jaksich, Executive Vice President, Chief Financial Officer; and Tim Francis, Vice President and Corporate Controller. Before we begin, please note that 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 like to now 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 you’ve all read the press release. I will quickly cover the highlights of the fourth quarter and then spend some time on the current global business environment. The irrigation segment experienced further weakness as a result of low commodity prices and high inventories of major crops such as soy, soybeans and corn. Lower volume led to de-leverage despite addressing variable and some fixed costs. On a positive note, our international irrigation sales and earnings increased in the quarter compared to the fourth quarter of 2013, even overcoming currency translation challenges. Our Utility Support Structures segment saw lower volume, continued pricing pressure and a product mix favoring smaller projects. As a result of customer scheduling changes, we saw a great number of projects moving in and out of the quarter, leading to loading inefficiencies in our plants and consequently to lower productivity. In the Engineered Infrastructure Products segment, the contributions of the Valmont SM and Shakespeare acquisitions drove the revenue increase. Excluding those, sales increases in North America, Europe and the Asia-Pacific region were largely offset by declines in Australia. In the Coatings segment, North American sales were relatively flat, despite lower internal volumes. Weak markets in Australia reduced segment sales and earnings. Summarizing fiscal 2014. Market conditions became progressively more difficult, particularly in the Irrigation and Utilities Structures businesses for reasons already mentioned, and the global economy continued to deteriorate, particularly affecting our businesses in Australia. The rapidly strengthening U.S. dollar added to our challenges. Our international results are also significantly reduced when translated into US dollars and there are no indications that this will reverse itself in the near future. During 2014, we refinanced our long-term debt at historically low interest rates, increased the dividend and repurchased a significant amount of Valmont stock. You may ask if we started our repurchase too early and with 2020 hindsight, the answer is obviously yes. However when we look at the long-term opportunities for Valmont, we were happy to purchase our stock at $150 and we were even more pleased to purchase at $125. On the question of whether we will expand the current purchase authorization when it expires, we will discuss this subject with our board before the current authorization expires in May. I want to remind you that we look at stock repurchases not only as a way to return cash to our shareholders but as a way to acquire the company we know best at an attractive value. We compare value afforded us in the public markets to multiples we would have to pay for acquisitions at any given time. Turning to other financial measures. Depreciation and amortization in 2014 was $89 million. Capital expenditures were $73 million. For 2015, we expect depreciation and amortization of about $95 million and capital spending of approximately $80 million. We generated cash flow from operations of around $174 million after a $39 million expense related to refinancing our long-term debt. Our ending cash balance was $372 million. Now let me turn to the current business environment and our outlook for 2015. Compared to very attractive market conditions in 2012 and ’13, particularly in our utility and irrigation segments, we are now facing a different environment. In the irrigation business, low farm commodity prices, high commodity inventories and lower net farm income have caused our farm customers to pull back significantly on their purchases. This is not unusual. We have seen this again and again since we pioneered this business more than 60 years ago. Agriculture is cyclical. In our irrigation business, cyclical peaks tend to be higher than the previous ones and the bottom of the cycles typically are higher than the previous ones also. We expect it to be no different this time. During the first half of 2015, our irrigation business will likely continue to weaken, possibly significantly. So our job is to manage our business as tightly as we can in that environment. Take out costs where possible without hurting the future of the business, continue to work on our lean journey and be ready for the next opportunity. Internationally, we will likely also see a decline as commodity prices are global. Local drivers, however, for this business can vary from country to country depending on government policies and local conditions. In our utilities structures business, more than 90% of our revenue comes from the US market. After peaking in 2013 and the pullback in ’14, it looks like the market will stabilize around the currently fairly high level for the foreseeable future. Our view is based on discussions with customers and transmission industry experts. Steel price decreases will impact the top line negatively but volume continues to be solid and our plants are staying busy. As we do not expect growth short-term and we do not expect the pricing environment to become markedly better, we will focus on operational efficiencies to improve the quality of our earnings. Let me give you a couple of examples of what that means. Over the last decade when the market was growing very rapidly, we had a decentralized organizational structure within in the utilities segment, with individual plant managers having great authority over their local businesses. This allowed us to capture the lion share of the available market, grow rapidly and deliver substantial profits. But it didn't always need to be optimum utilization of all plants. Going forward, we’re centralizing the loading of our plants depending on cost and capabilities. We are centralizing the purchase of steel and we will accelerate our lean journey in our factories. We have strengthened the operational leadership in this segment. I've just returned from a couple days of reviews with our utility management team and I'm pleased with the action plans in place. In the Engineered Infrastructure Products segment, we have an extensive footprint across a number of different markets worldwide. This business has improved its quality of earnings over the last few years despite the lack of public spending on infrastructure in many parts of the world. Public spending, we suspect, will continue to be under pressure in most domestic and international markets until national economies get more traction. Our Coatings business continues to operate well in North America despite seeing some de-leverage because of the slowdown in volume from internal customers. Our Australian coatings businesses, on the other hand, are suffering from lower volume and the resulting de-leverage. The Australian economy has weakened primarily as a result of the soft mining sector. On a macro level, we serve agriculture and infrastructure. On the agricultural side, you've probably seen John Deere predicting a significant decline in their North American revenues and Caterpillar recently forecasted their earnings for 2015 to be down 25%. Their markets and ours overlap significantly. We face the same challenges. Irrigation market would likely stay under pressure till commodity prices recover. The world economy must grow to support accelerated investment in infrastructure, or stimulus programs must be put in place to help growth. The dollar has appreciated 15% to 20% over the last year against a number of currencies which will negatively affect the translation into US dollars while international revenues and earnings and dampen exports. Lower oil prices can have both positive and negative consequences. Emerging markets such as Eastern Europe, Russia, North Africa and the Middle East are experiencing political turmoil and will be difficult places to do business for a period of time. In this environment, we ask three questions. One, have the long-term drivers of our businesses changed? The answer is no. The efficient use of fresh water for food production will become ever more urgent. Economic development cannot be sustained without upgrading or putting in place infrastructure. Question number two: Are we faced with new technologies that could threaten our business? Currently the answer is no. The center pivot technology continues to be the most efficient way to deliver water for large scale agriculture. In the structure businesses, we call the steel, aluminum, concrete, fiberglass and wood and until somebody finds a way to keep a utility line, our light bulb in the air without the support structure, we will have plenty of opportunities. Zinc coating continues to be the best protection for steel against the elements. Question number three: Have we lost our position in the marketplace to competitors? The answer is also no. So our long-term strategy is solid. It hasn't changed for more than two decades and doesn’t need to. Our markets will improve again. While we are faced with challenges beyond our control, we will focus on what we do control. We will focus on operational efficiencies so that our platforms would be more efficient and stronger when markets do improve. We are in the process of reviewing closely our overhead cost structure and our global facilities footprint to see if we can serve our customers efficiently with fewer locations. In the current somewhat unpredictable markets and with my recent unimpressive track record of giving accurate guidance, you will understand we would not give you specific EPS guidance at this time. However I should point out that we expect our first quarter to show a significant unfavorable comparison to the first quarter of 2014 when we had much stronger performance in our irrigation and utility segments. We will keep you informed as the year progresses. At this time, we will take our questions.

[Operator Instructions] Your first question comes from the line of Julian Mitchell from Credit Suisse.

Good morning. Just a question on the EIP segment. It was the one segment that had good profit growth in 2014, a lot of that I guess fueled by acquisition. And the commentary you’ve provided so far is pretty cautious on the outlook. So on EIP specifically, just wondered how you are feeling about the profit growth outlook this year?

Well, I think that over the last few years, I’ve said that until we get help from highway bill in North America, that's more than just an extension of the previous one and some increased commitment to public funding of infrastructure, we’re probably going to have a tough time getting to double-digit operating income. And I think that has not really changed. We’ve seen some progress in the commercial side of our business in North America but the public spending has not really moved in any significant way. As you probably have read, there are budget problems in Europe and I would say in China, the economy is slowing but our business in China has been doing fairly well. I think the biggest challenge there is we have a lot of EIP businesses in Australia and even though they may do fine in the local currency, although that is somewhat under pressure. When translated into US dollars, you have now seen the Australian dollar I think devalue about 18% against the US dollar and that we will lose that in translation.

Thank you. And my follow-up is on the irrigation business, you’ve given a lot of help on the sort of supply demand balance in the utility markets, somewhat that’s meant for pricing. How do you assess the supply demand balance in irrigation and are you seeing any change in the pricing environment there?

I would say that so far we haven't seen a lot of pricing changes in the irrigation market. The exception is always multi-system deals that tends to be more competitive. There's no program out there currently with any particular discounts or anything like that. But as I've also said the biggest risk to the irrigation business apart from volume is if pricing discipline becomes an issue. There’s absolutely no reason for it to happen because if you go back years and years and years the markets here in North America have not changed. So if there is a pricing move on the part of a player, it really doesn't translate into better sustainable market share.

Your next question comes from the line of Greg Bib from CJS Securities.

It sounds like you’ve done a fair amount of work in terms of looking across of the USS segment. Could you give us a little bit of magnitude of what the savings might be there?

Well, it is not a question necessarily of idling or closing down any plants. Our plants are busy. Volume is still fairly high. We've seen some pricing pressure over the last year which had reduced revenue. But you’ve also seen quite a significant reduction in steel. So the activity level in the plants is still pretty high. What I think we’re going to see the opportunities is in loading plants more efficiently and become more efficient in moving products through the plants. And to what extent we will see that in the bottom line, I would say that everything else equal, if volume doesn't change and pricing doesn’t change, that’s the only way you can look at that. We should see at least a couple of points improvement in the quality of earnings, in the operating income percentage.

And could you give us – I know you’re going to have -- the board is going to look at the repurchase in May. Can you give us an order of magnitude – comfort level in terms of debt to EBITDA, what you’re comfortable with, and maybe also talk about the other options for your capital like acquisitions?

Well, we issued earlier this year our capital allocation philosophy and one of the points of that was that we want to retain our investment grade rating. So that is one book end [ph] if you will when we look at it. But we have good cash flows and we have a solid balance sheet and whenever we look at acquisitions, and we’ve looked at a number that we have actually lost to private equity in recent times because they will pay multiples that we will not. We will not go out and make an acquisition to get EPS growth. We will go out and make an acquisition if we are comfortable that we will beat our cost of capital. So we look at stock repurchases the same way and we will go through that dialogue with our board and then if they determined that they should extend the current authorization or increase it, we will make an announcement at that time.

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

Mogens, in utility, have you seen any changes in the bid environment since one of your larger competitors was acquired there?

Yes, you’re referring – I mean there has been quite a turmoil in the utility business also from the standpoint of ownership. Earlier last year, Thomas & Betts’ Meyer subsidiary was acquired by Trinity and recently we understand that Sabre acquired Fort Worth towers. So you have some consolidation taking place. I'm sure leading up to it, they were probably more confusing in the marketplace than normal. But I would say we have not seen an improvement in the bid price levels but we have also not seen a deterioration in the bid price level. And I would think that the industry at some point of time should find a way to get the price levels back up.

And then in irrigation, do you feel your capacity overseas is adequate at this point or would you look at increasing that just considering you’re still seeing pretty good growth and penetration there?

Our capacity overseas is adequate. We manufacture in China. We manufacture in Spain. We manufacture in Jebel Ali in United Arab Emirates. We manufacture in South Africa and we manufacture in Brazil. We’re starting up an operation in Argentina. So I feel good about where we are from a capacity side. I did point out in my prepared remarks that we think that the international business will probably also see some pullback as we go forward because commodity prices by and large are global. And in 2014, international irrigation business actually will continue to grow but I am not so sure we will see that in ’15. Often international revenue is tied to major projects and often those come from the parts of the world that are seeing the most political turmoil: North Africa, the Middle East, Russia, Ukraine and I don't think we’re going to see much blue sky there for a while.

Your next question comes from the line of Brian Drab from William Blair.

I don't hear anything.

Sir, your line is open.

Sorry, can you hear me? Sorry, good morning, Mogens. I was on mute. So in the utility business, you said that you expect volumes to be flat going forward but pricing to be down. I'm wondering what -- did you say what you expect for margins in this business for 2015?

I didn't say I expect pricing to be down. I said I expect a continued difficult pricing environment. We’re not forecasting that pricing will continue to decline. We both talk to customers and I had an opportunity to talk to consultants that focus on the transmission industry. The consensus is that the activity levels we’re seeing now in the utility market will probably continue for a while. FERC 1000 is just in its infancy of being implemented but it does allow and it incentivize utilities to invest in transmission lines at fairly good returns on invested capital. So I would expect we will see some traction in that part of the business.

Okay. So you'd expect margins probably to hold here and over the longer term to improve from here, I guess is how I could model it?

That will be the plan if the environment stays where we think it is.

And then did you mention how – you said the international irrigation business was up in the quarter. Any particular geographies stand out as outperformers or underperformers and could you quantify at all how much of the international business was up?

It was actually widespread. We continue to see strength in Brazil towards the end of the year and also in Australia, New Zealand and in some of the other international markets, it was not really tied to any major project going through. But I think those are also the markets that would be affected by low commodity prices and therefore farm income.

And can you quantify in any way how much irrigation was up in the fourth quarter internationally?

I can but I won’t.

Okay. Understood. And then FX impacts for the first quarter and full year on the top line, what are your expectations I guess based on constant exchange rates?

I didn't hear the beginning of your –

Your FX – if you look at the FX impact, currency exchange –

Kind of doing the back of the envelope, if international earnings stay about where they are and if you look at the average exchange rate through ’14, to the current exchange rate for various currencies, you will see a negative impact of north of $0.30 a share, when translating constant earnings in local currencies into current US dollar exchange rate.

So a negative impact of $0.30 a share in 2015 is what we would see at constant rates?

Yes.

And how about on the top line, would that translate to I guess –

Well, you say that our international business is running close to 40% of overall business and then you can calculate at maybe the average exchange of somewhere between 10% and 12% and 14% in exchange rate.

Your next question comes from the line of David Rose from Wedbush.

Good morning. This is actually James Kim in for David. Just to follow up on the utility side, you talked about the work you're doing in reorg and you mentioned about a couple of points improvement. Can you talk about sort of the timeline for that? Are you expecting that maybe in the next year or further out?

Well I would expect to see some improvement this year as a result of some of our operational focus. That does not mean that I expect to see it in the first quarter but based on -- I spent two days with the managers of our utility business down in Birmingham and I'm pleased with what I saw, I am pleased with the strengthening of the operational side of that business and the focus they have. I mean these are people that – these are the same people that grew this business from $100 million to about $900 million and made us a lot of money. We just have to re-focus on what we concentrate on in this new environment and I have no doubt they will do a good job of that.

And kind of going along that line of cost reductions, you talked about implementing some of that also on the irrigation slide in the quarter. And if you could kind of give us a color on what was implemented and how – what can you do more to sort of stabilize your margins, looking at Q4?

In irrigation business, we're not talking about closing down any capacity. As soon as the site has changed, we will need that. We address direct labor immediately. We will -- we have addressed some of the overhead SG&A but we also have to make sure that we don't cut into investing in the future of this business from a technology standpoint and market development standpoint. So yeah, you can cut a lot but you will regret it one day, so we are trying to find the right balance between being prudent in the current environment and also ready for when the environment improves.

Okay, appreciate that. And my last question is on the EIP side. If you can give us a little bit more color on sort of the progress of your acquisitions Shakespeare and SM, I know – are they kind of performing in line with expectations? I believe combined annual sales run rate for the two acquisitions was about $250 million, I’d say, at the time of the announcement. So I just wanted to see how it’s tracking in terms of your expectation?

Let me take the one at a time. We have had Valmont SM for nearly a year and in their first year with us which is coming to a close here at the end of this month, they performed according to our expectations. You will see the impact of the exchange rate different, the Danish kroner is pretty much tied to the euro. So if revenue was about 200 million, it will be down to about 160 million, 170 million as a result of that. But in local currency, they are doing what we expected them to do. Shakespeare also is delivering what we expected. Now the Shakespeare acquisition is only a few months into life with Valmont but so far they are doing what we forecasted they would do.

[Operator Instructions] Your next question comes from the line of Nathan Jones from Stifel.

A couple of questions. Starting off in the utility business, you just talked about -- that secular growth in the irrigation business and you don't want to cut that too deeply. You were talking about the utility business, at least the market being flat for the foreseeable future, is there any thought to potentially cutting that business a little deeper, closing facilities, taking some capacity out to potentially balance the supply demand future and hopefully help margins?

Well, let me put it this way. Currently our plants are pretty full with what we can actually get through the plants, not necessarily from an equipment and facilities standpoint but from a people standpoint. We have challenges of hiring enough skilled welders in particular, not only in the utility business but throughout our businesses. They are in short supply throughout the country. So at the current time, if the current volume continues, we will probably keep these plants busy. Now looking out further, if our lean efforts continue to free up floor space, if you will, by becoming more and more efficient, at some point of time it could be the case. I should remind you though that we did exit a leased facility during 2014 in Texas that had revenue in north of $60 million. So that is now being absorbed in the other plants and we have also taking in outsourced material to the tune of maybe $25 million to $30 million, that are now at short in our own plants.

That's helpful. And I know in 2014, we were talking about a total lack of large projects in the utility business but there was some expectation that, that mix would improve in 2015. Are those projects still there and potentially you could see a better mix that will help margins in the utility market maybe in the back half of 2015?

The answer to that question is yes. And as I mentioned in my remarks, smaller projects, not only are they more price competitive but they are also much less efficient to plan for and move through the plants. And then on top of that, you have changes in customers’ delivery requirements constantly. Even if you look at the first quarter, we have a great number of projects that are moving into the first quarter from the second quarter and some from the fourth and we have a great number of projects moving up and that is a constant challenge to then put them in the right plants at the right time and respond to customers’ needs to either postpone or accelerate the projects. In the utility business also, and this adds to these challenges that because of the drastic reduction in oil prices, the Canadian activities had decreased sharply and projects have been postponed there because of the lack of investment in shale oil etc. etc. So there are a lot of moving parts but I think our challenge is to become faster in reacting to that and more efficient in having small projects run through our plants.

In terms of these change orders and timing from your customers, is that something you can get paid for or is the environment too competitive at the moment, was it something that you used to be able to get paid for but can’t anymore or how is that playing out?

Usually we've not been able to get paid for utilities customers moving up or moving out projects. The only case where you could end up being paid, if a customer cancels the project when you’re already in production, and then there's maybe a clause on the contract that gives you a fee for that. But in general our job is to be responsive to customers and move on their schedule.

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

In irrigation business, obviously you are implementing some changes to take some cost of out of the business and but obviously to protect the future. When do you think maybe given the current revenue environment you're expecting, when do you think you might have those actions fully implemented we begin to see some improvement in margin front. I don't think that you are not Baltimore implemented in the fourth quarter and going into this year interest in a report back P

Well, I don’t think – I think a number of them have already implemented in the fourth quarter and going into this year when it came to SG&A pullback and postponing some projects. And direct labor goes out right away. We are very good at saying that out very quickly. You cannot abort about sorts of fixed costs and so I don't think you're going to see a big change in the cost side. The biggest change in the bottom line of the irrigation business apart from what driven by volume is going to be with the pricing discipline stay in the in Asian market. That’s going to be the biggest because when you look at short-term order flows I think they are going to be down significantly going into this year.

My follow up question is ex the agricultural side, if you look at more of the industrial pieces of your business and you sort compared to where it was maybe three or four months ago trying. I am trying to get a sense of what the pace of business might be relative to just few quarters, or few quarters ago, do you a stabilize – and you see still de-acceleration, how do you look at the pace of business on any of that?

Well in the international business, I think actually we are pretty stable. I don’t think they’re going to get much traction on till you get more public funding into this side of our business. But they are not deteriorating. The deterioration we're seeing in our earnings and revenue is mostly as a result of currency exchange effect. It’s not that the volume has significantly deteriorated. Now lately here we have another unknown which is oil prices and in some ways they will benefit the people that -- benefit the farmers from an energy standpoint, maybe fertilizers. But in other parts of the world where we have business in countries that are very dependent on energy income, it could move the other way and it's too early to get a good feel for to what extent the pluses and minuses may outweigh each other. End of Q&A

There are no further questions at this time. I will now turn the call back over to Mr. Laudin for closing remarks.

Thank you, Vanessa. This concludes our call and we thank you for joining us today. The 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, Vanessa will read our forward-looking 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 perception 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, this will conclude today's call. You may now disconnect.