Valmont Industries, Inc. (VMI) Q1 2015 Earnings Report, Transcript and Summary

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

Thank you, Kayla. Welcome to the Valmont Industries' first quarter 2015 conference call. With me today are Mogens Bay, Chairman and Chief Executive Officer; Mark Jaksich, Executive Vice President and Chief Financial Officer; and Tim Francis, 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 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 that you've all read the press release and I'll summarize first quarter highlights and then discuss the restructuring trend we announced yesterday. The Irrigation segment performed well in a weak market environment, particularly when compared to last year's strong first quarter. A substantial revenue decline in North America was expected given weak agriculture commodity prices and the resulting outlook for significantly lower net farm income in 2015. Our International Irrigation business also experienced substantially lower volume reflecting weak global commodity prices. In Brazil, a drought has put the spotlight on water use in a country where agriculture and power generation compete for water, which led to lower sales as we saw some restrictions of water permits for irrigation. Expected changes in government financing programs in Brazil for agricultural equipment by the middle of the year could negatively affect our business there. We were pleased with the quality of earnings in this segment with operating income of 15.7 as a percentage of sales. Except for multi system deals, pricing as a whole remains somewhat stable. In the Engineered Infrastructure product segment, revenues increased modestly aided by last year's acquisitions. There'd be no near-term changes in the markets for this segment. The mining-driven Australian economy has not improved and government restraint and funding infrastructure projects around the world, particularly in Europe and North America, is still in place. The rapidly strengthening U.S. dollar created further headwinds in the quarter. A bright spot during the quarter was the delivery of a large export decorative light pole project from Europe. This was the combination of a three-year design collaboration with a customer in the Middle East. This showcases our unique engineering and manufacturing capabilities in a very high-profile project. Turning to our Utility Support Structure segment, there are a number of elements relevant to describe the quarter. The quality of earnings at less than 9% operating income as a percentage of sales was in line with what we experienced in the fourth quarter of 2014, but down substantially from the first quarter of last year. The pricing environment did not change from the fourth quarter. And the first quarter of last year benefited from a substantial backlog at higher profitability carrying over from the previous year. Whereas revenue this quarter declined 18% from the same quarter of last year, volume was only down slightly. Pricing was down quite a bit but the big difference was the price of steel. Let me add some color to that. Steel prices are down about 35% over the last six months. Steel accounts for roughly 50% of the revenue in this segment. So a hypothetical example of flat volume, no change in margin, revenue would be down around 17.5%, that is huge. I always say I really don't care where the price of steel is as long as it gets there slowly. That has certainly not been the case recently. We often get questions around capacity in this market. It is important to separate volume from revenue when steel prices move as rapidly as we have seen lately. There is actually no significant change in volume or tons produced or production hours in our utility plants between 2013 and 2014 and what we predict for 2015. The big difference is steel cost and margin pressure. As mentioned in our last earnings call, we have significantly stepped up our efforts and operational excellence in this business. Our lean journey, how we buy steel, how we load our plants, et cetera. I like what I see and I'm confident that we'll see good results of these efforts over the longer term. In the Coatings segment, our custom volumes and profitability in North America are solid, but we're experiencing reduced internal demand. The big challenge is in our Australian coatings facilities where volume is down leading to significant deleverage. Let me now turn to the restructuring plan. I mentioned in our fourth quarter earnings call that we were looking at our global footprint of facilities in view of persistent weakness in a number of our markets. We cannot control the value of the dollar. We cannot influence the level of public spending on infrastructure nor the mining economy in Australia, but we can react and make sure we're organized from a cost and facility standpoint to reflect the opportunities available to us in the near term. For obvious reasons we cannot give you much detail on the plan until and as we execute. The initial actions will involve the consolidation of operations and other cost reductions activities resulting in a pretax charge of approximately $30 million, $19 million in cash expenses and $11 million in non-cash charges. Most of the restructuring activities will take place in our Infrastructure businesses where an improvement in the Australian industrial and mining economy is not expected in the near term and public spending for infrastructure in Europe and North America continues to be constrained. The cash expenses are expected to be recovered through lower operating costs within 12 to 18 months. I can give you one example of what is happening. In Australia, we're consolidating eight small manufacturing facilities into four, partly just as a result of looking at ways to cut expenses in Australia, but also reacting to a change in the business model. More and more import from our China facilities are replacing what used to be manufactured in Australia. And even though the Australian dollar has weakened and therefore should make import less competitive, there's still a huge difference in steel costs between China and Australia. So this is part of what we're doing. Turning to other financial measures. Depreciation and amortization for the quarter was $24 million and capital expenditures were $17 million. For the full year we expect depreciation and amortization of about $95 million and a capital spending of approximately $70 million. We generated cash flow from operations of around $56 million during the quarter, up significantly from last year. We have repurchased 3.4 million shares and have $17 million remaining on our May 2014 authorization from our Board. Our ending cash balance was $318 million. And at this time, I will take your questions. Thank you.

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

A first question on the Utility business, the margins seem to have leveled out now around 9%. So wondering what you're thinking about an exit rate for this year and how quickly it can move up off that 9% level? I remember you talked about 200 basis points worth of cost reduction, so is it really about layering that on perhaps as soon as the second half?

Well, I agree that I expect to get everything else unchanged about 200 basis points from the productivity improvement activities. Now, I would say that what will affect quarterly profitability and it can move around a little bit is the mix between small projects and larger projects. And we continue to see what we find an unfavorable mix where small projects are more prevalent than larger projects. It will affect pricing but more importantly, it affects the productivity in plants. You have a lot of customers that move their required time for delivery around and smaller projects move less efficiently through our plants compared to our long utility line of pretty standard poles. So there is a lot of moving targets there, but I will say if we see a move towards larger projects and we start seeing the effect of the productivity improvement, that's the way to move the operating income percentage up.

And then my second question would be around capital allocation. You had the new repurchase program back in February, wondered how you were thinking about the relative appeal of acquisitions versus buy back right now?

Well as I've said before and the way we look at the repurchase of our stock as an acquisition and we compare that to what we have to buy for targets we're looking at and I gave the example at the last call of a couple of acquisitions where we were outbid significantly by private equity. And we've just experienced another one where we were significantly outbid. And as I've said many times, we can buy acquisitions and be competitive is all we're looking for is EPS accretion. But we're very disciplined in keeping an eye on how fast can an acquisition beat our cost of capital. And we're not going to get sucked into overpaying just to make an acquisition. Having said that, there will be acquisitions coming up where the determinant factor of the seller may not just be the highest price, but also finding a good home for their employees. So we're still very active in the acquisition arena, but the competition from private equity that's supposedly have $1 trillion committed continues to be tough. And we will not be able to compete head to head with private equity.

Our next question comes from the line of Schon Williams from BB&T Capital.

Wonder if we could dive into Irrigation. I wanted to maybe address your comments about specifically around pricing. I think you said for except for one sub component, there seems to be sable pricing. Maybe a little bit more color there would be helpful. And then I know you addressed Brazil, but I would be interested in the dynamics between domestic markets and international markets and what you're seeing there?

Out of Brazil or out of here, domestic and international?

Well, guess I would be interested to see outside of Brazil, is demand holding up? Is demand getting worse? I mean it sounded like there was some -- a component, country-specific risks around Brazil, but I'd be interested and maybe work the rest of the international markets versus what you're seeing domestic.

Okay, I understand. So let me first start with the pricing issue. I've said quarter after quarter over the last few quarters that the biggest risk to profitability is if pricing discipline disappears in this business. And historically, it has happened. Now it shouldn't happen because market shares in North America really do not change. Year-in and year-out it's about the same market share. So it's not a very productive endeavor to get into. And we're resisting it to the extent we can. We have not given up market share. But our deal organization has been pretty successful at hanging on to price as reflected in nearly 16% operating income in a fairly weak market. Now, does that mean that there are no pricing issues? Of course there is. Most of them is centered around multi system orders or some of the international orders that tend to be project orders. So, so far I would say so good. And now we're coming towards the end of the selling season, in another month or so, so I wouldn't expect a big change between now and the end of the selling season and then everything gets redialed depending on crop conditions this summer and commodity prices and how farmers feel going into the fall. So let me switch to the international business. Brazil has been a very strong market for us and even, I can say the same thing about Brazil as I say about North America. In good times it's a really, really good business. And when things are not so good, it's still a good business. And our Brazilian business is still good. But it's also faced with some headwinds. Some because of political uncertainty, some because of a drastic devaluation of the real. And some because of the outlook for local financing which is [indiscernible] financing has been around 3% or 4% and that's a pretty good financing rate when you have inflation running more than twice that. Now expectations are that that will move up and it could move up significantly. It could easily double. We don't know for sure what's going to happen, but it's most likely to happen by the middle of the year. So that's what's putting some pressure on the Brazilian market. Otherwise continued strength in southeast, in Australia, New Zealand, continued strength in South Africa. Okay in Europe, not very good in the Middle East and the Ukraine and Russia environment for obvious reasons. But then of course there's a lot of project business that pops in and out of our international business and I would say that currently there are not a lot of big projects in the current revenue and the current backlog. So I would say by and large, the international businesses continue to do fairly well but they are influenced be the commodity price drivers as we see in this country.

And then if I could, maybe jump in the Coatings. Could you talk a little bit about what you're seeing, I know Australia is weak for you there, but can you talk about what you're seeing in terms of domestic U.S. trends in Coatings and was there any effect from the weather this quarter?

Well there is always some effect from the weather. Our Canadian galvanizers in the eastern part of Canada, they were dealing with the same kind of weather that we saw in Boston and upstate New York. So yes we have some influences. But in general, activity levels with our outside customers in North America is staying very strong and profitability for those businesses are staying very strong. We have seen some decline in internal revenue for the Coatings business, some from Irrigation and some from our poles and Utility businesses. Some could just be volume in those and some it could be welding steel projects that could not require galvanizing. But the real challenge is the galvanizers in Australia where as you know, galvanizers, they lever up very well and they delever with the same speed. So that's the part we're keeping and rely on and see how we improve the cost structure in Australia.

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

For the Utility segment, is it your expectation that even if we do see better volume come through as 2015 progresses, the impact of lower steel costs will be tough to overcome in terms of driving some revenue growth this year?

Clearly. Revenue is going to be tied first and foremost to steel prices and so many of the steel contracts are tied to steel indexes. So it goes step in step. We don't know what's going to happen to steel going forward. Nobody expected, at that includes the steel companies, that steel would continue to decline as we went into this year. Expectations are that steel will stabilize and maybe start increasing going into the second half on the year, but there's no certainty to that. So from a revenue standpoint, it's going be tied exactly to steel prices as per the example I gave you. And normally steel moves not too fast and therefore it doesn't have a big impact on volume. But right now, revenue and volume in a way is disconnected from what we typically see. So no, getting back to your question, we do not expect that revenue will see any benefit short term from increased steel prices.

And then, Mogens, the old Delta operations in Engineered Infrastructure products, is the pressure you're experiencing across the board within that business, or is it half the business right now in Australia that's down? Maybe a little more color around that.

Well I will say the most pressure is probably in the access systems in Australia, the Webforge brand, because of the slowdown particularly in the mining economy. But that spills over to the general economy. We did acquire with Delta a fairly significant footprint in Australia. And as I explained in my prepared remarks, we're consolidating in a couple of businesses down there mainly Webforge. We're consolidating eight manufacturing facilities into four. We will still be able to support our customers as we have in the past and we'll be able to increase revenue there without having to add facilities. And part of it is the change in the business model that I talked about. You see more and more import into Australia and particularly from China. And our import both of poles and basic products within Webforge comes from Valmont's China facility, so we'll see a benefit there. But even though the Australian dollar has been weakening, which should make local manufacturing more competitive, in general that is true. But the difference in steel costs between China and Australia is more than overcoming that. So we're fortunate in the sense that we can switch to our own plants in China as opposed to have to source from others.

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

I had a couple of follow-up questions embedded in the restructuring and the first part of question is do I get a sense that you're less confident in following up on maybe Julian's question, if you're less confident in the USS opportunity? Because as early as or recently as January you still felt comfortable with 200 basis point margin all else being equal. And I'm getting the sense that you want to walk away from that 200 basis point improvement. Did I understand that clearly, or you still feel comfortable with 200 basis point opportunity?

I still feel comfortable with 200 basis point opportunity as a result of our different models of [indiscernible], if you will, in the Utility where we have switched the plants from being P&Ls to being measured on cost that we're loading the plant centrally. We're doing more mill direct purchasing, et cetera, et cetera. But that's just one element. The other elements is volume and price. We're expecting volume to be about flat with last year also going into this year. And that's why our plants are pretty full. Now that doesn't mean that we're not looking at ways to expand as a result of lean activities and others, expand activity levels in our lowest cost plants and being able to step it down in the highest cost plants. So yes I'm comfortable with the 200 basis points, but I would also say that the other effects on profitability are not exactly frozen in time. So we'll see how that part of it works.

Okay. And then following up with that, the restructuring, you've got a lot on your plate right now. I guess you no longer have a COO, Vik left as COO and you got this big project in with EIP. Who is managing that? Is he still there managing the EIP side? Who do you have that's going be overseeing all this? Obviously you have a much larger role, but my question is about bandwidth and who's going to be many charge of all of these lean initiatives?

Well a couple of different questions there. When you look at EIP, our Group President for EIP is David LeBlanc who joined us recently. And we have had discussions with him all the way back to last year when Vik Bansal was in the COO role and for that particular Group President role. So we reestablished those conversations. His background is out of Lincoln Electric. He has worked for Lincoln Electric both if Europe, in Latin America and in Asia. So he's very well qualified and very well experienced in the geographic footprint we have in EIP. From a corporate standpoint, we have added a new role as Executive Vice President of Operational Excellence that's going to oversee our lean journey in all of our segments. And on his staff we have the lean coaches that are working with the various business units. I think we're well covered from a Senior Management standpoint.

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

Looking at the Australian galvanizing operations, which has been causing you difficulties as I think about galvanizing, is there an opportunity to consolidate facilities, or how do you go about lowering your cost structure there in Australia in the galvanizng area?

There is only one way to do that and that is to either consolidate [indiscernible] and these are some of the things we're looking at. As you know you can't lower the temperature of the bath and you can't lower the level of zinc. So these are businesses that are operating and they have fixed operating costs and if you don't have business for all of them, you need to look at consolidation.

Okay. So if you consolidate though, isn't there a geographical range that these facilities can serve. And so if you consolidate, do you lose all that business that -- on the facility that you close?

Unless you consolidate within a radius that can be served by the other facility.

And then secondly, Valmont SM, your acquisition in The Netherlands, is there any -- how is that performing? Is there any need to restructure, is that included in the restructuring program anything there?

No, there is nothing in the restructuring program for Valmont SM. They serve a number of different industries. They have actually -- they serve the energy sector, but they have not had cancellations within that, but I would guess that that's part of their business will be softer. But they've seen pick up in the wind side of the business for the very large structures for offshore. And they have seen other opportunities to utilize their manufacturing expertise. So no there's no restructuring in relationship to Valmont SM.

Okay, so that operation has generally met your expectations since--

That's correct.

Our next question comes from the line of Tim Mulrooney from William Blair.

Last quarter you guys said that you thought you expected foreign currency to negatively impact EPS by about $0.30. Since that time exchange rates have changed a little bit more, I was wondering if you could give us an update on that number for your expectation for the year?

Yes, I'm going to ask our CFO, Mark Jaksich, to give you that update.

Yes, Tim, we announced the impact on the first quarter and if rates stay more or less where they are today at -- that effect on earnings per share related to foreign exchange might be closer to $0.40 because the dollar has continued to depreciate in general since the last time we had count. So that of course depends on how rates move going forward but that's our latest estimate.

And is that all translational or is there any transactional effects we should be aware of?

No, that's the translation component of it. Transactional are just things we have to manage on a day-to-day basis when we get exposures in nonfunctional currencies.

Our next question comes from the line of Nathan Jones from Stifel.

Just like to talk a little bit more about Utility and where the price pressure is coming from. Mogens in your prepared remarks, you said the volume is pretty much the same in 2013, 2014 and what you're projecting in 2015. So most of the top line hit is coming from steel. If I think about that business as pounds of steel put through your plant where you're charging your costs plus a margin on the value-add, I wouldn't have thought that the actual operating income dollars would have gone down that much. And if volume is relatively stable, I don't really understand why pricing has been such an issue recently. Could you maybe help me understand a little bit better, if volume hasn't really dropped off at all, what's giving rise to this pricing pressure?

Well the more smaller projects you have, the more people can participate in them. And we have had new entrants into that business over the last few years, both importers, particularly from Mexico, but we've also had changes in the competitive landscape in North America. We had first Thomas & Betts been sold to ABB and then selling their pole businesses to Trinity. We had Fort Worth Towers in the process of being or have just been acquired by Sabre. So there has been a lot of movements around and everybody wants probably more than our fair share of the volume available. And the smaller the projects, the more price competitive. And I would say that if you go back to when our operating income was north of 15%, we didn't have the capacity in place in the market that we have today and we had more larger projects than we have today. And to get from 15% operating income to 9% operating income, it's a 6% change in price. It goes straight to bottom line and we have seen more than that in the number of the smaller projects. We have seen pricing that is not really sustainable over the long term. So hopefully after all of these changes in ownership and combinations of businesses in North America is settling down, I hope we'll get more pricing discipline. But until then, we will live with what's there.

I guess the biggest driver there sounds like there's some increased capacity in the industry chasing the same volume. In your restructuring plans, is there any intent on your behalf to take capacity out on your side?

There are several people that have taken some capacity out and we did too. Last year we closed a leased facility in Texas. We have moved what was outsourced in house, in a way that's taking out capacity. And as I said in my prepared remarks, we're looking at moving as much volume as we can to our low cost facilities even if that means having to add shifts in those facilities. And to the extent we're successful at doing that, we may be able to down size facility elsewhere.

So there the potential for closing facilities, I know you don't want to get into too much detail about your restructuring plans, but the potential for closing facilities and taking out capacity is something that's on the table?

I will say more shifting capacity to lower cost areas.

[Operator Instructions].

If there are no more questions we can close the call, Kayla.

And there are no more questions.

Thank you. This concludes our call, 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, Kayla will read our forward-looking disclosure statements.

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 the Management's perceptions of historical trends, current conditions, expected future developments and other factors believed to be appropriated under the circumstances. As you listen 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 other 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. This concludes today's conference call, you may now disconnect.