Earnings Call Transcript - LNN Q3 2022

Operator, Operator

Good morning. My name is Joe, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Lindsay Corporation Third Quarter Fiscal Year 2022 Earnings Call. Please note that this event is being recorded. During this call, management may make forward-looking statements that are subject to risks and uncertainties, which reflect management's current beliefs, estimates of future economic circumstances, industry conditions, company performance and financial results. Forward-looking statements include the information concerning possible or assumed future results of operations of the company and those statements preceded by, followed by or including the words expectation, outlook, could, may, should or similar expressions. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. I would now like to turn the call over to Mr. Randy Wood, President and Chief Executive Officer.

Randy Wood, CEO

Thank you, and good morning, everyone. Welcome to our third quarter earnings call. With me today is Brian Ketcham, our Chief Financial Officer. Our third quarter results reflect the ongoing commitment of our employees around the world to support our customers and dealers in a very dynamic environment. Our entire organization continues to effectively manage through supply chain challenges, logistics constraints, and inflationary pressures, while our commercial teams have effectively managed pricing to preserve business quality. This teamwork, focus, and one Lindsey approach is evident in our results. Our third quarter revenue and operating income was the second highest in our company history, rivaling the highest quarter ever during the peak of the ag cycle in 2013. We thank our teams around the world for all they're doing to contribute to the success of our customers and our company. In the area of innovation, our Smart Pivot program continues to progress forward, and we're getting great customer reviews from our new FieldNET user experience that will be released later this fall. We're also seeing strong market acceptance for our new Road RoadConnect telemetry platform in the infrastructure business, and our relationship with Blyncsy continues to showcase the power of innovation that's possible with strong industry partnerships. To date, we have devices deployed in 27 states across the U.S. with several international sites ready to deploy before the end of the fiscal year. Turning to irrigation market conditions. The market continues to see a combination of factors impacting customer sentiment and business growth. Global commodity prices remain high, which is positive. However, this is somewhat tempered by increased input costs, which will keep U.S. net farm income relatively flat on a year-over-year basis. This year's crop will be one of the most expensive our customers have ever planted, so the positive yield and revenue benefit attained with irrigation through a center pivot should support market stability. Order demand in the quarter was consistent with the prior year. We did see an increase in orders beginning in mid-May due to large storms in the Midwest. Some of this demand did ship in the quarter and some carried over into the fourth quarter. In International Irrigation, we see continued strength across most regions. In the mature markets, this is supported by high commodity prices. And in the project-oriented or developing markets, this is supported by more secular drivers. Brazil continues to be a bright spot, where a combination of volume and price realization more than doubled the business versus the prior year. The 2022-2023 crop plan was also released this week. Government financing incentives for irrigation investments was set at BRL1.95 billion, a 44% increase over the prior plan. This was the largest increase in resources amongst all investment programs, highlighting the focus on expanding efficient irrigation in the region. We also see continued inquiries for project business across Europe, Africa, and the Middle East as concerns over food security and global grain supplies have been tightened by the ongoing conflict between Russia and Ukraine. We were pleased to attend the inauguration of the future of Egypt project site with President el-Sisi in May. This farm includes the 1,200 thematic pivots that shipped earlier this fiscal year. There was also news this week that Egypt will receive $500 million from the World Bank to boost food security, and a portion of this funding will go towards wheat storage, which will support more localized grain production and a strong irrigation market. Moving to infrastructure. Our commercial teams have been able to return to near pre-pandemic travel schedules, and this has helped to stimulate movement in our Road Zipper sales funnel. Their diligence and perseverance has paid off, and the two projects we have been anticipating in the second half of the year are now moving forward. Brian will provide additional details regarding each project in his financial update. In the Road Safety business, we're also seeing signs of a restart and normalized design and procurement processes at the state DOT level. The funding support provided by the infrastructure bill has been positive, but we do see some headwinds in this segment caused by inflation and labor availability. A number of project bids submitted months ago are being impacted by cost increases that have resulted in project delays or scope reduction. Overall, we remain optimistic regarding growth opportunities for this business based on the quality of our sales funnel and increasing commercial activity. I'll now turn the call over to Brian to review our third quarter financial results.

Brian Ketcham, CFO

Thank you, Randy, and good morning, everyone. Total revenues for the third quarter of fiscal 2022 increased 32% to $214.3 million compared to $161.9 million in the prior year quarter. Net earnings for the quarter increased 41% to $25.1 million or $2.28 per diluted share compared to net earnings of $17.8 million or $1.61 per diluted share in the prior year quarter. Irrigation segment revenues for the third quarter increased 35% to $188.7 million compared to $140.2 million in the prior year quarter. North America irrigation revenues of $96.2 million increased 10% compared to the prior year quarter. The increase in North America irrigation revenues resulted from higher average selling prices, while unit sales volume was lower year-over-year. As Randy indicated, order rates during the third quarter were similar to last year. However, we entered last year's third quarter with a larger backlog of orders as frequent and significant price increases at that time pulled orders forward. While an increase in storm damage replacement orders beginning late in the quarter provided some additional volume for this year's third quarter, most of this increased volume from storm damage replacement will be realized in our fourth quarter. In the international irrigation markets, revenues of $92.5 million increased 75% compared to the prior year quarter. This increase resulted from a combination of higher average selling prices and higher unit sales volumes in most international markets, with the most significant increase in Brazil. Also contributing to the revenue increase was the favorable effect of a net foreign currency translation gain of approximately $2.5 million compared to the prior year quarter. Total irrigation segment operating income for the third quarter was $39.6 million, an increase of 65% compared to the prior year quarter, and operating margin was 21% of sales compared to 17.1% of sales in the prior year. Improved operating margin resulted from improved price realization and additional volume leverage, which more than offset the impact of inflationary cost increases. Infrastructure segment revenues for the third quarter were $25.6 million, an increase of 17% compared to the prior year quarter. The increase resulted from higher sales of road safety products and Road Zipper System project sales, which were partially offset by lower Road Zipper system lease revenue. Lower lease revenue resulted from the completion of certain lease projects along with delays in the start-up of new lease projects. During the quarter, we began delivery of a Road Zipper project in Australia. The total value of this project is approximately $9 million, with about half of the value representing the sale of barriers and the other half representing the lease of two machines over a 30-month period. We delivered about half of the barrier in the third quarter and expect to deliver the remainder of the barrier in our fourth quarter. This is our first lease project in Australia, and we are optimistic about the future project potential in this market. Infrastructure segment operating income for the third quarter was $3.8 million, which was comparable to the prior year quarter. Current year results reflect a less favorable margin mix of revenues compared to the prior year, as well as certain under absorbed fixed overhead costs. Another one of the projects that we have been expecting in the second half of our year is a barrier replacement project in Massachusetts. This project has now been approved and is expected to be awarded in our fourth quarter. The value of our portion of this project is approximately $24 million, and we anticipate being able to deliver about two-thirds of this project in the fourth quarter and the remainder delivering in the first quarter of fiscal 2023. Turning to the balance sheet and liquidity. Our total available liquidity at the end of the third quarter was $145.7 million, with $95.7 million in cash, cash equivalents, and marketable securities and $50 million available under our revolving credit facility. Our total debt was $116 million, almost all of which matures in 2030. And at the end of the third quarter, we were well within the financial covenants of our borrowing facilities, including a gross funded debt-to-EBITDA leverage ratio of 1.2 compared to a covenant limit of 3.0. At this time, I'd like to turn the call over to the operator to take your questions.

Operator, Operator

We will now begin the question-and-answer session. Our first question will come from Nathan Jones with Stifel. Please go ahead.

Nathan Jones, Analyst

Good morning, everyone. Maybe starting on some of these barrier projects, I mean, you guys have been talking for the last couple of quarters about two projects going in the back half of the year and have been spot on with the guidance there. Maybe you can talk a little bit about what that pipeline looks like for '23 and '24 and confidence in conversion of those growth we should be expecting in that business, the impact of the infrastructure bill stimulus? Just any kind of outlook you can give us on the project environment there.

Brian Ketcham, CFO

Yes, Nathan, this is Brian. We have consistently expressed confidence in our sales funnel. The main challenge over the past couple of years has been the COVID environment, particularly travel restrictions, which have impacted the flow of some projects. However, we identified two projects late last year that we expected to progress this year, and we are now seeing that come to fruition. As we engage more with customers and conditions normalize, we anticipate continued movement of projects through the funnel. Additionally, on the leasing side, there is strong interest in incorporating Road Zipper into construction programs across several states. One project we have already started delivering in Australia is part of a construction program with a 30-month lease. Once we demonstrate the capabilities of Road Zipper, we expect to see additional business opportunities arise. Overall, we remain optimistic about our position and the growth prospects of that business.

Nathan Jones, Analyst

Thanks. I'm going to ask a question on inflation/potential deflation, just to say what kind of thoughts you can get on that or we can get from you on that. You've obviously had big revenue tailwinds over the last couple of years from inflation, which has been negative for margins, but probably positive for earnings. We've seen hot rolled coil prices in the U.S. come down quite a bit. The Fed is clearly focused on inflation. I'd just like to get any thoughts you have on the potential reversal here and how that could impact your business? If we saw steel prices revert back to where they were a few years ago, have you guys done the math to figure out, I guess, how much earnings you would lose from pricing going back to where it was? Do you think you could maintain some of that pricing? Just any thoughts you can give us as investors are clearly focused on what might happen here with the Fed that continuing to policy.

Brian Ketcham, CFO

Yes. Again, this is Brian. Just to put things in perspective, I mean we do see the hot rolled coil prices softening. It's roughly 15% of our cost of goods sold, but we still see structural steel, which is another 15% of our cost of goods sold. That continues to actually increase slightly. We see zinc, and some other input costs, logistics more recently increasing. So the overall inflationary environment, I would say, is still there. I'd say it's moderated, obviously, from what it had been, let's say, a year ago. So again, depending on what steel does going forward, if there's a recession and demand falls off, we would expect it to continue to soften. In that case, we're always, just as we were on the way up, focused on protecting our margins. And as prices begin to come down, if that happens, we would tend to lag as much as we can to retain the value that we sacrifice on the way up. But at some point, obviously, we'd have to respond to competitive movements in price, but our objective would be to maintain margins.

Nathan Jones, Analyst

Okay. Thanks for the commentary. I'll pass it on.

Operator, Operator

Our next question will come from Brian Drab with William Blair. Please go ahead.

Brian Drab, Analyst

Hi, good morning. Thanks for taking the questions. I wanted to start just by asking about drought conditions and how that's either positively or negatively impacting demand at the moment in the U.S. and abroad?

Randy Wood, CEO

Yes, good morning, Brian, this is Randy. I'll cover that one. We obviously watch the drought monitor, and you see some significant drought, particularly in the West. We've seen that now creep into Western Texas and the Panhandle, getting a lot closer to some of the core pivot irrigation market. So it does a couple of things. It probably provides some price support in the market, if the market feels that there's going to be some diminished yield potential in those areas, and that will impact certain commodities differently. It certainly could promote more efficient use of water if somebody's irrigating with something that's not a center pivot and they want to stretch their water application, switching to a center pivot, which would be more efficient, could be an option for them. But you also get to a point where there's not enough water to finish a crop. And unfortunately, there are some regions that may reach a point now where they don't have enough water to finish a crop, and that's a very difficult situation for those customers. But again, I don't know that there's going to be a significant impact for us. And if you look globally, it really depends where you are. I saw something about Australia getting too much water right now, really the opposite of a drought impact in several regions. But this time of year is a weather market. So whether it rains, whether the drought improves or gets worse, I think it does have an impact on commodity prices, particularly and customer sentiment. So it is something we watch, but I wouldn't say there's a significant impact on our demand up or down right now.

Brian Drab, Analyst

Okay. Thank you. And then gross margin impacts from the barrier projects is my next question. How should we think about maybe even just roughly directionally gross margin for the company overall, given the significant barrier revenue that you're going to recognize in just Road Zipper revenue in general in the fourth quarter?

Brian Ketcham, CFO

Yes. Brian, as we've spoken before, higher margins on barriers versus machines. And so in this case, the project in Massachusetts is all barriers, so that would tend to be a higher-than-average margin. So I would say it's going to be similar to what we've realized in the past on some of the larger projects. Japan being a good example of a year or two ago when we had barrier sales there.

Brian Drab, Analyst

What was the total for barrier revenue, specifically Road Zipper revenue, in the third quarter?

Brian Ketcham, CFO

Our total Road Zipper revenue would have been roughly $2.5 million from sales and leasing. I don't have that number broken out, but it was relatively light in the third quarter for Road Zipper.

Brian Drab, Analyst

Okay. I understand. So, that wasn't a major factor contributing to the notable increase in gross margin that you observed sequentially, regarding the Road Zipper or infrastructure in general?

Brian Ketcham, CFO

No, I would say on the infrastructure side, it was actually a negative gross margin due to the lease revenue, which is generally higher than even the barrier and machine sales. The lack of a reduction in lease revenue, combined with an increase in Road Zipper sales and Road Safety products, resulted in us being flat in operating income year-over-year.

Brian Drab, Analyst

Okay. And then the main driver of the 700 basis point increase in gross margin sequentially in the third quarter was what?

Brian Ketcham, CFO

It's going to be irrigation, and it's going to be both North America and international.

Brian Drab, Analyst

Volume leverage and the lease revenue, which is generally higher than even the barrier and the machine sales. So not having a reduction in lease revenue offset by an increase in the Road Zipper sales and Road Safety products, we were flat in operating income year-over-year. It's going to be irrigation, and it's going to be both North America and international.

Brian Ketcham, CFO

Yes, I would say it's price realization is probably the single biggest factor and then the volume. We're seeing that in both price and volume impacts internationally, to wear that. I think historically, we've talked about international being lower overall operating margin compared to North America. What we saw in the third quarter is that it's become similar to what we have in North America. So that was a real positive for us as well.

Operator, Operator

Our next question will come from Brett Kearney with Gabelli Funds. Please go ahead.

Brett Kearney, Analyst

Hi guys, good morning. Thanks for taking my question. Curious what kind of internal investments and CapEx projects you've lined up, either capacity or productivity-side with the balance sheet in great shape? Anything you've lined up kind of internal investments and thoughts on potentially any other uses of capital?

Brian Ketcham, CFO

Yes. I would say, Brett, we're currently more in an evaluation phase in terms of looking at our international business and where we need to add capacity. I think two areas would be Brazil and Turkey. As we see the growth in that project market increase, which is primarily serviced out of Turkey and then the Brazil market. We've done a lot of things to increase capacity without a whole lot of CapEx up to this point, but that would be an area that we would consider spending some money from a CapEx standpoint. I would say the other area is adding to our lease fleet on the infrastructure side. With some of the delays that we've seen in some of the lease projects, we've kind of delayed the CapEx associated with that as well. But going forward, that would be another source where we see good returns from additional CapEx.

Operator, Operator

Our next question will come from Jon Braatz with KCCA. Please go ahead.

Jon Braatz, Analyst

Good morning Randy, Brian. Brian, in the first two quarters, you had some significant LIFO charges. And you've talked about recovering those charges, recovering. Are we actually seeing that in the third quarter results?

Brian Ketcham, CFO

No, John. We really haven't seen that. I would mention there was actually a slight negative impact from LIFO in the quarter, around $1 million. The main point is that our inventory levels at the end of the quarter were similar to those at the end of the second quarter, so there was no benefit from LIFO this time. However, we are starting to see the effects of price realization, and we expect to see some LIFO benefits as inventory levels decrease.

Jon Braatz, Analyst

Okay. Brian, the Turkish lira has been very weak. What kind of role does that have on your margins and profitability in your Turkish facility?

Brian Ketcham, CFO

Yes. John, our Turkey business operates in U.S. dollars due to significant exports to various markets, and many of our input costs are also dollar-based. The main area affected has been employee compensation and some local expenses. We've experienced the effects of devaluation and inflation, necessitating adjustments to employee compensation. However, overall, there hasn't been a significant impact on our overall profitability in that region.

Jon Braatz, Analyst

Okay. Good. And then lastly, obviously, there's been a sizable working capital build this year. Of course, now you're entering the seasonally strong period in Brazil in the southern hemisphere, but how do you see that working capital maybe disinvestment in the next few quarters? Should we see that investment coming down?

Brian Ketcham, CFO

I would say, I would expect a reduction in North America, particularly in receivables as some of those get collected in the fourth quarter. On the international side, I think what we're seeing is we're supporting the growth in Brazil, also in Turkey, South Africa, where we have active project activity going on. We're carrying more inventory than we normally would just so that we can respond. These projects, we talk about them for quite a while. We've got line of sight to them. And then when they actually happen, they expect delivery pretty quickly. So I would say that's the area that's a little bit of an uncertainty. We're maintaining the inventory in the international business to be able to respond to that project business. I would say we expect to see some reductions flowing into the next quarter, particularly in our receivables in North America.

Operator, Operator

There are no further questions at this time. This will conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Randy Wood for any closing remarks.

Randy Wood, CEO

Thank you for your interest and participation today. Our infrastructure segment continues to be supported by the incremental funding provided by the Infrastructure Investments and Jobs Act and a return to more traditional travel capabilities that improve funnel management and Road Zipper project sales. This is tempered slightly by the impact of inflation and potential project delays caused by rising costs and labor availability. The irrigation segment of our business continues to see strong drivers connected to high commodity prices and international project demand, offset slightly by rising input costs that affect net farm income. We do believe the positive ROI provided by an investment in irrigated agriculture will continue to support a stable market. Both segments benefit from ongoing investments in technology and innovation that allow our customers to operate more sustainably and more profitably. This concludes our third quarter earnings call. We look forward to updating you on our continued progress following the close of our fiscal 2023 fourth quarter. Thanks for joining us.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.