AZZ Inc.

Good morning and welcome to the AZZ Inc. First Quarter Financial Year 2020 Financial Results Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw a question, please press star then two. Please note, today's event is being recorded. At this time, I would like to turn the conference over to Joe Dorme, Managing Partner, Lithum Partners. Please proceed.

Thanks, Chris. Good morning and thank you for joining us today to review the financial results of AZZ Inc. for the first quarter of fiscal year 2020 ended May 31st, 2019. On the call representing the company are Mr. Tom Ferguson, Chief Executive Officer, and Mr. Paul Fellman, Chief Financial Officer. After the conclusion of today's prepared remarks, we will open the call for a question and answer session. Please note there is a slide presentation for today's call, which can be found on AZZ's Investor Relations page under Financial Information at www.azz.com. Before we begin with prepared remarks, I'd like to remind everyone certain statements made by the management team of AZZ during this conference call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Except for the statements of historical fact, this conference call may contain forward-looking statements that involve risks and uncertainties some of which are detailed from time to time in documents filed by AZZ with the United States Securities and Exchange Commission, including the annual report on Form 10-K for the fiscal year ended February 28, 2019. Those risks and uncertainties include, but are not limited to, changes in customer demand and response to products and services offered by the company, including demand by the power generation markets, electrical transmission and distribution markets, the industrial markets, the metal coating markets, prices and raw material costs, including zinc and natural gas, which are used in the hot dip galvanizing process, changes in the political stability and economic conditions of the various markets that AZZ serves, foreign and domestic, customer requested delays of shipment, acquisition opportunities, currency exchange rate, adequate financing, and availability of experienced management and employees to implement the company's growth strategies. the company can give no assurance that such forward-looking statements will prove to be correct. These statements are based on information as of the date hereof, and AZZ assumes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise. With that said, let me turn the call to Mr. Tom Ferguson, Chief Executive Officer of AZZ. Tom?

Thanks, Joe. Welcome to our first quarter fiscal year 2020 earnings call, and thank you for joining us this morning. We are pleased with a solid start in fiscal year 2020. We generated 10% revenue growth and 35% net income growth versus prior year. Our energy segment had a fairly normal spring turnaround season, shipped the portion of the high-voltage bus Chinese order that pushed out of the last quarter, and regained operational traction in most businesses. The metal coating segment experienced increased demand in the solar and petrochemical markets and contribution from the acquisition of Tennessee Galvanizing and K2 partners. Overall, we generated $289 million in revenue, which is over 10 percent growth versus Q1 fiscal year 2019. The metal coatings team improved operational efficiencies as the usage of DGS, which is our digital galvanizing system, continues to grow in our galvanizing plants. We also experienced improved contribution from surface technologies and continued our emphasis on value pricing. We experienced lower cost zinc flowing through our kettles, although labor costs continue to rise as the craft labor market remains tight. Overall, we were able to drive net income up over 35 percent versus first quarter last year to 21.3 million. While our consolidated bookings were down 13 percent as compared to the first quarter last year, it is important to note During the first half of fiscal year 2019, we booked two large Chinese orders with $45 million in the first quarter and $55 million in the second quarter, and also had a very large international order for welding solutions. We continue to build on the positive momentum in the energy segment with a strong backlog of more than $300 million. This sets the stage for solid performance into the back half of the year, while our metal coatings business continues to gain traction from our key initiatives to drive growth both organically and through acquisitions. The metal coating segment revenue increased 6 percent from the first quarter of last year. Operating margins increased to 24.1 percent compared to 21.9 percent in the first quarter of fiscal 2019. This is due to lower zinc costs flowing through our kettles, value pricing, and the immediate contribution our two acquisitions made in the quarter. We have taken steps to improve labor productivity and are seeing our digital galvanizing system driving greater operational efficiencies and productivity. We remain the industry leader in North America with 41 galvanizing plants. We are pleased to be gaining meaningful traction in our new businesses, powder coating, plating, and galvanized rebar. These make up our AZZ Surface Technologies business group. This gives us growing confidence that our investments will yield positive financial performance in the years to come. Our energy segment high voltage bus business had a strong first quarter, executing on a large contract in China that, along with other Chinese contracts, will continue to be shipped throughout this fiscal year. While some of our electrical serve markets displayed improvement compared to prior year, our oil past businesses are seeing somewhat reduced demand. We are especially pleased with the demand for our specialty welding solutions both domestically and internationally, particularly as our investments in Europe, Brazil, and Canada have positioned us to participate in these opportunities and reduced our dependence on the U.S. nuclear market. We remain somewhat cautious due to the uncertainty related to tariffs and the Chinese trade situation, as well as the tighter market for labor in many of our U.S. locations. Looking forward, we are reaffirming our previously issued fiscal 2020 guidance of earnings per share in the range of $2.25 to $2.75 per diluted share. and annual sales in the range of $950 million to $1 billion, $30 million. And with that, I'll turn it over to Paul Feldman. Paul? Thanks, Tom.

For the first quarter of fiscal year 2020, we reported net revenue of $289.1 million, a $26.9 million increase, or 10.3% greater than the first quarter of fiscal year 2019. Net income for the first quarter of fiscal 2020 was $21.3 million, an increase of $5.6 million, or 35.4 percent greater than the prior year first quarter. Reported diluted EPS rose 35 percent to 81 cents compared to 60 cents in the prior year first quarter. Border 1 fiscal 2020 gross margins improved to 22.9 percent from a 22.4 percent on a year-over-year basis primarily on strong margin performance in the metal coating segment. Operating profit for the first quarter fiscal 2020 grew from $23.7 million in the prior year to $31 million in the current year, representing a 30.7% increase. Operating margins of 10.7% increased 170 basis points compared to 9% in the prior year. Our effective tax rate for the quarter was 21.1%, compared to last year's rate of 22%. As for our segment results, first quarter revenues in our energy segment were up 13.6% to $167 million compared to the prior year of $147 million. Much of the increase in sales can be attributed to high-voltage bus duct shipments to China and a stable domestic refinery turnaround market somewhat offset by lower international refinery revenues as we left a very good prior year quarter. Energy segment operating income increased 26 percent to $12.6 million compared to $10 million in the prior year. Gross profit in the segment improved to $32.6 million in fiscal year 2020 compared to $29.6 million in the prior year. This pushes the gross margin down slightly to 19.5 percent this year compared to 20.1 percent in the prior year first quarter. Operating margins for the first quarter, however, were 7.5 percent compared to 6.8 percent in the prior year. In our metal coating segment, first quarter fiscal 2020 revenues rose 6 percent to $122.2 million compared to prior year at $115.3 million while operating income grew 16.7 percent to $29.4 million compared to the $25.2 million in the same period last year. The increase was due primarily to lower zinc costs and an increase in pricing. Operating margins finished at 24.1 percent for the quarter, up 220 basis points compared to the 21.9 percent for the prior year. Cash flow from operations fell by $6.2 million in Q1 compared to the prior year first quarter, despite higher net income year over year. We normally see the first quarter as a negative cash quarter for the business, and this year was no different. We continued to invest in the business in the first quarter with two acquisitions now operating as part of the metal coating segment and already contributing to the bottom line in the first quarter. We will continue to seek more opportunities like these to continue to properly grow our metal coatings offerings. The risks to fiscal year 2020 that we described in the last earnings call still exist for the year as a whole, but for the most part did not materialize in the first quarter of the year as metal coating margins increased. We did indeed ship high-voltage bus stuff to China, and we are seeing firming orders for the fall turnaround season. With that, I'll turn it back to Tom.

Tom? Thanks, Paul. In closing, we are focused on improving productivity and efficiency throughout the company, continuing to adapt our products to new market opportunities and to develop innovative solutions for our served markets. We remain committed to driving our metal coatings operating margins back to the 23% to 25% range consistently and our energy margins to above 10%. We believe our first quarter performance is an early indication that we've emerged stronger and much better positioned to generate consistent operating results going forward. And now, we'll open it up for some questions.

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw it, please press star, then two. At this time, we will pause momentarily to assemble our roster. Today's first question will come from Joe Franzreb of Sedathian Company. Please proceed.

It's John. Good morning, Tom and Paul. How are you doing? Hey, John. Good start to the year. My first question is, Tom, you kind of characterized this spring as a normal turnaround season. What are your initial thoughts on how the fall turnaround season is shaping up relative to the spring?

Yeah, fall is stacking up to be stronger. And, you know, so we're quoting a lot of stuff already. We're getting some engineering bookings. We're seeing, you know, positive signs as we get closer to the fall season. And that's both domestic and international in that case.

Okay, great. But much of the beat in the quarter actually had come from the metal coating side of the business. So can we talk a little bit, I guess there's a couple of things here. One, K2 and the Tennessee acquisitions, how much in revenue do they contribute to the quarter? And it doesn't sound like they contributed anything to the op income line. Is that true?

Yeah, they were relative there. You know, there are normal bolt-on acquisitions, so relatively small revenue. We were just pleased that they did contribute. And they actually did contribute some operating income, but, you know, given their size, it's not really significant. We just wanted to call it out because the teams did such a great job getting them integrated quickly, giving them the support they needed. And, you know, just really for us, it just shows we're back on track with how we get these deals done and how we bring them into the company. and that we're acquiring good teams and good businesses.

Okay. You know, I'm sure this isn't material time. I'm going to ask it anyway. Just how you characterize the two businesses in the queue, you know, it sounds like K2 is more of a normal regional galvanizer, but Tennessee seems like it has a client base that's throughout the country. Is there a particular reason for that difference? Do they provide? any kind of different services that make them more of a country-wide business?

Yeah, you actually need to flip them the other way, John. KQ Partners is a powder coater and powder coater employer out of close by in North Texas. And then they've got a location over in Tampa. So they do, because they do a lot of automated type powder coating, they do attract business from you know, further away than you normally see from a galvanizing business. Tennessee gal is outside of Chattanooga, Tennessee, and they drop from that southeast market in eastern Tennessee. And, of course, we have a facility up in Nashville that picks up as you go further north.

Okay, fair enough. And one last question. Also in the queue, there was mention of the Westinghouse settlement. I'm wondering if that – if they had revenue contribution in the energy side of the business in the quarter, and kind of maybe just updated us on where that all stands.

Yeah, so we do call it out in the 10Q as part of the contribution on the revenue side. It's not the big contributor, though. We don't call out a number on it, but it's somewhat committed to what that is. In terms of the entire deal with Westinghouse, basically, we've entered into deals with the representative of Westinghouse to clear out the open items that we had filed with the bankruptcy court. So we are pretty much getting to the end of it, and it was a pretty favorable return.

Okay, Paul, thank you very much. I'll get back into the queue.

Our next question comes from John Bratz of KC Capital. Please proceed.

Morning, Tom. Paul. Hey, John. Morning. On the coding side, you called out a couple factors that contributed to the better margins, zinc prices, efficiency, productivity, and so on. Can you give us a little color on, obviously zinc prices can go up and down, but on some of the items that are more sustainable and more your ability to retain these margins in the face of maybe some rising zinc costs? I'm trying to get a better idea of how much real internal progress you're making on the margins as opposed to maybe taking advantage of the lower zinc prices.

Yeah, that's a great question or set of questions. Yeah, zinc costs move around. I think one of the – we have reorganized the sales effort a little over a year ago. And I think that's really taken root. We've tended to bring in more value-oriented technical sales folks and focus that effort on making sure that we're getting paid for the services we provide. Because we do, in some cases, we provide transportation services in other plants. We we do more handling than in others. So we've got about 35 or 38 different services that we consider we offer. So that focus on value pricing is really taking root. I feel good about the team's ability to get paid for the value that they're delivering. And then on the other side, DGS, we've always had a lot of focus on labor productivity, on efficiencies, drive, you know, keep our zinc scrap low, if you will. But I think with DGS, we're getting more instrumentation, more sensors. We're taking paper out of the plants. And when you think about how a galvanizing plant is laid out, you can have, you know, you have routers that are 150, 200 yards away from the office to get them to bring them in and get things inputted. So to me, that's where we're driving the labor productivity and efficiencies because we're now doing a better job using the digital tools that we've been working on for the last couple of years are finally truly coming into play. So I view that as that's what's going to allow the, we've got a great team there now and I feel like they're going to be able to sustain productivity and efficiency with the only caveat to that being that in some parts of the country we are scrambling to get direct labor end to handle the business. But we've done a lot of work on recruiting, retention, motivation, things like that to try to ease the demand for new labor as much as possible.

Assuming zinc stays at current levels, you still have a little bit of a headwind looking forward?

No, we've actually... I meant tailwind.

Yes.

Yeah, okay. Yeah, we do have a little more of a tailwind, and I'd go along with that. You know, we have a hard time predicting the direction of commodity costs like zinc. If you look back over the last few years, usually we'd probably bet wrong if we made a guess. But we feel pretty good. There's zinc supply and demand are kind of rocking in a range, and so we have done some things to keep our zinc predictable, I guess would be the way I like to put it. So as we look forward for the year, we have about six months of zinc inventory in our kettles. So we're getting close to that point where the cost of our zinc is pretty much in the bag by the end of this quarter anyways.

Okay. Tom, you talked a little bit about uncertainty surrounding China and the tariffs. Are those uncertainties or concerns reflecting your ability maybe to bid on new business, or is it issues that confront your customers and hence your ability to work with your customers? What exactly is sort of the uncertainty and concerns surrounding?

You know, a lot of these contracts date back a couple of years, and so, you know, they weren't anticipating anything. things like tariffs. And so, as we've mentioned before, we had switched from having a joint venture over in China to going with a wholly owned manufacturing facility and having that capability of having technicians in country, which allows us to control that better. But, you know, it is 30% tariffs for stuff coming out of the U.S. into China. And we're managing through that with a combination of One, negotiating with the customers, and two, what can we manufacture in-country that's not going to be subject to those tariffs? So I feel like our team there is managing this very effectively, but we keep it at the forefront just because it's a big chunk of our backlog. So making sure that we can generate the margins that we had estimated we were going to get and abide by the contractual commitments for deliveries and not get things hung up in customs. So, you know, the team working on that, they're really good. We've added some good resources in China, and they're helping us. And then our folks in the facility in Medway, they've been doing business in China for quite a while. So while we feel comfortable, we also feel, you know, we feel we should call it out.

Sure, sure. Okay, thank you much.

Again, if you do have a question, please press star then 1 on your telephone keypad. Our next question comes from Noelle Diltz of Stiefel. Please proceed.

Hi. Good morning, and congratulations on a nice quarter.

Thanks, Noelle. Good morning.

Good morning. So I just want to expand a bit on John's question on the metal coating margins. You know, is there any way you can kind of, again, walk us through how to think about how much of the improvement from the fourth quarter to the first quarter came from, you know, zinc versus pricing and then maybe incorporate the headwind from labor? And then, you know, just how are you thinking about – is there any clarity you can give us on how to think about the kettle cost of zinc through the year and if you think these margins and, you know, the 24 – around the 24 percent level are sustainable? Sure.

While we typically don't go too deep into that level of detail, it's pretty close to half and half from some pricing and then some cost reduction just for zinc. I would say that on the pricing, it's more of we've gone in and picked and chosen our pricing and how we're going to price in certain markets, so we're definitely not making blanket statements about the overall market. As far as the zinc pricing goes, one of the things we learned last quarter is that, you know, we do a different amount of zinc in every market, and that can be a little bit different the way it moves up and down. But I'd say going forward, Noel, as Tom alluded to earlier, basically on a comparative basis to the last year from here on out for another six to nine months, you should expect it to be a positive comparison just because you know where the Zip market has come from. And it's been down for the majority of the year. There have been a couple of blips here and there, but I think we're pretty well, I think, predictable is the word Tom used, which I think is exactly the right word to use for the next six to nine months. Now, having said that, we're still keeping an eye on the labor cost, but I would say that we're now getting into that zone that we had committed to get back to earlier. And while it may not be exactly 24, I think that I'm not making a forward-looking statement on exactly what this margin is, But we're back in that 23%, 24% range for a while. Tom?

Yeah, I think the one thing that, you know, as we continue to acquire powder coaters, which so far the ones we've acquired have been, you know, fairly, like I'd have to say as we get more, we start to get some of the same leverage points that we have with galvanizing. So that's one of the reasons we're trying to look at buying powder coaters and platers and building up within certain areas of of a couple of states and then expanding beyond that. But those margins typically would be a little bit lower than our galvanizing margins. And so as we do that, as continuous galvanizing rebar becomes a bigger part of our sales, that's why we're given a range of 23% to 25%. But we feel real good about the galvanizing's ability to be in that range.

Okay, great. think that's helpful. Then in terms of just shifting over to the energy segment, two questions. One, any additional clarity you can provide on the timing of the shipments on the project in China through the year that might drive some variation across the quarters? And second, you mentioned that certain electrical markets are improving. I know you said that the oil patch businesses have weakened a bit, but can you give us a little bit more detail on where you're seeing improvement?

Yeah, I think we now have three enclosure sites from Chattanooga up outside of Baltimore and then over to Kansas. And then we've got the two switchgear plants, one in Missouri and the other up in Oshkosh, Wisconsin. And we feel good about that coverage. So we feel like there's enough market activity that that's becoming, you know, the focus now is more on operational excellence and taking care of customers because we can move load around to some extent. We're far enough apart in some cases that transportation can become a little bit of a burden. But we can at least share resources better than we used to be able to. So we see that transmission distribution market is looking okay for us. We like the activity on data centers, and, you know, that's where I'd say we've adapted some of the things we've been doing in enclosures to go after that type of business and seeing those opportunities. And so that's just a lot of our internal business development is going on, targeting niches, versus the broad market. But we feel good about those. Where we haven't seen a lot of improvement is in medium voltage bus because we had to replace that nuclear portion of the business that isn't available to us anymore with traditional bus business. And that's where there's still a lot of competition out there And Damien hasn't improved enough, at least from my perspective, to occupy the capacity that's available. And then oil patch, those are relatively small business units overall, but we did want to call out the fact the oil patch-related business, which is lighting and tubing, they've just seen a little bit of a slowdown. So that's kind of the range of things we're seeing across those businesses.

Great, thanks very much.

All right.

This concludes our question and answer session. At this time, I would like to turn the conference over to Mr. Tom Ferguson, Chief Executive Officer of AZZ, for any closing remarks.

Yes, thank you. You know, we feel good about how we finished our first quarter. We feel good about where our teams are now positioned. We're building out a leadership bench to ensure that we have the right capabilities as we go forward. We have a lot of good things going on in terms of innovation and pursuing new opportunities. And as we de-risk away from nuclear to some extent, and depend more on our international opportunities and international sales and business development organizations. We feel good about the pipeline of, as I call them, the bolt-on acquisitions and feel good about our ability to focus on those and get them done and get them integrated effectively. So with that, I look forward to finishing out Q2, which My one caution is that is when there's not a lot of turnaround of outages in the season, so this Q2 tends to be a little bit lower, and I just highlight that for you. But then we get into the fall season, which right now looks positive for us. And with that, I appreciate it and look forward to talking to you all on the next call.

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