AZZ Inc.

Good morning, and welcome to the AZZ Inc. Second Quarter Fiscal Year 2020 Financial Results 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. 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 your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Joe Dorme. Please go ahead.

Thanks, Ben. Good morning, and thank you for joining us today to review the financial results of AZZ Inc. for the second quarter of fiscal year 2020, ended August 31st, 2019. On the call representing the company are Mr. Tom Ferguson, Chief Executive Officer, and Mr. Paul Feldman, Chief Financial Officer. After the conclusion of today's prepared remarks, we'll 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 AZV with the 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, and the metal coatings markets. Prices of 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 AZD serves, foreign and domestic, customer requests or delays of shipments, acquisition opportunities, currency exchange rates, 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 over to Mr. Tom Ferguson, Chief Executive Officer of AZZ. Tom?

Thanks, Joe. Welcome to our second quarter fiscal year 2020 earnings call, and thank you for joining us this morning. We are pleased with the continued strong performance of our business groups in fiscal year 2020. We generated 6% revenue growth and 38% net income growth versus prior year. Operating margins improved overall to 9.4%, in spite of about $1 million of tariff and FX impact on the Chinese project shipments during the quarter. Year-to-date, our business is tracking nicely ahead of our plans, which bodes well for the full fiscal year. Our energy segment experienced a normally slow summer season, shipped another portion of the high-voltage bus Chinese orders, and regained operational traction in most businesses. While our energy bookings were down 6% versus second quarter last year, we were lapping a quarter where we booked one of the large Chinese orders, so non-China-related bookings are in the range we expected. The metal coating segment experienced increased demand in the solar and petrochemical markets and contribution from the acquisitions completed earlier this year. The metal coatings team improved operational efficiencies as usage of DGS, which is our digital galvanizing system, continues to grow in our galvanizing plants. We also experienced improved contribution from surface technologies, which now includes eight powder coating and plating plants. We also continued our emphasis on value pricing. While we had lower zinc costs flowing through our kettles, labor costs continue to rise as the craft labor market remains tight. Overall, we were able to drive net income up over 38% versus second quarter last year to $15.6 million. 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 in 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 an aggressive acquisition program. The metal coating segment revenue increased 7.4% from the second quarter of last year. Operating margins increased to 23% compared to 19% in the second quarter of fiscal year 2019. This improvement was due to lower zinc costs flowing through our kettles, value pricing, and the contribution from our emphasis on operational improvement. We have taken steps to improve labor productivity and are seeing our digital galvanizing system drive greater operational efficiency and productivity while also improving customer service. We remain the industry leader in North America with 41 galvanizing plants. We are pleased to be gaining meaningful traction in our new surface technology businesses, which include powder coating, plating, and the galvanized rebar business. This gives us growing confidence that our investments will yield positive financial performance in the years to come. Our energy segment's electrical platform continues to focus on operational execution and improving customer service. While some of their electrical markets are improving compared to prior year, our oil patch businesses are seeing somewhat reduced demand. Profitability was negatively impacted by the tariffs on the high voltage bus Chinese shipments. We are especially pleased with the demand for 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 reduce our dependence on the US 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 US locations. Looking forward, We are raising our previously issued fiscal 2020 guidance of earnings per share in the range of $2.60 to $2.90 per diluted share, and annual sales in the range of $1.2 billion to $1.6 billion. We have completed our third quarter and experienced a very strong turnaround season internationally. We also have the benefit of our recent surface technologies acquisitions, have more Chinese backlog to ship in electrical, and continue to gain traction in our galvanizing business. With that, I'll turn it over to Paul Thurman.

Paul? Thanks, Tom. For the second quarter of fiscal year 2020, we reported net revenue of $236.2 million, a $13.4 million increase, or 6% greater than the second quarter of fiscal year 2019. Net income for the second quarter of fiscal year 2020 was $15.6 million, an increase of $4.3 million, or 38.4% greater than the prior year second quarter. Reported diluted EPS rose 37.2% to 59 cents, compared to 43 cents in the prior year second quarter. Q2 fiscal 2020 gross margins improved to 22.3% from 21.1% on a year-over-year basis, primarily on strong margin performance in the metal coating segment. Operating profit for Q2 fiscal 2020 increased grew from $17.1 million in the prior year to $22.2 million in the current year, representing a 29.8% increase. Operating margins of 9.4% increased 170 basis points compared to 7.7% in the prior year. EBITDA for Q2 fiscal year 2020 increased 10.5% to $33.8 million compared to the second quarter of fiscal year 2019. In early October, we announced that we were rescheduling the conference call for our second quarter fiscal 2020 financial results and delaying the filing of our Form 10Q. The delay was the result of an extensive review of AZZ's historical deferred tax accounting practices. As part of the review, which was concluded in early December, we identified several income tax accounting issues requiring adjustment that spanned several years, going back to calendar year 2012. However, we determined that these errors were not material to any prior period financial statements and that the cumulative effect of correcting these errors in the current period was not material. Accordingly, we corrected the cumulative effect of these tax accounting errors in the second quarter of fiscal 2020, which resulted in a one-time deferred tax benefit of $1.4 million or 5 cents per fully diluted share. Earnings per fully diluted share would have been 54 cents per share without this tax benefit. As for our year-to-date results, year-to-date through the second quarter of fiscal 2020, we reported net revenue of $525.3 million, a $40.3 million increase, or 8.3% greater than the first half of fiscal year 2019. Net income for the year to date ended second quarter of fiscal 2020 was $36.8 million, an increase of $9.9 million or 36.6% greater than the first half of fiscal 2019. Reported diluted EPS rose 35.9% to $1.40 compared to $1.03 in the first half of fiscal 2019. First half fiscal 2020 gross margins improved to 22.6% from 21.8% on a year-over-year basis, while operating profit for the first half fiscal year 2020 grew from $40.8 million in the prior year to $53.2 million in the current year, representing a 30.3% increase. Operating margins of 10.1% increased 170 basis points compared to the 8.4% in the prior year. For the first half of the year, cash flow from operations grew by $21.5 million in fiscal 2020 compared to the prior year as a result of higher net income and working capital performance year over year. Our ratio of free cash flow to net income is also higher compared to prior year. We continue to invest in the business of the second quarter with one acquisition and have announced one additional acquisition in the first month of the third quarter. both now operating as part of the metal coating segment, with both expected to be accretive to the segment this year. We will continue to seek more opportunities like these to continue to profitably grow our metal coatings offerings. As you can see, we are also deploying capital for organic spend and are also still giving capital back to shareholders. Most of the risks to fiscal 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 half of the year as metal coatings margins increased year over year. We did indeed ship high-voltage bus duct to China, but we did see related tariffs for the second quarter, and the fall turnaround season in North America has indeed firmed. With that, I'll turn it back over to Tom. Tom?

Thanks, Paul. We are focused on improving productivity and efficiency throughout the company, continuing to adapt our products to new market opportunities and developing innovative solutions for our served markets. We remain committed to generating metal coatings operating margins in the 21% to 23% range and getting our energy margins to above 10%. We're looking for acquisitions in the surface technologies arena that will generate 18% to 20% operating margins and greater than 25% EBITDAs. We have a very disciplined process for vetting opportunities now that we have built a core leadership team with deep experience in the surface finishing space. The second quarter performance continues to build confidence in our outlook for fiscal year 2020. Additionally, we have invested more heavily in talent acquisition, retention, training, and development to ensure we have the talent necessary to sustain our growth plans. Strategically, our focus is on growing metal coatings organically and on executing our aggressive acquisition program. In energy, we will continue to focus on reducing our exposure to the U.S. nuclear market while maintaining emphasis on domestic opportunities in the electrical enclosure and switchgear businesses. And now, we will open it up for questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-turned phone. If you are using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Noel Diltz with Stifel. Please go ahead. Hi, guys. Morning, Noel.

Morning. So, first, I was just hoping that you could give us a little bit more detail on the acquisitions that you've completed within metal coatings, what those operations do, and the expected revenue contribution. I know you said they'd be accretive, but a little bit more detail would be helpful.

Yeah, I think, you know, we did two in the first quarter, which were one traditional galvanizing Tennessee gal. We also did – the SimCon or K2 Partners, which had two facilities. And I guess the way I'd put it is galvanizing, you know, we're traditionally targeting something in the $10 million revenue range. On the surface technologies, powder coating side, they're smaller. So, you know, we talk about eight facilities, but you'd probably be looking at, you know, call it $3 to $5 million in revenue for a facility. So much smaller just in scope. We typically aren't going to talk too much about individual deals just because, you know, we view our pricing as proprietary. But hopefully that gives you some idea what we're talking about in purpose scope. Sure, that helps a bit.

So then I was hoping we could just shift over to galvanizing, digging in a little bit more, you know, obviously with just, with zinc trends and maybe some of the somewhat more favorable price-cost dynamics, it does seem like you guys should see pretty significant benefit here over the next few quarters. Could you just speak to how you're thinking about those dynamics and how you're thinking about margins now relative to some of the previous goals that you've talked about?

I like galvanizing at about 23%. I think the one cautionary note I'll give is over the holidays, just given the level of absorption, the number of hours we can generate, the reduced number of actual working days, we tend to have a little bit of a negative impact on margins in the fourth quarter for galvanizing for those reasons. Offset to some extent by lower zinc costs going through our kettles. But we're kind of down to a level now of what's flowing through there. I don't see that continuing to decrease a whole lot. Labor costs have been higher, but they've been stable recently. So we had made quite a few adjustments late last year and early this year in terms of wages we were paying to be able to attract the level of talent that we need in our facilities. I remain committed to the 23% on the galvanizing side, and the reason I stated that powder coating plaguing surface technologies are going to run lower than that, as those become a bigger piece of our business, they will provide a little bit of downside pressure to that 23% number across the total metal coatings piece. We are targeting 18% to 20% on average. Some do better. Some do a little bit worse. It takes us a couple of quarters to get them fully integrated on the powder coating side, whereas usually on the galvanizing side, it's almost immediate. And it's just the difference in scale, the amount of operating capability we have in galvanizing while we're still building it on the powder coating plating side.

Okay. And then one last question. I'll get back in queue on galvanizing. Could you just, you know, nice volume there in the quarter. Could you speak to some of the verticals where you're seeing strength versus those that may be a little bit more challenged?

Yeah, we've done well in solar, which has been extremely active. And I'd say petrochemical has slightly strengthened, which is good news. So particularly when you kind of look at a map of where a lot of our locations are in kind of the southeast and Texas and Texas Gulf Coast. So that tends to be strong for us. And then just general industrial, we've done well. We still haven't seen tremendous investment in infrastructure, but in terms of roads and highways, although as you go around here in Texas, you see lots of them under construction. So it's been general, but with heavy emphasis on solar and petrochemical having a lot of positive impact for us. And I'd also say we're doing what I view as a better job of going after new customers in some of these verticals, customers that we haven't done much business with, if any, and being more creative and innovative in how we work with them, So I think there's several things at play when it comes to solar and petrochemical.

Thank you. Once again, if you have a question, you can press star then 1 to enter the question queue. Our next question comes from John Bratz with Kansas City Capital. Please go ahead.

Morning, Tom. Morning, Paul. I'm just following up on the previous question. Was organic sales up in the quarter in metal coatings? Yeah, it was.

Yeah, we actually called out in the deck. Yeah. That's right. I'm sorry, what?

It's actually called out in the deck. Okay, okay. In metal coatings where it says 1%.

Okay, okay, okay, good, okay. And Tom, could you speak a little, you called out specialty welding a couple times and reducing your dependence upon the nuclear market. Can you tell me exactly where that business is going, what end markets you're serving, and sort of the growth opportunities beyond the U.S. and elsewhere in the specialty welding business?

Yeah, that's a great question. We've mentioned it before. We invested probably three or four years ago in Brazil, in Canada. We've continued to expand our Polish facility over in Europe. And so we have a strong presence in Europe, and we're picking up both refinery as well as waste-to-energy opportunities over there. When you come into Canada, Portugal, And Brazil, we're into our more traditional downstream refining, some FPSO work down in Brazil. So it's mostly petroleum-related, and we are the premier provider of automated high-end solutions, particularly for things like coca drums, large refinery reactor vessels, those kinds of things. We've done well in Canada. We've done well in Europe. And we feel good about what's going on in Brazil. We also do very well over in India. And we've recently expanded into China. But it's almost all oil and gas, petroleum downstream.

Okay. What is the competitive landscape in Brazil? especially welding-like. And when you look at the margins currently in that segment, how might that compare to where you think they could be in a couple years?

Oh, boy, that's, you know, part of the issue. We're using union contract labor, which everybody knows what their rates are. So when you go to a refinery, they know what our labor costs are. where we are able to improve price realization, if you will, is on the equipment side. And so the more of the specialty equipment, which is mostly we're taking your common Lincoln and Miller welding equipment and then heavily modifying it with controls, automation, things like that. So That's where, as we can get more equipment on jobs, particularly on these large international jobs, that tends to improve our margins. But labor is, you know, it's seasoned craft labor, pipe fitters and welders. And, you know, so that's just kind of the nature of that market.

Okay. Thank you very much. All right. Our next question comes from John Fransrip with Sidoti and Company. Please go ahead.

Good morning, guys. I apologize if you address these, but I've been bouncing between conference calls. But regarding the tax rate, what should we think about the tax rate going forward, not only in this current year, but into next year?

Well, obviously, this one had a little bit of a blip in the second quarter. But I think for This full year, you should probably be thinking about 22-ish. And the full year for next year, probably about the same. It may jump up to 23. It depends what sort of issues come up next year and what makes itself available in terms of opportunities.

Okay, got it. And regarding the spring turnaround season, what does the incoming order book tell you about how that's shaping up at this point?

Yes, spring is shaping up nicely. Sitting here and knowing how we did for the fall puts us in an interesting situation. Spring looks strong. We've had a lot of activity. There's some carryover in terms of some of the projects we had in the fall that are going to do additional portions of equipment in the refineries, which to me bodes well. It says we performed really well for our customers and that's always a good sign when they're ready to sign up for repeat work in the next turnaround season. So we are seeing some of that deferred maintenance finally come into being and I'd say the spring looks well, looks strong for us.

All right, got it, got it. And I think I mentioned You mentioned in your prepared comments an effort to reduce your exposure in the nuclear market. Are you doing something actively to reduce your exposure, or are you just assuming that the other businesses grow and that business diminishes?

Yeah, I'd say, you know, we've got two pieces that are, well, there were three, but we have two now that are exposed to nuclear. One is the Nuclear Logistics, Inc. business. Uh, we're, we're pretty much just maintaining that business. I, we're, we're not trying to, um, pull away from any customers, so to speak. Uh, but we're also not, uh, not seeking to grow it. So we're just maintaining. And then on the, um, on the specialty welding side, we, we are actively, uh, focused on growing in the non-nuclear. So, uh, I, I don't know that I'd say we're, we're trying, we're walking away from stuff, but, uh, but we're definitely taking refinery projects in favor over and above nuclear.

Okay, so it's asset allocations in the welding side and just leaving NLI as is. Got it, got it. Okay, thank you for taking my questions. All right, thanks.

Our next question comes from Bill Baldwin with Baldwin Anthony Security. Please go ahead.

Thank you, and good morning. Can you offer us some color on what you're seeing in the domestic switchgear and enclosure markets at this point in time and kind of what your thinking is about the longer term outlook, you know, looking out to the coming year? Yeah, I think switchgear is kind of mixed. In some of the larger stuff, we're seeing good activity and Some of the smaller stuff, it's less so. Our outlook is still positive. We like those markets. We've got two facilities focused on it in Fulton, Missouri, and up in Oshkosh, Wisconsin. And so being able to leverage the capabilities of those two facilities, we feel positioned as well for that. So it's kind of – I think the outlook as we go into next year, we're probably more positive than we are right at the moment. In terms of the electrical enclosures, we feel really good about that. The market or the capacity has consolidated, so to speak, and we've participated in doing that with a couple of acquisitions over the last three years or so. That's strong. There's a lot of activity in the e-houses, the data centers, the things like 5G, so So we're bullish on that, and we feel well-positioned. We're in Maryland, Tennessee, and Kansas, so we really don't get too much into the Gulf Coast, so not too much into the oil and gas space. We're mostly focused on the electrical utility, the data centers, and pipeline activity. Very good. Good insight there, and... So what's going on in the medium voltage bus business these days, Tom? You know, they had quite a bit of activity. They were exposed to the nuclear stuff that, you know, some of the plants, the one plant that decided not to go forward. And so we've been moving that capacity into the more traditional, utility and transmission distribution side. It's just okay. It's not a great market. We're looking for more opportunities, if you will. It's not a big facility, but it's a nice facility and a really good workforce. So we're trying to, I guess the best way to put it, we're trying to make lemonade out of lemons. But And we're looking for new opportunities, but it's not robust. And your high-holdings business, can you give us some insight there as to what that market's looking like? Yeah, you know, we still have a lot of backlog in China. The president of that business will be flying back to China probably this weekend. but we also have picked up more domestic opportunities. So, we're seeing that activity. We like that domestic activity. And so, we feel good about that business. And we've got the facility up in Massachusetts. And, you know, it's a very nice facility and well positioned for the opportunities that we see out there right now and the ones we've been participating in. So, So that's in a much better situation than the medium voltage side. And is most of your international business right now in high voltage? Is that the Chinese business, Tom? Yeah, that's pretty much it. We've got a joint venture in Saudi Arabia, but, you know, the activity there is – it's a joint venture, so – But the majority of our international backlog is high-voltage bus in China. Is there much opportunity to grow that business in Europe? No, it's a different market for us. We compete with the European high-voltage bus providers in some of these other international opportunities. but we don't see a lot of opportunity in Europe to go in there.

Okay. Thanks, Bill. Our next question comes from Noel Diltz from Stiefel. Please go ahead.

Did we lose her?

No. I think we might have lost her. Noel, can you star one again to enter the queue?

You may have to jump on the other call. Okay.

All right. Okay. That will end the question queue, and I'd like to turn it back over to Mr. Ferguson for closing remarks.

All right. Thank you. Just a couple of comments before signing off. We answered a lot of good questions. While we remain committed to achieving the 21% to 23% operating margins for our metal coating segment, we're going to be very inquisitive as well, particularly in the surface technology space. Additionally, we are continuing to review our portfolio of businesses based on what is core versus non-core to AZZ's long-term success. We'll announce any divestiture actions as they become likely and probable. So thank you for participating in today's call. We look forward to providing you an update on Q3 in just a few weeks. Thank you.

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