AZZ Inc.

Good day and welcome to the AZZ Inc. Third 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 touchtone phone. 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.

Thank you, Sarah. Good morning, and thank you for joining us today to review the financial results of AZZ Inc. for the third quarter of fiscal year 2020, ended November 30, 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 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 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 delay 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 ACZ 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?

Thank you, Joe. Welcome to our third quarter fiscal year 2020 earnings call. Thank you for joining us this morning. We are pleased with the continued strong performance of our business groups in fiscal year 2020 as a direct result of successfully implementing our strategic growth initiatives. We generated 22% revenue growth and 43% net income growth in the third quarter versus prior year. Operating margins improved overall to 11.5% with strong performance by both business segments. Our energy segment experienced a strong fall turnaround season, continued shipping the Chinese high voltage bus orders. Our energy team did a good job of focusing on operational execution for improved margins. Our bookings in the third quarter of $264 million were up 25% year-over-year, driven by improving market conditions in welding solutions, electrical enclosures, and domestic high-voltage bus. We continue to build on the positive momentum in the energy segment with strong third quarter bookings of $134 million, an increase of 32% versus last year. The metal coating segment experienced increased demand in the solar and petrochemical markets and contribution from the acquisitions completed earlier this year, resulting in improved volumes across most of our regions. We experienced continued revenue growth from our surface technologies group, which now includes eight powder coating and plating plants. On a consolidated basis, we were able to drive operating income up over 47% to $33.4 million versus third quarter of last year. The metal coating segment revenue increased over 20%, and operating income of $27.3 million was up 49% versus prior year. Operating margins increased to 21.1% compared to 17% in the third 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. offset somewhat by the growing impact from surface technologies, which currently operates at a lower contribution margin level. The metal coatings team improved operational efficiencies as usage of DGS, which is our digital galvanizing system, continues to be implemented throughout all of our galvanizing plants. 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, powder coating, plating, and galvanized rebar. This gives us growing confidence that our investments will yield positive financial performance in the years to come. Overall, our energy segment had a very good quarter with operating income of $17.4 million, an increase of 51% over prior year, demonstrating great leverage on the 23% revenue growth. Our energy segment's electrical platform continues to focus on operational execution and improving customer service. While some of their electrical markets, particularly for electrical enclosures, are improving compared to last year, our lighting and tubular products businesses are seeing reduced demand due to slower upstream production activity. During the quarter, we booked a nice domestic order for high-voltage bus. 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 reduced our dependence on the U.S. nuclear market. Our upgraded welding technology is earning us large new opportunities, and our teams are performing extremely well, which will help us maintain our differentiation in the downstream markets. Just to recap how we are doing year-to-date, overall our revenue is up 12.7% and net income up 37% versus prior year. Our metal coating segment has completed four acquisitions, resulting in the addition of one galvanizing plant and five surface technology plants. Year-to-date, our metal coating's revenue is up 11%, and operating income up 30% versus prior year, driven by both organic and inorganic growth. Our energy segment's revenue is up 14%, and operating income up 33% versus prior year, driven by growth at welding solutions and China high-voltage bus projects. We will continue to focus on AZZ's core strengths of customer service, productivity, and operational excellence. Looking forward, we are maintaining our previously issued fiscal 2020 guidance of earnings per share in the range of $260 to $290 per diluted share, and annual sales in the range of $1,020,000,000 to $1,060,000,000. And with that, I'll turn it over to Paul Fellman.

Paul? Thanks, Tom. For the third quarter of fiscal year 2020, We reported net revenue of $291.1 million, a $51.6 million increase, or 21.6 percent greater than third quarter of fiscal year 2019. Net income for the third quarter of fiscal 2020 was $22 million, an increase of $6.6 million, or 43.1 percent greater than the prior year third quarter. Reported diluted EPS rose 42.4 percent to 84 cents, compared to 59 cents in the prior year third quarter. Third quarter fiscal 2020 gross margins improved to 23.1% from 20.8% on a year-over-year basis, primarily on strong margin performance in the metal coating segment. Operating profit for Q3 fiscal year 2020 grew from $22.8 million in the prior year to $33.4 million in the current year, representing a 46.8% increase. Operating margins of 11.5% increased 200 basis points compared to 9.5% in the prior year. EBITDA for Q3 fiscal 2020 increased 34.4% to $46.8 million compared to the third quarter of fiscal year 2019. As for our year-to-date results, Year to date through the third quarter of fiscal 2020, we reported net revenue of $816.5 million, a $91.9 million increase or 12.7% greater than the same period in fiscal year 2019. Net income for year to date ended third quarter of fiscal 2020 was $58.9 million, which was an increase of $16.5 million or 39% greater than the same period in fiscal 2019. Reported diluted EPS rose 38.3% to $2.24 compared to $1.62 in the same period of fiscal 2019. Year-to-date fiscal 2020 gross margins improved to 22.8% from 21.4% on a year-over-year basis while operating profit for year-to-date fiscal 20 grew from $63.6 million in the prior year to $86.6 million in the current year. representing a 36.2 percent increase. Operating margins of 10.6 percent increased 180 basis points compared to 8.8 percent in the prior year. For the year to date, cash flow from operations grew by $14 million in fiscal 20 compared to the prior year as a result of higher net income offset slightly by higher working capital year to date. We continue to invest in the business in the third quarter with one acquisition now operating as part of the metal coating segment and is 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're also still deploying capital for organic spend and are still giving capital back to shareholders. 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 developing innovative solutions for our surf 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 will continue to acquire galvanizing businesses and look for acquisitions in the surface technologies arena that will generate 15% to 20% operating margins. and greater than 25% EBITDA. We have a disciplined process for vetting opportunities and have built a core leadership team with deep experience in the surface finishing space. The third quarter performance continued to build confidence in our outlook for fiscal year 2020 and beyond. 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. We've also increased our emphasis on the environmental sustainability, and we'll be making significantly more information available to our investors in this regard. 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 increasing emphasis on domestic opportunities in the electrical enclosure and switchgear businesses, as well as growing our welding solutions internationally. and now we will open it up for questions.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, 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 John Franzreb with Sidoti and Company. Please go ahead.

Good morning, Tom. Hi, Dylan. Good morning, John. John, hi. I guess I want to start with the high-volume bus stock business in China. Could you kind of remind me the duration of that project and how the distribution of revenue or recognition of revenue is going to be in that business in China?

Yeah, john, we're kind of losing you there. We've got some interference on on your phone. But to answer what I think you asked, it's actually several high voltage bus orders in China, they spread over a couple of years. So we still you know, we've shipped a good chunk of that backlog, we still have some of it left that will go into the next fiscal year. And then we'll be providing support for that even beyond next fiscal year. So And then, of course, we're looking to hopefully book some more opportunities. And as I mentioned, we also did book a nice domestic order, which tends to help us in our Medway facility.

Got it. I apologize for the interference. And switching over to the metal coating side, how much is surface technology of total quarterly revenue, either on a percentage basis or total?

You know, it's sub-10%. It's probably in the 5% or 6% range, maybe 7%. And part of that is we completed some acquisitions in the quarter, and we had just completed some coming into the quarter. So those are having – they will have a growing impact going forward. On an annual basis, it's still going to be – somewhere between 5% to 10% as we go forward next year.

Got it, Tom. And one last question. Tax rate's been jumping around. Can you kind of help us out there on what we should expect not only for this year but into next?

Right. So the third quarter here, this is a return to provision adjustment for the tax return. So that drove it up a bit. That's just kind of a normal occurrence late in the year. in any tax cycle. For the year, we're going to leave it about where we were at the last call, which was 22% to 23% for the year. That hasn't moved. So you were under in the second quarter. You're a little bit over in the third quarter. But we still expect that 22% to 23% for the full year, John.

Got it. Got it. Thanks, guys. I'll get back into queue. All right.

Our next question comes from Noel Diltz with Stifel. Please go ahead.

Hi, thanks, and good morning. Congrats on a good quarter.

Yeah, good morning.

Morning. Morning. So I was just hoping that you could comment a little bit on how you're thinking about the metal coating margin profile moving forward. You know, give us a little bit of a sense of how to think about those investments that you're making in the galvanized rebar and surface technologies. and kind of when you think those start to roll off. So how to think about the margin profile as we head into the fourth quarter and next fiscal year. Thanks.

Yeah, Noel, galvanizing is still the vast majority of the segment. And as we've talked about it, it's been holding in the 22%, 23% range for galvanizing. As we're doing these surface technology acquisitions, we're still targeting those to be near 20% over time. But unlike galvanizing, where we have tremendous operational capability to bring to bear immediately on an acquisition, here it takes us a little bit longer, I think, to bring the margins up. And so we're looking for things above 15%. And then over time, get those up closer to 20. But in the fourth quarter, the surface technology is still a relatively small piece of the segment. So while I think they're the margins will likely be a little, well, they're probably going to be relatively close to third quarters. Paul, I don't know if you want to add to that.

Yeah, Noel, they've been performing pretty well, as Tom pointed out in his discussion earlier, too. We had some costs involved there in the third quarter, some probably one time as we're bringing these businesses on. But he's spot on the money with the But the percentages, and I think you should expect to see about the same-ish in the fourth quarter.

Noel, I'll add one thing on that. One thing we did learn in the quarter is that as you kind of come into the late fall, winter season, that tends to be the downtime for some of these powder-coating plating businesses. So probably the better time to buy them would be in the spring and summer season. Okay. So as Paul's talking about some of those costs, it relates to kind of buying in in the down season.

Thanks. That's helpful. And you guys spoke about some of the end market verticals that exhibited strength in the quarter, solar and petrochem in particular. Could you expand upon what you're seeing in some of the other markets, particularly and how you're thinking about them into 2020, and also on the 2020 and 2021 outlook, curious how you're thinking about solar, given some of the uncertainty around the tax credit.

Yeah, I think, you know, generally the industrial markets, construction and bridge and highway, things like that, have been relatively solid in our metal coating segment. As we're getting into other surface technologies, it's taking us into more of the OEM markets and some of the other things. So that'll start to have a growing impact. And those look pretty good going into next year. Our guys feel pretty good about solar. But I'd say that's specifically around our customer base that serves that market. So in terms of the general tax credits and things like that, what impact that's going to have, I think that's yet to play out. But right now, the customers we have are feeling fairly optimistic for next year. And then we look for continued petrochemical. We'd love to see some more spend on infrastructure, particularly bridge and highway, but we're But we're kind of forecasting that, or our outlook is kind of about what it was this year, which wasn't really robust, but wasn't bad. But in general, our overall industrial markets, as we're looking for this quarter, which we're already well into, and looking into next year, are, I'd say, solid. I won't say robust, and I won't say weak. So they're kind of trending normal.

Okay, great. And then just one last question for me. Any comments on how the spring turnaround season is shaping up at this point?

Yeah, it looks really solid. You know, some of the – I mentioned some of the technology we've deployed, and it's being very well received in the marketplace. So there's some continuing or, you know, some things from the fall that are going to start again in the spring. So we're feeling really good about that spring season coming up.

Great. Thank you.

Again, if you'd like to ask a question, please press star, then 1. Our next question is a follow-up from John Franzreb with Sedodian Company. Please go ahead.

Yeah, just to follow up on the Wells question on the spring turnaround season, would you expect the spring season to be as good or better than the fall season you're coming off of? Because you really had a strong one this fall. Or, you know, just on a relative basis, how should we think about it?

We don't have – we look for it to be strong. Where I'm going to be a little cautious is we don't have a mega project like we had in the fall. that's being teed up for the spring. So while the activity is really, really strong, it's probably not going to be quite as good as the fall, but it's probably going to be better than last spring.

Perfect. I think that's great. Okay. When I think about the high-voltage bus stock domestic job that you just got, Is it fair to assume that that job would be a higher margin on business than the Chinese high voltage work? Yeah, that's a good assumption. Okay. All right. I guess that's it for me. Thank you, guys. I appreciate it. All right.

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

Thank you, and good morning. Good morning, Bill. Tom, could you remind me again what your differentiating core competencies are in the specialty welding segment of the market that you're doing so well in? What are the core competencies of AZZ there to differentiate you from the competition? Yeah, we've got the longest and largest track record, if you will, in in the really big complex things like coker drums, large reactor vessels. So when you get into the really big vessels that are critical to refinery operation, that's where our welding technology, our teams, our track record, our references come. are just vastly more and better than anybody else out there. So regardless of where those are in the world, that tends to be our sweet spot. So what we have done is we've continued to invest in that technology. moving to, and this is all custom. We take the standard Lincoln Miller welding equipment, and then we customize it significantly with our controls, our video equipment, and then deploy it. So our differentiation is with that customized equipment and in our experience. Okay. Thank you. Could you comment on what the outlook looks like for the markets for your electrical enclosure and your switchfield business, what you're seeing out there looking out over the next year or so? I think the enclosure market, we've got three facilities serving that, Chattanooga, Millington, which is outside of Baltimore, and in Pittsburgh, Kansas. We're in the Midwest and the East Coast. And, you know, those markets are strong. We've got a really good customer base. A lot of the major outfits are, you know, we've got purchase – I guess I'd call them – they're not really blanket agreements, but supply agreements with. And so we're looking at that being – being solid to pretty good next year. And part of that's just our presence, where we're at, what we've done to improve our operations, focus on customers. Switchgear, I think the bigger stuff out of Fulton is looking pretty good. We've got a really good backlog there going into the year and look to continue to grow that. On some of the smaller stuff, I think it's a little bit softer, but okay. What drives that smaller switchgear market, Tom? What are the main applications there? That's the industrial stuff instead of the utility grade. Okay, industrial. Okay. Yeah, yeah, so that's. That's where we get into a much broader set of customer opportunities, but it tends to drive off of that industrial spend. We just need a better spending on the manufacturing side of the economy, it sounds like there. We do. We need to have a little pickup there. We were doing good coming into this past year, but coming into this year, it's a little bit softer. Right. Okay. Well, thank you much, and... Good job with what you guys are doing there. All right. Appreciate it, Bill.

Our next question is a follow-up from Noel Diltz with Stiefel. Please go ahead.

Thanks. Just was wondering if you could comment on the lighting and tubing businesses, you know, with those businesses continuing to face some challenges. How are you thinking about those operations as a part of your portfolio from a strategic standpoint?

You know, our lighting business, we had converted the LEDs early in the cycle, going all the way back to probably 2013 and 2014. And so, you know, we look at that. We've got good technology, good application base, and we have broadened the market to differentiate away from just the oil patch to get into food processing and things like that. So we still feel really good about that. We've got good technology. We've got a good cost structure in that operation. And we've also expanded some representation outside of the country to pick up some international opportunities. So we feel good about the lighting business in terms of looking forward and how we're positioned. And so even while their volume's off a little bit, they're very profitable. On the tubing side, you know, that's our heritage. I call it the roots of the company in the tubing side. So it's not a big piece of business. We've got a really good team that's in that operation. And if we can find – we only need to find, you know, $2 million or $3 million of incremental volume to make it nicely profitable. So – You know, we look at that, and neither of these businesses, I mean, between the two of them, I like both of them because I like the operating teams. I like where they're positioned. And so any uptick in the oil patch would benefit that tubing business nicely. So I feel good about the outlook, and quite frankly, you know, they're both working to drive profitability in those operations.

Okay, makes sense. And then quickly, could you comment on what you're seeing in the electric transition and distribution markets, both on the galvanizing side and then with some of the switchgear equipment and enclosures?

Yeah, it's kind of just stable, if you will. I'd hesitate to, you know, it's really stable to... to maybe slightly off as we look forward on the galvanizing side. But we have a broad customer base there, so we're chasing opportunities. On the electrical side, it's good, and we look for it to remain that way. We still think there's a nice run on the T&D side for the electrical enclosures and switchgears.

Great, thank you.

All right.

This concludes our question and answer session. I would like to turn the conference back over to Mr. Tom Ferguson for any closing remarks.

Thank you, Sarah. I think just a couple of comments. We covered most everything between our scripts and the questions. But just a reminder, we're committed to driving 21 to 23 percent operating margins for that metal coating segment. inclusive of whatever acquisitions we do and as we continue to grow the service technologies piece. So we're going to remain acquisitive, and then we are continuing to review our portfolio of businesses and decide what is core and not core as we look forward. So we'll continue to keep you informed as we make decisions there. Thank you very much for participating in the call and look forward to talking to you in just a few months about our full year and Q4.

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