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Edited Transcript of AZZ.N earnings conference call or presentation 9-Jul-20 3:00pm GMT

Q1 2021 AZZ Inc Earnings Call

Fort Worth Aug 24, 2020 (Thomson StreetEvents) — Edited Transcript of AZZ Inc earnings conference call or presentation Thursday, July 9, 2020 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Philip A. Schlom

AZZ Inc. – Interim CFO, VP & CAO

* Thomas E. Ferguson

AZZ Inc. – President, CEO & Director

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Conference Call Participants

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* DeForest R. Hinman

Walthausen & Co., LLC – Research Analyst

* John Edward Franzreb

Sidoti & Company, LLC – Senior Equity Analyst

* Noelle Christine Dilts

Stifel, Nicolaus & Company, Incorporated, Research Division – VP & Analyst

* Sam Rebotsky

* Joe L. Dorame

Lytham Partners, LLC – Managing Partner

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Presentation

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Operator [1]

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Good day, and welcome to the AZZ First Quarter of Fiscal Year 2021 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Joe Dorame. Please go ahead.

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Joe L. Dorame, Lytham Partners, LLC – Managing Partner [2]

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Thanks, Sarah. Good morning, and thank you for joining us today to review the financial results of AZZ Inc. for the first quarter of fiscal year 2021 ended May 31, 2020. Joining the call today are Tom Ferguson, Chief Executive Officer; and Philip Schlom, Interim 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’s 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 29, 2020. 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 political stability and economic conditions of the various markets that AZZ serves, foreign and domestic; customer-requested delays of shipments; acquisition opportunities; currency exchange rates; adequate financing; and availability of experienced management and employees to implement the company’s growth strategies. In addition, AZZ’s customers and its operations could potentially be adversely impacted by the ongoing COVID-19 pandemic. 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, let me turn the call over to Tom Ferguson, Chief Executive Officer of AZZ. Tom?

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Thomas E. Ferguson, AZZ Inc. – President, CEO & Director [3]

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Thanks, Joe. Welcome to our first quarter fiscal 2021 earnings call. Thank you for joining us this morning. Let me first start by saying that COVID-19 is still very much front and center for all of us and was the single largest event affecting our Q1 results. Our top priorities at AZZ continue to be ensuring employee health and safety while supporting our customers during these unprecedented times. As an essential infrastructure manufacturing company, all of our facilities were allowed to remain open and did so. I am extremely proud of the way our folks managed through this crisis during our first quarter and took care of each other and our customers during this pandemic. We are truly grateful for everyone’s efforts that allowed us to continue safe operation of all of our plants worldwide.

For the first quarter of fiscal 2021, total revenues contracted 26.2% versus the same quarter prior year, totaling $213 million, with Metal Coatings revenue declining slightly, 2.6% to $119 million and Energy revenue declining 43.5% to $94 million. I will get into the details behind each segment’s performance as we go along.

We entered Q1 back in March with great enthusiasm just as the pandemic was beginning to reach our shores here in the U.S. by April, when we announced record sales and strong adjusted earnings for fiscal 2020, we made the decision to suspend fiscal 2021 guidance and cited the uncertainty COVID was creating on both segments, Metal Coatings and Energy. In particular, we pointed out uncertainty in the spring refining turnaround season, business disruption associated with our high-voltage bus orders in China and overall weaker demand as customers implemented capital spending and social distance and guidelines.

Normally a strong quarter for us, our first quarter ended up being as — or perhaps, even more challenging than we had imagined. Refiners shut down production, delayed both CapEx and maintenance spend and essentially took a pass on the spring turnaround season. International travel was restricted, and businesses significantly slashed capital spending. As a result, our revenue declined 26% in the quarter, while net income slid to $5.5 million or $0.21 per diluted share.

I wouldn’t normally call a 2.6% reduction in our Metal Coatings business a bright spot. However, with the backdrop of this challenging market, I’d say we performed much better than many probably expected. Sales totaled $119 million for the quarter as compared to $122 million for the same quarter a year ago. Our galvanizing team, in particular, was able to benefit from lower zinc costs while maintaining above-average industry pricing by offering outstanding quality and outstanding customer service.

While overall margins in the segment declined 300 basis points to 21.1%, galvanizing actually finished above 23%, pretty close to where they finished last year. The overall decline in our Metal Coatings margins was due primarily to lost operational efficiencies within our surface technologies plants as some had to shut down due to a temporary loss in volume from customers. We remain committed to our strategic growth plan for the Surface Technologies business and driving meaningful margin improvement post COVID-19 crisis and are also seeing improving market conditions as most customers have now reopened.

Our Energy segment first quarter fiscal ’21 revenue decreased 43.5% to $94 million, resulting in an operating loss of $1 million as compared to $12.6 million positive in the same quarter a year ago. As I mentioned previously, the decline in revenue was a result of a lack of a spring refining turnaround season, delays in bus shipments and service work resulting from COVID-related international business restrictions and overall weaker demand for electrical products.

While our industrial platform shops were open and working, very few crews were deployed during the normally busy spring season. In some cases, we had to get our crews home from international projects in countries that went on lockdown after crews had already been deployed, which caused additional expense and disruption.

Due to the prolonged uncertainty associated with the recent COVID-19 pandemic on many of our end markets, we cannot accurately provide an update at this time to our previously suspended fiscal ’21 earnings guidance range of $2.65 to $3.15 and sales guidance range of $970 million to $1,060,000,000. Neither the duration nor depth of this disruption can be accurately estimated at this time. We have adjusted capital spending plans, operating plans and headcount and have taken other mitigating actions in response to the crisis. Our low debt level, combined with our consistent ability to generate cash, gives us the confidence that we can manage both debt and liquidity satisfactorily throughout fiscal year ’21 and beyond. We hope to be able to reestablish our financial guidance as we get to the back half of this fiscal year. In the interim, we will work to provide as much context to our outlook as possible. So in that regard, the summer is a normally slow season for our industrial platform and shipments remain slower than normal for electrical as many customers have not returned to normal operations yet.

Our Metal Coatings business is operating at a fairly normal level, although there are restrictions in some of the states we operate in. We are also experiencing additional expense as we work to keep our facilities clean and safe, so our employees remain healthy and productive.

We are confident that our businesses remain vital to improving and sustaining infrastructure, so we will use this time of global pandemic to position our core businesses to emerge stronger and better equipped to provide sustainable profitability long into the future.

With that said, I’ll turn it over to Philip.

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Philip A. Schlom, AZZ Inc. – Interim CFO, VP & CAO [4]

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Thanks, Tom. I’d like to begin by also thanking our employees for supporting the business as we remain fully operational throughout the first quarter, an initial peak period of the COVID-19 pandemic. I’ll start by discussing the first quarter fiscal year 2021 financial results, and then we’ll provide an update on our liquidity, given the importance of maintaining a strong balance sheet in this environment.

For the first quarter of fiscal year 2021, we reported revenues of $213.3 million or 26.2% below the prior year first quarter revenues of $289.1 million. We believe the decrease was attributable to the multifaceted impact of COVID-19 that it had on our business, our customers and our suppliers.

Net income for the first quarter of fiscal 2021 was $5.5 million, a decrease of $15.8 million or 74.2% below prior year’s comparable first quarter. Reported diluted earnings per share of $0.21 was $0.60 lower than the $0.81 achieved in a strong prior year first quarter.

Q1 fiscal 2021 gross margin was 19.8%, 310 basis points lower than the 22.9% in the first quarter of 2020. Q1 fiscal 2021 operating income of $14.3 million was $16.7 million or 53.8% lower than the prior year first quarter. Our operating margin for the first quarter was 6.7%, 400 basis points lower than the 10.7% in the prior year first quarter.

On reduced pretax earnings, income tax expense of $4.7 million was $1 million lower than the $5.7 million recognized in the first quarter of the comparable prior year. However, our effective tax rate for the quarter increased to 45.8% compared to 21.1% in the prior year first quarter. The increase in our effective tax rate is associated with the establishment of reserves for uncertain tax positions related to research and development tax credits as well as incurring operating losses in foreign jurisdiction in which we were not able to recognize the benefit for U.S. tax purposes at this time.

I will now turn to the results of operations within our Metal Coatings and Energy segments. In our Metal Coatings segment, comprised primarily of our Galvanizing Solutions, Surface Technologies and Galvabar businesses, we generated first quarter 2021 reported revenues of $119 million, which were $3.2 million below the $122.2 million in revenues recorded for the first quarter last year.

Metal Coatings segment operating income of $25.1 million was $4.3 million or 14.7% lower than the $29.4 million achieved in the same quarter last year. Segment operating margins were 21.1%, down 300 basis points as compared to 24.1% in prior year first quarter.

While the Galvanizing Solutions gross margins exceeded 23%, the overall reduction in operating margins in the segment was due to lower productivity and higher costs of remaining open during the pandemic in the Surface Technologies business, which is more significantly affected by temporary closures or significant slowdowns due to the pandemic. Partially offsetting these higher costs was the favorable impact of lower zinc costs flowing through our kettles in the Galvanizing Solutions business.

In our Energy segment, reported revenues of $94.3 million were $72.7 million or 43.5% lower when compared to the $167 million generated in the prior year first quarter. As Tom had mentioned, our Industrial Solutions platform was impacted significantly as domestic and international customers shut in operations and several countries restricted travel. The Energy Electrical group was impacted by lower incoming bookings and worked down backlogs while customers adapted to the pandemic.

As a result of the unprecedented market conditions, the Energy segment incurred an operating loss for the first quarter of $1 million compared with operating income of $12.6 million in the prior year first quarter. Energy segment gross profit of $12.6 million was $20 million below the prior year first quarter. Gross margin was 13.3% compared with 19.5% in the prior year as a result of the COVID-related disruption in the segment. Segment operating margins in the first quarter were a negative 1.1% compared to 7.5% in the same quarter last year and was mostly attributable to the loss of the spring turnarounds within our Industrial Solutions platform. This is a cyclical business with a typically strong first quarter that carries into June of each year and then again peaks in our third quarter.

I will now turn to our balance sheet and liquidity discussion. The company typically experiences negative cash flows during the first quarter. This year was no different. However, net cash used in operating activities during the first quarter improved $6.7 million from a use of cash in the current quarter of $11.2 million compared with our use of cash of $17.9 million in the prior period. Capital spending in the first quarter was $10.8 million compared with $4.7 million last year. The company continues to fund growth initiatives, ongoing safety and maintenance-related capital spend. Our net debt position at the end of the first quarter was $219 million, $78 million or 26% lower than the $297 million at the end of the prior year first quarter as we continue to generate strong cash flows from operations.

In light of COVID-19, we assessed our liquidity position. And while not all-inclusive, we have taken the following actions: we did not draw down on our revolver to place cash on our balance sheet; we did temporarily suspend payments on our revolver; we elected to accumulate cash in the quarter, which we are now utilizing to repay borrowings; we did not repurchase shares in the quarter, however, we intend to again evaluate share purchases in quarter 2 under our current share repurchase program; we continue to pay dividends to our shareholders; and we remain diligence around the customer credit and collections.

As a result of our diligence, we have been able to navigate through our traditional negative cash position in the first quarter and COVID-19 without any significant deterioration to our strong balance sheet. We remain well within all boundaries on our existing debt covenants and continue to reduce uncertainties within our balance sheet and evaluate our capital structure.

I’ll now turn it back to Tom for his closing comments. Tom?

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Thomas E. Ferguson, AZZ Inc. – President, CEO & Director [5]

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Thanks, Philip. Just as I did on our previous earnings call, I want to share with you some key indicators that we are paying particular attention to.

For the Metal Coatings segment, fabrication activity remained solid in Q2, but we are seeing some reports of steel shortages.

Within our Galvanizing business, we are carefully tracking steel fabrication and construction activity. Zinc costs remain low, and the cost of zinc in our kettles continues to drop.

For Surface Technologies, we are primarily focused on getting back to normal production levels with both existing and new customers by the end of Q2 fiscal ’21.

Within the Energy segment’s Industrial Platform, we are seeing the fall turnaround season beginning to fill in, particularly in international markets. We are carefully monitoring the COVID situation in the states with large refining capacities domestically. Currently, we are in the normal seasonally slow summer months and still have travel restrictions in some countries.

For the Electrical group, we are carefully tracking proposal activity and expect bookings to increase in the second quarter and beyond, which should provide sufficient backlog for many of our business units in the back half of the year. For tubing and lighting, which make up a small portion of our Electrical group, we are looking for signs of life and rig activity but have already taken significant furlough actions.

Finally, for corporate, we have very good cash management processes and have further tightened our oversight on cash flow indicators and customer credit. Currently, we are not seeing any slowdown in customer payments.

Post COVID-19 crisis, we remain committed to our growth strategy around Metal Coatings in achieving 21% to 23% operating margins, including a growing contribution from Surface Technologies. We believe Galvanizing would tend to run to the high end, if not above the 23%, while Surface Technology should be able to consistently generate 15% to 20%. We were initially operating Surface Technologies somewhat separate from Galvanizing to ensure the new facilities could be incubated without distracting the galvanizing team. They are now operating fully on Oracle, which allows full integration with the galvanizing plants fairly easy. We believe the integration will now allow the outstanding galvanizing resources to be brought to bear to increase sales penetration, drive operational efficiencies and leverage the seasoned business development resources that they have.

For Energy, we will continue to focus on our core businesses and seek to divest things that are not core to our future strategic interest. Most of our Energy business units are experiencing a relatively modest level of disruption due to the COVID crisis, and we are taking the opportunity to rightsize operations and align them with expected demand post crisis. We have run numerous models around downside and even severe downside scenarios and do not currently see anywhere whereby we do not maintain a reasonable level of liquidity throughout the year.

The diversity of our customer base and scale of our galvanizing operations are providing a very sustainable level of income and cash flow. Our electrical businesses, for the most part, have fairly good backlogs to work with, but customers are delaying deliveries to some extent. While our industrial platform carries a certain amount of fixed cost, the majority of their craft labor pool is variable.

And finally, our cash management discipline, credit line with first tier banks, low debt levels and ability to react quickly to the changing market dynamics positions us well during these uncertain times.

We will remain active in the area of M&A with activities that support our strategic growth initiatives, particularly in Metal Coatings. While pandemic-related deal travel was restricted in Q1, we do see improving conditions and have an active portfolio of opportunities to pursue.

With that, we’ll open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question will come from John Franzreb with Sidoti & Company.

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John Edward Franzreb, Sidoti & Company, LLC – Senior Equity Analyst [2]

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I’d like to start with the Energy segment. Last quarter, you indicated that there were jobs that were being deferred into the second quarter and actually also into the third. I wonder if you can give us an update on those jobs that were deferred from Q1 into Q2. Are they still happening?

Also, is your expectations that with those jobs being pushed to the right that Energy revenues will be kind of flattish sequentially? And if so, have you taken enough cost out to keep the business in the black?

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Thomas E. Ferguson, AZZ Inc. – President, CEO & Director [3]

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Yes. You got a couple of things there, John. One, we did have — on the industrial side, there’s only a few active projects going on right now because the continued travel constrictions in a lot of areas. And places like India haven’t really — we’re hoping that by the end of the summer, they open up. There’s some activity there that we would hope to be able to deploy to.

So it has pushed to the right. It’s kind of pushing to the end of Q2. And as I mentioned, for Q3, for the fall season, it is starting to fill in, particularly internationally. Domestically, with the rise in COVID cases, we’re watching carefully to see what refineries decided to do for the fall. So we don’t have any really good indication of which way that’s going to go domestically, but good news on the international front.

On the electrical side, they’ve had orders pushed in terms of deliveries because customers aren’t deploying inspectors. They aren’t making — customers aren’t making decisions on final — accepting final deliveries, things like that. So that continues to push. So I think I haven’t — I should have, and maybe Philip knows, but sequentially, for Energy, I think we’ll do a little better than Q1. But versus prior year, probably a little lower than prior year on the Energy side.

And we have — we’re still looking at costs, and we’re still realigning things. We’ve taken quite a bit of action, 10% to 15% on the headcount side in the Energy piece; some on the Surface Technology, mostly furloughs, while we wait for some of the large customers to reopen their plants, which is starting to happen. So we feel fairly good. And on the Metal Coatings side, particularly Surface Technologies, by the end of the quarter, I think things would be fairly normalized again. That’s the indication we’re getting from customers, that they’re starting to ramp their production back up in some key areas. And we will continue to look at the cost side if we don’t see the backlogs improving. So we’re committed to do that.

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John Edward Franzreb, Sidoti & Company, LLC – Senior Equity Analyst [4]

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Okay. Fair enough. And you mentioned that the Metal Coatings is operating at, I think you said, normal or close to normal levels. What’s driving that? Can you just provide some color on what’s good in Metal Coatings?

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Thomas E. Ferguson, AZZ Inc. – President, CEO & Director [5]

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It’s — I think on the galvanizing side, it’s that diversity of locations and customer base, over 3,000 customers that we deal with. So it’s kind of a normal season. We’ve got areas that are slow and other areas that are really, really active. And here’s the good news. The fabricators right now are pretty busy and continuing on with projects. I noted their biggest concern is access, steady access to steel supply. On the solar side, we’ve seen really, really good activity there. That’s — those projects are continuing, and we’ve got a good position there. And then we’ve seen good activity in the transmission pole market.

So where it’s fallen off is things that we don’t — I mean they’re a decent part of our business, but stadium construction and that kind of thing, walkway rails, and that steps a little off, and so a real mixed bag. But overall, we feel pretty good. And the customers are saying, as long as they can get steel, their projects are going to continue. Solar is going to continue. So highway, bridge, at least in most parts of the south, is continuing. So — and that’s our concentration of galvanizing plants, is sort of somewhat to the east, but mostly in the Midwest, Upper Midwest, over into the Rockies, out to Nevada and Arizona and then down through the Southeast in Texas. So we’re just positioned pretty well with most of those states, even though they’re seeing, like here in Texas, a rise in COVID cases. The — you still see tons of road crews out there, and most cities and the states are repairing stuff and continuing on with projects while there’s still not tremendous activity on a lot of cars on the road. So those things, that’s why we’re fairly normal, I guess, you’d call it.

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John Edward Franzreb, Sidoti & Company, LLC – Senior Equity Analyst [6]

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Just to follow-up on that last thought, Tom. I’m based in New York City. I don’t have a good sense of what’s going on down there with the rise in COVID cases. Is there any discussion or thoughts about potential business disruptions? Or is it more likely that it seems like you and your customer is going to push on through this?

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Thomas E. Ferguson, AZZ Inc. – President, CEO & Director [7]

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Yes. I think we’re seeing and we’re going to push on through. The one concern would be if we see in the — in what’s normally the busy driving vacation summer months, if the refineries aren’t seeing that demand for gasoline grow, then do they pull their turnaround? That’s really our only concern. The rest of it, businesses are focused. They’re moving forward. Construction is going on. You see crews everywhere. So we feel pretty good about that. We’re in the states we’re located in. So it’s maybe kind of peculiar to us, but it’s our geographic positioning for galvanizing that makes us…

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