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AZZ Inc (AZZ) Q1 2020 Earnings Call Transcript

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AZZ Inc (NYSE: AZZ)
Q1 2020 Earnings Call
Jul 8, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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. (Operator Instructions) Please note, today's event is being recorded.

At this time, I would like to turn the conference over to Joe Dorame; Managing Partner, Lytham Partners. Please proceed.

Joe L. Dorame -- Managing Partner

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 31, 2019. On the call, representing the company are: Mr. Tom Ferguson, Chief Executive Officer; and Mr. Paul Fehlman, 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 would 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 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 market, the industrial markets -- 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 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?

Thomas E. Ferguson -- President and Chief Executive Officer

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% in net income growth versus prior year. Our energy segment had a fairly normal spring turnaround season, shift the portion of the high voltage bus, Chinese order that pushed out of the last quarter and regain operational traction in most businesses.

The metal coatings segment experienced increased demand in the solar and petrochemical markets and contribution from the acquisition of Tennessee Galvanizing in K2 partners. Overall we generated $289 million in revenue, which is over 10% growth versus Q1 fiscal year 2019. 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 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% versus first quarter last year to $21.3 million. While our consolidated bookings were down 13% 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% from the first quarter of last year. Operating margins increased to 24.1% compared to 21.9% 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 (ph) 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 display an improvement compared to prior year our oil patch businesses are seeing somewhat reduced demand. We're 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 $1,030 million.

And with that, I'll turn it over to Paul Fehlman. Paul?

Paul W. Fehlman -- Senior Vice President of Finance, Chief Financial Officer

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% greater than the prior year first quarter. Reported diluted EPS was 35% to $0.81 compared to $0.60 in the prior year first quarter.

Quarter one fiscal 2020 gross margins improved to 22.9% from the 22.4% on a year-over-year basis primarily on strong margin performance in the Metal Coatings 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 a 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 ducts 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% 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% this year compared to 20.1% in the prior year first quarter.

Operating margins for the first quarter, however 7.5% compared to 6.8% in the prior year. In our Metal Coatings Segment first quarter fiscal 2020 revenues rose 6% to $122.2 million compared to prior year at $115.3 million while operating income grew 16.7% 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% for the quarter up 220 basis points compared to the 21.9% 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 there is no different. We continue to invest in the business in the first quarter with two acquisitions now operating is part of the Metal Coatings Segment and already contributing to the bottom line in the first quarter. We will continue to seek more opportunities like these to continue to profitably grow our Metal Coatings offerings. The risks to fiscal year 2020 that we described in the last earnings call still just 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 ducts to China and we are seeing refining orders for the fall turnaround season.

With that, I'll turn it back to Tom. Tom?

Thomas E. Ferguson -- President and Chief Executive Officer

Thanks, Paul. In closing we are focused on improving productivity and efficiency throughout the company continuing to adapt our products to mid 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 emerge stronger and much better position to generate consistent operating results going forward.

And now we'll open it up for some questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session. (Operator Instructions) Today's first question will come from Joe Franzreb (ph) of Sidoti & Company. Please proceed.

John Edward Franzreb -- Sidoti & Company -- Analyst

It's John. Good morning, Tom, Paul. How are you doing?

Thomas E. Ferguson -- President and Chief Executive Officer

Hi, John.

Paul W. Fehlman -- Senior Vice President of Finance, Chief Financial Officer

Good, John.

John Edward Franzreb -- Sidoti & Company -- Analyst

Good start to the year. My first question is Tom you kind of characterize this spring as a normal turnaround season. What are your initial thoughts, how the fall turnaround season is shaping up relative to the spring?

Thomas E. Ferguson -- President and Chief Executive Officer

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

John Edward Franzreb -- Sidoti & Company -- Analyst

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 revenues they contribute to the quarter and it doesn't sound like they contributed anything to the op income line is that true?

Thomas E. Ferguson -- President and Chief Executive Officer

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

John Edward Franzreb -- Sidoti & Company -- Analyst

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

Thomas E. Ferguson -- President and Chief Executive Officer

Yes, you actually need to flip them the other way, John.

John Edward Franzreb -- Sidoti & Company -- Analyst

Okay.

Thomas E. Ferguson -- President and Chief Executive Officer

K2 Partners is a powder coater and powder coater in platter 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 further away you normally see from galvanizing business. Tennessee galv is outside of China and Denmark 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.

John Edward Franzreb -- Sidoti & Company -- Analyst

Okay. Fair enough. And one last question also in the queue there was mention of the Westinghouse settlement, I'm wondering 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?

Paul W. Fehlman -- Senior Vice President of Finance, Chief Financial Officer

Yeah, so we do call it out in the 10-Q as part of the contribution on the revenue side the contribution on the revenue side. It's not the big contributor though. But we don't call out a number on it, but it's somewhat de minimis 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've filed with the Bankruptcy Court so pretty much put into the end of it and it was pretty favorable return.

John Edward Franzreb -- Sidoti & Company -- Analyst

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

Operator

Our next question comes from Jon Braatz of KC Capital. Please proceed.

Jon Braatz -- KC Capital -- Analyst

Good morning Tom, good morning, Paul.

Paul W. Fehlman -- Senior Vice President of Finance, Chief Financial Officer

Hi, John.

Thomas E. Ferguson -- President and Chief Executive Officer

Good morning.

Jon Braatz -- KC Capital -- Analyst

On the coding side. You called out on a couple of 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 your ability to retain these margins in the face of maybe some rising zinc costs. So, I'm trying to get a better idea -- how much of -- how much real internal progress you're making on margins as opposed to maybe taking eventual lower zinc prices?

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah. That's a great questions or set of questions. The -- zinc cost me around. I think one of that, we have reorganized the sales effort a little over a year ago. So, and I think that's really taken root we candid to bring in more value oriented, sales technical sales folks and focused that effort. I'm making sure that we're getting paid for the services we provide because we do in some cases we provide transportation services and in other plants we do more handling then and another. So we've got about 35 or 38 different services that we consider we offer.

So that focus on value pricing it's 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 probably settle a lot of focus on labor productivity on efficiencies drive 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 when you think about how a plant galvanizing plants laid out you can have -- you have routers that are 150, 200 yards away from the office to get him to bring him in and get things inflated.

So to me that's where we're driving 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 that. We've got a great team there now and I feel like they're going to able to sustain productivity and efficiency with the only caveat to that being in some parts of the country we are scrambling to get direct labor and handle the business. But we've done a lot of work on recruiting, retention, motivation things like that to try that. To ease the demand for new labor as much as possible.

Jon Braatz -- KC Capital -- Analyst

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

Thomas E. Ferguson -- President and Chief Executive Officer

Now we've actually --

Jon Braatz -- KC Capital -- Analyst

I mean, tailwind. I mean, tailwind --

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah, OK. Yeah. We do have a little more of a tailwind and I go along with that. Yeah, we have a hard time predicting the direction of commodity cost like zinc. If you look back over the last few years usually we've probably bet wrong if we -- had made a guess. But we feel pretty good, there's zinc supply and demand are kind of rocking in the range. And so we have had -- 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.

Jon Braatz -- KC Capital -- Analyst

Okay. Tom, you've talked a little bit about uncertainties 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 the sort of the uncertainty and concerns surrounding?

Thomas E. Ferguson -- President and Chief Executive Officer

You know lot of these contracts date back a couple of years. And so they weren't anticipating things like tariffs. And so as we've mentioned before we had switch from having a joint venture over in China to going with a wholly owned manufacturing facility or having that capability of having technicians in country which allows us to control that better. But 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 yes we're -- I feel like our team there is managing this very effectively. But it's 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 estimating we're going to get, and by the contractual commitments for deliveries and not get things hung up in custom. So 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 we, while we feel comfortable. We also feel, we feel we should call it out.

Jon Braatz -- KC Capital -- Analyst

Sure. Okay. Thank you much.

Operator

(Operator Instructions) Our next question comes from Noelle Dilts of Stifel. Please proceed.

Noelle Dilts -- Stifel -- Analyst

Hi, good morning and congratulations on a nice quarter.

Thomas E. Ferguson -- President and Chief Executive Officer

Thanks, Dil.

Paul W. Fehlman -- Senior Vice President of Finance, Chief Financial Officer

Good morning.

Noelle Dilts -- Stifel -- Analyst

Good morning. So just, I just want a stand a bit on John's question on the Metal Coating margin. 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 zinc versus pricing and then maybe incorporate the headwind from labor. And then 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 -- 24 -- around the 24% level are sustainable?

Paul W. Fehlman -- Senior Vice President of Finance, Chief Financial Officer

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 some costs reduction just from the zinc. I would say that on the pricing it's more of we've gone into -- we've done in pick and choosing 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 noted last quarter is that, we would 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, Noelle, as Tom alluded to earlier, basically on a comparative basis to the last year from here on out for another six months to nine months you should expect it to be a positive comparison just because you know where the zinc market has come from. And it's been down for the majority of the year. There have been couple of blips here and there but I think we're pretty well, I think, predictable. That's the word, Tom used which I think is exactly the right word to use for the next six months to nine months.

Now, having said that we're still keeping eye on labor costs. But, I would say that we are 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 not making a forward-looking statement on exactly what the margin is. For backing at 23%, 24% range for a while. Tom?

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah, I think the one thing that you know as we continue to acquire powder cutters which so far the ones we've acquired have been fairly like I'd have to say as we get more as 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 -- for the couple of states and then expanding beyond that, that those margins typically would be a little bit lower than our galvanizing margins and so as we do that as continuous galvanized 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 ability to be in that range.

Noelle Dilts -- Stifel -- Analyst

Okay. Great. Thanks. That's helpful. And then in terms of just shifting over to the Energy segment two questions. One; any additional clarity you can provide on the timing of this shipment on the project in China through the year that might drive some variation across the quarters. And second; you know could you -- you mentioned that certain electrical markets are improving, I know you said that you know the oilfield services that the oil patch businesses we can debate, but can you give us a little bit more detail on where you're seeing improvement.

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah I think the even you know we now have three enclosure sites from Chattanooga up outside of Baltimore and then over to Kansas and then we've got to switch gear plants and one in Missouri and other up in Oshkosh, Wisconsin. And we feel good about that coverage that it's so we feel like there's enough market activity that's becoming the focus now is more on operational excellence in taking care of customers. And because we can move the 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 OK for we like the activity on data centers and 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 -- and 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 more traditional bus business.

And that's where it is still a lot of competition out there and demand hasn't improved enough to, at least in my -- from my perspective, to occupy that 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 and so that's kind of the range of things we're seeing across those businesses.

Noelle Dilts -- Stifel -- Analyst

Great. Thanks very much.

Thomas E. Ferguson -- President and Chief Executive Officer

Alright.

Operator

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.

Thomas E. Ferguson -- President and Chief Executive Officer

Yes. Thank you. 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, international sales and business development organizations. We feel good about the pipeline of, what is I call, the bolt-on acquisitions and I 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 turn around and 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. Look forward to talking to you on the next call.

Operator

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

Duration: 32 minutes

Call participants:

Joe L. Dorame -- Managing Partner

Thomas E. Ferguson -- President and Chief Executive Officer

Paul W. Fehlman -- Senior Vice President of Finance, Chief Financial Officer

John Edward Franzreb -- Sidoti & Company -- Analyst

Jon Braatz -- KC Capital -- Analyst

Noelle Dilts -- Stifel -- Analyst

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