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AZZ Inc (NYSE:AZZ)
Q3 2020 Earnings Call
Jan 9, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Joe Dorame. Please go ahead.

Joe Dorame -- Managing Partner

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 30th, 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 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 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

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 Coatings 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 [Phonetic] 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 Coatings 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.

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 electrical enclosures, are improving compared to last year, our lighting and tubular business -- 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 US 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 Coatings segment has completed four acquisitions resulting in the addition of one galvanizing plant and five surface technology plant.

Year-to-date, our Metal Coatings 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 the 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 $2.60 per diluted share to $2.90 per diluted share and annual sales in the range of $1.020 billion to $1.060 billion.

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 third quarter of fiscal year 2020, we reported net revenue of $291.1 million, a $51.6 million increase or 21.6% greater than the 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% greater than the prior year third quarter. Reported diluted EPS rose 42.4% to $0.84 compared to $0.59 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 Coatings 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 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% increase. Operating margins of 10.6% increased 180 basis points compared to 8.8% 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 Coatings 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?

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 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 will continue to acquire galvanizing businesses and look for acquisitions in the surface technologies arena that would 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 US 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.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from John Franzreb with Sidoti & Company. Please go ahead.

John Franzreb -- Sidoti & Company -- Analyst

Good morning, Tom. [Technical Issues]

Thomas E. Ferguson -- President and Chief Executive Officer

Good morning, John.

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

John, hi.

John Franzreb -- Sidoti & Company -- Analyst

I just wanted to start with the high-voltage bus duct business in China. Could you kind of remind me the duration of that project and [Technical Issues].

Thomas E. Ferguson -- President and Chief Executive Officer

John, we're kind of losing you there. We got some interference 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 -- we 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.

And then of course, we're looking to hopefully book some more opportunities. And as I mentioned, we also -- we did book a nice domestic order, which tends to help us in our Medway facility.

John Franzreb -- Sidoti & Company -- Analyst

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

Thomas E. Ferguson -- President and Chief Executive Officer

It's up 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've 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.

John Franzreb -- Sidoti & Company -- Analyst

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

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

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, it's -- we're going to leave it about where we were for -- in the last call, which was 22% to 23% for the year, that hasn't moved. So, you're under in the second quarter, you're a little bit over in the third -- over in the third quarter, but we still expect that 22% to 23% for the full year, John.

John Franzreb -- Sidoti & Company -- Analyst

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

Thomas E. Ferguson -- President and Chief Executive Officer

All right.

Operator

Our next question comes from Noelle Dilts with Stifel. Please go ahead.

Noelle Dilts -- Stifel -- Analyst

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

Thomas E. Ferguson -- President and Chief Executive Officer

Good morning.

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

Good morning.

Noelle Dilts -- Stifel -- Analyst

Good 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, 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 they'll start to roll off, so how to think about the margin profile as we head into the fourth quarter and next fiscal year? Thanks.

Thomas E. Ferguson -- President and Chief Executive Officer

Yes. Galvanizing is still the vast majority of the segment. And we've talked about it. It's been holding in the 22% to 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, so I think to bring the margins up. And so, we're looking for things of above 15% and then over time get those up closer to 20%. So -- but in the fourth quarter, the surface technologies is still a relatively small piece of the segment. So, while I think the margins will likely be a little -- they're probably going to be relatively close to third quarter's. Paul, I don't know if you want to add to that.

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

Yeah. No, they were -- 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 are probably one time as we're bringing these businesses on. But he is spot on the money with the percentages and I think you should expect to see about the same action [Phonetic] in the fourth quarter.

Thomas E. Ferguson -- President and Chief Executive Officer

And Noelle, 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. So as Paul was talking about some of those costs that it relates to kind of buying in at -- in the down season.

Noelle Dilts -- Stifel -- Analyst

Thanks. That's helpful. And you guys talk 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 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.

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah. I think generally the industrial markets, construction and bridge and highway, things like that have been relatively solid in our Metal Coatings segment. As we're getting into other surface technologies, it's taken us into more of the OEM markets and some of the other things. So that will 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 kind of forecasting that as a -- our outlook is kind of about what it was this year, which wasn't really robust, but wasn't bad. So -- but in general, our overall industrial markets are as we're looking for this quarter, which we're already well into and looking into next year, I'd say solid. I won't say robust and I won't say week. So, they're kind of trending normal.

Noelle Dilts -- Stifel -- Analyst

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

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah. It looks really solid. Some of the -- I mentioned some of the technology we've deployed and is being very well received in the marketplace. So there is some continuing or 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.

Noelle Dilts -- Stifel -- Analyst

Great. Thank you.

Operator

[Operator Instructions] Our next question is a follow-up from John Franzreb with Sidoti & Company. Please go ahead.

John Franzreb -- Sidoti & Company -- Analyst

Yeah. Just to follow up on Noelle's question on the spring turnaround session. 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 strong one this fall or -- just on a relative basis, how should we think about it?

Thomas E. Ferguson -- President and Chief Executive Officer

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

Noelle Dilts -- Stifel -- Analyst

Perfect, Tom. Thanks. That's great.

Thomas E. Ferguson -- President and Chief Executive Officer

Okay.

John Franzreb -- Sidoti & Company -- Analyst

And when I think about the high-voltage bus duct domestic job that you just got, is it fair to assume that duct job [Phonetic] would be a higher margin business than the Chinese high-voltage were?

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah. That's a good assumption.

John Franzreb -- Sidoti & Company -- Analyst

Okay. I guess that's it from me. Thanks guys, appreciate it.

Thomas E. Ferguson -- President and Chief Executive Officer

All right.

Operator

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

Bill Baldwin -- Baldwin Anthony Securities -- Analyst

Thank you, and good morning.

Thomas E. Ferguson -- President and Chief Executive Officer

Morning, Bill.

Bill Baldwin -- Baldwin Anthony Securities -- Analyst

Tom, could you remind me again what's 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 that differentiate you from the competition?

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah. We've got the longest and largest track record, if you will 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 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, move into -- and this is our custom. We take your -- the standard Lincoln and Miller welding equipment and then we customize it significantly with our controls, our video equipment, our -- and then deploy it. So our differentiation is with that customized equipment and in our experience.

Bill Baldwin -- Baldwin Anthony Securities -- Analyst

Got it. Thank you. And could you comment on what the outlook looks like for the markets for your electrical enclosure and your switchgear business, what you're seeing out there looking at over the next year or so?

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah. I think the enclosure market, we've got three facilities serving that, Chattanooga and Millington which is outside of Baltimore and in Pittsburg, Kansas. So, we're in the Midwest and East Coast. And we've -- those markets are strong. We've got a really good customer base. A lot of the major outfits are -- we've got purchase or -- [Indecipherable], they're not really blanket agreements, but supply agreements with. And so, we're looking at that being solid to pretty good next year. And part of that is just our presence where we're at, what we've done to improve our operations, focus on customers.

Switchgear, I think the big -- 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 and -- but OK.

Bill Baldwin -- Baldwin Anthony Securities -- Analyst

What drives that smaller switchgear market, Tom? What are the main applications there?

Thomas E. Ferguson -- President and Chief Executive Officer

It's -- that's the industrial stuff instead of the utility grade.

Bill Baldwin -- Baldwin Anthony Securities -- Analyst

Industrial. Okay.

Thomas E. Ferguson -- President and Chief Executive Officer

Yeah. So that's where we get into a much broader set of customer opportunities, but it tends to drive off of that industrial spend.

Bill Baldwin -- Baldwin Anthony Securities -- Analyst

We just need a better spending on the manufacturing side of the economy it sounds like there.

Thomas E. Ferguson -- President and Chief Executive Officer

We do. We need to have a little pick up there. We were doing good coming into this past year, but coming into this year, it's a little bit softer.

Bill Baldwin -- Baldwin Anthony Securities -- Analyst

Right. Okay, well thank you much and good job what you guys are doing there.

Thomas E. Ferguson -- President and Chief Executive Officer

All right. Appreciate it, Bill.

Operator

Our next question is a follow-up from Noelle Dilts with Stifel. Please go ahead.

Noelle Dilts -- Stifel -- Analyst

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

Thomas E. Ferguson -- President and Chief Executive Officer

Our lighting business, we had converted to LEDs early in the cycle going all the way back to probably 2013 and '14. And so, we look at that, we've got good technology, good application base and we have broaden 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 while the -- 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 volumes off a little bit, they're very profitable.

On the tubing side, it's our heritage, 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 $2 million or $3 million of incremental volume to make it nicely profitable. So, we look at that and neither of this business, 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, we would benefit that tubing business nicely. So, I feel good about the outlook. And quite frankly, the -- in other, they're both working to drive profitability in those operations.

Noelle Dilts -- Stifel -- Analyst

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

Thomas E. Ferguson -- President and Chief Executive Officer

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

Noelle Dilts -- Stifel -- Analyst

Great, thank you.

Thomas E. Ferguson -- President and Chief Executive Officer

All right.

Operator

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

Thomas E. Ferguson -- President and Chief Executive Officer

Thank you, Sarah. I think just a couple of comments. We covered most everything between our scripts and the questions, so but just a reminder, we're committed to driving 21% to 23% operating margins for that Metal Coatings segment, inclusive of whatever acquisitions we do, and as we continue to grow the surface 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, 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.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Joe Dorame -- Managing Partner

Thomas E. Ferguson -- President and Chief Executive Officer

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

John Franzreb -- Sidoti & Company -- Analyst

Noelle Dilts -- Stifel -- Analyst

Bill Baldwin -- Baldwin Anthony Securities -- Analyst

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