AZZ Inc. (NYSE:AZZ) Q3 2023 Earnings Call Transcript

AZZ Inc. (NYSE:AZZ) Q3 2023 Earnings Call Transcript January 10, 2023

AZZ Inc. beats earnings expectations. Reported EPS is $0.88, expectations were $0.79.

Operator: Good day, and welcome to the AZZ Inc. Q3 2023 Earnings Conference Call and Webcast. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Sandy Martin, Three Part Advisors. Please go ahead.

Sandy Martin: Thank you, operator. Good morning, and thank you for joining us today to review AZZ’s financial results for the third quarter of fiscal 2023 ended November 30, 2022. Joining the call today are Tom Ferguson, President and Chief Executive Officer; Philip Schlom, Chief Financial Officer; and David Nark, Senior Vice President, Marketing, Communications and IR. After the conclusion of today’s prepared remarks, we will open the call for questions. Please note, there is a webcast and slide presentation for today’s call, which can be found on AZZ’s Investor Relations page under latest earnings releases presentation at azz.com. Before we begin, I would like to remind everyone that our discussion today will include forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

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Forward looking statements by their nature are uncertain and outside of the company’s control. Except for actual results, our comments containing forward-looking statements may 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, 2022. These statements are not guarantees of future performance and therefore, undue reliance should not be placed upon them. Actual results could differ materially from these expectations. In addition, today’s call will include a discussion of non-GAAP financial measures. Non-GAAP financial measures should be considered as a supplement to and not a substitute for GAAP measures.

We refer you to the reconciliation of non-GAAP to the nearest GAAP measure included in today’s earnings release and investor presentation for further detail. The earnings press release and Q3 presentation are posted on our website and have been included in the Form 8-K submitted to the SEC. I would now like to turn the call over to Tom Ferguson, CEO. Tom?

Tom Ferguson: Thank you, Sandy. Welcome to AZZ’s third quarter earnings call and thank you for joining us this morning. We accomplished a lot this quarter, including completing the divestiture of 60% of our Infrastructure Solutions segment. We also paid off over $230 million of our debt, which improves our leverage to 3.4 times EBITDA. Both of our business groups grew their sales significantly and I will get into the specifics shortly, but let me first express, how appreciative I am of our AZZ Metal Coatings and AZZ Precoat Metals leadership teams. I commend them for the professionalism they have demonstrated as they have maintained focus on their customers, while dealing with continual supply chain and labor issues, as well as storms and other distractions.

Working with leaders that demonstrate so much pride and passion for their teams and business is truly invigorating. As you can see here, we achieved nice flow through of adjusted EBITDA on higher sales generating over $71 million or a 79% increase versus prior year. Net income on adjusted basis was $22 million, up 4% resulting in adjusted EPS of $0.88. Philip will talk about the one-time write-down on AIS shortly. Metal Coatings had another strong quarter with sales up 17% to $158 million. The growth was a result of volume, the earlier acquisitions of DAAM and Steel Creek and adding tubing to the Metal Coatings as it was not divested along with the rest of AIS. Operating income was only up slightly versus prior year due to inflationary pressures, particularly as zinc cost peaked in most of our kettles.

We continue to maintain our pricing discipline and focus on delivering value to our customers. Tubing is a good business, albeit relatively small and was significantly lower margins than our galvanizing business. Additionally, service technologies underperformed for the quarter. The net of these two things amounted to about 100 basis points of margin headwind for Metal Coatings. Metal Coatings team has already taken actions to strengthen Surface Technologies leadership and improved performance. EBITDA of almost $42 million was up 3% over prior year. We continue to benefit from our investment in DGS for the Digital Galvanizing System, which is driving both productivity and customer service. We are also seeing potential in the longer-term to improve performance of our kettles of rising out of technology efforts in conjunction with Texas and .

The outlook in the fourth quarter is for a typical winter season and we would hope to not experienced any more major storms like we navigated in December. Precoat in its second full quarter with AZZ had nice sales growth to $215 million, which generated over $34 million of EBITDA. While Precoat did grow its underlying unit volume modestly versus prior year, sales were lower than the second quarter due to normal seasonality as we have noted previously. The lower volume sequentially has about a 100 basis point impact due to the deleveraging effect on fixed cost. Precoat’s underlying business performance was solid given the continued inflation on indirect materials, labor shortages and extraordinarily high customer-owned inventories that caused significant inefficiencies and costs.

We have taken actions to improve the inventory situation and have focused initiatives to improve productivity at several plants, but are still dealing with skilled labor shortages and some logistical inefficiencies. Additionally, we have taken pricing actions to address the indirect material inflation and higher logistical costs. We have made progress on the $10 million of synergies we had noted at the time of the acquisition. And while so far the benefits have been balanced by the cost, these will be showing up in our run rates in fiscal year 2024. Year-to-date, our business on a consolidated basis has done well. To put it in perspective, we have generated sales approaching $1 billion in the first nine months, which used to be what we did all year.

We have generated over $238 million in adjusted EBITDA, which doubles the prior year. Adjusted net income of $97 million and adjusted EPS of $3.89 are up 56% versus the prior year. For the AIS joint venture, we have recognized a little over $1 million of equity income. While it has been a tumultuous year, we are positioned well as we finish up this fiscal year and prepare for fiscal 2024. So now, I’ll turn it over to Philip.

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Philip Schlom: Thanks, Tom. As Tom noted, we closed on the divestiture of our controlling interest in the AZZ Infrastructure Solutions segment to Fernweh Group at the end of September 2022, after just completing the second quarter. As a result, we are required to report the results of operation as continuing and discontinued ops from the second quarter onward. My commentary will focus primarily on the results from continuing operations. I will also walk through the consolidated adjusted EBITDA and adjusted EPS and bridge results to our 2023 full year guidance ranges. For comparability, I may refer to Precoat or AIS sales, so investors can track quarterly sales inputs or exclusions. Our adjusted numbers primarily exclude impacts from additional non-cash loss recorded on the finalization of the divestiture of AIS and excludes the depreciation and amortization related to the purchase accounting effects of the Precoat acquisition on both the quarter and year-to-date results.

AZZ generated third quarter sales of $373 million, $158 million for Metal Coatings and $215 million from Precoat. One month of sales from the Infrastructure segment for September prior to the divestiture of $42.3 million were included in the results from discontinued operations. Third quarter sales reflected continued stable demand with Metal Coatings up 17.2% and Precoat Metals up 14.8% on a comparable prior year same quarter basis. Gross profits from continuing operations for the third quarter totaled $73.1 million or 19.6% of sales. While aggregate profits are higher from a dollar perspective, the gross margin reflects increased cost of zinc flowing through our kettles within the metal coatings as well as transitional operational expenses and warehousing costs for Precoat.

As Tom mentioned, we have taken steps to address these issues. Operating margins from continuing operations were 12.2% of sales for the third quarter, as compared to 15.8% in the prior year. Excluding the impact of the Precoat purchase accounting related amortization and depreciation of $8 million, operating margins for the quarter would have increased to 14.3% of sales. Third quarter calculated EBITDA was $26.2 million, compared to $39.8 million in the prior year same quarter. When adjusted EBITDA for the quarter was $71.2 million or 19.1% of sales, up 78.8% compared to the prior year. Earnings per share from consolidated operations was a loss of $0.97, which included a $45 million loss associated primarily with the non-cash write-off and discontinued operations of the AZZ Infrastructure segment related to historical currency translation adjustments.

Excluding the loss and including the D&A from Precoat purchase accounting, third quarter EPS was $0.88, an increase of 3.5% versus 85% — a $0.85 in the prior year quarter. Year-to-date sales from continuing operations were $987.1 million, generating reported EBITDA of $63.3 million and adjusted EBITDA of $238.5 million. Year-to-date reported EPS was a loss of $2.35 as a result of the finalization of the AIS divestiture. Year-to-date adjusted EPS was $3.89 (ph). Year-to-date diluted EPS from continuing operations was $2.17, an increase of 39% compared to $1.55 diluted EPS from continuing operations through the third quarter of last year. Cash flows from continuing operations for the nine months were $68.6 million compared with $45.9 million in the prior year.

Our year-to-date capital expenditures from continuing operations were $35.1 million compared with $15.8 million in the prior year. The year-over-year cash flow (ph) increase was planned and contemplated in our strategic rationale associated with the Precoat acquisition. In terms of capital allocation, the company’s balance sheet is strong, and we continue to maintain a prudent capital allocation strategy. Utilizing proceeds received from the divestiture of AIS in addition to cash from operations. We reduced outstanding debt by $230 million. We invested $18.3 million during the quarter on capital expenditures. We expect to invest roughly $45 million in capital expenditures for the full fiscal year as we shuffle capital spending around due to continued supply chain disruptions.

Shareholder returns to common shareholders included Q3 dividend payments of $4.2 million, which represents an estimated annual dividend yield of 1.6% based on Friday’s closing price. We have an active pipeline of acquisition targets. However, do not plan any actionable transactions in the near-term horizon. As we focus on reducing debt, we do not anticipate any share repurchases. As described above, we reduced our Term Loan B by $230 million and improved our leverage to 3.4 times, a good step towards our 2024 target of getting back to or under 3 times leverage. As discussed last quarter, we have roughly 50% of our existing Term Loan B debt covered by swap agreement to reduce further interest rate exposure. Lastly, other than our current $3.25 million mandatory quarterly principal payments on our term loan, we do not have any maturities into 2027.

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

Tom Ferguson: Thanks, Philip. Market activity generally for Metal Coatings is normal given we are in the seasonally slower winter months. Fabrication activity remains solid. Zinc costs have peaked in most of our plants and will begin to normalize with current market levels. Precoat is more reliant on the construction sector, so they are typically more impacted by the winter season and major storms like we had over Christmas. We are beginning to see customer inventories normalize as supply chain disruptions are easing somewhat. And due to some of the actions we have already taken. Our pricing actions are also catching up to some of the inflationary labor, energy and non-paint materials costs. Naturally, we are continuing to focus on debt reduction, monitoring customer credit carefully and ensuring effective CapEx deployment.

We are maintaining our sales guidance of $1.275 billion to $1.325 billion and also our adjusted EBITDA guidance of $285 million to $305 million. We are raising our adjusted EPS guidance by $0.25 from the $3.80 to $4 range to $4.05 — from $4.05 to $4.25. This is based on the strong third quarter and the outlook for the businesses that we have previously discussed. This guidance does not include any potential equity income that we might receive in the fourth quarter from our 40% share of avail. I will also note that the fourth quarter EPS will be impacted by a more normalized tax rate than we experienced in the third quarter. Dividends in preferred equity or dividends on preferred equity and seasonally slower volumes. Our guidance reflects these impacts.

As a reminder, we will be getting back into our normal cadence on annual guidance and we’ll be issuing fiscal 2024 guidance in a few weeks. AZZ is the leading independent hot-dip galvanizing and coil coating company with an irreplaceable footprint serving a broad and diverse set of markets. As a high value-add tolling business, we are not directly exposed to metal commodities. Have the ability to shed variable costs quickly and thus are able to protect our margins pretty well during downturns. We generate great margins, returns and free cash flow by focusing on providing outstanding value to our customers, emphasizing operational excellence and continuing to innovate and develop our technology. With that, we’ll open it up for questions.

Q&A Session

Operator: We will now begin the question-and-answer session. . The first question comes from John Franzreb with Sidoti & Company. Please go ahead.

John Franzreb: Good morning, guys and thanks for taking the questions.

Tom Ferguson: Good morning, John.

John Franzreb: I’d like to start with the Metals Coatings business and the — incurring the high zinc cost. Can you talk a little bit about where you stand as far as those costs coming down and what’s the margin profile look like in the current quarter versus Q3?

Philip Schlom: On the margin profile, I think our zinc has peaked in December. And so we’ll start to see some decrease as we move forward into the fourth quarter and into fiscal year 2024.

John Franzreb: Okay. And what was the impact in Q3 of the higher zinc on the segment in Q3?

Tom Ferguson: We really don’t disclose that. But I’d say typically, we’re — well, because of — keeping in mind that our — we try to price in line with those zinc costs, so while we’ve kept our pricing discipline, I think the overall impact, we probably — I’d say, we’re looking at maybe 100 basis points overall, just kind of that headwind as we have about six months of zinc in our kettles and dependent on — but there’s a range of cost in each kettle across the fleet.

John Franzreb: Okay. And on the precoat side of the business, you talked about productivity issues at several plants where I thought you said, Tom. And you also talked about lower volume hurting the op margin profile by about 100 basis points. I guess two questions here. Is the balance of the volume sequentially? Is that the productivity issue? Is there anything else going on? And can you just remind us what the productivity issues are and when do you expect them to be resolved?

Tom Ferguson: Yeah. We’ve got a couple of different things going on. I think we’ve mentioned the very extremely high levels of customer inventory, which if you go into one of — most of precoats plants, that tends to, to get in the way of being efficient logistically and moving materials which were a material handling business. So that’s in the majority of plants that high inventory issue. As we noted, that’s coming down and I think, we’re probably within a couple of three months of being to more normalized levels in the majority of the plants. We do have three or four plants that have struggled with, I’ll call it, the mix of their business, so taking some of the lower margin type activity to maintain absorption levels and keep flow.

That’s something that’s going to take us probably a couple of quarters to work out. We’ve made some adjustments. We have several initiatives. There’s a really good team within precoat of operating support and focus on quality. So — but that’s going to take a couple of quarters. We’re going to be into next year before we see that move significantly. In terms of — we talked about the fixed cost leverage, that deleveraging effect as we had talked about, kind of just mostly because of how our fiscal quarters fall for precoat tends to hit the worst five months of the year in the third and fourth quarter. So fourth quarter is basically all winter, which construction activity is less and a lot of the metals building customers are kind of managing their inventories and managing their business.

So that part of the fixed cost deleveraging will continue through the fourth quarter. And then we hope for an early spring in March and bounce back to the really strong first and second quarters.

John Franzreb: Okay. Thank for taking my questions. I get back into queue.

Tom Ferguson: All right. Thanks, John.

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

Noelle Dilts: Hi. Thanks for taking my question. First, I was wondering if you could expand on the underperformance that you mentioned in Surface Technologies. And if you could quantify that impact, that would be great. And maybe how quickly you think that you’ll start to make some of those improvements that you referenced?

Tom Ferguson: Yeah. It’s not a huge impact overall, but it’s enough to move the needle. So you’re looking at a business of, what maybe $6 million, $7 million a quarter, but really low margins lower than we’ve experienced. So that the leadership changes were made several months ago and so I think that takes a little bit of time to gain traction. We like the initiatives that the team has going there. But I think we’re going to be into the first quarter probably well through spring before we start to see any significant improvement there. Part of it is just making sure we’re going after the right kinds of business. We find powder coating to be better than the plating side. So these are all adjustments in how we’re targeting the customers, how we’re approaching the business and then driving the normal focus on efficiencies, productivity at the six plants.

Noelle Dilts: Okay. Great. And then I recognize you said you’re giving guidance in a few weeks. But maybe could you give us some early thoughts on how you’re thinking about the outlook, particularly for Precoat as we look into the next fiscal year? If you could just walk us through some of the puts and takes in terms of growth. I know obviously, you’re continuing to gain share or see increased penetration of pre-coated metals. But I would think some of the more residential or consumer facing parts of pieces of the business might see a little bit more of a headwind. So could you just give us a sense of sort of how you’re thinking directionally about growth? Thanks.