AZZ Inc. (NYSE:AZZ) Q3 2024 Earnings Call Transcript

AZZ Inc. (NYSE:AZZ) Q3 2024 Earnings Call Transcript January 10, 2024

AZZ Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the AZZ Inc. Third Quarter 2024 Earnings 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 Sandy Martin, of 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 fiscal 2024 third quarter which ended November 30, 2023. Joining the call today are Tom Ferguson, President and Chief Executive Officer; Philip Schlom, Chief Financial Officer; and David Nark, Senior Vice President of Marketing, Communications and Investor Relations. After today’s prepared remarks, we will open the call for questions. Please note, the live webcast for today’s call, which can be found at www.azz.com/investor-events. Before we begin, I would like to remind everyone that our discussion today will include forward-looking statements made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

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 followed by AZZ with the Securities and Exchange Commission, including the annual report on Form 10-K for the fiscal year. These statements are not guarantees of future performance, therefore undue reliance should not be placed upon them. Actual results could differ materially from these expectations. In addition, today’s call will discuss non-GAAP financial measures. Non-GAAP financial measures should be considered as a supplement to and not a substitute for GAAP financial measures.

We refer you to the reconciliations from GAAP to non-GAAP measure included in today’s earnings press release. I would now like to turn the call over to Tom Ferguson. Tom?

Tom Ferguson: Thank you, Sandy. Good morning, and thank you for joining us to review our fiscal 2024 third quarter results. Today I’ll start by covering company highlights for the quarter before passing it over to Philip to discuss AZZ’s detailed financial results and our balance sheet. Then Dave will provide industry commentary on our end markets. And I will conclude our presentation by covering our sustainability efforts and AZZ’s full year outlook before opening the line for questions. AZZ is North America’s market leader in hot dip galvanizing and cold coating solutions, leveraging our scale and strategic footprint to better serve customers with excellence and expertise. Our leadership has been focused on strong execution this year, and I am pleased to report that the segments have performed exceptionally well through the third quarter.

These results are a testament to the strength of our company, talented teams, effective strategic plan, and ongoing commitment to operational excellence. Collectively, these attributes contribute to our ability to provide valuable, differentiated solutions and services to our customers. Turning to our results, total sales for the quarter were $382 million, up 2.2%. Momentum continued for Metal Coatings with third quarter sales of $163 million, up 3.1% versus last year’s quarter. Precoats Metals also grew during the quarter to $218 million, up 1.6% from a year ago. We grew sales organically and improved profitability in the quarter. And I am pleased to report that we continued to effectively secure market share without sacrificing our value pricing discipline.

We increased adjusted earnings per share for the quarter by 53% to $1.19, and grew adjusted EBITDA by 23% to $86 million versus prior year. This led to strong cash from operations for the quarter of $63 million. As a result, EBITDA margins were 30% for Metal Coatings and 18.4% for Precoat Metals during the quarter, both within the stated targeted ranges for each segment. In short, our dedication to delivering best-in-class customer service and ongoing enhancements in operations led to increased sales, improved profitability, and significant cash flow this quarter. We continue to develop and enhance our operational technologies, which sets us apart from the competition. Our Digital Galvanizing System or DGS is AZZ’s proprietary technology that connects our 41 galvanizing facilities to the company’s ERP system and provides real-time visibility and order tracking to allow superior customer service.

Similarly, in Precoat’s 13 facilities, [indiscernible] tracks customers’ inventory and provides real-time access to project scheduling. These advanced platforms along with our outstanding teams focused on providing excellent service, position AZZ as a highly differentiated Metal Coatings provider to customers throughout North America. As Philip will discuss more in a moment, we are strengthening the balance sheet and plan to continue to deploy capital carefully. We have worked diligently to reduce debt, improve our leverage ratio, and reprice our term loan at Revolver to lower interest costs, which continues to reinforce our decision to self-fund the Greenfield Precoat Metals facility in Washington, Missouri, instead of going with a sale-leaseback.

We are highly focused on long-term value creation through our sustainable solutions. We believe that by continually investing in our people and relentlessly executing our strategy, we will accelerate AZZ’s value creation and ensure sustainability. Our strategic transformation over the last 18 months has been a catalyst for generating significantly higher run rate EBITDA and cash flow. We will continue to scale our business through both organic and inorganic growth, leveraging our highly differentiated value proposition to customers as we create long-term value for our shareholders. With that, I’ll turn it over to Philip.

Philip Schlom: Thanks, Tom. Good morning, and thank you for participating in our third quarter update. All numbers referenced today are results from our continuing operations. As Tom mentioned, we reported fiscal year 2024 third quarter sales of $381.6 million compared to $373.3 million in last year’s third quarter. Total sales increased by 2.2% from a year ago on higher Metal Coatings sales of 3.1% and Precoat sales up 1.6%. Third quarter gross profit was $88.1 million, or 23.1% of sales, compared to $73.1 million, or 19.6% of sales in the prior year’s same quarter. The 350 basis point improvement in gross margin was a result of lower zinc and overhead costs and an accounting reclassification to corporate of intangible assets amortization, partially offset by increased labor costs.

Selling, general and administrative expenses were $35.3 million in the third quarter, which included a $4.5 million legal accrual related to a long outstanding commercial dispute with a Metal Coatings customer. Excluding the third quarter legal accrual, SG&A expenses for the fiscal 2024 third quarter would have been $30.8 million, or 8.1% of sales, compared to $27.7 million, or 7.4% of sales in the prior year. We reported third quarter adjusted EBITDA of $86.4 million or 22.6% of sales, compared with $68.9 million, or 18.5% of sales last year. This 410 basis point improvement in adjusted EBITDA margin was primarily driven by favorable mix and improved operational efficiencies in both of our segments. Interest expense for the third quarter was $26 million compared to $26 million in the prior year, mostly due to lower outstanding debt and the effect of our repricing of the term loan in August.

In a moment, I will discuss the recent repricing of our Revolver. Income tax expense was $8.8 million, which reflects an effective tax rate of 24.6% in the quarter, compared to 11.7% in the third quarter of the prior year. The prior year was favorably impacted by recognizing tax basis differences related to the AVAIL joint venture that were not repeated in the current quarter. We expect full year fiscal 2024 effective tax rate to be around 23%, with the longer term tax rate expected to remain in the 24% range. Adjusted net income for the third quarter was $34.8 million compared to $19.5 million in the prior year, up 78.3%. As Tom mentioned, our adjusted diluted earnings per share of $1.19 was 52.6% above the adjusted diluted earnings of $0.78 reported in the prior year’s same quarter.

Since the preferred convertible shares are dilutive in the current quarter, the preferred dividends are added back to the earnings for the company’s computation of EPS. Under a full conversion assumption for the preferred convertible shares, weighted average shares outstanding in the quarter and for the nine months are approximately 29.3 million shares. Turning to our financial position and balance sheet. For the first nine months of the year, we generated strong cash from operations of $180.9 million and free cash flow of $114 million. Free cash flows computed based on cash from operations, less capital expenditures, and was more than double from a year ago on improved segment performance with higher sales and improved EBITDA dollars and margins, and we benefited from our focus on working capital reduction.

Capital expenditures for the first nine months were $66.9 million, including typical safety, maintenance, and gross spending, as well as about $34 million related to the new Greenfield Coil Coating Plant under construction in Washington, Missouri. The building construction is near completion, and we are beginning to receive equipment scheduled to be installed in the upcoming months. Our construction progress remains on target, and we will continue to provide progress updates each quarter. Our full year forecast 2024 capital expenditure is approximately $119 million. I’m sorry, our full year fiscal 2024 capital expenditures projection, including $70 million for our new plant, are expected to be $119 million. And heavier spending will continue through the first quarter of fiscal year 2025 as we receive, install, and ready the facility for operational testing later next year.

During the third quarter, we further reduced our debt by $25 million. Through the first three quarters, we paid down $85 million of debt within our previously communicated targeted debt reduction estimate of $75 million to $100 million. As Tom noted, strong operational performance and focused working capital management allowed us to reduce our net debt to leverage ratio to 3.1 times, closer to achieving our target of 3.0 times or lower. In addition to repricing our Term Loan B during our second quarter of the fiscal year, we also successfully repriced our $400 million senior security revolver last month. The most recent repricing reduced our interest rate margin across all leverage-based pricing tiers from a fixed SOFR plus 425 to our current effective rate of SOFR plus 300 basis points, and we also were able to remove the existing credit spread adjustment of 10 basis points.

We will see a benefit going forward of lower interest costs through the maturity of our facility and plan to balance borrowings between the term loan and revolving credit facility to minimize interest costs. We have no maturities of debt until 2027. We remain confident in our ability to generate positive cash flows and support our growth plans while continuing to strengthen our balance sheet and reduce debt and leverage. As a reminder, we are in a three-year swap arrangement that fixes roughly half of the variable rate debt, and that arrangement expires in September 2025. During the first nine months of the fiscal year, we paid cash dividends to common shareholders of $12.8 million and also paid $10.8 million in dividends to our Series A preferred holders.

We made no share repurchases during the quarter or year-to-date as debt reduction continues to be our top priority. Before turning it over to David, I want to provide an update on two matters. Number one, equity and earnings of our unconsolidated subsidiaries for the current quarter increased to $8.7 million compared to $1.0 million in the prior year quarter. The increase is primarily due to higher earnings from the AVAIL of JV, a release of a reserve for liquidated damages on a large project they had, and three months of equity and earnings in the current quarter compared to only one month in the prior year third quarter. We do not expect to see near-term earnings levels this high during our fourth quarter or into fiscal year 2025. Lastly, earlier this morning, the company filed a Form S3 registration statement with the Securities and Exchange Commission as a universal shelf registration that will provide future funding options to the company.

Coming out of our annual strategic planning sessions earlier this year, we determined that a universal shelf registration is both prudent and good housekeeping for a business our size. With that, I’d like to turn the call over to Dave.

David Nark: Thank you, Philip. Good morning, everyone. As Tom covered, our strategic growth plan includes a combination of organic and inorganic expansion throughout North America. We plan to utilize our large footprint to leverage market-leading positions in both segments. AZZ’s trusted business partnership within our nationwide network is built on a growing base of over 3,000 customers, many of whom are longstanding blue chip customers. Additionally, we continue to attract and retain customers based on our deep technical expertise, customer-centric technologies, superior customer service, and highly specialized solutions and services. Metal Coatings benefited this quarter from continued strength in transmission and distribution, as well as bridge and highway projects.

Precoat Metal sales performance has recently trended better than the market, and our growing volumes continue to improve from intentional conversion selling, mix, and value pricing. Secular growth trends, including plastics to aluminum conversions, are important for Precoat, coupled with the team’s ability to convert captive paint lines inside other companies. Tom sometimes refers to this as our de-verticalization sales strategy, which is a growth area for AZZ as companies decide to cut costs or outsource their roll-coating needs. We expect transmission and distribution to continue to be strong in the coming months and are seeing continued evidence of infrastructure spending, including work on data centers and microchip plants. We continue to see long-term secular tailwinds associated with infrastructure projects tied to the AIIJA and CHIPS Acts, which we expect to positively impact our results in calendar 2024.

Although solar and renewables end markets have recently weakened, we are seeing pockets of regional strength across the U.S. for these projects. Finally, although our business this year has seen softer demand in HVAC and transportation, appliances and residential construction end markets are returning. Non-residential construction continues to perform well with strength in warehousing, manufacturing, and agriculture. We are also optimistic by the long-term expectations for manufacturing reshoring and the positive transition to pre-painted steel and aluminum. And, as I mentioned, we are seeing the gradual movement in the container category from plastics to aluminum throughout North America. Our Metal Coatings and Precoat Metals teams continue to make progress on market share gains and hot-dip galvanizing, as well as pre-painted coil projects with key customers.

With that, I’d like to turn it back over to Tom.

Tom Ferguson: Thanks, Dave. One of the most rewarding aspects of being a part of AZZ is the opportunity to work with over 3,900 incredibly talented people who strive to do the right thing for our employees, customers, partners, and communities where we live and work. We were recently recognized on Newsweek’s 2024 America’s Most Responsible Companies list based on our company-wide sustainability and ESG efforts. We are grateful that this is the second year AZZ was named among this prestigious list of companies. Collectively, our business segments provide sustainable, unmatched Metal Coatings solutions that enhance the longevity and appearance of buildings, products, and infrastructure that are essential to everyday life. Our solutions and services are synonymous with sustainability.

Regarding our business outlook in the fourth quarter ending in February, our fabrication customers continue to cite project backlogs and critical markets that Dave just discussed. Labor availability and employee turnover have both improved from a year ago. We continue to execute on our working capital initiatives and now are well-positioned to adjust inventories of paint and zinc when demand shifts, whether due to our growth initiatives or other micro or macroeconomic impacts. As Philip mentioned, the construction of our Greenfield aluminum coil coating facility in Missouri is progressing. The building is substantially completed and equipment has begun to arrive and be installed in the facility. We remain excited about the growth opportunity this investment creates.

We continue to anticipate a stronger fourth quarter compared to Q4 last year. Our Metal Coatings and Precoat teams have demonstrated their ability to drive operational efficiencies and sustain margins with superior quality and service levels. We are narrowing and somewhat revising up our fiscal 2024 sales guidance of $1.45 billion to $1.55 billion, adjusted EBITDA guidance of $315 million to $335 million, and adjusted EPS guidance of $4.15 to $4.35. And our capital expenditures for fiscal 2024 are estimated to be $119 million, which includes about $70 million this year related to the Washington, Missouri Greenfield plan. Although interest rates have increased this year and interest expense ran significantly higher than we planned, we were able to pay down debt, reprice our term and revolving debt, and offset the EPS impact with incremental equity and earnings from our minority interest in the AVAIL joint venture and focused operating performance from our business groups.

We plan to provide our fiscal year 2025 guidance in a few weeks for the new year that begins March 1. As always, I want to thank our hardworking and highly talented team who execute AZZ’s shared vision of growth, profitability, and operational improvements every day. Our mission is to create value in a culture where people can grow and TRAITS really matter. TRAITS is an acronym for trust, respect, accountability, integrity, teamwork, and sustainability. These are AZZ’s core behavioral values that continue to shape our future successes. Now, operator, please open up the call for questions.

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Q&A Session

Operator: [Operator Instructions] And our first question comes from Lucas Pipes of B. Riley Security. Please go ahead.

Lucas Pipes: Thank you very much, operator. Good morning, everyone. My first question is on the leverage. You’re within a stone’s throw of your prior leverage target of three times. Is there a desire to reduce leverage beyond, lower than three times, or do you think that kind of what you had outlined previously still stands today? Thank you very much.

Tom Ferguson: Yes, Lucas, good morning. I think, you know, 2.5 to 3 times is our long-term target. So due to this great performance of our teams, focusing on working capital and some of the other initiatives we’ve had going, we’ve been able to pay down debt quicker than even we’d hoped a little bit. We’re going to stay focused on that through the first quarter or through the fourth quarter of this year. We do have a board meeting coming up next week to get our budgets for next year approved where we’ll talk more about capital deployment strategies and get our CapEx approved and things like that So right now our focus is continuing to pay down debt this year. We still think we’ve got some that we can do. So I’d say, but artificially, we’re not really trying to drive towards that 2.5, 2.75 times right now.

We do not have any acquisitions in the pipeline, so we don’t have that as a cash need at the moment. But as we look at some opportunities for investments next year, I’d like to delay that until we discuss it with our Board first.

Lucas Pipes: Very helpful. Thank you. And then I want to ask about the guidance for fiscal ’24. On the sales side, increase the lower end of the range. But when I kind of look at year-to-date performance versus your full year target, low end 279 million for the fiscal fourth quarter up to like roughly flat at the high end, 379 million of sales. What would it take to come in at the low end? Is that a really conservative look here, or how would you frame that up? Thanks.

Tom Ferguson: Yes, that’s a very good catch, Lucas. I think that probably is very much so on the low end. We’re going to track much better than that. We’re not tracking to the high end either, which I guess is why it’s a range. I feel good. We’re not chasing business over aggressively right now. There is some price sensitivity out there, so we’re trying to keep our powder dry and let the folks focus on the business that’s attractive to us, taking good care of our customers, and keep from chasing business below price levels that we want to go after. So we’re maintaining that discipline, which is why we set the range. But, yes, 279 is definitely below what we would say we’re going to have any shot at getting to.

Lucas Pipes: That’s helpful. Thank you. Then a quick follow-up. I appreciate you’ll issue guidance in a few weeks or so, but in terms of kind of the big trends that you’re seeing heading into your next fiscal year, would you anticipate a slowdown when it comes to Chips and Science Act, for example, or infrastructure, or do you think those key markets will still, on the construction side, will still be kind of trending higher year-on-year? And then, of course, you have organic and inorganic growth opportunities that you outlined in your prepared remarks. So just trying to get a little bit of a flavor as to what would be potentially tracking positive versus where you might anticipate a little bit more softness in your next fiscal year. Thank you very much.

Tom Ferguson: Yes, Lucas, this is Dave. I think what you’ll see there, we continue to see positive signs. Our Metal Coatings business in particular is galvanizing a lot of steel for new chip plants and utility T&D projects, bridge and highway, and some solar for quite some time. So we think that’s going to continue. We also think that the impact of government spending is going to result in multi-year demand for our solutions on both sides of the house, particularly those focused on critical infrastructure and energy transition initiatives. So we feel pretty good about the macro.

David Nark: Well, and I’d add in that, you know, on the Precoat side, I think both their organic growth initiatives and as well as I think residential construction is probably bottom, so hopefully that starts to trend up. Commercial construction is looking okay. So I feel pretty good about the early part of the year, and as we get into it, the nice part is particularly for Precoat Metals, once those volumes start to pick up, we get some really, really good flow through pretty quickly as you start to – as we come off the bottom, so to speak, because as we said last time we’re down 10% to 12% on volume, depending on which market it happens to be, which is we’re outperforming the market itself, but still we’re tracking to where we should have improvement next year.

We have not built – well, I shouldn’t say that – we have not put our – of course, not put our guidance out, and these will all be good discussions about how aggressive we want to be next year and how we continue to maintain that focus on our value pricing and maintain that discipline. So I feel pretty good about the first part of the year, and then the outlook just gets a little fuzzier as I look into fiscal ’25.

Lucas Pipes: I appreciate the color. Thank you very much for all the details and insights, and continue best of luck.

Operator: The next question comes from John Franzreb of Sidoti & Company. Please go ahead.