AZZ Inc (AZZ) 2017 Q1 法說會逐字稿

Good morning, and welcome to the AZZ Inc first-quarter of FY17 financial results conference call.

(Operator Instructions)

Please note that this event is being recorded. I would now like to turn the conference over to Joe Dorame of Lytham Partners. Please go ahead, sir.

Thank you, Denise. Good morning, and thank you for joining us today to review the financial results of AZZ Inc for the first quarter of FY17 which ended May 31, 2016. As Denise indicated, my name is Joe Dorame. I'm with Lytham Partners and we are an investor relations consulting firm for AZZ Inc.

With us on the call representing the Company are Mr. Tom Ferguson, Chief Executive Officer, and Mr. Paul Fehlman, Chief Financial Officer. At the conclusion of today's prepared remarks we will open the call for a question-and-answer session. If anyone participating on today's call does not have a full-text copy of the press release, you can retrieve it from the Company's website at AZZ.com or numerous financial websites.

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 of 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 29, 2016.

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 electrical power generation markets, electrical transmission & distribution markets, the industrial markets and the hot dip galvanizing markets, prices in raw material costs including zinc and natural gas which are used in the hot dip galvanizing process, changes in the economic conditions of the various markets the Company serves, foreign and domestic, customer requested delays of shipments, acquisition opportunities, currency exchange rates, adequate financing, and availability of experienced management 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?

Thank you, Joe. Good morning to all of you on today's call, and we thank you for your continued interest in AZZ. I hope everybody had a great Independence Day. I'm very pleased with our solid financial performance for the first quarter of FY17. Top-line revenue was up 6% over the first quarter of FY16, and we achieved over 5% growth in EPS as compared to the strong first quarter of the prior fiscal year.

Upon completing the successful first quarter of the new fiscal year, we see mixed market dynamics that present a combination of challenges as well as opportunities. Despite the volatility of recent international events and a US election year, we feel confident in our strategic plan to grow our operating platforms in a fiscally responsible manner while investing in our key initiatives to drive organic growth and operating excellence. We remain focused on growing internationally and deploying capital resources that will position AZZ to continue executing on our growth and performance plans.

Given the current market dynamics, I'm very pleased with the results from our acquisition of PEI at the start of the quarter for our electrical platform on the Energy segment. Further, despite headwinds in certain markets, we posted solid bookings of $250.5 million, which were up over 16% compared to the first quarter last year. This created a record backlog of $354.2 million at the end of the quarter, which is up $35.3 million, or over 11% compared to last years first quarter.

In our Galvanizing business segment we continued to face some challenges in the oil producing areas of the Gulf Coast but made progress on improving pricing both in acquired and legacy plants during the first quarter. This is helping to drive a higher sequential operating margin. As I've discussed before, we continue to make progress on several technology and operational improvement initiatives that we believe will drive future organic growth and value in our Galvanizing business.

Turning to the Energy segment. First-quarter orders grew almost 18% compared to the same quarter last year. This was primarily due to a combination of the PEI acquisition and strong international business in our Electrical platform. Despite relatively flat sales in energy, both gross and operating margins grew steadily at over 4% each, in spite of mixed market conditions overall. Both our top-line and bottom-line in Energy were negatively affected by the wildfires in Canada that caused us to demobilize from a relatively large welding overlay project at the very end of the quarter.

Looking forward, our Galvanizing segment still faces headwinds on the Gulf Coast related to the impacts of sluggish oil and gas spending, but we are gaining strength in other sectors including bridge and highway construction, recreation, and electric utilities to help offset some of the current headwinds. We are particularly pleased with the continued improvements in operating margin in the segment and expect those to continue to grow through the rest of the year and regain historical norms.

The outlook for our Energy segment is positive. Refinery utilization rates remain relatively high and the continued deferred maintenance is causing more unplanned outages, resulting in quick turnaround or emergency work that helps us fill our capacity. We've also benefited from strong international opportunities in driving higher backlog. While domestic utility infrastructure spending is still somewhat muted, we have a strong backlog to work with due to the consistent performance of our sales team and expanded international efforts. We remain focused on establishing international joint ventures to provide broader market access to mitigate any softness in the North American market. Further, the acquisition of PEI should allow us to leverage the combined product portfolio of enclosures across a broader market area.

Again, I'm pleased with the solid quarter and believe we have the leadership team, products and services and balance sheet to generate above market results for a long time. We will continue to focus on leveraging the ground taken by strengthening our sales teams, focusing on cost control, and on maintaining a healthy M&A program while seeking to better focus our platforms on their core products and markets. We remain committed to getting our platforms to a more focused core of activities, but do not need to do any fire sales of assets.

We are reaffirming our guidance for FY17 with EPS in the range of $3.15 to $3.45 per diluted share and revenues in the range of $930 million to $970 million. This guidance is exclusive of any divestitures or acquisitions. Now I'd like to turn it over to Paul Fehlman to cover the financial highlights.

Thanks, Tom. For the first quarter of FY17 we reported net sales of $242.7 million, an increase of $13.8 million, or 6% over the first quarter of FY16. Net income for the first quarter of FY17 was $21.1 million, an increase of $1.1 million, or 5.7% over the first quarter of the prior year. Reported EPS grew 5.1% (sic - see press release, "5.2%") to $0.81. And our backlog finished at a record $354.2 million, up 11.1% versus the first quarter last year, as our book-to-bill ratio finished at 1.03 compared to 0.94 in the first quarter last year.

Gross margins grew to 26.1% from 25.9% in the first quarter year over year. And SG&A finished at 11.9% compared to 11.5% for the first quarter last year, driving a first-quarter operating margin of 14.2% compared to 14.4% in the first quarter of FY16. Our effective tax rate of 31.6% remained relatively steady compared to the first quarter last year rate of 31.7%. Cash flow from operations more than doubled year over year, rising 104.1% as we continued to focus on cash performance.

As for our first-quarter segment results, first-quarter revenues in our Energy segment were up 0.8% to $138.1 million compared to the first quarter of the prior year, while operating income grew 4.4% to $18.8 million compared to prior-year first quarter. As gross margins in this segment improved from 25.2% in the first quarter last year to 26.1% in Q1 of the current year.

In our Galvanizing segment, first-quarter revenues grew 13.8% to $104.6 million compared to the first quarter last year, while operating income rose 10% to $24.3 million compared to the same period last year. Operating margins finished at 23.2% for the quarter, up sequentially for the second consecutive quarter as we continued to see positive margin improvement in Galvanizing.

We continue to leverage our ability to generate cash and our strong balance sheet to support growing our operating platform, as evidenced by the purchase of PEI during the first quarter as well as our continued investment in organic growth initiatives. With that, I'll turn it back to Tom for concluding remarks. Tom?

Thanks, Paul. The key takeaways I'd like to leave you with are these. We have a solid balance sheet and strong cash flows, a great portfolio of products and services, significant international growth opportunities and a talented and seasoned leadership team. We will continue to focus on growing our Galvanizing business, both organically and through targeted acquisitions. We will continue to expand the presence of our Electrical businesses internationally, both directly and through joint ventures. We are now benefiting from our accelerated emphasis on operational excellence and customer service at both WSI and NLI.

As I've stated before, we are not a quarter-over-quarter business due to the impact of refinery turnaround and power plant outages cycles, as well as the dependence of some of our businesses on large projects. So please keep in mind that Q2 is not usually a strong quarter for us, particularly when compared to Q3. We expect a solid year in FY17 with earnings skewed to the back half of the year.

We will continue to leverage our expertise as a solutions leader in protecting metal and electrical systems that drive infrastructure. And with a good pipeline of acquisition targets, we are looking forward to continued growth in our businesses and greater impact from our new growth strategies for the balance of FY17.

Now, we'll open it up for questions.

Thank you, sir.

(Operator Instructions)

The first question will come from John Franzreb of Sidoti & Company. Please go ahead.

Good morning, Tom, Paul.

Good morning.

Good morning.

I guess the first thing I'd like to address is the wildfires in Canada. How much revenue was lost there? And should we view that as lost revenue or deferred revenue that we will recapture in the second quarter?

I'd consider it more deferred for the most part. But it was a couple million dollars, and probably a couple cents EPS in the impact. And the problem was is the way it occurred. We weren't as -- usually we would be able to redeploy assets, but because we had to demobilize and keep them available we weren't able to do that in this case.

Okay, great. And last conference call you kind of talked about expectations for the third quarter turnaround season, maintenance schedule was going to be a little longer. And basically that's how it was shaping up then. Is that still the case, or has something changed in the customer quotation activity?

We're still looking at a real strong turnaround season in the Fall. I think it's stacking up that way, all of our quotations are stacking that way.

We're actually hoping we can pull some up just a little bit and push some out, just so we can handle more activity. We did see some things delayed from the Spring season into the Fall. Normally, I guess in old times that might have been good news for us, though, because we were already relatively booked up for the Fall. Those are opportunities, like I said, we're hoping they move outside of the Fall.

But it doesn't seem to matter whether it's the power generation side or refining, but it's looking good. And then the other good news for us is some of that is pushing into next year. So some of these delays could actually help us better level load our resources. So we're feeling very positive about the Fall season.

When you say next year, you mean into Q1 of next year, right?

Yes, or early part of Q1 of next year.

Great. Okay, I'll get back into queue and let someone else go on. Thank you.

All right. Thanks.

The next question will come from Schon Williams of BB&T Capital Markets. Please go ahead.

Hi. Good morning, gentlemen.

Hi, Schon.

Can we talk about, I guess, Galvanizing margins. So incrementals on a year-over-year basis had been weak. But I think that's more been the acquisitions down in Texas, trying to get those kind of fully baked into the numbers and make some improvements there. But I just want to make sure I understand all of the moving pieces, because it still sounds like you're guiding for some improvement as we go forward. And I just want to understand, can you talk a little bit about are the acquisitions still a little bit of a headwind, where are we in terms of the price cost dynamic on zinc, and just a little bit more color there would be helpful?

Yes, I think that we're making progress on the acquired assets. The only concern we've had is that a lot of those assets were in the Gulf Coast oil producing areas that have been affected economically. So while we're gaining traction in operating performance, we're not seeing -- we've reached a point where they are now reasonably profitable but they are still off of our legacy norms. So we look for that to continue. We would like to see a little more volume, and that will come with economic improvement.

On the other hand, we are looking to --we are seeing better, or improvement in pricing versus the cost of zinc. And so we're encouraged by that. I think that it's -- as we continue to add services to our business, as we continue to focus on operating efficiency and effectiveness, and as we continue to provide a higher level of service to our customers we like to think we're earning that price differential, or price improvement.

And then the other thing we are looking at as we try to get a better handle on how long the impact on the economy in the oil producing areas is going to affect us, we are looking at a couple of sites we can repurpose towards some of the growth initiatives that we need resources and assets to be able to do to move more quickly. So those are the things we're focused on. And we still see real positive trends towards getting the overall back to the historical norms by the end of the year.

When you say historical norms, you're talking about operating margins close to that kind of 25% or so?

Yes, 25%.

Okay. And then seasonally Galvanizing actually was a little bit weaker than what I would have expected. Normally going into this quarter you'd see a bump as much as kind of 5% to 10%. You got a little bit less than that. I don't know, would you basically kind of still point back to the Gulf Coast region and some of the type of demand there, or was there anything else that changed in the quarter for you?

Yes. The other impact we had was a little longer winter in Canada and the North. So a couple of weeks of longer winter has an impact on us. So we did see that in addition to some of the softness in a couple of the areas along the Gulf. And a lot of the heavy rain as well.

While we're happy to kind of not have drought conditions here in Texas and along the Gulf, it was a little more rain than we anticipated. So we did have some sites, particularly down in the Houston area, that were impacted, even up in North Texas. So we look at a real heavy rainy season, a little bit longer winter. I'd say that's the vast majority of the impact.

All right, that's helpful color, guys. I'll get back in the queue here.

Thank you. Our next question will come from Brent Thielman of D.A. Davidson. Please go ahead.

Hi, good morning.

Good morning.

Tom, with the issues in Canada, were overall WSI sales down from last year?

Slightly. I think it was just slightly, because we had improvement on the SMS side of that industrial platform, if you will, and WSI was lapping in just a huge quarter last year.

Okay. And on the backlog at quarter end, how much of that do you expect to burn through this fiscal year?

We should be burning through approximately 75% to 80% of that, some of it's longer dated.

Got it. And then one more, if I could. Could you give us an update on what you're seeing kind of developing on the power generation market? I think that you mentioned a little slower on the US side, maybe a global perspective as well? That would be helpful. Thank you.

Yes, I think a couple of things. If you take on the Galvanizing side, we do well when there's a lot of solar work, and we do well if there was any coal-fired plants, too. But we're not anticipating any of those in the near future.

But solar, even though the subsidies were reapproved, I think that actually slowed things up a little bit. We anticipate that kicking in as the year goes on. So we look for that to be good as we get deeper into the year, into the second half.

On the other utility spending, it's a continuation of gas turbine stuff, and that's been okay for our enclosure businesses, the transmission distribution has been okay. I think the nuclear spend, maintenance activities have been okay, and that's been fine for kind of the book to ship stuff at NLI. It's been fine for the turnaround season for WSI but the -- we've still got some activity going on at the two new nuclear plants in the US that have just been kind of slow. And so we have not seen that activity.

And then there were a couple new announcements of nuclear plant closures that are way down the road, so it doesn't have any short-term impact on us. But I think just that -- so while we feel good about where we're positioned in the nuclear sector in the short term, I think were some of these other activities, we're keeping an eye on them. They don't impact us right now.

We do see transmission distribution improving. And should be stronger in the third quarter, which helps our Galvanizing business as well as helps our bus and switch group businesses.

Okay, great. Thank you.

Hopefully I didn't confuse you too much with that.

Think I got it.

(Operator Instructions)

The next question will come from Noelle Dilts of Stifel. Please go ahead.

Thanks, and good morning.

Morning, Noelle.

First question. Can you give us a sense of organic growth in the quarter in Energy and Galvanizing?

Sure. On the Energy side, are you really are just talking about PEI being in versus being out?

Yes.

Bookings clearly still would have been up organically. Sales would have been off a few percentage points organically. OI would have probably been about what it was, about even.

Galvanizing, little bit different of a story. We're seeing up organically there, single digits but got up organically there. And the good news is that pricing was up organically.

And then can you just give us some, I guess, some incremental thoughts on power electronics, just how you're thinking about accretion for the year?

We don't want to go too specifically into that yet. First quarter, other than it is expected to be had accretive for the year. I think in the past, maybe including all of the stuff included with acquisition costs, with purchase price accounting, it was still $0.05 to $0.10. We had talked about that before.

Okay, great. And then just in terms of NLI, again just kind of how you're thinking about the business now. I know we're looking at ideally a smaller but more profitable operation this year. We were talking maybe somewhere in the $30 million to $40 million range, I think, in revenues in FY17. And can you just give us thoughts on that, and then on how we should think about the margin profile of that business as we look at 2017 and into 2018?

Yes. I think the revenues are likely to be stronger than that, just because we came in with a good backlog and call it the book-to-ship orders, in spite of the fact there's not a lot of big projects out there, the book-to-ship type orders are coming in at a fairly normalized level. So we're actually feeling better about the revenues for NLI for the fiscal year. And we're also feeling better about the margins.

I think the margins, because we are getting some of that book-to-ship, we don't have the lower margin, big Westinghouse projects in there that we had last year, which was that $25 million of backlog, but we've been able to replace -- well not so much replace it, but we've been able to now put the business on an even footing. It's not going to be all that far off at the margins for the Energy sector as we continue on.

Okay. All right, great. That's helpful. Appreciate it.

Our next question will come from John Franzreb of Sidoti & Company. Please go ahead.

Yes. Just in regards to M&A, it sounded like that you may be a little bit more active in the year than I would have thought, because I would have thought you were going through a period of digestion, having made three acquisitions in the past year. Is that the case that you still have a full plate, or not? Or you really want to take a step back and fix the margins in US Galvanizing and things like that first?

Yes, I think we have a full pipeline on -- heavily focused on the Galvanizing side. I would say that we've got a lot of resources focused on improvement US Galvanizing margins and operating performance. And we're seeing the progress and we're doing, not as fast as we want to see it but we're seeing progress and like I said, I think some volume would help those a lot.

The acquisitions we're looking at are actually a little more widespread. So we aren't looking as aggressively in the Gulf Coast because we know how -- as we look out at a North American map we don't see much white space in the Gulf Coast area now that we've made the US (technical difficulties) acquisition. We are looking in other parts of the country.

So if you look at our pipeline, it's full of things that are in areas where we haven't acquired anything in a little while and in other services that we've continued to talk about that we want to get into, and we won't close all those deals. We don't have deal fever, so we aren't going to overstretch our resources. I will say that Tim Pendley and his team has done a nice job of building their bench and building some internal capabilities so that they can pursue the M&A activity pipeline that we have in front of them effectively.

Now, does anything fundamentally prevent you from looking at Galvanizing opportunities in Europe?

Nothing prevents us from doing it. We do kick the tires on some stuff over there once in awhile, and we have in the past 12 months. But it's got to fit our profile. It's got to be something we know we can come in and add value to. And quite frankly, it's got to be big enough that it gives us some critical mass. So we would not typically, since we don't have anything there we wouldn't go look for a one-site type of deal.

So it's going to have to be multi-site. It's going to be have to be scalable. It's going to have to be something we were confident that we can support and do something with. And so we're very, very careful versus bought a mom-and-pop here in the US where we can go kick the tires and have plenty of infrastructure to support it. So we are looking at them.

Great, great. Got it. And also in your comments when you talked about the guidance, you threw in a caveat about excluding acquisitions or divestitures. We just covered the acquisition side, I think.

The divestiture side of that comment, there's always been a small non-core business that's been banted about over the years. You've had ample time to review the Company pipeline. Is there anything else that you consider divesting besides that small business, or it's not even on the table anymore?

Well, we've identified a couple of things as non-core and -- but we've also said we're not -- that doesn't mean we action it, those things immediately, but -- so I want to be very careful. But we do have more than one small business that we view as non-core. And given the right opportunity, having said we're not looking to do fire sales but given the right opportunity, we're going to clean up the platforms.

We've made the statement, John, we've made the statement before, even in these last calls saying we're going to take a hard look at our portfolio this quarter. We always take a look at our portfolio performance. If we find the right combination of things going forward in terms of right fit for somebody else, if that's the case, that's fine. There's nothing that we've announced so far. We are always taking a look at both acquisitions and divestitures. That's just a constant, as we try to maintain the good balance on the portfolio.

We really do want to get more focuses on electrical, more focus in -- I mean, I'll say Energy is where we are looking, and we've got to get more focus in that -- across those Energy platforms.

Perfect, I understand. And one last question. I was just wondering in the quarter, the first quarter, were there any kind of one-time professional fees or anything you want to bring to our attention, or was it just a perfectly clean quarter?

I think you might be referring to the corporate expenses being up a bit?

Yes.

We had a couple of different things happening. One is we did have some fees from prior acquisitions that manifested themselves in the first quarter this year that weren't there last year. We also have a couple of other things.

Equity-based comp is up, simply because our equity has been doing well. And as old stuff rolls off, especially the old SARs and you get into RSUs that we replaced those with, they are occurring at a higher rate simply because the price of the stock is up. The other one is that we're happy about more of our people participating in our employee stock purchase program, which also drives a little bit of that year over year. And it's really a combination of a lot of different pieces. No one big thing to call out.

And we did plan for it.

Okay. I was just checking. All right. Thank you for taking my questions.

Sure.

(Operator Instructions)

The next question will come from Schon Williams of BB&T Capital Markets. Please go ahead.

Thanks for taking my follow-up. Tom, you've talked for a couple quarters now about looking at JVs on the Energy side and I'm just wondering is that, have you not found the right partner on that side yet? Is it a long and tedious process where you start negotiations and two years later we get kind of a result? I just wanted to see, are you telegraphing that you're open to something, or is there something that we should be expecting maybe more near term that's already in the works?

Yes, these are things we've been working on. And we reach a point where it's time to announce and we don't want to announce them to the market and give our competitors a heads up on these things until we have to. So -- but yes, these activities are reaching a head. They are reaching a fairly near-term point where we should be able to announce some things.

All right, that's helpful. And then to switch gears a little bit, just any thoughts on CapEx guidance for the year? CapEx came in a little bit hotter than I expected Q1. Just wondering, annual run rate $40 million, is that what you were thinking or was there something left over with Reno that hit the quarter? I want to get a little guidance around expectations for the full year?

Nothing really with Reno there. I'd say the guidance would be higher than last year. We've got a lot of things that we're taking a look at or investing in that would be more along the (inaudible) growth lines, so some product extensions, new products that take a little bit of investment now. And would be of the same or better returns than a lot of the acquisitions. So we're pretty high on a couple of these things.

And that would be more -- when you say new products, that would be more focused on the Galvanizing side?

Yes, more focused on Galvanizing. We've got some on the WSI piece, but I'd say the heaviest concentration is on the Galvanizing, the new services, products, technologies that we've been talking about, plan of the future kind of things. And so we feel good about these things as we're continuing to set ourselves up for sustainable long-term top- and bottom-line growth on the organic side.

And when, just in terms of a reasonable time frame, you're getting, I guess, some traction from some of the new services there. But what inning are we in, in terms of seeing that hit the income statement? Are we still -- are we halfway through, are we still early? What's kind of your timeline there?

Yes, we're in the second inning. We've got a lot of things underway, we've got a lot of things that we've got resources now deployed to. We've made some investments. Some of the acquisitions we're working on will help accelerate some of these things in terms of other services. But yes, second inning. We're very early. And we look to make a lot of progress to balance this year.

Perfect. Thanks, guys.

Thank you.

At this time we will conclude the question-and-answer session. I would like to hand the conference back over to Tom Ferguson for any closing remarks.

Great. Thank you. I'm confident we will make progress on the M&A front while improving the structure and focus of our operating platforms as we execute in FY17. I look forward to discussing the impact of these activities when appropriate.

Thank you for participating in today's call. We look forward to talking with you again at the conclusion of the current quarter. Again, thank you and have a great day.

Thank you, sir. Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.