Earnings Call Transcript - AZZ Q2 2021

Operator, Operator

Good morning, everyone, and welcome to the second quarter of fiscal year 2021 financial results conference call. All participants will be in a listen-only mode. Should you need assistance, please press the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one. Note that today's event is being recorded. At this time, I'd like to turn the conference call over to Mr. Joe Dorame.

Joe Dorame, Investor Relations

Thank you, Jamie. Good morning, and thank you for joining us today to review the financial results of ABC for the second quarter of fiscal year 2021, which ended March 31, 2021. Joining the call today are Tom Ferguson, Chief Executive Officer, Philip Schlom, Interim Chief Financial Officer, and David Knaack, Senior Vice President of Marketing and Communications and Investor Relations. After the conclusion of today's prepared remarks, we will open the call for a question and answer session. Please note there was a slide presentation for today's call, which can be found on the investor relations page under financial information at ABC.com. Before we begin with prepared remarks, I'd like to remind everyone that certain statements made by the management team during this conference call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Except for statements of historical fact, this conference call may contain forward-looking statements that involve risks and uncertainties, some of which are detailed in documents filed by ABC with the Securities and Exchange Commission, including the annual report on Form 10-K for the fiscal year ended February 29, 2020. These risks and uncertainties include 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, industrial markets, and metal coatings markets, prices and raw material costs, including zinc and natural gas used in the hot dip galvanizing process, changes in political stability and economic conditions of the various markets we serve, 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. Additionally, as customers and operations could potentially be adversely impacted by the ongoing COVID-19 pandemic, the company cannot provide assurance that such forward-looking statements will prove to be correct. These statements are based on information as of the date hereof and assume no obligation to update any forward-looking statements as a result of new information, future events or otherwise. With that out of the way, let me turn the call over to Tom Ferguson.

Thomas Ferguson, CEO

Thanks, Joe, and welcome to our second quarter fiscal 2021 earnings call. Thank you for joining us this morning. First, I want to acknowledge that COVID-19 continues to affect our results. Our top priorities remain ensuring employee health and safety, supporting our customers during these unprecedented times, finishing this fiscal year well, and positioning the company for fiscal year 2022. All our facilities remain open, and I am extremely proud of how our teams have managed through this crisis, taking care of each other and our customers during the pandemic. We are grateful for everyone's efforts that allowed us to ensure the safe operation of our plants worldwide. We entered the second quarter in June, which is typically the final month of the seasonal spring turnaround season, so the quarter started slowly. Historically, Q2 is sequentially lower for our Infrastructure Solutions segment. However, the metal coating segment navigated the economic uncertainty well. Nevertheless, results in our galvanizing business were impacted by several factors, which I will cover later. Our second quarter consolidated sales declined by 13.9% compared to the second quarter of the previous year. Adjusted net income decreased by 16.7% to $13 million or $0.49 per diluted share. Due to the disruption caused by COVID-19 in our markets and some of our operations, we decided to accelerate elements of our long-term strategic plan and initiate actions that will provide longer-term benefits. Our medical segment faced a range of challenges, including operational disruptions from hurricanes and civil unrest in some areas, and faced difficulties in hiring direct labor. Sales totaled $117 million for the quarter compared to $125 million for the same quarter a year ago. I am particularly pleased that our galvanizing team benefited from lower zinc costs while maintaining above-average industry pricing. These efforts, along with our quality of workmanship and outstanding customer service, resulted in overall segment margins that were flat at 23%, while galvanizing margins exceeded 25%. The Metal Coatings team effectively integrated the powder coating and plating operations during the quarter. Many of our powder coating customers that had closed due to COVID-19 began to place orders again. We remain committed to our strategic growth plan in the powder coating and plating businesses, which is why we chose to rename our surface technologies division to better reflect our focus. Due to the impact of COVID on the oil and gas and petrochemical sectors, we made the difficult decision to classify some underutilized facilities as assets held for sale and closed a couple of sites, integrating their operations into others. We also closed one plating site, relocating its operations to a nearby plant. We're excited about the progress the new integrated team is making, and we believe these restructuring actions should provide approximately $2 million in savings benefits. Our Infrastructure Solutions segment's second-quarter fiscal 2021 sales decreased by 22.5% to $86 million, resulting in adjusted operating income of about $3 million compared to $4 million in the same quarter last year. As mentioned, the decline in sales stemmed from a lack of refinery turnaround activity in June, lower China high-voltage bus shipments, and decreased demand for some of our electrical products and services. Our industrial platform shops opened and began deploying during the quarter, but summer is typically a period of weak activity. In line with our strategy to reduce involvement in the U.S. nuclear sector, we initiated several restructuring actions in this segment, including personnel actions and consolidations, and decided to divest some of our businesses to buyers interested in investing and growing these units alongside $2.5 million of inventory. We believe the third quarter will show sequential improvement over Q2. However, ongoing COVID travel restrictions and continued low demand for gasoline and jet fuel have constrained turnaround activity. Due to prolonged uncertainties associated with COVID-19 and election-related delays by customers, we cannot provide an accurate full-year outlook, but we can say our third quarter will improve sequentially over Q2; however, it is unlikely to generate the same earnings as the strong third quarter from the previous year. Our low debt level, combined with our consistent ability to generate cash, gives us confidence that we can manage our debt and liquidity satisfactorily throughout fiscal year 2021 and beyond. We hope to return to a normal guidance cadence as we enter calendar year 2021 and to see customers refocus on their business engagements. Our metal coatings business operates at a relatively stable level, despite some challenges in certain states and cities. We face ongoing expenses to maintain a clean and safe working environment for our employees. We believe our businesses are vital to enhancing and sustaining infrastructure, and we will use this global pandemic as an opportunity to emerge stronger and better positioned for sustainable profitability moving forward. With that said, I will turn it over to Philip Schlom.

Philip Schlom, Interim CFO

Thanks, Tom. For the second quarter of fiscal year 2021, we reported sales of $203.4 million, a decrease of $32.8 million, or 13.9% lower than the second quarter's sales of $236.2 million last year. Due to the impact of COVID-19, along with certain restructuring and impairment charges, the company reported a net loss of $1.8 million for the second quarter, down 111.5% from the prior year. Consequently, diluted earnings per share was a loss of $0.07 compared to EPS of $0.59 in the same quarter last year. On an adjusted basis, reflecting the impairment impact, the company's net income was $13 million, or $0.49 per diluted share. In the current quarter, the company recorded restructuring and impairment charges of $18.7 million, with $14.8 million net of associated tax benefits. As a result of the restructuring, we have classified four operating facilities as assets held for sale within the Infrastructure Solutions segment, and two others within the Metal Coatings segment. The impairments in the Metal Coatings segment affected operating income by $11.3 million and include loss of sale related to assets held for sale and closures, while the impact to Infrastructure operating income was $7.4 million due to asset write-downs and inventory impairments. Gross margins for Q2 fiscal 2021 improved to 22.7% from 22.3% year-over-year, primarily due to continued strength in the metal coatings segment. Reported operating profit for Q2 was $21.7 million, down from $22.2 million in the prior year. Adjusted operating income was $19.3 million, or 9.5% of sales, up from 9.4% in the previous year, a 10 basis point improvement. EBITDA, as reported for Q2, was $12 million. Adjusted EBITDA was $30.7 million, a decrease of 9.2% compared to the second quarter of fiscal year 2020. For the year to date through Q2 of fiscal year 2021, we reported sales of $416.7 million, a 20.7% decline from the previous year’s strength of $525 million. Ninety percent of this decrease occurred within the Infrastructure Solutions segment, which experienced the most significant impacts from the pandemic. Year-to-date net income for the second quarter was $3.8 million, a decrease of $33.1 million from last year. On an adjusted basis, year-to-date net income was $18.5 million, or $0.71 per diluted share, reflecting a 49.3% reduction compared to the prior year. Highlights on the balance sheet and liquidity position show that through the first half of the year, cash flow from operations was $32.2 million, down by $6 million or 15.7% from the previous year due to lower sales and net income generated by the business. Free cash flow year-to-date is $12.9 million. Current borrowings on a revolver in the second quarter were $47 million, reflecting a reduction of $31 million or 39.7% from $78 million at year-end February. We invested $19.3 million in capital spending during the first half of the year, a 17% increase from the prior year. During the quarter, we repurchased $6.4 million for 200,000 shares of our stock at an average price of just under $32 per share. We continue to announce and make dividend payments, and despite the pandemic's impact, we remain committed to pursuing acquisition targets primarily within our metal coatings division. Additionally, we completed the refinancing and upsizing of our 5.42% $125 million senior secured notes, set to mature in January. We entered the private placement market, borrowing $150 million in two tranches of secured notes with a blended rate of 2.98%. The new notes will finance our December and January maturities and will be used for repaying existing notes and reducing our revolving credit balance, as well as repurchasing shares to minimize further dilution from employee stock plans. I'd like to thank our employees for their commitment during this difficult year and demonstrating the company traits we strive for. With that, I’d like to turn it back to Tom.

Thomas Ferguson, CEO

Thanks, Philip. As was the case in the previous earnings call, I wanted to close by sharing some key indicators that we continue to monitor closely within our segments. Fabrication activity remains strong in Q3, and we started well in September. Within our galvanizing business, we are tracking steel fabrication and construction activity. Zinc costs are stable, and the costs of zinc in our kettles continue to gradually decline. In terms of powder coating and plating, our focus is to resume normal production levels with existing and new customers. Regarding our aerospace customers within the Infrastructure Solutions sector, we would like to see more activity as the fall turnaround season approaches. We're seeing improvements in turnaround activity, but not to levels experienced last year, especially in the U.S. market. Additionally, we are actively monitoring situations in states with large refining capacities, and currently, travel restrictions remain in some countries for our electrical group. We are tracking proposal activity and expect bookings to increase this quarter and beyond, providing sufficient backlog for many of our business units for the latter half of the year. As it relates to lighting, which comprises part of our electrical grid, we are seeking higher rig activity and have taken significant realignment actions. Regarding corporate strategy, we have solid cash management processes and are tightening oversight on cash flow indicators and customer credit. Currently, we are not experiencing a slowdown in customer payments. In the post-COVID-19 environment, we remain committed to our growth strategy around coatings and to achieving 21-23% operating margins, with a desired increased contribution from powder coating and plating. We believe galvanizing can operate towards the high end of or above 23%, while powder coating and plating should be able to sustain 15-20%. This integration will enable us to leverage the talent in galvanizing to increase sales and drive operational efficiencies. We will also continue to seek to divest non-core operations that do not align with our future strategic interests. Most of our infrastructure experience only a modest level of disruption due to COVID-19. We are confident in the actions taken and the restructuring activities that are underway, allowing us to finish this fiscal year strongly and position ourselves to enter fiscal year 2022 with momentum. Furthermore, we remain active in M&A, targeting opportunities that support our strategic growth initiatives. Although travel restrictions affected our ability to pursue deals during Q2, conditions are improving and we have a portfolio of opportunities we are pursuing, aiming to close one to three galvanizing deals within the remainder of the year.

Operator, Operator

And ladies and gentlemen, at this time, we'll begin the question and answer session. To ask a question, you may press star and then one. If you are using a speakerphone, we ask that you please pick up your handset before pressing the keys to withdraw your question. You may press star and two to ask a question. We'll pause momentarily to assemble the roster. Our first question today comes from John Franzreb from Sidoti and Co. Please go ahead with your question.

John Franzreb, Analyst

Good morning, gentlemen. I'd like to start with the comment you made about the hurricane season. Perhaps, Tom, you can compare and contrast the potential disruptions you've had in the quarter or are currently experiencing versus the opportunities for reconstruction activity in the region.

Thomas Ferguson, CEO

Interestingly, none of our facilities were directly hit, which is a relief. We faced limited facility damage, but our customers' ability to operate was impacted, especially since they were already struggling with reduced demand in the oil and gas sector. Overall, we experienced moderate disruption. It's still early to determine potential opportunities stemming from this, as we haven't seen significant damage to our customers directly, particularly in refining and petrochemicals. I anticipate that, on balance, we will recoup the losses we've incurred, assuming no further setbacks for the remaining hurricane season.

John Franzreb, Analyst

You also mentioned the turnaround seasons in the fall and spring, with the fall being muted and spring showing some building activity earlier than expected. Can you elaborate on why that might be?

Thomas Ferguson, CEO

In the U.S. refinery turnaround space, we noticed that a lot of activity was focused on the previous spring rather than the fall season we anticipated to be busy. As oil prices have risen, the demand overall hasn't rebounded as expected. Even though we've seen more traffic on the roads, summer demand did not drive the expected production levels. For spring, the good news is we've secured some engineering orders already, but our challenge will be accessing the required resources and ensuring we deploy our crews effectively. Restrictions on international travel to locations like India and parts of Asia also complicate access. That said, we believe the subsequent spring turnaround may extend longer than usual.

John Franzreb, Analyst

Could you clarify the assets classified as held for sale? Specifically, which businesses are they?

Thomas Ferguson, CEO

We aren't quite ready to disclose specific details. We’re currently engaged in negotiations and want to keep those discussions confidential until finalized. As soon as we can, we will announce those details. These assets are classified in non-core divisions, which gives you some guidance.

John Franzreb, Analyst

Could you provide an overall sales profile for those four businesses in terms of revenue?

Thomas Ferguson, CEO

On the infrastructure side, we estimate about $60 million in revenue. These are unfortunately low-margin businesses. Ideally, the new buyers will invest and improve their performance quickly as we refocus our efforts. On the metal coatings side, we primarily have real estate for sale from closed plants. We have already moved to sell a galvanized plant which faced overcapacity in the area and was further impacted by earlier issues in the Gulf Coast.

John Franzreb, Analyst

Thanks for answering my questions. I will return to queue.

Operator, Operator

If you would like to ask a question, please press star and then one. Our next question comes from Noelle Dilts from Stifel. Please go ahead.

Noelle Dilts, Analyst

Good morning. I wanted to follow up on your comment regarding the non-core business. While I know these are low-margin, can you confirm whether they still contribute positively to operating margins currently?

Thomas Ferguson, CEO

Yes, that is fair to say.

Noelle Dilts, Analyst

Can you provide details about the number of galvanizing facilities after planned closures and sales?

Thomas Ferguson, CEO

Post-closures and divestitures, we expect to retain a healthy number of galvanizing facilities, though we aren't disclosing specific numbers until deals are finalized.

Noelle Dilts, Analyst

Could you clarify the geography and strategic rationale for the acquisitions you are pursuing?

Thomas Ferguson, CEO

We aim to acquire businesses adjacent to our existing operations. This includes a focus on expanding into the northeast, which would diversify our geographical presence.

Noelle Dilts, Analyst

Can you elaborate on the restructuring of energy operations into infrastructure solutions? What does this mean for your involvement in that sector?

David Knaack, SVP of Marketing and Communications

Good morning. We decided to rebrand to focus on core markets such as transmission, distribution, and utility. We are particularly optimistic about our enclosure and switchgear business, which is a key area for investment. Our welding solutions have expanded into other markets beyond refining, which creates several growth opportunities.

Thomas Ferguson, CEO

In our welding solutions division, approximately 40% of the business now comes from non-refinery sectors. We have transitioned significantly from nuclear to more profitable markets, leading to stronger technology integration and value generation.

Noelle Dilts, Analyst

Are there specific verticals experiencing strength or weakness in the quarter?

Thomas Ferguson, CEO

We have observed improvements in sectors such as truck and trailer, wind, and solar energy. The shift towards renewables is particularly impactful, and the steel demand associated with these projects has remained robust. Transmission also continues to perform well.

Operator, Operator

Our next question comes from DeForest Hinman from Walthausen & Company. Please go ahead.

DeForest Hinman, Analyst

Hi, thanks for taking my questions. Great job on the debt transactions, particularly with an attractive fixed rate on the private placement market. Can you provide some color on the covenants attached to that debt?

Philip Schlom, Interim CFO

Absolutely, we entered the market to take advantage of the stable rate environment following 10 years outside of it. We had significant investor interest, allowing us to upsize our offerings. We've also managed to broaden our covenants to improve flexibility, mainly in our acquisition and dividend payment baskets.

DeForest Hinman, Analyst

Regarding M&A, are you targeting deals to close by the end of the year, and is that targeting our calendar or fiscal year-end?

Thomas Ferguson, CEO

We are aiming to close these deals by the end of the calendar year. That could mean one or two deals in calendar year 2021 and possibly three by the fiscal year end.

DeForest Hinman, Analyst

Could you clarify the expected cash outlay for these acquisitions and the multiple ranges you are observing?

Thomas Ferguson, CEO

These deals typically fall under $10 million, and we aim for a multiple of 5 to 7 times. Our galvanizing teams are skilled at quick integrations, often exceeding expectations within the first year post-acquisition.

DeForest Hinman, Analyst

Can you provide any updates on pending sales and their timing, along with potential proceeds?

Thomas Ferguson, CEO

We are eager to finalize pending sales, with the goal of completing them before the holiday season this calendar year. However, proceeds will likely be modest and not significantly impactful on overall financials. Our focus is on managing resources effectively for future growth.

DeForest Hinman, Analyst

Can you comment on capital allocation and strategy concerning dividends and share buybacks?

Thomas Ferguson, CEO

While we are reviewing the situation concerning dividends and buybacks, we're currently focused on minimizing dilution. We will evaluate opportunities aligned with our growth initiatives once we identify suitable acquisition prospects. Our capex allocation is primarily aimed at bolstering our military segments to remain productive.

Bill Baldwin, Analyst

Can you provide insight into the proposal activity and sales pipeline within your domestic closure and switchgear businesses?

Thomas Ferguson, CEO

Proposal and sales activities are on an upward trend. Engineering firms and contractors are resuming operations, and we’re optimistic for the remainder of the year. Our sales organizations have been focusing on professionalism, and this is expected to lead to more opportunities.

Bill Baldwin, Analyst

What’s the status of your international joint ventures and projects?

Thomas Ferguson, CEO

There is considerable activity in high voltage projects in China, though it doesn’t align perfectly with our core strengths. We continue to work on joint venture partnerships to improve our position. The U.S. also shows activity in this sector, as well as ongoing projects in Saudi Arabia.

Bill Baldwin, Analyst

Is there an opportunity to expand your enclosure and switchgear business into international markets?

Thomas Ferguson, CEO

Currently, that doesn’t appear to be on our immediate radar, but we will include that topic in our strategic planning discussions.

Bill Baldwin, Analyst

Do you feel like your domestic facilities are adequate for your current operational needs?

Thomas Ferguson, CEO

I recently toured our facilities, and the team has made remarkable progress. I believe we have sufficient capacity across our locations to meet our operational requirements, and further opportunities will present themselves as demand increases.

Operator, Operator

At this time, we've reached the end of the question and answer session. I'll turn the call back over to Mr. Ferguson for any closing remarks.

Thomas Ferguson, CEO

Thank you all for participating. We've had fruitful discussions, and I look forward to finishing a strong third quarter. We anticipate completing our strategic planning process shortly, which will clarify our core focus moving forward, and we hope to share more during our next call. Thanks again for your time, and take care.

Operator, Operator

And ladies and gentlemen, that will conclude today's conference call. Thank you for joining us. You may now disconnect your lines.