Good morning, ladies and gentlemen and welcome to the AZZ Inc. Third Quarter Fiscal Year 2019 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded. At this time, I would like to hand 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 third quarter of fiscal year 2019 ended November 30, 2018. As Denise indicated, my name is Joe Dorame, Managing Partner of Lytham Partners. On the call representing the company are Mr. Tom Ferguson, Chief Executive Officer and Mr. Paul Fehlman, Chief Financial Officer. After the conclusion of today’s prepared remarks, we will open the call for a question-and-answer session. Please note there is a slide presentation for today’s call, which can be found on AZZ’s Investor Relations page under Financial Information at www.azz.com. Before we begin with prepared remarks, I 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 U.S. Securities and Exchange Commission, including the Annual Report on Form 10-K for the fiscal year ended February 28, 2018. Those risks and uncertainties include, but are not limited to, changes in customer demand and response to products and services offered by the company, including demand by the power generation markets, electrical transmission and distribution markets, the industrial markets and the metal coatings markets; prices and raw material costs, including zinc and natural gas, which are used in the hot-dip galvanizing process; changes in the political stability and economic conditions of the various markets that AZZ serves, foreign and domestic; customer requested delays of shipments; acquisition opportunities; currency exchange rates; adequate financing and availability of experienced management and employees to implement the company’s growth strategies. The company can give no assurance that such forward-looking statements will prove to be correct. These statements are based on information as of the date hereof and AZZ assumes no obligation to update any forward-looking statements whether as a result of new information, future events, or otherwise. With that, let me turn the call over to Mr. Tom Ferguson, Chief Executive Officer of AZZ. Tom?

Thanks, Joe. Welcome to our fiscal year 2019 third quarter earnings call and thank you for joining us this morning. We finished the third quarter on a positive note achieving yet again double-digit growth on both the top and bottom lines. Our businesses are operating on a firm foundation as cash from operations improved by 56% to $60.4 million for the nine-month period. While we continue to make progress across most of our businesses in terms of customer focus and we’re fairly pleased with the improvement from last year, we were impacted by both the increasing cost of labor and materials. In spite of this, our businesses, in most cases, responded well in attracting new customers and opportunities. As we noted on the last call, we expect to maintain positive traction as we look to complete fiscal year 2019 on a strong note. We have finalized our WOFE in China and this gives us more confidence in our ability to manage through the trade uncertainties. We also finalized the joint venture in Saudi Arabia and our new facility is under construction, which provides us local capability and an improved position to pursue more service opportunities. While our new metal coatings initiatives are still running below our expectations, we are making real progress on them. We also remain highly active on the M&A front as we look to strengthen our core businesses and streamline our portfolio. We feel comfortable with our full-year earnings guidance, so with only a couple of months left in the year we are narrowing the range to $1.95 to $2.20 per diluted share. Metal coatings third quarter performance was mixed with strong sales, but weaker than expected margins as the higher cost zinc continues to run through our kettles and both skilled and semi-skilled labor is proving…

Thanks Tom. For the third quarter of fiscal year 2019, we reported net sales of $239.5 million, a $31.4 million increase which was 15.1% higher than the third quarter of fiscal 2018. Operating income for the third quarter of fiscal 2019 was $22.8 million, $21.2 million higher than the third quarter of fiscal 2018, which included special charges to both cost of goods sold and SG&A as more fully described in the 10-Q filed with the SEC this morning. Reported fully diluted EPS grew to $0.59 per share compared to a loss of $0.01 last year and our backlog finished at $307.8 million, which was up 8% versus the third quarter of last year. Our book-to-bill revenue ratio finished the third quarter at 0.88, compared to 0.86 in the third quarter of last year, and we currently expect to ship 54% of the backlog outside of the U.S. compared to 28% in the same quarter of last year. Gross margins for the quarter were 20.8%, 590 basis points higher than the 14.9% gross margin for the third quarter of last year. SG&A finished at 11.3% of total sales, compared to 14.2% for the third quarter of last year. As a result, we generated third quarter operating margins of 9.5%, compared to 0.7% in the third quarter of last year. We generated strong cash flow from operations of $60.4 million, which improved by $21.7 million or 56% in the first nine months of fiscal 2019, compared to cash flow performance for the same period a year ago, primarily due to higher net income. On a comparative basis, our quarterly interest expense rose 6.1% year-over-year or about $200,000, mainly as a result of rising interest rates, which was somewhat offset by a reduction in debt balances. Our effective tax rate increased to 17.8%, compared to the third quarter late last year. As for our third quarter segment results, third quarter revenues in our energy segment were up 23.4% to $132 million compared to the third quarter of the prior year while operating income of $11.5 million rose $23.6 million compared to the prior-year loss. Gross margins in the energy segment grew to 21.3%, compared to 5.6% in the third quarter of last year. Operating margins for the third quarter were 8.7%, compared to negative 11.3% in the third quarter last year. In our AZZ Metal Coatings segment, third quarter revenues were $107 million, a 6.3% increase compared to the third quarter of last year. Operating income fell 15.5% to $18.3 million, compared to $21.7 million in the same period last year generating an operating income margin of 17%, compared to 21.4% in the third quarter last year as a result of zinc cost realized during the quarter that was still higher than prior year despite falling slightly sequentially, as well as increased costs for labor. With that, I'll turn it back over to Tom for his concluding remarks. Tom?

Thank you, Paul. We remain moderately optimistic about fiscal year 2019 and we're gaining confidence in our outlook after three solid quarters of performance. As noted earlier, we are narrowing our guidance for fiscal 2019 with earnings to be in the range of $1.95 to $2.20 per fully diluted share and annual sales in the range of $940 million to $960 million. We're experiencing generally stable market conditions, and we feel confident about our organizational changes and realignment activities. Additionally, we are executing on our strategic initiatives to drive improved operational performance and pursue new growth markets and products. To reiterate, we are reenergizing initiatives focused on managing commodity costs and improvement, labor hiring and retention. We are also very intent on improving focus on our core businesses that are critical to our success in the future. We will continue to focus on driving performance the balance of this year and positioning AZZ for a stronger and better fiscal year 2020. With that, I'll open it up for questions.

Thank you, sir. [Operator Instructions] And the first question will be from John Franzreb of Sidoti & Company. Please go ahead.

Good morning, Tom and Paul. How are you doing?

Good morning, John.

Good morning, John.

Actually, I want to start with the exact same first question I had last quarter. Could you just talk a little bit about the zinc dynamic in Metal Coatings? Last quarter you said it's roughly six months, before you can fully work through those high costs that we had in the beginning of the year. We're a quarter later and it seems to have a more profound impact than I would have remotely expected compared to the last quarter. Can you just speak about what's going on there?

Yes, I think, the key thing here is we – the high cost zinc is starting to flow out of our kettles and that will continue at a pretty good clip as we finish out this year, and then get into the first quarter of next year. So that was kind of a fairly quick ramp up, and just because of the way it flows through our kettles, it's taking a little longer to get it out than we probably normally anticipate, but also keep in mind, we've got about 16 million to 20 million pounds of zinc that we move through our kettles every quarter, and when you're running about a quarter or $0.25 a pound higher, that just has a significant impact on you. And there's – while we're pushing zinc productivity and efficiencies pretty well, we haven't been able to do that enough to offset that kind of a significant increase. And we've also had good performance on our price realization, but in this case, also keep in mind labor is more expensive, tougher to find, more expensive. We're focused now on improving our retention, because getting people experienced and being able to retain them is a critical part and driving productivity for us.

John, it's Paul. Just a couple more things. And Tom is absolutely right, the zinc price did roll over in the third quarter – our lower cost per pound in the third quarter than the second quarter but it was – it is still well up from last year in the same quarter, the third quarter. The other thing is, if you go back and you take a look at the last quarter conference call, like what we were indicating is we expected to really see the change during the fourth quarter as the first real indication of change. So, it's a little fuzzy exactly how much lead time you need to clear the highest price stuff out of the backlog, but I think we had to pay pretty much right where we saw fourth quarter rather than third quarter, really more significant enough.

Paul, are you locked into annual contracts when you buy zinc? How much is some sort of annualized contracts versus buying on the spot market?

There were different contracts purchased last year that – at the end of last year, at the start of this year that continued to this year. And most of them though are based on – I think as you and I have actually discussed, whatever the spot rate is, but we don't go too far into it.

Yes, I think John, the thing to keep in mind, usually the buying cycle is right at the first of the calendar year, and you lock stuff in, so we had some contracts locked in that we don't feel real good about, but I feel better about what the new team is doing in terms of purchasing. So, yes, we've had a little bit longer duration of that higher cost zinc than we would like.

Okay. And then just moving quickly to the energy side of the business, can you talk a little bit about what you're seeing not only in the turnaround environment overall, especially as the important spring approaches for you, but also, if you kind of narrow it down to what you're seeing in the oil and gas [indiscernible] marketplace? There's certainly a lot of concern about what's happening there, given the recent split in commodity prices?

Yes, I guess there's – you got a lot of questions wrapped up in that one, John. I appreciate that. We're – we did have a better, much better refinery turnaround season, a lot of our initiatives in going – pursuing better international projects also has been paying off. We see that continuing naturally, the winter months in North America for turnarounds and outages tends to be slower. So, we anticipate – we've anticipated that in our guidance. For the spring, looking pretty strong. I think our folks on the industrial side, they're seeing a lot of activity, a lot of good quoting, and we've gotten some engineering orders in, a nice slate of international opportunities as we're facing the spring. So, at this particular point, we feel pretty good. So, unless something changes which can happen and refineries decide to pull in their horns again, we're feeling pretty good about the first quarter or the spring season. In terms of the power outages, less so, I think nuclear has continued to be a smaller and smaller piece of our activity in welding solutions, we still do have the NLI, Nuclear Logistics Inc., piece, and we've structured them to perform pretty well at this level of activity. So, we're not seeing anything that gives us, significant concern as we look at the spring. On the oil pat side, as you know, we're going to get a couple of businesses that are exposed to that. We've structured them for good profitability at a reasonably low level of opportunity. So, we've been there, we feel pretty good. And then on the electrical enclosures and switchgear businesses, we're working pretty hard to find leverage points. As I mentioned, there's five facilities that ostensibly build enclosures, two of those also do switchgear, but the enclosure piece – enclosure fabrication piece tends to be a pretty good piece of their value add. So, we're doing a lot of things there that, I think, are going to pay off in the future. We've seen a better market there with of course [Kuntz] I think, they – with what's left, they've got about one facility maybe of capacity and then we bought Lectrus out of bankruptcy. We're feeling pretty good about that part of the market. So, our focus now is what do we do to improve the North American activity for high-voltage bus. We've got good backlog internationally, particularly China. We are seeing some activity in Saudi Arabia that makes us feel better as we look forward into next year for both medium-voltage and high-voltage bus. Did I get them all?

Great. You've got a lot of that, Tom. Thanks. I'll let somebody else chime in.

[Operator instructions] The next question will come from Noelle Dilts of Stifel. Please go ahead.

Thanks. Good morning.

Good morning, Noelle.

Good morning, Noelle.

Good morning. So, I just wanted to go back to coating and dig into the margins just in a slightly different way. If you look at the year-over-year margin compression, I think about 440 basis points. Can you give us a sense of how much of that is the headwinds from zinc? How much is labor? And then how much slightly that drag from new product line? Also, is there anything that you might think of as more onetime in that compression? And I think the bigger question is really, when you look at margins moving forward into the fourth quarter and into next year, how quickly could we maybe start to see a rebound as some of that thing comes off?

Yes, I think the – you look at – it depends on how we want to cut this because we did – we looked at it as what we've offset with price, which I'd say, the team has done pretty well. Our reorganized sales effort has paid some dividends there. And I think that's being hidden by these significantly higher costs on zinc. To kind of frame it, normally about half of our cost increase comes out of zinc alone. And in this case, just because of the high labor market, some of the wage increases we've had to do and some of the productivity issues, it's labor and overhead has been a little bit higher impact than normal, so call that about 40% of it. And then maybe 10% on these new initiatives where we've got depreciation and operating expenses when we're not fully absorbed yet and continuing to chase that. So, 50, 40, 10, I think is kind of rough cut. Yes, I do think, the zinc productivity, we feel good about what the team's done in terms of zinc productivity, but where we've suffered is on the labor productivity side. So, we've got some work to do there. I think DGS is going to help us, but quite frankly, that's still – even though it's in all of our plants now, getting it up to full utilization and getting the benefits out of it, it's probably still a couple of quarters away. What you will see is – going to next year is, is the zinc in a lot of our larger plants, zinc cost does start to drop off pretty well. So, we feel better about as we go into next year. We've got good line of sight to it. In terms of the labor, that's something we've – we're putting a lot of work around, a lot of effort. I think it gets better because we are doing the things we need to, to improve that retention of, what I'll call, semiskilled labor. And where we have had good retention is in the plant management and structure, so we feel very comfortable about our plant management and where we're at. We did lose a couple of good ones, not due to normal attrition, but due to health issues and things like that. So – but I think, our bench is better. So, we feel better about our ability to plug and play as we go forward.

Okay. That's helpful. And then could you give us a sense of some of the trends that you're seeing in the coatings end market, generally an industrial kind of what you're seeing in downstream T&D, et cetera. Just generally to give us a feel for kind of the elements of the growth that you're seeing there?

Specific to coatings or kind of more of coatings and also the...?

Specific to coatings, I think you touched on some of the electric, but certainly would be happy to hear more – if you have more on the electrical side as well.

Yes, I think – I'm going to give you a general overview, then Paul probably chime in here because he is looking at a chart, but he'll have more specifics. I think, on the Industrial side, we've seen some petrochemical refinery kind of projects down in Gulf. Still not enough to offset the kind of the level of capacity that's down there, even though we closed the plant in New Orleans to reduce the capacity that's available out there. But we have seen some activity and that's the kind of thing we – those tend to be, they use a lot of steel. They are tending to buy domestic steel now and – which means we get an opportunity to galvanize it versus coming in pregalved. T&D still very active, and, of course, that affects both our coatings business as well as our electrical business. So, we feel real good about the trends there. I think, there's still several quarters plus of good activity levels that the industrial fabrication activity has been good. I think, as we look around where we're located, we've – we're seeing good activity levels. The thing that has shifted a little bit on us is solar. Some of the solar fabrication has moved from the West back towards the East again. So, we picked up some of that, but it does affect some of our plants in the West. So, overall, solar is fine. It's just that it's moved a little bit and where we've got some significant capacity, it's moved away from those plants. So that's probably more peculiar to where we're located than a general trend in the market because solar overall has been okay. And we'd actually seen some better activity. It just fell in the wrong places for us. But as we look at next year, I think we're seeing good activity in that solar and other power gen area. Paul, you want to add to that?

Yes. Noelle, look, the – Tom's absolutely right. Solar is still up over the last two years, hasn't quite gotten back to its levels at our highest year in 2016, but we've been pretty clear about that over the last few years and generally speaking about construction, industrial construction, those are up nicely. In fact, almost all of our end markets are up year-over-year, which is good to see, just a general health in that market. We, of course, like to see more bridge and highway spend, but that takes money coming from the government and we'd certainly encourage that to put more into bridge and highway, but that's actually up over year as is petrochem, funny enough, as he pointed out and even recreational. So, we're seeing positive trends almost across the board.

Okay. Great. Thank you so much. You guys also called out China, just maybe some general concern there as we look forward, and you've obviously picked up a lot of work here over the past year. Are you seeing – is it kind of a general concern? Are you seeing any changes in behavior or kind of how the projects are being bid? Could you just give us a feel for what you're seeing generally as it relates to China right now?

It's pretty normal. I think, the market share is always just such a big piece of our current backlog that a movement of a project by a month can impact a quarter for us. And so that's our biggest level of caution. What we feel better about is more control of a wholly-owned facility over there where we can be more flexible about what we produce in the U.S. versus what we produce in China. It also allows us to take advantage of some of the lower-cost components in China and not have to import as much. So, I think our caution will continue to abate as we kind of work through the existing backlog. We feel good about the contracts that were negotiated, feeling better about the terms we have in the contracts and backlog than probably 18 months ago. So, we call it out mainly because it's such a big piece of our backlog and can move the needle pretty readily, just projects move in a month.

Okay. And then just a couple of more housekeeping related questions. Given that you have been investing in initiatives, any thoughts on how we should think about CapEx as we move into 2020? And then, second, SG&A came in below my estimate, but pretty well controlled in the quarter, any opportunity or how are you thinking about further reduction there? And do you think SG&A could come in below 13% of sales next year?

Well, on the SG&A question, Noelle, you're right there. I mean, we've moderated the stock prices and how our performance has been. You see that has affected some of the long-term incentives, as well as short term. And where we want, we want to be fair and balanced about our own stats, so a lot of that has just been kind of on cost of employees and we understand, especially here at the headquarters, that we always deem to maintain a lot of vigilance over those costs, but we don't grow the overhead too fast for the Industrial business here. And so, it's mostly coming out of the employee cost and a lot of it is in the headquarters here. So, yes, we'll keep a very close eye on SG&A, and I know that's one of – that's Tom's favorite, for me to stay after.

Yes, and I think, we made some – on the CapEx side, we made some pretty big bets in DGS that we've called out, and we also – the big bets on Reno and also on a Galvabar facility in Oklahoma. So, those are behind us. Those really big onetime CapEx things. Not that we're not going to have some growth CapEx, but we're looking at how we manage that better on the Galvabar side as we look at another facility. We think we can do it a lot more efficiently and may even have a different approach on that. So, I think, maintenance capital pretty normalized as we look forward into next year. We've fixed some operating issues. Over the past couple of years, we’ve taken out four locations that were underperforming. So, we feel pretty good. Not that we may not still find some opportunities to consolidate plants where it makes sense, I just want to treat that now as something that we do on a regular basis as customers move and markets flip around. We'll continually look at that, where do we need to be. And then also on the acquisition front, some of the things we're looking at is to be able to probably do a better job of adding facilities as adjacencies to where we already serve rather than adding them within our own backyard and duplicating capacity. So, I think, we've reined in some of the ways we're looking at, at what we acquire and where we acquire it. I don't see as building any new hot-dip galvanizing plants any time in the future – in the near future, anyways, particularly next year.

Okay, perfect. Thank you very much.

And the next question will be follow-up from John Franzreb of Sidoti & Company. Please go ahead.

Yes. I was wondering, given your increased confidence in the contracts on the Energy side and given the lower input costs that you're getting on the Metal Coatings side and given – also on the Energy side, your expectations on an improved spring season, what are you more confident in happening first, sustainable double-digit operating margin in Energy or a 22% operating margin in Metal Coatings?

Yes, I think given our backlog and some of the things that have transpired in that Electrical sector, I think, they are couple years away from getting back to double digit. We're not ready to put our guidance for fiscal 2020 quite yet, we haven't...

I didn't say when, I just...

But yes, we are focused on developing that story. In terms of Metal Coatings, I think the zinc flowing through our kettles, they pop back above 20. We'll work them back towards 22. I think that comes before. As I look forward into next year, we'll focus more on consolidating margins and improving margins than we are on continuing growth. So, we're going to be much more focused on that operating improvement in terms of margins for next year for Metal Coatings. So, I think that comes first. I think, we've got a good plan on the Electrical side to drive margin improvement. But just given the nature of the backlog and kind of where the competitiveness in the market has been, and it's – we don't have any high-flying business units that are up in that 20%, 25% operating margin range. And we don't anticipate that happening like it was a few years back. So, I think that comes second. I do think we'll make margin improvement in Electrical and anticipate that as we go into next year.

Okay. Fair enough. And just said, you don't plan on greenfielding any new kettles. What does that say about potential M&A activity actually on both sides of the business?

Okay. I think, Metal Coatings, when it comes to galvanizing, we're always going to be fairly aggressive. Like I said, we're going to be a little more careful of not buying things that are going to have tremendous overlap with existing capacity. But wherever we can find some, call it, adjacent to where we already serve, we're going to be very, very, I hate to use the term aggressive, but we're – let's just say, very focused on making sure we attract those. On the Powder Coating side, we've got a very narrow range that we look at for what we're interested in, in terms of size and margin capability. So, we'll continue to look at those. I like some of the things. We've had an ongoing initiative around that with an investment banking firm Scout & Spur. So, we'll continue to look at those, but we're being very disciplined about it. Those kind like EPC, there's not a tremendous number of them out there, but there's a few and so we're very interested in those. On the Electrical side, you've heard me say it before, I tend to like enclosures and switchgear because it tends to be bigger stuff. You're not at the mercy of low-cost imports and we are domestic business in that realm. So, there is a couple out there that if they came available, we'd be interested. So, I don't want to preclude an electrical acquisition. On the Welding Solutions side, we're not anticipating anything out there.

Got it. And just one last question and if I missed this, I apologize. But what are we thinking about tax rate not only for this year, but maybe on a go forward basis?

Yes. Well, every time we call one, our head of tax continues to go out and use a nice tax planning, and find some extra pickup in there. I would say, for next year, at this point, we haven't put out guidance, but I would just say as a rule of thumb, stick with 21% next year until further notice.

Okay. Alright, thank you Paul, thank you Tom. Appreciate taking my questions.

And ladies and gentlemen, that will conclude our question-and-answer session. I would like to hand the conference back to Tom Ferguson for his closing comments.

Thank you, Denise. Thank you all for participating on today's call and I don't have a whole lot to add, so we look forward to talking to you again at the conclusion of our fourth quarter. Thank you.

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