AZZ Inc. — Form 10-Q Summary
Reporting period: Second quarter and six months of fiscal 2019, ended August 31, 2018. AZZ provides metal coating services, welding solutions, specialty electrical equipment and engineered services through its Energy and Metal Coatings segments. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Revenue | $222.8 | $196.3 | $485.0 | $401.6 |
| Gross margin | $46.9; 21.1% | $43.8; 22.3% | $105.6; 21.8% | $91.2; 22.7% |
| Operating income | $17.1 | $17.4 | $40.8 | $37.4 |
| Net income | $11.2 | $9.8 | $27.0 | $21.8 |
| Diluted EPS | $0.43 | $0.38 | $1.03 | $0.84 |
Q2 revenue increased 13.5% year over year; six-month revenue rose 20.8%. Q2 operating margin was about 7.7%, compared with 8.9% a year earlier, while six-month operating margin was about 8.4%, versus 9.3%. Net income benefited from a lower effective tax rate: 19.6% for the quarter and 21.0% for the six months, compared with 28.7% and 28.5%, respectively, in the prior-year periods. The company declared dividends of $0.17 per share for Q2, unchanged year over year.
Segments and material changes
- Energy: Q2 revenue was $106.5 million, up 9.5%; operating income was $4.3 million, up 80.8%. Six-month revenue increased 20.4% to $253.5 million and operating income increased 56.8% to $14.2 million. Management cited stronger U.S. refinery turnaround activity, international projects and electrical business, partly offset by continued nuclear-market softness.
- Metal Coatings: Q2 revenue was $116.3 million, up 17.4%, but operating income declined 5.7% to $22.1 million. Six-month revenue increased 21.1% to $231.5 million and operating income rose 5.8% to $47.3 million. Higher volumes and selling prices were offset by higher zinc costs and $1.3 million of facility-consolidation charges in Q2.
- Q2 sales growth also reflected acquisitions completed over the prior twelve months. AZZ acquired certain Lectrus Corporation assets for $8.0 million in March 2018; the filing describes the acquisition as not significant.
- Energy backlog was $336.0 million at August 31, up 26.6% from February 28 and 12.0% from August 2017. Q2 book-to-revenue was 1.14, compared with 0.97 in the prior-year quarter.
- Other income included a favorable revision to estimated losses on a non-trade note receivable connected to a debtor’s bankruptcy; the filing does not provide a clear amount for this benefit.
Cash flow, liquidity and debt
- Six-month operating cash flow was $17.5 million, versus $2.8 million a year earlier. Investing cash outflow was $14.8 million and financing cash outflow was $14.1 million. Cash declined $11.6 million to $9.2 million.
- Working capital was $240.2 million at August 31, compared with $197.4 million at February 28. Contract assets were $71.2 million, up from $51.8 million; management attributed changes in contract balances primarily to timing differences between performance and customer payments.
- Total debt was $296.0 million, comprising $125.0 million of senior notes and $171.0 million drawn on the revolving facility. Cash was $9.2 million. AZZ reported $259.8 million of additional credit availability and compliance with its debt covenants. The final $14.3 million payment on the 2008 Senior Notes was made at scheduled maturity in March 2018.
- Capital expenditures were $7.2 million for the six months. The company paid $8.8 million in dividends and reported no share repurchases during the period.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management said cash, operating cash flow and expected access to credit facilities should meet foreseeable cash needs.
- Risks cited include demand fluctuations across served markets, raw-material and energy prices (including zinc and natural gas), foreign exchange movements, economic and political conditions, customer shipment delays, and availability of financing and experienced personnel.
- Westinghouse and relevant subsidiaries are in Chapter 11. AZZ reported approximately $12 million of filed claims, including all pre-petition claims; the debtors estimated a 98.9%–100% distribution on allowed general unsecured claims. AZZ said claims filed exceed the book value of its exposure.
- A securities class action filed in January 2018 alleges misleading statements concerning Energy-segment revenue recognition. AZZ denies the allegations, says it intends to defend the case, and cannot predict the outcome; an adverse result could be material.
- Management concluded disclosure controls were not effective because of a material weakness in controls over revenue-recognition policies and transactions. The weakness followed prior-period revenue-recognition errors and restatements. Remediation is underway, but operational testing is still needed to validate remediation.
- ASC 606 was adopted March 1, 2018; management reported no significant effect on current-period revenue or cost of revenue and no opening retained-earnings adjustment. The filing also notes expected recognition of operating lease right-of-use assets and liabilities upon adoption of the new lease standard.
Important facts for investors to verify
- Progress and independent validation of the revenue-recognition control remediation, including whether any further restatements or control issues emerge.
- Conversion of the Energy backlog into revenue and cash, and the sustainability of segment margins amid softer nuclear activity and higher zinc costs.
- Collection and recoverability of contract assets, receivables and the Westinghouse claims, including the uncertainty around bankruptcy distributions.
- Potential financial exposure and developments in the securities class action, as well as the company’s debt, interest-rate exposure and remaining credit availability.