AZZ Inc. — Form 10-K Summary
Business context and reporting period
AZZ provides electrical equipment and engineered services through its Energy segment and galvanizing and other metal-finishing services through its Metal Coatings segment. This 10-K covers the fiscal year ended February 28, 2018 (fiscal 2018); it is not a filing for a standalone calendar 2017 fourth quarter. The company reported fourth-quarter results for the three months ended February 28, 2018.
Fiscal-year acquisitions included Powergrid Solutions, Enhanced Powder Coating and Rogers Brothers. A subsequent March 2018 acquisition of certain Lectrus assets is disclosed as a subsequent event.
Financial performance and liquidity
| Metric | Fiscal 2018 | Fiscal 2017 |
|---|---|---|
| Net sales | $810.4 million | $863.5 million |
| Gross profit | $160.3 million | $205.3 million |
| Operating income | $48.2 million | $98.9 million |
| Net income | $45.2 million | $61.3 million |
| Diluted EPS | $1.73 | $2.35 |
| Operating cash flow | $78.9 million | $111.2 million |
| Capital expenditures | $29.6 million | $41.4 million |
| Total debt at year-end | $301.3 million | $272.3 million |
- Gross margin declined to approximately 19.8% from 23.8%; net margin declined to 5.6% from 7.1%.
- Energy sales fell 13.7% to $421.0 million; segment operating loss was $1.8 million versus $52.6 million of operating income. The segment recorded a $10.5 million asset impairment and a $2.9 million doubtful-account provision, among other pressures.
- Metal Coatings sales rose 3.7% to $389.4 million and operating income increased to $84.3 million from $79.0 million. Acquisition contributions and higher prices helped, partly offset by softer volumes and higher zinc costs.
- Cash and equivalents were $20.9 million at year-end. Working capital was $197.4 million, and current assets of $329.2 million exceeded current liabilities of $131.7 million.
- Cash from operations declined by $32.3 million. Investing used $73.9 million, including $44.8 million for acquisitions. Financing provided $3.8 million, with increased revolving-credit borrowings offset by debt repayments, dividends and share repurchases.
- The company paid $0.68 per share in declared dividends during fiscal 2018. It repurchased 147,000 shares at an average $51.08 per share.
Material changes and unusual items
- Total sales declined 6.2%. Energy was affected by fewer U.S. refinery turnarounds, continued petrochemical softness, hurricane-related disruption, delayed or cancelled projects, and the Westinghouse bankruptcy. Metal Coatings benefited from acquisitions and pricing but faced weaker demand in several end markets.
- Energy backlog fell 16.5% to $265.4 million; the book-to-ship ratio was 0.92, down from 0.99.
- The 2017 Tax Cuts and Jobs Act produced a provisional $23.2 million reduction in tax expense: a $25.0 million deferred-tax remeasurement benefit partly offset by a $1.8 million transition-tax expense. Fiscal 2018’s effective tax rate was negative 46.2%; the tax accounting remained provisional and subject to further analysis.
- Fourth-quarter sales were $200.7 million and net income was $23.5 million, including the tax benefit. The third quarter recorded a net loss of $0.2 million.
- Westinghouse-related matters included approximately $12 million in filed unsecured claims; the company reported that the debtor disclosure statement estimated a 98.9%–100% distribution on allowed general unsecured claims. AZZ also de-booked $11.0 million of backlog for the halted VC Summer project and cited approximately $6.1 million of sales and $1.2 million of margin impact from cancellation of the Vogtle Bridge project in the second half.
Outlook, risks and contingencies
The filing provides no specific fiscal 2019 revenue or earnings guidance. Management said it believes cash, operating cash flow and access to credit facilities are sufficient for foreseeable cash needs. The $450 million revolving facility matures in March 2022, with a $150 million accordion feature; $162.0 million was drawn at year-end, and approximately $265.6 million of additional availability was reported after outstanding letters of credit under that facility. The company stated it was in compliance with debt covenants. Total letters of credit outstanding, including those issued by HSBC China, were $37.6 million.
Key risks include economic and project-spending weakness, fixed-price contract cost overruns, raw-material and natural-gas price volatility, customer project cancellations, acquisition integration, labor availability, and debt covenant restrictions. Management also cautioned that Energy backlog may not convert fully to revenue. Routine claims were not expected by management to be material, but a securities class action filed in January 2018 alleges misleading disclosures related to Energy-segment revenue recognition; AZZ denies the allegations and says it cannot predict the outcome.
Reporting controls and audit matters
The auditor issued an unqualified opinion on the consolidated financial statements but an adverse opinion on internal control over financial reporting. Management and the auditor identified a material weakness in controls over review and ongoing monitoring of revenue-recognition policies. AZZ said certain Energy contracts had historically been recognized at completion when percentage-of-completion accounting should have applied; the error required restatement of fiscal 2017 annual and the May and August 2017 quarterly financial statements. Management described planned remediation through new policy-review and transaction controls and additional training. Controls at three fiscal 2018 acquisitions were excluded from management’s assessment and the auditor’s internal-control audit.
Important facts for investors to verify
- Review the restated fiscal 2017 and 2018 interim statements and subsequent disclosures on revenue-recognition remediation and control effectiveness.
- Track Energy bookings, backlog conversion, project margins and exposure to Westinghouse-related claims or further cancellations.
- Monitor the provisional tax accounting, including finalization of the deferred-tax remeasurement and transition-tax estimates.
- Confirm debt balances, covenant headroom, revolving-credit availability and the impact of scheduled debt maturities.
- Assess acquisition integration and whether Metal Coatings growth and margins persist despite volume and zinc-cost pressures.
- Follow the securities class action, including any changes to the company’s assessment of potential exposure.