AZZ Inc. — Fiscal 2017 Second-Quarter 10-Q
Reporting period: Three and six months ended August 31, 2016. AZZ provides galvanizing services, welding solutions, specialty electrical equipment and engineered services through its Energy and Galvanizing segments. Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Financial performance
| Metric | Three months ended August 31, 2016 | Prior-year quarter | Six months ended August 31, 2016 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $195.0 | $214.2 | $437.7 | $443.1 |
| Gross profit | $41.9 | $53.5 | $105.2 | $112.8 |
| Gross margin | 21.5% | 25.0% | 24.0% | 25.5% |
| Operating income | $14.9 | $26.4 | $49.4 | $59.3 |
| Net income | $10.0 | $17.2 | $31.1 | $37.2 |
| Diluted EPS | $0.38 | $0.67 | $1.19 | $1.44 |
Second-quarter revenue fell 9.0%, operating income fell 43.6%, and net income fell 41.9% year over year. For the six-month period, revenue declined 1.2%, operating income declined 16.7%, and net income declined 16.4%. Calculated operating margin was 7.6% for the quarter and 11.3% for six months, versus 12.3% and 13.4%, respectively, in the prior-year periods.
- Segments: Second-quarter Energy revenue declined 11.9% to $97.6 million and operating income declined 9.0% to $8.2 million. Galvanizing revenue fell 5.8% to $97.4 million and operating income fell 40.7% to $15.0 million. For six months, Energy revenue was down 4.9% and operating income was approximately flat; Galvanizing revenue rose 3.4%, while operating income fell 17.1%.
- Cash flow: Six-month operating cash flow was $50.0 million, compared with $54.9 million. Investing used $42.1 million, including $22.7 million for acquisitions; financing used $32.3 million. Cash declined $24.3 million to $15.9 million. Capital expenditures were $19.8 million, versus $21.7 million.
- Liquidity and debt: Working capital was $159.2 million, compared with $157.8 million at August 31, 2015. Gross debt was $302.5 million and debt net of issuance costs was $301.4 million; cash was $15.9 million. The revolving facility had $95.0 million drawn and $108.6 million of additional availability after $21.4 million of letters of credit. AZZ reported compliance with debt covenants. Gross debt-to-equity was 0.59, versus 0.80 a year earlier.
Material changes and notable items
- Management attributed Energy’s quarterly sales weakness to fewer U.S. refinery turnarounds, continued petrochemical softness and delayed large projects. Galvanizing was affected by lower steel-processing volume in solar, petrochemical, and oil and gas markets, partly offset by higher pricing.
- AZZ recorded $8.0 million of second-quarter realignment charges: $6.7 million in cost of sales, primarily for galvanizing asset disposals and plant actions, and $1.3 million in SG&A for severance. The charges materially affected margins and segment operating income.
- The company acquired Power Electronics, Inc. (PEI) on March 1, 2016. Management said the acquisition increased backlog and that PEI’s historical results were not significant enough to require pro forma results. Backlog was $352.8 million at August 31, up 5.5% from February 29, primarily due to PEI. Second-quarter book-to-ship was 0.99, down from 1.09 a year earlier; incoming orders declined 17.1%.
- AZZ early adopted share-based payment accounting guidance, recording a $1.3 million tax benefit in the current quarter, primarily related to exercises of pre-FY2014 awards. The reported quarterly and six-month effective tax rates were 10.4% and 26.0%, versus 21.2% and 27.2% in the prior-year periods.
- After quarter-end, on October 3, 2016, AZZ agreed to sell its indirectly held subsidiary Nuclear Logistics LLC to Westinghouse for cash. Terms were undisclosed, closing was expected in fall 2016, and management said a possible loss was reasonably possible but not reasonably estimable.
Outlook, risks and contingencies
The filing gives no numerical earnings or revenue guidance. Management said available cash, operating cash flows and expected access to credit facilities should meet foreseeable cash needs. Risks highlighted include customer demand and project delays, commodity costs (including zinc and natural gas in Galvanizing and metals in Energy), foreign exchange and interest-rate movements, and the ability to pass cost increases to customers. The company noted that its hypothetical 10% market-rate or commodity-price changes were not expected to have a significant adverse effect if cost increases could be passed through, but cautioned that this was not assured. Routine lawsuits were not expected to have a material effect; no material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether Energy demand, delayed projects, and the 0.99 book-to-ship ratio improve, and how backlog converts into sales.
- Whether the galvanizing plant closures, conversion and other realignment actions deliver savings sufficient to offset near-term charges and weaker volumes.
- PEI’s contribution to revenue, profit and backlog, and the cash and debt implications of the planned Nuclear Logistics divestiture, whose terms and potential loss were not disclosed.
- Cash generation, working-capital needs, debt repayment and covenant headroom, particularly given the decline in cash and substantial scheduled debt payments.
- The degree to which commodity and foreign-exchange cost changes can be passed through to customers, and whether the reported tax benefit meaningfully affects comparisons of underlying earnings.