AZZ Inc. — Q1 FY2019 Form 10-Q
Reporting period: Three months ended May 31, 2018. AZZ provides metal coating services, welding solutions, specialty electrical equipment and engineered services through its Energy and Metal Coatings segments. Comparisons are with the three months ended May 31, 2017 unless noted.
Financial performance
- Revenue: $262.2 million, up 27.7%. Energy revenue rose 29.8% to $147.0 million; Metal Coatings revenue rose 25.2% to $115.3 million.
- Profit: Gross profit was $58.7 million versus $47.4 million; gross margin was 22.4% versus 23.1%. Operating income was $23.7 million versus $20.0 million, with operating margin of 9.0% versus 9.8%. Net income increased to $15.7 million from $12.1 million; diluted EPS was $0.60 versus $0.46.
- Segment operating results: Energy operating income rose 48.4% to $10.0 million and margin improved to 6.8% from 5.9%. Metal Coatings operating income rose 18.6% to $25.2 million, while margin declined to 21.9% from 23.1%, primarily due to higher zinc costs. Corporate expense increased 44.3% to $11.4 million.
- Cash flow: Operating activities used $12.4 million, compared with $15.8 million used a year earlier. Investing activities used $10.8 million, including $8.0 million for the Lectrus acquisition; financing activities provided $16.8 million. Cash declined $6.9 million during the quarter to $13.9 million. Working-capital outflows included accounts receivable and contract assets.
- Liquidity and debt: Working capital was $248.5 million at May 31, versus $197.4 million at February 28, 2018. Gross debt was $322.5 million, compared with $301.3 million at February 28; the $14.3 million 2008 Senior Notes were repaid at maturity. AZZ had $229.4 million of additional availability under its revolver after outstanding borrowings and letters of credit. The company reported compliance with debt covenants.
- Other metrics: Interest expense increased to $3.8 million from $3.4 million. The effective tax rate declined to 22.0% from 28.4%, primarily attributed to the Tax Cuts and Jobs Act. The quarterly dividend remained $0.17 per share.
Material changes and business developments
- Energy backlog reached $329.7 million, up 24.2% from February 28, 2018 and 7.6% year over year. Book-to-ship was 1.22, versus 0.94 in the comparable prior-year quarter; incoming net orders increased 65.4% year over year. Management attributed growth primarily to large international orders and higher Energy activity.
- Energy revenue benefited from U.S. refinery turnarounds, international projects, electrical business activity and recent acquisitions, partly offset by continued nuclear-market softness. Metal Coatings growth reflected higher selling prices and processed volumes, along with acquisitions.
- AZZ adopted ASC 606 on March 1, 2018 using the modified retrospective method. Management reported no significant effect on quarterly revenue or cost of revenue and no opening retained-earnings adjustment. Prior-year results were not restated.
- On March 22, 2018, AZZ acquired certain Lectrus Corporation assets for $8.0 million. The acquisition was described as not significant and is intended to complement its metal-enclosure and switchgear businesses.
Outlook, risks and contingencies
- The filing provides no specific financial guidance. Management stated that cash, operating cash flows and expected access to credit facilities should be sufficient for foreseeable needs.
- Key business exposures include customer demand, project timing and execution, competition, commodity costs (including zinc, natural gas, copper, aluminum and steel), interest and foreign-exchange rates, and the ability to pass cost increases to customers.
- Disclosure controls and procedures were deemed ineffective due to a material weakness in revenue-recognition controls. The weakness relates to prior errors in accounting for certain Energy contracts and resulted in restatements of earlier filings. Management described remediation efforts, including revised controls and additional training.
- A securities class action alleges misleading statements concerning Energy-segment revenue recognition. AZZ denies the allegations, intends to contest them, and says the outcome cannot be predicted; a loss could be material. Separately, AZZ reported approximately $12 million of filed claims in the Westinghouse bankruptcy and cited the debtors’ estimated 98.9%–100% distribution on allowed general unsecured claims; recovery is not assured.
- AZZ maintains letters of credit totaling $32.1 million, including $23.1 million under its credit agreement. The filing also describes routine legal matters but does not expect them to have a material effect.
Important facts for investors to verify
- Whether backlog converts to revenue and cash on expected schedules, and whether the improved Energy margins persist.
- Working-capital and cash-flow trends, particularly receivables and contract assets, alongside debt levels and revolver availability.
- Progress and effectiveness of remediation for the revenue-recognition material weakness and the status and potential exposure of the securities litigation.
- Actual recovery on Westinghouse claims and the effect of commodity-cost changes on Metal Coatings margins.