AZZ Inc. — Q3 FY2019 Form 10-Q
Reporting period: Three and nine months ended November 30, 2018. AZZ provides metal coating services, welding solutions, specialty electrical equipment and related services through its Energy and Metal Coatings segments. Amounts below are in U.S. dollars; financial figures are rounded to millions unless noted.
Financial performance
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Revenue | $239.5m | $208.2m | $724.5m | $609.8m |
| Gross margin | $49.8m (20.8%) | $31.1m (14.9%) | $155.4m (21.4%) | $122.3m (20.1%) |
| Operating income | $22.8m (9.5%) | $1.6m (0.7%) | $63.6m (8.8%) | $39.0m (6.4%) |
| Net income (loss) | $15.4m | $(0.2)m | $42.4m | $21.7m |
| Diluted EPS | $0.59 | $(0.01) | $1.62 | $0.83 |
- Q3 revenue rose 15.1%; nine-month revenue rose 18.8%. Energy revenue increased 23.4% in Q3 and 21.4% year to date; Metal Coatings revenue increased 6.3% and 16.0%, respectively.
- Q3 Energy operating income was $11.5m versus a $12.1m loss a year earlier. Metal Coatings operating income fell to $18.3m from $21.7m. Nine-month segment operating income was $25.8m for Energy and $65.6m for Metal Coatings.
- Nine-month operating cash flow was $60.4m, versus $38.7m. Investing cash use was $21.3m and financing cash use was $41.6m. Cash declined $3.4m to $17.4m.
- At November 30, cash was $17.4m, working capital $239.6m, and total debt $273.0m ($272.7m net of debt issuance costs). AZZ reported $282.9m of additional credit availability and compliance with debt covenants. Gross debt-to-equity was 0.46:1. Q3 interest expense was $3.7m; nine-month expense was $11.5m.
- Nine-month dividends declared were $0.51 per share. Capital expenditures were $13.7m; acquisition spending was $8.0m.
Changes, outlook and notable items
- Management attributed Energy growth to improved U.S. refinery turnarounds, more international projects and stronger electrical business, partly offset by continued nuclear-market softness. Metal Coatings benefited from higher volumes and selling prices, but higher zinc and labor costs weighed on margins.
- Energy backlog was $307.8m at November 30, up 8.7% from a year earlier and 16.0% from February 28, 2018. Q3 book-to-revenue was 0.88:1; net orders increased 17.5% year over year.
- Metal Coatings recorded a $1.3m second-quarter charge for impairment, severance and other disposal costs associated with consolidating two Gulf Coast galvanizing facilities. The prior-year comparison included an $8.3m Energy-related impairment and a $2.9m doubtful-account provision; neither was recorded in the current year.
- AZZ acquired certain Lectrus assets in March 2018; the acquisition was described as not significant. ASC 606 was adopted March 1, 2018, with no significant effect on reported revenue or cost of revenue and no opening retained-earnings adjustment.
- No specific earnings or revenue guidance was provided. Management said cash, operating cash flows and expected access to credit facilities should meet foreseeable cash needs. Risks cited include customer demand, commodity costs (including zinc and natural gas), economic and currency conditions, and execution of growth plans.
- AZZ has approximately $12m of claims in the Westinghouse bankruptcy, including pre-petition claims; the company reported that the claims filed exceed its book exposure and cited an estimated 98.9%–100% distribution on allowed unsecured claims in the debtors’ disclosure statement.
Controls, legal matters and contingencies
- Management concluded disclosure controls were not effective because of an outstanding material weakness in revenue-recognition controls. The weakness followed prior-period errors that required restatements. Remediation measures were being implemented, but operational-effectiveness testing was still needed.
- A securities class action filed in January 2018 alleges misleading disclosures concerning Energy-segment revenue recognition. AZZ denies the allegations, says it intends to contest the case, and cannot predict the outcome; potential damages could be material. Management did not expect routine lawsuits to have a material effect.
- The filing reported no material change in risk factors or market-risk disclosures and no material off-balance-sheet arrangements.
Important facts for investors to verify
- Progress and independent testing of remediation for the revenue-recognition material weakness.
- Developments in the securities class action and the ultimate recoverability and timing of Westinghouse-related claims.
- Energy backlog conversion, order trends and nuclear-market exposure, alongside Metal Coatings’ ability to offset zinc and labor cost inflation.
- Debt maturities, variable-rate borrowing costs, available credit (including letters of credit) and cash conversion as contract assets and working capital change.
- Effects of the facility consolidation and Lectrus acquisition, and the expected balance-sheet impact of adopting the lease accounting standard.