AZZ INC quarterly report, Q2 FY2013

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AZZ Incorporated — Q2 FY2013 Form 10-Q

Business context and period: The unaudited filing covers the three and six months ended August 31, 2012; AZZ’s fiscal year ends in February. AZZ operates Electrical and Industrial Products and Galvanizing Services segments. Unless noted, financial amounts are in U.S. dollars.

Financial performance

  • Revenue: Q2 sales were $153.4 million, up 34% year over year; first-half sales were $280.5 million, up 23%. Q2 segment sales were $66.5 million for Electrical and Industrial Products and $86.9 million for Galvanizing Services.
  • Profit and EPS: Q2 net income was $15.9 million ($0.62 diluted EPS), versus $9.6 million ($0.38) a year earlier. First-half net income was $31.9 million ($1.25 diluted EPS), versus $19.1 million ($0.75).
  • Margins: Q2 gross margin was approximately 28.2%, versus 26.5% in the prior-year quarter. Segment operating margins were 14% for Electrical and Industrial Products and 27% for Galvanizing Services. The first segment’s margin would have been 17% excluding NLI intangible amortization; Galvanizing’s would have been 28% excluding Joliet fire-related lost production.
  • Cash flow: First-half operating cash flow was $30.2 million, compared with $27.0 million. Capital expenditures were $12.6 million; acquisition spending, net of cash acquired, was $77.0 million. Cash declined to $68.7 million from $143.3 million at fiscal year-end, mainly reflecting the acquisition and other investing and financing outflows.
  • Liquidity and debt: Working capital was $167.6 million; the current ratio was 2.8:1. Debt was $210.7 million, with no revolver borrowings and $62.6 million of stated availability after $17.4 million of letters of credit. Long-term debt-to-equity was 0.62:1. AZZ reported compliance with debt covenants.

Changes versus prior comparable periods

  • Q2 segment operating income rose 38% to $32.9 million; first-half segment operating income rose 29% to $62.3 million.
  • Electrical and Industrial Products revenue rose 50% in Q2 and 20% in the first half; NLI contributed approximately $11.4 million of the Q2 increase. Galvanizing Services revenue rose 24% in both periods, supported by improved renewable energy, industrial and OEM demand and the prior-year Galvan Metal acquisition.
  • Q2 book-to-ship was 0.99 versus 1.07 a year earlier. Backlog was $213.1 million, up from $123.2 million a year earlier; about $78.5 million came with NLI.
  • Interest expense declined to $3.2 million in Q2 and $6.6 million in the first half. Effective tax rates also declined, to 35.5% for Q2 and 35.9% for the first half, partly due to elimination of a Canadian net operating loss valuation allowance.

Outlook, risks and unusual items

  • No formal numerical earnings or revenue guidance is provided. Management expected NLI revenue in Q3 and Q4 to be higher, on a pro-rata basis, than in Q2. It cited a strategy of protecting pricing rather than taking low-margin orders.
  • A fire destroyed the Joliet, Illinois galvanizing facility on April 29, 2012. AZZ recorded an approximately $4 million pretax impairment charge and received $10 million in insurance proceeds during the first half, resulting in a reported $6.0 million net gain on asset sale/insurance settlement. Management anticipated a further $10–$15 million of insurance recoveries when claims are settled; timing and final amount remain uncertain. Lost production reduced segment operating income by $1.1 million in Q2 and $1.7 million in the first half, with business-interruption proceeds expected in a future quarter.
  • On June 1, AZZ acquired substantially all NLI assets for $77.0 million net of cash acquired, assumed certain liabilities, and paid off $3.8 million of notes at closing. An earn-out of up to $20 million is possible; its recorded fair value was $8.5 million. NLI added $32.0 million of goodwill and $50.9 million of identifiable intangible assets in the preliminary purchase allocation.
  • After quarter-end, on October 1, AZZ acquired Galvcast Manufacturing and amended its Bank of America facility, increasing the revolving commitment from $80 million to $125 million and extending maturity to October 1, 2017.
  • Key risks include demand and economic conditions in served markets; customer shipment delays; commodity prices, particularly copper, aluminum, steel, zinc and natural gas; currency movements; acquisition execution and financing; and availability of experienced personnel. Management said there were no material changes to the prior 10-K risk factors. Routine legal matters were not expected to materially affect financial position or results.

Important facts for investors to verify

  • Final proceeds, timing and business-interruption coverage for the Joliet fire, including whether the expected additional insurance recovery is realized.
  • NLI’s post-acquisition contribution to revenue, operating margins and cash generation, and the potential earn-out payment.
  • Backlog quality, conversion into shipments, and whether AZZ can sustain pricing and segment margins as demand and order intake change.
  • Liquidity and covenant headroom after the Galvcast acquisition and the post-quarter credit-facility amendment.
  • Commodity-cost pass-through effectiveness and the impact of working-capital needs on cash generation.