Business context and reporting period
AZZ Incorporated’s Form 10-Q covers the three months ended May 31, 2014, the first quarter of fiscal 2015. AZZ supplies engineered electrical equipment and services to power, industrial, transmission and distribution markets, and provides hot-dip galvanizing services. Its operating segments are Energy and Galvanizing Services. Comparisons below are with the three months ended May 31, 2013 unless otherwise noted.
Financial results and key metrics
| Metric | Q1 FY2015 | Q1 FY2014 |
|---|---|---|
| Net sales | $216.1 million | $183.2 million |
| Gross margin | $55.4 million (25.6% of sales) | $50.7 million (27.7%) |
| Operating income | $27.8 million (12.9%) | $24.0 million (13.1%) |
| Income before taxes | $23.7 million | $23.4 million |
| Net income | $14.9 million | $14.5 million |
| Diluted EPS | $0.58 | $0.57 |
| Operating cash flow | $12.1 million | $39.9 million |
| Capital expenditures | $5.9 million | $11.6 million |
Sales grew 18.0%, while gross margin percentage declined. Net income increased 2.6%; reported net margin was approximately 6.9%, versus 7.9%. The effective tax rate was 37.0%, compared with 37.8%.
- Energy: Sales rose 35.3% to $130.5 million; segment operating income increased 5.9% to $13.8 million, while segment margin fell to 10.6% from 13.5%. Aquilex SRO contributed $72.9 million in sales and $6.9 million in operating income. Excluding Aquilex, Energy operating income declined $2.7 million year over year, according to management.
- Galvanizing Services: Sales decreased 1.3% to $85.6 million; segment operating income rose 2.3% to $22.0 million. Margin was 25.7%, including a $2.4 million Joliet insurance recovery. Excluding the recovery, management reported $19.6 million operating income and a 22.9% margin, versus $22.3 million and 25.7% in the prior-year quarter, which included a $0.8 million fire-related loss.
Liquidity, debt and balance sheet
At May 31, 2014, cash was $25.6 million, total debt was $400.4 million, and shareholders’ equity was $391.9 million. Working capital was $171.9 million, versus $167.9 million at May 31, 2013. AZZ reported $147.0 million drawn on its revolving facility, $14.5 million of letters of credit, and approximately $63.5 million of additional credit availability. The company stated it was in compliance with debt covenants and believed cash, operating cash flows and credit availability would meet foreseeable needs.
Operating cash flow fell to $12.1 million from $39.9 million. The quarter’s cash use reflected increases in receivables, inventory, prepaids and contract costs in excess of billings, partly offset by higher accounts payable. Cash declined $1.9 million from February 28, 2014. Dividends paid were $3.6 million. Debt was $400.4 million, compared with $453.4 million at May 31, 2013; debt-to-equity was 1.02:1 versus 1.31:1.
Material changes, outlook and risks
- Energy sales growth was substantially acquisition-related: Aquilex generated $72.9 million in the current quarter, versus $41.5 million in the prior-year quarter. On the filing’s supplemental pro forma basis, assuming Aquilex had been included from March 1, 2013, prior-year sales were $206.3 million, net income $17.4 million and diluted EPS $0.68. The current quarter was $216.1 million, $14.9 million and $0.58, respectively.
- The prior-year quarter included $3.2 million of Aquilex acquisition costs and a $4.2 million favorable lawsuit-settlement gain. Current-quarter galvanizing results included the $2.4 million insurance recovery. These items affect comparability.
- Energy backlog was $309.0 million at May 31, down 4.9% from February 28. Book-to-ship was 0.93 versus 0.99 in the prior-year quarter; bookings increased 10.2% year over year. Management attributed softer field-services bookings to the spring outage season, partly offset by stronger product orders.
- No specific earnings or revenue guidance was provided. Management cited demand across power generation, transmission and distribution, industrial and galvanizing markets; commodity prices (including copper, steel, zinc and natural gas), customer shipment delays, foreign exchange, labor availability and economic conditions as risks. Cost pass-through may not always be achievable.
- AZZ recorded a $9.1 million long-term liability for a potential NLI acquisition earn-out, currently estimated at $10.0 million payable in fiscal 2017, with a contractual maximum of $20.0 million. Warranty reserve was $1.0 million at May 31. The filing reported no material change in previously disclosed risk factors, no material legal-proceeding impact expected, and no subsequent events.
Important facts for investors to verify
- How much future Energy growth and backlog conversion depends on Aquilex and on field-services bookings after the spring outage season.
- Whether Energy and Galvanizing margins recover, considering the decline in underlying galvanizing income after excluding the insurance recovery and prior-year fire loss.
- Whether operating cash flow improves as receivables, inventory and contract assets rise, and whether available revolver capacity remains sufficient.
- The assumptions behind the NLI earn-out estimate, contract-cost estimates, receivable reserves, and goodwill and intangible-asset valuations.
- The company’s ability to pass through commodity-cost increases and maintain compliance with debt covenants.