Business context and reporting period
AZZ Inc. is a global provider of galvanizing services, energy-sector electrical equipment and engineered services. This unaudited Form 10-Q covers the second quarter and first six months of fiscal 2016, ended August 31, 2015, with comparisons to the prior-year periods. Its operating segments are Energy and Galvanizing Services.
Financial performance and liquidity
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $214.2 million, up 10.8% | $443.1 million, up 8.2% |
| Gross margin | $53.5 million; 25.0% of sales, versus 21.8% | $112.8 million; 25.5% of sales, versus 23.8% |
| Operating income | $26.4 million; 12.3% of sales, versus 11.9% | $59.3 million; 13.4% of sales, versus 12.4% |
| Net income | $17.2 million, versus $13.8 million | $37.2 million, versus $28.7 million |
| Diluted EPS | $0.67, versus $0.53 | $1.44, versus $1.11 |
For the six months, operating cash flow was $54.9 million, investing cash outflow was $70.9 million, and financing cash inflow was $14.6 million. Cash declined $2.3 million to $20.2 million. Capital expenditures were $21.7 million and subsidiary acquisitions, net of cash acquired, used $49.8 million.
At August 31, 2015, total debt was $360.2 million, including $22.7 million due within one year; cash was $20.2 million. Management reported working capital of $157.8 million, versus $159.6 million a year earlier, and a debt-to-equity ratio of 0.80, versus 0.98 a year earlier. Approximately $78.4 million remained available under the credit agreement after revolving borrowings and letters of credit. AZZ reported compliance with debt covenants.
Material changes and operating drivers
- Energy revenue increased 10.2% in the quarter and 7.2% for six months. Management attributed growth to a large nuclear-services project shipment and, for the half year, increased specialty welding activity in petroleum refining. Quarterly Energy operating income was $9.0 million, compared with a prior-year operating loss of $1.2 million.
- Galvanizing Services revenue grew 11.4% in the quarter and 9.5% for six months, helped by higher processed-steel volume, the U.S. Galvanizing acquisition, and activity in solar, utility and OEM markets. Higher zinc costs partly offset the volume benefit.
- AZZ acquired substantially all assets of U.S. Galvanizing on June 5, including six facilities, to expand its North American footprint. It also entered a long-term supply and service agreement to galvanize structures for Meyer Steel Structures.
- Energy backlog was $338.1 million at August 31, up 1.7% from February 28. Quarterly book-to-ship was 1.09, compared with 1.10 in the prior-year quarter; quarterly bookings increased 9.4% year over year.
- Quarterly interest expense was $4.0 million, down from $4.2 million, which management attributed to lower average debt. The six-month effective tax rate was 27.2%, versus 32.3%, mainly due to state tax benefits.
Outlook, risks and unusual items
Management said cash, operating cash flows and expected access to credit should meet liquidity needs for the foreseeable future. The filing provides no specific earnings or revenue guidance.
Risks cited include customer demand and shipment timing, commodity costs (including zinc, natural gas, copper, aluminum, steel and nickel alloys), foreign exchange, economic and political conditions, and access to financing and experienced personnel. Cost pass-through may not always be achievable. Management stated that a hypothetical 10% change in interest rates, exchange rates or commodity prices was not expected to have a significant adverse effect if cost increases could be passed on, but cautioned that outcomes could differ.
Fiscal 2016 second-quarter Energy results included $0.7 million of net realignment charges; the company estimated total capacity-consolidation costs at $0.9 million. Prior-year comparisons included $2.6 million of Energy realignment charges and $5.2 million of project cost overruns, as well as a $9.1 million reversal of an acquisition-related contingent liability in corporate expenses. Six-month results also included a $0.4 million net gain from insurance proceeds and sale of property. Foreign-exchange losses contributed to other expense. Routine lawsuits were not expected by management to have a material effect; no subsequent events were reported.
Important facts for investors to verify
- How much of sales and operating improvement reflects the U.S. Galvanizing acquisition versus organic growth, and how the acquired facilities perform.
- Whether Energy backlog converts to revenue and margins, given project timing and execution risks.
- Whether zinc and other input-cost increases can be passed through or contained.
- Debt levels, interest costs, covenant headroom, and remaining credit availability after acquisition spending and capital investment.
- The sustainability of reported margin improvement after excluding realignment costs, prior-year project overruns, and other unusual comparison items.