Business context and reporting period
AZZ Incorporated filed this unaudited Form 10-Q for the quarter ended August 31, 2014, the second quarter of fiscal 2015. AZZ provides galvanizing services, welding solutions, specialty electrical equipment and engineered services. Its reportable segments are Energy and Galvanizing Services.
Financial performance
| Metric | Three months ended Aug. 31, 2014 | Three months ended Aug. 31, 2013 | Six months ended Aug. 31, 2014 | Six months ended Aug. 31, 2013 |
|---|---|---|---|---|
| Revenue | $193.4 million | $189.8 million | $409.5 million | $373.0 million |
| Gross profit / margin | $42.1 million / 21.8% | $55.9 million / 29.5% | $97.5 million / 23.8% | $106.6 million / 28.6% |
| Operating income | $23.0 million | $29.7 million | $50.8 million | $53.8 million |
| Net income | $13.8 million | $16.4 million | $28.7 million | $30.9 million |
| Diluted EPS | $0.53 | $0.64 | $1.11 | $1.20 |
| Operating cash flow | Not separately reported for the quarter | $53.8 million | $55.2 million |
Second-quarter revenue increased 1.9%, while net income fell 15.9%. For the first half, revenue rose 9.8%, but net income declined 7.2%. Interest expense was $4.2 million for the quarter and $8.4 million for six months, lower than the respective prior-year amounts of $4.7 million and $9.1 million.
Segments and orders
- Energy revenue fell 3.4% to $100.6 million in the quarter; segment operating income moved from $10.7 million to a $1.1 million loss. For six months, revenue rose 15.2% to $231.1 million, while segment operating income declined 46.6% to $12.7 million.
- Galvanizing Services revenue increased 8.4% to $92.9 million in the quarter, but segment operating income declined 12.3% to $23.0 million. Its reported operating margin was 24.8%, versus 30.6% a year earlier. Six-month revenue rose 3.5% to $178.5 million and operating income declined 5.7% to $45.0 million.
- Energy backlog was $329.1 million at August 31, up 1.2% from February 28. Quarterly book-to-ship was 1.10, compared with 1.12 in the prior-year quarter.
Liquidity, debt and balance sheet
- Cash was $41.6 million at August 31, compared with $27.6 million at February 28. Six-month cash increased $14.1 million.
- Working capital was $159.6 million, compared with $179.7 million at August 31, 2013. Current assets were $315.9 million and current liabilities were $156.3 million.
- Total debt was $394.4 million, versus $452.5 million a year earlier; debt-to-equity was 0.98 versus 1.26. AZZ had $142.0 million drawn on its revolving facility and approximately $70.1 million of additional availability after letters of credit.
- Operating cash flow of $53.8 million funded $11.5 million of capital spending, the $10.5 million Zalk Steel acquisition and other cash needs. The company paid $7.2 million in dividends.
- AZZ said it was in compliance with all debt covenants and believed cash, operating cash flow and credit availability were sufficient for foreseeable needs.
Material changes, outlook and risks
- Management attributed Energy’s quarterly revenue decline partly to $16.2 million of customer-requested shipment delays at NLI and WSI. It expected those projects to be completed from the second half of fiscal 2015 through the first half of fiscal 2016. Energy profitability was also affected by $5.2 million of project cost overruns and realignment charges.
- AZZ recorded an estimated $4.0 million realignment cost: $1.3 million of severance and $2.7 million from fixed-asset disposals/write-offs. The remaining accrual was $1.0 million at quarter-end.
- General corporate expense benefited from a $9.1 million reversal of a contingent liability related to the NLI acquisition; management no longer considered an additional payment probable. The acquisition agreement had allowed for a potential payment of up to $20.0 million.
- Galvanizing’s comparison was affected by $2.7 million of business-interruption insurance proceeds in the prior-year quarter, higher depreciation and amortization associated with Zalk Steel and the reopened Joliet facility, realignment costs, and somewhat higher zinc costs. AZZ acquired Zalk Steel on June 30, 2014 for $10.5 million plus assumed liabilities.
- Management gave no quantified earnings or revenue guidance in the provided filing text. It cited risks including demand and shipment timing, commodity prices (including zinc and natural gas), currency movements, economic conditions, and the ability to pass cost increases to customers. The company uses contract escalation provisions and supplier pricing arrangements to mitigate commodity exposure, but said these protections may not always be available.
- Other comparative items include a $4.2 million lawsuit-settlement gain in the prior-year six-month period and $3.2 million of WSI acquisition costs in that period. The filing reported no subsequent events, no material change in disclosed risk factors, and no material effect expected from routine legal proceedings.
Important facts for investors to verify
- Whether delayed NLI and WSI projects are completed on the stated timetable and whether Energy project overruns recur.
- Whether the $9.1 million NLI contingent-liability reversal is supported by the acquisition terms and updated forecasts.
- How the realignment, Zalk Steel acquisition and Joliet facility affect ongoing segment margins and cash generation.
- Debt-covenant headroom, revolving-credit availability, scheduled debt payments and refinancing needs.
- Exposure to commodity costs, customer demand, shipment timing and the sustainability of the higher first-half revenue base.