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AZZ > SEC Filings for AZZ > Form 10-Q on 2-Oct-2013All Recent SEC Filings

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Form 10-Q for AZZ INC


2-Oct-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD LOOKING STATEMENTS
Certain statements herein about our expectations of future events or results constitute forward-looking statements for purposes of the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. You can identify forward-looking statements by terminology such as "may," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue," or the negative of these terms or other comparable terminology. Such forward-looking statements are based on currently available competitive, financial and economic data and management's views and assumptions regarding future events. Such forward-looking statements are inherently uncertain, and investors must recognize that actual results may differ from those expressed or implied in the forward-looking statements. In addition, certain factors could affect the outcome of the matters described herein. This Quarterly Report on Form 10-Q may contain forward-looking statements that involve risks and uncertainties including, but not limited to, changes in customer demand and response to products and services offered by AZZ, including demand by the power generation markets, electrical transmission and distribution markets, the industrial markets, and the hot dip galvanizing markets; prices and raw material cost, including zinc and natural gas which are used in the hot dip galvanizing process; changes in the economic conditions of the various markets that AZZ serves, foreign and domestic, customer requested delays of shipments, acquisition opportunities, currency exchange rates, adequacy of financing, and availability of experienced management employees to implement AZZ's growth strategy; a downturn in market conditions in any industry relating to the products we inventory or sell or the services that we provide; the continuing economic volatility in the U.S. and other markets in which we operate; acts of war or terrorism inside the United States or abroad; and other changes in economic and financial conditions. AZZ has provided additional information regarding risks associated with the business in AZZ's Annual Report on Form 10-K for the fiscal year ended February 28, 2013 and other filings with the SEC, available for viewing on AZZ's website at www.azz.com and on the SEC's website at www.sec.gov.
You are urged to consider these factors carefully in evaluating the forward-looking statements herein and are cautioned not to place undue reliance on such forward-looking statements, which are qualified in their entirety by this cautionary statement. These statements are based on information as of the date hereof and AZZ assumes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise. The following discussion should be read in conjunction with management's discussion and analysis contained in our Annual Report on Form 10-K for the year ended February 28, 2013 and with the condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q.
RESULTS OF OPERATIONS We have two operating segments as defined in our Annual Report on Form 10-K for the year ended February 28, 2013. Management believes that the most meaningful analysis of our results of operations is to analyze our performance by segment. We use revenue and operating income by segment to evaluate our segments. Segment operating income consists of net sales less cost of sales, specifically identifiable selling, general and administrative expenses, and other (income) expense items that are specifically identifiable to a segment. The other (income) expense items included in segment operating income are generally insignificant. For a reconciliation of segment operating income to pretax income, see Note 4 to our quarterly consolidated financial statements included in this Quarterly Report on Form 10-Q. Orders and Backlog
Our entire backlog relates to our Electrical and Industrial Products and Services Segment. Our backlog was $211.4 million as of August 31, 2013, a decrease of $10.3 million, or 5%, as compared to $221.7 million at February 28, 2013. Our book-to-ship ratio was 0.96 to 1 for the quarter ended August 31, 2013, as compared to 0.99 to 1 for the same period in the prior year. Incoming orders increased 20% for the quarter compared to the same period in fiscal 2013. The decrease in the book to ship ratio for the compared periods is a result of the hesitation of the market in regards to looming government regulations, mainly in the nuclear markets. A significant amount of anticipated orders for the second quarter have been delayed and are expected to be received in the third quarter of fiscal 2014.


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                                 Backlog Table
                           (in thousands)(unaudited)

                     Period Ended                Period Ended
Backlog                 2/28/2013   $ 221,714       2/29/2012   $ 138,621
Bookings                              181,092                     124,666
Shipments                             183,175                     127,143
Backlog                 5/31/2013   $ 219,631       5/31/2012   $ 136,144
Book to Ship Ratio                       0.99                        0.98
Bookings                              181,547                     151,804
Acquired Backlog                            -                      78,491
Shipments                             189,782                     153,385
Backlog                 8/31/2013   $ 211,396       8/31/2012   $ 213,054
Book to Ship Ratio                       0.96                        0.99

Segment Revenues
The following table reflects the breakdown of revenue by segment:

                                          Three Months Ended               Six Months Ended
                                       8/31/2013       8/31/2012       8/31/2013       8/31/2012
                                                       (In thousands)(unaudited)
Revenue:
Electrical and Industrial
Products and Services                $   104,134     $    66,530     $   200,600     $   111,212
Galvanizing Services                      85,648          86,855         172,357         169,316
Total Revenue                        $   189,782     $   153,385     $   372,957     $   280,528

For the three and six month periods ended August 31, 2013, consolidated revenues were $189.8 million and $373.0 million, respectively, an increase of 24% and 33%, respectively, as compared to the same period in fiscal 2013. The Electrical and Industrial Products and Services Segment contributed 55% and 54%, respectively, and the Galvanizing Services Segment accounted for 45% and 46%, respectively, of the Company's combined revenues for the three and six month periods ended August 31, 2013. For the three and six month periods ended August 31, 2012, the Electrical and Industrial Products and Services Segment contributed 43% and 40%, respectively, of the Company's revenues, and the Galvanizing Services Segment accounted for 57% and 60%, respectively, of the combined revenues.
Revenues for the Electrical and Industrial Products and Services Segment increased $37.6 million, or 57%, for the three month period ended August 31, 2013 and $89.4 million or 80% for six month period ended August 31, 2013, as compared to the same periods in fiscal 2013. This increase in revenue for the compared period is mainly attributable to the acquisition of NLI in June of 2012 and Aquilex SRO on March 29, 2013. Revenues from NLI were $12.1 million and $29.6 million, respectively, for the three and six month periods ended August 31, 2013. Aquilex SRO contributed $43.6 million and $85.1 million, respectively, in revenue for the three and six month periods ended August 31, 2013. Without the acquisition of NLI and Aquilex, revenues for this segment were below levels for the same period in fiscal 2013. The reduction in revenue excluding NLI and Aquilex was due to delayed shipments at the request of customers that will be recorded in future quarters in conjunction with expiring tax credits for renewable energy projects and an overall reduction in spending.
Revenues in the Galvanizing Services Segment decreased $1.2 million, or 1%, for the three month period ended August 31, 2013, and increased $3.0 million or 2% for the six month period ended August 31, 2013, as compared to the same periods in fiscal 2013. Excluding the acquisition of G3 and Galvcast, revenues declined 11% for the three month period ended August 31, 2013, as compared to the same period in fiscal 2013 and 8% for the six month period ended August 31, 2013 when compared to the prior period. Our recently acquired operations in Canada provided $10.4 million and $20.9 million, respectively, in revenues for the three and six month periods ended August 31, 2013. The reduction in revenue is attributable to lower demand from the transmission and distribution markets and a leveling off of renewable energy projects. In addition, petrochemical projects continue to be pushed back due to engineering and permit delays. Historically, revenues for this segment have closely followed the condition of the industrial sector of the general economy.


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Segment Operating Income
The following table lists non-recurring items that occurred during the three and
six month periods ended August 31, 2013 and 2012.
                                      Three Months Ended             Six Months Ended
                                   8/31/2013      8/31/2012      8/31/2013     8/31/2012
                                                 (In thousands)(unaudited)
Total Operating Income            $   36,978     $    32,889    $  75,724     $    62,318

Joliet Losses Incurred                   826           1,184        1,623           1,708
Business Interruption Insurance       (2,678 )             -       (2,678 )             -
Lawsuit Settlement                         -               -       (4,200 )             -

Adjusted Total Operating Income   $   35,126     $    34,073    $  70,469     $    64,026

Our total segment operating income increased 12% for the three month period ended August 31, 2013 and 22% for the six month period ended August 31, 2013 to $37.0 million and $75.7 million, respectively, as compared to $32.9 million and $62.3 million, respectively, for the same periods in fiscal 2013. Total operating margins decreased to 19% and 20% for the three and six month periods ended August 31, 2013 as compared to 21% and 22%, respectively, for the same periods in fiscal 2013. The Electrical and Industrial Products and Services Segment accounted for 29% and 31%, respectively, of the operating income while the Galvanizing Services Segment accounted for the remaining 71% and 69%, respectively, of operating income for the three and six month periods ended August 31, 2013. For the three and six month periods ended August 31, 2012, the Electrical and Industrial Products and Services Segment accounted for 28% and 26%, respectively, of operating income while the Galvanizing Services Segment accounted for the remaining 72% and 74%, respectively.
Segment operating income in the Electrical and Industrial Products and Services Segment increased 15% and 47% for the three and six month periods ended August 31, 2013, to $10.7 million and $23.8 million, respectively, as compared to $9.3 million and $16.1 million, respectively, for the same periods in fiscal 2013. Operating margins were 10% and 12%, respectively, for the three and six month period ended August 31, 2013 and 14% and 15%, respectively, for the same periods in fiscal 2013. Operating income increased for the compared period due to the acquisitions of NLI on June 1, 2012, and Aquilex SRO on March 29, 2013. These two acquisitions added $1.7 million and $9.2 million, respectively, in operating income for the three and six month periods ended August 31, 2013. Excluding these acquisitions, for the three month period ended August 31, 2013, operating income increased $0.6 million as compared to the same period in fiscal 2013, and decreased $0.6 million for the six month period ended August 31, 2013 when compared to the prior period. NLI had operating profits of $0.5 million and $4.7 million, respectively, for the three and six month periods ended August 31, 2013. Aquilex SRO had operating income of $1.2 million and $4.5 million for the three and six month periods ended August 31, 2013. Without the amortization of intangibles resulting from the acquisitions of NLI and Aquilex SRO, the operating margin would have been 14% for the three month period ended August 31, 2013 and 15% for the six month period ended August of 2013. The acquisition of NLI and Aquilex SRO resulted in the amortization of intangibles of $3.4 million for the three month period ended August 31, 2013 and $6.2 million for the six month period ended August 31, 2013.
In the Galvanizing Services Segment, operating income increased 11% and 13%, respectively, for the three and six month periods ended August 31, 2013, to $26.2 million and $51.9 million, respectively, as compared to $23.5 million and $46.2 million, respectively, for the same period in fiscal 2013. Operating margins were 31% and 30%, respectively for the three and six month periods ended August 31, 2013 compared to 27% for the same periods in fiscal 2013. Our recently acquired operations in Canada consisting of Galvcast and G3 contributed $2.0 million and $3.8 million, respectively, in operating profits for the three and six month periods ended August 31, 2013. During the six month period ended August 31, 2013 a payment of $2.7 million was received for business interruption insurance resulting from the loss of production due to a fire at our Joliet, Illinois facility in April 2012. Losses incurred at Joliet are expected to continue to be offset with insurance proceeds for business interruption in future quarters as the claims are settled. In addition, during the first quarter of fiscal 2014, a gain was recorded in the amount of $4.2 million as a result of a favorable lawsuit settlement. Without these non-recurring items and the losses incurred in the current and prior year, operating income would have been $24.4 million and $46.7 million, respectively for the three and six month periods ended August 31, 2013 and $24.7 million and $47.9 million, respectively for the same periods in fiscal 2013. Operating margins without these non-recurring items would have been 28%, respectively, for both of the three month periods ended August 31, 2013 and 2012 and 27% and 28%, respectively, for the six month periods ended August 31, 2012.


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General Corporate Expenses
General corporate expenses, (see Note 4 to the condensed consolidated financial statements) not specifically identifiable to a segment, for the three-month period ended August 31, 2013, were $7.2 million compared to $5.3 million for the same period in fiscal 2013. For the six month period ended August 31, 2013, general corporate expenses were $17.7 million as compared to $12.1 million in the prior fiscal year. As a percentage of sales, general corporate expenses were 4% for the three month period ended August 31, 2013, as compared to 3% for the same period in fiscal 2013. For the six month period ended August 31, 2013, general corporate expenses as a percentage of sales were 5% compared to 4% for the compared period in fiscal 2013. The Company incurred $3.2 million in acquisition costs in the first half of fiscal 2014 as a result of the acquisition of Aquilex SRO. (see Note 6 to the condensed consolidated financial statements).

Interest
Net interest expense for the three and six month period ended August 31, 2013 was $4.7 million and $9.1 million, respectively, as compared to $3.2 million and $6.6 million, respectively, for the same periods in fiscal 2013. As of August 31, 2013, we had outstanding debt of $452.5 million, compared to $210.7 million at the same date last year. Our long-term debt to equity ratio was 1.26 to 1 at August 31, 2013, as compared to .62 to 1 at August 31, 2012. The increase in interest expense is a result of the increased debt acquired to fund the acquisition of Aquilex SRO.
Net (Gain) On Insurance Settlement
For the six-month period ended August 31, 2013, the Company received an additional $0.8 million in funds in conjunction with the insurance settlement for the fire at our Joliet, Illinois facility. During the first quarter of fiscal 2013, the Company received $10 million in insurance proceeds. Based on a preliminary estimate of the damage sustained at the Joliet facility, a pretax asset impairment charge of approximately $4 million was recorded during the first quarter of fiscal 2013. The net gain on the insurance settlement of property, plant and equipment has been recorded as an item under Net (Gain) Loss On Insurance Settlement or On Sale of Property, Plant and Equipment. We anticipate receiving additional insurance proceeds from these claims in an amount ranging from $4 million to $7 million when all claims are settled. This item is shown as Other (Income) expense in Note 4 to consolidated financial statements.
Other (Income) Expense
For the three and six month periods ended August 31, 2013 and 2012 the amounts in other (income) expense not specifically identifiable with a segment (see Note 4 to consolidated financial statements) were insignificant. Income Taxes
The provision for income taxes reflects an effective tax rate of 36.6% for the three-month period ended August 31, 2013, as compared to 35.5% for same period in fiscal 2013. For the six month period ended August 31, 2013 the tax rate was 37.2% compared to 35.9% for the compared period in fiscal 2013. The increase in the effective tax rates is due to lower utilization of manufacturing credits, primarily as a result of the acquisition of Aquilex SRO on March 29, 2013. Without the acquisition of Aquilex SRO, the effective tax rates would have been equivalent to the prior periods.
LIQUIDITY AND CAPITAL RESOURCES We have historically met our cash needs through a combination of cash flows from operating activities along with bank and long term borrowings. Our cash requirements are generally for operating activities, cash dividend payments, capital improvements, debt repayment, letters of credit and acquisitions. We believe that working capital, funds available under our credit agreement, and funds generated from operations should be sufficient to finance anticipated operational activities, dividends, capital improvements, payment of debt and possible future acquisitions during fiscal 2014. In connection with the fire at our Joliet, Illinois facility, we estimate making approximately $9.0 million in capital expenditures during the remainder of fiscal 2014 related to the rebuilding of that facility. We expect to be reimbursed for a portion of this capital outlay as a result of the insurance settlement.
Our operating activities generated cash flows of approximately $55.2 million for the six month period ended August 31, 2013 and $30.2 million for the same period in the prior fiscal year. Cash flow from operations for the six month period ended August 31, 2013 included net income in the amount of $30.9 million, depreciation and amortization in the amount of $21.0 million, and other adjustments to reconcile net income to net cash in the amount of $5.9 million. Included in other adjustments were provisions for bad debt in the amount of $(0.1) million, deferred income taxes in the amount of $3.7 million, gain or loss on insurance settlement or the sale of assets in the amount of $(0.9) million, and non-cash adjustments in the amount of $3.2 million. Negative cash flow was recognized due to increased inventories, prepaids, other assets and revenue in excess of billings in the amount of $0.1 million, $2.9 million, $4.0 million and $6.5 million, respectively, as well as decreased accounts payable and other accrued liabilities in the


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amount of $0.1 million and $9.6 million, respectively. Positive cash flow was recognized due to decreased accounts receivable of $20.4 million. Accounts receivable average days outstanding were 57 days for the six month period ended August 31, 2013, as compared to 48 days for the six month period ended August 31, 2012.

Our working capital was $179.7 million at August 31, 2013, as compared to $167.9 million at August 31, 2012. The change in working capital for the compared periods is mainly attributable to our acquisition activity in the first quarter of fiscal 2014 offset by the additional debt incurred as a result of the Aquilex SRO acquisition.
During the six month period ended August 31, 2013, capital improvements were made in the amount of $23.8 million of which $13.4 million relate to the rebuilding of the Joliet facility.
During the six month period ended August 31, 2013, dividends were paid in the amount of $7.1 million.
On May 25, 2006, we entered into the Second Amended and Restated Credit Agreement (as subsequently amended, the "Previous Credit Agreement") with Bank of America, N.A. ("Bank of America"). This Previous Credit Agreement provided for a $125 million unsecured revolving line of credit maturing on October 1, 2017 and was used to provide for working capital needs, capital improvements, future acquisitions and letter of credit needs.
On March 27, 2013, we entered into a new Credit Agreement (the "Credit Agreement") with Bank of America and other lenders. The Credit Agreement replaced the Previous Credit Agreement, which terminated effective March 27, 2013, and provides for a $75 million term facility and a $225 million revolving credit facility, subject to a $75 million "accordion" feature. The Credit Agreement is used to provide for working capital needs, capital improvements, future acquisitions and letter of credit needs. The Credit Agreement provides for an applicable margin on the revolving credit facility ranging from 1.0% to 2.0% over the Eurodollar Rate and Commitment Fees ranging from .20% to .30% depending on our Leverage Ratio (each such term as defined in the Credit Agreement). The $75 million term facility requires quarterly principal and interest payments commencing on June 30, 2013 and matures on March 27, 2018. The Credit Agreement provides various financial covenants requiring us, among other things, to a) maintain on a consolidated basis net worth equal to at least the sum of $230 million, plus 50% of future net income, b) maintain on a consolidated basis a Leverage Ratio (as defined in the Credit Agreement) not to exceed 3.25:1.0, c) maintain on a consolidated basis a Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of at least 1.75:1.0 and d) not to make Capital Expenditures (as defined in the Credit Agreement) on a consolidated basis in an amount in excess of $60 million during the fiscal year ended February 28, 2014 and $50 million during any subsequent fiscal year. At August 31, 2013, we had $182.0 million of outstanding debt borrowed through the revolving credit facility provided under the Credit Agreement. As of August 31, 2013, we had letters of credit outstanding under the Credit Agreement in the amount of $17.7 million, which left approximately $25.3 million of additional credit available under the Credit Agreement.
On March 31, 2008, the Company entered into a Note Purchase Agreement (the "Note Purchase Agreement") pursuant to which the Company issued $100 million aggregate principal amount of its 6.24% unsecured Senior Notes (the "2008 Notes") due March 31, 2018 through a private placement (the "2008 Note Offering"). Pursuant to the Note Purchase Agreement, the Company's payment obligations with respect to the 2008 Notes may be accelerated upon any Event of Default, as defined in the Note Purchase Agreement. In connection with the 2008 Note Offering, the Company obtained the consent of Bank of America to the 2008 Note Offering and the agreement of Bank of America that the 2008 Note Offering would not constitute a default under the Previous Credit Agreement.
The Company entered into an additional Note Purchase Agreement on January 21, 2011 (the "2011 Agreement"), pursuant to which the Company issued $125 million aggregate principal amount of its 5.42% unsecured Senior Notes (the "2011 Notes"), due in January of 2021, through a private placement (the "2011 Note Offering"). Pursuant to the 2011 Agreement, the Company's payment obligations with respect to the 2011 Notes may be accelerated under certain circumstances. In connection with the 2011 Note Offering, the Company obtained the consent of Bank of America to the 2011 Note Offering and the agreement of Bank of America that the 2011 Note Offering would not constitute a default under the Previous Credit Agreement.
The 2008 Notes and the 2011 Notes each provide for various financial covenants requiring us, among other things, to a) maintain on a consolidated basis net worth equal to at least the sum of $116.9 million plus 50% of future net income;
b) maintain a ratio of indebtedness to EBITDA (as defined in Note Purchase Agreement) not to exceed 3.25:1.00; c) maintain on a consolidated basis a Fixed Charge Coverage Ratio (as defined in the Note Purchase Agreement) of at least 2.0:1.0; d) not at any time permit the aggregate amount of all Priority Indebtedness (as defined in the Note Purchase Agreement) to exceed 10% of Consolidated Net Worth (as defined in the Note Purchase Agreement). As of August 31, 2013, the Company is in compliance with all of its debt covenants.


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On October 28, 2011, the Company entered into a Private Shelf Agreement by and among the Company, Prudential Investment Management, Inc. ("Prudential") and the other purchasers identified therein (the "Private Shelf Agreement"), pursuant to which the Company may issue and sell, through one or more private placement transactions, up to $100 million aggregate principal amount of Senior Notes (the "Shelf Notes") with interest rates to be agreed upon by the Company and Prudential immediately prior to each issuance and sale of Shelf Notes (each, a "Note Offering" and together, the "Note Offerings"). Pursuant to the Private Shelf Agreement, the Company's payment obligations with respect to the Shelf Notes may be accelerated upon any Event of Default, as defined in the Private Shelf Agreement. Under the terms of the Credit Agreement, undertaking the Note Offerings will not otherwise constitute a default under the Credit Agreement. The Company has not undertaken any Note Offerings under the Private Shelf Agreement.
Our current ratio (current assets/current liabilities) was 2.29 to 1 at August 31, 2013, as compared to 2.78 to 1 at August 31, 2012. As of August 31, 2013, we had $452.5 million in long-term debt outstanding and our long-term debt as a percentage to shareholders' equity ratio was 1.26 to 1.
Historically, we have not experienced a significant impact on our operations from increases in general inflation other than for specific commodities. We have exposure to commodity price increases in both segments of our business, primarily copper, aluminum and steel in the Electrical and Industrial Products and Services Segment, and zinc and natural gas in the Galvanizing Services Segment. We attempt to minimize these increases through escalation clauses in customer contracts for copper, aluminum and steel, when market conditions allow and through protective caps and fixed contract purchases on zinc. In addition to these measures, we attempt to recover other cost increases through improvements . . .

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