AZZ

AZZ INC 10-Q Summary: Quarter Ended November 30, 2006

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for AZZ INC, an accelerated filer incorporated in Texas. The report covers the three and nine-month periods ended November 30, 2006 (Fiscal 2007). The company operates in two primary segments: Electrical and Industrial Products and Galvanizing Services. The fiscal year ends on the last day of February.

Key Financial Metrics

Segment Performance (9 Months): Electrical and Industrial Products generated $103.8 million in revenue with $14.4 million operating income. Galvanizing Services generated $76.9 million in revenue with $23.7 million operating income.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated net revenues increased 32% for the nine-month period and 47% for the quarter compared to the prior year. This was driven by strong demand in high voltage transmission, petroleum, and power generation markets, as well as the acquisition of Witt Galvanizing, Inc.
• Profitability: Net income increased 180% for the nine-month period. Segment operating income increased 134% (nine months) and 151% (quarter).
• Acquisition Impact: On October 31, 2006, the company acquired the galvanizing division of Witt Industries, Inc. for $13.5 million. This contributed one month of revenue to the current period and significantly increased inventory and receivables.
• Inventory Build: Inventories increased by $20.7 million in the cash flow statement, largely due to the Witt acquisition ($6.5 million) and rising zinc commodity costs ($9.4 million).
• Debt Levels: Long-term debt increased by $10.8 million to $30.7 million, primarily to fund the Witt acquisition.

Guidance, Outlook, and Risks

• Backlog: Backlog increased 22% year-over-year to $101 million as of November 30, 2006, indicating strong future revenue visibility.
• Margin Outlook: Management notes that Galvanizing Services margins (29-31%) may not be sustainable for the full year due to FIFO inventory accounting. If LIFO were applied, profits would be lower. Rising zinc costs are being passed to customers via price increases.
• Accounting Changes: The company adopted FASB Statement No. 123R (Share-Based Payment) on March 1, 2006, resulting in additional compensation expense of approximately $3.4 million for the nine-month period.
• Risks: Key risks include volatility in raw material costs (zinc, copper, aluminum, steel), natural gas prices, and the ability to pass cost increases to customers. The company also faces potential environmental liabilities related to the Witt acquisition, though the seller assumed certain remediation responsibilities.
• Liquidity: The company has a $50 million revolving credit facility with $9.9 million remaining available. Management believes cash flows and borrowing capacity are sufficient for operations and future acquisitions.

Investor Verification Checklist

• Inventory Valuation: Verify the impact of rising zinc prices on inventory carrying value and the sustainability of current gross margins given the FIFO accounting method.
• Acquisition Integration: Monitor the integration of Witt Galvanizing assets and the realization of projected $15 million in annual revenues from the acquired plants.
• Debt Covenants: Confirm compliance with the Credit Agreement covenants, specifically the Maximum Leverage Ratio (3.0:1.0) and Fixed Charge Coverage Ratio (1.5:1.0), given the recent increase in debt.
• Stock-Based Compensation: Review the ongoing impact of FASB 123R adoption on future earnings, noting the $329,000 in unrecognized compensation cost for SARs as of period end.
• Backlog Conversion: Track the conversion rate of the $101 million backlog into actual revenue to validate growth projections.