UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the Quarterly Period Ended: November 30, 2004
For the transition period from to
Commission File Number 1-12777
AZZ incorporated
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation of organization)
(I.R.S. Employer
Identification No.)
Registrant’s telephone number, including area code: (817) 810-0095
NONE
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
INDEX
Consolidated Condensed Balance Sheets at November 30, 2004 and February 29, 2004
Consolidated Condensed Statements of Income for the Three and Nine Month Periods Ended November 30, 2004 and November 30, 2003
Consolidated Condensed Statements of Cash Flow for the Nine Month Periods Ended November 30, 2004 and November 30, 2003
Notes to Consolidated Condensed Financial Statements
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PART I. FINANCIAL INFORMATION
Item I. Financial Statements
AZZ incorprated
CONSOLIDATED CONDENSED BALANCE SHEET
ASSETS
CURRENT ASSETS
CASH AND CASH EQUIVALENTS
ACCOUNTS RECEIVABLE (NET OF ALLOWANCE FOR DOUBTFUL ACCOUNTS)
INVENTORIES
RAW MATERIAL
WORK-IN-PROCESS
FINISHED GOODS
COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS
DEFERRED INCOME TAXES
PREPAID EXPENSES AND OTHER
TOTAL CURRENT ASSETS
PROPERTY,PLANT AND EQUIPMENT, NET
GOODWILL, NET OF ACCUMULATED AMORTIZATION
OTHER ASSETS, NET OF ACCUMULATED AMORTIZATION
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
LONG-TERM DEBT DUE WITHIN ONE YEAR
ACCOUNTS PAYABLE
BILLINGS IN EXCESS OF COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
ACCRUED LIABILITIES AND INCOME TAXES
TOTAL CURRENT LIABILITIES
LONG-TERM DEBT DUE AFTER ONE YEAR
SHAREHOLDERS’ EQUITY:
COMMON STOCK, $1 PAR VALUE SHARES AUTHORIZED-25,000,000 SHARES ISSUED 6,304,580
CAPITAL IN EXCESS OF PAR VALUE
CUMULATIVE OTHER COMPRENSIVE INCOME (LOSS)
RETAINED EARNINGS
LESS COMMON STOCK HELD IN TREASURY, AT COST ( 852,708 SHARES AT NOVEMBER 30, 2004 AND 887,744 SHARES AT FEBRUARY 29, 2004)
TOTAL SHAREHOLDERS’ EQUITY
See Accompanying Notes to Consolidated Condensed Financial Statements
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Consolidated Condensed Income Statement
(Unaudited)
NET SALES
COST OF SALES
SELLING, GENERAL & ADMINISTRATIVE
INTEREST EXPENSE
NET (GAIN) LOSS ON SALE OF PROPERTY, PLANT AND EQUIPMENT
OTHER (INCOME)
OTHER EXPENSE
INCOME BEFORE INCOME TAXES
INCOME TAX EXPENSE
NET INCOME
INCOME PER SHARE
BASIC
DILUTED
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CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW
CASH FLOWS FROM OPERATING ACTIVITIES:
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
PROVISION FOR DOUBTFUL ACCOUNTS
AMORTIZATION AND DEPRECIATION
DEFERRED INCOME TAX BENEFIT
NET GAIN(LOSS) ON SALE OF PROPERTY, PLANT & EQUIPMENT
NON-CASH INTEREST EXPENSE
NON-CASH COMPENSATION EXPENSE
EFFECTS OF CHANGES IN ASSETS & LIABILITIES:
ACCOUNTS RECEIVABLE
OTHER ASSETS
NET CHANGE IN BILLINGS RELATED TO COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
OTHER ACCRUED LIABILITIES AND INCOME TAXES
NET CASH PROVIDED BY OPERATING ACTIVITIES
CASH FLOWS USED FOR INVESTING ACTIVITIES:
PROCEEDS FROM SALE OF PROPERTY, PLANT, AND EQUIPMENT
PURCHASE OF PROPERTY, PLANT AND EQUIPMENT
NET CASH USED IN INVESTING ACTIVITIES
CASH FLOWS FROM FINANCING ACTIVITIES:
PROCEEDS FROM EXERCISE OF STOCK OPTIONS
PAYMENTS ON LONG TERM DEBT
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
NET (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS
CASH & CASH EQUIVALENTS AT BEGINNING OF PERIOD
CASH & CASH EQUIVALENTS AT END OF PERIOD
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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Summary of Significant Accounting Policies
The following table sets forth the computation of basic and diluted earnings per share:
Numerator:
Net income for basic and diluted earnings per common share
Denominator:
Denominator for basic earnings per common share –weighted average shares
Effect of dilutive securities:
Employee and Director stock options
Denominator for diluted earnings per common share
Basic earnings per common share
Diluted earnings per common share
Total comprehensive income for the quarter ended November 30, 2003 was $1,233,173 consisting of net income of $1,156,032 and changes in accumulated other comprehensive income of $77,141. For the nine-month period ended November 30, 2003, total comprehensive income was $3,306,861 consisting of net income of $3,035,127 and net changes in accumulated other comprehensive income of $271,734.
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Reported net income
Recognized Compensation, net of tax
Compensation expense per SFAS No.123, net of tax
Pro forma net income for SFAS No.123
Reported earnings per common share:
Basic
Diluted
Compensation expense per SFAS No.123:
Pro forma earnings per share:
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Net Sales:
Electrical and Industrial Products
Galvanizing Services
Segment Operating Income (a):
Total Segment Operating Income
General Corporate Expense (b)
Interest Expense
Other (Income) Expense, Net (c)
Income Before Taxes
Total Assets:
Corporate
A reserve has been established to provide for the estimated future cost of warranties on a portion of the Company’s delivered products and is classified within accrued liabilities on the consolidated balance sheet. Management periodically reviews the reserves and adjustments are made accordingly. Warranties cover such factors as non-conformance to specifications and defects in material and workmanship. The following shows changes in the warranty reserves since the end of fiscal 2003:
Warranty
Reserve
Balance at February 28, 2003
Warranty costs incurred
Additions charged to income
Balance at February 29, 2004
Balance at November 30, 2004
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On November 1, 2001, the Company entered into an Amended and Restated Revolving and Term Loan Credit Agreement (the “2001 Credit Agreement”), which replaced the previous term notes and revolving line of credit. The new agreement included a $40 million term facility and a $45 million revolving credit facility. Since November 1, 2001, the Company amended the 2001 Credit Agreement to reduce the number of banks participating from five to three banks, reduced the Company’s revolving credit facility from $45 million to $20 million, extend the maturity of the revolving line of credit to June 30, 2008, extend the maturity and amortization of the term facility to March 31, 2008, and revised the provisions of various financial covenants. These financial covenants consist of 1) Minimum Consolidated Net Worth 2) Maximum Leverage Ratio and 3) Minimum Fixed Charge Coverage Ratio. As of November 30, 2004, the Company was in compliance with all debt covenants. The availability under the revolving credit facility is contingent on asset-based collateral of inventories and accounts receivables. At November 30, 2004, the Company had $19.250 million outstanding under the term note and $8.5 million outstanding under the revolving credit facility. The remaining balance outstanding on the term-loan is payable in quarterly installments of $1.375 million through March 2008. At November 30, 2004, the Company had approximately $10.1 million of additional credit available under the revolving credit facility.
Interest on borrowings under the term note and revolving line of credit bear interest at a rate per annum equal to the lesser of the base rate plus the applicable margin for the base rate borrowings for the applicable facility, or the adjusted Eurodollar rate plus the applicable margin for Eurodollar rate borrowings for the applicable facility. The applicable margin range is based on the leverage ratio, which was 1.5% at November 30, 2004, and correlated to an interest rate of 4.92% on the term note after hedging and 3.80% on the revolving credit facility at November 30, 2004. Additionally, the Company is obligated to pay a commitment fee based on the leverage ratio at a rate ranging from .25% to .5% on the unused revolving credit facility.
FASB Statement No. 123R, Shared-Based Payment will revise FASB Statement No. 123, Accounting for Stock-based Compensation and supersedes APB No. 25 Accounting for Stock Issued to Employees. FAS 123R is effective for public companies in the first quarter beginning after June 15, 2005. FAS 123R will require that compensation cost be recognized in the financial statements not only for new awards but for previously granted awards that are not fully vested on the adoption date. The Company is still evaluating the provisions of FAS 123R; however, it believes the effects should be consistent with the pro forma net income and earnings per share data it has disclosed in Note 5 to the consolidated financial statements.
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Item2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD LOOKING STATEMENTS
This Report may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are generally identified by the use of words such as “anticipate,” “expect,” “estimate,” “intend,” “should,” “may,” “believe,” and terms with similar meanings. Although the Company believes that the current views and expectations reflected in these forward-looking statements are reasonable, those views and expectations, and the related statements, are inherently subject to risks, uncertainties, and other factors, many of which are not under the Company’s control. Those risks, uncertainties, and other factors could cause the actual results to differ materially from these in the forward-looking statements. Those risks, uncertainties, and factors include, but are not limited to: the level of customer demand for and response to products and services offered by the Company, including demand by the power generation markets, electrical transmission and distribution markets, the general industrial market, and the hot dip galvanizing markets; raw material and utility costs, including cost of zinc and natural gas which are used in the hot dip galvanizing process; changes in economic conditions of the various markets the Company serves, foreign and domestic, customer requested delays of shipments, acquisition opportunities, adequacy of financing, and availability of experienced management employees to implement the Company’s growth strategy. The Company expressly disclaims any obligations to release publicly any updates or revisions to these forward-looking statements to reflect any change in its views or expectations. The Company can give no assurances that such forward-looking statements will prove to be correct.
The following discussion should be read in conjunction with management’s discussion and analysis contained in our 2004 Annual Report on Form 10-K, as well as with the consolidated financial statements and notes thereto included in this quarterly report on Form 10-Q.
RESULTS OF OPERATIONS
Management believes that the most meaningful analysis of its results of operations is to analyze its performance by segment. The Company uses revenue by segment and segment operating income to evaluate its 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 7 to our unaudited quarterly consolidated financial statements.
Revenues
For the three-month and nine-month periods ended November 30, 2004, consolidated net revenues increased 14.9% and 10.4%, respectively, as compared to the same periods in fiscal 2004, to $38.3 million for the three-month period and $114.5 million for the nine-month period. For the quarter ended November 30, 2004, the Electrical and Industrial Products Segment contributed 65% of the Company’s revenues and the Galvanizing Services Segment accounted for the remaining 35% of the combined revenues. For the nine-month period ended November 30, 2004, the Electrical and Industrial Products Segment contributed 66% of the Company’s revenues, while the Galvanizing Services Segment accounted for the remaining 34%.
Revenues for the Electrical and Industrial Products Segment increased $3.9 million or 18.3% for the three-month period ended November 30, 2004, and increased $8.6 million or 12.8% for the nine-month period ended November 30, 2004, as compared to the same periods in fiscal 2004. The increase in revenues reflects the increase in utility spending in the transmission and distribution market. The additional spending in the transmission and distribution market results from the need to replace aging infrastructure equipment to improve the reliability and efficiency of the delivery of electrical power to industrial and residential
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users. The increased revenues in the transmission and distribution markets have been partially offset by continued lower demand from the power generation market dating back to 2002 and the slow recovery of the industrial market. The Federal Reserve Industrial Capacity Utilization report, while showing improvement, still remains below 80% utilization. Factory utilization was at 77.7% at October 31, 2004. A return to utilization levels experienced between 1992 and 2000, which averaged 82.6%, would have a positive impact on many of this segment’s operations, which are dependant on the industrial market. This segment is experiencing improved quotation activity, both domestically and internationally, but competitive pricing pressures continue as the industry continues to operate with significant levels of unused capacity. The Company has a three-year collective bargaining agreement with one of its units in the Electrical and Industrial Products Segment covering approximately 91 people. This agreement expires on February 28, 2005, and will be up for negotiation at that time. While the Company cannot presently determine the outcome of these negotiations, management believes the results of these negotiations will not have a material impact on the Company.
The Electrical and Industrial Products Segment’s backlog was $60.1 million as of November 30, 2004, as compared to $52.5 million at November 30, 2003. Backlog improved 11.7% from the $53.8 million reported as of August 31, 2004. Orders included in the backlog are represented by contracts and purchase orders that the Company believes to be firm. The following table reflects the Company’s bookings and shipments on a quarterly basis through the period ending November 30, 2004, as compared to the same periods in fiscal 2004.
Backlog Table
Backlog
Bookings
Shipments
Book to Ship Ratio
Revenues in the Galvanizing Services Segment increased $1.1 million or 9% for the three-month period ended November 30, 2004, and increased $2.2 million or 6% for the nine-month period ended November 30, 2004, as compared to the same periods in fiscal 2004. Pounds produced for the three months ending November 30, 2004, increased 9.2% as compared to the same period in fiscal 2004, while the selling price decreased .2% for the comparable three-month period. Pounds produced for the nine months ending November 30, 2004, increased 3.4% as compared to the same period in fiscal 2004, while the selling price increased 2.2% for the comparable nine-month period. Revenues for this segment have historically closely followed the condition of the industrial sector of the general economy. Any sustained recovery of the industrial sector of the general economy should produce improved results for this segment.
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Segment Operating Income
The Company’s total segment operating income (see Note 7 to consolidated financial statements) increased 5.4% for the three-month period ended November 30, 2004, to $4.1 million as compared to $3.9 million for the same period in fiscal 2004. For the nine-month period ended November 30, 2004, total segment operating income increased 10.7% to $12.1 million as compared to $10.9 million for the same period in fiscal 2004.
Segment operating income (see note 7 to consolidated condensed financial statements) in the Electrical and Industrial Products Segment increased 5.7% and 6.9% for the three and nine-month periods ended November 30, 2004, respectively, to $1.7 million and $5 million as compared to $1.6 million and $4.6 million, respectively, for the same periods in fiscal 2004. The increase in segment operating income is related to volume as operating margins continued to be negatively impacted by intense pricing pressures as a result of over capacity in all of this segments markets. The Company’s inability to pass along many of the material cost increases we have incurred also continues to adversely affected segment operating profits and margins. The Company continues to implement cost containment measures and review all strategic alternatives to lower the overall cost structure while maintaining product quality and customer service.
In the Galvanizing Services Segment, segment operating income (see note 7 to consolidated condensed financial statements) increased 5.2% and 13.5% for the three and nine-month periods ended November 30, 2004, to $2.4 million and $7.1 million as compared to $2.3 million and $6.3 million for the same periods in fiscal 2004. The improved segment operating results were achieved through higher revenues as well as a lower overall cost structure as a result of continued implementation of operation efficiencies throughout the year. Increasing zinc and natural gas cost will make it challenging for this segment to sustain the first nine months margin performance through the balance of the fiscal year. For the nine-month period ended November 30, 2004, zinc and natural gas represented 21% and 10%, respectively of cost of sales. Zinc cost increased $1.025 million for the nine-month period ended November 30, 2004, as a result of the average cost of zinc moving to 51 cents per pound as compared to an average cost of 39 cents for the same nine-month period in fiscal 2004. The current market price of zinc is approximately 55 cents per pound. Utility cost have increased $86,000 or 3% for the nine-month period ended November 30, 2004 as compared to the same period in fiscal 2004.
General Corporate Expenses
General Corporate expenses, (see Note 7 to consolidated condensed financial statements) not specifically identifiable to a segment, for the three and nine-month periods ended November 30, 2004, increased $482,000 or 35.8% and $1.1 million or 26.6%, respectively, as compared to the same periods in fiscal 2004. General Corporate expenses for the nine-month period were higher due to cost which does not qualify for capitalization associated with the implementation of our Oracle ERP System in the amount of $505,000 and increased professional fees in the amount of $343,000 primarily related to compliance cost associated with the Sarbanes-Oxley Act of 2002. As a percent of sales, General Corporate expenses were 7.3% and 7.2% for the three and nine-month periods ended November 30, 2004, as compared to 6.4% and 6.4% for the same periods in fiscal 2004.
Other (Income) Expense
For the three and nine month periods ending November 30, 2004, the amounts in other (income) expense (see Note 7 to consolidated financial statements) were insignificant. The prior year three and nine-month periods ended November 30, 2003, included the amounts of $95,000 and $298,000, respectively, for the gain on the sales of vacant land, which were not specifically identifiable to a segment.
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Interest
As a result of lower levels of outstanding debt due to reduced working capital requirements, net interest expense for the three and nine-month periods ended November 30, 2004, declined 43% and 35% compared to the same periods in fiscal 2004. As of November 30, 2004, the Company had outstanding bank debt of $27.8 million, a decrease of 10% or $3.1 million, as compared to $30.9 million at the end of fiscal 2004. With the reduction in debt, the long-term debt to equity ratio improved to .30 to 1 at November 30, 2004, as compared to .37 to 1 at the end of fiscal 2004. Variable interest rates increased to 3.80% for the period ended November 30, 2004, as compared to 3.14% in the comparable prior year period.
Income Taxes
The provision for income taxes reflects an effective tax rate of 37% for the three and nine-month periods ended November 30, 2004, and 38% for the three and nine-month periods ended November 30, 2003. The 1% reduction relates to lower state income taxes for the compared periods.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically met its liquidity and capital needs through a combination of cash flows from operating activities and bank borrowings. The Company’s cash requirements are generally for operating activities, acquisitions, capital improvements, and debt repayment. The Company believes that working capital, borrowing capabilities, and funds generated from operations should be sufficient to finance anticipated operational activities, capital improvements, scheduled debt payments and possible future acquisitions.
Net cash provided by operations was $8.7 million for the nine-month period ended November 30, 2004, as compared to $13 million for the same period in the prior fiscal year. Net cash provided by operations was generated from $3.4 million in net income, $4.4 million in depreciation and amortization of intangibles and debt issue costs, and $.9 million of net changes in operating assets and liabilities and other adjustments to reconcile net income to net cash. Positive cash flow was recognized due to decreased prepaid balances in the amount of $.4 million as well as from increased accounts payable and accrued liabilities balances in the amount of $ 2.1 million and $1.8 million, respectively. These positive cash flow items were offset by increases in accounts receivable, inventories, revenue in excess of billings, and other asset balances in the amount of $1.9 million, $.6 million, $.6 million and $.4 million, respectively. Working capital decreased 2.4% to $19.7 million as compared to $20.2 million at February 29, 2004.
For the nine-month period ended November 30, 2004, capital improvements were made in the amount of $5.4 million and long-term debt was repaid in the amount of $3.1 million. Approximately $1.6 million of the capital money invested during the nine-month period relates to the Company’s Oracle ERP system it is implementing. Capital improvements in the amount of $3 million were expended in the Company’s Galvanizing Service Segment. The Company received proceeds from the exercise of stock options in the amount of $ 247,700.
On November 1, 2001, the Company entered into an Amended and Restated Revolving and Term Loan Credit Agreement (the “2001 Credit Agreement”), which replaced the previous term notes and revolving line of credit. The new agreement included a $40 million term facility and a $45 million revolving credit facility. Since November 1, 2001, the Company amended the 2001 Credit Agreement to reduce the number of banks participating from five to three banks, reduced the Company’s revolving credit facility from $45 million to $20 million, extend the maturity of the revolving line of credit to June 30, 2008, extend the maturity and amortization of the term facility to March 31, 2008, and revised the provisions of various financial covenants. These financial covenants consist of 1) Minimum Consolidated Net Worth 2) Maximum Leverage Ratio and 3) Minimum Fixed Charge Coverage Ratio. As of November 30, 2004, the Company was in compliance with all debt covenants. The availability under the revolving credit facility is contingent on asset-based collateral of inventories and accounts receivables. At November 30, 2004, the
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Company had $19.250 million outstanding under the term note and $8.5 million outstanding under the revolving credit facility. The remaining balance outstanding on the term-loan is payable in quarterly installments of $1.375 million through March 2008. At November 30, 2004, the Company had approximately $10.1 million of additional credit available under the revolving credit facility.
Interest on borrowings under the term note and revolving line of credit bear interest at a rate per annum equal to the lesser of the base rate plus the applicable margin for the base rate borrowings for the applicable facility, or the adjusted Eurodollar rate plus the applicable margin for Eurodollar rate borrowings for the applicable facility. The applicable margin range is based on the leverage ratio, which was 1.5% at November 30, 2004, and correlated to an interest rate of 4.92% on the term note after hedging and 3.8% on the revolving credit facility at November 30, 2004. Additionally, the Company is obligated to pay a commitment fee based on the leverage ratio at a rate ranging from .25% to .5% on the unused revolving credit facility.
The Company utilizes interest rate protection agreements to moderate the effects of increases, if any, in interest rates by modifying the characteristics of its interest obligations on long-term debt from a variable rate to a fixed rate. Presently, the Company has two outstanding interest rate swaps. In February 1999, the Company entered into an interest rate protection agreement, (the “1999 Swap Agreement”) which matures in February 2006, whereby the Company pays a fixed rate of 6.8% in exchange for a variable 30-day LIBOR rate plus 1.25%(3.24% at November 30, 2004). The notional amount of the swap was originally designed to correspond to the maturities of the Company’s term debt that was outstanding in 1999, and at November 30, 2004, the remaining notional amount is $1.8 million. Prior to November 2001, this swap was treated as a cash flow hedge of the Company’s variable interest rate exposure. However, the Company refinanced its credit agreement in November 2001 and chose to cease its hedge designation for the 1999 Swap Agreement while not terminating the swap agreement. Since that time, the Company has been recognizing changes in the fair value of this swap directly in earnings, while amortizing the pretax amount included in accumulated other comprehensive income as additional interest expense. For the nine-months period ended November 30, 2003 and 2004, the Company amortized $55,000 as additional interest expense for each year and recognized mark to market gains of $106,000 and $87,000, respectively for subsequent changes in the fair value of this swap. At November 30, 2004, the fair value of the 1999 Swap Agreement was a liability of $34,000 and a loss of $53,000, net of tax and remains in accumulated other comprehensive income to be amortized as additional interest expense.
In conjunction with the debt refinancing in November 2001, the Company entered into a new interest rate swap (the”2001 Swap Agreement”) as a cash flow hedge of its variable interest expense related to the term note. The 2001 Swap Agreement involves the exchange of interest rate obligations from November 2001 through November 2005, whereby the Company pays a fixed rate of 4.92% in exchange for a variable 30-day LIBOR rate plus 1.50%(3.48% at November 30, 2004). The notional amount of this swap matures in stages and as of November 30, 2004, the remaining notional amount was $10 million and matures in November 2005. To date there has been no ineffectiveness related to the 2001 Swap Agreement. At November 30, 2004, the fair value of the 2001 Swap Agreement was a liability of $63,000 and a loss of $39,000, net of tax; is included in accumulated other comprehensive income.
Given the maturity dates of the Company’s interest rate swaps, all amounts included in accumulated other comprehensive income are expected to flow through earnings by the end of fiscal 2006.
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OFF BALANCE SHEET TRANSACTIONS AND RELATED MATTERS
Other than operating leases discussed below, there are no off-balance sheet transactions, arrangements, obligations (including contingent obligations), or other relationships of the Company with unconsolidated entities or other persons that have, or may have, a material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources of the Company.
CONTRACTUAL COMMITMENTS
2005
2006
2007
2008
2009
Thereafter
Total
Long-term debt and letters of credit
As of November 30, 2004 the Company had outstanding debt in the amount of $27,750 million, which consisted of a $19.250 million term note and $8.5 million outstanding under the revolving credit facility. The Company utilizes interest rate protection agreements to modify its characteristics from variable rate to a fixed rate. For further information regarding the Company’s long-term debt obligations and interest rate protection agreement see footnote 10 of the Notes to the Consolidated Financial Statements found on page 37 of the Company’s 2004 Annual Report. Maturities of long-term debt and the related interest which are based on rates as of November 30, 2004, are summarized in the above table.
At November 30, 2004, the Company had outstanding letters of credit in the amount of $1.4 million. These letters of credit are issued to a portion of the Company’s customers to cover any potential warranty costs that the customer might incur. In addition, as of November 30, 2004 a warranty reserve in the amount of $1.1 million has been established to offset any future warranty claims.
Leases
The Company leases various facilities under non-cancelable operating leases with an initial term in excess of one year. As of November 30, 2004, the future minimum payments required under these operating leases are summarized in the above table:
Commodity pricing
The Company manages its exposures to commodity prices through the use of the following. In the Galvanizing Services Segment, the Company utilizes contracts with its zinc suppliers that include protective caps to guard against rising commodity prices. These contracts are normally negotiated in December of each year and normally are for a twelve-month period of time. The Company also secures firm pricing for natural gas supplies with individual utilities when possible. There is no contracted volume purchase commitments associated with the natural gas agreements. Management believes these contractual agreements ensure
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adequate supplies and partial offset exposure to commodity price swings. In the Electrical and Industrial Products Segment, the Company has exposure to commodity pricing for copper, aluminum, and steel. Because the Electrical and Industrial Products Segment does not commit contractually to minimum volumes, increases in price for these items are normally managed through escalation clauses to the customer’s contracts, although during difficult market conditions these escalation clauses may be difficult to obtain. Although material costs have increased, the Company does not believe there has been a material change in the nature of its commodity commitments or risks since February 29, 2004. The table above reflects the contracted purchase commitments for zinc based on the closing price of zinc as of November 30, 2004. There are no contracted purchase commitments for any other commodity items including steel, aluminum, natural gas and copper.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of the consolidated financial statements requires the Company to make estimates that affect the reported value of assets, liabilities, revenues and expenses. The Company’s estimates are based on historical experience and various other factors that are believed to be reasonable under the circumstances, and form the basis for the Company’s conclusions. The Company continually evaluates the information used to make these estimates as the business and the economic conditions change. Accounting policies and estimates considered most critical are allowances for doubtful accounts, accruals for contingent liabilities, revenue recognition and goodwill impairment. More information regarding significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Annual Report on form 10-K.
Allowance for Doubtful Accounts- The carrying value of the accounts receivables is continually evaluated based on the likelihood of collection. An allowance is maintained for estimated losses resulting from our customer’s inability to make required payments. The allowance is determined by historical experience of uncollected accounts, the level of past due accounts, overall level of outstanding accounts receivable balances, information about specific customers with respect of their inability to make payments and future expectations of conditions that might impact the collectibility of accounts receivable. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Accruals for Contingent Liabilities- The amounts the Company records for estimated claims such as self insurance programs, warranty and other contingent liabilities requires the Company to make judgments regarding the amount of expenses that will ultimately be incurred. The Company uses past history and experience, as well as other specific circumstances surrounding these claims in evaluating the amount of liability that should be recorded. Actual results may be different than the Company’s estimates.
Revenue Recognition – Revenue is recognized for the Galvanizing Services Segment upon completion of the galvanizing process performed on the customers’ material or shipment of this material. Revenue is recognized for the Electrical and Industrial Products Segment upon transfer of title and risk to customers, or based upon the percentage of completion method of accounting for electrical products built to customer specifications under long term contracts. Deferred revenue presented in the balance sheet arises from advanced payments received from our customers prior to shipment of the product and are not related to revenue recognized under the percentage of completion method. The extent of progress for revenue recognized using the percentage of completion method is measured by the ratio of contract costs incurred to date to estimated total contract costs at completion. Contract costs include direct labor and material, and certain indirect costs. Selling, general and administrative costs are charged to expense as incurred. Provisions for estimated losses, if any, on uncompleted contracts are made in the period in which such losses are able to be determined. The assumptions made in determining the estimated cost could differ from actual performance resulting in a different outcome for profits or losses than anticipated.
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Impairment of Long-Lived Assets, Identifiable Intangible Assets and Goodwill– The Company records impairment losses on long-lived assets, including identifiable intangible assets, when events and circumstances indicate that the assets might be impaired and the undiscounted projected cash flows associated with those assets are less than the carrying amounts of those assets. In those situations, impairment losses on a long-lived assets are measured based on the excess of the carrying amount over the asset’s fair value, generally determined based upon discounted estimates of future cash flows. A significant change in events, circumstances or projected cash flows could result in an impairment of long-lived assets, including identifiable intangible assets.
An annual impairment test of goodwill will be performed in the fourth quarter of each year. The test is calculated using the anticipated future cash flows from the Company’s operating segments. Based on the present value of the future cash flow, the Company will determine whether impairment may exist. A significant change in projected cash flows or cost of capital for future years could result in an impairment of goodwill in future years.
Variables impacting future cash flows include, but are not limited to, the level of customer demand for and response to products and services offered by the Company to the power generation market, the electrical transmission and distribution markets, the general industrial market and the hot dip galvanizing market; changes in economic conditions of these various markets; raw material and natural gas costs; and availability of experienced labor and management to implement the Company’s growth strategies.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk relating to the Company’s operations results primarily from changes in interest rates and commodity prices. The Company has only limited involvement with derivative financial instruments and is not a party to any leveraged derivatives.
The Company manages its exposures to changes in interest rates through the use of variable rate debt and interest rate swaps.
The Company manages its exposures to commodity prices through the use of the following. In the Galvanizing Services Segment, the Company utilizes contracts with its zinc suppliers that include protective caps to guard against rising commodity prices. These contracts are normally negotiated in December of each year and normally are for a twelve-month period of time. The Company also secures firm pricing for natural gas supplies with individual utilities when possible. There is no contracted volume purchase commitments associated with the natural gas agreements. Management believes these contractual agreements ensure adequate supplies and partial offset against exposure to commodity price swings. In the Electrical and Industrial Product Segment, the Company has exposure to commodity pricing for copper, aluminum, and steel. Increases in the price for these items are normally managed through escalation clauses to the customer’s contracts, although during difficult market conditions these escalation clauses may be difficult to obtain. Although material costs have escalated, the Company does not believe there has been a material change in the nature of its commodity commitments or risks since February 29, 2004.
Item 4. Controls and Procedures
As of the last day of the period covered by this report, an evaluation was performed by management under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) of the effectiveness of the Company’s disclosure controls and procedures. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management’s control objectives. Based on that evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were effective in timely alerting them to material information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and in assuring the Company that such information is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms.
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The Company is in the process of implementing an enterprise resource system (“ERP” system) developed by Oracle to replace the Company’s legacy computer system and is making appropriate changes to internal controls and procedures as the implementation progresses. Other than the changes required by the implementation of the Oracle ERP system, none of which materially impaired or significantly altered the effectiveness of the Company’s internal controls and procedures over financial reporting, there were no material changes in the Company’s internal controls over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
While the Company believes that its existing disclosure controls and procedures have been effective to accomplish their objectives, the Company intends to continue to examine, refine and document its disclosures controls and procedures and to monitor ongoing developments in this area.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved from time to time in various suits and claims arising in the normal course of business. In management’s opinion, the ultimate resolution of these matters will not have a material effect on the Company’s financial position or results of operations.
Item 2. Changes in Securities – The Company has no investment Securities.
Item 3. Defaults Upon Senior Securities – Not applicable.
Item 4. Submissions of Matters to a Vote of Security Holders – There were no matters submitted to a vote of Security Holders.
Item 5. Other Information – Not Applicable
Item 6. Exhibits and Reports on Form 8-K
A list of the exhibits required by Item 601 of Regulation S-K and filed as part of this report is set forth in the Index to Exhibits on page 17, which immediately proceeds such exhibits.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Dana Perry
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EXHIBIT
DESCRIPTION OF EXHIBIT
AZZ incorporated Fiscal 2005 Stock Appreciation Rights Plan for Directors (incorporated by reference to Exhibit
10(53) to Form 10-Q filed by the registrant on September 28, 2004).
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